$1 Trillion++ Global Warfare: For Whom the War Bill Tolls By Stephen Gowans Global Research, January 15,

2013 gowans.wordpress.com Region: USA Theme: Global Economy, US NATO War Agenda The $1 trillion-plus Iraq and Afghanistan wars were the first US wars since the American Revolution to have been fought without a general tax increase to cover them. Without tax increases to pay for the Pentagons ballooning budget, the countrys debt as a percentage of GDP has grown. Since a rise in debt relative to income cant continue indefinitely without undesirable consequences, politicians are looking for ways to arrest the trend. Its very likely that the burden of covering the costs of ranaway US military spending will fall upon poor and middle-income Americans. High-profile economists like N. Gregory Mankiw are preparing public opinion for eventual rate hikes, concealing the role played by US war spending in driving up the percentage of debt to GDP, and blaming growing entitlement spending on the need to raise taxes. Harvard economics professor N. Gregory Mankiw, economic policy adviser to George W. Bush and Mitt Romney, and author of a widely used introductory economics textbook, weighed in this Sunday in The New York Times on the growing ratio of US debt to gross domestic product and what to do about it. [1] Forget about raising taxes on the wealthy, counselled Mankiw. Instead, stick it to everyone else. Heres Mankiws reasoning:

Debt as a proportion of national income is growing thanks largely to growth in entitlement spending. If debt to GDP continues to grow, investors will eventually refuse to lend at manageable rates, tipping the United States into a Greek-style financial crisis. The crisis cant be averted simply by raising taxes on the rich. There just arent enough wealthy taxpayers around to make much of a difference. Nor would tax increases on the wealthy be fair. The current tax system looks plenty progressive, says Mankiw. The rich are notshirking their responsibilities. Instead, entitlements need to be scaled back and taxes hiked on the vast majority of Americans.

Mankiw presents this as a corrective to too much wishful thinking on middle-class tax rates. But his argument is more snow job than corrective. Wasteful Military Spending The former chairman of the council of economic advisers misses the elephant in the room on federal spending: the military and the wars in Iraq and Afghanistan. According to World Bank figures, from 1999 US military expenditures have steadily increased as a share of national income, rising from 3.0 percent of GDP to 4.7 percent by 2011. [3] New York Times reporters Thom Shanker and Elisabeth Bumiller reported last year that the US military budget has doubled to $700 billion a year since the terrorist attacks of Sept. 11, 2001. [3] Yes, doubled. If anything is growing, the military is. The Pentagons budget is now the highest in absolute and in inflation-adjusted, constant (for any year) dollars since 1946, the year after the Second World War ended. Adding non-Pentagon defense-related spending, the total may exceed $1 trillion. [4] Before anyone says, Yes, but defense spending had to increase to deal with the threat of al-Qaeda, doubling the military budget doesnt stop someone from buying an airline ticket and concealing a bomb in his underwear. Police methods and foreign policy correctives, not stealth bombers and tanks, are needed to deal with terrorist attacks. Besides, whether the spending increase is justified or not, the fact of the matter is that outlays on the military have skyrocketed. That Mankiw fails to mention this is more than a little fishy. The US defense budget exceeds the combined expenditures of the next 14 highest spendersChina, Russia, the UK, France, Japan, Saudi Arabia, India, Germany, Brazil, Italy, South Korea, Australia, Canada and Turkey. All but two of these countries are US allies. [5] China and Russia are not part of a US-led military alliance. But their combined military expenditures are less than one-third of the Pentagons budget. Its difficult to imagine how hard headed deficit hawks arent scolding Washington for its wasteful overspending on defense, unless the professed deficit hawks are using debt as a pretext to argue for cut-backs in programs for poor and middle-income Americans. The Pentagons obesity is largely due to the United States becoming entangledno, startingtwo completely unnecessary and extremely expensive wars: one on Iraq, based on the lie that Saddam Hussein had weapons of mass destruction, and one on Afghanistan, to topple the Taliban who will likely return to power in a negotiated settlement.

Bumiller reported in 2010 that both wars had cost Americans a staggering $1 trillion to date, second only in inflation-adjusted dollars to the $4 trillion price tag for World War II, when the United States put 16 million men and women into uniform and fought on three continents. [6] With the war in Afghanistan dragging on at a cost of about $2 billion a week [7] another $200 billion has come due since Bumiller tallied up the original $1 trillion price tag. Genuine concern about managing US finances would have long ago led to an end to both wars (not just one), if not complete avoidance of either to begin with. Taxes were not raised to pay for either war. This is the first time since the American Revolution that Washington hasnt called upon taxpayers to ante up. [8] The reason Americans havent been asked to shell out for these wars is clear. Neither was likely to galvanize Americans to accept sacrifices. So, the only way to get Americans behind them was to fight the wars in a way that allowed the country to avoid breaking a sweat, as historian David Kennedy put it. [9] Many Americans are willing to acknowledge that the wars should never have been fought, but rationalize them by pointing to the supposed good theyve done (the toppling of Saddam Hussein, improved conditions for women in Afghanistan.) But how accepting will they be when theyre presented with the bill, as they most assuredly will be? Someone will have to pay eventually. The trick for politicians will be to blame the bill on something else. Entitlements come to mind. The Flat Tax System If Mankiw ignores the obvious links among rising military expenditures, absent tax increases, and a climbing debt to GDP ratio, he also ignores property, state, excise, and sales taxes, to argue that the wealthy are already paying their fair share, and that the current tax system looks pretty progressive. Well, yes, the current federal income tax system does look progressive, and Mankiw would be on target if federal income tax were the only one Americans pay. But they also pay sales taxes, property taxes and more. Factor in all other taxes and the tax system isnt quite as progressive as Mankiw would have us believe. As Washington Post reporter Ezra Klein noted in September, Confining the discussion to the federal income taxmakes the tax code look much more progressive than it actually is. [10] So, just how unprogressive is the tax system? According to the Institute on Taxation and Economic Policy, total taxes in 2011 as a percentage of income were [11]: Top Bottom 99%, 27.5% 1% of income earners, 29.0%

In other words, taking into account all the taxes Americans pay and not just the one Mankiw wants to confine the discussion to, the real tax system is essentially flat. The super-wealthy are paying about the same rate as everyone else. And yes, while the poor pay little if anything in federal taxes, they make up for it in state, local and other levies. Which means that were fed eral income taxes hiked on the bottom 99 percent, as Mankiw urges, the real tax system would go from flat to regressive.

Who Benefits? Its widely believed that taxes on the wealthy are redistributed to the poor, and while some redistribution of tax revenue from wealthy to poor does occur, whats less widely known, and rarely talked about, is the massive redistribution of tax revenue from the bottom 99 percent to the top one percent. This is clear if we recognize that: The bulk of taxes are paid by the bottom 99 percent (which is why defenders of the current flat tax system, like Mankiw, keep reminding us that hiking taxes on the rich will make little difference to government finances. The heavy lifting is done by poor and middle-income Americans.) A large fraction of tax revenue is used to fund activities the wealthy disproportionately benefit from. What do federal income taxes pay for? A large part goes to defense contractors, companies like Lockheed-Martin, Boeing, Northrop Grumman, Raytheon and General Dynamics. The top executives and shareholders of these companiesin other words, the super-richmake off like bandits in regular times, but have benefited even more handsomely ever since post 9/11 military expenditures doubled. Profits of the top

five defense contractors rose from $2.4 billion in 2002, adjusted for inflation, to $13.4 billion in 2011, a 450 percent increase. [12] Another part of US military funding is used to finance US wars. US military interventions almost invariably create profitmaking opportunities for the top one percent. For example, then US ambassador to Libya Gene Cretz was positively rhapsodic about the business opportunities that were opened by the US-led (from behind) Nato assault that toppled Muammar Gadhafi, not just petroleum-related but infrastructure contracts too. [13] In the charmed circle of US capitalism, defense contractors reap a bonanza of profits by supplying the Pentagon with arms, which the Pentagon use to destroy infrastructure that US engineering giants like Bechtel rebuild. War can be profitable. Military and non-military aid to other countries also eats up a sizeable chunk of the federal budget. The bottom 99 percent, who contribute the bulk of funds to these programs, benefit only indirectly, if at all. Instead, their tax dollars are converted into credits, which are doled out to other countries to purchase goods and service from US corporations, the direct beneficiaries. For example, the $3 billion in annual military aid Israel receives travels from taxpayers pockets to US defense contractors coffers. The arms industry sends military equipment to Israel, with payment for the purchase never leaving the United States. The same kind of arrangement is used to provide economic aid to poor countries. These countries dont get cash to spend as they see fit. They get credits to spend on American goods and services. There may be benefits to poor and middle-income Americans in job opportunities, but the benefits are disproportionately enjoyed by the top executives and shareholders of the companies on which the credits are spent. Another sizeable part of US tax revenue goes to purchasers of US debtthe debt that piled up to pay for the wars Washington didnt want to raise taxes to pay for. Needless to say, poor and middle-income Americans are not major holders of US debt. The super-wealthy are. And super-wealthy bondholders are often the same people who own shares in companies that supply the Pentagon and benefit from new foreign business opportunities that US military interventions secure. So, no, the tax system isnt a one-way circuit where the super-wealthy pick up the tab for everyone elses entitlements, as Mankiw and others would have us believe. Instead, a large part of the tax systems function is to transfer tax revenues from the bottom 99 percent to activitiesforeign aid, military appropriations, wars, and interest on debtthat the top one percent disproportionately benefit from. Conclusion The United States has doubled military spending since 9/11, outspending its peer competitors, China and Russia, by more than a factor of three. It has squandered more than $1 trillion on wars that never should have been fought, and continues to waste $2 billion a week on war in Afghanistan. This excess has been paid for by borrowing rather than taxes, presumably to avoid hurting Americans in their pocketbooks, a pain that would likely provoke anti-war opposition. But the bills are coming due. Mankiw, and other prizefighters for the super-wealthy, are drawing attention away from outsize military spendinga significant contributor to burgeoning debtand directing it instead to entitlements. Theyre also deceptively ignoring payroll, property, sales and other taxes, to argue that the US tax system is progressive and that the wealthy already pay their fair share. In other words, Mankiw is arguing for higher taxes on poor and middle-income Americans, misdirecting attention to entitlement spending to conceal what the bill is really for: military spending that the super-rich have used to fatten their bank accounts. Lessons learned. A. Nothing comes free. Military spending cant be doubledand $1 trillion-plus wars fought without someone eventually being handed the bill. And in the United States, the bill is always paid by the bottom 99 percent. This bill will be paid in entitlement cutbacks and tax increases. B. The job of establishment economists is to make robbing poor and middle-income Americans seem both necessary and desirable. Feudal lords relied on priests to justify the exploitation of working people. Bankers, top executives and investors have economists.

