385Readings(Y) Spring, 2011



China Raises Interest Rates

BEIJING—China's central bank said Tuesday it will raise its benchmark deposit and lending rates by 0.25 percentage point each, the first rate increase this year as the battle escalates to fend off rising inflation.

The rate move, effective Wednesday, signals more tightening may follow in the months ahead if consumer prices continue to rise.

The People's Bank of China said in a statement it will raise the one-year yuan lending rate to 6.06% from 5.81%, and the one-year yuan deposit rate to 3.00% from 2.75%. It didn't give a reason.

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The move comes after the PBOC announced its plan to raise benchmark lending and deposit rates for the first time in nearly three years on Oct. 19 and once again on Dec. 25. Those increases took effect on Oct. 20 and Dec. 26. In January, the central bank also raised banks' deposit requirement ratio by 0.50 percentage point in a bid to curb credit growth and rein in broader price pressures.

Analysts have expected a rate increase, as consumer prices are widely expected to keep rising sharply in the first quarter, driven by strong holiday demand and bad weather. The PBOC appears to have carefully selected the timing for the rate moves to take place on Wednesday, the first working day after the week-long Lunar New Year holiday.

The U.S. dollar rose immediately after the PBOC announcement, but has given up most of those gains, and against the euro it was recently fetching $1.3647, after earlier falling to $1.3620 following the news.

China's consumer-price index rose 4.6% from a year earlier in December, slowing from November's 5.1% increase, which was the fastest rate in more than two years. However, the PBOC remains uncomfortable with price pressures and some analysts expect inflation could rise by as high as 6.0% in certain months in the first half from year-earlier levels.

PBOC Gov. Zhou Xiaochuan warned recently that the central bank must be vigilant on inflation and may need to tighten reserve requirements further to address rapid capital inflows.

Speaking to Dow Jones Newswires on the sidelines of meetings in Kyoto, Mr. Zhou pointed out that Chinese price growth slowed slightly in December, but he said it was stronger than many had forecast and signaled it had more room to climb.

"Inflation is still higher than many people expected. It may be still going up a little, so we should keep vigilant on that," Mr. Zhou said in the interview on Jan 30.

—Victoria Ruan


Chinese Demand Lifts U.S. Wood Sales


Much of the $30 billion U.S. timber industry is still depressed because of weakness in the housing market, but some companies have found relief in a nontraditional customer: China.

U.S. timber exports to China are suddenly surging, especially from mills around the Pacific Northwest, giving a boost to companies like Weyerhaeuser Co. and Plum Creek Timber Co. Helping to spur the increase: One of China's biggest timber sources—Russia—increased tariffs on its wood exports in 2007, leading Chinese buyers to turn increasingly to the U.S. and Canada for wood amid the country's construction boom.

To China, With Bark

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Jake Stangel for The Wall Street Journal

Logs were loaded into Bay 5 at the Weyerhaeuser facility in Longview, Wash.

"Everybody in the Northwest is talking about China," said Dan Fulton, chief executive of Weyerhaeuser, a timber company in Federal Way, Wash.

On Friday, Weyerhaeuser said it had swung to a fourth-quarter profit from a loss a year earlier. It noted that a tripling of its Chinese log exports in 2010 helped offset a 10% drop in its total logging volume in the same period.

Mr. Fulton said the Chinese are mostly using wood for nonresidential purposes such as crates and pallets.

The export surge to China comes at a critical time for the U.S. timber industry. After being fueled by the nationwide housing boom for much of the last decade, it was hit by the property bust in 2008.

U.S. lumber production peaked at 40.5 billion board feet in 2005 and plunged to 23.4 billion in 2009, according to Western Wood Products Association and Southern Forest Products Association estimates.

To cope with the decline in domestic demand, many timber companies slashed costs by closing mills, among other moves. In all, roughly 35% of the U.S. timber industry's lumber mills remain closed, said Stephen Atkinson, a forest-products analyst at the Bank of Montreal.


Once-silenced sawmills in British Columbia are working around the clock, thanks to a building boom in China. WSJ's Joel Millman reports.

While exports to China aren't a long-term solution for the U.S. timber industry—the trend hasn't spurred many mills to hire new workers or expand capacity—they are a bright spot that is helping to stave off further declines and cuts.

"It's a step in the right direction," said Steve Chercover, an analyst at D.A. Davidson & Co. in Portland, Ore.

Timber demand from China began rising in 2007 when Russia imposed higher tariffs on its logs, and demand was particularly strong last year, said Hakan Ekstrom, president of the research firm Wood Resources International LLC.

Overall, the number of U.S. logs shipped to China shot up more than 10 times from 256,000 cubic meters in 2007—or less than 1% of the total logs produced in the region—to an estimated 2.4 million in 2010, or about 7% of the region's total log production, according to Wood Resources.

And prices for wood products are continuing to climb. Prices for hemlock logs destined for sawmills in the U.S. Northwest jumped 43% to $66 a board foot in 2010 from $46 in 2009, according to Wood Resources. The export surge also doesn't include wood from other regions. Prices for southern pine, for example, rose just 4.8% in the period, to $65 from $62.

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Jake Stangel for The Wall Street Journal

The benefits are greatest for U.S. timber companies with operations in the Pacific Northwest, where the access to China is easiest.

The West, including Washington, Oregon, Idaho and California, accounted for 44% of all U.S. timber production in 2009, compared with 50% for the South, according to estimates by the Western Wood Products Association and the Southern Forest Products Association.

In addition to Weyerhaeuser, Plum Creek and Rayonier Inc. have large operations in the Northwest. At Jacksonville, Fla.-based Rayonier, officials said they plan to increase their harvest level for logs "10% to 15%" this year from 2010 because of continued strong export demand driven mainly by China.

And Seattle-based Plum Creek said it expects that 7% of the logs destined for sawmills from its forests in Oregon during the first quarter will be exported to China, up from "nominal" volume in the fourth quarter.

"As you start to see a return to housing demand in the future," there is likely to continue to be an export opportunity, added David Lambert, Plum Creek's chief financial officer. Last week, the company reported that earnings more than doubled in the fourth quarter on a 38% jump in revenue. It also cited a firming of lumber prices, starting in December on the West Coast, as a sign the company's prospects will continue to improve in 2011.


Merkel's Harmonic Convergence

A single market does not require a single economic model.

Angela Merkel wants the nations of Europe to get competitive. But the German Chancellor would rather get there without any of these nations competing with each other. Instead, she and French President Nicolas Sarkozy on Friday unveiled a Competitiveness Pact for Europe designed to make the rest of Europe look more like Germany.

Under the proposals, Europe would harmonize its retirement ages, corporate tax regimes and labor-relations policies. The rest of Europe was rightly skeptical, if not always for the right reasons.

Germany has had a good year, with growth of 3.6% in 2010 while the rest of the EU stagnated or worse. Its unemployment rate is comparatively low and its public finances relatively benign. Berlin also holds the purse strings on the euro zone's ever-expanding bailout requirements, and the Franco-German proposal was offered with the implicit warning that if the euro zone's peripheral states can't live within their means, the bailout party might just come to an end.

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Associated Press

No one disputes the need for reform on a stagnant, overspending Continent. The question is how best to accomplish it. The euro zone was conceived as a great economic laboratory, in which member states would compete for business and economic growth without the distorting effects of currency devaluations. But that competition inevitably means that, at any given point in time, some economies will do better than others. Not everyone can be Germany. Not everyone wants to be, either.

Yet that doesn't mean the rest of the euro zone is doomed to economic decline. Spain may never be the industrial-exporting powerhouse that Germany is, but Germany is unlikely to match Spain's advantages as a tourist destination. Each of these comparative national advantages is a strength for Europe as a whole. By the same token, it's less likely that every European state will suffer economically at the same time if each of them pursues a competing models of growth.

It wasn't all that long ago that Germany was the sick man of Europe. And Berlin's economic model continues to have significant flaws, including taxes that are too high, a tax code that is too complex and a labor market that is over-regulated. If Mrs. Merkel wants the rest of Europe to do better, she would do better to furnish an example of what continuous reform can achieve than to lock her peers into a formula of "harmonization" that can only lead to stagnation. A single market does not require a single economic model.

Printed in The Wall Street Journal, page 11


Free Trade Foul-Ups

Obama and the GOP are muffing a chance for bipartisan deals.

Freer trade ought to be an issue on which House Republicans and the White House can agree, but both sides seem determined to make this harder than it needs to be. Only in Washington, kids.

President Obama continues to drag his feet on seeking approval in Congress for the U.S. trade deals with Colombia and Panama, which Speaker John Boehner wants to combine with the South Korean pact for a single House vote. In his mea minima culpa address to the Chamber of Commerce on Monday, Mr. Obama even resorted to the slippery words "as we pursue trade agreements with Panama and Colombia."

Huh? The Colombia deal was first signed in 2006 and renegotiated in 2007 after Democrats took Congress. Our Colombian sources tell us the Administration won't even say how it wants to "pursue" yet another rewrite. Perhaps Republicans should ask U.S. trade rep Ron Kirk when he makes a rare appearance before Congress today.

Meanwhile, Republicans seem all too ready to extend something called Trade Adjustment Assistance, a package of federal programs to retrain workers hurt by imports, mostly in manufacturing, where U.S. employment is now rising. TAA received $1.8 billion last year and is due to expire Saturday. Ways and Means Chairman Dave Camp (R., Mich.) is supporting a bill that ties TAA to an extension of the Andean Trade Preference Act.

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Associated Press

Ways and Means Chairman Dave Camp


Mr. Camp claims that tying the two issues is the only way to get Democrats to support the three big trade pacts and the Andean deal, which reduces or eliminates duties on imports from allies like Colombia. That is odd logic. If TAA and the Andean deals were separated, the Senate could vote on their respective merits and show who really supports fiscal prudence and free trade, and who doesn't. Senator Jon Kyl (R., Az.) supports this approach.

The danger is that TAA is turning into one more open-ended entitlement. It cost $406.6 million in 2001 but would cost $2.4 billion this year if it's extended to include add-ons from the 2009 stimulus. Those include TAA assistance to laid-off government workers.

Mr. Camp's bill would extend TAA through June, which his aides say will only cost a couple hundred million dollars. Ways and Means deputy staff director Sage Eastman told us Mr. Camp supports TAA because it's a "well-established program" that does an "important job retraining employees to deal with the complexities of international trade." In a follow-up email, he cited metrics Republicans put in place "to assure better program results, accountability, and cost-effectiveness."

There is little, if any, empirical support for these claims. The Department of Labor doesn't analyze whether re-employed workers would have found new jobs without TAA help. A 2008 American University study found that TAA helps workers find new jobs but at much lower wages—and concluded the program is of "dubious value." TAA also provides assistance for trade-related layoffs but not for those laid off because of technological change or productivity gains.

House leaders had planned a vote on Mr. Camp's bill yesterday but pulled it from the floor amid conservative concerns. We doubt tea partiers want to read that Republicans extended stimulus benefits in one of their first votes. In his effort to win over Democrats who will oppose trade bills despite TAA, Mr. Camp is complicating the job of winning Republican votes. Far better to junk the political bells and whistles and move the Andean trade bill and the other agreements for up-or-down votes as soon as possible.


Japan's Growing Sense of Crisis

If another generation experiences economic stagnation, Japan's otherwise stable democracy could be put to a test.



As Japanese follow Egypt's uprising, they may also ponder how the evolution of Japan's democracy has taken another detour as the initial euphoria surrounding the Democratic Party's rise to power has dissipated. Since its victory in Lower House elections in August 2009, the DPJ has stumbled badly. It lost its top leader to corruption charges and watched its first prime minister, Yukio Hatoyama, resign after just a year in office. Its public support evaporated.

The DPJ victory was due to the will of the Japanese people to elect a new party to lead them after more than a half-century of Liberal Democratic Party rule. Many observers hoped this was the beginning of a true two-party system in Japan, one in which parties would be forced to be more responsive to the desires of the Japanese voter.

Yet just a year and half later, Prime Minister Naoto Kan continues to make public missteps, most recently when he admitted he was unaware that Standard and Poor's had downgraded Japanese government debt. His cabinet's approval rating in December was just 21%, and his latest gaffe will do him no favors.

Part of the problem for Japanese leaders since 2007 has been the lack of a principled opposition party. After the DPJ took power in the Upper House in July of that year, it acted solely to stymie LDP policies and hamstring progress on budget issues, reform, and restructuring. Since taking a plurality of seats in the same house in July 2010, the LDP has threatened to act the same way, and next month's budget battles will show whether the LDP has decided to be as obstructionist as was the DPJ. Yet with Japan still teetering near deflation and its public debt approaching 200% of GDP, radical reforms are needed to prevent the country's economy from further, possibly catastrophic, weakening.

A third disturbance to Japan's political system stems from the ongoing saga of former DPJ leader Ichiro Ozawa. Mr. Ozawa has long been under investigation for fundraising irregularities and last week finally was indicted by Tokyo prosecutors. Prime Minister Kan has tried to get Mr. Ozawa to quit the party, ostensibly to stop dragging down the party's approval rating. Yet Mr. Ozawa remains very popular with DPJ rank and file parliamentarians, many of whom he recruited into the party.

This remains a threat to Mr. Kan, should the premier's position weaken any further. Mr. Ozawa, who lost a bid for party leadership late last year, is reviled by many Japanese, and his continuing ability to evade justice, despite his indictment, is so far in many Japanese eyes a blot on the ideal of impartial rule of law.

The result of the several factors above is a deep and abiding cynicism among Japan's citizens. The electoral system is rigged to overwhelmingly favor rural voters, with the result that Japan's agricultural sector is hopelessly protected from competition and highly inefficient. Recent court rulings in Japan that the electoral system is unconstitutional have so far produced no real move for reform. The two main political parties remain in a deadlock over moving forward on policies to cut government spending and develop sustainable growth policies. Meanwhile, Japanese have watched China surpass them as the world's second-largest economy, with an equal mix of concern and disinterest.

No one should think that Japan is anywhere close to massive public uprising, which is rare in any case in most developed countries. Even demonstrations of the kind seen in Great Britain over the raising of university fees, or the more serious ones in Greece over cuts in public spending, have not happened in Japan since the student uprisings of 1968. In the 1970s, Japanese bore recession, high prices, and shortages with relative equanimity, and since 1990, for nearly a generation, they have lived through a stagnant economy, the loss of corporate lifetime employment, and the steady aging of society.

But Japanese sense they are nearing a turning point. The phrase is undoubtedly overused, but a week talking with Japanese politicians, businessmen, academics and ordinary citizens reveals a powerful current of unease roiling society. True, many seem resigned to fall into what some Japanese academics call "middle power" status, but the majority of those in leadership roles recognize the country faces significant risks if it continues on the same path.

Corporate leaders, in particular, understand the danger of continued political paralysis, demographic decline, and inward-looking youth. The need to do something to change current trends is perceived by nearly everyone I talked with, yet an instinctive Japanese conservatism keeps things from going on the boil.

In the short term that may be a good thing, as it attests to the general stability in Japanese society. However, over a longer period, such fatalism and conservatism can wind up eroding public trust in democracy's ability to solve problems, even if the stumbling block may be the peculiarities of Japan's particular form of democracy. Such paralysis has led in the past to a radical remaking of Japan's political and social systems, something that all should be wary of.

Japanese have the luxury of not having to take to the streets to try to change their system. However, another generation of stagnation and the inherent strengths of that democracy may well be put to test, albeit in a less confrontational way than today in Cairo.

Mr. Auslin is director of Japan studies at the American Enterprise Institute and a columnist for WSJ.com. Follow him on Twitter at @michaelauslin.


Germany's Current Account Surplus Expands


FRANKFURT—Germany's current account surplus in 2010 rose to €129.9 billion ($177.09 billion), or 5.2% of estimated national output, according to figures released Wednesday by the Federal Statistics Office, Destatis.

The surplus is about €10 billion more than the previous year's, and reflects a recovery that has been overwhelmingly driven by the export sector. Destatis said that exports rose 18.5% on the year to €951.9 billion, while imports rose 20% to €797.6 billion. The merchandise trade surplus for the year totaled €154.3 billion, or 6.1% of gross domestic product.

Germany's trading partners often see its persistent external surpluses as proof of an unbalanced growth model, and the U.S. and various European Union members have repeatedly urged it to cut the surplus by boosting domestic demand. The current account surplus is well above the upper limit of 4% of gross domestic product suggested last year by the U.S. to the Group of 20 industrialized and developing countries.

German authorities, by contrast, see the surplus as the result of the country's competitiveness, saying there is no state policy to prioritize exports over the domestic economy.

The surplus has been a particularly sensitive topic in the last 18 months, as the rapid recovery in Germany has only slowly trickled down to its trading partners in the euro zone. German imports from the euro zone grew only 17% last year, compared with a 25% increase in imports from countries outside the EU, but Germany's surplus with its 15 partners in the single currency area was virtually flat on the year at just over €38 billion.

On a month-to-month basis, the current account surplus widened to €17.6 billion in December from a revised €12.9 billion in November. Economists polled ahead of time had predicted a surplus of only €14.0 billion.


A Breakthrough on the Reminbi?

by C. Fred Bergsten | February 8th, 2011 | 03:49 pm



There are encouraging signs that a breakthrough may have been achieved in the long-running debate over the exchange rate of China’s currency, the renminbi. Its real rate against the dollar is now rising at an annual rate of 10 to 12 percent, which if continued would complete the needed correction of 20 to 30 percent over two to three years, and official US reactions suggest that assurances that the adjustment will continue may have been received. This movement appears to derive from effective US pressure, increasing expressions of concern about the issue from other countries (especially a number of major emerging markets) and, most importantly, changes in economic conditions in China itself.

The nominal exchange rate of the renminbi has now appreciated by about 3.7 percent against the dollar since China announced last June that it would let the rate start moving upward again. During this same period, Chinese inflation has accelerated and is running substantially above that of the United States (which is less than 2 percent). Different indexes produce different results and all of the official numbers probably underestimate the actual pace of upward price movements in that country. It is safe to say, however, that the real exchange rate of the renminbi has risen by at least 5 percent against the dollar over the past seven months, producing a real appreciation against the dollar at an annual rate of at least 10 percent and perhaps as much as 12 percent.

China continues to intervene against the dollar to limit its appreciation, however, and the dollar has declined against most other currencies during this same period. Hence the trade-weighted average exchange rate of the renminbi has not appreciated by much. This "real effective exchange rate," or REER, should be the focus of our attention since the goal should be a sharp reduction in China’s global current account surplus rather than solely its bilateral surplus against the United States.

We must recognize, however, that the Chinese themselves continue to focus almost wholly on the dollar rate and that US officials, and especially Congressmen, often do so as well. We must also recognize that calculation of REERs is technically complex, because agreements would have to be reached on appropriate measures of inflation in both China and the rest of the world (the "real" component) as well as on the weighting of other currencies (the "effective" component); it is much simpler, especially in working out international agreements on the issue, to focus on the nominal bilateral rate. It is also true the dollar may rise as well as fall over the coming period, and that, if recent history is any guide, the Chinese will "ride it up" just as they have recently "ridden it down." But lasting adjustment will not be achieved until the REER for the renminbi, as well as its bilateral rate against the dollar, has appreciated adequately and permanently.

What is a reasonable goal? In testimony before the Senate Banking Committee last September, Secretary of the Treasury Tim Geithner implicitly endorsed an objective that I had proposed shortly before: that China replicate, over the next two to three years, the real effective appreciation of 20 to 25 percent that it permitted between 2005 and 2008. This implies a somewhat higher appreciation, of perhaps 30 percent, against the dollar. We thus need assurance that the renminbi will rise against the dollar by about 10 percent annually, the pace that has now eventuated since last June.

Why has China moved now? First, the United States has clearly escalated its pressure in a series of private conversations over the past six months while respecting China’s obsession with avoiding the appearance of capitulating to public admonitions. President Obama reportedly placed highest priority on the currency issue during his extensive bilateral conversation with President Hu Jintao around the G-20 summit in Seoul in early November. This took place after the US mid-term elections so it could not be interpreted by the Chinese as "simply playing domestic politics in the United States." China was clearly taken aback by the strong US criticism of a number of their policies over the past year, ranging from their naval activities in the South China Sea to their passivity regarding North Korea to a range of new trade and industrial policy issues, and recognized that resolving the currency issue was a key element to restoring comity in the overall relationship, which is of great importance to them.

It is not difficult to imagine that an implicit or explicit deal was struck at the private dinner between the two Presidents on the first day of Hu’s visit to Washington in mid-January: China will continue to let its exchange rate rise at the needed pace while the United States will avoid public commentary on the issue. The deafening silence from the US side throughout the visit, which has continued through subsequent events such as the World Economic Forum in Davos, supports such speculation. So does the subsequent Treasury report on foreign exchange issues, released on February 6, which could only exonerate China from designation as "manipulating" its currency on the basis of such an expectation. The two governments may not yet have created a fully functioning G-2, of the type I proposed over five years ago to provide an informal steering committee for the world economy, but the two Presidents have met eight times over the past two years and routinely discuss the entire range of global as well as bilateral issues; a resolution of the currency conflict would mark a major success for that process.

It is noteworthy that the actual jumps in the renminbi since last June correlate closely with episodes of US pressure: in early September in the run-up to major hearings on the issue in both the House and Senate, in early October when the Senate was considering whether to take up the China currency bill that the House passed on September 30, in early November prior to the G-20 summit, and from mid-December through mid-January as President Hu prepared to travel to Washington.

A second factor was the increased expression of concern over the renminbi issue by other countries, especially key emerging markets. France, the new chair of the G-20, has been extremely pointed on the topic behind closed doors. Central bank governors from Brazil and India have spoken publicly on it, and private criticism from those countries, and very sharply from others such as Mexico, has recently increased. Of particular importance may be the growing entreaties from other Asian countries, including a number of China’s neighbors, who have seen their exchange rates rise considerably more than China’s over the past half year.

Conditions inside China are presumably the most important factor in the authorities’ decision to let the renminbi rise significantly. Inflation has replaced growth as the leading concern for economic policy and a stronger currency in a very open economy like China’s is one of the most effective instruments to counter surging prices (and for the central government to impose its will on often-recalcitrant provisional governors). Growth itself continues at near double-digit levels and, with the high probability of reasonably robust expansion in the US and world economies for 2011 and beyond, the authorities can now be confident that China will not suffer a relapse even if its trade surplus declines a bit. They also observe that their economy continued to grow prodigiously throughout the earlier period of renminbi appreciation in 2005–08, tempering fears that the inevitable adjustments will be excessively painful. China’s evident desire to increasingly internationalize the renminbi may also tilt it toward reducing its intervention and letting the exchange rate move toward an equilibrium level.

The Chinese authorities have of course reiterated their intent to rebalance their economy, away from exports and the underlying investment in capital-intensive industries, for a number of years and have made commitments to the G-20 to do so. They have indeed imbedded that concept in the new five-year indicative plan that is scheduled to begin next year. They have apparently, and correctly, concluded that this is the perfect time to accelerate the adjustment process with inflation the new priority at home while unemployment remains of paramount concern in the United States and Europe, their two main trading partners.

It is of course impossible to know how durable any such agreement might turn out to be. The United States and the world as a whole will have to monitor renminbi developments closely and regularly. The US government will have to continue its private pressure and the Congress will have to maintain the prospect of renewed legislative initiatives if progress falters. In doing so, however, everybody must recognize that the rate will not rise monotonically because, as they have done since last June, the Chinese will want to keep speculators guessing by engineering periodic depreciations for a few days or even longer.

We must also have no illusion that the Chinese are letting market forces determine the rate. They will continue to intervene heavily and simply manipulate it to a stronger level that is both more beneficial to their own economy and more compatible with global equilibrium. In light of the gradual pace of appreciation, and the lags of two to three years between currency moves and trade results, we must also recognize that China will continue to run sizable (if falling) external surpluses for at least another five years (and thus keep buying more Treasury bills, albeit hopefully at a declining rate).

The postulated outcome, a rise of 20 to 30 percent in the renminbi over two to three years, would have major positive effects. China’s global current account surplus would drop by $300 billion or so from the rising path that it would otherwise be on, and retreat well within the unofficial norm of 4 percent of GDP that has been discussed by the G-20 and endorsed by some Chinese officials. The US external deficit would drop by $50 billion to $100 billion, creating perhaps 500,000 new and high-paying jobs (mainly in export industries) in this country. We know that currency changes produce these powerful results because the earlier rise of the renminbi during 2005–08 and the 25 percent fall of the dollar during 2002–07, along with the global recession, produced declines (with the usual lags) of fully one half in both countries’ imbalances by 2009 (before they started rising again last year because the currency corrections halted or reversed). The world’s only major currency misalignment would be largely corrected, and the outlook for world growth and global finance would become much stronger and much more sustainable.

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Tags: China, exchange rates, the dollar, United States


Now Comes the Global Revolution in Services

Imagine a Malaysian architect sketching a new office tower for London and a Chinese engineer assessing the soundness of the designs.


Asia has been a big winner from the development of global manufacturing supply chains. Japan and the four tigers—Hong Kong, Singapore, South Korea and Taiwan—showed how cheaper shipping could create opportunities for factories far from the intended market. As supply chains have grown more complex, the benefits have spread. Components now travel from Thailand, the Philippines, Malaysia and Taiwan to a factory in China, where they're assembled before hitting the shelves of an Apple store in New York as a finished iPhone.

Even as the manufacturing supply chains continue their evolution, a new question confronts Asia: How to profit from increasingly sophisticated supply chains in services? Despite all the political hype in the West about the ills of outsourcing and the perceived ubiquity of overseas customer-service call centers, services supply chains are still in their infancy.

Call centers are arguably among the lowest-hanging fruit in the services world. They require only phone lines, computers hooked up to the Internet and English-speaking workers with relatively basic educational attainment. But already outsourcing centers are bounding up the value chain: programming software, reviewing legal documents, processing expense reports and the like. The Philippines is home to a growing movie-animation business. China is skipping the call-center phase (poor English skills are a debilitating problem) and jumping right into providing research and development services.

We're heading for a day when a Malaysian architect will sketch out a new office tower for London, a Philippine architect will prepare detailed renderings, and a Chinese engineer will assess the structural soundness of the designs. Or a specialist firm in Bangalore will administer health benefits for a Kansas company. Indeed, such things already are happening on a modest scale.

Asia seems well-situated to capitalize on the lengthening of services supply chains. Of the 10 most promising services- outsourcing destinations recently identified in a survey from consultancy A.T. Kearney, seven are in Asia. India, predictably, tops the list, followed by China. Malaysia, Indonesia, Thailand, Vietnam and the Philippines are the rest, with Egypt, Mexico and Chile rounding out the top of the class. That survey measures future potential. A study last year from IBM examining actual investments found the Philippines edging out India to attract more business-service investment such as call centers (measured by job creation) than any other country.

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Associated Press

Opportunities on hold.

But nothing is inevitable. Investments in infrastructure, pro-trade policies and the right regulation and taxation at home positioned some Asian countries to start taking their profitable places in global manufacturing supply chains. Yet the advantages have always been relative. And as some economies have worsened their business climates over time, others have been happy to pick up the slack by improving theirs.

How this competition will evolve is anyone's guess, but already it's possible to make a few observations. One is that the field is still wide open. Having been a goods-exporting powerhouse does not necessarily translate into services prowess. China is an exporting dynamo, but many other countries in the A.T. Kearney top 10 are not. The skills and infrastructures required for manufacturing and services are different enough that one won't necessarily lead naturally to the other.

That's particularly apparent on the infrastructure front. Ask experts what a government needs to do to develop a services- outsourcing industry, and the first answer is usually "provide more reliable electricity" or "lay fiber-optic cable." True, but more important will be the human intangibles. Educating a sufficiently skilled work force—no small task in itself—is only the start.

Manufacturing supply chains applied modern transportation technologies to a millennia-old principle that if someone in a neighboring village can make a good more efficiently than you can, you should buy it from him. Service supply chains derive a new principle—that you no longer need to be geographically near the person providing you a business service—from modern communications technologies. Now countries need to figure out how they fit into this trend, and how to profit from it.

Mr. Sternberg edits the Wall Street Journal Asia's Business Asia column.


Reaganomics: What We Learned

From December 1982 to June 1990, Reaganomics created over 21 million jobs. The right policies can do it again.


For 16 years prior to Ronald Reagan's presidency, the U.S. economy was in a tailspin—a result of bipartisan ignorance that resulted in tax increases, dollar devaluations, wage and price controls, minimum-wage hikes, misguided spending, pandering to unions, protectionist measures and other policy mistakes.

In the late 1970s and early '80s, 10-year bond yields and inflation both were in the low double digits. The "misery index"—the sum of consumer price inflation plus the unemployment rate—peaked at well over 20%. The real value of the S&P 500 stock price index had declined at an average annual rate of 6% from early 1966 to August 1982.

For anyone old enough today, memories of the Arab oil embargo and price shocks—followed by price controls and rationing and long lines at gas stations—are traumatic. The U.S. share of world output was on a steady course downward.

Then Reagan entered center stage. His first tax bill was enacted in August 1981. It included a sweeping cut in marginal income tax rates, reducing the top rate to 50% from 70% and the lowest rate to 11% from 14%. The House vote was 238 to 195, with 48 Democrats on the winning side and only one Republican with the losers. The Senate vote was 89 to 11, with 37 Democrats voting aye and only one Republican voting nay. Reaganomics had officially begun.

President Reagan was not alone in changing America's domestic economic agenda. Federal Reserve Chairman Paul Volcker, first appointed by Jimmy Carter, deserves enormous credit for bringing inflation down to 3.2% in 1983 from 13.5% in 1981 with a tight-money policy. There were other heroes of the tax-cutting movement, such as Wisconsin Republican Rep. Bill Steiger and Wyoming Republican Sen. Clifford Hansen, the two main sponsors of an important capital gains tax cut in 1978.

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Associated Press

Ronald Reagan after signing his first tax cut, Aug. 14, 1981.

What the Reagan Revolution did was to move America toward lower, flatter tax rates, sound money, freer trade and less regulation. The key to Reaganomics was to change people's behavior with respect to working, investing and producing. To do this, personal income tax rates not only decreased significantly, but they were also indexed for inflation in 1985. The highest tax rate on "unearned" (i.e., non-wage) income dropped to 28% from 70%. The corporate tax rate also fell to 34% from 46%. And tax brackets were pushed out, so that taxpayers wouldn't cross the threshold until their incomes were far higher.

Changing tax rates changed behavior, and changed behavior affected tax revenues. Reagan understood that lowering tax rates led to static revenue losses. But he also understood that lowering tax rates also increased taxable income, whether by increasing output or by causing less use of tax shelters and less tax cheating.

Moreover, Reagan knew from personal experience in making movies that once he was in the highest tax bracket, he'd stop making movies for the rest of the year. In other words, a lower tax rate could increase revenues. And so it was with his tax cuts. The highest 1% of income earners paid more in taxes as a share of GDP in 1988 at lower tax rates than they had in 1980 at higher tax rates. To Reagan, what's been called the "Laffer Curve" (a concept that originated centuries ago and which I had been using without the name in my classes at the University of Chicago) was pure common sense.

There was also, in Reagan's first year, his response to an illegal strike by federal air traffic controllers. The president fired and replaced them with military personnel until permanent replacements could be found. Given union power in the economy, this was a dramatic act—especially considering the well-known fact that the air traffic controllers union, Patco, had backed Reagan in the 1980 presidential election.

On the regulatory front, the number of pages in the Federal Register dropped to less than 48,000 in 1986 from over 80,000 in 1980. With no increase in the minimum wage over his full eight years in office, the negative impact of this price floor on employment was lessened.

And, of course, there was the decontrol of oil markets. Price controls at gas stations were lifted in January 1981, as were well-head price controls for domestic oil producers. Domestic output increased and prices fell. President Carter's excess profits tax on oil companies was repealed in 1988.

The results of the Reagan era? From December 1982 to June 1990, Reaganomics created over 21 million jobs—more jobs than have been added since. Union membership and man-hours lost due to strikes tumbled. The stock market went through the roof. From July 1982 through August 2000, the S&P 500 stock price index grew at an average annual real rate of over 12%. The unfunded liabilities of the Social Security system declined as a share of GDP, and the "misery index" fell to under 10%.

Even Reagan's first Democratic successor, Bill Clinton, followed in his footsteps. The negotiations for what would become the North American Free Trade Agreement began in Reagan's second term, but it was President Clinton who pushed the agreement through Congress in 1993 over the objections of the unions and many in his own party.

President Clinton also signed into law the biggest capital gains tax cut in our nation's history in 1997. It effectively eliminated any capital gains tax on owner-occupied homes. Mr. Clinton reduced government spending as a share of GDP by 3.5 percentage points, more than the next four best presidents combined. Where Presidents George H.W. Bush and Bill Clinton slipped up was on personal income tax rates—allowing the highest personal income tax rate to eventually rise to 39.6% from 28%.

The true lesson to be learned from the Reagan presidency is that good economics isn't Republican or Democrat, right-wing or left-wing, liberal or conservative. It's simply good economics. President Barack Obama should take heed and not limit his vision while seeking a workable solution to America's tragically high unemployment rate.

Mr. Laffer is the chairman of Laffer Associates and co-author of "Return to Prosperity: How America Can Regain Its Economic Superpower Status" (Threshold, 2010).



New drilling method opens vast oil fields in US


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A new drilling technique is opening up vast fields of previously out-of-reach oil in the western United States, helping reverse a two-decade decline in domestic production of crude.

Companies are investing billions of dollars to get at oil deposits scattered across North Dakota, Colorado, Texas and California. By 2015, oil executives and analysts say, the new fields could yield as much as 2 million barrels of oil a day _ more than the entire Gulf of Mexico produces now.

This new drilling is expected to raise U.S. production by at least 20 percent over the next five years. And within 10 years, it could help reduce oil imports by more than half, advancing a goal that has long eluded policymakers.

"That's a significant contribution to energy security," says Ed Morse, head of commodities research at Credit Suisse.

Oil engineers are applying what critics say is an environmentally questionable method developed in recent years to tap natural gas trapped in underground shale. They drill down and horizontally into the rock, then pump water, sand and chemicals into the hole to crack the shale and allow gas to flow up.

Because oil molecules are sticky and larger than gas molecules, engineers thought the process wouldn't work to squeeze oil out fast enough to make it economical. But drillers learned how to increase the number of cracks in the rock and use different chemicals to free up oil at low cost.

"We've completely transformed the natural gas industry, and I wouldn't be surprised if we transform the oil business in the next few years too," says Aubrey McClendon, chief executive of Chesapeake Energy, which is using the technique.

Petroleum engineers first used the method in 2007 to unlock oil from a 25,000-square-mile formation under North Dakota and Montana known as the Bakken. Production there rose 50 percent in just the past year, to 458,000 barrels a day, according to Bentek Energy, an energy analysis firm.

It was first thought that the Bakken was unique. Then drillers tapped oil in a shale formation under South Texas called the Eagle Ford. Drilling permits in the region grew 11-fold last year.

Now newer fields are showing promise, including the Niobrara, which stretches under Wyoming, Colorado, Nebraska and Kansas; the Leonard, in New Mexico and Texas; and the Monterey, in California.

"It's only been fleshed out over the last 12 months just how consequential this can be," says Mark Papa, chief executive of EOG Resources, the company that first used horizontal drilling to tap shale oil. "And there will be several additional plays that will come about in the next 12 to 18 months. We're not done yet."

Environmentalists fear that fluids or wastewater from the process, called hydraulic fracturing, could pollute drinking water supplies. The Environmental Protection Agency is now studying its safety in shale drilling. The agency studied use of the process in shallower drilling operations in 2004 and found that it was safe.

In the Bakken formation, production is rising so fast there is no space in pipelines to bring the oil to market. Instead, it is being transported to refineries by rail and truck. Drilling companies have had to erect camps to house workers.

Unemployment in North Dakota has fallen to the lowest level in the nation, 3.8 percent _ less than half the national rate of 9 percent. The influx of mostly male workers to the region has left local men lamenting a lack of women. Convenience stores are struggling to keep shelves stocked with food.

The Bakken and the Eagle Ford are each expected to ultimately produce 4 billion barrels of oil. That would make them the fifth- and sixth-biggest oil fields ever discovered in the United States. The top four are Prudhoe Bay in Alaska, Spraberry Trend in West Texas, the East Texas Oilfield and the Kuparuk Field in Alaska.

The fields are attracting billions of dollars of investment from foreign oil giants like Royal Dutch Shell, BP and Norway's Statoil, and also from the smaller U.S. drillers who developed the new techniques like Chesapeake, EOG Resources and Occidental Petroleum.

Last month China's state-owned oil company CNOOC agreed to pay Chesapeake $570 million for a one-third stake in a drilling project in the Niobrara. This followed a $1 billion deal in October between the two companies on a project in the Eagle Ford.

With oil prices high and natural-gas prices low, profit margins from producing oil from shale are much higher than for gas. Also, drilling for shale oil is not dependent on high oil prices. Papa says this oil is cheaper to tap than the oil in the deep waters of the Gulf of Mexico or in Canada's oil sands.

The country's shale oil resources aren't nearly as big as the country's shale gas resources. Drillers have unlocked decades' worth of natural gas, an abundance of supply that may keep prices low for years. U.S. shale oil on the other hand will only supply one to two percent of world consumption by 2015, not nearly enough to affect prices.

Still, a surge in production last year from the Bakken helped U.S. oil production grow for the second year in a row, after 23 years of decline. This during a year when drilling in the Gulf of Mexico, the nation's biggest oil-producing region, was halted after the BP oil spill.

U.S. oil production climbed steadily through most of the last century and reached a peak of 9.6 million barrels per day in 1970. The decline since was slowed by new production in Alaska in the 1980s and in the Gulf of Mexico more recently. But by 2008, production had fallen to 5 million barrels per day.

Within five years, analysts and executives predict, the newly unlocked fields are expected to produce 1 million to 2 million barrels of oil per day, enough to boost U.S. production 20 percent to 40 percent. The U.S. Energy Information Administration estimates production will grow a more modest 500,000 barrels per day.

By 2020, oil imports could be slashed by as much as 60 percent, according to Credit Suisse's Morse, who is counting on Gulf oil production to rise and on U.S. gasoline demand to fall.

At today's oil prices of roughly $90 per barrel, slashing imports that much would save the U.S. $175 billion a year. Last year, when oil averaged $78 per barrel, the U.S. sent $260 billion overseas for crude, accounting for nearly half the country's $500 billion trade deficit.

"We have redefined how to look for oil and gas," says Rehan Rashid, an analyst at FBR Capital Markets. "The implications are major for the nation."


Associated Press writer James MacPherson contributed reporting from Stanley, N.D.



Corn Pops as USDA Sees Drop in Supply


The outlook for global grain supplies and food prices grew more precarious Wednesday as the U.S. Agriculture Department said it expects U.S. corn supplies to fall to the near-record low level set 15 years ago.

Red-hot prices aren't cooling the appetite for U.S. grain as in the past, which means U.S. supplies are continuing to be drained at a rapid rate to make ethanol fuel, fatten livestock and meet demand overseas.

"We're just not seeing prices ration demand," said Luke Chandler, head of agricultural commodity markets research at Rabobank. "The markets have changed in a structural way due to ethanol. ... Any relief will take considerable time."

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Bloomberg News

With Tuesday's gains, prices of corn futures contracts have climbed 97% since June; wheat is up 107% and soybeans are up 56%. Above, harvested corn is unloaded from a combine harvester into a grain cart on a farm near Peru, Ill.

According to USDA projections released Wednesday, the 12.4 billion bushels of corn harvested by U.S. farmers last fall will dwindle to just 675 million bushels by Aug. 31, when a new harvest begins to replenish inventories.

That ending stocks number, which is off 9% from the USDA's January projection, is extraordinarily low in the eyes of food executives because it represents just 5% of annual use, matching the stocks-to-use ratio set in 1996, which was the lowest recorded by the USDA for America's biggest crop since the Dust Bowl era, when the U.S. stocks-to-use ratio fell to 4.5% in 1937.

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In trading at the Chicago Board of Trade Wednesday, the corn futures contract for March delivery jumped 24.25 cents a bushel, or 3.6%, to settle at $6.98 a bushel. While the USDA left its wheat and soybean projections largely unchanged, prices of these commodities rose in sympathy with corn.

With Tuesday's gains, prices of corn futures contracts have climbed 97% since June; wheat is up 107% and soybeans are up 56%.

The USDA increased its one-month-old projection of how much of the recent U.S. corn harvest will end up as ethanol by 50 million bushels to 4.95 billion bushels, or 40% of the harvest.

While high grain costs are pinching many food companies, U.S. ethanol makers are generating profits in part because Washington is mandating that gasoline blenders use 12.6 billion gallons of biofuel this year, up from the 2010 mandate of 12 billion gallons.

Washington's support of the ethanol industry is intended to reduce U.S. dependence on foreign oil. But one reason the ethanol industry's appetite for corn is continuing to expand is that it is putting biofuel in foreign cars.


An even steeper rise in sugarcane prices is depressing exports of sugar-derived ethanol from Brazil, opening markets for the U.S. industry, which saw its exports triple in 2010 to 350 million gallons, according to the Renewable Fuels Association, a Washington trade group.

Evidence of the ethanol industry's expanding appetite for corn increased tensions between it and the food industry. "The fact that more U.S. corn is being exported in the form of ethanol at a time when corn supplies are already low is simply indefensible," said a statement issued by Tyson Foods Inc., the Springdale, Ark., meat giant. "We've got to get our energy and agriculture policies in sync."

The Obama administration defended its ethanol policy Wednesday. At a public appearance with other cabinet members, Agriculture Secretary Tom Vilsack said he doesn't think the ethanol industry's appetite for corn is raising food costs.

"I'm not concerned about it," he said. "I think there is going to be enough corn for food, for feed, for fuel and for export opportunities."

Still, grain analysts are having a hard time comprehending how grain consumption can continue at these high levels, and not just because of ethanol's appetite. Analysts say the cheap dollar is helping to insulate export demand for U.S. commodities, which is also being helped by production problems in farm belts around the globe.

The USDA said Wednesday it expects U.S. wheat export volume to soar 48% this year in the wake of the drought that decimated Russian wheat farms last summer, slashing exports from the Black Sea region.

Likewise, rising U.S. livestock prices are discouraging many farmers from shrinking the size of their herds, keeping up their demand for grain. U.S. pork exports are up in part because South Korea's effort to eradicate an outbreak of foot-and-mouth disease on its pig farms is forcing it to buy more foreign pork.

A drought in China is raising concerns about the condition of the wheat crop there but the USDA won't try to assess the size of the potential harvest there until its May report.

China is the world's biggest producer and consumer of wheat but it is far from clear how any significant drop might impact international markets. The Chinese government has a policy of maintaining enormous grain stockpiles as insurance against any bad harvests.

Indeed, the USDA projected Wednesday that China will control 49% of the world's combined corn reserves, and 33% of the world's total wheat reserves, this year.

—Ryan Tracy and Ben Lefebvre contributed to this article.

Write to Ian Berry at ian.berry@dowjones.com






Africa Rising

Catering to New Tastes as Incomes Climb

Zambian Beef Processor Expands to Nigeria With Aim of Spreading Out Across the Continent


IKENNE, Nigeria—After driving two hours—skirting truck-size potholes, fording a flooded town and dodging a body—Pieter Swanepoel arrives at a dilapidated farm about 50 miles from Lagos, Nigeria.

