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Wirtschaftsblunder

http://www.economist.com/finance/displayStory.cfm?story_id=2441670#footnote1


Feb 19th 2004
From The Economist print edition
Why has the German economy performed so much worse than the rest of Europe?
Over the past ten years, Germany's GDP has grown by an annual average of only 1.4%, barely half as fast as growth in the rest of the European Union, and roughly the same pace as Japan, which has been a byword for slow growth over the past few years. The most popular explanations for Germany's dismal performance are the costs of reunifying East and West Germany, and the arthritic state of the united country's labour markets. However, a new study* by Goldman Sachs, an investment bank, makes an intriguing claim: that it is an artificially low cost of capital, which has encouraged excessive investment, that has been most to blame. A rising cost of capital in recent years can explain much of Germany's weaker growth--and could continue to depress it for several more years.
The study starts with Germany's extraordinarily low return on capital. Goldman Sachs estimates that German firms have earned an average pre-tax rate of return on their capital of only 5% since 1991. In contrast, the average return in the rest of the EU has been 12% which, as the chart shows, is even higher than the 10% earned by American companies. Reunification has been partly to blame: the inclusion of firms in former East Germany and the massive boom in capital investment after unification both depressed average returns. But eastern Germany is only 11% of total GDP--too small to explain the unusually low overall average rate of return. In any case, firms in West Germany already had a low return on capital before reunification.
Some argue that Germany's powerful trade unions have raised wages and so reduced the return on capital. But unions are as strong and labour markets as rigid in other EU countries where returns are higher. Moreover, if trade unions had increased workers' total income, the consequent lower return on capital should have reduced investment. Yet quite the opposite has been true: since 1991 business investment has averaged 21% of GDP in Germany, 18% in the rest of the EU and 15% in America.
The combination of high investment and low returns, says the bank, suggests that the cost of capital has been much lower in Germany than elsewhere. Firms invest up to the point at which the extra return covers the cost of capital plus a profit margin. If capital costs are held down, the result is high investment and low returns. It is Germany's capital market, not its labour market, that sets it apart from other European economies. But in important (and worrying) respects this makes the country similar to Japan, where investment as a proportion of GDP is also very high, and returns on capital are correspondingly low.
Germany's financial system is distinctive in two important ways. First, firms rely much more on banks than financial markets. Bank debt accounts for half of the liabilities of non-financial firms, twice the share in the rest of Europe. Second, state-owned financial institutions (Landesbanks and savings banks) account for a big chunk of corporate borrowing. Debt issued by state-owned banks is guaranteed by the government, reducing their financing costs and hence their lending rates. Moreover, they were set up explicitly to assist the expansion of local business, so their objective has been to support investment not maximise returns. Small wonder that German banks' average return on equity is half that of banks in the rest of the EU.
Capital crunch
With borrowing cheap--their cost of capital was at least two percentage points lower than in the rest of Europe in the late 1990s--German firms invested more. But private-sector banks are now under pressure from shareholders to boost profits and in 2001 the European Commission ruled that public guarantees for state-owned banks were anti-competitive and must be phased out. The result is that firms' risk-adjusted cost of capital will rise to more normal levels. Indeed, the interest rates paid by many German firms have already risen in recent years, even as official rates have fallen.
According to Goldman Sachs, it is this rising capital cost that is largely to blame for Germany's weak investment and slow growth in GDP in recent years. Investment as a share of GDP has fallen from 24% in 1991 to 16% in 2003. It may well fall further, because corporate borrowing costs are still lower than in the rest of Europe, and it will take a long while for firms to adapt to paying more for their money. In Japan, where a low cost of capital similarly caused over-investment in the past, investment and growth have been depressed for more than a decade.
Making various assumptions, Goldman Sachs estimates that, if the average cost of capital in Germany rises to the European average, this could eventually reduce Germany's GDP by 5%. In other words, it could knock half a percentage point off its annual growth rate over ten years. And the country, reckons the bank, is only half way through that process.
