Monthly Archives: February 2012

Two reminders of the age-old debate over the merits of equities versus bonds emerged almost simultaneously in recent days.

First, Warren Buffett argued in his latest annual letter that shares are not only a better investment than fixed income instruments but are also superior to gold, the darling of many seasoned investors.

Just as that was being digested, the Financial Times reported that the Ford Motor Company had decided to put 80 per cent of its pension plan assets into bonds, up from 45 per cent previously.

While Ford makes great cars, I believe they got this decision wrong. In doing so, they fell prey to the classic mistake that many investors make: basing decisions on recent past performance rather than a more balanced view of long-term history and a clear vision of the future.

I’m betting that Mr Buffett will be proved correct. Over a reasonable period of time, shares will almost surely outperform fixed income instruments. (If they don’t, centuries of finance theory will have to be discarded.)

It’s easy to see why some investors might be tempted to go down Ford’s path. Over the past five- and 10-year periods, the US stock market (as measured by the Standard & Poor’s 500 index) has substantially underperformed the fixed income market (as measured by the BarCap index).

How dispiriting it must be for an investor to have endured the stomach-wrenching rollercoaster of equities over these periods, only to find himself at the short end of the stick. But as painful as a decade of only marginal share price gains must feel, the longer term picture is quite clear. Go back, for example, 35 years. Stocks have risen an average of 10.8 per cent per year since then, while the bond index has risen by 8.2 per cent annually.

That might not sound like a huge difference but as Mr Buffett regularly observes, the power of compounding can be immense. An investment of $10,000 in shares 35 years ago would be worth $366,756 today. The same sum put into bonds would be worth less than half that at $157,234.

Personally, I don’t imagine that either stocks or bonds will match the past 35 years over the next 35 years (or even a shorter period). Both investment routes benefited enormously from a steady reduction in interest rates as the stagflationary environment of the 1970s was dealt with.

But by almost any measure, stocks today are cheaper than bonds. For example, the S&P index trades at a 14.1 times multiple of most recent 12-month earnings, compared to an average of 16.8 times since 1977. Meanwhile, thanks to de minimus inflation and accommodating monetary policy, bond yields are near an all-time low.

Perhaps most dramatically – and almost without historical precedent – the dividend yield on the S&P index is currently higher than the 10-year Treasury yield. Either stocks are cheap or a lot of companies will soon be reducing their payouts.

If proved wrong, Ford would be among a lengthy and illustrious list of investors who turned away from shares at the wrong moment. In August 1979, for example, BusinessWeek magazine emblazoned “The Death of Equities” across its cover. An extraordinary US bull market began just seven months later.

Why is investing perhaps the only profession that non-professionals think they can do themselves? Few of us would try to be our own lawyers or doctors.

Mr Buffett shouldn’t be making cars and Ford shouldn’t be making investment decisions.

The writer is former head of the task force that oversaw the bail-out of Chrysler and General Motors

Response by Zvi Bodie and John Ralfe

Ford is right to match its pensions assets and liabilities

Steven Rattner takes Ford Motors to task for its plan to move 80 per cent of its pension fund into bonds, arguing that over any “reasonable period” equities will outperform bonds and that equities currently look cheap versus bonds.

There is no question that equities have a higher expected return than bonds. However, the “equity risk premium” is not a free lunch for investors. It’s a reward for the higher risk of holding equities, which unlike bonds, have no fixed annual payments or fixed redemption date or value. (A higher expected return says nothing about actual returns, which have been ugly in the last decade).

What about Mr Rattner’s anecdotal evidence that historically high multiples and low yields mean equities now look cheap versus bonds? Some of us believe that all information is already in the price of any financial asset, through investors buying and selling at the margin, so would argue that the likelihood of being able to outguess the market, over any period, is always 50/50.

But, whether equities are currently cheap or not is a red herring. Any individual investor who agrees that equities are cheap can themselves sell bonds and buy equities. They do not need Ford, or any other company, to do it on their behalf. This is an extension of the Modigliani Miller theorem, that increasing the leverage of a firm has, absent tax, no first order benefit for shareholders, since they can achieve the same level of leverage themselves directly. Equally by holding equities in its pension fund a company is doing nothing its shareholders cannot do themselves directly.

Ford’s decision is not an investment call based on the relative value of equities and bonds. It is a strategic decision to reduce its overall financial risk, by holding assets to better match its liability to pay pensioners over many decades. Matching pension assets and liabilities reduces the likelihood that it will have to make unwelcome deficit contributions, probably at a time when it can least afford them. Pensions are a major risk for Ford. Its total pension liabilities of $74bn, dwarf its $50bn market capitalisation.

Holding equities in the pension fund increases a company’s financial risk and gearing. It is exactly the same as the company issuing long dated bonds and investing the proceeds into a mutual fund. Would Mr Rattner advocate this as a strategy for Ford or other companies?

What about the tax implications of holding equities in the pension fund? By having financial risk in its pension fund, rather than on balance sheet though higher borrowings, a company is being tax inefficient, as interest payments on debt are tax deductible. The late Fischer Black, way back in 1980, recognised this in a paper advocating that companies should match their pension liabilities with bonds and then gear up on balance sheet by increasing debt.

Furthermore, in the UK, it is more tax efficient for private individuals to hold equities directly, because the dividend tax credit, which was abolished for pension funds in 1997, is still payable to individuals.

Matching pension assets and liabilities also reduces risk for scheme members, as the value of pension assets should always be enough to pay all pensions, regardless of movements in financial markets.

The UK is ahead of the US in recognising the risk of holding equities in company pension funds, and in matching pension assets and liabilities. Most famous is the case of Boots, which in 2001 moved its entire £2.4bn pension fund into long dated AAA/Aaa sovereign bonds. It then did a £300m share buyback to have risk on the balance sheet.

Mr Rattner is right that Ford should make cars, not investment decisions. A better match of its pension assets and liabilities takes a major risk and distraction off the table, allowing Ford’s management to concentrate on doing just that.

Zvi Bodie is professor of management at Boston University, and John Ralfe is a UK-based pension consultant and former head of corporate finance at Boots

Anyone with a political memory is thinking about Sarajevo these days as Bashar al-Assad’s artillery shells blast into Homs and families huddle in dark and unheated basements trying to stay alive as the shuddering assault edges ever closer. With the bombardment entering its fourth week, those watching video clips filmed with mobile phone cameras feel the same emotion they felt watching the siege of Sarajevo 20 years ago.

It is the feeling of shame.

You know it is shame when ‘the international community’ now talks, just as it did during the Sarajevo siege, not of stopping the carnage, but of offering “humanitarian” assistance. The very word is abject. The people in the basements of Homs would be insulted to be called innocent victims in need of humanitarian rescue. They have been fighting to overthrow a regime.

Theirs is a fight to the death. They know this government will do with Homs what Mr Assad’s father did to Hama 30 years ago. They know that the son’s regime rests on the father’s primal obscenity. The fighters in Homs are holding out now because utter desperation puts them beyond fear. Watching them fight on, we have reason to be ashamed if we think the only thing we can do is send them bandages.

Resigning ourselves to carnage is also strategically foolish. It will leave us in a world where any tyrant knows he can shell his own people into submission, safe in the assumption no one will step in to stop him. We need to understand what Mr Assad wants and deny it to him. What he wants is to plough Homs under as his father ploughed under Hama and leave Carthaginian desolation to guarantee that he rules until he dies peacefully in his own bed. He craves the reputation of “strongman” and Homs will be made to confer that benediction.

But he wants more than this. Unlike the father, the son has pretensions.

A while ago, before all this started, an eminent couple I know dined with Mr Assad and his wife in Damascus. The dinner was relaxed and low-key, two western couples talking about art and culture. As the president hunkers down now and orders his own people shelled, he must be hoping for the day when outsiders will persuade themselves once again that he is a modernising fellow held back by reactionary elements but determined on “reform”.

He must be stripped of these pretensions. The westernising Syrian middle class that jets between Damascus, Paris and London must be disabused of their illusions too. His hangers-on need to understand that, once and for all, Mr Assad has earned for himself that ancient term of obloquy, hostis humani generi, enemy of the human race.

But arming the rebels or providing them with close air support gives the president what he wants: a fight to the finish where his brutality wins. Punching humanitarian corridors in from Turkey and gathering rebel populations in safe havens risks creating another Srebrenica.

So what do we do? In place of military intervention, nations can impose a comprehensive quarantine of Syria, designed to treat Mr Assad and his regime as an outcast, deny him any pretensions to legitimacy, drain any remaining support away from his cadre and force him from power.

Why should any country that values freedom still permit a Syrian embassy on its soil? Why should any country with an airport allow a Syrian commercial flight to land? Why should any Syrian associated with the regime be allowed a visa to a foreign country? Why should tankers still be landing fuel and arms at Syrian Mediterranean ports? These are the questions that shame and outrage suggest. Their answers imply a concerted strategy – it does not require a UN resolution – of quarantine of an entire country until its ruler gives up and the battered survivors of his carnage emerge from their basements and create a nation in which, whatever else they wish to achieve, they are free of a father and son’s vengeance.

The writer teaches human rights at the University of Toronto

Economic cheerleaders on Wall Street and in the White House are taking heart. The US has had three straight months of faster job growth. The number of Americans each week filing new claims for unemployment benefits is down by more than 50,000 since early January. Corporate profits are healthy. The S&P 500 on Friday closed at a post-financial crisis high.

Has the American recovery finally entered the sweet virtuous cycle in which more spending generates more jobs, more jobs make consumers more confident, and the confidence creates more spending? On the surface it would appear so.

American consumers in recent months have let loose their pent-up demand for cars and appliances. Businesses have been replacing low inventories and worn equipment. The richest 10 per cent, owners of approximately 90 per cent of the nation’s financial capital, have felt freer to splurge. Consumer confidence is at a one-year high, according to data released on Friday.

The government on this side of the Atlantic has not succumbed to the lunacy of austerity. Republicans in Congress have just agreed to extend both a payroll tax cut and extra unemployment benefits, and the US Federal Reserve is resolutely keeping interest rates near zero.

Yet the US economy has been down so long that it needs substantial growth to get back on track – far faster than the 2.2 – 2.7 per cent projected by the Federal Reserve for this year (a projection which itself is likely to be far too optimistic).

A strong recovery can’t rely on pent-up demand for replacements or on the spending of the richest 10 per cent. Consumer spending is 70 per cent of the US economy, so a buoyant recovery must involve the vast middle class.

But America’s middle class is still hobbled by net job losses and shrinking wages and benefits. Although the US population is much larger than it was 10 years ago, the total number of jobs today is no more than it was then. A significant portion of the working population has been sidelined – many for good. And the median wage continues to drop, adjusted for inflation. On top of all that, rising gas prices are squeezing home budgets even more.

Yet the biggest continuing problem for most Americans is their homes. Purchases of new homes are down 77 per cent from their 2005 peak. They dropped another 0.9 per cent in January. Home sales overall are still dropping, and prices are still falling – despite already being down by a third from their 2006 peak. January’s average sale price was $154,700, down from $162,210 in December.

Houses are the major assets of the American middle class. Most Americans are therefore far poorer than they were six years ago. Almost one out of three homeowners with a mortgage is now “underwater”, owing more to the banks than their homes are worth on the market.

Optimists point to declining home inventories in relation to sales, but they’re looking at an illusion. Those supposed inventories don’t include about 5m housing units with delinquent mortgages or those in foreclosure, which will soon be added to the pile. Nor do they include approximately 3m housing units that stand vacant – foreclosed upon but not yet listed for sale, or vacant homes that owners have pulled off the market because they can’t get a decent price for them. Vacancies are up 1m from 2006.

What we’re witnessing is a fundamental change in the consciousness of Americans about their homes. Starting at the end of the second world war, houses were seen as good and safe investments because home values continuously rose. In the late 1960s and 1970s, early baby boomers took out the largest mortgages they could afford, and watched their nest eggs grow into ostrich eggs.

Trading up became the norm. Homes morphed into automatic teller machines, as baby boomers used them as collateral for additional loans. By the rip-roaring 2000s, it was not unusual for the middle class to buy second and third homes on speculation. Most assumed their homes would become their retirement savings. When the time came, they’d trade them in for a smaller unit and live off the capital gains.

The plunge in home values has changed all this. Young couples are no longer buying homes; they’re renting because they’re not confident they can get or hold jobs that will reliably allow them to pay a mortgage. Middle-aged couples are underwater or unable to sell their homes at prices that allow them to recover their initial investments. They can’t relocate to find employment. They can’t retire.

The negative wealth effect of home values, combined with declining wages, makes it highly unlikely the US will enjoy a robust recovery any time soon.

