57 by see tony

SPECIAL REPORT CHINA'S ECONOMY

of their efficiency. But even now, returns on equity among soEs are substantially lower than among private firms. Nor do SOES really "earn" their returns. The markets they occupy tend to be uncompetitive, as the OECD has shown, and their inputs ofland, energy and credit are artificially cheap. Researchers at Unirule, a Beijing think-tank, have shown that the SOEs' profits from 2001 to 2008 would have turned into big losses had they paid the market rate for their loans and land. Even if the soEs deserved their large profits, they would not be able to reinvest them if they paid proper dividends to their shareholders, principally the state. Since a 2007 reform, dividends have increased to 5-15% of profits, depending on the industry. But in other countries state enterprises typically pay out half, according to the World Bank. Moreover, soE dividends are not handed over to the finance ministry to spend as it sees fit but paid into a special budget reserved for financing state enterprises. soE dividends, in other words, are divided among soEs.

The wrong sort of investment Loren Brandt and Zhu Xiaodong of the University of Toronto argue that China's worst imbalance is not between investment and consumption but between soE investment and private investment. According to their calculations, if state capitalists had not enjoyed privileged access to capital, China could have achieved the same growth between 1978 and 2007 with an investment rate of only 21% of GDP, about half its actual rate. A similar conclusion was reached by David Dollar, now at America's Treasury, and Shang-Jin Wei of Columbia Business School. They reckon that two-thirds of the capital employed by the SOES should have been invested by private firms instead. Karl Marx made his case for collective ownership of the means of production in "Das Kapital". Messrs Dollar and Wei called their riposte "Das (Wasted) Kapital". Perhaps the best that can be said of China's soEs is that they give the country's ruling party a direct stake in the economy's prosperity. Li-Wen Lin and Curtis Milhaupt of Columbia University argue that the networks linking the party to the soEs, and the soEs to each other, help to forge an "encompassing" coalition, a concept they draw from Mancur Olson, a political scientist. The members of such a coalition "own so much of the society that they have an important incentive to be actively concerned about how productive it is". China's rulers not only own large swathes of industry, they have also installed their sons and daughters in senior positions at the big firms. The soEs provide some reassurance that the government will remain committed to economic growth, according to Mr Milhaupt and another co-author, Ronald Gilson. The party officials embedded in them are like "hostages" to economic fortune, "the children of the monarch placed in the hands of those who need to rely upon the monarch". That gives private entrepreneurs confidence, because the growth thus guaranteed will eventually benefit them as well-although they will have to work harder for their rewards. What are the implications of China's malinvestment for its economic progress? At its worst, China's growth model adds insult to injury. It suppresses consumption and forces saving, then misinvests the proceeds in speculative assets or excess capacity. It is as if Crusoe were forced to scatter more than half his barley on the soil, then leave part of the harvest to rot. The rot may not become apparent at once. Goods for which there is no demand at home can be sold abroad. And surplus plant and machinery can be kept busy making capital goods for another round of investment that will only add to the problem. But when the building dust settles, a number of consequences become clear. First, consumption is lower than it could be, beThe Economist May 26th 2012

cause of the extra saving. GDP, properly measured, is also lower than it appears, because so much of it is investment, and some of that investment is ultimately valueless. It follows that the capital stock, properly measured, is also smaller than it seems, because a lot of it is rotten. That would make for a very different kind of island parable, a tale of needless austerity and squandered effort. Fortunately there is another side to China's story. It has not only accumulated physical capital but also acquired more knowhow, better technology and cleverer techniques. That is why foreign multinationals in the country rely on local suppliers-and also why they fear local rivals. A Chinese motorbike-maker studied by John Strauss of the University of Southern California and his co-authors started out producing the metal casings for exhaust pipes. Then it learnt how to make the whole pipe. Next it mastered the pistons. Eventually it made the entire bike. China "bears" like Mr Chanos sometimes neglect this side of the country's progress. In his 2010 presentation he compared China to the Soviet Union, another empire in the east that enjoyed a stretch of beguiling economic growth. Like the Soviet command economy, China is good at marshalling inputs of capital and labour, he pointed out, but China has failed to generate growth in output per input, just as the Soviet Union failed before it. Yet this analogy with the Soviet Union is preposterous. Economists refer to a rise in output per input of capital and labour as a gain in "total factor productivity". Such gains have many sources. One textile boss got 20% more out of his seamstresses by playing background music in his factory, recalls Arnold Harberger of the University of California at Los Angeles. The striking thing about the growth in China's total factor productivity is not its absence but its speed: the fastest in the world over the past decade. Between 2000 and 2008 it contributed 43% of the country's economic growth, according to the APO. That is just as big a contribution as the brute accumulation of capital, which accounted for 44% (excluding information technology). Thus even if some of China's recent investment has in fact been wasted, China's progress cannot be written off. And even if some of China's past investment has been futile, adding nothing worthwhile to the capital stock, there is a consolation: it will leave more scope to invest later, suggesting that the country's potential for growth is even larger than the optimists think. The right kind of investment can still generate high returns. But what if the mistaken investments of the past disrupt the financial system, preventing resources from being deployed more effectively in the future? â&#x20AC;˘

Plenty of upside Net capital stock and GDP per person, constant 2010 $'000

0 South Korea O China 200 "Âˇ .. .. .. ... . ...

O Japan

United States

0 23

150 ...

0,_

-t 100

'5. (3

}980.. 1990

GDP per person Sources: Asian Productivity Organisation; IMF

SPECIAL REPORT CHINA'S ECONOMY

Finance

Bending not breaking China's financial system looks quake-proof, but for how long? VISITORS TO SICHUAN'S atmospheric mountains, home to both Tibetan and Qiang minorities, used to skip Yingxiu village on their way to more scenic spots higher up. But the devastating earthquake that struck the area in May 2008 has turned the village into an unlikely tourist attraction. The earthquake killed 6,566 people in the village, over 40% of its population. Its five-storey middle school collapsed, killing 55 people. Nineteen students and two teachers remain buried in the rubble. Four years on, the crumpled school remains. It has been preserved as a memorial to the disaster, but almost every other sign of the quake has been erased. The village is full of new homes with friezes painted in strong Tibetan colours. Other buildings are topped with flat roof terraces, a white concrete triangle in each corner, echoing the white stones that adorn traditional Qiang architecture. The new homes look a little like Qiang stone houses on the outside, one villager concedes. "But inside they are all Han." Yingxiu is an example of "outstanding reconstruction", according to a billboard en route. Outside this showcase village, people have rebuilt their lives with less government help. But there is no denying that China set about reconstructing the earthquake zone with a speed and determination few other countries would be able to match. A propaganda poster shows Hu]intao, China's president, bullhorn in hand, declaring that "Nothing Can Stop the Chinese". The earthquake did great damage to the region's property

The school that became a shrine and infrastructure. But although it left the local economy worse off, the pace of economic activity picked up in the wake of the disaster. There was much to do precisely because so much had been lost. Even today the mountain road is lined with lorries. Some economists worry that China may soon suffer a different kind of economic disaster: a financial tremor of unknown magnitude. Pivot Capital Management, a hedge fund in Monaco, argues that China's recent investment spree was driven by a "credit frenzy" which will turn into a painful "credit bust". Lending jumped from 122% of GDP in 2008 to 171% just two years later, according to Charlene Chu of Fitch, a ratings agency, who counts some items (such as credit from lightly regulated "trust" companies) that do not show up in the official figures. This surge in credit is reminiscent of the run-up to America's financial crisis in 2008, Japan's in 1991 and South Korea's a few

Homeric wisdom SPEECH MAKERS LIKE TO claim that the Chinese word for crisis (weiji) contains the characters for both danger and opportunity. Most Linguists dispute this. Either way, China's economic policyma kers don't seem to believe it. For them, a crisis is a reason to batten down the hatches. In 1996 China's governmenttold the IMFthatitintended to remove its controls on international capital flows within five to ten years. But when the Asian financial crisis struck a year Later, China's government retreated into its shell. Sixteen years Later the timing Looks better. Fear of capital outflows has been assuaged by China's vast foreign-exchange reserves. The opposite danger-excessive capital inflows-has also eased. Indeed, the yuan has come under downward pressure at several points in the past year. Reformers in the government are 12

testing the waters. In April regulators raised the amountthat "qualified" foreign investors can venture in the country's securities markets to $80 billion, and eased the Limitthat similarly qualified Chinese investors can whisk out of the country. The central bank also Loosened its grip on the currency a Little, widening the yuan's daily band from 0.5% either way to 1%. China has no obvious need for foreign capital: its own saving is more than enough to meet its investment needs. So Liberalisers may have ulterior motives in mind, calculating that external Liberalisation will force the pace of domestic financial reform. If capital could move more freely across borders, the authorities would struggle to keep interest rates artificially Low-unless they were prepared to Let capital flee and the currency fall. By opening the capital account soon,

China could claim several prizes, reformers argue. Its investors could acquire foreign firms at Low prices, thanks to European turmoil and American caution. The country could also take advantage of the world's disillusion with the dollar to promote the yuan as an international store of value and medium of exchange. Eswar Prasad ofthe Brookingsinstitution calls this a ''Trojan horse" strategy, after the gift horse described by Homerthattricked the Trojans into opening their gates. The reformers' ploy poses some risks. If China opens the capital account before it reforms its soEs, foreign Lending may help feed their investment hunger. An open border would also make it harder to contain a domestic banking crisis. Adifferent Homer put it best. Told that Chinese uses the same word for crisis and opportunity, Homer Simpson exclaimed: ''Yes! Crisa-tunity!" Apremature opening of the capital account would bejustthat. The Economist May 26th 2012

SPECIAL REPORT CHINA'S ECONOMY

years later (see chart s), Ms Chu argues. When Fitch plugged China's figures into its disaster warning system (the "macroprudential risk indicator"), the model suggested a 6o% chance of a banking crisis by the middle of next year. China's frenzied loan-making has traditionally been matched by equally impressive deposit-taking. Even now, most households have few alternative havens for their money. This captive source of cheap deposits leaves China's banks largely shock-proof. They make a lot of mistakes, but they also have a big margin for error. That will help them withstand any impending tremors. But this traditional source of strength will not last for ever. China's richest depositors are becoming restless, demanding better returns and seeking ways around China's regulated interest rates. The government will eventually have to liberalise rates. That will make China's banks more efficient but also less resilient. There remains great uncertainty about China's financial exposure. Not all of the country's "malinvestment" will result in bad loans. Some of its outlandish property developments, including the empty flats of Ordos, were bought by debt-free investors with money to burn. By the same token, not all of China's "bad" loans represent malinvestment. Rural infrastructure projects, to take one example, are often "unbankable", failing to generate enough income from fees, charges and tolls to service their financial obligations. But the infrastructure may still contribute more to the wider economy than it cost to provide. That is especially likely for stimulus projects, which employed labour and materials that would otherwise have gone to waste. But suppose a financial quake does strike China: how will its economy respond? Financial disasters, like natural ones, destroy wealth, sometimes on a colossal scale. But as China's earthquake showed, a one-off loss of wealth need not necessarily cause prolonged disruption to economic activity as measured by GDP. Yingxiu suffered a calamitous loss of people and property, but this was followed by a conspicuous upswing in output (especially construction) and employment. If this seems counterintuitive, that is because GDP is easily misunderstood. It is not a measure of wealth or well-being, both of which are directly damaged by disasters. Rather, it measures the pace of economic activity, which in turn determines employment and income. Financial distress will damage China's wealth and welfare, almost by definition. The interesting question is whether it will also lead to a pronounced slowdown in activity and employment-the much-predicted "hard landing". To put it in Mr Hu's terms, can a financial quake stop the Chinese? If the banking system as a whole had to write off more than 16% of its loans, its equity would be wiped out. But the state would intervene long before that happened. Despite the excesses of China's local authorities, its central government still has the fiscal firepower to prevent loans going bad, or to recapitalise the banks if they do. Its official debt is about 26% of GDP (including bonds issued by the Ministry of Railways and other bits and pieces). If it took on all local-government liabilities, that ratio would remain below 6o%. Alternatively, it could re capitalise a wiped-out banking system at a cost of less than 20% of G DP. Even if many loans do eventually sour, banks do not have to recognise these losses all at once. No loan is bad until someone demands repayment, as the saying goes. In March the gov~

The Economist May 26th 2012

ernment released details of a long-rumoured plan to roll over loans to local governments. Many of these loans were due to mature before the project they financed was meant to be completed. If the project is worth finishing, this kind of evergreening is an efficient use of resources. And some projects, once under way, are worth finishing even if they were not worth starting. Loan rollovers give banks time to earn their way out of trouble, setting aside profits from good loans before they recognise losses on bad ones. This task is easier in China than in other countries because its financial system remains "repressed". Banks can force their depositors to bear some of their losses by paying them less than the market rate of interest. Indeed, deposit rates are often below the rate of inflation, making them negative in real terms. A bank's depositors, in effect, pay the bank to borrow their money from them. Chinese banks can get away with this because deposit rates are capped by the government, preventing rival banks from offering higher rates. China's capital controls also make it hard for depositors to escape this implicit tax by taking their money abroad. As a consequence, Chinese banks luxuriate in a vast pool of cheap deposits, worth 42% more than their loans at the endof2on. This cash float gives Chinese banks a lot of room for error. In 2on new deposits amounted to 9.3 trillion yuan, according to official figures, more than enough to cover fresh loans of 7.3 trillion yuan. Although deposit growth is slowing, these inflows give banks a cash buffer, allowing them to keep lending, even if their maturing loans are not always repaid in full and on time.

Achronic complaint So China's financial strains will not result in the sort of acute disaster suffered so recently by the West. Instead, they will remain a chronic affliction which the state and its banks will try to ameliorate over time with a combination of government-orchestrated rollovers, repression and repayment. Such a combination is unfair to taxpayers and depositors, but it is also stable. According to Guonan Ma of the Bank for International Settlements, bank depositors and borrowers ended up paying roughly 270 billion yuan ($33 billion) towards the cost of China's most recent round of bank restructuring, which stretched over a decade from 1998. However, some commentators think that China will find it harder to repeat the trick in the future. Depositors are not as docile as they were. In fits and starts, resistance to China's financial repression seems to be growing. "Let's be frank. Our banks earn profits too easily," Wen]iabao, China's prime minister, admitted on national radio in April. He is right. The ceiling on deposit rates and the floor under lend-

Bubbles in the making Credit as% of GDP United States

South Korea

Japan

China* 225

-~··· · · · :m .:~•/•• :•·: .·.:•• •••_···.. :::

. . . -.. .7- · /. ..·. ./·- . . .... .. . . ..._].:--r~-.-

··· 150 ·· 125 100

2002 04

06 07

Source: FitchRatings

1994

1985 87

8990

2007 09

11121

*Filch-adjusted credit

1Estimate

SPECIAL REPORT CHINA'S ECONOMY

To avoid repressed interest rates, savers have overpaid for alternative assets such as property, contributing to China's worrying speculative bubble ~

looking for ways to circumvent the ceiling. Those with lots of money to park are driving the demand for "wealth-management products", short-term savings instruments backed by a mix of assets that offer better returns than deposit accounts. By the end of the first quarter of 2012 these products amounted to 10-4 trillion yuan, according to Ms Chu of Pitch. That is equivalent to over12% of deposits. Most had short maturities, leaving buyers free to shop around from month to month. Banks accustomed to sitting on docile deposits may struggle to match the timing of cash pay-outs and inflows, Ms Chu frets. The banking regulator may also be worried. It has now banned maturities of less than a month. The recent proliferation of wealth-management products

ing rates guarantee banks a fat margin, preventing competition for deposits and allowing big banks to maintain vast pools of money cheaply. If the deposit ceiling were lifted, small banks would offer juicier rates to take market share from incumbents. Conversely, the big banks would trim their deposit bases as they became more expensive. Households would be better rewarded for their saving, and China's banking "monopoly" would be broken, as Mr Wen professes to want. In fact, though, the government is still dragging its feet on rate liberalisation. Its hesitancy may reflect the political clout of the state-owned banks. It may also reflect the government's own fears. Most developing countries (and some developed ones too) that freed up their financial systems suffered some kind of crisis afterwards. Upstart firms can THE SMALL-BUSINESS association ofWenpoach the incumbents' best customers, zhou, a city in Zhejiang province renowned threatening their viability but at the same for its scrappy entrepreneurialism, used to time overextending themselves. Even in inhabitspartan premises in the city centre, America, rate liberalisation in the early but in March it graduated to plusher offices 1980s allowed hundreds of Savings and 15 floors up on the fringes of the city. It is a Loan Associations to throw their balance sign thatWenzhou's brand of wheelersheets out of joint, offering higher returns dealer capitalism is being spruced up. to depositors even though their assets The desk ofZhou Dewen, the associawere producing low fixed returns. In a tion's head, must be ten feet long. But he 2009 paper, Tarhan Feyzioglu of the IMF still does most of his talking on the couch and his colleagues strongly endorsed Chior in a nearby restaurant where he enternese rate liberalisation. But they also actains visiting businessmen. In his office, Mr knowledged that it can be mishandled, citZhou hears a pitch from Mao Shuhui, who ing America's s&L crisis as well as even runs the province's first and only etiquette worse debacles in South Korea, Turkey, company. Her clients include the local tax Finland, Norway and Sweden. The most office and a number of mostly state-owned famous study of these risks was written banks. Their staff sometimes need a few more than 25 years ago. Its sobering title pointers, she says. Their hair can be messy was "Goodbye Financial Repression, Heland their gestures impolite. Placing a lo Financial Crash". finger on each corner of her mouth, she teaches them how to smile as though they The risks of repression mean it. Howeverwidetheirgrins, China's These are good reasons for caution, but not for procrastination. Repressed banks have not been much help to most rates have their own dangers. To avoid Wenzhou entrepreneurs. Long-established them, savers have overpaid for alternative firms like Ritai, the shoe-manufacturing assets such as property, contributing to outfit run by MrZhou's deputy, Jin Zhexin, China's worrying speculative bubble. In can get a loan ifitis guaranteed by a more places like Wenzhou, a city in Zhejiang creditworthy enterprise. But most Wenprovince, rate ceilings have encouraged zhou entrepreneurs have turned elsefirms and rich individuals to make inforwhere. Businessmen with money to spare mal loans to each other, bypassing the reglend itdirectlyto firms in need, without a ulated banking system in favour of unsafe, bank as middleman. Wenzhou's shadow unprotected intermediation in the shadfinancial system amounted to 110 billion ows (see box). The patience of the public yuan in 2010, according to one estimate, at large is also wearing thin. At a centralequivalentto 38% of the city's GDP. bank press conference in April, a journalIn escaping China's financial represist (from Xinhua, the official mouthpiece, sion, however, the city's informal lending no less) refused to let go of the microsystem also ducked out of its financial safety system, including its prudential phone until her complaint about negative safeguards and its lender of last resort. As deposit rates was heard. A growing number of depositors are

Shades of grey

the central bank tightened credit in 2010 and 2011, desperate borrowers drew too heavily on greyfinance, taking loans they could not repay. Some simply fled. Unnerved, informal lenders began calling in their loans and refusing new ones. The crisis fed on itself. Eventually the government cracked down on borrowers and lenders alike, so the money dried up completely. In Wenzhou's Fortune Centre, where the most successful lenders once congregated, all that is left of one shadow financier are the indentations on a plaque where its name used to be. In another office, an erstwhile private lender has gone for a completely different sort of business, investing 10m yuan in a TV spy caper set during the Japanese occupation. He wears a Dennis Hoppen-shirtand keeps cans of Budweiser in the office fridge. In the past he could arrange a loan with a single telephone call. Now "the trust is destroyed." In the absence of trust, lenders demand more tangible collateral. The manager of Dongkai Pawnshop says his business has benefited from the crisis. People who could previously borrow on the strength of their relationships must now offer something solid, like the 100g gold bar commemorating the Beijing Olympics that is for sale in the lobby. In March the central government unveiled a number of sensible reforms to tame the Wenzhou system without crushing it. Informal lenders will henceforth need to be registered, more private capital will be encouraged and the issuance of high-yield bonds a pp roved. Yetthe government still resists the more elegant solution to the problem proposed by Mr Zhou: allowing borrowers and lenders the freedom to set whatever interest rate they like. The Economist May 26th 2012

SPECIAL REPORT CHINA'S ECONOMY

amounts to a de-facto liberalisation of interest rates, Ms Chu argues. The growing competition for deposits is showing up in other ways too. When the finance ministry auctions its own sixmonth deposits, banks are now willing to offer rates as high as 6.8%, more than twice the maximum they are able to offer to ordinary depositors. The government may seek to formalise this de facto liberalisation, gradually allowing banks more freedom to set rates on large long-term deposits-the kind that will otherwise disappear from banks' books. Net corporate deposits, for example, did not grow at all in 2011. Higher rates would help attract them back. That would also raise banks' costs of funding, forcing China to become more efficient in its allocation of capital. At the moment the system is segregated between big enterprises, which enjoy relatively low borrowing costs, and credit-starved private firms that could potentially earn much higher returns on investment. In a freer financial system, competition would begin to close this gap. If interest rates went up to match the return on capital, Chinese investment would fall by 3% of GDP, according to a study by Nan Geng and Papa N'Diaye of the IMF. More flexible interest rates would also raise Chinese consumption, says Nick Lardy of the Peterson Institute for International Economics. He calculates that if banks paid something resembling a market interest rate on their vast deposits, household income would increase by 2% of GDP. Higher incomes, heargues, would cause their spending to rise and their saving rate to fall. The idea that higher rates will make people save less is unorthodox, but Mr Lardy argues that the higher income from saving will have a bigger effect than the higher reward offered for it. Chinese households save towards a goal, he suggests, such as the down-payment on a house or the cost of a potential medical emergency. Lower the return to saving, and they will just save even harder to achieve their goal. Research by Malhar Nabar of the IMF suggests that higher interest rates would indeed bring down saving rates, but the effects would be modest. If the real rate on one-year deposits rose from roughly o% today to a more reasonable 3%, it would lower household saving by only about o.s% of GDP, he calculates. But if higher interest rates alone will not liberate Chinese consumption, what will? •

Consumers

Dipping into the kitty Chinese consumption is about much more than shopping ZHANG GUIDONG GREW up on a farm in Anhui, a poor inland province, where China's economic reforms made a humble beginning. He left home for Beijing in 1995 with only a few years' schooling. First he sold belts and lighters in Tiananmen Square. When that was banned, he joined some friends from back home in Beijing's Silk Market, where he sold vegetables and silk items to the staff of the embassies nearby. The Silk Market is famous for selling brand-name goods at suspiciously low prices, often to tourists who seem to enjoy the combination of rip-offs and knock-offs. Fined many times for selling fakes, Mr Zhang eventually decided to change his strategy. He sought a licence to sell genuine goods under the brand The Economist May 26th 2012

Squeezed China's consumption as% of GDP

···············-····· 30

1997 98

99 2000 01

Sources: Barclays Capital; The Economist

*To include undermeasured consumer spending

"Hello Kitty". A white bobtailed cat that first appeared on a purse in the 1970s, Kitty now counts as Asia's answer to Mickey Mouse. The brand's guardians were initially worried by all the fakes on sale in the market, but in the end they were persuaded that the place was trying to clean itself up. Mr Zhang's business is now doing well. In March he was set to move from his old tensquare-metre stall on the ground floor to a 15-square-metre spot on the third floor, where the market is grouping its more reputable outlets. Most of the other stallholders are also from the countryside, Mr Zhang notes. "I never dreamt that I could one day have a life like this." Most people think of China as an industrial powerhouse, not a consumer's paradise. Household consumption as a percentage of GDP fell for ten years in a row from 2001. By the end of that decade it amounted to only 34% of GDP, about19 points below Japan's lowest post-war ratio and 15 points below South Korea's. America's consumption did not dip far below so% of GDP even during the second world war, as Mr Lardy of the Peterson Institute for International Economics points out in his book, "Sustaining China's Economic Growth". But this declining ratio is deceptive. Consumption in China has actually been growing faster than in any other big country. Itisjustthat China's GDP has been growing even more rapidly. Consumption always lags income, both on the way up and on the way down, argue Carl Bonham of the University of Hawaii at Manoa and Calla Wiemer of the University of Southern California. This is partly because people choose to "smooth" their consumption over time, but also because people generally hesitate to abandon a lifestyle to which they have grown accustomed. Although China's output and income surged after 2000, its consumption habits have yet to catch up. Bootstrap businessmen from the boondocks do not always know what to do with their newfound wealth, according to research by Jacqueline Elfick, a cultural anthropologist. One couple, newly arrived in Shenzhen, lined their entire flat with bathroom tiles. Another complained that their bathroom windows lacked the blue translucent glass found in rural toilet blocks. A home buyer who had never previously lived in anything bigger than a two-room flat took a residence with six rooms, filling four of them with dining suites. But consumer habits are evolving. In Shenzhen, notes Ms Elfick, the constant churn of the population and relative absence of established hierarchies means "you are what you buy." The new rich announce themselves by spending profusely. They favour "heavy ornate furniture in faux Baroque". In Sanya, an advert for one luxury residence shows a painting of Napoleon crossing the Alps hanging on the wall as a woman in a low-

SPECIAL REPORT CHINA'S ECONOMY

backed evening dress lingers by the window. mand that is often neglected: the government. Its consumption But there is also a growing class of discerning customers spending (on health care, education, subsidised rent and so on) as a share of G DP has been growing since 2009, but it remains inwho look down on ostentation. They pride themselves on their appreciation of wine, tea and coffee. In Beijing the TV screens adequate and uneven. that now pop up in taxis teach passengers how to judge a wine's The patchwork state intensity and why they should not overfill their glass. "Knowledge of how to consume has in itself become a commodity," Ms China has greatly broadened its rural pension scheme, which collected contributions from 140m people in 2011, comElfick writes. Just as consumption failed to grow as quickly as incomes pared with under 8om a year before. But even now it reaches over the past decade, it will fail to slow as quickly over the deonly about 30% of the eligible population. The government has cade to come. As China's growth eases from 10% a year to somealso expanded the coverage of health insurance, bringing 95% of thing closer to 7% during this decade, consumption will rise natthe population into the net, according to the OECD. Patients now urally as a share of GDP. pay directly for only 35% of China's total health spending, cornSome economists think it has already begun to do so. Yiping Huang of Barclays Capital says the official statistics fail to reflect a surge in consumer spending since 2008. They are particularly bad at capturing extra spending on accommodation, such as rent payments by tenants or the benefits enjoyed by owner-occupiers. One proxy for consumer spending is retail sales, which have grown much faster than GDP in recent years. Unfortunately, these statistics are no better at capturing expenditure on accommodation. And in China they include many things other than household consumption, such as government purchases and trade in industrial products like basic chemicals. But even when those items are stripped out, Mr Huang shows, sales are rising fast. He thinks that the level of expenditure as well as its growth may be understated. Despite the conspicuous consumption, a lot of income and spending is hidden from the prying eyes of taxmen and statisticians. The best effort to throw light on this shadow income is a study by Wang Xialou of the National Economic Research Institute at the China Reform Foundation. His team asked about 4,000 of their friends how much they earned and spent. The answers they got were more candid, though also less representative, than official surveys. After doing some statistical tricks to eliminate the bias, Mr Wang calculated that the disposable income of China's households was 9.3 tril- An important source of demand lion yuan ($1-4 trillion) higher than the official 2008 figure of 14 trillion yuan. Drawing on this work, Mr pared with well over 6o% ten years ago. But progress has not Huang thinks that private consumption may have accounted for been uniform. China has one scheme for urban workers, another for non-workers and a third for rural folk, each administered 41% of GDP in 2010, about seven points higher than the official figure (see chart 6, previous page). by separate city or county governments. The contributions reMr Huang's calculations do not convince everybody, and quired and benefits provided differ a lot between the three schemes. According to the OECD, the rural scheme pays out an even if they are right, they have disturbing implications. Hidden income disproportionately benefits the better-off: the richest 10% average of only $16 per person per year and covers only 41% of the cost of in-patient care. of urban households take home over 6o% of it. That might help explain why China is now the world's largest market for luxury In social as in economic policy, the government prefers local experimentation and piecemeal expansion. That works well goods, according to one estimate. If that hidden income is counted, the top tenth of urban families are about 26 times better off for economic reforms, but in social policy it fails to pool risk efficiently. And the safety net is thin as well as patchy. This keeps than the bottom tenth, not just nine times, as the official figures suggest. These figures make China's economic imbalances look down its cost to the exchequer but leaves the population exbetter but its social inequities far worse. posed to dangers such as debilitating illness or job loss. Health However, there is another important source of final debenefits, for example, are capped, leaving patients uncovered for The Economist May 26th 2012

