The Top 10 Global Economic Risks

March 5, 2012

By Michael Hendrix, Research Manager

What do you get when you ask 469 experts from industry, government, academia, and civil society to think up their worst dystopian nightmares?  You get the World Economic Forum’s list of the top fifty global risks.  These seeds of disaster lie in wait just under the surface, nurtured by a lack of safeguards in our increasingly interconnected world.  Excited yet?  You should be, because these are the risks that may temper tomorrow’s rewards.

These fifty risks can be narrowed down to five categories:

  • Economic
  • Environmental
  • Geopolitical
  • Societal
  • Technological

For this blog, it’s the economic risks that merit the most attention.  Keep in mind as you read them not just the probability of these events occuring, but the mechanisms by which they may occur.

Here then are the top 10 global economic risks:

  1. Chronic fiscal imbalances (likely & large impact)
  2. Chronic labor market imbalances
  3. Extreme volatility in energy and agricultural prices (large impact)
  4. Hard landing of an emerging economy
  5. Major systemic financial failure (large impact)
  6. Prolonged infrastructure neglect
  7. Recurring liquidity crises
  8. Severe income disparity (likely)
  9. Unforeseen negative consequences of regulations
  10. Unmanageable inflation or deflation

Four of these economic risks (underlined above) are so-called “critical connectors,” meaning that they have a tremendous, systemic influence on all of the other fifty risks.  All of these connectors in turn orbit around one center of gravity: chronic fiscal imbalances.  Not only that, but every gepolitical and societal risk related to the collapse of governments or of trade is affected by this one fiscal risk.

Simply conjuring up risks isn’t quite enough.  We must know how they could end up shaping our future.  What you want to look for are the “pathways” through which risks manifest into reality.  Labor market imbalances, a society of broken opportunities, and chronically disrupted human and financial capital all fit that bill.  At the end of these pathways stands a decaying and uncertain global economic system.

The accumulation of massive public debts represents then the key global stress point.  All of these other risks become increasingly unmanageable the more that the piling up of debt outruns the ability to pay for it.

After looking at every possible risk nightmare square in the eye, the authors ask the all-important question:  How can fostering entrepreneurship prevent the seeds of dystopia from taking root?   This is where real leadership is needed.  Tackling chronic deficits without the means of economic growth simply means swapping one risk for another.  Our complex world will either blow out that one risk into a host of disasters or provide a resilient and global infrastructure for broad-based growth.  Entrepreneurship has the ability to thrive in risky and complex times.  It’s the pathway through which risks are mitigated into rewards, serving ultimately as a needed source of innovation and growth.

Chronic fiscal imbalances or global entrepreneurship — these are the forces that will define our future.


Leaving the App Economy Alone

February 24, 2012

By Sean Hackbarth, Blogger, U.S. Chamber of Commerce

If you have a smartphone, how many apps do you have on it? Being a tech junky I have over 70 on my iPhone–including 7 different Twitter apps! Each of those apps required people to design, code, and market them. (What, you thought Angry Birds magically appeared?) Those jobs didn’t exist a few years ago, and their numbers are substantial. Michael Mandel, chief economic strategist of the Progressive Policy Institute, concluded in a study that the App Economy has created almost 500,000 jobs since 2007.

One lesson he took from his research was not to burden this growing niche economy with regulations:

The key elements in the App Economy “team”–Apple’s development of the iPhone, Google’s development of Android, the buildout of wireless networks by AT&T, Verizon and other providers–were not the object of heavy government regulation. Government did have a role in unlocking and distributing spectrum and otherwise clearing the underbrush. But no government agency was in charge of supervising the burgeoning App Economy.

Is more regulation needed? Given that App Economy companies are creating jobs and investing in the United States economy during a period of economic weakness, there’s an argument for not messing with success. Government agencies should restrict themselves to ‘light-touch’ regulation of the App Economy unless there’s real problems in the market.

If only regulators treated the rest of the economy like this.

Originally posted on FreeEnterprise.com


The Chamber’s Briefing on the State of the Economy

February 10, 2012

In case you missed it…

The National Chamber Foundation, along with GFI Group, hosted the U.S. Chamber of Commerce’s Quarterly Economic Roundtable for Q4 on February 2, 2012. The Chamber’s Chief Economist and Senior Vice President Dr. Martin Regalia delivered the keynote address, offering an overview of America’s economic recovery. He noted that while there have been improvements and overall U.S. sectors are surviving, none are performing in a strong way.

