Lowy Institute

With Greece once again teetering on the brink of default, a recent paper from the Centre for International Governance Innovation explores one episode in the amazing saga of how this tiny country came to threaten the viability of the euro, and left a damaging legacy for procedures and governance at the IMF.

When the Greek crisis emerged late in 2009, many European leaders believed the problems should be resolved within the eurozone, just as a financial crisis in one of Australia's states would be resolved by Australian authorities without calling in the IMF to assist.

But the IMF, after a decade without any major call on its services, was anxious to affirm its raison d'etre. Its then Managing Director, Dominique Strauss-Kahn, perhaps with some personal political motivations, was eager to take a substantive role. The outcome, orchestrated by the powerful European voting faction in the IMF Board, was a key role for the Fund, but also a failure to restructure Greece's unsustainable foreign debt burden (much of it owed to German and French banks). The IMF's participation required it to depart from its own principles, under which it provided assistance only where there was a 'high probability' that foreign creditors would be repaid.

The Greek story is, of course, still unfolding. Despite the 2012 debt restructuring, the current level of  debt is unsustainable and will require further restructuring – a central element of the current impasse.

Meanwhile, the IMF has acknowledged some of the mistakes made in 2010, but the unhappy legacy remains. Having established the precedent of lending to countries which have an unsustainable debt level, Ukraine has also been given substantial assistance. The broad issue of rescheduling sovereign debt, which the Fund has struggled to resolve for more than a decade, remains. Perhaps most important all, this story is a reminder of why governance reform is so vital for the Fund's credibility. 

Photo courtesy of Flickr user Theophilos Papadopoulos.


Forecasts prepared for the IMF's 'Spring Meeting' in Washington last week predict global growth of around 3.5% this year, about the same as in the last few years. This is not the 'slowing' discussed so often in earlier Fund documents, but nor is it the normal robust recovery that might be expected after a deep downturn like the 2008 crisis. 

Larry Summers and Raghuram Rajan, Governor of the Reserve Bank of India, during the 2015 IMF/World Bank Spring Meetings, Washington DC. (Flickr/IMF)

Managing Director Christine Lagarde clearly thinks growth is too slow and that more should be done. Given the constraints on blunt speaking, however, Lagarde's policy message lacks punch: keep monetary policy accommodating; those countries not weighed down by excessive official debt should implement fiscal easing; and, as usual, everyone should implement structural reform.

But the post-2008 recovery has been so feeble that others are talking in terms of 'secular stagnation', the idea that the advanced economies have run out of dynamism and are stuck with chronic slow growth.

This idea was last in vogue in 1938. Rapid post-World War II expansion then took it off the table for a generation, but the slow recovery from 2008 has revived it. Robert Gordon blamed the stagnation partly on slower population growth. More controversially, he asserted that most of the really good ideas (innovations in technology, education and labour markets) have already been put into practice.

Since then a group of heavyweight economists have refined their arguments and policy prescriptions. Former US Treasury Secretary Larry Summers agrees with the idea of secular stagnation, but sees it as a shortage of demand rather than a supply-side limitation. The 'animal spirits' that should drive investment have become dormant. With policy interest rates already close to zero, monetary policy can't do any more to stimulate demand. But, at the same time, these low interest rates open the opportunity for countries (especially America, but Germany as well) to greatly expand fiscal spending on infrastructure, which is woefully run down in both countries.

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Former US Fed Chairman and now avid blogger Ben Bernanke agrees that the problem is deficient demand. While he supports the idea of more infrastructure spending as a short-term palliative, he worries about the longer-term implications for official debt if stagnation is indeed a chronic problem. As an alternative policy prescription, he has enlarged on his earlier view that the demand-sapping problem is global excess saving. Nearly a decade ago, he pointed the finger of blame at China, which supported its domestic economy by keeping its exchange rate artificially undervalued. This promoted exports, boosting Chinese production and income. Most of this boost was saved rather than spent, in the form of a substantial current account surplus.

Bernanke's preferred policy prescription focuses on the ongoing global current account surpluses. He sees this 'excess saving' as resulting from market-distorting policy settings in the surplus countries, which should be corrected. More 'naming and shaming' of foreigners is needed so that they rectify these policies.

How can these ideas be translated into policy?

Even if Bernanke is right about global excess savings (and his own table shows that the global imbalances have dramatically fallen since 2006), there doesn't seem much that policy can do about it. China was an easy target in 2006, but its surplus is now small. Germany isn't ready to do anything about its external surplus, running at over 7% of GDP, and the depreciating euro will actually strengthen its international competitiveness. Switzerland and Singapore (whose external surpluses are far larger than Germany's as a ratio to GDP) haven't even been named as recalcitrants. 

That leaves Summers' idea of greatly expanding infrastructure spending in America, Germany and some emerging economies. But what about the debt concerns that put an end to fiscal expansion in 2010?

Summers and Brad DeLong argue that the hand-wringing about government debt has been unwarranted for most advanced economies (Japan is the notable exception). Investors seem only too happy to take up government debt (Germany's 10-year bond yield is less than one-fifth of a percent; almost free money). They could borrow a lot more, and if they use it for beneficial purposes (some would say that is a big 'if'), it can be self-funding as it adds to GDP as well as to debt. In any case, DeLong argues that as countries get richer, they should have more public debt, because richer consumers want more of the goods which governments supply.

Meanwhile, the financial markets are fixated on something largely irrelevant to the challenge of boosting growth. They are trying to pick exactly when the Fed will raise the short-term policy interest rate, outdoing each other to name the day. All this single-minded anticipation might actually encourage the Fed to repeat the mistake of 1937 by raising rates too early in the recovery (a mistake made more recently by the Swedish central bank). Bernanke says that the rate should be set so as to bring savings and investment into equality at full employment. With all this talk of secular stagnation, the interest-rate rise should be much further off than the markets (or some members of the current Fed Board) are thinking.


