Economist Material for June 2nd Week : June 12(Interpretation), June 13(Discussion)

SINCE 2006 Japan has had no fewer than five prime ministers. Three of them lasted just a year. The feckless Yukio Hatoyama, who stepped down on June 2nd, managed a grand total of 259 days. Particularly dispiriting about Mr Hatoyama’s sudden departure is that his election last August looked as if it marked the start of something new in Japanese politics after decades of rule by the Liberal Democratic Party (LDP). His government has turned out to be as incompetent, aimless and tainted by scandal as its predecessors.

Much of the responsibility for the mess belongs with Mr Hatoyama. The man known as “the alien”, who says the sight of a little bird last weekend gave him the idea to resign, has shown breathtaking lack of leadership. Although support for his Democratic Party of Japan (DPJ) has slumped in opinion polls and the government relied on minor parties, the most glaring liabilities have been over Mr Hatoyama’s own murky financial affairs and his dithering about where to put an American military base. The question for the next prime minister, to be picked in a DPJ vote on June 4th, is whether Mr Hatoyama’s failure means that Japan’s nine-month experiment with two-party democracy has been a misconceived disaster.

The answer is of interest not just within Japan. Such is the recent merry-go-round of prime ministers that it is easy to assume that whoever runs the show makes no difference to the performance of the world’s second-largest economy. Now Japan’s prominence in Asia has so clearly been eclipsed by China, its flimsy politicians are all the easier to dismiss.

But that dangerously underestimates Japan’s import!ance to the world and the troubles it faces. With the largest amount of debt relative to the size of its economy among the rich countries, and a stubborn deflation problem to boot, Japan has an economic time-bomb ticking beneath it. It may be able to service its debt comfortably for the time being, but the euro zone serves as a reminder that Japan needs strong leadership to stop the bomb from exploding.

What’s more, stability around South and East Asia depends to a large extent on Japan’s 50-year-old security alliance with America, which acts as a counterbalance against Chinese military expansion. The nine-month stand-off between Japan and America over a marine base in Okinawa, a fight which Mr Hatoyama picked himself and has now done for him, is a glaring example of how poor leadership can muddy the waters.

Shogun to Japan’s head

With Mr Hatoyama out of the way, it is tempting to hope that the DPJ will put its problems behind it and quickly rebuild its credibility with the electorate and Japan’s friends abroad. There are two reasons for misgivings, however. The first is the role of Ichiro Ozawa, the Svengali-like figure who stood mischievously behind Mr Hatoyama. The second is the calibre of the candidates to become Japan’s next prime minister.

Mr Ozawa resigned as the DPJ’s secretary-general alongside Mr Hatoyama, but he, unlike his boss, has not promised to bow out of politics. Moreover, he has such influence over the party that he could continue to pull strings from behind the scenes, especially ahead of upper-house elections this summer. That would be inexcusable. Like Mr Hatoyama, Mr Ozawa has been caught up in campaign-funding scandals that have reeked as badly as they ever did under the LDP. He has meddled with good policies and failed to stop bad ones, such as the attempt to roll back the privatisation of the postal system. The “Shadow Shogun” represents the worst side of the old politics. If Mr Ozawa remains influential, he will only undermine any future party leader in the eyes of voters.

Whoever that leader is will have plenty to prove as it is (see article). As The Economist went to press, the most likely replacement for Mr Hatoyama was Naoto Kan, the finance minister. He has shown more financial nous than Messrs Hatoyama and Ozawa in arguing for fiscal reform in Japan. But he has kept so quiet about the DPJ’s failing leadership that it is hard to imagine him putting Mr Ozawa in his place. Other potential candidates, who have stood up more firmly to Mr Ozawa, will be opposed by many in the party who are under the man’s sway. And sadly, none looks like he has enough of the right stuff to restore Japan’s standing in the world.

Look up, Japan

For many voters, this all smacks of Japan’s earlier attempt to escape the LDP’s shadow, in 1993. The coalition government that replaced it—also under Mr Ozawa’s spell—lasted barely 11 months. But a lot has changed since then. Today the LDP has only slightly benefited from the DPJ’s woes, and is itself in danger of splintering. The legacy of two lost decades has left voters with little nostalgia for old habits. Having finally broken the mould of Japanese politics, it is almost inconceivable that they will vote the old lot back into office.

However far-fetched it seems at this sorry juncture, Japan’s leadership crisis presents a chance to progress to a new sort of politics, based more around policies than personalities. Besides its fiscal problems, Japan has an ageing population that will be a draw on the public purse. Its stock of savings is diminishing, and though it is riddled with misgivings about the presence of American troops in Japan so long after the second world war, it can hardly pay for its own defence. Factional politics has failed utterly to deal with these problems. But divisions within the political duopoly have produced splinter parties, some of which have sensible ideas for putting Japan’s economy back on track. The new DPJ leadership, however badly it does in this summer’s upper-house elections, should capitalise on that by forming coalitions with its ideological peers, rather than with the mavericks it has relied on so far. Getting rid of Mr Ozawa would be a sign of real change.

There is hope therefore that things are beginning to get so bad that reform really will appear relatively soon. But the main impression at the moment is of drift. The sad fact is that the world’s second biggest economy, home to companies that have changed industries around the world, is being kept out of dire trouble only by the loyalty of its own savers.

Israel and the world

Israel's siege mentality

Jun 3rd 2010
From The Economist print edition

The government’s macho attitude is actually making Israel weaker

THE lethal mishandling of Israel’s attack on a ship carrying humanitarian supplies that was trying to break the blockade of Gaza was bound to provoke outrage—and rightly so. The circumstances of the raid are murky and may well remain that way despite an inquiry (see article). But the impression received yet again by the watching world is that Israel resorts to violence too readily. More worryingly for Israel, the episode is accelerating a slide towards its own isolation. Once admired as a plucky David facing down an array of Arab Goliaths, Israel is now seen as the clumsy bully on the block.

Israel’s desire to stop the flotilla reaching Gaza was understandable, given its determination to maintain the blockade. Yet the Israelis also had a responsibility to conduct the operation safely. The campaigners knew that either way they would win. If they had got through, it would have been a triumphant breaching of the blockade. If forcibly stopped, with their cargo of medical equipment and humanitarian aid, they would be portrayed as victims—even if some, as the Israelis contend, brought clubs, knives and poles. As it was, disastrous planning by Israel’s soldiers led to a needless loss of life.

For anyone who cares about Israel, this tragedy should be the starting point for deeper questions—about the blockade, about the Jewish state’s increasing loneliness and the route to peace. A policy of trying to imprison the Palestinians has left their jailer strangely besieged.

Losing friends, strengthening Hamas

The blockade of Gaza is cruel and has failed. The Gazans have suffered sorely but have not been starved into submission. Hamas has not been throttled and overthrown, as Israeli governments (and many others) have wished. Gilad Shalit, an Israeli soldier taken hostage, has not been freed. Weapons and missiles can still be smuggled in through tunnels from Egypt.

Just as bad, from Israel’s point of view, it helps feed antipathy towards Israel, not just in the Arab and Muslim worlds, but in Europe too. Israel once had warm relations with a ring of non-Arab countries in the vicinity, including Iran and Turkey. The deterioration of Israel’s relations with Turkey, whose citizens were among the nine dead, is depriving Israel of a rare Muslim ally and mediator. It is startling how, in its bungled effort to isolate Gaza, democratic Israel has come off worse than Hamas, which used to send suicide-bombers into restaurants.

