JPMorgan loses yet another top executive as ‘heir’ joins Carlyle

The tightening financial regulations engulfing Wall Street’s biggest investment banks has led to yet more leading executives to jump ship towards more niche institutions. On March 25 it was announced that Michael J Cavanagh would be departing JPMorgan Chase to take up a new role as co-chief operating officer at private equity firm the Carlyle Group.

Cavanagh, who has been JPMorgan’s co-head of investment banking for the last decade, had for a long time been seen as a likely successor to CEO Jamie Dimon. It comes just a few days after one of the company’s leading Chinese executives, vice-chairman Fang Fang, announced he would be stepping down.

While Fang’s departure was thought to be as a result of an SEC investigation into the company’s hiring practices, Cavanagh’s is thought to be due to the tighter regulatory constraints being placed on large investment banks. Last year JPMorgan was forced to pay around $20bn in settlements for a number of investigations into its practices leading up to 2008’s financial crisis.

Investment banks have also seen a number of regulations designed to curb excessive risk taking, as well as calls to restrict high levels of executive pay. In contrast, private equity firms and hedge funds are able to offer highly attractive salaries alongside far greater regulatory flexibility.

Cavanagh…had for a long time been seen as a likely successor to CEO
Jamie Dimon

Announcing the news, Cavanagh said opportunity to join a leading private equity group at a time when the industry was too good to turn down. “This is a rare opportunity to join a premier global investment firm during a time of swift change for the industry. We accomplished an immense amount at JPMorgan and I am grateful to my colleagues, especially Jamie Dimon, for their friendship, support and confidence. Carlyle is an established innovator and I look forward to partnering with Glenn and the rest of the Carlyle team to help take the firm to the next level of success.”

Responding to the news, Dimon said the firm had hoped Cavanagh would stay, but accepted his decision to move on. “I have worked with Mike Cavanagh for more than 20 years. He’s a highly talented executive and has been an integral part of our management team, as our CFO for six years and as co-CEO of the corporate and investment bank. He’s also a special person and we wish him well in his choice to take on a new challenge. While we would prefer he stay at the firm, we are glad he’s going to a valued client in Carlyle. I know the whole operating committee joins me in thanking him for his years of service to our firm.”

Facebook to acquire Oculus VR for $2bn, fans express concerns

Facebook has unveiled its plans to acquire Oculus VR for approximately $2bn, in an effort to preempt the various ways in which social engagement will evolve over the coming years and gain a precious foothold in the emerging virtual reality (VR) market. Facebook’s statement says “The transaction is expected to close in the second quarter of 2014.”

“Mobile is the platform of today, and now we’re also getting ready for the platforms of tomorrow,” said the Facebook founder and CEO, Mark Zuckerberg in a blog post. “Oculus has the chance to create the most social platform ever, and change the way we work, play and communicate.”

[N]ow we’re also getting ready for the platforms
of tomorrow

The California-based firm is best known for its virtual reality Rift headsets, which have been generating hype in the gaming world for some time now, with various developers having already signed on to play a part in the revolutionary project.

However, following the announcement of Facebook’s involvement, a fair few associated parties proceeded to express their concerns, with some developers going so far as to remove themselves entirely from the Rift project. “We were in talks about maybe bringing a version of Minecraft to Oculus,” tweeted Markus Persson, the mind behind the hugely successful sandbox indie game. “I just cancelled that deal. Facebook creeps me out.”

With its roots as a humble Kickstarter campaign, Oculus’ 9,522 backers will no doubt be wondering where exactly the 18-month-old company will be headed now that their combined $2,437,429 in pledges have yielded a multi-million dollar return for the project’s founders. Crucially, many more will be left wondering as to the extent by which Facebook’s ethos aligns with that of the initial Kickstarter campaign.

“Facebook was founded with the vision of making the world a more connected place,” wrote the Oculus’ founder Palmer Luckey on Reddit, in an attempt to allay the fears of disillusioned supporters. “Facebook is run in an open way that’s aligned with Oculus’ culture. Over the last decade, Mark and Facebook have been champions of open software and hardware, pushing the envelope of innovation for the entire tech industry.”

Unconditional basic income ‘will be liberating for everyone’, says Barbara Jacobson | Video

World Finance is soon hosting a round table discussion on unconditional basic income. The debate will include economists, including Liam Halligan, and Guy Standing, proponent of basic income in Europe. To put forth a question to the panel, tweet @JournalistJenny

Unconditional basic income: the key to alleviating Europe’s alarming unemployment levels, or misdirected socialist macroeconomics? World Finance talks to Barbara Jacobson, one of the organisers of the European Citizens’ Initiative for an Unconditional Basic Income, about the implications of such a system for Europe: what it might mean for unskilled jobs, inflation, and the British economy.

World Finance: Well Barbara, a basic income paid to everyone. That’s the theory, but what exactly is this, and who will benefit?

Barbara Jacobson: Well we hope everyone will benefit from it, actually. The main concern is the people who are very poor at the moment in Europe, and the way the economies in Europe have been going down very quickly. We feel that basic income would support demand, and also be a fairer way of allocating money within the economy. The other thing it will do is simplify the benefits system dramatically.

World Finance: Well is this just the benefits system repackaged?

