By Barry Eichengreen

May 19, 2010

THE last few weeks have been the most amazing - and important - period of the euro's 11-year existence. First came the Greek crisis, followed by the Greek bailout. When the crisis spread to Portugal and Spain, there was the US$1 trillion (S$1.3 trillion) rescue. Finally, there were unprecedented purchases of Spanish, Portuguese, Greek and Irish bonds by the European Central Bank (ECB). All of this was unimaginable a month ago.

Europe's fortnight mirabilis was also marked by amazing - and erroneous - predictions. Greece would be booted out of the monetary union. The euro zone would be divided into a Northern European union and a Southern European union. Or the euro - and even the European Union - would disintegrate as Germany turned its back on the project.

But rather than folding their cards, European leaders doubled down. They understood that their gamble will be immensely costly if it proves wrong. They understand that their political careers now ride on their massive bet. But they also understand that they already have too many chips in the pot to fold.

Those forecasting the demise of the euro were wrong because they misunderstood the politics. The euro is the symbol of the European project. Mr Jacques Delors, one of its architects, once called the single currency 'the jewel in Europe's crown'. Abandoning it would be tantamount to declaring the entire European integration project a failure.

It is true that Germans are incensed about bailing out Greece. It is true that Dr Angela Merkel is the first postwar German chancellor not to have lived through World War II. But her views and actions are shaped by the society in which she lives, which in turn is shaped by that history. And what is true of Dr Merkel is still true of Europe. This is why European leaders swallowed hard and took their unprecedented steps.

But having doubled their bet, Europeans now must make their monetary union work. Europe has excellent bank notes. It has an excellent central bank. But it lacks the other elements of a proper monetary union. It needs to establish them - and fast - which requires finally addressing matters that have been off limits.

First, Europe needs a Stability Pact with teeth. This will now happen, because Germany will insist on it. As the European Commission has proposed, the strengthened pact will have tighter deficit limits for heavily indebted countries. Exceptions and exemptions will be removed. Governments will be required to let the commission vet their budgetary plans in advance.

Second, Europe needs more flexible labour markets. Adjustment in the United States' monetary union occurs partly through labour mobility. This will never apply to Europe to a similar degree, given cultural and linguistic barriers.

Instead, Europe will have to rely on wage flexibility to enhance the competitiveness of its depressed regions. This is not something that it possesses in abundance. But recent cuts in public-sector pay in Spain and Greece are a reminder that Europe is, in fact, capable of wage flexibility. Where national wage-bargaining systems are the obstacle, the European Commission should say so, and countries should be required to change them.

Third, the euro area needs fiscal co-insurance. It needs a mechanism for temporary transfers to countries that have put their public finances in order but are hit by adverse shocks.

To be clear, this is not an argument for Germany's dreaded 'transfer union' - ongoing transfers to countries like Greece. It is an argument for temporary transfers to countries like Spain, which balanced its budgets prior to the crisis but then was hit by the housing slump and recession. It is an argument for fiscal insurance running in both directions.

Fourth, the euro zone needs a proper emergency financing mechanism. Emergencies should not be dealt with on an ad hoc basis by 27 finance ministers frantic to reach a solution before the Asian markets open. And European leaders, in their desperation, should not coerce the ECB into helping. There should be clear rules governing disbursement, who is in charge, and how much money is available. It should not be necessary to obtain the agreement of 27 national parliaments each time action is needed.

Finally, Europe needs coherent bank regulation. One reason the Greek crisis is so difficult is that European banks are undercapitalised, overleveraged and stuffed full of Greek bonds, thereby ruling out the possibility of restructuring - and thus lightening - Greece's debt load.

That happened because European bank regulation is still characterised by a race to the bottom. 'Colleges' of regulators, the supposed solution, are inadequate. If Europe has a single market and a single currency, it needs a single bank regulator.

This is a formidable - some would say unrealistically ambitious - agenda. But it is the agenda Europe needs to complete to make its monetary union work.

The writer is Professor of Economics and Political Science at the University of California, Berkeley.

