Lowy Institute

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.


The Wall Street Journal:

China's economic growth slowed to 7.4% in 2014, downshifting to a level not seen in a quarter century and firmly marking the end of a high-growth heyday that buoyed global demand for everything from iron ore to designer handbags. The slipping momentum in China, which reported economic growth of 7.7% in 2013, has reverberated around the world, sending prices for commodities tumbling and weakening an already soft global economy.

Predictions of China economic slow-down have been routine headline stories over the past few years. Judging from this Wall Street Journal reporting, it seems to have returned with a vengeance. But it is seriously misleading.

China's 'high-growth heyday' ended in 2007, when two decades of double-digit growth were punctured by the global financial crisis. An enormous fiscal and financial stimulus in 2009 temporarily took growth over 10% again, but this was unsustainable. For the pasts three years, China's growth rate has started with a '7'.

Anyone putting much weight on the decimal figure misses the point. At the current pace, China is doubling its GDP in less than a decade, is growing at over twice the US pace and 10 times as fast as Europe.

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The 'China slowing' story belongs to an earlier period, and the world has already adapted to it. China's economic expansion has been so huge that, even with the lower growth rate, China's contribution to world economic growth in dollar terms is larger than in the double-digit period. 

What about the future? Is China about to stumble just when it has the substantial windfall of lower global oil prices?

The just-released IMF World Economic Outlook Update sees China's growth slowing to 6.7% this year and 6.3% next year. This sharp downward revision helps to perpetuate the gloom. But we need some perspective here. If the pace of China's expansion continues at around 7% (plus or minus one percent), it will extend one of the great development success stories. We should even count it as a stunning success if the trend includes some temporary bumps on the way, as China sorts out its housing and finance sectors and carries out a rebalancing from investment towards consumption.

The proper criterion is whether China can avoid the sort of persistent under-performance seen, say, in Brazil (barely positive growth in recent years and negative this year). If Michael Pettis turns out to be even remotely right (he has bet that 'average growth in this decade will barely break 3%'), this should be acknowledged. Yet despite the feverish WSJ reporting, this outcome is looking less likely with each passing year.

Photo courtesy of Flickr user Ernie.


The fall in the world oil price has created the opportunity to eliminate petroleum subsidies in a number of Southeast Asian countries. These subsidies have been the long-standing bane of economic reformers everywhere, but until now reducing them involved the deeply unpopular task of raising petrol prices.

But with the 50% fall in the global price of oil since June 2014, the subsidies could be eliminated by the fall in the supply price rather than by raising prices for consumers.

Indonesia illustrates just how sensitive this issue has been: during the 1997-98 Asian financial crisis, the IMF required that petrol prices should rise sharply in order to reduce the budget subsidy, as one of its conditions for providing funding support. The riots that ensued due to the price increase triggered the resignation of President Soeharto in May 1998.

Subsequent presidents have wrestled with the Sisyphean task of keeping the subsidy from overwhelming the budget as global oil prices rose over the past decade.

President Jokowi inherited a budget in which more than 20% of expenditure was allocated for energy subsidies. In November he took the courageous step of raising petrol price by more than 30%, only to find that by the end of the year world prices had fallen so far that, even with the subsidy abolished, nearly half of the November petrol price increase could be reversed. Fortune favours the brave. 

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The case for subsidising petrol in Indonesia has always looked flimsy. Petrol is characteristically consumed by middle- and upper-income groups. Nevertheless, it has proven very difficult to reduce, let alone eliminate. The direct blame rests with an imperfect political process where crass self-interest prevails and opposition parties take every opportunity to be unhelpful. But there is no doubt that this is a 'hot button' issue with the public. Historically, there has been a confused argument relating to Indonesia's role as an oil producer and net exporter: 'the oil belongs to us, the people of Indonesia, and so it should be cheap'. This perverse mind-set lasted long after Indonesia ceased to be a net oil exporter a decade ago.

The biggest subsidies are found in oil producing countries, with Venezuela's US2¢ per litre of petrol the leading example. But many developing economies which are not oil producers also subsidise some petroleum products — usually diesel and cooking energy such as kerosene or LNG. There is some argument for these subsidies on income-distribution grounds. But this policy inevitably runs into the ingenuity of consumers, who find ways to substitute diesel or even LNG for petrol.

Indonesia will continue to subsidise diesel modestly, and kerosene and LNG much more generously. Despite recent tariff adjustments, electricity subsidisation is still an expensive budget item, with the middle- and upper-income groups the main beneficiaries.

The ending of the petrol subsidy is a policy win that fell into Jokowi's lap.

Supporters of policy reform should take more heart from his willingness to take the unpopular action of raising petrol price last November. They might applaud the ending of the subsidy more strongly if the opportunity had been taken to end the authorities' price setting altogether (the price of 'premium' petrol will be set each month, based on world prices), as this would have made it easier to resist restoring the subsidy if world oil prices shift up again.

