Monthly Archives: July 2013

Once again, markets will pay close attention to signals from the US Federal Reserve’s Open Market Committee, which meets this week.

Coming on the heels of a dramatic two-month rollercoaster – as the S&P 500 fell 6 per cent between May 21 and June 24 before recovering to finish last week near its record high – the scope for misinterpretation is far from trivial. So here are seven points investors may wish to keep in mind as they navigate yet another fluid policy phase.


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The Fed has no choice but to operate through financial markets to achieve its mandated economic objectives. The central bank’s exceptional support of markets is a means to an end, and not an end in itself. And in a world where polarised politics sideline most other policy-making entities, higher asset prices are virtually the only mechanism available to promote growth and jobs.

The Fed is resorting to three tools to bring forward growth via beneficial wealth effects and invigorated animal spirits. Of the three – flooring policy interest rates at negative real levels for an exceptionally long time, providing aggressive forward policy guidance, and expanding the balance sheet via security purchases – only the latter two are in play.

Policy rates are not going anywhere for quite a while. Sluggish growth, low inflation and large excess bank reserves preclude the Fed from raising rates; and while markets have a tendency to forget this, a floored policy rate imposes downward pressure on short-to-intermediate market interest rates.

Forward policy guidance will evolve further as Fed officials experiment with ways to better connect expectations and economic objectives. In its quest for better “communication”, the Fed has progressed from specific calendar guidance to conditional economic outcomes. Yet results continue to disappoint, with an economy stuck in a liquidity trap and challenged by inadequate demand, structural headwinds, pockets of debt overhang and insufficient policy co-ordination. Moreover, the Fed cannot ignore the risks still facing Europe and the slowdown in systemically important emerging countries.

The Fed’s inclination to taper its balance sheet purchases is motivated by more than an optimistic view of the economy. While this may (and, I suspect, will) change in light of a disappointing second-quarter outcome and sluggish momentum into the third quarter, the Fed retains relatively optimistic 2013 growth projections. Some officials are also concerned about the potential collateral damage and unintended consequences of imposing experimental monetary policy on a sophisticated market economy for such a long time.

The Fed’s inclination to taper its balance sheet purchases is motivated by more than an optimistic view of the economy

The path forward is fraught with expectation-formation challenges. Most importantly, the natural desire of economists (and most Fed officials) for a well-telegraphed policy journey – thus minimising the scope for disorderly shocks – competes with the reality of investors seeking to price the final destination. This was certainly a lesson from the May/June market disruptions: with investors jumping quickly to perceived terminal values, Fed officials felt compelled to “talk back” their taper message.

The functioning of financial markets is less robust than many previously believed. This was another May/June lesson. Sudden price falls were accompanied by discomfiting changes in correlations, a worrying erosion of market liquidity, reduced intermediation capacity, and significant outflows – all of which threatened to undermine economic activity. Meanwhile, to the extent that Fed governor Jeremy Stein was correct in worrying about excessive market exuberance that could spell trouble down the road, the result of the markets’ two-month round trip could be quite disconcerting for the Fed: risk markets recovered from the sell-off while “risk free” assets did not.

The danger is that the wrong side prevails in what is proving to be an epic and historic policy tug-of-war

Given the extent to which investors have relied in recent years on the exceptional support of central banks, these seven factors speak to an asset price outlook that is inevitably full of unusual outright uncertainty (and not just the usual array of risk factors).

The hope is that this will be eventually nullified by a steady improvement in the outlook for economic fundamentals. By delivering incremental growth and validating prices for risk assets, this would enable the removal of the “Fed put” without unduly disrupting markets and the economy.

The danger is that the wrong side prevails in what is proving to be an epic and historic policy tug-of-war. Rather than a decisive win by economic fundamentals, the contest would end up being dominated by imperfect Fed policy tools that become increasingly ineffective at compensating for the lack of support from other policy-making entities.