He has reached the launching pad for Zambeef Products PLC's $10 million expansion into Africa's most populous country. A few hundred yards from where the South African accountant stands, neat rows of soybeans grow and a new meat-processing facility buzzes with activity where once there was a collection of derelict buildings.

Expanding a Beef Business in Africa

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Jane Hahn/Getty Images for the Wall Street Journal

Bulls in an enclosure at the new Zambeef farm in Ikenne, Nigeria

"There was sweet blow-all in terms of infrastructure," he says.

Under Mr. Swanepoel's leadership over the last two years, Zambeef has built an efficient supply chain and opened a handful of bustling retail stores in one of Africa's toughest but most promising markets. His goal is to turn the Zambian meat-and-produce company into Africa's Coca-Cola for meat, with Zambeef's Master Meats brand in shops and market stalls across the continent.

With annual revenue of $162 million, Zambeef is a bite-size example of companies small and large expanding in Africa, transforming the world's next billion-person market in similar ways to how earlier economic booms changed China and India.

While U.S. and European companies are waking up to the continent's accelerating growth, scores of African companies like Zambeef also are expanding. Telecommunications company MTN Group Ltd. has scooped up 116 million subscribers in 21 African countries on the continent from its headquarters in South Africa. Nigeria-based Dangote Cement PLC has acquired land and opened plants in Ghana, Cameroon and Ethiopia. Togo-based Ecobank Transnational Inc. set up branches in 30 African countries, doubling its presence in five years.

While the economies of U.S., Europe and Latin American contracted in 2009, Africa's grew. The International Monetary Fund in October forecast that growth in the 47 countries of sub-Saharan Africa will reach 5.5% this year. That growth is creating legions of consumers.

Around 10 million Nigerians moved into the middle-income bracket, meaning they could buy more than just necessities, in the past five years, according to an estimate by London-based private-equity firm Actis LLP. Nigeria's estimated $9 billion market for red-meat products is the continent's second biggest, after South Africa, according to a recent study sponsored by the British government.

Zambeef expects that as the middle class in this country of some 150 million people grows, so, too, will the number of people shopping in Western-style stores. The company hopes to lure customers used to buying meat in open-air markets by offering clean, packaged products while charging only slightly more than the markets. While a pound of beef might cost around $4.10 at a Lagos open-air market, Zambeef might charge about $4.75.

Multinationals also have high hopes for Nigeria. "We see Africa, with its one billion inhabitants, as a continent of limitless possibilities," Nestlé SA Chief Executive Paul Bulcke said last week as he opened an $80 million factory in the same state as Zambeef's farm.

No one, however, is discounting the perils of investing in a continent rife with corruption, short on dependable infrastructure and heavy with unstable governments, as Northern Africa has shown in recent weeks.

Mr. Swanepoel's experience as Zambeef's managing director in Nigeria shows that doing business in Africa will be just as messy as in other emerging markets. To deal with an unreliable power supply, Zambeef runs its equipment here on its own diesel-powered generators 24 hours a day at a cost of tens of thousands of dollars a month. As he travels among Zambeef's 11 stores and plants, Mr. Swanepoel (pronounced SWAH-nuh-pole) spends several hours a day stuck in Lagos traffic jams.

"A lot of the time you say to yourself, 'My god, how can we make this work?,' " Mr. Swanepoel says. "But eventually you figure the puzzle out. In Nigeria, you need logic and lots of patience. A bottle of good wine doesn't hurt, either."

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Zambeef's road to Nigeria began in 2009, after Shoprite Holdings Ltd. had expanded into the country from the supermarket chain's base in South Africa. Zambeef had been supplying Shoprite stores in South Africa and Zambia, and the chain wanted to use Zambeef as a supplier and to staff Shoprite butcher counters in Nigeria. Zambeef jumped at the offer to work with an established customer.

Mr. Swanepoel, meanwhile, was working as finance manager for Shoprite in Zambia, where he worked with Zambeef executives.

"At that stage, me and my wife weren't interested in working in South Africa, we wanted a different challenge," says Mr. Swanepoel, the son of a South African ostrich farmer. "They said, 'Are you up for Nigeria?' And I said, 'OK.' "

Zambeef has invested around $2 million in Nigeria and plans to invest another $8 million over the next eight years to hire staff, open more Master Meats shops and use the Ikenne farm as a hub to supply neighboring countries. The company in Nigeria records about $90,000 in sales a week to restaurants, hotels, Shoprite stores and from Zambeef's own outlets. Zambeef predicts revenue will more than double by year-end.

"What Zambeef has been able to do in Nigeria in a very short time frame is nothing short of a miracle," says Gerhard Fritz, Africa operations manager for Shoprite, which isn't related to ShopRite of the U.S.

Zambeef's expansion hasn't been easy. Since Nigeria lacks a sufficient manufacturing base, the company has had to import most of its equipment from Zambia or South Africa, with shipments taking about 80 days.

Getting a business license took Mr. Swanepoel nine months in Nigeria; when Zambeef started operations in Ghana, a license was issued in two weeks. And while Nigeria's official language is English, the cattle traders Mr. Swanepoel works with speak Arabic, so he hired a university professor of linguistics to translate.

To establish good will, he and other Zambeef executives attended a ceremony in which a local governor was made a chief. "A smile and a nod go a long way," says Mr. Swanepoel, who is fond of Montecristo minicigars. "They're not going to trust you if you come in like a cowboy swaying into town."

To secure its land in Ikenne, Zambeef entered a 25-year lease with Ogun state. Mr. Swanepoel surveyed the old dairy farm and saw milk-processing equipment buried under bushes and trees.

"The more brush we cleared, the more buildings we discovered," he says, peering into an abandoned room stacked floor to ceiling with never-used milk cartons bearing the Ogun State Dairy logo.

The farm now hums with several hundred head of cattle, pigs and chickens and eventually will have about 1,600 head and several thousand pigs. Zambeef also grows corn, soybeans and pineapple and employs about a dozen local residents on the farm's payroll of 85 people, Mr. Swanepoel says.

"Zambeef is like an answered prayer for us," says Yosola Akinbi, the economic adviser to Ogun's governor. "By the time they came on board, the farm was virtually dead. So it's good that this company is doing this and bringing it back to life."

Ms. Akinbi and other officials are trying to make it easier for Zambeef to do business, hoping other companies will follow. The state plans to spend $26 million to construct a cargo airport by 2015 so companies can avoid Lagos's often-chaotic international airport. The federal government recently moved toward opening the country's fickle state-run power grid to private investors.

After fighting through traffic, Mr. Swanepoel ends a recent day at a Zambeef facility in Lagos where a dozen employees chop and package beef and pork. An empty lot beside the factory is covered in brackish sludge with a lily pad in the middle.

He brightens. "Imagine that growing here," he says.



Soaring debt pushes Portugal towards bail-out

By David Oakley


Published: February 9 2011 17:58 | Last updated: February 9 2011 17:58

Portugal’s cost of borrowing hit a euro-era high on Wednesday amid growing concerns that Lisbon will have to turn to bail-out funds to revive its stagnating economy.

Hedge funds were selling Portuguese debt after purchasing bonds at a syndication of five-year bonds just 24 hours earlier, brokers said.


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Gillian Tett: The end of risk-free sovereigns - Jan-20

Investor worries are also rising that policymakers will fail to introduce the necessary reforms to beef up the eurozone bail-out fund.

Portuguese 10-year bond yields jumped to 7.35 per cent – the highest since the launch of the euro in January 1999 and a level regarded as unsustainable for Lisbon’s struggling economy.

Richard McGuire, rates strategist at Rabobank, said: “Once again we’re back into this lull where they [EU policymakers] have promised something and they haven’t given details. I think the market will become increasingly concerned about this, exactly as they did about packages for Greece and Ireland.”

A leading investor said: “Portuguese debt costs are in danger of rising further and further as there are no buyers of the country’s debt.”

Some European policymakers would like to see Portugal opt for bail-out loans, which offer rates of about 6 per cent and are considered the best way to deal with the country’s banking and economic problems. There are also hopes among some strategists that the rates offered on bail-out loans will be reduced to encourage Lisbon to accept financial help.

The country’s problems are highlighted by fund managers, such as Pimco, which are no longer prepared to buy the country’s bonds because of fears over high debt levels.

Pimco is switching out of eurozone debt and into emerging market bonds because of the higher yields and higher potential returns offered in these markets.

Lisbon needs to repay €9.5bn ($13bn) in maturing bonds by the end of June, which many strategists say the country will struggle to raise.

Significantly, the European Central Bank has been the only major buyer of Portuguese debt in recent months. However, the latest ECB figures show that the bank has not bought any government bonds in the past two weeks, which explains the drift higher in Portuguese yields.

Strategists say a summit of European leaders in March will determine whether Lisbon will have to follow Greece and Ireland in seeking emergency support. One fund manager said: “We are at a key moment in the eurozone crisis and Portugal is on the frontline. We will know soon whether Lisbon will have to accept a bail-out or not. That is the next test for the eurozone.”



Vietnam Devalues Currency by 8.5% as Inflation Looms



Vietnam devalued its currency by 8.5% as it struggles with high inflation and a large trade deficit, while China's Huawei Technologies is facing opposition over its U.S. developer purchase. WSJ's Jake Lee and Asia Economics Reporter Alex Frangos discuss.

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One of Asia's most inflation-plagued economies, Vietnam, devalued its currency 8.5% Friday to help arrest mounting economic problems.

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A woman counting Vietnamese dong bank notes in Hanoi.


But analysts say Hanoi's Communist policy makers instead risk triggering a new and potentially uncontrollable round of price rises.

Inflation is ringing alarm bells across numerous emerging economies amid rising food and fuel costs, and Vietnam is one of the main trouble spots. Years of loose interest rate policies and state-subsidized lending have ramped up its economic growth to China-like levels in a relatively underdeveloped country that analysts say is ill-equipped to handle it.

That is driving up prices for many basic commodities and sparking a series of currency devaluations that have erased one-fifth of the value of Vietnam's dong since mid-2008. Consumer prices jumped more than 12% in January compared with a year earlier and could rise further this month once the full impact of the Lunar New Year and Friday's devaluation is felt.

But Vietnam's economic planners have shown little inclination to get tough on inflation, despite anti-inflationary talk at the ruling Communist Party's twice-a-decade Congress last month. Devaluing the currency to pump up exports risks exacerbating the problem.

Rather than risk choking off the supply of new jobs for a young and growing work force by raising interest rates, Vietnam is instead continuing to focus on growth—it's aiming at 7.5% gross domestic product growth—while treating inflation as a secondary issue, economists say. This year, and for the next five years, the Communist Party's policy-making Central Committee is targeting inflation at 7% annually—the same as 2010, when inflation actually surpassed 11%.

Still, Vietnam risks making a bad inflation problem worse. Without higher interest rates or other measures to help contain price rises, economists fear that inflation will accelerate further after Friday's move because it leads to higher costs for key imported goods, especially refined oil products.

Friday's move "will adversely impact inflation," says Prakriti Sofat, a regional economist with Barclays Capital in Singapore. She estimates that one percentage point decline of the Vietnamese dong versus the dollar adds about 0.15 percentage points to inflation.

This suggests Friday's devaluation could add 1.28 percentage points to the current rate, although Ms. Sofat notes that some of the impact has already leaked into the consumer price index because of the widespread use black-market foreign exchange rates, where the dong has long traded at lower levels. Barclays now expects inflation to hit 13.5% by March and exceed 15% by June.

Vietnam is almost entirely out of step with the rest of Asia, where concern about rising fuel and energy prices is nudging many central banks to push up rates after a rapid recovery from the global economic slump. China increased interest rates for the third time in four months Tuesday. Thailand's finance minister, Korn Chatikavanij, said in a recent interview that rapid prices were one of his main concerns, following a series of rate increases.

Many countries also have allowed their currencies to gradually appreciate to help absorb the impact of inflation—a move that makes it cheaper to import items such as food and fuel. Malaysia's ringgit is trading at around 13-year highs against the U.S. dollar and the Thai, Philippine and Singapore currencies have all seen sharp rises over the past two years.

Vietnam, on the other hand, is regarded by some policy makers in the region as a cautionary tale of what can happen if monetary brakes aren't applied quickly enough.

"The underlying economic concerns are yet to be addressed, meaning that depreciation pressures may persist," says Sherman Chan, an economist with HSBC in Hong Kong. Those problems include a large trade deficit and inefficient state enterprises that dominate much of the economy.

With inflation rising sharply in recent months, ordinary Vietnamese have switched investments from dong to U.S. dollars or gold, the price for which is around 5% higher in Vietnam than on the international market because of the perceived stability of the precious metal. This has helped add to the downward pressure on the dong, to the extent that some companies, including Ford Motor Co., have said they have sometimes struggled to secure enough foreign currency to pay for imports.

Friday's devaluation, which pushed down the official rate for the dong to 20,693 dong to the U.S. dollar from 18,932 dong, was aimed at narrowing the gap between the official rate and the black market rate for the dollar, which was at about 21,320 dong prior to the devaluation. In theory this should make it easier for firms to get hold of foreign currencies.

The country's central bank, the State Bank of Vietnam, said in a statement that the move would help boost exports and rein in Vietnam's trade deficit, which has also weighed on the currency. Weaker currencies make a nation's exports more competitive abroad.

The move is also likely aimed at Vietnam's dwindling currency reserves. State media have reported that Vietnam's international reserves had fallen to "more than $10 billion" by the end of 2010 compared with $16 billion at the end of 2009 and $26 billion in 2008.

The cost of insuring against another default or restructuring of Vietnam's debts jumped higher after Friday's devaluation. The spread on Vietnam's five-year credit default swaps widened 20 basis points from 385 to 395 basis points on Thursday.

Economists say Vietnam needs to act more aggressively to address the critical flaws in its economy—especially in its inefficient but politically sensitive state enterprises—if it's to escape a deeper crisis. Many commentators blame much of the current inflationary pressure on billions of dollars in cheap loans handed out to state-owned enterprises, which then used some of the funds to launch failed projects or speculate in real estate or the country's financial markets. Others branched out into industries they didn't fully understand or were caught short by the extent of the 2008's global economic slump.

State-run shipbuilder Vinashin, formally known as Vietnam Shipbuilding Industry Group, came to the brink of bankruptcy last summer after amassing $4.4 billion in debts and prompting Moody's Investors Service and Standard & Poor's to downgrade Vietnam's sovereign debt. In December, the situation worsened when Vinashin defaulted on a $60 million loan repayment on a $600 million syndicated loan.

"In my view, (Vietnam's policies) would be more effective if they implement some kind of state-owned sector reform," said Ms. Chan at HSBC.











The Time for Spending Cuts Is Now

The White House argues that 'draconian' cuts will derail the economy. In fact, cuts are necessary to preserve tax rates that are compatible with economic growth.


The old bromide that citizens elect presidents for protection from other people's congressmen was reversed last November when a Congress was elected for protection from the president. This week House Republicans have been debating how to cut the ballooning budget. After ramming through an expansion of federal spending to levels not approached since World War II, President Obama is now calling for still more spending, with a renewed emphasis on infrastructure, that he claims will create jobs and economic growth.

Let's put this in perspective: With the Congressional Budget Office (CBO) now projecting a federal budget deficit this year of $1.5 trillion, Mr. Obama is on course to add as much debt in one term as all 43 previous presidents combined. Not surprisingly, the rating agency Standard & Poor's is warning of a Treasury downgrade.

Yes, the president is calling for a freeze on nondefense discretionary spending (18% of the budget). But this would leave that spending more than 20% higher than already- elevated 2008 levels, where Republicans would like to return. The freeze also cements in place a huge expansion of government originally sold as a temporary, emergency response to the economic and financial crisis.

Mr. Obama's Budget Director Jacob Lew asserts that the president has made tough choices, pointing to $775 million of proposed cuts—but that's one-tenth of 1% of nondefense discretionary spending. The Obama administration and its supporters dubiously claim higher spending will quickly strengthen the recovery and generate jobs, and that any "draconian" cuts would derail the recovery. Higher spending, deficits and debt are future problems, they argue, and even then higher taxes (especially on "the rich") won't harm the economy.

But government spending generally does little to boost the economy. Exhibit A is the failed 2009 stimulus bill, the president's American Recovery and Reinvestment Act (ARRA).

The strongest case for stimulus is increased military spending during recessions. But infrastructure spending, as the president proposes, is poorly designed for anti-recession job creation. As Harvard economist Edward Glaeser has shown, the ARRA's transportation spending was not directed to areas with the highest unemployment or the largest housing busts (and therefore the most unemployed construction workers). Indeed, last September Wendy Greuel, the City of Los Angeles controller, shocked the country when she revealed that the $111 million in ARRA infrastructure money her city received created only 55 jobs—that's a whopping $2 million of federal stimulus per job created.

Why is this so? Modern, large-scale public infrastructure projects use heavy equipment and are less labor-intensive than they were historically (WPA workers digging ditches with shovels in the 1930s). Federal transportation stimulus spending was $4 billion in 2009, leaving two problems with claims of "shovel-ready" projects: shovels and ready.

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Chad Crowe


The nation certainly has public investment needs, but federal infrastructure spending should be based on rigorous national cost-benefit tests. Most local officials are happy to have the rest of the country pay for spending on virtually any project, however modest the local benefits. Even so, several states have rejected high-speed rail subsidies as requiring unwise state spending despite the subsidies. California's estimates, for example, have soared.

Moreover, how will we pay for all this new spending? The CBO's 10-year projection sees the possibility of the debt-to-GDP ratio rising to an astounding 100%. Several recent studies (detailed on these pages in my "Why the Spending Stimulus Failed," Dec. 1, 2010) conclude that: 1) such high debt would severely damage growth, so fiscal consolidation is essential; 2) fiscal consolidation is likely to be far more effective on the spending than the tax side of the budget; and 3) substantially higher tax rates and spending cause permanent drops in income that are many times larger than the temporary fall caused by the recession. Thus, spending control is vital before debt levels or tax increases risk severely damaging growth for a generation.

In the 1980s and '90s, federal spending was reduced by more than 5% of GDP to 18.4% in 2000—a level sufficient to balance the budget at full employment and allow for lower tax rates. It was a remarkable period of growth, and there's no reason we can't repeat that success. In addition to rolling back ObamaCare and rolling up remaining TARP and stimulus funds, spending control should include these major reforms:

Consolidate, eliminate, defederalize and, where feasible, voucherize with flexible block grants. I pointed out in 2007 that 42% of federal civilian workers were due to retire in the coming decade. Replacing half of them (with exceptions for national security and public safety) with technology could improve services and save hundreds of billions of dollars. Beyond the savings, it would make necessary services more efficient. For example, the federal government's many separate job-training programs should be consolidated and voucherized to enable citizens to obtain commercially useful training.

A dopt successful business practices where possible. For example, consolidating IT infrastructure, streamlining supply chains, using advanced business analytics to reduce improper payments, and switching from expensive custom code to standardized software applications could save more than $1 trillion over a decade while upgrading and improving federal support and information services.

Gradually move from wage to price indexing of initial Social Security benefits. This would eliminate the entire projected Social Security deficit without cutting anyone's benefits or raising anyone's taxes. Also, raise the retirement age over several decades, preserve early retirement and disability, and strengthen support for the poorest. On Medicare, former Clinton Budget Director Alice Rivlin and House Budget Committee Chairman Paul Ryan propose gradually moving to fixed government contributions to purchase insurance, for large savings and more informed care.

The immense growth of government spending and soaring public deficits and debt are the major sources of systemic economic risk, here and abroad, threatening enormous costs by higher taxes, inflation or default. The problem is not merely public debt. A much higher ratio of taxes to GDP trades a deficit problem for sluggish growth. In recent decades, the large advanced economies with the highest taxes have grown most slowly. And the high-tax economies did not have smaller budget deficits. Rather, higher taxes merely led to higher spending.

Elected officials too often ignore long-run costs to achieve short-run benefits. But government policies can neither revoke the laws of arithmetic nor circumvent the laws of economics. The time to start reducing spending is now.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.



The Futures of America

Lessons of the NYSE-Deutsche Borse merger.

The likely sale of New York Stock Exchange parent NYSE Euronext to Deutsche Börse of Frankfurt, Germany, is playing as a blow to America's capitalist pride, and understandably so. It's painful at first blush to imagine ownership of the famous symbol of American financial markets transferred out of New York City. Yet the merger is itself a story of inevitable capitalist change and how no country or institution can take its dominance for granted.

The merger would continue the long-term consolidation of global financial trading, as new technology has upset old business models and leapt over geographic boundaries. The Big Board long ago lost its monopoly on trading listed stocks to Nasdaq and electronic exchanges. The result has been lower prices for customers wanting to buy and sell stocks, though perhaps at the cost of some stability in the markets, as orders are routed across dozens of trading platforms with varying rules.

Then last decade, the NYSE became a stock company to raise capital to expand, reaching abroad to buy Euronext in Paris and grab a share of the exploding derivatives market. NYSE Euronext has evolved to the point where it now collects only 3% of its earnings from U.S. stock trading.

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Getty Images

Traders on the floor of the New York Stock Exchange.


A Deutsche/NYSE combination would create a more formidable competitor for other leading exchanges, such as Chicago's CME Group. The German exchange operator is a leader in European interest-rate futures, and combined with NYSE's European assets it would match the CME Group's futures dominance in the U.S. Deutsche Börse is also a major player in options trading and with the acquisition will lead in U.S. market share. NYSE Euronext has developed valuable technology and has a well-regarded management team.

The combination could offer efficiencies of scale and technology that neither firm can achieve on its own. NYSE Euronext's competitive weakness has been evident in its share price, which is down 60% in the last four years. If the merger succeeds competitively, we doubt its shareholders will care if the headquarters is in Frankfurt or New York.

The merger is nonetheless one more lesson in how easily capital, both financial and human, can relocate. It's no coincidence that the heavily regulated equity business has languished or moved out of the U.S., while lightly regulated derivatives markets have boomed in the United States and elsewhere.

In the early 1990s, American exchanges played host to half of the world's new public companies. Last year, according to Dealogic, U.S. exchanges hosted 171 initial public offerings worth a total of $45 billion. But this U.S. deal-making was dwarfed by the action overseas, where 1,295 companies went public with a total value of $237 billion. The iconic NYSE now lags behind two Asian exchanges in IPO volume. This is partly the result of more rapid growth in developing economies, but it used to be that foreign companies wanted to float their shares in the U.S. Now they're as happy in Hong Kong.

U.S. over-regulation is certainly to blame here, especially the 2002 Sarbanes-Oxley law and its multimillion-dollar compliance burden on public companies. The Securities and Exchange Commission's own exhaustive 2009 survey of U.S. and foreign firms showed that the burden of complying with Sarbox remains a major deterrent to going public in the United States. Yet the agency still hasn't made a serious effort to pare these burdens.

If the merger proceeds, the temptation in Washington will be to fret about foreign ownership of U.S. financial assets. But far more constructive would be some reflection about Washington's contribution to sending these assets and trading offshore. The Dodd-Frank law requires mountains of new rules that will further burden U.S. financial players, not least in the new derivatives regime emerging from the Commodity Futures Trading Commission. We would not be surprised if the NYSE Euronext managers view the Deutsche Börse merger as a potential refuge for its derivatives business if CFTC Chairman Gary Gensler realizes all of his regulatory ambitions.

For most of the last century, America could count on the size of its economy and quality of its technology to give it a competitive edge. No more. If we want the U.S. to be home to the next great financial institution, or even to keep the ones we have, our politicians need to make America a more inviting place to trade and do business.


SJ FEBRUARY 11, 2011

Export Rebound Unlikely to Close Gap With Imports

·         By KELLY EVANS

Boosting exports is great. But it still isn't enough to fix the nation's trade deficit.

December trade figures due from the Commerce Department on Friday are likely to show U.S. exports within spitting distance of an all-time high.

As of November, the value of goods and services sold to other countries stood at roughly $160 billion, less than 4% below the previous July 2008 high.

That is good news, as exports are one of the cheapest, easiest and most politically palatable ways for a nation to boost growth. They also help generate jobs at a time when the U.S. economy needs it.

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Bloomberg News

Any export rebound isn't matching the surge in imports. Since May 2009, these have jumped 31%, while exports have risen about 27%.


They are vital enough that countries like China keep their currencies artificially low and exports cheap even as it stirs domestic inflation.

And while U.S. politicians stick to the mantra of a strong dollar policy, it is a weaker one that will help the Obama administration in its goal to double exports in five years.

Still, any export rebound isn't matching the surge in imports. Since May 2009, these have jumped 31%, while exports have risen about 27%. As a result, the trade deficit, that familiar scourge, is widening again.

It is expected to hit about $40 billion in December, from a low of about $25 billion in May 2009.

The gap largely reflects the twin Achilles' heels of the U.S. economy: imported oil and imported Chinese goods. Excluding those components, the U.S. actually would have managed a brief trade surplus at one point last year, notes Capital Economics. Alas, there is little hope of breaking free from their grasp anytime soon.

In fact, the better U.S. economic growth, the stronger demand for fuel and consumer products is likely to be.

That complicates things. Barclays Capital chief U.S. economist Dean Maki expects the trade gap will shave about a percentage point off gross-domestic-product growth this year, leaving it at about 3.1%.

"We tried a narrowing trade deficit for a while and we didn't really like it," he notes, referring to the global recession. "We seem to prefer stronger growth" even if it widens the trade gap.

And if oil prices really soar, leading to, say, $4-a-gallon gasoline, that would sap consumer purchasing power and further undercut growth.

The trade deficit is a slumbering dragon that easily could be awakened.

Write to Kelly Evans at kelly.evans@wsj.com















Yuan Rate Hits Record, Fueling Asian Currencies


SINGAPORE—China's central bank fixed the yuan's exchange rate at a record against the dollar Wednesday, setting the tone for a broad rise in Asian currencies as authorities aim to quell rising inflation pressures.

Central banks in South Korea and Malaysia were again selling their currencies for dollars to keep them from rising too quickly, traders said, showing authorities are taking care not to damage their export industries crucial to the region's economic growth.

Hours after raising interest rates to cool the economy, the People's Bank of China set its parity rate for the dollar at 6.5850 yuan, down from the Feb. 1 close of 6.5938 yuan in the over-the-counter market and that day's fixing rate of 6.5860 yuan. China's markets reopened Wednesday after being closed since last week for Lunar New Year holidays, and the currency ended over-the-counter trading unchanged from the Feb. 1 level.

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Agence France-Presse/Getty Images

A Chinese bank worker counts a stack of 100-yuan notes last year.


China's currency is now up 3.7% since the PBOC ended the yuan's two-year peg to the dollar in mid-June. Trading in yuan derivatives offshore show investors now expect the dollar to fall to 6.4270/6.430 yuan in the coming year, compared with the 6.4493/6.4728 yuan implied by one-year nondeliverable forwards before the Lunar New Year holidays.

Other Asian currencies, which have marked modest gains so far this year, continued to rise Wednesday. With China playing such a large role in the region's economy, other Asian nations watch Beijing's foreign-exchange policy closely, seeking to ensure that their own currencies don't rise so much that their exporters become uncompetitive.

The U.S. currency hit a 13-year low against the Taiwan dollar, and slipped against the Thai baht. It was firmed against the Korean won, and the Bank of Korea was suspected of buying dollars, Seoul traders said. The dollar edged higher against the Malaysian ringitt, and two local dealers said Bank Negara Malaysia defended the dollar at Tuesday's closing level of 3.0330 ringgit.

"China's rate hike should be good for Asian currencies, but the Malaysian ringgit isn't rising because Bank Negara is at the 3.0330 level," said one dealer.

Interest-rate increases put upward pressure on a nation's currency because higher rates draw foreign funds seeking higher yields.

The PBOC raised one-year lending and deposit rates by 0.25 percentage point each late Tuesday, to 6.06% and 3.0% respectively, the third increase since October, underscoring policy makers' discomfort with percolating price pressures across the economy. Since the start of 2010, the PBOC has also raised the ratio of deposits that banks must hold in reserve seven times.

Inflation has been picking up in the region, fueled by fast economic growth and soaring prices of food and commodities. In China, consumer prices are expected to keep rising in the first quarter on strong holiday demand and bad weather. The consumer price index rose 4.6% from a year earlier in December, less than November's 5.1% rise, but the central bank appears to be uncomfortable with price pressures and some analysts expect inflation could rise by as much as 6% in the first half of the year.

The PBOC was the latest central bank in Asia to tighten monetary policy in recent months. Authorities are gradually moving to remove monetary stimulus that helped spur economic recoveries from the global financial crisis but is now adding to inflationary pressures.

Central banks such as Bank Indonesia have signaled that stronger currencies will be a tool in the inflation fight, and investors appear to be buying into that notion.

The PBOC sets a daily central parity rate for the yuan, allowing the tightly managed local currency to move up to 0.5% either way. Yuan/ringgit and yuan/ruble can as much as 5%, while other currencies are allowed to move as much as 3%.

—Jean Jung in Shanghai, Aaron Back in Beijing, Min-Jeong Lee in Seoul, Lorraine Luk in Taipei, and Elffie Chew in Kuala Lumpur contributed to this article.

Write to Arran Scott at arran.scott@dowjones.com


Rising China Bests a Shrinking Japan

By CHESTER DAWSON in Tokyo and JASON DEAN in Beijing

China passed Japan in 2010 to become the world's second-largest economy after the U.S., a historic shift that has drawn mixed emotions in the two Asian powers: resignation tinged with soul-searching in long-stagnant Japan, pride but also caution in an ascendant China wary of shouldering new global responsibilities.


WSJ Assistant Managing Editor John Bussey is joined by Beijing Bureau Chief Andrew Browne and Tokyo Bureau Chief Jacob Schlesinger to discuss China overtaking Japan as the world's #2 economy.

The Japanese government made official the long-expected flip Monday morning in Tokyo, reporting that the economy shrank at a 1.1% annual rate for the last three months of the year, a period when China's gross domestic product surged 9.8% from a year earlier. With those figures, Japan's full-year GDP was $5.47 trillion—about 7% smaller than the $5.88 trillion China reported in January.

Both still remain considerably smaller than the American economy. Japan and China combined are still worth less than the U.S.'s 2010 GDP of $14.66 trillion. But the news marks the end of era. For nearly two generations, since overtaking West Germany in 1967, Japan stood solidly as the world's No. 2 economy. The new rankings symbolize China's rise and Japan's decline as global growth engines.

For the U.S., while Japan was in some ways an economic rival, it also has been a geopolitical and military ally. China, however, is a potential challenger on all fronts.

China's ascent has been the main source of popular legitimacy for the ruling Communist Party. But Beijing worries that the mantle of economic titan comes with unwanted obligations for a country still in many ways poor. "China Surpassing Japan to Become World's Second Biggest Economy—But Not the Second Strongest," said the headline on a recent article on the website of the People's Daily, the party's flagship newspaper.

The Long Rivalry

China passed Japan in 2010 to become the world's second-largest economy after the U.S. Compare the two economies over the past 50 years.

View Interactive


In Japan, the moment is seen as another marker of an extended weakening. "It's only natural that Japan would be overtaken considering China's ballooning GDP and larger population," Tokyo Gov. Shintaro Ishihara told reporters recently. The outspoken nationalist was once the proud voice of a cocky nation, co-authoring the bubble-era 1989 book, "The Japan That Can Say 'No.'" Now, he talks about his country's standing with a tinge of sadness. "It's just unfortunate that various other signs of Japan's decline stand out so much against that backdrop."

The complex reactions in both countries reflect the fact that China still lags behind Japan in many respects—and the reality that their growing interdependence makes them partners as much as rivals.

A Historical Shift

Take a look at major events in Japan and China over the past decades.

View Slideshow



China's per capita income is still only a tenth of Japan's. The World Bank estimates that more than 100 million Chinese citizens—nearly the size of Japan's entire population—live on less than $2 a day. Robin Li, chief executive of Chinese Internet search giant Baidu Inc. notes: "There's still the undeniably awkward fact that China still has yet to produce an enterprise with truly global influence commensurate with China's rising power," such as Toyota Motor Corp. or Sony Corp.

As many Japanese business leaders note, Japan's economy would have been even weaker without exports to China and an influx of Chinese tourists. China surpassed the U.S. as Japan's largest trading partner in 2009. "I expect China's GDP to be double Japan's" in about eight years, said 53-year-old Masayoshi Son, spokesman for a new generation of Japanese leaders as CEO of Softbank Corp., which has managed to grow amid the country's decline. China's rise also presents an opportunity: "If more Japanese companies also viewed this situation as something positive, Japan's economic prospects would also brighten up."

Japan's economy minister Kaoru Yosano on Monday welcomed the Chinese ascendancy to No. 2. "For a neighbor country like us, it is something to celebrate that the Chinese economy is making a leap forward," the minister said. He called China's expansion "one of the cornerstones for simultaneous growth in the region."

Still, there are clear strains, with historical tension lingering from Japan's brutal wartime occupation, and China flexing newfound muscle against a weakened neighbor. The recent defining moment: last fall's standoff over disputed islands near Taiwan, ending in Japan's sudden release of an arrested Chinese fishing captain under pressure from Beijing, despite video evidence that the captain had violently charged a Japanese coast guard vessel.

The contrasting outlooks of an ascendant China and a declining Japan was evident in Nielsen Co.'s latest international consumer confidence survey of 52 countries released last month. Chinese consumers were among the most optimistic, with a "confidence index" of 100, compared with the global average of 90. Japan's consumers tied with Romania's for fourth most pessimistic, with an index of 54. (Americans stood between the two, with an index of 81.)

For Beijing, being No. 2 means, among other things, new clout. China has trumpeted its willingness to use its $2.85 trillion hoard of foreign-exchange reserves to help stabilize struggling countries such as Greece by purchasing their bonds. Officials have chastised Washington for monetary policies they say could endanger the value of China's massive holdings of U.S. government debt.

But Beijing also suspects that developed countries want to use its rise to foist on it greater responsibilities in areas like carbon-emissions reduction and currency policy. When China's GDP passed Japan's on a quarterly basis last summer, official media outlets ran commentaries rebutting what they called "China responsibility theories" in the West exaggerating the country's global role. The theories, one Chinese expert told the Xinhua news agency, "are fabricated to slow down and check China's development."


At home, the rise to No. 2 complicates the Communist Party's national narrative, steeped in a sense of victimhood at the hands of foreign powers—not least 1930s Japan—that China is now overtaking. Party leaders are aware that China's image as an economic powerhouse risks calling attention to the shortcomings of a country both powerful and poor.

So the government takes credit for China's economic accomplishment while playing it down. When the National Bureau of Statistics reported China's 2010 GDP last month, director Ma Jiantang was asked about the looming No. 2 milestone. The rise "is the result of hard struggle and continuous progress of the Chinese people under the leadership of the Communist Party," he said—adding that China remains one of the world's poorer countries on a per capita basis.

The official ambivalence is mirrored in China's public reaction. "There might be people feeling thrilled about this, but I'm not one of them," said Zheng Maohua, a 65-year-old retired government official in Beijing. The GDP landmark "can't reflect the true situation of this society," which he described as "rich country, poor people."

In the 1980s and 1990s, Japan faced the same pressures China now fears, of global demands to shoulder extra responsibilities. China's official rise to Asia's top economy takes the spotlight off Tokyo. While still the oldest liberal democracy in East Asia and a cornerstone of the U.S. defense umbrella, Japan no longer faces the same pressure from Western peers to exercise "checkbook diplomacy" or open its markets—even though Japan's trade surpluses with the U.S. remain high.

Some Japanese elites are wistful for those demands. "Some of us look back to the era of Japan-bashing with nostalgia," says Takatoshi Ito, an economics professor at Tokyo University and a former top finance ministry official. "We were frustrated back then, but ignored is worse than being bashed."

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For others, the debate is on to define Japan's role and image for the era of No. 3. One influential Japanese ruling-party politician, Renho, who uses only one name, touched a nerve last year with her book titled "Do We Have to Be No. 1?" It encouraged Japanese to take comfort in the notion that Japan need not be a leader in everything—or anything—to be considered successful.

Japan now is more focused on different, less-quantitative, ways of defining success. Its influence abroad remains extensive, and in some ways has grown. But it is more low-key, less directed in contentious areas of strategic technology and more in the realm of cultural diplomacy.

The notion of Japan as a center of creativity and innovation—in hybrid-engine-powered cars or 3-D videogames—contrasts with its image 20 years ago as a copycat that mimicked design and technology pioneered elsewhere, and then outpowered the original makers with superior manufacturing. That label is now attached more to China.

The Ministry of Economy, Trade and Industry—once famous for crafting an industrial policy that helped Japan's manufacturers rule the world— has a new Creative Industries Promotion office designed to spread the appeal of anime cartoons, manga comics and Japanese videogames. "We see it as a matter of quality over quantity," said Motohisa Ikeda, a vice minister for trade, noting Japan's enduring prowess as a maker of high-value-added goods. "Japan is still a wealthy nation in many senses of the word."

— Loretta Chao in Beijing
and Juro Osawa in Tokyo contributed to this article.


Massive Population Lifts Nation's Growth


BEIJING—China's rise as the world's second-largest economy highlights a new postindustrial reality: Population counts as much as productivity in determining economic power.

Since the industrial revolution, that hasn't been the case. The productivity of workers in the U.S., Britain, Germany and Japan not only made those countries rich, but it also made them the world's largest economies despite having far smaller populations than China and India.

China's rapid growth over the past 30 years has pulled hundreds of millions of Chinese out of poverty and turned China into the world's factory floor. But China's per capita gross domestic product is still just $4,300, according to the International Monetary Fund. It is largely because of the country's population of 1.3 billion that China is moving to the top ranks of economic powers.

The Long Rivalry

China passed Japan in 2010 to become the world's second-largest economy after the U.S. Compare the two economies over the past 50 years.

View Interactive


On Monday, it formally surpassed Japan when Japan reported its 2010 GDP.

Look at the arithmetic. China has 11 times Japan's population. That is enough to propel it ahead of Japan in the GDP rankings, despite a per capita income of little more than one-tenth the level of Japan.


China passed Japan in 2010 to become Asia's biggest economy, and the world's second-largest. WSJ's Jake Lee talks to Economics Reporter Alex Frangos about the two country's and what this historic shift means for Asia.

For China to leap ahead of the U.S., which has one-fourth China's population, China needs to boost its per capita GDP to slightly more than one-fourth U.S. levels. Currently, China's per capita income is one-eleventh the level of the U.S.

"For the first time, you have this odd combination—one of the world's largest economies is also one of the world's poorest economies," said Qu Hongbin, an HSBC analyst in Hong Kong.

Whether China eventually passes the U.S. depends on how long China can continue growing much more rapidly than the U.S. Arvind Subramanian, an economist at the Peterson Institute for International Economics, a Washington think tank, figures this will occur around 2030, though others are cautious. Harvard economist Kenneth Rogoff said it is tough to predict because many poor countries trip up along the way, often because of banking crises.

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In the 1980s, economists predicted Japan would overtake the U.S., but as its economy has stagnated it has fallen further behind the U.S. since 1990.

It is extraordinarily difficult for poor countries to climb into the top ranks of world economic powers. The IMF classifies 33 economies as "advanced." Of those, only four non-European economies—Singapore, South Korea, Taiwan and Hong Kong—were poor before World War I. Another, Israel, didn't exist in 1914. One country that would have been considered advanced back then, Argentina, no longer makes the grade because of decades of economic and political mismanagement.

The IMF classifies seven nations as "major" advanced economic powers—the U.S., Canada, Britain, Germany, France, Italy and Japan—meaning they are rich in per-capita terms and are important economic powers. All would have been on a similar list before the assassination of Archduke Ferdinand.


WSJ Assistant Managing Editor John Bussey is joined by Beijing Bureau Chief Andrew Browne and Tokyo Bureau Chief Jacob Schlesinger to discuss China overtaking Japan as the world's #2 economy.

China is classified as an "emerging and developing" nation—again reflecting its duality as a poor nation when measured in terms of individuals, and a rich one when all those individuals are added together.

The industrial revolution pushed European nations and, somewhat later, Japan to the top of the economic heap. They added to their wealth by colonizing China, India and other nations in Asia and Africa for their resources, labor and markets. "If you were the biggest, strongest economy and you weren't the richest, you'd rectify that by conquering the others and taking their wealth," said Mr. Rogoff.

Toward the end of the 19th century, Britain and Germany were the world's largest economies. But by 1900, the U.S. had become No. 1, said H.W. Brands, a U.S. historian and professor at the University of Texas at Austin, as the country's greater population, natural resources and industrial productivity propelled it ahead of individual European nations. "There was a vogue for thinking in terms of a westering trend in economic history and how the center of gravity of the world economy was moving across the Atlantic from Europe to America," he said.

A Historical Shift

Take a look at major events in Japan and China over the past decades.

View Slideshow



Now, the fast-growing Asian nations are pushing that center of gravity to the east. China's rise to No. 2 matters a lot, even if many of its people remain poor. That is because it has become one of the world's largest traders, creditors and markets for commodities. Its buying and lending decisions shape markets globally. "GDP and size matters in crude superpower terms," said Mr. Subramanian. "It shows what resources you can bring to the table."

The economic power rankings are determined by converting a country's GDP into dollars at market exchange rates. That is seen as the best indicator, because it suggests what a country or its companies could buy in the international market, whether it is steel or stealth aircraft parts.

There is another GDP measure, called purchasing power parity, or PPP. In that calculation, adjustments are made to reflect the difference in prices for goods and services in different countries. A haircut may cost $1 in Beijing and $10 in Boston, though the differences between the two countries may be much less if you compare the cost of a haircut to a worker's paycheck. Essentially, PPP numbers try to reflect the differences in costs of living and tend to boost the economic rankings of poorer nations. By that measure, China passed Japan as No. 2 in 2001, according to International Monetary Fund statistics. Mr. Subramanian calculates that China's GDP as measured by purchasing power has already edged ahead of the U.S.'s, though the IMF doesn't expect that to happen before 2016.

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College graduates wait to enter a job fair in Yantai, in Shandong province, as police watch over the crowd.


To William Easterly, a New York University development economist, all the rankings are "a little bit absurd," because they simply reflect the different sizes of the population. "If you have a larger economy because you have a larger population," he said, "you could say, 'Why did it take you so long' " to catch up? By comparison, India, with a population almost as large as China's, has only started gaining on rich countries since the early 1990s, as a result of economic reforms there.

But Arthur Kroeber, managing director of GaveKal Dragonomics Research in Beijing, said the No. 2 ranking may have an important psychological effect in China, where many continue to view the country as poor and believe it bears little responsibility for international affairs. In trade negotiations and international financial summitry, for instance, China often plays a peripheral role. The U.S. and Western Europe generally continue to set the global agenda. "When you're the No. 2 country in the world, you can't make the argument any longer" that China can be a follower, Mr. Kroeber said."From an economic diplomacy standpoint, there's no place to hide."

More and more, China is asserting its economic power, he noted, by agreeing to finance infrastructure and other projects in Africa, Latin America and Central Asia in exchange for a secure stream of oil, food and coal.

Although the U.S. views some of these deals with alarm because it worries that China may lock up natural resources that should be freely traded, it has also been working hard to get the IMF and World Bank to change their voting schemes to give China a larger voice. As the No. 2 economic power, U.S. officials say, China should play a big role in any revamping of the global economic system, so it feels it has a stake in the outcome.

