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7 The world this week Leaders 11 China's economy

On the cover China's economy is more stable than its critics think: leader, page 11. It's financial system is inefficient, unfair and in need of reform, but it also has resilient qualities, says our special report after page46

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Volume 403 Number 8786 First published in September 1843

to take partin "a severe contest between intelligence, which presses forward, and an unworthy, timid ignorance obstructing our progress. " Editorial offices in London and also: Atlanta, Beijin g, Berlin , Brussels, Cairo, Chicago, Hon g Ko ng, Johannesburg , Los Angeles, Mexico City, Moscow, New Delhi , New York, Pa ris, San Francisco, Sao Paulo , Singapore, Tokyo, Washingt on DC

How strong is it? 12 The future ofthe European Union The choice 14 Bangladesh's politics Hello, Delhi 14 Energy markets The charges of the light brigade 16 Azerbaijan and Eurovision Nul points Letters 18 On the euro, Thailand, Facebook, trains, Alice Munro, Spanish banks Briefing 23 The euro crisis An ever-deeper democratic deficit 26 The costs of a Greek exit Cutting up rough United States 29 Government transparency The best disinfectant 30 Utah's health reform UnObamacare 32 Military innovation Stress testing 32 Fish stocks Plenty more in the sea 34 Government spending Penny wise, pound foolish 34 Maine's Senate race Crowning a King 36 Lexington Moral quandary

38 39 39 40

The Americas Energy in Canada The great pipeline battle The Dominican Republic After Leonel Colombia Peace or justice? Gay rights in Chile Atrocity prompts change

Asia 41 Politics in Bangladesh Banged about 42 Tattoos in Japan The shogun of Os aka 43 Violence in Karachi City at war 43 Pakistan and America Afateful call 44 Banyan More fun in the Philippines? China 45 China and America Asigh of relief 46 Officials and their families Hedging their bets 46 Trouble at Shaolin temple Kung fu fighting Special report: China's economy After page 46 Middle East and Africa 47 Cote d'Ivoire Can it regain its shine? 48 A South African cartoon No joke 48 Strife in Yemen Hadi tries harder 49 Racism in Lebanon Black, but not beautiful 49 Syria's strife From bad to worse 50 Algeria Football v politics

Euro crisis Alimited version of federalism is a less miserable solution than the break-up of the euro: leader, page 12. Concerns about democracy and accountability, page 23. The damage a break-up would do to Greece and the European economy, page 26. Italy's strained politics, page 51, and Spain's beleaguered banks, page 52. Summitryin Brussels: Charlemagne, page 54. Banksarestockpiling cash, raising the risks of a credit crunch, page 71

Britain's Jubilee What the celebrations for the queen's silver, golden and now diamond jubilee say about how Britain has changed: Bagehot, page 59

Europe 51 Italian politics Tremors and rumbles 52 Spanish banks The corralito risk 52 Serbia's election The gravedigger's victory 53 Azerbaijan The sound of music 54 Charlemagne The feeling's mutual Obama's open government Making information public, and hiding it from the public, has never been easier, page 29. The Republicansjustwant to cut, page 34 ~~

Contents continues overleaf

4 Contents

The Economist May 26th 2012

57 58 58

59 Brazil's richest man Eike Batista is betting big on resources and infrastructure, page 63

Deutsche Bank Hard questions loom for the new bosses of Germany's national banking champion, page 74. The rise of Kotak, an Indian powerhouse, page 73

Human Lab rats How crowdsourcing is changing the way psychological experiments are conducted, and whatthey find, page 77

Britain Electricity-market reform Volt from the blue Megrahi and Lockerbie To his grave Explaining economic weakness The slack race Bagehot The Jubilee as mirror

International 60 The NATO summit The Afghan endgame 61 Climate scepticism Toxic shock 61 Circassians Thoughts from abroad Business 63 Eike Batista The salesman of Brazil 65 The internet Breaking up is so very hard, Yahoo! 65 Google and antitrust Over to you, and hurry 66 Facebook' s flotation That sinking feeling 67 Re-imagining Piramal An Indian bets on America 67 Cars in Indonesia Letthem walk 68 Solar tariffs Blocking the sun 68 Recruitment Hiring by video games 70 Schumpeter New bosses

71 72

73 73

Finance and economics Europe in Limbo Credit crunches Buttonwood The nationalisation of markets Indian banking Kotak moment Rajat Gupta The trial begins

74 CoLLateraL management Security services 74 Deutsche Bank Two's company 76 Free exchange America's growth potential Science and technology 77 Experimental psychology The roar of the crowd 78 Ichthyosaurs Triassic lark 79 There be Dragons SpaceX heads for the ISS 79 Nanotechnology Afab result Books and arts 80 Joys of walking The wanderer's tale 81 Depression Melancholy journey 81 The political waning of America Unconvincing 82 The economic waning of America Myths large and small 82 Biology and instability Molecules of mayhem 83 The Barnes Collection A phoenix rises 88 Economic and financial indicators Statistics on 42 economies, plus a closer look at fiscal consolidation Obituary 90 Dietrich Fischer-Dieskau The Mastersinger

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Politics

cuts, this time on car sales and some financial transactions. In a presidential election in the Dominican Republic Danilo Medina, the candidate of the ruling party, won a narrow victory. The parties complained of vote-buying but international observers said this did not affect the result.

Chen Guangcheng, a Chinese activist, arrived inN ew York to start a new life with his family. Mr Chen, who is blind, escaped house arrest in April and turned up at the American embassy in Beijing. After assurances about his safety from the Chinese government he was taken to a hospital, but then said he wished to leave China. The incident had threatened to open a diplomatic rift between China and America. Barack Obama had a wobbly week. His re-election campaign's attack on Mitt Romney's time at Bain Capital came under fire from some Democrats for going too far in its criticisms of private equity. And in Democratic primary elections in Arkansas and Kentucky around 40% of the voters withheld their support for the president; some reckoned Republicans had crossed party lines to cause mischief.

Tragedy avoided Officials in Argentina said they found a bomb hidden in a theatre in Buenos Aires where Alvaro Uribe, Colombia's former president, was due to speak. Mr Uribe is campaigning against a constitutional amendment that might exempt Colombia's guerrilla leaders from prosecution if they make peace. Spain's Repsol said that an exploratory well in deep water off Cuba was dry, dashing the island's hopes of reducing its dependence on imported oil. In another attempt to inject life into Brazil's stagnant economy, the government announced a fresh round of tax

It's my party Russia's president, Vladimir Putin, unveiled a government dominated by loyalists, tightening his grip on the economy and national security after popular protests. The new government is likely to curtail the ability ofDmitry Medvedev, the prime minister, to pursue market reforms.

Serbia's presidential election was won by Tomislav Nikolic, who beat Boris Tadic, the liberal incumbent, by two percentage points. Mr Nikolic used to be an extreme nationalist but has changed his tune, vowing to promote integration with the European Union and promising to be a good neighbour in the Balkans. European Union leaders attended yet another summit in Brussels aimed at solving the euro-zone's sovereign-debt crisis. At the earlier G8 summit at Camp David, in Maryland, Germany came under pressure to do more for jobs and growth, though the communique also concluded that "the right measures are not the same for each of us." Abdelbaset al-Megrahi, a Libyan convicted of the 1988 bombing of a Pan Am flight over Lockerbie in Scotland, died from cancer. Mr Megrahi was released from prison by

the Scottish government on compassionate grounds in 2009, which outraged many relatives of the 270 people killed in the atrocity. He always claimed to be innocent.

With friends like these ...

Germany began a fresh round of talks with Iran over its nuclear plans, this time in Baghdad, hoping to persuade its government to agree to stop enriching its uranium to the high grade that would enable it to make a bomb.

A Pakistani doctor who helped the CIA track down Osama bin Laden was found guilty of treason under laws that govern the country's tribal areas. Shakil Afridi, who carried out fake vaccinations near bin Laden's compound so that he could gather DNA evidence on his family, was sentenced to 30 years in prison.

At least 100 people were killed by a suicide-bomber at a military parade in Yemen's capital, Sana'a. A group allied to al-Qaeda claimed to have carried out the attack ten days after Yemen's army launched an offensive againstjihadists in the southern province of Abyan.

In Malaysia Anwar Ibrahim, the leader of an opposition party and thorn to the government, was charged with inciting and participating in an illegal street protest on April 28th. Coming just four months after he was acquitted of sodomy (which is still illegal in Malaysia), Mr Anwar said the new charges were also politically motivated. Fitch downgradedJapan's sovereign-debt rating to A+, as its politicians squabbled about passing a rise in the sales tax. Japan's public debt is forecast to rise to 239% of GDP by the endof2012.

Whom should I vote for?

Eleven Lebanese Shia pilgrims were kidnapped in Syria. The Free Syrian Army, a group of rebel fighters, said that government forces, hoping to besmirch the opposition, were responsible. As a result, protests erupted in the Lebanese capital, Beirut, where people are divided over the uprising in Syria. Supporters of Mali's coup leader named him to head a new interim government in defiance of a deal brokered by the Economic Community of West African States (ECOw AS), a regional body that has been trying to mediate. The announcement provoked protests in Mali's capital, Bamako. Mali's interim president was beaten up by a mob.

Guinea-Bissau's military junta handed power back to a civilian government six weeks after the army staged a coup.

Fifteen months after the fall of Hosni Mubarak, Egyptians voted in their first free presidential election on May 23rd and 24th, with no opinion poll confidently predicting a winner among the three or four front-runners. But nearly all reckoned there would be a run-off, due a month later. Representatives of the five permanent members of the UN Security Council plus

A South African farm worker was found guilty of killing Eugene Terre'Blanche, the leader of a white-supremacist party, the Afrikaner Resistance Movement, who was beaten to death in his home in 2010. A debate over freedom of expression raged in South Africa over a gallery's display of a painting of }acob Zuma, the president, with his genitals exposed. The ruling African National Congress said the painting was disrespectful and sought legal action to have the artwork removed.

8 The world this week

The Economist May 26th 2012

Business Share prices IPO pri ce=100 130 120 110 100 90

The IMF'S annual review of the British economy found it to be underperforming relative to earlier expectations. The fund recommended more quantitative easing by the Bank of England and said growth-boosting measures, such as spending on infrastructure, could help, but only if they were fiscally neutral.

'- - - ' - - - ?o Days after IPO Source: Thomson Reuters

Facebook's long-awaited initial public offering didn't match the hype. The social network priced its shares at $38, but at the end of the first day of trading (that opened with a technical glitch) they had risen by just 23 cents, before falling well below the offer price in subsequent days, in contrast to other big tech IPOs (see Google). Adding to the disappointment, regulators began inquiries into whether favoured investors were alerted to Face book's weakening financial projections and dumped stock when buying was opened to the public. Still, Face book's stockmarket debut valued it at $104 billion. Mark Zuckerberg, Face book's boss, celebrated by marrying his college sweetheart.

An internet divorce After months of speculation Yahoo! announced plans to divest its 40% stake in Alibaba, a giant Chinese e-commerce firm. The pair will separate on amicable terms. Yahoo! is selling half of its stake now and will dispose of the rest later, with some of that to be sold when and if Alibaba floats on a stockmarket. Hewlett-Packard slashed another 27.000 jobs, or 8% of its global workforce, in line with its restructuring plan. Mike Lynch, who founded Autonomy, a British software firm bought by HP for $10.3 billion last year, is to step down from his job as head of information management. HP has found it hard lately to persuade markets that it has a strategy for responding to the challenge to its business from smartphones and tablets.

The learning curve The Bank of England bowed to pressure to launch independent reviews of its own performance during the crisis. The reviews will look at the central bank's emergency-lending operations in 2008-09, its inflation-forecasting record and the system for providing money to banks. But its critics want the reviews to go further and examine its pre-crisis attention to financial stability. Despite recent measures by the Reserve Bank of India to support the currency, the Indian rupee continued to fall. It is the worst-performing currency among Asia's emerging markets so far this year. JPMorgan Chase suspended its much-trumpeted share buy-back programme in light of its unexpected loss of at least $2 billion in trading on credit derivatives. Since reveal-

ing the loss its share price has taken a dive, wiping $30 billion from its stockmarket value. The bank was given the go-ahead for its buy-back plan after passing the Federal Reserve's latest "stress test" in March. Barclays decided to sell the 19.6% stake in BlackRock that it had obtained as part of its deal selling Barclays Global Investors to the asset-management company in 2009. The proceeds from the sale could help the bank in meeting new rules on bigger capital buffers.

The trial of Raj at Gupta on insider-trading charges got under way in New York. Among other things Mr Gupta is accused of passing sensitive information about Goldman Sachs when he was a director of the bank to Raj Rajaratnam, a former hedge-fund boss who was convicted of insider trading last year. Mr Gupta denies the charges. PTT, a state-backed energy firm in Thailand, tendered a surprise last-minute bid of $1.9 billion for Cove Energy, trumping an offer from Shell. Cove holds an 8.5% stake in a huge natural-gas field in Mozambican waters. PTT's bid is the biggest ever by a Thai firm for a

foreign one, and underscores the rush for oil-and-gas assets off the east African coast.

Coming to a theatre near you Dalian Wanda, a Chinese property group, agreed to buy AMC Entertainment, a ubiquitous American cinema chain. The $2.6 billion deal is the biggest foreign undertaking yet by a privately held Chinese firm. AMC has more than s,ooo screens across North America. It had considered going public before opting for Wanda's takeover offer. Blackstone, a private-equity firm, added Motel6 to its lengthy list of hotel acquisitions, by offering $1.9 billion to buy the business from its present owner, France's Accor. Motel6 was founded in 1962 by two building contractors in southern California whose plan was to provide bargain rooms for $6 a night. Moody's upgraded Ford's debt to investment grade, allowing the carmaker to regain ownership of the famous "blue oval" badge that stamps its vehicles, which it had mortgaged in 2006 along with other assets to stave off bankruptcy.

Other economic data and news can be found on pages 88-89

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Ho""' strong is China's economy? Despite a recent slowdown, the world's second-biggest economy is more resilient than its critics think

HINA'S weight in the global economy means that it commands the world's attention. When its industrial production, house building and electricity output slow sharply, as they did in the year to April, the news weighs on global stockmarkets and commodity prices. When its central bank eases monetary policy, as it did this month, it creates almost as big a stir as a decision by America's Federal Reserve. And when China's prime minister, Wen]iabao, stresses the need to maintain growth, as he did last weekend, his words carry more weight with the markets than similar homages to growth from Europe's leaders. No previous industrial revolution has been so widely watched. But rapid development can look messy close up, as our special report this week explains; and there is much that is going wrong with China's economy. It is surprisingly inefficient, and it is not as fair as it should be. But outsiders' principal concernthat its growth will collapse if it suffers a serious blow, such as the collapse of the euro-is not justified. For the moment, it is likely to prove more resilient than its detractors fear. Its difficulties, and they are considerable, will emerge later on.

Unfair, but not unstable Outsiders tend to regard China as a paragon of export-led efficiency. But that is not the whole story. Investment spending on machinery, buildings and infrastructure accounted for over half of China's growth last year; net exports contributed none of it. Too much of this investment is undertaken by stateowned enterprises (soEs), which benefit from implicit subsidies, sheltered markets and politically encouraged loans. Examples of waste abound, from a ghost city on China's northern steppe to decadent resorts on its southern shores. China's economic model is also unfair on its people. Regulated interest rates enable banks to rip off savers, by underpaying them for their deposits. Barriers to competition allow the soEs to overcharge consumers for their products. China's household-registration system denies equal access to public services for rural migrants, who work in the cities but are registered in the villages. Arbitrary land laws allow local governments to cheat farmers, by underpaying them for the agricultural plots they buy off them for development. And many of the proceeds end up in the pockets of officials. This cronyism and profligacy leads critics to liken China to other fast-growing economies that subsequently suffered a spectacular downfall. One recent comparison is with the Asian tigers before their financial comeuppance in 1997-98. The tigers' high investment rates powered growth for a while, but they also fostered a financial fragility that was cruelly exposed when exports slowed, investment faltered and foreign capital fled. Critics point out that not only is China investing at a faster rate than the tigers ever did, but its banks and other lenders have also been on an astonishing lending binge, with credit jumping from122% of GDP in 2008 to171% in 2010, as the

government engineered a bout of "stimulus lending". Yet the very unfairness of China's system gives it an unusual resilience. Unlike the tigers, China relies very little on foreign borrowing. Its growth is financed from resources extracted from its own population, not from fickle foreigners free to flee, as happened in South-East Asia (and is happening again in parts of the euro zone). China's saving rate, at 51% of GDP, is even higher than its investment rate. And the repressive statedominated financial system those savings are kept in is actually well placed to deal with repayment delays and defaults. Most obviously, China's banks are highly liquid. Their deposit-taking more than matches their loan-making, and they keep a fifth of their deposits in reserve at the central bank. That gives the banks some scope to roll over troublesome loans that may be repaid at a later date, or written off at a more convenient time. But there is also the backstop of the central government, which has formal debts amounting to only about 25% of GDP. Local-government debts might double that proportion, but China plainly has enough fiscal space to recapitalise any bank threatened with insolvency. That space also gives the government room to stimulate growth again, should exports to Europe fall off a cliff. China's government spent a lot on infrastructure when the credit crunch struck its customers in the West. But there is no shortage of other things it could finance. It could redouble its efforts to expand rural health care, for example. China still has only one family doctor for every 22,ooo people. If ordinary Chinese knew that their health would be looked after in their old age, they would save less and spend more. Household consumption accounts for little more than a third of the economy. Time is on my side That underlines the longer-term problem China faces. The same quirks and unfairnesses that would help it withstand a shock in the next few years will, over time, work against the country. China's phenomenal saving rate will start falling, as the population ages and workers become more expensive. Capital is also already becoming less captive. Fed up with the miserable returns on their deposits, savers are demanding alternatives. Some are also finding ways to take their money out of the country, contributing to unusual downward pressure on the currency. China's bank deposits grew at their slowest rate on record in the year to April. So China will have to learn how to use its capital more wisely. That will require it to lift barriers to private investment in lucrative markets still dominated by wasteful SOES. It will also require a less cosseted banking system and a better socialsecurity net, never mind the political and social reforms that will be needed in the coming decade. China's reformers have a big job ahead, but they also have some time. Pessimists compare it to Japan, which like China was a creditor nation when its bubble burst in 1991. But Japan did not blow up until its income per head was 120% of America's (at market exchange rates). If China's income per head were to reach that level, its economy would be five times as big as America's. That is a long way off. â&#x20AC;˘

12 Leaders

The Economist May 26th 2012

The future of the European Union

Europe's choice A limited version of federalism is a less miserable solution than the break-up of the euro

HAT will become of the European Union? One W road leads to the full break-up of the euro, with all its economic and political repercussions. The other involves an unprecedented transfer of wealth across Europe's borders and, in return, a corresponding surrender of sovereignty. Separate or superstate: those seem to be the alternatives now. For two crisis-plagued years Europe's leaders have run away from this choice. They say that they want to keep the euro intact-except, perhaps, for Greece. But northern European creditors, led by Germany, will not pay out enough to assure the euro's survival, and southern European debtors increasingly resent foreigners telling them how to run their lives. This has become a test of over 6o years of European integration. Only if Europeans share a sense of common purpose will a grand deal to save the single currency be seen as legitimate. Only if it is legitimate can it last. Most of all, it is a test of Germany. Chancellor Angela Merkel maintains that the threat of the euro's failure is needed to keep wayward governments on the path of reform. But German brinkmanship is corroding the belief that the euro has a future, which raises the cost of a rescue and hastens the very collapse she says she wants to avoid. Ultimately, Europe's choice will be made in Berlin. Last summer this newspaper argued that to break the euro zone's downward spiral required banks to be recapitalised, the European Central Bank (ECB) to stand behind solvent countries with unlimited support, and the curbing of the Teutonic obsession with austerity. Unfortunately, successive European rescue plans fell short and, though the ECB bought temporary relief by supplying banks with cheap, long-term cash in December and February, the crisis has festered and deepened. In recent months we have concluded that, whether or not Greece stays in the euro, a rescue demands more. If it is to banish the spectre of a full break-up, the euro zone must draw on its joint resources by collectively standing behind its big banks and by issuing Eurobonds to share the burden of its debt. We set out the scheme's nuts and bolts below. It is unashamedly technocratic and limited, designed not to create the full superstate that critics (and we) fear. But it is plainly a move towards federalism-something that troubles many Europeans. It is a gamble, but time is running short. Rumours of bank runs around Europe's periphery have put savers and investors on alert (see page 71). The euro zone needs a plan.

