Is Another Debt Crisis On the Way?

Kemal Derviş
A migrant worker on her tricycle at the demolition site of the Jiuxing furniture market

WASHINGTON, DC – Economic growth is accelerating across most of the world. Yet the world’s total gross debt-to-GDP ratio has reached nearly 250%, up from 210% before the global economic crisis nearly a decade ago, despite post-crisis efforts by regulators in many important economies to drive the banking sector to deleverage. This has raised doubts about the sustainability of the recovery, with some arguing that a rise in interest rates could trigger another global crisis. But how likely is that to happen?

To answer this question, one must recall that debt is both a liability and an asset. In a closed economy – and we don’t owe anything to non-Earthlings – overall debt and the corresponding assets necessarily cancel each other out. So what really matters is the composition of debts and liabilities – or, to put it simply, who owes what to whom.

High public-sector debt, for example, signals the possible need for tax increases – the opposite of the tax legislation being advanced by Republican legislators in the United States – and/or higher interest rates (real or nominal, depending on monetary policy and inflation). If debt is owed largely to foreign lenders, interest-rate risk is compounded by exchange-rate risk.

For private-sector debt, much depends on its type: the hedging sort, where a debtor’s cash flow covers all obligations; the speculative type, where cash flow covers interest only; or the Ponzi kind, where cash flow does not even cover that. As the late American economist Hyman Minsky explained, the higher the share of debt that falls into the speculative or Ponzi categories, the higher the risk that a confidence shock will trigger a sudden wave of deleveraging that quickly morphs into a full-blown financial crisis.

For both public- and private-sector debt, maturities also play an important role. Longer maturities leave more time for adjustment, lowering the risk of a confidence shock.

Yet while it makes little sense to focus on simple aggregate figures, both public institutions and private researchers tend to do precisely that. Consider the coverage of the Greek debt crisis. Headlines tracked the debt-to-GDP ratio’s climb from 100% in 2007 to 180% this year, yet little attention was paid to private-sector debt. And, in fact, as foreign public creditors replaced private debt holders and interest rates were lowered, Greece’s overall debt, while still high, became more sustainable. Its continued sustainability will depend partly on the trajectory of Greece’s GDP – the denominator in the debt ratio.

A similar mistake is made in assessing China’s debts, about which the world is most concerned.

The figures are certainly daunting: China’s debt-to-GDP ratio now stands at about 250%, with private-sector debt amounting to about 210% of GDP. But about two-thirds of the private-sector debt that is defined as bank loans and corporate bonds is actually held by state-owned enterprises and local-government entities. The central government has considerable control over both.

For China, the biggest risk probably lies in the shadow banking sector, on which reliable data are not available. On the other hand, a significant share of the growth in private debt ratios in recent years may be a result of the “formalization” of parts of the shadow banking system – a trend that would bode well for economic stability.

And there is more good news for China. Most Chinese debt is held in renminbi; the country possesses massive foreign-exchange reserves of close to $3 trillion; and capital controls are still effective, despite having been eased in recent years. The country’s leaders thus have a public-policy war chest that they can use to cushion against financial turmoil.

Among the rest of the emerging economies, there are some sources of concern. But, overall, the situation is relatively stable. Though private-sector debt has lately been rising, its levels remain tolerable. And public-sector debt has been growing only moderately, relative to GDP.

As for the advanced economies, there is little reason to believe that a debt crisis is around the corner in Japan. In the US, public debt is set to increase, thanks to the impending tax overhaul; but the blow will be cushioned, at least for the next year or two, by continued growth acceleration. And though low-quality assets held by the banking system are likely to impede Europe’s recovery, they are unlikely to spark a financial crisis.

In short, the world does not seem to face much risk of a debt crisis in the short term. On the contrary, the stage seems to be set for continued increases in asset valuations and demand-driven growth.

