Stall Speed Economy

By John Mauldin

When Cornwallis surrendered to George Washington at Yorktown in 1781, tradition has it that the British band played an old English children’s folk tune, “The World Turned Upside Down.”

Painting by John Trumbull

If buttercups buzz’d after the bee,
If boats were on land, churches on sea,
If ponies rode men and if grass ate the cows,
And cats should be chased into holes by the mouse,
If the mamas sold their babies
To the gypsies for half a crown;
If summer were spring and the other way ‘round,
Then all the world would be upside down.

In this letter I find myself recommending policies that not that long ago would have been extraordinarily distasteful to me. Yet, unless we pursue them, our economy will truly be turned upside down. I fully recognize these things have a cost. But the cost of inaction is much higher.

Our economic prospects looked bleak back in March and April. Much of the economy was closed down, we didn’t know how bad the virus would get, and it was hard to see a good outcome.

Now the outlook is relatively better. Unemployment, GDP, and other indicators aren’t great but they’ve improved. Yet a “better” outlook isn’t necessarily a good one. It’s just “not as bad.” Today’s numbers would be considered terrible if we weren’t comparing them to truly disastrous numbers from last spring. We avoided the worst because generous fiscal income replacement and business lifelines maintained consumer spending, and in some cases increased it.

If you fly a lot as I do (or used to), you’ve heard the term “stall speed.” An airplane needs to go a certain speed in order to stay aloft. The math behind that idea is pretty simple: lift from the wings must be equal to or greater than the plane’s weight. Lift, in turn, comes from the engine creating forward motion relative to the air. No air flow over the wings means no lift and no flight.

In economic terms, we stayed above stall speed by forcing extra fuel into the engine. The resulting forward motion gave the economy the lift it needed. Now the fuel is running out.

If this plane stalls, as is a real possibility, we won’t like the result. Today we’ll talk about why that is and how to stop it

No Reserves

The first point to observe: unlike airline passengers, we don’t all share the same forward momentum. Some of us are even going backwards.

Income loss comes mainly from job loss. This year’s job losses have been concentrated in lower-wage service jobs, often held by less-educated workers.

Source: BLS

Unemployment rose across the board but was much higher for those with less education. As of August, the headline unemployment rate was 8.4%, but it was 11.8% for non-high school graduates and only 5.6% for college graduates.

Continued unemployment claims from states suggest the monthly report undercounted the jobless workers. I assume there was some seasonal adjustment that made the difference, but seasonal adjustments are worthless during this crisis. “U-6” unemployment is a far better indicator of where we really are.

Source: BLS

My good friend Mike Shedlock (Mish) does an extraordinarily good job tracking the vagaries of unemployment during this crisis. Including both state and federal benefits shows a far larger number. The chart below includes gig workers, the self-employed, people who have exhausted their state benefits, etc.

Source: Mike Shedlock

Anybody with any connection to the real economy knows people are still falling through the cracks. We just have no way to measure it. As I mentioned, U-6 is 14.3%. I’ll bet you a dollar to 47 doughnuts that real unemployment is closer to 16%. The rest of Mike’s post points out that while things are improving, the rate of improvement is slowing down. But back to my main point.

For a while, “unemployment” didn’t necessarily mean income loss because Congress temporarily increased jobless benefits by a flat $600 weekly, while also sending out $1,200 per person checks, actually raising some workers’ incomes. 

That expired at the end of July. Trump’s stopgap measures have replaced some of it, in some states, but the amounts are much smaller.

This is already showing up in consumer spending. Banks can track this because most of the benefits are delivered electronically. 

They can analyze spending patterns for unemployment benefit recipients vs. everyone else. Here is what happened at Bank of America in August.

Source: Ernie Tedeschi

As benefits dropped, bank card spending growth fell for UI recipients while continuing to grow for everyone else. The drop was worse for lower-income consumers.

This shouldn’t surprise us. Long before COVID-19, a large part of the population spent practically all its income. Those who lost their jobs in March/April and haven’t been rehired have little choice but to cut spending. They have no reserves and little borrowing ability.

A few years ago, I wrote that 60% of America had less than $500 in savings. I haven’t seen recent data, but it is hard to imagine it’s gotten any better. The point back then was that Americans were living paycheck to paycheck. The point now is that many Americans are living unemployment check to unemployment check.

It’s easy to forget that the enhanced unemployment benefits helped more than the unemployed people. In many cases, the “recipients” were simply conduits. They received money from the government and immediately sent it on to their lenders and landlords. The fiscal stimulus kept those people afloat, too. And its ending will hurt them, too.

In fact, the income loss hits across the board. Bank of America also knows where unemployment recipients have been spending, since it processes their card transactions.

Source: Ernie Tedeschi

We see spending affected most in discretionary items like clothing, but also in grocery stores. And remember, this is only just beginning. Benefits payments come in arrears, so many people still got the higher amount in early August.

Quick math: If 20% of the adult population reduces spending 25%, the net effect is consumer spending falls 5%. That, alone, leads to an even deeper stall-speed recession. It will generate more layoffs and bankruptcies, meaning more unemployment, until something gives the economy the lift it needs.

Pointing Fingers

Our gridlocked US political system initially reacted to this crisis with surprising speed, passing several relief bills in March and April. At that point, they expected it would be a few weeks of lockdown then everyone would go back to work. 

The goal was to “freeze” the economy in place, compensate those who couldn’t work, and target aid to small businesses, airlines, and other affected sectors. The plan had flaws but, under the circumstances, was an impressive example of cooperation and compromise.