Goodbye to all that Is the euro really worth saving? Even the single currency's diehard backers now acknowledge that it was put together badly and run worse. Greece should never have been let in. France and Germany rode a coach and horses through the rules designed to prevent government borrowing getting out of hand. The high priests of euro-orthodoxy failed to grasp that, though Ireland and Spain kept to the euro's fiscal rules, they were vulnerable to a property bust or that Portugal and Italy were

trapped by slow growth and declining competitiveness. A break-up, many argue, would allow individual countries to restore control over monetary policy. A cheaper currency would help match wages with workers' productivity, for a while at least. Advocates of a break-up imagine an amicable split. Each government would decree that all domestic contracts-deposits and loans, prices and pay-should switch into a new currency. To prevent runs, banks, especially in weak economies, would shut over a weekend or limit withdrawals. To stop capital flight, governments would impose controls. All good, except that the people who believe that countries would be better off without the euro gloss over the huge cost of getting there (see page 26). Even if this break-up were somehow executed flawlessly, banks and firms across the continent would topple because their domestic and foreign assets and liabilities would no longer match. A cascade of defaults and lawsuits would follow. Governments that run deficits would be forced to cut spending brutally or print cash. And that is the optimistic scenario. More likely, a break-up would take place amid plunging global share prices, a flight to quality, runs on banks, and a collapse in output. Devaluation in weak economies and currency appreciation in strong ones would devastate rich-country producers. Capital controls are illegal in the EU and the break-up of the euro is outside the law, so the whole union would be cast into legal limbo. Some rich countries might take advantage of that to protect their producers by suspending the single market; they might try to deter economic migrants by restricting freedom of movement. Practically speaking, without the movement of goods, people or capital, little of the EU would remain. The heirs of Schuman and Monnet would struggle to restore the Europe of 27 when it had been the cause of such mayhem-even if a euro-rump of strong countries emerged. Collapse would be a gift to anti-Eu, anti-globalisation populists, like France's Marine Le Pen. There would be so many people to blame: Eurocrats, financiers, intransigent Germans, feckless Mediterraneans, foreigners of all kinds. As national politics turned ugly, European co-operation would break down. That is why this newspaper thinks willingly abandoning the euro is reckless. A rescue is preferable to a break-up. A problem shared But not just any rescue. Too much of the debate over how to save the euro puts the emphasis merely on a plan for growth. That would help, because growth makes debt more manageable and banks healthier. Mrs Merkel should have been more accommodating on this. But any realistic stimulus would be too modest to stem the crisis. The ECB could and should cut rates and begin quantitative easing, but official funds for investment are limited. More ambitious ways of boosting growth, such as the completion of a single European market for services, are sadly not even on the table. In any case, the euro zone's troubles run too deep. Banks and their governments are propping each other up like Fridaynight drunks. The ECB's support for the banks cannot prevent the weak economies of Spain, Portugal, Italy and Ireland from ~~

The Economist May 26th 2012 ~ enfeebling

their banks and governments. For as long as bond yields are high and growth is poor, sovereigns will face doubt about their capacity to service their debt and banks will see loans go bad. Yet that same uncertainty pushes up sovereign yields and stops bank lending, further inhibiting growth. Fear that the state might have to deal with a banking collapse makes government bonds riskier. Fear that the state could not cope makes a banking collapse more likely. That is why we have reluctantly concluded that the nations in the euro zone must share their burdens. The logic is straightforward. The euro zone's problem is not the debt's size, but its fragmented structure. Taken as a whole, the stock of euro-zone public debt is 87% of GDP, compared with over100% in America. Similarly, the banks are not too big for the continent as a whole, just for individual governments. To survive, Europe has to become more federal: the debate is how much more.

What's German for demoi? A lot, according to some gung-ho federalists. For people like Germany's finance minister, Wolfgang Schauble, the single currency was always a leg on the journey towards a fully integrated Europe. In exchange for paying up, they want to harmonise taxes and centralise political power with, say, an elected European Commission and new powers for the European Parliament. Voters will be scared into grudging acquiescence precisely because a euro collapse is so terrifying. In time, the new institutions will gain legitimacy because they will work and Europeans will begin to feel prosperous again (see page 23). Yet to see the euro crisis as a chance to federalise the EU would be to misread people's appetite for integration. The wartime generation that saw the EU as a bulwark against strife is fading. For most Europeans, the outcome of the Eu's most ambitious project, the euro, feels like misery. And there is no evidence that voters feel close to the EU. The Lisbon treaty and its precursor, the Eu's aborted constitution, were together rejected in three out of six referendums; ten governments reneged on promises to put constitutional reform to the vote. The parliament is hopelessly remote. Another version of the superstate is to accept that politics remains stubbornly national-and to increase the power of governments to police their neighbours. But that, too, has problems. As the euro crisis has shown, governments struggle to take collective decisions. The small countries of the euro zone fear that the big ones would hold too much sway. If Berlin pays the bills and tells the rest of Europe how to behave, it risks fostering destructive nationalist resentment against Germany. And like the other version of the superstate, it would strengthen the camp in Britain arguing for an exit-a problem not just for Britons but for all economically liberal Europeans. The â&#x201A;Ź50,300 ($64,000) question That is why our rescue seeks to limit both the burden-sharing and the concession of sovereignty. Rather than building a federal system, it fills in two holes in the single currency's original design. The first is financial: the euro zone needs a region-wide system of bank supervision, recapitalisation, deposit insurance and regulation. The second is fiscal: euro-zone governments will be able to manage-and reduce-their fiscal burdens only with a limited mutualisation of debt. But in both cases the answer is not to transfer everything to the EU level. Begin with the banks. Since the euro's creation, European integration has moved farthest in finance. Banks sprawl across national borders. German banks fuelled Spain's property

Leaders 13

boom, while their French peers funded Greece's borrowing. The answer is to move the supervision and support of banks (or at least big ones) away from national regulators to European ones. At a minimum there must be a euro-zonewide system of deposit insurance and oversight, with collective resources for the recapitalisation of endangered institutions and regional rules for the resolution of truly failed banks. A first step would be to use Europe's rescue funds to recapitalise weak banks, particularly in Spain. But a common system of deposit insurance needs to be rapidly set up. These are big changes. Politicians will no longer be able to force their banks to support national firms or buy their government bonds. Banks will no longer be Spanish or German, but increasingly European. Make no mistake: this is integration. But it is limited to finance, a part of the economy where monetary union has already swept away national boundaries. The fiscal integration can also be limited. Brussels need not take charge of tax and spending, nor need Eurobonds cover all government debts. All that is required is for overindebted countries to have access to money and for banks to have a "safe" euro-wide class of assets that is not tied to the fortunes of one country. The solution is a narrower Eurobond that mutualises a limited amount of debt for a limited amount of time. The best option is to build on an idea put forward by Germany's Council of Economic Experts, to mutualise the current debts of all euro-zone economies above 6o% of their GDP. Rather than issuing new national government bonds, everybody, from Germany (debt: 81% of GDP) to Italy (12o%) would issue only these joint bonds until their national debts fell to the 6o% threshold. The new mutualised-bond market, worth some â&#x201A;Ź2.3 trillion, would be paid off over the next 25 years. Each country would pledge a specified tax (such as a vAT surcharge) to provide the cash. So far Mrs Merkel has opposed all forms of mutualisation (and did so again this week-see Charlemagne). Under our scheme, Germany would pay more on a slug of its debt, subsidising riskier borrowers. But it is not a move to wholesale fiscal federalism. These joint bonds would not require intrusive federal fiscal oversight. Limited in scope and time, they do not fall foul of Germany's constitutional constraints. Indeed, they can be built from last autumn's beefed-up "six pack", which curbs excessive borrowing and deficits; and January's fiscal compact, which enshrines budget discipline in law and is now being ratified across the euro zone. Even this more limited version of federalism is tricky. The single banking regulator might require a treaty change, which would be difficult when ten EU countries, including Britain, are not members of the euro. The treaty setting up Europe's bail-out fund would also have to be changed to allow money to be supplied directly to banks. Countries would have to find convincing ways to commit future governments to pay their share of the interest on the Eurobonds. Greece's debts so outweigh its economy that it would need a further rescue before entering any mutualisation scheme-though the sum involved is small on a continental scale. So it is a long agenda; but it is more manageable than trying to redesign Brussels from the top down, and it is less costly than a break-up. Saving the euro is desirable and it is doable. One question remains: will Germans, Austrians and the Dutch feel enough solidarity with Italians, Spaniards, Portuguese and Irish to pay up? We believe that to do so is in their own interests. The time has come for Europe's leaders, and Mrs Merkel in particular, to make that case. â&#x20AC;˘

The Economist May 26th 2012

14 Leaders Bangladesh's toxic politics

Hello, Delhi It is up to India to try to stop Sheikh Hasina ruining Bangladesh

HEPunch-and-Judyshowof Bangladeshi politics, in T which the ruling party-run by the daughter of a former president-bashes the oppositionrun by the widow of a former president-before swapping places with it, has been running for decades. The outside world rarely pays attention because nothing seems to change. Recently, though, the squabbling has turned into a crisis (see page 41) which threatens to make life still worse for the 170m poor Muslims who suffer under one of the world's worst governments. Since Bangladesh's political leaders show no interest in their fate, outsiders need to do so. When Sheikh Hasina, leader of the Awami League and current prime minister, and Khaleda Zia, leader of the Bangladesh Nationalist Party (BNP ), alternated in power in the 1990s, things were pretty bad, but in the past decade they have got worse. The administration Mrs Zia headed from 2001 to 2006 was a brutal kleptocracy. It was followed by army-backed unelected technocrats. Then in 2008 the Awami League swept to power in a landslide victory. The League has 229 of 300 parliamentary seats compared with 31for Mrs Zia's BNP. Sheikh Hasina has used this mandate to consolidate power and hound her enemies, real and imagined. There has been a spate of mysterious disappearances. This month 33 senior members of the opposition were arrested on charges of vandalism and arson. A war-crimes tribunal to investigate the atrocities in Bangladesh's war of independence in 1971-some of the bloodiest in modem history-now looks like an attempt to discredit the BNP and its Islamist allies. And

the hounding of Mohammad Yunus, a pioneer of microfinance, creator of the Grameen Bank and a Nobellaureate, is seen as payback for his temerity in 2007 in trying to launch a "third force" in politics. Meanwhile, journalists and activists face intimidation and worse, and the vibrant NGOS that keep the spirit of democracy alive worry that proposed legislation would leave them at the mercy of government whims. Last year the League did away with the provision that caretaker administrations should oversee elections. The arrangement was not ideal. In January 2007 protests led by the League, convinced that the BNP would rig an election, led to a coup. But without some assurance of fair play the BNP will boycott the next election, due in 2014. So there is the prospect of yet more protests, which in Bangladesh often take the form of crippling strikes. There is also the real prospect of utter political paralysis, risking even worse turmoil on the streets.

The only voice in Dhaka The outside world is trying to do its bit. The World Bank has scrapped a deal to pay for a big bridge because of its suspicions of corruption. EU ambassadors have denounced the treatment of Mr Yunus and the harassment of activists. Hillary Clinton flew to Dhaka this month to stand by Mr Yunus. But the government seems unmoved. In a snub to Mrs Clinton, it announced a review into ownership of Grameen, a move to take over (and probably destroy) the bank. The only country to have much influence in Dhaka is India. Until recently the regional superpower tolerated Sheikh Hasina's excesses, in part because Bangladesh has cracked down on Islamists. India now seems to be hedging its bets between the two parties. But if it still wants to have a functioning democracy next door, it needs to speak out far louder in favour of it. â&#x20AC;˘

Energy markets

The charges of the light brigade The market, not the government, should determine the price of electricity in Britain RITAIN created the first electric light bulb and a pioneer2011 ing national grid. Then, in 1990, Pence per kWh, July-December it built one of the rich world's 10 1s 20 most liberalised energy marBritain kets. For years it enjoyed low prices and lectured other counEU15 tries about the virtues of deregulation. Not for it French-style state-owned monopoly utility firms. But the country has gradually lost faith in a free energy market. A bill published on May 22nd signals a drastic change. The bill is a response to two developments. One-particularly worrying to politicians-is rising electricity prices. The second, further off, is a looming capacity crunch. Roughly onefifth of Britain's existing power stations are due to be retired Domestic electridty

within the next decade, and if the country is to meet its EU targets, new capacity must come from low-carbon sources. The government's solution to all these problems is to replace a de regulated market with a command-and-control one. It has stated how much it expects each renewable technology to generate by 2020, as well as how many nuclear plants it wants, and where. It will create long-term contracts for supplying low-carbon energy, setting a minimum price for solar power, another for offshore wind and so on (see page 57). The hope is that this will give energy firms the assurances needed to invest in new forms of generation. The certainty is that David Cameron's Conservative-led coalition government is rowing hard against the free market. This is odd, and wrong. The market has not failed. Prices have been rising in Britain, but they remain among the lowest in Europe. Out of 15 EU ~~

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only Greek and Dutch consumers pay less. Bills have gone up because most British electricity is generated by burning gas, the cost of which has rocketed. If gas prices were to fall (as they may, with improving technology and plenty of shale gas) bills would come down again.

Best ways to be green The country certainly needs more generating capacity, especially of the low-carbon kind. But it is going the wrong way about encouraging it. Specifying how much power is to be generated from nuclear and from each form of renewable power means picking winners-something that governments generally do badly. Offshore wind and nuclear, the government's favoured technologies, are among the most expensive ways to get carbon out of the energy system. And all political promises to guarantee energy prices are notoriously unreliable and unlikely to spark investor confidence. In 2011 Germany suddenly decided to shut its nuclear power stations. Rather than interfere with and second-guess the market, the government should strengthen it. For investors to view the electricity-generating business with enthusiasm, they must be able to find out what the real price of electricity is. At present

that is impossible, because most electricity in Britain is "traded" between the generation and supply arms of the same firms. The government should have threatened to split them up (a gambit that worked wonders with British Telecom) and forced trading onto open exchanges, as happens in Germany. The best way to encourage green energy is to tax carbon. Australia took that brave step in 2011, admittedly with plenty of giveaways and exemptions for the early years. Under the European emissions-trading scheme carbon does have a price in Britain, but it is too low to be effective and is hard to increase. If Britain commits itself to unilateral action, the early price would still be low, but the government could promise to increase it over time. It is the price of carbon in 20 or 30 years, not now, that determines investment decisions. This move would encourage cleaner technologies but allow the market to choose which it favours and how much to pay. It is simple and more likely to endure than complex interventions. The energy business is changing fast. The price of solar power has fallen; the price of oil has soared. Shale gas is booming. Wave power, carbon-capture technologies and electricity storage could all prove revolutionary. All the more reason to let investors, not Mr Cameron, pick the winners. â&#x20AC;˘

Azerbaijan and Eurovision

Nul points More care should be taken over where to hold international pageants N THE face of it, Ilham Aliev, the president of Azerbaijan, and the Eurovision Song Contest, held in his country this week, are a good fit. Eurovision, in which viewers across Europe (broadly defined) select a winning song from competing national entries, is an annual festival of kitsch. Mr Aliev's fondness for opulence, his strongman moustache, and the cult of personality he has built around his father, Heidar, from whom he inherited his post in 2003, are all suitably retro. Alas, his regime also has some less amusing traits, which suggest that the organisers of shindigs like Eurovision should be more careful about where they are staged (see page 53). The story behind the songs is a sad one. Protests against Mr Aliev's rule, especially after the rigged elections that keep him in power, are routinely crushed. His critics have been beaten and imprisoned. Not only do Azerbaijan's human-rights abuses make a grim backdrop to the clowning of Eurovision: some have been perpetrated on its account. According to human-rights groups, scores of families have been forcibly evicted from their homes to make way for a new concert hall. Absurdly but terrifyingly, in previous Eurovisions Azerbaijanis were interrogated for voting for Armenia-the Caucasian neighbour with which Azerbaijan fought a war in the 1990s and may yet fight another. The lavish cost of the preparations is itself obscene in a place where many lack basic amenities, despite the gridlock of imported cars in central Balm, the capital. But then, Azerbaijan scores the full12 points for corruption. The wealth of a favoured few in Azerbaijan derives from oil and gas, pumped out of the Caspian and through a pipeline to

Turkey. Along with the country's sensitive location-between Russia and Iran-the oil helps explain the West's often indulgent attitude to Mr Aliev. Yet the indulgence must have a limit. Eurovision should have been beyond it.

Politics by other means A similar awkwardness recently arose over a more important tournament, the forthcoming European football championship, and a bigger country, Ukraine, its eo-host. Commendably, some diplomats are refusing to turn up unless Yulia Tymoshenko, a former prime minister now imprisoned on doubtful charges, is treated humanely. A long time has elapsed since Ukraine, with Poland, was awarded the football tournament in 2007: the intervening years have seen it not only build stadiums, but also lapse from a struggling but hopeful democracy into a darker place. Eurovision presents a different problem. Azerbaijan is host because it won last year's contest-somewhat unfortunately, in light of Mr Aliev's reputation, the victorious song was entitled "Running Scared". That rule should be changed. The bodies that oversee these extravaganzas are avowedly non-political; they argue that such contests promote international goodwill. But they become political tools, nonetheless. Although stable, democratic countries often approach them with wry amusement, for nasty leaders such as Mr Aliev these spectacles are valuable propaganda: Eurovision, the biggest thing in Azerbaijan since it became independent in 1991, has been presented as a diplomatic imprimatur. More discretion, for example relying on independent human-rights data, should be used in allocating them. Eurovision would have done more to further peace and fraternity if Azerbaijan had been refused the right to be the host until its government upheld those values. â&#x20AC;˘

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Greece on the precipice SIR- Leaving the euro zone is no option for Greece ("Fiddling while Athens burns", May 19th). The new drachma would be valueless, as there would be no demand for it. A country that finds it difficult to run its fiscal affairs cannot manage a national currency. The restored drachma would stay in circulation only if the Greeks were denied access to foreign exchange, preventing the informal use of the euro. That would require draconian exchange controls of the type put in place by Germany after the first world war, which ensured the circulation of the depreciating mark during a period of hyperinflation. What can Europe do for Greece? It can provide it with a stable monetary unit: the euro. What can Europe not do for Greece? Well, it cannot give it a sound fiscal system. The Greeks have to achieve that themselves if they wish to remain a sovereign country.

ERNST JUERG WEBER

Associate professor of economics University of Western Australia

Perth SIR- When are you going to wake up to the fact that the European federalist dream is over? The euro is finished as a world currency. This sorry saga has been dragging on for two years now, bringing Europe "ever closer", not to greater union but to being torn asunder. The euro was a grand scheme that pushed the boundaries of globalisation by trying to subsume countries whose peoples have enduring national identities into some kind of postmodern technocratic paradise. Yet polls show that those peoples actually liked their currencies and the control it gave them over their economies. What this crisis has thrown a light on is that we are not "Europeans" after all, but Greeks, Germans, French, British and so on. Let's hope that light doesn't blind us when we all rush for the exits.