In the long run, capital-market reform will lead to a more efficient use of capital, and hence higher rates of return. Indeed, total national income (including foreign income), in contrast to GDP, should increase. As the capital subsidy is eliminated, more money will be invested abroad as firms seek higher returns, making Germans as a whole better off. But for the economy to benefit, the labour market will need to adjust quickly because the shift of capital overseas will otherwise result in job losses.
So even if capital costs are the main source of Germany's sluggish growth, labour-market reform is still important because it would reduce the short-run loss of output as firms adjust to higher borrowing costs. Indeed, if labour costs can be squeezed by reforms, firms can adjust without having to cut investment as much. The snag is that, even if Germany pushes ahead with labour reform, rising capital costs will continue to constrain investment and growth. And with no immediate benefits, public resistance to reform in general is likely to grow.

* "No gain without pain--Germany's adjustment to a higher cost of capital", by Ben Broadbent, Dirk Schumacher and Sabine Schels. Global Economics Paper No. 103
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The reserve army
Feb 12th 2004
From The Economist print edition
The unemployment rate is only the beginning of the problem
RARELY does an economic indicator provide as much fodder for politicians and pundits as the unemployment rate. Far more than, say, current accounts or capacity utilisation, unemployment is something everyone can understand: you are either in work, not in work, or looking for work. As such, it is easily seized upon as an indicator of the broader health of an economy, or even of workers' eagerness to revolt.
The issue of unemployment has loomed especially large in America in recent months. That is partly because there are presidential elections in November, and much will hinge on whether George Bush can convince voters that an apparently booming economy is producing jobs. A glance at the unemployment rate would seem to give him the answer he wants. The unemployment rate has fallen from a post-recession peak of 6.3% in June to 5.6% last month, though that is still higher than the 5.0% that many economists consider to be the "natural rate" of unemployment--one that results merely from the normal or "frictional" patterns of job gains and losses at any one time.
But the unemployment rate is, in fact, a poor measure of economic health. It is defined as the fraction of the people in the labour force--those who are actively seeking work and available for it--who cannot find a job. And it relies on surveys to determine who is, in fact, actively seeking work rather than enjoying a spot of leisure. It is that subjectivity that makes the unemployment rate such a flawed statistic. A better question by far is how many people are employed--ie, are being paid by someone for doing something, since this should be less subject to doubt.
Or so you might have thought. Yet there has been a fierce debate in America recently over even this humble statistic. That is because the number employed in America is also still measured using surveys, and the two that are widely used tell different stories. One is taken of over 400,000 firms with formal payrolls. Another asks 60,000 households whether people in them are working. But both are hostage to the usual limitations of using small samples to estimate employment for the whole economy, though obviously to different degrees. They are, moreover, subject to big revisions. And both have their advantages.
The payroll survey uses a bigger, more easily verifiable sample. On the other hand, the household survey may better capture a rise in jobs among new small businesses and the self-employed, both of which seem to have accounted for a lot of new employment in the recent recovery. According to the household measure, nearly 139m Americans were in work in January, even more than had jobs at the height of the boom in March 2000. By the payroll measure, some 130m were in work--a fall of nearly 2% since employment peaked.
Left-leaning pundits naturally prefer the payroll survey. The Bush administration and its friends prefer the household version. Still, even the latter's figures would make job growth in the current economic recovery anaemic by historical standards.
Concerns over employment data are not just an American problem. According to a recent report from Barclays Capital, Germany's employment statistics may be overstating the numbers of self-employed because of a government initiative to subsidise previously unemployed workers in starting their own business. Combined with other shenanigans, this may produce an army of "hidden unemployed" of 1.4m, estimates the report, some 30% more than the number of officially unemployed. In Japan, the unemployment rate has never risen above 5.5% in recent years, despite a decade-long economic funk. That is in part because firms are reluctant to sack workers for social reasons.
Flawed though they may be, the employment numbers are of fundamental importance. Two crucial questions for economic output and for the suffering caused by unemployment are: what portion of the working-age population does not work and how many of those that do not work want to do so?
