Lowy Institute

Given that emerging economies continue to grow two or three times faster than advanced economies, the persistent gloom about their prospects is puzzling. The latest example comes from The Economist, which argues that convergence, the process by which poorer countries catch up to rich countries over time, was a temporary phenomenon that has largely run its course. The past 15 years have 'deceived people into thinking that broad convergence is the natural way of things.' 

How did they come to this view? The first decade of this century saw a rapid but unsustainable pace of convergence. China led the way with double-digit growth, and even the traditional laggards (such as India and Brazil) did well. Double-digit growth is not unprecedented (pre-1980 Japan, and a number of Asian economies, have come close) but it was never sustainable in the longer term

But just because convergence has slowed from this rapid pace doesn't mean it has ended. China's 7% growth rate doubles total income every decade. And it is sustainable. After all, even countries once seen as 'basket cases', such as Indonesia, recorded average growth of 7% for the three decades of the Soeharto era.

The other sleight of hand is to focus on the catch-up period associated with the 2008 financial crisis. The emerging economies continued to grow while the advanced economies had falling GDP, which has been followed by feeble recoveries. The fact that this was a 'once-off' conjuncture which is now behind us doesn't signal the end of convergence.

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On top of this, the World Bank data used by The Economist does indeed make this look like a halcyon decade: 'output per person in the emerging world doubled between 2000 and 2009; the average annual rate of growth over that decade was 7.6%'. It was  good decade, but not that good. IMF figures suggest that emerging economy growth in this period was around 2 percentage points slower than The Economist's.

The Economist's rose-tinted version of the past is contrasted with a gloomy outlook. It says that the IMF 'put the difference between the growth in emerging markets other than China and growth in the developed world at just 0.39 percentage points this year'. With this differential, full convergence would take 'more than 300 years'.

But the latest IMF forecasts show advanced economies growing at 1.8% while emerging economies are growing at 4.6%. True, this figure includes China's growth, but even so it is inconsistent with The Economist's numbers. This difference in growth rates shown in current IMF estimates (with the emerging economies growing around 2-3 percentage points faster) might be seen as closer to the overall convergence prospects than The Economist's 'indistinguishable from never' assessment. 

But in any case, the convergence story was never about aggregates, combining the diverse experience of all emerging economies taken together. The convergence story is the counter to the view that poor countries are inexorably stuck in poverty because of geography, lack of savings, or unreformable institutions. This pessimistic generalisation is refuted by the cases of Singapore, Taiwan and South Korea. Then, rebutting the argument that these were special cases, less dynamic economies like Thailand and Indonesia showed that the income gap could be narrowed, even in the face of inefficient and corrupt institutions. The point of the convergence story is that, with competent policies, poor countries can grow quickly by adopting proven technology and techniques.

It was never part of the convergence story that all poor countries would make the journey, or that it would be quick. Even China's three decades of outstanding growth have not made it rich, yet. And in any case, the objective of matching the moving target of rich-country living standards is not an essential part of the narrative. Even to get half way, to the stage where most people have been lifted out of poverty, would be a result to be cheered, not disparaged by glum mutterings about the 'middle-income trap'.

There is a message here with relevance for Australia. Convergence is happening, and it's happening in our region. Despite all the gloom from global commentators, the IMF data shows that 'emerging and developing Asia' has recorded a steady 6.5% growth rate, both in recent years and in the forecast. This is in a world full of talk of 'secular stagnation' in the advanced economies, with Europe still mired in debt and gloom, America's recovery yet to gain momentum and Latin America falling back into its traditional languor. Our part of the globe is doing just fine, thanks to convergence.

Graph courtesy of The Economist


Mike Callaghan is spot-on in arguing that Australia's foreign investment policy needs a wider reassessment than simply looking at limits on state-owned enterprises (SOEs). Let's try to take this a bit further.

This fixation with SOEs is a peculiarly American priority seen also in the Trans-Pacific Partnership conditionality and the debate on sovereign wealth funds, and reflects a touching faith in the magic of the free market. Private sector players, pursuing their own interests, are assumed to also pursue the national interest, while SOEs may not.

Of course the market is a powerful operational framework for a successful economy, but successful economies have often found an important place for government-owned enterprises as well. At the same time, there is ample evidence that private companies without appropriate regulation will not always pursue the national interest. This is not an issue to be determined on doctrinal grounds: we need to examine the behaviour of both private companies and SOEs.

Here's an example. As a major commodity producer with an 80% foreign-owned mining sector, Australia's national interest is to ensure that our minerals exporters get the best price in global markets and that we squeeze as much out of the miners as is sensible in the form of royalties and taxes. Our concerns should be to prevent transfer pricing, tax shifting, monopolistic price-setting or collusion between the demand and supply sides of the market. With these issues satisfied, there is no good economic reason to discriminate between domestic and foreign companies, or between private companies and SOEs. Our concern should be that the market is working well. For this, the national authorities need to have enough information about the operational market structure to ensure that our national interests are met.

We've just seen an example which illustrates how far we are from where we should be. Last year Glencore (a commodity producer and trader with sales of $250 billion) took over Xstrata, our largest coal miner (and itself already foreign owned). The transaction was so large (the fifth-largest in the global history of gigantic resource take-overs) and important for world commodity trade that it needed to pass the scrutiny of competition authorities in South Africa and China. The Europeans required Glencore to unwind its relationship with a zinc company and the Chinese required divestiture of its Peruvian copper assets (giving China the opportunity to acquire these assets).

Australia didn't require anything.

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It's hard to find any record that the Foreign Investment Review Board gave this matter substantive scrutiny, while the Australian Competition and Consumer Commission saw no problems within its remit. This is despite Glencore's reputation as an aggressive tax minimiser, its reputation for underhand dealings, its lack of transparency reflecting its Swiss domicile and its dominant position in segments of global commodity trade. Glencore itself says the transaction will allow it to 'capture value at every stage of the supply chain from sourcing raw materials deep underground to delivering products to an international customer base'. 