A truly bold move would have been to keep the price at its late-November level with a tax that could have supplemented Indonesia's inadequate budget. Indonesian budget revenue is only 15% of GDP, and this is expected to fall further. One reason is that Indonesia's own oil production will now be less profitable and raise less tax revenue. Thus the net effect of the ending of the petrol subsidy will be much less than the 200 trillion rupiah (say, US$17 billion) mentioned by the Minister of Finance.

Keeping the price at its higher level would not only have helped revenue, but would represent good policy in response to the substantial negative externalities associated with petrol. Even for non-believers in climate change, a tax would be justified on pollution and congestion grounds alone. A million extra cars and three million extra motorcycles are added to Indonesia's clogged roads every year, and public transport (the only viable longer-term response to this unfolding disaster) needs far more funding.

Still, Indonesia is not unique in being unable to persuade the public of the benefits of expensive petrol. Indonesia's price is now only 20% or so below Australia's, and about the same as in the US. Europe's higher petrol prices have revolutionised the size and technology of cars, but this approach is still a bridge too far for many of us.

Photo courtesy of Flickr user Riza Nugraha.


What does the fall in the price of oil do for global economic growth?

If the price of oil had swiftly risen by 50%, economic commentators would be calling this an economic disaster. In fact the price has fallen by 50% since June last year, yet this ray of good news hasn't pierced through the gloom of economic commentary, even though it represents an annual transfer of around 2% of world output from oil producers to consumers. 

Part of the explanation is that economists, like many commentators, find a gloomy story much more interesting than a happy one. As well, every silver lining is part of a dark cloud. There are winners and losers, and any sharp change in prices requires adaptation, which often causes problems. Moreover, the fact that no one saw this coming is a reminder of the uncertainty of oil-price setting (see graph above), which encourages forecasters to hedge their bets and investors to be cautious.

Let's try to set out the pluses and minuses.

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On the minus side, it might just be temporary. The lower price will be unprofitable for some suppliers, who might halt production. But the Saudis tried this in the 1980s and it was largely unsuccessful. What's more, limiting production now would just transfer revenue to rival suppliers who would use their stronger oil revenue to oppose Saudi interests in the Middle East.

Some commentators argue that the fall in oil price is just a reflection of how badly the global economy is doing; that it reflects an adverse demand shock (bad news) rather than beneficial extra supply (good news). Europe is certainly pathetically weak, but the main story is on the supply side. There clearly has been a substantial supply increase (much of it in the US, where technology has unlocked 'tight oil'). This extra supply has been putting downward pressure on prices for some time, with the sharp break coming after Saudi Arabia said it would not cut production to support the price.

In short, a reasonable guess suggests the oil price might rise a bit from the current level, but not much. The International Energy Agency's predictions of demand (93-95 million barrels per day) intersect an estimate of supply (see chart below) at around current prices (although note the sharp upward kick in the tail of supply, as more expensive sources are brought into production).

Of course the fall in price is bad news for net oil exporters, so does this balance out the benefit to the net importers?

Some governments in oil-exporting countries, particularly in Africa, will have to dramatically cut spending because of lower revenues, but they don't bulk large in global terms. Others, such as Russia, Iran and Venezuela (especially badly affected) aren't our close mates anyway, so we don't care much about their loss of income. It might even cause them to curb some of the behaviour we find offensive. But if the impact was so bad that one of them (say, Russia, where oil exports are 13.5% of GDP and provide half of budget revenue) had a total economic collapse, the spill-over would damage global growth. 

Still on the negative side of the argument, a lower price will discourage investment in energy production everywhere, which will trim overall economic demand. And for those worried about the environment and climate change, the lower price will encourage us to use more energy and lessen the incentive for energy-saving innovation ('tumbling oil prices have long been seen as kryptonite for clean energy companies').  Australia is a net importer of petroleum, but this benefit will be offset to some extent by the damage done to the price of our exports of coal, a close substitute. 

So much for the offsetting factors and things that could go wrong. What about the benefits of a lower oil price?

In a world of deficient demand, shifting a large amount of income from wealthy, high-saving oil-producers in the Middle East to the rest of us has to boost world demand, lower inflation and help the external account. In those emerging economies where petroleum consumption is subsidised (Indonesia, India and many others), this will help the budget. For the rest of us, it provides an opportunity to raise taxes on petrol, with beneficial effects on both the budget and the environment.

The IMF remains gloomy about global growth (despite its own figures showing essentially no slowing so far and none in the forecast). In its most recent World Economic Outlook (in October), the Fund was still identifying the main risk as an oil price increase with a $25/ barrel hike estimated to cut at least 0.5% off global growth. Now that the Fund is looking at a price shock twice as large and in the opposite direction, its tentative answer is that this will add between 0.3% and 0.7% to world growth. When the Fund incorporates this into its updated global forecast later this month, we'll see if this breaks the unrelieved gloom that has permeated discussion of global economic prospects since 2008. 

This is unambiguously good news for global economic growth (the similar oil-price fall in the 1980s ushered in a period of outstanding growth). Moreover, it presents opportunities to gather the windfall through a carbon tax and use the revenue to boost infrastructure and fix budget problems. But the reception to the good news has so far been so low-key that it looks like this policy-making opportunity will slip by almost unnoticed.

