Monthly Archives: July 2012

Among the oddities of the US system of government is the vice president. The position was created by the Constitution, but the founding fathers neglected to give him anything to do. His only constitutional role is to preside over the US Senate and break ties; he can’t even speak except to deliver vote totals and make the occasional parliamentary ruling; and the vast majority of the time his function is fulfilled by random members of the majority party who serve as president pro tempore of the Senate.

Of course, the vice president becomes president in the event that the president should die in office or resign. Of the 43 men who have served as president, nine achieved the office this way. Additionally, the vice presidency is often a stepping stone to the presidency, with five vice presidents later being elected president in their own right. George H.W. Bush is the most recent to do so.

Therefore, a third of American presidents became president directly or indirectly through the vice presidency. It is a decision to which great thought should be given.

Unfortunately, this is often not the case. The vice president is often chosen to satisfy some political need within a party. For example, Ronald Reagan thought he needed Mr Bush to balance his ticket and soften his image as a hardline conservative.

Ideally, presidential nominees would like to find a vice president who can deliver a big state that he would not otherwise carry. The classic example is John F. Kennedy’s choice of Lyndon Johnson in 1960. He undoubtedly carried the state of Texas for him and helped throughout the South.

Since it is rare for there to be a potential vice president who can carry a key state, presidential nominees often look for vice presidents who appeal to certain interest groups. Mr Bush chose Dan Quayle in large part because he thought his youth would appeal to younger Americans.

The key constraint in terms of using the vice president for purely political purposes is that he or she really does have to be capable of becoming president. Nominating someone who is manifestly unqualified can drag a candidate down to defeat.

It is widely believed that John McCain’s choice of Sarah Palin as vice president in 2008 doomed him to defeat, as it became clear during the campaign that she had neither the minimum knowledge nor temperament to be president.

Consequently, much of the discussion about who Mitt Romney should name has centered on those considered safe choices—people clearly qualified to be president who won’t pull the ticket down.

Current speculation has centered on 5 men: Ohio Senator Rob Portman, former Minnesota Governor Tim Pawlenty, Florida Senator Marco Rubio, Louisiana Governor Bobby Jindal, and South Dakota Senator John Thune. Last week there was also some speculation about former Secretary of State Condoleezza Rice.

Mr Rubio and Mr Jindal clearly are long shots because of their youth and relative inexperience. Some Republicans believe Rubio, who is of Cuban heritage, would help with the fast-growing Hispanic vote, although there is no evidence of this in polls. Mr Jindal, whose parents were born in India, would showcase the party’s inclusiveness.

Political professionals, however, think Mr Romney will probably pick one of the “boring old white men”: Mr Portman, Mr Pawlenty or Mr Thune. Each is qualified to be president and would be unlikely to cause controversy. But none would measurably strengthen the ticket except possibly Mr Portman, who may help Romney carry a state, Ohio, he needs to win.

Some scholars have long been troubled by the common practice of allowing a party’s presidential nomination to have the sole say-so in naming his running mate. Although the party’s convention nominally names the vice president, in practice it merely rubber-stamps the presidential nominee’s choice.

I think it would be a good idea to give parties a bigger role in choosing the vice president. Perhaps nominees could provide the party convention with a slate of acceptable choices and let them sell themselves to party delegates. At least it would add some excitement to an event that is otherwise almost entirely devoid of substance in an era when presidential nominees are chosen by state primaries long in advance of party conventions.

Related link:
US elections 2012 – FT

With global demand seemingly in free fall, both the US and China see increased foreign direct investment as a possible cushion. But despite the US and China having the world’s largest bilateral trade flows, Foreign Direct Investment flows between the two are surprisingly negligible.

During the so-called US – China Strategic and Economic Dialogue, a meeting of respective honchos from both countries, the most heated discussions involve China complaining about US security restrictions on direct investment and America arguing that China is too fixated on promoting “indigenous innovation.” Differences in culture certainly play a role as well, but mismatched motivations in intentions pose an even greater challenge.

Contrary to popular belief, the US accounts for only a few percent of FDI into China. This is puzzling given the prominent role that such investments played in jumpstarting China’s economy, making it among the top two destinations globally, second only to the US. FDI from European countries also has been much higher than from the US, mirroring their stronger export presence in higher end machinery and consumer products compared with the US whose top two export lines are food grains and recycled waste products, which do not warrant supportive FDI.

American affiliates in China also played a surprisingly minor role in mediating the contentious export growth of Chinese-made but American-branded products. US companies have found that retailing is more profitable than production. Thus most of the high valued components are produced elsewhere and only assembled in China, and even then often by overseas firms such as Foxconn (Taiwanese) in the case of Apple. In areas where prominent US brands stand out—fast food and hotel chains—the major costs are on the books of local partners while US multinationals benefit from franchise fees.

These days, American firms entering China are primarily driven by the desire to tap a huge consumer market. But Beijing does not need more capital; it wants technology that is unavailable locally.

No wonder US FDI in China is so trivial.

And going the other direction, even though China’s outward direct investment only became significant recently, a mere 1 per cent so far has gone to the US. Can America create a more receptive climate for China’s inflows given the hostility experienced by Japan decades ago when it was already a US ally?

Chinese companies seeking opportunities abroad are now primarily motivated by the search for resources with showcase examples in Africa and Latin America and a notable victim of politics being Cnooc’s pursuit of Unocal in the United States. That failure contrasts with the Cnooc’s attempted $15bn acquisition of Nexen’s oil and gas assets, which if approved by the Canadian Government could represent a landmark shift in how Canada views the US and China.

Collaboration on clean energy technologies offers such an opportunity. China’s rise to dominance in the manufacturing of solar energy equipment and wind turbines reflects its push to make clean energy a growth industry. Combining state support with acquired technical advances, the resulting scale economies have reduced energy costs to a fraction of what they were only recently.

