Having grown up in Cagayan, a province in the northeastern most part of the Philippines, our lives have always been defined by the wet and dry season as well as typhoons. My childhood memories are dotted with events when our village would be flooded or hit by typhoons. There were times when we had to evacuate and once permanently relocate following a catastrophic flooding of the province due to the swelling of the Cagayan River. My grandfather, then a tobacco farmer, would despair as his crops were frequently wiped out due to either flooding or drought. I recall that he once said that perhaps the seasons were also going senile (the popular saying in Filipino is “ulyaning panahon”) as they cannot seem to remember when they are supposed to occur.
The cliché of the single male jihadi took a blow last week when a Frenchman trying to reach Raqqa was stopped at an airport with his two daughters, ages four and two. This came days after reports that an entire French family of 12 had traded the northern city of Lille for greener pastures under the control of the “Islamic State” in the Levant.
The news echoes another exodus taking place at French airports: more than 5,000 French Jews – 1 percent of the community – made Aliyah to Israel this year amid a spike in anti-Semitic incidents at home. At a closed door meeting on anti-Semitism in Paris last week, officials estimated that only one-third of the 1,000 departures for Syria and Iraq are active fighters while the rest are making Hijra – a symbolic return migration to the holy lands of Islam.
Currently home to Europe’s largest Muslim and Jewish communities, 2014 France will be remembered as the year that record numbers of French Muslims and Jews heeded the old populist call to “love it or leave it.”
Does France deserve this grief? On the one hand, the French are part of a larger contemporary wave of cultural-economic malaise. But since France is suffering the worst of it, its political leaders should address the part of it they can control.
France is neither uniquely anti-Semitic nor is it the most anti-Muslim European country. The emigration waves reflect a pervasive social discomfort shared by many, adding a 21st century twist to the old concept of “circular migration”: Western Jihadis wend their way to the Islamic State, Ukrainian and Russian Jews flee to Israel and young Israelis move to Berlin. It’s a haunting game of musical chairs: sit down when the malaise stops.
Economic motivations also play a role in the decision to leave. In 2010, Germany was a net exporter of longtime residents who “returned” to Turkey in the context of growing anti-Muslim sentiment – and a Turkish economy that was growing at more than twice the German rate.
During the last major wave of anti-Semitic acts in 2002, French unemployment was under 8 percent (it’s 10.5 percent now). That year, Israel’s recruitment of French Jews paled in comparison to its success attracting almost 4 percent of the Jewish community candidates from Argentina, where the economy had collapsed. 6,325 Argentinians made Aliyah that year – nearly one in every thirty Jews – compared to 2,500 French citizens.
Today’s French Jews, traumatized by anti-Jewish riots and the second anti-Semitic murder spree by a French Muslim in two years, form the largest national group in the current cohort of immigrants to Israel. The reasons for leaving are different but the patterns are symptomatic of a French republican model under serious strain. In the context of estimated 40 percent unemployment rates for French Muslims, the 180 per million departures to the “Islamic State” is a tiny fraction but still twice the proportion of Libyan, Moroccan or Saudi citizens who have made their way to Syria and Iraq.
Unlike Germany, whose postwar vocation included “mastering the past,” French politics never fully digested the impact of the last century’s colonial and wartime history on the current political position of its minorities. As a result, Jews and Muslims in France feel more victimized by discrimination than any of their European brethren – despite the fact that Jewish and Muslim community organizations enjoy excellent access to policymakers.
Paradoxically, it is that very political clout and the embrace of outward signs of collective identity other than as French citizens – whether Islamic headscarves or Israeli flags – that remain the third rail of French politics. Feeling vulnerable, French minorities don’t see any advantage to forgoing a strong community identity. But organized lobbying groups are resented by those without the same influence and by republican purists for their resemblance to an American free for all. Recent surveys, however, suggest that American Jews and other ethnic groups feel less attached to their communities over time, not more so. Perhaps Aesop was right: the best way to get a man to remove his coat may be the warm sun, not a bitter wind.
If the current trend of self-exile and autonomy movements across Europe contains a lesson for policymakers it is that some form of devolution, whether for Scots in the United Kingdom or for Kurds in Turkey, is always preferable to dissolution. Just as the British political class visibly mobilized to persuade the Scots not to go, French leaders need to make a dramatic stand for pluralism in the Republic and demonstrate their commitment to win back their most alienated citizens before the drips become a flood.Authors
Hutchins Roundup: The Optimal Top Marginal Tax Rate, the Economic Benefits of Bankruptcy Protection, and More
What’s happening in fiscal and monetary policy right now? Here are this week's top pieces of research. We hope you find it useful.Optimal top marginal tax rate is close to World War II levels
Fabian Kindermann of the University of Bonn and Dirk Krueger of the University of Pennsylvania find that a 90% marginal income tax rate on the top 1% of earners provides the optimal level of social welfare. This result is primarily based on the increased level of social insurance benefits that the higher tax rate would allow.Credit availability has a big impact on auto sales
Using consumer survey data, Kathleen Johnson, Karen Pence, and Daniel Vine of the Federal Reserve Board conclude that vehicle financing conditions play a significant role in automotive sales – on par with factors like unemployment and income. This finding is important, as auto sales usually account for a disproportionately large share of the contraction of economic activity during recessions.Bankruptcy protection confers significant economic benefits
Studying a dataset of 500,000 bankruptcy filings, Will Dobbie of Princeton University and Jae Song of the Social Security Administration determine that Chapter 13 bankruptcy protection provides significant economic benefits to debtors. Comparing the outcomes of those granted protection and those whose cases were dismissed, Dobbie and Song find that Chapter 13 protection increased annual earnings by $5,562, decreased five-year foreclosure rates by 19.1%, and lowered five-year mortality rates by 1.2 percentage points.Chart of the week: U.S. bank revenues outpacing that of European banks Speech of the week: Rising college costs may prevent some from reaping the benefits of higher education
“Rising college costs, the greater numbers of students pursuing higher education, and the recent trends in income and wealth have led to a dramatic increase in student loan debt. Outstanding student loan debt quadrupled from $260 billion in 2004 to $1.1 trillion this year…Higher education has been and remains a potent source of economic opportunity in America, but I fear the large and growing burden of paying for it may make it harder for many young people to take advantage of the opportunity higher education offers.”
–Janet Yellen, Chair, Federal Reserve Board
- Brendan Mochoruk
- David Wessel
(version in 中文)
Raising the minimum wage is a polarizing issue. One side worries that raising it will lower employment. The other side downplays the impact on employment and plays up the positive impact on the living standards of the poor. Both sides are able to cling to their beliefs as the evidence, much of which comes from high-income (“advanced”) economies, is mixed.
The majority of the global labor force, however, is in the emerging markets. Moreover, for a number of these countries, instituting a minimum wage or raising it is squarely on the policy agenda. But little is known about the impacts of minimum wages on employment and living standards in emerging markets.
My recent work with Yi Huang and Gewei Wang tries to fill this gap by studying the impact of minimum wage policies on employment in China. As China accounts for nearly 25 percent of the global labor force, this evidence is important in its own right; it may also be more relevant for other emerging markets than the evidence from high-income countries.
Our study is the first to use data on minimum wage changes for over 2400 counties in China. We combine the information on minimum wages changes with employment data from the Annual Survey of Industrial Firms, which covers over 70 percent of China’s manufacturing employment. While China instituted a minimum wage system in 1994, enforcement of compliance with the law was significantly tightened only in 2004; the results described below are based on post-2004 data.
So what does the evidence show? On average across all firms, we find that an increase in the minimum wage leads to a small decline in employment: a 10% percent increase in the minimum wage lowers employment by a little over 1% percent.
The impact differs across firms, being greater in low-wage firms than in high-wage firms. This is shown in Figure 1, where firms are grouped into deciles based on the average wage. In the decile of firms with the lowest wages, a 10% increase in minimum wages lowers employment by nearly 1.8%. The impact declines steadily such that for the decile of firms with the highest wages, the impact is 0.6%.
We also find that the impact of the minimum wage on a firm’s wages depends on where the firm stands in the distribution of wages. On average, an increase in the minimum wage raises wages by about 1%. But, as shown in Figure 2, for firms in the lowest decile, the increase is about 2.5%. The effect declines steadily and there is essentially no impact for the highest decile.
