Monthly Archives: October 2013

It will be instructive to compare this Wednesday’s policy announcements from the Federal Reserve with the gradual tapering and forward policy guidance many analysts and commentators forecast just a few weeks ago. I suspect the US central bank will appear to be stuck with the same mix of policy tools even though growth outcomes have consistently fallen short of their expectations. And while recent congressional dysfunction has reduced its room for manoeuvre in the short term, there are deeper forces at play that blunt America’s job recovery, with implications that extend well beyond the Fed.

At the conclusion of their two-day policy meeting, Fed officials are likely to announce few if any changes to the big three components of their current policy stance: floored policy rates will not be touched; forward guidance language will not evolve much; and balance sheet purchases will remain as is, at $85bn a month (also with no change in composition).

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All over Europe, government officials are doing their best interpretation of Captain Renault in the movie Casablanca, who declared himself “Shocked – shocked!” when he learnt there was gambling going on. Rather than gambling, though, European leaders are expressing shock over the revelation that nations – even allies – spy on each other.

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Part of the surprise may arise from the fact that allegations of American tapping of senior officials’ mobile phones have come at the same time – and apparently from the same source – as earlier revelations of widespread data gathering and surveillance by the National Security Agency as part of US counter-terrorism efforts. Presumably, listening to the conversations of allied leaders does not have any counter-terrorism value.

At the same time, there are legitimate questions to be asked about the effect on privacy of US intelligence agencies gathering extensive data on communications in foreign countries. While Americans enjoy legal and constitutional protections against the invasion of their privacy, others – even those allied and friendly to the US – do not.

But the two issues should not be confused. Governments routinely gather information about the activities and thinking of other governments – yes, even of friendly or allied ones. It is the job of diplomats to help their capitals at home understand what is happening, and why, in the countries in which they are serving. Military attachés posted in foreign countries have the task of finding out what is happening with the armed forces and their equipment. And intelligence officers posted abroad gather intelligence in and on their host countries.


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Of course, diplomats, attachés and spies also co-operate with their counterparts in allied countries on many issues. In the case of intelligence officers, this includes sharing information about terrorist threats and other dangers – including information that may have been acquired through activities in the host country.

Much of their time is also spent finding out what is happening in the countries to which they are assigned: what senior officials are thinking on critical issues of the day; what pressures exist within their societies that might affect policy on these issues; and, yes, what stance they may take in negotiations involving both countries.

As the US Ambassador to Nato for the past four years, I spent a good deal of time talking and listening to my colleagues trying to figure out the positions of, and divisions within, allied nations on many critical issues, from future troop commitments to Afghanistan to whether our allies favoured a military operation in Libya. In classified communications to Washington, we reported on what we learnt so the US could formulate policies that advanced our interests and had a good chance of being supported by the alliance as a whole. And I was not the only one to do this. Every ambassador and diplomat is in the information-gathering business.

None of this should be surprising to European leaders. The only question is whether spying, through whatever means available, should be part of this information-gathering activity. And, if so, whether this should include spying at the highest levels of government.

Without in any way suggesting that spying has taken place among our allies, or is now doing so, should anyone be truly surprised if it did? After all, Webster’s dictionary defines a spy as someone “who tries secretly to get information about a country”. And, as US President Barack Obama said when the first allegations emerged: “I guarantee you that in European capitals there are people who are interested in, if not what I had for breakfast, at least what my talking points might be should I end up meeting with their leaders.”

So the question is not whether governments should or do collect information on each other; they do and they should. And they do and should gather it from countries that are friendly, as well as from countries that are not. The question is whether tapping the phones of leaders is the most effective means to that end – and whether the cost of public revelation is worth the benefit of acquiring this information. Given the public furore of recent days, there is good reason to doubt the benefits would be worth the costs.

More generally, one would hope and expect that such a cost-benefit analysis is always made before deciding to engage in such secret information gathering. Clearly whether and when to do so is a political judgment, one that should not and cannot be left to intelligence officers and agencies. It is therefore incumbent on our political leaders to establish that processes are in place to ensure it is always they who make that judgment before any such activity is authorised.

The fact that we can do certain things does not mean that we always should.
The writer, president of the Chicago Council on Global Affairs, served as US ambassador to Nato, 2009-13


Letters in response to this article:

Spying on an ally is reprehensible / From Mr Howard Norman

I’m embarrassed by NSA scandal / From Dr Michael Pravica

Time to re-evaluate our stereotypes / From Dr John Doherty

J McHugh illustration©J McHugh

To judge by recent newspaper headlines, something is going wrong with the British version of capitalism. There are two related items on the charge sheet. One is that companies are exploiting their customers in order to maximise short-term profits. The other is that this preoccupation with financial performance is holding back needed investment and helping to turn Britain into a low-skill, low-wage economy.

