Economic Interests

If you owe the bank £100, that's your problem. If you owe the bank £100 million, that's the banks problem.

Archive for the tag “GDP”

A Recovering Britain?


The new Bank of England Governor, Mark Carney, has shown impeccable timing. He leaves Canada in the best shape of the G7 members, boasting GDP at least 5% higher since the crisis began  compared to Britain, where GDP has still yet to catch up to its previous peak.  But he also leaves the country with some long term problems that he won’t have to deal with. Canada is facing a rising debt problem as more and more consumers are borrowing money they don’t have. This is compounded by Mr Carneys low interest rates, which are needed to boost growth but are now encouraging reckless borrowing. Growth is also slowing this year, with the Canadian central bank now cutting projection for the next few years.

As this graph shows, Britain is experiencing a worryingly slow recovery compared to previous years, with GDP still somewhat below the 2008 peak.  

In contrast he arrives in the UK at a possible turning point.  After five years of a deep recession followed by a failed recovery, the statistics are now finally pointing to better times. Manufacturing and construction are growing, consumer confidence is improving and new schemes to help boost lending and property buying seem to be working. GDP is set to grow at around 1% this year if the economy stays on track and unemployment is staying low compared to the rest of Europe.

Yet there is an underlying problem in Britain’s economy that will prove hard to fix for the new Governor.

The average wage in the UK has declined by 5.5% since mid 2010 when adjusted for inflation, falling further than some of the worse off countries in the EU like Spain. This won’t surprise Britons, where the cost of living is squeezing the incomes of many households. As wages have remain restricted since the recession by companies that can either not afford the higher costs or are simply taking advantage of the desperate workforce, inflation has been increasing at between 2-4% a year. This can particularly be seen in the steep rises of energy bills, which have  more than doubled in the period from 2004 to 2011. More price rises are set to happen in the future too, with some energy companies suggesting bills will be £100 more than government projections state for 2020.

As this graph shows, Wages and inflation have diverged negatively since the recession, squeezing real incomes. Found at http://www.economicshelp.org/blog/6994/economics/uk-wage-growth/

Even the new positive growth numbers hide this problem. Instead of salary rises, people are turning to borrowing again to supplement their income. Personal debt has increased by £4 billion in the last year and is worryingly becoming a necessity for families to keep up current costs, along with benefits. If growth recorded in the first quarter at 0.3% had been based on wages, it would have fallen by more than 1% and pushed Britain into recession. A real recovery will need wage growth to create real growth. Otherwise a debt inspired recovery could see interest rates start to rise, leading to costlier interest payments on the debt held by consumers, leading to more defaults and another market crash.

A worrying trend is that of the zero hour contracts, where companies do not have to stipulate what hours an employee is working each week. Additionally, they don’t have to provide the employment benefits that full time employees receive like sick pay and maternity leave. Regulation is lighter in such work places and offers no real job protection, leaving the employees less likely to spend freely if they don’t have a consistent salary or job. This can only harm the economy’s recovery at a fragile time.

Yet there are some positives. Unemployment has stayed relatively low in the UK since the recession because of the countries flexible labour market. Instead of industry wide lay-offs, companies were able to lower salaries to keep people employed. This was healthy, as employees on low wages were better than the unemployed claiming benefits. But with the economy now trying to recover, there is no longer that fear of a market crash to hold companies back from increasing wages.

Unemployment has remained steady and relatively low compared to the rest of Europe, when unemployment is more than double in Britain’s in countries like Greece and Spain. Found at http://www.goldmadesimplenews.com/analysis/unemployment-in-the-uk-rises-to-7-8-as-real-wages-have-go-down-for-nearly-5-years-in-a-row-9951/

The problem is that while consumer have been able to borrow money freely, companies are finding it a much harder task, especially the smaller and medium sized firms that employ the majority of the population. Banks, the biggest lenders to businesses, are focusing on building up their capital for new regulations, meaning they are averse to lending money to companies that don’t have the size and market share to guarantee their loans. There is a lack of a genuine back up to the banks for smaller companies, in contrast to the bigger companies that can lend from the international markets for affordable rates. This is restricting both current companies struggling to grow and new ones trying to enter the market.

 

This affects the public, as investment improves productivity which tends to influence higher wages. Right now business investment is down by a third since the recession, productivity has declined despite more people being in work and real wages have therefore fallen. Astonishingly, the UK ranks 159th in the world for its investment to GDP ratio.

The solution is therefore to improve the market for lending to small and medium businesses. This is easier said than done. Banks are still a long way off from their pre-recession lending rates; especially with two of the biggest banks still part owned by the government. People are wary to see banks go back to that sort of lending anyway, with bankers lending recklessly and risking too much money. But a middle ground must be found to provide capital to the rest of the market. Different lenders must be found as well; in America banks share a much a lower percentage of the lending market than in the UK and Europe, one example of why America has outperformed both since the recession. One such example is peer-to-peer leaning, where the two largest providers in the USA lent over $1.7 billion in the last five years. One recent improvement has been the “Funding for Lending” scheme which gives incentives to banks to lend by offering money that can only be used to lend to businesses.

Britain is further ahead than the rest of Europe in solving this problem and is thinking outside the box to improve the economies main weakness. If lending can pick up and even better without having to rely solely on the biggest banks, then investment can pick up and wages could start to grow.

It’s not the recession but how the country recovers that will come to define Britain.

Abenomics: A burst of energy in a country lacking it


If investors had taken a punt on the Japanese stock market six months ago, they could have seen the value of their shares go up by 70%. This was roughly about the same time that Mr Sinzo Abe, the new Prime Minister, was likely to lead the country once again. He was originally in office in 2006, before resigning within a year after a combination of poor health and low popularity. The second time round has been much more of a success, with opinion polls showing a 74% approval rating in April. It’s not hard to believe; GDP growth was up at an annualised rate of 3.5% in the first quarter, far above the likes of the USA, Britain and the eurozone (which is currently fighting recession across the region). While the yen has dropped 20% in value against the dollar, boosting Japans struggling exports that have long had to live with a strong currency making their products uncompetitive. Toyota for example are expecting net profits to increase by 40% this year.

A graph showing the incredible rise of the Japanese stock market in the last few months. Found at http://www.zerohedge.com/news/2013-05-15/bank-japan-headno-bubble-here-nikkei-rises-45-2013

Much of this is down to a massive stimulus package that Mr Abe publicized in January of ¥10.3 trillion. Earmarked to improve the infrastructure of the country and boost confidence, it is in stark contrast to the policies of America and Europe, where austerity rules the roost. Coupled with this, the Central Bank of Japan’s reigns was handed to Haruhiko Kuroda, a willing experimentalist and ally of Mr Abe. He promptly announced an inflation target of 2% (after years of deflation) to be met in the next two years, a confident claim that could prove difficult. But then that could be missing the point; it’s not about reaching the target per se, it’s about inspiring confidence to the nation and changing the atmosphere of gloom that has enveloped the country. Additionally, Mr Kuroda has committed the central bank to buying up ¥7.5 trillion in long term government bonds a month, roughly equating for 70% of the Japanese bond market. Finally he announced the institution would become the only major central bank to change its target from inflation rates to a monetary base system – the amount of money pumped into the economy.

The new governor of the bank of Japan, Haruhiko Kuroda, is taking a gamble on the economy. 

Yet there are repercussions to Abenomics. Japan is already struggling with a mass of debt on its shoulders, at over ¥1,000 trillion and set to reach 240% of GDP next year. That is by far the highest debt to GDP level in the world, while in numerical terms it is only second to America, whose economy is three times that of Japans. It is also 20 times that of current government revenue and takes up half of said revenue to service it. One solution is the expected increase of consumption tax to 8% in April next year and 10% in 2015, which was set to help achieve the lofty aims of halving the primary budget deficit by 2015 to 3.2% of GDP. The fiscal stimulus has thrown this ambition out the window, with the budget deficit now believed to have increased to 8.8% of GDP this year. Adding more debt to the pile looks risky, though the actual chance of a debt crisis is low; Japan plays very little for the money it borrows mainly because the bond market is dominated by local Japanese savers and the central bank. But this is clearly a gamble by Mr Abe, a last throw of the dice, to succeed (increase growth and revenues and start to cut into the debt pile) or fail (increase the level of debt and see the economy spiral out of control).

A graph showing the increasing rise in Japans debt over the last two decades. 

To only make matters worse, Mr Abe has inherited difficult long term problems. The first is the current energy crisis. Following the Fukushima nuclear meltdown, Japan drastically shut down the majority of its other reactors, leaving it to rely on importing energy, a costly measure. Nuclear energy accounted for 30% of the sector and was set to increase to 50% in the next two decades to account for a rising demand for energy. Mr Abe and his government are now struggling to make up for that shortfall in a resource low nation, with the possibility of electricity cuts not being discarded and a U-turn on nuclear power very unpopular. The imbalance could also push the narrow current account margin (currently 1% of GDP) into the negative, adding further strain to the budget deficit and public debt.

Only a few Nuclear stations are still online in Japan, causing an energy shortage in the country.