The future of the European Union The choice A limited version of federalism is a less miserable solution than the break-up of the euro May 26th 2012 |From the print edition WHAT will become of the European Union? One road leads to the full break-up of the euro, with all its economic and political repercussions. The other involves an unprecedented transfer of wealth across Europe's borders and, in return, a corresponding surrender of sovereignty. Separate or superstate: those seem to be the alternatives now. For two crisis-plagued years Europe's leaders have run away from this choice. They say that they want to keep the euro intactexcept, perhaps, for Greece. But northern European creditors, led by Germany, will not pay out enough to assure the euro's survival, and southern European debtors increasingly resent foreigners telling them how to run their lives. In this section

How strong is Chinas economy? The choice The charges of the light brigade Hello, Delhi Nul points Central banking Government and politics Public finance Bond markets Government bonds

This has become a test of over 60 years of European integration. Only if Europeans share a sense of common purpose will a grand deal to save the single currency be seen as legitimate. Only if it is legitimate can it last. Most of all, it is a test of Germany. Chancellor Angela Merkel maintains that the threat of the euro's failure is needed to keep wayward governments on the path of reform. But German brinkmanship is corroding the belief that the euro has a future, which raises the cost of a rescue and hastens the very collapse she says she wants to avoid. Ultimately, Europe's choice will be made in Berlin. Last summer this newspaper argued that to break the euro zone's downward spiral required banks to be recapitalised, the European Central Bank (ECB) to stand behind solvent countries with unlimited support, and the curbing of the Teutonic obsession with austerity. Unfortunately, successive European rescue plans fell short and, though the ECB bought temporary relief by supplying banks with cheap, long-term cash in December and February, the crisis has festered and deepened. In recent months we have concluded that, whether or not Greece stays in the euro, a rescue demands more. If it is to banish the spectre of a full break-up, the euro zone must draw on its joint resources by collectively standing behind its big banks and by issuing Eurobonds to share the burden of its debt. We set out the scheme's nuts and bolts below. It is unashamedly technocratic and limited, designed not to create the full superstate that critics (and we) fear. But it is plainly a move towards federalismsomething that troubles many Europeans. It is a gamble, but time is running short. Rumours of bank runs around Europe's periphery have put savers and investors on alert (see article). The euro zone needs a plan. Goodbye to all that

Is the euro really worth saving? Even the single currency's diehard backers now acknowledge that it was put together badly and run worse. Greece should never have been let in. France and Germany rode a coach and horses through the rules designed to prevent government borrowing getting out of hand. The high priests of euro-orthodoxy failed to grasp that, though Ireland and Spain kept to the euro's fiscal rules, they were vulnerable to a property bust or that Portugal and Italy were trapped by slow growth and declining competitiveness. A break-up, many argue, would allow individual countries to restore control over monetary policy. A cheaper currency would help match wages with workers' productivity, for a while at least. Advocates of a break-up imagine an amicable split. Each government would decree that all domestic contractsdeposits and loans, prices and pay should switch into a new currency. To prevent runs, banks, especially in weak economies, would shut over a weekend or limit withdrawals. To stop capital flight, governments would impose controls. All good, except that the people who believe that countries would be better off without the euro gloss over the huge cost of getting there (see article). Even if this break-up were somehow executed flawlessly, banks and firms across the continent would topple because their domestic and foreign assets and liabilities would no longer match. A cascade of defaults and lawsuits would follow. Governments that run deficits would be forced to cut spending brutally or print cash. Explore our interactive guide to Europe's troubled economies And that is the optimistic scenario. More likely, a break-up would take place amid plunging global share prices, a flight to quality, runs on banks, and a collapse in output. Devaluation in weak economies and currency appreciation in strong ones would devastate rich-country producers. Capital controls are illegal in the EU and the break-up of the euro is outside the law, so the whole union would be cast into legal limbo. Some rich countries might take advantage of that to protect their producers by suspending the single market; they might try to deter economic migrants by restricting freedom of movement. Practically speaking, without the movement of goods, people or capital, little of the EU would remain. The heirs of Schuman and Monnet would struggle to restore the Europe of 27 when it had been the cause of such mayhemeven if a euro-rump of strong countries emerged. Collapse would be a gift to anti-EU, anti-globalisation populists, like France's Marine Le Pen. There would be so many people to blame: Eurocrats, financiers, intransigent Germans, feckless Mediterraneans, foreigners of all kinds. As national politics turned ugly, European co-operation would break down. That is why this newspaper thinks willingly abandoning the euro is reckless. A rescue is preferable to a break-up. A problem shared But not just any rescue. Too much of the debate over how to save the euro puts the emphasis merely on a plan for growth. That would help, because growth makes debt more manageable and banks healthier. Mrs Merkel should have been more accommodating on this. But any realistic stimulus would be too modest to stem the crisis. The ECB could and should cut rates and begin quantitative easing, but official funds for investment are limited. More ambitious ways of boosting growth, such as the completion of a single European market for services, are sadly not even on the table. In any case, the euro zone's troubles run too deep. Banks and their governments are propping each other up like Friday-night drunks. The ECB's support for the banks cannot prevent the weak economies of Spain, Portugal, Italy and Ireland from enfeebling their banks and governments. For as long as bond yields are high and growth is poor, sovereigns will face doubt about their capacity to service their debt and banks will see loans go bad. Yet that same uncertainty pushes up sovereign yields and stops bank lending, further inhibiting growth. Fear that the state might have to deal with a banking collapse makes government bonds riskier. Fear that the state could not cope makes a banking collapse more likely.

That is why we have reluctantly concluded that the nations in the euro zone must share their burdens. The logic is straightforward. The euro zone's problem is not the debt's size, but its fragmented structure. Taken as a whole, the stock of euro-zone public debt is 87% of GDP, compared with over 100% in America. Similarly, the banks are not too big for the continent as a whole, just for individual governments. To survive, Europe has to become more federal: the debate is how much more. What's German for demoi? A lot, according to some gung-ho federalists. For people like Germany's finance minister, Wolfgang Schuble, the single currency was always a leg on the journey towards a fully integrated Europe. In exchange for paying up, they want to harmonise taxes and centralise political power with, say, an elected European Commission and new powers for the European Parliament. Voters will be scared into grudging acquiescence precisely because a euro collapse is so terrifying. In time, the new institutions will gain legitimacy because they will work and Europeans will begin to feel prosperous again (see article). Yet to see the euro crisis as a chance to federalise the EU would be to misread people's appetite for integration. The wartime generation that saw the EU as a bulwark against strife is fading. For most Europeans, the outcome of the EU's most ambitious project, the euro, feels like misery. And there is no evidence that voters feel close to the EU. The Lisbon treaty and its precursor, the EU's aborted constitution, were together rejected in three out of six referendums; ten governments reneged on promises to put constitutional reform to the vote. The parliament is hopelessly remote. Another version of the superstate is to accept that politics remains stubbornly nationaland to increase the power of governments to police their neighbours. But that, too, has problems. As the euro crisis has shown, governments struggle to take collective decisions. The small countries of the euro zone fear that the big ones would hold too much sway. If Berlin pays the bills and tells the rest of Europe how to behave, it risks fostering destructive nationalist resentment against Germany. And like the other version of the superstate, it would strengthen the camp in Britain arguing for an exita problem not just for Britons but for all economically liberal Europeans. The 50,300 ($64,000) question That is why our rescue seeks to limit both the burden-sharing and the concession of sovereignty. Rather than building a federal system, it fills in two holes in the single currency's original design. The first is financial: the euro zone needs a region-wide system of bank supervision, recapitalisation, deposit insurance and regulation. The second is fiscal: euro-zone governments will be able to manageand reducetheir fiscal burdens only with a limited mutualisation of debt. But in both cases the answer is not to transfer everything to the EU level. Begin with the banks. Since the euro's creation, European integration has moved farthest in finance. Banks sprawl across national borders. German banks fuelled Spain's property boom, while their French peers funded Greece's borrowing. The answer is to move the supervision and support of banks (or at least big ones) away from national regulators to European ones. At a minimum there must be a euro-zone-wide system of deposit insurance and oversight, with collective resources for the recapitalisation of endangered institutions and regional rules for the resolution of truly failed banks. A first step would be to use Europe's rescue funds to recapitalise weak banks, particularly in Spain. But a common system of deposit insurance needs to be rapidly set up. These are big changes. Politicians will no longer be able to force their banks to support national firms or buy their government bonds. Banks will no longer be Spanish or German, but increasingly European. Make no mistake: this is integration. But it is limited to finance, a part of the economy where monetary union has already swept away national boundaries.

The fiscal integration can also be limited. Brussels need not take charge of tax and spending, nor need Eurobonds cover all government debts. All that is required is for overindebted countries to have access to money and for banks to have a safe euro-wide class of assets that is not tied to the fortunes of one country. The solution is a narrower Eurobond that mutualises a limited amount of debt for a limited amount of time. The best option is to build on an idea put forward by Germany's Council of Economic Experts, to mutualise the current debts of all euro-zone economies above 60% of their GDP. Rather than issuing new national government bonds, everybody, from Germany (debt: 81% of GDP) to Italy (120%) would issue only these joint bonds until their national debts fell to the 60% threshold. The new mutualised-bond market, worth some 2. 3 trillion, would be paid off over the next 25 years. Each country would pledge a specified tax (such as a VAT surcharge) to provide the cash. So far Mrs Merkel has opposed all forms of mutualisation (and did so again this weeksee Charlemagne). Under our scheme, Germany would pay more on a slug of its debt, subsidising riskier borrowers. But it is not a move to wholesale fiscal federalism. These joint bonds would not require intrusive federal fiscal oversight. Limited in scope and time, they do not fall foul of Germany's constitutional constraints. Indeed, they can be built from last autumn's beefed-up six pack, which curbs excessive borrowing and deficits; and January's fiscal compact, which enshrines budget discipline in law and is now being ratified across the euro zone. Even this more limited version of federalism is tricky. The single banking regulator might require a treaty change, which would be difficult when ten EU countries, including Britain, are not members of the euro. The treaty setting up Europe's bail-out fund would also have to be changed to allow money to be supplied directly to banks. Countries would have to find convincing ways to commit future governments to pay their share of the interest on the Eurobonds. Greece's debts so outweigh its economy that it would need a further rescue before entering any mutualisation schemethough the sum involved is small on a continental scale. So it is a long agenda; but it is more manageable than trying to redesign Brussels from the top down, and it is less costly than a break-up. Saving the euro is desirable and it is doable. One question remains: will Germans, Austrians and the Dutch feel enough solidarity with Italians, Spaniards, Portuguese and Irish to pay up? We believe that to do so is in their own interests. The time has come for Europe's leaders, and Mrs Merkel in particular, to make that case.

Micro stars, macro effects

Meet the economists who are making markets work better

Nov 24th 2012 |From the print edition

ON THE face of it, economics has had a dreadful decade: it offered no prediction of the subprime or euro crises, and only bitter arguments over how to solve them. But alongside these failures, a small group of the worlds top microeconomists are quietly revolutionising the discipline. Working for big technology firms such as Google, Microsoft and eBay, they are changing the way business decisions are made and markets work. Take, for example, the challenge of keeping costs down. An important input for a company like Yahoo! is internet bandwidth, which is bought at group level and distributed via an internal market. Demand for bandwidth is quite lumpy, with peaks and troughs at different times of the day. This creates a problem: because spikes in demand must be met, firms run with costly spare capacity much of the time. In this section

Micro stars, macro effects Bargain like a Somali Running from the shadows The income appeal Ever sharper questions The education of Kweku Adoboli Running fast Euro angst hits home The argument in the floor

Reprints Related topics

eBay Auctions

This was one of the first questions that Preston McAfee, a former California Institute of Technology professor, looked at when he arrived at Yahoo! in 2007. Mr McAfee, who now works for Google, found that uses of bandwidth fall into two categories: urgent (displaying a web page) and delayable (backups and archiving). He showed how a two-part tariff (high prices when demand peaks, low ones otherwise) could shift less time-sensitive tasks to night-time, allowing Yahoo! to use costly bandwidth more efficiently. The solutiontwo types of task, two priceshas intuitive appeal. But economists ideas on how to design markets can seem puzzling at first. One example is the question of how much detail an online car auctioneer should reveal about the condition of the vehicles on offer. Common sense would suggest some informationa cars age and mileageis essential, but that total transparency about other things (precise details on subpar paintwork) might deter buyers, lowering the auctioneers commissions. Academic theory suggests otherwise: in some types of auction more information always raises revenues.

To test the idea, Steve Tadelis of the University of California at Berkeley (now also working for eBay) and Florian Zettelmeyer of Northwestern University set up a trial, randomly splitting 8,000 cars into two groups. The first group were auctioned with standard information, including age and mileage. The second had a detailed report on the cars paintwork. The results were striking: cars in the second group had better chances of a sale and sold for higher prices. This effect was most pronounced for cars in poorer condition: the probability of a sale rose by 23%, with prices up by 5%. The extra information meant that buyers were able to spot the type of car they wanted. Competition for cars rose, even the scruffier ones. But more information is not always better. Studies show that shoppers overwhelmed by choice may simply walk away. Mr Tadelis tested whether it would be better to tailor eBays auctions to users experience level. The options for new users were narrowed, by removing sellers who are more difficult to assess (for example those who had less-than-perfect feedback on things like shipping times). When new users had a simpler list of sellers to choose from, the number of successful auctions rose and buyers were more likely to use eBay again. Tailoring the market meant gains for buyers, sellers and eBay. The desire to use theory to challenge conventional thinking is one reason economists are valuable to firms, says Susan Athey, of Stanford University and Microsoft. When Ms Athey arrived at the software giant in 2007 it faced what was seen as an unavoidable trade-off: online advertising was good for revenues, but too much would deter users. If advertisers gained, users would lose. But economic theory challenges this, showing that if firms are dealing with two groups (advertisers and users, say), making one better off often benefits the other too. Ms Athey and Microsofts computer scientists put that theory to work. One idea was to toughen the algorithm that determines whether an ad is shown. This means ads are displayed fewer times, so advertisers lose out in the short-term. But in the longer run, other forces come into play. More relevant ads improve the user experience, so user numbers rise. And better-targeted ads mean more users click on the advert, even if it is shown less often. Empirical evidence showed that although advertisers would respond only after some time, the eventual gain was worth the wait. Microsoft made the change. Microeconomists have their sights on problems outside their home turf too. At the moment the policies picked by central banks and finance ministries are based on old news, since things like GDP, inflation and unemployment are measured with long lags. A team at Google headed by its chief economist, Hal Varian, is using search-engine data to provide more timely measures. Search terms like job, benefits and solitaire are closely correlated with unemployment claims (see chart). These types of relationship help construct new indexes that offer a real-time picture of the economy. If policymakers start to use these in a systematic way, their decisions could be based on how the economy looked yesterday, rather than months ago.

