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Friday, April 11, 2003

Sars Isn't Getting any Better

There is no sign of the SARS epidemic abating, quite the contrary it seems to be deriorating. Looking at today's figures - 3,000 cases and 117 deaths - the death rate seems somewhere just under 4%. A week ago the numbers were about 2,300 and 78 dead. That seems to be around a 30% increase per week, which is big, very big. On the good news front a team of investigators have established that it is a corona virus with a common point of origin. The bad news, this means that it can either be spread by direct contact. or by large droplets of body fluid deposited on surfaces. Hence the need to disinfect airplanes. Then there is the possibility of super-carriers. The cases in Singapore all seem to originate with one carrier who is immune. Also note the case of the marathon traveller who was in fact suffering from the disease. Like many people I'm reading Duncan Watts 'Six Degrees', and I'm convinced that major problems don't originate from catastrophes, but from a series of small but important incidents. Finally the proposed name for the virus: the Urbani SARS-associated coronavirus.

There is no sign of the global SARS outbreak abating, with a worrying surge in new cases in Hong Kong on Friday, and a senior Chinese health official warning that the outbreak is not under control. Epidemiologist Zhong Nanshan, director of the Respiratory Disease Research Institute in the Guandong province where SARS originated, disputed the Chinese government's claims to have controlled SARS. "Looking at this from a medical point of view, this disease has not been effectively controlled at all," he said. "The origin of this disease is still not clear, so how can you say it has been controlled?" He said "contained" might be a better description. Following initial work, the World Health Organization is to strengthen its investigative team in China. "This is necessary for us to have a better understanding of the disease and develop more effective control and treatment strategies for SARS," says Hitoshi Oshitani, a WHO regional adviser in Manilla, the Philippines. By Friday, Severe Acute Respiratory Syndrome (SARS) had killed at least 117 people and infected over 3000 in over 30 countries. The key problem hampering the efforts of health officials to halt the outbreak is their continued lack of understanding about how the virus that causes the disease spreads. As a result, draconian protective measures are being implemented in many countries around the world, with thousands being held in quarantine. On Friday, the Hong Kong authorities also barred people who have had close contact with SARS victims from leaving the region. Police have hunted down a number of people who fled quarantine. In Singapore, the authorities aim to ensure compliance by installing internet-linked cameras in the homes of quarantined people. And in Canada, blood donations from people who have visited SARS-affected regions have been stopped, as a precaution.Most SARS victims are either closely related to other victims or healthcare personnel working with patients. The virus probably spreads via direct inhalation of the body fluids expelled by coughing, or by touching surfaces soon after they are infected. But investigators are still examining how some unrelated people have contracted SARS. "Super-spreaders", who survive the disease but are highly infectious, are one possibility. A young Singaporean woman is now believed to be linked to virtually all of that country's 130 cases. New information has also emerged from the investigation of the Amoy Gardens housing complex in Hong Kong, where 200 resident caught SARS. The virus was found in basins and toilets, say officials, suggesting the virus travelled through the clogged sewage system. Malik Pieris, head of virology at the University of Hong Kong, also reports that tests show the virus can survive in faeces.
Source: New Scientist

New England Journal of Medicine: ABSTRACT

Background A worldwide outbreak of severe acute respiratory syndrome (SARS) has been associated with exposures originating from a single ill health care worker from Guangdong Province, China. We conducted studies to identify the etiologic agent of this outbreak.

Methods We received clinical specimens from patients in six countries and tested them, using virus isolation techniques, electron-microscopical and histologic studies, and molecular and serologic assays, in an attempt to identify a wide range of potential pathogens.

Results No classic respiratory or bacterial respiratory pathogen was consistently identified. However, a novel coronavirus was isolated from patients who met the case definition of SARS. Cytopathological features were noted microscopically in Vero E6 cells inoculated with a throat-swab specimen. Electron-microscopical examination of cultures revealed ultrastructural features characteristic of coronaviruses. Immunohistochemical and immunofluorescence staining revealed reactivity with group I coronavirus polyclonal antibodies. Consensus coronavirus primers designed to amplify a fragment of the polymerase gene by reverse transcription-polymerase chain reaction (RT-PCR) were used to obtain a sequence that clearly identified the isolate as a unique coronavirus only distantly related to previously sequenced coronaviruses. With specific diagnostic RT-PCR primers we identified several identical nucleotide sequences in 12 patients from several locations, a finding consistent with a point source outbreak. Indirect fluorescent antibody tests and enzyme-linked immunosorbent assays made with the new coronavirus isolate have been used to demonstrate a virus-specific serologic response. Preliminary studies suggest that this virus may never before have infected the U.S. population.

ConclusionsA novel coronavirus is associated with this outbreak, and the evidence indicates that this virus has an etiologic role in SARS. The name Urbani SARS-associated coronavirus is proposed for the virus.
Source: New England Journal of Medicine

An international airline is contacting some of its recent passengers after a man who made seven flights in less than a week was diagnosed on Thursday with the deadly Sars virus. The man's journey took him from Asia to several European capitals and back to Asia again. Lufthansa - the airline he used for all seven flights - has been trying to contact passengers and employees who had direct contact with him. One UK man who had contact with him has been taken into hospital with a probable case of Sars. The World Health Organisation has said the risk of air passengers spreading the disease mid-flight is extremely low. But the incident highlights the problems facing health officials attempting to halt the worldwide spread of the virus. The infected man, who has not been named, started and ended his journey in Hong Kong. The territory has so far recorded nearly 1,000 cases of the Sars virus and ranks as the most severely affected region after mainland China. According to the Department of Health in Hong Kong, the 48-year-old victim flew to Munich on 30 March, before travelling on to Barcelona, where he first developed symptoms of the virus. On 2 April he took another flight to Frankfurt, before moving on to London, back to Munich, back to Frankfurt and then finally returning to Hong Kong on 5 April. He was then admitted to a hospital in Hong Kong and diagnosed with Sars on Thursday, the Department of Health said. Lufthansa said it had disinfected all the planes involved and was confident that the chances of any passengers becoming infected were "very remote".
Source: BBC

StephenRoach on the IMF Forecsat

Here is Stephen Roach's latest post on the IMF forecast. He is downside on both Asia and Europe (primarily Germany). I haven't got any models to do my forecasting for me, but my gut instincts as an economist tells me he may be right. After all what we're seeing are downwards revisions all round right now, so if anything the models have too much backward-looking bias.

The IMF has just slashed its estimate of world GDP growth in 2003 to 3.2% -- a cut of 0.5 percentage point from the 3.7% forecast of record made last September. The revisions were largely concentrated in the industrial world. The European prognosis was pared the most -- from 2.3% to 1.1%. But the IMF also lowered its numbers for the United States (from 2.6% to 2.1%) and Japan (from 1.1% to 0.8%). In the developing world, the IMF’s cuts were mainly evident in Latin America, where their 2003 estimates went from 3.0% to 1.5%. By contrast, in developing Asia, growth estimates were left unchanged at a vigorous 6.3%.

In official circles, a cut of 0.5 percentage point off an annual estimate for world GDP growth is a big deal. But, in my view, the IMF’s latest cuts aren’t nearly big enough. Our current -- and also downwardly revised -- forecast calls for world GDP growth of 2.4% in 2003. That’s fully 0.8 percentage points below the IMF’s just-released estimate. But it’s not only the numerical difference that matters; these forecasts each depict a very different character of the global economy. The IMF’s 3.2% global growth estimate portrays a decided subpar growth trajectory, with world GDP growth estimated to be 0.4 percentage point below its 3.6% longer-term (post-1970) trend. By contrast, our latest estimate takes the world economy technically into the recession zone -- just piercing the 2.5% growth threshold normally associated with global downturns. To be sure, neither forecast depicts any vigor in the world economy. But our view certainly emphasizes the perils that lurk on the downside.

The bulk of the difference between us and the IMF can be traceable to two areas of the world -- Asia ex Japan and Europe. In Asia, the IMF is still carrying a 6.0% growth estimate for 2003, well in excess of our downwardly revised 4.6% prognosis. With this region accounting for fully 26.3% of world GDP as measured on a purchasing-power-parity basis, the Asian forecast difference accounts for fully half the total gap between our view and the IMF’s for 2003. Not surprisingly, the IMF does not appear to have made any modifications of its Asian growth estimates to reflect the impact of SARS -- severe acute respiratory syndrome. By contrast, we recently knocked 0.4 percentage point off our 2003 Asian growth forecast to reflect a sharp SARS-related reduction in tourism in these tourist-intensive economies. With tourism, travel, entertainment, and a variety of other key service activities (i.e., retailing) having come to a virtual standstill in this once-resilient region, I am certain the IMF would have made a similar adjustment had they gone through their forecast update a couple of weeks later. Nevertheless, our pre-SARS view of Asia appears to have been somewhat weaker than the IMF’s -- mainly reflecting more cautious forecasts of the so-called newly industrialized economies (NIE) of Asia (Korea, Singapore, Hong Kong, and Taiwan). This difference appears traceable mainly to our heightened concerns over a more cyclical outcome for the global trade cycle -- a big deal for trade-intensive Asian NIEs.

