I Dream of Naomi the Globophobe

Let me qualify that--I have bad dreams about Naomi Klein. She is, of course, the author of the popular book that attacked the evils of corporate globalization, No Logo. A favorite of the anti-globalization movement, she has recently released another, more ambitious book entitled The Shock Doctrine. The book makes an analogy between electroshock therapy applied to psychiatric patients and the "shock therapy" doctrine of wholesale economic makeover. (Although Jeffrey Sachs is associated with the term, he claims not to like it.) Just as electroshock therapy is designed to break down patients and make them susceptible to reprogramming, economic shock therapy supposedly does the same to entire nations. What else, this kind of shock therapy is often accompanied by coercion. To Klein, it's a cocktail of shocks: "Countries are shocked by wars, terror attacks, coups d’état and natural disasters"; afterwards, “they are shocked again — by corporations and politicians who exploit the fear and disorientation of this first shock to push through economic shock therapy.” Lastly, those who “dare to resist” are shocked for a third time, “by police, soldiers and prison interrogators.”

This exceedingly specious analogy is extended to a number of "case studies": Pinochet's Chile in 1973; the Falklands War in 1982; the Tiananmen Massacre of 1989; the rise of Russian oligarchs in 1993; September 11; the invasion of Iraq in 2003; and Sri Lanka after the 2004 tsunami. How deliberately conducted electroshock therapy relates to the catastrophic "shocks" of 9/11 (unless you buy the conspiracy theory that a US missile hit the Pentagon) and the 2004 tsunami is not given much explanation. Nor is it explained how the Falklands War, which, if I recall, resulted from the Argentinian invasion of the Falklands, led to liberalization, privatization, and deregulation in England. In effect, Klein tries to conveniently fit events on a Procrustean bed of an analogy by forcing the description of these events to fit an electroshock therapy/shock therapy analogy and its associated corporate-led violence. Muddling up actors, motives, and outcomes doesn't really matter. Aside from those neoliberal Argentineans who foisted liberalization, privatization, and deregulation on the hapless English, we have the Tiananmen massacre being the turning point in China's conversion to "getting rich is glorious," which Deng Xiaoping first uttered in 1979 if I recall correctly.

Needless to say, I would not hesitate to give any paper based on the idea that the Argentinian invasion of the Falklands was done in order to spur neoliberal reforms in Britain or one that suggested Tiananmen spurred China's turn to the market a failing mark. That such faulty logic could be extended to 500+ pages beggars belief. It's not ideological bias on my part. This is one of the very few blogs covering economics topics that has Marxist sources among its links. Nor would it be fair for me as an IPE instructor to deliberately give lower marks to papers that adopted a Marxist-leaning perspective. (Actually, it's often easier for students to write a good essay with such a perspective, but that's another story.) Rather, the faults with Klein's work are not ideological but logical. Even the renowned left-leaning author, the late great Andre Gunder Frank would have said that markets are not newfangled Western corporate contraptions designed to impoverish the world but have existed throughout the Orient since time immemorial. There's nothing necessarily wrong with markets if you go by the explanation that they're spaces where people come together to exchange things. As Amartya Sen noted in his magnum opus Development as Freedom:

The market mechanism, which arouses passion in favor as well as against, is a basic arrangement through which people can interact with each other and undertake mutually advantageous activities. In this light, it is very hard indeed to see how any reasonable critic could be against the market mechanism, as such. The problems that arise typically spring from other sources—not from the existence of markets per se—and include such concerns as inadequate preparedness to make use of market transactions, unconstrained concealment of information or unregulated use of activities that allow the powerful to capitalize on their asymmetrical advantage. These have to be dealt with not by suppressing the markets, but by allowing them to function better and with greater fairness and with adequate supplementation. The overall achievements of the markets are deeply contingent on political and social arrangements.

Joseph Stiglitz gets this point in his book review of Shock Capitalism: markets become acceptable insofar as institutions are established that enable an economy to function well and reflect the broader social fabric that markets are embedded in. Klein's Procrustean bed is sample selection bias at its worst. Select those cases where money, power, and occasional violence (the subtitle of my blog) come together and use them to make a wholesale indictment of "the market," never mind that the pieces don't fit the (incoherent) shock doctrine thesis. Sorry, but I don't do conspiracy theories. Like the Ahmadinejad variation ("Jews control the world") and the anti-American variation ("the corporate American Empire is bent on global domination"), the anti-globalization variation ("the free market is a myth designed to enrich the West and impoverish the rest of the world") suffers from the same tendency towards the grand narrative of market fundamentalists: "free markets automatically deliver peace and prosperity."

The world is too complex to be encapsulated by these conspiracy theory and libertarian simplifications. Grand narratives are fine for storytelling purposes, but for those of us who seek a more nuanced understanding of the dynamics of globalization, it's a much more difficult task. There are no easy answers. I leave you with Will Hutton's scathing but spot-on take on Klein's book:

In her delusional, Manichaean world view, privatisation, free markets, private property, consumer freedom, the profit motive and economic freedom are just other terms for corporate self-enrichment, denial of voice, limitation of citizenship, inequality and, sometimes, even torture. The discredited electro-shock psychological treatment of the Fifties, we learn, informed the thought system of the free marketeers; it is guilt by association and assertion rather than proof, a weaknesses of too much of the book.

Nothing good can ever come from globalisation, which is just more capitalism. Democracy, however, is a halcyon world of political and economic co-operation, citizen voice and engagement, with a freely arrived-at assertion of the common interest in which most think along the same lines as, say, Naomi Klein. She and free-market economist Milton Friedman, whom she has in her sights, are mirror images of each other in the absolutist categories in which they think.

US Student Loans: Subprime II?

Uh-oh, we've seen this movie before. Just as the subprime mess has revealed the troubles in America's love affair with costly credit (and not reading the fine print), it seems private student loans may be headed in the same direction with equally dire consequences. Instead of the pitch that adjustable-rate mortgages could be refinanced anyway since the housing market was unsinkable, the pitch here is that college graduates would be able to find good-paying jobs after their graduation that would pay for their college loans. In many instances, however, it seems that college graduates are having trouble finding jobs or jobs that allow them to pay off their loans. Needless to say, things may get worse if America's economic picture worsens further. End result? Some are predicting an explosion in private student loan defaults a la subprime. From the Associated Press:

The near doubling in the cost of a college degree the past decade has produced an explosion in high-priced student loans that could haunt the U.S. economy for years.

While scholarship, grant money and government-backed student loans whose interest rates are capped have taken up some of the slack, many families and individual students have turned to private loans, which carry fees and interest rates that are often variable and up to 20 percent...

Parents are still the primary source of funds for many students, but the dynamics were radically altered in recent years as tuition costs soared and sources of readily available and more costly private financing made higher education seemingly available to anyone willing to sign a loan application.

Students with no credit history and no relatives to co-sign loans (or co-signing parents with tarnished credit) were willing to bet that high-priced loans were a trade-off for a shot at the American dream. But high-paying jobs are proving elusive for many graduates.

"This is literally a new form of indenture ... something that every American parent should be scared of," said Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers.

More than $17 billion in private student loans were issued last year, up from $4 billion a year in 2001. Outstanding student borrowing jumped from $38 billion in 1995 to $85 billion last year, according to experts and lawmakers.

Rocketing tuition fees made borrowing that much more appealing. Consumer prices on average rose less than 29 percent over the past 10 years while tuition, fees, and room and board at four-year public colleges and universities soared 79 percent to $12,796 a year and 65 percent to $30,367 a year at private institutions, according to the College Board.

Scholarship and grant money have increased, yet for almost 15 years, the maximum available per person in government-guaranteed student loans, which by law can't charge rates above 6.8 percent, has remained at $23,000 total for four years. That's less than half the average four-year tuition, room and board of $51,000 at public colleges and $121,000 at private institutions.

Sallie Mae, formally known as SLM Corp., has been on the winning side of the loan bonanza. Its portfolio of 10 million customers includes $25 billion in private and $128 billion in government-backed education loans. However, private-equity investors who had offered $25 billion to buy the company backed out last week, citing credit market weakness and a new law cutting billions of dollars in subsidies to student lenders.

Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co., Wachovia Corp. and Regions Financial Corp. are also big players in the private student loan business. And there has been an explosion in specialized student loan lenders, such as EduCap, Nelnet Inc., NextStudent Inc., Student Loan Corp., College Loan Corp., CIT Group Inc. and Education Finance Partners Inc.

The question is whether everyone who borrowed will be able to repay. Experts don't track default rates on private student loans, but many predict sharp increases in years to come...

Meanwhile, complaints about marketing of private loans like ads promising to approve loans worth $50,000 in just minutes are on the rise. The complaints have made their way to lawmakers, who see a need to regulate the highly profitable and diverse group of companies and the loans they make to college students.

In August, the Senate Banking Committee approved a bill that would mandate clearer disclosure of rates and terms on private student loans. The bill also would require a 30-day comparison shopping period after loan approval, during which time the offer terms could not be altered.

New York Attorney General Andrew Cuomo said many graduates who borrowed owe as much if not more than most homeowners owe on mortgages. Unlike mortgages with clear consumer disclosure requirements even from nonbank lenders, private lending is "the Wild West of the student loan industry," he said in a telephone interview.

Critics say what happened in the mortgage market could happen in the student loan market. Cuomo, who conducted a nationwide investigation, said the parallels between the two markets are "provocative."

Demand for bundled student loans sold to institutional investors worldwide fueled lending to students. The market for private student loan-backed securities leapt 76 percent last year, to $16.6 billion, from $9.4 billion in 2005, according to Moody's Investors Service.

The student loan-backed securities market has yet to suffer noticeable effects of a global credit squeeze that was triggered this summer by a mortgage meltdown of borrowers with risky credit.

"Once the economy starts to slow, you're going to see a large increase of these people in bankruptcy court," said Robert Manning, a professor at Rochester Institute of Technology who has written about college students and credit cards.

A 2005 change to bankruptcy law puts private student loans on par with child support and alimony payments: Lenders can garnish wages if someone doesn't pay.

Cuomo's probe revealed what he calls an "appalling pattern of favoritism" for student lenders that provided kickbacks, revenue-sharing plans and trips to college administrators in exchange for recommended lender status. Other critics allege widespread corrupt arrangements propelled a student loan boom.

Lenders deny such charges, arguing that industry growth resulted from surging education costs and that higher interest rates are justified for unsecured loans to borrowers with blemished or insufficient credit records.

"Lenders take 100 percent of the repayment risk on flexible private-education loans made to people with limited credit histories, on which they will not get repaid for several years," Barry Goulding, a Sallie Mae official, told Congress last spring.

New regulations could dry up access to education financing, he and other industry executives argue. Some experts are skeptical, predicting waves of student loan delinquencies and defaults on what is outstanding.

"Should private student loans suffer the same sort of failure as (subprime) mortgages, as students graduate or drop out and find themselves unable to pay, we will do serious damage not only to the lives of many students but also to the economic and social fabric of our country that depends on college graduates for its strength," said Luke Swarthout at the U.S. Public Interest Research Group.

John Lipsky, the IMF's David Lereah

Recently resigned National Association of Realtors Chief Economist David Lereah is (was?) infamous for his ever-optimistic take on the state of the US housing market. His belief is best summarized by his book's title, "Why the Real Estate Boom Will Not Bust - And How You Can Profit from It: How to Build Wealth in Today's Expanding Real Estate Market." So infamous is Lereah that there's even a website critiquing his merry pronouncements of everlasting housing mirth. Unfortunately for the rest of us, while Lereah is gone, we still have to listen to another Lereah-esque character. Worse yet, he's at the IMF, the supposed guardian of the international financial system. Who will guard the guardians when the guardians are Wall St. cheerleaders?

Michael Panzer, Mr. Financial Armageddon himself, beat me to the punch in characterizing John Lipsky--First Deputy Managing Director of the IMF and former Vice Chairman of JPMorgan Chase Investment Bank--as a competitor to Lereah in the "don't worry, be happy" sweepstakes. While Lipsky also sounded a sanguine note on US real estate by noting in January that "a more stable US housing market [has] diminished risks in the global economy," he is more famous for his easygoing prognostications on financial derivatives. You know the Wall St. line as it is identical to Lipsky's: Financial derivatives are innovations which quantify risks precisely and enable market participants to diversify risks to those who can bear them. As recent events have demonstrated, Lipsky was wrong on all three counts. First, mark-to-model and rating agency shenanigans laid waste to realistic pricing of these instruments. Second, most hedge funds have shown how un-diverse their strategies were as most got hit at the same time. Third, all sorts of financial institutions have gone belly up.

Ah, but don't sweat it, Lipsky reminds the world at the IMF's Globalization & Risk Conference. Here is the non-apology for his previous statements:

A few months ago, I would have said that one of most striking features of financial globalization has been the broadening reach of financial institutions and markets, creating an ability to disperse risk much more widely than previously. The process of globalized risk transfer is being facilitated by securitization and by the use of complex derivative transactions. As is well understood, the key benefit of modern risk transfer instruments is that they allow investors to bear only the financial risks they wish to.

While I still believe this to be one of the most relevant facets of financial globalization, the events of the past few months have demonstrated that the process of risk dispersion contains some inherent potential [not realized?] problems. In particular, the complex composition of some derivative instruments-and the lack of transparency regarding some holders' balance sheets-make it hard to assess the risk exposure of individual entities, including some regulated institutions. For example, over the last couple of years, U.S. sub-prime and other mortgage-backed assets have been a key ingredient of structured credit products that have been sold to a broad set of investors, many outside the United States. In fact, this aspect of financial globalization has worked well up to now-abstracting from the issue of whether investors became excessively exuberant. [Worked well...in ripping off the ROW?]

Problems arose when it became apparent that the underlying assets were not performing very well-that is, when U.S. house prices began to weaken and mortgage delinquencies rose quickly. At that point, the lack of transparency regarding both instruments and investors created a sudden loss of confidence in the predictability of the mapping of changes in the underlying housing market, to the prices of the relevant derivative securities. Liquidity disruptions emerged quickly-both in terms of the market liquidity of the instruments themselves and the funding liquidity of some of the institutions that purchased them.

Got that? It was a liquidity problem at work. There was nothing much wrong with the instruments themselves. So what are we to do? This is the most head-scratching part. What Lipsky basically says is that "innovation" should not be stifled. Moreover, trying to regulate "innovation" to improve transparency is futile since we may end up watching out for yesterday's problems in an ever-changing world. Nevermind that it seems innovation is causing a lot of these emerging problems but...

Here, I would like to sound a note of caution: We must be careful not to focus excessively on new regulations intended to fight the last battle when the next one could be different. We already have made a lot of progress in recognizing that supervision should be "risk-based" and that regulation should be "incentive compatible." These principles should be kept in mind when we look ahead. The key will be to adapt these concepts to the problems of today with careful thought given to what we expect to happen tomorrow.

For this reason, I find some of the latest criticism of Basel II [banking regulations] to be just a bit too facile. It has been claimed that conduits and SIVs were conceived as a means to avoid Basel II capital charges by placing assets off bank's balance sheets. In a Basel II world, however, it would be less costly to put the assets held by conduits and SIVs on the balance sheet than in the current Basel I world, since their risk-sensitive ratings likely would have required less capital charges than in Basel I. The current debate about ratings agency regulation is another area where we must tread carefully in order not to stifle innovation...

Clearly, investors share the blame for recent market difficulties. They should not take a credit rating letter grade on complex securities as the principal element of their due diligence process. Nonetheless, rating agencies will continue to play an important role in providing third party opinions about credit risks, especially in areas where credit risks are difficult to assess.

Huh? We should do the rating agencies' jobs so we aren't hoodwinked by them, yet they will still have an "important role...where credit risks are difficult to assess"? Don't you feel safer now that the IMF is staffed by the likes of John Lipsky? I'll second Felix Salmon's thoughts on Lipsky: "I, for one, can't ever remember a public official being so Panglossian – certainly not an unelected one." (Someone, please set up a "John Lipsky Watch" before it's too late.)

Travel Cheaply w/ "Surging" Yuan

Here's a travel article from our favorite Party publication the China Daily that will either elicit your interest or have you scratching your head in disbelief. This article is yet another entry in the vast genre of travel stories that go like this: Ever since the currency of country X became that much stronger, citizens of X have gone shopping in country Y and other blighted places suffering from devaluation. (You can read Canada-US and UK-US versions, for instance.) The notable twist to this story is that China is country X and country Y is merely the city of Hong Kong. While the renminbi AKA the yuan has strengthened by about 10% against the US dollar (and consequently the USD pegged Hong Kong dollar), this story is a bit too self-serving IMHO for the Party line that the yuan is not being manipulated. Nevertheless, it's worth noting the large number of tourists emanating from the Middle Kingdom. Truly, a (camera and camcorder-toting) force to be reckoned with:

Shopping in Hong Kong or sunbathing in Thailand are proving more attractive than a domestic trip during the National Day holiday for mainland tourists - thanks to the rising yuan.

As Fang Fang, who plans to go to the special administrative region, said: "It costs the same to go to Yunnan or Hong Kong. Why not go overseas then?"

The price is around 3,000 yuan ($400) each for the overseas trip and the 23-year-old bank employee said the stronger yuan is the major reason for her travel plan.

"I want to buy a watch and cosmetics there. I heard from my friends that I can save at least several hundred yuan," she said.

The value of the yuan vis a vis the US dollar has surged nearly 10 per cent since July 2005, when the central bank unpegged the currency from the greenback and linked it to a basket of currencies.

Most travel agencies have said the number of tourists applying for overseas trips during the National Day holiday is higher than the same period last year.

"We have seen an increase of 10-15 percent in outbound tourism," said Lin Kang, deputy general manager of the outbound travel department of China International Travel Service Head Office.

Tour products to Europe, South Korea, Japan and some islands such as Maldives and Saipan, are also popular, he said.

"The rising renminbi has generated great interest in shopping overseas," he said.

Ctrip.com, an online travel service company, agreed, saying it is especially evident in Hong Kong tours.

It said the number of people applying for Hong Kong trips during the holidays has almost doubled from the same period last year.

"Though outbound tour packages cost the same as last year, shopping cheap is a big attraction," said Wu Jiaoli, an analyst with the company.

"Most mainland tourists go to Hong Kong for shopping. The rising renminbi obviously means they pay less," she said.

Outbound tourism has shown double-digit growth for five consecutive years.

Last year, 34 million Chinese traveled overseas, making them the sixth largest group of outbound tourists worldwide.

In the first half, outbound tourism grew 14 percent year on year, the China National Tourism Administration said earlier this month. It estimated that 37.4 million Chinese will travel overseas this year.

The UN World Tourism Organization has forecast China will become the fourth largest source of outbound tourists by around 2015.

The Burma<->Wonga ($) Nexus

I have a nasty neighbor like the Association of South East Asian Nations (ASEAN) does. Whereas I have to put up with a neighbor playing loud gangsta rap that goes "smack that biatch" and "kill those mofos", ASEAN's neighbor Burma actually does those things all the time. Why does Burma do so? Because it can. It's about the wonga (slang for money), naturally. Corporate social responsibility (CSR) issues aside, there's a heckuva lot of energy reserves not being tapped by America because of its sanctions just waiting for those who can stand dealing with the Burmese junta. As long as it can get a cut on such deals to sustain itself in power, the junta has a way to survive Yes, ASEAN has already made a pretty strong statement about the situation there for an outfit that has emphasized "constructive engagement" with Burma:

The ASEAN Foreign Ministers had a full and frank discussion on the situation in Myanmar at their Informal Meeting this morning in the UN and agreed for the Chair to issue this Statement. They were appalled to receive reports of automatic weapons being used and demanded that the Myanmar government immediately desist from the use of violence against demonstrators. They expressed their revulsion to Myanmar Foreign Minister Nyan Win over reports that the demonstrations in Myanmar are being suppressed by violent force and that there has been a number of fatalities. They strongly urged Myanmar to exercise utmost restraint and seek a political solution. They called upon Myanmar to resume its efforts at national reconciliation with all parties concerned, and work towards a peaceful transition to democracy. The Ministers called for the release of all political detainees including Daw Aung San Suu Kyi.

In addition, Indonesian President Susilo Bambang Yudhoyono has called on Burma to better its human rights record. Philippine President Gloria Macapagal-Arroyo has urged Burma to "redeem democracy." Singaporean PM Lee Hsien Loong says the situation is "very grave". Even Thai PM Surayud Chulanot who himself was installed by a military junta has "condemned the use of violence." However, it turns out that Thailand is the main customer of the biggest gas project in Burma run by the French energy giant TOTAL:

Total of France, which operates a natural gas project in Burma, has expressed its “deep concern” over the situation in the country but rejected the idea it should pull out.

The company argues that its presence benefits tens of thousands of people and serves as a model for “business and political leaders looking for ways to address the country’s human rights issues”.

Alongside Chevron of the US, Total is one of the leading western companies still active in Burma.

In a statement, it said: “A forced withdrawal would only lead to our replacement by other operators probably less committed to the ethical principles guiding all our initiatives. Our departure could cause the population even greater hardship and is thus an unacceptable risk.”

Total and Chevron are partners on the Yadana offshore gas project, which came on stream in 1998. Last year the field produced an average of 19.3m cubic metres a day, representing about half of Burma’s total gas output.

Most of the gas is sold to Thailand; PTT, the Petroleum Authority of Thailand, is a member of the Yadana consortium. Chevron, which acquired its stake when it bought Unocal in 2005, said it was monitoring the situation.

Production has been steady since 2001. Total said it would not invest in any new projects in Burma, but would continue to spend on maintenance and in areas necessary to sustain production, such as drilling new wells and installing compressors.

In 2003 Bernard Kouchner, now French foreign minister, was commissioned as an independent consultant by Total to write a report on the group’s involvement in Burma. He did not call for it to leave the country, but said the company “must come out clearly in favour of democracy”.

Human Rights Watch, the New York-based campaign group, takes a similar view, saying it has a responsibility to speak out on events in Burma.

Arvind Ganesan of HRW said: “The Yadana project is probably one of the biggest revenue raisers, if not the biggest revenue raiser, for the Burmese government, so it gives them the ability to do the things they want to do.”

He added that there was a similar responsibility on Thailand, which buys most of the Yadana gas, and other Asian countries that have been investing in Burma.

Western companies such as Premier Oil of the UK have pulled out.

But ONGC of India and CNPC of China, both state-controlled, have been building up their investments.

Burma’s gas resources are sizeable, if not enormous. Proved reserves were 540bn cubic metres at the end of last year, according to the BP Review of World Energy.

Aside from Thailand, that's quite a list of other states with interests in Burma's energy reserves. I've already mentioned Chinese involvement in Burma. Just as you don't expect the Thai military junta to be too rough on another military junta, you don't expect Chinese authoritarians wary of populist movements led by religious figures to compel Burmese authoritarians to negotiate with, er, populist movements led by religious figures. Shooting at monks is truly appalling stuff, but Burma uses its business ties well to curry favor with certain others in the international community. That is, enough favor to live out whatever sanctions the US would place on it. At the end of the day, it's all about the wonga.

Structurally Adjusting the IMF

And now here's an old-school, straight-up IPE topic: the fate of the IMF. As you know, the IMF was originally intended to be a lender of last resort when countries ran into balance of payments crises. When a country no longer had the ability to pay for its exports since its foreign exchange holdings were depleted, it had to call on the IMF. The most visible, relatively recent calls for help were made when the Asian financial crisis plunged East Asian countries into financial turmoil as foreign investors pulled out their FDI and portfolio investments en masse while regional currencies devalued severely. Countries that turned to the IMF had to follow tough "structural adjustment" policies that, above all, emphasized fiscal austerity. As Joseph Stiglitz famously suggested in Globalization and Its Discontents, these policies brought about severe social hardships since the socioeconomic effects of such policies were not often thought through.

Hit the fast-forward button and we now find a vastly changed global political economy: developing countries have accumulated vast reserves as mercantilist policies have taken hold, especially among Asian countries. The thinking behind such unprecedented accumulation is simple: "We've seen the terrible effects of resorting to the IMF and its 'structural adjustment' policies, so we're going to accumulate plentiful reserves to ensure we don't have to turn to the IMF." Even if these reserves could have arguably been used for better things such as health care and education as developing countries may have drawn the wrong lessons from the crisis, reserve accumulation continues apace. The flip side of developing countries weaning themselves off IMF support has been that the IMF has had little business for its lender of last resort function. Without lending, of course, the IMF earns no interest income.

What we have, nowadays, is the intriguing situation where the IMF needs to "structurally adjust" itself by undertaking fiscal austerity measures. Like the countries it so famously told to do some belt tightening, the IMF now needs to do the same. Here is an Economist introduction to the current financial state of the IMF:

What is a firefighter to do when there aren't any fires? The IMF spent 1994-2002 dashing from one financial conflagration to the next. But the sirens have been silent for some time. As a result, the fund's budget is shrinking and the morale of its staff is sinking. Some of its best customers are now doing without it, leaving some of its biggest shareholders wondering what to do with it...

Apart from generating reams of analysis, the fund's job is to furnish foreign exchange to countries that have temporarily run short. It can call on about $220 billion of hard currency in the first instance. That sounds like plenty. But some of its former customers now have big, shiny fire-engines of their own. South Korea, for example, has $217 billion in its vaults. Between them, eight East Asian countries (Japan, Singapore, Indonesia, China, Malaysia, the Philippines, Thailand and South Korea) command reserves worth about ten times the IMF total. These countries have even begun to pool a small fraction of their combined hoard, under what is called the Chiang Mai Initiative.

Lately no one has been calling on the fund's own supply. Brazil and Argentina have both repaid their debts. Only Turkey and Indonesia still owe it money on any scale. Quiet times are lean times for the IMF. Like any bank, it covers its running costs (which will amount to over $900m in the year to April 2007) from the interest it earns on its loans. But this financing model “is no longer tenable”, Mr de Rato's report says. By its own projections, the IMF will live beyond its means by almost $300m in 2009-10. The belt-tightening this implies has not gone down well with staff, who show little taste for the austerity they are notorious for prescribing to others.

In short, the IMF has gone from anti-globalization arch-villain to semi-irrelevant international organization in the space of less than a decade. The question has become, "is the IMF still relevant in today's global political economy?" With the imminent appointment of Dominique Strauss-Kahn as IMF chief, this matter has come to the fore. Some suggestions include (a) enhancing the IMF's surveillance role over exchange rates (though this is a contentious matter; (b) broadening the participation of developing countries in global economic governance; and (c) doing medium- to long-term lending like the World Bank. It's interesting stuff, and the International Herald Tribune identifies some of the key emerging issues for the IMF.

A decade ago, the International Monetary Fund helped to stabilize the world economy after markets collapsed in Latin America, Russia and Asia. While conservatives denounced its role in bailing out investors, liberals assailed its austerity measures imposed on several troubled economies.

Today the only crisis faced by the IMF is a crisis of identity. Countries rescued in the 1990s have mostly repaid their debts.

On Friday Dominique Strauss-Kahn of France is to be named the new managing director of the IMF, succeeding Rodrigo de Rato of Spain, who is resigning. He arrives at a time when the Bush administration, which backed him for the job, has joined a global chorus calling on the fund to rethink its priorities and its governance.

With a shrunken loan portfolio, the institution that lectures others about finances has lost operating income, is running a deficit and is facing staff cuts and considering the sale of gold to meet expenses...

"What might be at stake today is the very existence of the IMF as the major institution providing financial stability to the world, a global public good," Strauss-Kahn, a former French finance minister, told the fund's directors last week. "In sum, the two main issues are relevance and legitimacy."

The other key issue to be considered is the way the world's wealthiest countries choose the person to run the fund. Since the fund was established after World War II as part of the Bretton Woods postwar economic architecture, its chief is chosen in private by the leading powers in Europe.

After President Nicolas Sarkozy of France nominated Strauss-Kahn this summer, his selection was a foregone conclusion, just as it was inevitable that President George W. Bush would get his way in picking Robert Zoellick this summer to head the World Bank after the ouster of Paul Wolfowitz, the former U.S. deputy defense secretary.

But there is widespread unhappiness and embarrassment among the fund's board members over the clubby nature of the process, especially among the countries in Asia and Latin America bailed out in the 1990s. Many are now export powerhouses sitting on huge reserves and no longer need or want the fund telling them what to do.

Russia hoped to capitalize on these feelings in challenging the selection of Strauss-Kahn. It nominated its own candidate, Josef Tosovsky, a former prime minister of the Czech Republic, who told the board that as a "representative of an emerging market transition economy," he would bring a different perspective to the job.

Aleksei Mozhin, the board director representing Russia at the fund, said his country was "very, very proud" to nominate Tosovsky. "It is an open secret that the fund is barely alive," he added. "It is in the business of survival. The traditional modus operandi of the fund - you need our money, we tell you what to do - is gone."

De Rato, the outgoing managing director and a former economy minister in Spain, has won widespread credit for initiating many of the changes and rethinking at the IMF, though the Bush administration has made no secret of its impatience over the pace of change.

Last year, with American backing, the fund agreed to give more voting shares to China, South Korea, Turkey and Mexico.

A plan to further expand the voting shares of these and other emerging economies is still being debated. The Bush administration fears that if such steps are not taken, these countries may break away from the fund.

The administration has also gotten the fund to do more to monitor currency manipulations by trading partner countries, especially China, which Treasury Secretary Henry Paulson Jr. has accused of buying dollars to keep the value of its currency low so that its exports can be sold more cheaply in the United States [this is the contentious part].

As a result of American and European pressure, a panel set up by De Rato called on China to end its currency interventions earlier this year. It also called on Europe to deregulate its economy and on the United States to do more to close its looming fiscal deficits in the coming decades.

Paulson has made little secret of his desire for the fund to be more aggressive in pressing China on this issue. Treasury officials were irritated earlier this year when De Rato said he could not lecture China any more than he could lecture Bush about the projected cost of Social Security and Medicare [good comeback, De Rato--the IMF should not be an extension of US policy].

"We're satisfied that there has been progress on the currency issue," said Clay Lowery, an assistant secretary of the Treasury for international affairs. "But more needs to be done for the IMF to be as relevant as it has been in the past."

