Published: March 17, 2013
NICOSIA, Cyprus — Europe’s surprising decision early Saturday to force bank depositors in Cyprus to share in the cost of the latest euro zone bailout set off increasing outrage and turmoil in Cyprus on Sunday and fueled fears that the trouble will spread to countries like Spain and Italy.
President Nicos Anastasiades of Cyprus warned that rejection of bailout terms would bring a “collapse of the banking sector.”
Facing eroding support, the new president, Nicos Anastasiades, asked Parliament to postpone until Monday an emergency vote on a measure to approve the bailout terms, amid doubt that it would pass. The euro fell sharply against major currencies ahead of the action, as investors around the world absorbed the implications of Europe’s move.
In an address to the nation, Mr. Anastasiades painted an apocalyptic picture of what would happen if Cyprus did not approve the strict terms: a “complete collapse of the banking sector”; major losses for depositors and businesses; and a possible exit of Cyprus from the euro zone, the 17 countries that use the euro as their currency.
He said he was working to persuade European Union leaders to modify their demands for a 6.75 percent tax on deposits of up to 100,000 euros, a move that would hit ordinary savers.
“I understand fully the shock of this painful decision,” he said, speaking with a grim look on his face as he stood between the Cypriot and European Union flags in the presidential palace. “That is why I continue to fight so that the decisions of the Eurogroup will be modified in the coming hours.” The Eurogroup is made up of the 17 euro zone finance ministers.
By size, Cyprus’s economy represents not even half a percent of the combined output of the 17 euro zone countries. Yet the impact of this weekend’s decision by European leaders to impose across-the-board losses on bank depositors — from the richest Russian oligarchs, who have increasingly deposited their money in Cyprus’s banks, to the poorest Cypriot pensioners — in return for 10 billion euros, or $13 billion, in bailout money could not be more far-reaching.
After five years of bailouts financed largely by European taxpayers, wealthy European nations have decreed that when a bank or country goes broke, bond investors and perhaps even bank depositors will pay a significant portion of the bill.
The change is driven in no small part by the growing reluctance by residents of nations like Germany — whose chancellor, Angela Merkel, faces an election this year — to continue to finance bailouts of troubled neighbors like Greece, Portugal, Italy, Spain, and now Cyprus. The resulting turmoil could create a wave of investor contagion that will challenge Mario Draghi, the president of the European Central Bank, to make good on his promise to do whatever it takes to protect the euro.
On Sunday, it was clear that a majority of Cyprus’s 56 lawmakers would not approve the terms of the bailout, which would lead to a likely loss of the rescue money that Cyprus so desperately needs.
The government extended a bank holiday it had imposed over the weekend, meaning banks will not open Tuesday as planned. There was talk that they might not open Wednesday, either.
In response, the European Central Bank applied more pressure to have the deal approved, sending two representatives to Cyprus on Saturday night to assure Cypriot banks that the central bank was “here for them — as long as the bill goes through Sunday or Monday morning before financial markets in Europe open,” said Aliki Stylianou, a press officer for the central bank of Cyprus.
Mr. Anastasiades’s cabinet gathered early Sunday with the heads of the central bank and the finance ministry to discuss how to carry out the levy, should it pass.
But some analysts expressed skepticism about the measure’s long-term effects even if Cyprus approves it.
“Whether the Parliament approves the measure or not, the effect will be the same,” said Stelios Platis, the managing director of MAP S.Platis, a financial services firm, and a former economic adviser to Mr. Anastasiades. “As soon as banks in Cyprus reopen, people will rush to take all their money out” because they do not believe it will not happen again.
To some degree, this policy shift was foreshadowed last month when Jeroen Dijsselbloem, the finance minister for the Netherlands who was recently tapped to lead the Eurogroup, forced investors of a failing Dutch bank to pay their share by writing down 1.8 billion euros’ worth of high-risk bonds to zero.
But it is one thing to wipe out bond investors and quite another to force a loss on bank depositors, including Cypriot savers who had their deposits insured and, like people all over the world, had the impression that a government-backed savings account was inviolable.
This is the first time depositors have taken a loss in a euro-zone rescue, said Adam Lerrick, a sovereign debt expert at the American Enterprise Institute, who has long argued that debt-heavy countries in Europe must make private investors, including bank depositors if need be, share the cost of bank bailouts. “It prevented the insolvency from being transferred from the banking system to the government,” he said.
While such a notion may please the financial hard-liners, it carries significant financial risks.
Indeed, as many stunned Cypriots rushed to A.T.M.’s to remove their savings, Europe had to confront the prospect that savers in Spain and particularly in Italy — where cash-poor banks have been hit hard by loan losses — would do the same.
Public officials in Spain and Italy did their best over the weekend to say that the situation in Cyprus was unique and that deposits in those countries — especially Spain, which experienced a period of deposit flight last year — remained safe.
Also Sunday, George Osborne, the British chancellor of the Exchequer, said that Britain would compensate British government and military personnel based in Cyprus whose finances would be affected by the levy. About 3,500 British troops are based on the island.
The tax on deposits is sure to make small banks with bad loan problems in other countries seem all the more risky — to depositors as well as to investors holding the banks’ bonds.
Economists warn that the psychological consequence of such a shock could lead not only to a bank run but a devastating economic collapse and plunge in gross domestic product similar to what happened in Greece.
“There has been a huge shock, and fall in G.D.P. will be very large just as it was in Greece,” said Alexandros Apostolides, an economist based in Nicosia. “Why would someone keep their deposits in a bank here if he cannot be assured that there will not be another bailout?”
Indeed, throughout the weekend many Cypriots were withdrawing as much as they could from their bank accounts.
“Why should I leave my money in Cyprus?” said an investment banker who for the past two days had been withdrawing the maximum 2,000 euros he was allowed from his foreign bank account in Nicosia. “I have already instructed my bank to send my entire savings to London when the banks open on Tuesday. A precedent has been set — what is to stop them from doing this again?”