So much for the economics. Political scientists might recall that, while the fall in oil price in the 1980s didn't single-handedly bring about the collapse of the 'Evil Empire', it certainly made the Soviet economy susceptible to the disruptive political forces then operating. A number of oil producers in Africa and Latin America will now have to dramatically tighten their belts – never popular. There is potential for dramatic change.

Graph courtesy of Wikipedia Commons and IMF Direct.


It has long been a central tenet of conventional economic wisdom that there is a trade-off between growth and equality: if governments redistribute resources from the rich to the poor, growth will be slower. Even recognising this, many economists still favour redistribution, for broad social reasons.

Arthur Okun provided the clearest enunciation of this conventional wisdom in 1975, talking in terms of the 'Big Tradeoff' between equality and efficiency. Okun put himself in the middle of the spectrum of opinion, still ready to implement redistribution while acknowledging that the transfer from rich to poor was done with a 'leaky bucket'. 

At the other end of the spectrum were Milton Friedman and the Chicago School. In the three decades between Okun's book and the 2008 financial crisis, the weight of economic opinion shifted decisively towards market-based systems (helped by the collapse of the USSR and the acceptance of markets in socialist economies such as China and Vietnam). Part of the argument was in terms of the greater saving and investing propensities of the well-off, needed to drive growth. Entrepreneurs should get the benefit of their efforts, both to encourage them and to reward them for their contribution to society.

The keenest free-market proponents argued that the rich ought to get a bigger slice of the economic pie in order to reward their entrepreneurship while the poor should have a smaller share in order to encourage them to try harder.

More recently, this whole logic has been challenged.

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A recent IMF paper suggests there may not, in fact, be a trade-off between equality and growth. And a new OECD study finds that the poor could make a far greater contribution to growth if they had more resources to give them better education and opportunities. Moreover, income transfers don't seem to damage incentives.

These revisionist arguments come at a time when the old causal linkages are coming into question. In the development debate, getting more savings seemed central to encouraging growth, but we are now in a world where there seems to be a glut of savings in both developed economies (Japan and Germany) and emerging economies (China). We also observe the wealthy not spending just on productive investment but on mansions in the Hamptons and unproductive bling. Downton Abbey doesn't look like a paragon of efficiency. As income distribution has swung in favour of the rich, concerns about secular stagnation have been revived. 

In any case, leaving the facts and the causative linkages to one side, the zeitgeist has shifted. You don't need to have actually read Piketty's 700-page tome on income distribution or to have joined the Occupy Wall Street demonstrators in Zuccotti Park to know that the tide of public opinion is running against the 'one percent' (or more pointedly the 0.01%) who have dominated income increases in recent decades. The debacle of the Global Financial Crisis has to be an important part of the story. Did those Masters of the Universe need their huge bonuses to incentivise them to mess things up so badly? Would the IMF and the OECD (both long-standing free-market fellow-travelers and boosters) be fostering this kind of revolutionary research if public opinion had not become disillusioned with the 'magic of the market'?

For practical policy-makers, this change of rhetoric may not be so radical. Sensible economists have long known that incentives for entrepreneurship are one of the keys to growth, while wondering just how much incentive you need to get people to do things that they want to do anyway. They know that as growth gets underway, some will benefit much more than others. They also know that resources spent on giving some kind of equality of opportunity (especially in education) are vital to tap the full spectrum of talent in the population. They know that minimal levels of health care, working conditions and wages are needed to make society function smoothly. They know that there are some components of growth (like infrastructure) that the private sector doesn't provide in sufficient quantity. 

The proper debate is down at the detailed level, not the sort of pontificating broad-brush generalisations of the free-market ideologues. Arthur Okun's trade-off is still relevant, but we still have to work on how to make the bucket less leaky. The OECD work, in particular, is helping to get the focus where it should be, on these microeconomic issues.

Photo by Flickr user Colin Jagoe.


A few weeks ago Sam Roggeveen quoted PayPal founder Peter Thiel, who argued that competition is over-rated and monopoly would enhance innovation. We shouldn't be surprised that business people are in favour of monopoly. In 1776 Adam Smith observed:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.

For Adam Smith's invisible hand to work, self-interest has to be disciplined by competition. It's a routine observation that the very same business people who extol competition (often in loaded terms such as 'free markets') can simultaneously direct their business efforts towards monopoly. The unusual thing about Thiel is that he makes the argument in favour of monopoly publicly and identifies so explicitly the unattractiveness of the competitive business model (you only make 'normal' profits).

The argument that monopoly enhances innovation doesn't fit with Thiel's own experience. Three decades ago, the payments system in just about every country was a heavily regulated monopoly. To make a payment you either had to use cash or deal with a bank. The rationale was to protect consumer transactions from fraud. With financial deregulation, these restrictions to competition were removed, producing a torrent of innovation, including PayPal.

Who could argue that this competition has not been beneficial? Should the pace of future innovation now be placed, once again, in the hands of incumbent monopolies?

