1.What Is Globalisation And Is It Good?
WHAT IS GLOBALISATION?
Globalisation refers to a variety of events that are rapidly changing the world. The machine that powers
globalisation, however, is the global economy. At the heart of the global economy are the twin policies of
privatisation and deregulation, which national governments have adopted worldwide since the 1980’s. Terms like
free market economy, level playing field, monetarism, market economy, and neo-liberalism embrace processes such
as privatisation and deregulation.
Privatisation is about putting governments out of business. The economic theory behind privatisation is
that, Business knows best. In this age of globalisation, our governments cheerfully tell us that they are too
incompetent to manage our economy, so as a service to the public they will instead let the free market run it. Then
our governments sell off publicly owned businesses and assets, which usually end up controlled by multinationals
and financed by public shareholders. Competition within the marketplace rather than government management, we
are told, will allegedly produce lower prices and better services for consumers. This is called a better standard of
living, which implies that the public are better off for having a privatised economy so they should be happy about
it.
The strange part is that governments streamline their businesses, making them efficient and profitable,
before they offer them for sale. If governments can do that before they privatise, why were they not doing it all
along? Also, if governments are competent to get their businesses profitable and efficient, why not keep running
them that way in the future rather than sell them? If governments genuinely are that incompetent, how can the
public trust their competence to manage anything?
Why also do governments sell businesses that were always running profitably and were never losing
money? All these actions contradict the stated reason why privatisation is allegedly necessary. They also imply a
lazy, if not negligent attitude from government towards citizens, whose assets they are selling off, often at
undervalued prices.
Deregulation takes several forms. Within a country, the lifting of trade restrictions and easing of
government regulation in business is meant to allow business to run more efficiently. The best businesses will
survive the competition to give consumers a better standard of living, that is, more material goods for lower prices.
Deregulation also applies to national currencies. Currency is no longer pegged at a certain value by
government decree or gold reserves, but its value is floated in the global market place, where it will find its own
natural level in the ocean of other global currencies.
Deregulation does not just apply within a country though. Deregulation also involves opening a country up
to foreign competition. Foreign businesses can operate in our country, on the basis that our country’s businesses
can trade in other foreign countries.
What is the benefit from all this? A better standard of living through a wider range of cheap goods is what
globalisation is all about. This is what the media, politicglobalians and multinationals keep telling the public.
HOW DID GLOBALISATION ARISE?
Why are democratic governments now putting themselves out of business by selling their companies and
assets, and giving control of national infrastructures and economies over to multinationals? The present phase of
the process began in the latter 20th century.
After World War II most countries were in an economic mess. Governments were the only entities large enough to
get economies repaired and moving again. The governments took control of the commanding heights of their
national economies. Government directed economies were based upon the idea that Government knows best .
For three decades after WW2 the government led economies worked reasonably well. However, the US
monetary system had a problem left over from a 1930's quick fix, and this problem began to catch up by the 1970’s.
In 1971 the US economy was technically as good as bankrupt. President Nixon took an easy way out by severing
the link between the US dollar and gold. This allowed the US to have adequate money supply, where previously
gold had stifled it. While this fixed the short-term problem for the US, it created several long-term problems
globally.
Now US dollars had become freed from the restraint of a gold standard and the US banks could create as
much money as they chose to, virtually without effective regulation. The ensuing flood of money aggravated
1
economic malfunctions within many other countries that were still on the US dollar standard. As nations floundered
economically, they contaminated other trading partner economies. Stagflation, stagnant economies with rampant
inflation, became like an epidemic sweeping around the world.
Let us look at how inflation works. When money is in short supply (credit squeeze, recession), interest rates
go down to stimulate more lending, which puts more money into circulation. However, when there is an oversupply
of money (inflation) interest rates go up to curb lending, which removes money from circulation.
After global currencies lost the regulation of gold, the raising of interest rates no longer curbed borrowing
like it did under the gold standard. During the earlier 1980's so much money continued pouring into circulation that
many people could afford the higher interest rates and they kept on borrowing, which took inflation even higher.
The global banking fraternity could have regulated the inflation chaos that occurred after the US severed its
link to gold, but they did not. All the banks had to do was cut back on the number of loans they granted, but instead
banks kept on lending to the unwary world. Why? Because the banks knew that the day of reckoning would come,
when the interest burden of the loans inevitably caught up with and stalled the free flow of money. It is similar to a
pyramid sale scheme, but instead of the patsies ending up with a garage full of soap, they end up with a life or
business full of debt.
Why did the banks encourage an economic situation that they knew would stall itself? Because the banks
knew that when it stalled, they would be in a position to take control of vast amounts of property and businesses,
when the people that built them inevitably defaulted their loans. It was good business. As nations became debt
burdened, privatisation and deregulation did effectively deliver public property and businesses into multinational
control to pay off national debts.
The 1980’s and 1990’s were the decades of crippling inflation and stagnant economies. In Africa and South
America the 1980’s are referred to as the lost decade. Great Britain was brought to its knees, and the Mexico
currency crisis nearly destroyed the global economy. The 1990’s were when Japan, SE Asia and the USSR crashed
economically. The real cause of the economic instability was the willingness of the global banking fraternity to
oversupply a faulty money system. This was quietly ignored. The blame for the world's economic woes was instead
cast upon government interference and ineptitude in economics.
The global crashes of the 1980’s and 1990’s were caused by deregulation of the global financial system and
business decisions made by banks, not government ineptitude. No government could have survived what the banks
were doing (and continue to do). Banks reaped an economic harvest across the Earth while the cause of the problem
was deflected in the direction of national government incompetence. The governments had run up huge debts,
therefore they must be inept at running business. Its logical.
Through privatisation and deregulation, banks and other multinationals could now begin to purchase and
control infrastructures and businesses that had previously been run by national governments for reasons of national
security. Much of the essential business of running countries was now being put on the market for sale through
privatisation. The banks and their multinational affiliates began to purchase the infrastructures of countries, while
governments signed away national rights of control through international laws in the World Trade Organization
(WTO).
In the early 1980’s, England under Thatcher was the first country to embrace the principles of privatisation
and deregulation, which the Chicago School of US economists had been promoting since the 70's. The USA under
Ronald Reagan quickly joined in. As other countries around the world fell into economic chaos, the US economists
were close at hand to sell them the benefits of government privatisation and deregulation. The magic fix of the
market led deregulated economy seemed to work in the failing economies, and the economies began to stabilize.
But as countries bit the bullet through loss of national assets and jobs, all that really happened was that their
economies were being painfully reset to an even ledger again after selling the farm to pay off crippling debts. New
debt would continue to accumulate as it had before. Getting out of debt made governments look impressive to
voters and gave the voters false hope that perhaps now the economy might be fixed.
The illusion was that the globalisation mantra of Business knows best’ was an axiom of economic reality, a
fundamental truth. This was because government privatisation and deregulation seemed to stabilise economies.
However, the quick fix of privatisation and deregulation was not a long-term solution for the global economy
2
because the debt fault still remained. This meant that nations would eventually fall victim to uncontrollable,
escalating debt again.
WHO IS RUNNING GLOBALISATION?
The excessive lending by banks in the 1980’s had been the bait, and their catch was the gains they made
through bankruptcies and sales of national assets. As these profitable bankruptcies cleared away the immediate
economic chaos, the banks resumed more moderate policies of lending.
While governments had no choice but to float their currencies, doing so was just a short-term fix rather
than a long-term solution. In the new economy if countries did not join in and deregulate their currencies (and
economies) they became sitting ducks for global money speculators, foremost among which are multinational
banks. The floating of national currencies was an inevitable result of the US severance from regulated currency. It
was an offer to weaker economies that could not be refused - either join the club of globalised currency or be
clubbed by globalised currency. The floating of currencies partly addressed the threat from global money
speculators, but it did not fix the fault in the global monetary system, which continues to hamstring national
economies through debt.
Foreign debt is largely a misnomer. The debt is foreign in the sense that it is not owed within the same
country and its economy. The word foreign implies that the debt is owed to another country. These days that is not
entirely the case either, because most countries on Earth have excessive foreign debts. Foreign debt is mostly owed
to multinational banks, which have no loyalties to any nations and are in the business of creating debt.
Privatisation and deregulation also ignore the fact that debt growth outpaces economic growth in the post1970's global money system. Just as private debts had bankrupted citizens and companies through the 1980’s and
1990’s, debts are now preparing to bankrupt whole countries in one go.
Privatised and deregulated national economies have allowed multinationals to take control over the
business, infrastructures and economies that run countries and shape their futures. In reality, the world is really run
by an oligarchy of global corporations. After deregulation, national governments just take care of lesser, more
trivial tasks that still need doing, like building roads and taxing the nation. A country's economic destiny is dictated
to it and life for everyday citizens falls into line accordingly. Meanwhile, nobody is meant to notice that their
nation is steadily marching towards a precipice of debt.
WHAT IS GOOD ABOUT GLOBALISATION?
We have wide-screen TV's. We have cheap Chinese goods. The greatest benefit from globalisation is that it
gives some countries a greater range of cheap overseas goods to buy. The cheaper prices are not a lasting result of
globalisation though, but rather a reflection of the non-level playing field that currently exists within the global
economy.
Government subsidies, import tariffs and lower paid workforces are what make the playing field of the
global economy non-level. If the global economy ever reaches its proclaimed goal of a level playing field, then the
cheap goods will become more expensive again. There would not be cheap labour or protective subsidies anymore.
Cheap foreign goods are bait to encourage citizens to accept and assist the process of globalisation.
As wealthier nations buy those foreign goods they raise the wages of foreign workers and reduce the wages
of workers in our own countries by ultimately putting them out of work. Prolonged high unemployment eventually
leads to effective reduction in real wages.
So in effect, cheaper goods, which are an evident benefit from globalisation, are precisely what globalisation is
aiming to remove through its level playing field policy. Achieving a level playing field is a stated goal of the WTO.
WHAT IS BAD ABOUT GLOBALISATION?
The bad aspects of globalisation involve human wellbeing, the environment and economic realities.
Human Wellbeing and Quality of Life
Quality of life is at risk from globalisation in a number of different areas.
THE END OF DEMOCRACY AND NATIONAL CONTROL
While democratic-styled governments are being installed around the world in the name of freedom, the
essential structure of democracy itself is being undermined by globalisation.
Many fundamental areas of society that were traditionally administered by democratically elected
governments are now becoming administered by unelected and unapproachable multinational boards.
PERSONAL STRESS
3
Globalisation has created new kinds of stress into everyday life. Even proponents of globalisation admit
this, on the basis that "markets are relentless".
Corporations rationalise jobs whenever possible. This can be done by laying off workers or importing
cheap workers from other countries. Job insecurity and the escalating workloads of existing jobs are eroding quality
of life.
At any time fuel prices or interest rates may rise so much it hurts. What if there's a recession? What if the
stock market crashes? What if the real estate market spikes up high - or down low? A new culture of "fear of the
future" is entering society, caused by multiple long-term insecurities stemming from the new economy.
Environmental Survival
How big must the global economy grow in order to be big enough? How much is enough? Globalisation’s
answer is that there can never be any such thing as big enough. In 100 years when, at current growth rates the
global economy would have grown 50 times it present size, it would still not be large enough. Continual growth is
necessary for this present economy to survive because of the way it is designed. The growth rate is deceptive. 4%
annual growth does not sound like much but the global economy grows exponentially, not mathematically.
The destruction of natural resources like clean water, forests, arable land, ocean fish stocks, coral reefs and
so on are already causing extreme concern even in the traditionally conservative ranks of society. The current rate
of extinctions from the planet is comparable to the rate of the extinction event that destroyed countless millions of
species along with the dinosaurs from Earth 65 million years ago.
Earth is clearly not coping with the demand for resources in the present sized global economy. At present
rates of growth in 30 years the global economy would be about 4 times larger than today, and in 60 years it would
be 10 to 20 times larger than today.
The global economy, which must grow exponentially in order to survive, does not recognize the realities of
the natural world. The global economy is presently on a course to destroy itself through the planet’s lack of ability
to sustain it. Like a cancerous growth, the global economy is growing so vast that it will soon kill it host.
Economic Realities
Their still remains a fundamental flaw built into the post-1970's global monetary system, and economic
trouble is arising from it again. The flaw in global money supply ensures that debt will always grow at a much
faster rate than economies.
On its present course, unless there are fundamental changes made quickly to the global money supply
system, the global economy has no option but to collapse well before 2030.
IS GLOBALISATION GOOD?
It would be possible to have a different kind of global economy that works in the real world to sustainably
serve humanity. The pain and destruction caused by the global economy are not inevitable, but simply the result of
the way this particular global economy is designed.
Is there not more to life than cheap consumer goods? Environmental degradation, social breakdown and
high personal stress levels do not factor into mathematical profit margins.
The people of a nation care about the well being of their environment and society. Multinational
corporations have no such national sentiments. They would give the world for a dominant market share, and
presently they appear to be doing just that.
2.When did globalisation start?
“GLOBALISATION” has become the buzzword of the last two decades. The sudden increase in the
exchange of knowledge, trade and capital around the world, driven by technological innovation, from the
internet to shipping containers, thrust the term into the limelight.
Some see globalisation as a good thing. According to Amartya Sen, a Nobel-Prize winning economist,
globalisation “has enriched the world scientifically and culturally, and benefited many people economically as
well”. The United Nations has even predicted that the forces of globalisation may have the power to eradicate
poverty in the 21st century.
Others disagree. Globalisation has been attacked by critics of free market economics, like the economists
Joseph Stiglitz and Ha-Joon Chang, for perpetuating inequality in the world rather than reducing it. Some agree that
they may have a point. The International Monetary Fund admitted in 2007 that inequality levels may have been
increased by the introduction of new technology and the investment of foreign capital in developing countries.
Others, in developed nations, distrust globalisation as well. They fear that it often allows employers to move jobs
away to cheaper places. In France, “globalisation” and “délocalisation” have become derogatory terms for free
4
market policies. An April 2012 survey by IFOP, a pollster, found that only 22% of French people thought
globalisation a “good thing” for their country.
However, economic historians reckon the question of whether the benefits of globalisation outweigh the
downsides is more complicated than this. For them, the answer depends on when you say the process of
globalisation started. But why does it matter whether globalisation started 20, 200, or even 2,000 years ago? Their
answer is that it is impossible to say how much of a “good thing” a process is in history without first defining for
how long it has been going on.
Early economists would certainly have been familiar with the general concept that markets and people
around the world were becoming more integrated over time. Although Adam Smith himself never used the word,
globalisation is a key theme in the Wealth of Nations. His description of economic development has as its
underlying principle the integration of markets over time. As the division of labour enables output to expand, the
search for specialisation expands trade, and gradually, brings communities from disparate parts of the world
together. The trend is nearly as old as civilisation. Primitive divisions of labour, between “hunters” and
“shepherds”, grew as villages and trading networks expanded to include wider specialisations. Eventually
armourers to craft bows and arrows, carpenters to build houses, and seamstress to make clothing all appeared as
specialist artisans, trading their wares for food produced by the hunters and shepherds. As villages, towns, countries
and continents started trading goods that they were efficient at making for ones they were not, markets became
more integrated, as specialisation and trade increased. This process that Smith describes starts to sound rather like
“globalisation”, even if it was more limited in geographical area than what most people think of the term today.
Smith had a particular example in mind when he talked about market integration between continents:
Europe and America. The discovery of Native Americans by European traders enabled a new division of labour
between the two continents. He mentions as an example, that the native Americans, who specialised in hunting,
traded animal skins for “blankets, fire-arms, and brandy” made thousands of miles away in the old world.
Some modern economic historians dispute Smith’s argument that the discovery of the Americas, by
Christopher Columbus in 1492, accelerated the process of globalisation. Kevin O’Rourke and Jeffrey Williamson
argued in a 2002 paper that globalisation only really began in the nineteenth century when a sudden drop in
transport costs allowed the prices of commodities in Europe and Asia to converge. Columbus' discovery of
America and Vasco Da Gama’s discovery of the route to Asia around the Cape of Good Hope had very little impact
on commodity prices, they argue.
But there is one important market that Mssrs O’Rourke and Williamson ignore in their analysis: that for
silver. As European currencies were generally based on the value of silver, any change in its value would have had
big effects on the European price level. Smith himself argued this was one of the greatest economic changes that
resulted from the discovery of the Americas:
The discovery of the abundant mines of America, reduced, in the sixteenth century, the value of gold and
silver in Europe to about a third of what it had been before. As it cost less labour to bring those metals from the
mine to the market, so, when they were brought thither, they could purchase or command less labour; and this
revolution in their value, though perhaps the greatest, is by no means the only one of which history gives some
account.