In speeches, De Rato has said that, with its fading role in bailing out countries in crisis, the fund's new priorities should be in urging countries to take actions to prevent crises, monitoring the global economy and providing technical assistance. Fund officials say that Strauss-Kahn is likely to continue these policies.

But the French nominee has also told fund directors and some interviewers that he wants the organization to do more to alleviate poverty - a statement that some American officials say they hope does not lead to its trying to supplant the World Bank.

If the fund concentrates solely on monitoring the economy and seeking greater disclosure in the world financial system, that would suit some of its critics well. Adam Lerrick, an economist at Carnegie Mellon University in Pittsburgh and the American Enterprise Institute, a private research organization in Washington, is among those who say that the IMF needs to rethink its role in that direction.

"Without radical reform, the IMF will soon be totally irrelevant," Lerrick said. "The fund should focus on data gathering and the dissemination of financial information. Surprise causes financial crises. The more information markets have, the less likely there will be a crisis."

But many experts also warn against the complacency of the moment and say that the fund should be kept healthy in order to play a role in a future global crisis, even if rescue operations have to be carried out also by other players with large pools of reserves.

"It worries me a lot when people say the IMF can just go away," said Anne Krueger, a former first deputy managing director of the fund and now a professor of economics at Johns Hopkins University in Baltimore.

"You have to think of the fund as something of an insurance policy for the member countries," she added. "Times are good right now. But there are so many important economic issues that can't be done bilaterally any more. Big countries and small countries recognize that they need the fund."

Chinese SWF: All Hat, No Cattle?

Texans use the term "all hat, no cattle" to describe all hype, no action. In computerese, it's called "vaporware." Much discussion has centered on the possibility that the Chinese government would use its whopping $1.4 trillion in reserves to buy up the West and the rest of the world through its newly created sovereign wealth fund, the China Investment Company (CIC). As the CIC opens its doors this Saturday, Reuters' Alan Wheatley urges us not to believe the hype--for now at least. Among other things, the CIC is likely to be under the thumb of the People's Bank of China (PBoC). Lest we forget, there are also those past bugaboos of el crappo Western investments like Flint--I mean, Blackstone stock and rising Western protectionism for CIC to deal with:

The formal launch of China's investment agency may prove to be a milestone in the development of sovereign wealth funds but for now it is largely irrelevant to the conduct of the country's economic and monetary policy.

Besides giving Beijing a way to earn more on part of its $1.4 trillion in reserves, the agency was billed as a way of siphoning off some of the inflows from China's record trade surpluses that are boosting money supply and pumping up asset prices.

But as the China Investment Corp (CIC) prepares to open for business on Saturday, economists say the fund's initial remit is such that it will not make much of a difference to policy makers at the People's Bank of China, the central bank.

Critically, new net currency inflows will be bought not by the CIC, as was once assumed, but by the central bank.

As it issues yuan in exchange, the central bank will keep creating high-powered reserve money -- the building blocks for bank credit and money growth -- that it will have to keep mopping up through open market operations.

"This means that the scope of the current monetary policy implementation, as well as the complications, including forex reserve accumulation and sterilization, would remain largely unchanged with the establishment and operation of the CIC," economists at JPMorgan Chase said in a note to clients.

The sums of Chinese money chasing a home overseas are also likely to be underwhelming.

Although the CIC has initial capital of $200 billion, one-third of that will pay for Central Huijin, an investment vehicle that the PBOC used to pump foreign exchange into several big state banks.

Media reports have also said the CIC will be used to recapitalize two other banks and perhaps even to buy shares in big state-owned enterprises.

"The external implications are that the impact of the CIC, on the U.S. dollar and U.S. treasuries, at this phase may not be as negative as some market participants may have feared," JPMorgan Chase said.

Recent market turmoil and domestic criticism of the CIC for its purchase of a $3 billion stake in Blackstone mean the fund is likely to start off investing fairly conservatively in liquid foreign securities, said Michal Pettis, a professor at Peking University.

Shares in Blackstone have fallen 20 percent since the U.S. private equity group's initial public offering in June, handing the CIC a big paper loss.

"As the CIC grows, I would bet that an increasing amount of its assets is likely to be invested in strategic investments, which I suspect will include the financing of the foreign expansion of state-owned companies.

"This may turn out to be the most highly politicized aspect of the CIC's future business," Pettis said.

US cattle ranching...in Inner Mongolia

One of the truisms in development is that food demand increases as a country becomes increasingly prosperous. Nowhere is this dynamic more apparent than in the PRC. One of the (rather Westernized) habits that the Chinese have picked up is an appetite for beef, AKA heffers. So, enterprising American cattle ranchers have decided to set up shop near the booming Chinese market--in Inner Mongolia. However, big operations modeled after American methods will likely bring social (smaller farmers put at a disadvantage), environmental (carbon emissions and water pollution), and political (growing political-economic clout of big operators) dislocations. File this one under "what hath McWorld wrought?" From TIME:

Kevin Timberlake digs the toe of his cowboy boot into the caked earth and gives the coffee-colored dirt a scuff. Some 70 acres of scrubby land spread out in front of him under the washed-out blue sky. "See the soil. This is junk," Timberlake says. Under his breath, he counts a thin herd of cattle hanging their heads over the weeds. Once a horse trainer and breeder in Missouri, Timberlake now spends his days thinking about cows, and this time next year, he and his employer, Western Cattle Company, would like to see about 10,000 more living on this land. "I'd be taking the ground and turning it into something," he says.

Timberlake's dusty patch is not in Missouri — it's in China. Earlier this year, Western Cattle started to raise Holsteins on an American-style ranch and feedlot built in the wide open spaces of Inner Mongolia. Their goal: deliver truckloads of well-marbled beef to the waiting plates of urban China's growing middle class. With a target herd of 75,000, U.S.-based Western Cattle has the potential to be the leading company in the third-largest beef-producing nation in the world. And if the company's Western take on raising cattle catches on in the East, it could kick start the consolidation of China's disorganized beef-production chain, bringing to Inner Mongolia all the high-volume efficiency — and social and environmental concerns — that go with big agriculture.

A few years back, China wasn't much of an attraction for cattlemen. The Chinese traditionally serve beef sparingly, usually in stir-fried dishes, stews and hot pots for which tough, lean meat suffices. But the rise of McDonald's in China in the 1990s is credited with popularizing the all-beef patty, and today upscale restaurants and hotels in major cities commonly put steak on the menu. Consumption has risen 31% in the past five years alone, according to the U.S. Department of Agriculture. "The beef market is exploding," says Western Cattle president Jim Mueller. He's not exaggerating. Owing to soaring demand, China could face beef shortages as early as next year, says the Asian Agribusiness Research Center, a situation exacerbated by a dramatic decline in pork production brought on by an outbreak of blue-ear disease earlier this year. And for now, Mueller doesn't have to worry about competition from back home. Imports of beef from America — a top global supplier — have been banned in China since mad cow disease appeared in Washington State in 2003.

Mueller and his partners chose to set up their first feedlot outside Hohhot, Inner Mongolia's capital, partly because of the local government's aggressive pro-investment policies. Among other things, officials helped the company find land and provided introductions to potential business partners. Ultimately, though, it came down to the fact that Hohhot is a cow town. Two of China's biggest dairies, Mengniu and Yili, have headquarters in the area, and buy milk from thousands of farmers who raise dairy cows in their front yards. There are more than a million cows around Hohhot; the bustling city is plastered with garish advertisements for yogurt and ice cream, and nearby farming villages have developed de facto affiliations with whichever dairy buys their milk. By offering the farmers more money for milk than they earn for crops, the dairies have helped breathe life into Inner Mongolia's struggling economy.

Western Cattle is counting on the same farmers to help them push their agenda for beef. The private company doesn't breed cows; it buys them, fattens them up on a feedlot and then trucks them off to the slaughterhouse. Today, the half million male calves born every year around Hohhot are mostly sold to blood-serum companies that render the animals' plasma into products such as cosmetics. Timberlake, who is the on-site manager for Western Cattle in China, has been going head to head with serum companies since he arrived six months ago, hitting the dairies and villages with competitive offers for calves. The rangy 48-year-old, who has a salt-and-pepper moustache and shock of white hair, says he thinks he's offering the farmers a good bargain, but the deals he makes have got to be win-win. "We're here to do a service and to make money," he says. "We're not over here for our health, or I wouldn't be breathing smog."

Farmers are no less pragmatic about their relationship with the cattle buyers and big dairies. In the village of Bingzhouhai, the whims of the market rule the daily rhythms of life. Every morning, farmers who live in courtyard-style homes walk their cows past the patches of lettuce and squash gardens to the small milking station that Yili operates there. Before dairy became a local industry, people used cattle to plow the fields, but there was a better living to be made selling milk than grain. Now, that seems to be changing. "The price of feed is going up, but the milk price is stable," says He Erwen, a farmer who lives in Bingzhouhai with his family of seven. Though his cows cost more to feed now, he's keeping them with hopes that milk prices will climb, restoring his profits. As for the prospect of selling his surplus male calves to a newcomer like Western Cattle, He laughs. "Depends on the price."

Some worry that the livelihoods of small farmers will be threatened as Inner Mongolian agriculture modernizes. Western Cattle is providing farmers with an additional source of income, and the farmers are providing the company with inexpensive labor. But big feedlots in the U.S. are essentially factories, much larger than the biggest in China today, maintaining herds of tens of thousands of animals supplied by dedicated cattle ranches. As the industry grows, farmers could be squeezed out. Even now, they are at the mercy of middlemen like the dairies, which have some control over pricing. The farmers have none. "Only the big companies have the power," says professor Jiang Gaoming, a plant biologist with the Chinese Academy of Sciences.

No one expects China's beef industry to be transformed overnight. Others have tried Western production methods and failed. Steffen Schindler, a German butcher who runs two Beijing restaurants and a small meat plant, oversaw the first feedlot and slaughterhouse to sell hamburger meat to McDonald's in China. That joint venture went under after a local company set up a competing operation nearby. But as China keeps growing, Schindler thinks it's inevitable that the mom-and-pop industry will coalesce into large operations. "You cannot meet the demand if you're doing it the old-fashioned way," Schindler says.

Still, if more feedlots like Western Cattle's crop up around the country, communities can expect to deal with a new set of problems. Disease outbreaks in concentrated animal populations can be devastating. Even if the cows and their meat are well monitored and safe, feedlots foul the air and can be a source of water pollution. Growing the massive amount of corn needed to feed herds also means fertilizer and pesticide runoff in water supplies, and trucking feed and meat around the country is a big carbon emitter. Wen Bo, China program director with the NGO Pacific Environment, acknowledges that China's cattle industry needs modernization, but says slapping an American model onto the Chinese landscape won't work. "The situation in China is completely different," he says. "In many rural areas, they do not have the infrastructure for environmental treatment." To mitigate damage, Wen says, big companies and governments will need to invest in the communities they're developing, including funding for programs that help displaced farmers find new lines of work. Without investment, "the booming beef and cattle industry would mean the destruction of the community and environment they rely on," says Wen.

Officials in Hohhot don't see it that way. In the past seven years, the city has almost doubled in both population and physical size, a trend that's in keeping with Inner Mongolia's recent double-digit growth rates. Officials welcome Western Cattle's feedlots as a way to use marginal land, create jobs and produce more food. "If we have a very good feedlot here, it will help people become wealthy," says Teng Guiyuan of Hohhot's Bureau of Investment Attraction. "Small farmers want to make money, but they aren't powerful enough. They need a big company to lead the way."

The whole of China is wrangling with how to develop industry responsibly. But for a farmer like He, the question gets drowned out by how his seven cows are going to make the most money for him and his family. Officials like Teng are busy trying to figure out how to ensure their province does not get skipped in China's race to prosperity.

Timberlake, meanwhile, is buried in the day-to-day realities of getting a business off the ground — choosing a new site for the next feedlot and ranch, getting the word out that he's in the market for cattle, and preventing disease outbreaks in the herd. "Every time you try something new, you have your naysayers," Timberlake says. But he insists Western Cattle is offering Inner Mongolian farmers a better way of life — and some nice, juicy steaks, too.

EC: NGOs Distort LDC's Trade Views

Holy moley, the world is awash with a glut of trade news these days. Of course, I try to do the best I can to keep IPE Zone readers up to date. What we have here is the European Commission (EC) accusing NGOs like ActionAid and Oxfam of souring African nations on trade deals in general. In case you missed it, today was the NGO-sponsored "International Stop Economic Partnership Agreements" day (click on Oxfam link).

If you will recall, the EU for the longest time had preferential trade agreements with former colonies under the ACP (Africa, Caribbean, Pacific) grouping. However, the formation of the WTO subsequently led to the ACP becoming untenable for obvious reasons. The current Cotonou Agreement with the ACP is scheduled to end in 2007. It was originally designed to phase out preferential arrangements with the EC, with the now-reviled Economic Partnership Agreements (EPAs) being negotiated to come into effect from 2008 onward. NGOs have been playing the devil's advocate here, implying just how the Wicked Witch of the West has done Africa wrong with EPAs. From my POV, these ACP countries have had more than enough time to adjust. Moreover, prices of agricultural products are quite high nowadays--just as those of other commodities are. It's time for these ACP countries to take globalization by the horns, subdue it, and quit whining about the unfairness of it all. Let's start with the EC accusation about NGOs:

The European Commission accused non-governmental organisations on Thursday of "playing poker" with Europe's former colonies by urging them to reject new trade pacts.

The 78 African, Caribbean and Pacific rim countries making up the so-called ACP group and the European Union are struggling to clinch new agreements by the end of the year, when current preferential market access is due to expire.

To mark the five years since the negotiations were launched, many pro-development pressure groups mobilised on Thursday to protest against the new so-called economic partnership agreements.

NGOs such as ActionAid and Oxfam have accused the European Commission of threatening development of ACP countries by allegedly strong-arming them to sign the new trade pacts.

In an open letter to NGOs, EU Trade Commissioner Peter Mandelson and Development Commissioner Louis Michel said: "Calling for an end to ... negotiations when there is no credible alternative is playing poker with the livelihoods of those we are trying to help."

In a reaction to the letter, Oxfam said in a statement: "The (Commission's) claim that they are being flexible is belied by their behaviour in the negotiations."

The NGO added that the EU "continues to insist on the deadline and reiterate demands in areas such as services, investment and government procurement, that would have negative implications for development."

With the year-end deadline looming ever larger, the EU sought in April to boost the negotiations with an offer to scrap all tariffs and quotas on ACP countries' exports with the exception of sugar and rice.

The agreements are supposed to help ACP countries develop while they diversify their economies and meet WTO requirements that they allow for some opening of their markets to European goods and services.

Meanwhile, protests have broken out today in Kenya, Ghana, Mozambique, Cameroon and elsewhere (with the presence of NGOs, natch):

Kenyan activists and farmers on Thursday protested in the streets of Nairobi against what they said were unfair trade partnerships pushed by the European Union.

Protests were held in several African capitals to mark the fifth anniversary of the start of negotiations for Economic Partnerships Agreements (EPA) between the EU and African, Caribbean and Pacific rim countries (ACP), a spokesman for ActionAid said.

In Nairobi demonstrators crushed farm products and waved banners that read "Fight Poverty... Say No to EPAs".

The EPAs are trade pacts that are set to replace the current preferential trade agreements between Europe and its former colonies, which were deemed illegal by the World Trade Organisation and expire by year's end.

In a statement, the ActionAid organisation charged that Europe's "use of strong-arm trade politics will deny food rights and undermine good governance in the world's poorest countries."

The preferrential trade pacts between Europe and the ACP were initially designed to ensure a steady flow of supplies from former colonies.

Many poor countries argue that they will no longer be able to compete if they lose their special tariffs on exports to EU countries.

"Small scale farmers have systematically been driven out from the export markets in sectors like horticulture leaving only the big players to enjoy the boon," ActionAid said.

"A reciprocal free trade agreement will worsen this situation while limiting the capacity of our governments to protect agriculture especially for majority small scale farmers who produce most of the staple food."

Events and protests aimed at raising awareness on the implications of the new trade pacts were also held in Ghana, Mozambique, Cameroun and several other of the 78 ACP countries.

On a somewhat related note--on which I actually agree with--Oxfam is jumping the gun in asking the likely next IMF chief Dominique Strauss-Kahn to consider giving developing countries more say in IMF affairs:

Oxfam on Thursday called on the likely new head of the International Monetary Fund, Frenchman Dominique Strauss-Kahn, to institute reforms giving greater weight to the developing world.

"Mr. Strauss-Kahn should actively support changes to the way the IMF is managed, so that all developing countries get a fair say in the decisions of the institution," said Elizabeth Stuart of Oxfam International...

"The question of whether to give a bigger voice to poorer members has been dragging on for too long and must be answered now," said Stuart.

"Measures currently on the table would deliver woefully short of a meaningful reform," she added, referring to a reform under way of the voting rights and quotas for the 185 IMF member countries...

Stuart noted that Strauss-Kahn recently has emphasized the importance of such reform and the need for the IMF to adapt to a rapidly changing world.

"This is welcome, but he'll need to set the tone from day one in the position to make it happen," Stuart said.

"Where countries have achieved macro-economic stability, the Fund should simply pull out ... All developing countries ought to be able to decide their own future economic policies," she said.

Four Fantabulous FT Features

I am continually surprised by the breadth and quality of the content of the Financial Times. But, don't take my word for it. Have a look for yourselves at these pieces on Boeing v. Airbus, French national champions, Hollywood in Abu Dhabi [!], and drrrty rating agencies. Call it my overactive imagination, but the post-Murdoch Wall Street Journal is already falling behind the FT. Let's start with that old chestnut, Boeing versus Airbus, the pot-and-kettle contest. As most of you know, these firms have dueling claims pending at the WTO. In a nice twist, someone's been quoted as saying that the likely result of these shenanigans is "mutually assured embarrassment." IMHO, there's very little to choose from here as to who is more "innocent" from government support. They more or less cancel each other out:

Alleged illegal government subsidies to Boeing, the US aircraft maker, have cost its European rival, Airbus, some $27bn in lost revenues over the past three years, the European Union claimed on Wednesday at the World Trade Organisation, in the latest salvo in the bitter transatlantic dispute.

An EU statement released ahead of a WTO panel hearing into the EU case against Boeing said “lavish subsidies” had allowed Boeing “to engage in aggressive pricing of its aircraft, which has caused lost sales, lost market share and price suppression to Airbus on a number of select markets”. [No; it's because Airbus put its eggs on the underwhelming A380 while Boeing on the hugely successful 787 Dreamliner.] Brussels puts the subsidies to Boeing between 2004 and 2006 at about $5bn.

The claim was immediately rejected by Washington, whose own complaint against alleged illegal subsidies to Airbus is also before a WTO panel.

Pointing out that Airbus has gained 20 percentage points of market share from Boeing since 2000, Gretchen Hamel, US Trade Representative spokeswoman, said: “The EU has provided no basis to believe that the alleged subsidies have harmed Airbus.”

The EU’s WTO complaint challenges alleged illegal subsidies totalling $23.7bn that Boeing has received or is in line to receive since the mid-1980s and up to 2024 by way of federal and local tax breaks, and research contracts with the US Department of Defense and the National Aeronautics and Space Administration (Nasa).

However, Ms Hamel said on Wednesday that “the EU’s claims are to distract attention from its own massive subsidies”.

In the US case against Airbus, on which hearings have already been held, Washington argues that the $15bn of launch aid provided by France, Germany, Spain and the UK for the development of the Airbus fleet have am­ounted to a subsidy of more than $200bn compared with loans on commercial terms.

The EU has dismissed this suggestion as “ridiculous and absurd”.

Many experts believe that the outcome of the two cases, the most complex and costly the WTO has ever dealt with, will be a condemnation of both sides, or “mutually assured embarrassment”, as one EU official put it at the outset...

And speaking of national involvement, here is the FT on how French President Nicolas Sarkozy is keen on the French government retaking the commanding heights by creating state-owned titans. Naturally, cue up "We are the [French National] Champions":

Nicolas Sarkozy was at the Paris air show on a hot summer’s day in June when, in a speech laying out his vision for French industry, he threw out this simple phrase: “In economics, my only ideology is pragmatism.” Few outside France took note. But perhaps they should have done.

In recent weeks the French president’s pragmatism has led to the planned creation of a €70bn ($98.8bn, £49bn) power giant through the merger of state-owned Gaz de France and private utility Suez that will present a strong challenge to foreign competition in the French energy market.

His government is now turning its attention to Areva, the state-owned nuclear group, where it is mulling how to ensure French dominance of this growing market through a combination with home-grown companies such as Bouygues, Alstom, Total and EDF.

Finally, the industrial architects working away in the president’s Elysée palace are examining the potential for a third merger to create a French champion – this time in the defence sector – by bringing together Thales and Safran, two companies where the state has minority stakes.

All this national champion-building, added to the French president’s campaigns against the European Central Bank and European Union competition policy, has some of Mr Sarkozy’s European partners deeply worried.

The third feature has me scratching my head a bit as Warner Communications aims to establish a media center in Abu Dhabi, of all places. Call it a sign of the times. Perhaps media for the Middle East market is exceedingly particular--so much so that they need to create a presence there. In any event, government involvement probably means you won't see NC-17 and R rated content coming out of the UAE:

Warner Brothers, Time Warner’s film and TV division, has launched an “unprecedented” multibillion-dollar partnership to develop a media and entertainment hub in Abu Dhabi virtually from scratch.

The project, which is being undertaken with Aldar, Abu Dhabi’s largest real estate developer, and the emirate’s new Abu Dhabi Media Company, will include the simultaneous construction of a 6,000 acre theme park, hotel and cinemas as well as the creation of special funds to produce Arabic-language film, TV and video games.

Abu Dhabi will also establish a fund of $500m to co-finance production of Warner films – a figure that could grow over time.

Time Warner declined to comment on financial aspects of the deal, but said it was unprecedented in the scope and breadth of activities being undertaken. It is also significant, they said, in that it marked a long-term commitment to the Middle East by Hollywood’s largest studio.

“For our company and its further globalisation, growth for us is not just in . . . domestic markets. It’s largely outside the US,” said Dick Parsons, chief executive of Time Warner.

Lastly, here is news of a timely development. Just as accounting firms were limited from peddling accounting services to clients in the wake of the Enron, Worldcom, and Tyco scandals, so too are credit rating agencies feeling the heat over rating firms while at the same time offering them (paid) advice on how to improve their ratings. It's a drrty business model that they're trying to push and it's about time they cleaned up their act, I say:

Credit ratings agencies need to separate their rating and advisory functions because of conflicts of interest in their relationship with Wall Street, the newly appointed head of a high-level government advisory panel said on Wednesday.

Eric Mindich, who was named on Tuesday as head of a private sector group advising the White House, said investor confidence in the ratings agencies had been “severely damaged” and that their business model had inherent “serious ­conflicts”.

“I do not think that the market can discipline ratings agencies sufficiently,” said Mr Mindich, chief executive of Eton Park Capital and a former colleague of Hank Paulson, the Treasury secretary, at Goldman Sachs, the investment bank.

Mr Mindich said he was concerned that agencies issue ratings and also advise issuers of securities on how to secure better ratings. He suggested it might be necessary to separate those functions or require agencies to provide detailed disclosure of their contact with clients.

Lawmakers and investors criticised the companies for giving high ratings to subprime securities and failing to act quickly when borrowers began defaulting on loans backing the bonds...

Vickie Tillman, executive vice-president at S&P, defended the “issuer-pays” rating model, in which companies that issue securities pay the ratings agency to assign credit ratings. The executive said it was the only one that allowed ratings agencies to develop costly ratings procedures without charging investors high subscription fees.

Larry Summers, the former US Treasury secretary, said there were obvious conflicts of interest in the ratings industry: “If you are hired by someone at twice your regular fee to work collaboratively with their people to design a security that will receive a triple A rating from yourself” you are likely to deliver certain results. “There needs to be a lot of cleaning up in this area.”

Hu Jintao; Burmese Junta

The Chinese are famed for their so-called principle of non-interference in the internal affairs of other countries, most notoriously in Sudan. One of the more interesting developments is China's current reaction to the turmoil in Burma (Myanmar), as the Chinese government has worked closely with the military junta there. It's a familiar criticism of the PRC as a one-stop totalitarian shop offering to purchase natural resources, sell weapons to "silence" critics, and to veto UN measures against human rights violations. To China, Burma offers the lure of a country rich with raw materials and a relatively close location. In other words, ensuring the flow of resources to the Middle Kingdom is a priority. The New York Times reports that, in the background, China has been looking at possible scenarios should the junta be overthrown and ever after. Might the Chinese be negotiating with Aung Saan Suu Kyi soon? It's nothing personal, despots of all stripes--just business. Gotta keep those resources flowing. To stay ahead, you've got to plan ahead, or so it seems:

As China publicly calls for stability and reconciliation in Myanmar, it is also preparing for the possibility that the mounting protests could lead to the downfall of the military junta in its resource-rich neighbor, political analysts said today.

Although China is Myanmar’s most important trading partner, investor and strategic ally, Beijing has also maintained discreet links with opponents of its military rulers, and it tolerates the activity of some exiled opponents on Chinese soil, these analysts said.

While Beijing has shielded Myanmar’s government from its international critics — for instance, by blocking a United Nations Security Council resolution earlier this year condemning its human rights record — it has also urged the junta to avoid a repeat of the violent crackdown on demonstrations in 1988 that led to extended periods of house arrest for the opposition leader Daw Aung San Suu Kyi.

Tang Jiaxuan, a member of China’s State Council and a former foreign minister, told Myanmar’s foreign minister, U Nyan Win, on Sept. 13 that the Chinese government hoped its neighbor could restore stability and promote national reconciliation, the official Xinhua News Agency reported.

“If Aung San Suu Kyi became the leader of Burma tomorrow, China would be the first country to roll out the red carpet,” said Bertil Lintner, an analyst of Myanmar politics based in Thailand. “But they wouldn’t like to see it happen.”

China, already stung by human rights activists who have warned that its ties with Sudan’s repressive government could cast the 2008 Olympic Games in Beijing as the “Genocide Olympics,” wants to avoid further damage to its reputation from Myanmar’s handling of political dissent, analysts and foreign diplomats in Beijing say.

They also note that China wants stability in Myanmar because it is an important supplier of raw materials, including timber and minerals. Two-way trade between the countries increased 39.4 percent in the first seven months of this year over the same period in 2006, reaching $1.11 billion, according to official Chinese government customs figures.

Analysts say China is also eager to import energy from the country, which has 540 billion cubic meters of proven natural-gas reserves, according to a 2007 statistical review of world energy.

China would also like to keep a pliant government in place to develop strategically important access to the Indian Ocean, according to security experts.

In an effort to expand its influence in Myanmar, China has become the junta’s biggest arms supplier, and it has extended discounted loans and development aid to the economically embattled nation.

Moreover, analysts estimate that more than one million Chinese entrepreneurs and traders have crossed the border and settled in Burma in the past decade.

There have been reports that China wants to build a $2 billion oil pipeline from Myanmar’s coast on the Bay of Bengal to Yunnan Province in China. Such a pipeline would allow oil from the Middle East to reach China without having to pass through the Malacca Strait, a waterway that is plagued by piracy and that could easily be closed off in a war or international crisis.

Officially, China maintains its customary diplomatic stance of noninterference in the internal affairs of other countries.

“As a neighbor of Myanmar, we hope to see that its society is stable and its economy developing,” China’s Foreign Ministry spokeswoman, Jiang Yu, said on Tuesday at a regular news briefing in Beijing. “We hope and believe that Myanmar’s government and people can appropriately deal with their current problems.”

But analysts say there is evidence that China has been hedging its bets on political developments in Myanmar for some years.

Mr. Lintner, the Thailand-based analyst, said Beijing maintains unofficial contacts with exiled Myanmar opposition groups in Thailand and other Southeast Asian countries, in a bid to minimize their antagonism and to improve its understanding of political developments.

He said Beijing has also tolerated the presence of these groups in Ruili, a Chinese city on the border with Myanmar in Yunnan Province, where some of them maintain unofficial offices.

Other experts agree that these informal contacts with exiles, along with recent official statements from Beijing calling for a peaceful settlement of differences among all groups in Myanmar, suggest that China has doubts about the junta’s survival.

“One day, they expect the military will no longer be running the place,” said Trevor Wilson, an expert on Myanmar at the Australian National University who was the Australian ambassador to Myanmar from 2000 to 2003.

“It will be political parties, maybe even the current opposition, running the place,” he said, “and China needs to keep open some channels of communication with them, and not put them entirely offside.”

Despite China’s close economic and political ties with the junta, there are also signs that it is dissatisfied with some aspects of its performance.

Mr. Wilson said that senior Chinese diplomats in Myanmar have been bluntly critical of the junta’s poor economic management and its inability to stem the flow of illicit drugs across the Chinese border.

At times earlier in this decade, political tensions led China to suspend making new loans to Myanmar, he said. Political analysts also noted that China had openly called on the junta to show restraint in dealing with the protests.

In his meeting earlier this month with Myanmar’s foreign minister, U Nyan Win, Mr. Tang, the Chinese diplomatic envoy, also said that Beijing wanted Myanmar to move toward “a democracy process that is appropriate for the country,” Xinhua reported.

This did not mean China wanted Myanmar to adopt Western-style democracy, analysts said, but it was a suggestion that the junta should move toward a settlement with its opponents.

China has also recently shown that it is prepared to use its influence with the junta to ease diplomatic tensions with the United States. In June, China arranged in Beijing the highest-level talks between the United States and Myanmar in five years.

Flash Gordon, Meet Susan Schwab

With apologies to Brian May and Queen:

Schwab! Ah-ah...savior of the Doha Round!
She's for ev'ry one of us
Stands for ev'ry one of us
She'll save with a mighty hand
Ev'ry man ev'ry woman ev'ry child
With a mighty FTA!