The second long term problem is the demography issue. There are a growing number of elderly residents in Japan that will drain the states resources in the form of pensions, health care etc. In the next 90 years, the percentage of the population past retirement will grow from one fifth to nearly half. A rapidly declining birth rate coupled with a trend for smaller families means the number of pensioners living on their own will double by 2030 based on 2005’s population numbers. While the number of available workers is shrinking, resulting in less people contributing to the economy and more people taking state handouts. This may be a global problem in the rich world, with the average age of death continually rising, but Japan is a standout indicator predicted to experience the worse of the problems. In contrast India’s population is getting younger and will boast a 250 million increase in its working age population over the next decade.

Two graphs showing India’s bulging young population, found at http://www.economist.com/blogs/graphicdetail/2013/05/daily-chart-8

Encouragingly, Mr Abe is also striving for economic reform.  He is set to release his reform policy next month which is expected to include; steps to make it easier for female participation in the workforce and a deregulation and breaking up of the energy sector. More ambitious aims could include: easing barriers to investment in the farming sector, freeing up Japans rigid labour laws and increasing visa access. Though these could be held up until after the July elections for the upper house which if his Liberal Democrat party were to win a majority in (which seems likely), Mr Abe could pass legislation without hassle, a rarity in modern Japan.

Joining the TPP (Trans-Pacific Partnership) would prove an important step as well, by expanding trade with some of Japans most important trade partners and providing a timely boost to GDP growth. Entering the discussions so soon was warned against by his advisers, but it has only seemed to have improved his image further, giving him foreign credibility and respect. Going head to head against the lobbyists for protectionism will be tough, but opening up its economy is one of the few major moves Mr Abe can play to increase long-term growth.

Increasing trade with the USA via the TPP could be a massive boost to Japan’s economy. 

Disappointingly, Japan has increasingly become isolated economically, not attracting much foreign direct investment due to high taxes (with a corporation tax of 38%) and a society reluctant to integrate with foreigners. If Japan is to avoid a future disaster it will have to really embrace globalisation. Immigration could be a real solution to their ageing population, as immigrants tend to be both younger and embrace bigger families, as shown in the USA. Attracting foreign investment is also key, as the government cannot hope to keep up its stimulus package in the long term and will need the private sector to invest much more than it currently does. Japanese firms could be forced into growth strategies if their sectors were fully opened up to global competition. Only then could the government start to reproach – as it will certainly have to at one point – and start to cut the government spending and lower the public debt levels.

A return to growth for the world’s third largest economy, one that is equal to France’s, Italy’s and Spain’s combined, is a feat to celebrate. But if Mr Abe doesn’t implement the long term reforms and embrace globalisation, then he might find (both metaphorically and literally) the economy running out of energy.

Thatcherism: One foot in the grave?


On the 8th April, Britain said goodbye to their first female Prime Minister, arguably the most famous one since Winston Churchill. The reaction has been mixed to say the least, with Baroness Thatcher a bit like marmite; you either love her or hate her. On the positive side; she ended the trade unions grip on the country, reduced the high inflation rate, created a free market approach and helped retain Britain’s global influence at a time when other super powers were rising to the top. On the other hand, she helped divide the country even further, centralised power in Westminster, reduced public investment in infrastructure and hardly made a dent in the issue of equality. She also made a lot of enemies, in particular the mining industry, civil right activists and even her own party (who still suffer under her shadow).

But no matter what you think of her personally, her economy policies have had a lasting effect on the nation and the world as a whole. Her following loosely of the ideas of Friedrich Hayek was extremely brave when the rest of the world was dominated by Maynard Keynes ideas. The idea in general was to shrink the state and its effect on the country, thereby allowing the private sector to grow. When governments enter the markets they tend to crowd out private enterprises and mange sectors poorly, so Baroness Thatcher privatised big industries in transport and energy and eliminated state controls. This improved productivity in the nation and set off a trend of privatisation throughout Europe and the wider world. Germany fully privatised its national champion Volkswagen in 1988 while even France, a country that never fully caught on to privatisation, sold off shares in Renault in 1996 (though it still holds a 15% ownership to this day). In Eastern Europe and Latin America, privatisation became extremely popular, as it encouraged outward investment into the country that the governments couldn’t hope to create by themselves. In Poland between 1990 and 2004, 5,511 public owned enterprises were privatised, while Latin America keenly accounted for 55% of global privatisation in the 1990’s. Annual revenues from global privatisation as a whole peaked in 1998 at over $100 billion, showing the extent to which “Thatcherism” had an effect on the whole world in the aftermath of her term in office.

France privatized Renault, though they still hold a 15% stake.

Yet times do appear to be changing. The world-wide recession (a caveat of the free market economy Margaret Thatcher brought in) forced many governments to resume ownership of previously private industries, especially the banking sector. The UK government partly nationalised RBS in 2008 and now owns a majority 81% stake, Holland recently nationalised bank and insurance group SNS Reaal for €10 billion, Belgium nationalised their big bank Dexia in 2011 while Spain had to request almost €40 billion in bailout funds for its four nationalised banks late last year; Bankia, Catalunya Banc, Banco Gallego and NCG Banco. This isn’t all, in South America, a region so keen on privatisation, the trend is also reversing. Argentina last year took a majority 51% stake in YPF (an oil company) without giving its parent company Repsol (a Spanish Company which held 75% of YPF) a cent. YPF aren’t alone, Ms Fernandez (Argentina’s President) also nationalised their private pension funds and a large airline, with the latter flagging (44% of Aerolíneas Argentina’s flights were not running on time last year).  If it weren’t enough for Spain to lose YPF, they also lost another company to a South American President. Evo Morales, President of Bolivia, nationalised their national power grid company of which a majority was owned by a Spanish company. Mr Morales has at least in the past offered remuneration, though often it has been below free market levels. Finally there is Venezuela, who suffered their own loss of a famous leader, Hugo Chavez. The dominant leader was beloved by his public and encouraged national patriotism by nationalising large parts of the economy. But this is possibly the worst example of nationalisation. Mr Chavez employed only those loyal to him in powerful state positions, rather than those best for the job. He gave cash handouts to the population but has had one of the worst records in the region for lifting people out of poverty.

Another fallen political leader leaves behind another controversial legacy 

Margaret Thatcher was a willing accomplice to globalisation, which has seen trade explode between nations and barriers broken down. So she would be sad to see that the WTO has cuts projections for trade this year down from 4.5% to 3.3% due to increased squabbling over trade restrictions, while protectionist policies in some studies have been suggested to have increased by 36% in 2010/11. The financial crisis’s long lasting consequence has been the setback in the expansion of integration within the world, with countries now moving towards protectionist policies more and more. In the recent EU budget talks for example, one of the few areas not to be discussed were Frances protected agriculture subsidies (where tariffs on non-EU goods have known to reach 156%). Then there was the decision by Brazilian President Dilma Rousseff to increase Industrialised products tax by 30% in 2011 for vehicles where 65% of the value added did not originate in Brazil, despite breaking WTO rules.

More worryingly, the biggest trade zone right now is facing big doubts over its future.  The EU is the biggest backer of free trade in the world, so if it were to break up, it would set the world back years. The lack of tariffs and trade caps between EU nations majorly simplifies the whole process, reducing the red tape that clogs up businesses and increasing the number of options open to the consumer. The percentage of trade in EU states between each other is falling sadly, with Germanys decreasing by nearly 10% since before the financial crisis (though there are other contributing factors). The single market also bizarrely does not include services, which account for around 71% of EU GDP but only 3.2% of intra-EU trade.

Share of intra-EU trade in Germany's total foreign trade

Thatcherism however is hardly dead. Free trade deals that many thought were long gone are starting to pop up once again. The EU and USA are discussing a “transatlantic trade and investment partnership”, which could according to some estimates boost GDP in both regions by between 0.5-1% to perhaps even triple that, depending on the amount of restrictions reduced. Tariffs only average about 3% between the regions, but other barriers to trade are aplenty and go a long way to restricting trade. Additionally there are the Trans-Pacific Partnership talks between the North American and South East Asian regions. The aim is to cut trade restrictions between 11 nations, including; USA, Mexico, Canada, Japan, South Korea, Vietnam and Australia. The countries involved account for around 30% of global trade and could improve the economies GDP’s by an estimated 1%. Neither deal is even close to being finished, but they both bring hope to the idea of free trade that Margaret Thatcher helped popularise in the 1980’s.

After the global recession, many criticised the free market approach as the main cause for the financial crisis, but the easy excuse isn’t always the right one. A free market doesn’t have to result in a lack of regulation and poor preparation, which were the real causes for the banking crash. A balance is needed for it to work, free market policies used along with guidance (not interference) from the state.

Baroness Thatcher may have passed on, but her free market policies are still alive and kicking.

Is the EU being dragged apart?