The influx of about 150,000 tonnes of silver from Mexico and Bolivia by the Spanish and Portuguese
Empires after 1500 reversed the downwards price trends of the medieval period. Instead, prices rose dramatically in
Europe by a factor of six or seven times over the next 150 years as more silver chased the same amount of goods in
Europe.
The impact of what historians have called the resulting “price revolution” dramatically changed the face of
Europe. Historians attribute everything from the dominance of the Spanish Empire in Europe to the sudden increase
in witch hunts around the sixteenth century to the destabilising effects of inflation on European society. And if it
were not for the sudden increase of silver imports from Europe to China and India during this period, European
inflation would have been much worse than it was. Price rises only stopped in about 1650 when the price of silver
coinage in Europe fell to such a low level that it was no longer profitable to import it from the Americas.
The rapid convergence of the silver market in early modern period is only one example of “globalisation”,
some historians argue. The German historical economist, Andre Gunder Frank, has argued that the start of
globalisation can be traced back to the growth of trade and market integration between the Sumer and Indus
civilisations of the third millennium BC. Trade links between China and Europe first grew during the Hellenistic
Age, with further increases in global market convergence occuring when transport costs dropped in the sixteenth
century and more rapidly in the modern era of globalisation, which Mssrs O’Rourke and Williamson describe as
after 1750. Global historians such as Tony Hopkins and Christopher Bayly have also stressed the importance of the
exchange of not only trade but also ideas and knowledge during periods of pre-modern globalisation.
Globalisation has not always been a one-way process. There is evidence that there was also market
disintegration (or deglobalisation) in periods as varied as the Dark Ages, the seventeenth century, and the interwar
5
period in the twentieth. And there is some evidence that globalisation has retreated in the current crisis since 2007.
But it is clear that globalisation is not simply a process that started in the last two decades or even the last two
centuries. It has a history that stretches thousands of years, starting with Smith’s primitive hunter-gatherers trading
with the next village, and eventually developing into the globally interconnected societies of today. Whether you
think globalisation is a “good thing” or not, it appears to be an essential element of the economic history of
mankind.
From The Economist
3. Globalization in Retreat
By Robert Samuelson - December 31, 2012
WASHINGTON -- One fateful question for 2013 is this: What happens to globalization? For decades, growing
volumes of cross-border trade and money flows have fueled strong economic growth. But something remarkable is
happening; trade and international money flows are slowing and, in some cases, declining. David Smick, the
perceptive editor of The International Economy magazine, calls the retreat "deglobalization." What's unclear is
whether this heralds prolonged economic stagnation and rising nationalism or, optimistically, makes the world
economy more stable and politically acceptable.
To Americans, some aspects of deglobalization will seem delicious. Take manufacturing. Globalization has
sucked factory jobs from the United States. Now, the tide may be turning. Just recently, Apple announced a $100
million investment to return some Mac computer production home. Though tiny, the decision reflects a trend.
General Electric's sprawling Appliance Park in Louisville, Ky., once symbolized America's post-World
War II manufacturing prowess, with employment peaking at 23,000 in 1973. Since then, jobs have shifted abroad
or succumbed to automation. But now GE is moving production of water heaters, refrigerators and other appliances
back to Appliance Park from China and Mexico. Year-end employment is reckoned at 3,600, up 90 percent from a
year earlier, writes Charles Fishman in an excellent article in December's Atlantic.
Nor is GE alone, Fishman notes. Otis is moving some elevator production from Mexico to South Carolina.
Wham-O is shifting Frisbee molding from China to California.
The changes are harbingers, contends the Boston Consulting Group (BCG), which predicts a manufacturing
revival. China's labor cost advantage has eroded, it argues. In 2000, Chinese factory wages averaged 52 cents an
hour; but annual double-digit percentage increases will bring that to $6 an hour in high-skilled industries by 2015.
Although wages of U.S. production workers average $19 an hour, BCG argues that other non-wage factors favor
the United States. American workers are more productive; automation has reduced labor's share of expenses; and
cheap natural gas further reduces costs. Finally, higher oil prices have boosted freight rates for imports.
By 2015, China's overall cost advantage will shrivel to 7 percent, BCG forecasts. As important, it says, the
United States will maintain significant cost advantages over other developed-country manufacturers: 15 percent
over France and Germany; 21 percent over Japan; and 8 percent over Great Britain. The United States will be a
more attractive production platform. Imports will weaken; exports will strengthen. BCG predicts between 2.5
million and 5 million new factory jobs by 2020. (For perspective: 5.7 million manufacturing jobs disappeared from
2000 to 2010.)
Because the United States is the world's largest importer, this shift would dampen trade. Similarly, cross-border
money flows ("capital flows") have abated. Banks, especially in Europe, have reduced foreign loans to
"deleverage" and strengthen their balance sheets. From 2011 to 2012, bank loans to 30 "emerging market"
countries fell by one-third, says the Institute of International Finance, an industry group. "It's the most decisive case
of 'home bias' [in lending] being re-established," says economist Philip Suttle of the IIF. Government regulators
encourage the shift, he says, suggesting that "if you're going to cut lending, cut there and not here."
Of course, globalization won't vanish. It's too big and too entwined with national economies. In 2011, total
world exports amounted to nearly $18 trillion. The same is true of capital flows. Despite banks' pullbacks, those
same 30 emerging market countries in 2012 received an estimated $1 trillion worth of investment from
multinational companies, private investors, pensions, insurance companies and other lenders -- a still-huge total,
though down from its peak. But globalization's character may change.
For years, the world economy has been wildly lopsided: China and some other countries ran big trade
surpluses; the United States was perennially in massive deficit. Similar imbalances existed in Europe. Now, slumps
have dampened the American and European appetite for imports. The upshot is that "China and others are
recalibrating their export-led economic strategies" to focus more on domestic demand, argues economist Fred
Bergsten of the Peterson Institute. That's good, he says; the world economy will be more balanced. Likewise,
erratic capital flows have triggered past financial crises. Slower flows may promote stability.
6
Not everyone is so optimistic. Smick of The International Economy sees globalization as "the proverbial
goose that laid the golden eggs." The search for larger markets and lower costs drove investment, trade, economic
growth and job creation around the world. That's weakened, and there's "no new model to replace it." Domestic
demand will prove an inadequate substitute. Central banks (the Federal Reserve, the European Central Bank, the
Bank of Japan) have tried to fill the void with hyper-easy money policies. Smick fears damaging outcomes:
currency wars as countries strive to capture greater shares of stagnant export markets; and burst "asset bubbles"
caused by easy money. These visions clash.
4. Railroads and hegemons
Globalisation depends on technology and politics
HISTORICALLY, TECHNOLOGY HAS been the single most important force for opening up borders. In
the 1800s it was the spread of the steamship and refrigeration, the expansion of railroads and the invention of the
telegraph that gave a push to globalisation. In the 1980s and 1990s it was the shipping container, and more recently
it has been the internet, allowing information and services to be exchanged in the blink of an eye.
But technology is not enough; globalisation also needs political patronage. Writing in 1973, Charles
Kindleberger pointed to the importance of an economic hegemon who would act as an importer of last resort and
financier of the world’s monetary system. From the mid-1800s until 1914 that hegemon was Britain. In 1846 it
unilaterally reduced import tariffs by repealing the Corn Laws and in 1860 it signed a free-trade agreement with
France, starting a virtuous cycle of falling tariffs worldwide. As guarantor of the gold standard, Britain made
possible a system of fixed exchange rates, financing the deficits of some countries while absorbing the surpluses of
others.
In 1910 Norman Angell, a British journalist, concluded in his book “The Great Illusion” that Europe had
become so economically interdependent that war would be futile. Ten years and one world war later, John Maynard
Keynes wrote: “What an extraordinary episode in the economic progress of man that age was which came to an end
in August 1914! …The inhabitant of London could order by telephone, sipping his morning tea in bed, the various
products of the whole Earth, in such quantity as he might see fit, and reasonably expect their early delivery upon
his doorstep.”
Keynes worried, correctly, that the vindictive Treaty of Versailles would further fragment the damaged
global economic system. It tumbled into abyss a decade later because, Kindleberger wrote, “Britain could not act as
a stabiliser, and the United States would not: every country turned to protect its national private interest, the world
public interest went down the drain, and with it the private interests of all.”
In 1945 America took up the mantle of benevolent hegemon. “Our foreign relations, political and
economic, are indivisible,” said Harry Truman in 1947; and the pursuit of international peace and freedom was
“bound up completely with a third objective: re-establishment of world trade.” America underwrote the
International Monetary Fund and the Bretton Woods system of fixed exchange rates to end beggar-thy-neighbour
currency devaluations, and the General Agreement on Tariffs and Trade to end trade disputes.
The breakdown of Bretton Woods, two oil-price shocks and the Latin American debt crisis severely tested
globalisation in the 1970s and 1980s. Fearful of Japan’s growing economic clout, America turned protectionist.
Free trade gave way to managed trade. But in 1989 the Berlin Wall fell and in 1990 Japan’s bubble economy burst.
America became the “hyperpower” and presided over an unprecedented expansion of globalisation.
These days America is acting less like a hegemon. Americans have grown leerier of foreign entanglements
and more self-interested on economic matters. America walked away from the Doha trade talks in 2008 when it
concluded it was getting too little in return for its own sacrifices, and Congress has refused to expand the
International Monetary Fund’s resources. Many Americans think that China is violating the spirit of free trade.
Others also see America as less of a leader. In a poll earlier this year the Pew Research Centre found that in
23 of 39 countries the largest groups of respondents thought that China had already replaced, or would replace,
America as the main superpower. But China is not yet ready to take the hegemon’s mantle.
From the print edition: Special report (The Economist)
7
5. Educating globalisation’s Luddites
One of the great puzzles of contemporary politics is how globalisation came to have such a bad name. The
end of the cold war left governments around the world struggling to find a new framework for international
relations. It also seems to have left the protest movement in search of a new focus.
But why pick on globalisation when there is no agreement on what it is? For some people, it is primarily
economic and trade integration; others put more emphasis on cultural aspects. I would argue that it is all these and
more. Globalisation is the increasingly rapid exchange of ideas, people and goods made possible by falling
transport costs and technological advances, all leading to the closer integration of the world including — but not
limited to — the economy.
Confusion, though, suits those who want to climb on the bandwagon of opposition. Many of those involved
in the campaigns against globalisation clearly mean well even if, as some of us think, they are misinformed and
misguided. As Jagdish Bhagwati says in his book, the movement is a “motley crew, a melange of anti-globalisation
protesters … appearing to be an undifferentiated mass”. In Defense of Globalisation is an important contribution to
an often incoherent debate. It sets out a persuasive case in favour of globalisation.
Opposition to change is hardly new. The 19th century English Luddites bequeathed their name to all who
stood against industrial and technological progress. But the Luddites’ position had some logic; their livelihoods
were being threatened, though the progress they opposed stood to benefit a much larger cross-section of the
population. Yet most of today’s protesters, dependent as they are on e-mail and mobile telephones, are beneficiaries
of the technological changes they oppose.
For centuries, technological progress has had an impact on living standards. What made the 20th century
different was the scale and breadth of the rise in those standards. On a wide range of measures — poverty, life
expectancy, health, education — more people have become better off at a faster pace in the past 60 years than ever
before. All this occurred within the multilateral economic framework established at the end of the second world
war.
Trade liberalisation and expansion have been central to the post-war surge in living standards. The
progressive multilateral liberalisation of trade has driven rapid growth and that, in turn, has accelerated the
reduction of poverty. Yet more than anything else, trade, or rather opposition to it, is what seems to be inspiring the
anti-globalisation movement. Trade hurts the poor in developing countries, they say, or it costs jobs in industrial
countries.
Indeed, at the margin there will always be some people who find themselves displaced as the expansion of
trade or the advances of technology force economies to adjust. To make the benefits of trade more convincing, it is
important that we do all we can to make sure that appropriate safety nets are in place for those individuals. But we
must also remember that while some are adversely affected by import competition, others benefit from an increase
of industry jobs in the export sector.
It makes no sense to blame globalisation for creating jobs in developing countries — what the current row
about outsourcing amounts to — and for creating poverty in those countries at the same time. Wages are lower in
developing countries than in the industrial world. But that is what makes those countries competitive. Globalisation
is not a zero-sum game. There is overwhelming evidence that it creates extra wealth and everyone can benefit.
The economic achievements of the past few decades have been extraordinary. To be sure, the rich have got
richer. But so have the poor, to a considerable extent. What the protesters fail to recognise — or choose to ignore
— is that the progress that has been achieved derives from the policies they now so fiercely oppose. Of course,
there are downsides, as Mr. Bhagwati readily acknowledges.
We need to do more to reduce the short-term costs associated with globalisation. But the protesters are
actively hindering progress on this front. Many of them seem almost viscerally opposed to the very multilateral
institutions that offer the best hope of making globalisation work more effectively and with fewer short-term costs.
To this end, Mr Bhagwati’s book should give the protesters pause for thought.
Anne Krueger in Financial Times of London
6. The nuts and bolts come apart
As global demand contracts, trade is slumping and protectionism rising
COMPARISONS to the Depression feature in almost every discussion of the global economic crisis. In
world trade, such parallels are especially chilling. Trade declined alarmingly in the early 1930s as global demand
8
imploded, prices collapsed and governments embarked on a destructive, protectionist spiral of higher tariffs and
retaliation.
Trade is contracting again, at a rate unmatched in the post-war period. The global economic machine has
gone into reverse: output is declining and trade is tumbling at a faster pace. The turmoil has shaken commerce in
goods of all sorts, bought and sold by rich and poor countries alike.
It is too soon to talk of a new protectionist spiral. Nevertheless, errors of policy risk making a bad thing
worse — despite politicians’ promises to keep markets open. The leaders of the G20 rich and emerging economies
declared that they would eschew protectionism. But this pledge has not been honoured. According to the World
Bank, some members of the group have already taken numerous trade-restricting steps.
Modern protectionism is more subtle and varied than the 1930s version. In the Depression tariffs were the
weapon of choice. America’s Smoot-Hawley act, passed in 1930, increased nearly 900 American import duties—
which were already high by today’s standards—and provoked widespread retaliation from America’s trading
partners. A few tariffs have been raised this time, but tighter licensing requirements, import bans and anti-dumping
(imposing extra duties on goods supposedly dumped at below cost by exporters) have also been used. Rich
countries have included discriminatory procurement provisions in their fiscal-stimulus bills and offered subsidies to
ailing national industries. These days, protectionism comes in 57 varieties.
There are good reasons for thinking that the world has less to fear from protectionism than in the past.
International agreements to limit tariffs, built over the post-war decades, are a safeguard against all-out tariff wars.
The growth of global supply chains, which have bound national economies together tightly, have made it more
difficult for governments to increase tariffs without harming producers in their own countries.
But these defences may not be strong enough. Multilateral agreements provide little insurance against
domestic subsidies, fiercer use of anti-dumping or the other forms of creeping protection. Most countries are able to
raise tariffs, because their applied rates are below the maximum allowed by their WTO commitments. They may
choose to do so despite the possible disruption to global supply chains. And because global sourcing amplifies the
effect of tariff rises, even action that is permissible under WTO rules could cause a lot of damage. The subtler
variants of protection may be similarly disruptive.
The gears of globalization
The immediate cause of shrinking trade is plain: global recession means a collapse in demand. The credit
crunch adds an additional squeeze, thanks to an estimated shortfall of $100 billion in trade finance, which
lubricates 90% of world trade.
Just as striking as the speed of the downturn in trade is its indiscriminate nature. The World Bank has
January trade data for 45 countries. These are values, expressed in American dollars, and so have been depressed
not only by lower volumes but also by falling prices and a stronger dollar. The exports of 37 of these 45 countries
were more than a quarter lower than the year before. Countries as diverse as Ecuador, France, Indonesia, the
Philippines and South Africa saw exports drop by 30% or more. Commodity exporters, such as Argentina, have
suffered with sellers of sophisticated manufactures, such as Germany and Japan.
Kei-Mu Yi, an economist at the Federal Reserve Bank of Philadelphia, argues that trade has fallen so fast
and so uniformly around the world largely because of the rise of “vertical specialisation”, or global supply chains.
This contributed to trade’s rapid expansion in recent decades. Now it is adding to the rate of shrinkage. When
David Ricardo argued in the early 19th century that comparative advantage was the basis of trade, he conceived of
countries specialising in products, like wine or cloth. But Mr Yi points out that countries now specialise not so
much in final products as in steps in the process of production.