This current outburst of silliness on my part is driven by the journalistic hyperbole in the title of this Fortune piece about US Trade Representative Susan Schwab, "Can This Woman Save Free Trade?" Its equally grand subtitle is "Susan Schwab's Crusade to Keep Globalization Alive." Unlike most of the Bush junta, I've already indicated that I hold a generally favorable (gulp!) view of Susan Schwab. Nonetheless, it's of course an exaggeration to pin the hopes of the completion of Doha on the shoulders of the USTR. Still, this Fortune article provides an informative glimpse into her efforts to win over Democrats who Bush previously railroaded with previous trade deals before they gained majorities in both houses of Congress. Not that they're getting along exceedingly well with her, but there's no harm in trying:

Susan Schwab is sitting inside a VIP lounge at Dulles airport near Washington, waiting for a call from The Chairman. Jet fumes hang on the tarmac outside, but what Schwab smells is a deal.

That's why she's grounded for the moment on her way to Tampa, where she's scheduled to give a speech to 1,000 people the next morning. In this twilight March moment, waiting for word from The Chairman, there was no better encapsulation of the power shift that had taken place in Washington: President Bush's trade ambassador, yellow legal pad on lap, faux quill pen in hand, surrounded by a handful of aides, hoping for Charlie Rangel to call.

That is the kind of humbling moment that makes up Sue Schwab's lonely crusade to fight the rising tide of protectionism [sniff]. It was her fate to take this job just months before the Democrats gained control of Congress, bringing with them an end to the unfettered, free-trade era of Bush's first six years [never mind those steel tariffs].

During that time Bush and the GOP leadership in Congress rammed through global agreements to open trade in the U.S. and abroad - ignoring a shifting political zeitgeist in which Democrats were jumping off the free-trade bandwagon to complain that American workers were being harmed.

Now Schwab finds herself in the delicate position of pleading for support from the same Democrats who had been bulldozed by her White House boss for six years.

"Hello! Mr. Chairman!" Schwab coos after an aide announces the caller and delivers her cellphone. Even at age 52, draped in a St. John knit and an Hermès scarf, Schwab has a pixie quality; she's the classroom good girl whose razor intellect lies just below the surface.

By contrast, Rangel, at 76, is a natural showman who describes himself as having a "gift for living by my wits and hiding my inadequacies behind bravado." The call goes well. "We'll send those papers over - you got it," Schwab promises before hanging up to dial Treasury Secretary Hank Paulson with a status report: Progress made. No deal yet.

By May, Schwab will close this deal, and the press will label it "historic." In return for Democratic support, the administration will - for the first time ever - agree to global standards for protecting workers and the environment [which are phooey]. Paulson and House Speaker Nancy Pelosi will stand side by side at a late-night Capitol Hill press conference to celebrate their bipartisan good will. Schwab and her staff will pop bottles of champagne.

At last, after months of roller-coaster negotiations...Schwab will be able to take credit for saving America from protectionism.

Or will she? The Schwab story is not over - and this fall comes her biggest test yet. Powerful Democrats, under pressure from organized labor, have suggested they had crossed their fingers behind their backs last summer when signing off on the deal she and Rangel negotiated.

Now the stage is set for a titanic fight on Capitol Hill. The main targets of dispute are agreements with four countries - South Korea, Peru, Panama, and Colombia - that promise to open new markets for agriculture, machinery, financial services, and other industries.

More important, the outcome will signal to the world the direction America plans to take in writing the rules for a globalizing economy that promises riches for U.S. companies but uncertainty for U.S. workers.

Schwab understands the stakes. But can one woman, working for a lame-duck administration, make a difference...?

Everyone has his [sic!] own way of dealing with pain, but for Sue Schwab it has meant 250,000 miles of global shuttling to rescue trade talks, reassure anxious trading partners, and woo wary Democrats as she finds her footing in life again.

I first saw Sue Schwab in action inside Beijing's cavernous Great Hall of the People, where she had just emerged from delivering a lecture to China's vice premier, arguing that China's brand of government intervention in markets historically has led to "less stability, not more; less development, not more."

Schwab's history lesson might seem at face value like the musings of a scholar whose real-world experience ends at the Campus Drive stop sign. After all, the woman has academia written all over her: Williams College, master's from Stanford, Ph.D. from George Washington University...

As trade ambassador, Schwab understands that at any given moment, she is speaking to multiple audiences. In the case of her Beijing remarks, she was keenly aware that the Democrats - who had swept into power a month earlier and viewed China as the chief villain in America's mushrooming trade deficit - were watching closely. It was no time to get squishy toward her hosts.

Schwab has been looking over her shoulder at the Democrats ever since they declared victory last November. "I thought trade was in desperate straits," says Louisiana's Jim McCrery, ranking Republican on the House Ways and Means Committee and a key player in trade talks. "The Democrats had pretty much marched in lockstep with labor, opposing anything of great significance."

But it wasn't just politicians. A handful of prominent free-trade economists had flipped and were now suggesting that what's good for multinational corporations isn't necessarily good for American workers.

That meant a whole flotilla of free-trade initiatives was suddenly in jeopardy this year: newly minted agreements with Peru, Panama, and Colombia that would open business for such companies as Wal-Mart, Caterpillar, and Procter & Gamble. American financial services companies, among others, stood ready to tap into South Korea's middle class.

Despite the sea change, Schwab understood that top Democrats didn't want to be branded the "party of protectionism." Rangel, in particular, was open to finding a way forward. With 36 years in the House behind him, the Harlem Democrat had finally achieved his lifelong dream of running the House Ways and Means Committee and was eager to leave his imprint.

So Schwab marched up to Capitol Hill after the election and offered one word for virtually all of Rangel's conditions: yes. Yes to international labor standards, yes to environmental standards, and, later, yes even to softening drug company patents to let more generic drugs flow abroad.

"We're prepared to concede - just give it to them," she told me a couple of months later in March, after her airport tête-à-tête with Rangel was complete and our plane to Tampa was lifting off the runway. "It's a huge victory for Charlie Rangel and the Democrats, if they choose to take it. The question is, Does Nancy Pelosi want the Democrats to be the party that killed trade...?"

For months Schwab had been a fixture in Rangel's office, negotiating the bipartisan deal. The night before the flight to Tampa, she and Congressman McCrery spent two hours with the chairman and top staffers, quietly working out the details...

She said yes to an offer to become deputy U.S. trade representative in 2005, then was promoted in 2006 to trade ambassador, on the eve of the breakdown of the latest round of World Trade Organization talks in Geneva.

Determined to salvage the talks, Schwab traveled 87,000 miles in three months to try to piece the negotiations back together. "I'm enough of an economist that I really felt I was creating wealth, helping people, creating U.S. exports - all the things I believe in," she says. Whether negotiating over trade in autos or dark-meat chicken parts, Schwab played well in the nuances of trade disputes. "These specific line items mean someone does or does not make a sale," she says...

She has been on airplanes ever since. Longtime friend and former Senator Bill Brock, a Tennessee Republican who was President Reagan's trade ambassador, calls her restless diplomacy a "real tour de force."

Her performance seemed to pay off on the night of May 10, when Paulson and Pelosi convened the joint press conference to announce the bipartisan breakthrough. Then it all came apart again.

Union leaders, never fully onboard, publicly denounced it as a "sellout." They turned up the heat on Democrats, especially over the Colombia deal, citing continued violence against labor organizers in that country, and the Korea accord, pointing to U.S. trade imbalances with that country.

On June 29, as Congress was breaking for the Independence Day recess, Pelosi issued a press release saying the House wouldn't consider the Peru and Panama deals unless those countries first changed their labor laws.

Inside her office next door to the White House, a stunned and angry Schwab began crafting a three-page letter to Pelosi, objecting to the "unprecedented new preconditions on our trading partners" Peru and Panama. The letter ended with a passionate defense of free trade.

"American workers, farmers, consumers, and businesses cannot afford for Congress to hang up a CLOSED FOR BUSINESS sign," she wrote. The letter, Schwab told me a month later, was cathartic. It also forced her to examine the Democrats' press release, which appeared carefully nuanced to keep labor satisfied while moving free trade forward.

"They appear to be moving the goal posts," she says. "But they are saying the right things [privately]. Let's see if they deliver."

It is early August, and we are talking over coffee at the Hay-Adams Hotel, across the street from the White House. A relentlessly upbeat Schwab insists on blending realism with optimism on the WTO talks, too, which have had their own set of twists and turns.

This fall could be "the end of the road," she says of the six-year WTO session to lower trade barriers. "If it doesn't work this time around, we're probably done for now."

And then there's the most controversial trade issue of all - "fast-track" authority for the President, which gives foreign nations the reassurance that their trade deals with the President won't be picked apart by Congress and special interests. (Under fast-track, which expired in June, Congress can only vote up or down, not amend.) Labor leaders and their Democratic allies are reluctant to renew fast-track authority for Bush, though Rangel appears willing to reconsider if there's a WTO deal.

I ask her which is more difficult - negotiating with foreign nations or Democrats. She laughs, because it's something she has thought a lot about. "Whether it's the Indians trying to protect their agriculture or the Brazilians trying to protect their manufacturers or the Democrats trying to protect organized labor," Schwab says, "everyone has their political imperative."

What's generally agreed is that if anyone has the persistence and patience to bring the parties together, it's Sue Schwab. "She hasn't gotten discouraged," observes McCrery. "She's always bounced back from a disappointment to plow ahead." Maybe that's because for Sue Schwab, this crusade isn't just business, it's personal.

Some More Free Lunch Economics

One of the things I find most irksome are these endless apologists for American profligacy who purvey a brand of "free lunch" economics: Americans can spend all they like without any future consequences. As MAD Magazine's Alfred E. Neumann would put it, "What, me worry?" Here is the gist of their argument: While the recorded savings of US households are nearly zero, these figures reported by the Bureau of Economic Analysis (BEA) are inaccurate because they don't take into account the capital gains made by American households through their housing and equity investments. While I do concede that there is a definite "wealth effect" at work--Americans may feel "richer" as the price of their houses and stock holdings increase--these sorts of investments are not technically "savings."

From Investopedia: According to Keynesian economics, the amount left over when the cost of a person's consumer expenditure is subtracted from the amount of disposable income that he or she earns in a given period of time. More egregious than the sleight-of-hand performed in "redefining" savings is that "free lunch" specialists do not consider the liquidity of housing and stocks vis-a-vis savings as they are usually defined. Come the proverbial rainy day, one cannot sell off part of a house to meet obligations. It's either you sell the whole house or not. Then, of course, comes the question of where these house sellers would then live--if they sold their house at a higher price, doesn't that also mean they'd find it costlier to buy another house? Consider the replacement cost of housing, as Dr. Roubini would say. Besides, the last I checked, house prices were literally falling through the roof and some even predict that house prices will fall in the double-digit figures, making it more difficult to extract home equity which has been fueling the current jihad on fiscal sanity.

As for equities, you need to consider who is holding equities. Is it Joe Average and the rest of them as the Wall Street crowd would imply? Well, no. According to the Economic Policy Institute:

It probably would surprise a lot of people to know that less than half of American households are invested in the stock market in any form--either directly or indirectly through mutual funds or 401(k)s. The percentage of households that own stock declined from 51.9% in 2001 to 48.6% in 2004 – the first decline recorded.

Furthermore, the percentage of households with more than$5,000 in stock fell from 40.1% to 34.9%--the first decline in this share. Stock ownership remains concentrated among the wealthiest households. The wealthiest 20% of households own over 90% of all stock value [my emphasis]. For the top 1%, the average value of stock holdings was $3.3 million in 2004, down from $3.8 million in 2001. The average value of stock holdings for the middle 20% was $7,500 in 2004, down from $12,000 in 2001.

So there you have it. Houses are nowhere near as liquid as real savings and entail replacement costs that likely negate price rises of recent years (which are quickly heading south in any case). Moreover, stock ownership is concentrated in the hands of a wealthy few. End result: do worry and don't be ignorantly happy. But, mine's just one point of view. You can always listen to Bear Stearns' David Malpass for the Wall Street sunshine:

One of the enduring but incorrect concerns about the U.S. economy in recent years is that household savings are low and the consumer is weak because of it. The anxiety has been that consumer spending would hit the wall—Americans would run out of money, having depleted their savings. Instead, the economy has been solid since 2002, helped by steady growth in consumption. Despite housing and auto weakness, GDP rose 2.6 percent in 2006, and in 2007 it has re-accelerated from the first quarter’s housing-related weakness. Consumption growth in the fourth quarter of 2006 and the first quarter of 2007—supposedly weakened by housing, gasoline prices, the decline in mortgage equity withdrawals, and poor consumer finances—was actually the strongest for any two consecutive quarters since 2004.

The truth is that the U.S. isn’t running on empty. The household sector has the world’s biggest stock of financial savings, more than the rest of the world combined. How could such a huge sum accumulate if the savings rate is low?

The answer is simple: The published savings rate excludes the economy’s gains. Instead, it is calculated by subtracting personal spending from a narrow definition of personal income after taxes. But savings can grow even when you spend more than you earn in a particular month. For example, if you own $100,000 worth of stock and your portfolio rises by 10 percent (the annual average for the broad U.S. market), your savings rise by $10,000—a fact ignored in the official savings rate.

More and more Americans are working to accumulate assets: by funding a 401(k) plan that appreciates, buying a house and fixing it up, holding a job that pays a pension from long-term investments, or patenting an invention that will make them rich. Over the decades, this activity has added tremendously to America’s net worth (think Google or Warren Buffett), yet it gets excluded in the calculation of the savings rate.

Rather than looking at the savings rate, I prefer to look at a clearer, simpler, and more meaningful number: actual savings. Every three months, the Federal Reserve publishes America’s household balance sheet, which shows assets (for example, houses, cars, stocks, pensions, life insurance) and liabilities (mortgages, credit card debt, auto loans). Through March, household financial savings reached a record $29.1 trillion. This is a very conservative figure since it includes only financial assets (not houses, for example), but it also includes all liabilities (such as mortgage debt).

The International Monetary Fund tracks financial savings measures for other countries. At the end of 2006, Japan had $9.8 trillion, the UK $4.8 trillion, and France $2.6 trillion; Germany, at the end of 2005, had $3.2 trillion. In other words, the U.S. had about 40 percent more in financial savings than all these countries combined. If houses and automobiles are counted, too, the broader measure of savings would show an even larger gap between the United States and other large savers. The U.S. advantage makes sense because, more than any other nation, we have focused on the kind of innovation that brings capital gains, which increase the value of underlying assets.

Since the reported personal savings rate is lower now than it was in the past, the monthly reports give the impression that the U.S. savings rate has worsened. However, the official personal savings rate is being pushed down by the gains taking place in the economy. As more of the economy is oriented toward producing longer-term gains rather than current output, the personal savings rate can become negative even though actual savings increase.

But are savings being displaced by debt? Shouldn’t we worry that the debt burden is increasing? It is true that the ratio of household debt to disposable personal income has doubled over the last 25 years, rising from 65 percent in the early 1980s to 136 percent in the first quarter of this year. This rise, in large part, reflects the increase in home ownership, in the value of homes, and in the volume of associated mortgages.

Since both assets and debt have risen faster than income, both the debt-to-income ratio and the asset-to-income ratio have increased. The good news is that assets have been growing substantially faster than debt; thus, the big rise in savings. For example, while total household liabilities rose $1 trillion from the second quarter of 2006 through the first quarter of 2007 (the most recent data), households increased their assets by $3.7 trillion (financial assets by $2.5 trillion and housing assets by $1.2 trillion).

While we hear a great deal about its debts, the fact is that the U.S. household sector is the world’s largest net creditor, with a maturity structure well-positioned for rate hikes (most liabilities are fixed-rate, while many assets are short-term and earn more if rates go up.)

Shouldn’t people save more? Of course. Many people need more liquid savings to prepare for retirement, economic downturns, and asset price declines. There’s a strong argument for lighter taxation of savings, particularly interest income—one of the safest forms of investment. But as long as the United States is a confident society investing for future growth, the “personal savings rate,” as currently presented by the Commerce Department, will probably remain low even as actual savings grow to new records.

PRC: 3 Gorges Dam a "Catastrophe"

...and the worst mistakes are by thine own hand.
This is the most awful sort of article to read because nearly everyone everyone else told the Chinese that the mammoth Three Gorges Dam designed to finally "tame" the Yangtze River would entail massive environmental consequences. The rest of the world noted that it has already wrought such consequences, and now even Chinese officials are admitting pretty much the same thing. Was it worth it at the end of the day--all the social dislocations, cultural destruction, and now the ecological carnage? When even the World Bank--megadam project funder extraordinaire--pulls out of funding such a project, you know not much good would come out of it. It's a story as old as time, but you can add to the tally: Mother Nature 1, Man 0. [UPDATE: The FT also tracks this story...and so does the Economist.] From Xinhua:

Chinese officials and experts have admitted the Three Gorges Dam project has caused an array of ecological ills, including more frequent landslides and pollution, and if preventive measures are not taken, there could be an environmental "catastrophe".

While the dam has served as a barrier against seasonal flooding threatening the lower reaches of the Yangtze River and the electricity generated by hydropower has led to a decrease of 100 million tons of carbon emissions, the benefits have come at an ecological and environmental cost, officials said.

All the participants in a two-day forum held in Wuhan on Tuesday agreed that the project had exerted a "notably adverse" impact on the environment of the Three Gorges reservoir, with a total circumference of 600 km, and along the Yangtze since last year, when the project began operation.

They said the huge weight of the water behind the Three Gorges Dam had started to erode the Yangtze's banks in many places, which, together with frequent fluctuations in water levels, had triggered a series of landslides.

"If no preventive measures are taken, the project could lead to catastrophe," they said.

Tan Qiwei, vice mayor of Chongqing, a sprawling metropolis next to the reservoir, said the shore of the reservoir had collapsed in 91 places and a total of 36 km had caved in.

Frequent geological disasters have threatened the lives of residents around the reservoir area, said Huang Xuebin, head of the Headquarters for Prevention and Control of Geological Disasters in the Three Gorges Reservoir.

At the forum he described landslides around the reservoir that had produced waves as high as 50 meters, which crashed into the adjacent shoreline, causing even more damage.

Clear water discharged from the Three Gorges Dam has also threatened the safety of the protective embankments downstream, according to Hubei Vice Governor Li Chunming.

Both Tan and Li said the quality of water in the Yangtze tributaries had deteriorated and outbreaks of algae or aquatic weeds had become more common.

"We can by no means relax our vigilance against ecological and environmental security problems or profit from a fleeting economic boom at the cost of sacrificing the environment," said Wang Xiaofeng, director of the office of the Three Gorges Project Committee of the State Council.

The open discussion of the negative effects of the Three Gorges Dam comes a month after the Wall Street Journal reported on the rising concerns of landslides, pollution and flooding in the area.

It quoted environmental scientist Weng Lida, secretary general of the Yangtze River Forum, as saying, "We thought of all the possible issues. But the problems are all more serious than we expected."

Commenting on the newspaper report, Wang said he thought most of the statements were said out of a concern for the Three Gorges Project, but some of the phrasing did reflect ulterior motives.

But he also admitted, "The problems mentioned in the Wall Street Journal should merit adequate attention from all of us."

Wang said the Chinese government had also paid great attention to consequences in the wake of the construction of the Three Gorges Dam.

Wang revealed that during an executive meeting of the State Council held earlier this year regarding the key problems arising from the Three Gorges Project, Chinese Premier Wen Jiabao was said to have cited ecological and environmental woes as primary problems to be addressed.

While pledging to cooperate more with relevant central and local government departments in promulgating regulations for tightening management over the reservoir, Wang said comprehensive management measures would be taken to ensure the water in the Three Gorges Reservoir is clean.

"We have to make concerted efforts to attain the dual goals of constructing a first-rate hydraulic project and making it into a top-level showcase for the environment," said Wang, "we will work harder to turn the Three Gorges Reservoir Area into an environmentally-friendly society" [isn't this an oxymoron?]

The government has invested heavily in programs designed to restore and conserve the ecology of the Three Gorges area in recent years, including 12 billion yuan (about 1.5 billion U.S. dollars) spent on trying to harness geological disasters such as landslides.

It has also closed or relocated 1,500 manufacturing ventures, constructed more than 70 sewage disposal and waste treatment plants and resettled about 70,000 people from disaster-prone areas.

The participants in the forum in Wuhan also called for the establishment of a long-term mechanism on the prevention and control of geological disasters in the Three Gorges Reservoir Area, and a ban on fish farming in cages in the reservoir area to prevent an excess of nutrients degrading the water quality.

The Three Gorges Project, the world's largest water control facility, was launched in 1993, with a budget of 180 billion yuan (about 22.5 billion U.S. dollars).

Located on the middle reaches of the Yangtze River, the project boasts a 185-meter-high dam, completed in early 2006, and a five-tier ship lock. It has necessitated the resettlement of at least 1.2 million people.

Seventeen turbines - 14 on the northern bank of the Gorges and three more on the southern bank - are now in operation. They produced 23.77 billion kwh of electricity in the first half of the year, 2.65 billion kwh more than the same period last year.

Chinese Cars Invade Europe

As if a strong Euro didn't pose enough problems already for European carmakers, Chinese carmakers are gradually making inroads into their home turf. I myself can't recall having seen any Chinese cars in Birmingham, but things may be different on the continent as noted by the Boston Globe. Among the cars on offer to discerning and not-so-discerning European buyers alike is the "Hover Wingle" manufactured by the Great Wall Motor Company (pictured). I can't help but make this cheap shot, but I can see the pick-up lines of Hover Wingle owners already: Hey baby, do you wanna ride my [DELETED--the IPE Zone is a family-oriented blog]. What can I say? At least it isn't the "Geely Beauty Leopard." Daft names aside, Chinese cars are likely to pose a challenge not only to European but also to other Asian and American makes as soon as they get the marketing bit figured out:

They have names like the Brilliance BS6, the Landwind Fashion, or the improbable Hover Wingle, and though these sedans, vans, and sport utility vehicles are hardly as familiar to Europeans as, say, a Volkswagen Golf, they are beginning to show up on European roads.

"I've got air conditioning, ABS brakes, and air bags," said Carlo Scalvini, describing his Hover, a big and boxy sport utility vehicle built by the Great Wall Motor Co., with headquarters in Baoding in eastern China. "And the price is competitive: You pay 10,000 euros less in the end," more than $13,000.

The enthusiasm of people like Scalvini could influence the global auto industry and China's place in it. China's quiet inroads into Europe are the first test of rich markets by Chinese automakers as they build dealer networks and deliver small shipments of cars to test the reaction of drivers and auto industry experts.

Many of the dealers who have signed on with the Chinese previously worked with the Japanese and the South Koreans, and so have experience in coaxing Europeans to purchase cars with unfamiliar names and unusual looks, but sweet prices.

If business is starting fitfully, they foresee healthy profits down the road, aided by the weak dollar. European car dealers pay in dollars for the Chinese cars, yet are paid in strong euros when they resell them, pocketing nifty profits from exchange rates.

"The game the Japanese mastered in 15 years, and the Koreans in 10," said Nigel Griffiths, director of European light vehicle forecasting at Global Insight, "they will do in 18 months to five years."

Paradoxically, the Chinese have been helped in Europe by their alliances with Western automakers in China. Some of the Chinese cars being imported into European countries use electrical components from Bosch, the big German parts supplier, or have been designed by Italian firms like Giugiaro. Now, the Europeans are seeing their ideas and components flow back into their own markets.

That the European market is essentially open is also helping the Chinese. Because so many European cars are now being built elsewhere, a quota on imports is politically almost impossible.

There have been setbacks, like abysmal results on a crash test done on a Chinese car two years ago. Some specialists are skeptical that the Chinese can become major competitors in Europe and the United States. After all, car buying remains an emotional business. "There is a general lack of brand awareness, and distribution is a hurdle," said Michael K. McKenzie, a China expert at PricewaterhouseCoopers' automotive institute in Detroit.

But the Japanese and South Koreans overcame similar hurdles. Moreover, the Chinese are moving in several stages. "They are coming through the back door: first Russia, then working their way west," Griffiths of Global Insight said. He estimates that China will sell 54,000 cars in Russia this year, out of a total market of 2 million, compared with 31,000 last year.

The Chinese are arriving even as European carmakers struggle with flat prices and diminishing profit, and the Chinese presence is expected to ratchet up the pressure. That will force some European companies that stayed in the mass market for small cars, like Fiat, either to move up to larger, more expensive models, or to perish, McKenzie predicted. "They will undercut these companies, and the market will be more contested," he said.

It began when a Dutch Nissan dealer, Peter Bijvelds, visited China with a friend in 2004 to inspect the Landwind factory in Nanchang, a gritty city south of the Yangtze River in Jiangxi Province. The trip ended with Bijvelds' introducing a big and boxy Chinese-made SUV, the Landwind New Vision, a twin of GM's Opel Frontera, at the 2005 Frankfurt auto show. It did not handle like a European car and its engine had little excess power, but for Europeans tired of station wagons or wanting to tow a trailer, this car cost 25 percent less than a Kia or a Hyundai model. It had air conditioning, air bags, and aluminum wheels. In the first two weeks, Bijvelds said, he sold 500 of them.

Then, at about the time of the Frankfurt show, the German automobile club, known as ADAC, put the New Vision to a crash test. The driver's survival chances were about nil, the club's testers said.

Bijvelds' Chinese partners were dismayed. The New Vision was put on hold, while Landwind ironed out the kinks. A successor model, the Landwind Expedition, has a comely design by an Italian design studio, a German-built engine and all European safety features.

Bijvelds suggested that the automobile club might have been prompted by German automakers to undermine his project. A club spokesman, Maximilian Maurer, denied that. "I am sure that in time the Chinese will succeed here," he said, "and the ADAC doesn't want to keep them away. We simply want to inform consumers about the quality of these cars."

Bijvelds, 28, receiving a visitor at the headquarters of his Landwind Motor Corp. near Antwerp, Belgium, said, "We get so many products from China with Western brands, why not cars?" Europeans, he says, are after value for money, citing Renault's recent bonanza with the Logan, a car built in Romania that has a six-month waiting time for delivery in Belgium. "They want a lot of car for a little money," he said.

The German crash test, a colleague told him recently, may have been a blessing in disguise. "Now everybody knows you," the friend said, "For good or bad, they know you."

In Germany, Hans-Ulrich Sachs, a former Volkswagen executive who is chairman of HSO Motors Europe, is signing on dealers to sell the Brilliance BS6, a comfortable sedan with a vague resemblance to a midsize BMW. Indeed, Brilliance assembles BMW's 3 and 5 series cars for the domestic Chinese market.

By the end of this year, Sachs, 54, wants 150 showrooms in Germany, and by next year, 1,100 throughout Europe. This year, he hopes to sell 6,000 to 7,000 cars. The first 500 arrived in mid-March.

Why would a German buy a Chinese car? he asked rhetorically. "Value for the money."

For Europe's carmakers, alliances with Chinese companies could become two-edged affairs, providing models that one day may well compete against their own cars. Volkswagen, for instance, has joint ventures with Shanghai Automotive and First Auto Works. Yet Kai Grueber, spokesman for the Volkswagen Group China, played down the potential for competition, saying that VW was focused for now on the domestic Chinese market. "Future exports into the Southeast Asian area are conceivable in markets where we can expand our offering with new models," he said.

At Eurasia Motor here in Palazzolo, about 35 miles northeast of Milan, where Scalvini bought his SUV, a shipment of 360 arrived in November, and have all been sold through a network of 95 Italian dealers. "We're now expecting 800 more, in lots of 200 each, of the same model," said Federico Daffi, Eurasia's chief financial officer. Eurasia pays Great Wall $14,000 for the SUVs, and sells them for as little as 19,600 euros (about $27,000), still one-fourth below the South Korean competition. Eurasia then uses the lower price to market to middle-class families who until now could not afford an SUV.

Scalvini, 44, would buy more Hovers now, if they were available. He is the owner of Consorzio Vela, a company that employs about 800 people and maintains a large fleet of vehicles supplying services like delivery and catering to other Italian companies.

The Hover's Mitsubishi-built engine is fuel-efficient and will offer the option of shifting from gasoline to liquid propane gas in future models.

"I'm convinced it will be a winner," he said.

No Doha Round Action Under Bush?

The Financial Times has two articles conveying the very same message: the current Doha Round impasse is unlikely to be broken during the remaining days of the lame-duck Bush administration. House Ways and Means Committee Chairman Charlie Rangel (D-NY) goes so far as to say that "President [Hillary] Clinton is going to have to deal with it" [!]:

Success in global trade negotiations will most likely have to wait until a new president is in the White House, according to senior lawmakers on Capitol Hill.

The scepticism in Washington about a near-term breakthrough in the troubled so-called Doha round of trade talks underlines the difficulties faced by negotiators, even as officials at the World Trade Organisation in Geneva report some progress in the discussions.

Charles Rangel, the New York Democrat who chairs the House of Representatives’ ways and means committee, which regulates foreign trade, told the FT in an interview: “At this point in time I don’t think we have to deal with Doha, unfortunately . . . I think President Clinton is going to have to deal with it.” Mr Rangel is a long-time supporter of Hillary Clinton’s bid for the White House.

A senior aide to Max Baucus, Mr Rangel’s counterpart on the Senate finance committee, said the lack of progress in Doha had pushed the subject well down the senator’s agenda. Collin Peterson, chairman of the House agricultural committee, told the FT he had more or less discounted any chance of near-term progress in Doha.

Last week Crawford Falconer, the New Zealand WTO ambassador who chairs the farm talks, said there were encouraging signs of countries negotiating seriously over reducing farm tariffs and subsidies, including promises of cuts from the US. “The leviathan is beginning to move. That’s my impression. We’ll see if it remains that way,” he told delegates, according to one official present.

Susan Schwab, US trade representative, said she understood the scepticism in Congress given the lack of progress so far, yet argued that a deal was still possible.

But she underlined that any further reduction in US farm subsidies was contingent on big cuts in industrial goods tariffs by developing nations.

Some big emerging market countries have said that tariff reductions suggested in a text by Don Stephenson, the Canadian ambassador who chairs the goods talks, were too drastic.

“The countries that were signalling that they were going to be obstructionist in terms of the [industrial goods] text: what is their stance?” Ms Schwab said. ”Ask Brazil. Ask India. Ask Argentina. Ask South Africa. Ask China.”

