Amplifications http://blogs.reuters.com/amplifications Outside opinion and commentary Tue, 03 Jan 2012 17:03:28 +0000 en-US hourly 1 http://wordpress.org/?v=4.2.5 Will we ever grow out of growth? http://blogs.reuters.com/amplifications/2012/01/03/will-we-ever-grow-out-of-growth/ http://blogs.reuters.com/amplifications/2012/01/03/will-we-ever-grow-out-of-growth/#comments Tue, 03 Jan 2012 17:02:27 +0000 http://blogs.reuters.com/amplifications/?p=69 By Kenneth Rogoff

The views expressed are his own.

Modern macroeconomics often seems to treat rapid and stable economic growth as the be-all and end-all of policy. That message is echoed in political debates, central-bank boardrooms, and front-page headlines. But does it really make sense to take growth as the main social objective in perpetuity, as economics textbooks implicitly assume?

Certainly, many critiques of standard economic statistics have argued for broader measures of national welfare, such as life expectancy at birth, literacy, etc. Such appraisals include the United Nations Human Development Report, and, more recently, the French-sponsored Commission on the Measurement of Economic Performance and Social Progress, led by the economists Joseph Stiglitz, Amartya Sen, and Jean-Paul Fitoussi.

But there might be a problem even deeper than statistical narrowness: the failure of modern growth theory to emphasize adequately that people are fundamentally social creatures. They evaluate their welfare based on what they see around them, not just on some absolute standard.

The economist Richard Easterlin famously observed that surveys of “happiness” show surprisingly little evolution in the decades after World War II, despite significant trend income growth. Needless to say, Easterlin’s result seems less plausible for very poor countries, where rapidly rising incomes often allow societies to enjoy large life improvements, which presumably strongly correlate with any reasonable measure of overall well-being.

In advanced economies, however, benchmarking behavior is almost surely an important factor in how people assess their own well-being. If so, generalized income growth might well raise such assessments at a much slower pace than one might expect from looking at how a rise in an individual’s income relative to others affects her welfare. And, on a related note, benchmarking behavior may well imply a different calculus of the tradeoffs between growth and other economic challenges, such as environmental degradation, than conventional growth models suggest.

To be fair, a small but significant literature recognizes that individuals draw heavily on historical or social benchmarks in their economic choices and thinking. Unfortunately, these models tend to be difficult to manipulate, estimate, or interpret. As a result, they tend to be employed mainly in very specialized contexts, such as efforts to explain the so-called “equity premium puzzle” (the empirical observation that over long periods, equities yield a higher return than bonds).

There is a certain absurdity to the obsession with maximizing long-term average income growth in perpetuity, to the neglect of other risks and considerations. Consider a simple thought experiment. Imagine that per capita national income (or some broader measure of welfare) is set to rise by 1 percent per year over the next couple of centuries. This is roughly the trend per capita growth rate in the advanced world in recent years. With annual income growth of 1 percent, a generation born 70 years from now will enjoy roughly double today’s average income. Over two centuries, income will grow eight-fold.

Now suppose that we lived in a much faster-growing economy, with per capita income rising at 2 percent annually. In that case, per capita income would double after only 35 years, and an eight-fold increase would take only a century.

Finally, ask yourself how much you really care if it takes 100, 200, or even 1,000 years for welfare to increase eight-fold. Wouldn’t it make more sense to worry about the long-term sustainability and durability of global growth? Wouldn’t it make more sense to worry whether conflict or global warming might produce a catastrophe that derails society for centuries or more?

Even if one thinks narrowly about one’s own descendants, presumably one hopes that they will be thriving in, and making a positive contribution to, their future society. Assuming that they are significantly better off than one’s own generation, how important is their absolute level of income?

Perhaps a deeper rationale underlying the growth imperative in many countries stems from concerns about national prestige and national security. In his influential 1989 book The Rise and Fall of the Great Powers, the historian Paul Kennedy concluded that, over the long run, a country’s wealth and productive power, relative to that of its contemporaries, is the essential determinant of its global status.

Kennedy focused particularly on military power, but, in today’s world, successful economies enjoy status along many dimensions, and policymakers everywhere are legitimately concerned about national economic ranking. An economic race for global power is certainly an understandable rationale for focusing on long-term growth, but if such competition is really a central justification for this focus, then we need to re-examine standard macroeconomic models, which ignore this issue entirely.

Of course, in the real world, countries rightly consider long-term growth to be integral to their national security and global status. Highly indebted countries, a group that nowadays includes most of the advanced economies, need growth to help them to dig themselves out. But, as a long-term proposition, the case for focusing on trend growth is not as encompassing as many policymakers and economic theorists would have one believe.

In a period of great economic uncertainty, it may seem inappropriate to question the growth imperative. But, then again, perhaps a crisis is exactly the occasion to rethink the longer-term goals of global economic policy.

Copyright: Project Syndicate, 2012.
www.project-syndicate.org

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Why Ron Paul is so challenging to liberals http://blogs.reuters.com/amplifications/2011/12/29/why-ron-paul-is-so-challenging-to-liberals/ http://blogs.reuters.com/amplifications/2011/12/29/why-ron-paul-is-so-challenging-to-liberals/#comments Thu, 29 Dec 2011 21:03:21 +0000 http://blogs.reuters.com/amplifications/?p=61 By Matt Stoller

The views expressed are his own.

The most perplexing character in Congress, ideologically speaking, is Ron Paul. This is a guy who exists in the Republican Party as a staunch opponent of American empire and big finance. His ideas on the Federal Reserve have taken some hold recently, and he has taken powerful runs at the Presidency on the obscure topic of monetary policy. He doesn’t play by standard political rules, so while old newsletters bearing his name showcase obvious white supremacy, he is also the only prominent politician, let alone Presidential candidate, saying that the drug war has racist origins. You cannot honestly look at this figure without acknowledging both elements, as well as his opposition to war, the Federal government, and the Federal Reserve. And as I’ve drilled into Paul’s ideas, his ideas forced me to acknowledge some deep contradictions in American liberalism (pointed out years ago by Christopher Laesch) and what is a long-standing, disturbing, and unacknowledged affinity liberals have with centralized war financing. So while I have my views of Ron Paul, I believe that the anger he inspires comes not from his positions, but from the tensions that modern American liberals bear within their own worldview.

My perspective of Paul comes from working with his staff in 2009-2010 on issues of war and the Federal Reserve. Paul was one of my then-boss Alan Grayson’s key allies in Congress on these issues, though on most issues of course he and Paul were diametrically opposed. How Paul operated his office was different than most Republicans, and Democrats. An old Congressional hand once told me, and then drilled into my head, that every Congressional office is motivated by three overlapping forces – policy, politics, and procedure. And this is true as far as it goes. An obscure redistricting of two Democrats into one district that will take place in three years could be the motivating horse-trade in a decision about whether an important amendment makes it to the floor, or a possible opening of a highly coveted committee slot on Appropriations due to a retirement might cause a policy breach among leadership. Depending on committee rules, a Sub-Committee chairman might have to get permission from a ranking member or Committee Chairman to issue a subpoena, sometimes he might not, and sometimes he doesn’t even have to tell his political opposition about it. Congress is endlessly complex, because complexity can be a useful tool in wielding power without scrutiny. And every office has a different informal matrix, so you have to approach each of them differently.