The writer is a professor of public policy at the University of California at Berkeley, and was US secretary of labour under President Bill Clinton

Last year, 13 eurozone countries surpassed the deficit to gross domestic product ratio of three per cent. The latest forecasts by the European Commission suggest the region is slipping into a mild recession this year. As a consequence, in the absence of further policy measures, most of these countries risk missing their budgetary targets. This especially applies to Spain, where last year’s deficit was eight per cent of GDP. The Commission expects its output to decline by one per cent this year (not a particularly pessimistic forecast) yet the country is still supposed to reach the three per cent deficit threshold by next year. Many other countries are in the same boat.

The dilemma for the EU – especially for the Commission whose surveillance role is being enhanced – is how to respond to this situation. Should Olli Rehn, the Commission’s vice president, push countries to take further immediate actions? Or should he recognise that these targets are out of reach and put emphasis on efforts rather than outcomes? From a structural point of view, the preferred option is clearly the latter. However, the European fiscal framework has lost a lot of credibility. He may wish to use the opportunity to demonstrate his ability to enforce discipline.

Economic history teaches us that financial crises have long lasting, if not permanent, negative effects . Most European countries have already lost several percentage points of GDP and it seems wise to expect the second recession to do the same. Mr Rehn has good reasons to require action. However, demanding adherence to the 2013 targets has two major drawbacks.

First, immediate austerity measures would aggravate the recession. Recent research suggests that the short-run negative effects of austerity measures tend to be higher than we previously thought. Though most European governments have structural problems with their budgets, that does not call for impairing all automatic stabilisers in a recession year.

A second drawback of imposing immediate action is the form that this would almost certainly take. Closing a gap on short notice is not compatible with smart consolidation. The most effective way to achieve a dramatic result by next year would be to just raise existing taxes – with all the adverse consequences on potential output and no effects on the effectiveness of public spending.

A better path to sustainable public finances is to launch credible reforms today that ensure rebalancing of the government budget tomorrow. A typical example is the raising of the retirement age or reform of social benefits. However, it is hard for financial markets to monitor the implementation of such measures. The Commission is right to ask for them, and it should have an important role in the surveillance of policy actions and the evaluation of their effects.

Mr Rehn’s involvement in the budgetary policies of individual member states is motivated by their effects on other members. Attention has recently been focused on the negative effects of excess borrowing. However, in this era of major private deleveraging, the positives should also be considered.

This means minimum additional austerity over and above what is already planned in countries under direct financial stress and for no additional austerity at all in countries that do not face an immediate threat of losing access to the financial markets. Provided credible structural measures are implemented, this stance would be consistent with the EU treaty and budgetary sustainability. And it would certainly be better for the economy of the eurozone.

This article was co-authored with Coen Teulings, director the CPB Netherlands Bureau for Economic Policy Analysis. Jean Pisani-Ferry is director of Bruegel, the European economic think-tank

Matt Kenyon TAX illustration

Whoever wins this year’s US election, the combined effect of three events – the expiry of former president George W. Bush’s tax cuts, a renewal of the legally binding limit on federal borrowing and the start of a Congressionally mandated sequester, a mechanism that will automatically cut domestic spending from 2013 – will force the president and Congress to engage deeply with fiscal issues. The decisions made will do much to determine the country’s future.

For many observers, the central question in debates over deficit reduction is what can be done about entitlements. Growth in spending associated with an ageing population will be the major factor fuelling the growth of federal spending.


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The rising number of retirees to workers means that Social Security benefits at the current ratio to wages and salaries will not be sustainable without some kind of tax increase. Sooner or later revenues will have to rise or outlays will have to be curtailed.

But it is the trajectory of healthcare costs that will be the single most important determinant of the budgetary picture. While almost everyone agrees on the desirability of containing federal spending, achieving this is likely to be more difficult than many suppose.

Certainly, some beneficiaries can bear more of the cost of their government insurance. There are also steps such as malpractice reform and the further encouragement of preventative medicine that should be taken. Yet without intrusions into the private healthcare system that are unlikely to be politically acceptable, there are severe limits on what can be done to curb federal health spending.

The consequence of not acting, however, will be unacceptable reductions in the availability of care for the clients of federal programmes. And given all the uncertainties associated with new technologies, changing lifestyles and ongoing changes in the private system, healthcare reform will and should be a continuing project.

Less discussed in the context of major deficit reduction is tax reform. For a variety of reasons, 2013 should be the year when the tax code is overhauled in a substantial way.

First, the US will need to mobilise more revenue. This year, the federal government will collect less than 16 per cent of gross domestic product in taxes – far below the post-second world war average. The reality is that the combination of an ageing society, rising healthcare costs, debt service costs that will skyrocket whenever interest rates normalise, a still dangerous world in which our allies defence spending is falling even as that of potential adversaries rises rapidly, and a growing fraction of the population unable to hold steady work means that, in all likelihood, federal spending will need to be larger relative to GDP in the future.

Increasing marginal corporate rates or increasing individual rates beyond their Clinton-era level raises serious questions about incentive effects or the encouragement of shelter activities. It is in any event unlikely to be politically feasible.

A much better strategy for raising revenue would start from the premise adopted by the Simpson-Bowles bipartisan commission: that tax expenditures are a form of government expenditure and presumptively should be cut back unless they can be justified in the current environment.

Second, the current tax system is in certain ways manifestly unfair at a time of rising inequality. As is well recognised, America’s rich have become richer with the share of income going to the top 1 per cent increasing from about 10 per cent to about 20 per cent over the last generation while middle class incomes have stagnated.

There is plenty of room for discussion about the causes of this growing gap, the extent to which reducing inequality should be a central objective of government policy and the possible disincentive effects of excessively progressive taxes. But it is undeniable that certain fairly expensive aspects of the current tax system favour the most fortunate and border on the indefensible. Recent political debates, for example, have highlighted loopholes that permit a few to accumulate tens of millions of dollars in a tax-free individual retirement account (IRA) when almost everyone else is constrained by a $2,000 contribution limit.

Can the observation that Ireland, Bermuda and Luxembourg are three of the five jurisdictions where the US corporate sector earned the most profits reflect anything other than rampant tax sheltering? Anyone who doubts this should ponder the fact that in 2007, US corporate profits in Bermuda totalled 646 per cent of Bermuda’s GDP. The treatment of profit incentives paid to investment operators who do not use their own money but simply receive the “carry” as they invest other people’s money is another example of an inappropriate provision.

These examples, and the many more that could be adduced, are significant not only because of revenue the US Treasury could recoup while also making the tax system fairer. They also point to the power of special interests to shape fundamental aspects of economic policy. Reform could be an important step towards rebuilding confidence in the federal government that is sorely lacking today.

Third, even while raising too little revenue and giving much away to various shelter efforts, the current tax system places an excessive burden on economic activity. Corporate rates in jurisdictions at the very high end of the world range encourage businesses to manage their affairs in order to minimise reported US profits – using devices such as transfer pricing – and support the use of debt rather than equity finance. Employers who know that their workers face high tax rates endeavour to find ways of providing compensation in the form of tax-free perquisites, rather than money income. High marginal rates on individuals, along with a substantial capital gains differential, encourages them to devote a disproportionate amount of time that could be better spent to the problem of converting ordinary income into capital gains.

While the US tax code is altered frequently, serious reform is no more than a once in a generation occurrence. The last serious tax reform effort took place in 1986, so another is long overdue. The Simpson-Bowles proposal for eliminating all tax expenditures and radically reducing tax rates provides an excellent starting point for discussion.

The delicate question is how Washington should prepare for serious tax reform during what is likely to be a unique window of opportunity in late 2012-2013. The timing is essential both because of all the deficit reduction activity and because spending side reforms will have a much more difficult time becoming reality if the revenue side is not addressed as well.

It is tempting to say presidential candidates should put forward their tax reform proposals in detail and allow voters to choose. But this is unlikely to work. The more tax issues are discussed during the campaign, the more the candidates will be driven to make pledges about the things they will never do – pledges that might make tax reform that much more difficult.

So, here is an alternative. Leaders in both parties should commit themselves to the goal of tax reform for growth, fairness and deficit reduction. They should acknowledge that every tax expenditure or special break has to be on the table. They should ensure their staffs are compiling a large inventory of options. The relevant Congressional committees should take testimony from experts of all persuasions. And then, right after the election, the negotiations should begin. Nothing that is likely to done during the next presidential term will be more important.

The writer is Charles W. Eliot university professor at Harvard University and a former US Treasury Secretary

At this weekend’s G20 meeting, European countries are likely to press for an increase in the International Monetary Fund’s resources as a means to bolster the firewalls against the eurozone debt crisis. The other G20 members must resist such pressure until Europe starts showing more signs that it’s getting its act together. 

The balance sheet of the IMF – an organisation with 187 member countries – is already heavily exposed to the eurozone crisis. Greece, Ireland and Portugal combined account for almost 60 per cent of outstanding loans. And this is before the fund participates in the new bail-out for Greece that was announced earlier this week.

Europe is attracted to IMF financing for four reasons. It is a very cheap source of funding, especially for countries that are essentially shut out of private markets. It can act as a catalyst to unlocking other public and private financing. It is accompanied by a set of policy conditions, including both quantitative and qualitative performance targets. And it can come with technical assistance to strengthen the borrowing country’s administrative capabilities.

It should come as no surprise that over the last couple of years Europe has pressed the IMF very hard to make exception after exception - and it has succeeded. This has resulted in a number of firsts by an organisation that prided itself on the “uniformity of treatment” for member countries.

This went well beyond an easing in the maximum limits on loan amounts. More worrisome, it also involved supporting programmes that were inadequately designed when it comes to three core IMF criteria: they had little chance of restoring medium-term debt viability, they were not fully financed, and they risked the ‘preferred creditor’ status of the institution.

All this has understandably raised concerns among the other members, most acutely in Asia and Latin America where people still have vivid memories of what they were made to go through before receiving what now seem like relatively small loans compared to Europe. It has also damaged the standing of the IMF in the private sector.

There is some evidence to suggest that, in recent months, the IMF seems more willing to stand up to pressure from Europe. This is certainly commendable. Yet, as widely acknowledged, Europe is still significantly over-represented on the institution’s executive board and, therefore, retains a considerable influence.

The continued pressure on the IMF is also unfortunate given that Europe does not lack financial resources. The eurozone as a whole is a net creditor, with a tiny current account deficit. Its core countries, such as Germany, and regional institutions, such as the European Investment Bank, can borrow at very low interest rates.

Europe’s problem is not a lack of financing, but deep divisions about how the eurozone should operate in the presence of very different initial economic, financial and socio-political conditions among its member countries.

This is an internal issue that the IMF cannot, and should not be expected to, solve. It is up to the eurozone to decide whether to go forward in its current configuration towards a fiscal union or whether to first slim down to a more coherent and stable configuration. This would provide a better basis for a larger European-financed firewall.

As tempting as it is, Europe should not seek to obfuscate this critical decision by using IMF financing to give the appearance of sustaining the unsustainable. It must start making the necessary, albeit very difficult, decisions. Until this happens, the G20 has a global responsibility to protect the IMF from further damage to its credibility and legitimacy.

The writer is the chief executive and co-chief investment officer of Pimco

With the new Greek restructuring deal agreed, the question is whether fears about the sovereign debt crisis will abate or will the markets simply start looking elsewhere for other troubled waters?

In this regard, Japan increasingly looks like the real stand out. A variety of famous investors have come to the conclusion over the past two decades that Japan was on the verge of a major sovereign debt crisis, only to retreat quietly after it becomes clear that domestic deflationary pressures and strong domestic bond demand are continuing to keep Japanese bond yields remarkably low.

Japan has somehow managed to creep by with its problems untouched, or as some of us have described it, seemingly enjoying a “happy depression”. But the fact is that Japan’s outstanding debt to gross domestic product stands at a whopping 230 per cent and makes Greece’s latest 120 per cent by 2020 target seem like a picnic by comparison.

Late last year I repeatedly found myself asking Japanese investors why they were joining the rush to sell 10-year Italian bonds at seven per cent yields when their own 10-year bond yielded one per cent. With the exchange rate against the euro below Y100, shouldn’t they in fact be doing the opposite? Even though Italian yields are now back down to 5.5 per cent and the exchange rate has risen above Y106, it still strikes me as odd that Japanese investors are ignoring such an attractive relative investment.

Some of the investors I spoke to replied that Japan has external surpluses whereas Italy, like the rest of Club Med Europe, has external deficits. They could have said this then, but the argument weakened after Japan reported its first full calendar year trade deficit for decades. Moreover, given high energy prices and the fall in Japan’s industrial competitiveness, such deficits could well persist. It would raise the possibility that Japan’s days as an inveterate current account surplus country are coming to an end.

From a global perspective, this is not a bad thing as it is another sign along of global rebalancing. But it raises the thorny question as to who is going to be the marginal buyer for Japanese bonds? Unless the yen is going to get much weaker and 10-year yields much higher, it seems exceptionally unlikely that there will be international investors.