Meanwhile, the second article touches on a host of related issues such as various bilateral trade deals (most of which are also in limbo) and a farm bill in Congress that, if anything, grants even more subsidies in contrast to recent concessions made by US WTO negotiators on Doha. Already there is talk that the US will only escape inaction when the rest of the world's countries start making deals with each other, bypassing the US:

Mr Rangel’s heavy discounting of Doha’s immediate prospects is echoed widely across Capitol Hill and most of Washington.

With the Democrats in charge of Congress and President George W. Bush’s political capital dwindling weekly, there is a widespread feeling that, at least until next year’s presidential elections, any progress in trade talks will be narrow, halting and weighed down with scepticism about the benefits of globalisation.

Many argue that the expiry over the summer of “trade promotion authority” (TPA), formerly known as “fast-track”, which allows the White House to submit pacts to Congress without having them picked apart line-by-line, has diminished trading partners’ enthusiasm for negotiations.

Charles Grassley, the senior Republican on the Senate finance committee, says: “It is a chicken-and-egg situation. We have Democratic leaders in the Congress say: ‘When there is some sort of a breakthrough in Doha, we will do something on TPA. And then you have people around the world saying: why should we do something on Doha if the president doesn’t get TPA?’”

The four deals in the pipeline submitted before TPA expired – Peru, Panama, Colombia and Korea – arouse varying enthusiasm.

Their importance to US trade is in any case limited: only Korea is among its top 40 trading partners.

Peru is the first and most likely deal to be passed, not least because Mr Rangel and fellow senior Democrats have enshrined within it sufficient protection for labour rights and the environment that they can portray it as the kind of fair and balanced trade deal they want to see.

Panama may be of sufficient foreign policy importance to get through Congress. But the election of a man wanted in the US for the 1992 killing of a US soldier in Panama as president of the country’s congress has been cited as a “serious obstacle” to approval by Max Baucus, chair of the Senate finance committee.

In Colombia, the murders of trade union leaders there have alarmed Democrats with strong affiliations to organised labour.

Meanwhile ongoing problems with Seoul allowing American beef and cars into its market seem likely to give the Korea deal at best an extremely rocky ride.

The administration, which remains free-trade in its rhetoric, insists that the strategy of “competitive liberalisation”, or moving forward on all fronts, remains in place. Putting deals like the Korean “free trade agreement” [FTA] on hold risks the EU, which is also negotiating a bilateral pact with Seoul, stealing a march.

Susan Schwab, US trade representative, said in an interview: “A straightforward assessment of the [Korea] FTA is [that] it is a very strong deal for any US auto maker that wants to increase exports to Korea. [Question for Schwab: Why would Koreans need SUVs? Even the US government encourages Americans to buy Korean cars in the interest of fuel efficiency according to a recent flap.]

“When other constituencies . . . start to focus on the benefits of the FTA, they will see a real level of commercial benefits.”

On the global scale, flickers of movement at the Doha talks in Geneva are not registering on Capitol Hill.

The House of Representatives has just passed its version of the “farm bill”, which will set agricultural support for American farmers for the next five years.

Even more lavish than the current one, it could require radical surgery if the US accedes to demands from its Doha negotiating partners for cuts in farm subsidies.

Ms Schwab says American farmers would prefer to get more export market access than subsist on federal payouts. “This farm bill is not our Doha round offer” [???--don't the farm bill and the Doha offer need to be reconciled with each other?]

But a former administration official says American farmers will make tougher demands on developing countries to cut agricultural tariffs as a trade-off for reducing US subsidies, making an agreement yet harder.

Many observers think the outlook is bleak. Fred Bergsten, director of the Peterson Institute for International Economics, says: “Assuming the Democrats take the White House next year, there will be at least a couple of years’ inaction on trade while they try to enact legislation to soften the blow of globalisation . . . 

“Only then will the economic and foreign policy consequences of having the rest of the world sign trade deals between each other and ignore the US become sufficiently apparent for them to take action.”

It may not just be President Hillary Clinton who is asked to agree a difficult deal on Doha, but a President Clinton who is already running for re-election.

Does It Pay to be Gay?

I was looking through recent research papers posted at the Institute for the Study of Labor (IZA) when "The Sexual Orientation Wage Gap:The Role of Occupational Sorting, Human Capital, and Discrimination" by Heather Antecol, Anneke Jong, and Michael Steinberger caught my attention. It provides some preliminary answers to the question of why income differences persist among gay and lesbian Americans relative to their heterosexual counterparts--both married and unmarried. The authors investigate three reasons for these differentials: occupational sorting (some may choose more lucrative jobs than others), differences in human capital accumulation, and labor market discrimination. Using sophisticated economeric models that I need to read up on, the results appear to differ for gay and lesbian Americans.

Lesbian women earn more than their gay and heterosexual counterparts regardless of marital status due to their higher levels of human capital accumulation (read: education). On the other hand, while gay men earn more than their cohabiting heterosexual male counterparts, they earn less than those who are married. Unlike for lesbian women, this result is attributable mainly to workplace discrimination. However, top-earning gay males earn nearly as much as their married counterparts, while the advantage of top-earning lesbian females narrows. For sure, these are interesting findings that are bound to generate spirited discussions about sexual orientation and wage differentials. In any event, there is no definitive answer to the question posed in the title. Here is the conclusion from the paper:

Recent public and legislative debate has focused on earnings differentials between gay and lesbian Americans relative to their heterosexual counterparts. Sound policy must be based on addressing the underlying causes of these wage differentials. Using the 2000 U.S. Census we show that gay men face a wage penalty relative to their married counterparts, but enjoy a wage advantage relative to their cohabitating counterparts.

Given these patterns, it is unlikely that there will be a simple explanation for the sexual orientation wage gap. In fact, the explanations likely differ depending on whether the sexual orientation group under consideration enjoys a wage advantage or suffers from a wage penalty relative to their heterosexual counterparts. Therefore, we explore three potential explanations—occupational sorting, differences in human capital accumulation, and labor market discrimination—using an analysis of the mean wage gap. Specifically, using the Oaxaca-Blinder (1973) decomposition, we find that differences in human capital accumulation, particularly education, are the main reason behind the observed wage advantage enjoyed by lesbian females relative to their heterosexual counterparts (irrespective of marital status) and gay males and their cohabitating counterparts, while occupational sorting and discrimination play only a modest role. However, we find that the entire wage penalty suffered by gay males relative to their married counterparts is driven by discrimination.

Unfortunately, analysis of the mean sexual orientation wage gap overlooks that the gap is not uniform along the entire distribution of wages, thus we expand our analysis by examining the determinants of the sexual orientation wage gap along the entire wage distribution using a DiNardo, Fortin, Lemieux (DFL) decomposition. We find that while gay males experience an average wage penalty relative to married males, top-earning gay males earn wages nearly identical to their married counterparts. In addition, the wage advantage of top-earning lesbian females relative to their married counterparts is smaller than the average advantage. While the non-uniformity in the sexual orientation wage gap along the distribution of wages does lead to some small differences in the relative roles of our three alternative explanations across various portions of the wage distribution, the main conclusions from the analysis of the mean wage gap persist.

India: the Outsourcing of Outsourcing

It appears that our Indian friends, the masters of outsourcing, are now applying the tricks of their trade elsewhere. Not only are they setting up shop in more locations across the globe to leverage their know-how, but they are also advising others on how to do so--profitably. The International Herald Tribune likens the globalization of the outsourcing movement to Japanese manufacturing transplants. Just as Japanese manufacturing models have worked elsewhere without Japanese workers, so too are Indian outsourcing models being applied without Indian workers. It's interesting stuff, and it bodes well for the spread of "tacit knowledge" about the intricacies of outsourcing from which others can benefit:

From across India, thousands of recruits report to the Infosys Technologies campus here in India's deep south. Amid the manicured lawns and modern buildings, they learn the finer points of software programming.

But lately, packs of foreigners have been strolling the campus. Many are Americans, recently graduated from college. Some had been pursued by coveted employers like Google. Instead, they accepted a novel assignment from Infosys, the Indian technology giant: Fly here to learn programming from scratch, then return to the United States to work in the Indian company's back office.

Now India is outsourcing outsourcing.

One of the constants of the global economy has been companies moving tasks - and jobs - to India, where they could be done at lower cost. But rising wages for programmers here, a strengthening currency and companies' need for workers in their clients' time zones or for workers who speak languages other than English are challenging that model.

At the same time, India is facing increased competition from countries seeking to emulate its success as a back office for wealthier neighbors: China for Japan [!], Morocco for France and Mexico for the United States, for instance.

Looking to beat back these new rivals, leading Indian companies are opening back offices in those countries, outsourcing work to them before their current clients do.

Many executives in India now concede that outsourcing, having rained most heavily on India, will increasingly sprinkle tasks across the planet. The future of outsourcing, said Ashok Vemuri, an Infosys senior vice president, is "to take the work from any part of the world and do it in any part of the world."

In May, Infosys's Indian rival, Tata Consultancy Services, announced a new back office in Guadalajara, Mexico; it already has 5,000 staffers in Brazil, Chile and Uruguay. Cognizant Technology Solutions, with most of its operations in India, has now opened back offices in Phoenix, Arizona, and in Shanghai. Wipro, another Indian company, has outsourcing offices in Canada, China, Portugal, Romania and Saudi Arabia, among other locations.

Last month, Wipro said it was opening a software development center in Atlanta that would hire 500 programmers in three years.

In a poetic reflection of the new face of outsourcing, Wipro's chairman, Azim Premji, told Wall Street analysts this year that he was considering hubs in Idaho and Virginia, in addition to Georgia, to take advantage of "states which are less developed," Premji said.

Infosys is building an archipelago of back offices - in Mexico, the Czech Republic, Thailand and China, as well as in low-cost regions of the United States. The company wants to become a global matchmaker: Any time a company wants work done somewhere else, even just down the street, Infosys hopes to get the call.

It is a peculiar ambition for a company that symbolizes the flow of tasks from the West to India. Most of Infosys's 75,000 employees are Indians in India, and they account for most of the company's $3.1 billion sales in the year that ended March 31, from clients like Bank of America and Goldman Sachs. "India continues to be the No. 1 location for outsourcing," S. Gopalakrishnan, the company's chief executive, said in a telephone interview.

And yet Infosys is quietly stringing together a necklace of global outsourcing hubs, where local workers work with little help from Indian masters. The company opened an office in the Philippines in August and, a month earlier, bought back offices in Thailand and Poland from Royal Philips Electronics, a Dutch company.

Infosys's Indian outsourcing experience taught it to cut up a project, apportion each slice to the suitable worker, double-check quality and then export a final, reassembled product. The company believes it can clone its Indian back offices in unfamiliar nations and groom Chinese and Mexicans and Czechs to be more productive than local outsourcing companies could make them.

"We have pioneered this movement of work," said Gopalakrishnan. "These new countries don't have experience and maturity in doing that, and that's what we're taking to these countries."

Some analysts compare the strategy to Japan's penetration of automaking in the United States in the 1970s. Just as the Japanese learned to make cars in America without Japanese workers, Indian vendors are learning to outsource without Indians, said Dennis McGuire, chairman of TPI, a consultancy based in Texas that focuses on outsourcing.

For now, work that bypasses India remains a small part of Infosys's business, but it is growing. The company can be highly secretive, but executives agreed to describe some of the new projects on the condition that clients not be named.

In one project, an American bank needed to build a computer system to handle a new loan program designed specifically for Hispanic customers. The system had to work in Spanish and, in making approval decisions, had to comprehend variables particular to the Hispanic market. Many Hispanics, for instance, remit money to families abroad, which affects their bank balances. The bank thought a Mexican team would have the right language skills and grasp of cultural nuances.

But instead of going to a Mexican vendor or to an American vendor with Mexican operations, the bank retained three dozen engineers at Infosys, which had recently opened shop in Monterrey, Mexico.

Such is the new outsourcing. A company in the United States pays an Indian vendor 7,000 miles, or 11,200 kilometers, away to supply it with Mexican workers situated 150 miles south of the U.S. border.

In Europe, too, companies now hire Infosys to manage back-office work in their backyards.

In one example, a large American manufacturer with factories across Europe had to deal with bills from suppliers in multiple European countries. Each supplier billed the company in the suppliers' home country, creating a complex lattice of payments to multiple suppliers, from multiple offices, in multiple currencies.

Infosys manages the lattice. The manufacturer's offices scan the invoices and send them to Infosys, where each is passed on to the right language team. The teams verify the orders and send the payment to the suppliers while logged in to the client's computer system. More than a dozen languages are spoken at the office in Brno, Czech Republic.

The American program in Mysore is meant to keep open a pipeline of diverse workers for the company. Trainees had no software knowledge. By teaching novices, Infosys hopes to save money and attract workers who will turn down better-known companies for the chance to learn a new skill.

"It's the equivalent of a bachelor's in computer science in six months," said a trainee, Melissa Adams, 22. Adams graduated last spring from the University of Washington with a business degree and turned down Google for Infosys...

Stiglitz Lauds Ethiopian Growth, Too

The development community has noted the recent progress made by Ethiopia in terms of achieving much-vaunted economic growth. The IMF, for example, has lauded the progress made under the term of Miles Zanawi. In the last few years, the African nation has recorded nearly double digit GDP growth figures. Now, the IMF-bashing Mr. "Globalization and Its Discontents" himself Joseph Stiglitz has taken his turn at recognizing Ethiopia's achievements. He notes that Ethiopia has been able to promote growth without (a) startling increases in income inequality and (b) excess reliance on commodity exports to China, unlike some other African countries. (Along the way, he makes his customary digs at the US and critiques of globalization.) I guess this is one example where folks are pretty much in agreement that, yes, good things are being done, for lack of a better term. May this trend continue. From All Africa:

That Ethiopia's economy has been doing well over the last few years is not that disputable. In fact, it has got recognition both from the World Bank and the International Monetary Fund.

Recognized around the world as a leading economic educator, Professor Joseph E. Stiglitz on Monday also seemed impressed by Ethiopia's economic growth, although he was as well concerned on the challenges ahead to keep that growth sustainable for a longer period.

Invited by the Ethiopian Economic Association and the Ethiopian Development Research Institute to give a lecture on growth and globalization at the headquarters of Economic Commission for Africa, Stiglitz says, "It has been impressive to see Ethiopia's growth being sustained for the last four years by some ten percent."

According to him, most of the rest of the East African countries and other developing nations have also been doing well.

What, however, struck Stiglitz about Ethiopia's growth seemed the source of it. "Some of the growth these developing countries registered over the last several years is a result of increase in commodity prices, particularly in the case of China. The success in Ethiopia is clearly far more than that. It has got to do with an increase in production output, diversification, and going into new areas," says the professor.

According to Stiglitz, the main challenge will be keeping that growth for a longer period. "The question everybody is asking is how to make that growth sustainable and how to ensure that the benefit of that growth is widely shared."

The Professor says that Ethiopia was lucky given its recent history and the difficulties it had come through. "At least, Ethiopia has one of the most egalitarian distributions of income in the world," he says.

In contrast, in much of the developing world, not only are there high levels of inequality, but also the level of the inequality has been increasing very dramatically, according to the professor. Even in China, which has been very successful in reducing poverty, the level of inequality has reached alarming point, he says.

According to the professor, this increase in inequality both within and between countries is providing a real challenge for anybody concerned with egalitarian growth. And the notion that as long as there is growth everybody benefits in what is termed as a "trickle-down economy," has, in fact, proved wrong, says the world-renowned economist. "There was no good economic theory behind a trickle-down economy and the evidence that support it."

"The US current GDP is 20 percent higher than it was in 2000 and yet most Americans are poorer than they were six years ago. The number of people living in poverty in the US has increased. All that growth has gone to the people at the very top and the growth registered was pro-rich," Stiglitz says. "This phenomenon is worrisome and is happening in many parts of the world." Globalization is partly a cause of this, according to the professor.

While the debate in Ethiopia and in Africa is part of the broader argument on developmental strategy that has been going on for a long time, Stiglitz suggests a number of ways and means that Ethiopia and other African countries could do in order to help keep up their growth.

One important aspect that Stiglitz suggests is an effective role of the state in the developmental processes of African countries. "Market failure is one area where governments can play an important role," he says. Although there is governance problem, "no country has been successful without having an important role from the government." At one time or another, the government has played an important role in the US as well as Europe, according to stiglitz.

The professor also notes that developing countries should identify and focus at their comparative advantages in global economy.

Stiglitz suggests that access to finance is another area developing countries should consider. "Access to finance is essential for the long-term growth of especially small and medium enterprises, while these businesses are the source for more jobs."

The professor also indicates how knowledge would help the growth of developing countries.

Commenting on globalization, the professor would not deny that Africa was at disadvantage. "Many people had said that Africa had benefited from globalization probably because it has been least integrated into the global economy," Stiglitz says. "That may not be an accurate description because Africa has, sometimes alarmingly, been affected in many ways by what has been going in the world economy." According to the professor, the global rules of trade are unfair to the poorest countries. "Not only are the US and Europe the major beneficiaries of globalization, but the benefits they gain come also from the expense of the poor countries of the world."

While globalization has its ups and downs in the countries' economy, the concern growing with it is growing inequality within and between countries.

"If you see a world in which water flows uphill, you would say something is very weird about that world. Money should be flowing from the rich to the poor. But within this anti-gravity financial market, money has been flowing from the poor to the rich," Stiglitz says. According to him, some USD 500 billion last year went from poor countries to rich nations.

The good news is, says Stiglitz, that there was a growing recognition of many of these problems. "We can shape globalization to work. There are ways that could make globalization work for both the developed and developing countries."

"It is a time of change in Ethiopia and in Africa," the professor says. Given the growth that has been experienced, the challenge will be how to make that sustainable, according to Stiglitz. "I think there are some real opportunities with globalization, particularly if we can shape the way it is working now."

Deregulating US-EU Air Traffic

Battle will soon be joined in the Atlantic crossing between the United States and European Union as the Open Skies deregulation initiative comes into effect early next year. Although other carriers are not expected to make much inroads into flights coming into and out of London Heathrow--Europe's busiest airport--since the currently authorized US-EU carriers American Airlines, United Airlines, British Airways, and Virgin Atlantic have the route filled to capacity, other regional airports are bound to see more competition, hence lower fares. (The Heathrow situation may be subject to change as the controversial third runway nears fruition.) In the meantime, it's game on for carriers at other airports. From the Chicken Noodle Network (CNN):

The negotiations are over. The treaty has been signed. The skies across the Atlantic are now open for free movement of flights between European and U.S. cities. Now the battle commences between airlines as they prepare for their new-found commercial freedom when the Open Skies agreement comes into action in March 2008.

The main beneficiaries of increased competition between airlines are likely to be business travelers. And while they may not see a dramatic reduction in ticket prices, they can look forward to a greater choice of flights from a greater number of airlines as well as an increase in business-only services.

Airlines with the strongest brands and best quality products are likely to lure passengers away from European rivals by launching flights from other major European cities.

British Airways has confirmed it will launch its first transatlantic flights from continental European cities once the agreement comes into place next year. And while it is not ready to confirm branding, types of aircraft, or even final routes, a BA spokesperson said likely contenders for new transatlantic routes will be from business destinations such as Paris, Frankfurt, Brussels and Milan.

She also confirmed that, contrary to expectations, these flights would not be exclusively business class. Though they will offer premium cabins for business customers.

Virgin Atlantic is expecting to place a greater focus on its business customers and has established a team to work towards the launch of business-only flights in 2009. These will fly from airports such as Paris, Frankfurt, Milan and Zurich and the airline is currently in discussion with Airbus and Boeing to place orders for between 10 and 15 aircraft.

Virgin and BA are both confident they can entice customers away from European national carriers due to the strength of their brands and service offering. As Paul Charles, director of corporate communications at Virgin Atlantic says, "we are seen as a truly global brand and well-placed to compete with the quality of business services currently coming out of cities such as Paris and Milan."

Open Skies will put an end to the exclusive arrangement granted to British Airways, Virgin Atlantic, United Airlines and American Airlines to fly transatlantic out of Heathrow.

As a result, airlines including BMI, Continental Airlines and Northwest Airlines are all lined up to launch direct transatlantic flights from Heathrow from next year. But with the airport currently operating at almost-maximum capacity, it is likely that new flights will be limited.

Airlines operating from other airports, in particular the new business-only players such as Eos, Silverjet and Maxje, will, however, see an opportunity to expand their own services across the Atlantic.

Joshua Marks, executive vice president for planning and development at U.S. business-class airline, Maxjet, says it expects to "strengthen its position at Stansted" as a result of the Open Skies agreement. "With more flights moving from Gatwick to Heathrow, three major airports will become two in London." As such, he adds, Stansted could become the default airport for travelers coming from and to the east of the city.

Now that the U.S. Department of Transport has given approval for Maxjet to launch flights from Stansted to other countries with open skies agreements with the U.S., business travelers in London should also be able to pick up Maxjet flights to destinations such as India.

Maxjet has confirmed that it will not fight for slots at Heathrow, which Marks says has become an "operational nightmare."

Yet, other premium-only services are not ruling out the move. Silverjet, currently operating out of Luton, has been in discussion with (un-named) airlines interested in striking deals to launch flights out of Heathrow.

Opportunities have been offered for flights to U.S. cities such as Los Angeles, says Lawrence Hunt, Silverjet's chief executive. "This is an ongoing dialogue," he says.

But before they make the move, they would need to see major changes to facilities at Heathrow in order for it to offer the "personalized, discreet and carefree" travel experience Silverjet offers customers from Luton. "Heathrow has become a zoo and the customer experience has become appalling," he says.

Airline executives agree that growth in transatlantic flights as a result of the Open Skies agreement will be aimed at business customers. As Hunt says, airlines have little else to offer, or gain, in terms of economy long-haul seats.

And as Charles at Virgin points out, given the success of the new business-only entrants and the simultaneous ongoing demand for its business class seats, "there's clearly a market out there for business-only flights."

While there may be some softening of prices from Heathrow as airlines fight for slots, few expect prices for business travelers to drop dramatically as a result of the Open Skies agreement. As BA's spokesperson says, UK to North America is already a very competitive market. "It is not as if we are moving from a monopoly," she says.

Despite this, there is still a great deal to offer business customers and those that will make the most of the opportunity, says Anthony Concil, spokesperson from IATA, will be the most innovative.

"We have created a new playing field and it is up to players to make the most of that and for governments to take the agreement forward towards further liberalization."

SatNav: The Space Race Circa 2007

Two of the participants in the new space race should be familiar to all from their Apollo and Sputnik exploits: the US and Russia. However, they've now been joined by the EU and China in a different sort of space race. These countries are competing to launch global positioning systems (GPS). As a marketing ploy, the EU's Galileo project was designed to lure away customers from the US system by reiterating that the US would curtail use of its system for military purposes should the need arise. Just recently, however, the US has said that it will not limit use of its GPS for that reason, so users can take comfort. It all adds up to an intense four-way race in the GPS stakes. Never forget, of course, the strongly "dual-use" nature of these systems. From the Financial Times:

Space may be a big place but is it big enough to hold the coming-out parties of a new generation of world powers’ satellite navigation systems? The day before the European Union announced the relaunch of its planned rival to the US’s global positioning system, Washington sabotaged the launch pad by declaring it would make its own system more user-friendly.

Galileo, already troubled by internal EU feuding on how it would be funded, suddenly had one less reason to exist. Its proponents have long argued it was necessary because GPS, which has 98 per cent of the satellite navigation market, was designed for military purposes and can be disabled for civilian use in time of war.

US President George W. Bush, however, announced a third generation of GPS would not be equipped with such technology. The US has already pledged not to use such technology but the latest offer deprives it of even the option to do so. The White House said it was “eliminating a source of uncertainty in GPS performance that has been of concern to civil GPS users worldwide”. The Americans also hope to eliminate Galileo, claims Lieven Quoidbach, vice-president of Navteq, the US satellite mapping company. “They are desperate to keep their monopoly. It is kindergarten behaviour,” he said.

Other emerging big powers are also building expensive space toys of their own. China plans worldwide coverage with its Beidou satellite system. Although the details remain imprecise, the project is clearly of the highest importance. “Space technology reflects a nation’s overall power and is an important facet of the modernisation of national defence,” Sun Laiyan, chief of the China National Space Administration, said in May.

Meanwhile, a resurgent Russia, rich with oil and gas revenues, has begun spending heavily – 12bn roubles ($480m, €340m, £240m) this year – to improve its ageing Glonass military system. “In the 21st century, the state’s accessibility to a modern global navigation satellite system is just as important in determining a country’s [position] as possessing nuclear weapons or strategic reserves of energy resources,” said Sergei Ivanov, Russia’s first deputy prime minister, who is driving the project.

“This is a geopolitical ambition for Russia,” said Andrei Ionin, an aerospace expert at Moscow’s Centre for the Analysis of Strategies and Technologies, which is linked to the Russian defence ministry. “If you don’t have your own navigation system the key to high precision weaponry is not in your hands.”

Many doubt whether Russia will meet its target of Glonass providing full global coverage with 24 satellites in orbit by 2011. It has 11 satellites in orbit, providing coverage for just under half of Russia, but they are dogged by unreliability. “They’re like the Zhiguli car,” said Pavel Felgenhauer, an independent military expert, referring to the Soviet-era cars known as Ladas outside Russia. “They need to be taken in for repairs a great deal.”

India has agreed to help Moscow design better satellites. While all systems stress their civilian use – Glonass receivers are being installed in trains – it is more likely they will be driven by military needs.

Even though EU governments have yet to agree a plan to spend €2.7bn ($3.8bn, £1.9bn) to complete the 30-satellite Galileo, France and Germany insist on its importance as a guarantee of independence from the US.

Jacques Barrot, European transport commissioner, has said Galileo would not be for “military use but will have military users”. Michel Praet, of the European Space Agency, said the EU must spend more on space: “If you don’t have space in your tool basket, you will be relegated to the second tier in global competition: in military, economic and research terms.”

The business benefits are not in doubt, said Mr Quoidbach, citing uses for mobile telephones and driver safety.

Nath: India Not a Trade Obstructionist

The protracted nature of the WTO Doha Round has been partly due to leading developed nation negotiators Brazil and India holding out on a deal with the US, EU, and Japan over agricultural subsidies. US Trade Representative Susan Schwab has gone so far as to accuse Brazil and India of trying to "destroy the Doha round" (call me a ham, but I do love such hyperbole that enlivens normally staid trade talks). In his latest missive, India Commerce Minister Kamal Nath replies that India is not taking an especially difficult stance to the negotiation process. Rather, it's a matter of principle over unjust subsidies. This comes from the Times of India:

Rejecting the suggestion that India is taking a difficult stand in the World Trade Organisation (WTO) talks, Commerce Minister Kamal Nath has said New Delhi only wants a multilateral trading system that corrects the existing structural flaws in the global trade rather than perpetuate them.

The rules of the game are very important for India as it engages in the global trading system more and more, he told investors and entrepreneurs here on Friday.

Stressing the need for abolition of agricultural subsidies by the rich countries, he told the India-America Chamber of Commerce that these subsidies and non-tariff barriers greatly distort the system and are not justified.

Defending the protection of intellectual property rights, Nath emphasised that it is important as India graduates from user to producer of intellectual property. It is aimed at coming generations of entrepreneurs who through their innovation would create new products.

Besides, he said, it improves the credibility and standing of India in the international community as it fulfills the commitments made and translates into investments with the investors realising that the country not only has laws but implements them too.

"It is credibility of India which is bringing in investments in various sectors," he added.

Observing that the comparison between India and China is "misplaced", Nath said there is need to see where China was 15 years into the opening up process. He said India, which started economic reforms 15 years ago, is now getting double the investments China got at that point of time.

Note that the US has just agreed to the limits for agricultural subsidies suggested by Kiwi WTO agricultural ambassador Crawford Falconer to get the round going again. However, Bloomberg points out that while the amount spent on subsidies is to be cut, the subsidies that remain are reserved for highly contentious crops. The likely result? No deal in 2007. On to 2008, it seems...

U.S. willingness to accept proposals limiting farm subsidies and opening markets to both agricultural and industrial goods probably won't be sufficient to lead to a global trade agreement this year.

``It's a step in the right direction, but it won't break the impasse,'' said Brian Gardner, head of U.K.-based Food Policy International, which analyzes agriculture strategy. ``They still have a long way to go.''

The U.S. agreed for the first time to limit trade-distorting farm payments to between $13 billion and $16.4 billion provided other World Trade Organization members accept proposed cuts in agricultural tariffs, the WTO's top farm-trade negotiator said yesterday. The move was aimed at energizing talks that have dragged on for almost six years as rich and poor countries spar over cuts in import tariffs and farm subsidies.

Under the proposals put forward in July, the U.S. and other wealthy economies would have to slash spending that distorts commodity markets by as much as 73 percent and eliminate the use of subsidized exports by 2013. Total permitted U.S. spending in all forms would be cut from $48.2 billion a year to between $13 billion and $16.4 billion.

Joe Glauber, the chief U.S. negotiator on farm trade, accepted the proposed subsidy range contingent on other nations agreeing to the July plan for cutting tariffs on farm products, the WTO said [namely EU countries and Japan]. It was the first time the U.S. has made such a concession, Crawford Falconer, New Zealand's WTO ambassador and the head of the agriculture talks, told journalists in Geneva.

Still, two ``basic problems'' continue to dog WTO talks and make it unlikely that the more flexible U.S. position will lead to a quick agreement, Gardner said.

The U.S. remains ``particularly vulnerable'' because most of its domestic aid is in the most damaging classifications and would therefore be subject to substantial reductions, he said. A group of developing countries including Brazil, China, India, South Africa and Mexico are pressing for limits on U.S. aid.

The second big obstacle is the European Union's insistence that its most sensitive products remain in a category in which they are subject to lower aid reductions. The EU is ``not moving as far as the U.S. would like on market access,'' Gardner said.

Under the July proposals, the EU's spending would fall to between 27.6 billion euros ($37.5 billion) and 16.5 billion euros from a current ceiling of 110.3 billion euros.

The EU, the world's biggest agricultural importer, today welcomed the change in the U.S. position, said Peter Power, a European Commission spokesman.

