DannyQuah

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Category Archives: economic policy

It Is Not Easy Being Leader Of The World

Some days it’s just plain stressful when the world keeps looking to you to solve its problems, to be global hegemon.

(As always, by “hegemon” I mean not evil imperialistic power, but instead what historians mean from their study of the Delian League in Ancient Greece: “benevolent leader”.  A hegemon provides public goods, whether that is the defense of small Greek city states against the Persian Empire, being lender or consumer of last resort across nations, stabilising and regulating international financial markets, ensuring safety of international shipping routes, and so on.  The critical point is that hegemon implies benevolence; “benevolent hegemon” is redundant. If it were otherwise then, among other things, the evocative phrase “Hegemony or Empire” would be just a meaningless and empty contrast.)

Following the 2008 Global Financial Crisis, proponents of hegemonic stability theory (HST) – the idea that the world economy is most stable when some nation is powerful enough to assert its position as global hegemon – looked to the US to return with a roar to the world stage. Those proponents drew inspiration from Charles Kindleberger’s studies of the 1930s world recovery from the Great Depression. Then it was the US that led the way to global prosperity; so too now only when the US is restored as global hegemon will the world economy recover and global stability return.

In this view, as global hegemon the US cannot help but be benevolent.  The US provides global public goods on which the rest of the world either shirks responsibility or cannot afford. Under HST, the world looks with respect and admiration at its hegemon. The US’s soft power is complete: what the US wants is automatically what the rest of the world wants.

But HST proponents will find it difficult reconciling their view of what the US can do with what the US actually does. Matthew Klein in February 2014 described how the US Federal Reserve needed to base its actions only on what was happening in the US economy, not on any risks of potentially destabilizing other economies:

“the turmoil in certain emerging markets wouldn’t affect the policy decisions of the U.S. central bank. […] Monetary policy is hard enough without having to worry about the spillover effects to other countries that should take care of themselves.”

So, the Fed was not going to change its plans just because some emerging markets might be at risk.

Right before this Fed reassertion of its position, Raguhram Rajan, the highly-respected Governor of the Reserve Bank of India, had drawn attention to how, in contrast to the crisis days of late 2008, by early 2014 international monetary cooperation had broken down. Rajan noted how emerging markets had powered global economic recovery from the depths of early 2009 while the advanced economies remained moribund. But by January 2014 when those same emerging markets needed greater international cooperation with the advanced economies, the industrial countries were instead saying, “we’ll do what we need to, you do the adjustment”.

In Rajan’s view and experience (and those of many other observers), the global economy had become ever more inter-connected, to where one might think sensible policy-makers ought to believe:

“We would like to live in a world where countries take into account the effect of their policies on other countries and do what is right, broadly, rather than what is just right given the circumstances of that country.”

The industrial countries, led by the US, would not play by these implicit rules of the game.

Rajan’s statements together with a growing clamour from other emerging economies elicited a US response with four distinct lines of reasoning. First, there was fallback to how, within the rules of Federal Reserve System operations, the US central bank could not, by law, take into account the well-being of any party except the US economy when charting its actions. Thus, US global hegemony, i.e., US provision of global public goods, would run foul of US law.

Second, some observers in the US claimed that the world economy was not really as inter-connected as Rajan and others might think. Given the coordination that all policy-makers had embarked on to save the global economy in late 2008, this claim rings both false and self-servingly hypocritical. Third, some observers in the US suggested that if any foreign economy was adversely affected by US monetary policy, it was only because those economies ran “high current-account deficits, high fiscal deficits and relatively high inflation”. So, really, “the challenge is brought on by their own domestic policies [and] it’s unfair to say it’s all the Fed’s fault.”  And, finally, that old saw: What is good for the US is, ultimately, good for the world.

It must be tough to be global hegemon, being constantly reminded that stability of the world economy is your responsibility. No one could fault a diverse group of domestic observers and policy-makers for statements that are appropriate and sensible in difficult local circumstances, but when viewed from an international perspective are instead jarring and inconsistent with a modern, enlightened take on global policy-making.

The problem is, world leadership demands high standards. Soft power is hard to earn but easy to lose. In world leadership, whatever the reality, it is perception that matters. Suppose that instead of the US suggesting monetary policy was hard enough without having to worry about spillovers onto other countries, it was China responding to the charge that its exchange rate policy and savings behaviour were causing global imbalance: “Bringing hundreds of millions of my people out of poverty is hard enough without my having to worry about your trade deficits too”.

Suppose that economies adversely affected by US monetary policy were thus affected because those economies ran high current-account deficits and high fiscal deficits.  Then those countries adversely affected by the savings outflow from Asian Thrift?  They were thus affected because they were countries prone to high current-account deficits and high fiscal deficits anyway.  Indeed, the US itself would be an example of that.

The-Amazing-Spider-Man-movie-wide

If the US is to draw on the approbation of its domestic lawmakers before it can conduct economic policy that might turn out to be good for others, then the US really should not be lecturing Germany on how with great economic power comes great responsibility. how in the Eurozone Debt Crisis, Germany should be helping other nations at its own expense.

