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INSIDE THIS WEEK: a 14-PaGE SPECIaL rEPorT oN DEBT Britain’s tough budget The prince of India China, nukes and Pakistan How palm oil became embarrassing june 26TH– juLY 2nD 2010

Land of the rising yuan

Losing Afghanistan The war after McChrystal


W I D E O P E N.

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The Economist June 26th 2010 5

Contents 9 The world this week

On the cover Barack Obama has sacked his commander in Afghanistan. But the real worry is that the war is being lost: leader, page 13. The ga es that cost General Stanley McChrystal his job were symptoms of far deeper trouble, pages 29-31. The president and the generals: Lexington, page 38 The Economist online Daily news and views: news analysis, online-only columns, blogs on politics, economics and travel, and a correspondent’s diary E-mail: newsletters and mobile edition

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Volume 395 Number 8688 First published in September 1843 to take part in "a severe contest between intelligence, which presses forward, and an unworthy, timid ignorance obstructing our progress." Editorial o ces in London and also: Bangkok, Beijing, Berlin, Brussels, Cairo, Chicago, Delhi, Frankfurt, Hong Kong, Jerusalem, Johannesburg, Los Angeles, Mexico City, Moscow, New York, Paris, San Francisco, São Paulo, Tokyo, Washington

Leaders 13 Stanley McChrystal goes Losing Afghanistan 14 The age of easy credit Is there life after debt? 15 Pakistan, India and the anti-nuclear rules Clouds of hypocrisy 15 The yuan and global imbalances The long march 16 Britain’s budget Going for broke Letters 18 On Barack Obama and BP, unions, Canada hosting the G20, airports Brieng 29 Afghanistan More than a one-man problem United States 33 Health care The appeal of repeal 34 Peter Orszag to quit Budget blues 34 The housing market Double-dip drama 35 California’s pensions Sanity in the ong? 36 Trade with Mexico Signs of life 36 Tackling homelessness Getting strategic 37 Immigration law Our town 37 Divorce in New York Let them unwed 38 Lexington Kicking the general’s ass The Americas 39 Colombia’s presidential election Too much continuity? 40 The drugs business Successes in the war on drugs expose its limits 40 Maternal health in Mexico A perilous journey

Asia 41 Australia changes prime minister Rudd on the tracks 42 Japan’s new government Enter the prudent Mr Kan 43 The Bhopal disaster The slow pursuit of justice 43 Elections in Hong Kong Functionally democratic 44 Kyrgyzstan’s humanitarian crisis Sad homecoming 46 Banyan The mysterious Mr Gandhi Middle East and Africa 47 Nigeria’s troubled Delta The peace deal frays 48 Zimbabwe’s diamonds Blood and dirt 49 Repression in Rwanda Dissidents under re 49 The blockade of Gaza Hamas is making ground 50 A Saudi tower Mecca v Las Vegas Special report: Debt Repent at leisure After page 50 Europe 52 Russia and its neighbourhood An empty empire 53 French football Three neuroses on their shirts 53 Tax dodging in Italy Evasive measures 54 Turkey and the PKK A blocked opening 54 Organised crime in the Balkans A problem shared 55 Central European politics Poland’s close election 56 Charlemagne How the EU should handle China

Britain’s budget An admirably tough statement of intent, but there are dangers ahead: leader, page 16. The details of a punishing scal plan, page 57. George Osborne’s grand design and the trouble with democracy: Bagehot, page 60

China and Pakistan An o er to supply Pakistan with nuclear reactors shows China at its worst: leader, page 15. If the sale goes ahead, nuclear rivalry between Pakistan and India will intensify, and the damage will go far wider, page 61

The prince of India Though no spring chicken, Rahul Gandhi has a lot to prove before he takes over the family business: Banyan, page 46

1 Contents continues overleaf

6 Contents

Debt Rich countries borrowed from the future. Paying the bill will be dicult, and so will living in a thriftier world: leader, page 14. Borrowing has been the answer to all economic troubles in the past 25 years. Now debt itself has become the problem, see our special report after page 50

The Economist June 26th 2010

Britain 57 The emergency budget The meaning of austerity 58 Welfare reform A costly war 59 Asset sales Roll up, roll up 59 Taxing banks Soft touch 60 Bagehot The imperial moment International 61 Nuclear proliferation in South Asia The power of nightmares 62 The evolving blogosphere An empire gives way 63 Copyrighting facts Owning the news 63 International bureaucracies Secretarial work

65 66 66 Palm oil Green activists are doing their best to turn palm oil from a commodity into a liability. Companies are nding them impossible to ignore, pages 71-73

67 68 68 69 70

Rising yuan China’s move to free its currency is welcome but cannot work miracles: leader, page 15. Attention may now turn to others, page 75

Business Uniqlo Uniquely positioned BP and the oil spill Court tester Corporate governance in America The ght for better boards BASF buys Cognis Seeking a stable formula American agriculture Slaughterhouse rules AHAB and Maan al-Sanea Clash of the Saudi titans Legal outsourcing Passage to India Schumpeter The problem with title ination

Brieng 71 The campaign against palm oil The other oil spill

Finance and economics 75 The yuan unpegged Learning to crawl 76 Buttonwood Speculators and commodity prices 77 The Volcker rule Bang or whimper? 77 Art sales Stooping, not conquering 78 Friedrich Hayek Glenn Beck’s favoured read 78 Exchange-traded funds Explosive 79 Europe’s pressured banks Crash-test dummies 80 Economics focus Pricing immigration

83 84 84 85

Science and technology Chimpanzee behaviour Killer instincts Medical technology Watching your health Morality Rose-coloured spectacles? Computing A quantum hop

Books and arts 87 Siegmund Warburg His lives and time 88 The e ects of the internet Fast forward 89 Hedge funds Role models 89 Joseph O’Connor Bawdy Irishisms 89 Ancient Greece and Rome Full circle 90 Basel art fair Top of the heap

Grandiose job titles Ination in the names companies invent for jobs is approaching Weimar levels: Schumpeter, page 70 Principal commercial oces: 25 St James’s Street, London sw1a 1hg Tel: 020 7830 7000 Fax: 020 7839 2968/9 6 rue Paul Baudry, 75008 Paris, France Tel: +33 153 936 600 Fax: +33 153 936 603 750 3rd Avenue, 5th Floor New York, NY 10017 Tel 1 212 541 0500 Fax 1 212 541 9378 60/F Central Plaza 18 Harbour Road, Wanchai, Hong Kong Tel 852 2585 3888 Fax 852 2802 7638 Other commercial oces: Chicago, Frankfurt, Los Angeles, San Francisco and Singapore

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Obituary 91 Egon Ronay Scourge of Britain’s eateries 97 Economic and nancial indicators Statistics on 42 economies, plus closer looks at the wealthy and drugs

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The Economist June 26th 2010 9

The world this week Politics

General Stanley McChrystal was relieved of his command of American and NATO forces in Afghanistan after Rolling Stone published an article in which the general and his aides openly disparaged the Obama administration and America’s civilian leadership in Kabul. Although the general was picked by Barack Obama for command in Afghanistan, there have been skirmishes in the past between him and the White House over operations. Mr Obama said he welcomed debate but won’t tolerate division and that war is bigger than any one man. General David Petraeus, who has led coalition forces in Iraq, was handed the Afghan job. It emerged that Peter Orszag is to step down as Barack Obama’s top budget adviser. He will be the rst senior member of the president’s economic team to leave oce. Nikki Haley won the Republican nomination for governor in South Carolina’s primary run-os. Ms Haley’s parents are immigrants from India, which will make her the rst Indian-American female governor in America should she be elected in November, as seems likely. The Republicans also chose Tim Scott as their congressional candidate in a district that includes Charleston. Mr Scott will be the rst black Republican to sit in Congress since 2002 if he wins in the midterms. His opponent in the run-o was Paul Thurmond, the son of the late Senator Strom Thurmond, once a prominent segregationist.

On the rise Insurgents thought to be linked to al-Qaeda attacked the Baghdad headquarters of the stateowned Trade Bank of Iraq, killing at least 26 people. The assault followed the storming a week earlier of the country’s central bank, leaving at least 18 dead. Recent bombings elsewhere showed that the insurgency is far from over. Meanwhile, Iraq’s minister for electricity resigned after protests against the patchy supply of energy amid temperatures of 50 degrees Celsius (122 Fahrenheit). Many towns had electricity for less than three hours a day. Abdolmalek Rigi, leader of Jundullah, a Sunni guerrilla group that has carried out bombings in Iran’s southeastern provinces of Baluchistan and Sistan, was hanged in Tehran’s Evin prison after being convicted of terrorism. His followers promised to retaliate. A former head of Rwanda’s army, Lieutenant-General Kayumba Nyamwasa, who fell out with President Paul Kagame earlier this year, was said to be in a stable condition after being shot in Johannesburg. His wife accused Rwanda’s government of trying to assassinate him, a charge it described as preposterous. South African police arrested six suspects.

A grim toll

Kyrgyzstan’s interim president, Roza Otunbayeva, said that as many as 2,000 people may have died in clashes between ethnic Kyrgyz and ethnic Uzbeks in the south of the country earlier this month. An estimated 400,000 people

had been displaced, perhaps a quarter of whom crossed the border into Uzbekistan. The Kyrgyzstani government still plans to hold a referendum on June 27th, to approve a new constitution. Julia Gillard became Australia’s rst female prime minister. She took over from Kevin Rudd after successfully challenging him for the leadership of the ruling Labor Party, which has been doing badly in opinion polls of late. Sri Lanka’s government expressed concern about a decision by Ban Ki-moon, the UN secretary-general, to set up a panel to look into alleged human-rights abuses in the nal months last year of Sri Lanka’s civil war.

A strong family brand The rst round of Poland’s presidential election was won by Bronislaw Komorowski, candidate of the governing Civic Platform party. His opponent, Jaroslaw Kaczynski, twin brother of the late president, performed better than many had expected. A run-o vote will be held on July 4th. Dominique de Villepin, a former prime minister of France, launched a new centre-right political party. Some expect him to challenge Nicolas Sarkozy for the presidency in 2012. George Osborne, Britain’s chancellor of the exchequer, unveiled an emergency budget, aimed at eliminating Britain’s large budget de cit within ve years. Headline measures included a rise in value-added tax, to 20% from 17.5%, and a freeze in child bene t. The coalition government claimed that its budget was progressive, but the widely regarded Institute for Fiscal Studies said this was debatable. Spain’s parliament passed a labour-reform package that it hopes will bring down the close to 20% unemployment rate by reducing the costs of hiring and ring.

A minor gas war broke out between Russia and Belarus. Gazprom, Russia’s stateowned gas monopoly, accused Belarus of not paying its debts and began reducing supplies. Three days later Belarus said it had paid the debt in full.

Transfer of power Juan Manuel Santos won the run-o in Colombia’s presidential election, taking 69% of the vote. He is expected to maintain the policies of his predecessor, Álvaro Uribe, including confrontation with the FARC guerrillas and close ties to the United States. Argentina closed the second round of its debt restructuring with a 66% acceptance rate, bringing the total share of its defaulted bonds that have been exchanged to 92%. However, investors who did not participate say they will continue legal action to prevent the government from accessing capital markets. Flooding from heavy rains killed 44 people and left over 600 missing in north-east Brazil. Around 70,000 have been displaced. The un Oce on Drugs and Crime published its annual narcotics report. It found that Peru may have overtaken Colombia as the world’s biggest grower of coca leaf.

Jamaican police arrested Christopher Coke, an alleged drug-tracker and gang leader. He was on his way to surrender at the embassy of the United States, which has requested his extradition. Last month 73 civilians were killed when the government launched a house-to-house 1 search for Mr Coke.

The Economist June 26th 2010

10 The world this week

Business China surprised markets by ending the peg of the yuan to the dollar, a policy that was reintroduced in July 2008 during the nancial crisis. The yuan’s movement is still restricted to a rise or fall of no more than 0.5% against the dollar in a single dayit appreciated modestly soon after the announcement. Some politicians in America complain that China’s currency regime keeps its exports articially cheap and a debate began on whether China was serious about a exible currency policy, or if it was just manoeuvring to avoid criticism ahead of a G20 summit. Underlining the attractiveness of gold as an investment haven, Saudi Arabia’s gold reserves were said to be more than twice as high as previous estimates, according to the World Gold Council. The kingdom is thought to hold 323 tonnes of the precious metal, which is trading at record high nominal prices. Gold still accounts for only 2.8% of the Saudi central bank’s total reserves.

Shaky foundations After a tax credit ended for housebuyers, sales of new homes in America slumped by a much-higher-than-expected 33% in May compared with April, to 300,000 at an annual rate. The gure underlined the fragility of America’s recovery. The Federal Reserve again kept interest rates near zero for an extended period, but its accompanying language on the economy was markedly less optimistic than in recent months. Analysts pondered the decision by the European Union to release the results of stress tests for banks in July. The tests assess if capital reserves are adequate to withstand a severe downturn. The decision came after Spain moved to publish the results of an evaluation of its banks. It remained unclear whether the EU’s tests would go beyond Europe’s

25-odd biggest banks and if they would factor in the risk from sovereign debt held in southern Europe. Portugal’s central bank revealed that Portuguese banks borrowed 35.8 billion ($44.9 billion) from the European Central Bank in May, double the amount in April, as the euro-zone crisis made it increasingly dicult for the banks to raise funds through capital markets. BASF, the world’s biggest chemical company, diversied its business by agreeing to buy Cognis, which makes ingredients for food and cosmetics, in a 3.1 billion ($3.8 billion) deal.

Dudley do right BP said its costs so far from trying to contain the oil spill in the Gulf of Mexico had risen to $2 billion. Tony Hayward, the company’s hapless chief executive, turned over day-to-day leadership of the clean-up eort to Robert Dudley, who used to head BP’s operations in Russia. Meanwhile, the Obama administration appealed against a judge’s decision to overturn its moratorium on drilling in deep waters, which was introduced after the explosion

on the rig that caused the disaster in the gulf. Several oil-services companies and politicians in Louisiana have challenged the drilling ban on the grounds that it is arbitrary and has a negative economic impact on the region.

The Department for Transport in Britain launched a sale of the rights to operate the highspeed rail line that connects London to the Channel Tunnel. The auction could fetch up to £2 billion ($3 billion).

A sense of well-being Brazil’s Petrobras postponed until September a planned share issue that is expected to raise $25 billion. Questions have been asked about the energy company’s $224 billion spending commitments on various projects, such as developing oshore-oil assets. Petrobras said it was putting the share issue on hold because of a delay in a government valuation of its oshore reserves. In a signicant legal victory for YouTube, a judge ruled that the website had not infringed copyright laws by hosting copyrighted material on its website. Viacom brought the $1 billion claim three years ago, alleging that YouTube, which is owned by Google, was aware of the practice. But the judge made a distinction between a general awareness and a specic awareness of an infringement, and said YouTube had responded to any specic violation by taking the material down.

Access-to-medicine index 2010, score 5 = best 0






GlaxoSmithKline Merck & Co Novartis Gilead Sciences Sanofi-Aventis Roche Holdings AstraZeneca Novo Nordisk Source: Access to Medicine Foundation

The Access to Medicine Foundation, which is funded by governments and charities, including the Gates foundation, published a study on the eorts of 27 drug companies to provide medicine to the developing world. The ranking is based on more than 100 indicators, such as equitable pricing, patents and philanthropic work. The top three spots were taken by GlaxoSmithKline, Merck and Novartis, which are unique in taking risks and experimenting with new business models. Other economic data and news can be found on pages 97-98

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The Economist June 26th 2010 13


After McChrystal Barack Obama has sacked his commander in Afghanistan. But the real worry is that the war is being lost


HE national security adviser of the world’s greatest superpower is a clown , its vice-president a nobody and its president uncomfortable and intimidated . With those words the ocers around General Stanley McChrystal, the American commander in Afghanistan, engulfed America in a storm as damaging to its war eort as any Taliban raid. America rightly sets great store by civilian control of its armed forces and on June 23rd a distinctly unintimidated President Barack Obama made General McChrystal pay for his insubordination with his job. But presidential decisiveness cannot conceal a deeper truth. America and its allies are losing in Afghanistan. Mr Obama had every reason to cashier General McChrystal. Ocers, including his predecessor, have gone for less. Not to act could have left the president looking weak. And yet it was a heavy price to pay. Nothing could cheer the Taliban more than seeing General McChrystal out on his ear. He is a master of counterinsurgency (COIN), he was one of the few Americans who could work with President Hamid Karzai and his hand-picked commanding ocers are in charge of a forthcoming operation in Kandahar that will probably determine the course of the campaign (see page 29). To Mr Obama’s credit, his place has been lled by General David Petraeus, the star of the war in Iraq and the man who wrote the manual on COIN. Even so, the dismissal leaves America’s campaign pitched on the edge of failure. Mr Obama once described the ghting in Afghanistan as a war of necessity . The president must now put necessity aside and pose two fundamental questions. Can the American-led coalition still win in Afghanistan? And if so, how? Kabul ghting This is a terrible moment for the generals to fall out with the politicians. In June Afghanistan surpassed Vietnam to become, by some measures, the longest campaign in America’s history. More than 1,000 of its men and women have been killed and almost 6,000 injured. Yet the Taliban are rampant, assassinating tribal leaders and intimidating their people. A survey in 120 districts racked by insurgency, a third of Afghanistan’s total, found little popular support for Mr Karzai. Over a third of their inhabitants backed the insurgents. Since November, when Mr Obama promised 30,000 more of his country’s soldiers to the campaign, little has gone right. General McChrystal’s plan was for a surge that would seize the initiative from the Taliban and create the scope for Afghanistan’s government, backed by its army and police, to take charge. In practice that has not happened. Marja, a farming district in Helmand, was supposed to show how COIN would win over the people and send the Taliban packing. General McChrystal himself now calls Marja a bleeding ulcer . Mr Karzai’s supposedly corrupt half-brother was meant to go, but he remains in charge in Kandahar. Fanciful Pentagon talk of Afghanistan’s huge mineral wealth smacks of desperation.

America has, perhaps, until the end of the year to show that COIN can work. The charitable view is that frustration lay behind the reckless insults dished out by General McChrystal and his team in front of a journalist from Rolling Stone. COIN manuals stress the importance of unity of eort : damning the idiots back in Washington does not help. But if the generals have not always done well by the politicians, the politicians have far more often let down the generals. George Bush and his defence chiefs neglected the war in Afghanistan while they devoted themselves to bungling the war in Iraq. Mr Obama and his advisers, at odds over strategy, dithered over allocating troops and, far worse, set a date for them to start their withdrawal (see Lexington, page 38). This inghting and hesitancy signal a lack of commitment that has drowned out Mr Obama’s warlike rhetoric. That has blighted the war’s chances of success. Too few Afghans and Pakistanis have thrown in their lot with the West, because too many think America has no stomach for the ght. Were so much not at stake, it would be tempting to give up and call the troops home. Yet, although Western leaders have done a poor job at explaining the war in Afghanistan to their voters, a defeat there would be a disaster. The narrow aim of denying al-Qaeda a haven, already frustrated by the terrorists’ scope to lodge in unruly parts of northern Pakistan, Yemen and Somalia, would become impossible to achieve. A Western withdrawal would leave Afghanistan vulnerable to a civil war that might suck in the local powers, including Iran, Pakistan, India and Russia. Sooner or later, the poison would end up harming America too: it always does. Defeat in Afghanistan would mark a humiliation for the West, and for NATO, that would give succour to its foes in the world. And do not forget the Afghan people. Having invaded their country, the West has a duty to return it to them in a half-decent state. It would be idle to harbour such dreams if they were unattainable. Yet, grim as it is, the violence in Afghanistan even now pales beside Iraq at its worst. In the pit of that conict tens of thousands of people were dying each year, at least ten times more than in Afghanistan today. The ranks of the Afghan army and police force are slowly lling with recruits. There are reasons to think that many Afghans would like to be rid of the Taliban, if only they could believe in an alternative. Still the right plan That is where the appointment of General Petraeus comes in. A losing cause does not automatically have to become a lost one: Iraq showed that. The operation in Marja went badly, but putting down an insurgency needs time and lots of troops, preferably local ones. The real test will come in Kandahar. Worryingly, one of General McChrystal’s last acts was to postpone the operation there until the autumn, amid signs that local people were not yet ready to back it. Even so, Mr Obama owes it to the West and to the Afghan people to determine whether COIN can in fact succeed under his best general. The Afghan war may yet end in an ignominious retreat. But nobody should welcome such an outcome. 7

The Economist June 26th 2010

14 Leaders The age of easy credit and its aftermath

Is there life after debt? Rich countries borrowed from the future. Paying the bill will be di cult, and so will living in a thriftier world


EBT is as powerful a drug as alcohol and nicotine. In boom times Western consumers used it to enhance their lifestyles, companies borrowed to expand their businesses and investors employed debt to enhance their returns. For as long as the boom lasted, Mr Micawber’s famous injunction appeared to be wrong: when annual expenditure exceeded income, the result was happiness, not misery. For a long time debt in the rich world has grown faster than incomes. As our special report this week spells out, it is not just government decits that have swelled. In America private-sector debt alone rose from around 50% of GDP in 1950 to nearly 300% at its recent peak. The origins of the boom go even further back, reecting huge changes in social attitudes. In the 19th century defaulting borrowers were sent to prison. The generation that lived through the Great Depression learned to scrimp and save. But the wider take-up of credit cards in the 1960s created a buy now, pay later society. Default became just a lifestyle choice. The reckless lender, rather than the imprudent debtor, was likely to get the blame. As consumers leveraged up, so did companies. The average bond rating fell from A in 1981 to BBB- today, just one notch above junk status. Firms that held cash on their balance-sheets were criticised for their timidity, while bankruptcy laws, such as America’s Chapter 11, prevented creditors from foreclosing on companies. That forgiving regime encouraged entrepreneurs (in Silicon Valley a bankruptcy is like a duelling scar in a Prussian ocers’ mess) but also allowed too many zombie companies to survive (look at the airlines). And no industry was more addicted to leverage than nance. Banks ran balance-sheets with ever lower levels of equity capital; private equity and hedge funds, which use debt aggressively, churned out billionaires. The road to riches was simple: buy an asset with borrowed money, then sit back and watch its price rise. All this was encouraged by the authorities. Any time a debt crisis threatened the economy, central banks slashed interest rates. The prospect of such rescues reduced the risk of taking on more debt. Bubbles were created, rst in equities, then in housing. It was a monetary ratchet, in which each cycle ended with much higher debt and much lower interest rates. The end-game was reached in 2007-08 when investors realised a lot of this debt would not be repaid. As the credit crunch tightened, central banks had to cut short-term rates to 1% or below. And now the reckoning Rich-world countries now face two sets of problems. The most pressing is how to pay o their debts. Many people who have cut back their credit-card spending and rms which have seen their credit lines slashed would be horried to see how little the rich world’s overall burden has fallen. Much of the debt has merely moved from the private to the public sector as governments have correctly stepped in to support banks and save the economy from falling into depression. And in the future,

even more money will have to be raised, because of governments’ lavish promises of pensions and health care for the retiring baby-boom generation. All this debt will have to be regularly renanced and rolled over. Crises of condence are likely, given that the rich world’s trend rate of growth (and thus the ability of debtors to service their loans) looks set to slow. Worse, much private debt is secured against assets; while the value of the debt is xed, the value of the assets can fall. This can cause a vicious circle as debtors are forced to sell assets, driving prices down. Piling up more debt does not seem an option. There is little appetite on behalf of borrowers or creditors. All governments face the tricky balance of appeasing the markets without damaging growth: Britain’s new government had a go this week (see page 16). But living with less debt will present a second set of longer-term challenges. The road to purgatory A rich world with less debt would look very dierent. Banks are already facing demands for higher capital ratios (and thus safer balance-sheets). Western consumers, facing higher taxes and lower benets, will no longer have the freedom to spend; indeed, they will want to save more as they face long retirements. Sarah Jessica Parker and her Manolo Blahniks will be out; Grandma Walton and her sensible apron will be in. Houses will once again be somewhere to live, not vehicles for speculation. Some business models, notably private equity, will nd it tougher to thrive. Life will be harder for entrepreneurs: more than half of all new rms rely on debt nance. For policymakers, the priorities are clear. First, they need to focus on generating growth. America, with its relatively young, rising population, will nd that comparatively easy. Continental Europe, by contrast, runs the risk of ending up like Japan, which has spent two decades struggling to grow in the face of its debt burden and ageing population. The best and the brightest young Europeans may emigrate to countries without such burdens; and if the economy stagnates, those that remain may eventually decide either to default on their debts, or to cut benets to the elderly. Faced with those dangers, Europe needs to embrace the structural reforms necessary to make its economies as fast-growing and exible as possible. Second, policymakers need to begin the long task of rebalancing the world economy. It makes sense for Western countries, like workers in their 50s, to save for retirement rather than run up their credit-card bills. But if one lot of people saves, another must borrow. At the moment the developing world is unwilling to run current-account decits; even getting China to save less is a huge task (see page 15). All the same, a shift is in everybody’s long-term interestand the younger parts of the world should be the borrowers. Weaning rich countries o their debt addiction will cause withdrawal symptoms. Austerity does not appeal to voters, who may work o their frustrations on politicians and (worse) foreigners. Mr Micawber’s phrase may be turned on its head again. When annual income is forced to exceed annual expenditure, the result may well be misery. 7

The Economist June 26th 2010

Leaders 15

Pakistan, India and the anti-nuclear rules

Clouds of hypocrisy An o er to supply Pakistan with nuclear reactors shows China at its worst


HEN it comes to nuclear danger, North Korea and Iran grab everyone’s attention. One ounced out of the Nuclear Non-Proliferation Treaty (NPT) and tested two bombs; the other, though it denies it, seems headed for just such a breakout. Syria and Myanmar make the worry-list for getting secret nuclear help from North Korea. Even Israel, which keeps mum about its bombs, is now being named and (Egypt hopes) shamed. Pressing Israel to join nuclear talks was Egypt’s price for not ruining a big NPT review last month. Picking on Israel makes the silenceand hypocrisythat surrounds nuclear-armed India and Pakistan all the stranger. Like Israel, neither joined the NPT so their bomb-building did not break its rules. Yet their rivalry is fuelling the fastest, most dangerous build-up of bomb-usable plutonium and uranium anywhere. And a proposed sale by China of two civilian nuclear reactors to proliferation-prone, unstable Pakistan points to a further distinction. Although much of the world has co-operated over North Korea and Iran, everyone is competing over India and Pakistan to make things worse (see page 61). China’s reactor deal with Pakistan has incensed India and alarmed others. It would also break the rules of a little-known cartel, the Nuclear Suppliers Group (NSG), of which both China, Pakistan’s pal, and America, India’s friend, are members. The NSG has guidelines, intended to rule out nuclear trade with countries like India, Pakistan and Israel that do not allow international safeguards on all their nuclear industry. Until now there has been little pressure on China to play by the group’s rules and halt the Pakistan deal, though it obviously

should. But if China refuses, India has itself to blame too. India was jubilant in 2008 when America strong-armed an exemption from this no-trade rule past the NSG. India was fast running out of domestic uranium to keep building bombs as well as lighting homes. Now uniquely exempted from the NSG trade ban, India has various deals pending with Russia, France, Britain, South Korea and other NSG members that involve supplying reactor fuel too. So India is now freer to use more of its own uranium for bombs. Barack Obama did not like the India deal struck by his predecessor, George Bush. Helping India’s nuclear ambitions clashes particularly badly with Mr Obama’s promise to seek the peace and security of a world without nuclear weapons . In weighing those ne promises against America’s relations with India, however, Mr Obama has chosen not to oend India by helping Pakistan too. So Pakistan turned to China. Find courage and conviction This newspaper argued against the America-India nuclear deal, not least because it would intensify nuclear rivalry in an already ssile region. A second wrongshrugging the ChinaPakistan one through, on the basis of some sort of big-power tit-for-tatwill only double the damage. Before China joined the NPT and the NSG its proliferation record was execrable. It helped Pakistan make uranium and plutonium. It handed over the design of one of its own nuclear warheads, which Pakistan later passed on to Libya and possibly Iran. China hates talk of its irresponsible past. It will resent being told it is breaking NSG rules. But the other 45 countries in the group should nd the courage of their anti-proliferation convictions and call China to account. Like others in this sorry saga, China richly deserves embarrassment. 7

The yuan and global imbalances

The long march China’s slightly freer currency would be all the more welcome if it spurred moves to boost consumption


OR months the rich world’s policymakers have quietly Real effective exchange rate July 2005=100 pressed China to abandon its ex130 change-rate peg with the dollar. 120 On June 19th, a week before 110 world leaders from the G20 100 90 were due to gather in Toronto, 2005 06 07 08 09 10 China at last gave ground. The country’s central bank said it would again allow the yuan to move more freely against a basket of currencies, although it ruled out a one-o revaluation as unwarranted. The announcement was greeted cautiously by Tim Geithner, America’s treasury secretary, but in private he may be relieved that a potentially nasty row over the yuan has been averted. China’s move is also timely because it assuages fears that it Yuan

has become less committed to rebalancing its economy. Its huge current-account surplus was cut by more than a third as a share of GDP last year, and had seemed likely to shrink further. But a surge in exports in May raised concerns that China would once again rely on selling to foreign markets for growth now that the rich world has emerged from recession. By allowing a more exible yuan, China stands a better chance of disarming its critics in Congress who believe that it has been unfairly subsidising its exporters with a cheap currency (see page 75). It also gives China more tools with which to cool its economy and tame ination. A stronger yuan would cut the costs of imported goods. Even better, abandoning the xed tie with the dollar has liberated China’s interest-rate policy. The change in direction is welcome but will not work wonders quickly. One problem is that China’s exchange-rate policy 1

The Economist June 26th 2010

16 Leaders 2 will be judged in parts of Washington by how much ground

the yuan makes against the dollar, not against all currencies. If the euro weakens further, that would slow the yuan’s rise against the dollar and give fresh impetus to China-bashers in Congress in the run-up to mid-term elections in November. Yuan thing and another A lot also depends on how quickly the currency is allowed to rise. Some China-watchers expect the yuan’s ascent to resume at the speed it reached when it was last untethered from the dollar, in the three years after July 2005 (see chart on previous page). That may be too optimistic. China’s anxiety about the prospects for rich-world economies may mean that the yuan’s rise is more stately this time. China wants to stem the ow of hot capital into an economy that is prone to sudden jumps in stocks and house prices. To add to the protection a orded by capital controls, it will surely discourage the idea that the yuan’s appreciation will be steady and speedy. So the currency’s 0.4% rise against the dollar on the rst day’s trading after the announcement was partly reversed the following day.

In any case, xing trade imbalances is not a simple matter of currency adjustment. In principle, a stronger yuan would help by making exports less protable and by giving consumers more spending power. But workers displaced from China’s export industries will have to nd jobs elsewhere. And a host of distortions and frictions makes that harder than it should be. Until these obstacles are removed, a sharp appreciation of the yuan might result in a surge in Chinese lay-o s, not a boom in Chinese consumption. Reforms to tackle the root causes of excess saving in China are therefore needed as part of a lasting solution to global imbalances. That means more liberalisation to make it easier for small rms in labour-intensive services to challenge cosseted state-backed rms; it means better corporate governance to help unlock the cash hoarded by state-owned enterprises and spread it around the economy; and it requires a wider socialsecurity net to persuade Chinese householders that they need not insure themselves against every catastrophe. A stronger currency is a handmaiden to these changes. But it cannot do all the work of transforming China’s economy. 7

Britain’s budget

Going for broke An admirably tough-minded statement of intent, but there are dangers ahead


O ONE can deny that George Osborne has bottle. The emergency budget presented on June 22nd by Britain’s new Conservative chancellor of the exchequer aims to deliver a whopping scal retrenchment equal to 6.3% of gdp by 2014-15. Three-quarters of the adjustment will come from spending cuts, including cuts in welfare. The rest will come from tax hikes, both those planned by Labour and new ones, including notably a rise in the consumption-tax (vat) rate (see page 57). Government spending will fall from over 47% of gdp in 2009-10 to under 41%, and borrowing from 11% of GDP to 2%. This is tough stu , and the markets took it as such. Sterling and gilt-edged government bonds strengthened a bit; the credit-rating agencies expressed renewed condence. The messagethat, at a time of worldwide jitters over sovereign debt, Britain is determined not to be classed with the likes of Greeceis welcome. So is the balance of spending cuts and tax rises, and the reduction in the corporate-tax rate. When promises should be broken There are things to take issue with, though, small and big. Whether the budget is worse for poor people than for the better o is disputed, but Mr Osborne could have done more to counter the perception that it isfor example, by means-testing benets that go now to both. A chance was missed to redesign the tax systemby, for instance, including a new carbon tax. And Mr Osborne should not have accepted inherited plans to trim capital spending by as much as 1.5% of gdp; a growing economy needs modern roads, railways and the like. But there are bigger diculties. Can Mr Osborne deliver the savings he promises? If he does, will the economy stumble?

The single gravest error in this budget, and it is one that Mr Osborne will come to rue, was ring-fencing health. Granted, the Tories pledged before the election to maintain spending on the popular National Health Service. But health care absorbs almost a fth of government spending, and it grew faster during the past decade than any other public service. Walling o health means imposing enormous cuts on other departments, averaging 25% by 2014-15 unless more savings are found in welfare. These will be dicult to pull o politically, not least because they expose divisions between the Tory and Liberal Democrat bits of the coalition. Without ring-fencing, the cuts would be 14%. And there should be more emphasis on reforms to deliver services more eciently, less on measures that smack of nickel-and-diming a received agenda. The second question is whether the economy can take Mr Osborne’s strong medicine if he can, in fact, administer it. He is proposing to knock £113 billion a year out of the decit by 2014-15, £40 billion more than his predecessor. Britain will grow, Mr Osborne reckons, if the state steps back: businesses will invest, exports expand, employment take o . The important thing is to avoid a growing debt burden, which would mean more savage cuts in services and welfare down the road. He is right to take that bet, but he should also be aware that it is a gambleand adjustment may be needed. Britain’s recovery from a savage, six-quarter recession has been far from robust. Excess capacity could dampen business investment, and so will banks’ continued reluctance to lend. Lower government spending and higher taxes will do little to enliven the domestic market, and the euro area, Britain’s main trading partner, is struggling. Against this backdrop, what matters is caution and exibility. The increase in VAT, for example, is scheduled for Januaryit could well be delayed if the economy takes a turn for the worse. Mr Osborne has shown that he has courage; wisdom dictates that he have a Plan B as well. 7


Letters Tarred with the same Bush SIR  Lexington is mistaken in thinking that the oil-spill disaster o America’s gulf coast will have no lasting eect on Barack Obama’s presidency (June 12th). From the start of his time in oce Mr Obama has demonstrated a disturbing penchant for letting others set the agenda; the stimulus bill and health-care legislation are prime examples. Even his signature tough decision to increase troop levels in Afghanistan came after months of dithering. Mr Obama’s reaction to the oil spill follows the same narrative. Instead of leading by helping states and local authorities cut through the many bureaucratic obstacles of the federal government, the president has insisted on following the laborious process of conducting environmental reviews of local plans to build barriers that protect fragile wetlands. He also resisted a waiver to the Jones Act, a 90-year-old law that prevents foreign-owned and operated vessels from being used in the gulf clean-up, apparently for fear of alienating his union pals. In place of leadership we get photo-op trips to the gulf and the knee-jerk pattern of blaming others. In this case it is BP, presumably because there is no evidence that George Bush was scuba diving near the Deepwater Horizon rig on April 20th. Joe Hoerter Los Angeles SIR  I have a three-word response to your statement that America’s justiable fury with BP is degenerating into a broad attack on business: about bloody time ( Obama v BP, June 19th). It is increasingly clear that much of corporate America has been permitted to operate on the principle that it gets the prot but somebody else takes the risk. Like it or not, government is the only institution powerful enough to realign the risk-benet ratio so that the people’s interests are at least borne in mind. So your comparison of Mr Obama to Vladimir Putin, though worthy

The Economist June 26th 2010 of a titter, doesn’t hold up. There is no suggestion that the American president is attacking BP in order to force it into the hands of, say, Exxon Mobil at a re-sale price. He is simply trying to ensure admittedly with some histrionicsthat BP cleans up its mess. By making companies pick up their own tab I wouldn’t compare Mr Obama to Yukos-busting Vladimir Putin, but rather to trustbusting Theodore Roosevelt. William Spiegelberger Moscow SIR  I would suggest that the message of the $20 billion escrow fund and other demands on BP is that if your company destroys the Gulf of Mexico, you may indeed be subject to extraordinary government intervention. Similarly, if your rm’s risky investments threaten the entire nancial system, unusual measures may well be taken. Perhaps the best lesson for corporations is that if you want to keep the government’s hands o your business, avoid creating massive environmental or nancial catastrophes. Following basic safety rules, or basic principles of sound nancial risk management, might be a good start. Jonathan Harris Global Development and Environment Institute Tufts University Medford, Massachusetts SIR  Regarding your concern about the rule of law and BP, you were not so worried when the bondholders of General Motors and Chrysler were treated much worse by this administration. John Boncyk Madison, Wisconsin SIR  I won’t defend BP. Its carelessness, or worse, is indeed probably responsible for the oil spill. But a disaster is no time for nger-pointing. The government made a huge mistake when in the rst few days of the catastrophe it did not form a partnership with BP, work out and assign responsibilities, and then get on with sealing the well, protect-

ing the wetlands and cleaning up the oil together. Big problems need big solutions, teamwork and partnership. William Barrons Belmont, California A union man SIR  Schumpeter is wrong when he says that union talk of ghtingoends those who are more interested in getting on than getting even (June 5th). Fighting for rights is the only way that increasingly desperate workers can get on. Witness 8,000 ramp workers at Continental Airlines, the industry’s lowest paid. The management repeatedly cut their wages and benets. The employees fought a long campaign to form a union with the Teamsters and ultimately succeeded despite management’s best eorts. These workers not only talked ght but took to the frontlines in Houston, Newark and Cleveland. Sure, unions need to adapt. The Teamsters are champions of public services as well as defenders of workers. Truck drivers in America’s ports are allied with environmental groups to clean up the air. The slogan for our school-bus workers, driving up standards, refers as much to safety for students as it does to employee conditions. But it isn’t enough to think hard if we are to survive in the age of austerity. Workers’ prosperity has always come through ghting for rights, never from thinking hard about them. James Hoffa General president International Brotherhood of Teamsters Washington, DC Summit costs SIR  In response to your brief article on the expense to Canada of hosting the G20 and G8 summits ( A loonie boondoggle, June 19th) I would say that the events represent a unique opportunity, and the costs must be weighed against the potentially very signicant global benets. You can rest assured that Canada did not

take lightly the cost of hosting summits of this magnitude and complexity. We used a very sharp pencil in estimating spending for holding the gatherings of world leaders. The largest portion of the budget has gone to security, to ensure the safety of the 40 visiting leaders, 10,000 delegates, 3,000 media representatives, members of NGOs and, obviously, the citizens of Muskoka and Toronto. Moreover, the government of Canada has been transparent about the costs and is fully accountable to its citizens. Lawrence Cannon Minister of foreign a airs Ottawa SIR  I wonder if the cost estimates consider the full expense given the large drain on workers in Toronto from lost productivity and security measures. Instead of militarising Canada’s nancial district, might I recommend that in the future the G20 consider a nice airport Hilton? Evan Hughes Toronto Flustered travellers SIR  It was interesting to read about a new airport-security technology that spots suspicious individuals ( Peek-aboo, June 12th). The technology uses infra-red cameras to track an increase of body temperature, heart rate and breathing rate. Suspect individuals are ushered away for further questioning. I read this after taking a plane with my kids and a lot of luggage (comes with the kids), rushing around (also comes with the kids) and arguing with my wife (comes with marriage). Airports should start planning to build bigger interrogation rooms. Simon Majoulet Paris 7 Letters are welcome and should be addressed to the Editor at The Economist, 25 St James’s Street, London sw1A 1hg E-mail: Fax: 020 7839 4092 More letters are available at:

Online highlights

Northern ights Our correspondent travels to Svalbard for a meeting about saving the planet in one of its northernmost corners. How sustainable it is for 40-odd people to travel a very long way in order to attend yet another meeting on climate change is obviously open to debate, he observes

Mortgaging the future Debt has grown at an astonishing speed across the rich world in the past 50 years, as the nancial industry found more and more ways to lend. An interactive chart allows readers to compare how the debt burden varies across 14 countries and to examine dierent types of borrowing

Revolutionary road With a range of more than 300 miles the Opel Ampera is Europe’s version of the Chevrolet Volt, the plug-in hybrid car that helped to convince Barack Obama that GM had a future. It goes on sale next year. A correspondent dusts o his leather driving gloves and takes it for a spin nance

United States: Bene t or burden? Robert Shapiro, a former economic adviser to Bill Clinton, talks about the scal impact of a new wave of American immigration

Africa: An oily mess A constant stream of big oil spills far from America’s shore continues to devastate the Niger Delta and fuel instability there

Economics: Euro 2015 Our guest network of economists considers whether the euro zone will still exist in ve years’ time

Britain: The age of austerity Our economics correspondent discusses the implications of George Osborne’s budget

Europe: The man who would be president With his charm, outsider’s appeal and moral authority, Joachim Gauck has impressed many Germans

Culture: Sales of the century Sotheby’s and Christie’s had been expecting record prices at their Impressionist and Modern auctions in London. The outcomes were far more sobering

Americas: A royal conundrum The departure of a popular governorgeneral leads Canada to ponder its monarchy

Science: True-blue n Raising blue n tuna in captivity could reduce pressure on wild stocks. It worked for salmon

Middle East: Anyone but Algeria There may be an Arab country playing in the World Cup, but most football fans in Beirut are looking elsewhere for teams to support

Business education: We’re all global now Does it still matter where a business school is located?

Daily chart: Dead men walking

Which chief executives are the least likely to be in their jobs at the end of the year? A bookie oers odds

Subscribers to The Economist can search back 13 years by going to:


Executive Focus

The Economist June 26th 2010

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The Economist June 26th 2010



Executive Focus

Director, Office of Evaluation D2 The World Food Programme (WFP) is the world’s largest humanitarian agency, fighting hunger worldwide. We are currently seeking to fill the position of the Director, Office of Evaluation (D2), which will become available in our headquarters in Rome, Italy. The Director, Office of Evaluation, reports directly to the Executive Director, and consults with the Executive Board as required. He/she is responsible for providing an independent evaluation function of the relevance, effectiveness and efficiency of WFP’s programme and activities, and for the implementation of WFP’s evaluation policy as approved by the Executive Board.


At least 15 years’ of progressively responsible experience in both evaluation and management; Prior experience with United Nations Organizations, including field assignments; State-of-the-art knowledge of evaluation and methodology; Excellent communication skills; Ability to work with individuals from a wide variety of backgrounds; Outstanding strategic planning and action management skills; Excellent management and technical leadership skills; University Degree, preferably at advanced level, in social sciences, finance, business administration or management; • Working knowledge of English and intermediate knowledge of another WFP working language (Arabic, French, Spanish, Russian, Chinese or Portuguese). Please review the complete terms of reference and submit an application through the following link: Alternatively, please send your CV by email to with the subject line: Application to Evaluation Director D2 Deadline for applications: 01 August, 2010 WFP has zero tolerance for discrimination and does not discriminate on the basis of HIV/AIDS status. Qualified female applicants and qualified applicants from developing countries are encouraged to apply (REF: 10-0010718).

Fighting Hunger Worldwide FOUNDING DEAN DIVISION OF HUMANITIES AND SOCIAL SCIENCES ASIAN UNIVERSITY FOR WOMEN The Asian University for Women is a start-up initiative located in Chittagong, Bangladesh. This new University aspires to be both a center for excellence in education and scholarship, and renowned for preparing women from many nations, cultures, and socioeconomic backgrounds to be thoughtful and ethical leaders. The academic programs consist of a rigorous undergraduate program, which is comprised of a liberal arts and sciences core curriculum and in-depth study in areas such as Politics, Philosophy and Economics, Asian Studies, Biological and Environmental Sciences, and Computer Science, followed by professional graduate programs in fields such as Entrepreneurship and Management, Law and Human Rights, and Engineering. Instruction is in English. The University currently operates in rented facilities while construction of the first academic building on its permanent site is expected to begin in September 2010. The University seeks an outstanding scholar and dedicated teacher to be the first Dean of the University’s newly created Division of Humanities and Social Sciences. The new Dean will work with the Provost to develop the academic programs in humanities and social sciences, at the undergraduate and graduate levels, recruit and mentor exceptional faculty in these disciplines, and build the division into a center both for teaching and for scholarly excellence in areas that seek to address the challenges of developing Asia. The position calls for an outstanding academic leader who is interested in the opportunity to contribute to shaping the future of this new University. This is a senior appointment (rank of Professor) and priority will be given to those in Economics and Asian Studies with an exemplary record of external research funding, proven success as a teacher and mentor of undergraduate and graduate students, and experience with faculty hiring. Familiarity with and an understanding of developing Asia and an appreciation of the unique challenges of building a tertiary academic institution in such a setting will bolster the incumbent’s effectiveness. An excellent salary and benefits package will be offered that is commensurate with experience. Please direct nominations/applications for this position to Provost Mary Sansalone at: Additional information on the University is available at:, or by email request.

The Economist June 26th 2010

Executive Focus

The Economist June 26th 2010



Executive Focus

Contribute to Congressional Decision-making … • Conduct studies on important economic and policy issues • Provide objective analysis for Congressional deliberations • Write testimony for Congressional committees • Help prepare economic forecasts The Congressional Budget Office (CBO), a small nonpartisan agency, provides economic, policy, and budgetary analysis to the Congress of the United States. CBO seeks experienced economists and policy analysts to work on complex issues in the fields of: • Macroeconomic Analysis • Financial Analysis and Policy • Tax Policy • Health Policy

• Labor and Income Security • Transportation • Energy Markets and Fossil Fuels • Climate and the Environment

Positions require a strong quantitative background, the ability to clearly present work orally and in writing to non-technical audiences, and a desire to work on policy issues of interest to the Congress. Visit for detailed information.

An Equal Opportunity Employer

The Economist June 26th 2010

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The Economist June 26th 2010



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Sponsorship sales executive Location: Frankfurt The Economist Group is the leading source of analysis on international business and world affairs. We deliver our information through a range of formats, from newspapers and magazines to conferences and electronic services. What ties us together is the objectivity of our opinion, the originality of our insight and our advocacy of economic and political freedom around the world. Our conferences division organises management and industry meetings, dinner forums, half-day forums, government roundtables and peer group forums in more than 50 countries. We are currently looking for a sponsorship sales executive to join the Economist Conferences team on a permanent basis. The sponsorship sales executive will be responsible for increasing event sponsorship revenue from northern and eastern Europe, selling Economist Conferences in Europe and worldwide. This will involve managing the entire sales process, from deďŹ ning and qualifying prospects to drawing up proposals, negotiating and closing deals. It will also mean working effectively with other functions within the European conference team and across The Economist Group. The successful candidate will have solid experience in selling event sponsorship programmes, and feel comfortable selling to senior decisionmakers in large multinational corporations. You will demonstrate familiarity with editorial processes and the ability to develop and maintain strong relationships with clients and partners. You will have strong written and verbal communication skills, and enjoy working in a fast-paced, teamoriented environment. Fluent German is essential, as is good spoken and written English. Other languages from northern or eastern Europe are a plus. If you would like to develop your skills and career with a leading global brand, then please send your CV (preferably by e-mail) with a covering letter along with details of your current salary to or by post to The Economist – Recruitment ofďŹ ce, Boulevard des Tranchees 16, 1206 Geneva, Switzerland. The closing date for applications is July 14th 2010. The Economist Group values diversity. We are committed to equal opportunities and creating an inclusive environment for all our employees. We welcome applicants regardless of ethnic origin, gender, religious beliefs, disability, sexual orientation or age.

The Economist June 26th 2010

Executive Focus


THE INSTITUTE OF INTERNATIONAL FINANCE The Institute of International Finance is the world’s largest global association of financial institutions with over 400 members in more than 70 countries. We provide economic analysis to our members on global macroeconomic and capital market developments, act as a vehicle for exchanging views on global supervisory and regulatory issues, and serve as a forum for engaging the private financial community in discussions with the public sector on emerging markets policy issues.

Chief Representative, IIF Representative Office, Beijing, China The Institute currently seeks a Chief Representative to be based in Beijing to manage the IIF Representative Office and to focus on member relations and regulatory policy developments in China and the region. Responsibilities will include developing and enhancing relationships with regional financial firms and with global financial firms with offices in the region. The Chief Representative will also focus on developing and enhancing relationships with global and regional regulatory bodies. Applicants should have at least 10 years’ professional experience in the financial services industry (banking, insurance, securities or their related associations). They should also have excellent academic credentials including a Masters or PhD in economics, finance, or an international discipline. Flexibility to cover varied subject-matters and work with persons from various disciplines is essential, as are excellent English speaking and writing skills. Travel will be required.

Senior Economist – Asia/Pacific The Senior Economist will be responsible for writing macroeconomic analytical reports on select emerging market countries primarily in East Asia based on information gathered through country visits, membership contacts and published statistical and information sources. He/she will also be expected to maintain databases of historical time series and forecasts for assigned countries, maintain and check databases for consistency, construct external financing and debt profiles, maintain real-time monthly data, and prepare final databases both for internal use and external circulation. Applicants should have a Masters or PhD in Int’l Economics and 5-7 years’ professional experience writing macroeconomic analytical reports, preferably focused on East Asia. Strong English writing skills are essential, along with sound quantitative, spreadsheet and database abilities. Regional language skills will be given preference. Travel will be required.

