Eradicating World Poverty: Inspiring a New Generation to Act

This is a summary of a Davos session on "The Post-2015 Goals: Inspiring a New Generation to Act" on the eradication of world poverty and the millennium development goals. It featured, among others, David Cameron, Bono, and Ngozi Okonjo-Iweala (the Nigerian Finance Minister and the most impressive person I heard at Davos):

• David Cameron: tackling poverty is a holistic issue. We can't tackle poverty without tackling climate change, governance, corruption, justice, democracy, gender equality. Many of these reasons are why North Korea is poor but South Korea is rich
• Growth is insufficient. It must be in areas that create jobs for poor people (e.g. agriculture, housing), and we must create a social safety net
• People want two things: a job, and a voice. Can't just focus on the former
• As a result, the Millennium Development Goals (established following the 2000 Millennium Summit of the United Nations) cover eight different areas:
• Eradicate extreme poverty and hunger
• Achieve universal primary education
• Promote gender equality and empowering women
• Reduce child mortality
• Improve maternal health
• Combat HIV/AIDS, malaria, other diseases
• Ensure environmental sustainability
• Develop a global partnership for development
• Bono: I write lyrics like I write poetry. But, goals must be the opposite: hard and precise.
• Bono: 
• We should get out of the way of poor people. Ask them what they want, rather than presuming that we know
• Capitalism can be a great creative force, but also a great destructive force. Even if it's not immoral, it's amoral
• Bono: to me, transparency is even more important than debt cancelation
• If a firm is registered on the NYSE, it must publish what it pays executives. But, declared and actual pay is different. 
• Companies always lobby against transparency. The American Petroleum Institute lobbied against the Extractive Industries Transparency Initiative, which requires oil, gas, and mining companies to disclose the payments they make to governments for extractive projects
• The government must also be open. The question shouldn't be "are we open for business?" but "are we open"?
• Ngozi Okonjo-Iweala (Nigerian Finance Minister):
• Nigeria is forward-thinking compared to the rest of Africa, but shouldn't try to be an oasis in a desert, because the desert always wins
• Africa needs to move beyond extracting resources and use them to create wealth and equality
• Nigeria's policies are targeted. Use conditional cash transfers to encourage kids to attend school. Don't just receive aid, but use it to leverage private sector resources better
• We write off whole countries when there's a bit of sectarian conflict. But, even in such countries, we can try to get kids into school. As peace is being brokered, the next generation can get an education
• Cameron: 
• I reallocated the aid budget from India and China to other countries. India and China have resources to help themselves
• Some of the fastest-growing countries in the world are in Africa. But, there's lots of red tape hindering trade between African countries. Thus, lots of infrastructure has been build to export goods out of Africa, rather than trade within Africa
• Ngozi: gender inequality isn't limited to developing countries. Only 15% of Davos is female. But, because Nigeria is poorer, we can least afford it. I have to take the bull by the horns
• Girls' literacy is key. With the UK's Department For International Development, we pioneered conditional cash transfers to get kids into school. Attendance rose 40%
• Ngozi: everyone agrees we should invest in developing countries
• But, we typically think of investment being in hard assets - building schools and infrastructure
• We need to invest in soft skills: training midwives, teaching a mother to give water to a baby with diarrhea
• An educated woman has 2.1 kids, an uneducated woman 8.9
• Cameron: the UN must agree on a set of specific, measurable, inspiring goals that apply to everyone. We shouldn't have separate goals for the rich and poor. Anti-corruption, justice, transparency are goals for all countries
• Jasmine Whitbread (CEO of Save the Children): goals are universal, but the strategy to achieve them may differ across countries. 
• Tidjane Thiam (CEO of Prudential): we don't want to talk about Africa changing. Africa is still the same - it's weather and resources are the same. Instead, we want to talk about Africans changing - a change in people's attitude
• Bono: next year will be the 30th year of Live Aid. I hope that Bob Geldof and I are just guests - that we won't need Live Aid any more

Davos in a Nutshell (Part 2)

Here are key takeaways from additional sessions I attended in Davos. The last blog mainly covered sessions that were statements of fact (e.g. current economic indicators); here I cover sessions on which there was an exchange of opinions - in particular, different viewpoints around the world on what economic policies to adopt.