SPECIAL REPORT CHINA'S ECONOMY

the worst crises. And China's hospital-centric health-care system provides only one general practitioner for every 22,000 people. Older Chinese grew up in a society where many of their consumption choices were dictated by the state or by their workplace. They ate in state canteens and slept in state-provided dormitories or flats. It was a grinding, tedious existence. But in discarding the "iron rice bowl", the Chinese state failed to provide alternatives, including health care and minimum pensions. According to the World Bank, China spends only 5.7% of its GDP on these items and other forms of social protection, such as payments to support the very poor. Other countries in the same income category as China spend more than twice as much, an average of 12.3%. More social spending of the right kind would not crowd out private consumption. On the contrary, it would encourage it. The patchiness of China's safety net is one reason why households save so much of their incomes. According to Emanuele Baldacci and other economists at the IMF, a sustained rise in public spending by 1% of GDP, spread evenly across health, education and pensions, would increase the ratio of household consumption to GDP by 1.25 percentage points. The IMF'S Steven Barnett and Ray Brooks calculate that in urban areas every extra yuan the government spends on health prompts an extra two yuan of consumer spending. Can China afford to spend so freely? In one sense, it cannot afford not to. If investment were to falter and private consumption failed to compensate, China would be left with a big hole in demand, jeopardising employment and growth. If the investment rate were to drop back to its 2007 level, for example, the demand shortfall would run to over 6% of GDP. To make up for that, the government would have to spend about 3-4 trillion yuan this year, or face widespread joblessness. That is a substantial amount. With only a sixth of that sum, the government could raise the incomes of all of China's poor to the equivalent of $2 a day, according to calculations by Dwight Perkins of Harvard. The point of such a thought experiment is to demonstrate that China has enormous productive powers to mobilise, and has to spend a lot to mobilise them fully. There is another obvious measure, peculiar to China, that would lift consumer spending. That is the earliest possible repeal of the country's household registration system, or hukou, which limits the access of rural migrants to public services in the cities where they work and live. This keeps migrants unsettled and therefore unwilling to spend. Migrants without an urban hukou spend 30% less than otherwise similar urban residents, according to research by Binkai Chen of the Central University of Finance and Economics, Ming Lu of Fudan University and Ninghua Zhong of Hong Kong University of Science and Technology. Mr Zhang, the Silk Market trader, is a good example of the system's iniquity. He arrived in Beijing 17 years ago. He has a house, a son, a business and even a licence from Hello Kitty. But he still does not have a Beijing hukou. â&#x20AC;˘ The Economist May 26th 2012

The next chapter

Beyond growth China will have to Learn to use its resources more judiciously THE POLICYMAKERS WHO will determine China's future are trained at the Central Party School, a spacious oasis of scholarly tranquillity in north-west Beijing. The campus looks like an Ivy League school with Chinese characteristics. The grounds are dotted with stiff bamboo as well as pendulous willows, pagodas as well as ducks. The school remains largely closed to outsiders. In the past it did not even appear on maps. But it is opening up. The campus signpost, for example, is sponsored by Peugeot Citroen. The school has over 1,500 students and almost as many professors, many of whom are much younger than their students. It teaches economics, public finance and human-resource management as well as communist doctrine, such as Marx's labour theory of value. It takes only three or four classes to teach Deng Xiaoping Theory, the party dogma that legitimised China's economic reforms and still guides its Politburo. But if even that is too much, three famous clauses may suffice: "Our country must develop. If we do not develop then we will be bullied. Development is the only hard truth." Deng said these words 20 years ago, not at a portentous party conference in Beijing but on his "southern tour" of the workshops of the Pearl River Delta. He was inspired by practice, not theory, having just visited a refrigerator factory in the delta that had expanded 16-fold in seven years. Even the word he used for truth (daoli, which is often translated as reason or rule) is more colloquial than the loftier term, zhenli, reserved for high truths like Marxism-Leninism.

Giants playing catch-up Thanks to a sevenfold rise in its output since then, China is well past the point of being bullied. Its dollar GDP, measured at purchasing-power parity, may have already overtaken America's, according to economists such as Hu Angang of Tsinghua University or Arvind Subramanian of the Peterson Institute for International Economics. Converted at market exchange rates, it is still much smaller than America's. But even by that measure, China may catch up sooner than many people currently expect. To draw level with America by 2020, China's dollar GDP would have to grow at only about three-quarters of the average rate it recorded over the past decade. Now that China has become too important to be bullied, development may be less of an imperative. Indeed, in some quarters of society there is an increasing distaste for the unwelcome side-effects of China's growth model, which depletes the country's natural assets at the same time as it expands its physical ones, and which builds lots of property but often bulldozes property rights. Some party elites and vested interests may also have grown complacent, worrying more about how to divide the economic spoils than how to enlarge

#Our country must develop. Ifwedo not develop then we will be bullied. Development is the only hard truth"

SPECIAL REPORT CHINA'S ECONOMY

them. But at least in their rhetoric, leaders do not appear to be resting on their laurels. Asked about China's prospects of becoming the world's number one economy, Li Wei, head of the Development Research Centre, which advises China's cabinet, saw no reason to celebrate. The country's income per person still ranks around number 90 in the world. And even if its GDP overtakes America's by the end of the decade, China will remain as poor as Brazil or Poland are today, by one estimate. Hubris may be less of a danger than its opposite, a kind of economic diffidence. If China is still poor in the minds of policymakers, they may conclude that the economy is not yet ready for reforms that are in fact overdue. They may feel that a poor developing country does not need a more sophisticated financial system, cannot cope with a more flexible exchange rate and cannot afford to let its rural masses settle in the cities with their families. As long as the demand for investment remains strong and the supply of saving captive, China's policymakers can feel confident that their country's economy will continue to enjoy rapid growth and stability. But the faster that China expands, the sooner it will outgrow the development model that has served it so well for so long. Japan began to change its growth model back in the mid-1970s. By some measures China has already reached a similar stage of development, and yet its reforms remain tardy and timid.

School rules There are at least three schools of thought on China's economic prospects over the next few years. The first sees few dangers ahead. China has expanded quickly, always beating forecasts, and will continue to do so for the time being. It is a huge, fast-developing country with plenty of room yet to grow. It invests a lot-and so it should. These investments might not always generate good returns for the bankers that lent the money. But they will contribute more to the economy than they cost. The second school of thought argues that China's imbalances could overwhelm it. It cannot sustain its current high rate

Still plenty of room to grow 18

of investment, but there is nothing else to replace this as a source of demand. Much of the credit extended by banks and Reprints shadow banks to keep growth Reprints of this special report are available going will sour. A government at US$7 .00 each, with a minimum of 5 that owes its legitimacy entirely copies, plus 10% postage in the United to growth will find it hard to States, 15% postage in Mexico and Canada . Add tax in CA, DC, IL, NY, VA; GSTin Canada. contain the disappointment For orders to NY, please add tax based on that a slowdown will entail. cost of reprints plus postage. This special report subFor classroom use or quantities over 50, scribes to a third school of please telephone for discount information. Please send your order with payment by thought. It argues that China cheque or money order to: does face significant problems, Jill Kaletha of Foster Printing Service but nothing it cannot handle. It Telephone 866 879 9144, extension 168 has not obviously overinvested, or emailjillk@fosterprinting.com but it has often invested un(American Express, Visa, MasterCard and Discover accepted) wisely. That is imposing real For more information and to order special losses on Chinese developers, reports and reprints on line, please visit our depositors and taxpayers. Howweb site ever, China's financial system is www.economist.comjrights better equipped than many othFuture spedal reports ers to ride out these losses. It may be inefficient in its allocaThe Arctic June 16th London June 30th tion of capital, but it is quite staNatural gas July 14th ble. Indeed, it is resilient for Judaism and the Jews July 28th some of the same reasons that it Previous special reports and a List of is inefficient. forthcoming ones can be found on line: Until recently most econoeconomist.comfspecialreport mists believed that China was heavily dependent on exports. But it has carried on growing even as its current-account surplus has shrunk, and trade has subtracted from growth, not added to it. The country is undoubtedly investment-dependent, but its biggest problem is malinvestment not overinvestment. Most people believe that its past malinvestment will impede future growth. This special report has raised doubts about that. Clearly China would be better off had it not wasted so much capital. But if the capital stock is not as good as it should be, that gives the country all the more room for improvement. If the investment rate does fall, China will need another source of demand. The obvious place to look is household consumption, but consumers may not rise to the challenge. This special report has argued that a much higher rate of government consumption would be equally desirable-and perhaps more feasible. As China's capital accumulates, its population ages and its villages empty, saving will grow less abundant and good investment opportunities will become scarcer. China will then need to use its resources more judiciously. That will require it to free up its financial system, introducing more efficiency even at some cost to stability. China is a vastly more prosperous and expansive country than it was 20 years ago. It has broader horizons and can afford a wider range of concerns. Development is no longer China's only truth. But it is still hard. â&#x20AC;˘ The Economist May 26th 2012

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Also in this section 48 A controversial South African cartoon 48 Yemen's persevering new president 49 Racism in Lebanon 49 Syria's worsening strife

so Football and politics in Algeria

For daily analysis and debate on the Middle East and Africa, visit Economist.comfworldfmiddle-east-africa

Cote d' Ivoire

Can west Africa's jewel regain its shine? DUEKOUE

A year after ending a nasty civil war, President Alassane Ouattara is struggling to make peace permanent HE one thing that proud Ivorians can T agree on is that there was no civil war last year. Francophone Africa's foremost country does not have such things. Instead, politicians, soldiers and civilians claim that they merely endured a crise

post-electorale. After his defeat at the ballot box in November 2010, President Lament Gbagbo refused to leave gracefully and retreated to his palace. Winkling him out over the next four months required mortar duels, tank battles and barrages from helicopter gunships. More than 3,000 people died; a million fled their homes. The financial system collapsed as armed groups swarmed across the country. This capped a decade during which Cote d'Ivoire was cut in half, following an earlier rebellion. The UN patrolled a buffer zone that became a noman's land. But, absolument, it was no more than a passing hiccup. Ivorians may be forgiven their euphemisms. Their country was once the allround best run in west Africa. And now, on the first anniversary of the presidential inauguration of Alassane Ouattara, the 2010 election winner, things are looking up. Cote d'Ivoire's two halves have been reconnected; public administration has returned to the rebellious north. Cocoa producers need no longer export via neighbouring countries. Roads in Abidjan, the commercial capital and de facto seat of government, have been repaired; rubbish

is being collected again. The finance ministry's windows were recently cleaned for the first time since 2007. The economy is growing at a jolly 8% and tax revenue has shot up. Overdue reforms, such as raising the retirement age, are being tackled. Funds are pouring into new infrastructure. Mr Ouattara, a former IMF man, is doing what he knows best: imposing muchneeded discipline. Once terrible timekeepers, his civil servants are made to turn up for work at 7.30 every morning. As proof of the president's effectiveness, Abidjan's traffic starts jamming up a lot earlier than before. Africa's wars rarely produce good peacetime leaders, but Mr Ouattara may be an exception. Still, pity the man who little more than a year ago strode out of Abidjan's Golf Hotel after a long siege by government militias, vowing to bring peace to his people. Violence persists. Fear still stalks the countryside. Few dare venture out at night. Even in daylight drivers speed anxiously through trouble-spots such as Bangolo, a day's drive west of Abidjan. "They shoot out the tyres to stop you," says an official in nearby Man. "They" refers to ex-combatants with guns who have taken to fleecing travellers, either in ambushes or more brazenly at checkpoints. Lorries pay them $20 for a safe passage of 30km (19 miles). The culprits come from both sides. In Duekoue people fear the president's supporters, who massacred 8oo locals there in

early 2011. The priest at a Catholic mission says things got calmer late last year, but have worsened again. Further south, several thousand fighters carry out deadly raids from across the border with Liberia. These are former government soldiers who have become rebels, nicknamed "sobels" by UN types. More than 4,000 displaced farmers in a nearby camp dare not return home. "People in the villages still get taken away," says one. The root of the problem is political. The new rulers do not trust the police force that was trained in the Gbagbo era, so they have disarmed it. A gendarme in Man says, "I have only this," and throws a few punches. His 40 colleagues have three guns between them; the town's 200 regular police have no guns at all. Nominally the peace is kept by 400 armed soldiers, many of them ex-militiamen. They are the only ones trusted by the new rulers. A policeman in a Heckler & Koch T-shirt says, "If I had a gun, they would arrest me." The entire security sector needs overhauling, but so far the government's efforts have been hamfisted. Tens of thousands of former pro-Ouattara rebels were pushed willy-nilly into the regular army, which ~~

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48 Middle East and Africa ~

has grown to somewhere between 40,000 and no,ooo men: no body knows the exact number. Integration is snared in bureaucracy. Every ministry has a finger in the lucrative security pie. Meanwhile, members of the old officer class are appalled at being squeezed out of air-conditioned barracks by men they consider thieves. The rank-and-file occasionally fight among themselves. Mr Ouattara has made himself defence minister to sort out the mess. But he has also chosen to head the 15-country Economic Community of West African States, better known as Ecow AS, the main regional mediating club. After recent coups in neighbouring Mali and nearby Guinea-Bissau, the 70year-old is often too busy or tired to deal with security at home, where a rough balance of forces makes an Ivorian coup unlikely, at least in the short run. On top of such worries, Cote d'Ivoire is struggling to deal with past atrocities. All sides demand justice and talk of reconciliation. With much fanfare, the government has set up a truth commission; yet it lacks momentum and political legitimacy. Many see the former prime minister who has been put in charge as partisan. The government's focus so far has been on prosecution rather than reconciliation. Mr Gbagbo has been sent to the International Criminal Court, and many of his men are in prison, but not a single pro-Ouattara rebel has been indicted, though both sides fought dirty. This smacks of victor's justice. Mr Ouattara may have had no choice. He made a deal with the devil last year when he recruited the rebels of the Forces Nouvelles, who were allied to other shady armed groups, to eject his predecessor. Now it is payback time. Guillaume Soro, the leader of the Forces, has become parliament's speaker. His commanders still control swathes of the countryside and extract rent. Since they are heavily armed, the official army dare not confront them. And in many cases they are indeed the army. The legal opposition, inside and outside parliament, is doing its best to impede the president. Parts of the old regime are regrouping beyond the country's borders, and talk of fighting another day. The rest refuse to engage in politics and have rejected offers to join the government. The old ruling party boycotted a general election in December. So the government controls 88% of the seats, with the result that a good third of Ivorians are unrepresented. A new opposition party, Liberty and Democracy for the Republic (known as LIDER), looks promising, but got few votes. Mr Ouattara can still be hopeful. Most of the violence is criminal, not political. Many of his countrymen are tired of fighting. A civil war is unlikely to erupt soon. The opposition is weak militarily. But that could change. The president must keep moving fast before another crise looms. â&#x20AC;˘

The Economist May 26th 2012 ASouth African cartoon

Nojol<e CAPE TOWN

A cartoon of President]acob Zuma has provoked a storm of outrage ARDLY anyone would have heard about Brett Murray's satirical portrait of South Africa's president, Jacob Zuma, had the ruling African National Congress (ANC) not put out a statement on May 17th expressing its "outrage" over the "disgusting" depiction of its revered leader and demanding its immediate removal from the Johannesburg gallery where it was hung and from the website of the only newspaper that had noticed it. When both refused, the party promptly applied for a highcourt order to force them to do so. This, of course, sent thousands of South Africans rushing to the intern et to see what the fuss was about. There they found a cartoon of a fully clothed, bespectacled Mr Zuma, virtually unrecognisable save for the characteristic bump at the back of his shaven head, in a heroic Leninesque pose, but with his genitals hanging out of his trousers. Soon every newspaper in the land was carrying the portrait, entitled "The Spear". It promptly went viral, even earning its own page on Wikipedia. In his affidavit, Mr Zuma, who has four wives, two ex-wives and some 22 children, argued that the painting constituted a grave violation of his constitutional right to dignity "as it depicts me with my private parts showing". He felt "offended and violated", as it suggested he was a "philanderer, a womaniser. .. an abuser of power". It also, he said, tarnished the ANc's image as a liberation movement.

Don't twit my man

The work, said Gwede Mantashe, the ANC's secretary-general, was racist, suggesting that "black people were objects and inferior to whites." Zwelinzima Vavi, leader of the main trade union federation, said it could "only be the work of a very sick mind, full of hatred." No white leader, they said, would ever be portrayed like that. (In fact Bill Clinton, George W. Bush and Step hen Harper, Canada's prime minister, have-among others-been depicted naked in abusive cartoons.) On May 22nd the Zuma painting was all but destroyed with red and black paint by two enraged supporters of the president. One of South Africa's biggest churches, the Nazareth Baptist Church, has called for Mr Murray, a well-known anti-apartheid campaigner, to be stoned to death. â&#x20AC;˘

Strife in Yemen

Hadi tries harder, against the odds SANA' A

The new president, buffeted by bombs and in-fighting, seems to be persevering HE suicide-bomb that was set off on May 21st in the heart of Sana'a, Yemen's T capital, by an adherent of a branch of alQaeda, killing more than 100 soldiers and injuring several hundred more, epitomised the country's continuing insecurity. It also put a spotlight on Yemen's new president, Abd Rabbo Mansour Hadi. The blast walls that protect his house in Sana'a are said to be the highest in the country. Apparently he seldom ventures out. Yet, since the former vice-president was sworn in on February 27th, displacing his predecessor, Ali Abdullah Saleh, who lasted 33 years in the job, he has made the campaign against Yemen's jihadist network his priority. This month Mr Hadi unveiled a new effort to tackle al-Qaeda in its southern havens. The United States and the European Union are backing him up. The Americans are still giving military aid and have stepped up their deployment of drones. The jihadists, fighting under the banner of Ansar al-Sharia (Partisans of Islamic Law), said in a Facebook post that the suicide-bombing, carried out near the presidential palace, was aimed at Yemen's defence minister in retaliation for a campaign that has killed dozens of their fighters. Until the attack on May 21st, it was generally thought that the portly, balding, 66year-old Mr Hadi, a former military man from the south who has often been portrayed as shy and unassertive, had been doing rather well. Many Yemenis had doubted whether he would be able to step out of Mr Sal eh's shadow. But he had gradually begun to do so. "I don't think anyone ~~

The Economist May 26th 2012

Middle East and Africa 49

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he would come out looking as strong as he has, considering the challenges," said Abdul-Karim al-Iryani, a former prime minister, earlier this month. Apart from having to take on al-Qaeda and its allies, Mr Hadi has been engaged in a no less testing battle to cut down to size the remnants of Mr Sal eh's power circle. Under an agreement brokered in November by members of the Gulf Co-operation Council, led by Saudi Arabia, Mr Sal eh agreed to end his long rule in exchange for immunity for him and his family. Among other things, the armed forces, whose divisions during last year's uprising brought Yemen to the brink of civil war, were to be revamped. Mr Saleh has continued to intrigue behind the scenes, seeking to block decrees issued by Mr Hadi to reorganise the forces and to oust Mr Saleh's many relatives and friends from senior posts. But the former president has steadily been outflanked. Some say he now suffers from mild dementia, after a rocket attack last summer that nearly killed him and forced him to fly to Saudi Arabia for medical treatment. Hours after the suicide attack Mr Hadi sacked four high-ranking commanders and promised on television to fight on against al-Qaeda "until we have eradicated it, whatever sacrifices we must make." He has a long way to go. Rebels of the Houthi clan hold sway in much of the north, around Saada, while a secessionist movement has gained momentum in the south. Mr Saleh's system of tribal patronage is largely intact. A "national dialogue" is due to begin this autumn to accommodate Yemen's diverse groups and interests. If it fails, the country could fall apart. That would benefit Ansar al-Sharia and al-Qaeda. During the upheavals of last year, jihadists took over swathes of the rugged mountainous southern provinces of Shabwa and Abyan, where they have operated for years. But now, in a notable territorial advance, they also control several towns, which they proclaim to be an Islamic emirate. There the jihadists have virtually taken over the functions of government, providing locals with a modicum of law and order as well as electricity

and water. They also dispense justice based on sharia law. Al-Qaeda's black flag can now be spotted in parts of Aden, the strategic port that is the main city of the south. If the jihadists were to gain control of it, they could threaten the Bab al-Mandab strait at the foot of the Red Sea, through which much of the oil supplied to the West is shipped. This month Yemen's armed forces tried to close in on the jihadists' stronghold of Jaar, renamed "the emirate of Waqar", and on Abyan's capital, Zinjibar. Hundreds on both sides are said to have been killed. Some say the jihadists have a few hundred fighters, others several thousand. Plainly they can strike almost at will. In the past few months they have overrun several military bases in the south, seizing heavy weapons, even tanks. In one attack this year they captured 73 Yemeni soldiers. Mr Hadi may be planning a fresh assault before the fasting month of Ramadan, which starts this year on July 2oth. But his forces are likely to prove ineffective unless he first manages to sort out who really commands them: his fragile new establishment, or the rump of Mr Saleh's old one. â&#x20AC;˘

Syria's strife

From bad to worse RAN KO US

UN monitors are

unable to stop the violence from increasing HINGS are going from bad to worse in T Syria-for both President Bashar Assad and for the battered but resilient opposition. A month after a UN mission arrived to oversee a plan by Kofi Annan, a former secretary-general, to end the bloody crisis, the violence is once again rising. Mr Assad, who reckons he has little to gain by honouring the ceasefire, let alone providing for a political transition, appears to have told his forces to stop shelling Syria's biggest cities for the time being, but to continue hitting restless smaller towns and to go on arresting pro-democracy campaigners. Meanwhile, some of Mr Assad's opponents have been trying to assassinate senior members of the regime as well as shoot security men and pro-regime thugs.

Radsm in Lebanon

Blacl< is not thought beautiful BEIRUT

Racial intolerance is pervasive in Lebanon and in much of the region HE multilingual, fashion-conscious T residents of Beirut, Lebanon's capital, fancy their city to be cosmopolitan. But not everyone is welcome. Black people and foreigners from Asia and elsewhere in the third world who make up the bulk of migrant workers are often turned away from the city's smarter venues. Conscious of the bad blood this can cause, Lebanon's government has warned beach clubs against barring entry on the basis of race, nationality or disability. But racism is unlikely to be erased overnight, either in Le ban on or in many other Middle Eastern countries where blacks are routinely looked down on. Racist taunts are often heard on Egypt's streets, and in Yemen, darker-skinned people, known as al-akhdam ("the servants"), who make up perhaps 5% of the population, are confined to menial jobs and tend to dwell in slums. In Libya rebel militias often targeted darker-skinned people from nearby countries such as Chad and Mali and from countries further south, accusing them of being mercenaries of Muammar Qaddafi. Filipinos, Sri Lankans and ChineseAmericans, among others, whisper of racist slurs both at work and on Lebanon's streets. "When black or Asian

friends visit," says a young Lebanese professional, "I'm at the airport the moment they land to make sure immigration officers don't ask inappropriate questions. It's a disgrace." Some people blame the legacy of the slave trade, which brought sub-Saharan Africans, as well as others, to the region from the 7th century onwards. But Nadim Houry of Human Rights Watch, a New York-based lobby group says that racism persists in the region because governments have been lax about tackling it. "There are racists everywhere in the world, but in many countries it is now taboo to make comments, partly because there are laws against it," he says. "Here, even when there is legislation, it is never applied." Snobbery makes things worse. Millions of foreigners in the Middle East do cleaning and building jobs which locals consider beneath them. Sponsorship schemes often deny such workers basic rights. "People just see us as cheap labour," says a Filipino university graduate who makes $200 a month in a Beirut beauty parlour. Some beach clubs have already said they will ignore the new regulation. Their customers, they say, would not tolerate having to rub shoulders with the dark-skinned servant class.

so Middle East and Africa

The Economist May 26th 2012 Algeria

Football v politics ORAN

The rowdiness of football fans makes the regime queasy

OOTBALL terraces in President AbdF elaziz Bouteflika's Algeria are a privileged space for free speech expressed by

Whodunnit? ~ On

May 22nd, 11 Lebanese Shia pilgrims returning from Iran were kidnapped in Syria's northern province, close to Aleppo, the country's second city. It was always going to be hard for the UN to enforce a ceasefire on a country of 23m with just 300 people, of whom 270 have arrived. They have already been trying to cover wide stretches of Syria. But they may have to lessen their ambitions if security continues to deteriorate. Two UN convoys have already been targeted; nobody knows by whom. In any event, neither side is heeding the call for a national dialogue issued by General Robert Mood, the UN mission's Norwegian head. Still, the monitors' presence, even if scattered, has let the protest movement regain some ground. Since the regime killed four university students in Aleppo on May 3rd, protests have gripped that city, which had been relatively quiet. The national death toll is now thought to exceed 12,000. And the unrest is creeping closer to Mr Assad's doorstep, as angry Syrians fleeing violence in their hometowns are starting to fill Damascus, the capital. There, discontent is rising and clashes with government forces are becoming more frequent. The extent to which outsiders are becoming involved is unclear. Recent largescale bombings in Damascus can be the work only of the regime (or a nefarious unit within it) or of jihadists who want to attack the "heretical" Alawite minority that dominates the regime and to which Mr Assad belongs. Jabhat an-Nusra (the Salvation Front), a jihadist group praised on al-Qaeda websites, has claimed responsibility for nine bombings. The government has long blamed foreign terrorists for teaming up with the opposition. It fiercely denies any such charge. "We have been offered aid by Islamists, but we haven't taken it because we don't want to be framed as extremists," says a young rebel. "But we need weapons." Syria's

the part of the population that his regime fears most: angry young men. Thousands of police are bussed in to keep an eye on them at matches, but the fans have safety in numbers. The authorities anyway think football fanaticism a safety valve, preferable to protests on the streets. However, in the Algerian cup final, which saw the Algiers team, CRB, lose to the north-eastern city of Setif on May 1st, one slogan that rang through the stadium before the start of play was "Ouyahia out!", a rude reference to MrBouteflika's hapless prime minister, Ahmed Ouyahia, who has borne the brunt of anger over a lack of jobs that has left more than one in five young people out of work. Other chants called for a boycott of the recent general election, on May 10th. A recent slogan was, "One! Two! Three! Screw those who vote!", along with another old favourite (which rhymes in Arabic): "The firms are all closed down, the generals are all thieves!" The cheekiest of the jingles are speedily posted on YouTube. Not all the chants are political. The atmosphere is often good-humoured, with tambours and castanets accompanying club anthems. Mr Bouteflika has craftily proclaimed himself as the nation's football-fan-in-chief. Last year a huge poster showing him with a football was draped down one side of the capital's main soccer stadium. When the Algerian team played Egypt in a World Cup qualifying match in Cairo (and lost 2-o) in 2009, he provided cheap flights for many Algerian fans. But worries about football violence are rising. A policeman was killed at a big match in March. Players, police and fans have been wounded and seats burnt at more recent games. At one in Algiers on April 2nd two cameras belonging to a state television channel were smashed; a cameraman narrowly escaped harm. The regime still uses a more traditionMuslim Brotherhood, back on the ascent after years of lying dormant, says many within the country want to receive cash and arms. The rebels say the weapons pledged by Gulf governments have not yet arrived in large amounts. Meanwhile the political opposition, especially abroad, is at odds with itself. Representatives of the "local co-ordination committees" within Syria have threatened

al conduit for spreading its message among the restless young: the Friday mosque sermon. A recent homily, preached across the land, was devoted to persuading worshippers that the practice of self-immolation was not the best response to the difficulties of daily life. In the election on May 1oth, which was duly won by the independence-era National Liberation Front (FLN), the turnout was put officially at 43%, though many Algerians think it was probably a lot smaller. Young men were notable by their absence. A senior FLN man admitted, "Perhaps we are out of step with the younger generation." You Tube impertinence carries risks. Tarek Mameri, a young man from Algiers, began posting his unedited thoughts on the state of the country, urging a boycott of the election. Footage shot at dusk shows him and a couple of men throwing election billboards to the ground, to a soundtrack of frenetic Algerian rap. He was promptly picked up at home by police in plain clothes. He was later freed, but faces the magistrates at the end of the month.