So what should Japanese policymakers do to avoid a crisis? They need to do two things. In the medium term, Japan has to find a creative strategy to deliver a reduction in its long term debt. It must control public spending better, adapt its tax system, and combine this with a plan to raise its pitiful real growth potential. If the government is not going to encourage mass immigration, it will also need to introduce dramatic service sector reform. Strong productivity gains are essential if the growth rate is to rise beyond that implied by the country’s weak demographic profile. These issues are not dissimilar to those previously ignored by many of the Club Med countries. Now, forced by the crisis, the likes of Greece and Portugal are finally trying to make reforms.

In the nearer term, Japan simply has to announce a Swiss National Bank-style commitment to halting further yen appreciation. The currency’s strength is compounding Japan’s competitiveness problems as many of its leading multinationals struggle to cope with challenges from overseas rivals. Due to Japan’s persistent low inflation, some models suggests that the yen is close to a reasonable level. Other models that adjust for productivity rates suggest something closer to an exchange rate of Y110 against the dollar and Y130 against the euro would be more sensible. This would put it in a better position to deal with the mounting long term challenges. Without that, it looks as though Japan’s “happy depression” of the past 20 years is set to become less happy and more depressed.

The writer is chairman of the asset management division of Goldman Sachs and its former chief economist

As a critic of the intervention in Iraq, and even of its milder sequel in Libya, I am a big fan of what David Cameron is doing on Thursday for Somalia. This time there are no troops massed on the borders or Nato air strikes, just a conference at London’s venerable Lancaster House, which in colonial times regularly saw countries made and unmade.

For those who might not have noticed because Somalia is an unintentionally well-kept secret, he is hosting Somali and international leaders in an effort to begin to sort out the country’s future. And Somalia needs sorting. It has a violent civil war, the remains of a famine, a government whose writ does not run beyond the capital, a thriving piracy industry off its coast and terrorist training camps on shore.

Something should be done. But over many years very little has. On the face of it conferences seem a much less robust way of sorting out problems than deploying military force. But to an unapologetic UN multilateralist such as myself, military force is the last resort. Diplomacy, sanctions, development assistance, institution-building are the proper first response to a failing state.

This is the logic of the doctrine that has come to be known as The Responsibility to Protect. Too often we default to military force prematurely once events reach a point that the media and the public are understandably howling for action (as was the case in Libya) or because the politicians have their own agenda (as was the case in Iraq).

Statesmanship is about calmer kinds of intervention that head off a broader conflict. The difficulty is that modest pre-emptive investments in conflict prevention often lack the domestic political support that a call to send in the troops – when events have deteriorated beyond the point of no return – enjoys. It’s the security equivalent of investment in sensible public health measures, such as diet and exercise, rather than waiting for expensive cardiac surgery once the heart attack has happened.

The case for investing in Somalia conflict prevention today is Afghanistan in 2001. It had a growing internal conflict, a massive drug industry and there was evidence that it was harbouring terrorists. But Afghanistan remained a second tier issue for the rest of the world. Until 9/11 and the attacks on America it was crowded out by other problems. Afterwards it sparked the costly and destructive war on terrorism that is still with us, and has had profound consequences for the US and its allies, as well as for Afghanistan and its neighbours.

The Somali comparison stacks up as follows: the cost to the global economy last year of Somali pirate attacks on international shipping is calculated to be around $12bn. This was due to the disruption of shipping lanes and increased security, insurance and journey times. The actual ransom costs were a more modest $160m. Britain’s security services report that Somalia, together with with Pakistan and Yemen, are the principal training grounds for British terrorists. One think tank claims there are currently around 50 British nationals undergoing terrorist training in Somalia. It took far fewer than that to bring down the World Trade Center Towers and a wing of the Pentagon.

The Lancaster House conference will look at improved protection and justice against pirates, a strengthening of the African Union peacekeeping force and more support to Somalia’s feeble institutions and public services. Above all, it must try to work out a plan that can deliver a united government in return for plenty of decentralised powers to the various regional and clan groups that have long resisted rule from Mogadishu. It won’t be easy but bravo, Mr Cameron for trying.

The writer is chairman of global affairs at FTI Consulting, and former UN deputy secretary and head of the UN Development Programme

There was a certain inevitability about the Greek bail-out deal struck in the early hours of Tuesday morning in Brussels. The negotiators clearly decided to stick to coffee for themselves, and bread and water for the Greeks, rather than reaching for bottles of Mort Subite [Sudden Death], a Belgian beer worthy of its name. When the brinkmen get so close to the edge, as they did last week, they rarely jump.

There were some surprises, though. The unfortunate banks were asked to undergo yet another short back and sides. The central banks have agreed to disgorge some profits, to support lower rates for Greece. And some other creative accounting measures have brought the projected level of debt to GDP down to within a whisker of the magic 120 per cent number.

On Tuesday morning the markets opened as usual and begun to trade. But the notion that the day’s trading will be a meaningful verdict on the deal is fanciful, because we are now in territory where the markets have no particular wisdom. They cannot begin to answer the three outstanding questions, which will determine whether this latest deal is a turning point, or yet another false dawn on the slippery slope to default and “Grexit”, an ugly but vivid term coined by Willem Buiter of Citigroup.

The first question is – can the Greek government retain control of the streets? So far they have done so, but the mood in Athens and elsewhere is volatile.

The second is – what kind of government will be elected in March? Wolfgang Schäuble, the the German finance minister, betrayed his anxiety about the election outcome when he suggested an Italian-style technocratic administration. That was always unlikely, but Mr Schäuble has made it impossible. So next month’s elections will be crucial, and there are signs that the parties that have distanced themselves from the negotiations will do well. But a fragile coalition may not be able to deliver the dramatic spending cuts the deal implies.

Only the third and final question is economic in nature. Will the Greek economy pull out of its free fall and begin to stabilise this year? Even the strongest advocates of the terms of the Greek rescue recognise that austerity will only take us so far. Unless there is a return to growth before too long, the debt mountain will continue to grow more rapidly than the Troika can shovel it away.

Here the signs in Greece itself are not optimistic. If anything, the contraction has gathered pace in recent months. But some of that may be confidence-related. The optimists may also look to some tentative signs that the US is recovering more rapidly than foreseen, and the eurozone is not slowing as sharply as feared, to suggest that the global climate may be warming a little.

The odds on a happy end to this story? One would have to say that they remain quite long. The scale of internal devaluation required will impose severe strains on the social capital of a country whose stock is already low. But they are perhaps a little shorter than they were last weekend.

The writer is a professor at the Institute of Political Studies (Sciences Po) in Paris.

Ptolemy’s theory of the universe held that the earth was at its centre. All other celestial objects – including the sun – rotated around it. It was, of course, nonsense. Copernicus later came along with his far-superior heliocentric system. Luckily, he died before anyone could be offended by his theory. Galileo, a supporter of Copernicanism, was not so fortunate, ending up under house arrest under suspicion of heresy.

The eurozone is in danger of shifting towards a Ptolemaic system with Germany at its centre. But, like Ptolemy’s theory, a German-centric eurozone may wilt under close scrutiny. It requires economic adjustment by others to protect the interests of German taxpayers and voters. That, however, makes the system as a whole increasingly unstable.

Consider, for example, the need for improvements in competitiveness in the so-called peripheral nations. What does this actually mean? Presumably, the likes of Italy and Spain would have to have inflation rates – both of prices and of wages – significantly lower than the eurozone average. That, in turn, would require countries such as Germany to accept inflation rates well above the average.

In a Ptolemaic system, however, the good men and women of Berlin, Bremen and Bonn might simply dig their heels in, refusing to tolerate what they could regard as an unacceptable loss of price stability in Germany. The competitive adjustment within the eurozone would then either fail, or come about only after further painful austerity measures deliver excessively low inflation rates across the whole eurozone.

The Ptolemaic version of the eurozone also requires lopsided adjustment of so-called imbalances. It is more important, apparently, that the southern European nations reduce their current account deficits than that the northern European nations reduce their surpluses.

Perhaps the idea is that the eurozone as a whole should run a bigger surplus with the rest of the world (in which case, the terms under which the rest of the world runs a bigger deficit with the eurozone have yet to be enunciated). If, however, the adjustment in the eurozone is to take place via shifts in competitiveness, it follows not only that the real exchange rates of southern Europe should decline but, also, that the real exchange rates of northern Europe should rise. We are back to the need for different inflation rates in the north and south.

The Ptolemaic system also requires a skewed view of bond markets. High yields in the periphery and low yields in Germany and other core nations are two sides of the same coin. A flight to “quality” has both punished the periphery and rewarded the core. This is as much a reflection of concerns about the euro’s survival as it is an indication of excess borrowing in individual nations. Yet those who benefit from the euro’s systemic weaknesses – Germany, with its remarkably low borrowing costs is surely a prime example – choose instead to talk only about the potential costs associated with bailing out others.

The Ptolemaic system needs to be replaced. This is not an issue concerning Greece alone, even if investors remain focused on the minutiae of austerity, bail-outs and debt haircuts. It is, instead, about the need for adjustment by those who appear to be in strong financial position.

Germany can play its part, encouraging domestic demand to grow more quickly, allowing its real exchange rate to rise with a more tolerant approach to inflation, ensuring that its current account surplus is invested not in potentially-worthless chunks of peripheral debt but, instead, in factories in southern Europe and welcoming migrants from southern Europe as they try to escape from unemployment.

In other words, we need to drop Ptolemy and come up with a theory of eurozone relativity.

The writer is HSBC Group’s chief economist and the bank’s global head of economics and asset allocation research. He is a member of the Financial Times Economists’ Forum

You would be forgiven for being confused about the state of the British economy. The recent economic news is mixed and experts are divided in their views of the future.

On the positive side, the Bank of England’s latest inflation report forecasts a bumpy, but sustained pick-up, in economic growth in 2012. However, Moody’s recently changed its outlook on the government’s triple-A rating from ‘stable’ to ‘negative’ indicating a 30 per cent chance of a downgrade over the next 18 months. In the face of this uncertainty, UK companies are hesitant to invest the £730bn on their balance sheets as of last September, as Martin Wolf notes in his column on Friday.

The contrasting perspectives given by “stock” versus “flow” analyses contribute to the confusion. This difference is particularly relevant after a financial crisis when the stock of debt has ballooned and is not yet on a sustainable path. Britain’s public debt was an easily manageable £500bn in 2008 but it had doubled to £1,000bn – about 75 per cent of gross domestic product – as of last month. It will continue to grow as long as the budget is in deficit. While the fiscal squeeze is now reducing the deficit, this year the government will still have to borrow about one-quarter of what it is spending. It is hardly surprising that a credit-rating agency such as Moody’s warns that the economic signs it watches are more likely to get worse, than improve, over the medium term.

However, for most people, most of the time, economic flows are more important than stocks. British households took on a lot of debt during the housing boom of the last decade. The household debt-to-income ratio rose from 115 per cent to 160 per cent. However, the lower interest rates and inflation during this period meant that the share of household income spent on interest payments only rose from 13 per cent to 18 per cent. Since then, falling interest rates have brought the debt service ratio down to 11 per cent, although household debt has fallen much more slowly. In short, the higher debt was sustainable because servicing the debt was affordable.

The same dynamic is now at work with Britain’s public debt. The combination of tight fiscal constraints – to slow the growth of debt and then reduce it – and the Bank of England’s asset purchase programme – to keep interest rates on gilts low – is giving Britain the breathing space it needs to both deleverage and grow. The signs of revival in consumer confidence surveys and growing corporate interest in mergers and acquisitions may be the ‘green shoots’ that show this strategy is working.

Meanwhile, imminent budget decisions loom for the Chancellor. His first priority must be to keep his side of the policy bargain. There should be no relaxation in the aggregate fiscal stance. Any giveaways must be funded by new taxes or cuts elsewhere. Second, he should use his public platform to reverse the unfortunate perception that the coalition is anti-business and more concerned about redistribution than growth. This means pressing ahead with reform of the planning system which has been identified through independent research as the single biggest obstacle to small business expansion and job creation. It also means providing more certainty – perhaps a moratorium – on taxes that affect internationally-mobile investment and high-income professionals and entrepreneurs.

Finally, he should use whatever scope he has within his fiscal envelope to support retraining and apprenticeships for the motivated unemployed. This will help the short term rise in unemployment and address the long term skills gap which constrains Britain’s productivity and worsens income inequality.

The writer is chairman of Chatham House and a former member of the Monetary Policy Committee of the Bank of England

Wednesday’s release of the minutes from the January Federal Reserve meeting was one of the most anticipated ever. The wait proved worthwhile as the minutes did not only help explain historic Fed decisions (which was surely needed given the scale and scope of recent policy innovations). They also shed light on the future of its balance sheet operations and some of the challenges that its unusual policy activism faces in this fluid economic and political environment.