Economic Policy Around The World

• Mark Carney became governor of the Bank of England and adopted forward guidance - indicated that he would not raise rates until unemployment fell below 7%. He expected this to take 3 years, but it's likely to take 6 months - unemployment is currently at 7.1%. 
• Thus, just before Davos he issued a statement saying he wouldn't automatically raise once unemployment fell below 7%
• Since then he's said that he will use the output gap (the difference between actual GDP and potential GDP), rather than unemployment to guide policy
• Geoff Cutmore (CNBC anchor, moderator of this session): is this back-tracking a sign that monetary policy has failed?
• George Osborne: no. We're only discussing this because unemployment has fallen rapidly to 7.1% - because the exceptionally supportive monetary policy has worked
• 7% was never going to be a trigger for action, merely a threshold - one of many things that the Bank of England would consider when deciding whether to raise rates
• Moreover, the interest rate isn't the Bank of England's only tool. It has tightened the mortgage approval process and used the Funding For Lending scheme. The Bank of England is second to none in having all the relevant tools at its disposal - the interest rate and a variety of macroprudential tools
• Larry Summers: I'm worried about macroprudential complacency, due to human error
• Governments missed the 1987 stock market crash, the 2007 financial crisis. 
• Spain's countercyclical capital requirements didn't protect it against the real estate bubble
• Thomas Jordan (governor of Swiss National Bank): we don't do forward guidance, but this doesn't mean it's bad. Different policies are good for different countries. 
• Switzerland targets the exchange rate 
• Also has tried to rein in the property bubble through bank capital regulations, rather than interest rates
• Cutmore: the UK has seen a fall in the savings rate, and a housing market recovery, but no increase in exports nor productivity: rapid fall in unemployment despite modest rise in GDP suggests productivity hasn't risen. Growth has been bubbly, not balanced. 
• Osborne: the job is indeed only half-done. But, the progress has been good. The recovery has indeed been generated by the consumer, but income-generated, not debt-generated. Now we must hand over to business investment and exports
• Haruhiko Kuroda (Governor of the Bank of Japan): Abenomics contains three arrows: 
• Flexible fiscal policy: short-term fiscal stimulus, but the government aims to eliminate the deficit by 2020
• Supportive monetary policy: Quantitative and Qualitative Easing (QQE)
• Structural reforms
• Kuroda: Abenomics has worked so far. It aimed to achieve a 2% inflation target in 2 years. We're 9 months in, and consumer price inflation is at 1.2% (excluding fresh food)
• There's still a way to go; it's premature to discuss tapering. But, we're watching how other banks (e.g. Fed) are managing the tapering process
• The Fed only started tapering the second time around. The first time around, it blinked: in September 2013, Bernanke decided not to taper. In December, it reduced QE by $10bn/month to $75bn, and said it would wind down QE by end of 2014
• Monetary policy shouldn't be conducted in isolation. As we taper monetary policy, we can't do too much fiscal contraction 
• Larry Summers: 
• We are way better off than in 1929 due to good policy, but growth has only kept pace with population growth
• We have significant structural issues: structural unemployment leads to hysteresis, meaning that US output is way less than potential. 
• We don't know how to have sustainable growth. The growth in 2003-6 was said to be good because unemployment fell without inflation rising, but this was due to credit expansion and a fall in lending standards. 
• Summers: the good news of the past year allows us to shift focus from the public deficit to other deficits in the economy, such as the public investment deficit
• Construction unemployment is in double-digits. The US can borrow for 30 years at 3% in a currency that we print ourselves. Why not fix JFK airport?
• We spend 25% less on life sciences than 5 years ago. That's a deficit too
• Deficit isn't just financial debt, but other debts we bequeath to future generations
• Jordan: businesses will only invest when the feel confident; the near-death of the Euro made this much harder. Policymakers can't force a company in a free market to invest, but they can do everything to create conditions that support investment.
• Cutmore (to Osborne): Why are businesses not investing? What do they fear?
• That your government won't be around to follow through on its policies?
• The U-turn on forward guidance, which creates policy uncertainty?
• Osborne: we're building nuclear power stations and investing in fracking, which other governments aren't. The UK is prepared to take difficult decisions