Indonesian and Australian journalists were at the Lowy Institute on Monday, once again trying to explain why the press in each country plays such a minor and often perverse role in helping mutual understanding.

The causes are many, but one that deserves more thought is the way China hogs the headlines in Australia. This pushes out other Asian reporting. Once the editor has a couple of China stories, that's Asia covered for the day. Particularly in the financial press, China gets saturation coverage and Indonesia almost nothing.

Some might think this is as it should be, since China is so large and important to Australia. Indeed, China dominates our exports and affects global commodity prices in a way that sets it apart from the rest of Asia. And there is plenty of scope for hand-wringing over security issues.

But there is so little insightful hard news about China that most of these stories repeat what we already know. How many hundred stories have talked about the slowing of the Chinese economy, when all they amount to is that it has slowed from 7.5% to 7.1%, which means nothing given the unreliability of Chinese data? And none of this reporting has any real implication for the reader. Sure, the Chinese economy is important in a general way, but its importance is not changing from day to day. It's hard to get excited over China's inward-looking and secretive politics. Remember those endless articles on the formulaic changes to the Politburo Standing Committee, when the journalists didn't even know in advance when its meetings would be held, let alone what it all meant?

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Indonesia, on the other hand, has a new and amazing story every day, just waiting to be told. Its politics is open, packed full of gossip and fascinating goings-on. And it is possible to find out what is happening. Journalists can travel freely almost anywhere and report without Big Brother threating their visa if they don't stick to the party line.

As for security issues, our future in Asia might well involve vital issues between our two countries, perhaps bringing us closer together or perhaps tearing us apart. We're much more likely to be sorting this out without help from our Great and Powerful Friends, so it will be much more important for the Australian public to have a good understanding of the issues.

This is not, of course, the only explanation for the dearth of Indonesia reporting, and for the unhelpful fixations of the stories that are reported. By all means, let's go on hearing the same old content-free reporting on China, but let's also have a bit more on Indonesia's fascinating story.

Photo by Flickr user Shreyans Bhansali.


Earlier posts have discussed how the Trans-Pacific Partnership (TPP) – if it comes into force – will be part of the process of setting global rules across a wide range of issues, including intellectual property rights. The just-released Harper Competition Policy Review notes the importance of international treaty agreements in this area, and includes the following recommendation:

A separate independent review should assess the Australian Government processes for establishing negotiating mandates to incorporate intellectual property provisions in international trade agreements. Trade negotiations should be informed by an independent and transparent analysis of the costs and benefits to Australia of any proposed intellectual property provisions. Such an analysis should be undertaken and published before negotiations are concluded.

Protecting intellectual property is complex and contentious: it's not just a matter of rewarding people for having a bright idea. The key issue is how to foster innovation, and creating a monopoly through intellectual property protection isn't a first-best answer. Let's hope our negotiators have more guidance than is provided here

If the TPP goes ahead as scheduled, Ian Harper's recommendation will be overtaken by events, at least as far as the TPP goes. Would we pull back from signing if the intellectual property arrangements heavily favour intellectual property-owning countries such as the US? Not likely.

If the TPP goes ahead, we'll have to sign up or be left on the outer. It's not as if we can opt to stay in the old pre-TPP world. Our global environment will have changed and we'll have to go with the flow.

Photo by Flickr user Osbornb.


There has been much fretting about China's growth over the past five years. One special focus for hand-wringing has been the Chinese financial system and its non-banking component – the shadow banking system – in particular.

Financial growth in China has certainly been rapid since 2007, a classic warning of impending trouble. In the decade before 2007, credit grew only a little faster than GDP, reaching 187% of GDP, which is about normal for an emerging economy.

Then China applied a huge stimulus in 2009 in response to the global financial crisis, mainly in the form of easing the constraints on credit expansion. As a result, China sailed through the crisis with double-digit growth. But by 2014 the credit to GDP ratio had risen to 282%, a bit more than Australia or the US and much more than is normal in emerging economies. The shadow banking component led the expansion, growing at 37% annually since 2007.

This issue received special attention in the recent McKinsey Global Institute report on global debt. The Fung Institute in Hong Kong has also recently produced a couple of excellent papers on the topic. 

The shadow banking sector is harder to delineate than the core banking system because its precise size is confused by fuzzy definitions, double counting of some institutions and under-reporting of others. Based on Chinese central bank data, the Fung Institute puts shadow banking assets a little over 50% of GDP, or less than one-third the size of bank credit. McKinsey estimates that the sector is a bit larger.

This is much smaller than the American shadow banking sector, and the Chinese institutions are much less complex.

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In China, as in most countries, the expansion of shadow banking is the result of controls and distortions on the core banking sector which prevent banks from meeting the needs of savers and borrowers. They take their unsatisfied financing requirements to the informal financial sector, which expands to meet these needs. Depositors left the banking system because government controls made the interest return unattractive for savers. Borrowers went to the shadow banking systems because banks would not give them loans, or offered only unattractive short-term funding. 

With this in mind, the rapid expansion of the shadow banking system should be seen as a phase in the ongoing development of China's finances. There are benefits as well as dangers.

The answer is not to shut it down, but to develop the benefits and minimise the dangers. In the pre-2007 world, much of China's enormous savings ended up funding the expansion of state-owned enterprises, with this investment (or over-investment) becoming less and less efficient over time. Private sector enterprise (the dynamic element in the economy) was starved of funds, receiving only 20% of bank credit. 

The growth of the shadow banking sector is the transitional means for correcting this – imperfect, but a step towards a better financial system.

An efficient financial system provides finance across the full range of risks, offering safety for risk-averse depositors while also offering high-risk funding for the most dynamic entrepreneurs. The shadow banking sector's proclivity for excess and mindlessly low credit standards (also demonstrated in America and Europe in the period leading up to the 2008 crisis) needs to be reined in while at the same time retaining the dynamism and flexibility. Finding the right balance for the less-regulated non-bank institutions is a challenge for financial policy-makers everywhere, not just China.