THOMAS WILLIAMS

Dover, Kent

SIR- Echoing the sentiments of my co-peripheralist in Dublin (Letters, May 12th), I too am frustrated by the widespread misuse of the term" austerity". It must surely seem "austere" to cut by 30% the pension of a Greek civil servant who was undoubtedly counting on that income to live out the next 25 years of his life. But when the specific pension in question is, for example, the monthly €1,8oo ($2,300) paid to a retired assistant garbage-truck driver in the Peloponnese (I kid you not), perhaps some other term would be more appropriate. The new pension level of €1,200 is still so% above the starting wage of a schoolteacher. Austerity, like beauty, is in the eye of the beholder.

Finally, I would like to point out that the lese-majeste law is part of Thailand's criminal code, which also contains provisions on defamation and libel for private individuals. The law gives protection to the rights or reputations of the king, the queen, the heir-apparent or the regent in a similar way that libel law does for commoners. It is not aimed at curbing people's rights to freedom of opinion and expression, nor the legitimate exercise of academic freedom, including debates about the monarchy as an institution.

ALEXANDER SINGER

SIR- Your report on Face-

Athens

book's valuation missed the central conflict that jeopardises the firm's future success ("Zuckerberg's rocket, ready for lift-off", May 12th). Millennials like myself flocked to the social network because it was young and "cool". That strength now serves as its greatest weakness as Face book asks us to overlook its youthful indiscretions over privacy and hand over our credit cards. Themagnetofcoolvanished the moment they claimed to be responsible adults. Investors are chasing a moving target.

The Thai monarchy SIR- I want to

provide you with some facts on the death of Ampon Tangnoppakul, whom you wrote about in your article on Thailand's lese-majeste law(" An inconvenient death", May uth). First, we are deeply saddened by the death of Mr Ampon. An initial autopsy report confirms that he died from liver cancer. The final report of his autopsy, including a tissue-sample examination and toxicology testing, will be released in due course. It is regrettable that certain groups have tried to gain publicity from his death for their own political means. Second, Mr Amp on, as with other prisoners with health problems, was provided with proper medical treatment for his illness in the corrections department hospital. He was allowed to leave the corrections facility to receive chemotherapy treatment at an MRI centre five times in 2011 and twice this year. Third, the legal proceedings against Mr Amp on were carried out in accordance with Thai law and due process, including the right to a fair trial, assistance from lawyers and ample opportunity to contest the charges. He was also entitled to appeal.

RUTCHABHOOM BOONRAWD

Embassy ofThailand

London Losing some friends

STEPHEN SENTOFF

Arlington, Virginia Clickety clack SIR- I found

it interesting that designated quiet carriages on trains don't seem to be very quiet in some parts of the world ("Shhhh!", Mayuth). I also found the proposed solutions of signal jamming, fines and extra charges equally interesting, and a little stupid. I frequently travel by train from Washington, DC, to New York on the Amtrak Acela and have never had a problem with noise in the quiet car. What keeps the quiet and the peace is good old-fashioned peer pressure. The minute anyone gets on their phone or starts talking to their seatmate, there is always a fellow travel-

ler to "remind" them that the there is no talking in the quiet carriage. I have never seen this technique not work. BILL LEFFINGWELL

Rockville, Maryland SIR- Whenipointoutto phone offenders that they are in a quiet carriage the usual response is that they are only making a short call. A threeminute call from half the people in a 75-seat carriage ensures a constant babble all the way from London to Bristal. I did once move to the seat beside a persistent offender in mid-call and recited Coleridge's "Kubla Khan" aloud to him. Somewhere in the deep romantic chasm he understood my point and desisted.

PAUL BEARDMORE

London From one author to another SIR- Please tellJonathan Franzen that I went quite nutty with happiness over what he said about my work ("Purposefully dreaming", April 28th). Not to say blurbs aren't welcome ...

ALICE MUNRO

Clinton, Canada Punishment fits the crime SIR- Regarding the current travails at Spanish banks ("A rude awakening", Mayuth), Barcelona, arguably the birthplace of the modern bank, did not tolerate bankrupt bankers. According to Edwin Hunt's andJames Murray's history of business in medieval Europe, under a law passed in 1321 bankers who were in default were given only bread and water and had to settle their accounts within a year. In 1360 one banker, Francesc Castello, "was beheaded in front of his own bank."

DAN CHURCH

Bethlehem, Pennsylvania • Letters are welcome and should be addressed to the Editor at The Economist, 25 StJames's Street, London SWlA lHG E-mail: letters@economist.com Fax: 020 7839 4092 More letters are available at:

Economist.comjletters

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The Springfleld Centre IS a leader in the market systems approach to conomic d velopment, which has 1ncreas1ng Influence among international agenci s. Workrng with key organisations donors (eg DFID), INGOs (eg Mercy Corps), and charitable rusts (eg Gatsby Foundation)- we lead th1nklng and practice through · • high level advisory, research and consultancy 1npu s • Innovative training courses and workshops • strat glc partn rships w1th programmes and organasat aons We ar a mottvated, focused company with a reputation for andependent analysts. Increasing opportunities to dnve the market systems approach forward mean we wish to build our team based in Durham by r cruiting senior consultants/ consultants with expenence an areas such as: Private sector development Policy /regulatory reform Financial sector development Rural development Impact Assessment Health and education We are lookang for people w th strong capacitaes in techntcal analysts, writing and communication. P ople who enjoy workang in an informal and dynamic environment, are happy to travel Internationally on a regular basis and can lead new areas of work (as well as contnbu ang to our overall growth). For more anformat1on go to· www.springfteldcentre.com To apply, please send CV wath covertng I tter to Jan Hutchanson at global@ pringfteldcentre.com quotmg r ference M4P12. (Non-EEA apphcants must hav a vahd UK work permtt) Closing date: 6 July 2012.

TH The Economist May 26th 2012

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Creating Opportunity Where lt's Needed Most The Economist May 26th 2012

The billion-baht man Na Kham Mwe, the commander of the Democratic Karen Buddhist Army, lords it over a tiny strip of Myanmar near the Thai border. His relationship with Myanmar's government has grown cordial recently. ButThailand's drug tsar has put a gobsmacking bounty on his head

Battle igloo Frugal innovation is usually associated with entrepreneurs in emerging markets developing low-cost products. Butthe process can happen in the rich world, too: a British company planning to entertain festival-goers has ended up disrupting the business of battlefield simulation

The music's over As a genre, disco gets a rotten press. It tends to conjure up images of hairy chests, medallions and the worst kind of dad-dancing.Buttherecentdeathsoftwo disco heavyweights, Donna Summer and Robin Gibb, provide an opportunity for a re-evaluation of its origins and delights

Economist.comfnode/21555860

Economist.comfnode/21555777

Economist.comfnode/21555794

United States: Bringing the Bain If Mitt Romney cannot defend himself against Barack Obama's attemptto turn his business experience into a liability, he does not deserve to be president

Europe: Eurovision diary Playing hostto this year's Eurovision song contest gives Azerbaijan a chance to show off the fruits of its oil boom

Americas: War of attrition The stalemate between students and the Quebec government over university tuition fees shows no sign of ending

Economi st.comf node/ 21555 7 37

Economist.comfnode/21555828

Business: GoodTube Google wants You Tube, its popular on line video service, to become less about entertainment and more like the BBC

Sport: The leopard changes his spots Two British climbers prepare fora daunting challenge in the former Soviet Union

Economi st.comf node/ 21555845

Technology: Difference engine Why people drive what they drive Economist.comjnode/21555829

Economist.comjnode/21555734

Economi st.comf node/ 21555 755

Middle East: Seeds of the future On line activists continue to play an important role in the Arab spring Economist.comfnode/21555839

Business education: Stop planning How to make studying entrepreneurship more like being an entrepreneur

Culture: The price of being female Depictions of women often command the highest prices at art auctions. Works by them do not. Butthatis changing

Economist.comfnode/21555752

Economist.comjnode/21555730

China: Blame the messenger India-China relations might improve if their national press corps were better acquainted, or agreed on the purpose of journalism

Technology: More than just text Two-dimensional scans of books, while useful, leave out plenty of information

Economist.comjnode/215557 44

Economist.comjnode/21555556

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An ever-deeper democratic deficit

Also in this section 26 The costs of a Greek exit In other sections 54 Charlemagne: The feelings mutual

The level of further integration necessary to deal with the euro crisis will be hard to square with the increasing cantankerousness of Europe's voters

OR the past six decades, steps forward to greater European union have taken place at moments of incipient crisis. None, though, has been taken in a time of disaster. The next leap in integration looks set to change that. All the plausible solutions to the self-inflicted mess of the euro crisis require a significant new level of fiscal and potentially political union, not least because some countries, such as Germany, actively want greater political union and see it as the price of their co-operation. In order to make any such solution work, Europe's elites will have to address a problem they have long shirked: that of the democratic deficit at the heart of integration. And they will have to do so under the worst of conditions. The past week's near-continuous highlevel summitry has done little to reduce the risk of a Greek exit from the euro, which rose to higher levels than ever after the inconclusive results of the country's election on May 6th. The risk shows no signs of receding before the next vote, on June 17th. After that, risk may become reality (see next story). A consensus is slowly emerging that, whether a Greek exit is to be averted or weathered, there will have to be a greater level of integration in the euro zone, with tighter constraints on the freedom of na-

tional governments. Some countries, under some conditions, may put up with seeing their governments so constrained for a while: Italy and Greece (until recently) have had unelected, technocratic prime ministers, in large part as a result of pressure from outside creditors. But elsewhere, and in the long run, people seem likely to want to do the constraining they think proper by means of the ballot box, rather than having it forced upon them. If only you'd asked A new paper written for the European Council on Foreign Relations (ECFR) by Ulrike Guerot and Thomas Klau quotes a German government official putting his finger on the nub of the problem: "the weakness of the system is not about spending and how to promote growth, but about legitimacy." A move to fix the euro crisis with greater political union that does not take this into account will, at best, store up grave political problems for the future. At worst it will prove impossible to implement at all because of the politics of the here and now. The architects of the 1992 Maastricht treaty, who included Jacques Delors, then European Commission president, and Helmut Kohl, then German chancellor, always wanted political union to accompany the

71 Europe in limbo monetary union that the treaty envisaged. Some critics of the project, including the German Bundesbank, argued that the single currency would not work without it. But Maastricht, like many edifices, did not end up quite as the architects had wanted. There were rules on budget deficits that implicitly reached into the political decision-making of the member states. But they were not taken seriously, and swiftly broken without censure. In what has become something of a pattern in Europe, most voters were not asked whether they wanted such a treaty. Those who were showed themselves equivocal: a French referendum on the Maastricht treaty squeaked through by the narrowest of margins. Most of the euro zone's citizens came to accept the currency, as they have accepted the European Union (Eu), because until the crisis hit it seemed to bring clear benefits, or at least to do no harm. Once things started to go wrong, though, the voters protested. Since the euro crisis began in early 2010, no fewer than nine of the zone's17 national leaders have been ejected from office. The approval ratings for many countries' membership of the EU have been declining (see chart 1 on next page). Voters have been giving more support to fringe parties. The Greek election took this swing to extremes,

24 Briefing The euro crisis ~

The Economist May 26th 2012

with almost 70% of the votes going to parties that wanted to modify or tear up the country's bail-out deal. But something similar, if more muted, is visible from Finland to the Netherlands to Germany. It can be hard to tell anti-incumbency feeling from anti-Brussels feeling-but that is part of the problem. With no way to influence Brussels except through governments that seem not to be listening, the cynical antipolitics of impotence easily takes hold.

Flagging fortunes "My country's membership of the EU is a good thing", % polled

From January 2002 -

Germany France

PIIGS focus from January 2007 Poland

Britain

Italy

Democracy, eurocracy 30 This democratic deficit in Europe's institu20 tions is hardly new. Europe's first helms_1. 1I l l men deliberately eschewed populism-the 2002 03 04 05 06 07 08 09 10 11 tool of fascists and communists, in their Source: Eurobarometer eyes-in favour of dispassionate wellplanned gradualism as a road to the sort of ever closer union that would banish war A third was to claim that the European from the continent. Thanks to the decisive project was mainly about technical matintervention of Charles de Gaulle-whose ters such as competition, regulation and "empty chair policy" meant refusing to rules for the single market, all of which send French emissaries to Brussels, and could happily and unproblematically be thus paralysing the nascent institutions dealt with out of sight of the voters (in until his demands were met-the project most countries they are dealt with technosoon veered from a more centralised vi- cratically). The argument was that, so long sion to a more inter-governmental one; but as the EU did not touch the most important the powerful non-national institutions re- political issues for ordinary voters-such mained. as tax, spending, education, defence or Although it was an elite venture light on health care-its apparent lack of accountsuch fripperies as voters' consent, still less ability would not matter. accountability, the European project incorporated many less direct democratic fea- Coming unstuck tures from the start. Most fundamentally, Now the crisis has struck, all the putative membership was only open to democra- responses to the democratic deficit are becies. The inter-governmental Council of ing found wanting. The qualified majority Ministers and European Council-now the voting introduced by the Single European EU's prime driver of policy-thus repre- Act of the 1980s and the subsequent ensented the people. The commission-its largement of the union mean that nations, members chosen by elected national gov- especially small ones, can frequently feel marginalised, and their elecernments-would propose torates voiceless; the system is legislation; it would then have to be approved by both the One-way trip opaque, complex and remote. Turnout in European Countries outside the euro Council and the European Parliament elections zone are not party to some deParliament, another mode of % oftotal electorate cisions, which can make them legitimation. To begin with 65 fear marginalisation; the "six the parliament's members, too, were nominated by govpack" of fiscal regulations 1979 ernments from their national agreed last year and the newly 60 devised fiscal compact erode parliaments. From 1979 on1984 1989 even further the ability of a wards the members have 1994 government within the zone been elected directly. 55 to control its own fate. CruThe role of governments in setting policy and appointing cially, the pact imposes fines on governments in breach of personnel was one response 50 to concerns about democratic its strictures automatically, un1999 less a qualified majority of all accountability within the nathe others votes against doing scent EU. Another was to ar2004 45 so. In 2002 Francis Mer, newly gue that what really mattered installed as French finance for European citizens was 2009 minister, dismissed commis"output legitimacy": the no40 sion requests for budget cuts to tion that, so long as the comcomply with the stability and mon project produced evident benefits in the form of growth pact by saying that 35 "France has other priorities." prosperity, economic opporPierre Moscovici, Fran<;ois tunities and job creation, vot0 Source: European Hollande's new finance minisers would accept it, and even Parliament ter, stands no chance of being come round to welcoming it.

Ireland Spain

Portugal Greece

EU average

30 20 I

2007

similarly highhanded. This lack of governmental override worries not just debtor nations but also some creditor countries such as the Netherlands-and even German states. The other responses to the democratic deficit look even more tattered. Output legitimacy is a hard sell when the outputs voters use to reach a judgment are a crisis they didn't create and austerity they don't want. The idea that the EU is all about distant technical adjustments is laughable now that the euro is impinging on many basic functions of sovereign national governments, most obviously in Greece, Ireland and Portugal, but also in all the parties to the fiscal compact. If the euro is to survive, it will likely do so by impinging on them yet further. And what of the European Parliament? It has, if anything, widened the deficit it is meant to make up. It has increased its powers with every EU treaty, including the fiscal compact; but it has seen no parallel growth in its legitimacy. In the commission and in national capitals alike, frustration with the parliament has been growing. It is almost always in favour of new regulation and always in favour of more spending. Any claim that this is what the voters want is undermined by the fact that the voters show ever less interest in it. At every election for the European Parliament since 1979, the turnout across the continent has plumbed a new low (see chart 2). National elections see higher turnouts almost everywhere. And if fringe parties are doing well in many regional and national elections-as the Pirate Party has been in Germany, and Beppe Grillo's "Five Star movement" in Italy (see page 51)-they tend to do even better in votes for Strasbourg. How to elect a president If a more tightly knit euro zone needs better democratic credentials, then there is no shortage of ideas about what to do. The most obvious is to limit the extent of centralised powers. Constraints on national budget deficits-which the fiscal compact

The Economist May 26th 2012 ~

Briefing The euro crisis 25

wants written into national constitutions-do not need to mean common rules on spending or harmonisation of taxes. The long-established principle of subsidiarity should leave as much discretion as possible to national or local levels of government. Yet much tighter constraints on fiscal policy will still curtail national freedom, so they may need to be offset by schemes designed to increase democratic legitimacy. Old-style federalists say this means now is the time to bolster the European Parliament still more. One possibility would be to up the ante in its elections by making them indirect elections for the commission president as well. The idea is that the big political groups (the centreright European People's Party, the Socialists and the Liberals) should each have preferred candidates, and the member states should agree to choose the candidate of the block that does best at the next elections, due in 2014. Such schemes ignore the degree to which the parliament has become part of the problem, rather than the solution-unloved by the Eu's institutions, the governments of its member states, and its citizenry. In its judgment on the Lisbon treaty, the German constitutional court cast doubt on the democratic credentials of the European Parliament, arguing that the Bundestag had greater legitimacy. Another possibility, if elections are the answer, is to avoid the parliament and elect the president of the commission directly. Wolfgang Schauble, Germany's finance minister, has espoused this idea, most recently in his acceptance speech for the Charlemagne prize on May 17th. Last November, his party, the Christian Democratic Union that Angela Merkelleads, also came out in favour of an elected president. The opposition German Social Democrats are also interested. As in many matters, German enthusi-

asm is not enough in itself to win the day. Direct elections for a president (unlike appointment on the advice of the parliament) would require a new treaty. Even before the euro crisis, new treaties had proved hard sells (see timeline below). The EU's Lisbon treaty crept into force only because 26 of the 27 member states avoided putting it to a vote, and the 27th, Ireland, allowed itself a second vote after the first went the wrong way. The executive and the excluded If treaties are to be changed, though, Vernon Bogdanor, a professor at King's College, London, would push the elections yet further, and elect the entire commission on a Europe-wide basis. He argues that the euro zone is at a similar stage to the embryonic United States in the early 1780s. That was the moment when Alexander Hamilton took the big step of federalising the states' debts. In the euro zone, too, Mr Bogdanor suggests, it is time to move towards federalism with a new democratic input: hence the notion of an elected European Commission. To those who claim that there is no European demos to underpin such democracy, he argues that a Europewide election will itself create one. This is the sort of thing that Larry Siedentop, a former Oxford academic, warns against under the heading of "faux democracy". Sharing the general dissatisfaction with the European Parliament, Mr Siedentop doubts things can be improved by another elected body. In his prescient "Democracy in Europe", published in 2000, Mr Siedentop warned that, after creating the single currency, "European elites today are in danger of creating a profound moral and institutional crisis in Europe-a crisis of democracy." His suggested solution was to set up an appointed Senate, chosen from national parliaments; to those who feel democracy needs elections he points out that America's Senate was appointed untill913.