Finally, it almost surely remains true – as it has been for decades – that what is good for the US economy is good for the global economy.  But then so too what is good for India, China, Brazil, and Indonesia is directly good for over a third of humanity, and indirectly good for likely yet another third of humanity in the economies that trade with them.  The argument on US centrality in the global economy was literally true when the world’s economic centre of gravity hovered just off the eastern seaboard, somewhere in the Atlantic Ocean.  But in the last three decades that centre of gravity has already moved 5,000km east, drawn by the rise of China and the rest of East Asia.  Soon perhaps even more than what is good for the US economy, it will actually be what is good for the East that is good for the global economy.

Yes, HST is almost surely right that the connected global economy needs a global hegemon. The question is, are we looking for our hero where we should or just where we’ve come to out of laziness and habit?  When will we need to agree the US can no longer be global hegemon?

UK austerity and growth: Winter is coming

Policy debate in the current recession is often portrayed to be an irreconcilable political battle, pitting those pushing austerity against those advocating growth.  Indeed, substantive real differences do separate groups having different views on what different policies can achieve.  But, equally, uncertainty on the state of the economy clouds judgment on what appropriate policies should be, especially so in times of economic crisis.  This article examines that uncertainty.  By studying one example — UK policy options at the beginning of 2010 — it argues we need to understand better the implications of different measurements on an economy.

“You’re for me or against me. Choose.”

No one wants to live in a stagnant economy. Even those who don’t believe higher incomes make people happier can’t bear to see their honest, hardworking neighbours unable to make monthly rent or mortgage payment, or having to choose uncomfortably between new clothes and shoes for the kids or food for the table.  No one wants to see masses of unemployed on the streets.  Everyone is for growth.

But, at the same time, even the most diehard pro-growth proponents must acknowledge that government efforts to further  increase growth cannot always be appropriate.  If an economy were already close to full employment or were in any other way overheated, then it is right for fiscal and monetary stimulus to withdraw.  Raising tax revenues and lowering government spending — putting the government’s finances to order and restoring to health the nation’s balance sheets — all have a place in sensible, responsible policy-making.

Standing for growth does not mean constant and unwavering support for always high government spending and expansionary monetary policy.  By the same token, backing policies to lower debt and deficits does not mean wanting economic life to be wretched.  Even when the final goal is the same — to have a healthy, prosperous, inclusive economy — depending on circumstances there is a time and place for different approaches to government policy.

A debate on UK growth versus austerity is on one level a debate about what policy transmission mechanisms are most effective for bringing about long-run sustainable economic growth:  People disagree about what works.  But equally important the debate is one about the current state of the economy. Only after the fact will it become obvious what the right policy actions should have been.  Moreover, because of lags in their effectiveness, policy actions need to anticipate:  Will expansionary effects kick in only after the bottom of the economic cycle has already passed, and thus overheat an already healthy economy?

Many observers have firm views, conditioned by sound economic analysis, on the first of these issues, what appropriate growth and austerity policies are.  It strikes me, however, that the second matters much more in extraordinary situations: in those circumstances, knowledge of the current state of the economy necessarily carries far greater uncertainty.  Generally, the range of economic statistics to look at is broad and constantly changing.  External circumstances in a shifting world economy will confound historical regularities.  Economics education in every institution makes students understand mechanisms of how policies affect an economy, but hardly anywhere is there training on how to assess rigorously the state of an economy.  That latter is merely “monitoring”.  Perhaps accurately judging the state of the economy is impossible — but that doesn’t mean zero understanding is where one should stay.

Policy recommendations in a shifting world economy

That this is important is usefully emphasised by looking over a recent turn of events.  In February 2010 twenty economists signed a letter to London’s  Sunday Times supporting a plan to lower steadily the UK structural budget deficit, starting as early as the 2010/11 fiscal year.  (For transparency, I should say here I was one of those 20.)  The letter suggested that failure to do so could, among other things, raise interest rates and undermine UK recovery, given how the economy had entered the recession with a large structural budget deficit.  Not unexpectedly, this proposal was not uniformly accepted, and many distinguished economists suggested instead that such a policy was potentially risky and that the first priority had to be to restore robust growth.  But to bring about growth was never a point of dispute.  So, it might be useful now to look back and assess the balance of risks then extant.

On the one hand, for some observers, there has never been any doubt: “the UK had a depressed economy then, and it still does now.”  (Indeed, that particular writer upon reading that in August 2012 some of the original group of twenty had changed their minds expressed disappointment “to see so many of the prodigal economists asserting that they were responding to changed circumstances rather than admitting that they simply got it wrong.  For circumstances really haven’t changed [...].”  (Again, for transparency, I was one of those reported to have changed my mind, and indeed I was reported to have emphasized changed circumstances.)

Did circumstances really remain fixed, and were they really so transparent? Complicating the picture:  Statistics on recessions become available only with a fixed delay — to be in recession, an economy has to have had negative GDP growth over two successive quarters.   So, to be in a double dip recession, well, it’s not enough just to announce one’s beliefs, the data have to come out just so.

What did the world look like in early 2010?

Things look really bad: Major recession

In September 2008, Lehman Brothers had filed for bankruptcy.  In January 2009 the IMF had predicted world growth would fall to 0.5% for the year ahead, only three months later to revise the figure significantly downwards to -1.3%.  The World Bank had forecast in March that the world economy would contract by an even larger  1.7% in 2009:  This would be the first decline in world GDP since the Second World War.  The International Labour Organization estimated that 51mn jobs would be destroyed in 2009, raising world unemployment to 7.1%.  Growth in China had fallen from 9% in 2008 to an annual rate of 6.1% in the first quarter of 2009, the lowest recorded figure since 1992.  Between July 2007 and November 2008 world stock markets had lost US$26.4 trillion in value, more than half of world annual GDP.  In April 2009, Olivier Blanchard, the IMF’s Chief Economist, had written “the crisis appears to be entering yet a new phase, in which a drop in confidence is leading to a drop in demand, and a major recession.”  The UK had been officially in recession mid-2008, with the last two quarters of 2008 suffering declines in GDP.