So is this a worry?

China's central government has the resources and administrative capacity to prevent a serious macro-economic financial crisis. The central government starts with modest debt levels – 27% of GDP. Even if it had to absorb the losses envisaged in McKinsey's most extreme disaster scenario, this would take official debt up to around 75% of GDP – less than in most advanced economies. Many borrowers also have substantial deposits to offset against their liabilities. While there are substantial credit risks in the housing industry (property developers and builders), most homeowners have little or no debt.

China's huge foreign reserves are not available in any substantive way for domestic financial problems. But these reserves (and the current-account surplus) ensure that China cannot be affected by the flight of foreign money that made the 1997-98 Asian crisis so disastrous.

All that said, it is quite possible, even likely, that there will be numerous bankruptcies (a property crash would be serious, as McKinsey estimates that housing-related credit accounts for 40-45% of lending). The central government would have to bail out some local governments (it has already begun taking over small amounts of their debt). As well, the links between shadow banking and the mainstream banks would precipitate balance sheet strains for the banking system. 

Financial history tells us that countries which undergo financial deregulation always experience a crisis, to a greater or lesser degree. In China, the deregulation is taking place in a carefully staged fashion. But policy-makers can make mistakes. Markets can lose confidence and growth can be knocked off trend. China's low official debt, substantial government ownership of banks and enterprises, and enormous foreign reserves don't give it immunity from financial troubles, but they do mean that when things go wrong, they can be fixed with less disruption and quicker bounce-back. A Chinese 'Lehman moment' still seems unlikely.

Photo courtesy of Flickr user Sharon Hahn Darlin.


The 2008 global financial crisis provided a rare test-bed for macroeconomics — an opportunity to sort out some old controversies. One issue dominated the debate during the recovery phase: with national budgets and official debt pushed up by the crisis, should budget austerity be imposed as a matter of priority to reduce debt levels?

In this debate, the UK was seen as the clearest test-case — described by one observer as a 'laboratory rat.' The latest UK budget provides an opportunity to evaluate the test, and ask whether it is relevant here in Australia.

Some of the deficit and debt growth in the crisis-affected countries came from the need to bail out collapsing financial sectors. But the larger and more persistent factor was the sudden and sharp fall in GDP, followed by a lacklustre recovery.

In 2009, in the immediate aftermath of the shock, global policy-makers were unanimous in agreeing that automatic stabilisers (the budget components which automatically respond to soften the effects of the cycle, such as higher unemployment benefits and lower tax takings) should be allowed to take budgets into larger deficit. The G20 gave its seal of approval. So far so good.

Then, around the end of 2009, the Greek debt crisis arrived.

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Policy incompetence in a country smaller than the state of Victoria set off a market panic in the European periphery that focused global policy attention on official debt levels everywhere. Fears of Greek insolvency were translated into global insolvency concerns. The three most influential global financial institutions – the IMF, OECD and Bank for International Settlements – all strongly urged budget austerity focused on getting government debt down.

Some academics argued that if debt tipped over a critical trigger level (just a bit higher than where many countries found themselves), economic growth and recovery would collapse. Others revived an arcane view that budget austerity would actually be expansionary, with austerity boosting confidence so effectively that private sector expansion would outweigh the budget contraction. Economist-blogger Paul Krugman dubbed this the 'confidence fairy' effect.

Indisputably, the European periphery (Greece, Spain, Portugal and Ireland) was in such deep trouble that severe budget austerity was necessary, no matter how painful. But everyone joined in. Abruptly and universally, budgetary policy switched from supportive to contractionary.

The UK was the prime test-case for this new wisdom.

The newly-installed chancellor of the exchequer, George Osborne, endorsed the 'expansionary austerity' mantra. Certainly, the budget deficit was alarmingly high, temporarily inflated by the cost of bailing out the UK's bloated global banks. Undoubtedly, there was fat in the budget which would, at some stage, have to be trimmed. The critical question, however, was the pace of budgetary reform. Was it better to go 'cold turkey' (including raising the VAT — the equivalent of our GST — and cancelling infrastructure projects), or support the recovery while committing to make structural reforms in more favourable times? 

We can now judge this experiment. The taut austerity was maintained for 2010 and 2011, in which time the UK economy stagnated in the trough of the cycle. A good recovery started in 2013, but it was only at the end of 2014 that UK GDP returned to where it had been in 2007, before the crisis. The current budget has set off a strident argument over whether living standards have in fact returned to pre-crisis levels

This belated recovery has been taken by some (not least the Chancellor) as a vindication of austerity. But what about the seven years of lost potential output? Even with the strong recovery, GDP is 16% below the medium-term growth trend. Unemployment is down, but productivity (the source of rising living standards) has stagnated. Was this the best that could be done? 

More damaging for the 'expansionary austerity' theory, the UK had already departed from its planned path of budget austerity by 2012, pushing back the target for budget balance. The latest budget pushes it back even further; three or four years later than originally planned. The structural budget balance has hardly changed in the past two years.

The recovery should be linked to this easing of fiscal austerity, rather than be seen as a vindication of the initial harshness. Nevertheless, the Chancellor's hair-shirt rhetoric remains unchanged even in the current budget. To do otherwise would raise the question of whether the initial pain was really necessary after all.

Budget austerity has also seriously distorted monetary policy.

The initial hope for UK growth was that fiscal austerity could be balanced by abnormally accommodative monetary policy – near-zero interest rates and huge quantitative easing. But monetary policy is a weaker instrument than fiscal policy, and couldn't offset the budget contraction. The long period of low interest rates has eroded pension incomes and given misleading price signals to investment. Quantitative easing has distorted bank balance sheets, weighing them down with unwanted excess liquidity. Macro policy has been seriously out of balance. Yet in international discussions, some hold up the UK experience as an enviable model. Even here in Australia the new Treasury Secretary, John Fraser, called the UK austerity policy a 'clear success'.