For Europe, there is less of a disparity. Our latest forecast for 0.8% GDP growth in the euro area for 2003 is 0.3 percentage point below the IMF’s 1.1% forecast. The bulk of the difference shows up in Germany -- Europe’s largest economy, accounting for fully 28% of pan-regional GDP; our prognosis for “zero growth” in Germany this year is 0.5 percentage point below the official IMF outlook. While IMF can hardly be accused of having an upbeat view of Germany -- the industrial country it judges to be next in line for deflation after Japan -- it does appear to be somewhat more upbeat on the prospects for private consumption than we are. Subdued inflation is expected to provide a bit more of an assist to household purchasing power.
Source: Morgan Stanley Global Economic Forum

If Demographics is the Problem, What's the Solution

In the comments column of Brad's blog Amit Dubey asks the following:

So if demographics is the problem, what's the solution? And how should other countries handle it e.g. a big tax hike now in order to fund government consumption when demographic inflection hits? I don't think "immigration" is a good answer, because then what do India and China do a couple decades down the road? (and, perhaps more optimisitcally, what will Nigeria and Congo do a couple decades after that?)
Source: Semi Daily Journal

My attempts to answer this quite important and legitimate question have given rise to the following thoughts.

Firstly 'What's the solution'? Apart from stating there is no insta-pundit solution on this one, there are obviously things we can do. Reduce our deficits in the good times for one. Carry out pension reforms and encourage private saving for two. Increase the retirement age for three. Individually have more children, for four. And most important of all change our attitudes to immigration.

Of course, none of these 'solve' the problem. But they may make things better rather than worse. If Britain scores rather favourably on the ageing vulnerability index, for example, it is because it has made important progress on pension reform, immigrant acceptance and multicultural identity when compared with its European neighbours. Is this unequivocally good? No. The pension reform comes at a price of increased poverty among old people. Is there much alternative? I don't think so.

The point about India and China is a good one: one day the planet will run out of immigrants. But what may be only a stop-gap solution does buy time, and that could be important as this is what we need to feel our way forward.

Secondly: "if demographics is the problem"

Interestingly more and more people seem to be waking up to the fact that it might be at least part of the situation. Last month it was Alan Greenspan, now it is the deficit 'hawks' Volcker and company:

"Looming at the end of the decade is a demographic transformation that threatens to swamp the budget and the economy with unfunded benefit promises, like Social Security and Medicare, of roughly $25 trillion in present value. Our children and grandchildren already face unthinkable payroll tax burdens that could go as high as 33 percent to pay for these promised benefits. It is neither fiscally nor morally responsible to give ourselves tax cuts and leave future generations with an even higher tax burden."

Remember: the 'pension reform' which is most the likely outcome, even in the US, is tantamount to a massive Enron-style default on previously contracted obligations, only this time the defaulting party is the national exchequer. This is bound to have an impact on saving, consumption and the output gap.

What's the solution. This is a fair question, and the honest answer is that I don't know.

The best answer I can come up with right now is that since an economy is a form of complex adaptive system, then there will be some automatic stabilisers. Maybe our expectations form part of the picture. Maybe we are assuming as inbuilt growth patterns which have only characterised the last two hundred years.

Taking three parameters - technology, population and per-capita incomes - as key variables, we can see that for most of human history prior to the industrial revolution (outliers like the Greek and Roman empires being exceptions, and for interesting reasons) better technology meant more people and near stagnant living standards. This was Malthus' argument. Then came the industrial revolution, and both population and living standards increased rapidly with technological change. Now we have the information age, and technological change accelerates (possibly following a power law distribution?) population begins to decline, and we don't know what will happen to per capita incomes. Period: we don't know.

The point about Nigeria and Congo is also interesting. A demographer called Keyfitz once developed something called the population momentum equation. This is much more imporatnt than the name sounds, as it enables forward looking calculations on demography. Have you ever asked why the demographic problem has hit Japan first? Well Keyfitz goes a long way towards the answer. It's all about how quickly you make the first part of the demographic transition (the part which goes from 3-4 children per woman to below 2.1). Well if this occurs in less than one generation (simplifying greatly), then the population effectively becomes rapidly de-structured and enters a downward spiral. That is why Japan is first, and other countries like Italy, Spain , North Korea, Taiwan etc (who begin and complete their transitions later, and more rapidly than EU 'core' countries like the UK and Germany, and who also historically have less immigration) follow in quick succession. This could lead us to expect that in India, China and Brazil the situation could be still more dramatic (since latest word from the UN is that the transition is accelerating in these countries), and so on till we reach Nigeria and the Congo. That is if HIV-AIDS doesn't get there first. Remember, things get faster, faster.

Lastly, in terms of analysis, and especially in terms of more conventional economic analysis, this process can be approached from both a macro and a micro angle. With the proviso that it's only when you come to lay the macro-horizon on its micro-foundations that, I feel, the extent of the problem becomes clear.

On the macro side standard growth theory can serve as well as any other starting point.

Solow suggested that Y= A f(K,L)

Well I would suggest(following Mokyr) that this characterises fairly well industrial society with high proportions of fixed capital , but that in the information age (the age of human capital, remember the adage: a firms most important asset are its workers), a better formulation might be:

Y = A f(K, L1, L2,........Ln).

If the function looks something like this, then obviously if the sum of the growth in value of each of the various components of human capital exceeds the reduction in quantity, you can still have growing GDP. This problem is extremely tricky to model, as Solow notices in his critique of endogenous growth theory. It is easy to build a model with exploding, knowledge driven growth, it is far more difficult to envisage this occuring in practice. In part this is for reasons associated with our understanding (or lack of understanding) of Total Factor Productivity (or TFP). At present my understanding of this is still mirky, and it is better described as work in progress.

For the other part the actual values of the various human capital elements depend on the demand side equations, and it is here that consumption enters. I find Angus Deaton's notions of liquidity constraints enormously suggestive. Basically the collective constraint will be related to perceived rates of growth going forward, likelihoods of government debt (or pension) default, and the respective age structures and dependency ratios of the population. The nub of the matter seems to me to be how rapidly the younger age groups in society are willing to advance consumption, and, given their relative numberic weakness, at what rate of indebtedness.

This is as far as I have gone to date. Anyone willing and able to take this type of problem forward to a succesful conclusion deserves a Nobel in my book. Any good suggestions or lines of investigation, please contact me.

Everybody's Doing it.......

First it was Alan, now it's Paul and company. Seems like they're about to start a craze. What craze? The budget deficit gitterbug. And why? Becuase come the end of the decade the US Treasury will have enormous unfunded obligations to its citizens. Tell me something else I didn't already know. But still it's nice the see Alan Greenspan and Paul Volcker joining the club.

Looming at the end of the decade is a demographic transformation that threatens to swamp the budget and the economy with unfunded benefit promises, like Social Security and Medicare, of roughly $25 trillion in present value. Our children and grandchildren already face unthinkable payroll tax burdens that could go as high as 33 percent to pay for these promised benefits. It is neither fiscally nor morally responsible to give ourselves tax cuts and leave future generations with an even higher tax burden.
Source: New York Times via Brad Delong's Semi Daily Journal

Nikkei Continues to Drop

The Nikkei 225 fell today for the fourth consecutive day. If things go on like this it's going to be one of the shortest 'post war rallies' in history.

Tokyo stocks were lower in morning trade on Friday as blue chips continued to be sold off on investor nervousness regarding the state of the global economy in the wake of the Iraq war. The benchmark Nikkei 225 average was off 0.4 per cent to 7,945.99, while the broader Topix index was down 0.3 per cent to 790.07. The Nikkei has lost ground for four consecutive sessions this week, as investors increasingly focus on the underlying poor fundamentals affecting the Japanese market. Several Japanese companies, including NEC and Obayashi, a leading construction company, have slashed their annual profit forecasts for the year ended March 31 due to stock valuation losses. The Nikkei shed 26 per cent in the 2002 fiscal year.
Source: Financial Times

Eurozone Economy "May Have Shrunk"

The eurozone economy may have shrunk in the first quater 2003 according to the European Commission. The suggestion comes in the Spring 2003 economic forecast:

The Commission said on Thursday it had trimmed its estimates because of sluggish demand and uncertainty linked to the Iraq war, forecasting first quarter growth of minus 0.2 to 0.2 per cent and second quarter growth at 0.1 to 0.4 per cent. The gloomy estimates were released as the European Central Bank warned in its April monthly bulletin that the economic outlook was uncertain.The central bank said it expected "only a modest rate of economic growth for 2003" after recent data and surveys suggested the eurozone economy "remained weak" in the early part of this year.Economists said the tone of the bulletin signalled continued concern about the downward risks to growth and suggested the ECB was keeping the door open to another rate cut in coming months.
Source: Financial Times

