Monthly Archives: July 2007

The United Kingdom’s Debt Management Office (DMO) should become the United Kingdom’s Office of Sovereign Portfolio Management. (PMO). It won’t, however, be necessary for the UK government to create a full-fledged Sovereign Wealth Fund. My proposal for a PMO is not prompted by a desire to manage the financial asset windfall that is the counterpart of the extraction of an exhaustible stock of natural resources. It is rather that without investing in additional financial assets, the UK government will not be able to issue sufficient quantities of the scarce long-dated and in some ways innovative financial liabilities that the private sector is clamouring for.

One consequence of a decade or more of fiscal prudence is that there is not enough public debt around any longer. It is therefore desirable for the UK government to issue a much larger volume of gross financial liabilities than it can do (given its outstanding stocks of financial liabilities and assets and its prospective financial deficits) without acquiring additional assets. As there is no point in the UK state acquiring real assets, a globally diversified portfolio of financial assets is called for.

Why should the UK government issue more financial liabilities, if this is not necessary to finance its deficits or to refinance its maturing debt? The reason is that the state is the best issuer of certain very long-maturity instruments that the private sector for a variety of reasons does not issue but that would be extremely value assets for a number of key financial intermediaries and other financial institutions, including pension funds and life insurance companies. The instruments in question are long-maturity nominal and inflation index-linked treasury bonds (index-linked gilts in UK parlance), and nominal and index-linked longevity or mortality bonds.

Governments can issue long-dated instruments more easily that private institutions. While individual government administrations come and go, the institutions of government are pretty permanent. Given the strong convention that governments assume (accept responsibility for servicing) the debt left by their predecessors, government debt can have a maturity equal to the expected survival period of the state. Governments can establish important benchmarks for private asset pricing by issuing significant quantities of gilts at maturities of 10, 20, 30 and 50 years. Indeed perpetuities, or consols (government debt with an infinite maturity) should be issued again after a long interlude.

Index-linked debt is even scarcer than nominal long-dated debt. For pension funds, index-linking to a range of indices (RPI, CPI and Earnings) would be most helpful. Index-linked consols would not only be welcomed by economists trying to figure out what the truly long real rate of interest is, it would be welcomed by the markets too.

The absence of longevity bonds or mortality bonds (bonds whose interest rate varies with the life expectance of a given age cohort or collection of cohorts) is a major disadvantage to defined benefit pension funds whose liabilities are effectively index-linked annuities and index-linked deferred annuities. Index-linked longevity and mortality bonds (linked to the RPI, the CPI or to Earnings) would be a great boon for defined benefit pension funds and life insurance companies. They would at last be able to actively manage their exposure to longevity and mortality risk. The government is the natural issuer of such liabilities, because of their ability to tax, to vary transfer payments and benefits and to change eligibility requirements for benefits.

The government would also be doing the tax payer a favour by issuing these highly popular and in some cases somewhat innovative securities. Their marginal borrowing costs would be lower than it would be were they to issue shorter maturity nominal debt instead. It failed to do so even in January 2006, when the real yield on the newly issued 50-year index linker touched 0.38 percent. I tried to get a 50-year index-linked mortgage at those rates from my bank, but was told such an instrument does not exist (indeed, index-linked mortgages of any maturity are notable for their non-existence).

When the joys of issuing long-dated index-linked longevity bonds are put to the Debt Management Office the reply invariably is that if they were to issue more of the fancy new stuff they would have to reduce their issuance of the conventional gilts. The DMO wishes to remain present ‘in strength’ in all conventional market segments, to continue to establish important benchmarks. As indeed they should! And here comes the news: balance sheets have two sides: assets as well as liabilities. You can issue any amount of new liabilities without running a larger financial deficit and without retiring any existing conventional liabilities if you are willing the use the proceeds from the issuance of the new liabilities to invest in a portfolio of financial assets. Yes, says the DMO, but we only do liabilities. Yes, I answer, and that’s why you should become the Office of Asset and Debt Management or, more concisely, the Office of Portfolio Management.