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Consider the evidence. This week, first the Archbishop of Canterbury and then a former Conservative prime minister accused the energy companies of profiteering by pushing up prices at an unjustified pace. Making the case for a one-off windfall tax on the sector, Sir John Major said that “governments should exist to protect people, not institutions”.

This week also brought the go-ahead for a new nuclear power plant in Somerset, bringing massive investment into the southwest of England. Good news. But two things were noticeable about the announcement. No British investor had been willing to put up the long-term capital required for such a project; it would not be going ahead without French and Chinese money. And the UK had little to offer in the way of advanced nuclear technology.


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The suggestion was that the country that had opened the world’s first full-scale nuclear power plant – at Calder Hall, Cumberland, in 1956 – might find it difficult to get much beyond “muck-shifting” on this new project.

And it is not just nuclear power plants that are failing to attract British investment. This month the Office for Budget Responsibility reported that the main reason its forecasts for the economy had been much too optimistic was the disappointing pace of business spending in recent years. Back in 2010, the OBR expected business investment would have returned to its pre-crisis level by this summer, implying a rise of 34 per cent. Instead, it has dropped by a 10th.

Hence the rather bizarre headline in the Financial Times this week: “Danny Alexander urges business to invest its £500bn cash pile”. The Treasury chief secretary appeared frustrated by the way companies have been continuing to build up cash balances and run down investment, despite the growing evidence of economic recovery.

Even before the financial crash in 2008, business spending on investment was at its lowest level relative to the UK economy for 40 years, and Britain had a lower capital stock per worker than other similar economies. Now the picture looks worse.

One possible explanation for the way employment has held up so well in the recession is that companies have been substituting labour for capital: it is less risky to meet demand by taking on new people than it is to build new capacity. The consequence has been a spectacular fall in productivity. The OBR estimates that output per worker in the second quarter of this year was about £51,000 rather than the £60,000 that would have been consistent with pre-crisis expectations.

This in turn has fed through into wages, which after allowing for inflation have been exceptionally weak. The UK already had a relatively high proportion of low-paid workers compared with other rich countries. Now it seems that securing a job is no longer an assured way out of poverty. In its first state of the nation report last week, the Social Mobility and Child Poverty Commission reported that two-thirds of poor children in the UK now live in working households.

As for skills, a report from the OECD this month showed that, whereas older workers in England and Northern Ireland were among the most proficient in rich countries when it came to qualities such as literacy, younger cohorts ranked close to the bottom of the league table. The conclusion was that unless something changed, the overall stock of workplace skills seemed bound to deteriorate as today’s young adults grew older.

So what is going on here? Part of the explanation is cyclical. There have been lots of reasons for companies to hold back from investment in recent years: uncertainties about the outlook for demand, the fragility of the banking system and weak profitability.

At the same time, sharp falls in real incomes have made families especially vulnerable to price increases from which there is little or no room to escape, as with food and fuel bills. Many families are very hard up: a study reported by the Bank of England showed that almost a fifth of mortgage-type loans went to households with less than £200 of income remaining each month after housing costs and essential expenditure. For many of these people, a further sharp increase in fuel bills must be a nightmare.

Economic recovery will eventually bring higher wages and ease these pressures. But there is more to the problem than this, and it will not be fixed simply by a return to growth. There is a sense – particularly evident in the financial services sector – that some companies lost their sense of business purpose in the decades leading up to the crash. In his review of Barclays’ business practices, Sir Anthony Salz wrote that “the overriding purpose of Barclays in the lead-up to the crisis was expressed in terms of increases in revenues and profits”, and that the culture that emerged was one favouring transactions over relationships and the short term over sustainability. It was also one that depersonalised links with customers and society more broadly.

This approach was not confined to Barclays or to the banks, and it helps to explain the low esteem in which business is now held by the public. Several business leaders have recognised the problem, and are trying to do something about it. The most visible is Paul Polman, chief executive of Unilever, who believes that business needs to be reconnected to a sense of purpose beyond making money and getting bigger. Others are beginning to talk the same language.

But the clock is ticking, and a long general election campaign is getting under way. The message of the past few weeks is that, if business leaders do not get a grip, the politicians will attempt to do the job for them.

The writer, a former FT editor, is setting up a standards board for the banking sector

The temporary agreement to avoid a debt default in the US will produce severe consequences, not only in America but also in the rest of the world, notably in the eurozone.

As long as Barack Obama’s administration and US Congress remain in the hands of different parties, they will muddle through, trying to gain time by postponing the fundamental decisions. The deadline for raising the debt ceiling will be pushed forward, but there is no certainty that the worst scenario can be definitely avoided. In fact, the two main actors have an incentive each time to move ever closer to the precipice and try to obtain some advantage by threatening a default.

This is similar to the game of chicken European policy makers played during the eurozone debt crisis, bringing the single currency very close to collapse. Only at the last minute, when the risk of implosion became apparent, did European politicians ultimately decide to create a European Stability Mechanism and to move towards a banking union. The intervention by the European Central Bank, pledging to do whatever it takes to avoid a collapse of the monetary union, calmed the markets but catastrophic risk has not disappeared. It is reflected in the risk premium of some eurozone sovereign bonds.

