Month: July 2015

Greece’s failed economy should be lesson for U.S.

Posted on by j.giglio

Since the European Union (EU) was created, no member has skated as close to insolvency as Greece. The country teeters on the brink once again, drowning in debt. The crisis confronts the EU with its worst dilemma since the creation of the euro.

The Greek crisis also holds important lessons for the United States. We have our own debt problems, with the ratio of public debt to GDP climbing 40 percentage points to 105 percent since 2008. It would be far better to get our fiscal house in order and make structural reforms today, when there’s time to craft trade-offs rather than under duress when creditors are in danger of losing faith.

The immediate causes of the Greek crisis are clear. In 1992, members of the European Commission signed the Maastricht treaty which formed a more comprehensive EU, including a common currency . The Euro was launched in 1999.

Greece didn’t initially meet the fiscal criteria for joining the currency union. But in May 2000, the European Commission declared that the Greek fiscal deficit, including interest, was only 1.6 percent of GDP, inflation was only 2 percent; and the country met all the Maastricht requirements except for its government debt, a shortcoming that was hardly unique among member states.

Greece joined the euro zone in 2001 and when the markets opened, yields on Greek bonds fell to an all­ time low. The newfound perception of Greek debt as safe could most likely be attributed to investors believing that, by joining the euro zone, Greece had acquired an implicit European guarantee on its debt.

This enabled Greece to borrow money at very cheap interest rates. It borrowed plenty and embarked on an expansionary fiscal policy. This rapid growth in borrowing and spending was similar to the cheap credit that fueled the American housing bubble. One symbol of Greek extravagance was the 2004 Olympic Games, which cost almost three times the original estimate.

In the wake of the 2008 global financial crisis, the Greek economy slowed as tourism and shipping suffered from the decline in global trade. After a deep and prolonged recession, the economy has contracted by more than one quarter and unemployment now exceeds 25 percent. Today Greece’s debt is 180 percent of its GDP and will never be repaid without generating tax revenue from major economic growth.

To make matters worse, the Greek government misled the international community about its debt. When a new government took power in 2009, it announced that the deficit that has been projected to be around 5 percent would actually be about 12.7 percent.

Greece had been understating its deficits for years, raising alarms about the integrity of the country’s finances. The previous government had apparently been cooking the books, which shattered any faith that international investors might have had in the Greek economy and government.

Suddenly Greece was shut out of the financial markets. By the spring of 2010, it was veering toward bankruptcy. Two of the three international credit rating agencies cut ratings on Greek bonds to junk status and warned that further downgrades were likely.

The International Monetary Fund, European Central Bank, and European Commission issued the first of two bailouts for Greece, which would eventually total about 240 billion euros ($264 billion). Now, Greece is back in the soup and needs another $86 billion euros ($94 billion).

The lenders extended the bailout package in exchange for the Greek government agreeing to implement deep budget cuts, steep tax increases, and labor and pension reforms to make Greece a more attractive place to do business. But many believe these austerity measures alone will only quicken the shrinking of the Greek economy without providing debt relief.

If the United States is to avoid being in similar straits someday, we must learn some important lessons about borrowing to consume, living beyond our means and failing to invest in the productive capacity of our economy.
 

Originally Published: July 25, 2015

Reasons so many politicians don’t tell the truth

Posted on by j.giglio

More than a dozen Republicans and a handful of Democrats have announced they are running for their party’s 2016 presidential nomination. The campaign will flood the airwaves with grand promises that ought to be taken with a large dose of salt. Americans should have learned by now that telling the truth is a liability in politics. Perhaps one reason truth is a liability is that, to paraphrase T.S. Eliot, Americans cannot bear too much reality.

The candidates will talk endlessly about a long list of profound problems facing the country. They will remind everyone that until quite recently, the U.S. was widely regarded as an irresistible juggernaut, dominating the global landscape and that it must continue to lead in a world it has helped to make more dangerous. They will simplify the complex demands of pressing, interconnected problems as if each can be solved simultaneously despite constrained resources and the need to engage in trade-offs.