Paul’s office was dedicated, first and foremost, to his political principles, and his work with his grassroots base reflects that. Politics and procedure simply didn’t matter to him. My main contact in Paul’s office even had his voicemail set up with special instructions for those calling about HR 1207, which was the number of the House bill to audit the Federal Reserve. But it wasn’t just the Fed audit – any competent liberal Democratic staffer in Congress can tell you that Paul will work with anyone who seeks his ends of rolling back American Empire and its reach into foreign countries, auditing the Federal Reserve, and stopping the drug war.

Paul is deeply conservative, of course, and there are reasons he believes in those end goals that have nothing to do with creating a more socially just and equitable society. But then, when considering questions about Ron Paul, you have to ask yourself whether you prefer a libertarian who will tell you upfront about his opposition to civil rights statutes, or authoritarian Democratic leaders who will expand healthcare to children and then aggressively enforce a racist war on drugs and shield multi-trillion dollar transactions from public scrutiny. I can see merits in both approaches, and of course, neither is ideal. Perhaps it’s worthy to argue that lives saved by presumed expanded health care coverage in 2013 are worth the lives lost in the drug war. It is potentially a tough calculation (depending on whether you think coverage will in fact expand in 2013). When I worked with Paul’s staff, they pursued our joint end goals with vigor and principle, and because of their work, we got to force central banking practices into a more public and democratic light.

But this obscures the real question, of why Paul disdains the Fed (and implicitly, why liberals do not), and the relationship between the Federal Reserve and American empire. If you go back and look at some of libertarian allies, like Fox News’s Judge Napolitano, they will answer that question for you. Napolitano hates, absolutely hates, Abraham Lincoln. He sometimes slyly refers to Lincoln as America’s first dictator. Libertarians also detest Woodrow Wilson, and Franklin Delano Roosevelt.

What connects all three of these Presidents is one thing – big ass wars, and specifically, war financing. If you think today’s deficits are bad, well, Abraham Lincoln financed the Civil War pretty much entirely by money printing and debt creation, taking America off the gold standard. He oversaw the founding of the nation’s first national financial regulator, the Office of the Comptroller of the Currency, which chartered national banks and forced them to hold government debt to back currency they issued. The dollar then became the national currency, and Lincoln didn’t even back those dollars by gold (and gold is written into the Constitution). This financing of the Civil War was upheld in a series of cases over the Legal Tender Act of 1862. Prior to Lincoln, it was these United States. Afterwards, it was the United States. Lincoln fought the Civil War and centralized authority in the Federal government to do it, freeing slaves and transforming America into one nation.

Libertarians claim that they dislike Lincoln because he centralized authority in the Federal government. Of course, there is a long reconstructed white supremacist strain that hates Lincoln because he was an explicitly anti-racist President, and they hate the centralized authority and financing power that freed the slaves and turned America increasingly into more racially equitable society. This strain can be exploited by the creditor class, who also disliked how slavery – which they saw as a property right rather than a labor and human rights issue – was destroyed by state power. History, of course, has a nasty way of mocking us about long-held fights we thought were over. The conflict between labor/human rights and property rights continues today. Or as Carl Fox said in the movie Wall Street, “The only difference between the Pyramids and the Empire State Building is the Egyptians didn’t allow unions.” Without even getting into globalization, prison labor legally makes body armor, as well as products for Victoria’s Secret, Starbucks, and Microsoft. State centralized power can prioritize labor rights over property rights, and for this reason, creditors are wary of it.

On to Woodrow Wilson. Wilson signed the highly controversial Federal Reserve Act in 1913; originally, the Federal Reserve system was supposed to discount commercial and agricultural paper. Government bonds were not really considered part of the system’s mandate. But what happened the next year? Yes, World War I. And Wilson, who ran on the slogan “he kept us out of war” in 1916, started a long tradition of antiwar Democratic Presidents who took America to war (drawing the ire of, among others, Helen Keller, but garnering the support of union leader Sam Gompers who argued it was a “people’s war”). Wilson also implemented a wide variety of highly repressive authoritarian measures, including the Palmer Raids, the Espionage Act of 1917, and the use of modern PR techniques by government agencies. For good measure, Wilson was an unreconstructed white supremacist (even a bit out there for the time) and sent many antiwar opponents to jail. In the monetary arena, Wilson’s new Federal Reserve system began discounting government bonds. Like Lincoln, he had set up a tremendous war financing vehicle to centralize capital flows and therefore, political authority. In many ways, Wilson set up the rudiments of America’s police state, and did so arguably to help a transatlantic Anglo-American banking elite. Here, one can argue that libertarians are wary of centralized financing and political authority for liberal reasons – the ACLU was founded after the Palmer raids.

And finally, we come to Franklin Delano Roosevelt. Roosevelt’s Fed is a bit more complex, because he did centralize monetary authority using wartime emergency powers, but he did so in peacetime. FDR abrogated gold clause contracts, seized the domestic supply of gold, and devalued the currency. He constrained banks with aggressive regulation and seizures of insolvent banks, saving depositors with the Reconstruction Finance Corporation. He also used the RFC to set up much of what we know today as the Federal government, including early versions of disaster relief, small business lending, massive bridge and railroad building, the FHA, Fannie Mae, and state and local aid. Eventually, the government used this mechanism to finance college and housing for veterans with the GI Bill. Since veterans were much of the population right after World War II, effectively this was the first ever near-national safety net. FDR also fused the liberal and union establishments with the corporate world, creating the hybrid “military-industrial” complex that is with us to this day (see Alan Brinkley’s “End of Reform” for a good treatment of this process).

Later, this New Deal financing apparatus was used to finance the munitions industry and America’s role in World War II. At one point, the RFC owned eight war material producing subsidiaries, including the synthetic rubber industry. Importantly, FDR had the Fed working for him. The Fed kept interest rates pegged at an interest rate set by Treasury, and used reserve requirements to manage inflation. This led to a dramatic drop in inequality, and unemployment sank to 1% during World War II. In 1951, the Fed, buttressed by what Tom Ferguson calls “conservative Keynesian” corporate leaders, broke free of this arrangement, under the Treasury-Fed Accord, leading to the postwar monetary order. That accord is where the vaunted “Federal Reserve Independence” came from.

