Crisis Talk - The World Bank Group

Crisis Roundup

"It's Alive, It's ALIVE, It's ALLLIIIIVVVE!"

The economics profession may become more mathematical, and friendlier to women.

Unemployment in the US is going to be a problem for a long time.

Commodity prices aren't really based on fundamentals like weather and geopolitics.

Lords of Finance. Best business book of the year.

Brad DeLong ♥ Financial Times.

Surprise! Paul Krugman thinks that the stimulus is working, but wants it to be bigger.

China can't cool down its steel bubble.

There is a large gap between new and existing home sales in the United States.

People are eating out less frequently.

One bit of proof that the recovery is real.

Finally, the recession is taking its toll on California.

Today in Bubbles

The editors of the Financial Times appear to be concerned about bubbles. Three out of today's four op-eds are dedicated to the theme.

First, George Soros argues that the implosion of 2008 was an aggregation of a series of bubbles over the past decades, creating, in his words, a "super-bubble":

The crash of 2008 was caused by the collapse of a super-bubble that has been growing since 1980. This was composed of smaller bubbles. Each time a financial crisis occurred the authorities intervened, took care of the failing institutions, and applied monetary and fiscal stimulus, inflating the super-bubble even further.

The Case for Prudency: Latin America Edition

Bloggers at the IMF are looking at why Latin America fared better in this crisis than during previous episodes of financial duress. Their explanation: financial soundness mixed with enhanced credibility.

This improvement can be attributed to the fact that the region faced the crisis equipped with economic policy frameworks that were more solid and credible than in the past, and with smaller financial, external, and fiscal vulnerabilities. This allowed a number of countries of the region to implement countercyclical monetary and fiscal policies.

The estimates here suggest that these countries were able to “save” about 4 percentage points of GDP during the crisis, thanks to their better preparations for confronting external shocks.

A key element of this preparedness was credibility. Those countries which had responsibly managed their monetary and fiscal policies before the crisis were able to quickly lower interest rates, while increasing public expenditure and fiscal deficits. Countries such as Brazil, Chile and Peru managed to store away enough revenues from the commodity booms of the previous years in order to enact the necessary mix of countercyclical policies. Mexico, which is suffering from dwindling oil reserves, had less of a cushion, and has in turn struggled more than most of its neighbors.

Update: Vox has an interesting paper on the policy responses of Latin America Central Banks during the crisis, written by the former governor of the Central Bank of Ecuador.

History Lessons

As the crisis enters its second year, the economic history books have already begun publishing an early account of first stages of the crisis. In particular, two articles have been released this week that serve as essential reading.

First, this month's Vanity Fair features an excerpt from Andrew Ross Sorkin's upcoming book, Too Big to Fail. Sorkin's piece gives a thrilling, minute by minute account of the chaos within the halls of Wall Street during the aftermath of the Lehman collapse. The article offers a view of the day's events through the perspective of the most important players in finance, including Timothy Geithner.

China's Crisis Response Goes Global

China has been an essential player in fostering a global economic recovery. As one of the first countries to announce a massive stimulus package last November, China brought increased stability to markets when it was dearly needed. Today's conventional wisdom holds that in order to ensure a stable global recovery, Chinese consumers must increase their consumption patterns to fill the economic void left by their battered American counterparts (see previous post).

Can the Chinese government succeed in boosting domestic consumption? Are there other initiatives that China can take to put the global economy in motion?

The answer to both of these questions is a tentative 'yes'.

Declining Consumer Credit + Weaker Dollar = Time to Export

There are two noteworthy stories in the economic blogosphere, aside from the exciting news coming out of the World Bank.

The first has to do with the sharp decline in consumer credit in the United States. Buttonwood reports:

While governments round the world clock up more debts, American consumers are finally cutting back. The volume of consumer credit fell by $21.6 billion in July, the sixth monthly decline in a row. According to Lombard Street Research, this was the second largest percentage decline since World War Two. The 3-month annualised rate of decline is now running at 7%.

It appears that the recession has actually succeeded in frightening the American consumer into saving. This is not an insignificant feat.

Crisis Roundup: Financial Bureaucrats Edition

Tim Geithner wants tougher capital requirements...

...and seven of his European counterparts want to end banks' bonus culture.

Claude Trichet has a plan. So does Geithner.

Bernanke is the dollar's new father.

Volcker and Soros discuss innovation.

Finally, did miscommunication between the US and UK Treasuries push Lehman over the edge?

Bernanke's Challenges: Look North

Now that we are due for at least four more years of a Bernanke Fed, what will Act Two look like? The New York Times invited several economists to forecast the challenges lying ahead for Mr Bernanke.

Chief among these challenges is unwinding the massive stimuli and support mechanisms that the Fed introduced in order to "prevent another Great Depression" (in the words of Barack Obama). This will involve a deceleration of monetary easing as the Fed balances growth and recovery with inflation and the credibility of the dollar.

Iceland may be an interesting case study of what's ahead. Just as Iceland was a precursor to the severity of the credit crunch, it may be the first to feel the withdrawal symptoms of diminishing government stimulus policies. Robert Wade argues:

Credit Suisse: Where's the Asian Bubble?

Credit Suisse has released a new report (Asia: Show me the bubble) claiming that concerns of an Asian bubble are overblown:

It has become fashionable to argue that Asia’s monetary conditions are too loose and that too much domestic liquidity is creating asset price bubbles. Reflecting prevailing “wisdom” among market analysts, The Economist last week declared that (1) “Asia’s monetary conditions are too loose,” (2) “capital is already rushing in,” (3) “[central bank] foreign exchange intervention to hold down their currencies causes domestic liquidity to swell,” and (4) “the obvious solution is to let exchange rates rise.”

There is nothing “obvious” about any of the above, in our view. The entire region is being painted with a China-brush, which does not wholly apply.