Things looked grim.

The return to growth?

By the beginning of 2010, the UK recession was already 18 months in train.  In this modern era, advanced economies (like the US) have only had short sharp downturns: the 11 US recessions since 1945 averaged only 11 months in duration, with the four recessions between 1980 and 2001 lasting 6, 16, and then 8 months twice, respectively.  By 2007, the UK had gone 15 years since the end of its last recession, one that lasted just 15 months.  Of course, with hindsight, we now know it is well possible for slumps anywhere in the world to drag on, but set against both the UK’s own experience and against a broader history (that of advanced economies, like the US, towards which the UK had progressively become more similar), it was not unreasonable to think by early 2010 that the UK was about ready to grow again.

No one would have reckoned in early 2010 that the global economy had regained robust health.  But, equally, was it apparent the international situation was dismal?  By the first quarter of 2009, Brazil was reported to be no longer in recession, having grown 2% after the two previous quarters of GDP declines.  The OECD forecast the Eurozone and the US would show positive growth in the last six months of 2009.

Back on track:  Asia’s recovery by mid 2009

Back on track: By mid 2009 Asia’s industrial producation had recovered not just to pre-crisis levels but to its pre-2008 growth trend.

Early 2010 was six months past when incomes in China and the rest of emerging Asia had already recovered.  Industrial production was not just back to pre-2008 heights, but to its extrapolated pre-2008 growth trend.  The second quarter of 2009 saw a string of astounding figures from across Asia: all at annual rates, the South Korean economy grew by 2.3%, its fastest expansion in over five years; the Chinese economy grew 7.9%; the Malaysian economy expanded by 4.8%; the Thai economy grew 2.3%; both Japan and Hong Kong were showing rising incomes again, after four successive quarters of GDP declines.  Singapore announced its emergence from recession, big-time, with annualized GDP growth of 20% that quarter.

Sure, China’s government had announced in November 2008 a US$600bn (CNY4,000bn) fiscal stimulus package: that by itself was impressive enough, but also most observers at the time believed growth in export-oriented China and Asia occurred primarily from Western demand. The East was growing again.  Surely the West must be demanding.  It was natural to think that, somewhere somehow, the West must have recovered.

Stimulus is an aircraft carrier

That “somewhere, somehow” was not unreasonable to hypothesize in the slew of policy actions undertaken in all the world’s major economies between late 2007 and early 2010.  In September 2008 the US Federal Reserve, the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Canada, and the Swiss National Bank, in concert, added US$180bn of liquidity to international money money markets.  By November 2008, in the space of just four months, the US Federal Reserve had pumped US$592bn into the US$ monetary base, increasing that monetary base by 70%.  In October 2008, US lawmakers approved a US$700bn rescue package to purchase bad debt from US banks; the UK government unveiled a reform package. amounting to £400bn (i.e., again US$700bn) to provide funds to UK financial institutions; the Japanese government announced a US$270bn fiscal stimulus package targeted at families and small businesses.  The following month saw China’s fiscal stimulus of US$600bn (already-mentioned) and the European Commission’s US$260bn recovery plan.  Further add into the mix Japan’s April 2009 stimulus package of US$98.5bn or 2% of that country’s GDP, and we’re talking significant fiscal stimulus in all the world’s major economies.

It wasn’t all just fiscal expansion either.  From a value of 6.25% in early August 2007, the US Federal Reserve discount rate was reduced to 5.75% later that month, to 4.75% the month after, and then again to 4.5% the month after that.  In January 2008 the Fed cut interest rates by 0.75 percentage points, the largest single reduction in over a quarter of a century.  In October 2008, just one month after their concerted action on international money market liquidity, six of the world’s most important central banks coordinated a simultaneous interest rate reduction of 0.5 percentage points.  By the end of October, the US Federal Reserve had again slashed interest rates, this time down to 1%, the lowest level since 2004.  The following month, the European Central Bank cut interest rates by 0.75 percentage points, its largest ever single reduction; Sweden’s Riksbank, by a record 1.75 percentage points; the Bank of Korea by a record 1 percentage point; the Bank of Canada lowered its benchmark rate to 1.5%, the lowest since 1958.  In December, the US Federal Reserve’s discount rate had gotten down to between 0 and 0.25%; Japan’s, 0.1%; China cut interest rates for the fifth time in four months.  The following month, January 2009, the Bank of England reduced its interest rate to 1.5%, the lowest setting in over 300 years of the Bank’s operation.

Monetary stimulus had by then become not just a matter of reducing interest rates.  After all, interest rates were already effectively zero.  In November 2008, the US Federal Reserve injected US$800bn into the economy, buying US$600bn of mortgage-backed securities and applying the remainder to unclog consumer credit channels.  The Bank of England similarly engaged in quantitative easing, buying securities with newly-printed money (£75bn in March 2008, and then £50bn in May and then again in August 2009) to reach a total outlay of £175bn (US$294bn) by the end of 2009.  The European Central Bank, in June 2009, pumped US$628bn in one-year loans into the Eurozone’s banking system.