Write to Bob Davis at bob.davis@wsj.com







The Misleading Metaphor of Decline

Rome remained dominant for more than three centuries after the apogee of Roman power.


Is the United States in decline? Many Americans think so, and they are not alone. A recent Pew poll showed that pluralities in 13 of 25 countries believe that China will replace the U.S. as the world's leading superpower. But describing the future of power as inevitable American decline is both misleading and dangerous if it encourages China to engage in adventurous policies or the U.S. to overreact out of fear.

How would we know if the declinists are correct or not? First, one must beware of misleading metaphors of organic decline. Nations are not like humans with predictable life spans.

After Britain lost its American colonies at the end of the 18th century, Horace Walpole lamented Britain's reduction to "as insignificant a country as Denmark or Sardinia." He failed to foresee that the industrial revolution would give Britain a second century of even greater ascendancy. Rome remained dominant for more than three centuries after the apogee of Roman power.

It is also chastening to remember how wildly exaggerated were American estimates of Soviet power in the 1970s and of Japanese power in the 1980s. Today some confidently predict the 21st century will see China replace the U.S. as the world's leading state, while others equally confidently argue that the 21st century will be the American century. A fair assessment is difficult because there is always a range of possible futures.

On American power relative to China, much will depend on the often underestimated uncertainties of future political change in China. China's size and high rate of economic growth will almost certainly increase its relative strength vis-a-vis the U.S. This will bring it closer to the U.S. in power resources, but doesn't necessarily mean that it will surpass the U.S. as the most powerful country.

Even if China suffers no major domestic political setback, many current projections are based simply on GDP growth. They ignore U.S. military and soft-power advantages, as well as China's geopolitical disadvantages in Asia. America is more likely to enjoy favorable relations with its neighbors, allies like Europe and Japan, as well as India and others.

My best estimate is that, among the range of possible futures, the more likely is one described by Lee Kuan Yew as China giving the U.S. "a run for its money," but not passing it in overall power in the first half of this century.

Looking back at history, the British strategist Lawrence Freedman notes two features that distinguish the U.S. from the dominant great powers of the past: American power is based on alliances rather than colonies, and it is associated with an ideology that is flexible and to which America can return even after it has overextended itself. Looking to the future, Anne-Marie Slaughter of Princeton argues that America's culture of openness and innovation will keep it central in an information age when networks supplement, if not fully replace, hierarchical power.

On the question of absolute rather than relative American decline, the U.S. faces serious problems in areas like debt, secondary education and political gridlock. But solutions exist. Among the possible negative futures are ones in which the U.S. overreacts to terrorist attacks by closing inwards and thus cuts itself off from the strength that it obtains from openness.

But there are answers to major American problems that preoccupy us today, such as long-term debt (see the recommendations of recent deficit commissions) and political gridlock (for example, changes in redistricting procedures to reduce gerrymandering). Such solutions may remain forever out of reach, but it is important to distinguish situations where there are no solutions from those that could in principle be solved.

America is likely to remain more powerful than any single state in the coming decades. At the same time, we will certainly face a rise in the power resources of many others—both states and nonstate actors. We will also face an increasing number of issues to which solutions will require power with others as well as power over others. Our capacity to maintain alliances and create networks will be an important dimension of our hard and soft power.

Rather than succumb to self-fulfilling prophecies of inevitable decline, we need a vision that combines domestic reforms with smart strategies for the international deployment of our power in an information age.

Mr. Nye is a professor at Harvard and author of "The Future of Power" (Public Affairs, 2011).


Be My Valentine—With Back Up

The current norm is that the male must convert two months of after-tax income into special property for his fiancée.


When we set aside the carnations and candy hearts, Valentine's Day is fundamentally about reproduction. The event flourished during a sexual period very different than our own. But despite appearances of traditional morality, parish and similar records show that at the turn of the last century between one-third and one-half of all marriages occurred during a pregnancy.

On Valentine's Day, the infant Cupid—infant!—informs a potentially indifferent or recalcitrant male that he is "the one." More elegant than the old shotgun, Cupid's arrow points to the male presumed to be the father of the oncoming or projected child.

Whatever the seeming frivolity of the day, it pivots on very serious business: The choice of a mate with whom to carry on the next generation of the species.

It's the female who makes the fundamental choice. The peacocks may flail their gorgeous feathers, but it's the dull peahen who decides which of the posturing lot is healthiest and most likely to provide the necessary goods and services to support the trying matter of bearing and raising offspring.

Same with humans. Exclude romantic sentiment for a moment: The applicant for a woman's hand in marriage had better have some promise of resources—"prospects" in the terminology of Victorian novels and public television drama. The principal function of kinship systems is to protect the bond between mother and child from the vagaries between males and females. Assets help, which is why in our catch-as-catch-can-society it became an effective strategy for a female of a certain class to expect a guarantee of a man's commitment in the form of an utterly useless asset called the engagement ring. The current norm is that the male must convert two months of after-tax income into this special property for his fiancée.

Be my Valentine—with back up.

Getty Images

The biological bottom line is that it is the woman's responsibility to secure an acceptable long-term partner. Her stakes could not be higher. Marriage as an institution has largely been a means of protecting her (and often restricting her, too). And while marriage is by no means a romantic walk on the beach, it gets children raised and life goes on.

Then why the astonishing fact that 40% of babies born in the industrial world are to unmarried women? Of course, many such children are the result of loving and stable relationships; formal marriage need not be the core of raising kids. Still, the figure is dazzling. Why is it so high?

One reason is that many men are "unwilling to commit." But the likelier explanation is that 40% of women do not think the candidates available to them are worth the time and trouble. The ever-increasing disparity between females and males in terms of education and achievement has curtailed the available choices for affluent, well- educated females.

Our system increasingly favors females. In countless American colleges, the first day of classes involves a rape seminar—largely to please the lawyers, no doubt—which stigmatizes men as potential predators and women as victims. The back of every women's bathroom door at Colby College provides a list of things to do surrounding rape; first-year females at Brown are given a whistle to use when rape threatens.

Historically, women prefer to marry men who are slightly older and wealthier than they are, if for no other reason than to have an available breadwinner during the five to eight years the average mother withdraws partially or entirely from the labor force. And 85% of women have children, which explains the factoid that women earn 77% to the male dollar. It's accurate only in the literal sense, since women are forgoing annual increases for significant years or electing to take part-time jobs to raise kids.

Women can control their reproductive lives, which is as it should be. But to coin a phrase, men are becoming alienated from the means of reproduction, which presumably no one wants.

Is there anything to be done to reverse this trend? A good first step is for women to ease up on the patriarchy yammer, especially when it comes to romance: Ideology has no place in the nation's bedrooms.

For their part, men need to appreciate that female partners view relationships as of greater consequence and meaning than men do. And it's robust, timely and essential that they do so. These days, Cupid needs longer than a day (and night).

Mr. Tiger, a professor of anthropology at Rutgers, is the author of "The Decline of Males" (St. Martins, 2000) and, with Michael McGuire, of "God's Brain" (Prometheus Books, 2010).


China's Trade-off

It could keep its industrial policies and its slow pace of trade reforms. Or it could become a real global leader.


It is almost a decade since China joined the World Trade Organization. Back then, China imported "global order": it absorbed pre-existing, mainly U.S.-designed policies, rules and institutions. It acted rather like a small or medium-sized economy that could only adapt to the international terms of trade. Now China is one of the Big Three, alongside the U.S. and European Union. It is the world's second-largest economy and its leading exporter of goods. It is also the biggest post-crisis contributor to global growth.

In line with its growing economic size, Beijing wants to influence international prices and shape global rules. But that will require significant changes in the ways Beijing thinks about economic policy, and Beijing has resisted those changes to date. This creates uncertainty and instability for China and the rest of the world, and has implications for other leaders looking to China to play a constructive role in global economic matters.

Global trade issues best reveal China's policy shift, and also its policy dilemma. China's membership of the WTO has been a resounding success. Access to the WTO's rules-based system and dispute-resolution process has defused manifold tensions and smoothed China's rapid integration into the global economy. Beijing also has negotiated bilateral or regional free-trade agreements such as the one with the Association of Southeast Asian Nations.

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AFP/Getty Images

Liberalization under Wen Jiabao has been much more cautious.


But China also has been a conspicuously passive and marginal player in the Doha Round of talks to further liberalize global trade. Its default position is still to react, leaving other big players to take initiatives. And its FTAs tend to be fairly weak. Whereas, for instance, South Korea's FTAs with the U.S. and EU represent comprehensive liberalization in trade between major partners, Beijing's pact with Asean only eliminates tariffs; it hardly, if at all, tackles regulatory barriers to trade in goods and services, investment and public procurement. Other Chinese FTAs, such as its agreement with Pakistan, don't even eliminate most tariffs.

Meanwhile, China's historic opening to the world economy has stalled since about 2006. There has been paltry unilateral liberalization beyond China's WTO commitments. The leadership of President Hu Jintao and Premier Wen Jiabao is much more cautious than that of their predecessors Jiang Zemin and Zhu Rongji. Anti-liberalization interests—some ministries, regulatory agencies and resurgent state-owned enterprises (SOEs)—have grown more powerful. Despite, or perhaps because of, China's growing clout, it is unwilling to open markets unilaterally and haggles hard over reciprocal concessions.

Beijing's stalled liberalization is also of a piece with greater industrial-policy intervention, aimed to promote a core of about 50 SOEs, mainly in "strategic" manufacturing and resource-based sectors, and a handful of state-owned banks that dominate the financial system. China's response to the global financial crisis—a supercharged fiscal and monetary stimulus—bolstered the public sector and state power at the expense of the far-less-subsidized private sector. Beijing's frequent recourse to command-and-control mechanisms such as price controls to fight inflation makes market reform harder.

Protectionist trade policy and dirigiste industrial policy meet at several junctions. Export restrictions—most conspicuously on rare-earth metals—have increased. Tax incentives, subsidies and price controls, as well as administrative "guidance" on investment decisions, are used to favor domestic goods over imports. China-specific standards, such as on third-generation mobile phones, can create high compliance costs for foreign enterprises. Services barriers, notably in financial and telecommunication services, have come down very slowly, if at all.

Foreign-investment restrictions have been tightened in a range of sectors where SOEs operate, such as iron and steel, petrochemicals, coal, biofuels, news websites, audiovisual and Internet services. Discriminatory government procurement, in the guise of promoting "indigenous innovation," favors domestic companies. Joint-venture and technology-transfer requirements on foreign companies promote national champions in high-speed rail, electric cars and renewable-energy sectors. Finally, "investment nationalism" extends to China's Go Out policy: Resource-based SOEs in particular are buying up foreign assets with cheap capital provided by state-owned banks.

The problem is that this policy mix is incompatible with global economic leadership at a time when China has little choice but to become a global leader. Beijing can't expect its trading partners to accept indefinitely a flood of Chinese exports without opening its own market to their goods. Hence it is in China's own interests to restrain industrial-policy activism and its protectionist spillover. And it should proceed with "WTO-plus" reforms that move beyond the letter of its accession commitments. It could further reduce applied import tariffs, especially on industrial goods. It should reverse export controls on raw materials and agricultural commodities.

China's more substantial challenge is to tackle high trade-related domestic regulatory barriers in goods, services, investment and public procurement. These measures should be hitched firmly to domestic reforms to improve the business climate and to "rebalance" the economy—to make it more consumption- and less investment-oriented, with more freedom for the private sector and less public-sector control.

Most of this wish list is not on Beijing's agenda. Leaders are not minded to curtail industrial policy and proceed with reforms beyond their WTO commitments. The latter would mean not merely liberalizing product markets but also reforming highly controlled markets for factors of production like land and capital and for energy inputs like oil, water and electricity. Those lie at the heart of domestic economics and politics. The reforms China most needs now cut to the core of the Communist Party-government-public sector nexus and its grip on power. It is unlikely to happen soon.

The story is not necessarily as grim as might at first appear. Earlier liberalization has left China so deeply integrated into global supply chains that it can't afford to move too far backward on reforms, and Beijing increasingly can't afford to stand still either as it endeavors to deliver steadily rising prosperity. But until it finds a way to break this impasse, China will be limited in its ability to exercise meaningful global leadership. This fact calls for some humility from Chinese leaders who otherwise appear increasingly assertive on the world stage, and for realism from foreign leaders who wish China would exercise a greater leadership role at international forums like the International Monetary Fund, the WTO and the G-20.

Mr. Sally is director of the European Centre for International Political Economy and on the faculty of the London School of Economics.






Where and What Is U.S. Trading Internationally?

The Commerce Department reported today that U.S. trade rebounded strongly in 2010. The following charts detail who we’re trading with, and what we’re trading.








White House Expects Deficit to Spike to $1.65 Trillion


WASHINGTON—The White House projected Monday that the federal deficit would spike to $1.65 trillion in the current fiscal year, the largest dollar amount ever, adding pressure on Democrats and Republicans to tackle growing levels of debt.

The projected deficit for 2011 is fueled in part by a tax-cut extension that President Barack Obama and Republican lawmakers brokered in December, two senior administration officials said. It would equal 10.9% of gross domestic product, the largest deficit as a share of the economy since World War II.

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Associated Press

Willow Wimbush, left, and Nancy Harris, work on copies of the Appendix of the fiscal 2012 federal budget on Thursday at the U.S. Government Printing Office in Washington.



The new estimate is part of Mr. Obama's proposed budget for fiscal year 2012, which becomes public Monday morning.

Mr. Obama is proposing $3.73 trillion in government spending in the next fiscal year, part of a plan that includes budget cuts and tax increases that administration officials believe will sharply bring down the federal deficit over 10 years.

The deficit would decline in fiscal year 2012 to $1.1 trillion, or 7% of gross domestic product, under Mr. Obama's plan, as a year-long payroll tax holiday and an extension of federal jobless benefits expired, administration officials said. By 2017, the budget plan says, the deficit would be shaved to $627 billion, or 3% of gross domestic product.

Senior administration officials said the new budget would address concerns about the country's long-term fiscal challenges while spending more money on education and research programs that the administration says are needed to boost economic growth.

But Mr. Obama's plan is likely to be rewritten by Republicans who control the House, as proposed spending cuts in his budget fall short of the reductions congressional Republicans are seeking.

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Barack Obama is proposing $3.73 trillion in government spending in the next fiscal year.


Even before turning to Mr. Obama's plan for fiscal year 2012, which begins Oct. 1, lawmakers are battling over levels of government spending for the remainder of fiscal year 2011, which House lawmakers will debate this week.

"We're very eager to work with Republicans to cut spending and reduce our deficit," a senior administration official said Sunday night.

At $1.65 trillion, the administration's projection for the 2011 deficit is significantly larger than the $1.48 trillion estimated by the non-\partisan Congressional Budget Office a few weeks ago. In fiscal year 2010, the deficit was $1.29 trillion.

White House officials believe their budget proposal would shave $1.1 trillion off of accumulated federal deficits over 10 years, which they believe would push levels of federal spending into a healthier balance.

That would be less than the $4 trillion in reductions the White House's deficit-reduction commission proposed in December, but it's still a level administration officials believe is achievable and sustainable.

The budget wouldn't do much, though, to arrest a future spike in the projected costs of Medicare, Medicaid, and Social Security. Mr. Obama has said he's open to making changes in these programs, but he wants cooperation from Republicans before he will begin.

The savings in the budget come from a combination of spending cuts and increases in revenue. A five-year freeze on non-defense discretionary spending would save more than $400 billion over 10 years, the administration says.

The White House, in its plan for 2012, reduces certain programs to save an additional $33 billion. This includes more than $2 billion in cuts to travel, printing, supplies and other overhead costs. The plan also would cut more than $1 billion in grants to large airports and $950 million to revolving funds for state water treatment plants, among other things.

The proposed budget seeks to prevent many middle-class Americans from being subjected to the Alternative Minimum Tax, which would raise their tax bills, for three years starting in fiscal 2012. To cover the cost, the administration would put new limits on the ability of the wealthiest earners to utilize tax deductions to lower their tax burden, among them deductions for charitable contributions and mortgage interest.

The Alternative Minimum Tax was designed to ensure that wealthier earners do not use deductions to avoid most or all taxes. Lawmakers in both parties want to find a long-term solution that limits its growing reach into middle-class households. But Republicans are unlikely to agree to what, in effect, is a tax increase on wealthier Americans to pay the cost of doing so..

The budget will also propose averting scheduled reductions in payments to doctors who treat Medicare patients for the next two fiscal years, at a cost of $62 billion over 10 years. To cover the cost, savings would be found by making improvements in the health care delivery system that weren't detailed by administration officials.

The White House will propose cutting 12 tax breaks to oil, gas and coal companies, which it projected will raise $46 billion in revenue over 10 years.

The budget calls for $148 billion in overall spending on research and development, which includes $32 billion in biomedical research at the National Institutes of Health. It would create 20 new Economic Growth Zones, providing tax incentives meant to attract investors and employers in hard-hit economic areas.

The tax deal agreed to by the president and congressional Republicans in December extended all current tax rates for two years, continued an expanded federal jobless benefits program for a year, and exempted most Americans from having to pay payroll taxes for a year. When it was signed into law, it was estimated the compromise would cost more than $850 billion over the next decade.

Write to Damian Paletta at damian.paletta@wsj.com and Corey Boles at corey.boles@dowjones.com


Information technology and economic change: The impact of the printing press

Jeremiah Dittmar
11 February 2011


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Despite the revolutionary technological advance of the printing press in the 15th century, there is precious little economic evidence of its benefits. Using data on 200 European cities between 1450 and 1600, this column finds that economic growth was higher by as much as 60 percentage points in cities that adopted the technology.

“Printing, lately invented in Mainz, is the art of arts, the science of sciences. Thanks to its rapid diffusion the world is endowed with a treasure house of wisdom and knowledge, till now hidden from view. An infinite number of works which very few students could have consulted in Paris, or Athens or in the libraries of other great university towns, are now translated into all languages and scattered abroad among all the nations of the world”. --Werner Rolewinck (1474)

The movable type printing press was the great revolution in Renaissance information technology and arguably provides the closest historical parallel to the emergence of the internet (see the recent column on this site, van Zanden 2010).

The first printing press was established around 1450 in Mainz, Germany. Contemporaries saw the technology ushering in dramatic changes in the way knowledge was stored and exchanged (Rolewinck 1474). But what was the economic impact of this revolution in information technology? By lowering the cost of disseminating ideas, did the explosion of print media erode the importance of location?

A puzzle

Historians argue that the printing press was among the most revolutionary inventions in human history, responsible for a diffusion of knowledge and ideas, “dwarfing in scale anything which had occurred since the invention of writing” (Roberts 1996, p. 220). Yet economists have struggled to find any evidence of this information technology revolution in measures of aggregate productivity or per capita income (Clark 2001, Mokyr 2005). The historical data thus present us with a puzzle analogous to the famous Solow productivity paradox – that, until the mid-1990s, the data on macroeconomic productivity showed no effect of innovations in computer-based information technology.

New city-level data

In recent work (Dittmar 2010a), I examine the revolution in Renaissance information technology from a new perspective by assembling city-level data on the diffusion of the printing press in 15th-century Europe. The data record each city in which a printing press was established 1450-1500 – some 200 out of over 1,000 historic cities (see also an interview on this site, Dittmar 2010b).The research emphasises cities for three principal reasons.

  • First, the printing press was an urban technology, producing for urban consumers.
  • Second, cities were seedbeds for economic ideas and social groups that drove the emergence of modern growth.
  • Third, city sizes were historically important indicators of economic prosperity, and broad-based city growth was associated with macroeconomic growth (Bairoch 1988, Acemoglu et al. 2005).

Figure 1 summarises the data and shows how printing diffused from Mainz 1450-1500.

Figure 1. The diffusion of the printing press

The association between printing and city growth

City-level data on the adoption of the printing press can be exploited to examine two key questions:

  • Was the new technology associated with city growth?
  • And, if so, how large was the association?

I find that cities in which printing presses were established 1450-1500 had no prior growth advantage, but subsequently grew far faster than similar cities without printing presses. My work uses a difference-in-differences estimation strategy to document the association between printing and city growth. The estimates suggest early adoption of the printing press was associated with a population growth advantage of 21 percentage points 1500-1600, when mean city growth was 30 percentage points. The difference-in-differences model shows that cities that adopted the printing press in the late 1400s had no prior growth advantage, but grew at least 35 percentage points more than similar non-adopting cities from 1500 to 1600.

Diffusion of the new technology

Printing presses were not set down at random across European cities. Cities that adopted the printing press 1450-1500 subsequently enjoyed unusual dynamism. Did printers simply pick locations that were already bound for growth? This question can be addressed by exploiting supply-side constraints that limited the diffusion of the technology over the infant industry period.

The movable type printing press was developed by Johannes Gutenberg and his business partners in Mainz, Germany around 1450. Printing was from the outset a for-profit enterprise. But over the period 1450-1500, technical barriers limited entry on the supply side.

The key innovation in printing – the precise combination of metal alloys and the process used to cast the metal type – were trade secrets. The underlying knowledge remained quasi-proprietary for almost a century. The first known “blueprint” manual on the production of movable type was only printed in 1540. Over the period 1450-1500, the master printers who established presses in cities across Europe were overwhelmingly German. Most had either been apprentices of Gutenberg and his partners in Mainz or had learned from former apprentices. Thus a limited number of printers brought the technology from Mainz to other cities.

The restrictions on diffusion meant that cities relatively close to Mainz were more likely to receive the technology other things equal. Printing presses were established in 205 cities 1450-1500, but not in 40 of Europe’s 100 largest cities. Remarkably, regulatory barriers did not limit diffusion. Printing fell outside existing guild regulations and was not resisted by scribes, princes, or the Church (Neddermeyer 1997, Barbier 2006, Brady 2009).

An instrumental-variable approach

Historians observe that printing diffused from Mainz in “concentric circles” (Barbier 2006). Distance from Mainz was significantly associated with early adoption of the printing press, but neither with city growth before the diffusion of printing nor with other observable determinants of subsequent growth. The geographic pattern of diffusion thus arguably allows us to identify exogenous variation in adoption. Exploiting distance from Mainz as an instrument for adoption, I find large and significant estimates of the relationship between the adoption of the printing press and city growth. I find a 60 percentage point growth advantage between 1500-1600.

The importance of distance from Mainz is supported by an exercise using “placebo” distances. When I employ distance from Venice, Amsterdam, London, or Wittenberg instead of distance from Mainz as the instrument, the estimated print effect is statistically insignificant.

Positive spillovers

Cities that adopted print media benefitted from positive spillovers in human capital accumulation and technological change broadly defined. These spillovers exerted an upward pressure on the returns to labour, made cities culturally dynamic, and attracted migrants.

In the pre-industrial era, commerce was a more important source of urban wealth and income than tradable industrial production. Print media played a key role in the development of skills that were valuable to merchants. Following the invention printing, European presses produced a stream of math textbooks used by students preparing for careers in business. The first known printed mathematics text is the Treviso Arithmetic (1478). It begins:

“I have often been asked by certain youths...who look forward to mercantile pursuits, to put into writing the fundamental principles of arithmetic...Here beginneth a Practica, very helpful to all who have to do with that commercial art.”1

The first Portuguese arithmetic (1519) opens in similar fashion:

“I am printing this arithmetic because it is a thing so necessary in Portugal for transactions with the merchants of India, Persia, Ethiopia, and other places.”2

These and hundreds of similar texts worked students through problem sets concerned with calculating exchange rates, profit shares, and interest rates.

Broadly, print media was also associated with the diffusion of cutting-edge business practice (such as book-keeping), literacy, and the social ascent of new professionals – merchants, lawyers, officials, doctors, and teachers.

Local effects in a world with trade

Cities with printing presses enjoyed special advantages. Two key factors explain the localisation of positive spillovers.

  • First, positive spillovers were localised by high transport costs historically associated with inter-city trade. Print media was especially costly to transport because it was heavy and sensitive to damp. This limited the diffusion of print media. According to Flood (1987, p.25), “Outside the towns where books were printed or which were main centres of the burgeoning book trade the public were dependent on what itinerant traders offered them and on word of mouth.” As a result, shadow prices were often exceedingly high in cities without printing presses. Moreover, transport costs fostered co-agglomeration. The printing press attracted paper mills, illuminators, translators, students, and schools.
  • The second factor behind the localisation of spillovers is intriguing given contemporary questions about the impact of information technology. The printing press made it cheaper to transmit ideas over distance, but it also fostered important face-to-face interactions. The printer’s workshop brought scholars, merchants, craftsmen, and mechanics together for the first time in a commercial environment, eroding a pre-existing “town and gown” divide. The technology produced not just books, but also in the printer-scholar, “a ‘new man’...adept in handling machines and marketing products even while editing texts, founding learned societies, promoting artists and authors, [and] advancing new forms of data collection” (Eisenstein 1979, 250-251). These effects transformed intellectual and business landscapes at the local level.

Information technology, cities, and capitalism

The printing press was one of the greatest revolutions in information technology. The impact of the printing press is hard to identify in aggregate data. However, the diffusion of the technology was associated with extraordinary subsequent economic dynamism at the city level. European cities were seedbeds of ideas and business practices that drove the transition to modern growth. These facts suggest that the printing press had very far-reaching consequences through its impact on the development of cities.


Acemoglu, Daron, Simon Johnson, and James Robinson (2005), “The Rise of Europe: Atlantic Trade”, American Economic Review, 95:546-579.

Bairoch, Paul (1988), Cities and Economic Development, Chicago; University of Chicago.

Barbier, Frédéric (2006), L’Europe de Gutenberg: Le Livre et L'Invention de la Modernité Occidentale, Belin.

Brady, Tom (2009), German Histories in the Age of Reformations, 1400-1650, Cambridge University Press.

Clark, Gregory (2001), “The Secret History of the Industrial Revolution”, UC Davis working paper..

Dittmar, Jeremiah (2010a), “Information Technology and Economic Change: The Impact of the Printing Press”, forthcoming at Quarterly Journal of Economics.

Dittmar, Jeremiah (2010b), “Information technology and economic change: The impact of the printing press”, VoxEU.org interview by Romesh Vaitilingam, 1 October.

Eisenstein, E (1979), The Printing Press as an Agent of Change: Communications and Cultural Transformations in Early-Modern Europe, Cambridge University Press.

Febvre, Lucien and Henri Martin (1958), L’Apparition du Livre, Albin Michel.

Glaeser, Edward and Albert Saiz (2003), “The Skilled City”, NBER Working Paper No. 10191.

Mokyr, Joel (2005), “The Intellectual Origins of Modern Economic Growth”, Journal of Economic History, 65(2):285-351.

Neddermeyer, Uwe (1997), “Why were there no riots of the scribes?”, Gazette du livre médiéval, 31:1-8.

Roberts, John (1996), A History of Europe, Penguin.

Rolewinck, Werner (1474), Fasciculus Temporum (Cologne), quoted in Febvre and Martin (1958).

Swetz, F (1987), Capitalism and Arithmetic: The New Math of the 15th Century, La Salle, IL; Open Court.

van Zanden, Jan Luiten (2010), “Before the Great Divergence: The modernity of China at the onset of the industrial revolution”, VoxEU.org, 26 January. 

1 Reproduced in Swetz (1987), p. 40.

2 Cited in Swetz (1987), p. 25.

This article may be reproduced with appropriate attribution. See Copyright (below).




FEBRUARY 12, 2011


Mao's Great Famine and Depraved Indifference

Bryan Caplan



The Author of the Administrati...

Lessons of Smoot-Hawley...

In Mao's Great Famine, Frank Dikötter joins the elite club of historians who live up to their duty to impose "the undying penalty which history has the power to inflict on wrong."  On purely literary terms I still prefer Jasper Becker's Hungry Ghosts, but Dikötter's archival work on the Great Leap Forward is unsurpassed.  His bottom line: The standard horrific body count of 20-30 million deaths from starvation is grossly understated.  The true death toll is much higher - and open violence was an important secondary cause of death:

[A]t least 45 million people perished above a normal death rate during the famine from 1958 to 1962... [I]t is likely that at least 2.5 million of these victims were beaten or tortured to death.

One highlight:

Obsfucation was the communist way of life.  People lied to survive, and as a consequence information was distorted all the way up to the Chairman.  The planned economy required huge inputs of accurate data, yet at every level targets were distorted, figures were inflated and policies which clashed with local interests were ignored.  As with the profit motive, individual initiative and critical thought had to be constantly suppressed, and a permanent state of siege developed.

But how can we convict Mao of mass murder if he was caught in a web of his subordinates' lies?  The answer is simple: Mao's explicit policy of "kill the messenger (after calling him a 'rightist')" makes the whole tragedy an open-and-shut case of what lawyers call depraved indifference murder:

To constitute depraved indifference, the defendant's conduct must be so wanton, so deficient in a moral sense of concern, so lacking in regard for the life or lives of others, and so blameworthy as to warrant the same criminal liability as that which the law imposes upon a person who intentionally causes a crime.

If I were prosecuting Mao, I'd further cover my bases by pointing out that he gave explicit orders to literally enslave hundreds of millions, then invoke the felony murder rule.  However you slice it, Mao was a monster - and it's high time for China to tear down his remaining posters and replace them with monuments to his victims.

FEBRUARY 12, 2011


Mao's Great Famine and Depraved Indifference

Bryan Caplan



The Author of the Administrati...

Lessons of Smoot-Hawley...

In Mao's Great Famine, Frank Dikötter joins the elite club of historians who live up to their duty to impose "the undying penalty which history has the power to inflict on wrong."  On purely literary terms I still prefer Jasper Becker's Hungry Ghosts, but Dikötter's archival work on the Great Leap Forward is unsurpassed.  His bottom line: The standard horrific body count of 20-30 million deaths from starvation is grossly understated.  The true death toll is much higher - and open violence was an important secondary cause of death:

[A]t least 45 million people perished above a normal death rate during the famine from 1958 to 1962... [I]t is likely that at least 2.5 million of these victims were beaten or tortured to death.

One highlight:

Obsfucation was the communist way of life.  People lied to survive, and as a consequence information was distorted all the way up to the Chairman.  The planned economy required huge inputs of accurate data, yet at every level targets were distorted, figures were inflated and policies which clashed with local interests were ignored.  As with the profit motive, individual initiative and critical thought had to be constantly suppressed, and a permanent state of siege developed.

But how can we convict Mao of mass murder if he was caught in a web of his subordinates' lies?  The answer is simple: Mao's explicit policy of "kill the messenger (after calling him a 'rightist')" makes the whole tragedy an open-and-shut case of what lawyers call depraved indifference murder:

To constitute depraved indifference, the defendant's conduct must be so wanton, so deficient in a moral sense of concern, so lacking in regard for the life or lives of others, and so blameworthy as to warrant the same criminal liability as that which the law imposes upon a person who intentionally causes a crime.

If I were prosecuting Mao, I'd further cover my bases by pointing out that he gave explicit orders to literally enslave hundreds of millions, then invoke the felony murder rule.  However you slice it, Mao was a monster - and it's high time for China to tear down his remaining posters and replace them with monuments to his victims.

The Cambodian Case for Dollarization

Phnom Penh should use its stock exchange opening later this year as an opportunity to formally adopt the U.S. dollar.

The government didn't orchestrate this monetary reform; in fact it resisted most of the way. But Cambodians voted with their wallets, shunning the Cambodian riel and demanding dollars.

This is no doubt due to the country's tragic history, which made its people especially aware of the mischief governments can play with currencies and property rights. The same Khmer Rouge that killed one-quarter of the population in the late 1970s also abolished money and title to land. Though the riel came back into circulation in 1979, people preferred to use the Thai baht initially and then, once international aid poured into the country in the early 1990s, the dollar.

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The use of the dollar has soared since then, accounting for 90% of the currency in circulation today and 97% of banking deposits. Most banks don't even lend in riel.

This has brought the country a level of monetary stability it couldn't have achieved on its own. The Asian Development Bank notes that while inflation averaged 56% from 1990-98, it declined to 3.5% for most of last decade—a period the dollar took over.

That in turn created the foundation for greater investor confidence. The financial sector deepened, and foreign direct investment rose to $3.5 billion in 2007 from $38 million in 1990.

Now Cambodia faces an important decision as it prepares to start up a stock market in July. Last month, regulators convened a public workshop to decide whether to denominate stock prices in riel, dollars or both.

Not only would riel listings add costs and confusion in a largely dollarized economy, it would create an additional risk for international investors, driving them away. Instead, Cambodia could use the exchange opening as an opportunity to embark on formal dollarization.

In a neighborhood where governments debase their fiat money—Vietnam devalued the dong by 8.5% last week—Phnom Penh would stand out all the more by making a commitment to stick with the dollar. A stable unit of account for investment as well as trade after all was one key to Hong Kong's transformation from shanty towns to financial center in a single generation. Cambodia also shares Hong Kong's low, flat income tax and few barriers to trade and investment.

The country faces significant problems that Hong Kong never had though, including an autocratic ruler who has undermined civil liberties and the rule of law. But mitigating these shortcomings is part of the reason Cambodians use the dollar in the first place, and the fact that their savings cannot be held captive will gradually strengthen their ability to demand change from their government. Cambodia is providing a fascinating case study in the power of dollarization to promote development in even the most devastated and poverty-stricken of countries.

Printed in The Wall Street Journal, page 9

The ECB's Philosophical Shift

Mr. Weber's departure should make anyone with a stake in the euro nervous.

Axel Weber said on Friday that he'll step down as President of the German Bundesbank. To hear him tell it, his hawkish views disqualified him from getting the top job at the European Central Bank later this year. This turn of events should worry Germans and every European interested in low inflation and a stable euro.

Mr. Weber told Der Spiegel in an interview published Monday that his opposition to the ECB's bond purchases from ailing euro-zone countries "might not have always fostered acceptance of me with some governments." As a result, "since May of last year I have been aware that this would adversely affect a potential [ECB president] candidacy. During this time my conviction to not seek this important office has matured."

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Associated Press

Axel Weber

Mr. Weber has publicly criticized the ECB for buying distressed sovereign bonds to shore up their prices, warning last year that this move was fraught with "substantial stability risks." While the bank's exercise does not seem to have done much to ease the pressure on Greek or Irish sovereign debt, it has left the ECB deeply entrenched in fiscal policy and undermined its independence.

Mr. Weber also says he was isolated at the ECB governing council. "The [ECB] president has a special position, but if he supports a minority opinion on important questions then the credibility of this office suffers," Mr. Weber explained. Unlike the U.S. Federal Reserve, where the chairman can often push through his views, the ECB president governs by consensus.

Governments in Athens, Dublin or Madrid may be cheering that they won't have to deal with Mr. Weber at the helm of the ECB. But his isolation at the governing council and his premature departure suggest a worrisome philosophical shift at the European Central Bank. As a precondition for joining the single currency 12 years ago, Germany rightfully insisted that the Bundesbank's commitment to price stability would also become the European Central Bank's mantra. Mr. Weber's departure is a loss for the euro zone.

In the past year, the euro zone has abandoned the no-bailout clause that once anchored the Continent's single currency, has enmeshed the central bank in buying the bonds of its most spendthrift members, and now has no room for a bank president who would have the currency stay true to its founding principles. A euro zone that Mr. Weber doesn't feel comfortable leading is one that should make anyone with a stake in the success of the single currency nervous.

Printed in The Wall Street Journal, page 11





The ECB's Philosophical Shift

Mr. Weber's departure should make anyone with a stake in the euro nervous.

Axel Weber said on Friday that he'll step down as President of the German Bundesbank. To hear him tell it, his hawkish views disqualified him from getting the top job at the European Central Bank later this year. This turn of events should worry Germans and every European interested in low inflation and a stable euro.

Mr. Weber told Der Spiegel in an interview published Monday that his opposition to the ECB's bond purchases from ailing euro-zone countries "might not have always fostered acceptance of me with some governments." As a result, "since May of last year I have been aware that this would adversely affect a potential [ECB president] candidacy. During this time my conviction to not seek this important office has matured."

View Full Image

Associated Press

Axel Weber

Mr. Weber has publicly criticized the ECB for buying distressed sovereign bonds to shore up their prices, warning last year that this move was fraught with "substantial stability risks." While the bank's exercise does not seem to have done much to ease the pressure on Greek or Irish sovereign debt, it has left the ECB deeply entrenched in fiscal policy and undermined its independence.

Mr. Weber also says he was isolated at the ECB governing council. "The [ECB] president has a special position, but if he supports a minority opinion on important questions then the credibility of this office suffers," Mr. Weber explained. Unlike the U.S. Federal Reserve, where the chairman can often push through his views, the ECB president governs by consensus.

Governments in Athens, Dublin or Madrid may be cheering that they won't have to deal with Mr. Weber at the helm of the ECB. But his isolation at the governing council and his premature departure suggest a worrisome philosophical shift at the European Central Bank. As a precondition for joining the single currency 12 years ago, Germany rightfully insisted that the Bundesbank's commitment to price stability would also become the European Central Bank's mantra. Mr. Weber's departure is a loss for the euro zone.

In the past year, the euro zone has abandoned the no-bailout clause that once anchored the Continent's single currency, has enmeshed the central bank in buying the bonds of its most spendthrift members, and now has no room for a bank president who would have the currency stay true to its founding principles. A euro zone that Mr. Weber doesn't feel comfortable leading is one that should make anyone with a stake in the success of the single currency nervous.

Printed in The Wall Street Journal, page 11







George Osborne's Crony Capitalism

The Chancellor favors a system in which capital is privately owned but its use is directed by politicians.


Last week George Osborne told the British parliament what he has been able to extract from British bankers: They have promised to pay smaller bonuses to their staff, to pay more taxes, and to lend more to "regional" businesses.

The chancellor's speech had a triumphal tone, yet it displayed an alarming ignorance of how banks benefit society and what went wrong before the crisis. Mr. Osborne is moving the relationship between the government and the banking sector in precisely the wrong direction.

Start with his claim that, by getting large British banks to increase the capital they have committed to the "Business Growth Fund" to £2.7 billion from £1.5 billion, they will make "an additional £1.2 billion contribution to society." The idea that, when banks lend, the benefit to society is equal to the amount lent is absurd. Banks are merely conduits between borrowers and lenders. That "additional" £1.2 billion is a transfer from people who lend to banks to people who borrow from them. There is no £1.2 billion contribution to society.

Banks contribute to society by facilitating transfers between lenders and borrowers. Their branches, call centers and websites allow lendable funds to be collected and dispersed. By pooling lenders' funds, banks relieve someone who wants to borrow a given amount for a given period from going to the trouble of finding someone who wants to lend the same amount for the same period. Most importantly, the scale of lending done by banks means they can afford to develop credit-assessment skills that individual lenders cannot. Lending that is intermediated by banks is thus better directed toward sound borrowers.

These are the services that bank customers pay for, and the means by which banks benefit society. Alas, politicians who think that banks benefit society by the simple act of lending are inclined to become hostile to banks' credit-assessment standards. If only the standards were lower, more of that lovely lending would happen.

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European Pressphoto Agency

One way to make banks lower their credit standards is to set targets for lending to the "deserving." In America before the crisis, the supposed deserving were poor people who wanted to own expensive homes. Now, in Britain, the deserving are regional businesses whose commercial prospects are too poor to allow them to borrow. Some say that "perfectly good" businesses cannot now find willing lenders. This is implausible. Why would profit-seeking banks not lend to perfectly good businesses?

When governments force or subsidize banks to lend where they otherwise would not, they are harming society. The money has better alternative uses. That £1.2 billion "contribution to society" engineered by Mr. Osborne is in fact an assault on society, as was the politically directed lending to poor American home buyers.

But this waste is only the start of the problem. Bankers who do Mr. Osborne's bidding—who pay their staff what he says they should, who lend to his favored borrowers, who pay his special taxes without fighting him in the courts—can surely expect his protection in hard times. If Mr. Osborne directs their actions then he cannot let them fall when those actions result in losses.

Indeed, despite his stated desire to ensure that no bank is "too big to fail," Mr. Osborne made it clear last week that his public-spirited friends now have little to fear. In return for their obedience, "the Government commits to the success of a strong, resilient, stable and globally competitive financial services sector," he said. British bankers can be confident that, if they are good children, and comply with new capital regulations, they will always be bailed out. Mr. Osborne has increased the moral hazard in the banking system.

When Mr. Osborne became shadow chancellor, he gave the impression of favoring a market economy. Since becoming chancellor, however, he has changed his position. He now favors the economic system of fascist states in the 1930s, in which capital is privately owned but its use is directed by politicians. Under this system, a business's prospects depend on its relationship with the government. Business people start thinking not about what consumers want but about what politicians want. I predict that, keen to signal that they are in tune with the government's agenda, many British business people will soon be talking about the Big Society.

In last week's statement to parliament, Mr. Osborne said that the British had been let down by "those entrusted by us to regulate bankers and run our economy." If he had stuck to his old liberal principles he would have complained that no one should have been entrusted to "run the economy" in the first place. But now he likes the idea. This is understandable; running the economy must be thrilling for those who do it. But, given the corruption and inefficiency of crony capitalism, it is not so thrilling for the rest of us.

Mr. Whyte is a management consultant and author of "Crimes Against Logic," (McGraw Hill, 2004).

Want to Boost the Economy? Lower Corporate Tax Rates

The increased flow of capital to the U.S. would result in greater productivity and higher real wages.


President Obama has reached out to the business community with talk of lowering the corporate tax rate and improving the tax treatment of profits earned abroad by American companies. That would certainly be an important improvement in our tax system. Unfortunately, his desire to use the elimination of "loopholes" to avoid any loss of corporate tax revenue means that he cannot possibly go far enough in reducing corporate tax rates.

The U.S. corporate tax rate is 35% at the federal level and 39% when the average state corporate tax is included. The average rate in the other industrial countries of the Organization for Economic Cooperation and Development (OECD) is just 25%. Only Japan has as high a rate.

Eliminating every loophole in the taxation of domestic corporate profits identified by the administration's own Office of Management and Budget would raise less than $60 billion of extra revenue in 2011, enough to lower the combined federal-state corporate rate to 35%. The U.S rate would still be higher than in every other country but Japan, and a full 10 percentage points higher than the average in other industrial OECD countries.

This high corporate tax rate causes a misuse of our capital stock. More specifically, the high rate drives capital within the U.S. economy away from the corporate sector and into housing and other uses that do not increase productivity or raise real wages. And because interest payments by companies are deductible in calculating taxable profits, the high tax rate induces firms to use too much debt to finance their operations, increasing risks for them and the U.S. economy.

Moreover, the difference between the U.S. corporate tax rate and the lower rates abroad encourages U.S. firms to locate production in foreign countries and discourages foreign firms from producing in the U.S. unless absolutely necessary. The result is less capital at home, reduced productivity, and therefore lower real wages.

Our high corporate tax rate also makes the cost of capital higher for American firms than for their foreign competitors, forcing them to charge higher prices on American products. That makes U.S. producers less able to compete in global markets or with imports to the U.S. from abroad.

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All this is compounded by the unusual way in which U.S. firms are taxed on overseas incomes. Firms in every country pay taxes on the profits they earn at home and pay taxes to foreign governments on the profits they earn abroad. Generally, however, foreign firms pay only a small token tax if they bring their after-tax profits back to their home country.