From the US perspective, however, China’s emergence is yet another example of not playing by the rules. Public attention is dominated by the anti-subsidy cases filed against China by a small group of US clean energy manufacturers even though they run counter to the wishes of the larger numbers involved in distribution.

The politically charged scrutiny of bankrupt Solyndra’s access to US loan guarantees confirms that the clean energy business is risky. But given the environmental and energy security benefits, most countries provide subsidies. Without the technical improvements and volumes to lower costs, commercially viable approaches will remain unrealised. As the two biggest carbon emitters globally, the US and China have the most to gain.

Beneath all the sparring, however, investors from both countries are starting to make deals. China concentrates in relatively low margin hardware and assembly while American firms focus on niche, higher valued-added upstream production or more profitable downstream installation. Rising labour costs in China combined with the benefits of proximity to technology centers and more sophisticated markets are starting to generate proposals to produce more in the US. This provides an option similar to the relocation of Japanese auto plants to the US which helped to ameliorate tensions.

With US funding for clean energy drying up and pressures to develop lower cost approaches mounting, both sides should channel their political capital into encouraging mutually beneficial arrangements rather than entering into protectionist battles.

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

By assigning to the European Central Bank the task of “defining and implementing the monetary policy of the Community”, the EU Treaty implicitly considers that there should be only one monetary policy for the entire euro area. Yet, looking at a variety of indicators – from short or long term interest rates on a wide variety of assets to the flow of money and credit to the private sector – it is difficult to conclude that monetary conditions are currently uniform across the union.

The central bank typically implements its monetary policy by setting the rate of interest at which it lends to the banking system. Such a rate, which influences asset prices and affects the savings and investment decisions of the private sector, is determined with a view to achieve price stability. A key assumption underlying this operational framework is that financial markets are efficient and support a smooth flow of funds across the union. In other words, the transmission mechanism of monetary policy is expected to be stable and predictable.

This assumption is far from being satisfied. The euro area financial market, in all segments and maturities – including the very short term money markets – does not function properly, as banks deposit their excess liquidity with the central bank instead of lending to other banks. Cross-border banking flows have dried up. Households and firms across the union borrow at rates that depend more on the respective sovereign risk – just look at Spain, today, for example – than on their intrinsic creditworthiness. Interest rate decisions made by the central bank are not able to affect monetary conditions in the desired way in a large part of the euro area.

There are two ways to address the issue. The first is that the central bank adopts measures aimed at circumventing the prevailing disruptions to the transmission mechanism of monetary policy. Over the past two years the ECB has taken several actions in this direction, such as the provision of unlimited long term refinancing to banks, at a fixed rate. These measures have been effective, at least for some time, and there is probably room for more, but the transmission mechanism of monetary policy has remained impaired.

The second way is to repair the transmission mechanism. But who’s task is it? Central bankers tend to think that the responsibility lies primarily with national governments and supervisors, given that the malfunctioning of the financial markets is mainly due to the heightened banking and sovereign risk. Governments, on their part, contend that they have already taken strong actions and have committed to more but markets are too slow to recognise progress. Only the central bank has sufficient firepower to push markets towards a sustainable equilibrium.

Both are right, to some extent. But there can be no viable solution without actions being taken at the same time by governments and the central bank, each in their own field of competence. In allocating responsibilities, the euro area can build on the experience gained by the International Monetary Fund in dealing with crises for more than 40 years. First, strong conditionality is needed to ensure that governments consistently implement their adjustment programmes over time. Second, liquidity has to be provided in sufficiently large amounts so as to catalyse private financial flows and convince market participants that the system is stable.

To be effective, the solution requires confidence and trust between the policy authorities. The central bank has to be reassured that the conditionality adopted by the member states is sufficiently stringent, lasting and irreversible. In this respect, the experienced which followed last Summer’s ECB’s intervention in the secondary market for Spanish and Italian government debt has left a sour aftertaste. Governments, on their side, have to be reassured that the tough measures that they have committed are supported by the provision of sufficient liquidity to guarantee success over time. To be sure, the fiscal adjustments, which are being implemented, have little chance of succeeding unless the interest rates prevailing in these countries are rapidly brought down more in line with the rest of the euro area. This can hardly be done without the direct involvement of the central bank.

The strategy is successful if market participants are convinced that policy makers stand ready to do all that is needed to solve the crisis. Communication is key, and needs to be consistent with this requirement. In this respect, focusing on what the central bank should not do or does not intend to do, rather than what it might eventually do, if necessary, in order to address the problem, can be counter-productive. For example, repeatedly raising concerns in the public about the size and the risks of the central bank balance sheet, about the dimension of the cross-border payment imbalances (Target2 balances) or about the limited ability of monetary policy to solve all problems may fuel doubts among market participants about the determination of the monetary authorities. In a fiat money system, even the slightest doubt that the central bank may face constrains in ensuring the convertibility of the currency can fuel bank runs and generate financial turmoil.

The euro area crisis may have reached a point in which it can hardly be resolved unless the policy authorities are determined to take bold actions. This may require that the member states further strengthen their policy commitments, concerning in particular the structural reforms aimed at improving competitiveness and growth, and make these commitments irreversible, consistently with their membership of the euro area. It also requires that the central bank takes more drastic measures to ensure that there is a single monetary policy throughout the euro area, consistently with its mandate. Price stability is not in danger right now. The euro might be.

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

Ben Bernanke, chairman of the Federal Reserve, delivered on Tuesday a remarkably timid policy statement to Congress. This may reflect a hesitation to front run the FOMC, his policy-making committee, which next meets on August 1st. But the main culprit is probably elsewhere. The Fed increasingly finds itself in a large and deepening policy dilemma.

Mr Bernanke devoted almost the entirety of his written statement to recent economic and financial developments. Though he did not go far enough, he rightly emphasized what is now more than evident in recent data releases, including Monday’s retail sales numbers: America’s already inadequate recovery is weakening in the context of an increasingly synchronized global economic slowdown.

