Market Advisory Features
European Economies : A Cut in Time?
A Bigger Slice of a Smaller Pie
Japan’s Economic Mess
China : New Leaders, New Risks
The Economics of War
World Economy : Still Sickly
Argentina : Hanging by a Thread
remarkably resilient economy over the worst?
NEVER in the field of human commerce have so many spent so much on so little—and then wondered whether he will really like it. America's holiday shopping season began in spectacular style last week. On November 29th, the day after Thanksgiving, Wal-Mart, the country's retail giant, took in $1.4 billion at its tills—a 14% rise over 2001 and the firm's biggest one-day taking ever. According to a survey by the National Retail Federation, three out of every four consumers were out shopping last weekend—and they appeared to be spending freely. Sales for the weekend were running 12% above last year, according to ShopperTrak RCT, a firm that collates data from thousands of shops.
Festive logistics partly explains this spending fervour. With Thanksgiving falling late, there are unusually few shopping days before Christmas this year. Large price cuts by shops also pulled in the bargain hunters. Nonetheless, a quick look at the malls hardly suggests that the great American wallet is slamming shut.
Those Thanksgiving shoppers are the latest addition to a growing body of evidence that suggests America's economy may be on the mend. Less than two months ago, the recovery appeared to have suddenly stalled. The statistics showed that unemployment claims were rising, consumer spending was falling and confidence was plummeting. A rising chorus of forecasters fretted that a return to recession (the infamous “double dip”) was imminent. The Federal Reserve admitted the economy was in a “soft spot” and cut interest rates by half a percentage point in early November.
But since then a slew of statistics—from investment to productivity—have been stronger than expected, boosting the stockmarket and convincing economists that the risks of recession have receded. Stephen Roach of Morgan Stanley, perhaps Wall Street's most famous pessimist, acknowledged ruefully this week that “the second double-dip scare of 2002 now seems to be winding down.” That much is certainly true. Less obvious, however, is how strong the recovery will be.
Part of the optimism springs from hopes that business investment may finally be showing signs of life. Though overall figures on capital spending still look weak, much of the blame lies with a slump in spending on office buildings and other non-residential construction (which fell at a 20% annual rate in the third quarter of 2002). Exclude construction, and the picture becomes less dire. Overall investment in software and equipment is rising, albeit modestly.
There are other angles from which the figures look a little better: economists at J.P. Morgan Chase point out that, if you do not include the troubled energy and aircraft industries, firms' capital spending grew at double-digit rates in the third quarter. In October, orders for capital goods outside the defence industry (and excluding aircraft again) rose by 5.5%. The question, however, is whether sustained investment growth is plausible given the substantial amounts of slack capacity that exist in many industries. Overall industrial capacity utilisation is still running at just 75%.
Look at American manufacturing directly and this mixed picture is reinforced. First came a wave of good news, particularly from the heartland, that manufacturing activity was already on the mend. The Chicago purchasing managers index startled markets on November 27th by surging from 45.9 in October to 54.3 in November. (Any reading over 50 suggests that manufacturing activity is expanding, while a reading of less than 50 suggests recession.) Unfortunately, the equivalent national numbers, released on December 2nd, showed a less perky jump from 48.5 in October to 49.2 in November, leaving it in recession for the third consecutive month (see chart). In short, American manufacturing may be on the mend, but it is far from booming.
Consumption remains the driver of any recovery. And there the good news of the past few weeks is that Americans are still spending. After falling in September, overall consumption rose 0.4% in October. Car sales, which sucked up a lot of consumer spending during the summer, did not continue their decline. Contrary to fears at the beginning of the month, a respectable number of new vehicles (16m at an annual rate) were sold in November. The Conference Board's index of consumer confidence improved during the month from a nine-year low.
A big reason for this boost in confidence, and for economists' optimism that the risks of recession have receded, comes from the job market. Judging by the fall in the weekly number of initial unemployment claims during November, the pace of lay-offs has abated. Just before Thanksgiving the number of initial claimants fell to 364,000, well below its peak rate of 433,000 in September and below the 400,000 level usually associated with an economy in recession. Though few analysts expect a sharp rise in employment (November's jobs figures are due to be released on December 6th), the fear that a sharp rise in unemployment would undermine consumption has abated.
Meanwhile, the housing market—another prop for consumer spending—appears brisk. Sales of existing homes rose 6.1% in October. But the signals on the market are mixed. According to the National Association of Realtors, the median home price rose 9.8% in October, the fastest rise since 1987. But the Office of Federal Housing Enterprise Oversight reckons the appreciation in house prices is beginning to stall.
High house prices are a burden for some Americans but a source of relief to many more. Either way, they surely cannot continue to soar. According to economists at Goldman Sachs the ratio of house prices to rents and income is 10-15% above its long-term average. This is a higher premium than existed at either of the two previous property-market peaks of the past 25 years.
Look at all these indicators together and the picture is one of resilience rather than strong recovery. America's economy has yet again confounded the pessimists who expected it plunge into recession, but it has yet to offer much support to the optimists who predicted strong growth. The legacy of the bubble years—slack capacity in swathes of American industry and debt-laden consumers, justifying their spending by looking at house prices—will still give the faint-hearted plenty to fret about, even as they queue up to get something for their grandparents.
