Monthly Archives: June 2011

Greece avoided an imminent default by taking a brave vote for more fiscal austerity on Wednesday. Europe and the International Monetary Fund will now release short-term financing to enable Greece to service its debts at least through the summer. Yet there can be no doubt that this second bail-out, which follows a similar short-term package in March 2010, must be the last of its kind. Either Greece with its eurozone partners will agree on a long-term solution, or the rioters in the streets of Athens will prevail the next time that the Greek political system is pushed to the financial brink.

The stalwart Greek people deserve our gratitude for this week’s vote. A default could have led to a dramatic unravelling of the European economy, and even beyond. Many of my colleagues in academia have blithely called upon Greece to default, and thereby force an involuntary restructuring of its debts. I find such advice to be naive. Nobody can guarantee a managed default in today’s global financial system. Bank runs, a contagion to other countries, the triggering of credit default swaps, legal actions by vulture funds that buy up cheap Greek bonds and then sue for full repayments, and heated political recriminations within Europe, are but some of the consequences that could quickly follow a default. An unravelling of the monetary union could not be excluded.

A default may indeed eventually occur, but should never be a first or early resort. I say this not because of the sanctity of sovereign debt contracts, but out of pragmatism. I myself have helped to negotiate a number of sovereign debt restructurings, from Bolivia to Poland to Nigeria and beyond. But Greece is different. It is a developed economy. It has not collapsed into hyperinflation. It has not emerged from externally imposed communism, as in Poland two decades ago. Greece over-borrowed and overspent, then got caught in accounting shenanigans as well as the global financial meltdown in 2008. Now Greece needs to adjust, if that adjustment is within reason and decency rather than the kind that would kill the economy.

Many of those who argue for the inevitability of default claim that Greece can never repay its mountain of debt. They may eventually prove to be correct, but it is still far too early to say, or to act on that hunch. The claim of inevitability is that with public debt owed to foreign creditors around 120 per cent of national income, Greece’s debt servicing will break the economy and prove, sooner rather than later, to be politically unsustainable as well. With average interest rates on Greek bonds expected to stay above 6 per cent per year on the business-as-usual scenario put forward by the IMF and EU, interest servicing to foreign creditors would also remain higher than 6 per cent of gross domestic product in the coming years. That indeed would be an impossible load to bear, both economically and politically.

Fortunately, that dire forecast is not necessarily right. Greece need not pay anything near to that level if the financial crisis is better handled from this point forward. Here is how.

The IMF-EU estimates are based on the idea that Greece will have to pay high market-based interest rates that include a significant premium for the risk of default. The obvious problem facing Greece is a potentially self-fulfilling prophecy of default. High interest rates will lead to an intolerable debt-service burden and the inevitability of default. The prospect of default, in turn, will lead inexorably to high interest rates. The better policy is to get Greece’s interest rates sharply lower, consistent with an alternative scenario in which Greece is in fact able to manage its debts because debt servicing is moderate, gradual and backed by renewed economic growth.

Suppose that instead of sky-high interest rates, Greece is enabled to service its debts on Germany’s borrowing terms, roughly ten-year fixed interest rates of around 3.5 per cent per annum. With annual eurozone inflation of 1.5 per cent or higher, real interest rates would be 2 per cent or lower. If Greece can resume an annual economic growth rate of around 3 per cent, then Greece will be able to service its debts and reduce the ratio of its foreign public debt to GDP from around 120 per cent to around 70 per cent over a twenty-year period, while also keeping net resource transfers to foreign creditors to around 2 per cent of GDP per annum.

This is the main point: Greece can probably service its debts in the long term, without a default, if a low interest rate (at the level of today’s AAA sovereign borrowers) is locked into place and repayments are stretched out over 20 years. Simply stretching out repayments – as is now being discussed by the banks and the French Government – without permanent and significantly lower rates would not do. Nor would a “trigger” clause that raises Greece’s repayment rates when economic growth resumes. Greece can succeed only if low rates are locked into place.

Such favourable terms could conceivably arise through a spontaneous and self-confirming bout of optimism – the condition in which Greece’s greatest fear would no longer be “fear itself”, in the famous words of America’s greatest salesman of financial optimism, President Franklin Roosevelt. More realistically, we are past the point of self-confirming optimism.

Low interest rates should instead be put in place through Europe-wide guarantees on Greece’s debt service. In effect, Greece would be enabled to finance its debts on German and French borrowing terms, as those countries and the rest of the eurozone stand behind Greek debt servicing. German Chancellor Angela Merkel has so far resisted this kind of solution, while Axel Weber, former Bundesbank President, recently hinted at such an approach.

Ms Merkel is afraid to be tarred with a taxpayer-financed bail-out of Greece and the banks. This concern is grossly exaggerated, at least relative to the far-greater concerns regarding a disorderly default. After all, taxpayers would surely pay much more in that event. They would pay nothing at all on the guarantees if Greece indeed succeeds in servicing the debt over twenty years at the locked-in rates.

There is also an effective way to address the heavy political burden of a European guarantee on Greek debt. The EU has been moving towards new taxes on the financial sector, perhaps on bank balance sheets or on financial transactions. Such taxes could in effect back the guarantees on Greek debt servicing. Building up a guarantee fund at the European Central Bank that can be drawn in the event of a Greek default would be one option. In this way a triple bargain would be struck: Greece would repay at low interest rates, the eurozone would survive and the banking sector (ie wealthy shareholders and major investors, in effect) would stand behind the bargain.

In the best case, there would be winners all around. Greece would disprove today’s pessimists by repaying the debt over twenty years. Let’s face it. The pessimists are just guessing. A gradual repayment at low interest rates is worth a try. In the worst case, Greece defaults to its European guarantors, without triggering a banking panic or a breakdown of the single currency.

Of course the concept of a no-default workout is based on a critical assumption, that Greece can resume economic growth while remaining tethered to the Euro. There are many reasons to believe this to be the case. Greece in fact enjoys many interesting growth prospects.

Greece has vast solar and wind power to export to energy-hungry northern Europe. Greece offers a superb transport hub for Europe-Asia trade. Young Greek software engineers are making their mark in information technologies. And of course Greece remains one of the world’s glorious destinations for tourism, exploration, and ruminations on the human condition. With some luck, Greece will be ruminating in the future about how it stuck to a narrow path in the early twenty-first century, and found honour and vindication for its labours.

The writer is director of the Earth Institute at Columbia University.

With today’s vote in favour of a medium term fiscal plan, Greece has just escaped the immediate danger of financial collapse. But this will prove a short lived victory for the Greek government: in the coming days and months a series of crucial decisions are pending which mean the prospect of both fiscal default and political crisis will rarely be far from the headlines.

Greek Prime Minister George Papandreou’s problems begin again tomorrow, with a second parliamentary vote on the implementation of the plan that was barely agreed today. This would create a new body to handle the planned €50bn privatisation drive, and a new package of tax hikes, including on those earning small salaries. A “solidarity tax” is also planned on everyone earning above €12,000 per year, along with higher taxes for consumers and businesses In short, it offers a little something for everyone to hate.

That said, tomorrow’s vote is likely to pass too. It seems unlikely that anyone voting for austerity today would undermine the good it might do for Greece by voting against implementation tomorrow. Yet while passing both votes is a considerable achievement, ongoing waves of public outrage and protest make it difficult to see how this plan can be faithfully and efficiently implemented.

More political problems are certain to follow. PASOK, Mr Papandreou’s ruling socialist party, enjoys a thin parliamentary majority of just 155 of 300 deputies. Public fury against the government is unlikely to abate and may grow stronger. Greece’s bureaucracy inspires little confidence that it’s up to this job. In sum, today’s vote has bought the government several months, but by the end of the year, Greece will probably have new elections.

This is where the real problems begin. Mr Papandreou might have survived a parliamentary vote, but the chances on him surviving a public vote are slim. Any fresh elections will probably yield a new coalition government with New Democracy, the main opposition party, as leading partner and PASOK as the junior partner.

Superficially, that looks like it will create the new national political consensus and conciliatory approach that European Union negotiators wisely demand. It will, for instance, be much easier to demand future sacrifices from Greece if virtually its entire political class has publicly accepted the need for it.

But for a preview of the way any new coalition government will consider further austerity measures, consider the fact that New Democracy leader Antonis Samaras warned before today’s vote that any ND deputy voting in favour of the plan would be expelled from the party. There is little room for a conciliatory approach in his attitude, nor is one likely to emerge in the coming months. In short, there is simply no reason to believe that the opposition will throw away its chance to vilify PASOK for every imposition of pain when it doesn’t have to.

All that said, gaining time is the least bad outcome, both for Greece and Europe as a whole. The breathing room provides European negotiators to keep pressure on Greece to stick with as much austerity as its citizens and lawmakers will stomach. Any other available solution – restructuring the debt, bridge loans or outright default – would be much more painful for both Greece and the EU.

The successful vote limits the prospects for financial contagion, and gives the other peripheral nations precious time to buttress their fiscal accounts, and to dampen public opposition to further reforms in their own countries. It must be hoped that all concerned use this short period of grace wisely and effectively – or Europe’s problems will soon return with a vengeance.

Ian Bremmer is the president of Eurasia Group, a political risk consultancy, and author of ‘The End of the Free Market’

 

The daring night-time raid on one of Kabul’s best-known hotels by Afghan militants on Tuesday, underlines once again how much depends on the secret talks with the Taliban . Following President Barack Obama’s plan for a limited withdrawal of US troops from Afghanistan, hopes of a peace settlement that would allow a full and safe western troop withdrawal by 2014 depend on these negotiations.

However the recent leaks by government officials in Washington, Kabul and London, are extremely dangerous and could scuttle the talks just as they enter a critical phase. Even more dangerous has been the speculative naming by journalists of American, German and Taliban participants. Exposing names endangers these officials’ lives at the hands of groups such as al-Qaeda and others, who are vehemently against the talks and want to sabotage them at the outset.

I have followed in close detail the many attempts at dialogue in Afghanistan since 2005, in the hope that they could bring eventual peace to a country that has known nothing but war since 1978. These talks have largely been between Afghanistan’s President Hamid Karzai and the Taliban and only recently included the Americans.

At stake is not just peace for Afghanistan, but the entire region including a deeply precarious Pakistan. The talks are premised on the essential realisation that neither a successful western withdrawal from Afghanistan nor a transition to Afghan forces can take place, without an end to the civil war and a political settlement that involves the Afghan government and the Taliban, but also Pakistan, the US and the region.

In an attempt to avoid further speculation, I am laying out the bare facts of the talks as western officials have described them to me. The first face-to-face meeting between Taliban leaders and US officials took place in a village outside Munich in Germany on November 28 2010.

The meeting was chaired by a German diplomat and also there were Qatari officials whom the Taliban had asked to be present and involved. The talks continued for 11 hours.

The second round took place in Doha, the capital of Qatar on February 15. Three days after the Doha meeting, US secretary of state Hillary Clinton made the most far reaching US public statement to date, telling Americans, “we are launching a diplomatic surge to move this conflict toward a political outcome that shatters the alliance between the Taliban and al-Qaeda, ends the insurgency, and helps to produce not only a more stable Afghanistan but a more stable region”.

The third meeting took place again in Munich on May 7 and 8. All the same participants have taken part in the three rounds which have largely involved trying to develop confidence-building measures between the Taliban and the Americans, such as lifting sanctions from the Taliban, the freeing of Taliban prisoners, the opening of a Taliban representative office and other steps.

On June 17 in a major step forward, the UN Security Council accepted a US request to treat al-Qaeda and the Taliban separately in relation to a list of global terrorists the UN has maintained since 1998. There will now be two separate lists and UN sanctions on al-Qaeda members will not necessarily apply to the Taliban making it easier to take the Taliban off the list – a major boost to the dialogue process.

Mr Karzai has been fully briefed after each round and has unstintingly supported the Taliban’s desire to hold separate talks with the Americans, even as his government continues their talks with the Taliban at several levels. Pakistani leaders have also been recently briefed about the talks, although they have expressed some reservations about them.

One US-German target is to commemorate the tenth anniversary of the 2001 Bonn meeting that set up the Afghan interim government, with another international meeting in Bonn in December 2011 in which the Taliban will hopefully participate.

This would formalise the talks process, but there is still a long way to go before the Taliban agree to such a demand – all the more reason that the identity of interlocutors are well protected by governments and the media. Even then some believe that the Americans are going about the talks too slowly.

The process began when German officials at the request of the Taliban, held their first meeting in September 2009 in Dubai. Germany has always been admired by the Afghans because it has stayed neutral – never taking sides in Afghan conflicts and even tried to diplomatically mediate to end the 1990s civil war between the Taliban and their opponents.