PROJECT SYNDICATE

Source - The Straits Times http://www.straitstimes.com/Review/Others/STIStory_528369.html

By Yang Changyong (China Daily)

Facts on the ground prove that media claims about China's investment environment are far from true

The Western media recently claimed that China's investment environment is deteriorating, pointing out that, due to China's increasing "discrimination" against foreign investment and the "worsening" regulatory environment, the foreign-funded enterprises were facing more difficulties in investing and operating in the country.

Relevant facts and data, however, bear out that, rather than deteriorating, China's investment environment has been constantly improving.

According to a report released by the United Nations Conference on Trade and Development (UNCTAD) on January 19 this year, due to the severe impact of the international financial crisis, global foreign direct investment (FDI) inflows are estimated to have fallen by 38.7 percent in 2009, of which developed economies registered a fall of 41.2 percent, while developing countries saw a decline of 34.7 percent.

FDI inflows are estimated to have declined by 29.2 percent to the European Union, 57 percent to the US, and 53.4 percent to Japan. And, for developing economies, Brazil registered a fall in FDI of 49.5 percent, Russia 41.1 percent and India 19 percent.

In stark contrast, China has performed well in terms of attracting FDI in 2009 with only a slight decline of 2.6 percent. And, since August 2009, China's utilized foreign investment has been mounting steadily.

FDI inflows to China, which went against the global declining trend to some extent, could fully prove that the nation's overall investment environment is endorsed by foreign businesses.

According to the 2010 Special Report on the State of Business In China released by the American Chamber of Commerce, 71 percent of US enterprises in the country reported profits in 2009 and 46 percent reported comparatively higher China operating margins in 2009 than they saw worldwide.

With regard to the five-year optimism among US companies in China, 91 percent of companies reported that their outlook was optimistic, rebounding to the 2007 level.

More than 75 percent of companies believed that China remains a top-three priority in their company's global investment plans for 2010 and nearly 80 percent of American businesses in China planned to expand investment this year.

In recent years, with production factors such as labor, resources, land and environment becoming increasingly scarce, the cost factor is in catch-up mode.

Against this background, the main reason why foreign companies in China could report good profitability and maintain confidence in investment is that the investment environment here is improving, with reduced transaction costs for foreign businesses. This has enhanced the attractiveness of the nation's overall investment environment.

"The State Council Proposal on Further Improving the Work of Using Foreign Investment" released on April 6 put forward that China will further expand the scale of opening up, optimize foreign investment structure, promote diversified ways to attract foreign investment, deepen the reform of foreign investment management system and create a favorable investment environment.

This could be considered as the most explicit signal that the nation's investment environment will be further improved, as well as the most effective response to the accusation of deteriorating investment environment in China.

However, two points need to be clarified as far as the process of improving investment environment in China is concerned.

First, it needs time to optimize the investment environment in China, especially when it comes to improving the related institutions and regulations. Implementing the central government's regulations at various local government levels cannot be done overnight.

During this period, it is inevitable that foreign investors might encounter some dissatisfaction. Since embracing reform and opening up policies, China has shown great sincerity in attracting foreign investment and has amended the Catalogue for the Guidance of Foreign Investment Industries five times.

The scale of opening up is being constantly expanded. We believe that the general trend of China's improving investment environment will not change and the investment environment will definitely optimize gradually.

Second, to improve investment environment needs not only that China is sincere toward foreign investors, but also understanding and respect from their foreign counterparts, including foreign investors and media.

For foreign enterprises, abiding by the Chinese law, custom and culture is the most fundamental business ethic. As it is said in the Book of Rites - when you come to a new place, you should ask what is taboo first; when you come to a new nation, you should know the customs first; when you come to a new family, you should ask what is forbidden first.

Meanwhile, in the face of investment barriers, foreign investors could seek resolution through reasonable channels in coordination with the concerned departments.

If they merely resort to complaining about the investment environment and bad-mouthing the Chinese economy, which are then magnified by the Western media, it might delay the process of improving investment environment in China and will finally damage their own interests.

The author is an assistant researcher at the Institute for External Economic Policy Studies, National Development and Reform Commission.

(China Daily 05/18/2010 page8)

http://www.chinadaily.com.cn/opinion/2010-05/18/content_9860883.htm

By Dani Rodrik (China Daily)

The $140-billion support package that the Greek government has finally received from its European Union partners and the International Monetary Fund (IMF) gives it the breathing space needed to undertake the difficult job of putting its finances in order.