Keeping them under control

to pull out of the Syrian National Council (sNc), the main opposition group, because many of them opposed the recent re-election of Burhan Ghalioun, its head, who says he will step down eventually. The UN is in a bind. So far it seems willing to turn a blind eye to ceasefire violations, fearing that Syria will plunge into allout civil war if the mission pulls out before its mandate ends on July 2oth. â&#x20AC;˘

Also in this section 52 Spanish banks 52 Serbia's presidential election 53 Azerbaijan and Eurovision 54 Charlemagne: The row over Eurobonds

For daily analysis and debate on Europe, visit Economist.comfeurope

Italian politics

Tremors and rumbles

ROME

Earthquakes, political and geological, have disoriented Italy

WICE this week, Italians in the northT eastern Emilia-Romagna region felt the ground shift beneath their feet. The first time was on May 2oth, when an earthquake struck the region, killing at least seven people and leaving thousands homeless. Not as tragic or lethal, but perhaps more significant for Italy's future, was the jolt delivered by an election held as aftershocks continued the next day in the city of Parma, renowned for its hams, cheese and agro-industries. The city's well-to-do voters elected as their mayor the candidate of a party led by a shaggy-haired comic. In a two-way runoff, the Five Star Movement, founded by Beppe Grillo, a comedian and blogger, took 6o% of the vote. Mr Grill a, a vitriolic critic of political corruption and one of the first Italians to grasp the opportunities for mobilisation created by the internet, launched his movement less than three years ago. Recent polls have suggested it could take between 14% and 17% of the vote at the general election that has to be held before next spring. That would make it Italy's third-biggest political grouping, behind the centre-left Democratic Party (PD), led by Pier Luigi Bersani, and the conservative People of Freedom (PdL) movement, founded by Silvio Berlusconi. This is not the only parallel with the rise of Syriza, the hard-left party in Greece that

opposes that country's bail-out programme. Parma is among Italy's most indebted cities. It is reckoned to owe up to â&#x201A;Ź6oom ($7ssm), a figure that could soar if Federico Pizzarotti, the new mayor and a 39-year-old IT manager, were to honour his pledge to scrap the building of a new incinerator, incurring penalties of â&#x201A;Ź18om. In rejecting the centre-left candidate, voters implicitly rejected a form of bail-out negotiated by the PD with local industrialists. The result was a slap in the face for the PD, whose candidate was beaten by Mr Pizzarotti. Yet overall the centre-left fared relatively well, taking 14 of the 25 remaining provincial capitals where run-offs were held. For the PdL, on the other hand, the results were disastrous. It won in only six of the cities. In Parma the arithmetic implied Mr Pizzarotti was floated into office with support not just from disaffected left-wingers, but from voters who in the first round had backed the PdL. Some were no doubt disgusted former supporters of the Northern League, the PdL's coalition ally in the previous government. Last month the League's leadership was pitched into a scandal involving alleged misappropriation by senior officials, including the former leader, Umberto Bassi, and took a predictable drubbing in the mayoral ballots. Yet the result in Parma also showed that

some of the middle-class conservatives who kept Mr Berlusconi in power for eight years have become susceptible to Mr Grillo's populist rhetoric. One of the media tycoon's former ministers remarked that the comedian reminded her of Mr Berlusconi at the start of his own political career, when he too presented himself to the electorate as an alternative to the established order. Mr Grillo promises a seductively easy way out of the economic crisis that has engulfed Italy: exit from the euro and default on its huge public debt of more than 120% of GDP. It is a tempting notion for small businesses struggling with the tax increases and spending cuts imposed by Mario Monti's technocratic administration in an effort to reduce the budget deficit. Recent weeks have seen a spate of suicides by victims of economic hardship. The PdL's dismal performance tipped the party into crisis. There was talk of dissolution, and reports that Mr Berlusconi, who gave up the party leadership after he resigned as prime minister last November, might launch an altogether new movement. He could, however, find that others want to play the role of national saviour. Luca Cordero di Montezemolo, the chairman of Ferrari, hinted in a letter to Corriere della Sera, a daily, that he might stand at the next election as head of a new party. Many in the centre of Italy's political spectrum would like Mr Monti to lead them to the polls, even though a recent opinion poll indicated that his approval rating has dived to just 35% from over so%. All too often in Italy's recent past, uncertainty and instability have been accompanied by terrorist violence. Several homemade bombs have already exploded at tax-collection offices. Earlier this month a man held a tax-collection employee has- ~~

52 Europe ~

tage for several hours in Bergamo, north of Milan. On May 7th the chief executive of the nuclear-power subsidiary of the Finmeccanica group was shot in the leg. The attack was claimed by a mysterious group, the Informal Anarchist Federation (FAI), which had previously confined itself to dispatching parcel bombs. The next week Alfredo Davanzo, the jailed ideologist of the refounded Red Brigades, which carried out a number of murderous attacks from the late 1990s, told a reporter this was the "right moment" for revolution. It was against this troubled background that on May 19th a bomb was detonated outside a school in the southern city of Brindisi, killing a 16-year-old girl and seriously injuring others. It may prove to have been the work of a lone maniac, or the local mafia. But it was ominously reminiscent of the apparently random-and still mostly unexplained-bombings that brought terror to Italy from the late 1960s to the early 1980s. Mr Bersani, the PD leader, claimed to discern a strategy in the most recent attacks. That has yet to be established. But what is certain is that, in a matter of weeks, Italy has become not just a more unsettled place, but a darker and scarier one. •

Spanish banks

The corralito risl< MADRID

Spain is home to some of Europe's most vulnerable banks

HE word corralito does not need translating to Spaniards. They know it T means the partial freezing of bank accounts that afflicted Argentina as money fled the country a decade ago. That is what makes it so frightening. It should not happen in a solvent country like Spain. But as the spectre of a Greek euro exit is haunting Europe, Spanish banks have become a big concern. Ministers have had to deny the corralito risk. Nerves are fraying. Shares in Bankia, a part-nationalised bank, yo-yoed wildly after reports, later denied, that clients were taking their money out of Spain's fourthlargest lender. "I've been working since I was 13, and if they take it away I'll kill someone," said a Bankia client who collared Crista bal Montoro, the budget minister, on the street. Soraya Saenz de Santamaria, the deputy prime minister, appealed for "responsibility". Many cursed Paul Krugman, a Nobel-prize-winning economist-though all he did was point out that a euro-zone meltdown might involve Spain imposing cormlito-style controls.

The Economist May 26th 2012 In spite of all the anxiety, deposits across the banking system grew in March. It is Bankia's shareholders, rather than its account-holders, who should be upset. Those who believed the 2010 merger of seven savings banks, or cajas, laden with toxic property would transmute into a solid new bank were wrong. It was an unhapPY marriage: on May 23rd Luis de Guindos, Spain's finance minister, told parliament that the government would inject at least €9 billion ($n billion) into the ailing lender. The worries about banks go deeper. They have played for time by refinancing loans to struggling property developers ever since the 2008 housing bust. Two rounds of provisioning ordered this year, totalling €82 billion, may not be enough, though the government is expected to provide €15 billion of the necessary funds. On May 21st the government appointed two external valuers to scrutinise the banks' assets. Despite 24% unemployment, Spanish households have an excellent record of not defaulting on residential mortgages. Even so, they may conclude that still more capital is needed. Bad loans rose to an 18-year high of 8-4% in March. And with Spain's economy expected to contract this year and next (see chart), pressure will increase. The Institute of International Finance estimates Spanish banks might need €50 billion to €6o billion of fresh capital, equivalent to around 5% of GDP. Higher estimates go above €1oo billion. Spain's sovereign debt is already under fierce pressure. Worries about the banking system, unemployment and growth have pushed ten-year bond yields above 6%. This in turn makes it prohibitively expensive to recapitalise the banks. Spain's credibility has been dented by an upward revision of last year's budget deficit, from 8.5% of GDP to 8.9%. Big-spending regional governments were to blame. They must now find huge savings. Mariano Rajoy, the prime minister, is committed to a fiscal adjustment worth 5.9% of GDP in just two years. If carried out, this will deepen the recession. Is there no end to Spain's pain? •