The Germans made sure that the interlocutors fully represented the Taliban Shura or its governing council which is headed by Mullah Mohammed Omar. (The Americans have also taken their time to verify the authenticity of the Taliban.) The Germans held eight further meeting with the Taliban to build trust and confidence, before bringing in the Americans. The Germans have never doubted that their role is as facilitators – while the actual negotiations must take place between the US and the Taliban.

Qatar has played a role because the Taliban wanted a Muslim country at the table and considered Qatar neutral. Qatar has not interfered in Afghanistan, nor has it ever backed any of the regional countries who have taken sides in Afghanistan’s conflicts in the past such as Pakistan, Saudi Arabia, India, Turkey or Iran.

A former Taliban leader told me recently that “the fundamental problem is between the US and the Taliban and we consider the Afghan government as the secondary problem”. He added “the talks we (Taliban) want must involve the international community and end with international guarantees”.

If that is the case and the Taliban would like to see an orderly western exit from Afghanistan, the media and governments must allow these talks to succeed. The only way to do that is to respect the participants need for secrecy. These many Afghan efforts have always been undermined by rival governments in the region or extremists. The recent talks are clearly no longer secret but who participates, what is discussed and what progress made, must remain private if the talks are to have any chance of success.

The writer is author of ‘Descent into Chaos and The Taliban’

Response by Hilary Synnott

Ticking political clock means time is short for talks

Ahmed Rashid’s piece is the most authoritative account of the process of talks with the Taliban that I have seen so far. At one level, his account is encouraging: talks are proceeding, despite previous seemingly impossible Taliban preconditions, and with a sense of urgency. Indeed, this chimes with an experience I had earlier this year, when I met a senior Taliban official whom I had come to know in Islamabad in 2001. I was struck upon meeting him again by his new flexibility and moderation, and took this as a broader sign that progress may be possible.

It is interesting to note also that Pakistan, although being kept briefed on events, is not a direct party to the talks. Direct involvement has always been Pakistan’s aim, and with out there could yet be trouble in store. Even without this complication, Rashid is surely right about the delicacy of the talks process. In such cases, nothing is agreed until everything is agreed: the package, if one emerges, must be seen as a whole. By revealing only a partial picture, leaks can generate opposition and jeopardise the whole process.

Whether Rashid’s fellow journalists heed his plea for discretion is of course another matter. But the overall challenge remains that a successful western withdrawal from Afghanistan cannot take place without an end to the civil war, and a political settlement that involves the Afghan government and the Taliban, but also Pakistan, the US and the region. This points to a long term process, rather than any quick fix. The critical question, therefore is whether western political imperatives will allow this. Here, more depressingly, there remains considerable room for doubt.

The writer is the author of ‘Transforming Pakistan: Ways out of Instability’ and a former UK high commissioner to Pakistan

I remember sitting in a meeting at the International Monetary Fund back in the 1980s, debating the meaning of a small annotation in the margin of a memorandum that had just returned from the office of the managing director. It was just a squiggle; yet we debated possible interpretations for a full half an hour!

This is a small example of what is well known to IMF insiders – the post of managing director is not to be taken lightly in an institution that operates like a well-disciplined army, with staff looking up to the unquestioned general for decisive leadership.

This is why the resignation of Dominique Strauss-Kahn has been so disruptive to the functioning of the IMF. It is also why Christine Lagarde – who following Tuesday’s public backing from Tim Geithner, US treasury secretary, will assume the post shortly barring any legal complications – must move on five key issues in her first few months at the helm.

First, she must restore proper separation between the post and the political ambitions of the holder. This separation has been eroded in recent years by Europe’s decision to appoint politicians (Mr Strauss-Kahn and Rodrigo de Rato before him) and, was essentially eliminated by the widely-held view that Mr Strauss-Kahn was using his position as a springboard to the presidency of France.

To this end, Ms Lagarde must realise that Europe’s perceived entitlement to the top post has left a bitter taste in the mouths of the institution’s membership and anyone who believes in the importance of a legitimate IMF at the center of the global monetary system. The manner in which the entitlement was imposed once again with her appointment has alienated some steadfast supporters of the institution.

With this in mind, she should waste no time in establishing a legitimate selection process for the next managing director that is truly based on merit, not nationality. Rather than repeat the empty European promises that were also made after the appointment of her last three predecessors, Ms Lagarde should improve the institution’s governance by hardwiring a process that emphasises qualifications, meaningful due diligence and true openness to candidates irrespective of nationality.

Second, Ms Lagarde should reinforce her commitment to a meritocracy by eliminating other nationality-based appointments. She should start with the replacement for John Lipsky, the Fund’s first deputy managing director, and an American, who announced his intention to step down just a few days before Mr Strauss-Kahn was arrested. She should let this choice be based on merit, rather than another nationality-based directive – this time from the US Treasury Department.

Third, Ms Lagarde must strengthen the analytical robustness of the IMF’s response to debt crises. This should start with addressing the legitimate criticism that the institution’s role in the peripheral European bailouts was excessively influenced by political considerations, thus undermining its reputation of rigor and evenhandedness. In doing so, she would also enhance its ability to help address other systemic challenges, such as persistent global payments imbalances and deep-rooted structural rigidities that stifle employment creation.

Fourth, Ms Lagarde must prepare the Fund’s balance sheet for the risk of some future financial impairment on account of the massive loans made in the past year, particularly to Greece. The sooner she does this, the less likely that the IMF will fall victim to behavior patterns the ECB seems to be stuck in – that of denying a solvency problem in a member country because too much of the sovereign debt now resides on the bank’s balance sheet. This trap converts institutions from being part of the solution to being part of the problem.

Finally, Ms Lagarde must help restore the public standing of the IMF’s staff. The stunning arrest of Mr Strauss-Kahn has fueled a series of attacks that are inconsistent with the dedication shown by the institution’s talented staff.

In just a few weeks, previously inconceivable circumstances have catapulted Ms Lagarde into the role of presumed leader of the world’s most influential and fastest-responding multilateral institution. With Europe again imposing its will on the rest of the IMF membership, she will need to hit the ground running if her tenure is to be an inspiring story of institutional transformation, rather than one of maintaining a myopic approach to a critical international post.

The writer is the chief executive and co-CIO of Pimco, the world’s largest bond investor.

Response by Eswar Shanker Prasad

The old order has triumphed yet again

Christine Lagarde owes Agustin Carstens a debt for having made this an ostensible contest rather than a choice by acclamation. This may actually strengthen her legitimacy if she can turn the narrative around to having won the top job at the IMF in a fair and open contest. Still, for emerging markets, the selection process that culminates in Lagarde’s victory leaves a bad aftertaste.

Although emerging markets lost this round, Ms Lagarde’s victory may well turn out to be a good outcome for them in the long run. She brings to the position an excellent set of strategic and political skills that could make her an effective advocate for emerging markets at the IMF. Ms Lagarde can twist the arms of European countries that have blocked progress on governance issues by arguing that such reforms would be for the greater good of the IMF.

As a well-respected insider in European economic and political circles, Ms Lagarde has the clout and credibility to corral Europe into supporting further reforms at the IMF. Indeed, Mr Carstens may have been less likely to deliver on governance reforms (such as voting rights and representation on the executive board), despite his heart being in the right place, as he would have found it more difficult to overcome European resistance.

The immediate priority for Ms Lagarde, as Mohamed El-Erian notes, is to reset the IMF’s engagement with the debt crisis in Greece in a manner that avoids a blow-up but doesn’t smack of favoritism. Having been embroiled in dealing with the European debt crisis already, it remains an open question whether she can shed that baggage when she comes into the IMF job and can take a fresh and more objective perspective.

Ms Lagarde’s longer-term challenge is to rebuild the emerging markets’ trust in the IMF and make them feel they have a strong stake in the institution. Two factors have heightened the emerging markets’ perception that the IMF subjects them to a different set of rules than it does the advanced economies. One is the selection process for the next managing director. The second is the treatment of European countries in crisis, with the sense among emerging markets that they would not have been given as much rope as Greece seems to be getting if they did not meet policy commitments and targets.

Ms Lagarde will have to work hard to convince emerging markets that she will not let the IMF once again be dominated by European and American views and interests. Otherwise, her legitimacy and that of the institution could be sullied.

How can she do this? First, Ms Lagarde needs to ensure that the shifts in voting shares and executive board representation in favor of emerging markets that were agreed during her predecessor’s regime are carried through fully and quickly. Second, she needs to push for more aggressive reforms that bring representation at the institution more in line with existing economic realities on the ground.

Ms Lagarde takes over an institution that has become central to the global financial system. The way she manages the political, technical and strategic aspects of the job will help determine the IMF’s future legitimacy and effectiveness.

The writer is the Tolani Senior Professor of Trade Policy at Cornell University and former chief of the financial studies division in the research department of the IMF.

The pressure on Lorenzo Bini-Smaghi to resign from the executive board of the European Central Bank is a fundamental challenge to the bank’s independence and to its ability to represent European interests rather than those of individual countries.

When the ECB was being created, European politicians said it would be a truly European institution, making decisions for the benefit of the eurozone as a whole.  As such members of the ECB’s governing boards would be expected to act as Europeans rather than as representatives of their individual national governments.

To reinforce this independence, the Maastricht treaty states that officials of the ECB would not serve at the pleasure of their governments but would have appointments for a fixed term of eight years.  To reinforce this independence, the votes at the ECB are not disclosed, allowing individuals to take votes that favour the overall eurozone economy even when that is contrary to the interest of the member’s own country.

Like other eurozone myths, the goal of ECB independence that rests on the principle of fixed term appointments has now been destroyed. The French government has apparently succeeded in forcing Mr Bini-Smaghi to resign in order to make way for a French appointment to the ECB executive committee.

French president Nicolas Sarkozy has announced that Mr Bini-Smaghi will “voluntarily” resign before the end of the year. The French argue that it is wrong for Italy to have two members on the ECB executive board while France has none. So much for the idea of eurozone solidarity.

President Sarkozy made France’s support for the appointment of Mario Draghi – another Italian – as the next head of the ECB conditional on being able to replace Mr Bini Smaghi with a Frenchman. As someone who thinks Mr Draghi is the best candidate for that job, I find this move fundamentally undermines the ECB as an institution.

But national pressure trumps the Maastricht rules.  The Italian government will offer Mr Bini-Smaghi a suitable alternative job that will allow him to move on from the ECB with dignity. But the ECB will be the worse for it.

The writer is professor of economics at Harvard University and former chairman of the Council of Economic Advisers and President Ronald Reagan’s chief economic adviser.

Response by Lucrezia Reichlin and Charles Wyplosz

The row over Lorenzo Bini Smaghi’s place on the European Central Bank board proves, once again, that only passports matter when choosing Europe’s top central bankers. The problem, however, is not with the individuals involved, but with the process and its unavoidable glitches once nationalism gets in the way.

We have, of course, been here before. Due to a Franco-German deal whereby the ECB was to be located in Frankfurt in exchange for the first chairman to be French, the late Wim Duisenberg was forced to promise to resign to make room for the current chairman, Jean-Claude Trichet, who could not be appointed earlier because of pending litigation. In the end, the ECB’s reputation for independence survived that episode, and will probably survive another.

But as Mr Feldstein writes in his article, this kind of nationalist interference cannot be right. Indeed, this time, arguably, it is worse – Mr Duisenberg made his promise before the appointment was made. The deal was done ex ante. This time we are talking about pressurizing a sitting member of the board to resign.

One could argue that perhaps some extraordinary political haggling was inevitable at the inception of an extraordinary supranational institution such as the ECB. But now it is beginning to look like a bad habit. Sooner or later this will cast a shadow over the bank’s independence. Sooner or later a line will have to be drawn if the principle of independence is to be protected. Why not now?

We do not challenge the idea that elected politicians at the highest levels should have the right to appoint some of the most important non-elected policymakers in Europe. This arrangement fulfills two key democratic principles, namely that important decisions belong to elected representatives of the people and that delegation to bureaucrats is under exclusive control of elected officials.

Even so, this does not justify injecting nationalist politics into the process. It suggests that board members somehow represent their countries, which they explicitly are forbidden from doing. We fail to see what would be wrong if there were two Italians and no French on the board for a couple of years. So what?

Lucrezia Reichlin is professor of economics at London Business School, and Charles Wyplosz is professor of economics at The Graduate Institute in Geneva.

At their meeting last week, European leaders agreed again to “do whatever is necessary to ensure the financial stability of the euro area as a whole”. But they did not say how. Even if Wednesday’s vote in Greece’s parliament averts an immediate crisis, they would be well advised to make use of the long European summer season to turn this unspecified commitment into an action plan. Here are some modest suggestions for their holiday homework:

1. Complete the banking sector clean-up. Financial fragility is heightened by the still-unfinished recapitalisation of the weaker banks. Two years after the US successfully completed its stress tests, Europe is still struggling. The publication of new tests, expected in July, offers a chance to aggressively restore the soundness of banks across Europe.  This may cost public money and political capital, but no political expediency can justify missing the opportunity.

