Issue 10 - June 2012 by Nottingham Economic Review

Facebookâ&#x20AC;&#x2122;s Valuation - A Debate Is Economics a Science? One Child Policy - lifetime bachelors, leftover women and high savings rates

Nottingham Economic Review.

Dear NER readers,

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Editorial

It’s been another incredible few months across the world’s economic and political spheres. We’ve perhaps seen tentative signs of a recovery in Western economies – equity markets’ bullishness would certainly seem to suggest so. Our Cover Feature discusses one of the biggest talking points in stock markets at the moment: Facebook’s still-volatile market value. Might its longer-term resting point determine investor sentiment for the rest of the year? Nevertheless, with rich countries’ growth subdued for now, emerging markets are again expected to fuel the world economy’s motor. Our issue covers some of the longer-term outlooks for some of these nations: our Oliver Pawle Prize-winning essay considers the legacy of the One Child Policy on marriage prospects; whether Argentina’s cooking of the inflation books might land it in trouble (at a time when many of its counterparts are undertaking monetary policy tightening); and, whether China’s emergence as a global leader might mean the Renminbi replaces the Dollar as a global reserve currency.

Credits Editors: Roneeta Gupta AngusNaismith Sponsorship and marketing: Jack Childs Mike Harrison Ipek Ergin

We’re sad to say that, with the end of the year drawing near, for some of us our time editing the NER is also ending. We’ll be looking for more team members for next year: if you’re interested, email us at team@neronline.co.uk, or stay tuned for further word.

Design editor: Luke Askwith

Remember to keep checking the NER website – neronline.co.uk – for extra content!

Special thanks to: Hilary Clayton Sue Berry Chris Milner Oliver Pawle David Fenton

We hope you enjoy reading the fantastic and varied contributions of all the authors. Best wishes, NER Team

Illustration: Jennifer Yu Victor Lam

Contents Feature - Facebook’s Valuation Will the Baby Boomers Pay Over the Odds for Facebook? by Matt Wicks

Facebook’s Valuation - Do We ‘Like’ It? by Jason Lee

Economics

Warning signs for Japan’s Trade Balance and the TPP by Woo Lee

How the Argentine Government has inflated the possibility of serious economic problems by Joshua Jacobs

Is Economics a Science? by Veeral Manek

Have financial markets just become elaborate casinos? by Harman Gill

One Child Policy- lifetime bachelors, leftover women and high savings rates by Liz Jia

Chinese Pharmaceuticals by Kay Li

The Elephant’s Weight: India’s Rise by Saurabh Tripathi

Mergers And Acquisitions: Opportunity Cost by John Chatterjee- Woolman

Book Review - Why Nations Fail by Aleks Hughes

Politics The Decriminalisation and Legalisation of Drugs by Charlie Bentley

Populism in Europe as the freezer of effective politics by Luca Lixi

Interview An interview with David Fenton by Angus Naismith

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Feature

Facebook’s Valuation - A Debate

even lower value estimates for Facebook of around $50bn are credible to the prudent investor, let alone figures around twice that mark. With a price tag of around $100bn, shares would be trading at roughly 26-times revenues and with a price-to-earnings ratio of approximately 100 (based on a reasonable 10% leeway either way to account for weekly market fluctuations).

represents at 65% increase on 2010 profit levels. Yet even with these strong performance indicators and seemingly flawless business model we find ourselves pondering the very same questions: Has

Alarm bells must really start ringing as to whether such a price multiples are representative of Facebook ‘s long-term potential or simply yet another product of its hype. Bullish investors will naturally draw from the plethora of Facebook figures quoted ad nauseam. Naturally, the mention of Facebook’s 850 million regular users will be first out of the hat, followed closely by the 250 million photos uploaded a day statistic, and then ComScore’s highly abstract findings that one out of every seven minutes spent online is on Facebook. They are all extremely impressive individually – and as a collective set even more so – but what is crucial and undoubtedly more important is how those at Facebook can transfer this level of activity into profits. Image: Denis Dervisevic

Facebook, the social networking site started by Mark Zuckerberg, received market estimates of its valuation of between $75bn and $100bn, in the lead-up to its muchdiscussed and much-awaited Initial Public Offering. At the end of the day of its flotation on 18 May, its total value reached $104 billion. Investors, though, wondered whether this gave an accurate portrayal of its earning potential or could signify the beginning of another dot. com bubble, and what opportunities and threats are there to Facebook’s bottom line in the next few years. Two students discuss.

Will the Baby Boomers Pay Over the Odds for Facebook? By Matthew Wicks

he headline “the thousand Facebook millionaires” was one repeated in some form or another in every major tabloid, broadsheet and news website across the globe. It represented another major milestone in Facebook’s astronomic rise to stardom and

cemented its place firmly in Silicon Valley’s hall of fame, right next to Google, Apple, and Microsoft. While Facebook’s value has tumbled since its IPO, its still staggering market value of c. $70bn makes it easy to see what all the excitement is about.

The simple answer and the one which has been the main route exploited by Zuckerberg and co is that of using the vast swathes of information about its users for advertising and marketing purposes. Social media companies could well be considered unique in economic history as the only industry founded upon a business model where its raw material at source is essentially free (though processing procedures such as staffing and server space do create overheads).

While these colossal values are enormously impressive – especially considering the company is only 8 years old – are they representative of a renewed and sustainable goldrush in technology companies, or will Zuckerberg simply become the billionaire poster-boy of one giant has-been?

Not only do Facebook users freely give up staggering levels of (often private) information, but they then go on to file and sort it by themselves, making the sale of such invaluable data to the corporate marketplace almost completely effortless. In essence, it is every entrepreneur’s dream. It seems all Facebook staff now have to do is to sit back in their handcrafted Italian leather chairs, sipping on their frothy-mocha-frappuccinos and wait for the money to roll in as we, the Facebook users, further update profiles and news feeds with fresh data.

Many recent articles and economic commentators have begun to question whether

Quite frankly, a yearly profit of $1 billion in only its 7 years of trading should not be scoffed at. Nor should the fact that this figure

Image: Ohmega1982 / FreeDigitalPhotos.net

Facebook peaked? And does this current market price reflect a hype-based premium or does the market really value Facebook’s growth potential that much? One approach to answer these questions could lie in glancing back into the past at such social media sites as Bebo and Friendster. Unfortunately for these once-favourites, both have dropped by the wayside into an internet graveyard that contains some very familiar names. Us kids of the 90s often reminisce about rainy afternoons spent mashing games-controllers of the many consoles that now litter the attic, but often forgotten in such sentimental ramblings are the likes of Netscape Navigator, Geocities and AltaVista – each one, at one point, the ‘next big thing’ in the internet world. We may make light of our childhoods – heavily influenced by almost everything Japanese – but lest we not forget Facebook was a machine fuelled by the interest of the young. The young will always be the core initial user-base for any trend-setters and this represents a great problem for the market because it is that same young user base which left Bebo and

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Friendster in a hurry. Zuckerberg should be most grateful for, but also most fearful of, the under-30 demographic (figures by Burcher place 90% of Facebook users under the age of 34). What has been true and will always be true is that as quickly as the young are interested, they become bored. This is so regardless of whether it concerns social media, tin soldiers or Pikachu. Unless Facebook can come up with a way to continuously maintain the young’s interest over an extended period, investors should be wary. There are already danger signs of boredom within the Facebook community. One figure suggested that over 6 million US users left Facebook last year which represents about 4% of the country’s 150 million users. Whilst these levels are by no means writing on the wall they do represent a significant threat. Added to this are worries over internet privacy. It is not hard to imagine that with increasing features of smart phones which branch into GPS positioning and mobile banking facilities, not only will consumers demand greater protection directly, but so will regulators. Will Facebook be able to respond to such demands or will this open a niche to a rival? There is also another very important point that is often missed by the mainstream analysis of Facebook: the age of those who will actually buy the shares. Regardless of how many times my father may pick up his iPad or retweet KONY 2012, I rest assured in the claim that no man who wore flares at my age will ever again be part of the core demographic dictating trends in

Feature

‘fashionable’ websites. Yet, those like my father who grew up with rationed food and black and white TV are not wholly uninvolved in this grand event because it is those very same baby boomers who continue to control a large portion of investment funds – the very same funds that might be enticed by Facebook’s IPO. (The average age of Alpha magazine’s top 25-performing hedge fund managers in 2007 was 51, with only “four thirty-somethings”.) With the greatest respect, can this older generation really appreciate the true value of Facebook to the future generation, and can they tap-in closely enough to market tastes to accurately calculate projected earnings? In my opinion, the short answer is no. Of course there are many exceptions to the rule in the form of middle-aged IT consultants and those so-named ‘techies’, but not enough to restore the balance of information. Given this I worry that there is a significant amount of scope for such individuals to over compensate their market valuations, exaggerated by a desire to hop onto the techcompany gravy chain. And it is this matter that all those potential Facebook investors should be concerned most highly with if they wish to avoid the risk for significant revaluations by market forces at a later date. I do not think it is the case with Facebook that we have quite returned to the dot.com bubble days in which companies such as E-Toys had wild, almost magical valuations that were very quickly discovered to be unfounded (perhaps commentaries upon companies such as Groupon and Zynga

may be best for contemporary comparisons). Instead we have a profitable company with great promise and potential to dominant a large portion of social media. The choice simply is down to risk attitudes of the individual investor and whether they maintain the belief that Facebook represents a paradigm shift in technology companies – representing longevity and long term profitability. There is one piece of golden advice for investment in tech companies, which I’m sure many would echo for the likes of Facebook. If you find yourself holding stock that AOL want to invest heavily in, SELL UP AND GET OUT QUICK.

Fa c e b o o k ’s Valuation - Do We ‘Like’ It?