Now, if you’re a libertarian, and you believe that centralized power is dangerous, then it’s obvious that state control over finance and mass mobilization of social resources for warfare or other ends are two sides of the same coin. If you fear social spending, you could also be persuaded to believe that any financing mechanism for mass social spending is problematic. Creditors might just dislike the possibility of any state power centers that could challenge their hegemony and privilege labor/human rights over their property rights, though they do support captive state systems they control. If you are a white supremacist, centralized power can easily be viewed as a threat to racial homogeny, since historically it has acted as such in the past. But if you are against war, or you believe that a centralized state is likely to act in an unjust or repressive manner (as it also has in the past), then war financing is a reasonable target.

Modern liberalism is a mixture of two elements. One is a support of Federal power – what came out of the late 1930s, World War II, and the civil rights era where a social safety net and warfare were financed by Wall Street, the Federal Reserve and the RFC, and human rights were enforced by a Federal government, unions, and a cadre of corporate, journalistic and technocratic experts (and cheap oil made the whole system run.) America mobilized militarily for national priorities, be they war-like or social in nature. And two, it originates from the anti-war sentiment of the Vietnam era, with its distrust of centralized authority mobilizing national resources for what were perceived to be immoral priorities. When you throw in the recent financial crisis, the corruption of big finance, the increasing militarization of society, Iraq and Afghanistan, and the collapse of the moral authority of the technocrats, you have a big problem. Liberalism doesn’t really exist much within the Democratic Party so much anymore, but it also has a profound challenge insofar as the rudiments of liberalism going back to the 1930s don’t work.

This is why Ron Paul can critique the Federal Reserve and American empire, and why liberals have essentially no answer to his ideas, arguing instead over Paul having character defects. Ron Paul’s stance should be seen as a challenge to better create a coherent structural critique of the American political order. It’s quite obvious that there isn’t one coming from the left, otherwise the figure challenging the war on drugs and American empire wouldn’t be in the Republican primary as the libertarian candidate. To get there, liberals must grapple with big finance and war, two topics that are difficult to handle in any but a glib manner that separates us from our actual traditional and problematic affinity for both. War financing has a specific tradition in American culture, but there is no guarantee war financing must continue the way it has. And there’s no reason to assume that centralized power will act in a more just manner these days, that we will see continuity with the historical experience of the New Deal and Civil Rights Era. The liberal alliance with the mechanics of mass mobilizing warfare, which should be pretty obvious when seen in this light, is deep-rooted.

What we’re seeing on the left is this conflict played out, whether it is big slow centralized unions supporting problematic policies, protest movements that cannot be institutionalized in any useful structure, or a completely hollow liberal intellectual apparatus arguing for increasing the power of corporations through the Federal government to enact their agenda. Now of course, Ron Paul pandered to racists, and there is no doubt that this is a legitimate political issue in the Presidential race. But the intellectual challenge that Ron Paul presents ultimately has nothing to do with him, and everything to do with contradictions within modern liberalism.

This post is reprinted from its original publication on Naked Capitalism.

PHOTO: U.S. Republican presidential candidate and Representative Ron Paul (R-TX) speaks during a Town Hall Meeting at the Hotel Pattee in Perry, Iowa, December 29, 2011. REUTERS/Jeff Haynes

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A centralized Europe is a globalized Europe http://blogs.reuters.com/amplifications/2011/12/27/a-centralized-europe-is-a-globalized-europe/ http://blogs.reuters.com/amplifications/2011/12/27/a-centralized-europe-is-a-globalized-europe/#comments Tue, 27 Dec 2011 17:00:09 +0000 http://blogs.reuters.com/amplifications/?p=53 By Jean-Claude Trichet

The views expressed are his own.

PARIS – Whenever people seek a justification for European integration, they are always tempted to look backwards. They stress that European integration banished the specter of war from the old continent. And European integration has, indeed, delivered the longest period of peace and prosperity that Europe has known for many centuries.

But this perspective, while entirely correct, is also incomplete. There are as many reasons to strive towards “ever closer union” in Europe today as there were back in 1945, and they are entirely forward-looking.

Sixty-five years ago, the distribution of global GDP was such that Europe had only one role model for its single market: the United States. Today, however, Europe is faced with a new global economy, reconfigured by globalization and by the emerging economies of Asia and Latin America.

It is a world where economies of scale and networks of innovation matter more than ever. By 2016 – that is, very soon – we can expect eurozone GDP in terms of purchasing power parity to be below that of China. Together, the economies of China and India could be around twice the size of the eurozone economy. Over a longer time horizon, the entire GDP of the G-7 countries will be dwarfed by the major emerging economies’ rapid growth.

So Europe must cope with a new geopolitical landscape that is being profoundly reshaped by these emerging economies. In this new global constellation, European integration – both economic and political – is central to achieving ongoing prosperity and influence.

Like individuals in a society, eurozone countries are both independent and interdependent. They can affect each other both positively and negatively. Good governance requires that both individual member states and EU institutions fulfill their responsibilities.

First and foremost, every eurozone country needs to keep its own house in order. This means responsible economic policies on the part of governments, as well as rigorous mutual surveillance of those policies – not just fiscal policies, but also measures affecting all aspects of the economy – by the Commission and member states.

In a society, law-enforcement institutions can ultimately compel a citizen to abide by the rules. In the eurozone, a framework based on surveillance and sanctions has, until the most recent decisions, depended on offending states’ willingness to comply.

But what can be done if a member state cannot deliver on its promises? For countries that lose market access, the approach of providing aid on the basis of strong conditionality is justified. Countries deserve an opportunity to correct the situation themselves and to restore stability.

This approach nonetheless has clearly defined limits. So a second stage is now envisaged for countries that persistently fail to meet their policy targets. During this second stage, eurozone authorities would play a much deeper and more authoritative role in the formulation of countries’ budgetary policies.

This moves us away from the current framework, which leaves all decisions in the hands of the country concerned. Instead, it would be not only possible, but in some cases compulsory, for the European authorities to take direct decisions.

Implementing this idea also implies embracing a new concept of sovereignty, given the complex interdependence that exists between eurozone countries. But it is ultimately in the interests of all eurozone citizens that these changes be made.

It is my firm conviction that the Europe of the future will embody a new type of institutional framework. What might it look like? Would it be too bold to envisage there being an EU finance ministry one day?

Any future European finance ministry would oversee the surveillance of both fiscal policies and competitiveness policies, and, when necessary, impose the “second stage.” Moreover, it would carry out the usual executive responsibilities regarding supervision and regulation of the EU financial sector. Finally, the ministry would represent the eurozone in international financial institutions.

Recent events have only strengthened the case for pursuing this approach. Europe’s leaders are discussing a Treaty change to create stronger economic governance at the EU level, and eurozone citizens are themselves calling for better supervision of the financial sector. And I know that our partners in the G-20 look to Europe as a whole, rather than to individual member states, for solutions. So, increasingly, it seems that it would be too bold not to consider creating a European finance ministry at some point in the future.