After a sense of calm had finally emerged in the eurozone since last summer, panic has erupted once again. Cyprus’s long awaited bailout was carried out with little thought of the consequences, both short term and long. The initial decision to place a one off tax on all depositors in Cypriot banks, both over and under €100,000, was always going to lead to public uproar and a bank run. The second bailout decision was slightly better, only affecting those with over €100,000 in their banks accounts and winding down one of Cyprus’s biggest banks, the Laiki bank, while switching accounts to the Bank of Cyprus. But the damage had already been done; the government now has to enforce capital controls to keep money in the country, while the public won’t forget how close it came to them losing chunks of their bank balance. It has almost certainly ruined one of Cyprus’s biggest sources of income as an offshore financial haven, with the conditions of the bailout most likely requiring reforms of the country’s economy. Then there is the tourism sector (another big market) which will be hit, as foreigners won’t want to risk getting caught in the middle of another financial crisis. Worst of all, this will not be the end of it; the economy is set to retract by 5% in the more positive estimates and another bailout will need to be negotiated.

Cyprus’s  Debt-to-GDP ratio could overtake Greece in the future by some estimates. Found at http://trueeconomics.blogspot.co.uk/2013/03/2432013-are-cypriot-debt-dynamics-worse.html

Yet this is not the biggest worry for the European Union. Cyprus accounts for a tiny 0.2% of Eurozone GDP, its bailout at €10 billion is minuscule compared to the €246 billion needed to bailout Greece. If the economy crashed and defaulted on its debt, it would hardly tear the European Union apart. The bigger repercussions of this debacle are that the EU looks as divided as ever. The capital controls being placed on the Cypriot economy are not supposed to be possible in the EU – they are the first case of it since its creation. They are supposed to be short term, but then the same was said about Iceland 4 years ago.

 Cyprus’s Bailout is tiny compared to the other EU Bailouts. Found at http://www.economist.com/blogs/graphicdetail/2013/03/daily-chart-18

Even more worrying is that the much heralded banking union that the EU nations announced last year now seems less likely. The European Central Bank was set to bail out troubled banks directly, thereby cutting off the self-defeating link between weak banks and weak governments. But to some member countries that seemed too much like gifting money without conditions that have so far been ever present within bailouts e.g. reforms to the economy. Cyprus was the big test, to see if the ECB would directly fund the failing banks of the island, but disappointingly this was not to be the case. A banking union would have showed a more unified EU, with member countries prepared to provide assistance to troubled states. It could have possibly paved the way for joint government bonds, stopping the inconsistent borrowing costs that have spread throughout the eurozone. In reality the EU members have been diverging for awhile, amplifying the problems of the union.

Looking across the region, this isn’t the only sign of a gap emerging between EU states. Tensions are rising within the union, with the periphery nations growing resentful over the austerity policies being enforced onto their economies, while the central nations are becoming frustrated at having to rescue the weaker nations from their own mistakes. This is showing in the form of protest votes. Greece had a near miss in their latest election, where a party campaigning on leaving the euro ran the victors close. Italy went a step further, with the 5 Star Movement (a protest party lead by an ex-comedian) caused a political gridlock in the March elections which has yet to be resolved. This was helped by the far right being led by Silvio Berlusconi, a controversial billionaire who campaigned on ending the EU austerity in Italy. In Germany, Angela Merkel will soon face her own elections, where her popularity will be tested by opponents who will campaign against the continued funding of the EU by the German tax payers.

Beppe Grillo has captured votes for his 5 star movement party by campaigning for a referendum on EU membership. 

Then there is France, a country somehow caught in the middle. The nation is central to the EU, its partnership with Germany gives the union its clout and its leadership with Angela Merkel helped lead Europe through the financial crisis in 2008/2009. But Francois Hollande won his presidency by promising policies like the 75% tax on millionaires and the lowering of the retirement age, while he has backed the periphery economies in talks against austerity (to the annoyance of Angela Merkel). The French economy is in desperate need of reform and cuts however. The budget deficit is set to go over the set target of 3% of GDP, public spending is the highest in the EU at 57% of GDP and while Germany’s economy has become more competitive over the last decade, France’s has been left unproductive in the global economy. President Hollande is now set to implement the austerity measures he never mentioned during his campaign and has since seen his popularity plunge to the lowest since the firth republic began.

Showing the high public expenditure of France compared with similar sized countries. 

The contradictory aims of the different members are leaving the big decisions unmade. The lessons of the past bailouts are not being learnt; there is still no definite lender of the last resort, no banking union, no talks of the possibility of sharing out some of the debt across the union to help member states recover. Austerity is needed, but so are some pro-growth policies and just demanding more and more cuts from the bailed out countries is not going to get the right results. The EU budget could be restructured to help improve spending on much needed areas like infrastructure and reduce spending on subsidies like French Farming and the rebates that go to countries like Britain.

Britain is another obstacle awaiting the EU in the future. The government is set to hold a referendum after 2015 (if it wins) on its EU membership and if the union is still facing the problems it is today, it is not inconceivable that the nation could leave the club. The public are already frustrated at the European laws they have to abide by and the levels of immigration that arrive to their shores. Losing Britain would be a deep blow to the union, both as the third largest economy and as a good balance to Germany’s motives. But the growing popularity of the UKIP party, again campaigning on an exit from the EU, shows the split that is appearing between member states.

Together the EU is the biggest economic zone in the world, one which can rival the economies of the USA and China. Divided it is a bunch of quarrelling nations that can’t agree on the best policies to move forward. Right now the latter is a more poignant picture of the EU, with GDP retracting by 0.3% in 2012  and unemployment reaching a new high of 12%. Europe needs to integrate further both politically and economically if it’s reverse this slump. A move towards a banking union would be a good start, while sharing the debt burden of its weakest members would go a long way to restoring stability to an economic zone that has struggled with such a concept.

A divided Europe is a weaker Europe, let’s just hope it doesn’t take its members too long to remember this.

Was the Euro Doomed from the Start? (Essay from my graduation year of university last year)


The European Union (EU), an economic union between 27 member states in Europe, has recently suffered its first serious setback since its creation, termed as the “Euro Crisis”. Various members of the eurozone have been found to have serious debt problems which have affected the rest of the EU as they all share a single currency, the euro. But as Verhofstadt (2011), the former Belgian prime minister said “A state can exist without a currency, but a currency cannot exist without a state”. In this essay, I will discuss whether the euro was in fact doomed from the start from structural and unforeseen problems. First a short history of the euro will fill in any background information for this essay. Then the problems that will be considered are; the monetary policy problems, fiscal policy problems, a lack of preparation for any crisis, the lack of a real political union and a lack of equality throughout the EU. I will also explain reasons why the EU has been beneficial to its members including; the growth experienced before the crisis and the safety net the EU provided for the now failing economies in eurozone. The Mundell Fleming model will also be used to help show the different effects of both fiscal and monetary policies.

The euro first came into existence in 1999, though the physical representation of the money wasn’t fully circulated until 2002. Important institutions for the EU are; the European Commission, the European Council, the Court of Justice of the EU and the European Central Bank which decide important decisions within the EU like legislation, European law and interest rates for the eurozone. Entry into the EU was regulated by the Maastricht treaty which stated any nation that wished to enter must pass certain fiscal criteria; inflation must not be 1.5% higher than the average of the three best performers, the budget deficit must not exceed 3% of GDP, government debt to GDP ratio must not rise above 60%, long term interest rates could not be 2% higher than the three lowest members and the applicant should have mirrored the domestic currency to the euro for two years without devaluating currency. Greece famously did not originally meet these criteria and weren’t allowed to join until later on, while the UK and Denmark decided against adopting the euro currency. In 2004, the eurozone expanded to include smaller nations like Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia and then in 2007 Bulgaria and Romania. Out of these nations only Slovenia, Cyprus, Malta, Slovakia and Estonia adopted the euro currency, while the other nations faced difficulties adjusting. Then in 2007/2008 there was a global financial crisis that pushed the eurozone into its first official recession in the third quarter of 2008, experiencing negative growth in the second, third and fourth quarters of 2008 and then into the first quarter of 2009. Greece suffered a crisis in confidence as international creditors started to doubt their ability to repay the huge debts they had acquired; with the debt to GDP ratio at a staggering 159% of GDP. This meant the eurozone countries along with the IMF had to bail out the country for the first time in May 2010, totalling €110 billion. This was followed by a second bailout this year of another €130 billion to help the country finance itself, while other countries like Ireland have also had to be bailed out. This has lead to a new European Fiscal Compact to be created that enforces nations to adhere to fiscal stability. This states that national budgets must either be in balance or surplus, otherwise punishments of fines of 0.1% of GDP and the loss of some of the countries fiscal sovereignty can be used.