Investments are mediocre, and income figures have not increased dramatically, meaning the consumers whose spending accounts for two-thirds of the U.S. economy continue to have low levels of expendable income. While current government leaders have championed the most recent employment statistics, it appears the drop in unemployment is more attributable to disillusioned job seekers giving up looking for work and leaving the labor force (thus skewing the unemployment ratio).

The Federal Reserve is using aggressive monetary policies to keep inflation rates low and are likely to continue doing so for some time, but not indefinitely, Regalia warned. While consumers are no longer assuming large amounts of debt, they have not made significant progress paying what they owe.  As such, indebted consumers are “spending on borrowed time, if not borrowed money.” Simply refinancing debt is a good deal different than repaying it, and interests rates will not remain low forever.

“The growth we’re expecting will not be sufficient to resolve our unemployment,” Regalia said. “We will be stuck in this morass for a while, and we’re just going to have to weather the storm.”

Panelists addressed other pressing economic issues. David Crowe, Chief Economist of the National Association of Home Builders, said while many economists thought 2011 would show a housing recovery – Crowe admittedly included – last year was in fact one of the worst years for housing.

America’s gross domestic product (GDP) growth rate approached 3 percent at the end of 2012. In other circumstances, this could lead to decreasing unemployment, but the wildcard, said panelist Douglas Holtz-Eakin, President of the American Action Forum, is that people are actually dropping out of the labor force. The Baby Boomer generation is retiring by thousands of people a day, and the recession disproportionally hurt young workers.

In a globalized world, international markets and economies are intimately linked, said GFI Group Chairman and CEO Michael Gooch. The economic challenges named at the event, including the Eurozone crisis, show the United States is not fully insulated from economic disruptions around the world, though it is better positioned than many countries.

Panelists also offered insight on how U.S. policy can better support growth and economic recovery. Holtz-Eakin noted that on both sides of the aisle, discretionary policy actions are hurting inflation and unemployment. Temporary targeted measures and one-off tax measures, he said, are the epitome of the discretionary approach in policy making.


On the Myth of American Decline

February 7, 2012

By Michael Hendrix, Research Manager

Is it half-time in America?  Is our country facing an inevitable decline?  Not if Clint Eastwood has anything to say about it.  Somewhere between the Star-Spangled Banner and New York’s triumph in this year’s Super Bowl, Eastwood’s gravelly voice emerged to pitch cars “imported from Detroit.”  This wasn’t any normal ad though.  Clint Eastwood was making a statement about America’s place in the world.  He said unequivocally that it’s indeed “half-time in America.”  That “people are out of work and they’re hurting too,” but “all that matters now is what’s ahead and how do we come from behind.”

Eastwood honestly couldn’t have picked a better time to make these statements.  For the past month, pundits have begun to react to those who argue that America is in decline, that our competitors are nipping at our heels, and that the world’s economic doldrums are symptomatic of a deeper systemic decline in the West.  One author in particular, Robert Kagan, took it upon himself to refute these arguments.  He may be no Eastwood, but Kagan’s voice is coming through loud and clear for all those who say, as Eastwood did, that America’s best days are ahead of it.

Is America in its twilight years?  Robert Kagan doesn’t think so.

In the eyes of Robert Kagan, the challenges that America faces today are great, but they only seem overwhelming if we forget much of American history.  It seems that every forty years brings a fresh set of concerns that appear to portend the twilight of America’s dominance.  These are not just modern concerns.  Kagan even quotes the 18th century American patriot Patrick Henry who “lamented the nation’s fall from past glory.”  Nevertheless, considering whether America is in decline is vitally important for the future of the global economy and its political order.

