February 14, 2012 6:56 pm

How to crank up America’s economic dynamo

President Barack Obama said in his State of the Union that the US needs an economybuilt to last”. Unfortunately, in his populist rhetoric, Mr Obama missed an opportunity to tee up the conversation the US must have during this election season: How do we restart dynamism in our economy, delivering productivity growth and raising living standards?

The narrative that answers this question has three parts: innovation, investment and inclusion.


Innovation is the ultimate driver of living standards and future jobs. It comes in two forms. First, “non-destructive creation” – the development of entirely new products and business models.


Policies that support this include strong federal backing for basic research and financial sector regulation that considers incentives to lend as well as financial stability. Instead, the Dodd-Frank Act will limit the flow of credit to all but the largest and safest borrowers.

Creative destruction”, the other form of innovation, is also vital. It is important to recognise that net job creation is the difference between job creation and job destruction. In dynamic economies, both creation and destruction are high. In the 20 years before the financial crisis, annual job creation was 17 per cent of employment and annual job destruction was 15 per cent, according to John Haltiwanger of the University of Maryland.

In order to foster creative destruction we need to make it easier to replace failing management and to reallocate labour and capital. Message to Newt Gingrich: job destruction is an important part of economic dynamism. And, yes, private equity firms accelerate that process. Furthermore, low capital gains tax rates make it cheaper to sell assets, thereby helping capital flow more smoothly to its most productive use for the economy.

Investment is the second driver of dynamism. Policies should ensure that both domestic and foreign capital go to productive use. This requires reducing generous subsidies to housing through Fannie Mae and Freddie Mac. We also need tax reform that better allocates resources for investment: reducing marginal tax rates on corporate and individual incomes, broadening the tax base, and cutting back on double taxation of corporate equity returns, which are taxed once at the corporate level and again at the investor level via taxes on dividends and capital gains.

Ways to achieve this include a progressive consumption tax, equalising the tax treatment of debt and equity, and drastically lowering tax rates on dividends and capital gains. All of these ideas have been around in Washington for some time.

We must restrain spending to avoid a high-tax future and to encourage businesses to invest. Mr Obama’s proposal for a so-calledBuffett rule” is less about a minimum tax for high earners than a call for double taxation of returns to investment and risk-taking.

Finally, it is vital that economic policy emphasises broad inclusion in the gains from growth. We should support Americans caught in the change that is a byproduct of our dynamism. Replacing outmoded federal training assistance with personal re-employment accounts should be combined with tax subsidies and education reforms that increase the affordability of community college, technical training and university. Tax and insurance market reforms in healthcare can reduce cost growth and increase take-home pay.

In contrast, Mr Obama has centred his discussion of inclusion on the protection of incumbent firms, as in the General Motors bail-out, misguided financial regulation, and regulation to protect organised labour. This does not promote dynamism, since it speeds up the substitution of technology for jobs.

We have arrived at a fork in the road: growth and recovery or protection and decline. Mr Obama did not even pose the interesting question: How do we achieve an economy built to adapt and grow? Worse, his proposed policies are less consistent with an economybuilt to last” than one last built”.

The writer is dean of Columbia Business School, former chairman of the Council of Economic Advisers, and adviser to presidential candidate Mitt Romney. He writes in a personal capacity

Copyright The Financial Times Limited 2012.

From Argentina to Athens?

Mohamed A. El-Erian


NEWPORT BEACH – Let me set the scene: an increasingly discredited economic policy approach gives rise to growing domestic social and political opposition, street protests and violence, disagreements among official creditors, and mounting concerns among private creditors about a disorderly default. In the midst of all of this, national leaders commit to more of the same harsh austerity measures that they have been unable to implement for two years. Official creditors express skepticism, in private and public, but hold their collective nose and get ready to disburse yet another tranche of money into what they fear is a bottomless pit.

Sound familiar? It should, but not just because it encapsulates Greece today. It is also what Argentina faced in 2001. Unless Europe reflects on key lessons from that experience, the parallels that extend to Greece may also end up including a financial meltdown, a deep output collapse, and social and political turmoil.

I remember 2001 well. I was serving on PIMCO’s Emerging Market desk, where we were closely following developments in Argentina. In August of that year, the country was again begging the International Monetary Fund for more money in order to avoid a default. The authorities were willing to enter into yet another set of commitments knowing that they had consistently over-promised and under-delivered, and that the country had failed to make any progress on restoring growth, halting its competitiveness decline, and containing the rise in debt.

