Year: 2014

When Manmohan Singh was inaugurated as Prime Minister of India in 2004, the world expected him to oversee a period of rapid transformation, fuelled by breath-taking economic growth. Here was a man renowned for his economic acumen, clean from the corruption that had beset many of his predecessors, and with previous experience of running the country’s finances. Coupled with the vast potential India had and hopes that Singh would shred much of the country’s labyrinthine bureaucracy, many observers predicted the country would position itself as a more democratic rival to China and as one of the economic powerhouses of the world.

Fast-forward 10 years, however, and the impending departure of Singh is being greeted with many of the same calls for reform that were heard before his selection. While India has moved forward, the lacklustre pace at which it has happened has led to Singh being dubbed a disappointment of a leader who struggled to implement any meaningful change.

Now, as India heads to the polls once again, many people are hoping that voters will select a government with serious ambitions to radically overhaul the country’s economy. The signs are, if state elections are anything to go by, that Singh’s incumbent Congress Party could take a hefty drubbing at the hands of the right-leaning, pro-business, Hindu nationalist the Bharatiya Janata Party (BJP).

Recent opinion polls also suggest that the BJP, led by the charismatic Chief Minister of Gujarat Narendra Modi, are set to emerge as the country’s biggest party in May’s general election. However, the announcement of Singh’s intention to step down after the election has been seen as a sign that Congress know they need to do something radical to remain in power. Singh’s appointment of the young and dashing Rahul Gandhi, who just so happens to be a member of the prestigious Gandhi family that has dominated Indian politics since independence, suggests that Congress are looking to install some youthful vigour into the party.

The great-grandson of the country’s first Prime Minister Jawaharlal Nehru, the 43-year-old Gandhi is known for his reticence when it comes to interviews. As part of his election campaign, however, he has started to appear before the media, something that many observers feel he’d do better to avoid. An awkward television debate with confrontational interviewer Arnab Goswani saw Gandhi come across vague and evasive, and disappointed his legions of supporters who expected him to capture the general public’s imagination with a charismatic performance. Others have accused him of being superficial and heavily reliant on his family history.

Divisive option
Modi, on the other hand, has successfully positioned himself as the candidate most likely to get the economy powering forward. International investors seem keen for a Modi-led BJP government emerging from the election, and ratings agency Moody’s predicts that such an outcome would see the economy improve on the estimated five percent GDP growth seen last year. Legendary US investor Jim Rogers has also backed him, telling Indian daily The Economic Times he could “make a difference”. “I hope Narendrah Modi brings some positive change in India. People like him can make a difference, and there might be a big stock market rally. But, in the last few decades, no Indian politician has made things better. The Indian currency is not fully convertible, and it is very difficult for foreigners to invest in Indian financial markets.” CLSA chief strategist Chris Wood also described Modi’s emergence as a candidate “the Indian stock market’s greatest hope”.

Congress know they need to do something radical to remain in power

While the world of international business may be eager to see a Modi victory, many Indians are vehemently opposed to the prospect of such an outcome. A hugely divisive figure on social and religious issues, Modi has been accused of wilfully allowing violence in the aftermath of Hindu pilgrims being burnt alive by a Muslim mob in 2002. Not a popular figure with Congress, Singh has said that the potential election of Modi as Prime Minister “would be disastrous for India.”

Cutting red tape
India’s economy is expected to have expanded around five percent over the last six months, remaining flat after 2012’s figures. The problems facing any new government will be how to cut the country’s famously prohibitive bureaucracy while halting the overflowing levels of corruption throughout society. It is also hoped that more will be done to encourage foreign investment, as well as solving the problem of soaring inflation.

The priority of any new government is to stabilise the rupee, while also making it easier for businesses to grow. The country desperately needs to do something to encourage foreign investment, something that it has been reluctant to accept for many years. In order to do so, however, it must seriously crack down on the rampant corruption throughout the country’s political and business communities, such as favourable contracts being given to family members that have little or no experience on the relevant projects.

Slashing the red tape that binds and trips up businesses throughout India is also essential. Singh’s government has started to do this with its recent backing of the Indian Financial Code that will simplify financial law, but this is merely the first step in a much bigger journey towards a business-friendly legal system.

There is also an urgent need for India to invest in its infrastructure – as there has been for decades. For all the talk of grand, transformative schemes, little has actually been done to bring the country up to speed with the rest of the world.

While five percent GDP growth is nothing to be sniffed at, in the context of what is expected of an economy with such potential, it is somewhat disappointing. Years of dithering by Manmohan Singh’s government may not have lost India a decade, but the country has certainly missed a huge opportunity over the last ten years to establish itself as an economic superpower. It is not too late, however, for the world’s largest democracy to sit amongst the world’s largest economies.