Weekend Reading (and Listening)

What exactly is quantitative easing, and how do we measure its effectiveness? Buttonwood explains.

Is the Credit Crisis the largest outlay in American History? Some are arguing it is more costly than WWII. (via Ritholtz)

Zero Hedge shows us the Fed's balance sheet:

Foreign holdings of USTs and Agencies increased by $23.5 billion monthly to $2,810 billion from $2,787 billion in the prior month. This is now less than 20% of the comparable increase in Securities Held Outright by the Federal Reserve, implying foreign purchasers are starting to fall far behind in their purchases of US securities relative to the Fed's monetization rate.

Our East Asia blog writes on China's import surge.

Simon Johnson discusses bubbles and Goldman Sachs.

The IMF's new blog asks, "After averting a second Great Depression, what should policy makers do to foster recovery?"

The New Yorker's James Surowiecki and Ryan Lizza discuss the state of the stimulus (audio).

This Week in China

In honor of this week's US-China Strategic and Economic Dialog, today's Crisis Talk is dedicated to the latest discussions on Sino-American economic relations.

To start, Brad Setser has three excellent articles on Chinese-American monetary relations:

• The first article points out that the PBoC's balance sheet totals 70% of GDP, compared to the Fed's, which recently hit 15% (and was 6% before the crisis).
• The second asks, "Doesn’t a smaller (external) deficit mean less dependence on (external) creditors, including China?" Setser thinks so, and I agree.
• Third, for all its concerns about a weak dollar, China has been allowing its own currency to depreciate lately. 

Simon Johnson analyzes Tim Geithner's China strategy:

Any country that runs such a current account surplus is implicitly taking a great deal of currency risk – China was in effect deciding to take the biggest ever official long-dollar position.  The idea that the US government should spend time reassuring them is somewhere between quaint and not good strategy.

Today's FT has two commentaries on China and the dollar. The titles speak for themselves:

• Washington risks taking China too seriously
• Chatter about a new global currency is overblown

Finally, China Law Blog gives advice on how to avoid getting kidnapped in China.  The solution: "Plan in advance or go home."

World Bank VP: Recovery Uncertain

In an interview yesterday with Reuters, Marwan Muasher, the World Bank's senior vice president for external affairs, called any type of recovery "uncertain", and warned that the poorest nations are just starting to feel the worst of the crisis.  Muasher called for rich nations to set aside 0.7 percent of their stimulus packages for poorer countries, adding:

There are other measures that need to be taken, including the cleaning of the banking sector, putting in place new financial regulations, concluding the Doha round of trade talks so we don't end up in protectionist measures and makings sure that the poor are not left behind

The road out of the crisis risks leaving the world's poor behind, no matter what shape it takes.

Weekly Crisis Roundup

Frederico Sander from our East Asia blog examines the state of Thailand's economy and its prospects for recovery. His prognosis: very cautious optimism.

It now appears that the fire has been put out (with much liquidity…), but the green shoots emerging in the burned forest remain very fragile as hot spots remain and the risks of the fire re-igniting are not negligible

Over at Follow the Money, there is less caution about Chinese green shoots; rather, some are wondering if China's stimulus is working too well. 

In a two part Vox column, Guido Tabellini discusses the nature of the crisis, and then ponders exit strategies.

Real Time Economics has a guide to the best of the econ blogosphere.

Abnormal Returns provides a nuanced overview of the ongoing Goldman Sachs saga...

...with some added comic relief.

Deficits and the Dollar, Mutually Exclusive?

There has been a lot of chatter among policymakers about the future of the dollar. In particular, the BRIC countries have opined on the need for a new, global reserve currency to replace the greenback's predominance. (Last week, India chimed in).

At the same time, many emerging market countries, including the BRICs, continue to increase their dollar holdings. I recently posted on how foreign exchange reserves have been very useful in cushioning the adverse effects of the crisis. (Imagine how confidence in the Russian economy would differ if the central bank didn't hold over $400bn in reserves).

What do we make of all of this? How is it that the dollar's reserve status is being questioned, but simultaneously reinforced by the same countries who are doing the questioning? This paradoxical sentiment can probably be viewed as an expression of concern about the United States' deteriorating fiscal health.

Crisis Roundup

Here's a roundup of some of the more interesting crisis-related discussions in the blogosphere:

1.  Simon Johnson, former Chief Economist of the IMF, summarizes his main points from last week's World Bank conference in Seoul, "Lessons from East Asia and the Global Financial Crisis":  

If the size, nature, and clout of finance is the problem, then the official view is nothing close to a solution. At best, pumping resources into the financial sector delays the day of reckoning and likely increases its costs. More likely, the Mother of All Bailouts is storing up serious problems for the near-term future

2.  Should we be promoting access to finance in the developing world, even in the midst of a financial crisis? CGAP Microfinance

3.  Is the next bubble in emerging markets? FT Alphaville

4.  Nouriel Roubini discusses China's waning dollar appetite...

Our creditors' nervousness about the eventual debasement of the US dollar has some increasing validity.

5.  ...while others are less convinced.

Charting a Path out of the Crisis

The World Bank Group (WBG) has just released the first batch of a series of policy briefs on the financial crisis, whose aim is to assess government responses to the crisis, shed light on the financial reforms currently under debate, and provide insights for emerging-market policy makers. The first three papers cover a lot of ground in a short amount of space—sizing up the global policy response, forecasting what future financial systems will look like as a result of these policy responses, and determining how financial regulation will evolve. They will be followed by papers, written by different authors inside and outside the WBG, that will take ‘deep dives’ in specific crisis-related financial sector topics.

