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Linda Yueh

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December 4 Q&A on Economic Trends: Property Cycles

It is argued that property cycles in the UK and the US have historically been seen to run in 18-year cycles. But are they now a thing of the past?

Business cycles are not really ‘as usual’ at the present time, due to the unusual systemic financial crisis that the US and UK recently experienced. Instead of a short and sharp recession and recovery, the current business cycle is characterised by weak growth and credit constraints, which will affect the property cycle.

How much do the UK and US cycles affect the property markets in Asia and Africa?

The US cycles affect Asia more than Africa, since the former is closely linked by trade and exchange rates to the US. Asia and Africa are at different stages of economic development: in Asia, the property markets will reflect the fast-growing middle class; and in Africa, they are still industrialising and therefore slightly slower-growing nations.

What factors are significantly altering our understanding and forecasting of property cycles (Brexit, for example)?

The economic factors to watch are investment and consumption. If Brexit or the Trump administration’s policies increase uncertainty, then that could have a dampening effect on investment. Consumption trends are also important as a driver of economic growth, which in turn supports the residential and commercial property markets.

Should investors just not worry about property cycles altogether?

I think investors should pay heed to the business cycle and the impact the overall economic environment has on their specific sector. But, the global economy and a number of major markets are undergoing huge structural changes, so it is a far trickier business to understand economic cycles in the 21st century.

November 23 Time to reconsider the Budget rules and avoid "fiscal illusions"


The most startling part of the UK Budget and the economic forecasts it is premised on is the significant downgrade to growth and people’s incomes. Britons will be no better off in 2022 than they were in 2008; in fact, they’ll be worse off since real (after taking into account inflation) average pay will be £800 lower. The Office for Budget Responsibility (OBR) forecasts that real cumulative per capita GDP growth will be the slowest in the UK among G7 countries. It means that even by 2022, a decade and a half after the banking crash, people will still, on average, be worse off than they were before the crisis. That’s the stark consequence of slow economic growth due to a slump in productivity.

The OBR had been expecting productivity to pick up, but decided to forecast along the lines of what the Bank of England has done, which is to downgrade the potential growth rate of the economy due to slow productivity growth. Output per worker has been flat since the crash and the OBR had expected it to return to the previous growth rate of 2% per annum. As it hasn’t picked up nearly a decade later, the OBR has now downgraded the GDP growth rate of the British economy to around 1.5% (dipping as low at 1.3% for a couple of years before picking up to 1.6%) for the next five years. The UK used to grow at between 2-2.5%. To work out what that means for the size of the economy and national income, a rule of thumb is to divide the number 70 by the growth rate. So, at 2%, the UK economy would double in 35 years. But at closer to 1% would mean that our average income would double in 70 years. That’s why the growth downgrade is so troubling for standards of living.

This worrying downgrade of what the economy is capable of growing at is why the Chancellor decided to “loosen” fiscal policy to try and raise productivity to change this “new normal” growth rate. Of the additional spending of £25 billion announced in the Budget, £10 billion is earmarked for quick expenditure to try and improve these forecasts.

Even though it is a global issue in that productivity growth has slowed across major economies, Britain’s challenge is worsened by a dramatic cut in investment since the crash and having had low rates of investment before. The Chancellor is aiming to raise public investment as a share of GDP to a sustained 2.4%. That’s still lower than most of the G7 who have averaged 3.5% of GDP for two decades. Private investment has also been the lowest in the G7 since 1997, according to the OECD

Therefore, the fiscal stimulus in this Budget is divided between productivity-enhancing investment, including in housing and electric vehicles, and other spending needed to address urgent issues such as the NHS and preparing for Brexit. Focussing on the productivity-related measures, the government is increasing the size of the National Productivity Investment Fund to £31 billion and has extended its life to 2022. About two-thirds is geared at housing and transport infrastructure which leaves about a third on digital infrastructure and R&D. For instance, in 2017-18, the Fund will allocate £25 million to digital communication and £425 million R&D funding out of a total spend of £1.5 billion. There are also other measures such as increasing the R&D tax credit by 1 percentage point to 12% and £406 million allocated to improve STEM education to help produce skilled workers/researchers. Of course, better hard (transport) and digital or soft infrastructure would also raise productivity. But, focussing on the crucial component of R&D, these measures go toward realising the government’s aim to raise the UK’s investment in research & development to 2.4% of GDP in a decade in 2027. That is an improvement, but it would still be lower than other major economies.

Still, the technology-focus in the Budget is a welcome shift. The challenge will be whether these measures are sufficient to turn around a decade-low productivity slump. It takes time for investment to generate returns and for R&D to produce technological innovations that raise the productivity of the economy. It would also be hard to differentiate between whether a lack of productivity improvement is due to the length of time it takes to innovate or upgrade capital or due instead to insufficient investment by the government and private sector. In other words, although the Budget is mildly stimulative, the spending measures are modest because the Chancellor still aims to hit the government’s fiscal target of bringing the structural (non-cyclical) deficit down to 2% of GDP by 2020-21. He is able to do so in this Budget partly because of what the OBR calls “fiscal illusions.” In other words, by selling shares in the largely state-owned bank RBS and re-classifying housing associations as private, the balance sheet looks a bit better. But, the OBR warns it’s illusory and can mask risks in the underlying health of the economy.

Even with these “fiscal illusions,” the OBR judges the government has missed one of its fiscal targets which is to bring the budget into balance by the mid-2020s. Instead, it looks like the Budget won’t be in balance until 2030, which would mean three decades since the UK’s budget had last been balanced.

Given that the deficit target was hit due to the above measures and the fiscal objective of a balanced budget was missed, it’s arguable that the government’s fiscal rules are not as reassuring as intended. In which case, perhaps the government might consider a more straightforward change to its fiscal rules to allow for greater investment to try and turn around the productivity trend. By separating capital from current spending, so investment is not considered similarly to the day-to-day running of government, there would be greater scope to invest. By accounting for these categories separately, it would be transparent to financial markets to consider whether the government is acting prudently since the fiscal rules are intended to reassure investors and creditors of Britain.

That may be something to consider if productivity doesn’t pick up and slow growth worsens the budget deficit. After all, even after considering these new government policies, the OBR has forecasted that by 2022, the end of this Parliament, the productivity trend won’t have significantly improved and thus average incomes for Brits will not have surpassed 2008 levels. By doing more, there might be a greater chance of changing the current path of the British economy.

November 22 UK Budget shifts course



Not by a huge amount, but the 2017 Budget shifts course to promote economic growth. As declared by the British Prime Minister Theresa May and her Chancellor Philip Hammond, this was a “balanced” budget to meet the government’s fiscal target of reducing the structural deficit to 2% of GDP by 2021 while at the same time spending a bit more on productivity-enhancing measures such as supporting technological innovation as well as helping the national health service (NHS), preparing for Brexit ,and increasing house-building. In other words, it was a departure from previous years when the Chancellor would announce “fiscally neutral” Budgets that meant that any additional spending would be funded by a tax rise/spending cut elsewhere so that the UK could reduce its fiscal deficit that was 10% of GDP in 2009-10 to the Maastricht Treaty level of 3%. The European Commission today declared the UK met that target as the deficit was 2.3% this fiscal year, so it comes off of the Excessive Deficits list (two EU nations remain on it).


Irrespective of the EU-wide target, the government has been aiming to hit its own structural (underlying) budget deficit target that is not due to the business cycle. On current projections, it looks like it will do so as the structural deficit will fall to 1.3% in 2021.


But the government has decided against hitting it sooner because it has chosen to spend the minimal fiscal room it has on boosting economic growth. In other words, the government had been expected to run a £10 billion surplus in 2019-20 but that will now be a deficit of £35 billion instead. In 2022-23, there will still be a deficit of some £26 billion. Running a budget surplus has been abandoned and the reason was apparent from the start of the Chancellor’s speech. It’s due to a worrying growth picture.


The UK’s economic growth forecasts were severely downgraded due to slow productivity growth. Instead of growing at 2% per year as it was before the crisis, productivity growth has been flat. This has led the Office for Budget Responsibility to cut GDP growth to around 1.5% for the next 5 years of this Parliament. Growth is expected to be 1.5% this year and then slow to 1.3% in 2019 and 2020 before picking up a bit to 1.6% in 2022. This is in line with the recent assessment of the Bank of England that the potential rate of growth for Britain is now just 1.5% instead of around 2%.


So, the Chancellor has chosen to try and raise economic growth by spending what fiscal space is available to address the productivity challenge that has led to slow growth. Increasing support for R&D and investment in a range of technological sectors, including electrical vehicles, was part of the refrain heard during the Chancellor’s speech that stressed a post-Brexit, tech-oriented future. As faster economic growth usually means more tax revenues, this slight fiscal loosening to raise growth may help the government’s fiscal position in the coming years.


This somewhat looser fiscal position is more necessary because the Bank of England has begun to tighten monetary policy by raising interest rates and higher rates make borrowing and investment more costly.


Given the scale of Britain’s productivity challenge, if the measures announced today do not raise economic growth as expected or the government faces a worsening fiscal deficit because slower growth becomes a bigger drag on tax revenues, then there may be those who wonder whether more should have been done.

October 31 Is the UK about to have its first rate rise in a decade?




Many economists expect the Bank of England to raise interest rates for the first time in a decade on Thursday. With low unemployment and stable economic growth - and after being nearly zero for nearly 10 years, rates are due to rise. But, there are a number of reasons why the Bank may wait for a few more months at least.


First, although inflation is considerably above the Bank’s 2% target and expected to rise further to above 3%, that isn’t enough on its own. It’s because the Bank discounts inflation caused by weak Sterling. The Pound had fallen considerably after the EU referendum last June. When the Pound is weak, imports are more expensive so that raises the price level of the economy. Since the currency fluctuates – and Sterling has already regained some of its value, the Bank doesn’t act on its movements. They tend to “look through” such inflation.


Instead, the Bank focuses on wages. If firms pay more in wages, then their higher costs lead them to raise prices. Prices are essentially wages and costs plus a margin. At present, real wage growth – wages after taking into account inflation – is hardly budging. So, weak wage growth may lead the Bank to hold off raising rates. One wrinkle is that unit labour costs are over 2% amidst weak productivity growth, so that suggests that there are underlying cost pressures which could lead firms to raise prices. That suggests a rate rise is more likely, which is why Governor Mark Carney and others have pointed to a rate hike cycle as looming on the horizon.


Another factor has to do with consumer debt. The Bank has issued a number of warnings about the £200 billion consumers owe on their credit cards and other forms of debt. That figure has grown by nearly 10% over the past year. They warn that as much as £30 billion may never be repaid. If interest rates were to rise, that could lead to more defaults. Of course, waiting a few more months wouldn’t lead to a significant difference in the consumer debt load. But, giving plenty of warning about the impact of higher repayment costs may forestall further accumulation of debt and allow those who are indebted to plan accordingly.


Then there’s Brexit. The Bank has been worried for some time about the uncertainty around what will happen after the UK leaves the European Union. They have asked commercial banks to come up with contingency plans to ensure that the financial system won’t be disrupted should there be no deal with the EU in place in March 2019. But, it takes a year for banks to implement contingency plans, so the Chairman of RBS has said that absent a transition deal by March of next year, banks will have to start moving jobs out of London. Given the size of the City and the number of jobs linked to the financial sector, there will likely be an economic impact.


That could lead the Bank to wait for a few more months until next spring before raising rates. It’s also because central banks prefer to not have to reverse themselves – once they raise rates, they want markets to expect and plan for more rate rises and not wonder if rates will be cut again. Some central bankers disagree with this approach. They argue that should rates need to be cut again because the economy needs help, then it’s not problematic to reverse the direction of the rate cycle. But, the Bank of England has tended to move consistently in one direction.


So, we may be surprised on Thursday when the Bank of England doesn’t move on rates. They may wait a little while longer. Governor Carney has been hinting that a rate rise is imminent - but that’s why markets have dubbed him an unreliable boyfriend.


October 18 What next for UK plc? The future is uncertain. Here are five ways British businesses can survive and thrive

A prosperous future after Brexit will involve positioning Britain strategically in the global economy.

The UK can do this by securing trade deals to become a hub for global trade, including for services trade. Positioning Britain as a global trade hub would strategically exploit the fact that regional and bilateral free trade agreements (FTA) govern trade that is not covered by the World Trade Organization (WTO).

For instance, Mexico has a FTA with the European Union (EU) as well as one with the US as part of the North American Free Trade Agreement (NAFTA). US companies exporting from Mexico enjoy tariff-free access to the EU whereas selling directly from America would entail paying a 10% tariff on cars under WTO rules, to give one example.

If the UK had a trade deal with the EU after Brexit together with FTAs with countries that do not have a FTA with the EU, then Britain could serve as a hub into the world’s biggest economic bloc.

Given that it’s predominately a service-based economy, the UK would benefit from greater liberalisation of services trade. Britain has been a force for a greater opening of the services sector in the EU, which it can continue to pursue in a FTA. It would also benefit from continuing to support global initiatives, such as the EU-led Trade in Services Agreement (TiSA) that seeks to open up global markets for services trade in the same way as manufactured goods trade under the WTO regime. This would notably benefit the UK as the second biggest exporter of services in the world.

If the UK can strategically position itself to remain a hub for international trade while pushing for services liberalisation, then its economic future will look more assured.

September 21 Realising the aims of 'Global Britain': How can 'Global Britain' create an effective post Brexit growth strategy?

To be 'Global Britain' and realise the benefits of being an open economy that has allowed the UK to prosper through the years requires access to markets around the world. Of course, it’s possible to trade without specific free trade agreements (FTA) and instead operate under World Trade Organisation (WTO) rules, but that would be more restrictive and therefore more costly to export and import manufactured goods. It’s why there are a number of regional and bilateral trade agreements being pursued across the world, as countries recognise that there are gains from accessing global markets beyond what’s been liberalised under the WTO.

Even though the biggest economic entities in the world - the European Union, the United States, and China - do not have free trade agreements with each other, they are among each other’s largest trading partners. This shows there is still scope to expand world trade, which is why the EU is pursuing a trade deal with America and an investment treaty with China. Indeed, China doesn’t have many FTAs and its relatively closed markets are a perennial source of complaint by foreign companies. Therefore, how Britain manages its trade agreements with the rest of the world will have a significant impact on its post-Brexit economic future.

The multipolar world economy

Since the 2008 financial crisis emerging and developing countries have for the first time accounted for more of world GDP than advanced economies, according to the International Monetary Fund (IMF). Mirroring this trend, Britain now trades more with the rest of the global economy than with the world’s biggest economic bloc and its neighbour, the European Union.

One of the reasons is because that is where demand is growing quickly. In the past decade, the EU has had to contend with both the 2008 global financial crisis and the 2010 euro crisis, which depressed economic growth. By contrast, emerging economies were not as affected by these crises and have continued to grow, becoming more important than advanced economies in driving global demand. As these economies grow, their new middle class consumers will demand more goods, including services, which is a strength of Britain. Since the UK is the world’s second biggest exporter of services after the U.S., the emergence of a new global middle class bodes well for both countries.

That’s not to suggest that a trade deal with the EU is unimportant. The EU is on Britain’s doorstep. With supply and distribution chains that permeate much of international manufacturing, greater trade with countries that are geographically close is expected. The EU also has the most liberalised services sector among economic blocs, even if further reform is needed. The bulk of the UK economy is comprised of services, so negotiating post-Brexit access to the EU market of half a billion consumers is important.

Services are also the next big global trade push. If the global market for services were as liberalised as the market for manufactured goods, then that would benefit Britain and other services-based economies as well as the world economy. This is what the European Union is pursuing. In 2013, they, together with the United States, launched the Trade in Services Agreement (TiSA) that could eventually open up world markets for services trade in the same way that the WTO regime opened up the trade in goods. Services account for 70% of both world GDP and the national output of the 28 nations of the European Union. Yet, services comprise just 25% of EU exports. If TiSA were to come to pass and become adopted as the next multilateral round of trade liberalisation, that would boost growth for rich economies, including Britain. Thus, supporting TiSA would fit well with Britain’s post-Brexit trade strategy.

This is especially as the U.S., under President Trump’s 'America First' policy, is unlikely to continue to provide leadership on this global trade initiative. China is also unlikely to take a significant lead since its still developing services sector remains relatively protected, especially since segments of its financial sector remains state-dominated.

Therefore, there is scope for Britain to help shape the trade regime that will underpin an increasingly multipolar world economy. With less involvement by the biggest and second biggest economies, Britain, as the world’s fifth biggest economy, can play a leading role in moving forward global initiatives such as TiSA. The UK is currently supporting TiSA from within the EU. It would certainly be possible for the UK to continue its current engagement on TiSA after it leaves the European Union.

Trade strategies

As a general approach to trade, retaining its current trade engagements could serve as a useful principle after Brexit for the UK. Of course, offering support for services liberalisation would not be as involved as forming new trade agreements, so the former is simpler. But, aiming to retain current trade relations after Brexit would be less disruptive and practical given limited negotiating capacity.

For comparison, the United States is said to have perhaps the most efficient trade negotiating team of some 200 people in the office of USTR (U.S. Trade Representative) and they focus on one, and at most two, trade negotiations at a time. Since Britain would be leaving some 80 FTAs as a consequence of Brexit, adopting a continuation strategy to retain these FTAs in roughly their current form would be pragmatic.

Britain’s newly formed Department for International Trade has indicated that it will try to adopt wholesale the existing free trade agreements that the UK is currently party to as a member of the European Union after Brexit. At present, the EU has 32 free trade agreements in place. There are another 43 which are partly in place while awaiting ratification. Another four are being updated, while 19 are being negotiated.

Negotiating some 100 trade deals from scratch isn’t very feasible as it would take years for Britain to get back to its current position. Since the UK is already part of these trade agreements, retaining them would maintain the status quo and not be disruptive to businesses which are accustomed to these trade regimes. Pulling out of existing trade arrangements and re-negotiating them afresh would be far more challenging.

A retention policy would depend on its trading partners agreeing to “crossing out EU, writing in UK” on the existing trade agreements. Some may want to extract more concessions from Britain since it is a smaller market than the European Union. But, many are others are more open, such as Canada, who have indicated that they would be open to copying and pasting the existing provisions of CETA (Canada-European Union Trade Agreement) to form a UK-Canada FTA.

If there are issues with these existing trade agreements, then they can be addressed further down the line when Britain is past the immediate structural changes necessary to realise Brexit and would have greater capacity to re-examine trade relations. This approach would offer a 'status quo' transition whereby UK trade with non-EU markets would be unchanged.

In other words, right now, all of the UK’s trade agreements are via the EU. So, if it retained all of its current FTAs, then there would be no change in this respect on the day after Brexit in March 2019 since all existing trade arrangements would remain in place. The UK could avoid a 'two-step change' of dropping out of a FTA and then renegotiating it, which would entail two sets of operational adjustments for British companies that are exporting to those markets.

The UK has already announced that it will maintain an EU trade deal that allows in duty-free, quota-free imports from 48 of the least developed countries in the world, including South Asian nations such as Bangladesh, African countries such as Ethiopia, and the Caribbean including Haiti. It benefits these developing countries to have uninterrupted access to the market of one of the world’s biggest economies. Some small developing countries rely on British markets, e.g., nearly a quarter of Belize’s exports go to the UK while it’s 10-20% of exports from Mauritius, Gambia, Sri Lanka, and Bangladesh. For Britain, it helps to ensure undisrupted imports after Brexit, e.g., 79% of tea imports, 45% of clothing, and 22% of coffee, come from these nations. The UK is exploring extending this deal to Ghana, Jamaica, and Pakistan, where tariffs are already zero on some goods.  

Along these lines, if Britain replicated the EU-CARIFORUM trade deal, which is the 2008 EU FTA agreed with 16 Caribbean nations, the UK would retain cheap access to imported commodities, including mining products, minerals, and agricultural products such as bananas and sugar. The EU exports mainly cars, boats, telecoms equipment, and engine parts to the Caribbean. The trade is not negligible since the CARIFORUM nations are the EU’s second largest trading partner after the United States. There are also efforts to integrate services sectors. Both higher tech manufacturing and services are strengths of the British economy, so maintaining the market access that the EU has spent years negotiating with the Caribbean and dozens of other countries would be a practical way forward for Britain as it contemplates its post-Brexit trade negotiating strategy.

If Britain can maintain its current trade arrangements, then that would cover some 80 countries. A related move would be to treat the 23 countries that the EU is currently negotiating with as ongoing talks after Brexit. In other words, take as the starting point the already agreed provisions in the EU negotiations with countries such as Japan, India, and the United States. Since Britain is party to these negotiations, it has already essentially accepted where these talks have progressed to. So, rather than starting talks afresh, the UK could consider adopting the EU negotiating stance as of March 2019 as the initial British position in forging new trade deals.

Of course, it is unlikely to be that straightforward. Also, some of these trade talks, particularly the TTIP (Trans-Atlantic Trade and Investment Partnership) with the U.S., appear stalled. But, there is also the possibility that some of these nations could find it easier to do a trade deal with Britain since it does not represent 28 different national interests. The challenge will be to prioritise trade talks with Britain since other countries, just like the UK, have negotiating capacity constraints so pursuing several FTAs at any one time is a stretch.

Britain as a hub

The global economy is characterised by overlapping regional trade agreements (e.g., NAFTA covers the U.S., Canada, and Mexico) and bilateral FTAs. This allows for the creation of trade 'hubs'. For instance, Mexico is in NAFTA and also has a FTA with the European Union, so it benefits from being a 'hub'. U.S. car companies that manufacture in Mexico can sell into the EU tariff-free. The same car produced in America would be subject to a 10% tariff under WTO rules since there is no free trade agreement between the U.S. and EU. Another example is Israel. Until the late 1990s, Israel was in the unique position of having a FTA with both the U.S. and EU. It benefitted from its 'hub' status since trade was channelled through it in order to gain preferential access into American and European markets.

Britain has the potential of becoming a 'hub' into other major economies given its deep links with the EU and the U.S. Should the UK negotiate a preferential trade deal with the EU while also having FTAs with countries that the European Union does not have trade deals with, then that would make the UK an attractive 'hub' for international trade. Therefore, if Britain were to agree trade agreements with countries that don’t have a FTA with the EU - a list which includes the biggest economies in the world such as the U.S., China, and India as well as Commonwealth countries with which the UK has historical links such as Australia, Malaysia, and Singapore - then it could serve as a “hub” for trade.

If Britain were to benefit from the 'special relationship' and forge a trade deal with the U.S., alongside a comprehensive trade agreement with the EU, it would be in an enviable position. The U.S. has only 14 FTAs with 20 countries. None are in the European region; all bar three in the Asia Pacific (Australia, Korea, Singapore) are centred in the Americas and the Middle East. As a sizeable economy with a well-developed services sector to facilitate trade and investment, Britain would be an attractive hub for cross-Atlantic trade. Should the UK enter into a trade deal with China or India, then it would also be a 'hub' for Asian trade with the West.

This is a big 'if' given the discussion earlier about negotiating capacity and the intrinsic challenge of negotiating trade deals, especially with major economies. Trade is tied up with politics, so what looks like a simple deal often does not turn out to be straightforward. Nevertheless, realising the aims of 'Global Britain' will require a long-term strategic vision and positioning the UK as an important hub in a changing world economy.


None of this will happen overnight and there is a long road until Britain’s post-Brexit economic path is clear. But, strategically positioning itself in the world trade order would be an important part of the country’s continued economic prosperity. Continuing to be a liberalising influence on global trade negotiations would be particularly beneficial given the latest initiatives that are centred on opening up the global services economy.

Pragmatically speaking, by retaining and shadowing EU trade agreements and ongoing talks, it may be possible for Britain to have trade deals with over 80 countries not too long after Brexit. By offering tariff-free imports of agricultural products from developing countries, the UK can also quickly notch up some limited trade agreements that helps preserve cheap access to foodstuffs. With that foundation, Britain would have trade deals with about half of the world’s economies which could serve as a template with which to negotiate further FTAs. In deciding which countries to pursue, it would be advisable to consider which trade deals can help promote Britain as a 'hub' for international trade. That would help make the country 'Global Britain'.  

June 21 The Brexit dilemma


The General Election, which saw the Conservatives lose their majority in Parliament, has widened the potential future economic relationships with the EU. The start of formal Article 50 negotiations between the EU and the UK this week has cast into stark relief the Brexit dilemma.


In economics, there is a concept known as the impossible trinity or the macroeconomic policy trilemma. It says that you cannot achieve all three aims of monetary policy autonomy, fixed exchange rates, and capital mobility. Only two of the three are possible. For instance, as capital moves freely across borders, then a country has to choose between managing the currency or independent monetary policy. So, if monetary policy raises interest rates, then more money will flow into the economy and erode the pegged currency. Fixing the exchange rate means that monetary policy is geared at the currency since money supply must adjust to meet the peg and not to fine-tune the business cycle.


From the recent developments in the Brexit negotiations, it seems that there is a Brexit dilemma or even trilemma. After leaving the European Union, Britain will have to choose between the EU Single Market, forming a customs union with the EU, or negotiating its own trade agreements. All three are unlikely to be possible.


At present, the UK is in the EU Single Market and Customs Union, so it has not set its own trade policy since 1973 when it joined the European Economic Community. Thus, not all three aims are possible.


Just before Article 50 talks kicked off, European leaders such as French President Emmanuel Macron, German Finance Minister Wolfgang Scheuble, and European Parliament Brexit coordinator Guy Verhofstadt said that if the UK changes its mind, then the door is “open” for it to remain in the EU. According to the panel of economists and politics experts that I chaired at the London Business School last night, that did not seem likely politically for Britain where both major parties have opted for Brexit. In which case, the Brexit dilemma will require tough choices to be made.


After Brexit, if the UK were to negotiate a customs union agreement, then it would share a common external tariff with the EU. It would maintain frictionless goods trade with the EU which also means that no “hard border” would be imposed between Northern Ireland and Ireland. With the Northern Irish party, the DUP, in talks to support the minority Tory government, the border issue in Ireland has come to the forefront. But, a customs union would preclude Britain from doing its own free trade deals, which has been one of the benefits frequently mentioned after Brexit, i.e., establishing trade agreements with the rest of the world for the first time in over four decades. Turkey’s customs union agreement with the EU has precluded it from negotiating a free trade agreement with the United States since they must have the same outward facing tariff. So, the EU has insisted that Turkey must accept what it negotiates with America in the on-going TTIP (Trans-Atlantic Trade and Investment Partnership) agreement even though Turkey does not have a say. But, Turkey also controls its borders and sets its own migration policy. Thus, in this scenario, independent trade policy aim is not feasible.


If the UK were to negotiate instead to remain in, or have largely unfettered access to, the Single Market, then it could negotiate its own free trade agreements so that would rule out a customs union. For instance, Norway does so as part of the European Economic Area that includes countries that have entered into the European Free Trade Association (EFTA) but are outside the EU. Norway negotiates its own free trade deals, but is subject to what can be sold into the EU. In return, Norway pays into the EU Budget, has no say in Single Market rules, and accepts free movement of people, which is a sticking point for Britain as the Prime Minister has said that she wants to control migration. But, the German Foreign Minister Sigmar Gabriel has hinted that the UK may be able to remain in the Single Market if it accepts free movement of workers. So, free movement only for those with jobs. He also suggested that a joint EU-UK court may be feasible, which also addresses another British concern about sovereignty. Like the EFTA court which governs the EFTA countries, any such court would be expected follow the European Court of Justice in principle.


Therefore, the UK must decide whether it wishes to do its own trade deals, which rules out remaining in the Single Market, leaving the Norway option. Then, there’s also the choice of aiming for a comprehensive free trade agreement with the EU that must include services which are excluded from a customs union. That would also mean prioritising trade deals over a frictionless border for goods trade in a customs union. But, if it needs a customs union, particularly for the Irish border, then it’s unlikely to be able to negotiate free trade agreements with the rest of the world. Of course, as the saying goes, “politics is the art of the possible.” Still, hard choices are likely needed among these aims given the Brexit dilemma or trilemma.

April 6 How billionaires and Beijing shared the Tencent-Tesla tie-up

It’s not often we get to say a government policy is the victim of its own success. But the contrasting fortunes of two recent cross border deals – Dalian Wanda’s failed $1 billion bid for Dick Clark Productions and Tencent’s $1.7 billion investment in Tesla – are evidence that this is the fate of China’s Going Global strategy. It is also the reason Beijing is shifting from its previously laid-back approach to the greater discipline of Going Global 2.0.

