Hard Truths About Global Growth

Michael Spence

14 September 2012
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NEW YORKThe world’s high-income countries are in economic trouble, mostly related to growth and employment, and now their distress is spilling over to developing economies. What factors underlie today’s problems, and how appropriate are the likely policy responses?
 
 
 
The first key factor is deleveraging and the resulting shortfall in aggregate demand. Since the financial crisis began in 2008, several developed countries, having sustained demand with excessive leverage and consumption, have had to repair both private and public balance sheets, which takes time – and has left them impaired in terms of growth and employment.
 
 
 
 
The non-tradable side of any advanced economy is large (roughly two-thirds of total activity). For this large sector, there is no substitute for domestic demand.


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The tradable side could make up some of the deficit, but it is not large enough to compensate fully. In principle, governments could bridge the gap, but high (and rising) debt constrains their capacity to do so (though how constrained is a matter of heated debate).
 
 
 
 
The bottom line is that deleveraging will ensure that growth will be modest at best in the short and medium term. If Europe deteriorates, or there is gridlock in dealing with America’sfiscal cliff” at the beginning of 2013 (when tax cuts expire and automatic spending cuts kick in), a major downturn will become far more likely.
 
 
 
 
The second factor underlying today’s problems relates to investment. Longer-term growth requires investment by individuals (in education and skills), governments, and the private sector. Shortfalls in investment eventually diminish growth and employment opportunities. The hard truth is that the flip side of the consumption-led growth model that prevailed prior to the crisis has been deficient investment, particularly on the public-sector side.
 
 
 
 
If fiscal rebalancing is accomplished in part by cutting investment, medium- and longer-term growth will suffer, resulting in fewer employment opportunities for younger labor-market entrants. Sustaining investment, on the other hand, has an immediate cost: it means deferring consumption.
 
 
 
 
But whose consumption? If almost everyone agrees that more investment is needed to elevate and sustain growth, but most believe that someone else should pay for it, investment will fall victim to a burden-sharing impasse – reflected in the political process, electoral choices, and the formulation of fiscal-stabilization measures.
 
 
 
 
The core issue is taxes. If public-sector investment were to be increased with no rise in taxation, the budget cuts required elsewhere to avoid unsustainable debt growth would being implausibly large.
 
 
 
 
The most difficult challenge concerns inclusiveness how the benefits of growth are to be distributed. This is a longstanding challenge that, particularly in the United States, goes back at least two decades before the crisis; left unaddressed, it now threatens social cohesion.
 
 
 
 
Income growth for the middle class in most advanced countries has been stagnant, and employment opportunities have been declining, especially in the tradable part of the economy. The share of income going to capital has been rising, at the expense of labor. Particularly in the US, employment generation has been disproportionately in the non-tradable sector.
 
 
 
 
These trends reflect a combination of technological and global market forces that have been operating over the last two decades. On the technology side, labor-saving innovations in network-based information processing and transactions automation have helped to drive a wedge between growth and employment generation in both the tradable and non-tradable sectors.
 
 
 
 
In the tradable part of advanced economies, manufacturing automation – including expanding robotic capabilities and, prospectively, 3D printing – has combined with the integration of millions of new entrants into rapidly evolving global supply chains to limit employment growth. Multinational companies’ growing ability to decompose these global supply chains by function and geography, and then to reintegrate them at ever lower transaction costs, removes the labor-market protection that used to come from local competition for workers.
 
 
 
 
This challenge is particularly difficult, because economic policy has not focused primarily on the adverse distributional trends arising from shifting global market outcomes. And yet the income distributions across advanced economies, presumably subject to similar technological and global market forces, are, in fact, startlingly different, suggesting that a combination of social policies and differing social norms does have a distributional impact. Although the theory of optimal income taxation directly addresses the tradeoffs between efficiency incentives and distributional consequences, the appropriate equilibrium remains a long way off.
 
 
 
 
A healthy state balance sheet could help, because part of the income flowing to capital would go to the state. But, with the exception of China, fiscal positions around the world are currently weak.
 
 
 
 
As a result, deleveraging remains a clear priority in a range of countries, reducing growth, with fiscal countermeasures limited by high or rising government debt and deficits. Thus far, there is little evidence of willingness on the part of politicians, policymakers, and perhaps the public to reduce current consumption further via taxation in order to create room for expanded growth-oriented investment.
 
 

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In fact, under fiscal pressure, the opposite is more likely. In the US, few practical measures that address the distributional challenge appear to be part of either major party’s electoral agenda, notwithstanding rhetoric to the contrary.