That said, geopolitical risks should not be discounted. While markets tend to shrug off localized political crises and even larger geopolitical challenges, some dramas may be set to spin out of control. In particular, the North Korean nuclear threat remains acute, with the possibility of a sudden escalation raising the risk of conflict between the US and China.

The Middle East remains another source of serious instability, with tensions in the Gulf having intensified to the point that hostilities between Iran and Saudi Arabia and/or turmoil within Saudi Arabia are not unthinkable. In this case, it is Russia that might end up clashing with the US.

Even barring such a major geopolitical upheaval, which would severely damage the global economy’s prospects in the short run, serious medium- and long-term risks loom. Rising income inequality, exacerbated by the mismatch between skills and jobs in the digital age, will impede growth, unless a wide array of difficult structural reforms are implemented, including reforms aimed at constraining climate change.

As long as the geopolitical situation remains manageable, policymakers should have time to implement the needed structural reforms. But the window of opportunity will not stay open forever. If policymakers waste time on trickle-down sophistry, as is happening in the US, the world may be headed for severe economic distress.

Kemal Derviş, former Minister of Economic Affairs of Turkey and former Administrator for the United Nations Development Program (UNDP), is Senior Fellow at the Brookings Institution.

U.S. Tax Reform Has Europe Worried

Suddenly, the world’s biggest economy has lower corporate rates than the Continent’s giants.

By Joseph C. Sternberg

Photo: Getty Images/iStockphoto 

The tax reform passed in Washington this week is a gauntlet thrown down to Europe’s big taxers.

This column warned of that possibility in March, but the reality has turned out worse for Europeans than seemed likely nine months ago. Once President Trump signs it, the law will open a new battleground for competition with Europe’s highest-taxing governments. It also challenges Europe’s fundamental attitude toward taxation.

The reduction in tax rates is only part of it. The bill will cut the top federal corporate tax rate to 21% from 35%, bringing the average effective rate, including state and local taxes and accounting for deductions, down to around 23% from around 39%. That doesn’t sound so bad for Europe. The U.S. will only run roughly even with the European Union’s average effective rate of around 21%.

That EU average, however, conceals notable geographic diversity, embodying Europe’s grand tax bargain with itself: The smaller or the poorer a country is, the lower it can cut its tax rate.

European leaders gripe about Ireland’s 12.5% corporate rate. But they tolerate it because Ireland’s small size limits its capacity to draw business away from big countries such as France, Germany, Italy and Spain, whose tax rates approach or even exceed 30%. The same holds for the EU’s less-affluent formerly communist member states, whose statutory rates generally max out at 22%.

No EU rule outright prohibits a large member country from cutting its corporate rates, but in practice these states haven’t needed to consider such steps, because their size offered a form of comparative advantage that offset their high taxes. Britain, with a top rate of 17%, positioned itself as the main big-economy exception, an outlier as with most other matters European.

But being the big dog in Europe is no defense when the world’s largest and most dynamic economy is slashing its tax rates. A 21% federal rate in the U.S. will be impossible to ignore, given the incentives it creates for European companies to invest in America instead of at home. That’s the main conclusion of a report released last week by Germany’s Center for European Economic Research, and lest anyone in Berlin miss the point, the title of the press release was blunt: “Germany Loses Out in U.S. Tax Reform.”

Intriguingly, that assessment and others like it rely on estimates not just of the behavior of American companies—Google and Facebook are the names that most often come up in global tax debates—but also of the response from European companies to U.S. tax reform. As American accountants and tax lawyers sharpen their pencils, German executives will start asking themselves: Why build our next factory in Germany, with a 31% statutory corporate rate, more-onerous labor regulations and an aging population, when America beckons with a 21% rate, better demographics and the world’s largest market?

It’s hard to overstate what a shock to the European system this is. The Continent has long labored under the conviction that Europe’s main tax problem was that companies weren’t paying enough. Thus the biggest tax innovations in recent years have been new laws to discourage companies from availing themselves of “too many” legal breaks in low-tax countries. Brussels also has creatively interpreted its antitrust laws, claiming that lower taxes amount to unlawful “state subsidies.”