Those who take shots at America’s preeminence have no shortage of fodder.  The global financial crisis of 2008 not only helped precipitate economic devastation but seemed to throw into doubt the free enterprise system itself.  Our political order hasn’t fared much better amid constant evidence of political gridlock.  What’s more, all of America’s greatest efforts still can’t seem to stitch together a fractured Middle East.  Then there’s “the rise of the rest.”  Nearly simultaneous with America’s stagflation in the 1970s, a group of “Asian tigers” — South Korea, Taiwan, Hong Kong, and Taiwan — charged ahead into the elite grouping of high-income countries where their neighbor, Japan, already resided.  They were soon followed in the 1990s by the terrific economic growth of the BRIC countries: Brazil, Russia, India, and China.  Even our allies in Europe joined together to form a common economic union that could stand beside the United States in demographic and economic might.  What was once a golden age of American dominance in the 1950s seems to have become mired in a sticky swamp of faded empire.

The only problem is that the picture of American decline is incomplete at best.  Our economy may be battered, but it still stands tall with a steady 26% share of global GDP.  While I can’t defend our political system against all of its critiques, it must be said that gridlock and indecision have long been the hallmark (even the purpose) of American politics.  There’s nothing new on the Hill in that respect.  Farther afield, America’s apparent lack of influence in the Middle East today seems like a quaint notion when compared to the 1970s, when Arab nationalism blossomed into embargoes and revolution.  America’s brand image has always appeared tarnished to its detractors, even as very American brands like Pepsi thrived and thought leaders opined on our “soft power” abroad.  The truth is that there has been no golden age of unrivaled American dominance; ”the record is mixed, but it’s always been mixed.”

What is America’s place in the world?

Kagan then looks specifically at America’s geostrategic position in light of China.  America can no longer boast of its spot ahead of a pack of lesser powers.  The rise of China is great and it’s real.  China is far richer and more dynamic than the Soviet Union ever was during the height of the Cold War.  Even more so, the “Beijing Consensus” seems to resonate in a world where smaller powers yearn for the same state-driven growth and (relative) stability that China boasts.  The notion that the gravity of China’s ideas and industry would lead countries to fall into its orbit didn’t seem far-fetched back in 2004 when Joshua Ramo first articulated the finer points of the Beijing Consensus.  Except that we haven’t really seen that occur.  As Michael Beckley points out, “China’s growth rates are high because its starting point was low. China is rising, but it is not catching up.”  Furthermore, there isn’t what one could call a Chinese sphere of influence outside of the Shanghai Cooperation Organization and assorted trade links on the Malay Peninsula and in Africa.  America’s greatest rising competitor reaches about as far as its checkbook can go.  China’s geostrategic position is quite difficult too, especially in light of the American influence that surrounds the country on nearly every side, from our giant base in Okinawa to our friendship with burgeoning India.

Even if America boasts an enviable spot in the world, what of our country’s capacity and capability to operate in a world full of emerging powers?  Some speak of imperial overstretch — even hubris — in a time of yawning budget deficits.  Kagan’s reply is deceptively simple: Abandoning our global presence will cost us far more than we will ever save by abandoning our commitments abroad.  What is more, America’s military forces represent an ever smaller fraction of our total population, while our military’s budget is still far below its point throughout much of the Cold War.

Decline isn’t inevitable

To Kagan, the real concern is the infectious notion that America’s decline is somehow inevitable.  Rather, there’s much in our nation’s history to show that even in our darkest hours we are a resilient and resourceful people.  Many emerging countries will continue their rise, sometimes to greatness.  By their incorporation into a global network of trade and institutions, together with America’s continued support of the world order that it helped create, a growing world can be seen as the ultimate win-win.  America will emerge absolutely stronger as others grow in a relative sense.

Three specific trends portend America’s continued dominance.  First, America’s total debt is declining as a share of GDP.  Ken Rogoff’s This Time Is Different showed how financial crises usually saddle countries with debt deleveraging over the span of years, even decades, beyond the original crisis point.  Yet, as the McKinsey Global Institute reports, “Historical precedent suggests that US households could be as much as halfway through the deleveraging process.”  Second, our manufacturing sector is actually doing better than ever, prompting another consulting firm to declare an “American manufacturing renaissance.”  Third, the growth in shale gas and oil is combining to give America greater energy security than we’ve enjoyed for decades.

America may be down, but we’re not out.  As Clint Eastwood concluded, “Yeah, it’s half-time in America.  And our second half is about to begin.”


