Monthly Archives: October 2012

The focus is back on the debt crisis in Greece where a three party governing coalition is struggling to come up with a new economic reform programme that can secure parliamentary approval. Meanwhile governments, such as Germany’s, that extend support to Athens, are considering how best to approach their own legislatures with Greece’s request for even more aid.

We expect the various European officials to find a way to sort all this out over the next few weeks – not because they believe in the outright merit of what they are doing but because they fear the alternatives. But that means lots of unsatisfactory and unsustainable compromises. And by failing to address the underlying issues, yet another Greek rescue will stand no greater chance of success than previous ones. Meanwhile the trust of Greek citizens in the credibility of government and institutions will erode further.

Greece is seeking to finalise three distinct elements of its revamped programme: cuts in spending and tax rises, labour market reforms, and additional external financing from its European partners and the International Monetary Fund.

All three are the outcome of disappointing economic and financial developments: gross domestic product has contracted more than anticipated under prior bailout agreements; unemployment has risen further; domestic payment arrears are at record levels; and debt is way too high. Part of this reflects incomplete policy implementation by Greece, and part is due to problems in the design of previous programmes.

In order to secure additional financing, Greece’s governing coalition is very close to finalising a new fiscal package involving further cuts in the public wage bill, pension reductions and a broadening of the tax base. Coalition negotiations on labour reform – entailing lower firing hurdles, changes to the minimum wage legislation, and weaker collective bargaining – are proving more difficult. While one of the parties may withhold its support the two others will likely press ahead nevertheless, securing legislative approval by late next week, albeit via a very noisy process.

Government action is facilitated by the leniency being shown yet again by the troika of external creditors (the European Central Bank, European Union and the International Monetary Fund). Rather than pull the plug on Greece after yet more policy shortfalls, the troika has agreed to extend the fiscal adjustment period and commit billions more euros to support the country. As some of the funding requires individual country approval, several governments (including Germany’s) will need to deal with their own parliaments on what has become an increasingly unpopular issue among their citizens.

We expect this too to be worked out in the next few weeks. Yet it is hard to find many officials who believe that the revamped Greek programme will do what all of us hope for – namely, restore economic growth, jobs and financial stability.

Rather than provide a solution, the current approach seeks to buy more time and to avoid fundamental decisions. Judging from signalled actions (as opposed to the diplomatic words), there is insufficient commitment to retaining Greece within the eurozone, and there is no plans for an exit that minimises dislocations.

If the underlying objective were for Greece to remain a eurozone member, we would see much greater emphasis on official debt forgiveness, as recommended by the IMF; and ample multi-year long-term funding would be made available at low interest rates to support growth-enhancing measures. If the objective were to safeguard Greece’s wellbeing outside the eurozone, there would be much greater emphasis on how Greece could best return to a national currency, while staying within the European Union (as opposed to the eurozone), and deal with the convertibility and debt challenges that would come with this transition.

Instead, Greece and the troika have opted again for the muddled middle – one that talks about sustainable eurozone membership but does not do enough to make this highly probable.

While such a tactical approach may seem attractive, it is far from costless. Nor is it sustainable over the medium-term: it further undermines Greek citizens’ trust in domestic and European institutions – trust that is already at breaking point, if not broken. The Greek government, meanwhile, could lose control of the country’s management. With that, the threat would increase of a highly disorderly outcome – a sudden and unplanned Greek exit from the eurozone for example – which would result in further deprivation and poverty, and significantly increasing the already-considerable trials facing Greek citizens.

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

Some years ago it was common for Pakistanis to joke that they deserved a vote in American elections because the two countries are such close allies. Not any more. The noise coming out of Washington today is more likely to be Pakistan bashing than Pakistan loving. In the Pakistani city of Lahore, from where I write, attitudes toward the US have similarly soured.

Ahead of the US presidential election on November 6 BBC polling in 21 countries has shown that voters in all but one prefer Barack Obama to his Republican challenger, Mitt Romney. Pakistan is that exception. Obama would get just 11 percent of the vote in Pakistan. 60 percent of Pakistanis said they had no confidence in the current US president. Other polls show that 90 percent of Pakistanis are now anti-American

Last year the two so-called allies had a seven month falling out as Pakistan closed the road that carried NATO goods to the Afghan border. For part of this period all contact between the governments in Washington and Islamabad was cut off.

Traditionally the Pakistani military and political establishment have always favoured the Republican candidate in US presidential elections because it has been during Republican administrations that Pakistan’s multiple military regimes have flourished and received massive US aid. Ronald Reagan turned a blind eye to Pakistan’s clandestine nuclear programme. Under President George W. Bush Pakistan received nearly $20bn in aid after September 11 – 80 per cent of which went to the military. The younger Bush also turned a blind eye to the continued Taliban presence in Pakistan after 2001.

Democrat Presidents such as Carter and Clinton, on the other hand, have at times insisted on greater democracy and less aid for the military. Democrats tried to curb Pakistan’s nuclear programme, which is now believed to have around 100 operational weapons, and used sanctions on Pakistan in the 1990s while cosying up closely to arch rival India. As a result Democrat administrations have had a far more difficult relationship with Pakistan’s army and politicians

But Islamabad’s affiliations – Republican or Democrat – are now in the past.

It has been a big shock for Pakistan’s military to see Republican members of Congress insisting on a total cut off of aid to Pakistan and demanding Pakistan be treated as an unfriendly country. If Romney wins the assumption is that he will be under pressure to reduce foreign aid across the board but particularly for Pakistan.

Yet Pakistanis also feel deeply slighted by Obama’s term in office which has seen the use of drones to attack terrorist targets in Pakistan reach unprecedented levels along with regular US special forces incursions into Pakistan, notably during the killing of Osama bin Laden.

Instead of favouring Republicans over Democrats, or vice-versa, many Pakistanis are now simply gripped by anti-Americanism. Anti-US sentiment is now so rampant and Americans perceived as so hostile to Pakistan that most Pakistanis do not care who wins the presidential election, because they expect both candidates to continue to bash Pakistan.

Yet what Pakistanis are often not told by their leaders, is that Islamabad has so far done little to rectify the meltdown in the country. The government has not introduced economic reforms, curbed terrorist groups or put sectarian murderers, who are killing Pakistanis and Afghans as well as US forces in Afghanistan, into jail.

Pakistan has never had a comprehensive counter terrorism strategy. The intelligence agencies have always divided Islamic extremist groups into two categories – those friendly to Pakistan, who are not to be touched, and those unfriendly who are to be killed.

In the biggest irony of the US-Pakistan relationship senior Pakistani generals and religious leaders mouth their hatred of and sense of betrayal by the US, while large numbers of their family members live in the US. Such hypocrisy is mirrored at all levels of society as tens of thousands of Pakistanis try to get a Green Card and visa lines still snake around the US Embassy in Islamabad.

As a result of dynamics on both sides, the relationship between the US and Pakistan has now become extremely complicated. Although dialogue has been resumed neither side has a comprehensive plan or strategy to rebuild the relationship. The Americans would like to keep Pakistan sweet until the US withdrawal from Afghanistan is completed in 2014.

What happens afterwards will be fraught. Pakistan is strongly opposed to the US leaving behind 20,000 troops for the next five years to ostensibly train Afghans because that means drone attacks will continue. So will US incursions: many in Pakistan expect the US military to keep specially trained teams on its Afghan bases to dismember or seize Pakistan’s nuclear weapons were there ever a threat of extremists getting their hands on them.

That means for Pakistan’s military the Americans in Afghanistan will continue to remain a threat not an ally. As far as the Pakistani “street” is concerned, at the moment most Pakistanis would refuse to vote for either candidate in the US elections. Sadly that is how bad the relationship has got.

Ahmed Rashid is the author of several books about Afghanistan, Pakistan and Central Asia, most recently ‘Descent into Chaos’

The latest economic data show that conditions are worsening in the eurozone, not only in the periphery but now also in the core countries. This will further test the political determination to continue to implement the austerity measures and structural reforms required to restore financial stability.

For countries in the periphery like Greece, Portugal and Spain, the delay in economic recovery postpones the date at which debt to gross domestic product ratios stop rising. The reduction in budget deficits is also postponed, in spite of the tight austerity measures that have been adopted. Governments may try to ignore the negative effects of short-term economic data and focus on the structural budget, excluding the impact of the latest slowdown. But that will only be possible to the extent that markets believe that this slowdown is temporary.

As unemployment continues to rise, the light at the end of the tunnel seems to fade away, undermining the political support for protracted austerity and structural reforms.

In the core countries, the slowdown might undermine the political support for providing further financial assistance to other countries, including those which are undertaking a major adjustment effort. Economic hardship pushes public opinion to become more inward looking and focused on domestic problems. As a result, solidarity among eurozone countries may weaken.

What can be done to address the problem?

First, monetary policy should be allowed to function properly, in all parts of the eurozone. At present, monetary transmission is not working in several countries, as the European Central Bank has reminded us several times. This is due partly to the so-called “convertibility risk” in the euro which is reflected not only in the higher interest rates on government bonds of peripheral countries but also in the higher rates that banks in these countries charge on the loans to households and companies. Such high credit risk is transforming the relatively accommodating monetary policy decided in Frankfurt into the very restrictive monetary conditions prevailing in the periphery.

Unless monetary conditions are eased in these countries, the fiscal adjustment those countries are undertaking might become self-defeating. If borrowing rates remain high in peripheral countries, the recovery might be postponed even further. This might over time fuel new centrifugal forces in financial markets.

Given that the ECB has – rightly – made intervention to ease monetary conditions in the peripheral countries conditional on those countries adopting a fiscal adjustment program, the ball is in the court of the peripheral governments. Delaying the request of a programme, on grounds of political pride, ultimately increases the cost for the domestic economy.

On the other hand, it is not clear why countries which have already adopted a programme, like Ireland and Portugal, and are on track, should not benefit from a more accommodative monetary policy. The argument against the ECB buying the bonds of Ireland and Portugal is that these countries’ governments are currently out of the market and do not need such action. However, as long as the spreads on government bonds remain as high as they currently are in those countries, the private sector will not be able to borrow at lower rates. The transmission of monetary policy, which ultimately depends on the private sector’s access to credit, will remain impaired. And the economy will continue to suffer, making the fiscal adjustment last longer and be more painful.

With Irish spreads now at levels similar to those of Italy and Spain, and the Irish fiscal adjustment programme on-track, ECB intervention would improve the prospects for the Irish government and private sector to finance themselves in the markets rather than through loans from other eurozone governments.

The task of supporting growth should not, however, be left to monetary policy alone.

Fiscal policy currently has limited room for manoeuvre in the euro area. Countries have to abide by the constraints exercised either by financial markets or the fiscal compact. This is particularly unfortunate in light of the fact that the euro area as a whole, and most of its members currently, record a current account surplus, that on aggregate is expected to rise by around 1 percent of GDP this year and a further 0.5 percent in 2013.

Even if there is little scope for changing the overall size of the budget envelope in the different countries, there may be grounds for modifying the composition of revenues and expenditures in national budgets countries, with a view to foster growth and reduce imbalances within the eurozone.

For instance, countries which already record an external surplus – like Germany – should aim at reducing taxation on consumption (known as sales taxes in the US or VAT in England) and compensate the lower proceeds from taxes on consumption with a rise in personal income tax or in social security contributions. The opposite should be done by countries – like Italy or Spain – which still record an external deficit and need to restore competitiveness.

The above mentioned symmetrical adjustment would be budget neutral and lead to a reduction in imbalances within the euro area and stimulate overall demand. It would improve market sentiment and facilitate the task of monetary policy.

Such a policy requires strong cooperation between the fiscal policies of the member states. How can this be achieved? One way could be to use the new budget oversight procedures being developed in response to the crisis at the European level to assess the compatibility between the country-level budgets and the overall eurozone position. The initiative to do so is in the hands of the European Commission. Without such coordination individual member states’ fiscal policies cannot take into account the impact on each other. They are thus bound to be overly restrictive and further broaden imbalances.

