1.What Is Globalisation And Is It Good? WHAT IS GLOBALISATION?

Globalisation refers to a variety of events that are rapidly changing the world. The machine that powers globalisation, however, is the global economy. At the heart of the global economy are the twin policies of privatisation and deregulation, which national governments have adopted worldwide since the 1980’s. Terms like free market economy, level playing field, monetarism, market economy, and neo-liberalism embrace processes such as privatisation and deregulation.

Privatisation is about putting governments out of business. The economic theory behind privatisation is that, Business knows best. In this age of globalisation, our governments cheerfully tell us that they are too incompetent to manage our economy, so as a service to the public they will instead let the free market run it. Then our governments sell off publicly owned businesses and assets, which usually end up controlled by multinationals and financed by public shareholders. Competition within the marketplace rather than government management, we are told, will allegedly produce lower prices and better services for consumers. This is called a better standard of living, which implies that the public are better off for having a privatised economy so they should be happy about it.

The strange part is that governments streamline their businesses, making them efficient and profitable, before they offer them for sale. If governments can do that before they privatise, why were they not doing it all along? Also, if governments are competent to get their businesses profitable and efficient, why not keep running them that way in the future rather than sell them? If governments genuinely are that incompetent, how can the public trust their competence to manage anything?

Why also do governments sell businesses that were always running profitably and were never losing money? All these actions contradict the stated reason why privatisation is allegedly necessary. They also imply a lazy, if not negligent attitude from government towards citizens, whose assets they are selling off, often at undervalued prices.

Deregulation takes several forms. Within a country, the lifting of trade restrictions and easing of government regulation in business is meant to allow business to run more efficiently. The best businesses will survive the competition to give consumers a better standard of living, that is, more material goods for lower prices.

Deregulation also applies to national currencies. Currency is no longer pegged at a certain value by government decree or gold reserves, but its value is floated in the global market place, where it will find its own natural level in the ocean of other global currencies.

Deregulation does not just apply within a country though. Deregulation also involves opening a country up to foreign competition. Foreign businesses can operate in our country, on the basis that our country’s businesses can trade in other foreign countries.

What is the benefit from all this? A better standard of living through a wider range of cheap goods is what globalisation is all about. This is what the media, politicglobalians and multinationals keep telling the public.HOW DID GLOBALISATION ARISE?

Why are democratic governments now putting themselves out of business by selling their companies and assets, and giving control of national infrastructures and economies over to multinationals? The present phase of the process began in the latter 20th century.After World War II most countries were in an economic mess. Governments were the only entities large enough to get economies repaired and moving again.  The governments took control of the commanding heights of their national economies. Government directed economies were based upon the idea that Government knows best .

For three decades after WW2 the government led economies worked reasonably well. However, the US monetary system had a problem left over from a 1930's quick fix, and this problem began to catch up by the 1970’s. In 1971 the US economy was technically as good as bankrupt. President Nixon took an easy way out by severing the link between the US dollar and gold. This allowed the US to have adequate money supply, where previously gold had stifled it. While this fixed the short-term problem for the US, it created several long-term problems globally.

Now US dollars had become freed from the restraint of a gold standard and the US banks could create as much money as they chose to, virtually without effective regulation. The ensuing flood of money aggravated

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economic malfunctions within many other countries that were still on the US dollar standard. As nations floundered economically, they contaminated other trading partner economies. Stagflation, stagnant economies with rampant inflation, became like an epidemic sweeping around the world.

Let us look at how inflation works. When money is in short supply (credit squeeze, recession), interest rates go down to stimulate more lending, which puts more money into circulation. However, when there is an oversupply of money (inflation) interest rates go up to curb lending, which removes money from circulation.

After global currencies lost the regulation of gold, the raising of interest rates no longer curbed borrowing like it did under the gold standard. During the earlier 1980's so much money continued pouring into circulation that many people could afford the higher interest rates and they kept on borrowing, which took inflation even higher.

The global banking fraternity could have regulated the inflation chaos that occurred after the US severed its link to gold, but they did not. All the banks had to do was cut back on the number of loans they granted, but instead banks kept on lending to the unwary world. Why? Because the banks knew that the day of reckoning would come, when the interest burden of the loans inevitably caught up with and stalled the free flow of money. It is similar to a pyramid sale scheme, but instead of the patsies ending up with a garage full of soap, they end up with a life or business full of debt.

Why did the banks encourage an economic situation that they knew would stall itself? Because the banks knew that when it stalled, they would be in a position to take control of vast amounts of property and businesses, when the people that built them inevitably defaulted their loans. It was good business. As nations became debt burdened, privatisation and deregulation did effectively deliver public property and businesses into multinational control to pay off national debts.

The 1980’s and 1990’s were the decades of crippling inflation and stagnant economies. In Africa and South America the 1980’s are referred to as the lost decade. Great Britain was brought to its knees, and the Mexico currency crisis nearly destroyed the global economy. The 1990’s were when Japan, SE Asia and the USSR crashed economically. The real cause of the economic instability was the willingness of the global banking fraternity to oversupply a faulty money system. This was quietly ignored. The blame for the world's economic woes was instead cast upon government interference and ineptitude in economics.

The global crashes of the 1980’s and 1990’s were caused by deregulation of the global financial system and business decisions made by banks, not government ineptitude. No government could have survived what the banks were doing (and continue to do). Banks reaped an economic harvest across the Earth while the cause of the problem was deflected in the direction of national government incompetence. The governments had run up huge debts, therefore they must be inept at running business. Its logical.

Through privatisation and deregulation, banks and other multinationals could now begin to purchase and control infrastructures and businesses that had previously been run by national governments for reasons of national security. Much of the essential business of running countries was now being put on the market for sale through privatisation. The banks and their multinational affiliates began to purchase the infrastructures of countries, while governments signed away national rights of control through international laws in the World Trade Organization (WTO).

In the early 1980’s, England under Thatcher was the first country to embrace the principles of privatisation and deregulation, which the Chicago School of US economists had been promoting since the 70's.  The USA under Ronald Reagan quickly joined in. As other countries around the world fell into economic chaos, the US economists were close at hand to sell them the benefits of government privatisation and deregulation. The magic fix of the market led deregulated economy seemed to work in the failing economies, and the economies began to stabilize. But as countries bit the bullet through loss of national assets and jobs, all that really happened was that their economies were being painfully reset to an even ledger again after selling the farm to pay off crippling debts. New debt would continue to accumulate as it had before. Getting out of debt made governments look impressive to voters and gave the voters false hope that perhaps now the economy might be fixed.

The illusion was that the globalisation mantra of Business knows best’ was an axiom of economic reality, a fundamental truth. This was because government privatisation and deregulation seemed to stabilise economies. However, the quick fix of privatisation and deregulation was not a long-term solution for the global economy

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because the debt fault still remained. This meant that nations would eventually fall victim to uncontrollable, escalating debt again.WHO IS RUNNING GLOBALISATION?

The excessive lending by banks in the 1980’s had been the bait, and their catch was the gains they made through bankruptcies and sales of national assets. As these profitable bankruptcies cleared away the immediate economic chaos, the banks resumed more moderate policies of lending.

While governments had no choice but to float their currencies, doing so was just a short-term fix rather than a long-term solution. In the new economy if countries did not join in and deregulate their currencies (and economies) they became sitting ducks for global money speculators, foremost among which are multinational banks. The floating of national currencies was an inevitable result of the US severance from regulated currency. It was an offer to weaker economies that could not be refused - either join the club of globalised currency or be clubbed by globalised currency. The floating of currencies partly addressed the threat from global money speculators, but it did not fix the fault in the global monetary system, which continues to hamstring national economies through debt.

Foreign debt is largely a misnomer. The debt is foreign in the sense that it is not owed within the same country and its economy. The word foreign implies that the debt is owed to another country. These days that is not entirely the case either, because most countries on Earth have excessive foreign debts. Foreign debt is mostly owed to multinational banks, which have no loyalties to any nations and are in the business of creating debt.

Privatisation and deregulation also ignore the fact that debt growth outpaces economic growth in the post-1970's global money system. Just as private debts had bankrupted citizens and companies through the 1980’s and 1990’s, debts are now preparing to bankrupt whole countries in one go.

Privatised and deregulated national economies have allowed multinationals to take control over the business, infrastructures and economies that run countries and shape their futures. In reality, the world is really run by an oligarchy of global corporations. After deregulation, national governments just take care of lesser, more trivial tasks that still need doing, like building roads and taxing the nation. A country's economic destiny is dictated to it and life for everyday citizens falls into line accordingly. Meanwhile, nobody is meant to notice that their nation is steadily marching towards a precipice of debt.WHAT IS GOOD ABOUT GLOBALISATION?

We have wide-screen TV's. We have cheap Chinese goods. The greatest benefit from globalisation is that it gives some countries a greater range of cheap overseas goods to buy. The cheaper prices are not a lasting result of globalisation though, but rather a reflection of the non-level playing field that currently exists within the global economy.

Government subsidies, import tariffs and lower paid workforces are what make the playing field of the global economy non-level. If the global economy ever reaches its proclaimed goal of a level playing field, then the cheap goods will become more expensive again. There would not be cheap labour or protective subsidies anymore. Cheap foreign goods are bait to encourage citizens to accept and assist the process of globalisation.

As wealthier nations buy those foreign goods they raise the wages of foreign workers and reduce the wages of workers in our own countries by ultimately putting them out of work. Prolonged high unemployment eventually leads to effective reduction in real wages.So in effect, cheaper goods, which are an evident benefit from globalisation, are precisely what globalisation is aiming to remove through its level playing field policy. Achieving a level playing field is a stated goal of the WTO.WHAT IS BAD ABOUT GLOBALISATION?The bad aspects of globalisation involve human wellbeing, the environment and economic realities. Human Wellbeing and Quality of LifeQuality of life is at risk from globalisation in a number of different areas. THE END OF DEMOCRACY AND NATIONAL CONTROL

While democratic-styled governments are being installed around the world in the name of freedom, the essential structure of democracy itself is being undermined by globalisation.

Many fundamental areas of society that were traditionally administered by democratically elected governments are now becoming administered by unelected and unapproachable multinational boards. PERSONAL STRESS

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Globalisation has created new kinds of stress into everyday life. Even proponents of globalisation admit this, on the basis that "markets are relentless".

Corporations rationalise jobs whenever possible. This can be done by laying off workers or importing cheap workers from other countries. Job insecurity and the escalating workloads of existing jobs are eroding quality of life.

At any time fuel prices or interest rates may rise so much it hurts. What if there's a recession? What if the stock market crashes? What if the real estate market spikes up high - or down low? A new culture of "fear of the future" is entering society, caused by multiple long-term insecurities stemming from the new economy. Environmental Survival

How big must the global economy grow in order to be big enough? How much is enough? Globalisation’s answer is that there can never be any such thing as big enough. In 100 years when, at current growth rates the global economy would have grown 50 times it present size, it would still not be large enough. Continual growth is necessary for this present economy to survive because of the way it is designed. The growth rate is deceptive. 4% annual growth does not sound like much but the global economy grows exponentially, not mathematically.

The destruction of natural resources like clean water, forests, arable land, ocean fish stocks, coral reefs and so on are already causing extreme concern even in the traditionally conservative ranks of society. The current rate of extinctions from the planet is comparable to the rate of the extinction event that destroyed countless millions of species along with the dinosaurs from Earth 65 million years ago.

Earth is clearly not coping with the demand for resources in the present sized global economy. At present rates of growth in 30 years the global economy would be about 4 times larger than today, and in 60 years it would be 10 to 20 times larger than today. 

The global economy, which must grow exponentially in order to survive, does not recognize the realities of the natural world. The global economy is presently on a course to destroy itself through the planet’s lack of ability to sustain it. Like a cancerous growth, the global economy is growing so vast that it will soon kill it host.Economic Realities

Their still remains a fundamental flaw built into the post-1970's global monetary system, and economic trouble is arising from it again. The flaw in global money supply ensures that debt will always grow at a much faster rate than economies.

On its present course, unless there are fundamental changes made quickly to the global money supply system, the global economy has no option but to collapse well before 2030.

IS GLOBALISATION GOOD?It would be possible to have a different kind of global economy that works in the real world to sustainably

serve humanity. The pain and destruction caused by the global economy are not inevitable, but simply the result of the way this particular global economy is designed.

Is there not more to life than cheap consumer goods? Environmental degradation, social breakdown and high personal stress levels do not factor into mathematical profit margins.

The people of a nation care about the well being of their environment and society. Multinational corporations have no such national sentiments. They would give the world for a dominant market share, and presently they appear to be doing just that.

2.When did globalisation start?

“GLOBALISATION” has become the buzzword of the last two decades. The sudden increase in the exchange of knowledge, trade and capital around the world, driven by technological innovation, from the internet to shipping containers, thrust the term into the limelight.

Some see globalisation as a good thing. According to Amartya Sen, a Nobel-Prize winning economist, globalisation “has enriched the world scientifically and culturally, and benefited many people economically as well”. The United Nations has even predicted that the forces of globalisation may have the power to eradicate poverty in the 21st century.

Others disagree. Globalisation has been attacked by critics of free market economics, like the economists Joseph Stiglitz and Ha-Joon Chang, for perpetuating inequality in the world rather than reducing it. Some agree that they may have a point. The International Monetary Fund admitted in 2007 that inequality levels may have been increased by the introduction of new technology and the investment of foreign capital in developing countries. Others, in developed nations, distrust globalisation as well. They fear that it often allows employers to move jobs away to cheaper places. In France, “globalisation” and “délocalisation” have become derogatory terms for free

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market policies. An April 2012 survey by IFOP, a pollster, found that only 22% of French people thought globalisation a “good thing” for their country.

However, economic historians reckon the question of whether the benefits of globalisation outweigh the downsides is more complicated than this. For them, the answer depends on when you say the process of globalisation started. But why does it matter whether globalisation started 20, 200, or even 2,000 years ago? Their answer is that it is impossible to say how much of a “good thing” a process is in history without first defining for how long it has been going on.

Early economists would certainly have been familiar with the general concept that markets and people around the world were becoming more integrated over time. Although Adam Smith himself never used the word, globalisation is a key theme in the Wealth of Nations. His description of economic development has as its underlying principle the integration of markets over time. As the division of labour enables output to expand, the search for specialisation expands trade, and gradually, brings communities from disparate parts of the world together. The trend is nearly as old as civilisation. Primitive divisions of labour, between “hunters” and “shepherds”, grew as villages and trading networks expanded to include wider specialisations. Eventually armourers to craft bows and arrows, carpenters to build houses, and seamstress to make clothing all appeared as specialist artisans, trading their wares for food produced by the hunters and shepherds. As villages, towns, countries and continents started trading goods that they were efficient at making for ones they were not, markets became more integrated, as specialisation and trade increased. This process that Smith describes starts to sound rather like “globalisation”, even if it was more limited in geographical area than what most people think of the term today.

Smith had a particular example in mind when he talked about market integration between continents: Europe and America. The discovery of Native Americans by European traders enabled a new division of labour between the two continents. He mentions as an example, that the native Americans, who specialised in hunting, traded animal skins for “blankets, fire-arms, and brandy” made thousands of miles away in the old world.

Some modern economic historians dispute Smith’s argument that the discovery of the Americas, by Christopher Columbus in 1492, accelerated the process of globalisation. Kevin O’Rourke and Jeffrey Williamson argued in a 2002 paper that globalisation only really began in the nineteenth century when a sudden drop in transport costs allowed the prices of commodities in Europe and Asia to converge. Columbus' discovery of America and Vasco Da Gama’s discovery of the route to Asia around the Cape of Good Hope had very little impact on commodity prices, they argue.

But there is one important market that Mssrs O’Rourke and Williamson ignore in their analysis: that for silver. As European currencies were generally based on the value of silver, any change in its value would have had big effects on the European price level. Smith himself argued this was one of the greatest economic changes that resulted from the discovery of the Americas:

The discovery of the abundant mines of America, reduced, in the sixteenth century, the value of gold and silver in Europe to about a third of what it had been before. As it cost less labour to bring those metals from the mine to the market, so, when they were brought thither, they could purchase or command less labour; and this revolution in their value, though perhaps the greatest, is by no means the only one of which history gives some account.