Look for the Fed in the next few weeks to go further in revising down its job, growth and inflation forecasts for 2012. Given the institution’s dual mandate of price stability and maximum employment, this will inevitably raise expectations of additional policy activism.

Having exhausted long ago the effectiveness of traditional monetary policy tools, the Fed has no choice but to consider another mix of unconventional measures – specifically, additional purchases of securities, a lower interest rate on excess reserves, an even more aggressive communication policy, and enhanced access to the discount window.

But, more of the same will not have a durable beneficial impact, especially if other policymakers remain missing in action. Indeed, the advantages of another round of unusual Fed activism are declining while the risk of both collateral damage and unintended consequences is material and growing.

The Fed is stuck in a widening dichotomy between the need for a policy response and an increasingly impotent tool kit. I suspect that Bernanke and his colleagues recognize that their policy effectiveness is waning. Yet, understandably, they are unwilling to stand idle given the paralysis in virtually every other part of the economic policy apparatus.

In the meantime, too many politicians seem willing to maintain the myth that the Fed can lead the domestic economy out of its current malaise. It cannot. The best it can do is slow a de-leveraging that, in the absence of proper growth dynamics, eats away at the traditional resilience and entrepreneurship of the US economy.

Recognising this, Congress should be doing much more to awaken other policymakers from their deep slumber. This requires the type of constructive political interaction that has eluded the US for almost the duration of the current term of congress. And there is little to suggest that this will change any time soon, and certainly not before the November elections.

It should therefore come as no surprise that, in their meeting with Mr Bernanke on Tuesday, members of congress showed little interest in internalizing their need to respond quickly to economic priorities. Instead, they diverted the discussion to other issues that, while topical and important, do little to advance the policy agenda and improve the outlook for hundreds of millions of Americans.

So, was Bernanke’s trip to Congress a complete waste of time? No. Hopefully, members of Congress will take seriously his attempt to humanize the risks associated with an urgent policy challenge – that of America avoiding going over the fiscal cliff.

Citing the Congressional Budget Office, Mr Bernanke noted that Congress’s failure to deal with the full range of programmed and blunt tax increases and expenditure cuts would lead to a “shallow recession” next year and, most importantly, “1 ¼ million fewer jobs … created in 2013.”

Given global connections and Europe’s persistent crisis, even this Mr Bernanke warning may be too sanguine. The last thing the US needs is another blow to an unemployment rate that remains way too high, and that involves a damaging component of long-term joblessness in the context of overly-stretched social safety net.

It’s not easy being a former president. The old joke is that ex-presidents are like Chinese vases: everyone says they are very valuable but no one knows what to do with them. Some, like Bill Clinton, continue with a frenetic flurry of activity, others such as Vladimir Putin, do not actually relinquish power while those such as Silvio Berlusconi seem to treat their post-presidential time as a hiatus before running for office again.

Recently, the two best known former presidents of Brazil took part, almost simultaneously, in events that clearly illustrate very different ways of living the ex-presidential life. Fernando Henrique Cardoso won the Kluge Prize, one of the world’s most important awards in the social sciences. This $1m prize is awarded by the Library of Congress of the United States and has a nomination and selection process as rigorous as that of the Nobel prizes.

The jury emphasised that the award recognised Mr Cardoso’s intellectual achievements. Before entering politics he was an internationally recognised sociologist who made pioneering contributions on the relationship of inequality and racism to under-development. He was also the father of the once popular “dependency theory”, which holds that under-development is partly caused by the richest countries as a result of the exploitative relations they established with poor countries. This idea is no longer in favour and Mr Cardoso himself recognises that the world has changed and that its conclusions are no longer valid.

About the same time that Mr Cardoso was being feted at the US Library of Congress,  Luiz Inácio Lula da Silva spoke by video conference to the participants of the Sao Paolo Forum who were meeting in Caracas. The Forum is a gathering of Latin American leftist organisations that meets periodically since it was launched by Mr Lula’s political party, the PT (The Workers Party) back in 1990.

In his televised address Lula said, “Only thanks to [Hugo] Chavez’s leadership, the people have had extraordinary achievements. The poor were never treated with such respect, affection and dignity. These achievements should be preserved and consolidated. Chavez, count on me, count on the PT, count on the solidarity and support of every leftist militant, every democrat and every Latin American. Your victory is our victory. ”

It is perfectly legitimate for Mr Lula to express his affection and admiration for Mr  Chavez. Affects – like love – are blind and deserve respect. But it is not legitimate for Mr Lula to intervene in another country’s elections. That’s not what democrats do. And Mr Lula knows it. Or he should know it. But he seems oblivious to this and in fact it is not the first time that he bluntly intervenes in Mr Chavez’s favor during a Venezuelan election. In 2008, on the eve of a critical referendum, he also intervened in the process, claiming that Mr Chavez was “the best president the country has had in 100 years”.

Nor is it legitimate to distort, as Mr Lula did, the Venezuelan reality – especially that of the poor. Mr Chavez has had a devastating effect on Venezuela and the poor are the main victims. It is they who pay the consequences of living in one of the world’s most inflationary economies; they are the ones having to make ends meet with a real wage that has fallen to its 1966 level (yes, 1966). It is they who cannot get jobs unless it is in the public sector and only if they are deemed loyal to the revolution and are willing to display publicly and often their unwavering support for el comandante. It is they who see their sons and daughters killed at one of the highest rates of homicides in the world.

No wonder, therefore, that in the last parliamentary elections in 2010 more than half of the votes were against Mr Chavez. In Venezuela it is impossible to reach that percentage without the votes of millions of the poorest – the very people that according to Mr Lula are doing better than ever thanks to Mr Chavez. And, finally, it is not legitimate for Lula to applaud and encourage in another country public policies that are diametrically opposite to those he implemented with great success as Brazil’s president.

