The Great Debate UK

Democracy vs. austerity

By Kathleen Brooks. The opinions expressed are her own.

Throughout history it has always been difficult to take something away from someone once you have given it to them. Europe is finding that it is extremely difficult to reign in public finances once they start to go out of control. Democracies don’t like to vote for austerity, which is why Sarkozy lost the Presidency in France, why a radical left party came second in the Greek elections and why the Conservatives got a drubbing at last week’s local elections in the UK.

This tells us something about democracy in the western world. Governments have to manage the public finances directly – they have to sell the debt, do the sums and present budgets. However, the people who vote them into (and out of) power are the public, who rightly in most cases, believe they have worked hard, paid  taxes and deserve the services and retirement promises made to them.

So here we have the problem: some governments in the West have unsustainable debt loads and deficit levels and yet they don’t have the popular mandate to try and bring that under control. That isn’t the story all over the west. The Germans and the Dutch agree that the government books should be balanced. But if you asked the rest of Europe if they wanted to reduce public debt levels to make country finances more sustainable at the expense of public services and jobs, the recent election results suggest that you would get a resounding no.

So there isn’t one unified way of thinking about austerity in the West. Some people see it as a virtue, others as a type of hell. So what to do? Europe’s one-type fits all model that is largely designed by Germany could lead to social disorder and radical political parties grabbing the reins of power in Greece. However, the more people fight against austerity the more unlikely it is that their governments can attract enough investors to buy their debt to fund their public spending needs.

So where does this vicious circle end? The answer is that no one knows. Now that the true state of public finances in Europe has been revealed it can’t be brushed under the carpet and the Greeks et al can’t go back to the pre-2007 ways of living and spending. However, the opposite – harsh austerity designed to reign in public finances at half the time it took to amass the debt in the first place – isn’t working either.

A more sensible plan is for Europe to reach some sort of compromise. Germany and Greece (as the two extremes) need to realise there are multiple views about what a democracy should provide and how public finances should be controlled. The next step is to plan a fiscal pact that allows countries to reign in public spending at the same pace as it amassed it in the first place – and fiscal targets should be spread out over 10 years rather than the current demands to bring down deficits to 3 percent of GDP by the next fiscal year. The UK could probably follow suit and realise that the debts took two parliaments to accumulate, thus it should take two parliaments to rein them in.

Belgium: A role model for the rest of Europe?

By Mark Hillary. The opinions expressed are his own.

In addition to the economic meltdown, there is another political story in Europe at present – Belgium.

I’m not referring to the recent release of Steven Spielberg’s ‘Adventures of Tintin’ movie – though it might be argued that Captain Haddock bears a passing resemblance to several much-missed British political figures, thanks to the trademark slur.

I mean the government. Or lack of one. As I write, it is now 530 days since Belgium actually had a functioning Cabinet making decisions and showing political leadership – or actually doing anything.

They didn’t need an Occupy movement to destroy the government in Belgium. They just needed a general election where the votes were spread so thinly across so many political parties that it became impossible to form a coalition that could then appoint Cabinet representatives.

At the election in June last year, 11 parties won a place in the Chamber of Representatives, and since then the horse-trading over who will take seats in Cabinet has continued. It was June this year when Belgium passed the previous holder of the dubious honour of being the slowest country to ever form a government – Cambodia.

Without digging too deep into the background of the Belgian problem – and speculation over partition – I am surprised that failure to form a government in a western European nation has sailed under the radar of most people commenting on the European economic and political maelstrom.

from The Great Debate:

“Act and learn” versus “debate and wait”

By Mohamed El-Erian and Michael Spence The opinions expressed are their own.

In formulating policy, the process and the mindset can have a significant impact on the success or failure of outcomes. How you do it can be as or more important than what you do.

In today’s western economies, this observation may go a long way in explaining why policy outcomes have consistently fallen short of what policymakers themselves have expected, let alone what is needed to address important and growing economic challenges.

Signs of disappointing policy outcomes are, unfortunately, all around us. Over the last two years, American policymakers have failed miserably to lower persistently high unemployment despite a series of stimulus measures, fiscal and monetary, conventional and unconventional. In Europe, the debt crisis has spread despite numerous summits, declarations, policy actions and political changes.

