Market Advisory Features

Capitalism And Its Troubles
US Unemployment: Double-counting Chickens

Bouncing Back
The New Rome Meets the New Barbarians
Telecoms : Hanging on a Line
U.S. Undertaking Generational Weapons Shift

Getting To Know Hu


Capitalism And Its Troubles

The Economist

The capitalist system has proved surprisingly robust in the face of recent crises, but if it is to keep delivering the goods it needs an overhaul, says Matthew Bishop 

CAPITALISM has had a rotten time lately. Not as rotten as in 1917, when those revolutionary shots in St Petersburg launched a form of anti-capitalism that ended (except in Cuba and North Korea) only just over a decade ago. Nor, with luck, as rotten as in 1929, when a stockmarket crash on Wall Street set off the global Great Depression. But rotten, nonetheless. Nobody knows for sure yet, but 2001 might come to be seen as the year when two decades of mostly unbroken progress for capitalism gave way to something more ambiguous and uncertain.

That year was the first in ages, perhaps since the start of America's great equity bull market in 1982, when the world became significantly less wealthy. Total global marketable wealth—that is, all assets traded in the financial markets, such as shares and bonds—fell by 4% last year, according to a study by the Boston Consulting Group. The number of households with at least $250,000 of marketable wealth dropped from 39m to 37m. Those who believed that in today's economy wealth always increases and the rich keep getting richer have been proved wrong.

The sudden collapse of Enron, a Texan energy-to-finance-to-fraud conglomerate, has shaken faith of another sort: in the integrity of corporate America, and in the Wall Street-centred model of capitalism that has been hawking its wares to investors the world over. The dotcom bubble was one thing; the realisation that apparently profitable companies are not making any money quite another. Much of the appeal of American securities to investors rested on the belief that companies have become much more productive and profitable. After Enron, investors are now questioning the accounts of many American firms, including such admired stalwarts as General Electric and American International Group (AIG), as well as some foreign ones. Given that the American economy has become the engine of the world economy and its companies are being held up as models, this is troubling.

If the doubts about the supposed revolution in productivity and profitability prove justified, the consequences could be dire. Huge amounts of debt have been accumulated by firms and individuals alike, in the belief that the general optimism about corporate America—reflected in continuing high share prices—is justified. Huge amounts of foreign capital have flooded into America for similar reasons, allowing the country to run an enormous current-account deficit and keeping the dollar strong. If these trends were reversed, America's economy could suffer serious damage, and America's model of capitalism might lose much of its appeal to other countries.

In many countries, experience calls that model into question in any case. Argentina's problems have already dealt a serious blow to the idea that the global triumph of capitalism is inevitable. Even such rich countries as Japan flinch from American efficiencies such as securitising bad debt and getting it off bank balance sheets. To a lesser degree Europe is also a reluctant capitalist. Progress of the model can no longer be taken for granted in large parts of Asia, Latin America and the former Soviet Union, and has never been a serious prospect in much of Africa and the Arab world.

The most awful shock of the past year was the terrorist attack on September 11th. The financial system stood up to it remarkably well. Moreover, both the American economy and, more broadly, the world economy have rebounded much more strongly than anybody dared hope. Yet the attacks proved that even where capitalism is well established, it is increasingly vulnerable to those who hate it. No amount of success in the current war on terrorism will eliminate this hideous new risk, which is impossible to quantify—as the insurance industry is indicating by making cover against it prohibitively expensive. 

Assuming terror can be kept away from the developed world, there are two broad schools of thought about the future of capitalism. The bulls argue that the system's performance over the past year, particularly in America, bodes well for the future. Clearly, bursting stockmarket bubbles and scandal-ridden collapses of leading companies are cause for concern. But America has a long record of learning from its excesses to improve the working of its particular brand of capitalism, dating back to the imposition of antitrust controls on the robber barons in the late 1800s and the enhancement of investor protection after the 1929 crash. There is no reason why it should not turn the latest calamities to its advantage too. Senator Jon Corzine, a former boss of Goldman Sachs, puts the case for the optimists: “At the conclusion of any bull market there are always elements of excess that get washed out or cause the system to evolve. But the fact is, we are coming out of the most shallow recession in post-war history, and the outlook is good.”

Star performer

The resilience of the financial system has surprised even the regulators responsible for its health on both sides of the Atlantic. As one of them put it, “If you had told me on September 10th that we were going to get the terrorism, Enron and Argentina, I'd have predicted at least one major international financial institution going bust, and serious consequences for the economy.” As it is, the only financial firms to go under were on the fringes of the system: some banks in Argentina, and a handful of mostly long-troubled or small insurers. 

The bears too have been surprised by the system's resilience, but they still see a large remaining financial bubble which they fear may burst, possibly plunging America and the world into a depression similar to that of the 1930s, or at least of the past decade in Japan. The threat of further terrorism, fighting in the Middle East (with its repercussions for the oil price) and maybe a transatlantic trade war, conjuring up ghastly parallels with the 1930s, have all clouded their crystal balls further. With Argentina's default, they feel, perhaps globalisation has peaked.

The dotcom bubble has burst, but not the bubble in the broader stockmarket. Pessimists predict economic collapse when it does. As Robert Shiller noted in his best-seller “Irrational Exuberance”, it can take a while for bubbles to burst, and longer for their full economic consequences to become clear. The Wall Street crash of 1929 was followed by numerous rallies and dips, and only a couple of years later by the Depression. For now, Alan Greenspan, the chairman of the Federal Reserve (and the man who coined the phrase “irrational exuberance”), continues to blow air into the bubble that his loose monetary policy has created. But he cannot pull off this trick forever. Interest rates can go only so low.