The first fundamental problem with the euro was that it was expected a single monetary policy for all the countries would work. The monetary policy, which controls the supply of money into a country by targeting interest rates, is controlled by the European Central Bank (ECB) in the eurozone. This means every country in the eurozone has to operate under the same interest rates, despite the massive differences between the economies of the central countries (Germany, France) and the periphery countries (Greece, Spain). Andre Szasz, a retired Dutch central banker, supports this argument, suggesting it was a mistake to have “a monetary policy of one size fits all” as interest rates will be “too low” for some countries and “too high” for others.  This makes sense, as a country like Germany which produces a lot would be inclined to target low interest rates while a country like Greece which doesn’t produce enough would have higher interest rates. This led to the periphery states like Spain, Portugal and Greece being able to exploit the low interest rates that would not have been possible without being part of the euro. These low interest rates meant poorer countries could borrow money easily from international investors, not a big problem by itself, but when mixed with low productivity it encouraged nations to spend more money than they were making. This has lead to these nations building up vast amounts of debt that they cannot realistically pay back and with the financial crisis making credit scarce, these countries are finding it hard to obtain the loans they once found easy, with Portugal, Ireland and Greece being given junk credit status by credit rating agencies. This mass borrowing by the periphery nations (and Ireland) was good news for the central countries, especially Germany, as it meant new possible customers for their exports financed using money loaned from the richer nations like Germany: A vicious cycle. Zemanek (2010) supports this stating “Germany has experienced rising trade surpluses against the euro area countries starting from 2002 up to the recent crisis… other countries have large current account deficits, thereby accumulating increasing stocks of international debt”.

Bayumi and Eichengreen (1992) argued that the European monetary union could not be an optimum currency union. An optimum currency union is a region where a single currency would maximise economic efficiency, satisfying the criteria of; labour mobility, capital mobility, price and wage flexibility, fiscal transfers and similar business cycles. It is argued that the eurozone does not have price and wage flexibility, fiscal transfers or labour flexibility. Issing (2000) supported the lack of this last quality, arguing “dangers can be identified relatively easily. The most obvious one is the lack of flexibility in the labour union… this poses an almost lethal threat to monetary union”. A single monetary policy also meant individual countries couldn’t de-value their currency by printing. When the financial crisis hit, countries like the UK and USA were able to devalue their currency by printing more money, this helps boost exports and stop imports and can be an important tool in restructuring a countries economy. But countries like Greece and Portugal within the EU don’t have that option and therefore the only way to restructure their economy is through internal austerity; cutting wages and spending.  The Federal Union (2011) wrote “British government borrowing grew from 29.7% of GDP in 2002 to 36.5% in 2008… Since August 2007, the pound has lost 20 percent of its value against the euro”  showing the UK was fiscally irresponsible as well, but that they had the ability to de-value their currency and boost exports and therefore not have to adhere to severe austerity policies like their EU counterparts.

The second fundamental problem of the euro was the fiscal policy of the EU. In contrast to the monetary policy of the EU, each nation has a separate fiscal policy which leaves a very mixed economic structure for the EU. The fiscal policy refers to the government expenditure (e.g. new roads) and the collection of revenue (taxes) which affects the economy of the country. White (2011) suggested that it was “impossible to completely separate fiscal policy from monetary policy as central banks can prop up government bond prices by monetising debt” meaning the central banks of countries can buy up the debt of the country (though it is illegal to directly buy the debt, it can easily be bypassed) to help increase the supply of money, therefore affecting the monetary policy.

The Mundell-Fleming model (an adaptation on the IS-LM model) helps shows the relationship between a country’s interest rates, output and nominal exchange rates. The model argues that a country cannot simultaneously achieve a fixed exchange rate, free capital movement and an independent monetary policy. The EU for example has flexible exchange rates and instead decides to target interest rates and free capital movement. The model shows; the IS curve: Output = Consumption + Investment + Government Spending + Net Exports, the LM curve: Money supply/Price = Liquidity preference (Interest rates, Output) and the Balance of Payments curve: Current accounts (Net Exports) + Capital accounts (Cash Flow). The EU uses flexible exchange rates, which means the European Central Bank allows exchange rates to be determined by market forces alone. With flexible exchanges rates, the central bank can increase the supply of money to try and boost the economy (Monetary change). This causes the LM curve to shift to the right, thereby increasing output and lowering the domestic interest rate in comparison to the global interest rate. This depreciates the local currency, making local goods more attractive and thereby increasing net exports. Increasing net exports shifts the IS curve to the right as well, up until the point where the balance of payment is equal again and the domestic exchange rate equals the global interest rate. But while this returns to normal, the GDP increases once again, meaning any increase in the money supply doesn’t have an effect on interest rates in the long term, but does increase the GDP of the country and vice versa for a decrease in the supply of money. The European Central Bank increases money supply through Quantitative easing, where it prints more euros for all the countries to help boost the economies that are underperforming. Too much quantitative easing can be bad for the economy, leading to a poorer standard of living, bad reputation with foreign markets and even the risk of hyperinflation, while the ECB has to try and balance out whether quantitative easing would benefit all the countries in the eurozone. Another option with flexible exchange rates is to increase government spending (fiscal change), this causes the IS curve shifts to the right, causing an increase in GDP and in the domestic interest rates compared to global interest rates. This leads to the currency appreciating, making foreign goods more appealing and decreasing net exports. This shifts the IS curve back to its original position where domestic interest rates are equal to global interest rates and has no impact on the LM curve. This means if there is perfect capital mobility, then an increase in government spending has no impact on GDP and vice versa with cuts in spending. This shows that both the fiscal and monetary policy are integrated and cannot just be separated like the EU have tried to do with the euro.

A fiscal change with floating exchange rates graph shows what happens when government spending is increased (or taxes are decreased). A monetary expansion with floating exchange rates shows what happens when the supply of money is increased.

The EU also had to make an assumption that with interest rates fixed and a single currency, each country would be fiscally responsible. That assumption was proven badly wrong, as a lot of countries used low interest rates to borrow irresponsibly without having the output to support such loans and built up uncontrollable amounts of debt. Marian Tupy (Legatum Institute) argued that “Greece’s membership in the eurozone allowed the Greek government to borrow at lower interest rates, and thereby enabled its overspending” showing the allure the EU created for poorer nations to borrow beyond their means.  A new fiscal compact has recently been agreed between the countries in Europe (as described previously), with the UK and Czech Republic notably opting out of the treaty, which has the aim of stopping states running huge debts. This new fiscal compact shows an original problem with the structure of the EU, that regulation of fiscal activity in the eurozone was too relaxed. Dominguez (2006) came to this conclusion in her paper, writing “In 2000, one year after the euro was launched, five of the eleven countries in the eurozone were in violation of the public debt rule”, she then added “In 2005, the three largest eurozone economies – France, Germany and Italy – were out of compliance with both the budget deficit and public debt rules”.

Another fundamental problem with the euro was that it seemed totally unprepared for a crisis. As the Economist captured perfectly “the designers of the good ship euro wanted to create the greatest liner of the age. But as everybody knows, it was fit only for fair-weather sailing, with an anarchic crew and no life boats”. The European central banks main purpose was to keep inflation low, not deal with any potential credit problems which it had neither the financial nor political power to accomplish.  David Cameron (British Prime Minister) argued that successful currency unions have a lender of last resort, fiscal transfers, collective debt, economic integration and flexibility to deal with shocks, suggesting “currently it’s not that the eurozone doesn’t have all of these, it’s that it doesn’t have any of these”. Looking at the EU structure, it is easy to see what he is saying; countries are unable to transfer funds to struggling regions (e.g. Germany couldn’t transfer funds to Greece), debt is split unequally between different countries despite all using the same monetary policy, economies are kept largely separate with trade barriers still existing and there is absolutely no flexibility to deal with shocks as the financial crisis showed. Stelzer (2012) wrote ”Nor does Europe have a seamless method of transferring income from flush to stricken areas. America does: cash flows automatically to troubled states with falling tax receipts and rising welfare costs, from states doing better” which shows the one reason how America have been able to bounce back faster than the eurozone, because they have been able to transfer funds to poorer regions and have spread the debt collectively over all the states. But the most important of these factors is arguably having a lender of last resort, some sort of institution that can bail out the government if they can’t pay its debt. The USA has this in the form of the Federal Reserve, which can provide funds for any of the states if they require it. One of the main problems of the euro crisis was a lack of liquidity; this should have been the role of the European Central Bank as a lender of last resort. Instead the EU had a rule of no bail outs, relying on markets to keep a government from acting fiscally irresponsible, which has now backfired as the EU has hurriedly created a rescue fund to help solve a liquidity time bomb. The rescue fund created has little use however as it is massively underfunded, unable to bail-out a country the size of Italy for example. Without the ability to bail out countries, the EU could break up, a topic politically avoided. Ulrike Guerat of the European Council on foreign relations expresses fear in his paper that rather like the Soviet Union, the EU would go down quickly if the euro started to break up, showing a general worry that if a country like Greece (in the worst condition in the eurozone) defaults on its debt and leaves the euro, it could have a domino effect on the rest of the EU, with Portugal and Ireland very vulnerable to any shocks in the market.