An alternative, and attractive, source of democratic accountability might be found in Europe's national parliaments. Before 1979 there was an umbilical link between the European Parliament in Strasbourg and national parliaments, with some members circulating between the two. Now the different parliaments tend to see each other as rivals rather than as colleagues trying to hold the executive to account. The Lisbon treaty gives national parliaments only a limited role. Charles Grant, director of the Centre for European Reform in London, suggests enlarging this. He would give more prominence to cosAc, the group that brings together national parliaments' European affairs committees, perhaps putting a delegation of national MPS in Brussels to work more closely with the European Parliament. Others want to give the budget committees in national parliaments a clear role in monitoring and applying the fiscal compact. A continuing issue in all this is the balance between an inter-governmental and a federal system. Those leaning towards a bigger role for national parliaments and governments naturally favour the first. But Mr Klau of the ECFR points out that such a method makes it more likely that Germany, the biggest power and also largest creditor, will be identified as a target by the rest. Inter-governmentalism favours big countries, which is why small ones talk up the role of Brussels. The case for greater national involvement in running the euro zone is very strong. Whether Greece leaves or stays, the euro zone must be more politically integrated or fall apart. But deeper political union could provoke a backlash, in both creditor and debtor countries, that brings the whole system crashing down. In last year's Finnish election the True Finns under Timo Soini went from almost no support to close to 20% by campaigning against euro-zone bail-outs. In the Netherlands Geert Wild- ~~ Result: for/ against

Continental covenants EU treaty referendums since 1992 MAASTRICHT TREATY:

TREATY OF AMSTERDAM:

TREATY OF NICE:

CONSmUTION FOR EUROPE:

TREATY OF USBON:

Denmark (2/6/92)

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{19/10/02) 62.9/ 37.1

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Ireland

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EUROPEAN FISCAL COMPACT:

2000

,.,.... 07

12 cL

THE EURO:

January 1st 1999

Single currency launched: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain Source: Th e Economist

January 1st 2001

Greece joins

January 1st 2007

January 1st 2011

Slovenia joins January 1st 2008

Cyprus and Malta join

January 1st 2009

Slovakia joins

Estonia joins

26 Briefing The euro crisis ~

ers, who has just precipitated an election by withdrawing his support from the government, is now running as much on an anti-bail-out ticket as his more familiar anti-Muslim one. France's National Front has long been anti-euro as well as anti-immigrant, and Marine Le Pen's stand against the single currency contributed a lot to her strong showing in the first round of the presidential election. Given that voters are making their antipathy heard by means of their national elections, they might feel better represented if national MPS and governments played a bigger role in policing the boundaries of political union of the euro zone. But this may be too sanguine. A significant number of voters clearly want not a more democratic version of the EU, but a fundamentally different institution. With views highly polarised, it is hard to see how any useful treaty could now get accepted by all 27 nations-which is one of the reasons why the fiscal compact has an opt-in system. When Ireland votes on the compact on May 31st, it will be voting in or out for Ireland alone, not threatening to block everyone else. If Europe seeks a new political constitution, though, a dramatic lurch towards a rejectionist or extremist party on one country could lead to a break-up of the club. And there is also a profound structural problem. The new round of political integration is being driven by the need to govern the euro zone better; but ten of the 27 are not part of it. And although many of them have historically aspired to join, Britain and Denmark have formal opt-outs from the euro, and Sweden is also unlikely to join for many years, if ever. These countries have a strong interest in ensuring that, as the euro zone becomes more integrated, they do not lose their influence in debate or their part in decisions. But their voters are unlikely to accept commitment to a stronger political union. David Cameron's "veto" of the fiscal compact in December 2011 was seen as a petulant obstacle to progress by many of his fellow heads of government; his party's supporters in Britain greeted it with inordinate enthusiasm. When the architects of Maastricht were unable to produce a political union some of them comforted themselves with the idea that a common currency would in and of itself bring further economic integration from which political integration would naturally flow. They did not foresee that it would do so by throwing the continent into crisis. And they did not provide the mechanisms by which the citizens of the union could feel they were both in part to blame for the problem, as some are, and in a place to help find a solution. A political settlement that protects the euro without incorporating new ways to get and earn their assent is unlikely to last long-or to deserveto. •

The Economist May 26th 2012 The costs of a Greek exit

Cutting up rough

How much do Greece and the rest of Europe stand to lose?

COULD come sooner; it might well ItheTdragweek out longer; it can still be averted: but following the next Greek election on June 17th still looks set to be the time when the euro zone's debilitating fever peaks, and the patient's prognosis becomes clear. That election could well produce a government determined to renege on or radically renegotiate the reforms and austerity measures its predecessor committed the country to at the time of the second bail-out, earlier this year. If that happens, the rest of Europe will have to decide whether to be party to those negotiations or to walk away. If European leaders follow through on their threats to enforce those terms, the flow of bail-out money to the Greek government will stop. Since March Greece has received half of the €145 billion ($185 billion) it is due to get from the European Financial Stability Facility (EFSF), the euro area's temporary rescue fund, by the end of 2014. And it has received a first payment of €1.6 billion out of a total €28 billion due from the IMF by early 2016. Although the Greek government is close to running a primary budget surplus (ie, before interest payments) it still needs further official loans to honour obligations due this year, notably redemptions of bonds held by the European Central Bank (ECB), which were excluded from the restructuring in March that slashed the face value of €2oo billion of debt held by private bondholders by over half. If the lifeline from the EFSF were cut off by its creditor nations, Greece would be unable to pay

those debts. And if the ECB makes it a matter of principle not to lend (or permit the Bank of Greece to lend) to banks against collateral consisting of bonds and guarantees from a government in default, then it in turn would cut Greece off. Greek banks currently rely upon some €130 billion of central-bank funding. Without the ECB money the entire banking system would collapse. If the flow of money was reduced, and the conditions it is lent on tightened, the Greek government might start to issue 1ous to its workers to make up the shortfall. If the flow stopped, leaving the banks no euros to pay out, a new currency would be the only alternative. The government would redenominate domestic bank assets and liabilities into drachma and insist that domestic contracts, such as pay and prices, be also set in drachma. Capital controls would be necessary because the drachma would immediately fall against the euro, possibly losing so% or more of its value in a trice. In the short term Greece's economic agony-its economy shrank by 13% from 2007 to 2011 and is expected to contract by almost 5% this year-would intensify. A precipitous exit without preparation would leave the country without notes and coin. The surrounding chaos would paralyse economic activity, causing consumers and businesses to stop spending. Economists at UBS, a Swiss bank, have estimated that the cost of a catastrophic exit might amount to 40-50% of G DP in the first year. That figure assumes that Greece would have to leave the EU as well as the euro,

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28 Briefing The euro crisis ~

and thus lose access to the single market. On strict legal grounds that may be the case, in part because exit requires capital controls, and those controls are illegal under EU treaties. In practice European policymakers are making it clear they would do their utmost to keep Greece in the EU. Assuming such helpfulness, Mark Cliffe, an economist at ING, a Dutch bank, reckons that the effect would be less. He puts the first-year extra loss of output at 7.5% (see chart). Run like the wind If Greece's new currency avoided lurching into hyperinflation-which in a chaotic country with a weak government and a new currency would be a serious risk-the country might regain some of its losses the following year. Rather than having to spend years grinding down domestic costs, the exchange-rate fall would provide them overnight, boosting competitiveness. If the country looked safe, stable and welcoming, other Europeans would flock to take their holidays in the Aegean. That is another rather large if; and other Europeans may have a lot more to worry about than holiday planning. European governments would bear losses on the loans they have made to Greece in the various bail-outs. The ECB for its part is exposed in two main ways. Firstly, to calm market tensions after the May 2010 rescue it bought Greek bonds worth about €40 billion. Second, the Bank of Greece owes the ECB around €130 billion in "Target 2" debt, internal obligations within the European central banking system, which would turn into real debt in the event of an exit. All in all, the Greek government owes the governments and institutions of the euro area over €290 billion, about 3% of euro-wide GDP, say economists at Barclays Capital. After an exit most of this would probably never be repaid. On top of that, there is the exposure of the private sector. At the end of 2011 Greek companies and households owed international banks $69 billion. And, harder to quantify but just as real, there are losses from uncertainty and increased bond yields in other vulnerable countries that will follow from the demonstration that the euro really can be left. What might this mean in numbers? Recent forecasts by the European Commission project the euro zone's GDP declining by 0.3% this year, and then growing by 1% in 2013. Mr Cliffe estimates that following an orderly and well-managed Greek exitone with very limited contagion and some continuing support to Greece from the euro zone and IMF-the euro area would suffer an extra first-year GDP loss of 1.6%, making a mild recession harsher. The other troubled peripheral economies would be hit hardest, though in this model they would increase their commitment to struc-

The Economist May 26th 2012

Bad timing Additional change in annual GDP caused by: %

orderly Greek exit complete euro break-up 10

First year Second year • 4

2 - 0 + 2

Greece Italy Spain Ireland Portugal Euro area France Netherlands Germany United States Source: ING

tural reform having seen the alternative. Germany would be least affected. Its economy is in any case forecast to do better than the euro area, expanding by 0.7% in 2012 and 1.7% in 2013; relative to this baseline it would incur a first-year output loss of 1%. America, he thinks, might be hit half that badly. But could a Greek exit really be contained at its borders? European banks remain worryingly weak, not just in small economies like Cyprus-already in trouble, and very exposed to Greece-but also in large ones like Spain, the fourth biggest in the euro area. Bad loans in Spain have risen by a third over the past year, to €148 billion or 8-4% of outstanding loans, the highest since August 1994. Spanish banks are widely believed to require an injection of public capital of at least €30 billion (3% of GDP) and perhaps a lot more. Borrowing that much would be a hard task for the deficit-stricken Spanish government (which has yet again raised its estimate for last year's deficit, to 8.9% of GDP). With Spanish banking woes so prominent (see page 52), there is a danger of bank runs as citizens of vulnerable economies fear ending up with devalued deposits. Such runs would become much more likely after a Greek exit, but it is possible that they could start before one, and indeed precipitate it-possibly the worst of all bad options. If confined to relatively small economies like already bailed-out Ireland and Portugal this might be manageable. In an economy the size of Spain's or Italy's they would be a terrible danger. The "firewall" which is supposed to protect against contagion is neither de-

signed for bank runs nor adequate to the needs of large economies. At present the EFSF, the temporary bail-out fund, has €250 billion of uncommitted funds which it could use to provide financing for governments that find themselves cut off from the markets or facing punitive rates as they try to save their banking systems. The permanent rescue facility, the European Stability Mechanism (ESM) is due to start in July, but has not yet been ratified by several countries, notably Germany. Even when it does get going, the new lending capacity available from the two funds will be capped at €500 billion, supplemented by possible support from the IMF of up to $430 billion. Beyond the adequacy or otherwise of the funds' size, there is the problem of what they can be spent on. If they were used to bail out commercial banks directly, they could break the pernicious circle in which unstable banks use the debt of barely solvent governments to shore themselves up. But as things stand neither the ESM nor the EFSF is allowed to do that. To free them in this way would require both agreements to be ratified again, a politically risky and time-consuming process. That leaves the ECB as the last bulwark. It could buy bonds again, but this tactic would be less effective than before unless it dropped its insistence on being protected against any future haircut. If it does not, bond investors will regard every purchase it makes as pushing them down the pecking order, thus reducing any residual appetite they might have. It could also provide near unlimited liquidity through yet another huge long term refinancing operation. But this would involve loosening its collateral conditions and exposing the central banks to greater and greater risk. If neither the rescue funds nor the ECB can do enough, a wider break-up might ensue, with huge costs all around. Mr Cliffe says that a disintegration of the euro would be catastrophic even for core Europe, with first-year output losses of 8.9% for the euro area (as was). This time Germany would not be spared, incurring a GDP loss of 8.2% as its exporters contended with the strength of a reborn n-mark. Across the former euro area, there would be a wave of bankruptcies as firms suddenly found themselves either owed money in a depreciating currency or owing money in an appreciating one. Currency unions have cracked before, but none with the scale, ambition or interconnectedness of the euro area. Contemplating the dread consequences of such a disintegration may yet prompt concessions from both Greece and its creditors that prevent the worst happening. But can the level of fear be adequate to engender such a change of heart while not so powerful as to trigger panic? Again, the prognosis is uncertain. •

Also in this section 30 Utah's health-care reform 32 Military innovation 32 Fish stocks 34 Government spending 34 Maine's Senate race 36 Lexington: Moral quandary

For daily analysis and debate on America, visit Economist.comfunitedstates

Government transparency

The best disinfectant

ATLANTA

Hopes of "open government" under Barack Obama have been only partly fulfilled

ARACK OBAMA accepted an award B honouring his administration's cornmitment to transparency on March 28th 2011. It was given by a coalition of opengovernment advocates. But the meeting was closed to reporters and photographers, and was not announced on the president's public schedule. Occasionally life provides perfect metaphors. On his first full day in office Mr Obama declared that "government should be transparent," and said that his administration "is committed to creating an unprecedented level of openness in government". And so, in December 2009, he issued his Open Government Directive, which ordered federal departments to formulate and publish plans to become more transparent. Those plans were all duly published within five months. Also that December he created a new National Declassification Centre (No c), designed to streamline the declassification of government documents. The federal government now publishes a vast array of data at Data.gov. At Recovery.gov meanwhile, citizens can track how their stimulus funds were spent. Foia.gov, launched in March 2011, lets people see whether agencies are fulfilling their obligations to disclose information under the 1966 Freedom of Information Act (FOIA). That act governs what information must be released to the public. It is federal, but all so states have their own versions govern-

ing what records and meetings are public. These regulations are commonly known as sunshine laws. Eric Holder, Mr Obama's attorney-general, issued FOIA guidelines to agency and department heads encouraging disclosure, and promising that his Justice Department would take a much narrower view of what constitutes a defensible withholding of information than his predecessor's had. Mr Obama has not once claimed executive privilege to avoid turning over information to Congress. His predecessor, George Bush, made six such claims during his two terms, and the previous Democratic president, Bill Clinton, made five. And yet in this arena, as in others, Mr Obama has been better at rhetoric than reality. David Sobel, senior counsel for the Electronic Frontier Foundation, a digitalrights group, says that despite Mr Holder's promise of greater FOIA disclosures, "Those of us who file litigation in this area haven't really seen that happen." The NDC has made public a paltry 22.6m of the 400m pages of classified data that is currently in its backlog. The rate of document classification remains far higher than the rate of declassification. Mr Obama's administration is proving as fond of wartime secrecy as the administration he replaced. The American Civil Liberties Union is suing under FOIA to get it to reveal records of the use of drones by the CIA and the armed forces to kill partic-

ular people. The CIA'S response has been to "neither confirm nor deny the existence or non-existence of records responsive to this request". Yet perhaps none of Mr Obama's transparency promises has rung hollower than his vow to protect whistleblowers. Thomas Drake, who worked at the National Security Agency, was threatened with life imprisonment for leaking to the Baltimore Sun unclassified details of a wasteful programme that also impinged on privacy. The case against him failed-ultimately he pleaded guilty to a misdemeanour charge of "exceeding authorised use of a computer"-but not before he was hounded out of his job. Mr Obama's administration tried to prosecute him under the Espionage Act, a law passed in 1917 that prohibits people from giving information "with intent or reason to believe that it is to be used to the injury of the United States or to the advantage of a foreign nation". Mr 0 barn a has indicted six whistleblowers, including Mr Drake, under the Espionage Act, twice as many as all prior administrations combined, for leaking information not to a "foreign nation" but to the press. All of this comes despite the fact that whistleblowers often do a great deal of good: in 2010, for instance, 77% of the $3.1 billion that America won in fraud-related judgments and settlements came from suits brought by them. Of course any government is entitled to keep some secrets, and of course people who leak genuinely damaging information ought to be prosecuted. But the prosecution of Mr Drake and others like him smacks more of vindictiveness and message-sending than justice. If the federal government is dragging its feet, however, several states are powering ahead. Sam Olens, Georgia's attorney-general, led an effort to update Georgia's openrecords and open-meetings laws. Mr Olens ~~

The Economist May 26th 2012

30 United States ~

said that the laws, which had not been overhauled in many years, had grown convoluted and ambiguous. He also cited complaints that local governments were ignoring open-records requests. The changes Mr Olens championed-and which Nathan Deal, Georgia's Republican governor, signed into law on April 17thlower the cost of records obtained by the public from 25 cents a page to 10 cents, and require agencies to alert requesters if the records will cost more than $25 to provide (sunshine laws require agencies to provide information; they do not require it to be free). They increase the penalties for officials who violate the law, and let prosecutors bring civil charges, not just criminal ones, against violators. The law includes data, data fields and email in its definition of public records, and it lets citizens bring their own devices to a government agency to make electronic copies. Georgia thus joins a growing number of states that explicitly open electronic communication to and from government officials to the public. Among the most ambitious such programmes is Florida's Pro-

ject Sunburst, which its Republican governor, Rick Scott, announced on May 2nd. ÂŁ-mails sent or received by the governor or 11 of his senior staff members will be posted to a searchable database within a week of transmission. Another of Mr Scott's initiatives provides extensive pension and salary information for state employees. Some complain that by posting such information Mr Scott, whose budgets have trimmed Florida's already lean workforce, is stoking public anger against state employees and their generous pensions. Others warn that Sunburst's requirements can be avoided by such archaic practices as talking in person or by phone rather than by e-mail. And of course government employees can always skirt open-records laws by using personal rather than official e-mail accounts. But even so, the data show that in states with strong FOIA laws politicians are less likely to be corrupt, and those that are corrupt are more likely to be caught. "Sunlight", wrote Louis Brandeis, a Supreme Court justice, nearly a century ago, "is said to be the best of disinfectants." â&#x20AC;˘

Utah's health-care reform

UnObamacare SALT LAKE CITY

A conservative state believes it has a better answer to the health-care question

ARY HERBERT, the governor of Utah, loathes everything about Barack G 0 bama's health-care reforms, not least, he says, the way "Obama has come along and spoiled the name 'exchange'." After all, Utah conceived its own version of health reform, called the Utah Health Exchange, long before Barack Obama signed his Patient Protection and Affordable Care Act in 2010. Utah's reform is "market-based", says Mr Herbert, whereas "Obamacare" is a biggovernment monstrosity. But it too relies on exchanges, so now the word is tainted. Republican governors in New Mexico and New Jersey have even vetoed attempts by their legislatures to build health-care exchanges. For Utah this means that its reform needs a new brand name. "We'll have a contest," says Mr Herbert. Beyond that, Utah will continue its fight, with 25 other states, to get Mr Obama's reforms repealed, something that could happen as soon as next month, if the Supreme Court rules against them. But however that turns out, Utah will push on with its own reform, because "we think it's really cool," and a potential model for the other 49 states, says Norman Thurston, the man chiefly responsible for getting it up and

Keeping them healthy running. The history of the Utah Health Exchange is a reminder of the bizarre, tangled genealogies of America's various healthcare reforms. Utah's was nursed into being in the past decade when}on Huntsman, a Mormon Republican, was governor. At that time the main alternative reform was being cooked up in Massachusetts by its

then-governor, Mitt Romney, also a Mormon Republican. Both men advocated a "mandate" that required everybody to buy insurance, an idea that originated in a conservative think-tank. But Mr Huntsman and Utah subsequently dropped that idea, whereas Mr Romney held on to it. Since then, and unexpectedly, the notion of mandates has become toxic in conservative circles. Utah also decided that government subsidies should play no part in its reform, whereas the one in Massachusetts was based on them. Thus Mr Romney's plan became, more or less, the basis for Obamacare, whereas Utah started seeing its plan as a free-market alternative. (This year Mr Huntsman lost to Mr Romney in the Republican presidential primaries, which has not stopped most Utahns from swinging their support behind Mr Romney, a local hero not only because he is Mormon but also because he was brought in to rescue the Salt Lake City winter Olympics.) So the Utah Health Exchange is decidedly not Romneycare or Obamacare. But what is it? At first glimpse, it is a snazzy web portal where four of Utah's five largest health insurance companies offer about 140 plans to about 6,6oo employees of 285 small businesses. Each employer determines in advance how much he will contribute to an employee's insurance, as in a defined-contribution pension plan. The employee then filters the plans and selects his favourite-again, as he might choose mutual funds in his defined-contribution pension plan. As Patty Canner, the exchange's director, explains, this has advantages over traditional corporate health insurance. In the old system employers had no certainty about premiums, which often rise abruptly. And employees, offered little if any choice, often got stuck with inappropriate plans. Small businesses, specifically, offered no insurance in Utah. Their employees and families account for many of the state's 300,ooo uninsured, more than 10% of the population. So the fledgling exchange is by intention not very radical. A more fundamental reform, for instance, would have tried to break free of the American peculiarity that ties most private health insurance to employers rather than individuals. Indeed, Utah originally wanted to do just that, says Mr Thurston, but then decided that such a step would have to wait until federal tax law stops favouring employer contributions over individual contributions. At present, the exchange merely aims to "plant the seed for defined-contribution health care", he says. But the hope is very much that the exchange, which is now coming out of its test phase and into full-scale operation, will blossom quickly so that within a few years most or all small businesses will sign up, ~~

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32 United States ~ then

individuals as well, and finally even large employers-in short, almost everybody. And that would indeed be revolutionary. Utah would then do the proper conservative thing, says Mr Herbert, and privatise the exchange-like a stock exchange, say. If other states then want to copy Utah's example, good. If not, adds Mr Herbert, that is fine too, because as a conservative he does not believe that one model should fit all. And that, too, turns out to be another veiled jab at Mr Obama. If the Supreme Court upholds the federal law, says Mr Thurston, the Utah Health Exchange would not be derailed, but its adoption would remain limited to small business. Utah's reform would necessarily stay modest, in short. But if the federal law falls, Utah thinks it has a model to fill the void. â&#x20AC;˘

Military innovation

Stress testing WHITE SANDS MISSILE RANGE, NEW MEXICO

Bringing the latest kit to the toughest places

HAS been three weeks since the Ellisian IitedTarmy invaded next-door Attica. The UnStates, Attica's ally, quickly deployed troops to help re-establish the international border, and had advanced more than so miles by May 16th. The mission, however, was not an easy one. As well as facing rugged terrain and extreme weather, the American soldiers and Attican security forces had to contend with the radical Islamic Congress of Attica, the transnational Islamic Brotherhood for Jihad, the malicious hackers of the Wolf Brigade and the petty criminals of the area.

