The Great Debate UK

from Ian Bremmer:

The secret to China’s boom: state capitalism

By Ian Bremmer The views expressed are his own.

One of the biggest changes we’ve seen in the world since the 2008 financial crisis can be summed up in one sentence: Security is no longer the primary driver of geopolitical developments; economics is. Think about this in terms of the United States and its shifting place as the superpower of the world. Since World War II, the U.S.’s highly developed Department of Defense has ensured the security of the country and indeed, much of the free world. The private sector was, well, the private sector. In a free market economy, companies manage their own affairs, perhaps with government regulation, but not with government direction. More than sixty years on, perhaps that’s why our military is the most technologically advanced in the world while our domestic economy fails to create enough jobs and opportunities for the U.S. population.

Contrast the U.S. and its free market economy with China’s system.  For years now, that country has experienced double digit growth. Many observers would say that China’s embrace of capitalism since 1978, and especially since joining the World Trade Organization in 2001, has been responsible for its boom. They would be mostly wrong. In fact, a new study prepared for the U.S. government says it’s not capitalism that’s powering China, but state capitalism -- China’s massive, centrally directed industrial policy, where the government positions huge amounts of capital and labor in economic sectors it intends to nurture. The study, prepared by consultants Capital Trade for the U.S.-China Economic and Security Review Commission, reads in part:

In a world in which central planning has been so utterly discredited, it would be natural to conclude that the Chinese government and, by extension, the Chinese Communist Party have been abandoning the institutions associated with the communist economic system, such as reliance on state‐owned enterprises (SOEs), as fast as possible. Such conclusion would be wrong.

In a G-zero world where no country can claim the mantle of international leadership, China has pulled an accomplished head fake. While the media focuses on China’s special economic zones, like Hong Kong and Macau, and the rise of the banker class and Chinese tech industry, state directed spending is the real engine of growth.  Capital invested in infrastructure like factories, heavy industry, roadways, and high speed trains continues to power annual double digit growth in GDP. Reliable data from 2004 shows that 76% of Chinese non-financial firms are classified as State Owned Enterprises (firms with government ownership of greater than 10%).

In short, while the U.S. has spent decades and vast treasure building up its defense system (and yes, by extension, the sectors of the economy that service it), China has spent its time and money building up control over the broad direction of its entire economy. In today’s world, where the first sentence of this essay rings true, which country currently looks better positioned to, pardon the pun, capitalize, in the years ahead?

During last week’s euro zone bailout talks, French President Nicolas Sarkozy went hat in hand to China, painting a stark picture of China’s still-growing economic importance internationally. Never mind that the phone call didn’t result in any particular action; the mere act raised Chinese President Hu’s profile going into the G-20 talks in France this week. Not only that, the entreaty by Sarkozy made plain that China has nothing to hide about the economic path it’s chosen for itself. After decades of hectoring from the West, the tables are perhaps about to turn. After all, what economic model should China emulate? Europe’s? The United States’? “With all due respect,” you can almost hear President Hu saying, “we like the way our system is working, thanks.”

from Breakingviews:

Thai opposition win is good for growth

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own

The Thaksins' surprise win in the Thailand elections already has investors' vote. As the opposition party of Yingluck Shinawatra -- sister of exiled former premier Thaksin Shinawatra -- took a surprise majority in elections on July 3, the baht strengthened, and the cost of insuring Thailand's debt against default fell some 20 percent. The local stock market benchmark index rose 4.1 percent. In truth, there is some way to go before Thailand attains enough stability to regain favour with global investors -- but it's a good start.

Thailand doesn't need a political about-turn. The deposed Democrat Party shepherded the Thai economy prudently. Even a bout of bloody violence between the red shirts, who back Thaksin, and the yellow shirts who favour the royal establishment and Democrats, failed to knock the country off its course towards 8 percent GDP growth in 2010. That's largely because both sides respected the importance of strong banks, moderate leverage and fiscal prudence, and ensured that a downturn did not turn into an economic crisis. A dependence on exports, equivalent to around three-quarters of GDP, has helped separate growth from politics too.

But instability has brought a cost. Investors haven't piled into Thailand in the way they have neighbours like Indonesia and Malaysia. For Morgan Stanley, the country is its biggest "underweight" among emerging markets, partly because of an elevated sense of political risk. Around $1 billion of investment drained away in the month before the elections. Ongoing concerns that the victorious Puer Thai party might create discord by calling for an amnesty for Thaksin over corruption allegations -- or vengeance on those who supressed red shirt protests in 2010 -- could linger for months.