If the US political authorities continue to follow the same pattern, market participants will have to start pricing in a non-zero probability of a disaster scenario. The memory of Lehman Brothers has not faded away, after all. Tail risk is likely to increase in the near future.

A repricing of risk for Treasuries can be expected to affect a whole range of asset prices, including in other countries. At the global level, international investors will be induced to further diversify their portfolios, reducing the overweight of dollar-denominated assets in favour of real assets or financial assets denominated in liquid currencies such as the euro.

The incentive to rebalance investors’ portfolios may also be influenced by the US Federal Reserve’s reaction to the recent deal. Interest rates may remain low for longer and capital may be induced to flow outside the US, chasing higher returns.

Overall, the increased tail risk on US government bonds and the likely reaction of US monetary policy should increase demand for non-US assets. The best rated European sovereigns should benefit from such a portfolio shift. It is less clear, however, that the eurozone as a whole will benefit.

Indeed, the supply of euro-denominated assets is not increasing at the same pace as the global demand. As a result, the euro exchange rate can be expected to further appreciate, continuing the trend of the past few weeks. In fact, the European currency is rapidly heading towards the levels prevailing before the start of the euro crisis. The rising current account surplus of the eurozone, resulting from asymmetric internal adjustment, is further contributing to this trend. This restricts monetary conditions in the eurozone.

On balance, the recent US budgetary events will produce direct and indirect restrictive spillover effects in the eurozone, symmetrical with those the eurozone crisis produced in the US at the peak of the crisis between mid-2011 and 2012. However, eurozone authorities seem less well equipped to deal with these spillovers than the US authorities.

While at the peak of the euro crisis the US authorities flew frequently over the Atlantic to convince European policy makers to get their act together and take the steps needed to complete the institutional framework underpinning the single currency, it is more difficult to imagine Herman Van Rompuy, European Council president, meeting back and forth with John Boehner, speaker of the US House of Representatives, and Mr Obama to convince them they need to reach an agreement on the next debt limit in the interests of the world economy.

Furthermore, while the Fed embarked on various waves of quantitative easing to inundate financial markets with liquidity, avoiding an over-appreciation of the dollar, the ECB’s options are more limited. Cutting further the policy interest rate may help divert some of the demand for euro-denominated assets. The acknowledged weakness of the eurozone recovery and the low inflation rate – increasingly distant from the 2 per cent ceiling – provide the necessary justification for such a cut. It would hardly be sufficient, however, to discourage international investors’ demand for euro-denominated assets.

If the strengthening of the euro is a result of increased demand for euro assets by international investors, the only way to counter it – in the absence of capital controls – is to increase the supply of euro assets or to discourage demand. The only institution in a position to do so is the ECB. It could increase overall euro liquidity by operating directly in the markets, which would not be inflationary as long as the liquidity is held by foreign investors for diversification reasons. Alternatively, it could discourage demand for euro liquidity by imposing a negative interest rate on euro deposits held by the central bank.

Either measure would be a significant innovation for the eurozone. However, they may in the end be unavoidable to counteract the unintended consequences of the way the US is managing its debt problems.

The writer is a former member of the executive board of the European Central Bank and currently visiting scholar at Harvard’s Weatherhead Center for International Affairs and at the Istituto Affari Internazionali in Rome

When Prime Minister Nawaz Sharif meets President Barack Obama at the White House on Wednesday, their meeting will be critical for the future course of US-Pakistan relations. One issue at the top of the agenda – alongside the future of Afghanistan, Pakistan’s own much-weakened state and attacks by terrorist groups – will be the country’s nuclear weapons programme. Pakistan’s rapid development of battlefield nuclear weapons raises many questions in the region and abroad.

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By Ian Bremmer and Vuk Jeremic

On Thursday Saudi Arabia was elected to the UN Security Council as one of the 10 rotating members for the first time in history. On Friday it became the first country ever to decline that offer, sending diplomatic shockwaves around the globe.

In a public statement, the kingdom’s ministry of foreign affairs cited the UNSC’s inability to help bring about a solution to the Israeli-Palestinian conflict or to curb nuclear weapons proliferation in the Middle East. But most importantly, the Saudis cited the UNSC “allowing the ruling regime in Syria to kill and burn its people by the chemical weapons, while the world stands idly, without applying deterrent sanctions against the Damascus regime”. They said all of this was “irrefutable evidence and proof of the inability of the Security Council”.

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The latest growth figures in China – published on Friday – suggest that the country’s economic slowdown has indeed bottomed out. Its economy expanded at an annual rate of 7.8 per cent for the third-quarter of this year, up from a rise of 7.5 per cent in gross domestic product from the previous quarter. The storyline is becoming a bit monotonous and perhaps that is good. However, views over whether this rebound is sustained are mixed. Optimistic bulls predict the small uptick will continue next year yet the less convinced bears factor in a small decline. There are also extreme bears who still predict an imminent collapse or growth falling to an annual rate of 3-4 per cent. Of the latter two arguments, one is implausible and the other illogical.