Less impressively, the Federal Reserve began throwing liquidity in all directions. This kept financial markets functional and banks open, but at the cost of blowing a market bubble that will, when it pops, negate most of the benefits. 

Fed officials knew this, I suspect, but also knew they had to do something

They don’t have the tools to directly stimulate employment or capital spending. Jerome Powell has said many times that fiscal policymakers need to do their part.

The politicians, predictably, split on partisan lines. House Democrats passed a $3+ trillion bill that would extend the pandemic unemployment programs, disburse aid to states and localities, give benefits to their favored groups, etc. 

It has gone nowhere in the Senate, where Republicans object to both the bill’s size and some of the recipients. Pelosi had to know it was a nonstarter, just as Senate Republicans knew their $650 billion bill was a nonstarter. But I admit that I am surprised that it has taken them this long to find a compromise. It’s getting to the point where it is beyond serious.

The economy is just barely at stall speed, coasting along on the previously generated momentum but unable to accelerate. It can only stay in the air so much longer, and our pilots are pointing fingers at each other instead of restarting the engines.

Blood Sport

“Wait a second, Mauldin,” you may be saying. “You’re sounding mighty Keynesian here.” You are correct. My track record for the last 40 years is pretty much in favor of smaller government and government spending, lower taxes, etc. But now the world is upside down. Quoting John Maynard Keynes, “When the facts change, I change my mind. What do you do, sir?”

We are in an unprecedented situation. Close to 30 million workers are on unemployment benefits, and that’s after a partial recovery that is now tapering off. Those benefits are the only thing keeping us out of an outright depression that frankly could be worse than the Great Depression (and I don’t think that’s a hyperbolic statement), and they are about to disappear. I fully recognize my own philosophical flip-flop here. But I would rather be called a hypocrite than see millions suffering.

The fact is, we haven’t seen anything like this before. It’s not just another recession. The pandemic and our efforts to control it unleashed economic demons. We need an exorcist or at least some holy water. Instead we get boring sermons. I’m alarmed and you should be, too.

Philippa Dunne and Doug Henwood calculated this week the stopgap benefit payments, cash for which is coming from FEMA disaster relief funds, are almost exhausted:

FEMA is reporting that it’s spent $30 billion of the $44 billion allocated by the executive order, though all that spending has not showed up in the Daily Treasury Statement yet. In any case, the program will run out of money in a week or two. In fact, a number of states have already run through their allowances. The program will be history before the month is over. And that $44 billion is a bit more than half what the CARES Act program spent in its peak month, June—$80.4 billion. With nearly 28 million people drawing traditional and expanded pandemic benefits, a lot of people are suffering sharp cuts in income now and Congress doesn’t seem to be motivated to address the problem.

I think we have to give Trump at least an A in creativity, if not strict constitutionality, for his $300 a week plan. Congress has “power of the purse” but refuses to use it. I’m sure administration lawyers are looking for other creative financing, but there are important limits as to what the president can do. The much better way would be for Congress to do its job, because so much more is needed.

One objection to the extra unemployment benefits is they give some recipients more than they made while working, thereby creating a disincentive to work. 

That is indeed a problem, though with the Labor Department reporting 2.5 unemployed workers for every job opening, it is far from the only challenge (see chart below). But it’s easily solved if the right people want to solve it.

Source: BLS

In fact, some in Congress are actually talking sense. A new bipartisan House Problem Solvers Caucus unveiled a compromise proposal last week that may break the stalemate. It would, among other things, resume the pandemic benefits at $450 a week for two months, then cap the amount to not exceed $600 or the worker’s previous wage, whichever is less.

From my point of view, an even better compromise would be to very slowly reduce the unemployment benefits to provide incentive to go back to work. But that means jobs have to be available. Right now, we have already lost 100,000 businesses and it wouldn’t surprise me if that number doubles, or at least significantly increases, over the next 6 to 12 months. That will be partially offset by new businesses being created, but there will be a lag time.

(Sidebar: Let’s get real. Economists and analysts who use historical precedent to predict this recovery are committing mathematical economic malpractice. There is no historical analogy. This recovery is going to take longer, absent a vaccine which may be available later this year, but will take 6 to 9 months to actually deploy. And it may have to be an annual vaccine. There is just so much we don’t know about this virus. Back to the letter…)

On the downside (from my perspective), the Problem Solvers compromise bill would give state and local governments $500 billion. I think states and local governments should cover their own expenses with their own taxes. But that’s the nature of a compromise: No one gets everything they want. You get a little, give a little, and move forward.

That last item is a major sticking point for Senate Republicans. Yet, even there may be a compromise. Limiting the grants to actual revenues lost should get enough Republicans to go along. It would work like this. Say under the current compromise proposal, state A would get $4 billion. But its revenue is actually only down $2 billion, still a large sum. If you replace just the lost revenue, they would at least get something. Neither side will be happy, but that is the nature of a compromise.

I realize we are in a contentious election season. Feelings are running high. I wish more people would realize our economic challenges transcend politics. 

We will still be in deep trouble whether Trump or Biden is president next year, and regardless of which party controls the House and Senate. Neither side has all the answers. We need them to set aside the rhetoric and take care of all Americans.

My friend the late Pat Caddell, the famous Democratic pollster, used to say later in life (and on my stage to great applause) he wasn’t a Democrat or a Republican, but an American. In these tough times, I’m trying to adopt that same attitude. Politics shouldn’t be a winner-take-all blood sport. Making it one invites chaos because winners and losers still have to live together.

