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Painful death of the American economic dream
This crisis has been a long time in coming, and history suggests that the period of upheaval will be long and painful, just as it was between 1914 and 1945
It wasn't really supposed to end up like this. When the Berlin Wall came crashing down 20 years ago, the cold war ended with triumph for the West. Instead of two superpowers, there was one. Instead of competing ideologies, there was capitalism, and a particularly brash form of capitalism at that. The elder George Bush said the world should learn how to do things the American way. "We know what works," he said. "Free markets work." The reach of the market grew longer for two decades, encompassing China and India as well as the former Soviet Union and its satellites. Rapid growth brought impressive poverty reduction in China and India; there are few Poles or Czechs who hanker after the days when Moscow pulled the strings.
But it was always inevitable that, sooner or later, globalisation would run into a crisis, and what we have seen in the past two years is just the start of it. Don't be fooled by the sucker's rally of the past six months – Americans are once again running down savings to consume goods they can't afford; China's exports are booming. The global imbalances are back. A combination of political change and technological revolution has always produced upheaval. That was true when the spinning jenny met the Enlightenment, and it was true when a second wave of inventions – cinema, electric light, the automobile, aircraft – coincided with a crumbling of the 19th century balance of power.
Digital technology and bioscience will drive the third industrial revolution, but these changes take place at a time when the spread of the market has vastly increased the reserve army of labour. America's hegemony is being threatened by the rise of China. These, then, are combustible times. This crisis has been a long time in coming, and history suggests that the period of upheaval will be long and painful, just as it was between 1914 and 1945.
It didn't take long for the first cracks in the new global order to appear. The golden age lasted for barely half a decade – the period between the lifting of the iron curtain and the creation of the World Trade Organisation in 1994. Even during that half-decade there were signs of trouble, not least the impact of the shock treatment on the Russian economy in the early 1990s. But it was the succession of financial crises that began on the periphery of the global economy and gradually worked their way towards the core that gave the lie to the notion that there would be a smooth and steady transition to market nirvana. The warnings from Mexico, Thailand and South Korea, from the collapse of the hedge fund Long Term Capital Management and from the dotcom bubble were ignored.
Policymakers found it easy to dismiss these flashpoints as teething troubles. Growth was strong and inflation was low. The early 1990s to the mid-2000s were what Mervyn King, the governor of the Bank of England, once described as the NICE decade – the years of noninflationary continual expansion. Debt, of course, was the key. The loss of bargaining and spending power of workers in the west was compensated by raging asset price booms which allowed consumers to borrow against the rising price of their homes.
This was not just true of developed economies such as the US and Britain. The annual transition report by the European Bank for Reconstruction and Development, released today, says that large-scale capital inflows into eastern European countries had "contributed to credit booms and foreign currency lending. These, in turn, made the crisis deeper and complicated its management." Just as in Britain and the US, the easy availability of credit meant excessive levels of debt when the global economy turned down and demanded concerted international action to prevent an Iceland-style banking meltdown. Understandably, policymakers have been left bemused by the first systemic crisis of the global age. Up until 2007 they thought their job was to tinker with market economies; instead they face an existential challenge: where do we go from here? Option one is the Schumpeterian one: this is an era of creative destruction, so we may as well grin and bear it. The problem of the financial system is that the market has not been allowed to function properly: badly run banks need to be allowed to fail so that good banks can thrive.
The second option is business as usual, which, predictably enough, is the one favoured by the City and Wall Street. Given the size of their welfare cheques from the taxpayer, big finance can hardly demur at the prospect of tougher regulation, but it is lobbying hard against more radical change. There is plenty of talk of throwing the baby out with the bathwater and killing the goose that lays the golden eggs. The Conservatives are in this camp, not just because David Cameron bizarrely thinks the crisis was caused by too much government rather than too little but because Boris Johnson is actively lobbying on behalf of City hedge funds and private equity firms to block tougher European regulation.
Option three is business as usual plus extras. This recognises that there has been a systemic problem in the financial sector but sees the answer as tighter supervision, better surveillance of the global economy from the International Monetary Fund, changes to capital adequacy rules to ensure that banks can't lend as freely during booms, and new incentive structures for financiers that will favour long-term growth of the business over short-term speculative activity. This, no prizes for guessing, is where you would find Gordon Brown and Barack Obama. But there is a motley band of discontents for whom business as usual, in whatever form, means that another crisis will erupt before too long. They argue that the exiguous nature of current reform proposals is explained by the institutional capture of governments by the investment banks, the world's most powerful lobbying groups.