The eurozone certainly needs fiscal discipline. But fiscal discipline can be sustained only if supported by monetary policy and a better coordination of the member states’ budgets.

The writer is a former member of the Executive Board of the European Central Bank and currently Visiting Scholar at Harvard’s Weatherhead Centre for International Affairs

The final full week of the US presidential campaign will see both candidates intensely debate the future of economic policy. But despite the rhetoric about its means, most experts agree on its ends. First, re-establishing economic growth at a rate that makes real reductions in unemployment possible; second, placing the nation’s finances on a stable footing by putting in place measures to ensure that the nation’s sovereign debt is declining relative to its wealth; and third, renewing the economy’s foundation in a way that can support steady growth in middle-class incomes over the next generation as well as work for all those who want it.

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Where are the candidates on these three issues? Barack Obama has recognised the inadequacy of demand as the main barrier to growth and sought to bolster both public and private sector demand since becoming president. Recent work by the International Monetary Fund has confirmed the premise of his policies, namely that at a time when short-term interest rates are at zero, fiscal policies are especially potent as multipliers are larger than normal. The president has also respected the independence of the Federal Reserve as it has sought to respond creatively to the challenge of increasing demand. And he has put the economy on track to almost doubling exports over five years through a series of measures such as increasing government support for exporters. He has made clear his commitment to taking advantage of low interest rates to finance public investment and protect public sector jobs, to respect the independence of the Fed and to continue to promote exports.

Mitt Romney, in contrast, supports immediate efforts to sharply reduce government spending even as economic slack remains and Congress at the president’s behest has already legislated the most draconian cuts ever in domestic discretionary spending. Through some set of intellectual gymnastics he concludes that spending on new weapons systems by the government, or on luxury goods by the recipients of tax cuts, will create jobs but spending on fixing schools and highways do not. He also seems comfortable involving himself in monetary policy discussion on the side of reducing the supply of credit relative to current Fed policy. And his insistence that he will name China a currency manipulator on day one of his term even before his appointees have moved into their offices surely increases uncertainty by making a trade war possible.


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President Obama has embraced the principles though not all the details embodied in the Simpson-Bowles commission report on budget deficits. Like the group of chief executives who made a major statement on deficit reduction last week he insists that achieving sustainable finances means both containing spending especially on entitlements and raising revenue. The budget he has put forward has been thoroughly audited by the Congressional Budget Office and puts the US debt to gross domestic product ratio on a declining path within this decade. And he has made clear that in talks with willing partners to conclude a deal, he is prepared to go beyond his budget proposals to ensure that debt accumulation is contained.

Mr Romney, meanwhile, has not suggested even a partial approach to the budget that has enough detail to be fully evaluated by independent experts. He has, however, insisted on the need for military spending of at least a trillion dollars more than recommended by Robert Gates, George W. Bush’s defence secretary, and for 20 per cent across the board tax cuts which independent estimates suggest would cost close to $5tn over the next decade. To offset these measures, he has spoken of “closing loopholes” without naming any specific items and in the face of repeated demonstrations that even the elimination of every tax benefit for those with incomes over $200,000 would raise far less than the totality of his proposals would cost.

From the Lewis and Clark expedition to the land grant colleges, to the transcontinental railway, to the interstate highway system, to the original research and development that led to the internet, the federal government led by either political party has always sought to lay a foundation for future prosperity. President Obama has continued this tradition while recognising the inevitability that in an uncertain world some investments will work out better than others. While audits have found many fewer problems with public investments than most expected over the past few years, much has been accomplished. Major efforts to measure and act on student achievement results are now in place in most states. Medical records are being systematically computerised. Domestic fossil fuels and renewable energy sources are meeting more and more of our energy needs. New financial protections are in place for consumers even as the capital reserves required of financial institutions have been substantially increased and student lending has been streamlined. These steps illustrate the kinds of progress that a second Obama administration would strive towards.

Mr Romney, on the other hand, has made clear a preference for using any available resources to reduce tax rates below their current level – in the hope that there are great investments companies are not already undertaking even in the face of sub 2 per cent interest rates and the lowest effective tax rates in generations. If this represents a foundation for prosperity it will be a very different one than America has enjoyed historically.

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

In Apocalypse Now, Wagner’s “Ride of the Valkyries” provides the soundtrack to the dirty deeds of American helicopter crews. I don’t know whether Sir Mervyn King, Governor of the Bank of England and avid classical music buff, has been listening to Wagner recently but he clearly shares Francis Ford Coppola’s horror of helicopters. In Sir Mervyn’s case, however, the source of his angst is monetary, not military, helicopters.

In a speech on Tuesday night, Mr King outlined the limits to monetary policy. Following all the talk from the International Monetary Fund about magical multipliers, Mr King offered a much-needed dose of economic reality. Taking a leaf out of Japan’s “lost decade” experience, he warned of the dangers of rising non-performing loans, implying that the banking sector would take many years to recover. He was dismissive of the idea that the Bank of England should cancel gilts – UK government debt – that it has purchased as part of its programme of quantitative easing. And he sneered at the idea of dropping money from the aforementioned helicopters. Mr King, is not a believer in “get rich quick” schemes.

It’s not so much that monetary policy is ineffective. Rather, people expect too much from it. Those who hope for a return to the good old days choose to ignore the rather obvious fact that, back then, economic activity was heavily distorted: economic growth in the years preceding Lehman was driven by a housing boom, a sub-prime lending boom, financial market shenanigans, ever-higher levels of public spending and, frankly, not much else.

Early doses of quantitative easing were consistent with the desire to rebalance the UK economy. In anticipation of the first round of unconventional policies, sterling fell, offering the opportunity for an export-led recovery. In reality, however, the UK ended up with little in the way of extra growth and rather too much in the way of inflation. Sterling’s decline amplified the impact on the UK of higher global commodity prices. That wasn’t really part of the plan: the resulting squeeze on real incomes made deleveraging that much more difficult. Meanwhile, the much-heralded export recovery failed to materialise. Relative to the BoE’s own economic forecasts made towards the end of 2010 – and conditioned on the positive effects of QE – the UK economy’s performance has been very disappointing.

It may well be that unconventional monetary policy can prevent the worst outcome – the avoidance of another Great Depression, let’s say – but it is not obvious that it can take us back to the sunny uplands of the pre-crisis years.

Indeed, I would argue that unconventional policies create distortions that make an early return to economic health rather unlikely.

I have three concerns. First, QE delivers a flat yield curve – that is interest rates for long-term loans are not much higher than for short-term loans. That should certainly help boost the demand for credit. But a flat yield curve makes it difficult for banks to make money by borrowing cheaply at short-term interest rates and lending profitably at higher long-term rates. Lower bank profitability will restrict the supply of credit. During the early-1990s credit crunch, the Federal Reserve deliberately engineered a positively-sloped yield curve to “fix” the banks, the polar opposite of today’s policies.

Second, as the BoE now well knows, QE increases pension fund shortfalls. Admittedly, fully-funded pensions shouldn’t have many problems but, today, these are few and far between. Underfunded schemes have seen the net present value of their liabilities rise more quickly than their assets, creating uncertainty over future pension entitlements and contributions, dampening household confidence in the process.

Third, despite Mr King’s insistence that monetary and fiscal policy are entirely separate, this is no longer the case. In the upcoming pre-Budget Report, George Osborne will be able to delay fiscal consolidation thanks in part to the behaviour of the Bank of England, whose gilt buying has kept yields low allowing the government to borrow cheaply to fund deficits. QE has become the Chancellor’s lifeline, sparing him from a 21st century Greek tragedy.

This, however, is another example of avoiding the worst, rather than providing a path towards recovery. QE has allowed the government to live with high – and rising – levels of debt. It has not, however, delivered the kind of recovery that would, eventually, allow those debt levels to decline. In this way, the UK is emulating Japan’s experience: low rates, high government debt and disappointing growth.

Perhaps, then, the helicopters should, after all, take flight. Might a stirring rendition of some choice Wagner do the trick? Should we demand fiscal stimulus funded by the printing press – through the cancellation of government debt held by the BOE or some other form of “money drop”?

Roosevelt pursued such policies in the 1930s. They seemed to work. From the depths of Depression, the US staged a solid recovery accompanied by a dose of inflation. Yet Roosevelt’s inflation was only acceptable because of the earlier deflation.

As Roosevelt said in one of his fireside chats, “The Administration has the definite objective of raising…prices to such an extent that those who have borrowed money will, on the average, be able to repay that money in the kind of dollar which they borrowed. We do not seek to let them get such a cheap dollar that they will be able to pay back a great deal less than they borrowed”. In other words, in the absence of deflation, it’s difficult to justify the pursuit of inflation.

Helicopters are all very well, but they should be used sparingly. Mr King may protest too much about the independence of monetary from fiscal policy. He is surely right, however, to warn of monetary policy’s limitations.

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 United States is rapidly approaching the “fiscal cliff,” a dangerous combination of increased taxes and decreased government spending scheduled for January 1 that would reduce the budget deficit by five percent of GDP between 2012 and 2013. Although reducing America’s budget deficit is necessary, such a sharp cut now while the economy is still very weak would be a serious mistake.

If the fiscal cliff is not avoided or rapidly reversed, the American economy would soon be in a new recession with substantially higher unemployment. That would have a negative impact on the global economy. There is nothing that the Federal Reserve could do to prevent such a renewed economic downturn.

So just what is the “fiscal cliff,” why is it scheduled to happen now, and what can be done to prevent it?

The biggest piece of the “fiscal cliff” is the automatic expiration of the tax rate cuts enacted when George W Bush was president. They were scheduled to end in 2012 in order to limit the official projected revenue loss. Subsequent legislation provided additional tax cuts that will also end this year. Expiration would involve higher taxes on personal incomes, on estates, on corporate profits, and on payroll earnings.

Going over the fiscal cliff also includes cuts in government spending – half in defense and half in non-defense “discretionary” programmes (i.e., all programmes excluding Social Security and Medicare). This “sequester” will automatically start with $109bn of spending cuts in 2013. Over nine years it will lead to total cuts of $1.2tn unless Congress enacts a different multi-year budget plan that reduces the deficit by $1.2tn over those years.

The fiscal cliff can only be avoided by legislation passed by both houses of Congress and signed by the President. The critical issue that prevents such legislation is a conflict over tax rates between President Obama and Republicans in the Senate and House of Representatives. President Obama wants to extend the current tax rates for taxpayers with incomes below $250,000 but to raise taxes for those with incomes above that level to the higher rates that prevailed before the Bush tax cuts. The Republicans want to extend the current tax rates for everyone and can use their majority in the House to prevent the Obama plan from becoming law.

The conflict is important economically as well as politically. Although the high-income group represents only about three percent of all taxpayers, they pay more than 40 percent of all personal income taxes.

The election on November 6 will determine how the issue of the cliff is resolved. Although the Republicans will retain control of the House of Representatives, the outcome is uncertain for the Senate and for the presidency.

If Romney is elected and the Republicans win a majority in the Senate, the conflict over tax rates will not persist after the president’s inauguration in January. Even if President Obama were to block Republican-sponsored legislation to eliminate or postpone the fiscal cliff in the two months after the election when he is still president, the new Republican administration and Congress would rapidly reverse the automatic tax increases once Romney takes office. Doing so retroactively to January 1 would avoid most of the adverse short-run effect of going over the cliff. Postponing final legislation until mid-summer would give time to craft compromise reforms of taxes and entitlements that would have a positive effect on the economy.

If Romney is elected but fails to carry the Senate, a stalemate could remain. A bipartisan group in the Senate is working on a plan to postpone the fiscal cliff, substituting a combination of reforms to taxes and entitlements that would be a desirable alternative. It is too soon to know what the prospects are for such a compromise.

