January 1, 2010

Op-Ed Columnist

Chinese New Year

By PAUL KRUGMAN

It’s the season when pundits traditionally make predictions about the year ahead. Mine concerns international economics: I predict that 2010 will be the year of China. And not in a good way.

Actually, the biggest problems with China involve climate change. But today I want to focus on currency policy.

China has become a major financial and trade power. But it doesn’t act like other big economies. Instead, it follows a mercantilist policy, keeping its trade surplus artificially high. And in today’s depressed world, that policy is, to put it bluntly, predatory.

Here’s how it works: Unlike the dollar, the euro or the yen, whose values fluctuate freely, China’s currency is pegged by official policy at about 6.8 yuan to the dollar. At this exchange rate, Chinese manufacturing has a large cost advantage over its rivals, leading to huge trade surpluses.

Under normal circumstances, the inflow of dollars from those surpluses would push up the value of China’s currency, unless it was offset by private investors heading the other way. And private investors are trying to get into China, not out of it. But China’s government restricts capital inflows, even as it buys up dollars and parks them abroad, adding to a $2 trillion-plus hoard of foreign exchange reserves.

This policy is good for China’s export-oriented state-industrial complex, not so good for Chinese consumers. But what about the rest of us?

In the past, China’s accumulation of foreign reserves, many of which were invested in American bonds, was arguably doing us a favor by keeping interest rates low — although what we did with those low interest rates was mainly to inflate a housing bubble. But right now the world is awash in cheap money, looking for someplace to go. Short-term interest rates are close to zero; long-term interest rates are higher, but only because investors expect the zero-rate policy to end some day. China’s bond purchases make little or no difference.

Meanwhile, that trade surplus drains much-needed demand away from a depressed world economy. My back-of-the-envelope calculations suggest that for the next couple of years Chinese mercantilism may end up reducing U.S. employment by around 1.4 million jobs.

The Chinese refuse to acknowledge the problem. Recently Wen Jiabao, the prime minister, dismissed foreign complaints: “On one hand, you are asking for the yuan to appreciate, and on the other hand, you are taking all kinds of protectionist measures.” Indeed: other countries are taking (modest) protectionist measures precisely because China refuses to let its currency rise. And more such measures are entirely appropriate.

Or are they? I usually hear two reasons for not confronting China over its policies. Neither holds water.

First, there’s the claim that we can’t confront the Chinese because they would wreak havoc with the U.S. economy by dumping their hoard of dollars. This is all wrong, and not just because in so doing the Chinese would inflict large losses on themselves. The larger point is that the same forces that make Chinese mercantilism so damaging right now also mean that China has little or no financial leverage.

Again, right now the world is awash in cheap money. So if China were to start selling dollars, there’s no reason to think it would significantly raise U.S. interest rates. It would probably weaken the dollar against other currencies — but that would be good, not bad, for U.S. competitiveness and employment. So if the Chinese do dump dollars, we should send them a thank-you note.

Second, there’s the claim that protectionism is always a bad thing, in any circumstances. If that’s what you believe, however, you learned Econ 101 from the wrong people — because when unemployment is high and the government can’t restore full employment, the usual rules don’t apply.

Let me quote from a classic paper by the late Paul Samuelson, who more or less created modern economics: “With employment less than full ... all the debunked mercantilistic arguments” — that is, claims that nations who subsidize their exports effectively steal jobs from other countries — “turn out to be valid.” He then went on argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.

The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation. So I’d urge China’s government to reconsider its stubbornness. Otherwise, the very mild protectionism it’s currently complaining about will be the start of something much bigger.

Copyright 2010 The New York Times Company

Banking after the kindness of strangers

By Francesco Guerrera

Published: December 31 2009 12:10

”Whoever you are, I have always depended on the kindness of strangers”. The last line of Tennessee Williams’ A Streetcar Named Desire – uttered by its desperate heroine to the doctor taking her to a mental asylum – is an apt summary of the US financial sector in 2009.