What to do? For a start, why not require foreign investors (whether Swiss-based Glencore or Chinese SOEs) to provide the same degree of detailed public transparency required of Australian-domicile companies? This would give Australian authorities a starting point in assessing whether we are getting the best deal out of foreign investment.

Of course there are bigger issues as well. Why do the BCA and the OECD start with a strong presumption that the flow of FDI should be maximised, when there are alternative sources of funding for the current account deficit (debt or portfolio flows) which might be cheaper or more suitable?

In any case, foreign investment policy goes beyond economics. There are, for instance, no good economic reasons for limiting investment in real estate or agriculture, but many countries (including Australia) do so. When it comes to political issues, the overwhelmingly important one for Australia is that we are small and many of the investing countries are big. If Chinese companies (private or SOE) chose to make Australia an important part of their commodity security priorities, they will want to own a large proportion of our resources and agriculture. Politically, we will find this uncomfortable, perhaps even unacceptable.

Photo by Flickr user Kim Farnyk.


Sam Roggeveen is certainly right to praise the achievement of an Australia-Indonesia Code of Conduct.

There is, however, an additional point to be made. The ambiguity of the text, which Sam says is mutually beneficial, exposes the nature of the negotiations: Australia gave away nothing, and Indonesia had to back down from its initial position.

President Susilo Bambang Yodhoyono wanted to sort this out before his term ends in October, so he was under some time constraint, while the Australian negotiators have demonstrated by their 'sit on your hands and wait for the storm to blow over' attitude that they see no urgent need to fix the relationships with our close neighbour.

This outcome has two drawbacks. First, it confirms the commonly held Indonesian view that Australia is characteristically sombong ('arrogant'). More seriously, it shows that intelligence policy-making is still in the hands of the people who got us into trouble in the first place. It was a serious lack of judgment that had us listening to the telephone conversations of SBY's wife (and members of the Cabinet who were not sensible targets for this sort of operation, such as the Minister of Finance). This lack of judgment is, unfortunately, all too common. It was demonstrated again by the attempts to bug the Timor border discussions, to the benefit of Australian commercial interests.

This agreement would have been more beneficial still if it had demonstrated that the Canberra intelligence community has learned something from its mistakes.

Photo courtesy of DFAT.


'The Federal Reserve enters its second century as the closest the world has to a global central bank.' So says Ted Truman, who speaks with some authority as he played a key advisory role for many years with the Fed (the US central bank) and the US Treasury.  However, Truman's detailed account of the Fed's international role over the past three decades demonstrates how limited (and sometimes arbitrary) that role has been.

The central issue here is whether the US Fed can act for the global interest where American interests aren't involved or might conflict.

Truman identifies fourteen occasions where the Fed has acted in response to global events, and a clear pattern emerges: where US foreign policy interests are at stake, the Fed will act to assist with global problems. Thus Mexico's crises (in the 1980s and again in 1994) spurred a vigorous and helpful response. The 1998 crises in Thailand and Indonesia hardly rate a mention in Truman's account, while the concurrent crisis in South Korea (where 35,000 US troops were stationed) resulted in a path-breaking (and principles-breaking) intervention in which the US orchestrated controls on capital outflows from Korea. Foreign banks, pressured by their own national central banks, refrained from withdrawing funds which they had lent to Korean banks. An Australian bank (ANZ) was a significant participant in this stand-still, which fortunately turned out well, with Korea able to resume repayments within a short time.

The US Fed's swap operations are akin to global central bank operations, effectively making short-term US dollar loans to foreign central banks, which can on-lend these to their domestic banks to help them through a foreign currency liquidity crisis. This is analogous to traditional liquidity operations, where central banks make domestic currency loans to banks in need of liquidity.

These Fed swap arrangements have been a powerful and valuable stabilising element during global financial crises since 1965 or even earlier. Until recently, however, they have been available only to a small group of advanced economies (including Australia), plus Mexico.

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In 2008 the swaps were a crucial part of the crisis response, especially for Europe. The Reserve Bank of Australia was able to use this facility to on-lend US dollars to Australian banks in need of foreign currency liquidity when the New York money market dried up. 

The usefulness of this facility was demonstrated even more powerfully in 2008 when South Korea experienced a foreign currency crisis. Its own substantial foreign exchange reserves were not sufficient to stabilise confidence. The crisis ended as soon as the Fed's swap facility was announced, arriving like the US cavalry over the horizon to save the embattled Koreans.

As the Korea experience demonstrates, the swap facility is a more powerful instrument than a country's own reserve holdings. This is a current policy issue, as many emerging economies (especially in Asia) are building up huge foreign exchange reserves in readiness for renewed episodes of capital flow volatility. Such reserve holdings have to be funded, so are expensive and often disrupt monetary policy. Wouldn't it be helpful if the Fed really did act as a global central bank, offering this swap facility to everyone?

Unsurprisingly, the Fed offers swaps only to its trusted friends. In 2008, for example, it refused Indonesia's approach for access to the swap facility. It is not, and is unlikely to become, a global facility that would make the US Fed analogous to a global central bank.

Those, like Australia, in the swap network should be grateful that this powerful facility is available to us, though we might note that Truman reports earlier efforts by the Fed staff to close down the facility.

Truman avoids specifically addressing a vexed current issue. What obligations does the Fed have to consider the impact of its policies on other countries? Financial markets certainly expect a significant global effect from the unwinding of quantitative easing (QE). Raghuram Rajan, the Indian central bank governor, sees the Fed as having important obligations to countries so affected. But beyond ensuring that these QE operations are understood by financial markets, the Fed sees itself as having no wider obligations.

It's hard to see how the Fed could act otherwise. There are, in fact, historical examples where the US has helped its closest friends and paid a price. In 1927 it lowered the discount rate in response to the entreaties of Montagu Norman, governor of the Bank of England, who was struggling to contain the damage from Churchill's disastrous return to the gold standard two years earlier. This lower interest rate encouraged the asset-price boom which ended in 1929 with the Great Crash, ushering in the Great Depression.

