miércoles, diciembre 01, 2010

WHY THE SPENDING STIMULUS FAILED / THE WALL STREET JOURNAL OP EDITORIAL ( A MUST READ )

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OPINION

DECEMBER 1, 2010.

Why the Spending Stimulus Failed

New economic research shows why lower tax rates do far more to spur growth.

By MICHAEL J. BOSKIN

President Obama and congressional leaders meeting yesterday confronted calls for four key fiscal decisions: short-run fiscal stimulus, medium-term fiscal consolidation, and long-run tax and entitlement reform. Mr. Obama wants more spending, especially on infrastructure, and higher tax rates on income, capital gains and dividends (by allowing the lower Bush rates to expire). The intellectual and political left argues that the failed $814 billion stimulus in 2009 wasn't big enough, and that spending control any time soon will derail the economy.


But economic theory, history and statistical studies reveal that more taxes and spending are more likely to harm than help the economy. Those who demand spending control and oppose tax hikes hold the intellectual high ground.


Writing during the Great Depression, John Maynard Keynes argued that "sticky" wages and prices would not fall to clear the market when demand declines, so high unemployment would persist. Government spending produced a "multiplier" to output and income; as each dollar is spent, the recipient spends most of it, and so on. Ditto tax cuts and transfers, but the multiplier is assumed smaller.


Macroeconomics since Keynes has incorporated the effects of longer time horizons, expectations about future incomes and policies, and incentives (including marginal tax rates) on economic decisions.




Temporary small tax rebates, as in 2008 and 2009, result in only a few cents per dollar in spending. The bulk (according to economists such as Franco Modigliani and Milton Friedman) or all (according to Robert Barro of Harvard) is saved, as people spread any increased consumption over many years or anticipate future taxes necessary to finance the debt. Empirical studies (such as those by my colleague Robert Hall and Rick Mishkin of Columbia) conclude that most consumption is based on longer-term considerations.


In a dynamic economy, many parts are moving simultaneously and it is difficult to disentangle cause and effect. Taxes may be cut and spending increased at the same time and those may coincide with natural business cycle dynamics and monetary policy shifts.


Using powerful statistical methods to separate these effects in U.S. data, Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago conclude that the small initial spending multiplier turns negative by the start of the second year. In a new cross-national time series study, Ethan Ilzetzki of the London School of Economics and Enrique Mendoza and Carlos Vegh of the University of Maryland conclude that in open economies with flexible exchange rates, "a fiscal expansion leads to no significant output gains."


My colleagues John Cogan and John Taylor, with Volker Wieland and Tobias Cwik, demonstrate that government purchases have a GDP impact far smaller in New Keynesian than Old Keynesian models and quickly crowd out the private sector. They estimate the effect of the February 2009 stimulus at a puny 0.2% of GDP by now.


By contrast, the last two major tax cuts—President Reagan's in 1981-83 and President George W. Bush's in 2003—boosted growth. They lowered marginal tax rates and were longer lasting, both keys to success. In a survey of fiscal policy changes in the OECD over the past four decades, Harvard's Albert Alesina and Silvia Ardagna conclude that tax cuts have been far more likely to increase growth than has more spending.


Former Obama adviser Christina Romer and David Romer of the University of California, Berkeley, estimate a tax-cut multiplier of 3.0, meaning $1 of lower taxes raises short-run output by $3. Messrs. Mountford and Uhlig show that substantial tax cuts had a far larger impact on output and employment than spending increases, with a multiplier up to 5.0.


Conversely, a tax increase is very damaging. Mr. Barro and Bain Capital's Charles Redlick estimate large negative effects of increased marginal tax rates on GDP. The best stimulus now is to stop the impending tax hikes. Mr. Alesina and Ms. Ardagna also conclude that spending cuts are more likely to reduce deficits and debt-to-GDP ratios, and less likely to cause recessions, than are tax increases.


These empirical studies leave many leading economists dubious about the ability of government spending to boost the economy in the short run. Worse, the large long-term costs of debt-financed spending are ignored in most studies of short-run fiscal stimulus and even more so in the political debate.


Mr. Uhlig estimates that a dollar of deficit-financed spending costs the economy a present value of $3.40. The spending would have to be remarkably productive, both in its own right and in generating jobs and income, for it to be worth even half that future cost. The University of Maryland's Carmen Reinhart, Harvard's Ken Rogoff and the International Monetary Fund all conclude that the high government debt-to-GDP ratios we are approaching damage growth severely.


