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CONTENTS
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EDITORS
Jia Way Yew
BSc Economics, 3rd year. Spends free time writing fiction, but hopes that this admission will not cause readers to doubt the opinions presented in this magazine.
Jake Akcroyd
Talitha Chin Editor-in-Chief
MSc Regulation (Financial). It is her third year with the magazine and her fourth year at LSE. Very passionate about economic writing, has a strong interest in macroeconomic models, energy economics and behavioural finance.
MSc Political Economy of Europe. Previously lived and worked in Japan, Indonesia and Canada and snowboarded competitively. Particularly interested in European growth markets, institutional investment, policy making and redistribution.
Sam Foxall
MSc Economic History. Interested in European Integration, global financial institutions and regional banking across Europe and the US.
DESIGN TEAM
Honglin Jiang
MSc Economics. Formerly studied and worked in Sydney, Australia, trading equity derivatives for a proprietary trading firm. Especially interested in the interaction between macroeconomics and financial markets.
Jeffrey Mo
MSc Econometrics and Mathematical Economics. Has worked at the Organisation for Economic Cooperation and Development and at the European Bank for Reconstruction and Development. Also interested in the public and labour economics and political economy.
Kiran Krishna Eunice Tse
Copy & Design Editor
BSc Philosophy, Logic and Scientific Method., 1st year Enjoys philosophilising and food. 02
Design Editor
BSc Economics, 2nd year. She hopes one day to go into research or something related to economics policy, and to make a respectable Baked Alaska.
WRITERS
Priscila Rocha
MSc Economic History. Graduated from high school in Sao Paulo, Brazil, received her BA in Journalism (Hon.) in Chile. Prior to LSE, she worked as a reporter in New York City and a business consultant in Brazil. Would like to become a business reporter/writer.
Filip Balawejder
BSc Economics, 1st year. Interested in economic policy and applications of economic theory to real world problems. Would like to focus on topics such as growth, development and welfare, particularly those related to the European Union.
Louis Ariss
BSc Economics, 1st year. Passionate about the history of economic thought. Recent interests include business cycle theory and the evolution of British economic policy.
Drew Hopper
Bryan Cheung
LLB Law, 1st year. Has a strong interest in the interaction between technology and culture, and the transformative impact that technological developments will have on society as a whole – politically, economically and socially.
General Course, from Kalamazoo College, USA. ParticularSamuel Monk ly interested in the relationship BSc Mathematics and Econombetween law and economics. ics, 3rd year. Interested in monetary policy and its interaction with financial markets, in particular, unusual monetary policies, such as quantitative easing, and the resulting impact on asset prices.
Ellie Heatherill Design Editor
BSc Government and Economics, 1st year. Strongly interested in global macroeconomics and in particular how different governments are responding to crises today.
Anastasia Mishchanenko
BSc Economics, 1st year. Interested in the interconnection of economics and politics. Excited by the overlap between technical economic policy-making and underlying ideologies. 03
Letter from the Editor:
5 YEARS ON... Five years on from the financial crisis, four years since the world’s advanced economies emerged from negative GDP growth, 3 years from the first Greek bailout package and the establishment of the European Financial Stability Facility— the world economy is still teetering on an edge. Three years ago when Federal Reserve Chairman Ben Bernanke was addressing Central Bankers at the Frankfurt Conference on Nov 19 2010, he highlighted that the main issue stymieing international cooperation was a two-speed global recovery. Back then while the US economy rebounded from the crisis after mid-2009, the main concern was whether growth was transient and due to the short-term fiscal injection into the economy. While Bernanke’s latter concern persists till today, our global economy today looks very different. The biggest pendulum that has swung market optimism this year is the US government’s decision of tapering its fiscal stimulus package. While Ben Bernanke earlier declared that there will be “no fixed schedule” to asset purchases, financial markets have been for the past year on a bumpy ride reacting to sunspots engineered by the Fed’s policy and the 16day Washington shutdown. Although the rebound in the Manufacturing Purchasing Manager’s Index in November and the rising retail sales in October have spurred the Dow Jones to reach its record high, the OECD argues that further fiscal tightening might severely drag down the global economy. As France and Italy’s growth went into the red in the third quarter of 2013 and there was flat growth in the EU28, OECD Economist Pier Carlo Padoan warned that the 34 OECD economies would be in recession had the US cut it budget deficit by 6.5%. So, the global economy still sees turbulent times ahead as the US debt problem persists. The trillion-dollar question is: has quantitative easing (QE) worked? Sam Monk sheds light on this in his article that provides a helicopter’s view of post-crisis QE in US and UK. He argues that while it is doubted whether QE has material impact beyond the financial markets, the Bank of England has been successful in achieving its policy targets and now pulls ahead from fellow EU members in recovery. While profitability remains weak in the EU, Sam Foxall questions if European asset prices are a faithful reflection of value in a climate of inflation04
ary monetary policy. Echoing Schiller’s view of asset prices, he purports that markets today may be irrationally overpriced as asset purchases are driven by the momentum game. While investors are flocking to European assets, emerging markets are geared to slow down global growth. The OECD knocked off half a percentage point over 2014 global growth estimates to 3.1%. But what has happened to emerging markets, and in particular, China? One can recall that not too long ago in China’s Olympic year, the world was placing huge bets on China to take over the world. Growth slowed 14% in 2007 and close to 10% in 2008, and then dipped below the 8% baseline growth required for sustaining long-run prosperity this year. Honglin Jiang sheds light on China (and consequently the world’s) economic rebalancing as he argues that economic policies that benefit industries but weigh down on households need to be recalibrated. While China is facing its own problems and US’s growth is better but unimpressive, Martin Wolf, Chief Economic Commentator of the Financial Times and one of the speakers at the LSE-UCL Economic Conference iterates that the “future looks sluggish”. He points to global savings glut as the root of these imbalances. Emerging economies continue to accumulate current account surpluses (hence,“Made en Chine on the cover), while the world is sorely begging for an increase in investment to match savings. Is this the end of growth? On the brighter side, we would never know how the world would look five years on. While it has been five years on from the crisis, it has also been five years from the founding of the rationale. In our ‘five-year anniversary’ issue, we bring you a special feature on social mobility, in line with the latest Economic conference theme People and Economics. Jeffrey Mo investigates whether family history and socio-economic status is a precursor to a person’s path career path. Meanwhile, William Locke draws from historical and current evidence in questioning whether a child’s development is correlated with his mother’s employment. We hope you will enjoy the writing in this issue, and look forward to hearing more of your Economic ideas and perspectives next year. Talitha Chin
CHINA’S ECONOMIC REBALANCING: A PATH TO SUSTAINABLE GROWTH? BY HONGLIN JIANG In the immortal words of Herbert Stein: “if something cannot go on forever, it will stop”. China’s credit-fuelled and investment-driven model of growth is fast approaching the limits of economic sustainability, and will rebalance, one way or another. The billion yuan question is: how? The rise of China can barely be understated in its economic impact. In just one generation, it has advanced from near-irrelevance to superpower. Yet, its growth model is accumulating economic imbalances that will need to be addressed. In particular, the mix of consumption and investment as shares of GDP has reached proportions that are unprecedented in economic history. The other ‘Asian Tigers’ that China is frequently compared to (such as Taiwan and South Korea) had investment peaking at around 35% of GDP in
their development cycles; China’s share is now 47%. This imbalance results from a deliberate strategy to force up the savings rate by repressing consumption growth. Important features of this strategy include artificially depressing interest rates and the currency (renminbi), the imposition of capital controls, and the restriction of internal immigration (the hukou system). The effect of each these policies has been to benefit state-owned enterprises (SOEs) and manufacturers at the expense of households and consumers. How do these mechanisms achieve these effects? Firstly, the state imposes a cap on deposit rates offered by commercial banks to their depositors, going beyond the usual practice of setting the bank rate (such as the Federal Funds Rate in the US). This implies that depositors are
being underpaid on their savings, reducing interest income. Also, it allows banks to offer lending rates to finance investment at artificially low or even negative real interest rates. Reducing the cost of capital for business and investment naturally encourages firms to use more capital, and makes some otherwise unprofitable projects viable. Investment decisions made using a lower discount rate always appear to look more attractive with a higher net present value. Given the size of China’s deposit base and the deviation of capped deposit rates from estimated market rates, economists assess the size of this transfer at between 4-9% of GDP. Secondly, China pegs the renminbi to the US dollar, keeping it systematically undervalued. By maintaining this exchange rate policy, exporters and manufac05