The influx of about 150,000 tonnes of silver from Mexico and Bolivia by the Spanish and Portuguese Empires after 1500 reversed the downwards price trends of the medieval period. Instead, prices rose dramatically in Europe by a factor of six or seven times over the next 150 years as more silver chased the same amount of goods in Europe.

The impact of what historians have called the resulting “price revolution” dramatically changed the face of Europe. Historians attribute everything from the dominance of the Spanish Empire in Europe to the sudden increase in witch hunts around the sixteenth century to the destabilising effects of inflation on European society. And if it were not for the sudden increase of silver imports from Europe to China and India during this period, European inflation would have been much worse than it was. Price rises only stopped in about 1650 when the price of silver coinage in Europe fell to such a low level that it was no longer profitable to import it from the Americas.

The rapid convergence of the silver market in early modern period is only one example of “globalisation”, some historians argue. The German historical economist, Andre Gunder Frank, has argued that the start of globalisation can be traced back to the growth of trade and market integration between the Sumer and Indus civilisations of the third millennium BC. Trade links between China and Europe first grew during the Hellenistic Age, with further increases in global market convergence occuring when transport costs dropped in the sixteenth century and more rapidly in the modern era of globalisation, which Mssrs O’Rourke and Williamson describe as after 1750. Global historians such as Tony Hopkins and Christopher Bayly have also stressed the importance of the exchange of not only trade but also ideas and knowledge during periods of pre-modern globalisation.

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Globalisation has not always been a one-way process. There is evidence that there was also market disintegration (or deglobalisation) in periods as varied as the Dark Ages, the seventeenth century, and the interwar period in the twentieth. And there is some evidence that globalisation has retreated in the current crisis since 2007. But it is clear that globalisation is not simply a process that started in the last two decades or even the last two centuries. It has a history that stretches thousands of years, starting with Smith’s primitive hunter-gatherers trading with the next village, and eventually developing into the globally interconnected societies of today. Whether you think globalisation is a “good thing” or not, it appears to be an essential element of the economic history of mankind.

From The Economist

3. Globalization in Retreat By Robert Samuelson - December 31, 2012

WASHINGTON -- One fateful question for 2013 is this: What happens to globalization? For decades, growing volumes of cross-border trade and money flows have fueled strong economic growth. But something remarkable is happening; trade and international money flows are slowing and, in some cases, declining. David Smick, the perceptive editor of The International Economy magazine, calls the retreat "deglobalization." What's unclear is whether this heralds prolonged economic stagnation and rising nationalism or, optimistically, makes the world economy more stable and politically acceptable.

To Americans, some aspects of deglobalization will seem delicious. Take manufacturing. Globalization has sucked factory jobs from the United States. Now, the tide may be turning. Just recently, Apple announced a $100 million investment to return some Mac computer production home. Though tiny, the decision reflects a trend.

General Electric's sprawling Appliance Park in Louisville, Ky., once symbolized America's post-World War II manufacturing prowess, with employment peaking at 23,000 in 1973. Since then, jobs have shifted abroad or succumbed to automation. But now GE is moving production of water heaters, refrigerators and other appliances back to Appliance Park from China and Mexico. Year-end employment is reckoned at 3,600, up 90 percent from a year earlier, writes Charles Fishman in an excellent article in December's Atlantic.

Nor is GE alone, Fishman notes. Otis is moving some elevator production from Mexico to South Carolina. Wham-O is shifting Frisbee molding from China to California.

The changes are harbingers, contends the Boston Consulting Group (BCG), which predicts a manufacturing revival. China's labor cost advantage has eroded, it argues. In 2000, Chinese factory wages averaged 52 cents an hour; but annual double-digit percentage increases will bring that to $6 an hour in high-skilled industries by 2015. Although wages of U.S. production workers average $19 an hour, BCG argues that other non-wage factors favor the United States. American workers are more productive; automation has reduced labor's share of expenses; and cheap natural gas further reduces costs. Finally, higher oil prices have boosted freight rates for imports.

By 2015, China's overall cost advantage will shrivel to 7 percent, BCG forecasts. As important, it says, the United States will maintain significant cost advantages over other developed-country manufacturers: 15 percent over France and Germany; 21 percent over Japan; and 8 percent over Great Britain. The United States will be a more attractive production platform. Imports will weaken; exports will strengthen. BCG predicts between 2.5 million and 5 million new factory jobs by 2020. (For perspective: 5.7 million manufacturing jobs disappeared from 2000 to 2010.)Because the United States is the world's largest importer, this shift would dampen trade. Similarly, cross-border money flows ("capital flows") have abated. Banks, especially in Europe, have reduced foreign loans to "deleverage" and strengthen their balance sheets. From 2011 to 2012, bank loans to 30 "emerging market" countries fell by one-third, says the Institute of International Finance, an industry group. "It's the most decisive case of 'home bias' [in lending] being re-established," says economist Philip Suttle of the IIF. Government regulators encourage the shift, he says, suggesting that "if you're going to cut lending, cut there and not here."

Of course, globalization won't vanish. It's too big and too entwined with national economies. In 2011, total world exports amounted to nearly $18 trillion. The same is true of capital flows. Despite banks' pullbacks, those same 30 emerging market countries in 2012 received an estimated $1 trillion worth of investment from multinational companies, private investors, pensions, insurance companies and other lenders -- a still-huge total, though down from its peak. But globalization's character may change.

For years, the world economy has been wildly lopsided: China and some other countries ran big trade surpluses; the United States was perennially in massive deficit. Similar imbalances existed in Europe. Now, slumps have dampened the American and European appetite for imports. The upshot is that "China and others are recalibrating their export-led economic strategies" to focus more on domestic demand, argues economist Fred

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Bergsten of the Peterson Institute. That's good, he says; the world economy will be more balanced. Likewise, erratic capital flows have triggered past financial crises. Slower flows may promote stability.

Not everyone is so optimistic. Smick of The International Economy sees globalization as "the proverbial goose that laid the golden eggs." The search for larger markets and lower costs drove investment, trade, economic growth and job creation around the world. That's weakened, and there's "no new model to replace it." Domestic demand will prove an inadequate substitute. Central banks (the Federal Reserve, the European Central Bank, the Bank of Japan) have tried to fill the void with hyper-easy money policies. Smick fears damaging outcomes: currency wars as countries strive to capture greater shares of stagnant export markets; and burst "asset bubbles" caused by easy money. These visions clash.

4. Railroads and hegemons

Globalisation depends on technology and politicsHISTORICALLY, TECHNOLOGY HAS been the single most important force for opening up borders. In

the 1800s it was the spread of the steamship and refrigeration, the expansion of railroads and the invention of the telegraph that gave a push to globalisation. In the 1980s and 1990s it was the shipping container, and more recently it has been the internet, allowing information and services to be exchanged in the blink of an eye.

But technology is not enough; globalisation also needs political patronage. Writing in 1973, Charles Kindleberger pointed to the importance of an economic hegemon who would act as an importer of last resort and financier of the world’s monetary system. From the mid-1800s until 1914 that hegemon was Britain. In 1846 it unilaterally reduced import tariffs by repealing the Corn Laws and in 1860 it signed a free-trade agreement with France, starting a virtuous cycle of falling tariffs worldwide. As guarantor of the gold standard, Britain made possible a system of fixed exchange rates, financing the deficits of some countries while absorbing the surpluses of others.

In 1910 Norman Angell, a British journalist, concluded in his book “The Great Illusion” that Europe had become so economically interdependent that war would be futile. Ten years and one world war later, John Maynard Keynes wrote: “What an extraordinary episode in the economic progress of man that age was which came to an end in August 1914! …The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole Earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep.”

Keynes worried, correctly, that the vindictive Treaty of Versailles would further fragment the damaged global economic system. It tumbled into abyss a decade later because, Kindleberger wrote, “Britain could not act as a stabiliser, and the United States would not: every country turned to protect its national private interest, the world public interest went down the drain, and with it the private interests of all.”

In 1945 America took up the mantle of benevolent hegemon. “Our foreign relations, political and economic, are indivisible,” said Harry Truman in 1947; and the pursuit of international peace and freedom was “bound up completely with a third objective: re-establishment of world trade.” America underwrote the International Monetary Fund and the Bretton Woods system of fixed exchange rates to end beggar-thy-neighbour currency devaluations, and the General Agreement on Tariffs and Trade to end trade disputes.

The breakdown of Bretton Woods, two oil-price shocks and the Latin American debt crisis severely tested globalisation in the 1970s and 1980s. Fearful of Japan’s growing economic clout, America turned protectionist. Free trade gave way to managed trade. But in 1989 the Berlin Wall fell and in 1990 Japan’s bubble economy burst. America became the “hyperpower” and presided over an unprecedented expansion of globalisation.

These days America is acting less like a hegemon. Americans have grown leerier of foreign entanglements and more self-interested on economic matters. America walked away from the Doha trade talks in 2008 when it concluded it was getting too little in return for its own sacrifices, and Congress has refused to expand the International Monetary Fund’s resources. Many Americans think that China is violating the spirit of free trade.

Others also see America as less of a leader. In a poll earlier this year the Pew Research Centre found that in 23 of 39 countries the largest groups of respondents thought that China had already replaced, or would replace, America as the main superpower. But China is not yet ready to take the hegemon’s mantle.

From the print edition: Special report (The Economist)

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5. Educating globalisation’s LudditesOne of the great puzzles of contemporary politics is how globalisation came to have such a bad name. The

end of the cold war left governments around the world struggling to find a new framework for international relations. It also seems to have left the protest movement in search of a new focus.

But why pick on globalisation when there is no agreement on what it is? For some people, it is primarily economic and trade integration; others put more emphasis on cultural aspects. I would argue that it is all these and more. Globalisation is the increasingly rapid exchange of ideas, people and goods made possible by falling transport costs and technological advances, all leading to the closer integration of the world including — but not limited to — the economy.

Confusion, though, suits those who want to climb on the bandwagon of opposition. Many of those involved in the campaigns against globalisation clearly mean well even if, as some of us think, they are misinformed and misguided. As Jagdish Bhagwati says in his book, the movement is a “motley crew, a melange of anti-globalisation protesters … appearing to be an undifferentiated mass”. In Defense of Globalisation is an important contribution to an often incoherent debate. It sets out a persuasive case in favour of globalisation.

Opposition to change is hardly new. The 19 th century English Luddites bequeathed their name to all who stood against industrial and technological progress. But the Luddites’ position had some logic; their livelihoods were being threatened, though the progress they opposed stood to benefit a much larger cross-section of the population. Yet most of today’s protesters, dependent as they are on e-mail and mobile telephones, are beneficiaries of the technological changes they oppose.

For centuries, technological progress has had an impact on living standards. What made the 20 th century different was the scale and breadth of the rise in those standards. On a wide range of measures — poverty, life expectancy, health, education — more people have become better off at a faster pace in the past 60 years than ever before. All this occurred within the multilateral economic framework established at the end of the second world war.

Trade liberalisation and expansion have been central to the post-war surge in living standards. The progressive multilateral liberalisation of trade has driven rapid growth and that, in turn, has accelerated the reduction of poverty. Yet more than anything else, trade, or rather opposition to it, is what seems to be inspiring the anti-globalisation movement. Trade hurts the poor in developing countries, they say, or it costs jobs in industrial countries.

Indeed, at the margin there will always be some people who find themselves displaced as the expansion of trade or the advances of technology force economies to adjust. To make the benefits of trade more convincing, it is important that we do all we can to make sure that appropriate safety nets are in place for those individuals. But we must also remember that while some are adversely affected by import competition, others benefit from an increase of industry jobs in the export sector.

It makes no sense to blame globalisation for creating jobs in developing countries — what the current row about outsourcing amounts to — and for creating poverty in those countries at the same time. Wages are lower in developing countries than in the industrial world. But that is what makes those countries competitive. Globalisation is not a zero-sum game. There is overwhelming evidence that it creates extra wealth and everyone can benefit.

The economic achievements of the past few decades have been extraordinary. To be sure, the rich have got richer. But so have the poor, to a considerable extent. What the protesters fail to recognise — or choose to ignore — is that the progress that has been achieved derives from the policies they now so fiercely oppose. Of course, there are downsides, as Mr. Bhagwati readily acknowledges.

We need to do more to reduce the short-term costs associated with globalisation. But the protesters are actively hindering progress on this front. Many of them seem almost viscerally opposed to the very multilateral institutions that offer the best hope of making globalisation work more effectively and with fewer short-term costs. To this end, Mr Bhagwati’s book should give the protesters pause for thought.

Anne Krueger in Financial Times of London

6. The nuts and bolts come apart

As global demand contracts, trade is slumping and protectionism risingCOMPARISONS to the Depression feature in almost every discussion of the global economic crisis. In

world trade, such parallels are especially chilling. Trade declined alarmingly in the early 1930s as global demand

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imploded, prices collapsed and governments embarked on a destructive, protectionist spiral of higher tariffs and retaliation.

Trade is contracting again, at a rate unmatched in the post-war period. The global economic machine has gone into reverse: output is declining and trade is tumbling at a faster pace. The turmoil has shaken commerce in goods of all sorts, bought and sold by rich and poor countries alike.

It is too soon to talk of a new protectionist spiral. Nevertheless, errors of policy risk making a bad thing worse — despite politicians’ promises to keep markets open. The leaders of the G20 rich and emerging economies declared that they would eschew protectionism. But this pledge has not been honoured. According to the World Bank, some members of the group have already taken numerous trade-restricting steps.

Modern protectionism is more subtle and varied than the 1930s version. In the Depression tariffs were the weapon of choice. America’s Smoot-Hawley act, passed in 1930, increased nearly 900 American import duties—which were already high by today’s standards—and provoked widespread retaliation from America’s trading partners. A few tariffs have been raised this time, but tighter licensing requirements, import bans and anti-dumping (imposing extra duties on goods supposedly dumped at below cost by exporters) have also been used. Rich countries have included discriminatory procurement provisions in their fiscal-stimulus bills and offered subsidies to ailing national industries. These days, protectionism comes in 57 varieties.

There are good reasons for thinking that the world has less to fear from protectionism than in the past. International agreements to limit tariffs, built over the post-war decades, are a safeguard against all-out tariff wars. The growth of global supply chains, which have bound national economies together tightly, have made it more difficult for governments to increase tariffs without harming producers in their own countries.

But these defences may not be strong enough. Multilateral agreements provide little insurance against domestic subsidies, fiercer use of anti-dumping or the other forms of creeping protection. Most countries are able to raise tariffs, because their applied rates are below the maximum allowed by their WTO commitments. They may choose to do so despite the possible disruption to global supply chains. And because global sourcing amplifies the effect of tariff rises, even action that is permissible under WTO rules could cause a lot of damage. The subtler variants of protection may be similarly disruptive.

The gears of globalizationThe immediate cause of shrinking trade is plain: global recession means a collapse in demand. The credit

crunch adds an additional squeeze, thanks to an estimated shortfall of $100 billion in trade finance, which lubricates 90% of world trade.

Just as striking as the speed of the downturn in trade is its indiscriminate nature. The World Bank has January trade data for 45 countries. These are values, expressed in American dollars, and so have been depressed not only by lower volumes but also by falling prices and a stronger dollar. The exports of 37 of these 45 countries were more than a quarter lower than the year before. Countries as diverse as Ecuador, France, Indonesia, the Philippines and South Africa saw exports drop by 30% or more. Commodity exporters, such as Argentina, have suffered with sellers of sophisticated manufactures, such as Germany and Japan.

Kei-Mu Yi, an economist at the Federal Reserve Bank of Philadelphia, argues that trade has fallen so fast and so uniformly around the world largely because of the rise of “vertical specialisation”, or global supply chains. This contributed to trade’s rapid expansion in recent decades. Now it is adding to the rate of shrinkage. When David Ricardo argued in the early 19th century that comparative advantage was the basis of trade, he conceived of countries specialising in products, like wine or cloth. But Mr Yi points out that countries now specialise not so much in final products as in steps in the process of production.

