Daily Archives: January 2, 2013

At the last European Council summit of 2012, politicians decided to go ahead with the banking union while ending their reflections on fiscal union they had initiated in June, a time of acute market stress. The message: banking union is needed; the rest is not.

This behaviour confirms that the eurozone has little appetite to think about its own future. Like negligent or impecunious homeowners who only contemplate repairs when the roof threatens to collapse, their overriding motivation is to avoid imminent disaster. As market expectations of break-up have abated, even a discussion on whether integration initiatives would make the currency area more resilient or more efficient seems superfluous.

There are several reasons for this stance.

First, few leaders still have ambitions for Europe. Most are disillusioned. Fighting the crisis in the eurozone has already proved divisive. The less further initiatives they take, the less they risk political problems at home.

Second, there is no agreement about what is desirable. Most observers in southern Europe and France regard systemic reforms to governance as necessary but most in Northern Europe consider the crisis has resulted from national economic policy failures.

Third, mutual trust among eurozone countries has been dented. Cultural prejudices about the lazy south and the arrogant north are back in force.

Fourth, governments in Europe have limited respect for the European institutions (with the possible exception of the European Central Bank) and they are very reluctant to transfer competences and powers to Brussels.

This does not mean that the euro will not survive. The creation of a financial firewall, the new fiscal treaty and banking union are three significant developments. At any rate, projects for a fiscal capacity, common bonds or the creation of a European treasury are still sketchy and far from being implementable. But by consciously avoiding to discuss which reforms would make participation in the euro less risky and more beneficial for all, the European leaders have missed an opportunity to signal that the harsh economic adjustment which will continue to dominate the policy agenda in 2013 is not an end in itself.

2013 will be remembered as the year China became a more “normal economy”. What does normality mean for China? Soon-to-depart Premier Wen Jiabao’s oft-cited quote that China’s growth is “unbalanced, unsustainable and uncoordinated” is a good place to start.

China was an abnormal economy with its state-led capitalist approach that produced double-digit growth rates, no major financial crises and average wage increases of 12 per cent annually for decades. But the drivers of this impressive economic transformation will no longer be available to the new leadership. Beijing cannot simply open the monetary floodgates to stimulate the economy as was done in previous downturns.

Rates of growth in the 7-8 per cent range will become the norm and the key question is whether growth will be of higher quality – more balanced, sustainable and coordinated?

China is in fact already rebalancing – internally, externally and spatially. Internally, if consumption continues to increase at 9 per cent annually and investment growth declines from over 15 per cent to 6-7 per cent, the consumption and investment shares of the economy will become more “normal”. Externally, the current account balance will also continue to moderate as domestic demand increases with urbanisation and investors diversify by shifting more of their funds abroad. China will also become spatially more balanced as the interior will grow much faster than the coast and urbanisation will accelerate.

China’s growth can also be more financially and environmentally sustainable with further reforms. Actions to strengthen the banking sector are already underway but its fiscal system needs to be transformed to take on more responsibility for channeling resources. And China’s Five Year Plan provides a platform to achieve environmental sustainability by sharply increasing energy efficiency and curbing pollution.

In a normal market-driven economy, coordination is less about the state managing all key activities but more about strengthening its regulatory role to give the private sector room to spur innovation and efficiency.

But as a normal economy, China also becomes more vulnerable to business cycles. It can no longer maintain stability by controlling key economic prices such as interest and exchange rates and limiting capital movements. Its vested interests will be grounded less in the links between the Communist party and the state-owned banks and enterprises but as in the west China will become more vulnerable to private interests and “crony capitalism”.

Without state-led investment taking the lead, the economy will be susceptible to Keynesian risks of lack of demand. Corporate profits will be squeezed by higher interest rates and rising wages. Efficiency will be more important than capacity in the future.

Normality will also undermine the authoritarian nature of the old model which served China well when the priority was simply to push out more infrastructure investment and ensure that the requisite resources were available. China will now need a less heavy-handed administrative system that will promote entrepreneurship All this will call into question the existing governance system and may well prove to be the catalyst for far-reaching political reforms.

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