If the US Fed cannot be an effective global central bank, what about the IMF? Truman talks of the IMF as if it is a simple extension of US policy. Taken together, perhaps there is some truth in the idea that the US Fed and the IMF can serve as a global central bank. But a precondition for this to be acceptable to the rest of the world is to implement the IMF governance reforms (especially voting shares) which are currently held up, pending US Congressional approval.

Photo by Flickr user jareed.


The Interpreter hasn't had much to say about European growth for a couple of years, mainly because there hasn't been much of it. European Central Bank President Mario Draghi brought this melancholy story up to date at the central bankers' annual get-together at Jackson Hole, Wyoming, last week, far from the bustle of the financial markets. The bankers have exhausted the usual topics of monetary policy at past meetings; this time their focus was on labour markets.

The graph below shows the starting point of Draghi's narrative. US unemployment rose much more sharply than Europe's in the first phase of the 2008 crisis, but US unemployment came down substantially while European jobless rates continued to rise.

Most of this difference reflects the second wave of the crisis which hit the European peripheral countries (starting with Greece) at the beginning of 2010. But the overall euro-area unemployment rate of nearly 12% is not just a reflection of 25% unemployment in Greece and Spain. With the exception of Germany, none of the core European countries has had any recovery to speak of, with employment lower and unemployment substantially higher than before the crisis. The table below (source) shows the percentage change in GDP, employment and unemployment between the pre-crisis peak and the first quarter of 2014:

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What is to be done? Draghi's answer is 'a bit of everything'. He'll keep monetary policy loose (and presumably do 'whatever it takes' if the euro comes under threat). But he is looking for help from fiscal policy and structural reform. A call for structural reform (ie. productivity improvement) is a standard element of just about any macro-economic prescription, but it carries more weight and urgency given the duration and depth of the European recession. 

Draghi quotes figures showing that European structural unemployment (the part that can't be fixed just by getting economic activity back to full capacity) as having risen from 8.8% in 2008 to 10.3% in 2013 as a result of the crisis and the lacklustre recovery. This would imply that the usual instruments of counter-cyclical macro-policy can't take the unemployment rate down very far. 

He reports that Ireland has done better than Spain in terms of wage flexibility, but Ireland's main method of getting its unemployment rate down has been emigration, not only of disenchanted Irish youth but also the migrants from other parts of Europe who had flocked to Ireland when it was the Celtic Dragon, before the crisis.

Even this dismal litany doesn't complete the list of problems facing Europe. The European banking system is undercapitalised and in no position to support a strong recovery. And the unsustainable debt burdens on the peripheral countries make it most unlikely that a recovery can occur in these countries without a substantial additional debt write-off

Draghi (and others) are giving more attention to the possibility that Europe may be facing secular stagnation of the sort demonstrated by Japan over recent decades. This is not a novel idea, but its revival is gaining wider attention, including in this comprehensive e-book from Vox-EU

Just as a postscript on the Draghi speech, his presentation contrasted to the typical central banker's view, which is interested in the labour market only in as far as it affects inflation. Draghi began his speech by sounding, well, human:

No one in society remains untouched by a situation of high unemployment. For the unemployed themselves, it is often a tragedy which has lasting effects on their lifetime income. For those in work, it raises job insecurity and undermines social cohesion. For governments, it weighs on public finances and harms election prospects. And unemployment is at the heart of the macro dynamics that shape short- and medium-term inflation, meaning it also affects central banks. Indeed, even when there are no risks to price stability, but unemployment is high and social cohesion at threat, pressure on the central bank to respond invariably increases.


Perhaps the most fundamental change in international trade in recent decades has been the development of multinational 'supply chains'. The production process has been 'unbundled', with different stages of production taking place in different countries. An iPad is assembled in China, but only $10 of the total production costs takes place in China; most of the total cost comes from inputs made in other countries, including the intellectual property and design input from Apple in California.  

In conventional trade statistics, exports are counted in gross terms, so the cost of the assembled iPad (including those elements imported into China) is counted in China's export figures. Over recent years, the misleading implications of the gross trade figures have been more fully recognised. Since 2012, an alternative value-add data set has been available.  

The Reserve Bank of Australia has built on this data to provide new insights into Australia's international trade, particularly on trade-partner shares. The diagram below, from the RBA, illustrates the issue. If Australia exports $100 of iron ore to China, which is then used as the input for products which China exports to the US worth $110, conventional statistics would record this as $100 of Australian exports and $110 of Chinese exports. But China has, in this exaggerated example, only added $10 of value.

Comparison of gross trade and value added trade

Focusing on 'value-add' statistics changes the picture of Australia's export partners.

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In this example, the destination of $100 of iron ore exported by Australia is no longer China, but, in final product form, America. Comparing the two measures of Australia's export destinations, we get the following table: 

These value-added statistics also provide a very different perspective on the importance of the services sector to Australia's exports. In gross terms, services make up only 22% of exports, but services form an important input into other exports (especially manufactures). Recalculating exports according to value-added model takes the services component to over 40% of Australia's exports (a bit bigger than resources). This different perspective fits Australia's comparative advantage: our export future doesn't lie in manufactures, but in commodities and services.

These value-add statistics don't replace the conventional gross statistics, which are available more quickly and don't rely on so many assumptions. Nor are they the last word in the ongoing process of refining statics to reflect a changing world. But they provide a valuable alternative perspective, sometimes with policy implications. At the very least, they are a reminder of the complexity of international trade: our exports will depend not only on what is happening in China, but on what is happening in China's export destinations as well.


The Director-General of the World Trade Organization is sounding despondent after the latest setback to the December 2013 Bali Agreement. Meanwhile, a survey of exporters has given some endorsement for the alternative path of free trade agreements (FTAs). Is there any hope for furthering the multilateral trade agenda?

Mike Callaghan described the Bali Agreement signed last December as a small win for the WTO — the first multilateral trade agreement since the WTO replaced the GATT as the multilateral trade forum in 1995. The main components of the Bali Agreement were trade facilitation (aimed at cutting red tape and corruption in ports, thus encouraging international trade), an agriculture package that allowed governments to run food security programs without breaching WTO commitments, and a reaffirmation of market access for less-developed countries.

