The US "Fiscal Paraglide"

First off, Merry Christmas to all the readers of my blog, and may you also have a Happy, Healthy and Prosperous New Year!

I am currently out in the middle of Indian Ocean (just sailing towards Madagascar passed Reunion Island an hour ago) this Christmas Eve night, having spent a wonderful 3 days on the island of Mauritius.  While cruising the south Indian Ocean I have been reading the New York Times on virtually a daily basis and have been mesmorized by all the drama that unfolded in Washington DC over the past week or so connected with the so-called “fiscal cliff”.  So as there is only a week remaining to do anything about the approaching 

sequester that will happen after January 1^st, I thought it probably time to say something about it.

My immediate reaction to reading the news was to think “oh no, so if the US Senate democrats will not propose anything unless the Senate Republican leadership in the shape of Mitch McConnell undertake not to filibuster the measure put forward, how will that work, given that the Republicans just don’t seem to be able to unite their disparate factions?”  I think that we indeed are about to go over to the so-called “fiscal cliff”, and it is now likely that taxes will go up and that spending will be cut over the next few years. 

But then I started to think about this a little more deeply and I realized that there are a few things that are really important here from both an economic and a political point of view; first, US debt has already been downgraded over the difficulty in finding agreement over raising the debt limit - which caused the US to be in the situation that it is now in – and the world didn’t end; second, that the “fiscal cliff” will really not be a cliff but will act more like a “fiscal paraglide”; and third, that we are currently witnessing the end of the Republican party as we know it, and therefore a completely fractured political structure that will not lead to agreements on economics for many years to come. 

Let’s deal with each issue in turn.  First, the actual economic measures in the fiscal cliff and the size of the US national debt are not the most important issues – economic growth is.  The real issue is how does the US maintain the impetus behind US economic growth, and clearly tax hikes and spending cuts will not help, but these tax hikes and spending cuts are not exactly as draconian as those already implemented in the UK, and yet the UK has managed to totter on with anemic rates of economic growth despite the fact that further cuts were recently announced. What I’m really trying to say is that this is not a question of action, it is a question of timing.  The UK adopted fiscal austerity with increases in sales taxes and quite drastic reductions in spending just as the country was coming out of recession, which led to a “double dip” recession.  The timing in the UK was all wrong.  So the question is, given where the US is right now, can it withstand some small tax increases and cuts to military and some social programs right now, or is the economy already sputtering or heading into a private sector downturn?  I would argue that the US economy is now resilient enough to withstand some corrective fiscal action, particularly as even if President Obama manages to get a so-called “stripped down” bill agreed upon which leaves taxes for all but the wealthy where they currently are, the country will once again face raising the debt ceiling again in late February or March.  Also the Fed is still maintaining and in fact expanding what is already an extremely expansionary monetary policy that is tied to the labor market, so given that the housing market is definitely on a track to recovery, some corrective action to taxes and spending should not derail economic recovery like it did the UK.

In fact I believe that US economic growth impetus right now is being somewhat underestimated, so that if there is enough “upwind” to growth, the increase in taxes and the cuts to spending could restore some confidence that the country is once getting back on track with its fiscal policy and therefore (using a “paraglide” analogy), falling off the cliff might only at worst provide one quarter of negative growth followed by a strong cyclical upswing.

Last point – the Republican Party.  What has been distressing to watch in all this drama in Washington DC is that our politicians just don’t seem to be able to bridge their gaps anymore on fiscal policy, partly because the Republican Party appears so divided on what compromise (if any) is feasible ( - thanks mostly to Grover Norquist).  So if these gaps in fiscal policy cannot be bridged, we need a new mechanism to deal with fiscal policy-making in the largest economy in the world.  If the debt ceilings are maintained, then are we really going to impose periodic sequesters?  If debt ceilings are scrapped, what constraints should US fiscal policy have? 

More on this next time!

Are Corporations Immoral When They Don't Pay (Much) Tax?

I'm in the UK right now, and I'm not sure the fuss over US corporations paying little to no tax in the UK has hit the shores of the US yet, but this subject is causing quite a stir over here. And although no-one is mentioning the fact that the 3 corporations being named are all large US corporations, this is definitely apparent in terms of the 3 multinationals who have been named by the Chair of the UK Parliamentary Public Accounts Committee, Margaret Hodge (a Labour MP), and her use of the word "immoral" to describe the tax avoidance schemes used by Starbucks, Google and Amazon to avoid paying taxes in the UK (see here, here and here for some examples of the UK media coverage).  To be fair, in some articles I have also seen eBay and Ikea (the Swedish discount furniture giant) also mentioned.

 

In the show that I try to listen to every day on the radio here (The Today programme on Radio 4), Margaret Hodge accused Starbucks in particular of using "transfer pricing" rules which permit Starbucks UK to buy coffee beans from other subsidiaries at higher prices than exist in the market, and book loans at extremely high interest rates from the US Head Office, which then makes the UK subsidiary look like it is making losses when in reality it is making a profit. The basic idea here is to make subsidiaries in high corporate tax countries make losses, and subsidiaries in low corporate tax countries make profits.Thus Starbucks UK has not paid any corporate taxes in the past 3 years, despite having extremely "profitable" UK operations which resulted in the UK CEO being promoted up through the international organization, and yet Starbucks Switzerland (where corporate tax rates are only 12%) has consistently been making profits.

Google UK has also been quite closed-lipped on it's UK subsidiary's activities, but nevertheless was forced to provide some statistics to the UK PAC. Google paid £6m corporation tax on £2.5bn of UK revenues in 2011. That is a tax rate of 0.24%, significantly less than the headline UK corporate tax rate of 24%.

It also emerged, in new figures supplied by Amazon to the PAC, that the online retailer's total UK sales topped £2.9bn last year, while declaring Amazon.co.uk revenues of only £207m.
If Amazon UK is assumed to be paying a 24% corporate tax rate on it's (let's assume net) revenues, then doing the same calculations to obtain a corporate tax rate, that comes to a 1.7% tax rate. Obviously my calculations are wrong because for the past three years, Amazon.co.uk Ltd paid £2.3m in corporation tax ( - our assumption would have had Amazon paying £49m in corporate taxes for one year alone) on UK sales of £7.1bn.

Phillip Stevens of the FT comments that "Societies have sets of norms and ethics that extend beyond tax law. To function well they demand more of individuals and companies that they avoid breaking the letter of the law. Call it moral obligation or corporate responsibility, but the market economy cannot separate itself entirely from this broader notion of fairness.”