Most telling of all are the stirrings of disquiet in America, Israel’s most steadfast ally. Americans are still vastly more sympathetic to the Israelis than to the Palestinians. But a growing number, especially Democrats, including many liberal Jews, are getting queasier about what they see as America’s too robotic support for Israel, especially when its government is as hawkish as Binyamin Netanyahu’s. A gap in sympathy for Israel has widened between Democrats and Republicans. Conservatives still tend to back Israel through hell and the high seas. Barack Obama is more conscious that the Palestinians’ failure to get a state is helping to spread anti-American poison across the Muslim world, making it harder for him to deal with Iran, Iraq and Afghanistan. His generals have strenuously made that point. None other than the head of Israel’s Mossad, its foreign intelligence service, declared this week that America has begun to see Israel more as a burden than an asset.

That has led to the charge by hawkish American Republicans, as well as many Israelis, that Mr Obama is bent on betraying Israel. In fact, he is motivated by a harder-nosed appreciation of the pros and cons of America’s cosiness with Israel, and is thus all the keener to prod the Jewish state towards giving the Palestinians a fair deal. He has condemned the building of Jewish settlements on Palestinian territory more bluntly than his predecessors did, because he rightly thinks they make it harder to negotiate a peace deal. Mr Obama’s greater sternness towards Israel is for the general good—including Israel’s.

Harmony is not just a dream

Israel is caught in a vicious circle. The more its hawks think the outside world will always hate it, the more it tends to shoot opponents first and ask questions later, and the more it finds that the world is indeed full of enemies. Though Mr Netanyahu has reluctantly agreed to freeze settlement-building and is negotiating indirectly with Palestinians, he does not give the impression of being willing to give ground in the interests of peace.

Yet the prospect of a deal between Palestinians and Israelis still beckons. The contours of a two-state solution remain crystal-clear: an adjusted border, with Israel keeping some of the biggest settlements while Palestine gets equal swaps of land; Jerusalem shared as a capital, with special provisions for the holy places; and an admission by Palestinians that they cannot return to their old homes in what became Israel in 1948, with some theoretical right of return acknowledged by Israel and a small number of refugees let back without threatening the demographic preponderance of Jewish Israelis.

And what about Hamas, if Israel is to lift the siege of Gaza? How should Israel handle an authoritarian movement that refuses to recognise it and has in the past readily used terror? One answer is to ask the UN to oversee the flow of goods and people going in and out of Gaza. That is hardly a cure-all, but Hamas would become the world’s problem neighbour, not just Israel’s. The Arab world must do more, pressing Hamas to disavow violence, publicly pledge not to resume the firing of rockets at Israeli civilians and revoke its anti-Semitic charter. The West, led by Mr Obama, should call for Hamas to be drawn into negotiations, both with its rival Palestinians on the West Bank as well as with Israel, even if it does not immediately recognise the Jewish state. It is still the party the Palestinians elected in 2006 to represent all of them. None of this will be easy. But the present stalemate is bloodily leading nowhere.

Israel is a regional hub of science, business and culture. Despite its harsh treatment of Palestinians in the land it occupies, it remains a vibrant democracy. But its loneliness, partly self-inflicted, is making it a worse place, not just for the Palestinians but also for its own people. If only it can replenish its stock of idealism and common sense before it is too late.

Global economic policy

The deflation dilemma

Jun 3rd 2010
From The Economist print edition

Rich countries must act to prevent prices from falling. That will cause problems for emerging economies

SHOULD you fret more about inflation or deflation? Few questions matter more for investors and policymakers, yet few seem so uncertain. Financial markets are sending mixed signals. Falling yields on Treasury bonds suggest that many investors worry about economic stagnation and deflation; the soaring price of gold points to fears of runaway inflation.

Economists also differ in their assessment of where the greater risks lie, depending largely on the country and time frame they are looking at. Judging by the discussion in a new online forum of more than 50 leading economists from around the world, which The Economist launched this week, deflation is the bigger short-term danger in big, rich economies, whereas inflation is an immediate worry in many emerging economies and, potentially, a longer-term danger in rich ones.

That seems a fair assessment. In America, the euro area and Japan, deflation is either uncomfortably close or a painful reality, despite near-zero interest rates and other efforts by central banks. In the year to April core consumer prices rose by a mere 0.9% in America, the slowest pace in four decades. In the euro area they rose by 0.7%. And in Japan, which has battled falling prices for more than a decade, they fell by 1.5%.

Nor is there much reason to expect a sudden turnaround. Broad measures of money and credit growth are stagnant or shrinking in all three places. Unemployment is high and there are large gaps between the economies’ actual output and their potential. In the euro area, especially, austerity plans will further sap domestic demand. Thankfully, there is unlikely to be a sudden price plunge, not least because ordinary people still expect consumer prices to rise modestly, and these expectations of future inflation help anchor actual prices. But the short-term balance of pressures clearly points downward.

So, too, does the balance of risks. Deflation, if it becomes entrenched, is more dangerous than most forms of inflation. When prices fall consumers put off their purchases in anticipation of even greater bargains later, condemning the economy to a vicious cycle of weak spending and sliding prices. In heavily indebted economies falling prices would increase the real burden of consumers’ and governments’ debts.

Deflation is also harder to fight than inflation. Over the past two decades central bankers have gained plenty of experience in how to conquer excessive price increases. Japan’s ongoing inability to prevent prices falling suggests the opposite task is rather less well understood. Although it is true that heavily indebted governments might be tempted to erode their debts through higher inflation, there are few signs that political support for low inflation is waning (see article).

Add all this together and the world’s big three central banks—in America, the euro zone and Japan—should worry most about falling prices. The scale of budget belt-tightening suggests these banks’ policy rates could stay way down for several years. But this will cause problems elsewhere. Near-zero interest rates in the big, rich economies send capital flooding elsewhere in search of higher yields, making it harder for the healthier countries to keep their economies stable.

Helps here, hurts there

The problem will be most acute in emerging economies. Many are already overheating, with prices rising and asset bubbles inflating. Most have inappropriately loose monetary policy. Real interest rates are negative in two-thirds of the 25 emerging economies tracked by The Economist. Their inflation expectations are less stable, so prices can quickly spiral upwards.

This suggests a need for tighter monetary policy. Central banks in Brazil, Malaysia and elsewhere have begun. But the most important emerging economy, China, pegs its currency to America’s dollar, which limits its ability to raise interest rates. And even those with more flexible exchange rates worry that higher interest rates will send their currencies soaring.

In fact, stronger currencies in emerging markets are a necessary part of the “rebalancing” of the global economy that will allow enfeebled rich economies an escape from deflationary pressure. Tighter fiscal policy in emerging economies would help dampen price pressure. Capital controls should be part of their defences, too, against sudden floods of foreign cash.

History suggests, however, that none of these policies will be a panacea. When monetary conditions in the rich world are loose, emerging economies are prone to lending binges and asset bubbles. The price of avoiding deflation in the rich world today may be a bust in the emerging world tomorrow.

Masculine traits

To get the girl

Fighting off rivals may be responsible for masculine traits

May 20th 2010

Evolutionary forces at work

WHEN two drunken men fight over a woman, alcohol and stupidity may not be the only things at work. Sadly, evolution may have shaped men to behave this way. Almost all of the traits considered to be masculine—big muscles, facial hair, square jaws, deep voices and a propensity to violence—evolved, it now seems, specifically for their usefulness in fighting off or intimidating other men, allowing the winner to get the girl.

That, at least, is the contention of David Puts, an anthropologist at Pennsylvania State University, in an upcoming paper in Evolution and Human Behavior. Dr Puts is looking at how sexual selection gave rise to certain human traits. A trait is sexually selected if it evolved specifically to enhance mating success. They come in two main forms: weapons, such as an elk’s horns are used to fight off competitors; and ornaments, like a peacock’s tail, which are used to advertise genetic fitness to attract the opposite sex.

Researchers have tended to consider human sexual selection through the lens of the female’s choice of her mate. But human males look a lot more like animals designed to battle with one another for access to females, says Dr Puts. On average, men have 40% more fat-free mass than women, which is similar to the difference in gorillas, a species in which males unquestionably compete with other males for exclusive sexual access to females. In species whose males do not fight for access to females, males are generally the same size as, or smaller than, females.

