Finding the Keys to National Prosperity

Jeffrey D. Sachs

26 September 2012

NEW YORKIn many of history’s most successful economic reforms, clever countries have learned from the policy successes of others, adapting them to local conditions. In the long history of economic development, eighteenth-century Britain learned from Holland; early nineteenth-century Prussia learned from Britain and France; mid-nineteenth-century Meiji Japan learned from Germany; post-World War II Europe learned from the United States; and Deng Xiaoping’s China learned from Japan.

Through a process of institutional borrowing and creative adaptation, successful economic institutions and cutting-edge technologies spread around the world, and thereby boost global growth. Today, too, there are some great opportunities for this kind of “policy arbitrage,” if more countries would only take the time to learn from other countries’ successes.
For example, while many countries are facing a jobs crisis, one part of the capitalist world is doing just fine: northern Europe, including Germany, the Netherlands, and Scandinavia. Germany’s unemployment rate this past summer was around 5.5%, and its youth unemployment rate was around 8%remarkably low compared with many other high-income economies.
How do northern Europeans do it? All of them use active labor market policies, including flex time, school-to-work apprenticeships (especially Germany), and extensive job training and matching.

Likewise, in an age of chronic budget crises, Germany, Sweden, and Switzerland run near-balanced budgets. All three rely on budget rules that call for cyclically adjusted budget balance. And all three take a basic precaution to keep their entitlement spending under control: a retirement age of at least 65. This keeps costs much lower than in France, and Greece, for example, where the retirement age is 60 or below, and where pension outlays are soaring as a result.
In an age of rising health-care costs, most high-income countriesCanada, the European Union’s Western economies, and Japanmanage to keep their total health-care costs below 12% of GDP, with excellent health outcomes, while the US spends nearly 18% of GDP, yet with decidedly mediocre health outcomes. And, America’s is the only for-profit health system of the entire bunch. A new report by the US Institute of Medicine has found that America’s for-profit system squanders around $750 billion, or 5% of GDP, on waste, fraud, duplication, and bureaucracy.
In an age of soaring oil costs, a few countries have made a real difference in energy efficiency. The OECD countries, on average, use 160 kilograms of oil-equivalent energy for every $1,000 of GDP (measured at purchasing power parity). But, in energy-efficient Switzerland, energy use is just 100 kg per $1,000 of GDP, and in Denmark it is just 110 kg, compared with 190 kg in the US.
In an age of climate change, several countries are demonstrating how to move to a low-carbon economy. On average, the rich countries emit 2.3 kg of CO2 for every kg of oil-equivalent unit of energy. But France emits just 1.4 kg, owing to its enormous success in deploying safe, low-cost nuclear energy.
Sweden, with its hydropower, is even lower, at 0.9 kg. And, while Germany is abandoning domestic production of nuclear energy for political reasons, we can bet that it will nonetheless continue to import electricity from France’s nuclear plants.
In an age of intense technological competition, countries that combine public and private research and development (R&D) financing are outpacing the rest. The US continues to excel, with huge recent breakthroughs in Mars exploration and genomics, though it is now imperiling that excellence through budget cuts. Meanwhile, Sweden and South Korea are now excelling economically on the basis of R&D spending of around 3.5% of GDP, while Israel’s R&D outlays stand at a remarkable 4.7% of GDP.
In an age of rising inequality, at least some countries have narrowed their wealth and income gaps. Brazil is the recent pacesetter, markedly expanding public education and systematically attacking remaining pockets of poverty through targeted transfer programs. As a result, income inequality in Brazil is declining.
And, in an age of pervasive anxiety, Bhutan is asking deep questions about the meaning and nature of happiness itself. In search of a more balanced society that combines economic prosperity, social cohesion, and environmental sustainability, Bhutan famously pursues Gross National Happiness rather than Gross National Product. Many other countries – including the United Kingdom – are now following Bhutan’s lead in surveying their citizenry about life satisfaction.
The countries highest on the ladder of life satisfaction are Denmark, Finland, and Norway. Yet there is hope for those at lower latitudes as well. Tropical Costa Rica also ranks near the top of the happiness league. What we can say is that all of the happiest countries emphasize equality, solidarity, democratic accountability, environmental sustainability, and strong public institutions.
So here is one model economy: German labor-market policies, Swedish pensions, French low-carbon energy, Canadian health care, Swiss energy efficiency, American scientific curiosity, Brazilian anti-poverty programs, and Costa Rican tropical happiness.
Of course, back in the real world, most countries will not achieve such bliss anytime soon. But, by opening our eyes to policy successes abroad, we would surely speed the path to national improvement in countries around the world.