Barbara Jacobson: No, we hope it will be liberating for everyone. First of all, small businesses depend a lot on a lot of unpaid work, both by the entrepreneurs themselves, and usually their families and friends. Or with the ageing population, we need some kind of support system for people to be able to look after their relatives. It’s not that we’re against the services that are available, but many families would rather look after their elderly in their homes. And at the moment if they do that then they risk becoming very poor themselves.

World Finance: So how do you expect this to be funded?

Barbara Jacobson: The Citizens’ Income Trust reckons that it could pay a £10,000 income for everybody. There’s also an increasing divergence in the difference between tax on people who are earning versus tax on people who are on income that is unearned – so for example rents, share dividends, financial speculation tax, that sort of thing. Which would actually increase the amount of money significantly.

World Finance: Well critics might argue that this sounds frightfully socialist, if you like. And won’t this deter people from full-time employment?

We feel that basic income would support demand, and also be a fairer way of allocating money within the economy

Barbara Jacobson: The pilot studies around the world say no! There was a very interesting experiment in Canada called the Mincome done for about four years in the 1970s, which showed that actually the only people who really stopped working were young mothers of small children before school, teenagers who were trying to get into college and who were studying, and people who were close to the age of retirement anyway.

World Finance: Well do you think there could be a question of culture there? Because maybe in Canada people want to work more, whereas if you go somewhere else maybe they’ll be more work-shy?

Barbara Jacobson: What people have to understand about most means-tested benefit systems is that they are actually the cause of people being so-called ‘work-shy’. If you work on top of benefits – say if you’re in the tax credit system, or if you claim housing benefit in this country – the effective tax rate is 85 percent, which is a huge disincentive to work. If we had a citizens’ or a basic income, people would be able to keep the income that they get from that, they would be taxed on the income which they earn on top of that, and we just feel that would be a much fairer system.

World Finance: Well if this did come into practice, what would you think would happen in terms of people entering the country? Would they also be eligible for the same unconditional basic income?

Barbara Jacobson: What we’re saying is that anybody who is eligible for child benefit, so anyone who has the right to remain in this country. We also feel that if it were a European initiative, if it were Europe-wide, I think that would mean a lot of people wouldn’t have to move in order to feed their children.

World Finance: Well not to ask the awkward questions, but what do you think would happen to sort of, unskilled jobs then, that really rely on low wages? Because if they’re getting an unconditional basic income then perhaps they’d be less likely to do these sort of jobs?

Barbara Jacobson: Or they would be demanding higher wages! It’s a very strange thing at the moment, that work seems to be remunerated in inverse proportion to its social usefulness. Say for example, if all the nurses went on strike tomorrow there would be a disaster; if all the bankers went on strike, who would notice?

World Finance: Well assuming we do give everyone money, surely this will have severe inflation implications?

Barbara Jacobson: Well considering how indebted the economy is at the moment, I don’t think that’s too much of a problem. There would be a lot of people who would be paying down their debts with this, probably.

World Finance: In effect it’s really a fiscal stimulus; wouldn’t it be better to just invest in a policy that supports a long-term economic approach that creates jobs?

Barbara Jacobson: Well we feel this would create jobs, because people would be employing themselves. Or you know, they could pool their citizens’ or basic income to set up community projects or even business projects in their area.

World Finance: How do you think this will impact the British economy if it did come into practice, realistically?

Barbara Jacobson: The more money you give to poorer people, the more they actually proportionally spend into the economy. That’s what people seem to forget you know? Money seems to be trickling up as opposed to trickling down. In poorer areas, when people are spending money, that’s where the multiplier effect is. That’s where every pound spent actually creates another five or six pounds in that local economy.

What we would hope is that in very hard-pressed areas like the north, people would be able to stay there as opposed to coming down to London, and rebuild their own economies there.

World Finance: Barbara, thank you.

Barbara Jacobson: Thank you very much.

Hutchison Whampoa owner to sell retail stake, forgoing IPO

A plan by investment group Hutchison Whampoa to publicly list retail business AS Watson has been halted after its owner struck a deal with Singapore’s Temasek Holdings for almost $6bn. The announcement saw shares in the Hong Kong-based investment firm drop by 5.1 percent, the largest fall for the company in over two years.

Many had predicted that Hutchison Whampoa would list its retail arm on the London and Hong Kong stock markets. It comes after a six-month strategic review into its retail business that began last October. The review was intended to look at how best to publicly list AS Watson – a company that has become the largest health and beauty retailer in both Asia and Europe – but that’s now unlikely to happen for a couple more years.

It is thought that his plans for the business will see a partial retreat in Asia, as the company expands in North America and Europe

In a statement, Hutchison Whampoa announced that it would be selling almost 25 percent of AS Watson to Singapore investment firm Temasek, describing it as a strategic alliance. Group Managing Director Canning Fok said, “We are pleased to have Temasek, a renowned international investor, as our long-term partner. This demonstrates their confidence in the growth opportunities and prospects of our retail businesses. AS Watson has grown to become the largest international health and beauty retailer in Asia and Europe with 10,500 tores, of which 657 are here in Hong Kong.”