An additional structural problem with the euro was that there wasn’t a political union. George Soros (2011) stated “the euro is a flawed construct “by which he meant the euro needed a stronger political union behind it. He then went on to suggest a single-pan European Union welfare state would allow for the creation of one fiscal and monetary policy for all of Europe. The EU faces constant bickering from different members over different policies, and struggles to achieve a united front at times. One such example was with foreign policy, where the UK and France agreed to intervene in the conflict in Libya, while Germany decided against joining in, showing that a conflict in interests can divide the eurozone. The United States of America is a good body to compare the European Union to as it shows the difference of being united politically. The Economist supports this argument, stating “America created political union followed by a fiscal union. But Europe is doing things backwards, creating the euro in hope of fostering political union”. EU policy has long been seen as being dominated by the central nations, with Germany suggested as having a lot of sway in the decision making process. This has stemmed from EU policy benefitting Germany before the crisis; as a weak currency meant they could export their goods more easily and low inflation was suggested to be focused on strongly because of German fear of hyperinflation, indeed the European Central Bank’s main policy is to control inflation.  This has been resented by the periphery nations which feel they are not represented in EU policies. The EU parliament has long been an institution with little power, with the economist describing it well, suggesting they measure “themselves against America’s congress without having its means” meaning that unlike Congress, they have little sway in uniting different countries inside the eurozone and although it can decide how to spend the EU money, it cannot dictate how it is raised. The EU parliament gained mores powers in 2009 after the Lisbon Treaty to monitor national budgets but any decisions have to be debated between two other bodies; the European Commission and the Council of Ministers while all the major topics like education and health are decided by national governments. This sort of system keeps the different nations separate and makes decision making a long and tedious process. The German Chancellor, Angela Merkel, has spoken of a potential “political union” for the EU with a strong parliament, showing the lack of one originally has been realised as a mistake by the leading figures of the EU.

The final structural problem found with the euro was the lack of equality throughout the EU. There is a vast difference between the economies of the central nations and the economies of the periphery nations. Germany has been a highly competitive saving nation since the euro’s creation whiles the “PIIGS” countries (Portugal, Italy, Ireland, Greece and Spain) were the complete opposite; uncompetitive in production and too reliant on credit to finance themselves. This meant the capital flowing into these countries created a wage boom which saw wage growth rise above productivity growth, while Germany’s wage growth remained moderate meaning they could remain competitive over their rivals. A rigid labour market meant that when the financial crisis hit, real wages couldn’t adjust quickly enough in the periphery states, which coupled with an inability to devalue their currency led to a deep recession for these countries. Rogoff (2012) argued that the lack of labour mobility in the euro was a big problem, suggesting “if intra-eurozone mobility were anything like Mundell’s ideal, today we would not be seeing 25% unemployment in Spain while Germany’s unemployment rate is below 7%” meaning the eurozone is not one of Mundell’s optimal currency areas. Zemanek (2010) produced some facts, saying “while Germany and Austria broadly kept unit labour costs at the level of 1999. In Iceland, Portugal, Spain, Greece, Italy and the Netherlands unit labour costs have increased significantly – by up to 30% compared with 1999” showing how competitive Germany had become compared with most other countries. This inequality throughout the eurozone has destabilised the EU, leading to hugely contrasting current accounts; with Germany having a big surplus and Greece having a large deficit.

We can use the idea of an optimal allocation to show the problems with inequality in the eurozone. An allocation (consumption of an individual in an economy) is only an optimal allocation if it is both efficient and equitable. We can judge efficiency by using the idea of Pareto efficiency: that no-one can be better off without making another individual worse off. A lot of allocations can be pareto efficient but still be unfair however, for example if one person has 7 apples and another 3 this would be considered pareto efficient. To make the allocation equitable, it needs to maximise social welfare (benefit society). A good model to show this is the Utilitarian model, which shows an economy of two individuals, where a UPF curve shows the pareto efficient utilities of both consumers and the social welfare function curve shows the point on the previous curve where the allocation is both pareto efficient and equitable. In the case of the EU, the redistribution of endowments in the market is the responsibility of the EU government and they haven’t done this effectively, as the imbalances between different countries shows. Germany is highly productive, export more than they import and have high employment, this is in contrast with Greece where they import more than they export, have high unemployment and have low productivity. The EU needs to fix these sorts of problems, where jobs are available in some areas of the eurozone and non-existent in others. They could do this by producing more public sector jobs in areas that have low unemployment or improving infrastructure to attract private industry, but this will be hard as countries in the eurozone still have individual governments (not in the EU’s power) and political mistrust between countries will interfere in the sharing of resources e.g. Germany are unlikely to agree with strengthening their rivals in the market. A more unified European Union, as discussed in earlier points, in the shape of a real political union could help different countries become more equal in the EU.

Map showing the different debt to GDP ratios of the countries in the eurozone. This shows the contrasting levels of debt in the eurozone; with Greece, Italy, Portugal and Ireland in much worse positions than France and Germany. This inequality is bad for the EU and a collective measure of the debt would help sort out these issues. (Economist, 2011).

However, it cannot be said that the euro was all bad. Most of the countries that joined the EU experienced big growth in the period up to the crisis. Yannos Papantoniou (2011) found that in the years 1999-2008 compared to 1989-1998, the eurozone countries experienced; 1% lower unemployment, 1.1% lower inflation and GDP growth of at least 5% each year (excluding 2003). The periphery nations like Spain and Greece experienced big economic growth (with Greece growing larger than the eurozone in 2003) which has seen their standard of living for their people improve greatly. During this period life was good for those nations, despite it being financed by debt, and their business sectors and infrastructure were upgraded in the process.  Having the same currency also meant countries could trade with each other much easier without the need for different exchange rates. The euro has benefited businesses in Germany and France (whose main customers were in Europe) and tourism for countries like Greece and Spain (whose economies rely on this sector) as there were no longer any transaction costs for each country and made prices in each country relatively equal and transparent. Also it is comparable to look at Iceland who possesses a single currency and has had troubles with volatile exchange rates due to changes in the market. This shows the problems that each country could still be facing if they hadn’t been part of the euro; highly vulnerable to any changes in the world market like rises in oil prices or commodity prices. Papantoniou (2011) supports this stating “the growth of output seems to have been stabilised in the euro area since the end of the 1990’s. Although the eurozone has not been the only area enjoying this decline in volatility of output growth, the convergence of economic policies of the eurozone countries coupled with a steady monetary policy of the ECB in its response to major events, such as the global economic downturn in the early 2000’s”. By employing data over 1982-2002, De Sousa and Lochard (2005) found that the euro has raised flows of foreign direct investment within the euro area by 62%.

Another benefit of the euro has been the safety net that each nation in the eurozone now possesses. Since the euro crisis, Greece and Ireland have had to be bailed out by the EU and IMF, this wouldn’t have happened had they not been part of this union that they can fall back on. The EU can’t afford to let any nation default as it could trigger a domino effect, so all the countries in the eurozone will continue to help bailout any countries in need to stop another crisis. Also, though countries like the UK do have the option of de-valuing their currency that members of the euro don’t have, it does have negative effects. The Federal Union website supports this stating “devaluation leads to reduced living standards, higher inflation and creditors deprived of full repayments abroad” with the last factor leading to countries losing their credible reputation with foreign investors. White (2011) reiterated this stating “For the citizens of an open economy who want to enjoy cross-border trade and investment, and want to have a trustworthy currency, the option of their central bank to devalue carries a near zero or even negative value, while the benefits of membership in a common currency area are important and positive”. He went on to suggest “The euro has so far held its value better than the drachma or the lira or the peseta used to” meaning the countries in the eurozone could have been much worse off had they not shared a currency and seen their economies lose their value. Tilford (2012) suggests that the EU compares favourably with its rivals, stating “Eurozone members as a whole … have a lower budget deficit than the US and the United Kingdom, and a similar level of public debt. Unlike the US and the UK, the eurozone in aggregate is running a current-account surplus” though the problem is whether to perceive the EU as a single organism or a host of multiple countries. The economist also found that “Prior to the crisis, Italy’s government was running a primary surplus and bringing down its debt-to-GDP ratio. So long as markets were prepared to finance Italy’s old debt at low rates, it was in good shape. Now, of course, markets aren’t prepared to do that” showing not all the nations now in trouble were spending outrageously, it’s just that once markets were spooked it effected some fragile economies in the eurozone like Italy. The European Central Bank also managed to keep its inflation rates at low levels throughout the euro (at around 2%), an important step in making sure a problem of hyperinflation didn’t spread through the eurozone.

In conclusion, the euro has some fundamental problems that need to be solved if it is to survive. The first two problems are interlinked, as the EU cannot have one monetary policy and multiple fiscal policies. The EU will need to either centralise the fiscal policy of the eurozone, giving more power to the EU parliament over taxes/government spending or give up some of its power over monetary policy and allow countries to print their own euros with some sort of maximum limit in place. The first choice seems the most likely as the EU continues along a current path of greater unification (bailing out countries to keep the EU in existence) and this could result in Eurobonds, as a way of reducing borrowing costs for each country and creating a safer asset for the EU. The current structure of the EU has political fractures between different governments, as countries fight for their own interests, this will need to be sorted by giving more power to the EU parliament and getting rid of current trade barriers between nations. The vast inequality will need to be treated too, as contrasting statistics between central and periphery states (budget deficits, current accounts) will continue to split the EU. A solution could be to have a system like that in USA where the richer states can transfer funds to the poorer states; this is basically in use now in the eurozone as countries like Germany and France are being forced to bail-out their neighbours. The last fundamental problem of having no preparation for a crisis is already being resolved, as the recent Euro Crisis has caused countries to stop either living fiscally irresponsibly (Greece) or to stop relying on certain  markets (Spain too reliant on construction market). There is also more regulation over fiscal activity and bank credit, which was badly missing from the original set up and encouraged nations to live beyond their means. The euro did allow growth in poorer regions of Europe, but this was financed by easy debt. While the safety net it now provides relies on the belief that the countries footing the bill will continue to decide the costs of bail outs outweigh the costs of a breakup of the euro. Instead there should already be a lender of last resort set up, the European Central Bank for instance, which can help out any country and already have been financed by years of savings from each country. These points add up to suggest the euro was in fact doomed from the start due to innate problems in its structure and the only way it can survive in its current form will be through reforms in its monetary and fiscal policy and its political unity.