In the current Eurozone crisis, one hears talk of the troika (the European Central Bank, the European Union, and the IMF) taking a bazooka to the sovereign debt problem.  If so, the collection of 2008-2009 policy actions might seem more akin to sending in an entire aircraft carrier.

The second quarter of 2009 recorded the official end of recessions not just in the East, as described earlier, but also in the two largest Eurozone economies France and Germany, both seeing positive growth again after four consecutive quarters of GDP declines.  Financial institutions reported profits:  notably Goldman Sachs, JP Morgan Chase (profits up 36% from the previous year), Deutsche Bank (up 67% over the same period in 2008), Barclays, RBS, Italy’s largest bank UniCredito, and the Dutch financial services group ING.  By September 2009, the FTSE 100 had again breached the 5,000-point threshold, recovering completely all losses since October 2008.

Time to get ahead of the curve

Arrayed against this monetary and fiscal stimulus worldwide and the evidence of the world economy already growing again (admittedly most strongly in the East), one might conclude that policy-makers ought now cast a cautious eye on government balance sheets.

But that choice for the UK still remained in delicate balance.  In September 2009 the OECD had forecast the UK would be the only G7 economy still to be in recession by year-end, with both the US and the Eurozone predicted to show two quarters of consecutive growth.  Three months earlier, the OECD had suggested the pace of decline among its members was slowing and that the world economy had nearly reached the bottom of its worst post-War recession, but that the UK would continue to show zero growth in 2010. In July 2009 NIESR predicted that UK GDP per capita would not recover pre-recession levels until early 2014.

Effects of policies often only emerge with a lag.  And, generally, government policy-making errs too often by not getting ahead of the curve.  On top of all that, the UK is a small open economy, and its debt and output markets are strongly influenced by international developments.  Was 2010 the right time to start restoring the UK government’s balance sheet?

2010 EU Debts and Deficits

The UK’s debt/GDP ratio was in line with the largest Eurozone economies and therefore larger than Spain’s; its deficit/GDP ratio was worse than all except Ireland’s.

By July 2009, UK government debt had risen to 57% of GDP, the highest ratio since 1974.  That month, the UK’s public sector net borrowing showed its first July deficit in 13 years.  Earlier in the year, Spain had become the first AAA-rated sovereign nation to have its credit rating downgraded since Japan in 2001.  In December 2009, Greece acknowledged sovereign debt exceeding €300bn (US$423bn), the highest in modern history, resulting in a debt/GDP ratio of 113%, nearly double the Eurozone limit.  The chart shows the UK in 2010 right among the pack of the largest European economies (the size of each ball indicates total GDP) in its debt/GDP ratio, i.e., larger than Spain’s, but with a worse deficit/GDP position than all except Ireland.

In February 2010, it didn’t take a lot of imagination to see how, all else equal, UK government borrowing could easily have become just as expensive and as difficult as in the most stressed Eurozone economies.

Backing off from austerity

In retrospect, of course, we know the austerity policy did not work in the UK.  A reversal might well be warranted, because circumstances had changed, not because things were the same.

After the first couple months of 2010, the Eurozone economy went into free fall much faster and much further than one might have expected. This had two effects on the UK fiscal position:  on the one hand, UK debt turned out looking, well, not so bad after all relative to comparable advanced TransAtlantic economies. The fear that UK borrowing would become overly costly had become much less relevant.

Germany trades East

Germany has kept growing exports through a shift in their direction of motion.

On the other hand, the continued inability of both sides of the Atlantic to resume economic growth meant a further dramatic drag on UK economic performance. Unlike, say, Germany, the UK has historically consistently exported mostly to the slowest-growing advanced economies, and so this TransAtlantic slowdown has considerably depressed the UK exports and thus the UK economy. [Germany, by contrast, today exports more to Developing Asia than it does to the US.]

So, the international environment has shifted in such a way that the urgency for UK rapid debt reduction has lessened.

The other large factor is how market perception on the stance of UK monetary policy too has shifted. For most observers now, the Bank of England has made clear how it is willing to put even more resources into monetary easing.

Conclusion

What can one conclude from this?  First, policy-making needs to be sensitive to circumstances, and today in the UK, that means international circumstances especially.  Monitoring and assessing the state of the world economy is needed.  Second, expansionary policies need to be more sharply designed.  While austerity might not, under the current circumstances, any longer command the support it once did, pro-growth proponents need to explain things better. Just throwing money at the problem plainly does not work. Obviously, the world’s expansionary policies over 2008-2009 succeeded out East, but they did nothing to revive the UK economy.  Why will they do so now? How will this time be different?

(Also at Global Policy | Roubini Global Economics EconoMonitor | Blog Sina)

Some people are never satisfied

You think deficit spending a good thing. Someone suggests Obamacare might add gazillions to the federal deficit.  Isn’t the right response Thank you?  Just saying.
2012 August 20 - Newsweek cover rebuttal. Paul Krugman is wrong

A small proposal to rebalance the global economy: Just let China grow

Many take as fact that the current pattern of global imbalances — large and persistent trade deficits and surpluses across different parts of the world, eventually unsustainable — is due to China and the rest of East Asia consuming too little and saving too much. Since the global economy is a closed trading system, trade deficits and surpluses across all national economies must sum exactly to zero always. Therefore, that one part of the world saves too much and thereby runs trade surpluses means other parts of the world — notably the US — must be running trade deficits.