But that's not how it works for American firms. Our companies must pay the difference between the U.S. tax rate and the tax that they have already paid. For example, French and American firms that invest in Ireland pay a corporate tax of only 12.5% to the Irish government. The French firm can then bring its after-tax profit back to France by paying less than 5% on those repatriated profits while an American firm would have to pay the 22.5% difference between our 35% corporate tax and the 12.5% Irish tax.

The extra tax that American firms must pay when they repatriate foreign profits encourages those firms to leave profits abroad, investing those funds to expand foreign operations instead of bringing that money back to invest in new plants and equipment at home. The extra tax paid by U.S. firms when repatriating profits also raises the effective cost of capital to American firms operating in other countries, making them less able to compete in those markets. That shrinks their scale of global production, reducing the cost savings that would result from spreading domestic R&D and other fixed costs over a larger volume of sales.

American firms are also at a disadvantage in obtaining new technology by acquiring high-tech firms abroad. Because of the high cost of capital of U.S. firms, foreign firms can often afford to pay more in bidding to acquire those firms and their technology.

Fortunately, shifting the U.S. method of taxing foreign profits to the "territorial" method used by all other industrial countries would have little adverse effect on corporate tax revenue. According to the 2010 Report on Tax Reform Options of the President's Economic Recovery Advisory Board, the Treasury estimates that a territorial system might cost only $130 billion over 10 years but could be structured in a way that actually raises revenue. Even the $130 billion estimate ignores the favorable revenue effect of the resulting increase in profitable corporate investment in the U.S.

The other harmful effects of the corporate tax could be reduced by bringing the U.S. rate into line with those in other industrial countries. The increased flow of capital to the U.S. and the increased productivity of American firms would generate new tax revenue that would offset some of the direct revenue loss caused by a lower corporate tax rate. And since the increased stock of capital in the U.S. would raise productivity and wages, closing personal tax loopholes to make up the remaining revenue loss could still leave individual taxpayers with a higher after-tax income.

President Obama has recognized the importance of reforming the corporate tax system. Passing such legislation this year would help to stimulate the recovery as well as improve our long-run growth prospects.

Mr. Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors.








Shakedown in Ecuador

The comedy of legal errors against Chevron.

Woody Allen made "Bananas" in 1971 about a South American banana republic, but as a slapstick comedy it's hard to beat this week's $8.6 billion judgment against Chevron by a provincial court in Ecuador. The only thing more preposterous than the case is that the plaintiffs want more.

The suit, filed in an Ecuadorian court in Lago Agrio in 2003, charges that Texaco (since merged with Chevron) failed to clean up oil spills from wells it drilled in the 1970s, and thus should be liable for as much as $113 billion. The fact that Texaco cleaned up its sites and was released from liability by the government of Ecuador and state oil company PetroEcuador didn't stop the plaintiffs, led by attorney Steven Donziger, from concocting a case through legally dubious tactics.

Consider the tale of Richard Cabrera, an ostensibly "neutral" expert for the Ecuadorian court tasked with writing a report to estimate the potential cost of environmental damages for which Chevron could be held accountable, a figure he ventured at $27 billion. (The figure was later inflated further.) Chevron has produced evidence that his findings were shaped in collaboration with Stratus, a Colorado-based environmental consulting firm that was working for the plaintiffs.

Exhibit B is a vast archive of shady remarks in clips and outtakes from "Crude," a documentary on the case that captures potential misconduct by both the plaintiffs and the government of Ecuador. At one point in the film, Mr. Donziger calls all Ecuadorian judges corrupt and notes that "The only language that I believe this judge is going to understand is one of pressure, intimidation and humiliation. And that's what we're doing today."

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Getty Images

If the plaintiffs prevail, the result could be a global free-for-all against U.S. multinationals in foreign jurisdictions.


In the U.S., four federal courts have already said there is evidence that the behavior of the plaintiffs amounted to fraud. While many corporate defendants settle to avoid headline risk, Chevron has fought back, most recently with a RICO suit against the attorneys and consultants who have been its tormentors.

According to Chevron's complaint in federal court in New York, the plaintiffs falsified evidence in an attempt to extort a settlement. Egged on by American NGOs that know they can't prevail in U.S. court, the plaintiffs' PR campaign targeted investors with scare tactics about Chevron's potential foreign liability. They demanded investigations by the Securities and Exchange Commission and reached out to the Department of Justice and New York Attorney General Andrew Cuomo to intervene on their behalf. Mr. Cuomo obliged, writing a letter to Chevron CEO David O'Reilly in May 2009.

Last Tuesday, New York federal district judge Lewis Kaplan issued a temporary restraining order that bars the RICO defendants, including Mr. Donziger, from collecting monetary damages anywhere in the world. An arbitration panel at the Hague followed on Wednesday, instructing the Ecuador government to bar enforcement of any judgment pursuant to its Bilateral Investment Treaty with the U.S.

There's more at stake here than one company's bottom line. The Ecuador suit is a form of global forum shopping, with U.S. trial lawyers and NGOs trying to hold American companies hostage in the world's least accountable and transparent legal systems. If the plaintiffs prevail, the result could be a global free-for-all against U.S. multinationals in foreign jurisdictions.

Chevron has no assets in Ecuador and the stock market gave the judgment a collective yawn on Monday, suggesting that few investors expect the plaintiffs will ever pocket the far-fetched billions bestowed by the Ecuador court. We hope the company's refusal to surrender to lawyers in league with a banana republic sends a message to other aspiring bounty hunters.


Productivity and Growth: The Enduring Connection

It is simply untrue that there is a trade-off between efficiency and jobs in a dynamic economy.


President Obama recently used his weekly radio address to insist that the U.S. can out-compete any other nation on Earth if only we "unlock the productivity" of American workers. But the president's advocacy of productivity—getting more or better value for each hour worked—as the key to competitiveness may fall on deaf ears in some quarters. Longstanding misconceptions continue to undermine rational debate on productivity. Here are a few of the most pervasive.

Productivity is not a priority. The U.S. relies more than ever on productivity gains to drive GDP growth. Productivity generated 80% of total GDP growth in recent years compared with 35% in the 1970s. Now, due to our country's shifting demographics, we'll have to do even better.

In the past, productivity gains and an expanding labor force made equal contributions to economic growth. But this is changing as baby boomers retire and the number of women entering the work force levels off. If labor-force growth slows as projected and productivity increases at the average 1.7% annual rate posted since 1960, annual GDP growth will fall to 2.2% from its historic average of 3.3%. Americans on average would experience slower gains in living standards than did their parents and grandparents. To prevent this, productivity growth needs to increase to an annual rate of 2.3%—a rate not achieved since the 1960s.

Productivity is a job killer. Many Americans suspect that productivity is a job-destroying exercise. They point to the period since 2000, when the largest productivity gains in the U.S. came from sectors, such as electronics and other manufacturing, that have seen large job cuts. But when looking across the economy overall, as opposed to the ups and downs of individual sectors, productivity and jobs nearly always increase together. More than two-thirds of the years since 1929 have seen gains in both. It is simply untrue that there is a trade-off between productivity and jobs in a dynamic economy.

Productivity is only about efficiency, and is designed to bolster corporate profits. Productivity can come either from efficiency gains (i.e., reducing inputs for given output) or by increasing the volume and value of outputs for any given input (for which innovation is a vital driver). The U.S. needs to see both kinds of productivity gains to experience a virtuous growth cycle in which increases in value provide for rises in income that, in turn, fuel demand for more and better goods and services.

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Associated Press

The U.S. relies more than ever on productivity gains to drive GDP growth.


In the second half of the 1990s, the U.S. saw productivity gains come from both sources. Two sectors—large-employment retail, and semiconductors and electronics—collectively contributed 35% to the acceleration in productivity during this period and, at the same time, added more than two million new jobs. In contrast, the largest productivity gains since 2000 have come from sectors that experienced substantial employment reductions. The challenge for the U.S. is to return to the balanced productivity growth of the previous decade.

Productivity is just for laggard sectors and companies. Not so. As a critical component of competitiveness, rising productivity is essential to the overall health and wealth of the U.S. economy and to its ability to compete globally. Even the best-performing companies and sectors still have headroom to boost productivity by emulating the best practices of others and developing new innovations of their own. Even a productive sector like retail, for instance, can broaden its use of lean techniques from the stockroom to the storefront and continue to innovate.

It is true that the opportunity for gains may be larger in industries like health care that today have relatively low productivity. Our hospitals, without the driver of competition, have only just begun to embrace efficient practices and lean techniques in the purchase and delivery of services. Clearly, the public sector—at all levels—also needs to become more efficient. Boosting public-sector productivity will be critical to reducing the U.S. budget deficit without simply slashing public services.

Productivity gains have reached their limits. Some say that economic development and technological innovation in the U.S. have plateaued and that our productivity engine is running out of steam. We disagree. Our research suggests that the private sector can deliver three-quarters of the productivity gains that the U.S. needs to match historic growth rates simply by applying best practices across the economy and tapping into the next wave of innovation.

But to obtain the last one-quarter of what's required, federal, state and local governments need to tackle economy-wide barriers that have long hampered productivity growth—including our deteriorating infrastructure and the abiding burden of red tape. Government should also see to it that companies with a strong record of innovation have access to the talent and the right incentives to expand their U.S.-based operations. Working together, the public and private sectors can set a new global standard for productivity and competitiveness, while ensuring that future generations enjoy gains in living standards similar to those their parents experienced.

Mr. Manyika is director of the McKinsey Global Institute in San Francisco. Mr. Malhotra is chairman of the Americas, McKinsey & Co. in New York.


WSJ econ blog Feb 16, 2011
5:00 AM

Slowing Labor Force Growth Means U.S. Needs Big Productivity Gains

By Justin Lahart

Without a big productivity boost, the U.S. may be heading for decades of stagnation.

Productivity has long been a major part of America’s economic success. From 1960 to 2008, gross domestic product grew at an average annual rate of 3.3%. About half of that was due to an expanding labor force, as baby boomers started punching the clock and as more women went to work. The other half came from productivity growth — workers making more, and better, goods per hour.

But the leading edge of the baby boom generation has reached retirement age this year, and women’s participation in the labor force has plateaued, note researchers at McKinsey & Co.’s business and economics research arm in a report released Wednesday. As a result, the contribution to economic growth from a growing labor force will amount to only 0.5% a year over the next decade.

“We’re no longer getting the lift from expanding the labor force so all the lift has to come from productivity gains to keep the engine going,” said McKinsey Global Institute director James Manyika.

Without speedier productivity growth, the economy could be decidedly lackluster. Say it grows at its historic annual rate of 1.7%. With labor force growth of just 0.5%, that would make for GDP growth of just 2.2% a year — a full percentage point below the 50-year average.

Slower growth would slow gains in living standards. It would make the U.S. a less attractive place to invest — bad news for the dollar, for stocks and for bonds (and therefore interest rates). It would make the nation more prone to recession. And it would make the nation less able to care for those retiring boomers.

Mr. Manyika is hopeful that U.S. can boost its productivity. There is plenty of room for more efficiency in large sectors like health care, and even in places that have seen large productivity gains in the past several years, like wholesale trade, there are plenty of firms that have yet to embrace new technology and management practices.

But there are also some big hurdles. For one, investment in research and development has flagged in recent years. And even before the downturn, business spending on new equipment and software was growing at a slower pace than in years past.

What’s more, the type of productivity gains that companies have emphasizing lately have more to do with trying to save money — reducing their dependency on workers — than on making higher quality and more advanced products that improve people’s lives. That drive for efficiency can boost productivity over the short run, “but it’s not a sustainable way to drive productivity,” said Mr. Manyika.


The Phone Wars Aren't Over

None foresaw the wireless success of Apple and Google.

·         By HOLMAN W. JENKINS, JR.

Nokia proves the case for index funds. If you had the bright idea of making the company a core holding when it was on top of the mobile world, you probably want to kick the dog now.

The company is trying to rescue itself with its smart phone tie-up with Microsoft, and anyone who thinks the game is over should refer to paragraph one. The game isn't over. Chances are good that Apple and Google, today's dominant players, will also miss a beat at some point, in Apple's case perhaps through control freakery, in Google's because of creepiness with personal data.


Nokia said it will establish a strategic partnership with Microsoft, adopting the U.S. software giant's Windows Phone as its main smartphone platform. Can the relationship revive Nokia, which has been quickly losing share in the handset market?

That said, discount some of the strategy babble. "We're the swing factor," Nokia's Stephen Elop told The Journal this week. "We can swing it to Android or swing the industry over to create a third ecosystem."

"Ecosystem" is the meme of the day, as if we're reliving the Wintel versus Apple battle of the early PC era. Apple, of course, gave birth to the new meme by centering its mobile experience on "apps," really just mobile web bookmarks, albeit ones requiring programmers to use Apple's proprietary interface rather than the universal interface of a browser.

It made sense when Apple did it, as the pudding has proved. Others have followed. But even Google, owner of today's fastest-growing "ecosystem," seems to have recurrent doubts and an urge to restore the browser to centrality in mobile computing, as with its new app store accessible from the Web.

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Associated Press

The key to mobile success: A CEO named Steve.


And now we learn that Apple itself is contemplating a move downmarket with cheaper phones and a greater reliance on the cloud, steps that at least open the door to a shift away from app-centricity. The appeal of the cloud, after all, is access to your data from any device at hand. Meanwhile, moving memory and processing to the cloud, and out of the app, would free Apple to build less capability into its handsets, making them—voila—cheaper.

So though Microsoft and Nokia speak of creating a "third ecosystem" and saving the world from an Apple-Google duopoly, their deal should perhaps be seen less ambitiously. They've found a way to keep busy in the mobile space, making use of their existing assets, including Nokia's industrial design and mapping prowess, and everything Microsoft has to offer, including Bing, Xbox Live and Office.

Have no doubt their early efforts will be guided by the "ecosystem" meme. Have no doubt, either, that their partnership is liable to be rethought in a hurry as the marketplace and technology evolve.

In fact, all involved could do worse than stew a bit in the lessons of Nokia's rise and fall.

Nokia, a 150-year old Finnish conglomerate, blossomed as a mobile player at a time when, by the consensus of Silicon Valley bien pensants, Europe was whipping America's derrière in mobile. Nokia was on the ground floor as a designer of GSM, the mobile standard whose uniform adoption by Europe's governments was so envied in the 1990s by America's tech leaders.

Bill Joy, the Sun Microsystems guru, spoke for many when he complained at the time that America suffered from "too much competition," thanks to too many wireless companies promoting too many rival standards. We were ceding wireless leadership to the Europeans and Japanese, he warned.

He was right, in a way. Competition is messy and wasteful, but it also chivvies companies to discover or invent opportunity. And from nowhere, when the mobile broadband opportunity was finally ripe, came two American companies, Apple and Google, to seize most of the value.

Though some resist the knowledge, our "too much competition" is exactly what created the opening for Apple to go to market with a $600-plus, feature-rich, exquisitely engineered smartphone (which AT&T would subsidize for its customers).

The competitive neediness of Verizon and other AT&T rivals, in turn, created the opportunity for Google's Android, which in turn revived Motorola and lifted Samsung and HTC into global handset brands to rival Nokia.

Nokia once thought it wasn't important to be a player in the U.S. market, with its cacophony of conflicting standards. It's paying for that mistake now. Four years after the iPhone was introduced, Nokia still hasn't delivered a version of its Symbian operating system that holds a candle to its competitors. As one critic recently put it, "Symbian needs more keystrokes to do less than the iPhone and Androids even after a yearlong revamp."

The lesson for the new Nokia and everyone else is an old one: Nobody knows anything, and there's no substitute for messy, wasteful competition as a finder of solutions to problems we didn't even know we needed solutions for. Whether the mobile world will settle into one nonproprietary or many proprietary ecosystems is far from decided.


WSJ econ blog Feb 15, 2011
12:55 PM

Brazil Finance Chief Renews Attack on Fed

By Brenda Cronin

Brazilian Finance Minister Guido Mantega on Tuesday renewed his attack on the Federal Reserve’s most recent program of quantitative easing, saying the policy had goosed global flows of hot capital and heightened the global problems of rising commodity prices and inflation.

Last year, Mr. Mantega warned that falling currencies — including the U.S. dollar, due to the Fed’s plan to buy up to $600 billion of Treasurys — had triggered a currency war. On Tuesday, the finance minister renewed his opposition to the Fed’s program — at one point correcting his interpreter to specify “quantitative easing” and not just “monetary policy.”

He said that strong capital flows will continue to pour into emerging markets unless central banks in developed countries shape monetary policies that allow “alternative investments” to attract new capital.

In a Tuesday conference call with reporters before the meeting of the Group of 20 finance ministers in Paris, Mr. Mantega said food inflation in Brazil had increased early this year but there are signs that “political and economic measures by the government to mitigate demand,” will have an effect on slowing the rise in prices.

“Commodity prices will fall naturally once the market restabilizes itself,” Mr. Mantega said, but for now, their rise represents a significant concern for the global economy.

Issues on the agenda for the finance ministers’ meeting this week include getting a handle on rising commodity prices, addressing global economic imbalances as well as flows of hot money to developing economies and reforming the international financial system.

Although Brazil also has taken China to task for not letting its currency rise faster, Mr. Mantega said that his country had no plans to join with the U.S. in pushing Beijing for a more rapid appreciation.

Indeed, Brazil is “just as concerned about the U.S. economy,” and the relatively weak dollar, he said. He did note that as the health of the U.S. economy continues to improve, the commodity-price costs could ease.

The finance minister also blamed the U.S. — and other developed markets — for playing a role in rising commodity prices. The problem, Mr. Mantega said, isn’t solely due to increased demand, unfavorable weather and natural disasters, such as last summer’s drought in Russia. Agricultural subsidies in the developed world, and higher prices for fertilizer made by advanced economies also are factors, he said. One solution Mr. Mantega offered: encouraging production of agricultural commodities in developing, low-income countries. And one sure way to make the situation worse: any type of price controls or restrictions, which the finance minister characterized as the equivalent of shooting one’s self in the foot.

“Developed countries should remove subsidies and lift trade barriers to products of emerging countries,” he said. “Also, developed countries should provide new investment opportunities to prevent capital supplies from increasing commodity prices.”



G-20 Frets Over Inflation, Sovereign Debt


The Group of 20 nations sees rising commodity prices, potential overheating in emerging economies and sovereign-debt woes in advanced ones as key risks to the global recovery, according to a draft document.

The group's policy priorities are budget-cutting, freer exchange rates and structural changes, report says.

The early draft of a communiqué to be released Saturday, seen by Dow Jones Newswires, says the big industrial and developing powers have agreed on a "limited set" of indicators to gauge large economic imbalances, but it shows the indicators have yet to be decided.

The G-20 vows "coordinated policy action" to ensure "sustainable and balanced growth" for a global economy where recovery is "progressing in line with our expectations but is still uneven," according to the draft prepared for a Paris meeting of G-20 finance ministers starting Friday.

"While most advanced economies are seeing modest growth and persisting high unemployment, emerging economies are experiencing more robust growth, some with signs of overheating," the draft says. "Downside risks remain, including ongoing tensions on sovereign-debt markets in advanced economies, inflationary pressures—together with significant capital inflows in emerging economies—creating risks of asset bubbles, and rising commodity prices raising concerns for growth sustainability and food security."

The G-20 will develop guidelines to assess the imbalances before its next meeting, in April, the draft says.

The issue of global imbalances has proven contentious at past G-20 meetings, with the U.S. urging major "savers" such as China, Germany and Japan to do more to spur domestic consumption rather than building their economies around exports. The issue takes on added importance as the sluggish U.S. recovery means American consumers can no longer be counted on to drive global growth.

The U.S. floated the idea last year of informally targeting a cap on current-account imbalances at 4% of gross domestic product, but China and Germany objected.

Exchange rates also are likely to figure prominently, with the U.S. and emerging powerhouses like Brazil saying China deliberately undervalues its currency to benefit its exporters. China, meanwhile, accuses the U.S. of using easy monetary policy to devalue the dollar, which also serves as the world's main reserve currency.

The draft acknowledges that "tensions and vulnerabilities are clearly apparent" in the international monetary system, and calls for improvements "to ensure systemic stability and avoid large fluctuations of both exchange rates and capital flows."

The draft envisions the Paris meeting leading to a work plan for strengthening the monetary system, including measures to manage capital flows and global liquidity. It also says the group will discuss reports on the monetary system and capital controls by the International Monetary Fund and World Bank, among others.

The draft also expresses concern about the impact of commodity-price volatility, tasking G-20 deputies with crafting an action plan. The group says it will ask the IMF and others to recommend steps to curtail excessive volatility in gas and coal prices, according to the draft communiqué.

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Mr. Singh's Lament

India's prime minister suggests the buck doesn't stop with him.

India's Congress-led government has been besieged by allegations of graft since the middle of 2010. But Prime Minister Manmohan Singh tacitly suggests it's not fair to hold him responsible when he has little control over his own coalition government. That was the message of an hour-long television interview aired on Wednesday.

Asked what he was doing when Andimuthu Raja—the former telecom minister who belongs to a southern Indian party that's part of this coalition—allegedly perpetrated a $40 billion scam selling telecom spectrum, the prime minister responded, "In a coalition government, you can suggest your preferences but you have to go by what the leader of that particular coalition party ultimately insists." Mr. Singh says the buck does not stop with him: "I did not feel I was in a position to insist [on] auctions" instead of the first-come, first-serve way in which spectrum licenses were sold.

It's no secret that Mr. Singh has been India's weakest prime minister from the moment he took office. This was evident not merely from errant coalition partners, but also ministers of his own Congress Party. For instance, Environment Minister Jairam Ramesh has implemented his own activist agenda despite Mr. Singh's warning that environmentalism shouldn't become a new avatar of the old license-permit raj.

Mr. Ramesh, Mr. Raja and many others understand that at the end of the day they are answerable only to the Congress President Sonia Gandhi. When the party won parliamentary polls in 2004, it was Mrs. Gandhi, a member of the Nehru-Gandhi dynasty that has dominated Indian politics since independence, who anointed Mr. Singh to the top post.

But it's more than embarrassing when the leader of the world's most populous democracy throws his hands up at the hijinks of his own ministers. Accountability is clearly breaking down. India cannot be taken seriously on the world stage when its prime minister doesn't have the power to speak on the country's behalf. How much longer will the Gandhi family rule from behind the curtain?

Printed in The Wall Street Journal, page 9


India: Twenty Years Later

Economic opening, starting in 1991, may have created wealth in India. But it hasn't created a political constituency for reform.


The Indian government's annual budget statement later this month will mark close to 20 years since India finally turned its back on most of the economic policies that had placed it on the edge of an abyss in the early months of 1991.

The dramatic liberalization of that year and further policy changes by governments in the late 1990s were a smashing success in some ways—India has a far more stable economy and is far more prosperous than before. But the failure to push reforms over the past six years, along with the shortcomings of past reforms, tell us a lot about why liberal economic policies have little political resonance in India.

Say what you will about the quality of reforms, India has come a long way since 1991. Back then a profligate government, an uncompetitive and heavily protected economy, high tax rates, an overvalued exchange rate, and sudden capital flight had brought India within 15 days of an embarrassing default on its international loans. In response, the government cut tariffs, did away with industrial licensing and opened the economy up to foreign investment. Though New Delhi is battling similar problems today—a large budget deficit and a wide current account deficit, for instance—the Indian economy is on a much firmer footing thanks to the discipline imposed by those reforms.

These reforms are paying off not only at a macro level but also for individual poor households. Average dollar incomes have more than tripled since 1991. Diets have improved and more proteins are being consumed. School enrollment has soared. Human development indicators increased more in the first decade of the current century than they did in the 1990s. The demand for basic consumer goods is rising. Mobile phones, watches and ceiling fans are common possessions in poor communities.

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She reaps the benefits of liberalization. But is she voting the same way?


Yet the so-called 1991 Big Bang, and the reform process since then, left a lot undone. In the past few years especially, the Congress Party-led government of Prime Minister Manmohan Singh, the finance minister who helped introduce many of the most dramatic reforms from 1991-93, has lost its nerve for liberalization. Several important second-generation reforms, like the introduction of a unified goods and services tax that will finally stop distorting the tax incentives of producers, have not progressed since the Congress came to power in 2004.

More importantly, Mr. Singh has done nothing to liberalize India's labor laws, the key impediment to job creation. A plethora of labor legislation enacted since India's independence in 1947 makes it very difficult for firms to hire and fire people as they wish. Laws to protect existing workers have kept new workers out of jobs. Because of these laws, manufacturing firms have preferred to substitute otherwise cheap labor with capital. So even when India's companies grow, they aren't taking its workforce along.

Meanwhile, the government still struggles to provide basic public services. India is terrible at making sure its citizens have the opportunity to go to schools or hospitals, or even have drinking water. In some cases, it can't even promise law and order. These problems add an edge to the old complaint that the Indian state does too much in the economy and too little in governance. So reordering priorities should involve further economic reforms on the one hand and governance reforms on the other.

The major problem now is that these earlier reform failures are creating political conditions where it may be harder to push forward with more liberalization. India's biggest political-economy puzzle, and also one of its most serious challenges, is that earlier reforms have not created an effective political constituency for further reform. Voters consistently reward candidates promising greater welfare benefits or government intervention in the economy.

Why reformers don't win votes is clearest in the labor market. Even if the potential reform constituency now has phones and consumer goods, it doesn't have steady employment. Manish Sabharwal of staffing firm Teamlease Services points out that one number has stayed constant despite all the positive change in India over the past two decades: 93% of working-age Indians, estimated now at 500 million, continue to work informally—outside of the organized sector and without proper labor contracts.

This lack of modern employment opportunities, coupled with poor public services, has denied millions the upward mobility that was seen in most other Asian countries. Unemployed or underemployed Indians, still living an abject life without much dignity, look at the hype surrounding the Big Bang and wonder what was in it for them.

This disconnect between rising aspirations and the inability to meet those hopes quickly enough gives rise to a fault line in Indian politics. Politicians happily exploit it: Rather than summoning the will to push through reforms that would address the roots of the problem, it's easier to pitch illiberal spending and subsidies as an easy "fix."

This explains measures that already have moved India backward from its reform progress, including entitlements proposed by Mr. Singh himself despite his reform leadership in the early 1990s. The most obvious example is the rural employment guarantee scheme his government started in 2005, essentially paying the rural poor to work whether or not any actual work existed for them to do.

In 2010, the government passed the Right to Education Act, which empowers public teachers without caring for student enrollment and retention. And for the past two years, it's been contemplating a right to food act that would dramatically expand the current food subsidy regime, which already costs 500 billion rupees ($11 billion) a year. Expansions of all these programs depend on a thin tax base that could stretch state finances to the breaking point.

Will the new entitlement state affect India's post-liberalization story? The first decade after 1991 saw growing personal consumption as more Indians put the raw struggle for survival behind them. The second decade saw families invest in the future by raising their spending of services such as education and health. The third decade is now upon us. If India can't overcome the current political inertia surrounding reform, this decade won't see the positive strides the last two saw.

Of course, there is the possibility that the widening arc of prosperity will encourage voters to look beyond entitlements—to seek leaders who deliver more secure futures through expanded opportunities and better infrastructure. This has already started happening at the state level. Last November voters in Bihar, one of India's most backward states, re-elected Nitish Kumar, a leader who had reformed governance and who had managed to woo investors. In Gujarat, Narendra Modi's solid economic credentials have translated into political gains.

If this keeps up, national-level politics could change too. But for the moment, India still is waiting for national-level politicians who understand the importance of pushing forward with a second generation of reforms.

Mr. Rajadhyaksha is managing editor of Mint.




February 16, 2011

Self-Inflicted Poverty

By Walter E. Williams



Why is it that Egyptians do well in the U.S. but not Egypt? We could make that same observation and pose that same question about Nigerians, Cambodians, Jamaicans and others of the underdeveloped world who migrate to the U.S. Until recently, we could make the same observation about Indians in India, and the Chinese citizens of the People's Republic of China, but not Chinese citizens of Hong Kong and Taiwan.

Let's look at Egypt. According to various reports, about 40 percent of Egypt's 80 million people live on or below the $2 per-day poverty line set by the World Bank. Unemployment is estimated to be twice the official rate pegged at 10 percent.

Much of Egypt's economic problems are directly related to government interference and control that have resulted in weak institutions vital to prosperity. Hernando De Soto, president of Peru's Institute for Liberty and Democracy (www.ild.org.pe), laid out much of Egypt's problem in his Wall Street Journal article (Feb. 3, 2011), "Egypt's Economic Apartheid." More than 90 percent of Egyptians hold their property without legal title.

De Soto says, "Without clear legal title to their assets and real estate, in short, these entrepreneurs own what I have called 'dead capital' -- property that cannot be leveraged as collateral for loans, to obtain investment capital, or as security for long-term contractual deals. And so the majority of these Egyptian enterprises remain small and relatively poor."

Egypt's legal private sector employs 6.8 million people and the public sector 5.9 million. More than 9 million people work in the extralegal sector, making Egypt's underground economy the nation's biggest employer.

Why are so many Egyptians in the underground economy? De Soto, who's done extensive study of hampered entrepreneurship, gives a typical example: "To open a small bakery, our investigators found, would take more than 500 days. To get legal title to a vacant piece of land would take more than 10 years of dealing with red tape. To do business in Egypt, an aspiring poor entrepreneur would have to deal with 56 government agencies and repetitive government inspections."

Poverty in Egypt, or anywhere else, is not very difficult to explain. There are three basic causes: People are poor because they cannot produce anything highly valued by others. They can produce things highly valued by others but are hampered or prevented from doing so. Or, they volunteer to be poor.

Some people use the excuse of colonialism to explain Third World poverty, but that's nonsense. Some the world's richest countries are former colonies: United States, Canada, Australia, New Zealand and Hong Kong. Some of the world's poorest countries were never colonies, at least for not long, such as Ethiopia, Liberia, Tibet and Nepal. Pointing to the U.S., some say that it's bountiful natural resources that explain wealth. Again nonsense. The two natural resources richest continents, Africa and South America, are home to the world's most miserably poor. Hong Kong, Great Britain and Japan, poor in natural resources, are among the world's richest nations.

We do not fully know what makes some societies more affluent than others; however, we can make some guesses based on correlations. Rank countries according to their economic systems. Conceptually, we could arrange them from those more capitalistic (having a large market sector and private property rights) to the more socialistic (with extensive state intervention, planning and weak private property rights). Then consult Amnesty International's ranking of countries according to human rights abuses going from those with the greatest human rights protections to those with the least. Then get World Bank income statistics and rank countries from highest to lowest per capita income.

Having compiled those three lists, one would observe a very strong, though imperfect correlation: Those countries with greater economic liberty and private property rights tend also to have stronger protections of human rights. And as an important side benefit of that greater economic liberty and human rights protections, their people are wealthier. We need to persuade our fellow man around the globe that liberty is a necessary ingredient for prosperity.

Is Your Job an Endangered Species?

Technology is eating jobs—and not just obvious ones like toll takers and phone operators. Lawyers and doctors are at risk as well.


So where the heck are all the jobs? Eight-hundred billion in stimulus and $2 trillion in dollar-printing and all we got were a lousy 36,000 jobs last month. That's not even enough to absorb population growth.

You can't blame the fact that 26 million Americans are unemployed or underemployed on lost housing jobs or globalization—those excuses are played out. To understand what's going on, you have to look behind the headlines. That 36,000 is a net number. The Bureau of Labor Statistics shows that in December some 4,184,000 workers (seasonally adjusted) were hired, and 4,162,000 were "separated" (i.e., laid off or quit). This turnover tells the story of our economy—especially if you focus on jobs lost as a clue to future job growth.

With a heavy regulatory burden, payroll taxes and health-care costs, employing people is very expensive. In January, the Golden Gate Bridge announced that it will have zero toll takers next year: They've been replaced by wireless FastTrak payments and license-plate snapshots.

Technology is eating jobs—and not just toll takers.

Tellers, phone operators, stock brokers, stock traders: These jobs are nearly extinct. Since 2007, the New York Stock Exchange has eliminated 1,000 jobs. And when was the last time you spoke to a travel agent? Nearly all of them have been displaced by technology and the Web. Librarians can't find 36,000 results in 0.14 seconds, as Google can. And a snappily dressed postal worker can't instantly deliver a 140-character tweet from a plane at 36,000 feet.

So which jobs will be destroyed next? Figure that out and you'll solve the puzzle of where new jobs will appear.

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Martin Kozlowski

Forget blue-collar and white- collar. There are two types of workers in our economy: creators and servers. Creators are the ones driving productivity—writing code, designing chips, creating drugs, running search engines. Servers, on the other hand, service these creators (and other servers) by building homes, providing food, offering legal advice, and working at the Department of Motor Vehicles. Many servers will be replaced by machines, by computers and by changes in how business operates. It's no coincidence that Google announced it plans to hire 6,000 workers in 2011.

But even the label "servers" is too vague. So I've broken down the service economy further, as a guide to figure out the next set of unproductive jobs that will disappear. (Don't blame me if your job is listed here; technology spares no one, not even writers.)

Sloppers are those that move things—from one side of a store or factory to another. Amazon is displacing thousands of retail workers. DMV employees and so many other government workers move information from one side of a counter to another without adding any value. Such sloppers are easy to purge with clever code.

Sponges are those who earned their jobs by passing a test meant to limit supply. According to this newspaper, 23% of U.S. workers now need a state license. The Series 7 exam is required for stock brokers. Cosmetologists, real estate brokers, doctors and lawyers all need government certification. All this does is legally bar others from doing the same job, so existing workers can charge more and sponge off the rest of us.

But eDiscovery is the hottest thing right now in corporate legal departments. The software scans documents and looks for important keywords and phrases, displacing lawyers and paralegals who charge hundreds of dollars per hour to read the often millions of litigation documents. Lawyers, understandably, hate eDiscovery.

Doctors are under fire as well, from computer imaging that looks inside of us and from Computer Aided Diagnosis, which looks for patterns in X-rays to identify breast cancer and other diseases more cheaply and effectively than radiologists do. Other than barbers, no sponges are safe.

Supersloppers mark up prices based on some marketing or branding gimmick, not true economic value. That Rolex Oyster Perpetual Submariner Two-Tone Date for $9,200 doesn't tell time as well as the free clock on my iPhone, but supersloppers will convince you to buy it. Markups don't generate wealth, except for those marking up. These products and services provide a huge price umbrella for something better to sell under.

Slimers are those that work in finance and on Wall Street. They provide the grease that lubricates the gears of the economy. Financial firms provide access to capital, shielding companies from the volatility of the stock and bond and derivative markets. For that, they charge hefty fees. But electronic trading has cut into their profits, and corporations are negotiating lower fees for mergers and financings. Wall Street will always exist, but with many fewer workers.

Thieves have a government mandate to make good money and a franchise that could disappear with the stroke of a pen. You know many of them: phone companies, cable operators and cellular companies are the obvious ones. But there are more annoying ones—asbestos testing and removal, plus all the regulatory inspectors who don't add value beyond making sure everyone pays them. Technologies like Skype have picked off phone companies by lowering international rates. And consumers are cutting expensive cable TV services in favor of Web-streamed video.

Like it or not, we are at the beginning of a decades-long trend. Beyond the demise of toll takers and stock traders, watch enrollment dwindle in law schools and medical schools. Watch the divergence in stock performance between companies that actually create and those that are in transition—just look at Apple, Netflix and Google over the last five years as compared to retailers and media.

But be warned that this economy is incredibly dynamic, and there is no quick fix for job creation when so much technology-driven job destruction is taking place. Fortunately, history shows that labor-saving machines haven't decreased overall employment even when they have made certain jobs obsolete. Ultimately the economic growth created by new jobs always overwhelms the drag from jobs destroyed—if policy makers let it happen.

Mr. Kessler, a former hedge fund manager, is the author most recently of "Eat People And Other Unapologetic Rules for Game-Changing Entrepreneurs," just out from Portfolio.


Honduras's Experiment With Free-Market Cities

A poor country considers a new way to stimulate private investment.

Tegucigalpa, Honduras

What advocate of free markets hasn't, at one time or another, fantasized about running away to a desert island to start a country where economic liberty would be the law of the land? If things go according to plan, more than one such "island" may soon pop up here.

Honduras calls these visionary islands "model cities," and as the Journal's David Wessel reported from Washington 10 days ago, the Honduran Congress is expected to soon pass an amendment to the constitution that would clear the way to put the concept into action.

The idea is simple: A sizable piece of unpopulated government land is designated for use as a model city. A charter that will govern the city is drafted and the Congress approves it. A development authority is appointed by the national government. The authority signs contracts with the investors who will develop the infrastructure. The city opens for business under rules that act as a magnet for investment.

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Associated Press

Honduras President Porfirio Lobo


Sound fanciful? Perhaps, until the chief architect of the plan, 35-year-old Octavio Sánchez, points out that "model cities" are nothing new. "What I love about the concept," President Porfirio Lobo's chief of staff tells me in an interview, "is two things. First, that we will employ the best practices from similar projects around the world that have been successful. Second that it is entirely voluntary for people to move in. They are the ones who will protect it."

During the Cold War, Honduras was known mostly for its loyalty to the U.S. In 2009 it gained fame for deposing Manuel Zelaya because he was trying to extend his presidency in violation of the nation's constitution. Honduras refused to comply with international demands to restore Mr. Zelaya to power. Now the little country that stood up to the world to defend its democracy seems to be affirming a belief that it needs to change if it wants to ward off future assaults on freedom.

New York University economist Paul Romer is a global champion of the same concept by another name. Here's how Mr. Romer described his "charter cities" in a Jan. 25 interview with the Council on Foreign Relations' Sebastian Mallaby: "Some group of people who are willing to try something different say: Let's go off by ourselves. We'll develop both different laws, perhaps, but importantly, different norms about right and wrong. We'll reinforce that in our little culture that operates separately. And then, if these turn out to be a success . . . we'll not only demonstrate to others that there's something better, but we'll also provide a mechanism where people can move from the equilibrium where one set of rules and norms prevails to this other one."

The germination of model cities for Honduras started in Honduras. The reason is not hard to discern. Reformers have spent years trying to liberalize the economy only to be thwarted by special interests.

As Mr. Sánchez, who also worked in the government of President Ricardo Maduro (2002-06), puts it: "For me, for a very long time, it has been obvious that with the current system, we are going nowhere." The young lawyer says that almost a decade ago he began thinking about whether it would be possible to designate a small place where all the pro-market reforms would be law. He had no doubt that such a zone would grow fast and that the ideas behind it would spread.

The Americas in the News

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Over time the concept evolved and the 2009 political crisis seems to have generated interest in new ideas. In an interview here last week President Lobo told me that his polling shows that among Hondurans familiar with the proposal, there is broad support.

The amendment is expected to pass Congress within the next three months. This week Mr. Sánchez and Mr. Lobo will travel to South Korea and Singapore, where they will analyze successful model cities to aid in drawing up the first charter. They will also be looking for investors. Mr. Sánchez says that it is important that more than one model city is launched so that rule designers will have to compete.

Can it work? The critics—who interestingly enough seem to be mostly failed planning or development "experts"—say it is unlikely because, well, this is Honduras. But Mr. Sánchez is not deterred. He points out that both Japan and Chile were once proclaimed culturally incapable of development. He also argues that history is on Honduras's side. Separate legal systems inside cities generated untold prosperity as far back as the 14th century in Northern Europe's Hanseatic League and more recently in places like the Chinese city of Shenzhen.

Former president Ricardo Maduro is also a fan. "If we want to develop we have to find a way to counterbalance the populism that causes us so much harm. The model city is a way of decentralizing power and connecting people to their government."

Write to O'Grady@wsj.com


Ivory Coast Seizes Four International Banks

Associated Press

ABIDJAN, Ivory Coast—The disputed regime of Ivory Coast's Laurent Gbagbo has seized four major international banks that had shut down operations in the West African country, a spokesman for Mr. Gbagbo's government said on state TV late Thursday.

Spokesman Ahoua Don Mello read a decree on state TV saying that the banks didn't respect the law and closed without proper notice. According to Ivorian law banks have to give three months notice.

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The closed doors of a Société Générale branch in Abidjan.


Mr. Don Mello said Mr. Gbagbo's government had seized Britain's Standard Chartered PLC, France's BNP Paribas SA and Société Générale SA along with U.S. bank Citibank. These banks hold a majority of the bank accounts for civil servants.

Mr. Don Mello said that Mr. Gbagbo's government would nationalize the banks and would pay February salaries. The banks closed because of financial sanctions from the international community intended to force Mr. Gbagbo out. It is unclear if Mr. Gbagbo will have access to the banks' funds.

Nine private banks began shutting down earlier this week including Nigeria's Access bank. Société Générale's local subsidiary, the country's largest financial institution, announced it was shuttering all 47 of its branches, which serve 230,000 clients.

The international community had said it would use financial sanctions to dislodge Mr. Gbagbo, who is refusing to step down although results issued by his country's election commission and certified by the United Nations showed he had lost the Nov. 28 ballot by nearly nine percentage points. His opponent, Alassane Ouattara, was widely recognized by the international community as the winner, and is currently under U.N. protection at a hotel in Abidjan.

Among the sanctions slapped on Mr. Gbagbo's regime was the revocation of his signature on state accounts at the regional central bank, which prints the currency used in Ivory Coast. Once that happened late last month, the Gbagbo government was no longer able to make deposits into the private banks where government salaries are cashed.

The move was expected to prevent almost all government employees from receiving their salaries. Panicked people gathered in lines this week desperately seeking to take out their savings in fear of a cash shortage.

Diplomats and analysts have been wagering that once civil servants stop receiving their pay, they will defect en masse away from Mr. Gbagbo. He is still backed by the army, which has brutally cracked down on supporters of Mr. Ouattara.

Mr. Don Mello also said that the government has ordered the heads of the two French banks to report to the minister of economy Friday morning in Abidjan.

WSJ  econ blog Feb 17, 2011
3:42 PM

E-Commerce Surge May Hit Tax Revenue

By Justin Lahart

The rapid growth in internet sales is great for online retailers. But it’s not such good news for state and local governments.

The Commerce Department reported Thursday that e-commerce retail sales totaled $44 billion in the fourth quarter last year, up from $38 billion a year earlier. E-commerce sales now account for 4.3% of total retail sales (which include lots of things that don’t get bought online, like new cars, gasoline and restaurant meals), up from 1% a decade ago. For the year, e-commerce sales totaled $165 billion.

Many of those online purchases didn’t have any sales tax attached to them. Long before the Internet was on anybody’s radar, the Supreme Court ruled that states couldn’t require that retailers without a physical presence in a state, like mail-order companies, charge sales tax on their behalf. In recent years, states have tried to find ways around that ruling. Last fall, for example, Texas said an Amazon.com distribution center in Dallas counted as a physical presence and sent the retailer a past-due sale tax bill for $269 million. This month, Amazon said it is shutting down the distribution center as a result of Texas’s “unfavorable regulatory climate.”

But with the exception of New York and a handful of other states, online retailers don’t have to charge sales tax. (In many places, residents are supposed to pick up the tab, but few do.) Working with colleagues at the University of Tennessee two years ago, economist Donald Bruce  projected that state and local governments would lose some $10 billion in uncollected e-commerce taxes in 2011. Given how quickly online sales are growing, that estimate now seems quite conservative, he says.

