Monthly Archives: April 2012

Spain is rapidly approaching a liquidity impasse. Markets are nervous because it’s not clear how the government will finance its budget deficit and the rollover of its maturing bonds. Spain’s budget deficit now stands at 5 per cent of its gross domestic product and the bonds maturing in 2012 equal an additional 15 per cent of GDP. The IMF expects these large deficits and refinancing needs to continue for several years.

To meet its financing needs, the Spanish government needs the confidence of foreign and domestic investors. Those private investors must believe that Spain has a credible programme to eliminate the annual fiscal deficits and a back-up plan to deal with the maturing debt if there is a shortfall of buyers. If investors know there is such a plan that could be triggered in an emergency, it might never be needed. The Spanish government should quickly reduce its near-term fiscal deficits and develop an operational plan to deal with its needs in following years.

Spain’s commercial banks have little remaining lending capacity, the result of their previous purchases of Spanish government bonds and of their losses on real estate loans. The Bank of Spain lacks the money-creating ability of the US Federal Reserve and the Bank of England to buy government bonds. And the European Central Bank is explicitly precluded from financing fiscal deficits of member governments.

The Spanish government must therefore depend on foreign and domestic investors who are now reluctant to lend to a government that may be insolvent. The challenge is to rebuild their confidence.

Although eliminating annual budget deficits is politically difficult, Italy has recently shown that it can be done by a combination of reforms to spending (particularly pension reforms) and strengthening tax collections.  The IMF now forecasts that Italy will have a cyclically adjusted budget deficit this year of less than 0.5 per cent of its GDP and cyclically adjusted budget surpluses starting in 2013.

Like Italy, Spain should also be able to find the spending cuts and revenue gains, since Spanish government spending now exceeds 45 percent of GDP. The relative budget autonomy of the Spanish regions should be allowed to continue only if (as with the states in the US) they are required to limit their operating outlays to the funds that they receive from the central government and from their own taxes.

Even with tough political action, it will take years to achieve a balanced budget. That means there will continue to be budget deficits that need financing and therefore a possible delay in persuading investors to roll over existing debt as it matures. Building investor confidence during this process requires a plan to avoid a Greek-style default.

One part of such a plan is to negotiate access to the European Stability Mechanism, the €700bn fund created to protect member governments from default. But if the refinancing shortfall from private sources is very large, Spain will need to supplement the funds from the ESM.

Raising those additional funds by increasing taxes would push the Spanish economy into a deeper recession and would weaken the supply-side incentives needed to stimulate long-term growth.  Although some of the increased supply of lending might be achieved by changing the required asset holdings of the Spanish banks, the current condition of those banks leaves very little scope for such additional lending.

An alternative emergency approach would be to mandate, on a temporary basis, bond purchases by Spanish households and businesses.  Here’s how such a plan might be implemented.

The Spanish government could use the income tax system to levy a temporary “lending surcharge” on individual incomes. In exchange for those surcharge payments, the households would receive an interest-bearing government bond with a maturity of five to 10 years.  A similar surcharge could be levied on businesses based on corporate profits or the businesses’ value added.

Having this back-up plan in place to fill any shortfall in Spain’s finances could give private sector investors the reassurance they need to provide the funds that are needed.  With private sector confidence that a default would be avoided, it should not even be necessary to draw on the ESM or to levy the surcharge on households and businesses. The Spanish government should therefore move quickly to enact such a plan before it is overcome by its current liquidity problems.

Standard and Poor’s' multi-notch downgrade of Spain’s sovereign credit rating was largely shrugged off by markets. That is the good news. The bad news is that S&P’s reasoning speaks to dynamics on the ground that are likely to worsen if a more balanced Spanish policy mix is not accompanied by targeted external support.

In slashing Spain’s credit rating to BBB+ and retaining a negative outlook, S&P cited its forecast that the Spanish economy would contract by 1.5 per cent in 2012 (rather than expand as previously anticipated), the budget deficit would exceed 6 per cent of gross domestic product (compared to a government deficit target of 5.3 per cent), and the country’s debt-to GDP would rise steadily to almost 90 per cent by 2015. And all this in the context of recent government data that show that one in every four Spaniards is unemployed (with the youth unemployment rate alarmingly exceeding 50 per cent).

This difficult reality explains why Spain is experiencing the worrisome combination of high borrowing costs, a slowly shrinking bank deposit base, capital outflows, and an increasingly binding internal credit crunch. This is a scary combination. It systematically withdraws oxygen from a real economy that is already struggling mightily; and it worsens in to a vicious cycle unless pronounced progress is made in three critical areas.

First, Spanish policy needs to do a better job in convincing citizens that medium-term economic stability is both feasible and probable. To do so, it must act through both the numerator and denominator of debt sustainability; and, in particular, by striking a better balance between deficit containment (numerator) and growth (denominator).

Too much of the burden is being placed on budget austerity and not enough on structural reforms that enhance Spain’s growth and job creation in a sustainable manner. As such, there are doubts about the durability and effectiveness of Spain’s adjustment efforts.

Second, Spain needs to reduce worries about the potential impact on government finances of contingent liabilities that reside in its banks and on account of its real estate bubble. At a minimum, this requires further progress in consolidating the banking system, in allocating loan losses, and in convincing institutions to be much more aggressive in raising new capital from the private sector.

The greater the timidity of these actions, the larger the concerns that Spain’s funding needs will overwhelm the markets’ appetite to provide voluntary financing at reasonable terms. It is thus paramount for Spain to do more to reassure the world that its budgetary financing gap will not be crushed by the assumption of liabilities from other sectors of the economy

Third, Europe needs to be more willing and able to support Spanish adjustment efforts. As currently set up, European mechanisms for exceptional financing assistance are overly binary – either way too little assistance or, at the other end, a full blown rescue package that brings with it the risks of collateral damage and unintended consequences.

Existing procedures make it difficult for Spain, if not impossible, to receive targeted official financing without also signaling that it is becoming a ward of the European state. As such, rather than complement a market-financed adjustment program, recourse to European emergency funding could result in Spain foregoing virtually all access to private financing (as is the case today for Greece, Ireland and Portugal).

What is at stake here goes well beyond the wellbeing of 46m Spanish citizens. The country’s health is also central to the proper functioning of a vital European unity project that is already under pressure due to economic and financial dislocations elsewhere, as well as political uncertainties that are sure to continue increasing.

Spain does not have the public debt problems of Greece, nor its administrative dysfunction. Moreover, its government has not followed Ireland in assuming on its balance sheet the liabilities of an irresponsible segment of the private sector. But all this could prove irrelevant in avoiding a full-blown crisis if the country’s mounting difficulties are not tackled in a more balanced fashion by the government and, at the same time, supported by European partners in a more targeted fashion.

Larry Summers’ considerable intellect suggests that he would be an excellent contestant on the popular game show Jeopardy!. Of course, on the show, the question offered by the contestant must match the answer on the board. Summers and I disagree on the answer that matches the question “What is President Obama’s budget?” Let’s see why.

I asked two questions in an op-ed in Wednesday’s Wall Street Journal. (Neither question was addressed by Mr Summers, or in the simultaneous parallel critiques offered on the airwaves by US Treasury Secretary Timothy Geithner and former Council of Economic Advisers Chairman Austan Goolsbee). The first question was whether the tax increases on high-income individuals proposed by President Obama (the Buffett rule, higher taxes on dividends and capital gains, a higher top marginal rate, and so on) raised enough revenue to materially offset the country’s large budget gap or higher federal spending under President Obama. The answer, using revenue estimates from the Treasury Department and spending estimates from the President’s budget is ‘No’. The second question was what that spending growth implied for future tax rates. That is, if federal spending as a share of gross domestic product was to increase permanently as the president proposes, by how much would taxes need to rise? Answer: a lot and for everyone. This simple thought experiment presumes that we will not ratify permanently larger deficits.

Without addressing these questions, Mr Summers proposes a different one. President Obama’s budget is supposedly fiscally sound because the Congressional Budget Office (CBO) has estimated that the budget would stabilise federal debt as a share of GDP for a short while. Yet, let’s look at what the CBO said. First, while the CBO shows the debt-to-GDP ratio stabilizing for a period of time – at an uncomfortably high level – in the budget window, it is not stable in the long run. Second and more importantly, in its April 20, 2012 report, the same CBO that Summers cites so selectively observed that the permanent deficits in the President’s budget would reduce the level of economic activity. By CBO’s estimate, under the President’s proposals, the CBO estimates for the 2018-2022 period, that the nation’s real output would be between 0.5 and 2.2 per cent lower compared to what would occur under current law. This adverse effect would grow in the future, as deficits continue to mount.

The President’s budget has met with little success in Congress. The 2013 budget was voted down in the House of Representatives, 414-0. The Senate did not bring the 2013 budget to the floor, though the 2012 budget was voted down in the Senate, 97-0.

And Mr Romney? The Romney budget proposes to reduce federal spending as a share of GDP to 20 per cent (its pre-financial-crisis, long-term average level) by 2016. It is ironic that the administration has criticised Mr Romney for specific cuts (for example, block granting the Medicaid program), while Mr Summers now argues the plan is not specific. Mr Romney is also the first candidate to propose specific ways of slowing the growth of Social Security and Medicare, a subject not mentioned by the president. And Mr Romney’s call for fundamental tax reform – reducing marginal tax rates accompanied by reducing tax expenditures to be revenue-neutral and distributionally-neutral captures the spirit of the bipartisan Bowles-Simpson commission, which was both appointed and ignored by President Obama.