In my opinion corporations can either be viewed as collections of citizens who have grouped together to do business, or as separate individual entities in and of themselves.  Each notion of a firm leads to a different conclusion about the way in which corporates should be taxed. In the former case (businesses as collectives of individuals) only the income that is derived by those citizens who are involved in ownership of the business should be taxed and it should be taxed at the same rate as all other individual income. In the latter case (businesses as individual stand-alone entities), businesses should be taxed on the same basis as individuals - in terms of their revenue - not in terms of profits as currently is the case. The same income tax bands (presumably as for families) would apply to corporations, and then they would pay taxes like all the rest of us do. So to sum up, my view is this: either the government should i) tax the returns from company activity (i.e. dividends) as income to invidividuals (and not tax the companies at all); or ii) company revenues should be taxed at the same rate as individual income tax. 

I'm afraid I see things rather differently from Phillip Stevens. Why should the company be responsible to anyone other than their stakeholders - after all, they are the people who are involved in the company, aren't they?  Surely corporate responsibility involves obeying the law, and if the law allows these corporations to pay less taxes, why shouldn't they take advantage of this?

Clearly we don't use a system like my ii) above describes where company revenues are taxed, and this is unlikely to be introduced in the near future if corporations have anything to do with it! So we are left with i) which is the taxation of dividends as income but at the same time phasing out corporation tax. This is what I would advocate should be happening to the talks on the fiscal cliff in the US.  Despite what John Boehner and the Republicans say, we should be taxing dividends as income, but at the same time we should be lowering the rate of corporate taxation in the US to at least match what it is elsewhere.

It is obvious that corporate taxes are messy as not only do they tax profits, something that is easy to hide using international tax loopholes, but also even when we do tax profits paid to shareholders at dividends, we don't tax these payments as income but rather at a different rate to income tax rates.  Clearly a re-think on corporate taxes and capital gains taxes is needed, and the tax rules relating to multinationals are badly in need of reform.

Comments on the Euro Crisis delivered in the City of Sails!

I delivered these comments as part of a roundtable on the future of the euro at the University of Auckland, New Zealand, in October of 2012.  Enjoy!

"First, thanks to Univ of Auckland for hosting this event and in particular to Prof David Mayes and Mutsumi Kanazawa of the Europe Institute for organizing the event.

The starting point for me is the economic theory behind whether you should adopt a single currency or not.  As any student of international economics will know, Nobel Prize-winning economist, Robert Mundell, formulated the conditions under which it would be advantageous for a country or member state to join a single currency area.  This is known as the optimal currency area theory, and essentially says that your business cycle has to be synchronized with that of the other members of the group, or have some prospect of becoming synchronized, for it to be advantageous to join.

Mundell specified that you could also have some offsetting features that would then mitigate any lack of synchronization with the single currency, namely a high degree of labor mobility or supranational fiscal transfers.  Note that Europe has neither of these offsetting features.

So in 1991 when the Maastricht Treaty passed, it contained legal criteria for joining the euro, which had clearly been put in place by politicians and their civil servants, as at the time it was widely criticized by economists for being inappropriate.  The criteria were i) keep budget deficits below 3% of GDP; ii) keep public debt below 60% of GDP, including falling towards that level from higher levels; iii) keep long term interest rates within 2% of the average of the lowest 3 in the EU; iv) keep inflation rates within 1.5% of the average of the lowest 3 in the EU; and v) stay within the ERM for at least 2 years beforehand.

As you can see these criteria have little in common with Mundell’s simple idea of an optimal currency area, and indeed, not only were the Maastricht criteria misguided, but they also allowed too many EU member states that were not suited to a single currency into the euro area, Greece and Portugal being the prime examples.

To give you an analogy, it’s a bit like saying you’re going to start a bowling club, and although you know that the best members, regardless of their weight, ethnic background, height or hair color, will be those that are interested in bowling, you decide that membership should depend on being over a certain weight, under a certain height, long arms, and preferably black or blonde hair, simply because you might have watched professional bowling and seen that the players tend to have these characteristics, and therefore at the time of membership application these were the features you thought to look for. This is precisely analogous to what happened with the euro area. Those that were let in had to satisfy certain criteria at a certain point in time which had very little to do with whether the member state would be an appropriate member of a single currency.

Now there is also an extension to the OCA theory called the Endogenous OCA approach – it says that because monetary unions usually occur on top of common markets ( - think most federal or confederal states), then using the euro might stimulate more flows of factors of production between the member states, making them more economically integrated with one another which might then lead their business cycles to move more closely together.  In other words, before the fact or ex-ante, a member state might not look as though it’s eligible to be a member, but once it becomes a member or ex-post, it’s economic dynamics might change so that it would be selected as a member under the OCA approach.

So moving back to our analogy with the bowling club, if you let members in who were not very good at bowling but were committed to regular attendance and keen to get stuck in and to socialize and ask other more experienced and better players for advice, they could become good bowlers after a time.  Of course if you used the analogous method to the Maastricht criteria, in other words selecting members according to certain specific features, you would hope that the members you let in would grow longer arms, become shorter and weigh more, and change their hair color.  Oops, maybe my analogy breaks down a little here!

Given that we have this membership problem right at the outset, even before the economic downturn at the end of the last decade, some stresses and strains within the euro area were already apparent.  This is particularly because member states had to continue to limit their budget deficits under the Stability and Growth pact, but obviously when the major downturn occurred the OCA theory really began to highlight the membership problem. 

What I’m really trying to say here is that economics truly matters.  Just like you can’t build a house without obeying some principles of construction ( - unless you like to witness disasters), you can’t build a monetary union without having some preconditions and those preconditions are very neatly laid out in Mundell’s optimal currency area theory.  Ignore them at your peril!

Source:
http://www.guardian.co.uk/commentisfree/cartoon/2012/may/15/eurozone-greece-germany-euro-cartoon

Now when you look at the euro area through this lens, and I’ll be doing exactly this at my research seminar tomorrow, you’ll realize that as there is very limited labour mobility in the EU, and currently little prospect of a federal political system being introduced in Europe, then having synchronized business cycles is key to remaining part of the euro area.  My research shows that certain member states, although they might have been hitting the headlines recently for their economic problems, are much more easily going to be able to stay in the euro area than other troubled member states.  Member states like Spain and Italy, for example, even though they have deep-seated economic problems, have growth patterns that are quite similar to other euro area member states, while member states like Greece and Portugal do not have such similar patterns of growth, and therefore do not fit well, in good times or bad. Some member states like Finland seem to conform to the endogenous OCA view, as Finland started off not fitting too well, but over time it’s growth dynamic now appears to be much more in line with that of the rest of the EU.