The international brigade
Regardless of which survey you believe, more people of working age are at work in America than in Europe. America's employment rate is just over 70%--almost ten percentage points higher than Europe's. In other words, less than a third of working-age Americans are not in work, whereas in Europe the figure is closer to 40%, though the gap between the two economies has been closing in recent years, as America's employment rate has fallen and Europe's has risen.
Many of those that do not work would almost certainly like to. By the OECD's reckoning, the ranks of those who could be mobilised are thus far bigger than those that are formally classed as unemployed. Indeed, in most countries, according to the OECD, there are far more gains to be had in bringing inactive workers into work than in reducing unemployment to its "natural" rate. In Italy, for example, the OECD reckons that more than a fifth of the working-age population could be brought into work, and some 17% in Spain and Greece.
In the euro area, the relatively lower employment rate explains much of the region's lower GDP per person. And low employment is often the fault of misguided policies that discourage people from working, such as high payroll taxes; marginal income taxes that penalise the work of a lower-paid spouse; rules that make sacking workers expensive; and generous benefits that encourage the work-shy to be classed as disabled, to name but a few.
Such structural problems play a huge role in the differences in the wealth of nations. The trouble is that fixing them can be politically fraught. Just ask Gerhard Schr?der, Germany's chancellor, who resigned this month as head of his party, because of resistance to a package of modest reforms. Having jobs is one thing; working quite another.
Copyright ? 2004 The Economist Newspaper and The Economist Group. All rights reserved.
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Face value
After Parmalat
Feb 19th 2004
From The Economist print edition
Matteo Arpe and the noble pursuit of better banking in Italy
ONCE upon a time in Italy top bankers learned to play a delicate game. As they did their normal bankerly things, they knew that at any moment they might receive a phone call requesting help: could they use their influence with a longstanding client in trouble, or perhaps a smaller bank that needed a friendly rescue? Even the cleverest of the bankers sometimes struggled with the complex politics of the business. When did a favour turn from the sensible into the corrupt? Many a banker was compromised once he had agreed to do something "convenient". This rottenness lay at the core of Italian banking.
Today a new mood is evident. Consider, for instance, a stricture laid down by Matteo Arpe, boss since July 2003 of Capitalia, Italy's fourth-largest banking group, embracing three banks: Banca di Roma, Banco di Sicilia and Bipop Carire. Italian banking must change, he says. There are things that are legal and others that are illegal, things that sound good and those that sound bad. Illegal deals by definition are unacceptable. But Mr Arpe wants to go further: deals must be both legal and sweet-sounding.
Hang on a minute. Is not Capitalia hugely exposed to Parmalat, the bankrupt and scandal-ridden food group that may have defrauded investors of more than ?10 billion ($13 billion)? And was it not the house bank for Cirio, another food group that controversially went bust in late 2002 and whose former chairman, Sergio Cragnotti, was accused of fraud and arrested on February 11th? Capitalia does not seem the most obvious place to foster the modernisation of Italian banking. Indeed, if anything, it seems to exemplify the flaws of the old system.
Look again, however, and Mr Arpe appears less out of touch with reality. True, Capitalia's peak exposure to Parmalat was some ?394m (today it is ?40m less). But a good chunk of its lending was covered by collateral and stands a reasonable chance of being recovered. Moreover, Capitalia lent to Parmalat's operating companies, not to the financial arm where the fraud was orchestrated. Capitalia had no derivatives exposure. Nor, after Mr Arpe's arrival, did it underwrite any of Parmalat's bond issues.
The Cirio case is more awkward, if equally revealing. Mr Cragnotti had longstanding relations with Cesare Geronzi, Capitalia's chairman, who hand-picked Mr Arpe to run his banks. Mr Geronzi is one of the great survivors of Italian banking, but arguably he let Mr Cragnotti go too far. By the time Cirio went bust, Mr Cragnotti personally owed the bank around ?500m, and his company owed much more. Mr Arpe courageously called time on the lending to his (disbelieving) client. When loans are non-performing, he says, clients become counterparties. That was a shock to Mr Cragnotti, who to this day vituperatively blames Capitalia for the failure of his group.