``What we would like is that all partners make a commitment on both texts now,'' he told a news conference in Brussels. ``We hope we will be able to complete this round on that basis.''

That isn't likely, said Philip Whyte, a senior research fellow at the Centre for European Reform.

``The U.S. position doesn't change the underlying politics,'' he said by telephone. ``Bubbling under the surface, there is a sense among key negotiators that progress is being made; but despite that progress, the politics is still going to get in the way of a deal before 2009' [he is referring to the 2008 US elections, of course].

Invest in North Korea II

I've previously mentioned the latest FDI fashion of investing in North Korea despite the clear and present dangers of "political risk." What's driving North Korean investment? In a nutshell:

While inexpensive labor is one of North Korea's potential draws--its wages are significantly lower than those in China--North Korea also offers a well-educated labor force with a touted 99% literacy rate, plentiful untapped natural resources, and a favorable geographic location at the heart of Asian commerce.

TIME has a feature in its most recent issue adding more color to the North Korea as emerging market story. In a nice bit of hyperbole, they call the DPRK "the world's most dangerous investment" [isn't that CDOs full of subprime loans?] I guess it's a small world after all...

A few years ago, Chris Devonshire-Ellis, a Beijing-based business and tax consultant, was in the bar at Pyongyang's Koryo Hotel when he ran into another foreigner. "The guy's name was Vlad," Devonshire-Ellis says. "He'd come from Moscow on a train to sell tractors to the North Koreans. He had all these guys around him. Turns out, they were his team of bodyguards. The North Koreans paid him in cash — 1 million in U.S. dollars — and that's why he needed the bodyguards. He was comfortable doing business with the North Koreans. He said they always paid. But I must say, the guards with machine guns may be a bit much for the average Western businessman."

Such is the parlous state of commerce in the world's last Stalinist holdout. In recent months, North Korea's dictator, Kim Jong Il, has agreed to a rare meeting with South Korea's President and allowed international inspectors to examine the country's nuclear facilities, raising faint hopes that diplomatic progress in the effort to get Kim to abandon nuclear weapons, along with an easing of the country's self-imposed isolation, might ultimately lead to economic reforms. And for foreign investors lured by what Devonshire-Ellis calls the "barren romance" of the place, North Korea holds obvious, if modest, attractions: a highly literate workforce with average daily wages that are about half what Chinese earn; abundant mineral resources, including coal, iron ore and gold; a cash-on-the-barrel economy; and virtually no competition. It's not hard to gain a first-mover advantage, after all, if everyone else is standing still.

North Korea would be an economic basket case if only it could afford the basket. Once the industrial engine of the Korean peninsula, decades of disastrous central planning have left its infrastructure in a state of advanced decrepitude and its citizens in de facto peonage. The U.S. government estimates the North's per capita GDP to be about $1,800, which is roughly the same as Zimbabwe's. Per capita exports are around $60 a year — less than 1% of South Korea's. Aside from fishing, mining and cement production, the North has only a hodgepodge of functional industries, including, weirdly enough, its animation studios, which have been used by several European companies. One of the few export industries to flourish, meanwhile, has been the international trade in military hardware, drugs and counterfeit products, which, some Western experts estimate, may net Kim's regime up to $1 billion a year — equivalent to one-fourth of the country's legitimate exports.

Yet in spite of the depressing circumstances, North Korea continues to receive commercial support from neighboring countries, which hold out hope that Kim's hostile kingdom can be enlightened through greater integration with the global economy. China, North Korea's biggest trading partner, has increased its dealings with the North: according to the most recent figures available, trade between the two countries was up 5.4% in the first 11 months of 2006, to around $1.54 billion. Much of that commerce was one-way — Chinese food and electronics moving into the North — but about 150 Chinese companies are doing business there. "Once the political situation stabilizes and medium-sized enterprises begin to discover North Korea, it will have a dramatic impact," says Alexandre Mansourov, a professor at the Asia-Pacific Center for Security Studies in Honolulu and a former Soviet diplomat in Pyongyang. "I don't see why North Korea should be an exception to the economic miracle in which every country around China is benefiting from Chinese economic growth."

North Korea is already benefiting, a little. In 2005, Chinese trading company Tianjin Digital invested $650,000 to open a joint-venture bicycle plant in Pyongyang. "The conditions are really favorable," says Tianjin manager Liang Tongjun, whose company was granted a 20-year monopoly on bicycle manufacturing in the North. To eliminate competition, Kim's government even banned the import of second-hand bikes from Japan. A month after the factory opened, the Dear Leader himself paid a visit.

China's links to its neighbor and ally consist mainly of investments by individual companies. But in South Korea, economic engagement with the D.P.R.K. — the Democratic People's Republic of Korea, as the North calls itself — is government policy. South Korea has invested heavily in two well-known public-private development projects: a resort area at Mount Kumgang and an industrial zone in Kaesong, located about 10 km north of the Demilitarized Zone. There, 13,300 North Korean workers earning $70 a month churn out exports in conditions one former Western diplomat compares to a labor camp. So far, 15 South Korean companies have opened factories at Kaesong, producing shoes, watches, mufflers and other low-end consumer goods; another 150 have signed on to the project. Largely because of Kaesong, North Korean exports to the South shot up 63.3% in the first half of 2007. Hyundai Asan, the South Korean conglomerate that manages and has invested nearly $1 billion in the two projects, is convinced that North Korea is ready to embrace capitalism. "The North Koreans are really studying the market-oriented system," says Jang Whan Bin, Hyundai Asan's senior vice-president of international business and investor relations. Such optimism is essential for South Koreans, for whom investment in the North is less an overture for integration than a hedge against their neighbor's collapse. Better, perhaps, to nudge the D.P.R.K. toward prosperity now than to inherit a ruined state later.

Roger Barrett, founder of the Beijing-based Korea Business Consultants and one of the few Westerners to regularly do business in Pyongyang, says that the North seems eager to court new investment. "The D.P.R.K. government is very keen to demonstrate that joint ventures are welcomed," he says. Barrett, who has been facilitating business deals in the North for more than a decade, compares the country's current condition to that of South Korea before it emerged from military rule to become one of the world's export powerhouses. "You start to see how North Korea can move along in similar ways," he says. If it does, Barrett will be ready: last year, he even arranged a golf tournament — that indispensable ritual of international business culture — to attract new investors to Pyongyang.

A few other pioneers are already there. Orascom, an Egyptian conglomerate, recently signed a $115 million deal to buy a stake in a North Korean cement company. And later this month, a British firm will begin offering subscriptions for the first-ever D.P.R.K.-focused investment fund. Colin McAskill, the fund's director, says it will concentrate on pumping capital into the mining industry. "You have to think off the wall in North Korea, because nothing conventional has ever worked there," he says.

Deals in the North do have a marked tendency to go south. For example, a Thai telecom's plan to develop a mobile-phone network faltered after Kim's regime banned cell phones in 2004. South Korea's Unification Ministry has estimated that 1,000 South Korean ventures in the North have gone bust. Kelvin Chia, a Singapore-based lawyer who has worked with North Korean joint ventures since 2004, says many investors were spooked by the country's October 2006 nuclear test and its international fallout. "One of my clients was looking at going ahead with a substantial investment in a mineral-processing project," Chia says. "Before he went in, he had an indication from financiers it was doable. But then the nuclear issue blew up, and it became impossible."

To be sure, there's considerable political risk in partnering with a charter member of the "axis of evil." Consider the case of British American Tobacco. In 2001, the cigarette giant entered into a joint venture with a state-owned North Korean conglomerate to operate a factory in the North. But BAT pulled out of the arrangement after a British newspaper revealed details of the deal. Other companies have been scared off by the U.S. trade embargo. "There's already a reasonable amount of investment," says Devonshire-Ellis, who helped the North Korean government rewrite its foreign-investment regulations. "But companies try to keep it very, very quiet. I know one high-end Japanese brand is having clothing finished in North Korea. Another European men's fashion house is getting shirts finished there. The truth is, business executives in New York and Washington are walking around wearing expensive shirts made in North Korea."

Pyongyang has flirted with economic reform before, liberalizing prices and even encouraging some small measure of private enterprise by allowing farmer's markets. But the North's development schemes have often come to naught. Casting about for new investors after the collapse of the Soviet Union, the D.P.R.K. in the 1990s started a free-trade zone in Rajin-Sonbong, a remote area near the country's northeastern frontier. The experiment failed: the zone didn't attract much beyond a few hotels and a casino catering to Chinese tourists. Another special economic zone in Sinuiju, across the Yalu River from the Chinese city of Dandong, faltered in 2002 after the Chinese-Dutch orchid entrepreneur handpicked by Kim Jong Il to run the place was arrested by China for fraud.

The North was emulating an obvious precedent: Shenzhen, the special economic zone where China first experimented with capitalism. In January 2006, Kim Jong Il made a rare foreign visit, traveling by train — he reportedly abhors flying — to the booming south China city. Kim may see China as more than a path to prosperity. "To him it's an assuring message," says Mansourov. "Even if you open up economically, you can still maintain political control for his regime and his family."

Yet just as often as North Korea has opened a crack, it has slammed the door shut. In 2005, for instance, the government suddenly reversed its decision to allow private markets, forcing many North Koreans back into its food-rationing system. And at April's meeting of the Supreme People's Assembly, Kim's government sacked Prime Minister Pak Pong Ju, who had previously led a Cabinet-level economic think tank, and who was seen by some as friendly to reformers. (Pak and his deputies were reportedly trundled off for re-education.) "All of a sudden the wind seems to have gone out of the sail," says Brad Babson, a former North Korea specialist at the World Bank. "The economic reformers were back-benched, and something shifted internally so they got back into this military adventurousness."

Real reform, Babson says, would require North Korea to abandon its pipe dream of agricultural self-sufficiency — with a dearth of arable land, the country is literally dirt poor — and invest in labor-intensive manufacturing. But rebuilding the country's roads and ports and installing a reliable electrical grid would take billions of dollars in international loans — hardly a bright prospect given the country's history of defaulting on its obligations. Even then, by some estimates it will take a decade of investment to bring North Korean incomes up to a mere 55% of South Korea's.

Skeptics, meanwhile, see North Korea's current eagerness for investment as another in Kim's endless series of feints designed to keep his opponents off balance — and the aid handouts flowing. The country relies on foreign aid to feed as much as a third of its population. "The North Korean economic approach has always been to extract resources from outsiders," says Nicholas Eberstadt, a political economist at the American Enterprise Institute and the author of The North Korean Economy. "It's like what they say about champagne: in success, you feel like you deserve it; in failure, you need it."

And the possibility of failure is omnipresent. According to South Korea's central Bank of Korea, the D.P.R.K.'s economy shrank by 1.1% in 2006 after eight years of moderate growth. Under pressure from international sanctions, nearly every sector of the North's Lilliputian economy contracted, with new construction plummeting 11.5%. Torrential rains in August, meanwhile, destroyed an estimated 11% of the country's rice and corn crops, again raising the specter of mass famine like the one that killed up to a million people in the mid-1990s.

Small surprise, then, that Kim seems suddenly amenable to dealing with his erstwhile enemies in Washington and Seoul. Last week, the D.P.R.K. allowed an international team of inspectors to visit its Yongbyon nuclear facility. After the regime promised to shutter its nuclear program, China donated 50,000 tons of heavy fuel oil. The U.S. could follow suit with a similarly sized shipment. And at next month's summit between Kim and South Korean President Roh Moo Hyun, the South could offer North Korea a development-aid package that some experts speculate could be worth $20 billion — no small potatoes to a country in which one of the leading industries is, in fact, potatoes.

But a business opportunity in the North is still far from assured. Should Pyongyang renege on its program to dismantle its nuclear program, crippling U.S. sanctions will almost certainly continue. And South Korean presidential elections in December could usher in a new government with a less conciliatory stance toward its deadbeat neighbor. To see just how far North Korea still has to go, you need only visit the Sino-Korean Friendship Bridge linking the booming Chinese metropolis of Dandong with the sooty failed economic zone of Sinuiju. Commerce between the two nations is limited to a trickle of trucks on the bridge's single lane. At night, the contrast is vividly instructive: Dandong's bustling waterfront turns into a riot of neon, while Sinuiju is pitched into near-total blackness. How will North Korea ever pull itself out of the dark ages if it can't even keep the lights on?

From Mobutu to the "Yellow Man's Burden"

Here's yet another entry in the rapidly expanding category of Chinese investments in Africa. What we have here is Howard French ruminating on the implications of Chinese investments in Congo, formerly known as Zaire under the devastating regime of Mobutu Sese Seko. The book In the Footsteps of Mr. Kurtz by Michaela Wrong illustrates how the West turned a blind eye to the abuses of Mobutu and even fueled his excesses as a nominal Cold War ally. Those days are long gone, but a new foreign power has appeared on the scene: China. Once again, the question must be asked if the Chinese are any different from their Western predecessors. Are the Chinese fairweather friends who are just improving the country's infrastructure so that they can extract Congo's natural resources more quickly (the skeptic's view), or are they interested in the long-term development of Congo (the official stance)?

I will have more to say about Chinese involvement in Africa shortly. Let's just say that Chinese involvement in Africa lies somewhere between the purely selfish and purely altruistic (well, duh--but there's more to the story than that). One of the notable insights that French brings here is that the Chinese with their policy of so-called non-intervention in the political affairs of other countries (except maybe for Taiwan and a putative Tibetan state which are "part of China") is that they aren't at all keen on improving the governance of Congo and other African countries. As Wolfowitz would tell you, governance has been a large bugaboo setting back African nations. What good do more export earnings do if they aren't used for clearly developmental purposes? You be the judge. From the International Herald Tribune:

The entire world may not have sat up and taken notice in the last week, and that is probably just fine with China, which has just made a major move into central Africa.

With its agreement to lend $5 billion to Congo, what might have often looked like a grab-bag approach to the African continent by a country with only sporadic involvement there has finally taken on a distinct outline.

It turns out that China, which since the time of Deng Xiaoping has discouraged talk about its rise or its might, has a blueprint for Africa, and with the Congo deal, what we are witnessing is the shift of the Chinese embrace into high gear.

What will $5 billion buy? Quite a lot, should all of the projects in the announced deal materialize. Imagine Western Europe without practicable roads or functioning trains and you will begin to get a sense of Congo and its realities.

For half of the year, when the rains are heavy, the grandly named Route Nationale 1, which follows a path of about 260 kilometers, or 160 miles, between the capital, Kinshasa, and the country's sole ocean port, Matadi, cannot be said to connect the two cities.

Trucks sink up to their cabin doors in mud and must wait for weeks to be winched out. Mind you, this is arguably the most important road in the country.

Add to the lack of infrastructure an equatorial climate in which tropical diseases proliferate and thrive, and no education system worthy of name, forcing children by the millions to grow up without proper schools.

It is a dark picture, made all the more dire for the persistence of a low-grade civil war affecting large swaths of the country.

The $5 billion that China is plunking down promises a great leap forward for Congo, and this begins with about 3,200 kilometers of new rail lines and an equivalent amount of new roads. The money will also pay for 31 hospitals and 145 smaller health care centers, along with two large new universities and 5,000 new government housing units.

The Chinese promise not to dilly-dally, too. Most of this will be accomplished in a mere 36 months, they say, and I for one believe them, having seen the pace of change even in the most remote Chinese backwaters. If war or political upheaval doesn't get in the way, Congo stands to experience more progress in 36 months than it has in 47 years of independence from Belgium, or as a colony of Brussels for that matter.

The Chinese move is impressive on many levels, none more so than the fact of the immense vacuum in Africa they are moving to fill, and there are few characteristics more distinctive of an emerging superpower than filling vacuums.

When Laurent Kabila overthrow Mobutu Sese Seko in 1997, American companies like Bechtel rushed up blueprints for Congo's reconstruction, anticipating huge civil engineering deals.

No country is more richly endowed in minerals, and the world's mining giants, too, flew executives in on private jets, hoping to win big contracts. More war intervened, though, and all of this came to naught, leaving Congo's 65 million people mired in poverty, with little real development ever since.

China now has its eyes on the same prize: the world's richest assortment of minerals, from copper to cobalt to uranium to diamonds and gold and on and on, but its game plan reflects a truly Chinese perspective on the world.

The new roads and rails are meant not merely to revive Congo's prospects. Nor are they simply intended to facilitate extraction, as much as that remains part of the plan. China is redrawing the economic map in central and southern Africa, linking the copper zone of the south with the port at Matadi, and redirecting other portions of the country's huge mineral potential to Chinese-built networks in Zambia and Angola.

In doing so, it is largely avoiding South Africa, a potential but now badly outstripped competitor that is perhaps seen as too deeply involved with the West.

It must be said that China has chosen a daunting proving ground for its long-held ideas about engagement with the developing world, which could be summed up as "it's the economy, stupid." It is not merely for lack of good faith that the West has nearly abandoned this part of the world, despite its immense riches. History has shown this to be an extremely hard place to build lasting, productive enterprises.

Lest anyone assume anything different, I hasten to wish the Chinese and their new Congolese partners well. Africa desperately needs a hundred flowers to bloom.

The hard questions that merit posing, however, just won't go away. They will be proven one way or another. China's mastery of infrastructure is unquestioned, but can there be lasting development in Africa without big strides in political development, and without the emergence of strong civil societies?

What is the good of a university without books, or hospitals without medicines? Africa, sadly, has plenty of experience with this question, and nowhere more so than Congo, where foreigners with a hunger for the country's minerals, dreams of riches and a willingness to turn a blind eye to ugly political realities have visited before.

I think of the Inga Dam, built by the United States in the early part of Mobutu's regime and said to be able to power most of Africa, but now unable to keep even the capital lighted. I think of a towering Information Ministry tower built by the French, where one must walk up countless stairs for lack of a functioning elevator.

I think of V.S. Naipaul, who wrote unforgettably about this same country in "A Bend on the River": "Neither the president who had called it into being nor the foreigners who had made a fortune building it had faith in what they were creating. But had there been greater faith before?"

The Euro and the Damage Done

Put simply, the world economy is out whack. Yes, the dollar should be weak by any measure, but the countries that have borne the brunt of dollar weakness are not necessarily those which are running large current account surpluses with America (or in general). You've got your Asian countries pursuing mercantilist policies like China, India, Thailand that are busy trying to slow down inevitable dollar depreciation against their currencies. You've also got Middle East oil exporters that are making jillions of dollars with oil prices at current levels that still peg their currencies to the dollar. The end result? It's folks who for the most part "play fair" that are taking it on the chin. Case in point: the EU. Especially vulnerable are countries like Italy that compete in export markets with the likes of the Chinese. Let's just say not everyone is Euroland is a happy camper. From the International Herald Tribune:

Fears of an abrupt slowdown in Europe deepened on Friday, after the release of weaker-than-expected economic data and a new record in the euro's relentless rise against the dollar.

Europe's stampeding currency prompted a warning from the plane-maker Airbus that it might have to cut costs more than expected to restore its troubled operations to financial health.

"If the euro remained durably at $1.45, that would mean we have to find €1 billion in additional savings," Fabrice Bregier, the chief operating officer, said in an interview with a French radio station. The euro briefly traded at $1.41 on Friday morning before falling back slightly.

Airbus, which is controlled by France and Germany, is already in the midst of a radical cost-cutting campaign, forced by heavy losses on its A380 jet. Its voice is the latest in a chorus of complaints from French and Italian leaders that the strong euro could choke off European growth.

What concerns economists more, however, is a sharp drop in the monthly survey of purchasing managers in the 13-nation euro zone - evidence that the credit crisis that began in the U.S. mortgage market and infected British and German banks has now seeped into Europe's underlying economy.

An index of purchasing managers in the service sector dropped four points in September, its largest monthly decline ever, suggesting that commerce here is slowing faster than economists predicted.

"It's a bad surprise," said Thomas Mayer, chief European economist at Deutsche Bank. "All this talk of Europe not being really affected by the problems in the U.S. may have been whistling in the wind."

It is far too soon to speak of a recession in Europe, Mayer said. The European Central Bank has put off an increase in interest rates, possibly for the foreseeable future, and injected funds into the banking system to prevent the credit crunch from mutating into a broader financial crisis.

Still, the speed with which the turmoil in the financial markets has registered in the purchasing data alarmed economists. Most are busy scaling back their predictions for growth in Europe next year.

"It certainly got me nervous," said Erik Nielsen, the chief European economist at Goldman Sachs, who had already lowered his forecast for European growth in 2008 to 2 percent from 2.3 percent.

The record-breaking rise of the euro has injected another unpredictable factor into their calculations. Most European exporters have weathered the rally without complaint, having cut costs and hedged their exposure, either financially or by moving production to non-euro countries. But a noisy minority is starting to agitate, and political leaders, notably in France, have picked up their concerns, lobbying the European Central Bank to take steps to stem the appreciation of the euro.

"We hope the ECB, at its meeting in October, will examine the consequences and take appropriate action," the French finance minister, Christine Lagarde, said during a visit to China on Friday.

The ECB rejects such demands as political meddling, and it has responded in increasingly testy fashion to statements made by President Nicolas Sarkozy of France and his ministers.

In a speech in Paris on Friday, one of the bank's executive board members, Lorenzo Bini Smaghi, said, "In no other country do the political authorities make frequent and uncoordinated public statements about the exchange rate." It hurt the credibility of European monetary policy, he said.

Economists say the level of noise in each country is roughly proportional to its exchange-rate vulnerability. German officials, for example, have said relatively little about the recent rally. The exchange rate was not a central issue last week at the Frankfurt auto show, despite the heavy reliance of German carmakers on sales in the United States.

"There's no doubt that by any measure, the Germans are in much better position than the French," Nielsen said. "On unit labor costs, Italy has also done a better job than France."

Still, on Thursday, the Italian industrialist Luca Cordero di Montezemolo said, "The super euro worries us; we don't want to give anyone any lessons, but this could become a problem for exports."

Airbus is particularly vulnerable because it earns all its revenues in dollars and incurs about half of its operating costs in euros. That puts it at a big disadvantage to its U.S. rival Boeing.

Under its existing plan, Airbus plans to cut €2 billion, or $2.8 billion, a year in costs by 2010, through the sale of several factories and the elimination of 10,000 jobs. In his radio interview, Bregier said the cost-cutting plan was predicated on a euro exchange rate of $1.35.

Airbus has hedged enough of its dollar exposure through the end of 2008 that the dollar's swoon is not likely to have a major short-term impact, Rainer Ohler, the head of communications said.

"Our problem is what's going to happen in 2009 and 2010," Ohler said. "But nobody can predict what the dollar is going to do."

U.S. Treasury Secretary Henry Paulson said Friday that a strong U.S. dollar was in American interests [that's a good one, Paulson!], and that he was optimistic the U.S. economy would continue to grow this year, Reuters reported from Chelsea, Quebec.

"I feel very strongly that a strong dollar is in our nation's interest," Paulson said after a meeting with Finance Minister Jim Flaherty of Canada.

How NOT to Defend Globalization II

In this op-ed, the libertarian-leaning Reason magazine provides yet another example of how not to defend globalization in the form of trade and migration. Elided from this kind of analysis is that US wages have been stagnant since the start of the new millennium and its possible relationship with globalization. Instead of addressing often legitimate concerns about the potential pitfalls of globalization, what we have here is boilerplate Ayn Randian fare: (1) Politicians are dangerous panderers who don't know what they're doing and (2) the average person isn't smart enough to appreciate the wonders of globalization. Unfortunately, such divisive tracts do little to promote an open agenda. Preaching to the converted it is:

Bernie Sanders, the independent senator from Vermont, is the only self-proclaimed socialist in Congress. Lou Dobbs is a close-the-borders CNN host who donated $1,000 to George W. Bush’s first presidential campaign. But when they met on Dobbs’ show on June 21 to discuss the Senate immigration bill, the two aging bulls were harmonizing like the Pet Sounds–era Beach Boys.

“Is there any sense amongst your colleagues in the Senate,” Dobbs rumbled, “that it is time for people to begin to represent their constituents rather than these special interests, corporate interests?”

“You’ve got it,” said Sanders. “Their whole ideology is based on greed. They’re selling out American workers and, in fact, they’re selling out our entire country.”

It was “blatant,” Dobbs added, that both parties “are owned lock, stock, and barrel by corporate America and special interests included in the amnesty legislation.”

Clichés and all, this was a fairly ordinary political conversation in the summer of 2007. Nor was the convergence new. In 1993 conservatives such as Pat Buchanan and leftists such as Jeremy Rifkin stood shoulder to shoulder against the North American Free Trade Agreement (NAFTA), bemoaning the pending death of American manufacturing.

Fourteen years later, Dobbs and Sanders needn’t be so gloomy. Things are looking up for protectionists left and right. On June 28, the Senate anesthetized an immigration reform bill over concerns that it might grant “amnesty” to illegal immigrants already living and working in the United States. A day later, the House of Representatives let the clock run out on fast track, the presidential power to cut trade deals without congressional amendments.

And the leading candidates for president are saying amen. Take Sen. Hillary Clinton (D-N.Y.), the Democratic front-runner. When her husband was in the White House he lobbied hard for fast track and for NAFTA. In 2002 Sen. Clinton voted against fast track authority for her husband’s successor. In 2006 she voted against the Central American Free Trade Agreement, a pact with far fewer consequences than NAFTA.

Despite all this, she had to fend off charges that she is not protectionist enough. In June a not-for-attribution memo from the campaign of rival presidential candidate Sen. Barack Obama (D-Ill.) accused Clinton of courting Indian-American voters too closely and of imperiling American jobs by supporting companies that outsource to Bangalore and beyond. The memo referred to her as “Hillary Clinton (D-Punjab),” playing off her investment in an Indian electronic billing services company. Clinton’s campaign forced Obama to apologize for impugning her and for mocking Indian Americans—and then the two co-sponsored a bill punishing nations such as China for undervaluing their currency.

When you consider what NAFTA actually wrought—and you don’t count Bernie Sanders’ angina—this is all a bit mysterious. Americans are wealthier than they were 14 years ago and, with unemployment under 5 percent, are more likely to have jobs. (In the decade before NAFTA, unemployment averaged more than 7 percent.) More Americans own their own homes. Fewer Americans are going to bed hungry—dramatically so, if you scan the data on obesity [this is exceedingly silly and off-topic to boot].

“It’s not as if we’re on the ropes,” says former congressman Tim Penny, a Minnesota Democrat who retired after the NAFTA fight. “We have economic uncertainty but only in certain sectors. Overall unemployment is low; the economy is growing.”

The GOP’s front-runners aren’t adopting the trade demagoguery. Their speechwriters are too busy with immigration demagoguery. Eleven years ago the party rejected Pat Buchanan’s presidential bid and his proposed wall along the Mexican border. Not this year. No GOP candidate opposes a border wall. Former Massachusetts Gov. Mitt Romney and former New York City Mayor Rudy Giuliani, immigration enthusiasts in their previous political lives, spent June blasting the Senate’s immigration bill—not because of the restrictions it put on freedom of movement but because they objected to possible citizenship or special worker status for illegal immigrants.

To former Rep. Jim Kolbe (R-Ariz.), Republicans who pander to those voters are economically incoherent. (And political hemophiliacs too: The GOP lost the retiring Kolbe’s Republican-leaning seat in 2006 when it nominated a border hawk who thought Kolbe had been too soft on the issue.) “I don’t know many people who are ardent free traders and who want a wall built,” Kolbe says. “If you’re talking about the movement of goods, how can you not talk about movement of labor? How can you not talk about the movement of people? It’s absolutely absurd.”

It’s especially absurd when you look at the actual data. According to a 2005 study by the University of Bologna’s Gianmarco Ottaviano and the University of California at Davis’ Giovanni Peri, the surge of illegal laborers between 1990 and 2000 raised native-born wages overall but lowered the wages of Americans without high school diplomas by about 1 percent. These workers account for only 8 percent of the labor market, and their numbers are shrinking. In 2006 and 2007, tighter border controls managed to drive down the number of illegal workers picking crops in the Southwest. Americans didn’t flood the fields to do those jobs; the jobs went unfilled.

The immigration bill was badly wounded by intense, angry constituent calls to the Senate—so intense that the switchboard had to be shut down. But it’s unfair to blame rank-and-file voters for the backlash. That anger was ginned up by the party itself, which had built up immigration as a national security issue for the 2006 elections. One TV commercial run by the National Republican Senatorial Committee in Rhode Island attacked Cranston Mayor Steve Laffey (not even a Democrat, but a Republican primary challenger) for “accept[ing] Mexican ID cards that threaten our national security.” If voters nominated Laffey, the ad warned, he would “put our national security at risk in the Senate!”

Democrats can sound just as hyperbolic talking about the economy. After the short recession of 2001–02, the economy has been largely robust and unemployment has dipped everywhere but in communities that have lost manufacturing jobs. The loss of jobs is stark in the Rust Belt cities in Michigan, Ohio, and Pennsylvania; most of the rest of the country is undergoing a boom.

Interestingly, while polls showed a healthy chunk—in some surveys, a majority—of those Democrats opposed to the immigration bill, most elected Democrats supported it. Their party doesn’t pander when it comes to the labor market on the border. It panders on every other labor market.

The problem, Tim Penny theorizes, is that Democrats don’t want to take a political risk. They don’t want to explain why the economy could be growing without some of their loyal voters seeing marked local improvements. “Instead of acknowledging we’ve got challenges on worker training,” Penny says, “or that free trade is basically good but we can drive harder on workers’ concerns, we fall into the easy rhetoric of bashing trade: ‘Trade is bad, trade is bad, trade is costing us jobs.’ That’s not thoughtful. That is knee-jerk.”

That says it for both parties’ protectionist impulses. Voters have almost always harbored anxieties about the Other outside our shores, hungrily eyeing our jobs and snapping up our paychecks. NAFTA passed only narrowly; piecemeal tough-on-China bills never have trouble becoming law. It’s easier to demagogue these issues than to confront the economic and cultural dislocations in a post-industrial America.

The Democrats mounted their comeback in 2006 with no vision for entitlement reform or tax reform that could pay for, say, universal health care. Republicans are convinced that they can move on from national security and terrorism mistakes by focusing on an issue that has always sparked anxieties. Our elected representatives are turning away from open borders and open markets not because openness has failed but because the politicians have.

