China: an economy in coronavirus quarantine

If lockdown remains and infections continue to rise, shock to the rest of world could be significant

Tom Mitchell and Don Weinland in Beijing and Brendan Greeley in Washington

© Kevin Frayer/Getty Images | Beijing's business district is empty as coronavirus keeps people off the streets and businesses closed

This was the week that Chinese industry and commerce was supposed to stir back to life after an extended new year holiday triggered by the rapid spread from Wuhan of the highly contagious coronavirus.

But Lü Hua, who owns a factory making car parts in the southern city of Shenzhen, is still waiting for local government approval to reopen the plant, which exports 95 per cent of its output.

“We have prepared everything based on government guidelines — masks, hand sanitiser and so on,” he says. “But one day before reopening, we got a notice from the government that the policy changed. We need to fill a bunch of new forms and apply again. The government will then send an inspection team.”

He adds: “We’ve been calling and following up. But there is nothing we can do. They just told us to wait. It’s really hard to explain to our clients.”

A member of the media has his temperature checked before proceeding to a tour of a factory operated by Dasheng Health Products Manufacturing Co. in Shanghai, China, on Friday, Jan. 31, 2020. People across the globe are stockpiling facial masks to protect themselves from the new coronavirus, depleting online malls and store shelves from California to Beijing. Photographer: Qilai Shen/Bloomberg
Virus test: more than 64,000 people have so far been found to have Covid-19 in China alone

Even in Beijing, with a population of 22m, the response has been fitful. The Jing-A brewery, situated in one of Beijing’s glitzier shopping districts, remained open through some of the earliest and worst days of the epidemic, only to close on February 10 when district officials told staff they could not serve parties of more than two people.

With more than 64,000 cases of the virus in China alone, the prolonged shutdown in large parts of the country is beginning to cast a shadow over the rest of the global economy.

The Chinese economy is now more than four times larger than it was at the time of the 2002-03 Sars outbreak — and it is considerably more important as a source of demand and for its central role in many industrial supply chains.

As the immediate outlook for the Chinese economy worsened this week, shipping rates fell to record lows, oil demand is now expected to grow at its slowest rate in almost a decade and Fiat Chrysler warned it is weeks away from shutting a European plant because of supply shortages. The luxury industry is terrified about the idea of a long lull in Chinese tourists travelling abroad.

G0319_20X Bar chart showing Expected impact of the virus on global growth

The possibility of a deep slowdown in China comes at a time when growth in the eurozone is already limping and when US president Donald Trump is banking on the avoidance of an economic hiccup as he campaigns for re-election.

“Prior to the coronavirus outbreak, there had been signs that the worst was over for both world trade and the global manufacturing sector,” says Ben May, director of global macro research at Oxford Economics. “However, this tentative optimism has been dashed by the current disruption.”

In China, the evidence of a sharp deceleration is more than just anecdotal — it is starting to appear in broader indicators on economic activity.

On Wednesday national passenger traffic was down 85 per cent compared with the same day a year ago, according to data compiled by Morgan Stanley, indicating that workers were not returning to their posts at factories around the country after the Chinese new year break.

As of midweek, daily coal consumption at six large power generation groups was down 43 per cent year on last year, a sign that factories were not responding to directives from President Xi Jinping to restart production lines.

A passenger walks through an empty carriage on a high-speed train destined for Guangzhou as it leaves the station in Shanghai, China, on Tuesday, Feb. 11, 2020. The death toll from the coronavirus climbed above 1,000, as the Chinese province at the epicenter of the outbreak reported its highest number of fatalities yet. Photographer: Qilai Shen/Bloomberg
On February 12, passenger traffic in China was down 85 per cent compared with the same day a year ago, according to data compiled by Morgan Stanley

“Xi has reiterated that [the government] will stick to its growth targets despite this whole situation,” says Raymond Yeung, chief economist for greater China at Australian bank ANZ. “At the moment, they need to accept that hitting those targets will be very difficult.”

He notes that the global financial crisis pulled down Chinese growth in gross domestic product to 6.4 per cent in the first quarter of 2009, cutting it in half from the same period a year earlier. ANZ predicts growth could fall to as low as 3.2 per cent this quarter, half the rate for the first three months of 2019.

Others think that even this downgrade is wildly optimistic. “I can’t believe that it’s going to grow by even 2 per cent,” says Jörg Wuttke, head of the EU Chamber of Commerce in China.

G0319_20X Bar chart showing how China is critical for industry supply chains

Mr Wuttke notes supply shortages of basic materials such as packaging are common for many companies. Other challenges range from 14-day quarantines for truck drivers as soon as they return home from a trip, to a myriad of new special permits required by officials across the country as they attempt to protect their fiefdoms from the virus.

“Every city has turned into a little Alamo,” he adds. “You need a lot of permits just to get things from point A to point B. It is unbelievable the challenges logistics departments are dealing with.”

In this Feb. 10, 2020, photo released by Xinhua News Agency, Chinese President Xi Jinping gestures near a heart shape sign and the slogan "Race against time, Fight the Virus" during an inspection of the center for disease control and prevention of Chaoyang District in Beijing. China's daily death toll from a new virus topped 100 for the first time and pushed the total past 1,000 dead, authorities said Tuesday after leader Xi Jinping visited a health center to rally public morale amid little sign the contagion is abating. (Liu Bin/Xinhua via AP)
© Liu Bin/Xinhua/AP

Ether Yin at Trivium, a Beijing-based consultancy, says “officials are in a tough spot — they need to make sure they stop the spread of the virus in their jurisdictions. At the same time, they are under pressure to get things back to normal.”