However, just because deficits and surpluses are tightly inter-connected does not mean that trade surpluses in China, say, have been responsible for US trade deficits: absent further information, causality could well have flowed in the opposite direction. Moreover, China’s high savings might be dynamically welfare-optimizing for its citizens — for instance, private enterprise in China might find self-accumulation the only way to generate investment funds — and, at the same time, only minimally if at all welfare-reducing for already-rich US citizens. Finally, it might be that global imbalances should best be viewed not as a bilateral (US-China) problem but instead a multi-lateral one.

Be all that as it may, many US policy-makers focusing on US trade deficits and China’s trade surpluses urge policy actions against China to rebalance the global economy. Those policy actions include punitive tariffs against Chinese imports and tagging China a currency-manipulator — and thus moving it yet further from official free-market status. Some observers remark that without such external pressure, China will find it domestically too difficult to shift away from its reliance on export promotion, infrastructure investment, and restrained consumption towards a more balanced growth path (e.g., Michael Pettis, Nouriel Roubini, Martin Wolf).

The problem: To raise China’s domestic aggregate demand, especially consumption. The difficulty: China’s consumption cannot increase quickly enough to compensate for the shortfall in aggregate demand should both investment and exports decline. The danger: a hard landing for China and the global economy.

I want to suggest that such a re-direction need not be that difficult. My proposal: Let China grow rich as quickly as possible. Why might this do the trick?

Regional incomes in China

First, consumption within China is already rising faster than both income and investment, provided that we look at those parts of China where incomes per head exceed US$8,800 (Figures 1 and 2). Of course, China’s current per capita income overall now is only US$2200, less than 6% that of the US. What this suggests, however, is as China’s income grows, its overall savings rate will naturally fall. The right policy is to encourage growth, not adopt punitive actions that might retard that growth.

China's regional consumption

Figure 2a China’s regional consumption

(I took Figures 1-3 from a term paper that Daisy Wang wrote for my course Ec204 The Global Economy at the LSE-PKU Summer School, August 2011. The underlying data are from China’s National Bureau of Statistics.)

Second, as John Ross reminds us, investment too is aggregate demand. But, third, continuing to increase China’s investment in, among other things, infrastructure and transportation can help further as it allows those western, poorer regions in China (again Figure 2) better to integrate both nationally and globally, and thus become richer through raising demand and productivity.

China’s regional investment

Figure 2b China’s regional investment

While many observers make much of China’s high investment to income ratio, it is useful to note that that ratio is high not just because its numerator is being driven up, but also because the denominator remains so low. The right state variable for dynamic analysis in a neoclassical growth model is capital per head, not capital per unit of income. And here (Figure 3):

China's  per capita investment

Figure 3 China’s per capita investment

we see how China still has a long way to go on the upside.

Finally, Figure 4:

“The Chinese led the way in the rush to the Boxing Day sales, flocking to department stores to grab designer goods”, The Times of London, 27 December 2011

Figure 4: “The Chinese led the way in the rush to the Boxing Day sales, flocking to department stores to grab designer goods”, The Times of London, 27 December 2011

However much anyone might doubt those China statistics I used above, auxiliary evidence shows that rich Chinese consumers have no difficulty increasing consumption.

The evidence I’ve described doesn’t of course say that global imbalances can be easily erased through just more economic growth in China. However, the algebraic signs of the required relations seem to me to point at least in the right direction. Careful work to quantify these effects might end up showing that their magnitudes aren’t large enough. But, as far as I know, that calibration has not been done, which makes me wonder why some observers can be so certain that China’s current growth trajectory can only exacerbate global imbalances.

When China becomes rich, that will also dramatically lower inequality in the world — globally, the difference in incomes per head across nations overwhelms that across individuals within a single country. No one I know arguing for a more egalitarian society also says that that push for equality should stop at their nation’s borders and be kept from applying seamlessly across humanity’s 7 billion.


Also:

  1. “A small proposal to rebalance the global economy:  Just let China grow” EconoMonitor, 30 December 2011
  2.  “China’s growth could address imbalance”, China.org.cn, 02 January 2012
  3.  “Just let China grow”, The Edge Malaysia, 09 January 2012, p. 64
  4. 恢复全球经济平衡的一个小建议:让中国尽快变得富有, Blog.Sina, 13 January 2012
  5. Reprinted “A small proposal to rebalance the global economy:  Just let China grow”, Global Policy Journal, 11 October 2012

No one likes inequality. Just try not to be poor absolutely as well. And don’t grow so fast either.

No one likes inequality:

US inequality and median income

I just like mine a lot less when it comes together with grinding poverty.  Just saying.

Chinese poverty and inequality - the 100 yuan cigarette lighter

Chinese poverty and inequality - the 100 yuan cigarette lighter

“Oh, also, this thing you’re doing – unbalancing the global economy, eclipsing the current global hegemon, frightening the horses – please, could you stop thinking about just yourself for a minute, and not grow your economy so quickly?  Thank you.”

(Actually, at market exchange rates, the average person in China remains poorer than his counterpart in nine countries across Africa, poorer than the average person in Belarus, El Salvador, or Jamaica.)