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This is a big topic. For a taste, dip into the 300-page draft report of the Harper Inquiry into competition in Australia, which raises one issue germane to international relations: the global monopoly on ideas embodied in intellectual property (IP) rights. Here's what the report says:

IP rights can help to break down barriers to entry but can also, when applied inappropriately, reduce exposure to competition and erect long-lasting barriers to entry that fail to serve Australia's interests over the longer term. This risk is especially prevalent in commitments entered into as part of international trade agreements. 

As the Productivity Commission (PC) notes, the proposed Trans-Pacific Partnership Agreement (is)...specifically considering intellectual property issues. The PC suggests that Australia is likely incurred net costs from the inclusion of some IP provisions in trade agreements, pointing to analysis of extensions in the duration of copyright protection required by the Australia-United States Free Trade Agreement which imposed net costs on Australia through increased royalty payments. As Australia is, and will continue to be, a net importer of IP, these costs are potentially significant.

Earlier posts have identified the dangers here. Unlike trade-enhancing agreements (which are win-win for all participant countries), the TPP is a rule-setting arrangement, with winners and losers. The IP rules should be set to maximise global consumer welfare and encourage innovation, but in practice they are hammered out between the various vested interests (Silicon Valley versus Hollywood; pharmaceutical manufacturers, etc). Australia, as a small player in the TPP negotiations, can complain, but in the end has to accept the rules set by countries which are net IP producers.

Photo courtesy of Flickr user urbanwide.


Financial stability was not the most headline-grabbing topic discussed at the Brisbane G20 meeting, but judging from the official communique word-count (a full 175-word paragraph in the three-page document, plus four substantial items in the annexes), a fair bit must have happened.

Governor of the Bank of England and Chairman of the Financial Stability Board, Mark Carney.

The main promise given before the meeting was that the issue of 'too-big-to-fail' would be solved. Indeed, progress has been made on this issue, at least at the highest level of banks which are so large that their failure would present a threat to the global financial system.

There are around 20 such banks (G-SIBs), and new rules dictate that they will have to hold substantially more capital. Capital can be measured in various ways (either as a simple leverage ratio comparing capital with the total assets, or comparing capital with the risk-weighted assets). But measured either way, the G-SIBs will have to have about twice as much capital as ordinary banks.

Even this level of loss-absorbing capital is not a guarantee against failure, but it makes it much less likely that these banks would have to be bailed out by taxpayers as happened too often in the 2008 crisis.

The most accessible description of what was achieved can be found in Bank of England Governor Mark Carney's speech in Singapore on his way home from the Brisbane meeting. As Chairman of the Financial Stability Board (the operational body which has been working hard to put these new measures in place), Carney wants to put the new measures in the best light. And of course progress has been made. But does it fix the problem?

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One dissenting voice, economist Avinash Persaud, doubts that the extra capital will really be available in the event of a systemic crisis. Much of the extra capital comes in the form of contingent convertible bonds (COCOs), which pay a yield like a normal bond but can be compulsorily 'bailed in' if the bank is in distress and needs a top-up of capital. Persaud argues that these bonds will be held by insurance and pension funds and that in a systemic crisis, bailing them in will be politically unacceptable. Certainly judging from the yields at which COCOs have been issued so far, the investors see them as more-or-less the same as ordinary bonds, with little or no chance of ever being bailed in. 

Others see additional capital as a misdirected answer to the problem. What went wrong in the period before the crisis reflected managerial failure in the troubled banks. They were run by people who had the wrong mindset and the wrong incentives. They were not conservative risk-averse bankers but risk-takers, egged on by boards and shareholders demanding that they shift along the risk/return trade-off to pump up profits and share prices.

The answer, then, is not more capital but a different managerial style. To make banks safe they have to be separated from the free-wheeling go-getting parts of the financial sector and put back in the old-fashioned world of dull commercial banking. Various attempts to do this (Dodd-Frank in the US and ring-fencing in the UK and Europe) have not gone far enough. But to implement this solution would see the end of universal banking and a return to something at least as restrictive as Glass-Steagall, which is unacceptable to the powerful financial sector.

All is not lost. The new measures will undoubtedly put a bigger loss-absorbing capital buffer into the G-SIB balance sheets. Now individual countries will have to try to do the same for their banks which are not G-SIBs, but which are big enough to bring down their own domestic financial systems. Thus Carney is right to take some pride in what has been achieved in the six years since the crisis, while at the same time acknowledging that there is still further to go.

There is time for further improvement. The fresh memory of the 2008 crisis is the main insurance against a repetition. As well, the 2008 experience affirms an old truth, that where macro policies are sound and prudential regulators are diligent and politically well supported, financial systems are pretty safe.

Photo courtesy of Flickr user www.bankofengland.co.uk


Tom Allard recently reported in the Sydney Morning Herald that Australia and East Timor are ready to restart talks on the maritime boundary between the two countries, with all its complications of petroleum revenues and history. The tradition is to keep these talks under wraps, but Allard's article puts the topic back on the public stage. 

