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Trade wars, populism, and geopolitics. The world is quickly becoming more fraught as complex forces threaten to disrupt and reshape the global economy in profound ways. In this context, the Lowy Institute launched the Global Economic Futures project aimed at better understanding this rapidly changing global economic landscape, where it might take us, and the key choices to be made.

The project examines the future shape of the global economy especially given rising tensions between the world’s two largest economies – the United States and China – and the possible implications for, and changing roles of, major regional economies, including Australia, India, Indonesia and others.

Latest publications

The useful myth of central bank independence

One of the sustaining myths of modern economics is that central banks are independent, able to pursue monetary policy free from the pressures of politics. This makes monetary policy more effective: it gives confidence that the economy will be kept on a steady path unaffected by the exigencies of the election cycle.

President Donald Trump is undermining the credibility of this valuable myth. How much can he interfere with the US Federal Reserve before the myth is seriously devalued?

The subtlety of this issue has been demonstrated over recent months. The Fed raised interest rates in December despite the President’s clearly articulated opposition. The Fed’s Open-Market Committee knew that its actions would offend Trump, but members had little choice. Throughout 2018 the Committee had signalled its intentions through “forward guidance”, with specific prediction of four rate hikes in the year.

Independence, like beauty, is in the eye of the beholder, or in this case the sceptical judgement of fickle financial markets.

Thus, to miss the fourth increase in December would have been tantamount to announcing a return to the Arthur Burns/Richard Nixon era, when Burns, then Fed chairman, saw his role being to carry out whatever Nixon deemed necessary to facilitate the president’s 1972 re-election. The result was the inflation of the 1970s, only brought to an end by the painful Volcker Shock in 1979 (Can the Fed resist Trump’s pressure?)

After December Trump had been quiet, at least on this topic. This gave the Committee the opportunity to use its March meeting to reset the policy environment. No change in the Fed funds rate had been expected, so leaving the policy rate unchanged was no surprise. But the forward guidance of the “dot-plot” was reset, with masterly inaction being the watchword for this year. As well, the unwinding of quantitative easing (QE) will be slowed, then paused.

The immediate risk of an independence-sapping confrontation with the President was deferred. At the same time the risk of the Fed losing credibility through overly-tight policy has lessened. Fed independence has been maintained for the moment.

Now Trump has renewed his criticism, with the Fed blamed for the economy not being even stronger than it is. He is urging that expansionary QE should resume. Two names of potential new members of the Committee are now circulating – both with very close connections to the President and neither with expert knowledge of monetary policy.

It’s unlikely that Trump expects Fed Chairman Jay Powell to cave in and quickly lower the policy rate or resume expansionary QE: to go down in history as another Arthur Burns would be too humiliating. But if this sort of active criticism becomes the norm (as his economic adviser Larry Kudlow asserts it should), then resignation might be a serious option for an embattled Chairman at some stage.

That would leave the way clear for Trump to have a second go at appointing a pliable chairman. Depending on who was chosen, this might turn the Fed into another instrument for Trump’s unique brand of economic policy.

Fed Chairman Jay Powell in March (Photo: Federalreserve/Flickr)

Independence, like beauty, is in the eye of the beholder, or in this case the sceptical judgement of fickle financial markets. There are three key elements that influence the judgement: appointment of senior central bankers; the decision-making process for monetary policy; and the political skill of the chairman.

Central banks can’t be independent in the sense of being autonomous institutions, free to do what they want and choose their own leaders. Governments always have the right to appoint top central bankers. It is only established precedent, public scrutiny, and in the US the Congressional confirmation process that can ensure that appointees will be technically competent and politically neutral, rather than pliable.

Although it is a well-established norm for US presidents to appoint people of their own political persuasion, they have almost always chosen a well-qualified economist as chairman. Jay Powell, Trump’s appointment, was an exception: he is a lawyer, but had served on the Open Market Committee since 2012. Markets would take little comfort from the two new candidates, whose main qualification is seen as closeness to Trump.

An operational rule – such as inflation targeting – provides a decision framework which can resist political pressure. The Fed has an inflation target, but its model is the most-flexible variety, with the mandate giving as much weight to unemployment as to inflation. This gives more room for subjective judgment – enough to accommodate political objectives.

This leaves an essentially political task for the chairman: to demonstrate a readiness to resist the wishes of the politicians if necessary, but without being so defiant as to lose the job. This is the task Powell now faces.

Former Fed chairman Alan Greenspan provides the role-model. His reputation was severely tarnished by the 2008 crisis, but his record is peerless as a consummate political operator, glad-handing and smooth-talking the Washington politicians and opinion-makers. Greenspan dominated the Committee, politely but firmly out-arguing or over-riding any divergent views.

It will be hard for Powell to assume Greenspan’s mantle of “the Maestro”, as this came from decades spent poring over the entrails of esoteric economic data. But let’s hope Powell can reprise some of the political technique.