And living together becomes difficult if you don’t even have a place to live. Eviction notices are on hold right now, but not for long. Look at this chart:

Source: Arbor Data via The Daily Shot

We feel sorry for the poor people who are evicted, especially those with children. 

But landlords are quite often small businesses too, with mortgages that banks expect to be paid. It’s a vicious circle.

I plan to write another letter about the forces that brought us to this place. For now, I hope everyone understands we are on the edge of a cliff. Moves that would normally be harmless could spell disaster. We need leaders to represent all their constituents, not just those who voted for them. This necessarily means compromise. Yes, I’m using that word a lot. It’s not profane. It is a way to get things done. And right now, compromise may be the only way to keep this plane in the air.

Keeping the plane in the air is more than just avoiding a crash. It’s giving us the chance to bring it to a future runway safely.

It’s not all bleak. Even if true unemployment is 15%, it means 85% of us are employed. A free market economy with 100,000 “unemployed” entrepreneurs will soon figure out how to create jobs for the rest.

I am not saying a recovery is years off or impossible. I am optimistic we will recover, but it is not going to be a typical 12-month cycle to see recovery begin. We have to buy ourselves and those entrepreneurs some time to figure out what a post-COVID-19 world looks like. The more time we can buy, the stronger the recovery will be.

I get that adding debt will be a drag on economic growth. That can’t be helped. There’s a hole in the boat and we have to plug it, and while doing so we have to bail and row.

The world is going to be repriced. Everything. We are going to have to find new uses for a lot of things now in surplus, like strip malls and office space, lots of equipment, and those new uses may require lower prices. All while technology is disrupting our world in ways we don’t understand. No one ever said it would be easy.

The 85% of us who are working need to help those who aren’t. Bigger tips. Donations to food banks (have you seen some of the lines for food banks? Depressing.). Look around your own community. Are there ways you can help the at-risk population? We are seeing an epidemic of depression and suicide. Reach out to your neighbors who are lonely. I am sure you can think of your own ways. Then just do it.

In the meantime, call your senators and representatives and tell them to do their @#$%# job. Don’t yell at them for compromising. Support them when they do. We can resume yelling at them when unemployment is 6%.

Gym Time and Bear Market Timing

Something very good happened last week. The governor opened up more of Puerto Rico, including my gym. But what Puerto Rico really needs is jobs. 

The US Congress and the local government need to enact tax reform for pharmaceutical companies to come here. This used to be a pharmaceutical manufacturing powerhouse. 

The buildings are still here and it can be so again 50,000 high-paying jobs would make a monster difference to this island.

To give the locals credit, they have introduced extraordinary incentives to build solar energy plants, and theoretically the bondholders who own the power company bonds can lease the lines to companies that build solar capacity. 

The local power is so expensive (for good reasons, as we are an island) that solar can be a much cheaper alternative. All that construction would create jobs. 

And one thing Puerto Rico does have is lots of sun and land for solar plants. Now some entrepreneur just has to make it happen

Finally, I posted this on Twitter today from my friend Brent Donnelly. You should follow me here. I get to do a lot more fun, quick posts there. This is an historical reason why the next few days in the markets could be rocky:

Source: Brent Donnelly

And with that, I will hit the send button and wish you a great week!

Your planning on being in the gym more analyst,

John Mauldin
Co-Founder, Mauldin Economics

The corporate zombies stalking Europe

A big recapitalisation plan is the only way to address the serious damage that has been done to companies

Martin Sandbu

James Ferguson illustration of Martin Sandbu column ‘Corporate Europe needs urgent life support’
© James Ferguson/Financial Times

We do not yet know if the pick-up in coronavirus cases around Europe will send economies into a new downturn, or be manageable without great disruption. Governments may feel forced into lockdowns again. Even if they don’t, renewed fear may interrupt a return to normality. Alternatively, hospitalisation numbers may remain sufficiently low that most activity can resume.

What we do know, but are not treating urgently enough, is the serious damage that has already been done to Europe’s corporate economy. Many companies’ balance sheets have been hurt so badly as to put in doubt their ability to return to normal, let alone contribute to renewed growth. Even an unrealistically best-case scenario — where the virus recedes and activity bounces back — leaves serious problems.

Welcome to the zombie economy. The steepest downturn in generations forced many European companies to run down cash reserves and increase debt to the point where their solvency is threadbare. In May, the European Commission calculated that, in a relatively optimistic scenario, corporate Europe would lose €720bn by the end of the year.

One-quarter of all European companies with more than 20 employees would exhaust their working capital and run out of cash by then, even when benefiting from wage subsidies. The economy has in fact performed somewhat worse than those calculations assumed.

While the situation would surely have been worse had governments not stepped in to subsidise costs and ensure cheap and accessible credit, a loss temporarily paid for by a loan is still a loss and the erosion of corporate capital a danger to the economy.

A large number of undercapitalised companies will hold back Europe’s economic performance in two ways.

First, they do not invest. Simulations by the European Investment Bank show that European corporate investment could fall by more than half to meet cash needs. In coming years, businesses whose revenues barely cover their debt service — even with current record-low borrowing costs — cannot be counted on to make the big investment commitments that Europe needs.