A glimpse behind the scenes
Teasing out the impact of the minimum wage on employment is a difficult task. A firm’s employment can be affected by many factors, not all of which can be accounted for easily. Hence there is often a concern that the impact attributed to changes in the minimum wage may in fact be due to some factor that remains unaccounted for or is unobservable to the researcher.
To guard against this, the evidence presented above is based on analysis in which numerous other factors that could affect employment are accounted for, as described in detail in the working paper. One strategy we use is akin to the study of twins in many areas of research—the idea there is that since twins share much of the same genetic make-up, any observed differences between them are likely not due to genetic reasons but to other factors. In our study we make the assumption that firms in contiguous regions are more likely to have similar employment trends.
We then estimate the impact of the minimum wage on a firm’s employment, controlling for developments in employment at its ‘twin firm’. Without such controls, the estimated impact of the minimum wage is qualitatively similar to that shown in Figure 1 above but quantitatively smaller on average (see an earlier blog for details).
Information on the employment and wage impacts of minimum wage changes is a critical ingredient in deciding where to set the level of the minimum wage. Our study provides the first comprehensive estimates of these impacts for China, which has a large labor force and whose experience may be relevant for several other emerging markets.
Our evidence suggests that a 10% increase in the minimum wage lowers employment by 1%. Impacts of this magnitude have been found in studies for high-income countries but generally for sub-groups such as teenagers or low-skilled workers.
We also find significant differences in the impact of minimum wages on employment and wages across low-wage and high-wage firms. In low-wage firms, raising the minimum wage lowers employment but raises wages more than in high-wage firms. The setting of the minimum wage has to be sensitive to these differential effects. As in the case of other labor market institutions, the design of a minimum wage system has to balance considerations of equity and efficiency (see Blanchard, Jaumotte and Loungani, 2014 for a fuller discussion). Minimum wages can help the cause of equity by ensuring that workers, particularly low-wage workers, have enough to live on. But if raising the minimum wage lowers employment, and ends up excluding low-wage workers from employment prospects, it may have adverse effects on both welfare and efficiency.
After about six months of forced detention in the Democratic People’s Republic of Korea (DPRK), Jeffrey Fowle, 56, was released to the United States on October 21, 2014. Another surprise action by North Koreans in a series of surprises in the last few months. No missile-testing but rather, testing engagement?
Mr. Fowle had been arrested in May while visiting the DPRK for allegedly leaving a Bible at a hotel or restaurant. He was one of three American citizens involuntarily held in North Korea. Kenneth Bae, a missionary, age 46, has been stuck in North Korea for almost two years. He has been imprisoned after undergoing a North Korean trial. The youngest, Matthew Miller, 24, was sentenced a month ago to six years in prison for alleged espionage and intent to defame the Pyongyang regime. Miller allegedly wanted to experience prison life in order to reveal North Korea’s human rights violations. Videotapes of him asking for his government’s help and expressing disappointment in his country and president have been aired publicly.
Why has Mr. Fowle alone been released?
- He was the only one of the three detained who had not been tried and sentenced. So Pyongyang can’t claim that he was culpable of crimes against the state or the people and is releasing a guilty man. Therefore, letting him go is a “cleaner” bit of business than constructing new legal narratives to release the two who already have been found guilty.
- Mr. Fowle is the oldest of the three and the last to enter the DPRK.
- Jeffrey Fowle also comes from a humble background, one that fits the ideological status categories of the DPRK: a laborer. Back home in Ohio, he was a road-maintenance worker.
Is the DPRK turning over new leaves- toward friendlier diplomacy?
- Let’s wait and see. There are two other Americans in prison enduring harsh labor and illness (Kenneth Bae is very ill and goes back and forth from prison and labor camps to hospitals). If the DPRK wants to engage the U.S., releasing the other two prisoners is imperative. The U.S. government cannot and should not enter into serious diplomacy with Pyongyang while two of its citizens are wasting away without any proof that they should have been detained in the first place.
- But Pyongyang is on the right path: If it wants Washington to consider a new round of diplomatic engagement, letting Mr. Fowle go back to the U.S. is definitely the right move.
- Behind-the-scenes diplomacy must be given credit:The Swedish Embassy in Pyongyang, which represents U.S. interests in the DPRK, the “new explorers” (of the world outside) within the Kim Jong Un regime, and the U.S. government as a whole have been working hard at quiet negotiations.
If we look at the release of Jeffrey Fowle in the context of more upfront and personable moves by DPRK officials to initiate new diplomatic encounters, if not relationships, in recent months—e.g., high-level visits to Europe, United Nations General Assembly, constructive negotiations with Japan on abductees, surprise diplomacy to South Korea at the Incheon games, and soon-to-come diplomatic visits to countries in the Middle East and Africa— yes, this latest positive move can be interpreted as a step toward improved relations with as many countries as the North Korean net can catch. The United States, of course, would be the biggest fish to catch.Authors
By Rabah Arezki
Natural gas is creating a new reality for economies around the world. Three major developments of the past few years have thrust natural gas into the spotlight: the shale gas revolution in the United States, the reduction in nuclear power supply following the Fukushima disaster in Japan, and geopolitical tensions between Russia and Ukraine.
Over the last decade, the discovery of massive quantities of unconventional gas resources around the world has transformed global energy markets, and reshaped the geography of global energy trade (see map). Consumption of natural gas now accounts for nearly 25 percent of global primary energy consumption. Meanwhile, the share of oil has declined from 50 percent in 1970 to about 30 percent today.
Natural gas, however, is different from other energy sources. Being lighter than air, it is a commodity that doesn’t travel very easily and is expensive to transport. Hence, natural gas markets tend to be regional, and much less integrated than oil markets. Shipping or transporting natural gas requires either costly pipeline networks or liquefaction infrastructure and equipment, including dedicated vessels, and then re-gasification at the destination. The limited global integration of gas markets has resulted in substantial price differences across regions in recent years due to the U.S. shale gas boom and the Fukushima disaster, in spite of increasing liquefied natural gas trade.
U.S. shale gas revolution
With advances in shale rock drilling, a sharp surge in U.S. gas production has made the country the world’s largest natural gas producer, and soon expected to become a net exporter of natural gas. The shale gas boom has also had a significant impact on the patterns of global energy trade: U.S. fossil fuel imports decreased to $225 billion in 2013 from $412 billion in 2008.
Surging supply has also steeply driven down natural gas prices in the United States by about 70 percent in recent years, introducing substantial price differences across other regions (see chart). For instance, U.S. gas sells for $4 per million British thermal units, compared with $10 in Europe and close to $17 in Asia.
The U.S. advantage in natural gas has also led to an increase in U.S. competitiveness in non-energy products, in turn affecting its competitors.
The share of energy-intensive manufacturing exports in total U.S. manufacturing exports has been rising steadily, whereas the share of non-energy intensive exports has been declining.
Estimates show that cheaper natural gas in the United States has helped lift manufacturing exports by about 6 percent since the start of the shale gas boom. Further evidence suggests that the channels through which cheaper domestic natural gas prices in the United States might have an impact on manufacturing exports are operating both at the intensive (expansion by existing firms) and extensive (new firm entry) margins.
As more countries exploit new sources of natural gas, not only is the geography of trade in energy products likely to continue to change, but the geography of manufacturing exports is likely to change as well.
While energy users in the United States have been the main beneficiaries of the energy price declines, the shale revolution has helped to stabilize international energy prices including by freeing global energy supply for European and Asian markets, offsetting some of the shortages due to geopolitical disruptions.
The Fukushima disaster and aftermath
The Fukushima Daiichi nuclear disaster in March 2011 highlighted the environmental liabilities associated with nuclear power generation, and induced a sharp increase in the use of natural gas.
Before the disaster, about one-quarter of Japan’s energy was generated by means of nuclear reactors. Following the disaster, the Japanese government decided to halt production at all nuclear power plants in the country. To compensate for the resulting loss in electricity generation, Japanese electric power companies increased their use of fossil-fuel power stations and appended natural gas turbines to existing plants.
As a result, Japan’s liquefied natural gas imports have increased dramatically—by about 40 percent—since the disaster, making Japan the world’s largest importer of liquefied natural gas. The sharp increase in natural gas demand has led to higher prices in Asia—and Japan in particular—double that in Europe and four times higher than in United States.