Death to Ellisia

Thank heaven it was, in fact, a staged exercise, running from Fort Bliss, in west Texas, through to the White Sands missile range, an army base in New Mexico. Some 3,800 soldiers and several thousand military and civilian personnel were taking part in this spring's Network Integration Evaluation (NIE), the third round of a new twiceyearly series of exercises. Their point is to test how well fancy new mapping and messaging systems would stand up to the stresses of conflict in harsh conditions. The White Sands missile range, which dates from the 1940s, sprawls over 3,000 square miles of New Mexico. But it is not as isolated as the cacti and coyotes suggest. The army manages the area's frequency spectrum, in addition to its land and air space. The air force and the navy have a presence there too (the navy has a landlocked "ship" for testing purposes), as do federal agencies like NASA and the odd passing film crew. Fort Bliss, meanwhile, is one of the country's biggest army posts, a fact which draws private contractors and researchers to the region. Colonel Dave Miller, deputy director of the army's brigade modernisation command, explains that military communications systems have sometimes lagged years behind those in the commercial world. Surprising, perhaps, given that both the internet and GPS began as Pentagon experiments; but when it comes to acquisitions, the services are often hampered by long budgeting cycles and byzantine contracting procedures. The NIE, then, is part of the army's new "Agile" process. The idea is to bring in prototypes from the private sector, so that soldiers, new and experienced, can give them a spin. If a system is no better than the old version, or if a new radio tends to get jammed with sand, the army can scrap the order or retool it. One of the items being tested last week

was the Nett Warrior, a sort of rugged smartphone. An earlier version of the device had been on order last year, but was postponed when officials realised that it was much heavier, more expensive and not noticeably better than something that could be bought off the shelf. Systems that pass muster, however, can be fast-tracked. As a result, acquisitions should be faster, fewer and shrewder-saving money, but also making the army more efficient. Not that too much trust should be placed in technology. "None of these electronic tools replaces human judgment or experience, period," says Colonel Dan Pinnell, commander of the First Armoured Division's second brigade, who led the mission to restore Attica's border. But better to have today's smart system than a dumber one from five years ago. â&#x20AC;˘

Fish stocks

Plenty more fish in the sea Sensible policies are working

OR American fish, this is a good time to be alive. On May 14th the National Oceanic and Atmospheric Administration (NOAA) reported that a record six federal fisheries returned to health last year. After a decade of similar progress, 86% of America's roughly 250 federally monitored commercial fish stocks were not subject to overfishing; 79% were considered healthy. This is also good for American fishermen. Commercial and recreational fishing generates an estimated $183 billion a year and supports over 1.5m full-time or parttime jobs. Rebuilding America's 45 remaining over-exploited fish stocks, NOAA estimates, could generate an extra $31 billion a year and half a million jobs. That is a tribute to America learning a simple truth-that scientists, not fishermen or politicians, should decide how many fish can be caught-and enforcing this with simple rules. It has taken a while. America's main fishery law established the importance of scientific quotas in 1976. Yet this was routinely ignored because of poor science and weak enforcement, abetted by influential fishermen-notably in New England, which was built on once-rich Atlantic cod and haddock fisheries. The Massachusetts House of Representatives contains a conspicuous symbol of this: the "Sacred Cod", a 20o-year-old fish of solid pine, hanging from its ceiling. Despite this totem, in the late 1980s cod fisheries in the Gulf of Maine and Georges Bank collapsed. This led to efforts to improve the fishery act, in 1996 and 2006,

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The Economist May

34 United States ~ which forced

the eight regional bodies that manage federal fisheries to introduce science-based quotas and ten-year recovery programmes for depleted fisheries. The recent recovery of species, including New England scallops, mid-Atlantic bluefish and summer flounder and Pacific lingcod, is the result. This signals another truth: given a break, the marine environment can often replenish itself spectacularly. America's fisheries are probably now managed almost as well as the world's best, in Norway, Iceland, New Zealand and Australia. Yet there is plenty of room for improvement. State-run fisheries, which tend to be close to shore and dominated by small-scale and inefficient fishermen, are less well funded and well managed and much poorer for it. New England groundfish stocks, including cod, have also not recovered: they account for 13 of the remaining depleted populations. This appears to be partly the result of environmental change, climatic or cyclical. And the politicians are still interfering. On May 9th the House passed legislation forbidding NOAA from developing an in-

Maine's Senate race Cresting the wave

Crowning a l{ing

Fish-stock sustainability index* 600 550 500 450 400 350 300

12000

Source: NOAA

10 11

*Based on performance of 230 key fish stocks scored 0-4; maximum score possible= 920

novative means of apportioning fishing quotas, known as catch shares. These are long-term, aiming to give fishermen a stake in the future of their fisheries; marketbased, since they can be traded; and, in practice, good for fish. Sadly, the two Republican congressmen behind the ban consider they have been designed "to destroy every aspect of American freedom under the guise of conservation". â&#x20AC;˘

Government spending

Penny wise, pound foolish WASHINGTON, DC

Statistical surveys are not the best candidates for cuts 300,000 military veterans ROUGHLY live in Maricopa County, Arizona;

two-thirds of them are over 55. That information comes from the American Community Survey (Acs), a Census Bureau poll sent to 3m households each year. Early this year researchers from the Department of Veterans Affairs and four universities used such data to determine that poor, older veterans are up to twice as likely as non-veterans to be homeless. That sort of knowledge helps target government spending on those who need it most. Yet on May 9th Republicans in the House of Representatives voted to scrap the ACS. Daniel Webster, a Republican congressman from Florida, led efforts to kill the programme. In his view, "what really promotes business .. .is liberty, not demand for information." Republicans have done battle with number-crunchers before. In 2009 Michele Bachmann, a congresswoman and would-be president from Minnesota, refused to complete the form she was sent as part of the country's ten-yearly census. The bill targeted by Mr Webster already contained cuts of $2om for this year's Economic Census, a survey of businesses. Liberty is not all Republicans are bothered about. Mr Webster bemoaned the estimated cost of the programme, up

26th 2012

to $2.5 billion over a decade. Sloppy argument feeds perceptions of waste. Mr Webster complains that the survey is "random" rather than "scientific". Yet random sampling is a vital part of statistical analysis. Some Republicans also suggest that the survey is "unconstitutional". In fact, the constitution requires a ten-yearly census just a few paragraphs in-arguably a sign that the Founders had no great fears of mere data collection. From the mid-19th century the census gathered economic and demographic information, a development that was recently contested and upheld in court. In the 1990s Congress spun the (now defunct) "long-form" version of the census into an annual survey, the ACS, in response to demand for better and more frequent data. Its results now shape policy at all levels of government, touching on $400 billion in annual spending, and are useful for businesses, too. The Senate, in which Democrats hold a majority, is unlikely to follow the House in scrapping the Acs. Yet a compromise between them may nonetheless scale back its budget. In 2008 Barack Obama quipped that his Republican foes seemed to "take pride in being ignorant". In this area, congressional Republicans seem to feel that ignorance is bliss.

BRUNSWICK , MAINE

An independent Mainer wants to shake up partisan Washington

"'{ '1 ]HEN Maine's Olympia Snowe, one VV of the Senate's few moderate Republicans, announced in February that she was not seeking re-election, she pointed to partisanship and the increasing difficulty in finding common ground as the explanation. And so she set the stage for Angus King, a popular former governor, to run for the Senate as an independent. Flinty Mainers quite like the idea of electing an independent as an antidote to the problems of which Ms Snowe so despaired. Although a Democratic state when it comes to presidential elections, both Maine's current senators are Republican and more than a third of its voters are registered as independent. It has elected two independent governors in the recent past, including Mr King, who is now reckoned to have an excellent chance of winning in November. But how independent is independent? Lance Dutson of the Maine Heritage Policy Centre, a think-tank, points out that Mr King is socially liberal, has endorsed Earack Obama this time round and backs his health-care reforms; on the other hand he also backed George Bush in 2000, is a supporter of guns, and is no fan of the deluge of financial regulation emerging from the Dodd-Frank bill. Mr King describes being independent as "liberating". He can hire staff across party lines and is not answerable to anyone but voters. "We could send Pericles, Aristotle and Thomas Jefferson to Washington, but if they were Republicans, they would answer to Mitch McConnell [the minority leader of the Senate]," he says. He wants to remain independent, but is realistic, so will probably end up caucusing with one or other party if he is elected. But he has not said which one. Is Mr King's coyness good for Maine? Freshmen senators do not have much power-they traditionally keep a low profile while they learn the ropes. Parties provide support, from helping to get on committees to sorting out office space and staff. Mr King would be at the bottom of the totem pole. But he might end up with a lot more power than that. It is conceivable that he could hold the balance of the Senate in his hands, if Mr Obama is re-elected and the Republicans end up with so seats and the Democrats get 49 in November, as all looks entirely possible on the evidence of recent polls. "I could be the most popular girl at the prom," he jokes. â&#x20AC;˘

36 United States

The Economist May 26th 2012

Lexington I Moral quandary

that social issues were a vote-winner for them; now they seem to worry that too much righteous talk will put off centrists by making the party seem unpalatably moralising. Very few Americans rate gay marriage as the most pressing issue of the day, and those that do have surely long ago decided how they will vote; opponents for Mr Romney, and supporters for Mr Obama. Much the same goes for other subjects that rile the conservative faithful. Mr Romney suddenly seems to have few thoughts about illegal immigration, global warming or activist judges. Instead, he devotes himself almost exclusively to talk of the economy, with the odd jab at Mr Obama's health-care reforms. That, after all, is what swing voters care most about, and the area in which they are most unhappy with the president's performance.

N MANY respects, Mitt Romney makes a perfect spokesman for Icrisply America's religious right. He certainly looks the part: his clothes creased, his hair neatly gelled, his face habitually frozen in a look of square-jawed conviction. His personal life seems blameless. He is a regular churchgoer, and appears to live by the tenets of his faith. He married his high-school sweetheart, who bore him five strapping sons, who in turn have provided him with 18 grandchildren. He is a teetotaller, but not, like George W. Bush, as a break with the waywardness of his youth. Mr Romney spent much of his youth as a missionary, trying to persuade the French to give up wine. He once told a reporter that his greatest failing was that he devoted only one day a week to helping the needy (smugness is clearly a bit of an issue, too). The closest he has come to a scandal is the revelation that in his teens he once forcibly cut the hair of one of his schoolmates, in a prank that strayed across the line into bullying. Yet Mr Romney does not like to talk about his faith in any but the broadest terms, presumably to avoid reminding voters that he is Mormon, a religion that many Americans find peculiar and some doctrinaire Christians consider heretical. 0 bservers, trying to make sense of his inconsistent stances on abortion, gay marriage and the like, often assume that he is simply feigning abhorrence of them to curry favour with religious voters. But it is just as plausible that he faked the more tolerant views he used to espouse to curry favour with the liberal voters of Massachusetts, where he ran unsuccessfully for Senate and successfully for governor. At any rate, as a church leader Mr Romney is said to have encouraged women to favour child-rearing over their careers and to have discouraged them from having abortions. It is ironic, then, that even when "social issues" dominate the news, Mr Romney says almost nothing about them. For weeks the media have been parsing and probing Barack 0 bama's recent decision to endorse gay marriage. Yet Mr Romney simply reiterated his opposition to it before attempting to change the subject. This is part of the natural rhythm of a presidential election. Candidates tend to play to the base of their party during the primaries, only to quench the fire and brimstone once they have secured the nomination, the better to appeal to swing voters. But it is also a reversal of sorts. Republican strategists used to assume

It's not just the economy, stupid The hitch is that "pivoting to the centre", as the election jargon has it, is an especially awkward manoeuvre for Mr Romney. For one thing, the Republican faithful have always worried that the real Mr Romney is the relative liberal of his two races in Massachusetts, and that the present ardent conservative is the impostor. To allay their fears, Mr Romney must pivot more slowly and less far than he otherwise might. Thus when his appointment of an openly gay spokesman on foreign affairs caused a stir in conservative circles, the campaign quickly fired him. Try as he might, Mr Romney will find it almost impossible to get away from social issues over the next five months. Mr 0 bama, after all, is doing his best to avoid dwelling on the weakness of the economy. His campaign has, instead, spent the past week trying to stir up indignation about a Republican electioneering outfit that seems to have considered (but decided against) running an ad campaign about Mr Obama's ties to Jeremiah Wright, the pastor of a church the president used to attend and whose many racist, paranoid and unpatriotic utterances caused him great embarrassment during the 2008 campaign. That ploy forced Mr Romney to spend several days denying that he intended to bring up divisive racial issues, instead of hammering away at the president's stewardship of the economy. Mr Obama will be abetted in such diversions by those same Republicans who doubt Mr Romney's conservative bona fides. They are constantly cooking up new schemes to promote their notion of personal rectitude, in spite of the damage it does to the party's brand, especially among swinging (in both senses) single women. Last week, for example, Republicans in Virginia's House failed to approve the appointment of a judge whose sole disqualification seemed to be that he was gay. Republicans in Congress, meanwhile, are trying to restrict access to abortion in Washington, DC, a city none of them represents. And several states will hold referendums on gay marriage on election day. What is more, dogmatic legislators are not the only troublesome Republican voices. Anyone with a gripe and a fortune can now weigh in on the election via a "super P AC", a new sort of campaign group that can raise and spend as much as it wants on advertisements as long as it does not have any formal ties to a party or candidate. It was thanks to a super P AC that Mr Wright found himself in the news again, for example. Others have sprung up to fight abortion and gay marriage. Whatever the impact on Mr Romney's fortunes, in short, the religious right shows no inclination to let him run the election campaign he wants. â&#x20AC;˘ Economist.comfblogsflexington

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Energy in Canada

The great pipeline battle OTTAWA

The energy industry and Stephen Harper's government try to ensure tar-sands oil gets to market

AT FIRST glance, the public hearing of .1'"\.canada's National Energy Board that began on May 23rd involves only a minor matter. Enbridge, an energy distributor, wants permission to reverse the flow of Line 9, a duct of 195km (121 miles) which moves imported oil westward to petrochemical plants in Sarnia, Ontario. Instead, En bridge wants the pipeline to carry light crude oil eastward, from Alberta and North Dakota to a refinery in Nanticoke, Ontario, and then to others in Quebec. But environmentalists in both Canada and the United States have filed petitions against the switch. They worry that, if it is approved, Line 9 will soon start moving oil from the Alberta tar sands to Montreal and then, if the flow of another pipeline is reversed, to Portland, Maine for export. Oil production from the tar sands is set to rise from 2m barrels a day (b/ d) to 3.3m by 2020, or from 58% to 72% of Canada's total oil output. Getting this oil to market is a mounting worry for Canada's energy industry and for Stephen Harper's Conservative government. That is because the necessary infrastructure is opposed both by local communities and by greens, who want to halt development of the tar sands. Per barrel, the extraction of oil from bitumen emits between three and four times as much carbon and other greenhouse gases as conventional oil does, according to the Pembina Institute, an environmental think-tank in Calgary. But other estimates

are much lower. The Line 9 hearing comes as two other potential routes for tar-sands oil face problems. The Obama administration has withheld approval of the Keystone XL pipeline, which would take oil to Gulf coast refiners. (TransCanada, Keystone's promoter, still hopes for approval.) Mr Harper has courted China as an alternative market for the oil, but that depends on approval of Enbridge's Northern Gateway project, a C$5.5 billion ($5-4 billionh,177km twin pipeline from Edmonton to Kitimat in British Columbia. The route crosses the land of so or so First Nations bands (indigenous tribes). More than 4,000 people have registered to speak at the environmental hearings, which began in January. Last month another energy firm, Kinder Morgan, said it would spend $4.1 billion to double the capacity of the TransMountain to Vancouver, the only existing line to Canada's west coast. It hopes to start work in 2016. Vancouver's mayor opposes the idea, worrying that tourism will be wrecked by tanker traffic and spills. The government is pulling out all the stops to get these projects approved. The budget bill includes sweeping changes to the cumbersome procedures that govern environmental approval of energy projects. These now involve up to 40 federal departments and agencies. Under the bill, only those directly involved would be able to intervene in hearings; fishery habitat

Economist.comjamericas

will no longer automatically be considered; and most assessments will have to be completed within 18 months. The federal government would have the power to overrule the energy board, but also to cede the assessment process to the provinces. These changes could quicken the prospects of big hydropower schemes in Manitoba, Labrador, British Columbia and Quebec, aimed at exporting electricity to the United States. But pipelines are the government's priority. That is because natural-gas exports, long the mainstay of the energy industry, are threatened by shale gas in the United States (they have fallen by 5% over the past year). While there are legitimate environmental worries, replacing gas exports with tar-sands oil is vital for economic growth, argues Matthew Akman, an analyst at Scotiabank. Investment is pouring into the tar sands, but potential oil exports will outstrip pipeline capacity by 2015. Unless, that is, existing pipelines are rejigged-and not just Line 9. TransCanada's 3,oookm main line has carried Alberta's gas to Ontario and Montreal for more than so years, but now runs at less than half of capacity. Converting the line to oil, and adding a spur to a refinery at Quebec City, would cost more than C$5 billion and take several years. But it could still beat the Northern Gateway, and be politically more attractive. Refiners in eastern Canada currently use imported crude costing $20-30 a barrel more than western Canadian oil. The budget bill also includes money to investigate whether green charities are engaging in political activities incompatible with their status. But there are risks-not least to Canada's international image-in demonising environmentalists. The arguments for developing the tar sands are strong, but the opponents cannot be simply shrugged aside. â&#x20AC;˘