In this sense, perhaps Lula would be well advised to do as former president what he did as president: follow Mr Cardoso’s example. After all, Mr Lula knows that his success as president owed a great deal to his decision to continue and even expand his predecessor’s economic and social policies. Mr Lula should take his post-presidential clues from Cardoso and understand that a true democrat does not use his prestige and influence as a former president to improperly intervene in another country’s elections.

America’s economic debate is stuck in a time warp. On the one side, Mitt Romney’s conservative advisors defend tax cuts for the rich and spending cuts for the poor as if we hadn’t just lived through 30 years of failed Reaganomics. On the other side, Paul Krugman defends crude Keynesianism as if we’ve learned nothing in recent years about the severe limitations of short-term fiscal stimulus. Both sides merely raise their decibel levels at each announcement of bad news, as with last Friday’s data showing the failure of the US economy to generate sufficient new jobs in June.

The two sides of the debate live in timeless and increasingly irrelevant ideologies. The prescriptions of free market economics peddled by the Republicans – slash taxes and spending, end financial and environmental regulations – are throwbacks to the 1920s, far more naïve than even modern conservatives such as Milton Friedman and Friedrich Hayek, who recognised the need for government intervention for the poor, the environment, health care and more. Today’s free market ideologues are uninfluenced by the lessons of recent history, such as the financial crisis of 2008 or the devastating climate shocks hitting the world with ever-greater frequency and threatening far more than the economy. Their single impulse is the libertarianism of the rich: the liberty to enjoy one’s wealth no matter what the consequences for the economy or society.

The other side is also wide of the mark. In Paul Krugman’s telling, we are in the 1930s.  We are in a depression, even though the collapse of output and rise of unemployment in the Great Depression was incomparably larger and different in character from today’s economic stagnation.  Krugman channels Keynes, yet Keynes lived in a very different era. 

In Krugman’s simplified Keynesian worldview, there are no structural challenges, only shortfalls in aggregate demand. There is no public debt problem. There is no global competitiveness challenge, since “competitiveness” is a myth when applied to national economies. Fiscal multipliers are predictable, timeless, persistent, and large. All growth reversals can be solved through larger deficits. Politicians can be trusted to design short-term stimulus spending programmes of hundreds of billions of dollars. Tax cuts are about as good as increases in government spending, and short-term boosts in spending are about as good as long-term public investments.  Not one of these conclusions stands scrutiny. 

Why have we come to this vacuous debate between a free-market extremism and a Keynesian superficiality that addresses none of the subtleties, trade-offs, and uncertainties of the real situation? There are probably two main reasons. First, the world is noisy and overloaded with media messaging. Getting heard seems to require a short, sharp and exaggerated idea endlessly repeated: economics as a media brand. Second, the world is facing novel problems at the global level, and novelty is hard to factor into economics, which is a rigid, ideological, theoretically based, and largely backward-looking field. 

Here are some of the new problems of macroeconomic significance. 

First, the financial markets are global while regulation is at best national (and sometimes almost non-existent or criminal). This is killing the euro, but it is also undermining financial regulation and monetary policy everywhere. The US and UK are far more interested in defending Wall Street and the City than in fixing the global regulatory landscape. Germany has been much more interested in coddling its errant banks than in fixing the eurozone banking system.

Second, the world of work is being fundamentally transformed. Low-skilled work is the work of offshore workers, or immigrants, or machines.  In high-income countries, the only route to middle class jobs is through education, skills and active labour market policies that match jobs and needs. Germany and other countries of northern Europe have generally succeeded in creating these institutions.  The US and southern Europe have generally failed.  Keynesian aggregate demand cannot create long-term employment for the low-skilled workers left to sink or swim in today’s globalised labour market.  Only temporary bubbles (such as the dotcom bubble of the late 1990s or the housing bubble of the 2000s) briefly employ the low-skilled, but soon they unemployed again when the bubbles burst. 

Third, tax collections today are little more than a Swiss cheese of tax evasion and tax havens for the rich and corporations. VAT and payroll taxes can still be collected while capital income of all kinds increasingly escapes taxation. These trends greatly exacerbate the market forces pulling to increase inequality of wealth and income. 

Fourth, we are in the age of the Anthropocene, where global growth is limited by natural resources, climate change and hazards. If the world economy grows at 4 per cent or more, oil prices soar above $100 per barrel and food prices hit historic highs. This fact is of fundamental importance yet not properly part of any country’s economic strategy. The American illusory answer, hydrofracking of natural gas and more offshore drilling, will not solve the heat waves, floods, droughts and other disasters hitting the US and much of the world this year. Nor will it do much to ease the worsening resource constraints that will squeeze economic growth until we shift to new and sustainable technologies.

Fifth, the combination of falling tax collections on capital income and the rich, and rising costs of retirement and health care for a quickly aging population, poses serious long-term solvency challenges for most of our governments. These challenges can be met but require a long-term financial outlook and new approaches to pensions and healthcare delivery.

Sixth, in a world that requires serious regulation – for the environment, land use, financial markets and more – there are bound to be problems in coordinating public policies with private investments, and across sectors of the economy. Coherent economic strategies can help to break through investor pessimism and stagnation. Well-designed public investments (eg in infrastructure) can unlock significant private investments as well. 

In short, we need new economic strategies to overhaul broken systems of finance, labour markets, taxation, ecological management, budget management and investment incentives. Those challenges cannot be fixed through lowering taxes on the rich or higher fiscal deficits to create aggregate demand. The new approaches must be long-term, structural, sensitive to inequalities of skills and education, aligned with the need for more sustainable technologies and “smarter” infrastructure (empowered by information technology) and congruent with long-term demographic trends. It’s time we moved beyond the Republican Party economics of the 1920s and the Democratic Party economics of the 1930s, to a new macroeconomics for the 21st century.

We are now a year and a half into what many persist in calling the Arab Spring even though there is no end in sight to the turbulence and it is hardly certain to have a happy ending.

Nowhere is this more the case than in Egypt, the most populous and by many measures the most important country in the Middle East.