King's ideas for splitting up the banks into retail and investment arms puts him in the option four group, as does Adair Turner's support for financial transaction taxes. Others would go further. A recent report by the United Nations Committee on Trade and Development (UNCTAD) urged a rethink of the "conventional wisdom that dismantling all obstacles to cross-border private capital flows is the best recipe for countries to advance their economic development. Those who support a green new deal – expansionary monetary and fiscal policies designed to boost renewable energy and support firms developing environmental technologies – say that quantitative easing should have been used to support sustainable, productive investment rather than to re-inflate asset prices. If the root cause of the financial crisis was the imbalances in the global economy prompted by the search for higher profits, real reform will require higher real wages in the west, so that consumers are less dependent on debt. That means a shift in the balance of power between labour and capital; it also means a rethink of the shareholder model of capitalism.
Finally, there are those who believe that any conventional reform is doomed because any growth-based model is at odds with the viability of the planet. Where is the political centre of gravity now? Somewhere between option two and three. That represents not just a missed opportunity but a profound lack of judgment. The seeds of the next crisis are being sown. Right here, right now.
The Guardian, 2 November 2009
1 Read the article and answer these questions:
1 What do you know about the period of upheaval between 1914 and 1945?
2 What were the signs of crisis in the global economy before 2008?
3 What can be done to overcome financial crisis?
4 What does ‘American economic dream’ mean according to this article?
5 What are the advantages and disadvantages of any financial crisis?
2 Paraphrase the following sentences:
1 But it was always inevitable that, sooner or later, globalisation would run into a crisis, and what we have seen in the past two years is just the start of it.
2 A combination of political change and technological revolution has always produced upheaval.
3 America's hegemony is being threatened by the rise of China.
4 This crisis has been a long time in coming, and history suggests that the period of upheaval will be long and painful, just as it was between 1914 and 1945.
5 The warnings from Mexico, Thailand and South Korea, from the collapse of the hedge fund Long Term Capital Management and from the dotcom bubble were ignored.
6 There are those who believe that any conventional reform is doomed because any growth-based model is at odds with the viability of the planet.
United States (Economy)
The U.S. economy is immense. In 1998 it included more than 270 million consumers and 20 million businesses. U.S. consumers purchased more than $5.5 trillion of goods and services mutually, and businesses invested over a trillion dollars more for factories and equipment. Over 80 percent of the goods and services purchased by U.S. consumers each year are made in the United States; the rest are imported from other nations. In addition to spending by private households and businesses, government agencies at all levels (federal, state, and local) spend roughly an additional $1.5 trillion a year. In total, the annual value of all goods and services produced in the United States, known as the Gross Domestic Product (GDP), was $9.25 trillion in 1999.
Those levels of production, consumption, and spending make the U.S. economy by far the largest economy the world has ever known - despite the fact that some other nations have far more people, land, or other resources. Through most of the 20th century, U.S. citizens also enjoyed the highest material standards of living in the world. Some nations have higher per capita (per person) incomes than the United States. However, these comparisons are based on international exchange rates, which set the value of a country's currency based on a narrow range of goods and services traded between nations. Most economists agree that the United States has a higher per capita income based on the total value of goods and services that households consume. American prosperity has attracted worldwide attention and imitation. There are several key reasons why the U.S. economy has been so successful and other reasons why, in the 21st century, it is possible that some other industrialized nations will surpass the U.S. standard of living. To understand those historical and possible future events, it is important first to understand what an economic system is and how that system affects the way people make decisions about buying, selling, spending, saving, .investing, working, and taking time for leisure activities.
Capital, savings, and investment are taken up in the fourth section, which explains how the long-term growth of any economy depends upon the relationship between investments in capital goods (inventories and the facilities and equipment used to make products) and the level of saving in that economy. The next section explains the role money and financial markets play in the economy. Labor markets, the topic of section six, are also extremely important in the U.S. economy, because most people earn their incomes by working for wages and salaries. By the same token, for most firms, labor is the most costly input used in producing the things the firms sell.