Photo: Luke Askwith

By Jason Lee

s shocking as it seems, investors believe that the eight-year-old company founded by 27-year-old Mark Zuckerberg is worth more than the likes of Starbucks, Nokia and Dell. So are they right? Are we beginning another bout of ‘irrational exuberance’ or does Facebook actually possess the potential to become one of the world’s most valuable and profitable online companies ever? Facebook boasts impressive figures. The social network could soon reach one billion users with one out of every seven people having an account; if Facebook were a country, it would be the third most populated behind China and India. According

to research firm ComScore, Facebook accounts for 1 in every 7 minutes spent online and 3 in every 4 social networking minutes. Moreover, there are 250 million photos uploaded onto the site every day. These statistics are very appealing but have they earned anything yet? According to the Securities and Exchange Commission (SEC), Facebook had filed a document detailing its finances for the very first time. The document had shown that last year Facebook had made revenues of $3.7 billion

with a net profit of $1 billion. Although these are convincing results, it still does not justify a price tag which is 20 times last year’s revenues and 80 times year’s net profit. Though surely given such a value, investors must believe that the company has at least the potential to reach these figures in the future. In order for Facebook to continue to grow, the internet and technology sectors must also grow. Internet connectivity has grown rapidly throughout the past couple of years,

allowing more people to access Facebook: According to The Boston Consulting Group, there will be around 3 billion people online by the year 2016, up from 1.6 billion in 2010. The increased dependence on mobile phones is another factor to be considered. There are already 425 million people logging onto Facebook through these devices and investors believe that most of Facebook’s growth will eventually come from this area of technology. This could boost the amount of users to a figure beyond that of 1 billion.

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Furthermore, if Facebook can penetrate the Great Firewall of China – Facebook is currently blocked in the country – user numbers would surge, securing an even stronger revenue stream – as firms are quite inclined to advertise in China. At the moment, Facebook’s revenues depend mainly on the online advertisement market. Some around 85% of the site’s revenue came from adverts and there are signs that this figure will carry on growing in the future. The company may soon be able to sell their adverts on mobile phones as more people are accessing Facebook through their handhelds. There is even a possibility that Facebook could partner with a hardware company and invent a “Facebook Phone”, which will run on a ‘social operating system’ in order to connect and share with others who are using the same phone. This may be an alternative way for Facebook to earn revenues in the future. So, there are several factors which can drive Facebook’s growth. Nevertheless, there are also threats to this growth. Their competitors Google are certainly a central one. Recently, Google and Facebook have become tense rivals, with Google averaging 153 million unique users per month and Facebook averaging 137.6 million. Of course, Facebook has had an impact on Google’s revenues as businesses are increasingly trying out new methods of advertisement – for instance, through Facebook’s display adverts instead of Google Ads. Google, on the other hand, have created their own social network – called Google Plus – in the hope that users from Facebook will flock over in the same way that MySpace and Friendster users did to Facebook. In fact, there hasn’t been much movement between the two social networks – although Google Plus was recording 625,000 new sign ups per day during December last year. While some suggest Google Plus may have caused the slowdown in the rate of new Facebook signups, the real cause is that everyone who would sign up for Facebook already has. For the moment, Google Plus is not a particular threat to Facebook (although it may turn out to further down the road), and some may argue that Google Plus is more of a threat to Twitter than Facebook with its features so similar to Twitter’s ‘tweets’. Like Google, though, Facebook is beginning to see its fair share of privacy concerns. Throughout the past couple of years it has been under the scrutiny of

privacy watchdogs. Just last year, the social network was being investigated by America’s Federal Trade Commission. The commission had received numerous complaints about Facebook making use of the public data of its users which were supposed to be private. As a result, the company agreed to submit an audit of its privacy policies every two years for the next two decades. Privacy concerns are the site’s greatest worry: putting a foot wrong could mean encouraging legislation around the Image: owenwbrown

Being inspired to explore stays with you

world making it much more challenging for Facebook to make the most of the data it currently holds. That would certainly have an effect on future earnings growth. Despite governments becoming increasingly sensitive about privacy, Facebook has not yet triggered any serious governmental alerts and if it is careful, it may never do so. Overall, I believe that Facebook has a great future ahead. As Facebook develops, it will most likely hire more lawyers and lobbyists to fight their privacyrelated lawsuits. There will be greater investment in innovative ways to connect people – for example through mobile phones and tablet PCs – and improvements in the design and functionality of the site itself. In addition, there is likely to be more demand for Facebook adverts as the site increases further in popularity. The battle between Google and Facebook seems likely to intensify as Facebook continues to expand into other areas of the internet – creating more links, share buttons and perhaps even adding an online-search function. However, nothing is more important than the dynamism and passion of Mark Zuckerberg and his fellow Harvard companions which is surely to develop as the ‘college project’ becomes bigger. Only by combining these factors can Facebook really generate the earnings which are needed to justify its worth.

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Economics 11

10 Nottingham Economic Review

Source: WTO Image: Victor Lam

Warning signs for Japan’s Trade Balance and the

TPP

By Wooback Lee

n 13 November 2011, the Asian-Pacific Economic Cooperation (APEC) Leaders’ Meeting was held in Hawaii. APEC aims to promote freer trade and economic cooperation among its Pacific Rim members, which include some of the largest trading nations in the world, such as the US, China, Russia and Japan. At the meeting, participating countries discussed joining the TransPacific Partnership (TPP), a multilateral free-trade agreement which aims to foster closer economic relationships through trade liberalisation. Currently, the group only includes four states: Brunei, Chile, New

Zealand and Singapore. Specifically, the agreement tries to relax trade regulation within the AsianPacific region by abolishing both tariff barriers for goods, including manufacturing and agricultural products, and non-tariff barriers for services, such as intellectual property and medical services. At the meeting, Yoshihiko Noda, the current Japanese prime minister, expressed a willingness to introduce his country to the group, and emphasised the connection between the partnership and economic growth. This belief seems well-founded: Shujiro Urata, professor of economics at Waseda University, noted how expanded trade areas and a greater volume of exports could lead to the increased efficiency of allocating factors of production, specifically labour and capital. Theory suggests a closer economic relationship with the country’s major trade partners (including the US) could lead to the extension of intra-industry trade and a higher degree of specialisation of its main industries, notably semi-conductors and cars. There will be one-off (‘static’) gains: an increase in output brought about by greater exploitation

of comparative advantage; and longer-term (‘dynamic’) gains: an increased trade balance endowing the country with savings which can be used for further domestic investment, bringing about a long run growth bonus. Yet, the current government is facing fierce resistance from headstrong opponents. Their reasoning is simple but also cogent: cheap imports from other nations may surge in, severely damaging vulnerable industries such as agriculture, finance and construction. Due to these worries – some might call them special interests – the Japanese Government was previously reluctant to discuss the agreement. However, after the country experienced in 2011 its first trade deficit for over 30

years, of 32 billion US dollars (see Chart), the public have begun to voice their support for the agreement more strongly and the issue has climbed the Government’s agenda. Note that the – presumably temporary – trade deficit was brought about by the terrible tsunami which struck Japan just over a year ago. However, this is not sufficient reason to ignore the current trade deficit. There are two major threats possibly which could mean Japan faces a chronic trade deficit (or at least sluggish international trade).

and Central Banks have taken remedial action, none have been wholly successful as the crisis rages on with Eurozone debt uncertainty. The Western economies are some of Japan’s most important export markets, but have downbeat demand prospects: note that, Japan’s trade balance plummeted between 2007 and 2008, the starting point of the global downturn. Thus, providing that the Eurozone and the US continue to fail to make a speedy recovery, Japan has to continue to bear the effects of the fallout, which will include a worsened trade balance.

The first threat is the anaemic recovery of the global economy. The financial crisis originating from Wall Street has engulfed both the US and European economies. While governments

The second threat is the strong Yen. During the financial crisis, Western economies have witnessed the downgrading of their credit rating. As a result, investors moved part

12 Nottingham Economic Review

of their investment portfolios to a seemingly less-risky country: Japan, known for its robust economic and industrial structure. This movement raised the demand for Yen and made the country’s exports relatively more expensive to foreign consumers. This state of affairs has endured, and Japanese manufacturing firms have lost their competitiveness in a global market. Thomson Reuters reporting reflects the harsh reality facing these firms: some major Japanese electronics manufacturers, including Panasonic and Fujitsu, now possess only onethird of their market value compared to 10 years ago. The strong currency has accelerated the shift of production facilities abroad. J.P. Morgan predicts the proportion of Japanese car production overseas to rise to 76% in 2014, 27% more than in 2003. This continuous drain is likely to be hugely painful for the country’s economy: it not only lessens exports, but boosts imports, including the domestic firms’ own products. Eventually, this will deteriorate the country’s trade balance. Yet, according to the Chart again, Japan still has a large current account surplus (a country’s trade balance plus the net amount received for domestically-owned factors of production, including earnings from capital and land used abroad such as capital gains and interest payment). Does it have cause to be concerned? Unfortunately, the decrease in current account surplus was caused by the aforementioned

Economics 13

effects rather than by strong domestic consumption and investment. Furthermore, Japan’s national savings are likely to face negative winds. Firstly, firms’ profits will likely be less of a boon for the country’s current account. Since the 1990s, Japanese firms have benefited in terms of international competitiveness from moderate domestic wage increases and the Bank of Japan’s low interest rate. Usually, these profits were repatriated – a boon for the current account – but, in future, a strong currency might

The current government is facing fierce resistance from headstrong opponents. Their reasoning is simple but also cogent. incite firms to invest in new production facilities overseas rather than repatriate savings. Additionally, the other components of national savings – government saving and household saving – are likely to fall. The country’s debt has increased incrementally, and now stands at around 200% of GDP. Worse, its net tax revenue has not contributed to the debt reduction: net tax revenue has been negative for more than 20 years. The situation in household saving does not make for better viewing: it has fallen from 18% of disposable income in the 1980s to 3.3% in 2006, and Japan’s ageing population means this might only deteriorate.

A fall in national saving leads to lower inflows of investment income, and so further erosion of Japan’s current account surplus is likely in the next few years. In fact, Masaaki Kanno, a consultant at J.P. Morgan, predicts the country will face a deficit by 2015, even with the (perhaps tenuous) assumption of constant net foreign-investment income. It seems as if the TransPacific Partnership could be breakthrough for Japan, although not a panacea. It does not provide a direct solution to the appreciation of the Yen and the agreement will be a complement to the country’s numerous, previously signed Regional Trade Agreements (RTAs) with various countries such as India, Vietnam and Chile, rather than a trailblazer. However, while the country’s focus may still be very much on recovery from the destructive tsunami, there are other major threats to the country’s future status and prosperity: its trade balance is in bad shape; it is losing ground in technological and intellectual-property standards; and it is being outperformed by competitors such as China. However, a more immediate threat might be the Free Trade Agreement between the US and South Korea, brought into force on March 15. This could be especially dangerous to Japan as South Korea has many exporting industries similar to Japan’s. Japan seems to be between a rock and a hard place: either riling the captains of protected domestic industries, or being left out of new trading circles. Its leaders must make up their minds, and soon.