Mr Arpe is as modern as the banking code he endorses. Since he arrived, aged 37, as general manager of Banca di Roma in May 2002 he has made a huge impact. He cut his banking teeth during 12 years at Mediobanca, a Milanese investment bank that dominated post-1945 Italian finance. He was a prot?g? of Enrico Cuccia, for decades Mediobanca's famously powerful boss. Mr Arpe made his name working on big privatisations, such as that of Telecom Italia. Along the way his talent inspired jealousy, and he abruptly quit Mediobanca in 1999, resurfacing at Banca di Roma after a spell in London with Lehman Brothers.
It was not an obvious role for him. He had no commercial banking experience. He was very young--at least by Italian standards--to be put in charge. Moreover, Banca di Roma, in particular, was in dire trouble after years of slack lending. But Mr Arpe relished the chance to show that he could manage people and turn the group around. Mr Geronzi promised that he would not meet interference, even if proposed reforms were tough.
Looking good
The numbers--Parmalat apart--since his arrival are certainly impressive. Operating costs have been slashed. Capitalia has lifted its core capital ratio from a weak 5.3% to a respectable 6.9%, partly by shedding ?30 billion of financial risks, such as derivatives and off-balance-sheet exposures, and partly by rigorously tackling a huge ?13 billion portfolio of non-performing loans. Archon, a joint-venture with Goldman Sachs, is managing more than ?6 billion of bad loans with incentives to recover money quickly. Provisions of ?3.2 billion, equivalent to two-thirds of Capitalia's market value, have been squirreled away. All this, as Mr Arpe says, without recourse to shareholders.
Mr Arpe has also reshaped Capitalia's governance, not least by focusing on curbing bad lending. He now spends one-third of his time chairing a central credit committee, and has veto power over every loan. Managers of Capitalia's loan portfolio are wholly independent of the bankers who make the loans.
Finally, Mr Arpe has overseen a cultural shake-up. More than 200 new managers have joined the group. Almost everyone else has been moved to a new position. One new hire is an ex-banking analyst who a few years ago had refused to cover Banca di Roma on the grounds that its reported numbers were too unreliable. Now, he says, perhaps not wholly surprisingly, Capitalia is the bank of choice for ambitious young graduates.
Much remains to be done. Though out of intensive care, Capitalia remains in the recovery ward. Though pleased by its progress, investors remain somewhat sceptical. There continues to be talk of Capitalia having to merge, sooner or later, with another big Italian bank--though none seems noticeably keen to take on its bad debts. Mr Arpe will need luck as well as skill to complete his job. But he has a certain flair. Amid the bad publicity due to Cirio and Parmalat, he decided to reimburse retail customers for worthless bonds in those firms that they had been sold by Capitalia's salesforce. The cost will be ?41m. The goodwill it generates should be worth far more than that.
Copyright ? 2004 The Economist Newspaper and The Economist Group. All rights reserved.
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Corruption in South-East Asia
Who will watch the watchdogs?
Feb 19th 2004 | JAKARTA
From The Economist print edition
Despite a few encouraging signs, South-East Asia's record on fighting corruption at the top is still mostly lamentable
MALAYSIA is agog with speculation. The government, which charged a sitting minister and a prominent businessman with corruption earlier this month, says it has a list of 18 other high-profile suspects due for similar treatment. Opposition politicians say that Rafidah Aziz, the minister of trade, should be among them. She denies any wrong-doing and says she will sue her critics for defamation--a threat they claim to welcome as a chance to prove their accusations in court. Is the pervasiveness of corruption, a problem common to most countries in South-East Asia, at last getting a proper airing?
The region is certainly awash with celebrated corruption cases. Joseph Estrada, the deposed president of the Philippines, is currently on trial for "economic plunder". On February 12th, Indonesia's supreme court finally ruled on a long-running embezzlement case against Akbar Tandjung, the speaker of parliament. In 2001, Thailand's constitutional court heard charges that Thaksin Shinawatra, the prime minister, had concealed some assets during an earlier stint as minister. Last October, it sentenced a former health minister, Rakkiat Sukthana, to 15 years in jail for colluding with pharmaceutical firms.