turers receiving foreign currency as payment for their goods benefit by getting more renminbi in exchange. Of course, the flip side of this is that importers must pay more for their goods. Given that almost all of China’s households are net importers of foreign goods, the currency regime functions as a type of implicit consumption tax, transferring wealth from consumers to industry. The consensus estimate of the magnitude of this ‘tax’ among economists is around 15-30% - a substantial sum in the context of an economy where imports make up 27% of GDP. Thirdly, the imposition of capital controls means that households are effectively a captive market to China’s financial system. By controlling capital flows between the Mainland and the rest of the world, China avoids potentially destabilising rushes of foreign money (as in the Asian crisis of the late 1990s), but also gives its households no way of exporting their savings to where they might be more productively deployed. Instead, they are restricted to the
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domestic banking, capital and real estate markets. Of these markets, the Chinese have most enthusiastically channelled their savings into real estate, since deposits offer negative real returns and domestic equities suffer from corporate governance issues. Correspondingly, growth in real estate investment has even outstripped that of other types of investment, now making up around 10-13% of GDP. Finally, the hukou system restricts internal immigration, tying one’s rights to land tenure and public services to the region where they were born. While rural people are allowed to migrate to the cities to work for a higher wage, in doing so, they must leave behind family members to maintain tenure over their land and are limited in their claims on public or social services. The effect of this system has been to allow firms to access a vast, low-cost pool of labour that experiences little wage growth and has low bargaining power. The lower wages paid to migrant workers combined with the inability to make a home in their
new city also serves to restrain aggregate household income and consumption. Thus, the net effects of these policies show up in China’s national accounts as a high growth rate driven by high investment, an even higher savings rate, a positive current account surplus, and low consumption. Why does this matter and why can’t this model of growth continue indefinitely? It is because investments financed with artificially cheap debt are less likely to produce the returns necessary to create value. Indeed, as marginal returns to investment diminish, the risk of malinvestment and non-performing loans rise. Debt incurred in the financing of investments must be resolved in one way or another. If the asset’s returns cannot service the debt, then there must be a transfer from some other sector of the economy to cover the difference. Usually, this is the household sector, whether explicitly through debt default and deposit confiscation, or implicitly through inflation and interest rate mechanisms.
Thus, corporate and government non-performing loans in China can really be represented as a claim on household wealth. There is evidence to suggest that China may have indeed over-invested in certain areas. The steel industry in 2012 had a total capacity of one billion tons of production, yet only 720 million tons were produced - and profit margins were a razor-thin 0.04%. Commentators also point out examples of real estate malinvestment, such as the uninhabited ‘ghost city’ of Ordos, which was built to house a million people. Thus, if further growth in investment is financially constrained, where else might growth come from? China is already the world’s largest exporter in a global context of weak demand, so it is unlikely to be able to extract further growth from foreign trade without arousing the ire of its trading partners. That leaves domestic consumption as the natural driver of future growth. Liberalisation and reform of the institutional impediments to consumption growth could engineer a stable modernisation from an investment to a consumer driven economy. Interest rate liberalisation would boost savers’ wealth, and impose the correct cost of capital on businesses to prevent excessive malinvestment. A faster appreciation of the exchange rate would increase consumers’ purchasing power of imported goods. Freeing up capital controls would fit into the government’s long term strategy of internationalising the renminbi, and give Chinese savers a more diverse range of assets to invest in. Land and hukou reform allowing farmers to sell their land and giving migrant workers formal rights to social services would represent a significant one-off boost to
their wealth. Privatising more of the SOE sector and distributing the proceeds through income tax cuts or debt reduction would also increase household purchasing power. Policies such as these would likely decrease total GDP growth, possibly by as much as 2-4% of GDP a year. Commentators worry about the social and political effects of a slowdown. After all, the Party’s political legitimacy implicitly depends on delivering economic growth. Yet, these policies would not necessarily result in social instability since consumption growth would be making up a larger proportion of overall growth. They would almost certainly be difficult to implement politically, as the biggest beneficiaries of the investment-led growth model have been the political class and management of the SOEs. These vested interests in the government and industry will almost certainly oppose reforms to the system that enriched them. Nevertheless, the senior leadership’s recent rhetoric appears to acknowledge the need for reform. The devil will be, as it always is, in the details. So what do the best- and worst-case scenarios for China’s rebalancing look like? In “Avoiding the Fall: China’s Economic Restructuring,” Peking University professor Michael Pettis identifies six separate paths that China could plausibly follow. The worst would undoubtedly be to deny the need for rebalancing and maintain current investment levels until the weight of bad debt forces a hard stop to investment and causes GDP to plunge. Consumption would fall, but it would rise as a share of GDP since individuals losing all their income cannot halt all their consumption. Rebalancing could not be denied, as painful
as it might be. While China is currently creditworthy, debt constraints would eventually apply as domestic banking deposits fail to keep up with exponentially rising credit growth and foreign capital flees. Fortunately, this scenario is not inevitable, nor perhaps even probable, if China voluntarily rebalances. Not uncoincidentally, the best-case scenario for China’s economy would likely be the worst-case scenario for the country’s elite (short of a revolution). Flows of wealth to the state and industry sectors would not only have to be stopped, but reversed. Privatisation of swathes of stateowned industry would likely be the most efficient way of doing this if the proceeds are directly or indirectly disbursed to the household sector. Lifting financial repression through interest rate liberalisation and normalising the terms of external trade would also help roll back the accumulation of imbalances. As for the rest of the world, the implications of China’s rebalancing can be reasonably guessed at. The US trade deficit will narrow, mirroring a fall in China’s current account surplus, and its manufacturing industry will become relatively more competitive as Chinese wages rise. Raw materials and non-food commodities such as copper, iron ore and coal may fall in price as China reduces demand for capital investment. Associated commodity currencies such as the Brazilian real and the Australian dollar will likely fall and their country’s terms of trade deteriorate. Making the renminbi convertible, lifting exchange rate and capital controls and deepening the liquidity of the renminbi bond market will internationalise the currency, and may eventually give the renminbi reserve currency 07
status to rival the US dollar. In the short term, however, China’s leaders will have to navigate a maze of political constraints to resolve the underlying economic imbalances. The party will need to recognise on an institutional level that quality of growth - rather than just quantity - matters. SOE and industry dominance in the economy must be reduced to allow room for households, services and private enterprise to lead the way in growth. If they cannot muster the required political support for reforms, then they may eventually find the situation escaping their control in the form of a domestic financial crisis. Inevitably, with globalisation and trade links, the crisis would spread well beyond China’s borders. The world has barely reached escape velocity from its last crisis; it cannot afford another any time soon.
Comment
THE MISSING WEALTH OF NATIONS by Jeffrey Mo Does China own the world and, in particular, the United States? Numerous media reports have certainly suggested so. More broadly, capital has, counterintuitively, generally moved from poor to rich countries over the past twenty years, turning the rich world into net debtors. However, research published earlier this year indicates that official government statistics overestimate national debt as they fail to account for the assets held in off-shore tax havens. These hidden assets might be significant enough to turn Europe from a net debtor to a net credit. As a corollary, rich countries should focus on domestic imbalances – for example, by clamping down on tax evasion – rather than on international imbalances. And, perhaps the American media landscape should take a look at the data.