The Real Super Bowl Winners

February 6, 2012

By Rich Cooper, Vice President, Research & Emerging Issues

While it may not have been the most memorable of Super Bowls, the New York Giants victory over the New England Patriots in Super Bowl XLVI showed the power of commerce on multiple levels.  Beyond the chips, salsa and beer that were bought and consumed, the plethora of television ads, the ticket and sports merchandising sales, and entertaining millions of Americans, the game also generated millions of dollars for the host city, Indianapolis.

Sunday’s big game was a thrilling culmination to the week-long celebration in Indianapolis that drew more than 150,000 visitors to a city far better known for holding one of world’s foremost Formula One racing contests.  Beyond its entertainment value, the Super Bowl was a boon for Indianapolis’ local economy, with football fans spending millions of dollars on food, shopping and lodging. Hotels were at maximum capacity and because of the volume, many visitors stayed elsewhere in the state, extending the game’s economic gain beyond Indianapolis.

To prepare for the game and modernize the city, Indiana spent millions of dollars building new hotels and a stadium, updating streets and infrastructure, and fostering new business. The downtown $12 million, three-block Super Bowl Village – reminiscent of the accommodation centers built for the Olympic Games – offers new shops and restaurants. More than this, downtown restaurants and bars overall have doubled over ten years. These and other improvements all supported game day, but they also prepared Indianapolis for long-term prosperity and growth.

“There are so many people who are here who cite conventions or big meetings of their own – they’re all blown away,” said Indiana Governor Mitch Daniels.  “We have so many business guests that we’re trying to talk to about jobs for Indiana. When they see this [Super Bowl celebration and commerce], they understand why we like it here.”

To be sure, Indianapolis has some experience hosting large crowds, having hosted the NCAA Basketball Final Four multiple times and of course the Indianapolis 500 which literally attracts a crowd at least twice as large as that at Sunday’s game. Yet, hosting the Super Bowl in Indianapolis is a precedent – it is only the fourth northern city to host the game in 46 years.

For years, the NFL has had rules that prohibited the Super Bowl from being placed in temperatures that were below thirty degrees unless they were in locations with domed or covered stadiums.  With those conditions, it ended up being a fairly limited number of cities that could host the Super Bowl.  Given that blizzards and freezing temperatures tend to dissuade large turnouts, and some argue bad weather should not be allowed to impact the final game of the season, the reasons behind the NFL’s position were fairly understandable. Stadiums with retractable roofs and domes take the weather equation out of consideration – hence the reason places such as Minneapolis and Detroit have been able to host Super Bowls in the past.

With the addition of mega-stadiums, such as the new Cowboys Stadium (last year’s Super Bowl host) and Lucas Oil Stadium in Indianapolis, more and more cities are making their play to host one of America’s most unique and celebrated holidays. Besides the taxes and fees collected from the nearly 100,000 people in the stadium seats at the big game, every Super Bowl locale seems to benefit from the weeks of exposure the national media brings to the host city. It gives every host city the opportunity to put on its best face as media personalities take their audiences around the town to see what there is to be seen.  Places like California and Florida that have frequently hosted Super Bowls (given their great winter weather) have long enjoyed their place in the sun, but those locations are no longer the guaranteed hosts they once were.

The NFL chooses host cities years in advance, currently selected through 2015.  New Orleans, which has hosted multiple Super Bowls, will host the 2013 contest, but the year following will bring another first-time Super Bowl host to light. New Jersey’s new Meadowlands Stadium (now known as Met Life Stadium) is set to host the 2014 Super Bowl. Not only a first for the Garden State, the 2014 battle will see the NFL waive its weather/temperature rules for the first time in Super Bowl history as the game will be played outdoors, and with no dome or retractable roof, there will be a very real risk that Mother Nature may snow or chill the game. That game’s revenue is expected to be even larger than that generated in Indianapolis, with an economic boost to New Jersey and nearby New York City.

There is not total agreement on just how much revenue Super Bowls generate for the host city – some argue the NFL’s estimates on potential earnings are too high, suggesting the real economic impact is but a fraction of that. In any case, the value a city gleans from a Super Bowl goes beyond just dollars and cents

Beyond the one-time economic boost the Super Bowl offers in game-week spending, hosting the event also offers advantages for local and state competitiveness.  Indianapolis Mayor Greg Ballard said: “We’re getting exposure around the world. The image of Indianapolis has been enhanced this week.”