But an EU finance ministry would be only one component of Europe’s future institutional framework. One can imagine that, as various elements of sovereignty come to be shared, the European Council might evolve into the EU Senate, with the European Parliament becoming the lower house. Similarly, the European Commission could become the executive, while the European Court of Justice takes on the role of an EU judiciary. And, given European countries’ long and proud history, I have no doubt that “subsidiarity” will play a major role in the future Europe – significantly greater than in current models of federation.

Mine are the personal views of a European citizen. The future of Europe is in the hands of its democracies, in the hands of Europe’s people. Our fellow citizens will decide the direction Europe is to take. They are the masters. But, however Europe’s institutions take shape, a truly pan-European public debate is essential.

As Europeans, we identify deeply with our nations, traditions, and histories. These are Europe’s roots. But we also need to extend our branches more widely.

So, today, we should not look back. We must look forward – to opportunities of collective betterment, and to every country’s potential to be stronger and more prosperous in a well-functioning union.

Copyright: Project Syndicate, 2011.

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The power of living in truth http://blogs.reuters.com/amplifications/2011/12/20/the-power-of-living-in-truth/ http://blogs.reuters.com/amplifications/2011/12/20/the-power-of-living-in-truth/#comments Tue, 20 Dec 2011 16:01:36 +0000 http://blogs.reuters.com/amplifications/?p=47 By Jeffrey D. Sachs

The views expressed are his own.


The world’s greatest shortage is not of oil, clean water, or food, but of moral leadership. With a commitment to truth – scientific, ethical, and personal – a society can overcome the many crises of poverty, disease, hunger, and instability that confront us. Yet power abhors truth, and battles it relentlessly. So let us pause to express gratitude to Václav Havel, who died this month, for enabling a generation to gain the chance to live in truth.

Havel was a pivotal leader of the revolutionary movements that culminated in freedom in Eastern Europe and the end, 20 years ago this month, of the Soviet Union. Havel’s plays, essays, and letters described the moral struggle of living honestly under Eastern Europe’s Communist dictatorships. He risked everything to live in truth, as he called it – honest to himself and heroically honest to the authoritarian power that repressed his society and crushed the freedoms of hundreds of millions.

He paid dearly for this choice, spending several years in prison and many more under surveillance, harassment, and censorship of his writings. Yet the glow of truth spread. Havel gave hope, courage, and even fearlessness to a generation of his compatriots. When the web of lies collapsed in November 1989, hundreds of thousands of Czechs and Slovaks poured into the streets to proclaim their freedom  – and to sweep the banished and jailed playwright into Prague Castle as Czechoslovakia’s newly elected president.

I personally witnessed the power of living in truth in that year, when the leadership of Poland’s Solidarity movement asked me to help Poland with its transition to democracy and a market economy – part of what the Poles called their “return to Europe.” I met and was profoundly inspired by many in the region who, like Havel, lived in truth: Adam Michnik, Jacek Kuron, Bronislaw Geremek, Gregorsz Lindenberg, Jan Smolar, Irena Grosfeld, and, of course, Lech Walesa. These brave men and women, and those like Tadeusz Mazowiecki and Leszek Balcerowicz, who led Poland during its first steps in freedom, succeeded through their combination of courage, intellect, and integrity.

The power of truth-telling that year created a dazzling sense of possibility, for it proved the undoing of one of history’s most recalcitrant hegemonies: Soviet domination of Eastern Europe. Michnik, like Havel, radiated the joy of fearless truth. I asked him in July 1989, as Poland’s communist regime was already unraveling, when freedom would reach Prague. He replied, “By the end of the year.”

“How do you know?” I asked. “I was just with Havel in the mountains last week,” he said. “Have no fear. Freedom is on the way.”  His forecast was correct, of course, with a month to spare.

Just as lies and corruption are contagious, so, too, moral truth and bravery spreads from one champion to another. Havel and Michnik could succeed in part because of the miracle of Mikhail Gorbachev, the Soviet leader who emerged from a poisoned system, yet who valued truth above force. And Gorbachev could triumph in part because of the sheer power of honesty of his countryman, Andrei Sakharov, the great and fearless nuclear physicist who also risked all to speak truth in the very heart of the Soviet empire – and who paid for it with years of internal exile.

These pillars of moral leadership typically drew upon still other examples, including that of Mahatma Gandhi, who called his autobiography The Story of My Experiments With Truth. They all believed that truth, both scientific and moral, could ultimately prevail against any phalanx of lies and power. Many died in the service of that belief; all of us alive today reap the benefits of their faith in the power of truth in action.

Havel’s life is a reminder of the miracles that such a credo can bring about; yet it is also a reminder of the more somber fact that truth’s victories are never definitive. Each generation must adapt its moral foundations to the ever-changing conditions of politics, culture, society, and technology.

Havel’s death comes at a time of massive demonstrations in Russia to protest ballot fraud; violence in Egypt as democratic activists battle the deeply entrenched military; an uprising in rural China against corrupt local officials; and police in body armor violently dismantling the Occupy protest sites in American cities. Power and truth remain locked in combat around the world.

Much of today’s struggle – everywhere – pits truth against greed. Even if our challenges are different from those faced by Havel, the importance of living in truth has not changed.

Today’s reality is of a world in which wealth translates into power, and power is abused in order to augment personal wealth, at the expense of the poor and the natural environment. As those in power destroy the environment, launch wars on false pretexts, foment social unrest, and ignore the plight of the poor, they seem unaware that they and their children will also pay a heavy price.

Moral leaders nowadays should build on the foundations laid by Havel. Many people, of course, now despair about the possibilities for constructive change. Yet the battles that we face – against powerful corporate lobbies, relentless public-relations spin, and our governments’ incessant lies – are a shadow of what Havel, Michnik, Sakharov, and others faced when taking on brutal Soviet-backed regimes.

In contrast to these titans of dissent, we are empowered with the instruments of social media to spread the word, overcome isolation, and mobilize millions in support of reform and renewal. Many of us enjoy minimum protections of speech and assembly, though these are inevitably hard won, imperfect, and fragile. Yet, of the profoundest importance and benefit, we are also blessed with the enduring inspiration of Havel’s life in truth.

Jeffrey D. Sachs is Professor of Economics and Director of the Earth Institute at Columbia University. He is also Special Adviser to United Nations Secretary-General on the Millennium Development Goals.

Copyright: Project Syndicate, 2011.
www.project-syndicate.org

PHOTO: A woman walks past a mural of late former Czech President Vaclav Havel in Prague December 20, 2011. REUTERS/David W Cerny

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Fragile and unbalanced in 2012 http://blogs.reuters.com/amplifications/2011/12/15/fragile-and-unbalanced-in-2012/ http://blogs.reuters.com/amplifications/2011/12/15/fragile-and-unbalanced-in-2012/#comments Thu, 15 Dec 2011 15:37:32 +0000 http://blogs.reuters.com/amplifications/?p=42 Nouriel Roubini
The opinions expressed are his own.