Earlier this week Huang Qifan, a former mayor of Chongqing and an architect of Shanghai’s financial reforms in the 1990s, warned that the economic consequences of the disease outbreak could be “scarier than the epidemic itself”.

“Value chain and supply chain disruptions [stemming from the epidemic] will have a much larger impact than China-US trade frictions,” state media quoted Mr Huang as saying, referring to the almost two-year trade war with the US. “Once supply chains are relocated and replaced, it’s extremely difficult to get them back.”

When Mr Xi finally emerged after weeks of relative invisibility to interact with those on the front lines of the coronavirus epidemic on February 10, his belated appearance was almost entirely about politics.

China’s president urged the masses to have faith that the battle against the “devil virus” would be won. He lauded the heroic doctors and nurses who combat the highly contagious respiratory illness every day. Only towards the tail-end of its 20-minute lead segment on Mr Xi’s activities that day did China Central Television’s main news programme mention in passing his instructions on the economy, saying mass lay-offs must be avoided.

G0319_20X Bar chart showing China's share of global goods imports

But by Wednesday, as it became clear that efforts to restart the world’s second-largest economy were faltering, the party’s messaging started to become much more focused on the economy.

“We must correct overreactions [to the epidemic] and avoid an oversimplified approach involving blanket closures or suspensions of business,” state media quoted Mr Xi as saying at a meeting of the party’s most powerful body, the politburo Standing Committee.

Chen Long at Plenum, a Beijing research group, notes that China is the world’s largest importer of a wide range of products from raw commodities such as crude oil to “intermediate goods” used in the manufacture of everything from hair dryers to automobiles.

Outbound tourism, worth $278bn in 2018, is also drying up as countries impose increasingly stringent bans on visitors from China.

Beijing’s economic policy response to the epidemic has so far been modest, in keeping with the government’s longstanding campaign to rein in high debt levels and stamp out risky financial practices.

“The last resort would be easing property policies but I don’t think Beijing has made up its mind,” says Mr Chen. “It is just too risky to boost leverage.”

Yu Yongding, a prominent Chinese economist and former central bank adviser, says Mr Xi’s administration will need to be bolder.

“The battle against the coronavirus undoubtedly will be very costly and damaging to what China has achieved so far in reining in financial risks over recent years,” he says. “But in the face of the deadly virus, all problems of debt, inflation and asset bubbles are secondary.

“China can worry about these later when the situation has calmed down,” he adds.

It is more difficult to tell how severe an effect the virus will have on US growth. “We know that there will be very likely some effects on the United States,” Jay Powell, US Federal Reserve chairman, said during congressional testimony on February 11. “The question we’ll be asking is: Will these be persistent effects that could lead to a material reassessment of the outlook?”

Customers walk past near empty shelves in frozen food refrigerators at a supermarket in Shanghai, China, on Wednesday, Feb. 12, 2020. The Chinese Communist Party’s top decision body urged the nation to meet its economic targets this year even amid the downward pressure from the coronavirus shutdowns. Photographer: Qilai Shen/Bloomberg
Empty shelves in a Shanghai supermarket reflect the sharp decline in economic activity in China

According to UBS, the most likely ways in which the virus could dampen US growth are a decline in Chinese tourism and weaker demand for American exports. But neither of these is likely to have a major effect, provided the outbreak is contained relatively quickly.

China lags well behind Canada, Mexico and the UK in sending visitors to America. Chinese tourist flows to the US, at 3m people a year are roughly equal to those from Japan or South Korea. But as an export market, China is much more important to the US. Only Canada and Mexico buy more American products, and Chinese demand tends to be concentrated on higher value US goods such as aircraft, machinery, medical instruments and cars.

Even so, the US is not nearly as vulnerable to a downturn in Chinese demand as more export-driven economies such as Germany. America’s booming consumer economy and a supportive Federal Reserve protected it from a global slowdown in trade in 2019.

Ultimately, the extent of the economic damage wreaked by the coronavirus, both within China and elsewhere, will hinge on how quickly Mr Xi’s administration can nudge the workforce back to action while also tackling the rise in infections.

Rodney Jones at New Zealand -based Wigram Capital Advisors says the rate of spread of the virus is still very worrying and that aside from central Hubei province, where the epidemic began, “other provinces are unwilling to admit the severity of the problem”.

“The risks are greater than the market is assuming,” he adds. Only in March, Mr Jones predicts, will the epidemic “have either proved to have been a temporary shock that is already over, or it will have evolved into a more profound economic and human shock.”

Additional reporting by Xinning Liu


Britain’s regulatory-divergence dilemma

There will be costs to diverging from EU regulation. But there will be benefits, too

BRITAIN’S DEPARTURE from the EU, says Sir Bernard Jenkin, a Conservative MP, reminds him of an experiment his grandfather once carried out on a pet pike. He put a glass wall in the middle of the fish’s tank, thus halving its swimming space. After ramming the glass, “thunk, thunk” for a while, the fish adapted to its diminished quarters. But when the wall was removed, it continued making tight circles in half of the tank: it never grasped that its freedom had been restored.