Jeffrey D. Sachs is a professor at Columbia University, Director of its Earth Institute, and a special adviser to United Nations Secretary-General Ban Ki-Moon. His work focuses on economic development and international aid, was he was Director of the UN Millennium Project from 2002 to 2006. His books include The End of Poverty and Common Wealth


September 26, 2012, 7:09 p.m. ET

Sean Fieler: Easy Money Is Punishing the Middle Class

A policy of low but persistent inflation anesthetizes workers to declining real wages.



                                                                                                                        Getty Images

With the Republican Party committed to a gold commission and the Federal Reserve committed to easy money, a substantive debate about the principles underpinning our monetary system is finally in the offing. For sound money to carry the day, Republicans will need to do more than point out the still-hypothetical risks of easy money. The GOP will have to detail the harm that the middle class has already suffered as a result of a policy of low but persistent levels of inflation.

A little inflation appears to be a free lunch, lubricating the economy and gradually erasing past financial mistakes. But the nature of the free lunch is that its costs aren't absent—they're just distributed broadly. And in the case of low but steady inflation, the broadly distributed costs are borne by the middle class. Over time, rising prices have eroded American workers' standard of living. And, over time, the Federal Reserve's persistent easy money hurts the very person it is presumably intended to help, the American worker.

The notion that modest inflation is helpful to labor dates to John Maynard Keynes's "General Theory of Employment, Interest and Money." Keynes pointed out that the supply of labor is not a function of real wages alone. Rather, the instance in which the supply of labor is determined solely by real wages is a special case that fits into his broader "General Theory," which showed the strong influence that observed wages have over the supply of labor.

He noted workers' strong preference for a 2% wage increase in a 4% inflation environment to a 2% decrease in wages during a period of constant prices. But he also drew from this preference the obvious policy conclusion: A constantly rising price level can be used to make actual declines in wages more palatable, thereby reducing conflict with labor and leading to higher short-run employment.

The Federal Reserve doesn't just understand workers' tendency to use observed prices as a proxy for real prices; under Chairman Ben Bernanke's leadership, the Fed has become increasingly bold in the exploitation of this tendency. With inflationary expectations not yet unsettled by the Federal Reserve's $2 trillion balance-sheet expansion, Mr. Bernanke has committed the Fed to an open-ended round of quantitative easing in hopes of trading a little extra inflation for a little short-term employment.

The problem with Keynes's theory and the Federal Reserve's action—a problem that both Keynes and Mr. Bernanke long ago recognized—is that easy money only boosts employment in the short run. And, as Mr. Bernanke must now recognize, contrary to Keynes's assertion, we're not all dead in the long run.

The problem not fully recognized by either Keynes or Mr. Bernanke is that the low level of inflation necessary to anesthetize the American worker to declining real wages also has the long-run side-effect of anesthetizing the American worker to price signals needed to compete in the global marketplace. Inflation's subtle corruption of these price signals at the heart of the market's purpose underlies the unhappy situation in which both real wages and employment ratios have been in decline for decades.

The more than five-fold increase in the median income of the American household since 1971, to $50,000 from $9,000, certainly provides the clear appearance of progress. But after the dollar's 82% loss of purchasing power over the same period is factored in, the median household income rose just 12%. This much more modest increase is largely the result of the growing prevalence of two-income households.

The median real income for working men over the same 40-year period rose just 8%. And that improvement only accrued to the ever-shrinking percentage of men fortunate enough to still have full-time jobs—just 67%, according to the latest data from the Bureau of Labor Statistics, within a percentage point of the lowest level on record since the figure was first recorded in 1948.

In the past four years alone, since the Federal Reserve started aggressively expanding its balance sheet, the declines in the middle class's real income have been particularly severe. With American median household income unchanged at roughly $50,000 since 2008, inflation has been steadily chipping away at middle-class earnings. Adjusted for inflation, the real income of the average American household has fallen each of the past four years, resulting in a cumulative real decline of 7% since the Federal Reserve embarked on its experiment in money printing.

Having successfully protected the American worker from the sharp message of the market, the Federal Reserve is powerless to protect the American worker from the forces of technology and globalization reshaping the world economy. Recognizing the failure of so many American workers to adjust to the demands of the global market place, Mr. Bernanke has spoken passionately about the importance of education. But, the chairman's speeches aside, the only real support the Federal Reserve is offering the middle class is help in financing ever-growing levels of public assistance.

The alternative to this unhealthy status quo is clear. The Federal Reserve needs to stop infantilizing American workers and start providing them with the clear message that only long-run stable prices can provide. To retrain, to adjust, to compete, the American worker needs the market's unvarnished truth. This truth will in turn break the cycle in which American workers mistake the appearance of price stability for actual price stability, a mistake for which they receive the appearance of progress without its substance.