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To the extent that this is true of other advanced economies, the global economy faces an extended multi-year period of low growth, with residual downside risk coming from policy gridlock and mistakes in Europe, the US, and elsewhere. That scenario implies slower growth possibly 1-1.5 percentage points slower – in developing countries, including China, again with a preponderance of downside risk.
 
 
 
 
Michael Spence, a Nobel laureate in economics, is currently Chairman of the Commission on Growth and Development, an international body charged with charting opportunities for global economic growth. He is also Professor of Economics at NYU’s Stern School of Business, Distinguished Visiting Fellow at the Council on Foreign Relations, Senior Fellow at the Hoover Institution at Stanford University, and Academic Board Chairman of the Fung Global Institute in Hong Kong. He was previously Dean of Stanford’s School of Business and Professor of Economics at Harvard University.
 




Why Are Savings Patterns So Different?

Keyu Jin

14 September 2012

 


BEIJINGEver since the integration of emerging markets into the global economy began in the early 1990’s, three striking trends have emerged: a divergence in private savings rates between the industrialized core and the emerging periphery (the former experiencing a sharp rise, and the latter a steady decline); large global imbalances between the two regions; and a drop in interest rates worldwide. But, while global imbalances have preoccupied many observers, few have sought to explain the divergence in world savings behavior.
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In 1988, the household savings rate in China and the United States was roughly equal, at about 5%. Yet, by 2007, China’s household savings rate had risen to a staggering 30%, compared to just 2.5% in the US. The pattern is not uncharacteristic of other industrialized countries relative to emerging markets over the last two decades (Figure 1).


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Savings behavior invariably reacts to changes in interest rates, which have fallen steadily over the last two decades to today’s record-low levels. But how can savings patterns be so differentoften opposite – in globalized economies that are well integrated into world capital markets?
 
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The answer may be that credit markets are more developed in advanced economies than they are in emerging countries, particularly in terms of the degree to which households are able to borrow. Of course, one might argue that Asian thrift and American profligacy merely reflect asymmetric demands for credit: Asians are intrinsically more reluctant to borrow. In that case, however, the vast differences in household debt (Figure 2) – ranging from 25% of GDP in emerging Asia (Southeast Asia, China, India, Hong Kong, and South Korea) to more than 90% in the US and other Anglo-Saxon economies (including Australia, Canada, Ireland, New Zealand, and the United Kingdom) – would reflect only a dissimilarity in taste.
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A more plausible explanation is that institutional differences in the ability to borrow dictate to some extent the disparity in savings rates across countries. The argument is simple: All economies have both borrowers and savers, and changes in the cost of borrowing (or the return to saving) affect them differently.


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When interest rates decline, borrowers are able to borrow more. Savers, on the other hand, may be compelled to save more in the face of shrinking interest income.
 
 
 
 
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At the macro level, a less credit-constrained economy (with a large mass of effective borrowers) could then experience a fall in the savings rate as borrowing rose. However, in a country with a large mass of effective savers, the savings rate can rise, rather than fall. This asymmetry in savings patterns might thus reflect the simple fact that credit-constrained economies are less sensitive to drops in the cost of borrowing relative to less constrained economies.
 
 
 

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In joint research with Nicolas Coeurdacier and Stéphane Guibaud, we show that economic data supports this view. Borrowers and savers are naturally grouped by age. The young normally face low, current wage income, but faster growth in future income, and would ideally borrow against future income to augment consumption today and to invest in education.
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The middle-aged, preparing for retirement, are likely to be the economy’s savers. If asymmetric credit constraints are indeed important, young borrowers and middle-aged savers will display distinct patterns in constrained versus less-constrained economies.
 
 
 
 
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In fact, there was a remarkable contrast in savings behavior across age groups in China and the US in the period 1992-2009. For young Americans (those under 25), the borrowing rate rose by ten percentage points more than the borrowing rate of young Chinese, while the savings rate of the Chinese working-age population (ages 35-54) rose by about 17 percentage points more than the savings rate of their American counterparts.

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Another implication of this view is that the steep rise in savings in China is largely driven by a rise in the savings rate of middle-aged Chinese (rather than a fall in the borrowing rate of the young). Conversely, the fall in savings in the US is largely due to higher borrowing by the young (rather than a fall in middle-aged Americans’ savings rate).
 