Innovation pessimism Has the ideas machine broken down? The idea that innovation and new technology have stopped driving growth is getting increasing attention. But it is not well founded Jan 12th 2013 |From BOOM times are back in Silicon Valley. Office parks along Highway 101 are once again adorned with the insignia of hopeful start-ups. Rents are soaring, as is the demand for fancy vacation homes in resort towns like Lake Tahoe, a sign of fortunes being amassed. The Bay Area was the birthplace of the semiconductor industry and the computer and internet companies that have grown up in its wake. Its wizards provided many of the marvels that make the world feel futuristic, from touch-screen phones to the instantaneous searching of great libraries to the power to pilot a drone thousands of miles away. The revival in its business activity since 2010 suggests progress is motoring on. So it may come as a surprise that some in Silicon Valley think the place is stagnant, and that the rate of innovation has been slackening for decades. Peter Thiel, a founder of PayPal, an internet payment company, and the first outside investor in Facebook, a social network, says that innovation in America is somewhere between dire straits and dead. Engineers in all sorts of areas share similar feelings of disappointment. And a small but growing group of economists reckon the economic impact of the innovations of today may pale in comparison with those of the past. Related topics

Europe Massachusetts Institute of Technology United Kingdom Paul Romer United States

Some suspect that the rich worlds economic doldrums may be rooted in a long-term technological stasis. In a 2011 e-book Tyler Cowen, an economist at George Mason University, argued that the financial crisis was masking a deeper and more disturbing Great Stagnation. It was this which explained why growth in rich-world real incomes and employment had long been slowing and, since 2000, had hardly risen at all (see chart 1). The various motors of 20th-century growthsome technological, some nothad played themselves out, and new technologies were not going to have the same invigorating effect on the economies of the future. For all its flat-screen dazzle and highbandwidth pizzazz, it seemed the world had run out of ideas. Glide path The argument that the world is on a technological plateau runs along three lines. The first comes from growth statistics. Economists divide growth into two different types, extensive and intensive. Extensive growth is a matter of adding more and/or better labour, capital and resources. These are the sort of gains that countries saw from adding women to the labour force in greater numbers and increasing workers education. And, as Mr Cowen notes, this sort of growth is subject to diminishing returns: the first addition will be used where it can do most good, the tenth where it can do the tenth-most good, and so on. If this were the only sort of growth there was, it would end up leaving incomes just above the subsistence level. Intensive growth is powered by the discovery of ever better ways to use workers and resources. This is the sort of growth that allows continuous improvement in incomes and welfare, and enables an economy to grow even as its population decreases. Economists label the all-purpose improvement factor responsible for such growth technologythough it includes things like better laws and regulations as well as technical advanceand measure it using a technique called growth accounting. In this accounting, technology is the bit left over after calculating the effect on GDP of things like labour, capital and education. And at the moment, in the rich world, it looks like

there is less of it about. Emerging markets still manage fast growth, and should be able to do so for some time, because they are catching up with technologies already used elsewhere. The rich world has no such engine to pull it along, and it shows. This is hardly unusual. For most of human history, growth in output and overall economic welfare has been slow and halting. Over the past two centuries, first in Britain, Europe and America, then elsewhere, it took off. In the 19th century growth in output per persona useful general measure of an economys productivity, and a good guide to growth in incomesaccelerated steadily in Britain. By 1906 it was more than 1% a year. By the middle of the 20th century, real output per person in America was growing at a scorching 2.5% a year, a pace at which productivity and incomes double once a generation (see chart 2). More than a century of increasingly powerful and sophisticated machines were obviously a part of that story, as was the rising amount of fossil-fuel energy available to drive them. But in the 1970s Americas growth in real output per person dropped from its post-second-world-war peak of over 3% a year to just over 2% a year. In the 2000s it tumbled below 1%. Output per worker per hour shows a similar pattern, according to Robert Gordon, an economist at Northwestern University: it is pretty good for most of the 20th century, then slumps in the 1970s. It bounced back between 1996 and 2004, but since 2004 the annual rate has fallen to 1.33%, which is as low as it was from 1972 to 1996. Mr Gordon muses that the past two centuries of economic growth might actually amount to just one big wave of dramatic change rather than a new era of uninterrupted progress, and that the world is returning to a regime in which growth is mostly of the extensive sort (see chart 3). Mr Gordon sees it as possible that there were only a few truly fundamental innovationsthe ability to use power on a large scale, to keep houses comfortable regardless of outside temperature, to get from any A to any B, to talk to anyone you need toand that they have mostly been made. There will be more innovationbut it will not change the way the world works in the way electricity, internal-combustion engines, plumbing, petrochemicals and the telephone have. Mr Cowen is more willing to imagine big technological gains ahead, but he thinks there are no more low-hanging fruit. Turning terabytes of genomic knowledge into medical benefit is a lot harder than discovering and mass producing antibiotics. The pessimists second line of argument is based on how much invention is going on. Amid unconvincing appeals to the number of patents filed and databases of innovations put together quite subjectively, Mr Cowen cites interesting work by Charles Jones, an economist at Stanford University. In a 2002 paper Mr Jones studied the contribution of different factors to growth in American per-capita incomes in the period 1950-93. His work indicated that some 80% of income growth was due to rising educational attainment and greater research intensity (the share of the workforce labouring in idea-generating industries). Because neither factor can continue growing ceaselessly, in the absence of some new factor coming into play growth is likely to slow. The growth in the number of people working in research and development might seem to contradict this picture of a less inventive economy: the share of the American economy given over to R&D has expanded by a third since 1975, to almost 3%. But Pierre Azoulay of MIT and Benjamin Jones of Northwestern University find that, though there are more people in research, they are doing less good. They reckon that in 1950 an average R&D worker in America contributed almost seven times more to total factor productivityessentially, the contribution of technology and innovation to growththat an R&D worker in 2000 did. One factor in this may be the burden of knowledge: as ideas accumulate it takes ever longer for new thinkers to catch up with the frontier of their scientific or technical speciality. Mr Jones says that, from 1985 to 1997 alone, the typical age at first innovation rose by about one year. A fall of moondust The third argument is the simplest: the evidence of your senses. The recent rate of progress seems slow compared with that of the early and mid-20th century. Take kitchens. In 1900 kitchens in even the poshest of households were primitive things. Perishables were kept cool in ice boxes, fed by blocks of ice delivered on horse-drawn wagons. Most households lacked electric lighting and running water. Fast forward to 1970 and middle-class kitchens in America and Europe feature gas and electric hobs and ovens, fridges, food processors, microwaves and dishwashers. Move forward another 40 years, though, and things scarcely change. The gizmos are more numerous and digital displays ubiquitous, but cooking is done much as it was by grandma.

Or take speed. In the 19th century horses and sailboats were replaced by railways and steamships. Internalcombustion engines and jet turbines made it possible to move more and more things faster and faster. But since the 1970s humanity has been coasting. Highway travel is little faster than it was 50 years ago; indeed, endemic congestion has many cities now investing in trams and bicycle lanes. Supersonic passenger travel has been abandoned. So, for the past 40 years, has the moon. Medicine offers another example. Life expectancy at birth in America soared from 49 years at the turn of the 20th century to 74 years in 1980. Enormous technical advances have occurred since that time. Yet as of 2011 life expectancy rested at just 78.7 years. Despite hundreds of billions of dollars spent on research, people continue to fall to cancer, heart disease, stroke and organ failure. Molecular medicine has come nowhere close to matching the effects of improved sanitation. To those fortunate enough to benefit from the best that the world has to offer, the fact that it offers no more can disappoint. As Mr Thiel and his colleagues at the Founders Fund, a venture-capital company, put it: We wanted flying cars, instead we got 140 characters. A world where all can use Twitter but hardly any can commute by air is less impressive than the futures dreamed of in the past. The first thing to point out about this appeal to experience and expectation is that the science fiction of the mid-20th century, important as it may have been to people who became entrepreneurs or economists with a taste for the big picture, constituted neither serious technological forecasting nor a binding commitment. It was a celebration through extrapolation of then current progress in speed, power and distance. For cars read flying cars; for battlecruisers read space cruisers. Technological progress does not require all technologies to move forward in lock step, merely that some important technologies are always moving forward. Passenger aeroplanes have not improved much over the past 40 years in terms of their speed. Computers have sped up immeasurably. Unless you can show that planes matter more, to stress the stasis over the progress is simply a matter of taste. Mr Gordon and Mr Cowen do think that now-mature technologies such as air transport have mattered more, and play down the economic importance of recent innovations. If computers and the internet mattered to the economyrather than merely as rich resources for intellectual and cultural exchange, as experienced on Mr Cowens popular blog, Marginal Revolutiontheir effect would be seen in the figures. And it hasnt been. As early as 1987 Robert Solow, a growth theorist, had been asking why you can see the computer age everywhere but in the productivity statistics. A surge in productivity growth that began in the mid-1990s was seen as an encouraging sign that the computers were at last becoming visible; but it faltered, and some, such as Mr Gordon, reckon that the benefits of information technology have largely run their course. He notes that, for all its inhabitants Googling and Skypeing, Americas productivity performance since 2004 has been worse than that of the doldrums from the early 1970s to the early 1990s. The fountains of paradise Closer analysis of recent figures, though, suggests reason for optimism. Across the economy as a whole productivity did slow in 2005 and 2006but productivity growth in manufacturing fared better. The global financial crisis and its aftermath make more recent data hard to interpret. As for the strong productivity growth in the late 1990s, it may have been premature to see it as the effect of information technology making all sorts of sectors more productive. It now looks as though it was driven just by the industries actually making the computers, mobile phones and the like. The effects on the productivity of people and companies buying the new technology seem to have begun appearing in the 2000s, but may not yet have come into their own. Research by Susanto Basu of Boston College and John Fernald of the San Francisco Federal Reserve suggests that the lag between investments in information-andcommunication technologies and improvements in productivity is between five and 15 years. The drop in productivity in 2004, on that reckoning, reflected a state of technology definitely pre-Google, and quite possibly preweb.