If President Obama is re-elected, he would regard that as a mandate to raise taxes on high income taxpayers. Since the Republicans will still control the House, he may not be able to enact such a tax bill before the end of the year. Some Democrats advocate that the President allow the current tax law to expire and then propose new legislation in January to cut taxes on everyone with income below $250,000, daring House Republicans to vote against a bill that lowers taxes on 97 percent of taxpayers while raising taxes on no one. That same legislation could avoid triggering the sequester if it also broadens the tax base and cuts government spending.

But avoiding the adverse effects of the fiscal cliff under any of the scenarios would still not deal with America’s long run fiscal problems. The United States needs to slow the growth of the middle-class retiree programs and raise revenue by limiting tax expenditures in a framework of fundamental tax reform. Dealing with the fiscal cliff is just the first act of a play with many acts.

The absence of a discussion on climate change in the three debates between Barack Obama and Mitt Romney is a sign of how the topic has fallen off the US policy agenda since the financial crisis. This is a sad gap and one the next president must address.

Looking globally, however, there is some cause for hope. Last week, the board of the Green Climate Fund, a very important but little known international institution, decided to locate the fund permanently in South Korea. This was a good move. South Korea has been a global leader in promoting the important concept of “green growth”: economic growth combined with reduced greenhouse gas emissions.

The Green Climate Fund, agreed by the 191 countries that are signatory to the UN Framework Convention on Climate Change, is the key global instrument for enabling poor countries to undertake investments in renewable energy and climate change adaptation (that is, making the economy more resilient to the climate change that is already underway). The Green Climate Fund has been given a daunting assignment: to raise $100bn per year for low-income countries by 2020.

Rich countries need to finance poor countries for three reasons.

First, they owe it to the them. Around 75 per cent of the greenhouse gas emissions to date have come from the rich countries, but it is the poor countries, notably in the tropics, that are reeling from the brunt of human-induced climate change. If we had global tort law, the poor countries would sue the rich countries for damages in destroying their climate. Instead, we have an agreement on compensation.

Second, the world has rightly accepted that climate change action must be addressed within the overall context of development, meaning that poor countries must not be hampered by the costs of low-carbon energy and the burdens of climate-change adaptation.

Third, the world has accepted a pragmatic reality: without incremental climate financing, poor countries simply can’t afford a development strategy that combines low-carbon energy with universal access to electricity. They will be forced to choose the lower-cost, carbon-intensive energy systems.

Yet the rich countries have not yet accepted a formula to meet their $100bn-a year pledge. Those who have participated in the backroom negotiations know that it is the US above all other countries that has resisted a clear and accountable financing mechanism. This is par for the course. The US these days resists almost all calls for sharing the financial burdens of sustainable development. As a striking example, the US official development assistance budget, though large in absolute terms, is the lowest share of GDP of any advanced economy, just 0.18 per cent of national income.

The basic principles of financing the Green Climate Fund should be clear enough. Polluters should pay for the damages they are causing, so contributions should be linked to carbon emissions. Payments should be graduated in terms of ability to pay (and implicitly, as least, historical responsibility). And the use of the funds should be directed to the low-income countries, those in need of the climate financing.

Here is a straightforward way to reach $100bn that abides by these principles. The world would adopt a base assessment rate of $5 per ton of CO2 emitted by each country. The high-income countries would pay the full $5 per ton on their emissions. Upper-middle income countries would pay half-fare, that is, $2.5 per ton. Lower-middle income countries would pay half of that, $1.25 per ton. The low-income countries would not pay into the GCF, but would be the recipients. The World Bank’s country-classification scheme would be used to categorize countries by income.

Using the 2010 emissions by country reported by the International Energy Agency, we find that a $5-per-ton base levy would lead to combined assessments of $101bn. The largest assessment would be on the US, at $27 billion, equal to roughly 0.18 per cent of GDP. This reflects the U.S. 5.4bn tons of CO2 emitted in 2011. The second largest contribution would come from China, at $19bn and equal to roughly 0.17 per cent of GDP, reflecting China’s 7.7 billion tons assessed at $2.5 per ton.

Suppose that countries cover these assessments through carbon levies that are passed along to the consumer at the petrol pump and the home electricity bill. A tax of $5 per ton of CO2 emission would amount to roughly 1.1c per litre, or 4.4c per gallon of petrol. Similarly, that same carbon levy on the electricity produced by a coal-fired power plant would amount to roughly 0.5c per kilowatt-hour.

The advantage of this approach to the GCF is fairness – as it is based on the “polluter-pays” principle adjusted by ability to pay – and its simplicity, transparency, and predictability. There are no other financing proposals on the table that have these properties, nor are there likely to be. The US has been resisting such a simple formulation precisely because it would then be held accountable for the scale of its emissions and its ability to pay, if not for its historical responsibility in bringing the planet to the current state of climate instability.

Another advantage, clearly, is that such a global carbon-based levy would push countries to the right kind of domestic policy intervention: setting a social cost of carbon emissions to be collected through a carbon tax or the sale of carbon emission permits. Interestingly, the US has actually set a social cost of carbon of $21 per ton of CO2 for purposes of cost-benefit analyses by US regulatory agencies, but the government has not yet taken the next obvious step, of introducing that social cost of carbon into market transactions through corrective taxes or permits. The move to a global carbon levy for the CGF would nudge it and other governments to do just that, thereby promoting the market-based transition to low-carbon energy.

On Friday, a large bomb in the Christian section of Beirut killed an important Lebanese security official along with many others. People were quick to point fingers at Lebanon’s largest neighbour, including one parliament member, who said: “It is such a big explosion that only the Syrian regime could have planned it.” Whoever masterminded the attack, it is clear that the Syrian conflict has spilled well beyond its borders.

As the violence in Syria builds, powers outside the region are unable or unwilling to do much more than send in more weapons and watch what happens next. The attack on the US consulate in Benghazi – and its election year political implications – leave Washington even less keen than before on direct engagement with the various groups collectively known as Syria’s opposition. In Europe, leaders have their hands full with the eurozone crisis. China has no interest in greater involvement, and the Russians are content to sell
Bashar al-Assad more weapons.

But this is no ordinary civil war. It is a conflict of growing consequence for much of the Middle East. In short, Syria’s stalemate is becoming not only more costly but more dangerous, for the entire region.

Cross-border clashes involving Turkey’s military are unlikely to provoke a full-scale war, but they are generating more than enough uncertainty and anger to keep both sides on high alert. Ankara and Damascus are no longer communicating directly, and Turkey has adjusted its military rules of engagement to treat the proximity of Syrian troops near the border as a threat to Turkey’s national security. As with any such standoff, the risk that a simple miscalculation will trigger an escalation that no one can control is growing.

Then there is the Kurdish issue. In response to Turkey’s support for Syrian rebel groups, Mr al Assad has struck an implicit deal with a Syrian affiliate of the Kurdistan Workers’ Party (PKK) – the PYD, a group that has exploited the growing power vacuum in
northern Syria to increase its activity there. The Turkish military is already struggling to contain a new wave of PKK attacks within its borders – the deadliest since the 1990s. If the Assad regime increases its support for the PKK and new terrorist attacks originating from Syria hit Turkish cities, Ankara will find it tough not to escalate its low-level battle with
Syrian forces.

Syria’s turmoil is creating anxiety across other borders as well. In Lebanon, instability in the north of the country has allowed Syrian rebels to create a logistical arms base.

If the Lebanese government cannot act to stop this, Mr al-Assad may well order cross-border attacks, exacerbating already intense political and sectarian tensions inside Lebanon. In Iraq, Prime Minister Nuri al-Maliki’s long-term concern rests with the makeup of the regime that succeeds Mr al-Assad. If a radical Sunni Islamist – perhaps even Salafist – movement comes to prominence, it could provide support for Sunni Islamists inside Iraq.

In addition, though Israel’s government would love to see the back of the Assad regime, the risk of Syria becoming a failed state will pose a new and direct threat to Israel’s national security. Al Qaeda chief Ayman al Zawahiri has publicly signaled that a presence in Syria is a jihadist priority. Extremists need not take power in Syria to pose a threat. They need merely find room to operate if and when the country becomes ungovernable.

Finally, Jordan’s Hashemite regime finds itself increasingly surrounded by unfriendly governments. The rise of the Muslim Brotherhood in Egypt and regional demand for democratic change is a problem, but the presence of Islamists in Syria could create challenges inside Jordan that its government has only begun to address.

In short, it’s one thing for outsiders to resist direct involvement in a Syrian civil war. But as the conflict generates new risks across the region, it will become much more difficult for foreign powers to remain aloof.

European leaders are meeting in Brussels almost four months after their previous summit, at the end of June, where they launched a project for European banking union and agreed on direct recapitalisation of banks in crisis-hit countries. Since then the eurozone has benefited from a respite, but in fact many of the decisions taken in June still await implementation.

The European Commission tabled its proposals for common banking supervision in mid-September, but negotiations are far from complete. On the other components of banking union, especially a programme to wind up failing banks and the creation of a fiscal backstop – on which there was no firm commitment, anyway – discussions have not really started. Spain may soon agree on a memorandum of understanding with the European Stability Mechanism, but after months of delay. In the meantime, the European Central Bank has announced its outright monetary transaction programme but in the absence of a Spanish MOU, it has not yet been able to implement it. Furthermore, a dispute has emerged on the meaning and scope of direct recapitalisation of banks by the ESM.

Delay is sometimes justified. It is true that the details of supervisory arrangements matter considerably and, as Germany rightly points out, should not be overlooked in haste. But Europe’s leaders should not believe that positive market reactions to announcements will substitute for actual decisions for long.

With that in mind, what should we hope for from this week’s summit? And how should we assess the new proposals prepared by the EU president Herman Van Rompuy for discussion there?

By far the most important priority for this weeek’s meeting is to ensure a consistent follow-up on previous initiatives. Mr Van Rompuy’s report must be commended for stating clearly that banking union involves a single supervisory authority, a common framework for winding up failed banks, implemented by a common resolution authority and common standards for a national deposit guarantee scheme. Absent these dimensions common supervision alone would simply create new problems without solving the existing ones. The acid test for this week’s summit then will be whether the proposed blueprint for comprehensive banking union is actually endorsed by the European leaders.

For the longer-term Mr Van Rompuy does not deliver the comprehensive blueprint many of those who wonder how the eurozone may evolve were hoping for. Instead he makes two proposals, both of which are bound to be controversial, although they are couched in cautious and rather imprecise terms: he envisions a eurozone “fiscal capacity” equipped with an ability to borrow, that would help absorb asymmetric shocks. He also puts on the table again the pooling of sovereign funding instruments, in other words the issuance of eurobonds. Both ideas deserve serious discussion. But although the common perception is that they represent two sides of the same coin, it must be recognised that they in fact draw on two different, largely alternative models.

A fiscal capacity would be a sort of eurozone budget whose borrowing would result in bonds issued by a eurozone treasury. These would be federal bonds, whose collateral would consist in a eurozone power to raise revenues through its own resources. There are questions to be raised about the public goods this budget would finance, how large it would be, the volume of bonds it could issue and the nature of its own resources. But the model is clear enough: it draws on the federal template.

Jointly issued bonds, on the other hand, would rely on a mutual insurance model through which states would provide guarantees to each other, without creating a common budget or granting the eurozone revenue-raising powers of its own. Each state would spend separately but they would mutually guarantee a fraction of each others’ debt. The volume of bonds could be larger, because it would suffice to decide which part of the national debts to mutualise. But there are serious questions about the institutional arrangements that could underpin the provision of such guarantees. They would certainly require giving a common authority the power to veto national budgets.

Both avenues can be explored but it is clear that they lead to different outcomes and have vastly different economic and political consequences.

Uncertainty is even higher as regards the institutional arrangements envisaged in the report. Mr Van Rompuy rightly speaks of democratic accountability, but in general terms he mentions both the European parliament and national parliaments without specifying their roles.