On January 31st Britain leaves the EU. It goes into a sort of limbo—a transition period—until the end of 2020, when in dozens of areas, from trade, migration, environmental rules and farming to financial services, data policy, regional subsidies and state aid, the country’s freedom to run its own affairs will be constrained only by its ambitions to do deals with other countries. The big question, says Sir Bernard, an enthusiastic Brexiter, is whether it can remember how to roam.

Boris Johnson, the prime minister, is bent on taking full advantage. There will be crowd-pleasing changes—taking back control of the VAT regime will allow the Treasury to remove the levy on tampons, for instance—and weightier divergences. Earlier this month Sajid Javid, the chancellor of the exchequer, made clear that there will be no alignment with EU regulations once Britain is out of the single market and customs union, adding that there would be winners and losers.

The riposte from Brussels to Mr Javid’s remarks was swift. Ursula von der Leyen, president of the European Commission, repeated that greater regulatory divergence would necessarily mean a more distant trading partnership with the EU. The government’s own economic analysis of Brexit last year put the long-term loss in GDP per person of a close relationship (like Norway’s) at some 1.4%, against a loss of 4.9% for a more distant one. The difference is a proxy for the cost of regulatory divergence.

British manufacturers protested. The car and aerospace industries, chemicals and pharmaceuticals firms, the Confederation of British Industry (CBI) and Unite, the biggest trade union, all talked of the adverse consequences of divergence. Ministerial promises only to diverge when that is in Britain’s interests do not much reassure them. The only way to avoid customs, rules of origin and regulatory border checks is to make legally binding commitments to observe all current and future EU rules, which the government has rejected.

Some 80% of the auto industry’s output is exported, and over half those exports go to the EU. Regulatory divergence would mean cars (and car parts) being subject to compliance checks in both directions, increasing costs and delays. Some 60% of the chemicals industry’s output goes to the EU.

But there is bound to be divergence. Regulation is the expression of public attitudes to business and the state; since those are different all over the world, Britain’s rules will become increasingly British. And there could be benefits as well as costs.

Regulation in Britain tends to be based on principles, rather than prescription; the country’s common-law system builds on it over time. European regulation, by contrast, is more codified, which leads to a lot of prescriptive detail. The very word “directive” strikes fear into executives, says Helena Morrissey, a City financier.

Financial firms get snarled up in detailed EU rules. The cost to the British asset-management industry of obeying the revised Markets in Financial Instruments Directive, which came into force in 2018, for example, is an estimated €2.5bn ($2.75bn). The burden of regulation falls especially heavily on small firms, discouraging enterprise.

Britain’s new freedom to regulate flexibly and nimbly will be invaluable, says Rishi Sunak, chief secretary to the Treasury and a rising star in government. A particular opportunity, says the boss of a London-based exchange, would be to adopt America’s regime for regulating derivatives, considered the best in the industry. The EU recognises it, so London could ask to be treated in the same way, he says.

Two of the buzziest areas of finance are fintech and sustainable finance. The City has a better chance of getting ahead in those areas if it has its hands on its own regulatory levers, says Jonathan Hill, a Conservative politician and former financial-services commissioner for the EU.

One approach likely to be used more widely is the “regulatory sandbox”: rather than banning an innovation or approving it for use across the system, regulators allow it to be used on a limited scale and monitor its effects. If the risks seem low, the new practice is allowed wider application.

Britain’s different political priorities are also likely to show up in regulatory divergence. Britons have, for instance, a softer spot than most Europeans for their fellow creatures; hence rumours that Mr Johnson is planning to ban exports of live farm animals for slaughter.

Of more economic significance is the divergence in attitudes to finance. The long campaign to introduce a financial transactions tax has more takers in the EU than in Britain. And hostility to wealth is probably more pronounced within the EU than in Britain, hence one of the most disliked pieces of EU regulation—a cap on bankers’ bonuses introduced in 2014, which forces banks to raise the proportion of their costs that are fixed, thus potentially making profits more volatile.

The EU’s instincts, meanwhile, are more protectionist than Britain’s. Britain is, for instance, already moving away from the EU requirement that only airlines 50% owned by local companies have unrestricted rights to fly within the EU. And the noises coming out of the commission about the need to foster local tech titans suggests that the gap on this front may widen.

In science, too, Britain is likely to diverge from Europe. Britain’s empirical approach to intellectual life makes it more permissive, while the “precautionary principle”, for which the continent has more time, tends to be inhibitive. In July 2018, for instance, the European Court of Justice (ECJ) ruled that plants obtained by modern forms of mutagenesis, of which gene-editing is an example, fall under the EU’s GMO directive from 2001.

The GMO legislation, because it is complicated and expensive to comply with, amounts to a de facto ban. Sir Mark Walport, chief executive of UK Research and Innovation, attributes this hostility to GMOs in part to personal beliefs about the legitimacy or otherwise of fiddling with nature. “Now we can work in the context of UK society which in general thinks very positively about science.”

Britain is leaving the EU just as the bloc gets ready to clamp down on artificial intelligence (AI). It may impose laws for developers in what it considers high-risk sectors such as health care and transport. Many people will welcome the EU taking a robust stance on controversial AI products like facial recognition. But some worry that Brussels is rushing to regulate AI without stopping to consider the trade-offs. Post-Brexit, Britain will write its own regulations on AI and on data. Eventually there will be three regimes in the world—the EU’s, America’s and China’s. Britain’s rules could end up closer to those of America than the EU.