2. Explore options to address insolvency. Last week, the German proposal for a compulsory rescheduling of Greek debt was rejected. But to pretend that an insolvent country will repay its debt is no strategy.  There are only two economically consistent options. One, call it Plan A, is to socialise the Greek debt. It requires lowering the interest rate on official assistance to a level that makes Greece solvent and deciding who, if needed, will bear the corresponding cost – either the banks, through a special levy or, by default, the ordinary taxpayers. Plan B is to make private creditors pay through an orderly restructuring. To make it a viable option, preparations must be undertaken, not least by the ECB, so that when restructuring takes place its financial fallout can be contained. Each plan is anathema to some of the leaders, but one will eventually have to be chosen. The Europeans should make use of the time they have bought to evaluate their implications and choose a strategy.

3. Make better use of the crisis management facility. The recently created European Financial Stability Facility (EFSF) and its successor the European Stability Mechanism (ESM) are potentially powerful instruments to preserve financial stability. But lack of trust and domestic politics have led to attaching too many strings to their use. As they stand they can neither serve to prevent a crisis through precautionary lending nor to resolve it by serving as a backstop to debt restructuring. This is a waste of scarce resources. The EFSF/ESM should be turned into a more flexible instrument to help preserve financial stability.

4. Devise an adjustment and growth strategy for southern Europe. Fiscal consolidation is of paramount importance but ultimately, what will matter most is whether southern Europe can return to growth. So far the joint European Union and International Monetary Fund programmes have, with some success, focused on the fiscal front. But unlike Ireland, southern Europe has not started reducing the real exchange rate misalignment resulting from a decade of excessive inflation, and growth prospects remain remote. The EU should now move on this front. A first and simple step should be to make better use of the money it spends in Greece and Portugal. Both countries are major beneficiaries of structural transfers, but EU money is both under-spent and badly spent (because guidelines set long ago are at odds with current priorities). The EU should pass special legislation to speed up the disbursement of aid and, as long as assistance programmes are in place, allocate it to supporting their growth component.

5. Address the underlying weaknesses of the euro area. Euro area surveillance reform, about to be completed, will help diminish the risk of future crises. But nothing has been done to remedy the lethal correlation of banking and sovereign crises. Sovereigns should be better protected against the failure of their banks, through the centralisation of supervision and the creation of an insurance scheme akin to the US Federal Deposit Insurance Corporation. By the same token banks should be better protected against the failure of their sovereigns, through diversification of their bond portfolio. Today, any meaningful restructuring of the Greek debt would wipe out the capital of the Greek banks. As long as this concentration of risk persists, sovereign restructuring will remain more dangerous that it needs to be. This is the most potent justification for introducing Eurobonds, because they would offer a natural diversification instrument.

Throughout the crisis the European leaders have consistently demonstrated a strong commitment to the euro. But as Winston Churchill once said of the US, they can be trusted to do the right thing only after having exhausted all other possibilities. This behaviour is too costly to be sustained. The leaders should now move ahead of the curve and take initiatives.

The writer is a French economist and director of Bruegel, a Brussels-based think-tank focusing on global economic policy-making.



Response by Anand Menon

The political implications of the eurozone crisis must not be ignored

Jean Pisani-Ferry’s suggestions for addressing the crisis in the eurozone make a lot of sense. Strikingly, however, they relegate politics to mere observer status in the quest for efficient solutions to Europe’s economic woes. Thus, restoring banking soundness ‘may cost public money and political capital, but no political expediency can justify missing the opportunity’. Meanwhile, domestic politics helped attach ‘too many strings’ to the EFSF and ESM. In the world of economics, politics is often viewed as an unwelcome distraction. In the real world, however, ‘political expediency’ tends to take centre stage.

The European Community’s institutional structure was designed with an eye to the promotion of internal trade. The theory was that this would make everyone richer. Therefore, there was no need for the kind of democratic institutions necessary to legitimise large scale fiscal transfers.

As a result, there is no European mechanism for reconciling or legitimately choosing between the increasingly polarized attitudes of European publics. While German voters resent transfers to spendthrift Greeks, protestors in Athens rail against austerity measures imposed by unelected foreign technocrats. Hence, the kinds of steps proposed by Pisani Ferry are, at best, politically hugely problematic.

As important as the current economic crisis is, so too are its potential political implications. Voters are increasingly dissatisfied with responses to the crisis. This resentment is amplified by their inability to hold European decision makers to account in the way they can national political leaders. The result will doubtless be an increased sense of alienation and cynicism on their part, which their national leaders will be anxious to avoid.

Such public sentiments, moreover, may well spawn an increase in the popularity of eurosceptic parties (as in Finland) and an erosion of public support for European integration. Riding roughshod over domestic public opinion in a quest for optimal economic solutions will merely intensify such trends. As well as disillusion with national leaders, the results could be an equally serious political crisis for European integration.

The writer is professor of west European politics at the University of Birmingham and author of ‘Europe: The State of the Union’.

More than a year after the eurozone first announced support for Greece, the country’s trauma and the eventual fate of the euro itself remains unresolved.

When the euro was launched, I remember relatively objective commentators arguing that, to be successful, the economic side of economic and monetary union needed a much stronger political framework within which to manage the eurozone’s fiscal policies. They have been proved right.

This is not the moment, however, nor is there good reason to abandon seven decades of building union in Europe. It undoubtedly remains a huge challenge to complete the project. We are attempting to reconfigure the largest economic space in the world since the United States of America was created. But in a world that is fast tilting away from its postwar Atlantic centre of gravity, Europe needs more than ever to come together and maximise its competitive strength and market power.

While it has not been easy to discern the strategy of Europe’s high command in putting out the fire on its periphery, a three-stage response is emerging: first, to stop the immediate haemorrhaging by means of further transfusions of liquidity to the eurozone’s insolvent members; second, accept, finally,  that the fundamental problem, certainly in the case of Greece, is one of solvency not liquidity and prepare for an orderly reconstruction of their sovereign debt that is viewed as inevitable by private debt holders and preferable to a disorderly default which would halve Greek living standards overnight and remove any early prospect of economic reform and growth in the country; and, third, once the immediate crisis has passed, build on the tighter fiscal rules, early warning of macro imbalances, greater financial regulation and analysis of systemic risk of the past year and introduce more far-reaching fiscal interventions and controls across the whole area that, in effect, will amount to a significant step towards fiscal and political union.

None of this is going to be easy or straightforward to manage for the simple reason that Europe is facing not one but four interrelated crises.

There is the immediate crisis of insolvency among the eurozone’s weaker members but this is complicated by a continuing banking crisis.  Many European banks are still carrying real or potential significant losses and are heavily exposed to the sovereign debt of the eurozone’s insolvent members. We are familiar with Germany’s deep hostility to the costs of bailing out these states falling on the taxpayer alone. But the fact that is rarely mentioned in this debate is that it is a choice between bailing out these states, or bailing out the German, as well as other, banks that are their creditors.

These two interwoven elements – insolvency and vulnerable banks – have brought to a head the structural competitiveness crisis built into the eurozone from the start – the head start that the early member northern states had in productivity over the so-called periphery states such as Greece, Portugal and Spain. Before the crisis this could be papered over with a Europe-wide “structural reform” agenda – honoured more in name than action – that aimed to encourage convergence in productivity and competitiveness through tough industrial and other changes in product and labour markets. There was also a hope that a continuing rising tide of economic growth in Europe would “lift all boats”.

In practice much of the “lifting” of the economies of Greece, Spain, Portugal and Ireland over the past decade was driven by what was demonstrably an unsustainable credit-driven boom. A boom that lessened the pressure on these economies to address underlying structural issues, while lack of adequate financial regulation facilitated the recycling of financial surpluses in the form of imprudent lending in Ireland and the southern member states. The end of the boom left them severely weakened and exposed, with no freedom over their interest rates and currency to make any correction.

Challenging as all these problems might be, they would be soluble through strong political management and policy decisions, but for Europe’s fourth crisis: that developing over the European Union’s political legitimacy. And here is the rub. The major step towards economic and fiscal union – what the European Central Bank president Jean-Claude Trichet has called a “quantum leap” in euro area economic governance – however desirable in principle, would take the EU into new and highly problematic political territory. It would mean, in effect, giving European authorities the right to veto member state fiscal and competitiveness plans that fail to match up to what is need to deliver “adjustment”. Looking even further ahead, Mr Trichet envisages a ministry of finance for the EU.

Whatever the merits of such an approach – and logically the ECB president is right – I don’t see such moves easily winning public support. In national elections or further referendums, Europe’s current “integration fatigue” would almost certainly prevail. The German electorate, notably, would be hard to persuade. It could certainly be argued that Germany’s whole economic success depends on an integrated European economy that is the base for their global competitiveness and political stability, and the recreation of a soaring D-Mark would be disastrous for its export sector. But having experienced a decade of squeezed living standards and labour market reforms, following their belt-tightening to bring reunification about, Germans will not be keen on being tethered even closer to Europe’s underperforming periphery, in particular Greece where real wages have gone up 40 per cent in the past decade and yet tax evasion and corrupt and restrictive practices are rife. And the German public will not be alone.

So what is going to happen? The EU’s response, stretched over the next couple of years, is inevitably going to be a messy compromise between the urgent need for collective action and the huge political difficulty of taking the further explicit steps needed to fiscal union.

In my view, the basic logic and European belief in union will prevail. But it is going to be a rocky and hard fought road and advocates of greater union will need to be more honest with the public, and more sure of their arguments, than they have been in the past. It is possible that Europe’s political nerve will fail. But I would not put money on it. Few share the British prime minister’s apparent view that others can make as big a mess of it as they wish as long as the UK does not have to pay anything more – a shortsighted position that fails to recognise Britain’s wider economic interests.

There is a strong resolve in Brussels to do whatever it takes and get through all the current crises because economic failure would hurt a huge amount more than Europe’s amour propre. Politics has a way of conforming to political necessity.

The writer is a former UK business secretary and EU trade commissioner

Response by Desmond Lachman

Europe’s fiscal and political union train has long since left the station

The book of Ecclesiastes teaches that there is a time and a season for everything. The time for Peter Mandelson’s admirable call for Europe to come together towards greater political and fiscal union was before the euro’s January 1999 launch. For at that time the political spirit for greater European integration ran high and the extraordinarily large economic imbalances that presently characterise the European periphery were yet to manifest themselves.

Making the same proposal for greater political and fiscal union today in the midst of a major sovereign debt crisis seems distinctly odd. Europe’s political elite is experiencing the greatest of difficulties in carrying its electorate along in stitching together yet another bail-out package for Greece. Yet Lord Mandelson seems to think that these electorates can be convinced that it is in their own interest to sign on to a fiscal union that will involve permanent transfers of taxpayers’ money to the periphery.

One has to admire Lord Mandelson’s unbridled optimism in the face of mounting evidence to the contrary that politics has a way of conforming to political necessity and that the basic logic and belief in European union will prevail. However, one has to wonder whether this view does not overlook the major public finance and external imbalances in the periphery that are now tearing the eurozone asunder. It is difficult to see how political wishful thinking will redress these imbalances while keeping the peripheral countries  within the euro.

Rather than engaging in wishful thinking about the relative merits of greater fiscal and political union, Europe’s leaders should now be seriously thinking about plan B. How is an orderly debt restructuring and exit from the euro to be arranged for Greece, Portugal and Ireland? How are Spain and Italy to be ringfenced?  How is a major European banking crisis to be avoided when countries in the periphery exit the euro?

The writer is a resident fellow at the American Enterprise Institute

Many of the world’s oil consuming nations, led by the US, shocked oil markets this week as the International Energy Agency agreed to release 60m barrels of oil from strategic reserves over the coming month. The move was intended to offset price pressures brought about by Libya’s supply cut and comes in response to Opec’s recent inability to formally endorse new supply increases. The IEA action is also an example of growing concern over higher oil prices in Washington, where the White House is managing political fallout from high gasoline prices as next year’s presidential elections loom just over the horizon.

Yet, a year from now, we’re likely to look back on this moment and find that fears for supply have diminished. There are three reasons.

First, the most substantial fallout from the Arab world’s recent upheaval is behind us. Syria’s Bashar al-Assad continues to  fight for survival and Yemen continues to flirt with failed-state status, but the Gulf’s major oil-producing states are quite stable. So are other major producers. Even in Iran, with its leaders infighting, the green revolution has moved off the streets for now. While there are plenty of long-term structural challenges for many major economies – just ask China – for the moment there are no more Libyas left to explode. IEA action and the ongoing Saudi supply increases will neutralise what remains of the oil price’s political risk premium.