On one hand, there are elements of continuity. The military is predominant, having awarded itself most of the president’s traditional powers. There is no constitution; there is no parliament.

But there are also important changes. The old president is on his deathbed, far removed from power. Sitting in what was his ornate office is Mohamed Morsi, a popularly-elected member of the long-banned Muslim Brotherhood.

Egypt only arrived at this juncture by dodging a bullet. Namely, by allowing the Muslim Brotherhood to assume the presidency in the wake of elections. Had the military tried to foist its own candidate on the public there would have been massive protests that forced the military to either shoot into the crowds or back down. The generals would have forfeited their legitimacy whichever path they might have chosen.

By avoiding such a choice, General Tantawi and his colleagues have delayed the day of reckoning, but not permanently. The current co-habitation between a politicised military and a much-diminished president cannot last. Indeed, it may already be heading toward an end over the question of whether the parliament is to be restored now rather than after a new constitution is drafted and agreed on.

That said, de facto power sharing may linger for a time, if only because both sides have little appetite for making the hard economic decisions confronting the increasingly indebted country. Both the military and the Muslim Brotherhood fear alienating the people if they impose the necessary austerity. But the subsidies cannot go on. Egypt is akin to a start-up company that is burning its capital faster than revenues and investment are coming in. As the economist Herb Stein famously said in another context, that which cannot go one forever will not.

It is quite possible the military and the Brotherhood will agree on some necessary reforms, all the time pointing the finger at the other. But at some point the Brotherhood will tire of the imbalance of real power and force a showdown, and when it does, Egypt’s military is more likely to back down than not. The generals may fancy themselves in the mould of their Turkish counterparts who managed to “guide democracy”, but it is unlikely they will have the opportunity. Egypt is not Turkey, and even today’s Turkey is not the Turkey of old. Times have changed.

But what then? The honest answer is we have no idea. Many of the people running Egypt (or who soon will) were in the shadows only a year ago. But what is unknown to us and conceivably to them is how they will govern. What is to be the balance between the executive and rest of government? The balance between the public and private sector? The balance between government and society? For these and other reasons it is the debate over the constitution that will matter most.

In the end, the test of any individual or party is not a willingness to contest and win elections but rather the willingness to lose them. This is turn requires not just an honest count of the votes but a level playing field in terms of access to televison, the right to meet and organise, and the ability to raise money. We will learn if the Brotherhood is committed to democracy as a tactic or a principle.

What should outsiders do? For the US and Europe, interests are greater than influence. But this is not the same as having no influence. Economic and military assistance should be made conditional on behaviour — on moving in the direction of genuine democracy, respecting the rights of minorities and women, on fighting terrorists and honouring the peace treaty with Israel. Those running Egypt have the right to make their own choices, but they should understand those choices have consequences.

By any objective standard, Friday’s US jobs report was a poor one. Last month saw only 80,000 net new jobs, bringing the three month total to only 225,000. That is one third of the job creation rate of early 2012 and the weakest quarter in 2½ years. Once again, it confirms that the most noteworthy aspect of this economic recovery is how weak it is.

While the unemployment rate remained constant at 8.2 per cent, that is a misleading gauge of labour market health. Yes, this rate has fallen from the 10 per cent level of 2009. But, much of this improvement reflects shrinkage in the size of the labour force, rather than true employment gains. Broader measures of employment have not improved. The labour participation rate, which simply measures the percentage of working age adults with a job, just fell further to 63.8 per cent. That is a 27-year low.

These dismal job ratios reflect a fundamental lack of economic growth. Three full years have now passed since the trough of the recession. But, the US grew at only 1.9 per cent and an estimated 1.5 per cent for the first and second quarters of this year, respectively. For the full year, the consensus estimate is only 2 per cent. Such figures, well below the economy’s long run growth potential, are just not good enough to offset population growth and improve labour markets.

The obvious question is: why such a weak recovery? The answer traces back to the catastrophic 2008 credit market collapse. Namely, that the financial damage which it inflicted on consumers, lenders and homeowners has not been fully remedied. And, therefore, each of these three, broad sectors is struggling.

American households lost 20 per cent of their net worth during the collapse, as home values and financial assets plunged. So far, they have only recovered a bit more than half of this. As a result, they are financially cautious, for example saving nearly 4 per cent of their income, as compared to negligible, pre-crisis levels. This explains why consumer spending, which accounts for 70 per cent of GDP, remains relatively weak.

Then we all know the huge losses which so many lenders incurred in 2008 and 2009. It is no surprise that they, too, are hesitant. Total US commercial and industrial loans outstanding total $1.4tn, still well below 2007 levels. Lending criteria are tighter now, and marginal borrowers often cannot finance themselves.

Finally, millions of delinquent and underwater mortgages continue to depress the giant US housing market. New home construction is still running more than 50 per cent below its pre-crisis level. And, sales of existing homes, while slightly better, also have not seriously recovered.

The 2008 collapse and these resultant headwinds are not President Obama’s fault. They preceded him, and he has largely taken the right steps to counter them, i.e., fiscal stimulus, bank recapitalisations, and the like. And, the US economy is at least moving up, unlike Europe. Furthermore, he has consistently sought the right next step. Namely further stimulus now coupled with $3-4tn of long-term deficit reduction, beginning around 2014. But, the current economic weakness is the overarching election issue this year, and it portends a close outcome in November.

It feels like one more throw of the dice for central bankers stuck in the Last Chance Saloon. Last week’s rate cuts from the European Central Bank and gilt purchases by the Bank of England were certainly better than nothing. We shouldn’t kid ourselves, however, that they’ll provide the answer to life, the universe and everything. Our economic and financial problems are too big to be fixed with a simple flick of the interest rate switch or an extra £50bn of quantitative easing.

Yet, until now, the puppet masters who pull our economies’ strings have persuaded themselves they know how to deliver us to the Promised Land. Central bankers have persistently provided forecasts for economic growth which, in hindsight, have proved to be far too optimistic.