• Dealing with the Crisis: Taking Stock of the Global Policy Response provides an overview of the immediate financial sector policy responses to the financial crisis—including emergency liquidity support, expansion of financial safety nets, and interventions in financial institutions—that have succeeded in stemming widespread panic. But the effort has generally been ad hoc and insufficient. Issues that remain include the resolution of problem assets, the restructuring of troubled, systemically important financial institutions, and the development of credible exit strategies. Only a handful of countries have attempted to tackle these issues head-on. As past experience has shown, that may well have negative repercussions for the duration and strength of a subsequent recovery.

• The Reform Agenda: Charting the Future of Financial Regulation reviews the crisis-induced shift toward a tighter and more macro-prudential approach to financial regulation. But the reform agenda still needs to address the role of supervisory (rather than regulatory) failures, while the institutional arrangements needed to implement the new framework remain to be worked out. For most emerging economies, the existing reform agenda—developing institutional and legal underpinnings for the financial system and promoting financial access—remains valid. But for those characterized by weak financial oversight structures and more volatile economic cycles, adopting capital “buffers” as part of a macro-prudential regime may be a useful complement.

• Safe but Smaller? The Shape of Financial Systems to Come describes how global trends taken for granted in recent decades—the big expansion in global financial assets compared with underlying economic activity, growing global financial integration, shrinking role of the state in financial systems, and rising share of cross-border ownership of financial institutions—may reverse over the foreseeable future. In addition, the structure of financial systems, particularly in developed countries, will likely become oriented less toward capital markets and more toward traditional (and simpler) banking activities. The impact on economic growth and overall welfare is likely to be negative—perhaps the price we have to pay for living in a brave new (and presumably safer) financial world.

FX Reserves as Insurance Policy

Editor's Note: Brian Hoyt is a consultant in the Financial and Private Sector Development Vice Presidency of the World Bank Group.

A new report from Deutsche Bank on emerging market economies' anti-crisis measures highlights the benefits of FX accumulation. The top performers as identified by the report share one obvious commonality: massive dollar reserves. Nearly every country that has successfully weathered the crisis is either a petrostate and/or has a significant sovereign wealth fund. Not only have FX reserves been key in facilitating an economic stimulus, they have also have provided significant currency stability:

The amount of FX reserves in relation to external financing requirements is still crucial to the assessment of countries’ resilience to external shocks. From a policy perspective, accumulating FX reserves still seems to be pretty good insurance.

This observation seems to contradict concerns that central banks will be hesitant to accumulate further dollar reserves. The question remains as to how central banks' desire to purchase this kind of insurance can be squared with the need to resolve global macroeconomic imbalances.

The Jobs Agenda

As Simeon has pointed out, it may still be premature to predict the end of the crisis. Even if the worst of it is past, the negative impact of the crisis on a number of economic variables could be persistent. A prime example of this is employment, and, potentially, overall labor productivity. 

Public works programs have figured prominently among some stimulus packages (see here and here, for example). While these programs have the clear benefit of supporting employment, they are not without their potential downside. Neil Gregory, a senior adviser on Financial and Private Sector Development at the World Bank, explains the trade-offs:

Buiter on Emerging Markets

Willem Buiter is among the foremost European monetary economists who is providing commentary on the unfolding crisis. (Charles Goodhart and Martin Hellwig round up the top-3). Here is what Buiter wrote recently on his blog:

The prospects of the emerging markets depend:

• First, on their dependence on external demand
• Second, on their dependence on external finance and,
• Third, on the scope for expansionary domestic demand management and the ability of the authorities to use it intelligently and flexibly.

Krugman Throws Out the Baby, Bathwater, and Fellow Economists

Nobel prize winner Paul Krugman made a big splash across European newspapers this week, criticizing Europe’s governments for being too timid in their fiscal stimulus. He seems to have forgotten that most countries in Continental Europe already have large automatic stabilizers in the form of social safety nets, automatically driving up government expenditures during times of crisis. And while the Ricardian equivalence certainly does not hold one-to-one, additional government consumption might very well be partly off-set by more private savings, at least in countries like Germany, where even nearly a century after hyperinflation, inflation fears run still high.

Japan Tries Again

Stung by the label of a lethargic stimulator during the 1990s, Japan is competing with the US for how much money to put out now. The third stimulus package, at 150 billion dollars, is the latest of a series to come (see the BBC story).
 
The new money mostly goes into incentives to buy fuel-efficient cars and consumer electronics. As such, it is a subtle Buy Japanese package. Nothing wrong with that. Similar packages have emerged in nearly every car-producing economy. The plan also provides some extra security for temporary workers.
 
The government plans to finance it with a new issuance of bonds.

W

A new betting game has emerged - on what the shape of the eventual recovery will be. So far the candidates have been V, U, L. Enter W - and you thought you got rid of him!
 
A W-shaped recovery looks like this. An initial steep decline is followed by the Fed and the European Central Bank pumping money into the respective economies, and temporarily lifting demand, until it falls again. So for a while it looks like a V, then another prolonged collapse. So in a way it should be a combination of the letters VL. It also has another meaning - a very long recession.

Sachs on the Latest Treasury Plan

Jeffrey Sachs apparently has no shame. In the last few years, he has made a name for himself by asking rich countries to double and triple development aid. Without answering the obvious concern: much of aid seems to be wasted (says Bill Easterly and a host of academic research), so tripling it without any reform of the aid architecture just triples the waste. But these are just details, and they have not prevented Professor Sachs from hooking up with Bono and Angelina Jolie to "raise awareness." A few years back they declared victory, only to find out recently that the total amount of official development aid has actually declined. Oh, well - off to the next big cause.