Second, many businesses whose revenues largely go to debt service can, at best, hope to delay their inevitable insolvency. The wider economy’s interest in what happens to such companies is mixed. Keep them alive for too long and you stop workers and capital from moving to more productive activities — the process optimistically known as “creative destruction”. But a wave of insolvencies could also bring destruction without the creation.

As employer-employee relationships are severed, accumulated company-specific knowledge is lost; machines and skills atrophy as they wait to find new uses. In addition, the financially weakest companies are not always the same as the least productive ones.

In France, studies have found that a surprisingly large share of companies with pandemic-related solvency problems are at the top of their sectors in terms of productivity. As economist Marcel Fratzscher recently quipped: the biggest zombie company there ever was is Amazon.

All of this points to an urgent need to recapitalise much of corporate Europe to reduce debt overhangs without killing otherwise viable activities. Recapitalisation is particularly urgent for the small to midsized companies that in Europe have less access to equity markets than their counterparts in the US.

The question is how governments can make recapitalisation happen. At one extreme, repairing corporate balance sheets through straightforward grants would be extremely expensive and potentially poorly targeted: some of those teetering on insolvency were already moribund before Covid-19. At the other, bankruptcy can lead to liquidation rather than restructuring of otherwise productive businesses.

The solution is to inject new equity, either from taxpayer support in return for partial ownership stakes, or from creditors through expedited insolvency procedures that restructure companies without liquidating them. Subsidised terms can limit dilutions at small or family-owned companies if that is desired.

In the spring, such plans were debated but governments have since lost interest. In July, European leaders rejected a proposal for just such a “solvency support” fund in order to reach an otherwise path-breaking agreement on joint borrowing for a recovery package.

That has left national governments to do the job. Brussels has relaxed its state aid rules to allow this but, even so, the lack of a pan-European recapitalisation approach is a missed opportunity. Over-reliance on bank credit saps smaller European businesses of dynamism at the best of times.

The equity financing that should support risk-taking entrepreneurs is too shallow. Crisis recapitalisation could have kickstarted the EU’s ambition for a capital markets union, by having public schemes or restructured private creditors bring many European companies to equity markets for the first time.

It is said that a crisis is always also an opportunity. If the EU botches the repair of Europe’s corporate balance sheets, it risks mishandling both.

China Sends Warning to Taiwan and U.S. With Big Show of Air Power

Beijing sent 18 aircraft into the Taiwan Strait as a senior American diplomat held meetings on the island.

By Steven Lee Myers

In this photograph made available by the Ministry of National Defense in Taiwan, a Chinese bomber is said to have been detected near the island’s air defense zone on Friday./ Taiwan Ministry of National Defense, via Associated Press

China sent 18 fighter jets and bombers into the Taiwan Strait on Friday in a robust show of force that a military official in Beijing said was a warning to Taiwan and the United States about their increasing political and military cooperation.

“Those who play with fire are bound to get burned,” Senior Col. Ren Guoqiang, a spokesman for the Chinese Ministry of National Defense, said at a briefing in Beijing, warning the United States and Taiwan against what he called “collusion.”

The aerial drill came as a senior American diplomat held a series of meetings in Taiwan ahead of a formal memorial service on Saturday for former President Lee Teng-hui, who led the island’s transition from military rule to democracy.

Taiwan, the self-governing democracy that Beijing claims as part of a unified China, has become an increasingly tense issue in the deteriorating relations between China and the United States. Both sides have stepped up military operations around Taiwan, while accusing the other of risking a potentially dangerous clash.

Previous flights probing Taiwan’s air defense zones have generally involved pairs of aircraft, not so many at once approaching from multiple directions. That suggested Friday’s flights were intended as an escalatory warning.

The Chinese aircraft, including two H-6 strategic bombers, crossed the median line between the mainland and Taiwan in the strait from four different directions, according to officials and news reports from both sides.

The planes crossed into Taiwan’s southwestern air identification zone before returning to the mainland, according to the Ministry of National Defense in Taiwan, which said that it had scrambled fighter jets and activated its air-defense missile systems to track the Chinese aircraft.

China had already dispatched two military aircraft toward Taiwan on Wednesday, the day the American diplomat, Keith Krach, the under secretary of state for economic, energy and environmental affairs, arrived. 

Mr. Krach’s visit followed another in July by Alex M. Azar II, the secretary of health and human services, who became the highest-level American cabinet member to visit Taiwan since 1979.

Mr. Krach met with Taiwan’s president, Tsai Ing-wen, at a dinner on Friday night.

Drew Thompson, a former Pentagon official overseeing China policy who is now a professor of public policy at the National University of Singapore, said that the latest flights were provocative, intended to send a political message ahead of Mr. Lee’s memorial service and to test Taiwan’s “ability to simultaneously track multiple sorties.”

Chinese officials have become increasingly alarmed by American efforts to bolster Taiwan’s political standing and its defenses. The Trump administration is pushing a sale of seven more packages of weapons, including drones, artillery batteries, sea mines and missiles able to strike ships or targets deep inside Chinese territory.

The heightened military action around Taiwan has fueled a divisive debate over Taiwan’s defense policy. Supporters of Ms. Tsai’s Democratic Progressive Party have called for efforts to bolster the island’s ability to defend itself, while others have warned that such moves could serve only to provoke the Chinese.

Keith Krach, left, the American under secretary of state for economic, energy and environmental affairs, arriving in Taiwan on Thursday.