Saddam Hussein’s paperchase
With Iraq continuing to maintain that it has no programmes to make chemical, biological or nuclear weapons, and American officials insisting that it has, the United Nations weapons inspectors currently combing the country for clues are caught in the middle. Mr Hussein has urged Iraqis to remain patient in the face of “unjust, arrogant, debased American tyranny” while the inspectors prove to the world that there is nothing to be found. America thinks the inspectors should push harder, delve deeper and even spirit Iraqi scientists out of the country with the offer of asylum in exchange for information.
The paperchase will grow longer when, as some analysts expect, America responds to Iraq’s declaration with excerpts from some of its own intelligence about Iraq’s weapons programmes. The Iraqi regime said it would deliver its report to the UN on December 7th—a day before the official deadline. It is expected to be several thousand pages long. A resolution unanimously agreed by the Security Council ordered Iraq not only to co-operate with the inspectors but also to provide a “full, accurate and complete” list of material, equipment and any facilities that could be linked to making weapons of mass destruction—including anything with a “dual-use”, such as a petrochemical plant. It is likely to take weeks for experts to sieve through everything.
Even if America quickly condemns the Iraqi declaration for leaving things out, and thus being in further “material breach” of UN resolutions, it is unlikely to lead to immediate military action. Many experts believe America would first try to get the weapons inspectors to look specifically for things that American intelligence has uncovered. To bolster its case for an invasion, America needs Mr Hussein to either start to obstruct the inspectors or for the inspectors to turn up something incriminating.
This is because America has found only limited support in its attempt to build a coalition prepared to take part in military action against Iraq. Although Mr Bush has persuaded some countries, like Britain, to enlist, a number remain opposed. America, for instance, already uses Turkish air bases to patrol the “no-fly” zones established over Iraq at the end of the Gulf war. But despite American pledges to make a massive investment in those bases, the Turkish government would like the UN to agree to any military adventure rather than America take unilateral action.
This line is preached by others. At a recent summit between Russia’s leader, Vladimir Putin, and China’s president, Jiang Zemin, the two countries—both of which are among the five permanent members of the Security Council—said they also want the UN to determine if Iraq has breached its resolution. France, another permanent member, takes the same view. Gerhard Schröder, Germany’s chancellor, has said that America can use his country’s military bases for an operation against Iraq, but he has refused any other assistance.
By blitzing everyone with documentation, Iraq is certainly not hoping to help paper over these cracks. This means America’s campaign to convince other countries that Iraq has to be harshly dealt with is likely to move into a higher gear. Iraq could, of course, be completely open about its arms programmes. But American officials don’t seem to believe that is possible. Even Colin Powell, America’s secretary of state and someone considered to be a moderate member of Mr Bush’s administration, has said: “We are absolutely sure...that Iraq has had weapons of mass destruction in the past, we are absolutely sure they have continued to develop weapons of mass destruction, and we are sure they have in their possession weapons of mass destruction.”
The possibility of Iraq coming clean is one of three possible outcomes to the present stand-off suggested by the more hawkish Donald Rumsfeld, America’s defence secretary. Another is: “They could decide that the game’s up, and Saddam Hussein and his family could leave the country—which would be a nice outcome.” However, it is the third option that most members of Mr Bush’s administration are preparing for. This, says Mr Rumsfeld, involves Mr Hussein doing what he has long done and “continue to lie and deceive and deny”. The first evidence of that may well lie somewhere in the paperwork from Baghdad.
A cut in time?
FINALLY they bit the bullet. After months of dithering, the European Central Bank (ECB) announced on December 5th a cut in interest rates of half a percentage point. Outside the bank’s Frankfurt headquarters, there is a widely held view that lower interest rates have been far too slow in coming. The big questions now are: is the cut deep enough to provide some stimulus for the euro-area’s flagging economies, and if not, will the ECB be ready to cut again?
Necessary but not sufficient, that is likely to be the general verdict on the latest cut. Europe’s problems are now so acute that a greater short-term monetary stimulus may be needed to prevent, at best, stagnation, and at worst a slide back to recession in Germany and perhaps in some other economies.
Yet after waiting 13 months for a reduction in interest rates, nobody is going to bet on whether, let alone when, another rate cut will be forthcoming. Wim Duisenberg, the ECB’s president, did nothing to encourage hopes of a further monetary easing. Instead, he again urged euro-area governments to push through the economic reforms needed to help boost future growth.
Mr Duisenberg is right about the need for reform. But the ECB has managed to give the impression that it is less than surefooted in its approach to monetary policy. This is one reason for the indecisiveness which delayed the latest rate cut—and it explains why it would be unwise to count on further reductions in the near future.
It is hard not to feel some sympathy for the beleaguered central bank. It is, after all, a relatively new institution, still finding its feet and still trying to establish its credibility with the financial markets. With hindsight, the bank probably did not set about this the right way; although it is also fair to point out that it has found itself trying to set policy in an unexpectedly difficult international environment.