Former chairman Alan Greenspan (right) speaking with another former Fed chair Paul A. Volcker in 2014 (Photo: Federalreserve/Flickr)

The sudden interest in Modern Monetary Theory

The decade since the financial crisis of 2008 has been unkind to conventional economics. The gap between the observed facts and mainstream theory opened an opportunity for alternative theories to take hold. Among them, Modern Monetary Theory (MMT) fits the American zeitgeist: “big-ticket” expenditure proposals from reinvigorated “progressive” Democrats could be funded by the magic-pudding promises of MMT.

What’s gone wrong with mainstream economics? For those who thought that the economy had a strong self-equilibrating capacity to return quickly to full employment after an adverse shock, the post-2008 recovery has been disappointingly feeble. The textbook “V” shaped recovery is missing. Even now that full employment has been reached in the United States, GDP is 10% below the pre-crisis trend projection, and the new trend is flatter than before.


The main instrument of counter-cyclical policy – interest rates – have had little apparent effect in boosting demand. Inflation, too, has behaved unexpectedly. It didn’t fall much during the sharp downturn in 2008, and now that full employment has been belatedly achieved, inflation remains persistently at the low side of the target.

The traditional relationship between government debt and longer-term bond yield has broken down. Bigger debt used to mean higher interest rates. The 1990s “bond-market vigilantes” forced austerity on George H. W. Bush and Bill Clinton. Despite consecutive surpluses which wound government debt back towards zero by the turn of the century, bond yields remained high. Then, early in the new century, Greenspan’s conundrum saw bond yields stay low even as government debt rose. The large budget deficits associated with the 2008 crisis saw bond yields fall rather than rise. Donald Trump’s deficit-enlarging company tax cuts in 2017 have not pushed bond yields up, even though government debt is now headed for 100% of GDP.

MMT is not new, but the confusions in macro-economics has given its proponents the opportunity to tell a story which fits the facts and appeals to the left-of-centre politicians who want to fund their big-ticket spending on climate, education and health.

Could America, with debt less than 100% of GDP, follow the Japanese example, where government debt is around 250% of GDP and bond yields are zero?

MMT can be slippery to tie down, but a central tenet argues that budget expenditure should be expanded while-ever there is spare capacity, provided this doesn’t trigger inflation. This is an attractive idea, as recent experience suggests that budget expansion is the most reliable way of stimulating the lack-lustre economy. And if the spare capacity would otherwise go unproduced, isn’t this an attractive “free-lunch”?

This expenditure has to be funded, but higher debt seems readily absorbed by savers and doesn’t seem to raise interest rates. If new debt can’t be sold, or old debt can’t be rolled over, MMT argues that this is not a problem for countries which issue debt in their own currency: they can issue currency to roll over debt or fund new expenditure.

As a source of “free lunch” funding, this narrative doesn’t stand up. Suppose the government pays for extra expenditure by issuing currency, obtained from the central bank. The public already has all the currency it wants to hold, so deposits the extra currency with a commercial bank. The bank, too, now has excess currency and so deposits it at the central bank, in the form of banks’ reserves. In most countries, the central bank pays a market interest rate on these reserves.

Thus, the additional budget expenditure is not a “free lunch” but is financed by forced borrowing from the banking system, on which interest has to be paid, just like any other government debt. Rather than force the banks to fund the expenditure (which might be considered a form of “fiscal repression”), it would be more sensible to issue more government debt, to be held by the public.

This knocks out the central plank of MMT: issuing cash is not a limitless source of funding. But one element remains. If there is spare capacity, why not find some way of turning this potential into actual output? The Keynesian answer is to stimulate the economy with pump-priming expenditure. But what if the problem is not a cyclical recession, but rather secular stagnation where the private sector chronically saves more than it wants to invest? Can the government go on running deficits, funded by debt, to fill the demand deficiency on a permanent basis?

Conventional economic wisdom says “no”, although some of the earlier dogmatism has gone. Olivier Blanchard has reminded us that if the bond interest rate is lower than nominal growth rate (which has prevailed for most of the post-war period), a balanced budget implies that debt/GDP will fall over time. The capacity of a growing economy to service debt is rising faster than the servicing cost. This implies that a country starting from zero debt could run a modest deficit continuously without debt/GDP rising or creating a burden for future generation.

Few countries – certainly not America – start with zero or even small debt, so the Blanchard analysis is not an open invitation for expanded deficits. But just how far (and how long) should governments go in issuing new debt, in an environment of low interest rates and an eager appetite among savers to take up extra debt? Could America, with debt less than 100% of GDP, follow the Japanese example, where government debt is around 250% of GDP and bond yields are zero?

A consensus is emerging in America that productivity-enhancing additional expenditure – such as active labour policies and infrastructure – might be undertaken, tentatively exploring the room for deficit expenditures funded by issuing long-term bonds. But Federal Reserve chair Jay Powell sums up the mainstream consensus on MMT : it’s “just wrong”.

What might a US-China trade deal look like?

Perhaps they will, perhaps they won’t, but if China and the US do reach a trade agreement in coming weeks it will likely be very long. Meeting to seal the deal, President Donald Trump and China’s leader Xi Jinping will be able to display to the cameras a document of at least a hundred pages.

A deal will confirm that economic globalisation will continue and that the very difficult and very productive relationship between the two giant economies will remain at its centre. 