The contentious talks over how to rescue Cyprus have continued for more than six months and only accelerated in the wake of an election last month that brought into power a new government that promised to impose the austerity measures required by Europe.
But when it came to losses for depositors, the government had assured the public as late as this past Friday that this was a red line that would not be crossed.
In the capital, Nicosia, the long lines at cash machines Saturday disappeared temporarily — mainly because A.T.M.’s had been drained of cash. But on Sunday, at a main branch of Laiki Bank — one of Cyprus’s two major financial institutions — employees were seen inside the darkened building hovering over computers and filling machines with bills.
As word got out, groups of people arrived in a steady stream to withdraw money, but not before expressing anxiety over what they said were decrees from Brussels and Berlin that would have implications far beyond Cyprus’s shores.
The general feeling was that European leaders were using Cyprus to test whether confiscating deposits would work, before possibly applying it more widely.
“They are trying to make an experiment with a small country,” said Stefan Kourbelis, a manager at the Centrum Hotel in Nicosia’s main square, echoing a widely held view. “If it works, the next one could be Spain, Italy and others. If things go badly, they can just say, who cares about Cyprus?”
Liz Alderman reported from Nicosia, Cyprus, and Landon Thomas Jr. from London.
Lawrence Summers, a professor and past president at Harvard University, was Treasury secretary in the Clinton administration and economic adviser to President Obama from 2009 through 2010.
Europe’s economic situation is viewed with far less concern than was the case six, 12 or 18 months ago. Policymakers in Europe far prefer engaging the United States on a possible trade and investment agreement to more discussion on financial stability and growth. However, misplaced confidence can be dangerous if it reduces pressure for necessary policy adjustments.
There is a striking difference between financial crises in memory and as they actually play out. In memory, they are a concatenation of disasters. As they play out, the norm is moments of panic separated by lengthy stretches of apparent calm. It was eight months from the Korean crisis to the Russian default in 1998; six months from Bear Stearns’s demise to Lehman Brothers’ fall in 2008.
Is Europe out of the woods? Certainly a number of key credit spreads, particularly in Spain and Italy, have narrowed substantially. But the interpretation of improved market conditions is far from clear. Restrictions limit pessimistic investors’ ability to short European debt. Regulations enable local banks to treat government debt as risk-free, and they can fund it at the European Central Bank (ECB) on better-than-market terms. The suspicion exists that, if necessary, the ECB would come in strongly and bail out bondholders. Remissions sometimes are followed by cures and sometimes by relapses.
A worrisome recent indicator in much of Europe is the substantial tendency of stock and bond prices to move together. When sentiment improves in healthy countries, stock prices rise and bond prices fall as risk premiums decline and interest rates rise. In unhealthy economies, however, as in much of Europe today, bonds are seen as risk assets, so they are moving, like stocks, in response to changes in sentiment.
Perhaps it should not be surprising that Europe still looks to be in serious trouble. Growth has been dismal; the euro-zone gross domestic product has been below its 2007 level for six years, and little growth is forecast this year. For every Ireland, where there is a sense that a corner is being turned, there is a France, where questions increasingly arise about the political and economic sustainability of policy.
The controversy surrounding the decision by the European authorities to bail out Cypriot bank depositors suggests the degree of fragility in Europe. The idea that converting a small portion of deposits into equity claims in an economy with a population of barely more than 1 million could be a source of systemic risk suggests the hair-trigger character of the current situation.
Everything is compounded by political uncertainty. Italy’s last election was inconclusive even by Italian standards. Scandals and staggeringly high unemployment are taking their toll in Spain. France is much calmer about its situation than are many outside observers. And Germany’s primary concern is avoiding turmoil ahead of its fall elections. Given a choice, all would almost certainly prefer some kind of macroeconomic unorthodoxy to the breakdown of their monetary union. But there is a serious risk that as nations pursue their parochial concerns, the political and economic situation will deteriorate beyond repair.
Continued structural reform in the most troubled economies is essential, and the work of building a more satisfactory institutional foundation for the euro must go on. Critical to success will be (the belated) recognition of the paradox that in economic policy, as in so much of life, what is good for one is not good for all.
German policymakers constantly note that fiscal consolidation and structural reform were key to Germany’s rise from “sick man of Europe” to today’s position of strength. But Germany’s export growth and huge trade surplus were enabled by borrowing on the European periphery. If Europe’s debtor countries are to follow Germany’s historic adjustment path without economic implosion, there must be a strategy that assures increased external demand for what they produce. Simply put, there cannot be exports without imports. This could come from a German economy prepared to reduce its formidable trade surplus, from easier European monetary policies that spur growth and competitiveness, or from increased deployment of central funds such as those of the European Investment Bank or perhaps other sources. The crucial point is that no strategy for debt repayment can succeed without providing for an increase in the demand for the exports of debtor countries.
Invocation of necessity is not a strategy. As any student of Germany’s experience of the 1920s knows, it is far from a viable strategy to require a nation to service large debts by being austere when there is no growth in demand for its exports.
European policymakers, the International Monetary Fund and others with a stake in Europe’s outcome need to recognize that the history of financial crisis is a history of windows of opportunity missed. New business is always more exciting than unfinished business. And where matters are controversial, forced moves are easier for policymakers because they can be portrayed as moves of necessity rather than choice. So outsiders avoid confrontation and insiders embrace drift. The consequences could be grave.
One fateful question for 2013 is this: What happens to globalization? For decades, growing volumes of cross-border trade and money flows have fueled strong economic growth. But something remarkable is happening; trade and international money flows are slowing and, in some cases, declining. David Smick, the perceptive editor of the International Economy magazine, calls the retreat “deglobalization.” What’s unclear is whether this heralds prolonged economic stagnation and rising nationalism or, optimistically, makes the world economy more stable and politically acceptable.