Li Ka-shing, Hutchison Whampoa’s owner and Asia’s richest man, had been considering a dual listening for many months, and analysts believed it would represent one of the year’s largest IPOs. He has recently been divesting a number of his assets through IPOs, including Hong Kong Electrics Investments in January for around $3.1bn. It is thought that his plans for the business will see a partial retreat in Asia, as the company expands in North America and Europe.

Temasek’s head of investment, Chia Song Hwee, added that the deal would aid its long-term growth strategy. “The consumer retail sector is a good proxy to growing middle income populations and transforming economies. We continue to believe in the growth opportunities and long term prospects of Asia, particularly China, and a recovering Europe.”

Education, integrity key to investment management

Independent financial advisors around the world are often caught between a rock and a hard place. Not only are they expected to fully understand the needs and goals of each and every one of their clients, they are also expected to know about every product on the market, from insurance, regular savings plans, income protection, lump sum investments or pensions. As more products hit the market, an IFA must continually familiarise themselves with the best options at hand, tailor-making portfolios from a wealth of alternatives.

That alone can be a minefield. But then once the most appropriate plan is chosen for clients, the advisor then often has the rather arduous and mind boggling task of selecting the right investment funds to match their attitude to risk and growth expectations. Not only do many people expect their financial advisors to be market experts and know everything about the financial markets, they are also presumed to be skilled fund analysts who have thoroughly investigated every paragraph of every investment prospectus for any fund that has ever come across their desk.

If the markets go down, it is the advisor’s fault. If the fund has issues, it is the advisor’s fault. It can be a tough job.

The truth is, there are some very good independent financial advisors in this world, but they simply don’t have the time, knowledge or expertise to be able to accomplish these tasks when it comes to investing, and that is why they place a heavy reliance on the information provided to them by the investment houses themselves. This is often presented and explained by the fund representatives that take the time to visit them and discuss or promote the investment funds they represent.

Acorn International Fund Distribution, has been established in order to create a new breed of investment management

Problems arise, however, when it comes to retail fund sales and their representatives on an international level. There are so many investment funds to choose from, and if financial advisors are placing emphasis of selecting client investments on the information given by the fund representatives that come and visit them, how do they know they are choosing the best investment for their client?

Asset managers may have sales people pushing for institutional sales, but when it comes to a retail level, they simply don’t have the capacity. There seem to be two types of retail fund sales representatives actively ‘on the ground’ across the globe and seeing IFAs. The first group belong to the huge blue chip multi billion-dollar asset managers with many different fund offerings that can afford to have a substantial international retail sales team. The second is the more boutique fund houses that pay for their sales team, although the cost of it can hugely eat into the gross performances of the funds themselves. More and more research is showing that the best performing investment funds today are often neither of these. The asset managers really making a mark, those that are top quartile performing funds in their sectors year in year out, are those that still run hundreds of millions of dollars AUM, but just don’t have that level to afford an international retail sales team, and, are concerned about keeping their expense capital low to maximise performance and profitability of the funds they manage.

So how do advisors become aware of these funds? Chances are if they are residing in the country where the asset manager is based and they have the time to scroll through the weekly publications, they may have heard of them.

There are some third party marketing companies, and a new sales and marketing company, Acorn International Fund Distribution, has been established in order to create a new breed of investment management. A spokesperson for the firm outlined the marketplace in which they’ve identified a requirement. “We only work with funds and asset managers that have an impeccable reputation, long track record of strong performance, a credible investment team behind them, are in a regulated structure such as UCITs or SICAV, but simply aren’t at that multi billion dollar level where they can afford a huge international sales team. People often talk about ‘win-win situations’ in business, we wanted to create a ‘win-win-win-win’ situation: the asset manager gets to promote their retail funds around the world – where regulation permits – we get to work with asset managers and investment funds we truly believe in, the financial advisor gets informed about the better performing funds and regulated funds that are available to them, and the investors, should it fit their risk profile and match their investment needs, get to invest in what we consider to be some of the consistently top performing and better quality funds that they previously did not have an opportunity to do so, so everyone benefits all at once’.”

Asset managers have the ability to promote their investment funds on a retail level across the globe without having to pay a higher cost for their own international sales force. Established by two members with substantial experience of selling on international, Acorn further aims to promote responsible investing by donating five percent of annual net profits to a charity selected by the IFAs they work with. Fostering education and awareness, the company aims to build a reputation for integrity and longevity.

For further information email office@acorninternationalfd.com

Musa Shihadeh on CSR and sharia compliance | Jordan Islamic Bank | Video

With its Sharia quality rating of AA reaffirmed, Jordan Islamic Bank is going from strength to strength. CEO, Vice Chairman & GM Musa Shihadeh talks about being a “pioneer in Islamic banking” and the importance of social responsibility.

World Finance: Musa, let’s start talking about the continuous growth your bank has seen in assets, deposits, as well as financing and profits. What has been your key to success?

Musa Shihadeh: The key for that is that we are keeping our services to our customers on the latest technology, we train our staff, and we introduce always new products and services for the customers, to satisfy their needs.

World Finance: The banking sector is a very competitive marketplace, what sort of unique products or services do you offer?

Musa Shihadeh: We stick to the Sharia application, and we continue giving the services, whatever the customer asks for, and we have good relations with international and national banks, and people we deal with. We make their satisfaction our main goal in order to continue having this success.

World Finance: How do you look after your shareholders?