As the crisis abated, banks took maximum advantage of the kindness of taxpayers and regulators to return to their core business: making money for shareholders and employees.

Ultra-low interest rates, dwindling competition and pent-up demand for their services sparked a renaissance in profits and share prices of the financial institutions that emerged from the turmoil in reasonable shape.

The question is whether history will repeat itself, or even just rhyme, this year. Here are my ten, utterly personal and non-exhaustive, predictions for the year ahead in US finance.

1) Strangers will be a lot less kind. With banks boasting about their new-found health, regulators will pull the plug on most of the measures they introduced to drag the financial industry back from the brink. A host of acronyms (Tarp, Talf, PPIP, TLGP) will be forgotten but not missed.

2) Politicians’ influence over the financial industry will wane. As banks repay federal aid and the visible hand of the government retreats from capital markets, financial groups will become increasingly deaf to pleas for more lending and smaller bonuses and…

3) …banks will redouble their efforts to lobby against tough new financial rules. No longer required to show gratitude to taxpayers, the industry will launch an all-out attack against the new legislation. The planned Consumer Protection Agency and higher capital standards will be two favourite targets.

4) US manufacturing will experience an unlikely rebirth. Left for dead after the last recession, the industry of making things will benefit from a depreciating currency, an ample supply of labour and the country’s technological prowess to recover some of the ground lost to the service sector. The bad news is this will not be enough to trigger a lasting recovery throughout the country: the US economy will still need consumers and financial services to regain its footing.

5) Vikram Pandit will step down as chief executive of Citigroup. Either because the long-suffering company has repaid its government’s debts and is heading towards a brighter future as a smaller financial supermarket or because Citi has proven once again to be the messiest, most hapless of the big banks and has lost further ground to its rivals.

6) Goldman Sachs vs Morgan Stanley : something’s gotta give. Once as fiercely intertwined as Tom and Jerry, the two institutions formerly known as investment banks have taken opposite routes, with Goldman sticking to its advisory and trading model and Morgan Stanley going towards the retail business by assembling a big brokerage unit in expectation of regulatory curbs on its wholesale activities. Morgan Stanley’s profits have been lagging in 2009 but if it is right about regulation, the tortoise could overtake the Goldman hare.

7) New rivals to challenge the big boys. On three fronts. As regulators curb leverage and high-risk activities at too-big-too-fail banks, large hedge funds, such as Citadel and Blackstone, will try and supplant them. Big institutional investors (BlackRock, Pimco) will want in on the recent trading fees bonanza by setting up their own trading operations. Boutiques (Lazard, Greenhill) will keep making inroads in the takeover advisory business.

8) A new ruling class will emerge on Wall Street. After the crisis hastened generational change (farewell Stan O’Neal, Chuck Prince and Ken Lewis), the industry needs new leaders. James Gorman, who has replaced John Mack at Morgan Stanley, is a candidate but keep an eye on Goldman which could freshen up its traders-heavy top by appointing a investment banker as number three.

9) The year of the foreigners. Barclays Capital, Credit Suisse and Deutsche Bank have had a good crisis. Expect their newly-confident leadership to try and take market share and star bankers from weakened behemoths such as Citi and Bank of America. True to form, they could also launch into pricey, value-destroying acquisitions (Credit Suisse-DLJ or UBS-Paine Webber, anyone ?).

10) A little less Jamie Dimon, a little more action. Two books, a few magazine covers and “banker of the year” award. The JPMorgan chief has had plenty of personal exposure in 2009. This year, his bank should do the talking. If US consumers shake off their blues, by the second half of the year, Mr Dimon’s creation will really pull away from the pack.

Copyright The Financial Times Limited 2010

OPINION

DECEMBER 31, 2009.

Why Japan Needs a 'Hatobama' .

By IAN BREMMER
AND NOURIEL ROUBINI

Like President Barack Obama, Japan's new Prime Minister Yukio Hatoyama made lots of extravagant economic and foreign policy promises on the road to victory earlier this year. Mr. Obama has shown flexibility and the willingness to compromise. Will Mr. Hatoyama do the same? If not, Japan will be in for a rough ride in 2010.