Mohamed El-Erian is chief executive and co-chief investment officer of Pimco

Markets are having a hard time interpreting China’s economic slowdown and evaluating policy options. At one extreme, some observers are talking about a potential dynastic collapse. But most have turned to the notion that economic growth needs to be more consumption driven since the almost universal view is that China’s growth is unbalanced, with consumption as a share of gross domestic product having declined steadily to below 35 per cent – the lowest level of any major economy – while its investment share rose to above 45 per cent, correspondingly the highest.

The reason for this imbalance is often attributed to low interest rates or an undervalued exchange rate. This has been the easy explanatory option since financial markets are comfortable with prices driving outcomes. But in his article in The New York Times last week, Paul Krugman is unique among prominent commentators in getting it right. He notes that China’s unbalanced growth is explained by the Nobel Prize-winning model by Arthur Lewis that shows how the transfer of surplus workers from the rural sector to the modern economy, complemented by rising investment, leads to rapid but unbalanced growth. The model also lays out the conditions when labour supplies tighten, growth slows and China’s economy eventually becomes more balanced – referred to as the “Lewis turning point” – and this as argued by Mr Krugman is causing China to “hit its Great Wall”.

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At a Washington press conference earlier this year, a journalist quizzed the Federal Reserve chairman Ben Bernanke about his future role as the US central bank’s exit from its current, unprecedented, monetary policy stance. As you would expect, Mr Bernanke gave away little, but he did make it clear that he felt he was not the only person who could manage that exit.

A credible field of candidates has indeed emerged, should Mr Bernanke choose to step down as expected in January. One thing is clear already: whoever they turn out to be, the chairman – or chairwoman – of the Fed over the coming years will be judged, above all else, on how successfully they manage to steer monetary policy back to something resembling normality.

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On becoming prime minister of a troubled Pakistan earlier last month, Nawaz Sharif and his cabinet spent 90 per cent of the first few weeks discussing how to turn around the plunging economy and the 18 hours a day of no electricity that has shut down industry and agriculture.

His first change of track as he realised the depth of the crisis was from defiantly rejecting all help from the International Monetary Fund to accepting a $5.3bn bail-out from the organisation and possibly $4bn more from other institutions such as the World Bank.

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It is hard, if not impossible, to hear or read anything optimistic about Egypt these days. Unrest on the streets continues, with an uncomfortably high threat of renewed confrontation involving some combination of the supporters of Mohamed Morsi, the ousted president’s opponents and the military. The political class struggles to coalesce around immediate transitional measures to run the government, let alone those needed to restore the country on the road to A durable democracy. And the economy is in free fall as poverty spreads, shortages grow, inflation rises, unemployment increases and incomes collapse.

There is no denying. Today’s Egypt lacks any robust economic, financial, institutional and political anchors. Even its social anchors are under unprecedented pressure.

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The accusations of overcharging for the electronic monitoring of criminals by two of the UK’s largest outsourcing companies have revived questions about the risks and benefits of using the private sector to deliver public services. But it would be wrong to use the cases of G4S and Serco, and their contracts with the Ministry of Justice, to condemn the industry, especially before an investigation of the circumstances has concluded.

In 2008 I led a government review to define and assess the UK’s fast-expanding “public services industry”, the name given to the sector that provides facilities to the government and runs, for example, prisons and social care homes on behalf of the state. It revealed a growth sector with more than 1m workers and an expanding volume of exports. Our review of the research also found that, on average, there is a 10-30 per cent saving on the cost of public services, with no apparent decline in the quality of provision. Indeed, in many cases, the quality of service improved.


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Perhaps the most surprising finding of the review was that the benefits realised through outsourcing were achieved even when the incumbent public-sector provider won the bid. In other words, the very act of forcing existing providers to justify their costs and benefits led to a leaner government. It was the introduction of “contestability”, rather than competition, that brought benefits. The process of writing bid documents, clarifying the desired outcomes of the service, assigning clear accountabilities for risks and fixing a timetable for making decisions provided a focus and managerial clarity that is often lacking in public-sector operations.