Trade grows much faster in a world with global sourcing than in a world of trade in finished goods because components and part-finished items have to cross borders several times. The trade figures are also boosted by the practice of measuring the gross value of imports and exports rather than their net value. For example, a tractor made in America would once have been made from American steel and parts; it would have touched the trade data only if it was exported. Now, it may contain steel from India, and be stamped and pressed in Mexico, before being sold abroad. As a result, changes in demand in one country now affect not just the domestic economy but also the trade flows and economies of several countries.

By making trade flows more sensitive to falls in output, vertical specialisation may provide some insurance against widespread protectionism. Manufacturers that rely on imported inputs may resist higher tariffs because they push up the prices of those inputs, making domestic industry less competitive.

Nevertheless, there is plenty of evidence that developing countries, at least, continue to use tariffs extensively. In the World Bank’s study, tariff increases accounted for half of the protective measures by these countries. Ecuador raised duties on 600 goods. Russia increased them on used cars. India put them up on some kinds of steel. Developing countries have more scope for raising tariffs without breaking WTO rules than richer

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ones do, because the gap between their applied rates and the ceilings they agreed to is greater than for developed countries.

When governments do impose tariffs, vertical supply chains amplify their effects. Because tariffs are typically levied on the gross value crossing the border (with some exceptions, such as exports from Mexican maquiladoras), trade responds more to changes in tariffs—down or up—with global supply chains than without.

But there is another, more subtle reason to worry about even small rises in tariffs. Theoretical models that incorporate vertical specialisation find that it takes off only when tariffs fall below a threshold level. Once this happens, however, trade explodes, so that a slight lowering of trade barriers can cause a huge increase in trade. By the same token, if tariffs rose above a certain point— which might be below the maximum agreed on at the WTO—global supply chains would disintegrate. Trade would drop even more steeply than it has in recent months.

That said, supply chains need not snap so easily. Even if tariffs go up, other costs that determine the viability of supply chains may go down: the price of oil (and hence the cost of transport) has fallen along way in the past year. Firms have invested a lot in their supply chains and will be loth to abandon them. And if global supply chains do survive, vertical specialisation could help trade recover speedily when demand returns.

Although increased tariffs are a cause for concern, they are far from the only form of protection being used in this crisis. Two-thirds of the trade-restricting measures documented by the World Bank are non-tariff barriers of various kinds. As with tariffs, developing countries are the principal wielders of these weapons.

Indonesia has specified that certain categories of goods, such as clothes, shoes and toys, may be imported through only five ports. Argentina has imposed discretionary licensing requirements on car parts, textiles, televisions, toys, shoes and leather goods; licences for all these used to be granted automatically. Some countries have imposed outright import bans, often justified by a tightening of safety rules or by environmental concerns. For example, China has stopped imports of a wide range of European food and drink, including Irish pork, Italian brandy and Spanish dairy products. The Indian government has banned Chinese toys.

In addition, anti-dumping is on the increase. The number of anti-dumping cases initiated at the WTO had been declining, but it started to pick up in the second half of 2007. The number of cases ending with extra duties went up by 20%. India was the biggest initiator of anti-dumping action, and America and the European Union imposed duties most frequently.

Rich countries’ weapon of choice so far is neither tariffs nor non-tariff barriers to imports. They have been keen users instead of subsidies to troubled domestic industries, particularly carmakers. Some economists, such as Gene Grossman, of Princeton University, cite this as evidence that global sourcing has changed the political economy of protection. The American automotive industry no longer lobbies for direct protection, as it used to, because it imports much of its value-added and competes with foreign firms that assemble their cars in America. Carmakers now prefer explicit subsidies, and the world is replete with examples. Besides America, Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, Italy and Sweden have all also provided direct or indirect subsidies to carmakers. The World Bank reckons that proposed subsidies for the car industry amount to $48 billion. Nearly 90% of this is in rich countries, where it can easily be slipped into budgetary packages to stimulate demand.

The worry about such subsidies is that they could cause production to switch from more efficient plants (eg, in central and eastern Europe) to less efficient ones in rich countries with deep pockets (eg, in western Europe). Whether the location of output is shifting is not yet clear, but politicians plainly hope it will. On March 19th Luc Chatel, the French industry minister, boasted that Renault’s plans to create 400 jobs at a factory near Paris by “repatriating” some production from Slovenia was the result of government aid. Renault has denied this, saying that it was at full capacity in Slovenia.

There are some international rules to prevent distorting subsidies. The EU has regulations to limit state aid, and is looking into its members’ assistance to carmakers. Gary Hufbauer, of the Peterson Institute for International Economics in Washington, DC, argues that American subsidies transgress WTO norms.

Helpful ambiguityHowever, WTO action against subsidies is not straightforward. To complain successfully, a country has to

show that a subsidy meets several criteria. Then there is a pots-and-kettles problem: having subsidies of your own does not stop you from challenging someone else’s, but if you pick a fight they may have a go at yours. This uncertainty and ambiguity only adds to subsidies’ attraction. Governments can aid their carmakers and at the same time criticise others for their protectionist ways.

Protectionist urges are also being bolstered by countries’ seeming inability to co-ordinate their fiscal stimulus programmes. Some countries have been reluctant to work the budgetary pump for fear that their extra demand will leak abroad to the benefit of foreigners. To stop the seepage, some governments have inserted discriminatory conditions into their fiscal programmes, the prime example being the “Buy American” procurement rules. These were weakened after protests and threats of retaliation from abroad, but not before the prospects for

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global co-operation had been dented. Greater co-ordination of fiscal expansion would ease governments’ worries about leakage, because everyone else would be leaking too: all would gain from each other’s spending.

What should world leaders do to stop protection fraying the threads that tie the world economy together? The difficulty lies in devising something comprehensive and detailed enough to address the variety of protectionist measures that are being deployed in the crisis, and doing it quickly enough to maintain open trade.

Many argue that the most important thing for world leaders to do is to pledge a quick completion of the Doha round of trade talks, which stalled for the umpteenth time. By reducing tariff ceilings, this would place tighter limits on countries’ ability to increase tariffs. It would also ban export subsidies in agriculture, which are being used with greater vigour, especially as prices of farm goods fall. The EU, for example, has announced new export subsidies for butter, cheese and milk powder. Most important, completing Doha would be the clearest and most tangible evidence possible of a commitment to consolidating and building on the gains from more open trade secured in successive rounds since the second world war.

Some economists disagree. Aaditya Mattoo, of the World Bank, and Arvind Subramanian, of the Peterson Institute, argue that the Doha round is too ambitious given the state of the world economy, because it seeks to open markets for rich countries’ manufactured goods just when the politics are against it. At the same time, they point out that Doha would not restrict the use of some non-tariff measures causing most concern, such as the Buy American provisions or subsidies for failing industries. Messrs Mattoo and Subramanian suggest a new “crisis round” of world trade talks. In the first instance, WTO members could commit themselves to a standstill on all forms of protectionism.

Several other economists have also proposed a standstill. However, Messrs Mattoo and Subramanian suggest that in order to give governments a political reason to agree to this, they should also be allowed to postpone further liberalisation for the duration of the crisis. They would then embark on a new round instead of Doha, which would address the forms of protection that now look most pressing.

But the appetite for starting yet another series of talks is likely to be limited. Even if the crisis round’s agenda were more realistic than Doha’s (which isn’t obvious), there would be no guarantee that it could be concluded quickly enough to stop the bleeding in global trade.

Whatever they think about Doha or about the idea of a crisis round, most economists will agree that a simple promise to resist protectionism will not suffice. Some thing more specific is needed. A good start would be for governments, beginning with the leaders of the G20, to draw up a comprehensive list of protectionist measures that goes beyond tariffs and export subsidies. They could then agree to go no further with these than they have already.

Next, an agreement on co-ordinating fiscal policy would go a long way towards making such a standstill commitment credible, because it would alleviate worries about leakages abroad. Finally, empowering the WTO to name those who break the standstill would help to underpin it. The threat of embarrassment may make some countries think twice.

During the Depression, the volume of world trade shrank by a quarter. Nothing like that has been seen or forecast so far. Yet one lesson from the worldwide economic distress of three-quarters of a century ago is that once trade barriers come up, they take years of negotiation to dismantle. Preventing protectionism from getting worse is preferable to having to repair the damage afterwards. And even if a full-blown trade war can be ruled out, death by a thousand cuts cannot. The costs of myriad piecemeal measures could still add up to damaging protectionism. And when demand does eventually revive, if the world economy is supported by an open system of trade, it will recover all the faster.

From The Economist

7. Here, there and everywhereAfter decades of sending work across the world, companies are rethinking their offshoring strategies,

says Tamzin BoothEARLY NEXT MONTH local dignitaries will gather for a ribbon-cutting ceremony at a facility in

Whitsett, North Carolina. A new production line will start to roll and the seemingly impossible will happen: America will start making personal computers again. Mass-market computer production had been withering away for the past 30 years, and the vast majority of laptops have always been made in Asia. Dell shut two big American factories in 2008 and 2010 in a big shift to China, and HP now makes only a small number of business desktops at home.

The new manufacturing facility is being built not by an American company but by Lenovo, a highly successful Chinese technology group. Founded in 1984 by 11 engineers from the Chinese Academy of Sciences, it

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bought IBM’s ThinkPad personal-computer business in 2005 and is now by some measures the world’s biggest PC-maker, just ahead of HP, and the fastest-growing.

Lenovo’s move marks the latest twist in a globalisation story that has been running since the 1980s. The original idea behind offshoring was that Western firms with high labour costs could make huge savings by sending work to countries where wages were much lower. Offshoring means moving work and jobs outside the country where a company is based. It can also involve outsourcing, which means sending work to outside contractors. These can be either in the home country or abroad, but in offshoring they are based overseas. For several decades that strategy worked, often brilliantly. But now companies are rethinking their global footprints.

The first and most important reason is that the global labour “arbitrage” that sent companies rushing overseas is running out. Wages in China and India have been going up by 10-20% a year for the past decade, whereas manufacturing pay in America and Europe has barely budged. Other countries, including Vietnam, Indonesia and the Philippines, still offer low wages, but not China’s scale, efficiency and supply chains. There are still big gaps between wages in different parts of the world, but other factors such as transport costs increasingly offset them. Lenovo’s labour costs in North Carolina will still be higher than in its factories in China and Mexico, but the gap has narrowed substantially, so it is no longer a clinching reason for manufacturing in emerging markets. With more automation, says David Schmoock, Lenovo’s president for North America, labour’s share of total costs is shrinking anyway.

Second, many American firms now realise that they went too far in sending work abroad and need to bring some of it home again, a process inelegantly termed “reshoring”. Well-known companies such as Google, General Electric, Caterpillar and Ford Motor Company are bringing some of their production back to America or adding new capacity there. In December Apple said it would start making a line of its Mac computers in America later this year.

Choosing the right location for producing a good or a service is an inexact science, and many companies got it wrong. Michael Porter, Harvard Business School’s guru on competitive strategy, says that just as companies pursued many unpromising mergers and acquisitions until painful experience brought greater discipline to the field, a lot of chief executives offshored too quickly and too much. In Europe there was never as much enthusiasm for offshoring as in America in the first place, and the small number of companies that did it are in no rush to return.

Firms are now discovering all the disadvantages of distance. The cost of shipping heavy goods halfway around the world by sea has been rising sharply, and goods spend weeks in transit. They have also found that manufacturing somewhere cheap and far away but keeping research and development at home can have a negative effect on innovation. One answer to this would be to move the R&D too, but that has other drawbacks: the threat of losing valuable intellectual property in far-off places looms ever larger. And a succession of wars and natural disasters in the past decade has highlighted the risk that supply chains a long way from home may become disrupted.

Third, firms are rapidly moving away from the model of manufacturing everything in one low-cost place to supply the rest of the world. China is no longer seen as a cheap manufacturing base but as a huge new market. Increasingly, the main reason for multinationals to move production is to be close to customers in big new markets. This is not offshoring in the sense the word has been used for the past three decades; instead, it is being “onshore” in new places. Peter Löscher, the chief executive of Siemens, a German engineering firm, recently commented that the notion of offshoring is in any case an odd one for a truly international company. The “home shore” for Siemens, he said, is now as much China and India as it is Germany or America.

Companies now want to be in, or close to, each of their biggest markets, making customised products and responding quickly to changing local demand. Pierre Beaudoin, chief executive of Bombardier, a Canadian maker of aeroplanes and trains, says the firm used to focus on cost savings made by sending jobs abroad; now Bombardier is in China for the sake of China.

Lenovo, as a Chinese company, has its own factories in China. The reason it is moving some production to America is that it will be able to customise its computers for American customers and respond quickly to them. If it made them in China they would spend six weeks on a ship, says Mr Schmoock.

Under this logic, America and Europe, with their big domestic markets, should be able to attract plenty of new investment as companies look for a bigger local presence in places around the world. It is not just Western firms bringing some of their production home; there is also a wave of emerging-market champions such as Lenovo, or the Tata Group, which is making Range Rover cars near Liverpool, that are coming to invest in brands, capacity and workers in the West.

Such changes are happening not only in manufacturing but increasingly in services too. Companies may either outsource IT and back-office work to other companies, which could be in the same country or abroad, or offshore it to their own centres overseas. Software programming, call centres and data-centre management were the first tasks to move, followed by more complex ones such as medical diagnoses and analytics for investment banks.

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As in manufacturing, the labour-cost arbitrage in services is rapidly eroding, leaving firms with all the drawbacks of distance and ever fewer cost savings to make up for them. There has been widespread disappointment with outsourcing information technology and the routine back-office tasks that used to be done in-house. Some activities that used to be considered peripheral to a company’s profits, such as data management, are now seen as essential, so they are less likely to be entrusted to a third-party supplier thousands of miles away.

Coming full circleEven General Electric is reversing its course in some important areas of its business. In the 1990s it had

pioneered the offshoring of services, setting up one of the very first “captive”, or fully owned, offshore service centres in Gurgaon in 1997. Up until last year around half of GE’s information-technology work was being done outside the company, mostly in India, but the company found that it was losing too much technical expertise and that its IT department was not responding quickly enough to changing technology needs. It is now adding hundreds of IT engineers at a new centre in Van Buren Township in Michigan.

The economics of offshoring are changing in the corporate world. Offshoring in its traditional sense, in search of cheaper labour anywhere on the globe, is maturing, tailing off and to some extent being reversed. Multinationals will certainly not become any less global as a result, but they will distribute their activities more evenly and selectively around the world, taking heed of a far broader range of variables than labour costs alone.

That offers a huge opportunity for rich countries and their workers to win back some of the industries and activities they have lost over the past few decades. Paradoxically, the narrowing wage gap increases the pressure on politicians. With labour-cost differentials narrowing rapidly, it is no longer possible to point at rock-bottom wages in emerging markets as the reason why the rich world is losing out. Developed countries will have to compete hard on factors beyond labour costs. The most important of these are world-class skills and training, along with flexibility and motivation of workers, extensive clusters of suppliers and sensible regulation.

From The Economist

8. What was mercantilism?MERCANTILISM is one of the great whipping boys in the history of economics. The school, which

dominated European thought between the 16th and 18th centuries, is now considered no more than a historical artefact — and no self-respecting economist would describe themselves as mercantilist. The dispatching of mercantilist doctrine is one of the foundation stones of modern economics. Yet its defeat has been less total than an introductory economics course might suggest.

At the heart of mercantilism is the view that maximising net exports is the best route to national prosperity. Boiled to its essence mercantilism is “bullionism”: the idea that the only true measure of a country’s wealth and success was the amount of gold that it had. If one country had more gold than another, it was necessarily better off. This idea had important consequences for economic policy. The best way of ensuring a country’s prosperity was to make few imports and many exports, thereby generating a net inflow of foreign exchange and maximising the country’s gold stocks.

Such ideas were attractive to some governments. Accumulating gold was thought to be necessary for a strong, powerful state. Countries such as Britain implemented policies which were designed to protect its traders and maximise income. The Navigation Acts, which severely restricted the ability of other nations to trade between England and its colonies, were one such example.