To apply for either of these positions, please email cover letter (with salary requirements) and resume in Microsoft Word format to For more information on the IIF, please visit

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New business: online fairs ■ ■

Sales director Sales executive

■ ■

Marketing and customer experience director Marketing and customer experience executive

The Economist Group is the leading source of analysis on international business and world affairs. We deliver our information through a range of formats, from newspapers and magazines to conferences and electronic services. What ties us together is the objectivity of our opinion, the originality of our insight and our advocacy of economic and political freedom around the world. We are establishing a new business to create online fairs that will bring sponsors and delegates together within fields that are relevant to our audience, such as business education. We have a record of success with similar events, and perceive significant commercial opportunity in using technology to extend and improve our current offering. We plan to launch this business soon, and are in the process of building an ambitious and dynamic team to help us realize our commercial ambition. We are currently recruiting four front-line roles, based in our New York City office, for this global business. If you are a self-starter, looking for a fast-paced, challenging work environment which rewards creativity, this is your opportunity. These roles all require strong understanding of, and comfort with, the online space, and the ability to work within an initially small team. Sales director The sales director will spearhead overall sales efforts and demonstrate to sponsors the value that our online fairs can deliver. The successful candidate will identify and pursue aggressive sales objectives, establish and manage the overall sales process and apply creative solutions to new business challenges. Minimum five years’ experience.

Sales executive This is an excellent opportunity for a sales professional looking to develop their career in the online space. Understanding and communicating our value proposition to clients, you will have direct responsibility for delivering on individual and business sales targets through introducing new sponsors and advertisers to our business, while maintaining existing relationships. Minimum two years’ experience.

Marketing and customer experience director The incumbent for this role will be an experienced direct marketer, who will principally manage our delegate acquisition and relationship strategy. Besides being responsible for delegates, the successful candidate will be in charge of meeting sponsors’ requirements, along with those of our technology partners, after sales have been made. Minimum five years’ experience.

Marketing and customer experience executive This is a superb career development opportunity for a marketer who will support acquisition activity for delegates and customer service for sponsors. The successful candidate will work across a broad range of business needs, including implementation of predominantly online delegate acquisition and communication programmes. Minimum two years’ experience. To apply for any of these roles, please e-mail When writing, please include a cover letter with your resume. The closing date for applications is July 31, 2010. The Economist Group values diversity. We are committed to equal opportunities and creating an inclusive environment for all our employees. We welcome applicants regardless of ethnic origin, gender, religious beliefs, disability, sexual orientation or age.

The Economist June 26th 2010

Brie ng Afghanistan

The Economist June 26th 2010 29

More than a one-man problem Kandahar

The ga es that cost General Stanley McChrystal his job are symptoms of far deeper troublea war that is being lost


VER since he took charge of 65,000 NATO troops in Afghanistan in June last year, General Stanley McChrystal had acquired a reputation for straight talk about the war. He gave reporters free access to meetings in which the bleak progress of the drive against the Taliban was bluntly discussed. Frank and open-minded, genuinely interested in alternative views, the general happily took the press into his condence. In Dand, for example, a dusty region on the southern outskirts of Kandahar, he recently exhorted his troops, in front of this correspondent, to tell him what they thought was wrong with their eort to secure Afghanistan, whether they thought it was doable. He minced no words in telling them what would cause us to lose. And in a long interview, not short of self-criticism and uncertainty, he issued a daunting to-do list by the end of the year for southern Afghanistan, the Taliban’s heartland. I think I’ll need to be able to say there’s clear progress, and in some places irreversible progress, in the Helmand river valley and hopefully Kandahar, he said. In other words: without convincingand improbableimprovements in security in

those areas, NATO’s current eorts may be more or less over by Christmas. Such candour was impressive, and an eective way of managing the press. But it blew back in General McChrystal’s face this week, with the release of a prole of the general in Rolling Stone magazine that seemed to include every unguarded sentence he, or his aides, might have uttered. Asked about Joe Biden, an opponent of the surge in NATO troops now under way with an extra 30,000 American troops being deployed to the south, including those in Dandthe general says: Are you asking about Vice-President Joe Biden? Who’s that? Of similar opposition from America’s ambassador in Kabul, Karl Eikenberry, to his review of NATO’s operations, General McChrystal says: Here’s one that covers his ank for the history books. Now if we fail, they can say ‘I told you so’. None of this is exactly surprising. That Mr Obama’s overcrowded team of senior advisers on Afghanistan have disagreed over what to do therein the absence of any obvious good optionis well known. In particular, many senior Americans, and also Europeans and South Asians, share General McChrystal’s aversion to the root-

less oce of Richard Holbrooke, America’s AfPak special envoy: Oh, not another email from Holbrooke. I don’t even want to open it, the general groans. Among their own, senior soldiers have always grumbled about their civilian masters. General McChrystal’s blunder was to put too much trust in Rolling Stone. Yet the article appeared shortly after American casualties in Afghanistan had passed 1,000 and when even close aides to General McChrystal had been expressing grave pessimism about their prospects in the nine-year war. Its eect was devastating. After issuing his sincerest apology for the piece and oering to resign, General McChrystal was summoned to Washington to see an angry Mr Obama on June 23rd. He was sacked and replaced by General David Petraeus, chief of the US Central Command. Shifts and successes Politically, the general probably had to go: leaving him in place would have been seen as weakness. General Petraeus, America’s most admired soldier, is also a formidable replacement, not least because of his greater clout in Washington. But in Afghanistan General McChrystal will be much missed. With support from Mr Obama, who inherited (and publicly embraced) a losing cause from his predecessor, General McChrystal rst rewrote the campaign plan. The eect was to rene the haphazard counter-insurgency eorts of his predecessors, who include Mr Eikenberry: for example, by replacing a forlorn 1

30 Brie ng Afghanistan

The Economist June 26th 2010

2 hope of controlling all Afghanistan with a

serious bid to secure the densely populated reaches of the south. This is still a daunting ambition. Kandahar and Helmand are the heartland of an insurgency that aects most of southern and eastern Afghanistan and an increasing portion of the north and west. A recent American survey of 120 insurgency-stricken districts (around a third of all districts) found that only a quarter of the population supported the government, and that over a third were sympathetic towards, or openly supported, the insurgents. To beat back the insurgency, the American troops now being deployed to the south will have to bring both security and a massive change of heart. This eort, concentrated in a summer oensive in Kandahar, is likely to determine the success of what is now General Petraeus’s mission. The coalitiona 46-nation mélange dominated by America, which will soon have 100,000 troops in Afghanistanis meanwhile killing as many Taliban leaders as it can. American, British and other special-force soldiers are conducting over a dozen operations a night for this purpose including one last month that accounted for Mullah Zergay, the Taliban shadow governor of Kandahar. This is part of a wider NATO eort to use violence more discriminately, in particular by limiting the aerial bombing that has killed hundreds of Afghan civilians. In the ten months to April NATO planes dropped 2,838 bombs, a 19% reduction on the previous ten months, despite an overall increase in ghting. Atrocities persist, for which General McChrystal issued extraordinary apologies. He also started punishing the culprits: last month six American ocers received career-blighting black marks over the killing of 23 civilians. In an escalating war, with insurgency-related violence up by 87% in the six months to March, NATO’s losses are also climbing. On June 7th-8th, 12 soldiers were killed, including ve Americans by a roadside bomb: the deadliest 24hour period this year. Change has been ordered from Washington, too. The cases of thousands of Afghan detainees have been reviewed, and over 200 released or handed over to Afghan custody. On the battleeld, American troops are also said to be making more conspicuous eorts to respect their enemies’ rights. In a well publicised assault in February on Marja, a Taliban-administered segment of the fertile and crowded Helmand river valley west of Kandahar, American troops took pains to get enemy wounded to hospital. Aid workers in Afghanistan, who have long been scornful of American blundering there, are full of praise for these measures. One senior gure describes the McChrystal makeover as a change in military culture. It has brought some overdue realism,

too. NATO’s main enemies, the Taliban and two other insurgent groups, both linked to al-Qaeda and led by former commanders of the anti-Soviet jihad, Gulbuddin Hekmatyar and Jalaluddin Haqqani, are based across the border in Pakistanin the city of Quetta, in Baluchistan, and the rugged tribal areas. This makes them virtually unbeatable: no counter-insurgency has been won against enemies enjoying such a sanctuary. NATO’s surge is therefore mostly designed to weaken the Taliban, the biggest group, suciently to allow the weak and corrupt government of President Hamid Karzai to start administering areas they now control. To stand half a chance, governance will have to be vastly improved. A parallel army of foreign trainers and consultants has therefore been set to this task, in a simultaneous civilian surge. As the government consolidates and the insurgency cools, NATO fancies, many jobbing insurgentsor $10-a-day Taliban, as it calls themwill accept inducements to stop ghting. In fact, there is little evidence that this describes many of NATO’s enemies, or that they will do any such thing. More reassuringly, Afghanistan’s army and police force, which have been long neglected but are now being trained at express pace, will soon take the eld in earnest. That, more or less, is the plan. And it had better start working soon. To placate domestic opponents of the war, chiey within his own party, Mr Obama has promised to start withdrawing American troops from Afghanistan in July 2011. Struggling in Helmand No one familiar with the complacency and drift that has characterised NATO’s eorts in Afghanistan can be unimpressed by this new sense of purpose. It represents the apogee of a decade of hard and often inglorious ghting by American troops, and a reorientation of the world’s most formidable war machine. But will it be sucient to avert defeat in Afghanistan? Probably not. There is almost no chance that Afghanistan will be transformed by the time of Mr

Obama’s deadline. The insurgency is too robust. The government is too weak. Too much time has been lost. According to a senior NATO ocial, it takes on average 13 years to win a counter-insurgency campaign; and this campaign is, in eect, in year two. In fact, the campaign’s mismanagement has done great damage: a congressional report on $2 billion of NATO contracts in Afghanistan, details of which were leaked this week, describes a hideous new maa of politically connected warlords, enriched by contracts to protect the NATO convoys which some also allegedly attack. If General McChrystal’s plan is to be given a fair trial, the promised American withdrawal will therefore have to be remarkably gradual. Indeed, the expected withdrawal of 4,500 Dutch and Canadian troops over the next year will leave more gaps for Americans to ll. But Mr Obama, as General McChrystal noted, will be hardpressed to sanction this unless there is a signicant success for his plan. So far, not much is evident. Bits of Helmand, where a vicious micro-conict is fuelled by tribal rivalries and drug rackets, have been somewhat calmed since the arrival of 20,000 American troops last year to bail out 8,000 badly overstretched Brits. As evidence of progress in Lashkar Gah, the provincial capital, Britain’s ambassador, William Patey, says that on a (thickly guarded) walk through the town’s bazaar, two-thirds of the locals were prepared to shake his hand. Perhaps more telling is that one-third refused, in a province where nearly 300 British troops have lost their lives. There is even less good news in nearby Marja. Before launching an airborne assault there in February, General McChrystal earmarked it as a testing-ground for his strategy. Once security was established there, he predicted, a government-in-abox could be swiftly unpacked in the town, delighting its 60,000 inhabitants. But American forces in Marja are now under nightly attack, locals have been beheaded by the Taliban for co-operating with them, and there is little government in evidence. Given the town’s recent history, the transformation was always unlikely. If in fact it reeked of desperation, the Taliban could smell it. This has put enormous pressure on NATO’s plans for Kandahar, Afghanistan’s second-biggest city and the former seat of Mullah Omar, the Taliban leader. It is a violent place. The militants are considered to have freedom to operate in four of its ten parishes. They control much of Panjwayi, Zhari and Arghandab, three neighbouring districts, and have a strong inuence in Dand, between Kandahar and Quetta. In response to NATO’s push, the insurgents have announced a fresh oensive of their own. The assassination of around 30 aid 1

The Economist June 26th 2010 2 workers and ocials in Kandahar in recent

weeks may be a sign of this; pro-government local strongmen are also alleged to be involved. On June 9th a bomb-blast at a wedding-party in Arghandab killed 40 people, including many members of an American-raised local-defence militia. The district’s American-befriended governor was murdered shortly afterwards. Kandahar is mostly in government handsbut what hands they are. Ahmed Wali Karzai, the president’s half-brother, is the city’s main power-broker. He stands accused of running a maa-style empire of illegal and legal businesses, backed by government and NATO patronage, enforced by violence, and including drug-tracking, construction and private security. He denies these allegations, for which there appears to be no hard evidence. He is also alleged to have made millions of dollars from foreign contracts, some of them allegedly through a militia, Kandahar Strike Force, which works for the CIA. In 2009 its gunmen also murdered Kandahar’s police chief. Rightly or not, many Kandaharis believe the main representative of the law in Kandahar is above it. At the least, the power and money that ows from Ahmed Wali to members of his small Popalzai tribe have exacerbated local jealousies. Warlord-contractors To improve security in and around Kandahar, NATO is now deploying an additional 10,000 American troops there, including those already in Dand. In Panjwayi and Zhari this will involve a battlesometime after mid-September, when the leaves wither on the grape-vines where insurgents hide. With its slow progress in Marja in mind, however, NATO’s main focus is on improving Kandahar’s government. Even setting aside its alleged robber baron, this will be tough. The city’s police are

The men NATO needs, alas

Brie ng Afghanistan 31 largely untrained and corrupt, only eight of 120 stipulated judges are doing their jobs, and mains electricity and water are, for many Kandaharis, a rare treat. Even gauging what sort of progress Kandaharis want is not easy. Opinion polls in Afghanistan unsurprisingly point to Afghan unhappiness with insecurity, corruption and lack of economic opportunity. But nobody knows the degree to which these things drive them to the Taliban, or what sort of progress might win them to the government. Asked what NATO really understands about Afghan wants and fears, a senior adviser to General McChrystal says: I think we know we don’t know much, though it’s not for lack of trying. Random straw-polling of southern Afghans invariably shows little support for NATO’s coming oensiveand a good deal of suspicion about what, after all these years, the foreigners are really up to in Afghanistan. Sometimes the foreign forces come to our village and sometimes the Taliban. It’s a terrible situation. Both sides are creating problems for us and both suspect us, says Muhammad Khan, one of four turbaned farmers of Zhari gathered in a guesthouse in Kandahar. Two houses of his, he claims, were destroyed by NATO bombing, and he has received none of the compensation he was promised. If they really want to push the Taliban out of area, they can easily do soafter all, in 2001 they occupied the whole country, he says of the Western forces. We think they are not sincere, they don’t want to beat the Taliban at all. But in case they are sincere, Mr Karim oered this advice. Corruption is why people are turning to the Taliban. If thousands of [NATO] operations are carried out it will make no dierence so long as these corrupt ocials are in place. Western ocials have been badmouthing Ahmed Wali for years. This has

merely annoyed Mr Karzai, for whom his half-brother allegedly did valuable voterigging service in last year’s rotten presidential poll. With parliamentary elections due in September, Ahmed Wali remains a crucial placeman. NATO’s best hope is therefore to sideline him, partly by starving him, and other parvenu warlords, of some of their fat contracts. At a meeting in Kandahar to discuss the unwanted eects of NATO contracts, General McChrystal was informed that 570 of them, worth millions of dollars, had been issued from NATO’s airbase in Kandahar, and nobody was quite sure to whom. The general consoled his aides: We were in a hurry, we were ignorant, we created a business environment, and now it’s come back to hurt us. Yet it seems improbable that NATO, now in more of a hurry than ever, can x this mess. Private security companies now play a big role in this war. They are estimated to employ around 50,000 gunmen. In Kandahar there are 23 unregistered security companies, not including militias working with American specialforces soldiers and the CIA. In the short termon which NATO is being judged cutting o the cash to these mobs would lead to yet more insecurity. The abandoned turbine In these circumstances, turning Kandahar round can seem less like a plan than an aspiration. And there is more than a whi of unreality to NATO’s chief development proposal: to splurge over $200m on three vast diesel generators. America’s State Department has opposed the scheme, arguing that it would be unsustainable for a government that raises only $1.2 billion in taxes and taris. And a big hydropower plant at the nearby Kajaki dam should be able to light up Kandahar for a fraction of the cost. Alas, the turbine dispatched for this purpose, in an operation involving 5,000 British troops, still lies in the Kajaki dirt, the Taliban having made it impossible to truck in cement to install it. In approving the generator proposal, General McChrystal told his sta: While I think Kajaki is critical for a long-term solution, there ain’t no long-term if we don’t win short-term. The situation is grim. To stand even a moderate chance of success, General McChrystal’s counter-insurgency strategy would require more time than American and European governments are prepared to give it. Instead, NATO countries, perhaps including a reluctant America, are increasingly concluding that there will have to be a negotiated end to the war. But the Taliban are in no rush to talk. Their position is strong. Perhaps the best that can be hoped for NATO’s current operations is to weaken the militants suciently to bring them to the table. That near-impossible task now falls to the impressive, persistent, but human General Petraeus. 7

The Economist June 26th 2010 33

United States

Also in this section 34 Peter Orszag to quit 34 The housing market 35 California’s public-sector pensions 36 Trade with Mexico 36 Tackling homelessness 37 Immigration law 37 Divorce in New York 38 Lexington: Kicking the general’s ass

For daily analysis and debate on America, visit

Health care

The appeal of repeal NEW YORK

Republican e orts to undermine Barack Obama’s health reforms are intensifying


HE longer you look at it, the worse it smells. That is how Mitch Daniels, the governor of Indiana, recently described America’s new health-reform law to an audience in Washington, DC. His opinion matters, and not just because he is a likely Republican contender for the presidential race in 2012. His words threw petrol on a bonre, since a growing chorus of conservatives is now clamouring for the outright repeal of Obamacare. Of course, Republican leaders in Congress have long detested the new law. Since its passage in March various billsincluding a new one this month from Utah’s Senator Orrin Hatch, the American Liberty Restoration Acthave been introduced in both chambers with the aim of overturning the legislation. More than 20 states have also joined lawsuits that challenge the law’s individual mandate, the requirement that everyone should buy health insurance, as unconstitutional. Grass-roots opposition to health reform has been strong too. The tea-party movement has been pushing conservative candidates to sign up to its goal of repealing the president’s bill. Heritage Action For America, a lobbying group allied with the Heritage Foundation, a conservative thinktank, wants to foment similar unrest at the grass tops level of politics. Now, however, there are two new prongs to the attack, broadening the assault beyond the right. Many states are

complaining about the costs of the new law’s provisions. And businesses are grousing that the administration is breaking its promises that existing employerprovided health coverage would be exempted from the onerous requirements being imposed on new health plans. The gathering backlash Confronted by severe budget crunches because of the recession, many governors are complaining that they cannot aord to meet current obligations to fund Medicaid, the state/federal health scheme for the poornever mind the increased contributions that will come in under the law after 2014. Mr Daniels, for example, claims that the new legislation will increase his state’s health spending by as much as $3.6 billion by 2020, a lot for a state whose entire budget is only $13 billion a year. Other Republican governors are making similar claims. If true, this would be scal insanity. A recent study by the Urban Institute, an independent think-tank that closely tracks state spending on Medicaid, reckons that this number might be too high. The biggest component of that big increase in his budget, according to Mr Daniels, will be the expansion of Medicaid required by the new law. He reckons this will cost Indiana $972m-$1.3 billion in this decade. But John Holahan of the Urban Institute reckons it is more likely to cost the state only $478m$899m. And at the same time an astound-

ing $8.5 billion-$10.1 billion in federal funding will be available for providing health care for the state’s poor: so surely, on any non-partisan reckoning, this is an investment worth making by a state. Slightly dodgy numbers can still fuel a deadly backlash, though, as the second political fuss, over grandfathering, attests. Time and again as he battled for his bill, Mr Obama promised voters that If you like your plan, you can keep it. His words were meant to reassure people who worried that his reforms would scupper the coverage they got through employers. The Obama administration recently rearmed this pledge; but it warned that the grandfathering protection accorded to existing plans will no longer apply if companies switch insurance providers or signicantly change the terms or the cost of coverage. That has provided Republicans with an opening: they claim that Mr Obama intends to gut private health coverage by closing down the supposedly grandfathered schemes on technicalities. Then, rather than sign up for intrusively regulated insurance schemes, rms will prefer to pay a ne and leave their employees to buy insurance from new state-run insurance exchanges that are to be set up under the bill’s provisions. But it may not be quite fair to blame the administration. Companies are constantly switching providers, increasing co-payments, reducing benets and so on in an eort to cope with health-cost ination (which PricewaterhouseCoopers estimates will be a striking 9% next year). Independent of the new law, companies were anyway going to abandon many of those grandfathered plans to take up less generous ones. And there is little evidence of ight from employer-provided insurance in Massachusetts, which has already implemented reforms which are broadly sim- 1

The Economist June 26th 2010

34 United States 2 ilar to the national eort.

Having been caught on the back foot at rst, it now appears that the White House is ready for a counter-attack. Ocials now regularly berate insurers, a sure-re way to win populist points. On June 22nd, the three-month anniversary of the reform’s passage, a deant Mr Obama held a ceremony at which he declared: We’re not going back. It is rumoured that allies of the president are planning a $125m public-relations blitz in support of the reform. The charm oensive may not be enough to quell the backlash. Health reform still does not command much popular support mostly because its costs are front-loaded, while most of the benets will not come for years. Even some Democrats (such as the scally conservative Blue Dog coalition of congressmen) see Obamacare as a millstone around their necks. So might the backlash lead to outright repeal? On balance, that seems highly unlikely. Even if Republicans were to regain both the House of Representatives and the Senate this November, nobody thinks they will come close to holding enough seats to override a presidential veto. The more likely outcome is that Republicans will bludgeon Democrats with the issue during this autumn’s campaigns, then noisily demand revisions to the most contentious aspects of the health-reform law if they reclaim one or both chambers of Congress. The ght goes on. 7

Peter Orszag to quit

Budget blues Washington, dc

Exit a clever but disappointed man


ITH the recession over and healthcare reform passed, the rst round of sta-shuing in Barack Obama’s White House has begun. Among the rst to leave, it seems, will be Peter Orszag, head of the Oce of Management and Budget. A former head of the Congressional Budget Ofce (CBO), a wonk’s wonk and yet also a bit of a playboy, Mr Orszag has been a central member of Mr Obama’s economicpolicy team. An ocial departure date has not yet been set, but Mr Orszag is likely to leave by July. His tenure has been short, though not remarkably so. Both George Bush junior and Bill Clinton got through four budget directors apiece during their time in oce. Mr Orszag is also planning to get married in the autumn. And his time in the White House, which spanned a major economic crisis and an epic battle over health reform, has certainly been action-packed.

You’re on your own, says Orszag It has also been bittersweet. A doughty warrior against decit spending during his years at the CBO, Mr Orszag came to the White House hoping to stem the ow of red ink. The recession frustrated that eort, and Mr Orszag instead ended up helping design the $787 billion stimulus package passed last year. The administration’s draft for the 2011budget attempts to chip away at the federal decit, but substantial cuts have proved politically and economically impossible because the recovery is so weak. At the end of last year Mr Orszag was said to have clashed with Larry Summers, who heads the president’s National Economic Council, over just when the scal consolidation should start. The dispute arose after Mr Orszag asked cabinet agencies to prepare two budgets one with the administration’s requested spending freeze, and one which would cut spending by 5%, which is much closer to what will probably be needed. Most disappointing was the battle over health reform. In his CBO years Mr Orszag used to argue passionately that getting health-care costs under control was essential if America’s vast decits and debt were ever to be controlled. But although he was a key gure in getting this year’s health legislation passed, the nal bill fell far short of his goals. Congress was able to extend health-insurance coverage to almost everyone and to eliminate some of the system’s inequities, but it balked at measures designed to hold down costs over the long term. As Mr Orszag prepares to depart, rising spending on Medicare and Medicaid remains the biggest contributor to longrun growth in the federal debt, just as he warned of long ago. Mr Orszag’s successor is unlikely to have an easier time of things. The House of Representatives may not even pass a budget resolution this year, for the rst time since such resolutions were introduced in 1974. Arguments over the economy have made legislators reluctant to endorse ei-

ther new stimulus or decit reduction before the mid-term elections in November. And matters are unlikely to improve much next year. Democratic majorities are likely to shrink or even vanish, increasing the deadlock on Capitol Hill. Eventually, though, tough decisions will have to be made, and that is not something Washington does well. Just ask Mr Orszag. 7

The housing market

Double-dip drama Washington, dc

Feeble gures fuel fears


ORE than the European debt crisis is keeping American economic policymakers awake at night just now. Despite a year of government eort, a tentative recovery in the housing market appears to be on the verge of stalling. Home prices have now fallen for the past six months, according to the CaseShiller home-price index, after rising from their nadir for the ve months before that. (Another index, from the Federal Housing Finance Agency, has, however, shown a slight uptick in March and April.) As for sales volumes, last September home sales soared in anticipation of the planned expiry of a government housing-tax credit, only to tumble thereafter, despite the extension of the deadline to April this year. As the new deadline approached sales duly climbed again. But the latest data show that even before the credit window closed, fewer sales were going through (see chart on next page). Sales of new homes fell 33% from April to May, nearly the worst performance since the bust began. It is not as if the government has not tried. After the housing crash, millions of homeowners a full quarter of those with 1

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The Economist June 26th 2010

United States 35

2 mortgageshad loans larger than the value

of their homes. Barack Obama hoped to prevent defaults with a plan designed to encourage banks to renance the mortgages of those unable to pay. On the demand side, the Federal Reserve held down mortgage rates by buying up mortgagebacked securities, while Congress oered a generous tax credit to qualifying buyers. These programmes have not worked as well as had been hoped. Aordability is no longer the driving factor behind foreclosures; borrowers who took on more debt than they could handle defaulted on their loans long ago. Instead, the problem is negative equity. A borrower deeply underwater on his mortgage may have no choice but to default if he loses his job, since a sale would entail a huge loss. And a growing number of underwater borrowers are opting simply to walk away from mortgages that they can in fact aord. Banks are balking at rewriting mortgages, despite incentives to do so. Too often borrowers default later on. The latest data on the government’s programme show that 400,000 loans have been renegotiatedfar less than the goal of 3m-4m. Neither have government incentives to buy houses helped much. Credits may have done little more than move sales around. The steady drumbeat of foreclosures has continued; they have been running at a rate of over 300,000 lings a month for the past 15 months. By some estimates, it will take more than eight years of normal sales to clear the stock of houses now held by banks. This overhang holds down prices, meaning that the road out of negative equity is a long one. Yet policy failures can be blamed only so much. A new report from Harvard University’s Joint Centre for Housing Studies notes that, historically, sustained housing recoveries are far more dependent on job growth than on factors like the level of interest rates. So May’s disappointing jobs gures, showing that the private sector added just 41,000 workers, was doubly bad news. With nearly 15m Americans still out of work, a real turnaround could be a long time coming. 7

Unsafe as houses Home prices and existing home sales S&P/Case-Shiller home-price index*, January 2007=100

Existing home sales, annualised rate, m












2 2007


Sources: Standard & Poor’s; National Association of Realtors



*20-city composite

California’s public-sector pensions

Sanity in the o ng? Los Angeles

A deal with four unions is a good start


ALIFORNIA’S lame-duck governor, Arnold Schwarzenegger, has just scored a big victory. On June 16th he struck a tentative agreement with four public-sector unions, representing 23,000 of the state’s 170,000 unionised state workers, over future pension benets. If conrmed, the deal would require newly hired public employees such as reghters and trac police to contribute more of their own salaries, and retire later, to collect their pensions. The savings would be small. But there is a chance that California’s other unions will follow with similar deals. If they do, the eect would be historic. This is because it would begin the undoing of a policy disaster dating back to 1999. That was when the Democratic legislature and the then governor, Gray Davis, a Democrat elected with union support, thanked the unions by giving state workers pension increases of between 20% and 50%. Many highway-patrol ocers, for example, were allowed to retire at 50 with 90% of their nal salary. All told, California now has probably the most generous public-sector benets in the country. That, however, is not what outrages Mr Schwarzenegger, a Republican, or his brainy economic adviser David Crane, a Democrat. Rather, it is that the pension plansabove all the California Public Employees’ Retirement System (CalPERS), the largest such scheme in Americapretended that this generosity would not cost anything. In 1999 the dotcom bubble was still inating, and the plans’ actuaries predicted that their retirement funds would gain enough value to pay the increased pensions. By implication, they assumed that the Dow Jones Industrial Average would reach 25,000 in 2009 and 28m in 2099. It is currently at around 10,300. A few years ago Mr Crane tried, as a board member of the teachers’ pension plan (CalSTERS), to make the assumptions more sane. His fellow Democrats voted him o the board. But since then the stockmarket has fallen sharply and California has tipped into budget crisis, exacerbated by the additional contributions that taxpayers are obliged to make to top up the public-sector pension funds. On the same day that Mr Schwarzenegger struck his deal with the unions, for instance, CalPERS ordered the state to increase its annual pension payment to almost $4 billion. Two studies estimate California’s unfunded pension liability at

The wages of age California General Fund retirement programme costs $bn


State retiree health & dental programmes

CalPERS retirement programmes



6 5 4 3 2 1 0

1999 2001






Fiscal years ending June 30th Source: Legislative Analyst’s Office


about half a trillion dollars, almost seven times its ocial debt. Even some Democrats are starting to complain. Bill Lockyer, the state treasurer, is one. He warned the legislature that public-sector pensions will bankrupt the state and pointedly wondered whether the Democrats before him could x the problem because of who elected you. Voters are getting angry. Many nd it ironic that those Democrats who are wailing loudest over cuts to schools, universities and health care include people who voted for the pensions that are now crowding out those very programmes. Most private-sector employees have dened-contribution plans, which determine how much employers and employees pay in but not how much pensioners will get out, and which have shrivelled with the stockmarket since 2008. They do not understand why they should now pay to maintain the more generous dened-benet pensions of public-sector employees. To Adam Summers of the Reason Foundation, a think-tank in Los Angeles, the solution is clear. Publicsector pensions for new employees must become dened-contribution plans, as in the private sector. That may be asking more than is politically feasible. Mr Schwarzenegger is hoping merely to roll back public pensions to the formulas in use before 1999. Many union members are promising a ght. Worse, it is an election year. Neither the Democrat nor the Republican running to succeed the governor has dared oer specics about California’s budget or pensions mess. And the unions are preparing to spend oodles of money on the race. 7

The Economist June 26th 2010

36 United States Trade with Mexico

Signs of life SAN ANTONIO

Something cheery from the border


EWS about the relationship between Mexico and the United States has been mostly dismal of late. Every day brings reports of new murders in Mexico and new are-ups over border security. But in one respect, at least, things are looking up. According to the Bureau of Transportation Statistics, surface-transport trade between the two countries was $27.8 billion in March of this yearup nearly $8 billion from March 2009, and nearly as high as it has ever been. Roberto Coronado, an economist with the Federal Reserve based in El Paso, says that much of the growth is due to increased industrial production in America, particularly of cars. In the face of recession many manufacturers chose to cut their output, and Mexico’s maquiladora industry, a large part of which is devoted to making car parts, faltered as a result. As condence returned, the orders resumed. Without that surge, Mr Coronado notes, America’s GDP growth over the past several quarters would have been much smaller. It is a welcome sign of life for both sides. True, the eects of the North American Free Trade Agreement (NAFTA) have been hard to assess. But in south Texas and San Antonio, one of the cities where NAFTA was signed, there is no doubt that it has helped growth. A 2009 study from the SABER Research Institute, based at St Mary’s University in San Antonio, found that trade ows in south Texas increased almost 160% between 1994 and 2007 as a re-

Let the good times roll

sult of NAFTA. For Mexico the recovery is not just good for business. America’s downturn has hurt Mexico’s economy. It may also have made the place more dangerous. During the good years thousands of people from the interior of Mexico migrated to sprawling border cities like Juárez, looking for comparatively good jobs in the bustling factories. Ocials on both sides of the border, including Hillary Clinton, America’s secretary of state, have been worrying that a surge in unemployment has made it easier for the drug cartels to nd new helpers. Tensions persist. One has to do with trucks. When NAFTA went into eect in 1995, the United States and Mexico agreed on a provision to allow lorries freely to cross the border. The present system, with cargo unloaded on one side of the border and reloaded on to dierent trucks on the other, is inecient. But America quickly reneged. Unions opposed the provision as a threat to American labour, and environmentalists worried that Mexican trucks were not up to American standards. In 2007 George Bush announced a pilot programme to allow up to 100 Mexican trucking companies to trundle through the United States, and vice versa. Last year Barack Obama said he would cancel the programme. A frustrated Mexico then announced taris on an idiosyncratic list of 89 American products: 20% on Christmas trees, 45% on grapes, and so on. These added up to more than $2 billion in imports. Trucking remains contentious. Mr Obama has told the Mexican president, Felipe Calderón, that he will deal with it. But the administration wants to see more trade move to rail and sea and o the roads. And when the presidents meet they tend to be occupied with more pressing matters of border security stemming from Mexico’s drug war. Now they have at least one happier subject to talk about. 7

Tackling homelessness

Getting strategic new york

A national plan to end a national disgrace


T USED to be the case that the homeless were, almost exclusively, single adults. Today homelessness is aecting a growing share of families with children too. The number of homeless families has increased by 30% during the past two years. During the 2008-09 school year, America’s public schools reported more than 956,000 homeless pupils, a 20% increase over the previous school year. In New York City alone, some 8,200 families with children are homeless. Overall, the number without homes is staggering. The number of homeless veterans of the Vietnam war is greater than the number who died in it. On any given night in America more than 640,000 men, women and children are forced to seek shelter, live in their cars, or sleep on the streets. Last year nearly 1.6m people used an emergency shelter. The Obama administration unveiled a multi-agency national strategy to combat this national disgrace on June 22nd. The plan has four goals. It aims to end chronic homelessness (dened as being continuously homeless for more than a year) in ve years, and homelessness among veterans in ve years, too. It also seeks to end homelessness for families and children within a decade. And it will lay down a strategy for tackling all other types of homelessness as well. The 67-page plan, called Opening Doors, is the rst comprehensive federal eort to end the evil, which is normally a matter for the states. This is a tragedy we can solve says Shaun Donovan, secretary of housing and urban development and chair of the Inter-agency Council on Homelessness, which drew up the plan. Much of the progress made in battling homelessnesschronic homelessness has fallen by a third in the past ve yearshas been at local level. The new plan hopes to take what is working best in cities and counties and apply it nationwide. Expanding the supply of aordable housing would be a good rst step. According to the National Low Income Housing Coalition, there is a shortage of 3.1m lowcost rental units. Collaborative eorts at the state and local level, along with partnerships with private and non-prot groups, have reduced homelessness in places like Chicago by as much as 12%. Getting federal agencies to work together has helped to take veterans o the streets and obtain health benets for them. A multi- 1

The Economist June 26th 2010 2 agency eort that combines housing with

social-services support is essential, according to Mr Donovan, and results in fewer hospitalisations, fewer costly ambulance and police call-outs and fewer days behind bars. It will save money for taxpayers, too. Barack Obama seems determined to do something about homelessness. Last year’s stimulus package included $1.5 billion to prevent it. He also signed the HEARTH Act, which strives to rehouse rapidly those who lost their homes. The Reverend Glenn Chalmers, of the Holy Apostles soup kitchen in New York, is glad that the federal government has nally taken the lead on this issue. Perhaps because the queues for food begin early every morning outside his church and are as much part of the urban landscape as the skyscrapers, he remains a little sceptical. 7

Immigration law

Our town Fremont, Nebraska

A small city passes a controversial immigration ordinance


OME of the earliest settlers of Nebraska were Germans. During the rst world war the state forbade any teaching in their native language. But that was long ago. These days, just outside the tidy little city of Fremont, a new batch of residents is trying to settle in. The Regency II trailer park houses immigrants, mostly from Mexico. Many of the trailers are just imsy boxes. Others are painted brightly, or sport day lilies on a small lawn. One house has an American ag beside it. And on June 21st the Regency displayed a white sign at its entrance with the message: Vote No . That day Fremont voted yes to a new ordinance that aims to rid the town of illegal immigrants. It is the latest place to try to solve immigration problems on its own. This is our town, declares Jerry Hart, a retired worker for the Internal Revenue Service and one of the ordinance’s main advocates. Nobody is going to take care of us but us. Fremont is far from the heat of the border. But in recent decades farm states like Nebraska have seen a slow ebbing of their population and the inux of two new sorts of people. Slaughterhouses have moved from the cities to places where land is cheap and unions less pesky. Immigrants, seeking jobs, have followed. In 2007 foreign-born residents made up 5.6% of Nebraska’s population, triple the share of 1990. This has led to small are-upsa school overwhelmed by Spanish-speaking pupils, for exampleand big ones, such as clashes in 2008 between Hispanic and

United States 37 Divorce in New York

Let them unwed new york

Breaking up is a bit less hard to do


HANA and Simon Taub battled in the courts for years. Unlike every other state in the union, New York does not allow a fast, blameless divorce. Irreconcilable dierences or we grew apart won’t y; adultery, abandonment, or cruel and inhumane treatment must instead be proved. Mr Taub denied his wife’s claims of abuse. Both refused to leave their Brooklyn home; so a courtordered dividing wall split their living quarters. And the Taubs are hardly alone. Rudy Giuliani, a former presidential candidate and former mayor of New York, famously feuded for months with his ex-wife over who was cruel and inhumane. Both couples might have beneted from a new bill that has just been passed by New York’s state Senate. If the bill is also passed by the Assembly, New York will at last join the other 49 states in allowing people to divorce speedily without the consent of their spouse or a proof of fault. This worries Raoul Felder, a celebrity lawyer known to the gossip columns as Dr Estranged Love and the Duke of Divorce . He thinks that divorce rates will rise and that the only beneciaries of the change will

Somali meatpackers. In Fremont, as in many other such towns, the Hispanic population has surged. Between 2000 and 2008 the Hispanic share of Fremont’s population grew from 4.3% to 7.8%. Meanwhile Fremont’s white population dipped. Les Leech, Fremont Beef’s president, says that his company would have struggled without immigrants. I didn’t need cheap labour. I

be his fellow legal eagles. He is partly right. According to a 2007 paper by Justin Wolfers at the Wharton School, divorce rates rose sharply after other states adopted no-fault divorce, but this trend reversed within a decade. Indeed, Mr Wolfers found that 15 years after the reform, the divorce rate is lower. The New York State chapter of the National Organisation for Women (NOW) and the Catholic church for once agree; they are both vehemently opposed to the new measure. NOW fears the change will leave women unprotected. Liz Krueger, a state senator who cosponsored the bill, disagrees. The research shows female suicide and domestic violence fell in states that adopted no-fault divorce laws, she said. Ms Krueger had to move to Ohio to get her own divorce. Even judges are fed up with the outdated process, not to mention all the judicial time it wastes. New York’s divorce law is in the dark ages , lamented one law-school professor, but it is not the only antiquated law on the books. Adultery, for instance, is still a class B misdemeanour. needed labour, he explains. Not everyone has been encouraged by the change. The vote on June 21st followed more than two years of rancour. A city councilman proposed the ordinance in 2008, demanding that the city should evaluate the legal status of all renters and force businesses to check workers’ documents with a federal database, E-Verify. (The language was drafted by the same lawyer who helped craft Arizona’s recent anti-immigrant law.) After a failed council vote, a petition drive and a legal brawl to stop the referendum, in April Nebraska’s Supreme Court ruled that a vote should proceed. It was approved by 57% to 43%. It is unclear how the new law will curb illegal immigration. Hormel and Fremont Beef, the big local meatpackers, already use E-Verify. The plants themselves are outside city limits, as are trailer parks such as the Regency. You’ve got to start somewhere, insists Mr Hart. The most likely result, however, is further strife. Susana Patino, a HispanicAmerican born in Texas, works at a local tool-and-dye business. Her husband, born in Mexico, has been promoted at Hormel. But she worries about her family and friends. It’s stupid, crazy, she says, bewildered. We helped Fremont to grow. 7

The Economist June 26th 2010

38 United States

Lexington Kicking the general’s ass The McChrystal a air has revived doubts about Barack Obama’s qualities as a war president


EORGE McGOVERN ew 35 bombing raids over Nazi-occupied Europe during the second world war and received the Distinguished Flying Cross for bravery; but in the election of 1972 he lost 49 states. John Kerry received three Purple Hearts for service in Vietnam; but lost in 2004 to George Bush, who had spent the war safely at home in the Texan Air National Guard. For one reason or another, no matter how glorious their records, Democrats have often found it hard to persuade voters that they can make good war presidents. Will the disarray in Barack Obama’s Afghan strategy this week restore the old idea the Democrats are not to be trusted with national security? Mr Obama would be the rst to admit that it took a certain audacity for a former community organiser to run against an authentic Republican war hero in 2008, when America was at war on two fronts. Three things helped him neutralise John McCain’s military expertise. The rst was that many Americans thought the former community organiser had got it right by opposing the invasion of Iraq. The second was that by polling day the economy replaced both wars as the paramount concern of most voters. The last was that Mr Obama was careful to avoid giving the impression that this particular Democrat was some sort of cooing dove. He would ghtbut he would ght the good war in Afghanistan, not the misbegotten one in Iraq. Since becoming president Mr Obama has indeed taken his role as a warrior seriously. He was criticised on the campaign trail for suggesting that he would bomb al-Qaeda inside Pakistan but has sent the CIA’s drones to do just that, with murderous eect. To ensure continuity in national security and protect a vulnerable political ank, he asked Robert Gates, Mr Bush’s defence secretary, to stay in his job. He let Mr Gates replace the stolid General David McKiernan in Afghanistan with the piratical master of black ops, Stanley McChrystal. In the latter part of 2009, after weeks of intensive discussion, Mr Obama reset the Afghan strategy and decided to send an additional 30,000 troops, pushing the American total to around 100,000. And just in case his message of martial resolve was failing to get through, he used his acceptance speech for his Nobel Peace Prize last December to explain to some startled Scandinavian peaceniks why some wars, such as the one against al-Qaeda, were just and necessary.

All in all, Mr Obama has not shrunk from war and has waged it in a characteristically methodical way. But an old military saw holds that no plan survives contact with the enemy. However methodical his planning, the war has gone badly. If voters had not been paying much attention lately, that is only because they have been transxed by other things that have refused to go to plan, such as job creation and eorts to stop the oil gushing into the Gulf of Mexico. In recent weeks the media have ayed the president for failing to get a handle on the spill. Foes have mocked the counterfeit machismo of his promise to kick ass. So it may have been the timing of the McChrystal affair that made him feel he had to insist on the resignation of the egregious general. Mr Obama had to show that he could be decisive, and has done so, but he will pay a political price. Some of his foes will no doubt say that Mr Obama has put the amour propre of the White House above the successful prosecution of the war, though the choice of the hero of Iraq, David Petraeus, to replace General McChrystal will largely allay that fear. But the real failing exposed by the McChrystal asco is that the senior members of the president’s national-security team are at sixes and sevens and that he has allowed them to stay that way for a while. It has, accordingly, not taken long for this week’s events to revive the question of whether the Democrats can handle the armed forces as well as the Republicans. Les Gelb, a veteran journalist and former Pentagon ocial, suggests that the generals have more faith in Republican politicians to issue clear orders and stay the course when wars turn sour. An outcry on the left as well That is a harsh judgment to pass on a president who so far has adhered steadfastly to his doctrine that Afghanistan is a necessary war from which America cannot retreat. Indeed, many Democrats on the liberal wing of the president’s party think it is they who have the bigger cause for complaint. Some say that the war is unwinnable and that he should not have reinforced it. Memories of how Vietnam spiked Lyndon Johnson’s dreams of a Great Society haunt party elders. Younger Democrats complain that Mr Obama panders to his generals: he has not fullled his pledge to close Guantánamo, and for fear of the resistance the services mounted against Bill Clinton he has moved at a glacial pace to redeem his promise to let gays serve openly in the military. Mr Obama, it seems, wants it both ways. That is understandable. Like Johnson before him, he is torn between his desire to build a liberal America at home and his need to ght an old-fashioned war abroad. He wants to succeed in Afghanistan but senses the limits of what America can achieve there. He would like the courage of his convictions but also a second term. To square these wants he may therefore have been a bit too clever for his own good. The great review last autumn produced a plan that both ramped up the war in a hurry and, with an eye on the 2012 election, set a date of July 2011 to begin to wind it down as well. The aim was to give the generals a chance to make progress and himself a chance to extract the forces if the generals failed. It is ingeniousfar more so than the refusal of Mr Bush to believe the experts who told him the Iraq war was lost. But winning a war can require a single-minded will as well as a subtle brain. Mr Obama has the latter; whether he has the stubbornness to stick to an unpopular war remains to be seen. 7

The Economist June 26th 2010 39

The Americas

Also in this section 40 Progress in the war on drugs 40 Maternal health in Mexico

For daily analysis and debate on the Americas, visit

Colombia’s presidential election

Too much continuity? bogotá

Juan Manuel Santos (pictured) was elected as the heir to a popular incumbent. His hardest task will be correcting Álvaro Uribe’s excesses


HERE were no surprises this time. In the rst round of Colombia’s presidential election on May 30th, Juan Manuel Santos, the former defence minister of the current president, Álvaro Uribe, took 47% of the vote making fools of opinion pollsters who had him tied with Antanas Mockus, who got just 22%. The run-o on June 20th duly turned into a formality: Mr Santos won 69% of the vote and will have a strong mandate once he becomes president on August 7th. Mr Santos campaigned as the next-best thing to his popular predecessor, who was blocked by the constitution from running for a third term. In eight years, Mr Uribe transformed Colombia from a nearly failed state into a safer and more prosperous country. He crushed leftist guerrillas and demobilised right-wing paramilitaries, reducing violence and restoring business condence. Mr Santos could claim some of the credit for these successes. He also promised to sustain economic growth, having served as both trade and nance minister in previous governments. Mr Mockus, a former mayor of Bogotá, has no experience of national oce and was undone by gaes. Mr Santos said in his victory speech that his win was also Mr Uribe’s. He plans to keep his predecessor as a permanent adviser, although Mr Uribe may run for mayor of Bogotá. On paper, Mr Santos will

have an easier time getting legislation through Congress than the outgoing president did: his coalition, led by Mr Uribe’s U Party, holds 73% of the lower house and 70% of the Senate. But thanks to Mr Uribe, Colombia now faces far dierent problems than it did in 2002. Indeed, some of the trickiest were of Mr Uribe’s own making. Colombians elected Mr Santos above all to ensure that the farc and eln guerrillas, whom he battered as defence minister, do not recover. The insurgents tried to disrupt the vote by force, killing 10 policemen and soldiers on election day. Two days later, they paralysed public transport in the small town of Algeciras in western Colombia. But the eect was to show how much the threat they pose has diminished. A greater risk to public safety comes from urban criminal gangs, many of them led by former paramilitary ghters demobilised by Mr Uribe. These groups focus on drug-tracking, but are also thought to persecute trade unionists. As many as 40 labour leaders were killed last year. Mr Santos plans to train urban police squads to pursue the mobs, just as he helped develop army units for jungle combat. Mr Uribe’s critics say the demobilisation scheme was part of a pattern of undermining the rule of law. His government was indeed regularly jolted by scandals, including illegal telephone tapping of the opposition, ties between paramilitaries

and the president’s political allies, and even the murder of civilians by some army units to boost body counts. Mr Santos has tried to address these concerns. Referring to Mr Mockus’s vows of honesty and legality, he said in his victory speech that you and I share those banners. He has already met top judges who refused to see Mr Uribe. However, his proposed judicial reform would harm prosecutors’ independence by giving the president control of the now semi-autonomous attorney-general. And his plan to bolster military courts may be aimed at removing civilian judges’ jurisdiction over cases of human-rights abuses by the army. The battle for domestic security has also created foreign-policy headaches. Though far fewer labour activists are killed than in the past, America’s Congress has used the issue as an excuse not to ratify a free-trade deal with Colombia. And the government’s successes against the guerrillas have driven them to the borders with Venezuela and Ecuador. Mr Uribe accused his neighbours’ leftist governments of sheltering them. He bombed a farc camp in Ecuador in 2008, and expressed outrage when Swedish weapons bought by the Venezuelan army reached the farc. Hugo Chávez, Venezuela’s populist president, froze relations with Colombia last year, and vowed to end all imports from its second-biggest trading partner after Mr Uribe granted the United States facilities at military bases. Mr Santos has echoed Mr Uribe’s charges. But he is more worldly and conciliatory than his folksy, combative mentor. He has promised a foreign policy of diplomacy, caution and respect. Ecuador’s president, Rafael Correa, gave him a congratulatory call. But Venezuela said it would await friendly gestures. Mr Chá- 1

The Economist June 26th 2010

40 The Americas 2 vez campaigned against Mr Santos, and

says he backed a coup against him in 2002. At home Mr Santos faces a bankrupt health system, a persistent budget decit and an unemployment rate of 12%, one of the highest in the region. He promises to balance the budget by 2014 without raising taxes, and to cut unemployment to single digits. He says this can be done by reforming health care and reducing transfers of oil and mining royalties to the provinces. He has been cagey about reforming archaic labour laws that condemn most Colombians to the informal economy. While security requires constant vigilance, it is a sign of how much Colombia has changed that Mr Santos may be judged primarily on his management of the economy. 7

The drugs business

Full circle Successes in the war on drugs expose the policy’s limits


ARE good news in the bloody ght against narcotics gave drug warriors in the Americas reason to boast on June 22nd. First, Jamaican police arrested Christopher Dudus Coke, a gang leader wanted in the United States. The same day, the UN reported that the area used to cultivate coca leaf in the Andes fell by 5% last year. Mr Coke’s unexpected capture was a coup for the Jamaican government. On May 17th Bruce Golding, the prime minister, authorised his extradition to America and launched a search for him. The eort caused 73 deaths in reghts between the security forces and his supporters, but found no trace of him. Yet after a month on the run, Mr Coke decided to turn himself in. Police had conducted raids on his associates, which may have made him think they were closing in. He contacted a pastor to arrange a surrender at the American embassy. But Jamai-