So what should happen to resolve and therefore end the euro crisis?  My opinion is unashamedly research based, which is where I think we economists need to hang our hats if we are to have any credibility, particularly given our lack of foresight in other areas of major concern where we failed to take warnings seriously and do proper research to be able to make useful policy recommendations. 

So, in my humble opinion, either one of two things needs to happen.  Either:

1 – we move towards a more federalist structure in the EU, with permanent mechanisms in place for fiscal transfers.  Canada has them set up as a formal policy structure (the “equalization payments”) and the US has them on an informal basis ( - through the US budget).  Either would work, but that is the only way that if we stay with the current members that we’ll see this situation resolved in the long term; or

2 – the member states that do not form part of an OCA, and given that they’ve been members for over 5 years already, show little sign of becoming part of one in the future, need to be told to leave.  As an economist, I don’t care what means are used to get member states like Greece out of the euro – bribe them if necessary – but they need to leave, and leave fast before the situation there spirals out of control and the EU has more than just an economic crisis on it’s hands.

In my opinion the most dangerous path is that the Greeks decide to try and stay, despite the fact that their economy is in meltdown mode, and the austerity packages continue to fail because the economy is shrinking and so tax revenue is falling while at the same time public expenditures and wages are having to be savagely cut, hence reinforcing the downward spiral.  The costs of leaving might be large, but the given that I cannot see any way for things to get better right now, this is the only way to put some light back in the tunnel, so to speak.  

On the EU side, the danger of neither of the options occurring is probably greater than the danger of one of the corrective actions I have recommended.  Why is that?  Because if nothing is done, then internal indebtedness inside the EU must increase as lending to certain member states has to be maintained for them to remain members.  So if the Europeans decide to be polite – then no one is going to ask you to leave given that you want to stay, so the only way to stop contagion to other member states is to keep changing your bailout rules and mounting new lending programs, as we lurch from one emergency to the next. 

As Willem Buiter, who incidentally was one of my Professors at Bristol when I was there, recently said in the FT – if this continues much longer you might start to see Germany, Finland, Austria and others start to make noises about leaving the euro themselves, as despite the advantages of being members right now, if things continue too far down the road of trying to keep the current membership at the expense of the clear OCA members ( - the “hard core” if you like), then the disadvantages of being members may start to outweigh the advantages.  So the scales might then tilt so that it might appear to be the best course of action for these natural OCA euro members to leave.

So, now to put my political economy hat on, there are 2 remaining questions: of the options I have outlined, which a) would be preferable in an ideal world and why; and b) is going to be more palatable from a political point of view.

I think that from the perspective of European integration, a more federalist structure is preferable, as it then means that the OCA problem nicely goes away and no one gets booted out of the club.  Even Merkel has referred to this as being the best long term solution.  The big downside is that It likely means that Europe will splinter, as a federalist type EU governance structure is not something that the UK or many Central and East European member states ( - such as Poland) want. But the EU cannot be all things to everyone, and at some point the EU will have to accept this, and move into a world of what I think of as a permanent state of so-called “variable geometry”.

The upside to the second option, that of asking member states to leave (either directly by telling them to go, or indirectly by refusing to make any further concessions or mount bailouts), is that once done, you don’t have to worry about the euro area being an OCA either, because you lose the member states that were the problem in the first place, leaving the rest of the members to get on with it.  But the downside is really not good.  It means that there will be considerable resentment and bitterness in Greece, Cyprus and perhaps Portugal, if they end up leaving too.  It also means that the EU’s vision of a single currency for the whole of Europe can be essentially written off. Of course with this option you don’t have to consider further integration – essentially you move backwards and recognize that a monetary union without further integration is only viable with certain member states involved.

The most difficult aspect of this whole thing lies in the response to the last question I want to ask today: which of these options is going to be more palatable from a political standpoint?  The honest truth is that neither solution is palatable to the EU at the present time.  I think it will take another crisis of some sort to get them to act, and in the meantime the “hard core” of the EU will start making life more difficult for Greece et al so that it hopefully decides to leave on it’s own accord. That would open the door for others to follow.

So to end with, I see a much bigger danger here if the current trend of the “hard core” making life more difficult for the likes of Greece, Spain and Portugal continues, and that is that member states start to act on the basis not of the good of the whole (i.e. the EU), but in terms of what they themselves want.  This will obviously lead to much less compromise in the EU and will make it much harder to get agreements in other policy areas, as member states are more likely to be unwilling to compromise if they feel that they’ve been bullied or not dealt with fairly when it comes to their involvement in the single currency.

Let’s hope we don’t go down that path.

Thank you for your kind attention." 

A Young Person's Guide to QE3

The Federal Reserve Building, DC.

As we all know, the QE3 is a Cunard cruise ship, but this abbreviation has also the vernacular as the latest installment of the Fed's quantitative easing program. Although the media was very good at reporting the details as far as the announcement went (see here or here for example), there is very little commentary on what QE3 will actually have the potential to do to the economy - so here I'll attempt to shed a little light on that without hopefully offending either political party.

The term "quantitative easing" is used when the Fed can no longer use conventional methods to ease monetary policy further - that is by lowering interest rates.  Interest rates in the US are now extremely low and the Fed has decided that it doesn't want to see them any lower - this is the so called "lower bound".  So the Fed instead resorts (as the Bank of Japan did before it) to unconventional methods, namely "quantitative easing" which occurs whenever the central bank buys bonds which are longer term government bonds or bonds not issued by the government.  When the central bank buys or sells short term government bonds (known as T-bills) this is known as "open market operations" and is the usual channel in which monetary policy operates.  So what were QE1 and QE2?  In late November 2008, the Fed started buying $600 billion in mortgage-backed securities (MBS) - these are pieces of paper that represent bundles of mortgages, and they result from banks packaging together mortgages in big bundles and then effectively selling them on so they can free up their balance sheets. By March 2009, the Fed held $1.75 trillion of bank debt, MBS, and Treasury notes, and this reached a peak of $2.1 trillion in June 2010. Further purchases were halted as the economy had started to improve, but resumed in August 2010 when the Fed decided the economy was not growing fast enough. This was "QE1". In November 2010, the Fed announced a second round of quantitative easing, or "QE2", buying $600 billion of Treasury securities by the end of the second quarter of 2011. 