The Economist May 26th 2012

The Americas 39

The Dominican Republic

After Leonel SANTO DOMINGO

The new president risks governing in his predecessor's shadow

CONOMIC storms have battered the Caribbean of late, blowing away the tourists and remittances on which most islands depend. Most of the region has barely seen any growth since 2009. Several governments have been washed away by the slump: in the past six months unhappy voters have kicked out the ruling parties in Jamaica and the Bahamas. But the sun still shines in the Dominican Republic, where growth has continued at over 5% a year. On May 2oth Dominicans duly rewarded the ruling Dominican Liberation Party (PLD). But only just: Danilo Medina, its presidential candidate, won 51% of the vote, amid allegations of fraud. Mr Medina faced a weak opponent in Hip6lito Mejia of the Dominican Revolution Party, who campaigned under the enigmatic slogan "Here's Daddy". Mr Mejia mishandled a banking crisis when he was president between 2000 and 2004. He cried fraud this week. Observers from the Organisation of American States certified the election result but confirmed reports of vote-buying. Participaci6n Ciudadana, a local NGO, says that both main parties offered between soo and 2,500 pesos ($13 to $65) to buy people's voting cards. No one knows the scale of the fraud, but the electoral authorities received 400,000 applications for duplicate cards in the weeks before the poll. The government's vote-buying appeared greatly to exceed that of the opposition, claims Francisco Alvarez of Participaci6n Ciudadana. Mr Medina takes over from Leonel Fernandez, who as president for 12 of the past 16 years has dominated his country's political life, restoring confidence after the banking crisis and bringing inflation down from so% to 8%. Mr Fernandez wooed for-

eign investors in perfect New York English. He was a beguiling salesman for his country: "When businesspeople go to speak to Fernandez, they hear what they want to," says a diplomat, who calls him "the oracle of Santa Domingo". His opponents' claim that Mr Fernandez exercised a "constitutional dictatorship" is an exaggeration. But the PLD, which will control both houses of Congress until at least 2014, has colonised all branches of the government. As head of the National Council of the Judiciary, Mr Fernandez was able to oversee the appointment of members of the Supreme Court and the Electoral Tribunal. He also chose the members of the Chamber of Accounts, which keeps an eye on government spending. Patronage is baroque: the government at one stage included 334 deputy-ministers, and the foreign ministry employs 113 ambassadors despite having only 45 embassies. The PLD outspent its opponents in the campaign. Mr Medina promised "safe change". Certainly some things require reform. Nearly a third of Dominicans still live in poverty, a higher figure than before the banking collapse. Fast-growing telecoms and finance industries do not provide many jobs. Temistocles Montas, the econamy minister, says the country needs to develop higher-value tourism and swap textile factories, vulnerable to Chinese competition, for high-tech ones. That requires more highly skilled workers. Education spending is equal to only 2% of GDP, less than half the Latin American average. Doubling it, as promised, means expanding tax revenues, which are a paltry 13% of G DP. Consumers must also pay more for electricity, which is heavily subsidised and

Fernandez, Cedeno and Medina keep the party going

subject to power cuts. Squeezing people will be hard when many suspect that taxes are misspent. Some officials connected with public works have become inexplicably wealthy, according to local media. Transparency International, a watchdog, labels the country the most corrupt after Haiti among the larger Caribbean states. It is the worst of 142 countries studied by the World Economic Forum for wastefulness of public spending, the second-worst for "favouritism in decisions by officials" and thirdworst in diversion of public funds. (But it scores well for investor-friendliness.) Crime is another worry. The murder rate has risen from 14 per 1oo,ooo people to 25 within the past decade, as drug smugglers seek to evade the crackdown in Mexico. Last year police killed 289 people in a country of fewer than 10m. Again, corruption is hindering progress: leaked cables from the United States embassy linked senior officials to drug trafficking. Mr Medina risks having to govern in his predecessor's shadow. Mr Fernandez's wife, Margarita Cedefio, will be the new vice-president. Mr Fernandez himself will be eligible to run for a fourth term in 2016, and many suspect he will do so. Many of the country's problems pre-dated Mr Fernandez, and were even worse before him. Even so, if Mr Medina wants to make his own mark, he could start by trying to clean up public life. â&#x20AC;˘ Colombia

Giving peace a chance BOGOTA

Or lettingjustice rule untrammeled

IS "obsession", Juan Manuel Santos often says, is to hand over a country at peace by the time he steps down as Colombia's president. Although army pressure has diminished the threat from the leftwing guerrillas of the FARe and ELN, it is unlikely to persuade them to lay down their arms after almost half a century of fighting, especially if their reward is a lifetime in jail. To secure peace, the government thinks it also needs legal tools so that it can offer the guerrilla leaders some incentives. These are embodied in a constitutional amendment wending its way through Congress. It has sparked a furious national debate. As approved on May 15th, in the sixth of eight votes, the amendment would give Congress the power to set the criteria determining which crimes (and thus criminals) would be investigated by prosecutors, and which might be dealt with in ~~

40 The Americas ~

other ways, such as by a Truth Commission. It would also allow Congress to legislate on the conditions under which sentences could be suspended. Congress would be called upon to legislate on these issues only if and when serious peace talks were under way. These proposals have aroused the opposition of some strange bedfellows, including Alvaro Uribe, Mr Santos's hardline predecessor, and Human Rights Watch (HRW), a New York-based pressure group. Both see them as tantamount to an amnesty. Jose Miguel Vivanco of HRW says that the amendments "guarantee impunity" for those who have committed crimes against humanity. It would be better to offer sharply reduced sentences, he argues, rather than suspended ones or no prosecution at all. On the day of the congressional vote on the amendment, another of the vocal critics, Fernando Londoiio, narrowly survived a bomb attack on his car that killed two of his bodyguards. "Bogota covered in blood and the ... govt is pressing Congress to approve impunity .. .for heinous crimes," tweeted Mr Uribe, whom Mr Londoiio served as interior minister. (This week police in Argentina found a bomb in a cinema where Mr Uribe was due to speak.) Mr Santos's supporters point out that the amendment seeks to prevent the mistakes Mr Uribe made in handling the demobilisation of some 30,000 right-wing paramilitaries. His government's Justice and Peace Law of 2005 at first offered a virtual amnesty. But the Constitutional Court toughened the law, limiting the reduction of jail sentences only to those who made full confessions. Beneficiaries were also supposed to compensate their victims. Because it failed to make a sharp enough distinction between ringleaders and the rankand-file, the Justice and Peace Law has proved almost impossible to implement. There have been only seven convictions. Mr Uribe said at the time that "definitive peace is the best justice" and said his law was "adjusting the equation" between justice and peace. So in his current stance he is guilty of hypocrisy, or at least inconsistency. The government's argument is, in essence, that the demands of justice should not make peace impossible. Striking the balance should be the responsibility of a democratically elected legislature, rather than unelected international lawyers. But the legislators' hands are partly tied. When Colombia signed up to the International Criminal Court (ICe) in 2002, it deferred the court's jurisdiction over war crimes for seven years, to try to encourage peace talks with the different warring factions. With the deferral over, the ICC now has full jurisdiction, which means any amnesty for war crimes could be challenged there. International humanitarian law en-

The Economist May 26th 2012 Gay rights in Chile

An atrocity prompts change SANTIAGO

A sad milestone in the battle for tolerance

N March 3rd a young gay man, Daniel Zamudio, was beaten to a pulp in a park in Chile's capital, Santiago. His assailants carved swastikas on his body. He died in hospital three weeks later. Four men, alleged to have ties to a neoNazi group, have been charged with his murder. But the public outrage over Mr Zamudio's fate has had wider consequences: having languished in Congress for seven years, an anti-discrimination law has been hastily approved. Chile has never been an easy place for homosexuals. The Catholic church maintains a formidable, if waning, grip on public morality. Divorce was banned until2004, and gay sex decriminalised only in 1999 (in Argentina and Brazil it has been legal since the 19th century). Chile is one of only four countries in South America where the age of consent is higher for gays than for heterosexuals. In March the Inter-American Court of Human Rights berated the country for denying a lesbian mother, who was also

a judge, custody of her three daughters. In 2004 the Supreme Court had ruled that it would be detrimental to the girls' development to stay with their mother because she lived with another woman. But attitudes seem to be changing at last. President Sebastian Piiiera, an economic conservative but a social liberal, has boldly promoted gay rights, despite distaste from within his own coalition. He surprised many in 2009 by including openly gay couples in his campaign commercials. He invited gay activists to attend his state-of-the-nation address on May 21st. In this year's census, for the first time those Chileans who live with a gay partner can register the fact. For years Chile's homosexuals have gazed enviously over the Andes to Argentina, where sexual attitudes are more relaxed and where gay marriage is legal. It will be a while yet before Chile follows suit. But Mr Zamudio's horrible fate has helped to make the country a bit more tolerant.

Coming out in memory of Daniel Zamudio courages states to grant former insurgents amnesty for crimes such as rebellion, sedition and treason, but never for crimes against humanity such as deliberate attacks against civilians, murder, torture, rape, forced recruitment of minors and forced displacement. But these serious crimes have been the rule rather than the exception in the Colombian conflict. To complicate matters yet further, in a bizarre ruling Colombia's Supreme Court has decided that merely belonging to an illegal armed group constitutes a crime against humanity. Mr Santos enjoys a majority in Congress, and the amendment is likely to pass. But the debate in Colombian society about

how to strike a balance between justice and peace will continue. The country must find a solution that is "neither carte blanche nor a straitjacket", says Angelika Rettberg, a political scientist at Bogota's Los Andes university. The guerrillas, who still number about n,ooo, are no doubt watching with interest. Both main groups have recently flirted with the idea of peace talks. But the attacks continue. The FARC may have been responsible for the attempt on Mr Londoiio's life. A dozen soldiers were killed on May 22nd in a FARe attack launched from Venezuelan territory. Both sides in this argument will see such incidents as reinforcing theircase. â&#x20AC;˘

41 Also in this section 42 Tattoos in Japan 43 Violence in Karachi 43 Pakistan and the United States 44 Banyan: More fun in the Philippines?

For daily analysis and debate on Asia, visit Economist.comfasia Economist.comfblogsfbanyan

Politics in Bangladesh

Banged about DHAKA

The prime minister sets the country on a dangerous path

NCHING through the crowded streets of Iration Bangladesh's capital brings both exhilaand frustration. Dhaka's garishly painted tricycle rickshaws, battered buses, occasional goats and luxury cars somehow all manage to creep onward. Drivers skilled at furious honking are also masters of compromise and smiles. If only the bitter politicians could prove so deft. Some 18 months before a general election, Bangladesh suffers street protests. Opposition leaders are sent to jail, and disappearances and murders are widely blamed on an old rivalry for power. A confrontation over the next poll-who should oversee it, and whether it will be fair-is already so strident that some observers doubt a contested one will be held at all. Meanwhile, Bangladeshis fret over prices of food and fuel, chronic power cuts and broken promises of new roads. As the leader of the Bangladesh Nationalist Party (BNP), Khaleda Zia, tells it, all ills lie at the government's door. She ticks off a list of wicked acts she blames on her antagonist in an ancient rivalry, the prime minister, Sheikh Hasina. A young BNP politician abducted a month ago and very probably murdered. Two others killed earlier. Some 33 opposition figures, including senior MPS, dumped in jail this month over a trumped-up case of arson. In all, she says, 3,000 BNP members have been arrested. "It is to intimidate, to create

a sense of fear." There is plenty more darkness about. In recent months Bangladesh has endured a spate of other mysterious killings-a Saudi diplomat shot dead; a trade-union activist tortured and murdered; a pair of journalists butchered after investigating corruption. This correspondent was trailed in Dhaka by a pair of secret-service men on a motorbike. A rumour of a bizarre coup attempt, in January, was used by the government to get closer political control over the army. One of the country's best known figures, Muhammad Yunus of Grameen Bank, has been harassed for some time. An increasingly paranoid Mrs Hasina sees

1 Improving lives Bangladesh, population Living on Less than $1.25 a day {2005 PPP*).% oftotal 70 60 50 40

30 20 10

0 1984 86

Source: World Bank

96 2000 05

*Purchasing-power parity

him as a political threat. This month in Dhaka Hillary Clinton, America's secretary of state, met theN obel laureate and assured him of her support. It brought no relief. Ministers snipe at him, and the government has just ordered yet another official review of his bank. "We are very worried that the commission has been formed and terms of reference include ownership," says Mr Yunus. In effect, the government is seeking ways to grab Grameen, which is 97%-owned by its poor members, many of them women. Officials are also bent on settling scores with Mr Yunus, who oversees an ungainly charitable empire that includes a telecoms company as well as the bank. Over a lavish dinner, a group of government spies brags of having a thick file of allegations ready against the "money-monger". Engine trouble The list of gripes against the government is long. Corruption is pervasive enough for donors to be alarmed. The World Bank has scrapped funding for a bridge over the Padma river. Japan, the largest single giver of aid, has just sent its deputy prime minister to Dhaka to demand a clean-up. In a case of recent graft, a railway minister, who quit after police found sacks of cash in his aide's car, was suddenly cleared by an internal inquiry of any corruption and reinstated to the cabinet. Meanwhile, strong doubts persist about the fairness of democracy. The United States's ambassador in Dhaka this week repeated Mrs Clinton's warning that the next election must be "participatory", ie, run fairly so the opposition will take part. Most telling would be a shift in India's attitude. Long a close ally of Sheikh Hasina's Awami League-cheering her crackdown on Islamic extremists and insurgents from India's north-east, and being ~~

The Economist May 26th 2012

42 Asia ~ open

to more trade-India's ruling Congress party may now, sensibly, be hedging its bets. Pranab Mukherjee, India's finance minister, called on Mrs Zia recently, inviting her back to Delhi. Mrs Zia chuckles that she will go after Delhi's summer heat is past. She also calls the neighbour a "friend", a possible hint of change in a party that often seeks popularity by bashingindia. As Sheikh Hasina looks ever more strident, people may start tiptoeing away from her. Not every ill in Bangladesh can be laid at the prime minister's door. Although she did mess with the constitution, scrapping arrangements she had previously insisted on in opposition for a neutral caretaker to run the government for three months before election day, she now appears to want to keep her options open, possibly in order to be better able to skew the outcome of the next election. Meanwhile, Mrs Zia's party orders street protests and hunger strikes, and threatens angry mass rallies in June. The sad result is that politics grows more polarised and confrontational. Still, Mrs Hasina is not quite the allpowerful bogeywoman her bitterest opponents suggest. Certainly she seems set on cracking down on civil groups, for example with a new bill to put non-government organisations more firmly under political control. But it is hard to see how the murders and attacks on activists and journalists help her government, other than to spread a general sense of intimidation. The opposition, too, has a reputation for thuggery, corruption and intimidation, and does not bother much to hide it. A veteran leader of the BNP says that, should his party boycott the next election, 20 days of street protests by BNP supporters would then be followed by violent attacks by his party workers on their rivals. The shame of it all is how little heed the squabbling politicians pay to what should matter more: keeping the economy growing and reducing poverty further. In the face of electricity shortages, blocked roads and land disputes, the Bangladesh economy has been doing remarkably well. Its clothing industry has the potential to generate over $40 billion a year from exports, according to McKinsey, a consultancy. Indicators of well-being have been improving. If annual economic growth of over 6% is sustained, a country that not long ago was a byword for poverty can contemplate reaching middle-income levels in barely a decade. But that needs single-minded focus by the government on dealing with the country's economic bottlenecks and social needs. Instead, like Dhaka's wretched roads, politics looks jammed. Uncertainty leading up to the next election, and growing anxiety among diplomats and foreign observers of Bangladesh, suggest a hard, tense time ahead. More than anyone, blame the driver. â&#x20AC;˘

Tattoos in Japan

The shogun of Osal<a TOKYO

A revealing political crackdown on a usually hidden form of art

IS easy for outsiders to admire those in who sport tattoos. First, think of ItheTJapan pain. The body art known as irezumi is inflicted on a wearer's torso with wooden needles and charcoal ink. During up to so sessions, the irezumi master brooks no tardiness, insobriety or whingeing. Then there is the lifetime of pariah status that follows. Bathhouses and onsen (hot springs) usually forbid entry to tattoo wearers. So do swimming pools. Men may believe their swirling, ornate body engravings reflect a roguish masculinity. But the worst of it is that many Japanese women disagree. And so body-art narcissism takes place mainly among other tattooed men. Such groups of even innocent men immediately take on the air of gangsters, for yahuza and irezumi are inseparable. You might assume that an up-and-coming politician with a maverick streak, a descendant of social-outcast communities who used to dye his hair blond, would sympathise with such people. Yet Toru Hashimoto, the 42-year-old mayor of the huge city of Osaka, does not. He is on a mission to force workers in his government to admit to any tattoos in obvious places. If they have them, they should remove them-or find work elsewhere (though big companies are just as tattoophobic). Even Lady Gaga, the tattooed diva who has raised a fortune for victims of the March nth tsunami, would not get a job in his government, he insists. The crackdown says a few things about this clever nationalist, who is gaining huge

Yakuza, irezumi, mikoshi-and surely sake?

attention inJapanese politics. First, he likes a bit of blood sport. Picking fights with people who cannot easily defend themselves keeps him in the media gaze. Mr Hashimoto's campaign follows his order forcing teachers in Osaka to stand for the national anthem. Second, it sets him firmly in the socially conservative camp, displaying even a dash of authoritarianism. Since the end of the second world war, tattoo-wearers have mostly faced social-though not officialostracism. During the periods before then when tattoos were banned, it was either by repressive shoguns or by the Meiji modernisers in the late 19th century, who thought the sight of naked men with engraved buttocks would earn Japan ridicule in the West (which was mostly fascinated instead). Aligning himself with strongmen may serve only to boost Mr Hashimoto's popularity, at a time when many Japanese are fed up with the weak-willed characters in national government. The curious bit is that many of the tattooed have right-wing tendencies too. Many seem to approve of Mr Hashimoto's crackdown. Horiyoshi the Third, an irezumi master based in Yokohama, is forgiving of the Osaka mayor. He says he believes Mr Hashimoto understands very well that public officials showing off their tattoos must be considered threatening. The tattooist, whose silk paintings are now on display at London's Somerset House, keeps his own painted "body armour" well hidden beneath a pale-blue seersucker suit with a diamante broach on the lapel. Most of the time, the master says, irezumi should be concealed. Then he pulls back his sleeve a few inches to show the start of swirling decorations travelling up his arm. The simple act of revealing those tattoos, he says, is supposed to intimidate. Mr Hashimoto has a different way of showing that he means business, but it is equally effective. â&#x20AC;˘

The Economist May 26th 2012 Violence in Karachi

City at war

Asia 43 Pakistan and the United States

A fateful call ISLAMABAD

A man who helped find bin Laden is condemned as a traitor KARACHI

In the commercial capital, politicians and gangsters are bound together

IVILIANS armed with rocket-propelled grenades and AK-47S firing at C police in armoured personnel carriers are not images associated with the urban hearts of commercial capitals. But Karachi is no ordinary city. Earlier this month its crime-infested quarter of Lyari, a sprawling network of alleyways housing rm people, saw battles that pitted police against a powerful local gang. In one scene locals flattened a carrier's tyres with gunfire. Then they kept firing at the stationary vehicle, killing an officer inside. The 31 people who were killed, in addition to five policemen, were mainly innocents caught in the crossfire and included a seven-year-old. For a week residents were besieged. They had little access to food, water or power, as shops shut down and the battle had damaged infrastructure. Then a defeated government called the operation off. The police promised to return after 48 hours, but never showed up again. A senior police official was close to tears when he explained that the gangsters wielded weapons that law-enforcers did not know they possessed. The Lyari violence highlights the complicated relationship between crime and politics in Karachi. Political parties are organised along ethnic or sectarian lines, and represent the city's Urdu-speakers, Sindhis, Baloch, Pashtuns and Barelvi Sunnis. In turf wars over neighbourhoods, they attack each other's activists and ordinary folk alike. (This week indiscriminate firing on a Sindhi rally killed 11 people.) When deaths exceed a handful a day, the commercial capital grinds to a halt. It is this violence, rather than Islamist extremism, that holds Karachi hostage. Political parties coexist with criminal gangs, tacitly supporting some and actually controlling others. Lyari's dominant gangsters, the People's Aman Committee (P AC), have traditionally lent their support to the country's ruling Pakistan People's Party (PPP). Yet police appear to have launched the Lyari operation because some members of the ruling party had developed a rivalry with elements of the PAC. The rundown district has long been a bastion of the PPP, which had put up with or worked with Lyari gangsters for decades. But its neglect of the area has strengthened the PAC, especially once the gang started providing social services. "This operation was political victimisation," claims Zafar Baloch, the racket's sec-

AKISTAN and the United States are Paremeant to be allies, but their differences starkly drawn in the case of Shakil Afridi. He is regarded as a hero by American officials and a traitor by Pakistan. The CIA secretly recruited the Paldstani doctor during the hunt for Os am a bin Laden. He set up a fake vaccination programme, going from door to door in the northern town of Abbottabad, seeking a DNA sample from the house in which Americans suspected the alQaeda leader was living. On May 23rd Dr Afridi was sentenced in Pakistan, without a lawyer and under a hasty system of tribal justice, to 33 years in jail for treason. Behind the scenes, Americans scrabbled but failed to reach a deal to free Dr Afridi from Pakistani custody. His activities were discovered by Pakistan's spies and-in-command. "The people of Lyari have supported the PPP for 40 years, but when we spoke out against the lack of development here we were targeted." Karachi politics plays out at the expense of civilian lives. It did not hurt that the police operation would have pleased the Muttahida Qaumi Movement (MQM), a coalition partner, at a time when opposition parties are campaigning for the resignation of the prime minister, Yousaf Raza Gilani. The MQM (also involved in extortion in Karachi) complained that the government was targeting its people while letting the PAC get away with crime. But perhaps what makes the Lyari operation typical of Karachi was how, just as it

Just another day in the commercial capital

after the American special-forces operation a year ago that killed bin Laden. Le on Panetta, America's defence secretary, insisted Dr Afridi "was not in any way treasonous towards Pakistan". Working for a foreign intelligence agency is a crime in many places, including America. Pakistanis feel justified in punishing Dr Afridi. Although bin Laden was clearly an enemy of Pakistan, too, the American operation that killed him is seen as a national humiliation. The collapse in relations it sparked endures today (see page 6o). Not only Pakistani nationalists are angry at the CIA for using Dr Afridi. It has also damaged the credibility of vaccination programmes in Pakistan, including the one against polio. NGos condemn the ploy. The CIA is unrepentant. was escalating into a policing and humanitarian disaster, it suddenly came to a halt. Since then the PAC has not retaliated. Perhaps some unpublicised bargain has been struck. If so, that would be in line with the usual pattern of violence in the city. Karachi manages to hold together because bouts of brutal, though contained, violence are interspersed with dealmaking and calm. Imran Ayub, a journalist on the Karachi beat, thinks the PAC and the government will strike a bargain that preserves the PPP's Lyari constituency despite this disastrous operation. "This was no final showdown", he says. In the context of Karachi's violence, it is sobering to think what a final showdown would look like. â&#x20AC;˘

44 Asia

Banyan

The Economist May 26th 2012 I

More fun?