How the Argentine Government has inflated the possibility of serious economic problems By Joshua Jacobs

In a country with a past full of inflationary problems the latest is not only self-inflicted, but comes with the possibility of harmful long-term effects. Whilst the graph below would suggest inflation to be around 10% recently, reality suggests otherwise. It is believed that since 2007, the Argentine Government has been publishing incorrect inflation rates in order to hide the actual rate. Whilst this policy may have been implemented in the hope of maintaining confidence and consumer certainty, it has backfired. Independent economists have proven Argentina’s stated inflation figures to be alarmingly awry; perhaps understating the true rate by half. Fudging these figures substantially reduces the credibility of the Argentine economy, and also swindles bondholders of substantial amounts of money. Even more worryingly, the Argentine Government has sent threats and fines to the independent economists providing the correct figures. This has left Argentina looking chaotic and weak at a time when another inflationary crisis appears more and more likely. In contrast to previous problems with inflation, (which were also severe – in March 1990 inflation hit a scarcely believable 20,262.80%)

The Government does not appear willing to accept it has a problem, which will only exacerbate the crisis. the Government does not appear willing to accept it has a problem, which will only exacerbate the crisis. This comes at exactly a time when strong leadership and decisiveness are required. Unfortunately, such obstinate behavior is likely to have adverse effects on credibility, consumer certainty and primarily, inflation. There are also further indirect effects such as movement away from the Argentine currency into other, more stable currencies. As former banker Monica Guglielmini states,” foreigners don’t invest here and those Argentines with money take it abroad.”

This is likely to lead to a further weakening of the currency. The overall effect on the domestic consumer is substantial as their purchasing power erodes, and it is easy to foresee already shaky levels of confidence reaching new lows. In addition, the high inflation rate is likely to incur a ‘multiplier effect’ as speculators drive inflation on through their predictions. Speculators will be reluctant to predict anything other than a rise in prices with the Government’s current poor handling of the situation. Another conundrum posed at the Argentine Government is their notoriously reckless Government spending. At a time approaching

elections, where the Government hopes to boost popularity with voters, it is hard to see a fall in spending. Along with a surprisingly expansive fiscal policy, the Government’s refusal to resolve this issue of ‘official lying’ can be viewed as more critical. Despite its views being in the minority, the Argentine Government remains bullish about its economic prospects and has suggested that wage rates are increasing at a higher rate than inflation. Moreover, record sales in televisions and cars over the last year have given reason for optimism. Yet, it is likely these record sales are due to excessive spending in expectation of further lofty inflation rates. In spite of the Government’s positive spin, no one in Argentina is fooled by these fabricated statistics. General opinion alludes to changes in prices daily and of a Government desperately trying to plaster over enlarging cracks. Unfortunately, this is exactly the case. On a superficial level things may seem fine but by taking an even slightly closer look it is clear that the longer the Argentine Government live out this ridiculous notion, the less time they have to react to the very real threat of yet another inflationary crisis.

Image: Jennifer Yu

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Oliver Pawle Award 15

Is Economics a Science?

ven to this day, economists, scientists and philosophers continue to debate whether ‘Economics’ can be justly classified a science. Thomas Carlyle, a historian during the Victorian era, once famously called economics a ‘dismal’ science. Albert Camus, a French author and philosopher, described economics, as “the art of trying to satisfy infinite needs with limited resources.” More recently, the British economist

Lionel Robbins defined economics as “a science that studies human behaviour as a relationship between ends and scarce means which have alternative uses.” So what exactly is economics? Is it a science? Firstly, it is important to establish what we mean by ‘science’. The Cambridge Dictionary defines a science as “the systematic study of the structure and behaviour of the physical world, especially

by watching, measuring and doing experiments, and the development of theories to describe the results of these activities.” Taking the definition further, the eminent philosopher Karl Popper states that, “a statement is scientific only if it is open to the logical possibility of being found false.” This implies that no scientific theory is actually true; it has just not yet been contradicted.

positive science used to predict consequences of changes in circumstances.” Economics provides us with a set of analytical tools that can be used to explain why events unfolded the way they did, and to anticipate (to the best of our abilities) future outcomes, under similar or varied circumstances: What caused the financial crisis of 2008? What can we do to prevent it from happening again in the future?

According to these definitions, we can establish the similarities between economics and a science. Although their subject matters may be largely varied, it is worth noting that both parties share a common goal: to understand how the world works. George Stigler once said, “The central task of an empirical science such as economics is to provide a general understanding of events in the real world.” Economics makes plenty of falsifiable claims and tests them frequently. Take a simple theory: A rise in minimum wage will decrease unemployment. Economics can test this claim. Theories with mathematical precision are formulated, huge data sets on both individual and aggregate behaviour are collected and sophisticated statistical techniques such as regression are used to reach empirical judgements. Naturally, some are confirmed and become accepted, but some are disproved and rejected. Thus, economic theory can be considered scientific.

Economics, like a science, can be used to understand and improve an imperfect world and naturally, theories have been developed over time. The British economist Mark Blaug believes that economics resembles a science due to progress. “As economists we are ultimately in the business of understanding how the economy works in the same way that a physicist or a biologist is engaged in understanding how nature works.” In economics, there has certainly been theoretical, statistical and empirical progress. New and more accurate models are constantly being developed, statistical tools for econometrics are becoming more and more advanced and in this way, progress in economics could be seen as science-worthy.

Through science we develop theories in order to explain and predict. Milton Friedman says in The Methodology of Positive Economics, “economics is a

So in some respects, we have established that economics behaves like a science. However there are also significant differences between the two. While Mark Blaug was convinced that the extent of progress in economics is the same as a science, Alexander Rosenburg, the American philosopher, said that, “200 years of work in the same direction have produced

nothing comparable to the physicists’ directory of new planets or new technologies by which to control the mechanical phenomena that Newton’s laws systemized.” Perhaps this is true. It is said that 90% of the world’s economists did not predict the current crisis despite having plenty of knowledge to do so. The quality of an economist’s predictions and the growth of predictive power over time are not of scientific quality. It is often argued that economics turns a set of implausible and unrealistic assumptions into tidy, mathematically expressible theories that have little or no correlation to reality. Where chemists can predict the outcome of every single hydrogen atom reacting with every other element,

Although their subject matters may be largely varied, it is worth noting that both parties share a common goal: to understand how the world works. economics does no better than give generic predictions as opposed to specific predictions about each individual person. There are two main reasons why economists are not able to predict to the same degree as a scientist and why economic models are sometimes seen to be idealistic and unreliable. The main issue is human behaviour. People are the reason for a changing economy. While laws bind a physical science, humans are free to behave in unpredictable ways - they are affected by emotion. But, while individual

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14 Nottingham Economic Review

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Oliver Pawle Award 17

Financial markets have changed a lot since they first appeared in the 11th century. Then, agriculture was the big industry: banks managed their agricultural interests through organized exchanges and even traded in debts taken out by farmers. This can be likened to the securitization we see in modern financial markets, whereby mortgages, credit card loans and other forms of loans are bundled together and sold on. In 1602 the East India Company, by listing on the Amsterdam Stock Exchange, became the first company to ever issue shares, and it was around this time that the first bonds were issued. In the UK, the London Stock exchange opened for business in 1688.

economists have no choice but to reduce the number of variables in order to develop functional models. Simplifications may allow economists to use tools such as regression analysis to hold some variables constant to see the effect of others; but economists are still – inevitably – limited. Not all the factors can be measured - not accurately anyway. This is why statistics can appear to give misleading results. So, in light of what has been said, it is fair to say that there are too many issues at hand to explicitly conclude that economics is a science. In fact, it is in the nature of the subject that these dilemmas exist in the first place – they make economics what it is; they make it unique and useful. At most, economics approaches the world with scientific method but uses it only to the best of its ability. Carlyle’s “dismal” science was not such a bad name after all. It sums up economics’ failed attempt to be a science but is by no means demeaning. After all, the ‘laws’ of science are not necessarily as stable as they seem. There has been evidence of many scientific paradigm shifts in the past. One prominent one was the transition between the worldview of Newtonian physics and Einstein’s relativistic worldview. It can be argued that in the same way there was a significant paradigm shift in economics, that it is to say, a revolution of ideas: from classical economics to Keynesian economics. Evidently, the trend in science is similar to that of economics which is why they are often compared, but, in truth, they are two different subjects, both with their own unique aspects. members of a population are subject to idiosyncratic differences, the average behaviour of a group is more predictable than that of any individual member in it – the law of large numbers. This is the reason why models are based on general economic behaviour and sometimes seem impractical and unrealistic. The second problem for an economist is the fact that the real world is not a laboratory. Economists are not able to use controlled experiments to gather data to test theories. They must use what the world gives them and rely on statistics to draw conclusions. Economics requires deductive reasoning, meaning it must start with a theory before it can use the data to evaluate it. A science on the other hand uses inductive reasoning where an observation is made first and then data can be collected to test it. The economy is a bewilderingly complex system with myriad interacting factors, so

Thus, if economics is not a science, then what is it? Ultimately, economics provides us with a set of tools used to solve problems in the real world and it is how these tools are used that makes economics what it is. As Camus said, perhaps economics can be considered more of an art than a science in that it takes a creative and analytical mind to use these tools to uncover the most meaningful results. Robbins had reason when he called economics a science that studies human behaviour. As economists we are always trying to improve our techniques in order to accurately predict human conduct. The subject is usually classed in the ‘social science’ category, which seems plausible since human behaviour and experimental power cannot always be controlled. Let us not forget that Adam Smith, the founder of classical economics, was originally a philosopher, not a scientist.

Have financial markets just become elaborate casinos? By Harman Gill

he news is scattered with rogue trading scandals, the most notable recent case being the loss of £1.3 billion by UBS trader (and Nottingham graduate) Kweku Adoboli. We must ask what

kind of system have we formed that allows colossal sums to be lost and has forced authors to write books like ‘House of Cards: How Wall Street’s Gamblers Broke Capitalism’?