PIIGS in peril Budget-deficit reduction target, 2011-13, % ofGDP

GDP, % change on previous year* 2.0

1.5 1.0 0.5 +

0.5 4 -'---~-~---'-----'--

Spain

Italy

1.0

Greece Portugal Ireland

~~~~ Sources: European Commission; Eurostat; Government statistics; The Economist

* 2013 forecast

Serbia's presidential election

The gravedigger's victory A surprise win for Tomislav Nikolic

ERBIA has a new president. In a run-off poll on May 2oth Serbs elected Tomislav SNikolic, who was running for the presidency for the third time. He is sometimes known as "The Gravedigger" because he once ran municipal cemeteries. Mr Nikolic's election has electrified the country's political elite. Until his defeat of the incumbent Boris Tadic, Serbia's political future seemed clear. Now, says Braca Grubacic, a senior official in Mr Nikolic's party, "everyone is talking to everyone, and most options are on the table." This is because Serbia has no government. In parliamentary elections on May 6th, Mr Nikolic's centre-right Serbian Progressive Party (sNs), won, taking, with its allies, 73 of the 250 National Assembly seats. Mr Tadic's Democratic Party (ns) and allies won 67 and the Socialist Party of Serbia (SPS) and partners, led by Ivica Dacic, won 44. This left Mr Dacic in the position of kingmaker. He boasted he would be Serbia's next prime minister before announcing that his party would remain in coalition with the DS. But Mr Nikolic's victory has changed the dynamics. The most likely option remains a coalition of the ns and SPS. But now that Mr Tadic is out of a job, some in his party want him to become prime minister. He dismissed the idea after his presidential loss. But he may have second thoughts: if he does not take the job, his political career could be over. Dragan Djilas, the popular mayor of Belgrade, is waiting in the wings to become head of the DS. Another option is a grand coalition between the SNS and ns, and perhaps the SPS too. But for outsiders probably the

The Economist May 26th 2012 ~ most

important result is that, unless the forms a government without the DS, Serbia's pro-European Union stance is unlikely to change. Some observers were spooked by the presidential victory of Mr Nikolic, who once espoused a form of extreme nationalism. More recently he has changed his tune maintaining a consistent stance of European integration and good relations with Serbia's neighbours. Still, in the outgoing parliament his party did not vote for legislation needed for EU integration, nor for an historic resolution in 2010 SNS

Europe 53

that condemned the 1995 massacre of Bosniaks in Srebrenica. Whoever takes over the running of Serbia's government will have a tough time of it. Unemployment is running at 24%, and voters' anger about falling living standards and corruption was one of the main reasons Mr Tadic lost the presidency. "See you in some other movie," Mr Tadic told journalists after his defeat. It will probably take weeks before a government is formed. Serbia can ill-afford to wait to see if that is going to be Tadic: the sequel. â&#x20AC;˘

Azerbaijan and Eurovision

The sound of music BAKU

Europe's song contest has not brought change to Azerbaijan. What could?

HEN Azerbaijan won the Eurovision song contest last year, local campaigners hoped that hosting the contest this year would shine a fierce spotlight on the country's human-rights record. They have been disappointed. Many protesters inspired a year ago by the Arab spring are still in jail, independent journalists continue to be locked up and political murders remain unsolved. Families have been forcibly evicted with inadequate compensation to make room for new construction projects, including the Crystal Hall, the futuristic, LED-coated arena where Eurovision is taking place. The European Broadcasting Union (EBU), which owns Eurovision, has come under fire for treating the Azerbaijani government with kid gloves. Though it held a workshop on media freedom earlier this month with several of the country's human-rights groups, it has shied away from criticising the evictions and stayed silent on a demonstration in Balm, the capital, this week that was violently broken up. The EBU insists that Eurovision is "apolitical", even though countries such as Azerbaijan, desperate for international approval, clearly use it for political aims. As an association of broadcasters from 56 countries, the EBU is hamstrung. FrankDieter Freiling, chairman of the contest's board of governors, is disappointed that there has not been more criticism of the regime, but says governments should have used the opportunity to apply more pressure themselves. That seems unlikely to happen on any great scale: Europe sees Azerbaijan as a small but important contributor to reducing its dependence on Russian gas. And although Azerbaijan's relations with Iran and Turkey, two traditional allies, have been souring-lran recalled its ambassador this week-it is a strategic ac-

cess point to Afghanistan for America, and to Iran for Israel. By contrast, the foreign press has covered human rights extensively in the run-up to Eurovision. EBU officials privately wonder why places such as Russia and Turkey, with their own human-rights abuses, did not enjoy the same scrutiny when it was their turn to be host. Yet given the modest impact of the coverage so far, once the 1,500 international journalists in Balm have packed up and gone home any effect is unlikely to last. Optimists can see seeds of longer-term change. True, the economy remains overwhelmingly dominated by energy. Oil and gas revenues have allowed the government to boost defence spending, stoking fears of renewed conflict with neighbour-

All yours, babushki

ing Armenia. By 2017 the export capacity of the huge Shah Deniz gas field is expected to more than double. However, oil production, a far larger share of revenue, is falling. The squeeze on the budget will eventually force the government to think about diversifying the economy, says Sabit Bagirov, head of the Entrepeneurship Development Foundation, a think-tank. There is one promising sign, he adds: an e-government programme designed to reduce people's contact with officials is having an effect on rampant low-level corruption. Opposition parties, led by an ageing and exhausted generation, have shrunk to nothing more than "dissident clubs", says Hikmet Hadjy-Zadeh, a prominent member of one of them. But a new generation of internet-aware campaigners is becoming bolder. One of them, Mr Hadjy-Zadeh's son, Adnan, spent a year in jail for "hooliganism" when some thugs beat him up shortly after he had made a satirical video. At the time he was working as a spokesman for BP, the developer of the Shah Deniz field and the regime's most faithful prop. After an international outcry, the younger Hadjy-Zadeh got his job back once he had emerged from jail. Khadija Ismailova, an investigative journalist who has published stories about the private wealth of the clan of 11ham Aliev, Azerbaijan's president, was smeared by a secretly filmed sex video that was posted online. In her case, too, international indignation helped. The support emboldened her, she says, and the intern et makes her work easier. It will take years, however, for the new generation of dissidents to gather meaningful force. For now Mr Aliev's regime, which is already working on a bid for the 2020 Olympics, can assume that its opponents offer no threat. â&#x20AC;˘

The Economist May 26th 2012

54 Europe

Charlemagne I The feeling's mutual Mr Hollande and Mrs Merkel are clashing over Eurobonds, and more

OW quickly Franc;ois Hollande is changing the terms of EuroH pean politics. When he spoke about the need for more growth, others quickly echoed him. And now that the new French president is talking about the need for Eurobonds, even the IMF and the OECD have joined the chorus of those demanding joint euro-zone debt issuance. At his first European Union summit, over an informal dinner in Brussels on May 23rd, Mr Hollande found more allies. Predictably, though, he ran into firm opposition from Germany. That did not seem to bother him. Finding agreement can wait for the next summit, in late]une,if not later. For now MrHollande was demonstrating that he was different from his predecessor, who stood on the same podium in Brussels in March. Before every summit Nicolas Sarkozy would seek a common position with the German chancellor, Angela Merkel. By contrast Mr Hollande chose to meet the Spanish prime minister, Mariano Rajoy, before the pair took the train (not the presidential jet) to Brussels. Mr Hollande was all too happy to highlight his differences with the chancellor. "For Mrs Merkel Eurobonds are the end point of a process of integration. For me they are the starting point," he declared. This is a striking change of tone from the election campaign, when Mr Hollande, though critical of Mrs Merkel's brand of austerity, seemed keen to find an accommodation. He flew to Berlin within hours of his inauguration. Most of his calls for growth-inducing European investment seemed modest, based on existing proposals by the European Commission. When he spoke of "Eurobonds", he had once suggested that he merely meant "project bonds", a scheme to sweeten debt issued by private firms to finance Eu-backed infrastructure projects. That pretence is over. Mr Hollande now wants countries to pool new public debt. Is it acceptable, he asks, that Spain must borrow at 6% while Germany can raise money almost for free? This week Germany sold two-year bonds with a o% coupon. For Germans, Eurobonds are the wrong prescription at the wrong time. Mrs Merkel says they are illegal under EU treaties and do not contribute to growth. Financial Times Deutschland, a German daily, calls the dispute "The German-French Ice Age." Yet it is too soon to conclude that Franco-German relations have gone into the deep freeze. Any new French president is

bound to cause some realignment in Europe. Perhaps Mr Hollande, boosted by a successful trip to America, is setting out a tough opening position ahead of the June summit. Perhaps he is playing up his differences with Germany for the sake of domestic politics, as he seeks to secure a clear majority for his Socialist Party in elections to theN ational Assembly next month. There is certainly a need to reappraise policy as the euro zone's debt crisis enters a perilous new phase. Investors are fleeing both the banks and the sovereign bonds of Mediterranean countries. Without a restoration of confidence in the ability of the euro zone to survive, it is hard to see how growth can return. Spain, sucked into a worsening recession, is pleading for the European Central Bank (ECB) to inject more liquidity into its banks and buy its government bonds. More ominously, the exhausted Greeks may soon vote themselves out of the euro zone. Although the politicians said they wanted Greece to stay in, the Bundesbank seemed ready to boot it out. It declared that the turmoil caused by a Greek exit would be "considerable, but manageable given prudent crisis management." A bigger danger, it suggested, is that agreeing to a substantial renegotiation of Greece's bail-out conditions "would damage confidence in all euro-area agreements and treaties". Others are not so sanguine. Few have any real confidence in the firewalls erected so far. Thus the call for the ECB to do more with its vast arsenal. Two sets of longer-term reforms make sense. One is to create a form of "banking union", with a Europewide system of deposit guarantees, recapitalisation and regulation. This would help break the link between weak banks and weak sovereigns. The other is to move towards greater "fiscal union", including the creation of Eurobonds. This would reduce borrowing costs for troubled countries and create a safe asset for banks to hold. The euro's future So Mr Hollande is right to reopen the debate on the euro's future. He is also right in thinking that an exclusive Franco-German duopoly cannot pretend to run the euro zone. But there are limits to how far he should push the confrontation with Mrs Merkel. The chancellor is hardly without friends in Europe. She is backed by, among others, the remaining AAA-rated countries, such as Finland and the Netherlands. And everybody knows that the crisis has, for the moment, shifted financial power to creditor states. A prolonged Franco-German dispute will lead to a debilitating stalemate that will help nobody, least of all France. The harsh truth is that France is more vulnerable than Germany. It is forecast to miss its budget-deficit target next year, and French banks are dangerously exposed to troubled Mediterranean countries. So Mr Hollande will need to practise the art of persuasion. Above all Germany must be reassured that greater risk-sharing will not amount to handing its credit card to profligate governments. Mr Hollande might tell Mrs Merkel that creating a more solid euro zone, far from creating moral hazard, will make it easier to threaten Greece or others with expulsion. And setting out clear conditions for the introduction of Eurobonds could create incentives for countries to keep to the path of reform. Mr Hollande wants all issues to be put on the table. He, too, should be asked what France is offering by way of domestic reforms and concessions to Germany's wish for deeper political union. â&#x20AC;˘ Economist.comfblogsfcharlemagne

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Also in this section 58 Megrahi and Lockerbie 58 Explaining the weak economy 59 Bagehot: The Jubilee and Britain

For daily analysis and debate on Britain, visit Economist.comfbritain

Electricity-market reform

Volt from the blue

The government launches a drastic reform of the electricity market

N 1974 a Conservative government conItuted cerned about dwindling coal stocks insti- I the three-day week to conserve electricity. Industrial action by miners was responsible for the shortage then. Now politicians warn that Britain could again face blackouts if action is not taken soon to upgrade its energy sector. And if the warnings are dramatic, the government's proposals for changing the way electricity is produced and traded are no less so. Britain currently has an unusually deregulated, competitive energy market. But leaving the system as it is "would not be in the national interest", noted Ed Davey, the energy secretary, when introducing a draft bill on May 22nd. Many of the country's power plants face closure because they are inefficient, polluting or old. Energy firms have tended to sweat their assets rather than invest in new facilities. As a result, some 20% of generating capacity is due to come offline within a decade. Britain has also become increasingly reliant on imports, often from Russia, which uses commodities as a crude diplomatic tool. These days nearly half of Britain's electricity is generated from gas. A further 28% comes from coal, the most polluting fuel (see chart). Renewable technologies account for a mere 7% of current supplies. This sits ill with ambitious government pledges to cut planet-heating emissions and get 15% of energy from renewable

Current affairs Contributions to electricity supply,% Coal 28. 1

Oil

r - - - - - - - 1.2

Gas 47.2

Nuclear 15.5

L..__ _ _ _ _ _

Source: Department of Energy and Climate Change

sources by 2020. To achieve that, a far greater proportion of electricity must come from clean sources. All this will be expensive: the industry regulator reckons that around ÂŁ200 billion ($315 billion) needs to be spent by 2020. Investment currently amounts to ÂŁ4 billion-6 billion a year. But the move to greener powerinBritainmust be achieved without infuriating voters already upset at high bills. Brian Potskowski of Bloomberg New Energy Finance, an energy consultancy, compares electricity-market reform to preventive surgery. Does the surgeon know what he is doing? The bill introduces long-term contracts for low-carbon generation. These will set a

minimum price for electricity generated for each technology, paid by consumers through their bills, to assure firms they will recoup high upfront costs. The contracts are intended to spark investment in clean and nuclear power-which will help the country hit its emissions targets-while also expanding the portfolio of generating sources and replacing declining capacity. The government claims it will also get consumers "off the hook" of volatile fuel prices, which it takes to mean ever rising ones. Ministers warn that bills would go up faster if the country keeps burning fossil fuels at the rate it does now. The market certainly needs to adapt to the shifting economics of electricity generation. For traditional power sources such as coal and gas, generators' main cost is the price of fuel-set-up and running costs are fairly slim. That equation is inverted for both renewables and nuclear, where the fuel is free (wind, sun) or comparatively cheap (nuclear) but upfront costs are hefty and often paid out years before they reap any return. No deregulated market has attracted much low-carbon investment without some form of long-term guarantee, notes Ronan O'Regan of PWC, a consultancy, so some inducement for low-carbon generation may be needed. But the government has chosen not to use market incentives such as auctions, at least for now. The draft bill represents a huge aboutturn from the current deregulated market to a centrally-planned one. In a renewable energy "road map" in July 2011 the government specified how much energy it hoped to generate from different sources by 2020. The coalition is openly pro-nuclear. The new bill adds to the state intervention-in 2013 a minimum price for each technology will be specified. Some contract prices may ~~

58 Britain ~ even be decided on a project-by-project ba-

sis. That "makes a nonsense of competition", says Tom Burke of E3G, an environmental consultancy. The likely winners are some of the most expensive forms of generation. The government wants offshore wind to account for nearly a fifth of Britain's renewable energy by 2020, for example, yet by official estimates offshore generation currently costs between double and triple that from gas. Onshore wind, a far cheaper technology, is to account for only 12%. The real cost of nuclear reactors has gone up, not down, in the decades since such facilities were first built, yet ministers hope eight new ones will be constructed-and have already listed the chosen sites. It is doubtful that the draft bill has enough detail to break the current hiatus in

The Lockerbie atrocity

To his grave Some questions will not be answered HAT Abdelbaset al-Megrahi lived for T as long as he did was an embarrassment. The only man ever convicted of the aircraft bombing above the Scottish town of Lockerbie in 1988, which killed 270 people, was controversially released by the Scottish government in August 2009 on the ground that his prostate cancer would kill him within three months. Instead he survived at his home in Tripoli, Libya's capital, for almost three years, dying on May 2oth. Yet the fact that he lasted longer than Muammar Qaddafi raised hopes that Megrahi, a former Libyan intelligence agent, might be free to reveal more of the truth about Lockerbie. After years of wrangling about his extradition, he was convicted at a specially convened Scottish court, sitting in the Netherlands, in 2001. But others must have been involved-either in Libya or elsewhere. One alternative theory in Britain is that the real culprit was Iran. (There is less doubt about Megrahi's role in America, where 189 of the victims came from, and where there was widespread fury about his release.) Megrahi kept silent, except for protesting his innocence, as he had always done; the Scottish Criminal Cases Review Commission, which investigates miscarriages of justice, found grounds for a renewed appeal, but he dropped it to help his release. Alex Salmond, Scotland's first minister, insists that the Lockerbie investigation remains open. But given the upheavals in Libya, it seems possible that Megrahi's secrets, if he had any, went with him to the grave.

The Economist May 26th 2012 energy investment. It is still unclear how prices will be determined, how often they will be reviewed and how contracts will be implemented. Uncertainty about the form of the contracts compounds existing investor fears about the durability of government price guarantees on energy-British politicians have already rowed back on subsidies for solar generation, as have other European governments. The price of mishandling energy-market reform is high. Government predictions that fuel prices will keep rising may be mistaken and it will not be able to bat the blame for high electricity bills onto utility firms, as now. If the government gets it wrong, already sceptical consumers could turn against further efforts to mitigate climate change. The public already believes, wrongly, that it is paying dearly for green energy. And attitudes to the environment are hardening. Between 2005 and 2010 the proportion of people telling Ipsos MORI, a pollster, that they were not concerned about climate change rose from 15% to 27%. Electricity demand will grow again as Britain emerges from recession-the nation does not need more capacity tomorrow, but it will do soon. Meanwhile the legislative process drags on and the documents detailing the policies get longer and more complicated. "I'm not sure what plan B is," says Daniel Grosvenor of Deloitte, a consultancy. A phrase all too familiar from discussions about the economy could yet become apt in energy too. •

Explaining economic weakness

TheiMFv Beecroft Two sharply different takes on Britain's stalled recovery HAT is the problem with the British economy? Are animal spirits dulled by too much regulation, making businesses wary of hiring? Or is the more pressing issue weak spending stemming from an overhang of debt, a shortage of credit and the threat of collapse in the euro zone, Britain's main export market? Two reports published this week offer contrasting supply-side and demand-side views. The first, written at the prime minister's behest by Adrian Beecroft, a venture capitalist, emphasises the "terrible impact" of rules that make it costly to fire workers. The work-shy are free to coast, harming efficiency, it says. Small firms are wary of hiring for fear they will be stuck with a duffer. Mr Beecroft proposes that firms should be able to sack staff without cause, so long as they give notice and a payoff linked to salary and service. Tiny firms, which can-

Firing range Employment protection index* Selected countries, 2008

• • -

Permanent workers Specific requirements for collective dismissal Regulation on temporary employment 0

United States Canada Britain Japan Sweden Brazil Italy Germany • •• •• • • India China Greece France Spaint Turkey Source: OECD

*Scale of 0 to 6, with 6 being most protected 12009

not afford specialist staff to administer complex rules, should be exempt from many regulations. The Beecroft report reflects employers' fury about the difficulties of offloading a dud worker, and the lawyers who use the threat of court action to bargain for a bigger payoff. But as irksome as regulations are, they cannot readily explain the economy's underperformance. Britain's are among the least stringent job-protection laws: of the 40 countries in the index compiled by the OECD, only America and Canada have looser rules (see chart). And Britain's jobless rate has stayed remarkably low given economic weakness. By coincidence the report appeared the day before the IMF concluded its annual economic "mission" to Britain. The fund's take is rather different. It thinks the economy has too much slack, not too many slackers. It wants the Bank of England to begin another round of "quantitative easing" to boost demand. It is essential that Britain cut its large budget deficit, says the fund, though it would prefer a more growth-friendly tilt to austerity, such as cuts in public wages to pay for investment. The government should consider passing on its low borrowing costs to private firms and banks by buying their bonds. If none of this works and the darkest fears about the euro zone are realised, then budget cuts would have to make way for tax cuts and public works. In that event, it might make sense to copy Germany's response to the 2008 slump. It used temporary wage subsidies to make it easier for cash-strapped firms to keep workers-the opposite of the Beecroft fix, but the right one for the times. •

The Economist May 26th 2012

Britain 59

Bagehot I Once in a lifetime What three royal jubilees reveal about Britain

EFORE Queen Elizabeth's Silver Jubilee in 1977, the villagers of West Hoathly in Sussex were placed under secret observation. A file was drawn up, noting their views on the monarchy, the country and the impending celebrations. The royal family was marvellous but these festivities had better not cost too much, said one villager, recorded as "Nurse, female, so", explaining: "People are not in the mood." West Hoathly was reliably monarchist, the file records, with anti-republican sentiment boosted by recent American elections ("Fancy having Jimmy Carter," a villager shuddered). But still its Jubilee enthusiasts sounded a bit bleak. We're due a celebration, said "Male, 53"-we've made it to 1977 without a nuclear war. The files were commissioned by Mass Observation, a private social-research project that has studied the British since the 1930s. In all, 107 volunteers were recruited to record the Silver Jubilee. Their diaries and notes, together with complementary files on the 2002 Golden Jubilee, now form part of a vast archive held at Sussex University. On the eve of Queen Elizabeth's Diamond Jubilee-to be marked from June 2nd to sth-the archives offer a remarkably evocative glimpse of the recent past. The 1977 files describe a country that was tired and riven by industrial conflict. Its people talked of feeling a bit lost, and yetfrom a distance of 35 years-they seem enviably grounded in a shared culture with deep roots. There was striking uniformity to their celebrations. Invited to have fun, people first grumbled then formed committees. It is remembered that at previous royal jubilees children were given commemorative mugs, prompting endless rows about paying for them. "The Vicar! He needs grinding up afresh, that one," fumed a farmer's wife in north Wiltshire, on learning that her Women's Institute branch must buy mugs. "Not that I'm criticising him, of course," she added hastily. Celebrations in 1977 involved children's food-sausage rolls and jelly, hot dogs and ice cream-and beer for the grown-ups. There were violent sporting contests, from tugs-of-war to freeform football matches. To conquer reserve, fancy dress was worn, often involving men in women's clothing. From the West Midlands came news of an all-transvestite football game, with the laconic annotation: "all ended up in the canal." London displayed both patriotic zeal (flag-draped pubs in

Brick Lane, big street parties in Muswell Hill) and hostility (cheerless housing estates, slogans declaring "Stuff the Jubilee"). Scotland was a nation apart. A file reports "total apathy" in Croy. In Glasgow the anniversary was called "an English jubilee". Snobs sneered along with Scots. At Eton College, a wooden Jubilee pyramid was smashed by old boys. At Oxford University, examinations were held on Jubilee Day, in a display of indifference. The Silver Jubilee is not really about the monarchy, asserts a file from south Wiltshire: the day is about "people wanting a bit of fun". A report from Wimbotsham in Norfolk, close to a royal estate at Sandringham, stands out for its focus on the queen's 25 years on the throne. Locals held a service on the village green, praying for the monarch in "happy togetherness" under dripping umbrellas before a tug-of-war, races and tea for 700. By 2002 and the Golden Jubilee, Britain comes across as a busier, lonelier, more cynical place. The royal family was "just showbiz", sniffed a diarist from Sussex. There is angry talk of Princess Diana and how her 1997 death was mishandled by the queen. There are fewer street parties than in 1977, all agree. This is variously blamed on apathy, the authorities (whose job it is to organise events, apparently) and above all on health-and-safety rules. In 1977, in contrast, one Wiltshire village cheerfully let a "pyromaniac" doctor take Jubilee fireworks home to add extra bangs. The 2012 Jubilee finds Britain changed again. Diamond jubilees being rare (the last was achieved by Queen Victoria in 1897), the queen is firmly at the centre of the celebrations. Local councils have received more than 8,ooo applications to close roads for street parties, suggesting that 2002's passivity is fading. The country is not returning to 1977 and its home-made fancy-dress costumes or Coronation bunting dug out of attics. Today's shops heave withJubilee cakes, disposable decorations and flag-emblazoned baubles, letting consumers buy patriotism out of a box.

After 6o years on the throne, a jubilee about the queen Visiting Wimbotsham, Bagehot is shown elaborate plans: cakebaking contests, pony rides, a teddy bears' picnic, a sports day, a pensioners' tea. But there will be no tug-of-war (people might hurt themselves) and the face painters have liability insurance. Still, the festivities will dwarf those seen in 2002, locals say. The monarchy endured a "big lull after Diana", suggests David Long, the driving force behind Wimbotsham's DiamondJubilee. As the queen grows older, she is "more highly thought of". Linda Nixon, a Wimbotsham pensioner, credits Prince William's royal wedding with reviving enthusiasm. Prince William and his brother Prince Harry are "like everyday people", she says. In the Mass Observation Silver Jubilee files, critics grumble about the monarchy costing too much or entrenching privilege. Supporters say the queen confers global prestige or offers a bulwark against constitutional meddling by politicians. In short, the debate is about the best way to organise society. In both Golden and DiamondJubilee Britain, by contrast, the issue is whether the queen deserves to be respected, and whether the public can relate to her. In short, individualism is all. Diamond Jubilee Britain seems to be a hybrid. As in 1977, an unhappy nation fancies being cheered up, and the monarchy fits the bill. As in 2002, a truculent nation demands a monarchy on its own, emotional terms. Is that sustainable? Perhaps not, but it promises to be a fine party. â&#x20AC;˘ Economist.comfblogsjbagehot

Also in this section 61 Climate sceptics at bay 61 Circassia in exile

The NATO summit

NATO's risl<y Afghan endgame

A timetable for winding down the war leaves more questions than answers

UMMITS like to have broad agendas. But they can rarely focus on more than S one big thing. NATO's meeting in Chicago this week was dominated by the need to unite behind plans for an orderly retreat from Afghanistan-more politely labelled as a transition to Afghan responsibility for the country's own security. The alliance had other pressing issues too, such as "smart defence" (an attempt to pool capabilities to get a bit more bang for the euro), pressing on with a European ballistic-missile defence system (in the face of much angry growling from Moscow) and politely brushing aside the hopes of politically inconvenient applicants (partly because of wanting not to annoy Russia still more). But finding a respectable exit from the ten-year conflict against the Taliban and its allies has become the over-riding priority. Rather than plotting a convincing path to that goal, Chicago showed how difficult it will be to reach. A troubling sideshow was the failure to get an agreement with Pakistan to reopen the NATO-led coalition's southern supply route. This was abruptly closed last November, after a disastrous error led to the killing of 24 Paldstani soldiers by American air strikes. Pakistan's embattled (and deeply unpopular) president, As if Ali Zardari, was invited in the expectation that he would seal a deal to get the trucks rolling again. But although he showed up, his demands were

deemed so unreasonable that Barack Obama refused to meet him more than fleetingly. Mr Zardari wanted an apology from America for the deaths of his soldiers (Mr Obama has offered his condolences but not said sorry); a "tax" of $s,ooo for each truck passing through Pakistan to Afghanistan (NATO is prepared to pay $soo, double the previous amount); and an end to drone attacks on militants in Pakistan's lawless tribal areas (drones deserve much of the credit for the decline of "core" alQaeda and remain central to America's counter-terrorism strategy). Mr Zardari's position doubtless leaves room for haggling. But his apparent lack of negotiating space reflects both his own weakness and the virulence of anti-American sentiment among ordinary Paldstanis. For NATO, reopening the southern route is now less about supplying forces in Afghanistan than easing the logistical burden of getting vast quantities of materiel out by the end of 2014, when combat operations are meant to have ended. The summit also laid bare NATO'S need to please three different audiences. Mr Obama and his European counterparts are desperate to persuade their voters, weary of war and austerity, that the expenditure of much blood and even more treasure on what many now count as a hopeless cause really is coming to an end. At the same time, they also want to reassure Afghans, a large majority of whom dread the return

of a resurgent Taliban, that the world is not going to abandon them to civil war after 2014. That is what happened when the Soviet Union threw in the towel two decades ago. Third, they need to show the Taliban (and some of Afghanistan's unhelpful neighbours) that, even when most Western combat troops will have gone, the government in Kabul will still have the support it needs to survive. To that end, Mr 0 bama and the other 27 NATO leaders agreed to a modified version of the plan coming out of the Lisbon summit in 2010. The aim is for Afghan forces to take the lead security role in threequarters of the country before the end of this year and the other, most contested areas by the middle of 2013. They will then have 18 months to hone their abilities and learn from their mistakes while still having support from Western (mainly American and British) combat troops. Checks in the mail Thereafter, America and other donor countries have agreed to provide $3.6 billion a year for the Afghan national security forces (ANSF), with the Afghan government chipping in $soom, for a further ten years. Some doubt whether this will be enough. NATO will also keep an unspecified number of military trainers in the country (around 2,ooo), and, under an agreement reached last month, America will keep up to 20,000 military personnel in Afghanistan, to provide the Afghan army with the battlefield "enablers" it lacks. These include close air support, logistical back-up, medical evacuation and aerial surveillance. Although Mr Obama concedes that "the Taliban is still a robust enemy and the gains are still fragile", he also describes the road map "to responsibly wind down the war" as "irreversible". So far, the transition

The Economist May 26th 2012 ~

has gone fairly well, but the last two phases will be much more testing. They will see the ANSF take over responsibility for former Taliban strongholds, such as Kandahar and Helmand, and volatile provinces in the wild east of the country. Senior Afghan politicians worry that if they cannot cope, they have no Plan B. The Lisbon summit witnessed much talk about the importance of a comprehensive approach that linked security with development and governance. Neither of these got much mention in Chicago. The economy will suffer from the withdrawal of Western forces, in particular the winding down of the Provincial Reconstruction Teams (PRTS). These contained military officers, diplomats and development experts and were seen as crucial to the NATO-led mission. Afghan ministers fear a vicious circle in which PRT projects come to an abrupt end, the legitimacy of provincial governors is undermined and security then deteriorates. NATO may have agreed on a plan, but an inflexible timetable and dangerous pennypinching have made it a lot riskier than it should be. â&#x20AC;˘

Climate scepticism

Toxic shocl<

A climate-change sceptic is melting

HE Heartland Institute, the world's T most prominent think-tank promoting scepticism about man-made climate change, is getting a lot of heat. In recent weeks it has lost an estimated $825,000 in expected donations, a couple of directors and almost its entire branch in Washington, oc. At its annual shindig in Chicago this week, the institute's president, Joseph Bast, said Heartland had "discovered who our real friends are." The 100-odd guests who failed to show up for the "7th Climate Conference" were not among them. The institute's problems began in February when an American water scientist,

For true believers only

International 61 Circassians

Home thoughts from abroad BEIRUT

Circassians mourn the past-and organise for the future

AS LOST causes go, that of the Cir1"\..cassians is especially sad. Having fled their homeland on the north-east of the Black sea in the 19th century as imperial Russia expanded south, 90% of them (estimates range from 5m to 8m) are in exile. They gathered in 40-odd countries on May 21st, marking the massacres of, they say, a million or more in 1864. The rallies marked a new high point after decades in which the cause smouldered in a scattered diaspora. "For so long we limited ourselves to keeping alive our dance and language," says Tamara Barsil<, a 29-year-old Circassian-American from New Jersey. "But the intern et has let us read about Circassia. We are now working to develop a national identity." She and her colleagues study closely the tactics of other emigres who strive for far-flung causes, including Armenian, Estonian and Jewish groups. One aim is to win recognition for their past suffering. Activists are incensed by the choice of Sochi for the 2014 Winter Olympics. Now a Russian seaside resort, it was once the Circassian capital, and the site of events all but forgotten in modern Russia. "We want the athletes to know that if they compete here they will be skiing on the bones of our relatives," says Iyad Youghar, who heads the International Circassian Council, a lobby group. America gives a bit of support to the Circassians, broadcasting in one of the two main languages. The Georgian parliament, keen to annoy Russia, has officially termed the massacres "genocide". Peter Gleick, published internal Heartland documents that he had obtained under a false name. They provided details of its accounts-including references to an anonymous donor who gave $8.6m between 2007 and 2011-and of a plan to send teaching materials denouncing global warming

Scars and stripes Such moves help stoke suspicion in Russia that the Circassian cause is a Western plot. The remaining Circassians there are spread across three republics in the troubled North Caucasus. Though not beset by the violence of nearby Chechnya, the local authorities have kept a tight grip. "I didn't feel free or comfortable there," says Sataney Chigun, aJordanian-Circassian journalist who moved to the region as a child, but left in 2010. Yet Russia has its attractions tooespecially for the 1oo,ooo-odd Circassians caught in Syria's strife. Russian parliamentarians examined their plight in March; 25 families moved back in May. But Russia, twitchy about Muslims, wary of the Circassians' friends, and a staunch ally of the Damascus regime, has yet to decide whether to admit any more. to American primary schools. (Mr Bast says that far from exposing his institute, the documents exonerated it from charges that it was a front for the fossil-fuel industry.) Worse ensued early this month after the institute put up a digital billboard in Chicago that linked belief in global warming to madness and terrorism. It depicted the "Unabomber", a mass-murderer called Ted Kaczynski, with the slogan, "I still believe in Global Warming. Do you?" The offending sign lasted only for a day. But PepsiCo, BB&T bank and Eli Lilly, a pharma company, are among donors that announced the end of their support. Mr Bast decries double standards: those who accept global warming routinely call their opponents Nazis, he argues. He admits that the billboard was in "poor taste" but says it was designed to get attention, and was good value at $200. The real price is proving rather higher. â&#x20AC;˘

We created an insurance policy for a 64-story thrill ride . . , Boy, was that fun. The Chicago World's Fair was planned during the peak of the 1920s but didn't roll out until the height of the Great Depression . And Zurich wanted

to help make sure that nothing would prevent the "Century of Progress" '

from moving forward. The risk possibilities were considerable, so we worked with city officials to help reduce hazards and minimize risk . During its two-year run, the expo attracted a record 39 million people and brought $200 million to the city of Chicago. lt can be said that the 1933 World's Fair gave hope to the nation . And we couldn't be more proud to have been a part of it. Insuring success since 1912. Visit zurichna .com/100

In the United States, insurance cove rages are underwritten by individual member companies of Zurich in North America, including Zurich American Insurance Company. Certain coverages are not available in all states. Some coverages may be written on a non-admitted basis through licensed surplus lines brokers. Prior results do not guarantee a similar outcome. Risk engineering services are provided by Zurich Services Corporation.

63 Also in this section 65 Alibaba and Yahoo! to divorce 65 Google and antitrust 66 Facebook' s flotation 67 Reimagining India's Piramal 67 Bashing cars in Indonesia 68 America's pointless solar tariffs 68 Video games to testjobseekers 70 Schumpeter: New bosses

For daily analysis and debate on business and our weekly "Money talks" pod cast, visit Economist.comfbusiness-finance

Eike Batista

The salesman of Brazil RIO DE JANEIRO

Brazil's richest man is betting on resources and infrastructure. Can he deliver?