Going Global – also known as the Go Out policy - is the reason we see Chinese multinationals such as Tencent, owner of China’s most popular social network, WeChat, and property-based conglomerate Dalian Wanda operating in global markets in the first place. At the turn of the millennium, Beijing began to lift restrictions on outward foreign direct investment and urged homegrown businesses to buy abroad. China was keen to create multinational companies that were competitive on the global stage. Such companies would in turn contribute to China's economic competitiveness and growth. Although there had been state-led investments in sectors such as natural resources for decades, the first overseas commercial deal took place only in the early 2000s, with the purchase by TCL, an electronics business, of the TV and DVD division of Thomson Electronics of France. Outward FDI now exceeds $100 billion a year and China is a net capital exporter, investing more overseas than it takes in.

But this flood of outbound investment headed increasingly to the US and Europe has become a macroeconomic problem. It is hampering China’s control of cross-border capital flows and its ability to maintain capital account restrictions while it reforms the state-dominated financial sector by opening it up to greater competition. If too much money leaves the country, that reduces China’s ability to manage the pegged exchange rate, for instance. It also whittles away the deposit base of the banking system.

The capital controls are not the only shift in the policy. Beijing is increasingly strict about which sectors Chinese businesses may invest in. It is no longer enough for a deal to pursue the predilections of a particular tycoon; it must serve China’s economic goals. Dalian Wanda’s bid for the US company that produces the Golden Globes film and TV awards ceremony reflected the ambition of founder Wang Jianlin, one of China’s richest people, to expand his entertainment empire. He already owns America’s AMC cinema chain and has declared his intention to outflank Disney with his own amusement park complexes. Yet his acquisition of Dick Clark productions was reportedly nixed amid a regulatory clampdown on “irrational” investments - because he could not get $1 billion out of China. Buying an entertainment company does not comply with the goals of the Going Global 2.0 policy.

So Beijing is using capital controls to scrutinise outward investment exceeding $1 billion - and to evaluate the economic benefits of those investments. After all, the Going Global policy was originally designed to not only create competitive multinationals but also to improve growth potential. That is increasingly important if China is to escape the middle-income trap, which is when growth in a developing economy slows before gross domestic product catches up with that of the west. Expanding the natural resources, services, technology and high-skilled sectors will be more use than snapping up entertainment companies. With the government increasingly concerned about external macroeconomic management, the days when the Going Global policy was applied in a relatively lax manner appear to be over. After all, Wang Jianlin had previously bought AMC Theatres in 2012. 

Tencent’s acquisition of 5% of Tesla fits the bill for Beijing. It might seem odd that a company known for a mobile messaging app is investing $1.7 billion in a business from a separate tech sector. But for big Chinese groups such as Tencent, the 10th largest company in the world in market capitalisation and the only Chinese firm, tech is tech. Tencent has already invested in Shanghai-based electric car company Nio. It has taken stakes in Didi Chuxing, the Uber of China, and in Lyft, a US-based car service. Like other Chinese tech companies, it is growing so fast that diversification into a wide range of fields is more common than elsewhere. So for Pony Ma Huateng, the Tencent chief executive who co-founded the company 20 years ago, this is not an unusual move.

Jack Ma’s Alibaba, the e-commerce company best known as the Amazon of China, has also invested in Didi and Lyft. Not to be left out, the third big Chinese tech company, search engine Baidu, headed by Robin Li, has also invested in Nio. All three billionaires, who frequently compete with one another at home and abroad, are eyeing the potential of driverless cars in China. Tesla might gain a foothold in the Chinese market with a Chinese partner. For Tencent, which has a market capitalization of $275 billion - dwarfing Tesla’s $45 billion – this is a relatively affordable way to steal a march on its domestic rivals.

The tech tycoons’ sprawling spending habits are a good fit with the aims of Going Global 2.0 – which means Tencent’s $1.7 billion investment in Tesla and similar deals are agreeable to Beijing.

So -- in this iteration, at least -- we should expect more Beijing-approved tie-ups from different parts of the tech sector and far less prestigious but macroeconomically useless trophy hunting.

March 29 The continuing uncertainty of Brexit

On this day in two years’ time, the UK will likely have left the European Union as the Prime Minister Theresa May has today sent formal notification to the EU to trigger Article 50 of the EU treaty that starts the Brexit process. Brexit will then have taken place less than three years after the EU referendum of June 2016.

That is the most certain outcome of Brexit thus far, though that is less than 100% certain because there is the possibility of extending the two-year negotiating window if all 28 nations agree that more time is needed.

It’s not to say that we don’t have more detail than before. We know that Britain will prioritise the ability to control migration. The PM believes that means that Britain will not have unfettered access to the EU Single Market. Rejecting the free movement of people also means the Norway model of being in the European Economic Association is out. Yet, there are murmurings from Switzerland, which has its own migration issues, and even reportedly from Germany that some degree of control may be possible, though perhaps not that likely.

Similarly, PM May wants the UK to negotiate its own trade deals, so that excludes being part of the EU Customs Union which requires members to have a common external tariff with the rest of the world. A piecemeal approach has been deemed unlikely by European policymakers and may also violate World Trade Organisation rules too. Still, could some kind of deal be done since the UK is prioritising getting tariff-free access for its biggest manufactured goods export, cars, for instance? Minimising customs requirements at the border is another reason to seek some type of Customs Union associational membership, as the PM puts it.

What about financial and other services? That will require a separate agreement since Customs Union only covers goods, so the PM will have to negotiate a free trade agreement (FTA) with the EU to determine what access the services sector will have to the European Single Market. Since services comprise nearly 4/5th of the UK economy and Britain is the world’s second largest exporter of services, this is hugely important and a complicated area since non-trade barriers like standards are more relevant than tariffs and customs arrangements. There are few FTAs that comprehensively cover services. In fact, the most advanced FTA, the EU Single Market, is undergoing continuing liberalisation of the services market, so it is likely to take some time to craft such an agreement.

Finally, we also know that the British government will contemplate an implementation or transitional period after leaving the EU. But, until we know what the trade arrangements are with the European Union, which will likely take years to negotiate, what are Britain and the EU transitioning towards? That is clearly better than a “cliff edge” where current EU trade rules don’t apply on March 30, 2019. Still, what would transition itself look like? That’s another area of uncertainty.

The WTO regime would apply then, which would help. But, given the gulf between the preferential access to the EU at present and what the WTO rules cover, that still leaves ambiguity. At least in terms of the WTO, there is more economic certainty. Of course, between now and then, the UK and EU have to agree to split their current quotas, etc. to establish new WTO membership terms for both sides which needs to be agreed by the WTO member countries. Even if the rest of the 160 or so WTO members don’t agree to the new terms for the UK, the WTO rules dictate that the old rules would apply which in Britain’s case will be largely the same terms anyways. It doesn’t cross the T’s or dot the I’s, but the working arrangement will offer some certainty at least.

The European principle that nothing is agreed until everything is agreed means that we will unlikely see the end of economic uncertainty until March 2019 at the earliest. In one sense, less than three years from the vote to departure seems fairly quick in terms of unravelling international treaties. But, in another sense, it’s rather a long time to know where everything stands in post-Brexit Britain and in an EU that excludes the UK.

March 15 Fate of a post-Brexit nation

The UK’s Prime Minister Theresa May has said that no deal with the EU is better than a bad one, which may force the UK to rely on the World Trade Organization (WTO)’s rules for trading. But what happens the day after Brexit is confirmed? British businesses don’t want the uncertainty of being outside the EU with potentially no trade deals. So what are the options? 

Until Brexit happens, the UK has to negotiate any trade deals as part of the European Union. That will obviously change following Brexit. But it also means that the UK can't negotiate trade deals with other nations formally until it leaves the EU. So the question is: can the UK just rely on the WTO rules to buy and sell goods in the absence of any other trade deals? 

In theory, it could but the UK and EU need to agree on how to divide up the shared WTO “schedules” – the list of tariffs and quotas that the EU applies to other countries. This is because the UK is a member of the WTO through the union. To become a fully independent member of the WTO, the UK would have to establish its own schedules. 

As a member of the EU Single Market, the UK can import cars without facing any tariffs, for instance. But there will be tariffs of 10% on cars after Brexit and smaller amounts on other goods, plus a few higher rates on agriculture. There may not be an immediate economic impact, but there could be longer term ramifications the longer term for, say, car production chains.      

Bureaucratic issues 

Becoming a full WTO member presents a major challenge as the UK would need to disentangle itself from all the tariffs and quotas it has signed up to through the EU. It could take years to sort everything out and that’s before we’ve even considered free trade agreements. But trade experts have told me that it can be done, as long as the negotiators are sensible. It’s in everyone’s interests for there to be no disruption, so the UK should be looking to get on good terms with the EU and WTO.    

America is a good example of how to negotiate. The US has around 200 trade negotiators, which doesn’t sound like it’s many but they are incredibly efficient as they only do one or two deals at a time. Britain can learn from this by looking to agree terms with a small number of countries first and then going from there. It’s really important for the UK to rack up a few trade deals. It can then use those deals to entice other nations to come to the table.   

Getting the US on board would be a major move. We know that Prime Minister May and US President Donald Trump have met to discuss Britain’s relationship with America. But Trump has made it very clear that he prefers bilateral trade deals to free trade agreements. It’s really difficult to imagine Trump giving Britain a very good deal while talking about putting America’s interests first. After all, “hire American, buy American” was the mantra throughout his presidential campaign. 

Brexit’s impact on the UK economy

Will London still be an international financial centre if there are no firm trade agreements in place after Brexit? I’ve spoken with officials in China and other emerging markets who say they’re really worried about this. But it’s really hard to dislodge a city with such financial expertise. London has been a global financial capital for a long time, even though Britain’s not the biggest economy in the world.

The British government is trying to prevent efforts to entice financial services firms from London to Paris, Frankfurt or Luxembourg. This is fuelled by international banks with European headquarters expressing concern about Britain leaving the single market. British financial services providers are also worried. To diversify, Lloyd’s of London is setting up operations in Europe, while HSBC will relocate some staff to Paris when the UK leaves the EU. 

Striking trade deals won’t happen overnight. In the meantime, the UK would need an implementation or transitional deal with the EU after finalising Brexit to help smooth the process and avoid any disruption. I think we will see one, but what will the UK transition to if it has no free-trade deal with the EU? This is the practical question that British businesses are asking.   

Whatever happens, we know the only certainty about Brexit is uncertainty. However, it’s important to recognise that as the fifth biggest economy in the world, the UK is resilient. The key to maintaining that position long-term is to open up new markets after leaving the EU.  

March 8 UK Spring Budget reveals upcoming challenges (and it's not Brexit)


An upward revision to economic growth this year to 2% was accompanied by a reduction in the estimated budget deficit to fall below 3% of GDP in 2017. But, the long-term picture hasn't changed much: government debt as a share of GDP is still forecast by the independent Office for Budget Responsibility (OBR) to peak next year, albeit at just under 89% of GDP instead of 90%.

As with all deficit and debt forecasts, it depends on the economic growth rate. The OBR only revised up 2017 GDP growth; they downgraded growth through the end of Parliament to be 2% or below. That is below the long-term growth rate of 2.25%. If this proves to be too gloomy, then the budget deficit figures may look rosier. Brexit looms large over the growth figures as well as the government’s fiscal decisions.

The OBR also stresses that the budget deficit remains largely "structural" so revisions to economic growth won't really change the underlying budget position. The Chancellor recognizes that and proposed a budget where additional spending is met by tax increases. So, the Chancellor's "giveaway" of £3.1 billion in 2017/18 in a largely fiscally neutral budget has meant tax rises for the self-employed, directors of companies, etc. It certainly matters but won't have a big impact on UK public finances.

More worrying, the OBR believes that the government doesn't look "on track to return public finances to balance at the earliest opportunity date in the next Parliament." In other words, the structural deficit isn't likely to fall to 2% of GDP by 2021. The Institute for Fiscal Studies estimates that an ageing population and other pressures will raise spending on health, social care and pensions by some 1% of GDP by 2025. Part of the Chancellor's "giveaway" is to pay for social care and the government has announced a longer term study, which is certainly needed.

So, the need for greater social spending is pushing against the public spending cuts which will make the government’s fiscal targets more challenging to reach. That is the underlying concern that has been revealed by an otherwise fairly workman-like Spring Budget.

March 6 The economic practicalities of Brexit


Trade agreements are about opening up markets, but they’re also about reducing the frictions of cross-border trade. In other words, the gains from international trade result from, among other things, the reduction of tariffs and duties, especially in an era of global supply chains.


Once Britain leaves the European Union, these economic factors will come into play.


The white paper detailing the UK exit from the EU confirms that Britain will not seek to remain in the EU single market or the customs union. The UK will try to get preferential access for certain exports like cars into the EU. But, if there are differential tariffs and duties, there will be customs checks at the border to establish which duty should apply. These frictions largely pertain to manufacturing and agricultural products, and less so to services which make up more than three-quarters of the UK economy.


After Brexit, there will be a lot more customs checks at Britain’s national borders.


Just under half of British exports go to the European Union. They face minimal customs procedures. The principle is known as RORO or ‘roll-on, roll-off’. After Brexit, shipments to and from the European Union will be subject to the same level of checks as non-EU trade. These include customs declarations at the border, assessing the tariff or duty to be paid, and lorries as well as inspection checks for ships and planes.


Direct and indirect tariff costs


The British Chambers of Commerce estimate that by 2019, owing to Brexit and the overall increase in global trade through Britain, the annual number of customs declarations will rise to 390 million per annum from 90 million.


A quadrupling of the paperwork will require an IT system that can manage the additional load, as well as additional physical infrastructure to ensure that the customs checks don’t cause excessive delays for the shipments or gridlock on the roads.


In a measurable way, additional customs requirements will increase the cost and frictions of trading with the UK.


There are also likely to be greater trading costs associated with the fall-back position of relying on the World Trade Organisation if there is no trade deal with the EU. Under the WTO, the UK would trade under ‘most favoured nation’ status with the rest of the world. Around one-third of British exports would be zero tariff and many would have tariffs of just 2-3%. But for Britain’s biggest goods export, cars, tariffs would rise to 10% from the current zero. Others, mainly agricultural products, would be subject to higher tariffs.


Tariffs are an example of trade frictions that countries seek to reduce through free trade agreements. Although most tariffs are not large in magnitude, countries around the world have sought further FTAs in addition to their WTO membership to reduce these costs of trade further.


An increase in tariff rates and customs costs may well be manageable in the short term. But it adds pressure to the British government to maintain the long-term competitiveness of British goods exports by agreeing FTAs to bring those costs down.


What that implies is greater competitive pressure on British exports. EU officials have stated that Britain must trigger Article 50 of the Treaty of Lisbon before a trade deal can be discussed. Being in the EU also means that Britain cannot formally negotiate trade agreements with other countries. Informal talks are taking place and groundwork has been laid in the U.S., but it still means the UK won’t have any FTAs in place when it leaves the EU.


One implication is that those British products which now attract zero tariffs when exported to the 50 countries with which the EU has FTAs will see those taxes rise from zero to 'most favoured nation' levels after Brexit. Therefore, the additional friction will increase not just for exports to the EU, but also for exports to places like South Korea and Canada.


WTO membership terms


Friction surrounds the potential uncertainty regarding which tariffs or quotas apply once Britain has left the EU. The UK is a member of the WTO as part of the EU. It can replicate existing WTO schedules for tariffs and others by essentially crossing out EU and writing in UK for the most part in a process called rectification. But there are two areas where that is not feasible.


WTO subsidies and quotas are set for the EU as a whole and not for individual nations. There are about 100 quotas for imports of mutton and the like which will need to be divided between the EU and the UK. The EU and UK then need to present the new schedules to the other more than 160 WTO members which must agree unanimously to the new WTO membership terms.


To avoid confusion over which quotas or tariffs apply after Brexit, it is in the interest of both the UK and EU to agree their WTO membership terms quickly. It’s the sort of trade friction that is avoidable and suggests that the Brexit talks with the EU can’t be wholly devoid of trade negotiations. In other words, in a ‘no deal’ scenario with the EU, the UK will still need to do a deal with the EU.

January 18 Can we end poverty by 2030?

Is it possible to end extreme poverty? And by 2030?


That’s the aim of the first of the 17 UN Sustainable Development Goals (SDGs). These were adopted by all nations and have begun to drive conversations at global gatherings, including those that I have contributed to in recent weeks.


This ambitious goal builds on the dramatic fall in worldwide poverty since 1990.


Then, over one-third of the world’s population lived on less than $1.25 per day, adjusted for purchasing power parity or what a dollar buys in a country. That measures the level of abject poverty, and has since been adjusted to $1.90 per day. Based on these measures of extreme poverty, we are at a historic point where just 1 in 10 people in the world are poor.


It means that over 1 billion people have been lifted out of extreme poverty since 1990. The halving of the global poverty rate happened more quickly than the UN’s Millennium Development Goals (MDGs) had envisioned. The MDGs aimed to halve poverty worldwide from 1990 levels by 2015 – it was achieved in 2010.


So, the current SDGs are more ambitious. The aim is to end extreme poverty in just 13 years by 2030. It means lifting the remaining 767 million poor out of poverty. But, what has worked before may not be enough this time.


In other words, most of the poverty reduction occurred because of China’s economic growth as well as the rest of the East Asian region – countries which are on course to ending poverty.


The poverty rate in East Asia fell from 61% to 4% between 1990 and 2015. In South Asia, it's dropped from more than half (52%) to 17%.


By contrast, the number of poor isn’t declining in Sub-Saharan Africa and more than 40% of Africans still live in abject poverty.


This is despite Africa registering the second fastest growth rate after only Asia during this period. The implication is that though it has worked largely for China and other Asian nations, economic growth isn’t enough to reduce poverty. High levels of inequality, for instance, mean that an economy can grow and not help the very poor.


So, that means eradicating poverty requires new strategies, in addition to what has been tried in the past couple of decades.


Half of the 767 million poor live in Africa and one-third are found in South Asia. The remaining poor dwell in East Asia, Latin America, and Eastern Europe, all regions which are on track to end poverty.


Thus, the poor in Africa and South Asia should now be the focus. And devising economic growth that helps the poorest will require new approaches.


For instance, reducing income inequality should be a higher priority. That typically requires redistributive policies, but also pre-distribution ones such as mandating education to better equip the workforce.


Also, capital accumulation tends to be the engine of growth for industrialising nations, so investment funds are needed. This can come from public and private sources, and usually involves both governments and businesses working together to get financing into countries to fund entrepreneurship and infrastructure.


How these funds are deployed, of course, is where novel strategies are particularly needed. For instance, effective deployment of funds requires an understanding of the needs of the locality. Some of the most knowledgeable of a community’s needs are found in civil society organisations. NGOs or non-governmental organisations of any stripe can, for instance, help transmit the needs of a locality to government and businesses so that funding and resources can be used more effectively to foster economic growth. There is also a degree of accountability from smaller groups rooted in a community, as much of the evidence from social capital studies show.


Of course, there is not one recipe for economic success. But, involving more participants with a stake in society is worth considering. After all, policymakers and businesses have increasingly sought feedback from their citizens and customers about governance and needs. It’s just a step further to encourage individuals to become involved to help grow their communities.


Governments do not have all the answers, nor do business. Working with communities to support economic growth would be a natural step.


Without trying more eclectic ways of thinking about growth strategies, poverty is likely to persist. To realise the ambition of living in a world without extreme poverty will require trying something different and more collaborative going forward. 

January 2 Economists still gloomy on long-term effects of Brexit: FT annual survey of the UK economy

1. Economic prospects

How much, if at all, do you expect UK economic growth to slow in 2017? Please explain your answer.


I expect UK economic growth to remain fairly resilient, supported by relatively optimistic consumer confidence, a slower pace of fiscal austerity, and a weaker Pound. The UK will still be in the European Union in 2017, so there will be no fundamental change to market access to the EU Single Market. However, growth may be weaker than in 2016 if businesses defer investment decisions as a result of the continuing policy uncertainty related to Brexit.


2. Brexit

Compared to what you thought 12 months ago about the UK's long-term economic prospects outside the EU, are you now more optimistic or more pessimistic than you were?


More optimistic than 12 months ago

Feel about the same as 12 months ago

More pessimistic than 12 months ago


Please explain your answer.


I feel the same. Access to global markets is the key to the UK's long-term economic prospects. So, on the positive side there is undoubtedly a renewed vigour for striking international trade and investment deals, especially in fast-growing parts of the world and in the trade in services. However, it is likely to take longer than the rather optimistic assessments of how quickly these negotiations can be done.


3. Inflation

Inflation has started to increase in recent months. To what extent do you expect inflation to rise in 2017?


I expect inflation to rise but not to the heights seen in the aftermath of the 2008 financial crisis as the driver is the weaker Pound and not global price pressures. But, as we have seen in recent months, some of these price pressures are likely to be absorbed into profit margins, so the pass-through into consumer price inflation may be weaker than expected.


4. Monetary policy

In December, the Monetary Policy Committee said the next interest rate move could as easily be up as down. Will there be a shift in this monetary policy stance by the end of 2017? Please explain your answer.


The chances are that the MPC will not increase interest rates in 2017. The impact of Sterling's weakness on inflation is likely to be viewed as a temporary issue and not a serious risk to the inflation target over a two-year horizon. Plus, with the ECB extending QE to the end of 2017 (albeit with a smaller programme) while the Fed may well raise rates again, the contradictory impact from the UK's major trading partners will also contribute to a wait-and-see tendency.


5. Immigration

Immigration is likely to be central to the Brexit negotiations in 2017. How much do you think immigration will change and what effect do you think this will have on the UK economy?


I don't see much change in immigration next year as the process for leaving the EU is unclear and likely to take some time, so freedom of movement will be unaffected for a while. Of course, as the UK may want to remain in the EU Single Market at least for certain sectors, much of the economic impact will depend on if the EU will insist on maintaining free movement of people for any such access.


6. Fiscal policy

Philip Hammond is expecting government borrowing to fall in 2017. His new fiscal rules provide headroom for more borrowing than currently forecast. To what extent will he need to use it and why?


If growth disappoints, or higher borrowing costs result from rising inflation, then the Chancellor may find he borrows slightly more than expected. But unless anything major hits the economy or the public finances, he will likely hold back from any significant change in fiscal policy in the next year and wait until the impact of Brexit is clearer.


7. Donald Trump

How do you think Donald Trump's presidency will affect the UK economy in 2017?


Trump may favour trade deals with similarly developed economies as those tend to have less of a negative wage impact, so the UK could find itself as one of the trading partners the U.S. is looking to forge a bilateral trade deal with. But, Trump's focus appears to be on withdrawing from trade agreements or renegotiating current America's current 14 FTAs. In any case, if any informal trade talks were to occur, it would boost sentiment with respect to the British economy. Otherwise, his fiscal stimulus is likely to boost the dollar which will contribute to a weaker Sterling, among other currencies. Of course, Trump will continue to add uncertainty to the world, and any change to global growth will also affect the UK economy in 2017.

December 21 What to expect in 2017

2017 is likely to be a bumpy year for the global economy, with major economies facing political uncertainty too. The American economy will be led by a new president who faces a backlash against globalisation that could stymie trade deals. Even though it’s unlikely that globalisation will be rolled back, the lack of progress on opening markets and rising protectionist sentiment may contribute to prolonging the stagnant trade growth of the past year. China, the world’s second biggest economy, continues to be plagued by concerns over its slowing growth and rising levels of debt and could also see its president consolidating more power, which adds another level of uncertainty. The Chinese government is likely to continue to use fiscal stimulus to boost growth in 2017, despite concerns over how investment adds to debt. Finally, France, Germany and others all have elections or a referendum in 2017 that could see changes in government at a crucial time for the Eurozone, and the UK plans to formally trigger Brexit talks by March 2017. For all these nations, political headwinds may well be as important as economic reform plans in 2017.

December 1 Threat of currency volatility

For the decades under inflation-targeting, currencies were hardly mentioned for fear of moving the FX market. Along with the change in monetary policy regimes to include macroprudential regulation, currencies are no longer taboo to mention, though it still only occurs occasionally as central bankers are rightly concerned about igniting a currency war.

Exchange rate volatility or even a crisis has risen to the forefront of macro policy concerns. As with all such risks, whether a sufficient policy response exists matters a great deal. On this criteria, policymakers face a set of challenges.

Top of the list is China. The RMB is one of the currencies that's generating the most concerns. Until recently when the ceiling on the benchmark deposit rate and the floor of the lending rate were lifted, there was no market-clearing interest rate. The gap between the two may have helped the net interest margin that raises revenue for the mostly state-owned commercial banks but it prevented the accurate pricing of risk and the efficient allocation of capital. And, it made it difficult, if not possible, to determine the long-run value of the exchange rate since currency movements are linked to the real interest rate.

Now that the interest rate has been liberalised, the RMB is beginning to find its footing, helped by a stabilising current account balance even though global prices provide an ongoing challenge. More fundamentally, China's central bank hasn't relied a great on the interest rate to set monetary policy as a result so its gradual shift will bear watching. In the meanwhile, offshore currency traders are bring wrong-footed during this volatile period. Nearly $600 million worth of bets on the RMB weakening past 6.6 to the U.S. dollar, its low point during last year's surprise devaluation, have expired and become worthless.

Currency trades are bilateral and not just over time. The other major global currencies are also being tugged and pulled by divergent monetary policies. Stimulative policies by the ECB and BOJ are juxtapositions against the normalisation of U.S. monetary policy to the Fed. The resultant weakening and strengthening of their respective currencies, the most traded in the world, is making it challenging for the rest of the global economy. 

In other words, most emerging markets have pegged their currencies to the dollar and also to the euro. Some Asian economies, due to the predominance of regional supply chains, keep a close eye on the RMB as well as the yen. Yet, the Fed has raised rates while the ECB has just unleashed a slew of loosening policies, including more cash injections or QE. In Asia, China is cutting rates now but it still is sufficiently above the zero bound for interest rates while Japan is deep in negative territory for rates. Such divergences among the dominant currencies add to global volatility because they lead to divergences among the economies that are pegged to them. So, some emerging economies are seeing their currencies rise while others are experiencing devaluation. 

For those central banks, their main monetary policy aim is targeting the exchange rate. So, this has become more challenging. It's especially the case for commodity exporters, who tend to be pegged to the dollar as the currency in which commodities are priced, and are seeing their exchange rate appreciate alongside the dollar when they could use a weaker currency.

For what it's worth, it's even more challenging for major economies with free floating currencies. After all, the notion of a fully flexible exchange rate is that that there is no need to manage it. But, one of to members of the reserve currency club is now the RMB and there are those who worry about the Chinese currency's volatility as a risk to be managed when there really aren't many tools to do so.

Still, exchange rates are also driven by financial flows, so the new macroprudential powers have an indirect effect, similar to interest rates. Still, central banks rightly remain reluctant to target currencies explicitly. 

It means that we should not be surprised that at a time of divergent monetary conditions and Chinese reforms that currencies are volatile and there is little that can be done by central banks.

November 30 Trump and Asia Pivot: Post-TPP outlook

What are the strategic implications of President-elect Donald Trump’s decision to withdraw the U.S. from the Trans-Pacific Partnership (TPP)?


It would be the reverse of President Barack Obama's rationale for pursuing the TPP as part of his Asia Pivot, which is his wider foreign policy aim to re-orient America toward the fast growing economies in the region. President Obama pushed the TPP as a way of securing American influence in Asia and as a counter-weight to China, which was not part of the TPP. As President-elect Trump has now indicated that he will withdraw from the TPP on his first day in office, it opens up space for China to take the lead in establishing a free trade area in the Asia Pacific and increase its influence, both economic and geopolitical, in the region. Of course, much depends on what President-elect Trump chooses to do in Asia, as he is not indicating that he is withdrawing from the region – just from this free trade agreement.


Explain the potential impact of the Regional Comprehensive Economic Partnership (RCEP) and Free Trade Area of the Asia Pacific (FTAAP).  


These China-led regional free trade agreements have the potential of cementing China's influence in the wider Asia Pacific region, including the nations of the Pacific Rim and Latin America. As a middle income country, as compared with the U.S. which is a rich nation, China's aims and goals will be different and geared more at opening up markets for technology, services, and high-end manufacturing. This may well benefit other emerging markets, and there has already been interest from countries like Peru in joining a FTAAP. As the "hub" of a free trade area, China would be strongly positioned to set the terms of trade negotiations. Indeed, it would replace America which had been behind not just the TPP but also a free trade agreement with the European Union known as Transatlantic Trade and Investment Partnership (TTIP) which also looks uncertain.


