Dear NER readers,
Once again, a new edition of the Nottingham Economic Review is out, and considering you are reading this editorial, you are now the proud owner of one of just over a thousand copies to ever be produced. In a century’s time, these masterpieces will be auctioned off for thousands, and in subsequent centuries, the University of Nottingham’s archaeology department will display this very editorial as if it were the Magna Carta. But let us not forget the brilliance of the online version available 24/7 at neronline.co.uk, where you can find Wyn Morgan’s blog and hear Ed Miliband and his Shadow Cabinet’s answers to the NER’s Paxman-esque questions. In this edition, you will find articles spanning the full spectrum of economic and political events. The turmoil in Northern Africa has been thoroughly covered by the media, yet the economic consequences less so; they are extensively covered in the magazine. Our attention even extends beyond this planet at times; we consider why Earth will never be truly globalised unless we meet some aliens. Thank you to all the Oliver Pawle Prize entrants, which were of an impressively high standard, and congratulations go to Sean Jones, this semester’s winner. His article, and the runners up, can be found in the centre of this issue. The competition will run twice again next year, so there’s still time to have a go at winning that £1000. Sadly, all good things must come to an end. We have really enjoyed expanding the reach of NER over this past year through a revamped magazine, the new website, competitions and the Facebook page. Listen out for information on how to get involved with the magazine next year. We wish you a happy revision-filled Easter holidays and the best of luck with your exams. Enjoy reading! NER Team
Credits Editors: Jennifer Heath Mark Wainwright Robert Snashall Serena Qayyum Sponsorship and marketing: Craig Bettney Yasemin Ozturk Design editor: Beatrice Omisakin Design and illustration: Alisdair Gray Mark Wainwright Julie Walker With special thanks to: Chris Milner Kate Barker Richard Disney Hilary Clayton Tim Lloyd
Northern Africa: the revolution will be televised by Hugh Smith
The impact of the Middle Eastern protests by James Arter
Economics Hard times for hard cash by James Earl
Is the future of economics experimental? by Mark Wainwright
Forget the city - become a farmer by Cameron Spencer
ET, don’t go home! by Jason Davis
Commodity-driven inflation in 2011 by Jonathan Stead
Has China been blowing bubbles? by Sean Jones
The dangers of defence by Lily Steele
China, Latin America and the Beijing Consensus by Richard Pass
Some budget arithmetic by Richard Disney
Politics Same drugs, worlds apart by Benjamin Allen
South Sudan’s road to independence by Joseph Ogden
Economic policy in the shadows by Will Allchorn
Interview A conversation with Kate Barker by Serena Qayyum
Competitions and recruitment Quarterly market wrap-up
39 41 42
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Northern Africa: the revolution will be televised By Hugh Smith
ployment for university graduates” as the root of the revolt, and food prices are recorded by the UN as being at their highest since the record spike of 2008.
But from the rapid succession of revolts, it seems from that each protest draws strength from the last – that images of Ben Ali fleeing Tunisia gave Egyptians the confidence to oust Hosnai Mubarak. Ironically, this is the ‘domino effect’ that the West so feared during the Cold War.
“Finality,” Benjamin Disraeli told the House of Commons in 1859, “is not the language of politics.” Though 2011 is self-evidently not 1859, avoiding conclusions like the plague will be wise in the coming months and years as we watch North Africa and the Gulf. For as much as 2011 is not 1859, nor is it 1989, 1979, 1848, 1789, 1776 nor any other grand revolutionary year. What has happened in the region stretching from Morocco to Oman in the last few months has been so unique, so uncertain, and so unpredictable that it defies premature narratives and hasty conclusions. All we can do is try to explain what has happened and grope in the dark for any hint of the way forward. When trying to account for the wave of revolt that has hit North
Africa, we should resist lazy generalisations that may lead to unfortunate labels like ‘The Arab Spring’. Each country has its own pressure points: Yemen’s chronic water shortages are not found in Bahrain, whose unrest is largely due to secular Sunni/Shia tensions. Similarly, each country has not experienced the same level of upheaval: Morocco being a sea of tranquillity compared with Libya. However, it is no coincidence that the region as a whole has erupted in the space of a few months, and general underlying causes exist. Most Arab countries, and in particular Egypt, Tunisia and Algeria, have a large, educated, under-employed youth. This generation, when confronted with rocketing food prices, caused by increasing water instability
and irresponsible speculation on world markets, has taken advantage of social networks in order to take on an aging, nepotistic, militaristic autocracy under which they have lived their entire lives. It is evident that the revolts have been sparked by two factors: the first is political repression. The 2011 Freedom House Index classed all but one of the states in the region as “not free”, and Amnesty International has stated that “all across the region, state authorities have shown themselves either reluctant or downright unwilling to honour their international treaty obligations to protect and promote human rights.” The second is economic malaise. The Tunisian League for the Defence of Human Rights identified the “high rate of unem-
This is the effect of globalisation. In this case, globalised media and social networks have torn down the walls erected by Arab despots. This is the perspective taken by Rached Ghannouchi from the Tunisian Islamist party al-Nahda, who said “success is 30% to 40% thanks to Facebook, and the rest to al-Jazeera”. However, there is a danger of Western observers overstating the importance of social networking. In ‘The Net Delusion’, Evgeny Morosov points out that despite the Western media’s emphasis on the role of Twitter in the Green Iranian uprising following the rigged 2009 election, there were fewer than 60 active users in the country at the time. There’s no doubt that a small group of dedicated people can change the world, but to credit Mark Zuckerberg and Biz Stone with what has the potential to be the fourth wave of democratisation, would be going too far. Traditional community-based networks and organisations assembling to go en masse to Tahrir Square after Friday prayers arguably did more to end Hosni Mubarak’s 29
years at the top than a few tweets. One feature in common is that each revolt has been driven by internal, domestic factors. This wave of revolution has been a very pragmatic one, spurred by real-life hardship and deeprooted frustration, instead of utopian ideology. You need to dig pretty deep to hear the muffled cries of the Islamists. What this means is that each revolution is entirely down to its own people, and the successes and failures belong solely to them. For all the talk of ‘liberty’, ‘freedom’, and ‘democracy’ - which are without doubt held in the highest esteem – one thing is clear: no part of this belongs to the West. The USA and Europe have managed to disgrace themselves at every single turn in the last few months. From the former-French foreign minister’s offer to Ben Ali of some riot control expertise, to Hillary Clinton’s assertion that the Mubarak regime was “stable” just days before it fell, the West uniformly failed to predict the collapse of the despots, and in doing so underestimated the protesters’ commitment and belittled the legitimacy of their cause. Barack Obama hoped that that the line he followed with Iran in 2009 would appease those impressed by words of condemnation, without making puppets out of the occupants of Tahrir Square. In an ideal world it would attract the same kind of praise and the consensus would be that he acted responsibly. But this was a golden opportunity to escape 60 years of realist Pentagon dogma and
assert a foreign policy based not on short-term self-interest, but on values and principles. President Obama missed it. By hesitating to tell Mubarak to go, and by his continuing support of monarchs in the Gulf, he may have diminished his international standing. Hopefully a visible humanitarian effort on the ground in Libya will redress some of the balance. If the US has been embarrassed by the prominence of their stumbling, the EU’s problem has been almost the opposite. EU High Representative for Foreign Affairs Catherine Ashton and EU President Herman van Rompuy have been notable only by their absence. It does not bode well for Europe as a major player on the world stage if the European Union fails to put a unified European face on the response to a crisis just across the Mediterranean. In phone calls, President Obama has reportedly emphasised his belief that North Africa should be within Europe’s sphere of influence. Ashton should now strive to mobilise whatever diplomatic and economic firepower the EU might have to put Europe at the centre of the humanitarian reconstruction of Libya. If she does not, any chance of the EU playing a role in any future global crisis will evaporate. The British emerge from this exceptionally badly. Tony Blair’s warm embrace of the Colonel in 2004 was a masterstroke of realpolitik at the time, and the Blair government should be given credit that Gaddafi now doesn’t have biological or chemical weapons with which to attack
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Benghazi. However, this embrace didn’t need to be so warm as to make Britain complicit in Gaddafi’s atrocities. Arms deals to Colonel Gaddafi’s regime from British companies involved sales of sniper rifles, riot control gear and “bombing computers”. For the Foreign Office to say with a straight face that they do not approve arms contracts intended for internal repression is, at best, disingenuous. David Cameron’s plan to make the foreign office the UK’s salesman to the world now lies in tatters. The mercantile realism he advocated in last November’s speech to the Lord May-
If the revolutions in Egypt and Tunisia have been successful, how do we account for that success? Firstly, the militaries of both countries played an absolutely critical role. Their refusals to fire on protesters ensured that the revolutionary movements gathered the necessary momentum to drive out the Ben Ali and Mubarak regimes. This is not unlike Eastern Europe in 1989, or even France in 1789, when Louis XVI ordered his soldiers not to fire on the revolutionaries. Secondly, the conduct of the protesters can help us account for their success. The non-violence displayed in the movements across the region has allowed the revolutionaries to avoid being stuck with the labels of “troublemakers,” “extremists,” or “hooligans” that the exiled dictators so badly wanted them to be in order to justify a heavyhanded crackdown. The occupants of Tahrir Square should join the American Civil Rights movement and Gandhi’s followers in the distinguished history of non-violent protest. Thirdly, the gaping disconnect between the ruling elites’ illusions of their power and popularity and the
reality of their repression meant that their inadequate promises of compromise and reform would never be taken seriously. No number of reshuffles could have matched the symbolism of Ben Ali fleeing to Saudi Arabia. So: the burning question. What next? Predicting the future is a fool’s game, but certain things are evident. If the revolutions in Tunisia and Egypt are to be sustained, perhaps the most important change will be a transition to a system of government where the rule of law is sacrosanct and the people are never again made to feel like they are not being heard. If democracy takes hold, short-term unpredictability and concerns about relations with Israel will eventually subside as stability resumes. However, democracy should not be seen as a cure for all ills; we need look no further than Pakistan to see that Westernsupported democracies can still be hostile, corrupt, and vulnerable to the power of the military. In Libya, at the time of writing, a lengthy stalemate looks likely on both the military and diplomatic fronts as Colonel Gaddafi lacks the force to crush the rebels, who in turn lack the manpower, resources and organisation to take Tripoli. The longer Gaddafi survives, the more momentum the wave of Arab revolt will lose. If Arab reform is to succeed in the long-term, it needs more victories and the Colonel’s survival could bring the domino effect to an end. But finality is not the language of politics.
The impact of the Middle Eastern protests on the world economy By James Arter
Alisdair Gray messay.com
or’s banquet, when he declared that henceforth he would place “our commercial interests at the heart of our foreign policy,” has now given way to a kind of liberal interventionism with calls for a no-fly zone. Though his advocacy of human rights in his speech to the Kuwaiti parliament was encouraging, there is a very real danger of a rootless British foreign policy that could leave the UK unsure of itself and hesitant at the next crisis.
The Middle Eastern protests have dominated the news agenda ever since the ‘Jasmine revolution’ began in Tunisia in mid December. The protests have since spread to many neighbouring countries; there have been protests as far afield as Mauritania, Somalia and Iran. Libya is in the throes of a conflict approaching civil war as protesters opposed to Colonel Gaddafi have seized key cities such as Benghazi and Tobruk and are attempting to gain control of the capital Tripoli. The protesters have undoubtedly caused a seismic shift in the political landscape of the Middle East. Like most global events of this significance, it is already becoming apparent that the turmoil in the area is affecting the global economy. The Middle East is a major source of global oil production with Libya, Bahrain, Yemen, Iran and Algeria together
supplying a tenth of the world’s oil. Additionally Saudi Arabia, as the regional heavyweight, accounts for 8.5 million barrels per day, making it the world’s third biggest supplier.
speedy ousting of governments across the region and widespread protests appear to have spooked the market, raising fears of another oil shock similar to the first gulf war or the Iranian revolution.
