mgimo.ru курс. Реферирование… · web viewthe economic meltdown has popularised...

CONTENTS

Part I. Globalisation. World trade.

1. Turning their backs on the world2. Educating globalisation’s Luddites*

3. The nuts and bolts come apart4. Here, there and everywhere5. What was mercantilism?6. Globalization Revolution*

7. Opening the floodgates8. Not so nano9. The redistribution of hope10. Is globalisation doomed?*

11. The rich and the rest12. The crescent and the company*

Part II. National economic policy.

13. Remember fiscal policy?14. Leviathan stirs again15. An astonishing rebound16. 70 or bust!17. Warmer inside

* Articles marked with an asterisk (*) are intended for offhand translation.

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Part I. Globalisation. World trade.

1. Turning their backs on the world

Task:1. Read the article.2. Make a précis and an annotation of the article.

The integration of the world economy is in retreat on almost every front

THE economic meltdown has popularised a new term: deglobalisation. Some critics of capitalism seem happy about it — like Walden Bello, a Philippine economist, who can perhaps claim to have coined the word with his book, “Deglobalisation, Ideas for a New World Economy”. There are those, however, who fear the results will be bad.

But is globalisation really ending? The world’s economies are certainly slowing fast. And the speed and scale of this recession are raising doubts about the assumptions that had underpinned the drive to integrate world markets. Nobody ever said, however, that globalisation had ended economic ups and downs, but this feels different: prima facie evidence of big problems at least, and possibly of the failure of globalisation to deliver many of its advertised benefits, especially to the poor. True, economic slowdown is not the same as deglobalisation. And the slowdown has yet to affect one thing. For years, poor countries have been growing faster than rich ones; so far, they still are. The gap between real GDP growth in emerging markets and in rich countries widened from nothing in 1991 to about five points in 2007. Helping poorer countries catch up has long been among the benefits touted for globalisation.

And yet the process is going into reverse. Globalisation means the global integration of the movement of goods, capital and jobs. Each of these processes is now in trouble. World trade has plunged. As recently as the first half of 2008, boosted by rising commodity prices and a falling dollar, trade was growing at an annualised 20% in dollar terms. In the second half of

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2008, as commodities sagged and the dollar rose, growth slowed fast; by September, says the IMF, it was in reverse. In December, says the International Air Transport Association, air-cargo traffic (responsible for over a third of the value of the world’s traded goods) was down 23% on December 2007 — almost double the fall in the year up to the end of September 2001, a result affected by the 9/11 terror attacks.

The downturn has been sharpest in countries that opened up most to world trade, especially East Asia’s tigers. Singapore’s exports are 186% of GDP; its economy shrank at an annualised rate of 17% in the last three months of 2008. Taiwan’s exports are over 60% of GDP; and its economy may fall as much as 11% this year. The downturn has also hurt rich countries that specialise in staid old-fashioned manufacturing — supposedly a safer activity than the reckless delusions of finance. On average, says the IMF, rich countries will contract 2% this year. But Germany and Japan, big exporters of capital goods, cars and electronics, will do worse, their economies shrinking by 2.5% and 2.6% respectively. In the last quarter their economies contracted alarmingly, falling at an annualised rate of 8% in Germany and by 13% — the worst since 1974 — in Japan.

Small countries which went into businesses that grew in globalisation’s wake, like tourism, are also suffering. The World Tourism Organisation says international tourist arrivals fell 1% in the second half of 2008, which may not sound bad, but compares with growth of more than 5% a year for the previous four years. In the Caribbean, visitors may fall by a third this season; in some islands hotels are half empty, flights are being cancelled and national budgets, reliant on tourism, are strained.

In contrast, the biggest emerging markets are doing less badly so far. In India, where exports are around 15% of GDP, the government recently said growth in the year to April would be 7.1%; most forecasters put growth for the whole calendar year lower, but still about 5%. In Brazil the economy has been harder hit by falling commodity prices and declining exports. Most economists still think output grew a bit in the year to the fourth quarter, and put full-year growth at 1.5% to 2%. China was still growing by 6.8% in the year to the fourth quarter, though like Brazil it is probably stagnating. Chinese exports fell 18% and imports 43% in the year to January. All three

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countries have large domestic markets and relatively stable banking systems, which have not been liberalised.

The gap between toothless tigers and friskier BICs (ie, BRICs minus Russia, a special case because of oil) raises questions not so much about globalisation as a whole — after all, Brazil, India and China have been beneficiaries — as about particular aspects. Can one be too dependent on trade? How far should one liberalise banking? Is there a trade-off between taking advantage of good times and providing shock absorbers for bad ones?

Emerging markets’ trade problems have been worsened by shifts in capital flows, globalisation’s second big plank. According to the World Bank, net private debt and equity flows to developing countries will fall from $1 trillion to $530 billion this year, or from 7.7% to 3% of those countries’ GDPs. The Institute for International Finance sees an even steeper fall; it says that this year banks will extract more from emerging markets in debt repayments than they inject in new loans. Bond markets in those countries collapsed in the last quarter of 2008, doing less than $5 billion of business; in the second quarter, they had issued about $50 billion of bonds.

As with trade, financial deglobalisation is hitting countries in a variety of ways. In this case, East Asia has been less affected because most countries there are net creditors. But eastern Europe and Russia have been hammered because local banks went on a foreign-borrowing binge, foreign banks piled into their markets (and piled out again) and because some countries lacked insurance policies against tough times. Although many big emerging markets have built up foreign-exchange reserves and cut their external debts, in eastern Europe reserves have been flat, external debts have risen and current-account deficits have grown considerably in the past decade. In these countries, the reversal of globalisation has exacerbated problems that were building up anyway.

People in emerging markets have mixed feelings about financial liberalisation and may not regret its reversal. But foreign direct investment (FDI) is different. Most people welcome new factories and new jobs. FDI is also one of the commonest routes by which skills and technology are transferred from rich to poor countries.

This, too, is falling. The United Nations Conference on Trade and Development (UNCTAD) says worldwide FDI inflows shrank 21% to $1.4

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trillion. The World Association of Investment Promotion Agencies says FDI will contract by a further 12-15% this year.

In contrast to trade, the investment impact of the global downturn has so far been hardest on the countries where the woes began: rich ones. They have seen FDI falls of one-third on average and by half or more in Britain, Italy and Germany. Finland and Ireland have seen net outflows. FDI flows to developing countries were still growing in 2008, albeit by only 4%, after a rise of 21% in 2007. Flows to big South American countries were up by about a fifth; those to India more than doubled, though they may ebb as GDP falters.

The third of the three main aspects of globalisation—jobs—is following the other two, with a lag. The International Labour Organisation forecasts that unemployment worldwide will rise by around 30m above 2007’s level. Most of that rise will be the result of recession, not deglobalisation, but some will be attributable to the fall in trade (exporting companies will lay off workers) and some to declining investment (if expansion plans are cut, new jobs will not be created).

Deglobalisation will have a dire impact on migrants. In the past decade, more people have been moving voluntarily than ever before; now, some are going home. Those who provided labour for the housing boom in America (notably Latinos), Ireland (Poles) and China (rural Chinese going to cities on the eastern seaboard) have been among the first to be laid off. In Spain newly jobless builders are competing with migrants there for jobs picking fruit.

This will surely have an effect on the flow of remittances from rich countries to poor ones, although it has so far been quite resilient. In any case, economies that absorbed large numbers of foreign workers may take fewer. Some of the millions of South Asians who work in the Gulf, or the young Africans who flock to South Africa, or the Central Asians who work in Russia, may have to stay at home.

Yet for all the economic pain, the social and political fallout from deglobalisation has not yet been severe. Protests may still come. Or maybe national governments are absorbing most of the ire. In December, Greece saw riots after a police bullet killed a teenager. In France, unions brought over 1m people onto the streets for a one-day strike, and a riot in Latvia over economic policy ended in more than 100 arrests. But only in Britain, where

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workers have picketed refineries and power stations over the hiring of foreigners, has protest had a very anti-global tone.

This lag may be explained by residual support for globalisation, especially in emerging markets. A poll by the Pew Global Attitudes Project found that majorities in 47 countries saw international trade as good for them; majorities in 41 out of 46 welcomed multinational firms; in 39 out of 47, most felt better off with a free market. In more than half the countries where changes could be tracked, support for free markets was rising.

When consensus wobblesBut is that still true? In summer 2008, on the eve of the meltdown,

European Union pollsters reported that two-thirds of EU citizens saw globalisation as profitable only for large firms, not citizens. In 2002, according to the Pew poll, 78% of Americans thought foreign trade helped the country; by 2007 it was only 59%. A CNN poll in July 2008 showed that, for the first time, a small majority of Americans saw trade as a threat, not an opportunity.