With the U.S. presidential transition underway, identify three indicators of what a Trump trade policy approach might look like.     


President-elect Trump has said repeatedly that he will put "America First." It appears he is concerned about American jobs and also wages. Of course, there are a lot of reasons as to why median wages have been stagnant in the U.S. for decades, which include trade as one cause. Trade always entails "winners and losers" and those who have been left behind in this era of globalization are calling for reforms. When America trades with a poorer nation, there is more of a negative impact on wages in the traded sector. Manufacturing jobs come to mind, for instance. There are ways to address the distributional impact of trade, but those thus far have not been entirely satisfactory. So, Trump's trade policy may focus on pushing trade with comparably wealthy nations where there is less of a wage differential. For instance, during the campaign, Canada was less of an issue than Mexico in NAFTA [North America Free Trade Agreement]. Secondly, Trump is likely to use trade negotiations to address these distributional concerns, which is arguably better done through domestic fiscal policy. Third, Trump has more authority as President to withdraw or re-negotiate trade deals and impose tariffs than enter into new ones which requires Congressional approval. And he seems more focused on withdrawing than entering into new ones, so that may well be the priority in his trade policy.


How might President Xi Jinping and President-elect Trump build a pragmatic and productive relationship?     


As the leaders of two economic superpowers, they surely must find a way. China has always been pragmatic in its economic reforms. Appealing to businessman President-elect Trump may go some way toward speaking a common language about how to build a working relationship between two major economies which need each other's markets to grow. Specifically, it is in no country's interest to end up in a trade war. That's damaging for not only the countries involved but also the rest of the world which looks to the U.S. and China as the engines of global economic growth. And in numerous respects, the Chinese currency which had been a sore point for many years is no longer as under-valued as before, for instance, as China becomes more consumption-oriented and a middle-income country. Of course, there are other flash points such as over-capacity in Chinese industry in sectors like steel which are exported overseas. It's certainly in the interest of both nations to try to resolve differences short of tit-for-tat trade measures. 


Identify three Asia-related economic and trade consequential challenges facing the Trump administration.    


The Trump administration needs to determine where Asia sits in its priorities. The U.S. has historically close ties with Japan, for instance, which go beyond economic interests. But, the U.S. also has a number of foreign policy challenges in other parts of the world, so where does Asia fit in? President Obama's Asia Pivot is most unlikely to be the way forward, so what is the new agenda?


Second, does the U.S. wish to pursue trade agreements, including with nations in Asia as a collective? With global trade liberalization moving very slowing on a multilateral basis, other nations are pursuing regional trade deals. For instance, the ASEAN Economic Community (AEC) linking 10 Southeast Asian nations is a single market with a similar population to the European Union has just been established. Is Trump interested in a FTA on a regional basis with the AEC or just bilateral trade deals? Bilateral FTAs are of course also being pursued around the world, but those take time just like larger deals and also don't usually deliver the access to a huge market like the AEC or the EU, for instance. 


Third, given the focus on the impact on American wages and jobs, how interested is the Trump administration in negotiating trade deals with Asia which consists of a number of poor and still emerging nations? Will American attention shift more to the advanced nations in the region, such as Japan, Korea, and Australia? What about emerging markets like India? Since trade is increasingly via American companies establishing production and supply chains across borders, there may well be an impact on the competitiveness of U.S. multinationals who often locate low-end production in developing nations, including in Asia which dominates consumer goods production. 

November 23 Britain’s new fiscal mandate opens way to invest for economic growth


The Autumn Statement is the first indication of where the new UK government is headed in terms of fiscal policy. It’s a tricky course to navigate as the Chancellor Philip Hammond manoeuvres between the Prime Minister’s wish to help JAMs (just about managing) families (which means looser fiscal policy) and showing an ability to bring down the level of government debt which is now expected to peak at over 90% of GDP (and means continued tightening of fiscal policy).

The Chancellor’s solution is to adopt a new ‘fiscal mandate,’ which is a looser set of rules around government spending with targets that don’t need to be met until the next Parliament. Since the previous fiscal rules were missed, there is an argument over whether any such rules are credible. Nevertheless, the Chancellor has put forward new ones, but they run some of the same risks as the last set. In fact, the Institute of Fiscal Studies (IFS) finds that 10 of 12 fiscal rules in the past couple of decades have been breached.

In any case, the Chancellor believes the British government has to give guidance about where fiscal policy is headed, so there are now three new fiscal rules which mirror the old ones but are looser. Firstly, the welfare cap remains but won’t apply until the next Parliament. Secondly, public debt now has to fall as a share of GDP not every year but by the next Parliament.

The most significant change is how the budget deficit is measured. The target is for the cyclically-adjusted fiscal deficit to fall below 2% of GDP in 2021-22, so also in the next Parliament. 'Cyclically adjusted' means the government is targeting the structural deficit, which is the part of the budget deficit that is not due to the ups and downs of the economy. As an example, the independent Office for Budget Responsibility (OBR) estimates that the overall budget deficit is 4% of GDP at present, but the structural deficit is 3.8% of GDP. Of course, it is tricky to measure which parts of the deficit is “structural” and which are “cyclical” in economic terms. It’s a similar challenge as measuring the potential growth rate and the output gap of the economy.

A similar target would have been to aim for a primary surplus, so a budget surplus and not counting debt interest payments. Interest payments are not part of current government spending, so the primary budget position is used as a gauge of government spending and revenues in other countries to assess fiscal sustainability. A primary surplus target would have been harder to meet since the surplus or deficit includes cyclical as well as structural elements, but it is easier to measure and offers clarity. By the same token, it would have left less scope for borrowing if the economy stumbles, and the Chancellor mentioned several times that the effects of Brexit are to create uncertainty about the future so he wanted “fiscal headroom” to raise spending in case of a downturn.

So, over the remaining course of the Parliament, the new fiscal deficit target gives the Chancellor more room for spending on JAMs, for instance. The OBR estimates this fiscal rule gives the government scope for nearly 2.5% of GDP (£56 billion) more structural borrowing in 2020-21.

But, the OBR finds that downgraded economic growth forecasts have already taken away 0.9% of GDP (£20 billion) of that additional fiscal space.

Notably, the Chancellor has said that he will borrow to invest and fund innovation, which are both areas that require funding to support economic growth. He has committed to spend 0.4% of GDP (£9.5 billion), mostly in infrastructure spending but also with some measures for JAMs including raising the National Living Wage and revising the Universal Credit.

It still leaves 1.2% of GDP (£26.5 billion) of scope for borrowing by the government in case the economy weakens. In other words, if the potential negative impact of Brexit is worse than the OBR estimates, which is to reduce the size of the economy by 2.4% over the Parliament, then the government can raise spending and still meet the fiscal rules.

Despite the track record of missed targets, these new rules offer some guidance whilst giving the government more scope to use fiscal policy. If economic growth is boosted as a result of more investment in infrastructure and innovation and giving some help to JAMs, any missed fiscal targets may well become as unimportant as the other missed ones. Importantly, in the meantime, the new ‘fiscal mandate’ would have helped the Chancellor manoeuvre a delicate path.  


November 10 The economic effect of Trumpism


Trumpism is defined as: (1) the rejection of the current political establishment and the vigorous pursuit of American national interests; (2) a controversial or outrageous statement attributed to Donald Trump.

On winning the US Presidential election, Trump’s victory speech confirmed that he would put America first in his policies. That pursuit of America’s interests will permeate US economic and other policies in the years to come.

US President Donald Trump’s effect on the economy is hard to discern due to a lack of policy detail, but there are three main areas to watch: fiscal, monetary, and foreign including trade policy. In each area, there is potential for significant change. But, as with all public policies, there will be a trade-off that is yet to be dissected. For instance, he’s vowed to double America’s growth rate, critiqued the Fed, and expressed protectionist views. How will he achieve those aims? And at what cost?

Firstly, America’s economic growth has been slower than before the 2008 financial crisis. There are underlying trends that have led economists to debate whether the US, and other advanced economies, are facing “secular stagnation”. It’s a term first coined by Alvin Hansen in the 1930’s and recently revived by Larry Summers, which captures the notion that America may face a slower growth future.

Trumpism’s first aim will be to raise economic growth, and the policy to be deployed to achieve that goal is to cut taxes and reduce regulation. But would that square with his desire to reduce America’s debt? The independent Tax Policy Centre, jointly set up by the Brookings Institution and the Urban Institute, estimates Trump’s plan will double the growth in federal debt.

Will Trump be able to justify that trade-off in his fiscal policy? Of course, his plan to cut business taxes from 35% (which is among the highest in the OECD) to 15% (which would be among the lowest), as well as incentives to increase investment, may be welcomed by businesses who voted him into office.

The Tax Policy Centre also concludes that Trump’s plan would actually increase and not decrease the tax burden on middle class Americans, while cutting taxes for the better-off and corporations. Given the stagnant median wages that have squeezed the middle class, economic growth that does not raise incomes for the average American is less than desirable. The American consumer also drives the global economy, so there are wider implications.

Donald Trump by Gage Skidmore. CC BY-SA 2.0 via Flickr
Donald Trump, by Gage Skidmore. CC BY-SA 2.0 via Flickr

Second, and perhaps one that’s important for markets is what happens to the Fed. Trump has criticised the Chair of the US central bank, Janet Yellen, for acting in a politicised manner. It has led to concerns over the independence of the Federal Reserve as well as whether Yellen will remain in post until February 2018.

That adds prolonged uncertainty on top of the near-term economic uncertainty caused by the scant details of Trump’s economic plans. The dramatic market movements where the US benchmark stock index, S&P futures, fell so far it hit its bottom limit, as well as the plunge in the value of the dollar reflected the concerns of investors. Indeed, markets have downgraded the prospect of an interest rate rise next month to 50-50.

But the most significant market movements were seen in emerging markets; notably Asian stock markets and the Mexican peso gave an indication as to how emerging economy currencies were unsettled by Trump’s foreign and particularly trade policy.

Trump has said that he will revisit trade policy, including withdrawing from NAFTA if the agreement doesn’t benefit America, consistent with his philosophy of putting America first. This is an area where the President has the unilateral power to re-negotiate and even withdraw from trade agreements – congressional approval is needed to enter into free trade agreements (FTAs), but is not required to pull out. The same goes for the imposition of some tariffs, which President George W. Bush did on steel, until he was pulled back by the World Trade Organisation.

In a world economy that it already experiencing weak trade growth, a more protectionist US president is certainly worrying for the rest of the world, many of whom rely on selling to the vast American market. For Asian economies in particular, growth depends a great deal on exports, including to the US.

The immediate reaction to Trump’s surprise victory  – polls predicted a Hillary Clinton win when the voting began – was a dramatic fall in global markets, which reflected this surprise but also an underlying concern about where America is headed. Those market declines were moderated as the news sank in.

But what happens next will depend on the policy specifics around Trumpism.

Until we get more detail, there will be economic uncertainty about America, and by extension, the global economy. And that tends to be unsettling.

October 31 Redistribution: The heart of Clinton's plan

Redistribution is the focus of Hilary Clinton’s economic plan centred on ’inclusive growth’. Her proposals aim to raise middle class incomes and reduce the stark increase in income inequality that has seen the middle class shrink even as the economy has recovered and America as a whole has grown wealthier.


Both her tax and trade policies appear to have the same redistribution motivation, but with differing degrees of potential success. Tax policy, as well as government spending, are the core of fiscal policy and are unsurprisingly the main tools to achieve Clinton’s redistributive aims.


Her tax reforms would redistribute money away from the wealthy to fund programmes for the less well-off, including free university education for students from modest backgrounds and more tax breaks to help working mothers and others. She also plans to raise the federal minimum wage to $12 per hour and encourage states to go further, following a key policy goal of Obama.


The funds raised by tax increases would be used to invest in infrastructure. Of course, with record low borrowing costs, the US government doesn’t have to pay much to raise capital on bond markets either. Clinton’s $275bn infrastructure spending plan aims to ‘create good-paying, middle-class jobs in the construction, building, and transportation industries’. After all, raising incomes may work better than actual redistribution to help the middle class.


Clinton’s domestic policies to help the middle class and reduce the inequality that has created the ‘squeezed middle’ may well be effective in raising their incomes without adverse consequences on the overall growth of the economy. It is likely to help America’s growth since the country needs an infrastructure boost and the middle class comprise the core of consumers who keep the economy humming along.


However there are also challenges to achieving these ends. Clinton’s tax reforms add to the complexity of the tax system, a criticism often made even by those who stand to benefit, since it makes it both harder to know what to claim and more expensive to file taxes.


Redistribution without harming growth is harder to achieve in Clinton’s trade policies as presently conceived. Clinton has withdrawn her support for the TPP, concerned about the effects of such deals on wages in middle-skilled jobs that have suffered downward pressure with international trade over the past few decades. Those are, after all, the jobs and wages that she is seeking to support in her overall economic plan.


But, opposing greater trade links is likely to negatively affect economic growth. There are certainly distributional effects from trade – some groups will win, others will lose – even if the overall economy gains. This is even if the trade agreement levels the playing field for standards and other factors that the TPP does cover in part.


The answer to addressing the distribution impact from trade isn’t necessarily found in trade policy itself. It is more efficient, and also likely to be effective, to use domestic policy like taxes and government spending to address inequality. After all, it’s difficult to disentangle the effects of trade from domestic factors that hurt the middle class. And, targeted redistributive policies like the ones outlined above are more likely to succeed.


Undoubtedly, redistribution is overdue as America experiences a vast increase in inequality that has fuelled a rise in discontent in the nation. Clinton’s economic plan has a laudable aim but needs to be carefully administered so that it does not hurt growth, especially that deriving from the global economy. The rest of the world economy will certainly be affected too. 

October 10 Nobel Prize in Economics awarded for contract theory 

Oliver Hart of Harvard and Bengt Holmstrom of MIT shared the top prize in economics awarded by the Nobel Committee this year for their work on contract theory. ​This area of economics allows us to better understand the dynamics behind contracts insofar as there are always two sides of a transaction to consider. It applies to the contract between shareholders and employees, so what makes a firm efficient. Their work also looks at how contracting works more broadly, i.e., how firms and individuals best interact with each other. Applications are thus widespread, ranging from whether public or private ownership works best to how to reduce inefficiencies when designing contracts. Their research also sheds light on when contracts are incomplete, and how best to analyse the situation when contracts are less than optimal. 

October 4 Britain's Brexit plans and the market to watch


Markets certainly reacted after the UK Prime Minister Theresa May and her Chancellor Philip Hammond spoke at the Conservative Party Conference this week. There was some needed clarity over at least some aspects of Brexit. The confirmation of a timetable and importantly, the intent to not be within the Single Market after Brexit has led the currency to drop on the expectation of years of economic uncertainty since Britain will have to negotiate entirely new trade agreements without a template, such as the EEA or Norway model since those nations remain in the European Single Market.


Sterling has fallen to the lowest level since 1985, dropping to $1.277 versus the U.S. dollar which is a 31-year low and falling against all major currencies too. By contrast, stocks are up. The FTSE100 has surpassed 7,000, marking a high point since the Brexit vote, and the more domestically-focused FTSE250 has hit a record high. A large part of the rise is the inverse correlation between the Pound and stocks due to the preponderance of export-oriented listed companies that sell to the global market so their expected earnings are marked higher by a weaker currency. 


But, the market that hasn't shifted by much, and would have been expected to after the Chancellor's speech, is the gilt market. The bond market didn't react to the Chancellor ditching the 2020 budget surplus target and indicated that the UK government may compensate firms negatively affected by leaving the Single Market.


Philip Hammond had, of course, previously suggested that Brexit means fiscal policy will be re-considered. In a sense, Brexit has provided a reason for the new government to change course. But, actually, the global context has also shifted. 


Globally bond yields are at historic lows, fuelled by central banks' negative interest rates and expectations of slow growth in major economies. That is indeed what investors are now looking for: economies that are growing rather than worrying about another crisis in a change from the post-2008 financial and euro crises environment.


That's why the consensus is shifting around public investment, notably on infrastructure. Governments can borrow at negligible rates so it is an opportunity to take advantage of such low borrowing costs to rebuild investment that had been slashed during the Great Recession. Indeed, the Chancellor suggested that he was open to considering investment as separate from day-to-day government spending. The question is will he borrow to invest? Other governments are contemplating the same question.


After all, borrowing to build digital infrastructure or better transport systems is different from current public spending. Markets would be able to discern the difference and not judge all increases in the budget deficit the same. The muted response of the gilt market suggests that is the case and greater fiscal flexibility doesn't trigger "punishment" from the markets with rising borrowing costs.


Still, the Chancellor also hinted that the government would compensate firms hit with higher tariffs in post-Brexit Britain. How he will pay for that, as well as any investment, will matter. We likely won't find out until the Autumn Statement on November 23. And let's see how the bond markets react then.

September 28 Inequality is a global problem. Here's how to tackle it

“Inclusive growth” is a frequently heard term as countries grapple with the recent rise in inequality – even as poverty has fallen sharply over the past two and a half decades worldwide. To give the term meaning requires fashioning growth policies that reduce inequality without resorting to harmful protectionism.

Of course, there is much more to do in order to lift the remaining bottom billion or so out of abject poverty by 2030, as envisaged by the United Nations’ Sustainable Development Goals. Still, the impressive growth of emerging economies in the past two and a half decades has led to inequality between nations falling as poor countries “catch up” to rich ones during an era of globalisation characterised by greater integration of markets.

Because of the relatively faster growth of emerging economies, inequality has fallen across nations as the income gap has narrowed between developed and developing countries. Yet income inequality globally has been largely unchanged. That’s because within countries, inequality has generally risen, or else not improved significantly.

Take America. During the economic boom of the 1950s, the top 1 per cent gained a bit more than the rest – grabbing some 5 per cent of income gains. But since the Great Recession, the top 1 per cent have accounted for 95 per cent of the income gain, leaving the bottom 99 per cent with just 5 per cent of the pie.

Inequality in America has risen so much that the current era has been dubbed a Second Gilded Age: in fact, income inequality has surpassed the peak reached over a century ago. The problem is less stark elsewhere – but inequality is still an issue for many nations. In Britain and others, growing economic disparity has contributed to a backlash against globalisation and even capitalism itself.

The result is the touting by the new Prime Minister of “inclusive growth”, an idea which has also gained traction in America, where both presidential candidates have focused on the “squeezed” middle class and stagnant wages.

But what’s causing this stagnation?

The rise in income inequality can be traced to a number of factors, including globalisation – but that does not suggest the remedy should be found in trade policy alone.

Even if the overall economy gains from trade, there are certainly distributional effects – some groups will win, others will lose. This will happen even if trade agreements level the playing field for standards – something that the 12-nation trade deal known as the Trans Pacific Partnership, or TPP, does address in part.

Modifying trade deals in this fashion is one avenue, but it’s not enough. Trade policy alone is unlikely to address the myriad of distributional effects from trade. So it is more efficient – and also likely to be more effective – to use domestic policy like taxes and government spending to address inequality.

After all, it’s difficult to disentangle the effects on inequality stemming from trade versus domestic factors, such as technological change that rewards the highly skilled more than those workers in the middle of the skill spectrum. Regardless of the cause, targeted redistributive policies are more likely to be effective in tackling the unequal effects on incomes.

One example of a fiscal policy that can aid redistribution and economic growth is government-backed investment in infastructure, both hard (airports) and soft (digital). With borrowing costs at a record low, governments in the US, Britain, Japan, Europe and elsewhere don’t have to pay much to raise capital on bond markets, so it’s a good time to invest.

Infrastructure investment could generate better-paid, middle-skilled jobs, as the sector spans manufacturing as well as the digital economy. In that sense, these policies could reduce the inequality that has created the “squeezed middle” and depressed median wages, raising incomes for certain segments of the population without adverse consequences on overall economic growth. Indeed, better infrastructure and helping the middle class who comprise the bulk of consumers are likely to raise growth.

Even though domestic policies are more likely to be successful, the backlash against trade means that future trade agreements and further globalization are becoming more difficult. The global impact is already being felt.

For decades, international trade has helped developing countries “catch up” by giving them links to advanced economies – which have benefited in turn by trading with new markets. World trade growth is thought to lead overall economic growth – and indeed has outpaced the expansion of the global economy for decades.

But now, according to the World Trade Organisation, international trade is growing more slowly than even the sluggish world economy. On current trends, 2016 will see the slowest pace of global trade growth since the 2008 financial crisis.

That’s worrying for global inequality and emerging economies. The burst of foreign direct investment that has accompanied the growth of international trade since the early 1990s is one of the reasons developing countries grew so well that a billion people were lifted out of extreme poverty, reducing some of the gap between them and rich nations in the process.

For governments, tackling global inequality should be mostly a domestic rather than a trading issue. The consequences of the decisions taken on this in major economies will have global repercussions – and may already. For the rest of the world, the stakes are high.

September 22 Where the UK economy stands after the Brexit vote


The OECD has revised up its latest growth forecast for Britain for this year to 1.8% from 1.7% in their last quarterly forecast in June. It means that Britain continues to outpace other developed economies for this year at least. For next year, though, the think tank for advanced economies has halved its growth forecast for the UK to 1% from 2%. The reason is Brexit.

A quarter on from the UK's historic decision to leave the European Union after a referendum held on June 23, it is a good time to assess its short-term as well as long-term. Economists like those at the OECD believe that the British economy will be negatively affected by Brexit as it means having to renegotiate all of the nation's trade deals with not just the EU, but also the rest of the world. The risk for the UK if it struggles to do is significant given its record high current account deficit, financed by inward investment. 

But, the short-term negative impact hasn't come to pass, it seems. For one, it is too brief a period to assess the effect of Brexit. Indeed, Britain is still in the EU until it invokes Article 50 that triggers the formal talks to leave. Even then, there will be at least two years before Britain leaves the world's largest economic bloc. It means that economically Britain is in the same position as before until it formally leaves the EU. So, there is no immediate negative hit to trade or investment to speak of.

But, it doesn't mean there aren't negative effects from the greater economic uncertainty itself. So far, consumer spending has held up and unemployment as well as employment look much as they did before. The British economy looks to be recovering and not much has changed in three months, including its lingering productivity and low wage growth challenges. Of course, a few months is a very short period of time to assess an economy. Also, in the short-term in particular, sentiment and expectations matter for consumer spending and investment. Since most of the nation (52%) voted to leave the EU, there is cause for optimism among those who see a better future outside the EU.

Still, that better future depends on Britain convincing the rest of the world that Brexit is not the same thing as turning its back on openness and a global outlook. And the uncertainty of negotiating those deals will determine Britain's growth prospects.

In the meanwhile, there are signs as seen in the Bank of England’s business agents survey that some firms are holding off investing and and employing workers. Others are still doing deals, especially with foreign companies taking advantage of the weak Pound that makes British investment look more attractive. The mixed bag reflects how differently individuals respond to uncertainty in a sense. Some are more optimistic and others less so by nature. Business is run by people, so their reactions will also differ.

But, in the longer term, it won't be sentiment but the reality of how trade and investment deals look that will determine Britain's future. The more downcast economic forecasts reflect economists' belief that the UK will be hard pressed to achieve the same level of free trade as before when it is part of the European Union. Only time will tell, but what is certain is that three months is too short a period of time to assess the economic impact of Brexit.

August 9 Would cancelling Hinkley severely damage UK-China economic ties? 

Despite the warning from the ambassador that it comes at a “crucial historical juncture” and that China hopes that Britain will retain its openness, cancelling Hinkley wouldn’t severely damage UK-China ties. 

The relationship is at a critical juncture in any case. One reason is Brexit, as it throws into question Britain’s relationship with the EU. China would want to maintain good relations with its largest export market, the EU, while at the same time work with Britain which is a more welcoming hub in the West than America. 

The relationship is also broader than one project. There would be fallout from cancelling Hinkley, but there are many other ways to signal that Britain is retaining its international outlook after Brexit. That’s essentially what the Chinese will be watching for in the new UK government. And the UK has committed to pursuing trade deals, so openness isn’t in doubt. 

Besides, nuclear energy is a strategic sector that usually warrants additional scrutiny. The government doing so shouldn’t come as a surprise. The Chinese would do the same.

July 11 Infrastructure holds Europe's untapped potential

The European Commission President Jean-Claude Juncker’s infrastructure investment fund, the European Fund for Strategic Investments (EFSI), commonly referred to as Juncker’s Plan, has gotten off to a good start, eliciting pledges from not only European but also non-EU countries like China.


It seeks to raise 315 billion euros over three years, a considerable sum, by working with the European Investment Bank (EIB) which will issue bonds to finance projects that develop energy and other infrastructure projects, as well as improve funding for small and medium-sized enterprises (SMEs).


It’s the right approach to leverage a relatively small sum into an ambitious pool of money. In other words, the EU has put in 8 billion euros on top of 8 billion euros from existing budget funds as well as another 5 billion euros from the EIB. The top AAA rated EIB can then issue bonds, taking advantage of record low interest rates, to leverage the initial 21 billion euros into a fund large enough to make a difference in jump-starting European growth.


The aims are ambitious too. The EFSI aims to work with private companies to do the investment, thereby largely reducing the impact on government fiscal positions. That means that the infrastructure projects are reliant on public-private partnerships, which have a mixed record when it comes to maintaining infrastructure projects long-term, e.g., railways. Nevertheless, the debate over whether governments should be borrowing to invest, and if such capital expenditure should be separately considered in budgets, is not one for this fund.


The focus on SMEs, which are by the far the job creators and have suffered from the banking system re-building itself after the financial crises rather than extending credit, is also pertinent.


So, the focus on investment, with the usual caveats, should be welcome in Europe. After all, it’s well established that rich countries could use a rejuvenation of their infrastructure. Yet, during the last recession, it was public investment, with large hits to infrastructure, that was slashed in austerity programmes.


Investment in the Euro Zone is still some 15% below its pre-crisis level. Yet, ratings agency S&P estimates that greater government spending on infrastructure of 1% of GDP would translate into a bigger bang: increasing the Euro Zone economy by 1.4%. They estimate it’s even bigger in rich countries like Britain, where GDP would expand by 2.5%.


So, why has it been so difficult to raise investment since the crisis?


The main constraint has been the imposition of fiscal austerity by governments focused on the budget deficit. It’s only in the very recent past where economic growth has come back into focus.


So, that largely explains the public side. Private investment has also dropped sharply since the recession.


For instance, German companies have doubled their retained cash in the past decade, and others have followed suit. American multinationals have amassed record amounts of cash on their balance sheets.


The puzzle as to why firms don’t invest is key to understanding how one of the pillars of growth hasn’t delivered during the recovery. After all, government and consumer spending were hit hard and slow to recover, so exports and investments are counted on instead.


But, deficient demand – public and private – haven’t given firms the impetus to invest. The sharpness and the duration of the Great Recession also created uncertainty over whether or not to commit funds for investment that stretches well into the future. Plus, the decimated banking systems in Europe and America took a while to recover, so companies retained earnings to fund their needs just in case.


Now, the economies are largely back on their feet. Plus, the recent focus on growth by not just the European Commission but also governments like Britain’s offers an opportunity. Of course, one of the challenges remains the slowness of the approval process for big public projects. But, even so, the opening up of strategic sectors, like energy, to private investors could offer stable returns at a time when it’s challenging to put your money to work.


In other words, the low returns in the post-crisis environment affected infrastructure investments, like many others. And there were enticing places to put your cash, for those who were investing in stocks in any case. Those were pushed to sky high levels by cheap money and zero interest rates across major markets such as Germany’s Dax.


Global stock markets are deflating from their heady heights, whilst interest rates remain rock bottom in Europe, so fixed income investments continue to generate low returns. And there’s of course also uncertainty around interest rates, since there’s now a divergence between the tightening or normalisation of rates in America while the European Central Bank continues to inject cheap cash and has even set negative deposit rates for the banking system.


In that context, an investment with fixed returns, such as infrastructure, can be relatively more attractive. Traditionally, investing in roads or energy don’t earn high returns but they tend to be stable. Tending to be set by regulators, yields on senior debt used to finance infrastructure such as utilities and toll roads range from 3-4%. In the current low rate environment, that’s not a bad return.


Indeed, BlackRock estimates that insurers are putting 15% of their investment portfolios, double the pre-crisis proportion, into infrastructure in order to gain higher yields.


They’re not the only ones as Chinese businesses have also recently invested in utilities such as water in Britain for similar reasons, a predictable long-term return.