LOGGING insurance door-to-door is not easy. No one likes having lunch interrupted by a stranger who babbles about accidents and death. A salesman must be charming to stop that door from slamming in his face. This was Eike Batista's baptism of fire. He put himself through college in the 1970s by peddling policies. The skills he learned have come in handy since then. Mr Batista (pictured, sharing a stage with Brazil's president, Dilma Rousseff) dropped out of his engineering course and left Germany for his native Brazil. He bought gold from wildcat miners in the Amazon, sold it in Rio de Janeiro, and made $6m by the age of 25. He borrowed more-and lost most of it-buying out pickand-shovel operators and trying to mechanise their mine. Food, fuel and equipment had to be flown in. Workers got sick. Finally, the mine started producing. That taught him to stick to "idiot-proof assets", he now quips, with such high margins that even big setbacks can be survived. He bought more mines abroad. By 1986 he was chairman of a Canadian goldminer that grew to be worth a tasty $1.7 billion. By 2001, legal troubles in Russia and Greece had slashed that to $1 billion. Mr Batista resigned and returned home to Brazil to sell new dreams. Since 2004 he has set up and listed five companies: MPX (energy generation); MMX (mining); LLX (logistics); OGX (oil

and gas) and osx (shipbuilding). A sixth, one of his few non-Brazilian assets, a Colombian coal mine, will be spun off from MPX on May 25th. Together with four unlisted companies in entertainment, precious metals, information technology and property, these make up the EBX empire. (All those xs are supposed to represent wealth multiplying.) Few have yet made profits. Some were listed before they were much more than an idea. But selling patential has made Mr Batista Brazil's richest man and the world's seventh-richest, with a fortune estimated at $30 billion. That's more than Mark Zuckerberg of Facebook. Mr Batista says he will not be satisfied until he has taken the top spot from Carlos Slim, a Mexican telecoms tycoon. Batista's view of Brazil The EBX empire reflects Mr Batista's understanding of Brazil's strengths and weaknesses. The country has copious minerals; Mr Batista extracts them. It also has skimpy infrastructure. Not Copacabana bikini skimpy, but far too slight for such a big place: hence the queue of ships idling off Rio's beaches, waiting for a slot at its overburdened port. Mr Batista aims to build roads, railways, ports, ships and refineries to shift Brazil's minerals to the global market. He is also building power plants, to be fuelled by his own gas and coal. It was oax, Mr Batista's oil-and-gas

firm, that propelled him from rich to superrich. He founded it in 2007, a few months before Brazil's state-controlled oil giant, Petrobras, announced the discovery of huge offshore pre-sal ("sub-salt") oil reserves. Some promising blocks were withdrawn from auction later that year-but guided by old hands from Petrobras, including Paulo Mendonc,:a, its recently retired head of exploration, o Gx bid for those still on offer. It won 21, most in shallow water. Since then Brazil has auctioned no more offshore fields, leaving OGX as its largest private oil firm. Its 2008 listing raised $4.3 billion, at the time a record for Brazil. Sitting in his 22nd-floor office at EBx's headquarters in Rio, looking out at a picture-postcard view of Pao de Ac,:ucar (Sugar Loaf mountain), Mr Batista describes himself as a "truffle-sniffing labrador". Prospectors typically search in 17,000 places for every gold find, he says: in his goldmining days he got lucky eight times. Perhaps 85% of oax's test wells have struck oil. At its Waimea deposit OG x went from discovery to production in just two years, a world record. The first 1.2m barrels were sold to Shell in March. And unlike Petrobras, which is the sole operator in the pre-salregions, oax's production costs are low: in the bottom 20% globally. EBX has assets in nine Brazilian states. But it is at the Port of Ac,:u in Rio state that Mr Batista's vision of the new Brazil is clearest to see. The original idea was to build an offshore terminal through which to ship iron ore from his Minas-Rio mine. After that was sold in 2008 to Anglo American, the project grew into a joint venture with the global mining giant. Mr Batista started to think bigger. With 70% of Brazil's GDP in the south and south-east, why not add a container terminal to vie with the region's pricey, crowded ports? Then came ~~

The Economist May 26th 2012

64 Business ~ the

vast oil finds, and the plans expanded once more, to include an industrial complex, oil-handling facilities and a shipyard. Now LLX is trying to strike a deal with Vale, Brazil's biggest mining firm, to rebuild a dilapidated railway that passes nearby, and to persuade the government to upgrade local roads. A new city will be built to house workers(" a Venice of the tropics", Mr Batista likes to call it; to everyone else, it is "Eikelfmdia"). The first shipments of iron ore are scheduled for 2013, and both terminals should be ready by the end of that year. By 2015, if all goes to plan, A<;u will be the world's third-largest port complex, moving 350m tonnes of cargo a year.

Buy local, buy dear Brazil's government insists that oil-and-gas operators buy most of the equipment they need from overpriced domestic manufacturers. This is a heavy burden on Petro bras, which needs sophisticated kit to drill miles beneath the ocean floor, and a big reason why the company's share price has languished in recent years. But the rule is needed, says Mr Batista, to promote industrial development. "You think Brazil can lose this chance and not build a ship industry?" he asks. Even if it pushes up oGx's costs by so%, he says, his oilfields will still make money. Meanwhile, other parts of his empire are taking advantage of local-content rules. osx will supply ships and rigs to OGX and, Mr Batista hopes, to Petrobras too. He hints at other possibilities for co-operation with his giant competitor: perhaps it will dock its ships at his port and use his oiltreatment plant. And crucial to LLx's plans is the expectation that global suppliers, forced to set up in Brazil if they want a piece of the oil bonanza, will choose A<;uwhere, as a bonus, they will face state sales taxes of 2% instead of 18%, a holdover from the area's impoverished history. Mr Batista credits part of his success to his father, who pushed him out of the nest. During the 1980s and 1990s, when Brazil was suffering from hyperinflation and struggling to pay its foreign debts, Eliezer Batista, who put in two stints as chairman of Vale between 1961 and 1986 as well as a brief spell as minister for mines and energy, "thought, like many Brazilian fathers, that maybe Brazil would not make it." Prospecting for gold around the world toughened his son up. But he bridles at any suggestion that his father provided any more concrete assistance, such as telling the labrador where to sniff. "Nothing was given free to me," he says. His mining concessions were bought or claimed on terms that were available to everyone else, and likewise his oilfields. "I bid against Petrobras, Exxon, Shell, all the big boys, and I paid a billion dollars," he says. He is touchy too at the suggestion that he poached talent from Petrobras. They re-

tired and he rehired them, he insists. Mr Batista is neither a crony capitalist nor a self-made man, but something in between, says Sergio Lazzarini of Insper, a Sao Paulo business school. Part of his success is due to his vision and boldness-but he has also mastered the skill of developing and building on connections within government. He points to Mr Batista's strategic generosity: a wad of cash towards a flattering biopic about the previous president, Luiz Inacio Lula da Silva; $12m towards Rio's successful bid to host the Olympics in 2016; millions more to equip police in Rio's favelas. And quite apart from whether EBX's conglomerate structure makes operational sense, it certainly helps to get value out of such investments. "Links forged in one area of operations can be reused in another," says Mr Lazzarini. A commonly muttered criticism of Mr Batista is that he is too good a salesman to ATLANTIC OCEAN

1,500 km

Eike Batista's EBX empi re • Oil-a d-gas rights • Iron-or mines • Power stations • Shipbuilding and related • Ports and logistics

be true. Creating buzz right through the oiland-gas supply chain was essential to get firms to prepare for increased production, and hence to make Mr Batista's grand plans come to fruition, says Lucas Blender of Gera<;ao Futuro, a stockbroker. But Mr Batista's detractors dismiss him as the only person besides Bill Gates to have made billions from PowerPoint. His tendency to go to market soon after developing a concept can certainly misfire. Shortly after the 2010 listing of osx, EBx's shipbuilding arm, Brazil's environment ministry refused him permission to build a shipyard in the southern state of Santa Catarina, which had been described in the prospectus as central to the company's plans. Mr Batista picked himself back up and moved his planned shipyard to A<;u. But the setback fed doubts about his ability to keep his glittering promises. In March Epoca Neg6cios, a Brazilian business monthly, put Mr Batista on its cover, with the caption: "And so, Eike, are you going to deliver?" That provoked a

frenzy of tweets to his 865,000 Twitter followers. "And so, Epoca Neg6cios, when will you deliver reporting consistent with the facts?" ran one tweet. In another, he warned Epocanot to ask for access again. Mr Batista says he has already delivered plenty. EBX, he vows, will generate $1 billion in EBITDA this year, increasing to $10 billion by 2015. As for the idea that behind his showmanship there is little substance, he points to the various hardheaded types who have been through his books and gone on to become his partners. In 2010 Hyundai Heavy Industries, a South Korean shipbuilder, took a 10% stake in osx. In January E.ON, a German energy firm, signed a joint venture with MPX. In March Mubadala, a sovereign-wealth fund from Abu Dhabi, bought 5.63% of EBX for $2 billion. Many of his assets have been confirmed by independent regulators, he points out, and all his public firms are listed on the Novo Mercado, the segment of Sao Paulo's stockmarket with the highest standards of disclosure and transparency. Delivering everything he has promised will be tough for Mr Batista, says Mr Blender-but that is the price of fitting together so many pieces of Brazil's commodity-andlogistics jigsaw puzzle. Last month IBM bought a 20% stake in six Automa<;ao, EBx's technology-services subsidiary, and signed a deal to run all EBx's IT operations for the next decade. The aim, says Rodrigo Kede of IBM Brasil, is to manage the conglomerate's computing needs during a period of rapid growth, and to improve efficiency. "One idea we're working on is a predictive model for the maintenance of drilling platforms." Another is to use IBM'S "Smarter Cities" technology to plan and manage the residential areas that will grow up around LLX's ports. Selling his projects, and himself, so hard was a conscious decision, says Mr Batista. He points to another, more pleasing magazine cover, framed on his office wall: a mock-up of "Eike Xiaoping" captioned: "To become rich is glorious". According to Veja, a Brazilian weekly, Brazil's newly minted millionaires model themselves on Mr Batista. After so long in the economic doldrums, Brazilian entrepreneurs needed a confidence boost, he says. Another reason why Mr Batista courts publicity is to encourage-or shame-other rich Brazilians into giving away some of their lucre, he claims. Mr Batista is paying to clean up Rio's stinking Rodrigo de Freitas lake, but "Where are the other billionaires? Why don't they adopt a lake?" Asked what worries him, he first says rising labour costs, but then changes his mind. People are always asking what he is afraid of, but he can think of nothing. "Give me time. Let me work," he says. He has done enough to convince investors to give him more time. But sooner or later Brazil's salesman will have to deliver. •

The Economist May 26th 2012

Business 65

The intern et in China and America

Breal<ing up is so very hard, Yahoo! HONG KONG AND SAN FRANCISCO

Alibaba and Yahoo! agree to divorce

HE term "frenemies" could have been invented to describe the seven-year reT lationship between Yahoo! and Alibaba. The alliance between the American internet company and the Chinese e-commerce behemoth, sealed by a $1 billion stake that Yahoo! took in Alibaba in 2005, was supposed to be a match made in heaven. Yahoo! offered American cash and technology, plus a Taiwanese-born boss, Jerry Yang, who had already inspired other Chinese internet entrepreneurs. Alibaba offered access to what was then the world's biggest untapped market for ecommerce. Alas, the two firms were soon throwing plates at each other. They bickered over everything from censorship to the spin-off of Alibaba's online-payments business, Alipay. After more than a year of haggling, they announced a deal on May 2oth that will see them separate more or less amicably. That will come as a relief to shareholders on both sides. Jack Ma, Alibaba's feisty boss (pictured), has been keen to unshackle his company from Yahoo! so that it can pursue a stockmarket flotation. And Yahoo!, which has been shedding bosses like dandruff as it struggles to turn itself round, is keen to appease its long-suffering investors by returning cash to them. The deal will help the firms to achieve both goals. In a first step, Yahoo! is selling half of its roughly 40% stake in Alibaba in return for $6.3 billion in cash and $8oom of freshly minted shares in the Chinese firm. After tax, it will trouser $4.2 billion; call it Alimony. Later, Yahoo! will sell another 10% of the company as part of an initial public offering (IPO) of Alibaba, whose ecommerce website, Alibaba.com, is already listed in Hong Kong but is being taken private. Yahoo! will then be free to sell its remaining 10% whenever it chooses. Yahoo! executives have already said that most or all of the money from the first step of the divorce plan will go to its shareholders. The deal will have other benefits too. Exchanging airborne crockery with Alibaba wasted lots of managers' timeand especially that of Scott Thompson, who recently stood down as chief executive after it emerged that he had not earned a computer-science degree listed on his cv. Ross Levinsohn, Yahoo!'s interim boss, will now be able to devote more energy to promising new areas such as online video and to adding fresh features such as the Axis browser launched on May 23rd.

The Alimony was worth it Alibaba's Mr Ma will also have a freer hand. Yahoo! has agreed to give up its rights to an unfilled fifth board seat at Alibaba. It has also agreed that it and Japan's Softbank will reduce their combined voting rights to 49.9% immediately. At the same time, the deal makes it clear that Yahoo!'s obligation to hold on to a tenth of Alibaba's stock to sell as part of the Chinese firm's hypothetical IP o expires by the end of 2015. That is a powerful incentive for Mr Ma to act fast. Another reason for him to float his firm soon is that Alibaba, which has seen a spectacular rise to the top of China's ecommerce league table, may have to deal with powerful new rivals in the coming years. 36obuy and Dangdang, well-funded local competitors, are gaining ground. An even bigger threat may come from Ten cent, China's biggest gaming and social-networking outfit, which plans to set up a sep-

arate division to pursue e-commerce. Other problems, though under control today, may blow up in the future. Alibaba's costs are rising as it invests to fight off rivals. Mr Ma has said he will spend several billion dollars to improve logistics. Among other things, this will help defend Taobao, an Alibaba subsidiary that dominates online shopping in China. The platform, which somewhat resembles eBay, has been blacklisted by the United States Trade Representative's office as a notorious market for counterfeit goods. Alibaba has worked hard to clean up the site, but not hard enough. It has yet to persuade the Americans to remove it from their list. So Alibaba at last seems to be heading for a public listing, though this will not happen immediately. An Alibaba IPO could be even bigger than Face book's (see box on next page). But with luck, it will not be as stormy. â&#x20AC;˘

Google and antitrust

Over to you, and hurry

The European Commission puts the ball into Google's court

OAOUiN ALMUNIA has been in no rush. lt is more than two years since Google's competitors started complaining to him about the giant online-search company. Eighteen months ago Mr Almunia, the European Union's competition commissioner, began a formal investigation. Several times a decision has seemed imminent. On May 21st Mr Almunia said he wanted to get a move on. "I believe", he said, "that these fast-moving markets would particulady benefit from a quick resolution." Mr Almunia did not present a formal

case (a "statement of objections" in Eurospeak), but offered Google a chance to settle. He has four main areas of concern, and wants the company to propose remedies to each "in a matter of weeks". If he is not satisfied, the formalities will resume. Then he will impose his own answers and maybe a fine, too. Go ogle is Europe's biggest search engine, scooping about 85% of queries. In America, its home country, it scores a paltry two-thirds (see chart on next page). Mr Almunia suspects that Google abuses its ~~

66 Business ~

The Economist May 26th 2012

dominant position. His first concern is that Google favours its own specialised searches-for restaurants or flights, or comparing the prices of consumer goods-ahead of others. Second, he worries about its use of content such as restaurant or hotel reviews from competing specialists. Google "may", he says, be copying without permission. Google thinks this has been resolved; its competitors (and the commission) are not so sure. Third, Mr Almunia is vexed by exclusive agreements between Google and other website-owners, such as magazine publishers or broadcasters. When users type entries into the sites' search boxes, Google serves up the advertisements that appear alongside the results; rival suppliers do not get a look in. Fourth, the commissioner is concerned that advertisers cannot easily transfer campaigns from Google's Ad-

Words platform to rival systems. He thinks the terms of Google's contracts with software developers may be to blame. Mr Almunia's job is to protect consumers, not Google's rivals. To complicate matters, people do not pay for search; their

Face book's flotation

That sinl<ing feeling SAN FRANCISCO

The shine quickly comes off the social network's huge IPO T WAS supposed to be a coming-out party for the most eligible firm in the Iworld. But Face book's initial public offering (IPO) on the NASDAQ stockmarket on May 18th has swiftly turned into an inquisition. Face book's shares had fallen to $32, on6% below their issue price of $38, by the close of trading on May 23rd (see chart). Accusations are now flying as to who is to blame. And American financial regulators are polishing their magnifying glasses. The flotation has already led to legal action. Face book, Mark Zuckerberg, the firm's boss, and the underwriters who supported its IPO have all been sued by disgruntled shareholders. They claim that less wildly optimistic growth forecasts for the company were given to favoured investors just ahead of the flotation, rather than to the market as a whole. Face book says the suit is bull-

Unfriended Share prices, May 17th 2012=100 105 100 95

90 85 80 -.1.

-L-

May 2012 Source: Bloomberg

_.__ __.__

feathers. Separately, a regulator in Massachusetts issued a subpoena to Morgan Stanley as part of an investigation into whether the investment bank had selectively distributed revised forecasts for Face book. The bank says it followed the same procedure as in other public offerings and that it is "in compliance with all applicable regulations". Regulators may also look into the technical glitches on the NASDAQ that disrupted early trading in Face book's stock. These marred the firm's debut, though it has only itself and its advisers to blame for the rout. A few days before trading began, Face book increased the number of shares on offer by 25% and settled on a price well above the $28-35 range it had initially set. Its bankers must have believed that the appetite for Facebook shares was bottomless, and that investors would hang on to them. They were mistaken. "The underwriters are to blame for allocating so many of Facebook's shares to hedge funds and other clients that were planning on flipping the stock," says Jay Ritter, an IPO expert at the University of Florida. Face book's defenders claim the IPO was a success. It raised a whopping $16 billion for the company and its early backers. But it was clearly a public-relations disaster. Two congressional committees are demanding information. All this has sent a chill through Silicon Valley, and will make investors warier of other web outfits hoping to go public. May 18th may turn out to be the day the bubble in social media burst.

clicks trigger payments by advertisers to Google and its rivals. Google's critics say that the unwitting clicker is losing out. If Google pushes its rivals down its displays or snaffles their reviews, so that users stay with its own services, consumers may not get the best deals or information. Google replies that its software simply provides the most useful searches. If its own services come top, so be it. Even so, it has been saying for a while that it is willing to talk: a long fight after two years of skirmishing suits neither it nor the commission. Now, without paying too high a regulatory price, it has to placate Mr Almunia. Not only him. America's Federal Trade Commission is also looking at claims that Google unfairly favours its own services. The FTC means business: last month it appointed Beth Wilkinson, a lawyer who prosecuted Timothy McVeigh, the Oklahoma City bomber, to its Go ogle team. Regulators are not always beastly to Go ogle. On May 19th the firm said that China had followed America and the EU and approved its takeover of Motorola Mobility, a maker of mobile phones whose main attraction is its 17,000 patents. The deal, worth $12.5 billion, was completed on May 22nd. Still, on both sides of the Atlantic, Go ogle is in for a busy summer. •

How many hits for "dominant"? Google's share of intern et searches* March 2012,%

EU 60

Non-EU 80

100

Turkey India Spain Denmark Brazil Italy Netherlands France Germany Britain United States • • • • • • Japan Source: cam Score

*Including non-core websites

The Economist May 26th 2012 Reimagining Piramal

Blood, sweat, but no tears MUM BA!

An old Indian business house still has fire in its belly

l"' ]HEN his

brother's death in 1984 is

VV mentioned, Ajay Piramal, a big, calm

man, still looks sad. That tragedy propelled him at the age of 29 to the helm of one of India's big, old and flagging business houses. Since then he has run it with a stark lack of sentimentality and with outrageous success. Having sold the crown jewels-a generic-drugs outfit-in 2010, for $3.8 billion, he is now busy re-imagining the family firm for the third time. Given his record, it is worth paying attention. Piramal's first reincarnation came in the 1980s. The main textiles business was dying. Its workers were striking; its mills were outdated and packed into central Mumbai. Mr Piramal cut staff and moved out. Today the land he freed forms a new business district, where snazzy towers sprout from the ruins of old factories. Some textiles clans have since lived off their property. Others began new adventures. A branch of the Wadia family, old Mumbai royalty, started an airline. Piramal began making generic drugs for Indians, buying in 1988 the local unit of a British firm and then picking up similar operations from other foreign pharmaceutical firms which had lost hope in India. "Often multinationals move in a herd mentality," says Mr Piramal. By the late 2000s Piramal was India's third-largest drugs firm. This second incarnation ended abruptly. In 2004, with his brother's sons grown up, the clan split, apparently amicably, with Mr Piramal's nephews and their mother taking the property and textile units. In 2010 Ab bott, an American drugs firm with a history of failing to crack India, bid a preposterous $3.8 billion for the Indian generic-drugs business, which had just $425m of sales. It was a "stiff price", says the diplomatic Mr Piramal, who had not expected the bid and says the negotiations over price took only a few hours. What now? Mr Piramal has parked part of the proceeds by buying a stake in Vodafone's Indian arm, an arrangement that looks temporary. He is a critic of crony capitalism in India, which limits his options. The boom in infrastructure in 2007-10, when well connected "entrepreneurs" milked government links, "did not feel right", he says. Many are now in financial trouble and a few are under investigation. Instead, Piramal has three new areas of emphasis. One is a limited re-entry into property. Land prices have dropped as some Mumbai developers have become

Business 67 overstretched. And there has been a recent crackdown on the corrupt nexus between developers and officials. "People like us were at a disadvantage," he says. Now, at least for a while, they are not. The second new area is health-care services in America. On May 16th Piramal spent $635m on Decision Resources, a Massachusetts firm that analyses and crunches data on drugs and treatments. He is betting that treatments will become ever more specialised and that the buyers of drugs in America-state bodies and insurance firms-will become even more finicky and cost-conscious. Drug firms are outsourcing this kind of activity.

That logic seems to embody a conventionally gloomy view of the pharmaceuticals industry, which seems unable to discover enough new drugs or to protect its patents on old ones. Piramal's third area of expansion is thus a surprise: Mr Piramal wants to invent new blockbuster drugs. Surely that is a business model as obsolete as inner-city textile mills? Mr Piramal thinks not, especially if research and clinical trials can be shifted to India, where costs could be as little as a tenth of those in the rich world. "We're hopeful that we'll discover new drugs and make breakthroughs," he says. "We take a contrarian view." â&#x20AC;˘

Cars in Indonesia

Let them wall<

JAKARTA

A plan to stop ordinary folk from buying cars

T IS a fast-growing Asian country with Ijams slow-moving cars. Indonesia's traffic make molasses look runny. The delays may be irksome, but they are symptoms of a boom. Car sales in Indonesia jumped by 17% from 2010 to 2011, to nearly 900,000 new vehicles, and by11% year-onyear in the first quarter of 2012, despite global economic gloom. Indonesia's market is growing faster than China's much bigger one: car sales rose by only 2.6% in China between 2010 and 2011. Indonesians now buy more cars than any other south-east Asian nation, having overtaken Thailand last year. They also bought 8m motorcycles in 2011, anumber that could rise to 9m this year. Small wonder carmakers are piling in. Suzuki, Toyota, Nissan, Honda, GM, Daihatsu and BMW are all either expanding

A pedestrian paradise

operations in Indonesia or starting new ones. Since the beginning of 2011 these seven companies have announced investments in Indonesia totalling $2.2 billion, a record. "China and Indonesia are the two hottest markets in Asia right now," says Michael Dunne, the author of "American Wheels, Chinese Roads: The Story of General Motors in China". This worries the government. From June 15th Indonesia's central bank says it will require those who borrow money from a bank to buy a car to make a minimum downpayment of 30%. For motorbikes, the figure will be 25%. Housebuyers will also have to make a minimum deposit of 30%. The new rules are intended to prevent a potential bubble in consumer credit. Carmakers are aghast. Roughly 65% of sales of new cars are on credit, estimates Mr Dunne; for motorbikes, it may be even higher. A lot of buyers need wheels to get to work-public transport in Indonesia is patchy. Many cannot afford a 25% or 30% downpayment.Jongkie Sugiarto of the Association of Indonesian Automotive Industries, a trade group, urges the central bank to reconsider. "Otherwise the market will collapse," he says. Some Indonesians would not mind if it did. They blame carmakers for Jakarta's traffic jams. The number of cars is growing ten times faster than the roads they roll on; city officials in 2009 predicted that the Indonesian capital could experience total gridlock by 2014. According to Mr Sugiarto, the Jakarta Governor's Office has suggested that carmakers address this by producing fewer wheels. That is dandy for people who already have cars; others might prefer Indonesia to build more roads. â&#x20AC;˘

68 Business Solar tariffs

Sunspots

The Economist May 26th 2012 Recruitment

Worl< and play NEW YORK

The gamification of hiring American tariffs on Chinese solar panels are dangerous and pointless OLAR energy is at a delicate, maybe historic, moment. The cost of the glassy S photovoltaic panels that generate most solar electricity-by freeing electrons from a semiconducting material such as silicon-is plummeting. In the past four years their average cost has fallen by more than 75%. At less than $1 per watt of generating capacity, solar is now the cheapest power source in some sunny places, especially those, like India, that lack fossil-fuelled alternatives. This is starting to look like a revolution. Everyone who wants a reliable and nonpolluting energy supply, you would think, would welcome that. But on May 17th America's Commerce Department slapped a provisional tariff of 31% on 61 Chinese makers of solar panels, including some of the cheapest in the business. Another group of unnamed Chinese solar companies, which failed to respond satisfactorily to the department's inquiries, were hit with a 250% tariff. These duties, which are expected to be confirmed in October, were in response to an antidumping complaint from seven solar firms including SolarWorld, a German company with operations in America. China's panelmaking industry has seen explosive growth, fuelled by strong demand, mainly from Europe, but also by soft loans from state-owned lenders. Chinese panelmakers are reckoned by Bloomberg New Energy Finance (BNEF), a research firm, to be able to make panels for around 10% less than the industry's average cost. They have undercut European and American producers: between 2009 and 2011 the value of American imports of cheap Chinese panels soared from $640m to $3.1 billion. This has brought misery to higher-cost producers, which a recent slowdown in demand for solar panels, caused mostly by reductions in European and American subsidies, has greatly exacerbated. Many solar firms, Chinese and otherwise, are now furiously selling inventory-the bane of an industry where prices are falling-at a loss. Some have gone bust, including recently a clutch of once-pioneering German firms such as Solarhybrid, Solon, Solar Millennium and g-Cells. The American tariffs, if confirmed, will annoy Chinese panelmakers-and perhaps a wide array of American exporters, too, if China's "strongly dissatisfied" government launches retaliatory measures. But they are unlikely to save many West-

HE rules of Happy Hour are decepT tively simple. You are a bartender. Your challenge is to tell what sort of drink each of a swelling mob of customers wants by the expressions on their faces. Then you must make and serve each drink and wash each used glass, all within a short period of time. Play this video game well and you might win a tantalising prize: a job in the real world. Happy Hour, which will be unveiled to the public on May 28th, is one of several video games developed by Knack, a start-up founded by Guy Halfteck, an Israeli entrepreneur. The games include a version of Happy Hour in which sushi replaces booze, Words of Wisdom (a word game) and Balloon Brigade (which involves putting out fires with balloons and water). They are designed to test

Not everyone is equally competent

ern solar firms. The tariffs were long mooted (though they are even higher than expected), which has allowed Chinese exporters to build large inventories in the United States. Some developers of American solar projects have also signed precautionary deals, committing their Chinese suppliers to covering the cost of the mooted tariffs. The most integrated Chinese solar firms, such as SunTech, the world's biggest panelmaker, could probably stomach this, because panels represent less than a quarter of the cost of installed solar generating ea-

cognitive skills that employers might want, drawing on some of the latest scientific research. These range from pattern recognition to emotional intelligence, risk appetite and adaptability to changing situations. A pilot now under way with students at Yale combines the results of games with academic grades. As little as ten minutes of play can yield enough data to predict performance, says Mr Halfteck. Knack combines three fashionable trends: gaming, the use of massive amounts of data and the application of behavioural insights from science. According to Chris Chabris of the Centre for Collective Intelligence at MIT, a member of the Knack team, games have huge advantages over traditional recruitment tools, such as personality tests, which can easily be outwitted by an astute candidate. Many more things can be tested quickly and performance can't be faked on Knack's games, he says. The two biggest challenges, according to Mr Chabris, are ensuring the games are fun to play and convincing recruiters, who typically make no attempt to measure cognitive skills, to pay attention to these new data. Some firms seem to see the potential. The GameChanger unit of Shell, which seeks out new disruptive technologies for the oil giant, is about to test if Knack can help it identify innovators. Bain & Company, a consultancy, is to run a pilot: it will start by getting current staff to play the games, to see which skills make for a successful consultant. (The ability to charge a lot for stating the obvious is presumably not one of them.) "If someone can materially improve our ability to select the best talent, that is worth a lot to us," says Mark Howorth, a recruiter at Bain. And if not, at least the process will be fun. pacity. Financing, installation and other infrastructure costs account for the rest. They will also look to make or buy panels in other Asian manufacturing hubs, such as Taiwan and South Korea. These panels will not be subject to the tariffs, even if they are assembled into solar modules in China. Whatever the legal merits of SolarWorld's complaint, America will help neither the planet nor its own domestic consumers by shutting out Chinese solar panels. And, predicts BNEF's Nat Bullard, the tariffs will not even do much to protect American solar firms. â&#x20AC;˘

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The Economist May 26th 2012

70 Business

Schumpeter I The wheel of fortune The latest crop of bosses will have short and troubled tenures

OR a company, no decision matters more than picking the F right chief executive. A good boss can turn a so-so company into a scorcher. A bad one can turn a successful firm into a flop. Last year about 350 of the world's 2,500 biggest public companies appointed a new head honcho. What is to be expected from this brave new band of bosses? Booz & Company, a consultancy, has produced an annual survey of CEO turnover in these firms for the past 12 years. The latest survey offers a welcome chance to speculate. The omens do not look good. In appointing the boss class of 2011, company boards appear to have made two big bets. The first is that the world economy is about to grow briskly. Judging by the past decade's data, companies tend to hold on to their chief executive when the economy is doing badly and appoint a new one when they feel that spring is in the air. In 2011 they appointed a lot of new bosses. A hefty 14.2% of firms made a change at the top, up from 11.6% the previous year. The second bet is on hiring from outside. Outsiders are 22% of the class of 2011-a big increase from the 14% in 2007 and a sharp reversal of a decade-long trend towards recruiting insiders. There are many possible explanations for this. Perhaps companies now think that breadth of experience matters more than depth. Perhaps they think that outsiders will be better at managing the convergence of different industries: a retailing company might gain an edge by recruiting somebody with a background in information technology, for example. Both bets look rash. First, the economy. The euro crisis has paralysed Europe. America's recovery has proved shakier than expected. And growth in the BRIGs (Brazil, Russia, India and China) is slowing. Storms are brewing, and it is seldom wise to switch captains while waves are sweeping the deck. Second, the rush to hire outsiders. Booz's research has consistently shown that insiders do better, because they have a feel for how the firm actually works. A big firm is a complicated organisation. It has a culture that cannot be understood simply by reading the accounts. That is why a typical insider CEO lasts a year longer and produces better returns for shareholders: an average of 4-4% for insiders who left their jobs in 2009-11 compared with 0.5% for outsiders. Insiders are much less likely to be sacked, too.

The new bosses will receive intense scrutiny. Even their private lives are no longer off-limits: the boss of Stryker, a medical-devices firm, recently resigned after a kerfuffle over when exactly he should have told the board he was dating an employee. More important, the days when bosses could mark their own exam papers are gone. In 2011 only 14% of CEOs were also appointed to chairmanships; a decade earlier, 45% were. Boards are more professional (and more regulated) than ever before. More firms ask their outgoing CEO to become chairman: 37% of outgoing North American bosses and 63% of Japanese ones stay on as chairman. The idea is that the chairman will act as a mentor to his successor. But he may end up constantly second-guessing him. The new CEOS will have less room for mistakes than their predecessors. The professional life-expectancy of a chief executive has fallen over the past decade from 8.1 years to 6-4- It would have fallen further were it not for China, where bosses are lasting longer than they used to. (There are many more Chinese firms in the global top 2,500 than there were ten years ago.) Boards are showing more appetite for risk and less tolerance of failure. This could make for some swift defenestrations from the top floor. Bossicide is especially likely in Europe, where the economy looks darkest, where boards are the least forgiving and where a hefty 31% of incoming CEOs are outsiders. What can members of the class of 2011 do to succeed in such difficult circumstances? Booz has distilled some interesting advice from interviews with established CEOS. New bosses need to rearrange their senior teams quickly, to put allies into key positions and remove potential troublemakers (such as rivals who have been passed over or stick-in-the-muds who have outlived their usefulness). Andre-Michel Ballester, the boss of Sarin Group, an Italian medical-device maker, puts it neatly: you need to decide who are the "keepers" and who are the "leavers" in your first few weeks. At the same time, new bosses need to take a while to make strategic decisions. This is obviously true of outsiders, who need to learn the lie of the land. But it is also true of insiders, who need to learn that the view from the top can be very different from the view that they were used to as the head of a department or a region. A new CEO should not become a "superboss" of her previous territory. She must grasp that she has an entirely new job.

Find a spouse and a sparring partner The two most difficult things that new bosses have to deal with are isolation and pressure. The best antidote to isolation is to listen to the right people. Ian Livingston, the boss of BT (formerly British Telecom), says that the best source of advice is not a shareholder or a broker. Rather, it is a chief financial officer or a humanresources director, because these executives have an overview of the entire business. Several CEOS in Booz's survey talked about the importance of finding a "sparring partner"-someone you can shoot the breeze with without worrying that he is pursuing a personal agenda. The best antidote to pressure is to have a supportive family. Experienced cEos say that little can prepare you for the relentlessness of the pressure at the top, nor for the bewildering variety of jobs that confront you. There will never be a shortage of people jostling to be the boss. But the wheel of fortune is spinning more quickly than ever, and the knives and arrows are flying more thickly. â&#x20AC;˘ Economist.comfblogsjschumpeter

Also in this section 72 Buttonwood: Nationalised markets 73 Kotak, an Indian powerhouse 73 The trial of Raj at Gupta 74 The craze for collateral 74 Deutsche Bank's new bosses 76 Free exchange: US growth potential

For daily analysis and debate on economics, visit Economist.comfeconomics

Europe in limbo

Home and dry LONDON, MADRID AND ROME

Europe's weaker economies are in the grip of a worsening credit crunch

HE joke recounted by the boss of a large Italian bank is an old one, but it T captures the moment. Two hikers are picnicking when a bear appears. When one laces up his boots to run, his friend scoffs that he can't outrun a bear. The shod hiker retorts that it is not the bear he needs to outrun, merely his fellow hiker. "We're sitting at the picnic with our boots still on," says the bank boss. As policymakers and pundits try to work out the effects of a Greek exit, banks and investors have already been taking precautions. One course of action has been to pull money out of more fragile markets. Never mind the weakest economies like Greece, Ireland and Portugal; Spain and Italy have also lost foreign bank deposits of about €45 billion ($56 billion) and €1oo billion respectively from their

Once started Foreign holdings of government bonds, (peak)=100 -

Portugal(Feb2011)

Ireland (Apr2011) Spain (Dec 2010)

Italy (Jun 2011)

100

!t!t!

.a...J...L.J.J....L.W...

2 4 6 8 10 12 14 16 18 20 22 24

Months after peak Source: Citigroup