 
 
 
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Indeed, of the 20.2-percentage-point increase in aggregate household savings (as a share of GDP) in China from 1992 to 2009, the middle-aged cohort accounted for more than 60% (the remainder was largely attributable to the elderly). In the US, which experienced a 1.8-percentage-point decline in aggregate savings as a share of GDP, the savings-to-GDP ratio among the young declined by 1.25 percentage points, whereas the figure for middle-aged savers actually increased by about 1.5 percentage points.
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Apart from accounting for the global divergence in savings rates, tight credit constraints in China might explain the country’s high, and rising, savings rate – especially as the large rise in national savings is attributable mostly to household savings. This would mean that China’s much-publicized effort to boost domestic consumption might in fact call for appropriate credit-market reforms.
 
 
 
 
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US Federal Reserve Board Chairman Ben Bernanke’s notion of a “global savings glut” is a commonly cited explanation for falling world interest rates. Credit constraints in fast-growing developing economies may be the reason why the glut emerged in the first place.
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Keyu Jin is Lecturer in Economics at the London School of Economics.


CAPITAL

September 14, 2012, 4:15 p.m. ET

Central Bankers' Political Conundrum

  By DAVID WESSEL

 
 

As Ben Bernanke and Mario Draghi launch historic experiments in central-bank policy, both men warn that monetary medicine alone isn't enough.



The ultimate cure for what's wrong with the economy, they say, depends on elected politicians.
  
 
 
"Monetary policy, as I've said many times, is not a panacea," Federal Reserve Chairman Bernanke said Thursday, referring to the interest rates the Fed controls and its ability to print money and buy assets. "We're looking for policy makers in other areas to do their part. We'll do our part, and we'll try to make sure that unemployment moves in the right direction. But we can't solve this problem by ourselves."



Mr. Draghi, president of the European Central Bank, said much the same thing a week earlier: "In order to restore confidence, policy makers in the euro area need to push ahead with great determination with fiscal consolidation, structural reforms to enhance competitiveness and European institution-building."



Yet the very actions the Fed and the ECB are taking may relieve pressure on politicians.


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In the U.S., the Fed's bond buying has, by design, held down long-term interest rates in the bond market and boosted stock prices.



Those are welcome for an economy growing too slowly to bring down unemployment. But the bond-buying makes it easier for Congress to avoid contemplating more short-term fiscal stimulus. And the moves reduce financial markets' pressure on Congress and the president to heed Mr. Bernanke's pleas to fix fiscal policy—to avoid the "fiscal cliff" of tax increases and spending cuts set for year-end and to "simultaneously" act to reduce budget deficits.
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On the other hand, former Fed staff economist Stephen Oliner figures the central bank's moves will have only "a marginal positive effect on the economy," so a lousy economy will keep pressuring politicians to do something, and fiscal policy is one thing Congress controls.



In Europe, the ECB's new offer to buy more bonds of beleaguered governments that meet certain conditions, has lowered Spanish and Italian borrowing costs even before the bank spends a euro.



Recent history suggests that European leaders, who are coping with domestic political pressures as well as disagreements over budget austerity and European integration, move fastest when a crisis threatens. Of course, the ECB's defenders argue, at combustible moments like today, it is hard to a put a flame to countries' feet without setting them on fire.



There are long-standing differences between the approaches of central bankers on either side of the Atlantic. The ECB, particularly when Jean-Claude Trichet was in charge, saw monetary policy as a lever to get politicians to deliver on promised reforms or budget cuts, effectively delaying monetary ease if politicians procrastinated. The Fed, by contrast, has been more likely to compensate when fiscal policy is off course. Indeed, one reason Mr. Bernanke gave Thursday for stepping up the Fed's bond buying was the "fiscal contraction at the federal, state and local levels."




Messrs. Bernanke and Draghi, who both hold doctorates from the Massachusetts Institute of Technology, are demonstrating one thing to politicians: how to get things done. Both displayed political agility within their institutions by steering their policy committees to endorse massive bond-buying initiatives despite strenuous internal dissent—in the U.S. from some regional Fed bank presidents and in Europe from the German Bundesbank.



Both central bankers are giving their politicians time to get their acts together, though the circumstances differ. Mr. Bernanke is trying to spur an economy that is growing, however slowly. He doesn't have to worry about any of the 50 states abandoning the dollar. Mr. Draghi confronts recession and a fragile banking system—and is trying to keep the 17-country euro zone from disintegrating.



For the Fed, the major risks are that its monetary medicine doesn't work as intended or that extricating itself from very easy credit proves difficult and touches off unwelcome inflation. "The only way history treats him [Mr. Bernanke] badly is if they don't exit soon enough," said economist Anil Kashyap of the University of Chicago Booth School of Business. "The risk for the Fed is that politicians are going to make this so unpleasant for them that when the time comes to raise rates they'll have to do it sooner than they'd like to show they have the will to do it."