Thus, there are good reasons to consider investing in infrastructure, and thus the EFSI. Aside from China who’s already declared their interest, other countries such as those in the Middle East, as well as private companies sitting on cash may well consider putting some of their funds in Europe.


There’s no shortage of projects being proposed by EU member states for investors to choose from. The potential gains from the investment may well outweigh the downsides of PPPs at present.


Another upside is how much the European economy could be boosted by greater investment. Growth in the world’s largest economic entity would undoubtedly be welcome to the rest of the world.

July 1 What does a post-Brexit future look like for Britain?

As the UK contemplates its future with Europe, what’s needed now is a parallel pursuit of free trade agreements (FTAs) with the other major economies.


Trade agreements take years, as will Britain’s negotiations with the European Union, so the sensible approach is to start talks with the US, China, Japan, as well as the Commonwealth, which includes India, Canada, Australia, and others. Of course, there are others to consider too, but focusing on the world’s biggest economies (US, China, Japan) and the EU is a good start. There’s also the often-overlooked Commonwealth.


Global trade is far from free, so negotiating market access for trade and investment for British businesses is important, especially if the UK is to retain its international outlook that has contributed to its economic growth and strong position as the world’s fifth biggest economy.


It’s worth bearing in mind that countries around the world are pursuing a range of trade agreements.


There’s more attention than ever being paid to new and potential trade deals such as the TPP (Trans Pacific Partnership) between America and Asia, and the TTIP (Trans-Atlantic Trade and Investment Partnership) between the US and Europe. These are led by the US, so the UK would do well to start parallel talks with the world’s biggest economy. Indeed, the Republican Speaker of the House of Representatives of the US Congress has said that he is interested in starting negotiations with Britain as it negotiates Brexit. This is promising, though much hinges on their November elections to take it forward.


Similarly, pursuing a free trade deal with China, the world’s second largest economy, should be a priority too. The UK may be at risk of looking less attractive as a gateway to Europe, but that depends on the EU negotiations. Until that happens, in the meanwhile, it would be sensible to build on the existing strong links between Britain and China to secure a free trade agreement.


In many respects, Britain and China have complementary strengths and needs in their economies. China is seeking expertise in services and high tech industry, which Britain can offer. Britain needs to maintain strong investment inflows due to its persistent and large current account deficit, which is what China’s outward investment push offers. Unlike the EU which has more industry and agriculture to consider, the UK is in a comparably better position to agree a FTA with China. Of course, the detail and protection of losers from globalisation will matter, as well as a range of other political considerations.


China is a tough negotiating partner and has few FTAs. This is also a challenging time for China as it focuses on aligning external with internal priorities around reforming its slowing economy. In any case, having one or at least moving towards a FTA with China would also help with Britain’s negotiations with the EU if the UK can become the gateway to over a billion Chinese customers for EU businesses.


The same rationale of securing FTAs applies to other major economies, such as the world’s third biggest economy Japan.


There is, though, one grouping that is worth highlighting. It hasn’t gotten as much attention, but the Commonwealth is a network that Britain is well placed to pursue more trade with.


After all, economic studies consistently show that among the determinants of greater trade are historical ties, shared language and institutions. The 53 nations of the Commonwealth have that largely overlooked advantage.


Trade among these nations, which range from the rich such as Britain and Singapore to the poorer ones in Africa, has been growing rapidly. Even without being a formal trade bloc, intra-Commonwealth trade was estimated at $592 billion in 2013 and is forecast to surpass $1 trillion by 2020 by the Commonwealth Secretariat.


That’s due to the rapid economic growth, including in trade in these countries, in the past few years. Since 2000, global exports of Commonwealth countries have nearly tripled from $1.3 trillion to $3.4 trillion, accounting for 14.6% of world exports in 2013. In other words, if it were one economic entity, the Commonwealth would be the world’s largest trader, surpassing China.


But, it must be noted that just six Commonwealth countries account for 84% of Commonwealth trade: Australia, Britain, Canada, India, Malaysia, and Singapore. So, these are partners for Britain to focus on, which it can do more efficiently by focusing on the Commonwealth. There are also yet untapped smaller export markets, including some of the fastest growing economies in Asia and Africa.


A shift in UK trade has already been quietly happening. The current and previous governments have sought to develop greater links with faster growing emerging economies. For instance, in 1999, 55% of exports were to the EU. Now, the UK exports roughly more to non-EU countries than to the EU. Britain’s trade with the Commonwealth is less than one-quarter of that of the EU, so there’s room to grow.


Certainly, the faster economic growth of Commonwealth countries offers greater opportunities than before. In terms of share of global GDP, the Commonwealth overtook the European Union in 2010.


A lot has to do with demography. The UN estimates that population growth in the Commonwealth is expected to increase by 29.4% until 2020, while the Eurozone is expected to fall by 1.4%.


Finally, it’s worth recalling in 1973, the UK had to end special trade ties with the Commonwealth because it joined the EU which is a customs union that has common trade rules with the rest of the world. That won’t be a constraint after Brexit.


With a combined population of 2.2 billion across six continents, many of them faster growing than the rich economies of the West, fostering greater trade and investment links with the Commonwealth could prove to be helpful.


Having FTAs with the world’s biggest economies certainly would be important for Britain.


The dust hasn’t settled on Brexit and the European Single Market with its deep integration that eliminates non-tariff barriers through common standards which is economically valuable. The UK has a lot of negotiating to do there.


But, as the saying goes, “plan for the worst, hope for the best.” Britain should be actively securing its place on the world stage through pursuing trade agreements with the other major economies while it sorts out its future with the EU.


June 29 The Brexit trade-off


Amidst the uncertainty around what will happen after Britain’s historic vote to leave the European Union, there is some clarity about the next steps. Boris Johnson, the prominent Leave campaigner and PM contender, has set out his views in a newspaper article in which he says that Britons will have the right to live and work in the EU and the “only change” after Brexit is wresting control back so that we are no longer subject to EU laws. This includes the ability to control migration.

It’s worth remembering that the European Union views the freedom of movement of people as one of the four pillars of the Single Market (the others being the free movement of capital, goods, services), which grants the right to people within it to live and work freely anywhere in the EU. In other words, as a member of the EU Single Market, Brits have the right to live and work in the EU just as those from the EU have the same rights to live and work in the UK.

Is it possible to retain access to the European market but not be subject to EU laws, including the freedom of movement of people? So far, the EU hasn’t granted that to the non-EU countries which have negotiated the right to access the Single Market.

There are 3 countries in the European Free Trade Association (Norway, Liechtenstein, Iceland) plus Switzerland which also has access to the Single Market via a series of treaties in the European Free Trade Association. All accept freedom of movement of people in exchange for their varying degrees of access to the largest economic bloc in the world. Indeed, it’s described as “perhaps the most important right for individuals, as it gives citizens of the 30 EEA countries [EU plus these 3 countries] the opportunity to live, work, establish business and study in any of these countries.”

To give a sense as to how integral free movement of people is, Switzerland’s two year struggle to impose a quota on EU migrants is telling. In February 2014, the Swiss voted in a referendum for controls on EU migration. But, the EU wouldn’t budge on the principle of the freedom of movement of people, so the negotiations have dragged on with no conclusion. Ironically, they are exploring using the “emergency brake” that the British Prime Minister David Cameron had negotiated prior to the EU referendum in the UK that would have restricted in-work benefits for new migrants and potentially lessened the “pull factor” of economic migration to a higher income country.

Remaining in the European Single Market has also been touted by a range of businesses and policymakers, including the Mayor of London, as being crucial in Britain’s future relationship with the EU. Not all Leave campaigners may agree, of course, since some had advocated leaving the Single Market and just having a free trade agreement (FTA) with the EU.

A FTA wouldn’t confer the right to live, study, and work in the EU, so it remains to be seen whether Boris Johnson can deliver on what he wrote.

The Single Market is much more than a free trade agreement. By applying the same rules and standards on goods and services, it frees up trade and investment in ways that allows a business to treat the half a billion people in the EU as a single market for their business. So, it’s not about tariffs but what economists call non-tariff barriers that matter in some instances more, especially for small businesses where the ease of selling across borders can be heavily affected by standards and rules.

And, for businesses, small and large, the European market is important.

The Institute of Directors surveyed its members after Brexit. Of the 1,092 UK firms, a quarter were freezing recruitment, some 20% were considering moving their operations abroad, and 5% even said redundancies were possible.

This reaction reflects the uncertainty that has been seen most vividly in markets, but also importantly for the economy, the big question marks over the UK’s future relationship with Europe.

It may well be that the cost of gaining access to the Single Market is too great if it means accepting the free movement of people. Of course, it’s not just immigration policy. Like the other non-EU countries that access the Single Market, the UK will also have to accept the rules set by Brussels. And that may well be unacceptable since Boris Johnson had stressed that the only change was that Britain won’t be governed by EU laws.

But, that is the unavoidable trade-off: access to the EU Single Market versus control over migration.

Now, if the UK were to gain some, but not full, access to the Single Market, would the EU be willing to permit the UK to retain control over migration and compromise one of its fundamental principles? And what would that look like? Would other EU countries want the same deal or threaten to leave?

The EU hasn’t so far granted any such “Single Market-lite”, but there are those who have argued that Britain is a more important economy than Switzerland or Norway, etc. so the EU will want to sell to the UK and offer more concessions.

On the other side, there are others who insist that granting Britain the benefits of the Single Market without the free movement of people is setting the wrong example for other EU countries who also want to control migration and may leave too. A break-up of the EU is an outcome the EU leaders certainly want to avoid.

We will eventually find out who’s right, but there is no doubt that this is a challenging trade-off with a lot at stake for the economy.

June 20 The one certainty about Brexit 

The one certainty about Brexit is uncertainty. Some hiring and investment decisions have already been delayed since the announcement of the referendum on whether the UK will remain or leave the EU. Now, with just a few days to go, the latest indicator is the volatility of the Pound. Investors’ expectation of Sterling volatility is the highest since the 2008 financial crisis when the entire banking system could have brought the economy down. It’s not quite that high, but currency volatility has been rising. The closeness in the polls as to which side will win is fuelling uncertainty about what will happen to the Pound, which economists expect will fall if the vote is to leave the EU. 

But, investors appear to putting their money on one outcome - a hit to the economy regardless of the result. That’s reflected in gilt yields, the interest rate that the UK pays on its government bonds. Yields on 10 year debt have fallen to record lows – 1.125% is what the government now pays to borrow for a decade. Record lows were also reached for 20 and 30 year debt. For the first time, it costs less than 2% for the British government to borrow for 30 years. 

Bond yields reflect where markets expect interest rates to be, which is affected by the Bank of England base rate and the state of the economy. And those are related. If the economy is contracting or weak, the Bank of England would be expected to cut rates. It’s also influenced by the world economy that affects Britain, which doesn’t look too rosy as globally bond yields have also dropped. Thus, investors point to two main reasons for their global trades: Brexit and the Fed.

So, a lower interest rate in the future signals that investors are concerned about a weaker economy. But, they’re not concerned about the ability of the British governments to pay its debt, which would send yields higher. Confidence in the government alone of course doesn't move yields on longer-term debt as much as interest rates, economic growth, and inflation.

If Britain votes to leave on June 23rd, there will be at least two years of uncertainty while a new deal with the EU is negotiated. Uncertainty tends to dampen economic activity. But, if the Bank of England is right, they expect some continuing uncertainty which is likely to dampen economic activity for a while longer even if we stay in as the economy re-adjusts.

Investors may or may not be getting it right, but uncertainty tends to make people cautious. And, for the economy, that tends to mean being conservative about where it’s headed.

May 20 As the U.S. slaps a 522% tariff on Chinese steel imports, should the world fear a new trade war?

It’s certainly startling that the US has imposed a 522% tariff on Chinese steel. But this only applies to cold rolled steel, which accounted for a tenth of US steel imports last year. The bulk of Chinese steel isn’t subject to this tariff, and neither is most of the trade between the world’s two largest economies. This isn’t the start of a new trade war, but rather a protectionist reaction to the disruption caused by an industry undergoing a painful adjustment. As the Chinese government offers subsidies to cushion the downsizing of the sector and the unavoidable unemployment brought with it, the global impact is worsened. As a result, there may well be more tariffs in the coming months. But such protectionism is not widespread. If anything, the world is trying to agree more trade deals, like TTIP between the US and EU, and the recently concluded Trans-Pacific Partnership between the US and Asia. China is negotiating several too, because trade boosts growth, and all nations know they need more of that.

March 16 UK Budget is a missed opportunity


It is worrying that economic growth has been downgraded for every year until the end of the Parliament to 2% in the final three years, which is below the UK’s previous long-term growth rate. The Government has made economic growth a priority, and put the National Infrastructure Commission at the forefront of its push to raise output. It’s undoubtedly important since economic growth determines people’s standard of living, and it’s an even more important priority as the global economy is weak so more of the growth drivers need to be domestic.

Yet, the Budget seems to be a missed opportunity to align fiscal policy with the growth aims.

With record low borrowing costs, the UK government arguably has some scope to invest and reverse the dramatic declines in public infrastructure spending that had been slashed during the 2008 banking crisis to balance the books. For instance, public investment is projected to fall to just 1.4% of GDP in 2020, which is very low historically and comparatively to other nations. More public spending on housing or transport or broadband can make private investment more efficient. For instance, the OECD has recently called for more such investment as they argue it can generate growth and even reduce debt in the UK.

But, the nature of fiscal rules, and a looming referendum on the UK’s membership in the EU, tied the hands of the Chancellor. The latter may be a political constraint that’s hard to avoid, but the former is self-imposed.

In any case, the government will miss one of those self-imposed fiscal rules that debt will fall as a share of GDP each year of the Parliament to 2020. The reason for the miss is technical. Because inflation is so low, nominal GDP (so the size of national output in cash terms) is smaller than expected. Plus, the real growth rate has also been downgraded by a chunky 0.4 percentage points to 2%, down from last November’s forecast of 2.4%. That means that even though the total debt owed by the government is smaller than the year before, the debt-to-GDP ratio has risen to 83.7% (from 83.3% for 2014-15), and violates the fiscal rule.

Will this matter? There was no violent reaction in markets, borrowing costs didn’t shoot up. It’s, undoubtedly, a tricky line to tow since the reason why fiscal rules, including a new one by Labour and those in the Euro Zone, are intended to convey credibility to reassure creditors, among others.

Yet, fiscal rules often strain to be viewed as credible. It took taking monetary policy out of the hands of politicians and into independent central banks for it to have credibility that made inflation-targeting regimes work.

Politicians can always change their minds, so it’s hard to see how any self-imposed rule could constrain them. Indeed, or what happens if one is violated like in this Budget. So, credibility is needed but the way to achieve that in bond markets is unlikely due to strict fiscal rules that are more often than not broken. Just look at the Euro Zone’s fiscal pact, for example.

It also leads to budgetary tinkering to meet the rules which doesn’t help, as it can be challenging to see how the timing of various announcements such as raising the personal allowance and bringing forward capital expenditure nets out to a budget surplus by the end of the Parliament.

Labour’s new fiscal rule would allow borrowing to invest, subject to the caveat that monetary policy rates aren’t at rock bottom. The previous version under Gordon Brown was chucked when the banking crash hit, so it’s not easy to implement one rule throughout the business cycle which also doesn’t help on the credibility front.

Still, the willingness to invest offers a clearer growth strategy that is only partially embraced by this Budget.

The Euro Zone has a similar fiscal straitjacket and delegates the funding to the European Investment Bank (EIB) using Euro Zone starter funds. That’s how they hope to raise 315 billion euros for investment, leveraged from just 21 billion euros, over three years between 2015-2017. The AAA-rated EIB can issue debt to take advantage of record low borrowing costs and invest in infrastructure to jumpstart growth.

There are issues around which projects will be optimal and the delivery timeframe, but the push to boost economic growth is clear and welcome.

Of course, there were Budget announcements about HS3 and Crossrail 2 which won’t require much funding right now and are geared at growth. Companies such as Sky, though, have argued it’s not enough to focus on road and rail because there needs to be more invested in expanding broadband provision, while business associations are pushing for more spending on skills. All of which require a strategy, with clear funding outlined by the state. That would have been a bold Budget.

But, because of the deficit/debt constraints, the Budget was more cautious even where it shifted priorities in order to help economic growth. For instance, there were further tax cuts for corporations, including reducing the top rate to 17% and eliminating business rates for SMEs, which in effect re-distribute the tax burden from smaller to bigger firms.

Each of these announcements was couched in a “fiscally neutral” manner, so any additional spending is linked to a cut. Even the new sugar tax was couched in the same way.

Given the other fiscal rule that a budget surplus will be achieved by the end of the Parliament, this language isn’t surprising. To meet it though with growth downgraded in every year until 2019/20 will require more spending cuts, another £3.5 billion by 2020. Thus, the Budget had to make changes look fiscally neutral.

That makes it hard to be bold and limits the ability of the Budget to back the Government’s new focus on economic growth. As the Budget is the main instrument of fiscal policy, which is itself the primary economic tool to deliver policies such as growth, it’s a missed opportunity. 

March 15 Risks to the global economy: China and interest rates

China and interest rates are among the issues weighing heavily on the minds of investors and economists. Global markets have been in turmoil and some are wondering if the Fed raised rates too soon.

Equity markets, which are viewed as a leading indicator of the economy at least in the U.S., are reflecting an underlying concern about the global economy. After all, after the Great Depression ended in 1933, there was a second recession in 1937-38. It's been 8 years since the banking crash and Great Recession, but no parallels are perfect. This time, the two engines of the world economy bears watching.

And those risks are evident in the stock market. Of course, the record highs in equity markets were always likely to deflate with the end of QE and a rate rise in America. Still, it's a more complex time now with such great global integration.

Concerns about a slowdown in the Chinese economy amplify the sell-off of commodities. In addition, new US energy production adds to the downward pressure on oil. Yet, in economic terms, there are positive fundamental changes to the world's biggest economies.

China just unveiled its blueprint for growth for the next 5 years and it remains focused on re-balancing and slowing down as befits a middle income country. For instance, services are now more than half of GDP for the first time and outward investment to Europe has hit a record high. In other words, China has moved away from just being the factory of the world to relying on growth based on domestic demand and launching multinational companies. This slower growth will require global adjustment and that's likely to be bumpy.

Dealing with debt and innovation remain challenges that will weigh on investors' minds but that will not be quickly resolved through any government announcements but rather what they do in the coming years.

The other sector that has dragged down equity indices is banks. Negative interest rates across Europe and also in Japan weigh on bank stocks as they're designed to squeeze force greater lending through penalising cash deposits in central banks. Concerns about lending to slowing emerging markets, hit hard by China's slowdown and some by the end of the commodity boom, are another reason.

NIRP or negative interest rate policy also indicates that central banks don't have many conventional tools to stimulate the economy when they already inject cheap cash via QE. So, if there was another recession, there's now less capacity than when interest rates were at previously normal levels of around 5%.

So, there was always going to be volatility when the Fed normalised interest rates. It's compounded by the slowdown in China and continued easing in Europe and Japan.

Each country is doing what they believe to be best for their economies. The sum total though is a risky period in the global economy. 

February 8 Huawei, Xiaomi, and Lenovo will soon snatch at Apple's crown; Leader's slip from top spot may prove to be an omen  


Alphabet, Google’s parent company, this month briefly surpassed Apple as the most valuable listed business in the world — at over $550bn. In the long term, however, both companies may find it hard to hang on to the top spot as the dominant western tech companies face growing competition from China.


Looking at their share prices over the past few months, Google ’s ascendancy had a lot to do with Apple’s decline. Analysts have become more pessimistic about the growth potential of iPhone in markets that are nearing saturation. Apple currently commands one-seventh of the global market for smartphones, ranking second after Samsung

Two-thirds of Apple’s sales are outside the US, however, and it is in those markets the iPhone is facing considerable competition from cheaper brands. Indeed, the next three biggest smartphone markers are all from China: Huawei, Xiaomi and Lenovo. Samsung’s world market share has fallen from one-third to just over one-fifth in the past three years. The gainers are Chinese firms.


While search engines do not face the same saturation issue as smartphones, Alphabet may also face challenges to its dominance in the future. Just over half of its business is outside the US and its biggest product by far is Google, which accounts for two-thirds of the world market for desktop search engines. In second place is Microsoft’s Bing, followed by Chinese search engine, Baidu.


These percentages are reversed in China. In the world’s second-biggest economy, Baidu accounts for 70 per cent of the search engine market and has about 600m active monthly users — which is less than half of China’s population. Internet penetration in China is around 50 per cent and hundreds of millions of Chinese have yet to go online. The US reached that level 15 years ago and internet penetration has grown there to nearly 90 per cent.


Search engine market share is not everything, of course. Google’s email service, Gmail, and other apps have passed a billion monthly active users. And Google’s ability to operate a healthy profit margin through innovative ad sales matters a great deal more that just the share of the market it commands.


It is, however, hard to ignore the question of global reach. Under-developed online markets are in places like China and India. While there are vast differences between a company that is funded by ad sales versus one reliant on smartphone sales, Apple and other technology groups have Chinese firms hard on their heels. 

Alibaba has greater online reach than Amazon: Chinese are happier to buy online than Americans. E-commerce accounts for around one-tenth of all retail sales in China compared to about 7 per cent in the US.


Tencent’s WeChat messaging and calling app has over 650m active monthly users and is catching up rapidly with Facebook’s WhatsApp, which has just passed the billion user mark. Facebook is blocked in China, which has allowed microblogging website Sina Weibo to amass more than half a million users who not only post but use Weibo as a social media site similar to Twitter.


Until recently these Chinese tech firms largely focused on the domestic market, but increasingly they have global ambitions. Alibaba’s record-setting IPO in New York in 2014 is a prominent example, while Baidu is also eyeing overseas expansion and has recently entered Brazil. It is, like Google, developing driverless cars.


Google, Apple, Facebook and Amazon, the big four tech companies, may soon be competing more directly with Chinese firms — Baidu, Huawei, Sina and Alibaba, to name a few.


In the not-too-distant future we may see that Apple’s fall from the top spot foreshadows what other big western tech companies are up against as they seek further growth from global markets.

January 29 UK stock market decline doesn't mean recession


The UK stock market had fallen into a bear market, meaning that the FTSE 100 is down 20% since last April’s high. Worse, it’s at the same level it was a decade ago, so it has lost all of the gains since global central banks unleashed cheap money that has propped up equities since the 2008 global crisis. But, that doesn’t mean that further declines in stock prices, which may well happen, will necessarily trigger a recession.


The UK stock market never attained the highs of the U.S. indices, which saw the S&P 500 and Dow Jones establish numerous records in the past few years. The tech-heavy Nasdaq even breached the levels of the 2000-1 dot com bubble. Likewise, cheap cash injected under quantitative easing also helped push markets from Germany to India to record levels.


As that cheap cash comes to an end, at least in the United States, and the Fed last month raised interest rates for the first time in a decade, it shouldn’t be surprising that the froth is coming off some equity markets, including Britain’s. Indeed, the global stock market, as measured by the FTSE All World index, has also fallen into a bear market. That’s unlikely to be the end.


U.S. stocks are in so-called correction territory, down more than 10%, and may well drop into a bear market this year. There’s still cheap cash supporting equities from the European Central Bank and the Bank of Japan, but U.S. markets have a long way to come down from recent heady heights. Plus, there’s also trouble in the world’s second biggest economy. For China, there will most likely be another market crash. After all, it’s a stock market that’s volatile even during strong growth periods due to the unusual dominance of small, retail investors.


Indeed, the normalisation of U.S. monetary policy is compounded by a slowdown the Chinese economy, which has seen its stock markets already crash twice in six months. China’s global impact has led to widespread declines in commodity prices. Oil prices continue to crash this year, down some 20% in just 3 weeks.


And that’s why the UK stock market is falling. Compared with other major indices, the FTSE has a larger exposure to commodity firms and around half of its listings are international companies, which are more sensitive to the world economy.


But, that doesn’t mean that further stock market falls will trigger a recession. The stock market is deflating, but it was never as frothy as the American or Chinese ones. And for the UK, the hit to the market is coming from largely global, not domestic, factors.


It will be painful to investors as the market may well continue its decline, but the real trigger to watch for is yet to come. When the Bank of England raises interest rates, how the record level of household debt and the housing market fare will be key to how the British economy adjusts to the end of the era of near zero interest rates.

January 29 Are we heading for a crash?


For China, there will most likely be another market crash. Indeed, the normalisation of US monetary policy is compounded by a slowdown the Chinese economy, where stock markets have crashed twice in six months.

China’s global impact has led to widespread declines in commodity prices. Oil prices continue to fall this year, down some 20% in just three weeks. And that’s why the UK stock market is falling. But that doesn’t mean that further UK stock market falls will trigger a recession. The UK never attained the highs of the US stock markets, which establish numerous records in recent years.

Likewise, cheap cash injected under quantitative easing also helped push markets, from Germany to India, to record levels. As that cheap cash comes to an end, it shouldn’t be surprising that the froth is coming off some equity markets, including Britain’s.

January 27 Why the world's most valuable company faces a challenging future

Apple has reported record net profits of $18.4 billion, which beat its own record as the most profitable quarter in U.S. corporate history, after selling a record number of iPhones. Total revenues reached $75 billion for the three months to December, but it’s just a 2% increase which is a rapid slowdown from its previous double digit growth, on the back of the flat-lining sales of its iPhones. Thus, the outlook for Apple is more challenging than ever.

Chief Executive Tim Cook warned that the iPhone, which accounts for more than two-thirds of sales, may drop for the first time since it was introduced in 2007.

It may not be surprising since smartphone sales have plateaued in the United States as well as in Europe. Still, that’s not the only reason since growing competition is also squeezing Apple’s market share in the world’s biggest smartphone market which is China. Domestic Chinese firms, Huawei and Xiaomi, hold the top two spots in the world’s second biggest economy, pushing Apple into third place.

Globally, the competition is also heating up. Apple holds the second biggest market share after Samsung, but the next 3 firms are all Chinese. Lenovo joins Huawei and Xiaomi to make up the top 5.

With two-thirds of its sales outside the United States, global competition certainly affects Apple’s future. But, the unsaturated markets are dominated by emerging markets which may find it challenging to pay a premium for the iPhone. In other words, unlike Android phones, prices haven’t dropped significantly for Apple’s product. And in markets such as China and India where average incomes are much lower than the United States and Europe, cheaper competitors are gaining an edge.

Of course, Apple’s future is in its own hands since tech companies depend on innovation and some argue, product diversification away from the iPhone. Indeed, Apple has highlighted the services that it provides through its data storage iCloud as well as new products like the Apple Watch.

Tim Cook also commented uncharacteristically on virtual reality, saying that it’s not a niche product. Facebook has already pushed into this space through acquiring Oculus, a VR headset maker.

How successful Apple is in pushing ahead with VR or another innovation will determine whether it can hang onto the title of the world’s most valuable company by market capitalisation. Google, for one, is fast on its heels.

January 12 Why China's market crash is so unsurprising

Another slump in Chinese markets has led to global market turmoil. We should get used to it.

One of my predictions for 2016 was that we should expect further Chinese market volatility after last summer’s market crash. I have written before about how the unusual nature of China’s stock markets, which are dominated by small investors and are largely closed to foreigners, makes them prone to volatile behaviour.

The latest market slump has highlighted how difficult it is for policy makers to manage volatility in a transition economy where the stock market is still being reformed.

Last week the Chinese authorities tried to limit the fall of the market through the use of so-called circuit breakers. But halting the trading of shares for 15 minutes wasn’t reassuring to investors — especially retail ones, who saw it as preventing them from getting out of the market — so trading was suspended entirely on Monday and Thursday as well. After these failed attempts to halt the decline, the authorities suspended the use of additional circuit breakers.

But the unusual structure of the equities market remains unchanged. Chinese stocks remain prone to large swings in valuations. The stock market was down by nearly half in the first half of last year, which was when the big August sell-off caused global ripples. Then, by autumn, the market was up more than 20%, so it had swung into bull market territory in a matter of months. Now, in the first week of trading in 2016, it is again falling and will likely remain volatile over the next few months.

Notably, just as in other financial markets, retail investors tend to act in “herds,” where if someone pulls money out to take some profit from the bull market, others will follow, believing that the early movers have better information. And it’s worse in China because, unlike in developed country markets, information is less than transparent and the dominance of state firms means the books are not always easy to check.