The heavier brow and jaw of males might have developed to withstand blows from other males. (In prehistoric times, a broken jaw could have ended up being a fatal injury.) Heavy eyebrows, facial hair and deep voices all could serve to make a man more imposing to other men. Dr Puts does not dismiss mate selection outright. Women are attracted to some of the same traits that are good for dominating other men because they signal that the man will sire sons who will also be successful at mating. But female choice probably is not the primary cause of the traits.

It is a disturbing idea to modern minds, harking back to old stereotypes about violent cavemen battling with clubs while a passive woman, fetching in furs, waits helplessly to see who will win her. But Dr Puts emphasises that evolutionary biology is not destiny. Regardless of our evolutionary past, in modern societies men and women freely choose their mates. However, understanding the evolutionary pressures that made men the way they are could help us better understand male violence, including murder, domestic abuse, gang violence and perhaps even warfare.

Business.view

Changing course

Berkeley's is the latest business school to shake up its MBA courses

May 25th 2010

“VALUES” are all the rage at business schools nowadays. This week around 300 graduating MBAs at Harvard Business School will take an oath, pledging to play a positive role in society once they graduate. At the last count, this is slightly fewer Harvard MBAs than took the oath when it was introduced last year; but thanks in part to a new book by the authors of the oath, the idea is spreading through business schools like wildfire. There are now over 3,000 signatories from more than 300 institutions.

It will be unsurprising if, this time next year, taking the oath is compulsory rather than voluntary at Harvard, given Nitin Nohria’s recent appointment as dean of its business school. He, along with his colleague Rakesh Khurana, was an early advocate of an oath and helped the authors shape it. Even if Mr Nohria decides not to pick a fight over the ethical pledge with the many sceptics on his faculty, he has made no secret of his support.

On the other side of the country, another dean is making an audacious bid for leadership in the somewhat implausible crusade to turn business schools into moral wellsprings. “This feels like exactly the time for a business school to take values seriously—not just post them on the wall, but to really go for it,” says Rich Lyons, the dean of the Haas School of Business at Berkeley. The MBA students who arrive after the summer will take a course that has been thoroughly revamped, he says, in an effort to achieve a cultural shift that he believes will go much further than any MBA oath could achieve. “The oath has triggered lots of good discussions, but when 50% of your students sign on to something, that’s a conversation not a culture. It needs to be universal.”

Business schools have trailed behind leading companies in managing their internal culture

Mr Lyons reckons that business schools have long trailed behind leading companies in managing their internal culture. His models for cultural change are firms such as Procter & Gamble, General Electric, McKinsey and Southwest Airlines, as well as—whisper it softly—Goldman Sachs, where he was “chief learning officer” for two years before jumping ship with brilliant timing to become dean in the summer of 2008.

This approach puts Mr Lyons in the middle of a debate about strategy that has long divided business-school faculty. One camp aims to map the competitive landscape, and position their organisations at the point on the map that offers the greatest opportunity. The other camp prefers to focus inwardly on an organisation’s values and core abilities, and then to pursue success by playing to those strengths—which is what Mr Lyons says he is doing at Haas. In particular, he wants to turn what has hitherto been viewed by business as a downside of Berkeley’s culture—its radical non-conformism—into a virtue. A tendency to question the status quo can be translated into a capacity for innovation, he believes. The goal is that Haas MBA graduates will become “path-bending, innovative leaders.”

Haas already has a reputation for producing a different sort of MBA from other elite schools’, Mr Lyons claims. “Business schools are known as breeding grounds for over-confidence, for hubris, for arrogance, for self-focus. But recruiters tell us that one of the defining features of our students is ‘confidence without arrogance’.” Indeed, a similar phrase, “confidence without attitude”, is now one of four core defining principles behind the redesign of the MBA course, along with “question the status quo”, “students always” and “beyond yourself” (ie, “considering the long-term impact of our actions and the facility for putting larger interests above our own”).

Yale has scrapped conventional subjects; Haas is trying to teach the old subjects in a new way.

The reforms at Haas are being billed as one of the most radical shake-ups of an MBA programme since both Yale and Stanford changed theirs in 2006. But whereas Yale scrapped conventional subjects such as marketing, accounting and strategy in favour of more nebulous themes such as the customer, innovation and business and society, the Haas approach involves teaching the old subjects in a new way, by emphasising 15 specific skills, including experimentation, revenue-model innovation and risk-selection.

Only about a fifth of the curriculum will be different, but most of the changes will be at the beginning of each course, so students will feel a big change, says Mr Lyons. There will be three new core courses, out of 12: problem framing, exerting influence without formal authority, and leading people. The other nine are being revamped. For instance, the focus of the statistics course will now be to get students to think about what data they would like to have to make a decision, and how they would get that data—to “turn them from consumers of data into experiment designers, producers of data.”

In marked contrast to the rumblings of discontent heard at Harvard, Haas’s changes seem to have gone down remarkably well with its faculty. When Mr Lyons put his redesign to a vote four months ago, 54 of his teaching staff approved, four abstained and no one was against. Mr Lyons says the changes have also been well-received by both alumni and incoming students, who will now be more rigorously assessed for compatibility with the culture he wants to create. At the very least, this seems intelligent marketing for Haas in an increasingly competitive MBA marketplace. What difference it will make in practice to the quality and character of its MBA graduates, only time will tell. As with the MBA oath, talking the talk is a lot easier than walking the walk.

Continue reading: Business schools are having to adapt to a more difficult market (May 6th).

From Economist.com

Economics focus

A winding path to inflation

Jun 3rd 2010
From The Economist print edition

Even if governments could create inflation, they may not want to

IN THE short run inflation is an economic phenomenon. In the long run it is a political one. This week The Economist asked a group of leading economists whether they reckoned inflation or deflation was the greater threat; this was our inaugural question in “Economics by invitation”, an online forum of more than 50 eminent economists. The rough consensus was that in the near term, as Western economies struggle to recover, the bigger worry there is deflation. But as the time horizon lengthened, more experts cited inflation, because it seems the most plausible exit strategy for governments trying to deal with crushing debts. “Deflation is not a lasting threat,” wrote Arminio Fraga, a former president of Brazil’s central bank. “The more interesting question is whether they can manage to keep inflation down over time under the regime of fiscal irresponsibility now prevailing almost everywhere.”

Creating more inflation is harder than it sounds—even if rich-world governments were tempted to try, as a solution to their fiscal problems. It requires aggregate demand to return to, and exceed, potential output. Measuring the output gap (the shortfall of actual demand compared with potential GDP) is notoriously tricky. The OECD reckons for its members it will be about 4% this year, down from about 5% last year. It has revised that estimate down since November in recognition of better-than-expected growth, especially in America. Still, the revised gap is larger than at any time since at least 1970. America’s gap was larger in 1982, but inflation today is much lower. Indeed, the OECD estimates that in each of the G7 countries, inflation will be less than 2% through to the end of next year. The process could be hurried up if inflation expectations rise. But with underlying inflation below central banks’ targets in many countries, and dropping, expectations could move down instead.

Using monetary policy to generate the growth necessary to push inflation much above 2% would be difficult, since short-term interest rates are already below 1%. Fiscal policy is turning contractionary as America’s stimulus expires and much of Europe implements austerity measures.

Monetarists downplay the output gap and focus instead on the vast amount of money that has been created as central banks buy bonds or extend loans to banks. They worry that this money, which today is largely being hoarded by the financial industry, will eventually be loaned out into the real economy, prompting prices to rise. Yet this concern is probably overblown. After all, central banks can still raise interest rates, no matter how big the monetary base is, and they also have ways of withdrawing the exceptional liquidity measures put in place during the crisis. The European Central Bank successfully “sterilised” its recent purchase of government bonds by enticing banks to deposit an offsetting amount of money with the central bank. The Federal Reserve will start testing a similar system on June 14th.