One problem is the nature of the ECB’s inflation target. This it defines as a ceiling of 2%. It says it sets interest rates at a level consistent with achieving this target over the medium term, and as part of the process of judging future price stability, the bank pays close attention to monetary growth in the euro area (what it calls its first pillar of monetary policy). It is possible to quibble with the way the inflation target is set, and quite a few economists do, arguing that it makes a lot more sense to have a symmetrical target, allowing for fluctuations either side of a central rate—the framework used by the Bank of England, for instance.
But the main problem with the target in the short term has been the way the ECB keeps missing it. Both inflation and monetary growth have persistently bumped up against or exceeded the targets set by the bank. The ECB puts great emphasis on these numbers—as part of its credibility campaign—and unlike other big central banks, it also insists that economic growth is not part of its mandate. Consequently, the frequent breaches of the targets have made it awkward for the bank to drive interest rates down.
In practice, of course, Europe’s central bankers, however hawkish they might want to be on inflation, cannot ignore economic growth. Previous interest-rate cuts have, in practice, been responses to weak growth: the latest cut was unmistakably so. This means the bankers’ instincts have been in the right direction, though their public pronouncements have only created additional confusion.
Now there is increasing criticism of the technical side of the ECB’s decision-making. A new report from the London-based Centre for Economic Policy Research (CEPR) argues, among other things, that the ECB is mistaken to focus as much as it does on monetary growth. The report, written by a group of academic economists from around Europe, concludes that, in spite of the ECB’s rhetoric, there is a negative correlation between monetary growth and interest rates—in other words, when money growth rose sharply, the ECB has tended to reduce interest rates and vice versa. The problem then is that the ECB has to spend time and effort explaining this apparent inconsistency away.
The CEPR economists also point out—and they are not the first to do so—that the ECB left interest rates unchanged between November last year and this month. Yet the outlook for the euro area has deteriorated sharply since then. America, by contrast, has seen a slight improvement in its growth prospects, and still the Federal Reserve cut interest rates by half a percentage point on November 6th—on top of 11 rate cuts during 2001.
Drawing too many parallels with America can be misleading. America’s economy is more deregulated, with more flexible labour and capital markets—it has fewer of the rigidities which have hampered the euro area and which European governments have been surprisingly reluctant to tackle since the creation of a single currency.
Slow, sometimes negative progress on this front has exacerbated the difficulty of creating a one-size-fits-all monetary policy. Germany—the biggest euro-area economy—shows every sign of sliding back into recession: lower interest rates have already been welcomed by the German finance ministry. But some economies, including Spain's, the fourth largest in the euro area, still have reasonably healthy growth rates. More ominously, several have inflation rates way above the euro-area average: Spain, Ireland, Greece and the Netherlands all fall into this category, and, for them, cheaper borrowing costs could spell trouble.
The global economic environment is more daunting than anyone could have forecast at the time of the euro’s creation. That, coupled with foot-dragging on the economic policy front, has hindered rather than encouraged economic integration in the euro area—indeed, on some measures the euro economies are more divergent now than in 1999. It presents a big challenge to the ECB, and one that it has yet to show it is capable of meeting.
The economics of war
“IT SEEMS likely that Americans are underestimating the economic commitments involved in a war with Iraq,” says William Nordhaus, an economics professor at Yale University. Given all the imponderables surrounding such a war, it is surprising how many experts (like Mr Nordhaus) are trying to work out how much it might cost. After all, it is not clear whether Saddam Hussein's grip will crumble or if he might use weapons of mass destruction. And it is anybody's guess whether OPEC countries will replace any lost Iraqi production—or might slash output in a general Arab boycott.
The findings of the most ambitious effort to date, undertaken by the Centre for Strategic and International Studies, an American think-tank, were unveiled this week in New York. Over the course of the past few months, CSIS has tapped experts from various fields to try and quantify the likely impacts of war. First, the group's military and geopolitical gurus defined four likely military outcomes: no war; a benign war that lasts four to six weeks; a thornier intermediate option that lasts up to three months; and a “worse” case that drags on for as long as six months. The group intentionally set aside still worse possibilities, such as the use of nuclear weapons.
For each of these options, oil-market analysts convened by CSIS speculated over the likely path of oil prices. Their predictions were then fed into macroeconomic models that took into account the positive inputs, such as higher government spending, as well as the negative ones, such as higher inflation. They also factored in the role of market psychology, recalling the experience of the 1970s when oil shocks were accompanied by hoarding and panicky behaviour.
The group reached some striking conclusions. For a start, the no-war scenario is not necessarily the best for the economy. That is because lingering uncertainty about a possible war will continue to depress markets and add a risk premium that boosts oil prices and acts as a drag on growth. At the other extreme, if things turn ugly, the team predicts that oil prices could spike up to $80 a barrel and, more damaging in economic terms, stay at around $40 for many months thereafter (see chart).