In both cases, policymakers identified and sometimes mis-identified the problems and took highly publicized steps to solve them. Considerable financial resources and political capital were deployed. The credibility of policymakers (and policymaking itself) was placed on the line. Yet to no avail. The identified problems not only persisted, they deepened. When one compares policymaking episodes around the world – successful and less so – it seems clear that there is more at play than the content of policies. The mindset of policymakers and the process of policymaking seem to also have a lot to do with the disappointing outcomes. Indeed, one often hears policymakers point to political dysfunctionality as being the major hindrance to good outcomes.

In the US, it is the highly polarized nature of the political discourse and the associated lack of a “center.” In Europe, it is the need to get universal approval from the seventeen members of the Eurozone in what is often a cumbersome process that pits European necessities and realities against national interests and individual political party posturing. As valid as the political constraints may be, we believe that there is something even more fundamental at play. It is not just about politics. In the last few years, the policy mindset has been unhelpful and, as a result, the sequencing outmoded.

Western policymakers have been hostage for too long to a cyclical mindset. Their economies have been going through structural and secular changes brought about by major re-alignments at the national, regional and global level. Repeatedly, the extent and duration of the ongoing economic changes were not sufficiently understood and embraced. As a result, economies have suffered rather than evolved.

from Anooja Debnath:

When it comes to recessions, 40 is the new 50

If it were about age, 40-somethings would cringe. But it seems a dead certainty that 40 now means 50 -- or even higher -- when it comes to predicting the chances of a recession taking place.

Going by past Reuters polls of economists, every time the probability hits 40 percent, the recession's already started or is perilously close to doing so.

After the brief recovery period from the Great Recession, Reuters once again started surveying economists several months ago on the chances of developed economies stumbling back into the muck.

As the data get nastier and euro zone politicians wrangle over the sovereign debt mess, the probability goes higher. Just not high enough or fast enough.

The probability that Britain slides back into recession hit 40 percent in the Reuters poll this week, up from one in three last month.

The last time that happened was in July 2008, a few months before U.S. investment bank Lehman Brothers collapsed. The British economy contracted by 2 percent that quarter, its second contraction of 2008. And we all know what happened next. If 40 is the new 50, we're in it.

"It is a very big thing to say we are going into recession ... it is one of those things people are cautious sticking their necks out about," said Alan Clarke, who said there’s a 75 percent chance of that happening.

Ben Bernanke could teach the EU a thing or two

By Kathleen Brooks. The opinions expressed are her own.

Markets thrive on certainty. Anything that smacks of uncertainty, fence-sitting or indecision will lead to market turbulence, as investors punish those who don’t tell them how it is.

This is exactly what we are seeing in Europe right now. The markets are losing patience with the EU’s inability to come up with a credible plan to fight the sovereign debt crisis and that is why it is escalating at an alarming rate.

In general, investors in credit markets are a canny bunch. Bond spreads between Germany and Greece, Ireland, Portugal, Spain and Italy have already blown out, but in recent days spreads between Germany and France, Belgium and even Austria have increased to their widest level for more than two years.

So what does this all mean? In short it suggests that bond investors are going off Europe, even those members who were previously considered safe are no longer out of harm’s way. The credit markets are turning against the political make-up of the currency bloc and until concrete changes are made to the structure of the euro zone the pressure on European credit markets is unlikely to abate.

The various branches of authority in the Eurozone seem to lurch from one crisis to another. Because there is no central voice or authority you end up with a cacophony of voices talking at odds to each other that confuses the markets.

For example, Germany and the ECB continue to play out their differences in public on whether private investors in Greek debt should take a loss. A new low was when the EU President confirmed an emergency summit would be held last Friday, which some member states didn’t even know about.

Europe’s bigger crisis waiting to happen

By Kathleen Brooks. The opinions expressed are her own.

So it looks like Greece has staved off default for another few months at least. Investors are breathing a sigh of relief and buying up risky assets like the world is a rosy place again.

The markets always suffer from a chronic case of short-termism, but once a sovereign debt crisis takes hold it is very difficult to reverse. Investors may be concentrating on Greek, Irish and Portuguese funding needs for the next 24- 36 months now, but it won’t be long before investors start to scrutinise longer-term liabilities that are currently being clocked up for the next 10,20 even 30 years.