The complexity of a dynamic market economy is not easily captured even by sophisticated modeling (an idea stressed by Friedrich Hayek and Robert Solow). But based on the best economic evidence, we should reject increased spending and increased taxes.


If anything, we should lower marginal effective corporate and personal tax rates further (for example, along the lines suggested by the bipartisan deficit commission's Erskine Bowles and Alan Simpson). We should quickly enact an enforceable gradual phase-down of the spending explosion of recent years. That's what the president and congressional leaders should initiate. Then let the equally vital task of long-run tax and entitlement reform proceed.


Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.


Copyright 2010 Dow Jones & Company, Inc. All Rights Reserved

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miércoles, diciembre 01, 2010

WHY THE IRISH CRISIS IS SUCH A HUGE TEST FOR THE EUROZONE / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

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Why the Irish crisis is such a huge test for the eurozone

By Martin Wolf

Published: November 30 2010 20:21



The fault lines in the currency union stand revealed. The promise was that the eurozone would deliver its members from currency crises. But, as I, and others, warned, be careful what you wish for: credit crises would replace currency crises – and these are likely to be even worse.


Why would a currency union lead to credit crises? One answer is that divergences in relative costs lead to structural trade imbalances – large external deficits when the less competitive economies are close to potential output. The private or public sectors must then spend more than their incomes to sustain full employment. Such excess spending must, in turn, be financed from abroad. In the end, such lending will vanish. If the lending goes via the banking sector, as in Ireland or Spain, there will first be a financial crisis. If the lending goes via the public sector, as in Greece, the crisis will first be in state finances.


A deeper answer is that the common interest rate will appear very low in some member countries. In the eurozone, the fact that global interest rates were low and demand in core economies weak, exacerbated this effect. These ultra-low interest rates triggered asset price bubbles and credit booms in peripheral economies. These, in turn, encouraged construction booms. In these circumstances, what the late John Kenneth Galbraith called the “bezzle” – the stock of financial crime – rises, to emerge in the crash. As the financial system implodes, the economy collapses and the public finances, seemingly strong in the boom, turn sharply for the worse.


The result is a huge credit crisis. Under a floating exchange rate, some of the pressure would be relieved by a rising exchange rate in the boom and a falling rate in the bust. With a pegged rate, the collapse in the currency would normally restore competitiveness and growth, as happened to the worst-hit Asian countries in the late 1990s. In a currency union, these safety valves are lost. Instead, we have a joint credit and competitiveness crisis. The solution for the loss of competitiveness is a sharp fall in prices. But that worsens the credit crisis: this, then, is debt deflation, as Ireland knows.


That is one respect in which a currency crisis is less bad than a credit crisis. But a sovereign default also shakes confidence in the state, which is the foundation of the legal and political order. A banking crisis is almost as harmful. A currency crisis, on its own, simply is not.


This is the context in which the eurozone crisis must be understood. In the old days of the European Monetary System, there would have been currency crises in peripheral countries, whereupon the Greek, Irish, Portuguese, Spanish, Italian and, maybe, other currencies would have collapsed against the old D-Mark. That has already happened to the pound sterling. If Ireland were still in the sterling area, the punt would have fallen with it.






Now the eurozone must tackle its credit crises, instead. It is not doing well. Despite heroic improvisations, indicators of risk on the sovereign debt of the less credible countries have reached exalted levels. Markets ignored risks in the boom and turned savagely against the weaker credits in the bust.


The underlying dynamic is, again, similar to those of currency crises. In the latter, governments feel forced to offer such high interest rates that they undermine credibility, rather than increase it. In credit crises, markets again impose unbearable rates. A credible country enjoys low interest rates that strengthen trust. A country lacking in such credibility faces interest rates that undermine trust. Expectations are self-fulfilling. This is what is now emerging in peripheral eurozone credit: slow-growing countries with large fiscal deficits cannot promise sufficient tightening, given the high interest rates, to strengthen their credibility. Austerity may fail to deliver the credibility it promises.


So what, against this background, needs to be done by individual countries and the eurozone? Not what was done in Ireland, is one answer. The Irish banking system is worse than too big to fail; it is too big to save. The first duty of the state is to save itself, not to load its taxpayers with obligations to rescue careless lenders. If the eurozone is not a “transfer union”, that has to work both ways: taxpayers of one state should not rescue those of others from having to save their banks from their follies.