Rebuilding Banking in Europe

• A few months ago, probability of Italian default was 40%; the world had stopped funding some European firms. Credit default spreads were high, liquidity and bank capital were low
• So we've come a long way in a short space of time. The ECB took decisive action, and fiscal policy became more credible
• Tail risks (e.g. fear countries exiting the Euro) have been alleviated. As of January 2014 we now have more members of the Euro (Latvia has joined, so now 18 members) not fewer
• But, there's still a long way to go
• Anshu Jain (Deutsche Bank): 3/4 of credit in Europe comes from banks, not capital markets, so banks are key to the health of the overall economy
• While the European economy has recovered a little, this hasn't manifested in greater lending, either to businesses or households. Some people think that one more push (e.g. the Asset Quality Review) will finally get lending going again. 
• But, this is wishful thinking. The problem isn't insufficient supply of loans (we've already had a huge fall in bank funding costs which has increased loan supply), but an insufficient demand for loans. 
• Businesses won't demand loans for investment while there's still uncertainty over policy, and uncompetitive labor markets. 
• The European Central Bank will be the single regulator of all banks in the Eurozone from 2014. It will conduct an Asset Quality Review throughout Europe to "stress test" banks' portfolios, to see if banks are healthy.
• Are you worried that it will unveil severe problems? Jeroen Dijseelbloem (Dutch Minister of Finance): I hope so! We want to find problems so that we can fix them. 
• Having banks fail will show that the stress tests were done seriously. Europe first did some stress tests in 2010, but they were viewed as not tough enough. National supervisors did them independently, with little coordination. Thus, they had incentives to hide problems. This is why Ireland and Spain didn't fail more banks
• However, we must realize that stress tests aren't a panacea. They can't tell you definitively the quality of a bank's loan portfolio - this quality keeps changing. This is why bank capital is necessary, to help prepare for the unpredictable.
• Interbank lending is low, even with in Europe. The world's willingness to lend to European banks is also low. A stringent stress test will encourage lending to banks that pass the tests.
• Lord Adair Turner (former Chairman of the UK Financial Services Authority): the US's stress tests in 2009 were very successful as they were stringent. Also, it was very clear what would happen if a bank failed: it would be given a certain number of months to raise capital privately; if it failed to do so, there would be a public recapitalization.
• Dijseelbloem: but EU does have a clear set of next steps if a bank fails the stress test. It will be given time to deal with its problems. If unsuccessful, it must engage in a "bail-in", where existing bondholders see part of their debt written off (this happened in Cyprus). Only if it's undertaken a bail-in can it request government funds as a last resort. If the government can't recapitalize the bank because  it's too big, it will have to request a loan from the European Stability Mechanism, the eurozone's government bailout fund.
• December 2013: EU finance ministers created a Single Resolution Mechanism. It imposes levies on banks to build up national resolution funds, which will be gradually merged over 10 years into one European pot worth €55bn. This will act as a financial backstop
• When a bank fails, its shareholders and creditors (rather than the taxpayer) should pick up the bill. But, the resolution process may require outside funds, e.g. to recapitalize key parts of a bank before selling it, or provide liquidity. This is what the backstop is for
• While the resolution funds are being built up, the backstop will be the national government (and thus the ESM if the government has insufficient funds)
• €55bn pot criticized as being too small. The Spanish bailout cost €40 bn, ant that's only one country
• But this fund is only the last line of defense. We have been building up other lines of defense. Bank capital is the first line of defense, and banks have been recapitalizing. We also have national resolution funds
• Lord Adair Turner : we need to go further than the mutualization of a guarantee scheme
• We need a single banking union, just like in the US. It's not the case that New York banks just lend to New York, and New York depositors rely only on New York for deposit insurance
• We can't just close down a very large bank that's failing. We will need to put in public capital. This is why the Resolution Fund (financial backstop) is key. Until the fund is in place, we're still in danger
• In the US, there's a pan-US response if a bank fails. In Europe, it's a national response
• Trust is a huge issue in banks at the moment:
• LIBOR and Forex benchmark manipulation
• Commission-oriented salespeople sold Payment Protection Insurance that wasn't needed
• Banker bonuses despite losses
• David Rubinstein (Carlyle): not clear that popularity is the relevant criterion. Even in good times, the public never loves banks or PE. Unlike Apple or Starbucks, most people's relationship with banks involves paying fees 
• Lord Turner: the collapse of the financial system isn't a problem just for industry, but also for regulators and academic economists
• Policymakers used to think that more innovation, more efficiency is always better - they overly believed in market efficiency
• Central bankers thought the financial system unimportant for the real economy
• Most academic models don't contain a financial sector