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A tea-party supporter protest outside the US Supreme Court©AFP

For the past 20 years, American politics has been defined by Republican revolt. The rightwing radicalism that now worries the whole world first emerged in response to Bill Clinton’s election in 1992. It is not that Republicans were never extreme before that time; their challenge to the legitimacy of federal authority traces back to proslavery attempts at nullification and segregationist assertions of states’ rights. But it was 20 years ago that the Congressional wing of the Grand Old Party, led by Newt Gingrich, adopted belligerent non-co-operation as its defining stance.

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It was Mr Gingrich who turned bipartisanship from Washington’s greatest virtue to its most reviled vice. Under his leadership, congressional Republicans refused any quarter on healthcare reform and supplied no votes for the economic plan that spurred the long boom of the 1990s. In their new mode, Republicans refused to vote on presidential nominations and buried the White House in investigations and subpoenas. It was Mr Gingrich who, in 1995, invented the tactic of refusing to raise the debt ceiling as a cudgel to get Mr Clinton to agree to outsized spending cuts. It was Mr Gingrich who invented the tactic of shutting down the government for the same end.

Mr Clinton’s view was that the Republican refusal to be reasonable was all about him. Because he was elected in a three-way race without an absolute majority, he thought Republicans never accepted him as legitimate. An alternate view is that the radical Republican style was largely a matter of incentives and rewards. Abandoning traditions of responsibility and civility won the GOP control of both houses of Congress in 1994. Rejecting any compromise brought Republicans the perks and power of majority control for the first time in 40 years. Thus did the politics of total resistance become their path of least resistance.


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In subsequent years, the conservative movement built up an elaborate incentive structure to favour extremist views and tactics by individual politicians. State Republican parties redrew maps to create safe congressional districts where appealing to swing voters would no longer be required. Groups such as The Club for Growth and Americans for Tax Reform targeted Republican moderates for political extermination, recruiting primary challengers to run against them, scripting their attack ads and funding their campaigns. (No Koch brothers showered their millions on moderates.) The Tea Party emerged partly out of inchoate anger at social and economic change, and partly in response to these incentives.

In his first term, Barack Obama did his part to encourage the GOP hostage-taking. When Republicans demanded lopsided budget cuts in exchange for a debt-ceiling increase in 2011, the president was too willing to negotiate, giving them a victory in the form of the budget sequestration that took effect this year. By the time of his 2012 re-election campaign, however, Mr Obama had learnt the lesson that compromising with bullies only fuels their aggression. This time, he refused to negotiate, sending a message that the debt ceiling could not be used for leverage.

The unconditional surrender by John Boehner, the GOP speaker of the House of Representatives, was a watershed because it points to a change in the incentives that have favoured two decades of Republican recklessness. The party’s Senate elders are embarrassed. Mr Boehner’s unwillingness to stand up to the Tea Party has made them look ridiculous. It has a driven a wedge between the GOP and Wall Street, which was appalled by the calculated flirtation with default. It has reduced Republican chances of recapturing control of the Senate next year, which looked like a real possibility before the latest crisis. They are not going to try this tactic again.

But for many Republicans, the incentives remain unchanged. Texas senator Ted Cruz has done great harm to his party by instigating the showdown over “Obamacare”, the Affordable Care Act, but he made himself into a celebrity and the darling of the right. Many House Republicans will be home in their districts this weekend, bragging that they voted against the sellout. In the midterm election of 2014, no ultraconservative Republican is likely to face a moderate primary challenger with interest group support and outside funding.

What the GOP needs to become a serious governing party again is a set of countervailing incentives and rewards to support what were once its cardinal virtues: respect for tradition and process, aversion to radicalism and willingness to compromise. For the moment, however, the Tea Party remains its dominant force – soundly beaten in this round to be sure, but unbowed, unrepentant and still deliriously irresponsible.

The writer is chairman and editor-in-chief of the Slate Group

Can you hear the sound of cans being kicked down the road? The US disaster scenario has been avoided, for now. But given the deep disagreements between Democrats and Republicans and the even deeper divisions within the Republican party, we may end up going through the process all over again early next year.

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If it had been any other country than the US, we’d all have had a good laugh before putting our money elsewhere. The guilty nation would have faced a much higher cost of credit and a much weaker currency.

Because, however, the US dollar and Treasuries provide the anchor for the global financial system, we merely breathe a sigh of relief and keep our fingers crossed that, next time, a deal will be struck without too much blood being spilt.