In some ways, Mr. Hatoyama's victory was even more historic than the American election. His Democratic Party of Japan (DPJ) ousted the Liberal Democratic Party (LDP) that had held power virtually without interruption for more than five decades. Like Mr. Obama, he's had to come to grips with enormous immediate challenges, beginning with the need to kick start a stalled economy. Japan's public debt is approaching 200% of gross domestic product—by far the largest debt-to-GDP ratio in the industrialized world.

Mr. Hatoyama's promises were ambitious, and sometimes even contradictory. Recognizing Japan's financial limitations, he and his party pledged to slash wasteful state spending. Yet he has also called for "an economy of the people" that includes considerable state subsidies, and his government put forward a record high initial budget request of 95 trillion yen.

The government has now moved ahead with a new bond issuance, with a promise to cap the new debt at about 44 trillion yen. Mr. Hatoyama has announced plans to halt the privatization of Japan Post bank, an enormous enterprise with more than $3 trillion in assets that helps finance state spending. And he has reiterated a pledge that Japan will reduce carbon emissions 25% below 1990 levels by 2020, a promise that will soon prove too costly to keep.

On foreign policy, the new prime minister has argued that the U.S.-Japan relationship should develop toward a partnership of equals. But despite some blunt warnings from Washington, DPJ officials have yet to resolve the standoff over the controversial relocation of a helicopter base and 8,000 Marines from Japan to Guam. This is a deal the U.S. believes it settled with the previous Japanese government in 2006.

In Washington, the prime minister's critics are becoming more vocal. Former National Security Council director for counterproliferation strategy Carolyn Leddy recently accused the Hatoyama government of "increasing security policy schizophrenia."

Mr. Hatoyama's domestic approval numbers have taken a tough hit: A Kyodo News poll last weekend found that disapproval of the government surged to 38.1% this month from 25% in November. And the risk remains that he will try to keep too many of his campaign promises, deepening Japan's debt without actually spurring growth. He also risks undermining a security relationship with Washington that remains essential for East Asian stability.

There are two main reasons why Mr. Hatoyama's unrealistic goals are more worrisome than any of the economic plans Mr. Obama has proposed.

First, there are far fewer political checks on Mr. Hatoyama's ability to pursue them. Mr. Obama faces a hostile Republican Party, a divided electorate, and moderates within the Democratic congressional caucus skeptical of his plans. He has accepted compromise on important issues like health-care reform and troop deployments to Afghanistan because he knows he must. Recognizing the complexities involved, he's taken a go-slow approach on domestic climate change legislation and the closing of the prison at Guantanamo Bay. Fiscal conservatives in both parties make a second stimulus package all but politically impossible.

The DPJ, meanwhile, has built a strong single-party majority in the lower house and relies on a pair of coalition partners to dominate the upper house. Mr. Obama's party has majorities too, but Mr. Hatoyama faces fewer institutional obstacles, like the filibuster, to setting a political agenda and pushing it forward.

Finally, the U.S. has a two-party system that allows business and industry groups to hedge their bets by lobbying both sides. Five months ago, Japan had a one-party system—one in which business elites negotiated legislative language with an LDP-dominated bureaucracy. For the commercial elite, it now has a no-party system, a ruling coalition of mostly new faces with far fewer connections in the business world.

Mr. Obama's innate caution and his willingness to compromise are likely to serve him well. To spare Japan an unnecessarily turbulent 2010, Mr. Hatoyama needs to become "Hatobama," a pragmatist ready to disappoint ideological allies and assuage centrist fears of a policy agenda his country simply can't afford. Japan's recovery is riding on it.

—Mr. Bremmer, president of Eurasia Group, is co-author of "The Fat Tail: The Power of Political Knowledge for Strategic Investing" (Oxford University Press, 2009). Mr. Roubini is a professor of economics at New York University's Stern School of Business and chairman of RGE Monitor.