To Americans, some aspects of deglobalization will seem delicious. Take manufacturing. Globalization has sucked factory jobs from the United States. Now, the tide may be turning. Just recently, Apple announced a $100 million investment to return some Mac computer production home. Though tiny, the decision reflects a trend.
General Electric’s sprawling Appliance Park in Louisville once symbolized the United States’ post-World War II manufacturing prowess, with employment peaking at 23,000 in 1973. Since then, jobs have shifted abroad or succumbed to automation. But now GE is returning production of water heaters, refrigerators and other appliances to Appliance Park from China and Mexico. Year-end employment is reckoned at 3,600, up 90 percent from a year earlier, writes Charles Fishman in an excellent article in December’s Atlantic.
Nor is GE alone, Fishman notes. Otis is moving some elevator production from Mexico to South Carolina. Wham-O is shifting Frisbee molding from China to California.
The changes are harbingers, contends the Boston Consulting Group (BCG), which predicts a manufacturing revival. China’s labor cost advantage has eroded, it argues. In 2000, Chinese factory wages averaged 52 cents an hour, but annual double-digit percentage increases will bring that to $6 an hour in high-skilled industries by 2015. Although wages of U.S. production workers average $19 an hour, BCG argues that other non-wage factors favor the United States. American workers are more productive; automation has reduced labor’s share of expenses; and cheap natural gas further reduces costs. Finally, higher oil prices have boosted freight rates for imports.
By 2015, China’s overall cost advantage will shrivel to 7 percent, BCG forecasts. As important, it says, the United States will maintain significant cost advantages over other developed-country manufacturers: 15 percent over France and Germany; 21 percent over Japan; and 8 percent over Great Britain. The United States will be a more attractive production platform. Imports will weaken; exports will strengthen. BCG predicts between 2.5 million and 5 million new factory jobs by 2020. (For perspective: 5.7 million manufacturing jobs disappeared from 2000 to 2010.)
Because the United States is the world’s largest importer, this shift would dampen trade. Similarly, cross-border money flows (“capital flows”) have abated. Banks, especially in Europe, have reduced foreign loans to “deleverage” and strengthen their balance sheets. From 2011 to 2012, bank loans to 30 “emerging market” countries fell by one-third, says the Institute of International Finance (IIF), an industry group. “It’s the most decisive case of ‘home bias’ [in lending] being re-established,” says economist Philip Suttle of the IIF. Government regulators encourage the shift, he says, suggesting that “if you’re going to cut lending, cut there and not here.”
Of course, globalization won’t vanish. It’s too big and too entwined with national economies. In 2011, total world exports amounted to nearly $18 trillion. The same is true of capital flows. Despite banks’ pullbacks, those same 30 emerging-market countries in 2012 received an estimated $1 trillion worth of investment from multinational companies, private investors, pensions, insurance companies and other lenders — a still-huge total, though down from its peak. But globalization’s character may change.
For years, the world economy has been wildly lopsided: China and some other countries ran big trade surpluses; the United States was perennially in massive deficit. Similar imbalances existed in Europe. Now, slumps have dampened the American and European appetite for imports. The upshot is that “China and others are recalibrating their export-led economic strategies” to focus more on domestic demand, argues economist Fred Bergsten of the Peterson Institute. That’s good, he says; the world economy will be more balanced. Likewise, erratic capital flows have triggered past financial crises. Slower flows may promote stability.
Not everyone is so optimistic. Smick of the International Economy sees globalization as “the proverbial goose that laid the golden eggs.” The search for larger markets and lower costs drove investment, trade, economic growth and job creation around the world. That’s weakened, and there’s “no new model to replace it.” Domestic demand will prove an inadequate substitute. Central banks (the Federal Reserve, the European Central Bank, the Bank of Japan) have tried to fill the void with hyper-easy money policies. Smick fears damaging outcomes: currency wars as countries strive to capture greater shares of stagnant export markets and burst “asset bubbles” caused by easy money.
These visions clash. In 2013, we may learn which is right.
David M. Smick, a global macroeconomic adviser, is founder and editor of the International Economy magazine and author of “The World Is Curved: Hidden Dangers to the Global Economy.”
Here’s a prediction: The political party that controls the White House after January could, four years later, be out of power for a generation. The economic challenges are that daunting.
I’m not talking just about the fiscal cliff or America’s “budgetary crystal meth” habit, as financier Bill Gross recently described Washington’s inability to contain today’s exploding debt.
The risk stems from something more fundamental: The globalization model of the past 30 years is cracking up. And there appears to be no new model to replace it.
Since April, an ugly economic world has turned uglier. The annual growth rate of total global exports has collapsed. Exports were a crucial engine in powering the U.S. economy out of the worst of the recession in the second half of 2009 and remain important for growth.
Lately, even China and India, which were thought able to decouple from the weakness of the industrialized world, have fallen victim to the seizing up of global trade. The World Trade Organization is slashing its estimates for trade growth. The U.N. Conference on Trade and Development reports that economic growth is weakening worldwide.
Meanwhile, the Doha Trade Round is on life support. The world is at the edge of a currency war with at least 12 countries beyond China manipulating their currencies against the dollar for trade advantage. China is experiencing trade deficits and has slapped tariffs on American-made automobiles in response to U.S. duties on Chinese tires. Leto Research analyst Criton Zoakos argues that rapid Chinese wage inflation and new software-based cost-cutting manufacturing technologies in the United States are helping make the globalization model “obsolete.”
Financial liberalization, including the free flow of capital, is also under worldwide assault. Banks are rapidly becoming more nationalistic. This trend is heightened by regulatory barriers implemented in the wake of the global financial crisis and the subsequent euro-zone crisis. It is now more difficult for investment capital to move across borders.