While the agreement reached in Bali required subsequent endorsement, this was seen as a mere formality, as the text was signed by all trade ministers and had been painstakingly tailored to India's special sensitivities on food security. Yet India late last month blocked the deal.

The time limit for final endorsement expired at the end of July, with India insisting on re-opening the agricultural issues. The WTO Director-General, reporting to the WTO ambassadors in Geneva on 31 July, had a tone of desperation. This is not 'just another delay which can simply be ignored or accommodated into a new timetable'. Here is the wider context:

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I want to stress the importance of each of the three pillars of the WTO: disputes, monitoring and negotiations — not to mention our work on technical assistance and aid-for-trade. We saw the importance of our work during the financial crisis when, unlike with previous crises, there was no surge in protectionism. Having the rules in place and adherence closely monitored — with the dispute settlement mechanism there to back them up — helped to keep protectionism in check during a dangerous period for the global economy. The value of those pillars was plain to see — and they performed very well. But, when I took office last September, I was clear that I had real concerns for the future of the negotiating pillar. Bali was a very important moment in reviving and revitalising the negotiating function. But, just seven months later, once again I am very, very concerned.

The central component of the Bali Agreement (making ports more efficient) is hardly controversial. But why is food security policy such a sticking point? In an imperfect-market world, surely India should be able to offer some subsidies to its own farmers? When, however, the farm price-support programs result in what are effectively export subsidies, it becomes a multilateral concern

The WTO Director-General expressed some hope that the European summer holiday period might deliver a breakthrough when the ambassadors next meet in September. But if not, the consequences do indeed seem dire for the future of multilateral trade agreements. When a hard-fought negotiation, finally brought to fruition, can be torpedoed in this way, who will bother to try again?

Meanwhile, the rival model for international trade negotiation, FTAs, received some endorsement from a survey by The Economist Intelligence Unit. Senior executives from 800 exporters in Australia, China, Hong Kong, India, Indonesia, Malaysia, Singapore and Vietnam were quizzed on their experience.  All these countries have extensive FTA coverage. The survey finds that each FTA signed in Asia is used, on average, by only one in four exporters. But where they are used, the result is positive: more than 85% of respondents report that their exports to the markets concerned have increased either significantly or moderately as a result of FTAs. According to the EIU report:

Critics of FTAs have long warned this would happen. FTAs, they say, replace the relative simplicity of multilateral WTO agreements with a "noodle bowl" of overlapping preferences and rules and regulations that, in practice, often prove more trouble than they are worth for companies to use. But the result is nonetheless surprising, given the benefits in terms of increased exports reported by companies that do use the FTAs.

Of course exporters (the survey respondents) are not in a position to judge the overall national or multilateral benefit of FTAs. The central criticism of FTAs (which should properly be called 'discriminatory preferential trade arrangements') is that they divert a country from buying its imports from the cheapest foreign supplier. FTAs are unambiguously second-best, compared with multilateral agreements. But the current multilateral model seems in need of drastic modification.

Photo by Flickr user Betsy Dorset.


Standard and Poors' credit ratings. (Wikipedia.)

Foreign investors learn about the Australian economy from a variety of sources, but the credit rating agencies (CRAs) have a special place, as many investment managers are committed to following the rating agencies' assessments. As well, the CRA ratings are used in prudential supervision. This gives special importance to Standard and Poors' (S&P) latest pronouncements, reaffirming Australia's AAA rating.  

The S&P press release begins by noting 'the country's strong public policy settings, economic resilience, and significant fiscal and monetary policy flexibility' as well as its 'strong ability to absorb large economic and financial shocks, as was demonstrated during the global recession in 2009.'

So far, so good. Then come the caveats: 

Australia's high external imbalances, dependence on commodity exports, and high household debt moderate these strengths...In our opinion, while Australia benefits from many fundamental strengths, its key credit weakness is the economy's high level of external liabilities. The banking system in particular has a high degree of external indebtedness and remains highly reliant on the ongoing backing of foreign investors...Meanwhile, Australia continues to run significant current account deficits... 

Pressing the panic button? Not really. This is just having 'two bob each way', as S&P goes on to say:

In our opinion, however, the risks associated with Australia's high private-sector external debt are manageable because of the strength of the country's financial system, the high degree of foreign currency debt hedging, and an actively traded currency that historically has allowed external imbalances to adjust. Additionally, Australia's highly credible monetary policy framework remains able to help counter the impact of any economic shocks.

So we're OK after all? Not so fast.

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Just in case you’re getting lulled into complacency, S&P concludes with some warnings and a line-in-the-sand threat:

We could lower the ratings if external imbalances were to grow significantly more than we currently expect, either because the terms of trade deteriorates quickly and markedly, or the banking sector's cost of external funding increases sharply. Such an external shock could lead to a protracted deterioration in the fiscal balance and the public debt burden. It could also lead us to reassess Australia's contingent fiscal risks from its financial sector. We could also lower the ratings if significantly weaker than expected budget performance leads to net general government debt rising above 30% of GDP.

What would a country have to do to get a clean bill of health? Australia's banks are no longer obtaining new funding flows from overseas, and their outstanding balances are smaller than in 2008 (see graph below). Sure, the AAA government guarantee helped them to come through the crisis smoothly but the same thing could be provided again, if needed. The financial system was given the ultimate stress test in 2008 and came though well, unlike many countries. As for the warning on external imbalances, since 2008 the current account deficit is significantly smaller, as is the external income deficit

Source: Reserve Bank of Australia.

What about the 'line in the sand' on net government debt? With the current level at just over 20% of GDP, it would indeed be a major slippage if we were to find ourselves over 30%, so for S&P to finish its press release with this hypothetical outlier is drawing a long bow. It's drama-queen stuff, but it has been picked up by the press, always happy to spotlight an impending disaster, no matter how unlikely.  