The role of government in the U.S. economy is the subject of section seven. The government performs a number of economic roles that private markets cannot provide. It also offers some public services that elected officials believe will be in the best interests of the public. The relationship between the U.S. economy and the world economy is discussed in section eight. Section nine looks at current trends and issues that the U.S economy faces at the start of the 21st century. The final section provides an overview of the kinds of goods and services produced in the United States.
U.S. economic system
An economic system refers to the laws and institutions in a nation that determine who owns economic resources, how people buy and sell those resources, and how the production process makes use of resources in providing goods and services. The U.S. economy is made up of individual people, business and labor organizations, and social institutions. People have many different economic roles -they function as consumers, workers, savers, and investors. In the United States, people also vote on public policies and for the political leaders who set policies that have major economic effects. Some of the most important organizations in the U.S. economy are businesses that produce and distribute goods and services to consumers. Labor unions, which represent some workers in collective bargaining with employers, are another important kind of economic organization, So, too, are cooperatives -organizations formed by producers or consumers who band together to share resources - as well as a wide range of nonprofit organizations, including many charities and educational organizations, that provide services to families or groups with special problems or interests.
For the most part, the United States has a market economy in which individual producers and consumers determine the kinds of goods and services produced and the prices of those products. The most basic economic institution in market economies is the system of markets in which goods and services are bought and sold. That is where consumers buy most of the food, clothing, and shelter they use, and any number of things that they simply want to have or that they enjoy doing. Private businesses make and sell most of those goods and services. These markets work by bringing together buyers and sellers who establish market prices and output levels for thousands of different goods and services.
A guiding principle of the U.S. economy, dating back to the colonial period, has been that individuals own the goods and services they make for themselves or purchase to consume. Individuals and private businesses also control the factors of production. They own buildings and equipment, and are free to hire workers, and acquire things that businesses use to produce goods and services. Individuals also own the businesses that are established in the United States. In other economic systems, some or all of the factors of production are owned communally or by the government.
For the most part, U.S. producers decide which goods and services to make and offer to sell, and what prices to charge for those products. Goods are tangible things - things you can touch - that satisfy wants. Examples of goods are cars, clothing, food, houses, and toys. Services are activities that people do for themselves or for other people to satisfy their wants. Examples of services are cutting hair, polishing shoes, teaching school, and providing police or fire protection.
Producers decide which goods and services to make and sell, and how much to ask for those products. At the same time, consumers decide what they will purchase and how much money they are willing to pay for different goods and services. The interaction between competing producers, who attempt to make the highest possible profit, and consumers, who try to pay as little as possible to acquire what they want, ultimately determines the price of goods and services.
In a market economy, government plays a limited role in economic decision making. However, the United States does not have a pure market economy, and the government plays an important role in the national economy. It provides services and goods that the market cannot provide effectively, such as national defense, assistance programs for low-income families, and interstate highways and airports. The government also provides incentives to encourage the production and consumption of certain types of products, and discourage the production and consumption of others. It sets general guidelines for doing business and makes policy decisions that affect the economy as a whole. The government also establishes safety guidelines that regulate consumer products, working conditions, and environmental protection.
1 Read the article and answer the following questions:
1 Which country has the highest per capita income? What is it based on?
2 How can you characterize the United States market economy?
3 What is the role of individuals the U. S. economy?
4 Why is the role of producers so important in their economy?
5 What role does the government play in the national economy?
2. Give a summary of the text.
Death warmed up
Are living wills really the answer to banks that are too big to fail?
Professional negotiators recommend against making empty threats. Yet sometimes it seems that is all governments and regulators have left to throw at the banking industry. However bloodcurdling the political rhetoric, financial markets think banks will be bailed out again. That in turn means banks can borrow abnormally cheaply, giving them an incentive to maximise leverage and risk-taking again. Along with wrecked public finances and unemployment, moral hazard is the most toxic legacy of the credit crisis.
There is almost unanimous support for one set of remedies: making banks safer through bigger capital buffers and more intrusive supervision. Those wary of regulation's efficacy, however, should be pleased that the debate is now shifting to another tack-making credible the threat that next time, banks will be allowed to fail. Hence the voguish idea of "living wills", or more amusingly, financial "death panels", which would force banks and regulators to organise themselves so that it is easier to dismember systemically important firms in a crisis. That should minimise the cost to taxpayers of future bank failures. And if investors fear they could lose money tomorrow, they may penalise badly run banks today. Proposed laws will make it possible to kill any financial firm in a way "that imposes losses on firms' stakeholders", Tim Geithner, America's treasury secretary, promised Congress last month.