December 31, 2009

Op-Ed Columnist

Change Iran at the Top

By ROGER COHEN

It has come to this: The Islamic Republic of Iran killing the sons and daughters of the revolution during Ashura, adding martyrdom to martyrdom at one of the holiest moments in the Shiite calendar.

Nothing could better symbolize Iran’s 30-year-old regime at the limit of its contradictions. A supreme leader imagined as the Prophet’s representative on earth — Ayatollah Ruhollah Khomeini’s central revolutionary idea — now heads a militarized coterie bent, in the name of money and power, on the bludgeoning of the Iranian people. A false theocracy confronts a society that has seen through it.

The emperor has no clothes.

Still, let us give this theocracy credit. It has brought high levels of education to a broad swathe of Iranians, including the women it has repressed. In a Middle East of static authoritarianism, it has dabbled at times in liberalization and representative governance. It has never quite been able to extinguish from its conscience Khomeini’s rallying of the masses against the shah with calls for freedom.

The result, three decades on from the revolution, is precisely this untenable mix of a leadership invoking transplantation from heaven as it faces, with force of arms and the fanaticism of militias, a youthful society far more sophisticated than the death-to-the-West slogans still unfurled.
Nowhere else today in the Middle East does anything resembling the people power of Iran’s Green movement exist. This is at once a tribute to the revolution and the death knell of an ossified post-revolutionary order.

Something has to give, someone has to yield. If the Islamic Republic is incapable of honoring both words in its self-description — that of a religious and representative society — it must give way to an Iranian Republic.

The former course, of reform rather than overthrow, would be less tumultuous and so, I suspect, more attractive to a people weary of tumult and flanked by mayhem in Iraq and Afghanistan.

Yes, something has to give. Grand Ayatollah Hossein Ali Montazeri, whose death this month carried heavy symbolism in a land where symbols are potent, intuited the revolution’s unsustainable tensions two decades ago. It was then that the cleric once designated as Khomeini’s successor lambasted an earlier round of bloody repression and then that he began to criticize the office of the supreme leader.

Montazeri had been instrumental in 1979 in the creation of the system of Guardianship of the Jurist, or velayat-e-faqih, placing a leader interpreting God’s word atop circumscribed republican institutions. But he later apologized for his role in the establishment of the position and argued that he had conceived of it as exercising moral rather than executive authority.

His anger came to a head after the June 12 election, hijacked by the supreme leader, Ali Khamenei. Montazeri then declared: “Such elections results were declared that no wise person in their right mind could believe, results that based on credible evidence and witnesses had been altered extensively.” He lambasted what he called “astonishing violence against defenseless men and women.”

I witnessed that violence — a putsch in the spurious name of God’s will grotesquely portrayed by Khamenei as a glorious democratic moment — and it was clear at once that Iran’s leadership had taken a fatal turn. It had shunned the pluralistic evolution of the Islamic order in favor of a lockdown by the moneyed cadres of the New Right, personified by the Revolutionary Guards with their cozy contracts and pathological fears of looming counter-revolutions of the velvet variety.

You can do many things to the Iranian people but you insult their intelligence at your peril. The astonishing, taboo-breaking cry of “Death to Khamenei” echoing from the rooftops of Tehran signaled a watershed.

It is time to rethink the supreme leader’s office in the name of the compromise between religious faith and representative governance that the Iranian people have sought for more than a century. It is time for Iran to look West to the holy Shiite cities in Iraq, Najaf and Karbala, places from which Grand Ayatollah Ali al-Sistani exercises precisely the kind of moral authority and suasion — without direct executive authority — that Montazeri favored for Iran.

If the Guardianship of the Jurist can be rethought through compromise the Islamic Republic can move forward. If not, I cannot see the current unrest abating.

The Green movement is a loose coalition of divergent aims — much like the revolutionary alliance of 1979 — but is united in its demand for an end to the status quo.

A commander-in-chief transplanted from heaven is not what the Iranian people want, not after June 12; a moral guide, rooted in the ethics and religion of Persia, a guarantor of the country’s independence, may well be. It is time for a Persian Sistani.