Trade grows much faster in a world with global sourcing than in a world of trade in finished goods because
components and part-finished items have to cross borders several times. The trade figures are also boosted by the
practice of measuring the gross value of imports and exports rather than their net value. For example, a tractor
made in America would once have been made from American steel and parts; it would have touched the trade data
only if it was exported. Now, it may contain steel from India, and be stamped and pressed in Mexico, before being
sold abroad. As a result, changes in demand in one country now affect not just the domestic economy but also the
trade flows and economies of several countries.
By making trade flows more sensitive to falls in output, vertical specialisation may provide some insurance
against widespread protectionism. Manufacturers that rely on imported inputs may resist higher tariffs because they
push up the prices of those inputs, making domestic industry less competitive.
Nevertheless, there is plenty of evidence that developing countries, at least, continue to use tariffs
extensively. In the World Bank’s study, tariff increases accounted for half of the protective measures by these
countries. Ecuador raised duties on 600 goods. Russia increased them on used cars. India put them up on some
kinds of steel. Developing countries have more scope for raising tariffs without breaking WTO rules than richer
9
ones do, because the gap between their applied rates and the ceilings they agreed to is greater than for developed
countries.
When governments do impose tariffs, vertical supply chains amplify their effects. Because tariffs are
typically levied on the gross value crossing the border (with some exceptions, such as exports from Mexican
maquiladoras), trade responds more to changes in tariffs—down or up—with global supply chains than without.
But there is another, more subtle reason to worry about even small rises in tariffs. Theoretical models that
incorporate vertical specialisation find that it takes off only when tariffs fall below a threshold level. Once this
happens, however, trade explodes, so that a slight lowering of trade barriers can cause a huge increase in trade. By
the same token, if tariffs rose above a certain point— which might be below the maximum agreed on at the WTO—
global supply chains would disintegrate. Trade would drop even more steeply than it has in recent months.
That said, supply chains need not snap so easily. Even if tariffs go up, other costs that determine the
viability of supply chains may go down: the price of oil (and hence the cost of transport) has fallen along way in the
past year. Firms have invested a lot in their supply chains and will be loth to abandon them. And if global supply
chains do survive, vertical specialisation could help trade recover speedily when demand returns.
Although increased tariffs are a cause for concern, they are far from the only form of protection being used
in this crisis. Two-thirds of the trade-restricting measures documented by the World Bank are non-tariff barriers of
various kinds. As with tariffs, developing countries are the principal wielders of these weapons.
Indonesia has specified that certain categories of goods, such as clothes, shoes and toys, may be imported
through only five ports. Argentina has imposed discretionary licensing requirements on car parts, textiles,
televisions, toys, shoes and leather goods; licences for all these used to be granted automatically. Some countries
have imposed outright import bans, often justified by a tightening of safety rules or by environmental concerns. For
example, China has stopped imports of a wide range of European food and drink, including Irish pork, Italian
brandy and Spanish dairy products. The Indian government has banned Chinese toys.
In addition, anti-dumping is on the increase. The number of anti-dumping cases initiated at the WTO had
been declining, but it started to pick up in the second half of 2007. The number of cases ending with extra duties
went up by 20%. India was the biggest initiator of anti-dumping action, and America and the European Union
imposed duties most frequently.
Rich countries’ weapon of choice so far is neither tariffs nor non-tariff barriers to imports. They have been
keen users instead of subsidies to troubled domestic industries, particularly carmakers. Some economists, such as
Gene Grossman, of Princeton University, cite this as evidence that global sourcing has changed the political
economy of protection. The American automotive industry no longer lobbies for direct protection, as it used to,
because it imports much of its value-added and competes with foreign firms that assemble their cars in America.
Carmakers now prefer explicit subsidies, and the world is replete with examples. Besides America, Argentina,
Australia, Brazil, Britain, Canada, China, France, Germany, Italy and Sweden have all also provided direct or
indirect subsidies to carmakers. The World Bank reckons that proposed subsidies for the car industry amount to
$48 billion. Nearly 90% of this is in rich countries, where it can easily be slipped into budgetary packages to
stimulate demand.
The worry about such subsidies is that they could cause production to switch from more efficient plants
(eg, in central and eastern Europe) to less efficient ones in rich countries with deep pockets (eg, in western Europe).
Whether the location of output is shifting is not yet clear, but politicians plainly hope it will. On March 19th Luc
Chatel, the French industry minister, boasted that Renault’s plans to create 400 jobs at a factory near Paris by
“repatriating” some production from Slovenia was the result of government aid. Renault has denied this, saying that
it was at full capacity in Slovenia.
There are some international rules to prevent distorting subsidies. The EU has regulations to limit state aid,
and is looking into its members’ assistance to carmakers. Gary Hufbauer, of the Peterson Institute for International
Economics in Washington, DC, argues that American subsidies transgress WTO norms.
Helpful ambiguity
However, WTO action against subsidies is not straightforward. To complain successfully, a country has to
show that a subsidy meets several criteria. Then there is a pots-and-kettles problem: having subsidies of your own
does not stop you from challenging someone else’s, but if you pick a fight they may have a go at yours. This
uncertainty and ambiguity only adds to subsidies’ attraction. Governments can aid their carmakers and at the same
time criticise others for their protectionist ways.
Protectionist urges are also being bolstered by countries’ seeming inability to co-ordinate their fiscal
stimulus programmes. Some countries have been reluctant to work the budgetary pump for fear that their extra
demand will leak abroad to the benefit of foreigners. To stop the seepage, some governments have inserted
discriminatory conditions into their fiscal programmes, the prime example being the “Buy American” procurement
rules. These were weakened after protests and threats of retaliation from abroad, but not before the prospects for
10
global co-operation had been dented. Greater co-ordination of fiscal expansion would ease governments’ worries
about leakage, because everyone else would be leaking too: all would gain from each other’s spending.
What should world leaders do to stop protection fraying the threads that tie the world economy together?
The difficulty lies in devising something comprehensive and detailed enough to address the variety of protectionist
measures that are being deployed in the crisis, and doing it quickly enough to maintain open trade.
Many argue that the most important thing for world leaders to do is to pledge a quick completion of the
Doha round of trade talks, which stalled for the umpteenth time. By reducing tariff ceilings, this would place tighter
limits on countries’ ability to increase tariffs. It would also ban export subsidies in agriculture, which are being
used with greater vigour, especially as prices of farm goods fall. The EU, for example, has announced new export
subsidies for butter, cheese and milk powder. Most important, completing Doha would be the clearest and most
tangible evidence possible of a commitment to consolidating and building on the gains from more open trade
secured in successive rounds since the second world war.
Some economists disagree. Aaditya Mattoo, of the World Bank, and Arvind Subramanian, of the Peterson
Institute, argue that the Doha round is too ambitious given the state of the world economy, because it seeks to open
markets for rich countries’ manufactured goods just when the politics are against it. At the same time, they point
out that Doha would not restrict the use of some non-tariff measures causing most concern, such as the Buy
American provisions or subsidies for failing industries. Messrs Mattoo and Subramanian suggest a new “crisis
round” of world trade talks. In the first instance, WTO members could commit themselves to a standstill on all
forms of protectionism.
Several other economists have also proposed a standstill. However, Messrs Mattoo and Subramanian
suggest that in order to give governments a political reason to agree to this, they should also be allowed to postpone
further liberalisation for the duration of the crisis. They would then embark on a new round instead of Doha, which
would address the forms of protection that now look most pressing.
But the appetite for starting yet another series of talks is likely to be limited. Even if the crisis round’s
agenda were more realistic than Doha’s (which isn’t obvious), there would be no guarantee that it could be
concluded quickly enough to stop the bleeding in global trade.
Whatever they think about Doha or about the idea of a crisis round, most economists will agree that a
simple promise to resist protectionism will not suffice. Some thing more specific is needed. A good start would be
for governments, beginning with the leaders of the G20, to draw up a comprehensive list of protectionist measures
that goes beyond tariffs and export subsidies. They could then agree to go no further with these than they have
already.
Next, an agreement on co-ordinating fiscal policy would go a long way towards making such a standstill
commitment credible, because it would alleviate worries about leakages abroad. Finally, empowering the WTO to
name those who break the standstill would help to underpin it. The threat of embarrassment may make some
countries think twice.
During the Depression, the volume of world trade shrank by a quarter. Nothing like that has been seen or
forecast so far. Yet one lesson from the worldwide economic distress of three-quarters of a century ago is that once
trade barriers come up, they take years of negotiation to dismantle. Preventing protectionism from getting worse is
preferable to having to repair the damage afterwards. And even if a full-blown trade war can be ruled out, death by
a thousand cuts cannot. The costs of myriad piecemeal measures could still add up to damaging protectionism. And
when demand does eventually revive, if the world economy is supported by an open system of trade, it will recover
all the faster.
From The Economist
7. Here, there and everywhere
After decades of sending work across the world, companies are rethinking their offshoring strategies,
says Tamzin Booth
EARLY NEXT MONTH local dignitaries will gather for a ribbon-cutting ceremony at a facility in
Whitsett, North Carolina. A new production line will start to roll and the seemingly impossible will happen:
America will start making personal computers again. Mass-market computer production had been withering away
for the past 30 years, and the vast majority of laptops have always been made in Asia. Dell shut two big American
factories in 2008 and 2010 in a big shift to China, and HP now makes only a small number of business desktops at
home.
The new manufacturing facility is being built not by an American company but by Lenovo, a highly
successful Chinese technology group. Founded in 1984 by 11 engineers from the Chinese Academy of Sciences, it
11
bought IBM’s ThinkPad personal-computer business in 2005 and is now by some measures the world’s biggest PCmaker, just ahead of HP, and the fastest-growing.
Lenovo’s move marks the latest twist in a globalisation story that has been running since the 1980s. The
original idea behind offshoring was that Western firms with high labour costs could make huge savings by sending
work to countries where wages were much lower. Offshoring means moving work and jobs outside the country
where a company is based. It can also involve outsourcing, which means sending work to outside contractors.
These can be either in the home country or abroad, but in offshoring they are based overseas. For several decades
that strategy worked, often brilliantly. But now companies are rethinking their global footprints.
The first and most important reason is that the global labour “arbitrage” that sent companies rushing
overseas is running out. Wages in China and India have been going up by 10-20% a year for the past decade,
whereas manufacturing pay in America and Europe has barely budged. Other countries, including Vietnam,
Indonesia and the Philippines, still offer low wages, but not China’s scale, efficiency and supply chains. There are
still big gaps between wages in different parts of the world, but other factors such as transport costs increasingly
offset them. Lenovo’s labour costs in North Carolina will still be higher than in its factories in China and Mexico,
but the gap has narrowed substantially, so it is no longer a clinching reason for manufacturing in emerging markets.
With more automation, says David Schmoock, Lenovo’s president for North America, labour’s share of total costs
is shrinking anyway.
Second, many American firms now realise that they went too far in sending work abroad and need to bring
some of it home again, a process inelegantly termed “reshoring”. Well-known companies such as Google, General
Electric, Caterpillar and Ford Motor Company are bringing some of their production back to America or adding
new capacity there. In December Apple said it would start making a line of its Mac computers in America later this
year.
Choosing the right location for producing a good or a service is an inexact science, and many companies
got it wrong. Michael Porter, Harvard Business School’s guru on competitive strategy, says that just as companies
pursued many unpromising mergers and acquisitions until painful experience brought greater discipline to the field,
a lot of chief executives offshored too quickly and too much. In Europe there was never as much enthusiasm for
offshoring as in America in the first place, and the small number of companies that did it are in no rush to return.
Firms are now discovering all the disadvantages of distance. The cost of shipping heavy goods halfway
around the world by sea has been rising sharply, and goods spend weeks in transit. They have also found that
manufacturing somewhere cheap and far away but keeping research and development at home can have a negative
effect on innovation. One answer to this would be to move the R&D too, but that has other drawbacks: the threat of
losing valuable intellectual property in far-off places looms ever larger. And a succession of wars and natural
disasters in the past decade has highlighted the risk that supply chains a long way from home may become
disrupted.
Third, firms are rapidly moving away from the model of manufacturing everything in one low-cost place to
supply the rest of the world. China is no longer seen as a cheap manufacturing base but as a huge new market.
Increasingly, the main reason for multinationals to move production is to be close to customers in big new markets.
This is not offshoring in the sense the word has been used for the past three decades; instead, it is being “onshore”
in new places. Peter Löscher, the chief executive of Siemens, a German engineering firm, recently commented that
the notion of offshoring is in any case an odd one for a truly international company. The “home shore” for Siemens,
he said, is now as much China and India as it is Germany or America.
Companies now want to be in, or close to, each of their biggest markets, making customised products and
responding quickly to changing local demand. Pierre Beaudoin, chief executive of Bombardier, a Canadian maker
of aeroplanes and trains, says the firm used to focus on cost savings made by sending jobs abroad; now Bombardier
is in China for the sake of China.
Lenovo, as a Chinese company, has its own factories in China. The reason it is moving some production to
America is that it will be able to customise its computers for American customers and respond quickly to them. If it
made them in China they would spend six weeks on a ship, says Mr Schmoock.
Under this logic, America and Europe, with their big domestic markets, should be able to attract plenty of
new investment as companies look for a bigger local presence in places around the world. It is not just Western
firms bringing some of their production home; there is also a wave of emerging-market champions such as Lenovo,
or the Tata Group, which is making Range Rover cars near Liverpool, that are coming to invest in brands, capacity
and workers in the West.
Such changes are happening not only in manufacturing but increasingly in services too. Companies may
either outsource IT and back-office work to other companies, which could be in the same country or abroad, or
offshore it to their own centres overseas. Software programming, call centres and data-centre management were the
first tasks to move, followed by more complex ones such as medical diagnoses and analytics for investment banks.
12
As in manufacturing, the labour-cost arbitrage in services is rapidly eroding, leaving firms with all the
drawbacks of distance and ever fewer cost savings to make up for them. There has been widespread disappointment
with outsourcing information technology and the routine back-office tasks that used to be done in-house. Some
activities that used to be considered peripheral to a company’s profits, such as data management, are now seen as
essential, so they are less likely to be entrusted to a third-party supplier thousands of miles away.
Coming full circle
Even General Electric is reversing its course in some important areas of its business. In the 1990s it had
pioneered the offshoring of services, setting up one of the very first “captive”, or fully owned, offshore service
centres in Gurgaon in 1997. Up until last year around half of GE’s information-technology work was being done
outside the company, mostly in India, but the company found that it was losing too much technical expertise and
that its IT department was not responding quickly enough to changing technology needs. It is now adding hundreds
of IT engineers at a new centre in Van Buren Township in Michigan.
The economics of offshoring are changing in the corporate world. Offshoring in its traditional sense, in
search of cheaper labour anywhere on the globe, is maturing, tailing off and to some extent being reversed.
Multinationals will certainly not become any less global as a result, but they will distribute their activities more
evenly and selectively around the world, taking heed of a far broader range of variables than labour costs alone.
That offers a huge opportunity for rich countries and their workers to win back some of the industries and
activities they have lost over the past few decades. Paradoxically, the narrowing wage gap increases the pressure on
politicians. With labour-cost differentials narrowing rapidly, it is no longer possible to point at rock-bottom wages
in emerging markets as the reason why the rich world is losing out. Developed countries will have to compete hard
on factors beyond labour costs. The most important of these are world-class skills and training, along with
flexibility and motivation of workers, extensive clusters of suppliers and sensible regulation.
From The Economist
8. What was mercantilism?
MERCANTILISM is one of the great whipping boys in the history of economics. The school, which
dominated European thought between the 16th and 18th centuries, is now considered no more than a historical
artefact — and no self-respecting economist would describe themselves as mercantilist. The dispatching of
mercantilist doctrine is one of the foundation stones of modern economics. Yet its defeat has been less total than an
introductory economics course might suggest.
At the heart of mercantilism is the view that maximising net exports is the best route to national prosperity.
Boiled to its essence mercantilism is “bullionism”: the idea that the only true measure of a country’s wealth and
success was the amount of gold that it had. If one country had more gold than another, it was necessarily better off.
This idea had important consequences for economic policy. The best way of ensuring a country’s prosperity was to
make few imports and many exports, thereby generating a net inflow of foreign exchange and maximising the
country’s gold stocks.
Such ideas were attractive to some governments. Accumulating gold was thought to be necessary for a
strong, powerful state. Countries such as Britain implemented policies which were designed to protect its traders
and maximise income. The Navigation Acts, which severely restricted the ability of other nations to trade between
England and its colonies, were one such example.