The Chinese stock market has regularly exhibited such “roller coaster” behavior throughout its two-and-a-half-decade history. The difference now is that China is the world’s second-largest economy, and its market gyrations are monitored by global investors in companies that depend on selling to China. Indeed, the FTSE All-World Index fell 6.1% last week, which is the worst five-day run since that measure of global stocks was established two decades ago.

Importantly, the underlying concern about the health of the Chinese economy also hasn’t changed in the six months or so since the last market crash. Economic reforms take time, and the latest indications are that the economy continues to slow. Making the country’s growth model less breakneck, supported instead by innovation, is no simple task. And Chinese policy makers’ largely ineffective efforts to manage the financial markets aren’t exactly inspiring confidence.

In other words, reforming an economy of such scale as China’s is a tough task. It will require policy makers to adopt transparent and effective policies to fine-tune the economy, which will be a sea change from the diktats and administrative measures that have largely characterized policy making in the transition economy thus far. For instance, to shore up the market, rather than banning large companies from selling shares, policy makers could use taxes to deter excessive trading.

It’ll be a while before China can manage to find the right set of tools for its transition markets and convince investors that policy makers can manage difficult structural reforms of its economy. Understandably, the stock market isn’t developed enough to expect market-based tools, such as imposing transaction costs, to have the same effect as in developed markets.

But repeated failures in regulating the stock market won’t win back the confidence of either domestic or global investors. Failed policies, like the latest circuit breakers and the previous administrative interventions, instead compound the concerns around the health of the Chinese economy. So we should continue to expect volatility in Chinese markets for a while.

Q4 2015 Ahead of the pack: What could derail the UK's M&A bandwagon

The UK is currently way ahead of the European pack in the M&A market. Indeed, the country accounted for 39% of overall M&A in Europe this year. However, if this trend is to continue and if we are to see continued growth on the island, then there are four key challenges that need to be addressed.  

1. Low productivity

Britain’s low productivity growth since the 2008 recession has been described as “historic” by the Office for National Statistics. The gap between productivity in the UK and other members of the G7 is now wider than any other time since it was first recorded in 1991. While output per hour in the rest of the G7 has recovered and now exceeds pre-crisis levels, Britain’s productivity remains below. Looking across the G7, Britain is around 17% less productive than the US, Germany and France, and only exceeds Japan.

2. Skills shortage

Part of the reason for the stunted productivity is a shortage of engineering and technology talent. According to the Global Skills Index compiled by recruitment group Hays and consultancy Oxford Economics, employers have virtually been forced into a battle for talent. Alistair Cox, Hays' chief executive was quoted as saying: "UK growth prospects are better than they have been in a long time but employers are facing ever-greater challenges around finding the talent they need.” In a knowledge-based economy, where ‘acqui-hires’ are becoming commonplace, this skills shortage needs to be addressed urgently.    


3. Mid-market malaise

Small to medium-sized enterprises (SMEs) and mid-market firms are seen by many as the lifeblood of UK business. They are also vital to continued M&A growth. However, these firms are facing a funding crisis. According to the Confederation of British Industry (CBI), the total stock of medium to long-term (non-overdraft) bank lending to SMEs has fallen by £23b, down 22% since the start of the financial crisis. With banks, the traditional source of funding to this sector, seeking to de-risk their balance sheets, SMEs have turned to alternative lenders such as peer-to-peer funding – but whether this can act as a long-term solution is debatable.

4. Breaking away

The in/out decision in the EU referendum (or ‘Brexit) may take place earlier but it is likely to be in 2017. Most experts believe that this uncertainty ranks higher in the investment and strategic decisions of companies than ‘Grexit’ or the prospect of Greece leaving the eurozone. Markets dislike uncertainty and some firms may put off investment and headquarter location decisions until Brexit is resolved.

As the eurozone builds institutions to support the single currency which could take decades, there will be implications for the non-euro EU countries such as the UK. And this could be exacerbated by the UK breaking away from the EU.  Policymakers will need to fashion a plan to reduce that uncertainty as much as possible.

For Britain, setting out a plan to address these challenges will be key to raising economic growth and keeping the M&A juggernaut on the road.

December 17 What a Fed rate rise means for the world economy


The Federal Reserve raises rates for the first time in nearly a decade and ends the era of zero interest rates. Even though future rate hikes will be gradual, reaching lower than 1.5% in 2016 according to the forecasts by the U.S. central bank, it is signalling an important move toward the normalisation of interest rates. This is widely expected, so it shouldn’t be a shock to the global economy. But that doesn’t mean there won’t be volatility given that the U.S. central bank sets the cost of borrowing for the rest of the world.


What will matter most is what the Fed policymakers set out as the expected future path of interest rates. This will changes but at the moment it is as expected. There will be a series of slow and small increases (just 4 rate hikes next year on current forecasts) since headline inflation remains subdued even as the unemployment rate is around the 5% target level. These are of the course two targets of the U.S. central bank. Notably, Fed Chair Janet Yellen stressed during her press conference that wage growth is still problematic, and that underpins inflation. In any case, she and a unanimous Fed agreed that an initial small rate rise of 0.25% is warranted as they expect inflation to hit the 2% target over the medium-term.


Of course, emerging markets will be watching closely as their currencies are largely pegged to the US dollar. With China, Europe, and Japan respectively cutting rates and undertaking QE or quantitative easing, the world economy faces a divergence in global monetary policy that is hard to manage in their economies even if the path of Fed rate hikes is smooth and slow. In other words, their currencies will be pulled in two directions: moving upward with the U.S. dollar and trying to stay competitive with the RMB/euro/yen. This tricky course has really begun for these markets.


The impact is not limited to currencies and exchange rates. The other signal that markets will take from an increase in interest rates is that the cost of borrowing is rising, so investors will want to take less risk. On that front, the Institute of International Finance (IIF) expects that a net $500 billion has left emerging markets in 2015, which would mark the first net annual capital outflow in decades, since 1988 in fact. 


That may make it harder for some emerging markets which are highly indebted, especially in foreign currency terms, to repay those debts. That’s indeed what the International Monetary Fund (IMF) has warned about, which is the rising risk of a potential crisis given the rapid growth of private sector debt across the globe as cheap cash from QE in the United States, and elsewhere, has inflated asset prices in the world economy. And as that money leaves, will some countries become exposed?


The adjustment to a world where interest rates are no longer about zero will be sizable for major economies too. After all, it’s been seven years when the cost of money has been zero and nearly a decade since anyone has had to adjust to a rate increase by the Fed which sets the base cost for global markets. It was June 2006 when the Fed last raised rates.


For instance, in the UK, the Bank of England has warned that about one-third of households will have to cut their spending or borrow more if interest rates rose to just 2%. That’s about half of the level of the interest rate before the crisis. That is without a wage increase of course, which is another challenge since earnings have struggled to rise since the 2008 recession. The BOE may not follow the Fed straightaway in raising rates, but with the economy in recovery mode and unemployment dropping to 5.2%, which is close to the long-term trend rate, the UK will follow in due course.


For everyone around the world, it’s likely to be a volatile period as economies and companies and households adjust to a period where rates are no longer zero. That’s not the case of course if you’re living in Japan or the Euro Zone. So, that will also be yet another source of volatility as major economies diverge so dramatically in terms of their monetary policies.


Finally, we should of course always bear in mind that a United States that’s getting back to normal will be welcome for the global economy since it’s the largest economy and engine of growth.


But, we should brace ourselves for a more volatile era in 2016.

December 1 Dollar, RMB, euro: A new world economic order

That’s essentially what the inclusion of the Chinese currency, the RMB or yuan, as the fifth global reserve currency in the IMF’s SDR basket, signals. Whether it’s a symbolic or deeper shift remains to be seen.

In a sense, it’s unsurprising that the world’s biggest trading nation and its second largest economy would see its currency become a global reserve currency. But, that doesn’t guarantee that the RMB will rival the U.S. dollar and fundamentally transform the way the world economy operates. In other words, Japan became the world’s second largest economy but the yen never rivalled the dollar.

So, despite America’s major financial crisis, the dollar continues to comprise just under two-thirds of global reserve holdings. Similarly, despite the euro’s troubles since 2010, the euro zone’s currency accounts for around one-fifth. That leaves the other two SDR constituents, the yen and Sterling, which was the previous dominant reserve currency, each comprising less than 4%.

The yen, at one stage, was more important, particularly when it was the world’s second largest economy. But, it never approached the dominance of the dollar. So, the yen is one of the most traded currencies but was not similarly held as a store of value, which is what gives the United States the ability to borrow more cheaply since global investors demand and hold dollar-denominated assets as well as not having to pay for conversion fees for purchases of commodities which are priced in the greenback, for instance. It’s what gives the United States its “exorbitant privilege,” as described by the former French finance minister, Valery Giscard d’Estaing. That’s been the defining monetary feature of the U.S.-dominated world economic order.

It’s noteworthy that the euro has maintained its share of global reserves, which is higher than what the Deutsche mark had when it was replaced in 2001 by the single currency when the SDR basket was last reconstituted. Its second place position reflects a willingness to hold euros as well the size of the euro area as the world’s third largest economy after the U.S. and China.

For the RMB to similarly become held as a store of value, public and private investors will be looking for assurances that it is a stable currency whose value is market-determined, and that there will be greater financial openness in China. They will also want to see further reforms, given the worries over the still state-dominated banking sector that flare up from time to time. However, in one respect, the RMB has already defied convention to become a reserve currency without being freely convertible, though it is widely traded offshore and overtook the yen recently. Still, that is likely to come along with capital account liberalisation as the RMB joins the SDR basket.

Notably, China has recently liberalised its interest rate, which was previously controlled by ceilings and floors on the deposit and lending benchmark rates. That’s a significant step toward allowing the market to determine the cost of borrowing, which should lead to a market-determined exchange rate since interest rates are the dominant factor in valuations.

If that leads to the RMB stabilising in value and China’s financial reforms continue in a manner that promotes investor confidence, then we may well see the day when the RMB share of global reserve holdings rivals that of the dollar. When the dollar overtook the Pound, a new world economic order took hold. If that day arrives for the RMB versus the dollar, then it’ll mark another new era. 

November 27 There's no such thing as an "optimal" size of the state


“Unsustainable” is how the Chancellor described the size of the state in Britain in the latest Spending Review and Autumn Statement. A similar description was given by the German Chancellor Angela Merkel about government spending in the European Union, notably on welfare.

But, actually, there isn’t an “optimal” size for the state. Looking around the world, government spending as a share of GDP, from 2000-2010, ranged from around 20% in Asia to nearly 50% in the EU on average.

Average government expenditure (% GDP)



Developing Asia




Sub-Saharan Africa


Emerging economies


Latin America


Middle East/North Africa


United States


Central and Eastern Europe


European Union


(reproduced from my article in the Oxford Review of Economic Policy)

The Chancellor says that UK government spending was 45% of GDP when he took office, which was too high. It’s now less than 40% and forecast to reach 36.5% by the end of the Spending Review period.

To judge this statement depends on a number of factors. For instance, if government revenues are expected to average between 35-37% of GDP, then spending higher than this level will result in a fiscal deficit. The figures from the Office for Budget Responsibility from the latest report and also earlier ones show that tax receipts and other government revenues don’t exceed 40% of GDP.

So, in that sense, there’s an issue of sustainability if government spending perennially exceeds revenues.

And the revenue side looks remarkably stable. According to the OBR, this level of revenues isn’t expected to change in the next 50 years. By 2064/65, government revenues are expected to be 35.9% of GDP. 

Of course, the reasons for the growth of the state also matter. It’s not just due to the aftermath of the banking crisis. Government spending had been growing before the crisis, which suggests a structural change and therefore the current government’s efforts to reverse it is also an effort to re-shape the size and composition of the state’s role in the economy.

With the cuts, the UK is looking closer in size to the United States, and farther from other European nations. The welfare state, though, means that Western nations won’t, and may not want to, move toward the Asian small state model. With an ageing population in the West, that’s unlikely in any case. But, today’s plans by the Chancellor shows that the UK state is being reconfigured, and the voters will decide in 5 years’ time if they like what they see.

November 25 The useful Trojan horse of the UK productivity puzzle

The British government has placed productivity at the centre of its economic growth agenda. The UK economy has recovered to pre-Crisis levels, but productivity has noticeably lagged behind.

Even if the recent decline in output per worker shouldn’t be a huge source of worry, productivity matters for longer-term economic growth.

So, if it helps the government to focus on what does matter – higher wages, greater investment including in infrastructure – then it’s a helpful Trojan horse.

‘Benign neglect’ of the issue prior to, during, and indeed after the banking crisis is a phrase applicable to both parties when they were in power. The Conservatives will hope that their recent heightened focus – in the budget and via their new ‘productivity agenda’ – isn’t too little too late.

Britain’s productivity puzzle

First, by any number of metrics, UK productivity – output per hour – is lower than it should be based on pre-Crisis trends. The annual declines in GDP per worker since the banking crisis are unprecedented.

But, the other way to think about the past few years is that it’s a job-rich recession. Employment recovered a year earlier than output and unemployment never hit the 3 million mark reached during the last two recessions of the early 1980s and 1990s. So, as less output is demanded, including from each worker, output per hour was lower. Real wage flexibility also helped to maintain jobs. As wages declined, it was possible to hold onto workers. It also suggests that the process can be reversed once demand grows (Pessoa and Van Reenen 2013).

Still, employers hoarding workers instead of laying them off doesn’t explain the entire puzzle (Barnett et al. 2014). Part of it may also be due to the structure of the British economy, with a large services sector where both investment and output are poorly measured (Goodridge et al. 2013). But, the US has a large services sector, so mismeasurement is unlikely to be the whole story either.

Indeed, the Bank of England looked at this issue and concluded that there is a productivity puzzle where output per hour is around 16% lower than expected (Barnett et al. 2014). But, of the 16 percentage points, they can explain around only half of the puzzle, or 6-9 percentage points. The Bank attributes 4 percentage points to measurement issues. Nevertheless, that means a chunk of the productivity puzzle that can’t be explained by what they call ‘persistent factors’, e.g. low investment, inefficient allocation of capital, and ‘zombie’ firms.

Government’s renewed focus on growth

That ‘explained’ portion, unsurprisingly, is the focus of government policy. The appointment of Lord Adonis to head a National Infrastructure Commission signals the importance of investment alongside Lord O’Neill’s focus on linking the Northern Powerhouse.

It’ll take more than investing in rail and other ‘hard’ infrastructure. ‘Soft’ infrastructure is just as important to induce business investment. Britain has been somewhat a mixed bag on this issue. Development of the digital economy has been impressive in some parts. For instance, Silicon Roundabout in London has attracted more venture capital than other European cities. But, there are also areas of the country where even getting a mobile signal is challenging, so this can’t be overlooked as a policy priority. The other significant area of investment is skills. Prominent business surveys have pointed to a skills shortage cramping growth.

So, the government’s focus is in the right direction, but somewhat skewed. Perhaps because of the ambition to rebalance the economy towards making things once again, the focus on infrastructure first targets the ‘hard’ investments when ‘soft’ is just as important.

In any case, prompting private investment is also needed, and that’s tricky. Devolution of taxation powers to local governments amounting to an annual £26 billion in business rates is one way of decentralising decision-making authority to encourage more investment. This has proved to work elsewhere such as in Germany and China, where local banks and authorities have better knowledge and can strike deals more efficiently. But, it can also create inefficient competition among localities, with duplicative activities across localities, protected by local vested interests (Yueh 2013).

Aside from tax cuts, which can help boost private investment, clarity about policies and transparent regulations matter too. Some companies are deterred from making big infrastructure investments, which can actually be attractive due to their fixed returns, by regulations over the amount of capital they need to hold as one example. Others worry about Brexit, which adds to uncertainty over 

Britain’s future access to the EU single market.

Increasing public investment can help there, as it can have a ‘crowding in’ effect. In other words, government investment can make private investment more efficient, e.g. good telecoms infrastructure increases the returns to a pound invested by a private company. Between 2008 and 2011, public investment fell from 3.3% of national output to 1.9%, a decline of some 40%. There is a lot of ground to make up and, more pertinently, will this trend be reversed? A commonly heard argument in the US is over why the US government should take advantage of record low interest rates to borrow and increase public investment. Fiscal constraints should consider excluding investment, which generates future returns, so it’s a distinction worth making.

It’s not just government policy of course that matters for investment. The Bank also identified misallocation of capital, which is a related issue. To invest, businesses need to borrow, and that requires the banks to lend efficiently. It’s less of an issue for large firms, but the vast majority of the country’s businesses are small. A financial system that’s dominated by banks repairing their balance sheets with only a relatively small capital market is also an impediment – one that the US does not face where most of lending doesn’t come from banks. Introducing more competition into the banking system is hard for a relatively small economy. Will the new Capital Markets Union at the EU level help? Lord Hill is leading that development now.

There’s no question that investment is important, but there are also structural issues that underpin the productivity puzzle. Globalisation and the skills upgrading of the economy have affected wages. Cheaper overseas workers plus higher rewards going to those who work in the higher-skill end of the economy have depressed median incomes. Plus, cheaper workers means that companies also substitute workers for capital, which depresses investment, so the issues are all unsurprisingly related.

Raising incomes doesn’t just depend on higher productivity, but raising productivity is the sustainable way to raise incomes rather than relying on debt to grow.

This is why productivity matters even if the recent drop is less of a worry.

The causes of low productivity are not entirely unknown, but the consequences affect our future standards of living. So, if the productivity puzzle has risen higher on the policy agenda due to the crisis, then any reason is a good one to focus on this crucial issue.

November 24 Britain, investment, and Brexit


The former Bank of England governor Mervyn King foretold that there would be 7 lean years after the 2008 financial crisis that followed the 7 years of debt-fuelled strong growth that preceded it. 2015 is the end of that period. So, what about the next 5-7 years?

The General Election this year set out in stark terms the economic challenges facing Britain that have yet to be addressed as the record and promises of the various parties were dissected. For the Conservative government, there will undoubtedly be pressure to address some of the most pressing issues that were highlighted that are key to the UK’s growth over the next 5 years until the end of this Parliament and beyond.

Key among them are the productivity puzzle and the prospect of Brexit or Britain exiting the European Union, which both relate to the challenge of low investment.

Britain’s low productivity growth since the 2008 recession has been described as “historic” by the Office for National Statistics. While output per hour in the rest of the G7 has recovered and now exceeds pre-crisis levels, Britain’s productivity remains below. Looking across the G7, Britain is around 17% less productive than the U.S., Germany and France, and only exceeds Japan.

It is certainly the case that unemployment hasn’t risen by as much during this recession than the loss in output implied. The number of unemployed never reached 3 million as it did in the 1980s and 1990s recessions despite the deeper recession. So, it’s a positive sign that workers have been retained. That may help explain some of the fall in output per worker since more workers were kept on despite the fall in output.

But, the unemployment rate has pretty much bounced back in the U.S. to its long-term trend of around 5% too. So, the post-financial crisis context can’t be the entire reason since the United States was the epicentre of the banking meltdown and its productivity growth has recovered.

But, there is one key difference between the U.S. and the UK. Most of the financing in America comes from capital markets, while Britain, like the rest of Europe, relies predominantly on bank lending. So, while the banks rebuild their balance sheets and lending falls, investment in Britain suffers. Plus, public investment was cut back dramatically as part of the austerity package to reduce the fiscal deficit and low demand likely deterred private investment even by those larger companies with cash to do so.

This was essentially the conclusion of the Bank of England when it looked into the productivity puzzle. Without investment, workers will find it hard to produce more output. And if workers don’t increase their output, then it’s difficult to raise wages on a sustainable basis and therefore incomes.

Above-inflation price increases for much of the past 7 years have also reduced real wages and contributed to stagnant incomes for much of Britain. The latest ONS survey found that household incomes are still below pre-crisis levels and about the same as a decade ago. It’s not just due to the need for household consumption to boost economic growth. Improving standards of living is key to long-term prosperity. And this comes down to raising incomes, wages and therefore solving the productivity puzzle.

For instance, why are firms reluctant to invest? Is there accurate measurement of tangible capital investment versus intangible investment in human capital, especially as the latter may be more important in an economy dominated by the services sector which is more labour than capital-intensive in production? In order to grow by not relying on debt, it is perhaps more important than ever to consume based on income growth, so that is another reason why productivity is important.

The second big economic challenge may not have had a big impact thus far on firms’ willingness to invest, but could in the future. And, Brexit won’t be resolved for a while yet.

The in/out decision in the EU referendum may take place earlier and by 2017. That uncertainty ranks higher in the investment and strategic decisions of companies than Grexit or the prospect of Greece leaving the euro zone in many surveys.

Markets dislike uncertainty and some firms may even put off investment and decisions around the location of their headquarters until Brexit is resolved. That won’t help raise investment in the short term.

But, the longer term challenge is there regardless in one sense. As the euro zone builds institutions to support the single currency which could take decades, there will be implications for the non-euro EU countries like the UK. That’s an uncertainty that will linger for far longer, and it’s unlikely to be resolved through Britain’s Brexit negotiations. So, even as the EU referendum marks the end of one set of uncertainty, the bigger question of the relationship between euro and non-euro countries will likely remain for years to come. Policymaking within such a context will be more challenging than before, but essential to foster confidence, investment, and therefore growth.

For Britain, setting out a plan to address these challenges will be key to raising economic growth and ensuring that the 7 lean years doesn’t become a new reality.

October 23 Britain's productivity challenge: it's not solved by working like the Chinese

Should British workers be prepared to work hard like the Chinese and other Asians who toil in the same way as Americans if the UK wants to be a successful country?


It’s a peculiar way for politicians to discuss Britain’s low productivity dilemma, an issue that has taken centre stage in the government’s newly honed growth agenda.


Firstly, working longer hours isn’t the same as working more productively. And even there, British workers aren’t laggards once you dig into the figures.


Last year, the average annual number of hours worked in Britain was 1677, which was below the OECD average of 1770. The U.S. logged 1789, while Asian economies like Singapore and South Korea regularly top these tables working in excess of 2000 hours per year. China is around the level of its neighbours, at about 2000 hours in large cities, which is more than 40 hours per week.


But, Britain has a higher proportion of part-time workers than other major economies. For full-time employees, the average is 42.2 hours per week, which is in line with Asian economies and also slightly higher than the United States at 41.6 hours per week and exceeds both Germany and France at fewer than 40 hours.


So, it’s not that British workers aren’t putting in the hours. But, it’s hard to measure the productivity of that work when comparing an advanced economy with a middle income one like China. Just based on GDP per worker, the standard measure, China is around one-fifth as productive as Britain. It’s comparing apples and oranges, though, when a middle income country is measured against an advanced economy. In any case, British full-time workers clock around the same number of hours as the Chinese, so a more appropriate metric for the productivity puzzle, i.e., why productivity remains so low while GDP has recovered, is to compare the UK with advanced economies.


Britain is about 78% as productive as the United States. Business Secretary Sajid Javid says if we were as productive as the G7 average, then our GDP would be a whopping 30% larger.


The causes of low productivity are less than clear. The Bank of England attributes around half of the productivity gap to low investment, impaired credit markets, and the survival of “zombie” or inefficient firms.


That still leaves rather a lot to be explained. What is clear is that the answer certainly matters. To raise wages, and therefore incomes and standards of living, requires higher output per worker.


Correspondingly, median wages have struggled to rise. Cheaper overseas workers plus greater rewards going to the higher skilled have depressed median incomes. Plus, stagnant wages mean that companies find it more enticing to substitute workers for capital, which in turn depresses investment, so the issues are all related.


That’s why productivity matters even if the recent declines are less of a worry. Another way to view the past few years is that it has been a job-rich recession. Employment recovered before output and unemployment never hit the 3 million mark reached during the recessions of the early 1980s and 1990s. As less output is demanded, output per hour worked was lower.


But, employers hoarding workers instead of laying them off doesn’t explain the longer-term puzzle where the UK’s productivity has lagged behind the U.S., Germany, and France even before the crisis. Part of it may be due to the structure of the UK economy with a large services sector, where both investment and output are poorly measured. But, the U.S. has one too, so mis-measurement is also unlikely to be the whole story.


The productivity puzzle is a huge question hanging over the British economy. But, working hard like the Chinese is unlikely to be the answer. Now that the average worker works in the services sector and not in a factory, China is facing its own productivity challenge.


An EY survey found that Chinese workers spent nearly half of their time in the office not on work. Over an hour and a half each day was spent on activities that they themselves considered a waste of time. Another 2 hours and 20 minutes was spent on personal activities.


It seems that a good work ethic is a challenge everywhere. 

October 7 Britain's "special relationship" with China


The latest manifestation of the close relationship that Britain is building with China is the announcement that the Chinese central bank plans to issue short-term debt in London, the first time that it’s doing so outside of China.

The choice of the UK is no accident. Wooing China has been part of the UK’s strategy for some time.

London dominates global foreign exchange trading but would find it hard to hold onto its position if the currency of the world’s second largest economy, and its biggest trader, wasn’t choosing the UK.

For China, its currency is on the road towards becoming convertible. As part of its RMB internationalisation strategy, China intends to increase the use of its currency overseas and eventually emerges a global reserve currency.

In the interim, China is choosing where to base its currency transactions and London has so far gained a solid foothold in the RMB business.

For the People’s Bank of China to issue short-term debt in RMB in the City of London in the near future is another step down this path.

There isn’t a great amount of risk in a central bank issuing bills since they, after all, control the money supply.

The other announcement, though, made by the Chancellor George Osborne during his recent visit to China may engender a greater source of volatility. It’ll be interesting to see how far this progresses by the time of the Chinese President’s visit later this month.

The UK is launching a feasibility study to link the Chinese stock market, which is largely closed to foreign investors, directly to the London stock market.

So far, the dramatic double digit falls in Chinese stocks haven’t been transmitted globally, except indirectly by dampening investor sentiment. That’s because few global investors are able to invest freely in the A-share market. It’s one of the reasons why volatility in China doesn’t get transmitted the same way as America’s. But, if the Chinese market becomes linked to London, then London – and global markets – could be directly affected by the gyrations of Chinese stocks. The link between the stock markets of Hong Kong and Shanghai is one example, though the Hang Seng had been subject to shifting sentiment about China for a while due to the number of mainland companies listed there.

In some respects, London has also already borne more of the impact of the Chinese market crisis over the summer than others because it lists a number of commodity companies whose stocks have been dragged down by China.

Still, it’s a big step and one that the UK may well be keen on to cement a “special relationship” with the world’s second largest economy. It’s a strategy that makes sense over the longer term, since the special relationship with the U.S. has been largely a fruitful one for Britain. But, in the short term, any direct links with China will entail a cost of greater volatility. The UK will need to decide if it’s a price worth paying.

September 29 Bank of England and the changing face of central banking

The Labour Party has announced that it would review the mandate of the Bank of England with an eye to adding to its objective so that the British central bank doesn’t just target inflation, but also employment and economic growth, if it gets into power in 2020. The Shadow Chancellor John O’Donnell has given the assurance that it won’t affect the independence of the BOE, which has been one of the key factors that has increased the credibility of central banks since the early 1990s.

But, it is worth refreshing the objectives of central banks, especially as key relationship among monetary policy variables have changed alongside the structure of the economy.

Firstly, the attraction of inflation targeting, which was widely adopted among major economies since New Zealand in the early 1990s, was its simplicity. Central banks that targeted price rises, usually 2%, and only that, were more transparent which reinforced their perceived independence since they would not cut rates to boost growth, for instance. Yet, that is on the table now for the UK. But, it’s worth bearing in mind that the Fed has had a dual mandate: targeting price stability and employment which gave it greater scope to react to lingering unemployment while the economy looked to be suffering from deflationary pressures. The Fed’s credibility wasn’t challenged since the two targets were still clear. Indeed, it helped the U.S. central bank when it attempted to keep rates unchanged while inflation under-shot its target during this slow recovery. Having a dual target could have helped the BOE explain its stance better, especially as it has been under criticism for both over-shooting and under-shooting its 2% target for much of the past six years.

One reason for the need to target both is the difficulty of pinpointing the relationship between inflation and unemployment. The Philips curve has become flatter, perhaps due to globalisation and external factors affecting prices more than before, so that there is a less pronounced relationship between inflation and unemployment. In that case, it may make sense to target both – provided that the target is clear and not a generalised second target around economic growth, which would be more likely to damage transparency.

In any case, like other central banks, the Bank of England has already had a radical facelift in terms of its mandate. The relationship between price and financial stability had evidently broken down prior to the 2008 banking crisis. Low inflation masked the unsustainable build-up of credit in the U.S. and elsewhere, including the UK to some extent. So, the BOE and others have a new mandate to use macroprudential tools to target financial stability whilst also maintaining the inflation target.

