America at Stall Speed?

Mohamed A. El-Erian


NEWPORT BEACH – Judging from the skittishness of both markets and “consensus expectations,” the United States’ economic prospects are confusing. One day, the country is on the brink of a double-dip recession; the next, it is on the verge of a turbo-charged recovery, powered by resilient consumers and US multinationals starting to deploy, at long last, their massive cash reserves. In the process, markets take investors on a wild rollercoaster ride, with the European crisis (riddled with even more confusion and volatility) serving to aggravate their queasiness.

This situation is both understandable and increasingly unsettling for America’s well-being and that of the global economy. It reflects the impact of fundamental (and historic) economic and financial re-alignments, insufficient policy responses, and system-wide rigidities that frustrate structural change. As a result, there are now legitimate questions about the underlying functioning of the US economy and, therefore, its evolution in the months and years ahead.

One way to understand current conditions – and what is needed to improve them – is to consider two events that recently attracted considerable worldwide attention: the launch of Boeing’s Dreamliner passenger jet and the tragic death of Apple’s Steve Jobs.

Let us start with some simple aeronautic dynamics, using an analogy that my PIMCO colleague, Bill Gross, came up with to describe the economic risks facing the American economy. For the Dreamliner to take off, ascend, and maintain a steady altitude, it must do more than move forward. It has to move forward fast enough to exceed critical physical thresholds, which are significantly higher than those for most of Boeing’s other (smaller) planes.

Failure would mean succumbing to a mid-air stall, with tepid forward motion giving way to a sudden loss of altitude. Unless we are convinced of the Dreamliner’s ability to avoid stall speed, it makes no sense to talk about all the ways in which it will enhance the travel experience for millions of people around the world.

America’s economy today risks stall speed. Specifically, the question is not whether it can grow, but whether it can grow fast enough to propel a large economy that, according to the US Federal Reserve, faces balance-sheet deleveraging, credit constraints, and household and business uncertainty about the economic outlook.” And, remember, it is just over a year since certain US officials were proclaiming the economy’s summer of recovery” – a view underpinned by the erroneous belief that America was reachingescape velocity.”

Stall speed is a terrifying risk for an economy like that of the US, which desperately needs to grow robustly. Without rapid growth, there is no way to reverse persistently high and increasingly structural (and therefore protracted) unemployment; safely de-leverage over-indebted balance sheets; and prevent already-disturbing income and wealth inequalities from growing worse.

The private sector alone cannot and will not counter the risk of stall speed. What is desperately needed is better policymaking. Specifically, policymakers must be open and willing to understand the unusual challenges facing the US economy, react accordingly, and possess sufficiently potent policy instruments.

Unfortunately, this has been far from the case in America (and in Europe, where the situation is worse). Moreover, US policymakers in the last few weeks have been more interested in pointing fingers at Europe and China than in recognizing and responding to the paradigm shifts that are at the root of the country’s economic problems and mounting social challenges.

This is where the insights of Steve Jobs, one of the world’s best innovators and entrepreneurs, come in. Jobs did more than navigate paradigm shifts; he essentially created them. He was a master at converting the complicated into the simple; and, rather than being paralyzed by complexity, he found new ways to deconstruct and overcome it. Teamwork was an obligation, not a choice. And he eschewed the search for the single big bang” in favor of aiming for multiple breakthroughs.

Underlying it all was a willingness to evolve – a drive for perfection through experimentation. Moreover, he excelled at selling to audiences worldwide both his vision and his strategy for realizing it.

So far, America’s economic policymakers have fallen short on all of these fronts. Rather than committing to a comprehensive set of urgently-needed reinforcing measures, they seem obsessed with the futile search for the one “killer app” that will solve all of the country's economic problems. No surprise that they have yet to find it.

Teamwork has repeatedly fallen hostage to turf wars and political bickering. Little has been done to deconstruct structural complexity, let alone win sufficient public support for a medium-term vision, a credible implementation strategy, and a set of measures that is adequate to the task at hand.

The longer the policymaking impasse persists, the greater the stall-speed risk for an economy that already has an unemployment crisis, a large budget deficit, many underwater mortgages, and policy interest rates floored at zero. This is an atmosphere in which unhealthy balance sheets come under even greater pressure, and healthy investors refuse to engage. In the process, the risk of recession remains uncomfortably high, the unemployment crisis deepens, and inequities rise as already-stretched social safety nets prove even more porous.

Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and author of When Markets Collide.

Project Syndicate, 2011.