Musa Shihadeh: As for the shareholders, they are satisfied. We are the highest bank in the country that gives the shareholders return on their equity. The shareholder equity return this year, for example, was 18.7 after tax. Last year it was 16.7. It is the highest in the country between conventional and Islamic banks as well. So they are very satisfied with this return.

World Finance: Jordan Islamic Bank is known for being a pioneer in Islamic banking. Why do you think that is?

We are one of the oldest banks in Islamic banking in the world

Musa Shihadeh: Because we are one of the oldest banks in Islamic banking in the world. We started our business, as I mentioned, in 1979, and developed the system for Islamic banking. We started training our staff, we always get the latest technology to be applied in our services to our customers. We always give new products to satisfy the needs of our customers, and we connect our customers with other places and countries as well, so we are the best serviced, a fast service, to reach whatever they think the need and ask for.

World Finance: A big part of Sharia compliant banking is social responsibility. What sort of services do you offer?

Musa Shihadeh: Social responsibility, we are a pioneer in this as well, because we have a committee for social responsibility, from the board of directors as well as from the management. As a committee, we offer a lot of services, and we finance SMEs, small micro-financing. We give financing for the craftsmen, and engineers, doctors, whatever they need, and we always do the business which has helped the country as well, for example last year we were the first bank to introduce a solar energy system.

World Finance: And what’s next for Jordan Islamic Bank?

Musa Shihadeh: We always review our strategies yearly, in order to make sure that we are doing our business according to the satisfaction of all stakeholders, because we take care of all stakeholders, shareholders, staff. We train our staff to be a pioneer in the knowledge. We always apply new technology, and we give services to our customers, and we look forward to always to have this latest technology applied in the country, by having a company and staff do programs we need to apply Islamic banking.

World Finance: Thank you.

Musa Shihadeh: Thank you very much.

India needs political change fast to make vital economic reforms

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.

Budget 2014: good or bad news?

FOR: A budget for the makers, doers and savers

More savings freedom and income tax reductions, is good news for UK pensioners and workers, writes Sandra Kilhof

UK Chancellor George Osborne wooed pensioners and savers when he announced the budget for 2014 and unveiled the biggest shake-up of the pensions and savings area in a decade. The plans are good for the government, which is looking to gain voters’ confidence ahead of the elections next year. What’s more the increased freedom on savings and changes in tax brackets could give the UK economy a much-needed nudge upwards.

Osborne’s proposals will give people far more freedom to choose what they do with their pension pot. A key part of the plan is cutting the amount of guaranteed income people need in retirement to access their savings, from £20,000 to £12,000; increase the amount of total pension savings that can be taken as a lump sum, from £18,000 to £30,000; increase the capped drawdown withdrawal limit from 120 percent to 150 percent of an equivalent annuity, and raise the maximum size of a small pension pot which can be taken as a lump sum from £2,000 to £10,00, as well as increase the number of personal pots that can be taken under these rules from two to three.

Crucially, savers wanting unrestricted access to their pension pots will be taxed at the average marginal rate of 20 percent, instead of 55 percent under Osborne’s plans.
With the move, Osborne is hoping to encourage savings significantly by removing rules on often-criticized annuity purchases. Essentially, this gives pensioners the opportunity to access their pensions savings whenever and however they wish, from the point of retirement, instead of turning their savings into a guaranteed lifetime income in the form of an annuity.

[T]he increased freedom on savings and changes in tax brackets could give the UK economy a much-needed nudge upwards

What’s more the Conservative/Liberal Democrat government proposed that Individuals Savings Accounts – a long-standing form of tax-advantaged mass-savings products in the UK – be simplified, with an overall tax-free savings limit of £15,000 per year as of 1 July. This is good news for savers who can currently only invest £5,760 a year into a cash ISA or £11,520 in stocks and shares ISAs.

The idea is intended to give savers more flexibility on how they invest and is estimated to benefit more than six million people currently constrained by their cash and equities limits in ISAs.

The budget also signalled good news for the mass affluent, who will now be exempt from income tax, as a result of the decision to increase the personal allowance. Osborne has previously announced that in the 2014 – 2015 tax year, workers will be allowed to earn up to £10,000 before being liable for income tax.

With the newest budgetary changes, workers can earn up to £10,500 before having to pay tax as of April 2015 – giving people more money to spend and thereby boost the recovering UK economy.

The impact will most likely be significant as the Treasury estimates that it could take 288,000 people out of the income tax bracket in 2015-16, and that 25 million taxpayers will benefit as a result of the tax changes, typically saving £100 a year each.

Finally, Osborne made an unpopular, but necessary choice relating to the taxation of non-UK residents. By extending the tax regime on “high-value” residential property worth more than £500,000, instead of the previous limit of £2m, the Chancellor is targeting enveloped dwellings that could bring in an annual tax of £3,500 or £7,000.

Critics suggest that the tax could hurt individuals with little or no wealth, as property valuations in London especially, have risen. However, it is worth keeping in mind that the new tax is targeted at residential properties owned by companies, not individuals, and that said tax is being implemented at a time when the state of UK public finances still leave much to be desired. Alternative cuts could have impacted welfare spending for instance. In this respect, higher tax on residential property is a far less controversial way of generating much-needed income for the state budget.