And there are some amusing (and possibly apocryphal) stories of bullionism in action. During the Napoleonic Wars, the warring governments made few attempts to prevent their foes from importing food (and thereby starving them). But they did try to make it difficult for their opponent to export goods. Fewer exports would supposedly result in economic chaos as gold supplies dwindled. Ensuring an absence of gold, rather than an absence of grub, was perceived to be the most devastating way to grind down the enemy.

But there is an important distinction between mercantilist practice and mercantilist thought. The opinions of thinkers were often mangled when they were translated into policies. And a paper by William Grampp, published in 1952, offers a subtler account of mercantilism.

Mr Grampp concedes that mercantilists were keen on foreign trade. One often reads in mercantilist tomes that foreign trade would be more beneficial than would domestic trade. And some of the early mercantilists, like John Hales, were enchanted by the idea of an overflowing treasure chest.

But Mr Grampp argues that, on the whole, we should stop confusing mercantilism and bullionism. Few mercantilists were slaves to the balance of payments. In fact, they were alarmed by the idea of hoarding gold and silver. This is because many mercantilist thinkers were most concerned with maximising employment. Nicholas Barbon — who pioneered the fire insurance industry after the Great Fire of London in 1666 — wanted money to be

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invested, not hoarded. As William Petty — arguably the first “proper” economist — argued, investment would help to improve labour productivity and increase employment. And almost all mercantilists considered ways of bringing more people into the labour force.

Mr Grampp even suggests that Keynesian economics "has an affinity to mercantilist doctrine”, given their shared concern with full employment. Keynes, in a short note to his “General Theory”, approvingly quotes mercantilists, noting that an ample supply of precious metals could be key in maintaining control over domestic interest rates, and therefore to ensuring adequate resource utilisation. In some sense the Keynesian theory of underconsumption — that is, inadequate consumer demand — as a cause of recessions was presaged by mercantilist contributions. In 1598 Barthélemy de Laffemas, a French thinker, denounced those who opposed the use of expensive silks. He argued that purchasers of luxury goods created a livelihood for the poor, whereas the miser who saved his money “caused them to die in distress”.

Mercantilism is thought to have begun its intellectual eclipse with the publication of Adam Smith’s "Wealth of Nations" in 1776. A simple interpretation of the economic history suggests that Smith’s ruthless advocacy for free markets was squarely opposed to regulation-heavy mercantilist doctrine. But according to research by Lars Magnusson of Uppsala University, Smith’s contribution did not represent such a sharp break. The father of economics was certainly concerned with the effects of some mercantilist policies. He saw the damage that overweening government intervention could do. Smith argued that the East India Company, a quasi-governmental organisation that managed parts of India at the time, was responsible for creating the huge famine in Bengal in 1770. And he hated monopolies, arguing that greedy barons could earn “wages or profit, greatly above their natural rate”. Smith also grumbled that legislators could use mercantilist logic to justify stifling regulation.

But Smith points out circumstances in which government interference is necessary. He was in favour of the Navigation Acts. And in Smith’s lesser-known "Lectures on Jurisprudence", he outlines other cases where government intervention in trade is useful. Smith was not opposed to regulation per se, but rather instances where individuals and governments could abuse their position of power for personal gain.

Nicholas Phillipson, who recently wrote a biography of Smith, argues that the notion of “free markets” was alien to the father of economics. Smith made it clear that governments would always play a part in making markets — and could not conceive of a market where the government did not play a crucial role. And in this sense, his contribution does not represent such a sharp break from mercantilist thought. The question was not whether, but how much, of a role the state would play.

Though most of the world's rich countries remain committed to free trade today, mercantilist themes are often found in economic policy debates. China and Germany are often envied for their trade surpluses or seen as economic models, and China especially has very deliberately subsidised exports. President Barack Obama has made a doubling of American exports a major policy goal, as part of his plan to help America "win the future". This zero-sum way of looking at the global economy is less rooted in the national greatness side of mercantilism than in the focus on full employment, at a time when many rich economies are suffering from insufficient demand and high rates of joblessness; it is thoroughly Keynesian, in other words. Early in the recovery some economists gave a veneer of intellectual credibility to this perspective. Paul Krugman, for instance, wrote of America's 2010 trade agreement with South Korea:

There is a case for freer trade — it may make the world economy more efficient. But it does nothing to increase demand.

And there’s even an argument to the effect that increased trade reduces US employment in the current context; if the jobs we gain are higher value-added per worker, while those we lose are lower value-added, and spending stays the same, that means the same GDP but fewer jobs.

If you want a trade policy that helps employment, it has to be a policy that induces other countries to run bigger deficits or smaller surpluses. A countervailing duty on Chinese exports would be job-creating; a deal with South Korea, not.

But importantly, the case for bullionism as a demand stimulus evaporated with a role for bullion in monetary policy. The introduction of fiat money meant that balance-of-payment goals were unnecessary to maintaining a particular monetary policy stance, since central banks no longer needed an adequate hoard of gold to pump money into the economy. The mercantilist temptation is a strong one, however, especially when growth in the economic pie slows or stops altogether. More than two centuries after Smith's landmark work, economics's foundational debate continues to resonate.

9. The gated globeGovernments are putting up impediments to globalisation. It is time for a fresh wave of liberalisationOct 12th 2013 

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IMAGINE discovering a one-shot boost for the world’s economy. It would revitalise firms, increasing sales and productivity. It would ease access to credit and it would increase the range and quality of goods in the shops while keeping their prices low. What economic energy drink can possibly deliver all these benefits?Globalisation can. Yet in recent years the trend to greater openness has been replaced by an enthusiasm for building barriers—mostly to the world’s detriment.The worst did not happen…

Not so long ago, the twin forces of technology and economic liberalisation seemed destined to drive ever greater volumes of capital, goods and people across borders. When the global financial crisis erupted in 2008, that hubris was replaced by fears of a replay of the 1930s. They were not realised, at least in part because the world had learnt from that dreadful decade the lesson that protectionism makes a bad situation worse.

Yet a subtler change took place: unfettered globalisation has been replaced by a more selective brand. As our special report shows, policymakers have become choosier about whom they trade with, how much access they grant foreign investors and banks, and what sort of capital they admit. They have not built impermeable walls, but they are erecting gates.

That is most obvious in capital markets. Global capital flows fell from $11 trillion in 2007 to a third of that last year. The decline has happened partly for cyclical reasons, but also because regulators in America and Europe who saw banks’ foreign adventures end in disaster have sought to ring-fence their financial systems. Capital controls have found respectability in the emerging world because they helped insulate countries such as Brazil from destabilising inflows of hot money.

Sparingly used, capital controls can make financial systems less vulnerable to contagion, and crises less damaging. But governments must not forget the benefits of financial openness. Competition from foreign banks forces domestic ones to compete harder. Ring-fencing banks and imposing capital controls protects from contagion, but also traps savings in countries with little use for them.

Trade protectionism cannot claim the justifications that capital controls sometimes can. Fortunately, the World Trade Organisation (WTO), the trade watchdog, prevents most ostentatious protectionism, but governments have developed sneaky methods of avoiding its ire. New impediments—subsidies to domestic firms, for instance, local content requirements, bogus health-and-safety requirements—have gained popularity. According to Global Trade Alert, a monitoring service, at least 400 new protectionist measures have been put in place each year since 2009, and the trend is on the increase.

Big emerging markets like Brazil, Russia, India and China have displayed a more interventionist approach to globalisation that relies on industrial policy and government-directed lending to give domestic sellers a leg-up. Industrial policy enjoys more respectability than tariffs and quotas, but it raises costs for consumers and puts more efficient foreign firms at a disadvantage. The Peterson Institute reckons local-content requirements cost the world $93 billion in lost trade in 2010.

Attempts to restore the momentum of free trade at a global level foundered with the Doha round of trade talks. Instead, governments are trying to do so through regional free-trade agreements. The idea is that smaller trade clubs make it easier to confront politically divisive issues. The Trans-Pacific Partnership (TPP) that America, Japan and ten others hope to conclude this year aims to set rules for intellectual-property protection, investment, state-owned enterprises and services.

Regional free-trade deals are a mixed blessing. Designed well, they can boost liberalisation, both by cutting barriers in new areas and by spurring action in multilateral talks. Done badly, they may divert rather than expand trade. Today’s big deals are probably a net positive, but they may not live up to their promise: in the rush to sign a deal, TPP participants look likely to accept carve-outs for tobacco, sugar, textiles and dairy products, diminishing the final deal.…but it could be so much betterGate-building does not cause much outrage. Yet it is worth remembering what opportunities are being lost. In 2013 the value of goods-and-services exports will run to 31.7% of global GDP. Some big economies trade far less: Brazil’s total exports are just 12.5% of GDP. Increasing that ratio would deliver a shot in the arm to productivity. Trade in services is far lower than in goods; and even in goods, embarrassing levels of protectionism survive. America tacks a 127% tariff on to Chinese paper clips; Japan puts a 778% tariff on rice. Protection is worse in the emerging world. Brazil’s tariffs are, on average, four times higher than America’s, China’s three times.

In the past year the cost of impediments to trade has become clearer. Few countries have put up more gates than Russia, India and Brazil; growth in all three has disappointed. The latter two have suffered sharp falls in their currencies. Some countries have counted the cost and are opening up. China’s new leaders are tiptoeing towards looser rules for foreign capital and getting behind a push for a modest global trade deal. Mexico plans to readmit foreign investors to its oil industry in an effort to boost output. Japan hopes that the TPP will shake up its inefficient sectors, complementing fiscal and monetary stimulus.

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But the fate of globalisation depends most on America. Over the past 70 years it has used its clout to push the world to open up. Now that clout is threatened by China’s growing influence and America’s domestic divisions. Barack Obama’s decision to skip an Asia-Pacific leaders’ summit in Bali to battle the government shutdown at home was ripe with symbolism: China’s and Russia’s presidents managed to attend. Mr Obama must reassert America’s economic leadership by concluding a TPP, even one with imperfections, and force it through Congress. The moribund world economy needs some of the magic that globalisation can deliver.

From The Economist

10. In my backyardMultilateral trade pacts are increasingly giving way to regional onesOct 12th 2013 | From the print editionUKRAINE, LONG PULLED back and forth between east and west, is feeling the tug again, this time between rival trade blocks. Next month it hopes to sign a free-trade agreement with the European Union. But Russia wants Ukraine for its own customs union, which already includes two other former Soviet republics. So earlier this year, in a clumsy effort to change its neighbour’s mind, the Kremlin banned Ukrainian sweets because they allegedly contained carcinogens, then imposed long, intrusive customs checks that slowed Ukrainian exports of steel, machinery and chemicals to a crawl.

The tiff has geopolitical undertones: Russia does not want Ukraine, with which it has deep cultural and political ties, to drift into the West’s sphere of influence. But it also points to a change in the world trading system. Russia joined the World Trade Organisation in 2012, but it is less interested in strengthening the multilateral trading system than in building its own regional trade block. Fyodor Lukyanov, editor of Russia in Global Affairs, a foreign-policy journal, notes that with America trying to conclude sweeping trade agreements with its neighbours in the Pacific Rim and with Europe, “the whole structure of world trade is changing towards a more fragmented system. That’s why Russia is trying to build something of its own.”

Free-traders in the West worry that the proliferation of regional trade agreements (RTAs) is gutting the multilateral trading system. Arvind Subramanian of the Peterson Institute for International Economics calls the rise of ever larger RTAs an “existential threat” and gives warning that “multilateral trade as we have known it will progressively become history.”

The debate about whether RTAs help or hurt the multilateral trading system has gone on for decades. Supporters argued that wherever two countries entered into an RTA, they would create incentives for others to join or to negotiate their own RTA. Trade barriers around the world would fall, one by one, and political support for multilateral deals would increase. Detractors claimed that once inside an RTA, countries would discriminate against outsiders and lose interest in multilateral liberalisation, undermining the authority of the WTO. They would divert as much trade as they created and introduce big distortions.

For most of the post-war period, the optimistic view prevailed as regional and multilateral liberalisation proceeded in tandem, albeit unevenly. The forerunner of the European Union was established in 1957, even as members of the General Agreement on Tariffs and Trade, the WTO’s predecessor, continued to cut tariffs. In the 1990s Bill Clinton signed the North American Free-Trade Agreement just as the Uruguay round of trade liberalisation was completed. In the early 2000s China joined the WTO and the EU expanded into eastern Europe.In the past decade, though, RTAs have increasingly looked like an alternative, not a complement, to multilateralism. The Doha “development” round, which began in 2001, immediately ran into trouble as emerging markets chafed at the central bargain: big cuts in their industrial tariffs in exchange for more access to rich-world agricultural markets. Talks faltered in Cancun in 2003 and finally collapsed in Geneva in 2008. One negotiator recalls going to dinner that night convinced that a deal had been struck, only to learn the next day that it had failed.

As Doha began to founder, the appeal of RTAs grew. The number concluded rose from 104 in 1958-2001 to 154 since then. Many of these are tiddlers, but the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) have the potential to become mega-RTAs accounting for a huge share of global trade. TPP “wasn’t initially seen as the big alternative to WTO,” says Gary Hufbauer of the Peterson Institute, “but…the US position is, ‘If emerging market countries don’t want to play ball in the WTO, we have alternatives’.”In need of protection?The biggest obstacle to more multilateral trade deals is the changing balance of global economic power. Brazil, Russia, India and China (the BRICs) see themselves as countries still poor enough to need protection for their industries while the rich ones lower their own barriers, especially to agriculture. But the rich world increasingly

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views the BRICs as full-fledged economic competitors whose state capitalism is incompatible with a free and open global economy.

“For too long, much of the economic force and sacrifice in Geneva to produce global trade agreements has come at the expense of the US and EU,” says Ron Kirk, who was Mr Obama’s first trade negotiator. “We have been lectured over and over by our colleagues from the emerging markets that they have the economic heft and prestige to demand a seat at the table. And we agree.” But that, he says, means they too need to make sacrifices by opening up further to America and Europe.

These divisions became clear in the race to elect a new WTO director-general this year. The contest between Herminio Blanco, Mexico’s former trade minister, and Roberto Azevedo, Brazil’s ambassador to the WTO, became a referendum on Mexico’s liberal preferences versus Brazil’s protectionist stance. Rich countries backed Mr Blanco while emerging markets plumped for Mr Azevedo, the eventual victor. Mr Azevedo has stressed that he represents the interests of all members.

The emerging markets are not monolithic. They often want protection not just from rich countries but from each other, particularly China. Roberto Giannetti da Fonseca, an official with FIESP, Brazil’s largest industrial association, ran a trading company in the 1980s that sold Brazilian manufactured products to China. He struggled to find anything worth buying from China, often settling for arts and crafts. “I could not imagine that 20 years later they’d be invading Brazil with hundreds of products and we’d be crying that we cannot compete.” His organisation is a vocal critic of China’s mercantilist practices and has urged the Brazilian government to negotiate free-trade agreements with North America and Europe.

Trade liberalisation is now proceeding along two different tracks. One, preferred by America, goes “behind the border”, focusing on things such as harmonising safety, health and technical standards, currencies, national treatment of foreign investors, the protection of intellectual property, services such as telecommunications, and enforcement of labour and environmental protection. The other, preferred by China, concentrates on reducing tariffs—outside sensitive sectors.

America started on its track in 2007 when Democrats in Congress struck a deal with President George W. Bush that in future trade agreements, signatories’ adherence to environmental and labour standards would be subject to the same dispute-settlement rules as commercial disputes. Sandy Levin, a Democratic congressman who helped negotiate that deal, notes that people like himself who were intent on correcting market failures at home were also keen to use trade policy to do the same abroad. Their goal, he said, is “to shift the equation that has dominated discussions of trade as ‘free trade’ versus ‘protectionism’ to one of ‘free trade’ versus ‘free and fair trade’.”In practice, this means America is most likely to strike deals with countries at a similar stage of economic development, such as the European Union and Japan, or with developing countries willing to meet rich-world standards in exchange for market access, such as Mexico and Chile. America’s comprehensive free-trade deal with South Korea is the model for the TPP.