In the end, though, the group's assessment of the cumulative cost of war to the end of 2004 is not overly alarming: about $55 billion in the benign scenario, and around $120 billion in the worse-case scenario. (The higher numbers in the table below are for a whole decade.) The Congressional Budget Office and a committee of the House of Representatives have also done some sums, and both came up with estimates of $50 billion-60 billion for a shortish war. The Gulf war cost about $80 billion in today's money, although much of that was recouped by contributions from Saudi Arabia and other allies, which are not likely to be repeated this time. Even so, America can afford all the scenarios.
Some even suggest that the war could be an economic boon. Most wars in America's history have—thanks to massive government spending on defence—tended to stimulate the economy. A notable exception to that, however, was the Gulf war, which was followed by recession. Even so, say some extreme imperialists, if Saddam Hussein is ousted, then America will be able to turn Iraq into its own private pumping-station. Private or not, higher Iraqi output would mean that oil prices would drop for a while and America's economy (along with other oil-consumers') would benefit.
Larry Lindsey, a top
economic adviser to President George Bush, made precisely this argument
recently: “When there is a regime change in Iraq, you could add 3m-5m barrels
of production to world supply...successful prosecution of the war would be good
for the economy.” The snag in this rosy plan is the dilapidated state of
Iraq's petroleum infrastructure: oilmen say it would take 5-10 years for Iraqi
output to reach such unprecedented levels (even assuming a post-Saddam Iraq
would actually want to flood the world market with oil). Mr Lindsey offered an
even more cheerful forecast: he estimated that even a prolonged war would not
cost more than $100 billion-200 billion, or about 1-2% of America's GDP.
Hang on a minute, says Mr Nordhaus, who argues in the latest New York Review of Books that none of the recent analyses of war goes far enough. In general terms, he agrees with their estimates for the direct military costs for the various scenarios. But he insists they underestimate the long-term costs to America from an Iraqi war.
He points to the high costs likely to be incurred after a military victory is secured: eg, in peacekeeping, reconstruction and nation-building. Mr Bush has openly committed America to rebuilding Iraq after ousting Mr Hussein. By examining international experience in post-war Kosovo, East Timor, Haiti and other recent cases, Mr Nordhaus estimates that such non-military costs could reach $600 billion if a liberated Iraq turns out to be more like the West Bank than Kosovo.
He also worries that an Arab boycott or some other political factor could keep a significant share of OPEC oil off the market for many months. And that, of course, would mean higher oil prices, higher inflation, lost economic output, and so on. All told, Mr Nordhaus thinks that even an Iraqi invasion that went well would probably cost about $120 billion in today's money over the next decade—and one that went horribly wrong could end up costing a whopping $1.6 trillion.
The estimators differ in the purpose, methodology and sophistication of their analysis. But, taken together, recent prognoses point to one conclusion: even a short war will prove fairly costly, while a messy one could deal the economy a severe blow. Mr Bush has often stressed the possible price—in terms of national security—of not going to war against Saddam Hussein. These studies suggest that he should start preparing Americans for the economic costs of going to war as well.
TRADE disputes seemed so much livelier when Japan was an economic juggernaut. Western companies, especially American ones, complained that its economy was designed to shut out foreign goods and fleece local consumers, even as it flooded other countries with exports. Japan retorted that its companies, workers and products were simply better, and that western firms were too lazy to study Japanese consumers. (Remember when negotiators claimed that foreign meat was unsuitable for Japanese intestines? Or that foreign skis did not suit Japanese snow?) During the late 1980s, however, the government was pushed into concession after concession. Did it ever truly open up?
Judging by the noise level, things have improved. Although disputes among many of the world's trading partners still abound, Europe and America no longer routinely single out Japanese trading practices for criticism. Some of this has little to do with Japan. Under Bill Clinton and the younger George Bush, America has drifted further from its commitment to global free trade, and is thus less able to criticise others. The launching of the World Trade Organisation in 1995, with mechanisms for settling disputes, has also dulled the rhetoric of many trade battles. Clearly, however, Japan has also done its bit: imports have started to make a significant impact on its economy in the past few years.
Import levels depend on all sorts of economic factors, not just openness. But Robert Feldman, chief economist in Tokyo for Morgan Stanley, an American investment bank, points out that prices of many goods are now closer to their international levels—a sign that they are now easier to import. A weak economy has encouraged firms in some sectors, especially retailing, to compete harder on price, driving them to seek cheaper inputs from abroad.
Moderate reforms in Japan deserve some credit for this. Successive governments and parts of the bureaucracy have made an implicit, grudging admission that America was right, and changed some of the rules to make selling in Japan easier. The statist Ministry of Trade and Industry (MITI) was revamped to push slowly for deregulation, and has had the word “Economy” inserted into its name as a nod to broader thinking. Still, many of Japan's bureaucrats and business methods are still geared towards protecting local companies, and foreign firms and governments see plenty of room for improvement. The real reason they have stopped complaining about import barriers is not because Japan is genuinely open, but because two big shifts in Japan's economy have prompted them to change the subject.