Squeezing the balloon Coca plant cultivation, ’000 hectares 175 Colombia

150 125

Peru and Bolivia

100 75 50 25 0





Source: United Nations Office on Drugs and Crime


Maternal health in Mexico

A perilous journey

San cristÓbal de las casas

The mortal danger of poverty


UTSIDE the main hospital in San Cristóbal de las Casas, women in traditional multicoloured garb queue up to see a doctor. Many are pregnant or carry infants on their backs. One expectant mother says she fears there will not be a bed for her when she enters labour all too common in the overcrowded hospital. Tales of deaths from hypertension, haemorrhage or infection during or after giving birth are common in the second city of the state of Chiapas. In a nearby village, one doctor recalls a woman whose journey took so long that she died on the street outside his clinic. Maternal mortality in Mexico has fallen by 36% since 1990, but it is still higher than in other Latin American countries. The problem is far worse among Indians and in the poorer south. Mothers in Chiapas, Oaxaca and Guerrero states die in childbirth 70% more often than the national average, and indigenous women are three times less likely to survive birth than non-indigenous women. Most of these deaths are preventable. One of the rst obstacles for a pregnant woman is transport. To reach a doctor you need to get a car, a driver, petrol, and someone to take care of the other children. The roads to the nearest town hospital are often slow and danger-

ous. As a result, many womenincluding one-third of Indian mothersgive birth without any medical help at all. Another set of problems awaits at the hospital. Laboratory tests and medical supplies are often too costly for the poorest Mexicans. The quality of care is low: 40% of urban maternal deaths are caused by using the wrong medicine, by botched surgery or by other forms of malpractice. Lastly, there are cultural and social diculties. Many women are scared to go to a male obstetrician, which is frowned upon in areas with a macho, conservative culture. Those who do may have trouble communicating, since many indigenous women speak poor Spanish. Doctors sometimes make matters worse by denigrating rural patients, discouraging them from seeking medical help. More spending on midwives and contraceptives would help save mothers’ lives. New money is on the way: the Spanish government and the charities of billionaires Bill Gates and Carlos Slim announced plans this month to spend $150m on health care for the poor in Central America and southern Mexico. But the best way to reduce maternal mortality is via investment in infrastructure, health and educationall of which would help the south catch up in general.

can police were tipped o and stopped Mr Coke, dressed in a wig and hat, en route. At rst sight, the coca gures are equally encouraging. According to the un’s data, derived from satellite images, the total amount of Andean land under coca has dropped by nearly a quarter since 1990. Colombia has done especially well: partly because it switched from ineective cropspraying to large-scale manual eradication, its coca-growing land has been reduced by 60% in the last decade. Yet it is precisely such achievements that produce the most scepticism about counter-narcotics. The surrender or capture of 27 Jamaican gang leaders in the past month has created a power vacuum that may be lled by bloodshed. As long as political parties depend on the mobs at elections and the police cannot provide security, citizens will still suer. Similarly, the drop in land used to grow coca has been oset by better productivity. Since 2000, yields per hectare have risen by nearly two-thirds. And crude machines are replacing bare feet as macerators, while washing machines are being used as makeshift centrifuges. As a result, the un’s

current estimate of global cocaine production is 10% higher than it was in 2005. Moreover, growers continue to nd the weak links in the enforcement chain. In 1995 Peru and Bolivia were the world’s top cocaine producers. Much blood and money was spent driving the trade out of those countries and, inadvertently, into Colombia (see chart). In 1999 America sponsored a big anti-drug programme in Colombia. As a result, growers have moved back: in the past decade, the area used for coca rose by 55% in Peru and 42% in Bolivia. Bolivia’s president, Evo Morales, still leads a coca-growers’ union. He wants the leaf taken o the un’s banned-substances list to allow its industrialisation in drinks and creams. The new constitution passed last year calls coca part of Bolivia’s cultural heritage . No matter that cocaine is not. Peru’s president, Alan García, refuses to eradicate coca in a key valley, in part to avoid agitating Maoist guerrillas. The un report found that Peru may have passed Colombia as the world’s top coca grower last year. As a senior Mexican ocial says: Until legalisation, the only thing you can do is make it someone else’s problem. 7

The Economist June 26th 2010 41


Also in this section 42 Japan’s new government 43 The Bhopal disaster 43 Democracy in Hong Kong 44 Kyrgyzstan’s humanitarian crisis 46 Banyan: India’s enigmatic leader-in-waiting

For daily analysis and debate on Asia, visit

Australia changes prime minister

Rudd on the tracks as Gillard takes over SYDNEY

Losing popularity, the Labor Party stages a surgical strike in the leadership


ESS than a year ago Kevin Rudd rode high as one of Australia’s most successful prime ministers. Suddenly, his spectacular career has come to a crashing end. With his rating in the opinion polls sliding disastrously, and a federal election due soon, a panicked ruling Labor Party on June 24th dumped Mr Rudd as leader. They replaced him with Julia Gillard, his deputy. She will give a country once branded as a bastion of male chauvinism its rst female prime minister. As his support crumbled among Labor’s 115 federal parliamentarians, Mr Rudd had declared deantly the previous evening that he would ght a leadership challenge from Ms Gillard. But the coup turned out to be bloodless. Faced with a humiliating defeat, when the moment came Mr Rudd stood aside. His colleagues elected Ms Gillard unanimously. Wayne Swan, the treasurer, will take over as deputy prime minister. Instead of making a scheduled visit to the G20 summit in Canada, where he was due to meet Barack Obama, Mr Rudd has now become the only prime minister Labor has ditched during a rst-term government. The speed of his demise has astonished Australia’s political class. Labor had hailed him as a reformist hero after he led the party to power in late 2007, unseating the 11-year conservative coalition government under John Howard. Mr Rudd started by ratifying the Kyoto protocol on climate change, then issued a long-awaited formal apology to Australia’s

indigenous people for past injustices. His approval rating reached 71% in April 2008; it was still at 63% last October. Until recently the Liberals, the main opposition party, looked as if they would present no threat in this year’s election: since their defeat, they have swapped leaders three times. All that changed in early May, when polls turned badly against Labor. In one month Mr Rudd’s approval rating fell by 11 points, to 39%. Another poll earlier this month, showing the government’s vote had fallen to 33%, sent tremors through Labor powerbrokers. Votes leaked more to the Greens than to the Liberals; but the poll still gave the opposition a winning lead, even after the distribution of second-preference votes. The trigger was Mr Rudd’s decision in late April to defer a planned emissionstrading scheme (ETS) until at least 2013. Legislation for it is stuck in the Senate, the upper house of parliament, where Labor lacks a majority. Mr Rudd had made attacking climate change a dening pledge of his platform. His apparent decision to abandon it dismayed voters and damaged his credibility on other issues. One of these was a resources superprots tax which Mr Rudd announced last month. From 2012, it would tax mining prots at a rate of 40% after they reach a certain level. A noisy campaign against the tax by big mining companies drowned out Mr Rudd’s claim that it was only a fair way of returning a mining boom’s riches to Australians. Polls indicate public opinion

is evenly split on the tax. Fears about the government’s crumbling fortunes unleashed unhappiness among Mr Rudd’s colleagues over his management style. A workaholic, he tended to control government as a one-man band, running the public service in Canberra ragged and shutting some colleagues out of key decisions. One environment minister learned of the ETS’s deferral only by reading about it in the press. And Mr Rudd’s short temper had won him few friends to call on when the nal crisis loomed. Choked with emotion after seeing Ms Gillard take over, he took credit for invoking a swift response to the global nancial crisis with a scal stimulus that helped Australia avoid a recession. But Australians no longer seemed to be listening to his boasts about this and other achievements. The campaign starts here At 48, and with a reputation as one of parliament’s most combative debaters, Ms Gillard must now nd ways to make them start listening again. Born in Wales, she emigrated with her parents as a small child. She entered parliament 12 years ago, after working as a lawyer. Her red hair, broad Australian accent and sharp mind have made her one of the most watched gures in Australian politics. From her base among Labor’s left faction in Melbourne, Ms Gillard has moved pragmatically to the centre. She oversaw the Rudd government’s partial dismantling of the Howard government’s workplace laws, which had vested power mainly with employers. But she has also managed to forge cordial relations with business. Ms Gillard fronted her rst press conference as prime minister by declaring that a good government was losing its way. She o ered to re-prosecute the case for a price on carbon. And she proposed a deal to end the mining-tax row. She will cancel an expensive series of television ads the 1

42 Asia

The Economist June 26th 2010

2 government had bought to sell its case (to

no apparent avail), and ask the big mining companies to do the same. Both decisions will help give Ms Gillard something of a political honeymoon, and space to build support before the election she says will happen in coming months. Humanrights leaders, though, worry that she may be tempted to lurch to the right (as Mr Rudd promised not to) on another issue

draining the government’s support: the growing number of asylum-seekers arriving in northern Australia by boat. Tony Abbott, the latest opposition leader, rates poorly with women voters. Ms Gillard is popular across party lines. Still shocked, the government can only gamble that her fresh approach and capacity to charm will prove the weapon it needs to win a second term. 7

Japan’s new government

Enter the prudent Mr Kan Tokyo

The new prime minister tries a novel campaign strategy for upper-house elections


AOTO KAN, Japan’s new prime minister, seems to have a soft spot for the Britain of 1997, when Tony Blair’s New Labour swept to power. In his rst few weeks in oce, Mr Kan has not only pulled o the Blairite trick of giving his party’s old guard the slip. He has also wrapped himself in slogans redolent of the 1990s. The manifesto of his Democratic Party of Japan (DPJ) for elections to the upper house of the Diet, or parliament, on July 11th begins by promising voters a Third Way of economic policy. His government talks of private-nance initiatives. His scal plans are full of the word prudent. Mr Kan believes Japan is sitting on a dangerous heap of debt. If things go wrong, we could end up like Greece, he warned on television this week. As quaintly last-century as some of his slogans appear, they strike an unusually bold change of direction in Japanese politics. Since Mr Kan took oce on June 8th, replacing his discredited predecessor Yukio Hatoyama, he has yanked the DPJat least if you believe its manifestofrom a party of welfare largesse to one of scal discipline. Rival parties have joined the hair-shirt brigade. Suddenly, a debate on raising Japan’s consumption taxat 5%, the lowest in the rich worldhas vaulted to the centre of a national election campaign. In the general election last year that ended ve decades of rule by the Liberal Demo-

Counting calories Japan’s 2010 Diet upper-house election


Current seats held

Seats not up for election

New seats needed for majority

















Source: The Economist

cratic Party (LDP), the DPJ’s manifesto did not even mention the gaping hole in Japan’s public nances. Promising higher taxes to deationcoshed voters just ahead of an important election would be a strange calculation in any country. In Japan it has additional political and economic poignancy. The consumption tax reaped devastating results for its supporters in upper-house elections shortly after it was introduced in 1989. After it was raised to 5% in 1997, it once more harmed its sponsors and helped derail Japan’s economic recovery, plunging the country into a second lost decade of economic growth. But Mr Kan appears to have judged that, for three reasons, an election fought over tax will be less risky than in the past. First, because more voters acknowledge a rise in the consumption tax is necessary; second, because he hopes to achieve cross-party support for it; and third, because he can nesse the timing, depending on the health of the economy. The rst calculation is helped by the sovereign-debt crisis in Europe. Since January, when Mr Kan was nance minister in Mr Hatoyama’s government, he has been arguing ever more frequently that Japan, the country with the largest gross-debt-toGDP ratio in the developed world, is living beyond its means. For now, Japan has no trouble raising funds to meet its debts, and interest rates on government bonds are barely above 1%. But the nance ministry argues that within the next several years, debt on its current trajectory will exceed national savings, in which case Japan would have to look abroad for funding. That, government ocials believe, has alarmed the public enough for it to accept that some belt-tightening is unavoidable, though opinion polls send contradictory signals. On the one hand, two newspapers reported this week that more people favour a higher consumption tax than are

Kan bounce Japan’s party support rates, % 60 50


40 30 20



Sep Oct Nov Dec Jan Feb Mar Apr May Jun




Source: Yoshiuri Shimbun

against it. On the other hand, support for the DPJ, which doubled to about 40% after Mr Kan took over from Mr Hatoyama, dipped this week after he mentioned the tax rise (see chart). Happily for the DPJ, it is not alone in demanding higher taxes. The LDP and one marginal small party also call for a higher consumption tax in their manifestos. (Cunningly, Mr Kan has even referred to LDP’s proposal that the tax should double, to 10%, as a reference point, without stating a gure of his own.) Not only does this deect some of the heat onto the DPJ’s rivals, but it may also put the DPJ in a stronger position after the elections. On today’s voter preferences, political analysts believe the DPJ is likely to fall about ve seats short of the additional 60 in the upper house that it needs for a simple majority (see table). But if other parties including the LDP believe a higher 1

The Economist June 26th 2010

Asia 43

2 consumption tax is necessary, it may be

able to draw on their support in a vote. That would forgo the need for a more formal coalition of the type that helped doom Mr Hatoyama’s tenure. Mr Kan has accompanied his party’s manifesto with lengthy documents on scal reform and ways to rekindle sustainable economic growth after two decades of stagnation. Neither are particularly ambitious. The cut in the decit from 6.4% to 3.2% is not envisaged before 2015, ie, three years after the administration must hold another general election. Its nominal GDPgrowth targets are meagre. Even the consumption tax may not rise for two or three years, according to Mr Kan. Some argue that the timing is not bold enough. However, for all that Japan needs strong economic leadership, there is a danger in being over-zealous on the public nances. Though the economy barrelled along at a 5% annualised clip in the rst quarter, it is still running well below capacity and remains dependent on exports to China. Wage growth is miserly. Some argue that even the DPJ’s plans to freeze spending at 2010 levels may be too austere for such a fragile economy. More pressing than scal austerity, economists say, is the need to encourage a strong, well-balanced economy by deregulating inecient industries and encouraging more investment. If not, the country will remain brutally exposed to the ups and downs of the global economy, and its e orts at scal prudence may come to nothing. That, Mr Kan might note, is the depressing 21st-century legacy of New Labour’s 20th-century sloganeering. 7

The Bhopal disaster

The slow pursuit of justice Delhi

Still dying and still uncompensated VEN AS BP battles to check the damage caused by the oil spill in the Gulf of Mexico, India is showing how far it is from recovering from its own worst industrial accident. A group of government ministers appointed to suggest remedies for the disaster in 1984 at Bhopal, in central India, made its recommendations on June 21st. It urged the government to step up its e orts to extradite Warren Anderson, now a retired 88-year-old living somewhere in America, who was boss of Union Carbide, the American rm that owned the chemical-pesticides factory that caused the disaster. It also called for more compensation to go to the families of those who died. The plumes of poisonous gas that


Ill met by candlelight leaked from the plant killed thousands within minutes. Three years later Union Carbide agreed to pay the Indian government $470m in compensation, far short of an original $3 billion-worth of claims. But it was not until this year, on June 7th, that a court nally ruled on culpability for the accident. A district court in Bhopal convicted seven former Union Carbide executives of causing death by negligence and sentenced them to two years in jail. The ministerial group was convened in response to popular anger at the perceived leniency of the sentences. Long delayed by India’s snail-like judicial system, the judgment caused an outcry in India. Activists have spent the best part of three decades campaigning for proper compensation for Bhopal’s victims. Ocials put the number of deaths caused by the leak at fewer than 4,000, but others estimate that around 25,000 eventually died. Many were killed immediately; countless others died after long and dreadful illnesses. The ministers’ recommendations are unlikely to do much to soothe Bhopal’s angry people. Today as many as 100,000 are thought to su er from chronic sicknesses, such as cancer or neurological disorders. And more will probably follow. A study by the Centre for Science and Environment, an Indian NGO, last year found that even 3km (2 miles) from the factory, groundwater contained levels of toxic chemicals 40 times higher than the national limit. The revival in Bhopal-related anger has come at an unfortunate moment for the government. It has fuelled new opposition to the Civil Nuclear Liability Bill, which would cap foreign companies’ liability at little more than $100m in the event of a disaster. By international standards this is low, but the legislation is crucial to an historic civil-nuclear technology deal between India and America (see story on

page 61). Energy-starved, India wants American companies to help expand its nuclear power, but they are deterred by the lack of protection from big compensation claims. Opposition parties and humanrights activists, however, argue that the law could allow foreign rms to shirk paying proper compensation to the victims of a future Bhopal. 7

Elections in Hong Kong

Functionally democratic Beijing

For once, a Chinese political concession


FTER ve years of stalemate, a compromise between Hong Kong’s democrats and Chinese ocials has paved the way for the approval of ercely debated political reforms by the territory’s legislature. This spares the local government potential embarrassment. It will allow a majority of legislators to be elected by popular vote for the rst time in Hong Kong’s history. For China, too, these will be uncharted waters. Noisy demonstrations by hundreds of people outside the Legislative Council, or Legco, building in central Hong Kong suggested that the package will not end political feuding over the pace of democratic reform. The demonstrators accused the Democratic Party, the biggest pro-democracy group, of abandoning its principles by supporting the compromise. As The Economist went to press, Legco was still debating the most controversial reforms, of the next Legco election in 2012, but had approved changes to the election for the chief executive in the same year. Of Legco’s 60 mem- 1

44 Asia

The Economist June 26th 2010

2 bers only a dozen or so were expected to

vote against the Legco-related motion. Objectors say the package fails to spell out how Hong Kong will eventually achieve full democracy. One Democratic Party legislator quit the party in protest. Yet the concessions made by the Chinese and Hong Kong government are more striking. The reforms will increase the number of Legco seats to 70 in the next elections. Five of the new seats will be directly elected, representing geographical constituencies. The other ve will represent district councils, which look after local issues such as cultural events and environmental projects. Originally China had opposed any change in the equal split in Legco between geographical seats and those for functional constituencies, returned by business, professional and other interest groups. Members chosen by functional constituencies are mostly pro-government. Their votes, added to those of the handful of directly elected pro-government legislators, ensure that on most issues the government and its backers in Beijing get their way. Pro-democracy politicians demand that functional constituencies be scrapped by 2020, which is when China has promised universal surage for Legco elections. China is reluctant to abolish them. But during talks with Democratic Party leaders on June 20th, a senior Chinese ocial agreed to the party’s proposal for the ve new seats reserved for district councillors to be chosen by a much bigger electorate. The candidates would be nominated by district councillors, but everyone who does not have a vote in another functional constituency (about 93% of the electorate) would be allowed to pick the winners. Arcane and trivial though it sounds, this was a remarkable turnaround from earlier Chinese hints. Ocials probably worried that if they did not concede the point, the political-reform package might be rejected by Legco. Changes in voting arrangements need the support of twothirds of legislators, which in eect gives the pro-democracy camp a veto. In 2005 the government suered a severe political blow when legislators turned down its rst attempt at political reform. The Democratic Party has been bitterly attacked by its ideological allies for aban-

Tinkering at the margins Hong Kong legislative council 2012 (2008)

Functional constituencies 35 (30)

2012: 70 seats

of which: new district council seats 5 Source: The Economist

2008: 60 seats

Popularly elected 35 (30)

doning its earlier insistence on popular elections for all seats in 2012. They say that by accepting an expanded electoral base for the district council-lled seats, the Democratic Party has implicitly endorsed the idea of functional constituencies, and made it even harder to persuade China to abolish them. Approval of the package means Donald Tsang, Hong Kong’s chief executive, no longer has to worry about leaving oce in 2012 having made no progress towards greater democracy. That remains a stated goal of his and China’s governments, much as China clearly hopes to load the dice against democrats. It is for Mr Tsang’s successor, and new leaders who will take over in China too in 2012, to do battle with the democrats over the next steps. 7

Kyrgyzstan’s humanitarian crisis

Sad homecoming Almaty

Refugees start to return, to an uncertain future


WO weeks after about 100,000 ethnic Uzbeks ed from southern Kyrgyzstan to neighbouring Uzbekistan to escape deadly clashes with ethnic Kyrgyz, tens of thousands are returning. Some 46,000 people had crossed the Uzbekistan-Kyrgyzstan border by June 23rd, according to Kyrgyzstan’s border service. More are expected to do so in the coming days. This will relieve one of the greatest humanitarian crises to hit the former Soviet Union since its break-up. Uzbekistan’s government is being praised by the United Nations High Commissioner for Refugees (UNHCR) for its extraordinary co-operation in handling this deluge of refugees overwhelmingly women and children. Even so, the Uzbekistani authorities could not accommodate all those who wanted to come and eventually closed the border. The women are now trickling back to their husbands, fathers, and brothers, who stayed behind to protect their homesor what is left of them. Many houses were burned down, sometimes with their residents still in them. Now they have to go back and attempt to pick up their lives again, side-by-side with their ethnic-Kyrgyz persecutors. Breaking trust can be done very quickly, re-establishing it can take a long time, says Saber Azam, the UNHCR’s regional representative for Central Asia, who has just visited the refugee camps in Uzbekistan. The cause of the outbreak of violence on June 10th, which left an estimated 2,000 people dead, has not yet been determined. It is clear, however, that the attacks were

not a spontaneous outburst of ethnic unrest, but were in fact carefully organised. Among those suspected of involvement is Kurmanbek Bakiyev, the former president who was ousted from oce in April and now lives in exile in Belarus, and his family and supporters. Although the violence has subsided, the southern cities of Osh and Jalal-Abad are still tense. On June 21st Kyrgyzstani forces conducted raids in the south, killing two people and wounding 23, as they hunted those behind the clashes. Ethnic Uzbeks have accused the security forces of complicity in the attacks on them. Meanwhile the interim government, headed by Roza Otunbayeva, is pushing ahead with plans for holding a constitutional referendum on June 27th, in spite of concerns that it might trigger more violence. With another 300,000 people internally displaced due to recent events, many of them now living with host families, it is not certain how many eligible voters will be able to go to the polls. Yet the government insists that the vote on a new constitutionwhich, if passed, would reduce the president’s power and strengthen the parliamentis vital to ensure stability. A vote might also lend some legitimacy to the provisional government, which took power after bloody street protests. Following the referendum, parliamentary elections will take place in October. The weakness of the interim government worries Kyrgyzstan’s neighbours and allies. Russia has provided humanitarian aid to Kyrgyzstan, but rejected the interim government’s call (since retracted) for peacekeeping troops. Uzbekistan is seeking an international inquiry into the events. Kazakhstan’s state-owned media have openly chided the Kyrgyzstani authorities for not having a strong national leader (as Kazakhstan does). As if to show the people of multi-ethnic Kazakhstan that their country’s leadership takes better care of them, some of the Kazakh press has shown fairly graphic images of dead ethnic-Uzbek children. International organisations were quick to respond to the plight of the refugees, but governments, Uzbekistan’s excepted, have done little to help. If the referendum does indeed lead to renewed violence, the Kyrgyzstani authorities know they cannot look abroad for help. 7

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46 Asia

The Economist June 26th 2010

Banyan The mysterious Mr Gandhi Though no spring chicken, Rahul Gandhi has a lot to prove before he takes over the family business


HE young man with the future of India on his shoulders reportedly slipped out of the country to celebrate, perhaps with a long-rumoured Spanish girlfriend. But at home his birthday on June 19th was treated as a coming-of-age marked with reworks, donations of blood, poems and prayers, a seven-day temple pilgrimage through insurgency-infested forest, and lots and lots of gushing editorials and articles. For Indian youth, wrote a columnist in the Times of India, politics had become a sphere of terrible murkiness, symbolised by greed, ruthlessness and violence. Yet the young fellow had changed all this. Through talent hunts, membership drives and student meetings he had made young Indians believe that politics was a realm that could extend beyond the narrowness of nepotism. He had empowered a new breed of Real Young Turks as opposed to Privileged Young Jerks. He was the most refreshing arrival on the political block since decades. A couple of points briey trouble the mind over this assessment. First, Rahul Gandhi, more than any of his 1.2 billion compatriates, is the embodiment of privilege, and hardly an encroaching outsider. In colonial days his great-great-grandfather led the Congress party. His great-grandfather, grandmother and father became prime ministers (Jawaharlal Nehru, Indira Gandhi and Rajiv Gandhi respectively). Privilege comes at a terrible price. Both grandmother and father were assassinated. All the same, his family, like no other, has shaped the course of the republic. It believes in its due. Today Congress stands ready to do the family’s bidding, like a well-upholstered Ambassador car always at the front door. A second, even more impressive vehicle, known simply as India, boasts wheels of state, and its chaueur is respectfully called prime minister. It oers an exhilarating if often erratic ride (it belches smoke and lurches in unexpected directions, when it is not stuck in trac). It is currently on loan to a loyal and honest retainer, Manmohan Singh, no mean driver for a man of his years. But this car is Rahul’s heirloom. It is just a question of time before he asks for the keys back. A second troubling point has to do with all the recent references to Rahul’s youthful age. Forty, after all, is not really that young. By then a man might be expected to have made his mark

in the world, rather than be celebrating his coming-of-age. By the time they were Rahul’s age, Mozart and Alexander the Great had both been dead for several years. At 33 Jesus Christ had preached, healed, died and risen. The comparison is not wholly unfair, since Rahul’s disciples talk of him as India’s saviour. Consider, too, his own family. By Rahul’s age Nehru had already spent several years in British imperial jails; thanks to his enormous charm and political talents he had ascended to lead Congress by 34. By 40 Rajiv had been elected prime minister, admittedly as much thanks to a wave of sympathy after the assassination of his mother as on his own merits. Rahul Gandhi, by contrast, though ocially general secretary of Congress, has no place in government, while his mother, Sonia, grips the party tight. To be sure, being viewed as a political outsider keeps Rahul’s image pure. He is, at once, everywhere and nowhere. Mr Gandhi’s face is on billboards across the country, and television shows him descending by helicopter towards vast crowds of rural folk, the kind whom his grandmother, Indira, considered to be her beloved poor. But Mr Gandhi’s thoughts on policy remain a mystery. And as for press conferences or interviews that might test his mettle, forget it. To set against these doubts is one very big plus. For the past three or so years, Mr Gandhi has campaigned relentlessly, often staying with the poorno politician has travelled more. His energies help explain Congress’s unexpectedly strong showing in general elections last year. More than that, Mr Gandhi, through the party’s youth wing, is rebuilding Congress from the ground up. His eorts include not just membership drives but also a measure of intra-party democracy. There are limits: no one is suggesting that party panjandrums should be liable to be voted out, let alone the Gandhi clan. Still, it acknowledges Congress’s deep atrophy and lack of organisationwhat one academic, Mahesh Rangarajan, calls its lobotomisation under Gandhi family sway, particularly Indira’s. The eorts have paid o. In Punjab, Gujarat, Tamil Nadu and Bihar Congress’s fortunes have revived. But the big prize still to come is Uttar Pradesh, the most populous state with perhaps 180m people, which holds elections in 2012. For now, Mr Gandhi’s helicopter draws crowds of up to 100,000 coming to see the Prince of India. Success in Uttar Pradesh might prime Mr Gandhi for the big time. Some commentators speculate that might be when he steps into the prime minister’s shoes, while Mr Singh is ushered upstairs to the largely ceremonial presidency. A riddle, wrapped in a mystery, inside a leader-in-waiting Yet the question that remains is what Mr Gandhi believes in. Mr Singh, we know, seeks an inclusive growth that blends market liberalism with stronger state institutions. That is ne as far as it goes. But as Pratap Bhanu Mehta of the Centre for Policy Research puts it, he lacks the political clout to kick arse. So education and police reform and much more that could improve the security of the poorest are bogged down. Does Mr Gandhi share Mr Singh’s views? Or, rather, like his mother and her mother-in-law before that, does he view India’s poor as deserving recipients of welfare rather than people to empower? Who knows? India’s thronging, unruly streets are a dangerous place in which to take the wheel, yet the learner driver remains an enigma. 7

Middle East and Africa

The Economist June 26th 2010 47 Also in this section 48 Zimbabwe’s dirty diamonds 49 A Rwandan shooting 49 Easing the blockade of Gaza 50 A Saudi tower scrapes the heavens

For daily analysis and debate on the Middle East and Africa, visit Economist .com/africa

Nigeria’s troubled Delta

Can a local man make good? Port Harcourt

President Goodluck Jonathan’s biggest and most urgent challenge is to stop the violence in the Niger Delta, where last year’s amnesty for militants is fraying


N AN attempt at reassurance, a resident of Port Harcourt says cheerfully that there has been no kidnapping in the city for two whole days. That may be good news for a place with so violent and unsavoury a past. But it also suggests that hopes for a new era of peace and development in the Niger Delta are fading fast. Port Harcourt, capital of Rivers state, is the urban hub of the Niger Delta, where the creeks contain the bulk of Nigeria’s vast oil and gas reserves, the biggest in Africa. But since 2005 the creeks have also been at the heart of a violent campaign against the energy industry. Calling for a bigger share of the vast revenue from local crude, gangs attacked foreign oil groups’ pipelines and kidnapped hundreds of expatriate sta. Western companies in the Delta, such as Royal Dutch Shell and America’s Exxon Mobil, along with the Nigerian government and customers at petrol pumps around the world, have all been hit, as Nigeria’s oil production has dropped by some 25% in four years. This was to have ended a year ago, when President Umaru Yar’Adua negotiated an amnesty with the militant groups that carried out most of the attacks, particularly the Movement for the Emancipation of the Niger Delta (MEND). Tony Uranta, a member of the government committee that proposed the deal, recalls the desperate mood: Our oil receipts were down and violence was up. The boys were wreaking havoc.

The scheme started well. Thousands of youths came out of the creeks to swap weapons for cash and training. Oil output picked up, along with Port Harcourt’s nightclubs, some of which had been sadly reduced to oering afternoon sessions to let nervous expatriates scuttle home before nightfall. But in recent months tension has risen again as government promises have gone unfullled. The training is largely yet to materialise. Monthly stipends of 65,000 naira ($430) are often paid late. MEND ended its ceasere earlier this year, planting bombs outside government buildings where an amnesty conference was taking place. Other groups are said to be returning to the creeks. There are fears that they are rearming, says Patterson Ogun, a peaceminded Delta campaigner who has written a report on the amnesty’s progress. Goodluck Jonathan, Nigeria’s new president, has vowed to reboot the scheme since taking oce last month. Hopes have risen partly because he is Nigeria’s rst president to hail from the troubled Delta region. Government ocials blame the past sense of drift on the poor health of Mr Yar’Adua, who ew to Saudi Arabia for treatment last November, returned home in February and died in May, without properly handing over the reins during his long illness. In full charge at last, Mr Jonathan has talked a good talk. He has unveiled plans to send 2,000 youths at a time for two-week

stints at a special camp for militants where they can have counselling and discuss job prospects, but the camp’s opening date has repeatedly been pushed back. Even if Mr Jonathan manages to relaunch the scheme, it will fail unless he tackles some of the amnesty’s aws. It looks poorly planned compared with schemes elsewhere in the world where disarmament, demobilisation and reintegration, known in peacemakers’ jargon as DDR, have successfully taken place. For one thing, the amnesty does not guarantee jobs for the militants as alternative sources of income and activity. It certainly will not give work to the rest of the Delta’s jobless masses, who could yet become ghters. Opportunities are scarce in a country where, according to ocial data, half of young people in urban areas have no job. For another thing, traditional types of employment, such as farming and shing, have been badly hit by the dreadful pollution caused by oil over the past few decades. Moreover, the scale of the challenge is unclear. Mr Jonathan’s people say 20,000 militants have laid down arms. But in the Delta you hear gures as low as 5,000. No one knows how many militants still lurk in 1

The Economist June 26th 2010

48 Middle East and Africa 2 the creeks. In any event, the amnesty has

had little eect on crime. Politically motivated attacks on the pipelines and abductions of oil workers have fallen but there is still a lot of illegal oil-bunkering and kidnapping purely for ransom. Nigerian campaigners and foreign security people both say that outsiders are needed to help redesign and implement the amnesty. The United Nations has played a big part in most of Africa’s DDR programmes, which have taken eect in a score of countries since the rst scheme was implemented in Zimbabwe in 1979 (without UN help) after the end of the country’s civil war. The World Bank has also often played a part. The Economic Community of West African States, better known as ECOWAS, a 15-country regional

body, is also gaining clout as a mediator. Yet Nigeria refuses outside intervention. We know the cause of this crisis, says Bestman Nnwoka, who co-ordinates the amnesty in Rivers state. It is a local thing. But Nigeria is not against accepting nancial help. A consortium of oil companies has felt obliged to pledge $30m, and a group of donors led by a UN agency is also mulling over a donation. Mr Jonathan has time to save the amnesty if he drastically redesigns it. His roots in the area may have bought him a period of grace. It’s because Jonathan is an Ijaw that we still have this calm, says Udengs Eradiri of the Ijaw Youth Council, a lobby that represents the Delta’s biggest ethnic group. But , he adds more ominously, it means that expectations are high. 7

Zimbabwe’s diamonds

Blood and dirt Johannesburg

President Robert Mugabe is determined that diamonds should prop up his party


ENDAI BITI, Zimbabwe’s nance minister, has described the 60,000-hectare Marange diamond eld in the country’s east as the biggest nd of alluvial diamonds in the history of mankind . Potential revenue is estimated at $1 billion-$1.7 billion a year, about half the crisis-ridden country’s total forecast GDP this year and enough to end its economic woes almost at a stroke. But if the revenue fell exclusively into the hands of President Robert Mugabe’s ZANU-PF it could, critics argue, spell the return of a single-party dictatorship and end the present shaky power-sharing arrangement between Mr Mugabe and Morgan Tsvangirai’s Movement for Democratic Change (MDC). This was the conundrum facing the Kimberley Process Certication Scheme, the diamond trade’s international watchdog, when it recently met in Israel to decide whether to continue to ban the sale of Zimbabwe’s alleged blood diamonds or to let sales resume. Zimbabwe’s ministry of mines, controlled by ZANU-PF, reported earlier this month that it had stockpiled 4.6m carats of diamonds, worth some $1.7 billion, since the organisation suspended ocial sales in November after allegations that troops guarding the elds had, among other atrocities, massacred more than 200 suspected illegal panners. The Kimberley Process was set up in 2003 by governments, the diamond industry and NGOs to stop the trade in rough diamonds that had helped pay for rebel groups and governments to wage civil wars in countries such as Congo, Côte

Diamonds are forever for Mugabe d’Ivoire and Sierra Leone. Its 49 members, representing 75 countries, including Zimbabwe, have agreed to comply with strict standards and promise not to buy diamonds that have not been certied as conict-free . Civil-rights groups say that proceeds from the Marange eld are being used to pay ZANU-PF militias to continue attacking MDC people, human-rights campaigners and white farmers. The state-owned Zimbabwe Mining

Development Corporation, which is controlled by ZANU-PF, announced in January that it had paid an $800,000 dividend from the Marange eld, part of which is now being mined by two South African companies in joint ventures with the corporation. The London-listed African Consolidated Resources insists, however, that it has the mineral rights to the 1,800-hectare site, deemed to contain the eld’s richest deposits. Its claim has been upheld by Zimbabwe’s Supreme Court but continues to be ignored by the government. Mr Biti, an MDC man, says his treasury has received no diamond revenue at all. Instead of the outright ban on Zimbabwe diamond sales recommended by the World Diamond Council last year, the Kimberley Process decided in November simply to suspend sales for six months to give the government another chance to comply with its standards and to withdraw all troops from the area. Abbey Chikane, a former boss of the South African Diamond Board who was appointed the group’s rst head, was asked to monitor things. To the surprise of many, he recommended in a report leaked earlier this month that Zimbabwe be allowed to resume sales, despite reports of continuing human-rights abuse and the sale of uncertied diamonds on the black market, with proceeds going into the pockets of a group of ZANU-PF bigwigs and army ocers. The lengths to which Mr Mugabe and his party are prepared to go to keep a lock on this new-found source of wealth were exemplied by the arrest on June 3rd of Farai Maguwu, head of a Marange-based NGO and a rst-class source for what is going on in the area. He is accused of undermining the state by allegedly giving Mr Chikane a top-secret document believed to contain details of skulduggery. Bizarrely, Mr Chikane, whose brother Frank was chief of sta to South Africa’s former president, Thabo Mbeki, let Zimbabwe intelligence agents accompany him to his meeting with Mr Maguwu, despite warnings that this could endanger the NGO man’s life. Apparently believing that the document Mr Maguwu gave him may have been fraudulently acquired , Mr Chikane says he handed it to ZANU-PF ocials for authentication. If convicted, Mr Maguwu could face up to 20 years in jail. On June 18th Obert Mpofu, Zimbabwe’s powerful and wealthy minister of mines, told a meeting of his country’s chamber of commerce that he had got a letter from the Kimberley Process demanding Mr Maguwu’s immediate release if Zimbabwe were to be allowed to resume diamond trading. Mr Mpofu retorted that he could not possibly intervene in Zimbabwe’s justice process, which his party also happens to control. Zimbabwe, he said, would sell its diamonds whatever the group decided. Nothing will stop us. 7

The Economist June 26th 2010 A Rwandan shooting

Who is out to kill the dissidents? Nairobi

As an election looms, the politics of Rwanda become a lot nastier


T IS hard to imagine that a shooting in Johannesburg could spell instability in the distant heart of Africa. But that is what has happened after an unknown gunman tried to kill a dissident Rwandan general on June 19th. Lieutenant-General Kayumba Nyamwasa was lucky to escape with his life. Shot in the stomach, he tussled with his assailant, whose pistol jammed. South African police say they have captured the gunman and ve accomplices. Some are thought to be Rwandan. The general’s wife says this was a plot by Rwanda’s president, Paul Kagame, to kill a former ally. Mr Kagame’s spokesman has dismissed the accusation as preposterous. Plainly, the two men had come to despise each other. As a former head of military intelligence, the general had been close to Mr Kagame since their days in exile in Uganda. Both were commanders in the Tutsidominated Rwandan Patriotic Front (RPF), which took control of Rwanda after the genocide of 800,000 Tutsis and moderate Hutus in 1994. The party has since dominated Rwanda, and Mr Kagame the party. Now, with a presidential election in August, Mr Kagame is tightening his grip. Earlier this year General Nyamwasa ed Rwanda after an interrogation by a group of senior RPF ocials. The general said that his treatment was despicable, that ocials have become lackeys, and that basic freedoms are being stamped out. Mr Kagame, he said, had become a tyrant. Rwandan ocialsand the president himselfcoolly brush such assertions aside. The general, says one of them, had long ago gone rogue, putting his own interests ahead of those of a united Rwanda. But it is unclear what the general has been accused of. Various allegations have been aired. He had too much money in his bank account. He was a traitor, even a terrorist; some ocials linked him to a series of grenade attacks in Rwanda earlier this year. None of the accusations has been proven. The general denies them all, and says Mr Kagame is corrupt. This, too, is mere rumour. Even the president’s harshest critics usually concede he is personally austere. But opposition within Mr Kagame’s own set may be brewing. General Nyamwasa seems to have teamed up with a former head of Rwanda’s overseas intelligence service, Colonel Patrick Karegaya, who has also ed to South Africa. This has made the RPF nervous. It even had the

Middle East and Africa 49 country’s football federation boss, Brigadier-General Jean-Bosco Kazura, arrested recently for making a trip to South Africa that had not been ocially scheduled. Rwanda has had a number of unexplained killings. For example, Seth Sendashonga, a moderate Hutu who served as interior minister after the genocide, was shot dead in 1998 in Nairobi. Some of Mr Kagame’s intelligence ocers had been implicated in an earlier attempt to kill Mr Sendashonga, but the main suspect was granted diplomatic immunity. Dozens of Rwandan army ocers are thought to have been shot, have disappeared or have had accidents. Some harboured secrets and knew about cover-ups of government revenge killings after the genocide. Mr Kagame’s admirers say he is ghting

for Rwanda’s national interest; rotten elements in the army must be eradicated. In any event, the political space is being squeezed. A Hutu politician, Victoire Ingabire, who had hoped to compete against Mr Kagame in the coming presidential poll, is facing trial for genocide denial. And an American law professor, Paul Erlinder, who sought to represent Ms Ingabire, was briey jailed this month for challenging the government’s ocial history of the genocide. Mr Erlinder has been freed for medical reasons and has left Rwanda. He says he is alive only because he is foreign. The government press has not been kind to him or to Ms Ingabire. Now they must scurry back through the grimy crevicesfrom where they had crept, says the New Times. Paranoia on all sides is rife. 7

The blockade of Gaza

Hamas is making ground again Gaza

As pressure mounts on Israel to lift the siege, Hamas gains


FTER three years of campaigning for Israel to lift the siege of Gaza, some of the Islamists ruling the territory are having second thoughts. This week the agriculture minister for Hamas, the Islamist group that runs Gaza, was putting the nishing touches to a ten-year plan to wean it o dependence on Israel and make it self-sucient in food. Israel’s ban on fertilisers had helped his plan to replace fertiliser with compost made from sewage that otherwise spills into the sea, and turn Gaza into a big organic farm. Then Binyamin Netanyahu, Israel’s prime minister, promised to open the crossings. Some Gazans fear that Israeli merchants will sell cheap produce in Gaza, as they used to before the siege.

Don’t forget to pay your tax to Hamas

The minister, Muhammad al-Agha, says he is undeterred. To protect his farmers, he has told Gaza’s importers to buy licences each time they bring in Israeli foodstus they import. Garlic, which Gaza lacks, will be let in but no vegetables grown in Gaza. And once he realises his plan to plant a million fruit trees, he will ban fruit imports too. But keeping Israel’s supplies out will be hard. After three years of reliance on underground smuggling from Egypt, Gaza’s merchants are again buying Israeli. Since Mr Netanyahu’s promise to ease the blockade, an eerie silence has fallen over Gaza’s border with Egypt, which hitherto echoed to the whirl of a thousand winches hauling goods to the surface. Now shopkeepers fear being lumbered with shelves of unwanted tunnel-tattered products, as Israel’s neater goods pour in. In the past, underground trackers would have organised one of Gaza’s ghting groups to attack an Israeli position in order to provoke a closure and keep trade from Egypt owing. But as part of its informal non-aggression deal with Israel, Hamas is policing the border and pounces on anyone operating without its consent. So some tunnellers, burdened by Hamas taxes and market saturation, are closing down. Others will survive: Marlboro cigarettes from Egypt are half the cost of Israel’s version, even after Hamas’s tax. Egyptian petrol is cheaper still. Hamas may also keep tunnels open for weapons. The burrows are a conduit for cash, too. Other factors will keep the tunnels 1

The Economist June 26th 2010

50 Middle East and Africa 2 working. Israel has yet to spell out what it

will let in by land. Tony Blair, Britain’s former prime minister, who claims credit for negotiating the deal as the envoy for the Quartet (the UN, the EU, the United States and Russia), says he will not get the small print for two weeks. As the crisis following Israel’s recent bloody interception of a siege-busting otilla fades from the headlines, the pressure on Israel eases and its leeway for backsliding widens. Meanwhile, lest Israel and its allies try to prise the economy away from it, Hamas is tightening its hold over supplies by land. It has stiened customs and passport checks and is limiting exit permits for merchants. It is also restricting the import of goods, such as zzy drinks, which it has learnt to manufacture under the siege. And Hamas is looking at ways to prot as much from formal trade as they do from informal. We’re clever enough to understand the multiplier eect, says a Hamas man. Western governments and nearby antiIslamist ones, such as Egypt and Jordan, are wary of rushing in. When Hamas won power at the ballot box in 2006, Palestine’s foreign paymasters cancelled all development aid, limiting help to humanitarian supplies. Israel’s blockade prevented the West from sending material for reconstruction. Western governments have suggested operating through go-betweens such as the UN. But Mr Blair talks to people in Gaza only via video-conference. So the West’s regional allies are keeping their distance. Mahmoud Abbas, who professes to be president for all Palestinians, stays away. Egypt’s state security service still denies visas to Gazan businessmen. Amr Moussa, the 22-state Arab League’s secretary-general, paid a rare visit to Gaza earlier this month but met Hamas ocials as members of a faction, not as Gaza’s ocial authority, and asked Hamas’s security guards not to escort him. Even if Israel opens the crossings, some of the siege’s harshest aspects will stay. Exports are banned, the naval blockade is still in place, and most Gazans cannot yet freely come and go. We don’t need mayonnaise, says a Gazan, who recently heard him speak. We need freedom. Yet even the promise to open the crossings marks a watershed. Israel must realise that its closure has failed to bring down the Hamas regime. Increasingly, international envoys ask whether an economic opening to Gaza could lead to a political one. Mr Blair repeatedly says he would love to visit. The longer he stays away the more diplomatic ground he and the West seem to lose to Hamas and its friends. The Turkish Islamist group that helped organise the bloodied otilla is trying to invest in rebuilding Gaza’s port and generally bolstering Turkey’s role in the territory. American investors of Palestinian origin are set to open Gaza’s rst mall. Land

A Saudi tower

Mecca versus Las Vegas


Taller, holier and even more popular than (almost) anywhere else


IKE another famous town that beckons visitors in a searing desert, Mecca has only one big, if dierent, draw. Its 13m visitors a year are only a third as many as ock to Las Vegas, but numbers are rising. The holy city is striving to meet the challenge with some Vegas-like amenities. Mecca already boasts dozens of fancy international hotels. At the current building rate it could have 80,000 hotel rooms by 2015. The Mecca Clock Royal Tower Hotel, with more than 800 rooms, occupies what will soon be the world’s second-tallest building, a structure incorporating the world’s biggest clock, with faces at least six times the size of Big Ben’s, and capped by a spire topped with a golden crescent. The hotel building forms just part of part of the Abraj al-Bait complex, a Gotham City-like eruption of seven huge towers, conveniently sited a stone’s throw from the Great Mosque. With 1.5m square metres of oor space, including two helipads, a giant shopping mall and a prayer area said to cater for 30,000 worshippers, Abraj

al-Bait is substantially bigger than America’s two biggest buildings, the Pentagon and the Palazzo Hotel in Las Vegas, put together. Because many of its rooms directly overlook the Kaaba, the cubical building that houses the Black Stone, and towards which 1.5 billion Muslims turn in prayer, the complex can charge sizzling prices. A one-room studio apartment starts at $650,000. Much of the best land in the holy city has been razed to make way for developments including a planned expansion of the great mosque to t an extra 500,000 worshippers. Just one of the housing schemes under construction, Jabal Omar, is meant to accommodate 45,000 year-round residents as well as 150,000 pilgrims, but backers of the $5 billion project have struggled to raise enough money. Perhaps a new metro system will inspire investors. Its rst line, connecting the main sites of the haj ritual, should be up and running by November, just in time for the greatest annual inux of pilgrims.