The euro zone is at the heart of this deglobalization trend. European banks have traditionally been the source of roughly 80 percent of trade financing in emerging markets. Now these severely undercapitalized banks are forced to bring that capital home, and it is not clear that U.S., Japanese or Chinese banks are in a position to fill the gap. Capital scarcity combined with the need for banks to retain more capital are inhibiting global trade financing and ratcheting the deglobalization trend into higher gear. The U.S. economy can limp along under these conditions, but achieving the level of robust growth needed for full employment will be difficult. The rise of geopolitical tensions from globalization’s collapse will increase U.S. investor nervousness, contributing to a debilitating risk-averse environment.
It is difficult to underestimate the degree to which this flawed, sometimes frightening, good we call globalization has been the proverbial goose that laid the golden eggs. As a result, the public has unrealistic expectations about how much the economy can deliver in a post-globalization world.
To be sure, globalization’s benefits have been unequally distributed. Financial liberalization has also led to a frightening rollercoaster ride of financial terror and heartache.
Yet at the same time the globalization period that began in the late 1970s, slowly progressed in the 1980s and soared to extraordinary heights after the 1989 fall of the Berlin Wall led to a doubling of the global free-market labor force — from 2.7 billion to 6 billion. In the United States alone, globalization led to 40 million new jobs under both Republican and Democratic presidents. Gary Hufbauer of the Peterson Institute has pointed out that America has been “$1 trillion richer each year because of globalized trade.”
During this period, the Dow Jones Industrial Average climbed from roughly 800 in 1979 to over 13,000 by the end of 2007, as the brunt of the financial crisis was hitting. To match that stock market success in percentage terms over the next three decades, the Dow would have to far exceed 175,000.
In 2003, the peak of the era of financial globalization, financial services accounted for an absurdly high percentage of the U.S. stock market’s earnings — 30 percent — and 40 percent of corporate U.S. profits. Our regulatory guardians of systemic risk were asleep and the bubble burst. Yet now we have the opposite scenario. Our banks are broke, overregulated, risk-averse and unwilling to fuel much of an economic expansion.
No one can yet say what will replace this void in U.S. gross domestic product left by the shrinking of financial services. Many think the United States, with its ample natural gas supplies and new fracking energy retrieval techniques, can become an energy exporter. Yet reaching consensus on energy policy won’t be easy. Energy is a political battleground where the promise of energy independence has been elusive for decades.
So despite its flaws, globalization has been a wealth-creating machine. That is why the world’s governments spent $15 trillion and central banks increased their balance sheets by $5 trillion in response to the financial crisis, essentially to try to save that machine.
Yet the globalization model is cracking up anyway — and there’s no replacement in sight. Instead of addressing this dangerous tectonic shift in world economic affairs, our candidates in the debates have offered generalizations about “more government investment” and “tax reform.” There’s a reason for this fascination with the diversion of simple bromides. While jabbering away, each can avoid thinking about a terrifying possibility: that he might win in November.
IT IS not a fudge, but it is still a failure. The euro zone’s bail-out of Cyprus, which was sealed in the early hours of Saturday, did get the bill for creditor countries down from €17 billion to €10 billion, as had been rumoured. But the way it did so was somewhat unexpected.
Almost €6 billion of the savings for taxpayers in euro-zone countries came from losses imposed on depositors in Cyprus’s outsize banks. A one-off 9.9% levy will be imposed on all deposits over the insurance threshold of €100,000 before banks reopen after a bank holiday on Monday. That idea had been in the air for a while, not least because a lot of those uninsured deposits came from outside Cyprus, and from Russia in particular. The politics of saving wealthy Russians with money loaned by thrifty Germans were always going to be tricky.
What had not been anticipated was a 6.75% loss for savers with deposits in Cypriot banks below the insurance ceiling. Cypriots woke up this morning to find bank branches closed to them. By the time they will be able to get at their money, it will be too late. The offer of equity in banks to replace the value of their savings is meant to be a balm but it’s not a choice they would have made. Why this decision was taken is not yet clear. The most plausible explanation is that the Cypriot government itself preferred to spread the pain rather than wipe out non-resident depositors and jeopardise its long-term prospects as an offshore financial centre for Russian and other money.
Whatever the rationale, it is a mistake for three reasons. The first error is to reawaken contagion risk elsewhere in the euro zone. Depositors have come through the financial crisis largely unscathed. Now they have been bailed in, some of them in breach of an explicit promise that they can be sure of getting their money back even if a bank goes belly-up.
Euro-zone leaders will spin the deal as reflecting the unique circumstances surrounding Cyprus, just as they did the Greek debt restructuring last year. But if you were a depositor in a peripheral country that looked like it needed more money from the euro zone, what would your calculation be? That you would never be treated like the people in Cyprus, or that a precedent had been set which reflected the consistent demands of creditor countries for burden-sharing? The chances of big, destabilising movements of money (into cash, if not into other banks) have just shot up.
The second error is one of equity. There is an argument to be made over the principles of bailing in uninsured depositors. And there is a case for hitting everyone in Cypriot banks before any taxpayer in another country. But there is no moral imperative for whacking Cypriot widows and leaving senior bank bondholders untouched, as appears to be the case here; or not imposing any losses on sovereign-debt investors in Cyprus; or protecting depositors in the Greek operations of Cypriot banks, as has also happened. The euro zone may cloak this bail-out in the language of fairness but it is a highly selective treatment. Indeed, the euro zone’s insistence that this is a one-off makes that perfectly plain: with enough foreigners at risk and a small enough country to push around, you get an outcome like Cyprus. (That is one reason why people are now wondering about the implications of this deal for little Latvia, also home to lots of Russian money and itself due to join the euro zone in 2014.)
The final error is strategic. The Cypriot deal has no coherence in the larger context. The euro crisis has been in abeyance for a few months, thanks largely to the readiness of the European Central Bank to intervene to help struggling countries. The ECB’s price for helping countries is to insist they go into a bail-out programme. The political price of going into a programme has just gone up, so the ECB’s safety net looks a little thinner.