Dutch Stimulus Package

Last week the Dutch government announced new anti-crisis measures, worth €11.5 billion. First, an increase of the retirement age from 65 to 67 years, to take effect in 2011. Second, a €5 billion cut in government expenditures, coming mainly from cutting the salaries of government workers and lowering benefits. This will take effect in the 2011 budget. Third, a reduction in the employer's share of social security. The announced cuts in social security payments by employers follow similar reforms in several other EU members: for example the Czech Republic and Germany. Fourth, €6 billion in incentives to build energy-efficient housing and scrap old cars. Fifth, €250 million will go towards fighting youth unemployment. Sixth, scrapping a tax on airline tickets, to help Schiphol airport. The rationale for this measure is that the environmental tax on airline tickets has undermined Amsterdam Schiphol airport's competitive position - with many passengers simply booking flights in neighbouring countries instead.

These come on top of a previous €6 billion fiscal package. That stimulus was designed to improve the liquidity of small companies, grant a temporary reduction of working hours for firms facing economic problems, and to speed up infrastructure projects, including the new Delta flood control works. It would also pay government bills charged by companies faster, which would be especially helpful for small and medium sized companies. In addition, the Dutch government established regional labor mobility centers to help prevent imminent layoffs.

Previously, the financial crisis had already forced the government to nationalize two major banks - ABN Amro and Fortis - in order to prevent their collapse. In addition, the economic stimulus package included €20 billion, which was injected into the money market to guarantee interbank transfers. Aegon, an insurance company, received €3 billion and ING, a commercial bank, has received €10 billion.

China: Government Officials' Property Declarations Published

On February 17, 2009 the Chinese government announced that senior public officials in the Altai district, Xinjiang province, are the first in China to publish their property declarations on the Internet. This is the start of a pilot on officials' disclosure reform, which has been on the agenda for some time.

The 4 trillion RMB ($586 billion) stimulus package in China gives national and regional government officials greater powers to select projects for investment, thus increasing the risks of misuse of authority for personal benefit. "[In this context] the issue of publicity of officials' personal property raises a heated discussion in the whole society," reports China News, a major online agency.

The Chinese government is testing the disclosure reform in Xinjiang province before extending it to the whole country. The declarations published in the Altai district contain information on all types of material benefits received by officials, including salary, consultancy and author fees, gifts and sponsored holidays or celebrations. More than 1000 declarations by senior government officials at the district level are being made public. Information on assets, including real estate, vehicles, bank deposits, stocks and bonds, and liabilities, is also declared but kept confidential.

Li Chengrui, former Director of the National Statistics Bureau and one of the proponents of the reform, says that it "does not need preparation and re-preparation." The financial crisis, it seems, has become an opportunity for promoting greater disclosure by politicians.

Russian Stimulus Spending Debate: Opportunities for Greater Transparency

This last January the Russian Parliament adopted in a breakthrough vote the Law on Access to Government Information, which has been pending ever since… 1997! The context for this measure is a heated debate on the usage of stimulus money. If you Google “anti-crisis money” in Russian, you'll see what I'm talking about: all top results are about ensuring the transparency of spending.

Most importantly, the new Russian law, which will enter into force on January 1 of next year, reversed the principle of access to public information in the country. From now on, government information is presumed to be open. It is no longer the citizen who has to convince the official why s/he needs the information. It is the official who has justify why (if so) the information is not granted.

Being very high-tech minded, the authors of the law placed the responsibilities on the government agencies to proactively publish on the Internet their legislative acts and information on their structure, budgetary spending and activities. To ensure broader access, public Internet spots will be created in government premises and public libraries. Government websites will have email channels for submitting queries. Furthermore, for the first time ever, the law opens the door for citizens to attend meetings of government collegial bodies.

Access to public information is a crucial transparency area. Although critics say that the law may have weaknesses, Russia is definitely progressing in turning the financial crisis into an opportunity for greater transparency.

Stingy Europeans

I have wondered for some weeks why the Europeans are not more forthcoming with a bigger stimulus response to the crisis. Dani Rodrik's comment today (see this previous post) got me to thinking again.

Maybe it is all psychology, and not just in Western Europe. Simply speaking, the view is that the crisis started in the United States and therefore Obama and Geithner and Summers and Bernanke have to clean up the mess.

Even assuming that the origin of the crisis is 100% "Made in America," this is adolescent behavior. Imagine that you are an innocent passer-by who gets hit by a truck when crossing the road. You have two options: (a) lie prostrate on the road and shake your finger at the truck; or (b) do your best to get to the emergency room as soon as possible. What would you do? Option (b), right? Option (a) doesn't help and may even get you killed if another car comes along.

It's the same with a stimulus to get out of the crisis. Better do it quickly, and hope for the best.

There is also an asymmetry in the response (not that it is unusual for politicians to have asymmetric responses). When times were good, all the credit went to the politicians. When times turned bad, all the blame goes abroad.

New Blogroll

Our blog page has been updated to list other blogs that have interesting things to say about the crisis (see the Crisis Blogroll in the righthand column). One of the interesting things being said is a comment from Dani Rodrik's blog:

There are two things that can make a real difference to the world economy in the short run: (a) coordinated fiscal stimulus, and (b) massive increase in credit or liquidity facilities for the developing nations.  European obstinacy has taken off the table the first of these. And it is not at all clear that the second is being pushed hard enough by any of the rich countries (although the US proposal on the enlargement of the IMF is considerably more generous than what the Europeans have offered so far).

You can read the whole posting here.

Indonesia's Stimulus Package

The government received approval from the House of Representatives to launch the stimulus package on February 24, 2009. Of the total Rp 73.3 trillion ($6.3 billion) stimulus package, Rp 12.2 trillion is allocated to infrastructure projects and empowerement programs for people living in rural areas. Finance Ministry head of fiscal policy Anggito Abimanyu said the Rp 2 trillion increase (the government had initially asked for Rp 71.3 trillion) would be allocated to build roads in villages and municipalities, and irrigation schemes, which “can quickly generate employment." Another 4.8 trillion rupiah (400 million dollars) is dedicated to energy-saving investments.