The Irish state should have saved itself by drastic restructuring of bank liabilities. Bank debt simply cannot be public debt. If bank debt is to be such debt, bankers should be viewed as civil servants and banks as government departments. Surely, creditors must take the hit, instead.

That leaves the sovereigns. What is needed here, as eurozone leaders recognise, is a combination of generous funding with restructuring: the former is to reverse self-fulfilling panics; the latter is to recognise the realities of insolvency. Managing this combination would be very tricky.

Moreover, however helpful such expedients might be, membership of the currency union has transformed the financial position of members, which are deprived of a tame central bank and currency flexibility. As a result, they are far more likely to be driven to outright default than they used to be, as markets realise. The only ways out would be for the European Central Bank to buy the public debt or a fiscal union, with the capacity to bail out members in difficulty. Both are inconceivable. Germany would surely exit first.


So the big question now is not whether the eurozone can avoid a wave of fiscal cum financial crises. The question is whether the union will survive. The article this week by José-Ignacio Torreblanca of the European Council of Foreign Relations in Madrid, with its complaints about German attitudes, suggests the answer might be: no.


This is a political more than an economic issue. It is possible for a currency union to survive sovereign defaults. The question is, rather, whether members believe the arrangement remains beneficial. The difficulty for surplus countries is that they must finance those in deficit, accept external adjustment or push the eurozone into external surplus. The difficulty for deficit countries is that the cost of leaving the eurozone is to face debt crises. If those have happened already, the costs will seem smaller. If they think they have replaced currency crises with credit crises, which do not even restore competitiveness and growth, they may see the union as a bad deal. Political glue could melt. Such calamities do happen. It is now up to the members to see that they do not.


Copyright The Financial Times Limited 2010.

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miércoles, diciembre 01, 2010

LEAKED CABLES DEPICT A WORLD GUESSING ABOUT NORTH KOREA / THE NEW YORK TIMES ( VERY HIGHLY RECOMMENDED READING )

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November 29, 2010

Leaked Cables Depict a World Guessing About North Korea

By DAVID E. SANGER

WASHINGTON — With North Korea reeling from economic and succession crises, American and South Korean officials early this year secretly began gaming out what would happen if the North, led by one of the world’s most brutal family dynasties, collapsed.


Over an official lunch in late February, a top South Korean diplomat confidently told the American ambassador, Kathleen Stephens, that the fall would come “two to three years” after the death of Kim Jong-il, the country’s ailing leader, Ms. Stephens later cabled Washington. A new, younger generation of Chinese leaders “would be comfortable with a reunited Korea controlled by Seoul and anchored to the United States in a benign alliance,” the diplomat, Chun Yung-woo, predicted.


But if Seoul was destined to control the entire Korean Peninsula for the first time since the end of World War II, China — the powerful ally that keeps the North alive with food and fuel — would have to be placated. So South Korea was already planning to assure Chinese companies that they would have ample commercial opportunities in the mineral-rich northern part of the peninsula.


As for the United States, the cable said, “China would clearly ‘not welcome’ any U.S. military presence north of the DMZ,” the heavily mined demarcation line that now divides the two Koreas.


This trove of cables ends in February, just before North Korea began a series of military actions that has thrown some of Asia’s most prosperous countries into crisis. A month after the lunch, the North is believed to have launched a torpedo attack on the Cheonan, a South Korean warship, that killed 46 sailors.


Three weeks ago it revealed the existence of a uranium enrichment plant, potentially giving it a new pathway to make nuclear bomb material. And last week it shelled a South Korean island, killing two civilians and two marines and injuring many more.


None of that was predicted in the dozens of State Department cables about North Korea obtained by WikiLeaks, and in fact even China, the North’s closest ally, has often been startlingly wrong, the cables show. But the documents help explain why some South Korean and American officials suspect that the military outbursts may be the last snarls of a dying dictatorship.

They also show that talk of the North’s collapse may be rooted more in hope than in any real strategy: similar predictions were made in 1994 when the country’s founder, Kim Il-sung, suddenly died, leaving his son to run the most isolated country in Asia. And a Chinese expert warned, according to an American diplomat, that Washington was deceiving itself once again if it believed that “North Korea would implode after Kim Jong-il’s death.”