The lack of sales taxes on Internet purchases is one of the factors driving online sales growth, research suggests. When MIT economists Glenn Ellison and Sara Fisher Ellison looked at online sales of computer memory modules, for example, they found that sales were substantially higher to high sales tax states than to low sales tax states — “clear evidence that tax savings are an important motivation for online shopping,” they wrote.

That means that, to some extent, the sales that offline retailers are losing to online retailers is due to sales-tax differences. And if some of those Main Street stores don’t survive as a result, state and local governments lose even more tax revenue.

One suspects that, with all the budget strains they’re facing, more states will be going toe to toe with online retailers.


The Paris G20: Made in China

By Damian Paletta

Journalists from all over the world are descending on Paris this weekend for a summit of finance ministers and central bankers from the Group of 20 leading nations.

A hot topic: China, and whether its role as a huge exporter with what critics say is an “undervalued” currency is causing economic imbalances around the world.

Whether intentional or not, the official “G20? bag that the French organizers gave all reporters seemed to offer a reminder of tensions at the meeting. The bag contains a silver “thumb drive,” meant as a gift for each journalist, which read “G-20 France 2011? on the side.

The little white box the thumb drive is packaged in is blank except for a few symbols and its own three little words: “Made in China.”

Independently Incompetent

Regulators may drive derivatives markets out of the U.S.

New York Senator Chuck Schumer demanded on Sunday that the name of the New York Stock Exchange appear first in a possible merger of NYSE Euronext with Germany's Deutsche Börse. Mr. Schumer says he wants the merger to maintain New York City as the center of world finance.

But if he's concerned with the reality of keeping financial markets in the U.S.—as opposed to the perception created by a corporate brand—Mr. Schumer should conduct some oversight of the Commodity Futures Trading Commission. The agency's pending rules could drive offshore markets that are much more lucrative than the trading of stocks.

CFTC chairman Gary Gensler is ostensibly seeking to limit the power of big banks with proposed rules for derivatives-trading venues. Mr. Gensler has pushed for the boards of trading platforms and clearinghouses, which stand behind every trade, to include a majority of independent directors with no ties to these organizations or to the banks that trade through them.

When the CFTC passed a draft rule last year, he lacked the votes to require a majority of independent directors, so he settled for 35%. But as a final vote on the rule approaches, he's pushing again to raise the percentage to 51. Think of it: By law, these firms would be controlled by people who don't own them. Mr. Gensler also wants to limit the share of these firms that banks can own.

Meanwhile, the Securities and Exchange Commission has already passed a draft rule mandating a majority of independent directors for the derivatives venues that it regulates, though its regulatory turf is limited.

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Associated Press

CFTC chairman Gary Gensler is ostensibly seeking to limit the power of big banks with proposed rules for derivatives-trading venues.

As we've argued before, the way to limit the power of big banks is to break them up or take away their subsidies, not to engineer flaws into trading platforms that are ultimately backed by taxpayers. Overseeing the risks of a clearinghouse that will stand behind trillions of dollars in interest-rate swaps is not a job for amateurs. The expertise that exists in this area largely exists inside banks, and taxpayers will most likely value competence over independence.

We're still waiting for evidence that independent directors yield better financial results. Merrill Lynch's 2006 annual report proudly noted that 11 out of the 12 members of its corporate board were independent—people who had never worked at the firm and had little connection to it. Merrill was a model of trendy corporate governance, with a board of esteemed Americans who could offer an unbiased perspective.

As it turned out, what Merrill really needed was a board that knew how to manage financial risk. And it would have helped immensely if directors had understood the mortgage-backed securities on which they had unwittingly bet the firm. The report was released in early 2007, and by that October the company was searching for a new CEO after an $8.4 billion quarterly loss.

In 2008, the firm again boasted of independent captains manning the board deck as Merrill sailed into the financial crisis. The company had 11 directors by then, and 10 of them were untainted by intimate knowledge of the business. Several months later, the securities that the board never did comprehend forced Merrill to sell itself to Bank of America.

Today the regulators are pushing aggressively for independent directors at both public and private companies, but there is even less of an argument for such changes than there was at Merrill. Even if one supports the hypothesis that independent directors enhance returns, the point is to mitigate the potential conflict when executives are tempted to act on behalf of themselves instead of investors. But in this case, the rules are explicitly intended to do the opposite, by limiting the power of particular investors.

Yes, there are potential conflicts when, for example, a bank is a partial owner of a clearinghouse and is also one of the members trading through it. Such a bank might pressure the management to give it a better deal than other members. But large customers can exert the same pressure, whether or not they own part of the business or have seats on the board.

Meanwhile, an owner has a strong financial incentive not to destroy his own asset. And a director with a financial interest in the health of the organization is bound to focus very intensively on maintaining that health.


Limits on ownership and board control will discourage investment in American trading venues, which makes sense only if Mr. Gensler and the SEC are trying to move financial services from the United States to Europe or Asia. As bad as the Dodd-Frank law is, Congress clearly did not intend to drive the derivatives market offshore, and Congress specifically voted down a proposal to impose the type of ownership and board limits that the regulators are now pursuing.

More than a few Wall Streeters suspect that Mr. Gensler is seeking to shrink U.S. derivatives markets as a way to reduce systemic risk. But the Financial Crisis Inquiry Commission failed to prove that derivatives played a key role in the last crisis, and there's no evidence that moving these markets from New York to Shanghai will prevent the next one.

To pay for all this CFTC overregulation, the President's budget proposes new fees on derivatives trading, which will make foreign markets even more attractive. If Mr. Gensler dreams of being the next Treasury Secretary, handing over U.S. financial leadership to foreign competitors hardly seems like a resume builder.




Number of the Week: The Perils of Inequality

By Mark Whitehouse

Number of the Week


364% — Difference in the hourly earnings of high-paid and low-paid employees

US consumers are in a much better financial situation than they were just a couple years ago. But the poor and middle class still have at least one big incentive to get into trouble again: The growing challenge of catching up to the rich.

Various economists, most notably Raghuram Rajan of the University of Chicago, have stressed the pivotal role income inequality played in the financial crisis. Poorer Americans’ debt troubles, the logic goes, stemmed in part from their efforts to bridge the gap with the rich by borrowing money. A flood of cash from China, together with enterprising bankers and mortgage subsidies from the U.S. government, created the perfect environment for those efforts to get out of control.

Now U.S. consumers have managed to shed a lot of their debt. They’ve done so at great cost to the economy, which has swallowed hundreds of billions of dollars in bad loans. As of September 2010, total household debt stood at 118% of disposable income, down from a peak of 130% three years earlier. Much of that has shifted to the government, which has seen its debt to the public rise to 61% of GDP, from 36%, over the same period.

The inequality, though, hasn’t gone away. Rather, it’s hitting new records. As the economy bottomed out in 2009, the hourly wage of employees in the 90th pay percentile—those whose wage exceeded that of 90% of the working population—stood at $38.50, according to a new  study by the Congressional Budget Office. That’s 364% more than the $8.30 an hour earned by those in the 10th percentile. A decade earlier, the difference was 332%, adjusted for inflation. The difference is more pronounced for men than women, at 383% versus 319%.

The growing gap partly reflects the effects of globalization and technological change, which help highly educated workers get more for their skills. But inequality causes a lot of problems: It can contribute to political polarization, and it raises the stakes for less wealthy consumers who want to keep the American dream alive.

To be sure, it’s not as easy to get into debt trouble as it was before the crisis. Banks are more careful, and subprime lending has all but disappeared (with the notable exception of the booming junk-bond market). But the Federal Reserve is trying as hard as it can to get people borrowing again. And in some areas, people are beginning to rack up debt: In the last three months of 2010, credit-card balances rose at an annualized rate of 2.7%, the highest since mid-2008. As of December, margin debt in the stock market was also at its highest level since mid-2008.

Let’s hope recent history doesn’t repeat itself.





From the January - February 2011 issue: The Inequality That Matters

Does growing wealth and income inequality in the United States presage the downfall of the American republic? Will we evolve into a new Gilded Age plutocracy, irrevocably split between the competing interests of rich and poor? Or is growing inequality a mere bump in the road, a statistical blip along the path to greater wealth for virtually every American? Or is income inequality partially desirable, reflecting the greater productivity of society’s stars?

There is plenty of speculation on these possibilities, but a lot of it has been aimed at elevating one political agenda over another rather than elevating our understanding. As a result, there’s more confusion about this issue than just about any other in contemporary American political discourse. The reality is that most of the worries about income inequality are bogus, but some are probably better grounded and even more serious than even many of their heralds realize. If our economic churn is bound to throw off political sparks, whether alarums about plutocracy or something else, we owe it to ourselves to seek out an accurate picture of what is really going on. Let’s start with the subset of worries about inequality that are significantly overblown.

In terms of immediate political stability, there is less to the income inequality issue than meets the eye. Most analyses of income inequality neglect two major points. First, the inequality of personal well-being is sharply down over the past hundred years and perhaps over the past twenty years as well. Bill Gates is much, much richer than I am, yet it is not obvious that he is much happier if, indeed, he is happier at all. I have access to penicillin, air travel, good cheap food, the Internet and virtually all of the technical innovations that Gates does. Like the vast majority of Americans, I have access to some important new pharmaceuticals, such as statins to protect against heart disease. To be sure, Gates receives the very best care from the world’s top doctors, but our health outcomes are in the same ballpark. I don’t have a private jet or take luxury vacations, and—I think it is fair to say—my house is much smaller than his. I can’t meet with the world’s elite on demand. Still, by broad historical standards, what I share with Bill Gates is far more significant than what I don’t share with him.

Compare these circumstances to those of 1911, a century ago. Even in the wealthier countries, the average person had little formal education, worked six days a week or more, often at hard physical labor, never took vacations, and could not access most of the world’s culture. The living standards of Carnegie and Rockefeller towered above those of typical Americans, not just in terms of money but also in terms of comfort. Most people today may not articulate this truth to themselves in so many words, but they sense it keenly enough. So when average people read about or see income inequality, they don’t feel the moral outrage that radiates from the more passionate egalitarian quarters of society. Instead, they think their lives are pretty good and that they either earned through hard work or lucked into a healthy share of the American dream. (The persistently unemployed, of course, are a different matter, and I will return to them later.) It is pretty easy to convince a lot of Americans that unemployment and poverty are social problems because discrete examples of both are visible on the evening news, or maybe even in or at the periphery of one’s own life. It’s much harder to get those same people worked up about generalized measures of inequality.

This is why, for example, large numbers of Americans oppose the idea of an estate tax even though the current form of the tax, slated to return in 2011, is very unlikely to affect them or their estates. In narrowly self-interested terms, that view may be irrational, but most Americans are unwilling to frame national issues in terms of rich versus poor. There’s a great deal of hostility toward various government bailouts, but the idea of “undeserving” recipients is the key factor in those feelings. Resentment against Wall Street gamesters hasn’t spilled over much into resentment against the wealthy more generally. The bailout for General Motors’ labor unions wasn’t so popular either—again, obviously not because of any bias against the wealthy but because a basic sense of fairness was violated. As of November 2010, congressional Democrats are of a mixed mind as to whether the Bush tax cuts should expire for those whose annual income exceeds $250,000; that is in large part because their constituents bear no animus toward rich people, only toward undeservedly rich people.

A neglected observation, too, is that envy is usually local. At least in the United States, most economic resentment is not directed toward billionaires or high-roller financiers—not even corrupt ones. It’s directed at the guy down the hall who got a bigger raise. It’s directed at the husband of your wife’s sister, because the brand of beer he stocks costs $3 a case more than yours, and so on. That’s another reason why a lot of people aren’t so bothered by income or wealth inequality at the macro level. Most of us don’t compare ourselves to billionaires. Gore Vidal put it honestly: “Whenever a friend succeeds, a little something in me dies.”

Occasionally the cynic in me wonders why so many relatively well-off intellectuals lead the egalitarian charge against the privileges of the wealthy. One group has the status currency of money and the other has the status currency of intellect, so might they be competing for overall social regard? The high status of the wealthy in America, or for that matter the high status of celebrities, seems to bother our intellectual class most. That class composes a very small group, however, so the upshot is that growing income inequality won’t necessarily have major political implications at the macro level.

What Matters, What Doesn’t

All that said, income inequality does matter—for both politics and the economy. To see how, we must distinguish between inequality itself and what causes it. But first let’s review the trends in more detail.

The numbers are clear: Income inequality has been rising in the United States, especially at the very top. The data show a big difference between two quite separate issues, namely income growth at the very top of the distribution and greater inequality throughout the distribution. The first trend is much more pronounced than the second, although the two are often confused.

When it comes to the first trend, the share of pre-tax income earned by the richest 1 percent of earners has increased from about 8 percent in 1974 to more than 18 percent in 2007. Furthermore, the richest 0.01 percent (the 15,000 or so richest families) had a share of less than 1 percent in 1974 but more than 6 percent of national income in 2007. As noted, those figures are from pre-tax income, so don’t look to the George W. Bush tax cuts to explain the pattern. Furthermore, these gains have been sustained and have evolved over many years, rather than coming in one or two small bursts between 1974 and today.1

These numbers have been challenged on the grounds that, since various tax reforms have kicked in, individuals now receive their incomes in different and harder to measure ways, namely through corporate forms, stock options and fringe benefits. Caution is in order, but the overall trend seems robust. Similar broad patterns are indicated by different sources, such as studies of executive compensation. Anecdotal observation suggests extreme and unprecedented returns earned by investment bankers, fired CEOs, J.K. Rowling and Tiger Woods.

At the same time, wage growth for the median earner has slowed since 1973. But that slower wage growth has afflicted large numbers of Americans, and it is conceptually distinct from the higher relative share of top income earners. For instance, if you take the 1979–2005 period, the average incomes of the bottom fifth of households increased only 6 percent while the incomes of the middle quintile rose by 21 percent. That’s a widening of the spread of incomes, but it’s not so drastic compared to the explosive gains at the very top.

The broader change in income distribution, the one occurring beneath the very top earners, can be deconstructed in a manner that makes nearly all of it look harmless. For instance, there is usually greater inequality of income among both older people and the more highly educated, if only because there is more time and more room for fortunes to vary. Since America is becoming both older and more highly educated, our measured income inequality will increase pretty much by demographic fiat. Economist Thomas Lemieux at the University of British Columbia estimates that these demographic effects explain three-quarters of the observed rise in income inequality for men, and even more for women.2

Attacking the problem from a different angle, other economists are challenging whether there is much growth in inequality at all below the super-rich. For instance, real incomes are measured using a common price index, yet poorer people are more likely to shop at discount outlets like Wal-Mart, which have seen big price drops over the past twenty years.3 Once we take this behavior into account, it is unclear whether the real income gaps between the poor and middle class have been widening much at all. Robert J. Gordon, an economist from Northwestern University who is hardly known as a right-wing apologist, wrote in a recent paper that “there was no increase of inequality after 1993 in the bottom 99 percent of the population”, and that whatever overall change there was “can be entirely explained by the behavior of income in the top 1 percent.”4

And so we come again to the gains of the top earners, clearly the big story told by the data. It’s worth noting that over this same period of time, inequality of work hours increased too. The top earners worked a lot more and most other Americans worked somewhat less. That’s another reason why high earners don’t occasion more resentment: Many people understand how hard they have to work to get there. It also seems that most of the income gains of the top earners were related to performance pay—bonuses, in other words—and not wildly out-of-whack yearly salaries.5

It is also the case that any society with a lot of “threshold earners” is likely to experience growing income inequality. A threshold earner is someone who seeks to earn a certain amount of money and no more. If wages go up, that person will respond by seeking less work or by working less hard or less often. That person simply wants to “get by” in terms of absolute earning power in order to experience other gains in the form of leisure—whether spending time with friends and family, walking in the woods and so on. Luck aside, that person’s income will never rise much above the threshold.

It’s not obvious what causes the percentage of threshold earners to rise or fall, but it seems reasonable to suppose that the more single-occupancy households there are, the more threshold earners there will be, since a major incentive for earning money is to use it to take care of other people with whom one lives. For a variety of reasons, single-occupancy households in the United States are at an all-time high. There are also a growing number of late odyssey years graduate students who try to cover their own expenses but otherwise devote their time to study. If the percentage of threshold earners rises for whatever reasons, however, the aggregate gap between them and the more financially ambitious will widen. There is nothing morally or practically wrong with an increase in inequality from a source such as that.

The funny thing is this: For years, many cultural critics in and of the United States have been telling us that Americans should behave more like threshold earners. We should be less harried, more interested in nurturing friendships, and more interested in the non-commercial sphere of life. That may well be good advice. Many studies suggest that above a certain level more money brings only marginal increments of happiness. What isn’t so widely advertised is that those same critics have basically been telling us, without realizing it, that we should be acting in such a manner as to increase measured income inequality. Not only is high inequality an inevitable concomitant of human diversity, but growing income inequality may be, too, if lots of us take the kind of advice that will make us happier.

Lonely at the Top?

Why is the top 1 percent doing so well?

The use of micro-data now makes it possible to trace some high earners by income and thus construct a partial picture of what is going on among the upper echelons of the distribution. Steven N. Kaplan and Joshua Rauh have recently provided a detailed estimation of particular American incomes.6 Their data do not comprise the entire U.S. population, but from partial financial records they find a very strong role for the financial sector in driving the trend toward income concentration at the top. For instance, for 2004, nonfinancial executives of publicly traded companies accounted for less than 6 percent of the top 0.01 percent income bracket. In that same year, the top 25 hedge fund managers combined appear to have earned more than all of the CEOs from the entire S&P 500. The number of Wall Street investors earning more than $100 million a year was nine times higher than the public company executives earning that amount. The authors also relate that they shared their estimates with a former U.S. Secretary of the Treasury, one who also has a Wall Street background. He thought their estimates of earnings in the financial sector were, if anything, understated.

Many of the other high earners are also connected to finance. After Wall Street, Kaplan and Rauh identify the legal sector as a contributor to the growing spread in earnings at the top. Yet many high-earning lawyers are doing financial deals, so a lot of the income generated through legal activity is rooted in finance. Other lawyers are defending corporations against lawsuits, filing lawsuits or helping corporations deal with complex regulations. The returns to these activities are an artifact of the growing complexity of the law and government growth rather than a tale of markets per se. Finance aside, there isn’t much of a story of market failure here, even if we don’t find the results aesthetically appealing.

When it comes to professional athletes and celebrities, there isn’t much of a mystery as to what has happened. Tiger Woods earns much more, even adjusting for inflation, than Arnold Palmer ever did. J.K. Rowling, the first billionaire author, earns much more than did Charles Dickens. These high incomes come, on balance, from the greater reach of modern communications and marketing. Kids all over the world read about Harry Potter. There is more purchasing power to spend on children’s books and, indeed, on culture and celebrities more generally. For high-earning celebrities, hardly anyone finds these earnings so morally objectionable as to suggest that they be politically actionable. Cultural critics can complain that good schoolteachers earn too little, and they may be right, but that does not make celebrities into political targets. They’re too popular. It’s also pretty clear that most of them work hard to earn their money, by persuading fans to buy or otherwise support their product. Most of these individuals do not come from elite or extremely privileged backgrounds, either. They worked their way to the top, and even if Rowling is not an author for the ages, her books tapped into the spirit of their time in a special way. We may or may not wish to tax the wealthy, including wealthy celebrities, at higher rates, but there is no need to “cure” the structural causes of higher celebrity incomes.

If we are looking for objectionable problems in the top 1 percent of income earners, much of it boils down to finance and activities related to financial markets. And to be sure, the high incomes in finance should give us all pause.

The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.

To understand how this strategy works, consider an example from sports betting. The NBA’s Washington Wizards are a perennially hapless team that rarely gets beyond the first round of the playoffs, if they make the playoffs at all. This year the odds of the Wizards winning the NBA title will likely clock in at longer than a hundred to one. I could, as a gambling strategy, bet against the Wizards and other low-quality teams each year. Most years I would earn a decent profit, and it would feel like I was earning money for virtually nothing. The Los Angeles Lakers or Boston Celtics or some other quality team would win the title again and I would collect some surplus from my bets. For many years I would earn excess returns relative to the market as a whole.

Yet such bets are not wise over the long run. Every now and then a surprise team does win the title and in those years I would lose a huge amount of money. Even the Washington Wizards (under their previous name, the Capital Bullets) won the title in 1977–78 despite compiling a so-so 44–38 record during the regular season, by marching through the playoffs in spectacular fashion. So if you bet against unlikely events, most of the time you will look smart and have the money to validate the appearance. Periodically, however, you will look very bad. Does that kind of pattern sound familiar? It happens in finance, too. Betting against a big decline in home prices is analogous to betting against the Wizards. Every now and then such a bet will blow up in your face, though in most years that trading activity will generate above-average profits and big bonuses for the traders and CEOs.

To this mix we can add the fact that many money managers are investing other people’s money. If you plan to stay with an investment bank for ten years or less, most of the people playing this investing strategy will make out very well most of the time. Everyone’s time horizon is a bit limited and you will bring in some nice years of extra returns and reap nice bonuses. And let’s say the whole thing does blow up in your face? What’s the worst that can happen? Your bosses fire you, but you will still have millions in the bank and that MBA from Harvard or Wharton. For the people actually investing the money, there’s barely any downside risk other than having to quit the party early. Furthermore, if everyone else made more or less the same mistake (very surprising major events, such as a busted housing market, affect virtually everybody), you’re hardly disgraced. You might even get rehired at another investment bank, or maybe a hedge fund, within months or even weeks.

Moreover, smart shareholders will acquiesce to or even encourage these gambles. They gain on the upside, while the downside, past the point of bankruptcy, is borne by the firm’s creditors. And will the bondholders object? Well, they might have a difficult time monitoring the internal trading operations of financial institutions. Of course, the firm’s trading book cannot be open to competitors, and that means it cannot be open to bondholders (or even most shareholders) either. So what, exactly, will they have in hand to object to?

Perhaps more important, government bailouts minimize the damage to creditors on the downside. Neither the Treasury nor the Fed allowed creditors to take any losses from the collapse of the major banks during the financial crisis. The U.S. government guaranteed these loans, either explicitly or implicitly.

Guaranteeing the debt also encourages equity holders to take more risk. While current bailouts have not in general maintained equity values, and while share prices have often fallen to near zero following the bust of a major bank, the bailouts still give the bank a lifeline. Instead of the bank being destroyed, sometimes those equity prices do climb back out of the hole. This is true of the major surviving banks in the United States, and even AIG is paying back its bailout. For better or worse, we’re handing out free options on recovery, and that encourages banks to take more risk in the first place.

In short, there is an unholy dynamic of short-term trading and investing, backed up by bailouts and risk reduction from the government and the Federal Reserve. This is not good. “Going short on volatility” is a dangerous strategy from a social point of view. For one thing, in so-called normal times, the finance sector attracts a big chunk of the smartest, most hard-working and most talented individuals. That represents a huge human capital opportunity cost to society and the economy at large. But more immediate and more important, it means that banks take far too many risks and go way out on a limb, often in correlated fashion. When their bets turn sour, as they did in 2007–09, everyone else pays the price.

And it’s not just the taxpayer cost of the bailout that stings. The financial disruption ends up throwing a lot of people out of work down the economic food chain, often for long periods. Furthermore, the Federal Reserve System has recapitalized major U.S. banks by paying interest on bank reserves and by keeping an unusually high interest rate spread, which allows banks to borrow short from Treasury at near-zero rates and invest in other higher-yielding assets and earn back lots of money rather quickly. In essence, we’re allowing banks to earn their way back by arbitraging interest rate spreads against the U.S. government. This is rarely called a bailout and it doesn’t count as a normal budget item, but it is a bailout nonetheless. This type of implicit bailout brings high social costs by slowing down economic recovery (the interest rate spreads require tight monetary policy) and by redistributing income from the Treasury to the major banks.

The more one studies financial theory, the more one realizes how many different ways there are to construct a “going short on volatility” investment position. To an outsider, even to seasoned bank regulators, the net position of a bank or hedge fund may well be impossible to discern. It’s not easy to unpack a balance sheet with hundreds of billions of dollars on it and with numerous hedged, offsetting, leveraged, or off-balance-sheet positions. Those who pack it usually know what’s inside, but not always. In some cases, traders may not even know they are going short on volatility. They just do what they have seen others do. Their peers who try such strategies very often have Jaguars and homes in the Hamptons. What’s not to like?

The upshot of all this for our purposes is that the “going short on volatility” strategy increases income inequality. In normal years the financial sector is flush with cash and high earnings. In implosion years a lot of the losses are borne by other sectors of society. In other words, financial crisis begets income inequality. Despite being conceptually distinct phenomena, the political economy of income inequality is, in part, the political economy of finance. Simon Johnson tabulates the numbers nicely:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.7

If you’re wondering, right before the Great Depression of the 1930s, bank profits and finance-related earnings were also especially high.8

There’s a second reason why the financial sector abets income inequality: the “moving first” issue. Let’s say that some news hits the market and that traders interpret this news at different speeds. One trader figures out what the news means in a second, while the other traders require five seconds. Still other traders require an entire day or maybe even a month to figure things out. The early traders earn the extra money. They buy the proper assets early, at the lower prices, and reap most of the gains when the other, later traders pile on. Similarly, if you buy into a successful tech company in the early stages, you are “moving first” in a very effective manner, and you will capture most of the gains if that company hits it big.

The moving-first phenomenon sums to a “winner-take-all” market. Only some relatively small number of traders, sometimes just one trader, can be first. Those who are first will make far more than those who are fourth or fifth. This difference will persist, even if those who are fourth come pretty close to competing with those who are first. In this context, first is first and it doesn’t matter much whether those who come in fourth pile on a month, a minute or a fraction of a second later. Those who bought (or sold, as the case may be) first have captured and locked in most of the available gains. Since gains are concentrated among the early winners, and the closeness of the runner-ups doesn’t so much matter for income distribution, asset-market trading thus encourages the ongoing concentration of wealth. Many investors make lots of mistakes and lose their money, but each year brings a new bunch of projects that can turn the early investors and traders into very wealthy individuals.

These two features of the problem—“going short on volatility” and “getting there first”—are related. Let’s say that Goldman Sachs regularly secures a lot of the best and quickest trades, whether because of its quality analysis, inside connections or high-frequency trading apparatus (it has all three). It builds up a treasure chest of profits and continues to hire very sharp traders and to receive valuable information. Those profits allow it to make “short on volatility” bets faster than anyone else, because if it messes up, it still has a large enough buffer to pad losses. This increases the odds that Goldman will repeatedly pull in spectacular profits.

Still, every now and then Goldman will go bust, or would go bust if not for government bailouts. But the odds are in any given year that it won’t because of the advantages it and other big banks have. It’s as if the major banks have tapped a hole in the social till and they are drinking from it with a straw. In any given year, this practice may seem tolerable—didn’t the bank earn the money fair and square by a series of fairly normal looking trades? Yet over time this situation will corrode productivity, because what the banks do bears almost no resemblance to a process of getting capital into the hands of those who can make most efficient use of it. And it leads to periodic financial explosions. That, in short, is the real problem of income inequality we face today. It’s what causes the inequality at the very top of the earning pyramid that has dangerous implications for the economy as a whole.

A Fix That Fits?

A key lesson to take from all of this is that simply railing against income inequality doesn’t get us very far. We have to find a way to prevent or limit major banks from repeatedly going short on volatility at social expense. No one has figured out how to do that yet.

It remains to be seen whether the new financial regulation bill signed into law this past summer will help. The bill does have positive features. First, it forces banks to put up more of their own capital, and thus shareholders will have more skin in the game, inducing them to curtail their risky investments. Second, it also limits the trading activities of banks, although to a currently undetermined extent (many key decisions were kicked into the hands of future regulators). Third, the new “resolution authority” allows financial regulators to impose selective losses, for instance, to punish bondholders if they wish.

We’ll see if these reforms constrain excess risk-taking in the long run. There are reasons for skepticism. Most of all, the required capital cushions simply aren’t that high, so a big enough bet against unexpected outcomes still will yield more financial upside than downside. Furthermore, high capital reserve requirements insulate bank managers from the pressures of both shareholders and bondholders. That could encourage risk-taking and make the underlying problem worse. Autonomous managers often push for risk-taking rather than constrain it.

What about controlling bank risk-taking directly with tight government oversight? That is not practical. There are more ways for banks to take risks than even knowledgeable regulators can possibly control; it just isn’t that easy to oversee a balance sheet with hundreds of billions of dollars on it, especially when short-term positions are wound down before quarterly inspections. It’s also not clear how well regulators can identify risky assets. Some of the worst excesses of the financial crisis were grounded in mortgage-backed assets—a very traditional function of banks—not exotic derivatives trading strategies. Virtually any asset position can be used to bet long odds, one way or another. It is naive to think that underpaid, undertrained regulators can keep up with financial traders, especially when the latter stand to earn billions by circumventing the intent of regulations while remaining within the letter of the law.

It’s a familiar story, repeated many times in the past. If one recalls the Basel I capital agreements for banks, the view was that we would make banks safer by inducing them to hold a lot of AAA-rated mortgage-backed assets. How well did that work out? So, with no disrespect to the regulators or the sponsors of the recent bill, it is hardly clear that enhanced regulation will solve the basic problem.

For the time being, we need to accept the possibility that the financial sector has learned how to game the American (and UK-based) system of state capitalism. It’s no longer obvious that the system is stable at a macro level, and extreme income inequality at the top has been one result of that imbalance. Income inequality is a symptom, however, rather than a cause of the real problem. The root cause of income inequality, viewed in the most general terms, is extreme human ingenuity, albeit of a perverse kind. That is why it is so hard to control.

Another root cause of growing inequality is that the modern world, by so limiting our downside risk, makes extreme risk-taking all too comfortable and easy. More risk-taking will mean more inequality, sooner or later, because winners always emerge from risk-taking. Yet bankers who take bad risks (provided those risks are legal) simply do not end up with bad outcomes in any absolute sense. They still have millions in the bank, lots of human capital and plenty of social status. We’re not going to bring back torture, trial by ordeal or debtors’ prisons, nor should we. Yet the threat of impoverishment and disgrace no longer looms the way it once did, so we no longer can constrain excess financial risk-taking. It’s too soft and cushy a world.

That’s an underappreciated way to think about our modern, wealthy economy: Smart people have greater reach than ever before, and nothing really can go so wrong for them. As a broad-based portrait of the new world, that sounds pretty good, and usually it is. Just keep in mind that every now and then those smart people will be making—collectively—some pretty big mistakes.

How about a world with no bailouts? Why don’t we simply eliminate the safety net for clueless or unlucky risk-takers so that losses equal gains overall? That’s a good idea in principle, but it is hard to put into practice. Once a financial crisis arrives, politicians will seek to limit the damage, and that means they will bail out major financial institutions. Had we not passed TARP and related policies, the United States probably would have faced unemployment rates of 25 percent of higher, as in the Great Depression. The political consequences would not have been pretty. Bank bailouts may sound quite interventionist, and indeed they are, but in relative terms they probably were the most libertarian policy we had on tap. It meant big one-time expenses, but, for the most part, it kept government out of the real economy (the General Motors bailout aside).

So what will happen next? One worry is that banks are currently undercapitalized and will seek out or create a new bubble within the next few years, again pursuing the upside risk without so much equity to lose. A second perspective is that banks are sufficiently chastened for the time being but that economic turmoil in Europe and China has not yet played itself out, so perhaps we still have seen only the early stages of what will prove to be an even bigger international financial crisis. Adherents of this view often analogize 2009–10 to 1929–32, when many people thought that negative economic shocks had stopped and recovery was underway. In 2006, banks were gambling on the housing market, and maybe today they are, as the result of earlier decisions, gambling on China and Europe staying in one economic piece.

A third view is perhaps most likely. We probably don’t have any solution to the hazards created by our financial sector, not because plutocrats are preventing our political system from adopting appropriate remedies, but because we don’t know what those remedies are. Yet neither is another crisis immediately upon us. The underlying dynamic favors excess risk-taking, but banks at the current moment fear the scrutiny of regulators and the public and so are playing it fairly safe. They are sitting on money rather than lending it out. The biggest risk today is how few parties will take risks, and, in part, the caution of banks is driving our current protracted economic slowdown. According to this view, the long run will bring another financial crisis once moods pick up and external scrutiny weakens, but that day of reckoning is still some ways off.

Is the overall picture a shame? Yes. Is it distorting resource distribution and productivity in the meantime? Yes. Will it again bring our economy to its knees? Probably. Maybe that’s simply the price of modern society. Income inequality will likely continue to rise and we will search in vain for the appropriate political remedies for our underlying problems.

1See Jacob S. Hacker and Paul Pierson, “Winner-Take-All Politics: Public Policy, Political Organization, and the Precipitous Rise of Top Incomes in the United States”, Politics & Society (June 2010). For one criticism of those numbers, see Scott Winship, “Hacker-mania!”, ScottWinshipWeb, September 19, 2010. 2Lemieux, “Increasing Residual Wage Inequality: Composition Effects, Noisy Data, or Rising Demand for Skill?” American Economic Review, June 2006. 3See Christian Broda and John Romalis, “Shattering the Conventional Wisdom on Growing Inequality”, New York Times Freakonomics blog, May 19, 2008. 4Gordon, “Misperceptions About the Magnitude and Timing of Changes in American Income Inequality”, National Bureau of Economic Research, NBER Working Paper No. 15351 (September 2009). 5See Thomas Lemieux, W. Bentley Macleod and Daniel Parent, “Performance Pay and Wage Inequality”, Quarterly Journal of Economics (February 2009). 6Kaplan and Rauh, “Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes?” Review of Financial Studies (March 2010). 7Johnson, “The Quiet Coup”, The Atlantic (May 2009). 8See “Wages and Human Capital in the U.S. Financial Industry”, Thomas Philippon and Ariell Reshef, National Bureau of Economic Research, NBER Working Paper No. 14644 (January 2009).




Understanding Poverty in America (What the Census doesn’t count when reporting on the “poor.”)
National Review ^ | 9/10/2009 | Robert Rector

Posted on Thursday, September 10, 2009 10:26:33 AM by SeekAndFind

Today, the U.S. Census Bureau will release its annual poverty report. The report is expected to show an increase in poverty in 2008 due to the onset of the recession. It is no surprise that poverty goes up in a recession. What is surprising is that every year for nearly three decades, in good economic times and bad, Census has reported more than 30 million Americans living in poverty.

What does it mean to be “poor” in America? For the average reader, the word poverty implies significant physical hardship — for example, the lack of a warm, adequate home, nutritious food, or reasonable clothing for one’s children. By that measure, very few of the 30 million plus individuals defined as “living in poverty” by the government are actually poor. Real hardship does occur, but it is limited in scope and severity.

The average person identified as “poor” by the government has a living standard far higher than the public imagines. According to the government’s own surveys, the typical “poor” American has cable or satellite TV, two color TVs, and a DVD player or VCR. He has air conditioning, a car, a microwave, a refrig­erator, a stove, and a clothes washer and dryer. He is able to obtain medical care when needed. His home is in good repair and is not overcrowded. By his own report, his family is not hungry, and he had sufficient funds in the past year to meet his family’s essential needs. While this individual’s life is not affluent, it is far from the images of dire poverty conveyed by liberal activists and politicians.

Various government reports contain the following facts about persons defined as “poor” by the Census Bureau:

Nearly 40 percent of all poor households actu­ally own their own homes. On average, this is a three-bedroom house with one-and-a-half baths, a garage, and a porch or patio.

Eighty-four percent of poor households have air conditioning. By contrast, in 1970, only 36 percent of the entire U.S. population enjoyed air conditioning.

Nearly two-thirds of the poor have cable or satellite TV.

Only 6 percent of poor households are over­crowded; two-thirds have more than two rooms per person.

The typical poor American has as much or more living space than the average individual living in most European countries. (These comparisons are to the average citizens in foreign countries, not to those classified as poor.)

Nearly three-quarters of poor households own a car; 31 percent own two or more cars.

Ninety-eight percent of poor households have a color television; two-thirds own two or more color televisions.

Eighty-two percent own microwave ovens; 67 percent have a DVD player; 73 percent have a VCR; 47 percent have a computer.

The average intake of protein, vitamins, and minerals by poor children is indistinguishable from that of children in the upper middle class. Poor boys today at ages 18 and 19 are actually taller and heavier than middle-class boys of similar age were in the late 1950s. They are a full inch taller and ten pounds heavier than the GIs who stormed the beaches of Normandy during World War II.

Conventional accounts of poverty not only exaggerate hardship, they also underestimate government spending on the poor. In 2008, federal and state governments spent $714 billion (or 5 percent of the total economy) on means-tested welfare aid, providing cash, food, housing, medical care, and targeted social services to poor and low-income Americans. (This sum does not include Social Security or Medicare.) If converted into cash, this aid would be nearly four times the amount needed to eliminate poverty in the U.S. by raising the incomes of all poor households above the federal poverty levels.

How can the government spend so much and still have such high levels of apparent poverty? The answer is that, in measuring poverty and inequality, Census ignores almost the entire welfare state. Census deems a household poor if its income falls below federally specified levels. But in its regular measurements, Census counts only around 4 percent of total welfare spending as “income.” Because of this, government spending on the poor can expand almost infinitely without having any detectable impact on official poverty or inequality.

Also missing in most Washington discussions about the poor is an acknowledgement of the behavioral causes of official poverty. For example, families with children become poor primarily because of low levels of parental work and high levels of out-of-wedlock childbearing with accompanying single parenthood.

Even in the best economic times, the typical poor family with children has, on average, only 16 hours of work per week. Little work equals little income equals more poverty. Nearly two-thirds of poor children live in single-parent homes, a condition that has been promoted by the astonishing growth of out-of-wedlock childbearing in low-income communities. When the War on Poverty began, 7 percent of American children were born outside marriage; today the number is 39 percent.

President Obama is pursuing his agenda to “spread the wealth” through massive hikes in welfare spending financed by unprecedented increases in the federal debt. Before we further expand the welfare state and pile even greater indebtedness on our children, we need a more honest assessment of current anti-poverty spending and the actual living conditions of the “poor.”

— Robert Rector is a senior research fellow at the Heritage Foundation.

Taxes and the Top Percentile Myth

A 2008 OECD study of leading economies found that 'taxation is most progressively distributed in the United States.' More so than Sweden or France.


When President Obama announced a two-year stay of execution for taxpayers on Dec. 7, he made it clear that he intends to spend those two years campaigning for higher marginal tax rates on dividends, capital gains and salaries for couples earning more than $250,000. "I don't see how the Republicans win that argument," said the president.

Despite the deficit commission's call for tax reform with fewer tax credits and lower marginal tax rates, the left wing of the Democratic Party remains passionate about making the U.S. tax system more and more progressive. They claim this is all about payback—that raising the highest tax rates is the fair thing to do because top income groups supposedly received huge windfalls from the Bush tax cuts. As the headline of a Robert Creamer column in the Huffington Post put it: "The Crowd that Had the Party Should Pick up the Tab."

Arguments for these retaliatory tax penalties invariably begin with estimates by economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of U.C. Berkeley that the wealthiest 1% of U.S. households now take home more than 20% of all household income.

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This estimate suffers two obvious and fatal flaws. The first is that the "more than 20%" figure does not refer to "take home" income at all. It refers to income before taxes (including capital gains) as a share of income before transfers. Such figures tell us nothing about whether the top percentile pays too much or too little in income taxes.

In The Journal of Economic Perspectives (Winter 2007), Messrs. Piketty and Saez estimated that "the upper 1% of the income distribution earned 19.6% of total income before tax [in 2004], and paid 41% of the individual federal income tax." No other major country is so dependent on so few taxpayers.

A 2008 study of 24 leading economies by the Organization of Economic Cooperation and Development (OECD) concludes that, "Taxation is most progressively distributed in the United States, probably reflecting the greater role played there by refundable tax credits, such as the Earned Income Tax Credit and the Child Tax Credit. . . . Taxes tend to be least progressive in the Nordic countries (notably, Sweden), France and Switzerland."

The OECD study—titled "Growing Unequal?"—also found that the ratio of taxes paid to income received by the top 10% was by far the highest in the U.S., at 1.35, compared to 1.1 for France, 1.07 for Germany, 1.01 for Japan and 1.0 for Sweden (i.e., the top decile's share of Swedish taxes is the same as their share of income).

A second fatal flaw is that the large share of income reported by the upper 1% is largely a consequence of lower tax rates. In a 2010 paper on top incomes co-authored with Anthony Atkinson of Nuffield College, Messrs. Piketty and Saez note that "higher top marginal tax rates can reduce top reported earnings." They say "all studies" agree that higher "top marginal tax rates do seem to negatively affect top income shares."

What appears to be an increase in top incomes reported on individual tax returns is often just a predictable taxpayer reaction to lower tax rates. That should be readily apparent from the nearby table, which uses data from Messrs. Piketty and Saez to break down the real incomes of the top 1% by source (excluding interest income and rent).

The first column ("salaries") shows average labor income among the top 1% reported on W2 forms—from salaries, bonuses and exercised stock options. A Dec. 13 New York Times article, citing Messrs. Piketty and Saez, claims, "A big reason for the huge gains at the top is the outsize pay of executives, bankers and traders." On the contrary, the table shows that average real pay among the top 1% was no higher at the 2007 peak than it had been in 1999.

In a January 2008 New York Times article, Austan Goolsbee (now chairman of the President's Council of Economic Advisers) claimed that "average real salaries (subtracting inflation) for the top 1% of earners . . . have been growing rapidly regardless of what happened to tax rates." On the contrary, the top 1% did report higher salaries after the mid-2003 reduction in top tax rates, but not by enough to offset losses of the previous three years. By examining the sources of income Mr. Goolsbee chose to ignore—dividends, capital gains and business income—a powerful taxpayer response to changing tax rates becomes quite clear.

The second column, for example, shows real capital gains reported in taxable accounts. President Obama proposes raising the capital gains tax to 20% on top incomes after the two-year reprieve is over. Yet the chart shows that the top 1% reported fewer capital gains in the tech-stock euphoria of 1999-2000 (when the tax rate was 20%) than during the middling market of 2006-2007. It is doubtful so many gains would have been reported in 2006-2007 if the tax rate had been 20%. Lower tax rates on capital gains increase the frequency of asset sales and thus result in more taxable capital gains on tax returns.

The third column shows a near tripling of average dividend income from 2002 to 2007. That can only be explained as a behavioral response to the sharp reduction in top tax rates on dividends, to 15% from 38.6%. Raising the dividend tax to 20% could easily yield no additional revenue if it resulted in high-income investors holding fewer dividend- paying stocks and more corporations using stock buybacks rather than dividends to reward stockholders.

The last column of the table shows average business income reported on the top 1% of individual tax returns by subchapter S corporations, partnerships, proprietorships and many limited liability companies. After the individual tax rate was brought down to the level of the corporate tax rate in 2003, business income reported on individual tax returns became quite large. For the Obama team to argue that higher taxes on individual incomes would have little impact on business denies these facts.

If individual tax rates were once again pushed above corporate rates, some firms, farms and professionals would switch to reporting income on corporate tax forms to shelter retained earnings. As with dividends and capital gains, this is another reason that estimated revenues from higher tax rates are unbelievable.

The Piketty and Saez estimates are irrelevant to questions about income distribution because they exclude taxes and transfers. What those figures do show, however, is that if tax rates on high incomes, capital gains and dividends were increased in 2013, the top 1%'s reported share of before-tax income would indeed go way down. That would be partly because of reduced effort, investment and entrepreneurship. Yet simpler ways of reducing reported income can leave the after-tax income about the same (switching from dividend-paying stocks to tax-exempt bonds, or holding stocks for years).