The first of these is Japan's economic stagnation, which has led trading partners to focus on weak overall demand, rather than just the non-tariff barriers that crimp demand for foreign goods. In the early years of the slump, America and others urged the government to prime the pump. The Liberal Democratic Party's addiction to public-works spending has grown more controversial over the past decade, however, and these days the American government focuses on Japan's mountain of bad loans, which prop up weak firms and forestall recovery. When American economic officials visit Japan these days, some expatriate businessmen complain, bad loans are not just at the top of the agenda—they are the agenda.
The second broad shift is that—partly through persistence and partly through reform—many more foreign firms have now established local operations in Japan. As their local business ties increase, American and European firms are focusing more on ways to make operating in Japan easier—some of which also help domestic firms—rather than trying to pry open new markets. The American Chamber of Commerce acknowledged this shift last year, when it renamed its biennial list of complaints the “US-Japan Business White Paper”, replacing the “Trade” white paper it has put out since the 1970s.
The most obvious complaints involve competition policy, since Japan's Fair Trade Commission still does a poor job of reining in monopolies and preventing collusion. Dignitaries from Europe like to tout the progress that the EU's competition directorate delivered during the 1990s. More transparent procurement policies would also please Japan's economic partners. So, too, would efforts to make it easier for foreign firms to invest directly in Japan, such as through mergers and acquisitions.
Besides these broad issues, problems in specific sectors still draw complaints, but these increasingly involve services, rather than tradable goods. Financial services are an exception, having been opened extensively to foreigners. By contrast, a whole range of business services—such as accountancy and the law—are highly segregated, slowing down Japan's integration with the rest of the world.
Although Japan is still maddeningly averse to change, its trading partners now look on it through different eyes. Its stubborn ways damage its own economy even more than those of its trading partners; sooner or later, it must change.
Nov 21st 2002
From The Economist Global Agenda
WHAT is the world coming to? That is an unusually difficult question to answer at present, as the Organisation for Economic Co-operation and Development (OECD) implicitly acknowledges in its latest economic outlook, published on November 21st. The rich countries’ think-tank notes that the world economic recovery is “more hesitant and less widespread than expected”. More ominously, perhaps, it also notes that the risks are on the downside.
The OECD’s uncertainty is shared by other economic forecasters. The International Monetary Fund (IMF) made the same point when it published its own outlook in September, for example. Two months on, economists are no nearer to making confident predictions about the likely progress of the upturn. They think it will continue, but they worry both about it being blown off course and about the ability of policymakers to deliver the economic reforms needed to establish sustainable growth more firmly.
As the OECD acknowledges, most economic upturns are uneven in the months directly after recessions have ended. But the latest report points out one unusual feature of the rather weak pick-up in activity this year: the coincident fall in share prices around the world. Equity markets have continued to weaken even as most economists concluded that the worst was over in America and Europe. In America, the drop in share prices since the recovery began at the turn of this year is the first such fall in any of the 18 economic recoveries since 1912.
That is more than just another interesting statistic. Falling share prices undermine corporate and individual wealth and could in turn weaken economic activity. Business investment is already weak—the accounting and other corporate scandals in America have done little to help there—and if consumers start to lose heart as well, recovery could stall, and might even go into reverse.
Another unusual feature of the global recovery, which follows the first worldwide downturn for more than a decade, is its apparently divergent nature. The OECD does not think this is a cyclical phenomenon—ie, simply a matter of different regions being at different stages of recovery. It reckons that structural differences explain the different pace of the upturn in different parts of the world—and that, in particular, the potential for future growth in America is considerably greater than in other parts of the world. If this analysis is right, policymakers in Europe and Japan should be worried.
They are, of course. In the case of Japan—the industrial economy facing the greatest crisis—they are both worried and, as yet, incapable of the tough decisions needed to deliver reforms that are now long overdue. In Europe, governments are slowly waking up to the challenges which face them, and realising how much time they have lost. Policymakers in the euro area find themselves constrained by the fiscal deficits that make it difficult to inject stimulus into their economies. At the same time, they are under pressure from the stability and growth pact to take action to reduce those deficits. The OECD report gently points out that the difficulties now reflect missed opportunities to put houses in order in the boom years of the 1990s.
Of course, America too has seen its public finances deteriorate—those projections of huge budget surpluses far into the future that President George Bush inherited when he took office in 2001 have long disappeared. They have been replaced by deficits almost as far as the eye can see: Mr Bush’s tax cut, the jump in military spending and the economic downturn have all played their part. The rising deficits have also provided a big fiscal stimulus for America’s economy, though. And at the same time, the Federal Reserve has been slashing interest rates to keep monetary policy as loose as possible. In passing, the OECD comments that upward risks—and with them, the possibility of higher inflation—should not be completely ignored after such a monetary (and fiscal) relaxation.
The European Central Bank (ECB) has been much slower to cut interest rates, in part because the tough inflation target it was set has proved difficult to meet. Nevertheless, the OECD reckons that the sluggish, even slowing pace of recovery in some of the bigger European economies—Germany above all—will lead the ECB to cut rates by a further half a percentage point in the near future. There was further confirmation of the extent of Germany’s problems on November 21st, when figures showed that GDP grew by only 0.3% in the third quarter of the year, compared with the previous three months.