Daschle Bashed on Corn as Biofuel

Former US Senate Majority Leader Tom Daschle (D-South Dakota) recently wrote an article in Foreign Affairs favoring the use of (subsidized) corn as a biofuel with few downsides. In particular, he responded to a previous article by University of Minnesota professors Ford Runge and Benjamin Senauer critical of using corn as a biofuel, especially its potential to raise food prices for the poor. (Already, the FAO suggests this is happening.) In this most recent feature, Runge and Senauer reply to Daschle. For me, their comments are right on the money, though do re-read the original Runge / Senauer article as well to get a handle on the substantive points:

Senator Tom Daschle's comments reflect his longtime commitment to promoting corn-based ethanol as a member of Congress and now as a lobbyist for the ethanol industry. Whatever our differences with him over biofuels, they are not about politics; we supported his last race for senator from South Dakota. Nor are our differences due to a lack of familiarity with agriculture. We have spent careers in Minnesota analyzing agricultural trade and its impact on the environment and on markets for food. Finally, we agree with Daschle that corn-based ethanol will be at best a partial solution to our current energy needs.

But we disagree with Daschle on four of his points: that U.S. corn is fed mostly to animals with few implications for people, that the conversion of corn into biofuel is an efficient way to reduce the United States' dependence on foreign oil, that higher grain prices will help farmers in food-deficit nations, and that the current corn-based ethanol industry will be a platform for the next generation of biofuels, which will be made from cellulose and waste materials.

First, we, too, know that meat-producing animals eat more than half of the U.S. corn crop. But people do eat chicken, eggs, pork, steak; drink milk; and consume foods containing cornmeal, corn oil, and corn sweeteners. U.S. consumers spend over 20 percent of their food budgets on meat, eggs, and dairy. And the share of the corn crop used to produce ethanol will rise from less than ten percent in 2004 to an expected 20-25 percent of the crop next year. As more acres are devoted to corn, fewer acres are available for other types of dairy feed, such as alfalfa, or for table vegetables, such as green beans. As a result, milk and vegetable prices are rising. And as acres are bid away from soybeans and turned over to corn, the price of soybean-based feed is also increasing, adding to the pressure on meat prices. In March 2007, the U.S. Department of Agriculture forecast that demand for ethanol would push the prices of poultry, pork, and beef higher. The Wells Fargo economist Michael Swanson noted in June 2007 that the rising costs of corn and soybean feed also "have a direct and significant impact" on "oils, cereals and bakery products." Corn-based ethanol, Swanson concluded, "is indeed responsible for the increased rate of food inflation" (even though it is not its sole cause).

Second, even if every single one of the roughly 90 million acres in the United States devoted to growing corn goes into ethanol -- leaving none for feed, exports, or other uses -- corn-based ethanol would meet only 12-15 percent of the country's transportation fuel needs. Hence, ethanol's contribution to reducing U.S. dependence on foreign petroleum today is marginal at best.

Third, higher grain prices are translating into an increase in the prices of staple foods around the world. For some, this effect could be another way beside trade liberalization to raise the incomes of poor farmers. But the ethanol boom's distorting effects on commodity prices are hardly a substitute for expanded market opportunities for farmers in food-deficit nations. By definition, a food-deficit nation buys more food than it sells and hence is negatively affected by price increases. Most of the three billion people living on less than $2 a day are subsistence farmers with little or no surplus to sell or urban slum dwellers who consume but do not produce food. As consumers, they lose. Higher prices may induce more grain production abroad, but unless wealthy nations agree to import this grain by granting expanded market access to poor producer nations, it will be of no help to them. Finally, as the need for corn for ethanol production cuts more and more into U.S. corn exports, the United States is increasingly trading an export in which it has a tremendous comparative advantage (corn) for a product in which it has a comparative disadvantage (ethanol), especially vis-à-vis Brazil. This disadvantage is precisely the reason the United States has a 54-cent-a-gallon ethanol import tariff.

Fourth, Daschle's argument that corn-based ethanol will be a platform for cellulose- and waste-based fuels is undercut by three observations. For one thing, although cellulose from switchgrass holds promise, who will plant it while the price of corn is above $3.50 or more a bushel, as it is now? U.S. corn growers and the ethanol industry did not spend 30 years paying the campaign bills of members of Congress such as Senators Daschle and Bob Dole (both of whom now lobby for ethanol at the same firm) in order to give away the store to grass producers. If, moreover, the rapid technological development of cellulosic alternatives is to be promoted without "me too" subsidies matching those given to the corn-based ethanol industry, then the incentives currently favoring corn-based ethanol (such as tax credits, import tariffs, and production mandates) should be lowered. Giving huge grants to noncompetitive biomass production, rather than investing in basic research and development for conservation and renewable sources of energy, only pays down the cost of the inefficiency of that biomass.

On August 9, 2006, Senator Daschle noted in a speech before the American Coalition for Ethanol that advocates of corn-based ethanol "have always been acting more in the national interest than in self-interest." In truth, the ethanol industry is a textbook example of how agriculture and industry combine to influence Congress into transferring taxpayer and consumer dollars to wealthy and influential special interests.

EU Tries to Limit Gazprom's Clout

The EU is aiming to limit the powers of the Russian energy giant Gazprom from making further inroads into the EU energy infrastructure by creating ownership and reciprocal obligation requirements. There are good reasons for it trying to do so as a quarter of European supply already bears the name "Gazprom." Moreover, Vladimir Putin has made no effort to conceal Russia's intentions to use energy as a geopolitical tool. Already there's increased EU talk about separating energy production and distribution to prevent monopolies (i.e., Gazprom) in reference to the recent EU decision to fine Microsoft over its bundling of media software with its operating system.

My take is that the EU will not be able to free itself much from the tightening energy grip of Russia until it finds alternative energy sources. It's simple, really: you can fool around with Microsoft, but it's not so simple to do to your most important energy provider who can cut off supply at a moment's notice as it has already done to numerous former Soviet satellites. "Don't bite the hand that feeds the energy supplies." From the International Herald Tribune:

After years of Russia's using energy as a political weapon, the European Union sought to turn the tables Wednesday with a proposal to prevent the state-owned Russian monopoly Gazprom from taking over power networks in Europe.

Under plans submitted by the European Commission, non-EU companies would be barred from owning a majority stake in gas pipelines or electricity power grids unless their home country signs a reciprocal agreement with the EU. Such an agreement would have to give European companies access to the home market as well.

The proposal was contained in a package of measures designed to liberalize the European energy market, underlining European concern that Russia's state-owned, monopoly gas exporter would buy up energy assets across the continent. It also marks a new phase in the EU's efforts to apply pressure on Russia to open its pipeline infrastructure to European importers.

"We must not be naïve," said José Manuel Barroso, the European Commission president, denying that the EU was being protectionist.

"Fair competition is different from protectionism," he said. "We need to protect the internal market from noncompetitive behavior coming from elsewhere."

Several EU countries, however, want to water down the package because it would also force European energy giants involved in the power supply to hive off their transmission networks into separate companies. By contrast, the measures directed against companies like Gazprom are likely to be less contentious.

Barroso argued that if the EU liberalized its own internal market, it would be vital that non-European nations played by the same rules.

He won some backing from Fulvio Conti, the chief executive of the giant Italian utility Enel.

"When it comes to gas, I think it's appropriate that Europe takes some symmetrical approach and asks for reciprocity as a measure of deterrence," Conti said in London during an energy conference.

"We are speaking about a few large organizations that can supply gas to us, while we are here in Europe an umpteen number of operators trying to get this gas," Conti said. "You have to balance that to some extent.

"Europe can instruct us to unbundle things, but they will have to put some more political pressure on having a common voice when it comes to relationships with oil and gas producing countries," he said.

In a statement, Gazprom said it wanted to consult with the EU before giving its evaluation of the effect on "security of supply, the competitiveness of European energy markets and, finally, the energy prices in Europe."

"Gazprom is a reliable gas supplier to the European Union and a major investor in the infrastructure which brings gas to Europe," said Sergei Kupriyanov, spokesman for Gazprom. "We share the EU's core goal of ensuring long-term security of energy supply to the EU."

However some experts believe that the proposals need not have a large impact on Gazprom because it could buy into European utilities without taking a controlling stake.

"Classically Gazprom has acted in joint venture operations," said Simon Blakey, senior director for European research for Cambridge Energy Research Associates, or CERA. "When it comes to storage or transmission pipes this has been its usual modus operandi."

The impact of the proposals on the EU's tense relationship with Russia was also unclear.

"There is a huge amount at stake for both Russia and the EU in terms of the gas relationship and they are going different directions," said Daniel Yergin, chairman of CERA and author of an acclaimed history of the oil industry. "For 40 years this has been a stable relationship. The question is whether a crisis of confidence need lead to a crisis of supply."

Barroso said that Europe's 50 percent dependence on energy imports was set to rise to 65 percent by 2030. Gazprom supplies around one quarter of the gas used by Europe today.

The accession of former Soviet bloc countries to the EU has increased pressure for a tough line with Moscow, particularly following price disputes between Moscow and Ukraine, as well as with Belarus, which ended up disrupting supplies to European countries.

Jacek Saryusz-Wolski, a Polish center-right member of the European Parliament and chairman of its Foreign Affairs Committee, called on the EU to be "as consistent with Gazprom as we are with Microsoft."

There was, he added, "a double standard."

The European Commission has been fighting Microsoft for years since finding in 2004 that the U.S. software giant had abused its dominant position in desktop operating systems.

The proposals for "unbundling" power generation and transmission follow a study last year into the European energy market, which said the market blocked new entrants and provided insufficient competition.

Neelie Kroes, the EU competition commissioner, said that liberalization would reduce prices and that the continent's energy giants needed to remember that the "consumer is king."

Under the European Commission's proposals, large utilities involved in power generation and supply would be able to retain the ownership of transmission networks providing these are leased to a separate company under different management. Such arrangements would be policed by a new and tougher regulatory regime.

But this concession was insufficient for the continent's big power groups.

"Separating networks doesn't increase competition, doesn't lead to higher investment in networks and doesn't lead to lower prices," Christian Drepper, a spokesman for E.ON, said in a statement.

The proposals will go to the European Parliament and to the EU member states, where they face a tough slog.

Finance Minister Christine Lagarde of France said that Paris "will do everything we can with other opponents to oppose any unbundling." The package received a skeptical reception in Berlin as well.

Middle East buys up Western Finance

Two stories are out today in the Wall Street Journal (our favorite Murdoch publication) on how cash-laden Middle East countries are splurging on the Western financial infrastructure. First up is the emerging bidding war for the Nordic stock market operator OMX. The storyline is rather convoluted as it too involves taking out a share in the NASDAQ. As you would expect, the proposed deal is raising a protectionist ire (again) back in the States. In any case, these noteworthy developments showcase how the global political economy seems to be shifting its weight towards the Middle East as well as demonstrating the considerable financial clout of governments in that region. I will reiterate my idea here that developing states appear to be retaking the commanding heights in the perennial states-markets debate. Ultimately, financial access to the now-lucrative Middle East is at stake. Think petrodollar$, lots of 'em...

Nasdaq Stock Market Inc. and Borse Dubai on Thursday agreed to a three-way deal for OMX AB, that involves Borse Dubai taking a 19.9% stake in Nasdaq and buying a 28% stake from Nasdaq in London Stock Exchange Group PLC.

Shortly after the announcement, the Qatar Investment Authority, a rival bidder for LSE, said it had bought a 20% stake in the U.K. stock-market operator. The fund also said that it was evaluating options for OMX, amid traders' talk that it was actively buying up the Nordic market-operator's shares. The moves threaten an all-out bidding war between two rival Middle Eastern state-backed companies as they battle for access to Europe's financial infrastructure.

Nasdaq, under the agreements, said it will acquire all OMX shares through a two-step deal, in which Borse Dubai will purchase OMX through its existing offer of 230 Swedish kronor ($34.68) a share in cash. Borse Dubai will then sell OMX to Nasdaq for 11.4 billion Swedish kronor ($1.7 billion) and a 19.9% stake in Nasdaq, valuing Nasdaq shares at $41.01 a share. Borse Dubai will also take a 28% stake in LSE, paying £14.14 ($28.30) a share for the LSE stake and leaving Nasdaq with about 3% of LSE.

Terms of the Qatar/LSE deal were not disclosed. Saying it intended to be a long-term shareholder, the Qatar Investment Authority said it "sees itself as a shareholder that will provide stability and support for the board's strategy of developing further its business and thereby reinforce the City of London's position as the world's top global capital market." It ruled out a takeover bid for the time being, but said it reserved the right to change that position if someone else announces an intention to bid.

The London Stock Exchange, which declined to comment earlier Thursday about the Dubai deal, welcomed the Qatar investment. It said it had a long-standing relationship with the Qatari investors based on plans to develop the market in Qatar.

Meanwhile, Nasdaq will become a strategic shareholder and the principal commercial partner of Dubai International Financial Exchange, or DIFX. Borse Dubai is the holding company for DIFX and Dubai Financial Market. DIFX will be rebranded with the Nasdaq brand and licensed with market-leading technology from the Nasdaq/OMX combination.

"This is a unique situation that is a pure win" for OMX, Nasdaq and Borse Dubai, said Chief Executive Robert Greifeld on a conference call. "We'll be better able to serve our customers" across the world, he added.

The deal would make Dubai, part of the United Arab Emirates, the first Mideast government to hold a significant stake in a U.S.-based stock-market operator. Borse Dubai would get two of the 16 board seats for the combined Nasdaq/OMX, and its voting power as a shareholder would be limited to 5%. Finalization of a deal isn't guaranteed given the risk of pushback in Washington over giving a Middle Eastern country some influence over the second-largest U.S. stock market. The transaction was being monitored Wednesday on Capitol Hill. "This deal will raise serious questions that will need to be answered," Sen. Charles Schumer (D., N.Y.) said in a statement...

Dubai nosed out rival Gulf state Qatar for the stake in the LSE, underscoring a budding rivalry for dominance in the fast-growing world of Middle Eastern finance. Both nations have grown wealthy behind soaring energy prices, but Dubai could offer Nasdaq more because of the exchanges' mutual interest in OMX. For Qatar, losing the LSE stake represents a sharp disappointment in one of its first major forays into the deal making over global exchanges, and analysts this morning speculated about whether Qatar would start buying up LSE shares or make some kind of move to counter Dubai's latest announcement before the Qatar's announcement later in the day.

Qatar is determined to not let Dubai pull too far ahead of itself in the race to build a global financial center in the Middle East, a person familiar with the matter said. The fund also put out a statement today urging OMX shareholders to take no action with respect of Nasdaq and Borse Dubai's intentions for OMX. "The Qatar Investment Authority is currently evaluating the situation with regards to the OMX," the statement said, pushing OMX's shares higher as investors are seeing a potential bidding war. Shares had initially dropped early Thursday after news of the deal. Midday in Stockholm, they were up 4.2% at 250 kronors.

Nasdaq and Borse Dubai have been locked in a six-week bidding war for control of OMX. Borse Dubai recently built a 5% stake in OMX, with options to increase that stake to as much as 24%. Nasdaq in May agreed to buy OMX, but Borse Dubai came in with a higher bid this summer, giving it leverage in doing a deal with Nasdaq.

The three-way deal will create an exchange group with business that stretches through three regions: the U.S., Europe and the Middle East. Western exchanges are keen to expand their business in the Middle East, where capital markets are developing fast amid high oil prices and changes in corporate governance and regulation.

Dubai's earlier plans to buy OMX will require government approvals to move forward. For Dubai, purchasing the LSE stake and teaming up with Nasdaq on OMX could reflect concern that it couldn't gain approval to buy the entire OMX. A person familiar with the matter said that Dubai was less certain after a recent meeting with Swedish authorities.

Borse Dubai and its predecessors -- the exchange is the result of a merger of two stock markets in Dubai -- have wanted to become a larger player in international finance and have looked at various exchanges in Europe in recent years. In looking at Nasdaq's LSE stake, Borse Dubai had an advantage over Qatar because of Dubai's position in OMX, which Nasdaq wants to buy to expand its international business.

It is unclear whether Dubai has any interest in becoming an active shareholder in LSE, but according to people familiar with the matter, some at the London exchange had preferred the stake to be sold to Qatar instead of Dubai because Qatar had shown fewer ambitions to own an entire exchange. Dubai's stake would shrink to about 20% once LSE completed its own planned merger with Milan exchange operator Borsa Italiana SpA.

Becoming more global was partly how Dubai was selling itself to OMX: join with Dubai and gain access to one of the fastest-growing regions in the world. In particular, Dubai was keen to gets its hands on OMX because it supplied the technology to many of the Middle East's exchanges, making it easier to consolidate in the region.

Stock exchanges in the U.S. and Europe have been consolidating rapidly, after transforming themselves into public companies in recent years from clubby memberships owned by trading and brokerage firms. In the past two years, bidding wars and hostile approaches have characterized a sector where there are a scarce number of prestigious targets.

LSE is one of the most alluring of those targets, sought after by rivals on several continents, but it has fended off several suitors, arguing their bids undervalued it. Nasdaq, led by Mr. Greifeld, built a stake in LSE of about 31% while pursuing its own unsuccessful plan to buy the entire LSE earlier this year.

Since Nasdaq is selling its stake in LSE, the London exchange doesn't have the ultimate say over who buys it. Nasdaq could have used the cash from its LSE sale to improve its bid for OMX, which operates several exchanges and provides technology to dozens more. But instead, Nasdaq pursued a more inclusive approach, possibly giving Mr. Greifeld his first major international merger.

In recent years, other large exchanges from the Chicago Mercantile Exchange to the New York Stock Exchange to Frankfurt's Deutsche Börse completed big deals or international deals to transform their businesses.

Second, the investment authority of Abu Dhabi, Mubadala, is taking a non-voting stake in the storied private-equity firm the Carlyle Group. (As an aside if you're a Formula One fan, Ferrari race car drivers Felipe Massa and Kimi Raikonnen wear Mubadala caps in their post-race interviews if they finish on the podium). On to the second story:

The Carlyle Group is selling a 7.5% stake in its management company to an investment arm of the government of Abu Dhabi for $1.35 billion. The deal represents a 10% discount to a $20 billion valuation on the big, Washington-based private-equity firm.

The sale gives Mubadala, the strategic-investment arm of the small but wealthy Persian Gulf state, no voting rights. But the deal will give Mubadala downside protection. In other words, if -- or more likely when -- Carlyle follows its peer Blackstone Group to the public market, Mubadala will be compensated if the valuation is at a lower level than Thursday's today's price. Mubadala will also invest $500 million in Carlyle's latest flagship buyout fund.

Private-equity firms like to sell stakes ahead of public listings as a way to put a floor under their share price. That logic led the Blackstone Group to sell under 10% of itself to an arm of the Chinese government ahead of its initial offer -- a sale which valued Blackstone at about $30 billion. But the investment was heavily criticized in China as Blackstone's share price dropped steadily through the summer. That led other private-equity firms to seek alternative sources of capital.

Earlier this summer, Apollo Management sold a small stake in itself to the Abu Dhabi Investment Authority which has a mandate from the government to make non-strategic investments, in contrast to Mubadala. ADIA has almost $1 trillion under management. That deal was cut ahead of Apollo's listing on a Goldman Sachs Group trading platform.

The deal Carlyle has struck is the latest example of the huge investment clout of the Persian Gulf emirates. While Dubai is the best known, it also has the smallest coffers. Abu Dhabi is far wealthier but keeps a much lower profile.

Recently the government established the Abu Dhabi Investment Co. to help manage the flood of money that comes in with oil prices at current high levels. Mubadala has stakes in many infrastructure and energy firms such as Dolphin Energy and in some well known brands such as car company Ferarri.

The deal comes as good news to CalPERs, he California public pension fund. In 2000, CalPERs took a 5.5% stake in Carlyle for $175 million, giving it a healthy profit on its position.

Carlyle, which has $76 billion under management, has had the deepest relationships of any of the private-equity firms in the Middle East. Speaking at a Dow Jones conference in New York on Tuesday, Carlyle co-founder David Rubenstein said it was inevitable that in a few years all the major private-equity firms would go public. Carlyle has long toyed with the idea but this summer's turmoil in the market for financing buyouts has led it to put those plans on hold.

So, Where's the Decoupling?

Economic pundits were nearly unanimous in predicting a slowdown in the US this year. However, many also believed that the rest of the world would be able to "decouple" from America and continue on the impressive global growth trend of recent years. Perhaps it was due to vested interests, but many of the Wall Street firms sold this decoupling story. The IMF, on the other hand, was a tad warier of it. Anyway, Michael Sesit argues here that there has been no such thing as decoupling; the EU and Japan have had their growth slowed down as the US has hit a speed bump. It would have been better though if he talked more about decoupling outside of the G7 as perhaps the intra-G7 correlation is higher than outside of it:

Decoupling - the notion that the rest of the world can weather the effects of a slowing U.S. economy - had all the attributes of a successful advertising campaign. The message was simple, clear and succinct.

One problem: It doesn't fly, or at least not yet. It might even be argued that the powerful forces of globalization make decoupling impossible.

"Global growth will decouple from U.S. growth to a greater extent than in the past," Jim O'Neill, head of economic research at Goldman Sachs, said in a September 2006 report. The United States is now a less important destination for world exports, the report said.

"Domestic demand is on solid footing in Europe, Japan and key emerging markets," it said. "The underlying shock driving the U.S. slowdown is not global in nature but is linked to a slowing U.S. housing market."

Last year, Merrill Lynch said, "A sharp slowdown in the U.S. economy in 2007 is unlikely to drag the rest of the global economy down with it." It added, "The good news is that there are strong sources of growth outside the U.S. that should prove resilient to a consumer-led U.S. slowdown."

The firm dismissed the potential fallout from a U.S. housing downturn. "The world doesn't build U.S. houses," it said.

Both Goldman Sachs and Merrill Lynch were bullish on Japan. "Global star," Merrill called it. As for the 13-nation euro area, Merrill said, "The region has a good chance of avoiding the worst effects of a U.S. slowdown."

Now for the reality check.

Japan's gross domestic product contracted at an annualized 1.2 percent rate in the second quarter, down from 3 percent growth in the first quarter and 5.6 percent in the fourth quarter of 2006.

Euro zone GDP growth was a weak 0.3 percent in the second quarter, down from an average of 0.8 percent for each of the preceding two quarters and the lowest level since the last three months of 2004.

Central bankers have been no more accurate forecasters than their private-sector brethren.

"Strong money supply, driven by buoyant credit demand, adds to concerns that consumer-price increases in the euro area will stay on average significantly above 2 percent in coming years," the Bundesbank said in its monthly bulletin, which was completed at 11 a.m. on Aug. 17.

That was after central banks had pumped $350 billion of emergency funding into global money markets and just hours before the U.S. Federal Reserve cut its discount rate.

For months, the return of inflation and the need for central banks to resist it with higher rates were a concern. The real risk, though, is deflation, compliments of the U.S. subprime mortgage mess and tightening credit standards.

"Amid all the fear generated by the U.S. subprime meltdown, one key argument against the 'sky-is-falling' camp rested with the assumption that while the U.S. economy may be vulnerable to a credit shock, the rest of the world was doing just fine," said Joseph Quinlan, chief market strategist at Bank of America Capital Management.

Well, this month, concerns that the market turmoil may spread persuaded central banks in Europe, Britain, Australia, Canada and South Korea to hold off raising rates.

Not all decoupling advocates are giving up. Asian countries' dependence on the U.S. consumer has declined "dramatically" since the technology bubble burst, said Silvia Liu, an economist in Hong Kong with Merrill Lynch. Exports of consumer goods to the United States declined to 6 percent of total Asian exports in 2006 from 8 percent in 2001, she said.

Goldman Sachs economists reiterated their confidence in decoupling in a report last Wednesday, adding that the so-called BRIC countries - Brazil, Russia, India and China - remain "key to global decoupling."

The day will come when the rest of the world can escape the pull of the $13.3 trillion U.S. economy, especially when the BRIC economies mature.

For the time being, though, it's too soon to count the Americans out.

Chinese Fashion Show Marks Textile Quota's End

No, no, the IPE Zone hasn't turned fashionista all of a sudden. Rather, the Chinese are counting down till year end when EU quotas on Chinese textiles will be phased out. They've done so in style by mounting a Paris fashion show. Of all the wacky things I've come across today, this article from Agence France Presse er, "walks the catwalk." The models at the fashion show included Miss China 2003 and 2006 and the Borat-inspired bloke labeled the country's "most handsome man several years running ." (I am not making this stuff up. There is little need for drugs when you've got an Internet connection.)

On a serious note, however, temporary safeguards (i.e., quotas) were imposed by the EU on China as allowed by the WTO when the Multi-Fibre Agreement governing international textile quotas expired at the end of 2004 and resulted in a tsunami of Chinese textiles flooding the EU market. If you will recall, the subsequent brouhaha was labeled the "bra wars." However, the damage limitation deal covered only two years, 2005-07. After that it's back to unrestricted textile warfare. What may be scaring the European fashion industry is China's intention to move upmarket as demonstrated by the fashion show, replete with industry-leading fabric technologies. Can the Chinese crack the high-end market like it now dominates the mass market? I, for one, wouldn't rule the possibility out. Giorgio baby, we hardly knew ye:

With textile quotas about to expire, dozens of Chinese fashion firms are strutting their stuff jointly for the first time on Paris catwalks this week as Beijing attacks the high-end European market.

Making a debut appearance in the world's fashion capital, 82 clothes-makers from China descended on Paris for a four-day stint at a top trade fair, bringing their top models, including Miss Chinas 2003 and 2006, as well as the country's "most handsome man several years running", Zhang Xinghe.

From titillating G-string underwear to body-hugging evening gowns and trendy urban gear, 11 up-market labels paraded the catwalk at the Texworld fabrics trade fair while dozens more showed cashmeres, fine silks and sports-wear to 18,000 visiting buyers, some from France, the majority from across the continent.

"We must get to know each other better and reduce trade frictions," said Du Yu Zhou, the onetime national textile supremo who now heads the China National Textile and Apparel Council (CNTAC)."

Last October, China's Jefen fashion brand opened the march at the Paris women's ready-to-wear shows with a teen line of micro-bloomers and baby-doll dresses.

Speaking to reporters this week, Du said the country's fashion industry was putting the accent on producing high-end fashion apparel -- not the cheap-labour mass-produced gear generally associated with made-in-China goods.

"We are going up-market, seeking not quantity but quality and innovation," he said. "We are looking at technological progress and creating labels. This will help encourage our companies to export."

The European Union, whose quotas on Chinese textiles are finally to be dismantled at the end of the year, soaks up 15 percent of China's textile exports. The country's 20 million textile workers produce 400 billion euros turnover annually, a quarter for the export market.

"Textiles are of huge importance for our economy and for our export sector," Du said.

Star attraction at the fair, held on the eve of the Paris ready-to-wear shows, was what the Chinese call "Soft Gold" -- or cashmere.

"Our cashmere is the best in the world," proudly proclaimed Hei Liangjie, head of trade in the remote northern region of Ningxia bordering Mongolia, near the Gobi desert, whose six million people are mostly Muslim.

When cashmere prices rose steeply in the 1980s the region leapt in to consolidate its own raw material with raw cashmere purchased in Afghanistan, Pakistan, Iran and Mongolia, buying and selling at first before then realising huge profits were to be made by also processing and producing cashmere goods.

Over time it has become the top producer of cashmere products in China, which itself accounts for 70 percent of global production. Of the 20 million cashmere garments produced in Ningxia this year, 10 million were exported. One firm alone, Lingwu St Edenweiss, raises 350,000 goats a year.

"We are trying to develop our own labels aimed at the top-end market," Hei said. "The European market will be our biggest in the future."

Like cashmere, many of the Western-style brands paraded on the catwalk this week boast plus-size sales and production statistics.

Meters/bonwe, a late teens urban brand sporting skinny-jeans and leather jackets, has 1,800 speciality stores in China. Smart Garments, which paraded evening furs and glittery get-up, produces more than a million pieces a year.

White Collar's smart evening wear reportedly receives 5,000 customers a day, and a flowing designer brand based on oriental trends called Exception de Mixmind has 60 outlets across China.

No wonder that the EU opted to extend textile quotas in 2005 -- exports of some items of Chinese clothing surged more than 500 percent when international quotas expired on January 1, 2005.

"The levels of China textile exports following that liberalisation were so great that EU companies did not have reasonable expectations of adjusting, hence the extension," a European Commission spokesman said.

"They will expire at the end of this year and they will not be replaced. We don't have the legal basis to replace them. The temporary extension was possible because when China entered the WTO in 2001 there was a clause in its agreement which enabled people to unilaterally re-impose quotas up until 2008.

"In the end we didn't do it unilaterally, we negotiated it with China.

"But... I don't imagine the Chinese are interested in renegotiating quotas and we are about to lose the main basis for unilaterally imposing quotas," he said.

China Uses Price Freeze vs. Inflation

Here is something interesting: The Chinese government is retaking the commanding heights of the Chinese economy as it imposes a price freeze on items still within government diktat in an attempt to control rising inflation. The country has been subject to occasional riots in recent times, especially over higher food prices. Returning to Economics 101, I doubt whether artificially imposed price controls will spur the supply of necessary commodities at lower prices. Instead, China may very well get Venezuela-style shortages instead of being able to appease the increasingly anxious proletariat as suppliers become unwilling to sell at government-set levels. It all goes back to China needing to undergo rebalancing. By keeping the yuan artificially weak all these years, China has depressed the purchasing power of its citizens. How long can this system continue? From the Financial Times:

China has begun to enforce a freeze on all government-controlled prices in a sign of the central government’s alarm about rising popular anger over inflation, now at the highest rate in over a decade.

The order freezes a vast array of prices still under the control of governments in China, ranging from oil, electricity and water, to the cost of parking and park entrance fees.

The implementation order, issued jointly by six ministries, follows the issuance of a more vaguely-worded announcement on the need to prevent price rises late last month by the State Council, or cabinet.