In a ‘Final Jeopardy!’ round, if the answer is long-term fiscal sustainability without large, across-the-board tax increases, the question cannot be “What is President Obama’s budget?”. There are important debates to be had over policy – Mr Summers is right that this is a “very consequential election”. But we first must make sure that we agree on math. Fortunately, the concept that permanently higher spending eventually requires taxes to match is not a controversial one to most Americans. And, at the levels of higher spending proposed by President Obama, higher taxes on the well-to-do won’t fix the gap.

Budgets are statements of national priorities and require economic leadership. Mr Romney has made tough calls in his budget – there will rightly be a debate over whether they are the right ones. That debate will be more illuminating for voters than Secretary Geithner’s statement to the Congress: “We’re not coming before you to say we have a definitive solution to the long-term problem. What we do know is we don’t like yours.”

The writer is dean of Columbia Business School, former chairman of the Council of Economic Advisers, and adviser to presidential candidate Mitt Romney.

Political arithmetic is invariably suspect and one should always examine carefully the claims of those seeking votes. However, just as one should look at audited and unaudited financials very differently when deciding whether to invest in a company, smart observers have learnt to distinguish between the claims of political candidates and their advisers on one hand, and proposals evaluated by non-political scorekeepers such as the Congressional Budget Office on the other.

This principle has never been better illustrated than by the “budget analysis” put forward by Glenn Hubbard, an economic adviser, to Mitt Romney, the presumptive Republican nominee. In an op-ed published on Wednesday in the Wall Street Journal, he constructs a budget plan he imagines President Barack Obama might one day propose, engages in a set of his own extrapolations, then makes several assertions about it. He does not discuss Mr Obama’s actual plan or how it has been evaluated by the CBO. Nor does he defend the claims Mr Romney has made regarding his own fiscal plans.


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Lawrence Summers

Mr Obama has put forward a plan that would cut deficits by more than $4tn over the decade. It starts by making tough decisions on spending, bringing discretionary spending to its lowest levels since the 1960s. It includes $2.50 in spending cuts for every $1 in additional revenue. It also asks everyone to pay their fair share of taxes, repealing the tax cuts made by President George W. Bush for families making more than $250,000 and closing loopholes and shelters such as preferences for private jets, hedge fund managers, and offshore investments.

The independent CBO confirms that the plan would stabilise the debt as a share of the economy, returning us to a sustainable fiscal path. It would do that while allowing increased investments in education, research and infrastructure that are critical to stronger, shared economic growth in the years to come. By focusing on building a robust economy for the future, it expands the tax base and reduces pressures for future tax increases.

But rather than criticise this approach, Mr Hubbard ignores it – and instead chooses to invent a set of assumptions that bear no relationship to the president’s actual policies. His figures are not explained, but they apparently arbitrarily assume that the president must raise taxes to pay for spending above a level of Mr Hubbard’s choosing. This hypothetical exercise bears no resemblance to the president’s policies.

Rather than filling imaginary gaps in the president’s budget, which has been spelt out in sufficient detail to permit evaluation by independent experts, Mr Hubbard should perhaps fill in some of the many gaps in the current presentations of Mr Romney’s economic plans.

He could start with the tax plan. The Romney campaign has been very clear about what he is promising: $5tn in tax cuts on top of extending the Bush tax cuts, with those benefits heavily weighted towards the wealthiest taxpayers.

Mr Romney claims to pay for this plan by ending tax shelters, principally for the wealthy, but he has not specified a single tax break that he would close. I have been party for many years to searches for “high income tax shelters” that can feasibly be closed. There is no reputable expert in either political party who finds it remotely credible that there is anything approaching $5tn in revenues to be generated from this source.

Mr Romney has also proposed a huge increase in defence outlays, even while he says he will cut spending deeply enough to balance the budget. He has clearly explained why he will not tell voters which cuts he would make: because in past campaigns, he found that disclosing his planned budget cuts was politically damaging.

We have seen this narrative before. When Bill Clinton left office in January 2001, our country was paying down its debt on a substantial scale. I was privileged as secretary of the Treasury to be buying back federal debt. George W. Bush campaigned on a programme of tax cuts supported by economic advisers not subject to the rigours of official budget score-keeping. The results in terms of trillions of dollars of budget deficits speak for themselves.

This is a very consequential election. As we continue to recover from the largest economic crisis in generations, we still need to strengthen the job market, address large fiscal challenges and build an economy based on sustainable, shared economic growth. Voters should have a chance to choose between clear alternatives. Mr Obama has laid out a multiyear budget embodying his vision for the future, and it has been evaluated by independent experts. It is time for Mr Romney to do the same.

The writer was director of the national economic council under Barack Obama and is Charles W. Eliot professor at Harvard University

As Kofi Annan’s number two at the UN, I recall a long few days painstakingly monitoring with lawyers the procedures for the handover of the exiled Charles Taylor by his Nigerian hosts-turned-captors to the Liberian authorities and thence in mid-air to the UN and so to the Hague and his trial. Everything had to be done by the book to avoid later appeal but we were writing the book as we went along. This had hardly been done before. Until then international justice when it came to leaders who had run amok had been with the exception of Nuremberg more mouse than lion when it came to action. Indeed when Mr Taylor went to Nigeria he thought he had a deal ensuring him lifelong sanctuary.

Now the outcome of this special court, the verdicts of the International Criminal Court and the Balkan trials of Slobodan Milošević and fellow military and political leaders, Cambodia’s internationally supported prosecution of Khmer Rouge leaders and others tell a very different story of gathering international judicial activism. Leaders usually cannot get away with mass crimes against citizens anymore. Even if their own judicial and institutional systems are too weak to hold them to account, there is now a higher international authority that will.

This can, as it has in Sierra Leone and Liberia, offer a redemptive healing for traumatised societies where child soldiers incited by Mr Taylor had murdered and mutilated on a massive scale as he sought to control neighbouring Sierra Leone’s diamonds. But it’s more powerful use still is as a deterrent to other murderous leaders, such as Bashar al-Assad in Syria or Robert Mugabe in Zimbabwe, who are still used to getting away with it. Here the impact is more mixed.

These two leaders are probably more determined to hang on because of the risk of international trial if they step down. Whenever I was involved in discussions of what it might take to persuade Mr Mugabe to go there was often talk of allowing him perhaps to end his days in Zimbabwe itself where there might be some protection against an international arrest warrant. For Mr Assad there seems little prospect of a secure retirement with his in-laws in west London. The warrants would fly thick and fast given his vicious actions over the last year. The negotiations over Darfur were complicated by the ICC charges against President Omar al-Bashir of Sudan despite a provision in that court’s charter which would allow the UN Security Council to delay a trial if that would help the diplomacy forward.

So the threat of justice may make old leaders hang on. Where its deterrent value is much higher is with new leaders who as they embark on governing their countries recognise a new accountability. If they fall outside the pale and commit major atrocities they will be judged and there are political deals to ease their departure can no longer trump this. President Obasanjo of Nigeria gave Mr Taylor an offer of safe exile to stop the fighting. But when the wheels of international justice turned he very properly had to renege on his word.

The message is that there is nowhere left for murderous despots to hide. That is an extraordinary step forward in global accountability and responsibility and far outweighs the difficulties of temporarily making it harder to prise a long time offender  from office. We should celebrate today’s verdict by copying President Truman’s old White House office desk sign, “The Buck Stops Here” and sending it to all world leaders starting with A for Assad and completing with Z for Zimbabwe.

Technically speaking, the UK economy returned to recession in the first quarter of 2012, according to data released Wednesday morning by the Office for National Statistics. It shrank by 0.2 per cent, following a fall of 0.3 per cent in the previous quarter, thereby qualifying as a recession under the two-quarter rule of thumb used by many economists.  Over the year-to-date as a whole, the economy was flat.

These figures are worse political than economic news.  The Labour opposition will seize upon them as showing that the government’s austerity programme is too strict and is killing off growth. They will renew their calls for a fiscal loosening through a cut in VAT and a slowing of welfare reform.  The governing coalition may also suffer new strains as the Liberal Democrats seek to position themselves as more caring and in touch with ordinary voters than their Conservative colleagues.  While Britain is unlikely to face the political ruptures that have been provoked by austerity budgets in Spain, France and most recently the Netherlands, a weakening of coalition support and cohesion is likely over the next few months.

On the economic front, the gross domestic figures are hardly a shock although they do show a disappointing 0.1 per cent growth across the large service sector and an equally small decline in manufacturing. There are statistical reasons to be sanguine about such small deviations above or below zero when the largest negative contribution to the figures comes from the volatile construction sector.  There will be further disturbances in the coming quarters’ GDP figures because of distortions introduced by the Jubilee celebrations and the Olympics.  Politically sheltered policy makers at the Bank of England are unlikely to be swayed by such ups and downs unless a more sustained trend develops.

During a period of substantial deleveraging by both banks and households, growth is bound to be weak and quarterly figures choppy.  The bigger picture is that deficit reduction is on track (partly due to higher than expected tax receipts), unemployment has started to fall and the latest retail sales figures suggest consumers are spending again.  Provided the recessionary rhetoric at home and the dark clouds over the Eurozone do not choke off the confidence that is beginning to return to Britain’s high streets and board rooms, this should be one of the shortest recessions on record.