A flurry of optimism about the Philippines, a regional underachiever, is only partly justified

T WAS sadly typical for the Philippines. When it played host at Iopment the beginning of May to the annual meeting of the Asian DevelBank, the biggest single news story the event generated overseas was a negative one: that hoardings had been erected so delegates would not see some unpleasant slums. Sadly, too, the story itself is rather typical: giving things a sleek appearance sometimes seems to matter more than fixing sordid reality. The Philippines has, that incident notwithstanding, enjoyed an image boost in recent months. Under Benigno Aquino, a president avowedly intent on tackling corruption, economic prospects look good. It is one of few countries in Asia expected to grow faster this year than last-though partly because a slump in government spending dragged the growth rate down in 2011. The stockmarket has been one of the world's rare performers this year. Attention is now focused on the country's many assets: a young population; mineral wealth; robust external finances; even the strength of its sometimes ridiculed democracy, restored in 1986. A much-cited projection by a bank, HSBC, of the world in 2050 highlights "the striking rise of the Philippines, which is set to become the world's 16th-largest economy, up 27 places." The Philippine economy grew at an annual average rate of roughly 2% in the 1980s and 3% in the 1990s. It has achieved about 4.5% since the turn of the century. Future prospects are indeed enticing: besides the unexploited mineral resources, business-process outsourcing is booming, already employing some 6oo,ooo people. Remittances from all those Filipinos overseas have remained strong through economic crises. As costs rise in China, the Philippines is among places manufacturers eye as an alternative. Tourism has huge potential, recognised by the government's nicely pitched campaign: "It's more fun in the Philippines." It is also more fun with a newish president. Some of the present feel-good mood stems from what people call a "halo effect". The unlikely saint is Mr Aquino, known as Noynoy, or P-Noy (in a country fond of nicknames, the national one is "Pinoy"). He was swept to power in 2010, partly on a wave of affection for his late mother, Corazon Aquino, the first president after the dictatorship of Ferdinand Marc os. An undistinguished record as a senator did little to build hopes of a bold presidency. Yet Mr Aquino remains broadly popular. His government's

stand against perceived Chinese bullying in the South China Sea seems to go down well with a public mostly insouciant of the risks involved. A 52-year-old bachelor, Mr Aquino's love life fits the national penchant for turning politics into soap opera. But above all, he is liked as a welcome change after the nine-year presidency of Gloria Macapagal Arroyo, which in its final years was widely seen as corrupt. He has gained kudos for trying to bring her to account. The focus of that struggle at the moment is the attempt in the Senate to convict the chief justice, Renato Corona, who was among Mrs Arroyo's appointments to the Supreme Court, and has been accused of trying to shield her. The Senate trial, televised daily, has become crucial to the administration, both as a means of breaking the perceived hold of its predecessor over the judiciary, and as proof of its zeal in combating corruption. This has also entailed submitting a number of allegedly suspicious contracts awarded by Mrs Arroyo's government to fresh tenders. Clean-ups in the tax and customs authorities have impressed some businessmen, while vexing others who say procedures are now gummed up. The government has also started making some important reforms. In an effort to raise its revenues-at present a paltry12% of GDP-it wants to jack up "sin" taxes on alcohol and tobacco. The bill enacting this made important progress in May when it passed a House of Representatives committee-a triumph over powerful tobacco and alcohollobbies.lt still has to pass the full House and the Senate, however. In fact, the Aquino administration has little concrete to show for its two years in power. The centrepiece of its programme, public-private partnerships to tackle the inadequate infrastructure which is such a hindrance to all the nation's economic hopes, is only now stuttering to life after just one of the ten projects scheduled for approval last year saw contracts awarded. The pursuit of Mrs Arroyo and the chief justice is a distraction as well as a mission. Securing Mr Corona's conviction might entail so many promises to senators that the point of the exercise-enhancing the government's clean image-is lost. Failure to do so however, would leave the administration looking weak and silly. So Mr Aquino has his critics. Mr Corona, for example, who this week was in intensive care after a possible heart attack, portrays himself as the victim of a vendetta after a court ruling that land belonging to the Aquino clan should be redistributed. Mr Aquino's supporters scoff at this, and praise the president's scrupulous hands-off approach. But that too has a flip side. Some on the left have promoted a craze for "Noynoying", a form of protest involving striking a languid, idle pose. A common view has Mr Aquino as a reluctant president, who, just as his mother is said to have done, crosses off on a calendar the days until his term ends. Cometh the Manny? They are going by fast. Philippine presidents, barred from serving consecutive six-year terms, do not have long to make their mark. The backward-looking settling of accounts with Mrs Arroyo does not help. Already there is speculation about the 2016 presidential election. Pundits feel better placed in naming one of the frontrunners for 2022, who, being under 40, will be constitutionally barred in 2016: a world-champion boxer and congressman, Manny Pacquiao. If Mr Aquino's presidency is to be remembered as more than an interlude under a decent, likeable man who did his best, he needs to give some dynamic leadership to the reforms the Philippines so badly needs. Noynoyingjust does not cut it. â&#x20AC;˘

Also in this section 46 Moving the family abroad 46 Trouble at Shaolin temple

For daily analysis and debate on China, visit Economist.comfchina Economist.comfblogsfanalects

China and America

A sigh of relief

BEIJING

A vital relationship survives a critical test

he arrival of Chen Guangcheng, a T blind Chinese activist, in New York on May 19th marked a quiet resolution to a thorny problem for American diplomacy with China over human rights. It also suggested that, in spite of political tension at the highest levels of the Communist Party, Chinese leaders remain united enough to handle a crucial relationship pragmatically. But compromising with the superpower involves a balancing act at home. Chinese diplomats say privately that pressure from nationalist sentiment among Chinese citizens has become a growing complication in their dealings with the West. Negotiations between Chinese and American officials over how to deal with Mr Chen involved painstaking efforts by both sides to avoid provoking China's nationalists, who criticise any perceived weakness in the Chinese government, and whose ire (officials supposed) might have scuppered a deal. Mr Chen had taken refuge for six days in the American embassy in Beijing after escaping from house arrest on April 22nd. In the eyes of hardliners, that made him a traitor. Quietly, however, Chinese officials arranged for Mr Chen and his family to be put on a plane to America. They ordered the media to say virtually nothing about his departure or about any concession made to America (and it certainly was a concession: local officials enraged by Mr Chen's escape have been terrorising other

family members and friends in rural Shandong province since his departure). If Chinese officials had wanted to point out to their American counterparts how deep suspicion of foreigners runs, there was plenty of evidence in the days leading up to Mr Chen's departure. Anti-foreign comments were circulating on the internet, triggered by amateur videos of two incidents. One appeared to show a British man attempting to sexually assault a Chinese woman in a Beijing street. The other was of a Russian man harassing a female Chinese passenger on a train, as he rested his bare feet on her headrest. (His behaviour resulted on May 22nd in his dismissal from his post as the principal cellist of the Beijing Symphony Orchestra.) Some newspapers suggest that public outrage over the alleged sex attack may have been one motive for the launch on May 15th of a 100-day campaign in Beijing against the illegal employment of foreigners. Another motive may have been to show toughness at home when a concession was being made to America. It has been described as the first such publicly announced crackdown in the capital, which has become a magnet in recent years for unemployed Westerners hoping to cash in on China's boom. Some do not have proper work permits. On May 16th Yang Rui, a well-known presenter for the English-language service of Chinese state television, expressed sup-

port for the campaign in an astonishing rant on his microblog. The police, he said, were "getting rid of foreign trash" and arresting "foreign scum". Mr Yang said foreigners who could not find work in their own countries were coming to China and getting involved in "illegal business activities such as human trafficking and espionage". Many were living with Chinese women as a cover for their spying, he said. He praised the expulsion from China earlier this month of an experienced American journalist working for Al Jazeera, calling her a "foreign bitch". Mr Yang later said "shrew" would be a better English translation. His comments, he said, were "a reaction of the moment and nothing more". In the case of the activist Mr Chen, however, Chinese officials dealing with his case probably had little to fear from fiery nationalists and their online tirades. Indeed, officials might be more concerned that, throughout the recent saga of Mr Chen's flight and eventual departure for America, online comment has been mostly sympathetic towards him. Caixin, a popular online news portal, said both America and China had been "rational and pragmatic" in their handling of the crisis. According to American press reports, China's negotiator in the discussions about Mr Chen's fate at one point angrily said he did not want to talk to his American counterpart any more. But it could be there was less resistance within the leadership to a deal than might have been supposed. China has long used dissidents as bargaining chips, sometimes allowing them to leave the country, knowing that once abroad their influence usually diminishes and the doors can be shut to their return. Global Times, a newspaper known for its nationalist views, called Mr Chen's case a "colourful bubble" that leaves nothing when it bursts. â&#x20AC;˘

The Economist May 26th 2012

46 China Moving the family abroad

Trouble at the temple

Hedging their bets

Everybody was l<ung fu fighting DENGFENG

Shaolin temple takes a hit BEIJING

Officials, looking for an exit strategy, send family and cash overseas HE phrase "naked official", or T was coined in 2008 by a bureaucrat and blogger in Anhui province, Zhou Peng'an, luo guan,

to describe officials who have moved their family abroad, often taking assets with them. Once there, they are beyond the clutches of the Communist Party in case anything, such as a corruption investigation, should befall the official, who is left back at home alone (hence "naked"). Mr Zhou says the issue has created a crisis of trust within the party, as officials lecture subordinates on patriotism and incorruptibility, but send their own families abroad. You do not have to be corrupt to be "naked", however. Sending your family abroad is simply a state of maximum readiness. It does not suggest huge confidence in a stable Chinese future. Many wealthy businessmen have also been preparing exit strategies. One of the most common legitimate routes involves immigrant-investor programmes in America, Canada or Hong Kong, typically requiring an investment of up to $rm. Chinese nationals have rushed to apply for these. Three-quarters of applicants for America's programme last year were Chinese. The less well-heeled obtain passports from other countries-in the South Pacific, Africa or Latin America-at more affordable prices (as low as $2o,ooo). Li Chengyan, director of the Centre for Anti-Corruption Studies at Peking University, says countries that do not have an extradition treaty with China are particularly popular among corrupt officials. One crooked former governor of Yunnan province was found to have five foreign passports. "No need to wait for a visa if they have to run," saysMrLi. For senior officials the usual first step to getting naked is to send children overseas to study. Perhaps the most famous example is the recently purged party chief of Chongqing, Bo Xilai. Mr Bo's son, Bo Guagua, is a graduate student at Harvard University, after attending Harrow School and Oxford University in Britain. Mr Bo's wife, Gu Kailai (now detained on suspicion of murdering a British businessman in Chongqing), has lived abroad, and their broader family is worth more than $10om, according to the New York Times. The government has done little to stop the emigration. It began formally to monitor the whereabouts of officials' families and assets only last year, and then only by asking officials to fill in forms. In 2011 the

AS THE sun rises over the foothills of 1"\..Mount Song, thousands of young martial artists are kicking, punching and spinning spears and swords in unison on a huge open parade ground. They have flocked here to train at Shaolin temple, the birthplace of Shaolin kung fu. The parade-ground scene is timeless, but the surrounding temple is not. In December it failed its examination by China's National Tourism Association, after inspectors condemned the poor conditions of the sprawling temple complex and the abundance of pushy touts and dodgy fortune-tellers. Such hangers-on have arrived as part of the commercialisation of the Shaolin brand, tirelessly promoted since the 1990s by the temple's abbot, Shi Yongxin (pictured). Mr Shi is known in the Chi-

Shi Yongxin, the cEo? central bank published an estimate on its website, attributed to the Chinese Academy of Social Sciences, that up to 18,000 officials had fled the country between 1995 and 2008 with stolen assets totalling 8oo billion yuan ($130 billion at today's exchange rate). The bank then claimed the figures were inaccurate, and scrubbed them from its website (though not from the memories of those who had read them). The chief prosecutor, Cao Jianming, says that in 2011 foreign governments helped arrest 1,631 Chinese fugitives for "work-related crimes" (including officials and employ-

nese media as "the CEO monk". He has rented out the Shaolin name for films, reality-television shows and computer games, and approved an online store selling Shaolin kung fu manuals for 9,999 yuan ($1,6oo). Many Chinese believe he leads too lavish a life for a holy man. In 2009, the temple's website was hacked twice. In one instance a fake apology letter from the ab bot was posted on the site, listing his alleged misdeeds. In the other, a message was scrawled saying "Shaolin evildoer Shi Yongxin, go to hell". The temple last year twice issued statements rejecting unspecified rumours about Mr Shi that had spread widely in Chinese media and online. In its second statement in October, the temple even announced it was setting up a hotline offering a reward of 50,000 yuan for information leading to the source of the rumours. But as the temple feared in its statements, the damage to its reputation had already been done. The number of visitors during the Chinese new year holiday in January this year, traditionally high season for tourists, fell by nearly half. Then on May 16th, after spending millions of yuan sprucing up the temple, Shaolin passed the tourism board's re-examination, and so was able to retain its five-star scenic-spot status. Abbot Shi remained bullish: "The Shaolin scenic spot's problems are mostly caused by the intervention of the government," he said after the announcement. "I hope to return Shaolin temple to a peaceful religious environment." Restoring such an environment may not be so easy. Just days later, Chinese media reported that discussions were under way about building a magneticlevitation train around Shaolin, in order to boost tourism. ees of state-owned firms) and to recover 7.8 billion yuan in stolen assets. Some senior officials have pushed for reform. In January Guangdong province in southern China announced that officials whose families have emigrated will be barred from high-level posts. But this is an exception. Officials who can afford to send their families abroad are usually the most powerful, and the most aware of China's problems. Says Mr Li of Peking University, "They know better than anyone that the China model is not sustainable and that it's a risk to everybody." â&#x20AC;˘

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SPECIAL REPORT CHINA'S ECONOMY

Pedalling prosperity China's economy is not as precarious as it looks, says Si mon Cox. But it still needs to change

ACKNOWLEDGMENTS In addition to those quoted in the text, the author would like to thank the following for their help in preparing this special report: Vivek Arora, Kent Calder, Stephen Green, Han Gaofeng, Louis Kuijs, Edwin Lim, Koji Nomura, Jack Rod man, Andrew Sheng, Michael Spence, Murtaza Syed, Mark Williams, Xiao Geng and Wenlang Zhang

The Economist May 26th 2012

IN 1886 THOMAS STEVENS, a British adventurer (pictured above), set off on an unusual bicycle trip. He pedalled from the flower boats of Guangzhou in China's south to the pagodas of Jiujiang about 1,oookm (620 miles) to the north. He was disarmed by the scenery (the countryside outside Guangzhou was a "marvellous field-garden") and disgusted by the squalor (the inhabitants of one town were "scrofulous, sore-eyed, and mangy"). His passage aroused equally strong reactions from the locals: fascination, fear and occasional fury. In one spot a "soul-harrowing" mob pelted him with stones, bruising his body and breaking a couple of his bicycle's spokes. A century later the bike was no longer alien to China; it had become symbolic of it. The "bicycle kingdom" had more two-wheelers than any other country on Earth. Many of those bikes have since been replaced by cars-one obvious sign of China's rapid development. But even today the bicycle looms large in the battle for China's soul. For China's fast-diminishing population of poor people, bikes remain an important beast of burden, piled high with recycled junk. For China's fast-expanding population of city slickers, the bicycle represents everything they want to leave behind. "I'd rather cry in the back of your BMW than laugh on the back of your bicycle," as China's material girls say. Some dreamers in government see a return to the bike as an answer to China's growing problems of prosperity-pollution, traffic and flab. The country's National Development and Reform Commission wants government officials to cycle to work one day a week, though only if the distance is less than 3km. Even if it is a fading symbol of Chinese society, the bicycle remains a tempting metaphor for its economy. Bikes-especially when heavily lad-

CONTENTS

5 Exports The retreat of the monster surplus 8 Investment Prudence without a purpose 10

Local government The ballad of Mr Guo

12 Finance

Bending not breaking 12 Cross-border flows

Homeric wisdom

14 Shadow banking Shades of grey 15 Consumers Dipping into the kitty 17 The next chapter Beyond growth A list of sources is at Economist.comjspedalreports

An audio interview with the author is at Economist.comfaudiovideof spedalreports

SPECIAL REPORT CHINA'S ECONOMY

The alchemy of China's growth -

Contributions to growth, percentage points:

China's GDP growth %increase on year ago

Consumption

Investment

% ofGDP:

Net exports

China

South Ko rea

Private consumption

;

l ... -~-

...... 6

..... 20

.... 3

1980

Ja pan

.......... ~ . ...............,~ ......... ~ ~ .... ~ ...... .. ~

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............. -····-······· ..................... .. 10 30 11!1 ' ' " "

2000

" ""' '!! I""'" "

,If,!'