A Happy New Year?


As we head towards Christmas and the New Year, now is a good time to evaluate which economies are heading for troubling times in 2013. This isn’t so hard, with the world economy not exactly working in top gear, and the likes of even China appearing to slow down. But I have picked three countries that I believe are facing an especially tough and defining 2013.

First up is a struggling EU economy that could define how the rest of Europe solves the Euro crisis. No, it’s not Greece. It’s not even Spain or Italy. The country I believe is in considerable danger is France. One of the leading economies in the euro, its fate has large repercussions on the rest of the European Union. France has a host of problems; High unemployment at over 10% of the population, miserable GDP growth of just 0.1% this year and just 0.8% forecasted in 2013 (which is in itself seen as optimistic) and a budget deficit of 4.5% of GDP that needs to be brought down. Yet already the 2013 budget target of 3% of GDP seems unlikely. But worse than that is the longer running trend of the French economy.  France has over the last decades lost competitiveness to countries like Germany, with their products now either upmarket or non-existent. Even their food production is only surviving due to large subsidies from the French government and EU budget. Alongside this the French government is one of the biggest spenders in Europe, spending the highest proportion of its GDP  in Europe (57%) and racking up billions of public debt (equivalent to  90% of its GDP). But even these problems could be solved with significant reforms and cost cutting. The fact is however, that the French government doesn’t seem ready for such hardship. President Hollande campaigned on making the rich pay (with his famous 75% top income tax rate), not cutting budgets. While the likes of Italy and Britain employ heavy austerity measures and hard labour reforms to help fix their economies, France seems to be satisfied to keep an inflated government and unproductive economy. For now the nation remains under the radar of the markets, but this could quickly change in 2013, just ask Italy or Spain. President Hollande has only just started a 5 year term, if he doesn’t act now with time on his side, when will he?

Graph found at the Economist: http://www.economist.com/news/special-report/21566238-how-regain-competitiveness-doing-so-so. Shows Frances high public spending and low competitiveness. 

Next up on the list is one of the famed BRIC economies that seems to have lost its way. It may seem ridiculous to be picking a country that is set to have grown this year by 5.8% but India are in uncertain times. Inflation has been uncomfortably high for the last few years (currently near 10%) and is hurting the poor population of India. The Indian population relies on high growth of around 6% a year to keep lifting millions out of poverty, so the current slowdown of growth to just under 6% is worrying for the nation. This slowdown has occurred because India’s government is very badly run. It intervenes in the private market far too much, running important industries like the energy sector inefficiently. Corruption is also rife, leading to much of the money meant for those in poverty going into the pockets of local officials. The final nail in the coffin is a complete lack of reform in the last few years, with many markets rigid and inaccessible by foreign firms, leading to poorly run Indian firm producing below average goods and services. India’s growth was started by a series of reforms in the past that lead to greater competition and opportunities for the Indian population. A return to these policies would reignite the economy. But what makes me place India in this list is the complete lack of push for any such policies. Recent movements towards have creating greater competition in the country have lead to large protests and a standstill in the government. Even worse, the election in 2014 isn’t set to change anything, with the opposition just as bad if not worse than the current officials in charge. Change is not wanted, yet is exactly what is needed for the Indian economy to keep progressing forward. Standing still is going backwards.

India has a larger budget deficit and public debt than any other BRIC country in 2012. 

Finally, to complete my list, I end with South Africa. For so long the kings of Africa, their dominance is slowly fading. Growth of just 2.4%, high unemployment at 25% and a current account deficit (imports minus exports) of over 6% shows a leading country underperforming. Its crown is challenged by an oil backed Nigeria and a resurgent Egypt, while the smaller nations like Rwanda and Botswana are showing the larger nations how to successfully run an economy. Even its reputation as one of the most sophisticated nations in Africa is losing its shine, as the recent mining strikes show a deep unrest within the country. South Africa remains highly unequal, with a white South African (accounting for only 9% of the population) on average earning eight times more than a black South African. Its Gini coefficient (measuring inequality) has incredibly risen in the last decades from 0.59 to 0.63 (0=Perfect Equality, 1= Perfect Inequality). Education also remains a tragic failure, where the government has somehow managed to outspend every other African country yet still have one of the worst educational systems. Corruption has infested the current government, and with the next general election not till 2014, it seems unlikely anything will change in the next year for the good. Unemployment and poverty remain the big problem (with half the country still under the poverty line), but the problems are all interlinked. A poor educational systems produces unskilled labour, while high inequality keeps millions in poverty. If South Africa doesn’t start investing wisely into education, job creation and equality it is certainly set for a poor future. Don’t look now but South Africa’s crown may be slipping.

Unemployment in South Africa has been incredibly high for the last decade, one of many problems the country faces in 2013. 

There were a few more obvious candidates; Greece and the USA. But I decided against them for a few key reasons. Greece are forecasted to suffer another year of serious decline, but the IMF and the EU seem set on keeping Greece running, which in my view could help keep the economy progressing towards a better run state (with them already running a primary surplus). The USA could face a sudden recession with the fiscal cliff, but the problems are clear and I just can’t see America letting themselves go over the figurative cliff (even if that means kicking the can down the road).

The warnings of the fiscal cliff have been clear enough for America to avoid it. 

Even with my choices there are signs of progress. In France recently a report on the poor competitiveness of the country seems to have hit home, with President Hollande perhaps realising the true extent of problems he needs to overcome. While a crucial vote was won in the Indian Parliament that will open the retail sector to foreign competition.

Important steps maybe, but more is needed to avoid a year to forget.

No longer the king of the playground?


South Africa is the largest economy in Africa; in fact it is bigger than Angola, Ethiopia, Ghana and Kenya combined. From 2000 up to the financial crisis, the country had averaged growth of around 5% each year and last year was included into the much hyped BRIC club (Brazil, Russia, India, China), becoming the “S” at the end of the acronym. The country boasts the best infrastructure in the continent, the biggest stock exchange and still gets the most FDI projects.

But this only covers up the signs that the crown is slipping from South Africa’s head. GDP Growth since the financial crisis has barely averaged 3%, with the 2012 growth forecast cut from 3.8% to 2.8% in July. There are many reasons for this decline in growth, one being the increased competition from its neighbours. Whereas South Africa used to account for half of Sub-Saharan Africa’s GDP, it now barely makes up a third and faces big opposition from Nigeria (who have averaged 7% growth for the last decade) and Egypt (whose GDP nearly rivals South Africa’s in purchasing-power parity). While a more peaceful Africa has seen smaller countries like Kenya and Botswana attract more foreign investment directly, without the need to go through South Africa as in the past.

In Purchasing-Power Parity terms, Egypt is not far behind South Africa, found at http://www.economist.com/node/21556300

Another reason for slow growth has been a decline in its biggest industry, mining. The mining industry accounts both directly and indirectly for about 18% of GDP in South Africa, while the country possesses the World’s largest amount of mineral resources. This was great when Commodity prices were booming, but a sudden decline in prices over the last year has seen the economy affected. Additionally, Global demand has softened, with the Euro crisis in particular affecting South Africa as they account for 22% of the country’s exports. Mining quality has declined over the last few years as well, with the country falling from 37th to 54th in a “mining investment attractiveness” survey. The recent fiasco over mining strikes has also shown the poor conditions for workers in the mines and leads us onto the next problem: inequality.

The Fraser Institute’s mining investment attractiveness table, showing South Africa’s lowly position.

South Africa is rife with inequality; nearly half the population lives under the poverty line (60% for Black South Africans), White South Africans earn on average eight times more than Black South Africans (despite only accounting for 9% of the population) and since 1994 the company director’s salaries have risen by 29% compared to just 6% for workers wages. The Gini Coefficient – a measure of inequality where 0 = total equality and 1 = total inequality – was 0.63 for South Africa, an increase from 0.59 two decades ago, while the gap between the rich and poor is one of the biggest in the world, larger than known offenders such as Honduras.

The world map showing each countries GINI Coefficient, with South Africa a dark red (>.60)

The poor growth rate has substantial impacts on the whole economy, with high annual growth of 7% predicted to be needed to improve the severe unemployment figures. In South Africa nearly a quarter of the population is out of work and the high growth of pre-2007 years did not create the jobs that were hoped (rather lining the pockets of the already rich). The current president swept into power in 2009 on the promise of economic reform and job creation, but his target of getting unemployment as low as 14% by 2020 looks unattainable and since his party took over, 2 million jobs have been lost and unemployment hasn’t dropped below 22% since 2002.