The bigger beast that threatens Europe’s solvency is the demographic and entitlements crisis. While a lot is known about Europe’s aging population, the scale of the problem and its urgency are not well understood.

The IMF predicts that Greece will have the second highest growth in pension costs as a percentage of GDP in the G20 by 2030. Spain and Belgium aren’t in great shape either. Interestingly, by 2030 Italy and Germany will actually see their pensions’ costs start to fall, but that is because their populations are aging so fast that the bulk of their pension spending will be done in the next 10-15 years.

In Germany and Italy the demographic damage is done.  Research from Eurostat predicts that by 2040 there will be less than two people of working age for every retired person in Germany and Italy that compares with just over three today. In France things are slightly better as there will be just about two workers for every retired person. These statistics tell a bleak story, with this type of demographic shift it is inevitable that living standards will deteriorate in the next decade or so.

The fiscal crisis of the future could also have a domino effect. Once investors realised there was an enormous hole in Greece’s public finances they started to punish Ireland, Portugal, Spain and even Italy saw its bond yields rise. In the future investors may start to punish the credit markets of those countries with poor demographics.

Superstar economics: It’s all showbiz now

By Laurence Copeland. The opinions expressed are his own.

It seems barely a week goes by without another shock report about the ever-widening gap between those at the top of the earnings distribution and the rest of us. The facts are by now well-established. Throughout the Western world, but most noticeably in Britain and America, the earnings of the top one or two percent are accelerating into the stratosphere, leaving the middle class a long way behind, and the working class completely out of sight. How can one explain this global phenomenon?

Academic economics seems to be taking a surprisingly long time to reach a definitive answer, but I suspect there will turn out to be two long term trends at work here.

First, globalisation has doubled or tripled the supply of unskilled and semi-skilled labour. As long as China remained locked in Maoist isolation and the Indian economy had to carry the full burden of the Licence Raj, their respective workforces were shut off from the global labour market. The fact that products could theoretically be manufactured far cheaper in those countries was unimportant, because in practice Western firms could never take advantage of their rock-bottom labour costs.

Now that they have opened up and it is possible to outsource manufacturing to China and the paperwork to India, there is less and less left for our workers and middle-managers to do – unless, of course, they are willing to work for more competitive (i.e. lower) wages.

Moreover, the second phase of this transition is well underway, as the emerging economies start to exploit their vast pools of underemployed (and often excellent) graduates to move up the value chain, where they increasingly compete with our engineers, programmers, and even lawyers and doctors.

All over Europe and North America, people are asking: where will it all end?

Who is helping who in the China-Europe relationship?

-Kathleen Brooks is research director at forex.com. The opinions expressed are her own.-

The saying goes that you only really know who your friends are during times of crisis. Well European officials must have been beaming after two of the world’s largest economies promised to purchase the debt of the currency bloc’s most troubled nations. China came out first and pledged to “support Spain’s financial sector”, through participating in its upcoming debt auctions. Likewise, Japan pledged to purchase a quarter of the upcoming euro zone bond sale that will help fund the bailout of Ireland.

Who wouldn’t want China as a friend right now? Its growth rate is in double figures, 10.3 per cent for 2010. The Chinese authorities want to rebalance the economy toward domestic demand, and with hundreds of millions of people embarking on shifting from an agrarian to urban way of life the growth rate is set to remain high, even if the authorities try to set policy to avoid the economy from overheating.

On top of that it has huge FX reserves – more than $2 trillion. This makes the 85 billion euro bailout loan provided by the EU/IMF to Ireland look like pocket change. Essentially, China has the financial firepower to help provide all of the bridge loans necessary for European sovereigns in trouble. This is the friend you want when you have the market breathing down your neck and the world’s largest bond fund saying that it will stop purchasing peripheral nations’ government debt, which is the position that Europe found itself in at the start of this year.

So on the surface it looks like this is a fairly one-sided relationship: China buys up the bonds of troubled nations reducing their immediate financing issues. This leaves it with peripheral debt that Beijing will hopefully, one day, turn into a profit. But is this relationship really so simple, and could Europe be doing China just as much of a favour?