The ongoing crisis in Ukraine has highlighted European energy markets’ dependence on natural gas. Ukraine and countries in southeast Europe appear particularly vulnerable to potential disruptions of Russian gas supply. Should the gas cutoffs persist and be extended to other countries, the greatest impact will be on Ukraine and countries in southeast Europe that receive Russian gas transiting through Ukraine. Other countries, however, will be affected through rising spot prices, which may spread from natural gas to other fuels.
Fuel for thought
Overall, the pattern of global trade in liquefied natural gas, and energy more generally, is expected to evolve further. If the United States gradually becomes a net exporter of liquefied natural gas, we expect domestic natural gas prices to rise but still remain markedly lower than that in Europe and Asia, given liquefaction costs.
Natural gas is the cleanest source of energy among other fossil fuels (petroleum products and coal) and does not suffer from the other liabilities potentially associated with nuclear power generation. The abundance of natural gas could thus provide a “bridge” between where we are now in terms of the global energy mix and a hopeful future that would chiefly involve renewable energy sources.
While markets forces shape the energy mix, energy policy has a role to play, including for coal and renewable, in turn impacting global trade in energy. Here, Europe and Japan are at a crossroads, facing a difficult balance between environmental concerns, economic efficiency goals and energy security. Getting that balance right should figure prominently on policy makers’ agendas.
Read our commodities special feature in Chapter 1 of our October 2014 World Economic Outlook for more details on this issue.
I see it every time I come back to Honiara, Solomon Island’s bustling capital, soon after I arrive. Young people on the streets, wandering around in groups or by themselves with nothing to do. It’s the same thing my local friends and colleagues mention. Solomon Islanders also ask, “What kind of future lies ahead for our kids?”
Solomon Islands face new economic challenges and a rapidly expanding, youthful population. Seven out of 10 Solomon Islanders are under the age of 29.
Editor's Note: In this blog, Joshua Meltzer discusses the role of cross-border data flows and the Internet in bilateral trade and investment opportunities for the U.S. and EU. For a more detailed look at this topic, see his latest paper.
The most globally significant bilateral trade and investment relationship is between the U.S. and the European Union. An increasing amount of this economic relationship is underpinned by cross-border flows of data.
Whether the U.S. and the EU are able to take full advantage of the opportunities for international trade and investment presented by their increasingly online and digital populations will affect transatlantic economic relations. As the world’s two largest economies, the U.S. and EU decisions on support for cross-border data flows will also have global implications.
A recent paper of mine analyzes the importance of the Internet and cross-border data flows for US and E.U trade and investment with each other and globally.
Cross-border data flows between the U.S. and Europe are the highest in the world—50 percent higher than data flows between the U.S. and Asia and almost double the data flows between the U.S. and Latin America. (See the capacity of transcontinental fiber-optic cables in the figure below.)Submarine Cable Bandwidth (in Terabits per second, or TBPS)
Source: Telegeography 2014
The Internet and cross-border data flows are providing opportunities for small and medium-sized enterprises (SMEs) to participate in the global economy. SMEs can now use the Internet to reach customers globally wherever they have Internet access, process international payments, and, for a range of digital products, deliver them online. For instance, SMEs on eBay are almost as likely to export as large businesses and have a 54 percent survival rate compared with offline businesses (24 percent).
The Internet is also giving SMEs access to business services that can increase their productivity and global competitiveness. This includes online functions like Google search, which helps businesses develop market intelligence on competitors and learn about foreign laws and regulations. The cloud provides access to low-cost software on demand and data flows allow for regular updates and security patches. The Internet also provides opportunities for businesses to become part of global supply chains by providing discrete tasks.
In addition, businesses are increasingly using the Internet in innovative ways. For instance, the Internet has given companies the ability to harness the intelligence of users by interacting with customers, suppliers and other stakeholders in product development efforts. Crowdsourcing is another evolving Internet-based opportunity that allows people situated globally to contribute tasks or become co-creators. All of these new business models require data and information to move freely across borders.
There are no direct statistics that measure the value of transatlantic trade underpinned by data flows. Measuring digitally deliverable services—understood as services that may be, but are not necessarily, delivered digitally, reveals the capacity for the Internet to drive US-E.U. trade. For instance, in 2012, 72 percent of US services exports to the EU worth $140.6 billion were of digitally deliverable services.
Taking a global perspective, U.S. exports of digitally deliverable services in 2012 were $383.7 billion, comprising 61 percent of total U.S. services exports. And for the E.U. exports of digitally deliverable services in 2012 were $465 billion.
Digitally deliverable services such as consulting, engineering, design and finance are also inputs into the production of other goods and services. And where these products are exported, so are the digitally deliverable services used in their production. The following graph show that taking into account the value of digitally deliverable services in goods and services exports increases U.S. exports of digitally deliverable services to the world from $383.7 billion to $569.2 billion in 2012, equivalent to 32 percent of total U.S. exports. For the EU, exports of digitally deliverable services to the world increase from $465 billion to $748.8 billion, representing 24.8 percent of total EU exports.Digitally Deliverable Services Exports, 2012
Source: U.S. Bureau of Economic Analysis and Eurostat. For the EU, VA shares are from the most recent 2009 input-output tables, applied to 2012 gross exports.
It is also the case that a lot of U.S. imports of digitally deliverable services from the EU are used to produce goods and services that are then exported. This is increasingly the case in a world of global value chains; goods and services cross borders multiple times to produce a final product. WTO Director-General Pasqual Lamy has described this phenomenon as goods being “made in the world.”
The following graph shows the importance of intermediate services imports for U.S. and EU production of goods and services for export. For the U.S., almost $11.2 billion or 62 percent of digitally deliverable services imported from the EU were used to produce products for export. And for the EU, $22.3 billion or 53 percent of digitally deliverable services imported from the U.S. were used in the production of exports.EU Digitally Deliverable Services in U.S. Exports, 2009 U.S. Digitally Deliverable Services in EU Exports
Source: OECD-WTO Trade in Value Added database
 Jessica R. Nicholson and Ryan Noonan, “Digital Economy and Cross-Border Trade: The Value of Digitally deliverable Services”, US Department of Commerce, Economics and Statistics Division Issue Brief # 01-14, January 27, 2014
There’s been considerable discussion recently about building a “Culture of Health” in communities across the nation. This is now a core strategic focus of the Robert Wood Johnson Foundation, and it’s aligned with many pilot projects and other efforts in the public and private sectors to improve nutrition and exercise opportunities, early childhood programs, social supports, and the other big influences on population health. One of the most promising yet most challenging fronts in these efforts is bridging the gap between good “health” and good “health care.”
Insurers, hospitals, and healthcare systems are increasingly investing in efforts to improve prevention, wellness, and care management. Especially for populations with limited means, however, studies show that some of the best long-term ways to improve health outcomes are through addressing social service needs—including housing, environment, income and education. This means linking the healthcare infrastucture with public health, social service and community organizations. A hospital that invests in a community-based asthma program to teach patients how to manage their disease and avoid triggers, for example, may be able to prevent emergency room visits and hospital admissions by partnering with social workers or community health programs that can do family education and home modifications. But to make such a reform sustainable, the hospital would need to shift its payments from Medicaid, Medicare, and private health insurers from paying for the asthma complications to paying for keeping asthma patients well. This may be difficult – especially for hospitals that don’t have a well-integrated working relationship with social service providers, and for health insurers who would like hard evidence that these new payment reforms will really deliver on improving health and keeping overall costs down.
Health care reforms that focus on preventing complications are occurring. Payment reforms are now driving providers to better utilize health care resources to improve patient outcomes. After Medicare began penalizing hospitals with high levels of avoidable readmissions, many set up care management programs to help patients avoid readmission. This included clearer discharge instructions, medication assistance and better coordination with patients’ primary care physicians, and even some non-medical services like transportation to follow-up appointments for patients who can’t easily transport themselves. A growing number of health care providers have become Accountable Care Organizations (ACOs), which enables them to be paid at least in part based on reducing costly disease complications and providing better-coordinated care.
Unfortunately, proven, examples of extending health care reform to integrate community interventions that reduce short- and medium-term costs remain scarce. Collaborating with social service and community organizations also presents logistical and bureaucratic obstacles for clinicians. For this reason, ACOs have generally not made significant investments in non-medical, community-based prevention and wellness interventions
Some state Medicaid programs have tried to promote community-based reforms in ACOs or similar accountable-care arrangements. These initiatives involve a partial global or person-level payments that increase with better population health outcomes, plus steps intended to make it easier to coordinate services and integrate funding streams between health care providers and community-based health promotion initiatives. Some health care providers involved, including hospitals working with pediatricians, are using this promise of financial support if their efforts succeed to work with social service and community-level support systems. But many health care providers are reluctant to go down this path because of uncertainties about how and whether these programs would actually work, given the administrative and logistical challenges, not to mention uncertainties about whether these efforts will actually reduce costs enough to earn the additional funding.