peaks. Add in things like sales of government bonds by foreigners (see chart 1), and capital flight is probably equal to about1o% of GDP in those countries, say Citigroup analysts. Such outflows are hard to stop. The European Central Bank (ECB) has filled this funding gap by providing liquidity to the banks. But that has in turn reinforced the second precautionary tactic: matching assets and liabilities within countries as much as possible. It is a common refrain from bankers that the euro area no longer functions as a single financial market, although that has the paradoxical advantage of making a break-up less destructive. Banks have used ECB loans to borrow from the national central banks of the countries in which they have assets; that should mean that both sides of the balance-sheet would get redenominated in the event of a euro exit. Much of that ECB liquidity is meant to find its way into the real economy, of course. But the third precautionary technique, for both lenders and borrowers, is to hang fire while uncertainty is so high. The Economist has compiled a creditcrunch index, comprising a number of measures on everything from bank lending to the cost of buying insurance against default for banks, firms and sovereigns in the euro zone. A single index disguises big differences between weaker and stronger states, but it shows that credit is crunchier now than it was at the height of the banking crisis in 2008 (see chart 2). Much economic activity is being stran-

gled as a result. In Spain firms have put bond issues and asset sales on hold. Volatility makes it almost impossible to value an asset, bankers say. The Catalan government failed to sell 26 buildings in Barcelona earlier this year for about €450m because one of the bidders wanted to introduce a clause that said rents would be paid in dollars in the event of a euro break-up; the other bidder pulled out because it had been told by headquarters to hold off on deals in southern Europe. The number of Spanish companies filing for bankruptcy climbed by 21.5% in the first quarter. Nearly a third of these were in the property or construction industries, but the rot is spreading. Alestis, an aeronautical supplier to aircraft manufacturers, filed for bankruptcy earlier this month after failing to reach an agreement with banks to refinance its debts. The sound of credit crunching can also be heard next door in Portugal, where loans to non-financial companies fell by 5% in the first quarter compared with the same period last year, and credit to households by 3.6%. One of the conditions of the country's bail-out programme is that banks should reduce their total loans to 120% of assets. The quickest way to do that

Throttled Euro-area credit-crunch index* Maximum distress= lOO

2007 Sources: Bloomberg; ECB; Markit; The Economist

*Five-day moving average of six normalised indices on bank lending, Euribor-OIS spread, €-$ swap spread and five-year credit-default-swap spreads for financial, industrial and sovereign sectors

72 Finance and economics ~ is to

avoid making loans. Conditions are little better in Italy. The province of Varese, near Milan, is a manufacturing heartland: its factories make plastics, textiles and a range of engineering products. Once firms there griped about poor infrastructure and red tape; now the credit squeeze is their main complaint. The local bosses' association says that 40% of firms were hit by lowered borrowing ceilings between January and March, and 15% were told to pay back loans. Banks turned down 45% of requests for new funding. Those loans that are extended carry hefty interest rates, in part because higher

The Economist May 26th 2012

sovereign-borrowing costs have a knock-on effect on banks' funding costs. Differences in sovereign rates can be selfreinforcing, especially when German firms across the border are rivals. "A marginal northern Italian company competing against an equal company in Bavaria will go bust," says the boss of one bank. "Then the cost of risk goes up and has to be shared by all the other small companies." If firms cannot borrow from banks they lengthen payment terms to their suppliers, exacerbating the credit problem, says Michele Tronconi of Sistema Moda Italia, a body representing textiles and clothing

firms. Fashion is Italy's second-largest export industry, but no sector has a higher level of non-performing loans. This credit squeeze will have tightened since Greece's inconclusive election this month. That further dents growth prospects: estimates by Now-Casting, a forecasting firm, suggests that euro-zone GDP will contract by 0.2% in the second quarter. That in turn risks worsening the debt dynamics of the zone's peripheral countries at just the wrong time. Policymakers keep trying to buy time to solve the crisis, but they may be only speeding the end they are trying to avoid. •

Buttonwood I The rise of the financial-political complex ACH step taken by the authorities over the past five years has been designed to prop up the economy and save the financial system. But the cumulative effect has been the creeping nationalisation of markets. Central banks are the biggest players in many rich-world governmentbond markets. Equity markets seem to perk up only when central banks are expanding the money supply. And banking systems are incredibly reliant on implicit or explicit government support. Banks first. They exist to channel funds from savers to borrowers, traditionally from the household sector to companies. But modern banks raise funds not just from retail deposits, but also from the markets. Until 2007, European banks were able to borrow more cheaply from the markets than the better corporate borrowers (those rated investment grade). But for the past five years banks' borrowing costs have been consistently higher than those of non-financial firms (see chart). This raises huge question-marks over the banks' role as intermediaries. These funding pressures have been relieved by massive amounts of liquidity from central banks, most recently through the European Central Bank's long-term refinancing operation. The effect is that private-sector funding has been replaced with official lending. Central banks have been "lenders of last resort" for banks since the mid-19th century. But these were generally shortterm loans made at moments of panic. The ECB has lent a staggering €1 trillion ($L3 trillion) on a three-year basis. The hope is that these loans can be refinanced via the private sector in 2014 or 2015. That may be too sanguine. The funding woes of banks are already almost five years old. Loans from the official sector are being used to reduce the impact of private-sec-

The natural order reverses Euro-area bond spreads over sovereign bonds Basis points

600 500 400 300 200 100 +

0 100 2000

Sources: Thom son Reuters; The Economist

tor capital flight. Matt King of Citigroup estimates that €100 billion of capital left Spain in 2011, and €160 billion left Italy, largely as foreigners withdrew bank deposits or sold government bonds. European cross-border capital flows are cleared through the ECB. The net effect is that several countries are substantial debtors of the ECB, while Germany, Finland and Luxembourg are net creditors. The bond market has never been fully free of central-bank influence: expectations about the future level of short-term rates have always influenced yields. But the Federal Reserve has said that it will keep rates at current low levels until late 2014, an unprecedented commitment. Central banks have been putting downward pressure on yields through quantitative easing (QE) programmes. These are substantial: the Bank of England owns almost a third of the gilt market. The effect is that yields are not set solely by the balance of supply and private-sector demand. Nor is this the only rigged market. Many countries are following policies that are explicitly (or implicitly) designed to drive the value of their currencies down. And the

authorities are helping to prop up share prices: Ben Bernanke, chairman of the Fed, has welcomed a higher stockmarket as a side-effect of QE. As a result it is difficult to say what message the markets are sending. Do low bond yields show that investors are endorsing Britain's deficit-reduction programme, for example? Or do they mean that the government has plenty of room to ease fiscal policy and borrow more? Thanks to QE, it is hard to be sure. Banks have also been big buyers of government bonds in the past couple of years because of the "carry trade": they can borrow money from the central banks at low rates and lend it back to their domestic governments at a higher yield. In effect, this is a disguised subsidy to the banking sector. Banks may buy even more government bonds in future because international regulations assign a low capital charge to government debt and because banks will be required to hold a store of liquid assets, of which bonds will be a big part. So the government stands behind the banking system, and in turn the banks are big buyers of government debt. This financial-political complex is reinforced by the general unwillingness of governments to let banks go bust. Better to intervene so heavily in markets, the argument runs, than do nothing and repeat the mistake of the Depression. Maybe. But history suggests that once governments get involved in a sector, they find it hard to withdraw. Given the weak outlook, it is hard to imagine the circumstances in which liquidity support for the banks will be withdrawn, or the policy of low interest rates abandoned. This is a new financial and economic era. Economist.comfblogsfbuttonwood

The Economist May 26th 2012 Indian banking

l{otal< moment

Finance and economics 73 The trial of Raj at Gupta

The insider NEW YORK

The prosecution of one of the corporate elite gets under way MUM BA!

At last, a bank that didn't fall victim to Goldman envy

N1993 two Goldman Sachs partners,Jon Corzine and Hank Paulson, who both later ran the bank, were hosting a dinner in Hong Kong and needed a guest who could talk about India. They invited a relative unknown, Uday Kotak, whose firm financed cars and discounted bills there. Three years later the two firms formed an Indian investment-bankingjoint venture. In March of this year Goldman's board met in India for the first time. Invited to the shindig were the big beasts of India Inc. Among them was Mr Kotak, now boss of a leading bank and a multibillionaire. "My objective is to build something sustainable that lasts 100 years," says Mr Kotak, who is upbeat without being hyperbolic, not a trick all Indian tycoons manage. Kotak Mahindra Group's rise mirrors that of India. The bank was born in 1985, and although it thrived in the insular India of that time it was quick to seek foreign expertise as the economy opened up after 1991. As well as befriending Goldman, it also struck a car-financing pact with Ford. Kotak bought out the partners in both these ventures in 2005-06 as the India boom took off. By that point its investment bank had become a powerhouse capable of taking on the bulge-bracket firms (indeed, Goldman has never hit its stride in India since the venture ended). By March 2007, before the global crisis struck, investment banking made up 6o% of earnings. There has been a startling change of colours since then. Kotak correctly judged that India's investment-banking scene would slump as too many firms chased a smallish and shrinking revenue pot. And it chose not to go global. Although some emergingmarket firms, such as BTG Pactual of Brazil, harbour such ambitions, Kotak lacked muscle and in any case, says Mr Kotak, "the jury is still out" on the Anglo-Saxon style of capital-markets-led banking. Instead Kotak focused on India and on lending. In the year to March 2012, four-fifths of pre-tax profits came from lending. Profits have more than tripled since 2007. The shift was not all luck, the bank says. Its roots are in small-ticket lending to middle India, not supping with too-big-to-fail types. The firm's eo-managing directors, C. Jayaram and Dipak Gupta, have both spent two decades at the bank and predate the investment-banking adventure. Retail loans are mainly collateralised, and used to finance purchases of cars and houses. Wholesale loans are aimed at semi-rural

VOU can almost hear the boardrooms

.l shuddering. The trial of Raj at Gupta, a former managing director of McKinsey & Co, a consultancy, and a ubiquitous figure in the executive offices of private and public institutions, got under way this week inN ew York. Mr Gupta is accused of insider trading. He denies the charges, but the trial is enough in itself to invite questions about the way lots of business is done. To the prosecution Mr Gupta was the ultimate insider, a man on the board of Goldman Sachs and Procter & Gamble who betrayed both, passing on vital information about deals that affected their value to Raj Rajaratnam, a hedgefund manager with whom Mr Gupta had invested and who was found guilty of insider trading last year. In Mr Gupta's defence, his lawyers said the government lacks "real, hard, direct evidence". Yes, information may have slithered illicitly into the market, they suggest, but there were many other possible channels. Take the prosecutors' assertions that Mr Gupta had called Mr Rajaratnam after an emergency 2008 Goldman board meeting where he learned that Warren Buffett's Berkshire Hathaway would invest $5 billion, allowing Mr Rajaratnam to buy shares before the deal was announced. In response, Mr Gupta's lawyers noted there was no recording of the call, and that Mr Rajaratnam had other strong relationships at Goldman that could have been a source. Similar arguments over three other transactions will take place in the course of the trial. Its outcome will also rest on a request from Judge ]ed Rakoff for the opposing lawyers to submit a definition that the jury will use for insider trading, a notoriously murky law. Mr Gupta's team said the prosecution must prove that "Mr Gupta knowingly, intentionally and wilfully breached his fiduciary duty as a director" and "knowingly and intentionally entered into an bits of India and skewed towards purchases of vehicles and equipment. Kotak has shied away from the big infrastructure projects that are hurting other banks. Gross bad debts and restructured loans are a low 1.2% of the total, despite fast growth. As well as a weak economy, there are potential sources of disruption. New banking licences may be awarded to politically connected industrialists. And Indian banking is due for a bout of consolidation.

unlawful agreement with Mr Rajaratnam." The prosecutors offered a lower hurdle: that Mr Gupta "anticipated some kind of benefit, directly or indirectly, however modest, from providing Rajaratnam with the inside information." Which way Mr Rakoff leans may well determine the verdict of the jury. It is extraordinarily hard to prove a knowing, intentional and wilful breach of anything, but not so hard to prove a benefit, however modest. Whatever the jury decides, the trial will have wider ramifications. Mr Gupta is almost a parody of Davos man, with a vast and influential network of contacts. That is usually seen as a personal and professional virtue, particularly in a business like consulting, but only if there is trust at the core of each relationship. By casting doubt on the confidentiality of such relationships, even at the very highest levels of corporate life, the trial raises questions that are beyond any courtroom to resolve.

Rainmaker no more? Both events may be a year or two away, but will still probably come under the watch of Mr Kotak, who owns 41% of the firm. At 53 he has no plans to retire, and wants his family to retain a chunky stake in the long term. That may be no bad thing. Continuity is part of the magic formula. And, unlike some well-known Wall Street firms, there is little sign of hubris. "All of us have middle-class values," says Mr Kotak. "We never wanted to be grandiose." â&#x20AC;˘

The Economist May 26th 2012

74 Finance and economics Collateral management

Security services NEW YORK

Rising demand for collateral spells a moneymaking opportunity OLLATERAL acts as the financial equivalent of oiling the cogs C of global markets by providing lenders wn-40,

with some security in the event of a default. Demand for it is rising. Regulators are pushing over-the-counter derivatives towards central counterparties (ccPs), which are usually pickier than banks about the quality of collateral they will accept. Creditors are becoming warier about lending on an unsecured basis when things are so uncertain. That creates a vicious circle: as more borrowing is secured, fewer assets are available to other creditors in the event of default. A recent report by Morgan Stanley and Oliver Wyman suggested the move to clear derivatives trades alone could generate demand for $soo billion-$8oo billion of extra collateral. But there is a finite supply of safe assets, and that pool is dwindling as the creditworthiness of certain governments becomes more questionable. Many pension schemes, insurers and asset managers balk at the drag on returns associated with holding lots of safe assets to post as collateral. The only solution is to shake every last drop of wn-40 from the can. One technique is "collateral optimisation", a way of ensuring that safe assets are deployed as efficiently as possible. This means making sure high-quality government bonds, say, are not needlessly tied up as collateral for trades where lower-quality assets would be acceptable. It also means clearing trades in a manner that lessens collateral requirements-for example, by bunching transactions in a single CCP so that offsetting trades result in a reduction in overall margin requirements. Big banks and asset managers will have to do a better job of keeping track of margin requirements and the available stock of eligible collateral they have. The spreadsheets and e-mails previously used to monitor and communicate collateral requirements may be ditched in favour of dedicated applications. Smaller outfits will seek outside help. Investment banks are spending tens of millions of dollars on building sophisticated systems for managing client collateral. Banks and custodians will battle it out to provide a variety of collateral-related services in future, with third-party vendors and even CCPs themselves also vying for business. At a price, some firms may be able to wash their hands of the requirement to hold a portfolio of eligible assets altogeth-

er. "Collateral transformation" directly addresses a firm's shortage of safe collateral by, in effect, swapping a riskier asset for one that can be posted as margin. The service amounts to a repurchase, or "repo", transaction: an entity like an asset manager hands a bank a corporate or mortgagebacked bond and the bank supplies government bonds or cash in return. These assets can then be posted at a CCP on behalf of the asset manager. Banks may not have enough safe assets of their own to satisfy widespread demand from asset managers, pension funds and the like, so they may seek to broker

deals with others. Strong demand for safe assets could produce an attractive return for firms that have excess cash to lend out, particularly if low interest rates persist. Yet the use of collateral transformation on such a wide scale also carries risks. Firms that lend out safe collateral will need to apply rigorous haircuts on the riskier collateral they accept to ensure they have ample security if a counterparty implodes. Otherwise there is a chance that lenders may find themselves on the hook for billions of dollars of margin in the middle of a market meltdown. Even the search for a safer form of borrowing entails dangers. â&#x20AC;˘

Deutsche Bank

Two's company FRANKFURT AND LONDON

Hard questions loom for the new bosses of Germany's national banking champion THE entrance to Deutsche Bank's LonIinNdon office is a giant silver ball with a hole the middle that offers an inverted reflection of the viewer and bank. The sculpture, which is called "Turning the World Upside Down m", is a fitting metaphor for the changes sweeping the banking industry. Deutsche itself has had a good crisis, eschewing direct help from the German government and rebuilding its balance-sheet to regain its place as the biggest bank in Europe by total assets (see chart 1). Yet its world is turning upside down, too. The most obvious upheaval is in the executive suite. On June 1st two new eo-chief executives, Jiirgen Fitschen and Anshu Jain, will take over fromjosef Ackermann, who has run the bank for a decade. Mr Fitschen, the boss of Deutsche's German operations, is a far less controversial figure than Mr Jain, an Indian-born, Americaneducated British citizen who has propelled Deutsche's rise in investment banking. Mr Jain's elevation is a remarkable one in a corporate culture as crusty as Germany's: most bosses are either German or native

German-speakers from Switzerland or Austria. His appointment has also provoked a backlash from an "old guard" within Deutsche who fear the growing influence of the investment bank, which is based almost entirely in London and is staffed largely by non-Germans. Yet the focus on Mr Jain is a distraction. The bank's biggest task is not to convince Too big to screw up Total assets, â&#x201A;Źtrn 2.5

â&#x20AC;˘

Deutsche Bank Barclays

BNP Paribas

2.0 1.5 1.0 0.5 0

2000

Source: Bloomberg

10 11

The Economist May 26th 2012 ~

investors that it has the right executives in place-big investors and fund mangers see the new team as more shareholder-friendly than the old one. It is to prove that it has enough capital and liquidity to satisfy regulators and that it can adapt its business model to a topsy-turvy landscape. Start with capital. Deutsche has total assets of close to €2.1 trillion ($2.7 trillion), and total equity of €56 billion. In terms of simple leverage, the bank has just €1 in equity backing every €38 of assets. The bank argues that these figures are misleading. By netting off derivatives that offset each other and making a few other adjustments, it calculates its leverage ratio at 21 times, still considerably higher than most peers in Europe and America. Like other banks, Deutsche also argues that a simple leverage ratio is not much use in assessing the risks that lenders take. So a second measure to consider is its levels of riskweighted assets (Rw As), in which the size of the balance-sheet is adjusted to reflect its riskiness. Using RWAS as a lens is like looking at Deutsche Bank through its lobby sculpture, with the picture turned on its head. On this view Deutsche is a midsized and reasonably well-capitalised bank, ranking just eighth in size in Europe. Deutsche's risk-weighted assets are calculated to be a mere 17% of its gross assets, compared with 53% at JPMorgan Chase and 25% at Barclays. Different accounting standards and the high quality of German corporate and mortgage lending explain some of this gap, but not all. "Deutsche is the most complex institution I have to deal with," confesses one banking analyst. The question many investors ask is which of these two pictures is more accurate. Part of the answer is already being provided by regulators, who are tightening the definitions of what counts as core capital, capping total leverage and carefully scrutinising the risk-weightings that banks apply. The bank itself reckons that, were it to apply the new Basel 3 rules in full next year, instead of when legally required to do so by 2019, it would have a core Tier-1 capital ratio of 7.2%. That looks skimpy. The bank says it would have plenty of time to build up capital through earnings or that it could take steps to free up capital through asset sales. Still, the risk on many investors' minds is that the new team may be pushed into issuing shares at a deep discount to its book value. Regulators are also getting tougher on liquidity. Deutsche's home regulator is BaFin, the German financial watchdog, but its biggest and riskiest trading operations happen in its London branch. Those close to the issue say that Britain's Financial Services Authority (FSA) frets that it does not have enough direct control over Deutsche's London operations because of European Union branching rules. BaFin ap-

Finance and economics 75

Comparative advantage Five-year credit-default-swap spreads Deutsche Bank less peers*, basis points

~~d~~~·------~~----~--- 0

25 50

100 125 I 11' !!'

2007

lqp!!HI!

Sources: Markit; The Economist

'" " " ' "' "' "'"" '"

"" "' ""

150

*Bank of America , Barclays, BNP Paribas, Citi, HSBC, JPMorgan Chase and UBS

proves Deutsche's internal risk models, of which it has little other experience since Deutsche is the only complex bank it supervises. Regular trilateral sessions with the New York Federal Reserve and the FSA are supposed to give comfort on this score, but the FSA is haunted by the collapse of Lehman Brothers in September 2008, during which $8 billion of liquidity flew to America under the nose of supervisors. The FSA and Bank of England are trying to exert greater control by using their power to set requirements for branch liquidity. Fitschen for purpose? As well as convincing regulators on capital, the new team will have to convince shareholders about its business model. Investment banking has been the engine of profits in recent years, but this is the bit of banking where new rules bear down particularly hard (and may bite even harder if Germany were to consider a separation of retail and wholesale activities). In their defence, Messrs Fitschen and Jain can point to two strengths. First, Deut-

Dual passports

sche was quick to appreciate that many areas, such as foreign-exchange and interestrate swaps, were becoming volume (or "flow") businesses where scale and low costs were paramount. By investing in IT systems to reduce transaction costs, the bank has been able to gain market share. Yet the process of consolidation is well under way; further gains will be harder. A second strength has been the bank's domicile in Germany, which has the lowest borrowing costs of any of the big economies within Europe: on May 23rd Germany auctioned a two-year bond with a coupon of precisely zero. Partly as a result of being in Germany and partly because it is viewed as too big to fail, Deutsche Bank is seen as having a lower risk of default (see chart 2) than its peers. That translates into lower funding costs for its investment bank. "Can you hold it against us that we're in Europe's safest economy?" quips one executive. Despite these strengths, Deutsche's new bosses will need to rebalance the bank's earnings towards less racy areas such as retail and commercial banking. The bank has a long-standing ambition to earn more than half of its profits from divisions other than investment banking, yet these units have struggled to grow quickly enough to keep pace with Mr Jain's empire. The full acquisition of Deutsche Postbank, which gives the bank a far larger retail presence in Germany, will help shift the balance. It provides the scale for Deutsche to invest in computers and processing systems that, in theory at least, would allow it to build out a cost-competitive retail bank in neighbouring countries. The bank is also investing in its global-transactions service, which helps firms process payments and manage their finances abroad. This is a growing business, particularly in Asia, and one in which only a few big banks have the necessary scale to serve big multinational firms. A third area of focus needs to be on asset and wealth management. Both are lines of business that promise relatively stable income, but which Deutsche has yet to master. New chief executives usually have a honeymoon period in which they can reveal problems and blame them on the old management before having to prove their own worth. Mr Jain and Mr Fitschen may not have this luxury, given the acrimony surrounding their appointment, the impact of the euro crisis on confidence and familiar shareholder complaints over pay. They will be under immediate pressure to outline their plans to expand the divisions outside investment banking, while offering reassurance about levels of capital. Bankers on both sides of the Atlantic reckon that Deutsche is Europe's most credible competitor to America's universal-banking behemoths. But the new team is in a tougher position than that suggests. •

76 Finance and economics

The Economist May 26th 2012

Free exchange Humbler horizons I

America's economy is growing at an unimpressive rate. It may not be able to go much faster HEN the American economy emerged from recession three years ago, forecasters fell into two broad camps. Optimists W reckoned brisk growth would quickly return the economy to its long-term potential level of output, the maximum sustainable G DP that could be achieved with the capital and labour on hand. That would pull down unemployment and prop up inflation. Pessimists, however, predicted sluggish growth, persistently high unemployment and inflation that would slip ever lower as a result of unused capacity in the economy. What has actually happened since then has been a mixture of the two. Unemployment and inflation have moved in the directions that optimists expected. Since peaking at 10% in late 2009, the jobless rate has now fallen by nearly two percentage points. Core inflation, which excludes food and energy, dipped below 1% in 2010 but is now above 2%. Yet economic growth has averaged 2.5%, a rate more typical of the economy at full employment rather than when recovering from a deep bust. Economists advance several explanations for this dichotomy. The drop in unemployment may simply be mechanical, a snapback after employers fired workers too indiscriminately during the recession. Inflation has been underpinned by the indirect effects of higher commodity prices, rising rents and the influence of stable inflation expectations on prices and wages. Optimists say that GDP may be revised up later. But there is another, more troubling possibility: the crisis may have permanently dented America's productive capacity. If so, the "output gap" between the economy's current level of production and its potential level is much smaller than expected. Unemployment has fallen because there are fewer people available to work. Inflation is stable because there is less idle capacity to restrain prices. This would be bad news all round. America would be permanently poorer than would otherwise have been the case. The Federal Reserve would have less room to ease policy before inflation revives. More of the budget deficit would be structural, rather than the temporary result of a depressed economy. Policymakers do not embrace this scenario. Ben Bernanke, the Fed chairman, said last year that the crisis and recession had not left "major scars" on the economy's potential. Other countries' experience suggests he may be wrong. A 2009 paper* by the OECD, a think-tank, studied 30 developed countries and concluded that crises on average reduced the level of potential GDP by 1.5% to 2-4%. Severe crises-America's easily qualifies-

Hit, then miss GDP after crises*

US potential GDP, constant 2005 $trn

%below pre-crisis trend ; first year of crisis= 0

CBO estimates

knocked it back by nearly 4%. The International Monetary Fund, studying a much broader sample of crises, found that seven years after the onset of a banking crisis, GDP was on average still1o% below where its pre-crisis path would have put it. This is much greater than the impact of a currency crisis (see left-hand chart). What accounts for this stifling effect? Both the OECD and the IMF argue that crises stunt the three main ingredients of growth: capital, labour and innovation. First, by choking off the supply of credit and throttling sales, crises depress investment and thus productivity. Second, they leave prolonged high unemployment in their wake. Some workers lose their skills, which makes it hard for them to find jobs again. Others simply drop out of the workforce altogether, lowering labour-force participation rates. Third, and more controversially, the papers argue that crises undercut innovation, and the efficiency with which capital and labour are used, by interrupting the supply of capital to high-growth firms or by reducing spending on research and development. The upshot is a permanent reduction in the path of potential GDP. This does not necessarily mean a permanently lower growth rate: an economy whose trend growth was 2.5% before a crisis should return to that rate, but from a lower starting-point. Impotential Official forecasters are coming round to this way of thinking. The Congressional Budget Office has repeatedly revised down its estimates of America's output potential since 2007 (see right-hand chart). It reckons the output gap this year will be 5% of GDP; it would have been 10% had potential remained on its 2007 trajectory. A major factor in the revisions is the failure of labour-force participation to rebound since the recession ended. Back in 2007 the agency thought that the potential labour force would be 16om in 2012. The actual labour force in April was just 154m. Temporary factors explain some of this shortfall: discouraged workers have given up hunting for work because no jobs are available, and the young are staying in education longer. But much of the gap represents permanent departures from the labour force because of early retirement or workers going on disability benefit. Earlier this year, staff at the Federal Reserve also marked down their estimate of the country's potential GDP and the output gap in response to the surprisingly steep drop in unemployment. Details of the shift are not public, but a 2011 staff study sheds some light. The authors, Charles Fleischman and John Roberts, tease out the economy's potential by analysing how inflation, unemployment and other variables have behaved. They conclude that America's potential growth rate averaged just 1.8% from 2008 to 2010, far below the 2.5% that Fed policymakers generally cite as the long-term trend. Potential is an inherently slippery concept. Who is to say whether a former worker or a vacant factory will ever produce again? Nor is it written in a country's stars. How much potential is damaged will depend, in part, on how well policymakers prop up demand. The IMF notes that countries that responded to past crises with aggressive monetary and fiscal stimulus, structural reforms and rapid repair of their financial systems limited the loss of potential. American policymakers have tried to apply those lessons but not, apparently, hard enough. â&#x20AC;˘

8 1'

-1

Sources: IMF; Congressional Budget Office

2000

15 17

*Average of 88 banking and 222 currency crises

* Papers cited in this article are available at economist.comjuspotential12

Economist.comfblogsjfreeexchange

Also in this section 78 Ichthyosaurs and the bends 79 Bacteria and computer memories 79 The launch of the Dragon

For daily analysis and debate on science and technology, visit Economist.comfsdence

Experimental psychology

WEIRD,

The roar of the crowd

Crowdsourcing is transforming the science of psychology ACCORDING to Joseph Henrich and his ficolleagues at the University of British Columbia, most undergraduates are WEIRD. Those who teach them might well agree. But Dr Henrich did not intend the term as an insult when he popularised it in a paper published in Behavioral and Brain Sciences in 2010. Instead, he was proposing an acronym: Western, Educated, Industrialised, Rich and Democratic. One reason these things matter is that undergraduates are also psychology's laboratory rats. Incentivised by rewards, in the form of money or course credits, they will do the human equivalents of running mazes and pressing the levers in Skinner boxes until the cows come home. Which is both a blessing and a problem. It is a blessing because it provides psychologists with an endless supply of willing subjects. And it is a problem because those subjects are WEIRD, and thus not representative of humanity as a whole. Indeed, as Dr Henrich found from his analysis of leading psychology journals, a random American undergraduate is about 4,000 times more likely than an average human being to be the subject of such a study. Drawing general conclusions about the behaviour of Homo sapiens from the results of these studies is risky. This state of affairs, though, may be

coming to an end. The main reasons undergraduates have been favoured in the past are that they are cheap, and easy for academics to recruit. But a new source of supply is now emerging: crowdsourcing. Hivemind Crowdsourcing is a way to get jobs like deciphering images, ranking websites and answering surveys done for money by online workers. Several firms offer the service, including oDesk, CrowdFlower and Elance. But by far the most popular for scientific purposes is Mechanical Turk, which is run by Amazon and is named after an 18th-century chess-playing machine in which a human secretly moved the pieces. Mechanical Turk has more than soo,ooo people, known as Turkers, in its workforce. For the hard-pressed, cashstrapped psychologist, this is a godsend. Turkers, despite the fact that half of them have at least one degree, are willing to work for peanuts. (Their median wage is about $1.40 an hour.) Most, indeed, seem to regard the tasks they are set as more like a paying hobby than an actual job. And, crucially, they are growing more cosmopolitan with each passing year. Though 40% are still from America, a third are Indian and the rest come from about 100 other countries. That diversity means the "w" of

at least, can be dropped, and the

"I", "R" and "D" may often be dispensed

with as well. Of course, another bias-that of signing up for crowdsourcing-is introduced. But using Turkers instead of undergrads does offer some genuine diversity. One researcher who has taken advantage of that diversity is David Rand, a lecturer in psychology at Harvard University. He is using Mechanical Turk to reconsider the results of several experiments originally conducted mainly on students. In a recent study of moral decision-making, for example, he recruited hundreds of Turkers to repeat a classic thought experiment known as the trolley problem. This confronts its participants with a dilemma-a runaway railway trolley will kill a group of people unless the subject of the study chooses to push a single individual in front of it, in order to slow it down. Doing so will kill that individual, so the dilemma is whether to kill one person deliberately, or several through inaction. Dr Rand is unwilling to discuss the results of his re-run in detail, because they have not yet been formally published. But he will say that he found he could replicate the prior findings of trolleyology, as this branch of psychology is often known, only among the atheists in his sample of Turkers. Those with strong religious beliefs behaved in a dramatically different way, and such believers are more common among Turkers than Harvard undergraduates. This result suggests that other studies whose findings might be sensitive to religious belief need revisiting. Nor is religion the only area where this is true. Dr Rand is, for example, conducting another cross-cultural experiment, to see why Americans and western Europeans treat co-operation ~~

78 Sdence and technology ~

and punishment differently from people in other places. In this he is building on previous work, rather than breaking genuinely new ground. But he is also showing how crowdsourcing can permit psychologists to do easily and cheaply what was once complicated and expensive.

Many hands make light work Most researchers used to think the punishment of freeloaders was a universal human instinct that had evolved to promote co-operation. Studies in the West supported this belief. They showed that people band together to reward co-operative behaviour and to punish those who refuse to contribute to the common good. These experiments, which employed what are known as public-goods games to test individual choices, gave players money they could either contribute to the group, raising the value of everyone's stake, or hold for themselves, ultimately harming everyone if others refuse to co-operate. But they were lacking in two ways. One was their WEIRD participants. The other was more subtle. It did not occur to the experimenters to allow participants to punish co-operators as well as freeloaders, even though those who had been freeloading might wish to do so in revenge for having been punished themselves, in previous rounds of the game. But that did occur to Benedikt Herrmann of Nottingham university, in Britain. A few years ago Dr Herrmann ran a series of experiments designed to see how public-goods games would play out in 16 countries, not all of them rich and Western. This time, he allowed freeloaders to punish cooperators, a behaviour known as antisocial punishment. His results were striking. Most of the world, the experiments suggested, bears little resemblance to Harvard or, indeed, anywhere else in the West, where antisocial punishment is virtually absent. In places like South Korea, Greece, Russia and Saudi Arabia, antisocial punishment proved to be almost as common as collaboration. Dr Rand is re-running Dr Herrmann's experiments on Mechanical Turk-at a tenth of the cost of the original work. The early results, published last year in Nature Communications, suggest Dr Herrmann was right. Punishment did not evolve, as conventional wisdom has it, as a positive behaviour intended to encourage co-operation. Instead, it evolved as a self-interested weapon to fend off competitors, even when that competition is, in fact, a strategy Correction: In "Implicit promises" (May 19th) we said that Peter Davidson, a professor at Cambridge university, advised Britain's Engineering and Physical Sciences Research Council on matters of geoengineering. Or Davidson is, indeed, an expert in fluid mechanics, but he is not the Peter Davidson who advised the EPSRC. That Peter Davidson runs Davidson Technology, a consultancy based on the Isle of Man. Our apologies to both.

The Economist May 26th 2012

of collaboration. In places where rules and institutions do not protect co-operators, free loaders consistently dominate. Dr Rand's work is just a foretaste of what is possible. The ability to run experiments quickly, cheaply and globally promises to transform psychologists' understanding of human behaviour. Studies that would once have required months or years can now be done in days. Indeed, the technology of crowdsourcing itself may

be modified by psychologists' interest in it. Until recently, one constraint on the experiments was the inability of Turkers to interact with each other in real time. That problem has now gone. Siddharth Suri, of Microsoft's New York research laboratory, has solved it by writing a piece of software that allows as many as 6o Turkers to interact in real time-a number that is expected to rise in the near future. There are still plenty of kinks to be ~~