The asset side of the OPM should probably be invested in a globally diversified portfolio of financial instruments, preferably mainly equity and other equity-like assets. Of course, we don’t want the British state to get involved in a managerial role in any of its financial investments; they would be in it for the income, not for the control. This OPM is different from a Sovereign Wealth Fund in countries like Norway, Singapore, Kuwait, Russia or China. The OPM is simply a by-product of the desire to issue liabilities to meet a market need, not an instrument for achieving intergenerational equity in an economy with a significant dependence on exhaustible resources.

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The Unhappy Lot of the ‘M’-tarist and the Death of Monetarism Those economists who feel twinges of unease of varying degrees of intensity when observing the rapid growth of some broad monetary aggregate (M2 in the US, M3 in Euroland, M4 in the UK, M16 and AK47 elsewhere) may well be the victims of two fallacies: (1) the fallacy of misplaced concreteness and (2) the nominalist fallacy. According to Wikipedia – a fount of highly doubtful authority – the fallacy of misplaced concreteness, as described by the philosopher Alfred North Whitehead, involves thinking something is a ‘concrete’ reality when in fact it is an abstract belief, opinion or concept about the way things are. The nominalist fallacy is the belief that naming something defines its essence, and explains it. Every economist grows up learning and absorbing models in which something labelled ‘M’ has a unique role in the process determining the general price level. Some of us even teach the stuff. Even the most New-Keynesian follower of fashion believes in the long-run neutrality of ‘M’. Inflation is always and everywhere a ‘M’-tary phenomenon. Mapping that ‘M’ into some real-world counterpart is awkward. In fiat money economies, the monetary base – currency plus commercial bank deposits with the central bank – is probably the closest ‘real world’ counterpart. Currency is the most common numeraire and it is a means of payment and medium of exchange. It is also a store of value. The vast majority of analytical macroeconomic models ignore financial intermediation completely. The only financial assets are base money, government non-monetary debt and equity claims on real reproducible capital. There is also a complete contingent markets literature, which grafts base money onto an Arrow-Debreu complete markets model of a barter economy. This hybrid, although popular, is absolutely useless as a starting point for the analysis of monetary policy in the real world. While it has an exhaustively rich financial asset menu, there are no financial intermediaries and there is no financial intermediation in any meaningful sense. Where banks are considered, they tend to be a poorly motivated constraint on financial intermediation rather than a means for overcoming informational, monitoring, commitment and enforcement constraints. The same holds a-fortiori for non-bank financial intermediaries. No macroeconomic model I have ever seen creates a special role for the sight-liabilities of deposit-taking institutions (and their close substitutes) that make up most of M2, M3 and M4 in the real world, starting from reasonable primitive behavioural assumptions. Even more emphatically, there is no macroeconomic model that makes the case that that the real world M2, M3 and M4 play a role analogous to ‘M’ in the baby models we play with. My argument is quite different from the proposition that, if the monetary authorities use the short risk-free nominal interest rate as the instrument of monetary policy rather than the quantity of ‘M’, and if as a result of this, ‘M’ becomes endogenous, then all equilibrium prices and quantities that can be determined in the model can be determined without reference to the behaviour of ‘M’. This proposition goes through only if the economy is ‘block recursive’ in ‘M’, but this is the case for most of the models that litter the literature. When the interest rate is the monetary instrument, ‘M’ is all tail and no dog. However, in such models, the behaviour of ‘M’ over time itself may still be determinate (it will be so unless we are in a world with perfect price flexibility, in which case only the real value of ‘M’ is determinate). Ruling out this uninteresting special case, there would be a systematic relationship between the general price level and the endogenous stock of ‘M’. If in such a world prices had been rising for a long time by 2 percent per annum, real GDP by 3 percent per annum and ‘M’ by 14 percent per annum, we would all be scratching our heads. The world we appear to be living in is much more complicated than that. Not only is ‘M’ endogenous, it is unobservable, and is represented empirically neither by the broad monetary aggregates M2, M3 and M4 nor necessarily by the real-world monetary base or M0. We are clearly moving towards a world where the currency component of M0 can and probably will be displaced by private cash-on-a-chip and other networked or anonymous private and public payment