Deep down, the crisis is yet another manifestation of what I call "the political trilemma of the world economy": economic globalization, political democracy, and the nation-state are mutually irreconcilable. We can have at most two at one time. Democracy is compatible with national sovereignty only if we restrict globalization. If we push for globalization while retaining the nation-state, we must jettison democracy. And if we want democracy along with globalization, we must shove the nation-state aside and strive for greater international governance.

The history of the world economy shows the "trilemma" at work. The first era of globalization, which lasted until 1914, was a success as long as economic and monetary policies remained insulated from domestic political pressures. These policies could then be entirely subjugated to the demands of the gold standard and free capital mobility. But once the political franchise was enlarged, the working class got organized, and mass politics became the norm, domestic economic objectives began to compete with (and overwhelm) external rules and constraints.

The classic case is Britain's short-lived return to gold in the inter-war period. The attempt to reconstitute the pre-World War I model of globalization collapsed in 1931, when domestic politics forced the British government to choose domestic reflation over the gold standard.

The architects of the Bretton Woods regime kept this lesson in mind when they redesigned the world's monetary system in 1944. They understood that democratic countries would need the space to conduct independent monetary and fiscal policies. So they contemplated only a "thin" globalization, with capital flows restricted largely to long-term lending and borrowing.

The Bretton Woods regime collapsed in the 1970s as a result of the inability or unwillingness - it is not entirely clear which - of leading governments to manage the growing tide of capital flows.

The third path identified by the "trilemma" is to do away with national sovereignty altogether. In this case, economic integration can be married with democracy through political union among states. The loss in national sovereignty is then compensated by the "internationalization" of democratic politics. Think of this as a global version of federalism.

The United States, for example, created a unified national market once its federal government wrested sufficient political control from individual states. This was far from a smooth process, as the American Civil War amply demonstrates.

The European Union's difficulties stem from the fact that the global financial crisis caught Europe midway through a similar process. European leaders always understood that economic union needs to have a political leg to stand on. Even though some, such as the British, wished to give the European Union (EU) as little power as possible, the force of the argument was with those who pressed for political integration alongside economic integration. Still, the European political project fell far short of the economic one.

Greece benefited from a common currency, unified capital markets, and free trade with other EU member states. But it does not have automatic access to a European lender of last resort. Its citizens do not receive unemployment checks from Brussels the way that say Californians do from Washington, DC, when California experiences a recession. Nor, given linguistic and cultural barriers, can unemployed Greeks move just as easily across the border to a more prosperous European state. And Greek banks and firms lose their creditworthiness alongside their government if markets perceive the latter to be insolvent.

The German and French governments, for their part, have had little say over Greece's budget policies. They could not stop the Greek government from borrowing (indirectly) from the European Central Bank (ECB) as long as credit rating agencies deemed Greek debt creditworthy. If Greece chooses default, they cannot enforce their banks' claims on Greek borrowers or seize Greek assets. Nor can they prevent Greece from leaving the eurozone.

What all this means is that the financial crisis has turned out to be a lot deeper and its resolution considerably messier than necessary. The French and German governments have grudgingly come up with a major loan package, but only after considerable delay and with the IMF standing at their side. The ECB has lowered the threshold of creditworthiness that Greek government securities must meet in order to allow continued Greek borrowing.

The success of the rescue is far from assured because of the magnitude of belt-tightening that it calls for and the hostility that it has aroused on the part of Greek workers. When push comes to shove, domestic politics trumps foreign creditors.

The crisis has revealed how demanding globalization's political prerequisites are. It shows how much European institutions must still evolve to underpin a healthy single market. The choice that the EU faces is the same in other parts of the world: either integrate politically, or ease up on economic unification.  

Before the crisis, Europe looked like the most likely candidate to make a successful transition to the first equilibrium - greater political unification. Now its economic project lies in tatters while the leadership needed to rekindle political integration is nowhere to be seen.

The author, professor of Political Economy at Harvard University's John F. Kennedy School of Government, is the first recipient of the Social Science Research Council's Albert O. Hirschman Prize. Project Syndicate

 

(China Daily 05/14/2010 page9)

http://www.chinadaily.com.cn/opinion/2010-05/14/content_9848235.htm 

By Sophie Cerny and Jessica Tou