The UK experience seems to confirm some old lessons: when you tighten the budget, the economy slows; the 'confidence fairy' is still imaginary; and there is no painless schedule for structural budget reform.

Photo courtesy of Flickr user Number 10.


Should Australia join the Chinese-sponsored Asian Infrastructure Investment Bank (AIIB)? As often happens in international affairs, the answer is not found in the technical pros and cons of the proposal, but in the politics.

America seems to have strongly encouraged its close Asian friends (Japan, South Korea and Australia) not to join, concerned about China's growing influence in Asia. But now that the United Kingdom has decided to become a founding member, the pressure is on the hold-outs to sign up. 

There is no doubt that Asia needs much more infrastructure; that China has a lot of experience at building it; and that China has massive savings to help fund it. There is no doubt, too, that there would be some overlap with the World Bank and, perhaps more obviously, with the Asian Development Bank (ADB).

The AIIB does raise some questions. Would some competition between rival funding institutions be helpful? Would this new channel add to the resources going into infrastructure, or just re-channel the same funds? Is Australia more effective in improving AIIB governance by joining in from the start or by playing hard-to-get?

To start, the AIIB is just one more example of devolution away from the centralised global economic institutions created at Bretton Woods in 1944 and towards a more regional framework. The establishment of the Asian Development Bank in 1966 was an early example. The devolution process in Asia was given a huge boost by the Asian financial crisis of 1997-8. Many policy-makers in the region still hold the view that the IMF failed to understand the crisis, and from then on, they realised they should work to build regional institutions.

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Japan's attempt to create an Asian Monetary Fund in 1998 was vetoed by America (China also resisted). Since then, the Chiang Mai Initiative has encroached on IMF territory, although it has yet to demonstrate operational capacity. Regional groupings such as ASEAN have become stronger, and regional networks have established close personal relations between officials across a wide range of disciplines and levels. For the most part, these regional institutions have been slow developers (it's hard to see the Chiang Mai Initiative Multilateral (CMIM) becoming an effective rival to the IMF), but much of the interaction is now at a regional level. 

There is a powerful case for subsidiarity – pushing responsibility down to the lowest level practicable. Differences between the globe's regions are substantial, so regional knowledge and region-specific policies matter. Countries are also more likely to come to the assistance of neighbours. The Washington-based institutions have become top-heavy, weighed down by the need to placate universal representation. Rules imposed in response to specific problems are often applied globally.

The region already has the ADB. Does it need the AIIB, the BRICS New Development Bank and the Chinese New Silk Road initiative? Probably not. But Japan continues to monopolise control of the ADB (where Japan and the US each have voting rights well over twice as large as China's and the president is always a Japanese). The US dominates the Washington institutions, with the American Congress preventing even modest governance reforms at the IMF.

Given this ossified and unwelcoming environment, China's search for alternatives is inevitable. 

Rather than lobbying its allies to oppose the Chinese initiative, the Obama Administration might remind Congress of the cost of its recalcitrance. As for Australia, the answer on the AIIB is now obvious. New Zealand has decided to join. Will they, once again, get ahead of us in regional ties?

Photo courtesy of Flickr user Asian Development Bank.


This week the IMF Executive Board will consider a proposal to provide Ukraine with a US$17.5 billion Extended Fund Facility. The IMF Managing Director explains that this program 'can succeed'. But it has to be said that the chances are low, given current geopolitical circumstances and Kiev's recent economic performance. 

IMF Managing Director Christine Lagarde delivering a statement on a financial stand-by arrangement for Ukraine, 30 April 2014.

Why, then, is the Facility almost certain to be approved by the Executive Board?

The short answer is that no one has offered a viable alternative. Is the geopolitical clash for Europe's borders going to be lost because Kiev can't fund its budget? Will the battle be lost for want of a nail? The economic problems of Ukraine have  been shoved over to the IMF to sort out as best it can.

In April last year, the IMF provided Ukraine with a US$17 billion Stand-by Arrangement, around US$4 billion of which has already been disbursed. The current IMF proposal is that this should morph into an Extended Loan Facility (ie. a four-year loan rather than short-term support), which would form part of a bigger assistance program including contributions from other multilateral agencies, bilateral government lenders and debt relief from creditors. All this is envisaged to add up to a package of around US$40 billion – not yet agreed, but confidently expected.

The geopolitical environment gets a mention in the Lagarde statement ('And yet, while this is a comprehensive and strong program, it is also subject to high risks. The main risk, of course, relates to geopolitical developments that may affect market and investor confidence') but only to say that everyone hopes it will all work out for the best. Yet anyone watching the evening news might conclude that the war is not going well and has no prospect of early settlement.

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Meanwhile, back on Ukraine's home front, the economic outlook is parlous. GDP fell nearly 10% last year. Budget austerity has brought the 2014 deficit down to 4% of GDP on IMF calculations, but if the cost of bailing out the domestic banks and state enterprises is counted, the figure would be 13.5% last year and nearly 9% this year. Getting the budget into surplus won't be popular. The price of gas and heating oil has been raised but is still only around half the world-market price, with more consumer pain ahead with plans to bring it up to market parity by 2016.

Public servants are being asked to trim their pensions (currently absorbing 16% of GDP) and work longer. The current account deficit is 5% of GDP and foreign exchange reserves are minimal. Inflation is running at nearly 30%. The newly flexible exchange rate, which fell 45% after the fixed rate was abandoned last year, has lost a further half of its value this year and has fluctuated wildly. Bank depositors are shifting into foreign currency when they can do so. Foreign creditors are asking for repayment, with the largest, Russia, unlikely to cooperate with debt relief. Kiev was forced by the EU to make a US$3.1 billion disputed arrears payment to Gazprom late last year so that Gazprom would not cut gas deliveries to the EU.