Even as Mitt Romney was effectively crowned as the Republican party’s nominee to challenge Barack Obama in the 2012 presidential elections, we received a grim reminder of the deteriorating condition of America’s two bedrock social welfare programmes. It arrived on Monday in the form of non-partisan reports from the trustees of Social Security and Medicare - and what worrisome news it was.

The Social Security programme that supports old age and disability payments is now forecast to exhaust its resources by 2033, three years sooner than estimated just a year ago. Without any action, the trustees calculated that beneficiaries would then experience an immediate 25 per cent reduction in their pensions.

As for the Medicare health insurance plan for the elderly, while its outlook didn’t deteriorate last year, it remains in an even more dismal state than Social Security. Over the next 75 years, using realistic assumptions, Medicare costs are projected to increase from less than 4 per cent gross domestic product to more than 10 per cent of GDP.

Still more depressing than these grisly statistics is the utter lack of progress in addressing so obvious and so cataclysmic a problem. Every day that goes by either brings America’s elderly closer to a huge cut in their benefits or threatens every younger generation with an equally huge bill to pay.

With a presidential election looming in less than seven months time, the two ends of the political spectrum are more polarised than ever over how to address the problem.

Liberals, such as the New York Times columnist Paul Krugman, pooh-pooh all the Chicken Little talk and blithely assume that Medicare will be funded out of general tax revenue. That, of course, would do nothing to solve America’s broader fiscal problems or to halt the country’s march toward claiming an ever larger share of America’s economic resources.

Conservatives, led by Paul Ryan, the chair of the House Budget Committee, want to save Medicare by eviscerating it. Under his original scenario, seniors would be given a voucher with a fixed value; any costs for insurance above that would be their responsibility.

That would raise the share of health care costs borne by seniors from about 25 per cent at present to about 68 per cent. With public opinion polls showing that large majorities even of Tea Party members don’t want Medicare to be cut, I am confident that the American public would angrily reject this proposal if they understood it.

Ironically, for the all the intense emotion, fixing Social Security – the smaller and better funded of the two programmes – should not be too challenging. The Bowles-Simpson deficit reduction commission laid out one of several workable alternatives: to reduce cost-of-living increases, gradually increase the retirement age, extend the payroll tax to higher income levels and reduce benefits to wealthier Americans.

Medicare is tougher, not only financially but morally. With the normal market mechanism of price mostly neutered, little prevents patients from demanding ever increasing amounts of care and doctors from providing it.

In the face of intense public opposition to any form of rationing (recall the reaction to Sarah Palin’s ludicrous accusation that Obamacare provided for “death panels”), policy makers are correctly focused on pulling some of the same tax and benefit levers that the Bowles-Simpson commission recommended for Social Security. That won’t be enough. Equal attention must be paid to the flotilla of ideas emerging from academia and think tanks to address the rapid escalation of health care costs and excessive usage.

In addressing the needs of both programmes, let’s not forget a key principle: just like any pension programme or insurance plan, each cohort of beneficiaries should save as much as possible (via taxation) for its own retirement and medical needs.

Otherwise, America will simply be saddling its children and grandchildren with the responsibility for caring for the rest of us in our old age.

Monetary unions are successful mostly when they are also fiscal and, dare I say it, political unions too.  Think, for example, of the UK – even if the Scottish Nationalists would prefer a rather different arrangement – or the US.  The eurozone doesn’t yet share these credentials.  On the evidence of the now-defunct Latin and Scandinavian monetary unions – and, for that matter, the rouble area following the collapse of the Soviet Union – this threatens to be a fatal flaw.  This is no longer an issue for the periphery alone: with France and the Netherlands both now under strain, some investors are beginning to wonder whether the eurozone is rotten to the core.

The key question is this: is it possible to construct some kind of legitimate fiscal and political union for the eurozone while, paradoxically, allowing member states to enjoy some degree of sovereignty?

The answer, I think, is a cautious “yes”.  We talk about fiscal and political unions as if they are all much the same thing.  They clearly are not.  The UK’s union is glued together more securely than America’s.  Sales taxes are the same all over the UK whereas anyone who’s travelled from New York to Delaware will know that, in the US, there can be significant differences.  There are, then, different ways of constructing a fiscal and political union.

I propose that the eurozone create a “fiscal club”.  Members of the club would, most of the time, enjoy fiscal autonomy.  If, however, their fiscal positions deteriorated to the extent that they could no longer raise funds in international markets at a reasonable interest rate, they would automatically receive a bailout from the other club members.  The key condition of the bailout, however, would be an immediate loss of fiscal sovereignty.  During the bailout phase, the country’s finance ministry would be run by Brussels, thereby establishing a contingent principle of “no eurozone taxation without eurozone representation”.

This then, would be a political rather than financial penalty.  I would hope that, threatened with a loss of sovereignty, nations would run their fiscal affairs more conservatively, delivering surpluses during the good times to reduce the risk of Brussels stepping in.

The club would have democratic legitimacy.  All countries within the eurozone would be able either to opt in or to opt out.  The decision could either be made by national parliaments or be put to a referendum.  But the choice would be clear.  Those countries opting in to the club would benefit by having access – in extremis – to the tax revenues of all other club members, thereby reducing the risk of default and, hence, of widening spreads on their bonds.  In time, club members would be able to take advantage of common bond issuance.  The cost would be a contingent loss of sovereignty but countries that behaved themselves fiscally would be unlikely to face that particular humiliation.

Those countries choosing to opt out – thus retaining sovereignty under all circumstances – would have no access to the tax revenues of other eurozone countries in the event of fiscal slippage.  They would be at the mercy of international bond markets.  They would surely be faced with a permanently higher cost of borrowing relative to those who stayed in.  Even worse, their capital markets would increasingly be balkanised, leading to weaker long-term economic growth.  Sovereignty would come at a high price.

Those in the club would have made a further step towards pooled sovereignty but they would still be recognisable as independent nation states.  They would, however, have accepted three important principles: first, monetary union only really works with some kind of fiscal and political union; second, pooled tax revenues are a vital part of a successful monetary union; and, third, any moves towards fiscal and political union will only be successful if they enjoy the support of the people.

Those outside the club, meanwhile, would have to get used to life as euro-ised nations with no fiscal support from their neighbouring club members: the equivalent, perhaps, of dollarized Ecuador and Panama.

The risk of my scheme is obvious.  If no one votes in favour of the club, the euro simply crumbles.  But for the euro to survive, some kind of risk needs to be taken.  The euro needs some form of collective democratic legitimacy.  A fiscal club would be one way of providing it.

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

The first round results in the French presidential race were much as predicted. The nightmare of a second round pitting Francois Hollande against Marine Le Pen has been avoided. Now the real contest begins, with at least one head-to-head televised debate to come, which will give Nicolas Sarkozy the chance to prove to the electorate that his claims about Mr Hollande’s inexperience and irresponsibility have substance.

But though the headline outcome was as expected, the campaign so far has told us several things. First, there is a lack of positive enthusiasm for both principal candidates. The French have never warmed to Mr Sarkozy. He lacks a certain je ne sais quoi, as the English are wont to say. He has not grown into the office of President, so incumbency has been of little assistance to him so far. Yet though he led in round one, Mr Hollande has not been able to capitalise on this weakness as effectively as he might. The strenuous and successful campaign mounted by Jean-Luc Melenchon on the far left has shown that his grip on the left of centre coalition he needs to mobilise is less than secure.

The distribution of votes shows that there are many disaffected voters, who do not feel that their views are well represented by the mainstream parties. Many French would wish the world to be other than it is, and hanker after a version of “socialism in one country” or a monochrome 1950s paradise. Hollande was pulled to the left on economic and fiscal policy by Melenchon, just as Sarkozy was pulled to the right by Le Pen on immigration and social matters.

The question now is whether Hollande has done enough to entice all the Melenchon militants to rally to his cause, rather than staying at home, while not alienating the centrist votes he needs. Mr Melenchon has helped with a clear endorsement.  For Mr Sarkozy the balancing act is between persuading the National Front’s supporters, more numerous than expected,  to see him as their best bet and securing the lion’s share of the votes that went to Francois Bayrou of the Democrtaic Movement. The arithmetic suggests that he can only win if he pulls in the great majority of both groups – a tall order.

All is not yet lost for the President. The polls tell us that many voters remain undecided- enough to swing the result. But he has played most of the cards left in his hand, and there is an unmistakable sense that power is slipping from him. The era of bling bling may be drawing to a close and the age of Flanby, a kind of blancmange pudding which gives Hollande his nickname, could be just around the corner.

As the world becomes inexorably smaller, denser, more interconnected and more complex, the biggest danger the world faces is western groupthink, which fails to spot the thousands of nuances that are vital to interpret international affairs. Crisis after crisis would be avoided if the west could learn to understand these nuances better.

Take, for example, the crisis the west worries about most: Iran. The western narrative is clear: the Israeli government may have no choice but to bomb Iran this year, as time is running out to prevent an Iranian nuclear bomb. Yes, time is running out for the Israeli government. But the immediate threat in the minds of the Israeli government is not the Iranian bomb. It is the fear of Barack Obama’s re-election. As Mr Obama whispered to Demetri Medvedev, he will have more freedom to launch bold initiatives in his second term. And this is the Israeli government’s nightmare: that Obama will push for a two-state solution (even though, incidentally, it would be in Israel’s long-term interests).