Bambang Susantono, the deputy minister to the coordinating minister for the economy, in charge of infrastructure, said the government would launch the stimulus in early March, although it “still depends on the projects.” He said the government had also worked with the International Labour Organization (ILO) to generate more employment.

To reduce the burden of low- to mid-income workers, the government will also introduce an income tax cut to workers having a monthly income of less than Rp 5 million. Overall, the tax stimulus is worth 56.3 trillion rupiah and also consists of reduced corporate and value added taxes.

The stimulus package is expected to increase the 2009 budget deficit to 139.5 trillion rupiah ($11.62 billion) from 51.3 trillion rupiah ($4.27 billion), or to 2.5 percent of GDP.

Turkey's Stimulus

The Turkish government announced a comprehensive economic stimulus package on March 13, 2009. The package of economic measures amounts to 5.5 billion Turkish liras ($3.2 billion). New regulations will lower the private consumption tax rates (OTV) on the automotive sector and remove the OTV completely on home appliances, while the value added tax (VAT) on apartments over 150 square meters (1,614 square feet) in size will be lowered from 18 to 8 percent. The package also foresees measures to boost exports by allocating an additional 500 million liras ($296 million) to Eximbank, a state-owned bank geared to supporting exporters.

The new tax regulations seek to stimulate domestic demand in Turkey’s leading industries. Industry Minister Zafer Caglayan explained the details of the reduction of the OTV on motor vehicles and said that it might be implemented as early as March 17. For automobiles with engines of up to 1,600 cubic centimeters, OTV will be reduced from 37 percent to 18 percent, and for vehicles with engines of between 1,600 and 2,000 cubic centimeters, it will be reduced from 60 percent to 40 percent.

Representatives from other sectors also pointed out that given the three-month time limit on the tax cuts, the package would fall short of expectations and fail to stimulate the economy in the long run. Representatives of the housing sector noted that since only 5 percent of Turkey’s total real estate consisted of homes of more than 150 square meters, reducing the VAT on property was not likely to have a major effect. The VAT on houses with fewer than 150 square meters is already 1 percent.

Czech Stimulus Package

On February 16, 2009 Czech Finance Minister Miroslav Kalousek announced a stimulus plan worth 73 billion crowns (US$3.3 billion). The stimulus plan allocates 40 billion crowns (US$1.8 billion) in tax cuts, which is equivalent to 1.9 percent of the Czech Republic’s gross domestic product. "The main tasks we have set in an effort to eliminate impacts from an economic crisis include maintaining employment, and keeping public finances stable," Topolanek said.

The pro-export plan aims to preserve some 50,000 to 70,000 low-income jobs through welfare insurance cuts and stays away from directly handing out money to citizens. "We do not want to give people who lose jobs welfare pittance. The goal is to protect their jobs," Topolanek said. The measures include a corporate tax cut (already effective since January), more money for road construction and business loan guarantees. The government aims to encourage investment by relieving small firms and entrepreneurs of advance tax payments this year. Another measure is a value-added tax write-off for the purchase of new cars.

The government also expects to sell excess carbon-emission credits worth 10 billion koruny and spend the earnings on energy efficiency projects, such as heat-proofing public buildings and households, which should employ 12,000 people, Environment Minister Martin Bursik said.

The stimulus plan is based on the assumption that the economy will shrink by 1 percent or more this year, a darker scenario than the central bank's 0.3 percent recession forecast and the finance ministry's 1.4 percent growth outlook.

Summers at Brookings 2

In addition to the diagnosis of how the current crisis differs from previous ones (see my previous post here), last Friday's Brookings presentation by Larry Summers featured another important idea: what the country needs to have a sustained recovery. He called this Sources of Sustainable Growth: Exports, Healthcare, Energy, Education. (I have made a few cuts to make it relevant for more countries.)

If growth in the coming years is not to be driven by asset price inflation-induced consumption, other engines of growth must be identified. These forms of growth should be sustainable and shared by the majority of households.

Stronger exports are one sound foundation for sustainable expansion. These are issues both for global recovery - at a time when 2009 is likely to be the first year of negative global growth since the Second World War - and for a healthy, less debt-dependent US expansion.

China's Stimulus

The stimulus package, announced November 9, 2008 and worth $586 billion, includes a $73 billion reduction in the tax burden on firms and individuals, mainly through a VAT cut; $173 billion for building low-income housing and upgrading the national railway and road system, and spends $130 billion on reconstruction in regions affected by last year's earthquake in Sichuan Province.

On March 17, the prime minister indicated that additional stimulus would be available if the economy needs it. "We have prepared contingency plans to handle greater difficulties. We have prepared enough ammunition and we can launch new economic stimulus policies at any time."

Spain's Stimulus

The first package, announced in April 2008 and worth $13 billion, mostly focuses on faster VAT rebates for businesses and help with mortgages for poor families.
 
The second package, announced in August 2008 and worth $30 billion, has four main components:

1. Proposals to cut red tape to make Spanish firms more competitive;
2. Reforms in the housing, transport and telecommunications sectors;
3. A 400 euros rebate for 16 million workers and retired workers in the hope this would boost consumption; and
4. Help for the construction industry by awarding more money to construct subsidised housing.

The third package, announced in November 2008, is worth $21 billion. Of it, $12 billion is for infrastructure projects. Another $1.2 billion is for Spain’s ailing car industry. “We hope this will generate 300,000 jobs within a year,” Jose Luis Rodriguez Zapatero, the Spanish Prime Minister, told parliament. “These are urgent measures to generate jobs."

Time to Unite

Editor's Note: Charlotte Nan Jiang is an analyst on the Doing Business team and currently works on the Paying Taxes indicator.