After much humming and hawing by EU leaders, the much-anticipated banking union is on the cusp of becoming a reality. Only it’s five years too late. Much has been made of this united front behind the region’s banks, but negotiations have been protracted and laborious. However, it remains unclear if the so-called union will be fit for purpose, or even if it is what Europe needs right now, as it takes the first tentative steps towards recovery.

Talk of a banking union has been thrown about a lot since the onset of the crisis, and many – including the media – have tended to oversimplify the issue, stirring up unrealistic expectations of what it could do for the European banking industry.  Though this idea was borne out of the then very real threat of a Greek exit, and threat of a bank-run on Spain’s collapsing banks, it has taken so long to materialise that observers are wondering just how effective it will be, and whether it will do anything to speed up the recovery right now.

The idea behind a Europe-wide banking union is based on a collective bailout fund to cover the costs of bank failures. The blueprint also establishes guidelines for faster decision-making when it comes to determining the future of a troubled bank that would not require interference by politicians. “This would supposedly put European banks on an even keel under the protective umbrella of European supervision, European Capital support and deposit insurance,” explains Sony Kapoor, an advisor on economic and financial reforms, wrote in an FT column. And, in theory at least, the idea of a banking union seems like a sensible proposal.

[O]bservers are wondering just how effective it will be, and whether it will do anything to speed up the recovery right now

The main selling point of the proposal, as it stands today, is that when a shared bailout fund is established, European nations will share the risk that may crop up from the industry in the future. “It communicated that EU politics was not completely deadlocked in the face of the crisis, when the truth was otherwise,” says Kapoor. “But it was the promise made by Mario Draghi, president of the ECB, to ‘do whatever it takes’ to ease the market. Anyone who credits any progress on banking union with restoring confidence is being disingenuous.”

Seeing eye-to-eye
Of course, disputes have plagued the negotiations, and so the banking union is still something of a pipedream five years after the idea was first floated. Germany, in particular, is wary that a banking union would actually function more as a fiscal union of sorts. For bigger, more financially sound countries, there is a school of thought which suggests that a union of this type would only contribute to the spread of problems from periphery banks. So, in many ways, Germany’s early veto of the proposal to share risks and costs derived from enduring problems faced by peripheral banks was the first nail in the coffin of the banking union. Without these provisions, the scope of any future provisions will always be terribly limited.

In fact, much like it did when it vetoed the use of eurobonds, Germany has been putting its foot down a lot throughout the negotiation process. Finance Minister Wolfgang Schäuble has managed to ensure that failing EU banks will face the possibility of liquidation without Germany – or any other country – having to foot the bill.

Germany of course is in a rather unusual position in that it stands alone as an economically healthy country within the core of the EU, which has not endeared many others to its cause, and has generated plenty of acrimony. Though Germany has succeeded in protecting its own interests, to the envy of its peers in the union, it has also potentially fatally crippled the prospect of a strong and healthy union for good.

[Germany] has also potentially fatally crippled the prospect of a strong and healthy union for good

Scrap job
EU leaders have been busy trying to salvage what remains of the proposal. There are many concerns that the union, as it stands today, will simply not be strong enough to be effective, and would therefore do very little to reassure investors that the continent is on the up-and-up once again. “While decisions so far have been focusing on the moral hazards of banks, these measures fail to solve an additional market failure in the euro area caused by the moral hazard of governments competing on funding costs, which puts off a proper management of legacy losses via bank restructuring,” explains Diego Valiante, head of capital markets research at the Centre for European Policy Studies, in a blog on EconoMonitor. “Banking union in a single currency area, whether within a single state or a community of states, face three potential market failures: risk-taking behaviours; depositors’ run on banks; and financial disintegration.”

The reason why the banking union as it stands will never work is that as a ‘community of states’- and as such a community of economies sharing a currency, no single solution could ever purport to share-risks without also sharing problems. The economies linked within the EU are at different stages of development, and as such the euro is a single currency with very different values. A cup of coffee costs up to €5 in Paris and less than €2 in Lisbon. Before the gap can be closed between the economies of the European core and the peripheries, a banking union will only succeed in burdening more stable economies with legacy losses from the periphery.

That is not to say that a strong, healthy and well-supported banking union does not have the potential to make the European banking and financial sectors more robust and safe. But in its current state, this is not it.

Pope Francis warned last November that “ideologies which defend the absolute autonomy of the marketplace” are driving rapid growth in inequality. Is he right?

In one sense, Francis was clearly wrong: in many cases, inequality between countries is decreasing. The average Chinese household, for example, is now catching up with the average US household (though still with a long way to go).