But turning their promises into reality will require something that has been sorely missing in recent years: a strategy.

Leadership is required to make hard choices in a systemic, coordinated, considered manner. Everyone’s wants and needs can never be satisfied, regardless of the rosy campaign rhetoric. Some things are more important than others, even though politicians are reluctant to be explicit. An overarching strategy can identify and prioritize what is important.

The American people will decide who among these candidates has the shortest learning curve and best grasps the challenges facing the country as it comes to terms with new economic, social, and geo­ political realities such as the erosion in U.S. economic dominance and increasing global economic parity. Sure, some fraying at the edges of America’s economic hegemony was to be expected since it spent much treasure in planting the seeds of market capitalism as part of the fight against communism. Is it any wonder that others are catching up?

America’s domestic and foreign issues are tightly connected. For example, a weak economy leaves America in an appreciably weaker position to pursue foreign policy goals and keep its citizens secure. The voters must answer a fundamental question: who is capable of crafting the kind of overarching strategy that has been missing as America have stumbled from one crisis to the next?

Anyone running an enterprise knows that strategy matters. At its core, strategy is about creating and exploiting competitive advantage and adapting to the external environment; the ability to do something the competition cannot do based on your unique set of resources and strengths. How will these candidates make good on their promises and use America’s strengths to capitalize on external opportunities, while mitigating the threats and minimizing weaknesses in an increasingly competitive, dangerous, complicated and fluid global environment?

The good news is that America has plenty of strengths to leverage. Consider it is the world’s largest exporter of food; it has a per capita GDP over five times that of China; it has 17 of the world’s top 20 research universities; it has robust capital markets; and an entrepreneurial culture that excels in the kind of technological innovation that has made it possible to produce enough energy to be on its way to self­ sufficiency. Also, America has more favorable demographics than any of its most important economic competitors. And it is the economy that keeps American strong and powerful.

A grand strategy doesn’t have to be perfect; it just has to avoid being so wrong that it can’t be put right. Recent history teaches that it makes more sense to adapt strategy along the way than to try and control the dynamic global environment, only to stumble from crisis to crisis, stretching and wasting precious resources along the way.

Given the rough and tumble of global competition, it might also be wise to remember Mike Tyson’s observation: “Everyone has a plan until they get punched in the mouth.”

Originally Published: July 18, 2015

Obama free trade isn’t so free for US

Posted on by j.giglio

The fight for fast track legislation to allow President Obama to negotiate the secretive Trans-Pacific Partnership trade deal is over. After pulling out all the stops to push the deal through Congress, the President signed legislation giving him the authority to negotiate the trade agreement and put it before Congress for a straight up-or-down vote with no amendments allowed.

Americans are told that free trade is the best strategy for advancing global economic development, reducing poverty and achieving world peace. There is a lot to be said on behalf of the utopian dreams of free traders if you ladle enough frosting on the cake to compensate for its shortcomings. But if we want to help the American middle class -the stated goal of virtually  every politician -we would pursue different policy priorities.

To say that everyone benefits from free trade is misleading. Trade creates winners and losers and every American deserves to know the details buried in these deals. The benefits of the North American Free Trade Agreement and other trade deals have not been shared as broadly as promised.

Economists, businessmen and politicians, the most devoted acolytes, say technological advances lead to increased productivity, which means fewer workers are needed to get the job done. Yes, we have substituted capital for labor. But we have also substituted cheap offshore labor for American workers and the result is that Americans are losing jobs, their wages are stagnating and the middle class is coming apart at the seams.

How countries trade and whether they benefit from it are important questions. Starting with Adam Smith, economists have emphasized specialization and exchange as essential to increasing productivity and raising living standards.

The economic argument for free trade relies on the principle of comparative advantage developed by David Riccardo in 1817. His quaint theory, which built on Smith’s work, remains the cornerstone of free trade economics. So what in simple terms is comparative advantage?

Let’s assume that Lady Gaga, the world-famous entertainer, also happens to be a world- class typist. Rather than both entertaining and typing, she should specialize in entertaining, where her comparative advantage is greatest and she could maximize her income. This key insight is still endorsed today by the overwhelming majority  of economists.