The conceptual problem with this approach, which the Organization for Economic Cooperation and Development describes as combating “base erosion and profit shifting,” is that it’s blind to incentives. Most European tax-setting starts from the premise that the tax base is fixed, and the only thing that matters is that each national government get its “fair” share. The primary purpose of taxation, European officials seem to believe, is funding a heavily redistributive welfare state, never mind the consequences for growth.

Washington’s new approach couldn’t be more different. The U.S. reform acknowledges that tax incentives matter for investment, job creation and economic growth. One implication of America’s reform is that if Europe wants to have anything left to redistribute in this newly competitive world, it’s going to have to start paying attention to growth incentives.

Fortunately, this column’s other prediction from March also is coming true. Deregulation, improving sentiment and, now, tax reform are reviving the U.S. economy, which is on track to exceed 3% growth in 2018. This is lifting Europe’s long-suffering economies and providing fiscal headroom for tax reform. Europe even has a few leaders, such as French President Emmanuel Macron, who are prepared to push aggressive tax cuts. There will rarely be a better moment for a European tax revolution—a point for voters and politicians alike to remember.

We Give Up! Part 2: Consumers And Corporations Join The Debt Orgy

Late cycle behavior is everywhere these days. Governments have stopped worrying about deficits, and now the rest of us are apparently joining the orgy.

Corporations, for instance, are buying each other out – mostly with borrowed money – at a record pace:

December’s $361 Billion Deal Haul Is the Busiest in a Decade 
(Bloomberg) – Just as most people are packing up for Christmas, dealmakers across the world are rushing to finish up a slew of transactions in industries ranging from consumer to telecom and health care to gambling. 
Companies have announced about $361 billion of mergers and acquisitions this month, making it the busiest December in at least 12 years, according to data compiled by Bloomberg. On Friday, the last work day before bankers and executives break for the holiday, GVC Holdings Plc of the U.K. agreed to buy bookmaker Ladbrokes Coral Group Plc for as much as 4 billion pounds ($5.4 billion), Deutsche Telekom AG said it will buy Liberty Global Plc’s Austrian unit and Roche Holding AG announced the $1.7 billion acquisition of U.S. biotech Ignyta Inc. 
“We have announced three new takeover deals in the last month, and we have worked on a range of M&A continuing through the holiday,” said Gavin Davies, global head of M&A at law firm Herbert Smith Freehills in London. “Clients want to get deals done, for growth, for rationalization, and to get ahead of tech disruption, and they are working hard to make those deals happen‎, despite a more challenging political and economic M&A environment.” 
Europe has been a hot spot for M&A this year on the back of a more stable economic outlook and growing confidence. Still, the U.S. has seen the biggest transactions in December, led by CVS Health Corp.’s $67.5 billion purchase of Aetna Inc., creating a health-care giant that will have a hand in everything from insurance to the corner drugstore. Also in December, Walt Disney Co. agreed to acquire a large portion of media mogul Rupert Murdoch’s 21st Century Fox Inc. in a $52.4 billion deal. 

The busy end of the year may spill over to January and beyond, especially in Europe, according to Cathal Deasy, head of M&A for Europe, the Middle East and Africa at Credit Suisse Group AG.
“Against a backdrop of strong macro fundamentals in Europe, boardroom confidence and supportive capital markets, we are positive on the outlook for European M&A in 2018,” said Deasy. “The strong finish to 2017 gives us further conviction.”

Consumers have lately caught the same fever, and are enthusiastically buying stuff they don’t need with money they don’t have:

U.S. Consumer Spending Rises in November, Savings Rate at 10-Year Low
(Wall Street Journal) – Americans spent more and saved less in November, a sign that low unemployment, robust consumer confidence, the prospect of tax cuts and buoyant financial markets are underpinning a strong holiday shopping season.