Of the few worldwide polls to have been completed since then, one by Edelman for the World Economic Forum found that 62% of respondents in 20 countries said they trusted companies less or a lot less now. Manifestly, popular opinion backs more state regulation.

So far, this has mostly taken the form of pouring public money into banks and selected industries, notably cars. Barack Obama set out plans for another vast bank rescue, and the French government promised €6 billion ($7.8 billion) in preferential loans to Renault and Peugeot-Citroën in return for pledges that no car factories would be closed in France.

There has been somewhat less evidence of trade protectionism. India has raised some steel tariffs. The EU has reintroduced export subsidies for some dairy products. Russia has raised import duties on vehicles. But there has also been movement the other way. The American Senate softened the “Buy America” provisions of the stimulus bill. Mexico said that by 2012 it would cut tariffs on thousands of kinds of manufacture. And some countries have sought a safe harbour, rather than embracing pure nationalism. East Europeans are even keener on the shelter of the euro; Iceland has applied to

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the EU; the Irish are more likely than they were to vote for the EU’s Lisbon treaty.

Despite the downturn, the nations of the world have not shunned globalisation. It has been protected by the belief of firms in the efficiency of global supply chains. But like any chain, these are only as strong as their weakest link. A danger point will come if firms decide that this way of organising production has had its day.

From The Economist

2. Educating globalisation’s Luddites*

Pre-reading question: What are Luddites? What do you know about their movement?

Task:1. Read the article and translate it into Russian.2. Make an annotation of the article.

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

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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

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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

3. The nuts and bolts come apart

Task:1. Read the article.2. Translate the section “Helpful ambiguity” into Russian.3. Make a précis and an annotation of the article.

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 imploded, prices collapsed and governments embarked on a destructive, protectionist spiral of higher tariffs and retaliation.

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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.

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The gears of globalizationThe 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.

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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 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

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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,

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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 ambiguityHowever, 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 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

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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.

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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

Discussion point: Speak on the current round of WTO negotiations (its history, conflicts,

progress of talks etc).

4. 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

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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 bought IBM’s ThinkPad personal-computer business in 2005 and is now by some measures the world’s biggest PC-maker, 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

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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.

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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.

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 circleEven General Electric is reversing its course in some important areas of

its business. In the 1990s it had pioneered the offshoring of services, setting

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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

5. 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

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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.

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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 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

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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.

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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.

6. Globalization Revolution*

Pre-reading question: What do the terms “Washington Consensus” and “neo-mercantilism”

describe?


In the wake of the economic crisis, most of the discussion has been about stimulus, reforms, and bankers' pay. Yet the big story is the reordering of power and the advent of a radically new form of globalization.

For the first time, the United States and Europe have had to rely on emerging economies to overcome a crisis. The perception that the meltdown was caused by U.S.-style capitalism has greatly diminished America's prestige. The Washington Consensus is dead, and the West no longer has a monopoly on the solutions to global governance.

Meanwhile, the crisis has highlighted fissures in Europe's architecture and the limits of integration. The lack of a coordinated response has been

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striking. Although the EU emerged from recession ahead of the U.S., unemployment is expected to increase in almost every EU country. Debt levels have risen substantially as a result of the stimulus, and will be exacerbated by rising welfare costs owing to the aging population. Resurgent state intervention will worsen the rigidity of Europe's economies and hamper entrepreneurship. The picture for the next few years is of slow growth, high unemployment, and high public debt.

Also passing is an economic phase best described as "Asia and Germany make and America takes." The real cause of the crisis was not bankers' greed but imbalances in global savings, investment, and trade that have been widening for 20 years. These were the result of the symbiosis between the high-consumption, laissez-faire Anglo economies and the export-led, neo-mercantilist economies of East Asia and Germany. The enormous trade surpluses accumulated by the big exporters, coupled with the widening U.S. deficits and the enormous capital flows necessary to finance them, led to a huge distortion of both interest rates and risk management. The system was unsustainable and duly collapsed.

This has sparked all kinds of discussions about the need for Anglo countries to consume less and produce and export more, and neo-mercantilists to do the opposite. Such talk is comforting, but so far the major players have done nothing to execute it. Even if leaders did decide to reverse their priorities, moreover, it's not clear they could. We are speaking, after all, of a tectonic shift in the global economic structure that would mean a similar shift in political power.

Yet that shift must come; the days of export-led growth will soon be over. This will not mean an end to globalization, but it will revolutionize the game.

China has become the point of final assembly of a regionally integrated Asian manufacturing system. Many businesses are now reassessing their dependency on such systems, and increased transportation costs will intensify the process. Production is likely to move closer to end markets. That means a shift toward more regional and national supply chains.

The likely result is that we will see a fragmentation of economic models. The time when globalization meant Americanization is over; the compact of a market economy and political democracy has been buried. We

25

may see a return to greater state intervention and even authoritarianism instead, as the China-Singapore model gains greater acceptance. Even Europe has become more cautious about promoting freer markets.

The resulting world will be much more multifaceted and messy. The shift to a G20 has been welcome, but it will also mean a less wieldy system of global governance. Nationalism will rise, as even the U.S. may become less interested in securing global goods than in its own revitalization.

If it's all to turn out well, leaders must learn to play this very new and complicated game. The fiasco of the last climate summit underlines not only the urgency of the process, but also how hard it will be.

From Newsweek

7. Opening the floodgates


Imports can be as useful to developing countries as exports arePAUL KRUGMAN, who won the Nobel prize in economics in 2008 for

his work on trade, wrote in 1993: “What a country really gains from trade is the ability to import things it wants. Exports are not an objective in and of themselves; the need to export is a burden that a country must bear because its import suppliers are crass enough to demand payment.”

This view does not dominate the public debate. Most are thrilled by the idea of export growth, but cower at the prospect of more imports. Such prejudice certainly prevailed in India in 1991, when the IMF foisted tariff cuts on the economy as one of the conditions attached to a $2.5 billion bail-out package. Pessimists fretted that a flood of imports would destroy Indian industry.

For a group of American economists, however, that sudden trade liberalisation has provided an unusually clear lens through which to study the

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way that commerce affects the economy. This is precisely because it was externally imposed. That the government had to hew to the IMF’s diktats and slash tariffs across the board gave industries little scope to jockey for exemptions. This made the researchers confident that tariff cuts, and not differences in industries’ ability to lobby the government, were responsible for changes in India’s trade patterns after liberalisation.

As part of those reforms, India slashed tariffs on imports from an average of 90% in 1991 to 30% in 1997. Not surprisingly, imports doubled in value over this period. But the effects on Indian manufacturing were not what the prophets of doom had predicted: output grew by over 50% in that time. And by looking carefully at what was imported and what it was used to make, the researchers found that cheaper and more accessible imports gave a big boost to India’s domestic industrial growth in the 1990s.

This was because the tariff cuts meant more than Indian consumers being able to satisfy their cravings for imported chocolate (though they did that, too). It gave Indian manufacturers access to a variety of intermediate and capital goods which had earlier been too expensive. The rise in imports of intermediate goods was much higher, at 227%, than the 90% growth in consumer-goods imports in the 13 years to 2000.

Theory suggests several ways in which greater access to imports can improve domestic manufacturing. First, cheaper imports may allow firms to produce existing goods using the same inputs as before, but at a lower cost. They could also open up new ways of producing existing goods, and even allow entirely new goods to be made. All this seemed to hold in India. For example, its prolific film industry had continued to make some black-and-white films into the 1970s, in part because of the difficulty of importing enough supplies of colour film. But proving whether the theory applies in practice requires more detailed data, not just about how much firms produced but what they produced, and how all this changed over time.

Most attempts at addressing these questions have foundered because such information is not available. But with India, the researchers were helped, perversely enough, by highly restrictive industrial policies that the country had introduced in the 1950s. These included rules that required companies to report to the authorities every little tweak to their product mix — a burden for firms, but a gold mine for researchers. Happily, the

27

economists found that the data backed up the theory: lower import tariffs did lead to an expansion in product variety through access to new inputs. They found that about 66% of the growth in India’s imports of intermediate goods after liberalisation came from goods the country had simply not bought when its trade regime was more restrictive. These new inputs caused the price of intermediate goods to fall by 4.7% per year after 1989. And detailed data linking inputs to final goods showed that the imports led to an explosion in the variety of products made by Indian manufacturers; the average firm made 1.4 products before liberalisation, but by 2003, this had increased to 2.3. The increases in variety were largest for industries where the input tariffs were cut most, and these industries also saw increased spending on research and development. Overall, the new products that Indian companies introduced were responsible for 25% of the growth in the country’s manufacturing output between 1991 and 1997.