mechanisms for retail and wholesale purchases of goods and services(except for use by the criminal community and by foreign demand from underdeveloped countries with high inflation). The bankers’ balances with the central bank component of M0 could easily be replaced by overdraft facilities or contingent credit lines with the central bank. Functionally M0 will survive – being a liability of a key agency of the state and often endowed with legal tender properties, it is hard to beat for liquidity, but its conventionally measured quantity (‘stock outstanding’ as opposed to unused overdraft facility or credit line) could easily vanish. The non-M0 component of M2, M3, M4 etc. is part of portfolio demand, boosted by expanding and deepening intermediation and financial innovation and by growing private sector financial wealth relative to income. In the UK households hold net financial assets (including housing, admittedly) equal to 8 times their annual income. The broad monetary aggregates no longer have any close, systematic connection with transactions demand, that is, with imminent spending on currently produced goods and services. It is not at all surprising that it has grown in line with household financial wealth rather than with GDP. New financial institutions and new financial instruments are created on a daily basis. For some reason, the new instruments have not displaced the conventional liquid financial instruments counted in M2, M3 and M4. Most of the new financial institutions have ended up holding at least some components of M2, M3 or M4 on the asset side of their balance sheets. When that happens, the broad monetary aggregates can grow way faster than nominal GDP for years on end without this implying any inflationary threat in the markets for goods and services. It need not even imply any inflationary threat in the ‘outside’ assets markets, those for equity, housing, land etc. Of course, since the growing financial wealth is sitting there and since a significant chunk of it is liquid, it could at short notice produce a hefty spending boom in either asset markets or markets for currently produced goods and services. The threat of asset market inflation, consumer price inflation or producer price inflation is always there. That’s what makes monetary policy so much fun these days. There could be an ambush around any corner. However, for that risk to exist, prior rapid growth of broad monetary aggregates, or of credit to ultimate spending units (households and non-financial firms) or even of financial wealth generally are not necessary. All that is required is that the ultimate spending units have liberal, easy access to credit, so they can run large financial deficits. The corresponding financial surpluses can be run by the state, the domestic financial sector or, in an open economy, the rest of the world. It therefore behoves the central banks to track carefully the growth of credit to the ‘ultimate spending units’ – households and non-financial enterprises. Unfortunately, looking at the historical record of credit growth, as of broad money growth, risk both false positives and false negatives. Households are growing their net financial wealth-to-income ratios and gross assets and liabilities may be growing even faster than net financial wealth. With longer life expectancies (especially lower remaining life expectancies at retirement) higher financial wealth income ratios can be a stable, non-inflationary feature of the world. On the other hand, even if broad money growth and credit growth to households and non-financial firms have been well-behaved in the past, the potential for runaway credit growth and sudden sharp increases in the demand for goods and services or for outside assets is always there when households are creditworthy or have collateralisable wealth and when financial markets and institutions are well-developed and full of people who, while smart, are not nearly as smart as they think they are. I am a monetarist (really an ‘M’-tarist), through and through. Unfortunately, I don’t have a clue as to what the real-world counterpart of the textbook ‘M’ is today. It seems pretty clear though, that whatever it is, it’s not M2, M3 or M4. The ECB, to the extent that it pays special attention to a subset of the liabilities of certain deposit-taking institutions, is barking up the wrong tree. To the extent that the problem is caused by the nominalist fallacy, part of the solution is to stop referring to M2, M3, M4 etc as ‘money’ or ‘monetary aggregates’. Let’s call them L2, L3 and L4 instead, and stop worrying about them.

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Power, Control and Extortion: these are good times to be a terrorist As reported by Philip Stephens in the Financial Times of Friday, July 13, David Miliband, the new Foreign Secretary of the United Kingdom is much impressed with the following statement by Zbigniew Brzezinski, former US National Security Adviser under President Jimmy Carter: For most of human history, the power to control has been greater than the power to destroy; now he power to destroy is greater than the power to control.