The sons and daughters of disappointed revolutionaries do not seek renewed bloodshed. They seek peaceful change that will give meaning to the word “republic.” Khamenei, bowing to superior learning, in the best tradition of Shiism, should listen to the wisdom of Iran’s late turbulent priest.

Iran would thereby preserve its independence, the proudest achievement of the revolution, while better reflecting the will of its people, who overwhelmingly favor normalized relations with the United States.

It is time to retire the stale slogans of a bygone era. It is time for Iran to follow China’s example of 1972 in adapting to survive. Perhaps Khomeini, like Mao in Deng Xiaoping’s famous formula, was 70 percent right — and some brave Iranian leader could say that. He would thereby open the way for one of the Middle East’s most hopeful societies to move forward.

Speaking of tired slogans, it is also time for the United States — and especially Congress — to set aside formulaic thinking on Iran. Shiite Iran is not America’s enemy; Sunni Al Qaeda is, whether in Yemen, Nigeria or Pakistan. New sanctions against Tehran would only throw a lifeline to Khamenei and further enrich the Revolutionary Guards. President Obama’s outreach is still the smartest approach to Iran, a nation whose political clock has now trumped its erratic, wavering nuclear clock.

Back in February, I wrote: “The Islamic Republic has not birthed a totalitarian state; all sorts of opinions are heard. But it has created a society whose ultimate bond is fear. Disappearance into some unmarked room is always possible.” That was too much for the Iran-as-Nazi-incarnation-of-evil school, who cast me as an appeaser.

I also wrote that, “The irony of the Islamic Revolution is that it has created a very secular society within the framework of clerical rule. The shah enacted progressive laws for women unready for them. Now the opposite is true: Progressive women face confining jurisprudence. At some point something must give.”

With the birth of the Green movement, and in the spirit of Montazeri, something has given. The further, critical “giving” has to come in the supreme leader’s office, where the 30 percent error of 1979 has entrenched itself and so denied Iran the governance and society its vibrant population deserves.

BRIEFINGS

Emerging markets and recession

Counting their blessings

Dec 30th 2009
From The Economist print edition

Developing countries have come out of the recession stronger than anyone had expected. This will have profound consequences for the rest of the world

Illustration by Adrian Johnson

THE political and social consequences of the worst economic crisis since the Great Depression have been milder than predicted. In developing countries, at least, governments have not fallen in a heap, as they did after the Asian crisis of 1997-98. They have not battled their own people on the streets, as happened in Europe during the 1930s. Social-protection programmes have survived relatively unscathed. There have been economic-policy shifts, naturally, but no panicky retreat into isolation, populism or foreign adventures. The good news has not been spread evenly, of course: some countries have ridden the storm more successfully than others. And these are only first-round effects: things could still get worse. So far, though, resilience has been the order of the day.

This was not expected a year ago. Then, it seemed likely that normal rules would apply—that when the rich world sneezes, developing countries get swine flu. In the fourth quarter of 2008, when rich economies were contracting by 5% to 10% a year, real GDP fell at an average annualised rate of around 15% in some of the world’s most dynamic economies, including Singapore, South Korea and Brazil. The fall in Taiwan’s industrial output—down by a third during 2008—was worse than America’s worst annual fall during the Depression.

Emerging markets seemed likely to suffer disproportionately because of their trade and financial links with the West. Exports in that dreadful last quarter of 2008 fell by half in the Asian tigers at an annualised rate; capital flows to emerging markets went over a cliff as Western banks “deleveraged”. The Institute of International Finance (IIF), a think-tank in Washington, DC, forecast that net private capital flows into poor countries in 2009 would be 72% lower than at their peak in 2007, an unprecedented shrinkage.

As people peered ahead into 2009, no forecast looked too dire. “The end of globalisation” was a common refrain. Some thought emerging markets would turn inward to protect themselves from the contagion of the West. Others forecast that hundreds of millions of people would be tipped into hunger. The IMF’s managing director, Dominique Strauss Kahn, fretted that unless governments did the right things at the right time, there was a “threat of civil unrest, perhaps even of war”.