Successful outsourcing requires expertise on both sides of the deal. The government commissioners need to be clear in their contract specifications and neutral in their selection process. The winning bidder needs to maintain an open relationship with the commissioner after the contract is awarded so that any problems can be identified and resolved quickly. When things go wrong, as in this case of criminal tagging, the actions of both public and private parties need to be examined to find the root cause, assign accountability and draw lessons for the future. If that had been done after the G4S debacle over security for the Olympic Games, perhaps the current problems would have been spotted sooner.

One of the crucial benefits from outsourcing is innovation in service delivery. When a private firm wins the contract and takes over the existing staff, it often finds the best ideas on how to improve the service come from those staff. A survey undertaken by Serco of public-sector managers who had transferred to the private sector through outsourcing found that 93 per cent agreed or strongly agreed that “I have more autonomy than I had in the public sector” and 95 per cent said that “the transfer of the delivery of public services to the private sector resulted in improved (or significantly improved) service quality for the service users”. Even accounting for some bias in the sample, this is a strong endorsement for outsourcing from those with direct experience of service delivery in both sectors.

There is also some direct evidence from consumers. In 2007 the National Consumer Council surveyed users of three public services for which there are providers from the public, private and voluntary sectors. The private sector had the highest consumer satisfaction scores for domiciliary care for older people, the voluntary sector was favoured for employment services and those two sectors tied for social housing services. The public-sector providers came last in all three cases.

No doubt there is a need for more evidence from recent experience on the benefits and risks of outsourcing the delivery of public services. But in many respects the rationale for outsourcing in the public sector is the same as it has long been in the private sector where the practice is well established. Using a specialist provider whose reputation and share price are on the line, commissioned and monitored by an in-house procurement team, results in higher reliability, better quality and cost savings – it is better than doing it yourself. It’s a hat-trick too good for the public sector to pass up, especially when money is tight.

The writer is a former member of the Bank of England’s Monetary Policy Committee and led the Public Services Industry Review (2008) for the department for business

The recent visit to India of John Kerry, secretary of state, underscored the continuing American intention to develop a more robust partnership with India. Still, as one sage early architect of the US engagement of New Delhi put it: “The only thing more challenging in modern diplomacy than not having a relationship with India is trying to build one.”

The reality of this sentiment has played out in the up-and-down quality of relations between two of the world’s oldest and most populous democracies in the past few years. Yes, there have been important initiatives – the 2008 US-India civil nuclear agreement, American support for India’s entry into the Group of 20 leading nations and various high-profile visits of leaders to both capitals – but regardless of good intentions in both countries, the strategic relationship has not yet approached metaphorical escape velocity. It has been hampered by a degree of historical suspicion, occasional misunderstandings and a general lack of ambition. This has hindered areas of common purpose and impeded what should be a natural alignment for the 21st century.

Just why is this, and what can be done about it?

Despite best efforts of previous presidents, the modern era in relations really began during the George W Bush administration, with a grand gesture of the US inviting India into the nuclear club, acknowledging the nuclear capabilities Delhi had already demonstrated and opening the door to new areas of commercial nuclear co-operation. Ironically, some of the problems that occasionally bedevil the relationship reflect this dramatic move. American diplomats viewed it as a significant concession, requiring long-standing appreciation; Indians saw it simply as their due, a recognition of their accumulating influence in no way creating an enduring indebtedness to Washington.

Still, that opening helped create momentum in the relationship. At the turn of the century, US foreign direct investment in India was famously flat as a chapati. In 13 years it has quadrupled. The defence relationship has generally flourished and US arms sales to India are on the increase. And there has been a more regular, if somewhat mutually unsatisfactory, dialogue on Pakistan.