QUANTITATIVE EASING, HAS IT WORKED? BY SAMUEL MONK The Bank of England once argued that standard economic models are of limited use in unusual circumstances. Many economists argue that the global financial crisis is the worst since the Great Depression. According to the Bank of England then, such an event certainly meets the criteria for unusual monetary policy. In the wake of the financial crisis, this took the form of quantitative easing, with varying degrees of effectiveness around the world. USA The Federal Reserve began its first round of quantitative easing, QE1, in November 2008. Lasting for seventeen months, the Federal 08
Reserve spent a total of $1.7 trillion purchasing mortgage-backed securities and US Treasury bonds from private investors. In this time, the prices of financial assets such as stocks and corporate debt increased markedly, providing compelling evidence of financial recovery resulting from the programme. The Federal Reserve deemed QE1 a success, but it was not enough to prevent QE2 seven months later. A year on from QE2, and the Federal Reserve embarked on a further round of asset purchases that, subject to some changes, is still on going. The latest news from the Federal Reserve is that the timing of a “taper” on its $85
billion a month asset purchasing programme is completely dependent upon economic data. It will take a period of months to collate this data and truly understand the impact of the recent government shutdown, in which 800,000 federal employees were temporarily rendered jobless. Market participants have remained bullish, reflecting expectations that the Federal Reserve will maintain its stimulus programme into 2014. The S&P 500 index has generated an almost 30% return in the year to date, reaching several record highs in the past few months and continuing to grow. Meanwhile, the US Dollar continues to perform poorly, at a two year
low against a basket of rivals. This is evident in the deceleration of imports during the third quarter of this year. Despite this, real GDP growth increased to 2.8% from 2.5% in the second quarter, according to data from the Bureau of Economic Analysis. The Federal Reserve originally claimed that it would begin its “taper” of asset purchases when unemployment reached 6.5% or core inflation rose above 2.5%. This broader inflation measure, used by the Federal Reserve, stood at just 1% in August suggesting that spending is not increasing in the real economy as planned. Meanwhile, a slowing trend is evident in the US jobs market, where on a 3-month rolling average, 60,000 fewer jobs are added a month compared with six months ago. The Federal Reserve Chairperson-nominee Janet Yellen recently told Congress that monetary stimulus would still be needed to spur economic growth. There is little evidence then, that any
renaissance in the ‘real’ economy is a direct consequence of quantitative easing. Without doubt, quantitative easing has impacted significantly upon asset prices, but one may question whether private companies and institutions have utilised the increased monetary base to increase lending to the real economy. We must wait to assess the impact of the US government shutdown, but clearly low interest rates and quantitative easing will continue for the foreseeable future. UK The Federal Reserve began its first round of quantitative easing, QE1, in November 2008. Lasting for seventeen months, the Federal Reserve spent a total of $1.7 trillion purchasing mortgage-backed securities and US Treasury bonds from private investors. In this time, the prices of financial assets such as stocks and corporate debt increased markedly, providing compelling evidence of financial recovery resulting from the pro-
gramme. The Federal Reserve deemed QE1 a success, but it was not enough to prevent QE2 seven months later. A year on from QE2, and the Federal Reserve embarked on a further round of asset purchases that, subject to some changes, is still on going. The latest news from the Federal Reserve is that the timing of a “taper” on its $85 billion a month asset purchasing programme is completely dependent upon economic data. It will take a period of months to collate this data and truly understand the impact of the recent government shutdown, in which 800,000 federal employees were temporarily rendered jobless. Market participants have remained bullish, reflecting expectations that the Federal Reserve will maintain its stimulus programme into 2014. The S&P 500 index has generated an almost 30% return in the year to date, reaching several record highs in the past few months and continuing to grow. Meanwhile, the US Dollar continues 09
to perform poorly, at a two year low against a basket of rivals. This is evident in the deceleration of imports during the third quarter of this year. Despite this, real GDP growth increased to 2.8% from 2.5% in the second quarter, according to data from the Bureau of Economic Analysis. The Federal Reserve originally
claimed that it would begin its “taper” of asset purchases when unemployment reached 6.5% or core inflation rose above 2.5%. This broader inflation measure, used by the Federal Reserve, stood at just 1% in August suggesting that spending is not increasing in the real economy as planned. Meanwhile, a slowing trend is
evident in the US jobs market, where on a 3-month rolling average, 60,000 fewer jobs are added a month compared with six months ago. The Federal Reserve Chairperson-nominee Janet Yellen recently told Congress that monetary stimulus would still be needed to spur economic growth. There is little evidence then, that any renaissance in the ‘real’ economy is a direct consequence of quantitative easing. Without doubt, quantitative easing has impacted significantly upon asset prices, but one may question whether private companies and institutions have utilised the increased monetary base to increase lending to the real economy. We must wait to assess the impact of the US government shutdown, but clearly low interest rates and quantitative easing will continue for the foreseeable future.
ANGELA MERKEL AND THE EUROZONE: THE FINAL CALL FOR ECONOMIC PRUDENCE? BY ANASTASIA MISHCHANENKO The recent German Federal Election gave substantive evidence that Angela Merkel’s political strategy is widely supported by the German electorate. Given a reasonably high turnout of 71.5%, the Christian Democratic Union and its Bavarian sister-party CSU (Christian Social Union) just fell off the majority by gaining 311 seats in the Bundestag, comprising 49.3% of the total seats. (Source: www.electionresources.org) While Angela Merkel gained greater leverage to implement desired economic policies and reforms, she still needs to find the right coalition partner, and this could 10
give rise to some possible inconsistencies within the policy-making process. But for the sake of this edition’s main topic, we shall concentrate on the issues concerning the Euro zone crisis. It is widely accepted that trying to make countries, which did not actually meet the convergence criteria in the first place, operate within the same monetary union is at the heart of the problem. Latest figures show that economic growth in the Euro area remains substantially subdued, with just a 0.3% change in GDP in the second quarter of 2013.The unemployment rate
held at 12% in August 2013. These readings, which definitely do not resemble any clear signs of recovery, are mainly attributed to poor performance in the periphery countries, i.e. Greece, Italy and Spain. Amongst these three a relative looser is Greece, it underperformed its counterparts by hitting a record unemployment rate of 27.6% in July 2013. In addition, its GDP fell by 3.8% in the second quarter of 2013. By just skimming through provided indicators of economic performance, one can realise straightaway, that the Euro area remains one of the greatest challenges for
German policy-makers. Tied up in the economic monetary union, weak economies of the Euro zone cannot simply devalue to regain competitiveness or loosen monetary policy to stimulate the demand side. For core countries like Germany, the preferred solution lies in indebted nations reducing wages and prices. But this strategy only maintains anything like popular support in the stronger core Euro zone economies. The fact that America’s Treasury Department criticised Germany’s export-led growth model puts Berlin’s overall strategy under question. Some critics blame Germany’s over reliance on exports as
a main source of growth for the poor performance of the peripheral economies. Germany’s current-account surplus has exceeded 6% of annual GDP for the last seven years. To increase domestic demand in Germany is seen as a way out to by providing increased export opportunities for Greece, Italy etc. It is unclear if this is ultimately how the CDU see a way out of the crisis. Instead of supporting Europe’s beleaguered South, Angela Merkel would seemingly rather ensure Germany retains its competitive edge globally. This assertion led to some difficulties in shaping policies with potential
coalition partners- the centre-left SDP party (Social Democratic Party of Germany). The SDP argues for more generous social policies, including the creation of a minimum wage, providing exceptions to the state retirement age of 67 and raising taxes. For The CDU, it is a fear of declining competitiveness in Germany that relies on exports, that is still most prominent. So, whether we see the Euro zone climbing out of the crisis or not may well depend on whether the main political parties forming a coalition will find a credible compromise, not just for Germany but the Euro area as a whole.
EMERGING MARKETS OUTLOOK BY HONGLIN JIANG
The mere mentioning of ‘tapering’ US quantitative easing earlier this year was enough to send emerging markets into a tailspin. India, Turkey and Indonesia were among those hit the hardest, with volatility buffeting their stock, bond and currency markets. Dollar funded carry trades were unwound in a manner befitting their ‘escalator up, elevator down’ characterisation. Since then, relative order has been restored as the Federal Reserve eased its hawkish tone and delayed tapering. So what have emerging markets done with the time they have been given?