Following the unrest in many of these nations, the global price of oil, which had seen significant increases in the months before the protests, has rocketed to a high of $119 per barrel, the highest for two and a half years and the price seems set to rise with further unrest predicted. The market worries that oil production in the region could shrink due to the workforce either protesting or having fled to avoid the violence. Additionally, protests increase the price of future extraction. Investors would add a risk premium to any new projects in the area, making investment more expensive. Furthermore, markets don’t like sudden changes; the
Increasing oil prices directly affect consumers through higher fuel prices at the pump as well as additional costs through industries that use large quantities of oil as inputs or fuel. For example, last week both Thompson and Thomas Cook both added additional fuel surcharges onto the costs of flights in response to the increased price of fuel. Any increase in oil prices will have a knock on effect on general transport costs, for instance the cost of shipping food around the globe is likely to increase leading to further rises in global food prices. Food prices are currently already rising as a result of last year’s droughts in Russia and China
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and heavy floods in Pakistan. The current inflation rate in the UK is 4%, fully twice the target rate; any increase in fuel and food prices is likely to push this even higher. This will have significant ramifications for the wider economy. A higher inflation rate reduces the real wages of workers lowering overall spending within the economy. With the UK teetering on the edge of a ‘double-dip’ recession any decrease in consumer spending may weaken the struggling economic recovery.. However currently, disruption to oil supply is relatively slight. Libya for instance only produces about 2% of the world’s oil and other countries such as Algeria and Bahrain supply even less. If Saudi Arabia were to be affected by similar protests as have been seen in the rest of the region then it is likely that the effects would be much more serious. The Saudi leaders have promised reform in an attempt to placate the protesters and applied pressure on its neighbour Bahrain to take a strong line with its own protesters lest the protests spill over the border into the country. However a ‘day of rage’ has been called for the 11th of March in the capital Riyadh and the markets are understandably nervous as to the extent of the protest and any disruption caused to oil output. However the effects of the protests have been felt most keenly by the Middle Eastern countries themselves. With millions of people off work, foreign companies evacuating staff and the slowdown in commerce, the econo-
mies of the region almost halted. However long after the short term damage is repaired, the region’s international reputation will be tarnished. Rioting and large scale civil unrest do not attract business and unity governments or those thrust into power on the back of popular protest may be weak and leave the area prone to slip back into chaos. In recent years countries like Bahrain and the UAE have attracted huge levels of foreign investment with cities such as Dubai booming with vast sums of money. The recent violent clashes in Bahrain, where at least seven people have died, have dashed the image as the area being a ‘business idyll’. With the prospect of further conflicts in the area, it is likely that the Gulf States will find it harder to attract foreign companies and investment in the future. This could be devastating to the smaller states’ economies that rely on business tax revenues rather than the larger states with significant oil reserves. Tourism is a key part of many of the regions’ economies, for example 5.5% of Tunisia’s income comes from tourism and the sector employs one in five of the workforce. The violence has forced many tourists to leave the area and at least in the short term it is unlikely that tourists will return until the area’s reputation improves. The global stock markets have also not been spared the effects of the instability in the area, with many stock markets falling as the severity of the unrest increased and uncertainty as to the length
and impact of the protests grew. Companies that are exposed to oil price fluctuations have suffered the greatest with many airlines, for example, suffering falls in their share price as their costs rose. Undoubtedly the recent events in the Middle East offer great hope for the people of the region but will also be highly influential for the global economy. At present it seems like there will be a moderate increase in oil prices and the effects of such an increase will be amplified through higher prices for a variety of fuel dependent industries. These will have an effect on consumer spending and inflation and so have a knock-on effect on each countrys’ macroeconomic performance. Additionally the protests will have been felt across the business world with volatility in the stock market and lower investment in Middle Eastern countries. However the long term effects remain to be seen and depend heavily on what happens in the next few months. Were Saudi Arabia or some other major oil exporter like Iran to suffer some of the turmoil that their neighbours have, then the global effect of the protests could be far larger than initially predicted. With Libya still in a state of violent flux it is impossible to say what may happen into the future. If the violence was to continue for any length of time or result in any serious damage to the oil infrastructure in the country such as the export terminals in Tobruk, Brega or Tripoli then the world oil price would rise to new heights.
Hard times for hard cash By James Earl
Money doesn’t really exist. Currency as we know it is nothing more than ‘a promise to pay’ and only holds value by order of the ruling government; this is termed ‘fiat money’. Historically, currency has existed in the form of commodity money, based on the intrinsic value of the medium of exchange. This developed into a gold standard system, in which an economic unit of exchange is directly related to a fixed weight of gold. Today however, currency is independent of gold and is government determined. The reasoning behind any sort of money system is to solve the ‘double coincidence of wants’ within a transaction, where the wants and needs of the agents involved are likely to differ, such that the transaction is unlikely to take place without a common medium of exchange. This solution, coupled with the idea of a fiat money system, proves that there is theoretically no need for paper money; any form of transfer of government-approved tender is suffice to achieve the aim of completing the transaction between agents. It has become commonplace in modern society to make this transfer electronically, where the value that paper money infers is represented simply in the form of a number on a screen. This is not just your everyday consumer purchasing from a producer but government purchases, bank lending, cross country transfers, commodity trading. This sparks
the core debate of this paper: could the rise of technology render paper money obsolete? Certainly, there is evidence of a growing trend away from hard cash. For consumers in 2010, credit card spending in the UK was greater than the use of cash for the very first time. Perhaps most striking is that for the months of July through to September, credit card spending was 11% higher than for the same months in the previous year. Whilst cash still accounts for just under a half of all consumer transactions, the sheer rate at which this is changing is remarkable. The implications of this change are vast. Electronic transfer can exist in many forms, from the use of mobile phone technology to the standard chip and pin format. Significant changes are afoot in the market with new ‘wave and pay’ cards, working similarly to a normal debit card but without the need to input a pin code. These are designed at first for small purchases but with the potential to expand far beyond, even integrating with current pre-paid card systems. These innovations all have a common goal - efficiency gain. For economists devoted to the idea of maximum efficiency it is difficult to argue against a system that promotes these ideals, replacing the costs of printing cash, withdrawing it and actually physically spending it with an easy to use system that is hope-
fully seamless and at a low cost. The convenience of electronic money should not be underestimated. The typical individual faces a choice as to how much cash to hold based on the profitability of keeping it in a bank account (interest rate) and the cost of withdrawing the money (transaction cost). This trade off is noticeably altered in its nature by adding technological innovations in money accessing into the equation – lower transaction costs mean that money demand will be lower and households will prefer to hold more of their assets in the form of bonds rather than in the form or hard currency. Ultimately, this newfound convenience will benefit households through greater interest earned on their assets plus the direct benefit from not having to hold cash.. Clearly, a cashless society would be a markedly altered one. A key change would undoubtedly be on crime levels, but it is difficult to determine the exact direction of this change. Potential criminals would face new incentives; gone would be the days of balaclava-clad villains snatching handbags from old ladies, replaced by a new form of cyberthief, looking to hack a money system wholly based on software and networks. The flip side of this is that cash forms the core of the black market, which accounts for an estimated 5-8% of the UK economy. This is not just drug
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Whilst transparency is undoubtedly a coveted characteristic of an economy, the demise of cash has consequences for personal anonymity and privacy. Currency spends a short amount of time in the wallet of a particular consumer and as such is difficult to trace. In contrast, an electronically dominated money structure involves a relationship between the consumer and the bank in which personal details are exchanged and a close rapport is maintained with the aim of serving the needs of the consumer and protecting both of the agents against fraudulent activities. This protection is a desirable outcome and will become ever more important as digital money expands but there is evident concern over the information that is provided and the invasion of privacy that this entails. As society continues to adopt electronic money systems, the incentives for government monitoring of electronic payments will increase. A delicate trade-off between protection from fraud, laundering and black market activity and the invasive
side of this information collection must be balanced. Despite the obvious gain to the government from the possibilities for tax monitoring and the protection against black market activity (particularly terrorism), the issue is likely to be extremely contentious and politically divisive. The theory behind this new order of electronic money dominance is certainly attractive but the actual implementation of such a system is daunting. The pioneers are typically East Asian, with Singapore keen to develop a cashless society through the use of CEPAS (Contactless e-Purse Application) stored-value cards. Their aim is to use these cards to replace those small cash transactions that are most prohibitive to a cashless society, such as public transport and retail services. For a country that is 350 times smaller than the United Kingdom, this is a much more realistic aim than for many other countries but by leading the way they set the example for others to follow, providing the initial innovation necessary to make a cashless economy feasible and economically viable for others. Even the UK is welcoming the switch to electronic payment by committing to phasing out cheques by 2018, a move that signals the importance that the developed world has attached to this issue. Though it may be efficient to switch to electronic payment and economically prudent, there are equity concerns. The elderly, the homeless and those living in remote areas would be particularly vulnerable to a change and
are in fact already suffering from a degree of economic isolation, with the rise of the internet for both personal consumption and banking. Despite the efficiency failings of cash it is the universal language by which the world operates, available to any who choose to work for it and by its very definition cannot be rejected as a means of payment. As this inevitable switch to electronic payment gains momentum, society must remember the origins of money and the reason that it is so successful at solving the ‘double coincidence of wants problem’ – it is universally accessible. The decline of cash and the rise of electronic payment must be managed in such a way that this characteristic is maintained, or risk losing the very reason that money was created in the first place. The movement away from paper money is undeniable and is deeply ingrained in our everyday lives. If nothing else, the sheer cost of printing and handling cash is hampering efficiency in our monetary system. Steve Perry, executive vice president of Visa Europe, stated that “we [UK] spend more on payment than we produce on food,” in terms of relative GDP. It is obviously overly idealistic to imagine a society where cash is entirely obsolete but there is something fundamentally backward in pursuing a cash method which inflicts such a cost on our economy. Changes are afoot and they must be embraced – the revolution is here.
Is the future of economics experimental? By Mark Wainwright
barons and hooded gangs; this is the neighbours paying for their building work or the colleague smoking smuggled cigarettes. By replacing cash as a form of a payment, the system should become a more transparent one in which it becomes difficult to evade taxes and illegal activities are tougher to facilitate. In a time of economic uncertainty, where the UK has to face up to a debt estimated at 57.6% of GDP at the end of January (2011), dealing with the issue of the black economy has never been more appropriate.