Yet western groupthink suggests that the west is honest and straightforward while Iran, as usual, has been lying and mendacious. In fact, the record is less clearcut. For reasons still unknown, the US government walked away from a deal it asked Brazil and Turkey to offer to Iran, which Iran had accepted. This is why Mohamed ElBaradei, the former head of the UN nuclear watchdog, asked: “Can the west take yes for an answer?” Equally importantly, Ayatollah Ali Khamenei, Iran’s strongman supreme leader, said: “the Islamic Republic, logically, religiously and theoretically, considers the possession of nuclear weapons a grave sin.” This is as strong a message as Iran’s leader can convey to the Iranian people. If Iran is bombed after denouncing nuclear weapons, it will produce a century or more of anger towards the west, just as the Anglo-American coup against Muhammad Mossadegh in 1953 produced half a century of distrust. In short, any bombing of Iran would be an unmitigated disaster for the west.

Now let’s take another crisis: North Korea. Yes, it was foolish and unnecessary for impoverished North Korea to launch a rocket. But did the North Korean regime have any agenda besides developing the capability to reach America with a ballistic missile? Was it pure coincidence that it was launched on the 100th anniversary of the birthday of Kim Il-Sung, the regime’s founder? Was regime legitimisation an equally important goal? And wait – something even more amazing happened in North Korea. Immediately after the rocket failed, the North Korean government admitted failure. Holy cow – the North Korean government admitted it was fallible. This is truly a big deal. North Korea has taken a huge leap towards becoming a “normal” country. Did anyone in the west notice this nuance? Alas, no one. The US government once again imposed more sanctions. Does isolating an isolated country really work?

To answer this question, let us look at a third country that is slowly but steadily walking away from a crisis: Myanmar. Here too, the dominant western narrative is clear: western sanctions finally forced open Myanmar. Sadly, the dominant western narrative is wrong. Western sanctions did not work. ASEAN engagement with Myanmar did. The regional organisation forced Myanmar’s officials and leaders to attend thousands of meetings in ASEAN countries. These travels opened their eyes to how far Myanmar was falling behind: they realised it had to become a more “normal” country.

Malaysia’s prime minister, Najib Razak, was right in saying “that ASEAN has been instrumental in driving both economic growth and political development, and that there can be no clearer example than its relations with Myanmar. For many decades, Myanmar was on the receiving end of very public diplomatic scoldings, often backed up by sanctions… But ASEAN members took a more nuanced view, believing that constructive engagement and encouragement were just as effective, if not more, than sanctions and isolation in creating positive change.”

As usual, western media largely ignored this reality and gave all the credit to Hillary Clinton and David Cameron. A self-serving western narrative just cannot understand the complex new world that is emerging – and progressing, while the west languishes. Yet the era of western dominance is gone. Can the west begin to understand the new and more complex world order unfolding before our eyes day by day?

Pemex, PDVSA and YPF. These three large oil companies have more in common than the fact that they are state-owned. Or that their home countries, Mexico, Venezuela and Argentina, are rich in hydrocarbons. Their most surprising similarity is that during a period in which oil prices are booming, these three companies are declining. Their production, reserves and potential are lower than they used to be and their performance is far poorer than it could be, given the rich geology of the areas over which they enjoy a virtual monopoly.

Underinvestment, mismanagement, limited access to new technologies and the mistreatment of foreign partners are some of the ills they share. These ills are, of course, manifestations of the politicisation that has infected them. And the political meddling goes beyond the cronyism and patronage that undermine their ability to operate efficiently. Their governments impose taxes, regulations and price controls that cripple them and, in some cases, force them into activities that have nothing to do with their core mission.

Venezuela’s PDVSA, which used to be a paragon of a well-run state-owned company, is now an ineptly managed behemoth also engaged in large-scale import and distribution of subsidised food, social programmes, agriculture, housing and a huge foreign aid programme. Inevitably, rumours of corruption and suspiciously bad deals swirl around these companies.

Their decline is brought into even sharper focus by the rapid ascent of Brazil and Colombia as oil-producing countries. Brazil’s Petrobras, while state-controlled, has a governance structure designed to protect its management from political interference. The company has become a global player in the same period that its less fortunate Latin competitors were falling. Petrobras’ discovery of large Brazilian offshore reserves may well propel it to the top of the industry leagues once production there starts. Colombia, a nation that until recently had no significant presence in the oil industry, is also growing very rapidly.

This is part of the context in which Cristina Fernández de Kirchner announced on Monday that her government was taking over YPF, which was privatised a few years ago and acquired by Repsol, a Spanish company. Repsol “pursued a policy of pillage, not of production, not of exploration,” the Argentine president thundered. “They practically made the country unviable with their business policies, not resource policies.”

John Paul Rathbone explained in these pages the convoluted reasons behind the Argentine government’s decision. Objective observers agree that, despite the president’s fiery rhetoric, it was not part of an overarching development strategy, nor a manifestation of resource nationalism, nor any other carefully crafted initiative forming part of a broader design. Cronyism, rifts between rival oligarchs, political expediency, populism and the wish to please a public resentful of the privatisations of the 1990s all played into the decision.

Given Argentina’s track record with nationalisations, there is widespread scepticism that the government will run YPF efficiently. In the past decade, the Buenos Aires water company, the national airline, Aerolineas Argentinas, and several electricity companies that had been privatised in the 1990s have been re-nationalised with politically charged arguments similar to those now used to justify Repsol’s takeover. As Jorge Colina, an economist at the Institute of Argentine Social Development in Buenos Aires, explained to the journalist Charles Newbery, these three government-run companies are accumulating colossal losses. Last year, the state subsidy for them was 80 per cent larger than the spending on a child welfare programme.

Moreover, Ms Fernández took the decision to nationalise Repsol in the context of a rapidly deteriorating economic and political situation. Economic imbalances and distortions have been accumulating and will inevitably reach a boiling point, forcing the government to make the painful adjustments it has so far been able to avoid. Argentina suffers from high inflation, slowing economic growth, ballooning subsidies, price controls, capital flight, decaying infrastructure and a less than welcoming environment for foreign investors. It has had limited access to the international financial system since defaulting on its debts in 2001. Many of the president’s erstwhile supporters are abandoning her and labour unrest is becoming more frequent.

The question is not if but when will Argentina make the changes in its economic policies that will put the nation on a more sustainable path. The country needs to adjust and sooner or later the situation will become unsustainable and force the government to undertake what will surely be unpopular reforms. If Ms Fernández keeps postponing the reforms, her
last years in office will be a political and economic nightmare. At that point, nationalising yet another company will achieve nothing and YPF will be the least of her problems.

The writer is senior associate in the international economics programme at the Carnegie Endowment for International peace

Eurozone financial markets are again on a roller coaster. After a sharp fall at the start of the year, spreads between peripheral and core countries’ government bonds are increasing. The reasons may lie in the interaction between financial markets and the way policymakers act in democratic systems.

In its circular nature, this interaction looks something like a cobweb. Policymakers act when they feel the pressure of the markets, which gives them good arguments to convince voters and stakeholders that the time has come for unpalatable decisions that avert disaster. When these tough decisions are taken, they reassure investors that the authorities are indeed determined to solve the problem. Sentiment improves, spreads come down. However, as market pressure abates, policymakers start thinking that the worst of the crisis is over and that some of the measures they had designed may not be needed after all. Decisions are postponed, measures are watered down. As the political process stalls, markets start having doubts about policy makers’ determination and lose confidence again, which gives rise to new turbulence.

This cobweb behavioral pattern seems to explain quite well what happened over the last few months. In the autumn of last year, as spreads hit new highs – in particular between Italy and Spain on one side, and Germany on the other – the former announced tough budget measures and structural reforms aimed in particular at improving the functioning of labour markets. Governments justified the measures by the need to avoid becoming like Greece. The European Central Bank helped to reduce market tensions by undertaking two longer-term refinancing operations, which eased banks’ funding problems, and by broadening the list of assets that banks could use as collateral. European leaders made commitments to strengthen the eurozone’s rescue funds further, including increasing their overall funding. Supervisors set stringent deadlines for bank recapitalisations.

The markets reacted positively to these measures: spreads fell more than 200 basis points in the case of Italy, a bit less for Spain.

As tensions eased, the pressure for implementing the policies that had been announced abated. Governments in peripheral countries started flirting with the idea that the worst of the crisis was over. Contingency plans, to be applied in case of budgetary shortcomings, were dismissed. Privatisations programmes to reduce public debt decisively were abandoned. Structural reforms were designed primarily to avoid domestic political tensions, rather than to restore competitiveness and improve growth potential. Some central bankers started talking openly about preparing for “exit strategies” and setting limits to balance sheet exposures and expressed aversion to further non-standard measures. The European Council decision to increase the funds available to the European Stability Mechanism fell short of expectations. National supervisors raised the possibility of postponing deadlines for bank recapitalisations, citing improved market conditions.

Against this background, it is no surprise that international investors reassessed countries’ sovereign and bank credit risk. It’s also no surprise that policymakers reacted by blaming each other, and the markets, for the new instability. However, investors’ confidence will return only if national and European authorities show, in a credible manner, their determination to address the problems.