Firstly, they are bolstering their balance sheets by accumulating foreign exchange reserves, such as a $100 billion pool of reserves jointly created by BRIC nations and South Africa. This will enable them to provide dollar liquidity to their economies and support their currencies in the open market, if foreign capital flight resumes. Secondly, interest rate rises by Brazil and India have been implemented to control inflation and bolster their currencies. Thirdly, expensive subsidies on imports such as those on fuel in Malaysia and Indonesia have been reduced. Fourthly, the
market turmoil has added extra impetus to implementing structural reforms, such as the reforms to the labour market in Turkey. Will these measures be enough to handle the inevitable taper? Time will tell, though it will be harder than ever to break procyclical links between emerging economies and dollar liquidity, given the deepening of world trade and financial flows. In the context of weak global demand but normalising monetary conditions, emerging markets may have to simply adjust to a lower rate of growth. 11
SOCIAL MOBILITY WHAT’S IN A NAME? BY JEFFREY MO In their seminal 2003 paper, Are Emily and Greg More Employable Than Lakisha and Jamal? A Field Experiment on Labour Market Discrimination, Marianne Bertrand and Sendhil Mullainathan showed that job applicants with noticeably ‘black-sounding’ first names receive fewer callbacks for interviews, even when they have the same qualifications. Can your parents’ choice of name really affect your life trajectory? A follow-up paper by Roland Fryer and Steven Levitt, the latter of Freakonomics fame, conditioned these discriminatory findings. African-American children, regardless of the racial mix of the neighbourhood in which they lived, did not receive names noticeably different from the names received by white children until the Black Power movement in the early 1970s. After that period, the average black girl living in a predominantly black period would receive a name twenty times more likely to be given to a black girl than a white girl; before that, the ratio was only two. Thus, a ‘black-sounding’ first name does not simply indicate race but is also a signal of one’s socioeconomic status and other background characteristics – as Fryer and Levitt write, it “is primarily a consequence rather than a cause of poverty and segregation.” Since these papers, similar results have been obtained in different national contexts: “Kevinism,” where Germans with English-sounding given names unconsciously receive lower school 12
marks, smoke more, and are less popular on internet dating sites1; Canadian job applicants with Chinese-sounding names received fewer callbacks than those with white European-sounding names, and the difference was not eliminated once they adopted Anglicised first names2; and in Israel, job applicants with Sephardi last names (ancestrally originating from Iberia and North Africa) earn significantly less than those with Ashkenazi last names (ancestrally originating from Germany and northern Europe)3. This was observed by comparing children from mixed families (Ashkenazi father/Sephardi mother versus Sephardi father/Ashkenazi mother), and by comparing women who married within or outside their own ethnic group. The discriminatory effect was lost, however, if employers could ascertain the skin tone of the applicant, suggesting that last names are a proxy for ethnicity. The findings described above arise from recent historical events: the Black Power movement, the spreading of American popular culture (particularly to the former East Germany), and immigration to Canada and Israel. However, surnames, passed along family lines, can provide information linking generations separated by several centuries, and are therefore a source of information on social mobility. Gregory Clark, a professor at the University of California at Davis, has conducted research along these lines in the United
States, Europe, and Asia. Social mobility implies that elite surnames will lose their elite status over time, or in other words, they ‘regress to the mean.’ Moreover, rare surnames are both more likely to be elite and to be informative, as any two people holding that surname are likely to be related and in the same social class. Tracking the outcomes of the holders of such rare surnames, Clark and Cummins found that the elite surnames did indeed lose their elite connotations, but only at the rate of ‘discount rate’ of approximately 0.80 across generations. The elite status of the parent – typically measured via education, income, wealth, occupation, and health outcomes – explains about 80% of the elite status of the child. Moreover, this value was consistent across countries and across generations – the rate of social mobility has not varied across time or space. For example, using a (remarkably complete) database of all students who attended Oxford or Cambridge from 1170 to 2012 as a measure of elite status, Clark and his co-author, Neil Cummins, were able to identify certain surnames that were over-represented at these schools compared to their prevalence in the general population4. Convergence to the mean is so slow that although surnames were first adopted by the upper classes in the 13th and 14th centuries, elite surnames from that period are still over-represented at Oxford and Cambridge today. Indeed, many of these surnames
project an aristocratic undertone today: Baskerville, Mandeville, and Beveridge, among others. Clark’s results also indicate that the United States is not any more socially mobile than England. This seems counterintuitive in light of its relatively classless social structure and the widespread belief in the American Dream, which held that hard work could lift one to prosperity. Clark and his co-authors found that those surnames that were particularly common among Ashkenazi Jews (such as Cohen and Levinson), a ‘rich list’ published in 1923-1924 (such as Vanderbilt and Colgate), and the graduates of elite schools up to the mid-19th century were still between 2 and 8 times more prevalent among the surnames of doctors in 2010 as an ‘average’ surname5. Clark and co. measured the correlation
between generations in America to be between 0.65 and 0.80. It is even possible to see the persistence of elite status in China. For centuries prior to the Chinese revolution, appointment to privileged posts as mandarins (government bureaucrats) depended upon success in an imperial examination system, something that required investments in human capital that only a privileged upbringing could provide. This quickly gave way to the Republic of China with a westernised educational system, and then communism under Mao and his successors. One might expect that social mobility rose rapidly in the 20th century. However, the correlation in status between parents and children still hovered at over 0.8 during the Republic and around 0.65 during communism, similar to the United States and England6.
Moreover, this lack of social mobility is observed even when families move into new environments. In mid-19th-century England, as the mining industry in Cornwall collapsed, large numbers of Cornish mining families moved to North Yorkshire and continued their lives as miners there. Over a century later, many still live on council estates and lack professional qualifications7. Furthermore, names that were concentrated in one area in 1881 are still concentrated in that same area in 1998 – both social and physical mobility in Britain are lower than what has previously been predicted8. So is your name – not just your given name, but your surname and all of the history that is attached to it – reflective of how far you can go in life? Clark and others would say yes, and unfortunately, it seems like you are powerless to alter it.
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THE RELATIONSHIP BETWEEN CHILD DEVELOPMENT AND MOTHERS’ EMPLOYMENT BY WILLIAM LOCKE The Relationship Between Child Development and Mothers’ Employment in the UK ! The relation between a child’s development and his or her mother’s employment is a highly divisive issue, and is still hotly debated to this day. Traditional British family values have, in the past, strongly stressed the role of the mother as a housewife in order to aid child development, especially in a child’s younger years. Economists and academics in the post-war era of the 1950s reported that the most economically efficient way in which a mother could dedicate her time was into child-rearing, especially breast-feeding, which was seen at the time as vital for physical and mental progression in young children. However, as socioeconomic changes have taken place in the UK, particularly over the latter half of the 20th century, and new, contradictory research has been conducted, this view appears to be less credible than it was first considered. Sociologists provided a new slant on the issue in the 1960s and 1970s by suggesting that housewives become socially isolated if they are unemployed for long periods of time, leading to low self-esteem and depression, which can be harmful in their own way for child development. The question is, which view is more credible? What does the data suggest? Does the data suggest either of these theorems have any foundations? Over the second half of the 20th century, female labour participation in the British economy sharply increased. Although many 14
factors could be used to explain this pronounced increase, such as increasing cultural acceptability of women in work, as well as decreases in discriminatory action against female job applicants, the key reason why female labour participation rose so strongly over this period is because of the shortening in the break of employment after childbirth. For children born in 1958, half their mothers returned to work by the time their child was seven years old, but by 2000, half of mothers had returned to work by the time their child was only nine months old. Clearly then, the trend of mothers’ employment changed substantially over this period, meaning by 2000, fewer mother’s were housewives than ever before. This, by the logic of traditional Western family principles, should have led to a significant deterioration in child development, but it is clear that this is not the case. ! In fact, the association between a child’s development and his or her mother’s employment is weak. Out of eight measures used to determine a child’s development, only one showed a significant difference when a child’s mother was employed and when she wasn’t, that being a child’s reading score, which was negatively affected when his or her mother was employed. However, arguably, even this result is insignificant, as it equates to the average reading score for a child with an employed mother in the first year of his or her life being 2% lower than a child with an unemployed mother - not a huge difference - plus most of the
reading scores that caused this to become a negative relation where from children with mother’s in the least well-paid employment, with better paid mother’s getting similar results to children with housewives for mother’s. This combined with the fact that all of the other seven measures recorded mildly positive correlations between a mother being employed in the first year of a child’s life and child development shows that the relationship is complex and multilateral. Ultimately, the issue is vast and diverse, with no discernible correlation between a mother’s employment and a child’s development overall, but with huge variability between children and mothers. Such variability exists as the issues boils down to a mother’s particular judgement on how to allocate her time between motherhood and paid work to facilitate the best outcome for her children. Although there exist minor negative correlations between a child’s reading score and his or her mother being less well-paid work, and mildly positive links generally for other measures of child development and mothers’ general employment, these links are tenuous, and to make any bold and outright statements based on them would be brash. In the end, a child’s development is affected by many other factors asides from mothers’ employment, and it is difficult to provide a neat conclusion to the relationship between the two factors.
