Reform Stimulus

Reforming laws and policies could be an enormous stimulus for any economy, but changing them is almost impossible. Every law creates systems of economic winners and losers. So without real reform, a global recovery is nowhere in sight

The world is moving slowly into another recession. Europe is going through a sovereign debt inspired credit crunch. India’s industrial production dropped 5.1% in October from a year earlier. The Guangzhou government’s land sales program has seized up decreasing the province revenues by 70%. The United States has a massive deficit and political grid lock.

To resolve these issues the world has resorted to all sorts of economic solutions. In China they tried fiscal stimulus through massive bank loans, but only ended up with inflation and a housing bubble. The US tried quantitative easing, but only helped to create a commodities bubble while devastating savers and pensioners. The EU now is trying fiscal discipline, which will surely result in a recession. They have tried everything except the one thing that actually would work and cost nothing. They can’t resort to this simple solution because of politics. Printing money does not have a political downside. Real reform does.

Business cycles will always be with us, but economies are more resilient if their legal systems, their legal infrastructures, are economically efficient. In short their systems must make business easier. For example if you look at the World Bank’s Doing Business rankings, the economies that have survived and even prospered during this recession are the same economies that rank very high in the index. They include Singapore, Korea, Hong Kong, Norway, Sweden, Denmark and Canada. The US has a good ranking and has definitely had its problems, but nowhere near the issues of other many other countries. Two other countries near the top also help prove the thesis, Ireland and Estonia. Both countries recently were considered economic basket cases. Yet both countries have been able to go through painful ‘internal devaluations’ and are growing. In fact Estonia’s growth in the first quarter of the year was a blistering 8.5%, the highest in the European Union.    

Despite their devastating effects countries all over the world continue with disastrous policies. Subsidies are one of the worst. Nigeria is one of the world’s largest oil producers. Not surprisingly with its vast mineral wealth it subsidizes petroleum, which was meant to help the poor. Yet the cost of the subsidy is so great that it almost exceeds the oil export revenues. It also has created enormous inefficiencies and corruption. In the US a subsidy for ethanol has made it this year the cheapest motor fuel, but at the expense of higher food prices.

Laws in many countries that are supposed to protect labour have resulted in coddling some workers and insuring that others cannot get jobs. The labour market in Spain has become a two-tiered system. Older workers with jobs are protected from layoffs and have good benefits. Meanwhile, it is so difficult to hire and fire workers that the unemployment rate among younger workers tops 40%.

Brazil has a labour code taken from Mussolini’s Italy. It is just about as devastating. Getting rid of a worker without “just cause” can result in a fine of 4% of the total amount the worker has ever earned. The employee’s incompetence or the bankruptcy of the company are not considered just cause. Like Brazil, India’s infamous inflexible labour codes have made it impossible to take advantage of its inexpensive labour.

Revenue for the state usually in the form of taxes is a necessity, but how it is collected makes a big difference. In China since all land belongs to the state, so with a few experimental exceptions, there aren’t any real estate taxes. This makes the governments dependent on sales of land (actually sale of long term leases of up to 70 years) to developers for up to 40% of their revenue. Local governments also use the land as collateral for loans from state-owned banks. This system worked well as long as the money kept flowing and the prices kept rising. When Beijing restricted real estate sales and tightened lending, the real estate bubble started to collapse with potentially devastating consequences.

Subsidies, inflexible labour markets, and poorly designed tax codes are just the tip of an enormous iceberg. To these problems you could add protectionist policies, failure to protect property rights especially intellectual property rights, slow or corrupt judiciary and transparent markets.

All of these problems have to do with laws. Laws can be changed at no cost. Reforming these laws and policies could be an enormous stimulus for any economy, but changing them is almost impossible. Every law creates systems of economic winners and losers. As Mancur Olson free rider thesis predicted, those who benefit are willing to fight tooth and nail to protect what they consider their property interests even if it means economic suffering for all of their fellow citizens. So without real reform, a global recovery is nowhere in sight.

(The writer is president of Emerging Market Strategies and can be contacted at or



Industrial output -5.1%—worst since 2008-09 global recession

Industrial output actually shrunk by 5.1% in October—a contraction which is the worst since March 2009, when the world was hit by a global slowdown

India’s industrial output shrunk by 5.1% in October, mainly on account of the sharp contraction in the manufacturing and dismal performance of the capital goods sector. The current decline is the worst since March 2009 in the midst of the global slowdown.

The Index of Industrial Production (IIP) had recorded 1.9% growth in September 2011, which has now been revised to 2%. IIP had registered an 11.3% growth in October last year.

Last week, the finance ministry cut its gross domestic product (GDP) growth forecast for the current fiscal to 7.5% (+/- 0.25%) from 9% estimated in February.

The decline in industrial production numbers, as per the latest data, suggests continued sluggishness in the economy, experts said.

As per data released by the government today, industrial output grew by 3.5% in the April-October period this fiscal against 8.7% in the same period last year.

Output of the manufacturing sector, which constitutes over 75% of the index, declined by 6% in October compared to a growth of 12.3% in the same month of 2010.

Besides, mining output declined by 7.2% in October this year, as against a growth of 6.1% in October last year.