And there are some amusing (and possibly apocryphal) stories of bullionism in action. During the
Napoleonic Wars, the warring governments made few attempts to prevent their foes from importing food (and
thereby starving them). But they did try to make it difficult for their opponent to export goods. Fewer exports
would supposedly result in economic chaos as gold supplies dwindled. Ensuring an absence of gold, rather than an
absence of grub, was perceived to be the most devastating way to grind down the enemy.
But there is an important distinction between mercantilist practice and mercantilist thought. The opinions
of thinkers were often mangled when they were translated into policies. And a paper by William Grampp,
published in 1952, offers a subtler account of mercantilism.
Mr Grampp concedes that mercantilists were keen on foreign trade. One often reads in mercantilist tomes
that foreign trade would be more beneficial than would domestic trade. And some of the early mercantilists, like
John Hales, were enchanted by the idea of an overflowing treasure chest.
But Mr Grampp argues that, on the whole, we should stop confusing mercantilism and bullionism. Few
mercantilists were slaves to the balance of payments. In fact, they were alarmed by the idea of hoarding gold and
silver. This is because many mercantilist thinkers were most concerned with maximising employment. Nicholas
Barbon — who pioneered the fire insurance industry after the Great Fire of London in 1666 — wanted money to be
13
invested, not hoarded. As William Petty — arguably the first “proper” economist — argued, investment would help
to improve labour productivity and increase employment. And almost all mercantilists considered ways of bringing
more people into the labour force.
Mr Grampp even suggests that Keynesian economics "has an affinity to mercantilist doctrine”, given their
shared concern with full employment. Keynes, in a short note to his “General Theory”, approvingly quotes
mercantilists, noting that an ample supply of precious metals could be key in maintaining control over domestic
interest rates, and therefore to ensuring adequate resource utilisation. In some sense the Keynesian theory of
underconsumption — that is, inadequate consumer demand — as a cause of recessions was presaged by
mercantilist contributions. In 1598 Barthélemy de Laffemas, a French thinker, denounced those who opposed the
use of expensive silks. He argued that purchasers of luxury goods created a livelihood for the poor, whereas the
miser who saved his money “caused them to die in distress”.
Mercantilism is thought to have begun its intellectual eclipse with the publication of Adam Smith’s
"Wealth of Nations" in 1776. A simple interpretation of the economic history suggests that Smith’s ruthless
advocacy for free markets was squarely opposed to regulation-heavy mercantilist doctrine. But according to
research by Lars Magnusson of Uppsala University, Smith’s contribution did not represent such a sharp break. The
father of economics was certainly concerned with the effects of some mercantilist policies. He saw the damage that
overweening government intervention could do. Smith argued that the East India Company, a quasi-governmental
organisation that managed parts of India at the time, was responsible for creating the huge famine in Bengal in
1770. And he hated monopolies, arguing that greedy barons could earn “wages or profit, greatly above their natural
rate”. Smith also grumbled that legislators could use mercantilist logic to justify stifling regulation.
But Smith points out circumstances in which government interference is necessary. He was in favour of the
Navigation Acts. And in Smith’s lesser-known "Lectures on Jurisprudence", he outlines other cases where
government intervention in trade is useful. Smith was not opposed to regulation per se, but rather instances where
individuals and governments could abuse their position of power for personal gain.
Nicholas Phillipson, who recently wrote a biography of Smith, argues that the notion of “free markets” was
alien to the father of economics. Smith made it clear that governments would always play a part in making
markets — and could not conceive of a market where the government did not play a crucial role. And in this sense,
his contribution does not represent such a sharp break from mercantilist thought. The question was not whether, but
how much, of a role the state would play.
Though most of the world's rich countries remain committed to free trade today, mercantilist themes are
often found in economic policy debates. China and Germany are often envied for their trade surpluses or seen as
economic models, and China especially has very deliberately subsidised exports. President Barack Obama has
made a doubling of American exports a major policy goal, as part of his plan to help America "win the future".
This zero-sum way of looking at the global economy is less rooted in the national greatness side of mercantilism
than in the focus on full employment, at a time when many rich economies are suffering from insufficient demand
and high rates of joblessness; it is thoroughly Keynesian, in other words. Early in the recovery some economists
gave a veneer of intellectual credibility to this perspective. Paul Krugman, for instance, wrote of America's 2010
trade agreement with South Korea:
There is a case for freer trade — it may make the world economy more efficient. But it does nothing to
increase demand.
And there’s even an argument to the effect that increased trade reduces US employment in the current
context; if the jobs we gain are higher value-added per worker, while those we lose are lower value-added, and
spending stays the same, that means the same GDP but fewer jobs.
If you want a trade policy that helps employment, it has to be a policy that induces other countries to run
bigger deficits or smaller surpluses. A countervailing duty on Chinese exports would be job-creating; a deal with
South Korea, not.
But importantly, the case for bullionism as a demand stimulus evaporated with a role for bullion in
monetary policy. The introduction of fiat money meant that balance-of-payment goals were unnecessary to
maintaining a particular monetary policy stance, since central banks no longer needed an adequate hoard of gold to
pump money into the economy. The mercantilist temptation is a strong one, however, especially when growth in
the economic pie slows or stops altogether. More than two centuries after Smith's landmark work, economics's
foundational debate continues to resonate.
9. The gated globe
Governments are putting up impediments to globalisation. It is time for a fresh wave of liberalisation
Oct 12th 2013
14
IMAGINE discovering a one-shot boost for the world’s economy. It would revitalise firms, increasing sales
and productivity. It would ease access to credit and it would increase the range and quality of goods in the shops
while keeping their prices low. What economic energy drink can possibly deliver all these benefits?
Globalisation can. Yet in recent years the trend to greater openness has been replaced by an enthusiasm for building
barriers—mostly to the world’s detriment.
The worst did not happen…
Not so long ago, the twin forces of technology and economic liberalisation seemed destined to drive ever
greater volumes of capital, goods and people across borders. When the global financial crisis erupted in 2008, that
hubris was replaced by fears of a replay of the 1930s. They were not realised, at least in part because the world had
learnt from that dreadful decade the lesson that protectionism makes a bad situation worse.
Yet a subtler change took place: unfettered globalisation has been replaced by a more selective brand. As
our special report shows, policymakers have become choosier about whom they trade with, how much access they
grant foreign investors and banks, and what sort of capital they admit. They have not built impermeable walls, but
they are erecting gates.
That is most obvious in capital markets. Global capital flows fell from $11 trillion in 2007 to a third of that
last year. The decline has happened partly for cyclical reasons, but also because regulators in America and Europe
who saw banks’ foreign adventures end in disaster have sought to ring-fence their financial systems. Capital
controls have found respectability in the emerging world because they helped insulate countries such as Brazil from
destabilising inflows of hot money.
Sparingly used, capital controls can make financial systems less vulnerable to contagion, and crises less
damaging. But governments must not forget the benefits of financial openness. Competition from foreign banks
forces domestic ones to compete harder. Ring-fencing banks and imposing capital controls protects from contagion,
but also traps savings in countries with little use for them.
Trade protectionism cannot claim the justifications that capital controls sometimes can. Fortunately, the
World Trade Organisation (WTO), the trade watchdog, prevents most ostentatious protectionism, but governments
have developed sneaky methods of avoiding its ire. New impediments—subsidies to domestic firms, for instance,
local content requirements, bogus health-and-safety requirements—have gained popularity. According to Global
Trade Alert, a monitoring service, at least 400 new protectionist measures have been put in place each year since
2009, and the trend is on the increase.
Big emerging markets like Brazil, Russia, India and China have displayed a more interventionist approach
to globalisation that relies on industrial policy and government-directed lending to give domestic sellers a leg-up.
Industrial policy enjoys more respectability than tariffs and quotas, but it raises costs for consumers and puts more
efficient foreign firms at a disadvantage. The Peterson Institute reckons local-content requirements cost the world
$93 billion in lost trade in 2010.
Attempts to restore the momentum of free trade at a global level foundered with the Doha round of trade
talks. Instead, governments are trying to do so through regional free-trade agreements. The idea is that smaller trade
clubs make it easier to confront politically divisive issues. The Trans-Pacific Partnership (TPP) that America, Japan
and ten others hope to conclude this year aims to set rules for intellectual-property protection, investment, stateowned enterprises and services.
Regional free-trade deals are a mixed blessing. Designed well, they can boost liberalisation, both by cutting
barriers in new areas and by spurring action in multilateral talks. Done badly, they may divert rather than expand
trade. Today’s big deals are probably a net positive, but they may not live up to their promise: in the rush to sign a
deal, TPP participants look likely to accept carve-outs for tobacco, sugar, textiles and dairy products, diminishing
the final deal.
…but it could be so much better
Gate-building does not cause much outrage. Yet it is worth remembering what opportunities are being lost. In 2013
the value of goods-and-services exports will run to 31.7% of global GDP. Some big economies trade far less:
Brazil’s total exports are just 12.5% of GDP. Increasing that ratio would deliver a shot in the arm to productivity.
Trade in services is far lower than in goods; and even in goods, embarrassing levels of protectionism survive.
America tacks a 127% tariff on to Chinese paper clips; Japan puts a 778% tariff on rice. Protection is worse in the
emerging world. Brazil’s tariffs are, on average, four times higher than America’s, China’s three times.
In the past year the cost of impediments to trade has become clearer. Few countries have put up more gates
than Russia, India and Brazil; growth in all three has disappointed. The latter two have suffered sharp falls in their
currencies. Some countries have counted the cost and are opening up. China’s new leaders are tiptoeing towards
looser rules for foreign capital and getting behind a push for a modest global trade deal. Mexico plans to readmit
foreign investors to its oil industry in an effort to boost output. Japan hopes that the TPP will shake up its
inefficient sectors, complementing fiscal and monetary stimulus.
15
But the fate of globalisation depends most on America. Over the past 70 years it has used its clout to push
the world to open up. Now that clout is threatened by China’s growing influence and America’s domestic divisions.
Barack Obama’s decision to skip an Asia-Pacific leaders’ summit in Bali to battle the government shutdown at
home was ripe with symbolism: China’s and Russia’s presidents managed to attend. Mr Obama must reassert
America’s economic leadership by concluding a TPP, even one with imperfections, and force it through Congress.
The moribund world economy needs some of the magic that globalisation can deliver.
From The Economist
10. In my backyard
Multilateral trade pacts are increasingly giving way to regional ones
Oct 12th 2013 | From the print edition
UKRAINE, LONG PULLED back and forth between east and west, is feeling the tug again, this time between rival
trade blocks. Next month it hopes to sign a free-trade agreement with the European Union. But Russia wants
Ukraine for its own customs union, which already includes two other former Soviet republics. So earlier this year,
in a clumsy effort to change its neighbour’s mind, the Kremlin banned Ukrainian sweets because they allegedly
contained carcinogens, then imposed long, intrusive customs checks that slowed Ukrainian exports of steel,
machinery and chemicals to a crawl.
The tiff has geopolitical undertones: Russia does not want Ukraine, with which it has deep cultural and
political ties, to drift into the West’s sphere of influence. But it also points to a change in the world trading system.
Russia joined the World Trade Organisation in 2012, but it is less interested in strengthening the multilateral
trading system than in building its own regional trade block. Fyodor Lukyanov, editor of Russia in Global Affairs, a
foreign-policy journal, notes that with America trying to conclude sweeping trade agreements with its neighbours
in the Pacific Rim and with Europe, “the whole structure of world trade is changing towards a more fragmented
system. That’s why Russia is trying to build something of its own.”
Free-traders in the West worry that the proliferation of regional trade agreements (RTAs) is gutting the
multilateral trading system. Arvind Subramanian of the Peterson Institute for International Economics calls the rise
of ever larger RTAs an “existential threat” and gives warning that “multilateral trade as we have known it will
progressively become history.”
The debate about whether RTAs help or hurt the multilateral trading system has gone on for decades.
Supporters argued that wherever two countries entered into an RTA, they would create incentives for others to join
or to negotiate their own RTA. Trade barriers around the world would fall, one by one, and political support for
multilateral deals would increase. Detractors claimed that once inside an RTA, countries would discriminate
against outsiders and lose interest in multilateral liberalisation, undermining the authority of the WTO. They would
divert as much trade as they created and introduce big distortions.
For most of the post-war period, the optimistic view prevailed as regional and multilateral liberalisation
proceeded in tandem, albeit unevenly. The forerunner of the European Union was established in 1957, even as
members of the General Agreement on Tariffs and Trade, the WTO’s predecessor, continued to cut tariffs. In the
1990s Bill Clinton signed the North American Free-Trade Agreement just as the Uruguay round of trade
liberalisation was completed. In the early 2000s China joined the WTO and the EU expanded into eastern Europe.
In the past decade, though, RTAs have increasingly looked like an alternative, not a complement, to
multilateralism. The Doha “development” round, which began in 2001, immediately ran into trouble as emerging
markets chafed at the central bargain: big cuts in their industrial tariffs in exchange for more access to rich-world
agricultural markets. Talks faltered in Cancun in 2003 and finally collapsed in Geneva in 2008. One negotiator
recalls going to dinner that night convinced that a deal had been struck, only to learn the next day that it had failed.
As Doha began to founder, the appeal of RTAs grew. The number concluded rose from 104 in 1958-2001
to 154 since then. Many of these are tiddlers, but the Trans-Pacific Partnership (TPP) and the Transatlantic Trade
and Investment Partnership (TTIP) have the potential to become mega-RTAs accounting for a huge share of global
trade. TPP “wasn’t initially seen as the big alternative to WTO,” says Gary Hufbauer of the Peterson Institute,
“but…the US position is, ‘If emerging market countries don’t want to play ball in the WTO, we have alternatives’.”
In need of protection?
The biggest obstacle to more multilateral trade deals is the changing balance of global economic power. Brazil,
Russia, India and China (the BRICs) see themselves as countries still poor enough to need protection for their
industries while the rich ones lower their own barriers, especially to agriculture. But the rich world increasingly
16
views the BRICs as full-fledged economic competitors whose state capitalism is incompatible with a free and open
global economy.
“For too long, much of the economic force and sacrifice in Geneva to produce global trade agreements has
come at the expense of the US and EU,” says Ron Kirk, who was Mr Obama’s first trade negotiator. “We have
been lectured over and over by our colleagues from the emerging markets that they have the economic heft and
prestige to demand a seat at the table. And we agree.” But that, he says, means they too need to make sacrifices by
opening up further to America and Europe.
These divisions became clear in the race to elect a new WTO director-general this year. The contest
between Herminio Blanco, Mexico’s former trade minister, and Roberto Azevedo, Brazil’s ambassador to the
WTO, became a referendum on Mexico’s liberal preferences versus Brazil’s protectionist stance. Rich countries
backed Mr Blanco while emerging markets plumped for Mr Azevedo, the eventual victor. Mr Azevedo has stressed
that he represents the interests of all members.
The emerging markets are not monolithic. They often want protection not just from rich countries but from
each other, particularly China. Roberto Giannetti da Fonseca, an official with FIESP, Brazil’s largest industrial
association, ran a trading company in the 1980s that sold Brazilian manufactured products to China. He struggled
to find anything worth buying from China, often settling for arts and crafts. “I could not imagine that 20 years later
they’d be invading Brazil with hundreds of products and we’d be crying that we cannot compete.” His organisation
is a vocal critic of China’s mercantilist practices and has urged the Brazilian government to negotiate free-trade
agreements with North America and Europe.
Trade liberalisation is now proceeding along two different tracks. One, preferred by America, goes “behind
the border”, focusing on things such as harmonising safety, health and technical standards, currencies, national
treatment of foreign investors, the protection of intellectual property, services such as telecommunications, and
enforcement of labour and environmental protection. The other, preferred by China, concentrates on reducing
tariffs—outside sensitive sectors.
America started on its track in 2007 when Democrats in Congress struck a deal with President George W.
Bush that in future trade agreements, signatories’ adherence to environmental and labour standards would be
subject to the same dispute-settlement rules as commercial disputes. Sandy Levin, a Democratic congressman who
helped negotiate that deal, notes that people like himself who were intent on correcting market failures at home
were also keen to use trade policy to do the same abroad. Their goal, he said, is “to shift the equation that has
dominated discussions of trade as ‘free trade’ versus ‘protectionism’ to one of ‘free trade’ versus ‘free and fair
trade’.”
In practice, this means America is most likely to strike deals with countries at a similar stage of economic
development, such as the European Union and Japan, or with developing countries willing to meet rich-world
standards in exchange for market access, such as Mexico and Chile. America’s comprehensive free-trade deal with
South Korea is the model for the TPP.
