October 8, 2012 7:04 pm

The Brics have taken an unhappy turn

Ingram Pinn illustration©Ingram Pinn

Over the past three years, conventional wisdom divided the world’s major economies into two basic groups – the Brics and the sicks. The US and the EU were sick struggling with high unemployment, low growth and frightening debts. By contrast the Brics (Brazil, Russia, India, China and, by some reckonings, South Africa) were much more dynamic. Investors, businessmen and western politicians made regular pilgrimages there, to gaze at the future.

But now something odd is happening. The Brics are in trouble. The nature of the problem in each nation is different. But there are also some broad difficulties that link them. First, for all the hopeful talk of “decoupling”, the Brics are all affected by weak western economies. Second, all five nations are finding that endemic corruption is eroding faith in their political systems, and imposing a tax on their economies.

China remains the daddy of the rising powers. It is the second-largest economy in the world – and easily still the fastest growing Bric. And yet the country feels more uncertain about its economic and political future than in many years. As a Chinese friend put it recently: “Our economy is slowing sharply, our next leader has disappeared, and we are sending ships towards Japan.” Xi Jinping has since reappeared – as mysteriously as he disappeared in the first place. But political tensions remain high, with the trial of Bo Xilai about to start and a crucial party congress approaching.

For the past generation, China’s answer to political uncertainty was always the samerapid economic growth. But in 2012, for the first time since the turn of the century, China will grow at less than the totemic figure of 8 per cent a year. In some ways, this is natural, even desirable, reflecting the fact that the Chinese labour force is no longer increasing so fast. But slowing growth also reflects the fall in demand in Europe. Wages in Chinese factories are also rising fast, which is good news for workers – but bad for China’s competitiveness.

A slowing China has knock-on effects for the other Brics – since it is now the largest trading partner for Brazil, India and South Africa. Brazilian growth has dropped off particularly fast. It hit 7.5 per cent in 2010, the year after Rio de Janeiro was named host city of the 2016 Olympics. This year, the Brazilian economy will probably grow by less than 2 per cent.

As for India, when I visited the country a couple of weeks ago, a senior industrialist told me that business there was suffering from “clinical depression”. Growth, which topped 9 per cent before the financial crisis, is now just above 5 per cent. Over the summer, the country was reminded of its frailties by the world’s largest power cut: a blackout that affected some 600m people. The political system seemed paralysed and the economic reform process had stalled. A couple of recent announcements have raised hopes that reforms may restart. But the exuberant confidence of a few years back has largely disappeared.

Russia, too, is in trouble. Vladimir Putin’s return to the Kremlin provoked mass protests in Moscow. And the shale gas revolution in the US is potentially disastrous for Russia, since it is lowering the global price of gas. Russia’s central bank is predicting that the country will be running a current account deficit by 2015. The two pillars of the Putin system – an acquiescent middle class and a gusher of oil and gas money – are both looking wobbly.

Jim O’Neill, the Goldman Sachs economist who invented the term Brics, has long argued that the South African economy is not large enough to sit naturally alongside the others. Nonetheless, the country has attended the past two Brics summits; and will host the nextreflecting the group’s metamorphosis into a bloc of non-western powers.

Anyway, if the new marks of Bric status are a weakening economy and dysfunctional politics, South Africa merits its place in the group. The country’s mining industry is plagued by wildcat strikes and may well shed thousands of jobs over the coming year. Growth is likely to slip below 3 per cent – and the leadership (or lack of it) of President Jacob Zuma is causing deep anxiety.

There is no straight line that links unrest at South African platinum mines to troubles at Chinese electronics factories, via a power cut in India, a protest in Moscow and a corruption probe in Brazil. Yet there are broad themes that link the troubles of the Brics. First, declarations of “decoupling” from the west were premature. The EU remains collectively the largest economy in the world. Recession there and slow growth in the US inevitably affect the Brics.

Second, all the years of rapid growth have not brought political harmony to the Brics. One theme that I have come across repeatedly, visiting each of these countries democracies and autocracies alike – is that popular rage against corruption is central to politics. That makes both politicians and investors nervous about potential instability.

So does all this mean that the Brics story was a fairytale? Not really. It is true that the extreme version of the story – in which the Brics were portrayed as lands of untrammelled opportunity and optimism – was silly. For all their troubles, however, most of the Brics will continue to grow faster than the sicks for some years. This means that the movement of economic and political power from the west to the emerging world will remain the great story of our time.