At the start of 2010 there are indeed a billion hungry people, for the first time in 40 years. But the other forecasts now look excessively gloomy. Whereas the last three months of 2008 saw one disaster after another, the end of 2009 was a period of healthy recovery, as measured by capital, bond and stockmarkets.


During 2009 the largest developing-country stockmarkets recouped all the losses they had suffered during 2008 (see table). October 2009 saw the largest monthly inflow into emerging-market bond funds since people started tracking the numbers in 1995. Russia’s central bank estimated that the country would attract $20 billion of capital inflows during the fourth quarter, compared with capital outflows of $60 billion in the first nine months. The IIF now reckons that net private capital flows to developing countries will more than double in 2010 to $672 billion (still a long way below their peak). So much new money is flooding into emerging markets that calls for capital controls are echoing around the developing world.

This craze for emerging-market paper could perhaps prove a bubble. But as a measure of reputational change, it is accurate. Countries that were disaster zones at the start of 2009 achieved gold-rush status by the end of it. This turnaround reflects a resilient economic performance during the recession. It also reflects a stunning degree of political and social cohesion.

The most important economic reason for this is that emerging markets were less affected by the rich world’s recession than seemed likely early in 2009. Big populous countries—China, India, Indonesia—did not tip into recession; they merely suffered slower growth. Brazil and the Asian tigers saw output fall but bounced back. The pattern, though, was variable. The Baltic states endured a depression; Mexico suffered from its dependence on America; eastern Europe was harder hit than Asia; poor African countries suffered more than middle-income Asian ones.


Overall, the loss of output in emerging markets during 2007 was somewhat greater than it had been in the Asian crisis of 1997-98, but less than had been expected and much less than the fall in world gdp (see chart 1). Emerging markets benefited from their own economic-stimulus programmes and from policy activism in rich countries. Rich-country bail-outs and monetary loosening stemmed worldwide financial panic and helped stoke an appetite for emerging-market exports and assets. In addition, some developing countries built up big cushions of foreign- exchange reserves after the Asian crisis which afforded them some protection.

Surprising stability

This economic resilience has had big political and social benefits. Politically, the most striking feature of the crisis is how little instability it caused. The worst slump in decades has so far led to the fall of just one emerging-market government: Latvia’s (Iceland’s government also collapsed). Other east-European governments have come under pressure, notably Hungary’s.

But two of the biggest emerging markets—India and Indonesia—held national elections in 2009, and both were won by the ruling party. This was unusual in India, which traditionally votes against incumbents. In another emerging giant, Brazil, the outgoing president is likely to leave office in 2010 with poll ratings in the stratosphere (Luis Inácio Lula da Silva’s favourability ratings stayed above 60% for most of 2009). The global crisis seems to have consolidated, not undermined, the popularity of large developing-country governments, presumably because the economic crisis was perceived to have begun elsewhere and been dealt with efficiently.

Contrast that with what happened during the Asian crisis of 1997-98. Widespread rioting in the wake of abrupt devaluation led to the fall of Suharto’s 30-year dictatorship in Indonesia. Devaluation added to popular discontent in the Philippines, culminating in the overthrow of President Joseph Estrada. There was mass discontent in Thailand as millions of urban workers lost their jobs and wandered back to their villages. Financial collapse in Russia produced a political crisis and led to the sacking of the prime minister, Sergei Kiriyenko. A couple of years later, Argentina defaulted on its debt and ran through three presidents in ten days at the turn of 2001-02. (“What did you do for Christmas?”, ran the contemporary joke. “I was president.”) In country after country, governments reacted to financial stress and plunging currencies by imposing emergency austerity measures which brought them into conflict with rioters on the streets. That has been much rarer this time.

The second striking feature of the crisis has been that, with one or two exceptions, it seems not to have caused any fundamental shift of popular opinion. There has been no upsurge of angry pessimism, nor any significant backlash against capitalism or free markets. That doubtless explains much of the political composure.