Americans are saving at the slowest pace in a decade, likely in anticipation of continued job and wealth gains as stock indexes barreled to new records last month and the unemployment rate stood at a 17-year low. The personal saving rate in November was 2.9%, the Commerce Department said Friday, falling below 3% for the first time since November 2007, just before the last recession hit. 

Meanwhile spending was strong in a key month of the holiday season, outpacing income gains. Personal consumption expenditures, a measure of household spending, increased a seasonally adjusted 0.6% in November from the prior month. Personal income, reflecting Americans’ pretax earnings from salaries and investments, rose 0.3% in November from the prior month. 
The income data fell short of economists’ expectations, while the spending data exceeded them. 
“Very elevated consumer confidence makes people more comfortable saving less,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, said in a note to clients.  
Consumer spending accounts for more than two-thirds of U.S. economic output, and Friday’s report suggests momentum was strong as the final quarter of the year progressed. The latest spending data shows increased outlays in November were driven by spending on goods like recreational items and vehicles, boding well for holiday retailers.

The theme running through both of the above stories is repetition: The same let-it-all-hang-out debt-driven enthusiasm that prevailed at the end of the previous bubble has taken hold at the end of this one.

What happens next? If history is still a useful guide, growth will spike (since spending borrowed money counts as “growth” in the Keynesian economics practiced by most policy makers), leading to higher interest rates which raise the interest costs of over-indebted governments, businesses and individuals, which at last pops the bubble and sends us back to 2008.

At which point we’ll see lots of articles explaining how corporations and consumers haven’t been this cautious for at least a decade.

Uber: The uncomfortable view from the driving seat

The ride-sharing group faces its biggest challenge: keeping its drivers, some of whom sleep in their cars to make ends meet

In the airport waiting lot in San Francisco, there’s one topic that always sets Uber drivers’ tongues wagging: where are the best spots to spend the night sleeping in the car.

There’s a McDonald's just down the street that has a spacious parking lot, and drivers say they can stay there overnight, unbothered. For those doing bar runs, there’s a Safeway in the Castro district with room to park, although security guards there recently started cracking down on drivers sleeping in their vehicles. The parking lot of Planet Fitness, a gym, is also a popular spot, because drivers can easily take a shower in the morning.

“It sucks. Uber made us do this,” grumbles Edward, a driver who lives in central California and commutes 100 miles to work in San Francisco, often staying overnight in his car so that he can work as much as possible. He moved to the US 10 years ago from Iraq, where he worked as a translator for the US army. He and some other Iraqi drivers share a pizza in the airport lot, waiting for their next ride.

Ever since it was founded in 2009, Uber has had a single-minded focus on one thing: the passenger. As the company grew to more than 70 countries, and earned a valuation close to $70bn, passengers’ rides got better, faster and cheaper, with usage soaring as a result.

But during Uber’s years of breakneck growth, the drivers were left behind. Lawsuit piled upon lawsuit, alleging that drivers were misclassified, or that their pay was not calculated correctly. Meanwhile lots of drivers voted with their feet: nearly half of Uber drivers in the US quit in less than a year, according to company statistics collected in 2013-2015. More and more have started driving for rival Lyft, which has been gaining market share in the US, partly thanks to its pro-driver reputation.

Oneyda Oliveira, who has been driving for Uber on and off for a year, says: 'The whole "independent contractor" thing is BS, Uber completely manipulates the platform' © Jason Henry/FT

Even Uber executives have started to admit there is a problem. “These drivers are our most important partners. But historically we haven’t done the best job of honouring that partnership,” said Aaron Schildkrout, head of driver product at Uber. This summer the company launched a campaign to try and repair the frayed relationship.

Over the past eight months, Uber has been engulfed in a corporate drama that is unlike anything Silicon Valley has ever seen. Its former chief executive Travis Kalanick was ousted by investors in June, leaving the company leaderless until Dara Khosrowshahi was appointed in August. He has quickly had to put out one fire after another, including a decision by London’s transport authority to revoke Uber’s licence in its most important European market and the departure of its head of northern Europe.