Let's also put the current level (and even the 30% line in the sand) in perspective. Here are the equivalent IMF figures for the G7 countries:

Source: IMF Global Stability Report, Table

Remarkably, some of the key actors responsible for the 2008 financial debacle have managed to restore their reputations, and no rehabilitation is more remarkable than that of the Teflon-coated credit rating agencies. Leading up to 2008, they handed out AAA ratings to worthless mortgage securitisations (but of course these were a different sort of AAA rating: the debt issuers simply paid for it). Nor were the country ratings much better: S&P's 'investment-grade' endorsements of bankrupt Greece survived well into 2010.  The role of the CRAs was under critical review well before the 2008 crisis but no satisfactory answer has yet been found for their undue influence and they are still accorded a role in the Basel prudential supervision arrangements.   

Could it be that S&P is peeved because it recently lost its reputation-damning court case in Australia? It's little wonder that analysis of the sort produced by S&P for Australia evokes a derisive response. Can't they do better?


'Fight corruption!' A Corruption Eradication Commission event in Bandung in 2009. (Flickr/Ikhlasul Amal.)

Indonesia's reputation for corruption in not in doubt: it comes 114th out of 177 in Transparency International's ranking. For more than a decade, the Corruption Eradication Commission (KPK) has been putting high-level officials away for long jail terms. But any judicial body which boasts of having a 100% conviction rate is likely to have made some mistakes.

Having recently succeeded in putting the head of the Constitutional Court in prison for life and given lesser sentences to ministers close to President Susilo Bambang Yudhoyono, the KPK has returned to one of its long-term targets: the central bank. Since 1998, most of the senior members of Bank Indonesia have spent some time in jail or have survived long periods with this threat hanging over them. The causes have been various, but an ongoing issue has been the 2008 rescue of a failing bank, Bank Century. 

In the context of the global financial crisis, it was feared at that time that the collapse of even a smallish bank would set off a chain reaction of runs on banks. With Bank Century saved by the injection of lender-of-last-resort funds, Indonesia sailed through the 2008 crisis with GDP growth maintained at over 6%. Many would regard the support for Bank Century as an insurance premium well worth paying, especially recalling the damage of the 1997-98 financial crisis. 

But in any case the issue here is whether public servants should face criminal charges (and long jail sentences) when their policy decisions are harshly judged after the event.

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One member of the Bank Indonesia board (which made the decision to rescue Bank Century) has just been given a ten-year jail sentence. While his case is complicated by other factors, the KPK has indicated that it will now turn to the other members of the Bank Indonesia board*, including current Vice President Boediono (who was Bank Indonesia Governor in 2008) and one of president-elect Jokowi's suggested names for finance minister

The KPK has gone so far beyond its proper role here that 35 leading citizens — lawyers, former ministers, politicians — wrote an 'amicus curiae' ('friends of the court') letter to the KPK. Respected senior legal figure Todong Mulya Lubis said that 'If public policy is criminalised, many public officials will be afraid to take decisions'.

Indeed. It is already clear that Bank Indonesia will not attempt another lender-of-last-resort operation, should it be needed. Indonesia goes into a volatile period in global markets, with its own financial sector in a fragile state, without the most basic of crisis-management instruments. The new president begins his term with a commitment to combat corruption, but with the KPK already so politicised that an urgent task will be to discipline the KPK itself.

* Disclosure: some of these people are personal friends.

Photo by Flickr user Ikhlasul Amal.


One of the messages of John Edwards' Beyond the Boom is that Australia sailed through the 2008 crisis unscathed. As a result, Australia's GDP in 2013 was 16% higher than in 2007, while many of the G7 countries had barely regained their pre-crisis GDP level: the strongest rebound, in Canada, was only 8% above its 2007 GDP. These are feeble recoveries. The damage of the 2008 crisis is, however, even more serious and lasting than these figures suggest.

Economic recoveries usually involve a strong 'catch-up' component, when income grows much faster than its underlying trend rate. Workers and enterprises, unemployed during the downturn, are brought back into full production. Business cycles are often described as 'V' shaped. The implication is that that economies get back to their pre-downturn trend line.

There is growing evidence that this catch-up has not occurred during the present global recovery. The recovery is not a 'V'; it is a reversed 'J', never getting back to the old trend line.

One compelling study of the issue is provided by Johns Hopkins economist Larry Ball. Ball took the potential growth rate estimates made by the IMF and OECD in 2007 showing how each of the OECD economies could grow if running at full productive capacity. He then compared these 2007 potential growth trends with the similar potential growth trends shown in the latest OECD and IMF forecasts. The latest estimate is well below the 2007 estimate. He attributes the difference to the damaging effect of the 2008 global financial crisis. Here's how he summarises his results:

I find that the loss in potential output from the Great Recession varies greatly across countries, but is large in most cases. Based on current forecasts for 2015, the loss ranges from almost nothing in Switzerland and Australia to over 30% of potential output in Greece, Hungary, and Ireland. The average loss for the 23 countries, weighted by the sizes of their economies, is 8.4%.

This graph of the US (above), from the Congressional Budget Office (CBO), illustrates the point. The sharp downward break in actual GDP growth (the solid line) in 2008 has not been reversed. Eye-balling this as far forward as the actual data take us, it doesn't look like the US is getting back to its old trend line (the darker blue dash line) any time soon, or ever. The lighter blue dashed line shows the best current guess of where the potential growth trend lies.

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Nor are most of the other 22 OECD countries Ball examined doing any better. The current potential growth paths (as calculated by the IMF and the OECD) have fallen about as much as the actual fall in GDP during the recession. These countries are now on a permanently lower growth trajectory. Countries which suffered the biggest recessions (notably, the eurozone peripheral countries like Greece and Spain, but also eastern Europe) have lost the most in terms of potential growth.

Less marked examples of this phenomenon have occurred in the past, where a recession discourages investment and leaves a permanently smaller capital stock. Technological progress and innovation are less dynamic in downturns. Most notably, workers who lose their jobs adapt to worklessness and remain jobless either because they stop looking for work or take early retirement. Sometimes their sojourn in unemployment has diminished their skills. Those in education stay there longer, with little accumulation of work-relevant skills.