In the summer of 2010, for example, the sages of the Federal Reserve thought US economic growth would be between 2.9 per cent and 3.8 per cent in 2010 and between 2.9 per cent and 4.5 per cent in 2011. The actual outcomes were 3.0 per cent and 1.7 per cent respectively. The BoE was similarly optimistic, believing that the most likely outcome for UK growth in 2011 was around 3 per cent, a view conditioned on £200bn of asset purchases. The actual outcome was a rather more modest 0.7 per cent.

Does this mean monetary policy has lost its capacity to have any influence on economic outcomes? That, I think, is too pessimistic a conclusion. As the Bank for International Settlements notes in its 2012 Annual Report, the policy stimulus on offer post-Lehman was far greater than anything provided during the Great Depression. As a result, the economic outcome has been far superior: the overall peak-to trough decline in US GDP this time around was 5.1 per cent compared with a whopping 30 per cent or so in the early-1930s.

The problem, then, is not so much that policy hasn’t worked but, instead, that we expect too much from it. Stagnation is a lot better than Depression but there are still plenty of people out there who believe that, with a bit more effort and a few more macroeconomic policy wheezes, the good times will return – despite the evidence of persistent “optimism bias” in official forecasts based on no more than blind faith in the potency of policy.

For those who seem addicted to stimulus, the answer to monetary impotence is more fiscal stimulus. This, apparently, costs nothing (unless you happen to be unfortunate enough to be living in the eurozone). As part of the correspondence generated by their original provocative article (“A manifesto for economic sense“, 27 June 2012), Paul Krugman and Richard Layard argued that “If public sector deficits were increased, interest rates would rise little, especially if, as is desirable, the extra government debt was largely purchased by the central bank” (Letters, 1 July 2012).

It would be a cheap shot to mention the Weimar Republic or Zimbabwe in this context. Nevertheless, Messrs Krugman and Layard are making a highly-suspect assumption about the response of nominal activity to this kind of unconventional stimulus. Quantitative easing was supposed to boost UK growth but, instead, the UK ended up with higher inflation, squeezing real take-home pay and making debt repayment a lot more difficult. This was totally unexpected and thus provides a significant challenge to those who continuously demand even more stimulus. Can we be sure that the stimulus will affect real economic activity and not, even if indirectly, the price level?

Krugman and Layard’s manifesto stated that “today’s government deficits are a consequence of the crisis, not a cause.” Tautologically true (how could today’s deficits have caused the failure of Lehman?), the authors conveniently ignore the fact that fiscal positions had already deteriorated a great deal pre-financial crisis. During the good times, fiscal policymakers simply hadn’t been sufficiently frugal. Their subsequent firepower was, as a result, necessarily diminished.

The OECD estimates that, at the end of the 1990s, both the US and the UK were running cyclically-adjusted budget surpluses of around 3 per cent of GDP, excluding interest payments on existing debt. Long before the financial crisis, however, these 3 per cent surpluses had turned into 3 per cent deficits, thanks to big tax cuts and spending increases (the US) and spending increases alone (the UK). The subsequent collapse in economic activity obviously made fiscal positions far worse. Today’s fiscal predicament, however, stems in part from a lack of budgetary control during the good times. The convenient assumption was always that the good times would roll, a reflection yet again of a built-in “optimism bias”.

Promising a pot of gold at the end of the policy rainbow is all very well, but the public is surely now cottoning on to the fact that a succession of post-Lehman policy wheezes hasn’t delivered a sparkling recovery. Maybe they have recognised that, in a heavily-indebted world, there are limits to what policy can actually achieve. Yes, it can prevent the worst outcome but, no, it cannot take us back to “business as usual”. There is, of course, an obvious reason for that: business as usual would require a continuously-inflating housing boom, a persistent increase in household indebtedness and, as it turns out, ongoing fiscal stimulus. We won’t be returning to those conditions any time soon. Those who think we can must, then, be suffering from optimism bias.

Friday’s disappointing employment report out of the US is unsettling even for those of us that have consistently worried, and warned about the country’s weak job picture. It comes at a time when many people are understandably giving up hope of any major policy initiative out of Washington. And it confirms that this closely-watched release should be interpreted beyond its traditional role as a lagging indicator; these days, it is also a leading indicator for economic and political issues, both domestic and global.

It is not so long ago that a string of relatively strong reports – including monthly job gains averaging over 200,000 in the three months ended February this year – were fueling a bullish narrative about America’s prospects. After all, companies were sitting on lots of cash to finance new hiring and investment in plant and equipment; they were tapping into buoyant demand overseas, including in rapidly expanding emerging economies; and they had stretched their existing productive resources to the limit, thus setting the stage for a sustainable expansion.

This narrative got dismantled by successive monthly reports that did more than reduce average monthly gains to below 100,000. They also reinforced the fear that America’s labour market was risking structural impairment and, therefore, be much harder to fix.

Friday’s report adds to these concerns. Job gains were limited to just 80,000, again undershooting consensus expectation. The unemployment rate remained at 8.2 per cent, with a stunning 41.9 per cent of the 12.7m Americans out of work being long-term unemployed. The employment-population ratio stayed at the unusually low level of 58.6 per cent. And an alarming 23.7 per cent of teenagers in the labour force cannot find jobs.

The weak employment snapshot is consistent with other recent data releases, virtually all of which came in a lot worse than consensus expectations. It speaks to more than a subpar US recovery. It also illustrates the synchronized weakening of a global economy beset with limited policy effectiveness and adverse feedback loops – not just among individual countries, but also between economic fragility and political dysfunction and, especially in Europe, weak banks and deteriorating sovereign creditworthiness.

Economists who traditionally treat employment data as constituting lagging indicators – reflecting influences that have already played out in the economy – now need also to treat them as signals of future developments. And the consequences extend beyond America’s borders.

Worried about the reliability of their future income and given an already low household savings rate, consumers will spend less aggressively in the months ahead. Financial investors will also become more cautious. And companies will invest and hire less robustly.