Against: The problem with the budget

Perks for old Tory faithfuls and scraps for the poor; this was indeed an election year budget, writes Rita Lobo

A lot has already been said about George Osborne’s silver savers budget. Reviews have been – predictably – mixed. There is very little question about what Osborne’s priorities were when it came to hand-outs, though, and no one should be surprised that those getting the best deal will be the most faithful Tory supporter: wealthy older people.

For the wealthier echelons of the population it is an inebriating concoction of tax breaks, and leg-ups

Gideon’s ‘pension revolution’ might have been unexpected, but after some reflection it seemed like an obvious direction for him to take. This is the last budget before election year, the time to woo those Conservative voters who have been flocking to those eager Ukip shores. Coupled with Osborne’s insistence on bringing down the public debt to GDP ratio to pre-crisis levels before the election, and the result is a potentially fatal cocktail. For the wealthier echelons of the population it is an inebriating concoction of tax breaks, and leg-ups.

Osborne said it himself: “If you’re a maker, a doer or a saver: this budget is for you.” If you are unemployed and young, keep walking – there is nothing to see here.

Allowing savers to unlock their pensions and invest the money themselves is not without its merit, but it is also an opportunity for wealthier people to invest their money with no tax liabilities. The policy will clearly benefit wealthier pensioners more than anyone else, and Ed Balls, the Shadow Chancellor was right to question if there would be sufficient and adequate protections and education to prevent less experienced investors from squandering away their life-savings.

For lower income families, the news was not quite as generous, £0.01 off the pint of beer and a reduction on the tax for bingo, were the highlights. No plans were announced on how to boost youth employment, stuck in the doldrums for the past few years.

Analysts at the Institute for Fiscal Studies already suggests that 300,000 more children are living in poverty in the UK now than in 2010, and that number is set to soar by an addition 150,000 before the current parliament winds down. Osborne announced to measures to mitigate this drop in quality of life. In fact, his welfare cap will probably only help spread poverty, than lift people out of it. The welfare cap locks in the cuts for good, and ensures that people will continue to struggle with no jobs and no safety net.

There was good news in the budget. There are strong measures to tackle tax avoidance on an unprecedented scale, and the deficit is coming down- albeit much slower than Osborne would’ve liked. But it is an election year budget through and through: courting voters with nonsensical measures, and leaving the disengaged poor and youthful to fend for themselves.

Unity will not be the church of the banking industry

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.

US steps up Russia sanctions

Russia’s meddling in what was the Ukrainian state of Crimea already led to some rather tepid preliminary sanctions. However, because of Russian President Putin’s refusal to back down over his efforts to bring Crimea back within Russian territory, the US has decided to step up sanctions against some of his key advisors.

In the initial aftermath of the hastily arranged referendum on Crimean independence, both the US and EU announced a range of travel bans and asset freezes on 11 and 21 key individuals respectively. Met with little more than amusement from many of the targeted individuals, Russia has continued to push ahead with plans to reintegrate Crimea through a series of parliamentary votes.

Now President Obama has decided to toughen his country’s stance on the issue by taking aim at Putin’s inner circle of trusted advisors, many of who play important roles in Russia’s key industries. Obama last night announced that alongside the initial 11 individuals, sanctions would now include an additional 20 people, including presidential chief of staff Sergei Ivanov, Russian Railways chief Vladimir Yakunin, and Gennady Timchenko, the head of key Russian bank Gunvor. In response to the news, Timchenko quickly sold his 43 percent stake in Gunvor, the world’s fourth largest oil trader, to allow it to continue to operate “uninterrupted”.

Announcing the moves, Obama hopes that the moves will put increased pressure on Russia’s economy and force it to take a step back from its antagonistic actions. “We’re imposing sanctions on more senior officials of the Russian government. In addition, we are today sanctioning a number of other individuals with substantial resources and influence who provide material support to the Russian leadership, as well as a bank that provides material support to these individuals.”

While the moves appear tough, much of the response over the last week from Russia’s top brass has been indifferent. In reality, Russia does little business with the US, and so the sanctions seem largely symbolic. Yesterday the country even put its own travel bans on US officials that are similarly meaningless.

While the moves appear tough, much of the response over the last week from Russia’s top brass has
been indifferent

Obama has led the way in being tough on Russia, hoping to see his EU partners follow suit. While European leaders have imposed their own set of sanctions on some in the Russian leadership, they have been somewhat more reticent because of the level of trade that goes on between the two regions.

With Germany largely reliant on Russian oil and gas – around 40 percent of its energy comes from Russian pipelines – Chancellor Angela Merkel has found it difficult to take as tough a stance as Obama. However, yesterday she warned Putin of taking things further, saying that countrywide economic sanctions could be imposed. This could be something that gives Putin pause for thought, with Russia heavily reliant on European trade.

Merkel said: “The European Council will make it clear today and tomorrow that with a further deterioration of the situation we are always prepared to take phase-three measures, and those will without a doubt include economic sanctions.”

In related news, Ukraine’s newly installed leadership signed an agreement for closer ties with the EU, in a show of defiance to Putin. The deal will offer political and economic support to the Ukraine, said European Council President Herman van Rompuy.

“This gesture symbolises the importance that both sides attach to this relationship, and our joint will to take it further. It recognises the aspirations of the people of Ukraine to live in a country governed by values, by democracy and the rule of law, where all citizens have a stake in national prosperity. And the popular yearning for a decent life as a nation, for a European way of life.”