Full exploitation of a technology can take far longer than that. Innovation and technology, though talked of almost interchangeably, are not the same thing. Innovation is what people newly know how to do. Technology is what they are actually doing; and that is what matters to the economy. Steel boxes and diesel engines have been around since the 1900s, and their use together in containerised shipping goes back to the 1950s. But their great impact as the backbone of global trade did not come for decades after that. Roughly a century lapsed between the first commercial deployments of James Watts steam engine and steams peak contribution to British growth. Some four decades separated the critical innovations in electrical engineering of the 1880s and the broad influence of electrification on economic growth. Mr Gordon himself notes that the innovations of the late 19th century drove productivity growth until the early 1970s; it is rather uncharitable of him to assume that the post-2004 slump represents the full exhaustion of potential gains from information technology. And information innovation is still in its infancy. Ray Kurzweil, a pioneer of computer science and a devotee of exponential technological extrapolation, likes to talk of the second half of the chess board. There is an old fable in which a gullible king is tricked into paying an obligation in grains of rice, one on the first square of a chessboard, two on the second, four on the third, the payment doubling with every square. Along the first row, the obligation is minuscule. With half the chessboard covered, the king is out only about 100 tonnes of rice. But a square before reaching the end of the seventh row he has laid out 500m tonnes in totalthe whole worlds annual rice production. He will have to put more or less the same amount again on the next square. And there will still be a row to go. Erik Brynjolfsson and Andrew McAfee of MIT make use of this image in their e-book Race Against the Machine. By the measure known as Moores law, the ability to get calculations out of a piece of silicon doubles every 18 months. That growth rate will not last for ever; but other aspects of computation, such as the capacity of algorithms to handle data, are also growing exponentially. When such a capacity is low, that doubling does not matter. As soon as it matters at all, though, it can quickly start to matter a lot. On the second half of the chessboard not only has the cumulative effect of innovations become large, but each new iteration of innovation delivers a technological jolt as powerful as all previous rounds combined. The other side of the sky As an example of this acceleration-of-effect they offer autonomous vehicles. In 2004 the Defence Advanced Research Projects Agency (DARPA), a branch of Americas Department of Defence, set up a race for driverless cars that promised $1 million to the team whose vehicle finished the 240km (150-mile) route fastest. Not one of the robotic entrants completed the course. In August 2012 Google announced that its fleet of autonomous vehicles had completed some half a million kilometres of accident-free test runs. Several American states have passed or are weighing regulations for driverless cars; a robotic-transport revolution that seemed impossible ten years ago may be here in ten more. That only scratches the surface. Across the board, innovations fuelled by cheap processing power are taking off. Computers are beginning to understand natural language. People are controlling video games through body movement alonea technology that may soon find application in much of the business world. Three-dimensional printing is capable of churning out an increasingly complex array of objects, and may soon move on to human tissues and other organic material. An innovation pessimist could dismiss this as jam tomorrow. But the idea that technology-led growth must either continue unabated or steadily decline, rather than ebbing and flowing, is at odds with history. Chad Syverson of the University of Chicago points out that productivity growth during the age of electrification was lumpy. Growth was slow during a period of important electrical innovations in the late 19th and early 20th centuries; then it surged. The information-age trajectory looks pretty similar (see chart 4). It may be that the 1970s-and-after slowdown in which the technological pessimists set such store can be understood in this wayas a pause, rather than a permanent inflection. The period from the early 1970s to the mid-1990s may simply represent one in which the contributions of earlier major innovations were exhausted while computing,

biotechnology, personal communication and the rest of the technologies of today and tomorrow remained too small a part of the economy to influence overall growth. Other potential culprits loom, howeversome of which, worryingly, might be permanent in their effects. Much of the economy is more heavily regulated than it was a century ago. Environmental protection has provided cleaner air and water, which improve peoples lives. Indeed, to the extent that such gains are not captured in measurements of GDP, the slowdown in progress from the 1970s is overstated. But if that is so, it will probably continue to be so for future technological change. And poorly crafted regulations may unduly raise the cost of new research, discouraging further innovation. Another thing which may have changed permanently is the role of government. Technology pessimists rarely miss an opportunity to point to the Apollo programme, crowning glory of a time in which government did not simply facilitate new innovation but provided an ongoing demand for talent and invention. This it did most reliably through the military-industrial complex of which Apollo was a spectacular and peculiarly inspirational outgrowth. Mr Thiel is often critical of the venture-capital industry for its lack of interest in big, world-changing ideas. Yet this is mostly a response to market realities. Private investors rationally prefer modest business models with a reasonably short time to profit and cash out. A third factor which might have been at play in both the 1970s and the 2000s is energy. William Nordhaus of Yale University has found that the productivity slowdown which started in the 1970s radiated outwards from the most energy-intensive sectors, a product of the decades oil shocks. Dear energy may help explain the productivity slowdown of the 2000s as well. But this is a trend that one can hope to see reversed. In America, at least, new technologies are eating into those high prices. Mr Thiel is right to reserve some of his harshest criticism for the energy sectors lacklustre record on innovation; but given the right market conditions it is not entirely hopeless. Perhaps the most radical answer to the problem of the 1970s slowdown is that it was due to globalisation. In a somewhat whimsical 1987 paper, Paul Romer, then at the University of Rochester, sketched the possibility that, with more workers available in developing countries, cutting labour costs in rich ones became less important. Investment in productivity was thus sidelined. The idea was heretical among macroeconomists, as it dispensed with much of the careful theoretical machinery then being used to analyse growth. But as Mr Romer noted, economic historians comparing 19th-century Britain with America commonly credit relative labour scarcity in America with driving forward the capital-intense and highly productive American system of manufacturing. The view from Serendip Some economists are considering how Mr Romers heresy might apply today. Daron Acemoglu, Gino Gancia, and Fabrizio Zilibotti of MIT, CREi (an economics-research centre in Barcelona) and the University of Zurich, have built a model to study this. It shows firms in rich countries shipping low-skill tasks abroad when offshoring costs little, thus driving apart the wages of skilled and unskilled workers at home. Over time, though, offshoring raises wages in less-skilled countries; that makes innovation at home more enticing. Workers are in greater demand, the income distribution narrows, and the economy comes to look more like the post-second-world-war period than the 1970s and their aftermath. Even if that model is mistaken, the rise of the emerging world is among the biggest reasons for optimism. The larger the size of the global market, the more the world benefits from a given new idea, since it can then be applied across more activities and more people. Raising Asias poor billions into the middle class will mean that millions of great minds that might otherwise have toiled at subsistence farming can instead join the modern economy and share the burden of knowledge with rich-world researchersa sharing that information technology makes ever easier. It may still be the case that some parts of the economy are immune, or at least resistant, to some of the productivity improvement that information technology can offer. Sectors like health care, education and government, in which productivity has proved hard to increase, loom larger within the economy than in the past. The frequent absence of market pressure in such areas reduces the pressure for cost savingsand for innovation.

For some, though, the opposite outcome is the one to worry about. Messrs Brynjolfsson and McAfee fear that the technological advances of the second half of the chessboard could be disturbingly rapid, leaving a scourge of technological unemployment in their wake. They argue that new technologies and the globalisation that they allow have already contributed to stagnant incomes and a decline in jobs that require moderate levels of skill. Further progress could threaten jobs higher up and lower down the skill spectrum that had, until now, seemed safe. Pattern-recognition software is increasingly good at performing the tasks of entry-level lawyers, scanning thousands of legal documents for relevant passages. Algorithms are used to write basic newspaper articles on sporting outcomes and financial reports. In time, they may move to analysis. Manual tasks are also vulnerable. In Japan, where labour to care for an ageing population is scarce, innovation in robotics is proceeding by leaps and bounds. The rising cost of looking after people across the rich world will only encourage further development. Such productivity advances should generate enormous welfare gains. Yet the adjustment period could be difficult. In the end, the main risk to advanced economies may not be that the pace of innovation is too slow, but that institutions have become too rigid to accommodate truly revolutionary changeswhich could be a lot more likely than flying cars.

How did Lenovo become the worlds biggest computer company?

Jan 12th 2013 | BEIJING |From the print edition

LENOVO started humbly. Its founders established the Chinese technology firm in 1984 with $25,000 and held early meetings in a guard shack. It did well selling personal computers in China, but stumbled abroad. Its acquisition of IBMs PC business in 2005 led, according to one insider, to nearly complete organ rejection. Gobbling up an entity double its size was never going to be easy. But cultural differences made it trickier. IBMers chafed at Chinese practices such as mandatory exercise breaks and public shaming of latecomers to meetings. Chinese staff, said a Lenovo executive at the time, marvelled that: Americans like to talk; Chinese people like to listen. At first we wondered why they kept talking when they had nothing to say. Two Western chief executives failed to turn things around. By 2008, as the financial crisis raged, Lenovo was bleeding red ink. In this section

From guard shack to global giant France v Google Scoop! Nothing is certain Drill, or quarrel? The last great American airline merger A world of trouble

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Communications Hewlett-Packard IBM China Computer and peripheral manufacturing

Given all this, its recent success is startling. In the third quarter of last year, Gartner, a consultancy, declared Lenovo the worlds biggest seller of PCs, ahead of Hewlett-Packard (HP). Even if HP briefly recaptures the lead in the fourth quarter, the trend seems clear: Lenovo is on a roll (see chart 1). It is number one in five of the seven biggest PC markets, including Japan and Germany. Its mobile division is poised to leapfrog Samsung to grab the top spot in China, the worlds biggest smartphone market. This week it made a splash at the International Consumer Electronics Show in Las Vegas with what PC World called bullish bravado and a seemingly bottomless trunk of enticing new products. Lenovos rebound raises several questions. How did the firm recover from disaster? Is its new strategy sustainable? And does its rise signal the emergence of Chinas first world-class brand? Lenovos recovery owes much to a risky strategy, dubbed Protect and Attack, embraced by the firms current boss. After taking over in 2009, Yang Yuanqing moved swiftly. Keen to trim the bloat he inherited from IBM, Mr Yang cut a tenth of the workforce. He then acted to protect its two huge profit

centrescorporate PC sales and the China marketeven as he attacked new markets with new products. When Lenovo bought IBMs corporate PC business, it was rumoured to be a money-loser. Some whispered that Chinese ineptitude would sink IBMs well-regarded Think PC brand. Not so: shipments have doubled since the deal, and operating margins are thought to be above 5%. An even bigger profit centre is Lenovos China business, which accounts for some 45% of total revenues. Amar Babu, who runs Lenovos Indian business, thinks the firms strategy in China offers lessons for other emerging markets. It has a vast distribution network, which aims to put a PC shop within 50km (30 miles) of nearly every consumer. It has cultivated close relationships with its distributors, who are granted exclusive territorial rights. Conquering India Mr Babu has copied this approach in India, tweaking it slightly. In China, the exclusivity for retail distributors is two-way: the firm sells only to them, and they sell only Lenovo kit. But because the brand was still unproven in India, retailers refused to grant the firm exclusivity, so Mr Babu agreed to one-way exclusivity. His firm will sell only to a given retailer in a region, but allows them to sell rival products. In this way, Lenovo cultivates loyal brand ambassadors, who also give timely feedback on which products and features consumers like. That allows designers to speed up product-development cycles. The firms first smartphone flopped, but paved the way for a flurry of hits. Buoyed by success in corporate PCs and China, Lenovo has spent heavily to expand its share of the global PC market, especially in emerging markets. The brand is universally known in China; not so elsewhere. Spending on promotion, branding and marketing rose by $248m in the year ending in March 2012 (though the firm will not reveal the full amount). Acquisitions help, too. In 2011 Lenovo bought Medion, a European electronics firm, for $738m, which doubled its share of the German PC market. The same year it spent $450m to enter a joint venture with NEC that made it the largest PC firm in Japan. In 2012 it paid $148m to buy CCE, Brazils biggest computer firm. It is also opening factories in markets, including America, where it is surging. To focus on PCs, Mr Yangs predecessor sold Lenovos smartphone arm for $100m in 2008. Mr Yang bought it back for twice as much the next year. He believes that PCs and other devices will converge, so knowledge of one area will breed expertise in the other. He may be right. Smartphone sales are red hot in China, and Lenovo is now selling mobiles and tablets in several emerging markets. Fourteen quarters in a row, Lenovo has grown faster than the overall PC industry, which shrank by 8% last quarter. A year and a half ago, the firm held double-digit PC market shares in a dozen countries; today, it does so in 34. Alas, there is a tiny problem with Protect and Attack: the attack part is largely unprofitable. In most markets outside China, Lenovos mobile phones, tablets and consumer PCs (as opposed to corporate sales of ThinkPads) lose money. Profit is the long-term goal, says Mr Yang, but it helps to have a large revenue base. He vows to keep investing, regardless of returns, until the firm reaches a roughly 10% share in each of the target

markets. Only with such scale is long-term profitability possible, he insists. Wong Wai Ming, the firms chief financial officer, is confident Lenovo will eventually double its pretax profit margin of 2%. The long game In 2009 Mr Yang persuaded the board to give him four years to show results. If allowed to invest, he promised to turn a $226m annual loss into a profit; in fact, the firm posted a profit of $164m last quarter. He vowed to lift annual revenues, then around $15 billion, past $20 billion; they are now $30 billion (see chart 2). He also said he would raise Lenovos global market share from 7% to double digits; it is now close to 16%. Lenovo does not simply churn out cheap goods. It is spending heavily on branding, distribution, manufacturing and product development. And alongside its cheap gizmos are many mid-range and some premium gadgets, such as the Yoga, a laptop that cleverly converts into a tablet. On January 6th the firm announced a reorganisation: Lenovo Business Group will make things for costconscious consumers, while the new Think Business Group will chase the premium segment. Mr Yang wants the Think brand to compete with Apple; he plans to open fancy showrooms like Apples. Lenovos culture is different from that of other Chinese firms. A state think-tank, the Chinese Academy of Sciences, provided the original $25,000 seed capital, and still owns an indirect stake. But those in the know say Lenovo is run as a private firm, with little or no official interference. Some credit must go to Liu Chuanzhi, the chairman of Legend Holdings, a Chinese investment firm from which Lenovo was spun out. Legend still holds a stake, but Lenovo shares trade freely in Hong Kong. Mr Liu, one of those who schemed in the guard shack, has long dreamed that Legend Computer (as Lenovo was known until 2004) would become a global star. The firm is strikingly unChinese in some ways. English is the official language. Many senior executives are foreign. Top brass and important meetings rotate between two headquarters, in Beijing and Morrisville, North Carolina (where IBMs PC division was based), and Lenovos research hub in Japan. Only after giving two foreigners a try did Mr Liu push for a Chinese chief executive: his protg Mr Yang. Mr Yang, who spoke little English at the time of the IBM deal, moved his family to North Carolina to immerse himself in American ways. Foreigners at Chinese firms often seem like fish out of water, but at Lenovo they look like they belong. One American executive at the firm praises Mr Yang for instilling a bottom-up performance culture, instead of the traditional Chinese corporate game of waiting to see what the emperor wants. Still, the firm has some way to go. It is far too reliant on one market, China. Global investors will not tolerate its meagre profits for ever; some are already grousing. And its global marketing push, which targets go-getting youngsters, is a work in progress. Its slogan in English is not bad: Lenovo: for those who do. The firm sponsored the Beijing Olympics, is an official partner of Americas National Football League and has commissioned adverts by a director of James Bond films. Still, David Roman, a former HP and Apple executive who is Lenovos chief marketing officer, admits that none of the successful Chinese firms has yet got a global brand, including us.