Copyright The Financial Times Limited 2012.

Micro, Macro, Meso, and Meta Economics

Andrew Sheng, Xiao Geng

09 October 2012

HONG KONGGiven the crisis weighing down the world economy and financial markets, it is not surprising that a substantive reconsideration of the principles of modern economics is underway. The profession’s dissident voices, it seems, are finally reaching a wider audience.
For example, the Nobel laureate Ronald H. Coase has complained that microeconomics is filled with black-box models that fail to study the actual contractual relations between firms and markets. He pointed out that when transaction costs are low and property rights are well defined, innovative private contracts might solve collective-action problems such as pollution; but policymakers rely largely on fiscal instruments, owing to economists’ obsession with simplistic price theory.
Another Nobel laureate, Paul Krugman, has claimed that macroeconomics over the last three decades has been useless at best and harmful at worst. He argues that economists became blind to catastrophic macro failure because they mistook the beauty or elegance of theoretical models for truth.
Both Coase and Krugman bemoan the neglect of their profession’s patrimony – a tradition dating at least to Adam Smith – that valued grand and unifying theories of political economy and moral philosophy. The contemporary obsession with reductionist and mechanical models seems to have driven the profession from theory toward ideology, putting it out of touch with the real economy.
The simplicity and elegance of micro and macro models make them useful in explaining the price mechanism and the balance or imbalance of key aggregate economic variables. But both models are unable to describe or analyze the actual behavior of key market participants.
For example, the textbook theory of the firm does not examine the structure of corporate contracts, and delegates the study of assets, liabilities, incomes, and expenditures to “accounting.” How can firms be understood without examining the corporate contracts that bring together their stakeholdersthat is, their shareholders, bankers, suppliers, customers, and employees whose complex relationships are manifested in companies’ balance sheets and transaction flows? In concentrating on production and consumption flows, national accounts aggregate or net out such data, thus neglecting the importance of financing and balance-sheet leverage and fragilities.
Indeed, today’s mainstream micro- and macroeconomic models are insufficient for exploring the dynamic and complex interactions among humans, institutions, and nature in our real economy. They fail to answer what Paul Samuelson identified as the key questions for economics what, how, and for whom are goods and services produced, delivered and sold – and rarely deal with “where” and “when,” either.
The division of economics into macroeconomics (the study of economic performance, structure, behavior, and decision-making at the national, regional, or global level) and microeconomics (the study of resource allocation by households and firms) is fundamentally incomplete and misleading. But there are at least two other divisions in economics that have been neglected: meso-economics and meta-economics.
Meso-economics studies the institutional aspects of the economy that are not captured by micro or macroeconomics. By presupposing perfect competition, complete information, and zero transaction costs, neoclassical economics assumes away the need for institutions like courts, parties, and religions to deal with the economic problems that people, firms, and countries face.
By contrast, the economists Kurt Dopfer, John Foster, and Jason Potts have developed a Macro-Meso-Micro theory of evolutionary economics in which “an economic system is a population of rules, a structure of rules, and a process of rules.” The most important feature of a meso-economic framework is to study the actual web of contracts, formal or informal, in family, corporate, market, civil, and social institutions. Doing so provides a natural linkage between micro and macro, because the micro-level rules and institutions typically imply macro-level consequences.
Meta-economics goes still further, by studying deeper functional aspects of the economy, understood as a complex, interactive, and holistic living system. It asks questions like why an economy is more competitive and sustainable than others, how and why institutions’ governance structures evolve, and how China developed four global-scale supply chains in manufacturing, infrastructure, finance, and government services within such a short period of time.
In order to study the deep hidden principles behind human behavior, meta-economics requires us to adopt an open-minded, systemic, and evolutionary approach, and to recognize the real economy as a complex living system within other systems. This is difficult, because official statistics mismeasure – or simply miss many of the real economy’s hidden rules and practices.
For example, measurements of GDP currently neglect the costs of natural-resource replacement, pollution, and the destruction of biodiversity. Furthermore, it is common to assume in public policy that what is not easily measured statistically is insignificant or does not exist. Static, linear, and closed analyses applied to open, non-linear, dynamic, and interconnected systems are bound to be faulty and incomplete.
The British economist Fritz Schumacher understood that human institutions, as complex structures with dynamic governance, require systemic analysis. He defined meta-economics as the humanizing of economics by accounting for the imperative of a sustainable environment; thus, he included elements of moral philosophy, psychology, anthropology, and sociology that transcend the boundaries of profit maximization and individual rationality.
Similarly, Eric Beinhocker, at the newly established Institute for New Economic Thinking, argues for “a new way of seeing and understanding the economic world.” Such an approach requires incorporating psychology, anthropology, sociology, history, physics, biology, mathematics, computer science, and other disciplines that study complex adaptive systems.
We believe that the framework of “micro-macro-meso-meta-economics” – what we callsystemnomics” – is a more complete way to analyze human economies, understood as complex living systems evolving within dynamically changing complex natural systems. This is a particularly useful framework for analyzing the evolution of ancient but re-emerging economies such as China and India, which are large enough to have a profound impact on other economies and on our natural environment. 