The relationship has really floundered on four issues: Iran, global trade, Pakistan and Afghanistan. On the first, the US has been generally unsympathetic to India’s desire to maintain friendly relations with Tehran, a country with which it has enjoyed a long history. India (working with others) also in effect scuttled the last serious American effort to design a global trade round. The two nations have never really seen eye to eye on Pakistan. Finally, Delhi is apprehensive and suspicious about the American approach to Afghanistan, and there are strong Indian concerns about a rapid US withdrawal from that beleaguered nation.

To this formidable list, add the peculiar Indian style of diplomacy. Chinese diplomats are renowned for throwing banquets for visiting Americans, providing even the most obscure visitor with a sumptuous meal and “high-level strategic dialogue”. Indians are just as likely to keep a prominent US dignitary waiting 30 minutes in a hot anteroom for a harried second secretary.

Still, despite these challenges, a rich agenda lies just over the horizon in Asia for both India and the US. The US “pivot to Asia” coincides nicely with India’s “look east” policy. In both countries, the strategic elites recognise the need to direct more effort towards aligning policies in the rising east.

Several areas of common effort are ripe for consideration. The US and India share a desire for a positive relationship with China, and a trilateral dialogue between Delhi, Washington, and Beijing would help signal a common interest in promoting harmony among the three, particularly given potential areas of rising tensions. India has already engaged in trilateral engagements with the US and Japan, and a proactive stance towards diplomatic engagement with China helps dispel misplaced worries of a containment strategy afoot – something that both the US and India view as contrary to their strategic interests.

The US and India also need a deeper dialogue on broader Asian developments – from institution-building at the East Asia Summit and the Asean Regional Forum (which brings together the Association of South East Asian Nations with the US, China and other Asian powers) to exploring specific approaches to key countries such as Myanmar, Vietnam and Indonesia.

Furthermore, the time has come to finally bring India into the Asia-Pacific Economic Co-operation forum. Indeed, accelerating this process has the potential to provide a jolt of energy that is sorely needed. While India still engages in economic practices counter to global standards, the US is better off working with it inside an established framework committed to easing the burdens of doing business and promoting common commercial practices. It is not clear that such a romantic gesture as an invitation to join Apec will transform the relationship; but, if the two countries also maintain a joint focus on Asia, it just might.

The writer is chairman and chief executive of The Asia Group and on the board of the Center for a New American Security. From 2009-13 he served as the assistant US secretary of state for east Asian and Pacific affairs

The eurozone financial crisis has lasted so long and been managed so poorly because policy makers have disregarded some fundamental aspects of the way in which financial markets work. In fact, the euro was created under the assumption – or rather the illusion – that financial crises would never happen because markets would discipline member states’ budgets. Furthermore, when the first problems emerged in Greece, the risk of contagion to other countries was ignored and the crisis was addressed in a piecemeal approach. Only when contagion became apparent and threatened the integrity of the eurozone was an agreement reached to create a safety net.

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In a little-noticed paragraph of its final report, the British Parliamentary Commission on Banking Standards took aim at one of the shibboleths of bank risk management: the “three lines of defence” model. Ask any chief risk officer in a major financial institution these days how risk management and oversight are organised and it is a safe bet that they will soon begin to talk about “three lines of defence”. It has become almost ubiquitous, and not only because the UK Financial Services Authority, as was, blessed it with the regulatory equivalent of holy water. A 2003 paper recommended it as a useful template for banks to use.

Since then accountants and consultants have made a good living advising companies on how to put it in place. Roughly, the first line is supposed to be in the business itself, where line managers and risk folk are required to monitor the risks they are taking. The second line is made up of central risk managers, and the finance and human resources functions, who typically report to the chief executive, or the board, and not to business unit heads. The third line consists of the auditors, internal and external, bringing an independent perspective: they are the guys who tour the battlefield, after the carnage is over, bayonetting the wounded. The whole assembly is overseen by a committee of the board, now usually made up of non-executive directors.