The latest forecast for economic growth reveals some big downward revisions from that made by the OECD in June. For America, the OECD—often at the optimistic end of forecasting ranges—is now marginally more pessimistic than The Economist’s own poll of private forecasters. When it comes to Europe, the OECD has slashed its forecast; nonetheless, it is a shade more optimistic than The Economist’s poll.
Your guess is as good as mine
Ultimately, though, such numerical forecasts are little more than best guesses. They often include assumptions about policymakers’ behaviour which turn out to be wrong. Politicians are usually reluctant to make tough and unpopular decisions. Germany, for instance, has been slow to accept the need for drastic reforms to its labour market. Without fundamental changes, though, the country’s capacity for future growth is likely to remain heavily constrained—something that is gradually dawning on the government.
The loudest message from the latest OECD report is that short-term problems cannot be tackled effectively if long-term reforms are ignored. As the room for manoeuvre in fiscal and monetary policy becomes more restricted, the importance of tackling fundamental economic weakness grows. It’s an uncomfortable but important thought.
Nov 21st 2002
The Economist Global Agenda
The one bright spot in all the bad news came when Yutaka Imai, an OECD economist, said the organisation had changed its mind about the prospects for this year. New information available after the report went to press led the OECD to be marginally more optimistic. Mr Imai said he and his colleagues no longer expected Japan’s economy to contract this year. Instead, he said, it was likely to remain flat.
That zero growth is an improvement is a telling indication of Japan’s economic mess. This has not altered the OECD's broader assessment: that the economy is in serious trouble. The prospect is for virtually no growth till the end of 2004. There is no sign yet of an end to deflation, now in its third year. And the problems created by Japan’s crisis-ridden banking system are in ever more urgent need of attention. On the day the OECD report was published, there were further precipitous falls in the share prices of Japan’s biggest banks—by more than 16% in the case of Mizuho, the world’s biggest bank.
The problems of the banks, and the prospect of even tougher government action to tackle them, explain the collapse in their share prices of late. The recently appointed minister in charge of financial regulation, Heizo Takenaka, has made no secret of his desire to force through reform in the banking sector. A report published by him last month disappointed many observers because it pulled too many punches—its release had been delayed while influential politicians from the ruling Liberal Democrat Party (LDP) sought to tone down some of its provisions. But Mr Takenaka’s commitment to change has raised fears that one or more of the big banks will be nationalised, a move potentially made necessary by tougher and more realistic treatment of bad loans.
Change cannot come a moment too soon for the OECD, which noted that too much precious time has already been lost. Non-performing loans—where the borrower cannot make interest or capital repayments—need to be properly classified and sufficient provision made for them in banks’ balance sheets. The OECD thinks that proper incentives need to be provided for the disposal of such loans and that the banks should be forced to restructure themselves, with better management and credit assessment—even if this results in some banks closing. At the same time, bank lending needs to be made more profitable to give the banks a sounder basis on which to operate. The OECD criticises the authorities for putting pressure on banks to lend to small and medium-sized firms when the interest rates do not compensate for the risks involved.
But as the OECD report points out, progress in one policy area alone is not going to be enough to solve Japan’s economic problems. It calls for “concerted policy actions on all fronts”. Easier said than done, of course, given Japan’s cumbersome political and bureaucratic structure. In a sense, there are few fresh prescriptions in what the OECD has to say. But as the problems drag on unchecked, the need to confront them effectively becomes more urgent. The OECD believes that “a major change in the way the economy has operated since the early 1970s” is needed.
The news on November 21st, that the LDP's political leaders have finally agreed a new package of spending measures to be included in yet another supplementary budget, is hardly likely to convince the OECD that the necessary changes are imminent. (Nor will it do much to help the government's ballooning debt position.)
Besides the banking sector, the OECD identifies deflation, fiscal policy and the burgeoning government debt, and the uncompetitive nature of much of the economy as areas in need of urgent remedy. With the downside risks greater than they were, and no sign of an end to deflation, the OECD thinks monetary policy needs to move into uncharted territory. It urges the Bank of Japan to consider a range of new measures to tackle deflation. It also says that inflation-targeting might eventually have a role to play.
There are signs that the Japanese government is trying to push the Bank of Japan in the direction of further monetary easing—more, presumably, than the small tweak made by the bank at the end of its two-day meeting on November 19th. On the same day, the government formally requested the bank, when intervening in the foreign-exchange markets, to do so using what is known as “unsterilised” intervention—by leaving the yen it sells to buy other currencies as extra liquidity in the financial system. The finance minister, Masajuro Shiokawa, publicly acknowledged that he favoured this approach.
All this was interpreted by some foreign-exchange traders as signalling that more intervention to push down the value of the yen may be imminent. On several occasions in the recent past, Japan has sought to lower the yen’s level because of worries that its rise would hurt exports.
But the OECD is far more concerned about the large part of the economy that is not export-oriented. Japan has what the organisation describes as a dualistic economy: the domestic, or protected, part of the economy is “remarkably unproductive”, which reflects poor resource allocation underpinned by, above all, poorly enforced competition law and regulation.