Iin the jargon, it's known as 'hysteresis', and as a result output never gets back to the original potential growth path. In the US, the participation rate — the proportion of working-age population either working or looking for work — has fallen from nearly 66% in 2007 to less than 63% now. 

The powerful lesson here is: 'don't have a recession and, if you have one, recover quickly'. If you want to see what lasting damage a serious recession does to potential output, look at Larry Ball's graphs for Ireland, Spain or Greece.

But the CBO graph shows that something else is happening: the new potential output trend is not only lower, it is also flatter than before. This takes us to a broader debate about 'secular stagnation'. For example, the US used to have a potential annual growth rate of around 3%. The CBO now thinks it is just over 2% and some estimates are lower still. Demographics are reducing the relative size of the workforce. Various other factors are adding to the fall in participation in the workforce. Productivity seems to be slower in many countries.

There are plenty of esoteric arguments among the cognoscenti about all of this, and plenty of room for differences of opinion. A sensible concept of GDP is hard enough to measure and predict, and productivity is harder still. Many of the huge benefits we receive from technology (not just new products, but quality improvements in old ones) come to us at little or no extra cost, and probably don't get fully measured in the national accounts. Perhaps some of those who have dropped out of the work force are enjoying their new-found leisure, which is not counted at all in GDP.

There is, however, no doubt that the 2008 crisis was hugely damaging, and the inability of most of the OECD countries to achieve a normal rapid recovery has left a deep and permanent scar on living standards. In Australia we missed this bullet, through a combination of competent policy and good luck. The Hanrahans, with their relentless gloom, should be reminded of this.


Low global interest rates since the 2008 global financial crisis seem to provide an ideal opportunity for boosting infrastructure investment. Bond rates have been historically low, so many governments can borrow at less than the rate of inflation.

There is spare productive capacity in most advanced economies, but weighed down by a heavy legacy of debt, few advanced economies have been in a position to support their slack economies by expanding the stock of infrastructure. Emerging economies, less hobbled by debt, have seized the opportunity, but have their own constraints. This graph tells the story.The constraint for advanced economies has been an overload of government debt. Despite the strenuous efforts to get budget deficits down, deficits persist and thus debt continues to rise. Former US Treasury Secretary Larry Summers, worried about secular stagnation, sees infrastructure spending as a key response and cites a list of US infrastructure inadequacies. So far, debt concerns have overridden his argument.

The emerging economies, on the other hand, had quite low debt, and have used the opportunity to expand infrastructure spending, albeit from a low base. China, as usual, is a special case. Much of its expansion was in the form of a huge financial stimulus in 2009, to offset the global crisis. Other emerging economies didn't match China's expansion but have also boosted infrastructure funding.

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Most of this has been in the form of syndicated bank loans. Bank loans have the advantage of flexibility that suits the construction phase, but bonds are often a more appropriate form of longer-term infrastructure funding once the project is operational.  

Global financial markets, however, still have limited capacity to accommodate emerging economy bonds. Pricing anomalies are common. It's a puzzle why Indonesia has to pay 8% to borrow while Greece, with its dismal repayment record and patently unsustainable debt level, was able to issue 10-year bonds at 5%. More needs to be done, both by the national authorities and by financial markets (especially rating agencies), to develop these bond markets. The G20 may have something to say about this in November.

Of course there is a danger that low interest rates will encourage projects which aren't viable when funding costs return to normal. The Bank for International Settlements (the source of the graph above) is warning of the urgent need to shift interest rates back towards normal, with this sort of cheap-funding distortion in mind. No doubt there are white elephants among these projects. China is routinely mentioned in this context, but it seems pretty likely that Brazil has spent too much on football stadiums.

That said, the cost of the inevitable mistakes has to be weighed against the debilitating effect of inadequate infrastructure. Budget strictures are crimping maintenance in advanced economies, and most of the emerging economies (with the possible exception of China) have a long way to go before they have adequate infrastructure.


Economic convergence — the potential for poorer countries to catch up with the richer countries — may be the most important economic narrative of the post-World War II era. More than a billion people have shifted out of extreme poverty, largely by adopting technology and techniques already practised in the advanced economies. Convergence is not, however, an automatic process, like water finding its level. Not all poor countries will experience convergence, and even those that do will not necessarily catch up all the way. A new OECD report sets out this story in detail.

Some previously poor countries have made it all the way to equaling (or even exceeding) per-capita incomes in wealthier OECD countries. Singapore and Hong Kong have clearly done so, and South Korea and Taiwan have gone most of the way. But some of the great success stories among the emerging economies still have a long way to go; despite three decades of stunning growth, China is still well behind. 

The OECD report asks this question: if these countries continued to grow as they have over the past decade or so, which ones would reach the average per-capita income level of the OECD countries by 2050? The graph above gives the answer: those countries below the 45-degree line are closing in on the OECD countries fast enough to overhaul them by 2050; those above the 45 degree line (the majority) aren't growing fast enough to do this.

Of course this is just one aspect of the story.

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For a start, these countries may not go on growing at the same rate in the future. China can't sustainably return to its 10% rate, while others might do better than they have so far. In any case, what's the big deal about equaling the OECD? Quite a few countries are not far from the 45-degree line and will get a good distance towards closing the gap. They might well regard that as 'near enough'.

Yet there is a huge difference between catching up to where OECD countries already are and pushing out the frontiers to where no country has gone before. 

How fast the rich countries grow from now on will depend on the pace of technological advancement, innovation and a whole raft of other unknowns. Some economists argue that the rate of future growth for advanced countries will be substantially slower than before.

For emerging economies, however, the prospects are clearer, and perhaps easier. The technology that can take them to higher income already exists. They just have to copy it. It's a matter of learning the techniques, applying them, educating the labour force and, above all, putting in place the necessary infrastructure and institutions. No easy task, but what has been done before can be done again. This graph shows how much potential there is for increasing productivity by closing some of the gap with the US.