China, by contrast, has pursued a variety of bilateral deals with its neighbours, mostly in the hope of persuading them “that it sought a peaceful rise as an emerging superpower”, says Chin Leng Lim, a trade-law expert at Hong Kong University. China’s free-trade agreements are numerous but shallow, often leaving out sensitive sectors and subjects. Its agreement with the Association of South-East Asian Nations, for example, allows signatories to classify 400-500 tariff categories as sensitive and thus eligible for slower tariff reduction.

Regional trade liberalisation is better than no liberalisation at all, yet it interferes with globalisation in several damaging ways. By excluding sensitive sectors or imposing onerous rules of origin, it complicates life for multinational companies whose supply chains cross multiple borders.

And even global agreements have their limitations. One of the most successful global trade pacts has been the Information-Technology Agreement (ITA), signed in 1996 under the WTO’s auspices to liberalise international trade in technology products. But it is becoming less useful as technological development creates new products that are not covered by it. For example, it includes computer monitors and gaming software but not televisions and game consoles. As flat-panel televisions increasingly double as computer monitors for users to go online, and as video games migrate from consoles and personal computers to hand-held devices, the ITA’s scope is narrowing. WTO members had been negotiating for a year to update the pact to include 256 extra products, many of which did not exist in 1996. But in July China asked for more than 100 of these products to be taken off the table, including audio and video products. In effect, that put a stop to progress on a new ITA.

The WTO is in part a victim of its own success. Thanks to earlier rounds of tariff reductions, further liberalisation offers progressively less economic benefit. Mr Hufbauer, Jeffrey Schott and Woan Foong Wong reckon that a comprehensive (and improbable) Doha deal would lift participants’ output by a mere 0.5%. The Uruguay round in the 1990s is thought to have produced a gain of 0.5-1.3%. Even the TPP will boost participants’ output by only 0.5%, much the same as Doha would, reckons one study by Peter Petri of Brandeis University and Michael Plummer of Johns Hopkins.

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In theory, a successful TPP or TTIP could become a magnet for other countries, eventually achieving multilateral trade liberalisation by default. In practice that seems unlikely. China’s and Russia’s interventionism and attachment to state capitalism are difficult to reconcile with the “behind-the-border” liberalisation America and Europe are seeking. And having had no say in designing the pacts, China and Russia may be reluctant to join later.The decline of multilateralism may not make much difference to big countries able to negotiate regional agreements on their own terms. Small countries without such leverage may be harder hit. But the marginalisation of the WTO as a deterrent to protectionism would hurt everyone. And increasingly such protectionism is taking on new forms that are hard to deal with.

From The Economist

11. The fear factor

Why Asian firms need to take on the world

May 31st 2014 | From the print edition FUJIO MITARAI KNOWS more than most people about building a multinational. He is the 78-year-old

boss of Canon, one of Japan’s biggest firms. Worth $43 billion, it makes everything from scanners to lenses for Hollywood. It first opened a New York office back in 1955, but breaking into America took 20 years of hard slog and an Apple-style innovation. In 1976 the company launched a cheap, automatic single-lens-reflex camera on the back of a massive advertising campaign. Mr Mitarai was in charge and the memory still makes him smile. “Our competitors thought I’d gone crazy.” Canon became America’s biggest camera firm. Today it faces competition from smartphones and low-cost rivals. Mr Mitarai insists innovation will keep the firm ahead of the pack. It is developing a raft of new products, from surveillance cameras to virtual-reality design studios and 3D printing materials.

According to conventional wisdom, emerging Asia’s firms should go global as Canon did. But there is an alternative view. As domestic markets in China, India and Indonesia become vast, why do their firms need to bother to compete abroad? After all, the argument goes, they can grow and achieve economies of scale at home. There is a parallel with America, where listed firms tend to be domestically focused, whereas in Europe home markets are often too small to offer growth opportunities. American firms are frequently far more profitable in their own backyard than in foreign fields; Procter & Gamble’s American margins, for instance, are more than double its international ones.

Some industries in Asia will certainly remain local, not least property and utilities, which are dominated by local firms everywhere. In addition, just as American firms have got the cowboy-hat industry tied up, so specialised firms cater to Asia’s idiosyncratic habits. Dabur, based in India, makes Ayurvedic medicines and hair oils. In Greater China Want Want makes rice crackers and Tingyi makes noodles. But on closer inspection the American comparison falls down. Emerging Asian firms are growing up in a world that is radically different from that faced by Western firms in their early days. Globalisation has changed the rules of the game in several ways.

First, Asian firms face global competition at home. Big listed American and European firms have Asian investments with a book value of about $2 trillion. The biggest firms have vast businesses. But the queue to get in may be shortening. Last year American multinationals made an 11% return on equity on their Asian operations, down from a peak of 15% in the glory days of 2005-07.Not easy, but worth it

Some sectors and companies have found the going tough. Luxury-goods firms have been hammered by China’s crackdown on corruption. IBM, Vodafone and many others have been persecuted by India’s tax authorities. Mining companies in Indonesia have been subjected to tighter rules. Most of the 20-odd foreign insurance firms in India are struggling, as are big foreign banks in South Korea. And some foreign firms have failed to gain a foothold altogether.

Yet on the whole foreign capital is set to stay in Asia. Across the continent, consumer goods, hotels, fast foods, cars, beer and many other industries are pretty open to foreigners. And in industries where foreign firms are active, local firms have to try harder. An example is Li Ning, a Chinese sportsgear firm named after its founder, a former gymnast with a pile of Olympic medals. Despite its famous boss and its local connections the firm has struggled to take on Nike and Adidas with its global brands and global sourcing, and its shares have dived.Over the past 20 years most global industries have consolidated, with a few big multinationals becoming far more dominant. In his book, “Is China Buying the World?”, Peter Nolan, of Cambridge University, shows how the global markets for gases, brakes, databases, cash machines, constant-velocity joints and many other products are

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each controlled by three or fewer firms with a total market share of over 70%. They, in turn, have tight groups of global suppliers.

R&D budgets for individual firms tell a revealing story. Great Wall Motor, of China, and Mahindra & Mahindra, of India, are seen as Asian carmaking champions, yet their combined R&D budget is just 3% of Volkswagen’s. Asian firms were responsible for 33% of last year’s R&D expenditure by listed firms globally, but almost all of that was by Japanese companies, which accounted for 16 of Asia’s 20 biggest spenders. In emerging Asia only a handful of firms are close to matching the global leader in their industry.

Consumer tastes in Asia have also changed. Thanks to social media and the internet, they are now influenced by trends around the world. So in many industries companies in emerging Asia face competition from global firms selling to customers whose tastes are more globally influenced than before. In the medium term these firms will either have to give up or become more global themselves. Asia’s 100 biggest listed firms make only 32% of their sales abroad, and if Japanese firms are excluded this falls to 24%. For the 100 biggest Western firms the figure is 52%. Asia’s share of the world’s stock of foreign direct investment is 17%, far below its share of global GDP and market capitalisation.

But going global is hard. By the 1990s Japan’s expansion abroad ran out of steam as the bubble burst at home and too many deals went sour. More recent waves of Asian deals have proved tricky, too. Between 2004 and 2010 Indian firms spent around $100 billion on cross-border deals. Aditya Birla bought Novelis, a metals firm; Bharti Airtel acquired Zain, a mobile operator based in Africa; and Tata bought Corus, a British steel firm, and JLR, a carmaker. All were leveraged buy-outs, with a puny Indian unit raising debt against its target’s assets. The same frothy market conditions that allowed Indian firms to borrow heavily offshore also meant that their targets were overvalued. Only JLR has created value, and none of the acquired firms has been properly integrated with its Indian parent.

South Korean firms have expanded stealthily and more successfully, including in India. Hyundai Motors is becoming as globally minded as Samsung. Near Chennai, a southern Indian city with perhaps the world’s highest incidence of moustaches, it has invested $2 billion over a decade and a half in a factory that builds a car every 68 seconds. That makes it India’s second-biggest car firm, after Japan’s Suzuki. The facility looks, sounds and feels multinational. The working language is English. Indian engineers are rotated to South Korea (“Be careful what they put on your plate,” says one). Bo Shin Seo, Hyundai’s boss in India, says he benchmarks his operating performance against Hyundai’s American factory. Globally the group is hiring foreigners to its top ranks. It makes 56% of its sales abroad and is the world’s fourth-biggest car company, with a 9% market share including its affiliate brand Kia.

From The Economist

Financial fragmentation12. Too much of a good thing

Since 2008 global financial integration has gone into reverseOct 12th 2013 | From the print edition

IN 2005 ITALY’S UniCredit bought HVB, Germany’s second-largest lender, in what at the time was the continent’s biggest cross-border bank merger. At a stroke this gave UniCredit a commanding presence in Germany, Austria and Poland. It was widely hailed as a foretaste of deals to come thanks to Europe’s single currency. “We will become the first truly European bank,” declared Alessandro Profumo, Unicredit’s chief at the time. So it was something of a shock when in 2011 Germany’s bank regulator, BaFin, sought to limit the amount of cash UniCredit could transfer to its Italian parent, fearing that the German unit’s financial health might be compromised. This seemed to violate the spirit of free capital movement within Europe, and officials in Brussels complained.

Finance, the sector that globalised the most in the years leading up to the crisis, is threatening to go into reverse. Between 1990 and 2007 cross-border bank flows increased about tenfold, to around $5 trillion, according to the McKinsey Global Institute, the consultancy’s research arm. Last year the figure was less than a third of that. The decline extended across all regions, though Europe suffered most.

This has happened for two reasons. The first is the banks’ own efforts to deleverage, either to shed money-losing operations and assets or to meet stiffer capital requirements. The second is the realisation that cross-border banks were an important channel for transmitting the mortgage crisis in America and the sovereign-debt crisis in peripheral Europe to other countries. To limit such spillovers and save taxpayers having to bail banks out of their foreign misadventures, regulators around the world are seeking to ring-fence their banking systems.The case for integration

Before the crisis, the logic of financial globalisation seemed impeccable. Businesses were increasingly operating across borders and needed banks that could travel with them. America and Britain, which excelled at

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finance, were anxious to market their expertise abroad. A more integrated global economy also needed a financial system to funnel capital from countries with a surplus of savings to those with a surplus of investment opportunities. Banks had long played that role within countries, taking in deposits in one market and deploying them in another. It made sense to do the same thing across borders.

Recipients of such flows benefited in other ways, too. More efficient foreign banks could force local ones to raise their game. That was why China, for example, listed its state-owned banks on stock exchanges and permitted foreigners to hold minority stakes. In short order Goldman Sachs, Bank of America, UBS and Royal Bank of Scotland took up the offer, though some of them have since sold stakes.

In Europe the logic was especially powerful. The benefits of a single currency strongly suggested that there should be a single banking market as well, so that the interest rates which businesses and households paid were determined by the European Central Bank (ECB), not the relative health of their local banks.

Financial globalisation did just what it was meant to, perhaps a little too well. Cross-border bank flows expanded enormously between 2000 and 2007, with 80% of the increase coming from Europe, according to McKinsey. Those flows enabled debtor countries such as America, Spain and Greece to finance housing booms and government deficits without paying punitive interest rates. But a large part of those flows reflected banks’ own leverage as they both borrowed and lent heavily abroad.

Tellingly, the event that touched off the crisis in the summer of 2007 was an announcement by France’s BNP Paribas that it was suspending redemptions to an investment fund heavily invested in American mortgage securities. Eventually a number of banks across Europe needed government bailouts because of losses sustained on mortgages in America and elsewhere.

The cost of bailing domestic banks out of foreign misadventures exposed one risk of financial globalisation; the losses sustained by domestic creditors and savers when foreign banks went bust showed up another. In 2008, when Landsbanki, an Icelandic bank, went bust, British and Dutch depositors had to be bailed out by their own governments because Iceland would guarantee only Icelandic deposits. Sir Mervyn King, the former governor of the Bank of England, famously commented that “global banks are international in life but national in death.”

Regulators around the world, working through the Financial Stability Board, an international committee of central bankers, regulators and finance ministers, have since tried to reduce the threat of a big bank collapse and the need for a bailout, but many of these efforts have undermined banks’ incentive and ability to do business across borders. For example, domestic regulators used to allow foreign banks to rely on the capital, liquidity and regulatory oversight of the foreign parent. Now many of them are pressing units of foreign banks, and foreign units of domestic banks, to maintain sufficient liquidity and capital independent of the parent, sometimes by organising themselves as subsidiaries rather than branches.

In America the Federal Reserve will soon require foreign banks above a certain size to collect all their local units into a single, separately capitalised holding company that meets the same capital and liquidity requirements as American banks do. Until now the Fed has relied on foreign regulators to ensure that the parent bank can support its units in America. The proposal has prompted a flurry of opposition.

Nor is it just banks that have to abide by tighter rules. America’s Commodity Futures Trading Commission (CFTC) has ruled that anyone trading swaps with an American bank’s foreign unit must generally go through a central clearing house. Gary Gensler, the CFTC’s chairman, rattles off a litany of financial disasters involving offshore affiliates: AIG had run its derivatives out of London; Lehman’s London affiliate had 130,000 outstanding swaps contracts, many guaranteed by its American parent; Citigroup had set up many off-balance-sheet vehicles in the Cayman Islands; and JPMorgan Chase earlier this year suffered huge losses on trades in London. “Risk…comes crashing back to our shores from overseas when a run starts in any part of a modern, global financial institution,” says Mr Gensler.

The CFTC has agreed to exempt foreign swaps customers that operate under similar rules abroad, and the Fed has yet to issue its final foreign banking rule. But for the most part American regulators, like their counterparts overseas, have stuck to their guns. “We will not let the pursuit of international consistency force us to lower our standards,” said Jack Lew, the Treasury Secretary, in July.

Even when regulatory initiatives are not explicitly discriminatory, they make cross-border banking harder. Benoît Coeuré, a member of the ECB’s governing board, notes that Basel 3, a set of new international capital and liquidity standards for banks, is being implemented differently across countries: capital is measured differently under American and international accounting rules, and even within Europe, Britain, France and Germany have proposed different bank holding-company structures. “If you have an idiosyncratic local legal environment, then market participants will find it safer just to play on their home turf because of the legal uncertainty that goes with international activities, and we’ll lose the benefit of international financial integration,” he says.

Such changes have undermined the case for global banks. Huw van Steenis at Morgan Stanley comments that “if I’m a German bank, one of my edges is I have really cheap funding in Germany because I have more

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deposits than loans. If that advantage goes away, one of their unique selling points goes, too.” Morgan Stanley estimates that banks’ cross-border claims within the euro zone have fallen from nearly $4 trillion in mid-2008 to about half that amount now.

And regulation is only one factor at work. Another is the need to deleverage in order to shore up capital and meet higher capital requirements. Again, this is most apparent in Europe, where banks have been shedding loans and bonds in troubled peripheral economies. Non-residents have gone from holding 43% of Spain’s and Italy’s sovereign debt in 2010 to 35% now. American money-market funds have cut their exposure in Europe by 60% since 2010.

In some countries regulators have quietly pressed banks to increase domestic lending to boost their economies, at the expense of foreign operations. In others they have been more explicit. Britain’s Funding for Lending scheme, launched in 2012, offers banks cheap central-bank financing for increasing lending to British households. America’s Volcker rule would exempt that country’s debt, but not that of other sovereigns, from restrictions on banks’ proprietary trading.

In retrospect, much of the rise in cross-border lending was foolish. It made both European and American banks more vulnerable to a sudden drop in asset prices and increased the risk of a credit crunch. McKinsey’s work shows that cross-border bank lending is far more volatile than other capital flows such as bonds, equities and direct investment. Research by the Bank of England shows that over the past decade lending by foreign banks was far more cyclical than by domestic banks.