If anything, the record of quantitative easing in Japan should heighten worries of deflation. As Adam Posen of the Peterson Institute for International Economics notes in our forum, it “did not have a predictable or even large short-term result…We need more humility about what we are capable of doing with monetary policy once deflation begins.”

Even if inflation could be created, would it reduce the real government debt, the presumed purpose of such a policy? Not easily. First, for most countries the greatest long-term fiscal threat comes from unfunded retiree benefits, which by their nature are indexed to inflation. Second, the maturity profile of most countries’ marketable government debt is relatively short: over half of America’s and more than 40% of that of Germany, France and Italy matures within three years. Britain, at 20%, is the exception. This means that unless investors are repeatedly surprised, inflation will lead to higher nominal interest rates as debt is refinanced, and in turn to an unchanged real debt. If governments set out to create inflation, investors are likely to notice and react.

Even so, politicians could conceivably try to hold interest rates down, either by forcing banks and others to own government debt or by ordering the central bank to keep rates low or to buy the debt outright. This, however, would require overcoming the highest hurdle of all: the political and economic consensus for low inflation.

Long live price stability

The inflation of the 1970s had its origins in the 1960s, with economists who believed that a bit more inflation could buy lasting lower unemployment. The natural-rate-of-unemployment hypothesis of Milton Friedman and Edmund Phelps, the rational-expectations revolution and the dismal experience of the 1970s all put paid to that idea. Politicians, aware that high inflation often brought regime change, accepted the idea that central banks should be left to concentrate on inflation. The latest crisis has demonstrated that price stability is no guarantee of financial and economic stability—indeed, a narrow obsession with prices may have led central bankers to neglect asset bubbles and the condition of the banks. Yet in practice price stability has not been dislodged from the centre of central banks’ attention. If anything, some seem anxious to unwind their quantitative easing and normalise interest rates despite the preval‎!ent deflationary pressure.

More striking is the lack of political pressure to do otherwise. Central bankers’ reputations have been battered, but few have paid with their jobs. Senators who opposed a second term for Ben Bernanke as Fed chairman were more likely to cite regulatory failures than high unemployment. With the exception of Japan, there have been few instances of governments pressing central banks for more expansionary policies. To be sure, there’s not much more they could do. But perhaps politicians, like central bankers, are not yet ready to discard orthodoxy.

European banks

Waiting for the big one

Jun 3rd 2010 | BERLIN
From The Economist print edition

Where do Europe’s money-market jitters sit on the financial Richter scale?

IF YOU live in San Francisco you get used to the tremors. In banking, however, every shake and jerk still feels like it might herald another devastating earthquake. Investors are nervous and regulators are too. Monitoring risk in the financial system was once a job for officials thought to be too dull for monetary policy. Now financial seismology is where it’s all at.

When all three of the most-watched gauges of stability in banking deteriorate, as they did in Europe in the last week of May, there is naturally a rush to sound the alarm. Nerves had already been frayed by the Bank of Spain’s seizure of CajaSur, a savings bank, on May 22nd (despite the central bank’s efforts to telegraph this for months). Ratings downgrades of assets guaranteed by Spain’s central bank didn’t help either.

The first of these unsettling gauges is the rate at which banks are willing to lend to one another, known as LIBOR (London Interbank Offered Rate). As of June 2nd the three-month dollar LIBOR rate had more than doubled to above 0.5%, a level last seen a year ago, after lounging comfortably for months at about 0.25%. It continues to edge up, albeit at a slowing pace. Futures markets suggest that it may yet double again before the end of the year. Analysts at Citigroup reckon that LIBOR could triple to 1.5% over coming months as markets price in the risk that banks may suffer losses on some of their holdings of government bonds.

The second alarm is the widening in the spread between LIBOR and the relatively risk-free interest rate known as OIS (overnight indexed swap). In May it tripled to above 0.3 percentage points, suggesting that banks are hoarding cash rather than making it available on the interbank market. A rise in either LIBOR or its spread over OIS is unsettling. When both go up together they suggest that the delicate strands of trust that underpin the financial system are again beginning to fray.

The final signal is in the credit-default swaps (CDS) market, a measure of the price paid to insure debt issued. CDS spreads on even the biggest banks have also surged in recent days (see chart), indicating the risk of default, while low, has risen. For a few smaller European banks these spreads are at scary levels.

So far these are tremors, not quakes. Both LIBOR and the OIS spread would have to rise by about ten times before reaching the levels they did when Lehman collapsed. And although CDS spreads are rising, they remain lower than they were before the bail-out of Greece was announced. The financial system has been strained, but it has not broken down.

That partly reflects the extraordinary help that the European Central Bank and other central banks are still offering. The ECB is providing at least ?800 billion in loans to banks, much of it in exchange for slightly soiled government bonds and other dubious assets. Even as central bankers worldwide talk of withdrawing the special liquidity programmes put in place during the crisis, this amount has been creeping up from nearer ?700 billion at the beginning of the year, according to Alastair Ryan, an analyst at UBS.

Southern discomfort

Just how dependent firms in southern Europe are is hotly debated. One executive at a rival big bank nearer the North Sea than the Mediterranean laughs at the idea that Spain’s big firms can fund themselves without support. Spanish officials, though, insist their banks have not tapped more than their normal share of ECB borrowing, and that the big two firms are able to raise money from markets at a sensible price. They dismiss the rumours as ridiculous.

Part of the funding jitters reflects the remote but higher risk that the government of a big European economy, such as Spain, might default. This would be a calamity for European banks. But the nervousness also reflects the widespread belief that European banks have been slow to recognise losses on private-sector assets.

The numbers are certainly large. The ECB recently estimated that euro-zone banks would take ?123 billion of charges against loans this year. However, it reckoned this might be partly offset by profits from securities whose prices are recovering. And, in any case, that figure needs to be put in the context of a very big banking industry, with a lot of underlying profits, especially when compared with America’s. In 2009 euro-zone banks absorbed similar bad-debt costs to those expected this year while still making a net profit, and thus replenishing capital.

Yet it’s hard to ignore the worries of the past two weeks. Some banks are becoming dangerously addicted to the medicine the ECB has been administering. They can easily borrow from the ecb and then invest the proceeds in higher-yielding government bonds. Mr Ryan of UBS, reckons this “carry trade” may account for as much as 40% of the profits posted by some smaller Spanish banks and 20% at bigger ones. Banks have also reduced the maturity profile of their own borrowing, rather than paying higher rates for safer longer-term funds. When all banks make the same decision this is a form of collective madness because it makes the system vulnerable to market disruptions. Moody’s, a ratings agency, notes that the average lifespan of new bank debt has fallen to its lowest level in at least 30 years.

Most of all, even if the system is solvent, individual firms might not be—as the implosion of some of Spain’s savings banks highlights. Europe has dodged a big crisis this spring but still needs to put in place resolution regimes for failing banks, wean firms off volatile short-term funding and publish stress tests on individual banks (as America did, giving confidence a powerful boost). Until it does, it will be hard to ignore even the slightest tremor.

Charlemagne

The pain in Spain

Jun 3rd 2010
From The Economist print edition

Austerity packages are difficult to pull off, as the Spanish experience shows

FRANCISCO GRANADOS, a conservative Spanish politician, works in a tastefully modernised palace. He is guarded at street level by men in quaint uniforms (in his case, Civil Guards in patent-leather tricorne hats) and upstairs by serried ranks of aides. His limousine waits in the square below, watched over by pigeons and the bust of a dead aristocrat. All in all, he offers a fine study of political power as it is exercised across Europe every day.