China, by contrast, has pursued a variety of bilateral deals with its neighbours, mostly in the hope of
persuading them “that it sought a peaceful rise as an emerging superpower”, says Chin Leng Lim, a trade-law
expert at Hong Kong University. China’s free-trade agreements are numerous but shallow, often leaving out
sensitive sectors and subjects. Its agreement with the Association of South-East Asian Nations, for example, allows
signatories to classify 400-500 tariff categories as sensitive and thus eligible for slower tariff reduction.
Regional trade liberalisation is better than no liberalisation at all, yet it interferes with globalisation in
several damaging ways. By excluding sensitive sectors or imposing onerous rules of origin, it complicates life for
multinational companies whose supply chains cross multiple borders.
And even global agreements have their limitations. One of the most successful global trade pacts has been
the Information-Technology Agreement (ITA), signed in 1996 under the WTO’s auspices to liberalise international
trade in technology products. But it is becoming less useful as technological development creates new products that
are not covered by it. For example, it includes computer monitors and gaming software but not televisions and
game consoles. As flat-panel televisions increasingly double as computer monitors for users to go online, and as
video games migrate from consoles and personal computers to hand-held devices, the ITA’s scope is narrowing.
WTO members had been negotiating for a year to update the pact to include 256 extra products, many of which did
not exist in 1996. But in July China asked for more than 100 of these products to be taken off the table, including
audio and video products. In effect, that put a stop to progress on a new ITA.
The WTO is in part a victim of its own success. Thanks to earlier rounds of tariff reductions, further
liberalisation offers progressively less economic benefit. Mr Hufbauer, Jeffrey Schott and Woan Foong Wong
reckon that a comprehensive (and improbable) Doha deal would lift participants’ output by a mere 0.5%. The
Uruguay round in the 1990s is thought to have produced a gain of 0.5-1.3%. Even the TPP will boost participants’
output by only 0.5%, much the same as Doha would, reckons one study by Peter Petri of Brandeis University and
Michael Plummer of Johns Hopkins.
17
In theory, a successful TPP or TTIP could become a magnet for other countries, eventually achieving
multilateral trade liberalisation by default. In practice that seems unlikely. China’s and Russia’s interventionism
and attachment to state capitalism are difficult to reconcile with the “behind-the-border” liberalisation America and
Europe are seeking. And having had no say in designing the pacts, China and Russia may be reluctant to join later.
The decline of multilateralism may not make much difference to big countries able to negotiate regional
agreements on their own terms. Small countries without such leverage may be harder hit. But the marginalisation of
the WTO as a deterrent to protectionism would hurt everyone. And increasingly such protectionism is taking on
new forms that are hard to deal with.
From The Economist
11. The fear factor
Why Asian firms need to take on the world
May 31st 2014 | From the print edition
FUJIO MITARAI KNOWS more than most people about building a multinational. He is the 78-year-old
boss of Canon, one of Japan’s biggest firms. Worth $43 billion, it makes everything from scanners to lenses for
Hollywood. It first opened a New York office back in 1955, but breaking into America took 20 years of hard slog
and an Apple-style innovation. In 1976 the company launched a cheap, automatic single-lens-reflex camera on the
back of a massive advertising campaign. Mr Mitarai was in charge and the memory still makes him smile. “Our
competitors thought I’d gone crazy.” Canon became America’s biggest camera firm. Today it faces competition
from smartphones and low-cost rivals. Mr Mitarai insists innovation will keep the firm ahead of the pack. It is
developing a raft of new products, from surveillance cameras to virtual-reality design studios and 3D printing
materials.
According to conventional wisdom, emerging Asia’s firms should go global as Canon did. But there is an
alternative view. As domestic markets in China, India and Indonesia become vast, why do their firms need to
bother to compete abroad? After all, the argument goes, they can grow and achieve economies of scale at home.
There is a parallel with America, where listed firms tend to be domestically focused, whereas in Europe home
markets are often too small to offer growth opportunities. American firms are frequently far more profitable in their
own backyard than in foreign fields; Procter & Gamble’s American margins, for instance, are more than double its
international ones.
Some industries in Asia will certainly remain local, not least property and utilities, which are dominated by
local firms everywhere. In addition, just as American firms have got the cowboy-hat industry tied up, so specialised
firms cater to Asia’s idiosyncratic habits. Dabur, based in India, makes Ayurvedic medicines and hair oils. In
Greater China Want Want makes rice crackers and Tingyi makes noodles. But on closer inspection the American
comparison falls down. Emerging Asian firms are growing up in a world that is radically different from that faced
by Western firms in their early days. Globalisation has changed the rules of the game in several ways.
First, Asian firms face global competition at home. Big listed American and European firms have Asian
investments with a book value of about $2 trillion. The biggest firms have vast businesses. But the queue to get in
may be shortening. Last year American multinationals made an 11% return on equity on their Asian operations,
down from a peak of 15% in the glory days of 2005-07.
Not easy, but worth it
Some sectors and companies have found the going tough. Luxury-goods firms have been hammered by
China’s crackdown on corruption. IBM, Vodafone and many others have been persecuted by India’s tax authorities.
Mining companies in Indonesia have been subjected to tighter rules. Most of the 20-odd foreign insurance firms in
India are struggling, as are big foreign banks in South Korea. And some foreign firms have failed to gain a foothold
altogether.
Yet on the whole foreign capital is set to stay in Asia. Across the continent, consumer goods, hotels, fast
foods, cars, beer and many other industries are pretty open to foreigners. And in industries where foreign firms are
active, local firms have to try harder. An example is Li Ning, a Chinese sportsgear firm named after its founder, a
former gymnast with a pile of Olympic medals. Despite its famous boss and its local connections the firm has
struggled to take on Nike and Adidas with its global brands and global sourcing, and its shares have dived.
Over the past 20 years most global industries have consolidated, with a few big multinationals becoming far more
dominant. In his book, “Is China Buying the World?”, Peter Nolan, of Cambridge University, shows how the global
markets for gases, brakes, databases, cash machines, constant-velocity joints and many other products are each
18
controlled by three or fewer firms with a total market share of over 70%. They, in turn, have tight groups of global
suppliers.
R&D budgets for individual firms tell a revealing story. Great Wall Motor, of China, and Mahindra &
Mahindra, of India, are seen as Asian carmaking champions, yet their combined R&D budget is just 3% of
Volkswagen’s. Asian firms were responsible for 33% of last year’s R&D expenditure by listed firms globally, but
almost all of that was by Japanese companies, which accounted for 16 of Asia’s 20 biggest spenders. In emerging
Asia only a handful of firms are close to matching the global leader in their industry.
Consumer tastes in Asia have also changed. Thanks to social media and the internet, they are now
influenced by trends around the world. So in many industries companies in emerging Asia face competition from
global firms selling to customers whose tastes are more globally influenced than before. In the medium term these
firms will either have to give up or become more global themselves. Asia’s 100 biggest listed firms make only 32%
of their sales abroad, and if Japanese firms are excluded this falls to 24%. For the 100 biggest Western firms the
figure is 52%. Asia’s share of the world’s stock of foreign direct investment is 17%, far below its share of global
GDP and market capitalisation.
But going global is hard. By the 1990s Japan’s expansion abroad ran out of steam as the bubble burst at
home and too many deals went sour. More recent waves of Asian deals have proved tricky, too. Between 2004 and
2010 Indian firms spent around $100 billion on cross-border deals. Aditya Birla bought Novelis, a metals firm;
Bharti Airtel acquired Zain, a mobile operator based in Africa; and Tata bought Corus, a British steel firm, and
JLR, a carmaker. All were leveraged buy-outs, with a puny Indian unit raising debt against its target’s assets. The
same frothy market conditions that allowed Indian firms to borrow heavily offshore also meant that their targets
were overvalued. Only JLR has created value, and none of the acquired firms has been properly integrated with its
Indian parent.
South Korean firms have expanded stealthily and more successfully, including in India. Hyundai Motors is
becoming as globally minded as Samsung. Near Chennai, a southern Indian city with perhaps the world’s highest
incidence of moustaches, it has invested $2 billion over a decade and a half in a factory that builds a car every 68
seconds. That makes it India’s second-biggest car firm, after Japan’s Suzuki. The facility looks, sounds and feels
multinational. The working language is English. Indian engineers are rotated to South Korea (“Be careful what they
put on your plate,” says one). Bo Shin Seo, Hyundai’s boss in India, says he benchmarks his operating performance
against Hyundai’s American factory. Globally the group is hiring foreigners to its top ranks. It makes 56% of its
sales abroad and is the world’s fourth-biggest car company, with a 9% market share including its affiliate brand
Kia.
From The Economist
Financial fragmentation
12. Too much of a good thing
Since 2008 global financial integration has gone into reverse
Oct 12th 2013 | From the print edition
IN 2005 ITALY’S UniCredit bought HVB, Germany’s second-largest lender, in what at the time was the
continent’s biggest cross-border bank merger. At a stroke this gave UniCredit a commanding presence in Germany,
Austria and Poland. It was widely hailed as a foretaste of deals to come thanks to Europe’s single currency. “We
will become the first truly European bank,” declared Alessandro Profumo, Unicredit’s chief at the time. So it was
something of a shock when in 2011 Germany’s bank regulator, BaFin, sought to limit the amount of cash UniCredit
could transfer to its Italian parent, fearing that the German unit’s financial health might be compromised. This
seemed to violate the spirit of free capital movement within Europe, and officials in Brussels complained.
Finance, the sector that globalised the most in the years leading up to the crisis, is threatening to go into
reverse. Between 1990 and 2007 cross-border bank flows increased about tenfold, to around $5 trillion, according
to the McKinsey Global Institute, the consultancy’s research arm. Last year the figure was less than a third of that.
The decline extended across all regions, though Europe suffered most.
This has happened for two reasons. The first is the banks’ own efforts to deleverage, either to shed moneylosing operations and assets or to meet stiffer capital requirements. The second is the realisation that cross-border
banks were an important channel for transmitting the mortgage crisis in America and the sovereign-debt crisis in
peripheral Europe to other countries. To limit such spillovers and save taxpayers having to bail banks out of their
foreign misadventures, regulators around the world are seeking to ring-fence their banking systems.
The case for integration
Before the crisis, the logic of financial globalisation seemed impeccable. Businesses were increasingly
operating across borders and needed banks that could travel with them. America and Britain, which excelled at
19
finance, were anxious to market their expertise abroad. A more integrated global economy also needed a financial
system to funnel capital from countries with a surplus of savings to those with a surplus of investment
opportunities. Banks had long played that role within countries, taking in deposits in one market and deploying
them in another. It made sense to do the same thing across borders.
Recipients of such flows benefited in other ways, too. More efficient foreign banks could force local ones
to raise their game. That was why China, for example, listed its state-owned banks on stock exchanges and
permitted foreigners to hold minority stakes. In short order Goldman Sachs, Bank of America, UBS and Royal
Bank of Scotland took up the offer, though some of them have since sold stakes.
In Europe the logic was especially powerful. The benefits of a single currency strongly suggested that there
should be a single banking market as well, so that the interest rates which businesses and households paid were
determined by the European Central Bank (ECB), not the relative health of their local banks.
Financial globalisation did just what it was meant to, perhaps a little too well. Cross-border bank flows
expanded enormously between 2000 and 2007, with 80% of the increase coming from Europe, according to
McKinsey. Those flows enabled debtor countries such as America, Spain and Greece to finance housing booms and
government deficits without paying punitive interest rates. But a large part of those flows reflected banks’ own
leverage as they both borrowed and lent heavily abroad.
Tellingly, the event that touched off the crisis in the summer of 2007 was an announcement by France’s
BNP Paribas that it was suspending redemptions to an investment fund heavily invested in American mortgage
securities. Eventually a number of banks across Europe needed government bailouts because of losses sustained on
mortgages in America and elsewhere.
The cost of bailing domestic banks out of foreign misadventures exposed one risk of financial
globalisation; the losses sustained by domestic creditors and savers when foreign banks went bust showed up
another. In 2008, when Landsbanki, an Icelandic bank, went bust, British and Dutch depositors had to be bailed out
by their own governments because Iceland would guarantee only Icelandic deposits. Sir Mervyn King, the former
governor of the Bank of England, famously commented that “global banks are international in life but national in
death.”
Regulators around the world, working through the Financial Stability Board, an international committee of
central bankers, regulators and finance ministers, have since tried to reduce the threat of a big bank collapse and the
need for a bailout, but many of these efforts have undermined banks’ incentive and ability to do business across
borders. For example, domestic regulators used to allow foreign banks to rely on the capital, liquidity and
regulatory oversight of the foreign parent. Now many of them are pressing units of foreign banks, and foreign units
of domestic banks, to maintain sufficient liquidity and capital independent of the parent, sometimes by organising
themselves as subsidiaries rather than branches.
In America the Federal Reserve will soon require foreign banks above a certain size to collect all their local
units into a single, separately capitalised holding company that meets the same capital and liquidity requirements as
American banks do. Until now the Fed has relied on foreign regulators to ensure that the parent bank can support
its units in America. The proposal has prompted a flurry of opposition.
Nor is it just banks that have to abide by tighter rules. America’s Commodity Futures Trading Commission
(CFTC) has ruled that anyone trading swaps with an American bank’s foreign unit must generally go through a
central clearing house. Gary Gensler, the CFTC’s chairman, rattles off a litany of financial disasters involving
offshore affiliates: AIG had run its derivatives out of London; Lehman’s London affiliate had 130,000 outstanding
swaps contracts, many guaranteed by its American parent; Citigroup had set up many off-balance-sheet vehicles in
the Cayman Islands; and JPMorgan Chase earlier this year suffered huge losses on trades in London. “Risk…comes
crashing back to our shores from overseas when a run starts in any part of a modern, global financial institution,”
says Mr Gensler.
The CFTC has agreed to exempt foreign swaps customers that operate under similar rules abroad, and the
Fed has yet to issue its final foreign banking rule. But for the most part American regulators, like their counterparts
overseas, have stuck to their guns. “We will not let the pursuit of international consistency force us to lower our
standards,” said Jack Lew, the Treasury Secretary, in July.
Even when regulatory initiatives are not explicitly discriminatory, they make cross-border banking harder.
Benoît Coeuré, a member of the ECB’s governing board, notes that Basel 3, a set of new international capital and
liquidity standards for banks, is being implemented differently across countries: capital is measured differently
under American and international accounting rules, and even within Europe, Britain, France and Germany have
proposed different bank holding-company structures. “If you have an idiosyncratic local legal environment, then
market participants will find it safer just to play on their home turf because of the legal uncertainty that goes with
international activities, and we’ll lose the benefit of international financial integration,” he says.
Such changes have undermined the case for global banks. Huw van Steenis at Morgan Stanley comments
that “if I’m a German bank, one of my edges is I have really cheap funding in Germany because I have more
20
deposits than loans. If that advantage goes away, one of their unique selling points goes, too.” Morgan Stanley
estimates that banks’ cross-border claims within the euro zone have fallen from nearly $4 trillion in mid-2008 to
about half that amount now.
And regulation is only one factor at work. Another is the need to deleverage in order to shore up capital and
meet higher capital requirements. Again, this is most apparent in Europe, where banks have been shedding loans
and bonds in troubled peripheral economies. Non-residents have gone from holding 43% of Spain’s and Italy’s
sovereign debt in 2010 to 35% now. American money-market funds have cut their exposure in Europe by 60%
since 2010.
In some countries regulators have quietly pressed banks to increase domestic lending to boost their
economies, at the expense of foreign operations. In others they have been more explicit. Britain’s Funding for
Lending scheme, launched in 2012, offers banks cheap central-bank financing for increasing lending to British
households. America’s Volcker rule would exempt that country’s debt, but not that of other sovereigns, from
restrictions on banks’ proprietary trading.
In retrospect, much of the rise in cross-border lending was foolish. It made both European and American
banks more vulnerable to a sudden drop in asset prices and increased the risk of a credit crunch. McKinsey’s work
shows that cross-border bank lending is far more volatile than other capital flows such as bonds, equities and direct
investment. Research by the Bank of England shows that over the past decade lending by foreign banks was far
more cyclical than by domestic banks.
Less financial globalisation should also reduce the risk that contagion from one country’s banking
problems will cause economic damage elsewhere. That is the lesson of the Asian banking crisis of 1997-98. In
many countries loans in 1997 exceeded deposits by 20%, says Mr van Steenis, with the gap made up by wholesale
funding, often from abroad. When that funding disappeared, many banks teetered on the verge of collapse,
prompting the authorities in the countries concerned to put a cap on the use of such funding. This had the positive
effect that Asian banks suffered very little contagion from either the American mortgage crisis or the European
sovereign-debt crisis.