The central bank made history in a number of ways last month. It took transparency to a new level by publishing the policy rate forecasts of the individuals serving on the Federal Open Market Committee, and told us their expectations regarding the next rate hike. In addition, the FOMC members signalled that, collectively, they expected interest rates to remain “exceptionally low” (defined as under one per cent) all the way out to the end of 2014, if not beyond.

Each of these steps would have been deemed unthinkable not so long ago. Together they constituted a major historical evolution in how far this central bank is willing to go in its attempts to influence economic outcomes at a time when its rates are floored and its balance sheet has already expanded to an astounding 20 per cent of gross domestic product. Thus there is great interest in the official thinking underpinning all this.

Given the various views expressed in the minutes (ranging from “almost all” participants to “one” member, with lots of “several,” “some” and “a few” in between), this is clearly a group with diverse opinions. It tries hard to reach a consensus that, most likely, is heavily influenced by chairman Ben Bernanke himself.

It is difficult to avoid the impression that members are navigating, to use some Bernankisms, an “unusually uncertain” outlook with a less than robust assessment of the balance of “benefits, costs and risks”. They are also having to use imperfect policy tools.

Based on the information available to them, they did not wish to infer too much optimism from the recent improvement in US economic data. Indeed, and despite the inevitable uncertainties that accompany unusual policy activism, they seem inclined to do even more.

A few FOMC members already see a need for QE3 or “the initiation of additional securities purchases before long”. Others would go along with this if the economy were again to lose momentum or if inflation remains well behaved. The majority is keen to be even more transparent, with several seemingly interest in providing numerical inflation and unemployment thresholds that would govern the timing of future policy moves.

You should have no doubt. Wednesday’s minutes confirm that the Fed remains one of the most activist, imaginative and audacious central banks in the world. Motivated by the uncertain economic outlook and the reticence of other policymakers who are much better placed to remove impediments to growth and job creation, it feels compelled to do even more to boost the US economy. Yet its ability to deliver good outcomes is tempered by the fact that it is experimenting, deploying untested tools with inadequate support from other policymakers.

The bad news is that we will not know for a while whether the Fed’s unusual activism will work. However, when the time finally comes – and here is the good news – historians will have an unusual amount of information to understand the content in which innovations and important decisions were made.

The writer is the chief executive and co-chief investment officer of Pimco

When discussing Greece, some policy officials and market participants have suggested that ‘the markets are now better prepared to deal with a default’. When was the other time such statements were being made? Probably in mid-September 2008, a few days before the collapse of Lehman Brothers.

If there is one thing to learn from the past five years, it’s that financial contagion operates in unexpected ways, especially after a major shock such as the failure of a major financial institution or the default of a country.

Even if markets have prepared for the possibility of a default by Greece, the practical consequences of such an event can be of a much higher order of magnitude.

First, Greece would most probably have to exit the euro, as it would have no other way of financing its current expenditures other than to print its own money. Capital controls, bank holidays and nationalisations would be required to try to counter a run on the banking system. Litigations between creditors and debtors would rise exponentially. The social and political stability of the country would be in grave danger.

Second, the political crisis would spread to European institutions because of their inability to solve the problem. The losses experienced by taxpayers in other countries would fuel opposition against financial assistance to cash-strapped countries. The prospects for further strengthening the European Financial Stability Facility and the European Stability Mechanism would be weakened, and the safeguards against contagion seriously undermined.

Third, creditors would be further discouraged from investing in the eurozone, given its inability to manage its debt problems. Contagion could extend to the core of the euro system.

Fourth, the financial tensions around the euro would produce a serious blow for the economic recovery not only of Europe but also the US and Japan, and possibly in emerging markets. Public finances would further deteriorate in several countries, increasing the risk of a sovereign default. The world economy could plunge back into recession, as after the Lehman Brother’s bankruptcy.

So what should be done to prevent such a scenario from occurring?

Greece does not suffer from a typical balance of payment problem that can be dealt with short to medium-term adjustment and financing. It has a major structural problem that can be resolved only through a combination of macroeconomic, structural and social measures. It also needs prolonged technical assistance to be consistently implemented over the next decade. Even if it follows the agreed programme in full, Athens is unlikely to be able to access the markets for several years.

What is required is much more similar to the kind of programme that the International Monetary Fund applies to low-income countries, under the Poverty Reduction and Growth Facility (recently renamed Extended Credit Facility), with official financing provided for several years, at concessional terms to ensure debt sustainability. Strong conditionality has to be implemented, in line with the IMF practice for this type of programme, but not under the threat of continuous default that alienates the political support in Greece for the right policies and fuels instability in financial markets.

This avenue raises three fundamental issues. First, it is costly. But the alternative is even more costly, for everyone. Second, other debtor countries may be tempted to seek the same concessional conditions as those granted to Greece. But European authorities have stated that Greece is unique. They should stick to that commitment. In addition, other countries are unlikely to want to get into the dire situation Greece is in, just for the purpose of obtaining more concessional conditions. Third, at this stage of the negotiation, it might be too late to introduce such a game changer. But it’s never too late to try to avoid a disaster.

The writer visiting scholar at Harvard’s Weatherhead Center for International Studies and former member of the ECB’s executive board

Anne-Marie Slaughter, former director of policy planning at the US state department, talks to Gideon Rachman about arming the opposition and why it could lead to a drawn-out civil war.

After weeks of teasing the French voters Nicolas Sarkozy is set to fire the starting gun on Wednesday evening. He will, as expected, be a candidate for his job.

The rest of the field is still not settled. Marine Le Pen is having trouble securing the necessary 500 signatures from elected officials. But we should assume that, one way or another, her name will be on the ballot, along with the socialist François Hollande, the Green Eva Joly, centrist François Bayrou, left socialist Jean-Luc Melenchon, Dominique de Villepin, who might best be described as “ailleurs” (elsewhere), and one or two representatives of the more exotic fauna of French political life.

The dynamics of this eclectic group are complex. Le Pen fille is doing even better than Le Pen père did last time at this early stage of the game. There is a nightmare prospect for the centre-right of a second round between her and Mr Hollande, especially if Mr Bayrou continues to eat away at Mr Sarkozy’s support base. If that happens, the Socialists will win easily, as Jacques Chirac did when Lionel Jospin failed to make the cut. That precedent makes the nightmare less likely, so the assumption remains that Mr Sarkozy and Mr Hollande will be there for the face-off.

The outcome of that confrontation is very far from certain. That can, without a shadow of doubt, be credited to Nafissatou Diallo. The polls are as clear as they can be that if Dominique Strauss-Kahn had stood in the Socialist interest he would have won easily. The observation is the starting point for many conspiracy theories, but they are unlikely to play an important part in the campaign.

It means, though, that Mr Hollande carries a burden. He is known to be the party’s second choice, and would have stood aside had Mr Strauss-Kahn been available. He has never been elected to a significant political office. Ségolène Royal, his former partner, seemed likely to be another sort of burden, but she has now decided to campaign, even though she refers to the father of her three children through gritted teeth as “le candidat”. Angela Merkel seems likely to be a more enthusiastic supporter of the rear half of the Merkozy horse which has kicked its European partners into line at a succession of summits over the past year.

Nonetheless, Mr Hollande’s hand contains three important trump cards. His ace is that recent elections across Europe suggest that voters are in the mood to kick incumbents out, whatever their political colour. There has been regime change in Spain, the UK, Ireland, Portugal, Hungary, indeed wherever you look except Belarus. The Socialists have clean hands. Their own policy proposals, shall we say, need some further elaboration, but that may count for little if the French economy continues to soften.

That is Mr Hollande’s second trump. Mr Sarkozy unwisely made the maintenance of France’s triple A rating a policy goal – an odd decision for someone who simultaneously reviles the rating agencies for their inconsistency and general boneheadedness. More importantly, the eurozone crisis has exposed weaknesses in the French economy. In the first decade of the euro, France competed well with Germany. Their growth rates were similar, and France’s hourly productivity is higher than united Germany’s. But, although the last quarter’s figures were better, a worrying divergence has opened up recently, evidenced by a rapidly deteriorating current account balance. French unemployment is rising as Germany’s falls. The back legs of the pantomime horse are struggling to keep up.

The third trump is one whose value is still to be determined, and may settle the outcome. It is the personality of Mr Sarkozy himself. Even those French voters who respect their president for his energy, intelligence and ambition, and who are reluctant to vote for the left, exhibit little affection for him. There are signs that he is well aware of this problem, but struggles to respond effectively.

A feature of the phoney war of the last two months has been a series of revelations from off-the-record briefings Mr Sarkozy has given. They have appeared under the (to me) mysterious rubric “le ‘best of’ du off” in the Nouvel Observateur and elsewhere. (These days my English isn’t really good enough to enable me to work in France).

Mr Sarkozy confides that he made mistakes in his early years. His private life was too flashy and preoccupying. He thinks he gave the French people the impression that he had “abandoned them”. Whether voters of the middling sort in Lyon or Lille would put it quite that way is moot. French presidents tend to exaggerate the emotional connection they establish with their citoyens. Nonetheless, it is the case that Mr Sarkozy has never quite been accepted as presidential. Cheap shots about built-up shoes, which the French largely disregard are beside the point. But the affection and respect that has carried most fifth republic presidents into a second term is not in evidence.

Although he has made something of a recovery in the polls, and the official launch of the campaign will probably produce a further bounce, the polls are now against him. Whatever the outcome of the crisis in Greece, it is hard to see the economic news flow favouring incumbency in the next three months. So the campaign is Mr Hollande’s to lose. But his policy efforts so far suggest he could just manage that feat. He plans to renegotiate the new European treaty, which is highly unlikely to be possible, and wants the European Central Bank to lend directly to Greece, which it is legally unable to do. The presidential debates, in which he will have to clarify his views on the economy, and on Europe, may well be decisive.

The writer is a professor at the Institute of Political Studies (Sciences Po) in Paris.

Xi Jinping, China’s designated next leader, visits the US this week, in the middle of a divisive presidential campaign whose protagonists often find it convenient to blame China for America’s woes. He will face protests over unfair competition and currency manipulation, and tense discussions about human rights and security.

Chinese sensitivities, on the other hand, have been heightened by the election rhetoric and by US reaffirmation of its interests in Asia. Beijing is keen to strike a constructive note, urging collaboration to solve global problems. Such visits are also seen as an opportunity for Mr Xi to establish personal relationships, with planned side trips to Iowa and Los Angeles intended to show a softer, less formal side of the future leader. How Mr Xi is treated will be scrutinised. This will force Barack Obama and congressional leaders to weigh the pressures of partisan politics against the future of the relationship.

As to economic relations, there are two main threats. One is the increasing likelihood of a trade war. Recent US court verdicts forcing China to scale back production subsidies, along with draft legislation that would penalise China for currency manipulation, are aggravating relations. Many within China thought that the renminbi’s appreciation by some 30 per cent, coupled with a sharp decline in its trade surplus, would subdue criticism of its external policies.

Yet Beijing – which has benefited greatly from open markets – has little appetite for a full-blown trade war. The pattern of China’s growth is already shifting in ways that will moderate future trade imbalances. So Mr Xi will use the visit to reaffirm China’s intentions to step up imports and maintain its policy of gradual currency adjustments.

More worrying is the likelihood of a war over technology transfer that could dominate the relationship in future, as complaints mount from US companies forced to cede intellectual property rights as a condition for operating in China. This is serious because Beijing is intent on moving up the value chain and realises that production of more sophisticated products – especially control over their design and distribution – is where the real profits lie. IPads may be produced in China, but China sees that less than 5 per cent of their value is paid to Chinese assembly workers, with most high value components produced elsewhere and most of the profit accruing to Apple.

America, on the other hand, knows it must remain the undisputed leader in innovation if it is also to keep its global political and economic power. No wonder those politicians who can rise above the futile arguments over exchange rates worry more about technology transfer.

Increasingly, western firms think China overly aggressive in trying to acquire their technologies, but a cash-rich China sees little gain in welcoming foreign investors unless they can help it move up the technology ladder. Leapfrogging to “developed” status means relying more on indigenous innovation.

Yet the US pressure for clearer rules on technology transfer may be in the interests of both sides. For example, some US companies complain that China’s subsidies for green growth technologies – for example, the production of solar cells – are unfair. But many others see a growing Chinese presence as offering potential for profitable collaboration, creating jobs. China’s willingness to pour money into new technologies can drive down costs and make renewable energy technologies affordable to a much larger market. Those who see China’s involvement as the best chance for action on climate change would welcome the pairing of American innovation with China’s capacity for mass production.

So there is potential for productive discussion between Mr Obama and Mr Xi – provided Mr Obama does not begin with the usual complaints about misaligned exchange rates and unfair competition, but focuses on marrying America’s innovative strength with China manufacturing prowess. The US will underscore the need to respect the rules of the game – while China will note that these were established in a system where they had little say. China will also note that to offer US companies a more level playing field in China, there must also be more hospitable treatment of Chinese companies keen to invest in the US but deterred by what they see as unwarranted security concerns. These sentiments reflect the mistrust that has built up over years. The challenge for both sides is to turn sentiments around.