Mr Granados, a minister in Madrid’s regional government, administers more than 160,000 public servants. Add those who work for the central government, the city and other boroughs, and half a million of the capital’s 6.5m residents work for the state, he reckons. A further million are retired, a million are children and more than half a million are unemployed (national jobless rates are almost 20%, with youth rates double that). In short, almost half of all Madrileños depend on the state in some way.

Following other European countries, Spain’s Socialist central government recently announced austerity plans. Cutting public spending fast is not easy, and it is no coincidence that governments have trimmed things they directly control, like public-sector salaries: measures range from a pay freeze in Italy to a 25% pay cut in Romania.

With an eye to public opinion, governments have also tackled symbols of privilege, making deep cuts to ministerial pay or limousine fleets. Even in France, where the government rejects talk of “austerity” or public-sector pay cuts, the political elite is doing its bit: the education minister is reported to have started to decorate his offices with artificial flowers.

In several countries cuts are being stealthily applied by not replacing civil servants when they retire. Spain, for instance, has said that only 10% of those who retire will be replaced. An optimist might wonder if Europe is about to embrace structural reform by accident: after allowing public sectors to swell, the need for swift cuts is pushing them to slash the costs of the state. Alas, pessimists are entitled to some doubts. The 10% rule in Spain does not apply to areas like health, education or care for the elderly, and does not stop regional governments creating new posts.

Moreover, powerful men like Mr Granados are oddly powerless when it comes to changing the status quo. Spanish public workers essentially cannot be sacked. Last week Madrid’s regional government announced it was scrapping 48 of its 125 official cars, and replacing the remaining Audi and Peugeot limousines with midsized models. “The paradox is, I can’t get rid of any of the official drivers,” sighs Mr Granados. He can try moving government drivers to new duties, but only with their consent (though he is laying off 23 drivers on temporary contracts).

The minister cannot move an official from social services to the health department, or from a day to a night shift. Absenteeism rates average 18%, but little can be done about abuses: public workers can take three days off sick without medical proof. If he wants to recruit a star surgeon, the minister cannot offer a bonus. All surgeons must be paid the same rates—indeed, doctors’ salaries are tied to pay rates for all staff, including hospital cleaners. The conservative-led regional government might like to privatise some state enterprises, including Madrid’s two public television channels. But under collective agreements, workers laid off by new private owners would have to be taken back on to the public payroll. An army of 3,242 trade union representatives polices these agreements, their salaries paid by the Madrid region.

Spain is often cited as the big EU economy most in need of labour-market reform. The central government has spent months agonising over changes to a law that makes it expensive for private firms to make full-time staff redundant. But in truth parts of Spain’s economy are very flexible: just ask the 1.5m people who have lost jobs since the boom stopped. The problem is that the labour market divides insiders from outsiders. Immigrants on temporary contracts have been hit hard, as have the young.

Are you in or out?

Will the economic crisis force change, or entrench privilege? So far lots of outsiders have responded by trying to become insiders. Applications for posts in Spain’s national police force have tripled since the crisis began. Some 300 people apply for each new clerical job advertised by the Madrid government, officials say, though the number of posts available has fallen sharply.

At the Centro de Estudios Financieros (CEF), a private college in Madrid that prepares graduates for civil-service entrance exams, numbers are also up, despite fees of ?2,000 ($2,450) a year. Most tutors at such colleges are themselves moonlighting civil servants: public-sector hours run from eight till three, giving bureaucrats ample time to pursue second careers.

Free time and the guarantee of a job for life matter more than pay cuts, declares Almudena Gonzalez Menéndez, a CEF student who has just passed exams to become an employment-ministry inspector. She told, appalled, of friends telephoned in the evening by their private employers with work requests. As an official, she enthused: “you have your life to yourself”.

Yet some austerity measures could prove surprisingly effective, notably the non-replacement of retiring staff. Europe’s civil services are greying fast: in lots of countries, including Spain, 30% of staff will retire in the next 15 years. That sets the scene for big changes, if politicians dare.

More politically, the economic pain in Europe is likely to get worse. Not all public servants are privileged: some teachers in Romania earn ?250 a month, so a 25% cut would be brutal. But in places like Spain, an unsackable bureaucracy now co-exists with 40% youth unemployment. That is a recipe for reform or revolt. Half measures will not do the trick.

Economist.com/blogs/charlemagne

Copts and marriage

You can't just marry anyone

Jun 3rd 2010 | CAIRO
From The Economist print edition

A secular step in a conservative country

And if it goes wrong you can’t try again

EGYPT’S laws governing marriage and divorce are a multi-storeyed affair. For the majority of Egyptians, who are Muslim, they are set by sharia law as interpreted by Imam Abu Hanifa, an eighth-century Iraqi scholar who founded one of Sunni Islam’s four jurisprudential schools. For Christians the rules depend on which church you belong to; Protestant evangelicals are more tolerant of divorce than are the Coptic Orthodox, for instance, and Syrian Orthodox regulations stipulate—among other things—that a man may not marry a woman who breastfed him. Jewish family law is divided between Hasidic and Rabbinical Jews, though both provide that a “foul odour” can be grounds for divorce.

The Muslim marriage ceremony is fully legally binding, since a maazoun, a Muslim marriage registrar, is a public servant, but it is generally then also registered as a civil marriage at the justice ministry. But Christians must always register their religious marriage with civil authorities for it to be legal. This has given churches a lot of power: though Christians can get a civil divorce, the church will not remarry them, so the state cannot recognise a new marriage.

This has affected Coptic Orthodox Christians in particular, as their pope, Shenouda III, has taken his flock on a more conservative path since he became the 116th successor to Saint Mark the Evangelist in 1971. A steady trickle of Orthodox Copts has joined the evangelicals, who are seen as less laden with heavy ritual, more generous with welfare and more flexible over marriage and divorce. In the Orthodox church divorce is rarely granted, and then only through a special petition to the pope.

When the church refused Hani Wasfi Naguib a second marriage after his divorce, he sued Pope Shenouda in Cairo’s Administrative Court, which adjudicates matters of legal procedure. Mr Naguib won his case last year, when the court told the church it must grant him his right to divorce and remarry. The church appealed and lost, with the Supreme Administrative Court ruling on May 29th that “the right to establish a family is a constitutional right, which is above all other considerations.”

Defiant Coptic bishops say “there is no power on earth that could make us violate the teachings of our Lord Christ.” The case will now go to the Supreme Constitutional Court, the highest in the land. In the meantime, the affair has stirred a debate over whether civil and religious law should be separate. Secularists have long argued that Egyptians should be able to marry outside their faiths. Islam, for instance, forbids a Muslim woman from marrying a non-Muslim man. Egypt is still conservative in such matters, so things are unlikely to change soon. But the latest court ruling may have marked a notable first step.

An Argentine cult

Want Evita's handbag?

Jun 3rd 2010 | BUENOS AIRES
From The Economist print edition

The market in Peronist memorabilia

THE objects scattered around Mario Rotundo’s poky, windowless office in central Buenos Aires do not look like much. There is some old furniture, yellowing books and files, and personal effects—items of sentimental value if they had belonged to a favourite aunt, perhaps. But their original owners were Juan and Eva Perón, the former Argentine president and first lady who are still adored by much of the country. That makes the relics venerated—and Mr Rotundo means to make the most of that.

Mr Rotundo met Perón in 1970, during the president’s exile in Madrid, and the two became firm friends. Before he died four years later, Perón agreed to leave his worldly possessions to Mr Rotundo. By 1990 no copy of Perón’s will remained, but his third wife, Isabel, formally gave Mr Rotundo title to the belongings. She soon regretted her promise and tried to reverse the gift, but had no luck in the courts. Ten years later Argentina’s government put Mr Rotundo in charge of Perón’s effects in the presidential palace’s museum as well.