Second, big additional supply is coming, and it’s not all priced in. Offshore Brazil and Canadian oil sands are no longer new stories, but their collective impact has not yet been fully felt and is often undervalued. Iraq still draws undue scepticism but production there is showing serious promise. The country could add up to 300,000 barrels this year, with more contracts, more exploration and more drilling already in the works. Barring an unlikely and total implosion of the government, it is hard to see production slowing down this decade. The same is true for “tight oil” coming from unconventional sources. We are seeing this begin to play out in North American fields such as the Bakken in North Dakota. As technology and investment are dispersed over the coming year, oil supply should positively surprise.

Third, Saudi supply increases are not dependant on Opec. The country’s oil minister Ali Naimi left the cartel’s Vienna meeting earlier this month with complaints that the organisation had just endured one of its most contentious and least productive gatherings in many years. But that is only because the major oil players were not prepared to pretend that there was agreement on output quotas. With Iran chairing the meeting, an annoyed Venezuela in attendance and an embattled Libya looking on, it was much harder to get the group to put aside their differences and smile for the cameras. The Saudis have the most influence on price-moving output decisions and they increased production just as they had planned before the meeting proved so difficult. Economically stressed oil producers such as Iran and Venezuela always want higher oil prices. But the Saudis and other Gulf Co-operation Council producers maintain a longer-term moderating outlook and they are the ones with the spare capacity to make the difference.

Add that to your favourite economist’s projection on the softness of the global economy, and we may soon be asking whether or not this latest IEA move was worth it.

The writer is the president of Eurasia Group, a political risk consultancy, and author of ‘The End of the Free Market’

On Wednesday Barack Obama announced he would order a gradual troop withdrawal from Afghanistan. On a superficial level there is nothing surprising about this decision. Mr Obama is simply implementing what he had promised the American people in 2009 when he agreed to honour Gen Stanley McChrystal’s request for more troops. The surge was always going to be temporary, especially in view of budgetary pressures caused by the financial crisis.

A second glance at the president’s speech reveals something more interesting, however. In between the lines, what he said amounts to the elimination of a key component in the Afghanistan and Iraq wars, and the elevation of a minor practice.

The eliminated component is the counter-insurgency programme that in practice is a euphemism for nation-building. The elevated one is the use of drones and targeted bombing of selected individuals and groups. This is a new counter-terrorism strategy. It is sugar-coated in grand speeches such as those delivered by the president in Cairo two years ago, and it is not difficult to sell to Americans who are struggling with the weight of economic problems.

The difference between counter-insurgency and counter-terrorism is profound. The latter means targeting al-Qaeda and affiliates while seeking to minimise harm to the civilian populations where they operate. The former was more ambitious: to rid Afghanistan of the Taliban as well as al-Qaeda and to build a strong government that would marginalise radical Islam.

From the onset it was clear that killing al-Qaeda members was relatively easy and, thanks to drone technology, inexpensive in terms of American life. It was the nation-building aspect of counter-insurgency that was more controversial at home and more difficult to effect. The generals and military advisers of the previous and current administrations made it clear that counter-insurgency would only succeed if the military was given enough men, resources and time.

Mr Obama’s message to Gen David Petraeus was clear: time is up. Ten years, a trillion dollars and 1,600 American casualties later, the White House is essentially abandoning the attempt to build law and order in Afghanistan. The political response to the speech was remarkable. It used to be that Democrats were more squeamish about the use of bombs of any kind. Liberals in America have tended to prefer soft power and when hard power becomes inevitable they insist that a UN or Nato force lead the way as in Libya, all the time pressing for a minimum of civilian casualties. Imagine how these same liberals would have reacted three years ago if it had been George W. Bush who had been ordering a campaign of targeted assassinations – not to mention overriding legal advice on the decision to launch air strikes against the Libyan government.

The strident calls from some Republicans, including several seeking the party’s nomination to run for president, to cut overseas troop levels even faster are notable because they suggest there is now a bipartisan consensus. But what is this consensus on and how strong is it? There appears to be a general agreement on the high cost of the war, the prevailing importance of domestic issues – above all the economy – and the need for Afghans to take responsibility for their destiny as soon as possible.

By quietly conceding to Mr Obama’s decision to expand the use of drones, liberals seem to have accepted the basic assumptions of Mr Bush that terrorists are enemy combatants and that the US is at war. Try explaining to a Yemeni, Somali or Afghan survivor of a drone attack that America is not at war with Islam and means well. Many in the US and around the world wonder if Mr Obama’s speech – and the broad bipartisan support for it – is yet another sign of America’s decline. American power and weakness is often a matter of perception.

From the Taliban’s perspective, the withdrawal is a sign of US weakness and their impending victory. Not only the Taliban will see it this way: Iran’s and Syria’s regimes and the malignant units in the Pakistani military and secret service see a weak America that roars but retreats when the going gets tough. The short-term benefits of abandoning counter-insurgency may be politically appealing. The long-term costs may be greater than Mr Obama anticipates.

The writer is a fellow of the American Enterprise Institute and founder of the AHA Foundation, which works to protect Muslim women’s rights.

This is an edited version of the article as will appear in Friday’s print version of the FT.

Response by Xenia Dormandy

Withdrawal is a reflection of where US challenges stand today

Ayaan Hirsi Ali is absolutely right in identifying two factors – changing US goals and US politics – as the most important messages coming out of Barack Obama’s Afghanistan speech. While the debate on the numbers of troops to be withdrawn is an important one, only history will tell whether the policy announced is the right one.

The decision on how many troops to withdraw and how fast was based in very large part on these two factors of goals and politics. But I would gently turn the light to look at these issues from a slightly different perspective than Ms Hirsi Ali.

US goals in Afghanistan have changed over the past decade. In late 2001, when George W. Bush first ordered troops there, the goal was explicitly a counterterrorism one. Over the course of his presidency, it became apparent that nation building was a necessary, albeit not sufficient, step to achieve this objective and protect the American homeland. President Obama took office in 2009, and after a long consultative period he announced a surge of 30,000 US troops to “refocus on al-Qaeda, reverse the Taliban’s momentum, and train Afghan security forces to defend their own country”.

This year the focus has returned to counterterrorism. The question being asked and answered by the president is what is the security threat from terrorism and how best to defend against it? The answer does not lie in large numbers of US boots on the ground, which caused much antagonism and raised fears of colonialism, but instead on targeted military actions and a political solution. Both of these are being pursued.

This policy prescription is supported by the second factor that influenced Mr Obama’s decision making – politics. For the first time, US polls show that a majority of Americans (including a majority of Democrats and independents) believe that troops should be pulled out of Afghanistan as soon as possible. As Ms Hirsi Ali noted in her piece, even many of the Republican candidates for president support pulling out troops. What political leader can or should ignore the voices of their constituents?

Every country pursues its foreign policy according to its national interests. The major challenges facing the US today are first and foremost economic. Instead of continuing to spend $10bn a month in Afghanistan, as President Obama says, “it is time to focus on national building here at home”.

So, rather than see Mr Obama’s speech as “another sign of America’s decline” as Hirsi Ali closes, I would argue that this is instead a coming together, a consolidation, and a reflection of where America’s interests and challenges stand today.

The writer is a senior fellow at Chatham House working on the US’s changing role in the world

Even though the Greek parliament has given the government some breathing space with its vote of confidence late on Tuesday, a default by Greece is inevitable. With a debt to gross domestic product ratio of more than 150 per cent, large annual deficits and interest rates more than 25 per cent, the only question is when the default will occur. The current negotiations are really about postponing the inevitable default.

If Greece were the only insolvent European country, it would be best if its default occurred now. Cutting its debt in half and replacing the existing debt with low interest rate bonds would allow Greece to service its debt without the excruciating pain that would be involved if it tried to service its current debt.

But Greece is not alone in its insolvency and a default by Athens could trigger defaults by Portugal, Ireland and possibly Spain. The resulting losses would destroy large amounts of the capital of banks and other creditors in Germany, France and other countries. There would be a drying up of credit available to businesses throughout Europe and there could be a collapse of major European banks.

This inevitable contagion and its potential consequences for the European financial system is the reason the European Central Bank is determined to avoid a default at this time. The challenge, therefore, is to find a way to postpone the defaults long enough for the banks and other creditors to withstand the write-downs of bond values if Greece, Portugal and Ireland default simultaneously.

The process is complicated by the German government’s position that it will support the extension of more official credit now only if the existing private creditors participate. The ECB insists that the private creditor participation must be “voluntary” so that no technical default occurs.

The essential feature of any solution is therefore for the existing bondholders to “voluntarily” agree to capitalise the interest that is now due and to provide new multi-year loans at a below-market interest rate to replace the bonds that are now maturing. That should satisfy the German demand for participation of private lenders while meeting the ECB’s requirement that any adjustment be voluntary so that no default is deemed to occur.

But how to get the existing creditors to agree to these terms? If it is not to be mandatory, it must be in each creditor’s interest to do this. Three things might make this possible.

First, if a bank does not capitalise interest and provide a new loan, the old loan will default, reducing the bank’s accounting capital and its ability to lend. Banks and other creditors will want to avoid that. Second, the ECB has indicated that restructured debt that is the result of a default will not be eligible as collateral at the central bank while new loans that are voluntarily made will be. And, third, there will be peer pressure among banks and other creditors to recognise that they all benefit by avoiding a default.

Avoiding a loss of accounting capital, having an asset that can be used as collateral with the central bank and acceding to peer pressure may be enough to cause banks and other creditors to create new loans at favourable rates. If not, further inducements from the ECB and the European Union will be needed.

With time, the creditor banks and other financial institutions that hold the debt of Greece, Ireland and Portugal will be able to sell or otherwise transfer that debt to the ECB or other potential buyers and to accumulate earnings to build up their capital ratios.

When the ECB eventually determines that major creditors have reduced their holdings of the impaired debt by enough so that, in combination with their increased capital, they are able to withstand substantial debt writedowns, the ECB will allow Greece, Ireland and Portugal to have a simultaneous default in which they restructure their existing debt to levels that they can comfortably service.

This type of plan worked well for the Latin American debt in the 1980s, culminating with the substitution of Brady bonds for existing debts.

There is of, course, no guarantee that this will work for the eurozone’s peripheral debtors. A major uncertainty is whether Spain will also need to restructure its debt. Although the debt of Spain’s central government looks manageable, the impaired assets of the Spanish saving banks and the debts of the individual regions may make the eventual total obligations of the central government impossible for Madrid to service. And Spain’s potential debts are larger than the other three nations’ impaired sovereign debts combined.

There are two further problems that will make it difficult for this strategy to work in Europe. First, the contractionary fiscal policies that are decreasing aggregate demand and GDP in these countries cannot be offset by the expansionary effects of currency devaluations as they were in Latin America. Moreover, even when the debt overhang is eliminated, the peripheral countries will not be competitive in world markets at their existing exchange rates. As members of the eurozone, they cannot devalue.

So settling the debt problem would still leave these countries with the large current account deficits that now exist and that will continue to exist in the future.

The writer is professor of economics at Harvard University and former chairman of the Council of Economic Advisers and President Ronald Reagan’s chief economic adviser.

Response by Raoul Ruparel

Delaying tactics are only increasing the costs of the eurozone crisis

It now seems widely accepted that a Greek default is not a matter of if, but when. The most important question is therefore: when would such a default be most cost-effective? The answer to this extends beyond just the economic costs and into the political sphere.

While it is true that allowing creditors more time to buffer up against the write-downs resulting from sovereign defaults (in Greece and possibly Portugal and Ireland) could be beneficial, such delaying tactics come with three major drawbacks.

First, will the banks actually get their act together? The truth is that banks have had more than enough time to reduce their exposure to Greece. Even as late as February, Greek bonds were trading at 80 per cent of nominal value – a pretty decent recovery rate given the situation. Why have the banks not done so? There are a number of reasons for sure, ranging from greed to bad judgement. But one of the main ones, surely, is that they are continuing to expect that, given the enormous stakes, politicians and the ECB will continue to bail out Greece. The fact that Germany, for example, continues to resist stringent capital requirements for its banks is a sign that lessons simply aren’t be being learnt. This takes moral hazard to a whole new level and continues to fuel Europe’s debt bubble.

Secondly, the first round impact – and probably also the knock on effects – of a default will increase. We estimate that a 50 per cent haircut would be needed to get Greece down to a sustainable debt level, around 90 per cent of GDP. By 2014, following a second bailout, the necessary haircut would increase to 69 per cent.

Thirdly, and related to the prior two points, by our estimates the EU, IMF and ECB accounted for 26 per cent of Greek debt at the start of this year. By 2014, following a second Greek bailout, this will have risen to 64 per cent, meaning that roughly two-thirds of Greek debt will be taxpayer-owned by that date. Thus Europe is setting itself up for a massive political fall-out: taxpayers in creditor countries will utterly despise having to cough up cash (as loan-guarantees are turned into outright losses), as “bankers” are let off the hook. On the other side of the coin, the second bailout plan assumes that the Greek electorate is willing and able to swallow three more years of tough austerity measures. Even with some token private sector involvement, it looks as if taxpayers across Europe would judge a second €100bn-plus bailout of Greece a massive injustice. This is a major political gamble.