Coperation Between China, Europe, and the US

• Theme of session: these are the three largest economies. If they can work together, we can guarantee global growth and world peace. But, how can we foster cooperation?
• Nick Clegg: GATT reflected the old world order. Now, the balance of power has shifted from the west to the east. Thus, trade agreements are bilateral, not global
• Must ensure regionalism and bilateralism don't undermine multinatinoal agreements
• Lloyd Blankfein: trade is always a win-win. Everyone has a stake in everyone else. If oil is discovered anywhere in the world, it's best for the country that discovered it, but it's good for other countries too. The same goes for growth: any growth in the world is good for the rest of the world. 
• China will grow, but we have to manage our expectations. This is quite natural - if China would definitely grow and there are no risks involved, the market would be inefficient
• Angel Gurria (Secretary-General of OECD): it's OK to build brick-by-brick, as long as bricks fit into a coherent bubble
• Agreements should be not just on trade, but intellectual property rights and procurement
• State-owned companies must be on a level playing field with private companies. Common labor and disclosure rules. Need to pay dividends to the Ministry of Finance
• Joseph Nye: we must include Japan in these discussions, and not let tension between China and Japan get in the way
• Clegg: any open economy requires China; the UK is one of the most open economies. Chinese investment in the UK in the last 18 months has exceeded the investment in the prior 30 years
• Thus, UK must stay in the EU to be able to negotiate with clout with countries like China. UK is 60m people, Europe is 500m. 
• Clegg on trade: there's no future in protectionism, but we need to be true to our values. We can't ignore human rights.
• It's insufficient to sign up to new agreements; we must adhere to them, and have teeth in case countries don't adhere
• We've gone beyond haggling tariffs; we're now discussing norms and standards
• Should China see its future with the BRICs rather than the west, because the west isn't growing so fast?
• No, that would be very short-sighted. The US will still be huge. Even though China GDP will soon overtake the US's, China GDP/capita won't for a while, and this is a measure of economic effectiveness.
• Clegg: China should recognize that it's own future depends on sustainability. It can't ignore the environment
• Gurria: China is a big user of coal, which is very bad for the environment.
• China is so large that any actions that it take have global implications.

Challenges Facing US Competitiveness

• The World Economic Forum ranks the US #5 in global competitiveness, up from #7
• There are concerns that the government should stay arm's length with the private sector
• Michael Porter: 
• The US faces structural competitiveness challenges. The few jobs they are generating are in areas insulated from international competition, suggesting that the US is losing international competitiveness
• The problem isn't that the US doesn't have strengths (it has science, technology, entrepreneurship, innovation) but that it has allowed weaknesses to crop up: regulatory complexity, poor infrastructure, public education, tax complexity. Complying with regulations costs $17tr, $10k per employee. The tax system is so complex that companies would rather invest overseas
• Glenn Hutchins (Silver Lake): 
• There will be a global equalization of wage rates as China, former Soviet Union come into competitive markets. This will push US wages down, so wages may not be there to support consumption
• Employment has to be reformed. Unemployment benefit is not means-tested
• There's great opportunities to do trade agreements - no President since FDR has had such ability to negotiate trade, but little has been done.
• Healthcare costs are out of whack; Obamacare didn't get at the cost structure.
• The US will gain 35m workers, of which 43m (> 100%) will come from immigration. China will lose workers due to its 1 child policy
• Eric Cantor (House Majority Leader): we believe in a global economy as it reduces costs for consumers, but access to the US market requires reciprocity in turn
• Porter: the US is complacent. We think we're rich and will be rich foerever, while other countries are fixing regulation, investing more
• Unfunded Medicare liabilities seriously worsen the deficit
• Need to transfer from Defined Benefit to Defined Contribution pension plans, but the president won't go there

Davos in a Nutshell

I was very fortunate to have had the opportunity to attend the World Economic Forum in Davos last week, co-leading a session entitled "Making Better Decisions" on behavioral economics. My focus is mainly on microeconomics, and so I was grateful to learn about the current macroeconomic climate from leading policymakers, executives, and commentators. I wanted to create this posting to share what I learned. I will subdivide the post into different categories, but there will naturally be some overlap.