Neither the optimists' nor the pessimists' scenario is inevitable. In America and elsewhere, there are important choices to be made that will influence the outcome. Should there be new rules to curb abuses by investment banks? Can accounting information be made more meaningful? Can the incentives of company bosses be aligned more closely with the interests of shareholders? Can capitalism take root in the developing world? The answer to each of these questions is yes, up to a point, but what needs to be done to achieve that result is not easy. 

One big hurdle is that the will to reform may be lacking, especially if the world economy continues to recover. Already, there are signs that Congress is backing away from some of its more radical proposals (several of which will be no loss). As Harvard's Andrei Shleifer and others point out in a recent article, Wall Street's heart may not be in it either: “Compared to the profits directly related to high stock prices, those from unwinding bubbles must be minuscule.” Although market forces are likely to solve some of these problems, and are already punishing any firm that might conceivably become the next Enron, they may not be sufficient. Bill Gross of PIMCO, a huge bond fund, is unimpressed by the market's response: “My fear is that this newborn faux hostility in the investment attitudes of lenders and stockholders will go the way of many other short-term jiggles in the inevitable march of capitalistic excess.”

Is Mr Gross right? The answer lies in the financial system, which is where this survey begins.


The New Rome Meets the New Barbarians

The Economist

The United States is likely to be the world's top power for many years. This brings challenges that it should not try to face alone, writes Joseph Nye

SHORTLY after September 11th, President Bush's father observed that 

just as Pearl Harbor awakened this country from the notion that we could somehow avoid the call of duty to defend freedom in Europe and Asia in World War Two, so, too, should this most recent surprise attack erase the concept in some quarters that America can somehow go it alone in the fight against terrorism or in anything else for that matter.

But America's allies have begun to wonder whether that is the lesson that has been learned—or whether the Afghanistan campaign's apparent success shows that unilateralism works just fine. The United States, that argument goes, is so dominant that it can largely afford to go it alone. 

It is true that no nation since Rome has loomed so large above the others, but even Rome eventually collapsed. Only a decade ago, the conventional wisdom lamented an America in decline. Bestseller lists featured books that described America's fall. Japan would soon become “Number One”. That view was wrong at the time, and when I wrote “Bound to Lead” in 1989, I, like others, predicted the continuing rise of American power. But the new conventional wisdom that America is invincible is equally dangerous if it leads to a foreign policy that combines unilateralism, arrogance and parochialism. 

Even if China maintains high growth rates of 6% while the US achieves only 2%, it will not equal the US in income per head until the last half of the century

A number of adherents of “realist” international-relations theory have also expressed concern about America's staying-power. Throughout history, coalitions of countries have arisen to balance dominant powers, and the search for traditional shifts in the balance of power and new state challengers is well under way. Some see China as the new enemy; others envisage a Russia-China-India coalition as the threat. But even if China maintains high growth rates of 6% while the United States achieves only 2%, it will not equal the United States in income per head (measured in purchasing-power parity) until the last half of the century. 

Still others see a uniting Europe as a potential federation that will challenge the United States for primacy. But this forecast depends on a high degree of European political unity, and a low state of transatlantic relations. Although realists raise an important point about the levelling of power in the international arena, their quest for new cold-war-style challengers is largely barking up the wrong tree. They are ignoring deeper changes in the distribution and nature of power in the contemporary world.

Three kinds of power

At first glance, the disparity between American power and that of the rest of the world looks overwhelming. In terms of military power, the United States is the only country with both nuclear weapons and conventional forces with global reach. American military expenditures are greater than those of the next eight countries combined, and it leads in the information-based “revolution in military affairs”. In economic size, America's 31% share of world product (at market prices) is equal to the next four countries combined (Japan, Germany, Britain and France). In terms of cultural prominence, the United States is far and away the number-one film and television exporter in the world. It also attracts the most foreign students each year to its colleges and universities. 

After the collapse of the Soviet Union, some analysts described the resulting world as uni-polar, others as multi-polar. Both are wrong, because each refers to a different dimension of power that can no longer be assumed to be homogenised by military dominance. Uni-polarity exaggerates the degree to which the United States is able to get the results it wants in some dimensions of world politics, but multi-polarity implies, wrongly, several roughly equal countries. 

Power in a global information age is distributed among countries in a pattern that resembles a complex three-dimensional chess game

Instead, power in a global information age is distributed among countries in a pattern that resembles a complex three-dimensional chess game. On the top chessboard, military power is largely uni-polar. To repeat, the United States is the only country with both intercontinental nuclear weapons and large state-of-the-art air, naval and ground forces capable of global deployment. But on the middle chessboard, economic power is multi-polar, with the United States, Europe and Japan representing two-thirds of world product, and with China's dramatic growth likely to make it the fourth big player. On this economic board, the United States is not a hegemon, and must often bargain as an equal with Europe. 

The bottom chessboard is the realm of transnational relations that cross borders outside government control. This realm includes actors as diverse as bankers electronically transferring sums larger than most national budgets at one extreme, and terrorists transferring weapons or hackers disrupting Internet operations at the other. On this bottom board, power is widely dispersed, and it makes no sense to speak of uni-polarity, multi-polarity or hegemony. Those who recommend a hegemonic American foreign policy based on such traditional descriptions of American power are relying on woefully inadequate analysis. When you are in a three-dimensional game, you will lose if you focus only on the top board and fail to notice the other boards and the vertical connections among them. 

A shrinking and merging world

Because of its leading position in the information revolution and its past investment in traditional power resources, the United States will probably remain the world's most powerful single country well into this new century. While potential coalitions to check American power could be created, it is unlikely that they would become firm alliances unless the United States handles its hard coercive power in an overbearing unilateral manner that undermines its soft or attractive power—the important ability to get others to want what you want. 