HELP-TO-BUY: A STUDY OF GOOD INTENTIONS. BY FILIP BALAWEJDER It seems fair to say that a desire to own a house is something universal. That’s probably what your intuition tells you. If not, pollsters will. A report commissioned by Department for Communities and Local Government states that “eighty-six per cent [of respondents] say that if they had a free choice they would choose to buy […] their accommodation.” Someone who definitely doesn’t need convincing that this notion is true is David Cameron. Help-toBuy scheme, his pet-policy lunched this year, makes it clear that the Coalition Government is serious about helping people buy homes. Why would the Government do that? Well, housing costs in England are sky high. Eurostat’s housing affordability measure puts the UK at the bottom of the list. With 16,4% of the population paying more that 40% of disposable income on housing the UK scores better than only two countries in the EU - Denmark(19.9%) and Greece (24.2%)2. On top of that, homeownership fell since 2007 from 73.3% to 67.9%.3 Thus, it might seem that Help-to-Buy is exactly what the British economy needs. However, to say that the scheme is controversial is to say nothing. Let’s start with the basics. Help-to-Buy has two main parts. The first, called “equity loan”, provides loans of up to 20% of the value of a house, what allows borrowers to get a mortgage with a deposit of only 5%. It is aimed at first time buyers and applies to new built houses. The other, so called mortgage guarantee, also 2
requires you to put down only 5% but this time by insuring banks against the likelihood of default. The idea behind the scheme is to increase access to mortgages. People can’t borrow, reckons the government, because banks are still recovering from the crash. Let’s help them do that and they will find it easier to get onto the housing ladder. They will feel wealthier as homeowners, start spending more and most importantly give incentive to construction companies to build more houses. All this will give boost to the economy. What about affordability, though? Well, if demand gives rise to supply there is nothing to be worried about. However, if former outstrips the latter houses will become even less affordable. There are reasons we should be worried. One of them is a paper„The mortgage rate deduction and its impact on homeownership decisions”4 by Mr Christian Hilber, Professor of Economic Geography at the London School of Economics. In it he examines federal and state wide mortgage subsidy schemes in the US which similarily to Help-to-buy aimed at reducing cost of taking a mortgage. His conclusions are quite shocking. Not only did the mortgage subsidies failed to increase average rate of homeownership but also decreased it in areas where house building was strictly regulated, i.e. where supply was inelastic. That’s not all, though. Mr Hilber shows that the subsidy benefited mostly the wealthiest households and had hardly any effect on low-income families.
As it happens, he also studied the impact of regulatory restrictions in England on house prices5 and concluded that: yes, the level of restrictiveness in England is high and, yes, it tends to push prices up. Moreover, the scheme will give access to the market to households which wouldn’t have been able to access financing otherwise. This means that they are likely to be in a more fragile financial situation and in case of the fall in house prices they will be more likely to default on their mortgages. „Low income households often have more unstable jobs and greater income variation and they are more likely to default when the housing boom turns into a bust. The whole idea of trying to push marginal homebuyers into homeownership really is a very problematic idea as the US housing bust and the subsequent explosion of defaults demonstrated.” says Mr. Hilber. Some say it isn’t all doom and gloom, though. Charles A.E. Goodhart and Melanie Baker in their article “Help-to-Buy: more beneficial than the market thinks”6 set out this line of the argument. Considering that the number of new construction projects started and completed every year is much lower that the long term average (100 000 in 2012 compared to long term average of 155,000)7 and that the market for affordable mortgages shrunk from 14% to 2% since the start of the crisis, logical conclusion is the following: first, access to finance is a key to solving the housing affordability puzzle; second, there is considerable spare capac-
ity in the construction industry so provided there is enough demand the supply of housing will expand. Still, there are questions to be asked. House prices are almost at the same level as they were at the peak of the bubble in 2008.8 In spite of that construction has been sluggish which suggests the expansion of supply is unlikely. Also, additional demand will surely mean rising prices at least in the short
term. In a situation when real incomes are falling and the Bank of England might decide to increase interest rates sooner that it expected chances are that even less people will be able to afford a house. Thus, although the Government did identify the correct problem and even took action to tackle it, it seems that all this effort can be at best futile and dangerous at worst. Much more effective way
of increasing affordability would be to reform planning regulation law so that it is easier for construction companies to start new projects. However, considerng it is said that more that 200 000 houses should be completed every year in Britain to keep up with rising demand, the government has to start building itself if it’s serious about ending the housing crisis soon..
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GETTING PARENTS INVOLVED: A FIELD EXPERIMENT IN DEPRIVED SCHOOLS BY JEFFREY MO A field experiment in France has provided support for what seems intuitively obvious: when schools give parents the opportunity to participate in their children’s education, their children display improved attitudes and reduced truancy rates and disciplinary problems. Moreover, there are positive externalities from this treatment – not only do the children of participating parents benefit, but so do their classmates. From a public policy standpoint, simple parental engagement programmes can be a low-cost and effective way to improve educational outcomes.
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TECHNOLOGY E-CIGARETTES AND THEIR ROLE IN THE TOBACCO MARKET BY DREW HOPPER The electronic cigarette, or e-cigarette, has grown in popularity, fashion and demand over the past few years. It is unlike any other product from the tobacco industry and suggests that the ”Big Tobacco” firms of the past have begun to modernise. Rich countries have seen a rising trend towards ‘vaping,’ or vaporising a solution containing nicotine without the toxins present in tobacco. Meanwhile, smoking has steadily declined. Bonnie Herzog, a senior equity research analyst covering the tobacco industry for Wells Fargo, predicts the sales of e-cigarettes to exceed conventional cigarettes within a decade. Although the majority of recent studies say that e-cigarettes are far safer than conventional cigarettes, in large part due to the absence of the toxins of tobacco, they are still considered to be an addictive substance. However, boosting the demand for e-cigarettes is the fact that in most places, one can smoke e-cigarettes but not traditional nicotine-containing products indoors. This is a literal barrier that tobacco cannot overcome. Moreover, since they do not contain tobacco, e-cigarettes are not included in most tobacco laws. Many of these devices are produced in developing, low-income countries. So, their quality and safety may be vary substantially between brands. The nicotine cartridges themselves come in a wide variety of different flavours, ranging from tobacco to bubblegum to coffee. Some of these flavours obviously have a special appeal to 2
youth, and indeed, many current tobacco laws allow for youth to purchase e-cigarettes. Unsurprisingly, with this massive surge in demand, large tobacco firms have had an interest in and are successfully gaining an ever-increasing share of the market for e-cigarettes their derivatives. Lorillard, the United States’ third largest cigarette manufacturer, entered the market by purchasing Blu E-cigs for $135 million in 2012 and consolidated this with the acquisition of another e-cigarette manufacturer, SKYCIG, in late 2013. Philip Morris, the maker of Marlboro and the world’s leading tobacco firm with 29% of the market, will enter the e-cigarette market in 2014 with its own product developed in-house. According to the Wall Street Journal, global e-cigarette sales total $2 billion, which is a small fraction of the $800 billion tobacco market. However, Philip Morris expects cigarette sales to decline by up to 3% globally. More worrisome for the tobacco industry is that sales of e-cigarettes are expected to, according to David Adelman, a managing director at Morgan Stanley focussed on the
tobacco sector, replace that of 1.5 billion cigarettes in 2014. What at one point appeared to be a threat against the “Big Tobacco” firms appears poised to be consumed those same giant firms as their business models evolve. Upon introducing the Vuse e-cigarette brand to Colorado, Reynolds American, the second-largest American tobacco company, captured 55% of the e-cigarette market in 16 weeks. E-cigarettes use cartridges filled with a nicotine solution. If large tobacco companies do obtain control of this market, antitrust laws may come into effect as large companies may be able to price discriminate using bundled goods. If this is the case, one may expect antitrust regulation against such “Big Tobacco” firms in the future. The growth of the industry and of a product that is relatively benign compared to its tobacco-filled counterpart will largely depend on the course that regulation takes. Yet, with an ever-expanding proportion of the tobacco industry’s future under stake, competition and regulation in this market are bound to become progressively more difficult.