It sounds good. But for living wills to have this effect, they must move beyond mere contingency planning and towards a partial break-up of banks' balance-sheets. And it is far from clear that this is what the G20 leaders intended when they endorsed the idea last month.
Living wills could certainly help address the sheer bedlam that surrounds a dying bank. In America the Federal Deposit Insurance Corporation (FDIC) already has powers to wind down some banks, but its remit did not include America's largest banks, nor non-bank monsters such as American International Group (AIG), an insurance company. Lehman Brothers had 2,985 legal entities, and in the panic before its collapse it became abundantly clear that no one understood its counterparty relationships with the rest of Wall Street. Clients and creditors still have cash stranded in the failed firm as administrators in different countries pick over its bones. If living wills forced banks to simplify, allowing investors and administrators to get to grips with their inner workings quickly, failures might be less chaotic.
Yet it is a huge leap to imagine that living wills can resolve moral hazard. Improving the mechanics of an execution does not make the decision to put a big firm to death much easier. If it has other banks as its creditors and counterparties, its failure-controlled or otherwise-will damage their solvency and liquidity. The FOIC may have special powers but it only allowed one biggish dismemberment during the crisis, that of Washington Mutual. Its deposits were passed to JPMorgan Chase and its creditors thrown to the dogs. Even then the firm had just 2% of the system's assets and its failure was only permitted once it was clear that a blanket bail-out of Wall Street was likely.
Indeed, the whole idea of an "orderly failure" is a little fantastical. If a "death panel" seeks to unwind a bank it will induce, not prevent, panic among its counterparties and creditors. Sheila Bair, the boss of the FOIC, has said regulators should act as a bridge as firms are wound down. Yet the crisis showed that regulators can only offer blank cheques or no cheques at all to the biggest firms. AIG and Dexia, a Belgian bank, sucked up over $100 billion of "temporary liquidity" between them, at which point they had taxpayers by the throat.
Ringed fences and scrambled eggs
The logical solution to these problems is ringfencing. If banks were run as federations of self-contained units, it would be easier to swoop in and save some parts while allowing others to die. For a unit to be safe, though, it would have to have not just its own capital, but its own funding and minimal counterparty exposure to other bits of the group. Most banks hate the idea of having to unscramble eggs. Many use branch offices abroad, rather than full subsidiaries with their own balance-sheets. Their Byzantine legal structures owe as much to history and tax planning as safety and efficiency.
The easiest path would be to force banks to organise themselves into self-contained national subsidiaries, with local rules on capital, and restrictions on lending to other bits of the group. If drawn too tightly these rules could backfire, making it harder for businesses to trade with foreign customers and draining liquidity provided by Western banks to deposit-poor foreign subsidiaries in places like eastern Europe. There could be perverse results, too. One Swiss bank says it uses surplus international deposits to lend to Swiss customers. Ringfencing could make its domestic unit riskier. Yet a balance can be struck: HSBC is already organised with partially ringfenced country subsidiaries.
The trouble is that national subsidiaries do not really correspond to the bits of banks that most people want bailed out: the deposit-taking part. British taxpayers would be livid if they had to save the British bit of Barclays' investment bank. A living will for Barclays would ideally allow regulators to save its deposit-taking unit, while allowing Barclays Capital to fail.
Ringfencing deposits in anticipation of a bank failure would come close to a stealthy reimposition of Glass-Steagall, the 1933 American law which separated commercial and investment banking and was repealed in 1999. Yet if living wills are to be a serious tool to limit taxpayers' exposure and moral hazard, they must involve decisions about which bits of banking are worthy of a guarantee and the creation of structures to protect them. There is little point in writing a will that evades the question of who ends up with what.
From The Economist print edition, Oct 1st 2009
1 Read the article and answer the following questions:
1 What is implied by “living wills” and “scrambled egg” in this context?
2 How do you estimate such form of basking banks as bailing – out during a crisis?
3 Compare with the situation of the government’s support of our domestic banking system.
4 Do you agree with the idea of undertaken “orderly failure” of some financial firms?
5 What best way for banks to survive in a crisis does the article propose?
An uncelebrated century
Partners bank of Naples, Florida, earned a dubious distinction on Friday October 23rd. It became the 100th American bank failure of the year. On the same day six other lenders—two more in Florida and banks in Minnesota, Wisconsin, Illinois and Georgia—joined the rollcall of failure in the aftermath of the credit crisis.