The economist is often likened to the astronomer: one who is powerless to influence the forces they study and resigned to formulate their ideas based on observation alone. An ideal approach for economists would be to hold everything in a market constant, change just one variable of interest and then observe the result. Doing so is the only true proof of causality, but economists are generally considered powerless to do this. The closest they can come is when a ‘natural experiment’ is formed by chance, but these are never precise enough to truly isolate the effect of one change. However, astronomy is in one sense not as observational as it first seems; it is built on principles of particle physics, which have been well tested in the laboratory. Is there a similar role for
experimentation as a foundation for economic theory? The rise of experimental economics says so. A brief history In the 1950s, peripheral economic journals became scattered with papers describing findings from controlled laboratory experiments that had more in common with psychology, but whose results were being used to appraise economic theory. As this type of research became increasingly prevalent, it produced more and more surprising results that often directly contradicted well-established theory, and were thus taken with more than a pinch of salt. However, the exponential rise of the field became a trend in the following decades. Nowadays, a large proportion of published economics papers report or refer
to experimental findings, and experimentation is generally accepted as a valuable source of information in the discipline. In 2002, Vernon Smith and Daniel Kahneman won the Nobel Prize “for having established laboratory experiments as a tool in empirical economic analysis”, which is perhaps the clearest sign of the field’s coming of age. Experimental economics’ primary medium is the laboratory experiment. These have become more sophisticated over time, and nowadays usually involve subjects using computers to complete tasks and interact with other subjects. The most unique feature of economic experiments is that subjects are typically paid according to the payoffs they earn within the experiment, so that they are in-
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centivised to act as they would in a freely-occurring situation. What has it taught us? Much early experimental work focused on the idea of creating experiments that replicate real-world markets, with buyers, sellers and transactions. Vernon Smith was the pioneer of this use of experiments; using the principle of ‘induced values’ to gain control over subjects’ preferences, he found that the prices and quantities converged on the levels that a model of perfect competition would predict, despite almost all of its assumptions not holding. Because of the accuracy with which in-experiment markets can predict outcomes of those in the real world, experiments are often used as a ‘wind tunnel’ for new market designs. They have particularly been used in this sense to test various auction mechanisms, the results of which have often fed into the design of government auctions for telecommunications licences, emissions permits and more. The most common use of experiments in economics is to test pre-existing theories, similarly to how Smith’s experiments tested models of competitive equilibrium. Not all results have been as complementary to the theory as his, however. Results from individual decision making experiments can reject many of the assumptions made by standard decision and preference models, insofar as they are accurate. For example, ‘preference reversal’ is a puzzling yet robust finding that, when given a choice be-
tween two gambles, subjects very often choose the safer gamble, but place a higher value on the riskier one when asked to value the same gambles separately. Depending on interpretation, this example challenges standard assumptions of the procedureinvariance of preferences, and of their transitivity and consistency. Similarly challenging are ‘dictator’ and ‘ultimatum’ games, where subjects are often found to freely give money away to other players even when there is no game-theoretic explanation of why they might do so. Results from these types of experiment contest the assumption that preferences are solely self-regarding, and hint at the importance of concepts like altruism. Lab experiments are also a natural place to examine strategic interactions between multiple players. A particular focus, perhaps because of its clear policy implications, has been on public goods and testing the standard economic theory that nobody would voluntarily contribute to their provision, because of the ‘free-rider’ problem. Experiments have revealed, however, that concepts of altruism and reciprocity can sustain high levels of contribution. More broadly, the lab is often used to test how outcomes of strategic interactions compare to game theoretic predictions, with results suggesting that equilibrium concepts do not fully capture the outcomes of real-world interactions. These kind of observations are of great relevance outside of the lab. For example, in analysing the
effect of a policy change, welfare economics makes many of the assumptions that experimental results challenge. Knowledge of observed biases, furthered through experimentation, can and should be used to predict how individuals and groups will actually be affected by a policy change. Use of behaviour observed in experiments has also recently been used to argue for certain political approaches; in ‘Nudge’, Richard Thaler and Cass Sunstein advocate ‘libertarian paternalism’ – methods of influencing decisions without removing choice – which has its foundations behavioural observations in the lab, and that has gained traction with David Cameron and Barack Obama. Are experiments realistic? As a new and fast-rising field, experimental economics has faced a great deal of scrutiny, and is no stranger to criticism. Perhaps the most frequent critique is that economic experiments are simply ‘unrealistic’. It is natural to wonder whether observation of students sitting at computers playing abstract games can really make predictions about what might happen in a complex, dynamic marketplace. However, experiments are by their very nature abstractions of reality, so to analyse this criticism it is important to look at specific realism concerns and whether they cause the lab to be truly unrealistic, and thus unrepresentative, or whether they are just evidence of necessary simplification. For some, the relatively modest payoffs typically used cause
the lack of realism, if they are not high enough to encourage subjects to think through their behaviour as thoroughly as they would otherwise. This is not the reason why outcome-dependent incentives are used in experimental economics, however. Instead, they are used to create the some constraints and forces that subjects would feel in real world situations, and to ensure all subjects put the same value on outcomes. In this sense, experiments are designed to create situations that are no less realistic than the natural scenarios they model, only simpler. Even if increasing the stakes was argued to make an experiment more realistic, extensive testing has shown that doing so, sometimes hugely, does not drastically alter behaviour. Experiments could also be said to be unrealistic because they typically only involve students, whose decisions may not be representative of the wider population, limiting the predictive power of experiments. However, in theory-testing, this should not matter, because the predictions of economic models rarely depend on demographic factors. In others, such as decision-making experiments, this argument holds more weight. However, the only inherent reason why lab experiments rely on students is convenience; there is no reason why a wider subject pool could not be used, although this is often more easily achieved through field testing. Field testing is perhaps the most obvious reaction to criticisms of experimental realism. This approach, championed primarily
by John A. List, applies a lab-like methodology to naturally-occurring environments. Field experiments inherently sacrifice control to gain greater realism, but, as previously argued, there is little to suggest that lab experiments inherently lack realism. Considering that a lab experiment could offer incentives just as large as in the field, and use subject pools that are just as diverse, it is unclear what true benefit field testing brings. As James Heckman and Armin Falk argue in an article for Science, the real quest should not be for an abstract concept of ‘realism’ but for the best way to isolate the causal effect and most effectively control for the others. The future Experimental economics is becoming an integral part of research in a range of areas within economics, and rightly so. As it becomes more widely accepted, it is important to think of it as less of a niche sub-field and more of a tool that, when applied appropriately and carefully, can shed light on the gulf between economic theory and empirical reality in ways that were previously impossible. Whilst studying how individuals and groups should act has been historically integral to economics, it would be foolish to suggest that a study of how they actually act is not just as important. There are, however, some unresolved criticisms of the field. Inherent to experimentation are questions of whether issues like self-selection bias and the Hawthorne effect jeopardise results. Neither is generally considered
the major problem that they can be in other disciplines, and in some cases they can even be leveraged for the experimenter’s means, but despite this they are persistent issues that any experimenter must consider. There is also much criticism that is less credible. Catherine Eckel and Herbert Gintis argue, in a paper tellingly entitled “Blaming the Messenger”, that some criticism is symptom of little more than a lack of willingness to accept the often stark implications that experimental findings have for traditional economic theory. That this is the case is unsurprising given the meteoric rise of the field within a discipline that is more familiar with steady development. To me, the view that experimental settings are unrealistic fits too easily into this category of insincere criticism. It is often forgotten that experimental results are not inherently contrarian; experiments tend to give theory its ‘best shot’ and sometimes produce results showing that a theory has greater predictive power than was expected. Regardless, it is in economists’ best interests to remain openminded about developments in experimentation and to focus on a dialogue about genuine concerns with experimental methodology. In this way, problems can be addressed and methods refined so that experimentation can be used in as many areas of economics as it has the true potential to benefit. Experimental economics can become a significant part of the future of economics – as long as economists let it.
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Forget the city - become a farmer By Cameron Spencer
finance and information technology. Millions of young Europeans and Americans have been raised with an ‘unfashionable’ view towards becoming farmers and more of a focus on jobs in the newer, tertiary sectors. But what happens after this stage of development? How long can an economy keep growing until it simply cannot maintain its development, even with the life support systems of government intervention?
By the end of 2011, the global population will be 7 billion. Two centuries ago, the population was a mere 1 billion, indicating a staggering rate of increase. This dramatic growth is forecast to continue, albeit at a decreasing rate, meaning that figures of 9 billion could be reached as soon as 2045. Whilst the concept of overpopulation is nothing new, people seem to be forgetting some basic principles; if populations are booming then there is one thing that becomes crucial to sustain this rise – food. Since people will always demand food, it is important to remember that agriculture is at the heart of society, now so more than ever, and that agricultural yields cannot afford to fall behind population growth.
Recent spikes in food prices are sparking Malthusian fears that the demand for food is increasingly outstripping supply. The consequences of this are stark, including increased rates of starvation in the developing world, especially where food is already poorly distributed. Food prices are currently at a record high, with the UN even warning of food riots. Is it time, then, for more investors to enter the world of agriculture and cash in on the booming performance of the soft commodities? The paradox of development Historically, an economy will progress through agrarian and industrial phases before it can reach an era centred on services,
The collapse of numerous major financial institutions in the US and UK suggests that we may be seeing the end of a substantial period of growth. Maybe debtreliant and troubled economies need to wake up and swallow the medicine that they needs to re-stabilise both government and consumer spending. Perhaps what is truly needed to ensure recovery is a step back, rather than short-term strategies of quantitative easing and a continued reliance on debt. A new investment Many financial commentators believe that the most prosperous and certain future for investors is commodities, with a particular focus on agriculture. Knowledgeable investors have, for example, realised that soaring grain and crop prices translate into rising livestock prices. Take beef for example – every pound that is produced requires
9 pounds of cattle feed. Crops are crucial to meat production and the consumption of meat is sky rocketing in the developing world, with China now consuming four times as much meat as it did in 1980. These demands simply cannot be met unless agricultural investment can expand at a similarly rapid rate. Fresh water consumption is also crucial to livestock production; data from the University of Twente tells us that every kilogramme of beef requires 16,000 litres of water. One of the main pressures of a booming population is the depletion of scarce supplies of fresh water. If this continues and the supply of water for irrigation becomes restricted, crop yields may fall, creating further scarcity and therefore pushing up global prices of exchange-traded funds and commodity futures. As governments try to reduce independence on crude oil, the use of ethanol and biofuels has become an increasingly viable alternative. Ethanol is produced by the fermentation of sugars such as those found in corn, and biodiesel is derived from the organic fats found within soy; if these fuels ‘take off’ and become an efficient alternative to oil, they will also put serious pressures on already scarce crop yields. There is also a big problem of waste, which is taking a significant dent out of world food stocks. In the western world, bad habits are perhaps the biggest culprit; food remains cheap enough that many consumers
do not worry about the amount of which they dispose. Whilst this has no clear-cut solution, in poorer countries, wastage often occurs in storage or transit, to which greater investment in storage facilities and refrigeration could be a worthwhile solution. The benefits of agricultural investment are clear. According to Peter Schiff, food prices are increasing by more than 10% a year. In an uncertain future, there are also strong arguments for investing in necessities, and agriculture perhaps represents the purest example of this; people will forever need to eat and consume energy. Commodities are also a good hedge against an uncertain economic outlook; if global financial hardship truly ends, the price of commodities will rise, due to the increased pressure of demand. However, if economies remain weak, the temptation of quantitative easing may lead to the inflationary pressure of stagflation, much of which will be focused on commodities. The capacity to supply more crops and livestock still exists in many regions of the world. Investors George Soros and Jim Rogers have focused on South America, having purchased hectares of land in Brazil and Argentina with a view to fertilising and irrigating it through the hiring of native farmers. Adecoagro is a farmland operation established by Soros, producing sugar, coffee, soy beans, rice and milk in 270,000 hectares of land in Brazil, Argentina and Uruguay. The
success of these strategies may signal to other investors that they may be ones worth following. Exchange Traded Funds and Futures markets are one option that provides trading and investment opportunities in agriculture, but may be more volatile due to a dependence on one commodity. A safer investment may be in farming companies that specialise in a small number of different crops, for example. A long term strategy There is still much land out there that is uncultivated – approximately half a billion hectares, according to the World Bank – which means that global food output has the potential to rise rapidly. All considered, agricultural investors could be very well rewarded over a time period of two or three decades, providing that food prices continue to inflate. All the fundamentals are in place to suggest that this will be the case; population growth is continuing, development is shifting focus away from agriculture, India and China are particularly fuelling demand, and consumer preferences are shifting, with an increased focus on nutrition and eating well. Whilst the future for financial services looks uncertain, agriculture may become the biggest boom industry in the years to come – as long as it dawns on the developed world that the one thing we need the most is in danger of being the most undersupplied.
16 Nottingham Economic Review
ET, don’t go home!