Lenovo uses the hypercompetitive Chinese market as a test bed for products and strategies that are later rolled out globally. That is both a strength and a weakness. If Lenovo is to cement its market-share gains elsewhere, it must go beyond merely copying what works in China. Bad timing makes this problem more daunting. Lenovo has managed to get to the top of the PC mountain at precisely the moment when the mountain appears to be crumbling. Industry sales are shrinking as PCs are made obsolete by other devices. HP has even mooted quitting the business altogether. Some say Lenovos costly global expansion will end in tears. Mr Yang disagrees. Indeed, he shows an unfashionable faith in PCs, which are still 85% of Lenovos revenues. They will keep evolving, he insists, citing the Yoga. Inventive firms can still profit from them. He gushes about a PC+ approach, now being tried in China, that adds mobiles, tablets and smart televisions to PCs and connects them all with a local cloud. He also thinks Lenovo has a secret weapon. It has kept a lot of manufacturing in-house (why outsource to Foxconn when you already pay Chinese wages?). Mr Yang believes this in-house expertise gives his firm an edge in product development. But Lenovo must exploit that edge better than it has done so far if it is to compete with a technology powerhouse like Samsung and build a global brand anything like Apples. If Lenovo is to become Chinas first world-class brand, it must come up with products that consumers are passionate about. In December, as he was honoured as Economic Figure of the Year by Chinas national broadcaster, Mr Yang described the task ahead for his firm and country: My dream is that one day China will be more than a world factoryit will be a global centre for innovation.

A Strong Euro Starts to Worry Europe By Carol Matlack on January 16, 2013
A new obstacle lies in the path of euro zone economies struggling to regain traction. Its the strength of the euro currency, which is trading this week near a 10-month high of $1.34 against the dollar and threatening the competitiveness of European exporters. Dangerously high was how Luxembourg Prime Minister Jean-Claude Juncker described the exchange rate in a Jan. 15 speech. The euros rise is particularly worrisome for Germany, where exporters are already saddled with increasing labor costs. Berlin on Jan. 16 cut the countrys 2013 growth forecast to 0.4 percent, down from 0.7 percent last year. Germany has been the pillar of confidence for Europe, Daniel Weston, chief investment officer at Aimed Capital Management in Munich, told Bloomberg News. If exports weaken in Germany, European economic growth is a grave concern. For now, the European Central Bank is signalling that it wont act to weaken the currency. ECB council member Ewald Nowotny told reporters in Vienna today that the exchange rate was not a major concern. Central Bank President Mario Draghi said last week that he had no goal for the exchange ratea view echoed by ECB Executive Board member Peter Praet, who said in a Belgian newspaper interview published today that the rate was one variable to be factored in, but isnt a goal in itself. Still, economists at Citigroup (C) in London are forecasting that further strengthening of the euro could propel the ECB to cut the current 0.75 percent benchmark interest rate as early as the second quarter of this year. European politicians are increasingly worried about the effect of a strong euro on an already weak euro area economy, they wrote in a research note. Euro zone leaders arent the only ones fretting about exchange rates. Japans central bank has moved to weaken the yen in recent weeks, spurring alarms by trading partners whose exports risk losing competitiveness against the Japanese. Bank of Korea Governor Kim Choong Soo warned on Jan. 14 that the yens softening could provoke an active response by Korea. In Europe, Switzerland has blocked the appreciation of its currency against the euro. And the deputy governor of Norways central bank, Jan F. Qvigstad, said on Jan. 15 that the strengthening of the Norwegian kroner as a perceived safe haven against the euro could lead Norway to cut interest rates as early as March. Such comments prompted Alexei Ulyukayev, first deputy chairman of Russias central bank, to warn that the world is on the brink of a currency war, violating earlier pledges by major industrialized countries to refrain from competitive devaluation. The skirmishing, clearly, has already begun. The Jan. 15 comments by Luxembourgs Juncker and Norways Qvigstad marked the first day European policy makers fired a shot in the 2013 currency war, says Chris Turner, head of foreign-exchange strategy at ING (INGA) in London.

China as world's dominant superpower - Impact on America, Russia and EU

Written by Patrick Dixon Here is a fact beyond dispute: China is set to become the worlds largest economy. The only debates are by what date and by what measure? According to the IMF, Asian economies will represent at least 40% of global economic output by 2015, when adjusted for Purchasing Power Parity (PPP - which is just a way of saying that a McDonalds hamburger should be similar cost everywhere and if it is not, we need to make an allowance in exchange rates to calculate the true relative value of a nations economy). Many economists expect that on PPP calculations, China will overtake the United States long before 2020, probably by 2015-17. All global economists agree it is only a matter of time, by whatever measure. Leaders in developed nations should be ready for a major psychological, economic, cultural and political shift, which will impact the rest of this century.
Reality gap in perception of Chinas future

I lecture to tens of thousands of people, in up to 25 nations a year. I also correspond with over 42,000 followers on Twitter, 2,000 on Linkedin, and on YouTube or my own Website bulletin boards with representatives of another million or two a year. Here is what I observe: Most people I talk to in developed nations are really struggling to understand the deeper implications of the rise of China, to really comprehend what it all means, the scale of this gigantic convulsion on the global stage. Take the United States: both Presidential candidates fought electoral battles with similar messages about American being the greatest nation on earth, and the need to keep America so. Their messages were somewhat out of step with the uncomfortable reality that China is about to become, on simple economic terms, the most powerful economic force on the planet.
Lessons from British loss of Empire

Let us pause for a moment. Winston Churchill once said that to understand the future we need to look to the past. In the 19th century, the British Empire was the greatest single economic force, ruled from London. The Empire was a vast free trade area, that anticipated globalization today. The collapse of that Empire was a traumatic psychological blow for the British people, following the end of the Second World War. At the same time, our world faced the rise of a new Soviet force stretching across half of Germany and all Eastern and Central Europe, to the borders with Turkey, Canada and China. As a UK citizen I can say that it took half a century for British self-esteem to recover from deep unease about a colonial past. The UK has had to adjust to a lesser future, as a fringe component in a wider European Community of 26 other nations, with loss of autonomy on a huge range of day to day issues.

America as global defender of freedom and democracy

Since the end of the Second World War until the collapse of Communism, the United States saw itself as the natural global defender of freedom, justice, democracyand market forces, pitted against Russian and Chinese Communist superpowers in a bitterly fought Cold War. When the Iron Curtain collapsed, it became clear how far Russia had fallen, from a global Superpower with thousands of nuclear warheads, to a nation stricken by psychological malaise, low life-expectancy, corrupt institutions, bankrupt state-owned enterprises and a badly broken economy. China in 1990 also seemed to have severe problems of its own, which left the United States as the worlds sole Superpower, able to play a policing role on a global scale.
Global influence is changing rapidly

Russia continues to limp along to recovery but still aspires to a regional power-base. But China is being reborn as a dynamic and rapidly growing economy with a greater vision for regional influence, staking controversial territorial claims and spending billions more each year on army, navy and airforce. So now there are two Superpowers, and if that was not disturbing enough to many in America and Europe, the larger of the two is about to be China.
Chinas natural place in the world restored

To those in China, the nation is simply regaining its natural balance in the world after two centuries of decline. This a nation that has had a strong national identity for 3000 years, compared to a country that was created less than 300 years ago. The very name for China in Mandarin is the Chinese symbol for the whole world, with a line through the middle, literally "Middle Earth". China has always had one of the largest populations of any nation, and represents around 1 in 6 of all humans alive today. Combined with India, these two embrace a third of all the earths inhabitants. These two nations believe that as part of the natural order, that between them they should comprise therefore a third of the economicpower of the whole world.
American patriotism strong glue in a young nation

And the United States? America is a very young nation: a nation of many peoples, built into perhaps the world's most vibrant, dynamic and highly entrepreneurial community, on a foundation of pioneers, settlers and brave dissidents who struck out for freedom in a distant land. America is bound by the strong glue of national pride. In few other nations do you see so many national flags or symbols on buildings, outside homes, tied to cars. Such enthusiastic nationalism seems odd to nations to many people in Europe, who are on the whole more at ease with the cultural ambiguities in their national life, and tend to be more reticent about waving their national flags It can be hard for American leaders to talk about the relative decline of America economically, without

sounding unpatriotic. Rhetoric about a Strong America, is also often tied up with rhetoric about a Strong Dollar as we see in discussions on bulletin boards and Twitter. This is despite the fact that a primary reason why China is able to export so much and so cheaply, is precisely because the Dollar is so strong against Asian currencies, buys so many things, and makes similar US goods more expensive to export.
Calls for protection against "economic damage" from China

Many Americans passionately believe that the answer is to defy market forces and protect US jobs by imposing big import taxes on a wide range of goods. But as history shows, you can only prop up inefficient enterprises for so long, before the day of reckoning comes. And the day of reckoning could come even faster if America suffers retaliation in a similar kind of blockade against most important US exports. The truth is that even if America was to totally ban all imports of all goods from China, the end result will still be the same in terms of China's ultimate global position, because America is less and less important to Chinas economic growth with every passing year. A rapidly increasing proportion of exports from emerging markets, are imports into other emerging markets, many of them bought by the emerging middle classes who are increasing by 50-80 million people every year. In any case, in a complex manufacturing world, how do you prevent components from one nation being built into products in another? Vietnam is now a major supplier of components for Chinese factories. But the trend could easily switch so that Chinese components are built into everyone elses products to get around US import bans. The stronger the calls for protection against Chinas low cost goods, the more obvious it is that there is a failure to grasp the fundamental realities of the situation. Government leaders in the US, United States or Australia can no more prevent the rise of China by imposing trade barriers, than they can prevent the turning of the earth every 24 hours. It all adds up to a painful and inevitable adjustment.
A new moral force emerging across Asia

This will be a new world with a new moral force on a wide range of issues. If India and China combine in their global campaigning for a better future, they will be able to claim to be the legitimate voice of a third of humanity. Together, they will represent an increasingly dominant economic force, even more so, if welded into such an Alliance were all the members of the ASEAN community, who themselves represent a population of 600 million more. For the American people in particular, I believe these changes will be so profound, that as with the British after 1945, it could take up to 50 years for America to find its authentic voice again, not as the greatest nation on earth, but as the second, or maybe even after India by then, the third greatest nation on earth, measured on simple PPP terms. * What do YOU think about the rise of China and other emerging nations? What do you think the impact will be on the future balance of our world? Do comment below.