The Washington Post published a timely op-ed last Friday, Recovery Rides on the ‘G-2’, by Robert B. Zoellick and Justin Yifu Lin, about how a strategic partnership between China and the U.S. could shed light during this dark crisis.

In their view, the two economic powerhouses must cooperate to drive the Group of 20 so as to help the world’s economy to recover. They pointed out that the broader international payment imbalances are fueled by both over-saving in China and over-consumption in the U.S. If the two countries join forces to launch stimulus packages and economic dialogues that address those imbalances, it will “go a long way towards reducing the risk of global economic turmoil.”

Italy's Stimulus

Italy has had three stimulus packages to date: One announced last November, worth 80 billion euro over 3 years (though some analysts say it recycles some money which would have been spent anyhow). The second, announced in February 2009 for 2 billion euro, targets assistance to the car and household goods industries. The third, announced in March and worth 1.3 billion euro, will build a bridge to the island of Sicily and increase welfare aid.
 
The first stimulus package highlights tax stimulus: "The package includes tax cuts worth 2.4 billion euros for poorer families and pensioners; tax breaks for companies; a delay in the payment of VAT; a reduction in advance tax payments and speedier reimbursements of excess tax payments." Also, underwriting bond issues for banks: "The Treasury can underwrite, at the request of the banks, financial instruments issued by listed banks that do not carry voting rights. These instruments may be bonds that can be converted into shares at the request of the bank. The banks can redeem or repay the bonds providing the Bank of Italy does not think such a move would impact the bank's solvency."
 
The second package offers discounts of up to €3,000 for drivers who scrap cars at least a decade old to buy new models with lower-carbon emissions. Also announced are incentives on washing machines and other home appliances.
 
Other industries are upset, for example the high-fashion industry. Why not us, they say? We are big exporters. 
 
Indeed, why not?

Summers on Global Imbalances

Larry Summers in the Financial Times: "The old global imbalances agenda was more demand in China, less demand in America. Nobody thinks that is the right agenda now. There's no place that should be reducing its contribution to global demand right now. It is really the universal demand agenda." See commentary here.

Korea Plans to Introduce More Labor Flexibility

Reading through the stimulus packages, one consistent theme (no, it's not bailing out rich bankers) comes out. Countries are trying to ease the environment for doing business.
 
Korea's package is quite explicit. "The government is to streamline and reduce excessive regulations regarding environment, land use, and labour issues." More specifically, "Revision bills on labour market flexibility to be submitted to the National Assembly soon, after consultations with stakeholders. The government aims to submit the amendment within this year."
 
Indeed, recent research has shown that flexible labor regulations reduce informality. See, for example, Djankov and Ramalho's paper in the latest Journal of Comparative Economics issue. No wonder the Korean government is trying to prevent a rush to informality as a result of the crisis.

Singapore's Stimulus Package

I spent the weekend looking through some stimulus packages, and was impressed by the clarity of Singapore's. The summary is here. I also like the name: the Resilience Package.
 
Main points:

• Jobs Credit: Companies will receive a 12 per cent cash credit against employee salaries, up to a salary of $2,500, which is the median income. This is paid out at the end of the quarter for all preceding months that an employee was salaried.
• Skills Upgrading and Resilience: The government will pay 90 per cent of retraining fees, as well as an hourly lost productivity rebate, to keep employment while new job training takes place.
• Corporate Tax: The main rate is being dropped from 18 per cent to 17 per cent, with the effective rate estimated at 15 per cent.
• S$4.4b will be spent on infrastructure, health and education improvements.

Will The West Bail Out the East (in Europe)?

Absolutely. No question. Over the weekend, the heads of European Union states met in Brussels to voice their unity against protectionism and to discuss a possible aid package for the badly-hit Eastern members. Neither goal was fully achieved. (Read the BBC article on the meeting.) 
 
On the aid package, there were vague statements of support but no specifics. This will undoubtedly come. Western European banks cannot afford to have a collapse in the East. Their exposures are too large. So lobbying will be intense. And in the grand scheme of European things, the aid package would not represent a large part of what has already become a year of dishing out money left and right. Might as well do it. It will be good for a united Europe, and it will be good for business too.
 
So the question is when, not if.

Tax Stimulus Gathers Speed

As the crisis deepens, more and more governments resort to tax stimulus. On February 25th, China announced cuts in value-added taxes for metals exporters. This is in addition to the $17.5 billion in corporate income tax cuts announced last November. A week earlier, the Czech government announced cuts in social contributions (which are similar to payroll taxes), worth $1.3 billion. The goal is to save 70,000 jobs. The same week, Australia unveiled $3 billion in income tax cuts.

In January and February alone, 22 countries announced various tax stimulus measures: ranging from cuts in social contributions (Germany, Denmark, Finland, Norway, Vietnam, Latvia), cuts in value-added taxes (Israel, Singapore), tax rebates on payroll taxes (the United States), income tax reductions (Korea, Japan, Brazil, Chile, Mexico, India, Indonesia), and lower taxes for small businesses (Canada, the United States, Germany, Italy, Thailand).

The stimulus varies in relative size from country to country. In Finland, for example, 40% of the 2 billion euro package is slated for cuts in social contributions. In the US, 37% of the $787 billion package is tax stimulus. In Japan, it is 21% ($111 billion of $516 billion). In Brazil, tax stimulus represents about 7% of the $283 billion.

Trading Places: China and the US

World Bank President Robert Zoellick gave opening remarks at the FPD Forum, and much of it recapped the work of the World Bank so far in relation to the crisis. One-forward looking remark really caught my attention, though. Zoellick noted the variety of stimulus packages out there - in broad brush strokes, the US is favoring consumption, while China is favoring investment. In the long run, these two countries will have to trade places, with the US switching to greater levels of investment and China switching to greater consumption.