October 8, 2012 7:09 pm
The dollar’s days as reserve currency are numbered
By Barry Eichengreen

As the International Monetary Fund and World Bank redouble their warnings on the prospects for global growth, central banks continue to flood the markets with liquidity. The US Federal Reserve began its third round of quantitative easing in September; the European Central Bank is offering unlimited purchases of bonds of troubled eurozone countries. The People’s Bank of China, responding to slowing growth, has cut interest rates repeatedly and trimmed reserve requirements.

It may seem a strange time to worry about a shortage of global liquidity. But precisely this risk looms and, if nothing is done, it will threaten 21st-century globalisation.

The global trading and financial systems require lubrication by an adequate supply of homogeneous assets that can be bought and sold at low cost and are expected to hold their value. For half a century, US Treasury bills and bonds played this role. Their unique combination of safety and liquidity has made them the dominant vehicle for bank funding globally: it explains why the bulk of foreign exchange reserves are held in dollar form, and why the role of dollar credit in financing and settling international trade far exceeds the US share of international merchandise transactions.

But as emerging markets continue to rise, the US will unavoidably account for a declining fraction of global gross domestic product, limiting its ability to supply safe and liquid assets on the scale required. The US Treasury’s capacity to stand behind its obligations is limited by the revenues it can raise, which depend, in any scenario, on the relative size of the US economy. With emerging markets’ growth outstripping that of the US, the increase in the capacity of the US Treasury to supply safe and liquid assets will inevitably lag behind the increase in global transactions.

For the US not to address its looming fiscal challenges would be more alarming still. America may not be at risk of default, because the Fed is there to backstop the market in Treasuries. But if the current situation persists, America’s sovereign obligations will not hold their value indefinitely. And if they fail to hold their value, they will not hold investors’ confidence. If they no longer offer the safety that investors have come to expect, they will not function as the stable collateral required by bank funding markets. They will not be regarded as an attractive form in which to hold international reserves. And they will not be seen as a convenient vehicle for merchandise transactions.

A serious shortage of international liquidity would spell the end of globalisation as we know it. International financial and merchandise transactions would become more expensive. Without an attractive means to hold the reserves they need to intervene in international markets, central banks and governments would be reluctant to give those markets free rein. Controls would become widespread.

The only other economies large enough to supply safe and liquid assets on a meaningful scale are the eurozone and China. Europe is currently in no position to do so. Eurozone bonds would have the requisite uniformity and liquidity but they remain a bridge too far.

China, however, has not yet succeeded in developing a liquid bond market. Beyond that, there is the fact that every reserve currency in history has been the currency of a political democracy. In a democracy, the executive is subject to checks and balances.

This reassures investors, including foreign investors, that they are safe from expropriation. It is not yet clear whether China, as a one-party state, can finesse this problem.

If they are not to come from the US, European or Chinese governments, then where can an adequate supply of safe and liquid assets come from? Some observers point to the private sector. They suggest that international transactions can be financed and settled using high-grade corporate bills and bonds.

Corporate obligations, however, lack the uniformity of sovereign debt. To use them, those engaged in cross-border transactions would have to make expensive investments in information or, worse yet, rely on the rating agencies. Either way, the costs would be significant.

Others propose empowering the IMF to create international liquidity by authorising it to issue additional special drawing rights and, more importantly, requiring the Fed to accept them in return for dollar liquidity. This is a clever scheme, but Congress will never agree to it.