There is a strong argument to say yes, and it boils down to three factors. Firstly, since the onset of the financial crisis there has been a dearth of relatively risk-free assets that also provide a decent yield. Voila, the debt issued by Europe’s rescue fund, the European Financial Stability Facility (EFSF). This is not only rated triple A by the rating agencies, but it has a yield that is at a premium of approximately 50-90 basis points above German Bunds. This is an appealing prospect; it is essentially protected against default by Germany, the Eurozone’s largest economy, which continues to post record rates of growth – the 3.6 per cent registered in 2010 is the highest level since reunification. For sovereign wealth fund managers the EFSF bonds are like finding the Holy Grail after the recession when yields on fixed income products in the developed world had reached record low yields.

from Breakingviews:

EU bank levy idea is circular — and dangerous

By Peter Thal Larsen and Neil Unmack The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

LONDON -- Forcing banks to bail out countries may have the ring of poetic justice. But Europe's idea of using a bank levy to capitalise a sovereign crisis fund is circular -- and dangerous.

Brussels has floated the notion of a one-off 50 billion euro tax on lenders to fund the so-called European Stability Mechanism (ESM), the new sovereign bailout facility due to take shape in 2013. It is just one among several ideas and doesn't appear to be being pushed hard. That's just as well -- whacking banks so that governments can continue to prop them up makes little sense. Worse still, such a scheme could reinforce the moral hazard the European Union wants to end.

The plan is misguided in at least three ways. First, it is circular. One of the main causes of the euro zone's peripheral crisis is that governments have felt compelled to stand behind their banks. Ireland's decision to support the liabilities of its banking system overwhelmed the public finances, and has undermined investors' confidence in Spain, Portugal and Belgium. A blanket levy on bank assets would make weak lenders more likely to seek state support.

A second problem is that the levy would come on top of existing national taxes. At least 10 European countries, including the United Kingdom and Germany, have introduced or are contemplating bank levies to help raise revenue or finance bailout funds. Though most banks could easily cope with the EU's levy -- a mooted 0.2 percent of assets -- the cumulative effect of other taxes and new capital rules would provide a further brake on lending.

Perhaps the biggest objection is that this type of levy would reinforce the link between banks and governments. One of the main contributors to the current crisis is that bank creditors assumed -- correctly -- that governments would not allow large lenders to go bust. The levy would cement the expectation of future bailouts, while recouping only a fraction of the financial benefit that banks derive from being too big to fail.

Defining a post-crisis reputation for brand Ireland

– John Keilthy is Managing Partner of ReputationInc Ireland and is a former business journalist and director and chief operating officer of NCB Group.  Andrew Hammond is a Director in ReputationInc’s London office and was formerly a UK Government Special Adviser. The opinions expressed are their own. –

In recent weeks, the focus for Ireland and indeed the world’s financial markets has been on devising a plan to remedy the country’s precarious banking and fiscal affairs.

With the basis of an agreement having been reached with the IMF and the EU around initiatives to help restore Ireland’s financial credibility internationally, there is now a need to focus attention on restoring the nation’s reputation.

The economic and financial problems that the country faces are still daunting.  However, the nature of the crisis is, in truth, much broader and more serious in as much as the entire foundations of Ireland’s nation brand have also been undermined.

The concept of nation brands is founded on the realisation that, in an ‘overcrowded’ global marketplace, countries are, in effect, competing not just for the favour of investors and the wider financial community, but also for other globally focused stakeholders such as tourists, media, skilled employees, regulators and NGOs.

Thus, economic and financial fundamentals, such as a country’s fiscal position, tax regime, trade balances and business climate are only the most obvious elements of what drives international prosperity, with wider competition between countries, such as that for global talent, also key.  In this ultra-competitive environment, reputation can be a prized asset (or potentially a significant liability) with a direct effect on future political, economic, social and cultural fortunes. Successful countries identify their image and key strengths, and prioritise the appropriate policies to strengthen such attributes.

Countries with a range of branding problems right now, such as Ireland, Greece, Israel, and China, face an uphill battle changing the perception others have of them. However, history has shown that reputation can be recreated and once again become a key driver of not only national pride, but also economic success and what flows from that in terms of wider social and cultural benefits.