Thursday, April 10, 2003

The Two Pillars of Public Finance

The first of course in annual fiscal deficit, the other: the debt to GDP long term. Curiously enough the emphasis in the present interpretation of the EU growth and stability pact is on the former. But this is only important so long as it impacts on the latter. Categorising countries on the two measures gives different readings, and this was the basis for Pedro Solbes recent proposal for reform. One of the countruies which seems on the face of it to be a good-citizen in terms of the 3% limit, is in fact one of the worst offenders at global debt level. Fortunately the Belgium debt has not been increasing significantly recently, but the principal reason for this is declining interest rates. All in all the Belgium situation is far from good, which is one reason why the Global Ageing Initiative placed it ninthout of twelve on its Ageing Vulnerability Index. Morgan Stanley's Annemarieke Christian explains:

With markets primarily focusing on budget deficits at the moment, the danger is that they lose sight of the other important pillar of the Maastricht framework, government debt levels (for details, see Chris Lupoli and Vincenzo Guzzo's article “Country-Specific Spreads in Euroland,” Interest Rate Strategy: Global Perspectives, March 20, 2003). But while the deficit provides only a snapshot of fiscal policy, the debt level is key when it comes to the long-term sustainability of public finances. Belgium is an interesting case in this regard, being one of the most virtuous in the euro area on the deficit front, while sporting one of the highest debt levels, well above the 60% of GDP Maastricht limit. At first glance, the Belgian government seems to have been one of the most fiscally virtuous in the euro area lately. Despite the sharp economic slowdown, it has managed to keep its budget in balance, while its neighbours' budgets were running up marked deficits.

A key factor -- in addition to one-off measures -- in this stellar Belgian performance is the continued decline of interest payments in the Belgian budget, which helped to keep the budget balance out of the red zone last year. But on the debt level, the other pillar of the Maastricht framework, Belgium is near the bottom of the league in the euro area. Despite the output gap rising by three percentage points in the last two years, the Belgian government managed to keep its finances in balance, thanks to declining interest payments, spending discipline and asset sales. This is rather impressive, in our view, given that the sensitivity of the Belgian budget (0.65%) is estimated to be well above that of the euro area average (0.5%). As GDP growth fell from an average rate of 2.7% GDP in the second half of the 1990s to 0.8% in the past two years, the automatic stabilisers would have pointed to a budget deterioration of two percentage points. Yet the government managed to expand the budget surplus slightly to 0.2% of GDP in 2001 and kept its budget in balance in 2002. Next to real estate sales of around 0.3% of GDP in the past two years, the government stuck to a strict spending discipline. It even found room in its finances to ease the tax burden for households and companies. Further steps in income tax reform are planned for the next three years. In addition, the corporate tax rate was cut from 40.2% to 34.0% in 2003 and now lies just above the EU average, on our calculations. While corporate tax reform has been devised as revenue-neutral, the income tax cuts are to be financed by interest savings.

With growth to remain sub-par for a third consecutive year in 2003, we believe the budget balance is likely to slip into deficit this year. The Stability Programme target of a balanced budget, postulated in November last year, was based on a growth rate of 2.1% for this year.Large budget deficits, which reached more than 10% of GDP in the mid-1980s, led to the spiralling of debt up to a peak of 137.9% of GDP in 1993. Since then, however, the government has been on a prudent course of debt reduction, bringing down the debt level by around 32 percentage points to 105.4% of GDP in 2002. While one-off measures were the main reason behind the drop in debt in the mid-90s, the sharp pace of decline since then was achieved by strong growth, high primary surpluses and shrinking interest payments. Primary surpluses (government budget balance excluding interest payments) were built up from an average 2.5% of GDP in the decade up to 1993 to sustained surpluses of more than 6% of GDP in the last few years. At the same time, public spending has come down from a peak of 53% of GDP in 1993 to around 46% of GDP in 2002. This decline is largely driven by interest payments, which fell from almost 11% of GDP in the early 1990s to just under 6% of GDP in 2002.
Source: Morgan Stanley Global Economic Forum

Nikkei Back Down Below 8,000

In a sign of what may be in store for the post-war equity markets, the Nikkei fell below 8,000 today. With worries about Sars rising, Europe full of euro-related low groth problems, and the US job and profitability situation all focusing attention, it's hard to see a strong rally any time sooon. God, I can still remember that it was only March last year that we were all saying 10,000 would be a tipping point. Now it's down to 8,000 and heading South. Still, there will be a tipping point in there somewhere, the difficulty is only in identifying it.

The benchmark Nikkei average fell below the key 8,000-level in midday trade on Thursday, on continuing fears regarding the state of the global economy in the wake of the Iraq war.The benchmark Nikkei 225 fell 1.4 per cent to 7,941.96, while the broader Topix index was down 1.3 per cent to 790.76.Stocks were broadly lower, with Sony hitting a four-year low in intraday trade, on concern that Japan’s biggest exporters may feel the effects of a global economic slowdown following the Iraq war. Sony’s shares were down 3 per cent to Y3,900 in midday trade, a level last seen in January 1999. Downward pressures on blue chips. were exacerbated by corporate pension fund selling.
Source: Financial Times

Reform at the Bank of Japan?

The BoJ has decided to proceed with its plan for buying asset-backed securities (ABS's) in particular by buying securities from small and medium-sized enterprises, and to conduct this activity as a routine part of its monetary operations - even if only on a temporary basis - over the next few years. This was decided at the 7, 9 April meeting by a majority vote of 8 to 1. This initiative aims to provide smoother financing to Small and Medium Enterprises (SME's) by purchasing securities based on sales receivables and other assets. According to the bank, the objective is to strengthen the effects of monetary easing by nurturing the development of tan assett backed security market, thereby making available investment funds to smaller enterprises. The big questions, of course, concern whether this will really have any impact, either in facilitating the growth of newer, more dynamic enterprises, or in the more general area of increasing liquidity to provoke inflation. Morgan Stanley's Takehiro Sato has plenty of doubts:

The bank�fs decision to purchase private-sector debt, rather than government debt, itself appears to be a major policy shift. Governor Toshihiko Fukui is pursuing involvement in corporate financing to enhance the quality of liquidity supply after seeing the limited effect of quantity expansion promoted by former Governor Masaru Hayami. A key premise for purchase operations of such risk assets to be effective, however, is a market with sufficient size and liquidity. Yet the ABS market is still in its infancy and lacks adequate outstanding value and liquidity, particularly for SME securities, and transaction price transparency. Furthermore, the bank intends to purchase ABS backed by the assets of SMEs with credit standing comparable to �gnormal�h in bank self-assessments. This requirement can be expected to limit the scope of ABS eligible for BoJ purchase operations and may make the policy initiative effectively meaningless.........

It is likely to be confirmed that these operations will not make a quick contribution to SME financing. However, the BoJ decision to move beyond the eligible collateral level and involve itself in corporate credit has created the possibility of more direct financing to corporations over the medium term. For example, the Bank is already considering purchase operations for not only senior securities but also the mezzanine segment. If this happens, credit standing for eligible collateral and purchased assets may be reversed in some cases, similar to the situation with bank equity holding standards. Future policy developments might therefore lead to a relaxation of eligible collateral criteria in order to maintain policy coherence. Easier eligible collateral criteria could enable banks to underwrite corporate CP and improve funding. Yet this is likely to reduce the chance of corporate liquidity failures in the same way as recent quantitative easing measures. In other words, reinforcement of the safety net for non-financial corporations, in addition to banks, could postpone the shakeout and reorganization process and allow financial socialism to make further inroads.
Source: Morgan Stanley Global Economic Forum

Wednesday, April 09, 2003

What the Worst Performing European Economies all Have in Common

This one seems obvious. Sad, but true. Only one question: when will we understand why?

What is the single factor uniting Europe's worst performing economies? The answer is: they all use the euro, while those countries still using their own currencies are doing rather well, according to the European Commission's spring forecasts published on Tuesday. The euro was supposed to free up markets, encourage inward investment and generally pep up the economy, but almost five years after 12 EU members fixed their exchange rates some of the benefits remain elusive. The eurozone economy has been virtually stagnant since 2001, with average growth of little more than 1 per cent. Those predicting that Britain, clinging to the pound, would enter a period of decline have so far been proved wrong. Denmark and Sweden, the other two EU members still using their own currencies, have also outperformed the eurozone. Another feature of the Commission forecasts is that the 10 countries set to join the EU next year are also doing much better than the 12 members of the eurozone.There are many factors explaining why the eurozone is doing poorly compared with the rest of Europe other than the fact that it shares a currency. The structural problems in Germany and Italy in particular have held back growth. Meanwhile Greece and Ireland, which use the euro, have the fastest growing EU economies. But it remains true that membership of the fledgling euro is clearly not a precondition to economic health - in the short term at least.
Source: Financial Times

Euro Growth Forecasts Down

There seems to be a dearth of real economic news this week as everyone struggles to digest what the implications of the post-Iraq-war will mean (and what the impact of SARS may turn out to be). I must admit that even while blogging this piece I had the feeling of deja-vu 'yawn yawn'. I think we all have a fair idea of what is happening in Europe, so until we actually see it in the figures there is likely to be a sense of eery unreality about the sitaution (to echo Steven Roach's post of last week). Nonetheless there are a couple of details asociated with the new EU growth prospects report ( here ) which are worthy of mention. Firstly the situation in Italy keeps rearing its head. I think the Commission really are starting to get brassed-off with the prevarication and lack of reality being shown by the Italian Government, and if any of the excess-deficit procedures are well-earned it will be the one being threatened now against Italy. In all the euro navel-gazing, Italy's preoccupying economic and fiscal future is the one which seems to attract least attention. Secondly the little detail about the 'bright spots in the report arise from countries outside the 12 member eurozone'. Is this simply a coincidence? What value can we place on being able to control your own fiscal and monetary policy, and having the capacity to address directly balance of payments deficits (even if the UK does not seem to be using it much right now). Going back to the Harrod Balassa Samuelson effect for a moment, if this argument has validity, then surely it should be applied to the current growth trajectory of the 10 enlargement countries as they approach EU lock-in.