For all its size, however, the substance of the agreement is likely to be straightforward. The real interest will not be the deal, which is likely to be humdrum. It will be in what it signifies, which could be immense.

China has already agreed to buy more US goods and services, perhaps $200 billion a year more or $1.2 trillion over six years. It has already removed most foreign investment barriers in manufacturing and will commit to a faster schedule of liberalisation in services. Visa and Mastercard, for example, will be permitted to compete in domestic payments, and some US financial businesses may be able to offer more services in China as wholly owned subsidiaries. China may reduce automobile tariffs below 15%.

Useful, but not history-making changes.

China will also be able to meet many US demands on intellectual property. It will commit to cracking down harder on intellectual property theft. It will probably commit to disciplining provincial authorities where they require foreign corporations to transfer intellectual property into joint venture vehicles with a local partner. But foreigners are now permitted to enter almost all China’s manufacturing sectors without a local partner, so the “forced transfer” issue is of declining significance. Formally or informally, China may restate its adherence to the 2015 agreement between the US and China not to use state-sponsored cyber attacks to steal business secrets. (Stealing state secrets remains OK).

Again, not big changes.

US officials claim the agreement will cover industry subsidies, but it will probably reference only a small subset of subsidies. World Trade Organisation rules discipline many subsidies which directly affect other countries’ trade in a serious and specific way. In the forthcoming agreement, China may commit to more prompt WTO notification of subsidies that fall into the disciplined category. In July last year, China submitted a 170-page list of these programs to the WTO.

Most subsidies are not now covered by WTO disciplines. In his new book The State Strikes Back, US economist Nicholas Lardy estimates that direct subsidies to state-owned or controlled firms in China totalled around US $80 billion in 2015. An International Monetary Fund estimate, which also takes into account concessional or forgiven loans, offers an estimate three times higher.

Most of the direct subsidies are intended to promote government policies such as higher use of natural gas or electric vehicles. They are on a larger scale in China, but many governments offer such subsidies – including in the US and Europe. China would probably insist that if there is to be negotiation it include industrial and farm subsidies in the US, Europe, and Japan as well as in China.

Enforcement issues are said to have complicated finalisation of a deal, and may well yet wreck it. The most recent US position appears to be that penalty tariffs will be reimposed if, in the US opinion, China has not fulfilled the commitments it will make. China might let that through because, after all, the Trump administration would do it anyway. But China is unlikely to agree not to reciprocate, which is the US demand.

As to the wider issues that were earlier thought to be among the US ambitions, they would have proved non-negotiable. China will not accept any agreement to limit the role of the Communist Party, the role of state planning, or its technological ambitions, any more than the US would permit discussion of comparable institutional arrangements.

The likely deal will not alter the trajectory of the relationship between the US and China in any major way. It will do the opposite. It will imply that economic separation (“decoupling”) of the US and China has not been pursued. It will confirm that economic globalisation will continue and that the very difficult and very productive relationship between the two giant economies will remain at its centre. After more than a year of increasing danger to the global trade system, that would be a very important outcome.

The deal will also remind us that the economic trajectory of the US and China depends far more on decisions the US and China make about their own economies than agreements they reach with each other. As Lardy’s timely new account of China’s choices makes clear, most of the challenges to China’s growth are posed by its internal policies. Much the same can be said of the US.

China’s economic growth, Lardy persuasively argues, has been hampered by the poor performance of many of its state-owned enterprises. Some are subsidised to continue producing too much, at too high a cost. Yet in recent years, he shows, the share of total investment by state-owned enterprises has been rising, along with their share of loans from China’s largely state-owned banking system. This is inevitably at the expenses of the far more efficient private sector which provides nine-tenths of China’s exports. 

It follows from Lardy’s argument that if the US was successful in its broader aim of reducing industrial subsidies in China, of reducing the role of state-owned enterprises and of state planning instruments, China would become a more formidable competitor to the US than it already is.

Even with the portending deal, the tensions between China and the US will certainly persist.  Economic competition between the US and China will increase as China becomes technologically more advanced. There will be less symbiosis and more competition. At the same time, each will continue integrating into a global economy in which mutual dependence and prosperity are bound together.

An orthodox economic take on climate change shocks

In a debate as politically fractious as climate change, it is useful to have credible voices joining the fray. On Tuesday night, the Reserve Bank of Australia (RBA) waded into the waters with a speech by Deputy Governor Guy Debelle. It has immediately been seen as an urgent call to action.

More frequent and severe climate shocks thus mean the cost to the economy is not only greater but also less likely to prove purely transitory.

Some might question what the role of the central bank is to weigh in on such matters. Debelle’s answer is simple and notable – because climate change has a significant bearing on the macroeconomic outcomes, such as growth and inflation, which are the RBA’s core mandate.

An especially useful contribution was to place climate change within a very orthodox macroeconomic framework. We are used to thinking of climate-related shocks as transitory – cyclical occurrences around the trend. What is changing with global warming, however, is that such shocks are becoming more frequent and more severe.

Even temporary shocks can have permanent effects. For example, if workers drop out of the labour force and never return or their skills atrophy. More frequent and severe climate shocks thus mean the cost to the economy is not only greater but also less likely to prove purely transitory. As Debelle puts it:

The supply shock is no longer temporary but close to permanent.