A blame game broke out over who was responsible for “losingArgentina. Official creditors, led by the IMF, pointed to the Argentine government’s repeated policy failures. The government countered that official creditors were nickel-and-diming the country, rather than providing the financial cushion needed to restore confidence and re-engage private capital. Neither side seemed willing to acknowledge what was obvious to many: the country’s economic and financial framework gave it little chance of addressing the dual problem of too little growth and too much debt.

Not surprisingly, Argentine citizens were becoming increasingly fed up with the whole lot, caring little about distinctions between the government and official creditors. They had lost trust in an approach that continued to sell austerity as the price of stability, even as virtually every economic and financial indicator had worsened in the meantime, with scant hope of a brighter future.

Then there were Argentina’s neighbors – particularly fellow members of Mercosur, the regional political and economic agreement – which feared a tidal wave of contagion. Having experienced technical dislocations in their financial markets, they were urging Argentina to get its act together – while also building stronger defenses in case it did not. Meanwhile, Argentina complained that other Mercosur countries’ policies were magnifying its economic challenges.

To understand much of what is happening today in Europe, one need only replace Argentina with Greece, and Mercosur with the eurozone. Of course, Greece is a more advanced economy than Argentina. It is part of a far stronger regional arrangement than Mercosur, with vastly greater financial resources and better-developed economic and institutional underpinnings. Yet the similarities are strong enough to ask whether Europe can learn from Argentina’s experience a decade ago.

After the Argentine parliament approved yet another new austerity package, the IMF agreed to release its financing tranche. But it was too late to save a discredited approach, further undermining the Fund’s standing.

Indeed, rather than engendering confidence, Argentine citizens withdrew their bank deposits over the next few months. Capital flight accelerated. The government again failed to deliver on its policy commitments. Most important of all, social and political pressures mounted, reaching a tipping point.

Argentina defaulted in December 2001, closed its banks, and experienced the mother of alleconomic sudden stops.” The country was forced to dismantle its economic framework in a highly disorganized manner, staging a messy, unplanned transition to a new currency in the midst of capital controls and domestic-asset confiscation.

Greece’s future will resemble that of Argentina if its government and official creditors (namely, the European Central Bank, the European Union, and the IMF) fail to internalize some of Argentina’s lessons and do not undertake an urgent mid-course correction.

Specifically, they should take four steps. First, they should stop repeating the claim that there is noPlan B.” Telling people that there is no alternative to a discredited policy merely pushes them either to resist an approach that does not work, or to opt for mayhem. Recent official remarks heard in Greece (“We must show that Greeks, when they are called on to choose between the bad and the worst, choose the bad to avoid the worst”) do little to engender hope.

Second, Greece and its foreign interlocutors must recognize that Plan B, while not easy, has become critically necessary. It entails much deeper economic and debt restructuring, as well as institutional changes so that Greece can gain greater policy flexibility, improve competitiveness, and promote investment. All of this inevitably involves short-term risks, but it also promises brighter prospects for growth, employment, and the restoration of financial soundness.

Third, Greece’s official creditors should be more attentive to the expected return on their assistance. Every euro disbursed to Greece under the current approach is diluted in many ways.

Rather than a general approach implying multipleleakages,” official creditors would do better to target the country’s key needs more directly. Moreover, given Europe’s worries about its banking system, interventions should be coupled with greater pressure on banks to raise capital and improve asset quality.

Finally, the integrity and credibility of the ECB and IMF require much greater protection. Europe’s opportunism undermines the future effectiveness of these two key institutions at a time when they will be needed not only to stabilize Greece, but also to prevent liquidity problems from turning into solvency crises in other European countries and elsewhere, as well as to limit global contagion.

Greece need not continue to follow Argentina’s miserable example of ten years ago. Yet, unless Greek and European officials reflect on that example and adapt accordingly, Greece will be driven down the same dangerous dead-end path.

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

February 14, 2012 7:18 pm

Much too much ado about Greece

Ingram Pinn Comment Page illustration pfeatures

Why does Greece– a country with little more than 2 per cent of the eurozone’s gross domestic product – cause such headaches? On a daily basis, people living as far apart as Beijing and Washington read stories of promises not kept and conditions not met. Would it not be better, they must wonder, to let Greece default and exit from the eurozone, rather than persist in paying such attention to its largely self-inflicted plight?