Slash and churnBut one aspect of India’s experience after trade liberalisation did not

conform to what the researchers had expected. Normally, as new products are introduced, some older ones stop being made. This “churn” in the market is part of what makes people uncomfortable about lower trade barriers, because it may cause difficult adjustments for some workers or companies. But the Indian variant of creative destruction seemed unusually benign. The researchers found that firms rarely dropped products. One reason for this may be the diversity of India’s economy: there is always a segment lower down the economic pecking order which is happy to buy products that richer consumers scoff at.

This may be unique to countries like India where many levels of development co-exist. But Penny Goldberg, one of the authors, thinks that the methods used in the studies on India can be applied to many other countries where trade has been similarly liberalised and which have good data on firms, such as Colombia and Indonesia. She notes that one of her co-authors, Amit Khandelwal, visited a Coca-Cola bottling plant in China, and noticed that all the machinery was either Japanese or German. China, of course, is known as a big exporter. But it may never have achieved this success without access to a range of imports.

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From The Economist

8. Not so nano


The financial crisis may have strengthened the hand of the developing world’s emerging giants

THE world’s cheapest car, the Tata Nano — launched in Mumbai in a burst of flashbulbs and national pride — has turned the spotlight once again on the developing world’s emerging multinationals. From ArcelorMittal in steel to ZTE in telecoms, ambitious companies from India, China and other developing nations have marched onto the global stage in recent years, spooking the rich world’s established multinationals with innovative products and bold acquisitions. The Nano is a symbol of the ambition of these emerging giants.

But much has changed since Tata Motors first took the wraps off their tiny car. The financial crisis, collapsing stockmarkets and plunging commodity prices have hit companies in rich and poor countries alike. Tata Motors, which bought Jaguar Land Rover, a British premium carmaker, from Ford for $2.3 billion, now faces the difficulty of refinancing its debt, and was downgraded by Standard & Poor’s. Does this mean that the threat to established giants from emerging-market giants has receded?

Far from it. The crisis has strengthened the relative position of the emerging giants, for several reasons. First, as companies and consumers around the world cut costs and trade down, the emerging giants’ low-cost production models, based on cheap local labour, provide even more of an advantage. Second, even though growth in developing countries has slowed, it has not vanished altogether, so the emerging giants can fall back on their domestic markets. Car sales have collapsed in the rich world, for example,

29

but are still growing in many developing countries: they are expected to increase by 10% this year in China, for instance.

Third, many rich-country multinationals have become much more inward-looking as they struggle to cope with the recession, and are less able to invest to defend their market positions, providing opportunities for disruptive new entrants. Again, a good example is that of carmaking, where the convulsions of the established giants, and the switch to greener technologies, give newcomers an opening. Ratan Tata, the boss of the Tata Group, spoke of his ambitions to sell the Nano not just in Europe, but eventually in America, too. The electric car made by BYD, a Chinese battery-maker that branched into carmaking a few years ago, was the talk of the Detroit motor show in January.

Furthermore, many cash-strapped multinationals in the rich world are now trying to sell bits of themselves to raise capital, giving buyers in the developing world a chance to pick up technology, brands and other assets, says Harold Sirkin of the Boston Consulting Group, whose book “Globality” charts the rise of the emerging giants. Two Chinese carmakers, Chery and Geely, are interested in buying Volvo from Ford. Mahindra & Mahindra, an Indian maker of utility vehicles, is in the running to buy LDV, an ailing British truckmaker; there is also talk of a possible Chinese bid. Vale, Brazil’s mining giant, recently picked up a clutch of assets from Rio Tinto, its debt-laden Anglo-Australian rival. And ZTE, a fast-growing Chinese telecoms-equipment company with customers in over 60 countries, has been mooted as a possible buyer of the handset division of Motorola, the ailing American firm that ZTE is on the verge of evicting from the industry’s top five.

They’re behind youThere are, of course, weak points among emerging-market giants.

Some, including TataMotors, overextended themselves when commodity prices were high and credit was easy to come by. Mexico’s Cemex, the world’s third-largest cement firm, is selling assets around the world as it struggles to meet its debt repayments. ArcelorMittal, the world’s biggest steelmaker, which grew into a global giant from its roots in Indonesia, Trinidad and Mexico, launched a $1.5 billion convertible-bond issue to

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refinance some of its debt. But plenty of rich-world multinationals made the same mistakes and face similar problems, or worse.

The emerging giants of the developing world are still a rising force during the good times. The launch of the Nano serves to remind rich-world bosses that they still need to keep an eye on their rear-view mirrors.

From The Economist

9. The redistribution of hope


Optimism is on the move—with important consequences for both the hopeful and the hopeless

“HOPE” is one of the most overused words in public life, up there with “change”. Yet it matters enormously. Politicians pay close attention to right-track/wrong-track indicators. Confidence determines whether consumers spend, and so whether companies invest. The “power of positive thinking”, as Norman Vincent Peale pointed out, is enormous.

For the past 400 years the West has enjoyed a comparative advantage over the rest of the world when it comes to optimism. Western intellectuals dreamed up the ideas of enlightenment and progress, and Western men of affairs harnessed technology to impose their will on the rest of the world. The Founding Fathers of the United States, who firmly believed that the country they created would be better than any that had come before, offered citizens not just life and liberty but also the pursuit of happiness.

Not that the West was free of appalling brutality. Indeed, the search for Utopia can bring out the worst as well as the best in mankind. But the notion that the human condition was susceptible to continual improvement sat more comfortably with Western scientific materialism than with, say, the caste system in India or serfdom in Russia.

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Now hope is on the move. According to the Pew Research Centre, some 87% of Chinese, 50% of Brazilians and 45% of Indians think their country is going in the right direction, whereas 31% of Britons, 30% of Americans and 26% of the French do. Companies, meanwhile, are investing in “emerging markets” and sidelining the developed world. “Go east, young man” looks set to become the rallying cry of the 21st century.

Desperation RoadThe West’s growing pessimism is reshaping political life. The mood in

Washington is as glum as it has been since Jimmy Carter argued that America was suffering from “malaise”. The Democrats’ dream that the country was on the verge of a 1960s-style liberal renaissance foundered in the mid-terms. But the Republicans are hardly hopeful: their creed leans towards anger and resentment rather than Reaganite optimism.

Europe, meanwhile, has seen mass protests, some of them violent, on the streets of Athens, Dublin, London, Madrid, Paris and Rome. If the countries on the European Union’s periphery are down in the dumps it is hardly surprising, but there is pessimism at its more successful core too. The bestselling book in Germany is Thilo Sarrazin’s “Germany Does Away with Itself”, a jeremiad about the “fact” that less able women (particularly Muslims) are having more children than their brighter sisters. French intellectuals will soon have Jean-Pierre Chevènement’s “Is France Finished?” on their shelves alongside Eric Zemmour’s “French Melancholy”.

The immediate explanation for this asymmetry is the economic crisis, which has not just shaken Westerners’ confidence in the system that they built, but also widened the growth gap between mature and emerging economies. China and India are growing by 10% and 9%, compared with 3% for America and 2% for Europe. Many European countries’ unemployment rates are disgraceful even by their own dismal standards: 41% of young Spaniards are unemployed, for example. And the great American job machine has stalled: one in ten is unemployed and more than a million may have given up looking for work. But the change goes deeper than that—to the dreams that have propelled the West.

For most of its history America has kept its promise to give its citizens a good chance of living better than their parents. But these days, less than

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half of Americans think their children’s living standards will be better than theirs. Experience has made them gloomy: the income of the median worker has been more or less stagnant since the mid-1970s, and, thanks to a combination of failing schools and disappearing mid-level jobs, social mobility in America is now among the lowest in the rich world.

European dreams are different from American ones, but just as important to hopes of a peaceful and prosperous future. They come in two forms: an ever deeper European Union (banishing nationalism) and ever more generous welfare states (offering security). With the break-up of the euro a possibility, and governments sinking under the burden of unaffordable entitlements as their populations age and the number of workers contracts, those happy notions are evaporating.

Shift happens In the emerging world, meanwhile, they are not arguing about pensions,

but building colleges. China’s university population has quadrupled in the past two decades. The proportion of scientific researchers based in the developing world is increasing. World-class companies such as India’s Infosys and China’s Huawei are beating developed-country competitors.

The rise of positive thinking in the emerging world is something to be welcomed—not least because it challenges the status quo. Nandan Nilekani of Infosys says that his company’s greatest achievement lies not in producing technology but in redefining the boundaries of the possible. If people in other countries take those ideas seriously, they will make life uncomfortable for gerontocrats in China and Arabia.