A second bailout is not the way forward. The EU needs to face up to reality and plan for an orderly debt restructuring as soon as possible, which could involve a limited cash injection. The current delaying tactic is only increasing the economic and political cost of the eurozone crisis.

The writer is an economist at Open Europe, an independent think tank on the European Union.

In the past two months the world economy appears to have lost considerable momentum, reawakening similar fears to the early summer of 2010. Is the much feared yet anticipated “double dip” on its way?

Although not seen in all corners of the world, many economies have seen sudden softening including those that have not had much of a post-crisis recovery as well as some of the stronger ones. Similar culprits for this year’s slowing appear to be in force again; the impact of rising food and energy prices on disposable incomes and consumption, the European financial crisis, concerns about actual and future fiscal tightening and the ongoing difficulties for banks to lend capital when they are under pressure to hold more.

Two new factors are on the scene this year. First, some of the “growth economies” are slowing because their policymakers are deliberately trying to slow growth from above trend. This is especially true for China. Second, and the really intriguing one, the supply chain consequences of the Japanese earthquake and tsunami. In this regard, what happens to the fortunes of the Japanese chipmaker Renesas might be one of the more important things to watch in coming weeks.

Until a few weeks ago, I had never heard of this company. Renesas Electronics is a company established in 2010 and was a merger between NEC Electronics and Renesas Technology. It is a major supplier of microchips, especially to the world’s auto industry.

In the aftermath of Japan’s tragedy, I have to admit I was one of those that did not believe that the economic consequences would spread much beyond Japan’s borders unless it significantly contributed to higher global energy prices and supply shortages. Some sharper minded people realised immediately that in our globally connected world, the consequences would be broader and deeper.

On a recent trip to Tokyo I heard plenty about this company – and the broader topic. Some people I met told me that it is responsible for 40 per cent of the chips that go into the world’s auto industry, especially those produced by Japanese companies. On June 10 Renesas confirmed what some alert people had expected, that production at its Naka factory had suffered sharply in the aftermath of the crisis.

One policymaker I saw in Tokyo told me that he has a brother-in-law that works for the company and until recently always thought it was not much of a job. Now he suggested his information is one of the most valuable in the world. A different policymaker suggested that there were probably significant consequences for the world from its problems. He suggested that the UK, US, China, Thailand and Indonesia, in that order, would be the most likely to have suffered as these countries house most offshore Japanese car production.

While it is tough to explain the degree of weakness suddenly seen in both May and June in US economic data such as the Philadelphia Federal Reserve survey, for example, the most recent Fed Beige Book had quite a few liberal references to the issue of supply chains.

On my trip, luckily I heard that Renesas is now experiencing signs of a pick-up and expects to be back to pre-crisis levels of production sooner than it had a few weeks ago. Toyota also confirmed that it expected to be back to normal production by July. It will be fascinating to see if the world starts to bounce back around the same time even if many of the other challenges remain. If so, then Japan will need to be recognised as more relevant for the world cycle than many of us have become accustomed to in recent years.

The writer is chairman of the asset management division of Goldman Sachs and former chief economist at the investment bank.

 

Response by Peter Tasker

Japan is more than a 21st century Duran Duran

The world has come to think of Japan as the economic equivalent of Duran Duran – an overhyped 1980s phenomenon that has fallen into justly deserved obscurity. The triple disasters of March 11 have challenged these assumptions. Many of the great names of Japanese consumer electronics may indeed be shadows of their former selves, but Japanese companies, sometimes quite small ones, still play a crucial part in the supply chains behind such hot items as LCD panels and smart phones. The overall macro effect is not negligible. The recent drop-off in US car sales was caused mainly by the decline in sales of Japanese brands – itself a result of disruption to component production.

It is also worth pondering the fact that the first response of the currency market to the earthquake was to drive the yen higher. In fact since the subprime crisis broke in July 2007, the yen has risen 30-50 per cent against the pound, the euro, the dollar and the renminbi. Economists generally portray gross domestic product in local currencies, by which measure Japan has barely made back half the post-Lehman output loss of 8 per cent. Look at the world in yen, though, and you see a totally different picture. During the past four years US GDP has fallen 27 per cent in yen terms and UK GDP 46 per cent. In these troubled times, Japan’s global presence is actually growing in real money terms.

All that is not to say that recent signs of weakness in the global economy can be put down to Japan. The decline of US bond yields below 3 per cent suggests that what we are seeing is not a supply shock, which would be inflationary, but the re-emergence of the deflationary forces generated by the global credit crisis. The fall in the Shanghai stock market and other  signs of strain in the Chinese growth story are especially troubling. The possibility remains of the entire world turning Japanese – and not in a good way.

The writer is a Tokyo-based analyst with Arcus Research

At the roots of the eurozone crisis lies of course the past indiscipline of specific member states, Greece in the first place. But such indiscipline could simply not have occurred without two widespread failings by governments as they sit at the table of the European Council: an unhealthy politeness towards each other, and excessive deference to large member states.

This week will tell us whether this lesson – which is even more important for the future of the eurozone and the European Union than a “solution” to the Greek crisis – has been learnt. The events to watch are the Ecofin Council (eurozone finance ministers meeting) on Monday and the European Council meeting of EU leaders on Thursday and Friday.

As for politeness, would Greece have been able to run for years public deficits vastly above its officially published figures – until the excess became known in late 2009 – had Eurostat had the power to conduct serious investigations to check the adequacy of nationally produced statistics? Of course not.

Yet, when the European Commission proposed years ago that the European statistics office should be given those powers, most member states found the idea improperly intrusive. Led by Germany and France, they blocked it. Each government was, of course, aware that sharing a single market and even more a single currency with countries that might violate the rules would have dangerous consequences.

Nonetheless, to allow objective but indiscreet eyes to probe government accounting would definitely have gone – they thought – one step too far. Today they must all, including Greece, regret that the commission’s proposal was blocked.

More generally, an unhealthy degree of politeness has often characterised member states when it comes to peer review exercises. The understanding is that if a government is spared the domestic political embarrassment of receiving a very negative grade, it is likely to return the favour when the turn comes to assessing other governments.

As for deference to large member states, it is, in a sense, enshrined in the treaty. In fact, a large member state has more votes in Council deliberations and more members of the European Parliament than a small member state. Thus, it has more influence on the legislative process, as is perfectly justified on democratic grounds.

However, when it comes to the enforcement of EU laws or decisions, member states should all be treated as equal, and they normally are. There have been exceptions, however. They have had a lasting negative impact on the credibility of two key policy instruments of the EU over the last decade or so: the stability and growth pact and the Lisbon strategy towards greater competitiveness.

The credibility of the stability pact was severely impaired, as Chancellor Angel Merkel underlined when the Greek crisis exploded, by the decision taken by the Ecofin Council at the end of 2003. The commission had proposed issuing the prescribed warnings to France and Germany because they were on a collision course with the requirements of the pact, as it had done for Ireland and Portugal the year before.

The council, however, under the combined pressure of those two governments, helped by the Italian government which was holding the presidency, did not follow the commission’s proposal, as it had done for the two smaller countries. There was, one could say, an “excess of deference” procedure – to paraphrase the pact’s terminology.

So it can be no surprise that other countries, perhaps by tradition less keen anyway on the “culture of stability” promoted by Germany, took that almost as a licence to interpret the requirements of discipline in a more relaxed way. When the Lisbon strategy launched in 2000 was reviewed five years later, it was proposed that the commission should regularly publish a transparent scoreboard to put more pressure on member states to deliver on their commitments. Germany’s then chancellor Gerhard Schroeder strongly objected and the commission – wrongly, in my view – decided not to proceed to the “naming and shaming” of member states.

It is now recognised that a system of putting explicit pressure is needed. The “Europe 2020″ strategy stresses the need for explicit and candid monitoring. The commission published earlier this month bold recommendations for each member state, regarding both the stability pact and national reform policies.

So now for this crucial week. In the interest of an effective and disciplined enforcement of the new stability pact, the Ecofin Council should accept the two key requests of the European Parliament: first, an extended scope for the “reversed qualified majority” rule (a qualified majority would be needed to block a proposal, not to approve it) will ensure that the commission’s proposals will have a greater role, with reduced opportunities for exchanges of favours among member states.

Second, the European Parliament’s involvement as promoter of an open “economic dialogue” would, by ensuring greater transparency, make such exchanges – and indeed displays of deference – less likely. In short this would boost both the discipline and credibility of the eurozone.

The European Council should by no means dilute the recommendations for each member state. If their individual or combined resistance were to erode the commission’s recommendations, Europe 2020 would soon join the Lisbon strategy in lack of credibility and effectiveness.

When he chairs the council later this week, President Herman van Rompuy will have to be the guardian of healthy impoliteness – and lack of deference.

The writer is President of Bocconi University and a former European Commissioner.

Response by Megan Greene

Politics will break apart the euro

In the absence of fiscal union, any attempt to retain the one-size-fits-all policies required for monetary union in the euro area is doomed to fail. However, the euro area’s political leaders have demonstrated repeatedly that they lack the political will to achieve fiscal union, and this lack of political will is set to worsen over the next few years.

Stark divergences exist between eurozone countries, but these have been ignored in the European Commission’s attempts to impose formulaic fiscal and competitiveness targets on member states through the stability and growth pact and the Lisbon agenda.

By contrast, moving towards fiscal union – and introducing common banking regulation policies – would create a built-in shock absorber for such divergences. Without this buffer, monetary union cannot survive.

The reluctance of euro area leaders to move towards fiscal union reflects the political pressures they face from their electorates.

In Germany, popular opposition to the bail-out packages has seen the ruling coalition repeatedly hammered in regional elections despite a booming economy. In Greece, the prime minister has been forced into a cabinet reshuffle by persistent protests against the further austerity measures required before a second bailout can be approved.

This euro crisis has already claimed governments in Ireland, Portugal, Finland and the Netherlands. It will claim virtually every major government in the euro area before it is over.

A new political class will be brought to power by electorates in the core countries that are fed up with contributing to bail-out programmes. Following a few more years of retrenchment in the periphery, new leaders will be elected by voters even more sick of austerity and resentful of losing sovereignty to the troika than is already the case.

It is difficult to see the current eurozone leaders summoning the political will to pursue fiscal union, but it is even more difficult to imagine this looking forward a few years. In the absence of fiscal union, divergences between eurozone countries will cause the euro area to split apart.

The writer is an independent economist focusing on the euro crisis, having covered Greece, Ireland and Germany at the Economist Intelligence Unit.

From day one, immense challenges faced the coalition of international institutions that opted for a liquidity approach to address Greece’s debt solvency problems. Now that this coalition is stumbling and bickering publicly, the outlook for Greece has taken a significant turn for the worse. Even as George Papandreou, the Greek prime minister, prepares to reshuffle his cabinet, he must know his nation’s predicament is now extremely hard to reverse.

It is now commonly accepted that Greece’s predicament is due to two inter-related problems: the economy is unable to grow, and the debt burden is enormous. Yet neither has influenced sufficiently the approach that has been adopted by the crisis management coalition, consisting of the Greek government, its European creditors (namely other eurozone governments, the European Commission and the European Central Bank) and the International Monetary Fund.

Instead, the focus has been on dramatic austerity for Greece and massive loans from the official creditors. Not surprisingly, every economic, financial and social indicator for the Greek economy has deteriorated. This has happened both in absolutes term and, more alarmingly, relative to the coalition’s already grim expectations. Such failure naturally encourages a blame game, and sadly that is exactly what is now happening.

Judging from other crisis management episodes around the world, it is normal for both the Greek government and its people to feel let down by European neighbours who they feel under-appreciate the sacrifices made by its population, especially since these same creditors refused to lower interest rate on new loans. Equally, it is normal for the creditors to complain that it is Greece that is not doing enough to counter what is, after all, a home-grown problem.

In principle, these gaps need not be fatal. Yet the current attempts to bridge them are nowhere near enough. They would do little beyond, at best, prolonging for a few months an already unsustainable situation. More likely, they would be undermined rapidly by two recent developments that suggest that the current approach to crisis management in Greece is coming to its end.

First, and most importantly, the Greek government is losing control of the streets. As protests turn increasingly ugly, the pursuit of a national political consensus becomes even more elusive. This is especially true if all Mr Papandreou, or another leader, can offer is a step back to a discredited approach that involves sacrifices with no evidence of lasting benefits.

Second, even if Greece can deliver, European creditors fundamentally disagree among themselves as to how best to support the country — other than to push the IMF to lend more. Some, led by Germany, want fairer burden-sharing with the private sector, rather than to continue to fund both the needs of the Greek economy and full repayments to private lenders that are now exiting the country. But the ECB strongly opposes this, especially now that its balance sheet is contaminated by large holdings of Greek bonds.