Reach for the heavens

2.4* 8.2

Height in metres at time of opening


National GDP, % change on previous year:


in year of completion 5 years before completion

3.7* 5.6 -0.6 3.1

-8.9 2.4

-5.9 6.6

-7.4 9.9

5.8 4.8


6.2 5.7

500 400 300 200 100

Chrysler Empire State World Trade Building Building Center 319m 381m 417m† New York New York New York (1930) (1931) (1973)

Willis Petronas Taipei Clock Royal Tower‡ Towers 101 Tower Hotel † 442m 452m 508m 591m Chicago Kuala Lumpur Taipei Mecca (1974) (1998) (2004) (2010*)

Sources: Skyscraper Museum; Emporis; IMF; national statistics

prices in Gaza city have shot up. Saudi investors have asked management consultants to look for opportunities. For Mr Abbas’s Palestinian Authority, things look bleak. Its supporters complain that Hamas has shifted world attention from core issues such as Palestinian refugees and the status of Jerusalem, which Mr Abbas is trying to focus on, to those may-


Burj Khalifa 828m Dubai (2010)


†Not including antennae/spires ‡Formerly Sears Tower

onnaise supplies for Gaza. Israeli ocials this week approved the demolition of a score of Arab homes in Jerusalem beneath the most contested ground in the occupied territories, the Old City’s al-Aqsa shrine which the Palestinians prize as part of their hoped-for capital and Israel reveres as the Temple Mount. As Mr Abbas loses ground, Hamas gains itand consolidates. 7

Repent at leisure A special report on debt June 26th 2010

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The Economist June 26th 2010

A special report on debt 3

Repent at leisure Also in this section Paradise foreclosed The boom has left Florida with an excess of houses, shops and debt. Page 5

The morning after A $3 trillion consumer hangover. Page 6

Betting the balance-sheet Why managers loaded their companies with debt. Page 8

A better bust? Bankruptcy is becoming less calamitous. Page 10

The unkindest cuts Many countries face the dicult choice of upsetting the markets or upsetting their voters. Page 11

The travails of the rating agencies. Page 13

Borrowing has been the answer to all economic troubles in the past 25 years. Now debt itself has become the problem, says Philip Coggan

In a hole


Judging the judges

Stagnation, default or ination await. The only way out is growth. Page 14

Acknowledgments Apart from those quoted in the text, special thanks go to Mark Adelson, Thorhallur Arason, Wayne Archer, Amy Baker, Ken Baird, Jon Baldvin, Joe Carson, George Cooper, Richard Duncan, Sebastien Eisinger, Kathleen Gallagher McIver, Sigurdur Gudjonsson, Alan Hudson, Jon Jonsson, Matt King, Gyl Magnusson, Arnaud Mares, Richard McGuire, Brian Peters, John Psaropolous, William Rizzetta, James Russell, Je rey Sacks, Maarten Slenderbroek, Peter Spratt, Jon Taylor, Richard Tett, Loukas Tsoukalis, Arsaeli Valfells, Barrie Wilkinson, Martin Winn and Mike Zelouf. A range of additional charts and a list of sources are at An audio interview with the author is at

AN is born free but is everywhere in debt. In the rich world, getting hold of your rst credit card is a rite of passage far more important for your daily life than casting your rst vote. Buying your rst home normally requires taking on a debt several times the size of your annual income. And even if you shun the temptation of borrowing to indulge yourself, you are still saddled with your portion of the national debt. Throughout the 1980s and 1990s a rise in debt levels accompanied what economists called the great moderation , when growth was steady and unemployment and ination remained low. No longer did Western banks have to raise rates to halt consumer booms. By the early 2000s a vast international scheme of vendor nancing had been created. China and the oil exporters amassed current-account surpluses and then lent the money back to the developed world so it could keep buying their goods. Those who cautioned against rising debt levels were dismissed as doom-mongers; after all, asset prices were rising even faster, so balance-sheets looked healthy. And with the economy buoyant, debtors could aord to meet their interest payments without defaulting. In short, it paid to borrow and it paid to lend. Like alcohol, a debt boom tends to in-

duce euphoria. Traders and investors saw the asset-price rises it brought with it as proof of their brilliance; central banks and governments thought that rising markets and higher tax revenues attested to the soundness of their policies. The answer to all problems seemed to be more debt. Depressed? Use your credit card for a shopping spree because you’re worth it . Want to get rich quick? Work for a private-equity or hedge-fund rm, using borrowed money to enhance returns. Looking for faster growth for your company? Borrow money and make an acquisition. And if the economy is in recession, let the government go into decit to bolster spending. When the European Union countries met in May to deal with the Greek crisis, they proposed a 750 billion ($900 billion) rescue programme largely consisting of even more borrowed money. Debt increased at every level, from consumers to companies to banks to whole countries. The eect varied from country to country, but a survey by the McKinsey Global Institute found that average total debt (private and public sector combined) in ten mature economies rose from 200% of GDP in 1995 to 300% in 2008 (see chart 1, next page, for a breakdown by country). There were even more startling rises in Iceland and Ireland, where debt-to-GDP ratios reached 1,200% and 700% respectively. 1

The Economist June 26th 2010

4 A special report on debt

2 The burdens proved too much for those

two countries, plunging them into nancial crisis. Such turmoil is a sign that debt is not the instant solution it was made out to be. The market cheer that greeted the EU package for Greece lasted just one day before the doubts resurfaced. From early 2007 onwards there were signs that economies were reaching the limit of their ability to absorb more borrowing. The growth-boosting potential of debt seemed to peter out. According to Leigh Skene of Lombard Street Research, each additional dollar of debt was associated with less and less growth (see chart 2) Stopping the debt supercycle The big question is whether this rapid build-up of debta phenomenon which Martin Barnes of the Bank Credit Analyst, a research group, has dubbed the debt supercycle has now come to an end. Debt reduction has become a hot political issue. Rioters on the streets of Athens have been protesting against the junta of the markets that is imposing austerity on the Greek economy, and tea-party activists in America, angry about trillion-dollar decits and growing government involvement in the economy, have been upsetting the calculations of both the Democratic and Republican party leaderships. To understand why debt may have become a burden rather than a boon, it is necessary to go back to rst principles. Why do people, companies and countries borrow? One obvious answer is that it is the 1

Owe dear Debt as % of GDP, 2008 Financial* Households


Non-financial businesses Government






Japan Britain† Spain South Korea Switzerland‡ France Italy United States Germany Canada China Brazil India Russia

Source: McKinsey

*Asset-backed securities removed because of double-counting †Adjusted to remove foreign-owned financial debt ‡2007

only way they can maintain their desired level of spending. Another reason is optimism; they believe the return on the borrowed money will be greater than the cost of servicing the debt. Crucially, creditors must believe that debtors’ incomes will rise; otherwise how would they be able to pay the interest and repay the capital? But in parts of the rich world such optimism may now be misplaced. With ageing populations and shrinking workforces, their economies may grow more slowly than they have done in the past. They may have borrowed from the future, using debt to enjoy a standard of living that is unsustainable. Greece provides a stark example. Standard & Poor’s, a rating agency, estimates that its GDP will not regain its 2008 level until 2017. Rising government debt is a Ponzi scheme that requires an ever-growing population to assume the burdenunless some deus ex machina, such as a technological breakthrough, can boost growth. As Roland Nash, head of research at Renaissance Capital, an investment bank, puts it: Can the West, with its regulated industry, uncompetitive labour and large government, aord its borrowing-funded living standards and increasingly expensive public sectors? Sovereign default is far from inconceivable. Many people are forecasting that Greece, despite its bail-out package from the EU and the IMF, will be unable to repay its debts in full and on time. Faced with the choice between punishing their populations with austerity programmes and letting down foreign creditors, countries may nd it easier to disappoint the foreigners. Defaults have been common in the past, as Carmen Reinhart and Ken Rogo showed in their book, This Time is Dierent . Adam Smith, a founding father of economics, noted in The Wealth of Nations that when national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having being fairly and completely paid. Governments now face a tricky period when they have to deal with the debt overhang, decide how quickly to cut their decits (and risk undermining growth), and try to distribute the pain of doing so as equitably as possible. Debt is often treated as a moral issue as well as an economic one. Margaret Atwood, in her book of essays, Payback: Debt and the Shadow Side of Wealth , notes that the Aramaic words for debt and sin are the same. And some versions of the Lord’s Prayer say Forgive us our debts


It’s a drag US GDP growth in $ per additional $ of debt* 1.0 0.8 0.6 0.4 0.2 0 1956



Sources: Bureau of Economic Analysis; Federal Reserve; The Economist




*All domestic non-financial debt 3-year moving average

rather than Forgive us our trespasses . The Live 8 campaign in 2005 tried to shame developed nations into forgiving the debts of poor countries, particularly in sub-Saharan Africa. Economists have developed the concept of odious debt in which citizens should not be forced to repay money borrowed by tyrannical or kleptocratic rulers. Interest payments on debt are often regarded as an onerous burden placed on the poor; interest is seen as an unjustied reward for capital, a concept that goes back to Aristotle and is implicit in the Christian idea of usury. Islam forbids it altogether. The book of Deuteronomy suggested a debt amnesty every seven years, which survived into later Jewish custom. But conventional morality has not always been on the side of the borrowers. Some regard debt as the road to ruin and the failure to repay as a breach of trust. In the 18th and 19th century debtors in Britain were often thrown into jail (as in Charles Dickens’s Little Dorrit ), though Samuel Johnson spotted the aws of the practice: We have now imprisoned one generation of debtors after another, but we do not nd that their numbers lessen. We have now learned that rashness and imprudence will not be deterred from taking credit; let us try whether fraud and avarice may be more easily restrained from giving it. Movable morals In the past 100 years the moral battle has moved in favour of the debtors. Bankruptcy is no longer stigmatised but simply regarded as bad luck. When consumers borrow beyond their means, the blame is laid on lax lending practices rather than irresponsible borrowing. Governments have encouraged more people to become homeowners and thus to take on debt. And defaulting on one’s debts has become much less cumbersome; in the current housing 1

The Economist June 26th 2010

2 slump many American homeowners have

resorted to jingle mail, dropping their keys through the lender’s letterbox and walking away from their property. In business, a few failed directorships are a sign of entrepreneurship rather than incompetence. America’s Chapter 11 process allows the managers of companies to remain in place and the business to be protected from its creditors. The number of companies with safe AAA credit ratings

A special report on debt 5

has collapsed as more have acted on the theory that a debt-laden balance-sheet is more ecient (because interest payments are tax-deductible in most countries). The recent crisis has also diminished belief in the judgment of the nancial markets. The role of banks in the credit crunch and the cost of the nancial sector bail-out has undermined the idea that the markets assess risk fairly and rationally. Instead, higher borrowing costs are seen as the re-

Paradise foreclosed T HE giant iron gates are eerily reminiscent of the opening scene of the lm Citizen Kane. Each bears an impressivelooking crest, CR, with a statue of a rearing horse standing guard. The view beyond the gates takes in roads, elegant streetlights and specially planted trees. The plans were for an equestrian community with 11miles of bridleways and stables for 36 horses. But if a modern Orson Welles were to pan his camera beyond the gates, he would not nd a billionaire’s mansion. The gates are padlocked and the roads lead nowhere. This is the Cordoba Ranch, a few miles from Tampa in Florida, one of the many residential developments that were abandoned when the American housing market collapsed. Florida, with a long history of property booms, played its full part in the subprime excesses. It has ranked rst for mortgage fraud among American states in three of the past four years. In the fourth quarter of last year more than a quarter of all mortgages there were behind on at least one payment; more than a fth were at least 90 days behind or already in foreclosure. Estate agents reckon that prices have fallen 40-50% from their peak. The e ect on the state’s overall economy has been huge. In the year to April 2009 Florida’s population fell for the rst time in recent memory, by nearly 57,000. In a normal year it would be expected to grow by 200,000-400,000. Jobs have evaporated, particularly in construction, property and nance; the unemployment rate is 12%. With revenue from property taxes down, the state budget is $3.5 billion short. Since the government employs one

in seven workers, that will mean fewer jobs and cuts in services across the state. Florida’s best-known industry, tourism, has also su ered from the recession. A report by the Themed Entertainment Association found that although Walt Disney World in Orlando saw a small rise in visitors during 2009, both Universal Studios and Busch Gardens (in Tampa) suffered a substantial decline. Sean Snaith, an economist at the University of Central Florida in Orlando, says this has been an equal-opportunity recession, a ecting professors and plumbers. He reckons that Florida’s economy faces a long and protracted climb out of a deep hole, with unemployment remain-

sult of unscrupulous speculation. The role of sovereign credit-default swaps (CDS), a way of betting on the likelihood of a country’s failure to repay the money it has borrowed, has proved particularly controversial. Southern European nations, which have been at the heart of the recent market turmoil, have been quick to blame an Anglo-Saxon conspiracy, brewed up by hedge funds, credit-rating agencies and even newspapers like this 1

The boom has left Florida with an excess of houses, shops and debt ing in double digits until 2012. It will be 2014 before Florida’s payrolls recover to pre-recession levels, he predicts. Like many other states, before the bust Florida enjoyed a consumer boom that may have left it with too many retail outlets. At the Oviedo mall near Orlando there are empty shops everywhere. The remaining shopkeepers, led by Jim Pridemore of Ashton Photography, are mounting a plucky campaign to revive the mall, complete with family events and We’re Here to Stay badges. But they are competing for a share of a smaller consumer pie. According to Experian, a credit consultancy, the combined limit for the credit cards held by each of Florida’s consumers now averages $20,728, after a high of nearly $27,000 in the third quarter of 2008. Florida is not alone in having to shift away from consumption and towards investment and exports, but its lack of a big manufacturing base makes the task more dicult. Its main hope for growth is health care, thanks in part to its large population of retired people. Given the poor outlook for jobs and the oversupply of housing, Florida’s baddebt problems are likely to linger. In Daytona Beach, an Atlantic resort best known for its drag-car racing, estate agents are advertising lists of foreclosed properties for sale. These melancholy rosters highlight the gap between the grand claims of developers and the cold reality of market arithmetic. Who could resist a three-bedroom, two-bathroom house on East Paradise Lane, in the subdivision of Shangri-La? The answer, clearly, is lots of people. In late April the property could be snapped up for just under $100,000.

The Economist June 26th 2010

6 A special report on debt

2 one, for unfairly pushing up their borrow-

ing costs. The German government moved to ban short-selling of government bonds and some CDS transactions last month. As Charles Stanley, a stockbroking rm, cynically puts it, EU nations are saying: Please fund our lifestyles, but don’t hold us to any commitments. Why it matters If a husband borrows money from his wife, the family is no worse o. By extension, just as every debt is a liability for the borrower, it is an asset for the creditor. Since Earth is not borrowing money from Mars, does the debt explosion really matter, or is it just an accounting device? During the credit boom of the early 1990s and 2000s the conventional view was that it did not matter. Not only were asset prices rising even faster than debt but the use of derivatives was spreading risk across the system and, in particular, away from the banks, which had capital ratios well above the regulatory minimum. The problem with debt, though, is the need to repay it. Not for nothing does the word credit have its roots in the Latin word credere, to believe. If creditors lose faith in their borrowers, they will demand the repayment of existing debt or refuse to renew old loans. If the debt is secured against assets, then the borrower may be forced to sell. A lot of forced sales will cause asset prices to fall and make creditors even less willing to extend loans. If the asset price falls below the value of the loan, then both creditors and borrowers

will lose money. This is particularly troublesome if the economy slips into deation, as happened globally in the 1930s and in Japan in the 1990s. Debt levels are xed in nominal terms whereas asset prices can go up or down. So falling prices create a spiral in which assets are sold o to repay debts, triggering further price falls and further sales. Irving Fisher, an economist who worked in the rst half of the 20th century, called this the debt deation trap. Another reason why debt matters is to do with the role of banks in the economy. By their nature, banks borrow short (from depositors or the wholesale markets) and lend long. The business depends on condence; no bank can survive if its depositors (or its wholesale lenders) all want their money back at once. If banks struggle to meet their own debts, they have no choice but to reduce their lending. If this happens on a large scale, as it did in the 1930s, the ripple eect for the economy as a whole can be devastating. Both of these eects were seen in the debt crisis of 2007-08. Falling property prices caused defaults and a liquidity crisis in the banking system so severe that the authorities feared the cash machines would stop working. Hence the unprecedented largesse of the bank bail-out. Hyman Minsky, an American economist who has become more fashionable since his death in 1996, argued that these debt crises were both inherent in the capitalist system and cyclical. Prosperous times encourage individuals and companies to

take on more risk, meaning more debt. Initially such speculation is successful and encourages others to follow suit; eventually credit is extended to those who will be able to repay the debt only if asset prices keep rising (a succinct description of the subprime-lending boom). In the end the pyramid collapses. In the aftermath of the latest collapse it is clear that the distinction between debt in the private and public sector has become blurred. If the private sector suers, the public sector may be forced to step in and assume, or guarantee, the debt, as happened in 2008. Otherwise the economy may suer a deep recession which will cut the tax revenues governments need to service their own debt. If the Western world faces an era of austerity as debts are paid down, how will that aect day-to-day life? Clearly a society built on consumption will have to pay more attention to saving. The idea that using borrowed money to buy assets is the smart road to riches might lose currency, changing attitudes to home ownership as well as to parts of the nance sector such as private equity. This special report will argue that, for the developed world, the debt-nanced model has reached its limit. Most of the options for dealing with the debt overhang are unpalatable. As has already been seen in Greece and Ireland, each government will have to nd its own way of reducing the burden. The battle between borrowers and creditors may be the dening struggle of the next generation. 7

The morning after A $3 trillion consumer hangover


N THE autumn of 2009 Jonathan Mitchell, a British software developer, realised he had a problem. He had been running up his credit-card bills for years after his partner got sick and was unable to work. He ended up owing ÂŁ30,000. You think if they are going to give it to me, I must be able to aord it, he recalls. Mr Mitchell tackled his problem before the bailis arrived. He took advice and applied for an IVA (individual voluntary arrangement), a British scheme that allows the borrower to negotiate a plan for dealing with his debts. After allowing for essential spending, he now pays ÂŁ280 a

month to his creditors. If his house rises in value over the next ve years, he will have to take out a further mortgage to pay back other creditors. But his life is not too constrained: he still has a mobile phone and satellite TV. Mr Mitchell is one of millions of consumers across the developed world who are struggling to deal with their debts in reduced economic circumstances. By the standards of past centuries he has got o lightly. A failure to repay debts was once seen as a sign of moral laxity. Nowadays it is the lender as much as the borrower who is perceived to be at fault for extending

credit to those who should never have been granted it. The idea that debt is a shameful state to be avoided has been steadily eroding since the 1960s, when a generation whose rst memories were of the Depression was superseded by one brought up during the 1950s consumer boom. People were already used to buying houses and motor cars on credit, but suddenly a whole range of durable goodsTVs, fridges, washing machinescould be had on easy terms. Credit cards and charge cards came into widespread use. Buyers no longer had to scrimp and save to get what they wanted; 1

The Economist June 26th 2010

2 they could have it now. As the range of de-

sirable products grew, from Nintendo Wiis to iPhones, the urge to buy rst and nd the money later increased. Consumers’ attitudes have changed incredibly over the past 15 years, says Steve Rees of Vincent Bond, a debt-management agency. They have gone from aspiring to be just above their pay bracket to aiming a long way above their pay bracket. All this meant that growth in consumer credit regularly outstripped growth in GDP in the Anglo-Saxon countries and saving ratios fell to historic lows. At the end of the second world war in 1945 consumer credit in America totalled just under $5.7 billion; ten years later it had already grown to nearly $43 billion, and the party was just getting started. It reached $100 billion in 1966, $500 billion in 1984 and $1 trillion in 1994, or around $4,000 for every man, woman and child. The peak, so far, was almost $2.6 trillion in July 2008. Household debt approached 100% of GDP in 2007, a level seen only once before, rather ominously in 1929. America was not alone in embarking on a debt spree. In Britain household debt rose from 105% of disposable income in 2000 to 160% in 2008, according to the McKinsey Global Institute, and in Spain the ratio rose from 69% to 130% over the same period. Only in the past couple of years have consumers paused for breath. In America the volume of consumer credit in 2009 declined by 4.4%. By March this year the annual growth rate had crept up only to 1%. In Britain credit-card lending fell in eight of the 16 months between January 2009 and April 2010. In part, this is because consumers in many countries have become more frugal in response to the recession and the decline in house prices. In America houses turned into cash machines during the cred-

A special report on debt 7

it boom as people remortgaged to release equity and boost their spending. Mortgage equity withdrawal rose from less than $20 billion a quarter in 1997 to more than $140 billion in some quarters of 2005 and 2006. After 2007 it slowed abruptly and even went negative (homeowners paid down debt) in 2009. Consumers are also more cautious about borrowing in view of sluggish wage growth and rising unemployment in most of the developed world. In part, too, borrowing has slowed down dramatically because lenders have become much more chary about extending consumer credit. A survey by the Federal Reserve in October 2008, when the nancial crisis was at its peak, found that 60% of banks had reduced credit-card limits for both new and existing customers. Like mortgage lenders, credit-card companies found they had allowed lending standards to drop too far. This spring the default rate on American credit cards was a record 13%, according to Fitch. How do lenders decide whether consumers are creditworthy? In America one of the key determinants is an individual’s FICO score, named after the Fair Isaac Cor3

Feeling poor America: Personal bankruptcy filings*, m

Consumer debt†, %











0 1980


Sources: American Bankruptcy Institute; Federal Reserve






*All non-business filings † Debt payments as % of disposable income

poration, which devised it. The idea goes back decades, to a time when small retailers, which needed to o er credit, pooled information on which customers were good and bad payers. These days the bulk of the information is provided by banks and lenders such as credit-card companies. This is translated into a score ranging from 350 to 800, with the most creditworthy customers getting the highest rating. Life’s new essentials Andy Jennings of FICO says that customers’ rankings remain remarkably steady over time; the best payers remain the best payers. What does change is the level of bad debts across all categories when the economy hits a recession. During the subprime-lending boom mortgages were offered to borrowers with lower FICO scores than in the past. An updated version of the FICO model, to reect the subprime crisis, was released last year. The crisis has brought about one big change in consumer behaviour. The mortgage used to be the last debt people would default on. They did not want to lose their homes or to forfeit the substantial deposit they had had to nd. But during the subprime boom many borrowers were able to buy homes without putting down any money, which changed their attitude. In effect, they were renting with an option to prot from higher house prices. In the current recession some borrowers have given priority to their credit-card and car loans rather than their mortgages. After all, they can usually nd a new home to rent. But without a car many of them cannot get to work and without a credit card they nd it hard to shop. Perhaps the housing crash will change attitudes towards home ownership. For a long time it seemed like a one-way bet, with homeowners able to buy an appreci- 1

The Economist June 26th 2010

8 A special report on debt

2 ating asset with cheap debt. Having real-

ised that prices can fall as well as rise and that houses are illiquid assets, many more people may opt for the greater exibility of renting and hold their wealth in more diversied forms. That is what happens in Germany, which has a much lower rate of home ownership than Britain or America. Meanwhile, those who have maxed out their credit cards have been forced to turn elsewhere. One very expensive route is payday loans. As Jean Ann Fox of the Consumer Federation of America explains, this involves the borrower writing a cheque to the lender for the sum borrowed, plus the nancing cost, which the lender cashes on payday. Over two weeks the cost works out at around $15 of interest for every $100 borrowed, which amounts to an annual interest rate of 400%. People

who use the facility average nine payday loans annually, so they can end up paying more in interest than they have borrowed. The outcome is predictable. According to the Centre for Responsible Lending, a quarter to half of all payday borrowers default every year. Congress has restricted access to such loans for the families of members of the armed services. But why do consumers choose such an expensive way of borrowing money? A lot of people opt for a payday loan because it’s easy and the lenders don’t run a credit check, explains Ms Fox. For many, debt has become a necessity, not a choice. In real terms, the median wage of American workers has barely shifted since the 1970s. Thomas Schoewe, chief nancial ocer of Wal-Mart, says that more than ever, our customers are

living pay cheque to pay cheque. They’re very concerned about their own personal nances. Consumers got by because both husbands and wives went out to work and they borrowed heavily, as described by Raghuram Rajan, an American economist, in his book Let Them Eat Credit . A fate worse than debt After the nancial crisis it briey looked as if consumers were becoming more cautious. Between the rst quarter of 2008 and the second quarter of 2009 the saving rate surged from 1% to 5% of personal disposable income. But then it fell back again, perhaps because people found they simply could not aord to save. Consumption held up because the Obama stimulus plan boosted incomes. But that boost will be strictly temporary. And then what? 7

Betting the balance-sheet Why managers loaded their companies with debt


OUNTRIES may be desperate to hang on to their AAA ratings to keep their borrowing costs down, but companies do not necessarily share that concern. The median rating of the companies assessed by Standard & Poor’s has fallen from A in 1981 to BBB- today (see chart 4). That rating is the lowest possible investment grade or, to put it another way, is just one notch above junk bond status. By itself, this suggests that creditors as well as borrowers have had a change of heart. Traditionally the institutions that held the bulk of corporate bonds were not allowed to buy anything but investmentgrade securities. Bonds might have become junk because of a deterioration in the issuing company’s nances, but they did not start that way. However, in the 1970s and 1980s Michael Milken at Drexel Burnham Lambert realised there was a group of investors who were willing to take the risk of a diversied portfolio of junk bonds because of the extra yield on oer. And indeed over time the extra yield oered by these bonds more than compensated investors for the risk of default. Mr Milken’s lesson endured even though Drexel collapsed. In the 1990s and early 2000s more and more people wanted to trade higher risk for higher rewards as the returns on cash and government bonds dwindled. Special-

ist distressed debt funds emerged that looked for undervalued bonds, rather as value investors combed the stockmarket for bargains. After the dotcom bubble burst, actuaries encouraged pension funds to diversify their risk so that their portfolios were no longer dominated by equities. At the same time a long period of low interest rates and occasional mild recessions helped fuel the growth of hedge funds and private equity, which rely on the use of borrowed money to enhance their returns. The advent of these new investors may have been responsible for some wild swings in credit spreads (the excess yields paid by companies to reect the risk of default). At the height of the credit boom in 2006 spreads had fallen to historic lows. Jay Ritter of the University of Florida says the market sometimes underestimates the default risk on junk bonds. Investors tend to look at recent default rates, which may be misleading. A boom in junk-bond issuance leaves companies with large pools of cash. It takes them a few years to drain these pools and get into trouble. By pushing down spreads, investors reduced the cost of capital and encouraged companies to take on more debt. At the same time the desire for high credit ratings was going out of fashion. Managements that hoarded cash were told to return it to shareholders so it could be invested else-


Heading for junk Standard & Poor’s median corporate-credit rating AAA AA A+ ABBB BB+ BBB 1980







Source: Standard & Poor’s

where rather than being frittered away on value-destroying acquisitions. Standard corporate nance theory, rst expounded by Franco Modigliani and Merton Miller, states that whether a rm is nanced by debt or equity should make no dierence to its value; the cashow is simply parcelled out in dierent ways. But the theory leaves out the tax treatment of different kinds of nance. In most countries interest payments are tax-deductible but dividend payments are not. The tax system may have encouraged companies to take on debt, although Mr Ritter says studies have found little relationship between cor1 porate tax rates and debt.

The Economist June 26th 2010


A stronger motive for borrowing more may have been executive pay. Most incentive payments these days come in the form of share options, which if the share price rises rapidly can soon turn executives into multimillionaires. The strongest driver of a company’s share price, in the short term, is the ability to meet quarterly targets for earnings per share. And using spare cash to buy back a company’s equity tends to increase earnings per share. Managers should have been deterred from taking on too much debt because a leveraged balance-sheet is more risky, but that did not seem to worry them. Chief executives these days come and go almost as quickly as managers of football clubs. A high-risk strategy may pay o in the short term; higher debt levels may sink the company only in the longer term, after the executive has left. Moreover, the value of the option is related to the volatility of the underlying share price; a riskier strategy makes that price more volatile and thus increases the executive’s putative wealth. Even if the option expires unexercised, the executive is no worse o. However, the increased use of debt across the corporate sector has not been uniform. American companies learned some lessons in 2000-02 when the bursting of the dotcom bubble brought down giants such as Enron and WorldCom. Quoted companies were more cautious about taking on debt in subsequent years. A report by the McKinsey Global Institute found that the non-nancial business sector in most countries entered the recent crisis with lower leverage (measured as the ratio of debt over book equity) than they had at the start of the decade. Instead debt was more concentrated, particularly on those companies that had been acquired by private-equity rms in leveraged buy-outs (LBOs). In some ways private equity is a creature of the great moderation from the mid-1980s to the mid-2000s. Private equity needs willing investors, access to credit, steady economic growth (so that the debt can be repaid) and rising asset markets (so that acquired companies can be sold again). But conditions are now less favourable. Economic growth may be sluggish as economies work o their debt, and oating companies on the stockmarket may be harder. Among the biggest debt investors were the managers of structured products called collateralised loan obligations (CLOs), but since the credit crunch the market has dried up. And the debts accumulated in the 2006-07 boom have to be re-

A special report on debt 9

nanced. Moody’s reckons that some 250 billion of LBO debt will need to be rolled over in the next ve years. Private-equity loans were just one of many assets (for example, mortgage, car and credit-card debts) that were bundled together and repackaged into instruments bought by investors who themselves were using borrowed money (banks, hedge funds and specialist vehicles like conduits). Such investors were taking advantage of the carry trade, borrowing at low rates to invest in higher-yielding but riskier assets. In theory this trade should not be sustainable in the longer term; the higher yields should merely compensate investors for the default risk. In practice, however, a long period of economic growth and falling interest rates meant that for a while the trade paid ountil the debacle of 2007-08. Carry on regardless While those good times lasted, hedge funds thrived. They found it easier than conventional fund managers to play the arbitrage game because as well as going long on cheap securities they could go short (bet on a falling price) on expensive ones. Sometimes these arbitrage opportunities were small, so borrowed money was needed to enhance returns. And hedge funds could impose higher annual charges than conventional managers, with performance fees on top. But many of these strategies were variants of the carry trade, which changed the face of the nance sector. Banks have always borrowed short and lent long. But the fact that bank deposits were guaranteed by the government, allied to the implicit guarantees oered when central banks cut rates at times of nancial crisis, lowered the banks’ cost of capital and made lever-

age more attractive. Investment and commercial banks became integrated as the old division imposed by the Glass-Steagall act was abolished. Investment banking was no longer just about broking (conducting transactions in return for commissions) or giving advice; it was about using the banks’ balance-sheets to help clients or manage risks. This generated some fat fees but increased the size of the banks’ balance-sheets. In America, the non-nancial corporate sector increased its debt-to-GDP ratio from 58% in 1985 to 76% in 2009, whereas the nancial sector went from 26% to 108% over the same period. It was that leverage that made the banks so vulnerable when the subprime market collapsed in 2008; the assets they ended up owning were illiquid, dicult to value and even harder to sell. Banks such as Bear Stearns and Lehman made the fatal mistake of assuming that the markets (often their fellow banks) would always be willing to roll over their debts, but they suered a bank run. The only dierence was that the charge was led by institutions instead of small depositors. In turn, the collapse of the nance sector had a huge impact on the rest of the economy and created a dilemma for governments. They want to increase banks’ capital ratios to avoid future nancial crises. But that will cause bank lending to grow more slowly or even contract, an outcome they are equally wary of. After the crisis struck the banks needed the governments to rescue them, but now the governments need the banks to buy their bonds. One reason why EU governments eventually rescued Greece was that a default would have threatened the member countries’ banking systems. As debtors and creditors, banks and governments are locked in a tight embrace. 7

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10 A special report on debt

A better bust? Bankruptcy is becoming less calamitous


OING bankrupt used to be the worst thing that could happen to a company. The term stems from the Italian habit of conducting banking on wooden benches in marketplacesbanca rupta means broken bench. Traditionally, it spelled ruin. Slowly but surely, however, bankruptcy law has changed in favour of the corporate debtor. The main driver has been American law, which has always tended to favour debtors (farmers in the mid-West and South) against creditors (eastern money men). In the 19th century the nancial problems of some of the railroad companies made lenders more determined to keep the businesses going; the value of an operational railroad was clearly higher than that of the steel rails and wooden ties that made up its physical capital. In modern America that approach has morphed into Chapter 11, a structure that allows companies to continue operating and prevents creditors from foreclosing on the business. Chapter 11 has allowed some companies to come back from the dead, although in some industries (notably airlines) at the expense of more pro table rivals. The system has the great bene t of clarity, with the court ensuring that the creditors are paid in order of seniority, with secured lenders getting rst cut. Even so, the system struggled to cope with the sheer complexity of Lehman Brothers’ failure. The investment bank became the largest ever Chapter 11 deal, involving loans of $640 billion. In Europe bankruptcy law is undergoing steady reform. It used to be completely impossible to deal with cross-border failures, says Alan Bloom, head of restructuring at Ernst & Young, an accountancy group. That was before Europe-wide insolvency arrangements for dealing with multinationals were introduced in 2005. But it still leaves the issue of which country’s courts control the process. That depends on which nation is the centre of main interest for the company. There is scope for some legal arbitrage: Wind Hellas, a Greek telecoms company with headquarters in Luxembourg, managed to shift its centre of interest to Britain so it could restructure in the British courts. Generally speaking, Britain is deemed to have the most creditor-

friendly approach. At the opposite end of the scale is France with its sauvegarde scheme, where the priority is to save the business and the employees, with the creditors taking third place. Only the debtor can apply for sauvegarde. The company has to present a repayment plan to the court, but the court can reject it and impose a plan of its own. The plan also requires a majority vote, with large creditors able to vote down small ones and unsecured creditors able to outvote the secured. Debt repayment can be slow; even under a court order, it can take up to ten years. It looks brutal to creditors but this is often the subject of pre-negotiation, says Alan Mason of the Paris oce of Fresh elds Bruckhaus Derringer, a corporate-law rm. There are signs that rms, under pressure from creditors, are reorganising themselves to avoid sauvegarde. With lenders in most countries seeing their rights under bankruptcy law cur-

tailed, they might have been expected to insist on more safeguards upfront. Far from it. At the peak of the lending boom in 2006 and 2007, the fashion was for covenant lite deals which gave creditors fewer safeguards; traditionally, covenants were used to force debt repayment when the debtor missed certain nancial targets. But investors were so keen to chase higher yields that they were willing to dispense with these protections. A lot of this had to do with the shadow nance industry of non-bank institutions and lenders, and the structured products (such as CDOs and CLOs) it created. The industry had such an appetite for debt to feed these beasts that creditors were inclined to lend rst and ask questions afterwards. Now that the reckoning has come, sorting out the nances of troubled companies has become far more complex. It used to be that a relatively small number of banks owned a company’s debt, says Matthew 1

The Economist June 26th 2010

2 Prest of Moelis, a company that specialises

in debt restructuring. When things went wrong, the company knew whom to call. The banks, for their part, specialised in analysing credit and had workout teams to deal with trouble. These days companies may have several di erent types of debt, or leveraged loans that have been repackaged and sold round the world. The interests of the owners of di erent slices of debt are often at odds with each other, a state of a airs known as tranche warfare. Those who own the most senior securities in CDOs and CLOs, ranked AAA or AA, might want to sell the company’s assets immediately to ensure they get their money back. But the owners of the more risky types of debt would be wiped out by that, so they usually want to hang on in the

A special report on debt 11

hope that the company’s prospects improve. The owners of the riskiest tranches often have the most voting power. One potential conict, says Andrew Speirs of Hawkpoint, a rm that advises on corporate nance, is between distressed-debt managers and the original debt holders. The rst group has bought the bonds or loans at a discount and is looking for a quick return; the second, having paid the full price, would prefer to hold on in hope of a higher payout. Delay and pray In the CLO market, which largely consists of loans made to private-equity groups, there are special reasons to be patient with struggling borrowers. The private-equity managers have little interest in restructur-

ing the debt, since that would dilute their stakes. The banks are not keen either, since restructuring would require them to write down the value of the debt on their balance-sheet just as they are struggling to improve their capital ratios. Many loans are therefore limping towards maturity in a process known as extend and pretend or delay and pray. Signs of economic recovery and the support schemes organised by central banks have eased this process along. The prices of distressed debt have increased substantially since the dark days of 2008. But there is still a pile of debt that needs to be renanced over the next decade. With the old CDO/CLO machine damaged and with banks more cautious about risking their capital, trouble could still lie ahead. 7

The unkindest cuts Many countries face the di cult choice of upsetting the markets or upsetting their voters


ALL it the rich-uncle theory. When the private sector struggles, governments often step in to pick up the bill. And when individual countries have trouble meeting their commitments, they turn to their neighbours, or to the International Monetary Fund, for help. The recent recession, and the nancial crisis that precipitated it, have led to a sharp increase in government debt in the developed world, on a scale virtually unprecedented outside world wars. For some states this burden has arisen at a time when their nances were already stretched. And for most countries in the rich world this has happened when they are having to face up to a range of problems associated with ageing populations. Countries have long had a complicated relationship with their national debt. It was the need to repair its national nances that forced the ancien regime of Louis XVI in France to summon the Estates-General in 1789, an event that triggered the French revolution. In his book, A Free Nation Deep in Debt, James Macdonald argues that the national debt was a source of strength for countries such as Britain and the Netherlands, whose governments were nanced by merchants and bankers. In wartime such countries could easily outspend those run by aristocrats, which had a history of default. For Britain and the Netherlands there was no incentive to de-


The worst for decades G7 net government debt, % of GDP 150


120 90 60 30 0



Source: IMF





12 *Forecast

fault on the debt owed to the classes that controlled them. During the rst and second world wars governments on both sides of the conict exploited the patriotism of their citizens, persuading them to buy victory bonds and the like. Those same governments then penalised the patriots by inating away their debt after the war. From 1945 onward government debt became a tool of economic management as Keynesian decit spending was used to cushion economies during recessions. The booms of the 1980s and 1990s led to a surge in tax revenues and kept the debt problem under control. But the recent nancial crisis caused some of the biggest decits record-

ed in peacetime. The debt-to-GDP ratio of the G7 group of nations is at its highest level for 60 years (see chart 5). That has started to raise questions about whether countries can actually meet the bill. Allowing governments to assume debt has some obvious advantages. If companies, and in particular banks, go bust, they cause a lot of knock-on social costs, including lost jobs and consumer uncertainty. Governments are much less vulnerable to credit runs because they can raise taxes and print money to buy time for the debt shock to be absorbed. Governments also nd it easier to fund decits during recessions, when nervous investors are only too happy to shelter behind the safety of government bonds. But in the long run decit nancing is the equivalent of a private individual getting a new credit card and making the minimum repayment every month. For a while it seems like free money. The tricky point comes when the credit limit is reached. For governments, that credit limit can vary enormously. One reason why the crisis has hit the euro zone before other regions is that its countries have renounced the money-printing and devaluation options by adopting a common currency. In some ways the problems facing euro-zone members are akin to those facing countries on the gold standard in the 1930s. They had 1

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12 A special report on debt

2 to choose between imposing austerity to

maintain the standard or repaying creditors in devalued currency. The countries that went o gold soonest tended to recover fastest. But abolishing the link to gold was far easier than it would be to replace, say, the euro with a new drachma. With luck, today’s government decits will be temporary, gradually disappearing as the private sector comes to the fore again. Countries recovered from even bigger government debt burdens after the second world war. But at that time the personal, industrial and nancial sectors of the economy were much less indebted. Economists are still arguing about how quickly to cut government decits. Earlier this year the dierent schools sent rival letters to the Times, discussing the suitability of early eorts to cut Britain’s budget decit (the new coalition government announced cuts of £6 billion in May). The fear is that higher taxes and spending cuts will cause job losses and hit demand at a point when the economy is still fragile. The doves contend that the rst priority should be to stimulate growth, since that will automatically raise tax revenues and cut expenditure on items such as unemployment benets. The hawks counter that there comes a point when further decits are self-defeating. Carmen Reinhart and Kenneth Rogo suggest that the crunch arrives when the debt-to-GDP ratio reaches around 60% in emerging markets and 90% in developed economies. In rich countries median growth rates tend to fall by around one percentage point a year once that limit is reached. When debt gets too high, a number of problems arise. First, a spiral is set o in which lower credit ratings for a country lead to higher borrowing costs, in turn increasing the decit. Markets already seem unwilling to fund some countries at sustainable rates: by the time Greece turned to the IMF and its EU partners for help, its short-term bond yields were nearly 20%. Ramin Toloui of PIMCO, a fund-management group, explains the process this way: When government debt reaches extreme levels, concerns about government creditworthiness become so severe that additional government spending produces increases in long-term interest rates that exacerbate, rather than ameliorate, the economic contraction. Second, once a country is stuck in this debt trap, it has to bring in austerity programmes to reduce the decit; but such austerity holds back economic growth because higher taxes and lower spending re-

duce demand. Like the Red Queen in Lewis Carroll’s Through the Looking-Glass , the country has to run as fast as it can just to stand still. Ireland has been the good boy of the sovereign-debt markets, taking quick action to reduce its decit through measures such as cutting public-sector pay. But other countries may not be in a rush to emulate it: its nominal GDP has fallen by over 16%. Third, larger government decits imply greater government interference in the economy and thus a less ecient use of resources. One study found that each percentage-point increase in the share of GDP devoted to government spending reduced growth by 0.12-0.13% a year. Last, according to the doctrine of Ricardian equivalence, consumers and businesses see larger decits as the precursor to higher taxes in future, so they save more of their income, meaning that pump-priming by the government ceases to work. Even those governments that are tempted to keep stimulating the economy may nd that the markets punish them for it. Once a crisis of condence has occurred, governments nd it dicult to raise the money they need at an acceptable interest rate. A report by an economic adviser to the Bank for International Settlements in March noted that our projections of public debt ratios lead us to conclude that the path pursued by scal authorities in a number of industrial countries is unsustainable. Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability. Countries that decide to embark on deficit reduction may face another problem.

According to Andrew Smithers of Smithers & Co, a consultancy, a debt-cutting policy will make it harder for the government to bail out the private sector in times of need, as well as reducing companies’ cashow by imposing higher taxes. An even bigger problem may be the unfunded liabilities that government face from ageing populations. This is a double burden: benets for growing numbers of pensioners will have to be paid for by a shrinking band of workers. These liabilities are dicult to calculate. Pierre Cailleteau of Moody’s, a rating agency, says that the state of public-nance accounting is extremely rudimentary relative to privatesector accounting. A 2009 report by Jagadeesh Gokhale, of the right-wing Cato Institute in Washington, DC, estimated that the average EU country would need a fund worth 434% of its GDP, earning interest at the government’s borrowing rate, to meet such liabilities; alternatively, it would need to save 8.3% of its GDP each year. Neither seems realistic. The only answer is to cut future benets. But the elderly form a powerful voting block, with a higher turnout than their children, who will pay the bill. European extremes Neither Greece nor Iceland has had any choice about tackling its decits. They may be a long way apart, both geographically and culturally, but both are casualties of the debt crisis. Iceland was the little country that could. A land with just 300,000 people, best known for its volcanoes and its sh, it privatised its banks and suddenly became an international nancial powerhouse. In the Icelandic system, all the banks were aggressive broker-dealers like 1

The Economist June 26th 2010

Bear Stearns and Lehman, says Asgeir Jonsson, an economist and author of a book, Why Iceland? . A high exchange rate encouraged its corporate sector to go on an overseas acquisition spree. Its housing market boomed as shermen took out cheap loans in euros and yen. The country became an egregious example of the excesses of nancial liberalisation. Its politicians failed to halt its debt spiral because its citi-

A special report on debt 13

zens (and particularly its elite) seemed to be doing well out of the boom. Houses doubled in price, the strong krona allowed its people to go shopping in London and its billionaires to buy British retailers and football clubs. Greece, for its part, was not noted for an aggressive banking sector or a housing boom. It was traditionally dismissed by investors as a country of high ination and repeated devaluations. When it joined the

Judging the judges T HE rating agencies did not have a good debt crisis. They were accused of being, at best, naive about the safety of complex structured products such as collateralised debt obligations (CDOs) and, at worst, being less than impartial because of the fees they got from issuing CDOs. Now companies such as Standard & Poor’s, Moody’s and Fitch are back in the limelight. Every time they change the rating of a sovereign debt they move the markets. For a while the rules of the European Central Bank seemed to give enormous power to just one agency, Moody’s. Had it downgraded Greece, the country’s government bonds would not have been eligible for use as collateral for loans from

the ECB. (The ECB eventually amended the rules to accept Greece’s bonds, whatever their rating.) More recently the agencies have been accused of being too harsh, and even of being part of an Anglo-Saxon conspiracy to hold down the southern European nations. Countries have been outraged by downgrades. There has been talk of setting up a rival European rating agency. The agencies put up a vigorous defence, pointing to the good record of their ratings in predicting sovereign default rates. No country rated AAA, AA or A has gone on to default for 15 years. Nearly 98% of countries ranked AAA were still ranked either that or AA 15 years later.

euro zone in 2001 it reaped an immediate dividend in lower interest rates, but it failed to tackle its underlying problems. Dodgy accounting disguised the size of its government debt. Its businesses remained uncompetitive, causing a large trade decit. The economy is riddled with ineciencies and restrictive practices. For example, cruise ships are not allowed to take on new passengers at Greek ports, and the number of lorry licences is still the sa- 1

The travails of the rating agencies When Standard & Poor’s downgraded Greece to junk status in April, David Beers, its head of sovereign ratings, put the move into perspective: We provide an independent view that investors may or may not choose to consider. Ratings are one of many inputs that investors look at, and they are only one of many factors that may aect movements in the market. Mr Beers argues that people may be paying too much attention to maintaining the top AAA rating: People’s perceptions are that a downgrade from AAA means that minutes later you default, but in fact it means only a slight increase in default risk. But Pierre Cailleteau of Moody’s says that because of the crisis we have to dene the boundary between AAA and AA ratings very clearly. The agency uses three concepts: economic and institutional strength, government nancial strength and susceptibility to event risk. Mr Cailleteau says the key measure is not the debt-to-GDP ratio but the proportion of government revenues devoted to interest payments. Once that proportion exceeds 10%, keeping the AAA rating becomes more dicult. But the agency will not downgrade the country if the government is committed to decisive action to reduce the decit. But what constitutes decisive action? In judging that, the rating agencies are bound to be drawn further into tricky political territory. For example, they will have to weigh the new British coalition’s plans to deal with its decit, and assess how far EU countries are likely to go in bailing out their indebted fellow members. One thing is certain: the agencies will be shot at from all sides.

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14 A special report on debt

2 me as in 1990 even though GDP has dou-

bled. Such restrictive practices are keeping transport costs too high. According to Yannis Stournaras of IOBE, a think-tank, it is cheaper to transport goods to Athens from Italy than from Thebes, just 32 miles away. Greece is an exemplar of the aws in the European welfare model. The state gets remorselessly bigger because political parties of the right and left have bought votes by providing supporters with jobs or subsidies. Antonis Kamaris of Levant Partners, an investment group, says the state must remove benets that have built up like a ship accumulates barnacles . Public-sector workers were mollycoddled with pay for 13 or 14 months per year and arcane allowances for things like rewood or carrying les between oce oors. Tax evasion is widespread. A report by the London School of Economics estimates that it reduced Greece’s potential tax yield by 26%. It is normal to do deals under the table. On the birth of his baby daughter one parent was asked to hand over 2,500 in cash to the doctor, in exchange for a receipt for 1,500. The Greeks are attempting to tackle this issue. The austerity packages introduced over the past 12 months require higher earners to provide receipts for expenditure before they can qualify for their tax-free allowance. Market discipline did not work in either country. Greece beneted from the implied credit upgrade provided by joining the euro zone. Iceland, with its high interest rates, got a boost from the carry trade , with investors borrowing money in lowyielding currencies (eg, the yen) and buying high-yielding ones (eg, the krona). It was a classic case of monetary boom and bust, says Thordur Palsson, a former chief

economist at Kaupthing, a big Icelandic bank. The money supply increased at 40% a year over a ve-year period. Both economies face fundamental diculties. For Greece, being a member of the euro zone is now a hindrance rather than a help. Its costs are too high but it cannot devalue its currency, and trying to inate its way out of its debt would, in eect, be impossible. Iceland, which is not a member of the European Union, has been able to devalue the krona, but that created a problem for individuals and companies which had borrowed in foreign currencies. Its banks had to be nationalised and domestic depositors were favoured over foreign creditors. Both countries have had to call in outside help. The Icelanders have borrowed from the IMF, with their negotiations made more complex by a dispute with Britain and the Netherlands over compensation for foreign depositors in one of its big banks. Iceland is trying to reduce its scal decit, which in 2008 reached 13.6% of GDP, via increases in value-added tax, income tax, and petrol and alcohol duties. Rising unemployment has prompted many Icelanders to emigrate, causing the population to fall for the rst time since the 19th century. In Greece spiralling debt costs also forced the government to turn to the IMF as well as to its EU partners. But it remains to be seen whether the population will tolerate the austerity needed to bring the debt burden down to a reasonable level. The most recent package of cuts provoked a wave of strikes and riots in which three bank employees died. America also faces a huge debt problem. The Congressional Budget Oce cal-

culates that the federal government will accumulate a decit of $10 trillion between 2011 and 2020, and even that depends on some fairly optimistic assumptions about economic growth. Unless policies are changed, total government debt will reach 100% of GDP by 2023. There are unfunded liabilities on top of that. Chris Watling of Longview Economics reckons that the net present value of spending commitments under the Medicare, Medicaid and Social Security programmes is 276% of GDP. The Democrats resist cuts in entitlements and the Republicans resist tax increases, so nothing much gets done. Eorts to establish a bipartisan decit-cutting commission have failed. Advantage America But America has two huge advantages over other countries that have allowed it to face its debt with relative equanimity: possessing both the world’s reserve currency and its most liquid asset market, in Treasury bonds. Even in the midst of the credit crunch, when some of the biggest Wall Street banks were collapsing, the dollar rose and Treasury bond yields fell, making it easier and cheaper for America to nance its decit. There may come a time when America is hit by a funding crisis, but it does not look imminent. America would be more at risk if the Asian central banks and sovereign-wealth funds had an obvious alternative. But with Europe in the midst of its own debt crisis, the euro does not look like an appealing option. And there is simply not enough gold in the world to absorb a substantial portion of central-bank reserves. For the moment, the dollar is the one-eyed currency in the land of the blind. 7

In a hole Stagnation, default or in ation await. The only way out is growth


HERE is an old joke about a stranger who asks a local for directions and gets the cheerful reply: If I wanted to go there, I wouldn’t start from here. That advice sums up the dilemma the developed countries face in dealing with their debt. They have accumulated a mountain of it at every level, from the personal to the corporate and the sovereign. As this special report has shown, this was encouraged by a legal system that sheltered debtors, a cor-

porate and nancial sector that used debt to boost its returns and a cultural change that made it more respectable. Central banks and governments implicitly guaranteed this debt, riding to the rescue whenever a repayment crisis loomed. They intervened in a host of small nancial res, using low interest rates to put out the ames. But this merely allowed the tinder to build up that set o the huge conagration of 2008. Now the govern-

ments’ own balance-sheets have deteriorated. In America the amount of government debt per person has risen from $16,000 in 2001 to $34,000 now, and household debt has gone up from $27,000 to $44,000. In Britain government debt per head has almost trebled, from £5,000 in 2001 to nearly £18,000 today, and household debt has jumped from just under £14,000 to £24,000. Cutting the debt back to more accept- 1

The Economist June 26th 2010

2 able levels is both hard and unappealing,

since it may involve years of austerity and slow economic growth. It also requires some tough political decisions. If being able to borrow makes people feel richer (however illusory the sensation), having to repay the debt makes them feel poorer. They resent the sacrices involved, especially if they are imposed by outsiders. This is particularly true in democracies. In a referendum Icelanders voted overwhelmingly against a debt repayment deal with Britain and the Netherlands. Dani Rodrik, an economist at Harvard, has talked of a trilemma in which countries aiming for the three goals of deep economic integration with the rest of the world, national sovereignty and democratic politics can achieve two of them but not all three. Left to themselves, voters will resist the sacrices needed to remain competitive in a system of deep economic integration, and nation states are constantly erecting barriers to international trade. One way of eliminating those barriers would be to set up some sort of global federal government. Another would be to install a free-market Stalina gure in the mould of Chile’s Augusto Pinochetwho would force his country’s citizens to accept the constraints of the global market, including debt repayment. Neither option is appealing. The citizens of Europe may now be realising that debt transfers power from the borrower to the creditor. The rst world war destroyed Britain’s credit position and ushered in the era of American nancial dominance. Now the debt burden reects the shift in the balance of economic power from rich countries to developing ones. It is striking that on average developed countries now have a higher debt burden than emerging nations. Investors have certainly noticed, and have poured money into emerging-market bonds funds over the past year. Developing countries also have more chance of outgrowing their debt burdens. According to Tony Crescenzi of PIMCO, investors are asking themselves, Would I rather lend money to nations whose debt burden is worsening, or to nations where it is improving? This pattern of debt is the opposite of what you might expect. At the level of individual consumers, people tend to borrow when they are young because they are hoping for higher incomes in the future. As they reach middle age they start to pay o their debts and save for retirement. By extension, rich countries with their greying populations should be saving whereas

A special report on debt 15

younger, fast-growing developing countries should be borrowing heavily. But in fact it is the other way round. This is not unalloyed joy for the creditor nations. Once the exposure of a creditor to a borrower gets suciently large, the two sink or swim together. The relationship between China and America has been described as vendor nancing, in which the Chinese lend the Americans the money to buy their cheap manufactured goods; a collapse in American demand would cause substantial unemployment (and social unrest) in China. The longstanding system of vendor nancing may have encouraged the rich world to concentrate on consumption rather than investment and to enjoy the resulting articial growth, like a child on a sugar high. Richard Koo, who wrote a book about the Japanese recession, The Holy 6

Mountainous terrain US debt as % of GDP Financial

Non-financial businesses


Government 360 300 240 180 120 60 0






2000 10

Sources: Bureau of Economic Analysis; Federal Reserve; The Economist

Grail of Macroeconomics, refers to a debtnanced boom as cherry-blossom economics. He recounts the tale of the two brothers who bought a barrel of sake to sell to revellers at Japan’s cherry-blossom festival. But instead of taking money from the thirsty crowd, each brother charged the other for a cup of sake, then used the proceeds to buy a cup for himself, and so on. The brothers ended the day drunk and empty-handed. Jeremy Grantham of GMO, a fund-management group, is a detached and cynical observer of the nancial and economic scene. The way he sees it, all debt seems to do is bring growth forward a little. If you get people to spend 1% more than their income every year, after 20 years they are going backwards because interest expense is eating up more of their salary. Robert Bergqvist, chief economist at SEB Group in Sweden, is equally pessimistic.