“Any unauthorised price rises are strictly forbidden...and in principle, there will be no new price-raising measures this year,” the ministries’ announcement said.

The news since the initial State Council announcement that inflation in August hit an 11-year high of 6.5 per cent appears to have galvanised the bureaucracy into a tougher stance.

“As inflation has gotten worse, the government may feel it had to toughen its stand,” said Qing Wang, of Morgan Stanley in Hong Kong.

Rising inflation is especially sensitive in the lead-up to the five-yearly meeting of the communist party, which is due to open on October 15 in Beijing and will choose the top leadership until 2012.

The sharp spike in inflation is largely due to higher food prices, because of a shortage of pigs after a disease killed millions late last year and earlier in 2007, and the rising cost of feed, a global phenomenon.

But Chinese leaders and economists are increasingly worried that the impact of inflation, and the subsequent government policy response, could cause severe problems for the economy.

“We have entered a very delicate stage of development,” said a senior Chinese economist, who asked not to be named.

Once solely a domestic concern, Chinese prices are now also an international issue, because of the possibility of higher import costs feeding inflation in large export markets like the US and Europe.

Beijing has already raised borrowing costs five times this year, both to cool lending and to prevent negative real interest rates, which provide an extra incentive for people to take money out of banks to buy shares.

China raised the one-year deposit rate to 3.87 per cent last week, which is about equal to the eight-month average for inflation, but well below August’s 6.5 per cent.

But higher interest rates may attract further capital inflows, adding to an already swelling stack of foreign reserves and the domestic liquidity fuelling the frothy property and stock markets.

Economists said the price freeze is the kind of administrative measure redolent of China’s former planned economy, but it may be less effective in China today.

“They will not be able to control the price of everything,” said Chen Xingdong, of BNP Parisbas in Beijing.

In recent months, numerous small protests related to inflation have been reported, with students at three universities in southern China boycotting canteen meals this week because of smaller servings forced by higher food prices.

Spain: What Housing Bubble?

Chalk this one up to Spanish brio: As the fallout from the popping of the US housing bubble spreads to virtually all the ends of the Earth, our Spanish friends casually wave it off despite Spain having had some of the fastest house price rises in the world. Nope, there's real demand driving the supply, they imply. A presidential economic adviser says that Spain being affected by the US mess is "ridiculous" and "unthinkable." For the benefit of recent Spanish home buyers, let's hope he's right. From Bloomberg:

A residential real estate slump in Spain, where prices have almost tripled since 1997, is ``unthinkable,'' the top economic adviser of Prime Minister Jose Luis Rodriguez Zapatero said.

The solvency of the banking system and of real estate developers, as well as the unmet demand for new homes, will prevent any meaningful price erosion, David Taguas, head of the prime minister's economic research unit, said in an interview yesterday at his office at the presidential palace in Madrid.

``To talk about severe adjustments or a meltdown in prices is ridiculous,'' Taguas said in response to reports pointing to an end of the Spanish real estate boom. ``That sort of crisis is unthinkable.''

The gains in house prices are already slowing and excess supply may lead to a decline, predicted Gonzalo Bernardos, an economics professor at the University of Barcelona, who expects a 20 percent drop by 2009. Home prices rose 5.8 percent in the second quarter from the year-earlier period, the smallest increase in at least three years.

Shares of Metrovacesa SA, Spain's biggest real estate company, rose 1.05 euros, or 1.3 percent, to 79.65 euros in Madrid. Actividades de Construcciones y Servicios SA, the country's biggest builder, added 1.89 euros, or 5.7 percent, to 34.81 euros.

The Spanish banking system is also solid enough to withstand rising financing costs triggered by the fallout from the surge in defaults in U.S. subprime mortgages, Taguas said. A run on mortgage lenders such as Newcastle, U.K.-based Northern Rock Plc or funding difficulties like those at Countrywide Financial Corp. in the U.S. is ``unthinkable'' in Spain, Taguas said.

Such a situation ``is completely out of the question'' in Spain, Taguas said. ``We have the good fortune to have one of the most efficient financial systems in the world. That's insurance in times of turbulence.''

Housing demand has been sustained until now by an economic expansion that has outpaced that of the euro region for more than a decade and pushed unemployment to the lowest in almost 30 years. The European Commission predicted on Sept. 11 that the Spanish economy will grow 3.7 percent this year compared with the 2.5 percent rate for the euro region.

Still, borrowing costs are rising for both new and existing mortgages. The European Central Bank has doubled its benchmark rate to 4 percent since December 2005 as the euro-region economy grew the most since 2000. The fallout from the U.S. housing market, where prices are set to post the first annual decline since the 1930s this year, has pushed up the money markets rates that determine mortgage payments. More than 90 percent of Spanish mortgages are variable-rate loans linked to market rates.

``Spain is like the U.S. on speed when it comes to the housing market,'' Diana Choyleva, an economist at Lombard Street Research in London, said. ``It's highly likely that there will be falls in nominal prices.''

Bank of Spain Governor and European Central Bank council member Miguel Angel Fernandez Ordonez said today that the Spanish economy and the nation's banks are well positioned to weather the current turmoil.

``The Spanish economy couldn't be better prepared to confront this crisis,'' he said in testimony to parliament in Madrid. ``The Spanish economic system is immensely solid.''

For now, the biggest threat to the Spanish housing market comes from excess supply. About 700,000 new housing units will go on sale this year, 300,000 more than projected demand, says Fernando Rodriguez de Acuna, president of R. R. de Acuna & Asociados, a real estate research firm in Madrid.

Taguas, who estimates demand for new homes at around 500,000 a year, argues that supply will likely contract, averting a decline in prices. Home starts dropped 21 percent in May.

Fed Shows Us the Money

There's not much I can add about today's 50 basis point rate cut by the Federal Reserve. I subscribe to the Jim Rogers / Marc Faber point of view that the Fed's role is to guarantee the soundness of the dollar, not to "bail out hedge funds." As both of them reiterate, there's doubtful logic in easing monetary conditions when it's easy money conditions that brought about the current situation in the first place. So, here's to helicopters as the dollar reaches record lows against the Euro. I am also on board with Nouriel Roubini that while rate cuts can solve liquidity problems, they can't solve solvency problems. Whether what's on hand is a solvency problem or a liquidity problem I guess we'll soon see.

Program Trading: The Backlash

It is estimated that between 40 to 60% of the trading volume at the New York Stock Exchange is now done via program trading. That is, trading strategies based on algorithms account for nearly a majority or a majority of trading volume. It makes you wonder about the folly of those who closely follow computer-generated stock market gyrations via Bubblevision (CNBC) and the like. Although these media outlets like to generate pseudo-excitement, there is not so much "trading" between humans. In the end, it's more like machines executing predetermined routines for a couple of hours. I never got much thrill watching a computer opponent go up against another computer opponent, so it surprises me that so many do.

Now, it seems that the makers of these machines are reconsidering their reliance on technology as "black box" schemes have gone awry in the wake of the subprime meltdown. Guess what? In times of trouble, maybe there's still room for human judgment after all. Fancy that--maybe it makes sense for people to actually buy and sell shares. Wonders never cease. From Reuters:

The proliferation of so-called algorithmic trading models has prompted many to ponder what role the traditional dealer will play in a future possibly dominated by turbo-charged computer programmes.

Financial and technology experts on Monday said they believe the growing use of "black box trading systems" -- computer models that execute large buy and sell orders in milliseconds and offer users relative anonymity -- will not be able to fully replace the human touch when it comes to managing money.

The current turmoil in financial markets has cast some doubt over the reliability of these high-tech applications as a variety of investors have been hit hard by tight funding conditions and volatility at multi-year highs.

"I'm pretty sure we will see in the area of say, more straight-forward plain vanilla, high liquidity products, less human action there," said Wolfgang Eholzer, head of trading systems design for Eurex, a derivatives exchange, at a financial services round-table discussion.

"There will be plenty of complex products, complex derivatives and pricing, which you don't want to hand over completely to a machine, where innovation is extremely important," he said.

Algorithms, complex mathematical formulas that comb through a vast number of possible trades and execute orders in a split second, are the lifeblood of the statistical arbitrage.

This sort of operation takes advantage of fleeting price differences between securities that usually trade in correlation.

Algorithmic trading, or "Algo-trading" for short, is changing the face of the dealing room. Increasingly banks are on the look-out for physicists, mathematicians and other numbers whizzes that can manage the black boxes.

But dealers are not facing extinction.

"There will be dealers because I don't think that every single person that wants to engage in financial markets will have a tiny little 'bot (robot) on their computer at home keeping an eye on their wealth," said Jon Serocold, a director of the London Investment Banking Association (LIBA).

Nevertheless, the number of human dealers is expected to drop as black box trading becomes more mainstream and the volume of trades handled through a stock exchange picks up.

Part of the rise of algo-trading comes from sweeping regulatory changes coming into force this year.

The introduction in November of Europe's Markets in Financial Instruments Directive (MiFID) will require banks to offer "best execution" on client orders but will allow them to compete head-to-head with exchanges in trading shares.

The new regulations have given rise to a number of new competitors including Project Turquoise, Chi-X and BOAT that can already bypass the exchanges as the European Union strives to create a single financial services market.

"We're clearly on the cusp of some very dramatic changes on the trading landscape," said Eli Lederman, managing director, electronic and agency trading at Morgan Stanley.

"The very definition of what a trader is is changing," he said.

The spike in market volatility stemming from the crisis in the U.S. housing market in August has prompted much soul-searching within the financial community as hedge funds and banks alike have reported losses linked to the credit crunch.

Some of this volatility was exacerbated by the use of black-boxes, Lederman said, adding: "Even in August when (black boxes) were in every headline, when things started to go bad, people noticed and people turned off the black boxes and people decided to turn them back on again, so it's not all as robotic as you might believe."

The Carry Trade Devil in Mrs. Watanabe

No, no, it's not what you think. (For shame!) The IPE Zone hasn't gone "adult entertainment" on you all of a sudden. The IPE Zone is a family-oriented blog, rated PG. Anyway, let me explain what's going on here. I regard the carry trade as DEMONstrated by the likes of the NZD/JPY currency pair as a barometer for speculative foolishness; the higher the NZD/JPY trades, the more disdainful traders become of risk. I have always assumed that hedge funds (most of which are now eating dirt) were behind most of these carry trading shenanigans, but the Economist has other ideas. According to this recent article, it's not faceless, money-grubbing hedge funds that are the key forces driving the carry trade. Nope; it's the archetypal Japanese housewife, "Mrs. Watanabe," who is driving it.

As you all know, Japan has kept its interest rates extremely low for an extraordinarily long time in the hopes that it could escape the throes of deflation. But, as Claus Vistesen over at Alpha Sources would probably point out, low interest rates aren't likely to work; it's a monetary solution to a demographic problem. Suffice to say, it hasn't been solved. So, according to this argument, the average Japanese household has piled on bigtime into the carry trade to gain additional interest income. What am I to make of it? I am undoubtedly biased into blaming hedge funds for this bit of financial nonsense (an artificially weak yen), though this alternate argument deserves to be read nonetheless:

In most of the world in the past week, attention has been on highly leveraged hedge funds that have been forced to dump assets bought on margin. In Japan, however, a different species of margin trader has—until now, at least—stood firm: the housewife. On her shoulders may lie responsibility for some of the stability of the global financial system.

On August 15th the Japanese currency climbed to a 4½-month high against the dollar and continued to surge against the New Zealand dollar, raising concerns about the sustainability of the carry trade, through which investors borrow in cheap yen to buy higher-yielding assets elsewhere. This had made fortunes for international investors but, lately, Japanese retail investors had become the carry trade's greatest enthusiasts. The metaphorical Mr and Mrs Watanabe account for around 30% of the foreign-exchange market in Tokyo by value and volume of transactions, according to currency traders, double the share of a year ago. Meanwhile, the size of the retail market has more than doubled to about $15 billion a day.

One reason for the surge is margin trading. Brokers are offering leverage of as much as 200 times the down-payment (though the average is more like 20 to 40 times). In July Japanese retail investors' short positions on the yen (a bet that it would fall) exceeded the amount taken by traders on the Chicago Mercantile Exchange, a foreign-exchange trading hub. “The gnomes of Zurich were accused in their day of destabilising markets. The housewives of Tokyo are apparently acting to stabilise them,” boasted Kiyohiko Nishimura, a Bank of Japan board member, in July.

Strikingly, as the yen appreciated, retail traders, rather than dump their positions, saw a buying opportunity and sold yen for other currencies, softening its rise. “The Japanese government has not intervened—they've not had to, because the Watanabe-sans have been selling yen for them,” says James Gow of FXOnline Japan, a retail broker.

However, many institutions are unwinding their carry trades. In the last week alone, the yen has risen 10% against the New Zealand dollar. The fear is that, as investors buy yen, the losses for the remaining carry traders will balloon. If retail investors, too, lose faith, it could set off a stampede that would further disrupt global markets.

On the other hand, there may still be grounds for the carry trade to continue. Compared with other countries, the interest-rate differential remains attractive. Given the global credit turmoil, it is also looking less likely that the Bank of Japan will raise rates to 0.75% from 0.5% at its meeting on August 23rd [it didn't happen]. Whatever happens, Mrs Watanabe is on guard.

Meanwhile, the New York Times has another article on why "Japanese housewives are sweating in secret as markets reel." From a gender equality standpoint, it's a bit sad to note that gender bias and limited career opportunities for Japanese women may have played a role in driving Japanese housewives to engage in this undoubtedly risky business. If you play with fire...

Since the credit crisis started shaking the world financial markets this summer, many professional traders have taken big losses. Another, less likely group of investors has, too: middle-class Japanese homemakers who moonlight as amateur currency speculators.

Ms. Itoh is one of them. Ms. Itoh, a homemaker in the central city of Nagoya, did not want her full name used because her husband still does not know. After cleaning the dinner dishes, she would spend her evenings buying and selling British pounds and Australian dollars.

When the turmoil struck the currency markets last month, Ms. Itoh spent a sleepless week as market losses wiped out her holdings. She lost nearly all her family’s $100,000 in savings.

“I wanted to add to our savings, but instead I got in over my head,” Ms. Itoh, 36, said.

Tens of thousands of married Japanese women ventured into online currency trading in the last year and a half, playing the markets between household chores or after tucking the children into bed. While the overwhelmingly male world of traders and investors here mocked them as kimono-clad “Mrs. Watanabes,” these women collectively emerged as a powerful force, using Japan’s vast wealth to sway prices and confound economists.

Many bought and sold stakes worth into the millions of dollars through margin trading, a potentially lucrative but risky form of trading that uses borrowed money.

Until the credit crisis, which began with troubles in the American mortgage market, the value of foreign currencies traded online by private Japanese citizens, including women, averaged $9.1 billion a day — almost a fifth of all foreign exchange trading worldwide during trading hours in Tokyo, said Kazuhiro Shirakura, an analyst at the Yano Research Institute in Tokyo.

Now Japan’s homemaker-traders may become yet another casualty of the shakeout hitting the debt, credit and stock markets worldwide. If so, these married women could lose more than just an investment opportunity. They could also lose the newfound economic freedom that drew many to currency trading in the first place.

Most analysts estimate that Japanese online investors lost $2.5 billion trading currency last month. In fact, the subprime-mortgage crisis was the first severe market downturn since online trading took off here. Economists see the current tumult as the first real test of Japan’s homemaker-traders, and whether these newcomers have the stomach to ride out markets in a time of volatility.

“Mrs. Watanabe got burned this time,” said Masafumi Yamamoto, currency economist at Nikko Citigroup in Tokyo. “The question now is whether she can make a comeback.”

Indeed, online currency trading has become a phenomenon here, with a subculture of blogs, books and investing clubs for Japan’s legions of housewife-traders. The appeal, many of these women say, lies partly in the potential that online trading offered at least some financial independence for wives who still wanted to dutifully spend their days at home.

Some of the women used their own money, some used their husband’s, and some used a combination of both. But by trading, they challenged deeply held social prohibitions in Japan against money, which is often seen here as dirty, especially when earned through market speculation.

“There are strict taboos against money that isn’t earned with sweat from the brow,” said Mayumi Torii, a 41-year-old mother of one who said she earned $150,000 since she started margin trading in currencies early last year.

Ms. Torii is one of Japan’s most famous housewife-traders. She has written a book on her investing strategies and founded a support group for home traders, the FX Beauties Club, which now has 40 members. (FX is financial shorthand for “foreign exchange.”)

But until her book was released in July, she said, she was afraid to admit even to her friends that she was trading, though her husband knew and approved. Now she is a regular guest on television programs.

Ms. Torii said she intended to keep trading, despite the recent market setbacks. She said it was her best chance to “stand on my own economically,” a necessity she discovered after her first marriage ended in divorce, and she and her son had to live off her meager savings. “I never want to feel that vulnerable again,” said Ms. Torii, now remarried.

For other women, trading offered a more modest sort of independence, giving them a chance to build up savings separate from their husbands’ accounts.

One reason Japan’s homemakers can move markets is that they hold the purse strings of the nation’s $12.5 trillion in household savings [it's now more like $13.5T.] For more than a decade, that money languished in banks here at low interest rates. But as the rapid aging of Japan’s population has brought anxiety about the future, households are starting to move more of it overseas in search of higher returns.

A tiny fraction of this has flowed into risky investments like online currency accounts. Most of these accounts involve margin trading, in which investors place a cash deposit with a brokerage that allows them to borrow up to 20 or even 100 times their holdings for trading.

The practice has been popular not only because it vastly raises the level of potential profits, but also because it allowed wives to trade at home, said Hiroshi Takao, chief operating officer of TokyoForex, an online trading firm.

The housewife-traders were so secretive that many market analysts did not realize how widespread the trend had become until this summer, when the police arrested a Tokyo housewife accused of failing to pay $1.1 million in taxes on her foreign exchange earnings.

While day trading of stocks has also taken off in Japan, the women say they prefer currencies because of the relative simplicity: currencies might involve only a handful of nations, while trading stocks might mean keeping an eye on hundreds of companies.

For a time, margin trading seemed like a surefire way to make money, as the yen moved only downward against the dollar and other currencies. But last month, in the midst of the credit turmoil, the yen soared as hedge funds and traders panicked.

Ms. Itoh recalled that she had wanted to cry as she watched the yen jump as much as 5 percent in value in a single day, Aug. 16.

“But I had to keep a poker face, because my husband was sitting behind me,” Ms. Itoh said.

She did not sell her position, thinking the yen would fall again. But by the next morning, only $1,000 remained in her account, she said.

Yayoi Kawakage, a 40-year-old homemaker who works part time at a real estate consulting firm, said she limited her losses last month to $500 because she sold her positions quickly. She said that if markets become less predictable now, many housewives would likely abandon trading.

“The subprime problem showed good things don’t last forever,” she said.

Still, some analysts point out that the $2.5 billion that Japanese individuals lost last month was just a fraction of a percent of the nation’s overall household savings.

“It is about the same as what Japan spends in two weeks on horse racing, lotteries and pachinko,” said Tohru Sasaki, chief foreign exchange strategist at JPMorgan Chase Bank, referring to a pinball-like game popular among gamblers here.

Mr. Sasaki said he believed the losses were not big enough to scare away married women and other investors. And while the trading volume is far below last month’s, recent data show signs of a return to online trading, said Mr. Yamamoto of Citigroup.

Indeed, most of the half dozen homemaker-traders interviewed for this article said they were already trading again, and the rest said they soon would be — including Ms. Itoh, who said she would probably invest her remaining $1,000 in savings.

“There’s no other way to make money so quickly,” she said.

Hedge Funds (Heart) Carbon Offsets

I have always been cynical about hedge funds; now I am becoming increasingly cynical about carbon offsets as well as hedge funds have made money on them. A few months ago, the Financial Times noted that carbon offsets are a "smokescreen" that have few tangible environmental benefits. As if that weren't bad enough, it now turns out that one of the few strategies that have paid off for hedge funds during this trying year is carbon trading. If you needed any more proof that carbon trading is of suspect validity, leave it to hedge funds to sow doubt. Quite frankly, most couldn't care less about the environment (sigh). It's back to the ol' drawing board when speculators and not the environment benefits from these schemes:

Only three strategies adopted by hedge funds appear to have survived unscathed the rout of the sector last month, as the "absolute return" industry again mostly failed to protect investors against market turmoil.

The nascent freight and property derivative sectors and carbon credit trading proved resilient to the wild swings in equity markets in August with small funds specialising in the areas coming through well.

However, the poor performance of the rest of the industry - in which more than two-thirds of all funds lost money - has left many investors wondering what happened to the hedge fund aim of not moving in line with other assets or each other.

"Hedge funds didn't do what they say on the tin," said one senior hedge fund manager last week. Much the same happened in May last year when hedge fund systems designed to avoid being hit by plummeting markets did not work.

The problem, according to prime brokers and analysts, is caused by the hedge funds themselves. "There's one thing that comes out of all these shocks and it is really part of the increasing power of hedge funds," said the head of European prime broking at one Wall Street bank. "When they are going through a challenging return environment, a lot of their assets are more correlated than you might have expected."

This is caused by global multi-strategy funds, some of which deploy more than $100bn (£50bn) when fully leveraged. When they lose money in one area, they are forced to sell off other investments to cover margin calls from their lenders, prompting falls across all the asset classes they trade.

But the derivatives niches created for freight and property remain too small for the big hedge funds to operate in full time while few have dedicated carbon trading desks. Some other illiquid hedge strategies, such as pre-float private equity investment and direct lending, also had a positive August. But monthly valuations are questionable when there is no market for the assets.

Iceberg Alternative Real Estate, a joint venture between London's Reech Alternative Investment Management and property advisers CB Richard Ellis, will today tell investors it made 5.04 per cent after fees in August.

Iceberg, one several property hedge funds set up this year, made its money from both property derivatives and right calls on listed property companies.

Articles on China's Rebalancing Act

The September issue of the IMF publication Finance & Development has a whole bunch of articles on the need for Chinese rebalancing from investment and exports to domestic consumption. This is a longstanding refrain. Premier Wen Jiabao, for instance, has stated that China's current growth path is "unstable, unbalanced, uncoordinated, and unsustainable." Yes, we keep hearing this, but is anything different happening? I am afraid that I see very little change or improvement. Nevertheless, this bunch of articles from Finance & Development makes for interesting (and relatively light) reading:

Most economists agree that if China is to continue its strong economic growth it must rebalance its economy to rely less on investment and exports and more on domestic consumption.

The question is whether that rebalancing will happen on its own, the result of the natural course of the business cycle, or whether it will require concerted policy actions on the part of the Chinese government.

This is one of the issues explored in a group of articles in the September issue of the IMF's quarterly magazine Finance & Development, which also examines the dramatic changes in China's export structure.

In the past 20 years, China has added about $2 trillion to world GDP, created 120 million new jobs, and pulled 400 million people out of poverty. These are big numbers—equivalent to adding a country of the economic size of Portugal every year; creating as many new jobs each year as the total number of people employed in Australia; and eradicating poverty in Ethiopia, Nigeria, Tanzania, and Zambia combined. In recent years, China has grown more than 10 percent annually while keeping inflation below 3 percent. Today, it is the fourth largest economy in the world and the third largest trading nation.

Despite these remarkable achievements, there is growing unease within China and abroad about the state of its economy. At the National People's Congress this March, Premier Wen Jiabao cautioned, "the biggest problem with China's economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable." More generally, the question is whether the pace of growth is sustainable or whether the imbalances in the economy might slow growth, perhaps significantly. And this is why China's policymakers are looking to rebalance the economy to rely less on exports and investment and more on consumption as the source of growth.

Articles in the package look at the rebalancing conundrum as well as China's changing exports. Exports have increased 10-fold over the past 15 years as the country became the third-biggest exporter behind Germany and the United States. No longer is China merely the world's workshop, assembling imported inputs into low-tech exports. Instead, the country is selling increasingly complex products that rely heavily on its own domestic inputs. But as China moves away from being the low-cost, low-tech assembler, its fortunes become more closely tied to those of the global economy.

In a separate article, Hu Xiaolian, the Deputy Governor of the People's Bank of China, explains China's approach to development and economic reform, including efforts to promote consumption and consumer credit, reform the exchange rate regime, and improve macroeconomic management.

Read the group of articles: China's Rebalancing Act Jahangir Aziz and Steven Dunaway - China's economic miracle may be at risk unless the country relies more on domestic consumption. But a rebalancing of the economy is unlikely to happen on its own. What's needed is adjustment based on monetary policy, price liberalization, financial market reform, and changes in government expenditure policies.

Solving China's Rebalancing Puzzle Jonathan Anderson - Market forces will do the trick "naturally." Real rebalancing involves a slowdown in investment and a drop in net exports rather than a further pickup in urban consumption, and this is by far the most likely scenario through the end of the current decade.

China's Export Boom Mary Amiti and Caroline Freund - China's exports are not only booming, they are also becoming more sophisticated. An IMF study shows China moving out of agriculture, apparel, and textiles into electronics and machinery.

China's Growing External Dependence Li Cui - China is no longer just an assembler of imported inputs. The domestic content of China's exports is increasing and its economic fortunes are increasingly tied to those of the global economy.

Point of View China's Approach to Reform Hu Xiaolian - The Deputy Governor of the People's Bank of China gives an account of China's approach to development and economic reform, including efforts to promote consumption and consumer credit, reform the exchange rate regime, and improve macroeconomic management.

Volcker's Folsom World Bank Blues

It seems that Paul Wolfowitz's appointee at the World Bank's Institutional Integrity Department (INT), Suzanne Rich Folsom, is set to outlast her former boss for quite some time. Paul Volcker has just submitted his report reviewing the work of the INT. While finding that the INT has some "serious operational issues," its work looks set to continue. What's more, Folsom looks like she will retain her position at the INT. There's even a chance that she will be promoted to the rank of vice-president as one of Volcker's recommendations (see below) is to elevate the INT head to vice-president status. From the Wall Street Journal:

Mr. Volcker said he gave Ms. Folsom "high marks on the professionalism of the operation." But he argued that her role should change.

Currently, she runs the department and is also counselor to the World Bank president. Her critics have charged that the two jobs -- running the antigraft unit and dispensing political advice -- are incompatible. Ms. Folsom has said the two jobs helped give her "the ear of the president."

The Volcker panel urged that the department be headed by a bank vice president, who should focus on running it. That would help eliminate concern that the department chief's role as an independent investigator "might be compromised."

Mr. Zoellick said he would retain Ms. Folsom as a department head who would report to him but he would likely end her dual role as counselor. He didn't commit to making her a vice president, a higher rank than she now holds. "Suzanne has done very, very good work in a very tough job," Mr. Zoellick said.

Meanwhile, Ms. Folsom said she intended to stay at her job and hopes the bank "embraces the findings" of the Volcker panel.

Current World Bank President Robert Zoellick was quick to endorse the recommendations made by Volcker:

World Bank Group President, Robert B. Zoellick, has expressed his appreciation for the report of the panel led by Paul Volcker, which reviewed the work of the Institutional Integrity Department (INT) in the context of the World Bank Group’s governance and anticorruption strategy.

“This is an excellent and most useful report,” Zoellick said. “The Volcker report makes clear the serious challenges ahead in overcoming the cancer of corruption in operations supported by the Bank, and it offers constructive recommendations. Now it will be up to all of us to move forward, as part of our on-going commitment to address this vital issue.”

The Bank President said improving governance and overcoming corruption are critical factors toensure development resources reach the poor who need
them. “Stealing from the poor is not acceptable,” he said.

INT has the difficult job of investigating fraud and corruption in Bank-supported operations. It also investigates allegations of staff misconduct and administers the Bank’s Voluntary Disclosure Program, which encourages companies to adopt healthy business practices. INT performs important work that should be recognized and strengthened.

“The World Bank Group needs a strong, professional Institutional Integrity Department, backed by management and supported by a Bank-wide commitment,” Zoellick said. “As the report has explained, INT has achieved notable success, but we can do better and need to integrate its work into our operations more effectively and consistently.”

The Volcker panel’s detailed recommendations will be carefully and promptly considered by the World Bank Group.

As a first step, an internal working group from across the institution will be established to consider the panel’s recommendations, in light of its ongoing internal work on a governance and anticorruption strategy.

The World Bank Group will also encourage public comment on the report, which will be considered by the working group. A top priority will be defining a policy for disclosing information about INT’s work to Bank staff and management, the Board of Executive Directors, governments, development partners and the public.

The World Bank Group also proposes to improve INT’s effectiveness in the following areas:

Developing a capacity within INT to disseminate operational advice, lessons learned and best practices resulting from its work;

Ensuring that INT findings and recommendations are followed-up in a systematic and comprehensive manner, across all units of the Bank;

Working with the Audit Committee of the Board to strengthen accountability of INT and consider other steps to assure INT’s independence and support;

Reviewing and revising, as needed, staff rights in the conduct of investigations of alleged misconduct;

Considering the reassignment of investigations of staff misconduct, not involving fraud or corruption, from INT to another office;

Developing a policy to ensure that staff members are better informed of the outcomes of investigations of alleged staff misconduct; and

Evaluating the Voluntary Disclosure Program after the first year to assess its effectiveness.

The Bank will seek external comment on these initial proposals by posting them on the Bank’s website, along with the Volcker panel’s report and recommendations.

In considering the public comment, management and the working group will consult with the Bank's Board as an integral part of its deliberations prior to making final recommendations, which will be incorporated into the Bank’s new Governance and Anticorruption Strategy.

“The World Bank Group operates as a public trust,” Zoellick said. “It must be committed more than ever to improving its work on governance and anticorruption at all levels, as fighting corruption is critical to achieving its mission of overcoming poverty and encouraging sustained growth. As the Volcker report notes, there should be no illusions about the difficulty of the effort, yet the World Bank Group must continue to do better.”

The Independent Review Panel was constituted to review the work of the Department of Institutional Integrity (INT) and to place that work in the context of the World Bank Group’s Governance and Anticorruption (GAC) strategy.

Lastly, here is the executive summary of the report:

The Panel recognizes and emphasizes the critically important contribution that a coherent and forceful attack on corruption can and should make to the Bank-wide goal of facilitating economic development and reducing poverty. INT must play a central part in that effort. It cannot do so effectively in isolation. What is necessary is a fully coordinated approach across the entire World Bank Group, ending past ambivalence about the importance of combating corruption.