Also of note is the throwaway comment about Italy's "transitory" measures to massage down its deficit, and the urging that it confront its "high levels of national debt and looming pensions crisis". The Italian national debt is now around 105% of GDP, and the pensions situation, despite two reforms, is still 'unresolved'.

On more general matters, one of the criticisms that I suspect may be levelled against me is that while I may score highly on analysis of the EU-euro problem, I am, with the exception of the immigration proposal (and possibly the Turkey and other third world enlargement one), a little short on remedy. I would say that this point is a fair one. I have no 'insta-pundit-insta-cure'. We are facing a new situation, and we need bold and unorthodox remedies: but this does not mean reckless ones. We have, in my opinion, a long way to go before we start to find our way forward, and it is not realistic to expect solutions tomorrow. This doesn't mean we shouldn't keep looking. This is what the internet, and all the debates that are taking place in the innumerable comments columns, are all about.

But one 'solution' which is not a solution in the accepted sense of the term is the one which is currently being presented as 'structural reform' in Europe. This brings me to the point where I have most reservations about the Stephen Roach argument. He is absolutely right about the imbalances being produced by a US-centric global economy in my view, but is completely unrealistic in imagining that this can raise the pressure for strucural reforms in Japan and the EU in a way which will produce alternative growth engines. This is, in my book, a non starter. Of course, the EU reforms are necessary: without them we would have the universal bankruptcy which Keynes so feared. But they will not produce a re-run of the 1980's, the panorama we face moving forward just isn't going to be like that. If we consider the labour market and pension reforms which are currently on the agenda in both Europe and Japan we should be able to see that effectively they will have all the hallmarks of a massive default. Firstly, the pensions reforms will effectively mean the devaluation of all the 'forced savings' which an entire generation had been preparing for its retirement. The money being devalued may not, as in Argentina, be in fixed-term deposit accounts, but the difference is only a technical one. A huge quantity of notionally accumulated wealth is going to be written-off on behalf of a large number of people.

Secondly, the labour market reform has a similar look to it. What is about to be written-down via this reform is the market value of all that accumulated workforce experience which resides in Europe's larger corporations. This writing down takes two forms. First lower salary expectations, and secondly lower compensation when jobs are 'bought out'. This is where the European situation is similar to the Japanese non-performing loan one. In Japan the majority of businesses are overvalued due to the fact that they hold equites and debt within their asset portfolio which is being counted at face, and not market, value. Part of the reform in Japan is to reclassify this debt. Well in the same way many Europeans have their own individual non-performing loans: the ones they made to the government pension scheme and the ones they made by dedicating their working life to a single company. For the baby boomers the time is now rapidly approaching when they hope to collect, and the reform is there to make clear to them that the glass is half empty. Now who can hope in these circumstances for a serious revival in European consumption and productivity. For starters just think - Irving Fisher style - of the debt dynamics provoked by this enormous write-down. It's gonna be much bigger than the bubblenomics Steven.

Europe's growth forecasts for 2003 tumbled on Tuesday, with warnings that the continent could fall into recession if tensions over Iraq endure and consumers suddenly lose confidence.The gloomy spring forecast by the European Commission cut baseline eurozone growth predictions from 1.8 per cent to 1 per cent. Italy risks joining Germany, France and Portugal in breaching the EU's budget rules.

Gordon Brown, the British finance minister who presents his 2003 budget on Wednesday, will be pleased that the Commission believes the UK has weathered the downturn "rather well", albeit with a rising budget deficit. The 10 EU candidate countries, mainly from the former communist bloc, also continue to outstrip the performance of the eurozone countries, with growth predicted to be 3.1 per cent this year and 4 per cent or more in 2004. Pedro Solbes, EU economy commissioner, said Europe needed to pursue tough policies to "inspire confidence" at what he described as "a crucial juncture" in the EU's history. "If anything, the EU's weakness in the face of a global downturn has underlined the need to further strengthen the economy's growth capacity and resilience to shocks," he said. But he warned of recession in 2003 in the US should Iraq continue to cast a shadow, oil prices reverse their recent fall and consumer confidence worsen. The forecasts were unremittingly downbeat, with unemployment in the EU expected to rise by 100,000 in 2003, the first rise since 1994, with joblessness at 8 per cent.

While the Commission accepts that many of Europe's problems are homegrown, it also points a finger of blame at Washington, arguing that the twin US budget and current account deficits create instability.It also says international tension over the likely role of the United Nations in administering a post-Hussein Iraq could also knock European economic confidence. Mr Solbes believes EU member states are now starting to realise the seriousness of their predicament. He offers support for the reforms already proposed by Gerhard Schröder, German chancellor.Francis Mer, French finance minister, has also signalled that he is now prepared to backtrack on election promises not to alter course, so as to meet France's obligations under the EU's stability and growth pact. But Italy is accused of taking "transitory" measures to massage down its deficit, and is urged to confront its high levels of national debt and looming pensions crisis.
Source: Financial Times

Tuesday, April 08, 2003

Japan's Continuing Economic Crisis

One day or another Japan unfortunately is going to burst. Left on its present course, like the proverbial nineteenth century steamship with the boiler overheating, one day one too many of the bolts will sheer off, a boiler plate will give and then the devil take the hindmost. Of course one of the few debateable points remaining is whether or not there is really anything left to be done. Common sense says there is, and sheer humanity says that there ought to be. Recognising this is the easy part. The tricky bit is what to do. Ten years of sustained problems, various recessions, and the outbreak of what may be regarded as the developed world's first serious bout of sustained deflation have left little doubt about the depth and seriousness of what is taking place.................

In general terms, one of the problems with the whole Japan debate is that much of the available material fails to tackle the problem head-on. For instance the well-publicized Federal Reserve research report "Preventing Deflation: Lessons From Japan's Experience in the 1990s" rather surprisingly fails even to consider one of the most important factors which may be driving the Japanese deflation: DEMOGRAPHICS. This lacuna is not an isolated case. Even where the problem is mentioned, it is normally not explored.

So all of this is a bit like Hamlet without the prince. Little of the more fashionable analysis really helps us understand why Japan government debt is growing out of control - after all with deflation abounding, even government supplied services should get cheaper, and why raising interest rates at any point in the foreseeable future is going to be difficult. This is because many of the arguments rest on the assumption that eventually Japan will solve the slow growth problem and start to recover. Well, I'm afraid I wouldn't be too sureabout that. And if the problem is a faulty diagnosis, then how the hell do you expect the medicine to work............

As Robert Lucas among others has indicated, classical economists like Malthus and Ricardo saw the need to account for the dynamics of pre-modern societies, and in particular for the fact that in these societies per capita incomes normally did not increase, but rather tended to return to roughly constant levels despite technological improvement, as one of the central problems facing economic theory. Differences in ability to produce had the knock-on effect of leading to differences in population level, and not to differences in living standards. This static situation constituted what has become known as the Malthusian trap. With the coming of industrial society something new happened, we broke out of the trap. Population increased, but at the same time per capita incomes also continued to increase, systematically, and as never before in history. This 'modern era' has now lasted for around 200 years.

However, the signs are there that things are changing. We still continue to increase living standards in an unprecedented way, but planetary population is getting older, and soon, in some 33 developed countries according to the recent UN population revision, smaller. It seems we are once more in danger of falling into a population trap, one where population and economic growth again become ensnared, but this time in a downward spiral. Economic theory to date has notably and monumentally failed to come to terms with the implications of this change, and herein lies the significance of Japan.

SARS is Getting Preoccupying

It's not my intention to scare-monger, but the SARS situation seems to be deteriorating daily. This news from Hong Kong is not reassuring. For those, like me, who mugged up a bit on epidemiological theory back in the 'mad cow' BSE/nvCJD alert days, the bit about clustering, the housing block where many people are affected quickly, is the one that rings the alarm bells. Remember mobile phones, and all you ever read about viral marketing. The economic consequences of this are more or less plain to see (even if we don't yet know the extent of the damage), but it's the human part that bothers me most.