As Josef Joffe, editor of Die Zeit, has written, “Unlike centuries past, when war was the great arbiter, today the most interesting types of power do not come out of the barrel of a gun.” Today there is a much bigger payoff in “getting others to want what you want”, and that has to do with cultural attraction and ideology, along with agenda-setting and economic incentives for co-operation. Soft power is particularly important in dealing with issues arising from the bottom chessboard of transnational relations.

The real challenges to American power are coming on cat's feet in the night and, ironically, the temptation to unilateralism may ultimately weaken the United States. The contemporary information revolution and the globalisation that goes with it are transforming and shrinking the world. At the beginning of this new century, these two forces have combined to increase American power. But, with time, technology will spread to other countries and peoples, and America's relative pre-eminence will diminish. 

In a decade or two, Chinese will probably be the dominant language of the Internet

For example, today the American twentieth of the global population represents more than half the Internet. In a decade or two, Chinese will probably be the dominant language of the Internet. It will not dethrone English as a lingua franca, but at some point in the future the Asian cyber-community and economy will loom larger than the American. 

Even more important, the information revolution is creating virtual communities and networks that cut across national borders. Transnational corporations and non-governmental actors (terrorists included) will play larger roles. Many of these organisations will have soft power of their own as they attract citizens into coalitions that cut across national boundaries. It is worth noting that, in the 1990s, a coalition based on NGOs created a landmines treaty against the opposition of the strongest bureaucracy in the strongest country. 

September 11th was a terrible symptom of the deeper changes that were already occurring in the world. Technology has been diffusing power away from governments, and empowering individuals and groups to play roles in world politics—including wreaking massive destruction—which were once reserved to governments. Privatisation has been increasing, and terrorism is the privatisation of war. Globalisation is shrinking distance, and events in faraway places, like Afghanistan, can have a great impact on American lives. 

At the end of the cold war, many observers were haunted by the spectre of the return of American isolationism. But in addition to the historic debate between isolationists and internationalists, there was a split within the internationalist camp between unilateralists and multilateralists. Some, like the columnist Charles Krauthammer, urge a “new unilateralism” whereby the United States refuses to play the role of “docile international citizen” and unashamedly pursues its own ends. They speak of a uni-polar world because of America's unequalled military power. But military power alone cannot produce the outcomes Americans want on many of the issues that matter to their safety and prosperity. 

As an assistant secretary of defence in 1994-95, I would be the last to deny the importance of military security. It is like oxygen. Without it, all else pales. America's military power is essential to global stability and an essential part of the response to terrorism. But the metaphor of war should not blind us to the fact that suppressing terrorism will take years of patient, unspectacular civilian co-operation with other countries. The military success in Afghanistan dealt with the easiest part of the problem, and al-Qaeda retains cells in some 50 countries. Rather than proving the unilateralists' point, the partial nature of the success in Afghanistan illustrates the continuing need for co-operation.

The perils of going alone

The problem for Americans in the 21st century is that more and more things fall outside the control of even the most powerful state. Although the United States does well on the traditional measures, there is increasingly more going on in the world that those measures fail to capture. Under the influence of the information revolution and globalisation, world politics is changing in a way that means Americans cannot achieve all their international goals by acting alone. For example, international financial stability is vital to the prosperity of Americans, but the United States needs the co-operation of others to ensure it. Global climate change too will affect Americans' quality of life, but the United States cannot manage the problem alone. And in a world where borders are becoming more porous to everything from drugs to infectious diseases to terrorism, America must mobilise international coalitions to address shared threats and challenges. 

The barbarian threat

In light of these new circumstances, how should the only superpower guide its foreign policy in a global information age? Some Americans are tempted to believe that the United States could reduce its vulnerability if it withdrew troops, curtailed alliances and followed a more isolationist foreign policy. But isolationism would not remove the vulnerability. The terrorists who struck on September 11th were not only dedicated to reducing American power, but wanted to break down what America stands for. Even if the United States had a weaker foreign policy, such groups would resent the power of the American economy which would still reach well beyond its shores. American corporations and citizens represent global capitalism, which some see as anathema. 

There is no escaping the influence of Hollywood, CNN and the Internet

Moreover, American popular culture has a global reach regardless of what the government does. There is no escaping the influence of Hollywood, CNN and the Internet. American films and television express freedom, individualism and change, but also sex and violence. Generally, the global reach of American culture helps to enhance America's soft power. But not, of course, with everyone. Individualism and liberties are attractive to many people but repulsive to some, particularly fundamentalists. American feminism, open sexuality and individual choices are profoundly subversive of patriarchal societies. But those hard nuggets of opposition are unlikely to catalyse broad hatred unless the United States abandons its values and pursues arrogant and overbearing policies that let the extremists appeal to the majority in the middle.

On the other hand, those who look at the American preponderance, see an empire, and urge unilateralism, risk an arrogance that alienates America's friends. Granted, there are few pure multilateralists in practice, and multilateralism can be used by smaller states to tie the United States down like Gulliver among the Lilliputians, but this does not mean that a multilateral approach is not generally in America's interests. By embedding its policies in a multilateral framework, the United States can make its disproportionate power more legitimate and acceptable to others. No large power can afford to be purely multilateralist, but that should be the starting point for policy. And when that great power defines its national interests broadly to include global interests, some degree of unilateralism is more likely to be acceptable. Such an approach will be crucial to the longevity of American power. 