The writer is a senior associate at the Carnegie Endowment and a former World Bank country director in China

There is not much good news when it comes to managing the global system. The euro is (still) in crisis; trade talks are stuck; the Group of 20 has run into the sand; and then there is climate change – the greatest global challenge met by the greatest global short-sightedness. Or are we missing something?

Certainly, the 2009 Copenhagen conference ended in stalemate and the “climategate” affair has given sceptics a field day. Also, the financial crisis has turned attention away from the climate challenge. But, at a bad time in the news cycle just before Christmas, the parties to the UN climate convention, meeting in Durban, agreed that a global legally binding approach to controlling emissions would be undertaken, to be signed in 2015 and implemented from 2020.

Europe played a vital role in Durban. But the key shift was from China. Under pressure from vulnerable and poor states in Africa and elsewhere, it has shifted from naysayer to supporter of a global deal. The US found itself outflanked – with Saudi Arabia and Venezuela for company.

The challenge now is to avoid a repetition of Copenhagen. The world cannot afford three years of talks that founder at the last minute. Success in 2015 depends on several factors. First, we need to change the debate from being narrowly about climate to being broadly about resources. This means food, water and energy – on land and in the oceans. All three are obviously affected by climate change. All three interact in dangerous ways. Increasing our resource efficiency not only helps the climate but also will help our economy.

Second, Europe needs to show how low carbon contributes to our economic benefit not hardship. George Osborne, the UK chancellor of the exchequer, is fond of saying that “we will not save the planet by bankrupting the UK economy”. Of course we will not, but we can enrich Europe’s including Britain’s economy by putting ourselves at the head of a low-carbon revolution that represents an economic transformation at least as big as the entry of China into the global economy. Today, more than ever, Europe needs a common project to counteract the forces pushing it apart – leading the low-carbon revolution can be such a project.

Third, the debate needs to be rebalanced from “climate-makers” – countries that emit CO2 – to “climate-takers”, the people and countries that suffer from climate change. There are new political coalitions to be built here, aligning countries with common interests in a low-carbon future, outside the confines of the traditional monolithic UN blocs and balancing the powerful voices of carbon-burning industries.

Fourth, we cannot just hope for a shift in US politics on climate change. Barack Obama’s personal commitment is clear, but I do not know anyone who sees how a global agreement could get the necessary two-thirds support in the Senate. The Republican party is in the hands of the climate-change deniers. We need to work out how to accommodate the US without excusing them – or it will again become a pretext for others to refuse to move.

Fifth, national pledges of action made under the Cancún agreement of December 2010 need to be fulfilled. These do not get the world on track to keep emissions below the level likely to lead to a rise of 2°C this century, but they do provide a base on which to build.

Sixth, technological innovation is vital for action on emissions and for the political support necessary for transition to a low-carbon economy and society. The incentives – from prices to regulatory standards – need to be structured to drive investment and innovation in low carbon. This includes the vital issue of decarbonising energy supply. Europe and China could forge a remarkable low-carbon trade deal to promote low-carbon technological progress.

Seventh, there is the pressing issue of finance for adapting to and mitigating climate change. In Copenhagen, leaders made grand statements and pledged $100bn, but to date little real money has been committed. Not much will happen without finance and the right mechanisms for getting public support and private sector capital flowing to the low-carbon economy.

Finally, the scientific community has to rehabilitate itself. In 2014, the UN’s fifth assessment is set to report a significant worsening of the trends. But the communication of those facts and the strengthening of trust in climate science is critical.

Achieving a global deal will help, but a treaty is only as good as the actions countries take to implement it. Before the crisis, Britain enacted some of the world’s strongest pro-climate policies and was staking out a position as a leader in the green economy. We cannot let the age of austerity be the age of inaction – the climate will not wait. Reducing our dependence on foreign energy, investing in low-carbon infrastructure and innovating, and exporting, green technologies are critical levers for reviving the UK’s economy.

Low-carbon development raises issues of justice, security and prosperity. It is one of the hardest nuts to crack in the multilateral system. As leadership elections and transitions dominate politics in the next 18 months, this is a challenge the winners cannot be allowed to duck.

The writer was Britain’s foreign secretary and is a Labour MP

President Barack Obama’s budget for 2013 will set off a vitriolic battle. Republicans will rail against the Democrats’ “class warfare” and Democrats will rail against the Republicans’ “coddling of the rich”. Yet it is mostly for show. The rich will win in their fund balances while probably losing at November’s presidential polls, and the poor and working class will probably re-elect Obama but suffer a continuing decline in relative and perhaps absolute incomes.

Consider the bottom line of the Obama budget. The policy is to cut total primary (non-interest) federal spending from about 22.6 to 19.3 per cent of gross domestic product from 2011 to 2020, while revenues would rise from recession lows of about 15.4 per cent of GDP in 2011 to some 19.7 by 2020. Compare that with Republican congressman Paul Ryan’s budget a year ago. Mr Ryan’s budget aimed for about 17 per cent of GDP in primary outlays by 2020, with revenues at about 18 per cent of GDP. The difference is modest, but the important fact is this. Both sides are committed to significant cuts in government programmes relative to GDP. These cuts will be especially swingeing in the discretionary programmes for education; environmental protection; child nutrition; job re-training; transition to low-carbon energy; and infrastructure. The entire civilian discretionary budget will amount to only 2 per cent of GDP, or less, as of 2020, in the budget plans of both Obama and the Republicans.

There are far better alternatives for America’s future. Successful northern European countries spend much more as a share of GDP on early childhood development, family support, job training, science and technology, and infrastructure, and they raise higher tax revenues to pay for them. Through a better balance of private and public investments they achieve lower unemployment, lower trade deficits, lower budget deficits, less poverty, longer holidays, better child care, higher life expectancy and higher reported life satisfaction.

The true nature of Washington politics is thinly disguised by the heated political debate between them. Both parties depend on the money of rich corporate contributors from Wall Street, big oil, private healthcare, real estate, arms contractors and other corporate lobbies. Both cater to corporate desires, especially for tax cuts, unregulated executive pay and weak corporate regulation.

It is true that the parties’ economic policies are not identical. Mr Obama proposes to raise the top tax rate slightly from 35 per cent to 39.6 per cent. He advocates a minimum tax rate of 30 per cent on millionaires. These are modest measures and will be blocked by Republicans in Congress. He also resists even larger Republican cuts to programmes for the poor that are already on the chopping block. Yet Mr Obama also dangles the lure of further “tax reforms” to cut top personal and corporate income tax rates.

The plutocratic Republicans rail at Mr Obama’s modest proposals as if small tax increases or continuing small benefit programmes for the poor would end the liberty of America’s “job creators” – to use the Republican sobriquet for the rich. The public knows better. The public will likely back Obama for re-election, yet will earn thin rewards indeed for their successful vote.

Conceptually, US politics fits a modified version of the famous “median-voter theorem”, in which two political parties gravitate to nearly identical platforms to contest elections in the “middle”. In the US version, the parties converge not to the centre of public opinion, but well to the right of centre. They do so because electoral success depends not only on policy positions but also on raising huge campaign funds. Mr Obama has calibrated this well. His core constituencies of poor and working-class voters are the losers for it, though still better off than with a Republican president.

There are very high long-term costs to all this. Main street is in decline, despite the recent optimism over a revival of hiring. One of every two Americans is now in a low-income household. Only about one-third of Americans aged 25-29 have a bachelor’s degree, and the college completion rate falls to a distressing 11 per cent among young Hispanic men. Mr Obama’s policies are slightly more responsive to these realities than the Republican alternatives, but the larger truth is that a shrinking federal government will fail to meet America’s skill, education and infrastructure challenges.

Even as Democrats praise Mr Obama and Republicans castigate him for his headline proposals to tax the rich, the budget is actually more grim news for America’s poor and working class. The poorer half of the population does not interest the Washington status quo. A third political party, occupying the vast unattended terrain of the true centre and left, will probably be needed to break the stranglehold of big money on American politics and society.

The writer is director of the Earth Institute at Columbia University and author of ‘The Price of Civilization’

President Obama releases the politically-weighty final budget of his first term on Monday. It covers the fiscal year beginning October 1 and also contains long-term budget projections. However, none of the major proposals it contains will pass Congress in this presidential election year; it is as much a campaign document as an actual budget. The key budget date in 2012 is not now, but December 31. That’s when some major tax cuts expire, the mandatory budget cuts triggered last year commence and legislation raising the federal debt limit will again be needed.

So what does the President’s new budget tell us that is of interest? It may look different after the election, but, for now, enormous deficits will continue. Namely, a higher than expected $1,330bn for this year and $901bn for next year. As a share of gross domestic product, these deficits continue to be among the largest ever experienced. That translates into a grim outlook for federal debt, which currently exceeds 65 per cent of GDP and is widely expected to be above 90 per cent by 2020. Since 1789, it has been that high only during the second world war.

The main cause of these deficits is the financial collapse of 2008 and the Great Recession that followed it, which President Obama inherited. Federal tax revenues plunged, and higher countercyclical spending, such as unemployment insurance, was triggered. Indeed, the US economy is still very weak, having grown only 1.6 per cent last year. That’s why this new budget will propose one last round of fiscal stimulus ($350bn in tax cuts and spending increases) to accelerate recovery. That would be followed by $3,000bn of deficit reduction actions (half of which would come from tax increases on individuals), beginning next year. This approach of stimulus now and long-term deficit reduction soon thereafter is, in my view, the correct one.

Let’s return to the critical issue of timing. This presidential election year, in keeping with history, is not one for major tax and spending changes. Knowing this, the Obama administration has made Monday’s budget a framework for re-election. Indeed, it is consistent with the president’s recent more populist stance, especially in its call for broad tax increases on wealthy individuals.

But, there will be a profound budget moment on December 31 this year – one of the biggest in American history. This is the day when all of the Bush tax cuts expire, including the ones affecting the middle class. If these aren’t renewed, federal tax revenues are projected to rise sharply, by some $3,600bn over ten years. The date is also the starting point for $1,200bn of mandated discretionary spending cuts over the next decade, triggered by the failure of the Congressional Super Committee last November to reach agreement. Half of these will come from defence. And lastly, the date also marks the point when legislation to raise the federal debt limit, the object of much acrimony last summer, will be necessary again.

This confluence of important budget events is virtually unprecedented, especially during a lame duck Congressional session and just after a presidential election. It presents a golden opportunity for truly fixing America’s alarming deficit and debt trajectory. That’s because the new president, whoever he may be, can veto any new tax and spending legislation, such as an extension of any of the Bush tax cuts. But, December 31 is a world away, and it’s much too soon for that sort of optimism.

The writer is founder and chairman of Evercore Partners and former deputy US Treasury secretary, 1993-94

The Taliban’s public declaration that they will hold talks with the US after eleven years of war is a major break through for the political process. It is also vital for Afghanistan’s internal stability and the relative peace that America and Nato will need if they are to leave the country in good order and without too much bloodshed in 2014. But all the major players have a great deal to do before the pieces can be put together.

The clandestine talks brokered by Germany, fostered by Qatar, and starting with direct meetings between US officials and Taliban representatives, will hopefully conclude with a reconciliation with the Afghan government. The Taliban’s insistence that they will only talk with the Americans will probably be watered down. President Hamid Karzai’s policy flip-flops and contradictory statements mean that he is feeling insecure but not averse to the talks. The talks will go ahead because there is no other alternative to ending the war.

Attempts to calculate how successful western forces have been in combating the Taliban, notwithstanding heady announcements by Nato generals, are mired in considerable controversy. The ability of the Taliban to rebound from severe hits has proved them to be remarkably resistant to casualties, with a deep bench of commanders, logisticians, recruiters and administrators. They can still mobilise some 25,000 fighters for a summer offensive – the same as in 2005 and 2006. The sanctuary, support and logistics they receive in neighbouring Pakistan is directly linked to their survival.

The US and Nato are preparing to hand over control of the country in 2014 to the newly-trained 352,000 Afghan security forces and government representatives at the district level. However, an exit strategy is not a political strategy. That is precisely what is lacking for the future stability of Afghanistan and the volatile region that surrounds this landlocked country.

Barack Obama and Mr Karzai are entangled in a series of strategic conundrums that are far from resolved. The latter is determined to secure an agreement with the US and allow trainers and special forces to be based in the country well beyond 2014. America would like to do the same. The Taliban are vehemently opposed to any such agreement as it will appear to be targeted against them.

Mr Karzai will find it impossible to both conclude a strategic agreement with the US and a reconciliation agreement with the Taliban. The two are in direct opposition with each other.