The recognition that persistent, low-level inflation leads to lower, not higher, long-term employment will also clarify the organizing principle of our monetary system. The Federal Reserve was not created to address an employment problem. The Fed was set up to ensure bank solvency, a prime directive from which it has not wavered.

With the Federal Reserve's underlying mandate clear, we can weigh sound money that benefits the American worker against easy money that benefits the banks and leveraged financial institutions. Framed properly, gold money that holds its value over time will be clearly recognized as the best system for the American worker—if not the overleveraged banker.

Mr. Fieler, president of Equinox Partners, L.P., a New York-based hedge fund, is chairman of the American Principles Project, a Washington advocacy group.

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

jueves, septiembre 27, 2012



China’s Rebalancing Act

Yu Yongding

26 September 2012

BEIJINGChina’s 12th Five-Year Plan calls for a shift in the country’s economic model from export-led growth toward greater reliance on domestic demand, particularly household consumption. Since the Plan’s introduction, China’s current-account surplus as a share of GDP has indeed fallen. But does that mean that China’s adjustment is on track?
According to the IMF, the fall in China’s current-account surplus/GDP ratio has largely been the result of very high levels of investment, a weak global environment, and an increase in prices for commodity imports that has outpaced the rise in prices for Chinese manufactured goods. So the fall in China’s external surplus/GDP ratio does not represent economicrebalancing”; on the contrary, the Fund predicts that the ratio will rebound in 2013 and approach its pre-crisis level thereafter.

The IMF’s explanation of the recent fall in China’s current-account surplus/GDP ratio is broadly correct. Experience suggests that China’s external position is highly sensitive to global conditions, with the surplus/GDP ratio rising during boom times for the world economy and falling during slumps. Europe’s malaise has hit China’s exports badly, and undoubtedly is the most important factor underlying the current decline in the ratio.
By definition, without a change in the saving gap, there will be no change in the trade surplus, and vice versa. Furthermore, the saving gap and the trade balance interact with each other constantly, making them always equal. In response to the global financial crisis in 2008, China introduced a RMB4 trillion ($634 billion) stimulus package. While the increase in investment reduced the saving/GDP ratio, the resulting increase in imports lowered the trade surplus/GDP ratio. As a result, China’s external surplus/GDP ratio fell significantly in 2009.
In 2010, China’s government adjusted its economic policy. In order to control inflation and real-estate bubbles, the central bank tightened monetary policy and the government refrained from another round of fiscal stimulus.

China’s real-estate investment accounted for 10% of GDP, and slower investment growth in the sector necessarily reduces import demand, directly and indirectly. But, because the fall in import growth had yet to turn into a rout, while China’s exports to Europe plummeted, China’s current-account surplus fell further in GDP terms in 2011.
This situation is likely to change in 2012. The negative impact of the fall in real-estate investment since 2010 has been deeper and longer than expected; indeed, almost all categories of imports that fell by 10% or more in August were related to real-estate investment. As a result, it is possible that the fall in investment growth will reverse the declining external surplus/GDP ratio in 2012, unless the global economy deteriorates further and/or the Chinese government launches a new stimulus package.
Perhaps most important, China must now export more manufactured goods to finance imports of energy and mineral products. The worsening terms of trade have been a major factor contributing to the decline in the current-account surplus in recent years.
Nevertheless, despite the merits of its analysis, the IMF underestimates China’s progress in rebalancing. In my view, China’s rebalancing is more genuine – and more fundamentalthan the Fund recognizes, and the prediction of an eventual rebound in China’s external surplus/GDP ratio will most likely turn out to be wrong.
First, the roughly 30% real exchange-rate appreciation since 2005 must have had a serious impact on exporters, reflected in the bankruptcy – as well as the upgrading – of many enterprises in coastal areas. Though the market shares of Chinese exports seem to have held up quite well, this is attributable to price-cutting in foreign markets, which is not sustainable. Over time, real exchange-rate appreciation will cause a shift in expenditure, making China’s rebalancing more apparent.
Second, China’s wage levels are rising rapidly. According to the 12th Five-Year Plan, the minimum wage should grow by 13% per year. Together with real appreciation, the increase in labor costs is bound to weaken the competitiveness of China’s labor-intensive export sector, which will be reflected in the trade balance more clearly in the coming years.
Third, China has made significant progress in building its social-security system. The number of people covered by basic old-age insurance, unemployment insurance, workers’ compensation, and maternity insurance has risen substantially. Moreover, universal medical insurance is emerging, and a comprehensive system for providing aid to students from poor families has been established. As a result, the motivation for precautionary saving has been weakened somewhat, while some researchers have found statistical evidence that the consumption rate is rising, which is supported by China’s emergence as the world’s fourth-largest importer of luxury goods.
Finally, the worsening of China’s terms of trade will play an even more fundamental role in reducing its trade surplus in the future. Given weak demand, which may be prolonged, Chinese exporters must accept increasingly thin profit margins to maintain market share.