By Jason Davis
ET pointed his glowing finger towards Elliot and told him, “I’ll be right here.” If only he meant that he and his alien race were only going to be a few light-junctions from Earth down the, “Milky Way Motorway”. The first thought entering any economist’s head should be the limitless intergalactic trading opportunities of such a planet resulting ushering in a new age of globalisation. We could waive the WTO good bye, although maybe grudgingly greet the newly formed ITO (intergalactic trading organisation). Extra-terrestrial life would be the quickest and only way to increase all of our standards of living through globalisation. Although I may be exaggerating (just a touch), my over-zealous argument is using ‘artistic license’
(and royalties paid to Spielberg) to argue that the world we live in today is reaching its limit for globalisation and that the only way to bring the Earth truly together is with an outside competitor. You do not need to look far to see the recent return to protectionism. Chinese tariffs wars with the US and the Boeing and airbus subsidy war are just some of the examples I will touch upon. There will always be protectionism, given the nature of competition between individual governments around the world, which will prevent total globalisation. Are aliens the only way to create a fully globalised Earth (the Earth trading bloc!)? Before I explain my theory behind why inter-galactic trade
would help globalisation, I must first explain why we want globalisation at all. After all, many economies and people fear globalisation since it does come with its dark side. Globalisation can increase income inequality, it can remove national sovereignty and it can make countries reliant on imports for basic essentials (as seen in the recent Russia-Ukraine gas problem, which resulted in gas to the UK being switched off too). However, I am an advocate of globalisation for the simple reason that globalisation causes growth which in turn raises all of our standards of living. I do not want to get too bogged down in this article about the theory behind the resulting growth but if you do not believe me, consult the arguments about specialisation and comparative advantage in Adam Smith’s breakthrough book, the Wealth of Nations; a bona fide page turner! Jagdish Bhagwati once argued that the complex nature of the “spaghetti bowl,” of bilateral trade agreements would eventually coalesce into a globalised world. Bhagwati was wrong. Yes, globalisation has been increasing for a long time but there is a reason why countries are making bilateral and not multilateral trade agreements. There is a reason why the WTO is yet to complete its 2001 Doha Round and there is a reason why trade barriers exist even today. The reason is that individual self-interest re-
sult in protectionism between trading blocs and outside trade agreements forcing our planet to remain nationalized and preventing it from becoming fully globalised. Protectionism has declined over recent years but we may have now reached a limit. For every free trade agreement that is set up, it brings with it a common external tariff and for every common market that is set up, there remain non-tariff barriers (such a frontier controls or tax controls). Protectionism is all around us and you do not have to look far to find it. A very pertinent example of this is the Boeing and Airbus subsidy war between the US and the EU. This year the WTO ruled that the Boeing’s 787 Dreamliner benefited from illegal US government subsidies that distorted market competition and gave Boeing an unfair advantage. This subsidy war has been going on for years with both sides providing illegal subsidies. Trade share between the EU and the US is higher than anywhere else yet protectionism is still ripe between them. Another notable example is the US’s trade feud with China. One of Obama’s first moves as president was to prevent cheap tyre imports from China undermining US competition via imposing a tyre tariff partly in response to the contentious Chinese currency manipulation. You may at this point be thinking what do aliens have to do with all of this? My theory is that the introduction of competition with
this alien race is the only way to fully globalise Earth. The introduction of the EU allowed for tariff-free trade between member countries yet it imposed a common external tariff on those outside it. Whilst gaining the benefits of free trade with their ‘teammates,’ all members are also on a level playing field outside the EU. These advantages make the prospect of a fully globalised world unrealistic. However, an external competitor in the form of Aliens would be the perfect way to unite the Earth into a single trading bloc. Trading blocs protect themselves against shortages in supply, unemployment and uncompetitive prices with tariff and non-tariff barriers. In this case, the economies of Earth would be protecting themselves and their neighbours whilst also being on a level playing field with the outside competitor. Global competition will only be promoted by cooperation, if there is an incentive to cooperate and share. Without incentives for internal cooperation, removal of tariffs universally would surely only lead to increases in non tariff barriers such as those illegal subsidies seen in the Boeing airbus example, which in turn would result in retaliation and take us back to where it all began. The introduction of an outside competitor however allows the nations of Earth to benefit from being within a free trade area and still allows them to dose out their required amount of protectionism to our new friendly neighbours. The problem is how we enforce such a tariff. In Orson Scott Card’s book Ender’s World, a
trusty source to any seasoned economist, one of the central tenets of space strategy is that it is impossible to defend a planet. We already loose a huge amount of tax revenue on smuggled tobacco, and so how do we expect to enforce a global tariff. Also, what would we sell them? Considering our current state of technological progress, for the foreseeable future aliens are probably more likely to make contact with us than us with them. To them, our civilisation would seem woefully primitive. We could specialise in all the items their civilisation had long since dispensed with; like trees. Or we could also sell them our technology as art, akin to how on holiday a tourist may buy a blowpipe from the natives; why not buy a Toyota Prius to remember your trip to earth by. “Haha, these earthlings are so backward, they haven’t even invented the antimatter combustion engine!” Yes, they might flog us loads of useful hyperdrives and spaceships, but with the Earth trading bloc and the associated exorbitant tariffs, I think we would be the main winners there. Indeed, one of a catalogue of limitations to this argument might be the lack of aliens. However, it is important that we plan for when we do finally meet ET. How will we band together to form a truly globalised planet - and one that could sell him some iPods?
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Commodity-driven inflation in 2011 By Jonathan Stead
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Being the one who has the T-shirt
Over the last few years the world has experienced its first truly global economic crisis. Dubbed the ‘Great Recession’, the bursting of an unsustainable credit bubble and the crumbling of a flawed banking system left all but the world’s fastest growing economies on their knees. Now, nearly four years after the start of the crisis, the world is precariously poised and governments must pull off a difficult balancing act between further stimulus and austerity. 2011 has been labelled as potentially the “Year of Recovery”, but significant challenges lie ahead for both developed and emerging economies, with arguably the central threat coming from runaway commodity prices. This begs the following two questions- why are commodity prices so important, and how could they threaten economic resurgence? Commodity prices are
so integral to the economy because, ultimately, they are the inputs that businesses and consumers require in order to function. Oil is especially important, and will be the main focus of my analysis. Manufacturers depend on oil, many as a physical input to their processes, but nearly all use transportation that relies on oil. This makes oil price security crucial in increasingly globalised chains of production. Oil can have a knock on effect on other commodities such as food - because food distribution relies on transportation and shipping. If inflationary oil prices are then coupled with rising food prices (from shortages and so on) the effect is compounded, meaning suppliers and ultimately consumers face higher prices. Oil has recently been breaching $100 a barrel, a landmark figure. On the demand side, this has
been driven largely by an increasing hunger for oil from developing countries - notably the BRIC economies. More recently, the price rise has been heightened by instability in the Middle East and North Africa, beginning with trouble in Tunisia and Egypt, and now seemingly spreading across the region. If instability spreads to Saudi Arabia – which supplies more than 10% of the world’s oil the bubble could turn into a fully fledged crisis. In the 1970s, similar oil rises forced Britain into severe stagflation. Thankfully, the UK economy is now less vulnerable to oil shocks. The reasons are contested, but largely they can be attributed to the shift towards the service sector. This sector is far less dependent on oil, meaning the economy is driven less by oil prices - the heavy weighting on services (especially financial) ironically accentuated the downturn, but now makes the UK less sensitive to shocks. Further to this, unionisation is far less commonplace in the service sector, so, coupled with globalisation and the threat of foreign competition, workers’ bargaining powers have been heavily subdued, reducing the possibility of a wageprice spiral. The reduction to sensitivity in oil prices is underlined by the MPC’s refusal to alter the interest rate from its historic low of 0.5%, despite Mervyn King recently predicting inflation to reach 5%.
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The UK cannot be considered in isolation, though. The global economy is heavily interconnected, with the BRIC countries of obvious interest. Together
Brazil weathered the financial storm rather well: its recession was limited and, as of Q3 2009, the country’s economy was “out of recession” and growing. The Brazilian banking sector is somewhat more conservative than that of developed nations, so there was less exposure to the US subprime market and the contagion was limited. However, inflationary commodity prices pose a serious inflation threat, with the latest figure hovering just under 6% and leading to the central bank increasing interest rates to above
6% 5% 4% 3% 2% 1% 0% 2000
Figure 1 - UK CPI inflation
11%. Uncertainty over inflation stemming from commodity prices will perhaps dampen demand, but it is unlikely to be a sustained concern given that Brazil’s central bank is internationally renowned for being “hawkish” and is not likely to let the situation escalate. Further to this, Brazil now exports more to China than the US. While the US stutters its way to recovery, the Chinese economy is still raging, and so will assist in Brazilian economic recovery regardless of commodity prices. China is hugely reliant on its export market, which took a huge hit during the recession. However, the Chinese Government was incredibly proactive and its combination of large fiscal and monetary stimuli, along with an artificially low exchange rate, meant China only really faced a slowdown rather than any danger of recession. China’s economy, though, is very sensitive to inflation. Last year stocks plunged under inflation (and the associated interest rate) fears and the latest figure stands at around 5% with the general consensus being that China is perhaps being a bit sluggish to respond to the inflationary threat. It was one of the quickest and most decisive nations to act in the face of the recession, but now appears hesitant to put the brakes on and unnerve investors. Another significant threat to China is a wage-price spiral. Three quarters of firms working in China have said they are likely to increase wages this year by more than 5%. The combination of these factors means commod-
ity-led inflation is a real problem for China. It remains to be seen whether Chinese authorities will have the nerve to step in and be aggressive over inflation, accepting a slowdown in growth. Their policy with regards to the exchange rate certainly implies that economic growth is their one and only concern but inflationary problems may well force their hand towards late 2011. India also largely took the recession in its stride; such huge stimuli weren’t required because its economy is far less reliant on the export market. It is true that investment and confidence wavered, but only a mild slowdown was witnessed. India is far less reliant on energy and metals being service oriented but these commodities have had a knockon effect on food. Food inflation in India rose to 18% - a concern for general inflation but outweighed by the concern it poses to India’s people and their wellbeing. The Indian authorities are actively trying to get to grips with the problem, banning certain exports and cutting certain import tariffs in order to drive prices back down to acceptable levels, but these inflationary concerns are likely to be a threat to strong Indian growth in 2011. Russia was affected hugely by the recession. Its economy is export oriented, nearly fully consisting of energy and metals, which act as the lifeblood of their economy. The country’s emergence as a growth market was based on the increasing demand for more and more energy. The onset of the
US Energy Information Adminstration
Recent research showed that oil prices at $100 a barrel would “dampen GDP growth by 0.1% in each of 2011 and 2012”. This is evidently a burden Britain is willing to bear in order to keep monetary policy easy as a catalyst for filling the output gap.
Brazil, Russia, India and China make up 40% of the world’s population, and these countries are set to be the engines of global economic growth – China has recently overtaken rivals Japan as the second largest economy and, by 2030, India is anticipated to be vying for status with the US and China as a global superpower.
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Inflation will shoot well above target (2%), but this is due to the runaway commodity prices – external factors that are difficult to control. In the 1970s, such external factors threw the UK economy into a spin. But now the UK is more immune to such shocks, the inflationary risk is only shortterm and it can be disregarded in favour of keeping credit cheap to revive investment.
$160 $140 $120 $100 $80 $60 $40 $20 $0 2000
Figure 2 - Brent crude oil prices
crisis decimated oil prices, and a lack of global manufacturing demand (and so metals) meant that Russia suffered hugely. Ironically, now it is the commodities market that could prove to be Russia’s saving grace. A resurgence in oil prices and manufacturing inputs (accentuated by Russia’s introduction of a 10% export duty on nickel and copper) will help pull Russia out of stagnation and into growth. It appears that commodity-induced inflation will be a contained and limited issue for developed countries. Most monetary authorities have accepted inflation will rise but have taken the stance that the damage will be negligible and so have prioritised growth. A word of warning is due though. History has a habit of repeating itself, and traditionally commodity bubbles can have severe effects on economies. A severe reaction isn’t anticipated
but it will undoubtedly present a challenge to economic recovery, especially limiting any manufacturing-led resurgence. Across the globe, developing countries will be more troubled by the inflationary environment, with weaker monetary and fiscal authorities perhaps struggling to limit the impact of external shocks. For the BRICs (barring Russia), commodity prices will be a concern and could escalate, but are unlikely to be significant enough to derail their strong growth. Commodity prices can certainly be said to have huge importance in the global economy. This current bubble has highlighted, more than ever, just how important a diversified and balanced economy is when the world is so globalised and no event, shock or crisis can be considered as ‘isolated’ in our increasing interdependent world.