But what else can the Fund do other than 'whistle in the dark', hoping that things might get better while continuing to provide money to keep Kiev operational? Who else would offer to step in if the Fund wasn't ready to do the job?

All this is the political reality of international agencies' governance. The Fund is wheeled out by the major members to stop-gap whatever economic shortfall occurs, especially if the problem country is 'strategic'. The amount involved here is smaller than that for Greece in 2010 (where the Fund was dudded for US$30 billion), but is a much larger proportion of the overall support package. With no agreed procedures for sovereign debt rescheduling (thanks to Wall St's self-interested reluctance to change the messy status quo), the Fund's money will defer indefinitely the reality that creditors should be bearing the main burden of the external shortfall.

In all of this, the Fund has to preserve some semblance of its principles: that it only lends where it has good prospects of being repaid, and that it doesn't lend new money to bail out old creditors. It does this by rose-tinted optimism about how things will work out. In the process, its reputation for professional economic advice gets chipped away. And in order to preserve some modicum of its traditional function, the Fund imposes a standard reform agenda on Kiev that may well be inappropriate for a country with its back to the wall.

Photo courtesy of Flickr user International Monetary Fund.


The Trans-Pacific Partnership (TPP) is close to the make-or-break stage. It will either get US Congressional blessing soon or lose momentum and slip from the agenda. So it is surprising how little public debate there is in Australia about its important ramifications. For an excellent exception, see Peter Martin.

Trans-Pacific Partnership discussions on the margins of the APEC Leader meetings in Bali, Indonesia, 2013

How did Australia go from being a leading exponent of multilateral trade to being ready to sign a preferential trade arrangement universally acknowledged to be inferior to the WTO's multilateral model?

The short answer is that the global trading environment has shifted. The WTO is in stasis. The only path forward seems to be either multilateral agreements with very limited subject coverage (like the Bali agreement), or 'coalitions of the willing' – agreements between a smaller number of countries who are often regional partners. And then there are bilateral free trade agreements (FTAs) such as the ones Australia has recently signed with China and with Japan. These contradict the multilateral spirit of the WTO. Exporters are happy to get access to a new market, but FTAs may divert imports from the cheapest foreign supplier by giving preference to the FTA partner. Certainly the plethora of bilateral FTAs is a sub-optimal outcome.

An alternative method could be multi-member plurilateral agreements that would bundle up the relevant FTAs and enforce consistency in their conditions. With more members, there is less trade diversion. The ASEAN-based Regional Comprehensive Economic Partnership (RCEP) is an example.

But the TPP represents a different model again, one which aims to impose a set of consistent rules (especially 'behind the border' rules) on the participants. 

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Arrangements like the TPP can have a particular negotiating dynamic which helps overcome some of the deficiencies of bilateral FTAs. Sensitivity over issues such as agriculture and services could succumb to majority peer pressure. The 'noodle-bowl' of divergent rules-of-origin might be made uniform. The narrow trade focus of the bilateral agreements might be broadened to include 'behind the border' issues, as envisaged in the TPP.

Some progress is better than just lamenting the failure of the WTO, and these arrangements won't prevent greater multilateralisation later. It's possible to envisage the TPP and RCEP merging to form the APEC-based Free-Trade Area of Asia and the Pacific (FTAAP). That would overcome one problem with the current negotiations: the biggest trading nations – America and China – don't share a common agreement. If the Transatlantic Trade and Investment Partnership goes ahead between the US and Europe, there may even be a parallel arrangement with similar rules.

Thus it's easy to understand how Australia has moved over time from being one of the most energetic players in the GATT/WTO framework to actively seeking bilateral FTAs and participating in both the RCEP and TPP negotiations. To stay faithful to the multilateral ideals would have seen us lose competitive advantage (for example, to New Zealand with its hugely successful FTA with China). There are political considerations too: RCEP serves Australia's regional objectives, and the TPP supports our relationship with America. 

That said, the wide-ranging rule-making aspect of the TPP raises some issues. Are all these rules in our interests? One of the few things economists agree on is that multilateral trade openness gives advantages to all participating countries. The TPP's rules, on the other hand, may advantage one country over another.

Who writes the TPP rules? You might think that the rules of the lofty 'platinum-standard' TPP would be hammered out by a group of high-minded technocrats, with the world's collective interests as their priority. 

Unfortunately, this is not so.

Proposals on intellectual property, for example, reflect the vested interest of pharmaceutical manufacturers who want longer patent protection. Hollywood (famous for engineering the Mickey Mouse Protection Act giving Walt Disney products a century of royalties) will undoubtedly influence the outcome. Our main hope is that there will be some counter-balancing vested interests (perhaps in Silicon Valley). There may even be some salvation in the voice of public advocacy, arguing for shorter protection to allow cheaper generic drugs to reach the US market more quickly, though vested interests are usually better funded than public advocates.

Bilateral horse-trading has also found its way into the TPP process. Japan was a late joiner in the negotiations, but politics in both Japan and the US strongly support Japan's entry (joining would strengthen Prime Minister Abe's 'third arrow' – structural change). These side deals, however, make the net balance of advantages harder to assess.

One element that was initially resisted by Australia was an investor-state dispute settlement chapter. Our opposition to this sort of sovereignty-overriding measure was strengthened by Philip Morris' attempt to resist Australia's world-leading anti-smoking measures, though our attitude has apparently softened. Given the issues ahead on climate change and the environment, we may well want to introduce laws which foreign investors will see as disadvantaging their Australian enterprises (restrictions on the use of brown coal might be an example). An investor-state dispute settlement mechanism could make it harder for Australia to introduce such measures.