The outlook for the global economy in 2012 is clear, but it isn’t pretty: recession in Europe, anemic growth at best in the United States, and a sharp slowdown in China and in most emerging-market economies. Asian economies are exposed to China. Latin America is exposed to lower commodity prices (as both China and the advanced economies slow). Central and Eastern Europe are exposed to the eurozone. And turmoil in the Middle East is causing serious economic risks – both there and elsewhere – as geopolitical risk remains high and thus high oil prices will constrain global growth.

At this point, a eurozone recession is certain. While its depth and length cannot be predicted, a continued credit crunch, sovereign-debt problems, lack of competitiveness, and fiscal austerity imply a serious downturn.

The US – growing at a snail’s pace since 2010 – faces considerable downside risks from the eurozone crisis. It must also contend with significant fiscal drag, ongoing deleveraging in the household sector (amid weak job creation, stagnant incomes, and persistent downward pressure on real estate and financial wealth), rising inequality, and political gridlock.

Elsewhere among the major advanced economies, the United Kingdom is double dipping, as front-loaded fiscal consolidation and eurozone exposure undermine growth. In Japan, the post-earthquake recovery will fizzle out as weak governments fail to implement structural reforms.

Meanwhile, flaws in China’s growth model are becoming obvious. Falling property prices are starting a chain reaction that will have a negative effect on developers, investment, and government revenue. The construction boom is starting to stall, just as net exports have become a drag on growth, owing to weakening US and especially eurozone demand. Having sought to cool the property market by reining in runaway prices, Chinese leaders will be hard put to restart growth.

They are not alone. On the policy side, the US, Europe, and Japan, too, have been postponing the serious economic, fiscal, and financial reforms that are needed to restore sustainable and balanced growth.

Private- and public-sector deleveraging in the advanced economies has barely begun, with balance sheets of households, banks and financial institutions, and local and central governments still strained. Only the high-grade corporate sector has improved. But, with so many persistent tail risks and global uncertainties weighing on final demand, and with excess capacity remaining high, owing to past over-investment in real estate in many countries and China’s surge in manufacturing investment in recent years, these companies’ capital spending and hiring have remained muted.

Rising inequality – owing partly to job-slashing corporate restructuring – is reducing aggregate demand further, because households, poorer individuals, and labor-income earners have a higher marginal propensity to spend than corporations, richer households, and capital-income earners. Moreover, as inequality fuels popular protest around the world, social and political instability could pose an additional risk to economic performance.

At the same time, key current-account imbalances – between the US and China (and other emerging-market economies), and within the eurozone between the core and the periphery – remain large. Orderly adjustment requires lower domestic demand in over-spending countries with large current-account deficits and lower trade surpluses in over-saving countries via nominal and real currency appreciation. To maintain growth, over-spending countries need nominal and real depreciation to improve trade balances, while surplus countries need to boost domestic demand, especially consumption.

But this adjustment of relative prices via currency movements is stalled, because surplus countries are resisting exchange-rate appreciation in favor of imposing recessionary deflation on deficit countries. The ensuing currency battles are being fought on several fronts: foreign-exchange intervention, quantitative easing, and capital controls on inflows. And, with global growth weakening further in 2012, those battles could escalate into trade wars.

Finally, policymakers are running out of options. Currency devaluation is a zero-sum game, because not all countries can depreciate and improve net exports at the same time. Monetary policy will be eased as inflation becomes a non-issue in advanced economies (and a lesser issue in emerging markets). But monetary policy is increasingly ineffective in advanced economies, where the problems stem from insolvency – and thus creditworthiness – rather than liquidity.

Meanwhile, fiscal policy is constrained by the rise of deficits and debts, bond vigilantes, and new fiscal rules in Europe. Backstopping and bailing out financial institutions is politically unpopular, while near-insolvent governments don’t have the money to do so. And, politically, the promise of the G-20 has given way to the reality of the G-0: weak governments find it increasingly difficult to implement international policy coordination, as the worldviews, goals, and interests of advanced economies and emerging markets come into conflict.

As a result, dealing with stock imbalances – the large debts of households, financial institutions, and governments – by papering over solvency problems with financing and liquidity may eventually give way to painful and possibly disorderly restructurings. Likewise, addressing weak competitiveness and current-account imbalances requires currency adjustments that may eventually lead some members to exit the eurozone.

Restoring robust growth is difficult enough without the ever-present specter of deleveraging and a severe shortage of policy ammunition. But that is the challenge that a fragile and unbalanced global economy faces in 2012. To paraphrase Bette Davis in All About Eve, “Fasten your seatbelts, it’s going to be a bumpy year!”

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The 70% solution http://blogs.reuters.com/amplifications/2011/11/30/the-70-solution/ http://blogs.reuters.com/amplifications/2011/11/30/the-70-solution/#comments Wed, 30 Nov 2011 16:59:35 +0000 http://blogs.reuters.com/amplifications/?p=36 By J. Bradford DeLong
The opinions expressed are his own.

Via a circuitous Internet chain – Paul Krugman of Princeton University quoting Mark Thoma of the University of Oregon reading the Journal of Economic Perspectives – I got a copy of an article written by Emmanuel Saez, whose office is 50 feet from mine, on the same corridor, and the Nobel laureate economist Peter Diamond. Saez and Diamond argue that the right marginal tax rate for North Atlantic societies to impose on their richest citizens is 70%.

It is an arresting assertion, given the tax-cut mania that has prevailed in these societies for the past 30 years, but Diamond and Saez’s logic is clear. The superrich command and control so many resources that they are effectively satiated: increasing or decreasing how much wealth they have has no effect on their happiness. So, no matter how large a weight we place on their happiness relative to the happiness of others – whether we regard them as praiseworthy captains of industry who merit their high positions, or as parasitic thieves – we simply cannot do anything to affect it by raising or lowering their tax rates.

The unavoidable implication of this argument is that when we calculate what the tax rate for the superrich will be, we should not consider the effect of changing their tax rate on their happiness, for we know that it is zero. Rather, the key question must be the effect of changing their tax rate on the well-being of the rest of us.

From this simple chain of logic follows the conclusion that we have a moral obligation to tax our superrich at the peak of the Laffer Curve: to tax them so heavily that we raise the most possible money from them – to the point beyond which their diversion of energy and enterprise into tax avoidance and sheltering would mean that any extra taxes would not raise but reduce revenue.

The utilitarian economic logic is clear. Yet more than half of us are likely to reject the conclusion reached by Diamond and Saez. We feel that there is something wrong with taxing our superrich until the pips squeak so much that further taxation reduces the number of pips. And we feel this for two reasons, both of them set out more than two centuries ago by Adam Smith – not in his most famous work, The Wealth of Nations, but in his far less discussed book The Theory of Moral Sentiments.