The problem with negative supply shocks is that they raise the spectre of “stagflationary” effects, with inflation rising even as growth slows and unemployment worsens. This directly complicates the central bank’s job, as it is responsible for keeping all three close to their equilibrium levels. Yet, it can only manage the tensions and trade-offs between these policy objectives. It cannot make them disappear. That means households and businesses risk being caught in the worst of all worlds, facing both higher prices and weaker incomes, or one extreme or the other.

Financial fragility is also an issue. Extreme weather-related events pose a major challenge for insurance markets, while companies in carbon-intensive industries are at risk of finding themselves left with large assets on their balance sheets that suddenly become nearly worthless as economies shift in low carbon directions.

One bright spot is that the RBA expects a solid pipeline of investment in renewable energy over the coming years as these are now more cost-effective energy sources.

Aside from that though, it remains a gloomy picture. Human-induced warming has already increased global temperatures by 1 degree above pre-industrial levels and, after so much global dithering, keeping this below 1.5–2.0 degrees will require truly heroic efforts to cut emissions to zero over the coming decades.

Political leadership and international cooperation are obviously the two key ingredients required. Debelle, of course, avoided discussing these topics directly. Nonetheless, there were some interesting points here, too.

On international aspects, he pointed out the ways in which China’s efforts under its latest five-year plan to green its economy is actually benefitting Australia in terms of the increased demand for relatively cleaner coal, natural gas, and battery inputs like lithium. That’s uncontroversial but it makes a useful contrast to all the bluster coming out of the Trump administration that China’s industrial policies writ large are inherently damaging to other economies and must be curtailed. This is especially important to consider given China’s central importance to the trajectory of global emissions. Within reason, we should care more about where they are going rather than how they got there.

On politics, Debelle also made an interesting comparison between climate change and trade liberalisation. Both create winners and losers. But at least with open trade, it is a positive-sum game where it is, theoretically, possible for the winners to compensate the losers and for everyone to still be better off (even if in practice this often doesn’t occur to the extent needed). By contrast, the impact of climate change is a zero-sum affair and so more difficult to manage.

With such distributional issues a key driver, and target, of populist politics around the world, one can only expect that things are likely to get even messier. Hopefully, though, this will be with an eye to more action, rather than less.

Book review: Winners take all

Book Review: Winners Take All: The Elite Charade of Changing the World, by Anand Giridharadas (Knopf Doubleday, 2018)

Anand Giridharadas, TED talking-head, columnist, and former McKinsey consultant has used his insider status as a “thought-leader” in the world of the Davos elite to lob a bomb among them. The subtitle gives the flavour: “The Elite Charade of Changing the World”.

As the elite fly into Davos to discuss climate change or meet on a luxury cruise ship in the Bahamas to mull global poverty, they are an easy target for Giridharadas. Recording their extravagances, rationalisations, inconsistencies, and self-satisfaction takes up much of the text. If you like poking fun at pretensions, you’ll enjoy this.

But Giridharadas is not interested only in the social interactions of the elite. Nor is he much interested in recording how they got their wealth. Instead, his interest is how they use it to try to make the world a better place.

Andrew Carnegie’s century-old “Gospel of Wealth” provides a starting point. The raw competition of untrammelled capitalism is the powerful dynamic that drives production. If one industrialist took a softer approach (say, by paying workers more), that producer would make less profit and would in time be displaced by a more ruthless competitor. Once earned, however, the profits should be given away: “I should consider it a disgrace to die a rich man”.

Recall Adam Smith:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.

David Hume would remind us of the benefits of free trade: these are voluntary exchanges, which must make both parties better off. In short, “win-win” has always been a central theme of economics.

By the 1980s, Margaret Thatcher noted that “there is no such thing as society”. Ronald Reagan identified the nine most terrifying words: “I’m from the government and I’m here to help”. Free markets had won the economic debate.

Technology has added a further element, broadening competition geographically and greatly increased the advantage of scale – enhanced by the “winner-takes-all” of network effects. Conglomerates and de facto monopolies are acceptable.

With all this in mind, it’s hardly surprising that the elite of this free-market system – these hugely successful, mostly self-made entrepreneurs – are comfortable with the idea that their wealth is a just reward for their entrepreneurship. Like Carnegie, their philanthropy is not driven by a guilty conscience about the manner of accumulation. They don’t feel personally responsible for the maldistribution of income and other deficiencies in current America. Their desire to do good is not an atonement for earlier sins.

Some give charitable donations. Others build public infrastructure – museums and libraries – as memorials to themselves.

By transferring a little of their expertise, the benefactors will address society’s problems without cost to themselves and bask in the praise of like-minded benefactors. What a win-win!

Giridharadas’ special interest is benefactors who want to promote enterprise among the poor, rather than just give them handouts. This is the favourite focus of Silicon Valley’s tech billionaires and their counterparts in finance.

These entrepreneurs often see the business formula that worked for them as a universal panacea for poverty and society’s other ills.

