Why Inflation Is Not The Big Problem

What's the biggest risk to the global economy today? There are so many choices - the credit crisis, the housing slump, skyrocketing food and oil prices, and more. The trickiest of these problems, though, is inflation.

Why inflation? For starters, many countries are trying to strike the right balance in terms of monetary policy, attempting to choose benchmark interest rates high enough to reduce rising inflation, without slowing growth more than necessary. Were inflation not a problem, monetary policy choices would be much simpler.

In addition, the likely consequences of inflation are unclear. Most traditional inflation measures strip out "volatile" food and energy prices, which makes sense under normal circumstances - but does it make sense today? Increasing food and energy prices are putting serious pressure on incomes and discretionary spending. However, economists usually worry most about inflationary expectations . If wages do not rise, will we see an increase in inflationary expectations in the overall economy? And what if oil and food prices stabilize at their current (if high) levels? It's hard to say.

This Fortune magazine article touches on some of these questions. Some of the economists Colin Barr has spoken too think the inflation risk is overstated - they argue that the credit crunch has only started to be felt in the real economy, and that housing prices will continue to decline, unemployment rise, and American consumers, after all these years of spending, will finally start to pull back. And slower economic growth - a true recession, which we aren't technically in yet - will constrain inflation.

Did Bernanke and the Fed take these considerations into account when cutting interest rates? It's quite possible that they did, and that these factors made them more comfortable with steep cuts in interest rates. Without a doubt, though, the risk of rising inflation is as high as we've seen in the last 30 years.

http://money.cnn.com/2008/05/08/news/inflation_crunch.fortune/index.htm?postversion=2008050903

Is Foreign Capital a Luxury That Poor Countries Can Live Without?

Another pillar of free-market orthodoxy is re-examined in this article from the Economist. Developing countries abandoned the "Washington Consensus" almost a decade ago, in the aftermath of the Asian economic crisis, but its central principles - free trade, open capital markets, privatization and deregulation, have still been the core assumptions guiding U.S. foreign economic policy.

Yet all this time, academic researcheres have not conclusively shown whether or not it "works." The economic theory of liberalization is certainly sound, and still taught as such in universities, but the evidence in the real world is unclear - for instance, serious questions persist on whether free trade lowers wages or makes workers worse off (beyond the effects predicted by theory). The Economist article assess a longer research piece by Professsors Dani Rodrik of Harvard and Arvind Subramanian of the Peterson Institute, which raises similar questions around the assumption of open capital markets.

Their question is a timely one, since the breakdown in U.S. credit markets and the rise of dynamic economies elsewhere may well lead nations to rethink their need for capital market liberalization. Their central point is that, despite the best efforts of researchers, no clear link has been found between freer international capital flows and economic growth. They point out that while open capital markets can provide cheaper capital or discipline policymakers, they can equally lead to overborrowing, capital flight and upward pressure on the local currency.

Advocates of open capital markets assume that countries will simultaneously reform property rights and improve contract enforcement, which are needed to reap openness' full benefits. Yet it is precisely these weaknesses that make investing in developing countries difficult, and in Rodrik and Subramanian's view, it is these constraints on the "supply" of available investments that is the problem, not the "demand" for investments from foreign capital.

In the end, like almost all policy prescriptions for developing countries, adopting economic openness and liberalization works best when domestic systems, regulations and supervision are already sound. It's the classic chicken-and-egg problem - figuring out whether the greater problem is a shortage of investment that foreign sources can fix, or poor investment infrastructure, in which case opening up to foreign capital may do more harm than good. "It depends" is always an unsatisfying answer, but Rodrik and Subramanian conclude that “depending on context and country,” they write, “the appropriate role of policy will be as often to stem the tide of capital flows as to encourage them.”

Economist link: http://www.economist.com/finance/economicsfocus/displaystory.cfm?story_id=11016324
Full article: http://ksghome.harvard.edu/~drodrik/Why_Did_FG_Disappoint_March_24_2008.pdf

The Rise of the Rest

The always insightful Fareed Zakaria has another great article out, The Rise of the Rest. The trends reshaping the global economy Zakaria talks about have been visible, but scattered - many data points whose direction is as yet unclear. Trends like the astonishing economic development, and wealth creation, in formerly sluggish or even dysfunctional countries around the world; the growing challenge to American power from China; and the increase in intra-Asian trade that makes the United States less critical, though still an incredibly important trading partner. It's easy to try to make sense of these forces by saying the U.S. is in decline, but that doesn't really capture what is happening in the world.

Zakaria brings a greater narrative to the breathless "Flat World" hype that Tom Friedman gives us. Zakaria's view is that the United States has actually been very successful in spreading the ideas of capitalism, open markets, and economic reform, and that we are now witnessing the fruits of these efforts throughout the 1980s and 1990s. And as these countries generate their own multinationals and billionaires, their attention naturally begins to focus more and more on what's happening within their countries, and with Lakshmi Mittal, Carlos Slim or Ratan Tata rather than with Donald Trump, Bill Gates or George Bush.