The first reason applies to the idle rich. According to Smith:

A stranger to human nature, who saw the indifference of men about the misery of their inferiors, and the regret and indignation which they feel for the misfortunes and sufferings of those above them, would be apt to imagine, that pain must be more agonizing, and the convulsions of death more terrible to persons of higher rank, than to those of meaner stations …

We feel this, Smith believes, because we naturally sympathize with others (if he were writing today, he would surely invoke “mirror neurons”). And the more pleasant our thoughts about individuals or groups are, the more we tend to sympathize with them. The fact that the lifestyles of the rich and famous “seem almost the abstract idea of a perfect and happy state” leads us to “pity…that anything should spoil and corrupt so agreeable a situation! We could even wish them immortal … ”

The second reason applies to the hard-working rich, the type of person who:

devotes himself forever to the pursuit of wealth and greatness…With the most unrelenting industry he labors night and day….serves those whom he hates, and is obsequious to those whom he despises….[I]n the last dregs of life, his body wasted with toil and diseases, his mind galled and ruffled by the memory of a thousand injuries and disappointments….he begins at last to find that wealth and greatness are mere trinkets of frivolous utility….Power and riches….keep off the summer shower, not the winter storm, but leave him always as much, and sometimes more exposed than before, to anxiety, to fear, and to sorrow; to diseases, to danger, and to death…

In short, on the one hand, we don’t wish to disrupt the perfect felicity of the lifestyles of the rich and famous; on the other hand, we don’t wish to add to the burdens of those who have spent their most precious possession – their time and energy – pursuing baubles. These two arguments are not consistent, but that does not matter. They both have a purchase on our thinking.

Unlike today’s public-finance economists, Smith understood that we are not rational utilitarian calculators. Indeed, that is why we have collectively done a very bad job so far in dealing with the enormous rise in inequality between the industrial middle class and the plutocratic superrich that we have witnessed in the last generation.

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Asia is no longer a safe bet http://blogs.reuters.com/amplifications/2011/11/28/asia-is-no-longer-a-safe-bet/ http://blogs.reuters.com/amplifications/2011/11/28/asia-is-no-longer-a-safe-bet/#comments Mon, 28 Nov 2011 16:12:42 +0000 http://blogs.reuters.com/amplifications/?p=30 By Stephen S. Roach
The opinions expressed are his own.

For the second time in three years, global economic recovery is at risk. In 2008, it was all about the subprime crisis made in America. Today, it is the sovereign-debt crisis made in Europe. The alarm bells should be ringing loud and clear across Asia – an export-led region that cannot afford to ignore repeated shocks to its two largest sources of external demand.

Indeed, both of these shocks will have long-lasting repercussions. In the United States, the American consumer (who still accounts for 71% of US GDP) remains in the wrenching throes of a Japanese-like balance-sheet recession. In the 15 quarters since the beginning of 2008, real consumer spending has increased at an anemic 0.4% average annual rate.

Never before has America, the world’s biggest consumer, been so weak for so long. Until US households make greater progress in reducing excessive debt loads and rebuilding personal savings – a process that could take many more years if it continues at its recent snail-like pace – a balance-sheet-constrained US economy will remain hobbled by exceedingly slow growth.

A comparable outcome is likely in Europe. Even under the now seemingly heroic assumption that the eurozone will survive, the outlook for the European economy is bleak. The crisis-torn peripheral economies – Greece, Ireland, Portugal, Italy, and even Spain – are already in recession. And economic growth is threatened in the once-solid core of Germany and France, with leading indicators – especially sharply declining German orders data – flashing ominous signs of incipient weakness.

Moreover, with fiscal austerity likely to restrain aggregate demand in the years ahead, and with capital-short banks likely to curtail lending – a serious problem for Europe’s bank-centric system of credit intermediation – a pan-European recession seems inevitable. The European Commission recently slashed its 2012 GDP growth forecast to 0.5% – teetering on the brink of outright recession. The risks of further cuts to the official outlook are high and rising.

It is difficult to see how Asia can remain an oasis of prosperity in such a tough global climate. Yet denial is deep, and momentum is seductive. After all, Asia has been on such a roll in recent years that far too many believe that the region can shrug off almost anything that the rest of the world dishes out.

If only it were that easy. If anything, Asia’s vulnerability to external shocks has intensified. On the eve of the Great Recession of 2008-2009, exports had soared to a record 44% of combined GDP for Asia’s emerging markets – fully ten percentage points higher than the export share prevailing during Asia’s own crisis in 1997-1998. So, while post-crisis Asia focused in the 2000’s on repairing the financial vulnerabilities that had wreaked such havoc – namely, by amassing huge foreign-exchange reserves, turning current-account deficits into surpluses, and reducing its outsize exposure to short-term capital inflows – it failed to rebalance its economy’s macro structure. In fact, Asia became more reliant on exports and external demand for economic growth.

As a result, when the shock of 2008-2009 hit, every economy in the region either experienced a sharp slowdown or fell into outright recession. A similar outcome cannot be ruled out in the months ahead. After tumbling sharply in 2008-2009, the export share of emerging Asia is back up to its earlier high of around 44% of GDP – leaving the region just as exposed to an external-demand shock today as it was heading into the subprime crisis three years ago.

China – long the engine of the all-powerful Asian growth machine – typifies Asia’s potential vulnerability to such shocks from the developed economies. Indeed, Europe and the US, combined, accounted for fully 38% of total Chinese exports in 2010 – easily its two largest foreign markets.

The recent data leave little doubt that Asia is now starting to feel the impact of the latest global shock. As was the case three years ago, China is leading the way, with annual export growth plummeting in October 2011, to 16%, from 31% in October 2010 – and likely to slow further in coming months.

In Hong Kong, exports actually contracted by 3% in September – the first year-on-year decline in 23 months. Similar trends are evident in sharply decelerating exports in Korea and Taiwan. Even in India – long thought to be among Asia’s most shock-resistant economies – annual export growth plunged from 44% in August 2011 to just 11% in October.

As was true three years ago, many hope for an Asian “decoupling” – that this high-flying region will be immune to global shocks. But, with GDP growth now slowing across Asia, that hope appears to be wishful thinking.

The good news is that a powerful investment-led impetus should partly offset declining export growth and allow Asia’s landing to be soft rather than hard. All bets would be off, however, in the event of a eurozone breakup and a full-blown European implosion.

This is Asia’s second wake-up call in three years, and this time the region needs to take the warning seriously. With the US, and now Europe, facing long roads to recovery, Asia’s emerging economies can no longer afford to count on solid growth in external demand from the advanced countries to sustain economic development. Unless they want to settle for slower growth, lagging labor absorption, and heightened risk of social instability, they must move aggressively to shift focus to the region’s own 3.5 billion consumers. The need for a consumer-led Asian rebalancing has never been greater.

This piece comes from Project Syndicate.