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20 Nottingham Economic Review
Since the Global Financial Crisis of 2007, the term ‘bubble’ has become increasingly popular in modern financial journalism, particularly in asset markets. Despite this, surprisingly little solid economic theory or psychological foundation is ever mentioned in such articles, and bubbles are often seen as the ‘miracle explanation’ of over-inflated asset prices. To clarify, when the term ‘bubble’ is used, it is often meant in the sense that asset prices do not reflect their true underlying fundamentals. With respect to real estate markets, one would argue that house prices were far in advance of their key economic drivers (household income, interest rates etc.). Robert Shiller, a significant advocate of bubble theory in economics, attributes this to Alan Greenspan’s notion of ‘irrational exuberance’;
in other words, speculation that is purely psychological. The belief of agents that house prices will continue to rise ensures a self-fulfilling prophecy that ends in the bubble bursting and a whole heap of economic disdain. It is beyond reasonable doubt that such bubbles were ‘floating around’ during the buildup to the 2007 financial crisis. Speculation and feedback loops amplified house prices, there was an unprecedented rise in sub-prime loans, and eventually banks’ overconfidence in the continual rise of house prices caused one of the biggest financial crashes in modern history. In recent years there has been a significant shift in sentiment towards China’s real estate market, with news headlines moving away from an initial optimism toward the current “is China’s
housing market heading for a crash?” attitude that has attracted much media attention. So, why has there been growing cause for concern? Recent house prices in China are not only growing rapidly but are also outstripping increases in income (figure 1). Furthermore, the house price-to-rent ratio, a common indicator of inflated prices, has also been consistently rising. On the activity side, real estate investment now accounts for roughly 20% of total investment and 9% of China’s GDP. If we assume these data to be correct (or, in China’s case, consistently incorrect) then the first point worth mentioning is that house price-to-rent ratios in China are currently nowhere near the peaks of either the UK or the US. This is strong evidence
that prices are neither growing at unsustainable rates, nor that they are particularly overvalued. But there are other reasons why China’s housing market isn’t a bubble waiting to burst. Certainly, asset prices are inflated, but the key point here is that there is no element of unsustainability of these prices. Firstly, China has an extremely stringent lending policy. All mortgages in China are adjustable rate mortgages, and four state-owned commercial banks dominate the primary mortgage market. Furthermore, the People’s Bank of China sets a common interest rate for all. Once a mortgage is issued, borrowers are closely monitored and risk levels are adjusted in accordance with changes in their financial status. If a bank branch reaches a delinquency rate of over 5% its mortgage-lending license is removed. It is clear from these strict lending rules that the Chinese government are taking strong action to keep default risk as low as possible; quite the contrary to US and UK housing markets, where subprime lending was as popular as David Beckham on a trip to the Far East. Not only are Chinese mortgages much ‘safer’ than in the West, but they are also all backed by the enormous liquidity of the state, which stands at $2.5 trillion as of June 2010. Where the financial crisis of 2007 – and in particular the fall of Lehman Brothers – was largely attributed to a complete freeze in interbank lending, China is in no danger of such a liquidity squeeze and could easily ‘fund’ its way out of any dif-
ficulties in the mortgage market. Finally, housing is simply a hedge against inflation for most Chinese citizens and is their only means of storing wealth (bank savings rates are kept deliberately low). This means that there is little scope for speculation, particularly with regards to foreign investment, so Shiller’s irrational exuberance would be extremely hard to encounter in such a market. It is for the aforementioned reasons that I believe China’s housing market to be much more stable than the media make it out to be. Ultimately, while China continues to grow at its spectacular rate it is unlikely that its not-sospectacular growth in house prices will be its immediate demise. The kind of bubbles that the modern media frolic amongst would require a much more relaxed approach to credit, a more open foreign investment opportunity and a lot more speculative buying. On that note that we move to a more traditional way of explaining
house prices: real estate economics. There are many factors that might affect demand and supply of housing, and it has been shown quite strongly that ‘the classics’, such as household income, housing stock, unemployment and land prices all have significant effects on house prices, but there are three (hopefully enlightening) areas I see as paramount in explaining China’s housing market. A vital characteristic of China that is often overlooked is its population demographic. The 1978 introduction of its ‘One Child Policy’ has left China with a dilemma: its population is ageing rapidly. Figure 2 below shows quite clearly that the proportion of people aged 15-64 rose until 2010, but will fall thereafter, while the percentage of people over 65 will continue to rise. According to the life-cycle hypothesis, consumption-savings patterns vary with age; those who are young effectively borrow from the future (through loans) in order to purchase large
By Sean Jones
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Has China been blowing bubbles?
Figure 1 - Average house price to income ratio in China (2001=100)
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22 Nottingham Economic Review
Percentage aged 15-64 Percentage aged 65+
Figure 2 - Demographic make-up of China (1980-2050) assets (housing) in the present. As those people get older they begin selling their assets for income, thus driving down prices. This theory fits the trend in Chinese house prices we have seen in the lead up to 2010, and suggest a significant dampening in said prices as the first children of the One Child Policy become the working population. Next, as China makes its gradual transition from planned to freemarket economy there have been significant reforms in its housing policy. The most significant for the purposes of this discussion is the IAL system, which was introduced in 2002. To promote transparency in the land market, the government implemented a system whereby invitations to tender, auctions, or listings allow land developers to acquire land use rights through a competitive market. Despite these good intentions, competition actually drove land prices to become significantly higher than their equilibrium price.
Clearly, therefore, changes in domestic policy regarding land ownership have had, and will continue to have, a significant impact on house prices in China. Indeed, successful attempts at dampening house price inflation in 2010 have included relaxing land-supply constraints. They have also included raising minimum down-payment ratios for first mortgages from 20% to 30%, which brings us neatly onto my third and final major point. As discussed earlier, China currently has very strict rules on access to credit. It has an extremely infantile secondary mortgage market and very little exposure to foreign markets. I therefore intuitively introduce the notion that access to credit is the final piece in the Chinese housing puzzle. Throughout the past 3 years in particular, the Chinese government has used interest rates and mortgage requirements to dampen or support the housing market. As its citizens turn more and more to housing as an
So, where does all this leave us? Well, when looking at housing markets and particular that of China, there are two routes an economist can go down in his quest for understanding. The consistent and strong growth in China’s house prices is initially suggestive of an asset bubble, and has been popularised as just that. But asset bubbles are based on psychological factors that are not easily explained. Indeed their main arguments are herding and speculative buying, which are almost impossible in China because housing as an investment has not quite taken off, and because its mortgage market is built upon solid foundations. So we used a more traditional economic approach, but with a twist. Looking at China from an alternative perspective revealed that its political and economic uniqueness have influenced its housing market in a somewhat unconventional way. It is my belief that the role of Chinese population demographics, housing policy and access to credit will continue to have the most important role in house price determination. The Chinese housing market is alive, well-managed and flourishing; anyone for a bottle of bubbly?
The dangers of defence By Lily Steele
We have felt the catastrophic effects of economic contagion, and are now witnessing the birth of political contagion; prime examples include Tunisia, Egypt and now Libya. In a civilized and just world how did we allow one of the most profitable industries to be founded upon war and terrorism? By combining an economic and political dynamic, we may be able to determine the true role that arms and defence should play in today’s highly interdependent and globalised world. The defence industry is unique; no other legal industry exists that is allowed to operate at such high levels of secrecy, resulting from staggeringly low levels of transparency. Not only are weapons and arms heavily subsidised, but they also receive very high tax breaks and trade protection. The industry is further defined by its cyclical nature. Mass arms producers,
like the USA, will sell their most advanced technologies to the highest bidders, for example Saudi Arabia. This triggers a literal arms race between producers to rapidly develop more sophisticated equipment to ensure that they remain at the forefront of the industry. It is the prerogative of every nation to create and maintain their defence system in order to protect national sovereignty. It is this inherent right to defend and protect that enables countries to expand and advance their defence industries. The original 1947 General Agreement on Trade and Tariffs included a ‘national security exception,’ where nations are allowed free reign in determining
what they deem to be suitable ‘security measures.’ The ‘national security exception’ is embedded in the GATT, NAFTA and numerous other international trade agreements. Rampant exploitation of this security exception has accelerated the development of the defence industry on a global scale. The defence industry can assist in economic and political development. Security is a public good, and also a priority amongst the poor, according to interviews conducted by the World Bank. A well-governed and structured military provides stability and balance within a country, and creates educational opportunities, which may not be available without a well-financed military sector.
Percentage aged 0-14
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investment rather than simply a store of wealth, the demand for credit will increase. Furthermore, it is my belief that credit restraints will become more relaxed and FDI more welcomed into Chinese real estate markets. These two changes will certainly combine to fuel housing growth in the foreseeable future.
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24 Nottingham Economic Review
Nations would not allow such high levels of militarisation to exist within their borders if not for good reason. It is primarily the levels of profit associated with the arms industry that attracts such a great deal of business. The ‘war on terror’ has catapulted the defence industry to become one of the most profitable, since peace is not good for business in this industry. However, such extensive profit comes at the expense of millions of people around the world. Terrorist attacks around the world, most notably 9/11, have catalysed the procurement of weapons. The USA dominates the arms industry; as they are ranked first in worldwide arms transfer agreements. The developing world is the primary recipient of arms, with transfer agreements constituting 72.8% of global agreements between 20062009. The developing world is acclaimed for their undemocratic governance, poor human rights records and extremely unstable societies. In spite of America’s long run commitment to ‘peace
‘Offsets’ are increasingly vital components of international arms transfer agreements from the buyers perspective, as the arms seller is entitled to reinvest rents in the purchasing country. Therefore offsets can prompt economic growth within the purchasing country, which is most often a developing nation. Other benefits include greater civilian industrialisation and employment growth. Production can be relocated to the purchasing country allowing for domestic labour to be transferred to a more productive purpose.
and democracy,’ they continue to supply these nations with weapons and military education and training, where violent outbreaks are widespread. Such actions contradict the developed world’s commitment to creating stability and maintaining strict human rights. Soaring oil prices have fuelled the arms purchases of Middle Eastern countries and curtailed the demand from oil consumers, who tend to consist mostly of developed nations. Furthermore, it is somewhat ironic that the five permanent members of the UN Security council are also the world’s largest arms dealers. The Middle East is the most militarised region in the world, and also the most politically unstable, evident from recent uprisings. Currently it is the innocent and oppressed that suffer the most, as weapons fall into the hands of known human rights violators and terrorists. Already over 1000 Libyan civilians have died
as a result of violent confrontations between security forces and government demonstrators. Even though the demonstrators are fighting for democracy and freedom, the damage has been magnified as a result of high levels of militarisation. It has been revealed by the General Accountability Office that in July 2007, over 200,000 weapons were unaccounted for in Iraq, most likely to be possessed by Iraqi insurgents and criminals. Governments of arms producers do not intend for their weapons to migrate into the possession of terrorists and insurgents, nevertheless such outcomes are common within an industry renowned for secrecy and corruption. From an economic perspective, higher levels of militarisation are often associated with greater debt burdens. Even though the industry experienced an 8.5% dip in 2008 from the recession, countries are usually more than willing to take on higher levels of debt
if it is to finance greater defence expenditure. This is no surprise since armaments have long been used as instruments of foreign policy, wielded to strengthen or establish ties with other nations. The pursuit of such relationships fails to incorporate the spillovers, particularly the negative externalities associated with arms procurement. Arms sales can exacerbate already very tense foreign relations. For example, increased arms sales to Taiwan from the USA have aggravated US-Chinese relations. A 2008 report from the New American Foundation has stated “US weapons played a role in 20 of the world’s 27 major wars in 2006-07.” The defence industry has been accused of siphoning funds away from valuable development projects, such as health, education and transport, and having an overall negative impact on economic growth. It has been determined that this detrimental effect on social development programmes is magnified in developing countries, thus, the opportunity cost of defence investment is also much more distinct in developing countries. Governments argue that greater investment in the defence industry will improve employment opportunities; a statement that has been consistently disputed by many economists, like Dean Baker who has projected that America will sustain a long- term loss of 2 million jobs as a result of higher defence spending. Furthermore, the skills acquired within a highly militarised state may not be transferable to civilian life, and stability is not a guarantee either.
High levels of military expenditure are not conducive to democratisation or security enhancement within developing nations. The proposed theory that offsets are advantageous for a nation’s economic development, has been disproven so far by the evidence, reveals economist Jurgen Brauer. A plausible explanation for this lies within the cyclical nature of the arms industry; persistent innovation of military technology prevents these advancements from being transferred to the civilian sector. A causal relationship between economic growth and military spending has not yet been empirically established. It is more likely that a domestic arms industry would consume valuable resources, which would otherwise have been deployed to more productive and worthwhile sectors. There is a high degree of ambiguity surrounding the impact of military expenditure on socio-economic factors within a state. I do not deny that greater investment in the arms industry may contribute to economic growth in some nations, however the impact is unique to each country, and needs to be determined if one is going to pursue arms investment in the name of economic growth. In spite of these extensive criticisms of the arms industry it is highly improbable that nations will ever undertake disarmament. Extremism and terrorism have become so far integrated into our societies that countries, especially the USA and UK, will never surrender their arms. The USA plans to spend in excess of $7 billion on the development of
nuclear weapons in 2011, in order to “modernise the US nuclear weapons complex.” The lucrative nature of the defence industry, which is derived from the vast profit opportunities available, enable arms suppliers to disregard practices to which they claim to be adamantly against. Gross human rights abusers and nations, who were previously blacklisted as arms recipients, are now some of the greatest recipients of arms sales post 9/11. Countries may have had the right intentions when they initiated the ‘war on terror,’ to create a safer and more stable global environment, however they have inadvertently triggered a global arms race, with numerous nations fighting to become the most militarised. Since it is naïve to believe that countries will ever pursue total disarmament, stability and safety are more likely to be realised through international arms agreements. The Arms Trade Treaty, initiated in 2008 is the first step towards greater cooperation. The treaty aims to diminish transparency and inhibit the exploitation pertinent to the arms trade. Proposals state that the treaty will be enacted in 2012, however the success of such a treaty is questionable if all major arms producers and consumers do not comply with the legislation. A national defence system is vital to every nation, however steps need to be taken to protect civilians who consistently become collateral damage in such a corrupt and unstable industry; the pursuit of war is a poor path to peace.