British lawmakers were not impressed by what they saw of this system in practice. The model, they argue, appears “to have promoted a wholly misplaced sense of security. Fashionable management school theory appears to have lent undeserved credibility to some chaotic systems”. Far from complementing each other as happy teammates, they think the second and third lines are in the chocolate teapot category of uselessness, with “the front line, remunerated for revenue generation, dominant over the compliance risk and audit apparatus”.

This is a striking challenge to the current orthodoxy. Their observations are unlikely to find their way into legislation, but UK regulators have already begun to respond this week, by tightening up the internal audit code of practice so as to strengthen the independence of internal auditors. And beyond that companies will want to ask themselves whether the trenchant criticism, which certainly had validity in the two big Scottish banks, can be levelled at them.

One odd feature of this near-universal model is that no one is quite sure where these three lines were born, or by whom they were created. Some say they are rooted in sport, perhaps in basketball, where coaches talk of “line defence”. But we can find no specific tripartite analogy there. Others talk of a military origin for the phrase. But, again, it is impossible find a solid source. Academic papers provide little illumination, and tend to quote the FSA, who in turn refers to industry practice.

Does that matter? Perhaps not, but it would be helpful to find some kind of source which explains just how these defensive lines should be configured. Are they intended as concentric circles or parallel lines? Should all the lines be present all the time, functioning together as a unit, or is one or more of the lines there effectively to check that the others were doing their job? The Red Army used to operate with KGB units behind the front lines, shooting frontline troops who dared to retreat.

These questions are not frivolous. Because another striking fact about the model is that it is described in different ways in different places. Some definitions have the compliance function in the second line, some in the third. Auditors appear in a variety of locations. And McKinsey and Co offers a quite different definition. For McKinsey, the “resilience of the business model” is the first line. The company’s “skills and capabilities to deal with risks” is line two, while its third line is not organisational or people-based at all, it is the group’s “financial strength to absorb risks” – a balance sheet defence, in other words. Perhaps this is a more useful way of thinking about the company’s ability to withstand shocks when risks crystallise.

Certainly the commission is right to ask whether the second and third lines do have enough authority and expertise to provide an effective challenge to the traders and salesmen, and to ask whether, even if they do, they can operate in a timely enough way to head off trouble. The Halifax Bank of Scotland model was reviewed by Pricewaterhousecoopers, at the behest of the FSA, in 2004 and was deemed to be conceptually well-designed and appropriate for the bank. This was as the bank was putting on loans that brought it to its knees. We might conclude that structures are less important than authority and judgment.

“Three lines of defence” undoubtedly has a reassuring ring to it. Who could quarrel with the desire to wear a belt, braces and elasticated pants at the same time? No chance of your trousers ending up around your ankles. But experience shows that even this complex model cannot guarantee success, especially if there is inadequate effective challenge between the lines. Perhaps we need to look through the language and identify just where the power lies, and who can overrule whom and why, rather than being satisfied with a comforting sporting or military analogy, especially one whose origins and meaning are obscure.

The writer is a former chairman of the UK Financial Services Authority, former deputy governor of the Bank of England and former director of London School of Economics. He is now a professor of practice at Sciences Po in Paris. This article is co-authored by Maria Zhivitskaya, who is preparing a PhD in risk management at the London School of Economics

The map of Europe on the face of a two Euro coin©Reuters

The eurozone periphery is on a risky path to end fiscal austerity and accept larger budget deficits. Portugal is the most recent dramatic shift in that direction; Italy, Spain and even France are also abandoning plans to cut spending and raise taxes.

This move away from budget discipline reflects a combination of popular political pressure, more accommodating bond markets and encouragement from the International Monetary Fund.

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But ending fiscal austerity is not a strategy for achieving growth. It will reduce downward pressure on aggregate spending but will not lift growth and employment. Instead, it will raise interest rates and threaten a new fiscal crisis.

Europe needs three things: structural changes to boost long-run potential gross domestic product, a short-term stimulus to increase employment, and a commitment to longer-term spending reductions to shrink the national debt.