Photo: Guest attend the presentation of the new Qoros car in Shanghai November 28, 2011. Chery Quantum Auto Co., a joint venture between Chery Automobile and investment firm Israel Corp, on Monday unveiled the design of its first car, which it hopes will allow it to reverse a trend and export made-in-China cars to Western Europe. REUTERS/Carlos Barria

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Down with the Eurozone http://blogs.reuters.com/amplifications/2011/11/11/down-with-the-eurozone/ http://blogs.reuters.com/amplifications/2011/11/11/down-with-the-eurozone/#comments Fri, 11 Nov 2011 18:51:06 +0000 http://blogs.reuters.com/amplifications/?p=26 By Nouriel Roubini
The opinions expressed are his own.

The eurozone crisis seems to be reaching its climax, with Greece on the verge of default and an inglorious exit from the monetary union, and now Italy on the verge of losing market access. But the eurozone’s problems are much deeper. They are structural, and they severely affect at least four other economies: Ireland, Portugal, Cyprus, and Spain.

For the last decade, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) were the eurozone’s consumers of first and last resort, spending more than their income and running ever-larger current-account deficits. Meanwhile, the eurozone core (Germany, the Netherlands, Austria, and France) comprised the producers of first and last resort, spending below their incomes and running ever-larger current-account surpluses.

These external imbalances were also driven by the euro’s strength since 2002, and by the divergence in real exchange rates and competitiveness within the eurozone. Unit labor costs fell in Germany and other parts of the core (as wage growth lagged that of productivity), leading to a real depreciation and rising current-account surpluses, while the reverse occurred in the PIIGS (and Cyprus), leading to real appreciation and widening current-account deficits. In Ireland and Spain, private savings collapsed, and a housing bubble fueled excessive consumption, while in Greece, Portugal, Cyprus, and Italy, it was excessive fiscal deficits that exacerbated external imbalances.

The resulting build-up of private and public debt in over-spending countries became unmanageable when housing bubbles burst (Ireland and Spain) and current-account deficits, fiscal gaps, or both became unsustainable throughout the eurozone’s periphery. Moreover, the peripheral countries’ large current-account deficits, fueled as they were by excessive consumption, were accompanied by economic stagnation and loss of competitiveness.

So, now what?

Symmetrical reflation is the best option for restoring growth and competitiveness on the eurozone’s periphery while undertaking necessary austerity measures and structural reforms. This implies significant easing of monetary policy by the European Central Bank; provision of unlimited lender-of-last-resort support to illiquid but potentially solvent economies; a sharp depreciation of the euro, which would turn current-account deficits into surpluses; and fiscal stimulus in the core if the periphery is forced into austerity.

Unfortunately, Germany and the ECB oppose this option, owing to the prospect of a temporary dose of modestly higher inflation in the core relative to the periphery.

The bitter medicine that Germany and the ECB want to impose on the periphery – the second option – is recessionary deflation: fiscal austerity, structural reforms to boost productivity growth and reduce unit labor costs, and real depreciation via price adjustment, as opposed to nominal exchange-rate adjustment.

The problems with this option are many. Fiscal austerity, while necessary, means a deeper recession in the short term. Even structural reform reduces output in the short run, because it requires firing workers, shutting down money-losing firms, and gradually reallocating labor and capital to emerging new industries. So, to prevent a spiral of ever-deepening recession, the periphery needs real depreciation to improve its external deficit. But even if prices and wages were to fall by 30% over the next few years (which would most likely be socially and politically unsustainable), the real value of debt would increase sharply, worsening the insolvency of governments and private debtors.

In short, the eurozone’s periphery is now subject to the paradox of thrift: increasing savings too much, too fast leads to renewed recession and makes debts even more unsustainable. And that paradox is now affecting even the core.

If the peripheral countries remain mired in a deflationary trap of high debt, falling output, weak competitiveness, and structural external deficits, eventually they will be tempted by a third option: default and exit from the eurozone. This would enable them to revive economic growth and competitiveness through a depreciation of new national currencies.

Of course, such a disorderly eurozone break-up would be as severe a shock as the collapse of Lehman Brothers in 2008, if not worse. Avoiding it would compel the eurozone’s core economies to embrace the fourth and final option: bribing the periphery to remain in a low-growth uncompetitive state. This would require accepting massive losses on public and private debt, as well as enormous transfer payments that boost the periphery’s income while its output stagnates.

Italy has done something similar for decades, with its northern regions subsidizing the poorer Mezzogiorno. But such permanent fiscal transfers are politically impossible in the eurozone, where Germans are Germans and Greeks are Greeks.

That also means that Germany and the ECB have less power than they seem to believe. Unless they abandon asymmetric adjustment (recessionary deflation), which concentrates all of the pain in the periphery, in favor of a more symmetrical approach (austerity and structural reforms on the periphery, combined with eurozone-wide reflation), the monetary union’s slow-developing train wreck will accelerate as peripheral countries default and exit.

The recent chaos in Greece and Italy may be the first step in this process. Clearly, the eurozone’s muddle-through approach no longer works. Unless the eurozone moves toward greater economic, fiscal, and political integration (on a path consistent with short-term restoration of growth, competitiveness, and debt sustainability, which are needed to resolve unsustainable debt and reduce chronic fiscal and external deficits), recessionary deflation will certainly lead to a disorderly break-up.

With Italy too big to fail, too big to save, and now at the point of no return, the endgame for the eurozone has begun. Sequential, coercive restructurings of debt will come first, and then exits from the monetary union that will eventually lead to the eurozone’s disintegration.

This piece comes form Project Syndicate.

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The undeserving one percent? http://blogs.reuters.com/amplifications/2011/11/10/the-undeserving-one-percent/ http://blogs.reuters.com/amplifications/2011/11/10/the-undeserving-one-percent/#comments Thu, 10 Nov 2011 18:29:15 +0000 http://blogs.reuters.com/amplifications/?p=20 By Raghuram Rajan
The opinions expressed are his own.

It is amazing how the “one percent” epithet, a reference to the top 1% of earners, has caught on in the United States and elsewhere in the developed world. In the United States, this 1% includes all those with a 2006 household income of at least $386,000. In the popular narrative, the 1% is thickly populated with unscrupulous corporate titans, greedy bankers, and insider-trading hedge-fund managers. Reading some progressive economists, it might seem that the answer to all of America’s current problems is to tax the 1% and redistribute to everyone else.

Of course, underlying this narrative is the view that this income is ill-gotten, made possible by Bush-era tax cuts, the broken corporate governance system, and the conflict-of-interest-ridden financial system. The 1% are not people who have earned money the hard way by making real things, so there is no harm in taking it away from them.

Clearly, this caricature is based on some truth. For instance, corporations, especially in the financial sector, reward too many executives richly despite mediocre performance. But apart from tarring too many with the same brush, there is something deeply troubling about this narrative’s reductionism.

It ignores, for example, the fact that many of the truly rich are entrepreneurs. It likewise ignores the fact that many of the wealthy are sports stars and entertainers, and that their ranks include professionals such as doctors, lawyers, consultants, and even some of our favorite progressive economists. In other words, the rich today are more likely to be working than idle.