However, China’s large size and low per capita income and capital stock imply continued rapid growth in its demand for commodities. Thanks to supply constraints, China’s import bill for commodities and metals is likely to offset its processing-trade surplus in the near future.
In short, as long as China’s government is not so unnerved by the slowdown in output growth that it changes its current policy stance, the current-account surplus is more likely to continue to fall relative to GDP than it is to rebound in 2013 and thereafter. In fact, such an outcome is not only likely, but also desirable. After all, faced with “infinite quantitative easing,” being a large net creditor means being in the worst position in today’s global economy.
Yu Yongding was President of the China Society of World Economics and Director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. He has also served as a member of the Monetary Policy Committee of the People's Bank of China, and as a member of the National Advisory Committee of China’s 11th Five-Year Plan.

Markets Insight

September 26, 2012 11:45 am

Markets will learn to welcome QE3

The expansion of the Federal Reserve’s quantitative easing programme has raised a number of fundamental questions, namely: Will QE work in boosting the economy? Will it lead to an upturn in inflation? And what will the impact be on asset prices, notably global equity, bond and commodities markets?

Although previous QE programmes by the Fed and other central banks have arguably reduced tail risks to economies and markets, clearly economic growth in the US and the OECD area has been unsatisfactory. In his recent press conference, Ben Bernanke, Fed chairman, repeatedly referred to the slow progress being made in reducing US unemployment, the low level of demand and the lack of acceleration in real GDP growth.

Although the Fed has expanded its balance sheet from $800bn in September 2008 to close to $3tn, signalled the Fed Funds rate will stay historically low for an extended period and extended the duration of its US Treasury holdings, the impact of these moves so far has been muted.

Over a period when banks are deleveraging, when consumers are increasing their savings and reducing their borrowings, when companies are running historically high levels of excess liquidity and when fiscal policy is having a negative impact on GDP growth, it is clearly difficult for monetary policy to be effective, except as a backstop.

However, the US economy is showing signs of being at a turning point. The housing market has formed a base and it is realistic to forecast house prices will recover 5 per cent or more in the next year. Real consumption has improved with a trend recovery in personal incomes. Over the next 6-12 months real consumption could increase 1.5-2 per cent. There has been an upturn in consumer credit availability. High levels of corporate liquidity have started to decrease, driven by increased share buy backs, higher dividends and an improvement in real investment spending.

In contrast to Europe where significant work is still required to restructure the banking sector, the US banking industry has now largely been repaired with the rise in profitability and easier lending conditions. Consequently, at a time when the deleveraging of the consumer, corporate and banking sectors is showing signs of stabilising, the impact of QE should be more powerful, particularly when the Fed has left the timing and amount open-ended, has confirmed that interest rates will stay low until 2015 and has maintained the “twist” in its US Treasury holdings. The Fed has also indicated that the extent and timing of QE will be very dependent on the improvement in macro indicators and that, in the event of an upturn in activity and inflation, it will only reverse policy slowly.

In any event, given spare capacity in the US and the global economy, the lack of wage pressure and the limited impact of commodity prices on core inflation, it is premature to forecast that inflation will accelerate significantly.

As we may be at a turning point in the effectiveness of monetary policy, QE may likewise finally have a significant impact on investor behaviour. Although a number of equity markets, notably in the US and northern Europe have generated high positive returns so far in 2012, investor sentiment still remains subdued with a high degree of scepticism over the outlook for growth and corporate earnings. While there has been a clear flow of investor capital out of money markets into corporate, high yield and emerging debt, capital flows into equities have been relatively muted.

Given the probability of near zero returns in money markets for at least the next 2-3 years, negative real returns in most bond markets and the now narrow spreads in corporate and emerging debt markets, QE should drive funds into equity markets. This equity positive flow would be justified if growth improved with an associated turnround in corporate earnings in 2013. The impact on equity markets would occur at a time when investors were defensively positioned, markets undervalued by historical standards, when share buy backs and dividends were rising and when there were signs of improving M&A activity. Consequently, the outperformance of defensive sectors relative to cyclicals should reverse while undervalued emerging markets should benefit from increased investor appetite.

While a policy mix of exceptionally easy monetary policy and more austere fiscal policy is negative for the US dollar, particularly against the emerging currencies, the impact of QE on commodity prices – excluding precious metals – is less clear. Energy prices will depend more on Middle East geopolitics and industrial metal prices will be driven by a possible upturn in Chinese demand. Therefore, although risks remain, in particular resolving the USfiscal cliff”, investors may be surprised by the improved effectiveness of QE and the positive impact on markets.

Robert Parker is senior adviser to Credit Suisse

Copyright The Financial Times Limited 2012.