Europe's central bank and the euro crisis

Draghi strikes back II Feb 29th 2012, 12:56 by P.W. | LONDON

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AT LAST the waiting has ended. Over the past few weeks the markets have been obsessing over just how much liquidity banks would tap from the European Central Bank (ECB) in the second of its extraordinary three-year LTROs (long-term refinancing operations). The answer came on February 29th from the Frankfurt-based central bank of the 17-country euro area. The ECB announced that it had lent 530 billion ($710 billion), a bit more than traders had expected. The funding also exceeded the previous LTRO, in late December, which had already provided a massive 489 billion. The number of banks dipping into the honeypot reached 800, well above the 523 that borrowed in the first operation. Just as sequels rarely match the success of blockbuster movies, so with the ECB's second funding operation. For one thing, since the amount was only a bit higher than expectations, it should broadly be priced into the markets (though such rationality should never be taken for granted). For another, more of the take-up is likely to have come from banks outside the euro area. More important, the first three-year LTRO proved a runaway hit because the ECB showed its handor rather that of the wily Mario Draghi, who had taken the helm only weeks before, replacing Jean-Claude Trichet, the bank's previous president. No, Mr Draghi clearly signalled, the ECB under his leadership would not become the lender of last resort to troubled governments. Instead, it would become the lender of first resort to troubled banks, which could in turn prop up toppling sovereigns by purchasing their debt. Moreover, it would provide funds for a record length (LTROs are usually for months rather than years and the previous record was just one year) and at dirt-cheap rates (the three-year average of the ECB's main policy rate, currently at 1% and tipped to fall later this year to 0.5%). The ECB's eleventh-hour intervention in December dampened down the euro crisis, which had threatened to go critical. Italian and Spanish government bond yields had soared and scared investors had shunned European banks, causing an ominous funding drought. The first three-year LTRO broke this spiral of pessimism by removing fears of an imminent banking implosion. As confidence returned, funding markets re-opened for stronger banks in stronger European economies. And crucially, the ECB's backdoor approach worked a treat in Italy and Spain. Banks there lapped up the central bank's funds and purchased their own governments' debt. That pushed down Italian and Spanish sovereign bond yields whose spreads over German Bunds narrowed markedly. At best, the second LTRO will maintain that return of confidence for a while. But the ECB's provision of liquidity buys time rather than solving the euro area's deep-seated problems, which are as much political as economic. A sharp reminder of the dangers ahead came on February 28th when Enda Kenny, the Irish prime minister, unexpectedly announced that Ireland would hold a referendum on the European treaty to enshrine budget discipline in national law. Even if the Irish vote against it, the fiscal compact will take effect, since it requires only 12 countries in the euro area to back it. But the

referendum will reveal public resentment against the harsh austerity that has been imposed on Ireland under its bail-out. There are other tripwires ahead, highlighted by this week's decision by Standard & Poor's, a creditrating agency, to put Greece into selective default as a result of the debt-exchange deal that will slash the face value of private-sector holdings of Greek public debt by more than half. A vote in the German parliament endorsed the linked second bail-out of 130 billion, but opinion polls revealed that over 60% of Germans were opposed to it. Even if the debt swap goes according to plan, an election in April could move Greece closer to an exit from the euro area, with potentially forbidding consequences not just for Greece but the rest of the single-currency zone. Perhaps most worrying of all, the economic prospects are not just bleak for bailed-out and beleaguered Greece and Portugal but also for much larger Italy and Spain. Italian and Spanish borrowing costs may have fallen but that will be of little avail if these economies, already forecast to shrink this year, are unable to return to growth. Moreover, the austerity that Spain must undergo is fiercer than had been expected since its deficit last year has turned out to be 8.5% of GDP rather than the 6% that had been targeted. The ECB's second dollop of easy money has comforted markets. But the euro crisis has not gone away. It would not take that much for it to turn acute again.

Future of the European Union - Enlarged or Broken?

Written by Patrick Dixon Try to imagine what historians will write about Europe in the year 2100 about the Future of the European Union - does it still exist? Did integration succeeed in preventing a Third World War - as was the hope of the founders of the European Union? How stable was the Union after expansion to include many former Eastern bloc nations? What happened following the economic crisis of 2009 - 2011 and the threat to the Euro? What was the outcome of major showdowns between The Federal States of Europe and America through 2020-2030? How did the European Union cope with massive influx of foreign nationals? What happened to national parliaments, laws, markets, languages and cultures? Major challenges to the future of Europe lie ahead. If the great experiment succeeds, it will create an economic, political and military force to pose real challenges to the United States, with its enlargement to 25 countries and a population approaching 500 million. Recent expansion has already added 23% to the EU's land area and had included 75 million additional citizens, with a combined economy of $9.3 trillion, approaching that of the U.S.
Future of European Union will be costly

Expansion is a costly business: EU subsidies to the Eastern countries were $40 billion between 2004 and 2006, a large slice of the annual $97 billion Brussels budget - unlikely to scratch the surface in future. Anyone following the decline of Germany's economy following the years of integration had to recognise the immense investmentof resources by old West Germany into the East, for little economic return. Just visit smaller towns and cities in places like Slovakia or the Czech Republic, dominated still by Stalin-influenced mass-housing projects and decaying ex-communist infrastructure. Many of those 75 million new Euro citizens are existing on average incomes of no more than $450 a month, yet have an expectation of the same kinds ofeconomic and social rights that those in France, Germany and Britain take for granted. They also find themselves bound by tens of thousands of EU directives, such as rules on food preparation and hygiene in restaurants, which are impossibly expensive to implement without help. Deutsche Bank studies of GDP growth, productivity and other factors suggest it will take Slovenia, the most developed country, up to a decade to catch up with the EU average. The problem is most acute for Poland, the largest country in the new group, with a population of 39 million. The economy ground to a halt in 2002 with unemployment of 17% in early 2003. At current rates it could take 40 years for Poland to reach average EU living standards. Tensions may grow if workers in the West feel their jobs are not only moving East, but also their own tax money, which is being used to rebuild nations they care little about. If the future of the European Union continues as planned, a Greater Europe will rebalance unequal power struggles on the world stage, currently dominated by America even though America is

consistently out-voted on many issues. But if the European experiment fails, it will disintegrate eventually into conflict and chaos.
The Most Likely Future for Europe

The most likely scenario for the future of the European Union over the next decade and a half will be slow but steady progress towards integration, held back by the rich diversity of cultures and economic crises. A Greater Europe cannot be built without strong EU governance and visionary leadership, yet these are the two issues which are notably missing at present. The European Parliament does not command the same sense of respect as national Parliaments, nor the connection with ordinary people. This is a serious problem. Who makes decisions in Europe anyway? Is it EU councils of Ministers who are appointed by their own governments? Is it elected representatives of the people (MEPs)? And that is the heart of the problem. What happens when an economic crisis unfolds rapidly - affecting different nations in conflicing ways? What happens if a nation behaves irresponsibly, in ways that create instabilities and liabilities for other members of the Euro Zone?
The Future of Europe: Challenge of Tribalism

Culture differences are profound and deeply sensitive to the future of the European Union. Take language for example. In France there is great resentment about the dominance of the English language and it is illegal to play too many English songs on the radio. It is hard to imagine such a profound division between different States of America. Passions of large numbers of people within the EU can be easily inflamed by insensitive decrees from Brussels, or by "unfair" treatment by one country of another. Disputes over budget deficits, overspending, beef, lamb, asylum seekers, chocolate, Iraq and so on are not just superficial. They often hide very long, historical issues and profound resentments. Finding a way through will mean finding a common EU voice, a clear moral lead from a commanding EU figurehead who will bring confidence and clarity. The current system of a 6 monthly rotating leader is unsustainable, confusing, destabilising and makes effective leadership impossible.
The Future of Europe: Challenge of Rapid Enlargement

The European model is changing forever with rapid expansion to the East, doubling the number of countries and embracing nations that are extremely poor in comparison. Governance will be complex (we don't even have an elected President), and so will be the culture mix. Face the facts: ethnic cleansing is a daily reality in Europe - even in the UK. Every night somewhere in Belfast we see sectarian attacks and every morning the removal vans arrive to take another family away to another location. It is the same in Bosnia, and Kosovo, both part of old Yugoslavia, yet another part of the same old nation is entering the EU: Slovenia. So here we have nations rushing to become one, who cannot even stop people in the same street butchering each other because they want to be so different. So expect growth, extension, vast economic trading areas, and with it growing tensions, economic tensions, xenophobia and resentment.

Future of Euro and breakup of the EU / Eurozone

Written by Patrick Dixon * Patrick Dixon advises senior teams in many of the Europes largest corporations on a wide range of global trends including macro-economic issues. I am often asked about the future of the Euro and Eurozone nations. Will the Euro collapse? Will one or more nations leave the Eurozone? Will nations like Greece default on their national debt? Will EU nations like the UK who are outside the Eurozone be damaged in the possible chaos? (Article written July 2011 but very current issues - for latest on Europe, see Twitter posts plus other links below.) Since the late 1990s I have warned of the risks and challenges facing Euro nations, as they seek to manage their own economies with common exchange rates and interest rates, but without the proper financial disciplines that would be expected if Euroland were a single nation of separate States like America. Things can muddle along when the global economy is stable, but in economic crises, agility is always vital, with speed of response, rapid big decisions, firm and courageous action. These things are essential to restore market confidence. We have seen such clear leadership in nations like the US, Australia and the UK, but in the Eurozone we have seen dithering, bickering, posturing, point scoring, blaming, blocking, delays, denial, muddle, confusion, complacency and toxic paralysis. We have also seen protests, riots and significant further loss of governmentcontrol. So here is my answer about the future of Euroland written for non-economists, in non-technical language. Simple facts which cannot be avoided, and will drive the future survival of Europe for the next two decades.

More Euroland crises are inevitable

Euro nations will be at risk of crisis after crisis, for reasons I set out below, until the Eurozone is radically restructured as it must be. At the same time, they will also continue to benefit from the ability to buy and sell goods between them without exchange rate worries or costs but it remains to be seen whether these benefits will be worth their risk. The answer will vary from nation to nation. Those outside common currency areas will remain vulnerable to speculative attacks on their own individual currencies as we saw in the UK on Black Wednesday, an event which threw the UK out of the entry process for the Euro. It is much harder for global market traders to push a regional currency like the Euro up or down in a major way against say the dollar.
Hard facts which must be faced

Here are some hard facts about life with the Euro that have to be faced: facts that will not change and will dominate the long term future of Europe. These facts lock all nations inside the Eurozone into an economic prison from which there can be no escape unless they leave.

1) COMMON CURRENCY blessing and curse:

When nations share a common currency, they lose two vital control systems to balance boom and bust, inflation and deflation, over-growth or recession / depression. The first is a national exchange rate, and the second is a national interest rate. There are no other tools which are as powerful. Why do these matter so much? You may not notice when all is well, but in rapidly growing economic crisis, loss of both controls can be as dangerous as sailing a medium sized boat in a severe gale with a broken rudder, broken mast and no engine. To use another analogy, nations are like market stalls. Think of a local trader who sells oranges in a local fruit market. Every day, and from hour to hour, he varies his price to make sure he makes as much money as he can from his stock, and is left with as little unsold produce as possible. The value of his stock rises and falls. Imagine a government official coming along and telling him that from tomorrow, whatever the market conditions, all oranges must now be sold at a fixed price set at an average of his normal prices over the last three years. It will have a terrible impact on his business. On a good day he will run out of stock early, while on other days he will be left with mounds of rotting fruit. Sometimes he will be fortunate and be able to buy oranges from farmers at low prices and make a profit. On other days he will struggle to be able to buy any fruit at a price worth selling. He will soon be out of business. Every nation is similarly buying and selling its products in a market where conditions are constantly changing. All these products have to be paid for in local currency pounds sterling in the case of the UK. The more people buy, the more pounds they buy. As they buy pounds, the value of the pound increases in the global market. If they do not want to buy, the value of the pound falls until they are tempted to buy once more. So when you have floating exchange rates, the price of goods in every nation rises and falls for buyers in other nations even when the price remains the same inside the nation where those goods are made. So prices can stay relatively stable for trade inside a country, while export and import prices are adjusting rapidly.
Automatic adjustment for inflation

Suppose there is high inflation in the UK with wages increasing by 20% a year. So the price of UK goods for people buying in dollars is rising by the same amount. An American will soon find that they can get two prices for an almost identical product: high price from the UK, low from everywhere else. So they stop buying from the UK. If this happens on a large scale, as a direct result, the value of the pound starts to fall. As the pound falls, two things happen which are helpful to the UK economy: the American buyer soon starts buying from the UK again, and the British buyer finds it increasingly hard to afford foreign goods

 buying from local businesses instead, which helps support British jobs and communities. So we can see that a floating exchange rate provides a helpful, natural balance to inflationary pressures constantly adjusting prices of exports of a country, as the situation changes, and helping a nation to recover in a crisis. Now let us look at the example of two nations within the Euro with no exchange rate variations. They always know the price they are buying and selling at because they never have to worry about exchange rate fluctuations. Business deals are easier and less risky. But other risks become greater. If the UK joins the Eurozone and then has high wage and price inflation, UK goods will price themselves out of the wider European market very quickly, but the price of all imported goods from other European nations remains the same. Unemployment will then rise in the UK in our example, because people cannot sell outside the UK. Many businesses will shrink or collapse. In this Eurozone example, the only way that the UK can become competitive again is if people are willing to cut their wages right back to where they were before they started to rise faster than their neighbours that could be a 20%, 30% or even 50% cut. As it happens, they will have no choice. Those that continue to charge too much for their labour will soon be out of work. As wages fall and unemployment rises, more people cannot service their loans, house prices collapse, prices of other assets also fall, loans become larger than the assets they were used to buy, people default and walk away from over-mortgaged homes, property prices fall even more, banks start to collapse and the economyspirals into crisis. Deflation of say 10-20% a year, for several years, can destroy a nation far more effectively than inflation of a similar order. As prices start to fall, people stop spending, worried about their future, or because they hope for bigger bargains tomorrow. Shops start to close. Meltdown can follow. This is the story of Ireland in 2011: they have seen wage cuts right across public and private sector to try to restore competitive prices made worse because Ireland is locked into the Euro. In a similar situation, the UK currency has fallen by 20%, so British residents have found imports more expensive, but those outside the UK have found British products and services are now at better prices. Manufacturing exports are rising.
If Greece had stayed with the Drachma.