“Its move today is a protest and a warning to the United States and to Tsai,” Lin Yu-fang, a former legislator who is now a member of the National Policy Foundation, a think tank affiliated with Taiwan’s opposition party, the Kuomintang, said of the Chinese actions.

The Eastern Theater Command of the People’s Liberation Army of China said in a statement on Friday that the air and naval drills were intended to test the readiness of the military “to defend national unification and territorial sovereignty.” It was not clear how long the exercises would continue, though Colonel Ren, the spokesman, suggested that they would be held over some days.

On Saturday, China repeated the drill, sending 19 aircraft across the median line of the Taiwan Strait and into Taiwan’s air defense identification zone, according to Taiwan’s ministry of defense.

Global Times, a hawkish newspaper controlled by the Chinese Communist Party, in Friday cited military experts as warning that the People’s Liberation Army could “turn the exercises into real action any time if Taiwan secessionists insist on their obduracy.”

Amy Qin and Amy Chang Chien in Taipei contributed reporting. Claire Fu in Beijing contributed research.

The Ups and Downs of Turkish-Israeli Relations

By: Hilal Khashan

In 1949, Turkey recognized the state of Israel, becoming the first Muslim country to exchange diplomatic missions with it. Since then, their relations have gone through many highs and lows.

In 2004, the American Jewish Congress gave then-Prime Minister Recep Tayyip Erdogan its Profile of Courage award because of his positive attitude toward Israel and the world’s Jewry.

Ten years later, it asked him to return it because of his virulent criticism of Israel – which he “gladly” did. Turkish-Israeli relations are once again at a low point, following clashes over the Palestinian issue among other things.

But it’s unlikely they will stay that way; both countries are in need of regional allies, and their economic and security interests will outweigh any diplomatic disputes or gestures of disapproval.

The Honeymoon Phase

The relationship between the state of Israel and Turkey extends back decades. In 1957, the two countries established secret intelligence and security relations in response to the Soviet Union’s penetration into the Middle East to supply Egypt and Syria with military hardware and technical assistance. A year later, Israeli Prime Minister David Ben-Gurion met secretly with his Turkish counterpart and formed the Peripheral Pact, an alliance devoted to military and intelligence cooperation and containing communism.

However, they have also been at odds at various points throughout their relationship. In 1956, Turkey downgraded its diplomatic mission to Israel after Israel participated in the Anglo-French invasion of Egypt. Ankara did so again in 1980 when the Israeli parliament voted to annex the Golan Heights.

Turkey voted in favor of U.N. Resolution 3379 that equated Zionism with racism in 1975 and allowed the Palestine Liberation Organization to open an office in Ankara in 1979. Indeed, though the Turks never questioned Israel’s right to exist, the Palestinian issue has been a persistent roadblock to improving ties between the two countries.

But after the signing of the Oslo Accords between Israeli Prime Minister Yitzhak Rabin and Palestinian leader Yasser Arafat in Washington in 1993, Turkey and Israel went through a diplomatic honeymoon phase. The Palestinian Authority was formed shortly thereafter, in 1994, and Turkish Prime Minister Tansu Ciller, who led the secular True Path Party, visited Gaza and promised to support the Palestinians in any way she could, including by helping to build an airport, a harbor, housing and other infrastructure projects.

The honeymoon lasted a decade and in addition to improved economic and tourism ties included security partnership and technology transfers that helped strengthen the Turkish military. Contrary to expectations, Turkish-Israeli relations actually strengthened after Necmettin Erbakan, who led the Islamist Refah Party, became prime minister in 1996. During his brief time in office, Turkey agreed to allow Israeli air force pilots to train in Turkish air space.

Deteriorating Relations

Their relationship began to change in 2003 when Recep Tayyip Erdogan became prime minister. After Israel assassinated Hamas leader Sheikh Ahmed Yassin, Erdogan described his killing as state terrorism. And in September 2007, the Israeli air force flew over Turkish air space during a mission to destroy an illicit Syrian nuclear reactor northeast of Damascus, thwarting Turkey’s efforts to make peace between Syria and Israel.

In 2008, Erdogan walked out of a World Economic Forum summit in Davos to protest Israel’s Operation Cast Lead against Hamas and the Palestinian Islamic Jihad movement. And in 2009, he blocked the Israeli air force from participating in the Anatolian Eagle exercises because of Israel’s offensive in Gaza that year, causing the drills to be canceled.

Relations bottomed out in 2010, when Israeli commandoes killed 10 Turkish activists aboard the Mavi Marmara as the ship tried to break the blockade against Gaza. After Israel refused to apologize for the incident, Turkey expelled the Israeli ambassador to Ankara.

Still, the two countries continued to cooperate on several fronts. In 2012, Israel repaired five Israeli-built Heron unmanned aerial vehicles and returned them to Turkey. Turkey used them to manufacture its own Bayraktar drones, which were used in Libya and Syria. That same year, Erdogan dispatched a high-level representative to meet with Israeli officials, including Prime Minister Benjamin Netanyahu, in an effort to revive diplomatic relations.

In 2013, Israel’s Elta Systems agreed, after U.S. prodding, to deliver to the Turkish air force airborne electronic systems to fit on four Boeing-737s as a confidence-building measure to lay to rest the Mavi Marmara flotilla affair. Then, in 2016, U.S. President Barack Obama helped broker a rapprochement as the two countries restored diplomatic relations and returned their ambassadors to their posts.