Mr Rotundo says Perón’s instructions were to use the items to fund good works. He has already made $500,000 for his charitable foundation by selling selected objects. Earlier this year he decided to mount an online sale of the entire remaining collection of 14,000 items. Perón’s personal copy of an account of the year he took power by Félix Luna, a historian—complete with handwritten annotations disputing the retelling of several events—will set you back 57,000 pesos ($14,500). Propped against a table in Mr Rotundo’s office is a worn stone plaque that once marked the grave of Perón’s favourite dog in the garden of his Madrid residence. It bears the words “Canela—best and most faithful of friends”. Hanging nearby is the green silk gown Mr Rotundo says Perón wore on the day he died.

The idea of selling such items still rankles some guardians of Perón’s memory. Shortly after the auction was announced, Lorenzo Pepe, who runs a government institute that studies Perón, accused Mr Rotundo of having been a bankrupt and a fraudster and of now peddling Peronist paraphernalia of dubious provenance. The charge was later erased from the institute’s website. But Mr Rotundo is suing Mr Pepe for libel.

He says that potential buyers have been telephoned and warned to stay away. He adds that he himself was threatened on April 30th: a stranger approached him and ordered him to withdraw the libel suit and donate the memorabilia according to “instructions you will receive.” Perón’s legacy “could awake all kinds of passions,” he says. “Who knows if some madman will come and put a bullet in me?”

HIV/AIDS

Altogether now

Jun 3rd 2010
From The Economist print edition

Enlisting business to fight HIV

WHEN the Centres for Disease Control and Prevention (CDC), a federal agency, published its latest statistics on HIV in 2008, there was consternation: there were 40% more new HIV infections each year than had previously been thought. The survey also revealed that a fifth of Americans with HIV were unaware of it. One theory is that people have been lulled into a false sense of security about HIV because campaigns to publicise the condition have been scaled back and anti-retroviral drugs are more readily available.

For organisations such as the Global Business Coalition on HIV/AIDS, Tuberculosis and Malaria, or GBC—which is based in America but works mostly in developing countries—the news that HIV was still on the march back home came as a wake-up call. The GBC has promoted the use of businesses in disease-prevention programmes in developing countries for the past decade, with great success. Its premise was that no government or NGO could ever hope to tackle HIV, tuberculosis or malaria on its own. Many now think that public-private partnerships should be used to revive counter-HIV efforts at home.

“Anyone who, in this day and age, thinks that HIV will be solved by government alone is clearly not grasping the scale of the problem,” says Shannon Hader, director for HIV/AIDS at the District of Columbia’s department of health. Miss Hader was one of the first health officials to seize the opportunity to work with the GBC in America: 3.2% of adults and adolescents in the capital are infected with HIV, one of the highest rates in the country.

Since the majority of new HIV cases are linked to the behaviour of undiagnosed carriers of the virus, the GBC’s efforts in America focus on testing and prevention campaigns, with a strong emphasis on the use of condoms. These had taken a back seat in favour of promoting abstinence during the Bush years.

In the District, Miss Hader’s department was already planning a campaign to encourage doctors to offer HIV tests as part of routine health checks when the GBC suggested bringing in the sales force of Pfizer, a pharmaceutical giant. Pfizer does not produce HIV testing kits itself, but does sell many other drugs, which their sales representatives promote among the capital’s health professionals. With their new “Offer the Test” programme, sales reps simply take a few minutes during their regular visits to explain the campaign. By tapping into Pfizer’s network, DC’s health department is benefiting from relationships that would have taken it years, not to mention thousands of dollars, to build.

John Tedstrom, the chief executive of the GBC, says that contributions in kind are not only more valuable to the recipient, they are often worth more than companies would want to write a cheque for. Corporations, he adds, can also bring the same appetite for success to their HIV response that they apply to their businesses.

Ron Dellums, the mayor of Oakland, California, agrees. On June 1st his administration launched a new strategy to include the business community in the city’s existing HIV campaign, Get Screened Oakland (GSO). Oakland is one of the worst affected cities in America, thanks to large populations of high-risk groups such as Latinos, African-Americans and gay men.

Chevron, Walgreens, the Levi Strauss Foundation, Young & Rubicam and the city’s basketball team, the Golden State Warriors, will all work alongside the GSO’s public and non-profit partners to provide management skills, publicity, volunteers for community programmes and training. “Companies are smart about marketing, campaigns, advertising, technical assistance and they bring all of this to GSO, as well as financial contributions,” the mayor explains.

Mr Dellums hopes that this new strategy, devised with the GBC and the CDC, will become a national model. His hopes aren’t unreasonable: the GBC is providing findings from its member companies to the country’s first national HIV/AIDS strategy and it has been consulted both at the White House and on Capitol Hill.

Getting the corporate sector involved makes sense. Companies, after all, need healthy employees and consumers. Promoting the health of local communities—Chevron’s headquarters are just 15 minutes’ drive from Oakland, for instance—might be as much about enlightened self-interest as it is philanthropy. As Mr Dellums puts it, “at the end of the day, HIV is everybody’s business.”

Lexington

The open society and its discontents

Jun 3rd 2010
From The Economist print edition

In his last column, our current Lexington urges Barack Obama to defend the free flow of goods, people and ideas

A LONG time ago, the rising seas turned Tasmania into an island. A few thousand inhabitants were cut off from contact with the Australian mainland. Their technology regressed. They forgot how to make bone tools, catch fish and sew skins into clothes. It was not that they grew less intelligent. Their problem was that they no longer had many people to trade with. It took a lot of effort to learn how to carve needles out of bone. So long as there were plenty of people with whom to swap needles for food, it made sense to acquire such skills. But in a tiny, isolated society, there may have been room only for one or two needle-makers. If they both fell off cliffs, the technology died with them. When the first Europeans reached Tasmania, they found natives whose only shields against the winter chill were seal-fat smeared on their skin and wallaby pelts over their shoulders.

America, at its best, is the opposite of ancient Tasmania: a vast open society through which goods, ideas and people flow freely. “The success of human beings depends crucially, but precariously, on numbers and connections,” argues Matt Ridley, author of “The Rational Optimist: How Prosperity Evolves” and a former writer for The Economist. Trade allows specialisation. In narrower and narrower fields, people acquire deeper and deeper skills. Through trade, they share them. The fewer barriers there are to the free movement of goods and people, the more opportunities there are for ideas to meet and “have sex”, as Mr Ridley puts it.

How open does Barack Obama want America to be? The evidence so far is mixed. Last week he ordered another 1,200 national guards to the Mexican border. Was this a shrewd sop to nativists before Mr Obama pushes for a more welcoming immigration law? Or a cynical ploy to woo isolationist votes? Congressional Republicans are in such an obstructive mood that no immigration bill is likely to pass before the mid-term election. Mr Obama has often said he favours reform, but no one knows how much political capital he will invest in its pursuit.

Immigration policy is a mess. The process for getting a work visa is so arduous that many bright would-be immigrants give up. The government subsidises foreigners to acquire PhDs at American universities and then kicks them out of the country. The World Economic Forum talks of a “talent crisis”, and predicts that America will have to add 26m workers to its talent pool by 2030 to sustain the economic growth rates of the past two decades. Michael Bloomberg, the mayor of New York, describes America’s immigration policy as “national suicide”. In theory, one could lower the barriers to highly skilled workers without tackling the more controversial issue of unskilled migration. But politically, you have to do both together, says Bart Gordon, a Democratic congressman from Tennessee. Hispanic voters want a path to citizenship for their undocumented cousins. An immigration bill needs a broad coalition of supporters to pass, so it will need to offer something for everyone.