What’s next for global currencies in 2014?

The major themes I expect to be moving the forex market in 2014 are: the Federal Reserve’s tapering and its impact on the global economy; exceptionally low inflation, especially in Europe, but elsewhere as well; the change in European banking regulation; the decision on whether Abenomics is working; less restrictive fiscal policies in the G10, resulting in stronger growth; and the restructuring of the Chinese economy.

There are long-term trends in the forex market that last over a number of years (see Fig. 1). This graph shows the value of the dollar since it began floating, first against the Deutsche Mark, and then against the euro. The big question is whether the dollar is still in the uptrend that started in May of 2008, or whether it began a new downtrend last July. My view is that we’re still in the uptrend and this year we’re likely to see the dollar rally further.

The reason for that goes back to this year’s themes. Only the Reserve Bank of New Zealand is currently expected to tighten in 2014. Every other central bank is expected to keep policy steady. The RBA is expected to go next when it begins tightening in about a year, then the Fed, ECB and BoE are all expected to start around 18 months from now, followed by the Swiss National Bank two years from now.

The Bank of Japan isn’t expected to begin tightening even in three years. With rate differentials expected to remain so stable for so long, investors will be watching the economic data closely to see if any economy starts growing fast enough that the central bank might be able to start changing its stance earlier than expected. So growth rates will be key.

Race to the top
New Zealand and Australia are expected to be the fastest-growing countries in the G10 next year, which is why their central banks are expected to start tightening first. The US and the UK are next. I think that if these forecasts come true and US growth does improve that much, then the market will start to discount an earlier hike in interest rates in the US. That’s what is going to support the dollar, in my view.

Same thing with the pound. Forecasts for Britain’s growth in 2014 are about the same as for the US, although UK growth was lower this year. In other words, Britain should see an even bigger improvement in growth than the US. That’s likely to support the pound, at least against the euro. I think the dollar will still gain against the pound.

This is because I expect Britain’s inflation rate to remain exceptionally low, just like the rest of Europe. The BoE is likely to take advantage of the low inflation to keep rates lower for longer than they would have otherwise. That’s how the government will manage the fiscal retrenchment that they’re planning. The only problem is that British growth is based on borrowing and consuming, not investing and producing. On average, every adult in the country owes £28,489. There’s a limit to how long this can continue. But that’s probably a topic for 2015, not 2014.

While the eurozone is forecast to see a big improvement in growth this year, the absolute level of growth will still be too low to allow the ECB to even think of raising rates. On the contrary, one of the themes for next year is likely to be dangerously low inflation, particularly in the eurozone. This is directly the opposite of what the US is doing, which is why I expect the euro to weaken against the dollar. Also, next year’s restructuring of the eurozone’s banking supervision mechanism is likely to require that the ECB provides more support to the banks by expanding its balance sheet, which should be EUR-negative.

I think though that the most important currency to watch is the yen (see Fig. 2). This graph shows the ranked returns of the G10 currencies against the dollar each year. You can see that the yen is usually extreme. It’s been either the best or worst performing G10 currency for the last six years, and over the last 11 years it’s never been in the middle. It was the worst performing G10 currency in 2012 and 2013, and it might well wind up there again this year. That’s because 2014 is the year when Abenomics has to prove itself.

Predicting fiscal cause and effect
If Abenomics does start to get traction and the Japanese economy does improve, then Japanese investors’ risk appetite will increase and they’re likely to put more money abroad. That may seem like strange logic, but that’s what happens in Japan. A revival in confidence in Japan would probably cause an outflow of funds and a fall in the currency.

On the other hand, if Abenomics doesn’t start to show results, if it’s just causing consumer prices to rise with no increase in salaries or employment, or if the hike in the sales tax once again causes a recession like it did the last time they raised it back in 1997, then Shinzõ Abe has only one card left to play, and that’s to devalue the currency. In that case I’d expect the Bank of Japan to come out with yet another round of quantitative easing and my target of USD/JPY at 130 might well be reached. That’s not my central case, but I think it’s possible.

As for the CHF, I expect the Swiss National Bank to keep EUR/CHF floored at 1.20. So long as that’s the case, the dollar can’t appreciate against the CHF unless it appreciates against the euro too. But as I said before, I do expect the dollar to gain against the euro – and so I expect it will gain against the CHF too.

Finally, there are the commodity currencies. The Reserve Bank of Australia has stated clearly that it wants the Australian dollar to weaken, and if global inflation falls further, as I expect, the RBA could even cut rates to ensure that this happens.

The Australian dollar might also be weakened as China’s economy shifts away from investment and demand for commodities falls. The Bank of Canada too has removed its long-held tightening bias, and with Canadian households’ debt-to-income level now at a record 166 percent, it won’t be able to raise rates any time soon without bankrupting the whole country.

Also, Canadian oil prices are under pressure as US oil production increases. That’s likely to be a long-term factor depressing the CAD. The New Zealand dollar on the other hand is different. New Zealand has good domestic economic fundamentals and the only G10 central bank that’s intent on tightening. The currency may come under pressure occasionally because of Chinese restructuring, but its exports of food are likely to be affected less than Australia’s exports of minerals.