The deadly SARS virus showed signs of spreading to a new part of Hong Kong on Tuesday. There are signs that the disease was spreading in the district of Tuen Mun, where a hospital is treating dozens of SARS patients. Fourteen people in the town had contracted the disease, up from five late last week. Government officials were not immediately available for comment. The death toll in the territory has increased to 23, with the total number of people infected at 883. About half of the 278 people infected in the Amoy Gardens estate come from a single block and authorities are still investigating how they were all infected in a matter of days. Severe Acute Respiratory Syndrome (SARS) has been carried around the world by travellers, killing more than 100 people and infecting more than 2,600 in 20 countries. The disease has mostly hit Asia but it has killed at least 10 people in Canada, where it is concentrated in Toronto's large Chinese immigrant population. India reported its first suspected case of the virus, involving a US citizen who fell ill after travelling to Bombay from China. World Health Organisation experts are now in China's southern Guangdong province, where the disease first surfaced in November.
Source: Channel News Asia

Thank You Brad Delong

Just a word of thanks to Brad Delong for his continuing confidence in me: Semi-Daily Journal. The reference to Pygmies in the title is, I think, an allusion to the work of Luigi Cavalli Sforza - who really should be on everyone's list of "must read" - and to my admiration for him as the kind of scientist who gets out of the office to follow-up a long-shot hunch, in this case among the Pygmies of the African tropical rain forest. Anyone looking for more substance behind my arguments about Germany could do worse than check out Euro Watch where I bring-together my euro-related posts. On the Harrod-Balassa-Samuelson effect, I'm afraid you'll just have to check back later this week for a more considered opinion, because I'm still putting my thoughts together about the scandalous way a relatively sound idea is being used to justify extremely preoccupying inflation in Spain, Portugal and Greece.

Meanwhile, and by way of a hint, the core of what's worrying me in the way the argument is being used is this. Brad (and I think in this he is only reflecting what he feels is the Brussels 'conventional view') in an earlier post (here) says: "As time passes, and as the European periphery becomes richer and richer, its real exchange rates vis-a-vis the European industrial core have to rise". Now this idea of the periphery becoming richer and richer (relative to the core) is based on some growth theoretical assumptions which might well be extremely suspect. Rather than the model of all countries converging to a common homogeneous type, what we may have is a centre/periphery dependence based on an inter-relation of economies with different structural characteristics. The Southern Three (Spain, Portugal and Greece) have economies which are driven by construction and tourism, Germany and France have large machinery, equipment and technology components in the traded sector. These economies are not 'converging' in any meaningful sense of the word. A look at the 'Asian' model, Japan, the four 'tigers', and now China, is instructive in this sense. This model exports manufactured products to acquire strategic capacity which is then put to good use. This is not happening with the Southern Three whose structural dependence is inbuilt.

If you look at the tradeable and non-tradeable sectors you will see that, as theory predicts, productivity is higher and inflation lower in the tradable sectors. But it is what is happening in the non-tradeable sectors - low productivity growth and high inflation - that is preoccupying, since these form an important part of the cost structure of the tradeables, and their impact must be felt eventually, as non-tradeable sectors gradually get traded by importing from cheaper sources (look at Spain's ballooning current account deficit for one). Normally this problem would be resolved by a devaluation of the currency, but with EMU.......?

Equally the orginal rich-getting-richer argument could now be displaced to the new 'Eastern' entrants (who remember are not in the euro). The standard use of the H-B-S effect could serve to justify the idea that price deflation should now also take place in the Southern Three as the new entrants close to converge. This argument would have a lot more logic to it as they may well be more direct FDI competitors with the Southern Three. In fact the main impact of the euro in the Mediterranean countries (where, remember, negative real interest rates exist, and the savings accounts are quietly emptying-out as everyone sinks their money - possibly irretrievably - in concrete) is that the central core economies serve as guarantors for debt liabilities on the perifery. If Europe was one state this might work, but in a Europe of rising political tensions and lacklustre economic performance it is hard to see the centre being held fortune to the moral hazard presented by the perifery. One day the markets will wake up to this fact, and the willingness of the core to sacrifice for the periphery will really be put to the test.

And if you still have lingering doubts, remember Japan is a country with high tradeable productivity, low internal productivity with high prices, and ageing population. This will soon also characterise the much poorer Mediterranean three. But look what is happening to Japan. If you still feel I haven't made my case, as I said, check back at the weekend.

Monday, April 07, 2003

On Harrod-Balassa-Samuelson and European Inflation

A post from Brad Delong of late last week has started all kinds of bells ringing in my head:

As time passes, and as the European periphery becomes richer and richer, its real exchange rates vis-a-vis the European industrial core have to rise. This is the Balassa-Samuelson effect: poor countries have low real exchange rates because international trade is concentrated among the capital- and technology-intensive goods in which rich countries' absolute advantage is greatest, and so as countries catch up to the industrial core, their real exchange rates rise. In the case of poor countries inside the euro zone, convergence and the consequent rise in real exchange rates requires faster inflation than in the industrial core.

If development on the European periphery is successful, and if growth on the European periphery is rapid, then inflation on the European periphery will be rapid too. This means that, if eurozone-wide inflation is to be low, there must be deflation--falling prices--in the German-Belgian-French industrial core of the euro zone. Deflation is, in general, a bad idea for lots of reasons, one of the chief of which is the catastrophic consequences of nominal wage cuts for worker morale.

Yet as long as the ECB takes its goal to be low inflation eurozone-wide--rather than low inflation in the eurozone's industrial core, with the developing periphery seen as a special case--it seems that the ECB has committed itself to a much more contractionary monetary policy than even the Bundesbank would have ever dared impose on the Bundesrepublik.
Source: Semi Daily Journal

The more important bell relates to the use and abuse of the Harrod-Balassa-Samuelson effect, but I will try and post something on this when I've had more time to think the topic over. Meantime another topic relates to the HICP methodology and how the country weights are determined. After a little investigation I discovered that they are in fact based on national consumption expenditure shares, chain weighted two-years-post as the data come in from national income accounts. Anyone else whi is interested in the arcane world of Eurostat statistical deliberation might find intersting this paper from the Dallas Fed.

Among the jewels that may be found there are:

"Where does this place the HICP in the classification scheme proposed by Diewert? (Diewart is one of the luminaries of index number theory: EH) Eurostat states quite explicitly that the HICP is not a cost of living index, so its conceptual framework presumably lies in either the fixed-basket, axiomatic or statistical approaches to index number construction. However, Diewert shows quite convincingly that this cannot be the case, since all three of these approaches (as well as the economic approach) would rule out the use of the Laspeyres formula for the calculation of the HICP. We will return to the issue of the conceptual framework of the HICP below. For now, it suffices to note that the HICP does not easily fit into any existing approach to the index number problem."

What should be clear is that the methodology used is far from self-evident, and the inflation composite has to be an extremely dubious number for economic policy purposes. When you consider that there's been no Europe Boskin, and that methodology varies widely from one country to another, fine tuning on this must be a bit like taking the 'big hammer' for Um Quasr. In fact the degree of uncertainty regarding the validity of the individual country figures is significant given the lack of quality adjustments in most of them. I would say there is as much possibility that the German figure is 1% too high as there is that it is 1% too low. In which case we don't really know whether or not the German economy is already experiencing deflation. My only conclusion from my investigations is one I reached long ago: deciding whether monetary conditions are too tight or too loose on the basis of the HILP is a fools errand. So it's time to throw away the cucumber sandwiches and the fine lace and go to work to try to clutch Germany from the jaws of deflation before it's too late (assuming, that is, that it already isn't). Those interested in consulting these invaluable inflation numbers can find the latest set here

Steven Roach Feel No-one is Really Listening

It's getting to him. All these months of being out on a limb. Sometimes its a lonely job being right. While I don't go one hundred per cent of the way down the road with his bubblenomics, I'm prepared to go ninety five, especially if the housing situation deteriorates. He is also right about the structural imbalances. He only has to wise up to the demographic backdrop and he's got it all. But seriously folks, he has to be one of the best 'instinctive' economists (the natural) working out there. He's feeling lonely. He has got a feedback slot on the Global Economics Team page here. Let him know you're listening:

I’m tired of being so negative on the macro outlook. We all are. But I must confess it’s finally starting to get to me, purportedly one of the most bearish of the lot. It’s not that I’ve lost my sense of conviction. It’s actually a more disturbing thought -- that after all these years, I’m starting to sense that no one is really listening.

Sure, financial markets have been in a three-year funk -- a huge post-bubble correction in world equity markets and an equally extraordinary surge in bonds. Over the same time frame, the global economy has been in one recession and is back on the brink of another one right now (see my April 4 dispatch, “The Global Double Dip”). Yet convictions are still deep that these disruptions are temporary, not systemic, and that they have now gone on for long enough. As such, most investors, policy makers, and politicians remain convinced that mean reversion is imminent -- that fundamental macro relationships are about to return to their longer-term trends. Over the years, these are the gut feelings I have learned to respect the most. And yet now I find myself at odds with those very instincts. That troubles me. It forces me to ask myself repeatedly these days -- what am I missing?