The challenge there is not the additional mandate, but the tools needed to achieve it. There is also a coordination issue between the Financial Policy Committee and the Monetary Policy Committee. As that is being worked out, it may be a good time to adjust monetary policy still further if that means that central banks are better keeping up with the changing relationship between money, prices, growth and financial stability. The BOE has been at the forefront of the new paradigm for central banking in this respect, and it could continue to lead the way.

August 27 Here's how to prevent the next China crisis

China’s slowdown is only to be expected for an economy that’s reached middle-income status after three decades of astonishing growth. But Beijing is now worried that, having raised average incomes to $3,000 a year, the world’s second-largest economy will slow down so much that it will never become more prosperous. In other words, China fears falling into the “middle-income country trap” where nations, like many in Latin America, never make it to the top tier of the world’s richest countries. Indeed, only a few, such as South Korea and Spain, have made it into this club since the war.

There are doubts over whether such a trap exists, but Beijing won’t take that risk. What’s more, relying on investment to drive much of its growth has pushed debt levels to worrying levels, so the Chinese government has embarked on an ambitious restructuring of its economy to raise productivity and innovation. It now relies less on old drivers like investment and exports, and more on market forces, as befits a country with a new middle class whose consumption of goods and services can drive growth. But re-balancing the economy and producing innovative companies takes time, and there is no guarantee of success. Compared with other countries that have become rich, China has the added problem of reducing the influence of the state-owned sector, which still dominates key parts of the economy. 

No wonder there are doubts about the ability, and perhaps even the commitment, of the Chinese government to manage a challenging transition. That came to the forefront this week when a slump in Chinese share prices triggered panic in markets around the world. The slump may be a sign that the underlying economy is much more fragile than we thought. The ruling Communist party insists that the slowdown from annual growth of 
10 per cent to 7 per cent is all part of the plan but others worry that the transition is out of control.

Beijing’s failure to stop falls in the stock market, despite recourse to heavy-handed measures like preventing the sale of shares, is proof for many that it cannot manage the broader economy. Others are more sanguine but still worry that China’s slowdown will not be a smooth process. In any case, a slowdown is inevitable and will not merely affect companies producing commodities such as oil and copper but also multinationals selling wealthy Chinese a host of consumer goods and services. 

It has already affected us thanks to London’s importance as a financial centre. Around half the companies listed on the Stock Exchange are multinationals and many international commodity stocks are traded here. They were among the shares — and therefore investors — hit on Monday when the FTSE experienced its worst one-day fall since the 2008 financial crisis.

Britain will also be affected by the health of the world economy, and China is an engine of global growth. According to the International Monetary Fund (IMF), China has contributed as much to world GDP growth as the United States since the early 2000s, and even more than the world’s biggest economy since 2008. 

So, a prolonged Chinese slowdown will be widely felt. For western nations like ours, the sliver lining is that the countries worst affected are likely to be those in Africa and Latin America that export commodities to China. But it’s not just commodities. Imports of capital goods like industrial plant and machinery have also fallen, which will affect countries like Germany, one of our key trading partners.

Just as when the United States enters a recession, there’s not much that western companies or indeed countries can do about China’s difficulties apart from trying to reduce their dependence on it. 

The next phase of China’s crisis is likely to be felt in the wider financial sector, not just in shares. That’s where Britain and other western economies can prepare themselves. As China promotes the use of its currency internationally and begins to integrate its financial system with the rest of the world, the risk of contagion from a crisis in Beijing is growing. At present, this is why China’s troubles has nothing like the same effect a similar catastrophe in the US would have, as we saw when the collapse of Lehman Brothers in 2008 triggered a global recession. We must ensure safeguards protect us from future crises made in China, just as we would with the United States or the euro zone.

This week’s stock market crash isn’t like Wall Street in 1929 or even 2008. But if interest rates in the US and Britain begin to rise in the next year, as many expect they will, while China’s economy continues its bumpy ride to lower growth, it could trigger a second wave of global economic weakness reminiscent of the catastrophic recession of 1937-8 that blighted the world and condemned millions to poverty.

August 26 How a Chinese slowdown will hit global growth


As China’s markets fall and drag down global equities, the underlying concern is undoubtedly how much a slowdown in the Chinese economy will affect the rest of the world. Since the 2008 global financial crisis, China has notably emerged as one of the twin engines of world growth.

China has contributed as much to world GDP growth as the US in the past decade and a half, and even more than the world’s biggest economy since the 2008 financial crisis, according to the IMF. Indeed, the IMF projects that China will generate around double what the US contributes to world output until the end of the decade. Together, the US and China are expected to generate as much world output as the rest of the world put together.

Prior to China integrating with the world economy, the US was the biggest and sole engine of global growth as it accounted for nearly a quarter of world GDP, based on market exchange rates. So, it’s the rapid growth of China, which rose from accounting for a mere 2% of world GDP in 1995 to around 15% now, that helped the world economy grow so quickly in the 2000s.

As China slows from the nearly 10% growth rate that it clocked in the first three decades of its reform period, which began in 1979, to what is thought to be a more sustainable 7% or so, the world economy is likely to slow with it. The main areas where the impact will be felt would include not only commodities, but also consumer goods, including luxury goods.

China’s re-balancing of its economy means that consumption (what consumers buy) will become a bigger part of the domestic economy than investment, and services will become a more important driver of growth than manufacturing. As a result, a Chinese slowdown will affect not just commodities and capital goods, but also global consumer demand and thus the profits of multinational companies in America and Europe. Here’s a breakdown of the most affected:

1. Commodities exporters

The countries most affected by a Chinese slowdown are still likely to be those that export a great deal to China, notably commodity exporters such as Australia. As Chinese demand for raw materials and commodities decline, there will be a knock-on effect in terms of their economic growth.

For Australia, China accounts for around one-third of all exports.

For Sub-Saharan Africa, China is the the largest trade partner, accounting for around one-eighth of all trade. But the impact will be concentrated since five countries account for three-quarters of all of Africa’s exports to China: Angola, the Democratic Republic of the Congo, Equatorial Guinea, Republic of Congo, and South Africa.

China has surpassed the US as the most important trading partner for Latin America, which has traditionally been seen as America’s backyard and therefore most susceptible to the economic fortunes of its northern neighbour. But that is no longer the case. Latin American exports to China have risen to account for a record 2% of the GDP of the region.

As China’s growth slows, its imports have fallen by 8% from a year ago, as seen in the latest data for July, following a similarly sizeable 6% drop in June. The slowdown has been felt in the commodity price falls seen throughout the summer that has led to tens of thousands of job losses by oil and coal companies globally, as well as others.

2. Europe

But, it’s not just commodities. Capital goods imports have also fallen, which will affect countries like Germany where exports to China account for around 2% of GDP. Germany itself accounts for the bulk of EU exports to China so the largest country in Europe, which has recovered on the back of exports, will also feel the impact.

Indeed, the European Union is China’s largest trading partner, and China is the second-largest trading partner of the EU after only the US. So, a slowdown in China will affect Europe, which is also felt in the profit warnings issued by European companies such as Burberry and BMW as their sales in China slow.

3. The USA

Exports from the US to China, by contrast, are less than 1% of GDP. That stands in contrast to Japan where exports to China amount to a large 3% of GDP.

But that doesn’t mean that American multinationals will be unaffected. For instance, the world’s most valuable company, Apple, sells more iPhones in China than the US, and its CEO has reassured markets more than once that the Chinese slowdown won’t negatively affect their business.

4. Financial markets

Finally, the Chinese slowdown has been most visibly seen in financial markets. China’s stock market is largely closed to outside investors so does not have a direct impact on global investors. But, despite rebounding from their initial fall, equities markets are certainly reacting to the impact of a Chinese slowdown.

The UK’s FTSE will feel this most acutely, as it has a large portion of commodity stocks and around half are multinational companies, making it one of the most open bourses in the world. No wonder UK stocks experienced their worst one-day fall since the 2008 financial crisis when China’s market tanked.

Undoubtedly it’s unusual for the world’s second-largest economy to be a middle-income country that is not entirely market-driven. Given the importance of China to the world economy, it’s time to get used to monitoring China as well as the US even more closely and becoming accustomed to the greater ups and downs that are likely to be seen in the global economy as a result.

August 12 This isn't China's Lehman moment -- yet
According to a modern version of Metternich’s saying, when the US sneezes, the rest of the world catches a cold. Does the same now apply to the world’s second largest economy? If China implodes, could it drag down the global economy with it?

China’s stock market has fallen by about a third since the middle of July, and this week it has devalued its currency, the RMB, not once but twice, sending shockwaves through financial markets. Despite the seeming panic, so far prices have only fallen back to the same levels as at the end of March. In any case, fewer than one in 10 Chinese households invest in stocks and shares, and on average the stock market accounts for less than 15% of household wealth. So the tens of millions of small Chinese investors who play the stock market have mostly been betting relatively small amounts and haven’t lost their shirts.


And yet the current situation is worrying. China’s exports have plummeted by more than 8% in the past year, partially thanks to the RMB being pegged to a rising US dollar. A widespread loss of confidence could be very harmful for the economy, which is why the government has stepped in with some heavy-handed measures to stabilise the market, of which currency devaluation is only the latest example.


The measure is partially a symbolic response to the IMF stating that China wasn’t ready to be a global reserve currency: a gesture to show that the RMB is becoming more flexible. The immediate effect, though, has been to compound the global markets’ worries about Chinese growth – and to add a new one. Will China go so far as to launch a currency war to boost its growth?


China’s economy is at a crossroads. The government says that slowing growth is consistent with its plan to restructure the economy. Others worry that the slowest growth rate for 20 years is a sign of a prolonged structural slowdown. After three decades of rapid growth, China is now approaching the so-called “middle-income country trap”: a dramatic slowing of an economy after it has reached upper middle income status, which at present is around $14,000 (£9,000) per capita.


History is littered with examples of countries such as Argentina, where growth slows so much that they never join the ranks of the rich. The Organisation for Economic Co-operation and Development estimates that only a dozen or so countries, such as Korea and states in southern Europe including Spain and Italy, have escaped this trap in the postwar period.


Some dispute whether such a trap exists, but it’s not a risk that Chinese policymakers are willing to take. Its leaders view the slowing economy not as one that is losing momentum, but one making a necessary transition to a more sustainable path – relying more on the domestic consumer and less on the foreign one. The 2008 financial crisis showed the downside of being an export-oriented economy when millions of workers lost their jobs as global demand slumped. China is already the world’s largest exporter and isn’t expecting to gain more market share. Exports will no longer be the growth driver.


With its own newly formed middle class, China now has its own consumption base to serve. Consumption as a share of national output has increased in recent years from 35% to about 50%. For most advanced countries, consumption is around half to two-thirds of national output. So the well-known Chinese saver is now becoming more of a spender.


China, often referred to as the factory of the world, is also rebalancing away from manufacturing. Services have risen quickly to become the largest part of the economy, demand being driven by the fast-growing urban population. For China to emulate its neighbours Japan and South Korea, and break out of the middle-income trap, it will have to raise productivity and innovation.


Technological progress and globally competitive companies are the hallmark of prosperous nations. China has a few, but most sectors operate within rather than at the edge of the technological frontier. To achieve this, reform of legal and regulatory institutions, as well as scaling back the inefficient state-owned sector, are all needed. This takes time, especially as vested interests and culture must also change.


With an ageing population, achieving more output from existing workers becomes an imperative. Without it, the economy will continue to slow and its well-known high level of debt – much of which is owed by local governments – will become unsustainable. That could trigger a bust.


China’s slowdown is already being felt around the world, contributing to a slump in commodity prices. Oil companies have announced thousands of job cuts. And if Chinese consumers stop buying, it will affect a multitude of western and Asian companies selling to the aspiring middle class. Apple’s record results have been driven by iPhone sales in China, which has overtaken the US market. BMW is yet another company to issue a warning about the impact of a Chinese slowdown.


China’s financial system isn’t integrated with the rest of the world in the way the US’s was when the Lehmans collapse triggered a crash in the global banking system. But it is increasingly connected, such as through the RMB hubs that trade the Chinese currency located around the world, including in London. A deep slump will certainly affect global demand and economic growth, perhaps even enough to trigger recessions in some of its trading partners. So if China gets the sniffles, then the rest of the world should probably keep the tissues handy.

July 28 China's abnormal stock market

China’s stock market has plunged yet again, this time by 8.5% – the market’s second-largest fall in a single day, and the largest since the global financial crisis. The roller-coaster ride is far from over.

In fact, China’s stock market is more like a casino than an amusement-park attraction. Retail investors account for 85% of trades, in contrast to other major markets, where institutional investors – with their relative abundance of information – are the biggest traders.

The result, no surprise, is an extremely volatile market, in which rumor and emotion play an outsize role in driving outcomes. And that volatility is the other reason why the casino metaphor applies: China’s stock market can rise or fall by double digits without triggering a wider economic crash – at least so far. For example, China’s GDP growth was unaffected (in fact, the economy was growing at nearly 10%) when the stock market lost half of its value between 2001 and 2005 – or, for that matter, when the market then recovered (only to fall dramatically again after the 2008 financial crisis).

Since then, China’s stock market has been a global laggard – that is, until the past year, when it became the best performing in the world, rising by more than 150%. And yet the roller-coaster pattern continues: the 8.5% plunge came when the market re-opened on a Monday that followed the largest two-day rise since 2008. That rise had been preceded by a loss of nearly one-third of the market’s value from mid-June to early July.

This volatility highlights the challenges of ensuring a smooth process of financial liberalization in China. After extensive government intervention prohibited some selling of shares and froze trading for the bulk of the market, prices rebounded. Yet intervention is unlikely to prevent another crash.

The reason is that the Chinese stock market is not wholly liquid or globally integrated. Moreover, it is dominated by captive money from Chinese savers – the retail investors. Indeed, it was not until 2009 that most shares on China’s stock exchanges were tradable. Until the reforms that began in 2005, two-thirds of shares were non-tradable and held by state-owned enterprises (SOEs) or legal persons, which are typically state-controlled entities. Indeed, private firms still comprise a minority of China’s listed companies, though today fewer than 30% of shares cannot be traded.

To be sure, that has led to a huge infusion of liquidity over just the past few years. But China also imposes capital-account restrictions on portfolio-investment flows, which means that its stock markets remain relatively closed. Until the recent launch of the Shanghai-Hong Kong Connect corridor, which links the two markets, international investors could not directly buy A-shares on the mainland exchanges. Direct purchases remain subject to a quota, in the form of a limited number of so-called Qualified Foreign Institutional Investor licenses.

By the same token, aside from the very wealthy, who benefit from personal connections and other devices, the hundreds of millions of ordinary Chinese savers who have achieved middle-class status do not have easy access to global markets. Moreover, returns on deposits are low (and had been negative), and the state-dominated financial system offers few diversified products. As a result, housing and domestic equities are the main investments available to them.

But then the housing market stalled, as fears of a property bubble spurred a government clampdown on credit, leaving the stock market the place for middle-class savers to put their money. The ensuing boom was a mirror image of the pattern between 1998 and 2001, when the housing market was liberalized and the stock market fell.

The big question now is whether the recent volatility will spill over into other asset markets and the real economy. The double-digit drop in the Shanghai Composite Index since June has not triggered an economic crisis largely because fewer than 10% of Chinese households participate in the stock market, and equities comprise less than 15% of household assets.

But even a small fraction of Chinese households experiencing paper losses still amounts to tens of millions of people. That has caused enough concern for the government to act, including by relaxing collateral requirements to permit real-estate assets to be used to cover margin calls.

It was, in fact, the authorities’ clampdown on margin borrowing, together with a loss in confidence as global markets declined, that is thought to have triggered the market meltdown. And that, too, is a feature of a market dominated by small traders: the “herding” behavior that fuels major booms and busts becomes more prevalent, because individuals assume that others have better information.

The result, as we are now witnessing, is that a moderate sell-off can easily turn into a stampede. And government intervention to block the exits is inadequate. On the contrary, until China’s stock market opens up and its institutional foundation becomes predictable, volatility will be its only guiding rule.

June 16 Making the invisible parts of the economy visible (or why the UK economy may be in better shape than we think)


Services like banking, consultancy, law, education and retail make up around four-fifths of the UK economy. But, it’s output that’s often invisible or intangible, and hard to measure.


And the UK sells a lot of services overseas. Ranked only after the United States, Britain is the second biggest exporter of services in the world. But, it’s known as the invisible trade because it’s hard to see exports and imports of services.


Could making the invisible part of the economy more visible show us that the economy is in better shape than we thought? And that our trade position isn’t as dire as it appears?


Mis-measured national output


Economists are arguing that better measuring intangible assets would increase GDP.


When R&D and other intangible investment were included, U.S. GDP was increased by 3%.


The OECD estimates that intangible investment, including in human capital such as education and software, is as important as investment in tangible machinery and equipment in the UK.


Jonathan Haskel of Imperial College Business School says that if investment in private R&D were counted in GDP, then national output would be increased by around £15 billion. Along with better measurement of other intangible investment, he finds that UK GDP has been under-measured by about 1%.


Even though UK GDP had undergone the most far reaching changes in computation in decades last year when counting drugs and prostitution raised GDP by 0.7%, Haskel maintains that intangible investment is still hardly counted in the official data.


And intangible investment is what most firms in the services sector do. They invest in people. For instance, Sir Martin Sorrell, the chief executive of WPP, one of the world’s largest advertising companies, says that they invest 25 times more in human capital such as training programmes than physical capital in the UK.


Productivity puzzle


The challenge is how to better measure the largely invisible output and input.


It’s challenging to work out what’s produced in an hour by a consultancy versus a factory. It’s also hard to separate out the effects of a price increase or quality improvement. For instance, Paul Ormerod of Volterra Partners explained that his firm could charge double the price for the same consultancy report. In the official statistics, output would look like it’s doubled even though nothing has changed.


And, we all know that there are certainly meetings that could be done away with, but there are also the meetings where things get done. No wonder estimating productivity is hard.


This is why it’s difficult to know precisely how much of our national output is mis-measured.


But, if intangibles were better measured, then that could help explain some of the productivity puzzle. I’ve written before about how low investment is one of the key reasons as to why the UK has had low productivity growth throughout this recovery.


If Haskel is right and only tangible investment has dropped sharply while intangible investment has remained steady, then better measuring this type of investment and services output could show that productivity growth is higher.


More of us work in the services sector than manufacturing, construction, and agriculture combined. If the work of consultants and baristas were more accurately measured and productivity in the less visible parts of the economy proved to be better than thought, then that usually justifies higher wages and incomes.


That would be a welcome change from the years of stagnant wages that’s characterized most of this recovery.


Trade deficit


Better measuring services output also affects trade. The UK has had a stubbornly high trade deficit despite the depreciation of Sterling after the banking crisis. Even if we can afford to buy more from abroad than we sell, the trade deficit shows that there is scope to boost exports of tradeable services which would help pay for the imports of largely manufactured goods and commodities.


Looking at the third quarter of last year when new records were made in trade, exports of services had reached a surplus of 5.1% of GDP. That certainly goes against the picture of a dire overall trade deficit, which is due to the manufactured goods trade. Indeed, the UK’s trade in goods hit a record deficit of 7.1% of GDP in that quarter. It has improved since then but is still squarely in deficit.


But, services are hard to measure. Ricardo Hausmann and his colleague Federico Sturzenegger called services trade “dark matter” named after the physics concept because both are invisible but very important.


If we promoted services better, then that could improve the trade deficit. The consultants, EY, even predict that the surplus in services trade will reach 6% of GDP by 2018 and could push our record trade deficit into balance by then! 


Pro-services policies


Perhaps because of the bad behaviour of bankers and the difficulty of seeing what is produced in the service sector, policymakers have focused on promoting manufacturing.


Re-balancing the British economy hasn’t exactly worked: services have recovered to pre-crisis levels but manufacturing has not.


Yet, there is huge scope for growth in services, particularly in exports. Emerging markets are increasingly becoming middle class and consuming more services, including the types of high skilled professional services that Britain specialises in like education and law. But, they’re also producing competitor firms, so supporting services may become even more important to safeguard Britain’s position as the world’s second largest exporter of services.


Of course, promoting the services sector abroad and at home depends on seeing it clearly.


By making invisibles visible, we may see that the economy is in better shape than we thought, and how we might make it stronger too.

May 18 China, the U.S., and the emerging world order


China is investing tens of billions in infrastructure in emerging markets, focused on the Asian region. Normally, when developing countries have access to much needed funds for investment, there is widespread support. Yet, for China, whose vehicles for this investment include the new Asian Infrastructure Investment Bank (AIIB), the BRICS bank (that is supported also by Brazil, Russia, India, and South Africa) and the New Silk Road fund that seeks to link central Asia to the Far East, it’s not so simple.

How China is doing it is a cause for the scepticism around what its aims are. Rather than going through the established international financial institutions (IFIs) of the World Bank or the Asian Development Bank, China is setting up new development banks (AIIB, BRICS bank) to do so. Retaining control of the funds is one of the reasons since reform of the IFIs has been slow and decisionmaking in these organisations resides primarily with America. This is despite China and other emerging economies being asked to up their contributions to help in the aftermath of the 2008 global financial crisis. That was to be accompanied by governance reform of the IMF and World Bank.

Still, setting up entirely new multi-lateral institutions is of a different magnitude.

Yet, for the second biggest economy in the world to seek to play a larger international role wouldn’t be surprising. It’s certainly a reflection of the rise of China in a global system that remains dominated by the post-World War II Bretton Woods institutions that are run by the West. More than anything, China setting up alternative IFIs is the strongest indicator that the world economy has become multi-polar if not bipolar.

For most of the past 35 years since China adopted market-oriented reforms and re-emerged on the world stage, it has played a limited global role. China preferred to focus on its own development, and was predominantly inwardly focussed. As its growth propelled it to become the world’s biggest trader and an engine for the world economy like the United States, China was urged to pay greater attention to the external impact of its policy choices.

To be clear, China has continually engaged with the rest of the world. And, its one Party state has engendered much of the suspicion around its geo-political intentions. It’s the role that China plays with respect to the global economy that lagged behind its place as one of the main drivers of world growth.

The two are inter-related of course. China’s foreign policy isn’t detached from its economic aims and vice versa. For instance, China’s position as a permanent member of the United Nations Security Council ensured its global geo-political influence even during its weakest economic periods.

But, now, it seems that its economic strength is a driver for China’s growing engagement with the rest of the world. The New Silk Road, the BRICs bank, and the AIIB all seek to cement China’s commercial ties with trading partners from Asia and beyond. Much like its foreign direct investment policies in Africa, China is willing to invest in infrastructure to facilitate trade, particularly in commodities and raw materials. Building a road to transport oil that China has extracted increases energy security, for instance. 

So, building or re-building a trade route that could link parts of central Asia that borders Europe to the Far East and investing in southeast Asia could all facilitate China’s trade and investment on its home turf. By being the source of deep pockets would help cement China’s central position in Asia, and among other developing countries as the BRICS bank extends the influence of these major emerging markets.

This isn’t occurring in a vacuum.

President Obama’s “Asia Pivot” reflects America’s desire to reorient itself toward fast growing Asia. And it’s a pivot that excludes China in notable respects. The most evident of which is the Trans Pacific Partnership (TPP) which would create the world’s largest free trade area that links the United States with Latin America and countries in Asia, including Japan but excluding China.

The U.S. has a long history of engagement in Asia that dates to the Cold War. But, by seeking to reinvigorate its presence in Asia, the U.S. is challenging China on its home turf.

In fact, one of the arguments that President Obama used for the passage of the TPP during the visit of Japanese Prime Minister Abe was that if the U.S. doesn’t stake its position, then it will cede ground to China.

For China, though, this is in its backyard - in the same way that any actions taken in South America are undertaken with an eye on America since that is in its backyard.

This is not to suggest a replay of the Cold War in commercial terms. In the 21st century, this jockeying for economic influence is more subtle and also doesn’t exclude multilateralism. But, it is jockeying nevertheless.

For instance, if China were to join the TPP after its formation, it is more challenging for latecomers as they typically have to give up more to join a trade area.

Likewise, if America were to join the AIIB after its founding members, that include a number of European countries and other U.S. allies like Australia, set up its terms of reference, then its influence and position would be lessened.

At the heart of this jockeying is who gets to call the shots in the new world order where both the U.S. and China are drivers of global economic growth.

Investing, granting preferential trade terms, forging new alliances through new global organisations are all attempts by China and America to cement their influence in a multi-polar world. So, it comes down to who wields power in global decisionmaking.

It may be useful to bear in mind how the presidential scholar Richard Neustadt described power: it’s the power to persuade.

To be persuasive requires more than just cash and trade agreements. It takes leadership and values. That’s perhaps the lesson that both the U.S. and China should keep in mind as they each seek to lead in the global economy of the 21st century.

May 5 The future of business news

There are two words that sum that up: global and digital.

First let us consider global. Businesses are increasingly organised so that their supply chains and markets extend across national borders.

This means that events which happen in one part of the world can have important effects on businesses everywhere.

So, it is vital for business journalists to steer away from closed-economy thinking. Understanding and explaining the connections between consumers, producers, and policymakers in different countries is now essential to covering the beat.

Second, we are in the midst of a digital revolution when it comes to the way news is reported and delivered to audiences. I am not predicting that the end to TV and radio listings is right around the corner, but viewers increasingly want to watch and listen at a time when they want to.

I found this with my own programme, Talking Business with Linda Yueh, where many UK viewers watched via BBC iPlayer. Outside the UK, where the BBC’s on demand service was not available, the programme had multiple showings through the week.

It is inevitable that this trend will continue. The challenge for business reporting in the digital age, though, goes beyond simply making content more easily available online to suit viewer habits.

The prevalence of social media and the internet combined with smart phones mean that people have a huge amount of information available at their fingertips. News audiences are now more informed than ever before, especially in business. When news is reported on mainstream media, for many it is no longer new. Personally, I often find news items from social media and other online sources faster than traditional ones.

Therefore, business news should look to add value for its audience in terms of relevant and rigorous analysis rather than just the reporting of events. It should be a trusted source among the many sources of information from which the viewer can choose.

May 1 Voters and businesses weigh in on Britain’s post-election challenges


For Talking Business, I went around central London and spoke to British voters about whether they had concerns about the economy.


Along with the NHS, taxes and housing were the issues that were mentioned most frequently. One parent that I met was particularly irate that her adult children were still living at home because they couldn’t afford to move out, which she attributed to expensive housing as well as low wages.


Nationwide reports that house prices have risen strongly by 1% over the past month and average house prices have exceeded £190,000 for the first time. Those are the sorts of headlines that lead many to worry about “Generation Rent,” i.e., young people who can’t afford to get a foothold on the housing ladder.


It’s been a decade since the Barker Review which concluded that 120,000 new homes were needed each year to reduce house price inflation to 1.1% per annum. That’s per year, and not the monthly increase recorded by Nationwide and others which have similarly tracked the rise in house prices despite a slow recovery.


To address the needs of social housing requires around 20,000 new homes to be built each year. Altogether, it means that £1.2-1.6 billion of investment is additionally required.


It’s well known that home building has lagged demand, particularly in the past few years. In 2012/13, there were only around 108,000 completions in England, which is one of the lowest house building rates since 1923.


Policies that ease the demand side, including helping first time buyers, without increasing the supply of housing risks generating more upward price pressure. This debate is well-trodden ground as buyers appreciate the help while economists fret over the impact given the supply constraint.


In terms of affordability, there’s certainly an income dimension.


It's another long-standing issue made worse by the fact that wages that haven’t kept up with inflation, which has been a feature for most of this recovery. To sustain higher wages requires greater productivity. In other words, firms can pay more if there is higher output per worker.


The productivity puzzle in the UK that centres around why output per hour remains below what it was in 2008 when the rest of the G7 is now about 5% above that pre-crisis level is a persistent one.


I’ve written before about this puzzle (please link to my blog) and part of the explanation is the dramatic fall in investment since the 2008 recession. But, there’s likely to be more to it since other post-banking crisis countries like the U.S. have recovered better.


In any case, the end result is a squeeze on incomes, and thus the irate voter that I met whose children can’t afford to live outside the family home. It’s an all too familiar tale.


The budget deficit and Europe were also mentioned, but these weren’t of the greatest concern for voters.


By contrast, these are major worries for business.