The stakes are higher for the ECB. It says it will buy bonds of euro-zone governments only if they commit to budget cuts and reforms. But if it does, and if any government subsequently breaks its promises, the ECB will have to make the tough call of whether to stop buying bonds, which would send borrowing costs of the offending governments soaring.



"Does the ECB have the legitimacy to stop buying?" Mr. Kashyap asked. He is doubtful. "I can't imagine a situation where the ECB can exit." And if it keeps buying bonds of misbehaving governments, he speculated, that could turn German public opinion toward the ECB even more hostile, and perhaps lead Germany to abandon the currency.



Messrs. Bernanke and Draghi are aware of these risks. They obviously think they are worth taking.


Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved



September 14, 2012

Anti-American Protests Flare Beyond the Mideast

By RICK GLADSTONE 

 
 
 


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Anti-American rage that began this week over a video insult to Islam spread to nearly 20 countries across the Middle East and beyond on Friday, with violent and sometimes deadly protests that convulsed the birthplaces of the Arab Spring revolutions, breached two more United States Embassies and targeted diplomatic properties of Germany and Britain.
 
 
 
      
The broadening of the protests appeared to reflect a pent-up resentment of Western powers in general, and defied pleas for restraint from world leaders, including the new Islamist president of Egypt, Mohamed Morsi, whose country was the instigator of the demonstrations that erupted three days earlier on the anniversary of the Sept. 11, 2001, attacks.


   
The anger stretched from North Africa to South Asia and Indonesia and in some cases was surprisingly destructive. In Tunis, an American-run school that was untouched during the revolution nearly two years ago was completely ransacked. In eastern Afghanistan, protesters burned an effigy of President Obama, who had made an outreach to Muslims a thematic pillar of his first year in office.


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The State Department confirmed that protesters had penetrated the perimeters of the American Embassies in the Tunisian and Sudanese capitals, and said that 65 embassies or consulates around the world had issued emergency messages about threats of violence, and that those facilities in Islamic countries were curtailing diplomatic activity. The Pentagon said it sent Marines to protect embassies in Yemen and Sudan.
 
 
 
      
The wave of unrest not only increased concern in the West but raised new questions about political instability in Egypt, Tunisia and other Middle East countries where newfound freedoms, once suppressed by autocratic leaders, have given way to an absence of authority. The protests also seemed to highlight the unintended consequences of America’s support of movements to overthrow those autocrats, which have empowered Islamist groups that remain implacably hostile to the West.


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“We have, throughout the Arab world, a young, unemployed, alienated and radicalized group of people, mainly men, who have found a vehicle to express themselves,” Rob Malley, the Middle East-North African program director for the International Crisis Group, a consulting firm, said in a telephone interview from Tripoli, Libya.
 
 
 
      
In a number of these countries, particularly Egypt and Tunisia, he said, “the state has lost a lot of its capacity to govern effectively. Paradoxically, that has made it more likely that events like the video will make people take to the streets and act in the way they did.”


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Some of the most serious violence targeted the compound housing the German and British Embassies in Khartoum, the Sudanese capital, causing minor damage to the British property but major fire damage to the German one. The foreign ministers of both countries strongly protested the assault, which The Associated Press said had been instigated by a prominent sheik exhorting protesters to storm the German Embassy to avenge what he called anti-Muslim graffiti on Berlin mosques.
 

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The police fired tear gas to repulse attacks in Khartoum, where about 5,000 demonstrators had massed, news reports said, before they moved on to the United States Embassy on the outskirts of the capital.
 
 
 
      
In Tunis, the United States Embassy was assaulted at midday by protesters who smashed windows and set fires before security forces routed them in violent clashes that left at least 3 dead and 28 hurt. Witnesses and officials said no Americans were hurt and most had left earlier.
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The worst damage was inflicted on the American Cooperative School of Tunis, a highly regarded institution that, despite its name, catered mostly to the children of non-American expatriates, nearly half of whom work for the African Development Bank. School officials, who had sent the 650 students home early, said a few protesters scaled the fence and dismantled monitoring cameras, followed by 300 to 400 others, some of them local residents, who looted everything including 700 laptop computers, musical instruments and the safe in the director’s office, and then set the building on fire.
 
 
 
      
“It’s ransacked,” the director, Allan Bredy, said in a telephone interview. “We were thinking it was something the Tunisia government would keep under control. We had no idea they would allow things to go as wildly as they did.”
 