THE METEORIC RISE OF BITCOIN BY BRYAN CHEUNG Mid 2009, there was little interest in the digital currency at the time. It was fairly unknown, yet those in the know were brimming with optimism. It was a very interesting idea, full of possibilities – akin to the start of a great science project in the making. During that time, the value of a single unit of the currency, a bitcoin (BTC), was in the low tens. Some people treated Bitcoin as a hobby – a joke investment that would probably amount to nothing. Others purchased it (and attempted to use it in the real world to barter and trade) in the hope that further participation would allow Bitcoin to become more mainstream. For some, Bitcoin is a mere fad; a fiat currency, or a currency used by criminals and tax evaders. For others, it is a source of liberation, a currency that is not constrained by its physical composition. It is a currency that can be used to escape the debilitating effects of inflation, and a currency backed by the intricacies of mathematics, through the use of cryptography, which controls the transactions
within the Bitcoin network and prevents double-spending. It is a decentralised currency, one that is peer-to-peer. Despite the utopian ideals espoused by ardent supporters of the rising digital currency, the political issues (with regards to the regulation of Bitcoin and its use for illegal activity) are immediately apparent. The governments of countries such as the USA and China have already shown great interest in the development of the Bitcoin as an online alternative currency. Earlier this year in August, the New York financial regulator launched investigations into 22 companies who have had some involvement with Bitcoin. While the currency can be used for fairly legitimate purposes, such as the purchase of goods and services online (with its appeal being that the transaction fees being lower than the mandatory fees imposed by credit card processors), the nature of Bitcoin creates potential for criminal use, such as money laundering, tax evasion and the purchase of illegal goods. This was
reflected in the recent shutdown of the online 'Silk Road' marketplace by the FBI, which used Bitcoin as its source of currency and facilitated purchases of illegal goods such as drugs. Recent Chinese responses to Bitcoin have not been condemnatory. The Chinese government’s first encounter with Bitcoin occurred earlier in 2009, where attempts to suppress the currency by crippling its main exchange (QQ) failed when the Bitcoin algorithm was released publicly, creating the need for a new approach towards the currency. However, rather than inhibiting the growth of Bitcoin, supporting and legitimising the currency would have economic benefits. CNNMoney has postulated that the acquisition of large amounts of Bitcoin would be beneficial for China not only by increasing its financial leverage in the world economy, but also in terms of investment and interactions with the developing world, particularly in regions where banking services are not widely available. Bitcoin
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could replace the mobile banking phenomenon (through its low transaction rates), which has radically transformed how businesses operate in Africa. The American approach towards Bitcoin has been mixed. Despite increasing enthusiasm and interest in the populace, the government has been slow to react to the cryptocurrency’s development. However, several state agencies, such as the Federal Reserve and the US Treasury and Department of Justice, have made several reserved comments regarding the status of Bitcoin, which suggests that a focus on Bitcoin in the government and the various financial institutions has emerged. This is a positive development for the Bitcoin community as a whole and its task to obtain legitimacy as a currency used for transactions. The economic implications for the emergence of Bitcoin into the mainstream consumer economy (and possibly the wider economy) are tremendous. One benefit is Bitcoin’s ability to sidestep the high fees of credit card processors, as Bitcoin generally has low fees attached to transactions. For regions that do not have well-developed banking systems, or areas that are remote, Bitcoin can be used as a payment solution. Its ease of use could also mean that Bitcoin could become the 21st century version of 'cash', as transferring BTC from one Bitcoin wallet to another is a relatively simple process. The fact that a Bitcoin wallet takes no physical space and can be stored in an online storage container or in a USB flash drive also means that the wallet is easily portable. However, banks in the USA have been quite reluctant to offer their services to companies who are linked to Bitcoin, for a number of reasons. The amount of risk 4
that these companies shoulder in return is minimal, and the relatively anonymous (but not private) nature of Bitcoin adds to that. After all, they could be in trouble for aiding the transfer of money obtained via illicit means. Lack of regulation is another reason why banks are hesitant in regards to Bitcoin. Bitcoin does have its own issues with regards to its economics. There is the issue of inflation, as seen in the Bitcoin bubbles. The real value of the BTC is uncertain at this point. There is the possibility of the BTC losing its value overnight. The constrained supply of Bitcoins (which can only be acquired either through the purchase of Bitcoin from another person, or by 'mining' through the use of computing hours, which has experienced diminishing returns due to increased competition) and the increased interest in Bitcoin has caused the value of a single Bitcoin (in terms of $ USD) to increase rapidly, which is undesirable if Bitcoin is to become a currency used for normal transactions for goods and services. Instead, stability would be needed, and highly desirable. The legal hurdles remain as well. The issue of regulating the cryptocurrency and the use of Bitcoin
for illicit purposes have been a concern. Although Bitcoin is not truly anonymous (all transactions are recorded in a public file – the 'blockchain'), there is difficulty involved in matching Bitcoin transactions with real world identities. In addition, there is also the risk of cybercriminals stealing Bitcoin holdings through hacking. In the middle of 2011, the first Bitcoin bubble appeared, possibly sparked by an increase in interest. The prices of BTC dropped afterwards later that year, and remained fairly low in 2012 until the early spring of 2013. Stories of people making big returns on their investment in Bitcoin emerged online. New entrants to the Bitcoin sphere decided to follow the new bubble, leading to an eventual increase in prices to over $200 USD. It steadily dropped below $100 in June, prompted by fear amongst the Bitcoin community that they were still in the midst of a bubble, and that the BTC was overvalued. However, the trajectory has reversed since then. In October of 2013, the price of a single bitcoin, which had fluctuated around $100 USD, shot upwards. A month after, the price had doubled to 1 BTC: $208 USD. On the 11th of November, Busi-
nessInsider reported that the value of Bitcoin has passed $300 USD. One week later, on the 18th of November, the Financial Times published an article noting that Bitcoin prices have shot up to $785, spurred on by news of the US Senate hearing regarding Bitcoin. The currency has, according to the publication, 'risen more than 5,000 per cent in value this year'. The Winklevoss brothers, who have a significant holdings in Bitcoin, according to CNBC, have reportedly said that Bitcoin should be 'worth at least 100 times more than it's valued today.' From the printing press, to the Internet, to the invention of the blog, technology can have a truly
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BROADWAY INTERNET: AN INFORMATION SUPERHIGHWAY TO SEX CRIME? The internet has facilitated new forms of social interaction, but does that include sex crimes? Norwegian researchers used a natural experiment – the gradual roll-out of internet across Norway between 2000 and 2008 – to quantify the increase in reported sex crimes and their resulting charges and convictions. They found that had broadband internet not been introduced, then between 2000 and 2008, over 3% of rapes and 2.5% of sex crimes and child sex abuses would not have taken place. These increases are due, at least in part, to the ‘direct impact’ – the reduction in the costs of pornography (including the cost of being caught) – due to the advent of the internet.