All the poor need is technical advice and some capital. By transferring a little of their expertise, the benefactors will address society’s problems without cost to themselves and bask in the praise of like-minded benefactors. What a win-win!

What’s so bad about this? For Giridharadas, the problem is that these benefactors have narrowed the array of options and want to dictate the outcomes. They don’t want to do anything which would threaten their own favoured position. Like Lampadusa’s embattled nobleman in The Leopard, they want change only “so that everything can remain the same”.

Like Carnegie, modern entrepreneurs can’t contemplate softening their own management to provide, say, better wages and security for “gig workers”: this would undermine the dynamism of competition. Their monopoly positions are justified as technically inherent. They talk of poverty reduction, but not the reduction of inequality. Higher taxes (or even reduction of the many distortions which favour the elite) are not part of the agenda. All the proposals are win-win: none of the elites lose personally.

The elite focus on the narrow agenda at the micro-level (usually a new business enterprise or foundation), when what is needed is systemic change. Systemic change requires politics, not another meeting in Aspen. And it is rarely win-win.

Having broached the topic of politics, Giridharadas doesn’t say much about the way politics has been subverted by the wealthy. The elites are not politics-free, relying solely on the free market for their success. They use their considerable political power to advance their interests. Should we be surprised by this? Only to the extent that the political system allows them to have a much louder voice than others.

That raises the awkward question of how Americans, each armed with a vote, have failed to use this to bring about the required systemic changes: progressive taxes to reduce inequality, tight limits on political donations and lobbying, equal education opportunities, minimum-wages, and an effective social safety net, including for health. When Donald Trump is the outcome of the political process, the deficiencies identified by Giridharadas seem beyond political solutions.

Undoubtedly, America has many challenges. But has the market-based system really turned out so badly? Hasn’t post-war globalisation lifted a billion people out of poverty, even as it made lots of billionaires and created some losers? Are successful entrepreneurs solely responsible for the overall failings of the political system?

More specifically, would the world be a better place if Bill Gates and George Soros were spending their fortunes building civic memorials instead of fostering enterprise, social initiatives, and political reform? Have their efforts really diverted more deep-seated systemic reforms?

Even with all their own delusions and conceits, these business-oriented benefactors may still be net-positive for welfare.

Photo: World Economic Forum/ Flickr

A Tobin tax: an idea whose time has come for Indonesia

It is almost half-a-century since economist James Tobin proposed a small transaction tax to stabilise volatile global capital flows.

Tobin’s proposal followed the breakdown of the Bretton-Woods fixed exchange rate system in 1971. A tiny once-off transaction tax wouldn’t have much effect on medium and longer-term flows but would impinge more heavily on short-term flows. Tobin described it as “throwing sand in the wheels” of the speculative flows that had caused regular crises during the pre-Second World War gold-standard period.

Among the policy-wonks in Jakarta, the focus is on how to make the portfolio flows more ‘sticky’ so that funds stay put when global sentiment turns.

The idea fell on barren ground. It was overwhelmed by the ascendency of the “efficient markets” doctrine – financial markets were efficient in price discovery. Any transaction tax, no matter how tiny, would be distortionary and thus, by definition, a Bad Thing. For more self-interested reasons, professional currency traders opposed such a tax wholeheartedly. This doctrine was incorporated into the Washington Consensus, with the International Monetary Fund becoming the defender of free capital flows.

Many countries (such as Australia) adapted over time to the post-Bretton-Woods world. Crises were common enough – such as sterling in 1992 – but were not attributable to volatile capital flows as such. For emerging markets, however, flighty capital flows were a key vulnerability. Excessive inflows followed by sharp reversals were the central element in the 1997 Asian financial crisis.

Some academics retained doubts about “efficient markets” (including some who vigorously promoted deregulated financial markets while in policy roles), and the 2008 global financial crisis encouraged a re-think.

Over the past decade the IMF has belatedly come to accept that “capital flow management” (what formerly was dismissively termed “capital controls”) was a legitimate policy response for those emerging economies, which have from time-to-time been whip-sawed by volatile short-term capital flows.

Indonesia illustrates the issues. The response to the disaster of the 1997 crisis was to restrain growth and accumulate foreign exchange reserves. Even this was not enough to insulate Indonesia from the 2013 “Taper Tantrum”. 2018 saw another episode of capital flow reversal. A year ago, foreigners owned 42% of government bonds on issue. When the market mood shifted six months ago, what had been regarded as a sign of confidence in Indonesia morphed to become a vulnerability, with foreign bond-holding falling below 37%.

Around half of Indonesia’s capital inflow is in the form of portfolio investment – the restless money constantly scouring the globe for the highest yield, ready to react to the latest shift in risk-on/risk-off mood.

Indonesian policy-makers have learned how to handle these swings in foreign sentiment. They raise interest rates, tighten fiscal policy, and stand ready to intervene to defend the currency from extreme movements.

They did this last year and the drama was soon over. But this policy has a cost. Investment is discouraged, growth is trimmed, important budget expenditures are delayed, and financial markets are disrupted.

There ought to be a better way. If this short-term capital is so volatile, is it worth having? You can’t fund longer-term investment with money that is withdrawn on a market whim. Indonesia gains little benefit from these fickle funds, as it has to maintain substantial foreign exchange reserves to cope with the incipient outflow. The priority should be for stable flows rather than maximum inflow.