Ben Bernanke from an Article in The Atlantic Magazine

The third round of quantitative easing, or QE3, which was announced by Fed Chairman Bernanke a couple of weeks ago, was completely different, not because of what the Fed would do, but because of how it would do it. This time the Fed is going to buy $40 billion of mortgage-backed securities (MBS) per month, until the US labor market improves.  Bernanke said essentially that this program would be open ended, and would continue until the economy is well on it's way to recovery. Now what does this mean exactly?  Well, for a start, the Fed is committing itself to buying securitized US mortgages, which as any undergrad student of economics knows will increase the demand for this type of bond, and so will increase price, which will reduce yield.  The immediate effect then of doing this will be to keep mortgage rates very low, as banks will be able to issue up to $40 billion of new mortgages per month without putting any upward pressure on mortgage interest rates.  This in turn, will be a big stimulus to the housing market, one of the key sectors in the US economy.  All well and good so far.

The main problem with the policy though is that the so-called "transmission mechanism" for this form of unconventional monetary policy is not entirely clear, and here's why.  Given that this stimulates mortgage lending (as banks know that they can easily package up the mortgages and sell them on as MBS), this will clearly stimulate both existing and new housing activity, which will mean more housing construction.  So that will, in turn, mean more construction workers will be hired, which should increase employment, and that in turn will boost payroll numbers and bring down unemployment.  But employment in construction, even at the height of the housing boom in 2006 only represented about 8% of total US employment, so that is not really going to have a huge impact on the labor market, plus, many of the hires that do occur for manual construction jobs tend to be illegal or undocumented workers, so this won't feed into the official statistics either.

Of course I cannot imagine what the Fed economists have in mind for the transmission mechanism for QE3, but the only thing I can think of is that a mini-housing boom causes house prices to rise, and that in turn gives rise to so-called "wealth effects". These wealth effects result from people feeling better off because they have a net profit in their property, so go out and and spend as they did back in the 2000s.  There are also likely to be wealth effects arising from the stockmarket as well, as obviously market sentiment has improved in the knowledge that the Fed has backstopped the economy for the moment, and so share prices should continue to firm.  But the danger here is that these mechanisms are very - how might I put it - inexact. Obviously imprecision is not an excuse for inaction, but on the other hand it really is sending the Fed into uncharted territory.

Now please don't get me wrong here - I'd rather the Fed did something rather than nothing, as we clearly need more stimulus from somewhere, but I'm just a little uncertain as to how well QE3 will work.  I guess only time will tell.

The NHS, Obamacare and the priorities of a US President

http://www.flickr.com/photos/48459298@N07/7658481768/in/photostream/

I just came back from the UK and as you know if you read my blog regularly, I was at the London Olympics but more importantly I was in the UK to soak up the Olympic spirit and the great atmosphere that settled on London.  Now I saw Danny Boyle's Olympic Opening Ceremony like many people on the planet and was, I confess, a little surprised that Boyle emphasized the NHS as one of the "firsts" that the UK should celebrate as a nation. Now most of my US friends don't know what the NHS, but the National Health Service as it is known in the UK is the state funded healthcare system that has been in force since it was introduced in 1948 in post-WWII UK under the most left-leaning UK government under Clement Atlee, as one of the consequences of a reconstruction of the UK after the terrible hardships suffered by the country during the war (see here for more).  Health Minister Aneurin Bevan introduced the NHS with the following principles - i) it meets the needs of everyone; ii) that it be free at the point of delivery and iii) that it be based on clinical need, and not the ability to pay.

Now as you can see on the left, the NHS isn't necessarily seen as the most wonderful institution by all concerned in the UK ( - here David Cameron (UK PM) and Boris Johnson (Mayor of London) - are seen grimacing) in the way Boyle was determined to celebrate the NHS as a real achievement using real NHS nurses and doctors.

But one thing I think that people not from the UK need to recognize is that even the right wing party in the UK, the Conservative party, is not about to scrap the NHS because it is a beloved part of the UK landscape and although most people complain about various facets of the system, in the UK the horror stories about the US healthcare system are such that most Brits have no wish to embrace a private healthcare system like the US's system.

Now to Obamacare. Paul Krugman recently noted on his blog (here) that references a CEPR blog article (here) that comments on an article that criticises President Obama for focusing so much on healthcare in his first term in office when in the opinion of the author he could have been focusing more on the economy.  But in my way of thinking reform of the US healthcare system will probably be one of the major accomplishments of the Obama Presidency.

My basis for making this statement is partly because healthcare costs are an extremely large part of the government budget and because also they are much higher as a percentage of GDP than for any other country in the world. Whether you like Michael Moore or not, one of his major contributions must be his film "Sicko", which points out how expensive and inefficient the US healthcare system is, considering the economic resources that are absorbed by the healthcare sector.

But also I can make this statement from a personal point of view as I have been a recipient of healthcare under the US, Canadian, UK, and Finnish healthcare systems - how many people do you know who can say that? Now admittedly I haven't been on the operating table in any of these systems, so I haven't gone through the whole GP, to specialist to operation procedure, but I have received treatment by doctors in all 4 countries, and received some basic tests (blood work or some other basic testing). These are my observations about the US compared to the other systems:
 - a doctor's visit in the US involves much more basic "triage" than elsewhere - which might yield some useful observations, but is likely to be superfluous in most cases.
 - US doctors have an incentive to give many more tests than in other countries as they can charge for these tests - but they are permitted to give these tests according to the HMOs and PPOs, so naturally, they do!
 - US doctors will not contact patients on the phone - but they do elsewhere.
 - the HMOs and PPOs really determine the charges and expense of the system - thereby setting the minimum prices for the system.

Critics of both the Canadian healthcare system and the NHS say that they are "socialist".  Certainly in the UK that cannot be further from the truth. The structure of the system has been to create decentralized NHS "trusts" which are given a budget and then tasked with delivering care as efficiently and effectively as possible. In both the UK and Finland there are private options if you want to pay, but everyone pays for the NHS through their taxes, so that leads to a minimum level of care. And when you go to the doctors in Canada, the UK and Finland, the doctor personally invites you into his or her office without all the "triage" tests, and basically gets straight down to business. This "personal touch", in my experience, sets these systems apart from the US system, in which lawsuits and rent extraction are the main foci.

So, what do I think of Obamacare?  I think it really comes up short compared to the "single payer" systems that I think work more efficiently than the US healthcare system, but it is certainly better than what the US has right now. Will the US ever get rid of the middlemen ( - the HMOs and PPOs)?  The answer is likely no - they have way too much power now and are completely entrenched in the system.

So did President Obama waste his time focusing on reforming the US healthcare system?  No, I don't believe he did - it was an important task to complete, and now ranks as one of his biggest achievements over the past 4 years. 