More banks have failed in other years. The post-war record was set in 1989 when 534 banks went under. That was at the peak of the savings-and-loan (S&L) crisis, which erupted in the late 1980s and continued in the early 1990s. This year has seen more failures than any since 1992, but another 75 banks must go under to overhaul that year’s total.
Counting absolute numbers of failures, however, is not the best way to assess the extent of a financial crisis. The number of banks and thrifts has fallen dramatically since the S&L era, from some 16,000 lenders then to around 8,000 now. According to CreditSights, a research firm, when the current cycle is over, the rate of bank failures may be double what it was during the S&L crisis.
The total of failures also disguises the size of individual collapses. The demise of Washington Mutual, the biggest bank to fail in America so far in this crisis, means that banks accounting for more than 3% of the system’s total assets have fallen during the current cycle already, compared with 4.4% of assets over the entire S&L episode.
Yet passing the hundred mark symbolises how the financial crisis has shifted its focus from large banks to small ones. America’s big banks may face regulatory uncertainty but they take the shelter of government support. Most have diversified businesses so they can offset credit losses with buoyant earnings from investment banking. The recent slew of third-quarter results suggests that the number of non-performing loans is approaching a peak.
Small banks have no such comfort. They are too small to pose a threat to the entire system and thus too small to require saving. And they are heavily exposed to commercial property, an asset class that continues to go downhill fast. In the latest sign of distress, Capmark, one of America’s largest commercial-property lenders, filed for bankruptcy on Sunday.
These factors point to a sharp rise in bank failures. There are 416 institutions on the problem list of the Federal Deposit Insurance Corporation (FDIC). CreditSights estimates that more than 600 banks will fail if conditions stay as they are. If things get really sticky, more than 1,000 could go under (compared with over 1,800 in the S&L crisis).
That means lots of buying opportunities for other banks and private-equity investors. But it spells trouble for the FDIC, which administers failed banks and estimates that it will incur total losses of $100 billion over the course of this credit cycle. This weekend’s tally of bank busts added another $357m to the bill. The FDIC has already proposed ways to bolster its depleted deposit-insurance fund by requiring banks to prepay some $45 billion of insurance premiums into the fund. But many think its estimates of losses are too low anyway, particularly since the minnows of American banking, unlike the big fish, do not have the same buffers of equity investors and subordinated debtholders to help bear the costs of failure.
The crisis among small banks may not threaten the system in the same way as big-bank failures. But for taxpayers, there is the prospect of further outlays. A cash-strapped FDIC may yet be forced to tap a $500 billion credit line with America’s Treasury. For big banks, there is the threat that the agency will levy an emergency round of premiums.
As for borrowers, particularly small businesses that rely on local lenders, credit may be hard to come by. Barack Obama unveiled proposals on October 21st to increase the size of government-guaranteed loans to small businesses, and to make it more attractive for small lenders to ask for capital from the Troubled Assets Relief Programme. The national picture may be brightening: the next phase of the financial crisis will be local.
Economist.com., Oct 26th 2009
1 Read the article and answer the following questions:
1 How many banks have gone under since S&L crisis?
2 What’s the forecasted rate of bank failures for the current cycle?
3 What are the threats for large and small banks?
4 What measures are taken by large banks to survive?
5 What problems does FDIC face in the current situation?
6 What troubleshooting measures are taken by the State?
2 Decide whether the following statements are True or False:
1 The extent of the financial crisis is estimated by the number of bank failures.
2 Large banks are affected by the financial crisis less than small banks.
3 There are 416 troubled banks in the FDIC problem list.
4 There no parties who benefits from the situation.
5 FDIC-insured banks are forced to pay higher taxes.
6 Troubled Assets Relief Programme is the proposed bailout of US financial system.
Lucrative credit-card revenue is under threat
Issuers of credit cards are unpopular everywhere these days, and Britain's are no exception. Banks are grimly hanging on to £1.5 billion ($2.7 billion) in annual revenue that will be cut dramatically if the British consumer watchdog forces the world's two biggest credit-card associations and their bank members to reduce controversial charges. The so-called "interchange" fees account for around 15% of credit-card income in Britain, according to Mercer Oliver Wyman, a consultancy, a big whack for an industry that is struggling to keep profit margins steady.