But what might be the most important overlooked fact is that the rise in income inequality is not just at the very top, though it is most pronounced there. Academic studies suggest that the top tenth percentile of income distribution in the US, and elsewhere, is also moving farther away from the median earner. This is an inconvenient fact for the progressive economist. “We are the 90%,” sounds less dramatic than “we are the 99%.” And, for some of the protesters, it may not even be true.

Perhaps most problematic, though, is that something other than plutocrat-friendly policies is largely responsible for the growing inequality. That something is education and skills. True, not every degree is a passport to a job. Freshly-minted degree holders, especially from lower-quality programs, are finding it particularly hard to get a job nowadays, because they are competing with experienced workers who are also jobless. Nevertheless, the unemployment rate for those with degrees is one-third the unemployment rate for those without a high school diploma.

Close examination suggests that the single biggest difference between those at or above the top tenth percentile of the income distribution and those below the 50th percentile is that the former have a degree or two while the latter, typically, do not. Technological change and global competition have made it impossible for American workers to get good jobs without strong skills. As Harvard professors Claudia Golden and Larry Katz put it, in the race between technology and education, education is falling behind.

To acknowledge the fact that the broken educational and skills-building system is responsible for much of the growing inequality that ordinary people experience would, however, detract from the larger populist agenda of rallying the masses against the very rich. It has the inconvenient implication that the poor have a role in pulling themselves out of the morass. There are no easy and quick fixes to education – every US president since Gerald Ford in the mid-1970’s has called for educational reforms, with little effect. In contrast, blaming the undeserving 1% offers a redistributive policy agenda with immediate effects.

The US has tried quick fixes before. Income inequality grew rapidly in the last decade, but consumption inequality did not. The reason: easy credit, especially subprime mortgages, which helped those without means to keep up with the Joneses. The ending, as everyone knows, was not a happy one. The less-well-off ultimately became even worse off as they lost their jobs and homes.

The US needs to improve the quality of its workforce by developing the skills that are relevant to the jobs that its firms are creating. Several steps can be taken towards these goals, including improving community attitudes towards education, reforming schools, tying the curriculum in community colleges and vocational institutions more closely to the needs of local firms, making higher education more affordable, and finding effective ways to retrain unemployed workers.

None of this is easy or likely to produce results quickly, and some of it may require more resources. While eliminating inefficient spending, especially inefficient tax subsidies, can generate some of these funds, more tax revenues may be needed. The rich can certainly afford to pay more, but if governments increase taxes on the wealthy, they should do it with the aim of improving opportunities for all, rather than as a punitive measure to rectify an imagined wrong.

This piece comes from Project Syndicate.

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Why the euro needs to fall http://blogs.reuters.com/amplifications/2011/11/03/why-the-euro-needs-to-fall/ http://blogs.reuters.com/amplifications/2011/11/03/why-the-euro-needs-to-fall/#comments Thu, 03 Nov 2011 22:07:15 +0000 http://blogs.reuters.com/amplifications/?p=15 By Kenneth Rogoff
The opinions expressed are his own.

Although I appreciate that exchange rates are never easy to explain or understand, I find today’s relatively robust value for the euro somewhat mysterious. Do the gnomes of currency markets seriously believe that the eurozone governments’ latest “comprehensive package” to save the euro will hold up for more than a few months?

The new plan relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding. Even the best part of the plan, the proposed (but not really agreed) 50% haircut for private-sector holders of Greek sovereign debt, is not sufficient to stabilize that country’s profound debt and growth problems.

So how is it that the euro is trading at a 40% premium to the US dollar, even as investors continue to view southern European government debt with great skepticism? I can think of one very good reason why the euro needs to fall, and six not-so-convincing reasons why it should remain stable or appreciate. Let’s begin with why the euro needs to fall.

Absent a clear path to a much tighter fiscal and political union, which can lead only through constitutional change, the current halfway house of the euro system appears increasingly untenable. It seems clear that the European Central Bank will be forced to buy far greater quantities of eurozone sovereign (junk) bonds. That may work in the short term, but if sovereign default risks materialize – as my research with Carmen Reinhart suggests is likely – the ECB will in turn have to be recapitalized. And, if the stronger northern eurozone countries are unwilling to digest this transfer – and political resistance runs high – the ECB may be forced to recapitalize itself through money creation. Either way, the threat of a profound financial crisis is high.

Given this, what arguments support the current value of the euro, or its further rise?

First, investors might be telling themselves that in the worst-case scenario, the northern European countries will effectively push out the weaker countries, creating a super-euro. But, while this scenario has a certain ring of truth, surely any breakup would be highly traumatic, with the euro diving before its rump form recovered.

Second, investors may be remembering that even though the dollar was at the epicenter of the 2008 financial panic, the consequences radiated so widely that, paradoxically, the dollar actually rose in value. Although it may be difficult to connect the dots, it is perfectly possible that a huge euro crisis could have a snowball effect in the US and elsewhere. Perhaps the transmission mechanism would be through US banks, many of which remain vulnerable, owing to thin capitalization and huge portfolios of mortgages booked far above their market value.

Third, foreign central banks and sovereign wealth funds may be keen to keep buying up euros to hedge against risks to the US and their own economies. Government investors are not necessarily driven by the return-maximizing calculus that motivates private investors. If foreign official demand is the real reason behind the euro’s strength, the risk is that foreign sovereign euro buyers will eventually flee, just as private investors would, only in a faster and more concentrated way.

Fourth, investors may believe that, ultimately, US risks are just as large as Europe’s. True, the US political system seems stymied in coming up with a plan to stabilize medium-term budget deficits. Whereas the US Congress’s “supercommittee,” charged with formulating a fiscal-consolidation package, will likely come up with a proposal, it is far from clear that either Republicans or Democrats will be willing to accept compromise in an election year. Moreover, investors might be worried that the US Federal Reserve will weigh in with a third round of “quantitative easing,” which would further drive down the dollar.

Fifth, the current value of the euro does not seem wildly out of line on a purchasing-power basis. An exchange rate of $1.4:€1 is cheap for Germany’s export powerhouse, which could probably operate well even with a far stronger euro. For the eurozone’s southern periphery, however, today’s euro rate is very difficult to manage. Whereas some German companies persuaded workers to accept wage cuts to help weather the financial crisis, wages across the southern periphery have been marching steadily upwards, even as productivity has remained stagnant. But, because the overall value of the euro has to be a balance of the eurozone’s north and south, one can argue that 1.4 is within a reasonable range.

Finally, investors might just believe that the eurozone leaders’ latest plan will work, even though the last dozen plans have failed. Abraham Lincoln is credited with saying “You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time.” A comprehensive euro fix will surely arrive for some of the countries at some time, but not for all of the countries anytime soon.

So, yes, there are plenty of vaguely plausible reasons why the euro, despite its drawn-out crisis, has remained so firm against the dollar so far. But don’t count on a stable euro-dollar exchange rate – much less an even stronger euro – in the year ahead.

This piece comes from Project Syndicate.

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