As the OECD concedes, though, driving reform in so many areas at once is a difficult political task. Economic restructuring, which is likely to lead to more unemployment in the short term, is bound to be unpopular at a time of zero growth or recession. The government’s freedom of maneouvre on the fiscal front is very limited, partly because of its high budget deficit and soaring government debt, now running at nearly 150% of GDP. At a time when the country faces a rapidly ageing population, Japan badly needs to stabilise its fiscal situation.
Reform is beginning, in some areas at least, to move in the right direction—though the OECD describes much of this as “timid”. So far, the ambitious reform plans of the prime minister, Junichiro Koizumi, have been more noticeable for their absence than their effectiveness. The OECD is not, on the whole, prone to exaggerate gloom. That is why its report on Japan makes such depressing reading.
Hanging by a thread
MOST people expected Argentina to blink first. For weeks, the government of President Eduardo Duhalde had been threatening to default on the $805m payment to the World Bank due on Thursday November 14th. The threat was explicitly aimed at persuading the International Monetary Fund (IMF) to agree to a new programme for Argentina which would unlock new IMF money for the beleaguered economy. But the IMF, exasperated by Argentina’s failure to deliver economic reforms, refused to play ball. Argentina in turn decided it had nothing to lose by trying to force the issue.
So the economy minister, Roberto Lavagna, went in person to the World Bank headquarters in Washington to deliver the news that his government would only pay $79.2m, the interest element of the loan repayment due. Back in Buenos Aires, Mr Duhalde confirmed that the government was still negotiating with the IMF and would meet its obligations as soon as a deal was sealed.
This is a high-risk strategy for a country still reeling from the catastrophic economic collapse it experienced at the turn of the year. Argentina has now, in effect, cut itself off from its last source of outside financing. The government defaulted on its debts to the private sector last December—at around $140 billion, that made it the biggest default in history. IMF disbursements have also been suspended for ten months as negotiations on a new IMF programme have dragged on.
If the World Bank loan isn’t repaid within 30 days of the due date, no new loans will be forthcoming and there can be no interest-rate reductions on existing loans; if the government remains in default for 60 days, all disbursements of existing loans will stop as well. Since the World Bank money has been aimed at mitigating the worst effects of Argentina's economic crisis, the default has potentially unpleasant consequences for the country's poorest citizens.
Poverty has increased sharply in Argentina. By the end of this year, the IMF reckons the economy will have shrunk by about 20% over a four-year period. Unemployment has soared during the long recession that eventually made the country’s currency peg—fixed at parity with the American dollar—unsustainable. Instead of accepting the advice of many economists (and, in private, many governments) that the peg should be abandoned, the then government in Buenos Aires stubbornly stuck to the ten-year-old peg.
The crisis that unfolded in December 2001 was far worse than anyone had predicted. As the economy crashed, so did the banking system, and the government. Economic chaos was followed by political chaos. Mr Duhalde is the fourth man to hold the office since Fernando de la Rua was ousted last December. By bringing forward the presidential elections to next March, Mr Duhalde in effect put himself in charge of a caretaker administration. That hasn’t helped him stop the political infighting that has hindered economic reform.
It's reform that the IMF wants to see before it will put new money on the table. The Fund was heavily criticised in some quarters for providing Argentina with a new $8 billion loan in August last year without demanding an end to the currency peg. Those involved with that decision defend it on the basis that it is difficult to advise a government to abandon a policy which has widespread popular support—as the currency peg did—and to refuse new money when a government proposes an economic programme which, in principle, appears sustainable.
The critics remain unconvinced by that explanation, though, and the IMF has certainly taken a much tougher line this year, wanting clear evidence that promises of reform are credible. Senior Fund staff have privately expressed exasperation at Argentina’s reluctance to accept the need to put its economic house in order. Some of that frustration spilled over in public on November 15th, when Horst Köhler, the IMF's head, said that even in a crisis, “taking responsibility for oneself is unavoidable”.
On the face of it, defaulting on its World Bank loan makes Argentina’s negotiations with the IMF far more difficult. Some observers doubt a deal is possible this side of the elections: the IMF, they suspect, no longer trusts the current government enough and doubts its ability to deliver on any promises it does make.
And yet the Fund’s response to the default announcement was intriguing. It did not comment directly on Argentina’s decision. Instead, a statement said that progress had been made in the latest round of negotiations between Argentina and the IMF, but that further issues needed to be resolved. It also referred to the need to seek political consensus for what had already been agreed.
But in a sign that the IMF wants to give Argentina some breathing space, the statement also revealed that a deadline of November 22nd for payments due to the Fund would be extended. This apparently conciliatory gesture suggests that the IMF wants to reach a deal if at all possible.
In these elaborately choreographed negotiations, it is not just the Argentines who have much at stake. Even for an organisation like the IMF, used to playing the role of international scapegoat, the deadlock with Argentina is uncomfortable. It cannot afford to pour more money down a black hole: extending a loan without having properly sown up a reform programme would be politically disastrous for the IMF. Letting Argentina go further along the road to full-scale default with the multilateral institutions would not be much better. Apart from anything else, the IMF’s own financial structure means it cannot afford to see a big borrower halt all repayments—especially when problems in Brazil and Turkey still loom large.