Still, an unambiguous electoral result sets the country on the right path. Net foreign investment has been trending downwards for five years, helping to exacerbate an overall shortage of fixed investment, which runs at just a quarter of GDP. Infrastructure is needed to push Thailand out of middle-income mediocrity, and nudge GDP growth past the IMF's current forecast for 2011 of 4 percent. Thaksin's previous tenure saw corruption and discord, but also 6 percent growth, free-market policies and a focus on rural prosperity. If cool heads prevail, Thaksin redux will be no bad thing.

What could the Q1 GDP figures mean for my business?

By Jamie Jemmeson

-Jamie Jemmeson is a Trader at Global Reach Partners, the foreign exchange company. The opinions expressed are his own.-

The alarm bells have been ringing in the UK since the surprise contraction in Q4 GDP 2010.  The Bank of England (BoE) remains in limbo between the ECB, who recently hiked despite their problems with sovereign debt and the US, where quantitative easing remains in force until at least June. The release of the preliminary Q1 GDP on the 27 April could be instrumental in determining not just how the currency and financial markets perform, but in directing measures the BoE and coalition government may have to take. Since the surprise contraction in GDP, the BoE has been forced to sit on its hands and watch inflation continue to increase while reiterating its belief that this is just a temporary phase. There is a real dilemma in the UK that has split the market; will the UK face the daunting reality of a double dip recession?

Data that has recently been released has done little to reassure the markets; the British Retail Consortium reported that retail sales for the month of March tumbled at their fastest pace in 6 years as spending cuts, tax rises and high unemployment took their toll on consumer confidence. As a result, Sterling is very vulnerable to the outcome of the UK GDP figure later this month. This means businesses that import and export are exposed to a great deal of risk when protecting their budgeted rates in foreign exchange for the year.

If the UK does enter a double dip recession on the 27 April, the value of Sterling is likely to fall. Consumer confidence is already near record lows and will plummet further if we see the inevitable media frenzy that would accompany the news of a double dip. The result could be a decline in retail sales and higher unemployment, two factors that will not be greeted with open arms by UK businesses. The BoE’s task of tackling inflation will become a steeper uphill slog as the justification of an interest rate hike would become difficult. Various rating agencies have already warned that weaker growth could jeopardise the UK’s prized triple AAA rating, a downgrade can only have negative effects. Finally, let’s not rule out the possibility of further quantitative easing down track that would naturally weaken the Pound.  All of this uncertainty would weaken Sterling, and hurt businesses that import goods and raw materials as a result. However, companies that are manufacturing goods for the export market may embrace the weakness in the currency as the demand for British made goods become more appealing.

If the UK dodges the silver bullet and avoids the double dip recession, hope and confidence may start to be restored. The net effect should result in a stronger currency and strengthen the coalition government’s position. The main price driver this year has been interest rate expectations. A return to growth would give the BoE more scope to start tackling the mounting inflationary pressures by increasing interest rates. In this benign scenario it is more than likely that the nation’s AAA credit rating will be preserved thereby enticing business and foreign direct investment while allowing the Coalition Government to continue to plough on with their austerity plans to improve the nation’s finances.

The net effect will be positive for Sterling. The rising pound would assist in tackling some of the imported inflation. For those who are importing this would be a timely boost and a noticeable help in pushing prices lower. Conversely businesses that are manufacturing goods for export would see their products become less competitive in price terms.

from MacroScope:

Europe’s over-achievers and their fall from grace

Ireland's fall from grace has been rapid and far worse than that of its counterparts, even Greece. But life in the euro zone has still been one of profound growth, as it has for most of the other peripheral economies.

Take a look first at the progress of  PIGS (Portugal, Ireland, Greece and Spain) GDP since 2007 when the global financial crisis took hold. In straight comparisons (ie, rebased to the  same point) Ireland is far and away the biggest loser. Portugal is basically where it was.

But now take the rebasing back to roughly the time that the euro zone came together.  First, it shows that Ireland's fall is from a very high place. The decade has still been one of profound improvement in cumulative GDP even with the last few years' misery. But it is front loaded.

Perhaps most interesting, however, is what the second graph (courtesy Reuters' Scott Barber) says about the PIGS and the euro experiment.  Despite major financial and market crises, Greece, Spain and Ireland have all seen their economies accumulate at a higher rate than the euro zone average.  Only Portugal has been below average -- a perennial slow grower.