If Greece had remained outside the Euro, in 2010 and 2011 we would have seen a sharp fall in the value of the Drachma. Tourists would have flocked back into the country, taking advantage of cheap holidays, and Greek people would have had to get used to buying less foreign goods for a while, buying more from each other instead. The economy would have stabilized at a new level.

2) INTEREST RATES LOSS OF CONTROL

When prices rise by - say - 5% a year, the value of cash falls by the same amount. So after a year, 100 is worth only 95. No one in their right mind would want to save money in such a situation, unless they receive interest to compensate them for the difference.

When money is (almost) free of interest, people tend to borrow as much as available, and spend rapidly. As they do so, prices rise, we see a boom. When money is very expensive to borrow, people tend to pay back debt, spend very little, and prices fall. So governments have a powerful lever to regulate demand, by varying theinterest rates they are prepared to pay on government borrowings.
Regulating a house price boom

If there is a housing boom, a national government can offer savings certificates with a high rate of interest, encouraging people to stop spending and to save with the government. Mortgage interest rates then rise, because banks have to keep their borrowing and lending products broadly in step with what government is doing (market forces), and then house prices start to level off or fall. But in the Eurozone, imagine we have three nations with house price booms, and three others where house prices which are collapsing. What interest rate should the European Bank set? How do you make sure that three national economies are slowed down, and three nations speeded up? This was the dilemma when Ireland joined the Euro. The Irish economy was already growing fast, encouraged by cheap labour and low corporation taxes which attracted many large corporations into the country. At that very moment, this tiger economy entered the Eurozone, where interest rates were much lower than Ireland really needed. The reason was that Germany and other nations were struggling to grow, so the Central Bank had to keep rates down. Irish borrowers enjoyed a bonanza: a frenzy of low cost house loans followed, driving up house prices even higher. Dublin became a huge building site, with massive new estates springing up across the city. And still interest rates stayed low. When the inevitable collapse came, triggered by the global economic crisis, Irish house prices fell by an astonishing 50%. If Ireland had been outside the Euro, you can be sure that interest rates would have been much higher during the housing boom, and then slashed to almost zero as in the US and the UK but instead, Ireland has recently been hammered by far higher borrowing costs than they needed, imposed by European Central Bank. The reason: Germany and Frances own economies are now recovering, and of course we have all the newer additions to the Euro to consider, with higher growth rates than Ireland. So Ireland has to an extent been driven into mega-boom and then battered by a mega-bust as a direct result of being inside the Eurozone. To an extent we can see the same has happened in Greece one of the factors which contributed to the crisis in 2011. So then, we can see that the combined impact of European-average interest rates and exchange rate means that individual nations inside the Eurozone have lost their two most powerful tools in controlling their own economies.

Government debt ticking economic bombs

There is another huge hazard: lack of control over government debt in Euroland. If a nation like the UK is outside the Eurozone, and spends too much money, borrowing a huge amount in the market, or printing millions of pound notes, then its own currency become less valuable. So it faces the result of overspending in a very direct way, which is isolated from impact on other nations. If the UK overspends, or misbehaves in other ways, it will have to face more expensive imports, cushioned by cheaper exports. Inflation will also erode its owngovernment debt, but the government may find in future that it has to offer higher interest rates to get that debt refinanced in future. (Incidentally, the UK had a huge advantage in the recent crisis: much of its debt was tied up in long term contracts on fixed (low) rates which could not be renegotiated, unlike countries like Greece who were faced with fairly immediate needs to go to the market for refinancing. So the UK has been able to sit back, not worried too much about who is going to buy UK government debt in 2010 or 2011 or 2012, with breathing space to cut government spending, increase taxes, and restore market confidence in the nation as a whole. Inflation is welcome then, as it cuts the value of government debt, at a time when the markets are unable to insist on a better deal.) But if Greece does the same thing with Euro, running up vast debts which it probably cannot repay, the result is damage to the value of the Euro currency as a whole, which affects every other nation using the Euro. Greece will also find they have to pay higher interest on their debt in the global market, and they have to finance significant debt every few weeks. In summary, the Euro project only works in a sustainable way if you think about Euroland as a single nation, a single community, a single inflation rate, a single interest rate, a single exchange rate, a single economic policy, a single European budget for public services, a single mechanism for borrowing money and repaying public debt. That is the situation in the United States with considerable freedoms for State governments. But the big balancing factor in the US is mobility of the labour force. So as one State or another booms or declines, unemployment and wage costs rise and fall locally, and millions of Americans relocate, chasing better wages and job prospects. In Europe, we have seen increasing mobility especially in the case of workers from nations like Poland and Romania which has balanced out some of the latest crisis. For example, when the UK boomed, Polish workers flooded in. When the UK hit recession, many of them returned to Poland one reason why unemployment levels changed less than some expected. But we are still a very immobile cluster of societies compared to the US for cultural and language reasons. We are still very separate nations.

Expect major changes

The current situation in the Eurozone is unsustainable: we have very separate nations from the cultural and growth-rate point of view, locked into an economic prison whose walls are defined by common exchange rates and common interest rates which are by definition less than ideal for almost all Euro

nations. Their individual governments have lost huge economic power to Euroland, yet retain almost all powers to run up as much public debt as they want, spending freely on public services and failing to balance this indulgence with adequate taxation. There is a hard choice facing some nations soon: they have to decide either to manage their own affairs, set their own interest rates, allow their currencies to float, manage their own taxes and spending or to go the whole way and accept that in Euroland we all live and die together, which means accepting further loss of sovereignty, loss of freedom to overspend, less freedom to decide tax rates and so on. But there is a further problem: while diplomats, beaurocrats and politicians debate these things, the future of the most vulnerable nations will be dictated by the markets themselves. If pension funds, investment funds, banks, corporations and wealthy individuals all begin to worry about the economic future of a particular nation, that government will find it has to bribe investors with huge interest rates to raise money to pay its debts, or to refinance them as each loan comes up for renewal and renegotiation. How big will those bribes have to be? Can that nation afford to offer them, or will such bribes simply make future challenges even worse? That is the plight of Greece today, with Spain, Portugal, Ireland and others not far behind. What happens if a nation decides one day not to honor its debts, stops paying interest, refuses to repay loans? Much of that debt is probably held by its own banks, so the first thing we can expect is panic as millions of people rush to get their money out of those banks and preferably out of the country altogether. Banks can become insolvent almost overnight. Huge amounts of debt are held in other European banks, with risks of default insured all over the world in ways that are very hard to monitor. So a major default could create an uncontrolled wave of further economic crises, lasting several years, affecting many Euro nations and far beyond all at a time when governments have little extra capacity to stimulate their economies. The same could happen if a nation was to leave the Euro in an uncontrolled and sudden way. If Greece for example was to re-issue the Drachma, all their debts would be revalued in the new currency, and as the new currency floats, you can be sure a lot of people will sell very quickly, fearing that the currency will collapse and their holdings will soon be worthless. As they sell, their own worst predictions will become true, because the very act of selling the currency will force a further spiral down.

Will the Euro survive?

So what is the answer? You can be sure that the European Central Bank, IMF, European government leaders and heads of banks will work very hard to transform and stabilize the situation in small, clear, well-anticipated steps. The aim will be to reduce the debt burden of Greece by one means or another, and (likely I think) manage an orderly exit from the Euro. This will be a huge cost and risk for EU nations, but the alternative, regular crisis bailouts with likelihood of little return, is

also hideously expensive and also risky. Will the Euro currency survive? Almost certainly yes. Will it have as many members as today? Almost certainly no. Could we have a two tier Euro effectively splitting the currency into two kinds of Euro for two different kinds of nations? Possibly, but each smaller group will continue to face most of the problems above from common exchange and interest rates. Would it make sense for a strong nation like Germany to leave the Euro? Possibly. Germany is a dominant economy within the EU so interest rate policy has to be set with that in mind, and Germany, like France, is often as we have seen at a different stage in its boom and bust cycles than many smaller economies, with different requirements. Taking Germany out of the picture could make alignment easier. The German people are not impressed by the failure of the Greek government to manage its budget, collect taxes, deal with corruption, and keep the country stable. There will be a limit to which any democratically elected government in Germany can go in bailing out nations like Greece, without losing an election. So we could see an ultimatum, if the situation deteriorates far enough, in Greece and other nations: Either they go, or we go.

Coins Against Crazies

By PAUL KRUGMAN Published: January 10, 2013

So, have you heard the one about the trillion-dollar coin? It may sound like a joke. But if we arent ready to mint that coin or take some equivalent action, the joke will be on us and a very sick joke it will be, too.
Fred R. Conrad/The New York Times

Paul Krugman Lets talk for a minute about the vile absurdity of the debt-ceiling confrontation. Under the Constitution, fiscal decisions rest with Congress, which passes laws specifying tax rates and establishing spending programs. If the revenue brought in by those legally established tax rates falls short of the costs of those legally established programs, the Treasury Department normally borrows the difference. Lately, revenue has fallen far short of spending, mainly because of the depressed state of the economy. If you dont like this, theres a simple remedy: demand that Congress raise taxes or cut back on spending. And if youre frustrated by Congresss failure to act, well, democracy means that you cant always get what you want. Where does the debt ceiling fit into all this? Actually, it doesnt. Since Congress already determines revenue and spending, and hence the amount the Treasury needs to borrow, we shouldnt need another vote empowering that borrowing. But for historical reasons any increase in federal debt must be approved by yet another vote. And now Republicans in the House are threatening to deny that approval unless President Obama makes major policy concessions. Its crucial to understand three things about this situation. First, raising the debt ceiling wouldnt grant the president any new powers; every dollar he spent would still have to be approved by Congress. Second, if the debt ceiling isnt raised, the president will be forced to break the law, one way or another; either he borrows funds in defiance of Congress, or he fails to spend money Congress has told him to spend. Finally, just consider the vileness of that G.O.P. threat. If we were to hit the debt ceiling, the U.S. government would end up defaulting on many of its obligations. This would have disastrous effects on financial markets, the economy, and our standing in the world. Yet Republicans are threatening to trigger this disaster unless they get spending cuts that they werent able to enact through normal, Constitutional means. Republicans go wild at this analogy, but its unavoidable. This is exactly like someone walking into a crowded room, announcing that he has a bomb strapped to his chest, and threatening to set that bomb off unless his demands are met. Which brings us to the coin.