Argentine citizens who have lost their savings or their jobs, or both, already wonder what the IMF and the World Bank are for. However justified the IMF’s current stand, failure to break the deadlock could have others asking the same question.
New leaders, new risks
CHINA has announced the biggest shuffle of its leadership in more than a quarter of a century. But while there are many new faces at the top, real power will remain for the time being in the hands of the former party chief, Jiang Zemin, who is still in charge of the military and has stacked the politburo with his protégés.
The new line-up is unlikely to herald any significant shift in China’s foreign or domestic policies. For the first time, the politburo consists entirely of men (and very unusually, a woman) who began their party careers after the communists came to power in 1949. Yet all are committed to the same economic and political agenda as the late Deng Xiaoping, who began nudging China in the direction of a market economy in the late 1970s while crushing any challenge to the party’s monopoly on power.
As expected, the 59-year-old vice-president, Hu Jintao, has been named party chief. Mr Hu has been groomed for this position for the past decade, having been selected by Deng as Mr Jiang’s successor-in-waiting. His smooth elevation to the top is a tribute to Deng’s continuing influence beyond the grave. Yet the 76-year-old Mr Jiang has left a far bigger imprint on the politburo’s composition. Of the nine members of the politburo’s standing committee (expanded from a membership of seven), six are close allies of Mr Jiang's. Not one is a protégé of Mr Hu’s.
What remains unclear is how long Mr Jiang will hold on to his title as chairman of the Central Military Commission—in effect, commander-in-chief of the armed forces. It could be that he plans to imitate Deng, who retired from the politburo in 1987 but remained military chief for more than two years. Deng used this position to retain control over policymaking, particularly during the Tiananmen Square protests of 1989. But some analysts believe that Mr Jiang might relinquish his military title shortly before China’s parliament, the National People’s Congress, convenes for its annual session next March. At the congress, Mr Jiang is constitutionally obliged to step down as state president.
Even if Mr Jiang does not plan to keep his military position for long, he will continue to influence politics from behind the scenes using his proxies in the politburo. Principal among these is Zeng Qinghong, who is now formally the fifth-highest ranking member, but who informally will wield as much power as Mr Hu, if not more. Mr Zeng has worked quietly behind the scenes in recent years, helping Mr Jiang in his struggles against potential rivals. He is widely disliked among senior officials because of his identity with the “Shanghai faction” of leaders who enjoy political favours because of their support for Mr Jiang when he was the city's party chief in the 1980s.
The party’s second-highest position is taken by Wu Bangguo, another Shanghai-faction member who served as the city’s party leader in the early 1990s. It is possible that Mr Wu will take over as chairman of the legislature next year, succeeding Li Peng. Mr Li is among several party elders who have stepped down, including Zhu Rongji (who will remain prime minister until March), Mr Jiang’s rival Li Ruihuan, and top generals Chi Haotian and Zhang Wannian.
Another member of the new line-up is Wen Jiabao, who is likely to take over as prime minister. Like Mr Hu, he is quietly spoken and much more of a compromiser than the intolerant current prime minister, Mr Zhu. Mr Wen is widely regarded as Mr Zhu’s proxy in the top leadership. Li Peng has also secured a place for one his allies, Luo Gan, the lowest ranking member of the politburo's standing committee. But probably to Mr Li’s chagrin, Mr Luo does not hold the party’s anti-corruption portfolio (rumours of corruption have long swirled around members of Mr Li’s family). That job goes to Wu Guanzheng, now number seven in the line-up and an ally of Mr Jiang’s.
Also in the standing committee are Jia Qinglin, Huang Ju and Li Changchun, close allies of Mr Jiang’s who have served as regional party bosses in the wealthiest areas of China. Like every one of the committee members, as well as Mr Jiang, they are engineers by training. These technocrats who now dominate Chinese politics are pragmatists who, like Mr Jiang, will focus on developing the country’s economy and maintaining a stable external environment (including a relationship with America that avoids confrontation whenever possible).
One of the biggest uncertainties surrounding China in the coming years will be the cohesion of this new leadership. Mr Jiang enjoys nothing like the respect that Deng was able to command even in retirement. At the party’s 16th congress, which ended on Thursday, delegates agreed to revise the party charter to give Mr Jiang’s theory of the “three represents” (which essentially means that the party now represents the middle class as well as the proletariat) a place alongside the hallowed philosophies of Mao Zedong and Deng. But Mr Jiang’s name was not mentioned as the author of the “three represents”—thus consigning him to an inferior role in the party’s history books.
It is possible that even with a politburo full of his allies, Mr Jiang’s grip will weaken far faster than Deng’s did after his nominal retirement. Within a year or two, China could enter a period in which no individual is clearly the paramount leader (even after a decade in the politburo standing committee and three years as vice-chairman of the Central Military Commission, Mr Hu appears to have developed no significant power base). That would not bode well for political stability.