The semi-quote above is from Brzezinski’s book, Second Chance: Three Presidents and the Crisis of American Superpower, published by Basic Books in 2007 (ISBN: 0465002528) “The combined impact of global political awakening and modern technology contributes to the acceleration of political history. What once took centuries now takes a decade; what took a decade now happens in a single year.” This global awakening is “historically anti-imperial, politically anti-Western, and emotionally increasingly anti-American.”

Brzezinski illustrates the shift in dominance between the power to control and the power to destroy y contrasting the current state of affairs with that of British India in the 19th century; then the British ruled India with only four thousand civil servants and officers; “it took less effort to govern a million people than to kill a million people.” As the impotence of the US in Iraq illustrates, the opposite is true today “and the means of destruction are becoming more accessible to more actors, both states and political movements.”

Not only has the power of the state to control become less than its power to destroy, the power to destroy has been privatized, dispersed and democratised to an astonishing extent. Anyone with high-school-level command of chemistry and a mobile phone can put together a remotely controlled explosive device of enormous destructive power using ingredients that can be bought off the shelf in everyday shopping centres. If you are a suicidal maniac as well as a mass murderer, you don’t even need a mobile phone. Dirty bombs and chemical or biological weapons are somewhat more demanding as regards technology and organisational ability, but are also increasingly within reach of rather small groups of dedicated and reasonably well-financed private groups, such as the terror-franchising outfit Al Queda.

One implication of the privatisation and dispersion of the power of mass destruction is that the scope for political, ideological and religious extortion (as well as for old-fashioned financial extortion) has increased massively. Private groups will be able to extort political, ideological and religious concessions from state actors, as well as from other, more scrupulous, private actors.

I don’t yet foresee the day that, threatened with the destruction of London, by Al Queda, the Taleban or some North African Salafist outfit, the British government will order all British men to grow beards and all British women to wear burquas (or indeed all British women to grow beards as well), but who knows? Following the threats and attempted intimidation by the Minister for Parliamentary Affairs of Pakistan, Sher Afgan Khan Niazi, assorted high-level Iranian clerics, Al Queda’s number two, Ayman al-Zawahiri and many other odious personages and bodies in response to Salman Rushdie’s Knighthood, I don’t anticipate a peerage for Rushdie any time soon, even if he were to write half a dozen more Nobel-calibre novels.

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Do Only Puritans and Prigs Disapprove of Gambling? According to Ralph Waldo Emerson,

“A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.”