Once higher tax rates cause the top 1% to report less income, then top taxpayers would likely pay a much smaller share of taxes, just as they do in, say, France or Sweden. That would be an ironic consequence of listening to economists and journalists who form strong opinions about tax policy on the basis of an essentially irrelevant statistic about what the top 1%'s share might be if there were not taxes or transfers.

Mr. Reynolds is a senior fellow at the Cato Institute and the author of "Income and Wealth" (Greenwood Press 2006).


WSJ econ blog Feb 18, 2011
12:52 PM

Q&A: Peterson Institute’s Bergsten on China’s Currency

By Michael Casey

The widely quoted and influential director of the Peterson Institute for International Economics in Washington, Fred Bergsten has until recently been one of the most prominent critics of China’s policy of intervening in foreign exchange markets to weaken its currency. Now he thinks progress is finally being made to resolve this acrimonious dispute between the U.S. and China. In an article he wrote for the Institute’s website last week, he said that a “breakthrough” appeared to have been made because of a combination of Chinese inflation and the gradual appreciation in the yuan’s nominal exchange rate to the dollar since mid-2010, which is putting the inflation-adjusted exchange rate on track to achieve a needed correction of 20 to 30% over the next two to three years.

You recently wrote that the combination of inflation and gradual appreciation in the Chinese yuan’s exchange rate could be achieving a “breakthrough” in terms of U.S. demands for an increase in Chinese competitiveness. You said the increase in the inflation-adjusted real exchange rate was now in line with the trend that’s expected of China over the next two years. Can you explain?

Bergsten: The real [inflation-adjusted] renmimbi exchange rate has appreciated against the dollar at an annual rate of about 12% since last June, although considerably less on a trade-weighted basis. The dollar has fallen against most other currencies, so on a trade-weighted basis, the renmimbi has risen less. On the other hand, one has to accept that the Chinese think of this totally in dollar terms. So the dollar exchange rate is a legitimate focus for them, and if you believe that the dollar is going to bounce around and come back over time it will drag the renmimbi back up with it [against those other currencies.]

They have been letting [the real exchange rate] go up an average of 10 to 12% on an annual basis so it’s fair to say that if they would let that continue for another couple of years they would achieve a restoration of underlying equilibrium in the exchange rate. That would take away most, if not all, of the distortions that their persistent interventions have created.

About four months ago, you estimated that the yuan was 30% undervalued, and many commentators read that as a strong critique of China’s exchange rate policy. Have the changes over past four months improved things enough for the U.S. to accept that the policy of deliberate undervaluation has changed?
Bergsten: During its previous period of appreciation [between 2005 and 2008] the renmimbi went up 20 to 25% in a period of two and half years. I suggested recently that the goal should be the same amount this time and [Treasury Secretary Timothy] Geithner seemed to endorse this. I took that as a kind of wide agreement on what the outcome should be.

You’re talking about real exchange rate adjustments in which inflation plays a key role. Surely it would be China’s and other countries’ interests to have this adjustment take place through the nominal exchange rate and avoid the disruptions that inflation could cause in the world’s second biggest economy?
Bergsten: Yes, especially given China’s history of hyperinflation, it would be far better to adjust via the nominal rate. It has always surprised me that they seem to prefer to do part of it through inflation. And now that they are really worried about inflation, which has become the focal point of their economic policy, this would be the perfect time for them to let the currency adjust. They know the currency is going to adjust over time anyway and it is better to let it happen through the nominal rate. At the same time, it’s an ideal time for us if they make the move now because it will help rebalance our external accounts and help deal with our high unemployment. From the standpoint of both sides there couldn’t be a better time to adjust the nominal exchange rate for the renmimbi.

Surely other countries aren’t happy about China basing its appreciation policy solely on the dollar exchange rate when the dollar itself is falling sharply against other currencies, especially emerging market currencies.
Bergsten: One of the reasons the Chinese are moving now is because they have gotten a pretty wide array of complaints from other emerging markets — from Brazil, from India, from Mexico and others. They have been quite pointed in their criticism. Most of them have respected China’s desire not to be criticized publicly, so they do it privately. I’ve been in on some of those discussions, recently at Davos, for example. There is a lot of pressure on the Chinese from other emerging market countries.



Irish mist

The government elected next week should stick to pro-growth policies

Ireland’s troubles

THE story of Ireland is like a fairy tale: from rags to riches and back to rags again. Twenty-five years ago Ireland was mired in a deep peat bog of slow growth, high emigration and shocking poverty. Then came the miracle of the “Celtic Tiger”, which briefly made Ireland the second-richest country in the European Union. But hubris was followed by nemesis, as a frothy boom turned into a spectacular bust: the banks were rescued by the government, which in turn has now had to accept a humiliating bail-out from the EU and the IMF.

It is little wonder that, in next week’s general election, angry Irish voters are poised not just to kick out the government but to give Fianna Fail, haughtily accustomed to being Ireland’s ruling party, its biggest drubbing since it was founded 85 years ago. Nor is it surprising that many should now be fretting that the entire Celtic Tiger was an illusion—and that Ireland might be heading back to the gloom of the 1980s.

Such fears are overstated. Ireland’s people are experiencing a wrenching recession and a sharp cut in living standards. The Irish state is going to be weighed down by an intolerably large debt burden. But if the new government, which seems almost certain to be led by Fine Gael’s Enda Kenny, follows the right policies, the underlying economy is resilient enough, and Ireland’s demographic outlook is favourable enough, for it to return to the path of prosperity.

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This is to deny neither the epic scale of the Irish property bust nor the visible and not-so-visible scars it has left behind (see article). Clearing up this mess has already cost Ireland as much as one-seventh of its national income. The immediate concern for the new government must be its ballooning sovereign debt. Mr Kenny has promised to renegotiate the penal interest rate that the government is paying for its bail-out. He will meet fierce Franco-German resistance, but Ireland is another prompt for the EU, and Germany in particular, to look at a broader, formal restructuring (including Greece and probably Portugal). Investors know that the current bail-outs are not sustainable: a plan B is needed. In Ireland’s case a restructuring should involve a haircut for some bank creditors—and then a lower interest rate on the debt that is left.

What about the longer term? One priority for the new government ought to be to root out the cronyism (and its linked party financing) that gave property developers too much political influence. But Mr Kenny’s main responsibility is to sustain the policies that first fostered Ireland’s strong growth. These included encouraging more women into work, keeping tax rates low, luring foreign (notably American) direct investment and investing in secondary and higher education. A flexible labour market with sensible trade unions, and an openness to immigration, have also proved critical in enabling Ireland to cut real wages and regain some of the competitiveness it has lost against Germany. It has done this faster than the countries of the southern Mediterranean. In effect, the Irish have in the past two years carried out an “internal devaluation” similar to the one that Latvia achieved in 2009. As a result, exports are already growing and Ireland has moved into a current-account surplus. Far from seeing Ireland as a case-study in what not to do, the troubled Mediterranean members of the euro would do well to learn from it.

Doing Dublin down

Is there a risk of some of these sound policies being jettisoned? For the most part, Mr Kenny will find his hands tied on macroeconomic matters. Ireland cannot afford to quit Europe’s single currency, the euro. It will have to comply with the conditions set by the EU and the IMF for their bail-out, however much Mr Kenny may grumble about its terms. And surely nobody in Ireland wants to dump policies that have proved so beneficial to growth.

The worry lies, rather, in pressure from other countries in the euro. There is talk in the euro zone of building a stronger social and political counterpart to monetary union, which might include such notions as harmonised tax bases and labour laws. The symbolic pinch-point for Ireland is its 12.5% corporate-tax rate, which France and Germany self-interestedly want to force up. Their argument is that they are bailing out a bust Irish government which is holding taxes artificially low (never mind that Ireland’s low corporate-tax rate yields proportionally bigger revenues than in most other countries).

Fortunately tax matters are decided by unanimity in the EU. Mr Kenny and his new government must veto any attempt to impose a higher corporate-tax rate on Ireland. That would be welcome evidence that they will stick with the country’s pro-business and pro-growth policies.

After the race

Once among the richest people in Europe, the Irish have been laid low by a banking collapse and the euro zone’s debt crisis. What now?

Ireland's crash



“THERE’S a craze for land everywhere!” The line draws wry laughs from audiences in Dublin’s Olympia Theatre at a revival of “The Field”, John B. Keane’s play about a land dispute in south-west Ireland. Their country has been transformed since the play was first staged 45 years ago. But Mr Keane’s lines also belong to a more recent time in Irish history.

Consider St Michael’s Green, an abandoned half-built housing estate near the village of Lixnaw, in north Kerry. “Look at what’s coming soon to Lixnaw”, proclaims a sign at the entrance. Visitors who take up the offer are met with an apocalyptic sight. Four finished houses, complete with driveways, stand in line. Windows are broken; shards of glass are strewn on the ground. Peer (carefully) through the window-frames and you can see doors hanging from hinges and semi-carpeted floors. Opposite the houses, surrounded by metal fencing, some of it collapsed, are the exposed foundations of houses never built. Rubble and rubbish lie everywhere. With wind howling and rain lashing, it is easy to imagine that you are gazing on the ruins of a failed civilisation. And in a way you are.

Such “ghost estates” are only the most visible scars of Ireland’s extraordinary crash, which in four years has turned the country from Europe’s star performer into a sickly invalid. After a long history of poverty and unemployment, the Irish thought they had finally transformed their country into a successful modern state. Now they find themselves saddled with staggering debts and an international bail-out. Some wonder whether the country’s achievements in recent years counted for anything at all. How did this happen? And what comes next?

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In the 1990s Ireland became the “Celtic Tiger”. Sensible policies and a benign global economy helped it catch up with European neighbours that for decades had left it languishing. Between 1993 and 2000 average annual GDP growth approached 10%. But then someone put speed in the tiger’s water. Over the last decade the boom turned bubbly, as low interest rates and reckless lending, abetted by dozy regulation, pushed up land values and caused Ireland to turn into a nation of property developers. In County Leitrim, in the Irish Midlands, housing construction outstripped demand (based on population growth) by 401% between 2006 and 2009, according to one estimate.

Few minded. The Irish became, by one measure, the second-richest people in the European Union. “The boom is getting boomier,” said Bertie Ahern, Ireland’s taoiseach (prime minister), in 2006. The government began exporting the Celtic Tiger model, telling other small countries that they, too, could enjoy double-digit growth rates if they followed Ireland’s lead. People splashed out on foreign holidays, new cars and expensive meals. “We behaved like a poor person who had won the lottery,” says Nikki Evans, a businesswoman.

Then it all began to go wrong. Property prices started sliding in 2006-07, leaving the banks hopelessly exposed. “What happened in Ireland was very boring,” says Morgan Kelly, an economist at University College, Dublin, and one of the few observers to have predicted the crash. “There were no complex derivatives or shadow banking systems. This was a good old 19th-century, or even 17th-century, banking collapse.” On September 15th 2008 Lehman Brothers tumbled, sending a giant tremor round the world. Two weeks later, with the share prices of Irish banks in free fall, the government took the fateful decision to guarantee liabilities worth €400 billion ($572 billion) at six financial institutions.

The costs of the rescue mounted as the banks’ losses grew, springing a giant hole in the public finances. The banking crisis had become a sovereign-debt crisis. International investors began to target Ireland as a weak link in the euro zone, raising its borrowing costs to unsustainable levels. In November 2010 it became the second country in the euro zone, after Greece, to accept a bail-out from the EU and the IMF.

“I can’t tell you how depressing it is here now,” says Anne Enright, a novelist. An austerity budget pushed through to meet the terms of the €85 billion bail-out is starting to hit pockets. Unemployment has shot up to 13.4%, wages have fallen and, after a peak-to-trough contraction of 14% of GDP, the economy is still flatlining. “It’s very demoralising that this thing has happened when we thought we had arrived at a modern industrialised society,” says David Begg, general secretary of the Irish Congress of Trade Unions.

The myths of success

Not everyone welcomed the changes that prosperity brought. Kevin Barry, a writer who had been living abroad, returned home to find that “people only spoke about two things: property prices and commuting times. It was extremely boring.” Ms Evans, who runs PerfectCard, a pre-paid debit-card business, saw some of her younger staff acquire a sense of entitlement which made them hard to motivate. (It’s easier now, she says.)

As Ireland grew richer, one form of exceptionalism—the fatalistic belief that Ireland was destined always to be western Europe’s poor outpost—gave way to another: the myth of the Celtic Tiger. “We’re very narcissistic,” says Ms Enright. “We believed our boom was better than anyone else’s.” The twin articles of independent Ireland’s faith, Catholicism and nationalism, were eclipsed by material ambition: the desire to get on, to improve one’s station in life. “People lost interest in the other world while they were so successful in this one,” says Mark Patrick Hederman, abbot of Glenstal Abbey, near Limerick.

The new Ireland looked attractive to outsiders. When the country opened itself to new EU members after the 2004 eastward expansion, Poles and others poured in looking for work (see chart 1). Rather than resenting the newcomers, many Irish were proud that their country had become a place people wanted to enter rather than leave. “The country was welcoming, open, easy-going,” says Monika Sapielak, a Pole who began to visit in 2001 and who now runs a contemporary-arts centre in Dublin. “There was a sense that anything was possible.” Not any more.

Many people see the economic crisis as a chance to jettison the baggage of excess that marked the later Tiger years. The first casualty will be Fianna Fail, the party that presided over the “boomier” years and, in coalition with the Greens, the subsequent crash. In a general election on February 25th, voters will boot the party out; the polls suggest it could fall to third place, behind Fine Gael and the Labour Party.

This alone is a big story. Fianna Fail is the “natural” party of government in Ireland: it has been in power for three out of every four years since winning a landslide victory in 1932, and it has been the biggest party in parliament ever since. Yet it is hard to detect a whiff of revolution. The next government will almost certainly be led by Fine Gael (probably in coalition with Labour), a party with a centre-right platform not obviously distinct from Fianna Fail’s. (In Ireland’s peculiar politics, the difference between the two main parties dates from the 1922 civil war, fought over the terms of independence from the British.) Few believe the party would have been a more responsible steward of the Celtic Tiger. Enda Kenny, its leader and probably the next taoiseach, is no more setting Irish hearts alight in this campaign than in his 36 years in parliament. A telling sign of the mood is that although 95% of voters say they are unhappy with the government, 16% of them plan to vote for it.

Enda Kenny will renegotiate the bail-out—and fix your drains

At this tumultuous time for Europe—deadly riots in bailed-out Greece, hundreds of thousands marching over pension reform in France, a general strike in Spain—Ireland’s collapse may be the worst trauma of all. But apart from a union-led demonstration in Dublin in November, there have been few outward signs of rage. Why do the Irish seem so quiescent?

As a small country, Ireland is a hard place to hide in. Reports abound of disgraced bankers being hounded out of pubs by burned investors, or Fianna Fail candidates having dogs set on them. “There aren’t that many strangers in Ireland,” says Ruairi Quinn, a Labour frontbencher. This, some say, acts as a safety valve, allowing citizens to vent their anger directly rather than take to the streets.

But it also lends Irish politics an oddly intimate flavour. National candidates tout achievements that in other countries would be considered the domain of local councillors. This goes along with a proportional voting system that forces candidates of the same party to compete for votes, turning elections into intensely personal contests. “If you’re not seen to be helping your constituents, you will not be re-elected,” says Martin Ferris, Sinn Fein TD (member of parliament) for Kerry North.

During a windy canvassing session in a middle-class area of Tralee, County Kerry’s largest town, many voters say they will back Mr Ferris because they remember how, seven years ago, he worked to improve access to local footpaths and tackle anti-social behaviour. Not one mentions his party’s policies. You would expect this lot to be Fine Gael supporters, says a party worker, who appears to know them all personally. But Mr Ferris has won them round. She herself began canvassing for him because of his community work.

A TD working the campaign trail looks like democracy in action. But there are problems. Ambitious types do not want to spend their careers promising to fill in potholes and deliver passports, so they avoid politics. Moreover, the endless focus on local issues distracts from the business of running the country. “Politicians say, ‘Elect me and I’ll get you a swimming pool.’ You’ll get your pool, but there won’t be any money to run it,” says Damian Loscher of Ipsos MRBI, a market-research agency.

The radical transformation of Ireland into a globalised economy left some old attitudes untouched. Voters continued to tolerate levels of misbehaviour and, in some cases, outright corruption in their politicians that in other countries would have ended careers. Cronyism flourished, as businessmen, politicians and bankers sealed themselves off in a cosy world of golf matches, fine dining and the Fianna Fail tent at the Galway races. “It felt like an old boys’ club,” says Ms Evans—who had to use personal contacts, too, to get the government’s attention.

Fond, but not in love

When the EU and IMF delegations arrived in Dublin for bail-out talks last November, the Irish Times ran a lachrymose editorial asking if this was what the national heroes of the 1916 Easter Rising had died for. Outsiders saw this as a sign of resentment from a proud nation that was once again having its affairs run by foreigners. Yet the editorial went on: “The true ignominy…is that we ourselves have squandered [our sovereignty].” Having seen their leaders make such a mess of things, most Irish welcome the arrival of technocrats.

Still, one long-term effect of this crisis may be a cooling of Ireland’s love affair with the EU. When the country joined what was then the European Economic Community in 1973, children danced in the streets. Agricultural subsidies and infrastructure funding flooded in from Brussels. Equal membership in a club of nations was a seal of sovereignty. Ireland remains more positive about the EU than most other members. But the Irish have begun to suspect that the “solidarity” they hear so much about from European leaders does not apply to their troubled economy.

The terms of the European element of the bail-out arouse particular ire. There is something approaching a consensus in Ireland that the country rescued Europe (specifically, German and French investors that had lent heavily to Irish banks) last November, rather than the other way around. There have been heated exchanges between Irish and EU politicians over how to apportion the blame for Ireland’s crash. Some compare Ireland’s bank guarantee unfavourably with Iceland’s decision, after a similar meltdown in October 2008, to let the banks go to the wall, creditors be damned. Eyeing an opportunity, the parties that are likely to form the next Irish government have made extravagant campaign promises about renegotiating the bail-out package. They may find it difficult to keep them once in office.

Ireland is not about to adopt the Euroscepticism of its larger neighbour, Britain. But it is bound to become more pragmatic. The new government will, for example, fight hard for permission to impose bank losses on creditors not covered by the 2008 guarantee (something the European Central Bank rejected during the bail-out negotiations). “The attitude has shifted from ‘We want to be part of Europe’ to ‘We need to be part of Europe’,” says Mr Loscher.

One fear is that a growing number of young people will not be part of Europe at all. Lack of prospects will drive them to America, Canada or Australia. For at least 150 years, emigration has been the instinctive Irish response to hardship. Alan Barrett of the Economic and Social Research Institute (ESRI), a Dublin-based research body, says emigration is to the Irish what inflation is to the Germans: a trauma formed by economic wounds inflicted decades ago that still runs deep in the collective memory. The generation that came of age in the Celtic Tiger years was the first that did not feel it had to move abroad to thrive. But for now, those days are over.

A recent report by the ESRI, based on employment forecasts, estimates that a net 100,000 people will leave Ireland between April 2010 and April 2012. That is a lot: at its peak, the net annual outflow in the 1980s was 44,000. Evidence of the exodus is already emerging. Work-placement and visa-assistance companies are advertising widely. Election candidates report that emigration is a big issue on the doorstep.

Still, many argue that a population willing to move to where the jobs are is exactly what a country in Ireland’s predicament needs. Historically, labour mobility has helped to keep a lid on unemployment. And there have been other benefits: the diaspora, particularly in the United States, has proved a useful asset for Ireland, politically as well as economically. Moreover, a move abroad today is hardly the one-way ticket it was for many in the 19th century. When Ireland started to boom in the 1990s many émigrés returned home, bringing with them much-needed skills and capital.

But such arguments will ring largely hollow in a country where emigration is so strongly linked to feelings of national shame. “You can talk about the collapse in GNP,” says Mr Barrett, “but the emotional touchstone of emigration is a major issue. That’s why there is a great sense of regret.”

Tiger no more

In five years’ time Ireland will mark the 100th anniversary of the Easter Rising. The country will ask itself how far it has satisfied the hopes of those who fought for its independence. Some fear that the crash has shown the Celtic Tiger to have been a phantom, an illusionist’s trick that distracted Ireland from its underlying poverty with glitzy cars and big houses.

It is true that Ireland will not soon pull itself from the economic bog. Recovery will be slow at best, particularly if an inflation-wary ECB starts to jack up interest rates. Unemployment is likely to stay in double figures for some time. Some fear that the cost of servicing the debts to the EU and IMF, and of feeding the insatiable maw of the banks, will eventually force Ireland into a debt restructuring. This would be a terrible blow to a country desperate to believe that the worst is over.

Yet Ireland is not about to return to the dark days of the 1980s. Numerically, the recession has sent living standards back only to the levels of around 2002 (see chart 2). The flexible economy will remain attractive to multinationals seeking a toehold in Europe, especially if it keeps its low corporate-tax rate. Domestic demand is still depressed—a big concern. But unlike other troubled euro-zone countries, Ireland is regaining competitiveness by reducing unit labour costs. Exports are booming, and there should be a current-account surplus this year for the first time in over a decade. The demographic outlook is favourable. “There are no brakes to growth if we can get this thing going,” says Danny McCoy, head of the Irish Business and Employers Confederation.

At least as important, despite the fog of gloom sitting over the country, Ireland has much to be proud of. Not all the gains of the Celtic Tiger years were squandered. An optimistic, entrepreneurial spirit emerged that will not be crushed by a few years of recession. Higher education has expanded dramatically—30% of Irish students are the first in their family to attend university—as has the labour force. A generation has grown up knowing nothing but prosperity. This accumulation of expectation and experience makes Ireland a very different country from the weary, fearful place of the mid-1980s.

Perhaps the most hopeful future for Ireland lies in becoming, for the first time, an ordinary small European country, with a properly functioning democratic system and a stable, diversified economy. But first it must begin to see itself with sober eyes. Kevin Gardiner of Barclays Wealth, who coined the phrase “Celtic Tiger” in 1994, says that Celts have a nasty habit of extrapolating both good and bad times for ever (as a Welshman, he dares to make such generalisations). Just as the Irish suffered a bad bout of irrational exuberance in the boom years, they have now been overcome by excessive pessimism. Or, as Ms Enright puts it, “Ireland is a series of stories it tells itself. None of them are true


February 18, 2011, 6:00 am

 Emerging Markets as Partners, Not Rivals



Published: February 12, 2011

IN his State of the Union address last month, President Obama set the stage for a coming policy debate and his re-election bid with a catch phrase. Six times, he called on Americans to “win the future.” And he used the variant “winning the future” three other times. But is this really a good way to frame the economic challenges we face?

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David G. Klein

No doubt, the phrase appealed to White House political advisers and speechwriters. It is always better for presidents to focus on our future potential than the immutable past. And who doesn’t want to win? Americans love rooting for their favorite teams, and no contest seems more vital than that for international economic dominance.

Yet this catch phrase is also problematic. For one thing, “Winning the Future” was the title of a 2005 book by Newt Gingrich. It is almost as if Mr. Gingrich were to run for president in 2012 under the banner “Audacious Hope.” And then there is that pesky abbreviated form of the phrase — WTF — that does not exactly inspire confidence.

More troublesome to me as an economist, though, is that calling on Americans to “win the future” misleads us about the nature of the policy choices ahead. Achieving economic prosperity is not like winning a game, and guiding an economy is not like managing a sports team.

To see why, let’s start with a basic economic transaction. You have a driveway covered in snow and would be willing to pay $40 to have it shoveled. The boy next door can do it in two hours, or he can spend that time playing on his Xbox, an activity he values at $20. The solution is obvious: You offer him $30 to shovel your drive, and he happily agrees.

The key here is that everyone gains from trade. By buying something for $30 that you value at $40, you get $10 of what economists call “consumer surplus.” Similarly, your young neighbor gets $10 of “producer surplus,” because he earns $30 of income by incurring only $20 of cost. Unlike a sports contest, which by necessity has a winner and a loser, a voluntary economic transaction between consenting consumers and producers typically benefits both parties.

This example is not as special as it might seem. The gains from trade would be much the same if your neighbor were manufacturing a good — knitting you a scarf, for example — rather than performing a service. And it would be much the same if, instead of living next door, he was several thousand miles away, say, in Shanghai.

Listening to the president, you might think that competition from China and other rapidly growing nations was one of the larger threats facing the United States. But the essence of economic exchange belies that description. Other nations are best viewed not as our competitors but as our trading partners. Partners are to be welcomed, not feared. As a general matter, their prosperity does not come at our expense.

To be sure, there are exceptions to this rule. When China uses our intellectual property such as software without paying for it, we should view that as a form of theft. And when other nations’ economic growth has side effects on the global environment, as it does when they emit the greenhouse gases that contribute to climate change, the United States has good reason for concern. But these limited exceptions should not blind us into taking a more generally adversarial approach to international economic relations.

During the address, Mr. Obama lamented the fact that many foreign students attended colleges and universities in the United States and then returned to their countries of origin. “As soon as they obtain advanced degrees, we send them back home to compete against us,” he said. “It makes no sense.”

The president is right that we should encourage a greater number of highly educated foreigners to migrate here. Because skilled workers pay more in taxes than they receive in government benefits, increasing their supply would reduce the fiscal burden on the rest of us. But if these foreign students decide to return home, as many do, we shouldn’t worry that they are competing against us.

Instead, we should view higher education in the United States as one of our most successful export industries. The United States has 5 percent of the world’s population but most of the best universities. Is it any wonder that students from many nations flock here to learn? And as they do so, they create opportunities for Americans — from the professors who teach the classes to the grounds crews who maintain the campuses.

When the foreign students head home, they take the human capital acquired here to become productive members of their own communities. They spread up-to-date knowledge, so it can foster prosperity everywhere. Some of this knowledge is technological. Some of it concerns business, legal and medical practices. And some is even more fundamental, such as the values of democracy and individual liberty. Nothing could be better for the United States than these thousands of American-trained ambassadors who have seen at first hand the benefits of a free and open society.

As we confront the many hard policy choices ahead, let’s prepare for the future. Let’s invest for the future. Let’s be willing to make hard sacrifices for a more prosperous future. But let’s not presume that the future is a game requiring winners and losers.

N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President George W. Bush.



  • WSJ FEBRUARY 23, 2011

The Federal Reserve Is Causing Turmoil Abroad

Few protesters in the Middle East connect rising food prices to U.S. monetary policy. But central bankers do.


In accounts of the political unrest sweeping through the Middle East, one factor, inflation, deserves more attention. Nothing can be more demoralizing to people at the low end of the income scale—where great masses in that region reside—than increases in the cost of basic necessities like food and fuel. It brings them out into the streets to protest government policies, especially in places where mass protests are the only means available to shake the existing power structure.

The consumer-price index in Egypt rose to more than 18% annually in 2009 from 5% in 2006, a more normal year. In Iran, the rate went to 25% in 2009 from 13% in 2006. In both cases the rate subsided in 2010 but remained in double digits.

Egyptians were able to overthrow the dictatorial Hosni Mubarak. Their efforts to fashion a more responsive regime may or may not succeed. Iranians are taking far greater risks in tackling the vicious Revolutionary Guards to try to unseat the ruling ayatollahs.

Probably few of the protesters in the streets connect their economic travail to Washington. But central bankers do. They complain, most recently at last week's G-20 meeting in Paris, that the U.S. is exporting inflation.

China and India blame the U.S. Federal Reserve for their difficulties in maintaining stable prices. The International Monetary Fund and the United Nations, always responsive to the complaints of developing nations, are suggesting alternatives to the dollar as the pre-eminent international currency. The IMF managing director, Dominique Strauss-Kahn, has proposed replacement of the dollar with IMF special drawing rights, or SDRs, a unit of account fashioned from a basket of currencies that is made available to the foreign currency reserves of central banks.

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Associated Press

The turmoil in Iran is reminiscent of another period when the Fed was on an inflationary binge, the late 1970s.


About the only one failing to acknowledge a problem seems to be the man most responsible, Federal Reserve Chairman Ben Bernanke. In a recent question-and-answer session at the National Press Club in Washington, the chairman said it was "unfair" to accuse the Fed of exporting inflation. Other nations, he said, have the same tools the Fed has for controlling inflation.

Well, not quite. Consider, for example, that much of world trade, particularly in basic commodities like food grains and oil, is denominated in U.S. dollars. When the Fed floods the world with dollars, the dollar price of commodities goes up, and this affects market prices generally, particularly in poor countries that are heavily import-dependent. Export-dependent nations like China try to maintain exchange-rate stability by inflating their own currencies to buy up dollars.

Mr. Bernanke has made it clear that his policy is to inflate the money supply. His second round of quantitative easing—the controversial QE2 policy to systematically purchase $600 billion in Treasury securities with newly created money—serves that aim. But even for the U.S. it is uncertain that Mr. Bernanke can hold to his 2% inflation target. Oil is going up. Foodstuffs are going up. And when the Fed sneezes money, the weak economies of the world, and the poor masses who are highly vulnerable to price rises in the necessities of life, catch pneumonia.

The turmoil in Iran is reminiscent of another period when the Fed was on an inflationary binge, the late 1970s. The Iranian oil boom had brought many thousands of peasants out of the villages into the cash economy in population centers like Tehran. On top of the disorientation resulting from that change itself, Iranians were then victims of an outbreak of inflation and a sharp decline in the purchasing power of the rials in their pay envelopes. Confused and angry, they supported the clerical revolution that unseated the shah and has been a thorn in America's side ever since.

Today's Iranian revolt has similar causes and, if successful, could be the flip side of 1979, a nation again friendlier toward the U.S. But there is no guarantee of that, or that states now friendly, like Bahrain, will remain so after an Egyptian-style upheaval.

Indeed, it is unlikely that Americans themselves will escape the inflationary consequences of current Fed policy. Aside from the rise in oil and foodstuffs, higher prices of manufactured goods are in the offing. China's inflation rate is hovering at 5%. MKM Partners, a research and trading firm, last November reported that an internal study at Wal-Mart, a big importer from China, showed that the huge retail chain's prices are edging up at an annual rate of 4% a year. That recent trend showed up in last week's consumer-price index report.

The Fed is financing a vast and rising federal deficit, following a practice that has been a surefire prescription for domestic inflation from time immemorial. Meanwhile, its policies are stoking a rise in prices that is contributing to political unrest that in some cases might be beneficial but in others might turn out as badly as the overthrow of the shah in 1979. Does any of this suggest that there might be some urgency to bringing the Fed under closer scrutiny?

Mr. Melloan, a former columnist and deputy editor of the Journal editorial page, is author of "The Great Money Binge: Spending Our Way to Socialism" (Simon & Schuster, 2009).

  • WSJ FEBRUARY 23, 2011

Icelandic Freeze-Out

The tiny island nation shouldn't have to bear the costs of the Dutch and British bailouts.

Iceland's voters will once again get to have their say over whether they should bear the cost of the 2008 bailouts of British and Dutch depositors in Icelandic banks. And a new poll out yesterday suggests that this time, they might just approve the deal, struck in December between the governments of the three countries. A yes vote in a referendum likely to be held in early April would leave Iceland in hock to London and The Hague for as long as 35 years—and this because the British and Dutch governments decided, of their own volition, to bail out their own citizens.

The dispute dates back to the height of the financial panic. Icelandic banks, which had aggressively marketed high-yielding savings products in the EU, collapsed when the financial markets seized up that fall, leaving the deposits of more than 300,000 Dutch and British depositors in jeopardy. The decision to bailout Icesave depositors in their countries cost those governments £3.1 billion ($5 billion)—but all of that money went to their own countrymen, those who had made the choice of investing their savings in Iceland. It did nothing to stave off the near-total collapse of Iceland's banking sector or the collapse in its currency. And thanks in part to British and Dutch demands for repayment, Iceland remains, two and a half years later, shut out of global capital markets.

Last year, Icelandic voters overwhelmingly rejected an earlier deal to repay the money over 15 years. The new agreement should prove much less costly to Icelandic taxpayers than the original, with the President estimating that they could be on the hook for as little as £246 million in direct costs. But it's unclear why Iceland should bear the costs of bailing out the Dutch and British at all.

If those countries' governments felt it necessary to make their people whole, that is their affair. It's hardly surprising that the people of Iceland would prefer to put the whole business behind them, as the most recent polling suggests. But that should not be taken as vindication of the U.K.'s and Netherlands' two-and-a-half year campaign of vilification of Iceland.

Printed in The Wall Street Journal, page 11

  • WSJ FEBRUARY 23, 2011

The Myth of Corporate Cash Hoarding

Companies hire more workers when there's income to pay them. They don't liquidate financial assets.


American nonfinancial corporations were "sitting on" $1.93 trillion in liquid assets at the end of last year's third quarter, according to the Federal Reserve Board. This has become one of the most frequently echoed statistics, viewed as indisputable evidence that U.S. business leaders are unduly timid or evil.

Last September, Chris Matthews, the host of MSNBC's "Hardball," asked Politico's Charles Mahtesian, "You think business can sit on those billions and trillions of dollars for two more years after they screw Obama this time? Are they going to keep sitting on their money . . . to get Mr. Excitement Mitt Romney elected president? Will they do that to the country?" Mr. Mahtesian concurred.

More recently, Washington Post columnist Harold Meyerson opined that, "U.S. corporations can't sit on their nearly $2 trillion in cash reserves forever, but that doesn't mean they're going to invest their stash in job-creating enterprises within the United States." And the "nearly $2 trillion in cash" was included in this newspaper's four key numbers of the year—right up there with jobs, oil prices and world trade. "In an ideal world," that report suggested, "2011 would see cash-rich companies step up their hiring."

Like so many statistics used to score political points, this datum de jour has been totally misunderstood. The chorus of media outrage about supposedly excessive corporate cash reveals nothing about the financial health of any U.S. business. It simply reveals appalling ignorance of elementary accounting.

Consider four basic points:

1) There are two sides to a balance sheet: assets and liabilities.

2) Liquid assets serve as a vital safety cushion to minimize the impact (on workers and suppliers) of unanticipated business difficulties.

3) A corporate balance sheet is not an income statement.

4) Corporations commonly use both internal and external sources of funds to acquire both real and financial assets at the same time. Larger investments in money-market funds and bank CDs do not mean smaller investment in plant and equipment, as many seem to imagine.

Point No. 1, about two-sided balance sheets, reminds us that single-entry bookkeeping will not do. The financial health of corporations is not measured by the form in which assets are held (liquid or not), but by net worth.

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From 2007 to September 2010, the value of nonfinancial corporate real estate fell by more than 30%—a loss of more than $2.8 trillion. The ratio of cash to total assets rose largely because the value of total assets collapsed. Meanwhile, liabilities topped $13.6 trillion last fall, up from $12.9 trillion at the last cyclical peak. With real estate falling and debts rising, the net worth of nonfinancial corporations was only $12.6 trillion at last count—down from $15.9 trillion in 2007.

Point No. 2, about safety cushions, alerts us to the fact that $1.93 trillion of liquid assets would not begin to cover $3.67 trillion of short-term debts, let alone ongoing expenses such as payroll. To describe the liquid assets as "hoarding" (regardless of debts) is witless. The recession in 2008-09 would have been far less painful if nonfinancial corporations in 2007 had been "hoarding" more liquid assets (they had $1.53 trillion).

Point No. 3, about the difference between a balance sheet (what a company owns and owes) and an income statement (money received and spent) is basic accounting. Outraged proclamations about the $1.93 trillion figure show zero understanding of this difference.

Firms hire out of income, not by liquidating assets or adding to debt. No sensible employer plans on meeting routine payroll expenses by drawing down assets, liquid or not.

Decisions to increase or reduce hiring are unrelated to decisions to increase or reduce any assets on the balance sheet. Companies add workers if the expected addition to after-tax revenues is likely to exceed the addition to costs (including taxes and mandated benefits).

Point No. 4 is related to Point No. 3. Consider that in the balance-sheet section of the Federal Reserve flow-of-funds accounts, where the now-famous $1.93 trillion appears, investments in liquid assets are a use of funds, not a source of funds.

Sources of funds are both internal (profits) and external (debts). Uses of funds include adding to financial assets. The Smith family may invest part of its monthly paycheck in a bank CD or mutual fund and the Jones Corporation may likewise invest part of its monthly profits in the same way. Such liquid investments are viewed as something that could be tapped to meet unexpected expenses, or to make longer-term investments later—not as a substitute for regular monthly income.

Another use of funds is capital expenditures on tangible assets—plant, equipment and inventories. Such capital expenditures by nonfinancial corporations (at home, not abroad) were growing at an annual rate of nearly $1.1 trillion in the third quarter of 2010—a 42% increase from $752 billion in the second quarter of 2009. U.S. corporations obviously can and do increase their investments in plant and equipment at the same time they are increasing investments in so-called "liquid" assets (which include bonds, time deposits and mutual funds).

The widely repeated notion that prudent corporate investments in liquid assets have somehow reduced real investments or hiring is unqualified nonsense based on inexcusable ignorance of elementary economics and accounting.

Mr. Reynolds, a senior fellow at the Cato Institute, is author of "Income and Wealth" (Greenwood Press, 2006).


The war on baby girls



IMAGINE you are one half of a young couple expecting your first child in a fast-growing, poor country. You are part of the new middle class; your income is rising; you want a small family. But traditional mores hold sway around you, most important in the preference for sons over daughters. Perhaps hard physical labour is still needed for the family to make its living. Perhaps only sons may inherit land. Perhaps a daughter is deemed to join another family on marriage and you want someone to care for you when you are old. Perhaps she needs a dowry.

Now imagine that you have had an ultrasound scan; it costs $12, but you can afford that. The scan says the unborn child is a girl. You yourself would prefer a boy; the rest of your family clamours for one. You would never dream of killing a baby daughter, as they do out in the villages. But an abortion seems different. What do you do?

For millions of couples, the answer is: abort the daughter, try for a son. In China and northern India more than 120 boys are being born for every 100 girls. Nature dictates that slightly more males are born than females to offset boys’ greater susceptibility to infant disease. But nothing on this scale.

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For those who oppose abortion, this is mass murder. For those such as this newspaper, who think abortion should be “safe, legal and rare” (to use Bill Clinton’s phrase), a lot depends on the circumstances, but the cumulative consequence for societies of such individual actions is catastrophic. China alone stands to have as many unmarried young men—“bare branches”, as they are known—as the entire population of young men in America. In any country rootless young males spell trouble; in Asian societies, where marriage and children are the recognised routes into society, single men are almost like outlaws. Crime rates, bride trafficking, sexual violence, even female suicide rates are all rising and will rise further as the lopsided generations reach their maturity (see article).

It is no exaggeration to call this gendercide. Women are missing in their millions—aborted, killed, neglected to death. In 1990 an Indian economist, Amartya Sen, put the number at 100m; the toll is higher now. The crumb of comfort is that countries can mitigate the hurt, and that one, South Korea, has shown the worst can be avoided. Others need to learn from it if they are to stop the carnage.


The dearth and death of little sisters

Most people know China and northern India have unnaturally large numbers of boys. But few appreciate how bad the problem is, or that it is rising. In China the imbalance between the sexes was 108 boys to 100 girls for the generation born in the late 1980s; for the generation of the early 2000s, it was 124 to 100. In some Chinese provinces the ratio is an unprecedented 130 to 100. The destruction is worst in China but has spread far beyond. Other East Asian countries, including Taiwan and Singapore, former communist states in the western Balkans and the Caucasus, and even sections of America’s population (Chinese- and Japanese-Americans, for example): all these have distorted sex ratios. Gendercide exists on almost every continent. It affects rich and poor; educated and illiterate; Hindu, Muslim, Confucian and Christian alike.

Wealth does not stop it. Taiwan and Singapore have open, rich economies. Within China and India the areas with the worst sex ratios are the richest, best-educated ones. And China’s one-child policy can only be part of the problem, given that so many other countries are affected.

In fact the destruction of baby girls is a product of three forces: the ancient preference for sons; a modern desire for smaller families; and ultrasound scanning and other technologies that identify the sex of a fetus. In societies where four or six children were common, a boy would almost certainly come along eventually; son preference did not need to exist at the expense of daughters. But now couples want two children—or, as in China, are allowed only one—they will sacrifice unborn daughters to their pursuit of a son. That is why sex ratios are most distorted in the modern, open parts of China and India. It is also why ratios are more skewed after the first child: parents may accept a daughter first time round but will do anything to ensure their next—and probably last—child is a boy. The boy-girl ratio is above 200 for a third child in some places.


How to stop half the sky crashing down

Baby girls are thus victims of a malign combination of ancient prejudice and modern preferences for small families. Only one country has managed to change this pattern. In the 1990s South Korea had a sex ratio almost as skewed as China’s. Now, it is heading towards normality. It has achieved this not deliberately, but because the culture changed. Female education, anti-discrimination suits and equal-rights rulings made son preference seem old-fashioned and unnecessary. The forces of modernity first exacerbated prejudice—then overwhelmed it.

But this happened when South Korea was rich. If China or India—with incomes one-quarter and one-tenth Korea’s levels—wait until they are as wealthy, many generations will pass. To speed up change, they need to take actions that are in their own interests anyway. Most obviously China should scrap the one-child policy. The country’s leaders will resist this because they fear population growth; they also dismiss Western concerns about human rights. But the one-child limit is no longer needed to reduce fertility (if it ever was: other East Asian countries reduced the pressure on the population as much as China). And it massively distorts the country’s sex ratio, with devastating results. President Hu Jintao says that creating “a harmonious society” is his guiding principle; it cannot be achieved while a policy so profoundly perverts family life.

And all countries need to raise the value of girls. They should encourage female education; abolish laws and customs that prevent daughters inheriting property; make examples of hospitals and clinics with impossible sex ratios; get women engaged in public life—using everything from television newsreaders to women traffic police. Mao Zedong said “women hold up half the sky.” The world needs to do more to prevent a gendercide that will have the sky crashing down.



The worldwide war on baby girls

Technology, declining fertility and ancient prejudice are combining to unbalance societies




XINRAN XUE, a Chinese writer, describes visiting a peasant family in the Yimeng area of Shandong province. The wife was giving birth. “We had scarcely sat down in the kitchen”, she writes (see article), “when we heard a moan of pain from the bedroom next door…The cries from the inner room grew louder—and abruptly stopped. There was a low sob, and then a man’s gruff voice said accusingly: ‘Useless thing!’

“Suddenly, I thought I heard a slight movement in the slops pail behind me,” Miss Xinran remembers. “To my absolute horror, I saw a tiny foot poking out of the pail. The midwife must have dropped that tiny baby alive into the slops pail! I nearly threw myself at it, but the two policemen [who had accompanied me] held my shoulders in a firm grip. ‘Don’t move, you can’t save it, it’s too late.’

“‘But that’s...murder...and you’re the police!’ The little foot was still now. The policemen held on to me for a few more minutes. ‘Doing a baby girl is not a big thing around here,’ [an] older woman said comfortingly. ‘That’s a living child,’ I said in a shaking voice, pointing at the slops pail. ‘It’s not a child,’ she corrected me. ‘It’s a girl baby, and we can’t keep it. Around these parts, you can’t get by without a son. Girl babies don’t count.’”