Production of capital goods fell sharply by 25.5% in the month under review. The segment had grown by 21.1 per cent in the corresponding month of 2010.

Output of consumer goods also fell by 0.8% during the month under review, as against a growth of 9.3% in the corresponding month of 2010.

Furthermore, consumer durables production declined by 0.3%, compared to a growth of 14.2% in October last year.

During the month under review, output of consumer non-durables fell by 1.3%. The segment had expanded by 5% in October last year.

However, electricity production grew by 5.6% during the month under review, as compared to 8.8% growth in October 2010.

India’s economy grew by 6.9% in July-September 2011, the slowest rate of expansion in nine quarters.

India Inc had attributed the slowdown to rising interest rates, which have led to an increase in the cost of borrowing, thus hindering fresh investment.
The Reserve Bank of India (RBI) has hiked interest rates 13 times since March 2010 to tame inflation however, headline inflation has been above the 9% mark since December last year.




6 years ago

Paying the price for unproductive budget giveaways

What went wrong with Eurozone countries

 This desire to punish rather than co-operate ensures that the ongoing crisis continues and continues to get worse. Credit remains tight, capital flight from the Eurozone is becoming a real problem and Standard and Poor’s will most likely downgrade several member states

Like most investors I spent most of last week addicted to news about the crisis in the Eurozone. I have assiduously followed the progress of the European summit together with the market reaction. After extensive emersion in every newspaper, magazine, radio program and television show my conclusion is that I have totally wasted a week. Little if anything was accomplished. The reason is quite simple. The Europeans are trying to solve the wrong problem. What they should do is to learn from US history. They didn’t and it will cost them and everyone else.

The most recent agreement is based on the idea that fiscal malfeasance is the origin of the crisis. The thesis goes something like this. Wicked spendthrift governments mostly in Europe’s periphery borrowed a lot of money and blew it on social programs. Now they can’t pay the money back.

To solve this problem the summit decreed penitence. All Eurozone countries would be forced to adopt budgetary discipline through a “fiscal compact”. They would also pass ‘golden rules’ to ensure balanced budgets. If the rules were broken, they would be punished with automatic penalties. They also added a few Euros to the bailout fund, but much of the fund depends on leverage and anyway it wasn’t enough.

This approach was politically acceptable but has some definite problems. The first is that a recession is the wrong time to adopt an austerity package. Austerity creates a vicious circle of economic decline. It reduces domestic demand which raises unemployment and lowers revenues from taxes. This in turn creates larger deficits which lessens confidence in banks and shaky sovereign debt. Besides it isn’t the problem.

Before the crisis Spain, Estonia and Ireland had much better control of their deficits than Germany, Austria or France. They were in fact running a surplus. As a result of their fiscal discipline Estonia, Ireland and Spain has much better control of their public debt than Germany and France. Although Greece and Italy’s public debt is over 100% of their GDP (gross domestic product), Spain’s debt is only slightly more that Germany or Austria’s. Estonia and Finland have surpluses.

The real problem was competitiveness. The Eurozone countries that got into trouble, Estonia, Portugal, Greece, Spain, Ireland and Italy were all running substantial trade deficits. Estonia’s current account deficit was over 10% of GDP. So when the crisis hit in 2008 and private financing of the external imbalance dried up, the countries were in deep trouble.

Estonia is sort of the poster child for the problems of the lack of competitiveness and what to do about it. Estonia is a tiny country and its banking system is owned by foreign firms, mostly from Sweden. During a construction boom, Estonia’s growth was at double digits. After the crash it fell by 14%. The result was pain. Unemployment rocketed to 18%.

One tried and tested way to increase competitiveness is to devalue your currency. The Chinese are especially good at keeping the yuan low in order to insure their competitiveness. But since Estonia like Italy and Greece is a member of the Eurozone, this option was not available. Instead they went through an internal devaluation, which included slashing 9% of GDP from their budget and big cuts in nominal wages. The medicine worked. Estonia now has surpluses and its growth rate at 8.5% is the highest in Europe.

But Estonia had something else that was very important. It had a regulatory framework that encouraged business and was fairly clean. On the Doing Business Index and Corruption Index it scores slightly below Germany. In contrast Italy’s business climate is worse than Mongolia’s and Greece is worse than Yemen. As to corruption both countries are worse than Rwanda.

One thing that the Eurozone could do would be to create a form of joint liability like Eurobonds. These could be adopted with a credible sanction. Any country that spent too much couldn’t use them.

The success of this method was proved over 200 years ago in the United States. In 1790 the recently created country had a massive war debt of $54 million or about $4 trillion in today’s money. The problem was that the debt was very unequal. Some states like New York were deeply in debt, while others like Virginia were almost debt-free. One of the country’s “founding fathers”, Alexander Hamilton had an idea. The new United States federal government would assume all the debt and create joint liability of US bonds.

Mr Hamilton’s plan was an incredible success, but sadly no such solution was agreed to by the European summit. This desire to punish rather than co-operate ensures that the ongoing crisis continues and continues to get worse. Credit remains tight, capital flight from the Eurozone is becoming a real problem and Standard and Poor’s will most likely downgrade several member states. So don’t expect a happy New Year anywhere.  

(The writer is president of Emerging Market Strategies and can be contacted at or



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