Depending on the nature of fiscal arrangement, however, a choice must be made between two sources of legitimacy. If the resources that are mobilised come from national budgets – as is the case for the ESM – national parliaments are the legitimate bodies as far as accountability is concerned. The problem is that no one, in the national democratic accountability processes, is in charge of the European interest. Only through duress and crises are national parliaments reminded that the sharing of a currency has created new forms of economic interdependence. So the common interest only exists in the last resort. Yet the European parliament, which has no responsibility for raising the corresponding revenues, would not be a solution either. Rather, the logical response would be to build on national parliaments and find ways to let them socialise through a common parliamentary assembly.

If, alternatively, resources were to come from a federal budget – which is not the case at present – the European parliament, rather than national parliaments, would be the legitimate body.

In either case, clarity is what matters the most.

It is understandable that at this stage of its discussions the eurozone is still uncertain about its model. Leaders, however, should aim at intellectual discipline and explore consistent solutions. The blurring of responsibilities is the last thing Europe needs if it wants to engage its citizens.

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

Markets are fixated on whether the falling growth rate of China’s economy finally bottoms out this quarter but when the next generation of China’s senior leaders takes centre stage next month, this will be a trivial matter compared with three key policy choices they will face over the coming years. These are recalibrating the respective roles of the state and the private sector; reducing Beijing’s reliance on the banking and finance system in favour of the government’s own budget; and allowing the pace and pattern of urbanisation to be shaped more by market forces than centralised directives.

For the public, the overriding concerns are widespread corruption and increasing disparities. For the economic growth process to be enduring, it cannot continue to foment the kind of social unrest that now requires more to be spent on internal security than on the military. There is no simple solution for these concerns, but acting on the three choices will go far in addressing the root causes.

Beijing has succeeded in making the right choices in these three areas before. China became the world’s second-largest economy because its leaders allowed the private sector to play a greater role. It skilfully used its financial institutions to secure the resources to rebuild its basic infrastructure when its fiscal position was too weak to play this role. And improving connectivity and labour mobility across regions allowed China to benefit from the economies of scale that came with urbanisation.

Yet as successful as these initiatives have been, their impact has faded in recent years largely because of the emergence of vested interests which are now milking the system. The choices facing the incoming leadership are tough, not so much because of their analytical complexities, but because of the political capital required to tackle them.

Perhaps the most sensitive issue concerns the role of the state. A decade ago it was ideology that made scaling back the state’s dominance difficult. Now, with so many state entities having benefited from their privileged position, it is the potential for self-gain that is holding needed reforms hostage. The fate of these state-owned enterprises has become so interwoven with the interests of well-connected Communist party officials and state-controlled banks that many reformers have given up on the possibility that these unholy relationships can be broken. But the outlines of what needs to be done are known, including creating intermediary agents to separate ownership and operating responsibilities for state enterprises, and promoting more competition by opening up activities restricted to the state to private sector entry.

The financial sector has been the glue binding together various vested interests. China has relied on its banks to fund state-mandated initiatives, including many that should have been supported through fiscal channels. While critics have complained that this was achieved through financial repression, this strategy did make possible a massive investment-led growth process. But the weaknesses of this approach are now becoming more apparent. Funding biases have limited the opportunities for the private sector to drive innovation while the budget has been inadequate in meeting the escalating demand for social services at local levels, thus contributing to the sense of widening disparities.

Reducing the excessive dependence on the banking system requires overcoming the vested interests of the party which finds it easier to deal with a handful of state banks than two dozen provincial level budgets – even though a revitalised fiscal system would offer more transparency and accountability.

Managing the growth of cities including establishing more reliable sources of revenue is another important challenge. Many in China see rapid urbanisation as a mixed blessing. On the plus side it spawns more economic activity but this comes with emotionally tinged perceptions about increased congestion, environmental degradation and deteriorating services. Thus the debate has been about curtailing the pace of urbanisation and altering its pattern by promoting secondary cities while restricting growth in the larger ones. China’s mega-cities are generally perceived to be too large, but the problem lies more with flawed urban management practices than absolute size limits.

This year the proportion of China’s population living in urban areas reached 50 per cent, but given its enormous population relative to arable land, the urbanisation rate is still too low. Excessive numbers of Chinese are still working in rural areas for low returns. Their movement to more productive urban-based activities is the easiest option to secure the productivity increases needed to keep the economy growing at about 8 per cent over the coming decade.

The greatest barrier to China’s urbanisation process is its unique “hukou” system which makes it difficult for the country’s 250m migrant workers to establish legal residency and access services in the major cities. Liberalising the residency system would go far in ameliorating social tensions and stimulating expansion in services which is the key to unlocking China’s longer-term growth potential. But here too, strong vested interests are holding back reforms. Municipal leaders are reluctant to lift hukou restrictions because of unwarranted fears about reduced job opportunities for established residents and budgetary pressures for additional programmes.

With each generational change in the leadership, there is a burst of wishful thinking that major reforms may now materialise. The more cautious realise that China’s collective leadership system reduces the likelihood of game-changing shifts, and history tells us that progress is more likely to come from initiatives that are piloted locally and then adopted nationwide. This pragmatic approach has worked well in the past but for these three policy choices, vested interests create an imposing gridlock. Just one or two strong signals of policy direction coming from the new leadership can pave the way forward.

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

As European leaders gather once again in Brussels to discuss the eurozone crisis, a shift to an anti austerity stance is urgently required. Yet whatever the fate of the single currency, the current crisis is set to transform the European Union. If the euro is kept intact, it will be because of a shift to more federal structures within the eurozone. If it fractures, there will need to be a serious redesign, in a federal direction, if what’s left of the euro is to be saved.

In either case, we will need new thinking about the way the European Union works.

For fifty years the European Economic Community, and then the EU, have steered by the star of ‘ever closer union’. By any historical standard, it has been a dramatically successful navigation. The idea of a Europe whole and free has actually happened. What is more, Europe is more integrated and in many areas interdependent, than ever before.

But the political and institutional ambiguity inherent in ever closer union has been exposed by the idea of a “two-speed” Europe. The fiction was that opt outs, transitional arrangements and other legal innovations recognised different speeds of travel but not different destinations. That metaphor must now be given a decent burial. The question is what is the alternative to a two-speed vision?

One answer is to say that the future is a ‘two-tier’ Europe. Joschka Fischer, former German Foreign Minister, describes a vanguard Euro group and a rearguard of the rest. David Owen, one of my predecessors as UK Foreign Secretary, argues for a top tier of countries who merge their governance arrangements into a “single government”. A second tier, including Norway and Turkey, would embrace a “restructured single market”, along with a set of norms associated with social and environmental policy.

The Owen plan founders on a number of points. One is practical: I don’t see other countries embracing this vision. A second is more substantive: requiring countries to chose between a minimalist European Economic Area and a fully integrated European Union is a recipe for decline not renewal. It would simply deepen the divide between the euro ins and outs.

Instead the diversity of the EU’s membership, and the breadth of areas of policy cooperation, require flexibility not rigidity.

There is an alternative to two-speed and two-tier. In 1994 two parliamentary leaders of Germany’s conservative Christian Democratic Union, Wolfgang Schäuble (now Finance Minister) and Karl Lamers, produced a paper that reiterated the traditional German commitment to a federal state structure, but also embraced ‘elasticity and flexibility’.

“Those countries which are willing and in a position to go further than others in their cooperation and integration should not be blocked by the vetoes of other Members” they wrote.

In English, or at least diplomatic English, we call this “variable geometry”. In the European Treaties it is called enhanced cooperation. In plain English, it is the idea that the EU is a club of clubs.

It means that the European Union has a group of founding rules – from the single market, which is decided by qualified majority voting, to foreign policy cooperation, where each nation has a veto. On that foundation, further integration is possible – on currency, on defence, on migration and the like.

There are two major objections to this vision. One is that the euro is such a big exercise that its members will inevitably overrun the rest of the EU. But this is to forget that on issues such as the single market, the most important member of the eurozone, Germany, may have more in common with countries like Britain or Poland than with euro members such as Italy or even France.

A club of clubs solution accepts that membership of the euro, or a eurozone hard core, is not the end game for all EU members. But it avoids imposing second-class status on those countries outside the euro, which is not in the interest either of the eurozone or the wider EU.

But the second objection is that a club of clubs does not resolve the democratic deficit. That is true, but is an argument for developing more transparent political structures – whether formalising the role of national parliamentarians or directly electing the President of the Commission – rather than ditching the idea.

Time is now of the essence in this debate for Britain, but also for countries like Sweden, Denmark and Poland.

The key for my own country, and our interests in the development of the EU, is to ensure that being out of the euro does not become a prelude to being out of influence in Europe, and then out of the European Union altogether.

Unfortunately that is now a serious danger.

David Cameron’s botched ‘veto’ of the Fiscal Pact last December, botched because the Fiscal Pact went ahead anyway, weakened Britain and weakened Europe. His plan to opt out of Justice and Home Affairs agreements, announced earlier this week, adds further distance.

The stance Mr Cameron is expected today and tomorrow at the European Council, to privilege the repatriation of powers above all other issues, is dramatically to miss the point. It is vital that we learn the right lesson: the debate about the redesign of the European Union must be conducted on broader terms than the Prime Minister’s need to appease eurosceptics (and europhobes) in his own party.

The current UK Government is chronically weakened by its inability to empathise with any vision of the European project recognisable on the continent. That cannot stop the rest of us. If we cannot make a flexible EU work then we end up locking ourselves out of Europe altogether. So we need to argue for it with vigour and urgency.

The writer is the MP for South Shields, and former British foreign secretary.


The World Economic Outlook published by the International Monetary Fund last week has created new excitement around the debate on the effectiveness of fiscal retrenchment. The evidence that governments have consistently been underestimating the size of the fiscal multiplier – which measures the impact of deficit reduction measures on economic growth – has been used to suggest that austerity policies are doomed to fail.

That is the wrong conclusion to draw from the IMF study.

The fiscal multiplier quantifies the impact of a given change in taxes or public expenditures on gross domestic product (GDP). Those who interpreted the IMF study as evidence that austerity is self-defeating mistakenly believe the multiplier measures the impact of a change in the budget deficit on the long-term rate of growth of the economy. In fact the multiplier measures the one-off impact of budget changes on output when the adjustment is made.

Let us consider a simple example of a country with a budget deficit of 1 per cent of GDP, a debt to GDP ratio of 100 per cent and a trend growth rate of 1 per cent per year. A multiplier lower than one implies that when the deficit is reduced from 1 per cent to zero, GDP continues to rise – although temporarily at a lower rate than the trend – and the debt falls as a percentage of GDP.

If the multiplier is larger than one, the reduction of the deficit by 1 percent of GDP initially leads to a reduction in the level of GDP and to a rise in the debt-to GDP ratio. But if the deficit is kept at zero in the following years, the debt ratio would start falling in the second year, as growth returned to its trend rate.

This example is consistent with what has been observed in several euro area countries over the past couple of years: the sharp reduction of the deficit from very high levels has initially led to a contraction of GDP and an increase in the debt ratio.

But a multiplier larger than one does not mean that a cut in the deficit is not effective in reducing the debt burden in the long-term. It only implies that it takes more time and more pain to achieve a reduction of the debt.

What policy implications can be drawn from this finding? Should countries delay the adjustment or spread it over a longer period of time?

Front loading austerity measures produces an initial sharp reduction in output, and a short-term increase in debt over GDP. But soon after the economy should recover and the growth rate should pick up. A more gradual adjustment implies a prolonged period of low or stagnant growth, with debt ratios not falling for several years. It is not clear which scenario is preferable.

It partly depends on the reasons for the multiplier being larger than one. Some commentators have suggested that it is due to the fact that interest rates are close to the zero lower bound, which prevents monetary policy from compensating for the restrictive effect of the fiscal adjustment. In cases of severe fiscal adjustment, the economy might benefit from negative interest rates, but this is not generally an option for central banks. In such a case, however, the best way to reduce the debt burden would paradoxically be to engineer a fiscal expansion, even though that seems to contradict the experience of the eurozone in the run up to the financial crisis.

