Crisis brings a real chance for reform. Really?
Despite the tanking of the rupee and the lower GDP numbers, the Indian government is doing more of the same. It is trying to pass a controversial food subsidies program that could cost about $21 billion a year. The reason for the generosity is simple. Elections are coming
Markets rallied sharply this week. US President Obama took the novel decision to actually ask the people’s elected representatives whether he should order an act of war against another country. This decision postponed the ultimate decision for a week, but I doubt that it will change the outcome much. Punishing rulers we consider evil (and who are not acting directly in our strategic interest), is considered not only an American prerogative but also its historical duty. However, although missile strikes on Assad’s military assets may seem morally satisfying, it will not have a great affect the ultimate outcome. In the same way, the better purchasing managers’ index (PMI) numbers out of China and Europe might delay market problems, but will not change their course.
They might even make it worse. The promise or perhaps the illusion of better economic times over the past two months has allowed politicians to perpetrate more denial. Central bankers’ unorthodox policies seemed to solve the most difficult questions for our leaders.
With the economy seeming to be always on the cusp of growth, any real reform was not on the agenda. The problem is that central bankers have recently realized two points. First, according to recent research, the policy known as quantitative easing has very limited effects on the real economy. Second, the unintended consequences they have guessed at are for emerging markets quite real. Central bankers have compounded the error by insisting that their policies actually strengthen the economy instead of admitting the possibility of an error. Therefore, politicians in several countries have continued former failed policies in the name of political expediency.
One reason for the rally was the manufacturing numbers out of China. HSBC China PMI index came in at 50.1 ending three months of numbers below 50, which indicate a contraction. This sounds like good news, but a closer examination of the official numbers reveals something more disturbing, more of the same. While the large state owned firms’ index rose to 51.8, the smaller businesses posted their 17th successive month of contracting activity with a reading of 49.2.
Chinese leaders have been espousing a major change of policy. They want to stop pouring money into large, inefficient, money losing and often insolvent state owned businesses. Instead, they want to encourage more consumption by consumers and small businesses. This policy, although economically necessary, is politically unpopular, because many of the local leaders of the Communist Party depend on the state owned business for patronage and power. So, it appears that China is still encouraging economic policies that will add to its massive debt mountain, while stressing businesses that rely on the shadow banking system the most fragile aspect of its financial system.
Italy was another country that has an encouraging PMI. It rose from 50.4 last month to 51.3 building on a trend over the last three months. However, an improving economy has just allowed its government to continue to be irresponsible for reasons of political expediency. The prior technocratic government of Mario Monti introduced an unpopular property tax on first homes to meet fiscal targets. Italy’s sovereign debt is one of highest in the world. It was recently abolished by his successor Enrico Letta against the advice of the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD). He got rid of the tax to save his fragile coalition. Abolishing the tax was part of the policy of his coalition partner, headed by the recently convicted Silvio Berlusconi. The tax was important because it is more difficult to dodge, which addresses Italy’s notoriously poor record on revenue collection.
India was one country that definitely did not have good economic numbers this week. Nevertheless, despite the tanking of the rupee and the lower GDP numbers, the government is doing more of the same. It is trying to pass a controversial food subsidies program that could cost about $21 billion a year. The reason for the generosity is simple. Elections are coming.
Instead of repeating past mistakes, it could actually try to make its laws more appropriate for a growing economy. Included in the long list are structural reforms such as insurance industry liberalization, disinvestment of state-controlled enterprises, lifting limits on foreign participation, allowing foreign investment in the private pension industry and reducing. The list is long and has been repeated often over the past 10 years. The question is it too late to make these reforms.
One commentator, I read recently, suggested that it was. According to this savant, it is best to make reform during good time, because it lessens the cost. True, but as we have seen in numerous countries, even countries that have the potential of major economic meltdowns, the impetus for reform is not there as long as the future looks bright. It reminds one of Citigroup former CEO’s, Chuck Prince, famous quote in July of 2007 on the eve of the meltdown that "As long as the music is playing, you've got to get up and dance."
However, the music does stop and arguably, it has stopped in a number of countries. Rather than a lost chance, the crisis brings a real chance for reform. Prime Minister Manmohan Singh could never have reformed the Indian economy without the threat of collapse. The Securities Act of 1933 and the Securities Exchange Act of 1934 established the model for securities regulation around the world. They were passed only after the market crashed in the depth of the Great Depression. However, sadly these things will only happen when denial is no longer possible. Until then play on, “Give (them) excess of it; that surfeiting, The appetite may sicken, and so die.”
is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)