Russian roulette


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That may be a forlorn hope. Many Republicans voted Wednesday night in favour of default. Some, it seems, are prepared to play a financial version of Russian roulette, thinking that a default need not lead to disaster – in the same way that, five times out of six times, pulling the trigger does no harm. Others have regarded the recent federal government shutdown as a way to demonstrate the case for small government. They might be willing to do the same thing all over again in a few weeks’ time.

There are also some more serious undercurrents. One is the persistent absence of decent economic growth. During the 1980s and 1990s, the US economy happily chugged along at 3-3.5 per cent per year. Since 2000, the pace has slowed to an annual rate averaging around 2 per cent. Even though, this year, the budget deficit has ended up lower than expected, the longer term fiscal arithmetic is, to say the least discouraging. Unless Congress grapples with this challenge now, the fiscal debates will become even more protracted in years to come. The US will end up being either a high tax or low spending economy. Reaching agreement on which will be, to say the least, difficult.

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The second, related, issue is the incredibly high level of income inequality in the US. John F Kennedy used to claim that “a rising tide lifts all boats” but, in modern-day America, that aphorism no longer seems to work. The gap between ‘haves’ and ‘have-nots’ has become ever larger, and the number of ‘haves’ has got ever smaller: even wages for university graduates have, in many cases, struggled to keep pace with productivity gains. What role should government play in this story?

Some think it should be more than happy to redistribute slices of the economic cake. Others take a more 19th century view, arguing that, because the rich tend to save more, they are better able to provide the funds for long-term investment that might, otherwise, be squandered to buy votes.

The third issue is America’s financial relationship with the rest of the world. The battles witnessed in Washington over the last few weeks suggest that at least some US politicians have lost sight of the fact that the US is heavily indebted to the rest of the world.

Reserve currency status helps keep the creditors at bay – the costs of walking away from a dollar-based global financial system are possibly greater for America’s creditors than they are for the US itself – but reserve currency status also allows Washington to slip into bad habits that no other country could ever contemplate.

Even if the debt ceiling is raised, even if further shutdowns are avoided, there is a danger of a growing mismatch between America’s own fiscal ambitions and the interests of its creditors.

Vietnam War

It’s not quite the same story but the early-1970s break-up of the Bretton Woods system of fixed but adjustable exchange rates provides an intriguing precedent. The mounting costs associated with the Vietnam War led US authorities to crank up the printing of dollars in the late-1960s.

While this helped alleviate domestic fiscal pressures, the extra dollars in circulation threatened the dollar’s supposedly fixed link with gold. Foreign central banks began to fret, swapping their dollar reserves into precious metal, leaving US gold reserves precariously low.

Eventually, the growing inconsistency between US political ambition and global financial need led to the Bretton Woods system collapsing altogether, paving the way for the financial chaos of the 1970s.

Ironically, the current budgetary mess has also encouraged the printing of dollars. The Federal Reserve’s decision in September not to taper seems, in hindsight, to have been remarkably prescient. With the countdown to another potential debt ceiling stand-off already under way, it may even be tricky for the Fed to contemplate tapering in December.

The extra liquidity associated with quantitative easing has already triggered financial upheaval elsewhere in the world – most obviously in some of the more fragile emerging economies – but a further attachment to quantitative easing in a bid to mask Washington’s fiscal dispute may only encourage further problems down the road.

It may often seem that there is no alternative to a dollar-based international financial system. There is. It’s called financial chaos. The deal struck this week is more than welcome. The risk of financial chaos, however, has not yet gone away.

The writer is HSBC’s chief economist

With the US government shutdown and the possibility of a debt default occupying a lot of the bandwidth, last week’s International Monetary Fund/World Bank annual meetings struggled to deliver on already-low expectations regarding major policy breakthroughs. Yet, if they internalise well what was discussed in formal meetings, in panels and in the corridors, policy makers from more than 180 countries would return to their national capitals with four important realisations.

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On Friday the Organisation for the Prohibition of Chemical Weapons received the Nobel Peace Prize for “its extensive efforts to eliminate chemical weapons”. The OPCW has only been around for 16 years, and it has one-fifth the staff and budget of the International Atomic Energy Agency, the world’s principal nuclear watchdog. The Nobel Prize committee’s announcement made clear that the organisation’s recent work in Syria was the real catalyst. Few had heard of the OPCW until the UN tapped it to inspect and shut down chemical weapons in Syria.

The OPCW’s work in Syria deserves lasting support, but given that its work has barely begun, does it deserve the world’s most prestigious prize? The chemical weapons round-up may succeed, but it very well may not. Should the prize honour accomplishment rather than promise?

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Barack Obama’s cancellation of his planned trip to Malaysia, the Philippines, Brunei and Indonesia for the East Asia Summit and the Asia Pacific Economic Co-operation summit was a blow to his administration’s much-vaunted “pivot”, or rebalance, to Asia. What matters most now is how the US president and his team responds to this setback to the Asia-Pacific region, which had been anticipating Mr Obama’s visit to southeast Asia on several counts.