Update: Zoellick, along with World Bank Chief Economist Justin Lin, expands on this idea in an op-ed in the Washington Post.

Revising the Balance of Consumption

Marinus Verhoeven, a lead economist in public sector governance at the World Bank, raised an interesting question to my earlier post, Living in a Madoff World:

I am not sure excess provides a good framework for thinking about the crisis...It may have had something to do with inadequate control of the money supply, misguided legislation, and an unequal distribution of wealth, but excess consumption--no, I don't think so...The second issue is more controversial...is there a moral dimension here?.

This got me thinking.  So, here's my response. I was using excess as metaphor for bubbles we have had in real estate, in consumer spending, in leveraging, and so on...and excess consumption too.
 
Like most economists, who first look for a phenomenon and then go find a theory to fit it, let me try the same here…
 
Over the last decade, many countries became frugal, some by their demographics such as Japan, others by choice like the middle income countries (MICs), which, afraid of exchange-rate volatility, ran precautionary current account surpluses and accumulated large stocks of foreign reserves. And yet others like China where a combination of demographics, exporting more and spending less, induced large savings.

Remittances: Not as Bad as Predicted

Writing on the World Bank People Move blog, Dilip Ratha points out that not all the dire predictions about the crisis have come to pass. At least in the cases for which we have data, remittances have proven resilient. Mexico - one of the most important recipients of remittances and a country for which there is good data - is a case in point:

Remittance flows to Mexico dropped 10 percent year-on-year in December 2008, bringing the 2008 12-month total to $25 billion, a 3.6 percent decline compared to $26 billion registered in 2007. This decline is much smaller than the 8 percent decline projected by Mexico in August 2008.

As long as this is not a blip on the screen, remittances should help cushion the blow of the retreat of other forms of private capital flows. The Institute for International Finance warned late last month that "the outlook for private capital flows to emerging economies has deteriorated significantly in recent months." The fate of stimulus packages in rich countries consequently becomes all that more important for the rest of the world, as migrants will have a hard time keeping or finding jobs in the face of rising unemployment rates. 

Kaufmann Takes Aim At Corruption

Dani Kaufmann, one of the pioneers of the governance agenda at the World Bank, discusses the role that corruption played in the financial crisis:

There are multiple causes of the financial crisis. But we can not ignore the element of "capture" in the systemic failures of oversight, regulation and disclosure in the financial sector. Concrete examples abound.

First, the way Freddie Mac and Fannie Mae spent millions of dollars lobbying some influential members of Congress in exchange for, among other things, lax capital reserve requirements for these mortgage giants.

Second, how AIG's "small" derivatives unit located in London managed to obscure its accounts, be governed by lax regulatory oversight, and take inordinate risks that effectively brought down AIG's empire of 100,000 employees in 130 countries, accelerating the global financial crisis...

Third, how giant mortgage lenders such as Countrywide Financial switched regulators so to fall under the lax oversight of the Office of Thrift Supervision, which was funded by fees paid by the regulated banks (and which also supervised AIG's derivative unit).

Fourth, how in April 2004, during a 55-minute-long meeting at the Securities and Exchange Commission, the largest investment banks persuaded the SEC to relax its regulatory stance and allow them to take on much larger amounts of debt.

Finally, Madoff's giant Ponzi scheme, some of which appears to be plain fraud, though system-wide irregularities also point to subtler forms of corruption and capture. Years ago the SEC knew that Madoff, who had served on the commission's own advisory committee, had multiple violations and was misleading it in how he managed the funds of his customers. Yet the SEC failed in unmasking the Ponzi scheme.

Worse yet, more governance challenges are yet to come, as fiscal stimulus packages present all kinds of opportunities for the ethically challenged. Kaufmann recommends far-reaching measures to improve transparency as an antidote. I agree with that but doubt that's enough.

A Broken Record on East Asia

James Seward, a financial sector specialist working in East Asia and Pacific, admits that he is "beginning to sound like a broken record." Unfortunately, he has good reason. Most of the recent news coming out of East Asia does not sound good at all. Seward reports the following scary news on the East Asia and Pacific blog:

Banking problems are now increasingly expected to begin emerging across East Asia. Fitch just released a report that Chinese banks’ expected losses are mounting and projected that the loan losses would be 6 percent or more by end-2009. However, this was hedged by stating that “there are concerns with weaknesses in the banks' loan classification, the rise in hidden credit risk, and uncertainties about the reliability of collateral and guarantees, which may be contributing to widespread under-capturing of Chinese banks' credit risk exposure.” The Chairman of the banking regulator, the China Banking Regulatory Commission, stated that there will be a “reasonable tolerance” for rising bad loans in the banking system this year. Also, the various announcements by governments to push commercial banks into supportive lending may also result in additional problems.

In addition to nascent banking problems, countries across the region are seeing painful declines in trade accompanied by hits to employment. Perhaps most telling, Seward reports that some 1/3rd of crains in Singapore are sitting idle. Trade statistics see a delay of some months - crains don't. As for rising unemployment, the lunar new year is not looking too bright:

...about 10 million migrant workers [in China] lost their jobs by November, and many migrant workers are returning home for the lunar new year on one-way tickets. To round out the bad news on China, in December housing prices dropped for the first time on record and construction is projected to shrink by 30% this year.

Governments across the region continue apace with fiscal stimulus plans. How much of this will take the form of increased spending and how much the form of tax cuts? Seward doesn't offer a breakdown, although the repeated use of the term "infrastructure" suggests that most if not all will be in the form of increased government spending. If this is the case, hopefully these countries won't run into the kind of problems of 'disappearing money' that Simeon Djankov warns about in Bulgaria.