But another reason for the multiplier being higher than one could be that the potential growth rate of advanced economies has fallen sharply during the financial crisis, partly as a result of the deleveraging that is taking place in the private sector. If this is the case, growth would remain lower even in the absence of fiscal adjustment and the size of the multiplier would not fall over time.

Finally, the study does not show any non-linearity in the relationship between fiscal adjustment and level of output. That is the fiscal multiplier does not increase in the case of larger contractions. That would suggest there is no advantage in postponing adjustment.

The optimal timing ultimately depends on the patience of voters to endure a prolonged adjustment effort and the patience of financial markets to continue financing a government’s deficits.

The more patient the voters, the more the adjustment effort can be spread over time. Recent experience in the euro area suggests that voters may lose their patience if austerity drags on for too long and if they don’t see the light at the end of the tunnel.

The patience of financial markets depends on several factors, such as the size of the adjustment effort, the level of the debt, the underlying pace of economic activity and the willingness of the central bank to finance the Government. If markets become impatient, credit risks start to rise, market access is impaired and the overall adjustment costs increase in a dangerous feedback loop. In this case, market impatience, rather than the effect of excessive frontloading, leads to a higher fiscal multiplier.

The only way to ensure that a gradual fiscal retrenchment is sustainable over time and credible in the eyes of the markets and the voters is to implement it in the context of a multi-year adjustment program, possibly under the auspices of the IMF. The policy implication is that countries wishing to spread out fiscal adjustment should probably seek the assistance of the IMF.

That, rather than a rejection of austerity, may be the subtle message of the IMF study.

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

To belabour the obvious, the Federal Reserve and monetary policy are critical to any president’s success; presidential elections are usually determined by the state of the economy and the Fed has a great deal to do with that, arguably never more so than today.

Many observers believe that President Obama hurt himself by taking a somewhat lackadaisical attitude toward the Fed – leaving positions on the Fed board vacant for long periods, not moving quickly to appoint replacements and failing to back away from appointees that ran into Senate confirmation difficulties.

Were he elected it is unlikely that Mitt Romney will make the same mistakes. I expect that he will move quickly to put his stamp on the Fed. So what can we expect?

Republicans in Congress have been highly critical of Fed policy, especially the episodes of “quantitative easing” that took place in 2009, 2010 and again this year. Despite the continuing lack of inflation in the price data, Republicans believe that quantitative easing is highly inflationary and should be reversed as soon as possible.

Mr Romney will have an immediate opportunity to encourage a move in that direction. Among the many responsibilities of the president is making appointments to the seven member Federal Reserve Board, which must also be confirmed by the US Senate. Members seldom complete their entire 14-year terms creating opportunities for additional appointments to fill unexpired terms. The critical position of chairman of the Fed is one to which an existing member must be separately appointed and confirmed to a 4-year term.

The term of one current member of the board, Elizabeth Duke, has already expired, meaning Mr Romney would have the opportunity to immediately nominate a new board member.

This appointment could be especially important should Mr Romney want to replace Ben Bernanke as chairman of the Fed in early 2014 when his term expires. Most observers think Mr Romney would be highly unlikely to appoint Mr Bernanke to another term, even though Mr Bernanke was appointed initially by a Republican president, George W. Bush, whom Mr Bernanke also served as chairman of the Council of Economic Advisors.

Since the new chairman must already be a member of the board, it would be desirable, from Mr. Romney’s point of view, to have someone on the board ready to be named chairman when Bernanke’s term as chairman expires.

Whoever Mr Romney names as Fed chairman, it is almost certain that he or she will take a more hawkish line on monetary policy. There are already a number of inflation hawks on the 12-member policy making Federal Open Market Committee, which includes, in addition to the seven members of the Federal Reserve Board, five of the 12 regional Federal Reserve presidents. (These presidents are named by local boards for each bank and are neither appointed by the president nor confirmed by the Senate.)

At a minimum, it is doubtful that the Fed will continue to maintain its present policy of being highly accommodative. A key element of this policy has been the Fed’s “forward guidance” that it will continue being accommodative at least through 2015 – well past the point when Mr Romney will have had the opportunity to appoint a new Fed chairman and one or more new members of the board. (It is highly unlikely that Mr Bernanke would continue to serve on the board if he is not reappointed chairman.)

Even if Mr Obama is re-elected, major changes at the Fed cannot be ruled out. It is thought that Mr Bernanke may wish to return to academia when his term as chairman expires, regardless of the election results. He previously was a professor of economics at Princeton.

At a minimum, the ability of the Fed to credibly make promises about future policy is threatened by potential changes in party control of the White House and the wide divergence in the monetary views of the two parties. If policy is quickly reversed, it will call into question the ability of the Fed to use forward guidance as a policy tool again in the future.

In the event of a victory for Mitt Romney on November 4, who would be likely to replace Mr Bernanke?

The leading academic spokesman for the Republican point of view on monetary policy is the economist John Taylor of Stanford University. He is highly respected as a monetary theorist and served as undersecretary of the Treasury for international affairs during the Bush administration.

By all accounts, Mr Taylor was disappointed not to have been named chairman of the Fed when Mr Bernanke was named instead. Taylor’s very vocal support for Mr Romney’s election would appear to put him in a good position to achieve his goal should Romney win.

Possibly standing in the way of Mr Taylor’s ambition is the economist Glenn Hubbard of Columbia University, who is Mr Romney’s principal economic adviser. He also previously served as chairman of the Council of Economic Advisors under G W Bush. (Mr Taylor was also a member of the council in the administration of Bush senior.)

It is thought that Mr Hubbard is the one who thwarted Mr Taylor’s ambition to become Fed chairman previously by having Bernanke returned to the Federal Reserve Board in 2006, even though Mr Bernanke had only completed a three-year term on the Board the previous year.

This could be important because Mr Hubbard is thought to have ambitions to be either Treasury secretary or Fed chairman. (In the interest of disclosure Mr Hubbard and I worked together at Treasury during the elder Bush’s administration.) If named Treasury secretary, Mr Hubbard would have a great deal to say about who the president names to the Fed.

Following are the current members of the Fed and the dates when their terms expire:

Ben Bernanke: Jan. 31, 2020; term as chairman ends Jan. 31, 2014

Janet L. Yellen: Jan. 31, 2024; term as vice-chairman ends Oct. 4, 2014

Elizabeth A. Duke: Jan. 31, 2012 (term expired)

Jerome H. Powell: Jan. 31, 2014

Sarah Bloom Raskin: Jan. 31, 2016

Jeremy C. Stein: Jan. 31, 2018

Daniel K. Tarullo: Jan. 31, 2022

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’

Now that the party conference season has drawn to a close, David Cameron must return to the real task of stimulating growth, all the more urgent given the worsening economic and fiscal outlook. One of the most immediate challenges he faces is how to unlock private investment in the power sector as nuclear and coal-fired plants age.

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Government-induced policy risk is the single biggest deterrent to investment, with profound consequences for growth, energy security, electricity prices and a low-carbon future. The energy bill, to be introduced in parliament soon, is an opportunity to give investors the clarity and incentives they need. This is how it should be used to set the direction of government policy.

First, it must adopt regulatory and planning structures that encourage investment in new capacity both from established and new sources of electricity – recognising the differences between technologies as regards scale, risk and the stage of development of low-carbon sources.

The bill must create efficient markets for capacity that promote entrepreneurship. As low-carbon technologies mature, the carbon price rises and competition grows, it will become more efficient to hold auctions within these markets of back-up capacity from renewable sources whose supply is intermittent.


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The government must also increase its support for research into new technologies for generation and transmission, and should advocate the development of a European super-grid that allows more effective matching of supply and demand.

Suppliers are more likely to invest in low-carbon generation if they can rely on a strong and stable carbon price, underpinned by the floor mechanism, which the government last year said would take effect from April 2013. Such a price corrects a market failure.

The bill should also establish the framework to set up “contracts for difference”, which have the potential to give investors confidence in long-term revenues and reduce the cost of upfront capital expenditure for new low-carbon projects. This also requires a single independent body as counterparty, operating with transparent rules and strong underpinning from the government.

Crucially, the government must make a more credible commitment to low-carbon electricity generation. The climate change act requires consecutive five-year carbon budgets, with a target of cutting greenhouse gas emissions by 80 per cent by 2050. However, the carbon budgets do not give the power sector enough guidance and nor does the current energy bill. It is all too easy to suggest that some other part of the economy can do the work, but the power sector holds the key to emissions reductions elsewhere, including in transport.

Moreover, while the government backed an independent committee’s recommendation that the fourth carbon budget should halve UK emissions from 1990 levels by 2025, it introduced a review in 2014 that could weaken the target. High-carbon growth is not a credible strategy: it will eventually have such severe environmental consequences that growth and development could be disrupted and reversed, and other countries will exclude dirty goods.

Natural gas will have an important role to play but cannot achieve all the emissions reductions if unabated, so will need carbon capture and storage, or a strategy for exit, as the power sector is decarbonised.

The apparent splits in government and lack of consistency on these issues produces uncertainty for investors and drives up capital costs for low-carbon sources. To resolve this, the bill should include a clear decarbonisation target to signal the government’s long-term intentions.

This could take the form of an “emissions intensity target” for the power sector of, say, 50g of carbon dioxide per kilowatt-hour by 2030, which could be consistent with the economywide carbon budgets. This makes more sense than a target for the amount of energy produced by renewables, as it relates directly to the task of decarbonisation.

This is a moment when the leadership of the prime minister and the cabinet is crucial to the UK’s economic prospects. If they embed decarbonisation of the power sector in a sound framework for reform of the electricity market, they will attract efficient and responsible private investment that can drive growth for the next two decades.

The writer is a professor at the London School of Economics

Recently an American friend asked me how let down I must feel as a Pakistani at the tail-end of the first Obama administration.

It is true that Pakistan started out as a strategic ally of the US and ended up as a pariah. But if I were a Tunisian, Egyptian or Libyan who had overthrown decades of dictatorship, a Syrian fighting the bloodiest war ever in the Middle East against the foulest of dictators, or a Bahraini whose rulers have stopped injured demonstrators from going to hospital without a peep from Washington, I would feel equally let down by US foreign policy over the past four years.

President Obama raised expectations in the Muslim world early on with his now famous Cairo speech, but there has been little in the way of follow up.

Faced by rigged Iranian elections in Iran almost immediately after the Cairo speech the administration did not how to react and its policy wafted from one side to the next.

More recently, it took weeks before the US administration supported the Arab Spring and then, country by country, dictator by dictator, only slowly did the US shift its position. Finally when regimes were toppled by people in the streets there was no follow up by the State Department or support from the Pentagon.

Western military support for the rebels in Libya was largely left to the Europeans.

When elections occurred in three Arab states and the Muslim Brotherhood came to power in Tunisia and Egypt, it was a changed Brotherhood which spoke less about sharia and more about women’s rights. It was apparent that their model for the future was Turkey – a modern democracy, an economic powerhouse with the army in its barracks, with a civilian government led by an Islamic party. The Brotherhood barely glanced at the models of Iran or Saudi Arabia. Yet there was still no US follow up.

Secretary of State Hillary Clinton has clocked up more miles than any of her predecessors, but what has this face time achieved? She visited the capitals of the newly free Arab states, gave congratulations and quickly forgot as she moved onto the next place. Instead, despite the global recession, there should have been a US-led international effort to get these countries’ economies and education and health systems working again, and to help their new governments find their feet in the international system.

The Arab Spring has by and large been successful in slowly changing the attitudes of societies which had lived under one man rule for so long. But there has been no coherent US response. If Secretary Clinton could not handle such seismic shifts, she should have appointed senior and respected US diplomats who could lead and encourage the change. Or the US could have called on the World Bank, the UN or other international organisations to help reform. Instead there has been no follow through of any kind.

For many Americans on the right of the political spectrum the riots across the Muslim world and the tragic death of the US ambassador to Libya, which have followed the fake film on the Prophet Mohammed, are just more proof that Arabs can not be trusted and that US aid to the region should be quickly frozen.