The penalties of self-reliance
But reduced cross-border links come at a price. If a country suffers a domestic shock, it will have to bear
more of the consequences itself. Although regulators fret over shocks to a bank’s foreign parent or withdrawal of
that parent’s support, Peter Sands, the boss of Standard Chartered, a British bank, observes that “there are lots of
examples of shocks in the market when the support of the parent is needed.” International banks provided vital
funding to South Korea during its crisis in 1997 and to Dubai in 2009 when a state-owned developer almost
defaulted. “International flows of funds in the banking system can be a source of contagion but also of resilience,”
says Mr Sands.
Financial fragmentation also challenges one of the great promises of globalisation: that savings-poor
countries will be able to find the wherewithal to finance essential investment by borrowing abroad. In theory, if
capital is free to seek the highest potential return, domestic saving and investment should not be correlated. In 1980
Martin Feldstein and Charles Horioka documented that in fact they are, suggesting that national borders were
impeding the free flow of capital. Over the years that correlation diminished, particularly within Europe, but Mr
Coeuré points out that it has now returned.
The result is starkest in Europe, where Spanish and Italian businesses are obliged to pay 80-160 basis
points more than German ones to borrow. This is because of the higher rates on sovereign debt in those countries
and fewer deposits from healthier countries. A more balkanised financial market makes it less likely that German
savers will finance dodgy Spanish loans. But it also makes it more likely that they will finance low-yielding
German loans, sending high-yielding Spanish businesses away empty-handed.
In addition, financial fragmentation means less competition for often cosseted domestic banks from nimbler
foreign rivals. Studies of foreign banks entering Australia, Indonesia, the Philippines and Colombia found that they
reduced interest-rate spreads and made domestic banks more efficient (although sometimes also more likely to
make bad loans).
The best way to maintain financial globalisation without fear of shoddy regulation spilling over from one
country to another would be increased co-operation among regulators. This is beginning to happen at the Financial
Stability Board, which is trying to ensure uniform implementation of new capital and liquidity standards across
most countries and has been pushing for a European banking union.
Unfortunately this process has exposed divisions. America’s biggest banks, for instance, will have to
maintain a higher leverage ratio (a type of capital requirement) than stipulated by Basel 3. And although a single
European supervisor will replace national regulators for the euro zone’s biggest banks next year, prospects for a
common deposit insurance and resolution regime remain uncertain, for much the same reason that has made the
entire crisis so intractable: creditor nations such as Germany, Finland and the Netherlands are deeply reluctant to
make their taxpayers foot the bill for bank failures in debtor countries.
21
It seems unlikely, then, that banks will return to the highly globalised state of 2007 soon. But if crossborder lending remains subdued, that will put added pressure on capital markets to make up the difference—and
they, too, are feeling the pinch.
From the print edition: Special report
13. The rich and the rest
What to do (and not do) about inequality
APART from being famous and influential, China’s president, Britain’s prime minister, America’s secondrichest man and the head of the International Monetary Fund do not obviously have a lot in common. So it tells you
something about the breadth of global concerns about inequality that they have all worried, loudly and publicly,
about the dangers of a rising gap between the rich and the rest.
China’s president puts the reduction of income disparities, particularly between China’s urban elites and its
rural poor, at the centre of his pledge to create a “harmonious society”. Britain’s prime minister has said that more
unequal societies do worse “according to almost every quality-of-life indicator”. Warren Buffett has become a
crusader for a higher inheritance tax, arguing that America risks an entrenched plutocracy without it. And the head
of the IMF argues for a new global growth model, claiming that gaping income gaps threaten social and economic
stability. Many others seem to share their concerns. A survey by the World Economic Forum says its members see
widening economic disparities as one of the two main global risks over the next decade (alongside failings in global
governance).
Equally muddled
The debate about inequality is an old one. But in the wake of a financial crisis that is widely blamed on
Wall Street fat cats, from which the richest have rebounded fastest, and ahead of public-spending cuts that will hit
the poor hardest, its tone has changed. For much of the past two decades the prevailing view among the world’s
policy elite—call it the Davos consensus—was that inequality itself was less important than ensuring that those at
the bottom were becoming better-off. Tony Blair, ex-British prime minister, embodied that attitude. His party was
famously said to be “intensely relaxed” about the millions earned by David Beckham (a footballer) provided that
child poverty fell.
Now the focus is on inequality itself, and its supposedly pernicious consequences. One strand of argument,
epitomised by “The Spirit Level”, a book that caused a stir in Britain, suggests that countries with greater
disparities of income fare worse on all manner of social indicators, from higher murder rates to lower life
expectancy. A second thread revisits the macroeconomic consequences of income disparities. Several prominent
economists now reckon that inequality was a root cause of the financial crisis: politicians tried to counter the
growing gap between rich and poor by encouraging poorer folk to take on more credit. A third argument is that
inequality perverts politics, with Wall Street’s influence in Washington often cited as exhibit A of the unhealthy
clout of a plutocratic elite.
If these arguments are right, there might be a case for some fairly radical responses, especially a greater
focus on redistribution. In fact, much of the recent hand-wringing about widening inequality is based on sloppy
thinking. The old Davos consensus of boosting growth and combating poverty is still a better guide to good policy.
Rather than a sweeping assault on inequality itself, policymakers would do better to take on the market distortions
that often lie behind the most galling income gaps, and which also impede economic growth.
Begin with the facts about inequality. Globally, the gap between the rich and the poor has actually been
narrowing, as poorer countries are growing faster. Nor is there a monolithic trend within countries. In Latin
America, long home to the world’s most unequal societies, many countries—including the biggest, Brazil—have
become a bit more equal, as governments have boosted the incomes of the poor with fast growth and an overhaul of
public spending to improve the social safety-net (but not by raising tax rates for the rich).
The gap between rich and poor has risen in other emerging economies (notably China and India) as well as
in many rich countries (especially America, but also in places with a reputation for being more egalitarian, such as
Germany). But the reasons for this differ. In China inequality has a lot to do with the hukou system of residency
permits, which limits internal migration to the towns; by some measures inequality has peaked as rural labour
becomes more scarce. In America income inequality began to widen in the 1980s largely because the poor fell
behind those in the middle. More recently, the shift has been overwhelmingly due to a rise in the share of income
going to the very top—the highest 1% of earners and above—particularly those working in the financial sector.
Many Americans are seeing their living standards stagnate, but the gap between most of them has not changed all
that much.
The links between inequality and the ills attributed to it are often weak. For instance, some of the findings
in “The Spirit Level” were distorted by outliers: strip out America’s high murder rate (which many would blame on
22
guns, not inequality) or Japan’s longevity (diet, not equality), and flatter societies no longer look so much healthier.
As for the mooted link to the financial crisis, the timing is dodgy: America’s poor fell behind in the 1980s, the
credit bubble took off two decades later.
Message to Davos
These nuances suggest that rather than fretting about inequality itself, policymakers need to differentiate
between its causes and focus on ways to increase social mobility. A global market offers far bigger returns to those
at the top of their game, be they authors, lawyers or fund managers. Modern technology favours the skilled. These
economic changes are themselves often reinforced by social ones: educated men now tend to marry educated
women. The result of all this is the rise of a global elite.
At heart, this is a meritocratic process; but not always. Rules and institutions are often rigged in ways that
limit competition and favour insiders at the expense both of growth and equality. The rules can be blatantly unfair:
witness China’s limits to migration, which keep the poor in the countryside. Or they can involve more subtle
distortions: look at the way that powerful teachers’ unions have stopped poorer Americans getting a good
education, or the implicit “too big to fail” system that encouraged bankers to be reckless and left the rest with the
tab. These are very different problems, but they all lead to wider inequality, fewer rungs in the ladder and lower
growth.
Viewed from this perspective, the right way to combat inequality and increase mobility is clear. First,
governments need to keep their focus on pushing up the bottom and middle rather than dragging down the top:
investing in (and removing barriers to) education, abolishing rules that prevent the able from getting ahead and
refocusing government spending on those that need it most. Oddly, the urgency of these kinds of reform is greatest
in rich countries, where prospects for the less-skilled are stagnant or falling. Second, governments should get rid of
rigged rules and subsidies that favour specific industries or insiders. Forcing banks to hold more capital and pay for
their implicit government safety-net is the best way to slim Wall Street’s chubbier felines. In the emerging world
there should be a far more vigorous assault on monopolies and a renewed commitment to reducing global trade
barriers—for nothing boosts competition and loosens social barriers better than freer commerce.
Such reforms would not narrow all income disparities: in a freer world skill and intellect would still be
rewarded, in some cases magnificently well. But the reforms would strike at the most pernicious, unfair sorts of
income disparity and allow more people to move upwards. They would also boost growth and leave the world
economy more stable. If the Davos elites are worried about the gap between the rich and the rest, this is the route
they should follow.
From The Economist
Monetary policy
14. Glory days
May 23rd 2014, 10:19 by R.A. | LONDON
"THE Fed is a bit behind the curve", worries an official at HSBC. The Fed is always behind the curve on
inflation, says Charles Plosser, president of the Philadelphia Fed:
If borrowing begins to surge and those reserves start to pour out of the banking system, Plosser worries,
“that’s going to put pressure on inflation.” The result: the Fed could be forced to raise interest rates faster and
earlier than it would like and perhaps slam the breaks on the economic recovery.
This is a relatively common concern: that if the Fed isn't careful inflation may rise, forcing it to jack up
interest rates and crash the economy. But why would the Fed have to crash the economy if inflation rose above
target? It's possible Mr Plosser, and others who share his view, are simply arguing that the Fed is not very good at
its job and will dramatically overreact, raising interest rates far higher than necessary out of sheer incompetence.
It seems more likely, however, that this camp does not think crashing the economy is an error, but rather
that it is what one does to wipe out inflation. That is, the experience of the early 1980s is burned deep into their
minds. When Paul Volcker wanted to rein in high inflation, he had to push interest rates into double digits, touching
off a nasty recession in the process. This is the way the economy works, many seem to reckon: beating inflation
means jacking up rates and choking off growth until price-growth slows.
But this is deeply mistaken. The economy today is facing very different circumstances than the economy of
the early 1980s, and it is extremely troubling that key policy-makers seem not to understand this.
What's different? There are three significant ways in which now is not like then. The first is simply the
extent of inflation in the system. The price level rose 61% from 1977 to 1982 and 129% from 1972 to 1982. Over
the past five years, by contrast, the price level has risen just 11%, and just 26% in the last ten. Prices were rising
more each year in 1979 and 1980 than they rose over the whole of the last half decade. To think that the Fed would
23
or should react to 3% or 4% inflation as Mr Volcker did in trying to cool annual inflation rates of 12% to 14% is
absurd.
Second, Mr Volcker was working in an economy that was structurally very different. In the late 1970s
more than 20% of private-sector workers were union members, compared to just over 5% today. Many more
workers were on labour contracts with wage adjustments linked directly to inflation. That meant, first, that there
was a high level of pass-through from inflation to wage growth and then back to inflation. It also meant that
inflation was very persistent, since wage contracts were not easily or frequently renegotiated.
Third, and relatedly, it was not clear to many observers in the early 1980s that the Fed couldreduce
inflation, because of those "cost-push" pressures, while today it is taken for granted that the Fed can and will keep
inflation at very low levels. Public doubt in Mr Volcker's ability to reduce inflation meant that much of the work of
disinflation had to occur mechanically, through the creation of high levels of unemployment, rather than through a
simple reset of expectations. Today the dynamic is completely different. Because the Fed's control over inflation is
so well-established, inflation will tend to revert to target despite tightening conditions in labour markets: that's what
it means for expectations to be "well-anchored".
The Fed simply does not need to strangle the economy any more to get inflation to come down. In each of
the last three business cycles the Fed's policy rate has topped out at progressively lower levels, and the ensuing
recessions were short and mild—until the last one, at which the policy rate fell to zero, which takes me to a last
point.
Worrying about high inflation is particularly crazy given the current state of the American economy. On
the one hand, it smacks of a no-one-goes-there-because-it's-too-crowded kind of thinking. The economy has been
in a nasty slump for more than six years now, during which time growth, employment, and wages have all fallen
well below trend. A bit of inflationary pressure would mean that at long last the economy would be operating near
potential. We should welcome and celebrate that, not fret about it.
But on the other hand, a period of sustained inflationary pressure would be most welcome because it would
ultimately lead to higher nominal interest rates. If the Fed overreacted to the slightest uptick in inflation it would
guarantee that interest rates in this cycle peaked at a very low level—nowhere near the 5.25% peak for the fed
funds rate in the last expansion, for instance. That, in turn, would ram the American economy right back up against
the zero lower bound on nominal interest rates, and that would force the Fed either to accept a deeper and longer
downturn than it would prefer, or to go back to unconventional policy. Mostly likely a bit of both.
America is about the enter its sixth year of recovery. Looking back at the history of American business
cycles, only 15% of expansions made it to a sixth year. Right now, markets anticipate that the fed funds rate will be
just 1% when the recovery enters its eighth year. Only three expansions in America's history saw an eighth year.
To be plain: either America will have a sustained period of inflation above 2%, or America will be relying on
unconventional monetary policy for the foreseeable future. It's as simple as that. It is fine for people to complain
about the Fed falling behind the curve, but they should realise what they're saying. They are insisting that the
American economy establish a new normal, in which interest rates are perpetually at or near zero and
unconventional monetary policy becomes the Fed's main policy instrument.
15. One world
Asian and Western business will become more alike
May 31st 2014 | From the print edition
Come rain or shine, the future is global
ASIA PROSPERED OVER the past two decades by following a different economic model from the
West’s. But if it wants to continue to do well over the next 20 years, it will have to reform. What that involves will
vary from place to place. Myanmar, a big country with a difficult past, is beginning to pull itself out of the mire.
India and Indonesia, two chaotic democracies, have to create enough order to attract factories and industrial jobs. In
China the government needs to ease its grip on the economy. Japan is embarking on the world’s biggest experiment
to see whether a society can shrink and still remain prosperous.
The task for Asia’s companies is similarly varied. Selling shampoo sachets in rural Java is quite a different
undertaking from making smartphones in South Korea or writing computer code in Bangalore. But as this special
report has argued, all Asian firms will be affected by a range of important trends: the impact of higher labour costs
in China and ageing in East Asia; higher consumer expectations; the disruptive power of the internet; and the rising
barriers to entry in many global industries as they become ever more concentrated. Rising military tensions in the
region will also play a part.
24
To the extent that Asian companies face similar problems, their response should be similar. They need to
professionalise, focus, internationalise, improve R&D and create widely recognised brands. That will threaten the
traditional ownership pattern of Asian firms—state firms, family conglomerates and companies controlled by
Japan’s manager-kings. Such change is to be welcomed. The status quo has worked, after a fashion, for the past
two decades, but it has many flaws and may now lead to sclerosis. Emerging Asia’s best firms are already adapting;
those that do not may be gone within a decade.
Asia Inc is not about to become America Inc, but big Asian firms will increasingly come to look like global
multinationals. No one has yet invented a better model for the company. At the same time Western multinationals
will become more Asian, with a large chunk of their sales generated by the region’s huge consumer markets and
their ranks increasingly populated by Asians. They should inculcate some Asian business values, from restraint on
executive pay to longer planning horizons.
Many things could spoil this happy scenario. One is war between China and its neighbours, the risk of
which is higher than at any point in the past few decades. Another is a public backlash against inequality and
corruption. Asian countries score badly on The Economist’s Crony Index, which measures the wealth of tycoons in
sectors close to the government. China, India and Indonesia have all seen politically motivated attacks on foreign
firms in the past three years. Such attacks could spread to local firms. One happy side-effect of more dispersed
company ownership is that more people have a stake in companies’ future.
Innovation also needs a push. There is much talk in Asian business circles about the massive
entrepreneurial potential of young Asians. Yet in much of Asia powerful incumbents enjoy special privileges. The
financial apparatus to bring on lots of new firms—and particularly the venture-capital industry—is very immature.
Despite the hype over “new” Asian industries, such as green energy, health care and the internet, the number of
firms investing serious amounts of capital in them is small.
Asia Inc’s next two decades will create losers as well as winners. As China’s firms become more
sophisticated, more Western rivals that have so far had the field to themselves will face competition. The shift in
basic manufacturing away from China and the automation of factories across the region will destroy jobs. If South
Korea and Japan get better at services and creative industries, Hollywood screenwriters, French designers and
Australian pop stars might be in trouble. But more competition and more innovation is good for consumers
everywhere. If China successfully rebalances its economy, it will buy a lot more from the rest of the world. And
more global Asian firms should also create more jobs outside their own countries.