This is important for attracting business (and jobs) to Indiana, as well as stimulating investment and tourism. Ballard and Daniels also noted in interviews last week that the city is courting organizations to host their events and conventions in Indianapolis. Indianapolis Convention & Visitors Association Vice President Chris Gahl said 65 percent of those flocking to Indianapolis for the game were corporate decision makers, further evidence of the many opportunities offered by hosting the Super Bowl.

Given these benefits, along with the NFL’s seeming readiness to take the Super Bowl to other “cold” cities, competition for the chance to host America’s biggest game could increase among cities. That is a good thing. As the NFL season (particularly the playoffs) shows, spirited competition brings real talent to the surface on many memorable levels.  In a free and open market, it is healthy, essential and a principle driver in growth, something America’s cities desperately need and enjoy.


Stagnation and the Politics of Growth

December 22, 2011

By Michael Hendrix, Research Manager

When Tyler Cowen’s The Great Stagnation was first published this year, pundits everywhere had an “aha!” moment.  Now it’s Martin Wolf’s moment at the Financial Times. While Wolf is rather later to the game, his review of Cowen’s treatise is both timely and well written.

Wolf first asks, is the “great stagnation” argument true and, if so, so what?  What Cowen outlines at the beginning of his book are the all-too-familiar ills which have delighted declinists and offered endless fodder for debate.  Among these ailments are the declining growth in median wages, the decade’s listless job market, a looming fiscal crisis, and a general “willingness to let matters slide rather than face up to paying the bills.”  This much we know.

What Cowen argues though is that beneath the surface runs a “technological plateau” upon which our comatose economy lies.  We’ve done all we can to scale new heights, but what’s left to build with?  Resources and labor no longer come easily, and our labor force is already of a greater quality than we could have once imagined.  We can always do more to improve our economy, but at an ever dearer cost.

Where too are our big ideas?  Innovation appears to be wallowing in stagnant shallows.  This seems an odd thing to say in light of the information revolution — be it computers, the Internet, mobile phones or the like.  The innovations of yesteryear though were of a far more fundamental nature.

“The high point was the late 19th and early 20th centuries, which produced: modern chemicals and so artificial fertilizers; electricity and so the electric motor, light, refrigerator, vacuum cleaner, air conditioner, radio, phonograph and television; the internal combustion engine and so the automobile, the airplane; pharmaceuticals; and, not least, mass production.  These transformed lives.”

Compared to such dramatic achievements, our innovations today seem to be of the more incremental sort.  We’ve enjoyed a tremendous growth in wealth since the 1950s, but our lives aren’t too terribly different.  Earlier “big ideas” were building blocks for the technological plateau that we refine today.

The clincher to these points comes with multi-factor productivity (never a catchy sound bite there).  This indicator allows you to look at the sources of economic growth that lie separate from simply throwing more workers (human capitol) or money (financial capital) at a problem.  Here’s what it shows:

“The growth of multi-factor productivity in the non-farm business sector peaked in the first half of the 20th century and collapsed between 1972 and 1996.  It then surged in the ‘new economy’ wave.  But this impulse has faded.”

Yet we’ve assumed that the growth resulting from earlier innovations would continue.  Our policies presume this.  When the needed level of growth doesn’t materialize, debt grows and others scramble to rent seek.

Fortunately, the entire developing world is far from having reached its full economic potential.  To Martin Wolf, this is good news indeed.  Especially so when we think of the spillover effect of this growth on a developed world in need of cash.  Still, I don’t think anyone who has studied American history would say that our years of greatest growth were altogether smooth.  While India’s productivity hovers around a tenth of ours, we also see in their declining growth prospects for this year the real cost of a bureaucracy that so easily entangles.  So too for China’s opaque rules and open corruption.  Tough reforms cannot be ignored abroad, and we in America cannot rely on others to build our future.

In America, we have reached the point where tough choices are inevitable.  The politics of growth will not come easy.  To Cowen and Wolf, the hope is that investing in science and facing hard realities will grind our economy to a sharp edge.  All the better for carving out a brighter future.