So that’s my view on currencies for next year. A stronger dollar, a somewhat stronger pound, a weaker euro, and potentially a much weaker yen.

Marshall Gittler has been an investment strategist for 25 years at a number of major international securities firms, including UBS, Merrill Lynch, Bank of America and Deutsche Bank as well as serving as Chief Investment Officer at Bank of China (Suisse). He is Currently Head of Global FX Strategy at IronFX Global.

Nancy McKinstry on breaking into China | Video

Nancy McKinstry, CEO and Chairman of the Executive Board for Wolters Kluwer, discusses how her company has accelerated itself in China, how regulating and government mandating in the country is affecting businesses, and what other leaders need to do to break into the market there

World Finance: Why is China important to your company’s long-term business plan?

Nancy McKinstry: China is finally taking off as a market as it relates to serving professionals. What we do at Wolters Kluwer is, we provide information software and services to doctors, lawyers, accountants, other professional groups. And believe it or not, we’ve been in China for 25 years, and up until recently it’s been a relatively small market. But say, in the last five years or so, you’ve gone from no lawyers when we first entered in 1985, to today – there’s about 170,000. But what they predict by 2020 is two million lawyers. And to give you some context, there’s only about 1.8m lawyers in the US. So the market said the same statistic would be true in accounting and health; the professional markets are really starting to accelerate in terms of their growth. So that is why the market is more important to us going forward than maybe it was in the past.

[Y]ou’ve gone from no lawyers when we first entered in 1985, to today – there’s about 170,000

World Finance: What socio-economic factors are driving your business forward in China?

Nancy McKinstry: For us, what really drives the business is regulation and government mandating of certain compliance requirements. Whether it’s around healthcare, or around taxes, and so on. And what you see is that, that drive from the government, from a commercial perspective, is really increasing the number of lawyers, accountants, and so on. And in addition to that, you have the fact that you have a rising middle class. And as you have a rising middle class, you end up with more professionals serving them. So that combination of government and terrain are really driving certain kinds of regulation, combined with the rising middle class; it’s sort of a perfect environment.

World Finance: You’ve had to adapt your products to the digital age; how do you tailor them to the Chinese market versus the European?

Nancy McKinstry: Well in most of the markets, even now in health as well, but it’s certainly in tax and legal – the products are in local language, and very much tailored to the needs of the local customers. So that’s been, you know, the approach that we’ve taken largely in China as well. We do have some global products that would be in English language, and more tailored to a common set of customer needs. But generally we’re very much focused on the local needs.

World Finance: Are you competing with local publishing houses, or are the key players international?

[T]he professional markets are really starting to accelerate in terms of
their growth

Nancy McKinstry: We have these local partners. So for example, in law we deal a lot with China Law Press, the commercial press. And we have longstanding co-publishing arrangements, and that is true again when they’re working with us in the digital world. I would say in the global products, primarily in the health world, we’re clearly competing mostly still with big multinational global players. And I think that will still be the environment for several years.

World Finance: What advice would you give other business leaders looking to break into the Chinese market from any industry?

Nancy McKinstry: It’s a maturing market. My advice would be that they have to have a very specific target segment that they want to go after, and that they have to really understand what are the economics of that, and then see if it fits with their criteria for – not just the growth element – but really, how will they make profit in the country?

Banorte’s contributions strengthen Mexican economy

The promise of emerging market economies has attracted the attention of international investors across the globe. However, their contributions, while significant, are too often characterised by a focus on short-term returns as opposed to sustainable gains. For this reason, those with domestic ties are proving far more effective when it comes to spurring sustainable growth. A prime example is Grupo Financiero Banorte (Banorte) whose contribution to Mexico’s economy in recent years has been considerable to say the least.

Mexico faced headwinds in 2013 and exhibited a lower rate of economic growth than the previous year, in no small part due to a contraction in consumption and retail activity, reduced government spending, waning construction and infrastructure development, and weaker foreign trade. The country’s economic woes, however, were far from exclusive to domestic issues, as continued volatility in international financial markets came as a result of the Federal Reserve’s decision to taper its excessive bond-buying programme.

Even against this backdrop of relative uncertainty, however, Banorte’s performance was overwhelmingly positive last year, and as of September, the group’s profits had grown by 25 percent year-on-year. The institution manages $139bn in assets and is the only financial group of its size controlled by Mexican shareholders; and herein lies the key to Banorte’s success ahead of its international counterparts. The firm’s decisions are taken locally, without the influence of international headquarters, which has proven to be a significant advantage, considering the recent weakness of so many global institutions.

14.3%

Banorte return on equity

$139bn

Banorte total assets

Banorte offers universal banking products and services to those in the Mexican financial system through an integrated model, serving the premium, wholesale and mass retail segments, third party correspondents and 16 small- and medium-size enterprise (SME) centres nationwide.

The firm is currently the third-largest banking institution in Mexico measured by amount of loans and deposits. Aside from increasing its market share, Banorte has consolidated its position as one of Mexico’s most profitable banks and is recognised for its strong fundamentals and sound asset quality, as well as high capitalisation and liquidity levels.