Developing better evidence on health care reforms that bring health care delivery and community-based health improvement together is a critical policy priority. What evidence and changes in policy do health care payers and providers need to move forward with these reforms? Is it possible to develop better practical guidance for payers and providers on how they could implement such reforms now?
At the upcoming Population Health Forum on Oct. 22-24 in Washington, I plan to explore these kinds of novel payment approaches with on-the-ground implementers and experts who are developing successful strategies for health care providers to work more effectively with community health programs. Through collaboration and shared accountability between hospitals, health systems, clinics, behavioral health services, community organizations and patients, it is indeed possible to shift our focus from episodic acute care to a holistic approach that keeps populations well. But we have a lot of questions to answer before these strategies will successfully transform health care and population health.Authors
Banks are struggling to overhaul the way they do business given new realities and new regulations adopted in the aftermath of the global financial crisis. While banks are generally stronger—they have more capital—they are less profitable, as measured by the return on equity. There are a number of reasons behind this, including: anemic net income at banks, particularly in the euro area; higher levels of equity; and banks taking fewer risks.
If they cannot change their business models, there is a risk that banks will not be able to provide enough credit to help the economy grow and recover.
We’ve looked into this issue in our latest Global Financial Stability Report because banks will have to adapt their business models so they can do what banks should do: lend money.
A previous blog looked at the consequences of another change in bank business models—the reduction in market-making—on financial market liquidity.
Mind the profitability gap
Bank return on equity has fallen to a historically low level, excluding the height of the financial crisis.
As a result, banks with 80% of the assets of the largest institutions have a profitability gap—their return on equity is less than the cost of equity (capital) demanded by shareholders (see chart). This chart shows that while many euro area banks have a profitability gap, this problem is by no means isolated to Europe.
Re-pricing, re-allocating and retrenching
In this new paradigm—with low profitability and new regulatory requirements—banks have responded in several ways, including by cutting costs, selling non-core businesses and running off portfolios. But banks have to do more to be in a position to build and maintain adequate capital buffers without taking excessive risks. A combination of three different strategies—re-pricing, re-allocating and retrenching—could be employed.
Although banks have already increased interest rates on loans since the start of the crisis, they may need to re-price loans further. However, banks with less market power will find this difficult, either because they are surrounded by competitors in better financial shape that do not need to re-price, or because they face competition from players in the capital markets who supply credit, like mutual funds.
Banks may also re-allocate capital towards activities that can generate higher returns. But this may entail taking greater risks, and banks may find that they have limited capacity to re-allocate assets before they bump-up against risk-weighted capital requirements. As a result, banks may retrench from some activities altogether.
This means that as banks try to transition to new business models their ability to supply credit to the economy could be limited, potentially creating a headwind for the economic recovery. In fact, the simulations in our latest report suggest that out of a sample of 300 large, advanced economy banks, only 60 percent (by assets) are strong enough to deliver more than 5 percent credit growth without requiring a significant re-pricing of their loan books.
In contrast, even accounting for lower cyclical pressures on profits, almost 40 percent of banks require shifting to new business models before being able to meet credit demand when the economy recovers. The share of banks needing significant changes to business models rises to 70 percent in the euro area (see chart). This suggests that some of the economies that most need a recovery in lending may face particularly tough challenges in providing an adequate supply of credit.
Policymakers should ensure that bank balance sheets are up to the task of supporting the economic recovery. In the euro area, the ECB’s Comprehensive Assessment is a golden opportunity to clean-up banks, restructure weak institutions, and resolve nonviable banks.
This will ensure that the weaker banks do not distort competitive pressures, preventing the stronger banks from undertaking the necessary business model changes. Banks should also adopt a more transparent pricing model that better reflects the underlying risks they are taking.
Finally, regulators should consider whether barriers to nonbank credit supply could be lifted, though this should be accompanied by new tools to prevent the build-up of risks outside the banking sector.
Does Moving Across International Borders Boost Migrants' Incomes, Happiness and Freedom Satisfaction?
The recent economic crisis and subsequent lagging economic recovery have renewed the immigration debate in the United States and beyond. However, while the effect of migration on the well-being of native populations is important, so is the question of how migrants fare once they reach their destination countries.
Citizens of destination economies often argue that there are potential costs of migration for them, ranging from increasing strains on welfare systems to threats to the jobs of natives to the difficulties of assimilation. Despite these fears, on balance, migration’s benefits for the these destination economies outweigh the costs: Immigrants are net contributors to public coffers, and complementarities between low-skilled immigrants and natives exist—particularly when new migrants take low-skilled jobs that native workers eschew.
But what about the welfare of the migrants themselves once they have reached their new homes? This is an important issue, largely due to the sheer magnitude of migration stocks: About 232 million people lived outside their country of birth in 2013.
Most migrants move across international borders to maximize their earnings and to gain opportunities, and most do make significant income gains. Whether these earnings gains are mirrored by improvements in reported well-being and broader quality of life is still largely an open question, however.
Higher levels of immigrant well-being can be instrumentally important for social outcomes such as public health and productivity, as happier individuals are typically more productive and healthier. Immigrant dissatisfaction may reflect social exclusion and a lack of assimilation, and even extremist attitudes among natives, all of which can result in social unrest and lower economic output. From the point of view of the home countries, emigrant well-being is important as migrants send remittances and contribute to the well-being of their home countries through investments, the spread of ideas and technology.
Understanding the well-being consequences of migrating is challenging, as comparing the well-being of migrants with that of those who stayed behind in the sending countries or with natives in the destination countries is methodologically flawed. Such comparisons may simply reflect the traits of those who choose to migrate, and who may have differences in ability, risk tolerance, aspirations and motivation, among other traits. The direction of causality between well-being and migration is also unclear: While migration may influence well-being, well-being might well influence migration. A recent paper using South American data finds that respondents who intend to migrate in the next year are wealthier and more educated than the average respondent in the region, but are also less happy and more critical of their current and future economic opportunities.
Despite the large income gains typically associated with migration, the move can also be accompanied by declining happiness because of adaptation to new income levels at the same time that aspirations are rising. While migrants’ (absolute) incomes increase (see Figure 1), so do their expectations as they compare themselves to the high-earning natives in their host countries. In a recent paper, we use Gallup World Poll data and statistical techniques to understand the consequences of migration for the well-being (income and non-income dimensions) of movers from transition economies to advanced nations. Like other studies, we find unequivocal income increases due to migration. More importantly, we find that there are significant gains in life satisfaction (Figure 2) and in perceptions of freedom (Figure 3).
Source: Nikolova and Graham, (2014) based on Gallup World Poll Data.
Source: Nikolova and Graham, (2014) based on Gallup World Poll Data.
Source: Nikolova and Graham, (2014) based on Gallup World Poll Data.
We studied migrants from transition and post-transition societies as these are the predominant sources of migration for the OECD countries in Europe. For example, in 2012, Poland and Romania were among the top three migrant sources of OECD migrants. It is important to note that the migration experience of those who leave the transition economies and go to Europe, which is culturally very similar, is likely quite different from that of movers Asia, Africa and Latin America, for example.
We find that migrants from transition countries achieve a better quality of life after they go abroad. The average household income premium from migration for our sample is about 21,000 international dollars (about 10,500 ID per household member). And even if reference norms and aspirations change, migrants’ life satisfaction improves. The average benefit is substantively and statistically significant: an increase of about 1.0-1.2 (on a life satisfaction scale 0-10). Perhaps most importantly, migration positively affects perceptions of freedom (based on a question which asks whether or not respondents are satisfied with their freedom to choose in life), with migrants from the most recent European Union enlargements being nearly 40 percent more satisfied. Data from around the world show that freedom to make choices in life is a pivotal element of human well-being.