 
 
      
The school’s director of security, David Santiago, said a group of staff members formed a posse armed with baseball bats to chase lingering looters away hours after the assault. “Our elementary school library is burning as we speak,” he said angrily as he and his colleagues sought to assess the damage. “It’s complete chaos.”


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Thousands of Palestinians joined demonstrations after Friday Prayer in the Gaza Strip. Since there is no American diplomatic representation in Gaza, the main gathering took place in Gaza City, outside the Parliament building, where American and Israeli flags were placed on the ground for the crowds to stomp. Palestinians also clashed with Israeli security forces in Jerusalem and held protests in the West Bank.


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Witnesses in Cairo said protests that first flared Tuesday grew in scope on Friday, with demonstrators throwing rocks and gasoline bombs near the American Embassy and the police firing tear gas.


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Egyptian state media said Saturday that at least one person had been killed in Friday’s clashes near the American Embassy in Cairo. News reports said that a 35-year-old man was killed by shotgun fire and state media noted that he had a long criminal record. More than 224 people have been injured in four days of street battles, according to state media, and by Friday at least 99 Egyptian security officers had been hurt protecting the embassy in Cairo.


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In the eastern Libyan city of Benghazi, where J. Christopher Stevens, the American ambassador, and three other Americans were killed Tuesday, militias fired rockets at what they thought were American drones overhead, prompting the government to temporarily close the airport as a precaution. The bodies of Mr. Stevens and the others killed in the Libya attack were returned to the United States on Friday.
 
 
      
In Lebanon, where Pope Benedict XVI was visiting, one person was killed and 25 were injured as protesters attacked restaurants. There was also turmoil in Yemen, Bangladesh, Qatar, Kuwait, Bahrain, India, Pakistan and Iraq, and demonstrations in Malaysia. In Nigeria, troops fired into the air to disperse protesters marching on the city of Jos, Reuters reported. In Syria, about 200 protesters chanted anti-American slogans outside the long-closed American Embassy in Damascus, news reports said.


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In the Egyptian Sinai, a group of Bedouins stormed an international peacekeepers’ camp and set fire to an observation tower, according to Al Ahram Online, a state-owned, English-language Web site.
 
 
 
 
Three people, two Colombians and one Egyptian, were injured in the ensuing clashes.
 
 
 
      
In Yemen, baton-wielding security forces backed by water cannons blocked streets near the American Embassy a day after protesters breached the outer security perimeter there, and officials said two people were killed in clashes with the police. Still, a group of several dozen protesters gathered near the diplomatic post, carrying placards and shouting slogans.


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In Iraq, where the heavily fortified American Embassy sits on the banks of the Tigris River inside Baghdad’s Green Zone and is out of reach to most Iraqis, thousands protested after Friday Prayer in Sunni and Shiite cities alike.


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Raising banners with Islamic slogans and denouncing the United States and Israel, Iraqis called for the expulsion of American diplomats from the country and demanded that the American government apologize for the incendiary film and take legal action against its creators.


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Anger over the film even reached Sydney, Australia, on Saturday. Riot police officers in downtown Sydney clashed with about 200 protesters who were rallying against the film, The Associated Press reported. The police would not immediately confirm injuries or say whether arrests had been made.


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In Egypt, in particular, leaders scrambled to repair deep strains with Washington provoked by their initial response to attacks on the American Embassy on Tuesday, tacitly acknowledging that they erred in their response by focusing far more on anti-American domestic opinion than on condemning the violence.
 
 
 
      
The attacks squeezed Mr. Morsi and the Muslim Brotherhood between conflicting pressures from Washington and their Islamic constituency at home, a senior Brotherhood official acknowledged.
 
 
 
During a 20-minute phone call Wednesday night, Mr. Obama warned Mr. Morsi that relations would be jeopardized if the authorities in Cairo failed to protect American diplomats and stand more firmly against anti-American attacks.
 
 
      
On Friday, Mr. Morsi, on a scheduled state visit to Rome, called attacks on foreign embassies absolutely unacceptable.”
 
 
      

Reporting was contributed by David D. Kirkpatrick from Cairo; Alan Cowell from London; Monica Marks from Tunis; Nasser Arrabyee from Sana, Yemen; Tim Arango from Baghdad; Nicholas Kulish from Berlin; Steven Lee Myers from Washington; Alissa J. Rubin from Kabul, Afghanistan; Kareem Fahim from Beirut, Lebanon; Fares Akram from Gaza; Isabel Kershner from Jerusalem; and Christine Hauser from New York.