What might be done? First-best is an increased role for foreign direct investment – not only more stable but more beneficial. By international comparison, Indonesia’s FDI inflow is small: less than 2% of GDP. In dollar terms, FDI to Indonesia is not much larger than to Vietnam – a much smaller economy. In recent years Indonesia has encouraged FDI, shifting from 129th in the World Bank’s ranking on “ease of doing business” to 73rd. But a post-colonial nationalistic sentiment is never far below the surface when the going gets tough on the hustings, so vigorously promoting foreign ownership is not going to win April’s election.

Among the policy-wonks in Jakarta, the focus is on how to make the portfolio flows more “sticky” so that funds stay put when global sentiment turns. Hence the interest in some version of a Tobin tax.

Now that the Washington Consensus is (properly) seen as a general policy framework rather than a dogmatic doctrine, such ideas can be discussed without derision from Washington, although financial markets are still very ready to pour cold water on any idea which constrains their flexibility and profits.

The lead-up to a presidential election is no time for esoteric economic debates. Neither of the presidential candidates shows much interest in macroeconomics. As well, the precondition for such a tax is to find alternative inflows or reduce the current account deficit that has to be funded.

For the immediate future, Indonesia will have to accept the unpalatable deal which global financial markets offer: “we will lend you money in good times, but we’ll take it back whenever we have a fit of nerves”. But some variant on a Tobin tax seems an idea whose time is coming for Indonesia.

Is Australia wise to pick sides in US-China trade war?

The US-China trade war is viewed by many as a dark cloud over the global economy. So why is Australia’s ambassador to the US, Joe Hockey, seemingly urging Trump to go harder, and not settle for a “pyrrhic victory” that fails to resolve long-term differences between the US and China?

In October, the International Monetary Fund warned that the trade war risked making the world a “poorer and more dangerous place”. IMF Managing Director Christine Lagarde said that an all-out trade war would have “devastating effects”. This view was reflected in share markets, with analysts expressing fears that it raised the risk of a financial market “flash crash”.

With such dire warnings, there was an almost palpable sense of relief in November when over dinner at the G20 meeting in Buenos Aires Donald Trump and Xi Jinping agreed to a pause in the trade war. In particular, Trump held off imposing additional tariffs on $200 billion of Chinese imports to the US, pending further negotiations. The cease-fire lasts until 2 March and the markets fluctuate with reports regarding progress with the talks.

Is it prudent for Australia to be advocating that an unpredictable leader such as Trump, without a consistent view as to what he is seeking to achieve and what is achievable, should go harder in the US trade war with China?

Against that background, a story this week in the Australian Financial Review seemed to come from left field, with its headline of Hockey warning against Trump accepting a “pyrrhic” win with China. The Interpreter has asked the Department of Foreign Affairs and Trade about Hockey’s comments as reported, and will update with any response. What has been reported appears to be at odds with the calls made by Treasurer Josh Frydenberg at the IMF annual meeting last year on the need for cool heads as the world stares down the barrel of a global trade dispute. Specifically, Frydenberg called for an end of the US-China trade war.

Hockey’s views also seem to clash with the campaign being launched by a coalition of 200 US trade associations spanning agriculture, manufacturing, retail, technology, and oil, aimed at ending the trade war and even claiming it may be endangering babies.

Hockey’s comments were reported to have been made at a closed-door round table discussion in Washington DC. It reflected his apparent concern that Trump may do a deal with China that focuses solely on measures to reduce the US trade deficit with China, without tackling such structural issues as China’s intellectual property “theft” and corporate governance and subsidies to China’s state-owned enterprises.

If Hockey is concerned that the end of the trade war is based on Trump doing a “deal” whereby China agrees to buy more US products will not achieve much, then he is right. This, notwithstanding that Trump would no doubt claim it was the greatest trade deal “ever”.

Even if Trump was successful in reducing the bilateral trade deficit with China, unless the US improves its saving-investment balance, then there would be an increase in the US deficit with another country (ies) to an equal amount.

But the US dispute with China is generally considered to involve much more than reducing the size of the US-China trade deficit. The US allegations levelled against China include forced technological transfer, discriminatory investment acquisitions, state enterprises having all manner of unfair advantages over foreign competition, along with espionage and cyber-attacks. Former advisor Steve Bannon says Trump is engaged in a sophisticated form of economic warfare aimed at “uniting the west against the rise of a totalitarian China”. On this view, Trump is seeking to stop China’s economic and political rise.

Does Hockey want Trump to go harder on stopping the rise of China? As Stephen Grenville has observed (US versus China: the economic model), it would be over-reach for Trump to see China’s detailed planning for technological progress as somehow an illegitimate product of an authoritarian system. And John Edwards has noted (US-China trade: joke’s over) that China is not going to relinquish its ambition of becoming a global leader in advanced technological industries, which is central to its economic progress.