The Timor Sea and maritime arrangements between Australia and Timor Leste. (DFAT.)

If this issue were to be decided on the basis of 'they are poor and we are rich', then the facts are irrelevant, except perhaps for this fact: thanks to the existing treaty arrangements, Timor has a petroleum fund currently holding US$16.6 billion, unable to be effectively spent as fast as the revenue is flowing in

If poverty is not the criterion, then geography is. The original 1972 maritime boundary with Indonesia (West Timor and the parts of Indonesia to the east of East Timor) was drawn much closer to Indonesia than the mid-point between the two countries (see map above). This might seem unfair until you look at a cross-section map of the seabed or a map showing sea-depth (see map below), on which Australia's continental shelf is clear, as is the Timor Trench dividing the two land-masses.

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The treaty history is summarised here. Portugal was still in control of East Timor at the time of the 1972 treaty, and it didn't want to participate in defining the border, hence the 'Timor Gap'. After Indonesia took over East Timor in 1975, this gap was addressed in a treaty which left the border to be determined later, but created the Joint Petroleum Development Area (JPDA; see first map) so that, in the meantime, the just-discovered petroleum resources could be developed.

After East Timor's independence from Indonesia, these delineations were retained in the new treaties, but a much more favourable division of the petroleum revenues was agreed. The Sunrise gas field (the richest undeveloped field, with estimates putting its gross value at $40 billion) lies mostly outside the JPDA, with about 20% in the Area and 80% in Australia's territory. The initial treaty with Indonesia had split the revenue within the JPDA 50:50, with Indonesia getting no share of gas field revenues outside of it. After the renegotiations, the newly independent East Timor received 90% of the JPDA revenue and 50% of the upstream revenues from the Australian part of Sunrise.

Sunrise gas field (Hydrocarbons Technology Market & Customer Insight)

A key element of all the treaties was to delay any consideration of the final border delineation of the Timor Gap for 50 years. If no development agreement was reached for the JPDA during the six years after the 2006 treaty was signed, either party could terminate it, but so far the treaty remains in force. Terminating it would open up the possibility of looking at the border again. But it would also affect the status of the revenues which both parties get from current production and might halt further investment. 

What would happen in a renegotiation? Allard asserts: 'A boundary equidistant between the two countries — as is the norm under international law — would result in most of the oil and gas reserves, worth more than $40 billion, lying within East Timor's territory.'

Yes, if the border were drawn equidistant, this would put the JPDA resources in Timor's territory, but Dili already gets 90% of these revenues. and it's true that UNCLOS decisions have favoured equidistant borders because continental shelf features are often unclear and subject to huge dispute.But in this case the shelf and the trench are indisputable geographic features. That said, Australia is not ready to have this tested and in 2002 declared that it would not submit itself to international dispute resolution mechanisms relating to 'sea boundary delimitations as well as those involving historic bays or titles.'

Even if East Timor were to succeed in renegotiating the border to mid-way (which, to give some idea how this would look, is the south-eastern edge of the JPDA shown on the first map), this still wouldn't put the rich prize of Sunrise in Timor's territory. Most of Sunrise is clearly to the east of the nearly north-south line demarking the eastern edge of the JPDA. This border is not in dispute and it is drawn in accordance with the conventional rules based on the geography of East Timor and Indonesia.

Going one step further, if East Timor succeeded in getting an equidistant border, Indonesia would surely want to do the same thing and could find an excuse. This would put the largest part of Sunrise in Indonesian territory. East Timor might then see if Indonesia was ready to share the revenues 50:50 with it.

Australia's negotiating history on this subject is not a glorious one. Why, for instance, was it worth the risk of getting caught spying on East Timorese negotiators when, as the Foreign Minister of the time said, 'you didn't have to spy on the East Timorese to find out what their position was'. Defending the current arrangements shouldn't be too hard, either on legal or moral grounds. Let's hope we make a better fist of it this time.


The APEC Leaders' Meeting underway in Beijing seems to be finessing the various conflicting and overlapping trade initiatives and avoiding serious damage. But it is not resolving any of the underlying tensions.

At the multilateral level, the WTO remains in limbo after India pulled the rug out from under the Bali agreement. At the bilateral level, preferential trade agreements are still getting plenty of attention (Australia's agreement with China seems close to finalisation) despite their dubious benefits for global trade. The noodle bowl is getting more tangled.

Steering between these two models are the regional arrangements (the Trans-Pacific Partnership [TPP] and the ASEAN-based Regional Comprehensive Economic Partnership[RCEP]), which might be a way forward while we wait for the WTO to find a new format for reaching multi-country agreements. Some talk as if the TPP is close to finalisation, with the 12 negotiating countries meeting in Beijing. But with China excluded from the negotiations, this is hardly the moment for a breakthrough. 