Less financial globalisation should also reduce the risk that contagion from one country’s banking problems will cause economic damage elsewhere. That is the lesson of the Asian banking crisis of 1997-98. In many countries loans in 1997 exceeded deposits by 20%, says Mr van Steenis, with the gap made up by wholesale funding, often from abroad. When that funding disappeared, many banks teetered on the verge of collapse, prompting the authorities in the countries concerned to put a cap on the use of such funding. This had the positive effect that Asian banks suffered very little contagion from either the American mortgage crisis or the European sovereign-debt crisis.The penalties of self-reliance

But reduced cross-border links come at a price. If a country suffers a domestic shock, it will have to bear more of the consequences itself. Although regulators fret over shocks to a bank’s foreign parent or withdrawal of that parent’s support, Peter Sands, the boss of Standard Chartered, a British bank, observes that “there are lots of examples of shocks in the market when the support of the parent is needed.” International banks provided vital funding to South Korea during its crisis in 1997 and to Dubai in 2009 when a state-owned developer almost defaulted. “International flows of funds in the banking system can be a source of contagion but also of resilience,” says Mr Sands.

Financial fragmentation also challenges one of the great promises of globalisation: that savings-poor countries will be able to find the wherewithal to finance essential investment by borrowing abroad. In theory, if capital is free to seek the highest potential return, domestic saving and investment should not be correlated. In 1980 Martin Feldstein and Charles Horioka documented that in fact they are, suggesting that national borders were impeding the free flow of capital. Over the years that correlation diminished, particularly within Europe, but Mr Coeuré points out that it has now returned.

The result is starkest in Europe, where Spanish and Italian businesses are obliged to pay 80-160 basis points more than German ones to borrow. This is because of the higher rates on sovereign debt in those countries and fewer deposits from healthier countries. A more balkanised financial market makes it less likely that German savers will finance dodgy Spanish loans. But it also makes it more likely that they will finance low-yielding German loans, sending high-yielding Spanish businesses away empty-handed.

In addition, financial fragmentation means less competition for often cosseted domestic banks from nimbler foreign rivals. Studies of foreign banks entering Australia, Indonesia, the Philippines and Colombia found that they reduced interest-rate spreads and made domestic banks more efficient (although sometimes also more likely to make bad loans).

The best way to maintain financial globalisation without fear of shoddy regulation spilling over from one country to another would be increased co-operation among regulators. This is beginning to happen at the Financial Stability Board, which is trying to ensure uniform implementation of new capital and liquidity standards across most countries and has been pushing for a European banking union.

Unfortunately this process has exposed divisions. America’s biggest banks, for instance, will have to maintain a higher leverage ratio (a type of capital requirement) than stipulated by Basel 3. And although a single European supervisor will replace national regulators for the euro zone’s biggest banks next year, prospects for a common deposit insurance and resolution regime remain uncertain, for much the same reason that has made the entire crisis so intractable: creditor nations such as Germany, Finland and the Netherlands are deeply reluctant to make their taxpayers foot the bill for bank failures in debtor countries.

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It seems unlikely, then, that banks will return to the highly globalised state of 2007 soon. But if cross-border lending remains subdued, that will put added pressure on capital markets to make up the difference—and they, too, are feeling the pinch.From the print edition: Special report

13. The rich and the restWhat to do (and not do) about inequalityAPART from being famous and influential, China’s president, Britain’s prime minister, America’s second-

richest man and the head of the International Monetary Fund do not obviously have a lot in common. So it tells you something about the breadth of global concerns about inequality that they have all worried, loudly and publicly, about the dangers of a rising gap between the rich and the rest.

China’s president puts the reduction of income disparities, particularly between China’s urban elites and its rural poor, at the centre of his pledge to create a “harmonious society”. Britain’s prime minister has said that more unequal societies do worse “according to almost every quality-of-life indicator”. Warren Buffett has become a crusader for a higher inheritance tax, arguing that America risks an entrenched plutocracy without it. And the head of the IMF argues for a new global growth model, claiming that gaping income gaps threaten social and economic stability. Many others seem to share their concerns. A survey by the World Economic Forum says its members see widening economic disparities as one of the two main global risks over the next decade (alongside failings in global governance).

Equally muddledThe debate about inequality is an old one. But in the wake of a financial crisis that is widely blamed on

Wall Street fat cats, from which the richest have rebounded fastest, and ahead of public-spending cuts that will hit the poor hardest, its tone has changed. For much of the past two decades the prevailing view among the world’s policy elite—call it the Davos consensus—was that inequality itself was less important than ensuring that those at the bottom were becoming better-off. Tony Blair, ex-British prime minister, embodied that attitude. His party was famously said to be “intensely relaxed” about the millions earned by David Beckham (a footballer) provided that child poverty fell.

Now the focus is on inequality itself, and its supposedly pernicious consequences. One strand of argument, epitomised by “The Spirit Level”, a book that caused a stir in Britain, suggests that countries with greater disparities of income fare worse on all manner of social indicators, from higher murder rates to lower life expectancy. A second thread revisits the macroeconomic consequences of income disparities. Several prominent economists now reckon that inequality was a root cause of the financial crisis: politicians tried to counter the growing gap between rich and poor by encouraging poorer folk to take on more credit. A third argument is that inequality perverts politics, with Wall Street’s influence in Washington often cited as exhibit A of the unhealthy clout of a plutocratic elite.

If these arguments are right, there might be a case for some fairly radical responses, especially a greater focus on redistribution. In fact, much of the recent hand-wringing about widening inequality is based on sloppy thinking. The old Davos consensus of boosting growth and combating poverty is still a better guide to good policy. Rather than a sweeping assault on inequality itself, policymakers would do better to take on the market distortions that often lie behind the most galling income gaps, and which also impede economic growth.

Begin with the facts about inequality. Globally, the gap between the rich and the poor has actually been narrowing, as poorer countries are growing faster. Nor is there a monolithic trend within countries. In Latin America, long home to the world’s most unequal societies, many countries—including the biggest, Brazil—have become a bit more equal, as governments have boosted the incomes of the poor with fast growth and an overhaul of public spending to improve the social safety-net (but not by raising tax rates for the rich).

The gap between rich and poor has risen in other emerging economies (notably China and India) as well as in many rich countries (especially America, but also in places with a reputation for being more egalitarian, such as Germany). But the reasons for this differ. In China inequality has a lot to do with the hukou system of residency permits, which limits internal migration to the towns; by some measures inequality has peaked as rural labour becomes more scarce. In America income inequality began to widen in the 1980s largely because the poor fell behind those in the middle. More recently, the shift has been overwhelmingly due to a rise in the share of income going to the very top—the highest 1% of earners and above—particularly those working in the financial sector. Many Americans are seeing their living standards stagnate, but the gap between most of them has not changed all that much.

The links between inequality and the ills attributed to it are often weak. For instance, some of the findings in “The Spirit Level” were distorted by outliers: strip out America’s high murder rate (which many would blame on

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guns, not inequality) or Japan’s longevity (diet, not equality), and flatter societies no longer look so much healthier. As for the mooted link to the financial crisis, the timing is dodgy: America’s poor fell behind in the 1980s, the credit bubble took off two decades later.

Message to DavosThese nuances suggest that rather than fretting about inequality itself, policymakers need to differentiate

between its causes and focus on ways to increase social mobility. A global market offers far bigger returns to those at the top of their game, be they authors, lawyers or fund managers. Modern technology favours the skilled. These economic changes are themselves often reinforced by social ones: educated men now tend to marry educated women. The result of all this is the rise of a global elite.

At heart, this is a meritocratic process; but not always. Rules and institutions are often rigged in ways that limit competition and favour insiders at the expense both of growth and equality. The rules can be blatantly unfair: witness China’s limits to migration, which keep the poor in the countryside. Or they can involve more subtle distortions: look at the way that powerful teachers’ unions have stopped poorer Americans getting a good education, or the implicit “too big to fail” system that encouraged bankers to be reckless and left the rest with the tab. These are very different problems, but they all lead to wider inequality, fewer rungs in the ladder and lower growth.

Viewed from this perspective, the right way to combat inequality and increase mobility is clear. First, governments need to keep their focus on pushing up the bottom and middle rather than dragging down the top: investing in (and removing barriers to) education, abolishing rules that prevent the able from getting ahead and refocusing government spending on those that need it most. Oddly, the urgency of these kinds of reform is greatest in rich countries, where prospects for the less-skilled are stagnant or falling. Second, governments should get rid of rigged rules and subsidies that favour specific industries or insiders. Forcing banks to hold more capital and pay for their implicit government safety-net is the best way to slim Wall Street’s chubbier felines. In the emerging world there should be a far more vigorous assault on monopolies and a renewed commitment to reducing global trade barriers—for nothing boosts competition and loosens social barriers better than freer commerce.

Such reforms would not narrow all income disparities: in a freer world skill and intellect would still be rewarded, in some cases magnificently well. But the reforms would strike at the most pernicious, unfair sorts of income disparity and allow more people to move upwards. They would also boost growth and leave the world economy more stable. If the Davos elites are worried about the gap between the rich and the rest, this is the route they should follow.

From The Economist

Monetary policy14. Glory days

May 23rd 2014, 10:19 by R.A. | LONDON"THE Fed is a bit behind the curve", worries an official at HSBC. The Fed is always behind the curve on

inflation, says Charles Plosser, president of the Philadelphia Fed:If borrowing begins to surge and those reserves start to pour out of the banking system, Plosser worries,

“that’s going to put pressure on inflation.” The result: the Fed could be forced to raise interest rates faster and earlier than it would like and perhaps slam the breaks on the economic recovery.

This is a relatively common concern: that if the Fed isn't careful inflation may rise, forcing it to jack up interest rates and crash the economy. But why would the Fed have to crash the economy if inflation rose above target? It's possible Mr Plosser, and others who share his view, are simply arguing that the Fed is not very good at its job and will dramatically overreact, raising interest rates far higher than necessary out of sheer incompetence.

It seems more likely, however, that this camp does not think crashing the economy is an error, but rather that it is what one does to wipe out inflation. That is, the experience of the early 1980s is burned deep into their minds. When Paul Volcker wanted to rein in high inflation, he had to push interest rates into double digits, touching off a nasty recession in the process. This is the way the economy works, many seem to reckon: beating inflation means jacking up rates and choking off growth until price-growth slows.

But this is deeply mistaken. The economy today is facing very different circumstances than the economy of the early 1980s, and it is extremely troubling that key policy-makers seem not to understand this.

What's different? There are three significant ways in which now is not like then. The first is simply the extent of inflation in the system. The price level rose 61% from 1977 to 1982 and 129% from 1972 to 1982. Over the past five years, by contrast, the price level has risen just 11%, and just 26% in the last ten. Prices were rising more each year in 1979 and 1980 than they rose over the whole of the last half decade. To think that the Fed would

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or should react to 3% or 4% inflation as Mr Volcker did in trying to cool annual inflation rates of 12% to 14% is absurd.

Second, Mr Volcker was working in an economy that was structurally very different. In the late 1970s more than 20% of private-sector workers were union members, compared to just over 5% today. Many more workers were on labour contracts with wage adjustments linked directly to inflation. That meant, first, that there was a high level of pass-through from inflation to wage growth and then back to inflation. It also meant that inflation was very persistent, since wage contracts were not easily or frequently renegotiated.

Third, and relatedly, it was not clear to many observers in the early 1980s that the Fed couldreduce inflation, because of those "cost-push" pressures, while today it is taken for granted that the Fed can and will keep inflation at very low levels. Public doubt in Mr Volcker's ability to reduce inflation meant that much of the work of disinflation had to occur mechanically, through the creation of high levels of unemployment, rather than through a simple reset of expectations. Today the dynamic is completely different. Because the Fed's control over inflation is so well-established, inflation will tend to revert to target despite tightening conditions in labour markets: that's what it means for expectations to be "well-anchored".

The Fed simply does not need to strangle the economy any more to get inflation to come down. In each of the last three business cycles the Fed's policy rate has topped out at progressively lower levels, and the ensuing recessions were short and mild—until the last one, at which the policy rate fell to zero, which takes me to a last point.

Worrying about high inflation is particularly crazy given the current state of the American economy. On the one hand, it smacks of a no-one-goes-there-because-it's-too-crowded kind of thinking. The economy has been in a nasty slump for more than six years now, during which time growth, employment, and wages have all fallen well below trend. A bit of inflationary pressure would mean that at long last the economy would be operating near potential. We should welcome and celebrate that, not fret about it.

But on the other hand, a period of sustained inflationary pressure would be most welcome because it would ultimately lead to higher nominal interest rates. If the Fed overreacted to the slightest uptick in inflation it would guarantee that interest rates in this cycle peaked at a very low level—nowhere near the 5.25% peak for the fed funds rate in the last expansion, for instance. That, in turn, would ram the American economy right back up against the zero lower bound on nominal interest rates, and that would force the Fed either to accept a deeper and longer downturn than it would prefer, or to go back to unconventional policy. Mostly likely a bit of both.

America is about the enter its sixth year of recovery. Looking back at the history of American business cycles, only 15% of expansions made it to a sixth year. Right now, markets anticipate that the fed funds rate will be just 1% when the recovery enters its eighth year. Only three expansions in America's history saw an eighth year.To be plain: either America will have a sustained period of inflation above 2%, or America will be relying on unconventional monetary policy for the foreseeable future. It's as simple as that. It is fine for people to complain about the Fed falling behind the curve, but they should realise what they're saying. They are insisting that the American economy establish a new normal, in which interest rates are perpetually at or near zero and unconventional monetary policy becomes the Fed's main policy instrument.

15. One worldAsian and Western business will become more alikeMay 31st 2014 | From the print edition Come rain or shine, the future is global

ASIA PROSPERED OVER the past two decades by following a different economic model from the West’s. But if it wants to continue to do well over the next 20 years, it will have to reform. What that involves will vary from place to place. Myanmar, a big country with a difficult past, is beginning to pull itself out of the mire. India and Indonesia, two chaotic democracies, have to create enough order to attract factories and industrial jobs. In China the government needs to ease its grip on the economy. Japan is embarking on the world’s biggest experiment to see whether a society can shrink and still remain prosperous.

The task for Asia’s companies is similarly varied. Selling shampoo sachets in rural Java is quite a different undertaking from making smartphones in South Korea or writing computer code in Bangalore. But as this special report has argued, all Asian firms will be affected by a range of important trends: the impact of higher labour costs in China and ageing in East Asia; higher consumer expectations; the disruptive power of the internet; and the rising barriers to entry in many global industries as they become ever more concentrated. Rising military tensions in the region will also play a part.

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To the extent that Asian companies face similar problems, their response should be similar. They need to professionalise, focus, internationalise, improve R&D and create widely recognised brands. That will threaten the traditional ownership pattern of Asian firms—state firms, family conglomerates and companies controlled by Japan’s manager-kings. Such change is to be welcomed. The status quo has worked, after a fashion, for the past two decades, but it has many flaws and may now lead to sclerosis. Emerging Asia’s best firms are already adapting; those that do not may be gone within a decade.

Asia Inc is not about to become America Inc, but big Asian firms will increasingly come to look like global multinationals. No one has yet invented a better model for the company. At the same time Western multinationals will become more Asian, with a large chunk of their sales generated by the region’s huge consumer markets and their ranks increasingly populated by Asians. They should inculcate some Asian business values, from restraint on executive pay to longer planning horizons.

Many things could spoil this happy scenario. One is war between China and its neighbours, the risk of which is higher than at any point in the past few decades. Another is a public backlash against inequality and corruption. Asian countries score badly on The Economist’s Crony Index, which measures the wealth of tycoons in sectors close to the government. China, India and Indonesia have all seen politically motivated attacks on foreign firms in the past three years. Such attacks could spread to local firms. One happy side-effect of more dispersed company ownership is that more people have a stake in companies’ future.

Innovation also needs a push. There is much talk in Asian business circles about the massive entrepreneurial potential of young Asians. Yet in much of Asia powerful incumbents enjoy special privileges. The financial apparatus to bring on lots of new firms—and particularly the venture-capital industry—is very immature. Despite the hype over “new” Asian industries, such as green energy, health care and the internet, the number of firms investing serious amounts of capital in them is small.