But such examples do not negate the importance of rising inequality within countries. Both China and the US are dramatically unequal societies – and are becoming more so. In the US, the statistics are striking at both ends of the income distribution. The bottom quarter of US households have received almost no increase in real (inflation-adjusted) income for the last 25 years.

They are no longer sharing the fruits of their country’s growth. The top one percent of Americans, however, have seen their real incomes almost triple during this period, with their share of national income reaching 20 percent, a figure not seen since the 1920s.

Reaching the peak of growth
In many emerging countries, rapid economic growth has raised living standards to at least some degree for almost everyone, but the share of the rich and ultra-rich is increasing dramatically. Once these countries approach the average income levels of developed economies, and their growth slows to typical rich-country rates, their future may look like America today.

In one sense, Francis was clearly wrong: in many cases, inequality between countries is decreasing

Globalisation explains some of the bottom-quarter income stagnation in the US and other developed economies. Competition from lower-paid Chinese workers has driven down US wages. But technological change may be a more fundamental factor – and one with consequences for all countries.

Technological change is the essence of economic growth. We get richer because we figure out how to maintain or increase output with fewer employees, and because innovation creates new products and services. Successful new technologies always cause job losses in some sectors, which are offset by new jobs elsewhere.

Tractors destroyed millions of agricultural jobs, for example, but tractor, truck, and car manufacturers created millions of new ones. But new technologies come in subtly different forms, with inherently different economic consequences. Today’s new technologies may have far more troubling distributional effects than those of the electromechanical age. Imagine that 30 years ago, someone had discovered a set of magic words enabling us to speak to any friend anywhere in the world – ‘abracadabra John’ and you were talking to John, wherever he was. Provided she secured intellectual-property rights, the inventor would have become the richest person in the world; and her lawyers and those who provided her with luxury goods and services would have become pretty rich, too. But, beyond that, no new jobs would have been created.

Information and communication technology is not costless magic; but it is closer to it than were the innovations of the electromechanical age. The cost of computing hardware collapses over time in line with Moore’s law of relentlessly increasing processing power. And once software has been developed, the marginal cost of copying it is effectively zero.

The automated takeover
The consumer benefits of this technology are large relative to its price: the cost of each year’s latest computer, tablet, or smartphone is trivial compared to the cost of a new car in 1950. But the number of jobs created is trivial, too. In 1979, General Motors employed 850,000 workers. Today, Microsoft employs only 100,000 people worldwide, Google employs 50,000, and Facebook employs just 5,000. These are mere drops in the ocean of the global labour market, replacing very few of the jobs that information technology has automated away.

But increased unemployment is not inevitable. There is no limit to the number of service jobs that we can create in retail, restaurants and catering, hotels, and an enormous variety of personal services. Walmart, for example, employs two million people, and the US Bureau of Labor Statistics forecasts that more than one million additional jobs will be created in America’s leisure and hospitality sector in the next decade.

But the wages that the market will set for these jobs may result in yet greater inequality. And there is no reason to believe that politicians’ all-purpose answer to the problem – “increase workforce skills” – will offset this tendency. However many people learn superior IT skills, Facebook will never need more than a few thousand employees. And access to high-paid jobs is likely to be determined not by absolute skill level, but by relative skill in a winner-take-all world.

At least, however, IT products and services are very cheap, so even the relatively poor can afford them. That might make very unequal societies more stable than many fear. In his recent book Average is Over, the economist Tyler Cowen makes the deliberately provocative argument that while new technology will produce extreme inequality, the relative losers, satiated by computer games and internet entertainment, and provided with the basics of a minimally acceptable life, will be too docile to revolt.

Cowen may be right; the poor may not rebel. But extreme inequality should still concern us. Beyond a certain point, unequal outcomes inevitably fuel greater inequality of opportunity; and extreme inequality of either outcomes or opportunity can undermine the idea that we should all be equal as citizens, if not in material standard of living.

So Pope Francis was right: despite capitalism’s undoubted success as a system for generating economic growth, we cannot rely on market forces alone to generate desirable social outcomes. All new technologies create opportunities, but free markets will distribute the fruits of some new technologies in dramatically unequal ways. Offsetting such outcomes will be a greater challenge today than it has been in the past.

(c) Project Syndicate, 2014

The global economy had another difficult year in 2013. The advanced economies’ below-trend growth continued, with output rising at an average annual rate of about one percent, while many emerging markets experienced a slowdown to below-trend 4.8 percent growth. After a year of subpar 2.9 percent global growth, what does 2014 hold in store for the world economy?

The good news is that economic performance will pick up modestly in both advanced economies and emerging markets. The advanced economies, benefiting from a half-decade of painful private-sector deleveraging (households, banks, and non-financial firms), a smaller fiscal drag (with the exception of Japan), and maintenance of accommodative monetary policies, will grow at an annual pace closer to 1.9 percent.