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China, Latin America and the Beijing Consenus
Priscilla Jordao/Mark Wainwright
By Richard Pass
South America is a continent which is often forgotten about by us Europeans given our colonial past in Africa and the high media profile of Asia. Indeed, Chinese trade with Latin America is almost as great as that with Africa: In the year 2000, trade between China and Latin America totaled $10 billion. By 2010, this figure had risen to $100 billion. In recent years, the Chinese have been exerting what David Rothkopf, a former commerce advisor in the Clinton administration, calls ‘cheque book power’, power which is rivaling that exerted by the United States over the region since the Monroe Doctrine of 1823. Furthermore, as in Africa, increased trade has also been
complemented by a real effort by China to expand its diplomatic profile on the continent, by enlarging its embassies and sending numerous diplomatic trade missions to court the Latin American governments into signing more favorable trade agreements. However, what needs to be ascertained is whether this trading relationship will really benefit the people of Latin America and at what cost? The fundamental characteristic of Latin America’s trading relationship with China is that like Africa, it is built upon the export of low value added raw materials, in particular crude oil, iron ore, soya beans and copper. Superfi-
cially, this cannot be considered a bad thing given the extremely high prices being paid on the international market for such commodities. For instance, the price of iron has increased from $26 per tonne in the year 2000 to $212 in 2010. Thus, if one is a corporation like Vale which operates the worlds largest mine and produces a third of a million tonnes of iron ore per day, demand induced prices are a blessing for ones profit margins. Such is the demand from China for Brazilian iron ore (which is much purer than the iron ore produced in China) that 60% of Brazil’s iron ore exports currently end up in China. Brazil is certainly not alone in capitalizing on this de-
mand from China, with Chile, Peru and Uruguay among others trading heavily in raw materials. Like in Africa, it is the export of such commodities that is fueling a revival in growth rates. Another important component of Chinese influence in Latin America is through joint ventures with local firms. In March of this year, Bridas, an Argentine-Chinese joint venture purchased the refining and sales arm of Exxon Mobil operating in Paraguay and Uruguay. In Brazil, Wuhan steel has gone into partnership with LLX Logistica, in a $5 billion deal to build a new steel plant which will process iron ore mined in Brazil. Furthermore, last year, Ecuador signed around $5bn of bilateral deals with China, including $1.7 billion to help build a hydroelectric dam and $1 billion in investments for oil exploration and infrastructure projects. By comparison, in 2009, Chinese investment in the country was just $56 million. Such investments not only provide much needed capital, they also facilitate a transfer of technology. Few dispute the widely held belief that for Latin America to become more prosperous, it needs to diversify its economies away from commodity exports to processing and value added industries which can provide large scale employment: The potential ‘primarization’ of the economic structure of Latin America due to this new trading relationship is a major concern. The soy industry is a perfect example of this: While China has aided Latin America’s soybean exporters in expanding their access to global markets,
few benefits have gone to rural communities. Despite increased production, employment and wages have decreased with the rise of capital intensive production methods. Indeed, whilst Brazilian soy production increased fourfold between 1995 and 2009, employment in the sector actually contracted over the same period. For a continent with the highest income inequality in the world, this is a challenge which Latin American governments will find difficult to ignore. Moreover, the situation is worsened by the fact commodities are exported by a small number of companies in an even smaller number of industries. This is the case for most of Latin America. For example, in 2008, copper exports accounted for 80% of Chile’s exports. The same is true for Peru and Costa Rica in terms of the diversity of exports. In Chile, five firms account for 60% of its exports, whilst in Argentina, ten firms account for 70% of its exports. The worst case is in Costa Rica where Intel is responsible for 85% of the country’s exports to China. This pattern would be more acceptable if the governments were able to raise significant revenue from Chinese influence, but given the rush to attract Chinese FDI and trade, many states are cutting export and corporation tax rates and thus any examples on the contrary, according to a 2009 study by the German Development institute, ‘represent the exception rather than the rule’. Perhaps the biggest fear of many Latin American’s is the threat
cheap Chinese imports pose to local manufacturing and thus value added industries which provide valuable opportunities for employment. This is politically a very important issue to most Latin American governments given the fact that 189 million Latin American’s still live on less than $2 per day. Such is the threat from Chinese imports that Kevin Gallagher, author of the recent book entitled ‘Dragon in the room’, argues the numerous free trade agreements that countries like Chile, Costa Rica and Peru are signing with China could ship such countries ‘back to the 19th century’ for they are neglecting the importance of a diversified economy. Despite rapidly growing exports of commodities totaling $40 billion in 2009, Chinese exports to Latin America totaled $78 billion, a significant trade imbalance. For a country like the USA, this is not a problem but for countries with limited local industry, the opposite is true. Furthermore, it is increased competition by the Chinese in foreign markets like the USA which is making life difficult for many Latin American producers like Mexico especially. An irony which has probably not been lost on Latin American states is that the current period of sustained growth beyond 1% has been spawned by the success of a state whose development path follows that of the ‘Beijing Consensus’ as opposed to the Washington Consensus. In 1970’s and 1980’s China and Latin America were of a similar level of development. Both were relatively poor and set out to reform their economies, however, they did so
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in different ways as mentioned above. The Chinese followed a model of mixed ownership, basic property rights, and heavy government intervention, whilst Latin Americans followed the western doctrine of limited government intervention and liberalized trade and capital markets. Thus is it correct to assume Latin America could have been another China had they followed the ‘Beijing Consensus’? Probably not, as China certainly benefited from its proximity to important Asian markets and having a population of 1.3 billion people. However, it may have been possible that Latin American growth rates would have been closer to those experienced by the ‘Tiger economies’. Deng Xiaoping once described the Chinese development doctrine as ‘crossing the river by touching each stone’. Kevin Gallagher, author and Professor at
Tufts University, described the Latin American development experience as ‘diving in to the river and then finding out that they don’t know how to swim’. Indeed, the point analysts like Gallagher are trying to make, is that Latin American states should perhaps ease off the free trade agreements they are making with China and instead take a breath and decide whether the current route of development will allow a more diverse economy to develop. If the experience of developmental states like Singapore, Taiwan, Japan, South Korea and China are anything to go buy, the answer is probably negative. However given the academic divide in respect to the virtues of the developmental state, such opinion only represents one side of the argument. Thus far, this article has considered only economic issues. However, the biggest loser of
the commodity boom will likely be the environment, in particular, the Amazon rainforest. As mentioned earlier, Soya bean exports to China are huge but the damage to the rainforest is even greater: It is estimated that Soya production has been responsible for the destruction of 528 000 sq km of tropical rainforest in South America, an area the size of Yemen. In Brazil, a joint Brazilian-Chinese iron partnership between Cosepar and MinMetals has repeatedly been found guilty of illegal logging over the last five years, yet little has changed in the firms practices. Unfortunately, such an example is typical of China’s general disregard for the environment which has also been witnessed in Africa. Perhaps the only way to stem the tide against deforestation will be through international coordination modeled on the Yasuni initiative in which developing countries are paid not to damage the environment. Thus, is the presence of China in Latin America on balance a good thing? Such a question is very difficult to answer here as it is in respect to Africa. There can be little doubt that over the last decade, Latin American growth rates have been higher than many would have believed possible just 10 years ago. However, the problem is not the present but the future; the future of local industry and the future of the Amazon rainforest. If Latin American states find a way to guarantee the sustainability of both these assets, then the future may be as bright as the Latin American spirit.
Some budget arithmetic By Richard Disney [Professor of Economics, University of Nottingham & Research Fellow, Institute of Fiscal Policy]
The annual presentation of the Budget by the Chancellor of the Exchequer (this year’s budget was presented on 23rd March 2011) is seen as the most impoRtant event in the fiscal year – the point at which we learn how much more we will pay in taxes and whether the Chancellor will present any ‘giveaways’ to offset the tax burden. In fact the budget is a one-sided event – it describes how the government intends to pay for its spending, but the spending plans themselves have been announced long before the Budget. These spending plans of the government are normally announced in the Government’s Spending Review in the previous autumn – the latest Spending Review took place on 20 October 2010 and announced spending plans until 2014-2015.
in the budget itself – so that their total value appeared to accumulate. At the same time, significant increases in the tax burden, that could be achieved without headline tax increases, were hidden away in the small print of the voluminous budget statement that accompanied the speech in the House of Commons. Nevertheless, even less cynical Chancellors are adept at covering up painful medicine behind words such as ‘encouraging enterprise’, ‘promoting individual freedom/ responsibility’, emphasising the ‘importance of fairness’ and ‘prudence’, ‘stimulating investment’ and various other positive-sounding statements. City financial institutions generally run sweepstakes on how often particular words are used in the budget, with the person choosing the most-frequently mentioned cliché buying the champagne.
The spending component of the Budget therefore focuses on anything that may have caused the previous autumn’s spending plans to go awry and also on some headline-catching announcements of new spending, usually at relatively small cost but designed to sweeten the pill of the usual tax increases. Under Gordon Brown’s Chancellorship, the Treasury grew adept at announcing extra spending ‘giveaways’ several times – in the Autumn Statement, in leaks and hints between the Autumn Review and the budget and then
Beyond this frivolity, however, the budget stance of this year’s budget took place in an unusually difficult economic environment. The United Kingdom’s fiscal deficit had ballooned as a result of the ‘credit crunch’ in 2008 and the subsequent bailingout of several major UK financial institutions. This alone would have made the task of the then Chancellor (Alistair Darling) and, after the General Election of 2010, George Osborne, problematic. But that difficulty was enhanced by two factors. First, the UK economy was already running a
Background to the budget
structural budget deficit before the ‘credit crunch’, somewhat contradicting the over-optimistic view of the then Chancellor of the Exchequer that he would ‘never return to Tory boom and bust’. And part of the reason for this structural deficit was that the government had essentially lost control of spending in some key departments of government, notably the Ministry of Defence. The budget judgement All politicians and economists have therefore agreed that the budget deficit must be eliminated. The divisive issues have concerned how to cut the budget deficit (i.e. the relative weights attached to cutting spending versus raising taxes) and how rapidly to cut the deficit. On the first issue, of how to cut the deficit, the debate has polarised on familiar political lines, with the coalition choosing to emphasise public spending cuts over tax rises. Of the 7.5% reduction (as a share of GDP) in the public budget planned over the forecast period, the government envisages 6.2% coming from reduced public spending and 1.3% from rising tax receipts. The coalition argues that the economy needs ‘rebalancing’ (a fashionable piece of jargon) so that growth in private sector employment replaces growth in public sector employment, the latter having been the main
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Same drugs, worlds apart
source of growth in employment in recent years. The Labour opposition opposes the level of public spending cuts, although being somewhat vaguer as to what tax rises should replace them. The second issue, of how rapidly to reduce the deficit, raises more interesting issues for economic analysis. The budgetary stance of the government (i.e. how rapidly it brings the budget deficit down) has to steer a careful line between the Scylla of losing credibility with financial markets and the Charybdis of plunging the economy back into recession. This means that if the financial markets perceive the plans as not credible or too slow in restoring balance, then they will be unwilling to purchase the bonds required to finance the deficit; on the other hand, if the cuts drag the economy into a second recession, restoring the budget balance will be that much harder. On bond markets, both sides of the argument have a point. When only Greece and Iceland seemed to have serious budgetary problems, the risk of the UK losing its creditworthiness seemed remote. But the ‘domino effect’ of adverse investor confidence on other countries such as Ireland, the other Mediterranean countries and even Germany at one point, suggest that all countries have to be wary of the shifting climate of investor opinion. The coalition government points to the fact that it was able to sustain large bond sales through 2009-2010 without any rise in the basis point premium to UK gilts on sovereign debt markets, but
By Benjamin Allen
it should not be forgotten that through much of this period the Bank of England was engaged in ‘quantitative easing,’ which saw the Bank buying a large fraction of the UK government’s newlyissued debt. The test of whether the government can repeatedly finance large ongoing deficits, without a rise in interest rates paid to international lenders, has yet to be fully tested. Only time will tell whether the opposite risk, of prolonging recession, is an outcome of the government’s budget stance. Labour plans at the time of the last General Election implied a return to budget balance by the end of 2016-17 – at least a year after the plans of the coalition government. But even this restoration of budget balance by Labour relied on certain tax increases (such as a rise in National Insurance contributions), which have not been implemented,
and which the current opposition spokesmen are reticent to confirm are a continued part of Labour’s economic strategy. Most current analyses, including the report by Barclays Capital in the influential Green Budget published by the Institute for Fiscal Studies (IFS), suggest that growth will be more muted than that projected by government spokesmen and by the newly created Office of Budget Responsibility. This implies a greater probability that the government will miss its target of budget balance by 2015. However, a response to this of cutting harder surely risks a lowering of business confidence and, as the IFS suggests, a ‘Plan B’ of allowing a little more flexibility in the target, whilst retaining the current broad economic strategy, seems to be a sensible response to the budgetary problem.