But the warming of relations did not last long. Turkey again expelled the Israeli ambassador in response to Israel’s killing of 290 Palestinian demonstrators demanding an end to the blockade of Gaza in 2018. After openly admitting to intelligence sharing for 24 years, Turkey refused to publicize its intelligence meetings with Israel. It has continued to wield influence among dozens of Palestinian groups inside Israel’s green line, including Jerusalem, through financial aid and other types of support.

Every time Israel attacks Gaza and inflicts significant casualties, Erdogan labels it state terrorism. He has repeatedly warned that he will not allow Israel to annex parts of the West Bank. But his threats ring hollow. It would be militarily unwise and politically impossible for Turkey to stop Israel from moving into the Palestinian territories.

Indeed, his threats are mostly rhetorical and don’t extend much beyond recalling ambassadors and decreasing diplomatic missions. The two countries continue to share economic interests that have always risen above their political disagreements. In fact, despite their frayed relationship, the value of their trade increased from $4.7 billion in 2015 to $6.1 billion in 2019.

The two countries also continue to coordinate on security matters, as adversarial countries often do to prevent further deterioration of relations. The last known meeting between the Turkish and Israeli intelligence chiefs occurred in Washington in January.

Both countries share concerns over the presence of Iran and its Lebanese proxy, Hezbollah, in Syria. In fact, Israel Defense Forces followed with great interest the Turkish army’s defeat of Hezbollah’s elite Radwan unit in Idlib last February.

Rebuilding the Relationship

Following the Arab uprisings, Erdogan believed that political change would sweep the region and bolster Turkey’s regional position. But the counterrevolutions dashed his hopes for regional supremacy and turned many Arab states against Ankara. Israel, however, is still eager to restore close ties with Turkey, which it believes can help counter the Iranian threat. Ankara’s growing ties in Central Asia and its promotion of pan-Turkism complicate Tehran’s ability to expand into these former Soviet republics where Russian, Chinese and American influences are paramount.

Erdogan was highly critical of the recent Israeli-Emirati peace agreement, but he’s unlikely to make any retaliatory moves. The deal includes a powerful component on the structure of the region’s future economy, and Turkey does not want to be excluded. Its chances of joining the European Union are slim, and its exclusion from the unfolding economy of the Middle East would ruin its prospects for economic development. Although a 2020 Israeli intelligence report included Turkey in the list of countries and organizations that pose a threat to Israel’s national security, Israeli decision-makers tend to view Erdogan’s fiery rhetoric as strategically insignificant, more of an aggravation than a real threat. Israel is keen on maintaining an open channel of communication with Turkey, irrespective of what Erdogan says.

Among Turkey’s biggest concerns over Israel is its cooperation with Egypt, Greece and Cyprus in the Eastern Mediterranean. The exclusive economic zone that Turkey recently declared in the Eastern Mediterranean technically overlaps with shipping routes used for 99 percent of Israel’s foreign trade. But there is potential for cooperation between the two countries in this area.

Israel isn’t opposed to signing a maritime agreement with Turkey to ease tensions in the region; it actually declined to endorse a joint declaration in May signed by the foreign ministers of France, Egypt, Greece, Cyprus and the UAE denouncing Turkish provocation in the Eastern Mediterranean. And considering its dire economic state and need for natural resources, Turkey would likely also be open to maintaining good working relations with Israel (and, by extension, Washington).

The litmus test of improving Turkish-Israeli relations is the resumption of their diplomatic relations at the ambassador level. Turkey, which is now isolated from much of the Middle East and Europe, has a compelling reason to restore ties. Israel, which has forged strong relations with all of Ankara’s adversaries, likewise is looking for more allies in the region.

In reference to Necmettin Erbakan’s ascension to the role of prime minister in the 1990s, Israeli President Shimon Peres said, “Governments may change, but basic interests remain.” These two countries don’t need to agree on everything, but what they have in common exceeds what separates them.

What Will the World Look Like in 2030?

Wharton’s Mauro Guillen talks with Wharton Business Daily on SiriusXM about his new book on the trends that are shaping our future.

Big demographic, economic and technological changes are coming — from an aging population in the U.S. and the rise of sub-Saharan Africa as a compelling middle-class market to automation causing “technological unemployment,” according to Wharton management professor Mauro Guillen.

In his new book, “2030: How Today’s Biggest Trends Will Collide and Reshape the Future of Everything,” Guillen discusses how these changes will affect us in the years to come. During a recent interview on the Wharton Business Daily show on SiriusXM, Guillen noted that while these trends have been gathering pace for years, the pandemic is accelerating many of them.

Rising inequality across income, race and gender will demand urgent attention, and government policy making will need to become more innovative to address such challenges. Individual responsibility will play a role, too, in areas such as climate change, he says.

An edited transcript of the conversation follows.

Wharton Business Daily: Why did you write this book?

Mauro Guillen: Everyone sees change everywhere, and I think it’s important to figure out where are we going to be five to 10 years from now. How are consumer markets going to look? It’s extremely important for businesses and also for individuals – as investors, as savers and more generally as citizens – to figure out what the future’s going to look like.

Wharton Business Daily: What role has the pandemic played in that change?

Guillen: The pandemic essentially has two different effects, depending on the trend. One is to accelerate and to intensify some things. For example, consider population aging. Inevitably in a recession, we have fewer babies. The mere postponement of having babies accelerates population aging, so problems related to Social Security and pensions will arrive earlier.

Other types of trends get delayed, or even reversed, by something like this. One of them will be the growth of cities, especially in Europe and in the U.S.