European Economy

• General upbeat mood, as tail risks (e.g. likelihood of collapse of Euro) have been significantly reduced
• But, more a feeling of relief (absence of negative news that people feared this time last year) than optimism (presence of definitively positive news)
• Europe looks solid only compared to recent poor performance
• The US has done much better than Europe. Unemployment is below the pre-crisis level, the stock market is higher, and GDP is higher. In Europe, Germany is the only country that satisfies all three criteria
• Euro-area GDP growth at 1% is still anemic, and uneven across the Euro-zone: concentrated in the poorest countries
• Short-term growth has resulted from monetary and fiscal stimulus. Long-term growth will depend on structural issues: technology, innovation, trade, supply-side factors, which are weak
• Structural reforms needed to address these supply-side issues, but governments are notoriously sluggish
• Youth unemployment is a major supply-side concern in many countries: > 50% in Spain and Italy, 25% in France. Failure to get a job a year or two after leaving school / university substantially reduces the chance of getting one later
• Some technological changes (e.g. 3D printing) will lead to a substantial loss of jobs in some sectors, but the creation of jobs in others. Governments should be prepared
• Short-term risks
• European Parliament elections could see some Euro-skeptics being elected, which may have similar effects as the Tea Party in the US
• Imminent Asset Quality Review of European Banks; some may not pass
• Is more regulation is the optimal solution to a financial crisis?
• Axel Weber (UBS): Some regulations (on leverage and the banking system) were indeed necessary. Taxpayers were uncomfortable with the amount of risk that was being taken. But, need to remember that the goal of the banking system is to foster growth (by lending money), so we mustn't over-regulate
• Same applies to non-finance regulations. Freeing up access to data (e.g. medical records) can be helpful for growth
• Sir Martin Sorrell (WPP): best regulatory change would be to increase labor market flexibility. Firms are unable to lay off workers without excessive severance pay, so they don't hire to begin with

Deflation Concerns

• All OECD countries (except Turkey and Hungary) are below their inflation targets
• Why is deflation bad? 
• Households will postpone purchases if they think prices are going to fall
• Real (i.e. inflation-adjusted) debt rises when prices fall. This makes borrowers even more in debt, and makes them less likely to spend. The government is a major borrower, and deflation increases the real amount of public debt
• For the above reasons, low inflation may cause weak economic growth, rather than merely being a symptom of weak economic growth
• OK, I understand that negative inflation is bad, but shouldn't we target 0% inflation, not 2% inflation?
• Quality of goods rises over time, so 2% inflation is really 0% inflation, and this is not fully captured in updates to inflation calculations 
• Positive inflation allows real wages to fall even if nominal wages don't fall
• Some may argue that low "headline" inflation is because shale revolution has driven down energy prices, but "core" inflation figures (which exclude energy prices) are also low
• Policymakers feared that Quantitative Easing would lead to inflation, but QE has had a much bigger effect on the prices of financial assets (e.g. stocks) than real goods and services
• Major cause of deflation is debt overhang: firms have so much debt that they have few incentives to invest
• We don't know how to cure debt overhang, we only know how to move debt from the public sector to the private sector
• View that debt overhang is important suggests that the demand side, rather than the supply side, is key to avoiding deflation
• Monetarists (who advocate focusing on the supply side) predicted that quantitative easing would lead to inflation. But it didn't, it only reduced downside risks. This shows that demand-side considerations are important
• Economies only grew in the last decade due to debt. Private credit grew much faster than GDP. UK household debt/GDP was 15% in 1964 and 95% in 2008. Policymakers don't know how to growth without taking on debt
• Germany was the only country we could think of that has grown without debt, but they have grown due to a current account surplus: China has taken on debt to buy German goods. Thus, they've also required debt to achieve growth
• Earnings haven't yet risen, which is one of the key drivers of inflation
• Good deflation is where prices fall relative to wages, but here we have low wage growth
• Even though UK and US unemployment data are good, wage growth is surprisingly weak
• Yen fell in 2012 in anticipation of QE; Pound fell in 2008 for the same reason. Led to inflation the following year since input prices rose. Similarly, it led to other countries having falling inflation. Thus, QE in one country "exports" deflation elsewhere - it passes on the problem
• But, if all countries engage in QE together, this can stimulate the global economy.