Into this mélange, China dropped another loud indication that it was unhappy with its status in these various international arrangements. Just a week ago, it launched its alternative (or addition) to the World Bank and regional development banks in the form of its Asian Infrastructure Investment Bank. More recently, it lobbied to revive a dormant APEC-wide trade initiative called the Free Trade Area of Asia and the Pacific (FTAAP), which would be a regional arrangement with more members and broader geographic reach than either TPP or RCEP. The FTAAP has been on the back-burner for nearly a decade, and the US managed to have it returned there for the moment. So the game of rock-paper-scissors has ended without resolution.

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What should we make of all this? First, that China is becoming more impatient with the slow pace at which it is gaining a role in the established international agencies (IMF, World Bank) commensurate with its new-found weight in world affairs.

Second, that the US strategy of using the TPP to establish comprehensive international trading rules without China at the table is looking more tenuous. It's true that China had to accept the already-established WTO rules when it joined in 2001, but the world has moved on since then and China's weight in international affairs has increased enormously. If the TPP is concluded soon, the 'platinum standard' rules will have to be greatly watered down to accommodate Japan's constraints. If negotiators resist this watering-down or the US Congress is uncooperative, the TPP is on a slow track, with China's exclusion from the negotiations remaining a catalyst for unhelpful initiatives which are diluting the finite resources available for pursuing more open global trade.

Photo courtesy of Flickr user Jim Gourley.


Last week Canberra was alive with security and Parliament House was surrounded by guards with assault-rifles. Anyone who has gone into Parliament in past years knows it already has extremely tight security, but now we are ready for an invasion. True, there was the attack in Ottawa. so we need to assess if a lone gunman could have walked into our Parliament as easily as the one who walked into Canada's. If we were already sufficiently secure, the right answer was 'do nothing'.

Since 9/11, anyone involved with security seems to be ready to over-react and has an unlimited budget to do so. No one seems willing to say that the world is full of a wide variety of risks, and we can't hope to reduce the possibility of something going wrong to zero. With each type of risk, we have to weigh the probable damage against the cost (and feasibility) of reducing the risk.

We do that, implicitly, in many other instances. Traffic engineers know (and the rest of us intuitively understand) that we could reduce the number of road deaths and injuries if we spent more on straightening out the dangerous curves (Google 'Pacific Highway' and you'll have an example). Experts are reluctant to put out precise cost/benefit calculations on these trade-offs because that would mean putting an explicit value on human life, which they don't want to do. But the point remains: we decide to tolerate some deaths and injuries because we don't want to spend more.

Sometimes the risk-reduction takes the form of constraints on action, rather than expenditure. But the same principle applies. We don't reduce the vehicular speed limit to 15 kph, even though there would be fewer road deaths if this were to be done. How much inconvenience will we put up with at airport security queues before we say we'll take a chance on the hijackers (provided the pilots latch the cockpit door)?

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If we were interested in getting the best return on our public safety dollars, the money might be better spent on reducing the risk to the public of a king-hit from a drunken lout in Kings Cross on a Saturday night, rather than on another layer of protection against a terrorist attack.

Stirring up panic is always an easy story for journalists and shock-jocks. As well, behavioral economics tells us that people give too much weight to low-probability risks. Thus it's not surprising that we spend too much on some risks and not enough on others. In addition, perhaps security (and intelligence) matters avoid proper accountability because they can claim some need for secrecy.

In an earlier era, the stoic response was 'Stay calm and carry on'. It might still be the way to go.

 Photo courtesy of Flickr user Rusty Stewart.


Forecasts of China's growth always attract interest, even when they are a year old. Larry Summers and Lant Prichett are getting another good run with the paper they published last year (see my earlier post), which analyses emerging-economy growth in general, but of China and India in particular.

There is sophisticated econometrics here, but the key argument is a simple but powerful rule-of-thumb: 'reversion to the mean'. One of the great insights (not just in economics) is that natural phenomena vary around a mean, and when there is an observation well away from it, chances are the following observation will be closer to the average. You might flip a coin and get three 'heads' in a row, but the best forecast for the next toss is still 50:50. Applying this rule-of-thumb to China tells Summers and Pritchett that it's growth rate during the three decades before 2008 is an outlier in the history of global economic growth, and so in the future there is likely to be a lot less, and somewhere around the mean.

Economics has other rules-of-thumb which would support the idea that China's growth will slow. Herb Stein's famous 'law' is that 'unsustainable events don't go on forever'. And of course 'trees don't grow to the sky'.

But a powerful case can be made that reversion to the mean of global economic growth is not the most likely outcome for China, at least any time soon.

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Even the most powerful rules-of-thumb must be used in the right context. Let's start with another one, the rule of convergence. In the right circumstances, poor countries will converge towards the levels of per capita GDP achieved by the mature economies, because the technology to do so already exists. Accumulating the necessary capital and technology has been done before by quite a few countries. If they can do it, why not China and India? In this context, the more relevant mean is the average per capita GDP in mature economies. China and India have a long path of potential convergence –adding capital and technology – before they will run into the technological frontier where the mature economies currently are.