Here’s where I believe nobody really seems to care. America has had an ever-growing balance-of-payments deficit for most of the past 20 years and it hasn’t been much of a problem -- either to the US or to the rest of the world. What I’m missing, the critique goes, is that there’s nothing wrong with this arrangement. Lacking in demand of its own, the world has, in effect, been perfectly content to finance the profligacy of a saving-short US economy.

I have to confess that it’s at this point where I just lose it. I have the same problem with this logic that I did with bubblenomics in the late 1990s. Just because imbalances and excesses endure for longer than fundamentals suggest doesn’t mean we have the fundamentals wrong. Conversely, it may well mean that financial markets simply have asset valuation wrong -- that today’s dollar bubble is nothing more than the functional equivalent of the Nasdaq bubble some three years ago. To me, this is the most glaring example of a dysfunctional world. What concerns me most is that there’s nothing stable about the current imbalances in the global economy. Courtesy of a rapidly deteriorating US saving position, these imbalances can only get worse until something gives. I guess what I must be missing is the infinite tolerance of an ever-elastic US-centric world.

“It’s all the war” is the most common refrain I hear these days. In a postwar world, the argument goes, the combination of lower oil prices and a diminished “uncertainty factor” should provide a sharp boost to today’s weakened global economy. At that point, the combination of policy traction and the animal spirits of pent-up demand are expected to kick in -- precisely the opposite of what I expect and yet the perfect antidote to the angst that is currently gripping the world. I have no problem with the concept of postwar relief. But I have yet to figure out how it heals what is truly ailing a dysfunctional global economy. That’s the quick fix that I guess I must be missing.
Source: Morgan Stanley Global Economic Forum

China: An Unstoppable Macine of Competitiveness?

This is the question Andy Xie is asking. His answer: yes and no. Yes it is unstoppable, barring an anti-globalisation back draft, or an own goal. My own view is that the former is extremely unlikely given the force of this wave of globalisation, the fact that China is a customer as well as a supplier, that the negative network effects of shutting the doors are enormous, and finally, that putting China out of the picture really would leave a global economy running on half an engine (the post-bubble US). The own goal scenario is far more preoccupying. The recent SARS epidemic shows the difficulties a non-democratic China has in handling information, and these difficulties don't seem set to go away any time soon.

China does not appear to have any credible competitors in terms of global production location. Its labor quality and low-wage and high-savings rate make it an ideal production base. Its export price level is driven by internal rather than external competition. That China is a factory for the world is already a fact. Investing in China is increasingly a competitive necessity for multinational corporations. Global prices for manufacturing goods are being defined by Chinese costs. For survival, multinational companies are virtually undertaking most of their capex in China to stay in the game. China appears to be an unstoppable machine of competitiveness. Multinational corporations are rearranging the global economy around China’s competitive advantages. In my view, there are only two extreme scenarios that may stop China’s march towards becoming the biggest industrial powerhouse in the world. First, the world may rebel against globalization. Second, an internal event may decrease China’s competitiveness.Most pundits give significant odds to the first scenario. I disagree. China defies ‘us-versus-them’ analysis. Its model of development is to latch onto the global economy at every possible docking point. No other big economy developed in such a fashion. The Japanese model, for example, attempted to generate all indigenous capabilities necessary for a modern economy. These abilities then manifested through local companies that became globally competitive.

In contrast, China imports whatever capability it does not have. Any Chinese semiconductor company will speak volumes for China’s open-door approach. Its equity participants may include global technology companies, international private equity funds, and local government interests. Its management comprises mostly overseas Chinese engineers who worked with global technology companies for many years. This is why China was able to get its technology sector started so quickly. This is not the end of the story. If it were, China would be turned into a high-cost economy. Such technology companies hire large numbers of local workers who lack experience and, hence, receive low pay. However, over several years, they are likely to take over such businesses. By that time, expatriate talent will probably have to accept local pay or move on. However, equity awards for joining such companies should offset this risk. China, essentially, is totally capitalistic and color-blind in how it creates its competitiveness. A backlash against globalization is mostly about the demand side. No matter how competitive China is, it will grow much more slowly if cut off from wealthy customers in developed economies. That risk is quite low, in my view. The demand side that links China to its customers spreads its benefits to layers of interests in multiple countries. China-made products are mostly sold under existing western labels. A large number of companies in the world have built their franchises on passing the benefits of China’s low costs to wealthy customers in their home markets. Cutting off China would be like cutting a limb from one’s own body. As long as China remains passive in the global economy, I believe its industrialization and globalization will continue to move forward hand in hand.

In my view, only China can trip itself up. No economic force outside China is powerful enough to do so. This is why Chinese leaders are extremely careful about maintaining internal stability. The motto of the late Deng Xiaoping, ‘Cross the river by touching stones’, represents the best summary, in my view, of how Chinese philosophy handles issues that arise from its industrialization. China’s cautious approach works well most of the time...........

As China’s globalization deepens and its populace becomes more exposed to modern lifestyles, the cautious approach also brings its own risks. The SARS epidemic is such a case. Bureaucratic caution conflicted with the need for a quick policy response to the spreading of a new contagious disease. The good news is that China’s senior leaders now consider SARS a top issue. Chinese bureaucrats usually solve problems efficiently when they receive their marching orders. The SARS crisis will not be an exception, in my view. How China’s bureaucracy dealt with this issue in the absence of senior leaders’ attention speaks volumes about its relationship with the people and its critical weaknesses. Chinese bureaucrats believe that they know best what is good for the people and are inclined to make decisions on their behalf whenever possible. Tension is now being generated between the central role of the bureaucracy in Chinese society and the needs of China’s globalization.

The Chinese bureaucracy has one critical weakness, in my view. Its relationship with people is modeled on that between parents and children. This is why the bureaucracy (1) always tries to tell people what to do or think and (2) never manages to get corruption fully under control. Chinese bureaucrats believe in their superiority and have no compunction about making decisions on behalf of the people. The other side of this coin is that people feel inferior to bureaucrats and dare not think of changing official behavior, which can make official corruption a huge problem. How the SARS issue was first handled reflected the traditional thinking of Chinese bureaucrats. It wasn’t judged as a serious development. In a Chinese context, it did not look so. Industrial accidents kill far more than such a contagious disease. Panic would have caused economic chaos. The bureaucrats involved were essentially making such tradeoffs for the people when deciding how much information to release. What was lost was the people’s right to know and to modify their behavior for self-protection. The value of the individual versus society is the issue here. China’s bureaucracy has difficulty grasping this notion...........

China’s future depends on its bureaucracy. Its power derives from its economies of scale and its information advantage. No other organizations in China can compete. Advances in IT technology may erode its information advantage. How it responds to the spread of information will determine what kind of country China will become, in my view.Not everyone looks upon the rise of China favorably. Export-oriented manufacturing economies in Asia are being priced out of the global economy by China. They are being gradually forced into retirement and to live off their savings. Even though they trumpet access to China’s growth to project an optimistic outlook, their view could quickly change if they were to see an opportunity to slow China’s advances. The SARS incident has become a rallying point for some to make China look bad. It could become a real problem for the economy if multinational corporations were to change their view towards China, but I do not expect this to happen at this point.
Source: Morgan Stanley Global Economic Forum

Japan a Lost Decade

A number of hypotheses have been presented to explain Japan's continuing economic failure since the beginning of the ninetees: inadequate fiscal policy, the liquidity trap, depressed investment due to over-investment during the "bubble" period of the late 1980s and early 1990s, a broken banking system due to a combination of the former, outdated labour market and work practices, growing competition from China, and (my own strong hypothesis, of course) demographic processes. While we have many hypotheses, we have, as yet, no coherent and compelling account. The Hayashi and Prescott paper examines the history of the "lost decade" using a standard neoclassical growth model. It identifies finds two developments which seem to be important for understanding the Japanese economy in the 1990s. First and most important: there was a fall in the growth rate of total factor productivity (TFP). This, argue the authors, had the consequence of reducing the slope of the steady-state growth path and increasing the steady-state capital-output ratio. Their most important finding: that the drop in the rate of productivity growth alone cannot account for the near-zero output growth in the 1990s.

Japan a Lost Decade: Fumio Hayashi and Edward Prescott

This paper examines the Japanese economy in the 1990s, a decade of economic stagnation. We find that the problem is not a breakdown of the financial system, as corporations large and small were able to find financing for investments. There is no evidence of profitable investment opportunities not being exploited due to lack of access to capital markets. The problem then and still today, is a low productivity growth rate. Growth theory, treating TFP as exogenous, accounts well for the Japanese lost decade of growth. We think that research effort should be focused on what policy change will allow productivity to again grow rapidly.