Contradictory statements by the Afghan president on the issue of reconciliation and the opening of a Taliban office in Qatar suggest that this reality is now dawning on his government. Mr Karzai cannot be a partner to both the US and the Taliban, and expect the Taliban to buy it.

Mullah Mohammed Omar, the Taliban leader, will find it hard enough to sell the idea of reconciliation to his fighters. He will find it impossible to sell the idea of cohabitation with the Americans. Many Afghans, including Mr Karzai, want a prolonged presence of foreign troops to guarantee their security. There is not enough consideration in Washington or Brussels of this strategic conundrum.

With most of Afghanistan’s neighbours vehemently opposed to a prolonged US presence, Washington, Kabul and Nato can little to stop them interfering if the forces stay beyond 2014. We also don’t know yet what Pakistan will demand in return for restoring its relations with Washington, Kabul and helping the peace process.

A political strategy must include talks with the Taliban to help build confidence on both sides. It would help establish sorely-needed negotiations on power sharing between the Taliban and the Afghan government. However, the Obama and Karzai administrations are both deeply divided on talking to the insurgents and what concession to give them.

Secondly, an agreement among Afghanistan’s neighbours to limit their interference is vital. China, Russia, the five Central Asian Republics, Pakistan and Iran are against a long term presence of US troops. Only India is in favour.

Recently relations have deteriorated. There has been a collapse of relations between the US and Pakistan in the past six months, with the latter refusing to even meet with US officials. The crisis between Iran and the rest of the world regarding its nuclear weapons programme has further jeopardised any hope of Iran playing ball on Afghanistan.

Thirdly, Afghanistan needs greater internal political cohesion. Mr Karzai has failed to create a national consensus on talking to the Taliban, particularly with the opposition leaders of the former Northern Alliance, nor has he offered a vision for the future. Ethnic divisions could explode after 2014 and some experts predict civil war.

We cannot wait for the US, Nato and the Karzai administration to acknowledge these problems because they need to be addressed immediately, even before the summit in May. Nato has to be more constructive, proactive, flexible and honest in its planning than it has been so far.

The writer is the author of the bestselling book ‘Taliban’. His latest book, ‘Pakistan on the Brink: The Future of America, Pakistan and Afghanistan’, will be published soon

Growing up in India in the 1960s, I knew that America gave us wheat, and Britain gave us literature. One of my most vivid childhood memories is of watching Geoffrey Kendall’s Shakespearana troupe performing in my home town of Dehradun. Visiting my uncle in New Delhi, I saw a stack of elegant hardcovers on a table in his study, borrowed from the library of the British Council. Later, as a student at Delhi University, my own education in literature and history was largely shaped by the books from the same library. My uncle read V.S. Pritchett and A.J.P. Taylor. I preferred Anthony Powell and E.P. Thompson.

Those memories came back when, now temporarily living in London, I read the commentary in the British press about whether the UK should stop giving aid to India. Over the years, while the British Council libraries were allowed to run to seed, the Department for International Development supported rural health and education schemes. Several years ago, when Indian billionaires started buying British companies, calls were first heard for the dismantling of Dfid’s operations in India. Earlier this month when, despite continued aid activity, the Indian government said it might buy French warplanes rather than British ones, these calls were renewed.

The first contention, that its provision entails an exchange of favours, is incorrect: sovereign nations cannot easily be bribed into professions of loyalty to richer or more powerful countries. Lyndon Johnson expected that food aid would stop the Indians complaining about the carpet bombing of North Vietnam – it did not. The Bush administration poured money into Pakistan hoping it would co-operate fully in the war against al-Qaeda – the Pakistanis went along when it suited their interests, but acted otherwise when it did not. Barack Obama now thinks that threats to cut off aid will compel the new Egyptian regime to follow America’s policy on Israel – he, too, is likely to be disappointed.

The other argument is that India is now a rich country, and the Indians ungrateful (the foreign minister’s remark that British aid was “peanuts” provoked much outrage). This too is not entirely accurate. While the Indian economy grows at between 7 and 9 per cent per year, and there is a rising number of billionaires, several hundred million Indians are still desperately poor. And inequalities are growing.

Yet the primary responsibility for providing the poor with a social safety net and equality of opportunity must lie with the Indian state. It should improve its schools and hospitals, and provide safe housing for the large number of citizens without it. It should better use technology to remove leakages in the provision of targeted subsidies for the poor. And it should certainly be more energetic in taxing the super-rich.

There may still be a place for aid, but not, I believe, from any foreign government. The Indian elite, which likes to spend its spare cash on luxury mansions and private aircraft, must be shamed into doing more for their less advantaged compatriots. The example of the software entrepreneurs of Bangalore, who have generously supported initiatives in education and the environment, must be more widely emulated. Western charities and multilateral organisations must also continue their good work. India is now largely polio-free, thanks to a well-run government programme funded and monitored by the World Health Organisation and the Gates Foundation.

It is true that Britain and India have a somewhat special connection. No other relationship between a former imperial power and a former colony is so suffused with affection and so free of animosity. To maintain this spirit, the British would do well to focus on culture rather than economics or military hardware. Close down Dfid’s operations in India. Do not sulk when Indian entrepreneurs buy your companies or the Indian government buys guns or rockets from elsewhere. But, please, do restore and enhance the collections of the British Council libraries, and do send your best writers and (especially) actors on tours to India.

The writer is Philippe Roman Chair in History and International Affairs at the London School of Economics. His books include ‘Makers of Modern India’

After protracted negotiations, Greece’s prime minister announced on Thursday that agreement had been reached on a new adjustment programme. By all indications, it is a courageous and ambitious one that incorporates further painful austerity measures, substantial official financing and debt relief from private creditors. Yet the process that has led to this point is a worrying one, pointing to an uncomfortably high probability that this latest agreement will meet the same fate as previous ones – unravelling within a few months, and for legitimate reasons.

Greece’s seemingly endless negotiations are a function of two realities that complicate the decision making process and could derail the deal well before any of its durable benefits materialise.

First, it is never easy to reach agreement among parties with different perceptions and no common analysis. This is especially true in Greece where all three parties to the negotiations (the government, official creditors and private creditors) feel they have already been asked to do a lot, without seeing any actual or potential payback to their sacrifices.

Successive Greek governments have been forced into several rounds of austerity measures in the last two years. Yet every meaningful indicator of their country’s economic and financial state has worsened, both on a standalone basis and relative to what was anticipated in the series of adjustment programmes.

Official creditors have poured money into the country. In the process, national politicians have faced considerable domestic opposition, including in Germany. They have also risked the integrity and credibility of the European Central Bank and International Monetary Fund.

This official financing has done little to improve Greece’s long-term prospects and, rather than attracting new private financing, it has enabled some existing private creditors to get out at maturity with no principal losses. Meanwhile, those that still have Greek bonds complain that every time they have agreed to a haircut on their holdings, starting with a 21 per cent cut last October, other parties have moved the goal posts.

The second factor complicating the process is that no party sufficiently “owns” the adjustment programme. This is likely to prove a problem yet again.

The history of debt crises suggests that weak ownership translates into a lack of conviction. As a result, principals – be they government leaders, the ECB and IMF, or those negotiating on behalf of private creditors – find it very difficult to sell the agreement to constituents. No wonder macro agreements have often unravelled when presented to the many groups that must implement them in a sustained fashion.

Weak ownership also undermines the many corrections that are needed over the course of an adjustment programme. Only pure genius or enormous luck could produce a perfectly-designed Greek programme. It is almost inevitable, given the fluidity of the situation in Greece and the global economy, that whatever is agreed will need tweaking in the implementation stage. Without conviction, these mid-course corrections will serve as an opportunity to exit an imperfect agreement rather than to adapt and improve it.

I suspect that all three parties to the negotiations know in their hearts that their latest agreement, as brave as it is, will only last a few months at best. Yet no one wants to be seen as responsible for a change in course at this stage, fearing they could be blamed for a disorderly default in an advanced economy and a potential exit from the eurozone.

While welcoming the latest agreement on Greece, we should recognise that regrettably it stands only a small chance of placing the country on the path to high growth, ample jobs and financial stability. Based on available information, it appears to do too little to promote growth, still leaves the country with an excessive medium-term debt burden, and is unlikely to attract the new external inflows needed to fund new investments in productive and employment-creating sectors.

What Greece needs is a fundamental economic, financial and institutional reset.

Such resets are not easy, and they are neither immediate nor without considerable risk. But until they happen, repeated rounds of protracted negotiations are the rule rather than the exception – as are derailed agreements, finger pointing and disruptive blame games.

The writer is the chief executive and co-chief investment officer of Pimco. A longer version of this article is on the Opinion page

Roger Altman, former US deputy Treasury secretary, tells to John McDermott, FT’s executive comment editor, that America has more economic potential than any other country but it’s too soon to tell if the strong growth rate can be maintained.

Amid all the chest thumping and finger pointing about the failures of capitalism, let’s not forget the responsibility of governments across the globe. They relaxed regulatory requirements, turned blind eyes to dangerous – and in some cases, illegal – activities and indulged in their own excesses.

Capitalism is like an energetic small child who needs rules, boundaries and discipline. If a toddler accidentally sets his home on fire, it’s the parents who bear the blame. “Capitalism in crisis” could easily be subtitled “government in crisis”.

I’m not trying to excuse capitalism or its principal actors from a generous portion of the blame for the all too vivid pain of the past four years. Serious alterations are needed, only some of which have been put in place.

But government has also seriously let us down. The current mess in the eurozone is hardly the fault of capitalism or the financial system. Public officials who created the euro went ahead with the hare-brained scheme of their own accord. Indeed, many financiers (myself included) proclaimed loudly that the euro was ill-designed and likely to run aground.

Then, while the peripheral countries such as Greece were gorging themselves on cheap money, even the Germans turned a blind eye. It was no secret that Greece’s debt was exploding as it doubled government wages, expanded public job rolls by tens of thousands and even spent $14bn on the 2004 Olympics, more than twice what was budgeted.

Imprudent public finances were not limited to Greece. Countries throughout Europe burst through central government budget ceilings. Many were recently repaid with ratings downgrades.

Yes, a measure of increased public spending was needed to combat the recession that accompanied the financial meltdown. But in the case of the US, because of poor tax and spending policies in the seven preceding years, the nation went into firefighting mode with its tanks partly depleted, having squandered a fiscal surplus.

Or take the dramatic rise of global income inequality over several decades. That wasn’t a secret either, and yet, the US chose policy measures that exacerbated the problem rather than diminishing it. Tax cuts in 2001 and 2003 famously led to Warren Buffett’s secretary paying a higher tax rate than he did. In 1993, the 400 wealthiest Americans paid 29.4 per cent in tax; in 2008, it was 18.1 per cent.

By now, the failure of regulators to contain dangerous forces should be well accepted. In the US, deregulation gave rise to a series of problems, ranging from radioactive levels of leverage at securities firm to imprudent lending to homeowners.

For years, America has had consumer protections around everything from the safety of children’s sleepwear to interest rates on credit card borrowings. Yet, virtually no such help was provided to homebuyers as ever more tempting but ill-advised loans were dangled in front of them.

Nor were most overseers any better than their corporate counterparts at identifying the coming tsunami. In February 2006, Ben Bernanke, who has generally been an outstanding chairman of the Federal Reserve, said that “house prices will probably continue to rise”. Just five months later, they began their precipitous decline.

Undoubtedly the benefits of capitalism vastly outweigh its deficiencies. For all the recent devastation, no other economic arrangement could possibly have lifted the standard of living of so many so substantially in the postwar period.

More importantly, the global citizenry appear to agree. While past periods of extreme economic dislocation have often yielded demands for radical change, both Greece and Italy have installed technocratic prime ministers who are focused on correcting the past failures of government rather than imprisoning bankers.

So we must press on with fixing capitalism. My vote is that we devote equal attention to the public sector apparatus as to the evilness of business. Most urgently, an increasingly integrated global economy needs to be paired with global governmental structures. For example, while the various Basel accords have brought a measure of uniformity to bank reserve requirements, in other key areas, nations continue to go their own ways. The US has chosen to limit banks’ ability to engage in proprietary trading (the Volcker rule), the UK is separating deposit taking from trading altogether and some other countries have left their systems unchanged.

The rise of multinational corporations and lack of a global taxation regime has given rise to a race to the bottom in corporate tax rates, another contribution to growing income inequality. In the US, corporate taxes have dropped from 5 per cent of gross domestic product in the 1950s to 1.3 per cent last year.

According to a recent Edelman poll, substantial pluralities of citizens around the world believe business is not sufficiently regulated. If capitalists wish to avoid more regulation, they must get behind better governmental oversight.

The writer is former head of the US government taskforce that oversaw the federal bailout of Chrysler and General Motors.