Malaysia’s New Economic Model: Making choices

In June 2009, Malaysia’s Prime Minister Datuk Seri Najib Razak asked if I would serve on his council of economic advisors, the National Economic Advisory Council (NEAC). This Council was to come up with a New Economic Model for the country. It would not be a group that got together every month to finetune the economy. This Council was not to sift through the entrails of inventory reports, and propose economic policies to lean against the wind.
1. Background
No, the task assigned the NEAC was to put Malaysia back on a high-growth path, reinstating Vision 2020 that Malaysia would within these next 10 years achieve the status of a developed nation. Council was to do this against a post-1997 background of annual economic growth having nearly halved; investment as a fraction of GDP having plummeted to 50% what it used to be (private investment, to one third); with the economy relying on a workforce of which four-fifths were educated only up high-school level while over one quarter of local public university graduates remained unemployed 6 months after graduation, and with the human capital brain-drain becoming freshly re-energized (350,000 Malaysians in 2008 lived and worked abroad, half of them with university education).

By 2007, Malaysia seemed as far from the World Bank’s notion of a high-income economy as a decade earlier, in contrast to economies such as Slovakia, the Czech Republic, and Poland, all of whom had by 2008 broken through that high-income boundary but had earlier been roughly level with Malaysia.
Yet, Malaysia had been previously identified by the Spence Commission on Growth and Development as one of only 13 countries in the world that had for more than 25 years grown at rates exceeding 7% annually. At different times since the 1960s, despite having a population not even one-third the UK’s, Malaysia had been the world’s largest producer of tin, of rubber, and of palm oil.
Today, forty percent of Malaysia’s households earn less than US$15 a day (RM1500 a month), two thirds the World Bank’s low-income threshold. With Malaysia’s domestic income distribution what it is, only one million people pay income tax at the highest rate of 26%; there is no goods and services tax. Oil and gas revenues have, on occasion, provided up to nearly half the government’s total revenues, although by 2014 Malaysia is expected to become a net importer of oil. As much as 20% of the nation’s public expenditures routinely get spent on subsidies that keep prices of basic goods low but distort reality for Malaysia’s citizens.
Certain policy questions – for instance, monetary control and inflation; financial markets oversight, regulation, and development – are outside the NEAC’s remit, and rightly so. In Malaysia, all those issues were taken care of by others, and already attain world-class standards of performance.
The large facts I’ve just described seemed to me (and many other observers) precisely the ones raising the critical, first-order challenges for economic policy in Malaysia. The problem was how to organize them coherently and understand their resolution. But there is, further, the other critical, first-order challenge unmentioned so far: namely, Malaysia’s 40-year-old program of affirmative action.
I say unmentioned but of course that is not how the outside world viewed this. The international press emphasized most of all this dimension to Malaysia’s policy framework; I will bring this out further in the discussion that follows. For now, however, I just note that some foreign financial houses I spoke to about NEAC work downplayed the significance of all the other problems I have mentioned. They said to me, “Malaysia needs to fix its affirmative-action program; everything else follows.”
That proposition, by itself, is almost surely demonstrably false. On the other hand, the perception is obviously one that colors the views of many market participants who actually shift significant financial resources.
Article 153 of Malaysia’s Constitution, ratified in 1957, requires that the King protect the special position in Malaysia of the Bumiputras (ethnic Malays and a small number of other indigenous groups). The Article allows the federal government to protect Bumiputra interests by establishing quotas for public scholarships, public education, and the civil service.
In 1971, following racial riots, declaration of a state of national emergency, and suspension of Parliament, the then-Prime Minister Tun Abdul Razak—father of the current Prime Minister—introduced the New Economic Policy (NEP). This policy sought to eradicate poverty regardless of race and to eliminate the identification of ethnicity with economic function. The enabler for both these goals would be rapid economic growth, the speedy expansion of the economic pie to divide across all Malaysians, so that no subgroup would feel absolutely disadvantaged. A key feature of the NEP was its effort to raise Bumiputra equity ownership from 2.4% in 1971 up to 30% within two decades.
What has NEP progress been? At a fixed absolute income threshold (its exact value holding no significance as long as it’s fixed and applies across the board), poverty rates for Bumiputras declined from 65% in 1970 to 5% in 2007, while that for Malaysians overall, from 49% to 4%; Chinese, 26% to 1%; Indians, 39% to 2% (Table 4, p. 57, NEM). Wealth figures are widely disputed but most sources give Bumiputra equity ownership of 2–4% in 1971; official KL Stock Exchange statistics suggest Bumiputra shares of 29% by 1990 and 37% by 1996.
That was the background when in August 2009 PM Najib Razak delivered his keynote speech at the NEAC’s inaugural meeting, asking Council for ideas and direction to transform Malaysia into a developed nation by 2020. Malaysia, having successfully drawn foreign investment as low-cost producer was populated with businesses that, at the margin, had neither incentive nor vision to climb the quality ladder. Infrastructure and expertise in key areas remained under-developed. For Malaysia as small open economy, the global trading environment has already shown time and again how it could change suddenly, as it had just done during the 2008 global financial crisis, and further looked set to change even more dramatically but less suddenly from longer-term global carbon considerations. Reforms already begun in Malaysia by the Central Bank, the Securities Commission, and others were already liberalizing capital markets and taking forwards expertise and comparative advantage in Islamic Finance. Government transformation work had already begun to introduce meritocracy and performance measurement in the public sector itself.
What could Council do to help Malaysia re-locate its strategic position in the global economy?
2. The New Economic Model