There may be hope for me yet. I spend a fair share of my waking hours arguing against encroachment by the state on the domain of choice of the sovereign individual. Yet my primaeval self undoubtedly cheered when Gordon Brown effectively canned plans for a super-casino in Manchester. I just don’t like gambling, betting, games of pure chance, lotteries and anything else that smacks of a discretionary roll of the dice or turn of the roulette wheel. Games of chance, involving elements of strategic or exogenous uncertainty, or both, become less attractive to me the greater the role of luck relative to that of skill in determining the winner or the distribution of gains and losses. So lotteries are rock bottom in my list of entertainments while bridge is right up there with chess. Why is that? Probably a Puritan legacy overlaid on a priggish personality, but there are a few further rationalisations for a dislike for and disapproval of gambling. Gambling (now taken generically to include all man-made ‘lotteries’ that add to the net uncertainty in the world) is a regressive activity – it increases inequality without any efficiency gains other than the sheer fun and enjoyment gamblers derive from the activity – the thrills derived from the possibility of loss and the anticipation of possibly vast gain. Games of chance between small numbers of individuals are zero-sum games. Organised gambling, which requires real resources to organise and manage, is a negative-sum game (again ignoring the thrills, kicks and anticipation or imagination of otherwise unobtainable life styles). In the UK, instead of taxing the earnings from gambling the way all other profits are taxed (and allowing gambling losses to be offset against other income), both gambling winnings and losses escape the tax net altogether. Obviously, net tax revenues from including gambling winnings and losses in taxable income would be negative, but this piece of social engineering would reduce inequality without any deleterious side-effect on incentives. In addition, the financial sector in the UK has managed to structure many risky financial investments as activities that legally qualify as bets, so the profits from these activities also escape income tax. Formally, any risky investment can be restructured as a complex lottery or collection of bets, so the tax exemption of gambling winnings may well have serious implications for the asset income tax base. My very few trips to casinos have been of anthropological interest only. I have never gambled a dime or bet on anything. The sight of rows and rows of pathetic blue-haired wretches pulling one-armed bandits in some Las Vegas gambling den was enough to make me leave that soulless dump in a hurry and never come back. Whenever I see some dandruff-ridden drunk in a pub putting coins or tokens in a slot machine or fruit machine, I know that humanity is an evolutionary dead-end. Betting shops, the losers slouching in and out of them and the sleazy bookies – known as ‘turf accountants’ in the UK – put me in a time-warp to the 1930s. The posher the gambling or gaming venues, the more louche the clientele. In the most upmarket casinos, a disconcertingly large fraction of the male customers have the appearance and manners of prancing pimps and the majority of the (generally much younger) female customers tend to occupy the spectrum between posh totty and expensive tart. For reasons that I don’t understand, organised gambling, even when it is legal, frequently attracts the attention of criminals – in the management of the establishments, in extortion rackets living off the business and as providers of illegal goods and services demanded by customers with more money than taste or sense. Gambling is addictive. It has ruined many lives. As a vice it is more like smoking – which really has no redeeming value – than like imbibing alcohol, which in moderation is both healthy and pleasant. I would not want to ban gambling, but like alcohol and tobacco, gambling should be taxed, possibly quite heavily. It should not be banned because vices should not be banned, even if they involve stupid, offensive and ugly behaviour, unless (1) they cause material harm to others and (2) a ban can be enforced at a reasonable cost with a reasonable degree of success. Gambling is not quite a victimless crime – the dependents of gambling addicts are indeed harmed by the addict’s gambling, but the harm does not seem sufficient to warrant another intrusive intervention by an already over-bearing nanny state in our everyday lives. Making gambling illegal is also bound to be ineffective. It would no doubt lead to further criminalisation of the gambling and betting industry, similar to what we see in the USA. Still, Manchester can praise itself lucky not to be lumbered with the Titanic of British gambling. In all but the short run, the quality of life will be better in the area where this carbuncle would have been oozing its pus, had the gambling godfathers had their way.

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The browning of ‘Chindia’ (This post appeared first in Mint, daily business newspaper published by India’s HT Media Ltd in association with The Wall Street Journal,in New Delhi and Mumbai, Views, Thursday April 12, 2007.)
In the first part of this post, I considered two risks to the continuation of the spectacular growth of China and India: The risk of a cyclical downturn and the risk of serious social and political instability. I now turn to the third risk: The risk of domestic environmental supply-side constraints on economic growth becoming binding.

I want to focus here on the local (national) natural resources of clean, fresh water and fertile land. (Some would add clean air as well.) These are not only important domestic ‘consumer durables’ but also key inputs into the production of the goods and services that are captured by conventionally measured GDP indices. Although both fresh water and fertile land are in principle renewable or restorable given enough time, energy and other resources, they are in practice being depleted, polluted and poisoned at a spectacular, increasing and unsustainable rate.

These resources are either under-priced or not priced at all. In India, for instance, water is supplied to the agricultural sector virtually free of charge. ‘Flat rate pricing’ for agricultural power means that the private marginal cost of electricity use in agriculture is zero. The environmental externalities of land use (erosion, deforestation, desertification) also are not priced properly or internalized in other ways. The environmental consequences are disastrous. The resulting depletion and destruction of water and land resources is a form of environmental capital depreciation, which should be deducted from the net real output or real national income measures used in the growth accounting exercise. Instead, it is ignored. Output is, therefore, overstated. The water constraint is likely to be the first one to become binding in both China and India, certainly within 10 years. It will impair even the production of those goods and services included in conventional GDP measures. By 2020, OWEC (the Organization of Water Exporting Countries that will no doubt be created soon) may well be more influential than OPEC. It may seem strange that with 71% of the earth’s surface covered by water, this would become the binding constraint on growth. Unfortunately, only 3% of this surface water is fresh water.