Could any of this outperformance  have been attained outside the euro zone? Probably not. But the question now is whether the current troubles are going to wipe out everything that has been achieved.

from The Great Debate:

U.S., China and eating soup with a fork

-The opinions expressed are the author's own-

Are economists the world over using an outdated tool to measure economic progress?

The question, long debated, is worth pondering again at a time when two economic giants, the United States and China, are sparring over trade, currency exchange rates and their roles in the global economy.

In the run-up to U.S. mid-term elections on November 2, politicians from both parties, for different reasons, blamed trade with China for American job losses. China responded with irritation and hit back by accusing the U.S. of "out of control" printing of dollars tantamount to an attack on China with imported inflation.

Measured by Gross Domestic Product (GDP), the United States tops the list of countries. China overtook Japan in August to become number two. Depending on whose forecasts you believe, China will overtake the United States in 2020, 2035 or 2040 and therefore turn the 21st century into the long-predicted Chinese Century. It's becoming conventional wisdom that the United States will play a reduced role on the world stage.

Crystal ball gazers might do well to remember that long-range forecasts have often been wrong in the past. At the turn of the 20th century, eminent strategists predicted that Argentina would be a world power within 20 years. In the late 1980s, Japan was seen as the next economic leader, on the strength of supposedly unstoppable progress. Forecasters extrapolated from past GDP growth rates.

They are widely used to compare standards of living in one country with those in another but critics say GDP is too narrow to be a realistic indicator. Joseph Stiglitz, the Nobel-prize winning American economist, has complained that world leaders make a fetish out of it and suffer from GDP-obsession.

from MacroScope:

The IMF to turn on the rich

The latest International Monetary Fund meeting ended with emerging market powers getting a pledge from the organisation for stronger and "more even-handed" scrutiny of what is going on in large advanced economies.

As Reuters correspondents Lesley Wroughton and Emily Kaiser report here, the decision is a response to long-running frustrations among emerging economies, which reckon the Fund has  not been tough enough on its biggest shareholders, led by the United States.

The move reflects a number of things. First, it shows the growing clout of emerging economies within international institutions. The G-20, for example, is arguably now more influential than the old , richer G7. Secondly, it graphically underlines the current world-turned-upside-down state of the global economy, in which profligate rich economies are struggling to keep above water while supposedly poorer and less-developed ones enjoy solid growth and relatively stable finances. This graph makes the point:

One question  that has been raised, meanwhile, is whether the IMF is capable of taking rich countries -- its primary paymasters -- to task.  A comment from a craigbhill on the Reuters story encapsulates the issue:

This is like the bankers to the Mafia being politely asked to "give scrutiny" to the Mafia.

A bit harsh. But valid?

Weak UK recovery argues for consensus on cuts

– Ian Campbell is a Reuters Breakingviews columnist. The opinions expressed are his own –

A first estimate of UK first-quarter growth is a chilly 0.2 percent.  Failure of government policy, the opposition will say. Shows the folly of proposed Conservative spending cuts and tax increases, Gordon Brown, the prime minister, will claim. But a colder financial look will see that enormous stimulus has so far produced the weakest of recoveries. Whatever the election outcome, the UK’s leaders are going to have to be grown-ups. In this emergency, cooperation – or coalition – is required.

No emergency, some might say. January was inclement and the first GDP estimate may well prove too low. A still nascent recovery can perhaps gain strength.

But it will have to do so in the face of declining government help, for all Brown’s stimulating talk. The VAT rate went up in January, helping government revenue and stabilising the fiscal deficit at a frighteningly high level. But the VAT increase also helps to explain the 1.7 percent quarterly decline in retail sales. The consumer is struggling. Petrol prices are at record highs. Some Bank of England monetary policy members are worried about inflation.

The UK’s dangers are great. The deficit is among the worst in deficit-torn Europe. For Ken Clarke, the shadow business secretary, the choice is between a Conservative government and the International Monetary Fund. His reasoning is that faced with a hung Parliament, the markets will pull the rug from Britain, Greek-style.

That disaster can be avoided. A consensus on cutting the deficit, in which parties share the blame for the national pain, would be a way forward. Fiscal tightening, especially through spending cuts, would help to contain inflation. The BoE would then be able to keep rates low, favouring a weak pound that would assist the export-led recovery that the UK needs.

