Lowy Institute

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.


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.