But there are dangers, too. Optimism can easily become irrational exuberance: asset prices in some emerging markets have risen too high. And there is a danger of a Western backlash. Unless developing countries start taking their responsibility for global security seriously, Americans and Europeans may begin to wonder why they are policing the world to keep markets open for others to get rich.

As for the Westerners’ gloom, it has its uses. There is a growing recognition that the old rich world cannot take its prosperity for granted—that it will be overtaken by hungrier powers if it fails to deal with its structural problems. Americans are beginning to accept that their country

33

must become less spendthrift. Europeans are realising that they need to make their economies more agile and innovative. Both are beginning to treat this crisis as the opportunity that it is.

Nor should Westerners overdo the despair, for the emergence of new great powers will benefit them, too. True, their governments will find it harder to boss the rest of the world around; their most desirable properties will increasingly be owned by foreigners; their children will have to work harder to get good jobs in an increasingly globalised economy. But the rising number of Indians, Chinese and Brazilians who can afford to buy their products and services will help their companies prosper. The countries that have provided them with workers will increasingly provide them with customers too.

It may not feel like it in the West, but this is, in many ways, the best of times. Hundreds of millions are climbing out of poverty. The internet gives ordinary people access to information that even the most privileged scholar could not have dreamed of a few years ago. Medical advances are conquering diseases and extending lifespans. For most of human history, only a privileged few have reasonably been able to hope that the future would be better than the present. Today the masses everywhere can. That is surely reason to be optimistic.

From The Economist

10. Is globalisation doomed?*


According to its critics, globalisation has a lot to answer forIN CHOOSING the World Trade Centre for their principal target, the

terrorists were striving not merely to kill as many Americans as they could, but also to tear down a potent symbol of America's economic might, of its

34

ideas and values, of capitalism. The shock of this and many other attacks and the war on terrorism, as many believe, have put the West's faith in market economics to the test. Is it right to see it as merely a brief swerve in sentiment? Or does the terrorist “backlash” against the ideology of America and the West, if that is what it was, demand a deeper response — a reappraisal, even, of that very ideology?

Some in the West are arguing that it does. John Gray, a professor at the London School of Economics and a much-quoted thinker on these matters, spoke for many when he declared that the era of globalisation is over. “The entire view of the world that supported the markets' faith in globalisation has melted down... Led by the United States, the world's richest states have acted on the assumption that people everywhere want to live as they do. As a result, they failed to recognise the deadly mixture of emotions — cultural resentment, the sense of injustice and a genuine rejection of western modernity—that lies behind the attacks on New York and Washington... The ideal of a universal civilisation is a recipe for unending conflict, and it is time it was given up.”

Wicked and dangerousIs there no limit to the crimes for which globalisation must be held to

account? Not only does it oppress the consumers of the rich West, undermine the welfare state, emasculate democracy, despoil the environment, and entrench poverty in the third world; we knew all that already. In addition, it is a utopian scheme for global ideological conquest. Truly, the idea that people should be left free to trade with each other in peace must be the most wicked and dangerous doctrine ever devised.

Either that, or a lot of people are talking nonsense. In fact, this is a distinct possibility. Western governments do a poor job of explaining and defending globalisation — so poor as to breed disaffection with democratic politics. This does not alter the fact that the substantive charges of the anti-globalists fail to stand up. Globalisation undermines neither the welfare state nor democracy; it is entirely consistent with sound environmental policies; above all, far from increasing poverty in the third world, it is the most effective force for reducing poverty known to mankind.

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But what about the view that globalisation is a kind of cultural conquest? This too is plainly wrong. Under a market system, economic interaction is voluntary. This is the market's greatest virtue, greater by far than its superior productivity. So there is no reason to fear that globalisation itself threatens traditional non-western cultures, such as Islam, except in so far as individual freedom threatens them. McDonald's does not march people into its outlets at the point of a gun. Nike does not require people to wear its trainers on pain of imprisonment. If people buy those things, it is because they choose to, not because globalisation is forcing them to.

In some countries, governments may see globalisation as a threat to their power as tyrants. They probably overstate the danger, but in any case we leave Mr Gray to speak for them. Where governments reflect the preferences and beliefs of most citizens, democratically or otherwise, and where those preferences call for cultural distinctness and non-western values, economic integration does not militate against diversity, least of all against religious diversity. In the West, globalisation has been running at full power for years. Has it mashed the United States, France, Italy, Germany, Sweden and Japan into a homogeneous cultural putty? It has not, and there is no reason why it ever should.

This is not to say that the future of globalisation is assured. Far from it. Economic liberty suffered a terrible reverse in the 1930s, thanks to war, financial breakdown and bad government. That brought one era of globalisation to an end, and history could repeat itself. Let us at least agree, however, that if governments allow this to happen it would be a tragedy — and not for the rich West, first and foremost, but for all the poor of the developing world.

From The Economist

Discussion point: Do you agree with the authors of the article and the arguments they make

to defend the benefits of globalisation? Give reasons.

11. The rich and the rest

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What to do (and not do) about inequalityAPART from being famous and influential, China’s president, Britain’s

prime minister, America’s second-richest 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 muddledThe 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.

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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

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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 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 DavosThese 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

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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

Discussion points: Do you consider inequality and income disparities to be a major threat to

sustainable economic development? What, in your opinion, should be done to combat inequality? Do you share

the authors’ opinion on the matter?

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12. The crescent and the company*


A scholar asks some profound questions about why the Middle East fell behind the West

IN 2002 a group of Arab scholars produced a brave report, under the auspices of the United Nations, on the Arab world’s twin deficits, in freedom and knowledge. A salutary debate ensued. Not long ago, Timur Kuran, a Turkish-American economist based at Duke University, wrote an equally brave book on “how Islamic law held back the Middle East”. One can only hope that the result will be an equally salutary debate.

For most of its history the Middle East was just as dynamic as Europe. The great bazaars of Baghdad and Istanbul were full of fortune-seekers from hither and yon. Muslim merchants carried their faith to the far corners of the world. In the 1770s Edward Gibbon had little difficulty imagining Islamic theology being taught in Oxford and across Britain—if only the battle of Tours-Poitiers in 732 had turned out differently.

But even before Gibbon the balance of power had shifted. Angus Maddison has calculated that in the year 1000 the Middle East’s share of the world’s gross domestic product was larger than Europe’s—10% compared with 9%. By 1700 the Middle East’s share had fallen to just 2% and Europe’s had risen to 22%.

The standard explanations for this decline are all unsatisfactory. One is that the spirit of Islam is hostile to commerce. But if anything Islamic scripture is more pro-business than Christian texts. Muhammad was a merchant, and the Koran is full of praise for commerce. A second explanation is that Islam bans usury. But so do the Torah and the Bible. A third—popular in the Islamic world—is that Muslims were victims of Western imperialism. But why did a once-mighty civilisation succumb to the West?

In “The Long Divergence” Mr Kuran advances a more plausible reason. The Middle East fell behind the West because it failed to produce commercial institutions—most notably joint-stock companies—that were

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capable of mobilising large quantities of productive resources and enduring over time.

Europeans inherited the idea of the corporation from Roman law. Using it as a base, they also experimented with ever more complicated partnerships. By 1470 the house of the Medicis had a permanent staff of 57 spread across eight European cities. The Islamic world failed to produce similar innovations. Under the prevailing “law of partnerships”, businesses could be dissolved at the whim of a single partner. The combination of generous inheritance laws and the practice of polygamy meant that wealth was dispersed among numerous claimants.

None of this mattered when business was simple. But the West’s advantage grew as it became more complicated. Whereas business institutions in the Islamic world remained atomised, the West developed ever more resilient corporations—limited liability became widely available in the mid-19th century—as well as a penumbra of technologies such as double-entry book-keeping and stockmarkets.

How much does this matter for modern business? From the late 19th century onwards Middle Eastern politicians borrowed Western institutions in order to boost economic growth. In the 1920s Ataturk introduced a thoroughly secular legal system in Turkey. Today the Islamic world boasts muscular companies and hectic stockmarkets (the market capitalisation of the region’s three biggest countries, Turkey, Egypt and Iran, doubled between 2003 and 2008). Dubai is laying out a red carpet for the world’s companies. Turkey is growing much faster than Greece.

Yet the “long divergence” continues to shape the region’s business climate. Most obviously, the Middle East has a lot of catching up to do. Income per head is still only 28% of the European and American average. More than half the region’s firms say limited access to electricity, telecoms and transport is a problem for business. The figure in Europe is less than a quarter.