Well-informed observers of Chindia, such as Martin Wolf of the Financial Times, argue that Chindia will avoid these disasters by learning to price these scarce resources (especially water) appropriately. After all, the advanced industrial countries, including the UK, the US, Germany and Japan, have made considerable strides in that direction.

There are two problems with this optimistic perspective: Scale and speed. When the UK was 50 years into its industrial revolution (around 1820), it had 21 million inhabitants. Today, it has 60 million. The US in 1850 had 24 million people; it had 76 million in 1900 and today has 300 million. Today, a couple of decades into their industrial revolutions, China has 1.3 billion people and India 1.1 billion. Over the 80-year period between 1820 and 1900, UK real GDP grew at an average annual rate of 2.06%. Over the 50-year period between 1850 and 2000, US real GDP grew at an average annual rate of 4.07%.

China proposes to have an annual growth rate of real GDP of not much less than 10%. India shoots for 8% or 9% real GDP growth. What these two countries jointly propose is growth on a cale that is more than 200 times larger than what the UK and the US managed during their industrial revolutions. The national, regional and global environmental impacts will be cataclysmic. Chindia will not have a century or more to figure out how to make growth environmentally sustainable—a process still far from complete in the UK and the US. They have less than a decade. Unless China and India reorient their growth policies towards environmental sustainability, the 21st century may well become the century of Chindia—but for a very different reason from the one prophesied by the current cheerleaders.

I am not arguing that things are bound to go disastrously wrong. It is possible that all water and energy use (including agricultural) in India will soon be priced at something close to long-run marginal social cost. It is, however, more likely that neither long-run marginal social cost pricing of water and power, nor some other effective non-price rationing mechanism for scarce water and power, will be put in place in the foreseeable future. It follows that there is a significant risk that things will go disastrously wrong.

Just how likely are the prompt and massive reorientations of economic and social priorities in both India and China that are necessary to avoid disaster? History offers little guidance, as problems on this scale and of this scope have not occurred before. Because India’s 60-year experience with an open, pluralistic and democratic system of government gives it an edge over China with its 60 years of totalitarian communist party rule, I am more optimistic about India than about China.

But I have serious concerns even for India.