The political pressure to end austerity is widespread. Italian voters demanded relief from the higher taxes and the reduced pension benefits previously introduced by the Monti government. In France, President François Hollande won his election with a promise to end austerity and recently rejected the European Commission’s demands for specific budget cuts. Spain and Portugal reacted to public riots by negotiating with Brussels to delay deficit targets.


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The high interest rates on sovereign bonds that put pressure on governments to cut fiscal deficits fell sharply with the announcement last August by Mario Draghi, president of the European Central Bank, of a central bank Outright Monetary Transaction bond-buying facility. The pressure was further reduced when IMF officials encouraged the shift away from budget tightening.

The IMF staff responded by raising estimates of the fiscal deficits of France and the peripheral countries. The increase in current budget deficits and the expectation of higher future deficits have caused long-term interest rates to begin rising in all of these countries. As investors see fiscal deficits increase during the coming year, interest rates are likely to rise further and faster.

The relatively moderate pace of the recent increase in sovereign interest rates suggests that markets have forgotten the conditional nature of Mr Draghi’s promise. The ECB’s willingness to limit interest rates on peripheral country bonds depends on each country having an approved fiscal programme. With the countries shifting away from sound budgets, the ECB is no longer committed to act and would be unwise to do so.

Rising interest rates could bring back the fiscal crisis of a mutually reinforcing spiral of increasing national debts and rising borrowing costs. That could revive the risk that some countries would be unable to borrow and might therefore choose to leave the euro. If the ECB tried to prevent that despite the lack of fiscal discipline, the result would be escalating rates of inflation.

To prevent this, governments must combine long-run deficit reductions with short-run fiscal stimulus. Slowing the growth of pensions and other transfers would reduce future debt and prevent near-term increases in interest rates. To make these changes politically acceptable, governments should combine them with an immediate programme of infrastructure investment and manpower training. This would not only raise current GDP but would also strengthen long-run productivity and real incomes.

The slower growth of transfer programmes would also permit lower payroll tax rates, cutting the cost of labour and increasing employment. Lower labour cost would also raise the competitiveness of European products in international markets.

A lower value of the euro could provide a further boost, making it possible to lift employment while shrinking the short-term fiscal deficits. Although a lower euro would not change the exchange rate within the eurozone, countries outside the eurozone account for roughly 50 per cent of the peripheral countries’ trade.

Policies to allow budget deficits to rise are a dangerous mistake. Italy, France, Spain and Portugal should instead combine longer-term debt reduction with short-term fiscal stimulus. Together with a slowing in the growth in pensions and other transfers, this would boost productivity and lower deficits and payroll taxes to the benefit of all Europeans. The eurozone needs to adopt such policies.

The writer, a former chairman of the Council of Economic Advisers, is professor of economics at Harvard

Lurking in the background of the imminent US-China strategic dialogue are concerns about what role, if any, the world’s second-largest economy will play in the Trans-Pacific Partnership and how the that trade grouping will compete with or complement the Regional Comprehensive Economic Partnership. Getting the details of these mega-regional trade deals wrong could seriously damage Asia’s regional economic infrastructure – a point which is often overlooked. Preventing this will require both China and the US to take more active positions.

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U.S. Currency Production At The Bureau of Engraving and Printing©Bloomberg

No one is satisfied with the US corporate tax system. From one perspective, the main problem is that, while corporate profits are extraordinarily high relative to gross domestic product, tax collections are very low. Many very successful companies pay little or nothing in taxes at a time when the budget deficit is a serious concern; and when hundreds of thousands of defence workers are being furloughed, or sent on unpaid leave; and when lotteries are being held to determine which families cease to receive help from the Head Start pre-school education programme.