In terms of the fiscal deficit, there continues to be a divide between those working in markets – which want to see a clear plan to close the gap between government spending and revenues – and some academic economists who fault austerity for prolonging the recovery. This is certainly well-covered ground.


In terms of Brexit – Britain’s potential exit from the European Union – it figures prominently among the concerns of the business community. Grant Thornton conducted a survey among global businesses and found that Brexit was more of a concern than Grexit – the potential exit of Greece from the euro zone.


That may be surprising since Greece and the euro crisis have dominated headlines for years, and has triggered some fairly seismic changes in Europe, including the formation of a Banking Union and now a Capital Market Union.


Yet, Grant Thornton finds that nearly two-thirds (64%) of businesses believe that Britain’s exit from the EU would negatively affect Europe, as compared to just under half (45%) who believe that Grexit would have a negative impact. Among non-euro EU members, the figures are even higher where nearly four out of five businesses (72%) believe there to be a negative impact from Brexit.


This is consistent with research from the Centre for Economic Performance (CEP) at the LSE which finds that Brexit would cause a loss of national output of 1-3% per annum for Britain. A study by two German think tanks, Bertelsmann Stiftung and the ifo Institute, concurs and also finds that there will be a negative impact on German income until 2030.


For businesses such as those represented by the British Chambers of Commerce (BCC), there is support for re-negotiating the terms of Britain’s membership of the European Union. But, that is short of Brexit.


In the City, I’ve heard repeatedly that a potential referendum by 2017 leaves the situation uncertain for too long. After all, it’s a frequently heard phrase that markets don’t like uncertainty.


We may get some clarity about an EU referendum after the election, but the questions around Britain’s relationship with a reforming euro zone are likely to linger.


Former European Central Bank President Jean-Claude Trichet told me to not underestimate the institutions that have developed in the euro zone. He says it’ll take time for Europe to evolve and it won’t be entirely like the United States, but he described it as eventually evolving into more of a federal structure. So, it won’t be the United States of Europe anytime soon, but that is one direction of travel.


If the euro zone moves in that direction, then it raises a number of questions about where that leaves the non-euro European countries like Britain. Does it mean negotiations each time there is a new institution or major policy decided in the euro zone? How much sway would Britain possess when the euro zone decides on a rule for capital markets, for instance? Recall that Britain failed to block a financial transaction tax in Europe.


Thus, for the UK, there are certainly long-term economic challenges that will need to be addressed – by whichever party (or parties) come into power after the General Election.


May 1 Raise wages, raise growth?


We have the first indications of where economic growth is headed in the second quarter for major economies, such as Britain. And, the initial signs are worrying as to whether there will be a growth pick-up in the second quarter.


Today’s PMI releases paint a weak global picture for April.


PMIs are surveys of purchasing managers which reveal whether their businesses are expanding or contracting. The manufacturing sector isn’t looking particularly rosy in the latest figures.


Britain’s PMI reading was 51.9, which was a big drop from March’s 54, and the lowest in 7 months.


PMI was expected to remain at around 54, so it was a surprise to markets that manufacturing fell at the sharpest pace in 2 years.


Coming on the back of surprisingly weak growth in the first three months of the year of just 0.3%, it’s not a great start for those looking for signs of a pick-up in the second quarter.


Recall that the U.S. economy has come nearly to a standstill in Q1, growing by just 0.2% on an annualised basis, so it’s not just Brits looking for indications of stronger growth.


This reinforces the doldrums that many already feel that the recovery just lacks momentum. A stronger Pound as well as U.S. dollar played their parts by affecting exports.


But, a key reason is likely due to tepid consumption since consumers aren’t buying like they used to. After all, consumption comprises over 2/3rds of GDP. There’s likely to be a number of reasons for that, but one of the main reasons is likely to be weak wage growth.


Real wages have fallen every year since the 2009 recession and median pay is still some 10% below what it was before the crash. It’s an issue in America too where pay also hasn’t recovered, and there have been massive protests over the minimum wage across U.S. cities that I’ve written about before.


It’s one of the reasons why GDP per head still hasn’t recovered even as aggregate GDP finally has to pre-crisis levels. It’s worth noting that not all of the components of GDP have either. Services output is now above 2008 levels, but production, construction and agriculture remain below. So, it’s also a skewed recovery.


Focusing on wages, what would it take for pay to rise?


Higher output per worker, which goes to the productivity puzzle in Britain which I have written about (please link to my blog).


Greater demand for products, which for Britain also depends on global sales and those don’t look too healthy either. I’ve already mentioned the U.S., the world’s biggest economy. Today’s PMI figures also show that China barely came in above 50 and Japan fell just below it, so the second and third largest economies are also not growing that well. The Euro Zone continues to struggle.


So, global demand isn’t looking too rosy. That leaves domestic demand; in other words, consumers. That brings us back to the positive impact of higher wages and thus higher disposable incomes.


It’s an issue not just for Britain, but also the U.S. and other major economies.


Raising productivity and wages has the potential to create a virtuous circle of higher demand that feeds into more exports, so that there’s positive spillover among the biggest economies. Right now, unfortunately, it’s weakness that’s spilling over, making for a tepid start to the second quarter. That raises doubts as to whether the UK and US will achieve their forecasted growth rates for this year.


It’s not the only factor that will impact whether growth will gain a stable footing this year.


But, it does mean that addressing lagging wages could help ensure that economic growth picks up in the rest of the year.


April 30 Light at the end of tunnel for Shell?


That would be what oil majors like Anglo-Dutch giant Shell would want to see as their first quarter profits fell by a notable 56% to $3.2 billion. The $7.3 billion earned in the same quarter a year ago seems a distant memory which was before the big oil plunge that began last summer.


Their earnings would have been worse if not for an increase in profits from downstream refining and trading, which rose to $2.6 billion from $1.6 billion last year. It helped Shell to generate figures that were better than what analysts had been expecting, which was that profits would fall to $2.5 billion or so. After all, oil and gas production earnings fell dramatically to just $675 million from $5.7 billion. Because of coming in ahead of expectations, share prices initially rose on the news.


This is a similar to what BP and Total have reported – downstream earnings cushioning the impact from a significant drop in earnings from production. The factors at play are familiar ones. There’s greater supply in the U.S. which has not been offset by Opec. Plus, weaker global economic growth and therefore demand have contributed to oil prices dropping from more than $115 per barrel last summer to about $66 now, which is the highest this year.


That’s where there are some signs of stabilising oil prices. But, I should stress, there are more signs of volatility than stability and here’s why.


Brent crude has rallied in the past month and even approximates a bull market.


Oil prices have risen by around 20% since the middle of March from less than $55 per barrel to $66 at present. It helped the euro zone escape deflation in April as consumer prices registered 0% change from a year ago, rising from -0.1% in March.


But, it’s not the only surge by oil price rises this year. Prices rose from just over $50 per barrel by around $10 between mid-January and mid-February only to plunge again in March.


So, there is likely to be continued volatility while the sector adjusts.


And that is indeed what the oil majors are doing. Cutting investment by billions in places like Africa and Qatar, selling assets, and reducing costs are among the measures being taken by Shell, Total, and others. Also, the number of oil rigs has fallen by more than half in the U.S. and shale producers focus on the most productive sites. There’s of course also the response from Opec which are closely monitored, particularly as the landscape shifts around Iran.


The International Energy Agency sees the outlook for oil prices as getting “murkier” while the global oil market adjusts.


One example of the divide in opinion is seen in markets. Hedge funds have placed a big bet on an oil rally, while oil producers have rushed to lock in contracts to protect against future price falls.


For Shell in any case, they are moving ahead with their takeover of BG Group for £47 billion that I’ve written about before. So, at least one trend appears to be intact, which is the move to consolidate. It suggests that oil majors will be a big part of a year that’s shaping up to be one characterised by mega mergers. At the end of that particular tunnel, Shell and the rest of the oil industry could look very different by the end of the year.


April 29 First casualty of a strong dollar: US growth


The latest GDP figures for the US shows the economy has virtually ground to a halt as Q1 growth was just 0.2%. That’s 0.2% growth, on an annualised basis so that means that there was negligible growth in the first three months of the year relative to the previous quarter.


The biggest drag on that growth was exports. Exports fell by 7.2% with a drop of over 13% in terms of selling goods overseas. And that’s the impact of a strong U.S. dollar as well as disruptions at America’s biggest ports that affects trade.


The dollar has risen on the back of expected rate rises by the Fed, and has hit the highest level in over a decade against its trading partners.


That has hit the ability of US exporters to sell their wares overseas. Tellingly, services exports continued to grow by 7.3% since selling services isn’t very dependent on the price but rather rely on the quality of what’s proffered. It’s also not dependent on ports.


A strong dollar, though, helps consumption and imports registered positive growth of 1.8%. In other words, a strong dollar makes imports cheaper and keeps down price rises. Those imports feed into consumption, which expanded at 1.9%. That’s not the strongest growth rate, since there are also reports that cold weather makes consumers less likely to venture out and buy. But, it’s nevertheless a positive growth driver alongside investment, which also expanded by 2%. The final component of GDP, government spending, contracted by 0.8% due to continued cutbacks by state and local governments.


So, what growth the U.S. economy eked out was due to private consumption and investment.


And that’s been the traditional driver of the US economy – consumers. And, economists are already predicting that American consumers have completed their deleveraging process, so the engine of growth may well return later this year.


And thus the prediction that the Federal Reserve will begin to normalise, i.e., raise interest rates, later in the year.


For now, the impact of anticipating rate rises has strengthened the U.S. dollar since markets anticipate and “price in” what’s expected to happen.


And that has dented growth now.


For the Fed which concludes its 2-day policy meeting today, any signal that these figures are causing a re-think of when rates may rise will surely be closely watched.


And, markets are likely to again price in what that means.


In any case, the U.S. strong dollar policy which has favoured consumption over exports is likely to remain unchanged. After all, the United States is largely driven by consumption and a strong currency makes buying imports affordable. Besides, its services exports again are unlikely to depend on the value of the dollar so that surplus is intact even in today’s release.


For those reliant on the U.S. coming back as an engine of growth, the hope will be that this quarter is indeed just a blip due to the currency.


April 28 What Apple and Standard Chartered have in common


What do 2 big American and European multinational corporations have in common? Not much on the surface when comparing consumer giant Apple to the FTSE-listed Standard Chartered bank.


But, both have been significantly affected by emerging markets in their first quarter earnings. And how they’ve been affected is revealing of the maturation of emerging economies, particularly in Asia.


The emerging markets-focused bank, Standard Chartered reported a big fall in pre-tax profits of more than one-fifth in the first quarter (22% to $1.47 billion) as revenues fell by 4% and costs rose by 1%.


By contrast, Apple had a strong quarter where revenues rose by 27% to $58 billion, driven by a 40% increase in sales of iPhones. More than 61 million were sold globally, and notably, the biggest market was China for the first time and no longer the U.S. But, iPad sales fell sharply by 29%, and reflected an overall weak spot in their figures.


So, it’s a really tale of 2 emerging markets.


One side of emerging economies is a concern over their slowdown in growth which raises risks over loan repayment, not just in Asia but also commodity-exporters in Africa and the Middle East.


These are Standard Chartered’s key markets. Indeed, Standard Chartered took a $476 million charge on bad loans which is 80% higher than the first quarter of last year but loan impairments were lower than in the previous 6 months.


There’s the consumer side of emerging markets too though to consider.


For Apple, China’s rapidly growing middle class generated an impressive 72% increase in sales of iPhones. And, Greater China has even overtaken Europe to become Apple’s second largest market for the first time as revenues rose by 71% in that region to reach $16.8 billion, which accounts for much of Apple’s strong performance. Net profit was a third higher at $13.6 billion for the quarter.


So, as emerging markets, particularly in Asia, become middle income countries, companies that sell to those emerging consumers are well-positioned to benefit.


But, the period of rapid economic growth, particularly via debt-heavy investment, of key emerging markets is seemingly over. And companies, particularly banks, are liable to struggle as those economies restructure toward being increasingly driven by consumption.


Forecasts by the OECD and others project that more than half of the middle class in the world will be in Asia within the next decade. Middle income countries grow more slowly than those that are poor and industrialising. So, that’s perhaps the biggest adjustment for multinational corporations and others to make.


One thing is clear, we’re increasingly seeing the impact of emerging markets on the earnings of Western companies such as Standard Chartered and Apple. And that is likely to continue.


April 28 Why trade tops the agenda as Abe meets Obama


Could the biggest free trade area in the world be announced this week?


Well, it’s unlikely to be this week, but that’s the ambition that sits at the top of the agenda as Japanese Prime Minister Shinzo Abe undertakes a week-long trip to Washington.


It’s being termed a historic visit as Abe is the first Japanese PM to be invited to address both houses of Congress on Wednesday, and any remarks that he makes on the 70th anniversary of World War II will be closely monitored.


Yet, for Abe and perhaps also US President Barack Obama, it’s their progress on a trade deal that is at the top of the agenda.


Abe has said that they are near agreement on the Trans Pacific Partnership (TPP), which would create the largest free trade area in the world, linking the countries in Asia Pacific ranging from central America to southeast Asia. I’ve written before about the ambitious TPP (please link to blog which gives the numbers), which notably excludes China – a notable exception at that.


Given all of Japan’s economic challenges – struggle to defeat deflation as price increases have fallen back to zero – and low productivity to name a few, would a trade pact really make a huge difference?


Estimates by economists put the gains at 0.66% of GDP that increases to 2% by 2020 if factors like foreign direct investment are included.


For an economy that is struggling to grow, these are not huge amounts but certainly not negligible.


So, why is it the big focus in Abe’s visit to Washington?


For one, it’s a tangible example of a structural reform that is the crucial third arrow of Abenomics – Abe’s ambitious reform plans that includes three arrows. Monetary and fiscal stimulus comprises the first two arrows, but it’s the third one that is the key one to raise economic growth that has come under criticism for lacking focus. In other words, there are numerous policies that have been put forward by the Abe government, but few concrete initiatives to cite. One exception is Womenomics, where increasing female labour force participation to the same rate as men’s would add some 14% to GDP. Even with respect to that policy, it’s unclear how it can be achieved.


So, a new trade pact that puts Japan at the centre of the world’s biggest free trade area certainly has its appeal.


But, it’s not only up to Japan – the U.S. also has to agree.


And, it’s not just the usual hurdles of opening up agriculture or the auto sector to contend with. TPP has been described in U.S. media as “NAFTA on steroids.” The North American Free Trade Agreement was a contentious free trade area linking the U.S. with Canada and Mexico under the last Democratic president Bill Clinton. Free trade has been blamed for the loss of U.S. manufacturing jobs, for instance.


But, before that stage, President Obama also needs “fast track authority” for trade negotiations. The TPA allows the President to present to Congress an agreed trade deal and they can’t pick it apart. Unsurprisingly, it’s key for getting trade deals through Congress. One is in the works but is unlikely to get through Congress by the end of May much less this week.


For President Obama’s Asia Pivot where he’s reorienting American foreign policy more towards Asia, the TPP is a centrepiece. And one of the few areas where he may indeed be able to claim a legislative victory given that the Republican-controlled Congress makes it tricky for his last 2 years in office. I understand that the President may well be relying on Executive Orders like what he announced on immigration to put forward policies.


So, for both Japan and the U.S., a win on the TPP would be welcome.


For Abe, walking away with a concrete example of an economic policy that will boost growth would certainly make his historic trip to Washington worthwhile.


April 27 America’s place in a multi-polar world


At a global conference a few years ago, former US Treasury Secretary Larry Summers revealed that Americans would really prefer to be the G1. So, not the G7 grouping of the biggest economies or even the G3, but rather the G1 when America would be the sole decisionmaker. It may not be too surprising since the U.S. has been the sole economic superpower for most of the post-war period. 


But, times are changing.


A big sign of the shift was when the British and other Europeans as well as allies such as Australia and Korea all signed up to the China-led Asian Infrastructure Investment Bank (AIIB) to be founding members. Their actions were over the objections of the Americans who are not only concerned about China leading the AIIB which is a competitor to the World Bank, a multilateral institution led by the U.S., but also about not being consulted beforehand by the Brits who have a “special relationship” with America.


I was reminded of this when I was recently in Indonesia chairing a session at the World Economic Forum. The Chair of ASEAN, the organisation of the 10 nations of Southeast Asia, confidently told me that the ASEAN Economic Community (AEC) that they are concluding by the end of the year will rival not only the European Union, a single market with a similar population, but that the AEC will rival the United States as well.


It struck me that for countries who were rescued by the Bretton Woods institutions based in Washington DC (the IMF, World Bank) just a decade and a half ago during the Asian financial crisis, it was quite a shift that southeast Asia saw themselves as competitors to the world’s biggest economy.


The confidence of Asians – not just the Chinese but other Asians too – was notable.


Just a decade or so ago, Asians couldn’t push through the establishment of an Asian IMF in the aftermath of their financial crisis as America objected to competing multilateral organisations. Now, there’s not only the AIIB, there’s also the BRICS bank that is set up by the emerging markets of Brazil, Russia, India, China, and South Africa. 


Perhaps that’s one sign of declining influence. After all, America as the sole superpower holds effective vetoes over the main multilateral institutions which have led not only development but how countries are rescued and economies are managed for most of the past century. Those days look numbered as China in particular wields its economic muscle globally.


If a country doesn’t like the programmes offered by the IMF or World Bank could presumably go to the AIIB. Though the Chinese would insist that the AIIB is focused largely on Asia and infrastructure; though the World Bank started out focused on reconstruction in Europe, so institutions evolve. And the changes are in one direction: towards greater control by China of international policies.


For some economists, this isn’t surprising. The weight of global economic activity has been shifting East. The IMF finds that China has as important a driver of global growth as America, and that trend is set to continue even with the slowing down of Chinese growth.


Having another engine of demand surely helps a world economy that is struggling to get back to robust growth rates after the 2008 financial crisis. Wouldn’t Americans like to have other nations shoulder some of that burden?


That’s a question that I have posed to American audiences over the years. Wouldn’t it be better not to have all of America's actions scrutinised for global impact? Ending quantitative easing and raising interest rates because it suits the U.S. economy wouldn’t be a subject of criticism, for one.


Of course, America will remain in the spotlight because despite being challenged, the U.S. is still the most important economy and its policies hold worldwide consequences. Even if China overtakes it in terms of aggregate size, Americans will be richer in per capita terms and therefore be a more important consumer market for the rest of the world for some time to come.


But, it’s the relative decline of power that stings. After all, the Brits and other nations decided that any political repercussions from a displeased America weren’t enough to outweigh the economic gains of supporting China. Other nations are hedging their bets as they position themselves in a new multi-polar world where the U.S. is no longer the sole economic engine.


To be clear, they’re not turning their backs on America. The U.S. remains important – not just economically, but in political and military terms. 


But, for the U.S., it’s hard to get used to not being the sole superpower. The AIIB and BRICS bank sitting alongside the World Bank and IMF will be stark reminders.


Britain was overtaken by America in the early part of the last century. Perhaps there are lessons to share there.


April 23 The Great Unbundling: Google, Uber, HBO as the “disupters”


Google and Uber are the latest tech companies to disrupt how services are provided. “Unbundling” describes how mobile technologies and social media are affecting the products offered by traditional businesses.


Google as a mobile phone company


Google’s “Project Fi” is offering mobile phone services on its Nexus phones. It launches the web search engine into the mobile phone industry with a competitively priced offering: $20 per month for phone and texts and another $10 for data services.


Significantly, customers only pay for the data that they use, so it breaks apart the bundled mobile packages offered by traditional providers like Sprint and T-Mobile.


Google is using their infrastructure and targeting just their core customers, so it’s not a big venture but a notable one as it “disrupts” the standard offerings with an unbundled package. Usage-based pricing has the potential to disrupt the industry.


Uber as a shopping service


Similarly, the co-founder of Uber is taking on e-commerce giants, Amazon and eBay, with the Operator app.


The concierge service offered via the app is a combination of human expertise and algorithms to let people replace say a pair of shoes at the touch of a button.


Operator bets that the human touch will make its service superior to the current e-commerce firms and is a standalone service that doesn’t require an infrastructure of products since it will partner with retailers.


The service takes aim at Amazon whose Dash button to re-order washing powder at the touch of a button, which I’ve written about before as an example of the other big trend which is the Internet of Things.


Operator believes that for clothing and home décor, having a human working in conjunction with the algorithms that’s the industry norm will be a more appealing service.


Of course, that’s also more expensive and relies on retailers having enough workers to answer queries from the app. Still, Uber drivers already deliver food so could also do so for these goods so a speedier delivery could be expected as compared with the postal services of e-commerce sites.


In any case, it is a disruptive force in the online/offline retail industry that unbundles the way that business is done by combining the algorithms offered by the former with the human service of the latter.


Future of TV is online?


Perhaps the most notable example of the unbundling of services, and potentially the most disruptive, is found in the media industry.


We increasingly live in an on demand world. We watch TV shows and news videos when we want, for instance.


So, HBO has launched a service called HBO Now which allows subscribers to select the channels that they want to watch in a streaming service initially offered on Apple TV.


It unbundles the cable packages where consumers have had to buy packages of channels, and disrupts the traditional cable and satellite operators like Time Warner Cable.


It compounds the challenge confronting these media companies as customers increasingly watch shows online and are moving away from subscription TV.


It’s not the only one. Sony and Showtime are also jumping in with standalone version of their premium channels to be viewed online. CBS is also offering a paid streaming service for its shows.


The rapid growth of Netflix, which also offers original programming only online, to a record 62 million subscribers is a prominent example. By comparison, there are about 100 million pay-TV homes in the U.S. But, U.S. households are “cutting the cord” as the numbers of pay TV subscribers have been falling in the past couple of years. America’s largest cable company, Comcast, may even have more Internet than TV subscribers as the former surged to 22 million while the latter declines.


On demand world


When I interviewed Steve Forbes, the media mogul, he predicted that the only thing that we will watch live is sports.


In an on demand world, we would choose and select the programmes that we want to watch, when we want to watch them. We are increasingly being able to pay just for what we select, and not what is selected for us.


That’s a fundamental challenge to traditional media companies.


The great unbundling may well prove to be the great disrupter to traditional businesses.


For consumers, though, paying just for the services that we want, usually for a lower price than the bundled alternative, could mean that we end up as the winners from the disruptive force of tech companies.


April 28 Why trade tops the agenda as Abe meets Obama


Could the biggest free trade area in the world be announced this week?

Well, it’s unlikely to be this week, but that’s the ambition that sits at the top of the agenda as Japanese Prime Minister Shinzo Abe undertakes a week-long trip to Washington.


It’s being termed a historic visit as Abe is the first Japanese PM to be invited to address both houses of Congress on Wednesday, and any remarks that he makes on the 70th anniversary of World War II will be closely monitored.


Yet, for Abe and perhaps also US President Barack Obama, it’s their progress on a trade deal that is at the top of the agenda.


Abe has said that they are near agreement on the Trans Pacific Partnership (TPP), which would create the largest free trade area in the world, linking the countries in Asia Pacific ranging from central America to southeast Asia. I’ve written before about the ambitious TPP, which notably excludes China – a notable exception at that.


Given all of Japan’s economic challenges – struggle to defeat deflation as price increases have fallen back to zero – and low productivity to name a few, would a trade pact really make a huge difference?


Estimates by economists put the gains at 0.66% of GDP that increases to 2% by 2020 if factors like foreign direct investment are included:


For an economy that is struggling to grow, these are not huge amounts but certainly not negligible.


So, why is it the big focus in Abe’s visit to Washington?


For one, it’s a tangible example of a structural reform that is the crucial third arrow of Abenomics – Abe’s ambitious reform plans that includes three arrows. Monetary and fiscal stimulus comprises the first two arrows, but it’s the third one that is the key one to raise economic growth that has come under criticism for lacking focus. In other words, there are numerous policies that have been put forward by the Abe government, but few concrete initiatives to cite. One exception is Womenomics, where increasing female labour force participation to the same rate as men’s would add some 14% to GDP. Even with respect to that policy, it’s unclear how it can be achieved.


So, a new trade pact that puts Japan at the centre of the world’s biggest free trade area certainly has its appeal.


But, it’s not only up to Japan – the U.S. also has to agree.


And, it’s not just the usual hurdles of opening up agriculture or the auto sector to contend with. TPP has been described in U.S. media as “NAFTA on steroids.” The North American Free Trade Agreement was a contentious free trade area linking the U.S. with Canada and Mexico under the last Democratic president Bill Clinton. Free trade has been blamed for the loss of U.S. manufacturing jobs, for instance.


But, before that stage, President Obama also needs “fast track authority” for trade negotiations. The TPA allows the President to present to Congress an agreed trade deal and they can’t pick it apart. Unsurprisingly, it’s key for getting trade deals through Congress. One is in the works but is unlikely to get through Congress by the end of May much less this week.


For President Obama’s Asia Pivot where he’s reorienting American foreign policy more towards Asia, the TPP is a centrepiece. And one of the few areas where he may indeed be able to claim a legislative victory given that the Republican-controlled Congress makes it tricky for his last 2 years in office. I understand that the President may well be relying on Executive Orders like what he announced on immigration to put forward policies.


So, for both Japan and the U.S., a win on the TPP would be welcome.


For Abe, walking away with a concrete example of an economic policy that will boost growth would certainly make his historic trip to Washington worthwhile.


April 20 Malaysian trade minister rules out a single currency for ASEAN


The Malaysian Minister for International Trade and Industry, Mustapa Mohamed, says that the single market that the 10 nations of Southeast Asia (ASEAN) are forming by the end of the year will not include a single currency in their deliberations. 


Mr. Mohamed told me at the World Economic Forum in Jakarta that a single monetary policy is out of the question in the near future as we discussed lessons from the European experience that could apply to the ASEAN Economic Community (AEC) that is due to launch at the end of year. He pointed to the vastly different levels of income in ASEAN which would make sharing a currency and therefore monetary policy infeasible. He told me that there will not be the equivalent of the European Central Bank in the AEC in the foreseeable future.


Malaysia is Chair of ASEAN and will lead the conclusion of the talks to form a single market that will rival the EU in terms of population. With over 600 million people, ASEAN is seeking to link together 10 countries ranging from rich Singapore to poor Laos into a free trade area with free movement of labour, removal of tariffs, and common standards. 


Mr. Mohamed is confident that the AEC will soon rival the EU and could overtake it by 2020. He cited the 5% plus economic growth rate of ASEAN as compared to the 1-2% growth of the EU. 


Still, there are numerous challenges facing the formation of the AEC. There aren’t many pan-regional institutions, for one. The chief executive of AirAsia, one of the few pan-ASEAN companies, Tony Fernandes called for a strong commission for the AEC. Instead of going to 10 different governments, he would like to see the equivalent of the European Commission in the AEC. Though, Mr. Fernandes added that he would prefer a less bureaucratic version of the EC in ASEAN.


Others such as the Asian Forum for Human Rights and Development have called for institutions to protect human rights and workers, including a court like the European Court of Justice. That will be challenging as political differences in the region, including numerous non-democratic states, will make it tough to integrate politically as well as socially. Those are unsurprising the other 2 pillars of the AEC, which mirrors the development of European institutions since tying markets together requires more than just economic agreements.


Besides institutions, the region also faces challenges in terms of what economists call “deep” integration. There are many trade links in the region, but intra-regional trade in ASEAN is only around a quarter of total trade as compared with the EU or in particular the euro zone where the biggest trade partners are the other economies in Europe. Trade has increased in the past few decades, but it’s non-tariff barriers that protect some home industries that remain barriers.


Mr. Mohamed also emphasised that the impetus behind the AEC is to compete with the sizeable markets of the EU, U.S. as well as neighbouring China and India. Mr. Fernandes also pointed to the rise of regional free trade agreements being negotiated such as the TPP linking America to Asia, and TTIP tying the U.S. to the EU as to why there’s urgency for Southeast Asia to link their economies to compete.


With twice the population of the United States and one that is similar to the scale of the EU, the AEC has potential to become one of the largest economic entities in the world. And Mr. Mohamed is not only confident that the AEC will overtake the EU, he also believes that the AEC could rival the United States one day.


We’ll soon see if the AEC becomes a common reference point for the rest of the world like the EU is and a market like the US that global businesses have to be in. It seems that southeast Asians certainly have that ambition.


April 17 Britain’s foreign policy calculations


At the London Metal Exchange - owned by China since it was bought by the Hong Kong Stock Exchange 3 years ago, the shouts of traders haven’t been replaced by computers executing trades electronically. What else hasn't changed is the importance of the financial sector to the British economy. Preserving the City's position has been a priority for the Government - so China unsurprisingly looms large in British foreign policy.