5 years on...and no gold medal for the UK economy!

Today marks the 5 year anniversary of the beginning of the financial crisis that gave rise to what most economists have labelled the "great recession".  It marks the date 5 years ago when France's Banque National Paribas first reported having trouble with its hedge fund because it had invested heavily in US subprime mortgages.  Economists at that time lined up to say that everything was alright, that the economy would be fine and even the Federal Reserve and Bank of England seemed unconcerned at what appeared to be a minor problem with a French banking subsidiary.  But what it presaged was not pretty, as we now know, and led to deep recessions on both sides of the Atlantic, and particularly in the US.

As today is my last day in the UK for a while, I thought it might also be a good time to reflect on what has happened to the economies on both sides of the Atlantic in the last 5 years, and what might happen from this point onwards. In one sense the US might have been expected to have had by far the worse economic situation given the fact that it was its mortgages that had caused the crisis. Indeed the US economy was in a bad way, but government spending was ramped up in the first Obama administration to offset the collapse in consumption expenditure and investment as it was by the Brown regime.  The first interesting point from the diagram below which shows real GDP for both the US and the UK is that in fact the UK had a deeper recession than the US.  This was because the UK was affected by the US downturn and the consequent downturn, but also had it's own housing bubble and banking crises to deal with as well.

Data source: Real GDP volume, chain index from UK ONS and US BEA
Graphic by blog author

After the UK general election in 2010, and the new liberal-conservative coalition government took up office, the new Chancellor (equivalent to a finance minister), Charles Osborne, declared that it was more important to balance the budget and embark upon cuts to budgets to instill confidence than continue the high level of government spending that the previous labour administration had been undertaking. This was supposed to lead to a revival in growth, but unforunately the Chancellor appears to have got things badly wrong.  The graphic on the left shows the level of real GDP using 2007 Q4 as the beginning of the recession in both the UK and the US ( - in fact the US recession might have started a quarter after this date). It is easy to see that: i) the UK doesn't appear to have done quite as much stimulus in 2009; then ii) in the first half of 2010 the UK appears to be closing the gap and then iii) once there is talk of the policy U-turn things abruptly change in the second half of 2010.  But it's the period from the middle of 2011 when the difference is most stark.  Clearly the US is continuing on a "recovery trajectory", ending up with higher levels of output than at the peak of the previous boom, whereas the UK now slides into a "double dip" recession with output now still nearly 6% below where it was at the end of 2007.

To my way of thinking this suggests that the US has been doing something right on the economic policy front, and as suggested recently in the UK by the Prime Minister David Cameron, UK economic policy needs to be changed.  The danger is that the current UK coalition will go in for a tweak rather than a radical re-think. Figures published today in the UK relating to the trade balance make things look even worse - exports of goods are down 8.4% year on year and even though imports are down slightly too, the trade balance is now the worst on record. So in other words, the UK can't grow from exports, and it's banks are still not lending, so investment is sluggish.  The only thing left is government spending.  Let's hope George Osborne is brave enough to do a U-turn or at least a radical re-think!

The London Olympics and the UK economy

Nick Potts/PA Wire

The London Olympics are now underway, but against a backdrop of a recession now confirmed in the UK (regardless of the misreporting in a dreadful  New York Times article yesterday which stated that the country was on the verge of one).

Despite the extra spending in the run up to the Olympic games, Q2 of 2012 was the 3rd consecutive quarter of negative economic growth, with a decline of 0.7% compared with the previous quarter and a decline of nearly 0.8% compared to the same quarter a year ago.  The decline was clearly due to a 5.2% decline in the construction industry, which tells you that even though the Olympic building spree was in its final stages in the last quarter, other construction was clearly in heavy decline.  Why is this?  Partially because of the heavy budget cuts in terms of the UK coalition government's plans to balance the budget sooner rather than later (as in the US).  Although the UK Prime Minister, David Cameron, has stated that his government will now act to stimulate the economy, quite how this will be done is still unclear.

Here are some charts that show how bad the UK economy is faring right now.  The first shows real GDP growth using a year on year methodology.  It is clear that after a bounce back once the deep recession of 2008-09 had occurred, growth hit just over 2% and then has declined ever since.

Source: UK ONS   Calculations by me!

Despite this downtrend in growth, up until now the UK coalition has held to it's guns that it's economic priority must be to slash government spending and get it's levels of debt down.  And yet when you look at UK debt it is not that bad - a lower level in terms of % of GDP than the US or the euro area.

This can be clearly seen in some great analysis done by Matteo Radaelli which is reproduced in tablular form below

Source: Matteo Radaelli

What the table shows is that UK government debt is not the problem - if anything it is household debt that is the problem. In fact the net stimulus given to the UK economy in the major downturn was not that much considering that debt in the UK was already considerably higher than it was in the US. Also given that UK households are correcting their debt levels in the same way as US households have, then private savings rates have likely increased, given that also the future is uncertain and house prices have been falling. So in other words, it is no wonder the UK has gone into a double dip recession as the squeeze is on in both the public and the private sector. This is completely the opposite to what has been happening in the US where public spending has offset the private squeeze and has led to a modest economic recovery.

So the question is "what happens next?", as there is a "fiscal cliff" now looming in the US whereby if the leaders of the 2 parties cannot agree on increasing the debt ceiling, large cuts will occur in public spending next January. Some might think that the US has done enough of a stimulus so that The rosy scenario is that the US has done sufficient stimulus to boost global growth, the euro area comes out of its malaise and never-ending crises, and hopefully the UK government will U-turn sufficiently to weather any fiscal retrenchment in the US. But the likelihood of this happening is not high.  The UK therefore needs to do more than quantitative easing on the monetary side to lift the economy out of recession.  Some imaginative public infrastructure spending is needed - hopefully spending that will boost economic growth in the future.  Looking at the congestion on the highways in the UK, adding extra lanes everywhere would be a good start!

Is the path to an OCA paved with wasted euros?

First off, apologies to my blog followers for not posting in a couple of months!  I have been through a very stressful time at University ( - a lot of politics!), plus I am organizing a workshop in EU economics at George Mason University on the Euro area in 2 weeks time, so time has been in short supply!

It is always dramatic to hear when someone says "Europe is at a fulcrum" as Jim Cramer did the other day in his excellent program Mad Money on CNBC - but this time (and boy there have been many times recently), I think this call is spot on.  The main problem is that things are beginning to spiral out of control, and from a variety of perspectives there is no political consensus on how to fix things.  But before we get into the nitty gritty details about what might happen and what will probably happen, let's take a step back from the "rolling crisis" in Europe and look at the whole situation in a broader context.