If"'" "'' 5

Years since take-off

tl.t

''"

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0 40

Years since take-off

Source: CEIC ~

en-are stable only as long as they keep moving. The same is sometimes said about China's economy. If it loses momentum, it will crash. And since growth is the only source of legitimacy for the ruling party, the economy would not be the only thing to wobble. From1990 to 2008 China's workforce swelled by about 145m people, many of them making the long journey from its rural backwaters to its coastal workshops. Over the same period the productivity of the workforce increased by over 9% a year, according to the Asian Productivity Organisation (APO). Output that used to take 100 people in 1990 required fewer than 20 in 2008. All this meant that growth of 8-10% a year was not a luxury but a necessity. But the pressure is easing. Last year the ranks of workingage Chinese fell as a percentage of the population. Soon their number will begin to shrink. The minority who remain in China's villages are older and less mobile. Because of this loss of demographic momentum, China no longer needs to grow quite so quickly to keep up. Even the government no longer sees 8% annual growth as an imperative. In March it set a target of 7.5% for this year, consistent with an average of 7% over the course of the five-year plan that ends in 2015. China has been in the habit of surpassing these "targets", which represent a floor not a ceiling to its aspirations. Nonetheless the lower figure was a sign that the central leadership now sees heedless double-digit growth as a threat to stability, not a guarantee of it.

mand to China's growth has always been exaggerated, and it is now shrinking. It is investment, not exports, that leads China's economy. Spending on plant, machinery, buildings and infrastructure accounted for about 48% of China's GDP in 2011. Household consumption, supposedly the sole end and purpose of economic activity, accounts for only about a third of GDP (see chartl). It is like the small farthing wheel bringing up the rear. A disproportionate share of China's investment is made by state-owned enterprises and, in recent years, by infrastructure ventures under the control of provincial or municipal authorities but not on their balance sheets. This investment has often been clumsy. In the 188os, according to Stevens, China showed a "scrupulous respect for individual rights and the economy of the soil". The road he pedalled took many wearisome twists and turns to avoid impinging on any private property or fertile plot. These days China's roads run straight. Between 2006 and 2010 local authorities opened up 22,000 sq km of rural land, an area the size ofNew}ersey, to new development. China's cities have grown faster in area than in popula-

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XINJIANG 1 The penny-farthing theory "'() Go l:i I N N f R 80ongs!teng o~·--+-,._,.....,_ Stevens's 1886 journey across southOrdos Beijlng .,._,..____:;..._ east China was remarkable not only for the (kaugbashi) route he took but also for the bike he rode: a NINGXIA SHANXI SHANDONG "high-wheeler" or "penny-farthing", with QINGHAI ~ an oversized wheel at the front and a diminGANSU SHMNXI HENA~ JIA ,GSU utive one at the rear. The contraption is not Shanghai ~ Gush1 T I 8 E T widely known in China. That is a pity, be~ ~SHANGHAI ~ Yinglriuo H U8 El cause it provides the most apt metaphor for SICHUAN CHONGQING Jiujia" o 0 ----;;- zHEJIANG China's high-wheeling economy. ~ Yingta n Wenznou The large circumference of the penny-farthing's 'Z. front wheel carried it farther and faster than anything that preGUilHOU HUNAN ~ FUJIA~ ceded it, much as China's economy has grown faster for longer J YUNNAN than its predecessors. Asked to name the big wheel that keeps GUANGXI Guangzho;--- GUANGDONG 0 Sttenzhen Pearl~~~ China's economy moving, many foreign commentators would Hong Kong say exports. Outside China, people see only the Chinese goods that appear on their shelves and the factory jobs that disappear from their shores; they do not see the cities China builds or the H shopping aisles it fills at home. But the contribution of foreign de4

The Economist May 26th 2012

SPECIAL REPORT CHINA'S ECONOMY

Exports

The retreat of the monster surplus China's current-account surplus is on the verge of extinction

Keep those wheels turning ~

tion. This rapid urbanisation is a big part of the country's economic success. But it has come at a heavy price in depleted natural resources, a damaged environment and scrupulously disrespected property rights. The imbalance between investment and consumption makes China's economy look precarious. A cartoon from the 188os unearthed by Amir Moghaddass Esfehani, a Sinologist, shows a Chinese rider losing control of a penny-farthing and falling flat on his face. A vocal minority of commentators believe that China's economy is heading for a crash. In April industrial output grew at its slowest pace since 2009. Homebuilding was only 4% up on a year earlier. Things are looking wobbly. But China's economy will not crash. Like the high-wheeled penny-farthing, which rolled serenely over bumps in the road, it is good at absorbing the jolts in the path of any developing country. The state's influence over the allocation of capital is the source of much waste, but it helps keep investment up when private confidence is down. And although China's repressed banking system is inefficient, it is also resilient because most of its vast pool of depositors have nowhere else to go.

Not so fast The penny-farthing eventually became obsolete, superseded by the more familiar kind of bicycle. The leap was made possible by the invention of the chain-drive, which generated more oomph for every pedal push. China's high-wheeling growth model will also become obsolete in due course. As the country's workforce shrinks and capital accumulates, its saving rate will fall and new investment opportunities will become more elusive. China will have to get more oomph out of its inputs, raising the productivity of capital in particular. That will require a more sophisticated financial system, based on a more complex set of links between savers and investors. Other innovations will also be needed. China's stateowned enterprises emerged stronger-too strong-from the downsizing of the 1990s, but the country's social safety net never recovered. Thus even as the state invests less in industrial capacity, it will need to spend more on social security, including health care, pensions, housing and poverty relief. That will help boost consumer spending by offering rainy-day protection. The chain-drive was not the only invention required to move beyond the penny-farthing. The new smaller wheels also needed pneumatic tyres to give cyclists a smoother ride. In the absence of strong investment to keep employment up and social unrest down, China's state will also need a new way to protect its citizens from bumps in the road ahead. â&#x20AC;˘ The Economist May 26th 2012

THREE DINOSAURS LURK in a former factory district of Beijing. Bright red, with "Made in China" embossed on their bellies, they look like the cheap plastic toys China exports to the rest of the world. But these model dinosaurs are life-sized, towering over passers-by. And they look hungry. The three beasts are one of the imposing installations at the 798 Art District in Beijing. Sculpted by Sui Jianguo, a former factory worker, they are imprisoned in three cages, stacked on top of each other, like the 20-foot containers that carry the country's manufactures to the world. In resin, bronze and steel, the sculpture embodies the widespread fear that China's exporters will gobble up foreign markets and manufacturers. When it was made in 1999, the country's exports were less than a third of America's. Ten years later China was the world's largest exporter. Of the toys shipped to America and the European Union, 85-90% were made in China. The country's roaring exports contributed to a growing current-account surplus, which exceeded10% of its GDP in 2007 (see chart 3, next page). China's surpluses-its failure to import as much as it exported, spend as much as it earned, or invest as much as it saved-became an economic cause celebre, generating an equally impressive surplus of commentary and explanation. Ben Bernanke, now chairman of America's Federal Reserve, argued that China's surplus was adding to a "global savings glut".lt was the subject of much debate and diplomacy at G20 summits, and the object of much blame and many bills in America's Congress. The latest of those, which passed the Senate in October, calls for retaliation against any country that engineers an oversized surplus with an undervalued currency. Mitt Romney, the presumptive Republican nominee for president, has threatened to brand China as a currency manipulator on his first day in the White House. China's trade surplus with America remains large and controversial, but its current-account surplus with the rest of the world is dying out. Last year it narrowed to $201 billion, less than

Safely caged 5

SPECIAL REPORT CHINA'S ECONOMY

Less cheap China's exchange rate, March 2005=100 140

2005

Sources: Hong Kong Institute for Monetary Research Working Paper; BIS

~ 2.8% of the

country's GDP, the smallest percentage since 2002. In money terms it was smaller than Germany's. Is that small enough? The Senate bill relies on IMF methods to calculate a current-account "norm" for a country like China. Such calculations are more art than science: one exercise by the European Central Bank estimated China's norm 16,384 different ways. But an unofficial study using the IMF'S methods calculated a benchmark of about 2.9% of GDP over the medium term, which suggests China's surplus is about where it should be. Whether it remains there depends partly on why it narrowed in the first place. In its latest World Economic Outlook, the IMF id en-

Domestic demand in China's big trading partners has been slow to recover from the crisis. China's own spending, on the other hand, has surpassed all expectations. Investment as a share of GDP rose by over six points between 2007 and 2010 as banks lent liberally to help stimulate the economy. The IMF reckons that this rise in investment in itself accounted for between a quarter and a third of the narrowing of China's surplus. But it may also have been a contributory cause of some of the other factors, such as the rise in commodity prices and the increase in Chinese wages and prices.

Will it return? The surplus could widen again, for one of two reasons. First, China's high investment could set the stage for a renewed export boom. Second, China's investment rate could falter without consumption rising to make up for it, forcing China to rely on foreign demand to keep the economy moving. To imagine the first scenario, you only have to examine the recent past. Pieter Bottelier of the Conference Board, a thinktank, argues that China's big surpluses before 2008 owed something to an investment boom around the time China joined the World Trade Organisation in 2001. This investment created excess capacity in industries such as cars, construction materials and especially steel. At first these new factories displaced imports; then, when the domestic market proved too small, they flogged their surplus wares on foreign markets instead. China went from being a net importer of steel in 2004 to being the world's largest net exporter, note Brett Berger and Robert Martin of the Federal Reserve. But a repeat is unlikely. It would require China's low consumption rate to move still lower to make room for so much investing and exporting. It would also require China to make further rapid gains in global market share. The post-crisis investment boom was also different from the post-wTo one. It was weighted towards inland provinces, far from the seaports that ship China's goods to the rest of the world. Inland China's share of fixed-asset investment matched that of the coastal provinces for the first time in 2009, then exceeded it in 2010. The investment boom in 2009-10 was also concentrated in infrastructure and property. Neither can be traded across borders. But some economists believe that the latest investment boom will prove unsustainable. If construction collapses, some of the industries that fed China's building rush will turn their attentions overseas, as they did in 2006. The future of China's export monster thus depends on whether China's high investBack where it belongs ment rate is sustainable. Many China's current-account surplus think it is not. Economists like As % ofGDP Paul Krugman, a professor at Princeton University and a 10 commentator for the New York 8 Times, have gone from bashing China for its underpriced currency to fretting about its overpriced property. Its spectacular 4 building boom has diverted China's energies inwards, sucking in imports and displacing exports. It has thus eased the 2001 03 05 07 09 11 world's fear of China. But it has Source: CEI C raised fears for China. â&#x20AC;˘

The future of China's export monster depends on whether China's high investment rate is sustainable. Manythinkitis not tifies four reasons: China's exchange rate, its terms of trade, global spending and China's own investment expenditure. China's exchange rate has risen, if not as far or as fast as many Americans had hoped. This appreciation can be measured in various ways. The measure most economists watch is the real effective exchange rate (REER) adjusted for consumer-price inflation and weighted by trade. This has gone up by 27% since July 2005. An alternative gauge is the internal real exchange rate (IRER), which measures the price of Chinese goods that cannot be traded across borders relative to the price of things that can. According to a study by the Hong Kong Institute for Monetary Research, China's internal real exchange rate rose by over 35% between July 2005 and December 2011 (see chart 2). This appreciation encourages the Chinese to make more non-tradable goods and to buy more tradable ones. Both help narrow its surplus. The size of China's surplus also depends on some volatile prices, such as the cost of crude oil and other commodities that China imports. The price of China's imports has risen relative to the price of its exports in recent years. According to the IMF, this deterioration in China's terms of trade could explain up to half the drop in its surplus between 2007 and 2011. Those terms are unlikely to improve. As long as China remains the dominant force in the market for its main imports and exports, it will continue to influence the price of both. This pincer movement shows up in surprising ways. One British scholar argues that cheap Chinese exports have deterred burglaries in his country because a ÂŁ19.99 DVD player is hardly worth stealing. But others say that China's imports of copper have contributed to a rise in metal theft because China's appetite for such commodities has made them a more tempting target. 6

The Economist May 26th 2012

SPECIAL REPORT CHINA'S ECONOMY

Investment

Prudence without a purpose Misinvestment is a bigger problem than overi nvestment

(not to mention its rare earths and soft goat's wooD. According to Ting Lu of Bank of America Merrill Lynch, Kangbashi is an attempt to prevent Ordos's commodity earnings from disappearing to other parts of the country. China as a whole saved an extraordinary 51% of its GDP last year. Until China's investment rate exceeds that share, there is no cause for concern, says Qu Hongbin of HSBC. Anything China fails to invest at home must be invested overseas. "The most wasteful investment China now has is us Treasuries," he adds. When talking about thrift, economists sometimes draw on a parable of prudence written three centuries ago by Daniel Defoe. In that novel the resourceful Robinson Crusoe, shipwrecked on a remote island, saves and replants four quarts of barley. The reward for his thrift is a harvest of 8o quarts, a return of 1,900%.

GENGHIS KHAN SQUARE in Kangbashi, a new city in the northern province of Inner Mongolia, is as big as Tiananmen Square in Beijing. But unlike Tiananmen Square, it has only one woman to sweep it. It takes her six hours, she says, though Castaway capital longer after the sandstorms that sweep in from the Gobi desert. Kangbashi, or "new Ordos", as it is known, is easy to clean beInvestment is made out of saving, which requires concause it is all but empty. China's most famous "ghost city", it has sumption to be deferred. The returns to investment must be set attracted a lot of journalists eager to illustrate China's overinagainst the disadvantage of having to wait. In Robinson Crusoe, vestment, but not many residents. the saving and the investing are both done by the same EnglishOrdos was one of the prime exhibits in an infamous preman, alone on his island. In a more complicated economy, households must save so that entrepreneurs can invest. In most sentation by Jim Chanos, a well-known short-seller, at the Loneconomies their saving is voluntary, but China has found ways don School of Economics in January 2010. Mr Chanos argued that China's growth was predicated on an unsustainable mobilof imposing the patience its high investment rate requires. isation of capital-investment that provides only for further inMichael Pettis of Guanghua School of Management at Pevestment. China, he quipped, was "Dubai times 1,000". king University argues that the Chinese government suppresses His tongue-in-cheek reference to the bling-swept, debtconsumption in favour of producers, many of them statedrenched emirate caused a stir. But not everywhere in China owned. It keeps the currency undervalued, which makes imshrinks from the comparison. One property development that ports expensive and exports cheap, thereby discouraging the actively courts it is Phoenix Island, off the coast of tropical Sanya, consumption of foreign goods and encouraging production for China's southernmost city. It is a largely man-made islet, much foreign customers. It caps interest rates on bank deposits, deprivlike Dubai's Palm ]umeirah. Its centrepiece will be a curvaceous ing households of interest income and transferring it to corseven-star hotel, rather like Dubai's Burj Al Arab, only shaped porate borrowers. And because some of China's markets remain largely sheltered from competition, a few incumbent firms can like a wishbone not a sail. The five pod-like buildings already up extract high prices and reinvest the profits. The government has, resemble the unopened buds of some strange flower. Coated in light-emitting diodes, they erupt into a lightshow at night, featurin effect, confiscated quarts of barley from the people who might ing adverts for Chanel and Louis Vuitton. want to eat them, making them available as seedcorn instead. ~~ After a visit to Ordos or Sanya, it is tempting to agree with Mr Chanos that China has overinvested from its northern steppe to its southern shores. But what exactly does it mean for a country to "overinvest"? One clear sign would be investment that was running well ahead of saving, requiring heavy foreign borrowing and buying. The result could be a currency crisis, like the Asian financial crisis of 1997-98. Some veterans of that episode worry about China's reckless investment in tasteless property. But although China invests more of its GDP than those crisisstruck economies ever did, it also saves far more. It is a net exporter of capital, as its controversial current-account surplus attests. Indeed, for every critic bashing China for reckless investment spending there is another accusing it of depressing world demand through excessive thrift. China is in the odd position of being cast as both miser and wanton. Even an extravagance like Kangbashi is best understood as an attempt to soak up saving. The Ordos prefecture, to which it belongs, is home to a sixth of China's coal reserves and a third of its natural gas China's answer to Dubai 8

The Economist May 26th 2012

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What has China got in return? Investment, unlike consumption, is cumulative; it leaves behind a stock of machinery, buildings and infrastructure. If China's capital stock were already too big for its needs, further thrift would indeed be pointless. In fact, though, the country's overall capital stock is still small relative to its population and medium-sized relative to its economy. In 2010, its capital stock per person was only 7% of America's (con- Boom, boom verted at market exchange rates), according to Andrew Batson and ]anet Zhang of GK Dragonomics, a consultancy in Beijing. Even measured at purchasing-power parity, China has only about a fifth of America's capital stock per person, depending on how its PPP rate is calculated. China needs to "produce lots more of almost everything", argues Scott Sumner of Bentley University, even if it does not produce "everything in the right order". Its furious homebuilding, for example, has unnerved the government and cast a shadow over its banks, which worry about defaults on property

The ballad of Mr Guo

loans. But it still needs more places for people to live. In 2010 it had 140m-150m urban homes, according to Rosealea Yao of GK Dragonomics, 85m short of the number of urban households. About three-quarters of China's migrant workers are squeezed into rented housing or dormitories provided by their employer. Nor is China's capital stock conspicuously large relative to the size of its economy. It amounted to about 2.5 times China's GDP in 2008, according to the APO. That was the same as America's figure and much lower than Japan's. Thanks to China's stimulus-driven investment spree, the ratio increased to 2.9 in 2010, but that still does not look wildly out of line.

Malinvestors of great wealth SINGING KARAOKE WITH Taiwanese investors, smearing birthday cake on the cheeks of an American factory owner, knocking back baijiu, a Chinese spirit, with property developers: Guo Yongchang would do anything to attract investment to Gushi, a countyof1.6m people in Henan province, where he served as party secretary. His antics are recorded in "The Transition Period", a remarkable fly-on-the-wall documentary about his last months in office, filmed by Zhou Hao. Mr Guo persuades one developer to raise the price of his flats because Gushi people are interested only in the priciest properties. After a boozy dinner he drapes hi mself over the developer's shoulder and extracts a promise from him to add more storeys to his tower to outdo the one in the neighbouring city. The one-upmanship exemplified by Mr Guo has generated great economic dynamism, but also great inefficiency. When the centralgovernmenttries to stop economic overheating, local governments resist. Conversely, when the government urged the banks to support its 2008 stimulus effort, local governments scrambled to claim an outsized share ofthe lending. The result is a local-government debt burden worth over a fifth of China's 2011 GDP. The worst abuses, however, involve land. Local officials can convert collectively owned rural plots into land for private development. Since farmers cannot sell their land directly to developers, they have

to accept what the government is willing to pay. Often that is not very much. Such perverse incentives have caused China's towns and cities to grow faster in area than they have grown in population. Their outward ripple has engulfed some rural communities without quite erasing them. The perimeter ofWenzhou city in Zhejiang province, to take one example, now encompasses clutches of farmhouses, complete with vegetable plots, quacking ducks and free-range children. This results in some incongruous sights. Parked outside one farmhouse are an Audi, a Mercedes and a Porsche. Alas, they do not belong to the locals but to city slickers who want their hub caps repainted. Oddly, where electoral reforms have given Chinese villagers a bigger say in local government, growth tends to slow, according to Monica Martinez-Bravo of Johns Hopkins University and her colleagues. This is partly because elected local officials shift their efforts from expanding the economy to providing public goods, such as safe water. But it is also because a scattered electorate cannot monitor them as closely as their party superiors can. Fear of their bosses and hunger for revenues keep local officials on their toes. Mr Guo, star of"The Transition Period", was eventually convicted of bribery. He was not entirely honest in the performance of his duties, and not always sober either. But with all the parties, banquets and karaoke, no one could accuse him of being lazy.

In Defoe's tale, Robinson Crusoe spends five months making a canoe for himself, felling a cedar-tree, paring away its branches and chiselling out its innards. Only after this "inexpressible labour" does he find that the canoe is too heavy to be pushed the 100 yards to the shore. That is not an example of overinvestment (Crusoe did need a canoe), but "malinvestment". Crusoe devoted his energy to the wrong enterprise in the wrong place. It is surprisingly hard to show that China has overinvested, but easier to show that it has invested unwisely. Of China's misguided canoe-builders, two are worth singling out: its local governments (see box) and its state-owned enterprises (soEs). China's soEs endured a dramatic downsizing and restructuring in the 1990s. Thousands of them were allowed to go bankrupt, yet those that survived this cull remain a prominent feature of Chinese capitalism. Even in the retail, wholesale and restaurant businesses there are over 2o,ooo of them, according to Zhang Wenkui of China's Development Research Centre. soEs are responsible for about 35% of the fixed-asset investments made by Chinese firms. They can invest so much because they have become immensely profitable. The 120 or so big enterprises owned by the central government last year earned net profits of 917 billion yuan ($142 billion), according to their supervisor, the State-owned Assets Supervision and Administration Commission (sASAC). It cites their profitability as evidence The Economist May 26th 2012