Hence the stakes are high depending on the US objective in its trade war with China. True to form, however, the Trump administration seems confused as to what are its objectives. Former State Department official Kurt Campbell has identified three schools of thought in the Trump administration: the “traditionalists”, who would be content if China merely bought more goods from the US; the “structuralists”, who are demanding that China change the structure of its economic system; and the “decouplers”, who believe that the US and Chinese economic systems are irreconcilable and are encouraging US firms to pull out of China.

Who knows which school Trump favours, but going by his actions to date, he will not have a coherent position nor a strategy and will flip flop between all three approaches.

Notwithstanding Trump’s views on his capacity as a deal maker, is it prudent for Australia to be advocating that an unpredictable leader such as Trump, without a consistent view as to what he is seeking to achieve and what is achievable, should go harder in the US trade war with China?

Australia, along with all other countries, would benefit if China showed greater respect toward intellectual property rights and curbed the preferences awarded to state-owned enterprises. It is doubtful, however, whether the best path towards achieving these outcomes is through entering into a fully-fledged trade war with China.

More generally, the world would be a more stable place if all countries adopted the policy that regardless of the objectives, the answer is unlikely to be found in increasing tariffs.

Bottom line, Australia should not be a cheerleader for Trump in his trade war with China.

Why the gloom? Global economic prospects

“Winter is coming” warned Indonesian President Joko Widodo in his address at the October meeting of the International Monetary Fund and World Bank Group in Bali. He wasn’t talking of Game of Thrones feuds but instead was warning about the global economic outlook. Many commentators seem to share this view. Why the gloom?

There are three main concerns: tightening of United States monetary policy, Donald Trump’s trade war, and China’s slowing.

Financial markets have been volatile ever since the “normalisation” phase of US monetary policy began with the “taper tantrum” in 2013 (see: The sky is not falling on Asia’s central banks). The prospect of each well-telegraphed increase since December 2015 has caused hand-wringing among commentators. The December rate increase – again just as the Federal Reserve foretold – had the extra excitement of Trump pressure. Would the Fed defy the president’s call not to increase rates? Of course, they would, if they wanted to retain their reputation for independence. So they did.

It’s time to squeeze a few more concessions out of China, declare victory, and move on. Globalisation is robust and will quickly adapt to any residual distortions.

Untidy as it is, none of this is cause for gloom. American GDP is at full capacity, as indicated by low unemployment, rising inflation, and wage growth. The economy has been growing faster than capacity, so has to slow if it is to avoid running into capacity problems.

Can the Fed engineer a soft landing? Does an inverted yield curve (where the long-term interest rate is lower than the short-term rate) make recession inevitable? Does the length of this cyclical expansion make a downturn inevitable? Former Fed Chair Janet Yellen noted that “expansions don’t die of old age”, with her successor commenting that they are “murdered” by policy mistakes. Australia’s 27-year expansion suggests that, with competent policy, expansions can last.

There is a good chance the Fed will do whatever is needed to maintain steady growth, albeit a bit slower than in 2018.

Trump’s trade measures have been endlessly debated, but not all that much has happened so far: minor skirmishes rather than a full-out trade war. The IMF estimates that the initial announced actions might take around half a percent off growth in the US and China, but even these measures have not been fully implemented: the threatened hike in tariffs on $200 billion of imports from 10% to 25% has not yet occurred.

Trump promotes himself as the master of deals. If these measures are just part of a negotiation strategy aimed at bringing China to heel on intellectual property and the bilateral balance, the time may be coming when the tariffs have served their purpose.

Persisting is painful. Soybean farmers have lost their market as the Chinese applied a politically-targeted response. Tesla and other auto manufacturers are expanding production in China. American steel is benefiting, but each of the 8,500 steel jobs created costs $650,000. By pushing up the price of domestic steel by nearly 50%, all steel-using industries are disadvantaged. The much-vaunted renegotiation of NAFTA brought trivial advantage. America’s withdrawal from the Trans-Pacific Partnership is universally judged as self-inflicted damage. As for Trump’s muddled concern with bilateral balances, these are determined by domestic saving/investment balances, which Trump’s measures do not address.

It’s time to squeeze a few more concessions out of China, declare victory, and move on. Globalisation is robust and will quickly adapt to any residual distortions.

Lastly, there are concerns about China’s growth, which has provided one-third of global growth in recent decades. Debt is uncomfortably high. For decades, the dynamism of the private sector has offset the deadweight of inefficient state-owned enterprises, but this beneficial transition seems to be reversing under President Xi Jinping. There are other imbalances which need correction: investment is still unsustainably high. 

Without a doubt, these are valid concerns. But so far the doom-merchants have been wrong, or at least premature (see: China’s economic gloom merchants and China’s looming financial crisis). China has demonstrated both resilience and capacity to correct imbalances (such as the excessive current account surplus in the mid-2000s).

There are two reasons for remaining positive. Crises are typically unforeseen – recall the unanticipated shock of the 2008 global financial crisis. In China, however, almost all these problems are not only recognised, but the solutions are underway, even if the process is slow. Here, China’s second advantage is its authoritarian capacity to implement.