At the moment, the United States is unlikely to face a challenge to its pre-eminence from other states unless it acts so arrogantly that it helps the others to overcome their built-in limitations. The greater challenge for the United States will be to learn how to work with other countries to control more effectively the non-state actors that will increasingly share the stage with nation-states. How to control the bottom chessboard in a three-dimensional game, and how to make hard and soft power reinforce each other are the key foreign policy challenges. As Henry Kissinger has argued, the test of history for this generation of American leaders will be whether they can turn the current predominant power into an international consensus and widely-accepted norms that will be consistent with American values and interests as America's dominance ebbs later in the century. And that cannot be done unilaterally. 

Rome succumbed not to the rise of a new empire, but to internal decay and a death of a thousand cuts from various barbarian groups. While internal decay is always possible, none of the commonly cited trends seem to point strongly in that direction at this time. Moreover, to the extent it pays attention, the American public is often realistic about the limits of their country's power. Nearly two-thirds of those polled oppose, in principle, the United States acting alone overseas without the support of other countries. The American public seems to have an intuitive sense for soft power, even if the term is unfamiliar. 

On the other hand, it is harder to exclude the barbarians. The dramatically decreased cost of communication, the rise of transnational domains (including the Internet) that cut across borders, and the “democratisation” of technology that puts massive destructive power into the hands of groups and individuals, all suggest dimensions that are historically new. In the last century, Hitler, Stalin and Mao needed the power of the state to wreak great evil. As the Hart-Rudman Commission on National Security observed last year, “Such men and women in the 21st century will be less bound than those of the 20th by the limits of the state, and less obliged to gain industrial capabilities in order to wreak havoc...Clearly the threshold for small groups or even individuals to inflict massive damage on those they take to be their enemies is falling dramatically.”

Since this is so, homeland defence takes on a new importance and a new meaning. If such groups were to obtain nuclear materials and produce a series of events involving great destruction or great disruption of society, American attitudes might change dramatically, though the direction of the change is difficult to predict. Faced with such a threat, a certain degree of unilateral action, such as the war in Afghanistan, is justified if it brings global benefits. After all, the British navy reduced the scourge of piracy well before international conventions were signed in the middle of the 19th century.

Number one, but...

The United States is well placed to remain the leading power in world politics well into the 21st century. This prognosis depends upon assumptions that can be spelled out. For example, it assumes that the American economy and society will remain robust and not decay; that the United States will maintain its military strength, but not become over-militarised; that Americans will not become so unilateral and arrogant in their strength that they squander the nation's considerable fund of soft power; that there will not be some catastrophic series of events that profoundly transforms American attitudes in an isolationist direction; and that Americans will define their national interest in a broad and far-sighted way that incorporates global interests. Each of these assumptions can be questioned, but they currently seem more plausible than their alternatives. 

If the assumptions hold, America will remain number one. But number one “ain't gonna be what it used to be.” The information revolution, technological change and globalisation will not replace the nation-state but will continue to complicate the actors and issues in world politics. The paradox of American power in the 21st century is that the largest power since Rome cannot achieve its objectives unilaterally in a global information age.


US Unemployment: Double-counting Chickens

May 3rd 2002
The Economist Global Agenda

American unemployment jumped to 6% in April—confounding the forecasters and casting doubt on the strength of economic recovery. The figures come just ahead of the Federal Reserve’s decision on interest rates, due on May 7th

DON’T count your chickens before they are hatched. Anyone who has spent the past week celebrating America’s economic rebound might now be wishing they had heeded the old proverb. The unemployment figures for April, released on May 3rd, came as a bit of a shock to most economists. A small rise had been predicted, to 5.8% from the 5.7% rate in March. Instead, the rate jumped to 6%, the highest figure since 1994. And according to other data released at the same time, new job-creation was disappointingly slow.

Only a week earlier, economic euphoria had been the order of the day when it was announced that America’s GDP had expanded at the startling rate of 5.8% at an annual rate in the first quarter of the year. That, too, was a bigger number than most economists had predicted and led the incautious to conclude that the recovery was comfortably under way. Now that optimism must be tempered with the recognition that solid and sustained expansion cannot yet be taken for granted.

The Bureau of Labor Statistics posts unemployment figures and gives a snapshot of the American economy in figures. The American Bureau of Economic Analysis publishes GDP figures. The Institute for Supply Management and the Conference Board post more statistics on the US economy. The OECD and IMF paint a rosier picture for the world economy, led by American growth, in their recent reports. The Federal Reserve posts information on its monetary-policy decisions.

This rollercoaster ride is all too typical of economic turning points. A couple of good numbers has the optimists cheering the end of recession; that premature celebration only encourages a sense of alarm when the next figures turn out to be unexpectedly gloomy. As usual, the truth is somewhere in between. Certainly, one set of labour-market figures is not reason enough to conclude that the American recovery has stalled.

A closer look at the jobless figures shows that, according to data collected from American households, a rise in the number of unemployed adult women accounted for a large part of the overall increase in the unemployment rate. Figures calculated from businesses reveal that the construction sector saw most job losses in April; job losses in manufacturing were fewer in April, and service-sector employment rose. But revisions to earlier figures show that, contrary to previous assumptions, more jobs were lost than created in the first three months of the year. April saw a very slight net rise in jobs (excluding the farm sector). And yet not all is doom and gloom. Even at 6%, unemployment remains well below the level to which, a year ago, many economists were predicting it would rise. And one factor in the rise could be people moving back into the labour market, looking for jobs again but not yet able to find work—which could be the result of increased optimism, a good sign.

Nevertheless, the unemployment data is a sharp reminder that the recovery is still in its infancy, is still fragile and is likely to be a good deal slower than the recent GDP figures suggested to some people. Alan Greenspan, the powerful chairman of the Federal Reserve—America’s central bank—has repeatedly warned that after such an apparently mild recession last year, recovery is likely to be equally modest. And there is concern about America’s ability to exploit any recovery. Profits for many firms remain low, and partly as a consequence, business investment—seen by Mr Greenspan as the key to sustained growth—is disappointingly weak. Household and corporate debt remain high. And the recent, so far modest, slide in the value of the dollar promises to exacerbate America’s massive current account deficit, as well as threatening a sudden massive adjustment.