Ichthyosaurs and the bends

Triassic larl< It is extraordinary what you can tell from studying fossil bones

A diver surfaces too quickly, he may IhisFsuffer the bends. Nitrogen dissolved in blood is suddenly liberated by the reduction of pressure, just as the gas in a bottle of champagne is released when the cork is popped. The consequence, if the bubbles accumulate in a joint, is crippling pain and a contorted posturehence the name. If the bubbles form in his lungs or his brain, though, the consequence can be death. Other air-breathing species also suffer this decompression sickness if they surface too fast: whales, for example. And so, long ago, did ichthyosaurs. That these Mesozoic marine reptiles, contemporaries of the dinosaurs, got the bends can be seen from their bones. What can also be seen is a curious evolutionary tale-for not all ichthyosaurs succumbed. Bone is a living tissue, and if bubbles of nitrogen form inside it they can cut off its blood supply. This kills the cells in the bone, and consequently weakens it, sometimes to the point of collapse. Fossil bones that have caved in on themselves are thus a dead giveaway, as it were, of an animal that once had the bends. Bruce Rothschild of the University of Kansas knew all this when he began a study of ichthyosaur bones in order to find out how prevalent the problem was in the past. What Dr Rothschild particularly wanted to investigate was how ichthyosaurs-which, like whales, were descended from terrestrial animalsadapted to the problem of decompression over the 150m years that they roamed the oceans. To this end, he and his colleagues travelled the world's natural-history museums, looking at a total of 116 ichthyosaurs from the Triassic period (250m-2oom years ago) and 190 from the later Jurassic and Cretaceous periods (2oom-145m and145m-65m years ago, respectively). When he started, he assumed that signs of the bends would be rarer in younger fossils, reflecting their gradual

Bend me, shape me â&#x20AC;˘â&#x20AC;˘â&#x20AC;˘

evolution of measures to deal with decompression, such as the ability found in many whales to store lots of oxygen in their blood. Instead, he was astonished to discover the reverse. More than 15% of Jurassic and Cretaceous ichthyosaurs had suffered the bends before they died, but not a single Triassic specimen showed evidence of that sort of injury. If ichthyosaurs did evolve an antidecompression mechanism, then they clearly did so quickly-and, most peculiarly, they subsequently lost it. But that is not what Dr Rothschild thinks happened. As he reports in Naturwissenschaften, he suspects it was evolution in other species that caused the change. Whales that suffer the bends often do so because they have surfaced to escape a predator such as a large shark. One of the features of Jurassic oceans was an abundance of large sharks, and also of huge marine crocodiles, both of which were partial to ichthyosaur lunches. Triassic oceans, by contrast, were (from the ichthyosaur's point of view) mercifully shark- and crocodile-free. In the Triassic, then, ichthyosaurs were top of the food chain. In the Jurassic and Cretaceous, they were prey as well as predator-and often had to make a speedy exit as a result.

The Economist May 26th 2012 ~

ironed out. Like anything else on the intern et, those who use Mechanical Turk and its competitors are liable to spamming and to receiving answers from software "bats" pretending to be real people. And Turkers, despite being more diverse than undergraduates, are still a pretty skewed sample of humanity. In particular, they are younger and more liberal than people at large. Questions of ethics have also arisen. Some people think research projects which pay wages of less than $2 an hour are exploitative-even though that is the going rate for other Turker activities. Conversely, according to Karen Fort, of France's Institute of Scientific and Technical Information, at least one university has already prohibited the use of grant funds for this sort of study, for fear that Turkers could claim status as employees. For many researchers, though, the appeals of crowdsourcing-bargain prices, vast supply and enormous scale-are too attractive to ignore. Indeed, the new methodology might democratise the very practice of psychology, allowing those without a laboratory or university behind them to join in as well. Gabriele Paolacci, a marketing researcher at the Rotterdam School of Management who was once in precisely that position, has started a blog called "Experimental Turk" (experimentalturk.wordpress.com) to help draft guidelines for such freelance experiments. The revolution, then, has begun. So far, Google Scholar, a website devoted to academic matters, counts 3,000 published papers that involve crowdsourced experiments. Discussions at conferences, among psychologists, behavioural economists, political scientists, linguists and computer scientists, suggest that may be the tip of the iceberg. It would be an exaggeration to say that crowdsourcing has turned the whole world into a laboratory. But it has certainly made psychology a lot less WEIRD. â&#x20AC;˘

Sdence and technology 79 Nanotechnology

Afab result

A novel way of making computer memories, using bacteria OR half a century, the essence of progress in the computer industry has been to do more with less. Moore's law famously observes that the number of transistors which can be crammed into a given space doubles every 18 months. The amount of data that can be stored has grown at a similar rate. Yet as components get smaller, making them gets harder and more expensive. On May 10th Paul Otellini, the boss of Intel, a big American chipmaker, put the price of a new chip factory (known as a fa b) at around $10 billion. Happily for those that lack Intel's resources, there may be a cheaper optionnamely to mimic Mother Nature, who has been building tiny devices, in the form of living cells and their components, for billions of years, and has thus got rather good at it. A paper published in Small, a nanotechnology journal, sets out the latest example of the technique. In it, a group of researchers led by Sarah Staniland at the University of Leeds, in Britain, describe using naturally occurring proteins to make arrays of tiny magnets, similar to those employed to store information in disk drives. The researchers took their inspiration from Magnetospirillum magneticum, a bacterium that is sensitive to the Earth's magnetic field thanks to the presence within its cells of flecks of magnetite, a form of iron oxide. Previous work has isolated the protein that makes these miniature compasses. Using genetic engineering, the team managed to persuade a different bacteri-

um-Escherichia coli, a ubiquitous critter that is a workhorse of biotechnology-to manufacture this protein in bulk. Next, they imprinted a block of gold with a microscopic chessboard pattern of chemicals. Half the squares contained anchoring points for the protein. The other half were left untreated as controls. They then dipped the gold into a solution containing the protein, allowing it to bind to the treated squares, and dunked the whole lot into a heated solution of iron salts. After that, they examined the results with an electron microscope. Sure enough, groups of magnetite grains had materialised on the treated squares, shepherded into place by the bacterial protein. In principle, each of these magnetic domains could store the "one" or the "zero" of a bit of information, according to how it was polarised. Getting from there to a real computer memory would be a long road. For a start, the grains of magnetite are not strong enough magnets to make a useful memory, and the size of each domain (20 microns across) is huge by modern computing standards. But Dr Staniland reckons that, with enough tweaking, both of these objections could be dealt with. The advantage of this approach is that it might not be so capital-intensive as building a fa b. Growing things does not need as much kit as making them. If the tweaking could be done, therefore, the result might give the word "biotechnology" a whole new meaning. â&#x20AC;˘ There be Dragons At 3.44am on May 22nd the Dragon spacecraft breathed fire at last, blasting off from Cape Canaveral in Florida atop a Falcon 9 rocket. SpaceX, its maker, meanwhile, breathed a sigh of relief, along with NASA, America's space agency, whose cargo the capsule is ferrying to astronauts on the International Space Station (ISS). The successful launch follows months of delays caused by technical glitches, including an attempt on May 19th that was aborted with only half a second to go on the countdown clock, after excessive pressure built up in one of the Falcon's nine engines. If all goes to plan, on May 25th the Dragon, which settled into orbit 12 minutes after ignition, will have become the first private craft to dock with the ISS, ushering in a new era of space trucking.

Also in this section 81 A history of depression 81 The political waning of America 82 The economic waning of America 82 Biology and financial instability 83 The Barnes Collection

Prospero, our on line blog on books, arts and culture, appears every day. For analysis and debate, visit Economist.comfculture

The joy of walking

The wanderer's tale

Robert Macfarlane takes to ancient paths-and writes of place and pilgrimage

EADERS of Robert Macfarlane's previous books will not be surprised at how this one begins. Distracted on a snowy evening, unable to write, he leaves his house in Cambridge with a flask of whisky in his pocket, follows a field path, climbs a hill, finds a deer trail, tracks it through a hedge, comes upon rabbit prints, sees where they lead, and ends up lying on his back in deep snow, gazing up at the stars. Though a fellowship at Cambridge University's Emmanuel College ostensibly ties him down, this Boys' Own world is where Mr Macfarlane longs to be-in the mountains or the wilderness. He is torn between homing and roaming, but homing gets short shrift. To write this book he walked, by his own estimate, 7,ooo-8,ooo miles of paths: the prehistoric chalk tracks of England, the gneiss of the Isle of Lewis, the path that makes a kora, or sacred circle, round the pyramidal ice-mountain of Minya Konka in Tibet, a rocky forest branch of the road to Compostela and, most riskily, a network of wadi trails near Ramallah, in Palestine, under the eye of Israeli guards. He makes a strange, magical land-voyage (pictured) out along the shifting Broomway on the misty coast of Essex, where the watery silt mirrors his steps as if an ancestral double walks with him. Tenderly, he recounts a journey across the

The Old Ways: A Journey on Foot. By Robert Macfarlane. Hamish Hamilton; 433 路 Amenca 路 by pages; 拢 20. Tio be pu bt路1s hed m Viking in October; $26.95

Cairngorm massif to attend the funeral of his grandfather, also a hillwalker, and to lay a small posy of granite-grown flowers on his grandfather's favourite path. Along these trails he notices everything. The rock he treads on, whether quartz, feldspar, limestone or sandstone; the birds above him, whether exulting skylarks, hovering kestrels or a rising heron, "a foldaway construction of struts and canvas"; the foil or spoor of animals, and their eyes glowing orange or green in the dark (even spiders' eyes, he writes, show in the dark like tiny stars); trees, grass, fly-tipping, flowers. In an effort to get closer to the earth he sometimes walks barefoot, quite often coming a cropper. He ends up tweezering hawthorn spikes from his heels, or flossing sheep dung with grass from between his toes. Whereas walking is traditionally a solitary's delight, Mr Macfarlane often goes with friends, or makes appointments with strange characters obsessed with the land he moves through. In Lewis he meets Steve, who makes sculptures out of rock

and bones. In Madrid he calls on Miguel, who has fashioned books-cum-keepsake boxes of every walk he has done in the Guadarrama mountains. His most frequent companions, though, are ghosts, such as the Neolithic men, women and children who scampered or hunted across the mud near Form by in Merseyside, leaving their footprints behind, or the previous walkers who have dropped along his route the white stones that weave a connecting pattern through the book. In particular he walks with the tall, rangy, blue-eyed figure of a poet, Edward Thomas, whose tormented life first led Mr Macfarlane to pace the chalk of the "south country" in his shadow. The section on Thomas, towards the end of the book, feels slightly like an appendage. Expanded and interwoven with walking, it would make an extraordinary biography. But Mr Macfarlane's feet were obviously itching to go on, beyond, elsewhere. He does not pretend to have deep thoughts while walking. Walkers know it seldom happens that way. The tendency is to notice that tree, that stile, that passage of light (rionnach maoim, he tells us in a typically lovely aside, is Gaelic for "the shadows cast on the moor by cumulus clouds"). The priority is to pace the aching body. It is only later that the walker reflects that the process of walking is inward as well as outward exploration; that it is a way of connecting with his own past, as well as with the universal human past of crossing and recrossing the earth; and that even as the walker sculpts the landscape with his observing eye and tramping feet, the landscape in turn observes and shapes him. The word "learning", Mr Macfarlane notes, stems from liznojan, to follow a path, and ~~

The Economist May 26th 2012 ~

the word "write" from making tracks; when setting out, even on a familiar path, many walkers have imagined they may cross into visionary worlds. The acts of walking and wordsmithing are very close. As the pen rises from the page between words, so the walker's feet rise and fall between paces, and as the deer continues to run as it bounds from the earth, and the dolphin continues to swim even as it leaps again and again from the sea, so writing and wayfaring are continuous activities, a running stitch, a persistence of the same seam or stream.

Small complaints could be made. The middle section on sea-roads, while enjoyable, doesn't really fit; one senses here the inveterate explorer's unease with sticking to one subject, or one path. Several chapters cry out for maps; indeed, almost all do. But then Mr Macfarlane has always decried the use of maps, recommending instead the charts formed by memory, incident, fear or affection, and carried in our heads. Readers are invited, instead, to wander and lose themselves; and it is hard to think of a more pleasurable way to do so without leaving one's chair. •

Depression through the ages

Melancholy . JOUrney From Melancholia to Prozac: A History of Depression. By Clark Lawlor. Oxford University Press; 265 pages; $24.99 and £14.99

l '1 ]HAT is depression? The ancient VV Greeks believed it resulted from an imbalance in the body's four humours: blood, phlegm, yellow bile and black bile (from the Greek word melas or "dark" and khole, meaning "bile"), with too much of the latter resulting in a melancholic state of mind. Early Christianity blamed the devil and God's anger for man's suffering, with depression the result of the struggle against worldly temptations and sins of the flesh. In the Renaissance it was viewed as a disease of scholars, such as Robert Burton, author of "The Anatomy of Melancholy", who were given to abstract and intense speculation. In this well-researched book, Clark Lawlor of Northumbria University roams through the history and culture of depression and shows how attitudes to the illness have changed through the ages. He brings to life different schools of thought on the subject, and debates the role of the pharmaceutical industry in categorising and treating mental illness. The most thought-provoking part of the book covers the rise of the "new science",

Books and arts 81 when the focus on melancholia changed yet again. Much of this can be attributed to Emil Kraepelin, a German psychiatrist and eo-discoverer of Alzheimer's disease, who argued that biological pathology underlay each of the major psychiatric disorders. Kraepelin's work, however, was soon overshadowed by that of Sigmund Freud, whose conclusion that mental illness came from emotional causes, rather than physical ones, underpinned the rise of the psychoanalytical tradition in Europe and America in the 2oth century. These two views inform much of the continuing debate about the pathology and treatment of mental illness. For some, the illness is a medically treatable imbalance in brain neurochemistry-a serotonin deficiency-that can be remedied by selective serotonin reuptake inhibitors (SSRis) such as fluoxetine, better known as Prozac, which has been prescribed to more than 35m people worldwide since its launch in 1988. For others, depression comes about as a response to psychological damage, with the Freudian school of psychotherapy in particular linking this to how sufferers were nurtured in childhood. Today around 15% of people in developed countries suffer from depression, and the illness shows no sign of abating. The World Health Organisation's recent World Mental Health Survey Initiative, which interviewed 89,000 people, found that more than 120m people worldwide suffer from depression, and it is responsible for 850,000 suicides each year. Prescribing pills has become a popular treatment, in part because it is much faster than a course of psychotherapy, which can take months or even years. But research shows that a holistic approach that treats both body and mind through a combination of medication and talking therapy offers the greatest long-term benefits. The success of this approach would suggest that Kraepelin and Freud were both right after all. •

In the grip of the black dog

The political waning of America

Unconvincing Every Nation For Itself: Winners and Losers in a G-Zero World. By Ian Bremmer. Portfolio; 229 pages; $26.95 and £14.99

RAZIL and Turkey, once reliable backers of America's geostrategic goals, conB spicuously went their own way in 2010 when they sought to broker a deal with Iran over its nuclear programme, even as America pushed for new sanctions. Their new-found assertiveness was a product of both their growing economic weight and America's diminished clout. This is an example of what is in store for the world, predicts Ian Bremmer in "Every Nation For Itself". Countries like Brazil and Turkey want the status of a bigger global role. But they "balk at assuming the risks and burdens" that global leadership entails. Ideally a web of multilateral institutions and laws would impose order and hold wayward countries in line. But with America unable to afford, or unwilling to exercise, global leadership, and China still not ready to assume its responsibilities, there is no one to enforce these rules. In the 1960s President LyndonJohnson could divert a fifth of America's wheat crop to alleviate starvation in India. That could not happen now, when biofuels are aggravating food shortages and exporters hoard supplies for their own people. Global warming, nuclear proliferation and internet regulation are all harder to address, with the G7 and G20 supplanted by what the author calls the "G-Zero". MrBremmer, founder of Eurasia Group, a political-risk consultancy, specialises in big thoughts. His previous books tackled the path that developing countries travel from autocracy to democracy, and the growth of state-sponsored capitalism. "Every Nation For Itself" enters a more crowded field. Innumerable books and essays have already plumbed the consequences of America's loss, or possible loss, of global leadership, with the best providing either fresh insight or original reporting. Unfortunately, "Every Nation For Itself" does neither. It devotes endless pages to describing disparate arenas of global conflict, from cyberspace to water shortages, but these are largely a rehash of headlines and conventional wisdom. Their only purpose is to provide Mr Bremmer with repeated opportunities to assert that "in a G-Zero world" such conflicts can no longer be solved from above. Mr Bremmer is certainly right that a world without America's global leadership is a more dangerous place, but he overstates his case. Even when it stood ~~

82 Books and arts ~

alone as the world's superpower, America struggled to impose its will. In 1993 it pulled its troops out of Somalia when murderous warlords foiled its attempts to deliver food relief to the starving country. The global groups that Mr Bremmer imagines once ran the world were seldom that effective. The G7 occasionally influenced the direction of the dollar or the relations between rich countries and the emerging markets, but more often it issued anodyne, forgettable communiques. Neither America nor the multilateral institutions are as impotent today as Mr Bremmer claims. Brazil and Turkey failed in their negotiation over Iran's nuclear programme. The fact that Iran has been dragged back to the negotiating table and Myanmar is veering back towards democracy contradict Mr Bremmer's thesis that sanctions are becoming ever less effective. He is right that the World Bank and the International Monetary Fund have been weakened by China's growing power. But the opposite is true for the World Trade Organisation, whose clout has been enhanced significantly by the fact that both America and China abide by its rulings. "Every Nation For Itself" is a useful summary of current events. But as a guide to a complex world, it falls short. •

The economic waning of America

Myths large and small Time to Start Thinking: America in the Age of Descent. By Edward Luce. Atlantic Monthly Press; 292 pages; $26. Little, Brown; £20

Better, Stronger, Faster: The Myth of American Decline ... and the Rise of a New Economy. By Daniel Gross. Free Press; 272 pages; $26

HE recession has humbled the world's T largest economy. But the reversal of fortune also makes many Americans worry that the downturn is symptomatic of broader decline. One specific question: did the financial crisis mark the passing of the mantle of economic leadership from America to more boisterous economies, such as China and India? Edward Luce, a journalist with the Financial Times, amasses the evidence for decline in a new book, "Time to Start Thinking". Median incomes have scarcely risen in two decades, he notes. Innovative capacity is withering; more than half of American patents are now granted to foreigners. America's young people are poorly educated, and now rank 2oth or worse in international rankings of proficiency in science and maths. Its govern-

The Economist May 26th 2012 ment is venal, sclerotic and dangerously out of touch. Congress sits idly by while the nation's infrastructure falls apart. Meanwhile, firms are strangled by new regulations. Unless America abandons complacency and "starts thinking", he believes that steady decline looms. Such fears are not new. Mr Luce, a speechwriter for Larry Summers when he was President Bill Clinton's treasury secretary, quotes his old boss as arguing that "predictions of America's decline are as old as the republic ... as long as we're worried about the future, the future will be better." Yet Mr Luce also cites Mr Summers's support for unfettered markets and a hands-off state as a contributor to decline. America's economic rise was helped by high tariff barriers, aggressive public investment and active industrial policy-a very Chinese approach to growth. Now research at institutions such as the Defence Advanced Research Projects Agency, which contributed to the development of the internet and other innovations, is being neglected. Small wonder, he says, that America is in decline. Daniel Gross, economics editor at Yahoo! Finance and author of "Better, Stronger, Faster", takes a contrary view. The woes of an economy recovering from deep depression should not be mistaken for general decline, he argues. Nor is the rapid growth of relatively poor countries like China and India an indicator of American weakness or the superiority of more interventionist growth models. Asia's billions are simply catching up with American technology and living standards, and they have a long way to go yet. America's recovery may be disappointing, but it is better than the recovery in other places. America has done more than Britain on deleveraging, for example, and its corporate sector has been restructured more aggressively. The two authors seem to be describing different parts of the elephant. Mr Gross praises world-beating innovators like Facebook and Google. Mr Luce instead quotes old Silicon Valley engineers who yearn for an era of "hard innovation", of chips rather than apps. Occasionally their sources overlap. General Electric's chief executive, Jeffrey Immelt, complains to Mr Luce of America's lack of interest in proper industrial policy, whereas to Mr Gross he speaks of America's export prowess. The fact that existing industries would prefer more government support is neither surprising nor a sign of broad failure. In the end Mr Gross has the better argument. America's choking regulations are a problem, but less onerous than those in earlier, more optimistic moments. Its regulatory system often works better than those of other countries. Mr Luce cites the Food and Drug Administration's incompetence as a reason for worry, comparing it

unfavourably with European regulators. But it is in Europe that resistance to genetically modified food is stifling innovation. As Mr Luce admits, America is rising to the challenge. Its educational woes have provoked a push towards broad reform. It may yet prove more responsive to trouble than China or India, to say nothing of Europe. Certainly this will not be easy. There are worrying departures from the historical norm, notably in the distribution of the gains from growth. Congressional paralysis is also discouraging. Political leaders in Washington all see the need to let in more skilled immigrants, but they cannot agree on the detail. This makes reform hard if not impossible. America's great advantage, though, is that it has a private sector that is nimble enough to succeed when the state falls short. Its challengers may find this the most difficult strength to replicate. •

Biology and financial instability

The molecules of mayhem The Hour Between Dog and Wolf: Risk-Taking, Gut Feelings and the Biology of Boom and Bust. By John Coates. Fourth Estate; 310 pages; £20. To be published in America in June by Penguin Press; $27.95

HE financial crisis was caused by many things: greedy bankers, a glut of ChiT nese savings, shoddy regulation, an obsession with home ownership-take your pick. John Coates, once a trader on Wall Street and now a neuroscientist at Cambridge University, presents yet another culprit: biology, or, more precisely, the physiology of risk-taking. Financial traders, he says, are influenced by what is going on in their bodies as well as in the markets. Two steroid hormones-testosterone and

The Economist May 26th 2012 ~ cortisol-come

out in force during the excesses of bull and bear markets. Testosterone, "the molecule of irrational exuberance", is released into the body during moments of competition, risk-taking and triumph. In animals this leads to something called the "winner effect". A male that wins one battle goes into the next one primed with higher levels of testosterone, helping him to win again. Eventually, though, confidence becomes cocl<iness. The animal starts more fights and experiences higher rates of mortality. Mr Coates thinks the exuberance that turns a market rally into a bubble may be fuelled by the same chemical. Some of this is based on traders he knew who became ever more convinced of their own invincibility during the dotcom era. But he also offers harder evidence. In one experiment Mr Coates sampled testosterone levels in traders in London and found that higher levels of the hormone in the morning correlated with beefier profits in the afternoon. Such profits came from taking higher risks, not greater skill. Biology may also be responsible for worsening market sentiment in bad times. The body's response to prolonged periods of stress is to secrete increasing amounts of cortisol, a hormone that marshals resources to cope with crises. Sure enough, Mr Coates finds that cortisol levels in traders' bodies fluctuate in line with market volatility, even displaying a striking correlation with the prices of derivatives. A burst of chemicals can be helpful. Good traders seem to produce a lot of hormones, but only for short periods of time. The trouble comes when cortisol remains in the body for extended periods. Rational analysis becomes harder, allowing emotional responses to gain the upper hand; risk aversion grows as testosterone production is suppressed. "During a severe bear market," writes Mr Coates, "the banking and investment community may rapidly develop into a clinical population." One answer, he thinks, is to change the chemical make-up of trading floors by hiring more older men and, especially, women. Their bodies release far less testosterone. Women have the same levels of cortisol as men, but their stress response is triggered less by competitive failures and more by problems in their personal lives. That may make them more resilient when the markets turn against them. Mr Coates's thesis is not entirely convincing. The experimental data are too scarce and the distinction he draws between the masculine world of risk-taking traders and the more feminised world of asset managers skips over the fact that many supposedly cautious, long-term investors made poor bets in the boom. But it makes intuitive sense that biological responses inform the mood of the markets. This book puts flesh on that idea. â&#x20AC;˘

Books and arts 83 The Barnes Collection

A phoenix rises PHILADELPHIA

After decades of wrangling, the Barnes reopens

HROUGH the smoky lenses of his glasses, the eyes look rather wild. The T subject of this portrait (pictured) of a 1926

misanthrope by Giorgio de Chirico is Dr Albert C. Barnes. Chemist, businessman, educator and champion of equal rights for African-Americans, Barnes also assembled the greatest private collection of PostImpressionist and early modern art in America. Many people longed to see it; Barnes liked nothing better than to refuse, often adding an unprovoked insult. For instance, when T.S. Eliot wrote a note requesting a visit, Barnes scribbled "Nuts" before returning it. He built a mansion to house his collection in Merion, a smart suburb of Philadelphia, but kept out far more people than he let in. He was against catalogues, colour reproductions and any explanatory text on the walls. The Barnes Collection was simultaneously world famous and secret. Now all this has changed. After a long, bitter fight over its fate, the Barnes Foundation, the holder of the collection, is finally celebrating its move into the centre of Philadelphia. The new Barnes is a handsome, lowslung, stone and glass building surrounded by greenery and water. It is open to all. For the first time there is a cafe and a well-stocked shop that sells "Masterworks", a fat book full of colour reproductions from the collection. Lovers of the old Barnes feared that the move would destroy its magic. It has not. The surroundings are different, but the 24 art-filled galleries within are exactly as they were before-with one difference. Advances in glass technology allow the rooms to be flooded with natural light. The pinks now visible in Picasso's 1906 "Girl with a Goat", for example, are so vivid he might have applied them yesterday. Barnes made his fortune developing and marketing Argyrol, an antiseptic. He stayed rich by selling the company in 1929, before the crash. He began buying contemporary art even before the 1913 Armory show introduced the work of the modems to shocked Americans. And he was still collecting in 1951, the year he died in a car crash. His collection of 8oo paintings includes 181 Renoirs, 69 Cezannes, 59 Matisses and 49 Picassos. Courbet, Goya, Van Gogh, Hals, El Greco, Gauguin, as well as American painters such as Maurice Prendergast and William Glackens, are all there. A great many are masterpieces. Yet

The eyes have it

trophy hunting was never his sport (he preferred boxing). His goal was education. Barnes taught people to see how artists used line, colour, space and light to create their works. He believed this would lead to a feeling of connection between art and viewer and a sense of shared humanity. His first pupils were the mainly AfricanAmerican employees of his factory. The foundation continues to be a teaching institution. Aesthetics, not art history, drives the way the collection is displayed. There is no separation of fine and decorative art. Works are not arranged chronologically or geographically. A Matisse may hang alongside a Renaissance portrait or Native American jewellery, superb African carvings or Chinese ceramics. Small carved ivories, fine enamels and scores of decorative metal works (from slotted spoons to intricate hinges) share wall space with paintings. The visitor is constantly surprised. Coming upon Seurat's radiant "A Sunday on la Grandejatte" hanging above Cezanne's brooding "The Card Players"masterpiece upon masterpiece-is particularly exciting. For this writer, Cezanne's unfamiliar "Girl with Birdcage" from 1888 or thereabouts was the key that unlocked the previously under-appreciated depths of his landscapes, apples and portraits. Is the Barnes worth a detour? Make a beeline for it. The man could be a stinker, but his legacy is a treasure for all. â&#x20AC;˘

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Economic data %change on year ago

Gross domestic roduct Latest

United States China Japan Britain

+2.1 +8.1 +2.7 nil

01 01 01 01

gtr*

2012t

Industrial production Latest

Current-account balance Consumer rices Unemployment rate,% Latest 2012 t

+2.2 +2.2 +5.2 Apr +2.3 Apr +7.4 +8.3 +9.3 Apr +3.4 Apr +4.1 +1.8 +14.2 Mar +0.5 Mar -0.8 +0.4 -2.6 Mar +3.0 Apr ~~~ --- 2:_?J._~ _ _2!:_8_ .:!:_2.J. _ _ _ .:tJ,]_~ _ .:!:_2_,_Q ~ r_ nil 01 +0.1 -0.5 -2.2 Mar +2.6 Apr EuroArea +1.9 01 +7.9 +0.5 -0.9 Feb +2.3 Apr Austria +0.5 01 +1.2 -0.1 -4.0 Feb +3.2 Apr Belgium +0.3 01 +0.2 +0.3 -0.9 Mar +2.1 Apr France Germany +1.7 01 +2.1 +0.7 +1.5 Mar +2.1 Apr -6.2 01 na -7.1 -8.6 Mar +1.9 Apr Greece Italy -1.3 01 -3.2 -1.7 -5.8 Mar +3.3 Apr -1.1 01 -0.6 -0.8 +0.7 Mar +2.4 Apr Netherlands ~~n- ___ _:9:..1_ Ql_ _ _:-!.:)__:_l.:.Z _ _ _-1..Q:..1_~r- .:!:_2.J.~r_ -3.9 +0.3 -0.7 Mar +3.5 Apr Czech Republic +0.3 04 +0.4 04 -0.4 +0.7 -2.3 Mar +2.3 Apr Denmark Hungary -0.7 01 -5.1 -0.7 +0.6 Mar +5.7 Apr +4.3 01 +5.7 +0.9 +1.0 Mar +0.3 Apr Norway Poland +4.4 04 na +2.6 +2.8 Apr +4.0 Apr +4.9 01 na +3.5 +1.3 Apr +3.6 Apr Russia +1.2 04 -4.4 +0.7 -6.5 Mar +1.3 Apr Sweden +1.3 04 +0.4 +0.5 -1.4 04 -1.0 Apr Switzerland Turkey +5.2 04 na +3.5 +2.4 Mar +11.1 Apr +2.3 04 +1.7 +3.0 +2.1 04 +1.6 01 Australia +0.4 01 +1.6 +2.6 -2.2 04 +4.7 Apr Hong Kong +6.1 04 +7.6 +7.1 -3.5 Mar +10.4 Apr India Indonesia +6.3 01 na +5.9 +0.8 Mar +4.5 Apr +4.7 01 na +4.0 +0.6 Mar +1.9 Apr Malaysia +4.2 2012** na +3.5 -3.6 Mar +11.3 Apr Pakistan Singapore +1.6 01 +10.0 +3.1 -3.4 Mar +5.4 Apr South Korea +3.0 01 +3.7 +3.0 +0.3 Mar +2.5 Apr Taiwan +0.4 01 +1.1 +2.8 +8.4 Feb +1.4 Apr nil 01 +52.1 +6.0 -3.2 Mar +2.5 Apr Thailand Argentina +7.3 04 +3.2 +3.8 +2.1 Mar +1.4 04 +1.3 +3.3 -2.1 Mar +5.1 Apr Brazil +5.6 01 +5.7 +4.5 +0.5 Mar +3.5 Apr Chile +6.1 04 +5.4 +5.1 -1.6 Mar +3.4 Apr Colombia +4.601 +5.3 +3.5 +3.1Mar +3.4Apr Mexico ~~~e~ _ _ _±?&Ql. _ _2~2_ .:!:._4~ _ _ _ .±Q:.i~ -+1_3.:.§.~r_ Egypt +5.2 01 na +3.0 +26.5 Mar +8.8 Apr +3.3 01 +3.0 +2.1 -1.4 Mar +2.1 Apr Israel Saudi Arabia +6.8 2011 na +5.0 na +5.3 Apr South Africa +2.9 04 +3.2 +2.8 -2.8 Mar +6.1 Apr

Latest 12 months, $bn

%of GDP 2012 t

Budget balance

Interest rates,% %of GDP 10-year gov't 2012 t

bonds, Latest

year agQ

+2.3 8.1 Apr -473.4 04 -3.2 -7.6 1.72 +3.7 4.1 01§ +197.6 01 +2.3 -2.1 2.85§§ 6.33 6.51 nil 4.5 Mar +99.4 Mar +1.6 -8.1 0.87 79.2 81.8 +2.8 8.2 Feb tt -46.3 04 -1.6 -7.7 1.91 0.64 0.62 __:t£:_1_ _ _ ..Z.,~E.'_ --- :i9.:2~ -- _i',]_ ___ -:1~ __ _1.~ _ _ _ _ _1_._Q} ___ Q.,_9~ +2.3 10.9 Mar +11.8 Mar -0.1 -3.5 1.40 0.79 0.71 +2.3 4.0 Mar +8.0 04 +2.9 -3.8 2.44 0.79 0.71 +2.6 7.3 Mar -3.7 Dec +0.5 -3.1 3.30 0.79 0.71 +2.3 10.0 Mar -61.6 Mar -2.0 -4.4 2.75 0.79 0.71 +2.1 6.8 Apr +202.2 Mar +4.8 -1.3 1.40 0.79 0.71 -0.1 21.7 Feb -25.5 Mar -6.9 -7.8 29.92 0.79 0.71 +3.1 9.8 Mar -59.5 Mar -2.5 -2.2 5.81 0.79 0.71 +2.2 5.9 Mar +76.4 04 +7.6 -5.1 1.95 0.79 0.71 __:t-1..:.9_ __2.1_,!_112..':_ _ _ _ -:_2_1.:.§.~b- _ _i'& ___ -2.:~ __ _2.1..Q _ ___ _Q.z:1 __ _ Q,_D_ _ +3.3 8.4 Apr§ -6.3 04 -2.1 -3.3 3.28 20.3 17.5 +2.2 6.2 Mar +19.7 Mar +5.4 -3.5 1.34 5.91 5.32 +5.5 11.7 MarHt +2.0 04 +1.7 -3.5 8.62 241 193 +1.2 3. 2 Feb ll +70.7 04 +13.8 +13.3 2.05 6.01 5.62 +3.5 13.0 Apr§ -22.6 Mar -4.0 -4.0 5.50 3.49 2.82 +4.8 5.8 Apr§ +110.3 01 +3.9 -0.9 8.63 31.7 28.5 +1.6 7.8 Apr§ +38.9 04 +7.1 +0.2 1.54 7.18 6.37 -0.4 3.1 Apr +94.4 04 +13.3 +0.3 0.68 0.95 0.88 +9.5 1Q, 4 Feb§ -71.8 Mar -8.8 -1.9 9.43 1.86 1.60 +2.6 4.9 Apr -32 .8 04 -2.9 -0.7 3.17 1.03 0.95 +4.0 3.3 April +12.9 04 +6.5 +1.0 1.03 7.77 7.78 +7.7 9.8 2011 -59.0 04 -3.1 -5 .7 8.51t tt 56.1 45.2 +5.3 6.3 01§ -3.8 01 +0.2 -2.2 na 9,260 8,581 +2.4 2.9 Mar§ +29.7 01 +12.6 -5.3 3.55 3.15 3.06 +9.5 6.0 2011 -2.8 01 -2.1 -6.1 13.27ttt 92.0 85.8 +4.2 2.1 01 +53.2 01 +20.7 +0.1 1.49 1.28 1.25 +2.8 3.5 Apr§ +26.5 Mar +1.9 +2.7 3.73 1,173 1,098 +2.0 4.2 Apr +41.9 01 +8.1 -3.7 1.24 29.6 28.9 +3.2 0.7 Feb§ +6.5 01 -0.2 -2.5 3.61 _ 31.5 30.4 7.1 01§ nil 04 +0.1 -0.6 na 4.47 4.09 +5.3 6.2 Mar§ -49.8 Mar -2.6 -2.7 3.15ttt 2.09 1.64 +3.9 6.6 MarHl -4.2 01 -2.7 +1.8 na 511 473 +3.4 10.4 Mar§ -10.0 04 -2.2 -1.7 7.10 1,849 1,816 +3.7 5.1Mar -8.804 -1.3 -2.4 7.75 14.0 11.7 _±?~2_ __ l.,~M~ ---+Jj.:.ZQ! _ _ "!:]l_ ___ ~z._ __ g.~ ____ _±.~ ___ i:_22_ _ +10.4 12.4 04§ -5.4 04 -1.5 -10.4 na 6.04 5.95 +1.9 5.4 04 +0.2 04 -1.0 -3.7 4.49 3.86 3.50 +4.7 5.4 2009 +174.4 04 +23.6 +12.5 3.68 3.75 3.75 +5.4 25.2 01§ -13.7 04 -4.6 -5.2 7.71 8.43 7.02

Source: Haver Analytics. *% change on previous quarter, annual rate. tThe Economist poll or Economist Intelligence Unit estimate/forecast. §Not seasonally adjusted. **Year ending June. tt Latest 3 months. ii3-month moving average. §§5-yearyield ***Official number not reliable; The State Street PriceStats Inflation Index, Apr 25.73%; year ago 25.89% tttoollar-denominated bonds.

The Economist May 26th 2012 Markets

%change on Dec 31st 2011 Index one in local in$ May 23rd week currency terms United States (DJIA) 12,496.2 -0.8 +2 .3 +2.3 China (SSEA) 2,475.5 +0.7 +7.4 +6.8 -1.7 Japan (Nikkei 225) 8,556.6 -2.8 +1.2 Britain (FTSE 100) 5,266.4 -2.6 -5.5 -4.4 Canada (S&PTSX 11,564.8 +2 .1 -3.3 -4.2 "Eu~a-;;;;{ffiE E~w0) - 7oli - -=2.o - ~6-:o - -=8 .9 Euroarea (DJSTOXX50) 2,134.0 -1.9 -7.9 -10.7 Austria (ATX) 1,920.2 +0.6 +1.5 -1.6 Belgium (Bel20) 2,089.5 -0.7 +0.3 -2.8 France (CAC40) 3,003.3 -1.5 -5.0 -7 .9 Germany (DAX)* 6,285.8 -1.5 +6.6 +3.3 Greece (Athex Comp) 526.4 -5.2 -22.6 -25.0 Italy (FTSE/MIB) 12,960.9 -2.4 -14.1 -16.7 Netherlands (AEX) 289.2 -2.0 -7.5 -10.3 Spain (Madrid SE) 650.5 -2.8 -24.2 -26.5 Czech Republic (PX) 878.1 +0.3 -3.6 -6.6 Denmark (OMXCB) 400.6 -0.5 +12.3 +8.9 Hungary (BUX) 16,230.3 -1.9 -4.4 -3.8 Norway (OSEAX) 440.9 -3.3 -0.4 -1.1 Poland {WIG) 36,934.9 .J..£ -1.8 -3.4 Russia (RTS, $terms) 1,264.3 -8.0 -9.7 -8.5 Sweden (OMXS30) 974.6 -1.3 -1.3 -5.9 Switzerland (SMI) 5,817.9 -0.9 -2.0 -4.0 Turkey (lSE) 55,734.3 -4.1 +8. 7 +10.5 Australia (All Ord.) 4,118.8 -2.3 +0.2 -4.4 Hong Kong (Hang Seng) 18,786.2 -2.5 +1.9 +1.9 India (BSE) 15,948.1 -0.5 +3 .2 -2.3 Indonesia (JSX) 3,981.6 nil +4.2 +2.0 J!a~&aJ!<~Q ___ _.1 ,2]U _ .:tQ1_ _ . .:!:0.:2. _ .:!:1:1. Pakistan (KSE) 14,032.8 -0.3 +23.7 +20.9 Singapore (STI) 2,780.4 -1.8 +5.1 +6.5 South Korea (KOSPI) 1,808.6 -1.7 -0.9 -2 .7 Taiwan (TWI) 7,147 .8 -1.2 +1.1 +3.5 Thailand (SET) 1,110.7 -5.2 +8.3 +8.4 Argentina (MERV) 2,288.6 +5.9 -7.1 -10.4 Brazil (BVSP) 54,619.5 -2.3 -3.8 -14.3 Chile (IGPA) 20,396.2 -2.3 +1.3 +3.1 Colombia (IGBC) 14,519.9 -0.1 +14.6 +20.2 Mexico (IPC) 37,422.4 -0.2 +0.9 +0.3 Venezuela (!!!C) __240,255.3 .:!:.!·7 +105 na Egypt (Case 30) 4,921.9 -0.7 +35.9 +35.7 Israel (TA-100) 965.5 -4.5 -2.5 -3.4 Saudi Arabia (Tadawul) 7,061.4 -0.5 +10.6 +10.6 South Africa (JSE AS) 32,887.5 -2.7 +2.8 -1.5

Economic and financial indicators 89

Fiscal consolidation Most rich-world economies need to stabiLise their debt-to-GDP ratio, according to the OECD's Latest "Economic OutLook". This will require tightening the primary balance (before interest payments) of governments. The OECD expects its members to do this mainly by reining in spending-which is generally thought to be Less of a drag on the economy than raising taxes. Fiscal consolidation in Greece, for example, is supposed to bring down the country's deficit by 5% of GDP by 2013, Largely through spending cuts. But this is still a painful process. By the OECD's reckoning, reducing a government's primary balance, as a share ofGDP, by one percentage pointtypically cuts its growth rate by about 0.5%.

Forecast change in government primary balance 2011-13,% of potential GDP

Spending cuts • 1-0+1 Spain Portugal Greece Australia Italy Ireland Netherlands France United States Britain South Korea Japan Germany Denmark

•••••

Revenue increase 4

Source: OECD

Other markets

The Economist commodity-price index

%change on Dec 31st 2011 Index one in local in$ May 23rd week currency terms United States (S&P 500) 1,318.9 -0.4 +4.9 +4.9 United States (NAScomp) 2,850.1 -0.8 +9.4 +9.4 China (SSEB, $terms) 240.3 -0.2 +12.3 +11.6 Japan (Topix) 721.6 -2.3 -1.0 -3.8

2005=100

~~ti~~~~~~ - ~~- ~~ - ~~ - 21

World, dev'd (MSCI) 1,187.4 -1.4 +0.4 +0.4 Emerging markets (MSCI) 897.0 -3.0 -2.1 -2 .1 World, all (MSCI) 299.7 -1.6 +0.1 +0.1 ~o.!!_d~~U_Citig.!:_o~) 930.2 +0.2 +0.1 +0.1 EMBI+ (JPMorg~) - - 622Ji - -=o:S - -:;:-3f: - ~:4 Hedge funds (HFRX) 1,124.6 -0.5 +1.4 +1.4 Volatility, US (VIX) 22.3 +22.3 +23.4 (levels) CDSs, Eur (iTRAXX)t 180.0 +1.5 +2.3 -0.9 CDSs, NAm (CDX)t 121.6 +2.3 -0.9 -0.9 Carbon trading (EU ETS) € 6.8 +3.3 -4.8 -7.7 Sources: Bloomberg; CBOE; CBOT; CMIE; Cotlook; Darmenn & Curl; EEX; FT; HKMA; ICCO; !CO; ISO; Jackson Rice; JPMorgan Chase; Markit; NZ Wool Services; Thompson Lloyd & Ewa rt; Thomson Reuters; Urner Barry; WSJ; WM/Reuters. *Total return index. !Credit-default-swa p spreads, basis points.

May 15th

%change on one one May 22nd* month year

Dollar index