Sunday, April 06, 2003

IMF World Economic Outlook

The IMF site have a pre-release of the WEO available. The content deals mainly with 'housing bubbles' (see posts below):

To shed light on the relationships between asset price busts and macroeconomic and financial fluctuations, this essay describes the main empirical regularities across industrial countries over the past four decades. The appropriate conduct of monetary policy during an asset price boom will not be addressed, as it was dealt with extensively in a recent World Economic Outlook. The focus on the stylized facts of asset price busts obviates the need to measure or explain "bubbles", which - despite the frequent use of the term - remains highly controversial. While every asset price bust is different and depends on circumstantial factors such as the underlying shocks, the analysis shows that asset price busts and concurrent macroeconomic developments in the postwar period share common patterns that provide a relevant point of reference for assessing the current busts. These patterns are identified using event analysis - that is, on the basis of their timing, which does not imply causality. In particular, the essay will address the
following questions:

How frequent and how big are equity and housing price busts? Do all booms end in busts? Are busts synchronized across countries? What is the link between equity andhousing price boom-bust chronologies and
business cycles?
What macroeconomic and financial developments are associated with asset price busts? Are they always severe? If not, what are the conditions for busts to have serious implications?
How do the most recent busts compare with earlier episodes and what are the implicationsfor the outlook?
Source: IMF World Economic Outlook

Nokia Fight to Stay in Global Handset Market

In line with the comments in the last two posts, Nokia is now having to adapt its production to meet the rapidly growing demand for CDMA based third generation handsets in the third world. I'm no admirer of Rumsfeld, but hadn't ol' Europe better look out. The centralised (Brussels based) infrastructure and the problem of lock-in to prior decisions (ie UMTS) means that the European industry may be ill suited to the kinds of leapfrogging processes which typify the new economy sectors. Is this the shape of things to come? Certainly, in some areas the third world is capable of adapting and catching-up much more quickly than anyone would have imagined just a few years ago.

The world's top handset maker Nokia took steps on Monday to wrest from Motorola the top spot in the huge Chinese market by starting CDMA handset production there and merging its joint ventures. Nokia said it would have over 60 percent ownership in the newly combined company, which will be headquartered in Beijing. "The new company is well positioned to lead China's mobile handset and network markets as well as improve its competitiveness in the global market," Nokia said in a statement. "(It will be) one of the largest foreign invested enterprises, as well as the largest manufacturer and exporter in the mobile telecommunications industry in China," Nokia said. Nokia already dominates the world's largest mobile standard, GSM, but has lagged on phones using CDMA, or Code Division Multiple Access, which is popular in Asia and the United States. The company said earlier this month it wants 15 percent of the CDMA market in 2003 as a prelude to eventually leading the market with over 25 percent. Nokia had a 2002 global handset market share of around 36 percent. A Nokia spokesman said the merging of the joint ventures still needed Chinese regulatory approval, but this was expected soon. He said the company was currently happy with the size of its shareholding in the merged venture. Nokia's 2002 sales in China, the world's largest mobile phone market, were 2.8 billion euros ($3.01 billion), making the country its third-largest market behind the U.S. and U.K. Nokia stock was unruffled by the announcement, which had been rumored in the past week, and traded down 5.4 percent at 12.89 euros as European shares continued to fall on fears that the war in Iraq would drag on. Analysts welcomed the news, saying that while it would take time for the moves to bear fruit, it was a step in the right direction and would help Nokia battle Motorola as well as local Chinese rivals. "Nokia has to come up with something to counter the market share loss to local players," said Evli Bank analyst Karri Rinta, who has a "buy" rating on Nokia shares. "I'd expect to see meaningful handset volumes no sooner than the fourth quarter of this year. The big impact will be seen next year," he said.
Source: Reuters

Nokia Corp. plans to begin production of CDMA (Code Division Multiple Access) cellular phones in China, the company said Monday. The announcement comes as the country's second largest cell phone operator, China United Telecommunications Corp. (China Unicom), begins a three-month trial of its recently completed national CDMA2000 1X network. While the announcement signals a clear change in Nokia's product lineup, the company did not specify when production of CDMA phones would begin, saying it was awaiting approval from the Chinese government to make CDMA handsets. The phones will be based on CDMA chipsets made by Nokia, it said. Nokia has seen domestic handset makers cut into its share of China's rapidly growing cell phone market. It is looking to CDMA phones as a way to broaden its reach into the market, according to a company statement. Worldwide, Nokia sells handsets that support GSM (Global System for Mobile Communications) and GPRS (General Packet Radio Service) mobile networks. The company also makes a handset that supports the WCDMA (Wideband CDMA) third-generation mobile standard. "(Nokia is) clearly losing market share on the GSM side (in China), both to the local players and to Japanese handset makers," said Ted Dean , managing director of market research firm BDA China Ltd. "There are just more companies making handsets now compared to a year ago."

Domestic handset makers have been successful in China for several reasons, including strong distribution channels and innovative handset design, Dean said. As an example, he cited TCL Mobile Communication Co. Ltd., China's largest handset maker, which produces a clamshell-type phone that has a diamond set into the outside of the top cover. "They're giving consumers more variety," Dean said. But while Chinese handset makers may have grabbed a piece of the Chinese handset market, they are not close to overtaking their foreign rivals, Dean said. "Motorola (Inc.) and Nokia are still by far the No. 1 and No. 2 players in the market," he said. By producing CDMA handsets, Nokia can not only tap into demand from Chinese CDMA users, but it can also push into markets such as South Korea and the U.S., where CDMA is more prevalent than in China, Dean said. "(CDMA is) a growing piece of the handset market that they want to be a part of," Dean said.

China has one national CDMA network, launched in January 2002 and operated by China Unicom. That service got off to a slow start, falling short of initial subscriber targets, and construction of China Unicom's 2.5G (advanced second-generation) CDMA2000 1X network, originally expected to be completed at the end of 2002, was delayed by nearly three months. China Unicom announced that construction of the CDMA2000 1X had been completed on March 28, saying it would begin a three-month trial of the new service, called U-Max. But questions remain as to whether the new service will be a success. "It all comes down to implementation and Unicom's ability to deliver the goods when it comes to new services," Dean said. "Unicom doesn't have a good track record of rolling out new services."
Source: ComputerWorld Hong Kong

CDMA Handset Oversupply in China

As if to show that in the case of the technology market "if it ain't boom it's bust", latest estimates from Bloomberg suggest that the knock-on effect of ramped-up competition between Motorala, Nokia and the South Korean players will inevitably lead to oversupply. And what else? Downward price pressure.

An oversupply of CDMA handsets in China is likely to erupt this year as Nokia, Motorola and several South Korean handset makers scramble to ramp up production to further penetrate the world’s largest mobile phone market. It is estimated that domestic handset demand in China will reach about 65 million units this year, of which 15 million units will be CDMA handsets. China Unicom, the country’s largest CDMA mobile phone service provider, had 7.17 million CDMA subscribers as of the end of last year and is expected to add 13 million CDMA subscribers this year, according to an earlier Bloomberg report. On the supply side, Motorola, the only foreign company with a license to produce CDMA handsets in China and the largest handset vendor in the country, expects to increase its CDMA market share to 50% from about 40% last year, according to the China-based news site eNet (news.enet.com.cn). Samsung Electronics, the world’s largest CDMA handset vendor, plans to boost full-year CDMA handset production from six million to 10 million units this year at its factory in Shenzhen, Guangdong Province (China). The South Korean vendor held a 25% share of China’s CDMA market last year, eNet reported. LG Electronics (LGE) hopes to gain a 30% share of China’s CDMA market, and TCL Mobile Communication targets 20%, the report added. The potential oversupply situation is not seeing any relief as Nokia announced early this week that it will begin making CDMA handsets in China this year for sale to the local market. The handset giant, which supplied one in every three handsets sold worldwide last year, has only about a 10% share of the global CDMA market.
Source: DigiTimes


One topic which doesn't receive as much comment as it should is the current plight of the UMTS mobile phone situation, and the rapid rise of wCDMA. Two or three years ago we were being told that the technological future of Europe was being guaranteed by its UMTS lead. Whatsmore the superiority of the Brussels based 'central planning' uniform standards model was clearly being demonstrated. Now there's an eery silence. Obviously the small-components-loosely-joined argument was not 'well understood'.

A record-breaking 12 million users signed up for mobile phone services using CDMA technology in the fourth quarter of last year, bringing total CDMA subscribers to nearly 147 million as of the end of 2002, according to the CDMA Development Group (CDG), a US-based trade association. The total figure for CDMA subscribers included 33 million 3G CDMA2000 users, the association said. North America is the biggest CDMA market, with 62 million subscribers. The Caribbean and Latin America market comes in second, with 27 million users. CDMA subscribers in China contributed significantly to CDMA expansion in the Asia-Pacific region, where more than 13 million CDMA subscribers were added last year. Asia also has the highest proportion of 3G subscribers, driven mainly by CDMA2000 services in South Korea and Japan, according to the association. Aiming to penetrate the CDMA market, Nokia unveiled five new CDMA handsets – the 3586i, 6585, 2270, 2275 and 2285 – at the Cellular Telecommunications and Internet Association’s (CTIA) wireless conference in New Orleans last week.Nokia held a 35.8% share in the global handset market last year, but only has about a 10% share of the global CDMA market. South Korea’s Samsung Electronics and LG Electronics (LGE) are the world’s two largest CDMA handset vendors, with approximate 27% and 20% shares of the global market, respectively.
Source: DigiTimes

More on the IMF and Housing Bubbles

A little more info on the IMF view of the current global housing situation (see next post). This time from the Taipei Times. Conoisseurs of my arguments please note the point about the immigration demographic factor. This argument (to my knowledge) has been used by Alan Greenspan and Glenn Hubbard (in his case to explain why deflation 'isn't a danger') The importance given to the feed through of immigration for new home demand seems to me to be interesting, in particular for what it suggests might be the case if there were no immigration (eg Japan: house prices mired down at mid-eightees levels). Clearly we need more metrics on this, as well as metrics on lead-lags. My feeling is that in a first period (I've seen references to seven years in the sociological research) immigrant labour is largely poor, and sends a significant part of earnings (again the estimate is one third: the IMF does hold numbers on this) back home. This means these workers effectively should be classified as a partial import, with the practical peculiarity that the labour is exercised in the host country (and of course two thirds of the wages are spent there, a not unimportant detail: maybe the other third could be classified as raw material costs!!). The comes a second period, when the immigrant is more focused on life in the new country, ties with family become weaker, and the money going home slows down to a trickle. It is after this transition that the immigrant truly speaking enters the domestic housing market and in forward studies of housing prices and demand this factor needs to be identified and weighted.