The fees work as follows. When a customer charges a purchase, the store asks its bank to collect from the cardholder's bank. The merchant's bank pays an interchange fee to do so, and recoups it from the store. Card associations argue that the fees, which range from around 0.5% of the transaction in Australia to more than 1.5% in America, are needed to recover the cost of operating the credit-card system. Britain's Office of Fair Trading (OFT) begs to differ. On October 19th, it objected to fees imposed by Visa, just weeks after ruling that the agreement which sets MasterCard's British rates was anti-competitive. Its chief concern is that the fees are too high, inflating charges paid by merchants and thus the price of goods and services. In other countries-Mexico, for one-critics have used the same argument to force interchange fees lower. Australia introduced formal rules in October 2003 that cut average interchange rates from 0.95%. Whether prices to consumers in Australia have actually fallen since then is a moot point. Its central bank argues that fees paid by merchants to card companies dropped by A $580 million ($448 million) in the year to June 30th, and that competition will pass those savings to consumers. But card associations retort that there is no statistical proof of a fall in prices, and that retailers must be pocketing the cash instead. Many Australians now pay lower interest rates on their credit-card balances, however, even if some charges, such as annual fees, are higher and the value of reward-scheme points has diminished. Banks now compete much more on interest rates, instead of on extra card features traditionally funded by interchange fees. They have already recovered up to 40% of their lost revenue by raising costs that are more transparent to the average person than are interchange fees.
The same pattern is evident in other places where interchange rates have fallen, often as the result of regulatory threat. A study by Stuart Weiner and Julian Wright for the Federal Reserve Bank of Kansas City suggests that in many such countries annual card fees have increased. In America, where interchange rates are rising despite repeated court actions and a $3 billion settlement between card associations and retailers in 2003, the reverse has occurred: annual fees have declined and reward schemes become more generous. Morgan Stanley, an investment bank with its own credit-card business, estimates that American banks earn $24 billion from interchange fees, a figure likely to increase by $3.5 billion by 2010. But the fight over interchange fees is bound to continue. For the moment, merchants' lobby groups and consumer advocates-not always happy bedfellows-seem to have the upper hand. For what it's worth.
1 Read the article and answer the following questions:
1. What are the so-called "interchange fees" and how do they work?
2. What forces countries to cut average interchange fees?
3. If the fight over interchange fees is bound to continue, who will win?
The regulators' best friend?
Europeans embrace the logic of cost-benefit analysis just as some Americans grow suspicious of it.
According to one of the European Commission's pettifogging regulations, cucumbers sold in the single market cannot be too curvy. According to another proposal, packets of coffee and chicory must conform to weights specified in Brussels.
The first regulation is largely apocryphal, a myth propagated by Euro-skeptic newspapers in Britain and debunked by the commission's team of counter-spinners. But the second regulation is quite real. It was one of several examples of regulatory overkill lambasted by Günter Verheugen, a vice-president of the Commission, in a speech last month. Mr. Verheugen wants to withdraw such needless regulations, simplify others and subject new proposals to “solid cost-benefit analyses”.
Cost-benefit analysis—which typically quantifies the attractions and drawbacks of a regulation, converts them into dollars or euros, then tots them up—sounds both dull and innocuous. But its findings can be revealing. For example, Robert Hahn, a scholar at the American Enterprise Institute in Washington, DC, calculates that over 40% of American regulations impose costs that outweigh the benefits they confer. What might a similar review of the European Union's regulatory rule-book reveal? How many of the 90,000 pages of the acquis communautaire might be safely torn out, to the net benefit of the union?
The findings of Mr. Hahn and other cost-benefit analysts in America have not passed unchallenged, however. A number of critics doubt the worth of the techniques and distrust the motives of the practitioners. They say that America's current administration is guilty of “regulatory underkill” and that cost-benefit analysis is its weapon of choice.
Whether or not this is fair to President George Bush's administration, is it fair to cost-benefit analysis? Is the method fatally flawed and intrinsically anti-regulatory? The Centre for Progressive Regulation (CPR), a think-tank that shelters many skeptics, thinks so. It objects to two features in particular: the “translation of lives, health, and the natural environment into monetary terms” and “the discounting of harms to human health and the environment that are expected to occur in the future”.