A Tradable Future: Unemployment and the Productivity Curse

December 15, 2011

By Michael Hendrix, Research Manager

Edward Luce sparked a wide-ranging debate this week by arguing in the Financial Times (the article is behind a paywall) that America’s labor market is a wreck.  Luce’s point wasn’t surprising, but the way he got to it was.  Jobs aren’t forthcoming in the areas of our economy that are the most productive today and that cater to the “middle-skilled.”  The result is a mass of underemployment and “waning dynamism.”  One sentence from his essay captured his entire concern: “According to government statistics, if the same number of people were seeking work today as in 2007, the jobless rate would be 11 per cent.”

One of the sharpest comments came from Ryan Avent at The Economist where, after summarizing Luce and others, he noted something really important.  That is, that the way Luce spoke about economic sectors (especially manufacturing) merely threw up artificial barriers that reveal nothing about the true make-up of our economy or our labor market.

“…while the distinction between manufacturing and services is often meaningless, the distinction between tradability and non-tradability of products is most certainly not.”

Avent makes the argument that tradable goods (as opposed to non-tradable goods, such as haircuts) have a way of defining the state of the rest of the economy.  Since these goods theoretically can (as the name implies) be traded anywhere in the world, the price that can be charged for the good tends to fall into a narrow band defined by the lower cost competitors.  And since you can’t charge much more for the same good to get more income, the only choice is to make more of them.  There ends up being a direct line between productivity and income then.  This productivity leads to higher national income, which will then spillover into the market for non-tradable goods.  Conclusion?  ”An overall higher level of income in an economy, in other words, is only possible thanks to higher productivity in the production of tradables.”

Wonkiness aside, here’s the point.  Luce and Avent look at today’s job losses and stagnating incomes and guess that the real problem then is with productivity.  How much we’re producing for a set amount of work just is not keeping up with the degree to which prices are falling and labor costs are rising.

Labor markets and economies more broadly are complex beasts that aren’t readily reduced to pithy suppositions.  Nevertheless, Avent’s focus on productivity explains a lot about our stagnant incomes and shows where we need to look for answers to unemployment in America.  This is not necessarily a problem with you and me not working hard enough.  It’s that our economy as a whole has plucked the “low-hanging fruit” of progress.  It’s a challenge of finding the right big picture solutions that can make our hard work that much more worthwhile.  Together with much needed reforms in immigration and education, a pick-up in productivity will come then from heretofore unseen innovations in tradable goods and new ways to pair man and machine in making these goods.


Policy Uncertainty Linked to Less Job Growth

December 6, 2011


By Sean Hackbarth, Blogger, Policy Advocacy

Polls, like the Chamber’s Small Business Outlook Survey, show small business owners see policy uncertainty as an obstacle to greater job creation and more economic growth. This isn’t just perception. When economists take a serious look at this, they indeed find a connection.

In their paper “Economic Policy Uncertainty and Small Business Expansion,” Mark E. Schweitzer, Senior Vice President and Director of Research at the Cleveland Federal Reserve and Scott Shane, professor at Case Western Reserve University’s business school, build on the work of Scott Baker, Nicholas Bloom, and Steven Davis who developed a policy uncertainty index.

Using statistical tools, Schweitzer and Shane found “statistically significant negative effects of policy uncertainty on small business owners’ plans to hire and make capital expenditures.” According to their analysis, “the net percentage of small business owners planning to hire would be 6 percentage points higher if it were not for policy uncertainty.”

With small businesses accounting for almost two-thirds of job creation, this uncertainty has negatively affected significant numbers of jobs.

Now, the first rule of statistics is “correlation does not equal causation.” Schweitzer and Shane acknowledge this but write,

“The correlations between the two are strong enough to reject the argument that policy uncertainty is irrelevant for currently weak small business expansion plans. In our view, policymakers should take seriously the widespread anecdotal reports that policy uncertainty is adversely affecting small business owners’ expansion plans.”

[H/t Jonathan Adler]

[NOTE: This is cross-posted from The ChamberPost blog of the U.S. Chamber of Commerce.]


Too Big to Save?