A system in which policymakers act mainly under the pressure of markets, while thinking that markets are myopic and can be fooled, is not only unstable; it is inefficient. Indeed, trying to regain market confidence, having once lost it, requires much tougher actions. This causes economic pain and is not necessarily the best way to consolidate domestic political support.

The writer is a visiting scholar at Harvard’s Weatherhead Center for International Studies and a former member of the European Central Bank’s executive board

When finance ministers convene in Washington in a few days’ time to attend the G-20 and the IMF spring meetings, eyes will be on more than the cherry blossoms.

These meetings will in fact take place on the heels of recent developments in the European response to the crisis and amid renewed fears about the health of the peripheral economies. Eurozone countries have signed on to the fiscal compact, accepting further, more stringent obligations in the conduct of their fiscal policy, as well as the jurisdiction of the European Court of Justice for cases of non compliance. They have also agreed to establish a permanent rescue mechanism, the European Stability Mechanism. Like the temporary rescue fund (the European Financial Stability Fund), the ESM is expected to work closely with the IMF through joint lending programmes, to an extent never before seen at the institution, where such close collaboration has been unheard of.

Yet, there is an underlying tension in the relationship between the euro area and the IMF that these recent treaties just widen. Since the introduction of the single currency, the conduct of domestic monetary policy has been fully delegated to the ECB; however, the realm of international monetary relations remains a grey area, with responsibility opaquely attributed to the ECB and the eurozone group of finance ministers. As a result of this significant gap in the institutional design of the single currency, euro area member countries maintain their country-based — as opposed to a euro area-based — representation on the IMF’s executive board, the institution’s main policymaking organ, despite the increasing integration among eurozone countries in all other related policy domains.

This tension may escalate now due to some potentially adverse developments in IMF reform. The 2010 governance reform package, which aims to shift 6 per cent of the voting power to underrepresented economies, is most unlikely to be ratified this year. The US, the largest shareholder with power to veto, may do so no earlier than next year and only after the next Presidential campaign. This could mean a failure to ratify the agreement by the previously determined October deadline, which would put into serious question whether western Europe will indeed give up two seats by the forthcoming board election early this autumn, as had been decided in the context of the overall package to strengthen the voice of emerging members. Euro area countries would, in essence, be able to hide behind the US and postpone a much-needed consolidation of their representation, one that would be more in line with their own regional policies.

But all hope is not lost. Germany, France and Italy may yet provide a burst of leadership by unilaterally establishing their own joint representation by the autumn, through some transitional arrangements; this would signal an endurable commitment to the Euro. Mario Monti, Italian prime minister, has all the credentials to take this initiative forward with his peers in France and Germany. They would set up a “core” multi-country seat around which all euro area members would be included by the following board election in the autumn of 2014. By including countries, as opposed to European institutions, in the seat, the move would be in line with the fund’s legal framework and would reassure national political leaders in Europe.

At the same time, moreover, the move would signal a long-overdue shift towards a proactive strategy vis-à-vis IMF governance reforms whereby Europe could finally break with the current “wait-and-delay” tactic, precisely at a moment when it needs powerful allies within the fund membership in order to erect a credible global firewall. France, Germany and Italy would together help set the right tone for ongoing G-20 and IMF negotiations, where many non-European shareholders are expected to contribute to a sizable increase in the IMF’s financial capacity. This would, as well, jumpstart the forthcoming round of negotiations on the redistribution of the voting rights that will have to be finalised by January 2014, with Europe, this time, no longer in a defensive mode.

Jim O’Neill is chairman of Goldman Sachs Asset Management. This piece was co-authored with Domenico Lombardi, president of The Oxford Institute for Economic Policy and senior fellow at the Brookings Institution.

It is not whether you win but how you play the game. This old sports refrain can be felt after Monday’s announcement on the selection of Jim Yong Kim, the US nominee, as the next president of the World Bank. Yet it will only prove meaningful if Dr Kim now leads all sides to complete the reform of the Bank’s feudal appointment process – a long overdue step that has repeatedly eluded the international community both here and at the International Monetary Fund.

There is no doubt that this contest for the presidency of the World Bank was indeed different and ”better played.” For the first, three qualified and talented individuals were nominated and interviewed by the Bank’s Executive Board. Their expertise and experience were widely discussed in the media. All three took pen to paper to describe their qualifications and their vision for the institution. And two of them – Jose Antonio Ocampo and Ngozi Okonjo-Iweala – even participated in an open question and answer forum.

Stunningly, it took almost 70 years for these basic steps to occur. While they speak to better governance, they only materialized because of the courage and perseverance of a few brave individuals, most importantly Mr Ocampo and Ms Okonjo-Iweala.

Yet all is not good. Once again, overt political considerations trumped the more legitimate dominance of experience and expertise. And, once again, the deliberations of the Executive Board proved excessively mysterious and overly secretive.

Now that the selection is behind them, the major parties are expressing satisfaction, albeit less than complete. American officials are comforted that they retained their nationality-based entitlement to the presidency of the World Bank, just like their European peers did at the IMF last year. Yet even they are aware of the cost to their credibility and that of the Bank. The emerging countries that backed the two non-American candidates have welcomed the more competitive process, though their enthusiasm is restrained by the blatant persistence of nationality as the overriding selection criterion. And World Bank insiders, led by the Executive Directors are rallying behind the new President, noting that the institution is much more important than any particular individual.

It is important to remember that some similar feelings were in play on previous occasions, most recently after last year’s nationality-based appointment of Ms. Lagarde as head of the IMF. Moreover, in one of the previous rounds at the Fund, a senior European official had even acknowledged that the time had come to end the nationality-based entitlements to the leadership of these multilateral institutions.

Yet, every time push came to shove, attempts to crystalize this into proper reform repeatedly failed. And this will happen again if Dr Kim does not immediately spearhead certain changes when he assumes his new responsibilities on July 2.

During his first 100 days in the office, the new president has a golden opportunity to earn the respect of the world by ensuring that the next selection of the World Bank is indeed open, transparent and merit-based. To this end, he should take proposals to the Board that would hard wire much of the ad hoc approach that characterised the partial competitive elements of his selection, and reinforce them by a comprehensive due diligence process.

The IMF would find it very hard not to follow Dr Kim’s lead. Thus both organizations would be able to announce the much-delayed reforms in October at their annual meetings in Japan.

Don’t under-estimate the importance of such a step. With so many people watching around the world, renewed  failure to move forward with reforms at this critical juncture would accelerate the gradual disengagement from the two institutions by a growing number of countries. It would also undermine their standing in the court of public opinion at a time when both need to be viewed as “trusted advisors” and respected promoters of the global public good.

The reform of the appointment process at the IMF and World Bank is not an option. It is an obligation for all those that believe that the credibility and well-functioning of these institutions are central to the wellbeing of the global economy.

La France compte 65 millions de sujets, sans compter les sujets de mécontentement”. From a political standpoint, the famous sentence by 19th century polemicist Henri Rochefort applies perfectly: French voters are angry and politicians are struggling to respond to their anger. But from a market perspective, there are only three serious topics: first, public finances; second, competitiveness; and third, the country’s stance in Europe. The question is whether the next president will have the ability to tackle them without exacerbating the citizens’ anger.

Start with public finances. The numbers are bad though not exceedingly alarming, but the record of the past decades is weak: the country has repeatedly refrained from seriously attempting to reduce public debt; it combines a Nordic appetite for public spending with a Southern European willingness to pay for it;  and fiscal credibility is low.

Plans to change this state of affairs have not been seriously discussed during the campaign, but François Hollande and Nicolas Sarkozy have both pledged to reduce the deficit to zero by the end of their term. Whoever gets elected will thus be able to claim that he has been given a mandate to break with sloppiness. He may be able to change course if he sets the compass right from the outset, especially by devising a fiscal rule and by creating an independent monitoring body.

Competitiveness is more difficult. Over the last 10 years the current account balance has worsened  year after year, the share of manufacturing in output has shrank, the number of exporting firms has diminished and the share of exports in GDP has stagnated. France has a number of world-class companies but its medium-sized companies are too few an, the insufficiently profitable. They too often compete on prices rather than quality.  The disease is thus severe.

The campaign here has been less helpful. True, the two main candidates have acknowledged the problem and both have said priority will be given to supply-side measures. But there has been no comprehensive policy conversation about these and the candidates have pandered to the anti-profits, anti-offshoring, anti-globalisation mood of the electorate. So the next president will not have a clear mandate for politically and socially sensitive reforms.

As to Europe, it is increasingly evident that the bare-bones Economic and Monetary Union of the Maastricht treaty is a casualty of this crisis. A stable euro requires significantly more policy integration. There are discussions about what exactly is needed – a banking union, eurozone bonds or a fully-fledged fiscal union with transfer mechanisms – but all require giving additional powers and political legitimacy to Brussels.

As the country that first proposed the euro and because its economy heavily depends on European prosperity, France should be the champion of these reforms. It is also pivotal as Germany cannot move if it perceives France as double-minded. But both left and right include a strong and vocal eurosceptic wing. For this reason candidates have refrained from spelling out a genuine European programme. The next president, however, will have little time to let his true priorities known and hold serious discussions with Berlin and other partners before the German election campaign starts, de facto suspending negotiations.