Dire Straits

Hopping into a taxi at Sofia airport, it is as if I go back to the mid-1980s: the radio is playing Pink Floyd's The Wall. I have long noticed a strange regularity about taxis in Bulgaria: they always play 1980s music: Pink Floyd, Scorpions, Queen, Dire Straits. During our latest trip last summer, my wife (an American) noticed this too. So it's not my imagination. I also see this pattern in other countries in Eastern Europe - for example, the Czech Republic, Poland, FYR Macedonia.
 
This is the music I grew up on, so I like it. But I struggle for an explanation. Surely there is some decent music that has come since. And one could go back to the Beatles, the Doors, etc. I can come up with two explanations: either the radio is controlled by people of my generation, who do it for fun; or there is a general sense of nostalgia towards the high years of socialism (before it started crumbling). For the mid-1980s was a fun time, at least in Bulgaria. Full employment, an overall sense of security, good education.
 
I was hoping that for the sake of the region, I would be increasingly limited to listening to The Wall at home. But the unfolding economic crisis may increase nostalgia for the "good old times" and it may be all Dire Straits in the next few months/years.
 
The signs are around. I spoke to a software producer who said that demand for his company's products is down 15% relative to January 2008, and that payments on finished work are down 60%. That is, clients are trying to stretch payments so accounts receivables are accumulating. Some of these presumably will not be paid as clients go out of business. And this is in a sector which is supposed to be among the most crisis-resistant. Imagine what is happening in construction.
 
Fortunately, the music of that age offers some good anti-crisis advice. See, for example, the refrain in Money for Nothing (Dire Straits, 1984):

We gotta install microwave ovens
Custom kitchen deliveries
We gotta move these refrigerators
We gotta move these colour tvs, lord

In other words, increase household consumption. The lyrics stop short of recommending tax vs fiscal stimulus. Unless they are really deep and the title "Money for Nothing" suggests fiscal expansion will be wasted.

The Big Dig

Georgi Angelov (Open Society Institute, Bulgaria) alerted me to two interesting blog posts on the deficiencies of large fiscal expenditure projects. One is by Gary Becker (Chicago) and argues that "recessions are a good time to increase infrastructure spending only if these projects can mainly utilize unemployed resources. This does not seem to be the case in most of the so-called infrastructure spending proposed under various stimulus plans." The other post is on a paper by Linda Bilmes (Harvard) looking at the fiscal stimulus in light of Katrina, Iraq and the Big Dig (the largest US infrastructure project, in downtown Boston). The point here is that these projects took a long time to get off the ground, and lots of money was wasted.
 
Cheers to big spenders.

How Useful is Fiscal Spending Really?

If you hire your neighbor for $100 to dig a hole in your backyard and then fill it up, and he hires you to do the same in his yard, the government statisticians report that things are improving. The economy has created two jobs, and the GDP rises by $200. But it is unlikely that, having wasted all that time digging and filling, either of you is better off.

 

This is an example from a fun Gregory Mankiw article in the New York Times. Mankiw's main argument is that expanded government spending is less useful in crises than usually thought. The multiplier for government spending is not very large. The best evidence comes from a recent study by Valerie A. Ramey, an economist at the University of California, San Diego. Based on the United States' historical record, Professor Ramey estimates that each dollar of government spending increases GDP by only 1.4 dollars. So, by doing the math, we find that when the GDP expands, less than a third of the increase takes the form of private consumption and investment.

 

In contrast, a recent study by Christina D. Romer (the Obama appointee to head the Council of Economic Advisors) and David H. Romer, then economists at the University of California, Berkeley, finds that a dollar of tax cuts raises the GDP by about $3. According to the Romers, the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases.

 

This is why tax stimulus is starting to be discussed more and more as a good crisis response. To see a recent calculation of how it can work, see my paper Tax Incentives as Crisis Response with Georgi Angelov.

Tomorrow's Trade

Editor's Note: Caroline Freund is a Senior Economist in the Research Department of the World Bank and runs a research project on the effects of the economic crisis on trade.

Tension is developing between trade and employment policies in some countries. The need to reduce costs and improve profits has pushed many companies to restructure production globally, with the result of increased foreign outsourcing. For example, Dell, the world's number two PC maker, recently announced plans to shift manufacturing from Ireland to Poland to cut costs. The monthly minimum wage is over $2,000 in Ireland, compared to $406 in Poland.

Other firms that are reportedly planning to expand outsourcing in emerging markets include: the major entertainment company Warner Brothers, Ireland's Wedgewood, and Japan's Renesas. Financial companies - which already account for about 25 percent of revenues of the large Indian service offshoring companies Infosys and Wipro - are also expected to increase outsourcing to cut costs. This fragmentation of production will help firms improve productivity, while softening the blow of the financial crisis on low and middle income countries, which gain both jobs and technology. The allocation of resources around the world will be improved, leading to gains from trade.

However, government policies are countering this force. The incoming U.S. administration has signaled an end to tax breaks for companies that outsource abroad and promised tax credits to companies that maintain or increase U.S. workers relative to those abroad. In France, state aid will not be offered to
auto companies that plan to shift jobs to lower wage countries. Lou Dobbs, among others, is calling for similar restrictions on a U.S. auto package.

Even without restrictions, industrial subsidies are a threat to trade. They are contagious, and could result in a subsidy war that would leave everyone worse off. (See, for example, a recent article from Jagdish Bhagwati in the Financial Times on this type of scenario.) In addition, they pull resources away from more productive uses. It's not just the industrial countries at fault. Recent trade policy reversals in the developing and emerging markets are also of concern. At least 15 (including Brazil, China, India and Russia) have plans to expand protection in some sectors.

Yes, creating jobs and maintaining income during the downturn is crucial. But this is a global recession. World leaders should choose policies that stimulate domestic demand, without inflicting pain on others.