The leverage-led growth model is dead, he says. Households and corporates can increase borrowing and enhance today’s consumption and investments but that requires that we can assume higher future incomes and expected returns and/or rising asset values. And this is not certain. Running out of ammunition The debt burden may also have had a distorting eect on economic policy. In the 1960s and 1970s governments grappled with a wage-price spiral in which demands for higher wages forced companies to increase their prices, which in turn triggered demands for higher wages. The past two decades have seen a debt-interest rate spiral. It starts o with the private sector borrowing a lot of money. This is followed by a crisis in which the central bank cuts interest rates to help borrowers. That encourages the private sector to borrow more, which makes it all the more imperative for central banks to come to the rescue when the next crisis comes along. With short-term interest rates now at 1% or less in America, Britain, Japan and the euro zone, this process cannot go any further. If the 1960s and 1970s produced consumer ination, the debt-interest rate spiral created asset ination. In 2000 this pushed share prices to unprecedented peaks; indeed many stockmarkets have yet to regain the levels they reached a decade ago. Now the support of asset prices has entered a new stage, with central banks buying assets (in particular, government and mortgage-backed bonds) directly to boost the nancial sector. Indeed, that sector was the biggest beneciary of this spiral. Before the credit crunch it generated some 35% of all domestic prots in America. A highly sophisticated society would be expected to spend quite a lot on nance, but that gure still looked too high. We have been transferring aggregate income and wealth to the nancial-services industry. All this nancial activity is just a deadweight on the system, says Mr Grantham. During the debt boom the optimists argued that the huge growth in derivatives did not add to risk in the system because every buyer was matched by a seller. Nobody drew attention to the fact that with each new instrument the nance sector took a cut in the form of a fee, or the spread between buying and selling prices. As derivative was piled on derivative, debt on debt, the cut got ever larger. Financial prots may have articially boosted the government’s revenues across 1

The Economist June 26th 2010

16 A special report on debt


2 a range of items, from corporate prots to

capital gains and taxes on bonuses. Some of that revenue may now be lost for good. Mr Koo points out in his book that whereas in 1990 Japanese tax receipts were ¥60 trillion ($416 billion), in 2005 they had come down to only ¥49 trillion, even though Japan’s nominal GDP was 13% higher. When revenues were booming, governments thought they would keep coming and increased their spending accordingly. Now it is hard to see how the gap can be closed. The vast amount of debt at every level also raises the question whether the pool of savings is large enough to absorb it all. In the early 2000s there was no problem. Central banks and sovereign-wealth funds in the emerging economies seemed only too happy to recycle their current-account surpluses into the government bonds of rich countries. This forced down bond yields and tempted rich-world investors to look for better returns by buying mortgagebacked and high-yield corporate bonds. All that changed with the credit crunch. Suddenly the business sector found it very dicult to borrow. By contrast, governments found it easy because their debt was seen as safe. But once economies start expanding again, business and governments may start competing for the same pool of savings and the public sector may crowd out the private one. As the Greek crisis has shown, countries which want to dip into that pool would do well to keep their nances in order. If attracting international investors is too hard, governments will be tempted to lean on their domestic savers. Theo Zemek, who heads the xed-income division at AXA, a giant insurance company, reckons that a combination of regulatory and accounting changes will encourage banks and insurance companies to buy more

bonds, and ageing populations in the rich world will also want to hold more assets that produce xed incomes. Historical factors such as legal, tax and monetary policy have provided incentives for consumers, companies and (crucially) the nance sector to pile on debt. The level of debt has become untenable, but the options for reducing it are not enticing. Here’s how not to do it One example not to follow is Japan, which has suered a long period of stagnation accompanied by ever-rising governmentdebt-to-GDP ratios. This has proved sustainable only because of the country’s strong external position; it owes its debt to its own institutions. For nations that owe money to foreigners, a long period of stagnation is likely to lead to at least partial default. This may be the eventual outcome in Greece, despite the recent rescue package put together by

the IMF and the EU. Ms Reinhart and Mr Rogo argue that the world is due for a wave of sovereign defaults, which are common after serious nancial crises. Another undesirable model is to inate the debt away, as has often happened in the past. At the extreme, as in Germany in the 1920s, central banks monetise the debt, simply printing the money to allow the government to pay its bills. Some regard quantitative easingin which central banks create money to buy nancial assets, mainly government bondsas monetisation by another name. But many countries may nd this dicult, especially if they have a lot of short-term debt. Dhaval Joshi of RAB Capital, a hedge fund, explains that 53% of government debt will have to be rolled over by 2012, for example. If investors think ination is set to rise, they will demand higher yields, increasing the cost of servicing the debt. Stagnate, default, inatethey all seem equally grim. The best solution for rich countries is to work o their debts through economic growth. That may be harder for some than for others, given that many countries’ workforces are set to level out or shrink as their populations age. It will be all the more important for such countries to pursue structural reforms that will increase productivity. But outgrowing debt is not easy: the McKinsey study found that, out of 32 cases of deleveraging following a nancial crisis that it examined, only one was driven by growth. America, which has a younger workforce than Europe or Japan, might still manage it. But for many other countries the hole they have dug for themselves may already be too deep. 7

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The Economist June 26th 2010


Also in this section 53 French football 53 Tax evasion in Italy 54 Turkey and the PKK 54 Organised crime in the Balkans 55 The Polish election 56 Charlemagne: The EU and China

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Russia and its neighbourhood

Russia’s empty empire

Russia’s neo-imperialist ambitions founder on the rocks of reality


O MUCH for Russia’s zone of privileged interests and the West’s worries about it. The phrase was coined by Dmitry Medvedev, Russia’s president, in the aftermath of the 2008 war with Georgia, when Russian rhetoric reached shrill levels. The events of the past two weeks in Belarus and Kyrgyzstan have provided a humble reality check and exposed the hollowness of Russia’s neo-imperialist ambitions among the states that once made up the Soviet Union. Russia has long wished to keep the West away from its backyard. Now that America and the EU are tied up with their own problems, Russia has had its wish partly granted. Left to its own devices, however, it has shown little leadership, vision or sense of imperial responsibility in its vaunted zone. A spat over gas with Belarus has exposed the fragility of the embryonic customs union between Russia, Kazakhstan and Belarus, put forward by Moscow as the nucleus of a new Russia-dominated economic club. The bloody pogroms in Kyrgyzstan (see page 44) reveal the Collective Security Treaty Organisationa postSoviet military alliance of Russia, Kyrgyzstan, Uzbekistan, Kazakhstan, Tajikistan, Belarus and Armeniato be a chimera. In its dispute with Belarus this week Russia started to cut gas supplies to its supposed close ally, claiming it was owed

some $200m. The debt stems from Belarus’s decision to pay last year’s price of $150 per thousand cubic metres of gas, ignoring a Gazprom price increase. Alyaksandr Lukashenka, Belarus’s maverick leader, upped the stakes by ordering a cut in transit shipments of Russian gas to the EU, arguing it was also owed money. On June 24th Gazprom resumed full supply but Belarus maintained its claim. This is not the rst spat between Russia and Belarus, and it will not be the last. But, as Fyodor Lukyanov, the Russia editor for Global A airs, argues, this time the row has a political avour. For all his authoritarianism and anti-Americanism, Mr Lukashenka is disdained by Russian ocials for reneging on his promises and dragging his feet on agreements. He has skilfully managed to extract large subsidies from Russia while poking it in the eye and playing it o against the EU. Last year the Belarusian president refused to recognise the independence of South Ossetia and Abkhazia, the two breakaway Georgian territories over which Russia had warred with Georgia. That was followed by a Russian ban on Belarus’s milk products. More recently, Mr Lukashenka has decided to shelter Kurmanbek Bakiyev, the overthrown authoritarian leader of Kyrgyzstan, who is loathed by Moscow. Mr Lukashenka has also sabotaged the

customs union with Kazakhstan and Russia, demanding that Russia scrap its export duty on oil and oil products, which would allow Belarus to buy them at Russia’s domestic prices and to re-export them at a prot. (Russia wants to keep oil out of the union for now.) Russia’s response is to reach for its favourite weapon: the gas taps. In its relations with its neighbours, Russia has mostly relied on coercion. Consider its response to Mr Bakiyev’s fall and the subsequent pogroms in Kyrgyzstan. The Kremlin shed no tears for Mr Bakiyev, whom it saw as two-faced and greedy. Last year Mr Bakiyev extracted a $2 billion aid package from Russia in exchange for a promise to close an American military air base in Kyrgyzstan, as Russia insisted. He then raised the rent for the American base and allowed it to stay. Solve your own problems When, earlier this month, the Kyrgyz clashed with the Uzbek minority in the southern Kyrgyzstani city of Osh and the interim government appealed to Russia for military help, the Kremlin stood back. To the outside world it looked like the opportunity Russia had been waiting for to show that it dominates its backyard. To Russia it was a nightmare that evoked memories of Soviet involvement in Afghanistan in the 1980s. Russia’s ocial line was that it could not interfere in Kyrgyzstan’s internal affairs (a statement that sat oddly with Russia’s war against Georgia). In fact, Russia has neither the capacity nor the will for such intervention. As Alexander Golts, an expert on Russia’s armed forces, argues, the Russian armywhich largely consists of unskilled recruits and is plagued by bullyingis not equipped for the sort of peacekeeping operation they were asked to carry out in Kyrgyzstan. Be- 1

The Economist June 26th 2010 2 sides, Russia’s allies in the CSTO, particu-

larly nearby Uzbekistan and Kazakhstan, have no desire to see Russian troops setting a precedent by sorting out the internal affairs of a neighbouring state. Russia’s intervention would be unpopular at home too. Xenophobia towards migrant workers from Central Asia and memories of Afghanistan would make any sacrice of Russian lives in Kyrgyzstan unacceptable to most Russians. Yet, if Russia was right not to send troops to Kyrgyzstan, it was wrong to claim the country as part of a zone of privileged Russian interest. When ethnic clashes broke out in Osh 20 years ago, Mikhail Gorbachev sent in Soviet troops. Today’s government, for all its Soviet nostalgia, seems to feel no such obligation. What Russia’s response to Kyrgyzstan has made clear, Mr Golts observes, is that Moscow bosses imitate imperial ambitions in the same way they imitate democracy. 7

French football

Three neuroses on their shirts Paris

What the travails of Les Bleus say about modern France


AFFLED, shaken and nally repelled, the French have watched aghast at the existential drama that unfolded this week in South Africa, on the pitch and o it. World Cup winners in 1998, France were eliminated from this year’s tournament without winning a single game, and ew home in disgrace. But it was the team’s performance o the pitch that so appalled the French, described by the sports minister, Roselyne Bachelot, as a moral disaster that had tarnished the image of France . The asco began with a dressing-room row, in which a star player, Nicolas Anelka, yelled insults at Raymond Domenech, the coach. The French Football Federation sent Mr Anelka home, prompting a mutiny by the players, who refused to train for the next match. As recriminations ew, the captain, Patrice Evra, said that the problem was not Mr Anelka but the mole who leaked the row. The unloved Mr Domenech called the players imbeciles . Players and sta rowed in front of the cameras. President Nicolas Sarkozy even held a crisis meeting in response. The aair has provoked much agonised introspection. Aime Jacquet, the victorious 1998 coach, said he was ashamed , describing the team as the laughing stock of the world . Le Monde, the bible of the Paris intellectual, described the team as a mirror of French society today. Dominated by

Europe 53 Tax dodging in Italy

Evasive measures Rome

A decree brings new measures to reduce tax cheating


HE owner of ve Ferraris claims an income of 1,000 ($1,200) a month. A restaurant owner purchases a 750,000 home but declares nil income. An owner of a large property portfolio never les tax returns. Cases like these are part of the colourful patchwork of Italian tax evasion, which is estimated to cost the country around 100 billion a year, equivalent to some 6% of GDP. Little wonder that the government is trying harder to collect the money. A nancial-stabilisation decree enacted on May 31st contains several measures aimed at tax cheats. To encourage town councils to join the battle, the government is oering them one-third of revenues recovered and nes levied for their part in successful prosecutions. Another measure imposes checks on rms that shut within a year of being set up, which are considered likely vehicles for fraud. The decree also requires tax authorities to look at rms that declare losses in more than one tax year, stiens the rules on blacklisted tax havens and requires payments made to the state

tormented egos and star salaries, cut o from the reality of the country and their fans, split into clans . Bernard Kouchner, the foreign minister, called it an appalling soap opera . Jacques Attali, an economic adviser to the president, hoped that the affair would act as a wake-up call and show the French they could no longer be

He can’t even be satis ed with past glories

pensions agency to be cross-checked against tax returns. Some experts think that the most eective tool in the decree will turn out to be a reduction in the limit for cash transactions from 12,500 to 5,000, with heavy penalties for infringements. Italians still rely heavily on cashlast year they made only 66 non-cash transactions per person compared with about 170 in the euro zone. And it is cash that oils the black economy, where evasion is the rule, whether by a plumber who xes a leaking tap or a clinic that charges less for non-invoiced services. Yet as Italians prepared their 2009 tax returns to meet a mid-June deadline, cheats probably pondered whether they were at serious risk of being caught. And, according to Andrea Aleri, a Romebased accountant, the economic downturn may have had a pernicious inuence. Tougher times have eroded cash balances and, with less money in their pockets, many Italians may have ignored the tighter rules and continued thinking that taxes are optional. satised with past gloriesglory is the worst enemy of power, and nostalgia the worst poison for the future. The debacle, and the reaction to it, says as much about French neuroses as it does about football. First, there is the prickly matter of race and religion. Most of the French squad are black, and many are Muslim, including Mr Anelka, who is a convert to Islam, as is Franck Ribery, who is white. The 1998 triumph was hailed at the time as a turning point: the country nally recognising, and celebrating, its multicultural make-up. Since then, between banlieue riots and talk of burqa bans, France has struggled to integrate its minorities. (Of the 23-man Algerian squad, 17 are French-born.) The team seems to reect these tensions, with rumours of tribal divisions. Sensitivities are so acute that to criticise the players’ values, discipline or team spiritone philosopher called them a gang of yobs with the morals of the maa is to be accused of racism. Second, it exposes French distrust of money and globalisation. In a country that still has a wealth tax and whose president has declared laissez-faire capitalism nished , the footballers’ fabulous incomes many earned playing for English clubs are regarded as undeserved, if not corrupting. The World Cup asco, said François Hollande, a Socialist leader, revealed the 1

The Economist June 26th 2010

54 Europe 2 excesses of French society: money, individ-

ualism . He dismissed the French side as a team of traders . Even Rama Yade, the junior sports minister, denounced the team for staying in a ve-star hotel. Lastly, there is the constant tension between the French and authority. The French tradition of rebellion reaches way back, past 1789 to the 1358 Jacquerie revolt, and beyond. With continuing scandals about ministers’ perks, unrest is once again in the air. On June 24th protesters against proposed pension reforms took to the streets. This rebelliousness makes France, like its football team, particularly hard to govern. As more than one commentator pointed out, the only unusual thing about the players’ mutiny was that it was probably the rst time that French millionaires have gone on strike. 7

Turkey and the PKK


More violence threatens to unravel a wary Turkish- Kurdish rapprochement URKISH F-16 ghter jets screech across the skies. Armoured personnel carriers shuttle troops under the watchful gaze of snipers. The shadow of war again looms over Turkey’s mainly Kurdish south-east. Some 16 Turkish soldiers have been killed in recent attacks, as militants of the Kurdistan Workers’ Party (PKK) escalate their 25-year-old war. On June 22nd four soldiers and the daughter of an ocer died when the PKK’s urban arm, the Kurdistan Freedom Falcons, detonated a bomb on a bus carrying soldiers in Istanbul. For the rst time, there is a real risk that the PKK will carry the war outside the south-east, says Henri Barkey of the Carnegie Endowment for International Peace. Pressure is building on Turkey’s prime minister, Recep Tayyip Erdogan, to respond. Devlet Bahceli, leader of the nationalist opposition party, has called for martial law to be reimposed in the southeast. Sezgin Tanrikulu, a Kurdish humanrights lawyer, mutters of a last exit before Turks and Kurds go their separate ways. Yet last year Mr Tanrikulu was among thousands of Kurds who spoke hopefully of peace. They were prompted by Mr Erdogan’s so-called Kurdish opening . This was marked by the launch of the rst stateowned Kurdish-language television channel. It culminated last October in the return from northern Iraq of a group of PKK militants and supporters. Yet on their return the militants, dressed in full combat gear, declared victory at mass rallies organised by the pro-


Organised crime in the Balkans

A problem shared Serbian and Croatian police are starting to work together


TOUCHING video on YouTube shows three men embedded in the image of a heart. We see them relaxing on motorbikes and posing with weapons. These Serbs were gunned down last month in Bolivia, where it was reported they were working for a drug cartel. Serbs doing unusual jobs in unusual places should come as no surprise. This month Ivica Dacic, Serbia’s interior minister, visited Brazil, Argentina and Uruguay to solidify police co-operation in the ght against drug-trackers. There are plenty of Balkan gangs operating in Latin America, he lamented. The western Balkans suer from an image problem when it comes to organised crime. Yet some countries are starting to make eorts to take on the criminals, and to work together in doing so. On June 8th Serbia and Croatia, who were at war during the 1990s, signed a defence co-operation agreement. In May the two countries announced plans for a regional centre to ght organised crime. No one doubts the need. On the day the defence agreement was signed, a shooting in Zagreb became front-page news across the region. When Milos

Simovic shot (but failed to kill) Sretko Kalinic, it turned out that both belonged to Serbia’s notorious Zemun gang, which had taken part in the assassination of Zoran Djindjic, the Serbian prime minister, in 2003. Both men had been convicted in absentia for their part in the plot and had been hiding in Croatia. They reportedly fell out when Mr Kalinic had an aair with Mr Simovic’s wife. Mr Simovic ed to the Serbian border, reportedly by bicycle, where, after he had swum across a drainage channel, he found the Serbian police waiting for him. They were presumably tipped o by their Croatian colleagues. Co-operation between Serbia and Croatia has intensied in recent months, according to Daniel Sunter, editor of Balkan Intelligence, a newsletter. Police from the two countries are collaborating over the murder in 2008 of Ivo Pukanic, a Croatian publisher. The alleged assassins are on trial in Croatia but the gangster accused of giving the orders for his killing is being prosecuted in Belgrade. When it comes to ghting organised crime, the states of the western Balkans have much to do. Some, at least, have started doing it.

At least they’re on the same side now Kurdish Peace and Democracy Party (BDP). Turks were outraged. Support for the opening weakened further when the PKK killed seven soldiers in December. Mr Erdogan’s mildly Islamist Justice and Development (AK) party blames the PKK and what it considers to be its provocations for the collapse. The PKK and its BDP allies disagree. The rebels declared a ceasere in April 2009, yet the army continued its operations. Hardly a day passed that I did not attend a PKK ghter’s funeral, says Nijad Yaruk, the BDP’s provincial boss in Diyarbakir. He sees the past year’s

arrests of some 1,500 Kurdish activists and politicians, including elected BDP mayors, as proof that the opening is a lie. The Kurds say their demands are minimal, falling far short of independence. They include government negotiations with the imprisoned PKK leader, Abdullah Ocalan; amending the constitutional clause that calls all citizens of Turkey Turks ; a loosening of Turkey’s centralised government; and allowing Kurdish-language education in state-run schools. Can such demands be met? Ahmet Turhan, the AK-appointed governor of Bat- 1

The Economist June 26th 2010

Europe 55

2 man province, thinks some of them can.

Kurdish-language education might be considered during later phases of the opening, he suggests. Mr Turhan is among a new round of liberal AK appointees who have won some trust among Kurds. Locals dialling his emergency hotline are greeted in Kurdish. Dozens of schools, hospitals and roads have been built on his watch. Such eorts helped AK to overtake the main Kurdish party in the south-east in the 2007 general election. The PKK wants to provoke the government into its old repression so as to erode its popularity among Kurds. Yet this week Mr Erdogan pledged to continue his liberalising reforms. The chief of the general sta ruled out emergency rule. And the Turkish parliament began debating changes to laws that have led to the detention of 4,000 Kurdish youths for such crimes as chanting nationalist slogans

and throwing stones at police. Yet as the casualties mount and next year’s election approaches, Mr Erdogan is unlikely to risk nationalist ire by making more concessions. Even if he does, the PKK will keep raising the bar because it wants to be a party to the solution. Until it is, the violence is unlikely to stop. 7

Central European politics

The new rules

Poland’s closely fought presidential election is part of a wider picture


ECEIVED opinion earlier this year said Poland’s autumn presidential election would be boring, with the unpopular incumbent, Lech Kaczynski, losing heavily to whomever the governing Civic Platform party nominated. After Mr Kaczynski died in a plane crash in April and the election was brought forward, few gave his unpopular twin brother Jaroslaw, a divisive former prime minister, much of a chance. Received opinion was wrong. Bronislaw Komorowski, Civic Platform’s candidate and the speaker of the lower house, proved a poor candidate and Mr Kaczynski a good one. In the rst round on June 20th Mr Komorowski emerged only 5.1 percentage points ahead. He should still win the run-o on July 4th, if he can sweep up antiKaczynski votes cast for minor candidates. But his lineage (aristocratic and dissident) has failed to outweigh a wooden and vacuous manner. Mr Kaczynski’s camp scent an upset. Their older, poorer and more rural voters will be in Poland and voting while Mr Komorowski’s middle-class supporters are abroad on holiday. Mr Kaczynski’s destructive foreignpolicy image has softened, with emollient words to Germans and Russians. He has also moved to the largely empty centreleft, pledging as president to veto reforms that threaten the welfare state. Yet a win by Mr Kaczynski would risk ve more years of deadlocked politics and tussles over foreign policy. It could kibosh

hopes that Poland, the economic heavyweight of the ex-communist world, might nally obtain the political clout it merits. If Mr Komorowski wins, his job would be to keep quiet and to obey his sponsor, Donald Tusk, the prime minister. Given his predilection for gaes, his supporters are only half joking when they say he should start that silence now. In theory, winning the presidency should allow Civic Platform to start belat-

No bouquets yet for Civic Platform grandees

ed reforms to Poland’s wastefully provided public services, clogged labour market and growth-stiing bureaucracy. The country comes in at a dire 72nd place on the World Bank rankings for business-friendliness. Since taking oce in 2007, the government has blamed presidential vetoes. The cautious Mr Tusk may now argue that radical reforms are too risky in the run-up to next year’s parliamentary elections. The bigger question is how the Polish result ts into recent trends in central European elections, where outsiders and newcomers have been rewarded and candidates seen as corrupt, incompetent or complacent have been punished. Ivan Krastev, a Vienna-based political commentator, detects an echo of the anti-establishment tea party movement in America. Middle-class voters in the ex-communist world, he argues, are cross with bad, big, extravagant government. The economic crisis has dented faith in mainstream politicians and countered political apathy. At rst sight, Poland does not t into that picture. Economic growth and a popular, stable government mean Poles are not fuming about misrule. A xture in Polish politics since the 1980s, Mr Kaczynski is hardly an outsider. Poland’s go-getting middle classes, formidable in business and culture, still see politics as a mucky circus. But the deeper picture looks more worrying for Mr Tusk. The centre-left SLD polled surprisingly well in the presidential vote; younger voters are undeterred by its communist roots and attracted by its lonely social liberalism and anti-clericalism. Poles are worried by sleaze, even if many inch at Mr Kaczynski’s wild crusades against it. Mr Tusk should remember that Civic Platform, now the epitome of the establishment, emerged in 2001 amid boiling dissatisfaction with incompetent insiders’ domination of Polish politics. 7

56 Europe

The Economist June 26th 2010

Charlemagne Help them to help themselves The EU should not just hector China about universal values but encourage it to follow its own laws


HE European press has been lled with reports of the Universal Expo in Shanghai. They make for chirpy reading. The Spanish are oering Chinese visitors tortillas at their pavilion. In the Belgian pavilion (shared with the European Union), freshly made chocolates are being handed out every 20 minutes, drawing terric crowds. France’s eorts have included a mock mass wedding for Chinese couples, who received a Romantic Wedding certicate and invitations to visit France in person. The message is clear enough. This is not Europe as a shining city on the hill, a beacon of democracy and supranational co-operation. This is Europe as a nice place to shop and go on holiday. To be fair, the EU’s (rather small) stand in Shanghai talks about climate change and human rights. But such values are absent from European press reporting: the buzz is all about luring Chinese tourists and investment to recession-hit Europe. This marks a rapid shift. Until recently European leaders visiting China felt obliged to speak out on human rights. A decade ago, a diplomat recalls, European investment in China was routinely linked to the appointment of a foreign general manager. Now, he notes: the Chinese are buying Volvo. Five years ago, Euro-boosters still argued that the EU a peaceable club with an enviable social model and a lucrative internal marketwas uniquely positioned to make China a responsible stakeholder and an ally in a multipolar world order. Such hubris is long gone. China has given up waiting for the EU to integrate enough to become a geopolitical rival to America. The Copenhagen climate talks showed China’s disdain for binding international rules. More broadly, the West’s authority has been undermined by the nancial crisis. Europe has moved way beyond trying to persuade China to accept our values, a veteran diplomat admits. The goal has changed from making China a responsible stakeholder to we are not quite sure what. Yet Chinese envoys and semi-ocial scholars who tour European capitals complain that a declining Europe still wants to impose its values. Europe’s ex-colonial powers are ill-placed to lecture China about its behaviour in Africa, they say. And as for governance inside China, the Communist Party rejects Europe’s individualistic view of human rights: the priority is lifting millions from poverty and ensuring stability.

What is more, they conclude, ordinary Chinese share such views. In the face of such Chinese self-condence, the temptation is for Europeans to embrace decline, ditch their principles and engage without conditions. For one thing, Chinese leaders are right to point out that for hundreds of millions of their citizens, life is better than at any time in history. But Europeans should resist a surrender to moral relativism. Chinese arguments amount to a boast that their model of 21stcentury autocracy is proved superior by economic success. But what if China is rising despite its autocratic model, which inhibits such drivers of success as meritocracy, transparency and creativity? An alternative history of the past 30 years might be this: if you abandon some of the most economically destructive policies ever devised, the Chinese economy will stand up and grow. It is also possible that Europe is worth listening to precisely because it has made its own mistakes, some of which have their echoes in modern Chinese policy. Europe has tried mercantilism, militarism and inculcating youths with angry nationalism. Europe knows the limits of state-directed investment. Europe extended loans to kleptocracies in Africa before concluding that it was neither in its interests nor Africa’s. Many European countries used to jail dissidents and censor bad news. And so Europeans should be sceptical when non-democratic regimes say they can self-correct without independent checks and balances. But if China is in no mood to be lectured, is there anything the EU can do? It suers from two handicaps. China is brilliant at playing divide and rule among individual eu countries. And unlike its member states the EU as a union is bad at realpolitik, being a slow-moving bureaucracy based on rules and legal texts. Human rights are good for you Charlemagne has a modest proposal. The EU should turn its slow, legalistic style into a strength. Sidestepping sterile arguments about whose values are better, the EU should oer to help China obey its own laws. With their talk of placing stability and growth above individual rights, Communist ocials sometimes make human rights sound like air conditioning, or colour television: a luxury you can aord once you acquire a certain level of wealth. But China’s human rights would improve overnight if the authorities paid more heed to their own laws: whether environmental rules, worker protections, or laws designed to safeguard against abuse by corrupt local ocials. If lawyers were allowed to signal legal abuses, or police held to account for brutality, life would improve for thousands of Chinese. Local entrepreneurs as well as foreign companies would benet from better intellectual-property protection (piracy has killed o many Chinese software rms). Ocials like to blame all ills on local corruption, claiming that central government cannot stop abuses it cannot see. Let the EU call their blu: oering scholarships for prosecutors and defence lawyers, funding for environmental inspectors, or pressure when the central government blatantly outs its own laws, for instance by disappearing a dissident without trial. When EU ocials speak to Chinese audiences, let them say that this is what they are doing: reecting Europe’s commitment to rules-based governance by urging China to follow its laws. Handing out pralines is an easy way to make friends. But respect for the rule of law would be a far worthier European export.

The Economist June 26th 2010 57


Also in this section 58 Welfare reform 59 Asset sales 59 Taxing banks 60 Bagehot: George Osborne’s imperial moment

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Britain’s emergency budget

The meaning of austerity

A punishing scal plan leaves some big unanswered questions


DAY of reckoning has loomed ever since the banking crisis and recession took a wrecking ball to the public nances. That demolition job pushed the decit to a peacetime high of 11% of GDP in 2009-10, the scal year that ended in March. Even though the Labour government had set out long-term plans to repair the public nances, they lacked detail and fell short of what was needed. That made the emergency budget delivered on June 22nd by George Osborne, the Conservative chancellor of the exchequer, a momentous occasion, for both the coalition government and the country. A post-election budget gives any new government a unique opportunity to inict maximum pain while blaming the one that has just been booted out. Mr Osborne, an astute politician, had long grasped this point and duly administered some very astringent medicine. If the patient can take it, the cure should work. But there are real worries as to whether the chancellor can cut public services as much as his plans imply and how it will aect the economy. Mr Osborne may have passed control over economic and scal forecasting to the new Oce for Budget Responsibility (OBR), but he remains rmly in charge of scal policy. The rst crucial decision he had to make was his goal for the public -

nances: his scal mandate. He set an exacting objective of balancing the cyclically adjusted current budget (which excludes net investment) within ve years. In his next big decision, he plumped for overachieving: the specic plans he set out over the next four years mean that the goal should be met in 2014-15, a year early. The chancellor inherited a plan sketched out by Alistair Darling, his Labour predecessor, for a sizeable scal consolidation building up over several years. This aimed to wring just over 4% of GDP out of the public nancesa bit over twothirds from spending cuts and the rest in tax increasesby 2014-15. Mr Osborne added another 2.2% of GDP to this squeeze, taking the overall consolidation to 6.3% of GDP over the eective lifetime of this parliament (see chart). Spending cuts will by 2014-15 make up four-fths of Mr Osborne’s extra tightening and three-quarters of the total retrenchment. On taxes, Mr Osborne had much to announce for individuals and rms. His crucial revenue-raising decision was to increase the main rate of VAT, a consumption tax, from 17.5% to 20% in January 2011. This widely expected move will raise £12.1 billion ($18 billion), or 0.8% of GDP, in 2011-12. The chancellor had already indicated that he would lower the main

rate of corporation tax from 28% to 25%, but went a step further by reducing it to 24% by 2014-15. Osetting changes in allowances will make that revenue-neutral, but a new bank levy will raise just over £1 billion next year and over £2 billion a year from 2012-13 (see article on page 59). The chancellor retained the tax increases already planned by Labour, but took steps to mitigate the rise in nationalinsurance contributions (NICs) next April. He will do this for employers by raising their tax-free NIC allowances. For low-tomiddling earners he is increasing the income-tax personal allowance for under-65s by £1,000 a year, but conning the gain to basic-rate (20%) taxpayers. That was good coalition politics. The Liberal Democrats had made much in the election of their plan to raise allowances to take more people out of income tax. Mr Osborne was also able to reach a compromise between the Lib Dem demand for a sharp 1

Years of pain Fiscal tightening, % of GDP Labour: Coalition: tax increases spending cuts

tax increases spending cuts

7 6 5 4 3 2 1 2010




Financial years beginning April Source: IFS



58 Britain 2 rise in capital-gains tax and the strident op-

position among many Tories to such a move. The rate is being left at 18% for basicrate taxpayers, but is raised to 28% for those on higher rates. The net e ect of Mr Osborne’s various tax-raising and tax-cutting changes will be to raise revenue by 0.4% of GDP by the end of the parliament. The bulk of his extra scal tightening will come from spending cuts, which will yield 1.8%. That will raise their contribution to the overall retrenchment to 4.6% of GDP. Just as tax rises were a no-go area during the election, so too were cuts in the welfare budget (bar a few token gestures). It was always unrealistic to suppose that a massive scal tightening could leave out welfare, given that it makes up 28% of total spending. Mr Osborne announced an array of cutsof which half come from lessgenerous price indexationwhich will reduce welfare spending by £11 billion in 2014-15. That may sound a lot, but it is equal to only 0.6% of GDP. That leaves the main burden of cuts falling on the departments responsible for the public services. If no areas were safeguarded, their budgets set by Labour for this year would have to decline cumulatively by 14%, in real terms, by 2014-15. But because of the decision to ring-fence the massive health budget from real cuts (together with a commitment to keep raising overseas aid), the cuts in the unprotected areas will be 25%. And if, say, the government also wants to limit the reduction for schools and defence to 10%, the cuts elsewhere would have to be 33%, according to the Institute for Fiscal Studies (IFS), a think-tank. Whether such eye-watering cuts can really be made is one of the big unanswered questions raised by this budget. It will have to be resolved by October 20th, when the Treasury will produce a fouryear spending review allocating the pain among the departments. One way to reduce the squeeze on services would be to nd additional welfare savings. Another would be to make public-sector sta contribute more to their generous pensions. The other big question is the e ect of so severe a scal clampdown on the economy. According to the OBR, it will slow the recovery a bit this year and next: GDP will grow by 1.2% rather than 1.3% in 2010 and by 2.3% rather than 2.6% in 2011. But that forecast looks rather sanguine and some economists fear the tightening may take more of a toll on a still-delicate economy. Mr Osborne’s budget puts Britain on the path to scal redemption, but that path is a hard one. The economic risks are clear; the political risks no less so. The Tories’ coalition partners have taken the scal-austerity whip so far, but many show signs of unease as details of spending cuts unfold. Mr Osborne’s toughness may just reveal the government’s underlying fragility. 7

The Economist June 26th 2010 Welfare reform

A costly war Austerity may undermine the government’s ght against dependency


VEN IF George Osborne did not intend to exempt the NHS and foreign aid from cuts, the biggest-spending department in government would be an obvious place to wield the axe. Both Labour and the Conservatives were keen on welfare reform before the scal crisis. Blairite work and pensions secretaries (namely John Hutton and James Purnell) found common ground with Tories such as Iain Duncan Smith, who now runs the department. Yet there is a di erence between those men and Mr Osborne. The welfare reformers of recent years wanted to ght a dependency culture, not save money. Indeed, improving incentives to work can actually cost money, at least in the short term. Mr Osborne, by contrast, has his eye on the bottom line. He hopes to make cuts less severe elsewhere by squeezing as much from the £192 billion ($286 billion) welfare budget as he possibly can. His budget targeted things that trouble the likes of Mr Purnell and Mr Duncan Smith less. He cut payments to the middle classes, for example, by ending child-tax credits for households earning more than £26,000 from April 2012. He also wants claimants of disability-living allowance, which helps disabled people with the costs of care and getting around, to undergo medical checks to ensure eligibility (Mr Purnell did something similar for the separate out-of-work incapacity benet). Housing benet will be tightened, goodies such as health grants to pregnant women will be abolished, and lone parents must

Springing the trap for him

look for work once their youngest child starts school. These and other measures will save £11 billion by 2014-15, says Mr Osborne. But the longer-term slog against chronic unemploymentthe essence of welfare reformis what really animates the government’s welfare ministers. In pursuing this mission they are o to a strong start, not least because of public disdain for scroungers. Much of the intellectual heavy-lifting has been done. The likes of Lord (David) Freud, the architect of Labour’s welfare reforms, have been hammering out the policies for years; to implement one of them, the previous government had already begun paying private rms to get the long-term unemployed back to work. When Mr Duncan Smith eventually produces his welfare-reform bill, it is likely to look only incrementally di erent from Mr Purnell’s in 2009. Another reason for reformers to be hopeful is the sheer political clout they have. Mr Duncan Smith, a former Tory leader and still a voice for the party’s right, has long been immersed in his brief and does not want promotion to anything grander. He is helped by Chris Grayling, an e ective welfare spokesman before his brief stint as shadow home secretary. Lord Freud, who joined the Tories last year, is a minister in the department. Labour’s Frank Field, perhaps Westminster’s doughtiest champion of welfare reform, is also involved as poverty tsar. After the government’s austerity programme and its schools-reform policy, no cause has as much political capital invested in it. Still, there are obstacles to overcome. Labour found the Department of Work and Pensions hostile to reform. Depriving Jobcentre Plus, the state’s own unemployment agency, of its monopoly on getting claimants back to work incurred particularly strong bureaucratic resistance. The Tories’ partners in government may be squeamish. Welfare reform was not a big theme in the Liberal Democrats’ election manifesto and Steve Webb, their minister in the department, is on the party’s left. Much of the zeal in this area is informed by religious faith, or at least social conservatism: Mr Duncan Smith is a practising Christian, as is Mr Field, and Labour’s reforms were backed by Scottish MPs appalled at the social breakdown caused by unemployment. The Lib Dems have less of this conservative culture. But money is the biggest problem. Ending the welfare trap is crucial; many on benets are doing the rational thing by not taking jobs and seeing their state handouts vanish. But withdrawing benets more slowly from those who nd work is expensive. Mr Osborne’s desire to make savings from the welfare budget is not quite the same thing as this kind of welfare reform. Indeed, the one may endanger the other. 7

The Economist June 26th 2010 Asset sales

Roll up, roll up The government gears up to og bits of itself to the private sector


E-ANNOUNCING old plans was a favourite Labour PR trick. So when George Osborne, the chancellor, repeated old Labour plans to og o the few remaining bits of the government that private rms might be interested in, the sense of déjà vu was striking. Mr Osborne listed four candidates for a sell-o: the studentloans book; NATS (once the National Air Trac Control Service); the Tote, a stateowned bookie; and High Speed 1, the new name for the Channel Tunnel Rail Link, Britain’s only high-speed rail line. The government has been trying to nd a buyer for the Tote for years, and there is no particular reason to believe it will be able to this time. Disposing of NATS could be tricky too, since airlines hold 42% of the shares. One of them, easyJet, has already said it is not happy with the plans. Other assets look more attractive. A 30year concession to run High Speed 1 was put up for sale on June 21st. Rumoured bidders include Macquarie, an Australian bank, Infracapital and 3i (two British investment managers) and Eurotunnel, the owner of the undersea tunnel to which the railway runs. Insiders reckon the nal price will be around £1.5 billion ($2.2 billion), a useful chunk of cash though much less than the £6 billion the track cost to build. The student-loans book ought to nd a buyer too. Other tranches of student loans were sold in the late 1990s. But because interest rates on the loans track ination, they are not, currently, an exciting investment. Any deal will presumably be worth less than the face value of the loans. Compared with the early days of privatisation, when the government divested itself of huge telecoms, gas and electricity operations, ogging relatively obscure activities smacks of desperation. An interesting dinner-party game is to ponder what will be left to sell next time there is scal

Britain 59 crunch. Thirty years of privatisation have left the cupboard rather bare. Some think the Dartford Crossing over the River Thames could be sold; others point to passports and driving licences. One brave think-tank, the Social Market Foundation, advocates privatising the road network. But today’s projects could fuel tomorrow’s re sales. The government still plans to build Crossrail, a cross-London railway, and High Speed 2, which would link London and Birmingham. They might fetch a few bob one day. And how about the Ofce for Budget Responsibility? After all, it derives its authority from its independence. Take that thought a bit further, and perhaps it has a future as a privately run economic forecaster? 7

Taxing banks

Soft touch

Britain takes a cautious lead


EORGE OSBORNE, the chancellor of the exchequer, is no Robin Hood. Earlier this month Oxfam, a foreign-aid charity, and a coalition of other non-governmental organisations called for a tax which they reckoned could raise £20 billion a year from Britain’s nancial giants. Half of it, they proposed, should go to relieve poverty in Britain, with the rest split between foreign development aid and combating climate change. In his budget Mr Osborne set his sights far lower. From January 1st he plans to levy a tax on banks’ balance-sheets. This is expected to raise an extra £1.2 billion in 2011-12 from big banks and building societies operating in Britain, increasing to almost £2.5 billion a year. We’re disappointed by the level, says Max Lawson of Oxfam. Relieved bankers too had expected more. Of the big British banks, HSBC looks likely to pay the most, but only because of its sheer size. When the reduction in the rate of corporate tax, also announced in the budget, is taken into account, the net impact of the levy on HSBC’s earnings will be a minimal 1.6% in 2012, according to estimates by JPMorgan, an investment bank (see chart). Only the struggling Royal Bank of Scotland (RBS) will see much of a dent in protsperversely for taxpayers, who own 68% of the bank. But the new tax is aimed less at raising revenue than at changing banks’ behaviour, by encouraging them to go for lessrisky funding. It is applied to a bank’s entire balance-sheet minus its core capital, insured retail deposits and cash raised against holdings of government bonds. It

is eectively a tax on bank borrowings from the market, with short-term funds carrying twice the charge (0.04% next year, 0.07% thereafter) of those that are repayable after more than one year. Mr Osborne was brave to put numbers to his levy, given that Britain is the rst nancially signicant country to put a bank tax in place. A proposed American levy is held up in Congress. France and Germany have yet to specify how they will apply theirs (although Mr Osborne produced, along with his budget, a joint statement to the eect that all three countries would impose levies designed to make banks pay for the risks they impose on the system and encourage them to reduce the riskiness of their balance-sheets). Applying these levies to global banks will be complex. The tax will fall on branches of foreign banks as well as on their subsidiaries; but, since branches are underpinned by their parents’ capital, this will have to rely on a calculation of notional capital. That may change bank behaviour in unintended ways. Mr Osborne plans to consult during the summer before the tax is set in stone, giving banks plenty of time to lobby for changes. But the chancellor may spring further surprises. He is working, with his counterparts elsewhere, on IMF proposals for other measures to make banks less risky and less given to speculative behaviour, such as taxes on some nancial activities, on prots and on remuneration. A much-discussed tax on nancial transactions, which could potentially raise enormous amounts of revenue and put a brake on high-frequency, high-volume trading, is also lurking in the wings. Though the IMF has its doubts about the approach (and it is not alone), a tax on transactions would be easier to collect than one extracted from individual institutions. Tony Dolphin, senior economist at the Institute for Public Policy Research, a thinktank, argues that including such a tax with others on the British nancial sector could raise up to £20 billion. Now that would please the fans at 7

Rob, borrow, sell out Bank levy as % of estimated earnings, 2012 Just levy Levy and lower corporation tax together 0












348 81

Santander UK


HSBC Standard Chartered Source: JPMorgan

Bank levy, £m


60 Britain

The Economist June 26th 2010

Bagehot The imperial moment George Osborne’s grand budget and the trouble with democracy the British economy: between the public and private sectors, and among industries and regions. This was the most painful budget in living memory, and one of the riskiest. In its brief existence, the government has sometimes projected an air of levitysomething about the youth of its senior members, their tielessness, David Cameron’s recent agreement to give the racing tips on the radio. No longer. Mr Osborne, once regarded as a lightweight, looks destined to go down as either a prophet or a byword for political villainy. There is one glitch in his imperial vision, however. It is that Britain is not a place accustomed to rule by distant and impersonal diktat. It is rather a politically fractious, perilously pampered democracy.