London’s tech industry is also excited about what a trade deal with America might bring in the field of digital services, says Nicole Sykes, head of EU negotiations for the CBI. “We could create a more stable environment for technology firms large and small,” says Stephen Booth, director of Open Europe, a Eurosceptic think-tank.

The globalist wing of the Brexit movement is keen to boost the country’s competitiveness by lightening social, economic and environmental rules. Business will have plenty of suggestions.

Many dislike the requirement that obliges them to hire temporary workers after a short period of time. Smaller businesses in particular could be awarded more exemptions from labour regulations.

This worries the EU, which is particularly concerned that there should be a “level playing field”. On environmental protection, Brussels calculates that British industry could save €4.7bn a year if it departed from the EU’s rules on industrial emissions and pollution.

Yet Mr Johnson seems unlikely to go for much of this sort of deregulation. He is not that sort of Tory, and cutting labour and social protections would rile British voters—especially in the poorer areas where the Conservative Party has just made big gains. Although Britain originally got an opt-out from the Social Chapter of the Maastricht Treaty, it has sometimes gone above and beyond what Brussels wants: it has given temporary workers more rights and parents more leave than the EU demands.

The green movement is strong in Britain, and will keep a protective watch on environmental regulation. The government is reportedly inclined to toe the EU line and keep most of the massive REACH law that regulates chemicals. “There are plenty of things you might want to do in your dark free-market heart but the public doesn’t want it,” says Robert Colvile, director of the Centre for Policy Studies, a Conservative think-tank.

Focused as it is on boosting growth in England’s peripheries, the government seems more likely to diverge from EU state-aid rules than from social, environmental and labour protections. Mr Johnson has put the creation of ten “freeports”, that for customs purposes are legally outside Britain, high on the agenda. Freeports can offer zero tariffs, low taxes and loose regulation. America has 250 free-trade zones.

The EU claims to have 85 customs-free zones but in reality there isn’t much to them. Mr Sunak says EU single-market regulations and state-aid law have stopped Britain from using such zones properly. “The EU makes it very hard to make them seamless and really exciting,” he says.

Going free range

The biggest arguments are going to be around fisheries (see article) and agriculture. Farmers and fishermen, who voted enthusiastically for Brexit, make up a tiny proportion of GDP—0.6% and less than 0.1% respectively—but their travails will loom large: Scarry’s Law, formulated over a decade ago by this newspaper and named after Richard Scarry, a children’s illustrator, states that politicians mess at their peril with groups that feature in children’s books—farmers, fishermen, train drivers and suchlike.

The EU’s approach to farming is unpopular among an impressively wide range of people. Some dislike the fact that the common agricultural policy (CAP) has shovelled vast subsidies to a tiny sector, many of whose members are landed gentry; others that it depresses the price of agricultural products, thus impoverishing developing countries. Environmentalists regard automatic payments for agricultural land as an incentive to clear wildlife habitats and cut down trees. Farmers dislike the EU’s tight rules on the use of pesticides.

The government’s new agriculture bill proposes public subsidies for farmers who promote public welfare. They will in future be paid for things like improving animal welfare and air and water quality. But their future looks uncertain. Within the EU, farmers benefited from the power of the French agriculture lobby, which ensured that tariffs were high and the CAP swallowed up more than a third of the EU’s budget.

British farmers do not have that sort of clout. Declining subsidy is not the only risk they face: American farmers want access to British markets for their chlorine-washed chicken or hormone-filled beef. British farmers fear that they may find themselves sacrificed to the need for a trade deal.

Sectoral worries aside, surveys suggest that business sentiment soared after the election result.

A CBI survey of manufacturers published on January 22nd reported the biggest positive swing in confidence since the poll was first taken in 1958. Manufacturers’ absolute confidence level is now as high as it was in 2014 when the economy was emerging from recession.

This surge of animal spirits is down partly to the defeat of a left-wing Labour Party and partly to greater clarity about Britain’s future relationship with the EU. But it also springs from a hope that the government will not just throw off EU rules, but also improve the way it works with business. “We’ve got to park the past and make the best of what we’ve got,” says Sir Roger Carr, chairman of BAE Systems, a defence firm.

The hardest part of Brexit—negotiating a full trading relationship with the EU—is still to be achieved, but British business appears ready to be bolder than the pike.

The UK’s employment and productivity puzzle

Favourable trends in employment relative to population are not going to be repeated

Martin Wolf

FILE PHOTO: A courier for food delivery service Deliveroo rides a bike in central Brussels, Belgium January 16, 2020. Picture taken January 16, 2020. REUTERS/ Yves Herman/File Photo/File Photo
The 'gig economy' has contributed to a rise in UK employment levels © Yves Herman/Reuters

What has happened to the UK economy since the financial crisis at the most aggregate level?

What does this suggest about the issues lying ahead in the coming decade?

The short answer to the first question is that employment has boomed while productivity has been a disaster.

The combination has delivered a weak, but not catastrophic, rise in gross domestic product per head.

In the next decade, that is much less likely, unless the productivity trend improves.

A recent article by three economists, including David Hendry of Oxford university, a distinguished econometrician, sheds bright light on what has happened. Productivity and real wages have stagnated since 2007. But real GDP per head is up by 20 per cent since 2000 and 10 per cent since its trough in 2009. So what is going on?