The bail-out appears to move Europe further away from the institutional reforms that are needed to resolve the crisis once and for all. Rather than using the European Stability Mechanism to recapitalise banks, and thereby weaken the link between banks and their governments, the euro zone continues to equate bank bail-outs with sovereign bail-outs. As for debt mutualisation, after imposing losses on local depositors, the price of support from the rest of Europe is arguably costlier now than it ever has been.
It is also hard to square this outcome with the ongoing overhaul of finance. The direction of efforts to improve banks’ liquidity position is to encourage them to hold more deposits; the aim of bail-in legislation planned to come into force by 2018 is to make senior debt absorb losses in the event of a bank failure. The logic behind both of these reform initiatives is that bank deposits have two, contradictory properties. They are both sticky, because they are insured; and they are flighty, because they can be pulled instantly. So deposits are a good source of funding provided they never run. The Cyprus bail-out makes this confidence trick harder to pull off.
Why some think China is approaching a political tipping point
Mar 16th 2013 |From the print edition
FOR some of China’s more than 500m internet users the big news story of the week has not been the long-scheduled one that their country has a new president, Xi Jinping, who already has more important jobs running the Communist Party and chairing its military commission. Rather it was the unscheduled, unwelcome and unexplained arrival down a river into Shanghai of the putrescent carcasses of thousands of dead pigs, apparently dumped there by farmers upstream. The latest in an endless series of public-health, pollution and corruption scandals, it is hard to think of a more potent (and disgusting) symbol of the view, common among internet users, that, for all its astonishing economic advance, there is something rotten in the state of China, and that change will have to come.
Many think it will. According to Andrew Nathan, an American scholar, “the consensus is stronger than at any time since the 1989 Tiananmen crisis that the resilience of the authoritarian regime in…China is approaching its limits.” Mr Nathan, who a decade ago coined the term “authoritarian resilience” to describe the Chinese Communist Party’s ability to adapt and survive, was contributing, in the Journal of Democracy, an American academic quarterly, to a collection of essays with the titillating title: “China at the tipping point?”
Ever since the death of Mao Zedong in 1976, foreigners have been predicting the demise of one-party rule. Surely a political system designed for a centrally planned economy with virtually no private sector cannot indefinitely survive more or less intact in the vibrant, open new China. In 1989 China went to the brink of revolution. When reform came to the Soviet Union and its satellites, for a while China seemed like the next domino, waiting to topple. But the party proved far more durable—and popular—than seemed possible in 1989. And as China’s economy soared and the Western democracies floundered, authoritarianism proved more resilient than ever. With China booming, few tried to emulate the Arab spring of 2011. They were easily dealt with by the pervasive “stability-maintenance” machinery.
No single change explains why China might be nearer to a tipping point now. But the evolution of Chinese society is eroding some of the bases of party rule. Fear may be diminishing. Nearly 500m Chinese are under 25 and have no direct memory of the bloody suppression of the Tiananmen protests: the government has done its best to keep them in the dark about it. A few public dissidents still write open letters and court harassment and jail sentences. But millions join in subversive chatter online, mocking the party when not ignoring it.
“Mass incidents”—protests and demonstrations—proliferate. Farmers resent land-grabs by greedy local officials. The second generation of workers staffing the world’s workshop in eastern China are more ambitious and less docile than their parents. And the urban middle class is growing fast. Elsewhere, the emergence of this group has brought down authoritarian regimes, through people-power (in South Korea, for example) or negotiation (Taiwan). And much of China’s middle-class seems discontented, furious at the corruption and inequality the party has allowed to flourish, and fed up with poison in their food, asphyxiating filth in their air and dead pigs in their water-supply.
The internet and mobile telephony provide tools for spreading news and anger nationally. The party has to work hard to make sure that they do not also help unite all these atomised grievances into a concerted movement. It has a lot of hammers and a lot of nails. But it is still hard to pin jelly to the wall.
The other reason for expecting change is that Mr Xi and his colleagues profess to know all this and to be serious about political reform. It has been a recurrent theme at the annual session of the National People’s Congress (NPC), China’s Potemkin parliament, under way this week. What looks like a serious purge on conspicuous consumption by freeloading officials suggests the party begins to get it. The “streamlining” of government by merging ministries shows a new willingness to take on powerful vested interests. Mr Xi has urged the party to be brave in tackling reform: “like gnawing at a hard bone and wading through a dangerous shoal” (chewing gum while walking is for wimps).
Reform, however, does not mean tampering with one-party rule. Rather, as Fu Ying, spokeswoman for the NPC, put it: political reform is “the self-improvement and development of the socialist system with Chinese characteristics”. Put another way, it is about strengthening party rule, not diluting it. Mr Xi seems to agree. A New York-based website, Beijing Spring, has published extracts of a speech he made on a tour of southern China late last year. He affirmed his belief in “the realisation of Communism”.
Democracy in China
Mr Xi also spelled out the lesson his party should draw from the failure of its Soviet counterpart: “we have to strengthen the grip of the party on the military.” He is right to pinpoint the willingness or not of the army to shoot people as the crucial difference between the Chinese and Soviet experiences. It is hard to think of a sobriquet Mr Xi would find more insulting than “China’s Gorbachev”. From where he sits, the career of Mikhail Gorbachev is an object lesson in failure.
There is a vogue in Chinese intellectual circles for reading Alexis de Tocqueville’s 1856 book on the French Revolution, “The Old Regime and the Revolution”. The argument that most resonates in China is that old regimes fall to revolutions not when they resist change, but when they attempt reform yet dash the raised expectations they have evoked. If de Tocqueville was right, Mr Xi faces an impossible dilemma: to survive, the party needs to reform; but reform itself may be the biggest danger. Perhaps he will see more fundamental political change as the solution. But then pigs will no longer rot in rivers. They will fly.
China has the second-largest economy in the world. It is the world’s second-biggest trader. It has trillions of dollars invested around the world. China matters.