As it happens, an obscure legal clause grants the secretary of the Treasury the right to mint and issue platinum coins in any quantity or denomination he chooses. Such coins were, of course, intended to be collectors items, struck to commemorate special occasions. But the law is the law and it offers a simple if strange way out of the crisis. Heres how it would work: The Treasury would mint a platinum coin with a face value of $1 trillion (or many coins with smaller values; it doesnt really matter). This coin would immediately be deposited at the Federal Reserve, which would credit the sum to the governments account. And the government could then write checks against that account, continuing normal operations without issuing new debt. In case youre wondering, no, this wouldnt be an inflationary exercise in printing money. Aside from the fact that printing money isnt inflationary under current conditions, the Fed could and would offset the Treasurys cash withdrawals by selling other assets or borrowing more from banks, so that in reality the U.S. government as a whole (which includes the Fed) would continue to engage in normal borrowing. Basically, this would just be an accounting trick, but thats a good thing. The debt ceiling is a case of accounting nonsense gone malignant; using an accounting trick to negate it is entirely appropriate. But wouldnt the coin trick be undignified? Yes, it would but better to look slightly silly than to let a financial and Constitutional crisis explode. Now, the platinum coin may not be the only option. Maybe the president can simply declare that as he understands the Constitution, his duty to carry out Congressional mandates on taxes and spending takes priority over the debt ceiling. Or he might be able to finance government operations by issuing coupons that look like debt and act like debt but that, he insists, arent debt and, therefore, dont count against the ceiling. Or, best of all, there might be enough sane Republicans that the party will blink and stop making destructive threats. Unless this last possibility materializes, however, its the presidents duty to do whatever it takes, no matter how offbeat or silly it may sound, to defuse this hostage situation. Mint that coin!

Is Growth Over?
By PAUL KRUGMAN Published: December 27, 2012

The great bulk of the economic commentary you read in the papers is focused on the short run: the effects of the fiscal cliff on U.S. recovery, the stresses on the euro, Japans latest attempt to break out of deflation. This focus is understandable, since one global depression can ruin your whole day. But our current travails will eventually end. What do we know about the prospects for long-run prosperity?
Fred R. Conrad/The New York Times

Paul Krugman The answer is: less than we think. The long-term projections produced by official agencies, like the Congressional Budget Office, generally make two big assumptions. One is that economic growth over the next few decades will resemble growth over the past few decades. In particular, productivity the key driver of growth is projected to rise at a rate not too different from its average growth since the 1970s. On the other side, however, these projections generally assume that income inequality, which soared over the past three decades, will increase only modestly looking forward. Its not hard to understand why agencies make these assumptions. Given how little we know about long-run growth, simply assuming that the future will resemble the past is a natural guess. On the other hand, if income inequality continues to soar, were looking at a dystopian, class-warfare future not the kind of thing government agencies want to contemplate. Yet this conventional wisdom is very likely to be wrong on one or both dimensions. Recently, Robert Gordon of Northwestern University created a stir by arguing that economic growth is likely to slow sharply indeed, that the age of growth that began in the 18th century may well be drawing to an end. Mr. Gordon points out that long-term economic growth hasnt been a steady process; it has been driven by several discrete industrial revolutions, each based on a particular set of technologies. The first industrial revolution, based largely on the steam engine, drove growth in the late-18th and early-19th centuries. The second, made possible, in large part, by the application of science to technologies such as electrification, internal combustion and chemical engineering, began circa 1870 and drove growth into the 1960s. The third, centered around information technology, defines our current era. And, as Mr. Gordon correctly notes, the payoffs so far to the third industrial revolution, while real, have been far smaller than those to the second. Electrification, for example, was a much bigger deal than the Internet. Its an interesting thesis, and a useful counterweight to all the gee-whiz glorification of the latest tech. And while I dont think hes right, the way in which hes probably wrong has implications equally destructive of conventional wisdom. For the case against Mr. Gordons techno-pessimism rests largely on the assertion that the big payoff to information technology, which is just getting started, will come from the rise of smart machines.

If you follow these things, you know that the field of artificial intelligence has for decades been a frustrating underachiever, as it proved incredibly hard for computers to do things every human being finds easy, like understanding ordinary speech or recognizing different objects in a picture. Lately, however, the barriers seem to have fallen not because weve learned to replicate human understanding, but because computers can now yield seemingly intelligent results by searching for patterns in huge databases. True, speech recognition is still imperfect; according to the software, one irate caller informed me that I was fall issue yet. But its vastly better than it was just a few years ago, and has already become a seriously useful tool. Object recognition is a bit further behind: its still a source of excitement that a computer network fed images from YouTube spontaneously learned to identify cats. But its not a large step from there to a host of economically important applications. So machines may soon be ready to perform many tasks that currently require large amounts of human labor. This will mean rapid productivity growth and, therefore, high overall economic growth. But and this is the crucial question who will benefit from that growth? Unfortunately, its all too easy to make the case that most Americans will be left behind, because smart machines will end up devaluing the contribution of workers, including highly skilled workers whose skills suddenly become redundant. The point is that theres good reason to believe that the conventional wisdom embodied in long-run budget projections projections that shape almost every aspect of current policy discussion is all wrong. What, then, are the implications of this alternative vision for policy? Well, Ill have to address that topic in a future column.

Playing Taxes Hold Em

By PAUL KRUGMAN Published: December 20, 2012

A few years back, there was a boom in poker television shows in which you got to watch the betting and bluffing of expert card players. Since then, however, viewers seem to have lost interest. But I have a suggestion: Instead of featuring poker experts, why not have a show featuring poker incompetents people who fold when they have a strong hand or dont know how to quit while theyre ahead?
Fred R. Conrad/The New York Times

Paul Krugman On second thought, that show already exists. Its called budget negotiations, and its now in its second episode. The first episode ran in 2011, as President Obama made his first attempt to cut a long-run fiscal deal a so-called Grand Bargain with John Boehner, the speaker of the House. Mr. Obama was holding a fairly weak hand, after a midterm election in which Democrats took a beating. Nonetheless, the concessions he offered were breathtaking: He was willing to accept huge spending cuts, not to mention a rise in the Medicare eligibility age, in return for a vague promise of higher revenue without any increase in tax rates. This deal, if implemented, would have been a huge victory for Republicans, deeply damaging both programs dear to Democrats and the Democratic political brand. But it never happened. Why? Because Mr. Boehner and members of his party couldnt bring themselves to accept even a modest rise in taxes. And their intransigence saved Mr. Obama from himself. Now the game is on again but with Mr. Obama holding a far stronger hand. He and his party won a solid victory in this years election. And the legislative clock is very much in their favor, too. All the Bush tax cuts are scheduled to expire at the end of the month. A brief digression: Ive become aware of a new effort by the G.O.P. to bully reporters into referring only to the Bush-era tax cuts, probably in the hope of dissociating those cuts, which they want to preserve, from a president voters now regard with disdain. But George W. Bush and his administration devised those cuts and rammed them through Congress, and its deceptive to suggest otherwise. Back to the poker game: The president doesnt hold all the cards there are some things he and fellow Democrats want, like extended unemployment benefits and infrastructure spending, that they cant get without some Republican cooperation. But he is in a very strong position. Yet earlier this week progressives suddenly had the sinking feeling that it was 2011 all over again, as the Obama administration made a budget offer that, while far better than the disastrous deal it was willing to make the last time around, still involved giving way on issues where it had promised to hold the line perpetuating a substantial portion of the high-income Bush tax cuts, effectively cutting Social Security benefits by changing the inflation adjustment. And this was an offer, not a deal. Are we about to see another round of the president negotiating with himself, snatching policy and political defeat from the jaws of victory?

Well, probably not. Once again, the Republican crazies the people who cant accept the idea of ever voting to raise taxes on the wealthy, never mind either fiscal or economic reality have saved the day. We dont know exactly why Mr. Boehner didnt respond to the presidents offer with a real counteroffer and instead offered something ludicrous a Plan B that, according to the nonpartisan Tax Policy Center, would actually raise taxes for a number of lower- and middle-income families, while cutting taxes for almost half of those in the top 1 percent. The effect, however, has to have been to disabuse the Obama team of any illusions that they were engaged in good-faith negotiations. Mr. Boehner had evident problems getting his caucus to support Plan B, and he took the plan off the table Thursday night; it would have modestly raised taxes on the really wealthy, the top 0.1 percent, and even that was too much for many Republicans. This means that any real deal with Mr. Obama would be met with mass G.O.P. defections; so any such deal would require overwhelming Democratic support, a fact that empowers progressives ready to bolt if they think the president is giving away too much. As in 2011, then, the Republican crazies are doing Mr. Obama a favor, heading off any temptation he may have felt to give away the store in pursuit of bipartisan dreams. And theres a broader lesson here. This is no time for a Grand Bargain, because the Republican Party, as now constituted, is just not an entity with which the president can make a serious deal. If were going to get a grip on our nations problems of which the budget deficit is a minor part the power of the G.O.P.s extremists, and their willingness to hold the economy hostage if they dont get their way, needs to be broken. And somehow I dont think thats going to happen in the next few days.

That Terrible Trillion

By PAUL KRUGMAN Published: December 16, 2012

As you might imagine, I find myself in a lot of discussions about U.S. fiscal policy, and the budget deficit in particular. And theres one thing I can count on in these discussions: At some point someone will announce, in dire tones, that we have a ONE TRILLION DOLLAR deficit. No, I dont think the people making this pronouncement realize that they sound just like Dr. Evil in the Austin Powers movies. Anyway, we do indeed have a ONE TRILLION DOLLAR deficit, or at least we did; in fiscal 2012, which ended in September, the deficit was actually $1.089 trillion. (It will be lower this year.) The question is what lesson we should take from that figure. What the Dr. Evil types think, and want you to think, is that the big current deficit is a sign that our fiscal position is completely unsustainable. Sometimes they argue that it means that a debt crisis is just around the corner, although theyve been predicting that for years and it keeps not happening. (U.S. borrowing costs are near historic lows.) But more often they use the deficit to argue that we cant afford to maintain programs like Social Security, Medicare and Medicaid. So its important to understand that this is completely wrong. Now, America does have a long-run budget problem, thanks to our aging population and the rising cost of health care. However, the current deficit has nothing to do with that problem, and says nothing at all about the sustainability of our social insurance programs. Instead, it mainly reflects the depressed state of the economy a depression that would be made even worse by attempts to shrink the deficit rapidly. So, lets talk about the numbers. The first thing we need to ask is what a sustainable budget would look like. The answer is that in a growing economy, budgets dont have to be balanced to be sustainable. Federal debt was higher at the end of the Clinton years than at the beginning that is, the deficits of the Clinton administrations early years outweighed the surpluses at the end. Yet because gross domestic product rose over those eight years, the best measure of our debt position, the ratio of debt to G.D.P., fell dramatically, from 49 to 33 percent. Right now, given reasonable estimates of likely future growth and inflation, we would have a stable or declining ratio of debt to G.D.P. even if we had a $400 billion deficit. You can argue that we should do better; but if the question is whether current deficits are sustainable, you should take $400 billion off the table right away. That still leaves $600 billion or so. Whats that about? Its the depressed economy full stop. First of all, the weakness of the economy has led directly to lower revenues; when G.D.P. falls, the federal tax take falls too, and in fact always falls substantially more in percentage terms. On top of that, revenue is temporarily depressed by tax breaks, notably the payroll tax cut, that have been put in place

to support the economy but will be withdrawn as soon as the economy is stronger (or, unfortunately, even before then). If you do the math, it seems likely that full economic recovery would raise revenue by at least $450 billion. Meanwhile, the depressed economy has also temporarily raised spending, because more people qualify for unemployment insurance and means-tested programs like food stamps and Medicaid. A reasonable estimate is that economic recovery would reduce federal spending on such programs by at least $150 billion. Putting all this together, it turns out that the trillion-dollar deficit isnt a sign of unsustainable finances at all. Some of the deficit is in fact sustainable; just about all of the rest would go away if we had an economic recovery. And the prospects for economic recovery are looking pretty good right now or would be looking good if it werent for the political risks posed by Republican hostage-taking. Housing is reviving, consumer debt is down, employment has improved steadily among prime-age workers. Unfortunately, this recovery may well be derailed by the fiscal cliff and/or a confrontation over the debt ceiling; but this has nothing to do with the alleged unsustainability of the deficit. Which brings us back to ONE TRILLION DOLLARS. We do indeed have a big budget deficit, and other things equal it would be better if the deficit were a lot smaller. But other things arent equal; the deficit is a side-effect of an economic depression, and the first order of business should be to end that depression which means, among other things, leaving the deficit alone for now. And you should recognize all the hyped-up talk about the deficit for what it is: yet another disingenuous attempt to scare and bully the body politic into abandoning programs that shield both poor and middleclass Americans from harm.