This week, Uber’s board unanimously approved sweeping governance changes that will reduce Mr Kalanick’s influence, and lay the groundwork for a major investment deal led by SoftBank. That deal would strip “supervoting” shareholders of their extra voting rights, a highly unusual move, and helps cement Mr Khosrowshahi’s leadership. Equally radical changes are under way inside the company, where revelations about harassment and the departure of many top executives have led to soul-searching and low morale.

It is against this chaotic backdrop that the company is trying to turn over a new leaf with its drivers. In a broad sense, drivers are the biggest costs for every Uber fare: in the second quarter of this year, Uber’s global fares hit $8.7bn, and about $7bn of that went to drivers. The company’s losses narrowed to $645m in the quarter.

Uber has more than 2m drivers around the world, and its flexible, work-when-you-want platform is seen by some as pioneering a new model for the future of employment.

The company does have some converts among its drivers. Victor Liuzzi, a former cab driver, says he likes driving for Uber because he can make twice as much as he did in a taxi. “Now I work on my own schedule,” he says as he takes a break to clean his windshield, recalling the days when he used to get up at 3am to fetch his taxicab. “There is freedom, there is more money.”

Victor Liuzzi used to be a cab driver and now works for Uber: 'There is freedom, there is more money' © Jason Henry/FT

One benefit of the system is that pretty much anyone can sign up to work, as long as they can drive and pass the background check, making Uber an employer of last resort for many. But the system’s costs have been much less well understood — particularly by drivers.

As independent contractors, drivers are responsible for keeping track of expenses, filing taxes, and all the paperwork of running a small business. Many of them say they have not filed tax returns for their Uber earnings, and most do not keep track of their net income. Ronnie Fernandez, who has been driving for Uber since 2015, was recently hit with a $5,000 tax bill from his previous Uber earnings that he could ill-afford, as he works to support four college-age children.

Mr Fernandez, who is looking for another job, says low pay is the drivers’ biggest problem. “If you compare all your costs, the gas you buy, the maintenance, the oil changes, you are not making money,” he says. Because Uber drivers are not employees, they are not entitled to San Francisco’s minimum wage of $14 an hour — and most say that, after costs, they are making less than that. Harry Campbell, who drives for Uber and Lyft and runs a consulting service, The Rideshare Guy, says: “The average driver doesn’t have a great sense of what their costs are.”

The drivers that struggle most with the system are usually those who are in a precarious situation to begin with, and have the fewest opportunities to find other work. Uber has tried to make it as easy as possible for anyone to start driving — the company even offers debit cards to help drivers fill up their tanks.

“Recently I haven’t had the extra money for my gas,” explains Anthony who lives in San Jose. He relies on the Uber gas debit card, which allows him to spend up to $200 on petrol, and deducts it from his earnings. “That gets expensive because you don’t think about how much you are using,” he explains. “The next thing you know they are snatching $200 out of there, and you are like, ‘What?’ So it becomes a disappointing thing.”

Anthony often drives around Silicon Valley, picking up tech workers from Google and Facebook who choose to take an Uber home after work, or doing late-night restaurant runs for UberEats. But a few weeks ago he had to stop driving because his car registration expired and he did not have the $350 needed to update it. He got a job painting churches in the meantime. “I kinda miss my Uber driving,” he says.

On top of concerns over pay, many drivers express a wider frustration. “In the past it always felt like I was just a number on a spreadsheet to Uber,” says Mr Campbell. “It felt like a very transactional relationship.”

Uber has been trying to fix some of these problems. A campaign has introduced new features such as compensating drivers for time spent waiting, adding a 24/7 helpline and paying extra for carpool rides. Uber also added a tipping option to the app, following its rival Lyft.

A driver waits for fares at San Francisco airport © Jason Henry/FT

Senior Uber executives say this is part of an effort to change its rider-focused mindset. “The system kept getting more efficient, and we gave all the upside to the consumers. Drivers’ earnings were flat. That’s not right,” says one former Uber executive.