A less buoyant American economy will amplify the pressures imposed on the global economy by Europe’s endless and still-expanding crisis. And do not look to policy makers in Europe and the US for effective offsets. Central banks are already in full experimentation mode, having stretched their traditional tools to the limit. The threat of a potentially disruptive fiscal cliff is looming ever larger. Policy responses are undermined by political bickering and dithering. And polarisation will only increase as the weak economy boosts those looking to unseat incumbents, especially in the run-up to the November elections in the US.

The notion that the world can rely on its pockets of healthy balance sheets to do the heavy lifting is theoretically correct but practically unlikely. Given the disappointing multilateral policy coordination, emerging economies will not fully compensate for prolonged weakness in Europe and the US. They too will slow, and are already slowing.

I hate to say it, especially as it sounds so fatalistic, but it is the unfortunate reality for now: Friday’s weak job report does more than confirm the prospects of a sub-2 percent growing US economy with unusually high and stubborn unemployment; it also signals even greater fragility ahead for both the country and the global economy.

This report will make households and companies less optimistic about their future, accentuate political dysfunction, and increase the cost of inadequate policy responses and poor global coordination. Until all this serves as enough of a wake-up call for short-sighted politicians in congress, it will make people like me worry even more about the wellbeing of both current and future generations.

In the good old days when economies were growing close to trend, monetary policy was about setting interest rates. Nowadays it is a complex mix of quantitative easing, credit easing, liquidity provision, prudential controls and debt management. With economies stagnant and interest rates near zero, central banks are trying other ways to induce banks to lend and companies to borrow. As a practical matter, promoting financial stability and restarting growth are the priorities, rather than inflation control. This creates two major problems.

First, economic theory is lacking. Compared to the vast literature on interest rates, little is known about the transmission channels, the lags and the ultimate economic and distributional effects of these unconventional tools. Some of them were standard fare for central banks in the 1950s and 1960s but the field of economic history has been sadly neglected and, in any case, the world has changed since then. Without a solid steer from empirical research, it is risky for policy makers to rely on economic models that predict the impact of different policy options.  This is a classic case of “multiplicative uncertainty” for which the optimal response is to move very cautiously.  As Alan Blinder once said, “estimate what you should do and then do less”. The problem with this advice is that the media clamour for policies to promote growth is unrelenting whereas few would argue publically for higher inflation. Central banks are in the spotlight because they have more freedom to act than politicians, especially in the eurozone where many parliaments are involved.

The second problem facing central banks is policy coordination. The eurozone has a classic chicken and egg problem over which comes first: governments’ budgetary progress or more support to banks from the European Central Bank and the European Stability Mechanism. In Britain, the latest minutes from the Monetary Policy Committee report that some members wanted to wait and see what effect the Treasury’s recent “funding for lending” initiatives and the looser liquidity advice from the Financial Policy Committee would have on bank lending before they could decide on more quantitative easing. This reveals the muddle at the heart of the current separation of the two committees, with their partial overlap in membership. Not only does this give too much power to the Bank of England governor and other BoE insiders at the expense of the external members on both committees, it also risks policy gaps and inconsistencies.

It is not too late to change because the legislation to establish the FPC has not yet gone to parliament.  If, as the governor has suggested, we are less than half-way through this difficult post-crisis period, then the MPC will be using unconventional tools for some time to come.  The best way to deal with the intrinsic connection between monetary and financial levers is a single, accountable Monetary and Financial Policy Committee, with a solid quotient of external members,  published minutes, and a dual mandate for inflation control and financial stability.

Subsection 6 of Article 127 of the Lisbon Treaty, which amended subsection 5 of Article 105 of the Maastricht Treaty, has rarely loomed large in the discussions between heads of government at European summits. Perhaps Mario Monti, the eurocrats’ eurocrat, could always have recited it by heart, but it was not much mentioned by François Hollande on the election trail in France. Yet in the small hours of Friday morning it was at the core of the discussions on a future banking union.

The Articles in question relate to the role of the European Central Bank in banking supervision. Their language is opaque, reflecting past divisions of opinion on what the ECB should be empowered to do. In the debates on the Maastricht treaty, some argued that any self-respecting central bank must also oversee the banking system; others strongly resisted the transfer of national competences that would entail. The compromise was an awkward draft, which gave the European System of Central Banks as a whole the task of “contributing to the smooth conduct” of banking supervision, and allowed the Council of Ministers, acting unanimously, to give the ECB itself “specific tasks… concerning policies related to the prudential regulation of credit institutions”, without amending the treaty.

This might be thought a rather fragile legal basis on which to make the ECB the chief supervisor of a fully-fledged banking union. But last week’s summit clearly decided it was better than the other options. The European Banking Authority (EBA) could have been adapted, but it is a small body, which has evolved very recently from a committee of banking supervisors. Crucially, it also sits in London. Keeping it there was one of David Cameron’s “red lines” at the December summit, and a euro area banking supervisor sitting outside the zone would have looked odd, to say the least. If the timetable were more relaxed, the right answer might have been to create a brand new institution, but that would have required a new treaty. So the ECB it is.

Inevitably, there are many details still to be resolved, crucially which banks will be included: all, or just the largest systemic institutions? The Germans are keen to exclude their domestic savings banks, yet following that logic Bankia in Spain would not have been covered by the ECB. The best practical outcome might be a model copied from the Federal Reserve, whereby any bank wishing to operate across borders in the EU would need authorisation from the ECB, while purely national institutions could go to their local authorities. But the ECB would also be able to designate other banks as potentially systemic, as the Fed can do.

Just as important as these questions of scope will be getting the relations right between the ECB and other supervisors. Member states will be reluctant to wind up their national central banks, or non-central bank supervisors, as some have – another complication. And the ECB will take time to build up its hands-on capacity. But the direction of change must be made clear at the outset – the ECB must call the shots.