Seize the opportunities
Twenty years ago it was almost unimaginable that a South Korean firm would be a global car giant, that an
Indian firm would be one of the world’s largest technology outfits or that a Chinese internet colossus would list on
an American stock exchange. Today those things are facts of life. If it proves flexible enough, Asian business will
continue to power ahead. Perhaps in 20 years’ time Unilever will be run from Singapore and report its results in
renminbi, and McDonald’s will sell Maharaja Macs in New York as well as Mumbai. A new global digitalentertainment empire for the elderly may be based in Tokyo, and the world’s biggest bank may be China Mobile.
Even The Economist might be Asian-owned—and written beautifully by machines.
From the print edition: Special report
16. Bucked off
Europe’s leaders need to cut the power of Brussels in many areas, but in some they need to extend it
May 31st 2014 | From the print edition
“DETERMINED to lay the foundations of an ever-closer union among the peoples of Europe…” proclaims
the Treaty of Rome that began the European project in 1957. When the history of the European Union is written,
2014 will very probably come to be seen as an equally significant date, for this was the year that Europe’s voters
told its leaders to abandon the noble aspiration that launched the venture more than half a century earlier and has
shaped its policies ever since.
Even though a big anti-European vote had been expected, the scale of it still came as a shock. In France
Marine Le Pen’s National Front (FN) came top with 25% of the vote. The UK Independence Party (UKIP) did
better still, with 27%. Almost 40% of the vote in Greece went to broadly Eurosceptic or avowedly racist parties. As
25
many as 30% of the seats in the next European Parliament will be held by anti-establishment and/or anti-European
parties. Manuel Valls, the French prime minister, was right to speak afterwards of a political “earthquake”.
Prosperity v democracy
The direct political consequences may not in themselves be hugely significant. Within the European
Parliament, the populists will probably squabble so much that the pro-European 70% can continue in their usual
consensual way. But the longer-term ramifications could be enormous. Europe faces the possibility that Britain—
whose ruling Conservatives have promised a referendum on EU membership after the next election—will pull out.
The EU might survive a British withdrawal; but if France elected an anti-European of Ms Le Pen’s ilk and pulled
out, that would be the end of it.
Muddling through, the typical Brussels response to crises, is not an option this time, for if the EU does not
change voluntarily, voters will force change upon it. To respond to their hostility, Europe’s leaders need first to
examine the reasons for it.
Nationalism is clearly a factor. The message that voters do not want foreigners telling them what to do was
broadcast loud and clear from the platforms of parties such as UKIP and the FN, and this is not the first rejectionist
vote. The French and Dutch threw out the draft EU constitution in 2005 and the Irish rejected its replacement, the
Lisbon treaty, in 2008 before being asked to vote again.
Hostility to immigration is another motive. Most of the anti-EU parties are also against foreigners.
Resentment of the EU has risen since it expanded eastwards, and workers from those poorer countries moved
westwards.
Finally, economics is a big driver of discontent. It is notable that the French, whose leaders have no
solution to their stagnation, are far angrier than the Germans, whose economy is recovering nicely. Britain may be
growing now, but the fact that its economy shrank so sharply in the aftermath of the crisis helps explain the
grumpiness with its government.
There are two solutions to Europe’s problems: economic prosperity and increased democracy, which
basically means returning power to the states and institutions that voters trust. The two aims often coincide, but not
always.
There are plenty of areas of national life in which Brussels should interfere less. Much unnecessary red tape
should be torn up and many regulations scrapped. Freedom to fix many detailed social and employment rules—
parental leave, working time and so on—should be handed back to national governments. The European
Parliament’s powers should be reduced, and national parliaments given more say in EU legislation. At least
initially, such reforms can be made without the lengthy (and risky) business of treaty change.
But prosperity and democracy clash in two areas. The first is immigration. Yes, countries should be freer to
clamp down on “welfare tourism”, a particular source of anger: rules can be tightened to make it harder for
immigrants to claim benefits. And poorer new EU applicants could be subject to even longer transition periods
when free movement is limited. But the “four freedoms” of movement of goods, services, capital and labour
underpin Europe’s single market. To junk any one of these would not only call into question the point of the
enterprise, but also reinforce the economic stagnation that is a big reason for the current discontent.
The single market provides the second set of conflicts. In some areas—labour-market flexibility, for
instance—“less Brussels” will help growth. But not all. The euro crisis showed that the euro zone needs a banking
union, which centralises a lot of power. And the best hope of growth lies in expanding the single market. The next
commission needs to remove blockages to trade in services, energy and the digital economy. More free-trade deals,
starting with America, are another priority. Opening up Europe’s economy will annoy some voters (and scare some
politicians); but the alternative—years of economic stagnation—will doom the project anyway.
The quest for leadership
It may be, as Eurosceptics argue, that Europe cannot change. But the initial reaction from national leaders
has been encouraging. Germany’s Angela Merkel and the present commission president, José Manuel Barroso,
have both called on the commission to do less. France’s François Hollande says the EU is too remote and must
scale back its power. Italy’s Matteo Renzi has won backing for reform. David Cameron, Britain’s prime minister,
has been demanding a reduction in the powers of Brussels for years, while campaigning for a broader single
market. Europe’s other leaders would do well to adopt his ideas—and then pretend they did not come from Britain.
The first job is to appoint a new president of the European Commission prepared to implement radical
change. The continuity (and federalist) candidate, Luxembourg’s Jean-Claude Juncker, used to have Mrs Merkel’s
support. But she seems to have realised that doing nothing is not an option. Our choice would be Christine Lagarde,
the French boss of the IMF, a clever, brave outsider, who knows how to take on vested interests. With Ms Lagarde
as president, Britain would be more likely to stay in. If the EU is to survive, it will need that sort of leadership. And
its survival really is in question now.
From the print edition: Leaders
26
17. Currency disunion
Why Europe’s leaders should think the unthinkable
Apr 7th 2012 | From the print edition
THE Irish left the sterling zone. The Balts escaped from the rouble. The Czechs and Slovaks left each
other. History is littered with currency unions that broke up. Why not the euro? Had its fathers foreseen turmoil,
they might never have embarked on currency union, at least not with today's flawed design.
The founders of the euro thought they were forging a rival to the American dollar. Instead they recreated a
version of the gold standard abandoned by their predecessors long ago. Unable to devalue their currencies,
struggling euro countries are trying to regain competitiveness by “internal devaluation”, ie, pushing down wages
and prices. That hurts: unemployment in Greece and Spain is above 20%. And resentment is deepening among
creditors. So why not release the yoke? The treaties may declare the euro “irrevocable”, but treaties can be
changed. A taboo was broken last year when Germany and France threatened to eject Greece after it proposed a
referendum on new bail-out terms.
One reason the euro holds together is fear of financial and economic chaos on an unprecedented scale.
Another is the impulse to defend the decades-long political investment in the European project. So, despite many
bitter words, Greece has a second rescue. Its departure from the euro, Angela Merkel, Germany's chancellor, now
says, would be “catastrophic”. Yet Mrs Merkel is not ready to take the action needed to stabilise the euro once and
for all. Last week's decision to boost the euro's firewall to “€800 billion” ($1.07 trillion) is less than meets the eye;
the real lending power will be €500 billion. And there is no prospect, for now, of mutualising any part of the
sovereign debt.
So the euro zone remains vulnerable to new shocks. Markets still worry about the risk of sovereign
defaults, and of a partial or total collapse of the euro. Common sense suggests that leaders should think about how
to manage a break-up. Some may be doing so. But having described a split as bringing economic Armageddon,
leaders dare not be seen planning for it.
Instead, the most open thinking is being promoted by a British think-tank close to the Eurosceptic
Conservative Party. This week Policy Exchange announced a shortlist of five contestants for a £250,000 ($400,000)
prize for the best plan to manage a break-up of the euro. It may be a sign of the magnitude of the task that the
organisers did not declare a winner; instead they asked those on the shortlist to do more work and resubmit their
ideas. (A cartoon produced by an 11-year-old Dutch boy won a €100 voucher.)
One of the five entries, by Jonathan Tepper, lists 69 currency break-ups in the past century. Most have not
led to long-term damage, he says. In fact, leaving the euro would help troubled countries recover quickly. Drawing
on the demise of the Austro-Hungarian empire, among others, Mr Tepper sketches out a scenario for the departure
of the likes of Greece. A surprise announcement is made over a weekend, and all deposits are redenominated in
new drachmas while banks are kept shut. Capital controls are imposed to prevent the flight of money abroad. For
cash, Greeks at first use existing euro banknotes defaced with ink or a stamp. These are withdrawn as drachma
notes are printed. Border checks restrict the export of unstamped euro notes. Financial institutions are given time to
update software.
The real problem with the euro, says Mr Tepper, is the fact that many countries face large imbalances and
high debts. Devaluation for Greece would increase the burden of euro-denominated debt. This would be alleviated
by converting bonds issued under Greek law to drachmas. Foreign-law bonds would be restructured. Indeed, says
Mr Tepper, default is essential to recovery.
His formula might be summed up by three Ds: depart, default and devalue. Roger Bootle, another
shortlisted entrant, says it might be better to start with the departure of Germany and other strong countries. But
however it happens, any fragmentation will create winners and losers, with many bankruptcies and legal
nightmares. Anybody involved in cross-border activity will find that their assets and liabilities change value. Neil
Record says the sums involved would be so large, and the litigation so ruinous, that the best option would be to
abolish the euro as soon as one country leaves, so as to invalidate all euro contracts.
Unlike Mr Record, who favours secrecy, in their paper Jens Nordvig and Nick Firoozye argue that open
contingency planning would reduce uncertainty. They reckon there may be a total of €30 trillion-worth of crossborder exposure under foreign law, including bonds, loans, derivatives and swaps. Disruption, they say, could be
minimised by converting all euro contracts to a modified form of the European Currency Unit, the basket of
national currencies that preceded the euro. Catherine Dobbs, the final entrant, proposes to unscramble the omelette
by splitting the euro into two (or more) zones: “yolk” and “white”. All euros in all countries would be converted
into a fixed combination of the two. Savers would be protected, initially at least, and capital flight to other eurozone countries would be deterred. Over time, the weaker yolk would devalue against the stronger white.
Plan ahead
27
The fate of the euro will probably be determined by politics as much as economics. A debtor state may tire
of internal devaluation. A creditor may want to stop supporting others. And any one of the euro's 17 members may
balk at the loss of sovereignty involved in saving the currency. But the worst outcome of a euro split would be a
chaotic breakdown. An orderly process increases the chance that it might be possible to salvage from the wreckage
other gains of European integration, notably the single market.
So euro-zone governments need to think the unthinkable. No self-respecting general would refuse to plan
for a predictable war, no matter how much he dislikes the idea of fighting it.
18. Hail Helvetia
Some Swiss lessons for the euro zone
Jul 19th 2014 | From the print edition
THE euro crisis has recreated a rift between a Germanic north and a Latin south that decades of integration
tried to efface. Economists and political scientists puzzle over its persistence. Some point to patterns of
industrialisation, of literacy or even of Catholic and Protestant attitudes to sin and redemption. Whatever the roots,
the euro has made it worse.
Belgium offers a worrying glimpse of what the euro zone might yet become: a dysfunctional, overbureaucratic polity with bewildering layers of government, infused with a poisonous resentment between a
dependent French-speaking south and a subsidising Flemish north. But there is a more hopeful model: Switzerland,
which for all its linguistic and religious splits, combines prosperity with contentment and a dose of direct
democracy. An index of the best places to be born in 2013, compiled by our sister company, the Economist
Intelligence Unit, put the Alpine confederation comfortably first.
The European Union has often looked to America, a continental federation, for inspiration. But it could
usefully study how the Swiss bring together Catholics and Protestants and German-, French-, Italian- and
Romansh-speakers. The usual stereotype breaks down: rich French-speaking cantons like Geneva and Vaud pay for
poorer German ones such as Uri. There is something for every taste: Scandinavian standards of living, German
fiscal rigour, French-style “solidarity” transfers, Luxembourg-like love of bank secrecy, Irish tax competition and a
British cussedness about the EU. Switzerland is neither in the EU, nor in the looser European Economic Area. It
has a web of bilateral deals with Brussels—though these may yet be torn apart by the Swiss referendum in
February that rejected the free movement of workers.
Above all, Switzerland has a successful currency union without the euro zone’s onerous central edicts on
everything from deficits to labour policy, pensions and investment. Although the Alpine cantons started to bind
together in medieval days, they developed a single market only in the 19th century—starting, like the EU, with
goods and spreading imperfectly to services. A single currency replaced multiple cantonal ones from 1850.
What lessons does Switzerland offer? A strong doctrine of subsidiarity, whereby tasks should be done at
the lowest possible level of government. Cantons have ceded powers to the confederation piecemeal (its right to
raise taxes must be reviewed periodically), but have also devolved them to communes. All three levels of
government have taxation powers and provisions for issues to be decided by referendum. German economists also
point to Switzerland’s mechanisms to control public spending and enforce a no-bail-out rule. The big difference,
though, is that cantons have drafted their own balanced-budget rules and voters have forced similar ones on the
confederation. The euro zone imposed too much austerity on troubled countries, but Switzerland has shown that
running surpluses and paying back debt in good times creates more scope to respond in a crisis. The thrifty
burghers even voted down plans to bid for the winter Olympics.
So is Keynesian stimulus banned? Not entirely. Balanced-budget rules vary. Some allow for downturns or
exclude investment from the numbers. The confederation can approve exceptional spending, such as when it saved
UBS, a big bank. Switzerland’s “banking union”, to use the EU term, is narrower than the euro zone’s (it covers
28
just three “systemically important” banks) yet it is clear that the confederation ultimately guarantees the system.
There is no such euro-zone backstop. At the height of the financial crisis in 2008 stimulus was also entrusted to the
Swiss National Bank, which cut interest rates more than the European Central Bank. It has fewer qualms about
buying debt or, indeed, large amounts of foreign assets to hold down the Swiss franc.
The deeper difference is that Switzerland is a federation that calls itself a confederation, whereas the euro
pretends to be a federal currency but actually preserves 18 sets of national economic and fiscal policies. Swiss
monetary union came after centuries of political unity; the euro unwisely tried the reverse course.
All for one and one for all
Imbalances between Swiss cantons and shocks that hit some more than others are absorbed by the economy
as a whole: by an integrated financial system, by workers moving to where the jobs are, by countrywide provision
of welfare and public goods (eg, roads) and by transfers from rich to poor cantons. The confederal budget is
smallish, at 11% of GDP, but that is far larger than the EU’s, which is less than 1% of GDP. The EU could learn
from the Swiss “equalisation fund” (about 0.8% of GDP), which creates a transparent system of transfers from
richer to poorer regions. By reckoning the payments annually according to the tax base (rather than how cantons
tax and spend) and by providing lump sums instead of semi-hidden subsidies, the system preserves cantons’
freedom of action and also encourages tax competition.
None of this is to idealise Switzerland. Its politics is full of arguments about money. Sometimes
referendums play up social divisions, or stoke anti-foreigner populism. What is feasible in a small country may not
be across a continent: for instance, neutrality is not an option for most EU countries. But Switzerland offers useful
pointers for the euro zone. Restoring market discipline through a no-bail-out rule, stronger fiscal federalism, a
deeper single market and a more rational EU budget could create a system that requires less bossy interference by
Brussels. Establishing clearly defined tasks for every level of government, each with its own resources, would help
make the system more accountable. Direct democracy can transcend identity politics. “A bigger Switzerland” is a
term of insult among EU watchers. But the euro zone might do better if it were a little more Helvetic.
19. A world to conquer
Asian business is reforming. Its emerging multinationals will change the way we all live
May 31st 2014 | From the print edition
BUSINESS power follows economic power. In the 1920s British firms owned 40% of the global stock of
foreign direct investment. By 1967 America was top dog, with a 50% share. Behind those figures lie cultural
revolutions. The British spread the telegraph and trains in Latin America. American firms sold a vision of the good
life, honed by Hollywood and advertising. Kellogg’s changed what the rich world ate for breakfast, and Kodak how
it remembered holidays. The next corporate revolution, as we describe in our special reportthis week, is happening
in Asia. This too will change how the world lives.
Asian capitalism has brawn. The continent’s share of global GDP has risen from a fifth to 28% since 1984.