Responding properly to all this is an engineering nightmare and a political headache. Critically, it now requires giving up on at least one, and more likely at least two, of the three principles that have underpinned the coalition’s approach to Greece: avoiding a debt restructuring, a currency devaluation and a change in the fiscal set up of the eurozone.

Europe faces a moment of truth. The sooner this is recognised, the greater the chance of shifting to a “plan B”. If not the prospects are stark: the already-difficult outlook facing the three bail-out countries (Greece, Ireland and Portugal) will surely be compounded by a decade of internal economic implosion. The task must now be to limit fundamental contagion to countries that are yet to be bailed out (notably Spain), and to maintain the integrity of the Euro. But the time for action is fast running out.

The writer is Chief Executive and co-CIO of Pimco, the world’s leading bond manager.

Response by Daniel Gros

Argentina v. Greece : 5-nil?

Almost all independent observers of Greece have stressed from the beginning that Greece was facing a solvency, not a liquidity problem. This was also the case 10 years ago with Argentina; a country that had achieved financial stability by entering into a “quasi” monetary union using the US dollar and which had privatised every available public asset.

But the country during the late 1990s then ran a succession of twin deficits, both fiscal and external current account. When foreign creditors started to doubt the ability of the country to service the debt it had thus accumulated, the international community responded with very large financial support packages financed both by the International Monetary Fund and Spain because Argentina was supposed to face only a liquidity problem.

However, even a succession of three packages, of rapidly growing size, could not avert default because investors were not convinced, and the resistance of the population grew, along with the austerity efforts of the government.

How should one assess the chances of Greece avoiding an Argentine scenario today? A quick look at the fundamentals (Greece today versus Argentina before the default) is not encouraging:

Debt level (% of GDP): GR: 150% v. ARG: 50 %

Fiscal deficit (% of GDP): GR: 12% v. ARG: 5 %

Current account deficit (% of GDP): GR: 10% v. ARG: 2 %

Growth (real GDP): GR: -3% v. ARG: -2 %

Deposit flight (% change in bank deposits): GR: -10% v. ARG: -7 %

On these five fundamental indicators of an impending crisis it is thus five to nil for Argentina.

So where are we heading? As in Argentina in 2001 the population of Greece seems determined today to push the country towards the worst of all options: a disorderly default without having implemented first the structural reforms which would allow the country to emerge leaner and stronger from this “catharsis”. There is very little Europe can do to avoid this outcome.

The writer is the director of the Centre for European Policy Studies, a Brussels-based think-tank.

George Papandreou, the Greek prime minister, is out of ammunition. The embattled leader has been gradually losing control of his socialist party for some time, but the trend has sharply accelerated this week, as larger and angrier crowds take to the streets. He now plans to form a new government, but hopes that he can win passage in coming weeks for a new fiscal plan — needed to ensure the next European Union/International Monetary Fund loan tranche and any future bail-out package — are all but dashed. European leaders need to think about what to do next, and quickly.

To pass the plan, Mr Papandreou needs support from 151 lawmakers. With the loss of a deputy who quit on Tuesday, in protest at the prospect of further austerity measures, Pasok, Mr Papandreou’s party, now controls just 155 seats in parliament. Other party members are rumoured to be preparing to vote No, and the prime minister has already failed to win support for the plan from leaders of other parties, some of whom demand early elections.

Worse, a number of Greek politicians say they will join a unity government only if Mr Papandreou resigns. Antonis Samaras, leader of the main opposition New Democracy party, warns that the new government’s first task should be to renegotiate the current bail-out agreements with EU officials. That is not the outcome for which the rest of Europe has been hoping.

Aware that his country has run out of patience with austerity plans, Mr Papandreou has already offered to step aside once, and may have to do so again. He can make offers to bring Pasok and the centre-right ND party under a single political roof — but they are unlikely to work.

Attempts to create a new administration could generate positive headlines, if respected technocrats take up key posts and changes are made, for example, to the current agreement on corporate taxes. But even if Mr Papandreou manages to bring his country together, it won’t last; primarily because the current government has yet to persuade enough of its constituents that more belt-tightening is absolutely necessary if the country is to find its fiscal footing.

There is some good news here: it’s just not in Greece. Portugal and Spain are unlikely to follow Greece’s lead. The Portuguese aren’t as angry as the Greeks. Portugal has low trade union membership and loses fewer workdays to strikes than most other EU members. And that is in part because there is broad recognition in the country that reform is necessary.

The country’s main political parties also see the EU-IMF bailout as an opportunity to get on with much-needed structural reforms that can create new opportunities — by downsizing the state, freeing up labour markets and taking on a dysfunctional justice system. Over the medium term, if reforms in Portugal don’t yield visible results, the crowd may become restless. But the Greeks have already passed judgment on this question.

One of the primary problems facing Spain, meanwhile, involves the inability of the central government to force local lawmakers to rein in spending. But regional governments there are likely to adopt new austerity measures on their own as mandatory quarterly reports reveal that they are not meeting deficit targets and autonomous communities experience ratings agency downgrades and rising costs for funding. As in Portugal, there’s still hope that a sense of crisis can add momentum behind reforms and austerity measures that will strengthen the core of Spain’s economy.

The headlines today speak of chaos in the Greek political system and riots on the streets. Unfortunately, the reality is just as bad as they suggest. European leaders must prepare for the worst, as Greece barrels down the road to nowhere. They can only be thankful that Portugal and Spain aren’t yet following.

Ian Bremmer is the president of Eurasia Group, a political risk consultancy, and author of ‘The End of the Free Market’


Response by John Sfakianakis

Europe doesn’t have an alternative but to help Greece

Greece is in a perfect storm. On the one hand the political system is disintegrating ever faster and on the other hand the economy is falling into a recessionary tailspin. Society is losing confidence in its politicians by the day as the austerity measures hit the salaried workers and the pensioners. The majority of Greeks feel the wealthy, the journalists and the politicians have protected each other. A sense of injustice continues.

The vested interests, including the labour unions and the public sector, have remained untouched by the spending cuts as they are an important base of support for all political parties. While I was in Greece recently, several people shared in private their expectation that the country’s politicians would be further besmirched and its democratic principles endangered in the coming weeks.

Greece’s political system suffers from a credibility deficit which is multiples higher even than the country’s ballooning government debt. The infighting within the government is not new, but is exacerbated by its misguided policies. Society views the recent reshuffle as new wine in old bottles. George Papandreou could be searching for an honorable exit from the premiership.

Furthermore, the two main parties are perceived as collusive, especially as Mr Papandreou and Antonis Samaras, the leader of the conservatives, were roommates at college.

The problems are all the worse because the population that remains largely self-centred. Sacrifices have to be made – the public sector has to be reduced by around 80 per cent. But nobody wants to take the necessary steps. Politicians consider the political cost and Greeks are unwilling to pay the price. They have been given morphine shots since the early 1980s by their politicians and have turned into an unruly bunch that is now ungovernable.

While Europe doesn’t have an alternative but to help Greece, the situation in the country will get far worse before it gets better. Public spending has to fall fast and this can only happen by cutting the size of the state. A new tax collection agency is desperately needed. Endemic corruption needs to be tackled. The indictment of some politicians on corruption charges will certainly help boost public support for the spending cuts. New elections seem unavoidable and constitutional reform necessary.

Greece has to regain its sense of direction but that seems unlikely under the current political dispensation.

The writer is chief economist of Banque Saudi Fransi. The views expressed are his own.

Finally, America is on the verge of a major step towards reducing its dangerous and long-term fiscal deficits. This was seen as impossible six months ago. But, a combination of growing public antipathy to deficits, and, in particular, fierce opposition to raising the federal debt limit this summer has changed the environment and put Congress into a bind. It must raise the debt ceiling to enable continued national borrowing and avoid a catastrophic default. So, for political protection, its members now want to deliver a simultaneous, large deficit reduction package. Negotiations focus on $1,000bn-$2,000bn of reduction over 10 years, against an August 2 deadline on the debt limit. It may occur at the midnight hour, but an agreement is likely.

It is important that Congressional and White House negotiators settle on sector-by-sector reductions. Just setting future targets will not be credible. The approach also should be broad-based, including reductions in both tax expenditures and entitlements. But, even a $1,000bn deal would represent a quarter of the amount ultimately needed to stabilise the debt/gross domestic product ratio and solve the problem entirely. Crucially, it would reassure everyone that America is moving to fix this problem which is so threatening. Such an agreement would be an unambiguous plus, with one, key caveat.

Namely, the already anemic economic recovery has recently slowed even further. The evidence is unmistakable, which is why share prices have fallen for six straight weeks. This new weakness carries three implications for the deficit negotiators: 1) they should still press ahead to reach agreement; 2) the effective date of their reductions should be 2013, not next year; and 3) the three stimulus measures adopted in December last year should be extended one more year.

How serious is this new economic softness? The very latest data are clear. Manufacturing growth has slowed, consumer confidence is retreating and home prices continue to fall. Most importantly, labour markets are losing the limited momentum they had achieved. Last month produced only 54,000 new jobs and a rise in the unemployment rate to 9.1 per cent. A rate that high two years into the recovery is profoundly disturbing.

Yes, there are temporary factors involved, like higher gasoline prices, supply chain impacts of the Japan tragedy and widespread flooding. But, it is unlikely that these explain all of the recent slowing. Indeed, most 2011 growth forecasts are now below 3 per cent.

This should not slow the deficit reduction negotiations. An agreement is necessary to avoid the projected, very high US debt ratios which could trigger another financial crisis. It also would boost business and investor confidence. That will eventually translate into higher portfolio and fixed investment and assist growth.

But this impending agreement should include two additional features which, until recently, would have been unnecessary. The first concerns the year in which deficit reduction kicks in. Remember that it is, in theory, contractionary. This suggests that the start date should be deferred. Instead of immediate reductions, an effective date of 2013 makes more sense, in the expectation of a stronger economy. Second, the three one-year stimulus measures passed in last winter’s special Congressional session should be extended one more year.

The first of these was a payroll tax cut for employees, temporarily reducing their rate from 6.2 per cent to 4.2 per cent. This is good policy, as President Barack Obama just said, because its benefits primarily flow to individuals with a high propensity to spend. The second permitted business to deduct 100 per cent of this year’s capital expenditures for tax purposes, as compared to the usual, longer depreciation periods. Business investment is one of the few strong spots now, suggesting that this provision helped. Finally, emergency unemployment insurance, which temporarily extended benefits to 99 weeks for some, was continued through 2011. With job growth still so weak, many recipients cannot consume without this stipend.

These should be extended one last time because this fragile economy needs the boost. In particular, the phasing out of the big 2009 stimulus now represents an economic drag equaling 2.5 per cent of GDP. That is too much but would be mitigated by this three-part, $200bn infusion. Ideally, the budget negotiators would support these extensions now and send that positive signal, even though the three measures don’t expire until year-end.

It is incongruous to fashion a 10-year deficit reduction package which adds stimulus at the beginning? No. This amounts to helping the economy regain enough momentum, especially on job creation, to then take deficit reduction in stride. After all, the cuts will be permanent and the stimulus would cover only 2012. It is good economics and would be good politics.

Roger C. Altman is founder and Chairman of Evercore Partners and was US Deputy Treasury Secretary in 1993-94.

Response by Xenia Dormandy

Politics is going to restrict what is possible in the policy domain

There is policy and there are politics. We can debate long and hard about the right economic policy but it can not be seen in a vacuum. In America today, even more than usual, politics significantly restricts what is possible in the policy domain. With the first Republican debates now under way, and everyone looking to November 2012 and the election, politics affects everything.

And few things are more affected than economics. The President faces a number of economic challenges, all tightly bound together. As Roger Altman explains, the two principal issues are raising the debt ceiling (with a deadline of early August from Treasury Secretary Tim Geithner), and continuing to stimulate the economy. As Mr Obama looks for the right compromise, his task is complicated by the departure of almost the last of his original economic team, namely Austin Goolsbee, leaving only Mr Geithner as his economic powerhouse.

Mr Altman suggests that the President can both raise the debt ceiling at the same time as he provides more stimulus to the economy. These two things could have different timelines and so not be mutually exclusive. Unfortunately, each would require enormous political capital and significant compromises from the President. Even then it would be extremely unlikely, if not impossible, to get such measures through the Republican-controlled House. Even if Mr Altman is right in policy terms, together these two objectives are a bridge too far.

Vice President Biden is working intensively with a group of six leading senators and congressmen to find a solution to the debt ceiling. Even as progress is slowly being made, this will likely come down to an eleventh hour compromise between the President and the leaders of the House and Senate that will include major spending cuts.