As Europe’s debt crisis continues to demand undivided attention, the patient that is Europe has revealed a new wound: Hungary, where a slow-burn political crisis has finally come to a head. In recent weeks the forint has nosedived, stocks plummeted and debt yields spiked as markets sent an overwhelmingly negative message in response to the government’s willingness to jeopardise a potential European Union-International Monetary Fund safety net.

The new constitution that was rammed through parliament last summer took effect on January 1. In response to these developments, the European Court of Justice initiated an infringement procedure due to concerns over central bank governance, judicial independence and data protection, while the European Commission is looking to suspend the country’s cohesion funds on Wednesday. Rebukes have been forthcoming from among others, including Hillary Clinton, US secretary of state, and Human Rights Watch. Yet the EU’s moves will do little, if anything, to rein in the government’s push to centralise and consolidate power.

Viktor Orbán, Hungary’s prime minister, will formally respond to these concerns this week. But the markets and the international political and civic community are a little late to this party. Since his Fidesz party won an overwhelming parliamentary majority in 2010 it has been cementing its longer term influence. The renewed market discipline is welcome, yes, but much of the damage in Hungary has already been done. It will take much more to undo than investors and EU technocrats seem to appreciate.

Once agreed, the new EU-IMF programme will shore up Hungary’s financial position and provide a mechanism for the EU and the IMF to oversee (and where necessary, undo) economic policy and institutional measures that have hurt confidence. But this package will remain limited to economics and will do nothing to address the wider erosion of democratic governance.

The Fidesz party has pushed through vast changes since it took power. For example, a multitude of seemingly minor quasi-technical changes hailed as key to reforming Hungary’s electoral system serve to entrench Fidesz at the expense of smaller parties. And as discussed in our previous piece, the independence of each and every state institution has been systematically compromised, including the public prosecutor, the head of media board, state audit office and fiscal council. The central bank has been far from immune. The government’s recent “stability law” now entrenches basic elements of fiscal policy into the new constitution, which will require a two-thirds majority to change.

It is true that the EU institutions have now engaged. But the response is late and far from perfect, which speaks to the union’s limited arsenal for managing political miscreants once they are admitted to the club. Even with a EU-IMF programme in place, many of the key legislative pieces of Mr Orbán’s agenda will go unaddressed. In fact, it is Mr Orbán’s awareness of the EU’s futility that is impelling him to strike a deal in the first place.

Perhaps counter-intuitively, a final agreement between Budapest and the EU-IMF will only make the bigger political concerns in Hungary that much harder to combat. Here is why: market scrutiny is Europe’s best remaining weapon. But the sooner a deal is struck, the sooner market pressure will recede and the more likely Mr Orbán will feel once again emboldened to pursue his agenda. Softer policy tools, which ironically have sharper impact, such as sustained pressure from heads of state or representatives in the European parliament, have not yet been leveraged as effectively as they could or should have been.

And don’t look to domestic political opposition. Despite a slide in support for Fidesz, this has not improved their opponents’ prospects. They remain internally divided and have incoherent policies. Furthermore, Fidesz’s waning popularity has not generated fissures within the party: Mr Orbán has handpicked MPs and party leaders. They remain faithful, continuing to believe the country’s problems stem from the corruption and mismanagement of previous socialist governments, the debt crisis and an international conspiracy to undermine a strong and independent Hungary. While a new civic movement is certainly emerging, no opposition political party has yet stepped up to officially carry its voice.

So, this government will continue to be erratic, even with an EU-IMF programme in place and more oversight from European institutions. The underlying character of this government will not change. At most, the concessions it offers will amount to a tactical defeat for Mr Orbán. But they are unlikely to stop him seeking to entrench Fidesz’s longer-term influence.

This article was co-written with Mujtaba Rahman, a Europe analyst at Eurasia Group. Ian Bremmer is president of Eurasia Group and author of ‘The End of the Free Market’

Capitalism itself is not in crisis, but western capitalism is. This is a result of three strategic mistakes.

The first error was to regard capitalism as an ideological good, not as a pragmatic instrument to improve human welfare. Alan Greenspan was probably the greatest victim of this ideological conviction that markets always knew best.  The former chairman of the Federal Reserve fully agreed with the Reagan-Thatcher thesis that governments should step aside and let the markets roll. As Mr Greenspan also believed that market traders were smarter than government regulation, and he failed to regulate them vigorously. This has wreaked havoc on the world. But no Asian society, not even Japan, fell prey to this ideological conviction. Instead, Asians believe that no society can prosper without good governance. Indeed, in a way many of them have understood Adam Smith’s message better. As he wrote in The Wealth of Nations, “the interest of the dealers … however, in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public.”

For capitalism to work well, governments have to play an essential regulatory and supervisory role. This was forgotten by many western governments. To make matters worse, the west spawned a huge new financial services industry that was widely perceived to have added a lot of “value”. For a while, like all good Ponzi schemes, the industry seemed to create a lot of new wealth. Yet it is now clear that it added no real new value. Andrew Sheng, former Hong Kong central banker, has said, “how do financial engineers make five to ten times more salary than physical engineers year after year? Is there magic in the financial institutions’ ability to create return on equity that is significantly higher than real-sector companies like automobiles or energy? The answer is that they create risks through leverage and interconnectivity which, every ten years or so, become realised losses that are fully underwritten by the public sector through tax bail-outs. The financial sector is being subsidised by all the holders of financial paper through zero interest rate policies. Their liabilities are still guaranteed by central banks. Finance has become the biggest free rider of all time.”

This huge industry was allowed to “capture” the regulators whose duty it was to control and supervise its activities. AIG, which could have single-handedly destroyed the global economy, was allowed to choose a small regulator in Delaware to regulate its trillion-dollar operations. No one in Washington batted an eyelid.

The second strategic error was to forget the lessons that European capitalists learnt from the Marxist threat of the early 20th century. For capitalism to survive, all classes had to benefit from it. Social democracy was the European response to the threat of communism. Wages and welfare benefits of workers were increased. The capitalists became rich but the workers also gained. Even American capitalists, who were clearly not enamoured with the social democracy experiment, saw the value of increasing wages. According to Lee Iacocca, Henry Ford “shocked the world with what probably stands as his greatest contribution ever: the $5-a-day minimum-wage scheme. The average wage in the auto industry then was $2.34 for a 9-hour shift. Ford not only doubled that, he also shaved an hour off the workday.”

Sadly, all the lessons that the west learnt then have been forgotten. Chief executives at some of America’s largest companies earned an average of $11.4m in total pay – 343 times more than a typical US worker, according to a report by AFL-CIO, the labour federation. This rising inequality was a big challenge. Rising unemployment was an even bigger challenge. Asian governments fought off unemployment by creating incentive schemes to promote investment and employment. Western governments dismissed this as “industrial policy”, an ideological heresy. And when western workers suffered, the capitalists retorted, “markets know best.” Perhaps the time has come to for the west to learn from Asia how to manage the existential challenges of the capitalist system.

The third error made by the west was to aggressively promote the virtues of capitalism to the third world, including Asia, without realising that it had to educate its own populations on the critical concept of “creative destruction”. Economics textbooks correctly pointed out that when the automobile was invented, the horse and buggy industry had to disappear. And when digital cameras emerged, Kodak film had to go. Yet, the masses were never told that they would have to learn new trades and skills as new competitors emerged from China and India.

Hence, when manufacturing declined from 27 per cent of US gross domestic product in 1950 to 11 per cent in 2009, no policymaker took note or corrective action. Nor did American leaders warn that workers would have to be helped to find new skills and jobs.

For all its flaws and defects, capitalism remains the best system to improve human welfare. This is why the whole world (barring North Korea) has accepted it, in one form or another. But it is also an inherently imperfect system, as Adam Smith warned us from day one. It requires careful government regulation and supervision. Asians never forgot this. The west did. Hence, the time may have come for Asians to reciprocate the generosity of the west in sharing capitalism with Asia. Western policymakers and thought leaders should be invited to visit the industrial complexes and service industries of Japan and Korea, Taiwan and China, Hong Kong and Singapore. There may be a few valuable lessons to be learnt.

The writer is dean of the Lee Kuan Yew School of Public Policy at the National University of Singapore, and author of ‘The New Asian Hemisphere’

On Saturday Russia and China put their cards on the table. They vetoed the Arab League’s plan for resolving the Syrian crisis, a plan that asks president Bashar al-Assad to step down in favour of his vice-president, the formation of a unity government and free elections. They are putting their money on Mr Assad, betting that he can crush the political opposition movement and growing rebel forces spreading across his country if he is just willing to be brutal enough. In 2005 both nations approved the ‘responsibility to protect’ doctrine, which allows the international community to intervene peacefully or militarily in cases in which a government commits genocide, crimes against humanity, grave and systematic war crimes, or ethnic cleansing against its own people. A year later they voted for a Security Council resolution that affirmed the doctrine. But when it comes to the Syrian government’s murder of thousands of its own people, sovereignty trumps humanity.

So what now? A little time remains for continued diplomatic efforts aimed at shifting the allegiances of the Sunni merchant class in Damascus and Aleppo. Syrians in London, Athens, Cairo, Canberra and several other countries demonstrated in front of their own embassies to protest the most recent atrocities in Homs. It is possible that diaspora communities will relay information to their families back in Syria that contradicts the government’s account of a conspiracy by armed gangs and foreign forces to depose the Assad regime. The Arab League could co-ordinate a mass withdrawal of ambassadors from the region and beyond. They could also move to suspend Syria from the Organization of the Islamic Conference and other international bodies. They should not seek the indictment of Mr Assad and other top Syrian officials by the International Criminal Court – an indictment at this point would significantly decrease the chances that he could be forced from office in a political solution.

Within Syria and among foreign policy mavens with ties to the opposition, the presumed and desired next step is for the Arab League nations, Turkey, and other Nato countries to arm the Free Syrian Army, the loose coalition of groups of soldiers who have defected from the military and those members of the opposition who can get and use weapons. That path leads to certain civil war. Until now the FSA has operated mainly defensively, consistent with its original mandate to protect unarmed protesters from armed government forces. But the more the FSA goes on the offence in a drive to topple the government, the more the Mr Assad’s supporters will pull together and the more the conflict will divide along sectarian lines, with Druze, Christians, Alawites and possibly Kurds fighting Sunnis. This is exactly the scenario the government is determined to depict. Add in Iranian, Russian and Hizbollah support for the regime and the war is likely to be long, brutal and hugely destabilising for neighbouring countries.

An alternative, which in my view is still possible notwithstanding Saturday’s vote, is a military intervention by troops from various Arab League countries and Turkey to create safe zones for civilian protesters and all soldiers who wish to defect from the army. The sponsoring countries would have to make clear through every means possible within Syria itself that the goal of the intervention is to protect the population until a political settlement can be reached. That would not include arming the FSA. The point would be to stop the killing rather than to enable it on both sides.

The choice between these scenarios (assuming political will exists among Syria’s neighbours for taking up arms rather than sending them to FSA) should depend on which strategy saves more lives and is least destabilising to the region. Yet we must also make no mistake about the costs of inaction. According to Wendell Steavenson, a reporter for the New Yorker, when Rifaat al-Assad, who oversaw the massacre of tens of thousands of Syrians in Hama in 1982 but now lives in exile, was asked whether he would condemn the Hama action today, he replied: “We couldn’t have succeeded without doing it.” His nephew is facing a similar choice today and has given every indication that he is equally determined to succeed.

Hillary Clinton, US secretary of state, said on Sunday that the friends and partners of the Arab League would continue to work with it to press for a political settlement and to provide as much direct humanitarian assistance to the Syrian people as possible. William Hague, the UK’s foreign secretary, said that the League did not need the UN’s endorsement to continue with its work. That is the right stance. The Arab League and Turkey must remain in the lead. Even creating a contact group along the lines of the one created to co-ordinate assistance to Libya, as Ms Clinton suggested, would be likely to buttress Mr Assad’s foreign conspiracy narrative. The proper lesson to draw from Saturday’s vote is not the veto, but the remarkable degree of support for the Arab League’s plan from the thirteen other members of the Security Council, including Morocco, Pakistan, and Azerbaijan (all Muslim nations), Colombia, South Africa and India. The US and Europe should broadcast that support as directly as possible to the Syrian people, expand and tighten sanctions and exclusionary measures aimed at the Syrian elite, and provide all necessary assistance in a supporting role.

The writer is the Bert G. Kerstetter ’66 University Professor of Politics and International Affairs at Princeton University and former director of policy planning for the US state department

There are three ways to read the eurozone’s focus on austerity.

The first is that its leaders genuinely think that the current crisis is rooted in non-observance of the stability pact. But it is hard to believe that this could apply to countries such as Spain or Ireland, which always stuck to the rules. The second is that treaty-based discipline is the precondition for a fiscal union and the issuance of eurobonds. But is it wishful thinking enough to commit to retrenchment without any certainty that the next step will come?