The European Union was essentially a political project - one that would bind the countries of Europe together so that the events of the first and second World Wars would never be repeated.  In that the EU has been phenomenally successful as we have had no or little tension between the members of the European Union, countries that at one time were mortal enemies, since the founding of the Union in 1958.  But the EU has always had economic aspirations, aspirations that any entity its size are likely to have to be a major actor on the world stage.  The single market was the first real sign of those aspirations, and with the visionary Jacques Delors at the helm, the single market became a reality in 1992.  This is basically establishing the EU as a step beyond a free trade area - it is a customs union - a free trade area with common external tariffs.  A free trade area for Europe was a way of stimulating all the economies in Europe after a sclerotic period in the 1980s and the economic theory was completely behind it, as any student of economics will tell you.

All well and good - but Jacques Delors was not content to sit on his hands and let the momentum he had got behind the single market go to waste.  So the single currency was born on the shoulders of the single market, and justified by a now famous document called "One Market, One Money" which was published by the Commission as a justification for moving to a single money as a way to capture all the benefits from the single market plus some additional external benefits as well.  The only problem with a single money is that the economic theory behind adopting a common currency didn't back this further level of integration.

The theory behind adopting a common currency had been done in the 1950s and 1960s by the Canadian nobel-prizewinning economist, Robert Mundell, and is called "optimal currency area theory".  The theory essentially says that countries that have similar macroeconomic variable trajectories over time are likely to be good candidates to join a single currency.  And if there are some countries that don't quite fit the norm, as long as you have a single market for all factors of production and the equivalent of a federal government standing ready to do some redistribution of income, everything should work out alright.  In terms of the application of this theory, only a few decades later when a couple of seminal studies by a UK economist by the name of Michael Artis (University of Manchester) came out using cluster analysis in the late 1990s was it shown how problematic this was in the case of the EU.  If you looked at the pattern of movements in macroeconomic variables for all the candidates eligible and wanting to join the euro, there were clearly at least 3 distinct groups when compared with Germany - the most powerful country in Europe.  One was the so-called "hard core" of countries (all in Northern Europe) that tended to follow the German economy in almost lock step, one was the so-called "soft core" of countries that tended to be in Southern Europe and the third group was a rag-tag group of countries with different circumstances (Finland, Ireland, the UK, to name a few).  Clearly the UK was not what one would refer to as an "optimum currency area".  I even did my own update to the work of Michael Artis and others and it is available in working paper format from the Bank of Finland here.

Now as a side note, some economists (Jeffrey Frankel and Andrew Rose initiated this train of thinking)  made the point that even though the EU has nothing like a federal government to do some transfers of resources between countries that get into trouble, there is likely to be a harmonizing effect as all the member states adopting the euro will have the same monetary policy, which was not the case before they adopted the euro.  This so-called "endogeneity of optimal currency areas" (article available here) was a comfort, and led many to believe that the EU did not need to have the apparatus at a federal or (what the Europeans call a) supranational level in order for the euro to work.

So let's now fast forward to the current problems.  If we look at the groupings of euro area member states (and I am just about to finish a paper which does exactly this) based on how their growth rates are moving together (or otherwise), it is clear that there are basically 3 groups of euro area member states - those that are still in the "hard core", those that have transitioned or are transitioning towards the "hard core", and those that are still far from being in the "hard core" and if anything are moving in the opposite direction (read Greece).  It is therefore clear that unless something is done to give support to Greece's membership at the supranational level (which is unlikely given German opposition to such a development), it should leave.  The big question though is what would happen if Greece left, and how serious the "contagion" would be (some commentators have already claimed that these effects have started see Gavyn Davies's article in the FT here).  I would suggest that economic policymakers should look very carefully at what the economic studies are saying about the other member states that are likely to seek assistance if contagion occurs following a Greek exit (or Grexit as it is now called), before they go down the same path that they have with Greece.  Not all paths are paved with gold, and some might be paved with an awful lot of wasted euros!

The main point here is that if push comes to shove politics will once again trump economics.  The EU leadership can do only a certain amount to help Greece stay in the euro, and because there is little consensus on further help, a point will likely come when Greece either defaults or exits or both.

Investment cycles

As many of my blog readers know, as a macroeconomist I am a maverick as I believe in cycles.  It seems to me (and a few others, although it should be noted we are definitely in a minority), that cyclical behavior is just part of what economists label the “business cycle” and denying its existence or stating that the cycles are caused by shocks simply put you in denial of the facts.  I would go beyond just the business cycle as a stylized fact – I believe there are other irregular cycles that also permeate the macroeconomy, most notably in the shorter term “growth cycles” that we can also observe just by looking at the growth rate.  These shorter term growth cycles originate from a variety of different sources, but most notably is investment ( - a previous blog posting covered the cycles in consumption expenditure), the reason for this being that investment is one of the most volatile components of aggregate spending.

First off, we need to just clarify what we mean by investment expenditures.  Investment as a concept has a very specific meaning in economics which is quite specific compared with the everyday use of the term “investment” in common language.  Investment in economics means spending on plant, machinery, equipment, new commercial property etc ( - what is known as gross fixed capital formation to an economist), but also included in this category in the national income accounts one also finds spending on new residential housing, computers (whether for households or firms) and changes in inventories.  Note that investment in an economic sense does not include purchases of stocks and shares or bonds or spending on education etc.  Although we might use the term investment to talk about these types of expenditures in everyday language, to an economist this is NOT investment spending.

So let’s look at the different cycles that I hypothesize one should find in investment spending and why.  There are 4 cycles that I would hypothesize exist in the data and each would be expected to have a different periodicity and to depend on different macroeconomic variables.  Let’s take each cycle from the cycle that I would expect to have the longest frequency to one that I would expect to have the shortest frequency. 

The longest cycle that I would anticipate one should find in the data is a “technology innovation investment cycle”.  If new technology is introduced then firms are likely to adopt this technology over time, but in more competitive industries this adoption could be quite rapid.  These are cycles that depend on hardware and often require dramatic changes in the workplace.  For example we have gone from labor being the major input in the production process of automobiles, to computers determining speed of the assembly line and ordering of parts but mostly labor involved in actual assembly to computer-controlled robots actually doing assembly.  In each wave of technological change (computers then computer-controlled robotics), there have been longer term costs savings from a lower labor requirement but a substantial upfront investment on plant machinery and equipment.  These cycles should be longer cycles than the business cycle ( - what some economists refer to as “medium-term cycles”), but they are intimately linked with the business cycle, as they can lead to booms in economic output as manufacturing costs fall, and costs elsewhere in the economy should also fall.  The point is that we shouldn’t expect every business cycle to be driven by these technological innovations, but of course the business cycle will be affected when these changes happen.