N IMPERIUM, Ryszard Kapuscinski’s book about the crumbling Soviet empire, the Polish writer observes that, in such grandiose countries, there exists a certain class of people whose calling is to think exclusively on an imperial scale. If you ask these rulers questions about individual towns, they are utterly unable to answer them, since such petty details are of little overall consequence. In smaller countries, Kapuscinski writes, there is no equivalent of this class, which is preoccupied with the scale of large numbers. Britain, a mostly peaceable, moderately rich, medium-sized, rainy country, doesn’t generally require such thinking from its politicians. The challenges they face tend to be technocratic. They tweak the tax code or ddle with the National Health Service; they are not often called upon to alter the fates of millions with the stroke of a pen. The budget statement on June 22nd by George Osborne, the chancellor of the exchequer, may be about as close as a British minister has come since the second world war to the bold, savage generalisations Kapuscinski described. Mr Osborne announced a two-year freeze on most public-sector pay that will pinch millions of public servants. Conversely, 880,000 people will be lifted out of income tax by the raising of its lowest threshold by £1,000 ($1,500). Unless the government nds further savings in the welfare budgetand the changes Mr Osborne has already specied to child, housing and other benets will a ect millions of recipientsunprecedented, cumulative cuts of 25% on average will be required in departments’ spending, except for health and international development. Meanwhile, Mr Osborne’s hike in value-added tax is expected to raise a swingeing £13.5 billion by 2014-15. Daunting as they sound, it is easy to miss the meaning in these large numbers. And their impact has been somewhat ameliorated by the government’s concerted bid to prepare the country for bad news before the budget. But its import is seismic. Mr Osborne’s statement shattered and reversed the orthodoxy, which took hold in the last decade, that public spending must grow eternally. It has revised the relationship between the state and its employees, and signalled a reconguring of welfare support, which is set to be more generous to some of the very poor and stingier for many others. It was the start of a bid to create a new balance in

The long view Behind Mr Osborne’s lofty ratio between spending cuts and tax rises, there are human beings. Lots now know they will have to pay up, but many of those who will pay the mostie, with their jobsdo not, yet. When, in an authoritarian country, swathes of the population are given up to invaders or sacriced in battle, there isn’t much the victims can do to trouble the commissars. In Britain, there is: they can vote, of course, but also march through London, cripple the country with strikes, even riot. The moment when hundreds of thousands will fully realise that Mr Osborne’s budget is happening to them, rather than to someone elseas people like to believe for as long as possible will come in October, when he presents the results of a detailed spending review. The full implications for departmental expenditure will be spelled out. Policemen, social workers, university sta and the unions who represent them (some of whom have already denounced the budget as a declaration of war) will learn just how tightly their services are going to be squeezed. This imperial scal plan will be implemented over a grand time-frame, the hope being that the economy will be booming, and unemployment shrinking, by the time of the next general election. The spending cuts will be brought in over ve years, which ministers hope will mean that natural wastage in jobs can account for much of the retrenchment (along with the pay freeze and yet-to-be-determined reforms to public-sector pensions). But the scale is such that many entire programmes and agencies will necessarily be axed. Even natural wastage will have a depressing e ect on regions that are overdependent on state employment. Customersthat is, parents, students, victims of crime and otherswill ultimately be hit too. All that in turn will make another aspect of Britain’s political set-upthat it is governed not just by one elected party, but by twomore salient. In the raised income-tax threshold and other budget measures (such as an increase in capital-gains tax) that he championed, Nick Clegg, the deputy prime minister and leader of the Liberal Democrats, can point to policies that help justify his decision to join the coalition. His party’s inclusion in the government enhances its democratic mandate. But the more embittered the public mood becomes, the greater the internal pressure will be on Mr Clegg to extract wider, potentially destabilising concessions from his Conservative partners. Mr Osborne’s budget was a drastic statement of the executive power of government: the coalition’s imperial moment. Nudge, it wasn’t. But the real test of how the imperial approach works in a rainy little democracy is yet to come. 7

The Economist June 26th 2010 61


Nuclear proliferation in South Asia

The power of nightmares

Also in this section 62 Why blogs wane and rivals wax 63 Can facts be copyrighted? 63 Killing bureaucracies

China’s proposed sale of nuclear reactors to Pakistan will intensify nuclear rivalry with India. But the damage will go far wider


T FIRST sight, China’s proposed sale of two civilian nuclear-power reactors to Pakistan hardly seems a danger sign. Pakistan already has the bomb, so it has all the nuclear secrets it needs. Next-door India has the bomb too, and has been seeking similar deals with other countries. Yet the sale (really a gift, as Pakistan is broke) has caused shudders at the Nuclear Suppliers Group (NSG), an informal cartel of countries who want to stop their advanced nuclear technology getting into the wrong hands. They are meeting in New Zealand, for what was supposed to be a quiet and nerdish rule-tightening session. But their eorts may now fall victim to China’s rivalry with America. By any measure, Pakistan is a shocker. Its proliferation record would make the serial nuclear mischief-makers of North Korea blush. If the Chinese reactor deal goes ahead, the damage will be huge: beyond just stoking the already alarming nuclear rivalry between Pakistan and India. That does not deter China, which still seethes about the way in which the Bush administration in 2008 browbeat other NSG members into exempting America’s friend India from the group’s rules. These banned nuclear trade, even civilian deals, with countries like India and Pakistan, but also Israel and now North Korea, that resist full international safeguards on all their nuclear industry. America argued that India had a spotless non-proliferation record (it doesn’t)

and that bringing it into the non-proliferation mainstream could only bolster global anti-proliferation eorts (it didn’t). The deal incensed not just China and Pakistan but many others, inside and outside the NSG. An immediate casualty was the eort to get all members of the Nuclear Non-Proliferation Treaty (NPT), who have already promised not to seek the bomb, to sign up to an additional protocol on toughened safeguards. Many have, but on hearing of the America-India deal Brazil’s president is reputed to have atly ruled that out. And where Brazil has put its foot down, others have also hesitated. What particularly riles outsiders is that America did not get anything much out of India in return. It did not win backing for new anti-proliferation obligations, such as a legally binding test ban or for an end to the further production of ssile uranium or plutonium for bombs. India has since designated some of its reactors as civilian, and open to inspection, but others still churn out spent fuel richly laden with weapons-usable plutonium. India can potentially make even more of the stu. Now that it can import uranium fuel for its civilian reactors, it can devote more of its scarce domestic supplies to bomb-making. Pakistan suers no such uranium shortage and is determined to match India. According to analysis of satellite imagery by the Washington-based Institute for Science and International Security, it is greatly expanding its capacity to produce weapons-

usable plutonium, as well as uranium. China has given Pakistan lots of nuclear and missile help in the past. It even passed it a tested design of one of its own missilemountable warheads. This was one of the most damaging proliferation acts of the nuclear age, since the same design was later passed by Pakistan to Libya and possibly Iran and others. But after China joined the NPT in 1992 and the NSG in 2004, it reined in such help, at least ocially (some Chinese rms are still involved in illicit nuclear trade with several states). But on joining the NSG, it argued that it had already promised to build the second of two nuclear reactors for Pakistan at Chasma in Punjab and would therefore go ahead. Some grumbled. But it seemed a price worth paying to have China inside, playing by the NSG’s rules rather than outside, undermining them. The latest sale blows a hole in that hope. A big leaky tent China is trying a legalistic defence of the sale of the third and fourth reactors at Chasma. But its real point is this: if America can bend the rules for India, then China can break them for Pakistan. Pakistan hopes that it will eventually get a deal like India’s. Some in Barack Obama’s administration have supported this, on the ground that America needs Pakistan’s support in the ght against alQaeda and the Taleban. Israel wouldn’t mind such an exemption either. 1

62 International

The Economist June 26th 2010

Mushrooms in a nutshell Nuclear programmes Status (warheads*)

Delivery systems

Supplier/ helper

Joined NPT







Yes (1995)







Yes (1998)


Overt (60-80)

Land, air

Misused civilian help from US and Canada





Denied (none yet)


Russia, China, smuggling



Yes (1970)







Yes (1969)


Assumed (80-100*)

Land, sea, air

France, South Africa†, Norway (misused), US (Stolen†)





Denied (none yet)

None known

North Korea



Yes (1992)

North Korea

Denied (none yet)


Russia, Pakistan



Withdrew (2003)


Overt (70-90)

Land, air

China, North Korea





Denied and stalled‡


North Korea



Yes (1968)

Sources: Bulletin of the Atomic Scientists; The Economist


Possible sanctions


The NSG’s damage-control e orts now centre on a new rule to bar the sale of kit for uranium-enrichment or plutonium-reprocessing to any country outside the NPT. That, predictably, annoys India. The deal also a ects e orts to contain Iran. Western diplomats seeking support for UN sanctions on the Islamic republic nd themselves receiving a wigging over the double standards used with India. Iranian ocials used to argue that they just wanted to be treated like Japan. It has free access to advanced nuclear technology. But unlike Iran, Japan does not repeatedly violate nuclear safeguards. Some Iranian ocials now muse boldly that the big powers will eventually come to do deals with



‡Since bombing by Israel in 2007

them, just as they did with India. Iran’s latest raspberry in response to a fourth round of UN sanctions was to ban two nuclear inspectors from the International Atomic Energy Agency, the UN’s nuclear guardian. Iran dislikes its reports on the regime’s dubious nuclear activities. If Pakistan really is worried about India’s growing nuclear arsenal, diplomacy might work better than an arms race. George Perkovich of the Carnegie Endowment, a think tank, says Pakistan should lift its veto on a ban on the production of ssile materials for bombs. That would put India (which claims to support a ban) on the spot. Like enriched uranium, hypocrisy can be costlier than it seems. 7

The evolving blogosphere

An empire gives way

Blogs are growing a lot more slowly. But specialists still thrive


NLINE archaeology can yield surprising results. When John Kelly of Morningside Analytics, a market-research rm, recently pored over data from websites in Indonesia he discovered a vast eld of dead blogs. Numbering several thousand, they had not been updated since May 2009. Like hastily abandoned cities, they mark the arrival of the Indonesian version of Facebook, the online social network. Such swathes of digital desert are still rare in the blogosphere. And they should certainly not be taken as evidence that it has started to die. But signs are multiplying that the rate of growth of blogs has slowed

in many parts of the world. In some countries growth has even stalled. Blogs are a confection of several things that do not necessarily have to go together: easy-to-use publishing tools, reverse-chronological ordering, a breezy writing style and the ability to comment. But for maintaining an online journal or sharing links and photos with friends, services such as Facebook and Twitter (which broadcasts short messages) are quicker and simpler. Charting the impact of these newcomers is dicult. Solid data about the blogosphere are hard to come by. Such signs as there are, however, all point in the same di-

rection. Earlier in the decade, rates of growth for both the numbers of blogs and those visiting them approached the vertical. Now trac to two of the most popular blog-hosting sites, Blogger and WordPress, is stagnating, according to Nielsen, a media-research rm. By contrast, Facebook’s trac grew by 66% last year and Twitter’s by 47%. Growth in advertisements is slowing, too. Blogads, which sells them, says media buyers’ inquiries increased nearly tenfold between 2004 and 2008, but have grown by only 17% since then. Search engines show declining interest, too. People are not tiring of the chance to publish and communicate on the internet easily and at almost no cost. Experimentation has brought innovations, such as comment threads, and the ability to mix thoughts, pictures and links in a stream, with the most recent on top. Yet Facebook, Twitter and the like have broken the blogs’ monopoly. Even newer entrants such as Tumblr have o ered sharp new competition, in particular for handling personal observations and quick exchanges. Facebook, despite its recent privacy missteps, o ers better controls to keep the personal private. Twitter limits all communication to 140 characters and works nicely on a mobile phone. A good example of the shift is Iran. Thanks to the early translation into Persian of a popular blogging tool (and crowds of journalists who lacked an outlet after their papers were shut down), Iran had tens of thousands of blogs by 2009. Many were shut down, and their authors jailed, after the crackdown that followed the election in June of that year. But another reason for the dwindling number of blogs written by dissidents is that the opposition Green Movement is now on Facebook, says Hamid Tehrani, the Brussels-based Iran editor for Global Voices, a blog news site. Mir Hossein Mousavi, one of the movement’s leaders, has 128,000 Facebook followers. Facebook, explains Mr Tehrani, is a more ecient way to reach people. The future for blogs may be special-interest publishing. Mr Kelly’s research shows that blogs tend to be linked within languages and countries, with each language-group in turn containing smaller pockets of densely linked sites. These pockets form around public subjects: politics, law, economics and knowledge professions. Even narrower specialisations emerge around more personal topics that benet from public advice. Germany has a cluster for children’s crafts; France, for food; Sweden, for painting your house. Such specialist cybersilos may work for now, but are bound to evolve further. Deutsche Blogcharts says the number of links between German blogs dropped last year, with posts becoming longer. Where will that end? Perhaps in a single, hugely long blog posting about the death of blogs. 7

The Economist June 26th 2010

International 63 International bureaucracies

Secretarial work Bureaucracies grow faster than they can be pruned

C Copyrighting facts

Owning the news Copyrighting facts as well as words


ACTS, ruled America’s Supreme Court in 1918 in the hot news doctrine , cannot be copyrighted. But a news agency can retain exclusive use of its product so long as it has a commercial value. Now newspapers, fed up with stories being scraped by other websites, want that ruling made into law. The idea is oated in a discussion document published by the Federal Trade Commission, which is holding hearings on the news industry’s future. Media organisations would have the exclusive right, for a predetermined period, to publish their material online. The draft also considers curtailing fair use, the legal principle that allows search engines to reproduce headlines and links, so long as the use is selective and transformative (as with a list of search results). Je Jarvis, who teaches journalism students to become entrepreneurs at New York’s City University, says this sounds like an attempt to protect newspapers more than journalism. Germany is mulling something similar. A recent paper by two publishers’ associations proposed changing copyright law to protect not only articles but also headlines, sentences and even fragments of text. Critics say that would extend copyright to facts. It would also be hard to make either regime work in practice. In America, a regulator would presumably need to determine the period of commercial value: perhaps two hours for news of an earthquake, 30 minutes for sports results. In Germany, publishers want a fee on commercial computer use. Germany’s justice minister last week hinted at support for the news industry, but also said that a new law would not stir young people to buy newspapers. New products, she says, would be a better response to agging demand.

ONNOISSEURS of diplomatic rarities face a treat in July 2011: the closure of an international organisation. The Western European Union, set up in 1948, was a cold war spine-stiener. It was mildly important when the then European Economic Community was just a small common market. The Brussels-based outt has a sta of 65 and an annual budget of 13.4m ($16.5m). It has been an anachronism for decades, and trying to shut down since 2000. With it will go a parallel outt, the Paris-based European Security and Defence Assembly of the member states’ parliamentarians, which has a budget of 6m and a sta of 30. Both bodies will go to a nearly empty graveyard. Setting up international organisations requires only a political decision and some taxpayers’ money. They may not make progress, but they do provide process: so long as meetings happen, they create a sense that at least something is being done. Closing international organisations down is more dicult, involving ddly decisions on pensions and redundancies. Ocials are adept at nding reasons for postponement and in providing useful sinecures to their political backers. Wikipedia lists only 22 defunct international outts, and many of those are not dead but renamed or merged. One (the League of Corinth) went in 322BC. It is easy to nd further candidates for abolition. The Geneva-based United Na-

A oating secretariat has its advantages

tions Economic Commission for Europe was set up in 1947 to co-ordinate reconstruction in shattered post-war Europe. Its 220 sta members spend a $50m budget on tasks such as providing consumers with guarantees of safety and quality through the establishment of norms and standards . Many might think the EU already does that pretty thoroughly. The cost of such outts is not only nancial. However tedious their activities, member countries cannot aord to ignore their meetings or budgets. Doing that ties up scarce time and people. This is a particular burden for smaller and poorer countries, who nd their competent, multilingual ocials either overburdened or, worse, tempted away by the high salaries and undemanding duties of international bureaucracy. But the trend is towards more, not less. Next month the Community of Democracies, a Clinton-era ginger group for governments and campaigners, is relaunching at a big summit in the Polish city of Cracow, with strong backing from America’s secretary of state, Hillary Clinton. It dwindled to near-insignicance during the Bush administration: does anyone remember the Santiago Commitment of 2005 or the Bamako Consensus of 2007? But Poland, eager to make its mark as a diplomatic heavyweight, has provided a permanent oce in Warsaw. Under Lithuania’s presidency it gained a parliamentary assembly this year. That means lots more meetings, travel and papers. Last week Finland’s foreign minister, Alexander Stubb, said that the Arctic Council, a once-sleepy forum for the governments of countries near the North Pole, needed to become a proper organisation with a permanent secretariat. Unsurprisingly, he suggested that this be located in northern Finland. 7

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The Economist June 26th 2010 65

Business Uniqlo

Uniquely positioned TOKYO

Fast Retailing, Japan’s biggest clothes retailer, hopes an innovative strategy will make it the world’s biggest too ASICSeveryday items such as T-shirts, socks and jeans, in the jargon of the garment industryare not normally considered the most exciting part of the business. But they are found in almost every wardrobe. Uniqlo, a successful Japanese rm with big ambitions, has transformed them into a goldmine. Having conquered Japan, it is now taking on the world. Uniqlo’s parent company, Fast Retailing, is Japan’s biggest clothing company, with sales of $9 billion forecast this year. Whereas many Japanese businesses are ailing because of the stagnant domestic economy, Fast Retailing is ourishing. Last year sales grew by 17%, despite the recession, or because of it: its clothes combine a touch of style with enticingly low prices. The company is hailed as an example of a new, globally competitive Japan. Its founder and boss, Tadashi Yanai, emerged from humble origins to become Japan’s richest man, worth over $9 billion. Uniqlo ranks among Japan’s ten most valuable brands, according to Interbrand, a consultancy. Its low prices are even blamed for fuelling Japan’s deation. Now Uniqlo, whose name is a contraction of unique clothing, is on the move. In recent months it has opened huge agship stores in Paris, Moscow and Shanghai, which have been met with throngs of customers. Mr Yanai wants $50 billion in sales and $10 billion in prot by 2020. Although only 10% of Fast Retailing’s sales come from abroad, Mr Yanai expects overseas revenue to surpass domestic sales by 2015. And although it boasts around 800 stores in Japan and 140 overseas, it plans to open a staggering 500 new stores annually over the next three to ve years. Most will be in Asia, notably China, where it already has 54 shops but wants to have 1,000. Fast Retailing prefers to grow independently, but is also open to expansion by acquisition to enhance the rm’s presence in America or Europe. A future bride, says Mr Yanai, could retain its own identity while selling some of Uniqlo’s clothes, and could cost as much as $10 billion. But nding the right rm is dicult, he says. In recent years, Fast Retailing has successfully acquired smaller foreign brands including France’s Comptoir des Cotonniers for women’s wear and Princesse Tam-Tam lingerie, as well as America’s Theory. Fast Retailing is still smaller than its glo-


Fast narrowing Clothing retailers’ sales and profits, 2009, $bn Sales

Operating profit




Sales growth*, annual %









Fast Retailing† Source: Company reports

22 †Forecast for

*In local currency fiscal year ending Aug 31st 2010

bal peers. Its revenue is around two-thirds that of America’s Gap, Sweden’s Hennes & Mauritz (H&M) and Spain’s Inditex, which runs the Zara chain (see chart). But Fast Retailing is catching up fast, and has a record of startlingly rapid growth. When Mr Yanai declared in 2006 that its sales would rise from $3.5 billion to $10 billion this year, analysts derided him, but the rm is very close to the target. Fast Retailing also has a distinctive business model. Zara and H&M bring the latest fashions to the masses quickly, ordering new lines many times a year. Fast Retailing, by contrast, sells only around 1,000 items, far fewer than its rivals, and keeps them on the shelves longer. We don’t want to chase after ‘fast-fashion’ trends, explains Mr Yanai. This lets Fast Retailing strike lower-priced, higher-volume deals with suppliers (most products cost $10-20) and makes managing inventory a much simpler and cheaper aair. Uniqlo makes up for the narrowness of its oering by selling the same item in many colours: socks come in 50 hues at its agship store in Tokyo. Such basics, the rm believes, have the added benet of appealing to a wider audience than the preppy Americana sold by Gap or the faddish wares of Inditex and H&M. Although it opened its rst store in 1984, Uniqlo really got going in the early 1990s, just as Japan was entering a long period of economic anaemia. Mr Yanai bypassed middlemen by purchasing directly from suppliers. And he challenged the view that Japanese consumers would reject Chinese-made clothes (90% of its apparel is made in China). But the factors behind Uniqlo’s domes-1

Also in this section 66 BP and the oil spill 66 Corporate governance in America 67 BASF buys Cognis 68 Competition in American agriculture 68 AHAB and Maan al-Sanea 69 Legal outsourcing to India 70 Schumpeter: Title in ation

The Economist June 26th 2010

66 Business 2 tic success are of little avail as it expands

abroad. The belt-tightening environment in which it ourished does not pertain in many of the emerging markets it is targeting, although it certainly does in most of the rich world. Uniqlo relies mainly on small suburban shops in Japan but is opening giant stores in posh central locations overseas. (Experiments with suburban shops in Britain and America have gone badly.) Moreover, Uniqlo succeeded in basics but is now expanding into trendier lines, for example through a tie-up with Jil Sander, a German fashion designer. It will have to manage a multicultural, multilin-

gual workforcean area where Japanese rms often trip up. And merchandise will need to be tailored to national tastes, so scale will be harder to achieve. One’s strength can be one’s weakness: basics can be boring, Mr Yanai admits. Mr Yanai himself may also create problems. A brilliant strategist with uncanny fashion instincts, he is also unable to delegate, say Fast Retailing executives. He controls all decisions, down to approving samples and colours. Mr Yanai defends his meddling. A good business manager , he says, must pay attention to the details. This micromanaging has pushed talent-

ed executives to quit the rm, leaving no obvious successor to Mr Yanai, who plans to step down as boss (but remain chairman) in four years, at 65. Previous attempts to cede day-to-day control have been aborted. When pressed, Mr Yanai says that he has decided not to hand the company over to his sons. They will be big shareholders with board seats, but will not take operational roles. In this, he once again dees traditional Japanese business practices. Firms that rely on primogeniture, he notes, perform poorly. So, in the long run, do those that rely on a domineering leader. 7

BP and the oil spill

Corporate governance in America

Court tester

The ght for better boards

The Obama administration battles the courts while BP battles the slick


HOSE seeking to stem the ow of oil from the deep waters of the Gulf of Mexico are now struggling on land as well as at sea. A wayward robot briey interrupted the ow from the top hat BP is using to suck up oil from the ruptured pipes of its Macondo well this week, although another supplementary system attached to the well’s failed blowout preventer was working well. Meanwhile, a court threw out the six-month moratorium on drilling in deep water imposed by the administration after the original accident, despite fears that the practice is inherently unsafe. On June 22nd a federal judge sided with the oil industry and issued an injunction against the moratorium, arguing that it was arbitrary and capricious to assume that because one oil well had failed all the others might be at risk too. The White House said it would appeal and reimpose the moratorium. Drilling is unlikely to resume amid the uncertainty. At least BP’s latest eorts to siphon o the black goo gushing from the seabed are improving. It has been collecting 25,000 barrels a day (b/d) out of a ow estimated at 35,000-60,000 b/d. Further improvements should boost its hoovering capacity to 50,000 b/d in the coming weeks. And relief wells are still on course to stem the leak entirely in August, although the onset of the hurricane season could yet undo these plans. BP’s share price merely slid, rather than plummeted, to a 13-year low, although the stock of Tony Hayward, the rm’s beleaguered boss, continues to crumble. His defensiveness before a congressional committee earlier this month did him no favours, and his latest public-relations gaeparticipating in a yacht race in Britainhas further infuriated residents of the oil-soaked gulf coast.

To bring in a fresh face (and an American accent), BP appointed Bob Dudley, a former head of its troubled Russian joint venture, to lead the campaign to tackle the spill. The signs are that Mr Hayward is resigned to his fate. Mr Dudley will report to a boss whom he is the leading candidate to replaceperhaps sooner rather than later. But what will he inherit? New allegations are surfacing about BP’s awareness of problems with the well before the accident on April 20th. Anadarko, a 25% partner in the project, has accused BP of gross negligence . If the charge sticks, the smaller oil company will be o the hook for 25% of the clean-up costswhich BP says have now exceeded $2 billionalong with nes and damages. The nal bill could be $40 billion or more. BP is preparing to sell assets and raise cash in the bond market to pay. Keeping the cash owing to maintain huge investment commitments is as important to BP’s future as stanching the oil still pouring from the seabed.

Can’t a ord to waste a drop

New York

Financial reformers try to rede ne what it is to be a shareholder


EW regulations are emerging from Congress in response to the meltdown in the nancial industry. Yet their impact, likely to be felt by every public company in America, may weaken rather than strengthen corporate governance. It was the glaring weaknesses exposed in the boards of Wall Street giants such as Citigroup and Lehman Brothers that prompted some in Congress to propose making it easier for shareholders to nominate candidates for election as directors something that had hitherto been costly and time-consuming. CalPERS, a big Californian pension fund, is said to have been recruiting a bench of candidates in expectation of a sharp increase in contested elections. Then something went wrong in the process by which two dierent reform bills passed by the House of Representatives and the Senate are likely to be reconciled. Reformers have for years tried to make it easier for shareholders to nominate directors by securing readier access to the proxy forms that rms circulate before voting on board candidates at annual meetings. But company bosses have jealously guarded the proxy, which usually contains only the names that management wants on the board. Consequently, the names of alternative candidates have to be circulated separately by those wishing to propose them. The Securities and Exchange Commission (sec), the main markets watchdog, has often attempted to improve access to the proxyand is thinking of trying againonly to be deterred by erce business lobbying. Such lobbying seems to have been behind a controversial amendment proposed on June 16th by Chris Dodd, who has steered nancial reform through the Senate. The original bills passed in both 1

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The Economist June 26th 2010

Business 67

2 houses made clear that the SEC could or-

der better access to the proxy, leaving the exact details to be worked out later. But Mr Dodd wants shareholders wishing to nominate candidates to pass two tough tests. First, they must own at least 5% of the rm’s shares; second, they must have held those shares for a minimum of two years. This could lead to even fewer contested board elections than the 30 or so a year that has been the norm for the past decade (around one-third of which have been successful). The vast majority of contests are initiated by hedge funds or wealthy individuals such as Carl Icahn. Neither of these are known for their long-term share ownership, according to Missing in Activism, a study by Lee Harris in the Columbia Business Law Review. Even pension funds and mutual funds, which take a relatively long-term approach to investing, now trade their entire share portfolios every ten months or so (down from three years in the early 1980s), so might fall foul of Mr Dodd’s proposed rule. Besides, pension funds and mutual funds hardly ever initiate contested board elections, says Mr Harris. Mr Dodd’s proposal has alarmed institutional investors in America and abroad. A memo by the Council of Institutional Investors, which represents many of America’s big pension and mutual funds, claimed that it would essentially gut proxy access. Similarly, the International Corporate Governance Network, which includes many of the biggest foreign institutional investors, complained that the ownership threshold is too high, in particular for larger companies, and the holding period is too long. Mr Dodd’s ownership threshold would be less worrying if it were clear that it did not have to be a single shareholder having 5%, but could be several acting together. The SEC is considering a 1% threshold for big rms and a 3% bar for smaller ones. There are plenty of respectable supporters of a minimum holding period, including Warren Buett. Even the SEC is considering a one-year holding period. Yet there is no evidence that holding a share for longer makes an investor more engaged in corporate governance. As for fears that the interests of short-term investors may conict with those of longer-term shareholders, the great thing about elections is that if the majority do not like the slate of candidates oered by the insurgents, they don’t have to vote for them. As The Economist went to press, it was unclear if Mr Dodd’s amendment would succeed. Ominously, his proposed changes to shareholder rights are said to have the support of the White House. Even if it does not get through, bosses have signalled their determination to keep ghting attempts to make boards properly accountable to shareholders. That spells yet more trouble for reform. 7

is that its shareholders expect good returns on their investment, whereas some competitors, especially state-backed ones in the Middle East, invest to provide jobs and economic diversication rather than prots. The result is overcapacity, which brings down the returns for all producers. Given all this, BASF has for some time sought to reduce its dependence on commodity chemicals. Instead it wants to move into more specialised products with higher margins and steadier demand. It is not the rst chemical company to head down this path. Britain’s ICI, once a sprawling, integrated chemicals giant like BASF, spun o so many of its divisions that it ended up vanishing altogether as an independent company. Some of BASF’s competitors have pushed into pharmaceuticals and health care.

BASF buys Cognis

Seeking a stable formula BERLIN

The world’s biggest chemical rm buys into a less volatile business


ILD gyrations in the level of orders are enough to kill most businesses. In the chemical industry, they are routine. When economic crisis hit in 2008, demand for the basic chemicals used in everything from paints to plastic bags plummeted. BASF, the world’s biggest chemical company, saw its prots drop by half as both volumes and prices slumped. Although prices are now improving, that usually triggers capacity-building, which soon leads to a glut. No wonder, then, that BASF is attempting to dampen the perpetual upheaval, most recently through the purchase it announced on June 23rd of Cognis, a more specialised chemicals rm. BASF has coped with the swings of recent years better than most. Its size helps: it always has some big plants somewhere that can benet from a few months of quiet so that maintenance workers can open them up for a good scrubbing. Diversity helps too, since the prices of some chemicals may hold up better than others. And it has become well practised in the art of ruthlessly cutting costs. But for all these advantages, BASF also faces some real constraints. One is that as fast as it is growing in developing countries, it still has a huge presence in developed ones where employees are expensive and ageing. More important, perhaps,

Swallow and trim Few, however, have been as successful as BASF, which has proved adept at swallowing smaller competitors and then cutting their costs. Last year it bought Ciba, another specialist, and, despite grumbles that it had overpaid, seems to be getting its money’s worth by expanding its oering of the lucrative chemicals used to make paint and purify water. Now BASF hopes to repeat the trick with its purchase of Cognis, a smaller rm whose products are used, among other things, in cosmetics, food additives and household cleaning products. These achieve higher margins than most commodity chemicals and enjoy fairly stable demand. Even in the depths of last year’s recession Cognis was generating cash and paying down debt. The value of the deal was 3.1 billion ($3.8 billion), of which only $700m was the purchase price with the rest made up of debt that BASF will assume. As with the Ciba takeover, there are some complaints that it is overpaying. Moody’s said the takeover may aect BASF’s credit rating, although it acknowledged that the rm should have no trouble raising money and was generating cash. Over the longer run it seems an attractive deal because it makes BASF the world’s biggest supplier in markets that are growing fast and have big barriers to entry. In the boom that preceded the nancial crisis, chemical conglomerates like BASF risked falling prey to swift-footed privateequity rms which, armed with limitless cheap nance, would dismember them and then sell or oat the various component businesses. But Cognis’s private-equity owners have been trying to divest themselves of it since 2005, with their plans repeatedly undermined by stockmarket downturns. Now, with credit harder to nd, the big conglomerates with their diverse sources of cash are nding that they have become the predators. 7

The Economist June 26th 2010

68 Business Competition in American agriculture

Slaughterhouse rules Ewing, Nebraska

A ght looms over regulations for America’s meatpackers


ERTON CAP DIERKS, a tall, ageing cowboy, has been waiting for this a long time. His family has been raising cattle since 1883, after settling in the hills of north-central Nebraska. Mr Dierks is also a state legislator and with other independent ranchers has for years decried consolidation among meatpackers. Mr Dierks even got Nebraska to pass laws to try to protect small producers. But this month he won a new and powerful ally. On June 18th the Department of Agriculture proposed new regulations for big meatpackers and poultry processors. The agriculture and justice departments had already said they would study antitrust issues in agriculturethey have held two workshops so far, with a third, on dairy, scheduled for June 25th in Wisconsin. But the packer proposals show that regulators are prepared to do more than talk. Fred Stokes, a cattle rancher and leader of the Organisation for Competitive Markets, an advocacy group, is thrilled. Joaquin Contente, a dairy farmer due to speak at the Wisconsin hearing, hopes that dairy may see changes, too. The meat and poultry lobbies are horried. Farmers have long griped about a dearth of competition. Grain farmers say they are shackled to Monsanto. A few titansincluding Tyson, JBS USA and Cargillreign over livestock producers. The poultry industry has been almost completely vertically integrated for decades, with chicken producers operating under the tight rules of processors. The pig indus-

Meatpackers on the hook

try has scurried quickly toward integration over the past 15 years. Cattle ranchers are still dispersed, as young cows must be raised on expensive pastures such as those of Mr Dierks. Beefpackers, however, are consolidated giants. Across the livestock industry, the four biggest slaughter rms accounted for 68% of sales in 2008. Dairy farmers have their own complaints, operating within a complex system of price supports and federal marketing orders. But like their brethren in the pig, poultry and cattle industries, dairy farmers say they are beholden to a few big processorsDean Foods top among them. The result of all this, many farmers contend, is that big players engage in unfair practices and keep prices low. In 2009 a pig producer received 24.5% of the retail value of the animal, half the share that he did in 1980, according to the Agriculture Department. A cattle rancher received 42.5% of the retail value of a steer, compared with 62% in 1980. Mark Dopp of the American Meat Institute, the main lobbyist for meatpackers, says that the industry has simply evolved to be more ecient. Lower prices are the product not of anti-competitive behaviour but of economies of scale. Farmers have challenged big processors in court. Dean is fending o three antitrust lawsuits, the most recent led by the Justice Department itself. So far livestock farmers, however, have had little success. The Department of Agriculture’s proposed rule would mark a dramatic shift. Most importantly, argues Peter Carstensen of the University of Wisconsin, it would be much easier for small producers to sue under the 1921 Packer and Stockyards Act. The new rule would also change how big processors operate. Packers would be unable to give better terms to big producers than to small ones. They would be banned from selling animals to other packers. Contracts would become more transparent.

The proposed rule is going to increase cost, argues Mr Dopp. He points to an inevitable wave of litigation, administrative headaches and restrictions on sales. The Agriculture Department is now accepting comments on its proposed change. Mr Dopp is preparing a litany. Messrs Dierks and Stokes will meet other ranchers to organise support for their cause. An antitrust hearing on livestock will be held in Colorado in August. The Agriculture Department is likely to get an earful. 7

AHAB and Maan al-Sanea

Clash of the Saudi titans The contours of a Saudi nancial scandal become clearer


T THE weekend, many Saudis speed across the 28km (17-mile) causeway joining their country to the more relaxed kingdom of Bahrain to enjoy a drink, a lm, or a pair of beautiful legs , as one Bahraini delicately puts it. Sometimes, in their eagerness, they crash over the rails. The nancial trac between the two countries also produced a terrible wreck last yearone of the worst in the history of banking in the Gulf. In May 2009 The International Banking Corporation (TIBC), a Bahrain bank owned by a venerable Saudi merchant family, the Gosaibis, defaulted on its obligations. The default was an early sign that its parent, the Ahmad Hamad Algosaibi & Brothers Group (AHAB), was in nancial trouble. In the legal disputes that followed, AHAB alleged it was the victim of a spectacular $9 billion fraud, orchestrated by Maan Al-Sanea, a Saudi billionaire married to the daughter of one of the group’s founders. Mr Sanea, they alleged, enjoyed complete control of their nancial businesses, raising money in their name from as many as 118 banks. He siphoned billions out of the group, they claim, to entities he controlled. Mr Sanea denies any wrongdoing, and insists that although he used to be involved in the running of AHAB, he has not been for many years . The court battles surrounding TIBC’s collapse hinge on this row about the extent and nature of Mr Sanea’s rolesomething that recent court lings and TIBC’s former boss have shed some light on. The subject is urgent, as AHAB’s creditors are closing in. On June 16th TIBC’s administrators, Trowers & Hamlins, who are running the bankrupt rm on behalf of its creditors, led a $720m claim against AHAB in Saudi Arabia, the rst of a series of proceedings that they hope will recover $3.2 billion from the group. Others are pur- 1

The Economist June 26th 2010 2 suing the Gosaibis in Bahrain, London,

New York and elsewhere. Saudi Arabia’s king has formed a 12member committee to resolve the dispute, and Bahrain’s public prosecutor is questioning executives from time to time. One of them was Glenn Stewart, the chief executive of TIBC until its collapse. Mr Stewart recently escaped from Bahrain to America, eluding a travel ban. In a complaint to the United Nations Human Rights Council, Mr Stewart says that he was caught in the middle of a Clash of the Titans, between the Gosaibis and Mr Sanea. As boss of TIBC, Mr Stewart says he took instructions from Mr Sanea because he believed that the Gosaibis had given Mr Sanea full power of attorney to act on their behalf. Mr Sanea had indeed been given power of attorney to run one of AHAB’s nancial divisions, the Money Exchange, in 1983. But that was revoked in the 1990s, he says, and a narrower authority to sign documents on a case-by-case basis lapsed in 2003. In 2005 Mr Sanea resigned from the board of TIBC and other AHAB nancial businesses, citing too many pressures on my time. After TIBC’s default, he issued a statement saying he was not involved in the operations of AHAB in any way, although his spokesman now refuses to conrm or deny whether he had any continuing power of attorney related to AHAB. He also claims the Saudi committee has found no evidence of wrongdoing. The Gosaibis, in a lawsuit against Mr Sanea in the Cayman Islands, say he exercised complete managerial control of the business of Money Exchange, with the full trust and condence of AHAB. They allege that Mr Sanea abused their trust, concealing his borrowings from them and forging documents bearing the signature of Sulaiman al-Gosaibi, one of the founders of the group. The Gosaibis point out that TIBC’s nancial statements were purportedly signed by Sulaiman shortly before his death in 2009, when he was in a coma in Zurich. A guarantee to a creditor was supposedly signed in 2000 by Sulaiman’s brother, Abdulaziz, after a stroke left him unable to hold a pen. They say that Audrey Giles, a forensic scientist in London, has cast doubt on hundreds of Sulaiman’s signatures, nding that many were too perfect a match to one another to be true. Three of the documents she examined were the subject of a hearing last month in Bahrain, where Bank Muscat International of Oman is demanding $25m from AHAB. The tribunal ruled that they were not forged. But the ruling does not necessarily contradict Ms Giles’s ndings, since it merely concluded that the three documents were not among those she found to be forged. (For his part, Mr Stewart says he can explain Sulaiman’s signature on TIBC’s nancial statements, which were

Business 69 signed six weeks before, he says, but not formally issued until he had nished squabbling with the rm’s auditors.) Mr Stewart’s claims raise one further question about this murky a air. Why did he consent to be the boss of a bank he did not run? You are nothing more than a gloried servant, he admits. Wasn’t that a waste of his talents? Mr Stewart, who studied Islamic history and Arabic at Oxford, says that after his long years in the Gulf he would nd it hard to adjust to Western corporate culture. He is fascinated by the turbulence and anarchy of the Arab world, he says, although he is now bearing the consequences of that ill-discipline. 7

The growth of legal outsourcing

Passage to India Delhi

Companies and law rms are turning to India for cut-price legal services


ITU SOLANKI, a 28-year-old lawyer with a degree from Nottingham University, spends most of her time drafting contracts and legal memos for a telecoms rm in Britain. She, however, is in Gurgaon, a high-rise satellite city on Delhi’s edge, where she works for CPA Global, a legal-outsourcing company. A lawyer with similar experience at a London law rm might charge up to $400 an hour for the sort of work Ms Solanki does; her labour costs around $50 an hour. As law rms and corporate legal departments face mounting pressure to cut costs, an increasing number are choosing the Indian option. Last year, Rio Tinto, an international mining group, moved a tranche of legal work to Indian lawyers at CPA Global, which has its headquarters in Jersey, to save a fth of its legal costs. Others are following. In May CMS Cameron McKenna, a

British law rm, signed the legal industry’s biggest outsourcing deal with Integreon, an American company with operations in India. Over the next ten years, Integreon’s Indian sta will provide the British rm with services from human resources to legal research. Though India’s legal-process outsourcing (LPO) industry is still small, it is growing fast. In a recent report, ValueNotes, an Indian consultancy, estimated that India’s LPO revenues will grow from $146m in 2006 to $440m this year and $1.1 billion in 2014. The number of Indian rms o ering LPO services has swelled from 50 in 2005 to more than 140 today. Investors have spotted the potential. In February, Actis, a British private-equity outt that specialises in emerging markets, invested $50m in Integreon. Intermediate Capital Group, also based in Britain, has bought an undisclosed chunk of CPA Global. The growth in LPO has been boosted by the global economic slowdown. It’s a very obvious way to cut costs and it is hard to refute once you have seen the good work that is being produced, says Leah Cooper, CPA Global’s strategy director. Until four months ago, Ms Cooper was Rio Tinto’s managing attorney. Western lawyers have in the past been slow to outsource even the most basic work to India, because of worries about condentiality and quality. But they are now commissioning ever larger volumes. Developments within India’s outsourcing industry have also contributed to making the country a more compelling destination for legal work. Although still dominated by low-value process outsourcing, such as call-centres, the fastest growth is in companies o ering highly skilled work, from medicine to engineering and information technology (it). A growing number of newly qualied lawyers, trained in a legal system based on Britain’s and often educated at British or American universities, are drawn to the higher salaries and international experience now being o ered. Such lawyers are capable of doing more complex work than the document review and proofreading that currently forms the bulk of legal outsourcing. That said, many legal jobs, from court appearances to the handling of witness depositions, will never be outsourced. And fears persist among some senior lawyers about sending even the simplest chores o shore. A prot-inating scandal last year at Satyam, India’s fourth-largest IT outsourcing company, reawakened old worries. There is also the question of how young lawyers will cut their teeth if the jobs they typically do are sent instead to Delhi. Ms Cooper says: I hear that every day and my response is, I didn’t learn a thing as a baby lawyer digging through boxes in a storeroom. We may have to rethink how our lawyers are trained. 7

70 Business

The Economist June 26th 2010

Schumpeter Too many chiefs Ination in job titles is approaching Weimar levels


IM JONG IL, the North Korean dictator, is not normally a trendsetter. But in one area he is clearly leading the pack: jobtitle ination. Mr Kim has 1,200 ocial titles, including, roughly translated, guardian deity of the planet, ever-victorious general, lodestar of the 21st century, supreme commander at the forefront of the struggle against imperialism and the United States, eternal bosom of hot love and greatest man who ever lived. When it comes to job titles, we live in an age of rampant ination. Everybody you come across seems to be a chief or president of some variety. Title ination is producing its own vocabulary: uptitling and title-ung. It is also producing technological aids. One website provides a simple formula: just take your job title, mix in a few grand words, such as global, interface and customer, and hey presto. The rot starts at the top. Not that long ago companies had just two or three chief whatnots. Now they have dozens, collectively called the c-suite. A few have more than one chief executive ocer; CB Richard Ellis, a property-services rm, has four. A growing number have chiefs for almost everything from knowledge to diversity. Southwest Airlines has a chief Twitter ocer. Coca-Cola and Marriott have chief blogging ocers. Kodak has one of those too, along with a chief listening ocer. Even so, chiefs are relatively rare compared with presidents and their various declensions (vice-, assistant-, etc). Almost everybody in banking from the receptionist upwards is a president of some sort. The number of members of LinkedIn, a professional network, with the title vice-president grew 426% faster than the membership of the site as a whole in 2005-09. The ination rate for presidents was 312% and for chiefs a mere 275%. Title-ung is as rampant among the indians as among the chiefs. America’s International Association of Administrative Professionals formerly the National Secretaries Association reports that it has more than 500 job-titles under its umbrella, ranging from front-oce co-ordinator to electronic-document specialist. Paper boys are media distribution ocers. Binmen are recycling ocers. Lavatory cleaners are sanitation consultants. Sandwich-makers at Subway have the phrase sandwich artist emblazoned on their lapels. Even the normally linguistically pure French have got in on the act: cleaning ladies are be-

coming techniciennes de surface (surface technicians). What is going on here? The most immediate explanation is the economic downturn: bosses are doling out ever fancier titles as a substitute for pay raises and bonuses. But there are also structural reasons for the trend. The most basic is the growing complexity of businesses. Many not only have presidents and vice-presidents for this or that product line, but also presidents and vicepresidents for various regions. Put the two together and you have a recipe for ever-longer business cards: vice-president for photocopiers Asia-Pacic, for example. The cult of exibility is also inationary. The fashion for attening hierarchies has had the paradoxical eect of multiplying meaningless job titles. Workers crave importantsounding titles to give them the illusion of ascending the ranks. Managers who no longer have anyone to manage are fobbed o with inated titles, much as superannuated politicians are made Chancellor of the Duchy of Lancaster or Lord President of the Council. Everybody, from the executive suite downward, wants to u up their résumé as a hedge against being sacked. Firms also use fancy job titles to signal that they are au fait with the latest fashion. The fad for greenery is producing legions of chief sustainability ocers and green ambassadors. BP’s travails will undoubtedly have the same eect: we can expect a bull market in chief safety ocers and chief apology ocers. The American technology sector has been a champion of title ination. It has created all sorts of newfangled jobs that have to be given names, and it is also full of linguistically challenged geeks who have a taste for humorous titles. Steve Jobs calls himself chief know it all. Jerry Yang and David Filo, the founders of Yahoo!, call themselves chief Yahoos. Thousands of IT types dub themselves things like (chief) scrum master, guru, evangelist or, a particular favourite at the moment, ninja. But leadership in title ination, as in so much else, is passing to the developing world, particularly India and China. Both countries have a longstanding obsession with hierarchy (fancy job titles can be the key to getting a bride as well as the admiration of your friends). They also have tight labour markets. The result is an explosion of titles. Companies have taken to creating baing jobs such as outbound specialist. They have also taken to staging public celebrations of promotions from, say, assistant deputy director to principal assistant deputy director. Inated bene ts, understated drawbacks Does any of this matter? Title ination clearly does violence to the language. But isn’t that par for the course in the corporate world? And isn’t it a small price to pay for corporate harmony? The snag is that the familiar problems of monetary ination apply to job-title ination as well. The benets of giving people a fancy new title are usually short-lived. The harm is long-lasting. People become cynical about their monikers (particularly when they are given in lieu of pay rises). Organisations become more Ruritanian. The job market becomes more opaque. How do you work out the going rate for vision controller of multiplatform and portfolio (the BBC)? Or a manager of futuring and innovation-based strategies (the American Cancer Society)? And, far from providing people with more security, fancy titles can often make them more expendable. Companies might hesitate before sacking an IT adviser. But what about a chief scrum master? The essence of ination, after all, is that it devalues everything that it touches. 7

Brie ng The campaign against palm oil

The other oil spill Palm oil is a popular, cheap commodity, which green activists are doing their best to turn into a commercial liability. Companies are nding them impossible to ignore


ARLY on April 21st 2008, Greenpeace activists dressed as orang-utans stormed Unilever’s headquarters in London. Similar raids took place at the multinational’s facilities on Merseyside, in Rome and in Rotterdam. Furry protesters scaled buildings, occupied production lines and unfurled banners. Many read: Unilever: Don’t Destroy the Forests . Dove, one of the company’s best-known brands, was singled out by name. The tactic was a simple one, intended to draw attention to the damage done to Indonesian tropical rainforests by the production of palm oil, an ingredient in many of Unilever’s products. It was also eective: soon after the orang-utan invasion the company said it would draw all its palm oil from sustainable sources by 2015. The charges against palm oil are serious: environmental groups regard it as a danger not only to Asian wildlife but also to the health of the planet. Between 1967 and 2000 the area under cultivation in Indonesia expanded from less than 2,000 square kilometres (770 square miles) to more than 30,000 square kilometres. Deforestation in Indonesia for palm oil and illegal logging is so rapid that a report in 2007 by the United Nations Environment Programme (UNEP) said most of the country’s forest might be destroyed by 2022. Al-

though the rate of forest loss has declined in Indonesia in the past decade, UNEP says the spread of palm-oil plantations is one of the greatest threats to forests in Indonesia and Malaysia. In Sumatra and Borneo, palm-oil expansion threatens elephants, tigers and rhinos, as well as orang-utans. Enormous amounts of carbon dioxide are released as forests and peatlands are destroyed. Deforestation makes Indonesia one of the world’s largest carbon-dioxide emitters. On the bright side, it is true that palm oil has contributed to economic growth in the countries that produce it. But even that has been tarnished in some cases by social conict, for example when locals or indigenous groups have been turfed o their land to make room for plantations. Such matters are increasingly dicult for buyers of palm oil to ignore. Even though it takes only 4% of the global total, Unilever is the world’s biggest buyer, making it an obvious target for activists. Kraft and General Mills, two big American food companies, HSBC, a huge bank, and Cargill, an American agribusiness giant, have also come in for criticism. In the past few months, Nestlé, another food giant, has been attacked in a spoof online advertisement that shows an oce worker eating a nger of KitKat. The chocolate digit turns

The Economist June 26th 2010 71

out to belong to an orang-utan, with bloody consequences. These attacks are proving potent. Companies are changing their buying policies in response, and paying more attention to the distant reaches of their supply chains. And the lessons may reach far beyond palm oil. With oil of a dierent type continuing to spew into the Gulf of Mexico, companies’ environmental responsibilities have never been more public. Clean start The palm-oil story started in 1848, when it was discovered that the oil palm, a native of West Africa, grew well in the Far East. Its giant bunches of red fruits are rich in oil that proved useful in soap and later as a lubricant for steam engines. Demand grew, and plantations sprouted in Malaysia in the 1930s. As the industry matured, cultivation spread to Indonesia. These two countries today produce 90% of the world’s palm oil (see chart 1 on the next page). These days it is used in a vast array of food and consumer products, from peanut butter, margarine and ice cream to lipstick and shaving foam. Palm oil makes shampoos and soaps more creamy. WWF, an environmental group, says it is used in 50% of all packaged supermarket products. It is also a common cooking oil across Asia. It is becoming more popular as a biofuel. Laws that encourage the use of biofuels are adding to demand. Rising demand has pushed up the price of palm oil. Although it is lower than it was during a surge in vegetable-oil prices a couple of years ago (see chart 2), the average price in 2010 has been around $800 a tonne, says Siegfried Falk of Oil World, a 1

72 Brie ng The campaign against palm oil

The Economist June 26th 2010

2 rm of analysts. Oil World forecasts that

global production will reach a record 46.9m tonnes this year, up from 45.3m in 2009, with most of the increase coming from Indonesia. The oil palm is an ecient crop, yielding up to ten times more oil per hectare than soyabeans, rapeseed or sunowers. On 5% of the world’s vegetable-oil farmland it produces 38% of output, more than any of these other crops. Any substitute would need more land. Its bounty makes it relatively cheap. For years, worries about palm oil have been contained within an organisation called the Roundtable on Sustainable Palm Oil (RSPO). Set up in 2004, the RSPO involves growers, processors, food companies, investors and NGOs. Its purpose is to prod the industry into producing sustainable palm oilie, certied as not having involved the destruction of areas of high conservation value. But the supply of certied oil has grown slowly, perhaps because producers have to commit themselves only to certifying a portion of their crop as sustainable. Demand for certied oil has been sluggish, too: in the rst year of trading only 30% of the sustainable oil was sold as such. This year has been better. Vengeta Rao, secretary-general of the RSPO, says most of the 2m tonnes produced has been sold in recent months. Another problem is that the RSPO has struggled to create any eective action on setting standards for greenhouse-gas emissions associated with palm-oil plantations. Its critics have nicknamed it Really Slow Progress Overall, and its members account for only 40% of palm-oil production. Environmental campaigners have become increasingly impatient with it. Gavin Neath, senior vice-president of communications and sustainability at Unilever, says the problems started several years ago when Greenpeace published a report that made a number of accusations about some of its palm-oil suppliers. It ended up, he says, with people in orangutan suits climbing our buildings. Since Unilever committed itself to us1

Sources of discontent Palm-oil exporters, tonnes, m



Rest of world 40 35 30 25 20 15 10 5 0

1995 97

99 2001 03


Years ending September Source: Oil World


09 10* *Forecast


Market lubricants Vegetable-oil prices, $ per tonne




Palm 2,500 2,000 1,500 1,000 500 0





Source: Thomson Reuters

ing only palm oil certied as being from sustainable sources, more than 20 big companiesincluding Procter & Gamble, Unilever’s great rival, and Mars, a confectionerhave followed suit. But Greenpeace wanted Unilever to go further, and stop buying palm oil from producers the NGO believed were breaking the law. It wanted the company to convince suppliers to behave better by threatening the loss of a big contract. So Unilever looked into its supply chains. The news was not good. Mr Neath said more than a year ago, We found that, in one way or another, all of our suppliers have technically infringed either RSPO standards or Indonesian law. It isn’t as easy as saying just pick the best, we can’t. We are not in a position to do that. The industry almost certainly has to go through fundamental change. Mr Neath added that because palm oil had so many uses, not even Unilever had much leverage. By December 2009 Greenpeace had pushed Unilever into further action. The NGO made fresh allegations: that SMART, a palm-oil producer, a member of the RSPO and a part of Sinar Mas, an Indonesian conglomerate, was involved in illegal deforestation and clearance of peatland. Unilever, in response, suspended purchases from SMART, which has since commissioned an independent audit of the allegations. Nestlé, too, thought it was safe. It was a smallish buyer and a member of the RSPO, with a palm-oil policy in line with the industry standard. It was also buying some sustainable oil, but like many others did not plan to buy all its oil this way until 2015. Interviewed before the anti-KitKat video featuring the orang-utan’s nger appeared, José Lopez, who is responsible for manufacturing and supply chains, said that although deforestation was a worry, Nestlé used only 320,000 tonnes of palm oil a year. He added that the criticism of KitKat was frustrating because you would have to look through a microscope to nd the palm oil in the snack. However, like Unilever, Nestlé had two weak spots: a much-loved global brand

and insucient knowledge of its supply chain, although in other areas it prided itself on its relationships with and knowledge of growers. Its suppliers included Sinar Mas. On May 17th, after a clumsy attempt to bury the nasty spoof KitKat video (which merely increased the cacophony of online protest), Nestlé buckled. The video had been viewed 1.5m times and prompted 200,000 e-mails of protest. Nestlé said it had suspended all purchases from Sinar Mas, which has admitted to mistakes in the area of deforestation. The campaign, says someone close to the aair, was a wake-up call for Nestlé. Speaking about the video, Daniela Montalto of Greenpeace said, We had been asking Nestlé to stop buying products from rainforest destruction for two years before we launched our campaign. Nestlé cracked within just two months because the overwhelming public response made the company listen. In fact in response Nestlé went further than any company had gone before. It undertook to exclude companies running high-risk plantations or farms linked to deforestation from its supply chain. To make this happen, Nestlé has recruited the Forest Trust (TFT), a charity based in Switzerland, to provide an independent review of its palm-oil supply chains, right down to ground level. Every supplier will be audited for evidence of illegal activity. TFT’s executive director, Scott Poynton, says his group lls a gap that the RSPO cannot do as it is free to criticise any bad practice. However, the RSPO’s Mr Rao says that if hard evidence is found by independent auditors investigating allegations against RSPO members, such as digging up rainforests, memberships may be terminated. This would be a rst for the organisation. Sign of the times Such dramatic developments do not mean that the greens have won the battle for sustainable palm oil. Despite a few victories over well-known buyers, in parts of the industry environmental concerns are barely noted. In particular, the campaigns have focused on Westerners, not on Asian users. Moreover, even verifying the sustainable palm oil on the market is dicult. Big companies all buy from processors and traders, rather than directly from plantations. In an ideal world, plantations and mills would be certied as sustainable, and the oil they produce would be shipped separately. But this is expensive, say people in the industry, so there is no large-scale segregation of supply: if plantations produce oil certied as sustainable, it gets mixed in with the rest. In the same way that wind farms supply national grids, and sell renewable electricity, producers are able to sell on the certicates that show how much sustainable oil they have made. Sustainable oil could perhaps be sold at a 1