Americans who lose their jobs are becoming less rich so people in foreign countries can be less poor. In the aggregate, people are better off, but domestic workers bear the cost. It should be clear by now that on the home front, free trade contributes to rising inequality, wage stagnation, and lost jobs .

The gains from trade are often widely dispersed, while the losses are concentrated. The extent to which offshore outsourcing is responsible for some of our current labor market woes has become highly contentious in recent years.

Perhaps it is time to adopt a national strategy that can make the American economy grow fast enough to produce decent jobs for every member of the American family who wants to work. How about if we start by investing in our broken infrastructure so it can generate economic growth instead of hamstringing it, and educating our children so they become world leaders in something besides sports?

Then we just might become internationally competitive again, and restore our economy to full employment while we’re at it

originally published: July 11, 2015

US must confront the new realities

Posted on by j.giglio

The 21st century has witnessed the death of the old world economic order and the birth of a new one. America remains the world’s military superpower but Brazil, Russia, India, China and others are challenging our economic pre-eminence.

The parade of 2016 presidential candidates will offer short-form solutions unconstrained by resource limitations. They will blame others and predict impending doom if they are not elected. And the political rhetoric will surely be accompanied by nostalgia for the golden economic age of the decades that followed World War II.

But America’s dominance in the decades following World War II was a function of unique circumstances. Europe lay in ruins in 1945. In the rest of the world, cities were shattered, economies devastated and people were starving. In the two years after the war, the vulnerability of countries to Soviet expansionism heightened the sense of crisis.

The postwar economy was quite successful by any standard. The American middle class enjoyed higher wages from the end of World War II until the mid-1970s. Real wages, after inflation, continually rose until 1973. But that was when the United States accounted for a disproportionate share of the global economy, nearly two-thirds of the world’s gold reserves, and the dollar was the world’s reserve currency.

Prosperity was the governing theme of the postwar era. During those years, gross domestic product grew 140 percent and real (inflation-adjusted) per capita income doubled. Living standards improved to the point where the large majority of Americans could describe themselves as middle class.

The United States made the economic recovery of Western Europe and Japan a national security priority. Two basic motives guided policy.

Primo, the United States was increasingly concerned about the ambitions of the Soviet Union that had imposed communist governments on Eastern Europe and their threat to Western democracies.

Secondo, the United States believed stable, prosperous, democratic governments would serve as ramparts against Soviet expansion and bind these countries to us.

To restore Europe’s economic infrastructure, President Harry S. Truman signed what became known as the Marshall Plan in April 1948. Over the next four years the plan delivered $13 billion to modernize industry in 16 European countries. This funding, which translates into $103 billion in today’s dollars, enabled Europe to rejuvenate its domestic markets as well as export its way to economic recovery. By contrast, Afghanistan still can’t stand on its own after receiving about $110 billion in assistance.

The Marshall Plan along with cutting American tariffs by 35 percent to accommodate and promote foreign imports, which provided Americans with cheap foreign goods, supported the development of stable democratic governments in Western Europe. It also provided markets for American goods and services, a grand example of vendor financing.

The United States also developed and helped finance a comprehensive economy recovery program for Japan. The war had devastated the country and terminated almost all of its foreign trade.

It should not be overlooked that it was with America’s help that the world became a more prosperous and competitive place, which has indeed put downward pressure on wages as footloose companies take advantage of the information technology revolution to disperse supply chains contributing to the erosion of middle-class wages in the face of low-cost competition.

If America wants to maintain its status as the world’s economic superpower, it is time to jettison the addiction to past achievements and focus on new realities: The world is experiencing dramatic technological change and we face economic competition from millions of people around the world who are happy to work for a fraction of Americans’ wages.

We must get serious about issues that are the very foundation of American exceptionalism such as combating economic inequality and declining living standards for the shrinking middle class. If we don’t, Americans will have to drastically adjust their expectations about growth and opportunity and step back from our special place in the world.

originally published: July 4, 2015