Mr Greenspan will be studying the latest data carefully, in advance of the next meeting of the Federal Open Market Committee, the Fed’s main policymaking body, on May 7th. Fed-watchers have largely ruled out the chance of an interest rise then, and the unemployment figures will reinforce that view. Indeed, they might encourage the assumption that a rise in interest rates is not even likely at the FOMC’s June meeting: if correct, that would push any rate hike back at least to August. The contrast with 1994 is striking—then the Fed started to tighten policy when unemployment was 6.6%.

But though economists love to forecast, they often get it wrong. Even Mr Greenspan probably has an open mind about when interest rates will have to go up. He and his colleagues have prepared the ground. By indicating, at their last meeting in March, that they now saw the balance of risks evenly distributed between economic weakness and inflation, they were signalling that the long run of rate cuts had, almost certainly, come to an end. Eleven cuts in less than twelve months had brought borrowing costs down to a 40-year low. The Fed is unlikely to want to see them lower, unless the economic picture deteriorates sharply.

The Fed’s duties are clear—to maximise growth and employment as far as possible, but to do so while maintaining price stability. Notwithstanding some disappointing data in recent days, an increasing number of economists are now starting to think that inflation could become the Fed’s biggest concern this year. The Bush administration, in this case personified by Paul O’Neill, the treasury secretary, continues to insist that it believes a strong dollar is good for the economy and that it is unconcerned about the current account deficit. It is in any case not clear what effective action the government could take if it thought otherwise.The Fed’s duties are clear—to maximise growth and employment as far as possible, but to do so while maintaining price stability. Notwithstanding some disappointing data in recent days, an increasing number of economists are now starting to think that inflation could become the Fed’s biggest concern this year. The Bush administration, in this case personified by Paul O’Neill, the treasury secretary, continues to insist that it believes a strong dollar is good for the economy and that it is unconcerned about the current account deficit. It is in any case not clear what effective action the government could take if it thought otherwise.

But should market concerns intensify, and lead to a dramatic collapse in the dollar, Mr Greenspan might become very anxious about inflation—since the conventional wisdom has it that a sharp fall in a currency can lead to a rapid acceleration in inflation. The Fed might then find itself steering a tricky course between heading off inflationary pressures and sustaining what might become a very weak recovery. That is not the position now. But Mr Greenspan, who is famous for obsessively scrutinising the constant stream of economic data even at the best of times, will be acutely aware of the risks and uncertainties ahead.


Telecoms : Hanging on a Line

May 3rd 2002
The Economist Global Agenda

Telecoms companies are having a hellish time. Not only is overcapacity and debt weighing on profits, but competition regulations are preventing a natural consolidation of the industry. Unfortunately, things are likely to get worse before they get better

ANOTHER week, another crop of bad news from the telecoms industry. Bernie Ebbers, the chief executive of WorldCom, has been forced out. The share price of Qwest, another heavily indebted American telecoms company, fell to an all-time low, after it had announced a first-quarter loss of $698m. Siemens, a German company, said it would cut 6,500 jobs in its telecoms-infrastructure division, on top of 10,000 layoffs already announced. Marconi and JDS Uniphase, two other network-equipment vendors, announced or gave warning of gloomy results, and Telewest, a struggling British cable company, said that it would cut 1,500 jobs. At least NTL, Telewest's main rival, won the support of banks to restructure its mountain of debt.

Even as the broader economic climate begins to improve, the carnage in telecoms continues. “No bottom in sight,” is how Nikos Theodosopoulos, an analyst at UBS Warburg, puts it. He notes that, historically, the telecoms sector tends to recover six months later than the economy as a whole. But this time, he says, there is evidence of bigger structural problems in the industry that will not be solved by an economic recovery. That suggests the industry must undergo painful rationalisation before things start to improve.

How did this happen? Telecoms is an infrastructure-intensive business, and infrastructure takes a long time to build. So telecoms firms have to gamble on the level of future demand. In recent years, however, their bets—in both fixed and mobile telecoms—have gone spectacularly wrong.

In fixed-line telecoms, the problem is overcapacity. During the Internet boom, operators assumed that demand would continue to grow by 100% a year indefinitely. A vast construction programme ensued, fuelled by cheap capital. At its height, says Andrew Heaney of Spectrum, a consultancy, telecoms operators built seven years’-worth of capacity in a single year.

The result was a capacity glut, ferocious competition and frantic price-cutting. Traffic growth has not translated into extra revenue. Fixed-line operators have now cut their infrastructure spending to focus on picking up clients rather than expanding their networks. All of this is terrible news for equipment vendors. Two of the biggest, Nortel and Lucent, have cut around 50,000 jobs apiece in the past year or so.

Bankruptcies and mergers would appear to be the solution. But bankruptcies do little to solve the problem of overcapacity. When a steel firm goes bust, its mills can be knocked down; when a telecoms firm goes under, its network remains in the ground, so the capacity doesn’t go away. Mergers, meanwhile, are unattractive in the current climate; the industry’s woes mean there are few buyers. And mergers are also problematic for regulatory reasons. WorldCom’s attempt to merge with Sprint, a long-distance operator, in 2000 was rejected as anti-competitive, since it would have created a giant with huge market power. Both that argument and America’s rules stopping local operators merging with long-distance operators look harder to justify given today’s turmoil and the rapid pace of technological change. Wireless operators are cannibalising both local and long-distance traffic, and Internet connections can be used for voice as well as data. So perhaps regulators will think again. Indeed, says Henry Elkington of Boston Consulting Group, telecoms regulations around the world were based on a belief that more competition was sustainable than turned out to be the case. The natural-monopoly economics of telecoms, he suggests, are now asserting themselves.