Those who question cost-benefit analysis doubt that a price tag can ever be put on life. How could one seriously count the cost of death and injury caused by road accidents, for example? But, as Robert Frank, an economist now at Cornell University, has pointed out, even the fiercest critics do not get their brakes checked every morning. They have more pressing uses of their time. Road safety, then, does have an opportunity cost, and an economist will want to know what it is. Thus, when the CPR accuses economists of “pricing the priceless”, most economists would plead guilty as charged. They devote considerable effort, and not a little ingenuity, to discovering the implicit price of many things that are not traded directly in arm's-length markets.
As the critics allege, cost-benefit analysis works like a kind of universal solvent. It breaks qualities down into quantities, differences of kind into differences of degree, gold into base metal. A safe childhood, a breathtaking view, a clean pair of lungs—all are reduced to fungible “dollar-equivalents”. In doing so, the method forces into the open trade-offs that many would rather not face too squarely. Should taxpayers' money be devoted to keeping grandmother alive for an extra month in an intensive-care unit? Or would it be better spent reducing the risk of asthma faced by deprived children in the polluted inner city? Such comparisons may seem crass. But they are democratic.
The less sweet hereafter
Accused of pricing the priceless, economists are charged with under-pricing the future as well. Most practitioners of cost-benefit analysis assume that gains in the hereafter are worth less today than gains in the here-and-now. They discount future benefits, including lives saved, in much the same way that they discount future profits or costs.
But are lives saved 12 months' hence really worth less than lives saved this year? To say so, the critics argue, is to make a false analogy between financial resources, which can be borrowed from, or invested for, the future, and human life, which cannot. By discounting future lives, economists also further an anti-regulatory agenda, the critics allege. After all, the costs of most health and safety regulations arrive upfront. The benefits can take time to emerge.
Discounting future lives is indeed awkward, and some economists have fretted about it for decades. But it is not necessarily anti-regulatory. If regulators discounted costs, but not lives saved, they would defer action indefinitely, Mr. Hahn points out. The benefits would be the same if they waited a year (or a decade, for that matter) but the costs would always be less.
Cost-benefit analysis does not always argue for less regulation. It weeds out regulations that do not pay their way, but it can also identify measures not on the statute books, that should be. For example, defibrillators installed in workplaces might be a cost-effective way to save victims of heart attacks. The White House's Office of Management and Budget has sent about a dozen letters to the agencies it oversees prompting them to investigate such potentially beneficial regulations.
Fundamentally, it is not “anti-government” to weigh the costs of public action. On the contrary, the “regulatory excess” Mr. Verheugen sees in the EU has doubtless damaged the prestige of Brussels. Some regulatory circumspection, nudged by cost-benefit sheepdogs, might even rehabilitate it. If the EU had not mandated the weights of chicory packets, perhaps people would not so readily believe that it regulates the curvature of cucumbers.
1. Read the article and answer the following questions:
1. What is the core study of cost-benefit analysis?
2. Why do a number of critics distrust a cost-benefit method?
3. Who are the fundamental activists and critics of cost-benefit analysis?
4. What are the main advantages and disadvantages of cost-benefit analysis?
5. Should regulation and cost-benefit analysis be considered as contradictory or complementary?
2. Decide whether the following statements are True or False:
1. Günter Verheugen supported existing tight regulations of some products sold in the single market.
2. According to Robert Hahn 60% of American regulations are not economically rational.
3. The findings of cost-benefit analysts are criticized by many skeptics.
4. Skeptics of cost-benefit analysis believe that injury can be measured and priced in economic terms.
5. Many economists would accept that «pricing the priceless» is not worth practicing.
6. Discounting future profits and costs economists over-price future.
7. If regulators waited a year the benefits would be less but the costs would always be the same.
8. According to cost-benefit analysis, if regulations do not cover their costs, they should be corrected by the government.
9. The prestige of Brussels was damaged by «anti-government» cost-benefit analysis.
When is a recession not a recession?
The most conventional rule of thumb for defining a national recession is at least two consecutive quarters of negative GDP growth. Unfortunately, this simple rule does not translate well to the global context. First, quarterly real GDP data are not always available - for a number of major emerging market countries, quarterly output data do not exist before the mid-1990s, and there are still many countries that only report GDP annually rather than on a quarterly basis. Even among those that do report quarterly, national methods for seasonally adjusting output data differ to such an extent that meaningful aggregation is difficult. Second, while we cannot measure it exactly, it is likely that quarterly global growth does not turn negative nearly as often as does GDP within the typical country. Indeed, annual global growth has never been negative for any year in recent history - but this should not be interpreted as evidence that the world has not experienced a recession.