The most important point is that the aggregate productivity performance of the UK economy since the financial crisis of 2007-08 has been its worst by far since 1860. Never before over this long period, so far as we know (evidently, the measures for the distant past are even more uncertain than those for the present), has there been such a prolonged period of productivity stagnation.

This is the single most important fact about the economy. Needless to say, it has attracted essentially no serious political attention in the hectic debates of recent years. We do not know why this has happened. But one reason, surely, must be the fact that over 2010-19, the UK’s average investment as a share of GDP has been the second lowest in the EU (ahead only of Greece).

As one would expect, real wages have tracked productivity very closely over the entire period since 1860, including the recent period: stagnant productivity has meant stagnant real wages.

In fact, real wages have slightly lagged behind the stagnant productivity trend, because labour’s share in GDP has fallen a little. Unsurprisingly, this made the 2010s a joyless decade for many. For this reason, some duly sought a scapegoat — and found it in EU membership.

Chart showing  that the flatline trend in productivity since the Great Recession is unprecedented in 160 years. Productivity (output per worker) versus real wages. Indices (1860 = 100)

Yet, despite the stagnant real wages, real GDP per head is up significantly. The explanation for this divergence between real wages and GDP per head is the rise in employment relative to the population as a whole. Indeed, as the paper notes, “the present level of employment is the highest ever for the UK and has grown much faster than the population over the last quarter of a century”.

After a sharp fall during the crisis, employment again grew faster than the population: between 2009 and 2018, employment rose 12 per cent, while population rose only 7 per cent.

The rise in employment reflects a flexible labour market and new forms of demand for workers, notably the “gig economy”. Also important must have been the arrival of large numbers of working age immigrants, which meant that the active labour force increased more quickly than the population. In all, with both the total number of workers and the ratio of workers to the total population rising, and real wages flat, total earnings rose substantially.

This, in turn, explains the relatively buoyant performance of GDP per head.

A noteworthy part of the analysis is on the emissions of carbon dioxide. While real GDP and GDP per head have risen significantly, UK emissions fell sharply from 529m tonnes in 2008 to 361m in 2018. This is rather encouraging, though part of the explanation is that the UK is creating emissions elsewhere by importing emissions-intensive products, especially from net exporters of manufactures.

Chart showing The rise in employment relative to population has caused GDP per head to accelerate ahead of productivity. Real GDP per head versus real GDP per population. Indices, 1995 = 100

What are the implications of this analysis for the coming decade? Here there is bad news and possibly some good news.

The bad news is that the favourable trends in employment relative to population, notably since the crisis, are not going to be repeated. Unemployment is now very low. Immigration is almost certain to be cut.

Above all, the population is rapidly ageing. For all these reasons, the number of people in employment is quite likely to fall relative to the total population, reversing the favourable story of the last decade.

The good news is that, with a lower rate of growth of employment, it is likely that productivity will rise somewhat. Since one explanation for the productivity stagnation was the lower marginal product of labour in a rapidly growing labour force. But that will not be enough to generate a rapid rise in overall productivity.

Higher private and public investment and more dynamic innovation and competition will also be needed. In a country damaged by the coming Brexit shock, this is going to be a huge challenge.

Will it be met?

It will take a great deal of intelligent and determined effort to do so.

Inequality and Economic Growth

Economic policymakers can no longer afford to view inequality as an issue separate from boosting employment and incomes. Addressing it through a wealth tax, combined with more effective antitrust policies and enforcement, has become essential to sustaining economic growth, including by encouraging the creation and growth of new business.

Simon Johnson

johnson124_REB ImagesGetty Images_usmoneystackpile

WASHINGTON, DC – In previous eras, top economic decision-makers considered inequality to be distinct from the main concerns of macroeconomic policy. Since the Industrial Revolution, the general view has been that, on average, people want higher incomes and a larger number of good jobs – and that the best way to achieve these goals is through faster economic growth. Not surprisingly, therefore, much thought has been devoted to the question of how to design and run monetary and fiscal policies that can sustain higher aggregate growth rates.

Inequality was regarded as a separate issue, which could be addressed at the margin through making net taxes more or less progressive. Rich people would contribute a higher share of their total incomes to the public finances than would the middle class.

It is increasingly apparent that there are three main problems with this view of the world, at least as it applies to the modern United States. All three are made fully apparent in Heather Boushey’s brilliant new book, Unbound: How Inequality Constricts Our Economy and What We Can Do About It.

First, the tax system has ceased to be progressive. Warren Buffett famously remarked in 2011 that his tax rate is lower than his assistant’s – and this is not an isolated occurrence. Since the 1970s, effective taxes on income from capital (for Buffett) have fallen dramatically, while taxes have remained much steadier for wage earners such as assistants (including to billionaires, it turns out).

If we include health-care costs – insurance premiums, deductibles, and out-of-pocket expenses – then median take-home pay (available to spend on everything other than health care) has barely budged in recent decades. There is nowhere near as much redistribution as there was in the post-World War II decades. (In my book with Jon Gruber, Jump-Starting America, we examine the statistics and history in more detail.)

Second, the extent of inequality has increased, owing partly to barriers to market entry, which also undermine economic growth. It is easy to understand why Buffett likes investing in companies with “moats” – for example, in insurance, railways, and other sectors. Owning firms that are difficult for others to challenge is undoubtedly good for his profits. But economic policymakers’ goal should not be to maximize profits for one sector, let alone one group of investors. Across the entire economy, more entrepreneurship and more market entry tend to erode incumbents’ profits and thus mitigate inequality, because the entry of new firms into an industry will likely create more jobs, boost incomes, and lead to new products, better services, or both.