The cables about North Korea — some emanating from Seoul, some from Beijing, many based on interviews with government officials, and others with scholars, defectors and other experts — are long on educated guesses and short on facts, illustrating why their subject is known as the Black Hole of Asia. Because they are State Department documents, not intelligence reports, they do not include the most secret American assessments, or the American military’s plans in case North Korea disintegrates or lashes out.


They contain loose talk and confident predictions of the end of the dynasty that has ruled North Korea for 65 years. Those discussions were fueled by a rash of previously undisclosed defections of ranking North Korean diplomats, who secretly sought refuge in the South.


But they were also influenced by a remarkable period of turmoil inside North Korea, including an economic crisis set off by the government’s failed effort to revalue the currency and sketchy intelligence suggesting that the North’s military might not abide the rise of Mr. Kim’s son Kim Jong-un, who was recently made a four-star general despite having no military experience.


The cables reveal that in private, the Chinese, long seen as North Korea’s last protectors against the West, occasionally provide the Obama administration with colorful assessments of the state of play in North Korea. Chinese officials themselves sometimes even laugh about the frustrations of dealing with North Korean paranoia.


When James B. Steinberg, the deputy secretary of state, sat down in September 2009 with one of China’s most powerful officials, Dai Bingguo, state councilor for foreign affairs, Mr. Dai joked that in a recent visit to North Korea he “did not dare” to be too candid with the ailing and mercurial North Korean leader. But the Chinese official reported that although Kim Jong-il had apparently suffered a stroke and had obviously lost weight, he still had a “sharp mind” and retained his reputation among Chinese officials as “quite a good drinker.” (Mr. Kim apparently assured Mr. Dai during a two-hour conversation in Pyongyang, the capital, that his infirmities had not forced him to give up alcohol.)

But reliable intelligence about Mr. Kim’s drinking habits, it turns out, does not extend to his nuclear program, about which even the Chinese seem to be in the dark.

On May 13, 2009, as American satellites showed unusual activity at North Korea’s nuclear test site, officials in Beijing said they were “unsure” that North Korean “threats of another nuclear test were serious.” As it turns out, the North Koreans detonated a test bomb just days later.


Soon after, Chinese officials predicted that negotiations intended to pressure the North to disarm would be “shelved for a few months.” They have never resumed.


The cables also show that almost as soon as the Obama administration came to office, it started raising alarms that the North was buying up components to enrich uranium, opening a second route for it to build nuclear weapons. (Until now, the North’s arsenal has been based on its production of plutonium, but its production capacity has been halted.)


In June 2009, at a lunch in Beijing shortly after the North Korean nuclear test, two senior Chinese Foreign Ministry officials reported that China’s experts believed “the enrichment was only in its initial phases.” In fact, based on what the North Koreans revealed this month, an industrial-scale enrichment plant was already under construction. It was apparently missed by both American and Chinese intelligence services.


The cables make it clear that the South Koreans believe that internal tensions in the North have reached a boiling point. In January of this year, South Korea’s foreign minister, who later resigned, reported to a visiting American official that the South Koreans saw an “increasingly chaotic” situation in the North.


In confidence, he told the American official, Robert R. King, the administration’s special envoy for North Korean human rights issues, that a number of “high-ranking North Korean officials working overseas” had recently defected to the South. Those defections were being kept secret, presumably to give American and South Korean intelligence agencies time to harvest the defectors’ knowledge.


But the cables also reveal that the South Koreans see their strategic interests in direct conflict with China’s, creating potentially huge diplomatic tensions over the future of the Korean Peninsula.


The South Koreans complain bitterly that China is content with the status quo of a nuclear North Korea, because they fear that a collapse would unleash a flood of North Korean refugees over the Chinese border and lead to the loss of a “buffer zone” between China and the American forces in South Korea.


At one point, Ambassador Stephens reported to Washington, a senior South Korean official told her that “unless China pushed North Korea to the ‘brink of collapse,’ ” the North would refuse to take meaningful steps to give up its nuclear program.


Mr. Chun, now the South Korean national security adviser, complained to Ambassador Stephens during their lunch that China had little commitment to the multination talks intended to force North Korea to dismantle its nuclear arsenal. The Chinese, he said, had chosen Wu Dawei to represent Beijing at the talks. According to the cable, Mr. Chun called Mr. Wu the country’s “ ‘most incompetent official,’ an arrogant, Marx-spouting former Red Guard who ‘knows nothing about North Korea, nothing about non-proliferation.’ ”


But the cables show that when it comes to the critical issue of succession, even the Chinese know little of the man who would be North Korea’s next ruler: Kim Jong-un.