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OUTLOOK: CENTRAL & EASTERN EUROPE BY JAKE MCNAMARA ACKROYD Central and Eastern Europe has provided social scientists with a live experiment in theories for a generation. The extension of neo-liberalism to Central and Eastern Europe (and to an extent Latin America) have shown that markets do need trust and trust generating institutions to function effectively. Accession to the European Union has been able to solve some of the problems of CEE states as they have been able to borrow these trust and credibility generating economic institutions (as well as funds) from more established member states. However, this has fostered a forced reliance on FDI, mostly stemming from Germany. This process has led to a form of capitalism characterised by an overburdened reliance on FDI. This composition fundamentally alters how product, labour and capital markets function in the
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region. The CEE region has always been caught between two markets and spheres of influence, Europe in the West and Russia in the East - with an occasional flirtation with Middle Eastern trade. Currently data on the prominent Visegrad states is showing that growth is coming at a cost to employment; a trend showing little signs of easing up. As much of the region continues on its path to deeper integration or continues to benefit from the EU neighbour policy we see a fractious Russia leaning heavily on former soviet states to pursue a Moscow approved economic and foreign policy approach. Russia is currently directing it’s tried and tested bullying policies at Ukraine and has threatened against potential ramifications if Kiev continues on its trajectory, asking publically whether Ukraine ‘can afford to go Bankrupt’. The
state is being pushed into an awkward ultimatum between the possible long term yields of membership to the EU, which would take a lengthy trade based courting period and would eventually result in tied reliance to Western states FDI if other CEE models are anything to go by. Russia is offering the alternative of a Moscow led former soviet states trade community is showing no signs of weakness imposing bans on certain goods (as seen in Georgia, Lithuania, Belarus and others.) The reality in the immediate future is that Russia is pushing hard for former soviet states to side with it and failing to do so will inevitably incur the unfavourable wrath of Moscows displeasure – a fate made no more palatable by the alternative scene of stunted and sluggish growth in the Eurozone.
TOWARDS A PROGRESSIVE ECONOMY BY PRISCILA AZEVEDO ROCHA Pragmatic, incisive and idealistic, Brazilian intellectual Roberto Mangabeira Unger longs for a revision in the current institutional framework.
One November evening, Harvard Law School Professor and Brazilian philosopher Roberto Mangabeira Unger came to the London School of Economics to participate in a series of interviews conducted by BBC 4, titled “The Progressive Agenda Now. Unger is one of the most prominent contemporary intellectuals of our time. His set of publications includes fifteen books and a plethora of articles that range from a pure critique on economics to politics, sociology and law. Mr Unger has also been very active in the field of politics. In the United States, he tutored Barack Obama during his time at Harvard Law School and avidly supported the candidate during his 2008 campaign for presidency. However, for the 2012 elections, Unger controversially called for the defeat of Obama, stating that the Democratic Party needed to “revise its progressive agenda and the original nature of its liberal origins”. In his native Brazil, he served from 2007 to 2009 as a Secretary of Strategy Affairs, 22 2
under Luis Inácio ‘Lula’ da Silva’s second term. And on his last visit to England, he held a meeting agenda with the Labour Party. For more than two decades, he advocated that society is built on a set of rules that are both created and restrained by our imagination. While sitting there, at the Sheikh Zayed Theatre, he never flinched – not even for a second. At the beginning of the conversation, he looked at the audience sternly from behind his thick glasses and said: “Humans desire to die only once”, showing the intensity of his critiques on how society is organized. Drawing on the idea that we live in a man-made world, in which economic, political and social structures are products of our imagination, created to guide and direct behaviour, he insists that human beings should unchain themselves from these artificial constraints. In this sense, Unger proposes an institutional revision based in what he calls “compensatory redistribution”. Society should leave behind traditional conceptions of both the state and the market in order to change. Nowadays, he exemplified that changes only happens in times of crisis: “If there are no crises, there is no change”. He claims that we shouldn’t wait for a crisis in the financial sector or a war to take action; instead we need to incorporate a constant desire to seek improvement, to innovate, and “to achieve an expansion of our humanity”. For example, he emphasized that solidarity can only
exist when man overcomes family boundaries and starts caring for humanity in a greater capacity, which helps to “make us more god-like”. Although Unger believes in the role of the markets, the economy should be re-conceptualized. Our contemporary conception of a healthy, market-oriented economy should be left-behind in order to “seek for constant economic innovation and discovery”. According to his postulates, men need to transform market institutions to allow a redistribution and recombination of both people and resources. “Countries must have open borders”, he continued, suggesting that an individual ought to be able to move and start his life at a society where he is prone to make the most of his living and contribute to the development of human potential. Conversely, he believes that a globalized flow of capital is not always necessary. It all depends on the time and context: sometimes it may be necessary to constrain capital flows to adjust the economy. He stressed that experimentation is key to develop potential on the progressive agenda. We should not limit ourselves to conventional understandings of institutions such as property rights. “Man must not be tied to the individual”, he added. Nevertheless, changes in institutions and in the market structure are only the first steps towards a greater transformation. Unger engages in a line of thinking that sees education as a game-changer. “Schools
must be State-led”, in a way that stimulates analytical thinking to enable and encourage students to engage in a transformative society from the inception. In this regard, schools are funded and structured by the State, but not necessarily state-directed. This change in education is key to his vision for a sustained progressive society. As a result, educational gaps need to be filled and boundaries trespassed in order to generate constant and
non crisis-dependent changes.
After one hour and a half, the conversation with Professor Unger was over. But he didn’t leave the
London School of Economics without re-emphasizing his vision of a society in service of people, followed by institutional changes in which we can more freely and effectively strive for improvement. A place where human beings can exercise solidarity and be always driven by something bigger than the forces of market, culture and education advocated by our current system.
JOHN MAYNARD KEYNES: AN INTERPRETATION OF HIS THEORIES, LEGACY AND SUCCESS BY LOUIS ARISS John Maynard Keynes revolutionized macroeconomic theory in the 1930s. First of all, he argued that frictions prevent markets from being fully flexible. He also highlighted the role uncertainty plays in markets, and promoted controversial government spending in times of depression. Use of Keynes’ theories was largely absent from economic policy from the stagflation of the 1970s until 2008. However, his theories regarding business cycles were brought back into consideration by economists during the “Great Recession” of 2008. Keynes’ analysis of business cycles posed a question relevant to the current economic climate: namely, why do economies remain in sustained depressions? Keynes’ Treatise on Money (1930) highlighted the role of savings as a withdrawal from the circular flow of income. Indeed, history has shown that such withdrawals increase during depressions, where businesses are reluctant to invest these savings because of low business optimism and low expectations of future returns.