That Greece might indeed exit is now far from unthinkable. In a co-authored note published last week, Willem Buiter, chief economist of Citi and a devoted adherent of the euro project, judges that the likelihood of a Greek exit over the next 18 months is now as high as 50 per cent. “This is,” the authors add, “mostly because we consider the willingness of [eurozone] creditors to continue providing further support to Greece, despite Greek non-compliance with programme conditionality, to have fallen substantially.” But they also believe that the costs to the rest of the eurozone of a Greek exit are lower than before. The likelihood that this would be allowed to happen has, they suggest, risen correspondingly.

Let us consider the questions any sensible person should ask about the fraught negotiations with Greece.

First, can Greece agree with creditors over debt restructuring or “private sector involvement”, with the “troika” – the European Commission, the International Monetary Fund and the European Central Bank – over the latter’s participation, and with official creditors over a second bail-out? Can all this also happen prior to the next bond redemption, on March 20?

The likelihood is: yes. If so, a disorderly default would at least be postponed. One can identify three reasons for this outcome: despite popular rage, Greek politicians overwhelmingly agree on the desirability of staying inside the eurozone; despite by now pervasive mistrust, the eurozone’s powers that be fear a disorderly default and probable exit; and, finally, the IMF believes that a programme founded on strong structural reforms rather than massive further fiscal contraction or headlong privatisation could work, at least in theory.

Second, is it likely that such a programme would work at all well? The answer is no, as the Citi paper notes. “This is, first, because any restructuring agreed ... is most unlikely to bring the Greek sovereign to a 120 per cent of GDP gross general government debt stock by 2020 – a declared objective of the second Greek bail-out package – and, second, because even if, by some miracle, Greece were to achieve 120 per cent of GDP general government debt by 2020, this would be far too heavy a ... burden for the Greek sovereign to carry.” It is near certain then that more debt reduction would be needed in the years ahead, even if everything went perfectly. It will not.

Greece has made progress since the crisis broke, albeit largely as a result of austerity. Its primary fiscal deficit (before interest payments) has shrunk from 10.6 per cent of GDP in 2009 to an estimate of just 2.4 per cent in 2011. This is a big fall, given the scale of the recession. The Greek government is now close to the point at which it needs to borrow only to roll over debts and cover its debt service.

But this is not enough. Greece also still needs substantial inflows of foreign exchange, to cover its current account deficits, even if one ignores the external interest on its government debt. In 2011, for example, its current account deficit, before the interest on the debt owed by the government, was still as much as 4.6 per cent of GDP, despite the deep slump.

Would the structural reforms envisaged generate a sufficiently dynamic economy and, above all, the improvements in net exports needed to finance the imports demanded at anything close to full employment? The answer, despite improvements in competitiveness, is: not quickly, even if it can be done at all.

Third, is such a programme in Greece’s own interest? The Greek policymaking elite believes it is. The alternative – a disorderly default and probable exit from the eurozone – would be a step into the unknown. The country would have to introduce and then operate at least temporary exchange controls. It would have to manage a complex restructuring of its public and private debts. It would have to cope with an enormous depreciation of a new drachma and so soaring inflation. It would have to renegotiate its position inside the European Union. It would, finally, suffer huge falls in GDP and real incomes. Would all this be better than soldiering on? Probably not, though who can be sure?

Fourth, would the additional Greek programme be in the interests of the rest of the eurozone and indeed the world? The answer is: probably yes, but not certainly so. The arguments in favour are that a disorderly Greek default, plus exit, could still generate panic elsewhere in the eurozone and that the costs of preventing this by helping Greece are not large, set against the costs of such disorder. The argument against this position is that the eurozone has the means to halt the spread of panic even after a Greek meltdown, particularly if the ECB and the governments were willing to act decisively, in response to any runs on banks and sovereigns elsewhere. Yet another argument against, not to be taken that lightly, is that it would be better to end the pretence that the programmes with Greece will work and so make clear that failure does have consequences.

Finally, what does the Greek epic tell us about the eurozone? Greece itself, though an important irritant, cannot be decisive for the future of the currency area.