In the ensuing six months, Council met 4 times in Kuala Lumpur. At these meetings, Council members listened to presentations, mapped strategic visions, and debated subtle differences in emphases. Now and then, we would as a group take such a big-picture perspective that we would form a collective blindspot over the single largest difficulty in whatever we were discussing, completely missing the key concern. Now and then, we would micro-drill down and heatedly argue over whether the appropriate punctuation should be a comma or a semi-colon. But all of us remained energetic and enthusiastic and committed, and sometime during the 15 hours of meeting each day, or in seemingly interminable rounds of email 24/7, we would correct course and converge on the right balance.
We agreed our report had to be in two steps: First, to identify, propose, and persuade on the over-arching framework and strategic vision; second, to steer from that vision its delivery to be led by the executive branch and implemented by the civil service. Without successfuly convincing on the first, the second would never be executed. Without successfully executing the second, the first would have been in vain.
The single big-picture vision was that Malaysia had to become an advanced economy by 2020. Sure that included the Malaysian economy generating sufficiently high income. But that vision also included a subtext of inclusiveness – so that the poorest and most vulnerable in society would be taken care of – and one of sustainability, so that higher economic growth would continue into the future, not at the expense of degrading the environment for generations to follow.
Council concluded many of Malaysia’s malperforming situations were inter-linked. Underperformance in one setting was the rational response to underperformance in the next: Why work hard in school if you’re convinced it doesn’t benefit you afterwards? Why work hard in your job if your productivity is held back by so many unskilled around you? In these circumstances, what is needed is a big push to break out of that vicious circle of under-performance. But disruption would be needed not just in your own circle of school-mates and colleagues, but everywhere in the economy. Hence, we emphasized the big push of economic transformation needed to break the logjam of entrenched, special interests. We sought to build momentum and confidence in the mindset of citizens that more positive changes would continue to emerge but all of us needed to keep pushing.
This economic transformation would come with reform along eight strategic initiatives – slightly more concrete but only slightly:
  1. Re-energize the private sector so it could lead the process of economic growth;
  2. Develop a high-quality workforce;
  3. Create a competitive domestic economy;
  4. Streamline and make efficient the public sector as facilitator for private enterprise, when in the past large government-linked corporations (GLCs) had been viewed as competitors instead;
  5. Move to affirmative action that is (a) transparent, (b) market-friendly, (c) merit-based, and (d) conditioned on need ;
  6. Build infrastructure for a knowledge base;
  7. Enhance the sources of growth;
  8. Ensure the sustainability of growth.
Early on, Council decided it couldn’t be swayed by arguments about whether it was doing something truly novel or new or different. The only thing that mattered should be whether a proposal for implementation was likely to succeed and whether it would bring the highest benefits to the greatest number. Good ideas are hard enough to come by generally; why straitjacket oneself to not look at certain of them? This isn’t an exam: why not copy good ideas however and wherever you find them?
Nonetheless, having come to the end of putting in place the over-arching vision, we could see several ways where our approach differed from earlier ones.
First, we focused on growth through enhancements in productivity, not the sheer brute force of capital accumulation. It’s not that we ignored the latter – if we had, we wouldn’t have expressed concern about the sharp fall off in Malaysia’s investment. Instead, it is that we figured it would be innovative processes and cutting-edge technologies that would provide the surest platform for Malaysia’s producing high value-added goods and services in the future.
Second, we envisioned economic growth being private sector-led and market-driven, no longer dominated by large public investment through GLCs in selected economic sectors.
Third, we described the benefits of the government moving towards local autonomy in decision-making. State and local authorities needed to be empowered to develop and support more of their own growth initiatives – without unnecessarily duplicating function or project. While flat-out competition to produce identical public goods, over and over, would be obviously wasteful, a little competition between local authorities is healthy.
Fourth, we wanted to encourage local geographies to emerge – whether in clusters or corridors – as long as they exploited economies of scale and concentration, and thus raised productivity over the long term.
Fifth, we saw the need for continuing government support of private industry, as long as that support was geared towards innovation, entrepreneurial risk-taking, and high value-added goods and services. It would be those general principles that guided support, not past principles of picking winners.
Sixth, we welcomed talent and skills from everywhere: as long as anyone, local or foreign, is able to contribute to Malaysia’s transformation to an innovative, high-value added economy, they would be accepted and welcomed.
Finally, we emphasized how the global economy was changing, and we figured Malaysia’s strategic position within it needed to re-orient as well. For the entire 20th century, the world’s strongest economic powers have been the US, Western Europe, and Japan. Malaysia, like many others, tuned production and supply networks to service those markets. While we weren’t arguing that policy should be based on the economic centre of the world suddenly shifting tens of thousands of kilometers east, we felt that it was reasonable to acknowledge the change in that global landscape, and to develop further new regional networks centred on the fast-growing, Asia-focused emerging economies.
In a nutshell, that’s it. That’s the New Economic Model (NEM).
3. After, for now

For a relatively technocratic problem and solution, the NEM announcement on 30 March by PM Najib attracted unexpectedly heavy attention from the international press. All the major world press worked in discussion of Malaysia’s affirmative action program, both historical and prospective. The New York Times (30 March 2010) described the revision of Malaysia’s policy to focus on need, not race.