So, all these products –packaged loans, bonds and stocks – have been around for some time. So what is different? I believe the answer lies in leveraging, financial incentives for market participants and greater access to markets through increased technology and derivatives. Financial derivatives are considered by many to be useful tools for hedging against risk, but have been referred to as “time bombs” by Warren Buffet. They are financial products that derive their price from an underlying asset; an option, for example, which gives the right (but not an obligation) to buy an asset at a predetermined point in the future. While numerous variables cause the value of the option to fluctuate, a lot of the movement is attributed to the changing price of the underlying asset. If a multinational company wanted to use derivatives

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to manage the currency risk encountered through international goods trades, the value of the derivatives would be tied to the currency it holds. Recently, however, a lot of these products have been used purely for speculative purposes. I refer to a casino in the title, because creating and trading an option can be considered akin to betting on a roulette wheel if the derivative is not used for hedging purposes. A small initial deposit is put up and huge profits can be made if you were ‘betting’ on an unlikely event. You can also play the part of the ‘bookmaker’ in these option markets by selling options. In this case, the ‘writers’ of the option face huge risks, but spectacular gains if they get their ‘punt’ right. (Note that options were only introduced in the 20th century and are vastly different from any product available in 17th century financial markets) While there have been many outspoken critics of speculation through the ages – Adam Smith, in the Wealth of Nations, noted how some likened it to witchcraft – there have been many who recognise its importance. Smith himself points out that speculation (in the context of the grain market) helps to amplify important signals: food shortages, for example. Others have more recently outlined its importance in financial economics theory. It is common knowledge that greater participation in a market provides a greater mechanism for achieving a tradable price: a price at which enough traders are willing to trade. This leads

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to the idea that speculators increase market liquidity, which is generally desirable. I have been fortunate to have undertaken work experience with many financial firms in the City, one of which was a prop trading company. Such a company trades for its own account, in this case by seeking profits from speculating on financial products that derive their value from long term German interest rates. These traders have no actual interest in German debt; they have no physical German bond holding; but they seek to discover how macroeconomic variables influence the products they are trading. When I asked one of the traders what the products they are trading actually were, he replied, “it does not matter, I am just making profit from these numbers moving up and down on the screen”. Analysing price patterns without even considering real macroeconomic variables, as this trader was doing, is called ‘scalping’. To me, this style seemed scarcely different from laying bets at the Nottingham Greyhound track based on the pattern of dogs which have previously finished first. In addition, the money that these traders were staking was mainly provided by the company. This arrangement – with some detachment from the financial burden of losses but great pleasure from profitable trades – obviously affected the behaviour of these traders significantly. It encourages more risky behaviour, and a more gambling-like system. Financial markets have grown

to the size where, with so much speculation, we might not get the outcomes that Smith describes. Prices may not correctly communicate the true nature of the underlying assets. This could be the case as with bubbles: where investors follow one another rather than taking account of the underlying value of the asset. The gambling analogy is again useful: imagine a shifty character at the racecourse spreading rumours about a horse, crushing its odds with the punters even though the horse’s chances in the race have not changed. Adverts from spread betting companies are now inescapable in the financial press. I believe this is contributing to financial markets’ casino-like image. Spread betting is mainly targeted at retail investors, giving them the chance to speculate on asset prices without actually owning the asset. One major problem with spread betting is it is a highly leveraged activity: with an initial payment of £800, one could take a position on the FTSE 100 with a staggering downside risk of over £50,000. Retail investors’ lack of experience can pose huge dangers. Bets gone sour (with money that is not theirs) can leave them owing huge amounts to the spread betting firms. Perhaps the most telling about the product is that ‘bet’ is in the very name of the product. Since early times in financial markets we have seen speculation. It is not, on its own, the dirty practice some of the financial press make it out to be. It is when this speculation turns into irrational gambling that markets take on a casino-like culture.

One Child Policylifetime bachelors, leftover women and high savings rates By Liz Jia

he one child policy is arguably the most notorious social policy adopted in China. Introduced in 1979, its main purpose was to encourage economic growth via reducing the nation’s demand for natural resources and keeping a steady labour rate.

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espite modernisation, Chinese families (especially those living in rural areas) are known for their gender preference towards boys. This traditional mode of thinking is best captured (in exaggerated form) by the ancient book of songs (1000-700BC):

“When a son is born, Let him sleep on the bed, Clothe him with fine clothes, And give him jade to play... When a daughter is born, Let her sleep on the ground, Wrap her in common wrappings, And give broken tiles to play...” The main reason behind gender preference can be analysed in cold-blooded financial terms. A son is an asset as he is able to work to support a family. A daughter is a liability as after years of investment by the parents, she will be married off and is thus unable to financially support her own family. This logic seems dated but it is still highly applicable in rural areas where boys can perform hard labour. With this in mind, it should come as no surprise that the mix of prenatal gender detection and gender biasedness has resulted in an increasingly skewed sex ratio. A study by Zhang Qing, population researcher at the Chinese Academy of Social Services, found that out of the 29 provinces in China, only 7 are within the world’s average sex ratio. In 1980, 106 boys were born were born for every 100 girls. By 1997, it was 122 boys for every 100 girls. What does this mean in pure numbers? It means that one in five men in China will remain lifelong bachelors from the lack of potential wives. To put this into perspective, at the current rate of gender proportions, by 2020 there will be a population of lifelong bachelors the population of Texas. This problem – an ‘Era of Missing Girls – could give rise to a number of phenomena such as high household saving rates, countryside bachelors and more surprisingly, a stock of highly educated single women.

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Competitive Marriage Many mainstream economists argue that the high savings ratio in China is the result of a lack of a general social safety net; without secure welfare or government pensions, the Chinese must save themselves to ensure there have money saved for a rainy day. Columbia Professor Shang Jin Wei offers an alternative explanation. Wei explains that with so few girls, parents are accumulating as much wealth as possible to ensure that their child will not part of the 20% of men left unmarried, leading to what are simply called competitive marriages. Chinese households want to accumulate as much wealth as they possibly can so that their son is more attractive as a potential suitor. (It is worth noting that education and personal assets are attributes which also push up the rankings of a male on the ‘marriage charts’.) While, acknowledging that the marriage market is an explanatory variable for saving rates is somewhat ‘outside macroeconomic thinking’, Wei demonstrates in his research a pattern of household saving rates and entrepreneurship that rises as the competition for brides tightens. For example, comparing the savings rate of those households with sons against those with daughters, results show that firstly, households with sons evidently save higher than those with daughters and, moreover, this gap widens in areas with a more skewed gender ratio. Furthermore, despite the Chinese government’s extension of welfare reforms, the country’s savings ratio has continuously increased. Higher saving as a means of bettering a man’s chances of finding a life partner seems unromantic and icily materialistic. From the individual’s point of view, however, when the competition is tough, one cannot afford to not keep up; a phenomenon comically titled ‘Keeping up with the Zhangs’. It is worth noting that increased savings do not change the total number of men married, thus making it socially inefficient.

Unmarried, Uneducated A study conducted by D.J Lee and S. Subramanian explores the infamous by-product of competitive marriages, ‘Bachelor Villages’. This phenomenon of is best demonstrated by Gao Po - a rural village on Hainan Island. It is home to a population of 230; and precisely zero unmarried women. As the single women of these villages leave in search of a

better life in nearby cities, men stay behind to look after land and family. For these men, the chance of domestic bliss is almost zero. The demographic of males with low socio-economic status is hit by a double-whammy of a shrinking population and ‘marriage hypergamy’ – where women marry up in social class, wealth and age. With a generally shrinking population, mixed with sex selective abortions and the tendency for men to marry someone younger, you get a female mating pool that’s shrinking at a much faster rate than the male pool. In the last two decades, eternal bachelorhood has become an increasingly likely fate for those in remote areas without access to skilled jobs. As the population of desperate, sexually frustrated men grows, the situation darkens. L. Edlund published in 2007 a study showing that a 1% increase in sex ratio could lead to a 5% increase in crime rate. Researchers state that countries with an excess of men have historically been more violent. In contrast to the traditional gender biasedness, ladies of these villages are more recently regarded as treasures. Unlike their male counterparts, these women send the majority of their earnings back home. Moreover, with the demographics so heavily in their favour, they are likely to marry up in social economic status and further bolster the cash flow at home.

Sheng Nu It may seem that one of the

unintended social implications of the one child policy is that, statistically speaking, the average girl has a much easier time finding a partner. If this is true, then ladies who are self-sufficient and highly educated should go like hot cakes. Yet the Chinese media is rife with stories about urban single women termed ‘Sheng Nu’, a term that directly translates to ‘Leftover Women’.

height, occupation, educational background, and sometimes a picture of the individual). Many of these Sheng Nu say that their accomplishments in education and career are exactly what hinder them in finding a suitable mate; many members of the opposite sex are simply too intimidated.

This may seem surprising considering simple supply and demand of gender, but in a country with long held tradition of hypergamy, most highly educated women often end up without partners. “Men at the bottom of society get left out of the marriage market and the same pattern emerges for women at the top of society” says Yong Cai, a demographer at the University of North Carolina. In China, where universal marriage at a young age is the norm, these ladies face stark criticisms for choosing to stay single, especially as the countryside fills up with unmarried bachelors who outnumber marriage-age women. Viral videos, newspaper articles and commentators across China have often criticised these women for ‘gold digging’: holding out for higher savings or greater assets.

On the other end of the social spectrum, as the gender imbalance grows, it increasingly affects poor women in darker ways, such as forced marriages, prostitution and human trafficking. The shortage of girls could lead to a warped reversal of the imbalance. China’s astonishing savings rate could be a result of families’ pressure to accumulate cash to attract wives for their sons. “If you’re a dirt-poor peasant somewhere,” Edlund says, “maybe your optimal choice would be a daughter, who can get married.” This could lead to a new trend in the economy where the poor choose to have daughters, and the rich choose to have sons; as demonstrated by the demographics in Korea. But, relegated to the underclass, women’s ever increasing asset value may prime them to be exploited by illegal gangs or even their own parents.

When speaking to these women however, many claim that isn’t the case. Some of these ladies have even taken their search outdoors to the active marriage market in Shanghai People’s Park; where every weekend, parents of single children fill the park with their child’s dating resume (a document which includes information such as age,

This topic is a good illustration of the wide ranging effects of social policies. For China, the resulting sex ratio imbalance has many policy makers worried the future composition of society. If gender disproportionality is this much of a concern, then could it be worth considering immigration policies that encourage the import of women and export of men?

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Economics 23

Chinese Pharmaceuticals By Kay Li

s Chinaâ&#x20AC;&#x2122;s economic capability and global presence grows, it is with little surprise that the nationâ&#x20AC;&#x2122;s pharmaceutical industry is not only growing and expanding with great speed, but is also yet to achieve its even more massive potential. There are, however a number of obstacles which could hinder the realisation of this potential.