The South African Unemployment figures from 2000-2010, found at http://southafricaeconomywatch.blogspot.co.uk/2011_01_01_archive.html

That’s not the only problems the country faces either. One of the biggest problems is the poor education South Africans receive, where educational spending outstrips most other African countries per child but remains one of the worst educational systems in the continent. This creates the problem of an unskilled labour force (especially in IT skills) that is unqualified for the jobs on offer in the country (resulting in foreigners being brought in for the top jobs). Another problem is a lack of credit since the financial crisis, with the ratio of bank credit to GDP falling by 10% (see the Economist’s graph below). Bad economic indicators also show an economy in trouble; with the current account deficit at 5.5% of GDP (showing the weakening of exports due to the Euro slump and strong domestic currency) and the budget deficit at 5.6% of GDP (due to poor exports lowering income for the country) thought the debt to GDP ratio of the country is a lowly 33%.

Graph showing South Africa’s drastic drop in Bank credit to GDP ratio, found at http://www.economist.com/node/21559336

So is South Africa losing its crown?

At the moment the nation is still the biggest kid in the playground and remains far ahead of other countries in sophistication and diversity. Despite the country having the largest mineral reserves, the economy is not revolved around the mining industry; with clear signs of variety in different sectors like industrial production and some good headway in improving the service sector. But South Africa will find it hard to throw its weight around when all the other kids start experiencing growth spurts.

Will Ethiopia escape Zenawi’s shadow?


You just have to look at the USA and Europe to see what a lack of leadership can lead to; Republicans and Democrats bickering while an impending fiscal cliff approaches and a eurozone on the brink of collapse while national leaders debate the pro’s and con’s of a more unified Europe. In Ethiopia, the country had the complete opposite, a leader with a clear idea of where the nation was heading and more importantly how to do it. But following the death of their Prime Minister, Meles Zenawi (pictured below) the future of the country has suddenly become cloudier, as no likely successor is in sight.

Ethiopia, possessing the second largest population in the continent, has always been a big player in the history of Africa. Famously one of the oldest sites of human existence, Ethiopia was also one of the few countries not to be taken over by Europeans powers (embarrassing Italy in their attempted invasion) and is a founding member of the UN. Despite this they have had a patchy record in politics; after decades of monarchy, a military dictatorship took over in a coup which lasted from 1972-1991, from then the country officially adopted democracy (though many criticised its apparently “equal” elections). Meles Zenawi was elected Prime Minister in 1995 and won three more re-elections in 2000, 2005 and 2010 to the dismay of critics.

Politically, Meles Zenawi has clearly played dirty. In the 2010 elections his ruling party won an absurd 99.6% of the vote, leaving the opposition with only one seat in parliament. That is what’s left of the opposition, as parties were banned and leaders exiled or arrested (in March 2011, 200 opposition members were arrested alone). Then there is the media censorship, where citizens have little choice other than state owned networks and journalists are regularly arrested for being critical of the government (in 2011 several journalists were arrested for such reasons). Mr Zenawi also took upon himself to meddle in other countries problems, with notable incidents involving forced entries into Somalia and Sudan.

Protests against Meles Zenawi in Ethiopia.

But economically, Meles Zenawi has done a better job than many in improving his countries conditions. He has carried out many economic reforms on a country that practically used to have no private sector and youth unemployment as high a 70% (down to a reported 23.7% in 2011). He increased FDI flowing into the country (averaging $240 million from 1995 to 2004) though the global financial crisis hampered this somewhat. Meles Zenawi was primarily able to do this because of global aid, as his country became Africa’s biggest aid recipient. Mr Zenawi contributed to this by working his charms among the biggest nations of the world, with America a reported ally of Mr Zenawi despite his patchy human rights record. To his credit Meles used this money wisely, boosting manufacturing, agriculture and exports (with exports to the US nearly tripling from $270 million in 2009 to $690 million in 2011). In fact over the last 10 years, GDP has increased on average by over 10% a year, around double that of the countries surrounding it and even more impressive when you consider the country doesn’t possess any large scale natural resources to rely on. Recent plans have involved building new Hydroelectric dams that could boost energy output by five times its original amount in 2015. More importantly, Mr Zenawi has managed to lift 15% of the population out of extreme poverty, which for one of the poorest countries in the world is a big achievement. Under his reign, Ethiopia went from a starving country to a food exporter.

Graph showing average GDP growth rate for Ethiopia from 2001-2010. From 2002-2012 this increases to 10.6%. 

 

Like many things in life, Meles Zenawi’s reign is neither black or white, but more a shade of grey. His government has improved the economy and living conditions of its people, but the extreme measures used to stay in power are rightly condemned. The big question now is what will Ethiopia do now he is gone?

For all his good or bad, the running of the country was modelled around him. He left no real institutions in his place for the country to continue growing and leaves a vacuum of power that no-one looks like filling right now. The current successor, Mariam Desalegn (the foreign minister) is just one of the many yes men Mr Zenawi surrounded himself with and does not look up to the job of replacing him. The years of success that Ethiopia has had in reforming its economy and improving the country could now be wiped out if a power struggle tears apart the ruling party.

Mariam Desalegn looks ill suited to the position permanently.

But perhaps it can be lesson for both Ethiopia and for all of Africa. Economic success based on a dictator will always face succession problems, while human rights always lose out. The key to continued success is through democratic elections and the building of institutions. A current example of this is Myanmar, where recent deregulation of the past strict media laws are just one of many economic reforms going through the country in the build up to one of the first truly democratic elections to be held in the country in 2015.

Similar steps must be taken in Ethiopia if it is to grow from out of Zenawi’s shadow.

 

The Economic Medals


With the Olympics coming to an end, I thought it would be in the spirit of the times to award some medals to countries based on their economic performances in 2012. With it only halfway through the year, some figures will be based on predictions for the year 2012. I will also only include modern economies, thereby discounting a lot of African countries that are heavily reliant on aid and countries in the middle east that still recovering from civil or foreign war. A trend of Asian economies succeeding goes right through the different departments, while a few countries can count multiple medals.

First up is the big one, GDP Growth – the annual increase in the market value of everything a country produces. In bronze position is Thailand with a predicted 6% growth this year, after recovering from their worst floods in nearly 70 years in 2011. Just ahead of them in silver position is India with 6.6% growth, as the country continues to expand its economy to keep up with a burgeoning population. A recent mass power cut however showed the insecurities in their infrastructure, which could possibly hurt future growth for the country. Out in front is China with 8.1% growth predicted for the year, as the country strives to surpass the USA in the record books as top dog.

1st China – 2nd India – 3rd Thailand

Graph showing China’s growth over the years. 

The next event is Unemployment, where the nations are competing on their ability to get people into work. After getting bronze in the last event, Thailand comfortably wins the gold here, with the percentage of the population unemployed at an extremely low rate of 0.9%. This is contested however with Thailand accused of not seasonally adjusting their numbers (as farmers are out of work for long periods). If that is proven correct then the current runner up, Singapore would be awarded gold, with unemployment at 2%. The government has achieved this by both having a very stringent benefits policy and by having a low population of just over 5 million. In the fight for the Bronze medal, Switzerland just beats off competition from Malaysia and Norway. With unemployment at 2.9%, Switzerland has done well by having strict visa rules which can be adjusted to help keep employment high.

1st Thailand – 2nd Singapore –  3rd Switzerland

Graph showing Thailand’s unemployment rate since 2010. 

The third event is the Current Account Balance as a percentage of GDP. This is the balance between Imports and Exports, with the best countries exporting more than they are importing, therefore having a current account surplus. After narrowly missing out on a medal in unemployment, Norway capture Bronze with a current account surplus of 14.1% of GDP. This is thanks to their vast Oil and Natural Gas resources, with global prices increasing in recent times. Ahead of them in second place is once again Singapore, who boasts a strong current account surplus of 17.9% of GDP. This is because Singapore contains the busiest port in the world, allowing the country to become a global trade hub. Taking Gold in this event is Saudi Arabia; whose enormous oil reserves (the largest exporter of oil in the world) has allowed it to build up a current account surplus of 22.7% of GDP.

1st Saudi Arabia – 2nd Singapore – 3rd Norway

Graph showing the current account balance of Saudi Arabia 

Following this is the National Budget Balancing event. In this the best countries are able to make money from tax revenues after taking away government expenditure, thereby producing a budget surplus. In Gold and Silver positions are Norway with a budget surplus of 14.3% of GDP and Saudi Arabia with a budget surplus of 11.1% of GDP. These two top the pile because of the same reason as their high current accounts, they have vast Oil and Natural Gas reserves. Unlike Singapore whose high current account came from their successful port, the exportation of raw materials has boosted Norway’s and Saudi Arabia’s budgets by observable amounts. In a far off bronze position is Chile, who government has worked well to possess a budget surplus of 1.5%. This is partly down to the efficient running of the country by the government but is also down to a rise in the copper prices, of which the Chilean economy is highly sensitive towards.