Third, inequality has become a driver of worsening outcomes in a broader political-economy sense. When rich people spend their money to influence political decisions, they do not typically seek to ensure freer entry for others into the sectors that generate their wealth, precisely because that would likely mean less for them.

On the contrary, powerful incumbents want more protection from domestic and foreign competition. They also want more subsidies, whether through the tax code or otherwise. And their most cherished goal is to become too important to fail, so that they are likely to be bailed out in times of trouble.

Boushey connects these dots in a remarkable and refreshing manner. Even for people who have studied the issue, the links and specific policy issues she identifies are illuminating. This is not an argument against markets or against private enterprise, but it is an important cautionary tale: we get the inequality that we choose, regardless of whether we are aware that we are making a choice.

Unbound is not an explicitly partisan book, but it is easy to draw inferences for the current political season.

For starters, if the existing system is broken, the easiest and fairest way to fix it would be with a modest wealth tax. The specifics can be debated, but a tax on wealth over $50 million would impact only the richest 0.1% of all Americans.

Moreover, if barriers to market entry are becoming a problem, then we should change the focus of antitrust activity to reduce those barriers in a reasonable and timely manner. If traditional criteria, developed in and for the pre-Internet era, prove cumbersome or ineffective, then we should update them.

And if wealthy people are buying political access, with the result that the economy is becoming more distorted and less fair, then we should change the campaign-finance and lobbying rules. In the US, a higher rate of tax on wealth over $1 billion (or a similar very high level) would affect only about 600 people, but it would send a powerful signal that their outsize influence will be addressed.

Inequality at modern levels is not an accident. It is the result of policy choices that were influenced or swayed by relatively rich people (again, Unbound has the details). The pendulum can – and should – swing back in the other direction.

Economic policymakers can no longer afford to view inequality as an issue separate from boosting employment and incomes. Addressing it through a wealth tax, combined with more effective antitrust policies and enforcement, has become essential to sustaining economic growth, including by encouraging the creation and growth of new business.

Simon Johnson, a former chief economist of the IMF, is a professor at MIT Sloan and an informal adviser to US Senator Elizabeth Warren's presidential campaign. He is the co-author, with Jonathan Gruber, of Jump-Starting America: How Breakthrough Science Can Revive Economic Growth and the American Dream.

Berkshire Hathaway Posts $29.2 Billion in Quarterly Earnings

The conglomerate held $128 billion in cash as of Dec. 31

By Nicole Friedman

Berkshire Hathaway Chairman Warren Buffett, left, and Vice Chairman Charlie Munger at the annual Berkshire shareholder shopping day in Omaha, Neb., last year.
Photo: scott morgan/Reuters .

Warren Buffett sought to reassure investors that his Berkshire Hathaway Inc. BRK.B 0.51%▲ remains in strong shape as Berkshire’s cash pile remained near record highs due to a dearth of large deals.

Berkshire’s earnings surged last year due to unrealized investment gains, but the conglomerate’s cash pile totaled $128 billion as of Dec. 31, the company said Saturday, slightly down from $128.2 billion at the end of the third quarter.
Mr. Buffett, Berkshire’s chairman and chief executive, has for years lamented the challenge of finding acquisition targets that are large enough to move the needle for Berkshire and are reasonably priced.

While Berkshire has a long history of outperforming the stock market, the company has underperformed the S&P 500’s total return in recent years. The company’s stock rose 11% in 2019, the company said, compared with a 31.5% total return in the S&P 500, including dividends—Berkshire’s biggest underperformance since 2009.

“The opportunities to make major acquisitions possessing our required attributes are rare,” Mr. Buffett said in an annual letter to shareholders also released Saturday.

Nevertheless, he said, shareholders should not be worried about the future of Berkshire after the 89-year-old Mr. Buffett or his 96-year-old business partner, Berkshire Vice Chairman Charlie Munger, die. “Your company is 100% prepared for our departure,” Mr. Buffett said.

The Omaha, Neb., conglomerate reported net earnings of $29.2 billion, or $17,909 per Class A share equivalent, up from a loss of $25.4 billion, or $15,467 a share, the year before.   

Berkshire’s earnings a year ago were dragged down by an unexpected write-down at Kraft Heinz Co.

Berkshire posted operating earnings of $4.4 billion, down from $5.7 billion a year earlier, due to lower results in insurance underwriting and some of Berkshire’s smaller operating businesses.

Operating earnings exclude some investment results and Mr. Buffett has said they are more reflective of Berkshire’s performance than net earnings, which can fluctuate widely due to unrealized investment gains or losses.

In his annual letter, Mr. Buffett discussed corporate boards of directors, which he said are often ill-equipped to oversee companies and incentivized not to challenge executives.

He also said that at Berkshire’s annual meeting in May, shareholders will be able to ask questions of Berkshire executives Ajit Jainand and Greg Abel, the two leading candidates to succeed Mr. Buffett as CEO, in addition to questioning Messrs. Buffett and Munger.

Berkshire bought back about $5 billion of its own shares in 2019, the company said. The company changed its buyback policy last year, and some shareholders are frustrated the company hasn’t spent significantly more cash repurchasing its stock.