October 23, 2011 10:09 pm

Taxing the wealthy: Differences at the margins

More governments are raising taxes for the rich
Wealth of reform: Occupy Wall Street protesters call on America's richest 1 per cent to bear a greater share of the fiscal burden

Peter Norvig, Google’s director of research, made his fortune in Silicon Valley during one of the greatest eras of wealth creation the world has seen. The sheer thrill of building businesses made him sceptical about the oft-cited link between lower taxes and entrepreneurialism. “The rhetoric didn’t ring true,” he says. “I know a lot of millionaires and a dozen billionaires. They never said that marginal tax rates were too high.”

Such doubts about increasingly prevalent American anti-tax rhetoric are one reason he has decided to speak up in favour of greater taxation. He is one of about 200 members of Patriotic Millionaires for Fiscal Strength, a group formed last year to lobby for the expiry of cuts, introduced in 2001 by President George W. Bush, for people earning more than $1m a year.
The sight of wealthy citizens calling on government to raise their taxes has been met with both bemusement and cynicism. However, to proponents of more progressive taxation – the higher the income, the higher the rate – it is evidence of what some analysts consider a turning point in a long-running trend. After 25 years in which top rates have fallen, defining an era of market-driven economic policy, a growing number of countries are now moving to push them up. From London to Luxembourg, Milan to Madrid, the rich – particularly those in western European countries beset by soaring public debt – are braced to pay more.
But it is not yet clear whether the latest rises are anything more than a blip. For the moment their significance is mainly symbolic. In its latest assessment of taxation trends, the European Commission says that, while increases in top personal rates represent “an important political signal”, their revenue-raising effects are limited.
Still, for many of those involved in Occupy Wall Street and similar protest movements around the world, a move towards higher taxes on the wealthy is a necessary response to an era of growing inequality, which by many measures is now greater than at any time since the 1920s. Their claims have resonated with some commentators. “This is the beginning of change long overdue,” says Jeffrey Sachs, the Columbia University economist, who used a recent visit to the Wall Street protesters to call on America’s richest 1 per cent to pay their dues.
For western governments, political debate is dominated by talk of widening income gaps, unpopular austerity measures and the plight of the “squeezed middlebuffeted by high inflation and stagnant incomes. Asking the rich to do more is, many observers think, a reasonable response. Even some of those potentially on the receiving end agree. Maurice Lévy, chairman and chief executive of the French advertising company Publicis, wrote in the Financial Times in August that it was “only fair that the most privileged members of our society should take up a heavier share of this national burden”.
“To judge by the rhetoric, we are moving into the age of fairness,” says Catherine Tillotson of Scorpio Partnership, a UK-based wealth management consultancy that advises banks and fund managers as well as individuals. But, pointing to the large share of income tax paid by a small minority of taxpayers, she adds: “Fairness is a two-way thing. We hear a lot from politicians about this but how do the people paying the tax get their voices heard?”

In the US, that does not appear to be much of a problem. A fightback is already under way on behalf of rich but reluctant taxpayers. When Barack Obama, president, last month proposed a “Buffett rule” – under which no household making more than $1m annually would pay a smaller share of its income in taxes than middle-class families pay – he was branded a class warrior.
Named after Warren Buffett, the veteran investor who has repeatedly drawn attention to this perceived inequity, this proposal would affect a quarter of US millionaires, congressional researchers said earlier this month. Mr Obama’s move is widely seen as an attempt to define battle lines ahead of next year’s presidential election, in which tax reform is set to be a dominant issue for Republicans and Democrats alike.

But many of the highest earners reject the idea they are undertaxed. Harvey Golub, a former chairman and chief executive of American Express, lambasted “the unfair way taxes are collected”. He noted in an article in The Wall Street Journal that almost half of all filers paid no income taxes at all, and that the “the extraordinarily complex tax code is replete with favours to various interest groups and industries”. He also aired another commonly voiced objection, namely that government spending is inefficient and ineffective.

Beyond the charged rhetoric, there is a growing body of economic data that raises questions about the efficacy of raising rates. Sceptics point to empirical research suggesting that higher income taxes are bad for growth. A growth-oriented tax reform would shift part of the tax burden from income to consumption and residential property, according to the Paris-based Organisation for Economic Co-operation and Development. Jeffrey Owens, the OECD’s most senior tax official, says: “Just pushing up rates affects incentives to save, work and take risks.”