European Bank Regulation

• European Central Bank will be a common regulator across all European banks
• Uncertainty over whether there will be a common deposit guarantee
• Further political reform, and fiscal union, will further solidify Europe, but there are many opponents
• Is the financial system safer now?
• Anthony Jenkins (Barclays): yes, we understand risk better now, and there's closer supervision. However, whether the system is safer is not the only important question; we must also ask if it supports growth.
• Anat Admati (Stanford): no. The changes that have happened have been like reducing the speed limit from 90 to 85. Financial crises aren't exogenous natural disasters (like hurricanes) that we can do little about; they are man-made disasters created by faulty laws
• Paul Singer (Elliott Management): no. Banks still engage in substantial proprietary trading; they are 10 times more leveraged than his own hedge fund, and don't understand their risks (e.g. complex derivatives).
• Douglas Flint (HSBC): Move risk into places that it's transparent and understood (e.g. banks) than leaving it with people who don't understand it (e.g. leave a small business vulnerable to exchange rate risk as it's unable to hedge itself using derivatives.)
• Anthony Jenkins (Barclays): Northern Rock (building society), HBOS, RBS (commercial banking) failed, and these were not active in derivatives. Derivatives are socially useful for risk management. 
• It's unrealistic to think that banks should just get rid of risk, as this is impossible. However clever people are with algorithms, you can't spin straw into gold - you can't turn risky stuff into a AAA bond. They can't eliminate risk, but they perform a useful function by taking risk off others' hands (even though this means that they end up risky themselves)
• Thus, the goal should not be for banks to be safe, but just to understand the risks they are taking.

French Economy

• GDP growth of 0.0% in 2012, fell 0.1% in Q3 2013
• Weak government fiscal position
• Government spending at 53% of GDP is highest in G7
• Debt/GDP was 91% in mid-2012, versus the 60% target in the Stability Pact
• Huge unfunded pensions. As US states are finding, pay-as-you-go is another word for a pyramid scheme
• S&P downgraded France to AA, Moody's to Aa1. Fitch downgraded France and upgraded Spain at the same time
• Since creation of Euro, France has grown 0.8%/year versus Germany's 1.3%
• Unemployment rate of 10.9% (versus 5% in Germany), highest in 16 years. Youth unemployment of 25%
• Rigid product and service markets according to OECD surveys
• Rigid labor markets
• Strong employment laws make dismissals hard. Dismissals often challenged in court; workers have long time window to contest dismissals
• High minimum wage (€9.53/hour), beyond the productive power of many workers
• 35 hour work week, 60 year old retirement age
• High welfare and unemployment benefits discourage work
• Unexpected worsening in current account deficit in November 2013. Exports weak due to
• Rigidities in product, service, and labor markets
• Weakness in key trading partners (Italy, Spain). France is heavily exposed to Europe due to trade linkages and banking system; Germany, in contrast, exports outside Europe
• Due to the Euro, France can't devalue to maintain competitiveness. An increase in prices combined with a constant nominal exchange rate leads to a higher real exchange rate
• Since Hollande's election in mid-2012, little action
• Responded indignantly to IMF, OECD calls for France to reform its budget deficits, claiming that outsiders should not tell France how to run its economy
• Muddled policies. Increased business tax relief, but also reversed some tax reliefs of previous government and increased income tax to 75% above €1m
• No efforts to improve investment, innovation, eliminate 35 hour work week
• January 2014 announced €30b of payroll tax cuts. "Responsibility Pact" that, if businesses invest in France and hire young and old workers, they will get more tax cuts and fewer constraints on business activity
• Goal is to create 1.8m jobs to cut unemployment to 7% by 2018
• Tax cuts are welcome, and show pragmatism (as Socialist governments are not typically associated with supply-side reforms). Big question is how to finance it. Government can't borrow, as France is already indebted. Announced €53b of spending cuts over the next three years, but few details. Hollande has shown he can raise income tax, but cutting expenditure is much harder