There are more subtle echoes. Business across the region remains intertwined with the state while the wider commercial society is weak. The Global Entrepreneurship Monitor suggests that rates of entrepreneurship are particularly low in the Middle East and north Africa. Transparency International’s corruption-perceptions index suggests that corruption is rife:

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last year, on a scale from one (the worst) to ten, Western Europe’s five most populous countries received an average score of 6.5, whereas the three most populous countries in the Middle East averaged 3.2 (Turkey scored 4.4, Egypt 3.1 and Iran 2.2).

Culture’s long shadowThe “long divergence” also helps to explain some of the Islamist rage

against capitalism. Traditional societies of all kinds have been uncomfortable with corporations which, according to Edward Thurlow, an 18th-century British jurist, have “neither bodies to be punished, nor souls to be condemned”. But that unhappiness has been particularly marked in the Middle East. Corporations and other capitalist institutions were imported by progressive governments that believed the region faced a choice between Mecca and modernisation. Local businesses—particularly capital-intensive ones such as transport and manufacturing—were dominated by Jews and Christians who were allowed to opt out of Islamic law.

Mr Kuran’s arguments have broad implications for the debate about how to foster economic development. He demonstrates that the West’s long ascendancy was rooted in its ability to develop institutions that combined labour and capital in imaginative new ways. The Protestant work ethic and the scientific revolution no doubt mattered. But they may have mattered less than previously thought. People who want to ensure that economic development puts down deep roots in emerging societies would be well advised to create the institutional environment in which Thurlow’s soulless institutions can flourish.

From The Economist

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Part II. National economic policy.

13. Remember fiscal policy?

Pre-reading questions:1. What fiscal policy instruments can you name?2. What changes of fiscal policy are referred to as automatic stabilisers?


How to use fiscal policy in a recessionTHE standard objections to the use of fiscal policy—ie, changes in

budget deficits or surpluses—to dampen the economic cycle take two main forms. First are economic arguments that fiscal policy will have less of an effect on the economy than its advocates suppose, or even no effect at all. Second are political arguments that, even if taking the right fiscal steps would help the economy, governments are incapable of designing the right measures or enacting them at the right time. The endless squabbling in Washington which takes place any time an economic-stimulus bill is proposed seems to confirm the truth of this second claim: so far as one can tell, by the time a bill emerges from Congress, it will almost certainly be both badly designed and too late. Evidently, activist fiscal policy is best left alone; monetary policy is a better counter-cyclical tool.

And so it is, usually. When it works, monetary policy is fine. But sometimes it does not work. Problems arise, especially, under the circumstances that most interested Keynes when he first developed his thinking on deficit spending as a cure for recession—that is, at times of low, or even negative, inflation.

Thinking about how to conduct macroeconomic policy under such circumstances used to be an academic, even unreal, exercise. For years, up to the 1990s, inflation was high. So nominal interest rates were also high, on

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average, over the course of the cycle, giving monetary policy plenty of room for manoeuvre. But when inflation and nominal rates are low, the scope for monetary relaxation is more limited—or at any rate, less obvious. Certain kinds of recession may also be less susceptible to lower interest rates. All this suggests that fiscal policy deserves another look.

Consider first the economic argument—the claim that fiscal stimulus is ineffective, because people adjust their behaviour to cancel it out. The strongest version of this idea is due to Robert Barro who developed a theory that, if governments cut taxes or increase spending, consumers will increase their saving (because they expect higher taxes in future) so as to offset the stimulus entirely. But although this remains an intriguing and influential insight—it spawned an enormous theoretical literature—there is little evidence that it is true.

A smooth ideaHowever, there is more to fiscal scepticism than Mr Barro. Too much

public borrowing may raise long-term interest rates, offsetting the stimulus in a milder way. Such crowding out happens, the evidence shows, but only partially. Simple theory suggests another objection. People will prefer to smooth out their spending over time, rather than swing between famine and feast. So if the government enacts a once-off tax rebate, theory would lead one to expect that people would spread increased consumption over time, rather than go out and binge. In that case, a fiscal stimulus might be smoothed so much that it would have hardly any effect in the short term, when it is needed, but continue to boost spending later, when that may be the opposite of what is required.

In his article "Reviving Fiscal Policy" Laurence Seidman of the University of Delaware looked at recent evidence on the smoothing idea. The consensus is good news for fiscal policy: people do not smooth nearly as much as they “should”. The studies suggest a variety of reasons for this. Most consumers may be too uncertain about the future to plan much ahead. Or they may lack the wealth or borrowing capacity to make smoothing work, and are therefore accustomed to living paycheque by paycheque. In any event, the evidence is that consumption smoothing does not neutralise the stimulus effect of tax cuts.

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One would expect public spending to have an even bigger initial stimulative effect than tax cuts (because in this case none of the initial stimulus is saved). But spending is highly vulnerable to delay. Planning and administering a big rise in spending, and organising political support for it, are likely to take far longer than is required to arrange a tax rebate. Temporary increases in, say, support for the unemployed make better sense, in this respect, than programmes of public works. In any case, if counter-cyclical fiscal policy is to work, speed is crucial.

To that end, Mr Seidman discusses ways in which counter-cyclical fiscal policy, at least in America, could be made more automatic, either by having Congress pre-approve tax rebates that could be triggered by economic data, or by setting up an independent board (in its relationship to Congress, rather like the Federal Reserve) with powers to make limited changes to tax rates in response to economic circumstances. It all seems very ambitious. Politicians, whose privileges are at stake, will not be keen. But there is no denying that, now and then, arrangements such as this would be nice to have ready.

At least governments should open their minds to the idea that the fiscal option needs to be restored. Automatic or independent fiscal-policy adjustment (on top of so-called automatic stabilisers that operate in any case) may be difficult to develop. But once a country has achieved a reasonably sound long-term fiscal position, its government should regard that as an asset that can be drawn upon. Surpluses are not an end in themselves. Budget balance on average, together with wide and well-timed fluctuations around the average according to circumstances, is clearly the policy to aim for.

From The Economist

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14. Leviathan stirs again

Pre-reading questions:1. What does laissez-faire principle implies? Where does the phrase stem from?2. What historic event is referred to as the Boston Tea Party? What do you know about the Tea Party movement in the US nowadays?


The return of big government means that policymakers must grapple again with some basic questions. They are now even harder to answer

Back in 1990s it seemed that the great debate about the proper size and role of the state had been resolved. In Britain and America alike, Tony Blair and Bill Clinton pronounced the last rites of “the era of big government”. Privatising state-run companies was all the rage. The Washington consensus reigned supreme: persuade governments to put on “the golden straitjacket”, in Tom Friedman’s phrase, and prosperity would follow.

Today big government is back with a vengeance: not just as a brute fact, but as a vigorous ideology. Britain’s public spending is set to exceed 50% of GDP. America’s financial capital has shifted from New York to Washington, DC, and the government has been trying to extend its control over the health-care industry. Huge state-run companies such as Gazprom and PetroChina are on the march. Nicolas Sarkozy, having run for office as a French Margaret Thatcher, not long ago argued that the main feature of the credit crisis is “the return of the state, the end of the ideology of public powerlessness”.

“The return of the state” is stirring up fiery opposition as well as praise. In America the Republican Party’s anti-government base is more agitated than it has been at any time since the days of the Gingrich revolution in 1994. “Tea-party” protesters have been marching across the country with an amusing assortment of banners and buttons: “Born free, taxed to death” and

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“God only requires 10%”. On January 19th Scott Brown, a Republican, captured the Massachusetts Senate seat long held by the late Ted Kennedy, America’s most prominent supporter of big-government liberalism.

Many European countries have devoted a high proportion of their GDP to public spending for years. And many governments cannot wait to get out of their new-found business of running banks and car companies. But the past decade has clearly produced changes which, taken cumulatively, have put the question of the state back at the centre of political debate.

The obvious reason for the change is the financial crisis. As global markets collapsed, governments intervened on an unprecedented scale, injecting liquidity into their economies and taking over, or otherwise rescuing, banks and other companies that were judged “too big to fail”. A few months after Lehman Brothers had collapsed, the American government was in charge of General Motors and Chrysler, the British government was running high street banks and, across the OECD, governments had pledged an amount equivalent to 2.5% of GDP.

The crisis upended conventional wisdom about the relative merits of governments and markets. Where government, in Ronald Reagan’s aphorism, was once the problem, today the default villain is the market. Free-marketeers such as Alan Greenspan, the former head of the Federal Reserve, have apologised for their ideological zeal. A line from Rudyard Kipling sums it up best: “The gods of the market tumbled, and their smooth-tongued wizards withdrew”.