In the end the next president will be short of the mandate he should gain in the campaign: the election will have delivered barely enough on public finances, little on competitiveness and almost nothing on Europe. For sure, the French system is centralised enough to give the president the means to push through the agenda he believes in. But this, perhaps, is also the reason why Rochefort is still right, a century and a half later his famous editorial.

Once again, it’s the veil of secrecy that makes North Korea so dangerous.

From the moment we learned that Kim Jong-il had been dead for two days and that young Kim Jong-un would take his place, upbeat market reaction represented a triumph of hope over experience. Few miss the father, but the son was always ill-equipped to bring about constructive change—inside North Korea or in relations with others.

In fact, the new leader was overmatched from the beginning. The father was groomed for more than two decades before inheriting power in 1994 at the age of 53. The son, a 29-year-old political novice, was pushed into place late last year after less than two years’ experience with the family business. The steady deterioration of North Korea’s economy and infrastructure over several decades, particularly outside the capital, ensures that the boy and his minders have much to do.

The father knew the son would need help and he positioned his brother­-in-­law and the regime’s previous number two, Jang Sung-­taek, to act as regent. Mr Jang is believed to have strong personal ties with senior officials of the Korean People’s Army, guarantor of North Korea’s baseline security. Also among Mr Kim’s “guardians” are army chief of staff Ri Yong-­ho and Kim Jong-il’s sister Kim Kyong-hui. What is the true balance of power among these people? Outsiders have no reliable way of knowing.

That’s why, for the next few weeks, we should worry more about North Korea than about Iran. Compared with North Korea’s government, Iran’s theocracy is an open book. Bluster among players in the controversy over Iran’s nuclear programme has market watchers on edge, but the near-term risk of trouble here is over-rated. Americans and Europeans have little appetite for another Middle East conflict that’s sure to pressure oil prices and imperil their delicate economic recoveries. Israel is talking tough, but that’s at least in part to ensure maximum compliance with the next wave of soon-to-be-rolled-out sanctions. Iran has little interest in starting a war it can’t win. Real trouble will probably wait.

But apparent preparations for a North Korean rocket launch over the strong objections of the US and North Korea’s nearest neighbours remind us that Pyongyang remains uniquely unpredictable. South Korea and Japan have threatened to shoot the rocket down, but having made clear its intention to press forward, North Korea’s new government is in no position to cancel plans and lose face.

In addition, South Korea is less likely to back away from provocation than it was two years ago. In March 2010, a North Korean attack on a South Korean naval vessel killed 46 sailors. Eight months later, North Korea staged artillery and rocket attacks on South Korea’s Yeonpyeong Island, provoking fury and frustration within South Korea’s military. At the time, despite considerable domestic political pressure, President Lee Myung-bak ordered South Korean forces to exercise restraint. Another round of hostile acts might not draw such a measured reaction.

Why are the North Koreans doing this? Traditionally, hostile acts are intended to project confidence and deter threats. It’s worrisome enough if this latest show of bravado is intended for an international audience. But if the real concern is local, if someone within the elite believes a show of strength is needed to safeguard Kim Jong-un’s standing at home, then North Korea may have a whole new generation of surprises in store.

Credit Rick Santorum with accepting the obvious: he lost. Despite winning 11 primaries, Mr Santorum was always more of an irritant than a plausible contender for the Republican nomination. He surrenders the field having done a meaningful, though not enormous amount of harm to his side.

Mr Santorum made Mitt Romney’s task harder by forcing him to continue spend on the primaries money that could have gone against the general election, by exacerbating doubts about his conservative credentials, and by reminding swing voters that many Republicans remain unfriendly to women, hostile toward the separation of church and state, and too interested in other people’s sex lives.

Mr Romney is none of those things, however, and with Mr Santorum out of the way, he now can get on with the business of challenging Barack Obama. With the primaries unofficially over, the shape of the fall race is fast emerging. Simply stated, Mr Romney is going to run against the Obama economy while Mr Obama runs against Mr Romney himself.

The Republicans will argue that every problem the country faces, from the anemic economic recovery to high petrol prices is the fault of a well-meaning, but inept incumbent. The closest analogue to this campaign might be the one Bill Clinton conducted against the elder George Bush in 1992. Like Mr Clinton in that year, Mr Romney is attempting to exploit the lag between how the economy is and how it feels.

But Mr Romney lacks Mr Clinton’s political skills, to say the least. Also, his case will be a far trickier one to make, because the recovery is further along than it was at a comparable point 20 years ago. In interviews, Mr Romney is forced to concede that the economy is in fact growing, and must try to establish the more complicated proposition that Mr Obama is nonetheless holding back its true potential through excessive intervention. This puts Mr Romney in the sour position of constantly underscoring – and hoping for – bad economic news while foreclosing his own future options in dealing with it.

If Mr Romney’s pitch resembles a Democratic one, Mr Obama appears to be preparing a Republican-style negative assault on his opponent’s character. This is what George W. Bush’s advisor Karl Rove did in 2000, seizing on a few gaffes to cast Al Gore as a serial exaggerator, and in 2004, when he portrayed John Kerry as a slippery flip-flopper. Mr Obama’s advisors David Axelrod and David Plouffe are attempting to define Mr Romney as both a political opportunist who tailors his views to suit the moment and as an out-of-touch plutocrat who can’t relate to ordinary people.

Their chief ally in this effort has been Mr Romney’s mouth, from which have emerged the most extraordinary string of self-defaming comments, ranging from the pleasure he takes in being able to fire people to the fact that his wife has “a couple of Cadillacs.” The most recent blow was a story about Mr Romney’s plan to build an automobile elevator into his newest extravagant vacation home. Mr Obama will not attack Mr Romney’s wealth directly. Instead, he will portray his opponent’s policies as designed to benefit the rich at the expense of the middle class, as with his attack last week on the budget plan Mr Romney supports as “thinly veiled social Darwinism”.

The race begins with Mr Obama 5 to 10 percentage points ahead in national polls, better funded, and ahead in grass-roots organising in several of the key battleground states. But while the President starts with the upper hand, this is likely to be a close, hard-fought contest. One risk is that the personal assault Democrats level against Mr Romney backfires against Mr Obama, defining him as a thuggish, “Chicago-style” politician. At the very least, the President’s angrier, populist turn will cut against his efforts to convey a sunny, optimistic outlook. Another hazard for Mr Obama is the new vehicle known as the Super PAC, which allows the rich to contribute unlimited sums to technically “independent” efforts. Spurred by the billionaire Koch Brothers, Republicans expect to raise in excess of $400 million for advertising against Mr Obama.

The biggest risk to Mr Obama remains unchanged. With 209 days to go until the election, it is the US economy itself. A few more weak reports from the Labor Department or a replay of last summer’s recession scare could turn to mockery the President’s message that things are getting better. His modest lead is bound up with a still-tenuous recovery.

Why has it taken so long? Academics were among the early adoptors of the internet, and the best of them want their ideas to be shared as freely and widely among their peers as possible. Yet while other parts of the media industry have seen established business models destroyed by on-line competition, for-profit academic publishers have continued to charge high prices and generate fat profit margins, largely untroubled by a few upstart competitors offering their content on an open access basis.

There are two answers to the question. One is that publishing academic research is an expensive business, not the kind of thing you can do in the back office. The most prestigious publications have very high rejection rates, and require extensive peer reviews and cataloguing.

The other is that this is a world where established brands are very powerful. Academic researchers get recognition and promotion not just on the basis of the numbers of papers they produce, but also on the quality of the journal that publishes them. Titles with the strongest reputation get the pick of the best research papers, and you’d have to be both brave and confident to turn your back on them.

But now things are changing. Wellcome Trust, one of the world’s largest private funders of medical research, has long been pressing the scientists it funds to make their work freely available as soon as possible. Last year, it took this approach a big step forward by agreeing with two other leading research bodies, the Howard Hughes Medical Institute of the US and the Max Planck Society of Germany, to underwrite the costs of a new web-based science journal which will publish on an open access basis. An impressive team of editors has now been recruited, and eLife will start to appear later this year.

Its three backers have the reputation and the muscle to create a powerful new brand, and their timing is good. With university budgets under pressure everywhere, academics are becoming increasingly frustrated by the way their publicly funded research is being used to create large profits for publishers in the private sector.

Dr Timothy Gowers, a distinguished Cambridge mathematician, started the ball rolling in January this year in post on his blog explaining why he refused to submit his work to journals published by Elsevier, the leader in this field with titles like The Lancet and Cell. It charged too much, he said, it forced libraries to buy titles they might not want by bundling them into groups, and it supported legislation that opposed free access.

His message struck home. More than 9,000 researchers have now signed an on-line pledge to boycott publications owned by Reed Elsevier.

But the academic community as a whole is unlikely to move overnight to a new model. The top titles still have a very strong appeal to ambitious researchers, and generate the kind of profit margins that leave room for a fight back. Elsevier has already begun tweaking the pricing structure of a number of its products and can do more as competition intensifies.

And there are some questions about eLife’s business strategy. The idea is that after an initial period in which the journal gets established, authors will be charged a processing fee to cover some of the costs of publication. Wellcome rightly believes that research isn’t complete until it has been published, and is ready to provide the researchers it funds with extra money to cover the costs of publication where appropriate. Whether other funders will take this far sighted approach has yet to be seen.

So eLife may not be a game changer. But given the quality of its support and the mood of the times, it surely marks a long term shift in the business of academic publishing.