But the riots also reflect the anger of people who had expected help from the West rather than derogatory videos. Ultimately, I believe, this horrendous film and the riots which have followed will be seen as a small blip in the blooming of democracy and change in the Arab world. But the Obama administration’s outrage about the absurd views present in video has not come through strongly enough in the Muslim world. To many people in the Arab street it seems that US policy has been neither helpful nor supportive and has not changed since the Cold War.

Returning to my own country, we are faced with an ever worsening situation in Pakistan. Across the border in Afghanistan there is a plan for so-called transition from US to Afghan forces before 2014, but that too is not going well. There is no US strategic plan to secure the Afghan political process that will reach a crescendo of crisis by 2014, when presidential elections are due. The economy is likely to collapse and warlordism return. The lights may literally go off just as the Americans leave.

Pakistan remains on the brink of chaos and needs serious hand holding by outside powers starting with help on the economy. But Pakistanis also have to be told to help themselves by initiating a serious reform agenda starting with ending its double dealing with the Taliban. Relations have deteriorated so badly between the US and Pakistan that it is going to be a long haul just winning back each other’s trust. That too requires lots of follow through.

The only consolation for the Muslim world as we look back on President Obama’s term in office is that a Republican win would be a much greater disaster for everyone. Nobody in this region doubts that presidential hopeful Mitt Romney would soon plunge the US into another war in the Muslim world and we would be back to square one. For the Muslim world a Romney foreign policy has to be avoided at all costs. Barack Obama needs to win the election, and then he needs a team that will follow through.

The writer is best-selling author of several books about Afghanistan, Pakistan and central Asia, most recently ‘Descent into Chaos’

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If the global economy was in trouble before the annual World Bank and IMF meetings in Tokyo last week, it is hard to believe that it is now smooth sailing. Indeed, apart from the modest stimulus provided to the Japanese economy by all the official visitors and the wealthy financial sector hangers on, it is difficult to see what of immediate value was accomplished.

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The US still peers over a fiscal cliff, Europe staggers forward preventing crises King Canute-style with fingers in the dyke but no compelling growth strategy, and Japan remains stagnant and content if it can grow at all.

The Bric countries, meanwhile, are each unhappy stories in their own way. On the one hand, they are constrained by deep problems of corruption and financial imbalances that are impeding growth, while at the same time demographic trends cast doubt on their long-term prospects.

In much of the industrial world, what started as a financial problem is becoming a structural one. If growth in the US and Europe had been maintained at its average rate from 1990 to 2007, gross domestic product would have been between 10 and 15 per cent higher today and more than 15 per cent higher by 2015 on credible projections. Of course, this calculation may be misleading because global GDP in 2007 was inflated by the same factors that created financial bubbles. However, even if GDP was artificially inflated by 5 percentage points in 2007, output is still about $1tn short of what could have been expected in the US and EU. This works out to more than $12,000 for the average family.


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It will be argued that the process of international economic co-operation is failing. It will be suggested that there have been failures of leadership on the part of the major actors. There will be calls for changes in the international economic architecture.

There is some validity to this view. Domestic political constraints and imperatives do interfere with necessary actions in much of the world. US politics have been dysfunctional in the run-up to the 2012 election. The EU sometimes makes the US Congress look like a model of crisp efficiency in making decisions. In Russia and China, authoritarian leaders who lack legitimacy struggle to drive economic reform, but so do those with democratic mandates in India and Brazil.

Concern about politics and the processes of international co-operation is warranted but the best one can hope for from politics in any country is that it will drive rational responses to serious problems. If there is no consensus on the causes or solutions to serious problems, it is unreasonable to ask a political system to implement forceful actions in a sustained way. Unfortunately, this is to an important extent the case with respect to current economic difficulties, especially in the industrial world.

While there is agreement on the need for more growth and job creation in the short run and on containing the accumulation of debt in the long run, there are deep differences of opinion both within and across countries as to how this can be accomplished. What might be labelled the “orthodox view” attributes much of our current difficulty to excess borrowing by the public and private sectors, emphasises the need to contain debt, puts a premium on credibly austere fiscal and monetary policies, and stresses the need for long-term structural measures rather than short-term demand-oriented steps to promote growth.

The alternative “demand support view” also recognises the need to contain debt accumulation and avoid high inflation, but it pushes for steps to increase demand in the short run as a means of jump-starting economic growth and setting off a virtuous circle in which income growth, job creation and financial strengthening are mutually reinforcing.

International economic dialogue has vacillated between these two viewpoints in recent years. At moments of particularly acute concern about growth, such as in spring 2009 and now, the IMF and many but not all monetary and fiscal authorities tend to emphasise demand-support views. But the moment clouds start to lift, orthodoxy reasserts itself and attention shifts to fiscal contraction and long-run financial hygiene.

This is a dangerous cycle whatever your economic beliefs. Doctors who prescribe antibiotics warn their patients that they must complete the full course even if they feel much better quickly. Otherwise they risk a recurrence of illness and worse yet the development of more antibiotic resistance. So too with economic policy. Advocates of orthodoxy prize consistency. Those like me whose economic thinking emphasises promoting demand worry that expansionary policies carried out for too short a time will prove insufficient to kick-start growth while at the same time discrediting their own efficacy and reducing confidence.

The Tokyo meetings may not have had immediate impact. But the IMF’s emphasis on the need to sustain demand and its recognition of the importance of avoiding lurches to austerity can be very important for the medium term only if it is sustained through the next round of economic fluctuations.

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

When President Barack Obama was awarded the Nobel Prize at the end of his first year in office it was a strange bet on the future – perhaps he would be a peacemaker one day. Today’s announcement awarding the prize to the EU is an even stranger bet on its past.

The EU did build peace where there had been war and then drew Eastern Europe into an enlarged Europe. All would have been good reasons for a Nobel Peace Prize at the time. But those historic successes just make its dismal present look even more threadbare. Far from being a morale booster at a time of austerity, it is a grim reminder of just what bad times the European vision has fallen on.

That vision has been debased through the internal discord of an unresolved euro crisis that has exposed the region’s lack of political will at home. But the Nobel is awarded for what the recipient has done abroad. Here the Nobel committee is eloquent in its silence because, put bluntly, there is no European foreign policy today to speak of.

On issue after issue, from the Middle East peace process to the Arab Spring, from Iran to relations with China or a region such as Africa or Latin America, Europe is less than the sum of its parts. It has its own EU embassies now and no international meeting is complete without a clutch of national and Brussels officials, each in turn jumping up to speak “for Europe”. This is a circus of process and protocol with usually dismal results.

In a forum such as the UN in New York, there is an effort to allow one ambassador alone to speak for Europe on many issues and, while that has reduced the spectacle of a parade of speakers, it too has a price. What is said is, even by UN members’ standards, often bland to the point of absurdity in order to earn consensus support from all EU ambassadors.

On Turkey, the prize committee claimed that “the possibility of EU membership for Turkey has also advanced democracy and human rights in the country”. More relevant surely is that opposition inside Europe to Turkey’s membership has increasingly made it look elsewhere for friends and partners. And where is the leadership on the Arab Spring that Europe exercised so powerfully in its support for the transitions in Eastern Europe after 1989? Where economic assistance and soft power might have given Europe a powerful role, it is instead consumed by its own economic crisis.

On the Iran nuclear negotiations, the EU has a formal lead role but you would not know it, as policy is still made out of Washington – and increasingly it seems Jerusalem. Whenever US efforts to advance the peace process in the Middle East falter an observer might hope to see Europe, a major donor to the Palestinians and friend of Israel, step in, but again the will to lead is absent and internal European divisions, between those who favour Israel and others with greater Palestinian sympathies, are apparently irreconcilable.

This is Europe’s dilemma: even when not stricken by a fundamental crisis in its economic governance, it is a market, a society and even a culture more than it is a polity. It has reminded us of shared values and a shared history and has in good times bathed us in a common prosperity and in the warmth of shared citizenship after centuries of conflict.

But boldness and bravery in waging peace abroad, in the service of human rights and democracy, are the very antithesis of the values of this usually comfortable and complacent EU. On China, for example, an EU human rights agenda takes second place to the competition between different members to win trade and contracts. Now at a time of extreme economic discomfort, when conflict has displaced complacency, courage seems even more absent from Brussels than usual. Nobels are not forged from an obsession with process and procedure. The best go to brave individuals and institutions that have often defied their times and peers to open a path to peace. Many have courted unpopularity and controversy as they have done so. The Nobel sets that record straight and celebrates the best in human leadership.

So this Nobel seems a bizarre and sentimental tribute to Europe’s past that further shames its present. Only a Nobel for economics would have seemed stranger.

These are awkward days for deficit hawks who believe the US economy can return to health only if the nation puts its fiscal house in order. They are about to get their wish.

At the beginning of next year, the federal budget deficit is scheduled to shrink with a loud thud. Unless Congress does something to avert it, more than $600bn in tax increases and spending cuts will automatically come into effect. That is equivalent to about 5 per cent of the entire US economy, more than projected growth in gross domestic product next year.

The problem is that if America falls off this “fiscal cliff,” as it has come to be known, the nation will plunge into recession. That is because the meaures will withdraw too much demand from the economy too quickly, at a time when unemployment is still likely to be high. The Congressional Budget Office projects that if America goes over the cliff, real economic growth will drop at an annual rate of 2.9 per cent in the first half of 2013, and
unemployment will rise to 9.1 per cent by the end of next year.

As Spain and Great Britain have demonstrated, launching fiscal austerity at a time when a nation’s economic capacity is substantially underutilised causes the economy to contract. This makes the deficit and cumulative debt even larger in proportion to the size of the economy. Rather than reassuring investors, the result spooks them even more.

Ironically, America is about to fall off the fiscal cliff because Democrats and Republicans in Congress have been unable to agree on a plan for long-term deficit reduction – and this failure will trigger automatic spending cuts in January. Meanwhile, the temporary tax cuts enacted by former President George W. Bush in 2001 and 2003, and extended for two years by President Barack Obama, will run out on December 31st, as will the president’s temporary jobs measures – a payroll-tax holiday and extended unemployment benefits.

To make matters even more draconian, the alternative minimum tax – originally aimed at the rich, but never adjusted for inflation – is scheduled to hit some 30m middle-class Americans next year, while Medicare, the health programme for the elderly, is scheduled to slash payments to doctors by nearly 30 per cent.

In a rational world, deficit reduction on this scale would occur only when the economy was once again healthy – when unemployment had dropped to below 6 per cent, for example, and economic growth returned to at least 3 per cent. These would be sensible triggers. But hyper-polarised Washington has not shown itself capable of rational behaviour.

Indeed, Democrats and Republicans have been so much at each others’ throats that whenever one side senses the other wants (or fears) something more, the party that doesn’t want or fear it as much has a bargaining advantage in Congress’s ongoing game of chicken. This explains why the nation is heading over the cliff.

Congressional Democrats have concluded that Republicans are more afraid than they are of going over it because the pending tax increases will fall most heavily on America’s wealthy, and half the spending cuts would come out of the defence budget.

So most Democrats have decided to wait it out in order to maximise their bargaining power in negotiations over how to reduce the long-term deficit. They want a deal that raises taxes only on America’s wealthy and without substantial cuts to Medicare, Medicaid (the health programme for the poor) or Social Security. This is the opposite of what Republicans want.

Democrats also assume that, once the Bush tax cut has been terminated, Republicans will be unable to resist an offer to reduce taxes on the middle class (those earning $250,000 or less). After all, Republicans have pledged to vote for any and all tax cuts. Once Democrats get the best deal they can, they will make it retroactive to January 1st.

As a practical matter, then, negotiations over America’s budget deficit will drag on into the new year, right over and beyond the fiscal cliff. And because everyone will know that the final compromise is going to be retroactive to the start of the year, the cliff won’t feel like much of a cliff. In practice, it will be more like a hill whose slope remains uncertain but will almost certainly be gradual.