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In January 2010 the Chinese Academy of Social Sciences (CASS) showed what can happen to a country when girl babies don’t count. Within ten years, the academy said, one in five young men would be unable to find a bride because of the dearth of young women—a figure unprecedented in a country at peace.

The number is based on the sexual discrepancy among people aged 19 and below. According to CASS, China in 2020 will have 30m-40m more men of this age than young women. For comparison, there are 23m boys below the age of 20 in Germany, France and Britain combined and around 40m American boys and young men. So within ten years, China faces the prospect of having the equivalent of the whole young male population of America, or almost twice that of Europe’s three largest countries, with little prospect of marriage, untethered to a home of their own and without the stake in society that marriage and children provide.

Gendercide—to borrow the title of a 1985 book by Mary Anne Warren—is often seen as an unintended consequence of China’s one-child policy, or as a product of poverty or ignorance. But that cannot be the whole story. The surplus of bachelors—called in China guanggun, or “bare branches”— seems to have accelerated between 1990 and 2005, in ways not obviously linked to the one-child policy, which was introduced in 1979. And, as is becoming clear, the war against baby girls is not confined to China.

Parts of India have sex ratios as skewed as anything in its northern neighbour. Other East Asian countries—South Korea, Singapore and Taiwan—have peculiarly high numbers of male births. So, since the collapse of the Soviet Union, have former communist countries in the Caucasus and the western Balkans. Even subsets of America’s population are following suit, though not the population as a whole.

The real cause, argues Nick Eberstadt, a demographer at the American Enterprise Institute, a think-tank in Washington, DC, is not any country’s particular policy but “the fateful collision between overweening son preference, the use of rapidly spreading prenatal sex-determination technology and declining fertility.” These are global trends. And the selective destruction of baby girls is global, too.

Boys are slightly more likely to die in infancy than girls. To compensate, more boys are born than girls so there will be equal numbers of young men and women at puberty. In all societies that record births, between 103 and 106 boys are normally born for every 100 girls. The ratio has been so stable over time that it appears to be the natural order of things.

That order has changed fundamentally in the past 25 years. In China the sex ratio for the generation born between 1985 and 1989 was 108, already just outside the natural range. For the generation born in 2000-04, it was 124 (ie, 124 boys were born in those years for every 100 girls). According to CASS the ratio today is 123 boys per 100 girls. These rates are biologically impossible without human intervention.

The national averages hide astonishing figures at the provincial level. According to an analysis of Chinese household data carried out in late 2005 and reported in the British Medical Journal*, only one region, Tibet, has a sex ratio within the bounds of nature. Fourteen provinces—mostly in the east and south—have sex ratios at birth of 120 and above, and three have unprecedented levels of more than 130. As CASS says, “the gender imbalance has been growing wider year after year.”

The BMJ study also casts light on one of the puzzles about China’s sexual imbalance. How far has it been exaggerated by the presumed practice of not reporting the birth of baby daughters in the hope of getting another shot at bearing a son? Not much, the authors think. If this explanation were correct, you would expect to find sex ratios falling precipitously as girls who had been hidden at birth start entering the official registers on attending school or the doctor. In fact, there is no such fall. The sex ratio of 15-year-olds in 2005 was not far from the sex ratio at birth n 1990. The implication is that sex-selective abortion, not under-registration of girls, accounts for the excess of boys.

Other countries have wildly skewed sex ratios without China’s draconian population controls (see chart 1). Taiwan’s sex ratio also rose from just above normal in 1980 to 110 in the early 1990s; it remains just below that level today. During the same period, South Korea’s sex ratio rose from just above normal to 117 in 1990—then the highest in the world—before falling back to more natural levels. Both these countries were already rich, growing quickly and becoming more highly educated even while the balance between the sexes was swinging sharply towards males.

South Korea is experiencing some surprising consequences. The surplus of bachelors in a rich country has sucked in brides from abroad. In 2008, 11% of marriages were “mixed”, mostly between a Korean man and a foreign woman. This is causing tensions in a hitherto homogenous society, which is often hostile to the children of mixed marriages. The trend is especially marked in rural areas, where the government thinks half the children of farm households will be mixed by 2020. The children are common enough to have produced a new word: “Kosians”, or Korean-Asians.

China is nominally a communist country, but elsewhere it was communism’s collapse that was associated with the growth of sexual disparities. After the Soviet Union imploded in 1991, there was an upsurge in the ratio of boys to girls in Armenia, Azerbaijan and Georgia. Their sex ratios rose from normal levels in 1991 to 115-120 by 2000. A rise also occurred in several Balkan states after the wars of Yugoslav succession. The ratio in Serbia and Macedonia is around 108. There are even signs of distorted sex ratios in America, among various groups of Asian-Americans. In 1975, calculates Mr Eberstadt, the sex ratio for Chinese-, Japanese- and Filipino-Americans was between 100 and 106. In 2002, it was 107 to 109.

But the country with the most remarkable record is that other supergiant, India. India does not produce figures for sex ratios at birth, so its numbers are not strictly comparable with the others. But there is no doubt that the number of boys has been rising relative to girls and that, as in China, there are large regional disparities. The north-western states of Punjab and Haryana have sex ratios as high as the provinces of China’s east and south. Nationally, the ratio for children up to six years of age rose from a biologically unexceptionable 104 in 1981 to a biologically impossible 108 in 2001. In 1991, there was a single district with a sex ratio over 125; by 2001, there were 46.

Conventional wisdom about such disparities is that they are the result of “backward thinking” in old-fashioned societies or—in China—of the one-child policy. By implication, reforming the policy or modernising the society (by, for example, enhancing the status of women) should bring the sex ratio back to normal. But this is not always true and, where it is, the road to normal sex ratios is winding and bumpy.

Not all traditional societies show a marked preference for sons over daughters. But in those that do—especially those in which the family line passes through the son and in which he is supposed to look after his parents in old age—a son is worth more than a daughter. A girl is deemed to have joined her husband’s family on marriage, and is lost to her parents. As a Hindu saying puts it, “Raising a daughter is like watering your neighbours’ garden.”

“Son preference” is discernible—overwhelming, even—in polling evidence. In 1999 the government of India asked women what sex they wanted their next child to be. One third of those without children said a son, two-thirds had no preference and only a residual said a daughter. Polls carried out in Pakistan and Yemen show similar results. Mothers in some developing countries say they want sons, not daughters, by margins of ten to one. In China midwives charge more for delivering a son than a daughter.


Chasing puppy-dogs’ tails

The unusual thing about son preference is that it rises sharply at second and later births (see chart 2). Among Indian women with two children (of either sex), 60% said they wanted a son next time, almost twice the preference for first-borns. This reflected the desire of those with two daughters for a son. The share rose to 75% for those with three children. The difference in parental attitudes between first-borns and subsequent children is large and significant.

Until the 1980s people in poor countries could do little about this preference: before birth, nature took its course. But in that decade, ultrasound scanning and other methods of detecting the sex of a child before birth began to make their appearance. These technologies changed everything. Doctors in India started advertising ultrasound scans with the slogan “Pay 5,000 rupees ($110) today and save 50,000 rupees tomorrow” (the saving was on the cost of a daughter’s dowry). Parents who wanted a son, but balked at killing baby daughters, chose abortion in their millions.

The use of sex-selective abortion was banned in India in 1994 and in China in 1995. It is illegal in most countries (though Sweden legalised the practice in 2009). But since it is almost impossible to prove that an abortion has been carried out for reasons of sex selection, the practice remains widespread. An ultrasound scan costs about $12, which is within the scope of many—perhaps most—Chinese and Indian families. In one hospital in Punjab, in northern India, the only girls born after a round of ultrasound scans had been mistakenly identified as boys, or else had a male twin.

The spread of fetal-imaging technology has not only skewed the sex ratio but also explains what would otherwise be something of a puzzle: sexual disparities tend to rise with income and education, which you would not expect if “backward thinking” was all that mattered. In India, some of the most prosperous states—Maharashtra, Punjab, Gujarat—have the worst sex ratios. In China, the higher a province’s literacy rate, the more skewed its sex ratio. The ratio also rises with income per head.

In Punjab Monica Das Gupta of the World Bank discovered that second and third daughters of well-educated mothers were more than twice as likely to die before their fifth birthday as their brothers, regardless of their birth order. The discrepancy was far lower in poorer households. Ms Das Gupta argues that women do not necessarily use improvements in education and income to help daughters. Richer, well-educated families share their poorer neighbours’ preference for sons and, because they tend to have smaller families, come under greater pressure to produce a son and heir if their first child is an unlooked-for daughter**.

So modernisation and rising incomes make it easier and more desirable to select the sex of your children. And on top of that smaller families combine with greater wealth to reinforce the imperative to produce a son. When families are large, at least one male child will doubtless come along to maintain the family line. But if you have only one or two children, the birth of a daughter may be at a son’s expense. So, with rising incomes and falling fertility, more and more people live in the smaller, richer families that are under the most pressure to produce a son.

In China the one-child policy increases that pressure further. Unexpectedly, though, it is the relaxation of the policy, rather than the policy pure and simple, which explains the unnatural upsurge in the number of boys.

In most Chinese cities couples are usually allowed to have only one child—the policy in its pure form. But in the countryside, where 55% of China’s population lives, there are three variants of the one-child policy. In the coastal provinces some 40% of couples are permitted a second child if their first is a girl. In central and southern provinces everyone is permitted a second child either if the first is a girl or if the parents suffer “hardship”, a criterion determined by local officials. In the far west and Inner Mongolia, the provinces do not really operate a one-child policy at all. Minorities are permitted second—sometimes even third—children, whatever the sex of the first-born (see map).

The provinces in this last group are the only ones with close to normal sex ratios. They are sparsely populated and inhabited by ethnic groups that do not much like abortion and whose family systems do not disparage the value of daughters so much. The provinces with by far the highest ratios of boys to girls are in the second group, the ones with the most exceptions to the one-child policy. As the BMJ study shows, these exceptions matter because of the preference for sons in second or third births.

For an example, take Guangdong, China’s most populous province. Its overall sex ratio is 120, which is very high. But if you take first births alone, the ratio is “only” 108. That is outside the bounds of normality but not by much. If you take just second children, however, which are permitted in the province, the ratio leaps to 146 boys for every 100 girls. And for the relatively few births where parents are permitted a third child, the sex ratio is 167. Even this startling ratio is not the outer limit. In Anhui province, among third children, there are 227 boys for every 100 girls, while in Beijing municipality (which also permits exceptions in rural areas), the sex ratio reaches a hard-to-credit 275. There are almost three baby boys for each baby girl.

Ms Das Gupta found something similar in India. First-born daughters were treated the same as their brothers; younger sisters were more likely to die in infancy. The rule seems to be that parents will joyfully embrace a daughter as their first child. But they will go to extraordinary lengths to ensure subsequent children are sons.


The hazards of bare branches

Throughout human history, young men have been responsible for the vast preponderance of crime and violence—especially single men in countries where status and social acceptance depend on being married and having children, as it does in China and India. A rising population of frustrated single men spells trouble.

The crime rate has almost doubled in China during the past 20 years of rising sex ratios, with stories abounding of bride abduction, the trafficking of women, rape and prostitution. A study into whether these things were connected concluded that they were, and that higher sex ratios accounted for about one-seventh of the rise in crime. In India, too, there is a correlation between provincial crime rates and sex ratios. In “Bare Branches”††, Valerie Hudson and Andrea den Boer gave warning that the social problems of biased sex ratios would lead to more authoritarian policing. Governments, they say, “must decrease the threat to society posed by these young men. Increased authoritarianism in an effort to crack down on crime, gangs, smuggling and so forth can be one result.”

Violence is not the only consequence. In parts of India, the cost of dowries is said to have fallen (see article). Where people pay a bride price (ie, the groom’s family gives money to the bride’s), that price has risen. During the 1990s, China saw the appearance of tens of thousands of “extra-birth guerrilla troops”—couples from one-child areas who live in a legal limbo, shifting restlessly from city to city in order to shield their two or three children from the authorities’ baleful eye. And, according to the World Health Organisation, female suicide rates in China are among the highest in the world (as are South Korea’s). Suicide is the commonest form of death among Chinese rural women aged 15-34; young mothers kill themselves by drinking agricultural fertilisers, which are easy to come by. The journalist Xinran Xue thinks they cannot live with the knowledge that they have aborted or killed their baby daughters.

Some of the consequences of the skewed sex ratio have been unexpected. It has probably increased China’s savings rate. This is because parents with a single son save to increase his chances of attracting a wife in China’s ultra-competitive marriage market. Shang-Jin Wei of Columbia University and Xiaobo Zhang of the International Food Policy Research Institute in Washington, DC, compared savings rates for households with sons versus those with daughters. “We find not only that households with sons save more than households with daughters in all regions,” says Mr Wei, “but that households with sons tend to raise their savings rate if they also happen to live in a region with a more skewed sex ratio.” They calculate that about half the increase in China’s savings in the past 25 years can be attributed to the rise in the sex ratio. If true, this would suggest that economic-policy changes to boost consumption will be less effective than the government hopes.

Over the next generation, many of the problems associated with sex selection will get worse. The social consequences will become more evident because the boys born in large numbers over the past decade will reach maturity then. Meanwhile, the practice of sex selection itself may spread because fertility rates are continuing to fall and ultrasound scanners reach throughout the developing world.

Yet the story of the destruction of baby girls does not end in deepest gloom. At least one country—South Korea—has reversed its cultural preference for sons and cut the distorted sex ratio (see chart 3). There are reasons for thinking China and India might follow suit.

South Korea was the first country to report exceptionally high sex ratios and has been the first to cut them. Between 1985 and 2003, the share of South Korean women who told national health surveyors that they felt “they must have a son” fell by almost two-thirds, from 48% to 17%. After a lag of a decade, the sex ratio began to fall in the mid-1990s and is now 110 to 100. Ms Das Gupta argues that though it takes a long time for social norms favouring sons to alter, and though the transition can be delayed by the introduction of ultrasound scans, eventually change will come. Modernisation not only makes it easier for parents to control the sex of their children, it also changes people’s values and undermines those norms which set a higher store on sons. At some point, one trend becomes more important than the other.

It is just possible that China and India may be reaching that point now. The census of 2000 and the CASS study both showed the sex ratio stable at around 120. At the very least, it seems to have stopped rising. Locally, Ms Das Gupta argues†††, the provinces which had the highest sex ratios (and have two-thirds of China’s population) have seen a deceleration in their ratios since 2000, and provinces with a quarter of the population have seen their ratios fall. In India, one study found that the cultural preference for sons has been falling, too, and that the sex ratio, as in much of China, is rising more slowly. In villages in Haryana, grandmothers sit veiled and silent while men are present. But their daughters sit and chat uncovered because, they say, they have seen unveiled women at work or on television so much that at last it seems normal to them.

Ms Das Gupta points out that, though the two giants are much poorer than South Korea, their governments are doing more than it ever did to persuade people to treat girls equally (through anti-discrimination laws and media campaigns). The unintended consequences of sex selection have been vast. They may get worse. But, at long last, she reckons, “there seems to be an incipient turnaround in the phenomenon of ‘missing girls’ in Asia.”

* “China’s excess males, sex selective abortion and one child policy”, by Wei Xing Zhu, Li Lu and Therese Hesketh. BMJ 2009

** “Why is son preference so persistent in East and South Asia?” By Monica Das Gupta, Jiang Zhenghua, Li Bohua, Xie Zhenming, Woojin Chung and Bae Hwa-Ok. World Bank, Policy Research Working Paper 2942.

† “Sex ratios and crime: evidence from China’s one-child policy”, by Lena Edlund, Hongbin Li, Junjian Yi and Junsen Zhang. Institute for the Study of Labour, Bonn. Discussion Paper 3214

†† “Bare Branches”, by Valerie Hudson and Andrea den Boer. MIT Press, 2004

††† “Is there an incipient turnaround in Asia’s “missing girls” phenomenon?” By Monica Das Gupta, Woojin Chung and Li Shuzhuo. World Bank, Policy Research Working Paper 4846.



  • WSJ FEBRUARY 22, 2011, 7:27 A.M. ET

Nigeria Rejects IMF Currency View


ABUJA, Nigeria—The Central Bank of Nigeria will stick to a stable exchange-rate policy as the country ramps up its economic growth, the bank's top official said, rejecting recent comments from the International Monetary Fund that its currency is overvalued.

In an exclusive interview, Nigeria's central-bank governor, Sanusi Lamido Sanusi, said devaluing its currency, the naira, wouldn't help the economy and could fuel inflation—already in the low double-digits.

"Price stability is the mandate of the central bank," he said. "We aren't targeting a particular exchange rate."

Earlier this month, the IMF released a report on Nigeria stating that the central bank's policies of protecting the value of the currency and keeping interest rates low have eroded foreign-exchange reserves.

The IMF report "stressed that greater exchange-rate flexibility would prevent one-way bets in the foreign-exchange market and cushion external shocks."

But Nigeria's central-bank governor took issue with the IMF diagnosis. A cheaper currency wouldn't aid exports, he said, since much of what the country sells overseas is oil at prices dictated by the international markets. And since much of what Nigerian factories make depend on foreign materials, he warned a sharp currency devaluation that would make imports more expensive "could shut down manufacturing."

At the end of 2010, the IMF estimated Nigeria's foreign-exchange reserves at $34.1 billion, down from $42.4 billion the year before.

But Mr. Sanusi said the more important priority than preserving reserves was keeping on the economy on track. Last year, Nigeria not only had to deal with the global financial crisis; it also face heightened political uncertainty at home. The country's president died, militants kept up attacks on its oil infrastructure, and there was renewed fighting between Muslims and Christians around the volatile region of Jos.

The political uncertainty is set to continue for at least a couple more months. In April, Nigeria will hold elections for president as well as posts for powerful state governors.

And yet, Africa's most populous country and second-largest economy has weathered the global downturn better than most. The IMF projected Nigeria's economic growth at 8.5% in 2010, more than twice as fast as the continent's largest economy, South Africa. It predicted the economy would grow by 7% this year, thanks in part to the emergence of a consumer class and demand for retail goods, telecommunications and other services.

The central-bank governor said Nigeria could grow at twice that projected clip by overhauling the nation's lackluster infrastructure.

Rather than exchange-rate adjustments, Mr. Sanusi said, steps to improve roads and spotty power supply as well as distribution of fresh farm produce—most of which rots before arriving at market—will be more effective at boosting growth and bringing down prices.


  • WSJ FEBRUARY 18, 2011

The Corporate Governance Fix for Korea

Executives, lawmakers, prosecutors and minority investors all have a role to play.


Korean companies are among the best in the world, delivering innovative products from washing machines to high-tech smart phones. Yet this success is not reflected in the values of these companies' stocks, a problem Korea needs to fix to keep growing. Improving corporate governance is the key.

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Lee Ho-jin, chairman of the Taekwang Group.

Although many Korean companies have reached developed-economy scale in terms of revenue, name recognition or number of employees, they're still stuck in a family-business model in terms of corporate governance. Among the top 100 companies in market capitalization, almost all are controlled by members of the founding family. This encourages a sense that the company, even if it's listed, is the family's private possession, to be divided up or handed down to the children as the patriarch sees fit.

That fact alone can serve as a temptation toward activities that hurt the interests of small investors. For instance, it is considered normal to turn control of a company over to children of the founder at a relatively early age. According to a 2009 survey of 37 of these "royal kids" by business website Chaebul.com, the average age at which they take directorial positions is only 31.

The problem is compounded by weak institutional protections for minority shareholders. In theory, legal changes after the 1997 financial crisis bolstered the role of outside directors on corporate boards and created a better electronic reporting system for regulatory filings to enhance shareholder access to information. However, the culture still discourages regulators—especially public prosecutors—from vigorously defending the ability of minority owners to assert the few rights they do have.

Koreans cling to a belief that their economy is founded on the health of large conglomerates, known as chaebol, and that what's good for the chaebol (and its ruling family) is good for Korea. This explains why prosecutions of corporate corruption cases involving chaebol families are infrequent and rarely result in stiff sanctions even if prosecutors secure a conviction.

This was most clearly on display in 2008 in the case of Lee Kun-hee, chairman of Samsung and son of the chaebol's founder. In July of that year, he was convicted of tax evasion and other charges in connection with a scandal over transfer of his managerial control and wealth to his son. He was given a three-year prison term suspended for five years, and fined 110 billion won ($100 million). Yet he never served a day in prison; instead he received a presidential pardon. According to newspaper reports, President Lee Myung-bak decided to pardon Mr. Lee in view of the "national interest."

This kind of behavior—and Samsung's Mr. Lee is hardly alone in Korean corporate history—is a serious damper on the interests of minority shareholders. That may be one of the reasons for the so-called Korean discount, whereby the Korean market trades at lower average price-to-earnings ratios than its peers in Asia. Yet the back-scratching alliance of government and business often deters minority shareholders from exercising their rights or blocks them when they try. It's notable in this regard that one of the most common types of corporate scandal involves conglomerates maintaining slush funds with which to make political donations.

There are no quick fixes, and many pieces will need to fall into place—from policy makers to prosecutors to individual executives—to improve corporate governance. Lawmakers in particular must revise tax laws and corporate codes so that families are no longer able to extract shareholder value. The Korean government and the National Assembly are reorganizing the country's inheritance tax laws and other laws governing transparency of corporate financial dealings. These changes would be important improvements. But by themselves they won't be enough.

Crucially, minority shareholders are not powerless to push for change under the existing laws and regulations. One part of the solution is for these shareholders themselves to start exercising their rights more vigorously.

My company has achieved small victories improving corporate governance in several cases. Most recently, we pushed for significant changes at Taekwang Group, the 40th-largest chaebol with subsidiaries in petrochemical, finance, cable television and many other businesses. Although the founding families control 46% of the outstanding shares, we were able to start shedding a light on what we believe is wrongdoing that has hurt the interests of our fellow small shareholders.

In particular, we believe based on our own review of corporate financial statements, interviews with former executives, news reports, and in some cases tips from company insiders, that Chairman Lee Ho-jin transferred assets improperly between various business units and to outsiders. Based on company financial statements, he appears to have made almost $90 million by ordering affiliate companies to buy memberships in an unbuilt golf course owned by his own family. The prosecution alleges that he has created 440 billion won of slush funds in accounts held under false names and used part of the money for personal purposes.

Our research provided sufficient evidence for prosecutors to launch their own investigation. After a four-month investigation that covered our findings as well as other issues raised by former insiders, prosecutors indicted the chairman and six other senior executives on charges of embezzlement and breach of trust. According to news reports, the company admits to engaging in the undocumented transactions, but denies allegations related to efforts to lobby politicians. According to local media reports, Mr. Lee has not commented other than to apologize for causing the controversy, which in the Korean context is a standard response in such cases.

Public prosecutors might ordinarily be reluctant to take on such a case, given the prominence of the company and people involved. But Korean law allows minority shareholders to press prosecutors in such cases, and my firm has done just that. We have also spent two years conducting our own investigation into what we believe are governance failures at the company.

Our experience offers some evidence that bad governance accounts for part of the "Korea discount." After we started pursuing our case, the stock price of Taekwang Industrial—which had stagnated for almost three years—surged. The company's market capitalization reached 1.5 trillion won in late January, up from 800 billion won five months earlier. There was no other news at the time that might have moved the stock price, suggesting investors were responding to the prospects of better governance and, as a result, better earnings in the future.

We can't improve corporate governance alone. But we also can't afford not to do our part to improve governance. Doing so is good for us and our own investors, and for Korean companies and ultimately for Korea's healthy capitalism.

Mr. Park is president of Seoul Invest, a private-equity firm.



  • WSJ FEBRUARY 22, 2011

Fishy Business in Washington

A case study in nonsensical regulation.

President Obama has trumpeted his intention to rationalize economic regulations, and he even derided overzealous oversight of salmon in his State of the Union address. While he's on the subject of fish, Mr. Obama might want to school himself on the campaign against the Vietnamese pangasius.

The U.S. Department of Agriculture is seeking public comment on its proposal to classify the pangasius as a "catfish." A lot rides on that name. The 2008 farm bill specifies new safety inspection on imported catfish so onerous it would amount to a ban for at least several years while foreign fishermen struggle to comply. Pangasius is the target because it has a similar taste and texture to American catfish but is cheaper—the main reason American catfish farmers have tried for years to ban the imports.

The problem is that the pangasius is an entirely different species of fish. In an earlier bout of protectionism, Congress even passed a law making it illegal to call pangasius "catfish" for marketing purposes. Since that hasn't deterred American consumers from buying pangasius, Washington is willing to call the Vietnamese fish a catfish again if that makes it easier to ban.

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Associated Press

s would be funny if it weren't so costly and probably illegal. On health-and-safety grounds, both the 2008 law and USDA's moves to enforce it make little sense. Vietnamese pangasius, like all fish imports, already is regulated by the Food and Drug Administration. There have been no reported safety problems with the Vietnamese imports. In contrast, USDA has no experience regulating fish despite its history overseeing meat, and catfish will be the only fish species under its regulatory purview.

This explains why the Government Accountability Office last week included USDA regulation of catfish in its biennial report on federal programs at "high risk" for "fraud, waste, abuse and mismanagement." The GAO quotes a USDA estimate that it will cost $30 million over two years to ramp up a special inspection regime for this single fish while FDA remains responsible for other seafood. It's not clear from the language of the 2008 farm bill that the FDA would not still be responsible for catfish after the USDA takes over, raising the prospect that catfish could be regulated twice.

As for the illegality, stricter regulation is unlikely to pass muster at the World Trade Organization. Trade expert James Bacchus, in an opinion commissioned by fish importers, argues that the U.S. would likely lose if Vietnam sued precisely because FDA regulation already is effective. Trade judges would conclude the only reason to change the regulation was protectionism, and they'd be right. A former Democratic Representative from Florida, Mr. Bacchus was the chief judge of the WTO's appellate panel for eight years.

No wonder this pangasius stir has American exporters worried about retaliation. Senator Max Baucus (D., Mont.) is on record worrying that the Vietnamese could block imports of U.S. beef in response, and producers of soy products also have reason to be nervous. All this to protect American catfish farmers from competition and force American consumers to pay more for fish.

The Administration still has a chance to short-circuit this foolishness, if USDA exercises its discretion to rule that pangasius is not a "catfish." Barring that, Congress and Mr. Obama could revamp the questionable section of the 2008 farm bill. For anyone looking to cut waste and rationalize regulation, this should be shooting fish in a barrel.



  • WSJ FEBRUARY 23, 2011

Cocoa at 32-Year High As Ivory Coast Ban Extended



LONDON—Cocoa prices surged to 32-year peaks after the internationally recognized president of Ivory Coast extended a ban on the export of the key ingredient in chocolate.

Cocoa futures jumped 2.5% to close at $3,633 a ton on ICE Futures U.S.

The front-month contract, for March delivery, earlier hit an intraday high of $3,666. Although IntercontinentalExchange Inc. only has records from the mid-1990s, data from Dow Jones Market Data Group showed the front-month contract last settled at $3,635 on Jan. 12, 1979.

A bitter struggle for political control of the world's top producer of cocoa has sent cocoa prices rallying since December.

The monthlong ban implemented by Alassane Ouattara, who in November won the country's first election in a decade, was due to expire Wednesday but was prolonged to March 15, according to an order from Mr. Ouattara's government.

Major cocoa exporters say they are complying with the restrictions. Some analysts say it is likely that Ivory Coast cocoa beans are being shipped to international markets through neighboring countries.

Fresh clashes erupted between supporters of the rival presidents Monday, with army gunfire killing one civilian and injuring more than a dozen, while African leaders launched a new bid to break the impasse.

Kona Haque, a commodity analyst with Macquarie, said she expects cocoa prices on ICE to target $3,700 a ton as the crisis escalates.

"Despite favorable weather and attractive prices, the short-term outlook for cocoa supplies out of Ivory Coast has turned sharply negative," she said.

The extended ban is likely to put greater pressure on the small farmers who grow most of the cocoa beans. The flow of beans from the countryside to the ports will slow, resulting in quality problems and "severe social consequences for the rural communities," said Rodger Wegner, managing director of the German Cocoa Trade Association.

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Agence France-Presse/Getty Images

Cocoa's growers burn cocoa beans in front of the European Union delegation headquarters in Abidjan on Feb. 17, to protest against sanctions imposed on the cocoa-export trade to European countries.


Farmers are having problems financing and storing the upcoming crop, due to be harvested between April and May. Banks have closed branches, and warehouses are overflowing.

About 300,000 tons of cocoa are currently held in the country, including 100,000 tons at the ports, but observers warn that cocoa beans stored in poor conditions may deteriorate rapidly.

Trade has also been hurt by European Union sanctions barring ships entering the country's main ports. French shipper CMA CGM, the main carrier of Ivorian cocoa to Europe, said earlier this month that it had suspended visits to Ivory Coast by ships from a subsidiary.

Shipping services "have almost completely ceased, thereby inhibiting both export of products such as cocoa, and import of foodstuffs such as wheat and rice," the European Cocoa Association and the Federation of Cocoa Commerce said in a joint statement last week.

Write to Caroline Henshaw at caroline.henshaw@dowjones.com


Some recent articles on democracy



February 6, 2006


Liberty vs. Democracy

Many mistakenly believe democracy means liberty, but that is not true.


By : Richard W. Rahn  http://www.cgeg.org/issue_template.php?issue_id=2491


This piece was originally published February 5, 2006 in the Washington Times.


Would you prefer to live in a country that has:


(1) The rule of law with an honest civil service, strong protection of private property and minority rights, free trade, free markets, very low taxes, and full freedom of the speech, press and religion, but not a democracy?


(2) Democracy and a corrupt court and civil service, many restrictions on economic freedom, including very high taxes, with limited rights for minority religions, peoples and speech?


The first example describes Hong Kong under the British, which had full civil liberties, little corruption and the world's freest economy. The Chinese took over Hong Kong in 1997 and have allowed it to continue as the freest economy in the world. As a result of the British being benevolent dictators and the Chinese largely continuing economic noninterference, with a number of restrictions on freedom of speech and the press, Hong Kong has achieved a per capita income close to that of the United States and higher than almost all democracies.


Many mistakenly believe democracy means liberty, but a quick review of world democracies show that is not true. Almost all democracies restrict economic liberties more than necessary. Many have corrupt court and civil service systems, inhibit women's rights, constrain press freedom and do not protect minority rights and views. Iran, though a very restrictive theocracy, calls itself a democracy and holds elections.


The American Founding Fathers were concerned with liberty, so they set up a Republic to protect individual liberties from the passions of the majority at the moment. They worried about the excesses of democracy.


James Madison, the primary Framer of the U.S. Constitution, noted: "Democracies have been spectacles of turbulence and conflict." His views were shared by the other Founders. That is why the U.S. Constitution was designed to restrict a democratic majority from limiting freedom of speech, press, religion and so forth. It is a document of liberty, not of democracy.


The Bush administration has placed itself in a difficult position by advocating democracy rather than liberty as its global mission. The democratic elections in Iraq and Palestine may well result in subjugation of women, containment of basic freedoms of speech and the press, and support for terrorist activities.


We, the victors in Iraq, had a perfect right -- in fact, a responsibility -- to insist any new constitution protect individual liberties, including full rights for women, property rights and the right to follow one's own religious beliefs and not be forced to wear the majority's religious garb.


Remember, Gen. Douglas MacArthur and his fellow American officials virtually dictated the constitution of Japan after World War II, which abolished the emperor's role as a deity. That constitution served the Japanese well.


The Allies would have not accepted a German constitution that restricted minority rights, for good reason. Standards of tolerance and civil liberties should not have been lowered for majority Muslim nations. By doing so, we may end with hollow victories. Religious Muslims can do perfectly well under regimes that protect the liberties of all citizens, as demonstrated by successful Muslim communities in the U.S. and elsewhere.


It is argued you cannot have sustained periods of liberty without democracy, and that argument does have merit. Those economic/political units today that have liberty without democracy are almost all colonies or territories of large democracies (the notable exception is Hong Kong, which remains largely free because of the treaty).


England enjoyed several centuries of substantial liberty without being a real democracy. However, such cases were rare: Even the most liberal (in the original sense) monarchies and oligarchies most often ended up restricting liberties.


The Bush administration needs to revise its rhetoric and actions to put advancement of human liberty, including economic freedom, in the forefront of its global agenda. This does mean support for democratic governments and institutions within countries that help preserve liberty. Democracy should not be seen as the end goal in itself, but only as a mechanism, if properly constructed, to help create, preserve and enhance liberty.


Richard W. Rahn is director general of the Center for Global Economic Growth, a project of the FreedomWorks Foundation.




Democracy is more than voting


Jan 30, 2006

by Jack Kemp ( bio | archive | contact )


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Since the surprising victory by Hamas in the Palestinian parliamentary elections, there has been a significant measure of schadenfreude on the part of the media and Bush administration critics.  Pointing out that the administration has based its foreign policy largely on the thesis that spreading democracy throughout the Middle East is both doable and desirable, an article in the aftermath of the Palestinian elections posted at Salon by Juan Cole, professor of modern Middle East and South Asian history at the University of Michigan, asked sarcastically, "How do you like your democracy now, Mr. Bush?"


Formerly known as the Islamic Resistance Movement and designated as a terrorist group by the United States government and the European Union, Hamas declares itself opposed to the very existence of Israel and has claimed responsibility for dozens of suicide bombings. Beyond the sheer political embarrassment, Hamas' victory places the United States in a dicey diplomatic and legal situation.


Under U.S. law, the government may not have contacts or official dealings with any state or organization on the State Department's official terrorist list.  Yet the Palestinian elections were urged by the administration in spite of the fact that Hamas had not disarmed nor had it renounced its intention to drive Israel off the face of the Earth.  By every indication, the elections were fair and legitimate, and Hamas has the right to form a government.


The short answer to the gloaters and the basis for crafting a policy to deal with the situation is there is more to democracy than simply voting.  Elections without the accompanying institutions of democracy - the rule of law, individual liberty and civil rights, private property, civil society, functioning government institutions - is "all sail and no rudder." The political system scuds along at a frightening pace in whatever direction the wind is blowing, but it lacks any institutional steering mechanism to drive the system into the political winds to reach its ultimate destination of security and efficient delivery of government services.


The common-sense observation that democracies do not spring fully formed was confirmed by a United Nations University study that concluded premature or inadequately designed elections in a volatile environment may fuel violence, magnify chaos and lead to authoritarian regimes, thereby retarding - and sometimes reversing - progress toward democracy.


In theory the Palestinian democracy may have cast off too soon in such stormy seas, but in practice it is an accomplished fact, and the question is, can some political rudder be installed with Hamas at the helm?  The first practical problem that Europe and the United States must address is how a Palestinian government controlled by Hamas will be funded. The Palestinian Authority's annual budget is $1.6 billion, the majority of which comes from Europe, which has indicated it won't continue to finance a Palestinian government controlled by Hamas. Clearly, the United States government shouldn't, either, which means the $150 million in aid scheduled to go the Palestinian Authority in development projects cannot now occur.


Bush was right when he said of Hamas, "I don't see how you can be a partner in peace if you advocate the destruction of a country as part of your platform.  And I know you can't be a partner in peace if your party has got an armed wing."

That said, what policy should the U.S. government pursue now?


One option is to withhold any funding until Hamas either renounces its use of violence and its intention to destroy Israel or its government collapses.  The problem with this option is that there may be undesirable sources of money, i.e., Al-Qaida, Iran and others within the radical Islamic movement willing to fund a Hamas-controlled Palestinian government.  If we allow a Hamas government to struggle and collapse for lack of revenue, we may only increase the likelihood that the Palestinian Authority will implode into a failed experiment in democracy and become a breeding ground for terrorism.


The good news is that in spite of Hamas' continued anti-Israel rhetoric and its refusal to disarm, there has existed a yearlong cease-fire - the product of a complicated four-way negotiation between Israel, the Palestinian Authority, Egypt and Hamas - that actually has been observed better than the cease-fire between Israel and Fatah. If Hamas is not to suffer the same fate as Fatah at the hands of voters, it will need to do what Fatah could not - provide security, end corruption, deliver day-to-day services and advance negotiations with Israel toward final establishment of a Palestinian state.  Hamas has every incentive now to maintain the cease-fire.


Perhaps this same back-channel mechanism that gave rise to the imperfect cease-fire with Hamas can also be used and expanded to convince Hamas to begin to accept the state of Israel as a fait accompli. Now is clearly the time for creative diplomacy.


Jack Kemp is Founder and Chairman of Kemp Partners and a contributing columnist to Townhall.com.





Ousting an authoritarian regime is often far easier than sustaining   

freedom afterward. Indeed, the best way to achieve freedom is to use   

"people power," rather than top-down reform or armed revolt, says   

Freedom House.


A study of 67 transitions from authoritarian rule over the past 33   

years found that there are four key characteristics of political   

transitions: the societal forces driving it, the strength of nonviolent   

civic resistance, the level of violence and the sources of that   

violence. These determine how successful transitions to democracy are   

achieved, says Freedom House.


According to researchers:


   o    Regime changes generated by nonviolent civic resistance are

        more likely to be "free" or "partly free" today

        than countries in which political elites have launched the

        transition or opposition groups have used violence to

        topple the government.


   o    About five of the 47 countries that experienced generally

        peaceful transitions are currently rated "not free,"

        compared with four of the 20 countries in which the

        opposition employed violence.


   o    Policy makers should offer support to nascent civic

        resistance movements in order to foster democratic change.


Furthermore, in Iraq's case, the study offers no guide; only three   

of the transitions - Panama, who is rated "free," Bosnia "partly free"   

and Cambodia, who is "not free" - were driven by external   

interventions, says Freedom House.

Source: Adrian Karatnycky and Peter Ackerman., "How Freedom Is Won:   

From Civic Resistance to Durable Democracy," Freedom House, 2005.


For text:




For more on International:






The golden calf of democracy


By: Lawrence W. Reed




No one knew better how to deflate the inflated than the late political satirist and commentator H. L. Mencken. “Democracy,” he once said, “is the theory that the common people know what they want, and deserve to get it good and hard.” He also famously defined an election as “an advance auction of stolen goods.” With so many promises made in this year’s elections to so many, his description seems especially fitting.


Mencken was not opposed to democracy. He simply possessed a more sobering view of its limitations than does today’s conventional wisdom, which regards it as the unmentioned fourth branch of the Trinity.


Democracy may be the world’s single most misunderstood concept of political governance. Commonly romanticized, it is assumed in most circles to ensure far more than it possibly can. The Norman Rockwell portrait of engaged, informed citizens contending freely on behalf of the common good is the utopian ideal that obscures the very messy details of reality.


Pure, undiluted democracy would be unshackled majority rule. Everybody would vote on everything, and 50 percent plus one extra vote would decide every “public” issue — and inevitably, a lot of what ought to be private ones, too. Ancient Athens for a brief time came closest to this, but no society of any size and complexity can practice this form of governance for very long. It’s unwieldy, endlessly contentious, and disrespectful of the inalienable rights of individuals who find themselves in the minority.


People like the sound of “democracy” because it implies that all of us have an equal say in our government, and that a simple majority is somehow inherently fair and smart in deciding issues. Subjecting every decision of governance to a vote of the people, however, is utterly impossible. Many decisions have to be made quickly and require knowledge that few people possess or have the time to become expert on. Many decisions don’t belong in the hands of any government at all. A pure democracy, even if possible, would quickly degenerate into the proverbial two wolves and a sheep voting on what to have for lunch.


Suppose someone says, “I just don’t like people with boats and jewelry. I think we should confiscate their property. Let’s have a vote on that.” A democratic purist would have to reply, “All in favor say ‘Aye’!” Anyone interested in protecting individual rights would have to say, “That’s not a proper function of government, and even if 99 percent of the citizens vote for it, it’s still wrong.”


In common parlance, “democracy” has been stretched to mean little more than responsive government. Because of such things as elections, government officials cannot behave in a vacuum. That fact is laudable, but it hardly guarantees that government will be good or limited. Even the best and most responsive of governments still rest upon the legal use of force an inescapable fact that requires not blind and fawning reverence, but brave, intelligent and determined vigilance.


Elections are a political safety valve for dissident views, because they rely on ballots instead of bullets to resolve disputes. They allow for political change without resorting to violence to make change happen — but the change a majority favors can be right or wrong, good or evil. The folks who work to make it easier to vote so more votes are cast should also spend their time encouraging others to be well-informed before they vote.


In spite of this year’s candidates singing interminable paeans to “our democracy,” America is thankfully not one and never has been. Our founders established a republic, modifying democracy considerably. It provides a mechanism whereby almost anyone can have some say in matters of government. We can run for office. We can support candidates and causes of our choosing. We can speak out in public forums. And, indeed, some issues are actually decided by majority vote.


But a sound republic founded on principles that are more important than majority rule (like individual rights) will put strong limits on all this. In its Bill of Rights, our Constitution clearly states, “Congress shall make no law. ...” It does not say, “Congress can pass anything it wants so long as a majority supports it.


If you worship the golden calf called democracy, you might want to think about finding a different religion.


— Lawrence W. Reed is president of the Mackinac Center for Public Policy in Midland, Mich., and an adjunct scholar with the Bluegrass Institute.

Categories: Government, Federal; Government, General




Democracy: No Panacea          By Dale Franks                                                         08/13/2002




                    against each other."


                    We've all heard this bromide so often

                    that we uncritically accept it as true.

                    Upon thinking about it a second

                    time, however, perhaps the real

                    conclusion on this adage should be

                    the "Scottish verdict": Not proven.


                    Certainly, in modern times,

                    democracies have tended to be allies, rather than enemies. It is less

                    certain, however, that the tendency of modern democracies to foreswear

                    war against each other stems from some shared quality of democracy,

                    except insofar as democracies are reluctant warriors as a general matter.


                    But, until recently, there simply weren't a lot of democracies to begin with.

                    Prior to the First World War, the number of actual democratic states could

                    be counted on one's fingers. Indeed, even today, the number of

                    democracies is far smaller than the number of authoritarian regimes of

                    various stripes.


                    In addition, until the breakup of the Soviet Union, modern Europe, where

                    most of today's democracies are concentrated, has always operated

                    under the threat of one or another authoritarian government attaining

                    continental dominance. Indeed, the struggle between republican France

                    and imperial Germany to become the dominant continental power in

                    Europe lasted from the German Unification of 1870 until the end of the

                    Second World War. In that struggle, France's traditional enemy, Britain,

                    became a French ally against Germany. The authoritarian German state

                    was a greater threat to Britain - which was, by the end of the 19th century,

                    about as democratic a government as existed anywhere - than republican

                    France. This was true not, it must be understood, because France was no

                    longer a threat to Britain, but rather because Germany was a greater one.


                    In the post-World War II era, the number of democracies - in Europe, at

                    least - increased drastically. At the same time, those democracies were

                    forced to ally themselves against the threat posed by the Soviet Union.


                    It is true that democracies have tended not to war against each other in

                    modern times, but, as we've seen, they had other fish to fry. Authoritarian

                    regimes, who do not have to concern themselves with public audit, have

                    tended to be prone to cause trouble. In consequence, democracies have

                    banded together against the threats posed by autocrats because such

                    threats were more immediate. That may say a lot about the democracies'

                    shared commitment against authoritarianism, but it may not tell us an

                    awful much about how democracies treat each other in the absence of

                    compelling authoritarian threats.