The inflection point in China’s growth path was a decade ago, in 2008, when spectacular double-digit growth of the previous quarter-century became unsustainable. Expansion was temporarily sustained in 2010-2011 by massive stimulus but then settled back to the sort of pace seen in many emerging economies (including, for example, the previously chronic under-achiever India). Until China’s production techniques approach the technological frontier, the potential for catch-up growth remains. If China can manage these challenges as well as it has done in recent decades, then growth at around the current pace seems quite sustainable for a decade or more.

Economic forecasting is a mug’s game, with many opportunities to be wrong. Any of these three concerns could prove to be well-founded and unanticipated problems may arise. Gloomy stories seem to make more interesting news. The IMF’s new forecasts are universally reported as unhappy news but the Fund forecasts global growth to fall only slightly in this year and to rise a little in 2020. Reality, when it arrives, may turn out to be boringly routine ­– more-of-the-same, or at least a mild winter.

Could Ivanka Trump become the next World Bank President?

Will Ivanka Trump become the next World Bank President? There is speculation that the President’s daughter is among the names thrown into the mix to replace the current president, Jim Yong Kim, who recently announced his departure.

The idea of Ivanka Trump taking over as head of the World Bank was met with some scorn, with comments such as “this is among the most ridiculous proposals I have heard”.

But who takes over as President of the World Bank is not within the sole prerogative of Donald Trump. The position is not, as some commentators have suggested, the gift of the White House. Trump can nominate Ivanka Trump, Jared Kushner, or even his favourite rap star Kayne West. Whether they become World Bank President will depend on whether Trump’s nominee is supported by World Bank Executive Directors with at least 50% of the Bank’s voting power.

Departing World Bank chief Jim Yong Kim with Ivanka Trump (Photo: World Bank/Flickr)

Over the 75 year history of the World Bank, its President has always been an American. But the nationality of the President is not prescribed in the Bank’s articles. It has been an informal “gentlemen’s agreement” since the creation of the Bretton Woods institutions in 1945 that the head of the World Bank would be an American and the leader of the International Monetary Fund (IMF) a European.

However, with the changing structure of the global economy, and the increasing importance of emerging markets and developing countries, there has been growing pressure for the governance structures of these institutions to similarly change, both in terms of voting power and also the convention on the nationality of their leaders.

Trump’s nominee will need to be supported by World Bank Executive Directors with at least 50% of the Bank’s voting power.

The need to reform the governance of the World Bank and IMF has been a major topic on the G20 agenda. In 2009, the communique from the London G20 Summit said: “we agree that the heads and senior leaders of the international financial institutions should be appointed through an open, transparent and merit-based selection process”. While this wording was in response to pressure from other countries, the US (and many Europeans) opposed the inclusion of the phrase at the end of the sentence “regardless of nationality”.

To date, neither the US nor Europe has been prepared to abandon the convention on the nationality of the heads of the World Bank and IMF. And they need each other to maintain the convention. The US has just under 16% of the voting power in the World Bank. Taken together, however, the US World Bank Executive Director and those from the European Union have a combined voting power of nearly 50% – enough to appoint the President. The reality is that the US nominee for the position of World Bank President will require the support of EU countries, but this has been forthcoming for in return the US has always supported the European candidate to head the IMF.

It is only in recent years, however, that there has been some semblance of a contest for these positions. When Dominique Strauss-Kahn was forced to step down as IMF Managing Director in 2011, the two candidates were Christine Lagarde, the French Finance Minister, and Agustin Carsten, the Mexican Central Bank Governor and former finance minister. Lagarde had the backing of Europe, a number of other countries and the US. Australia, Canada, and Mexico were the only major countries to support Carsten – mainly on the basis that it was damaging for the institution if there was no support for a highly credentialed candidate from an emerging market.

When the position at the World Bank became vacant in 2012, the US nominee, Kim, was opposed by two former finance ministers (Ngozi Okonjo-Iweala from Nigeria and José Antonio Ocampo from Colombia). Many considered Kim’s credentials (a health professional and president of Dartmouth) to be weaker for the position than the other two candidates. Nevertheless, Kim was well regarded and the Obama Administration engaged in an aggressive campaign of arm twisting, in the end receiving support from South Korea, most of Europe, Canada, Australia, Russia, and reportedly, China, India, and Mexico.

The big step forward was that the process was open and not the outcome of deals in the back rooms of Washington and Europe – as had been the case in the past.

The key point, nevertheless, is that a US nominee will only be successful if supported by other countries and the US has had to work hard to ensure its candidate is successful. Consequently, while there is considerable hand-wringing about the potential damage to the World Bank if Trump nominates a candidate that supports Trump’s “America First” approach, his views on climate change, and apparent opposition to multilateralism, such a candidate would only take the mantle if supported by other countries, particularly from Europe.

Where to from here?

Instead of focusing on the machinations of Trump when it comes to US candidates, the rest of the World Bank membership should follow to the letter the agreed selection process for the position of President. Namely, this is to nominate highly qualified candidates who meet the agreed criteria ( a track record of leadership in a large organisation, international exposure, familiarity with the public sector, ability to articulate a vision for the World Bank, a commitment to multilateral cooperation, and effective and diplomatic communication skills).

They can then select the “best” candidate regardless of nationality in an “open, merit-based and transparent process”.


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