Whilst China is already home to the largest markets for sectors such as automobiles, telecommunications, and personal computers, it is also well on course to becoming the biggest global market for pharmaceutical products. In 2005, China was the 9th largest pharmaceutical market in the world. Just five years later, it became the 3rd largest market,

and is expected to climb to 2nd place by 2020, reaching a value of US$220bn. Massive Government funding of a universal reform of the healthcare framework will drive this growth.

A Global Competition The three largest players in the domestic Chinese market are Shanghai Pharmaceutical Group,

Beijing Pharmaceutical Corp and Guangzhou Pharmaceutical Holdings, but the three collectively account for only 15% of the domestic market, while domestic firms altogether account for 73% of the market (in revenue terms, 5 years ago). Many top global pharmaceutical companies have already established a footprint in China: Johnson & Johnson, for example,

has had a presence in the region dating back to 1985 and in 2008 acquired Beijing Dabao Cosmetics co. to add to its skincare and cosmetics portfolio. Elsewhere, in March 2011, Novartis is close to becoming the leading supplier of Chinese vaccinations since its purchase of an 85% stake in Zhejiang Tianyuan. With foreign competitorsâ&#x20AC;&#x2122; long-established success and expertise, there is real

Image source: The Competitive Advantage of Nations, Michael Porter (1990)

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pressure for Chinese counterparts to increase standards across the board, in terms of prices, quality, innovation and logistics, if they hope to reach such competitive heights.

Analysing Competitiveness: Porter’s Diamond Model Outline

The diamond model is an economic tool to analyse why some countries are leaders in the production of certain goods. Its six sections’ relations and interactions can be illustrated in the diagram below and provide a useful means to discuss the Chinese pharmaceutical industry.

Factor Conditions

At present China is still reliant on its cheap labour and low operating costs as its primary competitive advantage. This has allowed many of the world’s top drug companies to locate production and research centres in the country over the years in order to take advantage of these cost savings. Skilled labour, on the other hand, is crucial for producing innovative but complex drugs, pushing new drug discoveries and as a catalyst for upgrading the entire industry as it moves up the value chain.

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In a recent report from Price Waterhouse Coopers, a professional services firm, multinational companies such as GlaxoSmithKline (GSK) and AstraZeneca were noted to

have regarded favourably the high number of universities and vocational colleges specialising in medicine and pharmaceuticals. GSK also stated that the growing graduate talent pool was “leading to the rapid development of excellence in life sciences…and neuroscience.” Despite this, a vast number of graduates are having difficulty finding employment because of a skills mismatch – graduates lack soft skills such as communication, team working and management and the appropriate work experience to fill job posts.

DemandConditions

Perhaps the biggest driver of pharmaceutical demand, at present and for the near future, is healthcare reform in China. In April 2009, the Chinese government announced plans to implement a ‘four-in-one’ system of reform to improve public health, medical services, medical security and pharmaceutical security. These plans will attract increased investment from the

Government, private enterprises and foreign investment. Consequently, the pharmaceutical production industry will also be driven forward: it is essential to complement a modernized healthcare system with a modernized drug provision framework. Local governments will encourage greater competition in the healthcare market to force down prices, and the distribution network will have to be streamlined, making Chinese pharmaceutical companies more cost competitive. A second important factor to consider is that domestic demand for pharmaceuticals has increased dramatically in recent years, following economic expansion and increases in household income and consumption. For example, a side effect of higher incomes as a result of urbanization is a higher risk towards heart disease, respiratory conditions and cancers. The result is a growing demand for drugs to prevent and treat these growing threats. Furthermore, from both an increase in life expectancy and the effects of the one-child policy, it is predicted that by the year 2050, approximately one-third of the Chinese population will be aged 60 or over. This effect is likely to further push up demand for pharmaceuticals which treat age-related diseases such as dementia, chronic arthritis and osteoporosis.

Firm strategy, structure and rivalry

Chinese firms inevitably face fierce competition with multinational pharmaceutical

companies, many of whom have been present in the Chinese market for years. These multinationals represent both a foe and an ally to Chinese firms. On the one hand, they are competitors for customers and profits; on the other, through partnerships, they can contribute to knowledge ‘spillovers’. For example, GSK has joint ventures with Chinese firms in its four manufacturing bases in the region. Relationships with the biggest Western multinationals can encourage better practice and better management in domestic firms which could deliver powerful benefits in the future when Chinese firms gain greater independence.

Government

Policies related to healthcare reform will have the most significant effects on the industry. This is especially true in the medium to long term as the overhaul of healthcare provision and restructuring of the pharmaceutical distribution framework takes high priority. Large efficiency gains are likely to be had from the extensive industry restructuring the Government will undertake; specifically, encouraging the merging of many of drugs companies. This will allow Chinese firms to maintain a low cost advantage, reinforced by government efforts to reduce drug prices. Whilst healthcare reform ensures that drugs are more affordable, this could have two main adverse effects. Firstly, the cost-cutting drive could deter investment in drug discoveries if the projected profits are low. This is especially acute for the pharmaceutical industry, given the high volume of costs involved in drug development. The development of one drug can involve up to $1 billion in sunk costs before the product even reaches the market, let alone turns a profit. To prevent a lack of innovation, production subsidies should be offered, and pricing exceptions should be made for certain drugs. Secondly, larger mergers and regulated prices might mean new firms with new ideas will have even less incentive to enter the pharmaceutical market. Whilst the Government emphasises that competition should play a key role in improving the products offered to consumers, rigidity on overheads will deter entrants who may not be able to survive this pressure. These two problems may prove insignificant in the long run, though, due to the utter volume of the

Chinese pharmaceutical market and its consumers. In a 2011 Business Week article, Chris Viehbacher, CEO of Sanofi, argued, this volume “is able to more than compensate” for price-setting regulation. Another thorny issue for this industry is the support of patent protection in China. The next couple of years will see stiff competition in the fight for patented drugs as approximately half of all patent protected drugs from the world’s biggest companies face expiration. Whilst there has been steady growth in the number of patent applications by Chinese pharmaceutical producers – approximately 140,000 applications were made in 2004 – only a small proportion are being approved: 212, in 2005. A low acceptance rate may stall domestic firms’ growth aspirations One more problem that plagues the international competitiveness of Chinese pharmaceutical products relates to the counterfeit drugs market, the size and impact of which is hard to measure. The strength law enforcement varies between regions, which has domestic and international implications. The nation is a leading exporter of active pharmaceutical ingredients (API), so any lapses in quality (inherent in counterfeit drugs) could have massively detrimental impacts on foreign markets. To avoid ‘Anti-China’ product sentiment, the government and the entire pharmaceutical community must work together to curb illegal activity. Finally, the Chinese Government is aiming to move the industry’s growth from predominately manufacturing-based to knowledge-based. It is promoting a nationwide environment of innovation, through education and other means, aiming to make the country a research leader as well as a manufacturing powerhouse. This transition up the value chain is representative of China’s overall economy, suggesting that a bright future lies ahead. For the pharmaceutical industry specifically, the Government’s twin priorities of reforming the pharmaceutical framework and of promoting ‘indigenous innovation’ indicate a positive medium-term outlook, although there are many other influencing factors. Overall, policies should be directed towards creating a sustainable and innovative pharmaceutical industry: in the long run, the main determinant of competitiveness will be the extent to which its firms can reach the frontiers of innovation and production.

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Economics 27

The Elephant’s Weight: India’s Rise By Saurabh Tripathi

he 21st century is often quoted to be the Asian Century, because of the rise of Asia as the most aggressive player in global markets. The entry, or rather, reentry of China and India into the world scene has been spectacular to watch, with China’s economic focus being industry, and India’s being services. Over 2000 years ago, India contributed close to a third of world economic output. The first traces to trade can be tracked

ill-treated. India became slave to the world’s new superpower, Great Britain during an era better known as the British Century. This paralysed India completely, turning it into a largely poor country with major ethnic and religious differences. On 15th of August 1947, on gaining independence, India had a lot of social issues to solve, coupled with huge economic development to go through. India adopted welfare economics, choosing not to integrate its economy with the world to protect and initiate domestic supply and demand. Until 1991, India had a very slow growth rate of growth of 3% with almost no integration and high tariff rates. However, 1991 turned out to be the year of future change for the Indian Economy. Under the then Finance Minister, Manmohan Singh, India slashed most of its tariffs, changed taxation laws and attracted investor confidence. From 1991 onwards, India’s GDP (PPP) has experienced a near seven-fold increase. Currently, in 2012 US$, India stands to be the world’s third largest economy, below only the US and China.

The above figure shows India’s rapid growth in GDP by PPP between 1980 and 2012. 1991 proved to be an important year for Indian economic growth. Thereon the Indian economy has pushed forward to become a services-based economy that rides on skills and knowledge. The IT industry in India is second only the United States’. Due to the availability of extremely cheap labour, there is a huge demand for Indian workers in the world labour market. Another factor why Indian labour back to India, and its links with China and Europe, primarily consisting of ornaments and spices. Civilisations, the ancient equivalent of today’s bustling metropolises, first began in India with the Harappa and Indus Valley Civilisations. Maritime trade was at a high in India, with Bombay (Mumbai), Madras (Chennai) and Calcutta (Kolkata) being centres of economic prosperity and heavy trade. Nalanda University in India, established in the 5th century AD, was a pioneer in science

and technology, the domain that drove India to prosperity. Those were India’s golden decades. However, with the advent of imperialism, India slowly became suppressed under the British Raj. Colonialism not only hindered economic growth. It looted the country of its resources, created societal divide on religious lines between Hindus and Muslims, and created an immense gap between the rich and the poor in the country. Millions of people in India were suppressed and

is in demand is that India has the world’s second largest English speaking population after the US. At last count, the labour force of the country is approximately 500 million, behind only to China. However, there tends to be a high degree of disguised unemployment in India within the unskilled labour force, and this is a major concern for the allocative efficiency of labour in the economy. Also, since India is a services-based economy, it will need to develop a high base of skilled workers. This can be ensured only if educational facilities at the bottom of the pyramid improve drastically in the next few years.