                    We do, however, have knowledge of a time and place where democracies

                    rather regularly warred against each other. The democratic city-states of

                    Greek Classical Antiquity were built on a foundation of civic militarism.


                    The free yeoman farmers, who also served as the hoplites of the Greek

                    phalanx, voted on whether to go to war. They usually elected their military

                    leaders. As often as not, those leaders faced rigorous civilian audit of their

                    conduct of military campaigns when they returned to the polis and their

                    former hoplite subordinates reverted to their prior status as civilian voters.

                    In some cases even successful, victorious generals were put on trial for

                    their lives due to their lack of attention to their men's welfare while on



                    Modern democracies may, perhaps, tend to be less inclined towards

                    warfare in general when compared with authoritarian states. But it is not

                    entirely certain that democracies cannot evolve into warlike states



                    As UC Fresno Professor of Classics Victor Davis Hanson writes in his

                    book, Carnage and Cultures, "[T]he choice of military response to win or

                    protect territory was a civic matter, an issue to be voted on by free

                    landowning infantrymen themselves." Additionally, he reminds us, that

                    republican Rome operated in a similar fashion. "[T]he republican

                    legionaries themselves felt confident that they fought to preserve the

                    traditions of their ancestors (mos maiorum) and in accordance with the

                    constitutional decrees of an elected government."


                    Being a democracy seems to have done little to bar the development of

                    Athens as an imperial power in classical Greece, just as it presented no

                    particular obstacle in preventing republican Rome from doing likewise.

                    Both states were democratic. In both states, the military leadership was

                    elected or appointed by civilian leaders, and subjected to civilian audit of

                    their conduct on a regular basis. Yet, they both became warlike and

                    aggressive states.


                    There is no guarantee that a modern democracy could not do likewise.


                    For example, if a free, fair, and honest election were held in Palestine

                    tomorrow, the chances are quite good that Yasser Arafat and the

                    Palestinian Authority would be removed from power. Unfortunately, the

                    replacement government would probably come from the more radical ranks

                    of Hamas and the Al-Aqsa Brigades. It would be a perfectly democratic

                    result, but such a democracy would be fairly threatening to their

                    neighboring democrats in Israel.


                    Westerners in general, and Americans in particular, are prone to believe

                    some rather unrealistic things about democracy. Chief among these is the

                    idea that democracy in and of itself is inculcated with some virtue that

                    makes the people more peaceful and reasonable. Such a view is entirely



                    The reason democracy works as an ameliorating institution in the West is

                    because it is based upon a host of other liberal ideals. Democracy is the

                    result of ideas such as individual equality, open debate, freedom of

                    thought and speech, and freedom of the press. It is not a precursor to

                    them. Such ideas need to have relatively firm root in a society for

                    democracy to work as a restraining force.


                    Democracy is, of course a fine institution. If nothing else, it is a wonderful

                    method for ascertaining what the people want, and selecting leaders to

                    carry out the people's will. It is not, however, in and of itself, a particularly

                    good way of ensuring that what people want is the right thing.











Some Thoughts on the Problems of Democracy

found at http://www.mercatus.org/


                           Gordon Tullock

                           March 15, 2002



  Democracy is frequently referred to as a system of majority voting. Granted, the

  last election in the United States the opposing candidate received more popular

  votes than the winner, and neither received a majority of popular votes because of

  the existence of other candidates, it is surprising that our system is called that." Of

  course the winner did get a majority both in the Supreme Court and in the electoral

  college. The loser got a majority in the Florida Supreme Court. 1


  Why do we call it "majority voting" when . . .


  The failure to get a majority in the popular vote is not particularly uncommon.

  Lincoln, for example, got only 35 percent of the popular vote and if one of the

  three of his opponents in the election, Douglas, had met him in a 2 candidate

  election, he would have won. The 1912 election, once again, had a winner who

  received less than half the popular votes. In Wilson's case he had two opponents,

  either one of which could have beaten him if the other had not been present. The

  current government in Canada received less than half the popular vote and, except

  in wartime, no British government has been elected by more half the voters since

  1920. In both of these cases, of course, the winner had more than half of the

  representatives in Parliament. During its long reign in India, the Congress party

  never received a majority of the popular vote. Normally it received less than 45



  Another and interesting case is the election of 1960. Nixon had more popular votes

  than Kennedy but lost in the electoral college. The fact that Nixon had more

  popular votes, although not a majority of all votes, is almost a secret. 2


  The election of 1960 is interesting and here I foreshadow the major part of this

  article in that the two strongest candidates for the final election were eliminated in

  the selection processes of the two parties. It is reasonably certain that Johnson

  could have beaten Nixon in both popular and electoral votes and that Rockefeller

  could have beaten Kennedy . All of this does not indicate the system is inferior, but

  it does suggest that we stop calling it majority voting.


  The problem of more than two alternatives


  As on my readers will know, there are two general types of democracy, one

  originating in England long ago in which the voters directly select individual

  candidates. The other, which originated on the continent in the 19th century, is

  called proportional representation and I will to a large extent leave it out of the

  discussion below. Actually, I rather prefer proportional representation, but it is a

  different subject and requires different analysis.


  But to return to my main subject, the reader will have noticed that in each of the

  cases with a winner who did not have a majority of the votes, more than two

  alternatives were presented to the voters. With only two candidates or proposals

  before the voters these problems do not occur. Unfortunately, there are many

  people who would like to be the president and many ways which the government

  income could be spent.


  In the real world, it is likely that the system is confronted with more than two

  alternatives and it must either cut them down to two by some means or be willing to

  accept a candidate or proposition chosen by less than a majority. Of course it may

  happen that although there are three candidates or proposals one of him gets more

  than half of the votes. But we should not have a system which depends on that



The paradox: from Condorcet to Black and Arrow


  This problem has been known for a very long time and procedures to either simply

  take the one that has the most votes or reduce the number of alternatives to two

  and then vote on the those two are orthodox. Unfortunately, none of these

  procedures really overcome the problem. Shortly before the French Revolution

  two French aristocrats, Condorcet and Borda, looked into the problem and

  Condorcet found what is now known as Condorcet Paradox while Borda

  produced system which avoided that Paradox but introduced another.


  This was of course the period of the great expansion of democracy and, perhaps as

  a result of the enthusiasm for democracy, the problem was largely forgotten

  although some mathematicians seem to have known about it. In the mid-19th

  century, Lewis Carroll rediscovered the paradox and did considerable work on it

  without finding a solution. He too was largely forgotten and the problem was

  rediscovered by Black who also discovered that he had predecessors lost in the

  obscurity of minor mathematical publications.


  Black succeeded in reviving interest in the issue which is a little paradoxical since it

  is obvious he did not like the idea of democracy having paradoxes. Working with

  Newing he produced a proof that this paradox could not the avoided if there were

  more than two alternatives. 3 Notably he did not put out his work as a criticism of

  democracy because he was a firm believer in democracy. Nevertheless careful

  reading of his book with Newing shows the impossibility of avoiding the Paradox

  except in special cases.


  While Black and Newing were working, Arrow produced a general proof that the

  paradox cannot be avoided in the general case. 4 This was his famous general

  impossibility theorem. Notably it was only a remarkably long delay in the refereeing

  process which prevented the Black and Newing paper from being published before



  In the early days of research in public choice, papers dealing with the paradox

  were a major component of papers submitted to me as editor of the journal. I think

  that most of these papers were inspired by desire to avoid the paradox or at least

  to minimize it. If this was the inspiration, it failed. The paradox continues and indeed

  I have invented a much simpler although less elegant proof. 5


  After considerable delay I discovered a proof that the problem was not

  nonexistent, but of less importance than had been thought. If the voting preceded in

  the usual way of legislatures with anyone free to introduce an amendment is, it

  would precede to an outcome very close to the center of the cloud of individual

  optima. A dictatorial chairman, however, could lead the votes to almost anywhere

  he wished. Since the usual procedure is not involving a dictatorial chairman, this

  meant that the voting normally would lead to a more or less satisfactory outcome.

  Professor Arrow, in a very kind letter, accepted in the bulk of my reasoning but

  pointed out that the latter part was not really mathematically strict. He was right,

  but the reasoning was very strong even if not perfect, mathematicians standpoint. 6


  What are fans of democracy to do?


  The end result of all of this work is most disappointing for proponents of

  democracy. Since the author and all of the readers of this paper are such

  proponents of democracy we should all the unhappy about it. As far as I can see,

  however, the usual response is not to be sad, but to sweep the problem under the

  rug. Psychologically this is no doubt an optimal response, but it seems to me that

  scholars should busily search for some better way of dealing with the paradox. I


  frankly admit I have not found one, but the point of this article is to attempt to

  interest other scholars in a revival of voting problem, so important in the early days

  of Public Choice, but normally today not even mentioned in the average issue or,

  indeed, in the average 10 issues.


  This is particularly surprising granted that intellectuals are currently vigorously

  producing arguments for democratic governments, and hence would be one would

  think particularly interested in eliminating paradoxes in democracy. The new

  arguments for majority voting, and the authors normally refer to majority voting

  rather than simply democracy fall into two categories. The first is the allegation that

  democracy's tend to produce capitalistic economies and hence are prosperous.

  Dictatorships are allegedly less efficient in the economic field.



Democracy and economic progress


  In the first place, economists have long known for (or at least many of them have)

  that a capitalistic system is a better method and of producing prosperity than a

  centrally directed one. In the last few years most intellectuals have adopted this

  idea. Note however, that except for a certain number of "reactionary" economists

  this idea was not popular among intellectuals 50 years ago. Warren Nutter

  undertook a major research project in communist statistics and decided that the

  rate of growth of the Soviet Union was not in any way remarkable. Indeed it was

  about that of United States and markedly lower than that of Japan.


  As a result he was practically drummed out of the economic profession. Note that

  efforts to duplicate his research turned out to be surprisingly similar although the

  CIA which funded them never overtly admitted that. It was however not just the

  CIA which disagreed. To repeat, Nutter's career was more or less terminated in

  the economic profession. The University of Virginia did not give him significant pay

  raises and moved him to an inconvenient office. He could not go anywhere else

  because other universities also thought that he was following his ideology and not

  his science.


  This was a personal tragedy for Nutter and a policy tragedy for many governments.

  The view that economic progress required central control by someone not

  hampered by democratic mechanisms was widely held. Many of the people who

  felt this way remained in favor of democracy for reasons other than its economic

  effects. Nevertheless, the recent view sweeping intellectuals that democracy works

  better in economics than a communist dictatorship is recent. Further, as far as I can

  see, like the earlier enthusiasm for communist dictatorships in the economic field, it

  was based on nothing more than one of the waves of enthusiasm that tend to sweep

  the intellectual classes, although the collapse of the old order in Russia undoubtedly



  If we look at the real world, Japan, Germany, France, and India are all

  democracies and doing very badly in their economies while Singapore and Hong

  Kong continue to be prosperous with dictatorships and China, a clear-cut

  dictatorship and a rather impressive one, currently claims the highest rate of growth

  of any significant country. Speaking for myself, I tend to distrust communist

  statistics, but observation on a recent trip to China indicates it is very much better

  off than it was not too long ago, at the end of the great proletarian cultural



  Democracy and peace


  Another recent argument for democracy is that democracies are relatively peaceful.

  This began with view that democracies did not engage in aggressive wars.

  Apparently, after a while, some intellectuals read the history of 19th-century in

  which democracy's conquered much of the world, and the claim was reduced to

  one in which democracy's do not fight other democracies. The original claim was

  particularly surprising since many of the intellectuals who made it were American

  citizens and therefore should have been aware that United States had seized is

  present geographic area by a series of minor but certainly aggressive wars.


  Consider the reduced claim that democracies rarely fight other democracies.

  During a rather long period in which democracies were rare and hence had little

  opportunity to fight each other this was undoubtedly true. Still it should be kept in

  mind that in 1914 it could easily have been argued that both England and Imperial

  Germany were democracies, indeed the major undemocratic country in the war

  was Russia. Of course at that time all the monarchies were moving toward

  democracy and England and Germany were much farther along than Russia. The

  end product of the war was that what progress Russia had made towards

  democracy was canceled and one of the world's worst autocracies put in its place.


  The dissolution of Austria-Hungary was disastrous by any standard. The history of

  the fragments was complicated, but on the whole a setback for democracy. Since

  shortly after the war Italy became a dictatorship, albeit a rather mild one as

  compared to Russia, it is not very obvious that the allied victory expanded



  World War II had a very nasty dictatorship, the Soviet Union, on the same side

  with United States and England. Indeed it did most of the fighting. Japan had an

  elected legislature and the Emperor's powers were very modest. It seems likely that

  they should be regarded as a constitutional monarchy rather than as a dictatorship.

  The end product of the war was of course the great expansion of the Soviet

  dictatorship so that Europe in 1945 was less democratic than it had been in 1930.

  Once again to refer to the war as a war for democracy is misleading


  Better alternatives?


  I have been presenting all of this material which could be regarded as an attack on

  democracy, not in order to run down democracy but indicate that the enthusiasm

  for democracy in the last 10 years and for communist dictatorship in the early '50s

  were simply examples of the instability of intellectual opinion. Personally I prefer

  democracies, but I must admit that the arguments for a democratic state are much

  weaker than those for a capitalistic economy. Further, when you look around the

  world you realize that Prince Bismarck's invention, the welfare state is largely

  dominant in democracies. Since the long run prospects of that system are poor, this

  could be an argument against democracy. It is however quite possible to feel as I

  do that in spite of its defects, democracy is better than the currently known



  So far this paper has not had any dominant theme except that it shows little

  enthusiasm for democratic methods of government. I have to admit that I am not

  enthusiastic about democracy. Like Churchill, I favor it over its current

  competitors, but it seems to me that we should be looking for something better.

  The purpose of this note is first to deal with certain popular arguments for

  democracy, which I think are false, as a preliminary to encouraging my listeners to

  look for new forms of government.


  I find when talking to people about improvements in government the first response

  with respect to any idea is to ask, "Is it more democratic than our present

  methods?" If it were it would have the same defects. It could be, however, that

  there is another form of government which has all of the advantages of our

  democracy but adds something on to it. I have no suggestions at the moment but I

  believe that seeking a better form of government then democracy is sensible policy.

  It may be of course that the better form is a modification of our present democracy.

  If we look around the world we observe some democratic governments that are

  more successful than others. In my opinion the Swiss government is not only the

  best democratic government in the world but also the best government. Thus

  copying it would be an improvement even though I am great admirer of our

  Constitution. Melding the two might be an excellent idea. But I hope that the public

  choice scholars can do better.


  But let me return to my main theme which is problems with our present democracy.

  I will begin by once again turning to either the Arrow theorem, or the Black

  Newing proof that the voting process has paradoxes.


Back to the voting paradox


  Roughly speaking, simple majority voting works very well if they're only two

  alternatives. When there are more the outcome may be close to random. In

  general, in democracies there are more than two people who would like given job

  and they're more than two policy suggestions for any given problem. In most

  functioning democracies these multiple choices are winnowed down to two which

  are then voted on. It is not obvious that one of the alternatives eliminated in the

  winnowing down process could not get a majority over whoever wins in the

  election limited to the two survivors.


  Of course the winnowing down process does not always get the final choice

  pattern down to two alternatives. I above mentioned cases in the American system

  in which no one got a majority because there were more than 2 alternatives which

  attracted significant votes. If one looks at policy choices we once again find a

  number of alternatives offered which are then winnowed down to two by

  successive votes in accord with the procedural rules in use in that particular voting

  body. Granted the prospect of paradox, it is by no means obvious that one of the

  other alternatives which lost earlier could not be the winner selected by the

  operation of the rules of order.


  To take a simple and artificial set of choices, suppose that the various alternatives

  actually offered as amendments in the Senate are: A, B, C, D, E, and F. Note that

  these are only a set of amendments offered on the floor of the Senate. If we

  considered those offered in committee, the set of amendments to the House version

  and what was done in the conference committee, probably at least 25 or 30

  possible variants are proposed at one or another stage in the process. One of these

  numerous alternatives could be capable getting majority against the winner in the

  formal vote. Suppose for example that the votes are taken F against E, the winner

  against D. and so forth. This leads to B winning, but that B as never been offered

  against E, so it's perfectly possible that E could beat B but not beat D.


  This is simply an example of the standard possibility of circular majorities. We have

  no real measure of how often it happens. The first effort to find out how often was

  a joint article by Colin Campbell and myself which generated random preferences

  for a large body of synthetic voters in the computer memory and then tested them

  for cycles.


  The method is obviously crude but the only improvements on our design have been

  based on the same method but with larger collections of random numbers assigned

  to voters. Obviously, we need improvements but it is clear that the cycles are

  reasonably common. In this paper, I will make no effort to find out how common

  they are. I simply assume that they sometimes happen, and when they do, the

  outcome is not one we should respect. Of course, if they were rare we could

  regard the possibility as a minor defect, and go ahead. If they were common they

  would not be a minor but a major defect. Unfortunately we do not know.


  The effect of the paradox on Congressional elections


  But let us go on to the candidates selected by election. In addition to the paradoxes

  mentioned above, in the United States there is another very serious problem. In the

  2000 election year, 31 members of the House of Representatives chose not to run

  -- presumably mainly in order to retire. Of the remaining to 394, all but 11 were

  re-elected. It is sometimes said that the security of tenure held by members of the

  House of Representatives is greater than that held by members of the House of



  The basic reason for this security is that the members of the House are able to get

  the federal government to expend great resources for their re-election. They have

  large staffs, considerable free travel, access to a free television studio in the

  basement of the capital, and many other advantages. There doesn't seem to be any

  exact accounting for this money, but I asked a professional lobbyist how much he

  thought it was worth and he gave a figure of two and half million per congressman

  per election. It's obvious why they are so secure and obvious why they want to

  restrict campaign expenditures by potential opponents.


  Senators do not have as firm a grasp on their offices as the members of the House

  and a President probably even less. In the case of the President resources spent by

  the federal government to get him re-elected are immense. It is probably true that

  resource expenditures have the highest payoff when there is little other information.

  Thus, the value of these large government expenditures would be highest for the

  House. It should be noted that in the 19th century when these expenditures were

  not as large congressman normally served only one term.


  This leads us perform a mental experiment. There must be several thousand people

  who would like to be President and who think at least a little bit of running. Most of

  them drop the idea almost immediately, but some will give it further consideration

  and talk to people about the possibilities. At this stage we're down to something

  like the 50 possible candidates. They "test the water." There was a senator

  unknown to me who recently visited Washington to a give a speech to an

  organization which he thought might support him. The Washington Post reported

  him as " testing the water" and said he received an enthusiastic response. This put

  him a bit above many of the above 50, perhaps in the top 10 or 20.


  At this point he would begin trying harder to get support from one of the parties,

  from special-interest groups, etc. he would also begin trying to raise money.

  Eventually he would either be nominated or not. Whether he became President

  would depend on who else was nominated and, in particular, how many were

  nominated. The prospect that somebody who could beat the eventual winning

  candidate was eliminated early in the game is certainly good. In other words the

  paradox exists here as well as in the choice of issues. Indeed it appears to even

  stronger here.


  Some suggestions for improvement


  This rather lengthy essay has raised a number of difficulties of a fundamental nature

  with democracy. They do not prove that democracy is inferior to any other given

  system, but they do indicate that we should substitute hard research for enthusiasm.

  In recent years there's been very little effort to solve these problems. I would like to

  encourage my audience to go back to the fundamentals.


  As a sort of study aid for people looking for improvements in the structure of

  government I should like to list some suggestions that already been made. This is

  not intended to be a complete list of possible changes, but only a set which have

  been made but have received little or no attention. I think they should be given

  more attention by students in this field, but I hope that someone will invent even

  better ones.


  I begin with Clarke's demand revealing process. This has had more attention than

  the others including a complete issue of public choice devoted to it. As the reader

  may know, I have done some work in this area and am an enthusiast for the

  system. It permits the voter to express not only which alternative he prefers, but

  also how much he prefers it. The outcome might lead to a minority of intense voters

  defeating a majority of near indifferent voter.


  My second proposal is Earl Thompson's suggestion to put individual policy changes

  up, in essence, to a bid. Among other things this permits compensation of the

  losers. The third proposal is Hanson's betting procedure in which the voter may be

  rewarded for favoring a decision for certain proposals if ex post an impartial

  commission finds that it adds to the national welfare.


  All three of these methods are radically different from our current voting

  procedures. Indeed, it could be argued that they're not really voting at all.

  Nevertheless they are a start. Note that all three permits a minority to win over a

  majority. Also, all three of these suggestions are subject to the Arrow, Newing and

  Black problem. If there are more than two alternatives, the order in which they are

  taken up may lead to different outcomes. Voting on all alternatives at the same time

  may also lead to different outcomes. As in other cases where these problems arise,

  voting on the order of taking them up to also leads to paradoxes. Still these are a

  start in investigating radically different ways of making decisions, and they're not



  Alternative voting procedures


  These are variants on the actual voting procedure. Other possible changes involve

  the problem of who can vote. Dennis Mueller suggested that voters to given a short

  examination before being permitted to vote. The intent, of course, is to restrict the

  voting to people who at least know some elementary facts about the government. I,

  myself, perhaps influenced by my knowledge of China, have suggested an

  examination for the candidates. Following the Chinese precedent the examination

  for different offices would be of different degrees of difficulty. A man who would

  fail the president's exam might well pass that for alderman. Again following the

  Chinese precedent the examination would leave several candidates for each office

  to be selected by the voters. They would remain in control but the number of

  alternatives would be reduced. If the examination were well-designed the

  alternatives would also be improved.


  It is not obvious that one man one vote is ideal. Corporations give different people

  different votes depending on how many shares they own. As an aside, this system

  was originated by Lord Clive. He not only started the British Empire in India by his

  victory at Plassey, but he also, in an unsuccessful effort to control the Honorable

  Company, caused changes from one man one vote to one share one vote. It's not

  at all obvious which is the best system. I find, however, that most people are

  strongly opposed to, let us say, the one vote for every dollar in taxes paid. Whether

  this is merely opposition to a new idea or a rational position, I do not know. When

  I talk to people about it their objections normally are not well reasoned. Indeed

  they normally offer no reason at, all, merely opposition.


  There are other proposals for giving different people to different numbers of votes.

  Nevil Schute wrote a whole novel, In the Wet, devoted to this idea, and one of the

  richest men in United States - Hunt -- also produced a book on it. The additional

  votes could be distributed in terms of payment for services. For a modest example,

  suppose any war veteran who actually got shot at gets an extra vote.


  Another radical idea is to permit people to hold their votes in abeyance. I could, for

  example, decide not to vote for president in 2004 and then cast two votes in 2008.

  Or perhaps I could have credit, testing two votes in 2004 and none in 2008.

  Perhaps to charge interest, I might be prohibited from casting votes for Senators in



Undemocratic governments and conclusion

  But let us consider some undemocratic ideas. Gibbon thought the period of the

  adoptive Emperor's in Rome was the happiest in human history. Mexico used a

  somewhat similar system from 1931 to 1987. It also had a reasonably good

  government by the rather moderate standards of Mexican government's. For a list

  of other governments which are not democratic, I suggest my forthcoming


  "Undemocratic Governments".


  The reader should keep in mind that it is not necessary for the government form to

  be suitable for a nation state. It may be suitable only for use in individual

  governments which form only a part of the nation. If these were undemocratic, they

  would nevertheless be subject to popular control because of the possibility of

  moving. Note that some government functions cannot conveniently be broken up.

  In military matters economies of scale require large government units. There are

  other areas where breaking up government is unlikely to be successful. As an

  obvious example consider the regulation of the electromagnetic spectrum. No

  doubt the reader can think of many others. Nevertheless, pre-1870 Germany

  seems to have been pretty well governed although none of the constituent

  monarchies were democratic.


      I do not claim that any of the alternative governments I have listed is ideal.

   Nevertheless, I think they should receive careful study. Further, I think we should

   look for other forms of government. There is no natural law which says we cannot

   invent new forms of government which are better than the current sample. It is to

  encourage the reader to engage in such radical thought that this essay is dedicated.









  • Wsj FEBRUARY 24, 2011

'Tinker Bell' Economics Colors Inflation Predictions


Oil prices are rising. Food prices are up. The world economy is gaining momentum. Central banks, still fighting aftereffects of the financial crisis, are keeping interest rates low. Is an outbreak of U.S. inflation around the corner?

Federal Reserve Chairman Ben Bernanke says it isn't. It's hard to sustain inflation with so many people out of work and so many offices, stores and factories empty, he reasons. Plus he sees no big rise in "inflation expectations," the wage and price increases that business executives, consumers, workers and investors anticipate.

Related Reading

"Inflation expectations remain well anchored," Fed officials concluded confidently at their last meeting, minutes show, despite obvious inflationary threats abroad. Translation: Food and energy price increases won't prompt higher wages and prices throughout the U.S., partly because people don't think they will.

The notion is that if we all expect inflation, we'll seek higher wages, prices and rents, and that will produce the inflation we expect. Conversely, no matter what's happening in Libya or grain markets, no matter how much yelping about commodity prices squeezing profit margins, if we all believe the Fed won't permit inflation to take off, it won't. Call it the Tinker Bell school of economics.

This actually was an improvement in economic thinking. Fifty years ago, economists assumed people expected future inflation to match the recent past. Then came a generation of economists arguing that people are smarter than that: Their expectations change when the world does. (If it usually takes you 20 minutes to get to work, and you hear one lane will be closed for construction, you'll leave earlier.)

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So central bankers began tracking inflation expectations. It seemed smarter than steering the economy by looking in the rear-view mirror of last month's consumer price index. "The state of inflation expectations," Mr. Bernanke said in a 2007 lecture, "greatly influences actual inflation and thus the central bank's ability to achieve price stability."

Managing inflation expectations became part of a central banker's job—with substantial success. As Goldman Sachs wrote in a recent note, food and oil price spikes in the mid-1980s led to large, persistent increases in economy-wide inflation. Lately, they haven't. "[T]he most likely explanation for this change...is the improved anchoring of inflation expectations since the mid-1980s," Goldman's Sven Jari Stehn wrote.

It sounds comforting, but there are a few rubs.

One is that inflation expectations are easier to define than to measure precisely.

The Federal Reserve Bank of Philadelphia surveys professional forecasters quarterly. They see a spike in inflation this quarter on higher food and energy prices, but over the next decade see 2.3% annual consumer-price-index inflation, a bit below forecasts they have made over the past decade.

Consumers aren't so relaxed, perhaps because they focus more on gasoline and groceries. The University of Michigan/Reuters survey found, on average, that consumers expect prices to rise 3.4% over the next year, faster than they did a year earlier. But the five-to-10-year outlook, which the Fed watches, is stable at about 2.9%.

Alas, there is no reliable inflation-expectation survey of business decision-makers. But in a 1992 survey by Princeton economist Alan Blinder, half the businesses said they "never take economy-wide inflation into account" in setting prices.

An alternative is to look to financial markets. To gauge their expectations, compare yields on Treasury debt that pays interest at a fixed rate, say 3.5% for 10 years, with yields on debt that adjusts so the return rises with the Consumer Price Index. The late economist Milton Friedman liked this measure so much, he proposed that Congress require the Fed to target it. But this gauge can be hard to read, particularly in a financial crisis in which jittery investors flock to the most liquid Treasury securities—conventional ones—and shy away from inflation-protected securities.

At face value, this measure suggested a late-2008 deflation scare that has abated. Inflation expectations now are back at pre-crisis levels, hardly a warning of danger. A more complicated dissection of markets by the Cleveland Fed finds a steady decline in inflation expectations over the past 20 years and now see inflation of just 1.8% over the next decade.

The other rub is that inflation expectations are "anchored"—until they're not. They may change faster than the Fed responds. "The tricky issue is forecasting whether inflation expectations might change," says Joel Prakken of Macroeconomic Advisers, whose model uses inflation expectations to help forecast inflation. "They have been remarkably steady for more than a decade. Presumably this is related to Fed credibility, but it also might be that we've been lucky not to have the big inflation shocks we suffered in the '70s and '80s."

Not so long ago falling inflation expectations at a time of low inflation had the Fed worrying about much-dreaded deflation. That moment has passed. Now, the central bank faces a two-fold challenge: To avoid being stampeded into tightening credit prematurely by the uproar over food and energy prices while also avoiding complacency bred by overreliance on measures of inflation expectations.

Write to David Wessel at capital@wsj.com


Tuesday, January 04, 2011

CEOs: Bright Brazil Outlook 

BETTER?: What is the outlook for Brazil, here represented by Sao Paulo? (Photo: Mario Roberto Duran Ortiz)


Brazil remains a shining star for many multinationals despite its share of challenges.


Foreign investors are expecting solid growth in Brazil this year, driven by a combination of factors, including a growing middle class, expanding technology, hospitality and energy sectors and the upcoming 2014 World Cup and 2016 Olympics.

“Brazil’s economy continues to be the envy of many developing and developed states with strong domestic demand and rapidly recovering investment flows pushing real GDP growth to the highest level in 15 years,” says Rodolpho Cardenuto, Latin America president for Germany-based SAP, the world’s largest business software company. “Brazil is already one of the five most important operations in the world for SAP, and we don’t plan on slowing down.”

Brazil led the other BRIC countries (China, Russia and India) in growth during fiscal year 2010 for US-based Microsoft, the world’s largest software company. A large reason for that is a 16 percent growth in PC’s sold in Brazil, according to Hernan Rincon, Latin America president for Microsoft.

“Microsoft intends to ...

  • WSJ FEBRUARY 24, 2011

Irish Remedy for Hard Times: Leaving


Jean Curran for The Wall Street Journal

Martin Lynch anticipated that his family would leave Ireland to pursue better opportunities.

CARLOW, Ireland—The people of Ireland go to the polls Friday to deliver what's expected to be a knock-out blow to the governing party. But many are choosing to vote in a traditional Irish fashion: with their feet. Tens of thousands are joining in a new wave of emigration, turning their backs on a country mired in economic malaise.

Martin Lynch's family is one of many that are being scattered to the four winds. In the past year, one son has moved to Germany, another to England. His daughter is planning her departure for London, and Mr. Lynch and his wife are bound for Australia.

"Ireland has let me down," says the 62-year-old, a retired caretaker of the local technology institute here in the southeastern town of Carlow. "We just seem to be incapable of governing ourselves."

Nothing seems to better symbolize Ireland's economic crisis than the re-emergence of large-scale emigration, a scourge many hoped had been slain for good. It's a theme that has cast a long shadow over the campaign for this election, which polls suggest will uproot Fianna Fail, the party that has dominated Irish politics for 80 years.


The great recession has triggered yet another wave of Irish emigration. WSJ's Don Duncan reports on how that is playing out in the national election.

On the hustings and on voters' doorsteps, emigration is on everyone's lips. For many it encapsulates the sense of hopelessness that has descended on Ireland as the country grapples with one of the worst economic crises in its history.

"We never thought we'd see this again," says Alan Barrett, an expert in migration at the Economic and Social Research Institute, a Dublin think tank. "It brings back a lot of bad memories."

Forced emigration was long Ireland's curse. A million fled in the decade after the great potato famine of the mid-19th century, which killed some 800,000 people. There was a huge exodus a hundred years later, with thousands lured away by a building boom in the U.K. Another mass migration followed in the 1980s.

The country's fortunes appeared to change for good in the mid-1990s, when years of big spending on higher education, low corporate taxes, generous European Union aid and an influx of foreign investment helped transform Ireland into the "Celtic Tiger." Between 1995 and 2000, the economy grew nearly 10% a year on average, and Ireland began to catch up with its richer European neighbors. The country's far-flung diaspora started trickling back to feast on the new opportunities.

However, by 2008, as Ireland's banking crisis triggered a deep recession and unemployment soared to 13%, the tide turned again. Ireland's Central Statistics Office predicts that 100,000 people will emigrate over the next two years, more than twice the number that left in 2009 and 2010. That comes to about 1,000 per week, and exceeds the last peak in emigration in 1989 when 44,000 people moved away.

The overall figure represents just over 2% of Ireland's population of 4.47 million, which economists say by itself isn't enough to prevent a recovery.

But there are fears that the more people leave, the greater the tax burden on those who stay and the bigger the decline in public services like education and health care.

An exodus could also reduce demand for housing, depressing already low prices and deepening the losses faced by Irish banks. Since the government is on the hook for banks' liabilities, more losses could worsen Ireland's fiscal crisis, leading to more austerity measures and higher unemployment. Such a "fiscal feedback loop" could increase the incentive to leave, says John McHale, an economist at the National University of Ireland, Galway.

And while demographic data on emigrants is scarce, many of those leaving are believed to be well-educated professionals—precisely the people Ireland needs to lead a recovery. "In a modern, knowledge-based economy, dense, diverse cities full of highly-skilled people are a critical competitive advantage," says Mr. McHale. "If the most enterprising people leave, you undermine that advantage."


Ireland's loss is others' gain, and global demand for Irish workers has increased dramatically. "We've had more inquiries over the last six weeks from companies targeting Irish people than we've ever had before," says Stephen McLarnon, head of SGMC Media Group in Dublin, which organizes exhibitions for those wanting to work abroad. Mr. McLarnon says two-thirds of his current applicants have college degrees. Booths at SGMC's next exhibition have been snapped up by federal and state governments in Australia, New Zealand and Canada.

It's not just English-speaking countries that the Irish are heading for. After the U.K., the favorite destinations for Irish people last year were new European Union member states such as Poland and the Czech Republic, with older EU countries like France and Germany coming in third, according to figures from Ireland's Central Statistics Office.

Opposition politicians pin the blame on Fianna Fail. Enda Kenny, leader of Fine Gael, and the man expected to be Ireland's next prime minister, said in an interview that fighting unemployment, the main driver of emigration, will be his party's top priority if it wins the election. The party has pledged to create 20,000 new jobs a year over the next four years, and invest €7 billion, or $9.5 billion, in broadband, renewable energy and water infrastructure.

Yet whoever comes to power, Ireland faces years of austerity as it tries to wrestle down a massive budget deficit. To secure a €67.5 billion international bailout last year, the country committed to a four-year spending plan that envisages savings of €15 billion, or nearly 10% of its annual economic output. Pensions and benefits will be cut and taxes hiked.

Not all economists see emigration as a bad thing. Some say it could act as a crucial safety valve to help restore equilibrium to labor markets. And in a globalized world, moving abroad for work isn't necessarily a permanent loss for the homeland. Workers could gain experience and skills that will give them an advantage in the job market if they return home.

"It's terrible that it has to happen, but it's probably preferable to go abroad in search of work than to stay unemployed here," says ESRI's Dr. Barrett. "At a minimum it keeps their skills active, and it takes the strain off the social welfare budget."

Mr. Lynch's story encapsulates the history of Ireland, with its ebb and flow of migration and return. His father moved to London in 1924 from the hardscrabble western county of Roscommon in search of work. It was a difficult time, with job ads routinely featuring the phrase, "No Irish Need Apply." He flourished nonetheless, running a string of pubs in London.

But he always felt homesick, and the family moved back to Dublin in the early 1950s, when Martin was five. They managed pubs there, but never attained the quality of life they'd enjoyed in Britain. "My parents always regretted coming back," Mr. Lynch says.

In the 1950s, the main pattern of migration was in the other direction. In the decade after 1945, some 320,000 people left Ireland, most of them for the U.K., then in the grip of a post-war labor shortage, and for the U.S. The Irish countryside was littered with abandoned houses, and parishes struggled to muster full football teams.

Mr. Lynch remembers the "American wakes" of the time, all-night parties fueled with dancing and potcheen, a local moonshine, that marked the departure of young men for the U.S. "It was just like a wake, because you knew you'd never see them again," he says.

In 1966, Mr. Lynch emulated his father, moving to England to serve in the British army. But he returned after less than a year when his parents fell ill. Over the next 14 years he worked in sales at various Irish oil and gas companies. In the recession of the 1980s he lost his job, and spent much of the next eight years unemployed.

It was a tough decade for the whole country, and many emigrated. Mr. Lynch recalls seeing tearful reunions at Dublin Airport as smartly-dressed sons and daughters came back home for the Christmas holidays. "I remember thinking—I hope to God my kids don't end up leaving like that," he says.

A quarter century later, Mr. Lynch's children are doing just that.

Last year, his eldest son, Eoin, 29, met and fell in love with a German woman, took two years' leave of absence from his job at an insurance company and moved to Stuttgart. The college graduate is now studying German there in the hope of becoming a teacher. He says he was glad to get out when he did.

"There was a lot of negativity," he says. "People didn't have lots of money to spend on life insurance and pensions." Germany, in contrast, "is absolutely booming."

Another son, Damien, 28, studied aeronautical engineering at Limerick University but couldn't find work in Ireland. He landed a job last year with a British engineering firm in the northern English town of Derby.

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Jean Curran for The wall Street Journal

Clare Lynch plans to emigrate to the U.K.


Neither Eoin nor Damien say they had qualms about quitting Ireland. But their sister, Clare, who is 24, is more conflicted.

A nurse, she recently completed postgraduate training in pediatrics. But since the course ended last October, she's been unable to find a full-time job, partly due to a hiring freeze imposed by Ireland's state-run health service.

She has a temporary job with an agency, working at a center for children with learning disabilities in Cork. It's a 60-mile commute every day from her home in Limerick. She doesn't know from one week until the next whether she'll be kept on.

"When I started, people said nurses and teachers would have jobs for life," she says. But by the time her studies were drawing to an end, that had changed. Clare recalls her dean of studies telling her at her graduation ceremony, "'I hope we won't lose you to England, but I'm pretty sure we will.'"

That prediction has now come true. Ms. Lynch says she has made the "painful" decision to try her luck in the U.K., where demand for nurses runs high. She spent New Year's with her brother Eoin in Germany, and "realized that we were all going to be living in different countries," she says. "It's heart-breaking."

For Mr. Lynch, Carlow symbolizes Ireland's downturn. A town of 18,000 in the country's southeast, it was once a magnet for foreign companies. But investment has dribbled away. A big sugar factory closed in 2005, taking 350 jobs with it, and a German engineering firm shut down its car component plant in 2007. Two years later, Procter & Gamble Co.'s Braun unit, which had once employed more than 2,400 staff in the town, closed an electrical appliance factory. Carlow's quaint high street—once nicknamed the Golden Mile—is pockmarked with boarded-up shops.

"Our economic miracles are always of such short duration," says Mr. Lynch. "We just can't seem to have a sustainable economy."

At the Seven Oaks hotel in Carlow, the talk around the bar is of leaving.

Declan Gordon, a tattooed mechanic who repairs wind turbines, says most of his friends are packing their bags. Some are bound for the U.K., he says, where the 2012 London Olympics has spurred demand for construction workers. The membership of his local Gaelic Football club has dwindled from 30 to 15 in less than a year as teammates have drifted away.

"It's not like the U.S., where you can move to another state if the work dries up," he says. "This place is so small, you have to leave."


  • wsj FEBRUARY 24, 2011

An Antidote for the Corporate Poison Pill

Shareholders could reduce its toxicity if they could replace board majorities more quickly.


In a major decision issued last week, William Chandler of Delaware's Court of Chancery ruled that corporate boards may use a "poison pill"—a device designed to block shareholders from considering a takeover bid—for as long a period of time as the board deems warranted. Because Delaware law governs most U.S. publicly traded firms, the decision is important—and it represents a setback for investors and capital markets.

The ruling grew out of the epic battle between takeover target Airgas and bidder Air Products. Air Products made a takeover bid for Airgas in 2010, increased it several times, and kept it open until last week's decision. Airgas's directors argued that defeating the premium offer would prove, in the long run, to be in shareholders' interests. As the Chancery Court stressed, however, the directors based their opinion solely on information publicly available to shareholders. Why should shareholders, who have powerful incentives to get it right, not be permitted to make their own choice between selling and staying independent?

Chancellor Chandler stated that he would have preferred to let shareholders make the choice at this stage, as they "know what they need to know . . . to make an informed decision." But he felt that denying shareholders' right to choose was required by previous Delaware cases, which recognized directors' right to block offers out of concern that shareholders would accept them "in ignorance or a mistaken belief" concerning the value of remaining independent.

Yet the empirical evidence indicates that when directors use their power to block offers, it often proves detrimental to shareholder interests. A research project I am carrying out with colleagues John Coates and Guhan Subramanian has found that boards that defeated premium offers failed on average, even in the long run, to produce returns for their shareholders that made remaining independent worthwhile.

Moreover, the power of boards to block bids weakens the disciplinary force of the market for corporate control. A substantial body of empirical research indicates that boards' increased insulation from such discipline is associated with lower firm value and worse corporate performance and decision-making.

Despite the Delaware court's decision, investors still have recourse—because a poison pill is powerful only as long as the directors supporting it remain in place.

Airgas's directors were able to use a poison pill for more than a year because Airgas's board is "classified." As such, only one-third of directors come up for election in each annual meeting, so replacing a board majority requires waiting through two annual meetings.

If, by contrast, a company's shareholders could replace a majority of its board more quickly, the board's power to block a takeover bid would be correspondingly weakened.

Support for changing corporate governance arrangements to allow for board declassification is expressed in the proxy voting guidelines of many investment managers, including American Funds, BlackRock, Fidelity and Vanguard. Indeed, shareholder proposals in favor of board declassification have received average support exceeding 65% of votes cast in each of the last five years. This makes sense given the evidence (documented in a 2005 article I co-authored with Alma Cohen, and confirmed by subsequent research) that board classification is associated with lower firm valuation.

In response, public companies have been agreeing to declassify, thus committing not to block an offer favored by shareholders for too long. The number of S&P 500 companies with classified boards declined to 164 in 2009, from 300 in 2000. Still, there's a great deal of room for improvement: Among the 3,000 public companies with takeover defenses tracked by FactSet, about half still have classified boards.

While incumbents have for now won the right to use poison pills indefinitely, pressure by shareholders could substantially limit their toxicity. That would produce considerable benefits for investors and for our capital markets.

Mr. Bebchuk is professor of law, economics and finance at Harvard Law School and director of its corporate governance program. He has assisted institutional investors in negotiating board declassification at publicly traded firms.

  • wsj FEBRUARY 24, 2011

Sergei Magnitsky and the Rule of Law in Russia

For one foreign investor, success proved ephemeral when officials set their sights on his firm.


Earlier this week, in a Wall Street Journal interview about investing in Russia, Russian Deputy Prime Minister Igor Sechin surprised me. He cited my experience in Russia as an example of the strength of the Russian investment climate. Mr. Sechin argued that, based on the "economic efficiency" of my investments in Russia, I should be "a happy man." While Mr. Sechin is correct that my investors realized significant returns on their investments in Russian equities, I would hope that no one ever has to endure the nightmare that my colleagues and I suffered in Russia after achieving this success.

I founded Hermitage Capital in 1996 and built up the firm to become the single largest investor in the Russian stock market. We fought corruption and pushed for transparency at a number of the companies we invested in. Not everyone appreciated our efforts. In November 2005, the Russian government suddenly revoked my visa and declared me a threat to "national security."

Until this point, Hermitage had been widely acknowledged as one of the biggest success stories of Russia's post-Soviet capital markets. Unfortunately, this success proved ephemeral once my firm was targeted by corrupt government officials. In his interview, Mr. Sechin said that "nobody touched" my investors. This is true. We were able to move all of my clients' money out of the country before senior Russian officials working in league with private criminals expropriated Hermitage's investment holding companies. Amazingly, these officials then embezzled—from the Russian state itself—$230 milli