The Economist June 26th 2010 2 premiumbut this would be dicult to

maintain in commodity markets, because sustainable and unsustainable oil are physically identical. Might it be possible simply to use less palm oil? Perhaps, but it would be costly to replace. Nevertheless, Lush, a niche British cosmetics company, has done away with it altogether and uses (among other things) coconut oil instead. There is no such thing as sustainable palm oil: it doesn’t exist, says Lush’s campaign manager, Andrew Butler. Some food companies, such as Findus, Mars and Marks & Spencer, are reducing use of palm oil but say this is for nutritional reasons (palm oil is a saturated fat). Harder to palm o Because of palm oil’s connection to deforestation, environmentalists are unlikely to reduce the pressure on companies that use it. WWF publishes an annual scorecard of the palm-oil policies of 59 European companies. At the bottom are companies such as Danone, a French dairy-goods company, and E. Leclerc, a hypermarket chain. Some, such as Aldi, a German retailer, and Géant Casino, another French hypermarket group, decline to answer questions about their palm-oil policies. The Forest Footprint Disclosure project, supported by the British government and several charitable foundations, has just started an annual call for companies to indicate the extent to which their procurement policies for palm oil, soya, timber, beef, leather and biofuels are linked to deforestation. In the rst year most companies chose not to respond. However, the project has the endorsement of institutional investors holding assets of $4 trillion. These sign a letter requesting disclosure, which will be sent annually to several hundred companies. This might become inuential, especially now that the Gulf of Mexico oil spill has focused fund managers’ minds on environmental risks. In June a group of British MPs of green inclination called for pension funds to be forced to reveal more about such risks. Furthermore, deforestation has arrived rmly on the agenda of international bodies such as the World Bank and the UN, as well as of the European Union and national governments, including America’s, Britain’s and Norway’s. For example, a new European law to ban illegal timber from the EU looks likely (with help for poor countries to comply). The EU may also have to revise its targets for biofuel use in the light of reports that palm oil (and other oils) fails to meet standards of reducing emissions by 35% compared with a litre of fossil fuels. Greens have learned to appeal to governments’ protectionist tendencies. Earlier this year the Nature Conservancy, an American green group, took representatives of America’s National Farmers Union

Brie ng The campaign against palm oil 73 and the American Farmland Trust on a trip to Brazil to see how illegal forest clearance was hurting US businesses by ooding markets with cheap and unsustainable products. A new report from David Gardiner & Associates, a consultancy, says the 13m hectares of mostly tropical forest that are lost annually allow the large-scale and low-cost expansion of timber, cattle and agricultural production. The report argues that policies to conserve rainforests would boost American agricultural revenue by as much as $190 billion-270 billion between 2012 and 2030. Some companies may still take the view that decisions about buying palm oil are purely a matter of costa comparison of the price of oil from a sustainable source with that of buying the stu from anywhere. But as the political pressure rises, the nancial calculus changes. There are other forces at work besides pestering from greens and governments. One is attitudes within companies. Mr Poynton believes an important reason why Nestlé changed its policy was the opinion of its sta. For years companies have been saying that a commitment to corporate social responsibility (CSR) can improve the quality of sta that they can recruit. It follows that these recruits then care about the behaviour of the company that employs them. The threat from Facebook The public, too, expects more of companies these days. At a conference on CSR in London in June, David Jones, head of Havas Worldwide, an advertising company, said that whereas in the previous decade the point of CSR had been to create a competitive advantage, the new era of social media meant a shift of emphasis to limiting the damage that could be done to a company. All rms, he said, will have to demonstrate transparency and authentic-

A basket of trouble

ity. The palm-oil episode provides a good example of how greens can use social media to make consumers aware of what goes into the products they buy. Fearful of losing sales, companies have responded. It is not only companies that are being pressed. Helped by $1 billion from the government of Norway, Indonesia has taken action. A month ago the Indonesian president announced a two-year moratorium on new concessions to clear natural forests and peatlands. Indonesia will also set up its own certication body, a rival to the RSPO, which is expected to impose obligations on producers who are not members of that organisation. Some argue that the palm-oil industry can continue to expand in Indonesia through productivity gains and the availability of grassland or previously deforested land. That remains to be seen, because hitherto the nance for palm-oil plantations has come from the sale of cleared timber. And because palm oil is an important source of calories and income for the poor, there is a great deal at stake. What happens from now on will depend on whether pressure is kept up on all parts of the industry. Clearly, the industry would not have moved so far, so fast, without pressure from green activists. Several companies have learned that they are vulnerable, politically and therefore commercially, when they do not control the distant ends of their supply chains. That applies not only in South-East Asian palm-oil plantations but in many other places too: in sweatshops employing young children, or in Chinese factories where workers take their own lives. Mr Poynton may be overstating the case when he says: Most of the environmental and social issues are embedded in products at extraction, at the resource level. But he is surely right when he adds: It is no longer possible to ignore that end. 7

The Economist June 26th 2010 75

Finance and economics

Also in this section 76 Buttonwood: Commodity prices 77 Parsing the Volcker rule 77 A brace of patchy art sales 78 Friedrich Hayek, meet Glenn Beck 78 ETFs under scrutiny 79 Europe’s tricky stress tests 80 Economics focus: Immigration

For daily analysis and debate on economics, visit

The yuan unpegged

Learning to crawl Hong kong

China’s new-found exibility on its currency should ease trade tensions with America, but may turn attention to others


HEAP goods from China can sour relations with America even when they are sweet. Earlier this month, for example, American ocials seized a shipment of honey from China because it violated food-safety standards. It contained an antibiotic used to treat foulbrood, a disease that aicts bee larvae. The bust was lauded by Charles Schumer, a Democratic Senator from New York, who condemned China’s honey launderers. But honey is not the stickiest issue dividing the two countries. Mr Schumer and many other members of Congress also rail against China’s currency, the yuan, which they believe is articially cheap. They have been urging President Barack Obama to get tough. On June 16th he wrote a letter to the 1

Flexible friends INVERTED SCALE

China’s yuan per $, intraday price

6.79 6.80 6.81 6.82 6.83 18



June 2010 Source: Bloomberg



leaders of the G20 underscoring that market-determined exchange rates are essential to global economic vitality. Many feared a case of foul mood when the leaders gathered in Toronto on June 26th-27th. But on June 19th China unveiled a potential remedy. The People’s Bank of China (PBOC), the country’s central bank, said it would increase the exibility of the yuan, which has been tightly pegged at about 6.83 to the dollar since July 2008. In setting the exchange rate, it would pay heed to a basket of currencies, it said, as well as market supply and demand. In China’s edgling foreign-exchange market, the central bank sets a central dollar parity for the yuan each morning. For the past two years, it has allowed the currency to move barely a whisker from this rate. Now it seems prepared to let it rise by up to 0.5% on any given daybut not to let it rise by that much day after day. On the Monday after its statement, the PBOC let the currency appreciate by over 0.4%, generating quite a bit of excitement. At that rate the yuan would double in value in just 174 trading days. The next morning the central bank set its parity to reect the previous day’s close. But as Tuesday wore on, it decided that market supply and demand needed a bit of a nudge. Heavy dollar-buying by the country’s big state banks, presumably at the PBOC’s behest, pushed the yuan down against the dollar, allowing the central bank to set a Wednesday-morning

parity of 6.81 (see chart 1). The last time the central bank let the currency crawl, it clambered up by 21% against the dollar over three years. But it may not match that pace this time. China will not want the yuan to get too far ahead of other signicant currencies that may be falling against the dollar. As the central bank says, China now has a long and diversied list of trading partners. Against a broad basket of their currencies, the yuan has already risen this year; against the euro it has strengthened by 17%. On any given day the yuan may also slip, as well as climb, against the dollar. The central bank is keen to deter hot money that might seep past the country’s capital controls, looking to prot from a stronger currency. Mark Williams of Capital Economics, a research rm, thinks it has already succeeded. The currency forwards market expects the yuan to appreciate by only 2.2% over the next 12 months, a slender return given the hassle of getting money in and out of China. Even without the central bank’s guidance, the upward pressure on the yuan may be more bearable this time, according 1

Minor China

China United States

Trade balance*, $bn

400 200 +

0 –

200 400 600 800 1,000 2004


Source: CEIC




09 10

*Year to each quarter


The Economist June 26th 2010

76 Finance and economics 2 to Zhao Qingming, a former economist at

the PBOC, and David Li, an adviser to the central bank. In an interview with HSBC, they point out that China’s trade surplus has narrowed signicantly (see chart 2, previous page). Six months ago William Cline and John Williamson of the Peterson Institute of International Economics in Washington, DC, calculated that the yuan would have to strengthen by 40% against the dollar to restore equilibrium , which they dened as a current-account surplus of 3% at full employment. Now they reckon it would have to climb by only 24% against the dollar and 14% against its trad-

ing partners overall. But although China’s trade surplus is not as conspicuous as it was before the crisis, America’s tolerance for such imbalances has also fallen. China’s currency manipulation would be unacceptable even in good economic times. At a time of 10% unemployment, we simply will not stand for it, said Mr Schumer in March after introducing a bill to slap duties on any country intervening persistently in the foreign-exchange market. When the world economy is short of demand, argues Paul Krugman, a Nobel prizewinner, countries that persistently spend far less than they

earn contribute to global unemployment. In his letter to G20 leaders Mr Obama criticised the heavy reliance on exports by some countries with already large external surpluses . China is not the only country at fault. Germany’s current-account surplus ($135 billion in 2009) is less than half the size of China’s ($297 billion) in dollar terms; it is also smaller relative to the size of its economy. But China’s surplus is dropping faster. According to projections by the Economist Intelligence Unit, a sister company of The Economist, Germany’s surplus will narrow by only $20 billion this year; China’s by $68 billion. That rep- 1

Buttonwood Clearing the usual suspects Investors may not have caused commodity price rises


O ONE likes paying more to fuel their car. The uctuations in the oil price caused by political turmoil in the Middle East are hard enough to bear. But the idea that speculators are driving commodity prices beyond their true level seems particularly galling. To many, that oil went from $65 a barrel in June 2007 to $145 in July 2008, and back down to $31 in December of the same year, is proof the price was not being set by supply and demand. Academics who have proclaimed on the issue come down on both sides of the argument. A recent report* from the OECD analyses the literature, applies its own statistical tests and nds investors not guilty. Technically speaking, the report does not deal with the inuence of speculators on commodity markets but with the role of index-tracking funds. But the spectacular growth of these funds (from $90 billion at the start of 2006 to almost $200 billion at the end of 2007) coincided with the boom in raw-materials prices, so it is hardly surprising they have been ngered as suspects. The big buyers were pension funds and endowments. They became convinced, after the bear market of 2000-02, that they were overcommitted to shares. So they started to diversify into alternative asset classes that were not correlated with equities yet oered the prospect of hefty returns. Commodities tted the bill. Surely this lumbering herd must have had an eect on prices? There are some sound theoretical reasons why they might not. For a start the index funds buy futuresa contract to buy or sell an asset at a future datenot the physical good. They are not cornering the commodity, as the Hunt brothers from Texas attempted to do with silver in the late 1970s. Higher futures prices could have sent a

signal to commodity producers, who then decided to hoard their stocks rather than sell them in the cash market. The shortage might then have pushed spot prices higher. The evidence, however, is that inventories were falling, not rising. An even more telling argument is that commodities without futures markets (apples, edible beans) or futures markets where index funds did not get involved (milk, rice) also saw price rises during 2006-08. Nor was there any correlation between the size of index funds in particular commodities and the price rise for those raw materials. After analysing data on both prices and individual holdings from America’s Commodity Futures Trading Commission, the OECD study found that there was no convincing evidence that positions held by index tradersimpact market returns ; indeed, the OECD reckons that larger positions led to lower market volatility (although data issues mean the nding is more convincing for agricultural products than for energy markets). So if the funds are innocent, who was guilty? The report does not give an answer

but some economists have made the attempt, variously citing demand from China and other developing nations, the diversion of crop use from food to fuel oil, and production constraints. These explanations may seem to strain plausibility, given that the oil price fell by 79% within ve months. The Chinese did not suddenly cut their oil consumption by four-fths. But if supply and demand are in close balance (as they were in the oil market), even very small changes in either component can lead to large price shifts. In his book, The Logic of Life: Uncovering the New Economics of Everything , Tim Harford postulates a marriage supermarket in which men and women who agree to wed can present themselves at the checkout and share $100. Given equal numbers of men and women, say 20 apiece, one would expect couples to split the $100 down the middle. But assume there are 20 women and just 19 men. If the women are determined to get married, this shortage of males will cause a bidding war. None will want to be left in the aisles so they will agree to cut their share of the pot. In theory, the lack of just one male will mean the men get to keep $99.99 of the proceeds, leaving the women with one cent. Similarly, in boom conditions commodity consumers will be so desperate to get their hands on raw materials that they will drive prices up to absurd levels, at least for a short time. When demand falters, or new supply shows up, the price bubble can evaporate as quickly as it arose, without a speculator in sight.

.............................................................. * Speculation and Financial Fund Activity , Draft Report, OECD Trade and Agriculture Directorate

The Economist June 26th 2010 2 resents an injection of extra demand for

the rest of the world’s goods and services this year, relative to last. Like China for the past two years, Germany has also pegged its exchange rateto the euro. No one is accusing the European Central Bank of manipulating the currency, but the euro’s slide implies that the zone’s members will be relying on foreign demand, not their own, to restore their fortunes. Goldman Sachs expects the euro area’s current account to show a surplus this year, which will only grow next year. Perhaps Mr Schumer should demand the interdiction of Frankfurter sausages. 7

The Volcker rule

Bang or whimper? NEW YORK

A much-hyped reform may not have much e ect on alternative investors


ONALD REAGAN once quipped that he didn’t know what the Ten Commandments would have looked like if Moses had run them by Congress. If only Congress could run nancial reform past Moses. Legislators from the House of Representatives and the Senate this week continued the erratic process of reconciling versions of bills passed by each chamber. By the middle of the week, a number of dierences had been ironed out, including the creation of a consumer-protection bureau housed within the Federal Reserve, the regulation of debit-card interchange fees and measures requiring rms that securitise loans to retain a portion of the risk. But the trickiest issues were still to come. Among them was discussion of the Volcker rule , which was designed to restrict banks’ proprietary trading activities (bets made for their own account) and sponsorship of hedge funds and privateequity rms. The provision, named after Paul Volcker, a former chairman of the Federal Reserve, was rst unveiled by Barack Obama in January. Since then some bankers have worried that they might be forced to sell their hedge funds and private-equity units because politicians consider those activities too risky. Their worst fears seem unfounded. As The Economist went to press, it looked likely that a diluted version of the Volcker rule would pass, allowing banks to keep running hedge-fund and private-equity units for clients who want to invest in them, and perhaps to keep putting a small share of their own capital in them as well. To placate those who wanted to see a stricter version, some senators were pushing a provision that would give regulators less say in how to enforce the rule.

Finance and economics 77 Many banks had already been betting that the Volcker rule would not cause them to surrender their role in the alternative investment sector. Citigroup has plans to raise more than $3 billion for its privateequity and hedge funds, an audacious move considering regulators’ watchful eyes. JPMorgan Chase, whose Highbridge hedge fund has an estimated $22 billion under management, reportedly wants to buy Gávea Investimentos, a Brazilian asset manager. They may not be able to invest as much of their own capital in these vehicles, but it looks as if they can keep making money on them. The Volcker rule will have some eects on the relationship between Wall Street and alternative investment companies. Already, proprietary traders have started to leave banks and go to hedge funds, where they feel more certain about their longterm employment prospects, say headhunters. Tim Sangston of Greenwich Associates, a research rm, expects a further migration of traders out of banks once the bill is nally passed. Some traders may also try to start their own hedge funds, although the fundraising environment is bleak. The Volcker rule could make things even worse. Funds of funds owned by American banks provide around $180 billion, or about 16% of all its assets under management, to the hedgefund industry. Some of that is seed money, which goes to managers who are starting funds. If the nal version of Volcker prevents banks from investing as much capital in hedge funds, start-ups may have fewer potential backers. Alternatives thinking Not everyone thinks the Volcker rule will be bad news, however. Non-banks with seeding funds, such as Blackstone, a private-equity rm, and Citadel, a hedge fund, may ll some of the fund-raising gap. And if banks are required to reduce their own investments in alternative assets, that should be a boost for the secondary market for stakes in private-equity funds. Harvey Lambert of PineBridge Investments, an alternative-asset manager, estimates that banks could choose to sell as much as $100 billion in private-equity positions, which is around two or three times the size of the whole secondary market now. Even so, these potential eects look relatively modest compared with the splash the rule made when it was rst unveiled. Peter Clarke, the boss of Man, a large hedge fund, pooh-poohs the importance of the Volcker rule. He says the continued deleveraging of banks will inuence returns at hedge funds more than the new rules. Irrespective of the Volcker rule, banks’ need to get rid of assets and unwind trades will be good news for many in the alternative-investment industry, he says, because there will be less competition for returns. 7

Art sales

Stooping, not conquering Auctions at Christie’s and Sotheby’s were not as successful as they claim


HEY were expected to be the biggest art auctions ever: 113 carefully chosen lots that would shatter records and prove, once and for all, that the market had returned to the boom years of 2006 and 2007. When it came to it, though, evening sales at Christie’s and Sotheby’s of Impressionist and Modern art in London on June 22nd and 23rd were patchy at best. Sotheby’s came rst, and had the worst time of it. The Bond Street auctioneer drew a stellar crowd that included Laurence Gra, a British jeweller specialising in huge diamonds, and Larry Gagosian, an inuential New York art dealer who rarely appears in person at auctions. Sixteen of the 51 lots failed to nd a buyer, however, including works that should have been popular: two Edgar Degas pastels, a late Picasso of a woman seated in an armchair with a cat, and a circus scene by Marc Chagall. Only three lots generated any real sense of excitement: a beautiful study of a woman reclining by Henri Matisse, that fetched a hammer price (before taxes and commissions) of £5.2m ($7.7m), more than twice the top estimate; a colourful tree scene by André Derain that came from the collection of Picasso’s dealer, Ambroise Vollard, and had never previously been oered for sale; and a still life of peonies by Edouard Manet that sold to Patti Wong, the chairman of Sotheby’s Asia, on the telephone on behalf of a private client. Steven Cohen, an American hedge- 1

The Economist June 26th 2010

78 Finance and economics 2 fund billionaire, sent his adviser, Sandy

Heller, to oversee the sale of Sotheby’s star lot, Manet’s 1878 self-portrait, which he had consigned to the sale and which featured on the cover of the catalogue. The picture had once belonged to Steve Wynn, a Las Vegas casino builder, and was estimated to fetch £20m-30m. Despite determined eorts by the auctioneer, Henry Wyndham, it raised just one lacklustre bid at the reserve price, selling to Franck Giraud, a New York-based dealer. Though a record for Manet, the nal price (£22.4m, including commission and taxes) was a disappointment. The buyer is believed to be a Middle Eastern museum. Christie’s sale, the following night, had the better pictures and raised its highest total for a London sale. But even here, 16 of

the lots failed to reach their reserve price. Picasso’s early portrait of Angel Fernández de Soto, acquired by Andrew Lloyd Webber, a composer of musicals, in 1995 for £18.1m, sold to an Asian bidder on the telephone for a hammer price of £31m, just above its low estimate. Picasso’s La Liseuse elicited just a single bid, which at £5m was well below the low estimate. Nymphéas , a water-lily scene by Claude Monet, which was estimated at £30m-40m and which Christie’s hoped might sell in line with another similar scene sold two years ago, failed to attract a single bidder. With interest rates at record lows, art is an attractive alternative for the rich. But the lesson from both these sales is that buyers are skittish. They turn up, yes, but they easily vanish. 7

Glenn Beck and Friedrich Hayek

Essential reading What would Hayek have made of his new cheerleader?


HE credit crisis was kind to the reputation of John Maynard Keynes, whose scribblings from over 70 years ago inspired practical men of action to ght the recession with uninhibited stimulus. Now that a backlash against expansive government is taking hold, one of Keynes’s old antagonists is getting his turn in the sun. For the past few weeks Friedrich Hayek’s 1944 classic The Road to Serfdom has battled Swedish thrillers and vampire novellas atop Amazon’s charts. The Viennese apostle of the free market owes much of his success to Glenn Beck, a TV host on Fox News, who believes the book carries an urgent message for today’s Americans. Hayek left Austria for London in 1931, then watched with growing dismay as Britain’s policymakers slowly succumbed to the same collectivist habits and distaste for the free market that he believed had set Germany on the road to National Socialism. Mr Beck thinks that America is on the same path. We have a government car company, government banks, we’re talking about government oil companies, government is hiring all the workers. We are there, gang! What would Hayek have made of his new fans? The book’s popular success surprised him and his publisher the rst time round, but he would probably have taken the latest surge of sales in his stride. The free market, after all, satises demands that no planner could anticipate. But the enthusiastic welcome his book earned in America disquieted him almost as much as the savage attacks it also provoked. In Britain, labouring

Hayek’s road to surfdom under wartime rationing, planning was a practical problem. In America socialism was still a fresh ideaa cherished dream for some; a repellent spectre for others. That made it hard for Americans to talk about it calmly, he wrote. He found his critics and fans a bit hysterical. Hayek would probably have shared Mr Beck’s concerns about government banks and car companies. But even if he supported some of right-wing America’s attacks on liberals , he would certainly have objected to its choice of words. As he wrote, I am still puzzled why those in the United States who truly believe in liberty should not only have allowed the left to appropriate this almost indispensable term but should even have assisted by beginning to use it themselves as a term of opprobrium.

Exchange-traded funds

Explosive New york

A fast-growing industry is attracting more regulatory attention


VEN the best nancial innovations have a nasty habit of spinning out of control. No surprise, then, that regulatory antennae are twitching at the rapid growth of exchange-traded funds (ETFs), investment pools that are listed on stockmarkets. ETFs have plenty of attractions, giving retail investors a relatively cheap way to diversify their holdings. But their dangers are also becoming more apparent. The sheer size of the industry is one cause of concern. At the end of May ETFs in America held around $792.6 billion in assets, according to Morningstar, a research rm. The worldwide total passed $1 trillion at the end of 2009. Morgan Stanley predicts the industry will grow by 20-30% in 2010. The market has rapidly evolved to meet demand for more exotic products, particularly in commodities, where many worry about the impact of the appetite for ETFs on prices (see Buttonwood). ETFs also gained popularity because investors can trade them all day long, whereas a mutual fund can be liquidated only at the beginning and end of the trading day. Retail investors, who are thought to make up half the American ETF market, are probably better o holding on to investments rather than day-trading them. And the ash crash on May 6th demonstrated that it is not always easy to exit from ETFs. As liquidity disappeared that day, many ETFs traded down nearly to zero. The events of May 6th may have been exceptional but a period of market volatility is not. That spells danger for investors in leveraged ETFs, which use debt to magnify the returns of the index they follow. Because these ETFs reset on a daily basis, they can easily stray from their targets. If an index worth $100 drops 10% one day and gains 10% the next, it is worth $99, a loss of $1. You might assume that a fund leveraged to deliver twice the returns of this index would be worth $98, a loss of $2. In fact, an ETF of this sort would be worth $80 on the rst day and $96 on the second day, for a loss of $4. Whether retail investors understand this is not clear. Similar concerns dog other types of ETFs which use derivatives to achieve their results. An ETF tracking the price of oil, for instance, might not buy oil itself, but may make a swap deal with another nancial rm guaranteeing a payout if the price of oil goes up. These synthetic funds entail hidden counterparty risks. If the rm guaranteeing the results of this oil ETF goes 1

The Economist June 26th 2010 2 bankrupt, for instance, investors might

lose their money regardless of the oil price. In late March the Securities and Exchange Commission (SEC) issued a moratorium on the creation of new ETFs that use derivatives. Among other things, the government says it wants to assess whether a fund’s prospectus clearly conveys how it uses derivatives. Pressure is also mount-

Finance and economics 79 ing in Europe, where some have suggested banning retail investors from buying inverse funds, which are designed to benet from falling prices, or leveraged products. The SEC hopes to nish its review by the end of summer and says its goal is to craft a policy that will permit ETFs only limited use of derivatives. Otherwise the industry’s explosive rise may end badly. 7

Europe’s pressured banks

Crash-test dummies

The tortuous process of stress testing Europe’s wobbly banks


CCORDING to the version of nancial history favoured by America’s Treasury and the Federal Reserve, the stress tests they did on big American banks in the rst half of 2009 were a turning-point in the crisis. By independently examining banks’ books, estimating losses, making public the results and forcing banks to raise capital, they restored market condence. Reality is more complex than thatthe bail-outs of Citigroup and Bank of America in early 2009 had just a bit to do with restoring condence, too. Europeans tend to view the tests as a dazzling piece of PR, followed by brazen trumpet-blowing. One banker says the American experience was both fantastic and a little depressing . A regulator agrees: People have a naive view about what stress tests can deliver. Yet with funding markets almost closed to some of their banks, many Europeans have changed their minds. The diculties of Spanish banks are well known. Portugal’s banks have also been tapping the European Central Bank (ECB) at a furious pace. There is talk that the malaise has spread to Italy. Americans are particularly reluctant to lend. Huw van Steenis at Morgan Stanley says that more banks now accept that an American-style stress test may be needed to restore condence. Spain has become a passionate advocate and others have signed up, too. On June 17th the European Union’s leaders agreed that stress tests should be made public in late July. The good news is that a process already exists for doing stress tests. The bad news is that it involves the kind of European group-hug that inspires derision, not condence, in hedge-fund managers. America’s tests were run in military style by the Fed, with the Treasury writing the cheques. In Europe the economic scenario is being set by the ECB and the European Commission, which is then interpreted by the Committee of European Banking Supervisors (CEBS), a quango of regulators run with a skeletal sta, which in turn liaises with na-

tional supervisors in each country. CEBS did organise some tests last year, on 22 banks, but the results were kept private. It has just nished gathering data on 25 banks in what was meant to be just another routine and condential test. These data will form the foundation of the souped-up public tests the politicians want, although more banks will be included. Yet given the stakes and compared with the mighty Fed, CEBS is fathoms out of its depth. A lot depends, then, on national regulators, which do have real muscle and resources. But it is hard to avoid the impression of inconsistency. A supervisor from a medium-sized country says it has played a pretty passive role in the CEBS tests, with the banks interpreting what the broad macroeconomic scenario might mean. In another big country, the regulator says it just plugged the CEBS scenario into its model and sent them the results. This is concerning. Daniel Tarullo, a Fed governor, recently emphasised that some American banks weren’t much good at doing stress tests on their own and that supervisors’ judgment, not just models, was vital. The tests are being taken seriously by regulators in France and Spain, at least, which could pressure others to follow suit. That still leaves the delicate issue of

Was it the stress tests wot done it? Dow Jones US banks total stockmarket index January 1st 2009=100

120 100 80 60








2009 Source: Thomson Reuters



40 S



how to factor in Europe’s sovereign-debt jitters. The tests are unlikely to assume a sovereign collapse, with the possible exception of Greece. Imagining anything worse would be tricky politically; it also goes beyond what most ocials view as a plausible worst-case scenario. I don’t need to run a stress test to understand what a default of Italy means, says one. Instead the tests will probably assume slower growth as a result of bunged-up debt markets and get banks to recognise the market price of sovereign instruments in their trading books (but not in their larger loan books). As well as this middle-ofthe-road worst case , the tests will also dene banks’ capital generously, using Tier-1capital rather than the more stringent measure of core equity, which the Americans used and new Basel rules endorse. Marco Annunziata, the chief economist at UniCredit, says a stress-test lite won’t be much use. Two things would help. The rst is a really serious kick of the tyres in Spain. If investors are convinced that all bad debts in Spain’s banking system have been revealed and if Spain’s government shows it can raise the cash to recapitalise weak lenders, then fears about the country’s solvency should recede. That in turn would make a no sovereign default assumption in other countries’ tests more plausible. So far Spain’s bail-out fund has raised 12 billion ($15 billion) and faces drawdowns of 10 billion. Providing the total bill stays below, say, 50 billion, its government should easily be able to raise the cash, even in nasty debt markets. Hide and seek Second, the stress tests should ideally provide uniform disclosure on individual banks’ exposure to weaker countries, so investors can make their own minds up. Simon Samuels of Barclays Capital says disclosure has been patchy to date. Furthermore, what rms say is hard to reconcile with the overall estimates. This has led to a game of who’s hiding dodgy debt? , something that is familiar to students of the subprime debacle. A recent study of condential submissions from over 30 big European banks by Jean-François Tremblay of Moody’s, a ratings agency, concluded they had exposure to Greece of 100 billion. Based on data from the Bank for International Settlements that leaves another 90-odd billion sitting in Europe’s banks, presumably smaller ones. It took a decade before Japan’s supervisors lost patience and published their estimates of banks’ aggregate bad debts in 2002 and 2003 (prompting banks to admit to more losses). As in Japan, the banks and regulators have lost the market’s full condence. Unlike Japan’s banks, European banks rely heavily on wholesale borrowing that needs to be renanced now. Europe will have to bite the bullet soon. 7

The Economist June 26th 2010

80 Finance and economics

Economics focus The price of entry A new proposal from Gary Becker to make a market in immigration


ORTH AFRICANS risk their lives to try to cross the Mediterranean to southern Europe. Mexicans pay mules to get them across the border with the United States. Afghans camp outside Calais in lthy surroundings, waiting to cross into Britain. Everywhere, it seems, there are people trying to get into another country. Even those who seek to move legally in order to work face huge barriers to entry in certain countries. People on work visas account for 70% of legal migrants to Germany, for instance, but only 5.6% of those entering America, the original land of opportunity. Most of the rest get in because a member of their family is already in the country. America’s annual quota of visas for the highly skilled can run out in a matter of weeks. More people want to move to rich countries than are able to. In a lecture delivered on June 17th at the Institute of Economic Aairs, a think-tank in London, Gary Becker proposed a radical solution to this messy problem. Fittingly for a Nobel laureate who pioneered the application of economics to areas such as discrimination, crime and the family, his answers involved market mechanisms. Mr Becker argued that immigration was out of kilter because of the absence of a price that would match supply and demand. Governments, he suggested, could use economic principles to allocate visas, either by selling the right to migrate at a price that called forth a desired number of migrants, or by auctioning immigrant visas. As with any price, one for immigration would allocate the ability to migrate to those who desired it most. Successful migrants, Mr Becker argued, would still be better o, even after paying a hefty fee for the privilege. But the receiving country would benet, too. Adjusting the price from year to year would allow governments to retain control over how many immigrants came while responding to changing labour-market conditions. And the revenue raised might go some way to assuaging the concerns of those who oppose immigration, especially now when clever thinking is needed about ways to improve public nances. Charging $50,000 for the right to immigrate would net America $50 billion if it let in 1m immigrants, roughly as many as it currently admits legally. More importantly, the immigrants most tempted by such a fee-based system would be those who would garner the biggest

economic benet from migrating, such as those whose wages would increase by the largest amount. Mr Becker reckons that such people would have other desirable qualities. They would be the kind of innovative, hard-working go-getters countries want to attract, such as the engineers of Indian or Chinese extraction who received 14% of the patents awarded in America between 2000 and 2004, even though these ethnic groups make up less than 5% of the population. The young, he argues, would also be more interested than the old, because they would have more years to recoup the costs of the visa. An attractive idea, perhaps, in a rapidly ageing Europe. What about people who are talented but unable to pay? Mr Becker proposes a system where potential migrants could borrow from the government, under something like a student-loan scheme. Or perhaps employers could lend foreign workers the visa money, which the worker could pay back out of his wages over time. But if governments had to lend immigrants the money, the idea would not do much at rst to reduce budget decits. And the idea of people bonding themselves to a foreign employer in return for the costs of getting to their place of work, and then repaying the debt through labour, has been tried before. In the 19th century it was called indentured servitude. Among its legacies are the many Caribbean descendants of Indians who migrated to work on plantations. Just as Mr Becker proposes that a worker would be able to buy his loan o his present employer if he decided to change jobs, the bond in the Caribbean could also be bought o. Even if employers do not resort to the tactics used by Caribbean sugar-plantation owners, Abhijit Banerjee of the Massachusetts Institute of Technology thinks the system would still have problems. A rm importing a worker under such a scheme would presumably pay him a lower wage than it would pay an equivalent local (otherwise why not just hire a native?). A mutually benecial contract could be entered into, since the worker would still make more than at home. But having arrived the immigrant’s best option would be to get red (perhaps by not working) and get a new job at the market wage. To prevent this, the employer would need to threaten the worker with things like deportation. The very existence of such a threat would allow the employer to reduce wages further. Migrant migraine Sendhil Mullainathan of Harvard University points out another problem with the idea. Prices lead to allocative eciency when the benet of what is sold (in this case, a visa) accrues entirely to the individual who buys it. But the entry of an immigrant has effects on the wider societywhat economists call externalities . When the private and social benets of a person’s presence in a new country dier, basing admission decisions on willingness to pay may not be the best approach. America may want lots of scientists, for instance, but could wind up instead with an excess of Indians near retirement age, tempted by the idea of using their accumulated savings to buy free Medicare for the rest of their lives. If the benets of immigration depend more on people’s characteristics than their willingness to pay, the answer may already exist. Countries like Britain and Canada use a points system, which aims to select migrants who have educational levels or specialised skills that are deemed economically desirable. The politics of immigration in rich countries are too poisonous for Mr Becker’s radical rethink. But it is not clear one is even needed. 7



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Science and technology

The Economist June 26th 2010 83 Also in this section 84 Medical technology 84 The morality of sunglasses 85 Quantum computing

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Chimpanzee behaviour

Killer instincts Like humans, chimpanzees can engage in guerrilla warfare with their neighbours. As with humans, the prize is more land


EOPLE are not alone in waging war. Their closest living cousins, chimpanzees, also slaughter their own kindin brutal attacks that primatologists increasingly view as strategic, co-ordinated assaults rather than random acts of violence. But however tempting it is to see these battles through the lens of human warfare, the motives for chimp-on-chimp violence are poorly understood. In particular, researchers have long debated whether the apes ght for land, or for females. A report just published in Current Biology may help to settle the question. The study it describes, led by John Mitani, of the University of Michigan in Ann Arbor, is the rst to o er a detailed picture of organised conict between chimpanzees. Drawing on a decade of observations in the eld, it concludes that, as with human conict, wars between chimpanzees are fuelled by territorial conquest. Between 1999 and 2008 Dr Mitani and his colleagues shadowed a group of chimpanzees called the Ngogo, who live in the Kibale national park in Uganda. Most of the time, the Ngogo chimps were anything but model soldierssquabbling, foraging and lolling about their domain. But on 114 occasions Dr Mitani’s colleague Sylvia Amsler watched large groups of males strike out on silent, single-le patrols to the fringes of their territory.

These forays often turned violent. All but one of the 18 fatal attacks Dr Amsler witnessed occurred during boundary patrols. In each case, males colluded to kill chimps from a neighbouring group. The territorial imperative To understand what motivated this violence, the researchers looked at which chimps were actually attacked. If the purpose of chimpanzee warfare were either rape or the abduction of mates, then the expectation would be that adult males would be the targets of lethal violence. On occasion, they were. But most victims were juveniles, and of both sexes. Furthermore, chimpanzee mothers were often beaten as the raiders snatched and killed their o spring. Though these assaults on mothers were rarely lethal, patrolling chimps were clearly more likely to batter females than recruit them as mates, suggesting that other motives might drive their violent behaviour. The researchers therefore asked whether geography o ered a better explanation. Using the Global Positioning System to map patrol routes and attack locations, they saw that the Ngogo chimps’ reconnaissance fanned mainly beyond their north-eastern border, encroaching onto the land of a neighbouring group. Almost all of the killings occurred in this disputed

territory, which sported particularly ne stands of the chimps’ favourite fruit-tree. By the time the study ended, the Ngogo group’s campaign had displaced its rivals completely, annexing the north-eastern lands and enlarging its range by 22%. Though the territorial upgrade may eventually attract new mates, none of the displaced females has been spotted joining the Ngogo group. This suggests that real estate, not a tight mating market, is the true motive for chimp combat. Such motivation makes sense in the context of the discovery in 2004, by Jennifer Williams of the University of Minnesota, that larger territories enabled chimps in neighbouring Tanzania to produce more o spring. This provides an evolutionary incentive for the apes to expand their rangeand its associated resourcesby any means necessary. Can chimpanzee skirmishes tell people anything about their own violent tendencies? One lesson, which may surprise cynics, is that humans are more peaceful than chimps. The rate of killing Dr Mitani reports is between one-and-a-half and ve times that seen in human agricultural societiesand between ve and 17 times higher than attrition due to warfare among hunter-gatherers, who could have less need to defend territory than farmers. (It is also, it must be acknowledged, higher than that reported for other chimpanzee communities, suggesting that the Ngogo troop may be exceptionally bellicose.) In the context of comparisons with humans, though, the 1 Correction: In No end to dementia (June 19th) we reported that America’s National Institutes of Health was cutting back on the amount of money it spends on Alzheimer’s disease. In fact, the apparent cut is due to a revision of the agency’s accounting methods. On a like-for-like basis spending is rising from $411m in 2007 to a projected gure of $480m next year.

The Economist June 26th 2010

84 Science and technology 2 most salient feature of chimpanzee com-

bat may be its co-operative nature. Chimps avoid single combat. To ght successfully, they must maintain complex, collaborative social networkssuggesting that only by bonding within groups can chimps engage in violence between such groups. This has big implications. It may be the ability to form bonds with strangers was forged by the demands of war. Thus, the human tendency to coalesce around abstract concepts such as religion or nation, which underpins civilisation, may well be an evolutionary legacy of a violent past. Signs of anything similar in a species that, albeit a close-ish relative, parted company from the line leading to humans at least 5m years ago are therefore interesting. Unfortunately for the chimpanzees of Kibale, they are not the only combatants locked in a central African territorial dispute. Even as bushmeat poachers, exoticpet traders and encroaching farmers have landed the quarrelsome primates on the endangered-species list, decades of resource-driven conicts between humans have destabilised conservation eorts. On June 21st, in an attempt to protect chimp populations, the Wildlife Conservation Society of New York and the International Union for Conservation of Nature announced a new conservation plan for the species. By identifying the areas most in need of protection, researchers hope to preserve the culture of chimp communities such as the Ngogo for future study. 7


Rose-coloured spectacles? Cheats may or may not prosper, but they despise themselves for cheating


HOSE who buy counterfeit designer goods project a fashionable image at a fraction of the price of the real thing. You might think that would make them feel rather smug about themselves. But an intriguing piece of research published in Psychological Science by Francesca Gino of the University of North Carolina, Chapel Hill, suggests the opposite: wearing fake goods makes you feel a fake yourself, and causes you to be more dishonest in other matters than you would otherwise be. Dr Gino and her colleagues provided a group of female volunteers with Chloé sunglasses that cost about $300 a pair, supposedly as part of a marketing study. They told some of the volunteers that the sunglasses were real, and others that they were counterfeit. They then asked the volunteers to perform pencil-and-paper mathematical quizzes for which they could earn up to $10, depending on how many questions they got right. The participants were spun a yarn about how doing these quizzes would allow them to judge the comfort and quality of the glasses.

Medical technology

Watching your health A medical monitor that does not intrude


OU are old. You live alone. You suer a heart attack. You cannot raise the alarm. You die. That, unfortunately, is the way that many people in the rich world shue o this mortal coil. One way around the problem is to wear an alarm bracelet that detects when something is wrong and calls an ambulance. That means remembering to put the bracelet on, howeverand many people do not want to wear one in the rst place. PassivSystems, of Newbury, England, is therefore working on an alternative. This is a device that can detect remotely when something is wrong with somebody in the room it is monitoring. The technology to do this, which was developed by Helen Prance and her colleagues at the University of Sussex, is based on electrocardiography. A conventional electrocardiogram (ECG) is made by attaching electrodes to a person’s body and recording signals that originate in the heart. Dr Prance’s

version uses ultra-sensitive electrodes to record the eects of bodily electrical signals on the ambient electric elds that pervade a room, and deduce from that what is going on. As Dr Prance puts it, a person is just like a big bag of water: any movement which the bag makes will disrupt the elds in the room. Apply enough computing power to the signal caused by this disturbance and it is possible to detect an individual’s movement (and thus, for example, a fall) from several metres away. More subtle movements, such as those of the chest caused by breathing and the beating of the heart, can be registered from a distance of about half a metre, and PassivSystems is trying to increase that range. If the rm’s engineers succeed in doing so, the result will be like an electronic nurse that can keep an eye on someone and know when to call the doctor. Not so much Big Brother, then, as Big Sister.

The real thing Crucially, the quizzes were presented as honour tests that participants would mark themselves, reporting their own scores to the study’s organisers. The quiz papers were unnumbered and thus appeared to be untraceable, and were thrown away at the end of the study. In fact, though, each had one unique question on it, meaning that it could be identiedand the papers were recovered and marked again by the researchers after they had been discarded. Of participants told that they were wearing authentic designer sunglasses, 30% were found to have cheated, reporting that they had solved more problems than was actually the case. Of those who thought they were wearing fake sunglasses, by contrast, about 70% cheated. The results were similar when the women completed a computer-based task that involved counting dots on a screen. In this case, the location of the dots determined the nancial reward. The women who thought they were wearing counterfeits lied about those locations more often than those who did not. In a third part of the study, the participants were asked questions about the honesty and ethics of people they knew and people in general. Those who thought they had knock-os were more likely to say that people were dishonest and unethical. It looked, then, as if believing they were wearing fakes made people feel like fakes. To test that hypothesis, Dr Gino and her colleagues ran the experiment again, this time including a test meant to detect selfalienation. They asked the participants if they agreed with statements like, right now, I feel as if I don’t know myself very well. Those who thought they were wearing fakes did indeed feel more alienated from themselves than those who knew 1

The Economist June 26th 2010 2 they were wearing the real things.

It remained possible, however, that it was the sense of self-alienation which was normal, and that believing you were wearing designer glasses made you more at ease with yourself. To test that, the team ran one nal set of experiments, in which some people were given sunglasses to wear without any indication of their provenance. Volunteers in this control group

Science and technology 85 behaved like those who believed the glasses were authentic. The moral, then, is that people’s sense of right and wrong inuences the way they feel and behave. Even when it is someone else who has made them behave badly, it can aect their subsequent behaviour. Next time you are oered fake accessories, beware: wearing them can make you feel like a bad person, not a better one. 7

Quantum computing

A quantum hop Not a leap, perhaps, but two important steps on the way to making quantum computing practical


OME technologies seem a long time coming. Their story has a familiar script: a breakthrough is hailed; overblown expectations are aroused; disappointment follows. Away from the public’s impatient gaze, however, tinkering scientists turn out incremental improvements, furtively catching up with the revolutionary rhetoric of yore. This appears to have been the case with the sequencing of the human genome. It also illustrates the recent history of quantum computing. An ordinary computer stores and processes information using bits, which take the value of either one or zero (physically represented by dierent voltages of electric current). In the bizarre world of quantum mechanics, however, subatomic particles can exist in several states at once. Such superposition means, for instance, that the property of an electron known as its spin can be not only up (representing, say, one) or down (representing zero) but also some combination of the two. In quantum computing, such superposed values are named qubits. Additional qubits can be added by a process called entanglement. Each extra entangled qubit doubles the number of parallel operations that can be carried out. A three-qubit device could run eight operations, a four-qubit system 16, and so on. At least in theory. In practice the results so far have been disappointing. Experimental quantum computers require exotic materials and work only at a tad above absolute zero. But the latest incremental improvement may help lift the eld out of the slough of despond. First, it does its computing in siliconthe workhorse of more familiar computers. Second, it does it at the balmy temperature of -269°C, or four degrees above absolute zero. The magicians who have pulled o this double trick are Thornton Greenland of University College, London, and his colleagues. As they describe in this week’s

Nature, they rst doped the silicon with phosphorous atoms. They then used a short, high-intensity pulse from a fancy laser to jolt electrons orbiting those phosphorus atoms into what is known as a Rydberg state. In this state, each atom’s quantum wave-functionits eective sizeextends several billionths of a metre from its nucleus. That is huge in atomic terms, and permits the entanglement of atoms that would normally be too far apart to interact. This, in turn, means they can become collaborative qubits. Once their wave-functions had been expanded, the atoms were zapped again, inducing them to emit a controlled burst of light called a photon echo. This would be used to read out the result of any calculation the system had performed. Magical mystery tour The result is something that could, in principle, do calculations and spit out the answersand which could be made industrially using the sort of equipment that turns out conventional chips. That it works at

four degrees above absolute zero is a bonus. It might sound pretty chilly, but it is a temperature that can be maintained fairly easily using liquid helium, which boils at 4.22 degrees above absolute zero. Dr Greenland’s discovery, then, brings practical quantum calculation closer. And a second paper in Nature, by Morgan Hedges, of the Australian National University in Canberra, and his colleagues, has advanced another aspect of the eld by describing a type of quantum memory that uses light. Atoms and electrons are not the only particles that can get entangled. Photons, the particles of light, are also susceptible. If they could be integrated into the world of quantum computing, that would help with the transfer of qubits from place to place. The problem with light, though, is its speed. However handy its high velocity is for whizzing information over great distances through optical bres, it is unhelpful if any calculating has to be done. For that to happen light needs to be pinned down. In 2008 Hugues de Riedmatten of the University of Geneva and his team managed to do that. They built what was, in essence, an echo chamber on a chip and held a single photon there for a microsecond (a period when that photon would normally have expected to cover about 300 metres). Dr Hedges’s echo chamber did considerably better than that. By using such exotic materials as yttrium orthosilicate crystals and praseodymium ions it trapped photons in bunches of as many as 500 at a time. It was also good at preserving entanglement, increasing the amount of quantum information it could hold without being corrupted or destroyed to a level that might be practically useful. Sadly, the developments of Dr Greenland and Dr Hedges do not spell supermarket shelves stacked with quantum PCs any time soon. They do mean, though, that the tinkerers have more to tinker withand that, ultimately, is how new technologies really develop. 7

Chuck Close + AOL The Project on Creativity

25 yeArs

The Economist June 26th 2010 87

Books and arts

Also in this section 88 The internet and the brain 89 Understanding hedge funds 89 New ction: Joseph O’Connor 89 The inuence of Greece and Rome 90 Art Basel and its e ects

Art.view, our online column on art markets, appears on Wednesdays. For daily analysis and debate on books and arts, visit

Siegmund Warburg

Taking the long view It is easy to be romantic about the greatness of bankers past. But Siegmund Warburg was a man from whom today’s nanciers could learn a lot


IGH nance might sound like an oxymoron nowadays, but that is what Siegmund Warburg practised, even if he preferred to call it la haute banque. Warburg was a man of letters and, for the most part, high moral principle, in stark contrast to the reckless moneymen who more recently have pushed banking to the precipice. He was, concludes Niall Ferguson, the rst biographer to be given access to Warburg’s private papers, the presiding genius of the City for more than 30 years after the second world war. Warburg did more than most to boost London’s standing, even if his own rm was to lose its way and fall to a foreign rival after his death. A scion of one of the great GermanJewish banking dynasties, with connections stretching over the Atlantic (one relative helped design the Federal Reserve system), Warburg chose London as his base after eeing Hitler’s Germany. His bank became notorious in 1959 when it engineered the rst hostile takeover of a large British company, British Aluminium. Warburg’s role in the so-called Aluminium war was that of the scrappy outsider. Most of the nancial establishment had opposed the takeover and one competitor, Morgan Grenfell, refused to do business with him for 15 years afterwards. But the aair fundamentally transformed the culture of the City, marking the dawn of a new era in British nance, when merchant

High Financier: The Lives and Time of Siegmund Warburg. By Niall Ferguson. Penguin Press; 548 pages; $35. Allen Lane; £30 banks would no longer politely leave each other’s clients alone. Warburg also helped develop the market for Eurobonds (debt denominated in a currency dierent to that of the country where it is issued). This innovation greatly boosted London’s standing as a crossborder nancial centre. Eurobonds remain popular, accounting for around 90% of international bond issues. Less well known is his importance as a management innovator. He pioneered open-plan oces and corporate democracy. S.G. Warburg & Co would take on a client only if every senior executive agreed. It chose well, for the most part. Robert Maxwell, a dodgy press baron, was given short shrift when he came knocking. Not all the rm’s recruitment methods were widely copied, though. Warburg was one of the few believers in graphology, the analysis of handwriting, as a way of gaining psychological insight into his applicants. Though nance was Warburg’s trade, his interests ranged widely. He left his personal library of some 3,000 books, minus his favourite copies of Stefan Zweig and Thomas Mann and a collection of pornog-

raphy, to St Paul’s Girls’ School, London. He was, Mr Ferguson asserts, the best-read banker of all timeand he was not shy about making his views known on a host of issues, whether in letters to the Times or, behind closed doors, as a condant of political leaders. He advised Harold Wilson in the 1960s, even writing speeches for him on economic matters. This led one contemporary to brand him as the pipe-sucking prime minister’s nancial Rasputin. Not all Warburg’s advice was good, but no one doubted the potency of his nancial power and political inuence. Warburg used his position to champion European integration, rightly seeing that closer links in capital markets would strengthen ties in other areas. By establishing London as Europe’s dominant banking centre, for instance, he saw how the explosion of the Eurobond market would help pave the way for Britain’s entry into the forerunner of the European Community. But Warburg was also a staunch Atlanticist and an early prophet of globalisation. In truth, preoccupations came and went. He was constantly falling in and out of lovewith ideas, institutions and people. He ran his rm paternalistically but was quick to cold-shoulder colleagues whom he felt had let him down; even a minor transgression could mean months of frostiness. He was not above throwing telephones when riled. A messy desk or sloppy punctuation might be enough to set o a temper tantrum. He once called a fellow director on Christmas Day to complain about a missing comma in a memo. But if his perfectionism bordered on pedantry, Warburg continued to inspire great loyalty. That is just as well, as Warburg bankers were expected to work longer hours than their rivals, even to take weekend strolls around Belgravia to chew 1

The Economist June 26th 2010

88 Books and arts 2 over strategy with the boss. The working

day began at 8am, the crack of dawn for investment bankers in those days. One of Warburg’s maxims was that bankers never got ill from overwork, but only from bad organisation or bad business. Though certainly driven, it was not primarily by the desire to accumulate capital. Well-groomed, Warburg also had an ascetic streak. He had relished the hardships of wartime. He loved books, but had no interest in rst editions. You have never truly been a servant of Mammon, his friend Paul Ziegler wrote to him in 1981, the year before his death. Money for you is just a raw material, as oil paints were for Cézanne. But for his forced exile from Germany, Warburg would probably have stayed there as an intellectual or politician, reckoned Ziegler. For all his prowess in the City, he never identied with its overprivileged elite, whose inuence he saw as largely corrosive. He played golf just once and never attended a polo match. Indeed, Warburg placed as much emphasis on moral standing as he did on capital or connections. His mother had taught him that happiness in life consists in fullment of duties and not of desires. Investment banking should not be about gambling but about honest Vermittlung, nancial intermediation built on client relationships, not speculative trading or eeting transactions. Warburg was always queasy about prots made from punting the rm’s own capital, preferring income from advisory and underwriting fees. He was, in fact, compulsively riskaverse. He worried more than most about liquidity risk, the danger of cash-ows and funding drying up (which many nanciers ignored at their peril in the last boom). He was suspicious of rms that grew quickly, believing that there were diseconomies of scale in his industry. He worried a lot about the dangers of what he called expansion euphoria . That fear proved prescient. Despite his concerns about bigness, Warburg felt obliged to try to turn his rm into a global bulge bracket investment bank to compete with the big American and continental European houses. But a series of increasingly convoluted alliances bore little fruit. After Warburg died in 1982, his bank embarked on ill-judged expansions while becoming complacent in its core businesses. In 1995 the rm that had advised on so many cutting-edge takeovers itself fell prey to Swiss Bank Corporation, for a fraction of what it would have fetched a few years earlier. The Warburg name disappeared seven years later in a rebranding exercise. Ultimately, then, this is a story of failure, at least for Warburg the company. But, as Mr Ferguson concludes at the end of this ne biography, if ever there was a time to learn from the true high nancier that was Warburg the man, it is surely now. 7

The e ects of the internet

Fast forward The Shallows: What the Internet is Doing to Our Brains. By Nicholas Carr. Norton; 276 pages; $26.95. Published in Britain by Atlantic in September as The Shallows: How the Internet is Changing the Way We Think, Read and Remember ; £17.99


N 1492, the same year that Christopher Columbus crossed the Atlantic, a Benedictine abbot named Trithemius, living in western Germany, wrote a spirited defence of scribes who tried to impress God’s word most rmly on their minds by copying out texts by hand. To disseminate his own books, though, Trithemius used the revolutionary technology of the day, the printing press. Nicholas Carr, an American commentator on the digital revolution, faces a similar dichotomy. A blogger and card-carrying member of the digerati , he is worried enough about the internet to raise the alarm about its dangers to human thought and creativity. The recent uproar over privacy on Facebook is only the latest backlash against man’s newly wired existence. Mr Carr did his bit to encourage the anxiety in 2008 with an essay in the Atlantic entitled Is Google Making Us Stupid? His new book is an expanded survey of the science and history of human cognition. Worry of this kind is not new: a decade ago, the rst evidence suggested that PowerPoint changed not just how executives presented information, but also how they thought. Mr Carr’s contribution is to oer the most readable overview of the science to date. It is clearly not intended as a jeremiad. Yet halfway through, he can’t quite help but blurt out that the impact of this browsing

Fried brains is a delicacy in France

on our brains is even more disturbing than he thought. Humans like to believe they control the tools they use, even if Socrates, Marshall McLuhan and Ivan Illich are among those who have argued that often they do not. From the alphabet to clocks and printing, every major new technology has profoundly altered the way in which humans think. The digital gadgets on which we now depend, Mr Carr explains, have already begun rewiring our brains. Neurological research has demolished the myth of the static brain. Neural networks can be rapidly reorganised in response to new experiences such as going on the web. Mr Carr surveys current knowledge about the eects on thinking of hypermedia in particular clicking, skipping, skimmingand especially on working and deep memory. He draws some chilling inferences. There is evidence, he says, that digital technology is already damaging the long-term memory consolidation that is the basis for true intelligence. Only by combining data stored deep within our brains can we forge new ideas. No amount of magpie assemblage can compensate for this slow, synthetic creativity. Hyperlinks and overstimulation mean the brain must give most of its attention to short-term decisions. Little makes it through the fragile transfer into deeper processing. Clearly, argues Mr Carr, this is a radical upending of the literate mind that has been the hallmark of civilisation for more than 1,000 years. From a society that valued the creation of a unique storehouse of ideas in each individual, man is moving to a socially constructed mind that values speed and group approval over originality and creativity. True, there are compensations: better hand-eye co-ordination, pattern recognition and the very multitasking skills the machines themselves require. Sceptics will rightly point out that similar concerns have accompanied each new technology. Something is always lost, and something gained. Some evolutionary biologists claim that the scholarly mind is an historical anomaly: that humans, like other primates, are designed to scan rapidly for danger and opportunity. If so, the net delivers this shallow, scattered mindset with a vengeance. Mr Carr oers few prescriptions. The author himself retreated to an (unplugged) mountain hideout to write his book, but he thinks most people depend too much on the net for work and fun to do the same. And he fails to address the ways in which the internet acts like a drug. Other critics have probed this issue more deeply, notably Jaron Lanier, a virtual-reality pioneer, in a recent book, You Are Not a Gadget . Yet surely online bingeing is no dierent from eating too many sweets: its remedy is a matter of old-fashioned self-restraint. 7

The Economist June 26th 2010 Hedge funds

Over the edge More Money Than God: Hedge Funds and the Making of a New Elite. By Sebastian Mallaby. Penguin Press; 482 pages; $29.95. Bloomsbury; £25


HAT is it about hedge funds? Many people don’t really know what they do, other than pay themselves and their principals absurd amounts of money. When something goes wrong in the nancial marketsa currency crisis, a housing collapse or a sovereign defaultthey are quick to be blamed, their shadowy character making them ideal scapegoats. Sebastian Mallaby’s new book, More Money Than God, addresses this ignorance. A superbly researched history of hedge-fund heroes stretching back to the 1950s, it is a fascinating tale of the contrarian and cerebral mists who created successful, exible businesses in an otherwise conventional nancial world. Yet what are they doing, beyond gambling in stock, bonds, currencies and credit? Most hedge-funders are believed to be mere lucky attendees at the casinoa view which Mr Mallaby convincingly refutes. Drawing on Warren Buett’s observation that it cannot be a coincidence that a group of investors taught by Benjamin Graham can make above average returns, Mr Mallaby presents original research on the performance of a group of fund managers who worked with Julian Robertson at Tiger Management, and similarly reveals superior returns. Great investors and traders, like great sportsmen or artists, can be poor at explaining what they do. Making money systematically is still dicult. The true edge of the successful minority is unlikely to be easily identied. Mr Mallaby, who is married to The Economist’s economics editor, Zanny Minton-Beddoes, goes on to argue that hedge funds may provide a template for the wider nancial sector. Their performance through the credit crisis suggests they have served their clients well. None has gone cap-in-hand to the government, nor have they been given extra help to prevent systemic failure, although some of this may be fortuitous; Long Term Capital Management (LTCM), a New York fund, came close to precipitating a global crisis in 1998. Hedge funds’ interests are directly aligned with those of their investors. The main fund manager is usually the largest investor and remuneration depends on the fund performing protably. Often the individuals who own a company are those who began it, and it is in their interest to see it continue its successful trajectory.