Asia Inc’s next two decades will create losers as well as winners. As China’s firms become more sophisticated, more Western rivals that have so far had the field to themselves will face competition. The shift in basic manufacturing away from China and the automation of factories across the region will destroy jobs. If South Korea and Japan get better at services and creative industries, Hollywood screenwriters, French designers and Australian pop stars might be in trouble. But more competition and more innovation is good for consumers everywhere. If China successfully rebalances its economy, it will buy a lot more from the rest of the world. And more global Asian firms should also create more jobs outside their own countries.Seize the opportunities

Twenty years ago it was almost unimaginable that a South Korean firm would be a global car giant, that an Indian firm would be one of the world’s largest technology outfits or that a Chinese internet colossus would list on an American stock exchange. Today those things are facts of life. If it proves flexible enough, Asian business will continue to power ahead. Perhaps in 20 years’ time Unilever will be run from Singapore and report its results in renminbi, and McDonald’s will sell Maharaja Macs in New York as well as Mumbai. A new global digital-entertainment empire for the elderly may be based in Tokyo, and the world’s biggest bank may be China Mobile. Even The Economist might be Asian-owned—and written beautifully by machines.From the print edition: Special report

16. Bucked off

Europe’s leaders need to cut the power of Brussels in many areas, but in some they need to extend itMay 31st 2014 | From the print edition

“DETERMINED to lay the foundations of an ever-closer union among the peoples of Europe…” proclaims the Treaty of Rome that began the European project in 1957. When the history of the European Union is written, 2014 will very probably come to be seen as an equally significant date, for this was the year that Europe’s voters told its leaders to abandon the noble aspiration that launched the venture more than half a century earlier and has shaped its policies ever since.

Even though a big anti-European vote had been expected, the scale of it still came as a shock. In France Marine Le Pen’s National Front (FN) came top with 25% of the vote. The UK Independence Party (UKIP) did better still, with 27%. Almost 40% of the vote in Greece went to broadly Eurosceptic or avowedly racist parties. As

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many as 30% of the seats in the next European Parliament will be held by anti-establishment and/or anti-European parties. Manuel Valls, the French prime minister, was right to speak afterwards of a political “earthquake”.Prosperity v democracy

The direct political consequences may not in themselves be hugely significant. Within the European Parliament, the populists will probably squabble so much that the pro-European 70% can continue in their usual consensual way. But the longer-term ramifications could be enormous. Europe faces the possibility that Britain—whose ruling Conservatives have promised a referendum on EU membership after the next election—will pull out. The EU might survive a British withdrawal; but if France elected an anti-European of Ms Le Pen’s ilk and pulled out, that would be the end of it.

Muddling through, the typical Brussels response to crises, is not an option this time, for if the EU does not change voluntarily, voters will force change upon it. To respond to their hostility, Europe’s leaders need first to examine the reasons for it.

Nationalism is clearly a factor. The message that voters do not want foreigners telling them what to do was broadcast loud and clear from the platforms of parties such as UKIP and the FN, and this is not the first rejectionist vote. The French and Dutch threw out the draft EU constitution in 2005 and the Irish rejected its replacement, the Lisbon treaty, in 2008 before being asked to vote again.

Hostility to immigration is another motive. Most of the anti-EU parties are also against foreigners. Resentment of the EU has risen since it expanded eastwards, and workers from those poorer countries moved westwards.

Finally, economics is a big driver of discontent. It is notable that the French, whose leaders have no solution to their stagnation, are far angrier than the Germans, whose economy is recovering nicely. Britain may be growing now, but the fact that its economy shrank so sharply in the aftermath of the crisis helps explain the grumpiness with its government.

There are two solutions to Europe’s problems: economic prosperity and increased democracy, which basically means returning power to the states and institutions that voters trust. The two aims often coincide, but not always.

There are plenty of areas of national life in which Brussels should interfere less. Much unnecessary red tape should be torn up and many regulations scrapped. Freedom to fix many detailed social and employment rules—parental leave, working time and so on—should be handed back to national governments. The European Parliament’s powers should be reduced, and national parliaments given more say in EU legislation. At least initially, such reforms can be made without the lengthy (and risky) business of treaty change.

But prosperity and democracy clash in two areas. The first is immigration. Yes, countries should be freer to clamp down on “welfare tourism”, a particular source of anger: rules can be tightened to make it harder for immigrants to claim benefits. And poorer new EU applicants could be subject to even longer transition periods when free movement is limited. But the “four freedoms” of movement of goods, services, capital and labour underpin Europe’s single market. To junk any one of these would not only call into question the point of the enterprise, but also reinforce the economic stagnation that is a big reason for the current discontent.

The single market provides the second set of conflicts. In some areas—labour-market flexibility, for instance—“less Brussels” will help growth. But not all. The euro crisis showed that the euro zone needs a banking union, which centralises a lot of power. And the best hope of growth lies in expanding the single market. The next commission needs to remove blockages to trade in services, energy and the digital economy. More free-trade deals, starting with America, are another priority. Opening up Europe’s economy will annoy some voters (and scare some politicians); but the alternative—years of economic stagnation—will doom the project anyway.The quest for leadership

It may be, as Eurosceptics argue, that Europe cannot change. But the initial reaction from national leaders has been encouraging. Germany’s Angela Merkel and the present commission president, José Manuel Barroso, have both called on the commission to do less. France’s François Hollande says the EU is too remote and must scale back its power. Italy’s Matteo Renzi has won backing for reform. David Cameron, Britain’s prime minister, has been demanding a reduction in the powers of Brussels for years, while campaigning for a broader single market. Europe’s other leaders would do well to adopt his ideas—and then pretend they did not come from Britain.

The first job is to appoint a new president of the European Commission prepared to implement radical change. The continuity (and federalist) candidate, Luxembourg’s Jean-Claude Juncker, used to have Mrs Merkel’s support. But she seems to have realised that doing nothing is not an option. Our choice would be Christine Lagarde, the French boss of the IMF, a clever, brave outsider, who knows how to take on vested interests. With Ms Lagarde as president, Britain would be more likely to stay in. If the EU is to survive, it will need that sort of leadership. And its survival really is in question now.From the print edition: Leaders

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17. Currency disunionWhy Europe’s leaders should think the unthinkableApr 7th 2012 | From the print edition

THE Irish left the sterling zone. The Balts escaped from the rouble. The Czechs and Slovaks left each other. History is littered with currency unions that broke up. Why not the euro? Had its fathers foreseen turmoil, they might never have embarked on currency union, at least not with today's flawed design.

The founders of the euro thought they were forging a rival to the American dollar. Instead they recreated a version of the gold standard abandoned by their predecessors long ago. Unable to devalue their currencies, struggling euro countries are trying to regain competitiveness by “internal devaluation”, ie, pushing down wages and prices. That hurts: unemployment in Greece and Spain is above 20%. And resentment is deepening among creditors. So why not release the yoke? The treaties may declare the euro “irrevocable”, but treaties can be changed. A taboo was broken last year when Germany and France threatened to eject Greece after it proposed a referendum on new bail-out terms.

One reason the euro holds together is fear of financial and economic chaos on an unprecedented scale. Another is the impulse to defend the decades-long political investment in the European project. So, despite many bitter words, Greece has a second rescue. Its departure from the euro, Angela Merkel, Germany's chancellor, now says, would be “catastrophic”. Yet Mrs Merkel is not ready to take the action needed to stabilise the euro once and for all. Last week's decision to boost the euro's firewall to “€800 billion” ($1.07 trillion) is less than meets the eye; the real lending power will be €500 billion. And there is no prospect, for now, of mutualising any part of the sovereign debt.

So the euro zone remains vulnerable to new shocks. Markets still worry about the risk of sovereign defaults, and of a partial or total collapse of the euro. Common sense suggests that leaders should think about how to manage a break-up. Some may be doing so. But having described a split as bringing economic Armageddon, leaders dare not be seen planning for it.

Instead, the most open thinking is being promoted by a British think-tank close to the Eurosceptic Conservative Party. This week Policy Exchange announced a shortlist of five contestants for a £250,000 ($400,000) prize for the best plan to manage a break-up of the euro. It may be a sign of the magnitude of the task that the organisers did not declare a winner; instead they asked those on the shortlist to do more work and resubmit their ideas. (A cartoon produced by an 11-year-old Dutch boy won a €100 voucher.)

One of the five entries, by Jonathan Tepper, lists 69 currency break-ups in the past century. Most have not led to long-term damage, he says. In fact, leaving the euro would help troubled countries recover quickly. Drawing on the demise of the Austro-Hungarian empire, among others, Mr Tepper sketches out a scenario for the departure of the likes of Greece. A surprise announcement is made over a weekend, and all deposits are redenominated in new drachmas while banks are kept shut. Capital controls are imposed to prevent the flight of money abroad. For cash, Greeks at first use existing euro banknotes defaced with ink or a stamp. These are withdrawn as drachma notes are printed. Border checks restrict the export of unstamped euro notes. Financial institutions are given time to update software.

The real problem with the euro, says Mr Tepper, is the fact that many countries face large imbalances and high debts. Devaluation for Greece would increase the burden of euro-denominated debt. This would be alleviated by converting bonds issued under Greek law to drachmas. Foreign-law bonds would be restructured. Indeed, says Mr Tepper, default is essential to recovery.

His formula might be summed up by three Ds: depart, default and devalue. Roger Bootle, another shortlisted entrant, says it might be better to start with the departure of Germany and other strong countries. But however it happens, any fragmentation will create winners and losers, with many bankruptcies and legal nightmares. Anybody involved in cross-border activity will find that their assets and liabilities change value. Neil Record says the sums involved would be so large, and the litigation so ruinous, that the best option would be to abolish the euro as soon as one country leaves, so as to invalidate all euro contracts.

Unlike Mr Record, who favours secrecy, in their paper Jens Nordvig and Nick Firoozye argue that open contingency planning would reduce uncertainty. They reckon there may be a total of €30 trillion-worth of cross-border exposure under foreign law, including bonds, loans, derivatives and swaps. Disruption, they say, could be minimised by converting all euro contracts to a modified form of the European Currency Unit, the basket of national currencies that preceded the euro. Catherine Dobbs, the final entrant, proposes to unscramble the omelette by splitting the euro into two (or more) zones: “yolk” and “white”. All euros in all countries would be converted into a fixed combination of the two. Savers would be protected, initially at least, and capital flight to other euro-zone countries would be deterred. Over time, the weaker yolk would devalue against the stronger white.Plan ahead

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The fate of the euro will probably be determined by politics as much as economics. A debtor state may tire of internal devaluation. A creditor may want to stop supporting others. And any one of the euro's 17 members may balk at the loss of sovereignty involved in saving the currency. But the worst outcome of a euro split would be a chaotic breakdown. An orderly process increases the chance that it might be possible to salvage from the wreckage other gains of European integration, notably the single market.

So euro-zone governments need to think the unthinkable. No self-respecting general would refuse to plan for a predictable war, no matter how much he dislikes the idea of fighting it.

18. Hail Helvetia

Some Swiss lessons for the euro zoneJul 19th 2014 | From the print edition

THE euro crisis has recreated a rift between a Germanic north and a Latin south that decades of integration tried to efface. Economists and political scientists puzzle over its persistence. Some point to patterns of industrialisation, of literacy or even of Catholic and Protestant attitudes to sin and redemption. Whatever the roots, the euro has made it worse.

Belgium offers a worrying glimpse of what the euro zone might yet become: a dysfunctional, over-bureaucratic polity with bewildering layers of government, infused with a poisonous resentment between a dependent French-speaking south and a subsidising Flemish north. But there is a more hopeful model: Switzerland, which for all its linguistic and religious splits, combines prosperity with contentment and a dose of direct democracy. An index of the best places to be born in 2013, compiled by our sister company, the Economist Intelligence Unit, put the Alpine confederation comfortably first.

The European Union has often looked to America, a continental federation, for inspiration. But it could usefully study how the Swiss bring together Catholics and Protestants and German-, French-, Italian- and Romansh-speakers. The usual stereotype breaks down: rich French-speaking cantons like Geneva and Vaud pay for poorer German ones such as Uri. There is something for every taste: Scandinavian standards of living, German fiscal rigour, French-style “solidarity” transfers, Luxembourg-like love of bank secrecy, Irish tax competition and a British cussedness about the EU. Switzerland is neither in the EU, nor in the looser European Economic Area. It has a web of bilateral deals with Brussels—though these may yet be torn apart by the Swiss referendum in February that rejected the free movement of workers.

Above all, Switzerland has a successful currency union without the euro zone’s onerous central edicts on everything from deficits to labour policy, pensions and investment. Although the Alpine cantons started to bind together in medieval days, they developed a single market only in the 19th century—starting, like the EU, with goods and spreading imperfectly to services. A single currency replaced multiple cantonal ones from 1850.

What lessons does Switzerland offer? A strong doctrine of subsidiarity, whereby tasks should be done at the lowest possible level of government. Cantons have ceded powers to the confederation piecemeal (its right to raise taxes must be reviewed periodically), but have also devolved them to communes. All three levels of government have taxation powers and provisions for issues to be decided by referendum. German economists also point to Switzerland’s mechanisms to control public spending and enforce a no-bail-out rule. The big difference, though, is that cantons have drafted their own balanced-budget rules and voters have forced similar ones on the confederation. The euro zone imposed too much austerity on troubled countries, but Switzerland has shown that running surpluses and paying back debt in good times creates more scope to respond in a crisis. The thrifty burghers even voted down plans to bid for the winter Olympics.

So is Keynesian stimulus banned? Not entirely. Balanced-budget rules vary. Some allow for downturns or exclude investment from the numbers. The confederation can approve exceptional spending, such as when it saved UBS, a big bank. Switzerland’s “banking union”, to use the EU term, is narrower than the euro zone’s (it covers

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just three “systemically important” banks) yet it is clear that the confederation ultimately guarantees the system. There is no such euro-zone backstop. At the height of the financial crisis in 2008 stimulus was also entrusted to the Swiss National Bank, which cut interest rates more than the European Central Bank. It has fewer qualms about buying debt or, indeed, large amounts of foreign assets to hold down the Swiss franc.

The deeper difference is that Switzerland is a federation that calls itself a confederation, whereas the euro pretends to be a federal currency but actually preserves 18 sets of national economic and fiscal policies. Swiss monetary union came after centuries of political unity; the euro unwisely tried the reverse course.All for one and one for all

Imbalances between Swiss cantons and shocks that hit some more than others are absorbed by the economy as a whole: by an integrated financial system, by workers moving to where the jobs are, by countrywide provision of welfare and public goods (eg, roads) and by transfers from rich to poor cantons. The confederal budget is smallish, at 11% of GDP, but that is far larger than the EU’s, which is less than 1% of GDP. The EU could learn from the Swiss “equalisation fund” (about 0.8% of GDP), which creates a transparent system of transfers from richer to poorer regions. By reckoning the payments annually according to the tax base (rather than how cantons tax and spend) and by providing lump sums instead of semi-hidden subsidies, the system preserves cantons’ freedom of action and also encourages tax competition.

None of this is to idealise Switzerland. Its politics is full of arguments about money. Sometimes referendums play up social divisions, or stoke anti-foreigner populism. What is feasible in a small country may not be across a continent: for instance, neutrality is not an option for most EU countries. But Switzerland offers useful pointers for the euro zone. Restoring market discipline through a no-bail-out rule, stronger fiscal federalism, a deeper single market and a more rational EU budget could create a system that requires less bossy interference by Brussels. Establishing clearly defined tasks for every level of government, each with its own resources, would help make the system more accountable. Direct democracy can transcend identity politics. “A bigger Switzerland” is a term of insult among EU watchers. But the euro zone might do better if it were a little more Helvetic.

19. A world to conquer

Asian business is reforming. Its emerging multinationals will change the way we all liveMay 31st 2014 | From the print edition

BUSINESS power follows economic power. In the 1920s British firms owned 40% of the global stock of foreign direct investment. By 1967 America was top dog, with a 50% share. Behind those figures lie cultural revolutions. The British spread the telegraph and trains in Latin America. American firms sold a vision of the good life, honed by Hollywood and advertising. Kellogg’s changed what the rich world ate for breakfast, and Kodak how it remembered holidays. The next corporate revolution, as we describe in our special reportthis week, is happening in Asia. This too will change how the world lives.