Yet even before Lehman Brothers collapsed the state was on the march—even in Britain and America, which had supposedly done most to end the era of big government. Gordon Brown, Britain’s chancellor and later its prime minister, began his ministerial career as “Mr Prudent”. During Labour’s first three years in office public spending fell from 40.6% of GDP to 36.6%. But then he embarked on an Old Labour spending binge. He increased spending on the National Health Service by 6% a year in real terms and boosted spending on education. During Labour’s 13 years in power two-thirds of all the new jobs created were driven by the public sector, and pay has grown faster there than in the private sector.

In America, George Bush did not even go through a prudent phase. He ran for office believing that “when somebody hurts, government has got to

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move”. And he responded to the terrorist attacks of September 11th 2001 with a broad-ranging “war on terror”. The result of his guns-and-butter strategy was the biggest expansion in the American state since Lyndon Johnson’s in the mid-1960s. He added a huge new drug entitlement to Medicare. He created the biggest new bureaucracy since the second world war, the Department of Homeland Security. He expanded the federal government’s control over education and over the states. The gap between American public spending and Canada’s has tumbled from 15 percentage points in 1992 to just two percentage points in 2010.

The public’s demandsThe expansion of the state in both Britain and America met with

widespread approval. The opposition Conservative Party applauded Mr Brown’s increase in NHS spending. Mr Bush met no significant opposition from his fellow Republicans to his spending binge. It was clear that, when it came to their own benefits, suburban Americans wanted government on their side. A banner at one of those tea-parties sums up the confused attitude of many of the so-called anti-government protesters: “Keep the government’s hands off my Medicare.”

The demand for public services will soar in the coming decades, thanks to the ageing of the population. The United Nations points out that the proportion of the world’s population that is over 60 will rise from 11% today to 22% in 2050. The situation is especially dire in the developed world: in 2050 one in three people in the rich world will be pensioners, and one in ten will be over 80. In America more than 10,000 baby-boomers will become eligible for Social Security and Medicare every day for the next two decades. The Congressional Budget Office (CBO) calculates that entitlement spending will grow from 9% of GDP today to 20% in 2025. If America keeps its distaste for taxes, it will face fiscal Armageddon.

The level of public spending is only one indication of the state’s power. America’s federal government employs a quarter of a million bureaucrats whose job it is to write and apply federal regulations. They have cousins in national and supranational capitals all round the world. These regulators act as force multipliers: a regulation promulgated by a few can change the behaviour of entire industries. Periodic attempts to build “bonfires of

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regulations” have got nowhere. Under Mr Bush the number of pages of federal regulations increased by 7,000, and eight of Britain’s ten biggest regulatory bodies were set up under the current government.

The power of these regulators is growing all the time. Policymakers are drawing up new rules on everything from the amount of capital that banks have to set aside to what to do about them when they fail. Britain is imposing additional taxes on bankers’ bonuses, America is imposing extra taxes on banks’ liabilities, and central bankers are pondering ingenious ways to intervene in overheated markets. Worries about climate change have already led to a swathe of new regulations, for example on carbon emissions from factories and power plants and on the energy efficiency of cars and light-bulbs. But, since emissions are continuing to grow, such regulations are likely to proliferate and, at the same time, get tighter. The Kerry-Boxer bill on carbon emissions, for example, runs to 821 pages.

Fear of terrorism and worries about rising crime have also inflated the state. Governments have expanded their ability to police and supervise their populations. Britain has more than 4m CCTV cameras, one for every 14 people. In Liverpool the police have taken to using unmanned aerial drones, similar to those used in Afghanistan, to supervise the population. The Bush administration engaged in a massive programme of telephone tapping before the Supreme Court slapped it down.

Another form of the advancing state is more insidious. Annual lists of the world’s biggest companies have begun to feature new kinds of corporate entities: companies that are either directly owned or substantially controlled by the state. Chinese state-controlled companies have been buying up private companies during the financial crisis. Russia’s state-controlled companies have a long record of snapping up private companies on the cheap. Sovereign wealth funds are increasingly important in the world’s markets.

This is partly a product of the oil boom. Three-quarters of the world’s crude-oil reserves are owned by national oil companies. (By contrast, conventional multinationals control just 3% of the world’s reserves and produce 10% of its oil and gas.) But it is also the result of something more fundamental: the shift in the balance of economic power to countries with a very different view of the state from the one celebrated in the Washington

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consensus. The world is seeing the rise of a new economic hybrid—what might be termed “state capitalism”.

Under state capitalism, governments do not so much reject the market as use it as an instrument of state power. They encourage companies to take advantage of global capital markets and venture abroad in search of opportunities. Malaysia’s Petronas and China’s National Petroleum Corporation run businesses in some 30 countries. But they also use them to control the economy at home—to direct resources to favoured industries or reward political clients. Politicians in China and elsewhere not only make decisions about the production of cars and mobile phones; they are also the hidden hands behind companies that are scouring the world for the raw materials that go into them.

The revival of the state is creating a series of fierce debates that will shape policymaking over the coming decades. Governments are beginning to cut public spending in an attempt to deal with surging deficits. But the inevitable quarrels over cuts will be paltry compared with those about the growth of entitlements. America’s deficit, boosted by recession, is huge, and the American economy depends on the willingness of other countries (particularly China) to fund its debt. The CBO calculates that the deficit could rise to 23% of GDP in the next 40 years if it fails to tackle the yawning imbalance between revenue and expenditure.

Crises can be the midwives of serious thinking. The stagflation of the 1970s prepared the way for the Reagan and Thatcher revolutions. More recently, several countries have dealt with out-of-control spending by introducing dramatic cuts: New Zealand, Canada and the Netherlands all reduced public spending by as much as 10% from 1992 onwards.

In the early 1990s Sweden faced a home-grown economic crisis that foreshadowed many of the features of the global crisis. The property bubble burst and the government stepped in to save the banks and pump up demand. Public debt doubled, unemployment tripled and the budget deficit increased tenfold. The Social Democrats were elected in 1994 and re-elected twice thereafter on a programme of raising taxes and slashing spending. All this points to an irony: a crisis which promotes state growth in the short term may lead to pruning in the longer term.

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But pruning will still be more difficult than it has ever been before. Getting the public sector to do “more with less” is harder after two decades of public-sector reforms. Across the OECD more than 40% of public goods are provided by the private sector (thanks to privatisation and contracting out) and 75% of public officials are on some sort of pay-for-performance scheme. The ageing of the population makes earlier reforms look easy. Governments will have to ask fundamental questions—such as whether it makes sense to let people retire at 65 when they are likely to live for another 20 years.

The rise of state capitalism is fraught with problems. It may be hard to argue with China’s 30 years of hefty economic growth and $2.3 trillion in foreign-currency reserves. But subordinating economic decisions to political ones can come with a price-tag in the long term: politicians are reluctant to let “strategic” companies fail, and companies become adjuncts of the state patronage machine. Giving the imprimatur of the state to global companies is also fraught with risks. America’s Congress prevented Dubai from taking over American ports on grounds of national security.

Anatomising failureThe most interesting arguments over the next few years will weigh

government failure against market failure. The market-failure school had been gaining strength even before the credit crunch struck. The rise of cowboy capitalism in Russia under Boris Yeltsin persuaded many people—not least the Chinese—of the importance of strong government. And the threat of global warming is an obvious example of how government intervention is needed to deter people from overheating the world. Advocates of market failure have also been advancing a broad range of arguments for using the government to “nudge” people’s behaviour in the right direction.

But the fact that markets are prone to sometimes spectacular failure does not mean that governments are immune to it. Government departments are good at expanding their empires. Thus a welfare state that was designed to help people deal with unavoidable risks, such as sickness and old age, is increasingly in the business of trying to eliminate risk in general through a proliferating health-and-safety bureaucracy. Government workers are also good at protecting their own interests. In America, where 30% of people in the public sector are unionised compared with just 7% in the private sector,

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public-sector workers enjoy better pension rights than private-sector workers, as well as higher average pay.

The public sector is subjected to all sorts of perverse incentives. Politicians use public money to “buy” votes. America is littered with white elephants such as the John Murtha airport in Jonestown, Pennsylvania, which cost hundreds of millions of dollars but serves only a handful of passengers, including Mr Murtha, who happens to be chairman of a powerful congressional committee. Interest groups spend hugely to try to affect political decisions: there are 1,800 registered lobbyists in the European Union, 5,000 in Canada and no fewer than 15,000 in America. Mr Bush’s energy bill was so influenced by lobbyists that John McCain dubbed it the “No Lobbyist Left Behind” act.