But there is less to this flurry of righteousness than meets the eye. For starters, prosecutors have not had much success against grand defendants like Messrs Thaksin and Tandjung. Both persuaded higher courts to overturn earlier rulings against them. Mr Estrada, too, managed to evade impeachment while in office, and prosecutors are making heavy weather of their current case against him. Even the convicted Mr Rakkiat has not yet begun his prison term, since he jumped bail and went into hiding. What is more, all the countries in the region save Singapore and Malaysia still rank in the bottom half of the most recent "Corruption Perceptions Index" compiled by Transparency International, an anti-graft watchdog. Vietnam ranked 100 out of 133 countries, Indonesia 122 and Myanmar a dismal 129.
This poor showing stems in part from a lack of laws, personnel and money to combat corruption. But the resource in shortest supply is political will to tackle the problem. All countries in South-East Asia have at least one anti-corruption agency. But the ones that work best, argues Jon Quah, a professor at the National University of Singapore, are centralised, independent agencies such as Thailand's National Counter Corruption Commission. By contrast, Malaysia's Anti-Corruption Agency reports to the government, and so is subject to political control. The Philippines, meanwhile, has adopted no fewer than seven anti-corruption laws in the past 50 years, and created 13 anti-graft agencies, according to Mr Quah's count. Dramatic but disputed corruption allegations, such as the claim that the president's husband is managing multiple slush finds, simply get lost in all this bureaucracy.
Even theoretically independent agencies, of course, are still subject to political interference, most obviously through appointments. The governing coalition in Thailand has learned how to maximise its say on the panels that select members of the country's various watchdog agencies--which have become much less meddlesome as a result. Indonesia's parliament, which just set up a similar agency called the Corruption Eradication Commission, declined to appoint the most crusading candidates as commissioners.
The courts can also undermine counter-corruption efforts. In the Philippines, cases can be drawn out for so long, through so many appeals, that the risk of prosecution does not provide an effective deterrent to corruption. In Indonesia, all courts are for sale, according to one supreme-court justice. At any rate, they often return quixotic rulings. The supreme court, for example, accepted Mr Tandjung's argument that he should not be punished for misappropriating funds as a minister, since he apparently did so on the orders of the president of the day, his administrative superior. At the very least, argues Harkristuti Harkrisnowo, a law professor at the University of Indonesia, the court should have considered Mr Tandjung an accessory to corruption. Instead, she worries, the new precedent paves the way for the court to dismiss several other pending corruption cases. And only a handful of cases have made it to court at all, despite Indonesia's many multi-million dollar corruption scandals in recent years.
That is where political will comes in. Indonesian politicians often speak of the need to combat corruption, but dragged their feet over the creation of the Corruption Eradication Commission. Members of parliament freely admit that they are on the take, so were naturally reluctant to put themselves under scrutiny. Gloria Arroyo, the president of the Philippines, also pays lip-service to anti-graft efforts. But when corrupt tax collectors rebelled against a reforming new boss last year, she backed down and accepted his resignation. In Thailand, Mr Thaksin implied during his own corruption trial that scrutiny of ministers was an unwarranted intrusion into the workings of government. Since becoming prime minister, he has stacked his cabinet with former businessmen, yet has not instituted any formal system to prevent them taking decisions that might affect their families' firms.
The counter-corruption mechanisms in Malaysia have not changed at all since Abdullah Badawi became prime minister last year. Yet instead of prosecuting a whistle-blower for releasing details of corruption investigations, as his predecessor did, Mr Badawi has hauled a minister into court. True, an election is imminent, and the minister in question is scarcely a heavyweight. But Mr Badawi is also taking serious steps to reduce corruption in the long term, such as awarding government contracts by open tender. If Malaysia had only instituted such a policy a decade ago, there might not have been any secret list of suspects to argue about.
Copyright ? 2004 The Economist Newspaper and The Economist Group. All rights reserved.