Proponents of lower tax rates for the rich often point to the experience of the past 30 years when countries across the worldled by the US and Britaincut top tax rates. In the UK, for example, top marginal rates for the highest sliver of income were cut from 83 per cent in 1979 to 40 per cent in 1988. The cuts have been associated with a huge rise in the share of income tax paid by the rich. For example, the top 1 per cent of US taxpayers paid 40 per cent of income tax in 2007, up from 28 per cent in 1988.
However, the causes of this dramatic rise in the tax take remain unclear and have become fertile ground for heated arguments among economists. Early research suggested it could be ascribed to the tax cuts inspiring people to work harder and put less effort into avoiding tax. But some economists argue that the cuts gave windfalls to those whose incomes were already rising sharply because of factors such as disproportionate pay rises for top earners.

Evidence about how people respond to tax changes is relatively sparse. In Britain, 20 high-profile economists recently warned that the 50p rate for incomes more than £150,000 (introduced last year by the previous Labour government) was unhelpful in terms of attracting business people and entrepreneurs, but they could point to few examples to make their case. Nonetheless, many governments are convinced of the need to compete to attract and retain highly skilled workers. (US citizens, however, are taxed on a worldwide basis, making them less susceptible to incentives.) Fifteen industrialised countries – almost half of the OECD’s members – have introduced targeted concessions for high-skilled workers, according to a newly published OECD report.
Governments need to ensure that their tax systems compete on a global stage, according to KPMG. The average top rate in western Europe of 45 per cent was increasingly being compared with Asia’s 23 per cent, it said. KPMG argued that “truly globally mobile international executives move around the world and tend not to stay in the one region. They are not weighing up London against Dublin or Geneva but looking at Hong Kong, Singapore, Dubai, all around the globe.”

Competitive pressures will ensure that top rates stabilise or even fall, according to the OECD’s Mr Owens. Instead of pushing them up, he says, governments should focus on collecting the tax they are due. Concentrating on better compliance will help make the system fairer because, for example, it is usually the wealthy who hide money offshore.
Piling on certain types of taxthose that address inequality but do not damage growth – could also play a part in convincing the public that the tax system is fair. Property taxes and inheritance taxes are the most suitable. For example, says Mr Owens, “Japan is the least unequal industrialised economy because it has an effective inheritance tax.”
This idea is unlikely to go down well with rich individuals, according to Stephanie Jarrett, head of Baker & McKenzie’s Wealth Management Practice Group in Geneva. “In my experience, high net worth individuals don’t like paying capital taxes, such as inheritance taxes and wealth taxes,” she says. “Their feeling is: ‘You have made your money, you have already been taxed and you are being taxed again and again.’”
But they are unlikely to be the hardest hit, she says. “The more seriously wealthy are not going to be so affected. It is those in the middle, moderately wealthy and less flexible, who are going to be hardest hit because they have a greater percentage of their wealth tied up in property.”
The widespread perception that sophisticated taxpayers can use myriad concessions and exemptions to minimise their bills has coloured every aspect of the debate about taxing the rich. There are mutterings among the peers of the wealthy folk speaking out in favour of higher taxes that some of their portfolios are structured in a way that would be immune to rate rises. “There is a feeling that publicity-seeking millionaires here and there are riding on the coat-tails of Warren Buffett, some of whom know that it’s cheap talk for them since they are protected againstregulartax at home – and so anyone who speaks out is now regarded with a high degree of cynicism,” says one critic.
But in the US, the Patriotic Millionaires for Fiscal Strength brush off accusations of bad faith. Increasing taxes on the richest 1 per cent would make a “significant contribution to deficit reduction”, they say.
For Mr Norvig, the desire to pay more tax is an acknowledgement that his own achievements were built on the back of government investment in education, infrastructure and the internet. In his view, the continued deferral of investment could jeopardise the chances of the next generation. “I see a lot of things in our country and our state that need fixing,” he says.

GLOBAL REGIMES: The world’s rich escape a Rockefeller-style soaking

In recent weeks, plans for new levies for the highest earners have come thick and fast. France has announced a temporary 4 per cent surtax (levied in addition to other taxes) on incomes of more than €500,000 ($692,000); and Japan plans a similar measure to help tackle damage wreaked by the March tsunami. President Barack Obama has proposed a rule ensuring no US household making more than $1m pays a lower average rate than “middle-classfamilies. Italy has debated a “wealth tax”; Spain plans to reintroduce its own, just three years after it was dropped.

Even Switzerland, known as a refuge for the wealthy, is joining in. Last month Schaffhausen voted to become only the second canton – after Zurich in 2009 – to scrap lump-sum levies offered to foreign residents.