These perverse incentives mean that governments can frequently spend lots of money without producing any improvement in public services. Britain’s government doubled spending on education between fiscal 1999 and fiscal 2007, but the spending splurge coincided with a dramatic decline in Britain’s position in the OECD’s ranking of educational performance. Bill Watkins of the University of California, Santa Barbara, calculates that, once you adjust for inflation and population growth, his state’s government spent 26% more in 2007-08 than in 1997-98. No one can argue that California’s public services are now 26% better.

“The question that we ask today”, said Barack Obama in his inaugural address, “is not whether our government is too big or too small, but whether it works.” This is clearly naïve: with deficits soaring, nobody can afford to ignore the size of government. Mr Obama’s appeal for pragmatism has some value: conservative attempts to roll back government regulations have led to disaster in the finance industry. But left-wing attempts to defend entitlements and public-sector privileges willy-nilly will condemn the state to collapse under its own weight. Policymakers will not be able to give a serious answer to Mr Obama’s question of whether “government works” without first asking themselves some more fundamental questions about what the state should be doing and what it should be leaving well alone.

From The Economist

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Discussion point: What degree of government intervention in the economy do you consider

to be reasonable?

15. An astonishing rebound


Asia’s emerging economies are leading the way out of recession; now they must make their recovery last

IT NEVER pays to underestimate the bounciness of Asia’s emerging economies. After the region’s financial crisis of 1997-98, and again after the dotcom bust in 2001, outsiders predicted a lengthy period on the floor—only for the tigers to spring back rapidly. Six months after the crisis struck it was argued that such export-dependent economies could not revive until customers in the rich world did. The West still looks weak, with many economies contracting, and even if America begins to grow, consumer spending looks sickly. Yet Asian economies, increasingly decoupled from Western shopping habits, are growing fast.

The four emerging Asian economies which have reported their quarterly GDP figures (China, Indonesia, South Korea and Singapore) grew by an average annualised rate of more than 10%. Even richer and more sluggish Japan, which cannot match that figure, seems to be recovering faster than its Western peers. But emerging Asia should grow by more than 5% this year—at a time when the old G7 could contract by 3.5%. Western politicians should brace themselves for more talk of economic power drifting inexorably to the East. How has Asia made such an astonishing rebound?

Out of smoke and mirrors, say some Western sceptics. They claim China’s bounceback is yet another fake. The country’s numbers are certainly dodgy: the components of GDP do not add up, and the data are always published suspiciously early. China’s economy probably slowed more

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sharply in late 2008 than the official numbers suggest. But other indicators, which are less likely to be massaged, confirm that China’s economy is roaring back. Industrial production rose 11% in the year to July; electricity output, which fell sharply last year, is growing again; and car sales are 70% higher than a year ago.

And surely the whole of Asia cannot be engaged in a statistical fraud. South Korea’s GDP grew by an annualised 10% in the second quarter. Taiwan’s probably increased by even more: its industrial output jumped by an astonishing annualised rate of 89%. India was hit less hard by the global recession than many of its neighbours because it exports less, but its industrial production has also perked up, rising by a seasonally adjusted rate of 14% in the second quarter. Output in most of the smaller Asian economies is still lower than a year ago, because they suffered steep downturns late last year. But at economic turning points, one should track quarterly changes.

Thrift in the boom, stimulus in the slumpAsia’s rebound has several causes. First, manufacturing accounts for a

big part of several local economies, and industries such as cars and electronics are highly cyclical: output drops sharply in a downturn and then spurts in the upturn. Second, the region’s decline in exports in late 2008 was exacerbated by the freezing up of global trade finance, which is now flowing again. Third, and most important, domestic spending has bounced back because the fiscal stimulus in the region was bigger and worked faster than in the West. India aside, the Asians entered this downturn with far healthier government finances than rich countries, allowing them to spend more money. Low private-sector debt made households and firms more likely to spend government handouts; Asian banks were also in better shape than their Western counterparts and able to lend more. Asia’s prudence during the past decade did not allow it to escape the global recession, but it made the region’s fiscal and monetary weapons more effective.

Western populists will no doubt once again try to blame their own sluggish performance on “unfair” Asia. Ignore them. Emerging Asia’s average growth rate of almost 8% over the past two decades—three times the rate in the rich world—has brought huge benefits to the rest of the world. Its rebound now is all the more useful when growth in the West is likely to be

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slow. Asia cannot replace the American consumer: emerging Asia’s total consumption amounts to only two-fifths of America’s. But it is the growth in spending that really matters. In dollar terms, the increase in emerging Asia’s consumer-spending this year will more than offset the drop in spending in America and the euro area. This shift in spending from the West to the East will help rebalance the world economy.

Beijing, Bangkok and Bangalore: beware boastfulnessIt is easy to boost an economy with lots of government spending. But

Asian policymakers now face two difficult problems. Their immediate dilemma is how to sustain recovery without inflating credit and asset-price bubbles. Local equity and property markets are starting to froth. But policymakers’ reluctance to let their currencies rise faster against the dollar means that their monetary policy is, in effect, being set by America’s Federal Reserve, and is therefore too lax for these perkier economies. The longer-term challenge is that once the impact of governments’ fiscal stimulus fades, growth will slow unless economic reforms are put in place to bolster private spending—something Japan, alas, never did.

Part of the solution to both problems—preventing bubbles and strengthening domestic spending—is to allow exchange rates to rise. If Asian central banks stopped piling up reserves to hold down their currencies, this would help stem domestic liquidity. Stronger currencies would also shift growth from exports to domestic demand and increase households’ real spending power—and help ward off protectionists in the West.

Hubris is the big worry. With the gap in growth rates between emerging Asia and the developed world heading towards a record nine percentage points, Chinese leaders have taken to warning America about its lax monetary policy (while Washington has stopped lecturing China about the undervalued yuan). But it would be a big mistake if Asia’s recovery led its politicians to conclude that there was no need to change their exchange-rate policies or adopt structural reforms to boost consumption. The tigers’ faster-than-expected rebound from their 1997-98 financial crisis encouraged complacency and delayed necessary reforms, which left them more vulnerable to the global downturns in 2001 and now. Make sure this new rise is not followed by another fall.

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From The Economist

16. 70 or bust!

Pre-reading question: What do the following terms mean?

- lump of labour fallacy- seniority pension system- final-salary and career average salary pension schemes


Plans to raise the retirement age are not bold enoughPUT aside the cruise brochures and let the garden retain that natural

look for a few more years. Demography and declining investment returns are conspiring to keep you at your desk far longer than you ever expected.

This painful truth is no longer news in the rich world, and many governments have started to deal with the ageing problem. They have announced increases in the official retirement age that attempt to hold down the costs of state pensions while encouraging workers to stay in their jobs or get on their bikes and look for new ones.

Unfortunately, the boldest plans look inadequate. Older people are going to have to stay economically active longer than governments currently envisage; and that is going to require not just governments, but also employers and workers, to behave differently.

Trying, but not very hardSince 1971 the life expectancy of the average 65-year-old in the rich

world has improved by four to five years. By 2050, forecasts suggest, they will add a further three years on top of that. Until now, people have converted

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all that extra lifespan into leisure time. The average retirement age in the OECD in 2010 was 63, almost one year lower than in 1970.

Living longer, and retiring early, might not be a problem if the supply of workers were increasing. But declining fertility rates imply that by 2050 there will be just 2.6 American workers supporting each pensioner and the figures for France, Germany and Italy will be 1.9, 1.6 and 1.5 respectively. The young will be shoring up pensions systems, which are riddled with problems.

Most governments are already planning increases in the retirement age. Some countries are heading for 67, and even 68. Others are moving more slowly. Belgium allows women to retire at 60, for instance, and has no plans to change that. Under current policies the mean retirement age by 2050 will still be less than 65, barely higher than it was after the second world war.

Because life expectancy continues to rise—people in rich countries are gaining a little under a month a year—even the American and British plans are inadequate. In Europe the retirement age should be raised to 70 by 2040; America, with a younger population, can afford to keep it a smidgen lower.

Working longer has three great advantages. The employee gets more years of wages; the government receives more in taxes and pays out less in benefits; and the economy grows faster as more people work for longer. Besides, older workers are a neglected consumer market.

Yet too many people see longer working lives as a worry rather than an opportunity—and not just because they are going to be chained to their desks. Some fret that there will not be enough jobs to go around. This misapprehension, known to economists as the “lump of labour fallacy”, was once used to argue that women should stay at home and leave all the jobs for breadwinning males. Now lump-of-labourites say that keeping the old at work would deprive the young of employment. The idea that society can become more prosperous by paying more of its citizens to be idle is clearly nonsensical. On that reasoning, if the retirement age came down to 25 we would all be as rich as Croesus.