Conceivably, high-speed (“broadband”) Internet connections might someday generate the traffic needed to fill operators’ empty pipes. But broadband has been slow to take off for a variety of reasons, so it would be foolish to expect it to make much difference any time soon.

Operators of mobile networks also made what turned out to be an ill-judged bet on future demand. With voice revenues stabilising, the industry hoped that new data services, piped over whizzy “third generation” (3G) networks, would provide growth. But consumers in most parts of the world have been far slower to embrace new data services than the operators had hoped. Worse, European operators hobbled themselves with huge debts by overpaying for 3G licences.

Investors now worry that mobile telecoms is merely a low-growth utility, rather than an industry on the verge of a new phase of explosive expansion. The uncertainty has had a knock-on effect on wireless-infrastructure vendors, who were banking on selling vast amounts of 3G equipment. Ericsson and Motorola, for example, are each laying off more than 40,000 workers.

Once again, consolidation might help to sort out the mess. Arguably, having dozens of mobile operators in Europe makes no more sense than having dozens of car makers. But consolidation is held back by regulation: as things stand, if a 3G operator folds or merges with a rival, it must give up its licence. European governments, however, are expected to change the rules soon to enable licences to be bought and sold. That will cause further pain as the market determines how little these expensive rights are really worth. But it should also help to dispel some of the continuing uncertainty around 3G.

In short, even though Internet traffic continues to grow and mobile phones remain popular, telecoms firms bet everything on a surge in demand that has so far failed to materialise. Backing out of these bets is proving to be very unpleasant. The carnage will continue for some time yet.


U.S. Undertaking Generational Weapons Shift
3 May 2002


A recent Defense Department decision to kill a costly artillery system program represents the start of a generational shift in weapons systems. Despite opposition from with the army, U.S. Secretary of Defense Donald Rumsfeld likely will be successful in moving the United States away from manned aircraft and self-propelled artillery toward more advanced technologies. This will also put the United States several generations ahead of other major powers.


A recent decision by the U.S. Defense Department to terminate the $11 billion Crusader self-propelled artillery system is not an isolated event. Nor is it one that is directly linked to the current war on al Qaeda. Rather it is part of a massive repositioning of the U.S. military that was directed by Secretary of Defense Donald Rumsfeld prior to Sept. 11. The Bush administration has, for example, also called for the curtailment of the F-22 fighter and the Joint Strike Fighter program.

In effect, the Defense Department is in the process of rotating between weapons cultures. Manned aircraft and self-propelled artillery are part of the 20th century's arsenal, but they pose severe challenges in the 21st century. For one thing, they are logistical behemoths, and it is difficult to deploy them rapidly into unexpected combat regions.

Not only are they cumbersome to move but they require substantial logistical commitment on the ground between supply bases and their theaters of operations. In the lead-up to Desert Storm it took six months to transport to the region both the equipment and the supplies, petroleum, munitions and spare parts needed to launch an operation. The United States was fortunate that the Iraqis were unwilling or unable to launch further attacks into Saudi Arabia during the period between the decision to deploy and the actual effective deployment.

These older weapons also have substantial vulnerability. They are highly visible on the battlefield, and in a symmetrical war, with a technically sophisticated enemy, they would be extremely vulnerable to enemy counteraction. The F-22, while stealthy, is extremely costly, and its ability to hide from future generations of sensors is doubtful. Moreover, the maneuvers required to defend against anti-air missiles would take manned aircraft beyond the limits of a pilot's endurance.

Even in asymmetric warfare against a technically unsophisticated enemy, the added capabilities of these weapons would be unnecessary. Existing artillery and fighters would be both effective and survivable.

Thus, the Defense Department had reached the conclusion prior to Sept. 11 that it was time to shift generations of weapons. An artillery system is designed to deliver a certain amount of various types of munitions on a target. It does this by moving within a few dozen miles of the target, which sometimes requires travel over thousands of miles to get within range. Manned aircraft are similar in this regard. The Defense Department has argued that the emergence of new technologies allowed the transition from these older 20th century systems to newer ones.

The key representatives of this new breed of system are cruise missiles and other re-usable unmanned aircraft. As the range and speed of these systems increase, it will be possible to carry out the mission of delivering munitions without a massive forward deployment of men and material. The key to this evolution is intelligence and information management. In order to hit a target, it is necessary to know that it is there; in order to hit it within a reasonable time frame, it is necessary to manage the information in a rapid and secure fashion.

Therefore, the Defense Department determined that vastly expanding the amount spent on unmanned aerial technologies, space-based intelligence and communications systems and efficient "sensor-to-shooter" data management systems -- while maintaining existing weapon systems -- was more important than introducing new generations of artillery and fighter aircraft.

Some might have thought that this reorientation had been aborted after Sept. 11. However, quite the opposite is true. Events in Afghanistan, for better or worse, convinced Rumsfeld and his staff that even last-generation air power using precision-guided munitions, combined with a small number of highly trained special operations units armed with advanced communications and intelligence systems, could be devastating in asymmetric warfare. Since the Defense Department had severe doubts about the survivability of traditional systems in symmetric warfare, this drove the policy home.

A system like the Crusader was regarded as inherently inefficient and lacking in cost effectiveness compared to more advanced technologies. Obviously, this generated massive resistance in the army and the other armed services. If the Crusader is irrelevant, then the conventional artillery of the army is also irrelevant. Rumsfeld's decision is properly understood to represent a watershed in U.S. military history: artillery, over the next century, will be going the way of the horse cavalry.