“We’re going to have to think very carefully in political terms and in social terms about the implications of further automation, especially in the service sector.”

Wharton Business Daily: North America, Europe and Asia have been vital in the last several decades, but you talk about other areas of the world picking up and having a larger impact in the years ahead.

Guillen: I am very bullish on sub-Saharan Africa because of their demographic dynamism, and because the biggest cities in Africa are growing and creating an expanding middle class. Now, only maybe 15% of the sub-Saharan African population is middle class. But that proportion is growing.

That will change the world, because Africa will soon become the second most populous region in the world.

Coming Shifts in Technology

Wharton Business Daily: What significant changes do you see in terms of technology?

Guillen: As a result of the pandemic, technology adoption has been progressing much faster, out of necessity. We’ve been confined to the home, students cannot attend school and so on and so forth. But we also need to watch carefully the new incentives for automation, especially in the service sector, that this public health crisis creates.

We’re going to see more automation. We’re going to see, unfortunately, more technological unemployment. Many other jobs have been lost in the American economy. I don’t think they’re coming back. We’re going to have to think very carefully in political terms and in social terms about the implications of further automation, especially in the service sector.

Wharton Business Daily: Would the increased emphasis on automation also influence policymaking and education?

Guillen: Yes. In terms of policy making, we have to figure out how to retrain people and how to help those people find other jobs. We may have to consider very seriously ideas such as a universal basic income, which you have discussed on your show on several occasions. This used to be a fringe idea, but it’s quickly becoming more mainstream.

Wharton Business Daily: We’ve seen a little bit of that here in the U.S. with the $1,200 stimulus checks that were part of a $2.2 trillion package of coronavirus relief measures. But what you’re talking about concerns how governments look out for their citizenry, correct?

Guillen: Exactly. It’s not just about being nice to people, which I think we should be. But universal basic income also has a business case. Remember, two-thirds of the American economy is [made up of household] consumption. If people don’t have jobs or don’t have well-paying jobs, then we need to compensate for that.

Wharton Business Daily: You also focus on how currencies may change. To a degree, we’ve already seen that with bitcoin.

Guillen: Yes, we need to seriously consider how entrepreneurs can come up with new ideas as to what cryptocurrencies, or to be more precise, crypto tokens, will be used for.

“I hope that the two presidential candidates start debating exactly how they’re going to deal with increasing inequality.”

If cryptocurrencies are just a substitute for the money that governments issue, then I don’t think we’re going to get too far because our regulators are always against cryptocurrencies as a competitor for legal tender.

But if we add other functions or other uses to those digital tokens — like if they will help us vote, keep politicians in check or provide incentives for people to save the environment — then there is a bright future ahead for digital tokens. So instead of digital currency, I would say digital tokens, which would include a currency component to them.

Inequality: The Next Frontier

Wharton Business Daily: How do we address the wealth gap?

Guillen: That’s a huge development of the last 20 years, and the pandemic only exacerbates inequality. Not everyone can work from the home, and therefore they have to expose themselves to the virus while taking public transportation to go to work.

Consider students. It is estimated that up to 20% of K-12 students in the U.S. don’t have the hardware or the connectivity that they need at home in order to continue school work. This is the most unfortunate part of this pandemic, and it exacerbates inequality based on income and race.

That is true even by gender. Unemployment is growing faster among women than men. So, this is something that we need to pay attention to. I hope that the two presidential candidates start debating exactly how they’re going to deal with this increasing inequality.

Wharton Business Daily: Are we ready to tackle these issues?

Guillen: There is increasing awareness, but I guess we will have to wait until after the presidential election. But whoever happens to be in the White House and whoever controls the Senate come January, I don’t think they will be able to ignore the issue of inequality. We’re seeing social tensions and all sorts of frictions proliferate. The sooner we start tackling it, the better.

Wharton Business Daily: People are worried about various individual issues. But should the emphasis be on changing the overall mindset about how we want our world to look in 2030?

“We’re seeing social tensions and all sorts of frictions proliferate. The sooner we start tackling it, the better.”

Guillen: I do believe so. For example, many parents are now concerned about whether their children will be able to have the kind of life that they have been able to have. The way things are going, maybe only a small fraction of them will do better than their parents.

Here in the U.S., one of the single most important values that we have is that we want every generation to do better than the previous one. And this is becoming increasingly difficult.

Millennials right now are suffering from — for a second time during their adult lifetimes — a very difficult labor market.

There’s more consciousness and awareness of this, and the culture will need to adjust in terms of revisiting some of our values.

Wharton Business Daily: How will the mindset of governments and policymakers need to change?

Guillen: The time has come to be a little bit more innovative, to explore things in terms of government policy making that 10, 20 years ago we thought were completely out of bounds. The problems have become so large. By the way, we haven’t even talked about climate change. We really need to start thinking outside of the box.

Wharton Business Daily: What should we be doing?

Guillen: We need to focus on two things. One is international collaboration among governments when it comes to climate change, but also in other areas like trade, where it is completely absent right now. The second one, which is the one that I push in my book, is we as individuals need to take ownership of this. We need to be less wasteful. We need to economize our resources. We need to be more pro-environment in our own behavior as consumers.

The Great Services Illusion

In the wake of COVID-19, some economists are calling for developing countries to shift from industrialization to services, or even to bypass the manufacturing stage of development altogether. But blind faith in services-led growth is a dangerous illusion, and the arguments supporting it are deeply flawed.