It is the world’s factory, a diverse region of rivals bound together by supply chains. But it lacks brains and global
savvy. Asia smelts 76% of the world’s iron and emits 44% of its pollution, but hosts only a tenth of its most
valuable brands and venture-capital activity. Its multinationals punch below their weight, owning 17% of the
world’s foreign direct investment. Wealthy Japan and South Korea have a cast of superstars, such as Toyota and
Samsung. But few other firms command the world stage.
That is because Asian capitalism has been too cosy. In the boom between 2002 and 2010 easy profits were
made at home—growth was fast and labour and credit cheap. Two-thirds of big Asian firms are state-controlled or
29
“business houses” (often family-run). These incumbents tend to be chummy with the government and get cheap
land and loans. Half of all billionaire wealth in Asia has been made in sectors, such as property, that are prone to
cronyism, versus 15% in the West. Outside Japan, Taiwan and South Korea, innovation has been neglected.
Mahindra & Mahindra and Great Wall, car champions from India and China, have a combined research-anddevelopment (R&D) budget that is 3% of Volkswagen’s.
For Western firms, Asia’s shortcomings have been a relief. The iPhone shows why: although it is made by
the hands of Chinese workers, it is the brains behind it, at Apple and at high-tech component-makers in the rich
world, that take nearly all the profits. Now, however, the rules that have governed Asian capitalism for the past two
decades are changing. Asian firms are having to become brainier, more nimble and more global.
The immediate motivation is underperformance: growth has slowed, and Asian shares have lagged
American ones by 40% in the past three years. Three deeper trends are also at work. First, labour costs are rising,
not least in China, and East Asia’s workforce is ageing. Second, Asia’s middle class is becoming more demanding.
They are no longer satisfied with fake Louis Vuitton handbags; they want clean air, safe food and more leisure, and
are madly in love with the internet. Third, competition has intensified from Western multinationals, which have
invested $2 trillion in Asia. They also now use the same cheapish labour, and they generally have much more
sophisticated supply chains, brands and R&D.
With their home markets no longer quite so safe, Asian firms are adapting—and becoming stronger. In
response to rising wages, production (of clothes, for example) is shifting from China to South-East Asia and Africa,
led by Japanese firms which are also worried about a war with the Middle Kingdom. Chinese firms such as Haier,
which makes fridges, plan to automate factories and get into cleverer products. And as the Chinese push upmarket,
the Koreans are redoubling efforts to stay ahead. Samsung’s spending on R&D rose by 24% in 2013. If they get
their act together, India and Indonesia, Asia’s bumbling giants, will attract lots of factory jobs. Their best firms are
also getting brainier. Once dismissed as “body shops”, India’s IT-outsourcing firms are now leaders in big data.
Rising consumer aspirations are helping internet firms disrupt traditional industries. Alibaba, a Chinese
internet giant, is expanding into banking, telecoms and logistics. Analysts think it might be worth $150 billion,
more than China’s steel industry. China’s drive to reform its state-owned firms is meant to make them more
responsive to customers. Xi Guohua, the boss of China Mobile, plans to give shares to his staff. Across Asia
demand for health care is likely to create a whole new generation of companies—the industry comprises only 4%
of the region’s stockmarket, compared with 12% in the rich world.
In order to challenge foreign rivals, Asian firms are globalising, following the example of Samsung and
Toyota. Lenovo, a thriving Chinese computer firm, has Western-style governance and many foreign staff. Huawei
has overtaken Ericsson in telecoms equipment. India’s Sun Pharma is now one of the world’s biggest generic-drugs
firms. Tencent, China’s Facebook, has hired the footballer Lionel Messi to advertise its services abroad. Sprawling
business houses are evolving into focused multinationals. Tata Sons is now a superb IT firm and luxury-car maker
tied to a ragbag of Indian assets.
Cereal killers
Asian business needs to do much more. Big firms are spending 50% more on R&D than five years ago, but
must get better at breakthrough innovations. Conglomerates must focus on a few areas where they can achieve
global scale. Governments can do their bit, by freeing state firms from meddling and ensuring that powerful
incumbents do not stifle entrepreneurs.
Western firms should pay attention. In some industries—aircraft manufacturing, for example—the barriers
to entry are still immense, but in other sectors brands and technology will no longer be a shield from emerging
Asian competition. The threat to low-paid Western jobs may recede. Haier’s Chinese workers are paid 25% of what
30
its American workers get, up from 5% in 2000. Instead it may be copywriters, scientists and designers who feel the
chill of competition from the East.
History suggests consumers will adapt fast. In 20 years, miracle cures for the old will come from Japan, the
best web apps from India and couture from China. And cornflakes, once a cutting-edge food, will be rivalled by
congee and dosas, sold in boxes by a global brand. Asian capitalism will change the world—even, maybe, what it
has for breakfast.
Дополнительные тексты для перевода offhand
The ECB and inflation
Please ease
May 6th 2014, 15:27 by P.W. | LONDON
A MONTH ago Mario Draghi, president of the European Central Bank, expressed irritation about advice to
get on with tackling low inflation that was dished out to the ECB on the eve of its monetary-policy meeting by
Christine Lagarde, head of the International Monetary Fund. This month it is the turn of the Organisation for
Economic Co-operation and Development to urge action ahead of the ECB’s council meeting on Thursday, which
will be held for a change in Brussels rather than Frankfurt.
Issuing its latest set of forecasts today, the OECD called upon the ECB to take “new policy actions” to
move inflation more decisively to target. It suggested in the first instance bringing down the ECB’s main lending
rate from 0.25%, where it has been since last November, to zero. It also advocated possibly taking the deposit rate
paid to banks for overnight funds they stash away at the central bank from zero, where it has stood since July 2012,
into negative territory.
The OECD accepts that there is a general disinflationary trend in the 34 mainly rich countries that belong to
it but it says that “disinflationary pressures are now strongest in the euro area”. Since September 2011 headline
inflation has fallen from 3.2% to 1.6% in March 2014 across the OECD, with most of the decline (1.25 percentage
points) because of moderation in energy prices. But the fall in the euro area over the same period has been greater,
from 3% to 0.5%, and though more favourable energy prices have again been the main reason, accounting for
three-fifths of the decline (1.5 percentage points), core inflation (excluding more volatile items like energy and
food) has contributed one percentage point to the fall.
As was the case in April, the ECB seems likely to disregard such well-meaning, if unsought, advice. One
reason is that inflation, though still worryingly low, has climbed off the floor of 0.5% that it reached in March,
returning to 0.7% in April. Though that is still a long way off the ECB’s target of “below but close to” 2%, the core
inflation rate has gone back to 1% after falling to 0.7% in March.
Another is accumulating evidence that the recovery is gathering momentum, which should eventually stave
off disinflationary pressures. Today’s retail-sales figures from Eurostat show that their volume rose by 0.7% in the
first quarter of 2014, whereas it had dropped by 0.5% in the final quarter of 2013. And the second quarter of this
year appears to have got off to a good start according to business surveys. Today’s final versions of the regular
purchasing-manager reports compiled by Markit, a research firm, confirm the upbeat picture painted in its
preliminary findings. A reading above 50 in these surveys represents expansion, one below 50 indicates
contraction. So it was encouraging that the composite index for the euro zone’s services and manufacturing output
reached 54 in April, almost a three-year high. In Spain, the euro zone’s fourth-biggest economy, which suffered a
harsh double-dip recession lasting over two years between the spring of 2011 and the summer of 2013 (leaving
31
output 7.4% lower than its pre-financial-crisis peak at the start of 2008), the index reached 56.3, the highest in more
than seven years.
The signs of strengthening recovery along with the somewhat better inflation figures are likely to satisfy
the ECB’s council sufficiently to postpone any big move for at least another month, until early June. That is the
expectation in the markets, where surveys show few economists tipping a rate cut on Thursday.
An advantage for the ECB in deferring a decision until June is that it will then have available its latest staff
forecasts for inflation. In March they showed inflation averaging 1% this year and 1.3% in 2015. These projections
already look outdated, especially for this year. The European Commission forecast on May 5th that consumer
prices would rise by 0.8% in 2014 and 1.2% in 2015. The OECD for its part envisages inflation of just 0.7% this
year rising to only 1.1% in 2015. That is a long time for inflation to be below and far away from 2% and raises the
risk that an unforeseen upset pushes the currency club into outright deflation, a nightmare for its many debt-laden
economies since falling prices raise the real burden of debt.
Euro-zone lowflation
Getting the message
Apr 3rd 2014, 17:09 by P.W. | LONDON
ON the eve of today’s monetary-policy meeting of the European Central Bank’s governing council,
Christine Lagarde, managing director of the International Monetary Fund, called for “more monetary easing
including through unconventional measures” in the euro area. Speaking today after the council had failed to follow
her advice, Mario Draghi, the ECB’s president, said how “extremely generous” the IMF was in proffering such
advice; and wondered whether it might extend the courtesy to other central banks, such as the Fed, the day before
its policy committee met.
Tiffs apart, the ECB does seem to be getting the message even though it left interest rates, its conventional tools,
unchanged today. With inflation dropping further in the euro zone to just 0.5% in March, Ms Lagarde had
highlighted the emerging risk of “lowflation”. Mr Draghi said that the council was unanimously committed to using
unconventional as well as conventional measures to “cope effectively with risks of a too prolonged period of low
inflation”. With little conventional ammunition left, since the ECB’s main lending rate is already just 0.25%, he
spelt out that the unconventional measures might include quantitative easing–buying assets with central-bank
money–as well as charging negative interest rates on overnight deposits left at the ECB by banks.
Tackling lowflation in the euro zone is thus a common cause. There is nonetheless a subtle difference in the
risks of a long period of weak inflation that are worrying the Washington-based IMF and the Frankfurt-based ECB.
For Ms Lagarde it is the damaging impact on demand and output; a prolonged period of low inflation can “suppress
growth and jobs”, she said on Wednesday. For Mr Draghi it is the possibility that lowflation may feed into inflation
expectations, dragging them down and thus making it harder to meet the ECB’s inflation target of “below but close
to” 2% over the medium-term.
In fact, that is not the only worry about lowflation. Another is that when inflation is so weak, it would take
only one further unfavourable shock to demand to tip the currency club into outright deflation, which would harm
growth by creating an incentive to postpone purchases and by exacerbating already onerous debt burdens in real
terms. A worsening in the Ukraine crisis resulting in trade sanctions that would hurt Europe as well as Russia could
be such a shock, points out Willem Buiter, chief economist of Citigroup. Revealingly, Mr Draghi highlighted the
possible repercussions of geopolitical risks for price stability.
Despite such concerns, the ECB is still sticking doggedly to its plan A, which relies on the economic
recovery strengthening sufficiently to combat disinflationary pressures. The upturn since last spring has been
sustained but feeble, with growth of 0.3% in the second quarter of 2013, 0.1% in the third, and 0.2% in the fourth
(revised down by Eurostat this week from 0.3%). Annualised, these rates were 1.3%, 0.6% and 0.9% respectively.
32
That’s nothing to write home about but the prospects for the first quarter of 2014 hold more promise. The
Bundesbank said recently that it expected “very strong” growth in Germany, which has been the engine of the
recovery. Output is now rising, though modestly, in Italy and Spain, the third and fourth biggest economies in the
euro zone, both of which took a beating during the long double-dip recession. Confidence and activity surveys
across the euro zone are also pointing to a solid performance. The European Commission’s economic-sentiment
indicator, which tends to track GDP growth, reached 102.4 in March, the highest for nearly three years, and above
its long-term average.
The sense of today’s meeting is that the ECB is prepared to give its plan A some more time, but not that
long. Although headline inflation dropped to 0.5% in March, core inflation (excluding more volatile elements like
energy and food) was somewhat higher, at 0.8%, in line with its average over the past six months. The timing of
Easter, which fell in March last year but is in April this year may have contributed to the weakness of headline
inflation in March since prices often tend to rise before the festival, an effect that happened a year ago but not last
month. This may in turn lead inflation to recover in April.
But if inflation in May is weaker than expected, then that could well prompt the council to move beyond
rhetorical threats and to act in June. One conventional step the ECB could take would be to cut its main lending rate
to just 0.1%. But if it does resort to unconventional measures, the most likely option would be to charge negative
interest rates on funds parked by banks at the ECB, which would help to stave off the unwelcome appreciation of
the euro that has contributed to weak inflation.
The euro-zone economy
Frost in spring
The recovery may be warming but inflation is cooling
Apr 5th 2014 | Finance and economics
VIEWED from one perspective, the euro area is a minor miracle. Instead of collapsing in a heap, as seemed
possible two years ago, the currency club is not just intact but has a new member, Latvia, which joined in January.
An economic recovery has been under way since last spring and appears to be strengthening. But seen from another
standpoint the euro zone is an accident waiting to happen. As inflation slips ever lower, a slide into Japanese-style
deflation looks increasingly likely. That would raise an already onerous debt burden in real terms and pull down
growth.
The actions of the European Central Bank (ECB) will be crucial if such an outcome is to be averted. The
ECB’s mission is to achieve price stability, and since 2003 it has interpreted this to mean an inflation rate over the
medium term of “below but close to” 2%. Yet despite a fall in annual inflation to just 0.5% in March, the central
bank was expected to hold its fire when its council met on April 3rd (after The Economist had gone to press).
Previously, it had lowered the main policy rate to 0.25% in November.
One reason for the ECB to wait was that underlying inflation, excluding more volatile elements such as
energy and food, has been broadly stable over the past six months, at around 0.8% (see chart). The council also sees
grounds for being patient and allowing its very low interest rates to take effect. It thinks that the recovery, which
started in the second quarter of 2013 after a double-dip recession lasting a year and a half, should eventually bring
inflation back towards the target.
Indeed, the once-sickly euro zone is losing some of its pallor. The recovery, though feeble, has nonetheless
been sustained. Output rose by 0.3% (an annualised rate of 1.3%) in the second quarter of 2013, and although
growth slowed to 0.1% in the third, it picked up to 0.2% in the fourth. More important, there are signs that the pace
may be accelerating this year.
33
Despite the crisis in Ukraine, euro-zone surveys of confidence and activity in the first three months of 2014
have been encouraging. The European Commission’s economic-sentiment indicator, based on what both businesses
and consumers are reporting, rose in March to 102.4, the highest since July 2011 and a little above the long-term
average of 100 since 1990; at the worst of the recession in late 2012 it had fallen to 85.8. The indicator tends to
track growth, which suggests that it is picking up. That chimes with surveys of manufacturing, compiled by Markit,
a data provider, which show the sector in the first quarter at its healthiest since the spring of 2011.
A reassuring feature of the recovery is that it is spreading to the once-afflicted countries of southern
Europe. Germany, which remains the main engine of growth in the euro zone, is likely to have expanded strongly
in the first quarter of 2014, according to the Bundesbank. But the recovery is also being boosted by a return to
growth, albeit sluggish, on the part of both Italy and Spain, the third- and fourth-biggest economies in the euro
zone.
The peripheral economies are benefiting from falling long-term interest rates. Ten-year government-bond
yields in Italy, Spain and Portugal are now lower than they were four years ago, shortly before the Greek crisis
flared up and led to the first bail-out (see chart). Remarkably, yields in Ireland, which exited its rescue programme
only last December, have fallen to their lowest since the euro started 15 years ago. Peripheral yields have been
dragged down both by the fall in German yields and the narrowing of their spreads over German bonds since the
height of the crisis. Although the spreads are still wider than before the crisis, their tightening reflects a broader
reassessment of risk: investors no longer shun peripheral Europe on fears of a euro-zone break-up, whereas they
fret about emerging markets.
Despite these promising developments, there is still a concern that the recovery may have come too late and be too
weak to avert the onset of deflation. Consumer prices are falling in several peripheral countries, notably Cyprus and
Greece, but also now in Spain, where in March they declined by 0.2% on a year earlier.
The advent of deflation in the euro-zone periphery can be seen as part of a one-off adjustment as the crisis
countries claw back lost competitiveness. But balefully high unemployment across the euro area will continue to
bear down on wages, which in turn will keep prices weak. The jobless rate in February remained at 11.9%, only
marginally down from its peak of 12% for much of 2013. Though unemployment has fallen over the past year from
already low levels in Germany and has declined in Spain, it has risen sharply in Italy.
Making matters worse, the strength of the euro, which has appreciated by 7% against the dollar in the past
year, is an endorsement the still vulnerable euro-zone economy could do without. For the time being the ECB is
choosing to fight disinflationary pressures through words and threats rather than deeds. But, as Christine Lagarde,
the head of the IMF, said on April 2nd, a long period of “lowflation” can be bad for growth and jobs. If inflation
weakens any further, the ECB will have to act.
34