Berkshire’s biggest deal in 2019 was a $10 billion investment in Occidental Petroleum Corp. ’s bid to acquire Anadarko Petroleum Corp.

Some of Berkshire’s 60-odd subsidiaries completed acquisitions, but those deals tend to be small. Berkshire spent $1.7 billion on bolt-on acquisitions in 2019, the company said, up from $1 billion the prior year.

Berkshire also sold a workers’ compensation insurer called Applied Underwriters last year. Earlier this year, Berkshire said it would sell its newspaper business to Lee Enterprises Inc.

The conglomerate runs a large insurance operation as well as railroad, utilities, industrial manufacturers and retailers. Its holdings include recognizable names like Dairy Queen, Duracell, Fruit of the Loom, Geico and See’s Candies.

Berkshire’s insurance business sits at the core of its moneymaking machine. Insurance brings in billions of dollars of “float,” upfront premiums customers pay and that Berkshire invests for its own gain. Berkshire also holds large stock investments, including in Apple Inc.and Wells Fargo& Co.

Class A shares closed Friday at $343,499, up 1.1% for the year. In contrast, the S&P 500 is up 3.3% this year.

Japan’s Pension Whales May Be Making Waves in Currency Markets

The yen’s surprise decline makes more sense in the context of the country’s pension funds shifting an increasing portion of their assets abroad

By Mike Bird

One-time events in Japan haven’t stopped rapid yen appreciation in the past. / Photo: Toru Hanai/Bloomberg News .

The yen has slumped this week, perplexing investors who associate periods of uncertainty and stress with a rising Japanese currency.

The pattern makes more sense in the context of falling hedging costs and the country’s gargantuan institutional investment firms, which are increasingly moving assets abroad to escape low-yield Japan.

The dollar moved around 1.9% higher in the two sessions to Thursday, reaching almost 112 to the yen, the largest two-day shift in almost 2½ years.

Analysts at Rabobank and elsewhere had wondered if the yen’s diminishing role as a haven was because Japan’s economy is itself at risk of being further upended by the coronavirus outbreak.

A survey of the Japanese manufacturing sector released Friday showed the sharpest reduction in activity in seven years during the initial weeks of February.

But one-time events in Japan haven’t stopped rapid yen appreciation in the past: The yen rose almost 6% during the 2011 nuclear disaster at Fukushima.

The yen has risen when North Korea’s missiles have flown over Japan. The currency market isn’t always a place of relentless logic.

Data released by the Ministry of Finance might indicate what is going on.

In January, the trust accounts that act for Japanese pension funds booked over 2 trillion yen ($17.94 billion) in net purchases on long-term foreign bonds. That isn’t just the highest amount on record, but 62% higher than the next highest. It is equivalent to around five months of purchases based on the 2017-19 average.

Hedging costs go some way to explain the shift. Japanese hedging costs have been high for several years: In late 2018, a one-year dollar-yen forward contract effectively cost a Japanese investor 3.4% relative to the spot Price.

That hedging cost has ticked almost continually lower as U.S. bond yields declined, falling to around 1.9% this month.

Periods in which hedging costs are falling, more than the actual level of the costs, tend to be correlated with large-scale purchases of U.S. government bonds.

Indeed, in the three months to December—the last for which we have data—Japanese investors bought more U.S. government and agency bonds on net than at any point over the past 3½ years, according to the Treasury Department.

But some purchases aren’t likely to be hedged at all. Rule changes late last year allowed the ¥168.99 trillion Government Pension Investment Fund to class fully hedged foreign bonds as domestic debt. That allows for more unhedged purchases, which would further fuel the yen.

The failure of the yen to appreciate in a risk-off scenario can also become self-fulfilling. If it is no longer received wisdom that Japanese investors will repatriate foreign profits and pivot back home in times of stress, markets will no longer treat the yen as a haven.

Either way, traders who expect the yen to rally in risk-off periods may find themselves in an unenviable position, fighting flows from the country’s pension giants’ deep pockets.

What if Brexit Works?

Britain is remaking itself again. The shape of its society and economy, and its place in the world, are very much up for grabs.

By Mark Landler

Supporters of Brexit arriving at Parliament Square to celebrate the United Kingdom’s leaving the European Union on Friday.Credit...Mary Turner for The New York Times

LONDON — Britain’s departure from the European Union on Friday drew a mournful reaction from many people who have long viewed Brexit as consigning their country, once the vanguard of Europe, to a future of economic mediocrity and geopolitical irrelevance.

But there are many others who view Brexit as a day of liberation, when Britain, unshackled from the bureaucracy of Brussels, will stride into a future of economic innovation and vigorous, cleareyed politics — a “moment of real national renewal,” in the words of Prime Minister Boris Johnson.

That positive case for Brexit will now be tested, and it is prompting even those who ardently opposed it to wrestle with a question they had mostly dismissed during three and a half years of debate: What if it works?

“Disruptive change can be beneficial for a country,” said Tony Travers, a professor of politics at the London School of Economics. “That is, in a sense, what Brexit has accomplished.”

Britain is no stranger to disruptive change, of course. After the end of World War II, it adjusted to the end of empire by embedding itself in an Atlantic alliance and building a European-style welfare state. In the early 1980s, Margaret Thatcher led a free-market revolution that dismantled parts of that state and nurtured a British nationalism that fully flowered in the wrenching debate over Brexit.

Now, Britain is remaking itself yet again, cast off from Europe and facing an uncertain future in which the shape of its society and economy, and its place in the world, are still very much up for grabs.