The OECD is concerned that productivity increases derived from shifting people out of low-productivity industries (agriculture, for example) to higher-productivity industries (manufacturing) will soon be used up. It will be necessary to learn how to do things better within each industry. This is harder. But anyone who has sat in a Jakarta traffic jam or battled with the city's slow internet (only 15% of Indonesians have internet) knows the potential for dramatic improvement in the way business is done. Moreover, those who have experienced the world-class standards of a Jakarta five-star hotel know that it can be done.

Perhaps the most original message the report delivers is how much room there still is for the emerging economies to become more globally integrated (which is good for everyone's productivity). By 2060 non-OECD countries will account for three-quarters of world trade.

The promise of convergence was not that every poor country would become rich. Rather, the message was that it was possible to close the gap dramatically. That seems obvious enough now, but that was not the conventional wisdom in the post-World War II decades. Gunnar Myrdal's Asian Drama: an Enquiry into the Poverty of Nations was representative, and deeply pessimistic. The OECD report carries traces of this old-fashioned gloom (look at the title of that first graph above). But it also acknowledges that the path to higher living standards is open for the taking.


Lowy Institute Paper

Debating Beyond the Boom

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'We'll all be rooned,' said Hanrahan, 'before the year is out.'  

Pessimism is a key part of the great Australian tradition, reflecting a history of booms and busts. It has infected the debate on the mining boom of the past decade. But how does it make sense to treat a once-in-a-century windfall of astonishing export prices as if we would have been better off without it? John Edwards' Beyond the Boom provides a much-needed antidote to this pessimism.

It's one thing for business leaders and journalists to put forward attention-grabbing gloom. But the hand-wringing has been shared by high-profile economists with rigorous analysis to back their views. John Edwards addresses this group with a detailed deconstruction of what the minerals boom has brought.

The starting point is an increase in our terms of trade, which is unprecedented in size and longevity. This triggered a four-fold increase in mining investment. Remarkably, these extraordinary changes did not unbalance the macro-economy. The economy grew at around its usual pace, inflation remained low and stable, wages have been restrained, and the current account actually improved.

To make sense of this successful balancing act, Edwards takes us through each of the components of the national accounts: income, expenditure and production. Mining investment increased, taking an extra 5% of GDP. This didn't push production beyond the limits of capacity because about half of this extra expenditure was channeled into additional imports. For the rest, there was some reallocation from other possible uses, particularly through restraint of consumption. The income component of the national accounts shows the background to this restraint. In the decade before the mining boom, households had gone on a spending spree, encouraged by booming housing prices. During the mining boom, they repented and saved, making room for some resources to shift into mining investment. 

Why were households so thrifty when the terms of trade delivered an enormous windfall to the economy?

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There is no doubt that the improvement in the terms of trade gave a huge boost to income, but by and large it was not Australians who benefited. The largest part of the increase in income went as profits to the mining companies, which are four-fifths foreign owned. Of course some went to mine workers, but mining is capital intensive and in any case the workers were wage earners, not equity participants in the huge windfall. Federal company tax on mining companies was limited by the favourable depreciation allowances that the miners were receiving on their huge new investment expenditures. Glencore-Xstrata (our largest coal exporter) has gone further, arranging its affairs so it pays no company tax in Australia.  

This skewed distribution of mining income may reconcile John Edwards' narrative with that of leading academic Bob Gregory. Professor Gregory calculates that the terms of trade increase boosted our income by a whopping 14%. He (and many of the rest of us) worried about what would happen when the terms of trade fell (as was inevitable). But if the greater part of the benefits have gone to the foreign miners, we won't miss what we never had. 

In fact, the terms of trade haven't fallen much so far, so the point has not been tested. But we might take a kind of perverse comfort from this paradox: Australians may have avoided the problem of the well-known 'resource curse' by giving a large part of the windfall to foreigners.

How did we avoid a blow-out of the current account deficit, which usually accompanies a boom? Export prices saved us. We didn't produce much more or export substantially more in terms of volume, but with iron ore and coal both fetching seven times their pre-boom price, enough foreign currency was being earned to keep the deficit from growing. Why didn't the huge profits show up as capital outflow? They did show up in the detailed accounts, but were offset in the aggregate figures as the miners funded most of their new investment by ploughing back their profits.

Edwards is clearly right in saying that things have turned out well enough for Australia so far (what other advanced economy has maintained 22 years of sustained growth?). Looking ahead, our prospects are good. We have ended up with a lot more investment (albeit, still predominantly foreign owned), with much more to come in the LNG industry. Additional export volumes are starting to flow (again, with much more to come from LNG). 

When the miners have used up their depreciation allowances, federal company tax will take around 14c in every dollar the miners produce and state royalties about six cents. Australian workers will receive nearly 20c. Australian shareholders own a fifth of the mining investment, and will get the benefits of this. In total, Australia will end up with around half of the long-term export income stream. 

In addition, we're well placed to benefit from China's ongoing expansion, when exports of high-end food and services (tourism, education, technical expertise) will keep exports growing even when iron ore demand slows. If the terms of trade fall back further (which is quite likely), most of the impact will be felt by the mine owners — mainly foreigners. The exchange rate will depreciate, increasing the competitiveness of non-mining sectors.

That said, could we have done better? And did we make any obvious mistakes? With hindsight, the most serious error was the failure to put in place a resource-rent tax that would capture a large share of the mining boom, as we had done earlier with petroleum and gas.

The belated effort to do so, when the boom was well underway, was an abject political failure. The miners, despite having billionaires as their spokespersons, were able to convince the public that if they were asked to pay a resource-rent tax, they would shift their investment to rival resource-rich countries. Rio Tinto's painful experiences dealing with the governments of these countries (with Simandou iron ore in Guinea, Riversdale coal in Mozambique and Oyu Tolgoi copper in Mongolia) were ignored as the CEO warned us that Australia was his largest sovereign risk. The Rudd resource-rent tax was renegotiated by the former BHP chairman, with predictable outcomes for expected tax revenue. The current government is removing even this feeble tax. Mining royalties, a state government domain, fall victim to special relationships and inter-state competition to attract projects.