Every day we buy things made in China, though they may be made there by American or Dutch or Korean corporations. China buys a lot of our government’s debt and lately it has been buying small pieces of American companies and land. American companies can win or lose based on their strategies for doing business with China. Chinese students love our schools.
We gain much from the economic relationship. American consumers and companies chose to spend $400 billion in 2011 on goods made in China. China was the third-largest buyer of our exports, a source of strength for our economy. American companies looking for investors and American homeowners looking for buyers benefit from Chinese money coming to the U.S. Chinese tourists are visiting the U.S. in greater numbers.
The relationship also has serious problems. It’s not clear the Chinese government sees trade as a win–win—it seems to want China to always win more. Coming from a country where competition is mostly about politics, Chinese firms don’t always follow the rule of law. The U.S.–China economic relationship has many sides to it, and a few of them are a bit seedy.
Jobs Don’t Depend On China
A lot of talk about the People’s Republic of China (PRC) is a bit removed from the real world. But the big question is very real world: Does trade and investment with the PRC take jobs away from Americans? The answer is no, mostly. The Chinese government and Chinese enterprises do some things that cost American jobs. We need to deal with these things. But the idea that China is stealing millions of our jobs is wrong.
An eye-catching figure is the huge trade deficit we run with China, close to $300 billion last year. Unemployment goes up and down, the value of the currency goes up and down, but the trade deficit just seems to go up. In the past 25 years, the trade deficit has fallen only twice. The two years that it fell were 2001 (slightly) and 2009 (sharply).
Those were recession years, with 2009 being much more painful. The trade deficit is about the strength of our economy; when it’s strong, our trade deficit with the PRC rises. Protectionists call 2009 a great year because the trade deficit plunged—but no one else does.
We should also remember that we don’t track our trade deficit very accurately. For example, the way we count it, an iPad assembled in China and sold in the U.S. makes our trade deficit bigger even if some of the parts for the iPad originally came from the U.S.
Trade Cures Worse Than Disease But suppose you’re worried about the trade deficit. In theory, the government could do a couple of things about it. We could put tariffs on Chinese goods. But tariffs are just a fancy name for sales taxes on things Americans want to buy. Why is raising taxes on Americans a good idea? Or we could allow only a certain amount of Chinese goods into the U.S. But that would be our government telling ordinary Americans that they’re not allowed to buy what they want. That would make us poorer and less free to spend our own money as we see fit.
Worse, very little of what we get from China can be called luxuries. Clothes, furniture, TVs, cell phones—making these more expensive or harder to find will hurt working Americans most.
A more popular idea is to subsidize our exports. Subsidies pick winners and losers, pure and simple. And the money for subsidies doesn’t come from thin air. The government takes that money from other companies and the American people. Why should our government decide that everyone else should pay to make one company’s exports cheaper?
It’s Not About the Money
Many Americans are concerned about the value of China’s currency. They hear arguments that China keeps its currency cheap, so its products are less expensive than they would be, and that this drives everyone else out of business. This is complicated—but a picture is worth a thousand words:
In the 1990s, China made its currency cheaper, which many people argue is bad for us. Yet in the 1990s, our unemployment rate fell. Starting in 2005, the PRC slowly pushed the value of its currency up, making its goods more expensive. Many people say this is good for us. Yet after 2005, American unemployment soared.
The explanation for this is simple: The PRC barely matters to our unemployment rate. In the 1990s, we had a healthy economy. In the 2000s, we didn’t. That’s the result of our choices, our failures, and our successes. Blaming China is like saying it’s the neighbors that make your house clean or dirty.
Where the Problems Are, and Why
Trade is about comparative advantage: people doing what they are best at. If I’m better at fighting fires and you’re better at making cars, I can protect you from fires and you can build cars for me. That way, we’re both better off. If the PRC assembles computers better, we benefit from that because it lets us buy computers at lower prices. China doesn’t hurt the U.S. by trading with us. It hurts the U.S. by undermining our comparative advantage.
The most important way China undermines our comparative advantage is by blocking American exports. The PRC reserves large parts of its market for state-owned enterprises. Beijing demands that its state-owned firms dominate domestic markets in coal, telecom, railways, and so on. These firms can’t go bankrupt. This means that American products can only do so well in the Chinese market, whether they’re better or not.
Competition creates prosperity, because it leads to better products at lower prices. When China competes in the American market, that helps our economy. When China doesn’t allow American companies to compete in China, that hurts everyone except the Chinese state-owned firms that should go out of business.
Another problem is the way China deals with intellectual property. America is the world’s leader in innovation. We have the most ideas, and we try to protect those ideas with patents, trademarks, and copyrights. These ideas are a major part of what makes many of our products appealing here and around the world. The iPad uses many of the same computer chips as a lot of other products; what’s special about it is the way it’s designed and programmed. That’s intellectual property.
The PRC is the world’s biggest thief of that kind of property. Chinese firms and individuals frequently ignore patents and other legal guarantees, or even steal trade secrets outright. By illegally taking our ideas and our technology, China undermines our biggest advantage in trade. When this occurs, trade becomes far less beneficial. This is why so many Americans see trade with China as harming our economy, and it is one of the real issues in U.S.–China trade that our government should be working on.
Chinese Investment Not That Important
Americans are also concerned about Chinese investment in the U.S. The Chinese buy U.S. government bonds, real estate, and American companies. Are the Chinese buying America? Can they use their holdings as leverage? No, they can’t.
The amount of money the Chinese are investing in our companies is tiny compared to the size of our economy. The Heritage Foundation follows this kind of Chinese investment all over the world in the China Global Investment Tracker. At the end of 2011, China had $30 billion invested in the U.S., much less than one percent of the $15 trillion American economy.
The Chinese do buy a lot of U.S. government bonds. The PRC may hold about 10 percent of the U.S. national debt, though their share has been falling. Unfortunately, this is because our debt has grown so much that Chinese purchases can’t keep up. If we don’t like China owning so much of our national debt, the answer is simple: We shouldn’t run such big deficits. Then we wouldn’t need to sell our debt to China or to anyone else.