There is also another group of congressmen working on a compromise solution to the budget deficit that has drawn criticism from Republicans towards fellow party members for crossing the aisle to work with the Democrats. The Republican candidates for president are lambasting Mr Obama’s economic policy and will continue to do so. Meanwhile, Peter Diamond, the Nobel laureate in economics, who was nominated to be on the Federal Reserve Board of Governors, has just withdrawn from consideration after he was blocked by the Republicans.

Economic policy in America today is driven not just by debates about the right policy solution, but also by partisan politics. Mr Obama will have to prioritise. This means that we will, before the deadline is out, see a bipartisan solution to raising the debt ceiling. But, unless the environment changes, the White House and Federal Reserve will remain opposed to a third round of stimulus measures.

Xenia Dormandy is a Senior Fellow at Chatham House working on the US’s changing role in the world.

Just a few weeks ago, Barack Obama’s re-election bid was beginning to look like an easy downhill jog. The daring raid that the US president ordered delivered Osama bin Laden to the bottom of the Indian Ocean. Economic prospects looked brighter. Perhaps most helpfully, the Republican party seemed to be indulging some kind of collective death-wish, putting Donald Trump first in the polls and Paul Ryan’s budget-cutting at the top of its legislative agenda. The GOP’s early presidential skirmishing took place in a land of conservative make-believe, where tax cuts grow on trees and the president can be described as any sort of alien – foreign-born, Muslim, collectivist – that one chooses.

Mr Obama’s spring peak came at the White House correspondents’ dinner in late April, when he jovially deflated Mr Trump, while the Navy Seals were en route to Abbottabad. But since then, the political weather has turned less favourable. Unemployment rose to a treacherous 9.1 per cent, while the Dow fell almost 1,000 points from its peak. The odds of a serious economic aftershock to the Great Recession have risen. Most alarmingly, the Republican party appears gradually to be going sane.

The GOP presidential field, while hardly dominated by political giants, appears far less outlandish than one might have predicted. At the first Republican debate in New Hampshire on Monday the seven candidates competed not for evangelical or libertarian favour, but for the status of someone plausible to compete with the president for swing voters.

Here are some of the things that did not happen in the debate. No one called Mr Obama a socialist. No one gave ambiguous encouragement to the “birther” faction. While all of the candidates oppose gay marriage, no one bashed homosexuals. With the exception of the marginal former Pennsylvania Senator Rick Santorum, no one directly endorsed the Ryan Plan. Two months ago, every Republican in the US House back this plan; now no one wants to talk about it.

There were cringe-making moments, such as the pizza executive Herman Cain’s assertion that Sharia Law is used in American courts, former House Speaker Newt Gingrich’s seeming call for Muslim-Americans to swear loyalty oaths, and former Minnesota governor Tim Pawlenty’s claim that America’s founding documents describe it as a nation “under God” (neither the Declaration of Independence nor the Constitution uses this phrase). But overall, there was little of the usual thunder on the Right. The sometimes fiery Mr Gingrich has returned from the Greek Cruise that prompted his staff to mutiny en masse perhaps excessively rested, wondering aloud about the absence of an American encampment on the moon. Even so, the Tea Party and former Alaskan governor Sarah Palin, touchstones for the populist right, seemed like phenomena from a past era.

It was former Massachusetts governor Mitt Romney who held centre stage, literally and metaphorically. As critics have alleged, Mr Romney is something of a political weathervane. More precisely, he is a businessman, with an instinct for what product will sell at a given moment. Having evaluated the marketplace, he recognises the demand for competence rather than ideology. Thus Mr Romney now accuses Mr Obama of failure, rather than leftism. He also does not repudiate his belief that human activity is causing climate change or his support the legislation that his overhyped rival Mr Pawlenty calls “Obamneycare.”

Instead, Mr Romney takes the coherent (if somewhat silly) federalist position that healthcare reform ought to take place at the state level. Mr Gingrich and Mr Pawlenty, no more principled than Mr Romney, but with poorer political instincts, have simply boarded a train going in the wrong direction.

In the dynamic glimpsed last night, Mr Romney is now running against Mr Obama, while the other Republicans are running against Mr Romney. The most credible challenge to the Republican frontrunner is likely to come not from someone more conservative, but his coreligionist Jon Huntsman, the even more liberal former Governor of Utah who is expected to announce his candidacy within the next week. Mr Huntsman, who has in the past supported not only civil unions but Mr Obama’s stimulus spending, has expressed his intention to show “civility” not just toward his Republican rivals, but to the Democratic President he recently served as Ambassador to China.

Primaries usually pull candidates to the margin, but the GOP is now experiencing a politically healthy course correction. Until recently the most evident forces were indeed pushing them away from the centre. We are now seeing an opposite shift, away from then margin, and toward the middle. For Mr Obama, this movement, and the outbreak of Republican sanity it signals, is a worrying development indeed.

The writer is chairman of the Slate Group.

Response by Reihan Salam

A debate that shows Republicans winning the battle of ideas

I agree with Jacob’s central point. But my sense is that this return
to seriousness has been going on for some time. While “birtherism” and Sarah Palin have drawn outsized attention, the deeper shift in conservatism has seen a renewed focus on the seemingly mundane but actually all-important question of how government works.

The recent battles in Wisconsin, for instance, in which Gov. Scott Walker proposed rolling back collective bargaining rights for public employees, was as heated and polarising a cable-news Kulturkampf as the battles over Terri Schiavo, or no-hope attempts to introduce a Federal Marriage Amendment. The difference is that the current outcome in Wisconsin actually matters for the fiscal future of state and local governments across the country.

Left-leaning Americans are inclined to see the same old fever-swamp irrationalism at work in the right’s attempts to subject bloated budgets to sustained scrutiny, but this is actually a debate that conservatives and libertarians are winning on the merits.

Rep. Paul Ryan’s Medicare reform proposal has been crucial to this revival of the right. Jacob notes that only former Senator Rick Santorum embraced the proposal in all of its particulars during the debate on Monday. That, I suspect, is exactly what Rep. Ryan would have anticipated.

For years, conservatives in Congress have railed against the size of government, yet they’ve studiously avoided talking about entitlements in any detail. President George W. Bush’s push to reform Social Security was plagued by a lack of specificity, which fueled the most paranoid interpretations of what dastardly right-wingers intended to do to a beloved programme.In truth, Rep. Ryan’s plan is not the most realistic on offer. That distinction belongs to the plan put forth by former Clinton budget director Alice Rivlin and former Republican Senator Pete Domenici, which would make for an excellent compromise between the visions of both parties.

But it is not and never was Rep. Ryan’s job to lay out a compromise proposal. Rather, it was to rally congressional Republicans behind a plan that they could bring to the negotiating table. For all the plan’s weaknesses, it represents a huge advance over what had been the do-nothing Republican status quo on entitlements.

If the next Republican presidential candidate takes Rep. Ryan’s lead and crafts a more politically palatable plan for entitlement reform, the GOP will establish itself as the grown-up party. And that will pay electoral dividends.

The writer is co-author of Grand New Party: How Republicans Can Win the Working Class and Save the American Dream

China’s announcement today that inflation in May hit a three-year high of 5.5 per cent and industrial expansion exceeded expectations will buttress those who see an inevitable economic crash coming. But even those who remain confident that a soft landing is possible seem to agree that China’s economic growth is unbalanced, with these imbalances widely blamed for trade surpluses with the west. This view, however, is much exaggerated.

Compared to other countries China’s consumption to gross domestic product ratio of 35 per cent is exceptionally low, suggesting consumption is not actually being repressed. China’s investment to GDP ratio of more than 45 per cent, meanwhile, is exceptionally high. This leads many to propose a standard solution to “rebalancing”: China must increase consumption and dampen investment.

The problem is this view is static. Growth, however, is inherently unbalanced. What matters are not indicators pointing to imbalances, but the direction of change. It is true that China’s private consumption to GDP ratio has declined by 15 percentage points over the past 15 years. But this is a pattern that mirrors many east Asian economies, and also that of the US during its industrialisation own in the 20th century. Despite all the admonitions, this ratio will not begin to increase until household savings rates decline or labour’s share of income increases.

Savings rates will also not fall anytime soon, because there is as yet no credible social welfare system. Households are currently saving more because they have doubts about the viability of pensions, while social security deductions are seen as a tax, encouraging more saving rather than less. Growing aspirations for home ownership also ratchet up savings. All of these factors contribute to a prolonged upturn in personal savings rates.

Increasing labour’s share of income is not a viable solution at this time either. Paradoxically, as more workers move out of agriculture and into industry – which is obviously a good thing – labour’s share of income will fall. Labour’s share of income in agriculture is almost 90 per cent, but in industry it’s only 50 per cent. Workers enjoy higher earnings and productivity increases, but the percentage of income that goes directly to workers actually drops.

Contrary to expectations, labour’s share of income within industry is also declining, because of the expanding role of the private sector relative to the state – but this is to be welcomed too. In the end, the declining share of labour – which shapes the consumption pattern – is a consequence of China moving to a more efficient growth path. It is not a problem.

Behind today’s figures and more talk of unbalanced growth, the truth is that China’s economy will change – in time. As the availability of rural labour falls and the relative shares of state and private enterprises stabilise, the ratio of consumption to GDP will begin to increase – just as we have seen in other higher income countries. But China is still several years away from this.

The perception that China has invested too much is also misleading. Actually, China’s capital stock relative to GDP is lower than other comparable east Asian countries. Moreover, much of the surge in investment over the past decade is due to housing construction, where the country is still making up for the shortfalls from the Mao era.

In all this we must also remember that directing resources away from investment to consumption may be neither feasible nor desirable. China’s investment-led growth model, by generating faster growth than otherwise would have been possible, has in fact arguably led to sustainably higher – not lower – consumption levels. The country’s yearly 8-9 per cent growth in consumption, and 10 per cent in real wages, puts China at the top of its peers.

The bottom line is that China’s growth is not unbalanced. Even so its trade surplus continues to be a major irritant with the west. In principle the problem is not hard to solve, but the solution runs counter to conventional wisdom. China’s trade surplus is now running around 2-3 per cent of GDP, so if consumption, investment and government expenditures all rose less than one percentage point of GDP each, the problem would evaporate.

But in which order should this happen? The best near-term solution rests not with higher consumption but with public expenditures, paid for by increasing dividend payments from state enterprises to the government. Since pre-tax profits of state enterprises have surged to more than 7 per cent of GDP, channelling just a fraction of these surpluses into public social services would make a big difference.

If China acted in this way, its already high investment rates may not need to decline in the short term, but with the right financing vehicles there needs to be more spending on social housing and less high-end speculative construction. Together with continued support for social infrastructure, these actions would be enough to eliminate China’s trade surplus sooner rather than later. This would also buy the necessary time to improve welfare and consumer credit programmes so that households are eventually inclined to save less and spend more.

Such actions would prevent trade surpluses from re-emerging when the pace of investment is likely to fall by the second half of this decade. They can be achieved without compromising China’s growth or restraining global demand, allowing the west’s recovery so it can continue coming out of the global economic slowdown. And perhaps most importantly, they would allow China to dispel the myth of its unbalanced economy once and for all.

Yukon Huang is a senior associate at the Carnegie Endowment and a former country director for the World Bank in China.

Response by Kerry Brown

Ominous signs grow for China’s future growth

For some commentators China’s economy has been about to implode for most of the last two decades. But threats have come and gone, from the 1998 Asian economic crisis, to the challenges of exposing china’s domestic companies to international competition on entry to the World Trade Organisation, to the 2008 collapse of exports after the international economic crisis, and still the Chinese economy has motored along.

The bottom line is that for all the imbalances, there is plenty of room for growth. If the Chinese government delivers on its aim of getting the country to middle income status (with a per capita gross domestic product of $8,000) by 2010, then the gross size of the Chinese economy will be well on its way to overtaking the US.

During this process, wealth creation will in turn be able to deal with issues like constructing an adequate social welfare system, dealing with some of the vast pension deficits, and letting the burgeoning middle class relax a bit so that they can become better consumers.

The problem is that journey to 2020 is beset by all sorts of challenges, some of which are starting to look ominous – perhaps more ominous than Yukon Huang’s article above acknowledges. On a tour round central china this week, I’ve seen some of the 60m or more empty flats and houses that currently can’t find a buyer. Another report warned that China’s central government may have committed up to $400bn in bailing out the bad debts of local governments. Meanwhile, domestic reports put inflation way higher than the official 5 per cent figure released today, with unemployment reaching as much as 15 per cent.

The important issues, however, are not so much economic as structural and political. The structural issue is the continuing problem of fiscal reform, so the current highly centralised tax raising system begins to allow individual provinces to make more of their own decisions. At present the problem remains bureaucrats in Beijing calling the shots about relatively minor problems, many thousands of miles away.

The political problem remains that the state-owned sector, after several years in the shade, is now coming back with a vengeance. This sector is seen by political leaders in the communist party as their bulwark against the global financial crisis, and a vindication that maintaining strong state control over key parts of the economy was the right thing to do.