As far as predictions go, Citi predicts that India will become the world’s largest economy by 2050, surpassing China and the US, both by a comfortable margin. According to its research, the GDP of India will touch levels of $86 trillion. However, the report does also include that for India to be able to get to the top spot, it’ll need to undertake a second wave reforms and policy changes like the ones in 1991 to tackle basic social problems of illiteracy and poverty. Reforms must help in curbing malpractice and corruption at the top level and eradicate poverty completely. The government must undertake reforms that ensure provision of infrastructure to its citizens, as that is a major hurdle to India’s growth. Below is an image of Citi’s prediction. Microfinance will be the centre of the next wave of reforms that is already due. Empowering the poor is

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the imperative part – we do not need to teach the poor what to do. They know how to remove themselves from poverty. The image above shows that by 2050, the 860 million in poverty can be reduced to 330 million. To be able to achieve this, India’s leaders will need to show the will to improve the current state of affairs. But with levels of corruption and money laundering hitting peaks in Indian bureaucracy, such a reform is far from reality. More

than reducing poverty, what India needs is a new generation of politicians and bureaucrats who care for the common good and the welfare of the public. The difference between India’s growth and China’s is in the method of governance. One reason why India cannot and should not be compared to China is because China is a command economy, and India is a democracy. In a democracy, the decisionmaking process to decide on almost anything takes considerably more time than in a command economy, where decisions are passed without anybody’s consent. A democracy is accountable to the country, and will take time to develop, while a command economy can simply march ahead without having to provide any explanations for its decisions. China itself isn’t much ahead of India given that it has a population that is ageing fast and is not satisfied with its autocratic government. The problem of an ageing population could be huge – it is one of the main reasons for the Japanese economy’s decline in recent years. It is reported that in the next 15 years, while China and a few other developing economies will lose 100 million people of working age population, India will be gain 130 million. This will definitely prove an enormous

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advantage to India’s strategy to global economic dominance. India, China and Japan together have managed to put the weight of dominance in Asia, in contrast to recession in the west. India is taking precedence in the business world with its corporates taking control over big businesses in the west. Just one example is Tata Motors purchase of British carmakers Jaguar and Land Rover from Ford for $2.3 billion. Business culture in India will help the economy move forward faster, with entrepreneurship on the surge in India like never before. Companies like Infosys are key components of the American economy’s services sector. India is currently the world’s most preferred outsourcing destination, and will continue to be, because of cheap labour. All of this development comes with the world’s most diverse cultures, languages and religions. India contains a predominantly Hindu population with massive populations of Muslims, Buddhists and Sikhs. It also has hundreds of languages. India has impressively harbored all its differences and managed to move on as one country. Along the years, India’s aim will be to become a global power where its citizens have the basic right to elect their own government. Corruption, red-tape bureaucracy and poverty will need to be eradicated completely, while other basic rights such as education, sanitation and healthcare will need to be drastically improved. Employment prospects for the poor need to be increased – currently 74.7% of the population lives on less than $2 a day. Now all India waits for is the second wave of reforms, which should hopefully come into being by the next general elections in 2014. On the whole, being an economy that is driven by heavy and strong domestic demand, India holds a big advantage over China, which is heavily dependent on exports and external demand. Also, according to American strategy, it will be able to provide a geo-political counterbalance with the US against the likes of China. With the world’s third largest active military, India is well poised to take on as a regional superpower, and a possible global superpower. But, India will look to be the super power that spreads peace, tolerance and progress, not one that would be a threat to international peace or world economy.

Mergers And Acquisitions: Opportunity Cost

The Second Wave (1916-1929) – Industries introduced from the first wave merged for oligopoly. This ended with the 1929 stock market crash and the subsequent Great Depression.

By John Chatterjee-Woolman As consumers, we vie for good value for money. We believe we are getting the best deal when we know that we can go to a selection of companies to get what we want. But what happens when some of these companies merge or acquire one another? Does it have any real effect on our choices?

M&A – A Brief History Making the distinction

Mergers

• Two or more firms, of ten of about the same size, agree to go for ward as a single new company. • Both companies’ stocks are surrendered • New company stock is issued in its place.

Acquisitions

• One firm takes over an other and clearly estab lishes itself as the new owner. • The buyer’s stock continues to be traded.

big steel, telephone, oil, mining, manufacturing and transport industries in the USA, but activity halted with the recession of 1903 and the 1904 Stock Market Crash.

Conglomerate Mergers (19451968/70) – Diversification created giants such as LTV – which grew from an electrical contracting business into wire and cable, aerospace, and meat packaging industries, and by 1969 employed 29,000 workers. Its stocks, like many other companies’, crashed in 1969-70.

his decade has seen record levels of M&A transactions. With $2.7 trillion in deals, 2005 was hailed as the coming out party for large Leveraged Buyouts (LBOs). 2006 was another rosy year. These years fell into the shadow of 2007, which saw M&A transactions exceed $2 trillion by the second quarter. It may be a long while before we see another period quite like it. M&A is an age old business strategy, as old as the history of commerce itself. Major periods of activity cluster like waves: Mergers for Monopoly (1890s1904) – Major mergers created the

The 1980s – A period of frenetic activity, with hostile bids and takeovers through junk bond financing, and LBOs. Activity began to peter out by the middle of the decade, partly due to the ‘poison pill’: a strategy by the target company to make its shares less attrative to a potential buyer, allowing its shareholders to buy stocks at a discounted rate, thereby diluting its value. There was a stock market crash in 1987, and, ultimately, the junk bond market collapsed. The 1990s – Unprecedented merger deals were completed, such as Boeing–McDonnell Douglas and AOL–Time Warner. Mergers and acquisitions lost momentum after the Time Warner deal, widely regarded as the ‘worst ever’: just two years after, the group announced a loss of $99 billion when AOL ceased to be profitable. After the

30 Nottingham Economic Review

crash, banks tightened their lending standards and mergers were not looked on so kindly by equity markets. A New Wave (2002 – 2008) – Record M&A deals were brought about by globalisation and the availability of low-interest finance. The arrival of the great economic shock of 2008 ended cheap finance, so M&A slowed. (‘Merger Clusters during Economic Booms’, BanalEstañol et al, 2006)

Primary Motivations and Effect on Choice By looking at the motivations for mergers and acquisitions, we can determine their advantages and disadvantages for consumers.

Capturing Economies of Scale and Scope Reduction in duplicated departments or operations Advantage – Cost savings leading to increased profit. Disadvantage – With fewer employees required, staff layoffs ensue. The least ‘valuable’ employees are laid off, perhaps making them less attractive to potential employers, and thereby removing value from the economy. Opportunity to diversify in order to reduce risks Advantage – extreme changes in supply or demand can destroy small firms. For example, Basic Power acquired many customers in 2000, offering the cheapest tariffs by eschewing marketing and thirdparty electricity brokers, but folded in 2005, unable to withstand fluctuating market prices. Disadvantage – the lack of market plurality is not conducive to encouraging competition or entrepreneurship.

Economics 31

services more cheaply through bargaining strength, thereby making their products more economical. Disadvantage – Companies acquire part of a supply chain and benefit from the resources. Note, though, there is no value added to the economy because whilst at one end of the supply chain the consumers pay a lower price, at the other end, companies generate lower revenue.

Growth and consolidation of market share Advantage – M&As allow companies to expand quickly. The acquired company may get an injection of capital and expertise. Advantage – Cross border buy-outs can create certain strong national or global champions. A study by Lehman Brothers showed on average a 1% appreciation of the national currency of the target relative to the acquirer. Disadvantage – Managers have larger companies and hence more power. WorldCom’s tremendous growth reaped benefits for the Directors at the expense of its internal operations and customers, resulting in a crash and impacting shareholders, employees and consumers. Disadvantage – Increased market share can increase market power, moving further from perfect competition.

and the EC Treaty ensure tight regulatory scrutiny and control over M&A. A Consideration Industries appear to follow M&A as a route for expansion. However, a study found that less than one third of CEOs had a clear strategic rationale for the transaction, and that half of those that did were found to be off the mark (Planning for a Successful Merger or Acquisition: Lessons from an Australian Study, McDonald, Coulthard, de Lange, 2005). Perhaps that is why not all giants treat consumers in the same way. Looking at the automotive

Skoda - each with their identity - are all owned by Volkswagen. Here M&A improved the quality of our choices while maintaining the quantity of players in the market – lower costs – meaning lower prices – is one advantage among many.

In the energy market the picture is very different. Since deregulation, Ofgem has issued over 100 licenses for energy suppliers for the UK. Some companies started to acquire others whilst smaller competitors were forced out. Companies were not motivated to retain the brand name or products of their

M&A and Regulation Often businesses find M&A more attractive than years of effort building market presence. But what stops firms from acquiring so many competitors that they form monopolies? Who protects choice? Regulation is clearly needed.

To gain better technology or employees

The detrimental effect on the economy following waves of M&As highlights a failure to protect choice. A number of Acts introduced from the 1920s lacked any teeth. And acts passed in the 1940s and 1960s created the Monopolies and Mergers Commission (MMC) – which rules on whether a proposed merger is in the public’s interest – also failed to stop crashes.

Advantage – A large company can take advantage of specialisation of labour. They can afford higher salaries to attract the best staff. Advantage – Pecuniary savings: buying goods or

However, from 1965 onwards, the MMC’s powers were fleshed out. The Board of Trade, the 1973 Fair Trade Act, the 1980 and 1998 Competition Acts,

and the energy industries, both of which have experienced considerable amounts of M&A activity, we will find treatment of consumers differing hugely.

An acquisition in the motor trade usually maintains the identity of the target company thereby maintaining customers’ choice. For example Seat, VW, Audi and

acquisitions. Today, six giants account for ¾ of Great Britain’s electricity generation and dominate retail supply. Market participants have evolved from simple suppliers of energy to providers of many associated services – through M&A – but the giants of this market have ended up mirroring each other in price, and product and service diversification. In 2003, British

Gas, one of the giants, diversified into telecoms and was followed shortly by E.On, another giant. Unfortunately, as the products were similar and both ventures were unsuccessful many consumers were left in the lurch.

Some mergers and acquisitions survive the test of time because of happy customers and a sound economic model. HSBC, which has a long history of acquisitions (in the UK, Midland Bank, and Marks and Spencer’s Financial Services arm), recognises that commitment to understanding customer needs and delivering outstanding service is the foundation for a successful business, and consistently wins awards for its all-round performance. Skoda, one of the oldest carmakers, had severe reliability issues, until Volkswagen Group acquired the company and restored its respectability: its cars are now frequently praised for reliability and value for money. Conclusion Looking at all the aspects, M&A has a positive influence on choices only if the driving mechanism is consumer interest rather than profit. However, we need to take a close look at the choices which will remain after M&A. Choice defines us as free people – it is a necessity, not a want. Its validity cannot be measured by the quantity available. Choices essentially are unique identities of their own and if the available ones are just packaged differently, but are fundamentally the same, how can we still call them choices?