At a time when there is ample reason to be concerned about the state of world affairs, our research findings are a “happy story:” By voting with their feet, migrants from transition economies can improve their well-being. Surely migration does not solve the problems in the countries the migrants left, nor can we be confident at this stage that our results apply to migrants from other parts of the world or those going to destinations outside the OECD. Yet it does suggest that win-win outcomes are possible from increasing mobility in global labor markets. That is a story worth learning more about.Authors
Editor's Note: This blog post is in response to the newest Brookings Essay, "The Bad News About the News," by former Washington Post Editor Robert G. Kaiser.
Robert Kaiser's essay admirably surveys the problems facing journalism. I want to add a few thoughts about where the replacement for lost ad revenues may come from—and about some potentially troubling implications, including for Kaiser’s great paper, The Washington Post.
Over the past 50 or more years, we journalists have had the luxury of thinking of journalism as our product, and of readers as our customers. It was a great ethic to maintain, but from an economic point of view it was never right. In the newspaper business, our real customers were our advertisers, who paid the bills; our product was our readers, whose eyeballs we sold to advertisers; our journalism was our marketing hook, luring readers. Now that our marketing hook can no longer deliver our product competitively to our customers, our customers—advertisers—are going away.
The question now is: who is our next customer, if in fact we have one? I suspect part of the answer will be: corporations, investors, and other business interests that can harness journalistic methods and talent to promote their interests and brands.
One example, emerging rapidly, is so-called “native content” (aka “sponsored content” or “branded content”), which Wikipedia nicely defines as “a form of online advertising that matches the form and function of the platform on which it appears”: in other words, paid-for content that mimics the surrounding journalism but is produced for and placed by advertisers seeking to burnish a brand or disseminate a message. This stuff is often written by accomplished journalists to high professional standards, so it’s readable and interesting, sometimes better than the “official” goods. Don’t snicker, purists! In a provocative post recently (“Brace for the Corporate Journalism Wave”), Monday Note’s Frederic Filloux puts traditional journalists on notice that native content will eat their lunch. It will be free; it has a business model; readers will like it; and it will enjoy preferred access to the corporate insiders who are, after all, paying for it.
Or what if, instead of just buying ads that look like content, a corporate chieftain buys a whole newspaper? Every morning I thank Jeff Bezos, the founder and CEO of Amazon.com, for rescuing the Post, a national treasure, but I doubt he did it only for his health. If a giant company is engaged in cutthroat competition with other giant companies, and if it has all kinds of vital interests before the government, the country’s second most powerful newspaper might be a handy thing to have. I have no reason to think Bezos would slant the Post’s coverage of, say, electronic retailing or antitrust regulation, but how can the public be sure? And bundling Post content with Amazon's dominant Kindle platform would give the Post a leg up: good for the Post, but potentially not good for other outlets that lack comparable access.
This new age is already here. I hear stories from friends in PR about ostensibly independent bloggers who, under the pressure of time, reword corporate press releases and post them online as news, or even ask PR people to write news items for them. I don’t know that the cultural wall between traditional journalism and corporate PR will come down completely, but I do know that “down” is the direction it’s going.Authors
Winning is not a singularly American concept, but from our sports teams to our military we expect a winner.The Army Operational Concept
At the Association of the United States Army Symposium this week in Washington, D.C., U.S. Army Chief of Staff General Raymond Odierno unveiled the Army’s new concept for operating in our ever-changing world. This new Army Operational Concept (AOC) characterizes the environments of conflict for the future. It does not try to determine where our next fight will be, but instead anticipates the threats of the future operating environment and recaptures a term that has arguably been missing from our defense and security vernacular for the last several years–winning.
After 13 years of war, policymakers and military leaders alike have tread lightly on the concept of winning. Conflicts like Iraq and Afghanistan, and many of the conflicts that our nation will face in the future, are not and will not be contests of pure military might among nation-states. Rather than a series of force-on-force combat operations that result in enemy capitulation and eventually surrender, winning in the future environment will be much harder to qualify.
The Army is unique in its ability to deliver a powerful strategic message. While the appearance of a U.S. Navy carrier in troubled waters or U.S. Air Force combat patrols in contested airspace is meaningful and can have coercive effects, the AOC suggests that only “the arrival of Army forces demonstrates to partners and adversaries U.S. resolve and sustained commitment to achieving security objectives.” From the Normandy invasion to the Thunder Run for Baghdad, history demonstrates that only boots on the ground defeats our adversaries.New Challenges And A New Concept of Winning
As the Army considers an environment that will present unique challenges, it must be prepared to prevent conflict, shape the security environment to facilitate national objectives and ultimately defeat adversaries across the full range of military operations. The Army Operating Concept will provide the roadmap for advancing technologies that ensure a comparative advantage–complementing the joint team, integrating special operations and focusing on the development of agile and adaptable leaders who can scope the problem and find a solution.
To achieve these objectives the AOC will focus on critical tenets and core competencies, from demonstrating simultaneity across the military domains to shaping the security environment with critical multinational and interagency partners. Innovation and adaptability become as important as lethality and mobility.
How will we define winning in the future security environment? Preventing conflict before it occurs, like bringing aid to those suffering from Ebola in West Africa, is winning. Shaping the security environment with regionally aligned and globally responsive forces, like an airborne infantry battalion in the Baltic states, is winning.
War is a contest of wills. America expects its military forces to win no matter what challenges lie in store. The AOC, by recognizing the demands of future armed conflict and underscoring the merits of leader development, ensures that the Army has the will to win in a complex world.Authors
- John R. Evans, Jr.
The global financial crisis reminded us that banks often take risks that are excessive from society’s point of view and can damage the economy. In part, this is the result of the incentives embedded in compensation practices and of inadequate monitoring by stakeholders. Our analysis found the right policies could reduce banks risky behavior.
In our latest Global Financial Stability Report we take stock of recent developments in executive pay, corporate governance, and bank risk taking, and conduct a novel empirical analysis.
Using a sample of 830 banks from 72 countries, several definitions of risk, and four different empirical methods we found that when banks align their compensation practices with long-term performance (for example, by paying bonuses with restricted stock), they also show lower levels of risk taking.
Policies to make banks safer
Recently, President Obama urged top regulators in the United States “to consider additional ways to prevent excessive risk-taking across the financial system, including as they continue to work on compensation rules and capital standards.”
Our analysis supports some of the policy measures currently being implemented in that area, and recommends new ones.
First, banks should better align compensation with risk. Banks could link compensation better to their overall financial health by paying managers partly with long-term bank bonds. Tying compensation to the bank’s default risk that way may help prevent managers and shareholders making risky bets when banks are financially weak.
Second, banks should make sure variable compensation becomes available to executives only with a lag. They should also include clawback provisions that would force managers to return past bonuses if, for example, their decisions cause losses over the longer term.
Third, the boards of directors of banks need to be independent of bank management and should establish risk committees.
Finally, policymakers should consider measures to ensure that boards effectively represent not only the interests of shareholders but also those of the creditors of the bank. For instance, they could consider granting board representation to certain types of bond holders. This could improve the ability of these creditors to monitor bank managers.
Measures can have an impact
How much can these types of measures contribute to prudent risk taking by banks and foster financial stability? Apparently quite a lot.
Policymakers so far have required increases in bank capital to make the financial system safer, and this has indeed had the effect of reducing the amount of risk that banks are willing to take.
Our data show that an increase in the Tier 1 Capital (the predominant form of regulatory capital under Basel III) of 2 percentage points generally leads to a decrease in risk taking of about 5 percent.
We then compare this decrease in risk with that which would result from the changes in governance structures and compensation practices that we propose. Our figure below shows that the associated risk changes are of similar magnitude. Still, we should keep in mind that capital requirements and improvements to governance and compensation practices should be seen as complements, not substitutes, and are best implemented together.
We are not done yet
We also found evidence that a bank’s risk culture matters. According to our study, banks where the CEO has a professional background in retail banking or risk management—where the risk culture is usually seen as more conservative—also show lower levels or risk. Figure 3.5 in the report shows this in more detail. The opposite is true for banks where the CEO comes from investment banking (where risk taking is more ingrained), even after controlling for bank specialization and other firm-level characteristics.
It is therefore important that bank supervisors complement their evaluation of the risk management function with a qualitative evaluation of a bank’s culture.
For instance, supervisors may inquire whether managers are setting the right “tone at the top” and whether this tone actually trickles down to the rest of organization. Does the organization reward responsible behavior? Does the staff understand the core values of the bank and are employees (including senior management) held accountable?
However, while we know that risk culture matters, we still do not fully understand why and how exactly. Academics and policymakers should make it a priority to find out.