Yet the fact that this small, economically weak and chronically mismanaged country has been able to cause such difficulty also indicates the fragility of the structure. Greece is the canary in the mine. The reason it has caused such difficulty is that the country’s failings are extreme, not unique. Its plight shows that the eurozone still seeks a workable mixture of flexibility, discipline and solidarity.

The eurozone is in a form of limbo: it is neither so deeply integrated that break-up is inconceivable, nor so lightly integrated that break-up is tolerable. Indeed, the most powerful guarantee of its survival is the costs of breaking it up.

Maybe that will prove sufficient. Yet if the eurozone is to be more than a grim marriage sustained by the frightening costs of dividing up assets and liabilities, it has to be built on something vastly more positive than that. Given the economic divergences and political frictions revealed so starkly by this crisis, is that now possible? That is the most difficult question of all.

Copyright The Financial Times Limited 2012

Getting Technical


Don't Get Left Standing When the Music Stops


The relationship of stocks, bonds and currencies has been a fluid one for the past few years but the most dominant of late has been classified as "risk-on" versus "risk off." Basically, when investors feel aggressive, they buy risk assets such as stocks. And when they feel defensive, they buy the U.S dollar and Treasury securities.

Unless the relationship between markets has changed—and I do not believe it hasone side of this risk trade is now wrong. This week, stocks, bonds and the dollar are all rising at the same time.

Stocks have been in rally mode since late November and over the past eight weeks there has barely been a hiccup in the rising trend. Until Wednesday, the longest losing streak was three days, and so far in February all intraday declines led to strong finishes by the ends of respective days (see Chart 1).

Chart 1


It has been a relentlessly rising tide, bringing the majority of stocks higher.

Since the start of the year through last week, while stocks moved higher the dollar fell. We can rationalize that a weaker dollar is good for U.S. companies as it makes their products cheaper overseas. The technical angle is that stocks and dollar simply have an inverse relationship, albeit not a perfect one.

In the bond market, the relationship is a bit different thanks to the Federal Reserve's efforts to provide liquidity for the financial markets and drive down long-term interest rates. On a day-to-day basis, as stocks rallied, 30-year Treasuries fell in price. And on the rare occasions when stocks fell, bonds tended to move higher in price. But overall, bonds have held firm for months albeit with a slight downward bias.

Money may be moving into stocks but it is not coming from the bond market, at least not en masse. Investors still seek the safety of U.S. Treasuries where the return of capital is in higher demand than a return on capital.

Again, if the risk-on versus risk-off relationship is still intact, then either bonds and the dollar should not be firm or stocks should not be as strong as they clearly have been. As they say, something's gotta give.

Currently, there is a rather lopsided view that stocks have a long way to run. From sentiment surveys at very high levels of market optimism to the glut of articles in the financial press telling investors they need to own stocks, expectations are very high. Indeed, some say that the European debt crisis is already priced into the market, and it is the resolution, not escalation, of the problem that will surprise the market.

In other words, investors' unabashed optimism should perk up the ears of a contrarian investor.
There are two other factors to consider. The first is Apple (ticker: AAPL). Even a technical analyst can see that the world's premier technology company sports a relatively low trailing price/earnings ratio.

But it seems that analysts are falling over themselves to raise their price targets. And for the market's most valuable stock by market capitalization, a 28% rise in 2012 to date seems quite frothy -- and unsustainable. Indeed, Apple's shares swung from a high of $526 around noon EST to a low of $502 just an hour later and ended the session under $500.

The second is gold. The yellow metal is now holding firm despite the new strength in the dollar.

Typically, gold and the greenback move inversely, but that has not been the case this month. In fact, gold seems to be marking time following a bullish breakout from a six-month correction (see Chart 2).

Chart 2


It is very difficult, and costly, to fight the stock-market trend. But that does not mean we have to blindly follow it, either. The music is still playing, but investors should dance close to the exit doors.

The Global Future of Europe’s Crisis

Kemal Derviş


WASHINGTON, DC – It is now clear that the eurozone crisis will continue well into 2012, despite early February’s recovery in stock markets. Negotiations between Greece and the banks over Greek sovereign debt may yet be concluded, but sufficiently wide participation by banks in the deal remains very much in doubt. Meanwhile, the International Monetary Fund has raised the issue of official-sector debt reduction, possibly even by the European Central Bank, sending the message that a “haircut” for private bondholders will not be enough to return Greece to financial sustainability.