First, a visit would have underscored the president’s determination to make the East Asia Summit the foundational leaders’ meeting for the region. There was also the hope at the Apec meetings for significant progress around remaining sticking points associated with the complex negotiations over the Trans-Pacific Partnership.

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A new study of adult skills across a range of advanced economies is a wake-up call for UK policy makers and business leaders. It highlights serious shortcomings in the provision of the most important workplace skills – literacy, numeracy, and the ability to use digital technology – and points to an all but inevitable decline in economic competitiveness unless the problems are fixed.

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The study, conducted by the OECD, covers adults in England and Northern Ireland, and finds their overall performance in literacy is roughly in line with the average of the 24 countries included. But relative performance is significantly worse when it comes to numeracy, which is seen as the best predictor of economic success. And the really shocking news is the poor showing of young people.

England/NI is one of the three highest performers in literacy when comparing 55 to 65 year olds, but in the bottom three when looking at 16-24 year olds. Proficiency tends to decline with age, given the impact of ageing and of training programmes that favour the young. Yet of all the countries on the list, only in England do adults in the oldest age group perform a little better than those in the youngest. This means that young adults are entering a much more demanding and competitive labour market no better prepared to cope than those who are retiring. And unless something changes, the overall stock of workplace skills seems bound to deteriorate as today’s young adults grow older.


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What is the explanation? The broad message is not so much that performance has slipped, but more that it has risen much faster in many other countries across successive generations. To take one example, South Korea trails the pack when comparing the skills of its oldest workers, but is second only to Japan among 16-24 year olds.

Several clues about what is going wrong emerge from the mass of data. Social background is important: there is a high correlation in England between economic deprivation and poor academic outcomes. This in turn contributes to a highly polarised labour market – with large numbers of jobs requiring only minimal skills.

Another important feature, highlighted in a different OECD report, is the shortage of vocational provision in England for young people after secondary level. The number of high quality apprenticeships has increased rapidly since 2009, which is good. But less than a 10th of the age cohort have the right kind of vocational training after school, compared with up to a third in other OECD countries. There is a growing demand in advanced economies for adults with postsecondary qualifications that involve something less academic than a bachelor’s degree. For school leavers in England, however, the dominant postsecondary qualification remains a university degree – and the lack of provision at the vocational level helps to explain the skill shortages that are already evident.

The good news in this latest study is that countries do not have to live with the second rate. The Netherlands and Nordic countries, for example, provide a model of how to improve computer skills in the workforce across generations.

Business leaders and politicians in England and Northern Ireland have to get together to drive through the necessary changes. Businesses need to stop whingeing about school leavers and make a step change in their degree of integration with the education system, helping to shape relevant teaching and providing much more workplace experience.

Politicians need to develop a bipartisan approach to skills training, rather than upending the system every time power changes hands. Those most at risk of falling behind in skills proficiency should be identified and supported from an early age; qualifications should be less complex and more consistent.

David Cameron likes to talk about the UK’s position in the “global race” for economic competitiveness. But England’s share of the global talent pool is shrinking fast. Unless these challenges are urgently addressed, the prime minister might as well save his breath.

The writer is chancellor of the University of Warwick, a former head of the Confederation of British Industry and previous editor of the Financial Times

Paul Krugman has posted an interesting and concrete analytical comment (Phantom Crises”) in reply to my October 3 op-ed in the Financial TimesBritain should not take its credit status for granted”. Prof Krugman explained why he never felt any need to temper his famously strong advice to the UK government to massively raise borrowing, even though he simultaneously believed (and widely opined) that the Eurozone might very well soon blow up.

I should also thank Simon Wren-Lewis for his response: he recognised that my op-ed clearly was not intended as a piece of advocacy to justify the UK’s exact policy trajectory. In fact, I point to several areas where it could have been significantly improved, for example, greater infrastructure spending. I am, however, arguing that the insurance elements of the problem need to figure more prominently in the discussion.

Prof Krugman’s comment, using a simplified version of the canonical modern IS-LM macroeconomic model, shows that even if a euro collapse would have led to a run on sterling, the result would be depreciation of the pound and a rise in demand for British traded goods. At the same time, he argues that even if this built-in automatic stabilizer were not enough to prevent a “squeeze” on long-term bonds, the Bank of England could just print money and buy them up en masse thanks to the liquidity trap. (Prof Wren-Lewis, who Prof Krugman cites, also makes this point.) Thus there was in fact no need to reconcile his debt management advice with his euro red alert.

I beg to differ.

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As the annual meetings of the International Monetary Fund and World Bank approach, I remember vividly the exceptional collective awakening that took hold of this same gathering five years ago. Hundreds of officials from around the world came to the joint and simultaneous realisation that the global economy they inhabited was on the verge of falling into an abyss.

This collective “intervention” led to unusually candid policy conversations, common analysis and admirable policy co-operation. It culminated six months later in the highly-actionable London Group of 20 Summit. There, the world’s major economic powers agreed on co-ordinated fiscal and monetary policies that helped to sidestep a very costly global depression. Hundreds of millions of people consequently avoided devastating poverty and misery.