The menace of a housing-price bust hovers over Britain, other European countries and possibly even the US, the IMF warned Thursday. Housing prices, even after inflation, had shot up 70 percent in Britain and even further in the Netherlands and Ireland from trough to peak, IMF chief economist Kenneth Rogoff said. "In the United States, where prices are up by 27 percent in excess of inflation since the last trough, the housing price appreciation has been less spectacular," he told a telephone news conference. "But it is still greater than any of the booms we clocked for the United States since 1970," said Rogoff, who was presenting an IMF study on the impact of asset price bubbles. The house price appreciations for all four countries exceeded the IMF statistical definition of a boom, which implied a 40 percent risk of a later bust. "The impact of housing price busts, when they do occur, is much more significant on the real economy, probably double the average impact of an equity price bust," said IMF global economist Jonathan Ostry. "Although equity price busts occur much more frequently, the impact of housing price busts is much more severe," he said. Equity price busts on average occurred every 13 years while housing collapses happened once in 20 years, the IMF study said.Housing price busts on average knocked back gross domestic product -- total economic output -- by 8 percent, it said, compared to 4 percent for stock market collapses. IMF economists hesitated to describe the US housing market as a boom, but they urged the Federal Reserve to monitor it closely. Federal Reserve chairman Alan Greenspan last month played down the risk of a bust. "Clearly, after their very substantial run-up in recent years, home prices could recede," Greenspan told a bankers' convention. "A sharp decline, the consequences of a bursting bubble, however, seems most unlikely."David Robinson, IMF deputy research director, said the scale of the house price increase fell into the IMF statistical definition of a boom but it was too early to declare it a bubble. Immigration had pushed up the US population, and low interest rates had opened housing to more people, stoking demand for housing and suggesting higher prices may be sustainable. "It is something we need to keep our eye very much on in the United States because it is historically high," Robinson said, however. He urged particular caution for regional US housing hot spots. The risk of a housing bust was higher in Britain, given the sharper run-up in prices, IMF analysts said. A house price collapse in one country can have a global impact, the IMF's Rogoff said. "Housing is a significant component of wealth across countries and given that there are linkagaes -- trade, finance, business cycles -- a housing bust in one country will have spillovers to the rest of the world."

IMF Warns on Housing Busts

Oh how wonderful it is not to feel so lonely. First it was Alan Greenspan who started to get interesting on the US social security situation and the state of the refi market. Now it's Ken Rogoff, who once more is confirming that under his stewardship the World Economic Outlook is going to be a 'must' read. This is soooo different from what was coming out ten years ago. If only the OECD could take a leaf from their book - the numbers crunched out may look the same (since the models are more or less similar), but the analysis is light years behind. What makes a good economist is not the capacity to think like a computer, but the capacity to exercise judgement. Looking at the working papers the OECD have some interesting economists on board, so maybe it's time to change the Chief Economist. Incidentally, two more points: I am also not clear that the US situation constitutes a housing bubble. The UK and Spain clearly do. I am merely worried about what will be the consequences of a slowdown in housing in the US for consumer spending, if this happens without an acceleration in capital expenditure. Then we would see the full impact of the March 2000 NASDAQ burst, and this looks like it may now be happening. (Of course one of the difficulties in identifying a bubble may well reside in a lack of agreement about what really constitutes one, even after the event). Which brings me to the second point: the difference between an economist and an index can be seen in the 15% probability assigned to the double dip. I would give it a far higher probability than that, so to all appearances would Stephen Roach and Brad Delong. By their friends shall you know them.

Housing booms such as those in the US and the UK over the past decade are frequently followed by crashes, the International Monetary Fund warns in a forthcoming biannual report on the state of the international economy. Selectively released chapters from the IMF's World Economic Outlook, due out next Wednesday, also warn that excessive corporate debt continues to hold back recovery in the eurozone and the US. But the report also said current debt levels implied only around a 15 per cent chance of another US recession. Ken Rogoff, the fund's chief economist, warned that the long boom in house prices - up 28 per cent in the US since 1996, and 70 per cent in the UK since 1994, adjusted for inflation - put them in danger territory."Forty per cent of all housing booms are followed by busts, with housing price drops that typically average 25-30 per cent," Mr Rogoff said. House prices were more susceptible than stock prices to a bust after a boom, and big economic contractions generally accompanied a crashing housing market, the IMF found.

The IMF also stressed that central banks should continue to monitor house prices as part of their wider assessment of inflationary pressures, rather than target asset prices directly.The new report declined to say whether the US housing market had reached bubble territory. But David Robinson, Mr Rogoff's deputy, said: "It is something we need to keep our eye very much on because it is historically high." A sanguine US Federal Reserve has largely insisted that the size of the US market and the ease of construction make a US housing bubble unlikely. But Bank of England policymakers have expressed more concern at the rapid rise in UK house prices. Elsewhere in its economic outlook, the IMF said that the huge build-up of corporate debt, some of which remained in spite of companies' attempts to deleverage, had held back economic recovery.Mr Rogoff said excessive debt had cut eurozone growth by 2.5-3 percentage points last year, and US growth by up to 1 percentage point. He said it would continue to drag on the recovery this year. But an index that predicted recessions based on corporate leverage and macroeconomic conditions suggested only a 15 per cent chance of a double dip, the IMF said.
Source: Financial Times

World Cancer Rates Predicted to Rise

This story seems interesting for all sorts of reasons. The report from the WHO is only stating the obvious: more people on the planet will mean more people with cancer. And secondly, an increase in population age structure will mean a higher incidence of cancer. It is a good example of how changing population structures affect us in ways we don't initially think about. Of course, our individual likelihood remains unchanged, but we can feel we know more people with a cancer related illness. Thus our experience of the world can and will change, in this and many other ways. The recent SARS epidemic is another example. While the origin is still unknown, and its precise nature a mystery, it is clear that with more people using more antibiotics, the chances of viral and bacteriological mutation also increase. And with more older people, our demographic vulnerability to things like flu also increases. Lastly, of course, there is the lifestyle component. Do we really live better than our parents? The WHO claim effectively that we don't: this is the poor exercise and fatty food bit. But life expectancy is increasing so this must only be part of the story. Nutrition in the womb, and in early childhood could also be important. So, of course, could genetics. We really don't know how to put weights on all this. So in the meantime accept daddy's advice: quit smoking, eat less industrially processed food, and start walking to work. (By the way, there is of course no special importance about New Zealand cancer rates, it was just a choice of source. This story is being run everywhere).

The World Cancer Report, released by The World Health Organisation (WHO) yesterday, said rates could rise to an alarming 15 million cases with nine million deaths a year by 2020. In 2000, 10 million cancer cases were diagnosed worldwide and six million people died of the disease. The report blames steadily aging populations, high smoking rates, and an unhealthy Western lifestyle rich in fatty foods and poor exercise. It said the trend could be controlled if people changed their lifestyles. WHO cancer researcher and co-author of the report Paul Kleihues said action by governments and the public now could prevent one-third of all cancers, cure another third, and provide care to the remaining third. He predicted cancer rates in developing countries would also increase as they adopted the Western lifestyle. Christchurch Hospital oncology department clinical director Chris Atkinson said New Zealanders had to focus on cutting smoking rates. "We have turned around the number of men smoking but we still have a problem with women smokers," he said. Dr Atkinson said health planners had to "think smart" to address the fact there would be more people with cancer. The public had to decide where to spend precious health dollars, he said. "We desperately need a cancer control strategy. We need better co-ordination of care, including screening, detection, and palliative." Late last year the Government released a draft cancer control strategy that will overhaul New Zealand's treatment and prevention programme. The strategy plans to reduce the advertising of unhealthy food to children, increase the number of smokefree environments, and develop a systematic approach to cancer screening. New Zealand cancer expert Otago University Professor David Skegg said the cancer epidemic did not mean an individual's chance of developing cancer increased.
Source: Stuff.co.nz