If the peer-pressure dynamic of plurilateral agreements often fosters progress, this can also work to our disadvantage if our interests have been overridden. Just as we had no choice (for political reasons) but to sign off on the Australia-US FTA, not signing up to the TPP if it is finalised would be an admission of failure at the political level. We'll sign on, even to a disadvantageous treaty.

While there are good reasons for conducting these negotiations behind closed doors, the general principles of our approach shouldn't be secret. What issues do we feel strongly about? What do we have to give away and what will we win in return? We need more colour than can be found here. With an agreement possibly imminent, we need a public discussion to let the broader community judge whether this looks like a good deal. Time for a detailed speech from Trade Minister Andrew Robb.

Photo courtesy of Flickr user US Department of State.


Leon Berkelmans is in good company in defending the policy actions which have come to be described as 'currency wars'. 

Ben Bernanke gave the same defence of the US Fed's actions while he was Chairman: while low interest rates and 'quantitative easing' (QE) may give the domestic economy an extra competitive advantage via a lower exchange rate, the whole world really benefits because of the extra growth in the domestic economy.

You could argue that the proper post-2008 settings for macro policy in the US (and other advanced economies) was to have less austerity (or better still, actual stimulus), rather than relying entirely on monetary policy.

Fiscal policy gives a more direct and powerful stimulus at the trough of the cycle without depreciating the exchange rate, while monetary policy is feeble in these circumstances. The extreme monetary settings (near-zero policy interest rates and huge excess central bank liquidity), while giving an abnormal boost to international competitiveness, distorted the longer-term price signals for both investors and savers.

QE was a desperate effort to compensate for recovery-sapping fiscal austerity, which was itself a product of political failings and serious macro policy misjudgments. QE might have been an admirable second-best policy, but it was still 'beggar-thy-neighbour'. 

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In any case, the 'currency wars' debate in the global setting has moved on.

Brazil, the leading complainant, has other more serious economic problems of its own making. India, whose central bank governor gave the most cogent criticism of the US depreciation strategy, is now recording the fastest growth of any major economy (quiet, sceptics!). And the US, whose QE set off the debate in the first place, is now in a stronger phase of the cycle, with its exchange rate substantially appreciating in the process.

The debate is not totally dead, however. It has reverted to an earlier phase, where US industry lobby-groups (and Fred Bergsten of the Peterson Institute) are once again targeting China's comparative advantage. The industry groups are insisting that a 'currency manipulation' chapter be included in the Trans-Pacific Partnership (TPP) treaty soon to be debated in the US Congress. 

To say the least, this is inconvenient for the success of the finely balanced TPP deliberations.

The attempt to include such a chapter is inappropriate, as it trespasses on the International Monetary Fund's territory. Moreover, at this late stage in the negotiations it would probably doom the whole exercise to failure. In any case, China has also moved on. With large capital outflows rather than inflows, its exchange rate is under downward (not upward) pressure against the greenback and its intervention is to support the renminbi, not to keep it from appreciating.

There are those as well who would turn this proposed amendment against its instigators. They would have a credible argument that the US itself was a 'currency manipulator' in the post-2008 recovery period, with the exchange rate held down by seriously imbalanced 'beggar-thy-neighbour' macro-policy settings.

Photo courtesy of Flickr user Tim Evanson.


Mike Callaghan reminds us that where we are on the global GDP ranking may not be all that important to how well we live. When the press tries to dramatise the relationship between global rankings and our prospects of keeping a place at the G20 table, there is another point to be made: G20 membership is not just about size of GDP (however measured).

Look at PwC's list of 20 biggest-GDP countries in 2050 and ask yourself whether this would be the best group to sort out global economic issues:

When the original G20 grouping was formed in 1999 among finance ministers and central bank governors, there was a lot of elbowing and shoving from countries which were surprised to be excluded (Spain and Holland come to mind). The case for Australia’s inclusion was not just about GDP (where we were marginal, even then), but on the contribution Australia could make to the new group, consciously structured to represent a newer look for global governance. Was it better to have an Asian-focused new-world country with a successful economy (which had just shown itself to be a useful player in the Asian crisis), or yet one more European representative of the Old Order?

If we see value in staying in the G20, how do we ensure that we are such a valuable member that there will be a quorum to retain us? Let's tick off a couple of examples already clocked up. First off, we ran a good show when it was our turn as G20 chair. Second, our sterling performance as chair of the UN Security Council was widely noted.

If G20 membership depends on GDP, we know we've lost already. If we want to be there, we've got to work to ensure that it is about much more than GDP.


The press is making much of the academic qualifications of Greece's new finance minister, Yanis Varoufakis. His specialisation is economic game theory, which in this case might be described as 'the art of bargaining'. Good bargaining skills are, indeed, important. But there are also some basic realities that can't be altered by the skill of the bargainers.

The first of these is that Greece has more official debt than it can ever hope to pay back (175% of GDP). But there is no realistic prospect that this debt can be written off (or even written down to a manageable figure) in the current negotiations. The second basic fact is that all parties to the negotiation would rather Greece continue as part of the euro, because 'Grexit' would be a disruptive mess.

These basic realities should define the logic of the negotiation. First, the repayment should be pushed even further into the future and the interest burden should be trimmed. Second, there has to be a continuation of 'conditionality', the reform requirements that keep Greece's 'feet to the fire'. But this has to be calibrated to the needs of economic growth, not as a punishment for debt recalcitrance.

To settle the details around these basic realities and the semantics of any agreement, a bargaining 'game of chicken' is underway. This is where game theory might be relevant. The negotiator who is most willing to go to the edge is likely to get the best deal on the details. But there is a chance that he will take the negotiations over the edge, leaving him with the blame for ending up where no one wants to go.

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Politics provides the dynamic energy for this game of chicken. New Greek Prime Minister Alexis Tsipras has promised his electorate that he would get a fundamental resolution of the debt, not a simple extension. He promised, too, that the fiscal stranglehold will be eased. 