When GlaxoSmithKline chief executive Andrew Witty declared in January that GSK would be making price cuts to drugs in developing nations and reinvesting 20% of profit from those nations back into the local economy, few could doubt his sincerity. Unsurprisingly though, Witty himself made no secret of the insignificant amount involved, as GSK’s profits in developing nations are as little as 5m. It seems an overly accepted consensus that a little is quite enough when it comes to creating balance in the international drug market. The conflicting and intensely politicised interests of the stakeholders involved in this market are the main reason for this. These have developed into a screen play of antagonism between social, legal and economic pressures. For the pharmaceutical companies the driving force is economic growth. This growth however can come into conflict with the interests of customers who rely on these medicines to be available, accessible, and as cheap as possible. What is key in this dynamic is that, whilst for pharmaceutical companies efficiency is measured in profit margins, for the consumer true efficiency is attained when drugs are at their cheapest and used most effectively. Confined as a national problem, this dynamic is a significant hurdle to a more fluid drugs market
but the implications internationally, especially on the developing world are seismic. The problems in the developed world operate as an intense sub-plot to greater international concerns. Qualms for the patient in the west centre around costs, rebranding of the same compound medicines, thus creating waste, not using cheaper alternatives, as well as the strangely American phenomenon of unnecessary over-prescription. In America, drugs companies have found huge benefits by finding a way into the doctor-patient relationship, where GPs may receive incentives to promote certain drugs, often giving patients the illusion that they need a particular drug. Similarly,
as one of only two nations in the world which allows direct drug company to consumer advertising, a habitual drug taking culture has arisen. One salient example is the painkiller Vioxxhaving spent more money on advertising annually than Budweiser, concerns were raised that this unnecessary spending increased the price of the drug. The nadir of Vioxx’s problems came when the drug was withdrawn after adverse reactions increased heart problems, hospitalising 1.5 million Americans and being attributed to 100,000 deaths. This is one of many prominent examples that all serve to illustrate that through the search for higher
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Many of these most commonly used drugs are simply edited versions of an already competent original. Between 1999 and 2007, 78% of newly registered drugs in America were simply repressed compounds of others already registered, known as ‘’Me-too ’ drugs’ . Drugs are being rebranded in the same way that our commodities or music are, repackaged and renamed to stimulate customers to believe that a certain drug will make their health better. Closer to home, the withdrawal of premium diabetes treatment Avandia in the UK, which was almost twice as expensive but equally as proficient as its’ predecessor has dramatically shown the waste of medical research, time and money recreating drugs has become. The drug’s value in the UK alone was worth £1.9 billion at its height in 2006 before withdrawal. A comprehensive understanding of business is hardly required to illustrate how a CEO in a major pharmaceutical company would see it more fit to concentrate on a market within a developed nation that provides billions in revenue than focus on people who quite simply cannot afford their drugs. The business notion of re-branding and keeping costs as high as possible becomes a daunting one when we consider millions
of lives, each year, are at risk. The one incentive that could be provided for medical companies to lower prices overseas and decrease profit margins would be a healthy dose of competition. However, the pharmaceutical oligarchy seems as prevalent as ever with the largest companies enveloping competitors in the last 12 months. Pfizer purchased Wyeth for $68 billion, Genetech gave way to a Roche buy out for $46 billion and Sanofi-Aventis bought Genzyme for $20 billion. The reason for the buying frenzy has been cited as a response to the ending of 11 international patents in quick succession which have a combined international sales value of over $70 billion. This reaction is a tell tale sign of how important these patents are to pharmaceutical companies. Essentially the implementation of these patents has enabled them to maintain a firm control over potentially developing markets, at home and abroad. These patents, whilst protecting pharmaceuticals from undercutting competitors, do not protect those who are ill in developing nations. They hinder the availability of drugs as those who buy medicines in the developing world are still paying for all the costs, research, overheads and advertisement that the likes of GSK and Roche are paying for in the west. If our drug production markets were as open to competitors as our other trade markets the developing world would be in a much better position. Nonetheless, in the past few years
a trend has certainly started to arise, that has offered a refreshing new chapter in the pharmaceutical screenplay. Pharmaceutical companies from the rising economies of China, India and Brazil have developed a different approach to drug production, one described in the economist recently as a ‘frugal’. Stripping back the production process, eradicating waste through advertisement, rebranding, luxurious medical research facilities and a distinct lack of wasted funds in terms of government lobbying, they have still managed to make significant headway through innovation. Since 2005, PWC’s innovation scorecard has suggested that France, America and the UK have all become less innovative whilst China, Brazil and India have become the most innovative. In China for example, stateowned medical research facilities have also eradicated inherent conflict of interests between the consumer and the pharmaceutical companies, allowing a more fluid and rational drugs market to develop. It is certainly a relief to see that these cheaper markets in foreign countries are developing a culture which not only spurs the behemoths of the western pharmaceutical world to cut prices and seek alternatives, but that these new markets are also far more likely to tap into those areas that are genuinely needy rather than simply lucrative.
South Sudan’s road to independence By Joseph Ogden
profits, vast sums are being wasted that could be more suitably applied to underdeveloped markets. Cheaper alternatives are sometimes left in the wake of drugs which have had millions spent on research.
For the 98.83% of southern Sudanese citizens who voted for independence from the North in a referendum held on January 9th, secession will mark a new, hopefully peaceful beginning to the decades of conflict in which some 4 million people have been displaced from their homes and an estimated 2 million people killed. The overwhelming result of the referendum, held as part of the Comprehensive Peace Agreement signed in 2005, will see south Sudan become an independent country on July 9th of this year. However, south Sudan faces a vast array of economic and political issues such as the ongoing dispute over the region of Abyei (ownership of which is being contested by north and south), security arrangements, an agreement over oil revenue, and the formation of a stable government. If these issues cannot be
adequately settled they will continue to present major obstacles to Sudan’s long search for stability, peace and development. The biggest threat to a peaceful transition to independence is a return to civil war. Aside from a temporary break between 1972 and 1983, Sudan has been engaged in war since 1956. The signing of the 2005 Peace agreement has brought with it another episode of relative peace. However the possibility of violence remains (with both sides retaining large weapons supplies which they have been stockpiling since 2005). One likely source of violence are the tribal and ethnic rivalries in the south. Such tensions were the cause of various atrocities during Sudan’s most recent civil war (1983-2005), particularly between the Dinka and Nuer tribes. There are legitimate
concerns that problems could resurface as the 40-plus tribes in the region wrestle for power in the newly formed state. The government’s creation of a police force is therefore welcomed. However it will require further investment to ensure security. An even more pressing security concern is the need to arrive at a settlement over the much disputed Abyei region situated on the north-south border. Abyei is yet to have its own referendum to decide whether to join the north or south as the north’s President Omar al- Bashir and the leader of southern Sudan Salva Kiir have been unable to agree on which tribes should be eligible to vote. The delay of the referendum has intensified the conflict between the Dinka Ngoc tribe and the nomadic Misseriya groups. Increasingly violent clashes between the tribes could result in the involve-
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ment of the northern and southern armies which would immediately disrupt the peace process and throw Sudan back into a state of civil war. The future of Abyei is crucial not only because it straddles the border but because it is home to a large proportion of Sudan’s oilfields upon which both the north and south are deeply reliant. Oil contributes to 60% of the north’s revenue and 98% of the south’s. Prior to the referendum there was an agreement that oil revenues would be split between the two nations. However, as 90% of Sudan’s oilfields are in the south, the government in north Sudan’s capital Khartoum are concerned that the resource which keeps its economy afloat may escape their control. The north will have to be assured that secession will not lead to oil becoming monopolised by the south and that they will continue to receive sizeable revenues from production. Should President Bashir receive no such assurances he would be well placed to exploit the south’s instability- he has already been the subject of allegations of arming rival tribal groups to destabilize the south. Coming to an agreement over oil that the north considers appropriate will be the biggest challenge in the coming months before independence is official. Although a settlement over oil revenues is crucial to ensuring that President Bashir accepts the freedom of the south and doesn’t begin to exploit its instability, an over-reliance on oil revenues will be a major economic challenge
for the government of south Sudan post-independence. Oil output in the south is expected to peak in 2011-2012, which leaves the government in urgent need of diversifying its economy in order to become less dependent on oil which could run dry in 20-30 years. It is a region rich in minerals such as gold, copper, and iron and has large areas of fertile and cultivable land. The government will need to invest in such areas to ensure that it retains a flow of revenue when its oilfields become less profitable. Moreover the government of south Sudan must do more to ensure that economic growth is equitable and benefits its own people. Since 2005, a rise in a variety of companies in South Sudan such as motorbike taxi-firms and stalls charging mobile phone batteries for people without access to generators has been made possible by light regulation. However most of these companies are owned by foreigners, mainly Ugandans and Kenyans. The people of the south have seen little of the profit. In the coming years the government will have to do more to ensure that it includes its own citizens in its economic growth.
Even if issues surrounding Abyei and oil revenues are resolved, on July 9th, south Sudan will still be one of the world’s poorest and least developed countries. Decades of fighting and minimal assistance from the government in Khartoum have left it with little infrastructure with only around 62 miles of paved roads in a region the size of France. The healthcare system is almost
non-existent, as is the education system. A south Sudanese girl is more likely to die in childbirth than learn how to read and write. In order to develop the new nation’s general infrastructure, public services and alleviate the vast poverty, the south needs a fully functioning government. It is estimated the government of the south has received around £1.3 billion in revenue annually since 2005 from oil, which if it had been well invested would have gone some way to developing the region. However the government’s capacity to use such money to provide for its citizens has been heavily questioned. Corruption is believed to be rife within the government, most of whom are semi-literate with a military, rather than a political background. The capacity of the government to deliver prosperity and peace is further undermined by the inadequate civil service in the country, half of whom lack primary education. The split of Sudan is undoubtedly a step towards peace in the region. For too long the south had been neglected by the government in Khartoum. However the success of secession will depend on the government’s ability to deal with the serious issues facing the new country. With one baby in six dying before their first birthday and only 30% of people having access to health care, it is vital these issues are addressed quickly and effectively. All eyes will be on the government of south Sudan, as they should be.
Economic policy in the shadows By Will Allchorn
With the appointment of Ed Balls at the end of January, the question on many a political commentator’s lips is whether the new shadow Chancellor can meet the policy challenge of an economic response to the coalition’s agenda of cuts. This is closely related to the opposition’s role at such a time of economic recovery: scrutinising the executive and providing a well-articulated and credible alternative vision to the U.K’s current austerity measures. Ed Miliband’s Labour, bereft of Balls, had so far failed in this sense. Other signs of the wider public perception of his leadership have not helped this. The view has been popularised that he’s ‘a bit square’, that he is unable to change the party (with only a third of respondents of a YouGov poll last October believing that Miliband would change Labour), and that all he must do is ‘sit back’ and let the coalition government unravel before his eyes. Balls, however, has attract-
ed similar criticism; the Radio 4 political analysis programme ‘Week in Westminster’ found Balls lacking on the key stylistic credentials that make a successful shadow Chancellor. Norman Lamont, former Chancellor under Margaret Thatcher, suggested that unlike John Smith, former shadow chancellor and leader of the Labour party, Balls ‘does not have sufficient wit to complement his political savvy’. The policy challenge However, a key question that we must ask ourselves is to what extent Ed Balls’ tenure has seen a substantive change in Labour’s economic policy, from predecessor Alan Johnson. The straightforward answer is a significant and politically strategic response to the coalition with overtones of his previous boss, Gordon Brown. An example of this can be found in an opinion article written by Balls himself in January.