What about another favourite rule-of-thumb: the story of the statistician who drowned while crossing a river with an average depth of only a metre? The moral here is that there is a range of experiences – often widely different – hidden within the average. True, Brazil had more than two decades with no growth at all in per capita income. On the other hand Taiwan, Singapore, South Korea and Hong Kong (and earlier, Japan) had quite long periods of fairly sustained economic growth which have taken them to high levels of per-capital income. What relevance does Brazil's failed growth experience have for China? It's a warning that you can mess things up for a sustained period, but China already knows this from its own experience.

Where does this leave us? It's stale news to say that China can't sustain the double-digit economic growth that occurred in the three decades before 2008. Since then, China's underlying growth has been 7-8%, with an exceptional year in 2010 when there was a gigantic temporary policy stimulus. Proper analysis shouldn't rely too much on the average experience of all emerging economies (many of them clearly quite different from China), but look at the variety of experience in the convergence process, and ask if China's actual circumstances will allow it to mimic the success stories rather than the failures. 

The serious debate is whether China can sustain an underlying rate of economic growth around the current pace or whether there are specific factors, such as financial problems, environment, demographics and rebalancing difficulties, which could take this down to 3%, as Michael Pettis argues. The history of emerging economies tells us that it's easy to mess up and fall off the convergence path. But China has done pretty well for the past three decades, and that experience is relevant to the forecast.

To look at these specifics is more useful than thinking in terms of 'reversion to the global mean'. If China achieves even 5% growth until 2050, it will reach OECD average per capita GDP. That's amazing, but not unrealistic.

Photo courtesy of Flickr user Richard Atkinson.


Sometimes a picture is worth a thousand words.

With the G20 focused on increasing economic growth, it's worth remembering where the global action is. The above graph from the IMF Multilateral Policy Issues Report, published in July, shows that the emerging economies have been doing the heavy lifting, at least as measured in purchasing power parity terms. There is a reminder here, as well, of how they carried global growth during the 2008-09 downturn following the financial crisis.

The October IMF World Economic Outlook is forecasting that the emerging economies will grow as fast in 2015 as they did in 2012 and 2013, so the red bars will be a bit bigger (their rapid growth makes them bulk larger in the global growth calculation). And our region ('emerging and developing Asia') is forecast to continue its steady 6 .5% growth.


Economic forecasting is the butt of jokes, but someone has to do it. You can't make sensible macro policy without some view of how the economy will travel. It's the IMF's thankless job to be the high-profile forecaster for the globe. The Fund's latest World Economic Outlook acknowledges its recent forecasting errors, and offers an explanation.

It's one thing to get the forecast wrong. It's another to be consistently wrong in the same direction. Figure 3.1 from the the 2014 World Economic Outlook shows the story of the past four years.

The Fund says (see Box 1.5 here) that the main problems with its forecasts were 'serial disappointments in emerging markets'. In particular, it identified the BRICs (Brazil, Russia, India, China) as the main issue (where the Fund missed the change in the underlying trend, particularly in China), plus the difficult-to-forecast shocks of the 2010 European periphery crisis and the Japanese tsunami in 2011.

But here's what the forecast record looks like if we compare the first forecast the Fund made (in April of the previous year) with the actual outcome.

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The revisions for the advanced economies are as substantial as the revisions for the emerging economies. What is more relevant for the policy debate, however, is that global growth was sluggish because of weakness in the advanced economies. The emerging economies were growing three times as fast. 

Suppose the path of the advanced economies had been foreseen more accurately in 2010. Would the G20-instigated fiscal stimulus have been maintained, instead of being replaced with the firm fiscal austerity reflected in Figure 1.6 (below)? If Europe had foreseen a decline of 0.7% in 2012 followed by a further decline of 0.4% in 2013 rather than the forecast of growth of 1.8% in 2012 and 0.9% in 2013, would policy have remained so passive?  Was it so hard to foresee that Europe was headed for stagnation, that Japan was still stuck in the lost decades or that fiscal restraint was keeping the US recovery on an uncharacteristically slow path?

Figure 1.6, World Economic Outlook 2014.

The IMF's successive downward revisions, and the gloomy commentary which accompanies them, might give the impression that global growth is weakening. However the Fund records that this year's global growth is the same as in the previous two years, with an increased forecast for next year. This seemingly contradictory story can be reconciled by saying that the global economy has been chugging along at a steady pace but too slowly for comfort, and the Fund's forecasts have gradually caught up with this reality. 

Usually, we can join the mirth that accompanies economists' failed forecasting efforts. This is one example where more accurate forecasting might have improved the policy debate and altered the outcome for the better.


In its latest World Economic Outlook, the IMF has joined the chorus of international institutions (G20, OECD) calling for more infrastructure spending.

What new elements does the Fund bring to this argument? Global growth has been disappointing. One reason is that governments have cut back on expenditure — including infrastructure — to get their budget deficits under control and their high debt levels down. But the Fund argues that, at least in advanced economies, for every dollar spent on public investment, these economies can expect an increase of 40 cents of GDP in the first year and $1.50 after four years (or double this figure under the right circumstances). Infrastructure spending stimulates demand and increases supply, and thus actually improves the debt/GDP ratio after a few years.