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Pakistanis are sitting on a volcano. Unless the country’s principal stakeholders – the army, the politicians and the mullahs – get their act together and declare zero tolerance for violent militant behaviour, Pakistan will lose its war against extremism and terrorism.

Over 200 people were killed last week in terrorist attacks that included the killing of an army general, 85 Christian worshippers in Peshawar, housewives in Karachi. On Sunday a massive car bomb killed 40 people in Peshawar– the third terrorist attack in the city in a week.

The country has never undergone such a baptism of fire by a range of secular and religious extremists who have taken the law into their own hands. Nawaz Sharif, prime minister, has been forced to reverse his earlier call for talks with the Pakistani Taliban, hinting now at a more robust policy. Yet it remains unclear what policy he will pursue.

Such uncertainty has already fuelled tensions between Islamabad and its neighbours – two of which, India and Afghanistan, have called Pakistan the epicentre of regional terrorism in the region – as well as alienated the international community.

Pakistan is beset with three major insurgencies. In the North West the Pakistani Taliban are attacking the army and vulnerable elements of society such as Shia and Christian minorities. Further south separatists are trying to create an independent Balochistan. Karachi is a maelstrom of militias, mafias and malcontents whose violent ways have deeply undermined the country’s main port and trading centre.

The spate of terrorist attacks and the lack of a serious counter terrorism strategy has exposed the continuing deep fissures between the army and the civilian government.

Even though the army has been viciously targeted – a general and colonel were killed by the Taliban in mid-September – the military has long maintained a two track policy towards the militants. On the one hand there are those militants judged not to be enemies of Pakistan and who are allowed to fight in Indian Kashmir or Afghanistan; on the other hand there are those committed to undermining the Pakistani state, and who are targeted by the army.

Right now, the army is not in favour of direct talks with the anti-state Pakistani Taliban factions, although it has not spoken out against Mr Sharif’s call for talks. However, the military is also unwilling to launch an offensive against the Pakistani Taliban in their bases in North Waziristan, because that would affect the Afghan Taliban, whom they see as “friendly” – the army wants to continue using the Afghan Taliban as a proxy force for influencing the future political make-up of Afghanistan.

Similarly, the country’s main political parties also pursue a twin-track approach towards militants, protecting those seen as supporting their interests. Political parties try not to arouse militant groups based in their heartlands – for example, the Punjab, stronghold of the ruling Pakistan Muslim League. Groups having sanctuary in Punjabinclude the virulent anti-Shia group Lashkar-e-Jhangvi which has massacred hundreds of Shias across the country and Laskhar-e-Toiba, which continues to fight in Indian Kashmir.

In Karachi where everyday violence can claim two dozen victims, political parties also protect the districts that they govern by cutting deals with militants or mafias. In recent months Karachi has faced a new threat too – an increase in Taliban-initiated bank robberies, kidnappings for ransom, protection rackets and killings.

For some politicians the alternative is evidently too scary to contemplate. The leadership of the Awami National Party, which is vehemently anti-Taliban, has been virtually wiped out by Taliban suicide attacks – a strategy that has terrified politicians, judges, police and paralysed state machinery.

Meanwhile the heads of Islamic and other conservative, religious-based parties, even question the existence of such groups as al-Qaeda and the Taliban, blaming terrorist attacks on some alleged US-Indian-Zionist-Afghan conspiracy. Similar views are also shared and articulated by mainstream politicians, including Imran Khan, the former cricketer, which creates only further confusion in the public’s mind.

Neither the politicians, the army nor the ulema – religious leaders – have articulated a clear and consistent narrative to the public which explains why and how these groups have expanded in Pakistan, nor do they condemn by name their murderous actions nor offer a countervailing strategy to deal with the threat.

The lack of a clear narrative supported by all parts of the state – civil and military – has led to the present confusion, fear and denial amongst a deeply disturbed public, which is also trying to deal with a severe economic downturn, acute unemployment among the young and the lack of electricity. The violence is having a devastating effect on Mr Sharif’s efforts to revive a slumped economy and to improve its relations with its neighbours, with whomPakistanneeds to improve trade.

There were high hopes in June when Mr Sharif was elected and began an intensive dialogue with the military, politicians and civilian experts about developing a coherent counter-terrorism strategy. Such an initiative, he hinted, would include the creation of a National Security Council, the sharing of intelligence between the military and civilian agencies, and a comprehensive strategy that would include several multi- dimensional tactics including the use of force, economic development and potential dialogue with some Taliban.

But in the end Mr Sharif resorted to what he and his party have practised in the past in Punjab province – the path of least resistance – an entire strategy based on talking to the Taliban, even as they expressed no interest in talks and continued their murderous spree.

Until there is a zero tolerance policy for extremism strongly expressed and acted upon by all civil and military elements, violence in Pakistan is likely to lead to much larger social eruptions which could ultimately become uncontrollable.

