Lowy Institute

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


With the passing of the presidential baton from Susilo Bambang Yudhoyono to Joko Widodo just a month away, Indonesia is at a political crossroad, with the first clear break from the politicians who were part of the Soeharto years. Monday's Indonesia mini-update at the Lowy Institute, a half-day version of the Australian National University's annual analysis of Indonesian politics, economics and social developments, revealed an economy also at a transition point.

The easy years of the commodity boom are over. Growth was a respectable 5-6% throughout SBY's decade, and the macro-economics were well managed. But growth has now slipped below 5% and the global economic environment is unhelpful.

SBY's second presidential term achieved much less than the optimists had hoped. Petroleum subsidies (affecting not only fuel but also electricity) still count for over a fifth of budget expenditures. These, together with the large financial transfers to regional governments, leave the national budget with no room to manoeuvre. There has been painfully slow progress in addressing the backlog of needed infrastructure projects. Sharp increases in labour costs in the formal sector are making Indonesia's large-scale manufacturing uncompetitive. Corruption remains endemic. Income maldistribution has worsened appreciably.

The president-elect brings corruption-free credentials and a successful administrative record, albeit at the sub-national level. The incoming vice-president is experienced and energetic. But the election campaign gave extra momentum to nationalist economic sentiments which are never far below the surface in a country where memories of foreign colonial exploitation still linger. Measures to force greater domestic processing of ore exports are gradually being sorted out at a practical level, but some damage lingers to Indonesia's reputation as a welcoming host of foreign investment.

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A better assessment of the prospects will be possible when Jokowi picks his ministerial team. So far he has skillfully side-stepped pressure from the nationalist PDI-P, the political party he is associated with, to appoint party cronies with their baggage of dirigist economics. But Jokowi's own philosophy has not yet been clearly articulated.

All this is playing out in a global economy full of gloom, especially regarding the prospects of emerging economies. Indonesia did successfully handle the 'taper tantrum' in the middle of last year, when global markets over-reacted to the prospect of America unwinding its quantitative easing. Indonesia came through substantially better than other members of the 'Fragile Five' (India, Brazil, South Africa and Turkey) identified by financial markets to be at greatest risk. But markets remain nervous and Indonesian government bond yields remain well above those of countries like the Philippines, whose bonds were previously ranked alongside Indonesia's.

If the going does get tougher, Indonesia is poorly placed to handle a more serious crisis, either at the global level or domestically. As a still heartfelt legacy of the 1997-8 crisis, Indonesian policy-makers would be reluctant to seek help from the IMF. The operational effectiveness of the Chiang Mai Multilateral Initiative is extremely doubtful. Domestically, the Financial Sector Safety Net bill was rejected by parliament in 2008 and has little prospect of early revival, leaving policy-makers with few options in the event of financial-sector problems. 

An experienced commentator at the mini-update likened the current situation to the early 1980s, when a commodity boom was ending and Indonesia required strong structural reform to set the economy on a less resource-dependent development path. At that time, policy-makers rose to the challenge, introducing growth-enhancing reform measures. 

Jokowi operates in a far more difficult political environment compared with the 1980s. Will Indonesia, without the easy boost of spectacular commodity prices, squib the necessary structural changes and slip into the much discussed middle-income trap? Or will it reprise the restructuring of the 1980s, which could put it back on the 7% growth rates which characterised the Soeharto years? This is Jokowi's economic challenge.

Photo courtesy of Flickr user Ignatius Win Tanuwidjaja.


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

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

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

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

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

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

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

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

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

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

Graph courtesy of The Economist


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

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

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

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

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

Australia didn't require anything.

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

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

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

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

Photo by Flickr user Kim Farnyk.


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

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

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

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

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

Photo courtesy of DFAT.


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

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

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

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

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

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

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

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

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

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

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

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

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

Photo by Flickr user jareed.


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

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

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

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

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

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

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

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

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

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


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

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

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

Comparison of gross trade and value added trade

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

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

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

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