Of course, as other countries rise, the United States declines on a relative basis. The U.S. will be the world's largest economy for a few more decades, and most likely the world's most important country for yet longer, but relative decline seems unavoidable, and a source of anxiety for Americans. Zakaria's view? Things aren't all that bad. Outside of Iraq and Afghanistan, despite all the negative reporting, the world is as peaceful as it has ever been, even including hotspots and conflicts in Nigeria, Somalia, Darfur, etc. And the major countries? While they are happy to have a greater say, even occasionally troublesome China and Russia prefer a stable, orderly, and smoothly functioning international system, and are not likely to rock the boat (yet).

Therefore, Zakaria concludes that the "Rise of the Rest" is a good thing (and inevitable), and that the U.S. still has the opportunity to be the "indispensable country" and chief architect of the new international system. The question, of course, is whether the U.S. can rise to that challenge given its completely dysfunctional politics of the last eight years. Zakaria concludes here, but the question of whether the U.S. will align itself better with the rest of the world is a huge question. Why haven't we fixed our health care system? Why aren't we adequately funding research into newer and cleaner energy sources? Why is our foreign policy so myopically focused on terrorism, ignoring the most powerful countries and forces at work today? These problems are all solvable. I, for one, am hopeful that Americans will recognize and be galvanized by these trends, and/or that better political leadership can tackle the nation's problems. "The Rest" will be watching.

Rise of the Rest (Foreign Affairs):
http://www.foreignaffairs.org/20080501facomment87303/fareed-zakaria/the-future-of-american-power.html
Rise of the Rest (Newsweek):
http://www.newsweek.com/id/135380/

China Needs Old Boys With MBA's

A lack of management talent is one of the key constraints on China's otherwise astonishing economic growth. This article looks at this problem from the point of view of managers in China today, and also raises the old question of whether "Western" or "Chinese" management practices are needed in China. It seems like both are needed - Chinese practices most importantly (like guanxi), to navigate the uncertainty, corruption and lack of trust.

But for companies that seek to be come dynamic global competitors (remember, China has virtually zero homegrown multinationals so far), and especially for founders that want their companies to continue growing once their unique relationships and resources are gone, professional "Western" management seems to be an absolute necessity. Can China pull it off?

http://www.nytimes.com/2008/04/19/business/19nocera.html?hp=&pagewanted=print

A few excerpts:

One evening in Beijing, I wandered into a local bookstore. I couldn’t read a thing, of course, but I had been told that Chinese urbanites are voracious readers, and that I could get a feel for that in any decent bookstore. The place was enormous; its five floors of wall-to-wall books made your typical suburban Barnes & Noble look puny by comparison. Shoppers sat on the floor, reading.

On shelf after shelf, I could see copies of Jim Collins’s “Good to Great,” Jack Welch’s “Straight From the Gut,” Tom Peters’s “Re-Imagine!” and just about everything the late Peter Drucker ever wrote. There was no management topic, no matter how arcane — the science of H.R. anyone? — that didn’t have its own section.

Can the Cellphone Help End Global Poverty?

This is an interesting New York Times article on a "consumer anthropologist" who photographs and documents human behavior for Nokia, in order to design more usable and relevant cell phones - especially for the global poorest, who are the last untapped market for otherwise ubiquitous cell phones. Maybe this is an approach that can be used to design other useful products for the proverbial "Bottom of the Pyramid"?

http://www.nytimes.com/2008/04/13/magazine/13anthropology-t.html

Some excerpts:

This sort of on-the-ground intelligence-gathering is central to what’s known as human-centered design, a business-world niche that has become especially important to ultracompetitive high-tech companies trying to figure out how to write software, design laptops or build cellphones that people find useful and unintimidating and will thus spend money on.

The premise of the work is simple — get to know your potential customers as well as possible before you make a product for them. But when those customers live, say, in a mud hut in Zambia or in a tin-roofed hutong dwelling in China, when you are trying — as Nokia and just about every one of its competitors is — to design a cellphone that will sell to essentially the only people left on earth who don’t yet have one, which is to say people who are illiterate, making $4 per day or less and have no easy access to electricity, the challenges are considerable.

The BRIC Road

The BRIC Road

A blog on international economics, finance, and the macro trends shaping the world as we know it. If you're here, you probably know that Goldman Sachs coined the term "BRICs" in 2003 to describe the most important emerging markets of the 21st century - Brazil, Russia, India, and China, which are on track to overtake the US, Japan and Europe as the largest economies in the world - if they can stay on the BRIC Road!