By giving the Brexiteers a chance to put their ideas into action, Professor Travers said, British politics could be reinvigorated. With the country shorn of its links to the European Union, Mr. Johnson and his aides will not be able to blame Britain’s shortcomings on anyone else. British voters will get to hold their leaders accountable.

The economic case for Brexit is harder to make. Most experts said Britain’s decision to leave the bloc was likely to deprive the country of significant additional growth over the next decade or so. But the warnings of catastrophe are probably overstated, and it is hard for people to miss what they never had.

Britain, experts said, is likely to grow in line with the rest of Europe over the next several years — a growth rate that is hardly sparkling, but likely to be a shade higher than those of Germany or France.

If that happens, and Britain is able to establish a stable trading relationship with the European Union, Brexit’s champions may claim a measure of vindication. That is even more likely if, as many experts predict, the bloc enters a bumpy stretch economically.

“Boris Johnson’s argument is that 10, 15, or 20 years from now, we’ll look back and say, ‘Getting out was in our national interest,’” said Mujtaba Rahman, a managing director at the political risk consultancy Eurasia Group. “The jury is out on that, but if he can pull this off, there are reasons to think Britain will prosper.”

The Brexiteers are far less guarded. They speak of a “global Britain,” bursting with technological innovation, unencumbered by regulations — an agile free agent, ready to do business with the world. Britain, they said, would strike lucrative trade deals and become a magnet for foreign investment.

“It starts with free trade,” said Patrick Minford, an economist at Cardiff University. “Everyone talks about the E.U. as if it is a bastion of free trade, but it’s not. We want to trade freely with everybody, especially the United States.”

Professor Minford contends that Britain could add 8 percent to its gross domestic product over the next decade if it is able to strike down all trade barriers, and 4 percent if it is able only to eliminate a portion of them. There could be further gains from technological innovations in industries like artificial intelligence, he said.

Most mainstream studies, though, predict Brexit will cut the rate of Britain’s growth by depriving it of gains to gross domestic product it would otherwise have had. Those lost gains could amount to between 1.2 percent and 4.5 percent of its gross domestic product, depending on the terms of Britain’s exit from the European Union.

Having taken back control of their affairs from the unelected bureaucrats in Brussels, the British people will be able to enact rules that suit them, not 27 other countries. They will be rule makers, not rule takers, in a popular phrase often used by Brexiteers. That, they said, is a stirring victory for sovereignty.

“The elemental case for Brexit is the democratic one,” said Daniel Hannan, who just stepped down as a Conservative member of the European Parliament. “Having got power back from Brussels, we should not let it fester in Whitehall. This requires not just leaving the E.U. but reviving our domestic democracy.” 

Even some of those who lobbied to stay in the European Union acknowledge that in the post-Brexit era, the debates in Parliament could become more rational — focused on what kind of society and economy Britain now wants to have. They also concede that Britain’s membership in the European Union was deeply unsatisfying.

Because it refused to join the monetary union, Britain was always going to feel left out of Europe’s innermost councils. After the adoption of the Maastricht Treaty in 1993 — which formally established the European Union — Europe became as a much a political union as an economic club, something that many in Britain never accepted. “We opted out of bits and pieces of it, so we were never at the top table,” said Jonathan Powell, who was a chief of staff to former Prime Minister Tony Blair. “If you’re going to be a halfhearted partner, then there’s no point to being in it at all.” 

Still, Mr. Powell said, it was fanciful to assume that by leaving the European Union, Britain would be able to discard the bloc’s rules and regulations. Other nonmembers, like Norway or Switzerland, adhere to European standards as a condition of trading with it. That will be particularly true in Northern Ireland, which will stay closely aligned with a maze of European rules and regulations.

Britain, the critics say, will continue to be a rule taker. It just will no longer have a seat at the table where those rules are drafted.

Despite his landslide election victory last December, Mr. Johnson has not really articulated the pro-Brexit case. He has spoken in general terms about reunifying and reviving the country but has yet to lay out an agenda for how Britain plans to exploit its independence for economic or political gain.

Partly that may reflect Mr. Johnson’s determination not to be triumphalist after a debate that divided the country. Partly, his critics say, it reflects the prime minister’s lack of fixed convictions. He used Brexit more as a vehicle to amass power, they said, than to impose a particular worldview. 

Mr. Johnson must also balance the different parts of his Brexit coalition.

Voters in the Midlands and the North of England, where many districts abandoned the Labour Party to embrace Mr. Johnson’s promise to “get Brexit done,” have a very different vision of what Brexit means from the free-market evangelists in London, who want to remake Britain as a kind of Singapore-on-Thames — an enclave with little regulation and low taxes.

“The pain will be felt differentially,” said Mr. Powell, the former chief of staff to Mr. Blair. “Sunderland and other places that voted for Brexit will be hardest hit,” he said, referring to the industrial city in northern England where the early returns from the June 2016 referendum foretold that the country would vote to leave the union.

With Britain likely to hammer out some sort of trade agreement with the European Union, the most alarmist predictions about Brexit — food shortages, trucks lined up for miles at ports — are not likely to happen. Rather than a triumph or a tragedy for the country, Brexit may end up being a long twilight.

“We’re not going to go off a cliff,” Mr. Powell said. “It will be more of a glide path. Britain is going to have to come to terms with being a small country.”