Compared with people in the West, those in big emerging markets seem in almost sunny mood. In China, India and Indonesia, according to the Pew Global Attitudes Project in Washington, DC, more than 40% of respondents say they are satisfied with their lives (in China the figure is 87%). In France, Japan and Britain, the share is below 30% (see chart 2). This is unusual: measures of “life satisfaction” tend to rise with income, so you would expect levels to be lower in emerging markets, as they were in 2002-03. The reversal of that pattern may reflect a sense in those countries of their quick recovery.

It is true that the overall levels hide some disturbing trends. A study of Bangladesh, Indonesia, Jamaica, Kenya and Zambia by the Institute of Development Studies at the University of Sussex found that people there said they were saving less, celebrating together less often and thought that neighbourly support was declining. People also thought children and old people were being abandoned more often. But, overall, such concerns are as great or greater in rich countries.

The mood in emerging markets is both unusual and consequential. To see how, compare what is happening there with trends in parts of the West. Americans, for example, seem to be hankering for isolationism. According to Pew’s polling, 49% of Americans now think their country should mind its own business internationally. That is more than 30 points higher than when the question was first asked in 1964. Jim Lindsay of the Council on Foreign Relations points out worrying parallels between what is happening now and America’s reaction to the Great Depression, which sparked a period of introspection that ended only with the second world war. Developing countries are not suffering such anger or frustration.

That same resilience informs their attitudes to markets. Arvind Subramanian, of the Petersen Institute for International Economics in Washington, DC, argues that the recession has set off “no serious questioning of the role of the market” in developing countries. It is true that China has seen a disproportionate rise in lending to state-owned enterprises, but this is not necessarily regarded with favour. China’s media have been flooded with reports of abuses by state firms, all featuring a newly popular, negative-sounding term guojin mintui, which means “the state advances and the private sector retreats”.

Asked “Are you better off under free markets?”, people in emerging markets are more likely to say yes than those in rich ones. The share of respondents who think they are better off fell in 2009 by between four points (Germany) and ten points (Spain). In most emerging markets, the share either rose (in India and China) or stayed flat (in Brazil and Turkey). No sign of an anti-capitalist backlash there.

The combination of political stability and popular composure has given emerging markets what might be called “policy space” in which to act. They have used it to the full—and mostly for the better. This, in turn, has enhanced their reputations for economic management.

Little big spenders

At the start of 2009 falls in foreign-trade taxes, remittances, aid, commodity prices and capital inflows all threatened developing countries’ fiscal positions, and their social spending especially. For a few, the threat materialised: 20 countries, many in eastern Europe, signed standby arrangements with the IMF and tightened fiscal policy. But by and large, the slash-and-burn approach to crisis management associated with previous bouts of economic trouble was avoided. For the first time in a global recession, emerging markets were free to loosen fiscal policy.

Some produced big stimulus programmes. China’s is the best known, but Russia, Hong Kong, Kazakhstan, Malaysia, Vietnam, Thailand, Singapore, Brazil and Chile also unveiled large anti-crisis budgets or counter-cyclical spending programmes. As a share of GDP, stimulus spending by the emerging-market members of the G20 was larger than spending by the rich members. In that sense, emerging markets did more than their Western counterparts to combat global recession. Even countries that could not afford emergency programmes like China’s let their fiscal balances deteriorate as counter-cyclical spending got under way. In Africa, oil importers let their budget deficits rise from 2.2% of gdp in 2008 to 6% in 2009.

By ring-fencing social spending, developing countries managed to protect some of their poorest people. Brazil expanded the coverage of its assistance programme for the poor, called Bolsa Familia, by over 1m households to 12m. India expanded to the whole country a programme that guarantees 100 days’ employment on public works each year to any rural household that wants it. China’s massive stimulus programme may have forestalled disaster in the migrant-labour force. Half the 140m labourers working in Chinese cities returned home in early 2009; a fifth stayed there, and another fifth could not find work when they returned to the cities. But as spending on infrastructure started to kick in, employment surged; by the middle of the year, joblessness among rural migrant workers was down to less than 3%. Beyond China, fear of social unrest associated with jobless migrants (as in 1997-98) has not materialised. A forthcoming study of 11 countries by Oxfam, a British NGO, found that migrants took new jobs, often at lower wages or with longer hours. In Vietnam some were even given money to stay in the cities by their families in the countryside—a kind of reverse remittance. But there was no mass return to the villages.