Moreover, so-called tail risks (low-probability, high-impact shocks) will be less salient in 2014. The threat, for example, of a eurozone implosion, another government shutdown or debt-ceiling fight in the United States, a hard landing in China, or a war between Israel and Iran over nuclear proliferation, will be far more subdued.

Still, most advanced economies (the US, the eurozone, Japan, the UK, Australia, and Canada) will barely reach potential growth, or will remain below it. Households, banks, and some non-financial firms in most advanced economies remain saddled with high debt ratios, implying continued deleveraging. High budget deficits and public-debt burdens will force governments to continue painful fiscal adjustment. And an abundance of policy and regulatory uncertainties will keep private investment spending in check.

[G]rowth will remain anaemic in most advanced economies

The outlook for 2014 is dampened by longer-term constraints as well. Indeed, there is a looming risk of secular stagnation in many advanced economies, owing to the adverse effect on productivity growth of years of underinvestment in human and physical capital. And the structural reforms that these economies need to boost their potential growth will be implemented too slowly.

Same old problems
While the eurozone’s tail risks are lower, its fundamental problems remain unresolved: low potential growth; high unemployment; still-high and rising levels of public debt; loss of competitiveness and slow reduction of unit labour costs (which a strong euro does not help); and extremely tight credit rationing, owing to banks’ ongoing deleveraging. Meanwhile, progress toward a banking union will be slow, while no steps will be taken toward establishing a fiscal union, even as austerity fatigue and political risks in the eurozone’s periphery grow.

In Japan, Prime Minister Shinzo Abe’s government has made significant headway in overcoming almost two decades of deflation, thanks to monetary easing and fiscal expansion. The main uncertainties stem from the coming increase in the consumption tax and slow implementation of the third ‘arrow’ of ‘Abenomics’, namely structural reforms and trade liberalisation.

In the US, economic performance in 2014 will benefit from the shale-energy revolution, improvement in the labour and housing markets, and the ‘reshoring’ of manufacturing. The downside risks result from political gridlock in Congress (particularly given the upcoming midterm election in November), which will continue to limit progress on long-term fiscal consolidation; a lack of clarity about the Federal Reserve’s planned exit from quantitative easing (QE) and zero policy rates; and regulatory uncertainties.

Emerging markets’ difficult year in 2013 reflected several factors, including China’s economic slowdown, the end of the commodity super-cycle, and a fall in potential growth, owing to delays in launching structural reforms. Moreover, several major emerging economies were hit hard in the spring and summer, after the Fed’s signal of a forthcoming exit from QE triggered a capital-flow reversal, exposing vulnerabilities stemming from loose monetary, fiscal, and credit policies in the boom years of cheap money and abundant inflows.

Emerging economies will grow faster in 2014 – closer to five percent year-on-year – for several reasons. Brisker recovery in advanced economies will boost imports from emerging markets. The Fed’s exit from QE will be slow, keeping interest rates low. Policy reforms in China will attenuate the risk of a hard landing. And, with many emerging markets still urbanising and industrialising, their rising middle classes will consume more goods and services.

Ongoing fragility
Still, some emerging markets – like India, Indonesia, Brazil, Turkey and Venezuela – will remain fragile in 2014, owing to large external and fiscal deficits, slowing growth, below-target inflation, and election-related political tensions. Some of these countries – for example, Indonesia – have recently undertaken more policy adjustment and will be subject to lower risks, though their growth and asset markets remain vulnerable to policy and political uncertainties and potential external shocks.

The better-performing emerging markets are those with fewer macroeconomic, policy, and financial weaknesses: South Korea, the Philippines, Malaysia, and other Asian industrial exporters; Poland and the Czech Republic in Europe; Chile, Colombia, Peru, and Mexico in Latin America; Kenya, Rwanda and others in Sub-Saharan Africa; and the Gulf oil-exporting countries.

Finally, China will maintain an annual growth rate above seven percent in 2014. But, despite the reforms set out by the government, the shift in China’s growth model from fixed investment toward private consumption will occur too slowly. Many vested interests, including local governments and state-owned enterprises, are resisting change; a huge volume of private and public debt will go sour; and the country’s leadership is divided on how quickly reforms should be implemented. So, while China will avoid a hard landing in 2014, its medium-term prospects remain worrisome.

The global economy will grow faster in 2014, while tail risks will be lower. But, with the possible exception of the US, growth will remain anaemic in most advanced economies, and emerging-market fragility – including China’s uncertain efforts at economic rebalancing – could become a drag on global growth in subsequent years.