Some people worry that China can sell off our Treasury bonds and hurt our economy. They can’t. All sellers need buyers. If Beijing sells and there is strong demand, China will simply be replaced by other buyers. If Beijing can’t find a buyer, it will have to cut the price it’s asking for. Then the U.S. government would be able to buy back its own bonds for less money than they are worth. That would cut America’s debt at China’s expense.
So Chinese purchases of federal debt don’t hurt us. Unfortunately, these purchases don’t help us much either. By buying our bonds, the PRC makes it easier for the U.S. to run large budget deficits, which damages the private sector and reduces long-term economic growth. That isn’t China’s fault, it’s ours.
There’s your bottom line. We need to get our own house in order. If we do, we can much more easily cope with the genuine problems that we have with China. If we don’t, we’ll hurt ourselves far more than the Chinese ever could. The American future doesn’t rest with China. It rests where it always has: with us.
NICOSIA—Cyprus baulked again on Monday at putting an EU bailout to a vote in parliament as the crippling terms sparked a public outcry and mounting talk of a rethink by eurozone creditors, even as the uncertainty forced a prolonged closure of the island’s banks.
A Central Bank official confirmed that all bank branches on the island will remain closed until at least Thursday while politicians review with lenders an unprecedented demand for every account holder on the island to pay a tax of at least 6.75 percent on their balances as part of the rescue package.
Banks were closed anyway Monday for a scheduled public holiday but the uncertainty over the fate of the latest eurozone rescue package sparked jitters on world markets and fury from another key Cyprus creditor, Russia.
A final decision has to be taken on the details of the levy on balances before bank branches can reopen, or else there will be a run on accounts as depositors scramble to protect their money.
Eurozone finance ministers, who along with the International Monetary Fund demanded the deeply unpopular levy in marathon negotiations that climaxed early on Saturday, were set for new talks to review the deal, an EU official said.
“We really want to reduce the impact” on smaller savers but the “idea is still to achieve the same objective, (of raising) 5.8 billion euros,” the official said.
Eurozone leaders rejected a Cypriot request for 17 billion euros in rescue financing, insisting such a large debt would be unsustainable for the Mediterranean holiday island of less than one million people.
They offered just 10 billion euros, insisting the balance be made up from within the island, principally through the levy on bank deposits.
Hundreds of protesters gathered outside the parliament building in Nicosia to register their anger at the unprecedented tax, not asked of other eurozone countries that have sought rescue.
“Wake up, they are sucking our blood,” demonstrators called to their fellow Cypriots.
As they delayed the emergency debate, Finance Minister Michalis Sarris and Central Bank governor Panicos Demetriades told MPs they were seeking a fresh formula that would protect people with small bank deposits.
They said they were seeking to exempt those with balances of less than 100,000 euros ($129,000), who under the current plan would have to pay a 6.75 percent levy.
Parliament speaker Yiannakis Omirou said: “There are changes to the proposed government bill to be put forward, so we need more time in parliament and the finance committee to study these new proposals.”
EU officials confirmed that discussions were under way to amend the bailout package.
“If Cyprus’s president wants to change something regarding the levy on bank deposits, that’s in his hands,” European Central Bank board member Joerg Asmussen said. “He must just make sure that the financing is intact.”
Moscow, which has an outstanding 2.5 billion euro loan to Cyprus and billions more in deposits in the island’s banks, reacted angrily to the EU levy.
Estimates vary but the Moody’s rating firm estimates that Russian companies and banks keep up to $31 billion in Cyprus, which accounts for between a third and half of all Cypriot deposits.
“We should say this directly: this simply looks like the confiscation of other people’s money,” Russian news agencies quoted Prime Minister Dmitry Medvedev as saying.
The Cypriot finance minister is to visit Moscow on Wednesday and the government remains hopeful of Russian help.
The uncertainty over the EU bailout terms dealt a serious blow to global confidence by stoking fears that other eurozone countries in difficulty might be called on to take the same course of action.
Europe’s main stock markets lost ground and the euro fell under $1.30. Asian equities also fell heavily as did the price of oil.
US stocks also fell for a second straight day Monday and the Dow Jones Industrial Average finished down 62.05 points (0.43 percent) at 14,452.06.
“If European policymakers were looking for a way to undermine the public trust that underpins the foundation of any banking system, they could not have done a better job,” said CMC Markets analyst Michael Hewson.
After a rush to ATM machines by worried account holders over the weekend, the Association of Cyprus Banks urged customers “to remain calm and to avoid panic.”
The Cyprus stock market said it too would remain closed if the banks did. It said it had unsuccessfully sought exemption from the levy for an investment fund set up in an earlier bank rescue.
Washington called for a “responsible and fair” resolution of the crisis. “It is important that Cyprus and its euro area partners work to resolve the situation in a way that is responsible and fair and ensures financial stability,” the US Treasury said.—Charlie Charalambous
Singapore’s Lessons for an Unequal America
By JOSEPH E. STIGLITZ
The Great Divide is a series about inequality.
Inequality has been rising in most countries around the world, but it has played out in different ways across countries and regions. The United States, it is increasingly recognized, has the sad distinction of being the most unequal advanced country, though the income gap has also widened to a lesser extent, in Britain, Japan, Canada and Germany. Of course, the situation is even worse in Russia, and some developing countries in Latin America and Africa. But this is a club of which we should not be proud to be a member.
Some big countries — Brazil, Indonesia and Argentina — have become more equal in recent years, and other countries, like Spain, were on that trajectory until the economic crisis of 2007-8.
Singapore has had the distinction of having prioritized social and economic equity while achieving very high rates of growth over the past 30 years — an example par excellence that inequality is not just a matter of social justice but of economic performance. Societies with fewer economic disparities perform better — not just for those at the bottom or the middle, but over all.