Flexibility is strength

The Oxfam study describes the myriad ways in which countries resisted the recession. Remittances held up better than expected. Parents refused to take their children out of class, or else switched them from private to public schools. Some even cut down on their own food to keep children in education. There were outright job losses in some parts of countries’ economies, such as export sectors and mining. But the commoner reaction to falling demand was to cut hours and wages, reduce benefits and insist on more flexible working conditions. In other words, the main result of the slowdown was not unemployment (though there was some) but a move towards more flexible labour markets.

How long this can go on is unclear. Cash-transfer and make-work schemes are expensive: most poor countries cannot afford them. Worse, the poorest were more vulnerable than middle-income countries anyway because of the food-price spike of 2007-08: hence the rise in the number of hungry people to 1 billion, the highest figure since 1970. In general, the informal sector (home workers, ragpickers, street vendors) has been hit harder than the formal sector and is beyond the reach of government anti-poverty programmes. Although developing countries have done what they can, it would be wrong to think their people have escaped the recession entirely.

It is worth adding that not all the actions of developing-country governments have been equally enlightened. Emerging markets have been the worst sinners in a new round of protectionism. Whether you look at the number of new trade-damaging measures tracked by the World Trade Organisation, or the numbers of sectors or trading partners hurt, Russia, China and Indonesia are all among the top five protectionists; Argentina is in the top ten. Rich countries have been slightly less destructive. Still, as Simon Evenett, a professor of trade at the University of Saint Gallen, Switzerland, points out, this is not as dreadful as it might have been, or as it was in the 1930s. Only four countries have implemented restrictions affecting more than a quarter of their product lines: across-the-board tariff barriers are not the fashion. But as growth picks up and fights for market share increase, these restrictions could lay a basis for further trade disputes.

The tectonic consequence

When the Earth’s tectonic plates grind against one another, they do not always move smoothly; sometimes they slip. A year after the West’s slump began to spread to emerging markets, it has become clear that the recession has been a moment of tectonic slippage, a brief but powerful acceleration in the deep-seated movement of economic power away from rich nations towards emerging markets.

Illustration by Adrian Johnson

Since 2007, according to Goldman Sachs, the biggest emerging markets—Brazil, Russia, India and China—have accounted for 45% of global growth, almost twice as much as in 2000-06 and three times as much as in the 1990s. It used to be said that although emerging markets were contributing an expanding share of world growth, they could not claim to be the real engine for the global economy because final demand for their exports lay in America. But that argument is weaker now that China has overtaken America as the main market for the goods of the smaller Asian exporters. The recession showed that economic power is leaching away from the West faster than was thought.

Previous recessions have left most developing countries with their reputations for economic management in tatters, and with credibility to regain in capital markets. This time, it is the rich whose reputations have been damaged. The fiscal response of many emerging markets has enhanced their credibility, and they find themselves with an unexpected reputation for fiscal prudence. The debt-to-gdp ratio of the 20 largest emerging markets is only half that of the top 20 rich nations. Over the next few years rich countries’ debt will rise further, so emerging markets’ indebtedness will be only one-third of theirs by 2014. Already there are signs that financial markets are rewarding them for good behaviour. Sovereign-risk spreads have been lower in the biggest emerging markets than in some euro-zone countries; in 2009, Hong Kong did more initial-public offerings than New York or London.

At the start of the crisis, a Mexican minister sighed: “At least this time it’s not our fault.” The comment was laden with sad irony: like everyone else, he expected that Mexico’s innocence would make no difference and that emerging markets would be hammered anyway. But they have not been. So far the story of global recession in emerging markets has had that rarest of themes: virtue rewarded.

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