With any luck, by the time significant tax increases and spending cuts take permanent effect, unemployment will already have dropped and growth will have accelerated. In other words, the irrational and irascible American political process may come up with a timetable for reducing the budget deficit that’s surprisingly sensible.

The biggest event of our time is the re-emergence of China, which within five years is set to become the world’s largest economy in purchasing power parity terms.

Given the enormity of this event, it is strange that two parallel narratives – a western and an eastern one – are emerging to describe it. The western narrative concedes that China’s economy has grown. However, it couples this concession with constant observations that the story is too good to be true. In one way or another, the Chinese economy is bound to sputter and possibly even collapse in the years to come.

Many different causes could trigger this collapse. A slowdown in the global economy could kill the Chinese export-driven growth model. Alternatively, major social unrest, with 40,000 demonstrations each year, could bring this great growth story to an end. The current focus, however, is on the purported fragility of the Chinese political system.

Most western analysts are clear that the sudden removal and expulsion of the Chongqing party secretary Bo Xilai is only the first surface crack in a political system that is starting to break up as a result of factional struggles within the Chinese Communist Party. Indeed one retired senior western diplomat, who had specialised in China for nearly 30 years, told the FT this month that the Bo Xilai case had prompted an “epiphany”: he had finally come to realise that the top party officials were as corrupt as junior party officials. Since corruption had now taken over the top levels of the CCP, it was only a matter of time before this political edifice cracked up and came crashing down.

This may well happen. We live in an era of big surprises, where not a single analyst foresaw the Arab uprisings, and it is conceivable that this western narrative of a fragile China could prove to be true. Alternatively, it could all prove to be western wishful thinking.

The eastern narrative focuses on the strengths and not the weaknesses of China’s economic resurgence. Yes, there is no doubt that Bo Xilai did try to mount some kind of political challenge to the established institutional processes of the CCP. However, instead of cracking under the strain, the institutionalised processes worked. They recognised the challenge and worked out a way of sidelining, marginalising and ultimately expelling him. In short, the CCP passed a major stress test with Bo Xilai.

In theory, the CCP is a dictatorship. It is true that it enjoys absolute rule, as the Soviet Communist Party did. Yet it is rare, indeed inconceivable, for dictators to step down voluntarily. Dictators cling to power. Yet we can all confidently predict that both Hu Jintao and Wen Jiabao will step down after the CCP Congress on 8 November.

What system is working to give us the confidence to predict this will happen? What system of rules has been put in place? And what institutional processes are generating these rules? Far from being an arbitrary dictatorial system, the CCP may have succeeded in creating a rule-bound system that is strong and durable, not fragile and vulnerable.

Even more impressive, this rule-bound system has thrown up possibly the best set of leaders that China could produce. Most dictators do not pick strong deputies. Nor do they like to produce successors that might outshine them. Yet it is quite conceivable that the new team of Xi Jinping and Li Keqiang could do better in the next 10 years. Some reports suggest that the close relationship between Xi Jinping, Li Yuanchao and Wang Qishan could lead to the emergence of a group of leaders as strong and visionary as Zhu Rongji.

In short, instead of a sputtering Chinese economy over the next decade, we might see a talented group of reformers injecting new drive and dynamism. This team would start with huge advantages: the world’s largest foreign reserves, the world’s largest industrial base, the world’s best new infrastructure, the world’s largest emerging middle class, the world’s largest output of science and technology graduates, to name just a few.

A reasonably competent set of leaders would do a lot with these accumulated advantages. A set of leaders who are more than competent could achieve a lot more: they could even set in train a further major growth spurt in China.

Of course, all this could represent eastern wishful thinking. Let’s wait and see. I would place my bet on the eastern narrative.

The monthly US employment report has evolved steadily: once a lagging indicator of the underlying state of the economy, it is now seen more as a leading indicator of economic, political and social trends. Friday’s data tell us, for once, rather good news.

Let’s start with the numbers that make headlines and move markets. With 114,000 new jobs in September, the unemployment rate falling to 7.8 per cent (after fluctuating all year from 8.1 per cent to 8.3 per cent) and earnings increasing on account of both hours worked and average pay, the labour market is gaining traction. This healthy development is crucial for supporting consumption, encouraging investment and limiting further income and wealth inequality.

Yet this brighter picture must be sustained if America is safely to deleverage those segments of the economy that remain over-indebted. A significant part of the monthly improvement is associated with part-time, rather than full-time, employment. With Congress too divided to enact meaningful policy measures, the Federal Reserve will have no choice but to remain deeply engaged in uncertain policy experimentation.

The implications go well beyond economic policy and extend to the political process.

The unemployment rate is now back where it was when Barack Obama assumed the presidency in January 2009. Friday’s report will therefore make it harder for his opponent Mitt Romney, however energised he may be after Wednesday’s televised debate, to refocus the presidential campaign on disappointing economic outcomes. Remember that to win Mr Romney needs not only to provoke voter concerns about the economy, but also to convince more Americans that he is suitable for the White House.

The data will also resonate in congressional races that are important to future co-operation between the executive and legislative branches of federal government – thus affecting the ability of the political system to respond properly after the November elections.

These debates will no doubt play out in the media in the coming days, but they should not obscure issues that also matter a lot in the long-term: the structural health of the labour market and its ability to recover in a sustained and robust manner.

With an increase to 58.7 per cent, the employment-population ratio is edging up from a multi-decade low. This is important as the country cannot rely on a steadily declining share of its adult population to maintain and improve living standards, meet rising health costs and foster less divisive income inequality.

There is another labour market issue that deserves mention here, and that is the number of workers out of a job for six months or more. At 4.8m (and 40.1 per cent of the total), long-term unemployment is still too high: it is slowly improving, but still includes too many who are young (the teenage unemployment rate is an alarming 23.7 per cent) or have limited education (an 11.3 per cent unemployment rate for those with less than a high school diploma).

Such long-term joblessness is particularly detrimental for households, communities and government. It inhibits labour market flexibility, erodes skill levels over time and strains already-stretched (and often inadequate) safety nets. For those who have yet to secure their first “real” job, it risks tipping them from being unemployed to unemployable.

The bottom line is simple. We should certainly welcome Friday’s data, the best we have seen for a while. But it is too early to celebrate. And we should certainly not relax the pressure on politicians in Washington to do more to overcome the US unemployment crisis.

Between those in Congress ignoring the severity of the problem and others delaying substantive policies, America’s insidious jobs crisis could become still more entrenched. If that happens, human suffering will increase and politicians will find it even harder to overcome other policy challenges – from the impaired fiscal outlook to a still-fragile housing market – that are already deeply structural in nature.

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

Mitt Romney is the presidential candidate of one of the world’s oldest and most powerful political machines. Henrique Capriles is the candidate of an ad hoc and inchoate amalgam of Venezuelan political groups. Both men are running against incumbents who are deft politicians with broad popular support, but the similarities end there. The US Republican is running for office in a mature democracy where the incumbent faces strict limits on using the state’s resources in his campaign. Mr Capriles faces Hugo Chavez, one of the world’s longest serving heads of state and an autocrat who has never shied away from treating the nation’s oil wealth as his own or changing laws at will.

Yet confounding expectations, Mr Capriles has run a flawless campaign and on Sunday will confront Chavez with the strongest challenge he has ever faced at the polls. In contrast, Romney’s campaign, lavishly funded and full of the best political consultants money can buy, has suffered from endless gaffes, mistakes and miscalculations. Peggy Noonan, a Republican columnist, has famously called it “a rolling calamity”.

So is there anything that Mitt Romney, the 65-year-old veteran of politics and business, can learn from a 40 year-old from a backward country with a deeply flawed democracy? Yes, quite a bit, as it turns out.

First, he could learn the virtue of being enthusiastically inclusive. He should ignore his advisers and reach out to the voters everyone says will never support him. Mr Capriles has engaged even the most stalwart Chavez backers and constantly reiterates that if elected, he will be inclusive, tolerant and will allow no score-settling against Chavez followers. Mr Romney instead sounded sincere in his now-notorious dismissal of the 47 per cent of voters whose lifestyle and income put them securely in Barack Obama’s camp.

Second, he should beware of ideology – which will never pay the rent or cure your sick child. “What I learned as mayor and governor is that people want concrete solutions to their concrete problems,” Mr Capriles often says. In contrast, Mr Romney’ rhetoric is long on ideology and short on details, a pattern that is making him vulnerable. People want to hear specific proposals that will improve their daily lives. This is as obvious as it seems to be easy to forget.

Mr Romney should also be careful to avoid bickering. While Mr Chavez regularly spews a torrent of insults at his rival, Mr Capriles has always been respectful and careful in the way he addresses the president. This is surprising, given the deep political rifts that divide the country. Yet Mr Capriles has understood that despite the polarisation, there is a growing popular hunger for reconciliation and a strong desire for politicians to stop bickering and get on with solving the country’s problems. While the polarisation is less pronounced in the US than in Venezuela, polls show that US voters think politicians’ squabbling is preventing them dealing with problems such as the fiscal cliff, high indebtedness or welfare reform and that this gridlock is bad for the nation.

While it is true that negative advertising often works, there may be significant gains to be made by tapping Americans’ hunger for more civility and collaboration among politicians.

Empathy is the next quality Mr Romney should cultivate. The only thing worse than a politician displaying a forced empathy is one who shows no empathy at all. Bill Clinton is, of course, the master at making people feel he genuinely understands their predicament. While empathy towards the poor and the needy also comes naturally to Mr Capriles, he has been very deliberate in making it one of the central features of his political persona. Mr Romney is trying hard to convey that he feels people’s pain. But too often he lets slip comments that make it patently clear that the privileged life he has led makes it hard for him to really get into poor people’s shoes. He should try harder.

Despite Mr Capriles’ flawless campaign he may still lose Sunday’s election and despite Mr Romney’s flawed one he may win in November. Mr Obama may turn out to be vulnerable and, thanks to his charisma, oil money and dirty tricks, Mr Chavez may prove invincible. If Mr Capriles wins on Sunday, however, his final lesson to the world will be to show that abusive autocrats can be beaten by a great candidate who runs an impeccable campaign.

Falling sales. Too many factories producing too many cars at excessive cost. Mounting losses at manufacturers. An urgent need for action. That’s what my colleagues and I found when we took up our posts as members of President Barack Obama’s auto taskforce and that is what confronts European carmakers today – except without a taskforce or a central government to ram through the needed changes.

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Battered by the European sovereign debt crisis and recession in countries from Italy to Britain, car sales within the EU are on track for a fifth consecutive year of decline. Yet, notwithstanding increasingly shrill cries of distress from industry executives, absolutely nothing of consequence has been done to staunch the bleeding.

Meanwhile, the restructuring of the American motor industry – admittedly helped by stronger economic conditions and recovering sales – has resulted in profits at every carmaker and expanding employment.

That stark difference in health results not just from weaker economic conditions in Europe but, perhaps more significantly, from the region’s stultifying structural problems. Most importantly, the lack of a sufficiently robust central governing authority makes establishing anything that even faintly resembles Mr Obama’s auto taskforce unimaginable.


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And so, with unemployment high, the laser focus of every European country is on trying to protect its own jobs. That hit home for me during my service on the taskforce as we tried to help General Motors curb its European losses by closing unneeded factories. Quickly, we found ourselves receiving regular visits from European ambassadors and government officials entreating us to please spare their country.

Other structural problems create equally great challenges, particularly the rigidities around the labour markets of “old Europe” that prevent companies from driving costs down, as they are able to do in the more flexible US.

That has been vividly on display in Italy, where Sergio Marchionne, the chief executive of both Fiat and Chrysler, has tangled repeatedly with political leaders as he tries to overcome powerful union interests. Among Mr Marchionne’s favourite statistics: in 2009, Fiat’s five biggest assembly plants in Italy produced 650,000 cars using 22,000 workers. That same year, a single Fiat plant in Tychy, Poland, produced 600,000 cars with 6,100 workers each earning about a third of their Italian counterparts.