America has not raised barriers to trade much on Mr Obama’s watch, but it has not lowered them either. Trade pacts with Colombia and South Korea have been stuffed in the freezer. Average duties have barely budged, calculates Douglas Irwin of Dartmouth College, but that takes no account of trade-distorting subsidies and the “Buy American” bias in public procurement. Mr Obama says he favours open trade, but he has taken some steps backwards, such as slapping tariffs on Chinese tyres. The White House sometimes gives the impression that it sees trade policy as a way to advance environmental and social goals, rather than trade itself, frets Sallie James of the Cato Institute.

The number of temporary visitors to America (tourists, businesspeople and so on) fell sharply after September 11th 2001, recovered strongly and then briefly fell again when the recession struck. America is a wonderful place to visit, but its border bureaucracy is arguably the worst in the rich world. This is a shame: Simon Anholt, a consultant on national image, finds that foreigners who visit a country in person gain a much more positive view of it, especially if they make friends there.

Mr Obama, lift your lamp

Openness has strategic advantages, too. America’s military dominance cannot last for ever. China is catching up fast. North Korea has the bomb and Iran may soon follow suit. In future America’s global sway will depend less on the threat of force and more on soft power. Fortunately, its charms are more potent than its arms. Foreigners devour American cultural exports, from “Desperate Housewives” to the Harvard Business Review. Young people from traditional societies watch “Friends” and see the possibility of greater independence, of living without parents and uncles breathing down their necks, reckons Martha Bayles of Boston College. Foreign leaders are disproportionately educated at American universities, where they cannot help but notice that political freedom need not spell chaos. If and when China eventually embraces democracy, this will surely be part of the reason.

The financial crisis has shown that cross-border flows of money need tighter regulation. It has not undermined the case for the free movement of goods and ideas and people, but many Americans think it has. Openness is unsettling. It provokes fierce opposition. It can be reversed. Ruinous tariffs are easy to impose, as was discovered during the Depression. Foreigners can be mistreated without electoral consequence, since they cannot vote. Yet this would be a colossal mistake. These days it is not only the world’s tired, poor huddled masses who yearn to breathe free. More often, it is the energetic and upwardly mobile. A fifth of China’s graduates say they want to emigrate; few peasants do. The open society needs defenders. So it would be nice if Mr Obama spoke up more often for the ideals etched on a certain statue.

Economist.com/blogs/lexington

Schumpeter

A mixed blessing

May 27th 2010
From The Economist print edition

The cheaper euro will be good for some European companies—up to a point

A FEW years ago even global celebrities bowed down before the almighty euro. Gisele Bündchen, a Brazilian supermodel, insisted on being paid in the currency. Jay-Z waved ?500 notes in a rap video. The Wu-Tang Clan, fellow American rappers, listed the price of one of their CDs in euros rather than dollars on their official website.

Today the euro has lost much of its glamour, gangsta or otherwise. It has fallen by 15% against the dollar since December. Most analysts think that the decline still has some way to go. Some even talk of parity between the two currencies. This is a severe blow to Europe’s self-image. But is it such a bad thing for business in the euro zone?

Exporters had seen the overvalued euro as a heavy cross to bear. For example, Anne Lauvergeon, the boss of Areva, a French nuclear firm, complained loudly that her company lost its bid to supply four reactors to Abu Dhabi thanks to the currency’s strength. The euro’s decline, in contrast, should bolster exports for big manufacturers (particularly in northern Europe) and luxury-goods companies (particularly in Italy and France) while boosting tourism across the continent.

Daimler-Benz expects a billion-euro gain in its operating profits this year. Sales of its Mercedes brand have already surged by 26% in America in the first four months of this year—and those sales are worth more in euros than they would have been at the beginning of the year. EADS, the parent company of Airbus, has seen its share price rise, despite disappointing earnings, in anticipation of a similar “euro effect”. Rémy Cointreau, which pays for the production of most of its goods in euros but sells most of them outside the euro zone, could be in for a bonanza.

European exporters, particularly Germany’s mighty car companies, have worked hard to boost productivity during the era of the strong euro. They are now well placed to reap the fruits of their good management. They can also wallow in a little Schadenfreude as American and Asian companies take up the cross of a higher dollar. The likes of Procter & Gamble and Colgate-Palmolive, which are already suffering from weak consumer spending and expensive raw materials, will now have to cope with a mightier dollar as well.

Yet they are hardly singing the “Ode to Joy” in Europe’s boardrooms. That is partly because most businesses loathe uncertainty, and European ones are now having to rejig contracts with foreign suppliers and recalibrate investment plans. But it is also partly because many big companies have worked hard to protect themselves from the opposite problem to the one they are now confronting. Some have locked themselves into hedging arrangements that will prevent them from taking advantage of the lower euro until next year or even the year after. PPR, a French holding company which owns Gucci and several retail chains, has already declared that it will be adversely affected by its hedging policy, for example.

Some of Europe’s most successful exporters operate in markets where price is far from being the primary consideration. Europe’s export powerhouse, Germany, is more focused on industrial goods than consumer ones. It is also dominated by highly specialised companies—many of them small—that produce bespoke goods for individual customers. Georg Tacke, of Simon-Kucher & Partners, a consultancy, points out that even those companies that are enjoying windfall profits are reluctant to treat the euro’s decline as an opportunity to gain market share, through cut-throat pricing, since they are well aware that what goes down can also go up.

Some of Europe’s great success stories in recent years have been driven by the overvalued euro. A swathe of European companies—think of Spain’s Santander or Italy’s Banca Intesa—have used the currency’s strength to buy companies in Britain, the United States and Latin America relatively cheaply. Arturo Bris, of IMD, a Swiss business school, points out that the lower euro is likely to put an end to this acquisitions frenzy—or, at the very least, shift it to those countries in eastern Europe whose currencies are pegged to the euro.

Heads I win, tails you lose

European companies are also grappling with the iron law of currency movements: that what you gain on the swings you lose on the roundabouts. European companies will find it more expensive to raise capital internationally. They will also have to pay more for commodities such as oil which are priced in dollars. This means that the huge number of European companies that export mainly within the euro zone are seeing the costs of their raw materials rise without any accompanying benefits. Even Germany does more trade with France than any other country.

The biggest worry for European business, however, is not so much the decline of the euro itself but rather what it says about the European economy. European governments will have to reduce public spending dramatically to allay the market’s fears. Spain has already announced that it is cutting public-sector wages by 7% and Greece by 16%. This will inevitably remove spending power from the European economy and so dent its short-term prospects.

The euro’s slide also hints at deeper worries about Europe’s ability to promote growth and create jobs. The introduction of the single market and the single currency were supposed to spark a glorious period of innovation and productivity growth. This has not happened. The European economy remains dependent on long-established corporate champions such as Daimler and on public-sector jobs. The old continent has dismally failed to create local equivalents of America’s Microsoft and Google. The problem for European business, in short, is that silver linings come with dark clouds attached.

Insurance

Too far, too fast

Jun 3rd 2010 | NEW YORK
From The Economist print edition

Prudential’s plans for Asian domination hit a brick wall

McGrath’s shareholders have the thumb screws ready

WHEN it was unveiled in March, the agreement by Britain’s Prudential to buy AIG’s Asian life-insurance unit, AIA, for $35.5 billion was widely hailed as the deal that would help transform the stodgy insurance industry, radically reshaping both buyer and seller. Prudential would become the dominant insurer in the world’s most exciting markets; AIG would get cash to repay a big slug of the bail-out it was forced to accept in 2008.

With the transaction’s collapse on June 2nd, it is Prudential’s top brass, rather than the industry, that can expect a shake-up. Faced with little hope of getting the 75% approval needed in a shareholder vote on June 7th, Prudential’s chief executive of just eight months, Tidjane Thiam, had tried to negotiate a 14% price cut. But AIG was having none of it.

Prudential’s leaders messed up. They misread the British financial regulator’s reservations about the deal. And they misjudged shareholders’ appetite for a giant, $21 billion rights issue to fund the takeover. It didn’t help either that AIA executives seemed horrified, raising the spectre of mass defections. A pioneer of shareholder activism in Britain, Prudential has been given a taste of its own medicine.