The only solution, then, is for the US, Europe and China to share the burden. They can do so by putting in place measures to enhance investor confidence in their sovereign issues. And in each case the solution is at least as much political as it is economic.

The writer is professor at the University of California, Berkeley. This article is a version of a paper published by the DWS Global Financial Institute

Copyright The Financial Times Limited 2012.


The Renminbi Challenge
Barry Eichengreen
09 October 2012

SEOUL – Last month, China unveiled its first aircraft carrier, and is gearing up to challenge the United States in the South China Sea. By initiating a plan to internationalize its currency, China is similarly seeking to challenge the dollar on the international stage.
In carving out a global role for the renminbi, Chinese policymakers are proceeding deliberately. In the words of the venerable Chinese proverb, they are “feeling for the stones while crossing the river.”
The authorities’ first step was to authorize Chinese companies to use the renminbi in cross-border trade settlements. As foreign firms exporting to China accepted payment in renminbi, the currency piled up in their bank accounts in Hong Kong. That led to the next step: Foreign firms wishing to invest in China were allowed to tap those deposits by issuing renminbi-denominated bonds, and eligible offshore financial institutions were permitted to invest renminbi funds in China’s interbank bond market.
Then, last summer, China announced plans to allow banks in Hong Kong to lend renminbi to companies in Shenzhen, opening that city financially to the rest of the world. The expectation is that if financial opening works in Shenzhen, it will be implemented more widely.
Finally, as a step toward making the renminbi a reserve currency, China signed currency-swap agreements with the Philippines, South Korea, Japan, and Australia. Meanwhile, Malaysia, Nigeria, and Chile have already acquired modest amounts of renminbi reserves. Other central banks are expected to follow.
So, will China’s plan for transforming the renminbi into an international rival to the dollar succeed?

The answer, in my view, turns on how China addresses four challenges. First, China will have to build more liquid financial markets. Its bond markets remain small, and trading volume is low, because the majority of bonds are held to maturity by domestic investors. This is a matter of considerable importance to central banks, which value liquidity when deciding which currencies to hold as reserve. After all, it is the liquidity of US Treasury bonds that makes them the world’s leading reserve asset.
Second, much will depend on how China navigates the transition to a more open capital account. History is littered with financial crises occurring in the wake of precipitous capital-account liberalization. Falling prey to a crisis would not exactly encourage international use of China’s currency.
Third, the renminbi’s international and reserve-currency prospects will be shaped by how China handles its growth slowdown. The key will be whether it manages a smooth deceleration, in which case renminbi internationalization will proceed, or suffers a hard landing, in which case social unrest will intensify and all bets are off.
The last challenge can be stated as a question that is rarely posed: Is China’s political system an obstacle to renminbi internationalization?
The pound sterling and the dollar, the principal international and reserve currencies of the nineteenth and twentieth centuries respectively, were issued by democracies. Britain and the US had contested elections and political systems that limited the arbitrary exercise of executive power institutions that are absent in China’s political system.
One reason why democracy might matter for international currency status is that democratically elected governments are best able to make the credible commitments needed to develop deep and liquid financial markets. They can commit not to expropriate creditors, since the latter will vote them out of office if they do. And the same respect for creditor rights that reassures domestic investors – both official and private – as well. Might it be possible for China to establish limits on arbitrary executive power and strengthen creditor rights sufficiently without undertaking a full-fledged transition to democracy?
Until now, constraints on decision-making by the general secretary of the Chinese Communist Party, the country’s highest-ranking official, have been how to put it politely? – limited. But that is beginning to change. The general secretary is increasingly constrained by the CCP’s other institutions. The deliberations of the National People’s Congress, for example, are becoming less ceremonial and more substantive.
Other bureaucratic decision makers, for their part, are increasingly constrained by requirements of transparency and disclosure. Internet-based movements are forcing Chinese policymakers to strengthen labor and environmental standards. Why not creditor rights?
Since the early nineteenth century, the leading international currencies have been those of countries with democratic political systems, where arbitrary official action is constrained and creditors are well represented.
This does not imply that China must have a Democratic Spring before the renminbi becomes a leading international and reserve currency. But it does suggest that it will have to strengthen the powers of the National People’s Congress further and create a more transparent rules-based bureaucracy in order to achieve its monetary goals.

Copyright Project Syndicate - www.project-syndicate.org
Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His most recent book is Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.