The current negotiations might be seen as the preliminary rounds, with each contestant feeling the other side out for weaknesses. But at some stage soon both sides need to acknowledge that there is room for a satisfactory outcome short of Grexit.

The Greeks need to understand that they can't take the terms of their electoral victory as the immutable basis for renegotiation. One of the required skills of successful politicians is knowing how to get away with breaking electoral promises. For their part, those European countries (like Norway Finland) that focus on the sanctity of debt should understand that this debt is not worth anything like its face value. If the negotiations do go over the edge, the creditors won't get much back. 

When the parties get down to the detail, they will find numerous embellishments which both sides can count as 'wins'. 

First, the debt extension. Even though there is no chance of a definitive solution, several important improvements could be made. The interest burden could be trimmed (it is already quite manageable, at around 2% of GDP). This might best be done by the Europeans taking over the IMF share of the debt, replacing it with the cheaper lending which the European Financial Stability Facility provides. This would make amends for the way the Europeans conned and ramrodded the Fund into providing its share (12% of total debt) in the 2010 rescue, totally contrary to the Fund's sensible principle that it shouldn't lend when there is no good prospect of being repaid. And when the debt is written off at some later stage, it will also address the awkward fact that another sound IMF principle will have been transgressed: that the Fund's lending, provided in the midst of a crisis, should have priority over all other creditors.

It would also have a big cosmetic presentation benefit for the Greeks: the overbearing troika (IMF, European Central Bank and European Commission) would be disbanded, to be replaced by a single task-master.

How tough should the reform conditionality be? The current debate needs to be shifted to a more realistic level. A healthy and growing Greek economy would be the best outcome not just for the Greeks, but for the other Europeans who will get more back when the debt eventually comes to be trimmed to a manageable size. 

So the central question is: what fiscal stance will maximise Greek growth over the next decade or so? There will be no clear-cut answer, but at least we won't waste too much time wishing that the Greeks were as stoic as the Latvians, who cut their budget deficit by 8% of GDP in a single year. There will be many detailed instances where the external pressure will actually help the Greek administration do the things it knows it has to do, but which are fiercely opposed by domestic vested interests.

When it comes time to package whatever agreement is reached, a pretty good story can be told of the Greek reform process (see these six graphs). The missing part of the narrative so far is an economic recovery. The Greek basic budget (ie. excluding interest) is now in surplus thanks to painful cuts. Now to get on with the harder structural reforms, such as selling some government assets.

Photo courtesy of Flickr user Day Donaldson.


The 2008 financial crisis left no doubt that ill-considered debt can cause major damage not just to an individual country, but to the global economy.

You might think that by now, six years later, balance sheet repair would have taken debt below pre-crisis levels. However, debt burdens are substantially greater in almost all countries. McKinsey's latest analysis, Debt and (Not Much) Deleveraging, captures this reality.

Global debt has grown by $US57 trillion since 2007, raising the ratio to GDP from 269% to 286%. The ratio has increased in all advanced countries, although this average hides some big variations (such as Japan and Spain, with over 500% and 400% respectively).

Financial sector leverage has grown slowly and even contracted slightly in the crisis countries, simplifying the multiple layerings of debt that proved so fragile in 2008. Offsetting this improvement is the dramatic expansion of government debt, boosted by the 2008 financial bail-outs, fiscal stimulus in 2009 and the impact of the slow recovery on budgets. Reversing this rise in government debt would require Herculean budget austerity, amounting to 3-4% of GDP in Japan, Spain and Portugal, and not much less in France and the UK. Deleveraging would not only present a mighty political challenge, but would further dampen current feeble global economic growth.

Household debt has fallen in some of the financially troubled economies (US, UK, Ireland and Spain), in part as a result of default and rescheduling. Elsewhere, it has risen, including in Australia, which is high on global rankings.

All this looks pretty worrisome. But this is not the first time the panic button has been pressed on global debt, and last time it was a false alarm: Reinhart and Rogoff claimed that there was a critical cut-off point for sustainable government debt. It turned out their data didn't support the claim.

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Any simple debt rule will mislead (this was Reinhart and Rogoff's main sin, not the careless use of data) but it's indisputable that debt is rising quickly and more debt creates vulnerabilities. But we need to go behind the aggregate figures to see why debt has risen and where the greatest dangers lie. 

More leverage was part-and-parcel of the process of financial deregulation which began in the 1980s, a desirable process that opened up the benefits of borrowing to a wider community. For example, American household debt has risen from 15% of income just after World War II to nearly 100% today because the financial sector now does a better job of meeting households' legitimate needs. But sub-prime lending to NINJAs ('no income, jobs or assets') was not a necessary part of financial development. The 2008 crisis was a failure of prudential supervision and a misplaced faith in the self-regulating capacity of financial markets.

Simple debt/income ratios are a misleading indicator of risk when borrowers have sound assets to match their debt. Governments which use their borrowing to fund useful infrastructure will be in a better position than those which borrowed to fund pensions and welfare (or, for that matter, to rescue failing banks). High leverage based on real estate collateral will be safe unless there is an unsustainable asset-price boom. When the debt belongs to high-income borrowers, high debt-servicing ratios are sustainable.

In short, inter-country comparisons are no more than a starting point in risk analysis.

Similarly, government debt has to be put in context. It's true that Japan would need to shift its budget dramatically towards surplus to get its stratospheric debt ratio down. But much of the debt is held by government institutions (including by the Bank of Japan) and most of the rest is held by stable domestic investors.

The McKinsey report provides a specific example of the benefit of case-by-case detailed study: China.

China refutes the idea that debt has to grow quickly in order to stimulate growth. In China's double-digit growth decades before 2007, debt grew slowly and remained tiny. It has accelerated sharply in the slower-growth period since 2007, so rapidly as to raise universal concern. Even though its total debt in not high as a percentage of GDP, China is probably headed for some uncomfortable financial fall-out: most countries have had some kind of financial crisis during the phase when the embryonic financial sector was growing fast to catch up to the real economy. 