As recently as February 2009, the American Consulate in Shanghai — a significant collection point for intelligence about North Korea — sent cables reporting that the Chinese who knew North Korea best disbelieved the rumors that Kim Jong-un was being groomed to run the country. Several Chinese scholars with good contacts in the North said they thought it was likely that “a group of high-level military officials” would take over, and that “at least for the moment none of KJI’s three sons is likely to be tapped to succeed him.” The oldest son was dismissed as “too much of a playboy,” the middle son as “more interested in video games” than governing. Kim Jong-un, they said, was too young and inexperienced.


But within months, a senior Chinese diplomat, Wu Jianghao, was telling his American counterparts that Kim Jong-il was using nuclear tests and missile launchings as part of an effort to put his third son in place to succeed him, despite his youth.


“Wu opined that the rapid pace of provocative actions in North Korea was due to Kim Jong-il’s declining health and might be part of a gambit under which Kim Jong-il would escalate tensions with the United States so that his successor, presumably Kim Jong-un, could then step in and ease those tensions,” the embassy reported back to Washington in June 2009.


But carrying out plans for an easy ascension may be more difficult than expected, some are quoted as saying. In February of this year the American Consulate in Shenyang reported rumors that Kim Jong-un “had a hand” in the decision to revalue the North’s currency, which wiped out the scarce savings of most North Koreans and created such an outcry that one official was executed for his role in the sudden financial shift. The cables also describe secondhand reports of palace intrigue in the North, with other members of the Kim family preparing to serve as regents to Kim Jong-un — or to unseat him after Kim Jong-il’s death.


Andrew W. Lehren contributed reporting from New York.

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miércoles, diciembre 01, 2010

IRELAND RESCUE IS NOT A GAME CHANGER / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

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Ireland rescue is not a game changer

By Mohamed El-Erian


Published: November 29 2010 11:26

Europe tried to strike a delicate balance this weekend. It granted emergency loans to boost liquidity, an approach that has visibly lost traction in containing the dislocations in the continent’s periphery. But it also moved towards a more durable approach to tackles solvency problems, although one that involves greater risk of collateral damage.


The new liquidity package does little to deal with Ireland’s debt overhang, or to reduce the embedded cost of its debt.
Instead it aims to introduce stability into market conditions, which in turn should allow the Irish government to implement its recently announced austerity package.


Ireland will get €67.5bn to recapitalise its banks, and fund the state’s balance sheet. The financing carries an average interest charge of 5.8% - not cheap but considerably better than market terms.


The package, therefore, is not a “game changer”. It will reduce the risk of contagion to other peripheral countries, until a regional resolution framework is put in place. But it will not significantly improve Ireland’s medium-term growth and employment prospects.


That this package delays rather than solves the European Union’s problems is not lost on Ireland’s European neighbours. They know that time is being bought to formulate a sovereign debt reduction mechanism, to be made operational in 2013.


Such a mechanism would expand the range of alternatives to deal with future debt crises, while also providing for politically more acceptable burden sharing. But a number of conditions must be met even if this weekend’s package is to work.


Ireland itself must be able to implement its new, ambitious adjustment program – and do so with taxpayers carrying a considerable burden, while no haircut is being imposed on creditors.


Ireland’s creditors and depositors must also quickly signal their reassurance at the new package, and also their confidence that Europe’s timeline for imposing any loses on creditors will not be accelerated.


Finally the same (repeatedly challenged) liquidity approach from the EU and the International Monetary Fund must stop contagion to other peripheral European countries.


It took time for Europe to recognise the severity of the peripheral debt crisis. Now it is also recognizing that liquidity support (while necessary) may not be enough. Instead Europe is embarking on a gradual transition to a medium-term mix of liquidity and solvency solutions.


Understandably, Europe wants this transition to be orderly, and relatively long. But it is walking a difficult line. Any slippage on this most recent deal will quickly see European officials facing a transition that is quicker and less orderly than they would like.


The writer is chief executive and co-chief investment officer of PIMCO


Copyright The Financial Times Limited 2010

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