~~~--- ~~..i. -- ~~-- ~~- ~~£ Food ____ _?Q?:2_ __ ~L_5___- ~8- _ .:Z·1 Industrials All .. }W4..... 159,.6, , .... ~5 ..4 ... ~22,. 3 ..~f?.t.... ..... 176.7 .. .F~·1 ....... .~?·.~ .. . .~} !-: 9 -4.2 -17.2 Metals 153.4 152.5 Sterling index -1.2 -12.6 All items 209.1 211.8 Euroindex nil -5.6 All items 179.5 179.3 Gold +4.2 1,589.4 -3.3 $ per oz 1,552.5 West Texas Intermediate $ per barrel 93.2 91.2 -11.5 -8.4 *Provisional !Non-food agriculturals.

Indicators for more countries and additional series, go to: Economist .. comfindicators

Dietrich Fischer-Diesl<au Dietrich Fischer-Dieskau, baritone, died on May 18th, aged 86 AS HE rubbed the horses down in the bitfiter cold and slush of the Eastern Front in 1943, Dietrich Fischer-Dieskau, then 18, sang songs into their ears. Brahms's "Four Serious Songs", perhaps, or a Bach cantata, both of which he had been learning before he was ordered to put on a Wehrmacht uniform. He himself never said what they were. But fans of the century's best baritone suspected, indeed hoped, that they were from Schubert's great, sad "Winterreise", the Lieder cycle he made his own. He had sung it for the first time in public shortly before he left Berlin, interrupting it when the RAF strafed the street and the audience dived for the cellar, then resuming at the song called "Riickblick", "A Backward Glance". As he led the feeble horses out into the snowy Russian waste, humming and dreaming of the love and music left behind, he was the very figure of Schubert's desolate winter traveller. He took the horses to a pond where they could break up the thick ice and drink. This, too, seemed a portent. For him song meant movement, refreshment, life, awakening, often in the face of stodgy teaching and "doughy", "dusty" orchestras. The qualities he most praised in singing were flexibility, naturalness and transparency, by which he meant that the interpreter should disappear within the work. For all

this, as well as his cheerfulness and his love of soft, swift mezza voce singing, his name was linked irresistibly with Schubert's pure, rushing mountain streams. Ei Bachlein, liebes Bachlein ... Me in rauschender Freund!

He saw himself as an explorer, possessed by a restless, youthful curiosity to find out where music came from and where it led. Each one of his distinguished accompanists-none longer-serving than Gerald Moore, an Englishman, seen at work with him above-taught him something about a piece and made him see it with new eyes. If it challenged him, so much the better. He patiently teased out Tippett and Henze, Hindemith and Reimann, despite believing that, ever since Schonberg, music had merely been dancing round in convulsive spasms. He had a go at singing almost everything, even if it hurt. On the concert stage he stood tall and still, arms hanging loose from his broad shoulders, "wearing his tone like a crown" as he put it, apparently so relaxed that only his chubbily handsome face was working. In fact he was at a pitch of nervous tension, so immersed in the song that each performance would change in step with how fast his heart was beating. Opera, at first, seemed a less natural fit for him, but he

worked at his acting until he became famous for Hans Sachs in "Die Meistersinger", the count in "The Marriage ofFigaro", even Verdi's rollicking Falstaff-despite his feeling that, as a Prussian, he was not cut out for comedy, and his refusal to wear Papagena's silly feathers in "The Magic Flute". Vocally his range was huge, from the calm command of Bach's bass arias to the lightness of Hugo Wolf's mezzo-soprano songs. Some critics complained that he overdid the emotion, wringing out every last ounce of meaning. He would counter that Lieder in particular, though they might seem mere miniature settings of mediocre lyric poems, contained a whole cosmos of experience; and that he became a different person, with a different life to breathe out in music, with every song he sang. His repertoire was intensely German, and his favourite singing place-despite his wanderings across the world-remained Berlin, where he was born. But the Germanness was important. After1948 this exprisoner-of-war represented to battered Europe the better sides of Germany: its poetry, its landscape, the beauty of the language and, above all, its music. His immaculately rounded voice, singing of love and loss, administered the balm that post-war audiences needed. For that reason, too, Benjamin Britten asked him to sing the role of the baritone soldier in his "War Requiem" in the rebuilt Coventry Cathedral in 1962, ending with Wilfred Owen's words, "Let us sleep now ... " Under the piano He was shy and unforthcoming to strangers, slipping away after performances to eat his favourite semolina in his hotel room alone. He often felt uncertain about roles. What he never doubted was that music was meant to be his life, ever since he had listened, curled up under the piano like a small burrowing animal, to the eerie vibrations of his father striking the keys. His four marriages and three sons meant much to him, he conceded; but music meant more. It was his love and his life, the gift he had been given, the rock he clung to and the compulsion he laboured under, as his beloved Schubert had done. His booklength study of the Lieder concluded that the world was a mere shadow to the composer. It was the same to him. In later life he took up painting, mostly of woods around his Munich house. This gave him the chance, he said, to prove he could create from scratch as well as recreate. But interpretation possessed him even after he retired. To bring songs alive for new ears; to break the ice, and find fresh water; to revive again and again the joy of spring, the gleam of green and even the figure of Schubert's hurdy-gurdy man, playing his heartbreaking tune for someone, anyone, in the snowy waste to hear. â&#x20AC;˘

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