November 11, 2011

By Michael Hendrix, Research Manager

Take your mind back to 2008, when the go-go days of the 90s weren’t such a distant memory and there were only echoes of a growing storm on Wall Street.  Rumor had it that banks had stuffed their balance sheets with bad loans of unknown value.  Main Street seemed fine, but the storm clouds were growing and casting a deepening shadow. It wasn’t until September of that year that Lehman Brothers shook our complacency.  A known entity was being threatened and in time we saw the venerable bank collapse.  Yet we still thought ourselves sheltered from the storm.  Time and loss proved us wrong.  We weren’t as safe as we thought we were.

Now, what if you had been told at the time of Lehman’s collapse that its liabilities were much larger than people claimed; not just two times, but three times its stated size?  What if $2.6 trillion in debt was hanging in the balance?  Would you have been more concerned about the health of the economy then, about contagion, with the apparent maladies of Wall Street infecting Main Street?

Brink of Disaster

I know that I would be concerned, almost dearly so.  So, what if I told you that the hypothetical I posed was real?   Today, Italy stands on the brink of disaster.  It is the third largest debtor in the world, paired with some of the slowest growth in the world. Its leaders dither and prevaricate like there’s a tomorrow.  And all the while countries on its periphery suffer from equally dire debt burdens – one readily thinks of Greece, Ireland, and Portugal, all countries whose combined debt don’t even come close to equaling that of Italy’s.

In short, the tempest that blew through the world economy in 2008, the one we’ve been recovering from for nearly three years now, may not even hold a candle to what may be on the horizon today.  Just as in 2008, we are distracted by lesser worries, such as Christmas tree taxes and Kardashian drama.

What’s at Stake?

Let’s be real then about what’s at stake.  First, the sanctity of Italy hangs in the balance.  Why?  Since the turn of the millennium, Italy’s growth has hovered around zero.  Its economy is tangled in a mess of red tape in the eyes of the IMF.  Productivity growth, as measured by the OECD, has barely crept past 1% in the past ten years.  Unemployment among the young sits at 27%, such that Italy’s most productive workers are left working part-time or short-term jobs for their best years.  To top it all off, Italy’s good governance indicators have been cratering since 2000 as well. This is a product not just of poor political leadership but of endemic levels corruption that chew up more than 17% of Italy’s GDP every year.

As of this week, a fatal threshold has been crossed. Similarly to Lehman Brothers, Italy stays afloat as long as its debt can be rolled over and then papered over with new debt issuance.  When Italian debt hit the 7% interest mark on the open market on Wednesday, traders had to start posting further collateral every time they handled Italian bonds in order to protect against the risk of default.  Ignoring the significant psychological impact that crossing that 7% line holds, Italy quite simply faces the haunting likelihood that when it turns to the bond market to issue further debt for obligations new and old, that traders will throw up their hands and say it’s not worth the cost.  It happened with Lehman and we know how that story ended.

Without the European Central Bank (ECB) stepping in to guarantee Italy’s debts (which it would somehow have to make credible) or buy its bonds in large quantities on the open market (which it has so far refused to do), Italy will likely default on its debts.  Any large-scale ECB action would likely be made on the assumption that Italy’s problem is one of liquidity rather than solvency, and it increasingly looks like the latter.   The European Financial Stability Facility, first created in May of last year to stem the European sovereign debt crisis, would simply be overwhelmed in the event of an Italian claim.  Banks across the Eurozone would be hit by a tidal wave of red ink, and on top of that American banks are more exposed to Italian debt than to any other Eurozone country.

Even with ECB support and a technocratic government at the helm in Italy, the only real way out of its debt burden is economic growth, and that takes time that the bond market may not provide.  According to Barclays this week, “Italy may be beyond the point of no return.”

The Eurozone itself is at stake too.  It’s no longer a matter of a two-speed Europe, with the fast (Germany) funding the slow (Greece).  We are already there.  As many Euro-crats are starting to murmur, we’re more likely at the point of a two-tiered Europe, with only the strongest countries holding on to the Euro.  As one European Union (EU) official said this week, “‘The difference now is that some countries are moving forward very quickly … The risk of a split, of a two-speed Europe, has never been so real.’”  The scariest prospect is simply that no one knows what happens then.  European Community law makes no provision for a country to leave the Euro.  It’s uncharted territory, and there’s nothing like the fear of the unknown to spur credit contraction.