In domestic election campaigns European politicians display a kind of cognitive dissonance. They  must be aware that any propositions on European policy will be subject to close reading in the embassies and chancelleries of their partners, yet they tend to talk as if they will only be heard by a domestic audience. The French Presidential campaign, which officially began on Monday, is a case in point. All the major candidates have made commitments on their European policies – to renegotiate this, or abandon that – which may appeal to elements of their target market, but which will not go down well with the Chablis at the first EU summit after their election.

Should one simply classify these declarations as flights of fancy, articulated in the heat of battle, and pay little heed? Perhaps, but one cannot exclude the possibility that at election time politicians, freed from the constraints of office, may be saying what they really think or, indeed, what they think the people really think. And it just may be that they will feel the need at least to attempt to deliver on their promises.

The election takes place at a difficult moment for the European project. Previous certainties about the relentless march of the euro, and progress towards the “ever-closer union” of the Treaty have been thrown into doubt. This ought to benefit Marine Le Pen and the National Front, who want a return to the franc. Whether it would be a ‘franc fort’ or a ‘franc faible’ is not spelled out. But though the travails of the eurozone have given her a good song to sing, there are not yet enough voters prepared to sing along with the chorus.

Most of the other candidates are, ostensibly, “Good Europeans”, though this designation is capable of many interpretations in France. The centrist Francois Bayrou is the most federalist: he argues for a directly elected European President. Bayrou attracts support from many bien pensant French, particularly in the regions, but Europe is not the centrepiece of his campaign which, in any event, is treading water.

More significant, perhaps, is the rhetoric adopted by Jean-Luc Melenchon of the Left Front. He has been the big winner of the campaign so far, threatening to push Le Pen into fourth place in the frst round. If he does, there will be a price to pay by Hollande, who remans the favourite to triumph in the second, for his endorsement. Melenchon is not a deep thinker on European policy, but he has firm views on the European Central Bank, which he would like to see under political control. He sees the ECB’s single-minded pursuit of price stability as one of Europe’s major problems. Hollande is unlikely to be pushed so far, but he himself favours giving  the ECB  a dual mandate like the Federal Reserve, with priority given also to full employment – not self-evidently an absurd proposition. This would be part of the intergovernmental Treaty renegotiation, to which he is firmly committed.

He has attracted much criticism for his hostile stance on the Treaty, which many think he will quietly abandon if elected. I wonder whether they are right to dismiss the renegotiation idea as mere posturing. By the second round of the French election the Treaty will have been signed, but not ratified, and it is by no means clear that the Eurozone will survive intact with only fiscal austerity and a modest increase in support funds.

Hollande has openly questioned the continued viability of the Franco-German motor, now conveniently dubbed Merkozy. He wonders aloud whether it has recently been influenced by France at all. In saying so he reflects a view widely held in the French administration, and not just in the Socialist party. Many in Paris are deeply sceptical about the terms of the Treaty. They fear distancing themselves from the Germans, but they fear the consequences of following their hard economic line even more. The French have always wanted economic governance of the eurozone, and know that may mean going further in collectively guaranteeing member states’ borrowing, and accpeting a more interventionist role for the ECB.

Hollande was snubbed by Merkel when he visited Germany. At one point she planned to campaign for Sarkozy, though that idea was quietly shelved when polls revealed she would be a vote-loser for him. Cameron also gave Hollande the cold shoulder. They would have done better to devote time to undestanding his point of view.

Which leaves the President himself. An intriguing poll among foreign observers in Paris gives Hollande a slight edge, but the foreign press still think Sarkozy will win. So the evolution of his own European policy remains of more than academic interest.  Sarkozy has said France will cut its contribution to the EU Budget, which hints at another rerun of the British rebate debate. More importantly he has called for a Europe which “protects” its citizens. The subtext is clear: part of Europe’s response to the crisis must be to put up the barriers, to immigration and to foreign competition. The French now support measures to exclude foreign firms from public contracts if their home countries do not allow reciprocal access, and he has said that if the Schengen agreement is not revised within a year, France will leave unilaterally,

This latter commitment may not be as tough as it sounds. There is already a process of review under way, which in fact the French have been leading. But the broader aim of a protected European market, linked with a demand that France’s budget contribution should be cut back, is more menacing if the French pursue it with determination, and when they settle on a European policy, they are rarely backward in coming forward.

So whoever wins in May there is trouble ahead in Brussels, Berlin and indeed London. The Commission, with the possible exception of Michel Barnier, will not like the protectionist impulse. The Germans will strongly resist Treaty revision, or any attempt to meddle with the ECB’s mandate. And there is nothing whatsoever in the programmes of any of the serious candidates to please the British. Plus ca change, as we say in England.

A shorter version of this piece appeared in Tuesday’s FT.

The US economy starts the year well, job creation picks up, and concerns about sluggish economic growth give way to expectations of a strong recovery … only to be dashed by a mid-year slowdown. This narrative played out both in 2010 and 2011. Friday’s disappointing employment report serves as a cautionary note that America may not have overcome as yet this unsettling pattern; and, the implications would be even more consequential this time around.

Friday’s employment report disappointed on several fronts. After a revised monthly average gain of some 258,000 for non-farm payrolls in the first two months of the year, net job additions in March slumped to just 120,000, well below consensus expectations of 200,000. The average workweek fell by a notable 0.3 hours to 40.7 hours, offsetting a 0.2 per cent rise in average hourly earnings. And, in the separately measured survey, the unemployment rate fell by only 0.1 percentage points to 8.2 per cent despite yet another worrisome decline in labour force participation.

These disappointments partly reflect changing seasonal factors, including the prior impact of this winter’s unusually mild weather. But there is something much larger in play, and the implications go beyond economics; they influence key elements of the political narrative for the upcoming presidential and congressional elections.

Particularly in today’s unusually-fluid global economy, companies’ decisions to hire involve distinct lagging and leading components. Having cut jobs and costs to the bone during the great recession, many companies found themselves understaffed for the business pickup they already experienced over the last few months. They had no choice but to play catch up in hiring. But, where they do have a choice – in hiring for expected future business – they lack conviction despite generally solid profitability and rock-solid balance sheets.

The hesitancy is understandable, particularly given the uncertain outlook for demand. American consumers, as a group, still carry too much debt and have to cope with higher oil prices. The prospects for exports, which have grown markedly, are gradually dimming now that the rest of the world is slowing. Meanwhile, policymakers have yet to find a way to deal properly with a year-end fiscal cliff, the result of Washington’s repeated inability to design coherent fiscal policy.

This demand uncertainty compounds worrisome structural impediments to growth. America is increasingly lagging the advances made by other countries in education (particularly, in maths and science) and worker training. Housing and housing finance are still problematic, inhibiting labour mobility and maintaining a cloud over the largest component of wealth for the average American. And credit remains patchy; it is amply available to those that need it least but still eludes a range of productive investment opportunities in small- and medium-sized companies.

Left unchecked, this combination will aggravate the structural labour problems highlighted by Friday’s data release – be it long-term unemployment (stubbornly stuck at over 5 million), the average time out of work (a worrisome 39.4 weeks), or a joblessness curse that disproportionately hits the young (a stunning 25 per cent unemployment rate for 16-19 year olds) and those with limited educational degrees (a 12.6 per cent unemployment rate for those lacking a high school degree compared to just 4.2 per cent for those with a bachelor degree or higher).

After a period of relative calm, Friday’s employment report should again sound alarm bells in many parts of Washington. The combined risk of an unemployment problem that is increasingly structural in nature and a rate that is bottoming out way too soon is bad news. It is the last thing America and, more broadly, the global economy need, especially at a time when Europe remains fragile.

The hope is that Friday’s report will act as a catalyst for a renewed initiative on the part of congress and the administration to lift the impediments to growth that have been repeatedly identified yet never suitably treated. More likely, however, is that political bickering and dithering may again deliver a depressingly familiar seasonal pattern that undermines the wellbeing of millions and renders the subsequent recovery even more difficult to secure.

Diplomacy is inching forward. This might not be obvious from the confusion that surrounded the recent Friends of Syria meeting in Istanbul. Despite being at sixes and sevens about whether to arm the rebels or ease up on the demands that President Assad must go, Damascus has proposed a ceasefire date of Tuesday 10 April as a first step in implementing Kofi Annan’s six-point proposal. UN Security Council members have made it clear that they now expect the regime to live up to its promise and an Annan team has been dispatched to Damascus to work out how it will monitor implementation of the ceasefire.

There is plenty of reason for scepticism towards the promises of a leader who is responsible for deaths of thousands of his citizens and has broken his word repeatedly during this conflict. Nevertheless, Mr Annan’s patient diplomacy is starting to pay dividends.

First, the ceasefire date was not decreed from outside by the UN Security Council or Arab or western states but rather it was proposed by the regime itself. Second, Syria now faces a re-united Security Council. Both Russia and China have announced following Mr Annan’s visits that they support his plan. Third, there is under the plan the prospect of some humanitarian access to bring in desperately needed medical and other supplies. Fourth, if the plan does allow a measure of peace it will transform the context for the political negotiation that it calls for. Mr Assad has used the fear of chaos and violence to hold together the coalition of Syrian minorities that support his regime. With diminished violence and an orderly negotiation about the country’s future that card loses its value.