Hutchins Roundup: Debt Restructuring, Mitigating Loss from Sudden Shocks, Inflation Expectations, and More
What’s happening in fiscal and monetary policy right now? The Hutchins Roundup is a new feature to help keep you informed on the latest research, charts, and speeches. We hope you will find it useful.Debt restructuring boosts economic conditions
In an analysis of debt restructurings in both emerging markets (between 1979 and 2010) and advanced economies (between 1920 and 1939), Carmen Reinhart of Harvard University and Christoph Trebesch of the University of Munich argue that these episodes led to higher growth, lower debt servicing burdens, and improved international capital market access.Fiscal stimulus is an effective response to natural disaster shocks
Using the 2009 “Aquilano” earthquake as a natural experiment, Francesco Porcelli of the University of Exeter and Riccardo Trezzi of the Federal Reserve Board of Governors conclude that fiscal policies can effectively mitigate (PDF) the output loss from sudden negative shocks. While the multipliers on reconstruction grants were relatively loww—between 0.14 and 0.36—these grants prevented a fall in economic activity. The estimated multiplier on tax cuts was much higher, at 2.56.Inflation expectations shaped by a combination of statistics and inaccurate memories
Alberto Cavallo of MIT, Guillermo Cruces of the Universidad Nacional de La Plata, and Ricardo Perez-Truglia of Microsoft find that individuals' inflation expectations are highly influenced by both price changes of certain goods and by published inflation statistics. They note that consumers form inflation expectations based on their own memories of price changes in supermarket goods, but those memories are highly inaccurate. These findings have implications for central bankers as they attempt to influence household decisions on consumption and investment.Chart of the Week: Bank trading books down 34% from mid-2011. Speech of the Week: Fed’s priority is U.S. economy, but it has to consider feedback effects of its actions on rest of the world, too
"[T]he U.S. economy and the economies of the rest of the world have important feedback effects on each other. To make coherent policy choices, we have to take these feedback effects into account. The most important contribution that U.S. policymakers can make to the health of the world economy is to keep our own house in order—and the same goes for all countries. Because the dollar is the primary international currency, we have, in the past, had to take action—particularly in times of global economic crisis—to maintain order in international capital markets, such as the central bank liquidity swap lines extended during the global financial crisis. In that case, we were acting in accordance with our dual mandate, in the interest of the U.S. economy, by taking actions that also benefit the world economy. Going forward, we will continue to be guided by those same principles."
– Stanley Fischer, Vice Chairman, Federal Reserve Board
- Brendan Mochoruk
- David Wessel
An informed understanding of North Korean leadership stymies analysts and policy makers alike. Isolated, idiosyncratic, and intensely secretive, Pyongyang seldom reveals much about its decision making. However, there are occasional moments when the closed world of North Korean politics opens ever so slightly. But speculation and rumor also thrive under such circumstances, making it very difficult to view the North’s situation with clarity or certainty.An Unexplained Absence
The past month and a half provides a telling example of this challenge. On September 3, Kim Jong-un, the North’s peripatetic young leader, appeared at a concert in Pyongyang, and then disappeared from view, not reappearing in official media until October 14. His prolonged, unexplained absence triggered intense interest in his whereabouts, health, and political standing, and in the stability of the regime.
What best explains Kim’s absence from public view for nearly six weeks? We need to begin with known facts. On July 8, Kim walked with a pronounced limp in a memorial service commemorating the 20th anniversary of the death of his grandfather, Kim Il-sung. Videos of this event and of several subsequent political occasions did not obscure his physical condition, though there was no official explanation. On September 26, there was a single cryptic reference in official media that Kim was experiencing “discomfort.” His absence from the anniversary of the founding of the Korean Workers Party on October 10 appeared to confirm continued, if undisclosed, physical problems.Rumors of Political Infighting and Health Concerns Spread
Kim’s extended absence triggered a torrent of rumors and speculation, much of it emanating from elite defectors from the North now living and working in South Korea. While conceding that Kim might have some serious physical problems, these defectors insisted that his larger problems were political. They offered a steady stream of claims, all purportedly based on sources in the North. One group contended that Kim had been ousted in a quiet coup by leaders in the Party’s Organization and Guidance Department; others argued that unnamed senior generals had overthrown him. Some defectors claimed that there was an ongoing power struggle at the top, all while Kim was suffering from numerous debilitating medical conditions, including gout, diabetes, renal failure, and severe ankle and leg problems.
There was (and is) no way to definitively prove or disprove these arguments. But they provided catnip for newspapers and broadcast media in South Korea and beyond. Sensational claims appeared in numerous publications and on U.S. news networks. Moreover, Kim’s increasing obesity and his smoking and drinking habits lent credence to assertions about Kim’s health problems. Several leading South Korean media outlets, for example, reported that German and French doctors had visited the North to address Kim’s purported medical issues (kidney failure in the case of an unidentified German doctor, and surgery on both ankles in the case of an unidentified French doctor).
There was at least superficial plausibility to some of these reports. The Kims have relied in the past on European doctors to address serious maladies afflicting members of the ruling family, including Kim Jong-un’s father, Kim Jong-il, who suffered from kidney failure and from heart disease. But elite defectors, being deeply alienated from the North Korean system, were predisposed to seize on reports of Kim’s health problems, believing that his days (and perhaps the regime’s days) were numbered.Examining the Evidence
Various elite defectors emphasized the inherent implausibility of a young, untested, and impetuous leader wielding absolute power in Pyongyang. To some, this suggested that Kim was a figurehead, albeit the “next of Kim” selected by his father. Others argued that senior figures near the center of power had grown increasingly disenchanted with Kim’s repeated purges of senior officials and his disruptive and destructive policies, thereby undermining the internal stability on which this most Confucian of systems has long rested.
However, if there had been an intense, ongoing struggle for power at the top of the system, was there evidence to substantiate it? Some sources alleged that Pyongyang was in virtual lock down in recent weeks, but visitors to the North Korean capital reported nothing to substantiate this claim. At the same time, leading South Korean and American officials detected no signs of internal upheaval such as troop redeployments or unusual activities of internal security personnel. The chairman of the Republic of Korea (ROK) Chiefs of Staff, Admiral Choi Yun-hee, informed Korean parliamentarians that Kim “[did] not have major problems in ruling the country.” Admiral Choi also stated that South Korean military intelligence disputed claims that Kim was in a vegetative state, though he demurred from responding to a query about the overall status of Kim’s health. Similarly, the spokesman of the Ministry of Unification has declared that “Kim Jong-un’s rule is in normal operation.”
Another reputed North Korean source informed a leading newspaper in Seoul that Kim underwent ankle and foot surgery in mid-September and was recovering at a villa away from Pyongyang. But this source claimed that senior party and army officials were visiting Kim regularly and receiving orders directly from him. These purportedly included Vice Marshal Hwang Pyong-so, Kim’s closest aide at present and one of three senior figures who traveled on one day’s notice to Incheon last week for the closing ceremonies of the Asian Games, where he also met with senior South Korean officials. Hwang and his colleagues flew to the ROK on Kim Jong-un’s personal aircraft, the first time it had ever been flown outside North Korea. Even more important, it defied rationality that three ranking officials would leave Pyongyang even for 12 hours if the capital was in the midst of an intense power struggle.Kim’s Reappearance
But the longer Kim remained absent, the more it raised doubts about his well-being. Kim’s recent reappearance while relying on a cane suggests that his immediate physical problems concern one or both legs and ankles. The new photographs appearing in North Korean media suggest tentative, somewhat awkward bodily movements; Kim seems far from fully recovered from what ails him. It is also possible that he confronts other undisclosed conditions. But Kim must have decided that it was better to resurface (albeit in a somewhat diminished state) than remain absent from the political scene. Even within a hermetically sealed leadership process, visibility matters.
Kim Jong-un’s return does not mean that all is settled in Pyongyang. North Korea remains an acutely damaged society confronting prodigious problems, overseen by a young, self-important leader who seems unable or unwilling to grasp the enormity of the longer-term crisis that the regime confronts. But understanding North Korea must begin with what is known, not with what those outside the North hope for or imagine.Authors
On Tuesday October 14, the national security industrial base working group at Brookings held an event on the arcane-sounding topic of performance-based logistics or PBL. This idea is a way of making the Department of Defense more efficient and more economical in how it maintains equipment. The results of the discussion were encouraging, because while they promised no easy relief from the pain associated with sequestration—due to return in just a year if no way can be found around it—they did suggest that at least several billion dollars a year can ultimately be saved in Pentagon maintenance accounts, perhaps within half a decade or so, through this innovative concept.