His hypothesis was further developed in his celebrated General Theory of Employment, Interest and Money; when an economy contracts, income contracts concurrently, causing savings to fall dramatically. In 1929 Americans saved $3.7bn of their income. In 1932 and 1933 they were saving nothing (Heilbroner, 2000, p.270). Heilbroner, author of ‘The Worldly Philosophers’, summarized this succinctly: “An economy in depression could stay there. There was nothing inherent in the economic mechanism to pull it out. One could have “equilibrium” with unemployment, even massive unemployment.” (Heilbroner, 2000, p.273)
Keynes saw capitalism as a cash-generating machine rather than a goods-generating one. In other words, money developed a purpose other than simply as a medium of exchange. Money allows consumers and firms to store wealth, protect themselves against an uncertain future, and delay investment and consumption decisions. Keynes described money as “above all, a subtle device for linking the present to the future…a barometer of our distrust…concerning the future” (Keynes, 1973, p.116). Robert Skidelsky, the acclaimed biographer of Keynes, claims that contemporary economic theory has failed to consider the importance of uncertainty. Keynes believed that uncertainty explains a number of phenomena: why consumers maintain liquidity through paper money, why volatility increases in times of depression, and why low expectations can dampen business activity for longer than expected. He argued that in times of uncertainty, we fall back on conventions, or ‘safe-havens’. This depresses 23 3
aggregate demand, paving the way for government stimulus spending and inflationary monetary policies with the aim to promote optimism and confidence, both of which are key drivers of the economy. Similarly, Alan Greenspan, former Chairman of the Federal Reserve, highlights the ‘underpricing of risk worldwide’ as a major cause of the ‘Great Recession’. Efficient Market Theory states that financial instruments reflect the best possible calculations of risk attached to ownership of this asset, considering all available information. It assumes that the distribution of risk is represented by a Gaussian bell curve, where diversification reduces risk: this is the basis of all bank risk-management models. However, these ignore the possibility of correlation of risks. During the 2008 financial crisis, it was said that “10% risks became 90% risks or higher, and all at the same time” (Skidelsky, 2009, p.41). We must therefore start taking into account the distinction between risk and uncertainty: a major conclusion of Keynes’ research. The recent ‘Great Recession’ has revealed the continued importance of Keynes’ theories and legacy. On the other hand, the classical response, cutting interest rates to stimulate borrowing and investment, has suffered significant setbacks. Banks have recovered large balance sheet losses by increasing their interest rate spread, limiting the effects of low bank base rates. Moreover, enterprise always involves some degree of risk, regardless of how ‘cheap’ borrowing is. Even so, it should be said that Keynesian policies are, clearly, not flawless. Bailouts and stimulus plans aim to relieve market failure (due to imperfect information and other frictions) through the issuing of government 22 4
debt. However, this simply diverts resources from one use to another. The added debt absorbs savings that would otherwise go to private investments. Keynesian policies also have substantial limitations in light of recent financial and sovereign debt crises. The IMF and ECB have argued in much-cited papers that economic growth for individual countries slows down when their debt-to-GDP ratios reach around 90% (Gold, 2012), implying that for those countries most in need, the Keynesian remedy is not suitable. Nevertheless, President Obama’s stimulus plan in 2009 does reflect a policy consistent with New Keynesian ideas. The output gap, at the time, was estimated at around $2.9tn, while Paul Krugman, an American economist, called for $1.2tn of stimulus. The end result: $800bn spread over three years, with too many tax cuts. Its impact faded over time, and any initial employment boosts were not sustained. This story is remarkably similar to the Great Depression. The necessary spending to provide full employment - $103bn - only occurred during World War Two - $103bn (Skidelsky, 2009, p276). Despite significant American stimulus in the mid-1930s, unemployment never dropped below 14%. The European sovereign debt crisis provides a unique case study to assess Keynesian policies. The collateral for European govern
ments is tax revenue, and this has clearly been decreasing as unemployment and spare capacity have increased. This has undermined governments’ ability to sustain high debt levels, resulting in rising yields, especially in southern European bond markets. Angela Merkel’s government has helped steer the European economy towards the tough cure of austerity. Perhaps as a direct reflection of a quote by Keynes, Merkel stated, “in the long run, you can’t live beyond your means” (FT, 2012). Keynes would likely have encouraged the numerous debt ‘haircuts’ that Greece has undergone in the last few years. Yet politicians have been reluctant and inconsistent in their approach to Keynesian policies. In turn, they are accountable to citizens who are wary of excessive government deficits. Krugman argues that, ultimately, “no country has driven itself into a debt crisis with stimulus – nor has any country with significant debt regained investor confidence through austerity” (Krugman, 2012). Keynes’ theories provide crucial insight into the contribution of uncertainty in leading to a sustained depression. Even so, political willpower and unsustainable government debt presents a strong barrier to Keynesian stimulus in Europe. Therefore, austerity, with some limited supply-side measures to induce growth, has momentarily become the preferred option, though it remains to be seen whether austerity.
THE PRICE OF PURSUING YOUR DREAMS BY BENJAMIN AW If you put your mind to it, anything is possible” - so goes the adage. As successive generations enjoy a rising standard of living, pragmatism slowly fades into the background as young people are increasingly encouraged to pursue their ambitions. The rationale of the argument is that if one is passionate about a particular field, one will perform his best in it and his employer will be thrilled to harness his enthusiasm. All the while he will reap the benefits of having the career of his dreams. If he is happy, then his employer will also be happy as his employer will reap maximum efficiency at the given compensation level accruing to him. Of course, for most the idea of being able to combine a ‘good’ job with an enjoyable one is unrealistic but, we have all heard of such stories. The obscenely idyllic narrative: Person pursues their dream, achieves success and enjoys the result of aforementioned success happily ever after. So, why can’t everyone do the same? As always, the answer can be found in a core economic principle - scarcity. Many with dreams, especially the most ludicrous, will realise eventually that there is a serious mismatch between what they desire of their careers – and those which the job market provides. Can anyone and everyone become Prime Minister? Of course not. Can anyone and everyone 22
introduce an idea that shifts global perceptions of the world as Einstein achieved with his theory of relativity? Of course not. Can anyone and everyone who wants to be a millionaire achieve it? Bar a swift strike of hyperinflation, of course not. Those who embark on a journey down the proverbial gold paved street to achieving their dreams will inevitably become quickly and sharply aware of the key problem of achieving your dreams. Those who achieve this goal do not do so simply because they want to, or are more passionate. They achieve because they have superior ability. Whether it is charisma, intellect, or acumen these are things that are intrinsic to a person. You either have them, or you don’t. Passion is put on the back burner because the labour market selects the most able (or most potentially able) and not the most passionate. Besides, passion is at best a current asset when contrasted with the long-term asset that is ability. Faced with the reality of the situation those with less ability inevitably lose hope and gradually lose their passion. Does this then render passion worthless? No, it’s just better thought of as utility-fuel for the worker. Even the most able worker could not sustain a career without at least minimal interest in it. Does this then make passion a pre-requisite for success? Quite the opposite actually. As children few love doing maths before at least an attempt to learn the first
natural numbers. This translates onto a larger scale; most people who end up loving a discipline do so only after they’ve tried it out and discovered an innate ability for it. Following this process then, It is success that first drives passion, before passion next drives success. So, before encouraging a generation en masse to pursue their dreams, perhaps people should first ask whether all those who they are pushing have the ability to do so. If you put your mind to it, anything is possible” - so goes the adage. As successive generations enjoy a rising standard of living, pragmatism slowly fades into the background as young people are increasingly encouraged to pursue their ambitions.
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FINANCIAL MARKETS DOES THE MARKETS REPRESENT REAL VALUE IN THE CURRENT ECONOMIC CLIMATE? BY SAM FOXALL It’s been a bullish 12 months for European Markets. All three major indices (London, Paris and Frankfurt) have yielded above 20% returns over the year. Meanwhile, the Euro Stoxx 50, the leading Blue Chip Index for the Euro zone, has returned over 25% in the same period. But do markets in Europe really reflect true value? After a period of sell-offs the two years preceding, global Investors have raced back into European assets over the last 12 months. The world’s first and third largest economies are undertaking their largest asset purchasing programmes in History, so all those dollars and yen are bound to chase off somewhere. With a slowdown in emerging markets, Europe has
simply become a relatively lesser looking evil. Equally, monetary policy on the continent has been conducive to inflating equity prices with the BOE holding rates at a record low of 0.5% throughout the period and the ECB cutting rates twice from 0.75% down to 0.25%. The question is: are European markets overpriced and a prime target for a taper meltdown? That depends to an extent on how you view the relationship between market returns and economic growth. If you see economic growth as an explanatory variable for market gains then you intuitively assess the recent Bull Run as just plain bull. But if you view the market as a leading
indicator of economic activity, inferring that in the last 12 month European businesses are gaining in confidence, than growth could be just around the corner for Europe. The question is does the market know something we don’t? In the case of Britain the answer might already be yes. A strong first half to the year for the market has been followed by impressive GDP growth in the second. Your view on this will subsequently determine whether you are bullish or bearish on Europe in general. Keep looking to the markets for the real answer though. Can Europe’s major indices continue to deliver such impressive returns when the BRIC’s re-heat and the Fed starts turning off the tap?
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An Ending Note on Financial Regulation- Five Years On... By Yew Jia Way To anyone watching the deadlock on the Dodd-Frank reforms or the ongoing struggle to pass the Vickers Commission’s recommendations, it might be said that five years after Lehman Brothers, we still haven’t done enough. Some measures have been sensible: heightened capital requirements, to an extent, are uncontroversial. However, there is still no mechanism in place for resolving the collapse of an international bank with sprawling subsidiaries. While the best option might be a carefully considered system of global regulations, fencing off banking systems is more politically palatable. Asking big investment banks to run as groups of self-sufficient subsidiaries, though, would distort competition by forcing them to hold more capital than domestic banks. Capital tied up in subsidiaries will also no longer be able to be funnelled into its most efficient use. This hasn’t stopped nations from doing this quietly through asking local subsidiaries to hold more capital. Aside from increasing borrowing costs, fragmenting the global financial system in this way promises to cut the return to investment in countries with excess savings. Losing the ability to spread out risk worldwide might even make failures more common. Blame the results on intensive lobbying if you wish, but five years on, perhaps it’s still not at all clear what is to be done
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