The flurry follows an average rise of 0.4 per cent in the top rate of income tax in 2010, when about one in three countries changed their rates, according to KPMG, a professional services firm. Among the sharpest was a 10 percentage point increase in the UK, where rates rose to 50 per cent on earnings of more than £150,000 a year.

But this year there have been cuts, too. Indeed, a KPMG global survey published in September showed the average top income tax rate has fallen by 0.3 per cent. Notably, Hungary slashed its top rate from 40 to 16 per cent, adopting a flat rate to try to revive the economy and curb evasion.

Top rates still look modest compared with previous eras. Following the second world war, Americans faced a rate of more than 90 per cent on income more than $200,000. The UK’s 95 per cent rate inspired the Beatles to sing: “Should 5 per cent appear too small, be thankful I don’t take it all.” In 1967, a UK investment surcharge created a top rate of more than 136 per cent. Yet these rates were accompanied by loopholes that undermined the fairness and efficiency of the system.

The trend for creating new brackets for top-rate taxpayers also pales by comparison with the past. In the 1930s, the US had more than 50 brackets, with a diminishing number of occupants towards the top of the income scale. One bracket established in 1935nicknamed the “soak the richact by opponentsapplied to income of more than $5m. It had just one taxpayer: John D. Rockefeller Jr.
Copyright The Financial Times Limited 2011.

10/24/2011 12:00 AM

Bonjour Tristesse

France Stares into the Euro-Crisis Chasm

By Stefan Simons and Isabell Hülsen

Falling productivity, a stagnating economy and growing debt: France's economic health leaves plenty of room for improvement. Markets have begun to notice and the country threatens to become mired in the ongoing European debt crisis.

When it comes to French economic competitiveness, Guy Maugis has a front row seat. The 58-year-old is president of the German-French Chamber of Commerce and head of Bosch France. Some 8,400 people work in the French subsidiary of the German electronics giant and Bosch France long enjoyed a cost advantage over its parent company. "But we've completely lost it in the last 10 years," says Maugis.

Maugis' observations are reflected in the data as well: The French economy is losing its competitive edge. Productivity has declined dramatically and the balance of trade is chronically negative.

And now the country is also being sucked into the euro crisis. Last week, the ratings agency Moody's threatened that France's top AAA rating could be in jeopardy unless the government makes an effort to get its finances under control in the next three months. The country's national debt of €1.7 trillion ($2.3 trillion) is equal to 84.7 percent of economic output, the highest debt-to-GDP ratio of all euro member states with triple-A ratings. The weak growth of the French economy is already insufficient to reduce the country's budget deficit to below 3 percent -- as called for by EU rules -- by 2013 as planned.

The country's banks are also in trouble. All three major ratings agencies -- Moody's, Fitch and Standard & Poor's -- downgraded several top French banks not long ago, including Société Générale and Crédit Agricole. Furthermore, even as President Nicolas Sarkozy and his cabinet ministers tried to allay the public's fears, the Belgian-French bank Dexia was on the verge of bankruptcy. Since then, hardly a day has gone by without renewed speculation over the troubles facing the country's large financial institutions.

Woefully Inadequate Austerity

French banks are invested far more heavily in Greek and Italian government bonds than their European competitors. In late March they owned €53 billion in Greek debt, making them Greece's largest creditor. There are serious concerns that a new bank crisis would stifle already weak French growth and drive up government debt even further. Indeed, Sarkozy would like to see the euro backstop fund, the European Financial Stability Facility (EFSF), take the lead in recapitalizing French banks rather than the government in Paris.

His greatest concern is France's top rating. Should that be lost, it would mark the point when the euro crisis will have finally eaten its way into the core of Europe. The funding of the EFSF, and with it the fate of the monetary union, would also be in the balance.

But Sarkozy's room for maneuver is shrinking as next spring's election approaches. In light of the precarious financial situation, the austerity package currently in the works seems woefully inadequate. The plan calls for little in the way of government spending cuts, while taxes on alcohol, soft drinks and supplementary health insurance are increasing.

"France has a chronic fiscal problem, no matter what the rating agencies are saying at the moment. That's why there can be no progress without real reform," says Stéphane Boujnah, the head of Santander Bank in France and the co-founder of a think tank called "En Temps Réel" (In Real Time). "French politics has gotten used to incurring debt. Austerity is virgin intellectual territory for politicians. It's sort of like expecting geese to look forward to Christmas."