Gambling and losing so soon into the job has severely weakened Mr Thiam, a former McKinsey consultant and government minister in his native Côte d’Ivoire who until recently was one of the brightest stars in the insurance firmament. At best, he has a long slog rebuilding trust: it took years, for example, for Arun Sarin to mend relations with Vodafone’s investors after pursuing an unpopular and ultimately unsuccessful bid for AT&T Wireless. Mr Thiam and his chairman, Harvey McGrath, are both under pressure to step down. The revelation that Prudential must pay £450m in break-up and other fees will only add to shareholders’ ire.

Missing out on AIA is not disastrous for Prudential, whose Asian business is already big and growing fast. There is talk of the failed deal presaging a break-up. On paper, Prudential is worth as much as 50% more in pieces than its pre-deal market value. But while its Asian arm would attract plenty of interest, potential buyers of the more mature British and American operations are few in number and have been weakened by the financial crisis.

The stakes are just as high for AIG, and for America’s Treasury and Federal Reserve, to which it owes $132 billion. The Americans refused to renegotiate in part because they feared Prudential’s investors would have rejected even the lower price, hitting AIA’s perceived valuation. AIG’s united front was misleading, however. Its chief executive, Robert Benmosche, reportedly wanted to stick with Prudential but ten of the 11 other directors—most of them appointed since the bail-out, with the Treasury’s blessing—voted against.

There remains a tension at the heart of AIG’s predicament. Taxpayers want their money back, but flogging jewels such as AIA may not be the best way to maximise value. In a letter to employees this week, Mr Benmosche said: “We remain focused on monetising AIA…as quickly as possible”, but on “appropriate terms” given its “unique strengths”—strong management, a formidable local sales force and zippy profits growth that shows no sign of slowing. The Treasury may be less inclined to force the issue, having recouped more of its outlays from the Troubled Asset Relief Programme than expected.

AIG might sell its Asian arm to another insurance firm; Prudential was not the only bidder. But it will probably resort to its original plan, an initial public offering (IPO) of perhaps half of AIA in Hong Kong, with further chunks to be sold later. Market volatility and a crowded IPO calendar in Asia—Chinese banks need to plump up their capital cushions—make the timing and the proceeds uncertain. Failing to secure a sum that matches even Prudential’s revised offer would be embarrassing indeed. Mr Thiam is not alone in having taken big risks.

A special report on South Africa

The price of freedom

Jun 3rd 2010
From The Economist print edition

Since embracing full democracy 16 years ago, South Africa has made huge strides. But, says Diana Geddes, not everything has changed for the better

SPORT matters in South Africa. In his new year’s address to the nation, President Jacob Zuma described 2010 as “the most important year in our country since 1994”. To outsiders, playing host to this year’s football World Cup seemed perhaps a less momentous event than holding the country’s first fully democratic elections that established a black-majority government 16 years ago—especially when the national team, Bafana Bafana, may be knocked out in the first round. But with the kick-off on June 11th, just days after the country’s 100th birthday on May 31st, the world’s eyes will be on Africa’s leading economy for the next few weeks.

Can the “miracle” nation, which won plaudits around the world for its peaceful transition to democracy after centuries of white-supremacist rule, conquer the bitter divisions of its past to turn itself into the “rainbow nation” of Nelson Mandela’s dreams? Or will it become ever more mired in bad governance, racial tension, poverty, corruption, violence and decay to turn into yet another African failed state? With Zimbabwe, its neighbour to the north, an ever-present reminder of what can happen after just a couple of decades of post-liberation single-party rule, many South Africans, black and white, worry that their country may be reaching a tipping point.

Western fans arriving in South Africa for the World Cup could be forgiven for thinking that they were still in the rich world. Much of the infrastructure is as good as you will find anywhere—particularly those parts that have been given multi-million-dollar facelifts in preparation for the tournament. Ten spectacular stadiums have been newly built or upgraded at a cost of 15 billion rand (see box for currency conversions). Visitors arriving at O.R. Tambo, the main international airport, will be whisked into Johannesburg by the Gautrain, Africa’s first high-speed rail link (pictured above). And many of the country’s hotels and restaurants are world-class, including Bushmans Kloof hotel, three hours’ drive from Cape Town, recently voted the world’s best by Travel + Leisure website, and Cape Town’s La Colombe, ranked 12th in this year’s S.Pellegrino list of the best restaurants.

Not as rich as it looks

But in reality South Africa is no more than a middle-income developing country with a GDP per person of around $10,000 (at purchasing-power parity), a quarter of the American figure. On a per-head basis, it is the seventh-richest country in Africa by some measures. The average hides huge disparities. Under apartheid, whites were encouraged to believe they were part of the Western world. It was only when they had to start sharing their streets, goods and services with their darker-skinned compatriots that they began to wonder whether they really were. Many now complain about falling standards. Yet most whites have done rather well since apartheid ended—better, in fact, than most blacks. They still enjoy a good life, helped by cheap domestic help and first-class private medical care and schools.

For the majority of South Africa’s blacks, however, the living is not so easy. Although many of the poorest now get some kind of government support, it is only a pittance. Most blacks still live in shoddy shacks or bungalows without proper sanitation in poor crime-ridden townships outside the main cities. Their schools and hospitals are often in a dire state. And, in a country where there is little public transport, most blacks do not own a car. Although it has the world’s 24th-biggest economy, South Africa ranks a dismal 129th out of 182 on the UN’s Human Development Index (and 12th in Africa).

The country’s constitution, adopted in 1996, is one of the most progressive in the world. It enshrines a wide range of social and economic rights as well as the more usual civil and political freedoms. Discrimination is banned not only on the grounds of race, gender, age and belief, but also of pregnancy, marital status, sexual orientation and culture. Every one of the country’s 49m people—79% black, 9% white, 9% coloured (mixed race) and 3% Asian/Indian—is guaranteed equal protection under the law. Freedom House, a Washington-based research foundation, gives South Africa a respectable rating of 2 in its “freedom in the world” index, where 1 is completely free and 7 totally unfree.

South Africa is a land of contrasts. It has fabulous mineral wealth, with 90% of the world’s known platinum reserves, 80% of its manganese, 70% of its chrome and 40% of its gold, as well as rich coal deposits; yet 43% of its population live on less than $2 a day. It has just announced plans to develop a satellite programme (with India and Brazil) and is the leading candidate to host the world’s biggest science project, the Square Kilometre Array radio telescope; yet in international maths, science and reading tests it performs abysmally. It has sky-high unemployment yet at the same time suffers from crippling skills shortages. It was the first country to perform a heart transplant, and some of its doctors are still among the best anywhere; yet its people’s health record is among the world’s worst. And, leaving aside war zones, it is one of the most violent and crime-ridden countries on the planet. This special report will look at South Africa the way that most of its people see it. The results are often harsh.

The bright side

Yet there are some encouraging signs that the contrasts are getting less stark. South Africa has recently cut its murder rate in half; virtually eradicated severe malnutrition among the under-fives; increased the enrolment in schools of children aged seven to 15 to nearly 100%; provided welfare benefits for 15m people; and set up the world’s biggest antiretroviral treatment programme for HIV/AIDS.

What about race? South Africa remains obsessed by it. That is hardly surprising after 350 years of racial polarisation, including nearly half a century of apartheid, when inter-racial sex was a criminal offence and non-whites were even banned from using the pavements. The subject waxes and wanes. Only last August Mr Zuma was warning his compatriots against reviving the race debate. But the murder in April of Eugene Terre’Blanche, leader of a white-supremacist group, and the racist outbursts by Julius Malema, the leader of the powerful Youth League of the ruling African National Congress (ANC), have brought it to the fore again.

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