The changes, which have delivered a small boost to driver earnings, are in part a response to the inroads made by Lyft. “It used to be that Uber was winning this race by having more drivers on the road,” says Max Wolff, chief economist at Disruptive Technology Advisers, a boutique bank. “But as the rideshare consumer becomes more sophisticated, they become more tuned into the quality of the experience, not the quantity of cars.” This means it is important for ride-hailing companies to not only have the most drivers, but also to have the best.

Forces outside of Uber could bring about even bigger change, as multiple employment lawsuits argue that Uber drivers should be classified as employees or workers, rather than independent contractors.

Drivers have mixed feelings about their status. “The whole ‘independent contractor’ thing is BS,” says Oneyda Oliveira, who has been driving for Uber on and off for a year, and previously worked as an executive assistant. “Uber completely manipulates the platform. They control everything. If you cancel a ride, if you accept a ride, everything is based on ratings. And they deactivate you without warning,” she says.

Several drivers say that sense of control is heightened by the way the app starts to govern their every move as it tells them where to go and who to pick up. “It gets to a point where the app sort of takes over your motor functions in a way,” says Herb Coakley, a longtime driver who developed an app that helps drivers simultaneously drive for both Uber and Lyft.

“It becomes almost like a hypnotic experience,” he explains. “You can talk to drivers and you’ll hear them say things like, I just drove a bunch of Uber pools for two hours, I probably picked up 30-40 people and I have no idea where I went.

“In that state, they are literally just listening to the sounds [of the driver’s apps]. Stopping when they said stop, pick up when they say pick up, turn when they say turn. You get into a rhythm of that, and you begin to feel almost like an android,” he says.

Adding to the feeling of control is the way that Uber uses an ever-changing set of bonus targets that are designed to get drivers to complete just a couple more rides. Called “quests”, the bonus payments are at different levels for each driver, as Uber’s algorithms assess what sort of financial incentive might lure each individual to work just a bit more.

Full-time drivers in San Francisco say they rely on bonuses to make ends meet — incentive payments can be worth 25-30 per cent of their weekly earnings. But hitting the goals can be demanding, often requiring long hours in the car, seven days a week.

Ms Oliveira says she is rarely able to hit the lucrative bonuses. Still, she keeps driving. “Uber became my life,” she sighs. “You just get addicted to it.” She even finds herself compulsively checking the app when she’s not working. “It’s frustrating, but we need the job.”

Status issue: The fight to be an employee

Few American critics of Uber are as outspoken, or as powerful, as Shannon Liss-Riordan. The Boston-based lawyer is spearheading a class-action lawsuit that accuses the company of mis-classifying its drivers as independent contractors, when they should be employees — a charge Uber denies.

“Uber has taken advantage of this vast workforce for whom it has ignored all wage and employment laws,” she explains. “Its business is built on the backs of these workers.”

She has already won similar lawsuits against big companies including FedEx, and some smaller ones, such as a strip club that incorrectly classified its dancers as independent contractors.

Her class action suit against Uber, which represents drivers in California and Massachusetts, has been winding its way through the courts over the past few years, with ups and downs along the way. An upcoming ruling in the US Supreme Court, which will decide whether arbitration clauses prevent participation in class action lawsuits, could have a big impact on determining the scope of the “class” of drivers participating in the case against Uber.

Similar issues over worker classification have been cropping up in other Uber markets as well. In the UK, a tribunal last year found that its drivers should be considered workers rather than employees.

The judge in the case wrote: “The notion that Uber in London is a mosaic of 30,000 small businesses linked by a common ‘platform’ is to our minds faintly ridiculous.”

Uber is appealing the ruling. It argued in court last month that its drivers were no different than minicab drivers, who have long been independent.

However, other UK minicab companies have come under scrutiny recently, with a tribunal ruling last month that drivers for Addison Lee, a minicab group, should be considered workers, rather than independent contractors.