Raising the official retirement age is only part of the solution, for many workers retire before the official age. Martin Baily and Jacob Kirkegaard of the Peterson Institute in Washington, DC, reckon that raising actual EU

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retirement ages to the official age would offset the impact of an ageing population over the next 20 years.

For that to happen, working practices and attitudes need to change. Western managers worry too much about the quality of older workers. In physically demanding occupations, it is true, some may be unable to work into their late 60s. The incapacitated will need disability benefits. Others will need to find a different job. But this should be less of a problem than it used to be now that economies are based on services not manufacturing. In knowledge-based jobs, age is less of a disadvantage. Although older people reason more slowly, they have more experience and, by and large, better personal skills. Even so, most people’s productivity does eventually decline with age; and pay needs to reflect this falling-off. Traditional seniority systems, under which people get promoted and paid more as they age, therefore need to change.

The missing $3 trillionIn some countries the huge cost of pension schemes is being dealt with

in the private sector. Final-salary schemes are hardly ever offered to new employees these days. In the public sector, however, they are still standard. In Britain the recent report by Lord Hutton made some sensible suggestions for reform. The accrued rights of workers should be maintained but their future pension rights should be based on the state retirement age (many public-sector workers currently retire early) and on a career average, rather than final, salary. That would both prevent abuses and make part-time working easier.

The public-sector pension problem is sharpest in American states. The deficits in their pension funds may amount to $3 trillion. They face legal and constitutional constraints that prevent them from following the British lead. Unlike wages, pension promises have been deemed, weirdly, to be permanent and sacrosanct. But as budget pressures bite, politicians are going to have to change laws and constitutions.

Private-sector workers face a different problem. The demise of final-salary pensions leaves them facing two big risks: that falling markets will undermine their retirement planning, and that they will outlive their savings. So governments should encourage workers to save more, nudging them into

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pension schemes by requiring them to opt out rather than opt in. And the basic state pension should be high enough to give those unlucky elderly with insufficient savings a decent income, without penalising those who have been thrifty. That is the least people deserve in return for toiling until they are 70.

From The EconomistDiscussion point:

Outline the key features of the pension system in Russia (in the country you come from).

Do you think it is necessary to increase the retirement age in Russia (in the country you come from)? Give reasons.

17. Warmer inside

Pre-reading question: What is the Phillips curve? Draw a graph and comment on it.


The gains outweigh the lossesTHIS crisis has tested many schemes and wheezes (some to

destruction), from securitised mortgages to collateralised-debt obligations, from light-touch regulation to inflation targeting. How does the euro fare in this reckoning? According to one school of thought it is a fair-weather set-up, seemingly effective when economies are expanding but poorly equipped to deal with crises and manage the pressures and conflicts of a sinking economy. Conversely, many in Brussels and Frankfurt argue that being in the euro zone helped member countries emerge relatively unscathed from the worst financial crisis since the 1930s. Which view is right?

The extreme lurches in markets during the worst of the crunch last autumn made the certainties of fixed exchange rates look enticing. One

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lesson from the crisis is that asset prices can be unduly volatile and often veer wildly from their true values, in ways that undermine economic stability. That goes especially for housing but is also true of other asset prices, such as exchange rates. Another message is that interest-rate policy is not as powerful a stabilising force as had been thought. Other means of shaping demand are needed to complement it. Swapping an independent monetary policy for the stability of a fixed exchange rate now seems less of a sacrifice. That also closes off the escape route of letting the currency slip if wages move out of line with productivity. Yet deflation seems such a threat precisely because prices and wages are proving less “sticky” on the way down than macroeconomic textbooks had reckoned with.

On standard gauges of competitiveness, such as real effective exchange rates, a number of euro-zone countries appear to have big problems. Yet things may look worse than they are. Measures based on relative unit wage costs across the whole economy are crude. In booming Spain and Greece, much of the heat in wages was in parts of the economy, such as construction, that serve domestic spending and are sheltered from foreign competition. Export industries may have a better chance of benefiting from a global recovery than the figures suggest at first glance.

Spain, in particular, may not be quite as uncompetitive as it seems. José Luis Escrivá, an economist at BBVA, a Madrid-based bank, reckons that Spanish exporters have performed fairly well in retaining export market share against other countries, bar super-competitive Germany. “What Spain had mostly was an import boom,” he says. Now imports are declining at a much faster rate than GDP, which will trim Spain’s current-account deficit to a more manageable size.

A recent study by the European Commission lends some support to that view. The export-market shares of Spain and Greece fell only slightly between 1999 and 2008. Export growth was stronger than in Belgium, France and Portugal, if not as vibrant as in Austria, Finland, Germany and the Netherlands. Ireland’s export-market share increased over the period, even if the greatest strides were made in the euro’s early years. Perhaps its exporters, many of them big American-owned firms, were wise enough to hold back on big wage and price increases in a country that could not devalue.

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Italian exports, however, were dismal. Firms in Italy lost market share faster than in any other big euro-zone country. Italy’s undoing is to specialise in industries such as textiles and furniture where competition from China and other emerging markets is particularly keen.

A devaluation might offer temporary respite for Italian exporters, but it would not be a lasting solution to being in the wrong businesses. Neither could it disguise the economy’s real problems: legal protection for jobs that stops workers moving from dying industries to growing ones; a wage-bargaining system that has made for poor matches between pay and productivity; and an unimpressive record on innovation that has inhibited the emergence of new firms in high-value-added industries. This familiar Italian litany is the “never-ending story of things that need reform”, sighs one economist.

However, there are signs of progress. Confindustria, Italy’s biggest employers’ body, recently signed an accord with two of the three largest trade-union confederations to overhaul the national wage system. CGIL, the largest union group, did not sign up to the deal, but the Italian government said it would go ahead anyway.

DeconstructedSpain and Ireland have more to worry about than wage costs in export

industries. Big construction busts are, as a rule, hard to recover from. At the peak of their housing booms, up to a fifth of their workers had jobs related to construction or property sales. Many of those jobs will not come back, and finding other things to do for such an army of redundant workers will take time. Ireland has a more flexible jobs market, so its recovery is likely to be swifter, if still far from painless. Spain’s economy is more hidebound, so it will take longer to revive.

It is hard to see how a devaluation would help much even if that option were available. “If Spain’s main problem were competitiveness, I wouldn’t worry,” says Mr Gros of the CEPS: “The Phillips curve [which suggests an inverse relationship between wage inflation and unemployment] would take care of it.”

The lack of a “fiscal euro zone”, a central spending body financed by a shared pool of tax revenues, has hampered an effective response to the

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economic downturn. Yet without the euro things might have been a lot worse. Co-ordinating a European response amid a series of currency crises or exchange-rate rows would have been far trickier. Bond investors have become choosier about sovereign credit risk, so some euro-area borrowers have had to stump up higher coupons for their recent bond issues. But no one was frozen out of markets. Even when spreads were at their widest, Greece and Ireland, the euro-zone’s high-yielders, were able to finance their borrowing needs at a reasonable cost. The security of access to financing has made the euro area even more attractive to the EU’s eastern states, some of which have had to fall back on rescue loans or precautionary credit lines from the IMF.

The prospect that a euro-zone country might default on its loans, never mind leave the euro, is fairly remote. But the taboo around the subject leaves bond investors uncertain about how such a problem might be resolved if it did occur. That uncertainty should be dealt with. Policymakers have dropped hints that should one country’s financing troubles spread to another, a bail-out plan is in place. Yet the risk of contagion is overblown. An orderly debt restructuring for a country within the euro zone would not be the end of the world, or indeed of the single currency. A bail-out by fellow members might do greater harm by damaging popular support for the single currency.

There is a central irony about the euro. Many of its architects saw it as a means of advancing political union in Europe and were barely interested in a monetary union as an economic venture. Their hopes have been dashed, but as a technical exercise the euro has been a huge success. The currency is accepted in vast swathes of the rich world and quite a bit of the poor world too. The value of euro banknotes in circulation and the market for euro-denominated securities already rival the dollar, a long-established currency backed by a single nation-state.

For economists such as Robert Mundell and others, who saw huge benefits in shared currencies but had despaired of politicians giving up monetary control, the euro is an exciting experiment. By contrast, the politicians that made the leap have been disappointed by the euro’s failure, so far, to spur deeper political integration.

For all its shortcomings, the euro zone is far more likely to expand than shrink over the next decade. Most EU countries that remain outside, bar

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Britain and Sweden, are eager to join. The harm done by housing and construction booms in Ireland and Spain should be a caution to would-be members who, once inside, may get carried away by low borrowing costs. Against that, a big lesson from the crisis is not to rely too much on short-term interest rates to rein in credit and home-loan booms. The rush to join the euro zone is surely a vote of confidence. It must be doing something right.

From The Economist

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