What’s Next?

Faced with dire prospects at all turns, Italy itself could very well choose to simply switch its currency back to the lira from the euro.  The low interest rates of the Eurozone clearly no longer hold true, and having its own currency would allow Italy to inflate away its debts and makes its exports more cost competitive.  On paper, it’s quite an easy prospect.  Italian legislators could simply pass a law saying that all financial transactions were to be conducted in lira and Italy’s problems would be solved. Except that’s not quite the whole story.  If you knew that by tomorrow all of your dollar savings would be worth half their value tomorrow, what would you do?  If it were me, I would send my money out of the country to someplace where its value would stay intact.  Imagine a whole country doing that — at the same time.  It would be one of the largest bank runs in history; that is, until capital controls and travel restrictions ensued causing chaos of their own.  At that point, you wouldn’t be incorrect to expect a domino effect (the fact that this statement vaguely rhymes doesn’t improvement its reality), with Greece and others choosing to re-adopt their own currencies. At that point, the Eurozone would become a shell of its former self.

Ryan Avent at The Economist summed it up well:

“I have been examining and re-examining the situation, trying to find the potential happy ending.  It isn’t there.  The euro zone is in a death spiral.  Markets are abandoning the periphery, including Italy, which is the world’s eighth largest economy and third largest bond market.  This is triggering margin calls and leading banks to pull credit from the European market.  This, in turn, is damaging the European economy, which is already being squeezed by the austerity programmes adopted in every large euro-zone economy.  A weakening economy will damage revenues, undermining efforts at fiscal consolidation, further driving away investors and potentially triggering more austerity.  The cycle will continue until something breaks.  Eventually, one economy or another will face a true bank run and severe capital flight and will be forced to adopt capital controls.  At that point, it will effectively be out of the euro area.  What happens next isn’t clear, but it’s unlikely to be pretty.”

As the dust settled on Lehman Brothers’ collapse in 2008, talk turned to whether banks were “too big to fail.”  With storm clouds growing now over Europe, the threat now may very well be whether a country is too big to save.


The Cost of Doing Business in America

October 31, 2011

By Michael Hendrix, Research Manager

Every year the World Bank releases its Doing Business report, a collection of rankings aimed at putting a number to every factor a business must take into account when trying to “do business” and comparing that figure across countries.  Increasingly, with the release of every new report America has found itself lower and lower on some portion of the list.

Lest we panic too quickly, America is still a tremendous place to start and run a company.  Barring only three – Singapore, Hong Kong, and New Zealand – the US sits at the top of the overall country list.  The specifics tell a different story though.  We are ranked 72nd in the world in “paying taxes”, meaning that the cost and hassle of our corporate tax system is stifling business in the eyes of the World Bank.  Who else is ahead of us?  Practically the entire developed world, as well as others such as Afghanistan and Cambodia.  According to The Economist, America’s “tax code is as simple to understand as a thesis on post-structuralism translated into Klingon.”

“Trading across borders” is also an area in which America holds rather dismal rankings – 20th at last count.  With the passage of three free trade agreements, it is easy to think that American firms can trade with relative impunity.  It is true that tariffs are on the wane, but note that the World Bank includes trade facilitation issues in its ranking, meaning that it looks at the red tape a business must cut through in order to trade.  In short, rules matter to the World Bank and ours are becoming onerous.

Other concerns are small, but growing.  Take the cost of starting a business.  In 2004, the World Bank judged that it cost 0.7% of income per capita to get a firm off the ground.  Today, that number practically doubled to 1.4%, and with this rising trend our rankings have also fallen.

The World Bank may well be doing us a favor by highlighting growing areas of concern for business in America.  It is far too easy for commentators in a country as big as America to compare our performance only to ourselves.   That is a recipe for complacency.  The World Bank has the ability to step back, line us up against other countries, and figure out whether the fundamentals of our economy are as strong as we like to think they are.

It is also tempting to take any piece of data and project onto it our own visions of where America is failing, a surprisingly common pastime for an optimistic country.  The truth is that America’s fundamentals remain strong on average.  And on average, everything changes eventually.  These rankings will deserve a watchful eye in the coming years.