The right balance
With a robust strategy and extensive local knowledge, Banorte has been able to partially offset lower expansion in its loan portfolio and an unfavourable interest rate environment with an improvement in its funding and loan mix, as well as the payment of some high interest paying liabilities, such as a syndicated loan and a perpetual bond.

Core deposits are growing close to 15 percent on a yearly basis, while consumer loans are increasing close to 20 percent, driven by payroll and credit cards increasing 40 percent and 21 percent respectively, year-on-year. As a result, the bank’s net interest margin is currently expanding, which is a positive development, considering that the last time Mexico underwent an easing monetary cycle in 2008, Banorte’s net interest margin contracted by over 300 basis points.

As a result of higher net interest margins and non-interest income, total revenues have expanded by 12 percent over the past 12 months, and expenses by eight percent. Further still, provisioning costs are normalising after having to cover the expected losses of homebuilder exposures during the first half of the year. The group is delivering a significant expansion in earnings on the back of positive operating leverage and the integration of Afore Bancomer’s results. Return on equity (ROE) currently stands at 14.3 percent, despite the dilution of earnings per share and the ROE stemming from a recent equity offering, while return on assets is 1.4 percent, having expanded 16 basis points over the past 12 months.

Banorte’s capitalisation levels are adequate, reaching almost 15 percent, and its leverage ratio is above 12 percent. The firm is entirely Basel III-compliant in terms of capitalisation requirements, which allows it to concentrate more on achieving its growth targets and less on meeting new regulation, as other banks in the world are having to do.

Banorte’s shares trade in the Mexican Stock Exchange with the ticker ‘GFNORTEO’. It is the third most liquid stock in Mexico and has one of the largest floats among publicly traded companies of approximately 90 percent, even before a follow-on share offering carried out in July 2013. The group has more than 3,900 investors, including approximately 400 large global institutional funds, and its various corporate policies meet and even exceed international best practices.

Last year, in particular, was full of changes aimed at increasing shareholder value. Throughout 2013, Banorte implemented a variety of initiatives to consolidate its presence in the Mexican market and strengthen its financial position.

Successful offering
To complement a string of acquisitions in recent years, in July, Banorte’s sound fundamentals and positive outlook were recognised by investors in the global follow-on offering in the local and international ECM markets, which became the most significant transaction in Mexico’s history. The shares were sold through the Mexican Stock Exchange – in which 447,371,781 common shares were subscribed at a price per share of MXN 71.50, equivalent to MXN 31.99bn (approximately $2.5bn). The follow-on offering was so successful that the stock price increased by more than 10 percent the day after the offering, and as of the end of 2013 the price exceeded the offering price by more than 26 percent.

Banorte’s performance was overwhelmingly positive last year, and as of September, the group’s profits had grown by 25 percent year-on-year

As a result of Banorte’s promotional efforts in Mexican and international markets, and in spite of continued volatility, an oversubscription of 3.4 times was achieved, representing a demand of more than $8.5bn (over subscription was 4.7 times in the international offering and 2.8 in the local offering). The share allocation was 63 percent among international investors and 37 percent among local investors. In this offering, 10,126 Mexican retail investors, 22 Mexican institutional funds (including four of the most important Afores) and 160 global institutional funds participated. This primary follow-on offering is the largest in Mexico’s history, the greatest from a locally controlled Mexican financial institution, the second most important public offering in the country’s history and the ninth most important carried out by a Latin American financial institution. Furthermore, it is the most important executed by a Mexican financial institution, measured in terms of the amount placed among local investors.

Banorte’s domestic focus extends to those who are so often neglected by international financial institutions and the firm maintains a commitment in all it does to promote financial inclusion and access to banking products and services for lower income segments. The bank has been supporting SME financing with special guarantees, as well as other priority sectors including agribusiness, low- and middle-income housing and infrastructure financing for some time.

Moreover, Banorte has launched a green platform for MiSMEs (micro-, small- and medium-sized enterprises) within the framework of the Green Businesses Summit 2013, organised by the Global Institute for Sustainability, which aims to achieve a more sustainable production chain to establish SMEs as bank clients and in effect ensure service providers are more competitive.

The bank has also penetrated a sizeable percentage of Mexico’s unbanked population through third party correspondents, and early in 2012 launched MiFon so users could withdraw funds at thousands of ATMs worldwide and transfer money from one account to another via their mobile phones.

Banorte’s corporate social responsibility efforts have seen the bank commit to the United Nations Global Compact – an initiative that aims to integrate 10 principles in the areas of human rights, labour, the environment and anti-corruption into organisational business strategy and operations. The bank has participated for a second year in the carbon disclosure project, and has been selected once again to feature on the Mexican Stock Exchange’s Sustainability Index.

The bank as a whole is very engaged with local communities and environmental protection throughout Mexico, and is committed to exceeding best market practices in corporate governance. Currently, 67 percent of the board members are independent, doubling the percentage required by current stock market legislation in Mexico. The Audit and Corporate Practices’ Committee is fully comprised of independent members, ensuring the utmost transparency in all operations.

What is clear from the example of Banorte is that with a distinctly local focus and close ties to the region’s wider development, institutions can overcome market volatility and boost the long-term prospects of emerging market economies, regardless of shaky circumstances in the international marketplace.

Extreme inequality: a price to a pay for economic growth?

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

A risky future for advanced and emerging economies

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.

(c) Project Syndicate, 2014