The issue is not whether China has potential financial problems. It's whether it can sort them out without a significant crisis. On the positive side, the biggest banks are state-owned, making bail-out easier. There are no foreign-debt concerns. The central government is not heavily indebted, and could absorb significant  losses. There is still room for substantial urbanisation and upgrading of the housing stock as incomes grow. On the negative side, local governments seem difficult to discipline. At some stage, the grossly abnormal pace of housing construction will have to slow dramatically as the stock of housing comes to match the population's need and the catch-up phase thus draws to an end.

Above all, the McKinsey report reminds us how little we know about the links between debt and economic performance. Japan operates with an apparently unsustainable level of government debt. Denmark operates successfully with mortgage debt three times the global average. Singapore is almost at the top of the debt list but isn't a concern.

We don't have much of an analytical framework. We know that the 'zero net debt' view (additional expenditure by borrowers is cancelled out by lenders' reduced expenditure) doesn't capture the reality, but we can't tie down the relationship between debt and spending. We know that more debt makes a country more vulnerable to cyclical excesses and disruptive reassessments, just as more international trade makes a country more vulnerable to the vicissitudes of global trade. But being able to borrow and lend — shifting purchasing power from those with no immediate spending requirements to those with productive opportunities — ought to make the economy work better.

We don't know what a safe level of debt for governments or households might be, and if we did, we don't know how to enforce such limits while keeping the economy fully employed. Few of us saw the 2008 crisis coming. The one thing we know for sure is that we won't see the next one beforehand.

Photo courtesy of Flickr user epSos.de.


In the decades leading up to the 2008 financial crisis, international trade typically grew much faster than GDP.

This reflected increasing global economic integration: tariff barriers were coming down, trade groups (eg. the eurozone, NAFTA, ASEAN) facilitated trade through regulatory simplification, costs of international transport fell with containerisation and bulk shipping, and the supply-chain revolution spread production between countries. 

But since 2008, international trade hasn't (quite) kept pace with GDP growth.

It doesn't seem to be just the disruption of 2008 and the slow recovery, as growth during this period was much the same as in the two decades before 2000. Maybe the fast growth of trade reflected a series of one-off institutional changes and trade agreements: the formation of the European Community, NAFTA and China joining the WTO in 2001.  

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Perhaps it's unrealistic to expect trade to go on growing appreciably faster than GDP forever. When Thomas Friedman's 'flat world' arrives, or the Japanese 'flying geese' finish taking most manufacturing production to cheap-labour economies, there will no longer be a reason for trade to grow faster than GDP.

Whatever the reason, the slow growth of trade is unhelpful for the global recovery. There is still the chance that America's 'platinum standard' trade deals, like the TPP and TTIP, will come to pass and provide big boosts to global trade.

But one other indicator suggests that the momentum of global economic integration is running out of puff. Foreign direct investment has grown more slowly recently than earlier in the century.

Again, it may be that the 'low-hanging fruit' was picked in the early decades of integration, but the benefits of integration are far from over.


When the IMF produced its last World Economic Outlook in October, one of the risks it forecast was a possible oil price increase. A US$25 per barrel increase, the IMF said, would take at least 0.5% off global economic growth.

Now, even with the change in oil price twice as large and in the opposite direction, the IMF has once again revised its growth forecasts down, trimming 0.3% off global economic growth this year and next.

These persistent downward revisions to the IMF's forecasts (see Box 1.2 here) always hog the headlines, with their melancholy message that things are worse than we thought. But the commentary should do more than focus just on the downward revisions to the forecast numbers. The forecasts should also be put in the context of what has already happened during the recovery phase since the 2008 crisis, summarised in this table:

Table cites fourth-quarter growth rates rather than year-on-year growth, to better reflect of the shape of the cycle.

The post-2008 recovery started well enough, with worldwide fiscal stimulus boosting growth in 2009 and 2010. But the 2010 Greek crisis triggered widespread angst about excessive government debt. Fiscal stimulus was replaced by austerity.

Instead of the above-average growth normally associated with a recovery (the US, for example, typically records around 5% growth after a recession), growth in the advanced economies was anaemic. Overall global economic growth was, however, maintained at a reasonable pace by the continuing good performance of emerging economies, which grew three to four times faster than advanced economies.

So, this is not a story about a slowing global economy, either in recent years or in the forecast: global economic growth has started with a '3' for the past three years and in the two years that have been forecast. Instead of talking about forecasting failures, the theme should be why this recovery — both in the recent past and in the outlook — has been much less vigorous than usual, with the advanced economies stuck in a rut.

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So why is world GDP below trend and growing slower than normal?

(Source: Min Zhu, 'Unlocking Global Growth', International Monetary Fund)

Any explanation has to acknowledge the policy failures of the past six years: the mistaken switch from stimulus to austerity in 2010; the failure to reschedule adequately the unsustainable peripheral debt (Greece, Spain, Portugal, Ireland and Italy); the European Central Bank's ham-fisted monetary performance; and the lost opportunity to use the sustained period of low interest rates to tackle widespread infrastructure inadequacies. 

But recessions don't last forever. Eventually balance sheets are repaired; old equipment needs replacing and housing over-investment is taken up. The fiscal austerity (which took 2% off European growth in  2011 and 2012 and the same off US growth in 2012 and 2013) has now run its course. The ECB has finally agreed on some quantitative easing-style stimulus. The downward cyclical phase in the European periphery has found a turning point, with even Greece and Spain registering some growth (from a miserable starting point 25% below the 2007 GDP level). And the global oil price is down more than 50%, which the IMF says, taken by itself, would add 0.3-0.7% to global economic growth.

This might be the moment to call an end to the repeated downward revisions to growth forecasts, and take a punt on global economic growth being a bit stronger (this year and next) than the new IMF forecast predicts.