The next longest investment cycle has to do with the business cycle.  As consumption is cyclical, any downturn in the economy will result in a fall in consumption which will lead companies to pare back expansion plans, cancel those plans or indeed reduce production capacity.  This will result in a fall in investment as equipment wearing out will not be replaced and new equipment orders will be cancelled. This “demand-led investment cycle” should lag the business cycle.

The third investment cycle also has to do with the business cycle as well, but originates in Keynesian and Austrian thinking.  The real interest rate determines how costly it is to invest and determines the volume of investment according to a negative relationship between the cost of borrowing (the real interest rate) and the amount of investment undertaken.  This could happen through 2 different channels: i) the Austrian school channel which states that the interest rate is inversely proportional to the average length of the production process so that lower real interest rates lead to longer production times ( - and therefore a greater amount of capital required to produce the same amount of output at a given time in the future – a relationship known as the Hayekian triangle); and ii) the Keynesian school that simply states that lower real rates make it cheaper to borrow and thus more firms should borrow in order to expand.  Either way this implies that monetary policy will have an impact on investment and indeed exogenous shocks that lead to low or expectations of negative real rates would create incentives to increase investment.

The fourth investment cycle is of variable length but has to be with depreciation cycles.  If historically there were cycles in investment for whatever reason (“technology innovation” or “demand led” cycles) then these cycles will likely replicate themselves as this equipment will eventually wear out and need replacing.  Presumably the equipment would need replacing at roughly similar times given the fact that it was installed at roughly the same time, so this will lead to “upgrade” programs to replace old equipment and this tends to occur over a relatively short period of time relative to the business cycle.  This I will call “depreciation investment cycles”.  Obviously if we assume technology to be fixed, the depreciation investment cycles will depend on the quality of the capital and the availability of parts.  An obvious example of this would be aviation or transportation equipment that usually is used until it wears out and parts no longer exist or are prohibitively expensive.

The fifth investment cycle relates to the relative price of capital, and this is usually measured by something called “Tobin’s q” theory.  If you think of companies as using factors of production labor and capital, then the valuation of a company is usually done based on it’s “assets” which, ignoring  labor force skills is calculated by the value of the physical assets (capital) which would remain if the company ceased to operate.  Comparing the value of the company (as measured by the cost of replacing its assets) versus how much the stockmarket currently values the company (how much the company is worth in terms of future profitability) gives a relative value of capital and is known as “Tobin’s q” theory after the Yale economist James Tobin.  Any calculation of “Tobin’s q” (Stockmarket value to replacement value) appears to move in cycles, and therefore implies that at certain points the stockmarket values capital more highly than the cost of capital and therefore there is an incentive to expand by increasing investment. 

The last investment cycle I will outline is a “competition-driven investment cycle”. In competitive economies with industry structures that resemble anything other than monopolies, there will be pressure to “keep up with the Jones’s” in order to maintain market share.  Although competition has a role to play in the “technology innovation investment cycle”, it also has a role to play in terms of offering a similar consumer experience as competitors do, and this might require software or equipment upgrades to meet consumer expectations in a competitive marketplace.  Examples of this type of investment may well take place by “third party” suppliers such as internet service providers for banks, modern décor in coffee shops or the look and feel of a supermarket.  This “competition-driven investment” is likely to occur over a discrete period of time between the different firms in the marketplace as firms attempt to differentiate themselves from one another. 

OK, enough theory.  The proof of this approach will clearly be in the pudding. More next time on the relationship between stockmarkets, economic growth and investment. 

Greece: the end-game nears

It is not surprising there are now riots in Athens.  It is now all too clear that even though Greek levels of debt are not yet at Japanese levels, Germany doesn't want Greece in the euro anymore.  If Greece doesn't leave the euro then not only will all political parties have to agree to institute the measures insisted on by the other euro area finance ministers, but also they will have to endure economic misery in the form of a depression for at least the next 5 years, if not longer.

As we say in economics, you have to evaluate the net benefits from doing this or from leaving the euro, because both are not going to be pleasant for Greece, and the possible choices facing Greece have potential ramifications for the rest of the world.  So let's look at this in terms of the choices facing Greece and then what the implications will be on the EU and on the rest of the world.

Scenario 1: Stay in the euro and Greek politicians behave. 

Greece has entered it's 5th year of recession, and unemployment is now at over 20%, and will undoubtedly approach Great depression levels of 25% this year if the austerity programme that the EU insists must be implemented goes ahead.  Now €130bn sounds like a lot of money, but in the context of the whole EU economy it is a relatively small amount.  The point here is that the Northern Europeans are tired of this never ending Greek bailout saga and they want this to be the last bailout so they are really tightening the screws. 

Staying in the euro would probably be the best solution for the rest of Europe and the rest of the world as long as this really is the last bailout and Greece accepts that it has to remain in depression for another 5 years.  Doing this though would likely see the Greek social order implode. As the Archbishop of Athens put it: "Homelessness and even hunger — phenomena seen during (World War Two) — have reached nightmare proportions. Patience among Greeks is running out, giving way to a sense of anger, and the danger of a social explosion cannot be ignored any longer. The medicine we are taking has proved fatal for the nation. More painful, and more unjust measures are now set to follow along the same, hopeless course."

So what's best for Europe and the rest of the world is probably worst for Greece, as it doesn't default, has it's hands tied and it's population have to endure more years of misery.
 
Scenario 2: Stay in the euro and Greek politicians misbehave.
 
This option essentially kicks the can down the road yet again, but still imposes misery on Greece and at the same time means that Greece will be back again for a further bailout in less than a year.  The Germans were right to suggest that someone from the Commission should be in Athens overseeing the Greek budget as historically it has been one of the most untrustworthy economic documents in terms of statistical reliability.  And the fact that the Greeks were affronted and said no means that if they take the bailout money this time around the rest of the EU has very little control in terms of what actually happens with the money and over the setting of future budgets.  This is despite the letters that have been signed by the current leaders of the political parties.  Add to that that political leaders are changing all the time in Greece right now, and you can see that the letters are only a commitment of one particular political leader, with the whole austerity package therefore having an automatic "loosening bias" as political leaders change through time.  The other point here is that politicians like to get re-elected - why would you vote for someone who is honestly going to impose austerity on you?  If I were a Greek I would much rather vote for a politician that says all the right things with a nod and a wink so that things are not nearly as bad as you expect. 
 