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From another perspective, the main problem is that the US has a higher corporate tax rate than any other leading economy and, unlike other countries, imposes severe taxes on income earned outside its borders. This is thought to burden unfairly companies engaged in global competition, to discourage the repatriation of profits earned abroad and – because of the patterns of investment that it causes – to benefit foreign workers at the expense of their US counterparts.

These two perspectives on corporate taxes seem to point in opposite directions. The first points towards the desirability of raising revenues by closing loopholes; the latter perspective seems to call for a reduction in corporate tax burdens. It seems little wonder that corporate tax reform debates are so divisive.


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Many get behind the idea of “broadening the base and lowering the rate” – but consensus tends to collapse when the issue becomes the means to broaden the base. Indeed, a principal objective of many business-oriented reformers seems to be narrowing the corporate tax base by reducing the taxation of foreign earnings through movement to a territorial system.

Where, then, should the debate go? Despite the tension between the critical perspectives on corporate tax reform, the current debate has landed us in so perverse a place that win-win reform is easy to achieve. The centre of the issue is the taxation of global companies. Under current law, US companies are taxed on their foreign profits (with a credit for taxes paid to other governments) only when they repatriate these profits. Right now American businesses are holding nearly $2tn in cash abroad. The companies argue – with some justification – that the current rules are a burden on them: they make it expensive to bring money home and at the same time the tax raises little revenue. This is the case with respect to the corporate tax.

The problem is made worse by an odd feature of the tax debate that a homely example might help illustrate. Imagine a library where many books have been borrowed and are overdue. There is a case for an amnesty to allow the culprits to bring the books back and move on. There is a case for saying that rules are rules and fines must be paid. But the worst strategy is to keep indicating that an amnesty may come soon without ever introducing it. Something similar is where we are in our corporate tax debate.

Companies hope for, and call for, relief, arguing that it will help them bring money home – at a minimum for the benefit of their shareholders and possibly to increase investment. Others campaign against the idea. They ask why companies that have used what could politely be called aggressive accounting practices to locate income in low tax jurisdictions should be given further tax relief.

So, in the meantime, what is a corporate treasurer to do? Hoping for some kind of relief, there is every reason to delay repatriating earnings to the US, even if the company has no good use for the cash abroad. And so the debate encourages exactly what everyone can agree on the desirability of avoiding – corporate cash is kept overseas to the detriment of companies and to no benefit for the American fisc.

A clear and unambiguous commitment that there will be no rate reduction or repatriation relief for the next decade would be an improvement on the current situation, because companies would know that they were going to have to pay taxes on their foreign profits if they wished to make them available to shareholders and would no longer have an incentive to delay.

But this would not be the best outcome. As a very general rule, improvements are possible whenever taxpayers complain that a tax imposes a substantial burden without generating substantial revenue for the government. One can cut back red tape while getting them to pay more. Policy makers can make them better off and help the fisc. That is what should be done with corporate taxes.

The US should eliminate the distinction between repatriated and unrepatriated foreign corporate profits for US companies and tax all foreign income (after allowance for taxes paid to other governments) at a fixed rate well below the current US corporate rate of 35 per cent, perhaps about 15 per cent. A similar tax should be imposed retrospectively on accumulated profits held abroad.

Such a proposal could easily be designed to raise revenue relative to the current baseline, encourage the repatriation of funds to the US, and reduce the competitive disadvantage faced by American multinationals. It is a fair compromise between businesses and reformers. It is as close to a free lunch as tax reformers will ever get.

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

Events are moving so far and fast in Egypt that it is difficult to follow, much less take stock of, what is transpiring. But stock-taking is needed all the same as what is said and done (and not said and not done) in the coming hours and days could prove crucial to developments there and beyond.