I am puzzled by commentators who are certain that governments had it all wrong, at every step, in balancing stimulus and stability in the aftermath of the crisis. One often sees claims, for example, that the UK borrowed heavily in the distant past with little ill effect. So today’s leaders were foolish not to engage in even heavier borrowing and stimulus. These people seem to believe everything will be fine when it comes to public debt: like Voltaire’s character Dr Pangloss, they assume “all’s for the best in the best of all possible worlds”.

According to the debt panglossians, UK leaders watched as the economy stagnated, rationing stimulus out of a baseless concern over credit risks. Even though the UK ran one of the largest deficits of any advanced country, the panglossians say it should have borrowed more. Perhaps, but their logic is based on a shallow reading of the evidence – and on amnesia about recent risks to eurozone stability.


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They do have some very solid points on their side, particularly when it comes to high-return infrastructure projects. Such projects, if done at a reasonable cost, pay for themselves. Governments should have done more, and not just to stimulate demand. There are good neoclassical arguments for higher government spending in a slack economy when resources are cheaper. But debt panglossians are far too confident that the UK’s credit status is bulletproof, and too dismissive of the risks.

Yes, from the 1800s until the first world war, the UK was a global superpower that commanded vast colonial resources and investments. Over long periods, these foreign assets yielded returns well in excess of interest on debt. But comparing government debt ratios back then, when the UK was a massive net creditor, to debt ratios today, when British foreign liabilities exceed foreign assets, is utterly misleading. Moreover, back in the 1820s, the UK was pioneering the industrial revolution; things are not quite the same today. Back then, the UK did not have to worry about pension liabilities or existential threats to the banking system that could require massive injections of cash to fix.

From the Depression to the mid-1970s, as the empire faded, the UK’s credit performance was less than stellar. During the 1930s, Britain defaulted on debt to the US accumulated during the first world war and its aftermath. Though all but forgotten today, the UK’s Depression default was arguably of comparable magnitude to some of the more spectacular emerging market defaults of the past three decades once eventual recovery rates are taken into account. This was arguably an “excusable default” but it is not a forgettable one.

It is often stated that after the second world war the UK debt reached almost 250 per cent of gross domestic product and was brought down merely through growth and inflation. This is a myth. As Carmen Reinhart has argued in her work on financial repression, had the UK not used a labyrinth of rules and regulations to hold nominal interest rates on debt below inflation, its debt-to-GDP ratio might have risen over the period 1945-55 instead of falling dramatically.

Then there is the high-inflation era of the 1970s – another de facto default. Last but not least, what about the UK’s serial dependence on International Monetary Fund bailouts from the mid-1950s until the mid-1970s? This is hardly a country with an indestructible credit status.

From early 2010 until quite recently, there was every reason to worry about a disorderly exit from the eurozone potentially blowing up the whole thing. This was the big call – the one that everyone was focusing on. To state that credit risk was gone by 2010 is ludicrous. None other than The New York Times columnist Paul Krugman prognosticated the euro’s early demise regularly from April 2010 to July 2012. His big call has turned out – so far – to be dead wrong. But his estimate underscores the uncertainty policy makers faced – and inconsistency in the debt panglossians’ advice.

On the one hand, they were berating the UK government for worrying about large deficits and soaring debt. On the other hand, they were saying that its greatest fear was likely to materialise. I suppose one could argue that a collapse of the eurozone would have caused a stampede into gilts. Maybe. But this was a country that was still running twin current account and fiscal deficits. More likely, a euro collapse would have triggered a stampede out once investors realised that the UK banks and trade would be savaged, a flexible currency notwithstanding. In that scenario, UK leaders would have been forced to close massive budget deficits almost overnight. That would have been truly catastrophic austerity.

We now know the euro did not collapse. With 20-20 hindsight, yes, the UK could have borrowed more. But we do not have hindsight at the moment decisions have to be taken. To pretend we always knew everything would be fine, and to assess performance accordingly, is just plain bunk.

I am certainly not arguing that the UK or other advanced countries handled the post-crisis period perfectly. There should have been more infrastructure spending, even more aggressive monetary policy and probably more ruthless bank restructuring. But there has to be a balance between stimulus and stability. To assume we always knew things would calm down, and to retrospectively calibrate policy advice accordingly, is absurd.

The writer is a professor of economics at Harvard and co-author of ‘This Time is Different’


Letters in response to this article:

UK government has, in fact, borrowed much more than planned / From Mr Stephen Beer

Looking back is the only way for governments to learn / From Dr Jacob A Jordaan

It is worth taking a moment to cheer the United Nations for its outstanding successes this past week. The UN is the global home of diplomacy, the art of maintaining peace and co-operation in a world all too ready to head to war. Sometimes it succeeds; often it is brushed aside, by great and small powers alike. Four times last week the UN proved its enduring worth.

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