Books and arts 89 New ction

Molly and the playwright Ghost Light. By Joseph O’Connor. Harvill Secker; 246 pages; £16.99


OR those unfamiliar with thespian superstitions, the ghost light is a lamp that is kept burning in a theatre overnight, so ghosts can perform their own plays. Joseph O’Connor’s third and nal book set in historical Ireland is about Molly Allgood, an actress, and her controversial love aair a century ago with John Synge, a well-known Dublin playwright. Synge died of cancer, aged 38, before the couple could marry, but his ghost remains eternally animated in Molly’s thoughts. We meet Molly in a dilapidated lodging-house in London in the 1950s, an alcoholic, penniless vision of faded glamour. She sets out, in a gin-induced haze, to sell the last remaining letter she has from Synge before repairing to the BBC to record a play. Her roamings across the city prompt ashbacks of Synge, their clandestine romps through the wilderness, stilted rehearsals at the Abbey Theatre and awkward family introductions. Mr O’Connor’s Irish cynicism spotlights the grime as well as the glitz. The reader is not enveloped in a whirl of romance; instead, he is the audience. Molly is a perpetual performer: You are no beggarwoman, after all, but an artist, she tells herself. Her memories, too, are a palimpsest of the real and the staged; their courting scenes in a play. But Mr O’Connor also shows the Molly behind

Hedge funds are not too big to fail. Many have collapsed as businesses, but even the big ones are systemically unimportant. Is this a model for banking and nancial services generally? Mr Mallaby is right to point out that hedge funds seem tailormade for managing funds, but most of the management wealth at Bear Stearns and Lehman Brothers was equity in those rmsand little good it did them. People make foolish decisions with their own money as well as others’. The dierence between hedge funds and other nancial institutions may be more profound. Economies of scale in banking are not an advantage in fund management. Growth in assets limits investment opportunities and constrains returns. A hedge fund that grows large inevitably becomes institutional and conservative, and loses the culture of unconventional, independent thought that gives it its most important characteristic, true edge. 7

the mask; her thoughts are a stream of bawdy Irishisms that belie her ladylike conduct. One producer would dynamite the walls of Jerusalem for two bucks and a beer, piss in the bottle and sell it back to you for champagne, she proclaims. The author grew up about a mile from Synge’s home, and his grasp of the Irish vernacular could not be made up. However, he has used more artistic license in eshing out his characters, including William Butler Yeats, and the couples’ love letters ow directly from Mr O’Connor’s heart and pen. He enhances the romance to expose Molly’s miserable circumstancethat of a burned-out star who lost her soul mate too young and is haunted by the ghosts of happier times. This is an entertaining read that carries a touching tale.

Ancient Greece and Rome

Back to basics Full Circle: How the Classical World Came Back to Us. By Ferdinand Mount. Simon & Schuster; 438 pages; £20


ERDINAND MOUNT has enjoyed an unusually varied careercolumnist, novelist and literary editor, head of Margaret Thatcher’s policy unit in Downing Street, and author of a delightful memoir entitled Cold Cream that was an unexpected bestseller last year. His new book, Full Circle, is an altogether more serious and demanding work, but it is imbued with the same wit as its predecessor and is both entertaining and thought1 provoking.

The Economist June 26th 2010

90 Books and arts 2

Mr Mount argues that there is an astonishing resemblance between life in ancient Greece and Rome and the manner in which we live now. It is as though the intervening 1,500 years had never been. We have been on a round tripand we are back at the jetty we embarked from. Now, as then, there is an obsession with the body. The baths and gyms of the classical world employed more people than any other institution except the army. We are hugely concerned with cleanliness and tness. Many have personal trainers or pay inordinate sums to go to Shangri-spa . In our attitudes to sex and food we are much closer to the Romans than to those who lived in the Dark Ages or the Victorian eraor even the 1950s. There has been a similar reversion in our mental attitudes. In the section on the mind Mr Mount draws some amusing, and generally convincing, comparisons. Anaximander, a pre-Socratic philosopher, was the rst Darwinian. Lucretius is the Richard Dawkins of 55BC. Mithras and Mick Jagger are the god and demigod on the brink of satisfaction. Long before Jade Goody was famous for being famous the Romans were obsessed with celebrity, with the Triumph rather than Big Brother and Socratic dialogue in place of Jeremy Paxman’s Newsnight . The return to the ways of ancient Rome has closely paralleled the decline of Christianity . The art of religion has been replaced by the religion of art and with that has come degeneracy. The fact that it has happened for a second time suggests that we might be programmed that way . Mr Mount mourns the fact that we live in a post-Christian society, and he excoriates the anti-God-botherers such as Mr Dawkins and Christopher Hitchens, though he reveres Charles Darwin as the inventor of the age we live in. Richard Jeeries, a Victorian naturalist, and a German philosopher, Hans Vaihinger, are other heroes who provide grounds for optimism that a return to a concern for Mother Earth and adoption of an as if (the Christian religion were true) philosophy can enable us to rediscover Cicero’s vision of immortality, Scipio’s Dream . Half a millennium separates the democracy of Athens, under the incorruptible Pericles, from the tyranny in Rome of the emperors Caligula and Nero; they were very dierent epochs and places. It is unsurprising therefore that Mr Mount has been able to select parallels between aspects of our society and some of those of the classical world, while ignoring others such as slavery (immigrant workers?) and gladiators (World Cup footballers?) that do not t as well. However, his central premise is an arresting and disturbing one. What if our civilisation is followed by a second dark age? Will it last for 1,500 years or for ever? 7

Contemporary art

Global frameworks Basel

Art-fair musical chairs


ONTEMPORARY art is a futures market in which derivative is a bad word. Art Basel, which ended on June 20th, heard a lot of phrases adapted from the nancial markets. To be a good bet against near-zero interest rates and unpredictable currency uctuations, art needs the potential of a global market. Thus, local artist has become a synonym for insignicant artist and national damns with faint praise. International is now a selling point in itself. Aided by banks and royalty, international art fairs are spreading belief in contemporary art. UBS sponsors Art Basel and its sister fair, Art Basel Miami Beach; Deutsche Bank subsidises London’s Frieze Fair and the Hong Kong International Art Fair. In the Middle East, local rulers are patrons of Art Dubai and Abu Dhabi Art. Art fairs accelerate the transnational exposure of artists and Art Basel is the unrivalled leader in this, partly because it has always dened itself as international. This year, its 41st, the fair featured 300 galleries from 37 countries. Careful curation is required for this global mix to be properly diverse. As Lucy Mitchell-Innes of Mitchell-Innes & Nash, a New York gallery, warns: It’s a problem if four or ve booths have the same artist’s work. A good international fair wants Chinese galleries to bring talented Chinese artists, not another Anthony Gormley.

Windows on the world

There are many components to the globalisation of art. Marc Spiegler and Annette Schönholzer, co-directors of Art Basel, suggest that private collections internationalise in the process of becoming more serious. Collectors often start by acquiring art from their own nation, then their own region, then nally internationally, explains Mr Spiegler. The hierarchy of fairs is dierent from the auction market. The top three cities for auctions are New York, London and Hong Kong, in that order. But the hierarchy of fairs is in dispute. Everyone agrees that Basel comes rst, but it is unclear which comes next: Miami or London. Or if New York, with the Armory Show and Art Dealers Association of America show, or Paris with FIAC, is third. The situation in the lower tiers is even more volatile. Madrid’s ARCO fair used to be the most important fair for South and Latin American galleries but it has been usurped by Miami. Now ARCO is perceived as an afternoon of cultural exposure for Spanish punters rather than a pressing business occasion. Two newcomers are shaking things up. The Hong Kong International Art Fair, which took place at the end of May, boasted 155 galleries from 29 countries. Hong Kong is the nancial and geographical centre of Asia, a transport hub where people from West and East feel equally at home, and there are no duties on art. Lehmann Maupin, a New York gallery, was one of many delighted with the results. As the primary dealer on a range of Asian artists including Do Ho Suh, a well-known South Korean, Lehmann Maupin’s inventory proved attractive to the pan-Asian audience that had own into town. The other fair that is the subject of much discussion is Abu Dhabi Art. Last November it welcomed 50 galleries from 19 countries as a rst move towards interesting visitors in a vast museum building project that will see its rst openings in 2013. David Zwirner Gallery was convinced to participate in the next edition of the fair by Richard Armstrong, director of the Guggenheim Museum. As Mr Zwirner explained, The Guggenheim Abu Dhabi will open soon, so it has to get cracking with its acquisition programme. The fair is therefore a key venue. My business model relies on museums educating the public. The globalisation of art is not all about money. A growing number of not-forprot biennials are being developed alongside the market structures. Massimiliano Gioni, a curator based in Milan and New York, who is overseeing the Gwangju biennial, which opens in South Korea in September, recalls that the avant-garde was built on a transnational community of kindred spirits, adding, sometimes I long for that. Art has often aspired to universal values. Perhaps it is nally in a position to have them. 7


The Economist June 26th 2010 91 war, had opened a café serving German erzatz coee brewed up over a bonre. His favourite meal of all was his wife’s Irish stew, or an underdone cheese omelette browned under the grill. Though he thought McDonald’s hamburgers inedible, from clapped-out cows , their chips were rather good. So were baked beans, which he ate for the rst time, with a cautiously probing fork, on a TV chat show. He inspected airports, motorway service stations, hospitals, schools and park cafés on behalf of the ordinary public, for whom his round blue seals of approval, stuck on a window or a door, soon became a sine qua non of dining. He found Lyons Corner Houses very acceptable. To check transport cafés he would even don an anorak and cap, while the Rolls was parked around the corner.

Egon Ronay Egon Ronay, rst career critic of British food, died on June 12th, aged about 94


HAT, Egon Ronay often asked himself, was the most unforgettable meal of his life? Being Hungarian, his mind would y rst to sulz, an indescribable delicacy of pigs’ trotters in aspic, or to his mother’s Transylvanian stued cabbage; he would even spare a fond thought for the Imperial rolls, washed down with milk, which had sweetened the breaks between lessons at school. Being a man of high standards, from his backcombed hair to his exquisitely shined shoes, he found himself pining for the lobster bisque at Maxim’s. And yet his most truly unforgettable meal was something quite dierent from these. It was, in fact, a mere cup of tea, costing a few pence, bought around 1950 from the buet at Victoria station. It came from a big tea-urn at the corner of the counter, dispensed by a woman who slopped it into the cup and then indicated the sugar. That was heaped in a bowl, and dangling near the bowl was a spoon, which had somehow been tied to the ceiling with string so that customers would not steal it. The sight of the spoon was a Damascene moment for Mr Ronay. It summed up all the culinary horrors of the country to which, in 1946, he had ed. By and large he admired his adoptive land, but for one thing: the British would never complain about their dreadful food, but soldiered

on, inured to suering by wartime austerity and Dickensian public schools. Venturing into a restaurant, they would quietly and even gratefully accept some tepid muck masquerading as Brown Windsor soup, with a smear of margarine on bread, followed by Spam and bottled salad cream on two wilting leaves of lettuce, topped o by jelly and custard. It would not do. In that station buet, Mr Ronay was launched on a tide of anger into the crusade that came to consume his life. He would tell the British what good food was, and where they could hope to nd it. At the beginning he was a one-man band, possessed of only four wheels, two legs and one remarkably tolerant liver, travelling the length of the country. He would eat two lunches and two dinners a day, sparingly, anonymously, and paying for everything. When his Guide , rst published in 1957, became a success he recruited a team of inspectors, working in pairs, but the principles remained the same. Mr Ronay wrote the guides himself, updating from scratch every year, deantly aronting the English language (A surprise receives you in the back room ) in his determination to shake up English taste. He was far from a snob, in his own mind. No one could be a snob who, in the freezing ruins of Budapest at the end of the

Beyond fake onions Yet a Rolls set the tone for most of his life. His father had been the fth-highest taxpayer in Budapest, owner of ve restaurants. His childhood was pampered, and even as a penniless exile he had contacts enough to get into the restaurant trade in Piccadilly, rather than Portsmouth. High standards were as vital as the proper use of paprika (sweet and noble , never hot) and the proper spelling of gulyas (which is, in fact, a soup ). In restaurants he tolerated the 1960s taste for fake onion-bunches and Chianti bottles; but he did not like waiters in pullovers, giant menus or tables set too close. He approved of formality, even romance, as in his mention of la patronne at Floris in Soho: One feels regret, tinged with a slight worry, that the fresh rose spray worn by this smart, greying lady, is only to be seen occasionally now. Many said he revolutionised British eating habits. He was less sure. Several things had helped, among them Elizabeth David’s explorations of French and Italian cooking, cheap holidays abroad and the rise of a new middle class which had more money, and less sangfroid, than before. Meals eaten in old age up and down Britainfor he never stopped, and the palate, insured for £250,000, never failed himinformed him that food was still being murdered everywhere, though now with tomato purée and deep-frying. A generation of chefs, among them Raymond Blanc and Marco Pierre White, looked on him with aection, for his stars had got them going. But, though the guides survived, his inuence had faded before the age of the celebrity chef, a creature he had little time for. He did not want elaborate sculptures and arty ourishes for food. Give him sauerkraut, venison, frankfurters, sour cream, walnut beigli, a good Bordeaux; and then a cup of good, dark, bitter coee, with multiple sugars from a clean and unattached spoon. 7



The Economist June 26th 2010


The Economist June 26th 2010



Appointments Telecommunications Regulator The Republic of Vanuatu has undertaken a telecommunications regulatory reform program over the last number of years. The 2009 Act, among other things, provides for the establishment of an independent regulatory body. Due to contract expiration the need has arisen to appoint a new Telecom Regulator. The Regulator will report to the Minister of Infrastructure and Public Utilities and will be responsible for managing the regulatory team.

The primary responsibilities of the position include, but are not limited to: Regulation of telecommunications & radiocommunications subject to the Telecommunications & Radiocommunications Regulation Act No. 30, 2009 ■ Enforcement of the provisions of the Act ■ Advising the Vanuatu Government on Telecom Policy & regulatory framework ■ Professional management of required political, legal, business & social networks within Vanuatu & the Pacific

Required Experience: Extensive regulatory or legal expertise in the telecommunications industry (ideally in developing countries) specifically on: licensing, dispute resolution, competition issues, interconnection, universal service, spectrum management, tariffs, consumer protection & standards ■ 10 years’ minimum experience in telecommunications ■

Required Character Attributes: Demonstrated management & leadership, ethical judgement, advanced communications skills, highly motivated & initiative-driven ■ Exposure & or ability to contribute culturally & professionally in an emerging sector ■

RP International on behalf of the Government of Vanuatu is currently conducting this search. In order to discuss this position further please contact Jonathan Lasenby of RP International on:

Email: Office: +65 6236 1687

United Nations Development Programme Afghanistan UNDP Afghanistan is supporting the Government to find innovative solutions to its development challenges. Key priority areas for UNDP assistance are in strengthening democratic governance, crisis prevention and recovery and reducing poverty. UNDP is strengthening the institutional capacities of key national government and sub-national authorities which aim to Afghanistan enhance human security, human development, peace and stability in Afghanistan. UNDP in joint partnership with FAO and UNEP is currently implementing a joint “Strengthened Approach for the Integration of Sustainable Environmental Management in Afghanistan” (SAISEM) programme. This Joint Programme is designed to promote a strengthened approach for the integration of sustainable environmental management into national sectoral policies and strategies; promote capacity and institutional building of relevant government counterparts to operationalise and implement the environmental concerns reflected in the national policies and strategies. UNDP Afghanistan is seeking to fill the following post:

Environment Mainstreaming Policy and Guidelines Development Expert The selection criteria and background for the position is: • Post Graduate Degree (Masters Level) in Environment and Natural Resource Management or Rural Development with 10 years senior level working experience with proven and exemplary experience in developing policies, National Environment Mainstreaming Guidelines including manuals and tools for mainstreaming environment into policy, planning and implementation. • Experience working with institutional capacity development with regard to integration and mainstreaming new concepts such as environmental management into overall institutional policy, planning, investment and implementation in the context of rural development. • Experience in development of environmental policies, strategies, regulations with specific relevancy and applications to EIA processes. • A good track record of achievement in the Environmental sector, strong understanding of governmental policies and rules, strong business reporting writing and in depth knowledge of evaluation and assessment. Detailed job description and selection criteria can be found at UNDP is an equal opportunity employer and encourages applications from both male and female candidates. Please note that only applications who are short-listed will be contacted. However, other strong CVs will be placed on the UNDP Roster for possible engagement in future for similar assignments. The Economist June 26th 2010



is recruiting well qualified candidates: Senior Internal Auditor Investigator Evaluator For more details visit:

QUANTITATIVE ANALYST Weiss Multi-Strategy Advisers LLC is seeking a QUANTITATIVE ANALYST for its New York City office to research, develop and design quantitative financial models and proprietary quantitative multifactor ranking models. Must have experience utilizing techniques applicable to building portfolios of various financial asset classes (eg: volatility correlations techniques on a portfolio of hedge funds within a fund of funds), applying co-variances, creating value-at-risk models, performing linear optimizations, factor analysis, and performing complex strategy analysis of various external hedge fund managers and applying that knowledge to developing new strategy methodologies. Must have proficiency in Visual Basic (VB) programming, experience writing mathematical algorithms designed to solve logical problems, proficiency in MS Office, Bloomberg and Per Trac. Requires a Bachelors degree in Finance, Economics or related field. To apply, please email cover letter and resume to or fax to (860) 240-1263.

Two Economists Salary in range £30,000-£45,000, depending on skills and qualifications The Office of Health Economics (OHE) wishes to recruit two well qualified, highly

motivated and energetic Economists to contribute to all three of the OHE’s core activities: • peer-reviewed research • consultancy • advising the Association of the British Pharmaceutical Industry The OHE is a London based economic research and consultancy organisation, founded in 1962. Our scope is international and our client portfolio spans all three sectors: public, private and charitable. OHE’s work covers a broad range of analyses into the economics and policy: (1) of health care systems, (2) of pharmaceutical and other life sciences industries, and (3) of health technology assessment. We are keen to recruit two Economists. One post would suit applicants with strong skills and interest in econometrics and its application to analysing health system data, data on health outcomes and preferences and data on medicines’ usage/ consumption. The other post requires thorough knowledge of the economics of industrial organisation, competition and regulation. Applicants should have: • a good first degree, majoring in Economics; • a postgraduate qualification and practical experience in applied econometrics or/ and industrial economics; • interest in, and understanding of, policy related to health care systems and/or the life sciences sector; • demonstrable ability to research, write and present clearly argued analyses within tight deadlines. For further details please contact Claire Devaney at the OHE, 12 Whitehall, London, SW1A 2DY, UK; email or telephone +44 (0)20 7747 8855. Applications must be received by Friday 16th July 2010. Interviews for shortlisted candidates will be held in London on Tuesday 27th July 2010.


Business & Personal

The Economist June 26th 2010

London - Oliver Slater

Frankfurt - Mona von Rahden

Tel: (44-20) 7576 8408

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Readers are Recommended

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to make appropriate enquiries and take appropriate advice before sending money, incurring any expense or entering into a binding commitment in relation to an advertisement. The Economist Newspaper Limited shall not be liable to any person for loss or damage incurred or suffered as a result of his / her accepting or offering to accept an invitation contained in any advertisement published in The Economist.

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NOTICE OF PRE-QUALIFICATION FOR THE CONCESSIONING OF THE INTERNATIONAL AIRPORT OF BAMAKO-SÉNOU The Government of Mali, represented by the Ministry of Equipment and Transport (Ministry in charge of civil aviation), invites private investors to participate in the tender process for the concessioning of the operation of the Bamako-Sénou airport for a period of thirty (30) years. The project aims at improving the operations of the airport infrastructure and at developing airside and landside infrastructures for total planned investments in an amount of 100 million Euros with more than 60% of the investments to be carried out during the last ten (10) years of the concession. The objectives of this public-private partnership are: -

Achieving flexibility and efficiency in the operation of the Bamako-Sénou airport with the participation of private capital;


Developing and maintaining airport facilities in good working condition through substantial investments;


Raising the quality of services provided to users, and strengthening of safety and security.

The tender process involves a pre-qualification phase in accordance with Decree No. 08-485/P-RM of August 11, 2008. Interested investors may obtain further information and the pre-qualification documents along with the information memorandum by sending a written request to the Direction Administrative et Financière du Ministère de l’Equipement et des Transports, BP: 78; Telephone: +223 20 23 14 42; fax: +223 20 23 90 60; Email:; Darsalam à Bamako –République du Mali, with a copy to the Coordinateur du Projet d’Appui à la Croissance and to Chef de Projet de formulation et de mise en place d’un Partenariat Public-Privé des aéroports du Mali before July 15th, 2010. This notice is translated from French. The French version will prevail.

Courses JUSTICE LAW AND ORDER SECTOR EXPRESSION OF INTEREST TECHNICAL ADVISOR – TRANSITIONAL JUSTICE The Justice Law and Order (JLOS) is in the process of re-building the justice structures in the conflict affected areas and developing an appropriate policy and legal framework for accountability, reconciliation and the transition from conflict to peace in Uganda. JLOS wishes to recruit an International Technical Advisor for Transitional Justice who will be responsible for providing programme management support, policy and planning and technical advice to ensure the successful development of an appropriate transitional justice system in Uganda within the framework of JLOS. The Technical Advisor will be responsible for policy formulation, planning and monitoring the implementation of transitional justice programmes; provision of technical advice to JLOS Structures, capacity building, fundraising and preparing periodic reports to JLOS and Government. The detailed job description can be obtained on The Technical Advisor will report to the Senior Technical Advisor, Justice Law and Order Sector. Required Qualifications: - Post-graduate degree (legal background preferred); - 7-10 years’ experience in post conflict and transitional environments, with local or international organizations; - Prior experience in other African Countries implementing transitional justice mechanisms; - In-depth knowledge of transitional justice and expertise on the Rome Statute; - Prior experience with devising strategies in linking various transitional justice mechanisms; - Experience in working on human rights issues or with victims; - Managerial experience; - Fundraising experience; - Good networking abilities; - Excellent writing skills. Interested applicants may send a letter of application, copies of testimonials and Résumé (indicating telephone number and email address) to be received not later than 5.00p.m. (EAST) on the 23rd July, 2010 to: The Solicitor General, Ministry of Justice and Constitutional Affairs Fourth (4th) Floor, Queens Chambers, Parliament Avenue P.O. Box 7183, Kampala, Uganda Applications can also be emailed to:

The Economist June 26th 2010

The Economist June 26th 2010 97

Economic and nancial indicators Overview Ination in America fell by a fth of a percentage point to 2% in May. On a seasonally adjusted basis, prices fell by 0.2% from a month earlier. On June 23rd the Federal Reserve voted to keep interest rates unchanged, remarking that underlying ination had trended lower in recent months. The number of new houses sold in America during the month of May fell by nearly a third from a month earlier, to an annual pace of 300,000, 18.3% lower than the corresponding rate a year earlier. America’s current-account de cit for the 12 months to the end of the rst quarter widened to $391.9 billion from $378.4 billion for the year to the previous quarter. Ination in Canada eased to 1.4% in May from 1.8% in April. Excluding energy prices, ination slowed by a tenth of a percentage point to 1.0% last month. The euro area’s current-account de cit shrank to $48.9 billion in the 12 months to the end of April from $52.6 billion in the year to the previous month. Industrial output in Taiwan surged by 30.7% in the year to the end of May. Ination in Malaysia edged up by a tenth of a percentage point to 1.6% in May. Prices rose by 0.3% from the month earlier, the rst month-on-month increase since January. Hong Kong’s ination rate rose by 0.1 percentage points to 2.5% in May.

Indicators for more countries, as well as additional series, can be found at

High-net-worth individuals In 2009 the world was home to 10m people who had at least $1m to invest, according to Capgemini, a consulting rm, and Merrill Lynch, an investment bank. Between them, such people had a total of $39 trillion in investible assets. That is 16.3% higher than last year’s 8.6m, but still slightly lower than in 2007. America is home to 2.9m very wealthy people, over a quarter of the world’s total. Although it had only 127,000 high-net-worth individuals in 2009, India saw the numbers of such people grow by over 50% last year alone. Among the countries studied, the chances of running into a very wealthy person are highest in Switzerland, where 30 out of every 1,000 people make the cut.

Output, prices and jobs % change on year ago Gross domestic product latest qtr* 2010† United States +2.5 Q1 +3.0 +3.3 Japan +4.6 Q1 +5.0 +2.7 China +11.9 Q1 na +9.9 Britain –0.2 Q1 +1.2 +1.3 Canada +2.2 Q1 +6.1 +3.2 Euro area +0.6 Q1 +0.8 +1.1 Austria +0.2 Q1 –0.4 +1.0 Belgium –1.0 Q1 +0.4 +1.1 France +1.2 Q1 +0.5 +1.4 Germany +1.7 Q1 +0.6 +1.7 Greece –2.5 Q1 –4.0 –4.5 Italy +0.5 Q1 +1.7 +0.9 Netherlands +0.6 Q1 +1.0 +1.1 Spain –1.3 Q1 +0.3 –0.4 Czech Republic +1.1 Q1 +2.0 +0.9 Denmark –0.4 Q1 +2.6 +1.3 Hungary +0.1 Q1 +3.6 –0.3 Norway –0.9 Q1 –0.5 +1.3 Poland +3.0 Q1 nil +3.0 Russia +2.9 Q1 na +4.8 Sweden +3.0 Q1 +5.9 +1.9 Switzerland +2.2 Q1 +1.6 +1.9 na +4.8 Turkey +6.0 Q4 Australia +2.7 Q1 +2.0 +3.2 Hong Kong +8.2 Q1 +10.4 +5.6 India +8.6 Q1 na +7.8 Indonesia +5.7 Q1 na +5.6 Malaysia +10.1 Q1 na +6.9 Pakistan +2.0 2009** na +4.4 Singapore +15.5 Q1 +38.6 +8.4 South Korea +8.1 Q1 +8.8 +5.9 Taiwan +13.3 Q1 +11.3 +8.5 Thailand +12.0 Q1 +16.0 +4.1 Argentina +6.8 Q1 +12.5 +4.5 Brazil +9.0 Q1 +11.4 +6.3 Chile +1.0 Q1 –5.9 +5.0 Colombia +2.5 Q4 +4.7 +2.4 Mexico +4.3 Q1 –1.4 +4.2 Venezuela –5.8 Q1 na –5.5 Egypt +4.8 Q4 na +5.2 Israel +1.4 Q1 +3.6 +3.2 Saudi Arabia +0.2 2009 na +3.6 South Africa +1.6 Q1 +4.6 +2.8

2011† +3.0 +1.7 +8.2 +2.1 +2.9 +1.3 +1.4 +1.4 +1.4 +1.6 –4.3 +1.1 +1.4 +0.6 +2.0 +1.8 +2.6 +1.5 +3.4 +4.0 +2.4 +1.9 +4.0 +3.5 +4.4 +8.0 +5.9 +3.9 +4.3 +4.5 +4.0 +4.6 +4.1 +2.9 +4.5 +4.7 +3.8 +2.6 –2.6 +5.4 +3.6 +3.7 +3.7

Industrial production latest +7.6 May +25.9 Apr +16.5 May +2.1 Apr +2.6 Mar +9.5 Apr –2.8 Mar +9.6 Mar +7.9 Apr +13.2 Apr –5.1 Apr +7.8 Apr +10.2 Apr +3.0 Apr +10.9 Apr +1.5 Apr +9.7 Apr –4.6 Apr +9.8 Apr +12.6 May +7.3 Apr +5.3 Q1 +17.0 Apr +0.9 Q4 +0.4 Q1 +17.6 Apr +3.7 Apr +10.1 Apr +5.6 Apr +51.0 Apr +19.9 Apr +30.7 May +21.3 Apr +9.3 Apr +17.4 Apr –1.3 Apr +7.6 Apr +6.1 Apr –13.3 Mar +4.5 Q4 +9.9 Apr na +8.7 Apr

Consumer prices Unemployment latest year ago 2010† rate‡, % +2.0 May –1.3 +1.9 9.7 May –1.2 Apr –0.1 –1.0 5.1 Apr +3.1 May –1.4 +3.3 9.6 2009 +3.4 May§ +2.2 +3.0 7.9 Apr†† +1.4 May +0.1 +1.7 8.1 May +1.6 May nil +1.4 10.1 Apr +1.8 May +0.4 +1.4 4.9 Apr +2.3 May –0.4 +1.6 11.6 Apr‡‡ +1.6 May –0.3 +1.6 10.1 Apr +1.2 May nil +1.0 7.7 May +5.4 May +0.5 +2.7 11.6 Mar +1.4 May +0.8 +1.4 8.5 Q1 +1.0 May +1.6 +1.2 5.6 May†† +1.8 May –0.9 +1.5 19.7 Apr +1.2 May +1.3 +1.6 8.7 May +2.2 May +1.3 +1.8 4.1 Apr +5.1 May +3.8 +4.1 11.8 Apr†† +2.5 May +3.0 +2.7 3.7 Apr§§ +2.2 May +3.6 +2.7 11.9 May‡‡ +6.0 May +12.3 +6.4 7.3 May‡‡ +1.2 May –0.4 +1.4 8.8 May‡‡ +1.1 May –1.0 +1.1 4.0 May +9.1 May +5.2 +10.1 13.7 Mar‡‡ +2.9 Q1 +2.5 +2.7 5.2 May +2.5 May +0.1 +2.4 4.6 May†† +13.3 Apr +8.7 +12.0 10.7 2009 +4.2 May +6.0 +4.9 7.4 Feb +1.6 May +2.4 +1.7 3.6 Mar +13.1 May +14.4 +11.6 5.2 2008 +3.2 May +0.2 +2.3 2.2 Q1 +2.7 May +2.7 +3.1 3.2 May +0.7 May –0.1 +1.8 5.2 May +3.5 May –3.3 +3.5 1.2 Apr +10.7 May*** +5.5 +11.2 8.3 Q1‡‡ +5.2 May +5.2 +5.5 7.3 Apr‡‡ +1.5 May +3.0 +2.1 8.6 Apr††‡‡ +2.1 May +4.8 +2.9 12.2 Apr‡‡ +3.9 May +6.0 +5.7 5.4 Apr‡‡ +32.0 May +27.7 +32.9 9.2 Q1‡‡ +10.5 May +10.2 +12.2 9.1 Q1‡‡ +3.0 May +2.8 +2.2 7.2 Q1 +5.4 May +5.5 +3.5 na +4.6 May +8.0 +5.8 25.2 Mar‡‡

*% change on previous quarter, annual rate. †The Economist poll or Economist Intelligence Unit estimate/forecast. ‡National definitions. §RPI inflation rate 5.1 in May. **Year ending June. ††Latest 3 months. ‡‡Not seasonally adjusted. §§Centred 3-month average. ***Unofficial estimates are higher.

The Economist commodity-price index 2008 2009

Number of very rich people*, m Selected countries


0.5 1.0 1.5 2.0 2.5 3.0

United States


















India Sources: Capgemini, Merrill Lynch; IMF; The Economist

HNWIs per 1,000 population, 2009


*Individuals with at least $1m of investable assets


% change on one one Jun 22nd* month year

Jun 15th Dollar index All items 204.0 203.9 Food 196.0 198.0 Industrials All 214.4 211.6 Nfa† 209.9 211.1 Metals 216.8 211.9 Sterling index All items 208.8 209.0 Euro index All items 153.3 153.5 Gold $ per oz 1,226.50 1,232.15 West Texas Intermediate $ per barrel 76.86 77.07 *Provisional †Non-food agriculturals.

+0.5 +3.1

+12.3 –3.0

–2.4 nil –3.7

+38.8 +67.3 +27.0









98 Economic and nancial indicators

The Economist June 26th 2010

Trade, exchange rates, budget balances and interest rates Trade balance* latest 12 months, $bn United States –550.1 Apr Japan +79.3 Apr China +144.9 May Britain –132.5 Apr Canada –2.4 Apr Euro area +41.4 Apr Austria –5.2 Mar Belgium +20.0 Mar France –60.1 Apr Germany +211.9 Apr Greece –44.3 Mar Italy –13.1 Apr Netherlands +53.2 Apr Spain –70.7 Apr Czech Republic +9.0 Apr Denmark +14.9 Apr Hungary +6.8 Apr Norway +55.0 May Poland –5.0 Apr Russia +148.1 Apr Sweden +10.9 Apr Switzerland +20.1 May Turkey –49.4 Apr Australia –12.4 Apr Hong Kong –38.2 Apr India –99.7 Apr Indonesia +20.1 Apr Malaysia +37.0 Apr Pakistan –1.6 May Singapore +29.9 May South Korea +39.4 May Taiwan +15.5 May Thailand +13.1 Apr Argentina +15.1 Apr Brazil +21.7 May Chile +15.7 May Colombia +2.3 Mar Mexico –2.3 May Venezuela +30.0 Q1 Egypt –22.5 Q4 Israel –5.4 May Saudi Arabia +104.4 2009 South Africa –1.1 Apr

Current-account balance latest 12 % of GDP months, $bn 2010† –391.9 Q1 –3.2 +176.0 Apr +3.5 +282.2 Q1 +4.1 –28.8 Q4 –1.0 –40.4 Q1 –1.9 –48.9 Apr –0.1 +8.7 Q4 +1.2 +2.7 Dec nil –58.2 Apr –2.1 +190.4 Apr +5.5 –41.3 Mar –7.2 –63.6 Mar –2.8 +46.9 Q1 +5.3 –74.3 Mar –4.3 –2.0 Apr –2.4 +14.2 Apr +2.9 +0.4 Q4 –0.2 +60.3 Q1 +16.0 –8.6 Apr –3.0 +73.2 Q1 +5.1 +31.5 Q1 +6.8 +48.2 Q4 +8.9 –24.7 Apr –4.8 –52.9 Q1 –4.3 +16.1 Q1 +8.4 –31.5 Q4 –1.7 +9.8 Q1 +2.0 +32.4 Q1 +13.7 –3.7 Q1 –1.2 +34.2 Q1 +12.6 +32.6 Apr +3.5 +39.8 Q1 +8.3 +15.1 Apr +6.1 +9.6 Q1 +2.7 –36.2 Apr –2.8 +4.9 Q1 –0.1 –5.1 Q4 –1.8 –5.0 Q1 –1.4 +19.5 Q1 +9.7 –3.2 Q4 +0.4 +7.2 Q1 +2.6 +20.5 2009 +13.0 –11.4 Q4 –5.0


Budget Interest rates, % balance Currency units, per $ % of GDP 3-month 10-year gov’t † Jun 23rd year ago 2010 latest bonds, latest – – –8.8 0.29 3.11 90.1 95.4 –7.8 0.22 1.15 6.81 6.83 –3.1 2.60 3.10 0.67 0.61 –12.0 0.75 3.43 1.04 1.15 –4.5 0.57 3.23 0.82 0.71 –7.0 0.74 2.69 0.82 0.71 –4.7 0.74 3.14 0.82 0.71 –6.0 0.75 3.49 0.82 0.71 –8.4 0.74 3.07 0.82 0.71 –5.5 0.74 2.64 0.82 0.71 –9.9 0.73 9.83 0.82 0.71 –5.1 0.74 4.03 0.82 0.71 –6.2 0.74 2.89 0.82 0.71 –9.9 0.74 4.54 21.0 18.5 –5.5 1.24 4.05 6.08 5.31 –5.8 1.17 2.73 229 198 –5.0 5.25 7.55 6.51 6.43 9.9 2.66 3.30 3.33 3.22 –3.0 3.86 5.88 31.1 31.2 –3.9 7.75 5.72 7.79 7.84 –2.1 0.72 2.67 1.11 1.08 –1.3 0.11 1.55 1.58 1.55 –4.5 7.78 4.71‡ 1.15 1.24 –2.9 0.54 5.33 7.78 7.75 0.6 0.51 2.31 46.2 48.6 –5.5 5.67 8.12 9,030 10,350 –2.1 6.92 5.10‡ 3.23 3.53 –5.5 2.72 1.67‡ 85.4 81.6 –5.5 12.29 8.74‡ 1.39 1.45 –2.7 0.50 2.16 1,188 1,283 –2.1 2.46 4.87 32.0 32.9 –3.1 0.91 1.25 32.4 34.1 –3.6 1.42 2.92 3.93 3.79 –2.8 12.31 na 1.80 1.96 –1.9 10.15 6.16‡ 534 531 –2.2 0.84 1.93‡ 1,897 2,154 –3.9 3.58 4.75‡ 12.7 13.3 –1.0 4.59 6.85 5.30 na –3.1 14.53 6.55‡ 5.68 5.60 –8.7 10.22 6.05‡ 3.85 3.93 –4.2 1.69 3.69 3.75 3.75 4.3 0.73 na 7.55 8.04 –6.3 6.58 8.64

*Merchandise trade only. †The Economist poll or Economist Intelligence Unit estimate. ‡Dollar-denominated bonds.

Global opium production According to the UN Oce of Drugs and Crime (UNODC), the global production of opium declined from 8,890 tonnes in 2007 to 7,750 tonnes last year. Most opium, which is derived from poppies, is converted into heroin. Two-thirds of the rest is consumed in just ve countries: Iran, Afghanistan, Pakistan, India and Russia. Nearly nine-tenths of the world’s poppy cultivation, however, takes place in Afghanistan, though signi cant amounts also come from Mexico, Myanmar and Colombia. Afghan production has declined for each of the past two years. The UNODC reckons that a blight will cause Afghan opium production to fall this year, even though the area under poppy cultivation will probably remain unchanged.

Tonnes, ’000 Afghanistan Laos

Myanmar Rest of world 9 8 7 6 5 4 3 2

United States (DJIA) United States (S&P 500) United States (NAScomp) Japan (Nikkei 225) Japan (Topix) China (SSEA) China (SSEB, $ terms) Britain (FTSE 100) Canada (S&P TSX) Euro area (FTSE Euro 100) Euro area (DJ STOXX 50) Austria (ATX) Belgium (Bel 20) France (CAC 40) Germany (DAX)* Greece (Athex Comp) Italy (FTSE/MIB) Netherlands (AEX) Spain (Madrid SE) Czech Republic (PX) Denmark (OMXCB) Hungary (BUX) Norway (OSEAX) Poland (WIG) Russia (RTS, $ terms) Sweden (OMXS30) Switzerland (SMI) Turkey (ISE) Australia (All Ord.) Hong Kong (Hang Seng) India (BSE) Indonesia (JSX) Malaysia (KLSE) Pakistan (KSE) Singapore (STI) South Korea (KOSPI) Taiwan (TWI) Thailand (SET) Argentina (MERV) Brazil (BVSP) Chile (IGPA) Colombia (IGBC) Mexico (IPC) Venezuela (IBC) Egypt (Case 30) Israel (TA-100) Saudi Arabia (Tadawul) South Africa (JSE AS) Europe (FTSEurofirst 300) World, dev’d (MSCI) Emerging markets (MSCI) World, all (MSCI) World bonds (Citigroup) EMBI+ (JPMorgan) Hedge funds (HFRX)† Volatility, US (VIX) CDSs, Eur (iTRAXX)‡ CDSs, N Am (CDX)‡ Carbon trading (EU ETS) ¤

Index Jun 23rd 10,298.4 1,092.0 2,254.2 9,923.7 880.8 2,693.8 226.5 5,178.5 11,807.5 850.5 2,704.8 2,426.5 2,494.3 3,641.8 6,204.5 1,525.5 20,358.9 335.1 1,022.7 1,150.0 386.0 21,479.3 410.5 40,347.9 1,418.4 1,047.7 6,381.9 55,906.4 4,509.4 20,856.6 17,755.9 2,924.8 1,329.7 9,715.4 2,871.1 1,725.8 7,582.2 806.5 2,327.0 65,160.3 18,925.1 12,464.6 32,663.3 64,635.5 6,318.6 1,039.5 6,343.5 27,617.9 1,040.0 1,095.9 960.2 282.1 813.4 517.7 1,151.3 26.9 124.9 128.0 15.4

% change on Dec 31st 2009 one in local in $ week currency terms –1.1 –1.2 –1.2 –2.0 –2.1 –2.1 –2.2 –0.7 –0.7 –1.4 –5.9 –2.8 –1.3 –2.9 +0.3 nil –21.6 –21.5 +2.9 –10.5 –10.3 –1.1 –4.3 –11.7 –1.0 +0.5 +0.9 –0.2 –7.1 –20.7 –0.5 –8.8 –22.2 +0.7 –2.8 –17.1 –0.8 –0.7 –15.3 –0.9 –7.5 –21.1 +0.2 +4.1 –11.2 +0.2 –30.5 –40.7 –1.0 –12.4 –25.3 +0.1 –0.1 –14.7 +2.2 –17.6 –29.7 –1.0 +2.9 –9.8 +1.0 +22.3 +4.3 +0.2 +1.2 –16.9 –0.9 –2.3 –13.3 –1.8 +0.9 –13.3 +1.2 +0.7 –1.8 +0.2 +10.1 +0.8 –1.7 –2.5 –9.3 –0.9 +5.8 +0.6 –1.4 –7.6 –10.0 +4.0 –4.6 –5.0 +1.7 +1.7 +2.5 +2.3 +15.4 +20.1 +2.0 +4.5 +10.6 +3.0 +3.5 +2.2 +0.8 –0.9 –0.1 +1.2 +2.6 +0.6 +1.7 –7.4 –7.5 +2.5 +9.8 +13.1 +0.2 +0.3 –3.0 +0.6 –5.0 –7.8 +0.6 +13.8 +8.1 +0.4 +7.4 +15.7 –0.4 +1.7 +4.7 –1.0 +17.4 na –0.5 +1.8 –1.7 +1.5 –2.4 –4.1 nil +3.6 +3.6 –0.2 –0.2 –2.6 +0.1 –0.5 –15.2 –1.4 –6.2 –6.2 +1.8 –3.0 –3.0 –1.0 –5.8 –5.8 +0.7 –2.1 –2.1 +0.7 +5.0 +5.0 nil –0.5 –0.5 25.9 21.7 (levels) –4.9 +78.4 +52.2 –8.5 +17.8 +17.8 –1.2 +21.3 +3.5

*Total return index. †Jun 22nd. ‡Credit-default-swap spreads, basis points. Sources: National statistics offices, central banks and stock exchanges; Thomson Reuters; WM/Reuters; JPMorgan Chase; Bank Leumi le-Israel; CBOE; CMIE; Danske Bank; EEX; HKMA; Markit; Standard Bank Group; UBS; Westpac

1 0 1995







Source: United Nations Office on Drugs and Crime


Indicators for more countries, as well as additional series, can be found at

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