Looking back, the coalition government has repeatedly emphasised the importance of engaging more with emerging markets, so re-balancing away from Europe and towards fast growing countries like China.


But, with China, there is a balance to be struck between economic gains and addressing political issues such as human rights.


When David Cameron met the Dalai Lama in May 2012, he was cheered by some. But, China froze out Britain for more than a year. When relations finally thawed, Britain seemed to redouble its efforts to make up for lost ground.


The focus of its efforts is the Chinese currency. Dubbed the internationalisation of the RMB or Yuan, the Chinese government is promoting the use of its currency in overseas markets - a significant reform since the RMB is closely controlledand this is the first step toward it becoming freely traded. When it does, the RMB would rival the US dollar in importance.


The government wants London to be the leading Western hub for the offshore trading of the Chinese currency. After all, London is the dominant player in foreign exchange markets, but it wouldn't remain so for long if it didn't trade the RMB.


Last summer, the Chancellor George Osborne hosted the Chinese premier along with a high-level delegation. They were pleased to announce that Britain was granted links with a Chinese bank that would provide it with RMB which would help cement the government's ambition.


Shortly thereafter, the Luxembourg Finance Minister told me that they were also granted links with a Chinese bank.


And that captures the Chinese attitude toward Europe. China keeps European nations on their toes.


Does China need Britain? Probably not as much as Britain needs China. After all, China can choose to partner with Luxembourg or Germany to access overseas markets.


It may explain why Britain was the first Western nation to apply to join the China-led Asian Infrastructure Investment Bank or AIIB last month. The AIIB pools money from member countries to invest in infrastructure in Asia.


Others like Germany quickly followed. This was despite American protests since the AIIB is a direct challenge to the World Bank which is led by America.


The U.S. is critical of Europe shifting East even as President Obama pursues his "Asia Pivot" that reorients American foreign policy towards Asia - though it should noted, the pivot excludes China in key respects.


For Britain and other nations, it's tricky positioning between 2 superpowers. It's worth bearing in mind what the economist John Kenneth Galbraith once observed: Under capitalism, man exploits man. Under communism, it's just the opposite.


April 15 Is it a choice between higher pay or a job?


Raising the minimum wage to $15 per hour has become a rallying cry for fast food and other U.S. workers who are protesting low pay by walking off the job in over 200 cities.


This won’t be reassuring, but economists are split as to whether raising the minimum wage will be at the cost of jobs.


In the U.S., though, the campaign to raise pay has been growing for several years. Workers have complained that the federal minimum wage of $7.25 per hour isn’t enough to live on. That’s why they chose today – tax filing day – to highlight that people who work are forced to rely on public assistance.


Employers are beginning to respond to the ongoing protests. Wal-mart, McDonald’s and others have recently said that they will raise their minimum pay to $9 per hour. But, workers are after more.


At present, 42% of U.S. workers make less than $15 per hour. Half of African Americans, 55% of women and nearly 60% of Latinos make less than $31,000 annually.


A study by the University of California at Berkeley finds that nearly three-fourths of all recipients of public assistance are from households where at least 1 member works. The researchers conclude that it’s costing the U.S. government $152 billion per year in public support to make up for the shortfall in income from private sector work.


In just a couple of days since its release, it’s already generated disagreement.


The low pay debate is a reflection of income inequality as well. I’ve written before about the Second Gilded Age in the U.S. Economic growth hasn’t translated into more income for households: median incomes have stagnated as have wages.


When I asked Jason Furman, Chairman of President Obama’s Council of Economic Advisers, about what the administration was doing to address inequality. He pointed to their call to raise the minimum wage from $7.25 to $10.10 per hour. Raising the income of the poorest workers is an attempt to narrow the income gap and reduce poverty for an estimated 45.3 million people who live below the poverty line.


Focusing on those living in poverty, CEA estimates that it would boost incomes for about 12 million people and lift 2 million out of poverty.


The proposal is still hotly debated over concerns that it could make it harder for low-skilled people to find employment since employers may be able afford fewer workers. And that is still the crux of the debate over the impact of raising the minimum wage.


A survey of academic economists by the University of Chicago asked if raising the federal minimum wage would find it harder to low-skilled workers to find employment. The result was split between those who agreed and disagreed (34% and 32%, respectively) and 24% was uncertain.


But, 42% of those academics agreed that raising the federal minimum wage to $9 would be a desirable policy because it would raise the incomes of those low-skilled workers who can find employment. It should be noted, though, that one-third was uncertain about whether that benefit outweighs any impact on employment.


One boss has decided to act after reading that people are happier if they make an annual salary of $70,000. So, he raised the “minimum wage” for his 120 workers to $70k by trimming his own nearly $1 million salary to $70k and sharing more profits. That would certainly do a great deal to reduce the 300 time salary multiple between the CEO and an average worker. It’s certainly eye-catching and the progress of this company will surely be followed.


Bosses making the same as workers – now that would radically transform the workplace.


April 15 The end of an era for China


Probably the least surprising thing about China’s GDP growth rate for the first three months of the year is that it slowed to 7%. After all, that’s the target for the year.


What’s more surprising are the drivers: consumption more than investment, services outpacing manufacturing, and domestic demand rather than exports. Taking today’s figures and the data for March together with the full year picture for 2014 shows that China’s growth drivers are changing.


Consumption contributed 3.8 percentage points to 2014’s 7.4% growth rate, which is more than investment which accounted for 3.6 percentage points. Net exports – so exports minus imports – contributed nothing.


Consumption has risen to account for more than 50% of GDP, which is a sizeable increase from 2009’s 35%, and finally places China in the realm of market economies where consumption is between half to two-thirds of GDP.


It mirrors the rise of the services part of the economy, which includes non-tradeables like haircuts, becoming larger than manufacturing that included many exported goods. Indeed, industrial production in March expanded by 5.6% in March, the slowest on record, which was significantly outpaced by retail sales – a measure of consumption – which grew at over 10%.


This is what China has been trying to achieve – a re-balancing of its economy away from excessive reliance on exports and investment and more on its own middle class consumers and expanding services. It’s part of their aim of overcoming the middle income country trap to become prosperous by improving the quality of the growth drivers in the economy.


Growing more through consumption and services is similar to the growth drivers of developed economies such as the U.S. and Europe. So, China’s re-balancing also marks the beginning of the end of a period of rapid growth that is based on industrialisation. Manufacturing and “catching up” launched China from a poor to a middle income country in the past 35 years. The next stage is growing as a middle income economy, which will naturally be slower than the initial phase. After all, 5% growth for an emerging market looks slow while 3% growth for a developed one would be considered fast.


Still, any slowdown poses risks. For China, it’s notably in terms of real estate and investment which may be slowing down too quickly and poses a risk for banks. It’s why the government has introduced measures to support the housing market and cut interest rates to stimulate lending.


The government is also likely to spend to support the economy if job growth slows. But, so far, a slower growth rate hasn’t meant fewer jobs since a services economy is labour-intensive and last year saw 13 million plus jobs created against a 10 million target. The unemployment rate is 5.1% - though that’s likely to be mis-measured since rural area employment isn’t well captured.


So, the picture in terms of re-balancing looks better than the headline growth rate of the slowest quarterly growth rate since the global financial crisis. But, the biggest uncertainties lie beyond the macroeconomic statistics, which aren’t always reliable, and instead reside in the micro picture for the financial system.


The IMF yesterday downgraded China’s growth to below 7% this year and next year. If growth slows down considerably – even if planned as part of the restructuring of the economy – then will lower demand affect the ability to repay loans? Commercial developers are leveraged and there are reported difficulties in leasing office space. House prices have fallen across the country and requirements have been loosened for mortgages.


These are questions that will undoubtedly be raised as China seeks to do what no other country has done, which is to overcome the middle income trap for a billion-plus population. What the rest of the world also has never experienced is its second largest economy undertaking such a dramatic structural transformation that is likely to entail volatility.


The U.S. growth engine looks like it’s coming back, and it’s certainly not too soon as the era of rapid growth in China comes to an end.


April 14 What’s driving global growth


The latest IMF forecast for the world economy sees growth picking up this year and next. Global GDP is expected to expand at 3.5% this year and 3.8% next year.


The U.S. is powering ahead with 3.1% growth in both 2015 and 2016. The UK is also expected to grow well at 2.7% this year but slow to 2.3% next year. The euro area is recovering but slowing, as it’s expected to expand at around 1.5%.


China is also slowing. From above 7% growth, the IMF sees Chinese growth dropping to 6.6% and 6.4% in the next 2 years. Russia’s economy is forecast to contract for 2 years: by 3.8% this year and another 1.1% next year. Brazil is recessionary as well as its 2015 GDP growth is expected at -1% this year. India, though, is forecast to grow faster than China at 7.5% for the next couple of years. They had the biggest growth upgrade by the IMF among major economies.


The divergent fortunes of emerging markets is one of the reasons why as a group, the IMF is projecting 4.3% growth this year which is slower than the previous 2 years. By contrast, advanced economies are expected to grow faster at 2.4% than in 2013 and 2014.


In 2013, world GDP growth of 3.4% was due to advanced economies growing by 1.4% and emerging markets at 5%. But, this year, GDP is forecast to grow by 3.5% with advanced economies expanding by 2.4% as compared with emerging markets at 4.3%. The U.S., UK and other non-euro economies are powering a bigger part of global growth in a change from the years when emerging economies were driving more of world output. Still, emerging markets like China and India are likely to contribute more to global GDP over the longer term as their middle class consumers emerge. But, the near term forecasts reflect a recovery in post-banking crisis economies that will be welcome after years of trying to climb out of the worst recession in a century.


The other sizeable growth driver is oil prices.


In their simulations, the IMF estimates that oil prices are roughly 40% lower for 2015 but will gradually rise but still be 20% lower than expected by 2020. The baseline is August 2014 and oil prices have fallen by around 45% since last autumn.


The boost to global output is considerable. If there’s full pass-through from international to domestic prices – meaning that consumers experience the same drop in the prices that they pay as global prices – then oil prices alone could add about 1 percentage point to growth by 2016. Even if not all of the price declines are passed through, global output would still be boosted by more than half a percentage point in the next 2 years.


After years where high energy costs were squeezing incomes, a drop in oil prices is a nice change. For oil importers in any case.


The IMF emphasises that their projections hinge on oil prices remaining low until the end of the decade.


For now, lower energy prices are a boost to income that is like a fiscal stimulus. Recall that during the global financial crisis, the IMF was encouraging G20 governments to spend the equivalent of 2% of their GDP to boost growth.


Cheaper oil is adding as much as 1 percentage point to global GDP. Bearing in mind that global GDP is growing at 3.5-3.8%, cheaper oil accounts for a notable chunk.


There are risks around exchange rates and interest rates that the IMF stresses. Still, after years of slow growth, if cheaper oil can help raise global growth to 4% by 2020, that will certainly be a welcome driver of world output. This is particularly as emerging economies begin to enter middle class and slow down accordingly.


April 8 Biggest deal yet


A whopper of a deal comes along just a day after yesterday’s FedEx/TNT merger. Shell’s $70 billion cash and stock bid for BG Group would make it not only the biggest deal in the oil and gas sector in a decade but would also rival last year’s Comcast/Time Warner mega deal in size. It is the biggest merger and acquisition (M&A) deal this yearand the 14th biggest ever.


The merged company would become the biggest oil company by production – though ExxonMobil is larger by market cap -- and cement Shell’s dominance in liquefied natural gas (LNG). Indeed, Shell has produced more gas than oil in recent years and the purchase of BG would allow them to focus on gas as well as deepwater production, according to Shell’s chief executive Ben van Beurden. It gives Shell access to key reserves around the world and indeed raises their proven reserves by a sizeable 25%.  


I wrote yesterday about whether this is the year of mega mergers. For the oil and gas sector, the halving of oil prices in the past year and the rise of shale gas has led to a slump in stock prices that is reminiscent of the late 1990s. That was when BP acquired Amoco and Arco, Chevron merged with Texaco, and Exxon purchased Mobil.


BG shares have dropped by around 28% since last June alongside the decline in global oil prices. Its shares have jumped on the news, up around 40% at one stage. That’s still short of the 50% premium being paid by Shell to create the merged company, which would leave BG with a 19% stake.


BG’s slump mirrors the plummeting share prices of other oil majors. The oil and gas component of the FTSE is down some 17% since last summer, which always raises the possibility of takeovers.


The Big Five – ExxonMobil, Royal Dutch Shell, BP, Chevron, Total – have also piled on record amounts of debt this year. Total debt issued by the largest US and European energy companies jumped to $31 billion, taking advantage of low borrowing costs and helping cover cash shortfalls. It’s the other driver for M&A that I mentioned in my prior blog. It lays the ground for acquisitions as slumping energy prices hit smaller rivals harder than the oil majors.


As for the Shell/BG deal, it’ll become the biggest company on the FTSE, and may well herald a wave of consolidation last seen during the last oil price crash. And it’ll certainly add to the potential for 2015 to be the year of mega deals.


April 7 The year of mega deals?


After only the first quarter, this year is shaping up to beat last year’s frenzied deal-making. Years of low interest rates and cheap borrowing costs, record high stock markets, and a recovery that is finally picking up steam had combined to mark 2014 as the busiest year for mergers and acquisitions (M&A) since the recession. This year’s pace is even faster as consumer spending has picked up over the past year.


The latest is a $4.8 billion deal announced between U.S. company FedEx and Dutch firm TNT, which would propel it into one of the three largest parcel delivery services in Europe, rivalling DHL and UPS if approved. Strikingly, the 8 euros per share offered in cash by FedEx is 33% higher than TNT’s share price. FedEx is aiming for a foothold into Europe through this acquisition and believe they can turn around struggling TNT.


Like last year when 10 of the 15 largest acquisitions were U.S.-based companies, the FedEx deal reflects the cash-rich balance sheets of American multinationals after years of rising stock markets.


According to Thompson Reuters data, global M&A activity rose 47% from 2013 to reach $3.5 trillion last year. They were driven by large deals like FedEx’s – those valued at $5 billion or more. There were 95 of those in 2014 and several mega deals such as Comcast’s $70.67 billion deal with Time Warner Cable. This year, there’s the Heinz Kraft $40 billion mega merger which I have written about before. And last month also saw AbbVie’s $21 billion deal to buy Pharmacyclics. M&A transactions in the biotech and pharma sector have already reached $59 billion in 2015, which is a 94% increase over the same period a year ago.


Towers Watson and Cass Business School find that the first quarter of 2015 was the busiest for M&A since at least 2008. 41 large deals, worth over $1 billion, have closed, which is an all-time high for the first three months of the year.


The deals are happening largely in the U.S., Europe as well as Asia, so the reach is global. M&A activity rose by 51% in the U.S., while European deals rose by an even more 55%. Asia saw the largest number of deals ever, reaching a total of $716 billion, which is though less than half of the 2014 total for America at $1.5 trillion.


KPMG surveyed 735 M&A professionals from American companies, private equity firms, and investment banks and found that 79% had made 1 acquisition in 2014 and an impressive 4 out of 5 (82%) planned to make at least one deal in 2015. 40% said that large cash reserves were the main driver of their M&A activity.


The Federal Reserve says that there is a record amount of cash sitting on U.S. corporate balance sheets, of some $2.05 trillion. When cash sits idle – that’s when there’s more than is needed for financing operations, there’ll be questions over whether that money could be put to better use, say through investment and creating jobs. High U.S. corporate tax rates are thought to have contributed to American companies parking money overseas. And that’s caught the attention of President Obama whose 2016 budget aims to raise $238 billion from an one-off 14% tax on about $2 trillion in earnings stashed overseas by American multinational companies and will use that money for infrastructure investment.


Surely that move will help spur more cash deals. So, coming back to 2015 being another record year for M&A, the most active sectors are healthcare, tech/media, and consumer goods.


FedEx’s latest acquisition reflects the growth of both the tech and the consumer goods markets. As bricks and mortar shops struggle against the rise of e-commerce, there’ll be more goods ordered online to be delivered to homes. In the UK alone, Barclays estimates that products ordered online in 2013 generated over 1 billion deliveries, and this number is forecast to grow by nearly 30% by 2018. Even so, the entry of Amazon and the failure of CityLink show that the parcel delivery market is a highly competitive one.


Doing deals in the first part of the year may be even more important as companies aim to take advantage of record low borrowing costs before U.S. interest rates are expected to rise, likely later this year. This is why 2015 is being viewed as another strong year for M&A. Seeing cash being put to work will be welcome, but it will also mean greater uncertainty for jobs as M&A usually means restructuring operations.


So, it looks like we’ll be seeing more of these billion dollar deal headlines for a while.


April 2 Amazon and the Internet of Things


Amazon is known for wanting to provide everything that you buy and their latest foray is aiming to do just that. Amazon Dash are buttons that you stick on household items. And with a click, you can re-order your dishwashing detergent from Amazon and it’ll arrive on your doorstep just like your books and other gadgets bought from the e-commerce website.


Connecting things wireless to the Internet is termed the Internet of Things or IoT. I recently did a programme on it being hyped as the next big thing in tech. The reason is because of the numbers.


Imagine your household gadgets, smart metres, and other things are all connected to the Internet (and thus it’s called the Internet of Things). For instance, things like wearable tech such as fuel bands that track your daily activities are recorded online (and tell you that you need to sleep more). Driverless cars are another example.


Thinking about how many gadgets there are… it’s unsurprising that it is being viewed with such excitement. ABI Research estimates that there are already more than 16 billion wireless connected devices, an increase of 20% from a year earlier. By 2020, Gartner forecasts that the market will generate incremental revenue of over $300 billion.


No wonder Amazon wants a slice. It’s known for making virtually no profits despite strong revenues and a sizeable market share. For instance, Amazon has a dominant share of the e-book market and is one of the top 10 retailers in the U.S., largely due to its low prices and out-competing bricks and mortar competitors.


Last year, Amazon registered $89 billion in revenues, but a loss of $241 million. For years, its revenues and profits have been headed in the opposite directions. From 2007, its revenues surged from $15 billion, but profits steadily fell from $436 million to a loss now. Its stock fell by about 20% last year but has recovered some ground. Analysts are wondering how long investors would support a minimally profitable business.


Founder and CEO Jeff Bezos is active experimenter, trying everything from drones to deliver products to the Fire Phone. Some have been successful, but many have not.


Bezos will be banking on IoT being the next big thing and not just hype, and that his foray will pay off.


March 31 Jay-Z, Empire, and the new music business


It’s life imitating art. The popular U.S. TV show, Empire, is based on a music mogul whose record label offers artists a rare share in the business. It’s thought to be based on the life of rapper Jay-Z, whose real name is Shawn Carter, who has launched a music streaming business where artists ranging from Madonna to Coldplay are equity partners.


In Empire, Lucious Lyon, player by Terrence Howard, entices Snoop Dog to his label with a share of the profits. He and his sons win over artists by outlining a vision of a label that understand that people listen to music streamed on the Internet and offers them part ownership in the newly publicly traded company.


Jay-Z has garnered some 15 artists as co-owners of Tidal, a music streaming business that is based on his recent acquisition of Swedish Aspiro for $56 million. He’s offering stock and cash in exchange for their promotion of Tidal.


I’ve written before about the end of the record collection as music streaming has grown rapidly – registering over 50% growth in 2013 from a year earlier in global markets.


In the U.S., for the first time, streaming is bigger than CDs. In 2014, streaming services generated more revenues than CDs, according to the Recording Industry Association of America. Streaming services such as Spotify and Pandora accounted for $1.87 billion in revenues in 2014, which amounts to 27% of total industry revenue, growing from 21% the year before even as the industry’s revenue growth has remained flat for the last 5 years.


This is while digital downloads, such as those purchased from Apple’s iTunes store, have been in decline since 2012. Downloads had been the largest source of digital revenue for a decade, but revenues have fallen from that peak and dropped by 8.7% in 2014, though they still account for 37% of total industry revenues. It follows that Apple will soon launch a streaming service, Beats Music, after it acquired Beats Electronics for an eye watering $3 billion from hip hop artist Dr Dre last year.


Just like in Empire, there’s un-missable symbolism in a company that’s owned by artists in an industry dominated by big record labels. In a dramatic depiction of the tensions between artists and record bosses, Jamal Lyon, played by Jussie Smollett, dangled the boss of Creedmore over a balcony to get the rights to his father’s music back.


Tidal isn’t seeking to be a record company. Jay-Z describes Tidal as a record store. As such, it’ll face stiff competition from the players already in the market.


Pandora and Spotify each have more than 70 million subscribers who access the free tier of their streaming services. Streaming is certainly popular, but its fast growth may well be because it’s free.


Indeed, the numbers are a lot smaller when just counting those who pay a subscription fee. Spotify counts 15 million subscribers who pay $9.99 per month and Pandora says they have 3.3 million who pay $5 per month.


Tidal won’t have a free subscription service. It’ll offer 2 tiers – standard definition at $9.99 per month in line with Spotify and a high definition stream for $19.99 a month. Apple’s Music Beats, to be launched this summer, also will not have a free tier.


The artist/owners of Tidal, including Alicia Keys, Beyonce, Coldplay, Daft Punk, Jack White, Kanye West, Madonna, Nicki Minaj, and Rihanna, are planning to offer “exclusive experiences” to make choosing Tidal and paying for a subscription worthwhile. It’ll need to be fairly appealing to win over those paying customers who are but a small fraction of those enjoying music streaming on the Internet.


For the music business, the trend is clear. The music industry, like many others, is being transformed by the digital age.


March 27 Is it possible to end global poverty?


Later this year, the UN is expected to adopt the World Bank’s ambitious target of ending extreme poverty by 2030. It would mean that for the first time, everyone in the world would able to afford a refrigerator and other goods that would make life a bit easier.


But, what would it take? Could we really see the end of poverty within a generation?


First, there’s been a great deal of progress already.


The poverty rate in the developing world has more than halved since 1981. Back then, 52% of those in developing countries lived on less than $1.25 per day. That's now dropped to 15%.


In terms of the UN’s Millennium Development Goals, it meant that the target of having poverty by 2015 from 1990 levels was achieved 5 years early. In 1990, more than one-third (36%) of the world's population lived in abject poverty. That was halved to 18% in 2010. But, it was due largely to China. So, there are still about a billion people who live in extreme poverty.


Sub-Saharan Africa is the only region where the number of poor people has increased during the past 3 decades. Even though the percentage of the African population living in extreme poverty is slightly lower than in 1981 - population growth means that the number of people has actually doubled.  They account for more than one-third of the poor in the world, despite Africa making up just 11% of the global population.


By contrast, in East Asia, progress has been remarkable. 4 out of 5 people lived in poverty in 1981 and that has dropped to 8%. On current trends, the fastest growing region in the world could see the end of poverty within a generation.


But, what about the billion people who still live in poverty?


The World Bank projects that it’s possible to end extreme poverty by 2030. But, it would take a heroic effort. The number of poor people will have to decrease by 50 million each year. That is the equivalent of a million people each week for the next 15 years.


I asked the World Bank President Jim Yong Kim if it was achievable. He was confident, but emphasised that it would require funding and a raft of targeted policies to raise incomes and productivity. He praised countries like Britain who could commit 0.7% of their GDP to development, and added that it would bolster British “soft power” abroad. That’ll be welcome to those who have been debating the UK’s role in the world amidst cutbacks.


In these debates, definitions also matter. So, what precisely does the end of poverty look like? It doesn’t mean that no one lives on less than $1.25 per day.


The World Bank assumes that a 3% poverty rate is equivalent to the end of poverty since there will be some who move in and out of poverty, say when they lose their jobs so there will always be some “frictional” poverty.


Even so, the task of reducing task at that pace is so daunting that economists forecast that the global poverty rate will more likely be 8% in 2030. That works out to be around 664 million people still living in poverty versus a quarter of a million out of an estimated 8.3 billion people on the planet.


Which policies could work to get us to that outcome?


For China that has accounted for the bulk of the poverty reduction in the past few decades, the answer is economic growth. But, Paul Collier of Oxford University calls the China precedent “misleading” when it comes to lessons for Africa. He points out that income growth in Africa has been based on natural resources and the gains are not widely shared.


China’s context is that of an economy transitioning from central planning and under the governance of a one-Party state. That means, for instance, land is all effectively owned by the government. It doesn’t mean that some haven’t gotten very wealthy developing land based on government favour. But, it means that wages and self-employment have accounted for most of the rise in incomes, and not land or resources.


These aren’t the only reasons for China’s poverty reduction, of course, or for East Asia which has seen such dramatic falls in poverty. But, in particular, China hasn’t relied on external aid. The evidence of the impact of aid on reducing poverty across countries isn’t compelling even though there are successful in-country examples, which has led to a fiery debate over the effectiveness of international aid. Kevin Watkins, head of the Overseas Development Institute (ODI), believes that there is a role for aid to play, but there needs to be an overhaul of the way that it is used. Paul Collier agrees and argues that aid should be used to attract private investment in some of the poorest countries in Africa.


So, it’s hard to draw lessons from the past 2 decades in terms of the remaining stubborn pockets of poverty. After all, Africa has been the second fastest growing region in the world but hasn’t seen falls in the number of the poor. For instance, Tanzania which has grown well and been devoid of conflict has seen the number of poor rise from 9 million two decades ago to 15 million today. South Asia also lags in terms of the progress made in East Asia, so you can’t just count on growth to lift the bottom billion out of poverty. But, policies such as raising agricultural productivity – something that Henrietta Moore of UCL argues for – would help.


Doubtless, the circumstance of individual countries matter a great deal in terms of what works. But, if the progress made in the past couple of decades can be replicated in some fashion­ and tailored to individual countries,­ then it’s possible that another 18% of the world population can be lifted out of poverty. That would imply that the 36% poverty rate in 1990, which has dropped to 18% in 2010, would fall by another 18% by 2030. It would indeed mean the end of poverty in our lifetimes.


To paraphrase Nobel Laureate Robert Lucas on economic growth, once you start thinking about it, it's hard to think about anything else.


March 25 Warren Buffett’s latest elephant deal


On the hunt for a big buy, billionaire Warren Buffett has again teamed up with Brazilian private equity firm 3G. They together bought Heinz in 2013, and now, Heinz will merge with Kraft Foods to create the third largest food and beverage company in North America and the fifth biggest in the world.


Heinz, controlled by Buffett’s Berkshire Hathaway and 3G, would own 51% of the new firm, The Kraft Heinz Co, and shareholders in Kraft would hold 49%. The new company will have revenues of around $28 billion and the CEO will be Heinz’s current boss, Bernardo Hees.


It’s a behemoth of a consumer goods company with around a dozen brands that each generate revenues in excess of half a billion, including Jell-O, Maxwell House, Oscar Mayer, Planters, and Velveeta. 3G also owns Burger King and has become a major player in food and beverage industry, having invested as well in Wendy’s.


Kraft’s shares have soared on the news. After all, revenues last year were flat and net profit fell 62% due to commodity costs as the company lost market share in its U.S. businesses. The new company is aiming for substantial cost savings of $1.5 billion by the end of 2017.


But, it’s still an “elephant” for Buffett. Known for choosing companies with strong product lines, Buffet has described the deal as bringing together “2 iconic brands.” And both companies have plenty of those, but are facing pressures from changing consumer tastes, which I’ll come back to.


The trend in the global food and beverage industry is certainly creating giants. Just 10 companies control nearly all of the packaged foods that we buy. Nestle, Unilever, Coca-cola, PepsiCo, Danone, Mars, Mondelez International, Kellogg’s, General Mills, and Associated British Foods are among the companies that generate over $1 billion in sales each day around the world.


With this merger, Kraft Heinz will jump into the mix. When I interviewed executives from Nestle and Unilever earlier this year, there was an optimistic sense that consumer spending is coming back that will help their bottom lines. They also faced pressures, though, from consumer tastes that are changing, including in their attitudes toward processed foods and what happens to all that packaging. I wrote before, for instance, about Unilever aiming for zero non-hazardous waste in their factories.


Warren Buffett is aiming for his slice of the food industry that accounts for an estimated 10% of world GDP, so that’s a sizeable $7 trillion per year. And he’s doing so again with a Brazilian investor that may surprise some since there aren’t many that come from emerging markets. But, Brazil is a commodity exporter and it’s no wonder that 3G is eyeing the recovery in consumer spending that can turn lower agricultural prices into a virtue for food retailers.