The principal reason that global growth is rarely negative is that world output is more diversified than national output. For example, the USA, Europe, and Japan do not always experience downturns at the same time. Data on annual real GDP indicate that the current slowdown has a similar level of synchronisation as earlier episodes in the mid-1970s and early 1980s, even though growth in China (in particular) has remained relatively robust during this slowdown. The lower level of synchronization in the early 1990s was an exception - largely reflecting specific regional events, including the asset price bubble in Japan and the consequences of German unification activity in continental Europe. It is also the case that trend growth for the world is higher than for most advanced economies because developing countries grow faster on average, so it takes a steeper dip to hit negative territory.
While global output may rarely decline, it is useful to have a simple benchmark for identifying slowdowns that could be labelled as global recessions. One reasonable solution to this conundrum is to adjust world output growth for growth in world population, and declare that a sufficient (although not necessary) condition for a global recession is any year in which world per capita growth (measured on a comparable basis) is negative. In the figure overleaf, the first bars show unadjusted world GDP growth during the major recent slowdowns, 1975, 1982, 1991 and 2001. In no case did world growth dip below 1 per cent, much less turn negative.
In 1975, GDP growth of 1.9 per cent was almost exactly offset by world population growth, so that per capita GDP growth was about zero. However, per capita GDP growth actually turned negative in 1982 and, to a lesser extent, in 1991. By contrast, per capita GDP growth in 2001 was over 1 per cent, well above zero. Compared with the earlier episodes, unadjusted growth was stronger at 2.5 per cent, instead of dipping below 2 per cent as in the previous episodes. Also, world population growth is lower today (1.3 per cent) than it was a decade earlier. Thus, the current slowdown has not come close to meeting the hurdle of negative per capita annual GDP growth, which would automatically qualify it as a recession. This partly reflects the relatively high weight of China, which has continued to grow strongly.
Can we declare that the world is not in recession simply because annual global per capita growth is positive? No, not necessarily. Whilst negative per capita GDP growth is a sufficient condition to identify a global recession, by itself it would probably be unduly conservative. As in the case of individual recessions, one cannot rely absolutely on any mechanical rule, but instead some element of judgment is required. That is how recessions are identified in the USA by the National Bureau of Economic Research (NBER), for example.
The NBER defines a recession as a significant decline in activity spread across the economy and lasting more than a few months, and focuses on economy-wide monthly series (especially non-farm employment and real personal income less transfers). It also looks at data from manufacturing (real manufacturing and trade sales and industrial production), although - as the NBER notes - this is a relatively small part of the US economy whose movements often differ from those of other sectors. The rule of thumb of at least two quarters of negative growth often referred to by commentators is simply a useful way of approximating this system. Indeed, in a downturn, the NBER committee chose to identify the US slowdown as a recession even though, based on current information, GDP growth was only negative in the third quarter.
1 Read the article and answer the following questions:
1 Can the rule of the thumb for defining a national recession be applied to the global economic performance?
2 What makes the process of data gathering so difficult and time-consuming?
3 Why is global growth rarely negative?
4 Why advanced economies have slower growth rates then the whole word?
5 What do the first bars in the figure show? How can this data be interpreted?
6 How does the NBER identify a recession?
2 Decide whether the following statements are True or False:
1 Most developing countries have their performance data available on quarterly basis.
2 Output data is internationally comparable due to similar national methods of aggregation.
3 If global growth is generally positive, it means that the world has never experienced a recession.
4 Specific regional events cannot affect the level of economic synchronization among countries.
5 It is impossible to set a benchmark for identifying recession declines.
6 Adjusted GDP growth makes a big difference to recession assessment.
3 Agree or disagree with the following statements:
1 The best indicator of the recession is two consecutive quarters of negative GDP growth.
2 If GDP growth in one country is negative, this fact leads to the global economic downturn.
3 Emerging economies suffer from a crisis more seriously then developed economies.
4 Global output can never decline.
5 Russia is on the way to recovering from the recent crisis.
6 When annual global per capita growth is positive, the world is not in a recession.
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