Célestin Monga

monga8_EYERUSALEM JIREGNAAFP via Getty Images_ethiopiafactory

CAMBRIDGE – As the world prepares for the post-pandemic era, the quest for sustainable economic growth is becoming ever more intense – especially for developing countries. It is tempting to call for these countries – the main engine of global growth in recent decades – to shift their development strategies from industrialization to services.

As new technologies increasingly allow services to be produced and traded just like goods, some economists even suggest that low-income economies should skip the manufacturing stage of development altogether and go directly from traditional agriculture to the new “growth escalator” of services.

The belief that services represent the new holy grail for developing countries stems in part from empirical studies showing that trade in services has increased faster than trade in manufactured goods since 2000, and in particular since 2011. The disruption of global value chains caused by COVID-19 has only reinforced this belief.

Moreover, new technologies such as 5G networks and cloud computing are fragmenting service processes and opening up new possibilities to outsource high-wage and costly activities. These trends are driving a so-called “third unbundling,” whereby some previously non-tradable services become tradable.

With the world’s largest economies engaged in tariff wars and global trade declining sharply, many regard services as the most appropriate growth and employment engine, because they can be digitized and are less susceptible to customs and other logistical barriers.

But this blind faith in services-led growth is a dangerous illusion, and the arguments supporting it are deeply flawed.

For starters, the downward trend in the global trade-to-GDP ratio over the past decade should be put in perspective: a study by Giovanni Federico and Antonio Tena-Junguito shows that although world trade since 1800 has often suffered temporary retreats, the fundamental and consistent trend is upward. Trade and globalization have on balance made the world much wealthier, and will remain the most reliable routes to global prosperity and peace.

Second, manufacturing – not services – remains the primary driver of global growth. True, high-tech innovation is blurring the lines between physical and new digital production systems, and also changing the conventional boundaries between agriculture, industry, and services. For example, new developments in information and communications technology (ICT) are allowing traditional farmers around the world to connect to global value chains in agro-industrial production and services.

But these changes do not alter the fact that industrialization is still paramount in the quest for economic prosperity. The digital revolution is mainly opening up new opportunities to accelerate innovation and boost the value-added content of manufacturing output.

A recent report by the United Nations Industrial Development Organization shows that value added in world manufacturing averaged 3.1% annual growth between 1991 and 2018, slightly higher than the average GDP growth rate of 2.8%. As a result, manufacturing’s contribution to world GDP growth increased from 15.2% in 1990 to 16.4% in 2018.

Third, the current value of global trade in services is only one-third that of manufactured goods, even though services account for 75% of GDP and 80% of employment in OECD countries. Advanced economies’ greater share of employment in tradeable services is simply a logical step in the process of industrial upgrading and structural transformation, and also reflects their comparative advantage in being near the technological frontier and relying mainly on relatively high-skilled labor and financial capital.

By contrast, developing countries’ comparative advantage is low-cost labor, and they should not seek to mimic the services-led growth strategy in vogue in advanced economies without having the skills base to sustain it. Policymakers from Bolivia to Burundi to Bhutan would be ill-advised to try to emulate Switzerland’s services-led growth simply because they also are landlocked countries.

Moreover, the claim that industrialization will create fewer job opportunities than in the past because robots are increasingly replacing human labor remains conjectural. Although automation will eliminate a large number of jobs, it will also likely create new industries and jobs in more skilled activities.

Once we consider indirect effects along the value chain, the increase in the stock of robots used in global manufacturing is actually creating employment, not destroying it. Moreover, in situations where technological progress and the proliferation of artificial intelligence (AI) lead to unemployment and worsen inequality, sound public policies (such as non-distortionary taxation levied to compensate those who otherwise lose their jobs) can counter these negative effects.

Fourth, services’ status as the main source of growth in many developing countries (at least according to official national accounting statistics) mainly reflects the failures of industrialization strategies that were not aligned with these economies’ comparative advantages, as well as excessive informalization in traditional agriculture and relatively unproductive activities. Low-skilled services may help many people to escape extreme poverty, but they are not reliable engines of growth and sustainable economic development.

To be sure, tradeable business services (including ICT services, financial intermediation, insurance, and professional, scientific, technical, and medical services) can provide opportunities for service-based global integration because of the large wage differences across countries. But, again, this will happen only when developing countries improve their human-capital base – a long-term and costly process.

Similarly, the emergence of advanced digital production technologies (including robotics, AI, additive manufacturing, and data analytics) opens up new possibilities in services such as telemedicine and telerobotics. But these activities also require highly skilled workers, and most developing countries’ education systems and outcomes unfortunately prevent much of the labor force from competing successfully.

Given these constraints, advocating that economies with weak human capital leapfrog industrialization is a recipe for further informalization and poverty.

For poorer countries, industrialization remains the main avenue for successful development. It yields higher productivity growth, and it builds and strengthens the skills and capabilities that countries need to secure a competitive niche in the global economy.

New technologies also allow latecomers to build environmentally sustainable manufacturing firms.

In short, developing countries should dismiss reports of the demise of manufacturing as the key to future prosperity. High-end services can and must wait.

Célestin Monga, a former managing director at the United Nations Industrial Development Organization and former senior economic adviser at the World Bank, is Visiting Professor of Public Policy at Harvard University’s John F. Kennedy School of Government. He is the author, most recently, of The Oxford Handbook of Structural Transformation and the co-author (with Justin Yifu Lin) of Beating the Odds: Jump-Starting Developing Countries.