It’s hard to believe how far this city-state has come in the half-century since it attained independence from Britain, in 1963. (A short-lived merger with Malaysia ended in 1965.) Around the time of independence, a quarter of Singapore’s work force was unemployed or underemployed. Its per-capita income (adjusted for inflation) was less than a tenth of what it is today.
There were many things that Singapore did to become one of Asia’s economic “tigers,” and curbing inequalities was one of them. The government made sure that wages at the bottom were not beaten down to the exploitative levels they could have been.
The government mandated that individuals save into a “provident fund” — 36 percent of the wages of young workers — to be used to pay for adequate health care, housing and retirement benefits. It provided universal education, sent some of its best students abroad, and did what it could to make sure they returned. (Some of my brightest students came from Singapore.)
There are at least four distinctive aspects of the Singaporean model, and they are more applicable to the United States than a skeptical American observer might imagine.
First, individuals were compelled to take responsibility for their own needs. For example, through the savings in their provident fund, around 90 percent of Singaporeans became homeowners, compared to about 65 percent in the United States since the housing bubble burst in 2007.
Second, Singaporean leaders realized they had to break the pernicious, self-sustaining cycle of inequality that has characterized so much of the West. Government programs were universal but progressive: while everyone contributed, those who were well off contributed more to help those at the bottom, to make sure that everyone could live a decent life, as defined by what Singaporean society, at each stage of its development, could afford. Not only did those at the top pay their share of the public investments, they were asked to contribute even more to helping the neediest.
Third, the government intervened in the distribution of pretax income — to help those at the bottom, rather than, as in the United States, those at the top. It weighed in, gently, on the bargaining between workers and firms, tilting the balance toward the group with less economic power — in sharp contrast to the United States, where the rules of the game have shifted power away from labor and toward capital, especially during the past three decades.
Fourth, Singapore realized that the key to future success was heavy investment in education — and more recently, scientific research — and that national advancement would mean that all citizens — not just the children of the rich — would need access to the best education for which they were qualified.
Lee Kuan Yew, Singapore’s first prime minister, who was in power for three decades, and his successors took a broader perspective on what makes for a successful economy than a single-minded focus on gross domestic product, though even by that imperfect measure of success, it did splendidly, growing 5.5 times faster than the United States has since 1980.
More recently, the government has focused intensively on the environment, making sure that this packed city of 5.3 million retains its green spaces, even if that means putting them on the tops of buildings.
In an era when urbanization and modernization have weakened family ties, Singapore has realized the importance of maintaining them, especially across generations, and has instituted housing programs to help its aging population.
Singapore realized that an economy could not succeed if most of its citizens were not participating in its growth or if large segments lacked adequate housing, access to health care and retirement security. By insisting that individuals contribute significantly toward their own social welfare accounts, it avoided charges of being a nanny state. But by recognizing the different capacities of individuals to meet these needs, it created a more cohesive society. By understanding that children cannot choose their parents — and that all children should have the right to develop their innate capacities — it created a more dynamic society.
Singapore’s success is reflected in other indicators, as well. Life expectancy is 82 years, compared with 78 in the United States. Student scores on math, science and reading tests are among the highest in the world — well above the average for the Organization of Economic Cooperation and Development, the world’s club of rich nations, and well ahead of the United States.
The situation is not perfect: In the last decade, growing income inequality has posed a challenge for Singapore, as it has for many countries in the world. But Singaporeans have acknowledged the problem, and there is a lively conversation about the best ways to mitigate adverse global trends.
Some argue that all of this was possible only because Mr. Lee, who left office in 1990, was not firmly committed to democratic processes. It’s true that Singapore, a highly centralized state, has been ruled for decades by Mr. Lee’s People’s Action Party. Critics say it has authoritarian aspects: limitations on civil liberties; harsh criminal penalties; insufficient multiparty competition; and a judiciary that is not fully independent. But it’s also true that Singapore is routinely rated one of the world’s least corrupt and most transparent governments, and that its leaders have taken steps toward expanding democratic participation.
Moreover, there are other countries, committed to open, democratic processes, that have been spectacularly successful in creating economics that are both dynamic and fair — with far less inequality and far greater equality of opportunity than in the United States.
Each of the Nordic countries has taken a slightly different path, but each has impressive achievements of growth with equity. A standard measure of performance is the United Nations Development Program’s inequality-adjusted Human Development Index, which is less a measure of economic output than it is of human well-being. For each country, it looks at citizens’ income, education and health, and makes an adjustment for how access to these are distributed among the population. The Northern European countries (Sweden, Denmark, Finland and Norway) stand towards the top. In comparison — and especially considering its No. 3 ranking in the non-inequality-adjusted index — the United States is further down the list, at No. 16. And when other indicators of well-being are considered in isolation, the situation is even worse: the United States ranks 33rd on the United Nations Development Program’s inequality-adjusted life expectancy index, just behind Chile.
Economic forces are global; the fact that there are such differences in outcomes (both levels of inequality and opportunity) suggests that what matters is how local forces — most notably, politics — shape these global economic forces. Singapore and Scandinavia have shown that they can be shaped in ways to ensure growth with equity.
Democracy, we now recognize, involves more than periodic voting. Societies with a high level of economic inequality inevitably wind up with a high level of political inequality: the elites run the political system for their own interests, pursuing what economists call rent-seeking behavior, rather than the general public interest. The result is a most imperfect democracy. The Nordic democracies, in this sense, have achieved what most Americans aspire toward: a political system where the voice of ordinary citizens is fairly represented, where political traditions reinforce openness and transparency; where money does not dominate political decision-making; where government activities are transparent.
I believe the economic achievements of the Nordic countries are in large measure a result of the strongly democratic nature of these societies. There is a positive nexus not just between growth and equality, but between these two and democracy. (The flip side is that greater inequality not only weakens our economy, it also weakens our democracy.)