The just-ousted President, Mohamed Morsi, often spoke about how his legitimacy stemmed from victory at the polls. What he failed to understand is that legitimacy in a democracy transcends the ballot box; elections are necessary but hardly sufficient. In the way he ruled over the past year, Mr Morsi squandered his legitimacy and his opportunity alike. Millions of Egyptians protested in the streets as they felt excluded from meaningful political participation and fearful that Egypt’s first real election would prove to be its last. Continue reading »

HS2 rail©PA

M y experience has taught me that the hardest thing in politics is to say you have changed your mind. Politicians instinctively hate u-turns as they denote fallibility and, they think, weakness. But reversals can be a sign of strength and courage. I once supported High Speed 2, a proposed rail link from London to the north which the Labour government of which I was a member first put forward. There are no simple options when it comes to transport – but I now fear HS2 could be an expensive mistake.

In any decision of the magnitude of HS2, understanding of the costs and benefits involved will evolve. Politicians should not be afraid to think again about a project whose estimated cost has just risen again by a quarter, to £42.6bn. In 2010, when the then Labour government decided to back HS2, we did so based on the best estimates of what it would involve. But these were almost entirely speculative. The decision was also partly politically driven. In addition to the projected cost, we gave insufficient attention to the massive disruption to many people’s lives construction would bring. Why? Not because we were indifferent but because we believed the national interest required such bold commitment to modernisation.


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Remember the context. We were emerging, or so we hoped, from the worst financial crisis of our lifetimes. We were on the eve of a general election and keen to paint an upbeat view of the future. Such publicly built infrastructure projects seemed to provide so much of the answer to our short- and longer-term economic and employment needs. We did not imagine that the taxpayer would meet all of the costs; HS2 looked a sure candidate to attract private funds. This is now far from clear.

But in truth, this was about the limit of our collective cabinet consideration. We were focusing on the coming electoral battle, not on the detailed facts and figures of an investment that did not present us with any immediate spending choices. The vision was exciting, a lot of spadework had been done in the transport department and the cabinet adopted HS2 as a “national cause”, competing with the then Conservative leadership whose enthusiasm for the project had predated our own.

Probably the most glaring gap in our analysis were the alternative ways of spending the £30bn cost, appraised against the stated objectives of HS2. These included the provision of future rail capacity, the creation of economic growth and jobs, the rebalancing of the economy between north and south and a contribution to a low-carbon future. Ambitious claims for HS2 were made in all these respects. All were based on the central assumption that if you could cut the travelling time between London, Birmingham, Manchester and Leeds, HS2 would transmit business and economic growth across the country, justifying the tens of billions of expenditure involved.

This assumption was neither quantified nor proven. We are still waiting for independent analysis to support it. Meanwhile alternatives – upgrading the east and west coast mainlines, major regional rail enhancements and mass transit projects in regions and provincial cities – were not actively considered.

A further key argument was that existing intercity services would reach full capacity. Without HS2, it was claimed, many people and freight would simply be unable to move. But this ignored what has only emerged since then: building HS2 would threaten rail services between the pole points of Birmingham, Manchester and Leeds. As resources dried up, the bullet train would risk becoming surrounded by railway deserts.

A big cut in intercity services running on the “classic” mainlines is built into the Department for Transport’s business case for HS2, including £7.7bn of savings in subsidy to existing services. In the business case, these savings offset part of the HS2 operating cost.

The government also predicts that the removal of a large number of intercity services would enable an increase in commuter rail services operating on the three lines into London. So, if the rebalancing argument is to be made, it perversely represents a shifting of rail resources away from the north to the south east commuter belt.

This is not the vision that captured our imagination in 2010. The goals of spreading growth and rebalancing have become even more pressing since then. There are plenty of important infrastructure needs to which a future Labour government will, rightly, want to commit itself. It is therefore reasonable that those who previously supported the project should not offer it an open cheque and should, instead, insist on keeping their options open.

By all means, let the cost-benefit analysis, and even the paving legislation currently going through parliament, continue. But all the parties – especially Labour – should think twice before binding themselves irrevocably to HS2. It is not all it seems and has the potential to end up a mistake, damaging in particular to those people that it was intended to help.

The writer is a former business secretary and is chairman of Global Counsel


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