The army's counter-argument is that the new technologies are insufficiently mature to form the basis of ground forces. This argument is persuasive. The cost and efficiency of non-artillery munitions-delivery systems hasn't arrived at a high enough capability level for national security to be based on. Therefore, the army is counterattacking for both parochial and substantial reasons.

They will not win on the Crusader, which will be only the first of new systems that the army wants and will not get. They will not win because any symmetrical foe is a generation away and these systems will be obsolete by then. Current asymmetric threats can be handled with existing systems. Therefore, Rumsfeld's reasoning appears to be that this is the time to shift the geometry of U.S. forces; in effect, the war with al Qaeda actually provides Washington with a strategic opportunity for repositioning. Even Iraq should be manageable by current systems.

The only threat to Rumsfeld's plan is failure in the war on al Qaeda and a collapse of his credibility as secretary of defense. Barring this, the United States is now positioning itself for a generational shift in weapons. If successful, this will leave Washington several generations ahead of other great powers. Although it will likely be successful, the risk of failure is always there and the consequences of failure are substantial.


Bouncing Back

Apr 26th 2002
The Economist Global Agenda

The strength of America’s economic recovery in the first quarter of this year has been breathtaking. Can the expansion really continue at such a scorching pace? And if growth is maintained, will American interest rates have to go up?

WOW. That neatly sums up the initial reaction to the latest surprise delivered by the American economy. Government figures released on April 26th showed that GDP grew by 5.8% at an annual rate in the first three months of this year. By any standards, that is impressive, and it was sufficiently above expectations to catch even the optimists out. The pace of recovery from last year’s recession suggests that the resilience of the world’s largest economy remains unparalleled.

But let’s not get too carried away just yet. The GDP figures are surprisingly strong, but few economists or businessmen expect growth to continue at such a scorching pace. A more pressing question is whether growth, even if it does slow, can be sustained at a still-healthy level, or whether it will tail off again. Will the continuing weakness in business investment, for example, undermine the momentum of recovery? And how will the Federal Reserve (America’s central bank) respond—more specifically, when will it raise interest rates?

The American Bureau of Economic Analysis publishes GDP figures. The OECD and IMF paint a rosier picture for the world economy, led by American growth, in their recent reports. The Institute for Supply Management and the Conference Board post more statistics on the US economy. The Bureau of Labor Statistics provides a snapshot of the American economy in figures. The Federal Reserve posts information on its monetary-policy decisions.

A closer look at the elements which make up the GDP figure suggest that the overall picture is still somewhat mixed, despite a startling overall result. Domestic final demand, up 3.7% at an annualised rate in the first quarter, is only a shade slower than in the final quarter of 2001. Some of the quarter’s strong growth reflected a slowing of the rate at which industry was running down inventories, though this was less of a factor than anticipated. A bigger factor was a large rise in government spending. Defence for instance, rose at a 20% annual rate, the fastest since the Vietnam War. The combination of higher government spending and tax cuts is likely to continue to contribute to the recovery over the coming months, though there are limits to how long that can be the main engine of growth.

The figures which give most pause for thought are those relating to business investment. Overall investment fell 5.7% and final sales of computers dropped by more than 20%. Alan Greenspan, chairman of the Fed, has repeatedly warned that a recovery in business investment will be critical for a sustained economic recovery. So far it is clear that the upturn in investment which Mr Greenspan is so eager to see has yet to take place.

Nevertheless, consumer demand continues to defy expectations. For much of last year, valiant (or spendthrift) American shoppers prevented the recession from deepening. Anecdotal evidence continues to suggest shopping remains a favourite national pastime. Mickey Levy, chief economist at Bank of America, argues that what really stands out in the latest GDP figures is the 3.5% annualised growth in personal consumption. Overall car sales, it is true, are now declining, but this drop comes only after the very large increase seen at the end of last year, fuelled by special zero-interest-rate loans. And even car sales are not falling as much as expected. In fact, General Motors recently confirmed that it had revised its production forecast for 2002 up from 5.1m to 5.4m vehicles.

The Bank of America's Mr Levy is one of those who consistently expected the economy to emerge more rapidly from the downturn than many thought it could. And yet even he expects the pace of growth to moderate in the coming months. So does Mr Greenspan, who has argued on several occasions that the mildness of last year’s recession—the mildest on record, in fact—will be matched by a similarly modest recovery. So the Fed will not be getting over-excited by the latest data.

Nor will the official arbiter of American recessions, the Business Cycle Dating Committee of the National Bureau of Economic Research. The committee did not confirm that America was in a recession, and had been since March 2001, until the autumn of last year. It warns that it will not try to pinpoint the turnaround date until some months after the event. Its caution is understandable—the figures released on April 26th are, after all, only the advance version: they will be revised twice more before a final figure is published on June 27th (the day after the Fed's June interest-rate meeting). Revisions can often be significant.

And yet an annualised rise of 5.8% cannot be dismissed entirely. Even before the latest figures were published, Mr Greenspan had begun to consider the appropriate monetary policy for recovery. The Fed’s job is to nurture the economy at this still-delicate stage in the cycle while at the same time keeping a careful eye on the threat of nascent inflation. It is a tricky balance to strike, and the Fed has begun to prepare the ground. At its last meeting, in March, the Fed shifted its view about future risks, saying that these were now evenly divided between inflation and economic weakness. Nobody really thinks that inflation is a serious short-term threat. But this was the Fed’s way of ensuring that when it does start raising interest rates again—as it inevitably will—it does not come as a shock. If growth continues, will it raise interest rates in May, or wait until June (or even later)? Most bets are probably still on June, but the buoyancy shown by the latest GDP figures might persuade Mr Greenspan and his fellow Fed governors to act earlier.