If government had been able to get hold of more of the mining revenue, this would have opened up opportunities to address the other sore point of the resources boom: its effect in pushing up the exchange rate to levels uncompetitive for traditional industries, particularly manufacturing. The awkward consequence of big cyclical swings on mining prices is correspondingly big swings in the exchange rate. The Australian dollar was worth much less than 50c in 2001 and well over parity ten years later. An effective resource-rent tax could have funded a sovereign wealth fund (as has been done by many other resource-rich countries), to be used to counter cyclical swings in commodities. Perhaps some could have been put aside to soften resource depletion. The result would have been a lower exchange rate and a more balanced economy; perhaps less investment in mining, and more in a variety of other industries. 

In short, we had more than our share of the luck. We didn't blow the opportunity presented. We did well in macro-management of the boom. With better politics we could have done a lot better, but looking around the world, we've done better than most and we're well placed to keep up the good performance. John Edwards has set out this story with clarity and precision, providing the counter-case to the modern-day Hanrahans chanting 'we'll all be rooned'.

Photo by Flickr user josh.


Sam Roggeveen yesterday showed us how much demand for coal has risen in Asia during this century. Now consider what the future will hold.

A recent joint publication from the International Energy Agency and the Economic Research Institute for ASEAN and East Asia forecasts what is in store for the ASEAN countries  over the next twenty years. The report covers everything from the variation in technical efficiency of burning coal, to fossil fuel subsidies (more than $50 billion a year).

These two graphs show a key message: that there is going to be a lot of coal burnt in our neighbourhood in the next twenty years. The first graph shows how much catching-up the ASEAN countries have ahead of them, starting as they do with per-capita electricity consumption only about one-seventh of OECD countries. As your income gets higher, you consume more electricity. The second graph shows estimates of how this will boost coal consumption much faster than other energy sources, because coal is cheapest.


The long running Argentine debt-default saga has taken another step forward (or backwards, depending on your viewpoint). The US Supreme Court has ruled definitively against Argentina over 'sovereign immunity'. The ramifications, however, go far beyond Argentina.

Although sovereign debt restructuring falls outside the usual bankruptcy laws, a mix of formal and ad hoc processes have in the past facilitated some sort of resolution when countries are unable to repay. The Supreme Court's confirmation of earlier court decisions has brought informal voluntary resolution to an impasse.

Just as couples getting married do not typically plan for divorce and armies do not regularly practice retreats, financial contracts are made on the assumption that things will turn out well. But the existence of divorce and bankruptcy laws demonstrate that contracts do not always work out as hoped and the law must help to resolve the mess. Sovereign debt contracts, however, have no clear legal resolution methods when the sovereign says it can't pay: sovereign immunity restricts the legal recourse of the creditor.

The US courts have lost patience with sovereign immunity. The plaintiffs, a vulture fund that bought Argentine debt cheaply after the majority of creditors agreed in 2005 to a restructure, can now use the normal methods of debt recovery (such as threatening seizure of Argentine assets anywhere in the world) in order to get a better deal, perhaps even full repayment.

The International Monetary Fund, which has been struggling for more than a decade to find a sensible solution for sovereign debt restructuring, had this to say:

In essence, the US courts have interpreted a 'boiler plate provision' of these contracts (the pari passu clause) as requiring a sovereign debtor to make full payment on a defaulted claim (in this case, held by the secondary market purchaser) if it makes any payments on the restructured bonds. As discussed in the 2013 Board paper, the Argentine decisions, if upheld, would likely give holdout creditors greater leverage and make the debt restructuring process more complicated for two reasons. First, by allowing holdouts to interrupt the flow of payments to creditors who have participated in the restructuring, the decisions would likely discourage creditors from participating in a voluntary restructuring. Second, by offering holdouts a mechanism to extract recovery outside a voluntary debt exchange, the decisions would increase the risk that holdouts will multiply and creditors who are otherwise inclined to agree to a restructuring may be less likely to do so due to inter-creditor equity concerns. 

Other commentators have been more explicit on how unhelpful this court decision is:

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This new regime is based on the idea that dealing with a defaulted sovereign will become so risky and expensive that it is simply not worth it. As a result, the country will become a financial pariah, unable to do basic financial business outside its borders. In sum, the decisions leave the prevailing system for sovereign debt management badly shaken.  

It's understandable that Argentina gets little sympathy, and not just from the financial press (which is reporting all this with a tone of glee). The problem, however, lies in the implications beyond Argentina.

Just as individuals default, countries also reach a stage where they can't repay their debts in full. Simply insisting on the 'sanctity of contract' doesn't get us far in resolving the issues. The debt problem is usually as much the fault of the creditor as the debtor — remember all those Euro-periphery bonds that were bought at yields almost the same as Germany's? Sitting down to reach a practicable resolution makes sense. When the clear majority of the creditors have done exactly that, those who come along afterwards to buy the 'hold-out' debt at a heavily-discounted price and then act as if they should be paid in full shouldn't be surprised if they earn the title of 'vultures'.  

The damage is now done. Sovereign debt resolution can't be left in this unsatisfactory state. Europe provides many examples (Greece being the most prominent) of where the outstanding debt is clearly unsustainable and more restructuring is needed.

This presents a particular problem for the IMF. How can the IMF provide funds to rescue a stricken economy if these funds are then used to repay creditors who shouldn't have lent in the first place? A restructure of private debt ('bailing in the creditors') has to be the prior step. The Fund has struggled manfully (actually it was Anne Krueger who did the heavy lifting) to come up with a sensible solution, only to be frustrated by the Wall St proxies on the Fund's executive board.

Despite the large role played by sovereign debt in the 2008-2010 global financial crisis, this issue was not resolved consistently or satisfactorily. It's just possible that the dead-end of the US court decision may be the catalyst that gives the Fund the opportunity to get a sensible restructuring framework in place.

Photo by Flickr user marsmettnn tallahassee.