The IMF’s concerns are valid, but the Fund’s idea is being resisted fiercely, owing to fears of political contagion: other debt-distressed eurozone countries might press for equal treatment. Moreover, the promised increase in IMF resources that would allow it to build a stronger firewall against financial contagion has still not arrived. And all of the changes agreed upon for the European Stabilization Fund (ESF) and the European Stability Mechanism (ESM) have yet to be implemented.

Of course, some positive steps have been taken. The ECB’s generous provision of liquidity to European banks at only 1% interest for up to three years has prevented a banking crisis from piling on top of the sovereign-debt crisis. But that initiative has not succeeded in reducing the “problemcountrieslonger-term borrowing costs to levels compatible with their projected growth rates: there is just too much long-term uncertainty, and growth prospects are simply too discouraging. Indeed, in mid-January Standard & Poor’s downgraded AAA-rated France and Austria, in addition to seven other eurozone countriesSlovenia, Slovakia, Spain, Malta, Italy, Cyprus, and Portugal.

It now seems clear to almost everyone that one key challenge facing the eurozone stems from the fact that it is a monetary union without being an economic union, an arrangement that has no counterpart anywhere. As a result, divergences in production costs over time cannot be compensated by exchange-rate adjustments.

In the absence of somewhat higher inflation in the surplus countries, say, 4% a year, adjustment requires deflation in the crisis countries to bring about a noticeable relative decline in production costs over time. In practice, such deflation can be achieved only at the cost of high unemployment and social distress. It is therefore unclear whether the current strategy of combining austerity and deflation is politically feasible, which explains the huge uncertainty hanging over the entire eurozone.

Somewhat higher inflation in the surplus countries and larger cross-border resource transfers would give the deficit countries more time, allowing for structural reforms to produce results and reducing the need for deflation. But Northern European surplus countries reject such an approach, fearing that it would weaken the pressure on Southern European debtor countries to undertake structural reforms in the first place.

Beyond the specific problems of the monetary union, there is also a global dimension to Europe’s challenges – the tension, emphasized by authors such as Dani Rodrik, and Jean Michel Severino and Olivier Ray, between national democratic politics and globalization. Trade, communication, and financial linkages have created a degree of interdependence among national economies, which, together with heightened vulnerability to financial-market swings, has restricted national policymakers’ freedom of action everywhere.

Perhaps the most dramatic sign of this tension came when Greece’s then-prime minister, George Papandreou, announced a referendum on the policy package proposed to allow Greece to stay in the eurozone. While one can debate the merits of referenda for decision-making, the heart of the problem was the very notion of holding a national debate for several weeks, given that markets move in hours or minutes. It took less than 24 hours for Papandreou’s proposal to collapse under the pressure of financial markets (and European leaders’ fear of them).

Around the world, the stock of financial assets has become so large, relative to national income flows, that financial-market movements can overwhelm most countries. Even the largest economies are vulnerable, particularly if they are highly dependent on debt finance. If, for some reason, financial markets and/or China’s central bank were suddenly to reject US Treasury bonds, interest rates would soar, sending the American economy into recession.

But being a creditor does not provide strong protection, either. If Americans’ appetite for Chinese exports suddenly collapsed because of a financial panic in the United States, China itself would find itself in serious economic trouble.

These interlinked threats are real, and they require much stronger global economic-policy cooperation. Citizens, however, want to understand what is going on, debate policies, and give their consent to the types of cooperation proposed. Thus, a more supra-national form of politics is needed to re-embed markets in democratic processes, as happened during the course of the twentieth century with national politics and national markets.

The scale of this challenge becomes apparent when one sees how difficult it is to coordinate economic policies even in the European Union, which has moved much further than any other group of countries in the direction of supra-national cooperation. Nonetheless, unless globalization can be slowed down or partly reversed, which is unlikely and undesirable in the long run, the kind of “politics beyond borders” for which Europe is groping will become a global necessity.

Indeed, the European crisis may be providing a mere foretaste of what will likely be the central political debate of the first half of the twenty-first century: how to resolve the tension between global markets and national politics.

Kemal Derviş, a former minister of economics in Turkey, administrator of the United Nations Development Program (UNDP), and vice president of the World Bank, is currently Vice President and Director of the Global Economy and Development Program at the Brookings Institution.