Fretting about in which particular month an interest-rate rise will come might seem a little obsessive to those whose perspective is longer-term and broader. But getting the policy response right can be especially important when economies are at a turning point: moving too soon or too late could undermine the recovery, or allow inflationary pressures to build up. As recent forecasts from both the IMF and the OECD made clear, a sustained American economic recovery this year and next is important for the rest of the world, not just for America. The United States remains the engine of global economic growth. There is a lot riding on what Mr Greenspan and his colleagues decide. That is a pretty hefty weight for anyone’s shoulders.


Getting To Know Hu

Apr 26th 2002
The Economist Global Agenda

Hu Jintao, who will in the autumn probably take over as leader of China’s ruling Communist Party, arrives in the United States this weekend for his first official visit. Will it mark the start of a beautiful friendship with President George Bush? Not if recent Sino-American tensions are any guide

Who's Hu?

A MERE seven months ago it was possible to say that the terrible events of September 11th at least provided China and the United States with a chance to put aside their differences and use the war against terrorism as a unifying theme around which to reconfigure their relationship. That view may now look to have been too optimistic.

This week, Hu Jintao, China's vice-president and likely successor to Jiang Zemin as the nation's leader, left for his first official visit to the United States with plans to meet President George Bush and the vice-president, Dick Cheney. On April 24th, in a stopover in Kuala Lumpur, Mr Hu made what looked like a sideswipe at his American hosts. While not mentioning the world's only superpower by name, he said in a speech to a Malaysian think-tank that China “opposes the strong lording it over the weak and the big bullying the small.” China, by contrast, “has long pledged not to seek hegemony” in its region.

Mr Hu's travels follow a trip by Mr Jiang that ended on April 20th and which took him to, among other countries, Libya and Iran, both of which have been labelled by the United States as state sponsors of terrorism. The picture of the smiling Mr Jiang with the Libyan leader, Muammar Qaddafi, is unlikely to have raised a smile in Washington. In Tehran Mr Jiang used a television interview to set out China's view of the Israeli-Palestinian conflict: that it was critical of “Israeli killings”, and that Israel should withdraw from all occupied territories.

China , Taiwan, United States

The US State Department provides information on America's relations with China. The White House posts news on Mr Hu's visit. China's Ministry of Foreign Affairs gives information on foreign policy.

But China's main concern, and the one that is likely to be top of Mr Hu's list in his talks with the Americans, is much closer to home. This is American military and political support for Taiwan, which China considers its own.

According to the thinking among military and intelligence officials in China after September 11th, the two countries stood a chance of returning to something more like the cosy days of the 1980s, when the Soviet Union served as their common foe. The new common foe was international terrorism. The need to defeat it did allow the two countries for a time to paper over their differences. China raised no serious objection to the American-led attack on its neighbour Afghanistan. Indeed, the defeat of the Taliban undermined Muslim separatism in China's north-west. The Chinese looked the other way when several thousand American soldiers were stationed in Kirgizstan, on China's western border.

The tolerant mood was apparent during Mr Bush's short visit to Beijing in February and his talks with Mr Jiang. Although the two men seemed unable to establish a personal rapport, their teams of advisers achieved their modest goal of sidestepping problems and maintaining a cordial tone. But the winds of March blew cold. The Taiwanese defence minister, Tang Yao-ming, was allowed to visit the United States to attend a defence contractors' convention in Florida, where he met the American deputy defence secretary, Paul Wolfowitz, and an assistant secretary of state, James Kelly.

These contacts were among the highest-level known to have taken place between American and Taiwanese officials since 1979, when the United States shifted diplomatic recognition from Taiwan to China. The Chinese were deeply disturbed and were none the happier when it was reported that Mr Wolfowitz had repeated words used by Mr Bush last year, that America will do “whatever it takes to help Taiwan defend itself”. Although the Taiwan Relations Act of 1979 does commit America to provide Taiwan with the means to defend itself, America has always maintained a studied ambiguity about its potential role in any conflict. China is likewise annoyed with the American Congress for supporting Taiwan's entry to the World Health Organisation, a privilege the Chinese government insists can be offered only to a sovereign country.

Jiang's legacy?

To China, all of this feels like a slap in the face. “China tried to co-operate with the Americans in the war against terror, but the Bush administration is not doing much to promote the relationship,” says Jia Qingguo of Beijing University's School of International Studies. Mr Jia finds it particularly alarming that the American government is expanding its military dealings with Taiwan while essentially banning any form of military contact with China. He frets that if hawks in the Bush administration “push things too far, we might face a crisis”. On the other hand, Robert Ross, of Boston College, says that the dominant line coming from China is that the Taiwan issue “could become a problem, not that it is a problem”. The tricky bit in diplomatic negotiations is judging where the “red lines” are.

Is Mr Hu competent to deal with these potential dangers? Remarkably little is known about the 58-year-old heir-apparent, who is expected to take over as Communist Party chief in the autumn and assume China’s presidency early next year (although nothing is certain in China's murky succession manoeuvres). He has never been interviewed by a western newspaper. His expertise is said to be hydraulic engineering. However, Mr Jiang would not have sent a dummy to Washington. Mr Hu will have been trusted to challenge the Bush administration's favours to Taiwan without doing it so harshly as to derail the relationship.

It is one Mr Jiang's basic policies, and one he hopes will form part of his legacy, that China can stay stable and grow stronger only if it avoids serious conflict with the United States. The apprentice leader will be aware that Mr Bush could stay in power for another seven years. The chemistry between the two men could set the tone for Chinese-American relations for a fair time.