Titled ‘Same Old Tories, still doing Maggie’s way’, he capitalised on recent claims by Chancellor George Osbourne that there was ‘no plan B’ for the economic recovery. Balls echoed Labour’s 2010 manifesto pledge of ‘securing the recovery by supporting the economy’, and claimed the Chancellor was ‘in denial’ of what Balls believed to be a new global Keynesian consensus. Balls endorsed his U.S. counterpart’s description of this consensus, “education, innovation and investment”, and assertion that deficit-cutting measures were not the “responsible way” to address the recovery. An example of political strategy came in mid-February when the Shadow Chancellor levelled criticism at Mervyn King, the Governor of the Bank of England, with accusations compromising the Bank’s independence - a piece of policy for which Balls was the architect. This was in response to the Governor’s endorsement of the Coalition’s ‘fiscal consolidation’ as the ‘only plan A’. Balls, in an interview with the Financial Times, suggested King was wrong to step into the political arena and tie his reputation to deficit-reducing measures that he labelled “extreme”. A continuation of Labour’s Brownite economic agenda was at the centre of Ed Balls’ 25th February interview with Progress Magazine. In direct contradiction
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with party policy, the Shadow Chancellor, once described by Tony Blair as not being able to understand aspiration, proposed lowering the 50p tax band to £100,000 and bringing in an annual ‘mansion tax’, comprising a 1% levy on dwellings worth over £2m. What are we to make of these three examples with regards to articulating an alternative vision? Steve Richards, political columnist and author of ‘Whatever it Takes’, Brown’s latest biography, sums up Balls’ actions best. Richards, a recent guest speaker for Nottingham’s Centre for British Politics, told the NER that ‘if anyone can...Balls will draft the substantive Labour alternative vision of economic recovery’. Indeed Balls has been as strategic and vocal as his leader has hoped. His first month of tenure has attested to his role as an economic policy attack dog, crucially living up to a PoliticsHome survey which found 47% of respondents in agreement that he is the most formidable opponent of the coalition. Even in his widely derided comments about the Bank of England he drew praise from Nobel Prize-winning economist, Paul Krugman. Presentation, presentation, presentation After making the case that Balls’ appointment and actions will signal a drift to a more vocal and Brownite economic agenda, we must ask what the wider implications for the Labour Party are. The first, proposed by George
Parker, a columnist for the Financial Times, is that Balls’ bifurcating rhetoric of Labour Keynesianism and Coalition radicalism has staked out the terms for a ‘battle to the death’. The implications are stark. If Balls’ side of the rhetoric loses - if he is wrong that the coalition’s economic policy is strangling the economy, in the public’s eye at least - he could put his party out of power for a decade. Equivalently, if George Osbourne presides over a doubledip recession, his political career will be in tatters. The second implication, from the aforementioned Financial Times and Progress Magazine interview, is that Balls’ tenure will continue to highlight the personal divide between the ‘two Eds’, which could also be tempting electoral fate. It is largely true that Ed Miliband’s choice of Balls as Shadow Chancellor has nearly everything to do with a positive assessment of his potential contribution to Labour’s renewal. A key example of the personal discord is when Balls was quoted in the Financial Times boasting about his party’s wealth of experience, whilst his leader is attempting to rebrand Labour as the bringer of new politics and burier of the recent past. The evident split in the leadership touches on the paradox at the centre of the current Labour leadership: both Ed’s are at the same time politically young but in policy terms, also very old. Both have been within Labour circles for the past two decades; Ed Miliband as a policy advisor under the first ‘new’ Labour
government and Balls presiding over the build-up of economic ‘systemic risk’ at the Treasury. And both were fierce rivals in last year’s Leadership contest. How they reconcile this paradox will define Miliband’s premiership.
A conversation with Kate Barker Interviewed by Serena Qayyum
Conclusion In many ways Ed Balls has been a political asset in his brief stint at the head of the party’s economic policy. He has articulated a more vocal and well-defined alternative vision than his predecessor, self-confessed economic novice Alan Johnson, ever did. However, Miliband must find ways to hone and discipline Balls’ tactics in order to quell claims of a divided leadership. In some ways this now defining element of Miliband’s leadership is similar to Blair’s taming of Brown’s ambition at the start and throughout their frontline political careers. However, unlike Blair and Brown, the two Eds are going through some turmoil that their predecessors did not: their necessary transformations from policy advisors to ‘charismatic’ politicians. Unlike David Cameron, who was given plenty of time by his predecessor to reorientate the party, this has to be effected under fierce public scrutiny during an economic recovery often associated with Labourcaused recession. The resolution of the aforementioned paradox, viewed from the perspective of economic policy, will therefore rely on presentational factors and organisational discipline - the taming of Balls - rather than policy nous. How very ‘new’ Labour!
Kate Barker was the longest-serving member of the Bank of England’s Monetary Policy Committee (MPC), the body responsible for setting interest rates to meet the government’s inflation target. She was also formerly Chief European Economist at Ford Europe and Chief Economic Adviser at the CBI. She is currently senior advisor to Credit Suisse.
What are your comments on yesterday’s budget? Does the supposedly pro-growth budget actually set out strong enough measures to boost growth?
We caught up with her after her Leverhulme Globalisation Lecture in March, to discuss the recent budget, and her views on the approach of the current Monetary Policy Committee.
Looking at recent growth and borrowing figures, there are causes for concern. The Office of Budget Responsibility has revised growth predictions downwards and the UK will have to borrow £43bn more between 2011 and 2015. Is the plan to cut the deficit on track?
That depends on the kind of growth being talked about. There are strong concerns prevailing about low demand and rising unemployment. The budget in many ways does not address this issue, but there are good measures aimed at improving productivity. I welcome the lower corporation tax rate and changes to the planning system. The government is perhaps, however, tightening too fast.
Yes, the plan to cut the deficit has come out rather well. Measures that are painful in the short run but assist long term recovery naturally create tension. There is also the question of whether the economy is robust enough to take these short term effects. The government’s basic strategy is on track.
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The budget announced financial help to first time buyers. Is pumping money into the demand side of the housing market a sensible way to support it? It’s certainly not the worst way to help it. It only provides a discount on new build, hence it could really encourage the house-building industry, which is at its lowest since 1924. The house-building industry also does not tend to import much, so its recovery could help domestic recovery. In another sense, it is again a short term measure and could push prices up in the longer term. What do you think of the proposed changes in planning reform? The budget does actually go a long way in terms of planning reform, for example with the decision to allow office space to be turned into houses. However these reforms are battling against a background where ministers have set a localism agenda. This could create confusion as current reforms will start off battling against previous reform. You focused in your talk earlier on the global savings glut of the last decade and how the resulting search for yield impacted the behaviour of financial institutions. Did the Monetary Policy Committee’s remit of using monetary policy to manage short term fluctuations of inflation around the target allow underlying risks to build up in the economy? Within the framework we were
given, we were not asked to control credit in the economy. We did allow the household sector to take on too much borrowing. However, we genuinely thought that because inflation had become so much more manageable in the last decade and because interest rates were structurally lower, that the household sector could cope with more debt. Debt is said to be a malign thing, but it does serve the very useful function of allowing people to spread their consumption over their lifetimes. We did not fully appreciate the tail risks being taken on by financial institutions, and they did not appreciate it themselves. The government had also taken on a large deficit, so fiscal policy could not provide a cushion when the crisis struck. In your nine years on the MPC, has there been a change in the Bank of England’s approach to monetary policy? Yes. For most of those nine years there was a precise focus on getting inflation to target, whereas during the crisis we really had to think big. Previously we worked with central forecasts in setting interest rates, whereas the MPC’s task is now to manage inflation between a much larger spectrum of risks. Attention to tail risk, or low probability-high impact risk, is much more a part of the discussion now. UK inflation has risen to 4.4%, but with the economy continuing to be weak, the majority of the MPC have voted to keep rates low. Do you agree with the decision and do you expect high
inflation to tail off in the medium term? I do expect it to tail off, but probably not as much as the committee expects it to tail off. There is a worry that when oil prices finally fall back, we may find latent pressures elsewhere. I have some sympathy for the view that it may be time to move rates up a bit to reassure the markets that the MPC is committed to managing inflation, but it is certainly not the time for big interest rate changes. A rise in the interest rate from 0.5 to 0.75 is trivial. The Bank’s interest rate is more divorced from other rates so the effect on the economy would be even smaller. I don’t quite agree with Mervyn King that it would be a “futile gesture”, but it is the least that could be done. And finally, as a female economist at the top of your profession, have you ever come across a glass ceiling in the industry? No, I would have to say that I have not faced a glass ceiling. Truthfully, I became an economist at exactly the right time; there was a calling for female economists. It has never been an issue.
Competitions We are pleased to announce the winners of our recent competitions. Sean Jones was the winner of the Oliver Pawle Essay Prize in Economics, and will be awarded £1000 upon graduation. Runners up were Lily Steele and Jonathan Stead, and all the winning entries can be read in pages 19-25 of this issue. Once more, our thanks go to Oliver Pawle for his generous support. We also thank Chris Milner, our Head of School, for judging the competition. Cameron Spencer was the winner of our ‘Predict the Market’ competition, whose guess of 5680.35 was closest to the actual FTSE 100 close of 5,598.23 on the 16th March. We also ran a competition for a randomly selected fan of our new Facebook page (facebook.com/ neronline) to win an iPod, which went to Jess O’Malley.
Website Our website is going from strength to strength, and offers all the articles from this and previous issues, alongside exclusive content such as blogs from staff members like Wyn Morgan, and a detailed weekly market wrap-up from the University of Nottingham Investment Society.
Recruitment Sadly, our time with the NER is coming to an end, and we will be recruiting a team for the next academic year soon. If you are interested in having an editorial, marketing or web position, listen out for an email at the beginning of June with information on how to get involved.
Macro The first quarter of 2011 brought mixed macroeconomic news. In the UK it was revealed that GDP for the last quarter of 2010 shrank by a revised 0.6%, increasing fears of a double-dip recession. At the same time inflation spiked to 4% in February on the consumer price index measure. Along with an unemployment rate of 8%, this mix of twice target inflation and sluggish growth has given the Bank of England’s Monetary Policy Committee – the UK’s interest rate setters - a serious and continued dilemma. In March, the base rate remained on hold at 0.5%. In February, growth in European services and manufacturing industries accelerated at the fastest pace in over four years, giving hope of a strong figure for first quarter GDP, whilst in the US, consumer confidence is at a three-year high despite a cut in the estimate of fourth-quarter growth from 3.2% to 2.8% on an annualised basis. Elsewhere, China overtook Japan as the world’s second biggest economy last year. Analysts predict China will replace the US as the world’s leading economy within a decade. Furthermore, economists believe the recent Japanese earthquake and tsunami will have a significant impact on Japan’s economy, with the cost of rebuilding putting further pressure on the country’s record public debt.
Foreign exchange The Eurozone sovereign debt crisis had by no means disappeared at the beginning of January, with Spain and Portugal not seeing any improvements in their fundamentals’. The Euro was still trading at lows against its major trading partners at the end of January. Into February and March, however, the debt crisis had fallen into the background as FX markets were predominantly driven by yield differentials. The pound lost out heavily to the euro despite UK inflation being at 4 percent. The dollar started to lose its status as a ‘safe haven’ currency and investors turned to the Swiss franc instead. The largest gain over the period was for the euro, up around 8.5 percent against the dollar.
Quarterly Market Roundup Equities The FTSE 100 was fluctuating around the 5950 mark until the mid-to-end of January when the Middle East crisis increased in severity, pushing up oil prices. It then started to rise again once Hosni Mubarak stepped down, until the second major phase of the North African revolutions, when the Libyan conflict cum civil war commenced. Towards the end of the quarter it started to fall drastically in response to the Japanese earthquake crisis. European stocks started to rise from January due to improvement in the sovereign debt situation. However, concerns still exist over Portugal’s increasing debt. They too fell towards the end of the quarter as fears over Japan’s situation spread to Europe. In Emerging Market equities, a combination of factors has left the MSCI Emerging Markets Index down from 1165 to 1093, or 6.2%, so far this year. Instability in the Middle East led to increasing oil prices upon concerns surrounding the lack of supply from Libya and potential conflict in Saudi Arabia, the largest oil producer in the world. Coupled with the recent earthquake in Japan, and high inflation in China, confidence has been lost in equities in emerging markets, which are particularly vulnerable to these external shocks.
Commodities The commodity price boom has continued through the first quarter of 2011, and is likely to continue for the rest of the year. The concern on inflationary pressure and rising commodity prices have driven investors to hedge against further price appreciation by buying gold as a means of wealth preservation. So far, the prices of precious metals and soft commodities have reached record highs. The continued unrest in the Middle East could lead to further commodity price spikes, especially crude oil, which has risen over 27% in just a few weeks. The devastating Japanese earthquake and tsunami, together with extreme weather conditions around the world may also exert further price pressures on these commodities.
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