This scenario is bad, but not quite as bad as scenario 1 for Greece - I would expect that the economic outlook is not quite as bad for Greece in the short term, but of course will likely lead to another crisis in the future and therefore we could be back at this crossroads again.  It is definitely not good for the rest of Europe, and likely not so wonderful for the rest of the world either.  The reason for this is that kicking the can down the road clearly involves a future decision about whether to kick Greece out of the euro because the next time around there will likely be a disorderly default, and then the rest of the EU will not want the contagion connected with this and will want Greece out of the euro.  The trouble is there is nothing in the Maastricht Treaties that specifies under what circumstances a country is forced to leave the euro.  This would be a real headache for the rest of the EU and would hence threaten the whole "harmony" within the euro and the consensus decision-making at the ECB.  Spain, Portugal, Ireland and Belgium would obviously all be watching the events that unfold around this scenario very carefully.


Scenario 3: Greece leaves the euro and returns to the drachma
This is, I now think, the most likely scenario. The immediate effect on Greece would be cataclysmic as money flows out of the country.  Exactly what happened in Argentina when they left the currency board will likely happen in Greece.  Anyone holding euros in a Greek bank would see these frozen and then converted into Drachmas at the official exchange rate that Greece entered the euro at, and then once the drachma is floated the accounts are unfrozen.  That means that savings are now converted into drachmas and then the drachma will obviously collapse against the euro meaning that savings will immediately be devalued by a huge amount making everyone a lot poorer in international terms and causing a severe bout of inflation as all imports are priced in non-drachma terms.  Of course the way to avoid this is to get your money out of the country now, so I'm sure there are huge capital flows happening right now to safeguard savings and other assets against this particular scenario.

The immediate effect would be horrible for Greece, as it was in Argentina, but the pain in these "almost instantaneous" adjustments is usually short-lived, and once the drachma gets into equilibrium with other currencies again, things usually quickly improve.  Obviously there is absolutely no way that Greece could repay any loans made in euros, so a disorderly default is inevitable. 

The pain here is on the Greeks, as well as private creditors in the rest of the euro area and on the credibility of the euro area, as it has it's first casualty as a country voluntarily leaves the euro.  Note that Greece would not be leaving the EU, and it's exports should improve dramatically as the national currency sinks to a new equilibrium level, and it would lead to a surge in inflation and therefore an automatic adjustment to real wages.  The credibility of the euro and the EU officials here would be badly hit, as would private banks that hold Greek debt.  Also if Greece does come out of the euro and quickly turns things around other countries might also be tempted to do the same, which could prompt a partial unravelling of the euro as well.  The effects on the rest of the world would be negligible, but could impact the banking sector as a domino effect occurs through European banks.

Scenario 3: Greece returns to the drachma and sets up a currency board

This is a variation on scenario 4 above.  Here though Greece leaves the euro area but reintroduces the drachma and allows the drachma to circulate alongside the euro at fixed rates, which presumably it would determine in such a way to take into account inflation differentials with the rest of the euro area over the past 9 years, and then some.  This way some of the pain for the Greek public associated with scenario 4 could be overcome, but at the same time the Greek government would likely have to default on its debt.  This would be an attempt at an "orderly exit" from the euro rather than the usual "disorderly exit" that happens when fixed exchange rate regimes collapse.  The big question here is how would Greece come up with the euro assets to fund the currency board?  Part of that might lie in persuading creditors to agree to a swap of a Greek euro denominated debt into Greek drachma debt and favorable rates and then use this Greek euro debt as an asset to fund the currency board.  This would be akin to asking investors to take a stake in the "new" Greece, in exchange for giving up old "soon to be worthless" assets.

I think this is a viable option for Greece, and probably is the best option in terms of Greece leaving the euro from an economics perpective.  Of course whether Greek politicians have the nouse or the will to think something like this through is another matter.  We shall see.

2012 Preview: Coupling and Economic Growth

Happy New Year for 2012 to all my blog readers.  Having just returned from spending the festive season in South Africa (St. Francis Bay and Cape Town to be exact), with a stop in Dubai on the way out, I wanted to reflect on the global economy and its prospects in 2012.

While on the plane, I was reading the Xmas/NY edition of The Economist, and it struck me that the notion of "coupling" and "decoupling" has really not gone away, but at the same time has not been properly explored in academic circles in economics.  And whether we like it or not, when we talk about prospects for different parts of the globe it is all within the context of some kind of international business cycle, which is mostly determined by what goes on in the US.  So as I am doing more research which looks at economic cycles right now, I have also been interested in trying to characterize how different the US cycle is from cycles elsewhere, not in terms of the size of it's ups and downs ( - it's amplitude to a physicist) but more in terms of its shape, compared to other economies.  The first place though to start should be within the US itself though and here the dynamic graphic above comes into play.  This is an Oldham coupling mechanism (taken from this Wikipedia page) where the cycles are clearly not in sync and amplitudes are quite different.as well, but all three wheels have the same cycle periodicity.  This is something like what we see in economics, except of course that there isn't the regularity that we see here because economies are not "pinned" together like these wheels are.  Nevertheless, the fact that there is cycle dependency is what interests me in terms of my research and this is one of the research themes I will be exploring in more detail this year.

If this type of coupling is one of the processes that is at work then it (partially?) explains why certain economies (like India's and China's) have much more growth volatility than does the US and other developed economies. Given that you accept the idea of a loose international synchronization of growth rates, then the good news is that 2012 will likely be markedly better for economic growth than most of the pundits expect - and I think we're already seeing that in the US employment numbers released in the first week of the year.

So what does this mean in terms of finance and investment?  Apart from following the general advice about keeping quite a lot of funds in US stocks and avoiding European stocks given the problems with implementing the austerity measures in the euro area, the Standard and Poor's downgrades, together with the cuts to public expenditure in the UK, there seems to be little consensus on what else to do with your money in 2012.

So where else is promising? I think Africa has still a lot of unfilled potential, and particularly those corporations based in South Africa or US corporations or European corporations that operate in Africa.  Parts of East Asia, in my view, are also still interesting - India, Malaysia, Indonesia and Taiwan in particular, but China is worrying, given the large property bubble that still exists there.  South America also still has potential, but is largely dependent on central banks being able to restrain inflation while ensuring growth.

But my main point in this posting is that prospects everywhere are extremely dependent on the international business cycle, which in turn is determined largely by what happens in the US and Europe.  While the US increasingly looks to be doing better, Europe still has large clouds hanging over its prospects in 2012.