Mr Annan, whom I served at the UN between 1999 and 2006, has been criticised for not making Mr Assad’s departure an explicit condition of his proposals. However, whether with Saddam Hussein in Iraq, or Muammar Gaddafi in Libya, he has seen that if a demand for a dictator to step down is a pre-condition for negotiations, this makes diplomacy impossible. What leader signs his political death warrant before the bargaining starts? However, once around a negotiating table, an opposition in a situation such as Syria can move the agenda to that point because even a government’s supporters will recognise their interest will be better served by the departure of a leader with this much blood on his hands. He quickly becomes part of the problem not the solution.

Indeed there is growing suggestion that although the Alawites and other groups that have supported the regime continue to hold together, their patience with the Assad family is failing. The latter appears locked into a myopic, disengaged view of the conflict, which was reflected in their leaked family emails reported in The Guardian. In a negotiation their immediate future may quickly become less secure than it has appeared in recent weeks.

Diplomacy of course may not work. The Assads may well use it to play for time as they seek to re-consolidate military control. This is what they have done in the days running up to next Tuesday’s ceasefire.

And certainly change in Syria is unlikely to be easy or straightforward. But Mr Annan’s mission has at least raised the possibility that the national civil war or wider regional conflagration that looked increasingly likely a few weeks ago may be avoidable. To paraphrase Winston Churchill there may still be room for jaw-jaw not war-war.

Mark Malloch-Brown was the Deputy Secretary-General of the UN and author of ‘The Unfinished Global Revolution’. He is now at FTI Consulting

America is the only developed country that does not offer some form of national health insurance to all its citizens.

Those over the age of 65 have coverage through Medicare and the poor are covered through Medicaid, both established in 1965. Those who are neither poor nor old are expected to obtain their own health insurance or get a job that provides coverage. The federal government does subsidise private insurance through the tax code by allowing its cost to be excluded or deducted from taxable income. This reduces federal revenues by some $180bn per year.

In 2009, the Obama administration put forward a plan for extending health insurance to those who did not have it through an employer, those who could not afford it and those who could not obtain coverage due to a pre-existing medical condition. A complex system of subsidies was established to make coverage affordable to everyone and a mandate was put into place requiring people to get coverage or else pay a fine.

The mandate is by far the most controversial element of the Affordable Care Act. Its rationale is that insurance companies cannot be forced to cover those with pre-existing conditions without it, or else people will simply wait until they are sick before buying health insurance. Nevertheless, many Republicans view the mandate as an unconstitutional intrusion into the economy and they have brought a case before the Supreme Court to declare the legislation null and void for that reason. Court watchers believe the case could go either way, with a final decision expected just before the election in November.

Exactly what would replace the Affordable Care Act if it is found unconstitutional is a mystery. The Obama administration appears to have no back-up plan and Republicans have steadfastly refused to offer any proposal for expanding health coverage. One problem is that before Barack Obama became president, Republicans were the primary supporters of an individual mandate, viewing it is as a more market-oriented way of expanding health coverage without a completely government-run health system. Indeed, Mitt Romney, the likely Republican presidential nominee, established a healthcare system in Massachusetts, where he was governor, that is virtually identical to the national system created by Mr Obama.

Simultaneously, Republicans are keen to cut spending for Medicare and Medicaid, because they are among the most rapidly expanding government spending programmes. A plan supported by Republicans in the House of Representatives would effectively privatise Medicare, giving the elderly a government voucher to buy insurance or health services, in lieu of the pay-for-service system that exists now. Medicaid would be devolved to the states.

What neither party has made any effort to grapple with is the extraordinarily high cost of health, public and private. According to the Organisation for Economic Cooperation and Development, the US spends more of its gross domestic product on health than any other country by a large margin. Americans spent 17.4 per cent of gross domestic product on health in 2009 – almost half of it came from government – versus 12 per cent of GDP or less in other major economies. Britain spends 9.8 per cent of GDP on health, almost all of it through the public sector. The total government outlay is almost exactly the same in the US and the UK at 8.2 per cent of GDP. This suggests that for no more than the US government spends on health now, Americans could have universal coverage and a healthcare system no worse than the British.

However, the option of a completely government-run health system was never seriously considered in the US when the Affordable Care Act was debated in 2009. Americans are too convinced that everything government does is less efficient and costs more than if the private sector does it. The fact that this is obviously wrong in the case of healthcare has never penetrated the public consciousness.

At the moment, everyone is waiting for the Supreme Court to speak before moving forward on any serious new health reform plan. Whichever way the court rules, it is likely to give some push to further action next year regardless of the election outcome. Moreover, the growing governmental cost of Medicare and Medicaid is something that has to be addressed if there is any hope of stabilising the national finances. That alone would be an impetus for action even if the Affordable Care Act had never been enacted.

The writer is a former senior economist at the White House, US Congress and Treasury. He is author of ‘The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take’

The Bo Xilai affair has transfixed observers from Beijing to Boston. But amid the intrigue, do not forget the importance of China’s recent National People’s Congress.

Premier Wen Jiabao’s report to the legislature covered every problem facing the country. He and his generation recognised China’s many ills. But these same issues have been highlighted every year — while the pace of reforms has slowed. It’s wise to separate good intentions from action.

Is there any way we can trust the policy messages coming out of the NPC?  Continue reading »

Luxury retailers are smiling. So are the owners of high-end restaurants, sellers of upscale cars, holiday planners, financial advisers and personal coaches. For them and their customers and clients, the recession is over. The recovery is now full speed.

But the rest of America isn’t enjoying a recovery. It’s still quite sick. The finances of many Americans remain in critical condition.

The Commerce Department reported last Thursday that the economy grew at a 3 per cent annual rate last quarter (far better than the measly 1.8 per cent in the third quarter of last year). Personal income also jumped. Americans raked in over $13tn, $3.3bn more than previously thought.

Yet all the gains went to the top 10 per cent and the lion’s share to the top 1 per cent. More than a third of the gains went to 15,600 super-rich households in the top one-tenth of one per cent.

We don’t know this for sure because all the data aren’t in for 2011. But this is what happened in 2010, the most recent year for which we have reliable figures (courtesy of my colleague Emmanuel Saez and Thomas Piketty, who analysed tax returns) and nothing about the direction of this recovery has changed since then.

In 2010, 93 per cent of the gains went to the richest 1 per cent. Some 37 per cent gains went to the top one-tenth of one per cent. No one below the richest 10 per cent saw any gain at all.

In fact, most of the bottom 90 per cent lost ground. Their average adjusted gross income was $29,840 in 2010. That’s down $127 from 2009 and down $4,843 from 2000 (all adjusted for inflation).

Meanwhile, employer-provided benefits continue to decline among the bottom 90 per cent. The share of people with health insurance from their employers dropped from 59.8 per cent in 2007 to 55.3 per cent in 2010, according to the Commerce Department. And the share of private-sector workers with retirement plans dropped from 42 per cent in 2007 to 39.5 per cent in 2010. Yet the so-called “talent” in executive suites is getting gold-plated healthcare coverage for themselves and their families, along with deferred compensation and fat pensions subject to few, if any, taxes.

If you’re among the richest 10 per cent, a big chunk of your savings are in the stock market where you’ve had nice gains over the past two years. The value of financial assets held by American households increased by $1.46tn in the fourth quarter of 2011. And since 90 per cent of those financial assets are owned by the richest 10 per cent and 38 per cent by the top 1 per cent, the richest 10 per cent became $1.3tn richer and the top 1 per cent gained $554.8bn.

But if you’re in the bottom 90 per cent, you probably own few, if any, shares of stock. Your biggest asset is your home. And that’s a big problem. Home prices are down over a third from their 2006 peak and they’re still dropping. The median house price in February was 6.2 per cent lower than a year ago.

Which means if you’re in the bottom 90 per cent you’re likely to be even deeper underwater – owing more on your home than it’s worth. An estimated one in three homeowners with a mortgage are now holding their breath.

This is the most lopsided recovery in US history.

When the American economy began recovering from the depths of the Great Depression, the gains were widespread. From 1933 to 1934 the bottom 90 per cent gained 8.8 per cent in average income.

Yet recent recoveries have become more and more lopsided. The top 1 per cent got 45 per cent of Clinton-era economic growth and 65 per cent of the economic growth during the Bush era. So far in the Obama recovery, the top 1 per cent has pocketed 93 per cent of the gains.

But Washington doesn’t want to talk about this lopsided recovery. The Obama administration would rather focus on the recovery without mentioning whose it is. Perhaps it’s because almost all Democratic and independent voters are in the bottom 90 per cent.

Republicans would rather not talk about the lopsidedness of this recovery either because they’d rather not bring up the subject of inequality to begin with. Their reverse-Robin Hood budget plans cut taxes on the rich and slash public services everyone else depends on.

Fed chairman Ben Bernanke – who doesn’t have to face voters on election day – says the US economy needs to grow faster if it’s to produce enough jobs to bring down unemployment. Well, yes. But he leaves out the critical point.

We can’t possibly grow faster if the vast majority of Americans, who are still losing ground, don’t have the money to buy more of the things American workers produce. There’s no way spending by the richest 10 per cent will be enough to get the economy out of first gear.

The writer is the chancellor’s professor of public policy at the University of California at Berkeley and former US secretary of labour under President Bill Clinton. He is author of ‘Aftershock: The next economy and America’s future’

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