As a result, Fiat’s Italian assembly plants operate at less than 40 per cent of capacity, far below the rest of Europe. Other carmakers have allocated production to the most efficient countries. When it comes to rigidities, Italy may be the poster child but it is hardly alone. When Peugeot tried to close a factory in France and eliminate 6,500 jobs, President François Hollande said simply that the plan “will not be accepted”.

By contrast, Britain’s car sector has fared well, in large part because of its more flexible economy. Its plants are operating at more than 90 per cent of capacity, slightly higher than even in the US.

That’s particularly striking for me. In 1981, as a young journalist in the London bureau of The New York Times, I wrote about two identical Ford plants, one in Germany and one in Britain. In those early Thatcher years, the British plant was half as productive as the German plant (40 hours of labour per car versus 21 hours in Germany). Britain has come a long way.

To be sure, Europe’s leaders are hardly unaware of the car industry’s dire straits and have tried to address them. But instead of spending billions of euros on fundamental restructuring, the programmes focused on a “cash for clunkers” scheme and on subsidising wages to preserve jobs.

Europe needs to bite the bullet and accept the reality of a smaller – and stronger – car industry. As was the case in the US, only through amputation can the patient be saved.

According to AlixPartners, about 30 of the 98 assembly plants in Europe are operating below 70 per cent of capacity, most of them belonging to middle-market manufacturers such as Fiat and Opel. By contrast, manufacturers of luxury brands such as Mercedes and BMW have escaped much of the carnage because export demand remains robust.

High-cost plants must be closed, regardless of where they are, and greater labour flexibility needs to be afforded for the rest. By some estimates, eliminating one redundant car worker in Europe can, absurdly, cost as much as €200,000. By closing plants, utilisation rates at those remaining will rise, making them profitable and, importantly, reducing the excess supply of cars that has led to rampant discounting and still more pressure on profits.

The US economic model is not always right for other countries but in this case Europe would do well to study the restructuring of the US auto sector and adopt its principles.

The writer was counsellor to the US secretary of the Treasury under Barack Obama

The consequences of reputational damage can be overwhelming. Warren Buffett, a man with a quote for every season, has wisely noted that: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Sir David Walker, the incoming chairman of Barclays Bank, is clearly preoccupied with this question of culture and reputation. In his evidence to Andrew Tyrie’s Parliamentary Commission on Banking Standards, which has just begun its work, Sir David regretted that he had not said much on the topic in 2009, when he led a review of banks’ corporate governance for the Financial Services Authority. The commission is closely interested as well.

But which “things” need to be done differently, and precisely how? Sir David is by no means alone in finding this a difficult problem to address. The Basel Committee on Banking Supervision has noted that many banks failed to recognise the reputational risk associated with some of their business practices in the lead-up to the financial crisis, and that “the art of protecting reputation is poorly developed and understood”.

Unfortunately, banks think they are better at reputational risk management than their regulators do. They seem to recognise the problem: a recent survey conducted by the insurers Aon showed that financial institutions identified reputational risk as the third-biggest threat to their business, after the risks of economic downturn and changes in regulation. (For global companies overall, it is fourth on the list, though second in the UK, which may say something about our media.) Yet surprisingly, given the high-profile reputational disasters of recent years, 65 per cent of financial institutions think they have the issue well under control. Somehow that statistic is not reassuring.

There is no shortage of high-minded advice available to banks on how to behave well and maintain their reputation. One example is a well-intentioned paper on “Ethical Concern and Reputational Risk Management” published by Arthur Andersen in 2001, just before the Enron scandal blew up. It is not the only company where there has been a gap between aspiration and performance.

A key reason is that reputational risk, unlike harder-edged risks such as market and credit, is hard to measure and even harder to manage directly. There are no Excel spreadsheets for analysts to populate with spuriously accurate value at risk numbers. Reputational damage is usually a derivative of another problem, and often magnifies it: research published by the Federal Reserve Bank of Boston shows that the share price losses from reported cases of internal fraud are far higher than the sums lost by the fraud itself. Indeed, reputational risk may arise even where there are no losses: the Fed’s definition is the “potential that negative publicity regarding an institution’s business practices, whether true or not, will cause a decline in the customer base, costly litigation or revenue reduction”.

A consequence is that it is not sensible to charge one individual or department with defending the bank’s reputation. Nor is it wise to try to manage reputation directly. Holding the press and public relations departments responsible for reputation is a doomed strategy. Indeed the more an institution is perceived to be attempting to manage public perceptions, in a way detached from the reality of the business, the less successful this is likely to be.

Case studies of relatively successful reputational risk management in other industries suggest that a better approach is to begin by identifying the different groups whose behaviour and perceptions contribute to a company’s reputation. They clearly include employees, customers, suppliers (as NatWest bank recently discovered) and third-party agents, who may be the prime interface with customers, investors and regulators. The views of media and politicians, which will influence opinion, will typically be shaped by these groups that are more directly involved.

Companies need different reputational risk relationship managers for each of these different groups – although they will certainly not carry that title on their business cards. Both supervisors and human resources managers must bear responsibility for the behaviour of their employees. Business line managers should take primary responsibility for treating customers fairly, but the performance of support functions such as information technology, whether inhouse or outsourced, is also crucial. So awareness of reputational risk must be built into the terms of contracts, and into resilience and service standards.

There is a role for press officers and for investor relations folk. But they cannot be expected to make an editorial silk purse out of the sow’s ears of IT disasters, unearned telephone number bonuses or egregious cases of customer exploitation.

Perhaps the most overused phrase in this territory is “tone at the top”. It is both a cliché and a truth. Finely drafted codes of conduct are easy to ridicule. I imagine Enron had one, and maybe even Bernie Madoff too. The chief executive’s commitment to high ethical standards is indispensable, but in any large company it will not carry far beyond the corner office unless it is buttressed by a well-articulated risk management system, assigning responsibility for the different dimensions of reputation to the right places.

This article is co-authored by Maria Zhivitskaya, who is preparing a PhD in risk management at the London School of Economics

Politicians at last seem to be getting serious about the need to address the lamentable failings of vocational education in England – shortcomings that mean up to a third of young people today get little or no benefit from education after the age of 16. The government has started the ball rolling with some mostly sensible plans for reform, and now Ed Miliband has outlined how a Labour government would take things further forward. A lot of the detail has yet to be filled in, but the broad direction looks right.

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Alison Wolf spelt out the challenges in her groundbreaking review of these issues last year. Vocational education in England has been micromanaged from the centre for decades, creating structures that are extraordinarily complex and opaque. Policy priorities are constantly shifting. Not nearly enough attention has been paid to raising standards in literacy and numeracy. There has been too much emphasis on quantity rather than quality – so, for instance, a major difference between English apprenticeships and those elsewhere in Europe is the small proportion that offer qualifications equivalent to A-levels, rather than lower-level GCSEs. The public accounts committee has also expressed concern about the way essentially short training programmes for existing workers are now being classified as apprenticeships.

And policy has failed to recognise fundamental shifts in the labour market, driven in part by changes in regulation and in employers’ assumptions about the skills of school leavers. Even before the impact of the recession, far fewer jobs were becoming available for 16 to 17-year-olds than was the case only 20 years ago.


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In response, the government has committed among other things to raise standards in English and maths for all young people up to the age of 19, to simplify the system radically and to remove incentives to place students on low-level rather than high-achieving courses.

For his part, Mr Miliband’s most eye-catching idea is a new deal for businesses: they would get direct control of a sizeable chunk of public funds in return for driving up the volume of vocational training and quality apprenticeships. This has a number of attractions. It would distribute power away from the centre. It would increase engagement between business and further-education colleges, which is very patchy at present. It would encourage businesses to provide general as well as specific skills, and it would help drive out the brokerage and other middleman activities between the funders and the company that add to costs but not much to value in the present system.

It is not clear exactly how all this would work in practice. But the good news is that the proposals are not too prescriptive.

It would be up to business to decide whether the funding should be channelled through sector skills bodies, local groups of employers or a single company’s supply chain such as Nissan in the north-east. It would also be for businesses to determine what powers they might need to deal with free-riders – rivals that do not provide training themselves but pinch people from companies that do. This flexibility makes sense, because the one thing that would kill this idea stone dead would be a detailed mandate from Whitehall setting out precisely who should do what to whom in this respect.

Mr Miliband’s ideas for a technical baccalaureate are also well worth exploring. As proposed by Andrew Adonis in his stimulating new book on education, this would be for students over 16 who were not following the A-level route: it would include English and maths GCSE, a reputable qualification in an occupational area, and quality work experience. A higher level would be available for those who had already reached the basic GCSE level and were looking for further technical skills.

The writer is chancellor of the University of Warwick, a former director-general of the CBI and a previous FT editor

Now that Mikheil Saakashvili has lost the Georgian parliamentary election, some will pronounce the “Rose” revolution dead and buried – and that would miss the point entirely. The 2003 popular insurrection in the streets of Tbilisi was never simply the replacement of Eduard Shevardnadze with Mr Saakashvili or of a Soviet-era clique with a post-Soviet generation of leaders.

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Instead, the Rose revolution, like all genuine revolutions, was the replacement of a sclerotic political order unresponsive to public demand for change with one that at least begins to reflect the aspirations of the people who triggered and sustained it.

Mr Saakashvili, still just 44, has many faults. His ego is enormous and he sometimes defends democracy with authoritarian tools. His economic reform plans were often badly conceived and erratically implemented, and he built himself a presidential palace fit for a central Asian autocrat. To attract foreign investment and buttress his popular support, he invested considerable sums in expensiveand flash architectural projects in a country plagued with crumbling infrastructure. Attempts to legally exclude leading opposition figures from the ballot raised justifiable concerns and recent video images of torture in Georgian prisons suggested a sinister edge to the country’s supposedly modern attitude towards human rights.


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And despite repeated warnings from friends in Washington, Mr Saakashvili stumbled his country into war in 2008 by needlessly provoking a Russian military that was itching to be provoked.

But Mr Saakashvili was always more than a callow, western-educated political leader with a too-high opinion of his own worth. He was, and is, a democrat. He institutionalised a democratic system that stands in marked contrast to the central Asian autocracies – and to Russia’s Potemkin democracy. Georgia’s economy will grow by about 7.5 per cent this year. State corruption has been drastically reduced. A strengthened constitution will take effect next year and the president conceded defeat when the votes did not come his way.

Mr Saakashvili will remain president until an election is held next year, but now taking political centre stage is the billionaire Bidzina Ivanishvili, a man worth about half of Georgia’s gross domestic product who made his fortune in Russia. Mr Ivanishvili, who will probably become a forceful and active prime minister, will bring a less contentious, more pragmatic approach to relations with his country’s giant neighbour to the north. That is smart, given Georgia’s small size, lack of natural wealth and its tough neighbourhood. At the same time, he says he wants Georgia to join Nato and plans an early trip to Washington. That is smart, too. As a transit route for Caspian gas making its way to Europe, and as a western-friendly government located strategically between Russia, Turkey, Iran and central Asia, Georgia can expect friendly overtures from east and west.

But make no mistake: Georgia will now enter a contentious moment in its politics. Mr Ivanishvili is a political novice and his Georgian Dream party contains an odd collection of European-minded liberals and hardcore Georgian chauvinists united only by hatred of the other guy and respect for their man’s cash. They won’t always have strong incentives to work together, and Mr Saakashvili and his party, which will continue to wield significant influence in parliament, will work hard to obstruct the new government’s plans.

But take the longer view: a generation ago, newly independent Georgia plunged straight into civil war. When Mr Saakashvili came to power in 2003, the capital city’s great immediate need was a steady supply of electricity. Georgia just held a genuinely contested election and we are about to see a peaceful, if grudging, transfer of political power. Outside the Baltic states and Ukraine, no other former Soviet republic can say as much.

There will be plenty of time for cynicism later. Today we must recognise the triumph of Georgia’s (ongoing) Rose revolution.

The writer is the president of Eurasia Group

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