32 Nottingham Economic Review

Economics 33

Book Review: Why Nations Fail

With two economic heavyweights fluently refining a theory of national wealth through lots of interesting and pertinent examples, what’s not to like? Why Nations Fail is written with great clarity and structure, with clear subdivisions within naturally flowing chapters. This is a great strength but at times I

By Aleks Hughes

hy Nations Fail’s authors are of a high economic pedigree. Acemoglu is ranked the 7th most cited economist by IDEAS/ RePEc and is a winner of the John Bates Clark Medal. Robinson is a widely published Harvard professor of government. Together, they address the central question in development economics: what keeps large chunks of humanity in poverty? The book starts with a comparison of the twin towns Nogales, Arizona, USA and Nogales, Sonora, Mexico. This gives a clear illustration of the reasons for unequal success as the two towns share many characteristics: the same valley, same racial mix and broadly similar histories. Predictably through, Sonora, Mexico is the poor relation in multiple measurable aspects of economic prosperity. The authors then consider various popular hypotheses for national failure generally. Theories considered include culture (think: Max Weber’s ‘protestant work ethic’ theory), geography (think: Jeffrey Sachs’s theory that the climate of poor countries tends to hamper development, or Jared Diamond’s differing endowments of natural resources theories). Ultimately though, these are all dismissed with logic and compelling real world evidence. Why Nations Fail’s core theory is that economic success is inextricably linked to a society’s political structure. It gives two necessary conditions of any political structure wishing to achieve national prosperity: political power needs to be “centralized” and “inclusive”. Centralized and clearly-defined government is a widely accepted necessity; without it there is confusion and disorder. The “inclusive” feature is the more subtle concept with grander implications. The authors define inclusive institutions as those that “encourage popular

found myself feeling as if I were being spoon-fed the argument through extensive repetition. The greatest strength of the book is the variety and the level of detail in the side-stories the authors use to demonstrate their points. All sorts of national successes and failures are examined. My favourites were the contrasting,

participation and allow independent choice” and list some criteria of such institutions: “they must feature secure private property, an unbiased system of law, public services which give the population a level playing field...”. The authors argue that only with these two conditions together can a country have stability and provide the incentives necessary for a populace to work hard and take the risks needed for progress through innovation. The flip side of the theory is an “extractive institution”. This is a general term used for political structures where the needs of the elite are put first. The elites’ desires are shown through historical evidence to inevitably conflict with what is best for society, limiting potential success. This theory seems straightforward and intuitive. However it becomes controversial when applied to China and its path of development, in Chapter 5. Many will be aware of the predictions that China will soon overtake the USA as the world’s largest economy (in 4 years’ time according to the IMF) and will probably continue to prosper, eventually surpassing the US in terms of living standards as well. Why Nations Fail does not share this view. It predicts that as long as China keeps an absolutist political structure, it has a ceiling to its growth and will not achieve modern levels of development. In another sense, it is structurally unable to overtake and maintain a lead over nations with inclusive political structures. The book argues that the path from “exclusive” to “inclusive” structures is circumstantial. Called the “contingent path of history”, the authors argue that inclusivity only emerges if the right activists can form the right coalitions at the right time. There are some mild policy prescriptions for the rich world to foster inclusive structures.

almost ‘laboratory experiment’, cases of the two Nogales’s, North and South Korea, East and West Berlin. There are so many more varied examples. There are cases of nations sliding into failure through the ages: Rome’s downfall, Mediaeval Venice’s stalling prosperity, and Soviet Russia’s disintegration; and towns starting with a failing political structure and adapting: early US settlers in Jamestown. These stories dominate the book and the style of a big-picture historical review is very satisfying and absorbing. I strongly recommend the book to other economics undergraduates in particular. We frequently complain that the course is too theory based. Why Nations Fail should soothe this complaint with plenty of real world case studies. It also nicely weaves together development politics and economics, two sister subjects that shouldn’t be considered in isolation. Come for the academic prowess of the authors and the grand question it tries to answer; stay for the charm of the varied examples and the controversial views over Chinese development!

The blog: whynationsfail.com is a very close parallel to the book in writing style, blog entries are well researched previews to the book. The most recent: Labour incentives in Nepal.

Why Nations Fail: The Origins of Power, Prosperity, and Poverty. By Daron Acemoglu and James A. Robinson, Crown Business

Twitter: @WhyNationsFail is Professor Acemoglu’s account, he has recently been very active.

34 Nottingham Economic Review

Politics 35

The Decriminalisation and Legalisation of Drugs

to prohibitionists: it accepts that drug use is wrong in itself and is inconsistent as it treats drugs differently from each other.

By Charlie Bentley

Whilst the liberal imperative to legalise drugs is important, hopefully the numerous benefits which are provided by legalisation are convincing enough to those who see legalisation as a step too far. In terms of harm reduction, we are best able to deal with harm where the production of the substance can be controlled; this is only possible through legalisation. Minimum standards, purity levels and research and development into recreational drugs to reduce adverse side-effects of drugs are all made possible through drug legalisation, working to significantly benefit the consumer and reduce their risk involved. The presence of other toxic chemicals in a dose is a major cause of drug-related deaths, particularly in respect to heroin overdoses. With the average purity of street heroin in the UK last year at just 30%, regulated production could save lives.

he decriminalization of drugs debate rears its head on the public policy agenda every so often when a celebrity comes out as an advocate, or a Drugs Health Adviser is forced to resign after considering decriminalization as a viable policy option. Recently the issue has become especially prominent with the appearance of Richard Branson, Virgin CEO and Commissioner on the Global Commission for Drug Policy, before the Home Affairs Select Committee during their review of British Drug Policy. Further weight has been thrown behind decriminalization by a recent YouTube drug debate, and the growing popularity of the Students for Sensible Drug Policy Movement, both in the US and the UK, which have given a significant boost to public awareness of the issue. Whilst their determination to see their goals achieved is noble, what must not be lost sight of is that this must be a step towards a goal of legalization rather than just decriminalization of drugs as a goal in itself. If we are to believe we live in a liberal democracy, the use of drugs of all kinds should be legal. Mill’s famous dictum that “the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others” maintains that the state imposing its will on the individual over a selfregarding choice is abhorrent. “His own good, either physical or moral, is not sufficient warrant,” but where drug use harms others, it is possible to justify government intervention. The typical argument that drug use ‘fries’ users’ brains and therefore renders them unable to make rational choices – meaning prohibition is needed to protect them from themselves – is faulty in that evidence of long term mental damage from drugs is absent. While most users are not addicted, the issue of understanding where weak will ends, and addiction begins, is extremely difficult, so understanding where a person becomes non-autonomous is impossible. There are further inconsistencies in relation to the treatment of addictive substances in British Drug Policy currently. Some highly addictive substances

are legal and controlled, such as tobacco, whilst others such as cocaine are not, tending to suggest that addiction is not the central motivation for the present illegality of drugs in Britain. We further expect the state, in a liberal democracy, to be value neutral in its treatment of each citizen; in relation to religion it should accept all religions, in relation to sexual preferences we expect it to honour all preferences equally. The same principle must apply to choices of drugs. From alcohol to heroin there can be differences in the legislature suggesting that one is a more ‘worthy’ substance than the other. The main concepts that a liberal drug policy must respect are then: consistency, respect of personal autonomy and control of harms to others created by substance. This, therefore, sets bounds of where the state may intervene: education to provide full warning of risks, taxation to cover costs generated by drug use, criminal trials for drug driving, and limits on advertising and age, hours and quantities of sale as occurs with alcohol and tobacco. This can provide assurance against possible harm whilst respecting the limits of autonomy and is what campaigners should be working towards as a long-term goal. This, however, comes into conflict with social acceptability. A large minority do agree that drug laws in both the UK and the US are currently too harsh and advocate decriminalization but tend to shy away from advocating legalization, especially of drugs such as heroin, because of their alleged harm. This, however, cedes far too much ground

The innovation brought on by legalisation will come with benefits and remove the costs of innovation currently faced under criminalisation. The spread of legal highs, specifically Mephedrone and Methoxetamine (also known as M-Ket), as synthesised replacements for illegal counterparts is disconcerting. With a lack of research into these chemicals, the long term effects of their use is not understood which means education cannot be provided, and as a result it is impossible to make an informed, rational

decision. With the legalisation of drug provision, both MDMA and Ketamine, will be available in a pure form, indeed, perhaps engineered to limit some of the negative effects that these substances currently create. The revenue generated could be used to reduce the current impact of drug use on the health system for non-users that currently exists. Both the taxable profits of the pharmaceutical companies synthesising and growing drugs, and the users paying for the healthcare costs of drug use through taxes on recreational drugs, would reduce the burden on society. Furthermore, savings can be made in police expenditure, more than is possible in the case of decriminalization where drug dealers are still pursued by the police. The support for health, treatment, drug education and research into addiction and pharmacology, would be extensive as the government would more likely have sufficient revenue to adequately support these programmes. There is no evidence to suggest countries with more liberal drug regimens incur higher drug usage levels, simply because the threat of punishment does not deter the vast majority of those who wish to use drugs. In the muchtouted example of Portugal, decriminalization of possession for up to 10 days has provided no significant change in recreational drug use behaviours. In addition, looking to Sweden and Norway with harsh and liberal policies towards drug use respectively, there is very little difference in addiction rates. An increase in drug use, then, is unlikely.

Finally, society would see a benefit. A reduction in crime would most likely come with legalisation. The criminalization of the user through associations with drug dealers and the loss of respect for the law in their ability to freely use drugs would be obviated. Importantly, the prohibitively high cost of illegal drugs due to the risky nature of enterprise necessitates a high cost for the end user. W Legalisation would lead to a massive drop in cost, resulting in the high levels of drug-related robbery and theft decreasing dramatically. A final consideration is the elimination of the gang-culture element of drug dealing that would also reduce crime rates. There would be no casualties from ‘turf-wars’ if pharmaceutical companies formalised the operation of drugselling. These benefits are important in the rationale for drug legalisation. Whilst those who are more liberally minded might be persuaded of the legalisation argument based in the rights of individuals, those who see the need to protect society as a primary concern require more convincing before agreeing to what is something that is indeed radical. The increasing presence of student, intellectual and celebrity engagement with the issue is very encouraging, however. But to make serious progress, the more radical conception of legalisation as opposed to decriminalization needs to be discussed. Whilst it is a mistake to run before you can walk, to not even begin to think about moving forward, quicker, is to lose the momentum you have already built up.