1st Norway – 2nd Saudi Arabia – 3rd Chile

Graph showing Norway’s superiority over the rest of Europe with its high budget surplus. 

Finally, to finish off the medal ceremony is the government’s 10 year bond yields. These are the interest rates that each government must pay to loan money on the international markets, where the lower the number is, the more secure international creditors believe you are. For example Spain is currently facing very high interest rates, while the likes of Greece are not even able to borrow money on the international markets (leaving them reliant of bail outs). In Bronze position, Japan is able to borrow very cheaply in the long run with interest rates at 0.81%. These figures are somewhat distorted though as the government puts pressure on Japanese banks to buy their bonds, helping to drive down the bond yield rates. In silver position, Hong Kong boasts an even cheaper rate of 0.74% on long term loans. With a AAA credit status and heavy links to China (where heavy capital controls restrict international investment) the city state has become very popular in the bond markets as a secure investment. But in Gold position and winner of the event is Switzerland with interest rates of 0.63% on long term bonds. Switzerland are treated to such low interest rates namely because of the euro crisis, as the countries surrounding Switzerland face the ever present danger of a euro collapse. Switzerland (not in the EU) is therefore seen as a safe haven in a sea of chaos called Europe.

1st Switzerland – 2nd Hong Kong – 3rd Japan

Table showing the worlds lowest bond yields on the 1st June 2012. Since then Hong Kong has overtaken Denmark and Japan into second place

Britain: The Coalitions first two years


Have David Cameron and Nick Clegg been good leaders?

So the Coalition has been in power for two years now, that’s long enough to paint a good picture of where they are leading the country and how well they have done in charge.

One of the biggest factors in the coalition’s reign has been their reforms in education, health and the military. With education the government has set about creating “academies” which are schools that have been freed from local authority and allowed to make their own decisions on budgets, working hours and teaching styles. This has really kicked off across the country, with nearly half of all state schools being turned into these “academies”. Along with this the government is changing the exam structure in secondary schools, with the old O-level system being brought back in to replace GCSE’s. This is aimed to make exams harder after renowned criticism of exams becoming easier each year, while it also hoped to raise Britain’s poor standing in international tables for key subjects like Maths and Science. All in all, this makes sense as the current structure is flawed and corrupt (with schools manipulating the system to rise up the league tables), but those students unlucky enough to be the guinea pigs will likely achieve lower results. Finally there has been changes to higher education, with the cap on university fee’s raised to £9,000 from £3,000, to much protest from current and potential students. This is a debateable subject, with fees now very expensive considering you would have to study three years plus the costs of living, but the fact that student loans are accessible to everyone means it shouldn’t punish the currently poorer families too much (though the maintenance loans have been accused of being too low).

Protests against University tuition fee increases.

Next up are the reforms in the health sector, with a shake-up wanted for the NHS. The idea was to diversify the NHS, make doctors more accountable for budgets and open up the private market more. This has been an unmitigated disaster however; with substantial criticisms leaving the health bill a complicated mixture of compromises. This leads back to the Governments clear weakness throughout their reign, poor public relations. The government failed to make clear what exactly they wanted to change about the NHS (an already popular institution) and made it worse by not publicising such plans in the election campaign. Then there is the military, which the government has proceeded to cut down. With budgets tight, the army has been a big victim to the government’s cuts, with it being told to lowers its numbers by 60,000 people by 2015. This is to help close the £38 billion hole found in the defence budget, but critics now suggest the UK military is markedly weaker and would struggle to win conflicts such as a possible Argentinean invasion of the Falkland Islands.

Protests against the NHS reforms (you can see a pattern starting to emerge).

Even away from these big sectors there have been big reforms to the country. The government tried and failed to implement elected mayors in some major cities, with nine of the ten referendums being rejected. Then there are the big reforms to the police, which are set to integrate democracy into the Police hierarchy and allow the outsourcing of tasks like office work. Welfare is also being tackled, with benefits capped at £26,000 per household and David Cameron even pondering whether to drop the housing benefit for under 25’s. Finally there are possible changes to the Civil service being planned, to try and make individuals more responsible for their actions after criticism over the difficulty in passing through bills. So rightly or wrongly, the government cannot be accused of doing nothing, with a possible criticism instead being that they perhaps tried to do too much in such a short space of time.

Next we can look at the country’s economic performance. On the positive side of things, Britain surprisingly kept unemployment relatively low since the financial crisis, with the current figure of 8.1% (only 1% higher than the pre-crisis level) lower than its European counterparts; with Greece at 21.9%, Spain at 24.1% and even France at 10.1%. In fact, public sector jobs cuts of 424,000 over the last two years have more than been accounted for by a rise in private sector jobs by 843,000. In debt terms Britain isn’t too bad either, its public debt sounds incredibly high at just over £1 trillion, but this only accounts for 67% of their GDP. In comparison to other countries this isn’t too bad, with Germany and France having similar debt to GDP ratios, while Greece, Portugal and Italy boast debt levels over 100% of their GDP’s. In fact, all the worry over the Eurozone crisis has driven investors to Britain, with bond yields incredibly low at around 1.6% meaning Britain can borrow money very cheaply right now.

Current unemployment in Europe shows Britain in the bottom half and fairing better than its neighbors.

However, Britain is struggling deeply in other terms. Despite debt levels not being too high, the current budget deficit is 8.4% of GDP, which along with Ireland is the highest in the eurozone. This means that although Britain’s debt isn’t too high, they are adding to it much faster than any other countries in Europe. Even more disappointing is the Primary budget deficit which discounts the interest being paid on current debt. This stands at around 3% of GDP and is the highest in Europe, deafening criticism when the likes of Greece are boasting a surplus. It basically shows Britain is reliant on foreign money to survive right now, and is the main reason why the government is making such drastic cuts to the public sector. On top of this is Britain’s poor growth, with the country currently in recession, after a GDP decline of 0.4% in the final quarter of last year followed by a decline of 0.3% for the first quarter of this year. Though this isn’t a severe recession, it follows a long term trend of poor growth for the UK, with just 0.5% annual growth forecasted this year preceded by 0.7% annual growth last year. Such poor growth is not all Britain’s fault with oil prices and the Euro crisis obviously having an effect, but more must be done to implement growth within the country. At times the government is too set on cutting costs, with little ideas for boosting growth, a policy that is born to fail as low growth will only lead to less taxes and higher benefits being dished out. So in economic terms the government has done well to cut budgets without dropping the country into another deep recession, but without some sort of plan for Growth, they will be fighting a losing battle to lower the budget deficit.

The GDP forecasts of Britain show weak growth compared to Germany and France. 

Finally there are the international issues the government has had to face. International conflicts have seen Britain take a bigger role, with the intervention in Libya lead by Britain and France and the chaos in Syria seeing David Cameron condemn President Assad and argue the case for harsher sanctions and possible intervention. While the current disagreement with Argentina over the Falklands islands has been handled well, with a referendum set to end the debate and keep the islands under British control if the people reach such a conclusion (as is expected). However the debate over Scotland remains a touchy subject. Scotland is set to hold a referendum themselves over whether to stay as part of Britain and there is general worry that a decision could go against what the Coalition are hoping for. A messy split would not help the economy and debateable issues such as the North Sea oil revenues and transfer of Scottish bank debts could take a while to be sorted out. But by and large the biggest international issue remains the Euro crisis. Britain are one the few countries in the EU not to hold the euro currency and this has helped them devalue their currency, meaning the internal devaluing (public sector cuts etc) didn’t have to be as drastic. But the downside is that they are highly vulnerable to a break up without the safety net of having the EU bail them out. Britain actually doesn’t have much money tied up in Greece itself (roughly 0.4% of GDP) compared to Germany and France. But the combined money exposed to the weaker economies (Greece, Portugal, Spain, Italy and Ireland) accounts to £190 billion, which is higher than France or Germany’s exposure and is roughly 12.7% of British GDP. That’s not to take into account the money exposed to Germany and France at around £116 billion, which would be in big danger due to the domino effect expected to happen if just one economy in the eurozone fully crashes. So far Britain has gone against the trend in European discussions, opting out of the fiscal compact (such budget targets were beyond Britain right now) and largely looking out for itself (with the transfer of sovereign powers back to Britain high on the coalition’s plans). This has seen them marginalised somewhat and there is sense that if the EU is to solve this crisis they would have to become more unified. This leaves Britain with a big question to face in the near future, whether they join the new EU or leave the eurozone permanently.

Graph shows the extent to which Britain is exposed to the euro crisis. 

Overall, the Coalition government has had an eventful two years do far. Big changes to the county have had mixed effects, while the same could be said for their economic performance. Internationally they have fared well but will need to decide what direction they want to take in regards to the European Union. I would give them a 6/10, as they have fared okay in most departments, while it possibly could have been higher had they publicised their actions better. This has been the big problem with this government so far, they have dealt poorly with public opinion and are unpopular not down to their decisions as such, but rather the ways they have gone about making such decisions.

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