I organized and moderated the panel, which included Jay DeFrank of Pratt and Whitney, George Mitchell of Sikorsky Aircraft, and Alan Banghart of Deloitte. All three are heavily involved in PBL programs. DeFrank and Mitchell work for companies that already perform these services for DoD; Banghard studies the programs and advises DoD on how to make optimal use of them.
The basic logic of PBL is fairly simple, and rather elegant from the point of view of theoretical economics—and it has also now been proven in the real world, as it is already employed in 5 to 10 percent of all Pentagon maintenance contracts. Traditionally, the Department of Defense has paid contractors to repair equipment on a transactional basis—that is, fee for service. When something breaks, it is fixed. Contractors make more money the more work they do to maintain and repair equipment. This system gives contractors no direct financial incentive to make repairs more efficient, and also often reduces the availability of key equipment since much of it is frequently in the shop.
By contrast, a PBL contract pays a contractor per successful flight-hour, steaming day, or mile driven of a plane, ship, or vehicle. It leaves it to the contractor to figure out the optimal schedule for doing not only repairs but preventive maintenance. It also therefore encourages the contractor to bundle maintenance activities into a single visit to the shop, so that many things can be done efficiently and economically at the same time. As Mitchell, Banghart, and DeFrank explained, this system also leads contractors to do more detailed studies on which parts tend to break most often, so that they can perhaps be reengineered or otherwise made more durable.
Savings from this approach typically range in the vicinity of 5 percent to 20 percent though, as Banghart noted, they can be even greater. Mitchell cited a University of Maryland independent study making the same basic point. There can also be second-order savings from other effects of successful PBLs. For example, if aircraft are available a higher percentage of the time, the Department of Defense will not need to buy as many to ensure that a given number are ready to go on any given day. As such, not only maintenance costs (funded in the Department of Defense’s Operations and Maintenance or O&M budget) but also equipment purchase costs (funded in Procurement) can be reduced.
There are some cases where PBL may not be applicable—for brand new systems using new technology (since no dependable baseline exists for knowing likely maintenance costs, making a PBL a gamble for all parties), or for systems about to be retired (since it takes time to set up a PBL and make it efficient). But on balance, the panel tended to agree that, over time, up to $70 billion or $80 billion of annual O&M costs could be addressed through the PBL approach, meaning that by 2020 or so, a systematic use of this approach might yield the Department of Defense annual recurring savings in excess of $5 billion.Authors
Low interest rates and other central bank policies in the United States have sent investors looking for higher returns on their investments. Money is pouring into mutual funds and exchange-traded funds, which is fueling a mispricing of credit and a build-up of risks to liquidity in the markets—the ability to trade in assets of any size, at any time, and to find a ready buyer.
Mutual funds and exchange-trade funds are the largest owners of U.S. corporate and foreign bonds (Chart 1). This means they provide a lot of credit to grease the wheels of the financial system because they have taken investors’ money and lent it to corporates.
In our latest Global Financial Stability Report, we analyze this trend, which can create an illusion of liquidity. It turns out what we face is really a liquidity mismatch because investors can sell their mutual funds or exchange-traded fund investments almost anytime, but these funds have in turn invested their money in instruments that don’t trade quite as often, such as high-yield bonds.
While this is not a problem in good times, markets can turn volatile when the U.S. Fed starts to raise interest rates, particularly if this happens in an unexpected way. If that were the case, there is a risk that many investors would want to start selling all their holdings at once, causing asset prices to drop, which would then lead to further selling by investors, which may in turn create a vicious circle of further losses and more selling.
All this would complicate the task of a smooth exit from these monetary policies because of the risk of a bumpier exit associated with greater losses and volatility in fixed income markets. We’ve already seen an increased sensitivity of financial markets to price shocks since the crisis (Chart 2), especially for credit products, which can lead to faster selloffs.
To complicate matters, all this money flowing into mutual funds and exchange-trade funds may have created this illusion of liquidity at a time of other changes across financial markets:
- Inflows into these vehicles have enhanced “inflow’ liquidity, or the capacity to trade assets cheaply, but other structural measures of liquidity in markets, such as its depth and breadth, have deteriorated.
- A few fund managers hold large amount of assets, and there is what we call a “brand risk” stemming from high concentration in the decision making across funds, as well as increasing concentration of holdings of individual bond issuers.
- There is a reduction in the liquidity available from banks, which are traditional “shock absorbers,” as well as increasing sensitivity of hedge funds to asset price changes, and institutional investors playing less of a countercyclical role.
$3.8 trillion up in smoke
The result of a rapid switch to highly volatile markets would drive a faster rise in term premiums, and widening credit spreads would spill over to global markets. For example, we estimate that an unexpected market adjustment that causes term premia in bond markets to revert to historic norms (a 100 basis points increase) and credit risk premia to normalize (a repricing of 100 basis points) could rapidly push up bond yields (Chart 3), reducing the market value of global bond portfolios by over 8 percent—that’s $3.8 trillion.
These risks to exit mean officials need to address the existing liquidity mismatches. They can do this through prudential policy measures such as removing incentives of asset owners to run—by aligning redemption terms of funds with the underlying liquidity in the assets invested.
In September, the Center for East Asia Policy Studies held weekly events on key issues related to the Korean peninsula and the Northeast Asia region. Topics of discussion included:
- the evolving purpose and feasibility of the U.S. rebalance toward Asia, with a special focus on whether the rebalance might improve Korea-Japan relations;
- regional and national preparedness for unification led by South Korea and the differing scenarios for unification;
- critiques of the current U.S. “strategic patience” policy toward North Korea;
- new rationales for putting the reins of leadership for engagement with the DPRK in South Korea’s hands;
- successful Track II efforts by Americans and others around the world in contrast to official U.S. stasis; and
- ROK leadership in green economic development and climate change.
The events featured 19 speakers and 13 additional participants from the U.S. and the ROK, and a total of 350 guests attended the three events. Presenters and audience alike expressed great satisfaction with the generous time provided for discussion and debate among experts and with the audience.
Although the events covered a wide landscape of issues and policies, analysis of the current state of humanitarian and human rights challenges were absent. We address these issues at the end of this piece.
September 18: The Seventh Seoul-Washington Forum, jointly organized and sponsored with the Korea Foundation in Seoul, featured panel discussions on the rebalance to Asia, Korean unification and South Korea’s new leadership role in green growth and climate change. While many agreed that the United States rebalance to Asia was strategically and economically beneficial for South Korea’s interest, participants were skeptical of its sustainability and practical contributions to enhanced security cooperation and stability in the region. Opposed to the view that the rebalance is intended to contain China, Gary Clyde Hufbauer of the Peterson Institute for International Economics (PIIE) stressed the mutual economic advantage of the rebalance, especially if China is included in the Trans-Pacific Partnership. Contrasting visions of unification by the DPRK and the ROK were highlighted in the discussion. Debate also focused on China’s concerns over what kind of political and economic arrangements on the peninsula would accord with its own security interests and its likely opposition to a continued U.S. troop presence on the peninsula. The debate elicited a fundamental question by Sook-Jong Lee, president of the East Asia Institute and former Brookings Visiting Fellow, whether there could ever be a unification structure agreeable to both the United States and China. David Maxwell from Georgetown University responded that the certain inevitability of unification will force China to support it as long as their core objectives are met. Experts on South Korea’s role in green growth and climate change were the most diverse in background and analytical focus. So-Min Cheong from the University of Kansas compared the soft laws of South Korea and France on adaptation planning to the environment. Although soft laws, such as international declarations or conventions, are important in signaling a change in behavior and serving as a source of information, Cheong emphasized that deeper discussion is required to turn these into binding laws due to the complexity of climate change. Jay Koh, partner of Siguler Guff & Company and member of the Private Sector Advisory Group to the UN Green Climate Fund (GCF), assessed South Korea’s new role as host country of the GCF Secretariat and its leadership over the international process of establishing governance structures and fundraising.