The Wall Street Journal ran articles on two successive days (30 March, 01 April 2010), talking about the recalibration of Malaysia’s decades-old affirmative action and asserting how “the New Economic Policy has hindered Malaysia’s competitiveness in recent years. The U.S. and European Union have singled out Malaysia’s insistence on maintaining preferences for ethnic-Malay owned businesses in government procurement contracts for stalling the development of free-trade pacts”. The Journal’s Opinion Asia column (01 April 2010) contextualized PM Najib’s speech by observing how ‘A few years ago it was inconceivable that a Malaysian premier would express dissatisfaction with the “rent-seeking and patronage” inherent in the country’s four-decade-old affirmative action policies and call for a more “transparent” system based on merit and need. Former strongman Mahathir Mohamad used to label people with such ideas “extremists.”‘
Great cynicism continues to be expressed by some of my friends, Malaysian and otherwise, who say they have seen over the years many politician promises made only to be broken subsequently. Personally, however, I see great optimism instead. Why? I contrast PM Najib’s 30 March speech with what I imagine someone wanting an easy ride through life might have said, in light of both the general skepticism and fervent fear-mongering in the runup to the event.
Two days before the NEM announcement, Kevin Brown wrote in the Financial Times (28 March 2010) how there was “widespread doubt” that PM Najib would take any political risk at all of dismantling Bumiputra special privileges, not least in a new economic model that might greatly dilute that historical affirmative action. James Hookway’s Wall Street Journal article of 22 March 2010 gave considerable space to Ibrahim Ali, a right-wing extremist Malay MP, and to Perkasa, the NGO that Ibrahim Ali founded devoted to defending Malay rights, reporting how “Mr. Ibrahim reckons Mr. Najib is misreading the depth of anger many Malays feel toward any change in a policy that has given many a leg up and helped to build a large middle class.” The Economist newspaper (11 March 2010) extrapolated from their interview with Najib and with others to sub-lead their article, “Najib wavers over undoing affirmative-action policies”.

Not least, of course, there is the now-infamous interview Ibrahim Ali granted Al-Jazeera on 29 March 2010, the eve of the launch of the NEM, where Ibrahim Ali gets bleeped three times speaking, with some vitriol, on the position of other races in Malaysia.

Domestic reporting too emphasized the emerging political tensions (e.g., Malaysian Insider, 04 March 2010; 28 February 2010; and many others). And the Malaysian blogosphere – sometimes thoughtful and insightful; sometimes not; always vicious – don’t even go there.
Now, contrast what PM Najib actually said with what all these observers predicted he would say. Think of the political onslaught, the wavering, the self-protection going on around him. If Najib had wanted an easy way out, he could have taken it and no one would have been surprised. He didn’t. He continues along that difficult but worthwhile path.
One final comment. In this international reporting, by far the greatest attention has gone towards Malaysia’s New Economic Policy and its possible adjustment. In Council’s work, we knew this was important, but so too were all other seven strategic initiatives. Affirmative action matters. No significant advanced country in the world gets by without affirmative action programs of some kind – it is in human nature to take care of the weakest and most vulnerable in our society. So too for the members of Council, where that bottom 40% of the Malaysian population is targetted to receive significant help and attention. But fixing all the other problems matters too: it’s one big push for all of them.
Council has now finished Step 1. Step 2 starts. Everyone likes to say, Now the hard work begins – as if I’ve never heard that one before. But I am energized. I continue to do this work (and, for the record, for practically no pay compared to outside options) because I think things actually are looking up in Malaysia.
(This appeared also on Wednesday 14 April 2010 Business Times, New Straits Times Malaysia B4ff and, in Chinese, in Sinchew Daily, again 14 April 2010.)

Economics is a martial art

A scream for help from the alleyway; what do you do? Move in cautiously but quickly? Or hold back because you worry that the whole thing might get messy?

Do you fret that you haven’t yet published the perfect model of these kinds of social dynamics and that until you do, you might do more harm than good? Or that you won’t have the credibility? Credibility for what, for standing up to street hoodlums?

Do you let someone else look into this? Who, people not as well-trained and not as physically fit as you? People without your punching and kicking abilities and your instincts honed from years of practice in a safe training environment?

Do you stand on the sidelines and criticize those trying to help for not dispatching the hoodlums faster?

What if you realize the scream is your mom or your kids or anyone else who looks to you to protect them? What do you do?

They’re not asking for perfect certainty and total rigor. They just want to be safe again. You can’t tell them this isn’t really what you were trained for, that you are much more a kicker whereas these hoodlums will likely be better dealt with by grappling or boxing. You are there, you are physically fit, you have a reaction time faster than those of others around you. That’s all they expect of you. That’s all that should matter.


So too in economics.

You don’t have to be the world’s top martial artist street fighter. Or the world’s deepest thinker on economic policy. You don’t have to expect to come out of every street situation or every economic policy encounter unscathed, whether physically or in reputation.

You just have to do a bit of good in the world. And the more of you there are, the more the bad guys lose.

(Photo credit: Cung LE is a Vietnamese-American kickboxer and mixed martial artist. Following the fall of Vietnam, he came to the US where bullying forced him to learn to fight. In March 2008 he became Strikeforce Middleweight champion by TKO when a sequence of powerful kicks ended up breaking his opponent’s right arm.)

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