36 Nottingham Economic Review

Populism in Europe as the freezer of effective politics By Luca Lixi

ack in the day, when I was first approaching the study of history at school, my teacher told me that to study what happened in the past was useful because it could help society to avoid committing the same errors that had previously led to periods of darkness. This method, in all its simplicity, should probably be considered today by many European leaders of the major political parties. The fact that today’s Europe is undergoing a severe period of crisis is widely accepted. Nevertheless, few political leaders seem to have understood that the major consequences of an economic downturn will not come from rating agencies or world leading banks. In a more predictable way, if a glance at the past two centuries is taken, the biggest consequence that political leaders will have to face will arise from the malcontent of the people. Debts, classification through rating agencies and public debts are byproducts of a complex financial system and it would be a dramatic mistake if they monopolized

Politics 37

today’s political agendas. This is because, since the first organized society was formed, the biggest difficulties for national governments have come from the people that started to revolt against the political elites when lacking basic needs, and when they did not felt represented. No one is suggesting a French Revolution actualized in modern times, nor political leaders hanging in public squares, but nevertheless, to dismiss the possibility of radical changes in our European political scenarios by not addressing its causes may have serious consequences on the way with which our democracies are governed. The spectre of the ‘30s in Europe, with the emergence of the Nazi and Fascist regimes, has significantly affected many emerging parties since the postwar period. In fact, many political leaders looked at the German and Italian examples with terror, making sure that similar periods found attention only when studying their destructiveness in history books. Today there is a large consensus on the fact that whatever peril and changes our democracies can be facing, the risk of a similar authoritarian tendency is firmly unlikely. Nevertheless, due to this idea, too many problems have been dismissed in the last 20 years as unimportant and today, with all our economic difficulties, many of these issues have piled up, with serious consequences for many political systems in Europe. If we look back in the past century, we can see the most dramatic examples of how in periods of crisis, when scarcity

becomes a daily problem for the people, charismatic leaders find their way using populism as a crafty tool to reach great consent. The equation is basal. If the people are hungry, if people feel they are left out from a system, they will automatically fall for whoever appears hands out bread, whoever appears to understand their problems, and proposes a radical solution. This “linear” socio-political equation is the main motor of the wave of populism that has flooded our political systems. If we take Europe’s leading countries one by one, there is no exception to the discovery of some kind of political organization that form within government coalitions or as mere opposition, have had a very significant impact on the policy making of that country. Examples are hence abundant, from the FPO in Austria to the Lega Nord in Italy, arriving at the French radical right party guided by Le Pen, the Front National. Radical populist parties started to raise consent in the late 1980s. This was due to the fact that society, led by ever greater globalization and integration, was entering a post-productivist phase. Within a new social framework mainstream traditional parties were redundant, anachronistic, and did not reflect the partisans motifs and traditional ideologies. In particular this has been the case with left wing parties. Traditionally, particularly after WWII, left wing parties found their electoral basin through a very tight contact with bluecollar workers, typically workers from the new industrial system of production. With the shift towards a post-productivist

society, and an ever growing increase of white collars workers, left wing parties adapted to a general political shift of the main parties towards the “median voter”. Parties therefore converged greatly in their policies, looking to expand their electorate in a more moderate newly raised middle class. Many blue collar workers thus felt abandoned. Globalization was forcefully changing the way social and political life was run in their society and they rightfully felt like losing out from the whole “modernization” process. This is why it is largely agreed that the left shares great responsibility for the raise of radical populist parties, particularly right wing ones. Leaving behind its classical electorate the left renounced to a great share of votes that were thus left volatile. The capability of populist charismatic leaders such as Bossi in Italy or Le Pen in France was hence great in steering those votes towards their parties, Lega Nord and Front National.

party, radical parties did not find their way into government coalitions, due to being marginalized by mainstream parties. Nevertheless, they attracted enough support to make them indirectly influential in the policy making of incumbents. This is due to the fact that, feeling the need to win back votes that were starting to align in the Front National’s basin, incumbents started to approach various issues that were in the radical party’s agenda, and again, above all, developing immigration policies that responded to the fear created by populist leaders.

In order to maximize their possible electorate, such populist parties campaigned with great insistence on themes such as unemployment, the inefficiency of politics and immigration. In fact, in order to increase their appeal to those that felt left out from modern society, these parties needed to portray scapegoats for the problems of the people, on an external and an internal level. The political elite was therefore pictured as corrupted and inefficient whilst immigrants, whatever their form, were depicted as threats to the local’s jobs and to their culture. From these ideas, a new sense of belonging to a region or state was promoted, creating a larger electoral base.

in those countries in which radical parties have not had great influences in national governments, with election coming close we can see how the tendency of incumbents to direct policies in response to fears of the population is oriented, in many cases, towards securing votes rather than to governing in the interest of the state. An example of this political phenomenon is the very recent position of Germany towards the bailout of Greece. Although knowing how much Germany has benefitted from European integration, with generous trade agreements with countries like Greece, Angela Merkel maintained a line that followed the populist simplistic belief that “German taxpayers were not going to pay for Greece’s crisis”. Angela Merkel knew very well that as such, this idea did not signify much, but nevertheless did not move against it, not wanting to lose votes.

The reasons that have led various academics to refer to Europe’s modern politics as a “populist Zeitgeist” are strictly correlated to the way in which populism find its way and influences many European governments. Various examples suggest multiple ways of explaining this influence. In fact, in cases like Italy for example, radical populist parties have found their way into government coalitions. Reaching almost the 10% of the votes in various national elections the Lega Nord members of parliament have managed to have a say in appointing ministers. As a consequence to this, we can see how a very direct influence on the government has marked policy making, responding to issues which concern the populists such as the fear of immigration. In other cases, like that of the French Front National

It is important to note, nevertheless, that populism is not contained solely in radical parties. In fact, even Populism has become the main motor of European politics. This phenomenon is amenable to the way problems coming from a new globalized world have been dealt with, or to be more precise, have not been dealt with.

Populism has therefore become the main motor of European politics. This phenomenon, manifest in different forms, is amenable to the way problems coming from a new globalized world have been dealt with, or to be more precise, have not been dealt with. It is thus vital that mainstream parties don’t follow the populist habit of running politics with a mere vote count in mind, but actually address the problems that leave a large portion of population frustrated and insecure. If such actions are not taken, and the possibility is left to radical parties to transform such fears into hate, then the stagnation of our political system is bound to materialize. A risk that any history teacher could see coming.

38 Nottingham Economic Review

Interview 39

An interview with David Fenton, Senior Economist, RBS Interview by Angus Naismith David Fenton is a Senior Economist within the RBS Group. He monitors developments across the corporate and household sectors, with a view to identifying risks and opportunities for RBS and its customers.

avid Fenton delivered a fascinating talk entitled A Ringside View of the Economic Crisis, talking candidly about his own and other economists’ experiences of the crisis, RBS’s role, and where the company – and the broader economy – ‘go from here’. The talk offered a view of the crisis from a special perspective: while RBS has endured considerable criticism from the public, and academic economists have attempted to comprehend the crash, it is rare to have an opinion which bridges both disciplines. We interviewed David before his talk to ask a few extra questions. Your lecture considered why economists – and RBS – failed to foresee the crisis. What were the

key reasons for this? There were several important factors. For one, those who might be expected to predict such an event face a small sample size of crises: financial crashes – especially one as sizeable as the most recent one – don’t come around very often, and most people in or connected to RBS wouldn’t have experienced a crash before. The economic models many used to monitor and forecast developments in the macroeconomy also proved not to be up to the job. They tend to be mean-reverting – rendering them less helpful in times of extreme stress. They also had a poorly-specified role for credit flows, being very much founded on the real economy. But, in fact, it was not as if RBS employees (and others) failed to recognise tensions, or warning signs, in the economy – such as global imbalances. It was just that people failed to join up the dots. It seems to be a common theme throughout this crisis; that more ‘macro-prudential’ supervision is required. This fills a gap in the existing regulatory framework, and RBS is working with policymakers to shape this going forward.

Can you summarise yours – or RBS’s – current economic outlook? It’s quite pessimistic! Privatesector demand is highly subdued. Despite some deleveraging, debt/ income ratios are still historically high. To restore private-sector demand, we need average incomes – ‘the denominator’ in the ratio – to increase to offset this deleveraging, but this is challenging in the climate we’re in, with high unemployment.

Nevertheless, the customer-facing nature of my role has been hugely interesting. It has been good to speak to customers about the conditions they’re facing, how they are coping, and how RBS is helping them. It has really brought home that ‘this

Along with ‘cleaning up’ the past mistakes of the bank, this has to be our focus for decades into the future, and will be the key to the job that we have to do for society.

is real’ – the tough economic data we hear every day are impacting on real people. It has been very inspiring, though, to see customers in their business coming up with such innovative ways of coping: cost-cutting, and finding new sources of revenue.

Your talk comes just after Vince Cable’s letter suggesting RBS should be turned into a Government bank to lend to small and medium enterprises was leaked. Any thoughts? I haven’t had a chance to read the proposal, but RBS is already punching above its weight in terms of lending to SMEs: last year, it accounted for 48 pence of every pound lent to small businesses. And, it’s important to note that our relationship managers tell me that loan demand is much weaker than it was three to four years ago.

Net trade – encouraged by a weaker pound – was expected to stimulate growth, but this has run out of steam in recent months, as the Eurozone debt crisis has dented demand in our core export market. In fact, the UK’s current situation bears eerie similarities to Japan’s in the 1990s. [Mr Fenton later said in his talk: “I’m not saying what happened to Japan is our fate, but if it is then we would need a complete rethink of macro policy – and we would really need to get quite radical” (in terms of policy measures)] Working as a professional economist in such dramatic times must have been quite exhilarating? I would say it has been fascinating and humbling in equal measure. While it has been confusing – I have often had to reassess what I thought I knew – this is the case for the economics profession as a whole. Significant questions about where it went wrong are being asked.

Going forward, what opportunities are there for RBS? The priority has to be supporting our customers. We are spending huge amounts of time and energy and money taking cost out of the business and reinvesting that cost in improved customer service.

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