Another important question to address is the ECB’s accountability. Here the eurozone may usefully look across the channel at the debates under way in the UK parliament about the accountability of the newly expanded Bank of England. It is widely accepted that it makes sense to endow a monetary policy institution with a high degree of independence. Arguably the ECB is too independent for its own good: unlike the Bank of England it defines its own inflation objective. But in any event the accountability for decisions on banking supervision, where property rights are at issue, and taxpayers’ funds may be put at risk, must be different. How will the European Parliament equip itself to do this job? Indeed, is the European Parliament the right body at all, as its influence on potential bailout funds is minimal? There are great risks here for the ECB, if it is not seen to have the right degree of democratic oversight.

Lastly, there is the vital “ins and outs” question. The logic for creating a banking union derives from the single currency. The UK, and others with their own currencies, will not be included. Some of the other “outs” may consider themselves to be “pre-ins”, but they may have to remain in that category for some time, and the UK will certainly not join in the foreseeable future.

So how will this “variable geometry” work? The EBA is still empowered to make rules for the single financial market as a whole. There is so far no proposal to transfer that power to the ECB, which would be highly controversial and certainly opposed by the UK. But will a system where the EBA makes rules for 27, which are then transposed differently for 17, work in the longer term? Will the eurozone come to act as a bloc, with the ECB acting for it? If so, decision-making within the EBA will be lopsided. Most decisions are made through a version of qualified majority voting. If the ECB speaks for 17 the rest, including the UK’s Financial Services Aauthority or the Bank of England from next year, might as well stay at home.

There are therefore some awkward negotiations ahead. In theory, the UK could block the change, which requires unanimity, but to obstruct the whole banking union idea would be seen as a destructive move. It will, however, need some security for its banks within the single market. Arguing for the interests of British banks, and other banks based in London, may go against the grain just now, but the UK chancellor will have to hold his nose and do so – up to a point at least.

China’s economy will probably grow by less than 8 per cent this year due to weak international demand and a sluggish domestic real estate market. Now the talk among China-watchers is that it is approaching a breaking point on its path of growth: the episode of high growth is over and the country is heading towards a path in the range of 6-7 per cent.

This mood is strong inside China. When Justin Yifu Lin, who just returned to China from his position as chief economist of the World Bank, announced China would keep growing by 8 per cent before 2030, the Chinese media dubbed his claim as “shooting a satellite” – a phrase referring to the widespread phenomenon of output exaggeration in the Great Leap-forward of 1958.

China’s slowdown is bad news for countries that are linked to its production chain. This includes East and Southeast Asian countries, regions that export to China, as well as China’s raw material and energy providers such as Australia, Brazil and the traditional oil producers. However, China’s slowdown can be good news for the developed world, especially the US. My colleague Yiping Huang and David Li, professor at Tsinghua University, both believe that the share of household consumption in GDP has increased in the past several years. China’s current account surplus also declined substantially to a mere 2.8 per cent of gross domestic product last year.

There are good reasons to believe China’s slowdown is permanent. The growth of China’s labour force has been falling since 2010 and by 2020 its stock will start to decline. In accordance, wages are increasing fast; China’s episode of cheap growth is approaching its end. On the international stage, the eurozone has fallen into recession again and the light of recovery is still deep in the tunnel. In the US, federal government debts will grow to more than 100 per cent of GDP even by the most conservative estimates.

However, an international comparison gives hope that China may be able to maintain an 8 per cent growth rate for at least another decade. China’s per-capita GDP is about the level of Japan’s in 1962 and the level of Korea’s in 1982. Both countries grew by 9.7 per cent in the following 10 years after they reached China’s per-capita income of today. A contrast is Brazil. It reached China’s current per-capita GDP in 1978 but then stagnated for more than 20 years. But the Brazilian case – and for that matter, those of other Latin American countries – is peculiar because its stagnation was triggered by a sovereign debt crisis. China has a sound – even too good by many opinions – international balance of payment and a Latin American-type of crisis is a remote possibility for the country.

Inside the country, several factors will help China maintain fast growth in the next several decades. The most significant is continuous improvement of young people’s educational achievement. The bulk of China’s workforce is rural migrants. Compared with a decade ago, men in rural areas aged between 21 and 29 have two more years of schooling today and women in the same age group have 2.6 years more. In the city, the average years of schooling have reached 11 for both men and women in the same age group. The government has announced a national plan of education for 2020. One of its aims is to allow rural young people to finish high school (including professional high school) education. Another aim is to raise the college enrolment rate to 40 per cent.

The return to education is high, averaging 10 per cent for one additional year of schooling. The schooling gap between people aged from 21 to 29 and those between 50 and 59 is 4.3 years. This means the new generation is 43 per cent more productive than the old and retiring generation. This will more than offset the loss of labour in the coming decade. Nobel Prize laureate Robert Fogel predicts China’s economy would be 40 per cent of the world total in real terms by 2040. I asked him if this prediction was too optimistic when I met him in Chicago last November. His answer was no. Instead, he believed that improvement of education alone would allow China to do that.

Improvement of education is supplemented by the Chinese government’s investment in research and development. By the 12th Five-Year Programme, R&D expenditure will be increased from the current 1.7 per cent of GDP to 2.2 per cent of GDP in 2015. This will place China close to the rank of developed countries.

The world economy of this decade resembles that of the 1980s in many ways. On one count, it will probably be as sluggish as the 1980s. However, that decade witnessed the rise of the East Asian tigers. China has a much bigger economy than the tiger economies and export cannot be a long-term driver of its growth. But China can also benefit from having a large population. The recent growth of household consumption is an encouraging sign. It is likely that the country’s economy will continue to turn to domestic consumption to look for growth. As the level of income increases, the advantage of a large country will only become stronger. In the end, China will be likely to maintain an average rate of growth of 8 per cent before 2020. This will probably allow the country to take over the US to become the largest economy in nominal term by 2020.

The writer is director and professor at the China Center for Economic Research, Peking University

 

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