The third is that consolidation in southern Europe is the cornerstone of a broader strategy of economic reforms, which in turn will contribute to competitiveness. It is hoped that governments caught between market pressures and fiscal tutelage will realise that the only path to economic growth is to implement long-delayed structural decisions. Seen in this light, austerity is not (or not only) an end in itself but also the driver of a broader transformation. The question is, can it deliver?

Buffers from market pressures can indeed slow down reforms. This was vividly illustrated last August when Rome backtracked on tax reform commitments a few days after the European Central Bank started buying Italian bonds. However, austerity and reform are not always complementary. Germany implemented reforms under Gerhard Schröder (but without austerity) in the 2000s, and then austerity under the Merkel-Steinmeier coalition (but without reforms). Governments under extreme intense pressure may have no choice but to do everything at once, but when political capital is scarce, prioritising fiscal consolidation is usually at the expense of reforms. Reforms may also involve budgetary costs, if those who lose from them need to be compensated.

Governments also need to show their citizens that effort pays. If, after a few quarters of fiscal adjustment and painful reform, the situation and outlook are only worse than they were before, reform-minded coalitions may wane or lose power. Risks are compounded by simultaneous retrenchment in several countries at once. Southern Europe plus France, which is also in need of budgetary adjustment and structural reform, accounts for more than half of the eurozone’s gross domestic product. Keeping the pressure on will only be a credible strategy if accompanied by an effective growth programme for the entire eurozone.

The first component has to come from supportive ECB policies. The central bank has acted forcefully on liquidity support but has not yet outlined its monetary stance. As growth falters, it should cut its policy rate further and let it be known that it intends to keep it low. Consequently the exchange rate may weaken, triggering more external demand and higher domestic inflation in northern Europe. As long as average inflation remains close to two per cent, these developments should be welcomed, because they contribute to the process of internal adjustment. What the eurozone needs in the years to come is inflation at two per cent on average, but more than this in the north and less in the south.

Second, the European Commission should make it clear that countries must commit on budgetary efforts, not outcome. When growth is slowing, the right approach is to stick to a medium-term retrenchment path, not to stack successive packages with the aim of reaching a specific short-term deficit target. Too many countries, starting with Spain and France, are committed to hitting unrealistic headline targets in 2013. Markets suspect this won’t happen. It’s high time to acknowledge it. There should be no relaxation of efforts, but no fiscal overkill either.

Third, the type of adjustment being enacted matters greatly. The emergency consolidation plans introduced throughout Europe since last summer have in general been biased towards short-term fixes, such as tax rates increases and indiscriminate spending cuts, which are detrimental to medium-term growth. The EC should monitor the composition of adjustments and insist on pro-growth packages based on selective cuts and supply-friendly tax reforms. It should accept that reforms may slow down the pace of adjustment.

Fourth, the European Union should mobilise the array of instruments at its disposal – from its budget, including regional development funds and social funds, to regulatory policies and competition policy. It should also launch new initiatives to boost growth. Europe cannot afford to keep on running EU-level policies as if nothing had changed in its order of priorities.

Protracted recession in southern Europe would soon put the single currency in danger. Having opted for a strategy of adjustment and reform, the eurozone must now do all it can to give it a chance to succeed.

The writer is director of Bruegel, a European think-tank focusing on global economic policymaking

In the pantheon of financial crisis villains Fred Goodwin and the former Royal Bank of Scotland board stand tall, especially in the UK. But elsewhere in Europe the rating agencies jostle for position. Following a less than glorious performance in the subprime debacle, their unhelpful downgrades of European sovereign debt have kept them firmly in the line of fire. Any politician on the stump in France, Italy or Greece can raise a cheer by promising retribution.

The European Commission has already shot these tiresome messengers twice, with regulatory measures known as CRA I and CRA II. The new rules roughly parallel moves in the US to promote competition and improve the transparency and informativeness of ratings, especially those applying to securitisations. There is also a useful global initiative, led by the Financial Stability Board, to diminish the role of ratings in regulation. There has been too much “hard-wiring” of ratings in banking regulation, though reversing this is not straightforward.

These changes are still being digested by the agencies and by the financial markets. It is too early to assess how effective they are. The Commission has nonetheless proposed to shoot the messengers again, and this time it is a machine-gunning that threatens to injure innocent bystanders as well. It opens up clear blue water between the EU and US regimes, which will make life difficult for  investors and those seeking to raise capital. It could in the long run damage Europe’s capital markets.

The most intrusive proposal advanced by Michel Barnier, European commissioner for internal market and services, which would allow regulators to suspend the issue of sovereign ratings in certain circumstances, was wisely rejected by other commissioners. But there are signs that the European parliament may try to reinstate it. Other elements of the current draft are also problematic, especially the rotation requirement, and the proposed oversight of rating methodologies by the European Securities and Markets Authority.

It is proposed that an agency can only provide a solicited rating for three consecutive years. It must then withdraw for a period at least as long. So issuers who want to have continuous ratings will have to switch agencies regularly, potentially to firms that lack detailed knowledge of their business. The idea seems to be derived from similar proposals for mandatory audit rotation. But the supporting evidence is weak. Recent research from Italy suggests that there are no beneficial effects of mandatory audit rotation. And an International Monetary Fund paper on recent US experience concludes that “event studies suggest that the arrival of an additional credit ratings agency to a market has led to lower rating quality/higher ratings”. It could also be argued that a mandatory rotation requirement amounts to an unreasonable restraint of trade.

Regulatory oversight of rating methodologies could also have perverse effects. The consequence could well be pressure for a standardised methodology, which would run counter to the aims of reducing the market power of individual agencies, and creating greater diversity of approaches.

While the political mood remains hostile to rating agencies – which, it must be said, have not done themselves many favours – there is a clear risk that ill-considered proposals are legislated in haste. The Danish government in particular appears to want to declare a quick victory in this area. It should think again. The views of corporate issuers and investors need to be heard before Europe rushes into new legislation given that the impact of the earlier directives has not yet been assessed.

The writer is a former chairman of the Financial Services Authority and former deputy governor of the Bank of England. He is professor at Sciences Po in Paris

Has inflation targeting reached its sell-by date? Given the Federal Reserve’s formal adoption of an inflation target only last week, the answer is presumably No. There is, nevertheless, something odd about the enduring enthusiasm among central bankers for inflation targeting. The pursuit of price stability, after all, was supposed to be the best way of delivering overall economic stability. Yet, despite the widespread adoption of inflation targets, the developed world succumbed in 2008 to the biggest economic and financial crisis in generations.

This terrible performance surely should have led to a period of introspection, a desire to examine the role of inflation targeting in contributing to the crisis. Central bankers, however, have mostly brushed objections to one side, preferring to lay the blame on regulatory and supervisory failures or the misdemeanours of individual titans of finance.

Inflation today is determined increasingly by factors beyond an individual central bank’s control. In the early years of the new millennium, many countries in the developed world benefited from rapid declines in import prices, thanks to the growing role of China and other low-cost producers in the global supply chain. As a result, inflation had a tendency to undershoot target. Central bankers were faced with a choice: allow inflation to drop to unusually low rates or keep interest rates low in order to boost domestic demand and, hence, lift domestically-generated inflation.

They mostly did the latter. Real interest rates – nominal rates minus inflation – were left at unusually low levels, contributing to the bubble in house prices and the boom in credit growth. Inflation targets were met, but only at enormous cost.

Meeting an inflation target in any one year increases the risk of instability in the medium term. It’s one reason, perhaps, why the Fed’s two per cent inflation target is an ambition only “over the longer run”. This, however, seems remarkably imprecise, leading Lorenzo Bini Smaghi, a former member of the European Central Bank, to argue in the Financial Times earlier this week that “the long-run is not a ‘policy-relevant’ time horizon and has little value for those attempting to understand the central bank’s next moves”.

That might be so, but shorter-term horizons have their own problems. Mr Bini Smaghi says that “central banks should be held accountable” over a one to three-year period. On that metric, the Bank of Japan was right to have set interest rates at very low levels between 1986 and 1988 – consumer prices initially fell but Japanese inflation returned to about two per cent by 1989. However, low rates also contributed to Japan’s extraordinary late-1980s financial bubble that paved the way for deflation. Conversely, the Bank of England was apparently wrong to have cut interest rates so aggressively in 2008 given elevated inflation rates in 2010 and 2011, even though the UK was, at the end of 2008, on the verge of economic collapse.

One of the most important lessons from the crisis is that inflation targeting has not delivered the lasting economic stability we all crave. Low inflation creates the aura of stability, but too often allows central bankers to take their eyes off the ball. The rapid expansion of credit pre-2008 was, after all, mostly ignored simply because inflation itself was so well-behaved. Unfortunately, US inflation was also well-behaved in the roaring 1920s yet it prevented neither the Wall Street crash nor the Great Depression that followed.

Price stability is, of course, desirable but inflation targeting itself is in danger of turning into a fetish. It’s time for a thorough re-examination of its contribution to our economic welfare.

The writer is HSBC Group’s chief economist and the bank’s global head of economics and asset allocation research. He is a member of the Financial Times Economists’ Forum

Republicans are doing something quite strange at the moment. They are in the process of choosing a candidate whom hardly any of them actually likes. Though Mitt Romney won the Florida primary handily yesterday, by a 14 point margin, rumbles of disaffection continue. Most of the others said they would prefer the choice of someone who is not currently running.  Week by week, the Republican nomination is not so much being won by Mr Romney as it is defaulting to him for lack of any compelling alternative.

The case for voting for Mr Romney goes as follows: of those on offer, he is the only one with any real chance of defeating Barack Obama in November. In support of this electability hypothesis, Mr Romney’s advocates elaborate such qualities as the candidate’s lack of any obvious mental defect, the non-extremity of his views, and his vastly superior financial and organisational resources. Seldom, however, do his half-hearted supporters evince any affection or enthusiasm for the man himself. They generally acknowledge Mr Romney to be an insipid, somewhat blank personality, who is almost absurdly variable in his positions and core beliefs.

In this respect, Mr Romney strongly resembles two similarly unloved Democratic nominees from the recent past, Al Gore and John Kerry. These both suffered from the same characterisations that are applied to Romney – too wooden in person while too flexible in their views. Their supporters often argued that qualifications were what mattered. But ominously for Mr Romney, both lost winnable races because of their flawed personalities.  George W. Bush, on the other hand, was elected and reelected, despite his enormous substantive shortcomings, because ordinary people found it easy to relate to him at a personal level. They felt he wasn’t trying to be someone different from who he was.

Romney, Kerry and Gore are all, in a way, versions of the same political type. Statuesque, handsome, from privileged backgrounds and impeccably credentialed, they have no log cabin stories to humanise and ground them. Unlike a Lyndon Johnson, a Richard Nixon, a Ronald Reagan, a Bill Clinton, or a Barack Obama, they didn’t overcome humble origins or broken families. Mr Romney’s background is alien to most Americans not because he descends from polygamists but because his father was a governor of Michigan, an automobile company chief executive and a presidential candidate.

In his attempt to overcome his privileged origins, the unloved candidate struggles to establish his plain-folks ordinariness in ways that inevitably backfire. He touts his plebian tastes – pick-up trucks, country music, trashy food – and inevitably overdoes it or gets the background music completely wrong.  Mr Gore’s attempt to look less like a Washington politician yielded the “earth tones” fiasco. Mr Kerry asked for his Philly cheese-steak with Swiss cheese, and was photographed nibbling at the alien object rather than tucking into it, as one does.  Mr Romney defended his claims as a sportsman by asserting that he had been hunting for rodents and varmints “more than two times.”

The public usually picks up on this authenticity gap – the space between who the candidate really is and how he wants to be seen. In each case, the problem manifests itself in a slightly different way. A technocrat by nature, Mr Gore disliked the performative side of politics. He wildly over-compensated for this by angrily shouting his speeches at rallies, and demonstrating his ardour for his now ex-wife with a cringe-making soul kiss at the Democratic Convention. His hyperbolic passion on the campaign trail made it a simple matter for Republicans to brand Mr Gore as a compulsive exaggerator who claimed to have invented the internet. Mr Kerry’s problem was that he was pompous, too senatorial and loved of the sound of his own voice.  This allowed the Bush reelection campaign in 2004 to paint him as “French”: an effete snob and an unprincipled flip-flopper.

Even more than Gore and Kerry, Mr Romney is running away from his own perfection.  He must grapple with the affliction of excessive handsomeness, mussing his hair just so before appearances to avoid looking like a television anchorman. He struggles to seem ordinary despite his riches. But anything Mr Romney does to downplay his wealth merely highlights the vastness of it, his personal fortune estimated at more than $250m. And for the time being, at least, Mr Romney must disguise his reasonableness, his record of businesslike practicality and his ideological moderation.  The number of people who can sympathise with such problems is very small indeed.

The writer is chairman and editor-in-chief of The Slate Group and author of ‘The Bush Tragedy’

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