Indeed, France has lived beyond its means for 37 years. The last balanced budget was in 1974. "Toujours plus" ("Always More"), a 1982 book by François de Closets, is being quoted a lot these days. "We are indeed the country of more and more," says Maurice Lévy, head of the Publicis advertising agency and one of the signatories to an open letter to the president calling for higher taxes on wealthy people like him. "France has borrowed money to pay for things, without considering that we'll have to pay the bill one day."

A Pyromaniac for the Fire Department

For decades, all French presidents have employed the same basic recipe: upping expenditures while lowering taxes. As a result, the number of tax loopholes has grown to a respectable total of at least 500 today. They includes such bizarre provisions as tax relief for truffle hunters, and a discount on the capital gains tax applicable to the sale of show horses or real estate in French overseas territories.

Hardly anyone has expanded the list more energetically than Sarkozy. A reduction in the value-added tax for bars and restaurants alone costs the state €2 billion a year. Many restaurants post a sign on their front door that reads: "VAT is going down, and so are prices." But consumers have hardly noticed the cut. And despite the debt crisis, the campaign gift to bar and restaurant owners is not up for discussion.

In August, the Socialist opposition leader, former Finance Minister Laurent Fabius, fumed that having Sarkozy as France's top austerity commissioner is like a "pyromaniac suddenly becoming head of the fire department."

As necessary as a rigorous austerity program would be, "if the government does not quickly address serious reforms, France will lose even more market share," says Michel Didier, president of Coe-Rexecode, an economic research institute with close ties to the employer lobby. He wants to see the government help the country's export industry get back on its feet. The problem with the French economy is that it lacks the backbone of mid-sized companies that are partly responsible for strong exports in Germany. And nothing much has come of politicians' campaign promises to make France the country of entrepreneurs once again.

Robert Lohr is all too familiar with the problem. His family-owned business, Lohr Industrie, headquartered in the Alsatian village of Hangenbieten, employs about 2,000 people and is the world market leader in the production of car transporters. From his office window, Lohr has a view of a large, idyllic park.

Not Enough Work

And yet sometimes Lohr wishes he could relocate the company. In fact, only 20 kilometers (13 miles) would already be enough to make his life easier. "In Germany, politicians listen to industry, because they are dependent on mid-sized companies. But in France the government is only interested in the biggest companies," says Lohr, whose company is one of the country's important but not well-known businesses. The country's biggest industrial firms include companies like electronics manufacturer Alstom, which produces the TGV high-speed train and its successor, the AGV, as well as defense giant Thales.

Particularly the introduction of the 35-hour workweek, a centerpiece of French economic policy, cost Lohr a lot of money. "It was a catastrophe," says the entrepreneur. Wages went up and productivity suffered. "It wasn't a problem as long as there was enough work. But now we don't have enough work."

Lohr is also up against high social security costs. French employers pay up to 49 percent of gross wages in taxes, compared with only 28 percent paid by their German competitors. On the whole, labor costs increased by 39 percent between 2000 and 2010. In Germany, by comparison, labor costs went up by only 19 percent in the same period.

What is driving up costs, most of all, is the army of employees in the public sector. About one in five workers in France draws a salary from the government. Private companies, says Bosch France chief Maugis, must bear the burden for the state's ever-climbing expenditures.

The French have recently begun looking with envy to the "modèle allemand," or German model. The papers are full of tables and charts, all showing Germany at the head of the pack.

Crisis for Everyone

The French are suddenly treating the labor market reforms of Germany's package of reforms known as Agenda 2010 as their blueprint. But they are also impressed by the social partnership that exists in Germany between employees and employers, and not just on the labor side of the equation. "The strong cooperation between labor unions and business helped companies to remain flexible during the crisis," says employer lobbyist Didier.

This admiration for the German approach is new. Only last year, Berlin had to listen to then French Finance Minister and current International Monetary Fund head Christine Lagarde tell them that German frugality was detrimental to consumption in neighboring countries. In the country of savoir-vivre, it was felt that German discipline was somehow small-minded. But now, according to a survey in the magazine Le Parisien, the French have more confidence in German Chancellor Angela Merkel than they do in President Sarkozy.

"Europe is a constant beauty pageant, and Germany has just won," says Jean-Paul Fitoussi, an economist at the OFCE economic institute and an advisor to the prime minister. But he also warns: "If we try to improve our competitiveness by taking the same approach as Germany, it will be at the expense of other countries in Europe." There is only one way out of the crisis for everyone, says Fitoussi: more Europe.
Translated from the German by Christopher Sultan