This is a big shift from the Fund's initial views on budget deficits in 2010, when it thought that the fiscal multiplier was less than one (and even its revised view from 2013 that the fiscal multiplier might be positive). Back in 2010, international financial institutions were all fixated on the debt implications of the crises in Europe. How times have changed. The Fund's summary for the 2014 World Economic Outlook is 'The time is right for an infrastructure push'.

This sort of broad case for infrastructure spending needs caveats, which the Fund duly applies.

For one thing, this fiscal multiplier logic doesn't apply in countries are already operating at full capacity. And the IMF acknowledges the usual problems with infrastructure: projects are often large, complex and long-lived, making it hard to evaluate their social return. Even when the social returns are high, it is often difficult to get those who benefit to pay in full. In these circumstances, political forces can take over the project selection process ('pork barreling'). In Australia, the Darwin-Alice Springs railway is an example. Elsewhere, Japan's 'bridges to nowhere' are often cited, although the Fund points out that Japan's budget blow-out during the 'lost decade' was caused by increases in social expenditure, while public investment actually fell.

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The IMF doesn't push public-private partnerships as a means of funding. The Fund has adopted the powerful argument that well-chosen infrastructure projects add assets to a government's balance sheet. The resulting debt from infrastructure spending should therefore not be seen as a burden on future generations, as it would if the budget deficit were to be driven by social expenditure. This issue is of particular interest in the context of the budget debate in Australia. Figure 3.3.1 from the World Economic Outlook shows how strong the Australian Government balance sheet is, either taken alone or in comparison with other countries. 

The case for infrastructure spending is a strong one (such spending is perhaps even a 'free-lunch'), and the Fund shows that the quality of infrastructure in both America and Germany has deteriorated substantially since 2008. In emerging economies, the case is made compelling by noting just how far they lag behind the advanced economies in provision of electricity, telephones and roads (see Graph 3.3 here).

The infrastructure bottleneck is often in project appraisal and legal issues such as land acquisition, rather than financing (although funding is always included on the list of issues to be resolved). Also high on the list of problems for emerging economies is the low efficiency in terms of the use of infrastructure. 

There is no denying the importance of the Fund's main message that there are many infrastructure projects which are not only viable (especially at today's low global interest rates), but which would also spur lagging global growth. This seems likely to be a widely held view at Brisbane's G20 meeting. Improving global growth while at the same time fixing the infrastructure shortage is a compelling idea. But, as usual, 'between the idea and the reality...falls the shadow'. The G20 needs to turn the generalities into operational prescriptions, like having the World Bank restore its detailed project appraisal capacity and for the credit-rating agencies to improve their capability to sort the beneficial projects from the lemons.



With other international institutions reiterating their forecasts of declining growth in the emerging economies, the latest Asian Development Bank Outlook Update has a more positive view, at least those in our region. Not only are they sustaining a 6%-plus growth rate, but trade integration continues apace.

Australia has not found much of a role for itself in this supply-chain revolution so far, but our strong services sector gives us potential opportunities.

Among the many reasons for Asia's superior economic performance has been the success of supply-chains (what the ADB calls global value chains), which divide the production process so that each stage is carried out in a country which has comparative advantage in that particular process. From 1995 to 2008, the share of Asia's value-chain trade in worldwide manufacturing exports almost doubled from 8.6% to 16.2%. The message from the IMF on emerging economies has been gloomy for the past few years, but those in Asia have sailed ahead at a pace around three times that of the advanced economies, and the ADB sees this continuing. 

What made this possible was close integration and freedom of regional trade.

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Following the implementation of the ASEAN Free Trade Area, over 70% of intra-ASEAN trade incurs no tariff, and less than 5% of that trade is subject to tariffs above 10%. Non-tariff trade facilitation – making it easier to ship things across borders – is the objective of the Asian Economic Community and the Regional Comprehensive Economic Partnership initiatives. The national single window (a one-stop shop to speed customs clearance within ASEAN) has gone live in Indonesia, Malaysia, the Philippines, Singapore, and Thailand, with full roll-out planned for all significant ports and airports by 2015.

Where does Australia fit into all this? Have we been left behind with these fast-expanding opportunities, just at the time when we need to find a substitute for commodities to drive our growth? What have we got to offer?

Japan played a key role in promoting supply-chains when it shifted its manufacturing to lower-income countries. Taiwan provided managerial support for the initial stage of China's manufacturing growth, with Foxconn as the prime example. South Korea's sophisticated electronics industry provided inputs for other countries' manufacturers. All of these countries had inherent advantages in finding a role in the supply-chains. Australia, as a net capital importer and commodity exporter with modest manufacturing capacity and few global manufacturing brands, has found it hard to find a role in the manufacturing boom in Asia.

Many of our best opportunities will be found in services. Our engineers are seen all over Asia, in mining and infrastructure. Australian accountants, lawyers and financiers are there too. But the supply-chains should provide new opportunities, especially as Asian manufacturing goes up-market and needs sophisticated design and better distribution know-how to gain greater access to Western markets. 

Photo courtesy of Asian Development Outlook 2014 Update