Asian capitalism has brawn. The continent’s share of global GDP has risen from a fifth to 28% since 1984. It is the world’s factory, a diverse region of rivals bound together by supply chains. But it lacks brains and global savvy. Asia smelts 76% of the world’s iron and emits 44% of its pollution, but hosts only a tenth of its most valuable brands and venture-capital activity. Its multinationals punch below their weight, owning 17% of the world’s foreign direct investment. Wealthy Japan and South Korea have a cast of superstars, such as Toyota and Samsung. But few other firms command the world stage.

That is because Asian capitalism has been too cosy. In the boom between 2002 and 2010 easy profits were made at home—growth was fast and labour and credit cheap. Two-thirds of big Asian firms are state-controlled or

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“business houses” (often family-run). These incumbents tend to be chummy with the government and get cheap land and loans. Half of all billionaire wealth in Asia has been made in sectors, such as property, that are prone to cronyism, versus 15% in the West. Outside Japan, Taiwan and South Korea, innovation has been neglected. Mahindra & Mahindra and Great Wall, car champions from India and China, have a combined research-and-development (R&D) budget that is 3% of Volkswagen’s.

For Western firms, Asia’s shortcomings have been a relief. The iPhone shows why: although it is made by the hands of Chinese workers, it is the brains behind it, at Apple and at high-tech component-makers in the rich world, that take nearly all the profits. Now, however, the rules that have governed Asian capitalism for the past two decades are changing. Asian firms are having to become brainier, more nimble and more global.

The immediate motivation is underperformance: growth has slowed, and Asian shares have lagged American ones by 40% in the past three years. Three deeper trends are also at work. First, labour costs are rising, not least in China, and East Asia’s workforce is ageing. Second, Asia’s middle class is becoming more demanding. They are no longer satisfied with fake Louis Vuitton handbags; they want clean air, safe food and more leisure, and are madly in love with the internet. Third, competition has intensified from Western multinationals, which have invested $2 trillion in Asia. They also now use the same cheapish labour, and they generally have much more sophisticated supply chains, brands and R&D.

With their home markets no longer quite so safe, Asian firms are adapting—and becoming stronger. In response to rising wages, production (of clothes, for example) is shifting from China to South-East Asia and Africa, led by Japanese firms which are also worried about a war with the Middle Kingdom. Chinese firms such as Haier, which makes fridges, plan to automate factories and get into cleverer products. And as the Chinese push upmarket, the Koreans are redoubling efforts to stay ahead. Samsung’s spending on R&D rose by 24% in 2013. If they get their act together, India and Indonesia, Asia’s bumbling giants, will attract lots of factory jobs. Their best firms are also getting brainier. Once dismissed as “body shops”, India’s IT-outsourcing firms are now leaders in big data.

Rising consumer aspirations are helping internet firms disrupt traditional industries. Alibaba, a Chinese internet giant, is expanding into banking, telecoms and logistics. Analysts think it might be worth $150 billion, more than China’s steel industry. China’s drive to reform its state-owned firms is meant to make them more responsive to customers. Xi Guohua, the boss of China Mobile, plans to give shares to his staff. Across Asia demand for health care is likely to create a whole new generation of companies—the industry comprises only 4% of the region’s stockmarket, compared with 12% in the rich world.

In order to challenge foreign rivals, Asian firms are globalising, following the example of Samsung and Toyota. Lenovo, a thriving Chinese computer firm, has Western-style governance and many foreign staff. Huawei has overtaken Ericsson in telecoms equipment. India’s Sun Pharma is now one of the world’s biggest generic-drugs firms. Tencent, China’s Facebook, has hired the footballer Lionel Messi to advertise its services abroad. Sprawling business houses are evolving into focused multinationals. Tata Sons is now a superb IT firm and luxury-car maker tied to a ragbag of Indian assets.Cereal killers

Asian business needs to do much more. Big firms are spending 50% more on R&D than five years ago, but must get better at breakthrough innovations. Conglomerates must focus on a few areas where they can achieve global scale. Governments can do their bit, by freeing state firms from meddling and ensuring that powerful incumbents do not stifle entrepreneurs.

Western firms should pay attention. In some industries—aircraft manufacturing, for example—the barriers to entry are still immense, but in other sectors brands and technology will no longer be a shield from emerging Asian competition. The threat to low-paid Western jobs may recede. Haier’s Chinese workers are paid 25% of what

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its American workers get, up from 5% in 2000. Instead it may be copywriters, scientists and designers who feel the chill of competition from the East.

History suggests consumers will adapt fast. In 20 years, miracle cures for the old will come from Japan, the best web apps from India and couture from China. And cornflakes, once a cutting-edge food, will be rivalled by congee and dosas, sold in boxes by a global brand. Asian capitalism will change the world—even, maybe, what it has for breakfast.

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The ECB and inflationPlease ease

May 6th 2014, 15:27 by P.W. | LONDON

A MONTH ago Mario Draghi, president of the European Central Bank, expressed irritation about advice to get on with tackling low inflation that was dished out to the ECB on the eve of its monetary-policy meeting by Christine Lagarde, head of the International Monetary Fund. This month it is the turn of the Organisation for Economic Co-operation and Development to urge action ahead of the ECB’s council meeting on Thursday, which will be held for a change in Brussels rather than Frankfurt.

Issuing its latest set of forecasts today, the OECD called upon the ECB to take “new policy actions” to move inflation more decisively to target. It suggested in the first instance bringing down the ECB’s main lending rate from 0.25%, where it has been since last November, to zero. It also advocated possibly taking the deposit rate paid to banks for overnight funds they stash away at the central bank from zero, where it has stood since July 2012, into negative territory.

The OECD accepts that there is a general disinflationary trend in the 34 mainly rich countries that belong to it but it says that “disinflationary pressures are now strongest in the euro area”. Since September 2011 headline inflation has fallen from 3.2% to 1.6% in March 2014 across the OECD, with most of the decline (1.25 percentage points) because of moderation in energy prices. But the fall in the euro area over the same period has been greater, from 3% to 0.5%, and though more favourable energy prices have again been the main reason, accounting for three-fifths of the decline (1.5 percentage points), core inflation (excluding more volatile items like energy and food) has contributed one percentage point to the fall.

As was the case in April, the ECB seems likely to disregard such well-meaning, if unsought, advice. One reason is that inflation, though still worryingly low, has climbed off the floor of 0.5% that it reached in March, returning to 0.7% in April. Though that is still a long way off the ECB’s target of “below but close to” 2%, the core inflation rate has gone back to 1% after falling to 0.7% in March.

Another is accumulating evidence that the recovery is gathering momentum, which should eventually stave off disinflationary pressures. Today’s retail-sales figures from Eurostat show that their volume rose by 0.7% in the first quarter of 2014, whereas it had dropped by 0.5% in the final quarter of 2013. And the second quarter of this year appears to have got off to a good start according to business surveys. Today’s final versions of the regular purchasing-manager reports compiled by Markit, a research firm, confirm the upbeat picture painted in its preliminary findings. A reading above 50 in these surveys represents expansion, one below 50 indicates contraction. So it was encouraging that the composite index for the euro zone’s services and manufacturing output reached 54 in April, almost a three-year high. In Spain, the euro zone’s fourth-biggest economy, which suffered a harsh double-dip recession lasting over two years between the spring of 2011 and the summer of 2013 (leaving

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output 7.4% lower than its pre-financial-crisis peak at the start of 2008), the index reached 56.3, the highest in more than seven years.

The signs of strengthening recovery along with the somewhat better inflation figures are likely to satisfy the ECB’s council sufficiently to postpone any big move for at least another month, until early June. That is the expectation in the markets, where surveys show few economists tipping a rate cut on Thursday.An advantage for the ECB in deferring a decision until June is that it will then have available its latest staff forecasts for inflation. In March they showed inflation averaging 1% this year and 1.3% in 2015. These projections already look outdated, especially for this year. The European Commission forecast on May 5th that consumer prices would rise by 0.8% in 2014 and 1.2% in 2015. The OECD for its part envisages inflation of just 0.7% this year rising to only 1.1% in 2015. That is a long time for inflation to be below and far away from 2% and raises the risk that an unforeseen upset pushes the currency club into outright deflation, a nightmare for its many debt-laden economies since falling prices raise the real burden of debt.

Euro-zone lowflationGetting the message

Apr 3rd 2014, 17:09 by P.W. | LONDONON the eve of today’s monetary-policy meeting of the European Central Bank’s governing council,

Christine Lagarde, managing director of the International Monetary Fund, called for “more monetary easing including through unconventional measures” in the euro area. Speaking today after the council had failed to follow her advice, Mario Draghi, the ECB’s president, said how “extremely generous” the IMF was in proffering such advice; and wondered whether it might extend the courtesy to other central banks, such as the Fed, the day before its policy committee met. Tiffs apart, the ECB does seem to be getting the message even though it left interest rates, its conventional tools, unchanged today. With inflation dropping further in the euro zone to just 0.5% in March, Ms Lagarde had highlighted the emerging risk of “lowflation”. Mr Draghi said that the council was unanimously committed to using unconventional as well as conventional measures to “cope effectively with risks of a too prolonged period of low inflation”. With little conventional ammunition left, since the ECB’s main lending rate is already just 0.25%, he spelt out that the unconventional measures might include quantitative easing–buying assets with central-bank money–as well as charging negative interest rates on overnight deposits left at the ECB by banks. 

Tackling lowflation in the euro zone is thus a common cause. There is nonetheless a subtle difference in the risks of a long period of weak inflation that are worrying the Washington-based IMF and the Frankfurt-based ECB. For Ms Lagarde it is the damaging impact on demand and output; a prolonged period of low inflation can “suppress growth and jobs”, she said on Wednesday. For Mr Draghi it is the possibility that lowflation may feed into inflation expectations, dragging them down and thus making it harder to meet the ECB’s inflation target of “below but close to” 2% over the medium-term.

In fact, that is not the only worry about lowflation. Another is that when inflation is so weak, it would take only one further unfavourable shock to demand to tip the currency club into outright deflation, which would harm growth by creating an incentive to postpone purchases and by exacerbating already onerous debt burdens in real terms. A worsening in the Ukraine crisis resulting in trade sanctions that would hurt Europe as well as Russia could be such a shock, points out Willem Buiter, chief economist of Citigroup. Revealingly, Mr Draghi highlighted the possible repercussions of geopolitical risks for price stability.

Despite such concerns, the ECB is still sticking doggedly to its plan A, which relies on the economic recovery strengthening sufficiently to combat disinflationary pressures. The upturn since last spring has been sustained but feeble, with growth of 0.3% in the second quarter of 2013, 0.1% in the third, and 0.2% in the fourth (revised down by Eurostat this week from 0.3%). Annualised, these rates were 1.3%, 0.6% and 0.9% respectively.

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That’s nothing to write home about but the prospects for the first quarter of 2014 hold more promise. The Bundesbank said recently that it expected “very strong” growth in Germany, which has been the engine of the recovery. Output is now rising, though modestly, in Italy and Spain, the third and fourth biggest economies in the euro zone, both of which took a beating during the long double-dip recession. Confidence and activity surveys across the euro zone are also pointing to a solid performance. The European Commission’s economic-sentiment indicator, which tends to track GDP growth, reached 102.4 in March, the highest for nearly three years, and above its long-term average.

The sense of today’s meeting is that the ECB is prepared to give its plan A some more time, but not that long. Although headline inflation dropped to 0.5% in March, core inflation (excluding more volatile elements like energy and food) was somewhat higher, at 0.8%, in line with its average over the past six months. The timing of Easter, which fell in March last year but is in April this year may have contributed to the weakness of headline inflation in March since prices often tend to rise before the festival, an effect that happened a year ago but not last month. This may in turn lead inflation to recover in April.

But if inflation in May is weaker than expected, then that could well prompt the council to move beyond rhetorical threats and to act in June. One conventional step the ECB could take would be to cut its main lending rate to just 0.1%. But if it does resort to unconventional measures, the most likely option would be to charge negative interest rates on funds parked by banks at the ECB, which would help to stave off the unwelcome appreciation of the euro that has contributed to weak inflation.The euro-zone economy

Frost in spring

The recovery may be warming but inflation is coolingApr 5th 2014 | Finance and economics

VIEWED from one perspective, the euro area is a minor miracle. Instead of collapsing in a heap, as seemed possible two years ago, the currency club is not just intact but has a new member, Latvia, which joined in January. An economic recovery has been under way since last spring and appears to be strengthening. But seen from another standpoint the euro zone is an accident waiting to happen. As inflation slips ever lower, a slide into Japanese-style deflation looks increasingly likely. That would raise an already onerous debt burden in real terms and pull down growth.

The actions of the European Central Bank (ECB) will be crucial if such an outcome is to be averted. The ECB’s mission is to achieve price stability, and since 2003 it has interpreted this to mean an inflation rate over the medium term of “below but close to” 2%. Yet despite a fall in annual inflation to just 0.5% in March, the central bank was expected to hold its fire when its council met on April 3rd (after  The Economist had gone to press). Previously, it had lowered the main policy rate to 0.25% in November.

One reason for the ECB to wait was that underlying inflation, excluding more volatile elements such as energy and food, has been broadly stable over the past six months, at around 0.8% (see chart). The council also sees grounds for being patient and allowing its very low interest rates to take effect. It thinks that the recovery, which started in the second quarter of 2013 after a double-dip recession lasting a year and a half, should eventually bring inflation back towards the target.

Indeed, the once-sickly euro zone is losing some of its pallor. The recovery, though feeble, has nonetheless been sustained. Output rose by 0.3% (an annualised rate of 1.3%) in the second quarter of 2013, and although growth slowed to 0.1% in the third, it picked up to 0.2% in the fourth. More important, there are signs that the pace may be accelerating this year.

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Despite the crisis in Ukraine, euro-zone surveys of confidence and activity in the first three months of 2014 have been encouraging. The European Commission’s economic-sentiment indicator, based on what both businesses and consumers are reporting, rose in March to 102.4, the highest since July 2011 and a little above the long-term average of 100 since 1990; at the worst of the recession in late 2012 it had fallen to 85.8. The indicator tends to track growth, which suggests that it is picking up. That chimes with surveys of manufacturing, compiled by Markit, a data provider, which show the sector in the first quarter at its healthiest since the spring of 2011.

A reassuring feature of the recovery is that it is spreading to the once-afflicted countries of southern Europe. Germany, which remains the main engine of growth in the euro zone, is likely to have expanded strongly in the first quarter of 2014, according to the Bundesbank. But the recovery is also being boosted by a return to growth, albeit sluggish, on the part of both Italy and Spain, the third- and fourth-biggest economies in the euro zone.

The peripheral economies are benefiting from falling long-term interest rates. Ten-year government-bond yields in Italy, Spain and Portugal are now lower than they were four years ago, shortly before the Greek crisis flared up and led to the first bail-out (see chart). Remarkably, yields in Ireland, which exited its rescue programme only last December, have fallen to their lowest since the euro started 15 years ago. Peripheral yields have been dragged down both by the fall in German yields and the narrowing of their spreads over German bonds since the height of the crisis. Although the spreads are still wider than before the crisis, their tightening reflects a broader reassessment of risk: investors no longer shun peripheral Europe on fears of a euro-zone break-up, whereas they fret about emerging markets.Despite these promising developments, there is still a concern that the recovery may have come too late and be too weak to avert the onset of deflation. Consumer prices are falling in several peripheral countries, notably Cyprus and Greece, but also now in Spain, where in March they declined by 0.2% on a year earlier.

The advent of deflation in the euro-zone periphery can be seen as part of a one-off adjustment as the crisis countries claw back lost competitiveness. But balefully high unemployment across the euro area will continue to bear down on wages, which in turn will keep prices weak. The jobless rate in February remained at 11.9%, only marginally down from its peak of 12% for much of 2013. Though unemployment has fallen over the past year from already low levels in Germany and has declined in Spain, it has risen sharply in Italy.

Making matters worse, the strength of the euro, which has appreciated by 7% against the dollar in the past year, is an endorsement the still vulnerable euro-zone economy could do without. For the time being the ECB is choosing to fight disinflationary pressures through words and threats rather than deeds. But, as Christine Lagarde, the head of the IMF, said on April 2nd, a long period of “lowflation” can be bad for growth and jobs. If inflation weakens any further, the ECB will have to act.

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