The UK’s realities are uncomfortable for all the political parties. There are no easy solutions. First in the private sector, then in the public one, the country has lived far beyond its means for a long time. The essential belt tightening is going to be difficult for everyone. After the election, the UK’s leaders would do well to pull together on the belt.

from Breakingviews:

Sovereign debt maths show risk of vicious circle

How can a country support debt of over 100 percent of GDP for many years and then suddenly start spiralling towards insolvency? That question of sovereign debt maths is not merely academic. It is highly relevant to the likes of Greece and Italy.

The answer is that size of the sovereign debt burden is not everything when it comes to keeping up with interest payments. No matter how high the ratio of debt to GDP may be, it does not need to increase as long as the government has two factors going its way: the "primary" budget balance -- the balance before interest payments -- and the growth rate of nominal GDP.

To see how these play out, consider two countries. One has a moderate debt load, 50 percent of GDP, which carries a 4 percent average interest rate. If the budget is in primary balance, the government will still run a deficit of 2 percent of GDP, which is 4 percent (the interest rate) of 50 percent (the debt). As long as nominal GDP grows by 4 percent, the ratio of debt to GDP stays the same.

The other country is highly indebted, with a debt/GDP ratio of 100 percent. Assume it also pays an interest rate of 4 percent. With a primary budget balance, its fiscal deficit is 4 percent of GDP. However, as long as nominal GDP keeps growing at 4 percent a year, the ratio of debt to GDP stays the same -- 100 percent.

In effect, the highly-indebted government doesn't pay a penalty for its profligacy, as long as growth keeps up and interest rates stay low. Greece and other heavily indebted countries benefited from such a happy environment for years.

But the equilibrium is fragile. It can be disturbed in three ways: nominal GDP growth can decline, interest rates can go up or the country can start running a primary deficit. The pain is much worse for highly indebted countries like Greece, which has managed all three at once.

Start with growth. Imagine nominal GDP growth drops to zero. If nothing is done, the debt/GDP ratio will rise by 2 percentage points in the moderately indebted country, but by 4 percentage points in the highly indebted one.

The UK should not waste its fiscal crisis

–  The author is a Reuters Breakingviews columnist. The opinions expressed are his own  –

 The UK should not waste its fiscal crisis. As Britain embarks on its election campaign, this is a perfect opportunity to engage in radical tax and spending reforms designed not just to restore the country’s fiscal balance but to boost its long-term productivity and competitiveness.

It is, of course, necessary to cut the deficit, which is currently running at an unsustainable 12 percent of GDP. It is also important that spending cuts rather than tax rises bear the brunt of the belt-tightening. Otherwise, the UK will find that companies and rich people are increasingly driven off-shore.

The two main political parties — the Labour government and the opposition Conservatives — broadly buy into this. However, neither party has spelt out what spending it would cut and where it would raise taxes. Nor have they given any inkling of seeking to take advantage of the crisis to push through deep-seated reforms. They are unlikely to do so during the coming campaign, fearing that too much detail will scare the voters.

GUIDING PRINCIPLES

Nevertheless, the next government, faced with the immensity of its fiscal challenge, will be forced to slaughter at least some sacred cows. What then are the principles that should guide it?

First, simplicity. The current tax system is a patchwork quilt of loopholes, allowances and special arrangements. This is an incentive to engage in elaborate contortions to avoid tax.

from Breakingviews:

Goldman Sachs needs to admit it made mistakes

By Chris Hughes

Even the mighty Goldman Sachs makes mistakes. The Wall Street bank's decision to help Greece keep some of its debts hidden from public view in 2001 was one of them.

The transaction allowed the Greek government to present accounts which understated the state's liabilities by 1.6 percent of GDP.

The arrangement was not illegal, not against any regulations and was approved by Europe's statistical authorities. Still, helping a client lessen the transparency of its finances is ethically questionable. For its own sake, Goldman should just admit that the firm compromised the principles it is supposed to hold dear.

At the time, it may have seemed that the deal's goal, comforting Greece's fellow members of the euro zone, justified the means. In retrospect, though, it's hard to reconcile such financial alchemy with Goldman's expectation that its people comply fully with the "letter and spirit of the laws, rules and ethical principles that govern us".

There are, to be sure, mitigating factors. Goldman, which carefully considers the ethical and reputational risks of individual transactions, wasn't alone. Other banks helped governments take advantage of the European Union's weak fiscal governance. But Goldman regards itself as the global standard setter, demanding "high" ethical standards of its people, and eschewing the practices of the crowd.

Similarly, it can be argued that Goldman followed its overarching business principle that client interests always come first. And it certainly remained faithful to another tenet: that the firm should strive for creativity. It's also true there have been almost no complaints about this transaction until now.