Because of this the state sector operates in an even more benign environment than ever – it is now almost above questioning. Today, as I sit in Shanghai, with prices for almost everything (except taxis) higher than in the UK, the best one can say is that china’s economic transformation continues to get more complex and more uncertain by the day. But for a regime that have placed almost everything on economic growth, there isn”t a clear plan B.

The writer is Head of the Asia Programme at Chatham House, and author of Ballot Box China.

The muddle-through approach to the eurozone crisis has failed to resolve the fundamental problems of economic and competitiveness divergence within the union. If this continues the euro will move towards disorderly debt workouts, and eventually a break-up of the monetary union itself, as some of the weaker members crash out.

The Economic and Monetary Union never fully satisfied the conditions for an optimal currency area. Instead its leaders hoped that their lack of monetary, fiscal and exchange rate policies would in turn see an acceleration of structural reforms. These, it was hoped, would see productivity and growth rates converge.

The reality turned out to be different. Paradoxically the halo effect of early interest rate convergence allowed a greater divergence in fiscal policies. A reckless lack of discipline in countries such as Greece and Portugal was matched only by the build-up of asset bubbles in others like Spain and Ireland. Structural reforms were delayed, while wage growth relative to productivity growth diverged. The result was a loss of competitiveness on the periphery.

All successful monetary unions have eventually been associated with a political and fiscal union. But European moves toward political union have stalled, while moves towards fiscal union would require significant federal central revenues, and also the widespread issuance of euro bonds — where the taxes of German (and other core) taxpayers are not backstopping only their country’s debt but also the debt of the members of the periphery. Core taxpayers are unlikely to accept this.

Eurozone debt reduction or “reprofiling” will help to resolve the issue of excessive debt in some insolvent economies. But it will do nothing to restore economic convergence, which requires the restoration of competitiveness convergence. Without this the periphery will simply stagnate.

Here the options are limited. The euro could fall sharply in value towards – say – parity with the US dollar, to restore competitiveness to the periphery; but a sharp fall of the euro is unlikely given the trade strength of Germany and the hawkish policies of the European Central Bank.

The German route — reforms to increase productivity growth and keep a lid on wage growth — will not work either. In the short run such reforms actually tend to reduce growth and it took more than a decade for Germany to restore its competitiveness, a horizon that is way too long for periphery economies that need growth soon.

Deflation is a third option, but this is also associated with persistent recession. Argentina tried this route, but after three years of an ever deepening slump it gave up, and decided to default and exit its currency board peg. Even if deflation was achieved, the balance sheet effect would  increase the real burden of private and public debts. All the talk by the ECB and the European Union of an internal depreciation is thus faulty, while the necessary fiscal austerity still has – in the short run – a negative effect on growth.

So given these three options are unlikely, there is really only one other way to restore competitiveness and growth on the periphery: leave the euro, go back to national currencies and achieve a massive nominal and real depreciation. After all, in all those emerging market financial crises that restored growth a move to flexible exchange rates was necessary and unavoidable on top of official liquidity, austerity and reform and, in some cases, debt restructuring and reduction.

Of course today the idea of leaving the euro is treated as inconceivable, even in Athens and Lisbon. Exit would impose big trade losses on the rest of the eurozone, via major real depreciation and capital losses on the creditor core, in much the same way as Argentina’s “pesification” of its dollar debt did during its last crisis.

Yet scenarios that are treated as inconceivable today may not be so far-fetched five years from now, especially if some of the periphery economies stagnate. The eurozone was glued together by the convergence of low real interest rates sustaining growth, the hope that reforms could maintain convergence; and the prospect of eventual fiscal and political union. But now convergence is gone, reform is stalled, while fiscal and political union is a distant dream.

Debt restructuring will happen. The question is when (sooner or later) and how (orderly or disorderly). But even debt reduction will not be sufficient to restore competitiveness and growth. Yet if this cannot be achieved, the option of exiting the monetary union will become dominant: the benefits of staying in will be lower than the benefits of exiting, however bumpy or disorderly that exit may end up being.

Nouriel Roubini is chairman of Roubini Global Economics, professor of economics at the Stern School of Business NYU and co-author of ‘Crisis Economics’ that has been recently published in its paperback edition.

 

Response by Sony Kapoor

A ‘Plan B’ for Europe is possible

European Union leaders are getting their knickers in a twist over Greece, again. The facts are well-known: a debt spiralling up to 170 per cent of  gross domestic product, a stubborn double-digit deficit, the collapse of private investment and a shrinking economy. Plan A – liquidity support and structural reform under an EU-IMF programme – has run aground. But instead of accepting a wider crisis as inevitable, as Nouriel Roubini seems to do in his article above, what Europe now needs is a credible Plan B.

At present Greece cannot repay its debt in full, but asking European taxpayers to share the burden through a write-off is politically toxic. Simply restructuring debt owed to the private sector will bankrupt the Greek banking system, and trigger contagion. Increasing public support to Greece also makes little economic sense. Instead the new path must move between the constraints of what is economically sensible and politically feasible.

This means haircuts on Greek government bonds are arithmetically unavoidable, and that any Plan B must differentiate between the various creditors. EU loans and European Central Bank support provided after Greece landed into trouble must be treated preferentially. Another category of creditors, Greek banks, will also need to be protected. This is not because of fairness or political expediency, but because a haircut will bankrupt all Greek banks, imposing enormous economic costs on Greece and its foreign creditors, and triggering contagion.

Next, Greek bonds held by the ECB and Greek banks should be swapped for new par bonds that are excluded from restructuring. Changes to Greek domestic law will also be needed to smooth restructuring and target a debt stock of just below the psychologically important 100 per cent threshold. Here the burden would fall mostly on private external holders of Greek debt, of which German and French banks are the biggest. Well-capitalised French banks, such as BNP Paribas, can comfortably absorb the 50 per cent haircut needed. German banks can also handle the haircuts.

Finally, contagion to Ireland and Portugal can be avoided through the introduction of a European stability mechanism clause that allows debt restructuring only when the debt/GDP ratio and debt servicing/GDP ratios exceed 110 per cent and 6 per cent respectively, levels that neither Ireland nor Portugal are expected to breach. The markets recognise that Greece is different. It will still need to work very hard to cut deficits and restore growth. For that there is no Plan B.

The writer is managing director of Re-Define, an International Think Tank. This is an extract of a longer article which will be published in the FT on Tuesday, June 14.

Even with the 2008-2009 policy effort that successfully prevented financial collapse, the US is now halfway to a lost economic decade. In the past five years, our economy’s growth rate averaged less than one per cent a year, similar to Japan when its bubble burst. At the same time, the fraction of the population working has fallen from 63.1 per cent to 58.4 per cent, reducing the number of those in jobs by more than 10m. Reports suggest growth is slowing.

The A-List

An exciting new comment section featuring agenda-setting commentary on global finance, economics and politics

Contributors will include financier and philanthropist George Soros, chief executive of Pimco Mohamed El-Erian, chairman of Goldman Sachs Asset Management Jim O’Neill, political scientist Francis Fukuyama, professor of politics Anne-Marie Slaughter and former EU trade commissioner Peter Mandelson

Beyond the lack of jobs and incomes, an economy producing below its potential for a prolonged interval sacrifices its future. To an extent once unimaginable, new college graduates are moving back in with their parents. Strapped school districts across the country are cutting out advanced courses in maths and science. Reduced income and tax collections are the most critical cause of unacceptable budget deficits now and in the future.

You cannot prescribe for a malady unless you diagnose it accurately and understand its causes. That the problem in a period of high unemployment, as now, is a lack of business demand for employees not any lack of desire to work is all but self-evident, as shown by three points: the propensity of workers to quit jobs and the level of job openings are at near-record low; rises in non-employment have taken place among all demographic groups; rising rates of profit and falling rates of wage growth suggest employers, not workers, have the power in almost every market.

A sick economy constrained by demand works very differently from a normal one. Measures that usually promote growth and job creation can have little effect, or backfire. When demand is constraining an economy, there is little to be gained from increasing potential supply. In a recession, if more people seek to borrow less or save more there is reduced demand, hence fewer jobs. Training programmes or measures to increase work incentives for those with high and low incomes may affect who gets the jobs, but in a demand-constrained economy will not affect the total number of jobs. Measures that increase productivity and efficiency, if they do not also translate into increased demand, may actually reduce the number of people working as the level of total output remains demand-constrained.

Traditionally, the US economy has recovered robustly from recession as demand has been quickly renewed. Within a couple of years after the only two deep recessions of the post first world war period, the economy grew in the range of 6 per cent or more – that seems inconceivable today. Why?

Inflation dynamics defined the traditional postwar US business cycle. Recoveries continued and sometimes even accelerated until they were murdered by the Federal Reserve with inflation control as the motive. After inflation slowed, rapid recovery propelled by dramatic reductions in interest rates and a backlog of deferred investment, was almost inevitable.

Our current situation is very different. With more prudent monetary policies, expansions are no longer cut short by rising inflation and the Fed hitting the brakes. All three expansions since Paul Volcker as Fed chairman brought inflation back under control in the 1980s have run long. They end after a period of overconfidence drives the prices of capital assets too high and the apparent increases in wealth give rise to excessive borrowing, lending and spending.

After bubbles burst there is no pent-up desire to invest. Instead there is a glut of capital caused by over-investment during the period of confidence – vacant houses, malls without tenants and factories without customers. At the same time consumers discover they have less wealth than they expected, less collateral to borrow against and are under more pressure than they expected from their creditors.

Pressure on private spending is enhanced by structural changes. Take the publishing industry. As local bookstores have given way to megastores, megastores have given way to internet retailers, and internet retailers have given way to e-books, two things have happened. The economy’s productive potential has increased and its ability to generate demand has been compromised as resources have been transferred from middle-class retail and wholesale workers with a high propensity to spend up the scale to those with a much lower propensity to spend.

What, then, is to be done? This is no time for fatalism or for traditional political agendas. The central irony of financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it is only resolved by increases in confidence, borrowing and lending, and spending. Unless and until this is done other policies, no matter how apparently appealing or effective in normal times, will be futile at best.

The fiscal debate must accept that the greatest threat to our creditworthiness is a sustained period of slow growth. Discussions about medium-term austerity need to be coupled with a focus on near-term growth. Without the payroll tax cuts and unemployment insurance negotiated last autumn we might now be looking at the possibility of a double dip. Substantial withdrawal of fiscal stimulus at the end of 2011 would be premature. Stimulus should be continued and indeed expanded by providing the payroll tax cut to employers as well as employees. Raising the share of payroll from 2 per cent to 3 per cent is desirable, too. These measures raise the prospect of sizeable improvement in economic performance over the next few years.

At the same time we should recognise that it is a false economy to defer infrastructure maintenance and replacement, and take advantage of a moment when 10-year interest rates are below 3 per cent and construction unemployment approaches 20 per cent to expand infrastructure investment.

It is far too soon for financial policy to shift towards preventing future bubbles and possible inflation, and away from assuring adequate demand. The underlying rate of inflation is still trending downwards and the problems of insufficient borrowing and investing exceed any problems of overconfidence. The Dodd-Frank legislation is a broadly appropriate response to the challenge of preventing any recurrence of the events of 2008. It needs to be vigorously implemented. But under-, not overconfidence is the problem, and needs to be the focus of policy.

Policy in other dimensions should be informed by the shortage of demand that is a defining characteristic of our economy. The Obama administration is doing important work in promoting export growth by modernising export controls, promoting US products abroad and reaching and enforcing trade agreements. Much more could be done through changes in visa policy to promote exports of tourism as well as education and health services. Recent presidential directives regarding relaxation of inappropriate regulatory burdens should also be rigorously implemented.

Perhaps the US’ most fundamental strength is its resilience. We averted depression in 2008/09 by acting decisively. Now we can avert a lost decade by recognising economic reality.

The writer is Charles W. Eliot University Professor at Harvard and former US Treasury Secretary. He is an FT contributing editor

The A-list … an exciting new comment section featuring agenda-setting commentary on global finance, economics and politics.

Starting on Monday June 13, the FT A-List will publish exclusive and original daily comment from its network of globally renowned leaders, policymakers and commentators. Topics will range from economics and finance to world politics and diplomacy, with the headline commentary accompanied by at least one response from a related expert.

To mark the launch Lawrence H. Summers will write the first of a series of monthly columns appearing in the FT addressing the crisis of America’s jobless recovery. Nouriel Roubini will then launch the A-List commentary addressing the eurozone’s prospects. Readers will be able to participate in the debate and comment online.

The A-List includes financier and philanthropist George Soros, chief executive of Pimco Mohamed El-Erian, chairman of Goldman Sachs Asset Management Jim O’Neill, political scientist Francis Fukuyama, professor of politics Anne-Marie Slaughter and former EU trade commissioner Peter Mandelson.

 

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