September 23: “People-to-People Outreach, Americans and North Koreans: A Conversation with Ambassador Donald Gregg” featured a conversation between former U.S. Ambassador to the ROK Donald Gregg and CEAP’s Katharine Moon, SK-Korea Foundation Chair in Korea Studies. Moon posed important questions about the role of Track II engagement between the United States and North Korea and how to assess progress and impact, as well as some lessons Track II interactions might offer to governments. Gregg provided candid and informative assessments of his Track II activities with North Koreans including English education programs, training for economic development, and study of international business law. He emphasized the importance of continuously engaging North Koreans in order to dispel both countries’ negative views of each other and cultivate mutual trust. As chairman of the Pacific Century Institute, Gregg organized the first-ever meeting between the two countries’ Korean War veterans, who resolved to prevent such devastation from occurring again. Gregg observed that North Koreans displayed a sincere desire to learn about the larger world and admitted their urgent need for technical training in the English language, the workings of international institutions, trade, and business management.
September 29: Gi-Wook Shin and David Straub from Stanford University unveiled their recent study, titled “Tailored Engagement,” for the first time to the U.S. public. Just weeks prior to this event, the scholars presented their study at the ROK National Assembly where it received bipartisan support. Guided by the principles of mutual interests, application of market principles, international collaboration, and flexibility, the study argues for a realistic policy approach toward North Korea. They emphasized the following:
- South Korea should lay down the groundwork for reunification with a focus on strengthening the ROK itself;
- South Korea should de-link future interactions on non-nuclear issues from the North’s nuclear program; and
- The ROK should fine-tune its sanctions, especially the May 24th Measures, to allow room for engagement opportunities.
This last view was also supported by both ruling and opposition parties at the National Assembly, as members believe the measures should be relaxed in order to resume Inter-Korean dialogue.
The timeliness of this event as well as the points raised in the study were highly significant, considering North Korea’s “surprise diplomacy” on October 4 when both Koreas took a bold step toward a more independent, Inter-Korean diplomacy.
Important for U.S. policymakers and think tanks is the fact that many of the speakers in these three events, American and Korean, shared skepticism and disappointment with the United States’ “strategic patience” approach toward North Korea. Experts believe this strategy has produced little to no progress over the past two years and that it has amounted to neglect. And although it is necessary for the United States to implement bilateral and multilateral sanctions to impede North Korea’s nuclear capabilities, experts worry that the lack of simultaneous efforts at positive engagement will prolong tensions on the peninsula. Discouraged by perceived inaction by the U.S., many speakers shared the view that South Korea is no longer a “shrimp among whales” in the international community and must now take over the leadership role when approaching North Korea, with the United States playing a supporting role.
Absent was discussion of the impact of sanctions on the humanitarian needs of common Koreans, especially the most vulnerable—children, pregnant women and new mothers, and the elderly. Food shortage, inadequate healthcare, poor sanitation and lack of clean water are grave concerns. Currently, UN humanitarian programs in North Korea face serious problems due to low funding. One of the reasons for the low funding is due to the unintended consequences of international sanctions. Sanctions targeting North Korea’s Foreign Trade Bank, the country’s main route for money transfer, have prevented the flow of earmarked funds by foreign aid groups. In 2013, UN agencies in North Korea received only 34.8 percent of the $150,090,000 needed to address critical humanitarian needs of North Koreans. More recently, the World Food Program (WFP) warned that its program in the DPRK is on the verge of shutting down as early as January 2015 if additional funding is not secured. Dangerous consequences for the North Korean people are foreseeable for the program’s targeted 1.63 million of the most vulnerable populations.
Missing also was China’s role in the forced repatriation of North Korean border-crossers by the Chinese government. China has been violating international law despite being a state party to the UN Refugee Convention. However, China recently has shown signs of a policy shift when a group of North Korean defectors detained on the border of Laos and China were reportedly released rather than being sent back to the DPRK. Given the increasing importance of ROK-Sino relations, coupled with China’s frustrations with Pyongyang, both the ROK and United States should promptly pick up on this positive momentum to induce China to comply fully with its UN treaty commitments.
The surprise visit by the trio of top North Korean governing elites to Incheon on October 4 may signal potential improvements in Inter-Korean relations. In light of this development, tailored engagement and increased people-to-people interactions with North Korea may be the appropriate and effective approaches at this time to decrease tensions on the peninsula.Authors
- Paul Park
- Katharine H.S. Moon
By iMFdirect editors
What a week it’s been. Practical and existential questions on how to do good and be good for the sake of the global economy and finance dominated the seminars at the IMF’s Annual Meetings in Washington.
Our editors fanned out to cover what the panelists, moderators, and audiences said in a variety of seminars, and two big themes caught our eye.
Jobs & growth
The average unemployment rate in developed economies stands at 8.5 percent, and among young people it’s 13 percent, Christine Lagarde said in a day-long seminar on jobs and growth.
Inequality has reached critical levels.
“The world’s richest 85 individuals control as much wealth as the world’s poorest 3.5 billion people,” she said, citing research from Oxfam.
Even economists know money can’t buy happiness, but it can buy a country bridges and roads. While spending on infrastructure is a good for growth, who pays and what it means for the public purse is another matter.
And more important, can it over come the world economy’s lethargy, particularly in Europe?
“Yes, yes, yes”, affirmed Larry Summers of the University of Harvard.
Others were a bit wary.
“Will it come at the expense of something else that is valuable for growth, such as education, or research and development?” said Christina Romer of the University of California at Berkeley.
“When you have a limited purse, it is tough,” said Ngozi Okonjo-Iweala, Nigeria’s Finance Minister.
Even the idea the purse could be limited was up for grabs. Paul Krugman, columnist for the New York Times and professor at Princeton University said the phrase “fiscal space” disturbs him a little.
“The idea that we can adequately say how much a country can really take on is not necessarily right,” said Krugman. “The notion that there are hard limits is simply not borne out by events. Fiscal space should not be a reason to not spend at a time when you should be spending.”
Still, Stanley Fisher, vice chair of the U.S. Fed, said in terms of what can be done ”much depends on the politics of each country.”
Jeroen Dijsselbloem, president of the Eurogroup said that while growth in the eurozone is lagging, the European Central Bank has taken a number of measures, while a couple of countries (France and Italy) need to do more and have the “political stamina” to get it done.
“We should expect a little less from the central banks and a little more from the politicians,” he said.
Ethics, banks & finance
The faithful packed the proverbial pews Sunday morning to participate in a day’s discussion of the future of finance. First up: ethics.
Ever since bankers lit a match under the global economy, they have had a hard time getting back people’s trust.
The ethical failures that led to the crisis included mercenary and greed-driven behavior, and a disembodiment of finance from the economy, according to panelists. The structure of bankers’ compensation also played a role (more from the IMF on this here).
“Confidence builds over time and dies overnight,” said Christine Lagarde, and getting it back is important because finance fuels and oils the economy.
“The heart of reconstruction of confidence is in ethical and worthwhile banking, which has at its heart ambition for heroism, not only for internal rate of return,” said the Most Reverend Justin Welby, Archbishop of Canterbury.
“What would you like the system to look like? No one has told us that yet,” said Douglas Flint, chairman of HSBC. “If you define the system, then you can use the regulation to shape that outcome.”
“Where are the living wills?” said Simon Johnson of MIT. “How will we handle the failure of a large, complex, global bank?” (Earlier in the day Mark Carney said we could expect big news on too-big-to-fail at the upcoming G20 Summit in Australia).
While there is still a lot we don’t know about shadow banking, there is a silver lining according to some.
“They serve the real economy, which is the most important part of shadow banking in emerging markets,” said Nor Shamsiah Mohd Yunus, deputy governor of Bank Negara Malaysia. “They serve those who have trouble getting loans from traditional lending, so they promote financial inclusion.”
The day wrapped up with cyber risks, who should own your data, and how technology can make finance both more risky and democratic.
The rapid rate of technological innovation means we can pay for anything electronically.
“There is something scary about someone taking a cell phone, hitting four buttons, and getting money,” said Dean Karlan of Yale University.
Can regulators hope to keep up with the pace of innovation?
“Regulation is like a moat around a castle: effective when the enemy shows up as knights on horseback, but totally ineffective when they show up with cannon,” said Peter Sands of Standard Chartered Bank.
In the face of so much uncertainty, we turn to the Archbishop and Aristotle for guidance.
“We need heroism as it was in the classical sense: that causes us to leave a mark on the world that contributes to human flourishing.”
Amen to that.
Contributors: Gita Bhatt, Maureen Burke, Jacqueline Deslauriers, Lika Gueye