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Too many cheers for ‘Chindia’ (This post first appeared in Mint, daily business newspaper published by India’s HT Media Ltd in association with The Wall Street Journal,in New Delhi and Mumbai, Views, Wednesday April 11, 2007.) There has been a world-wide bout of ‘Chindiaphoria’—the widespread conviction that China and India can continue with their current growth rates for a long time, possibly decades. While everything is possible, I believe the risks to economic growth in these two countries are much more serious than markets and pundits recognize. I shall focus on three risks: The risk of a sharp credit contraction and cyclical downturn, domestic and political risk, and environmental risk. The second is obviously not independent of the third.
First, the cyclical risk. Both India and China are in the terminal stages of a credit boom. So there will be a cyclical slowdown in both. If the monetary and fiscal authorities act in time (they seem well behind the curve in both countries), and if they have the right instruments and the political will and freedom, the credit boom can end with a whimper.
A hard landing seems more likely, since the politically feasible tools for restraining credit growth are only partly effective. China’s authorities rule out the most effective and least distortionary policy response: Raising interest rates and allowing the yuan to appreciate more rapidly. Instead they rely on ineffective increases in reserve requirements and distortionary command-and-control techniques—basically selective credit controls from the central planning days. In India, the belated increases in the Reserve Bank of India’s (RBI) key policy rate to 7.75, and the accompanying increase in reserve requirements by 50 basis points, is rather late and still too little. The effectiveness of these and earlier RBI restrictive measures last year has also been undermined by the extraordinary spectacle of the finance minister, P. Chidambaram, cajoling public-sector banks not to pass on interest-rate increases to borrowers. Other populist, distortionary and, in all but the short run, ineffective anti-inflation measures of the Union government have included a ban on wheat exports.
Second, domestic political risk to growth is seriously under-priced by domestic and global investors. In China, economic liberalization is proceeding side by side with continued political repression. Growing wealth and rising average prosperity levels are accompanied by equally spectacular increases in inequality and, more recently, by growing numbers of people who are worse off and often reduced to living in absolute poverty. The sustainability of such a social-political-economic configuration has never been tested. India has had a representative form of government for 60 years. I believe this is an important socio-political safety valve.
Unfortunately, India needs such a safety valve. It is hamstrung by the widening gap between the urban and rural communities, by the continuing debilitating effects of its caste system, and by serious religious tensions, especially between fundamentalists in the Hindu and Muslim communities. India also has an atrocious record for educating its underprivileged in general, and its women in particular. The Maoist Naxalite terrorist movement is a serious internal threat to security and stability. There is a clear risk of greater religiously motivated extremism and terrorism, and of unholy alliances between home-grown and domestically oriented terrorism and international terrorist movements, especially the fundamentalist Islamist terrorist networks. There is no evidence that the political establishment is about to come up with a policy that is tough on domestic terrorism and tough on the causes of domestic terrorism. Blaming Pakistan for every bomb that explodes is not a policy.
Third, and probably most importantly, the environmental risk. Environmental constraints on growth in Chindia rarely figure prominently in discussions. The same omission invalidates the recent growth accounting exercise for India and China by Barry Bosworth and Susan M. Collins of the Brookings Institution. In this approach, the growth of output is the sum of the contributions of physical capital accumulation, agricultural land area growth, labour input growth and total factor productivity growth. Output is seriously mismeasured and a key input—the services yielded by the stock of environmental capital—is ignored completely. For Chindia, this omission matters even in the medium run.
The environmental constraints I want to focus on are not India’s and China’s contribution to global climate change and to other global environmental externalities, although these are of growing significance. Global warming may bring some benefits to parts of the globe (especially the current cooler and colder regions of the northern hemisphere). It will be an unmitigated negative for the Indian subcontinent and for China.
In my next post, I will focus on how the local or national natural resources of clean, fresh water and fertile land may in no more than a decade become binding constraints on economic growth in Chindia.

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China’s Environmental Worm is Turning Sooner Than Expected Today’s Financial Times (Tuesday July 10 2007) reports that “Campaign to clean the Yangtze under way”, “Official willing to sacrifice growth” and “Factories must improve or close”. It even looks as though the State Environmental Protection Agency (SEPA) may be developing into something more than a hopelessly understaffed paper tiger . Mr Li Yuanchao, Communist party secretary of Jiangsu province, is quoted as saying that “The measures [to protect the environment] must be strictly implemented even if they cause a 15 percent downturn in the province’s gross domestic product’. Probably nowhere in the world is measured GDP a worse proxy for the value of currently produced goods and services than in China, where in the heavily industrialised regions the air is unbreathable, the water undrinkable and much of the soil unfit for cultivation or residential use. The environmental and ecological externalities of the Chinese miracle are of such a staggering magnitude that they will soon begin to impinge even on the production of those things captured in conventional GDP measures. They have long since driven a growing wedge between measured GDP and any measure of economic welfare (MEW). The external effects are partly global in their impact (through global climate change driven by greenhouse gas emissions) but many are national, regional and local in nature. I would add the food safety problems that are now affecting Chinese exports but have been a well-established public health problem inside China to the list of urgent Chinese environmental and ecological challenges. Unless they are addressed promptly, the Chinese miracle could become a nightmare.

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Maverecon: Willem Buiter

Willem Buiter's blog ran until December 2009. This blog is no longer active but it remains open as an archive.

Professor of European Political Economy, London School of Economics and Political Science; former chief economist of the EBRD, former external member of the MPC; adviser to international organisations, governments, central banks and private financial institutions.

Willem Buiter's website