That will require strong Bank leadership, not simply by the President and the Executive Directors but by those directly responsible for operations and for supporting staff. The GAC strategy calls for a wide-ranging two-pronged program. Building capacity among member states for combating corruption must be accompanied by measures to protect and enhance the integrity of the Bank’s own operations. Those goals should be, and can be, mutually reinforcing.

Within that context, INT has the clear and critical responsibility to investigate fraud and corruption in Bank programs. Its mandate extends to education and training to identify risks and risk prevention measures. Closer and more trusting relationships with Operations staff can encourage detection of corruption in projects. INT findings in particular cases should provide "lessons learned," with implications for building anticorruption protection in Bank projects.

INT has achieved some notable success in its relatively brief life. It is staffed by dedicated and competent personnel. It uses innovative strategies to aid investigations in often demanding working environments. Nonetheless, serious operational issues and severe strains in relations with some Operations units have arisen, at times contributing to counterproductive relations between the Bank and borrowers and funding partners.

It is these matters that the Panel has addressed in its specific recommendations as summarized below (and listed in Appendix B):

INT’s Organizational Relationships. The head of INT should have the rank of Vice President, and the line of direct responsibility to the President should be maintained. The current role as Counselor to the President should be dropped in the interest of clarifying the purpose and independence of the INT function. The Audit Committee of the Board of Executive Directors, as part of its responsibility for overseeing INT, should help assure that INT’s potential contribution to the implementation of the GAC strategy is realized. A small external Advisory Oversight Board should be established to protect the independence and strengthen the accountability of INT. Properly constituted with widely respected individuals with strong professional credentials drawn from outside the Bank, this Advisory Oversight Board would provide a fresh perspective free of institutional conflicts when troublesome issues arise.

INT’s Preventive Role. INT should develop an internal consulting unit, drawing on staff with operational as well as investigative experience. The purpose would be to work collaboratively with Operations units in developing protections against corruption, assisting with education and training, and advising about appropriate responses to allegations of corruption that INT does not investigate. The lead responsibility for the critical task of preventing corruption in the Bank’s operations should be created elsewhere in the Bank’s organization.

Remedial Action. To ensure that the Bank responds promptly and effectively to INT’s findings of corruption in Bank projects, the relevant Managing Director should be made accountable for ensuring that a comprehensive action plan is developed and implemented. The full range of appropriate responses—disclosures, required remedial responses, and "lessons learned"—should be addressed for the President’s approval.

Disclosure Policies. While recognizing the need for confidentiality of certain matters—most importantly witness protection—the Bank and INT should modify disclosure practices to assure that funding partners as well as relevant Operations staff are informed of the initiation and status of an investigation if immediate action to protect funds is needed, to permit Operations staff to review draft investigation reports for factual accuracy, and more generally to give effect to the presumption of transparency through disclosure of investigative procedures and final INT reports.

INT’s Investigation of Bank Staff. The Bank should reassign outside INT the investigation of staff misconduct not involving allegations of significant fraud or corruption. The Bank should clarify and strengthen the rights of Bank staff in connection with all internal investigations, while taking steps to monitor and reduce the time taken to complete staff misconduct investigations.

INT’s Staffing, Management, and Evaluation. INT should ensure more diversity in its staff, consistent with the need to recruit investigators of the highest technical competence. INT should be subject to regular internal audit and further measures to evaluate its performance.

Finally, the World Bank Group, and INT within it, should work with other multilateral institutions in developing, defining, and following "best practices" in protecting institutional integrity and investigating corruption. The Bank should be at the frontier of best international practice in tackling corruption. These recommendations are designed to ensure that the Bank as a whole, and INT in particular, can play that part with conviction and effectiveness.

BRICs Among World's Drrrtiest Places

If there ever was a list you wouldn't want to be on, it would be this one. The Blacksmith Institute has just issued its list of the world's most polluted places. Heading the list are three of the BRICS: China, India and Russia. Each of these nations has two areas on the list. In alphabetical order by country, here's the top ten:

Sumgayit, Azerbaijan
Linfen, China
Tianying, China
Sukinda, India
Vapi, India
La Oroya, Peru
Dzerzhinsk, Russia
Norilsk, Russia
Chernobyl, Ukraine
Kabwe, Zambia

Note that the study doesn't use a specific indicator or group of indicators for overall pollution rankings. These areas suffer from different kinds of pollution whose antecedents and consequences may differ significantly. From the Financial Times:

China, India and Russia top the list of the world’s most polluted places, a study of global pollution found on Wednesday.

The three countries are each home to two of the world’s top 10 polluted sites, while the others are in Peru, Ukraine, Zambia and Azerbaijan.

Linfen and Tianjin are the worst polluted places in China because of poor air quality and the metal industry respectively. Sukinda and Vapi are the worst in India, the former because of mining and the latter from general industry. Norilsk, where metals are extracted, and Dzerzhinsk, home to weapons manufacture, are Russia’s most polluted ­locations.

The Blacksmith Institute, which produced the report on the “dirty 30” most polluted places on the planet, said it was not possible to rank the top 10 in order because of the different forms of pollution in each place and because they differed widely in their geography and population.

“All sites in the dirty 30 are very toxic and dangerous to human health,” said David Hanrahan, director of global operations at Blacksmith.

Richard Fuller, director of the institute, said: “The fact of the matter is that children are sick and dying in these polluted places and it’s not rocket science to fix them.”

Mining was found to be the most frequent cause of pollution in the dirty 30 but metals extraction, petrochemicals and other industries were also to blame.

The worst places for air pollution were Linfen, Lanzhou and Urumqi in China, Magnitogorsk in Russia and Mexico City.

The Dandora dump in Kenya made it on to the list for being the worst site polluted by urban waste.

Chernobyl’s legacy of nuclear contamination put the region in the top 10, and Mailuu-Suu in Kyrgyzstan was also judged one of the worst polluted for its nuclear site.

The list was drawn up by a panel of experts including members from Green Cross Switzerland, a charity that works to overcome the damage caused by industrial and military disasters. The panel based its judgment on the toxicity of the pollution of the site, its scale and the number of people affected.

The study found most of the polluted sites were far beyond the ability of local populations to clean up and that national government assistance or international aid would be needed. The study said: “Unfortunately there are too many of these industry towns still carrying on where there is no economic alternative for the local population.”

The authors said the way to clean up such sites was to “begin with supporting a core group of concerned ­people and officials to create a consensus and build momentum, starting with some simple but visible improvements to show that progress is possible”.

It's Official: World's a Service Economy

I'm somewhat surprised that no one has really blogged about this yet: The International Labor Organization (ILO), in its recently released fifth edition of the Key Indicators of the Labor Market (KILM) Program, has found that the biggest sector of world employment is now the services sector, surpassing agriculture. From a development standpoint, the ILO finds it curious that the usually theorized progression is not followed here of agriculture-->industry-->services. Of course, it would be ideal to differentiate the sophistication or "value-added" of various service sector jobs for not all service jobs are created equal when it comes to skill requirements. Here is the ILO's blurb on the epoch-making sectoral shift:

In recent years agriculture has lost its place as the main sector of employment and has been replaced by the services sector, which in 2006 constituted 42.0 per cent of world employment compared to 36.1 per cent for agriculture. As for the industry sector, it represented 21.9 per cent of total employment, which is almost unchanged from ten years ago. Although textbook theory suggests that economic development entails a structural transformation with a shift away from agriculture to the industry sector, this no longer seems to be reflected in reality. Instead of moving into high-productivity jobs in the industry sector, people are moving directly into the services sector, which consists of both high- and low-productivity jobs. Therefore, it is unclear if the sectoral shift goes hand in hand with productivity increases and thereby a better utilization of the workforce.

Agriculture is still the main sector of employment in the world’s poorest regions. Two-thirds of workers in sub-Saharan Africa and almost half of workers in South Asia and South-East Asia & the Pacific are in agriculture.

In most regions of the world, industry accounted for about one-fourth to one-fifth of all people employed in 2006, with the exception of sub-Saharan Africa and South-East Asia & the Pacific, which had the lowest proportions at 10.0 and 18.6 per cent, respectively.

In 2006, the share of employment in the services sector ranged widely from 71.2 per cent in the Developed Economies & European Union down to 24.1 per cent in sub-Saharan Africa. While all three Asian regions contained about one-third of employment in the services sector, the remaining regions had shares from 45.6 to 59.6 per cent.

Although the gender gap for sector employment is quite noticeable at the global level, it is even more prominent at the regional level for some sectors.1 For example, in 2006 women had a much higher share of agricultural employment than men in East Asia and the Middle East and men had a higher share than women in Latin America & the Caribbean, whereas in all other regions the shares were relatively equal.

In all regions, women’s share of employment in industry was lower than that of men in 2006. The difference was particularly striking in the Developed Economies & European Union, where only 12.7 per cent of women worked in this sector compared to 34.4 per cent of men. As for developing regions, the differences were considerable in Central & South-Eastern Europe (non-EU) & CIS, the Middle East and Latin America & the Caribbean.

Within services, women had a much higher share than men in Latin America & the Caribbean, the Developed Economies & European Union and Central & South-Eastern Europe (non-EU) & CIS while the shares were considerably lower for women than men in South Asia and the Middle East.

Segregation of occupations by sex is only slowly changing while stereotypes of women as caretakers and home-based workers still exist and are often being reinforced. Meanwhile within each sector women tend to occupy jobs with lower productivity. This may be perpetuated into the next generation if restricted and inferior labour market opportunities for women continue to lead to underinvestment in women’s education, training and experience.

Box 4b shows the shift over ten years' time in sectoral employment:

Meanwhile, Figure 4b shows that--surprisingly to me at least--China still has most folks employed in agriculture (as do a few other countries):

The Christian Science Monitor has a good article on this topic as well.

The life story of Brazilian Valdir de Santos, who has gone from farmhand to taxi driver, is in essence the career path of workers around the globe.

For the first time in human history, more people are laboring in service trades than in food production, according to data gathered by the International Labor Organization (ILO), an agency affiliated with the United Nations.

As recently as 1996, agriculture accounted for 42 percent of world employment, with another 21 percent of workers in goods-producing industries and 37 percent in services. By last year, the ILO says in a report released over the weekend, 42 percent were in services, 37 percent in agriculture, and 22 percent in industry.

It's too soon to talk about a white-collar world. Many of these newly urbanized workers aren't employed so much as they are scraping for survival on city streets. Mr. De Santos's own life has become easier, yet he recalls his father's farm as "a civilized life compared to the life the poor live today in big cities."

But if this great job shift is wrenching, the transition, if managed properly, can be as positive as it is inexorable, economists say. "The switch...frees people from geography," says Gregory Clark, an economic historian at the University of California, Davis. "Singapore can be as rich as Canada, even though Singapore has no land."

Technology, in fact, is opening the door to a new phase of economic competition in services – from banking to tourism and healthcare. This could expose advanced economies like the United States to new challenges, even as it presents enticing new opportunities for entrepreneurs. The Internet and air transport now make it as easy to trade many services across borders as it is to trade goods.

This migration away from farm work represents a vital phase in human progress, Mr. Clark says. In many places, it is occurring at a surprisingly slow rate. Once people make that step, they tend to live in larger communities, acquire more skills, and eventually make more money. The trend doesn't make manufacturing unimportant. But as the world gets wealthier, a rising share of income gets spent on services. And rising factory productivity allows more people to work in services.

Now, service jobs are growing worldwide, benefiting millions. Brazil's experience typifies the broad but uneven impacts. The country is globally competitive in agriculture and aerospace, among other industries. But services are where the growth is. In São Paulo, such jobs are springing up from posh tourism and financial districts to middle-class homes in search of cooks and maids.

"Driving a taxi is much easier than working the fields, I can tell you," Mr. De Santos says in Portuguese as he plies the streets of São Paulo. As a young man, "I worked 12 hours a day and I sweated from 7 in the morning until 7 at night. It was hard work. Here you think a little and it's not hard at all."

Yet all around him he sees jobs characterized by numbing drudgery and low pay. Many people who move to São Paulo simply swap a rural struggle against poverty for an urban one.

The ILO voices similar concerns in its new report on "key indicators of the labor market," released over the US Labor Day weekend.

Many workers remain "underutilized," it says. For all the challenges posed by the transition, the rise of services appears to coincide with positive trends in the economy or social indicators in most regions of the world. China and India have lifted millions of people out of poverty. Banking and tourism sectors are growing fast in many developing nations. The former Soviet bloc is capitalizing in part on expertise built up during the communist era, such as computer programming.

"They had to do it behind the Iron Curtain for military applications," and now they're deploying those skills for economic advantage, says Gary Kleiman of Kleiman International, a Washington consulting firm that tracks emerging economies. The UN's human development index, based on factors such as life expectancy and education, has been rising in most areas, although Sub-Saharan Africa remains a worrisome exception.

Economists generally say there's no reason the world's various regions can't enjoy simultaneous development. One's gain need not be another's loss.

"It's not a zero-sum game at all," as long as pro-growth policies are pursued, says Mark Weisbrot, a development expert at the Center for Economic and Policy Research in Washington. Straightforward steps can make a big difference, labor experts say. For instance, reducing child labor means that more children can get an education. "You'd be surprised ... how quick one can reap the benefits" of policies that boost labor productivity, says Lawrence Jeff Johnson, author of the new ILO report.

Every country will continue to need a mix of low- and high-skill workers, but global incomes may hinge on skill growth in the service economy. "As these economies strengthen, then we have pillars of strength around the globe," Mr. Johnson says. "This is a positive thing. It shouldn't be viewed as a fearful thing."

But some economists do worry about disruptions. As technology and rising education levels in developing nations turn services into tradable commodities, workers in Boston may find themselves in competition with lower-cost rivals in Brasilia. And workers in Brasilia could find themselves competing with even cheaper labor in Bangladesh.

At a congressional hearing this summer, Princeton University economist Alan Blinder warned that America faces the potential offshoring of millions of service jobs. From hair stylists to trial lawyers, providers of "personal services" will be OK, he predicts, but workers are vulnerable in fields where work doesn't need to be done near the customer.

Even unabashed proponents of globalization's virtues talk about the need to help displaced workers adjust. "Trade ... might even double in the next 20 years or so" as a share of the economy, predicts Jagdish Bhagwati of Columbia University in New York. "It's a fantastically good situation for everybody involved. [But you] have to have institutional support to handle the volatility" of jobs.

For now, most workers in Brazil are simply focused on local realities, not global opportunities. Natalia Torres, a university student in São Paulo, says her friends all see their futures in office work, or service industries, or some similar job that doesn't demand manual labor. She opted to study public relations because she likes dealing with people. She's working as an office assistant while attending classes at night.

"Young people today are lazy," she says in Portuguese. "My grandparents came from Europe and worked hard in the fields. I am certainly lazier than them and even [than] my mother…. The only people who work in the fields today are those that don't have the means to get to the big city."

Canada Mulls Slowing Globalization

In this op-ed, David Crane of The Star ponders what Canada's next move will be when it comes to globalization as the likes of the US, Japan, Germany, and France appear to be slowing down the globalization train to protect national interests. Call it preserving national security or raising protectionist barriers, but things aren't as freewheeling as they used to be. Many of the measures being taken by these countries are summarized below. Will Canada join the globalization countermovement? A "Competition Policy Review Panel" headed by "Red" Wilson (no, he's not in cahoots with that proto-socialist London Mayor Ken Livingstone) is due to report soon on how Canada should treat foreign investment and competitiveness. Stay tuned:

The climate for foreign takeovers is changing in a reaction against globalization, and this change is most pronounced in the world's richest countries now worried about where they will fit in a future world of shifting economic power.

A new report by the World Economic Forum on global risks argues that "unfettered globalization and growth is coming to an end, as governments seek to balance economic expansion with political priorities and sustainability concerns."

One sign is a growing belief that corporations in certain "key" sectors of the economy play a strategic role in a country's economic potential and that this is weakened if those corporations are sold to foreign investors. This belief is often subsumed under the heading of "national security."

Just before departing for Australia for this year's summit of Asia-Pacific Co-operation Council leaders, U.S. President George W. Bush signed a new law, the Foreign Investment and National Security Act of 2007, making takeovers of U.S. companies more difficult. The new law subjects more sectors to "national security" reviews and gives members of the U.S. Congress the right to intervene, opening the door to a much more politicized process.

At the same time, Japan has just toughened its laws on foreign takeovers of Japanese companies by blocking more than 10 per cent foreign ownership in Japanese companies producing technologies that can also be used in weapons systems, such as semiconductors and specialty metals. Some 137 items are listed in the new regulations, effectively shielding many well-known Japanese companies from foreign takeovers.

France has not introduced new laws since it published a list of "strategic" sectors in 2005. But French President Nicolas Sarkozy is aggressively pursuing efforts to build up large-scale French "national champions."

Last week he engineered the merger of Suez and Gas de France to create one of the world's largest energy companies and a leader in liquefied natural gas technology. The French government will effectively control nearly 40 per cent of the new company.

Now, Sarkozy is pushing the restructuring of Areva, France's government-controlled nuclear technology company to make it a world leader as countries seek nuclear power.

A new report on world investment prospects to 2011 from the Economist Intelligence Unit and Columbia University's Program on International Investment, concludes that while foreign direct investment will continue to grow, "the risk of protectionism is now appreciable, the global geopolitical climate appears more threatening, and the outlook for securing a stable and co-operative international trading and investment environment is worse than in the recent past."

The gradual lowering of barriers to foreign takeovers around the world over the past two decades could now go into reverse in a "re-balancing" of polices, it says. A growing number of countries, the report said, may tighten existing investment rules to regulate foreign investments and protect "strategic sectors" from foreign takeovers.

Interestingly, it is the United States that is seen as leading this turnaround. The EIU report said it is taking a more restrictive approach on trade and investment. The U.S., it says, "will block foreign takeovers of key U.S. companies, which has become more likely following recent legislative changes. All this will make for constrained globalization and less foreign direct investment than might otherwise be the case."
As key global economies – notably the U.S., Japan, Germany and France – adopt a more restrictive approach in response to the huge shake-up of the world economy now under way, what should Canada do?

This is what Red Wilson, who is chairing a review of our Investment Canada Act, is supposed to tell us. Let's hope there will still be some strong Canadian-owned companies left by the time he reports.

Lighter Posting Till Saturday...

Dear readers, I 've been subjected to an unexpected lack of Internet availability. I've recently moved into new quarters a week before they were supposed to officially open. Unfortunately, my landlord omitted the rather important detail that Internet service would not be available for a week. I am £$%^&*! annoyed as I've been practically cut off from the world. No Skype, no VOIP Stunt, no e-mail, no Firefox, no Blogger...I didn't fully appreciate how dependent I've become on the Net. I will try to post when I come to campus, but expect regular service to resume on Saturday. I am not a very happy camper.

Reports of Unrest Muzzled in China

There have been many reports over the years of rural unrest in China over inadequate compensation for those who have been forced to move in order to make way for various projects. BBC News reporter Dan Griffiths narrates a rather chilling story of how he was detained when he tried to visit Shengyou, some three hours away from Beijing. In 2005, Shengyou was the site of a fatal riot over residents being forcibly removed to make way for the construction of a power plant. Though the Chinese authorities tried to keep this incident under wraps, footage is widely available on the Net. It's another reminder that behind the Olympic show China wants to put on to showcase itself, a controlling aspect still lurks in the background:

Round a bend in the road, I see two white vans. Several policemen are standing beside them. They look as out of place in rural China as I do.

The questions come thick and fast. What am I doing? Where have I come from? Who is my contact in the village?

Over the course of the next few hours they will ask me this last question again and again. From nowhere a black car pulls up and I am ushered inside.

Two years ago there was a riot in Shengyou. In the early hours of a November morning a gang of more than 100 men entered the village.

They were wearing camouflage gear and construction helmets, some armed with hunting rifles, clubs and shovels.

What happened next was filmed by a local resident and smuggled out to the international media.

The video showed a series of bloody clashes between the villagers and the attackers. Gunshots could be heard above the shouting and screaming.

When the fighting finally stopped, six people lay dead, more than 50 were injured.

With the dramatic footage circulating, the authorities moved quickly.

State media said the Shengyou residents had been resisting the takeover of their property by an electricity company which wanted to build a power plant.

It emerged that there had been a similar clash earlier in the year, which had gone unreported. Several local officials were sacked and the villagers won their claim to stay on the land.

But now the police are back in Shengyou.

I am in the backseat of the black car on the way to the nearby town of Dingzhou.

Next to me is one of the men from the checkpoint. He is not wearing a police uniform and refuses to give me his name or show me any ID.

The questions keep on coming - how do I know about Shengyou? Why was I on foot?

I tell him that my taxi driver was too scared to go near the village. He laughs. At one point he reaches over and tries to grab my mobile phone.

I ask some questions of my own - why are they detaining me? What is going on in Shengyou? He says nothing.

At the town's government headquarters, an official shakes my hand. "You are welcome to Dingzhou," he says, pretending that I am an honoured guest.

We sit around a large oval table. I am on one side, officials are on the other. Several refuse to give me their names. They want to see my journalist's identity card. And again the questions.

New regulations issued this year were supposed to give foreign journalists much greater freedom to travel around the country.

They were also supposed to mean less harassment from local officials - a common problem in the past and one that has not gone away.

I tell them I heard reports about problems in the village and had come down to look around.

People living near Shengyou say that armed police were sent into the village two weeks ago.

That was after residents dug up the bodies of those who had died in the violence in November 2005. They wanted to protest at the lack of official compensation for the families of those who were killed or injured then.

What is happening in Shengyou is not unique. It is another reminder of growing social tensions in rural China.

The government has admitted that there were tens of thousands of rural protests last year. Many are about land grabs like the one attempted in Shengyou, others about corruption or the growing gap between rich and poor.

The authorities in Beijing say they want to do something about these problems - but often officials at the local level ignore these edicts.

The interview is over. Officials say they will escort me back to the highway.

I meet up with my driver, who has been waiting for me. Three officials also get in the car. They sit either side of me on the back seat. Another in the front.

As we drive out of town a black car comes alongside. The driver says we must pull over. This game of cat and mouse continues up the highway to Beijing. Finally I tell my driver to ignore them and head home.

"Have you been to Beijing before?" I ask the officials. They laugh nervously.

Then I see blue and red flashing lights. The police will not say why they have stopped us, nor will they say when we can go. We wait at the side of the road.

Up ahead there is a big neon sign lit up in green - "One World, One Dream". It is the official slogan of the Beijing Olympics.

"Is this how you will treat journalists when China hosts the Olympics?" I ask one of them. "Oh, everything will be different then," he says.

Then another car pulls up, with representatives from the local office of China's foreign ministry. I know my colleagues in Beijing have been pressing the foreign ministry to take action.

"There has been a terrible mistake, we are so sorry." They insist that we must go out for dinner with the officials from Dingzhou, then we can go back to Beijing.

It is a strange experience sitting round the same table with the men who detained me.

It is not until the next day that my driver discovers that while we were eating, someone tampered with our car by removing several of the bolts that attach the wheels to the chassis.

It is nearly midnight by the time we arrive back in Beijing. We drive down the wide, brightly-lit boulevards, past the new office blocks.

This is the China that Beijing wants the world to see. But in Shengyou there is another China - a world that goes unreported by the country's state-run media.

China's president, Hu Jintao, has promised to build what he calls a "harmonious society", but three hours south of Beijing no-one in power seems to be listening.

A Doha Round Double Feature

The never-ending Doha Round is entering, what, its seventh year of stalemate. The United States has upped its rhetorical offensive against the developing nation negotiating bloc led by India and Brazil. US Trade Representative Susan Schwab has suggested that they may be trying to "destroy the Doha Round" [it seems pretty broken already to me]. From the Financial Times comes this latest tale of trade woe:

The US has accused South Africa, Argentina, India and Brazil of jeopardising the Doha round of world trade talks by thwarting fresh efforts to reach a deal on cuts to agricultural and industrial tariffs.

Susan Schwab, US trade representative, said a small group of countries had the power to “destroy the Doha round” and cited the four nations as obstacles to progress.

The US is keen to advance quickly with negotiations on the basis of draft agreements advanced by the World Trade Organisation to open markets to farm and manufactured goods. But some WTO members argue that the proposed cuts that poorer nations are asked to make in industrial tariffs are far bigger than the concessions being asked of richer countries on agricultural products, thus undermining the aim of the Doha round to focus on farming as the issue of most concern to developing countries.

President George W. Bush has made reviving the talks his economic priority at the Asia Pacific Economic Co-operation summit in Sydney, which brings together 21 countries that collectively generate half of global trade.

In a speech in Sydney on Friday, he added his criticism of countries blocking progress. “No single country can make Doha a success, but it is possible for a handful of countries that are unwilling to make the necessary contributions to bring Doha to a halt,” he said. “We must focus on what we have to gain, not what we could to lose.”

He said the US was committed to seizing the “once-in-a-generation chance” provided by the Doha round to ”open markets and help millions rise from poverty”.

Ministers at the summit of Pacific Rim nations agreed on Thursday to accelerate the trade talks, which resumed this week in Geneva.

The Japanese trade minister said the negotiations were entering their final phase and called for convergence, after hearing appeals from Pascal Lamy, director-general of the WTO.

The US hopes the expression of support for the talks from Apec members – including China, South Korea and Indonesia – will help isolate those advanced developing countries resisting an agreement. [See next article.]

This week Peter Mandelson, European Union trade commissioner, said all countries had to make compromisesbut em­phasised the need for the US to offer deeper cuts in farm subsidies. “We are in a stalemate on this and I believe that the US holds the key to unlocking it,” he told the BBC.

Christine Lagarde, French economic minister, last week said she did not expect a global trade deal in the foreseeable future because the divisions among WTO members remained “too wide”.

The draft agreements were issued by the WTO after bilateral negotiations be­tween the US and the EU produced a breakthrough on farm goods, but then failed to bring about a wider deal this summer when talks were extended to include India and Brazil.

Crawford Falconer, New Zealand’s ambassador to the WTO, who chairs the agriculture negotiations, has proposed a deal under which the US would reduce farm subsidies to close to $13bn a year and the EU would cut its highest agricultural tariffs by 73 per cent.

On the other hand, the Sydney Morning Herald writes that President Hu Jintao of China has been prodded by corporate leaders into pushing for the successful completion of the Doha Round. Hu wins and Hu loses from trade liberalization? Various US cases against China at the current moment aside, it's kind of obvious as the Chinese export steamroller powers ahead. Other developing nations that are reluctant to complete Doha may have a growing fear of China:

The Chinese President, Hu Jintao, has flagged a strengthening of his country's commitment to the Doha round of global free-trade talks and raised expectations that China will offer new concessions to help get the stalled deal over the line.

Mr Hu told corporate leaders at the Asia-Pacific Economic Co-operation business summit yesterday that a successful conclusion of the Doha agreement was essential to continuing strong growth in the world's economy, signalling that China was willing to strengthen its role in the negotiations.

"The WTO [World Trade Organisation] Doha round negotiation is now at a crucial juncture," he said. "We must say no to trade protectionism, eliminate trade barriers and move the Doha round negotiation towards a comprehensive and balanced outcome at an early date."

Since its accession to the WTO, China had honoured its commitments to cut tariffs and open its economy to trade, he said, adding: "We will continue to implement a win-win opening-up strategy and support the establishment of a fair, open, equitable and non-discriminatory multilateral trading regime."

The federal Trade Minister, Warren Truss, welcomed Mr Hu's "strong statement" and "new commitment". "It will be a very valuable resource to have a more active China around the [WTO] table," Mr Truss said.

"It is a fair comment to say that, in the past, China has tended to take the view that, as a recently ascended WTO member, little or nothing could be expected of it in the way of any concessions arising out of the Doha round.

"I trust that China's new commitment to the Doha round will also include a willingness to go to the table and make an appropriate range of concessions to help achieve a satisfactory outcome."

China's move came as foreign and trade ministers called for a successful conclusion of the Doha negotiations. "An open rules-based multilateral trading system under the WTO, and the successful conclusion of the Doha development agenda, with an ambitious and balanced outcome, provides the best means for sustaining economic growth," a statement said.

The summit's ministerial meeting also finalised a report on strengthening regional economic integration, including the long-term prospect of a free-trade area of the Asia-Pacific.

Business leaders this week said APEC leaders needed to consider an alternative agreement if the Doha round failed.

Ministers addressed business's concerns about the difficulties and cost of complying with a "spaghetti bowl" of inconsistent bilateral free-trade agreements in the region by approving three "model chapters" on which new agreements could be based.

The meeting also finalised new regional measures to protect intellectual property.

■ Australia and China have agreed to regular meetings of top business leaders. A memorandum of understanding, setting out the arrangements for the Australia-China CEO Roundtable, was signed by the Foreign Affairs Minister, Alexander Downer, and China's Minister for Commerce, Bo Xilai, yesterday.

Heads of businesses will make recommendations to their governments in important policy areas, and Australian and Chinese chief executives will regularly meet senior government leaders.

FAO: Costly Food May Mean Unrest

The United Nation's Food and Agriculture Organization (FAO) has warned of the potentially dire consequences of high food prices worldwide due to (1) increased demand from fast-growing developing nations like China and India; (2) a rising global population; (3) climate change wreaking havoc on agricultural production through floods and droughts; and (4) the substitution of grains from food to biofuels. I have previously noted that activists have become wary of the possibility that biofuels may cause food security issues, but this is one of the first instances an international organization has brought up the topic as well. From the Financial Times:

Developing countries face serious social unrest as they struggle to cope with soaring food prices, inflation that shows no signs of abating, the United Nations’ top agriculture official has warned.

Jacques Diouf, director-general of the UN’s Food and Agriculture Organisation, said surging prices for basic food imports such as wheat, corn and milk had the “potential for social tension, leading to social reactions and eventually even political problems”.

Mr Diouf said food prices would continue to increase because of a mix of strong demand from developing countries; a rising global population, more frequent floods and droughts caused by climate change; and the biofuel industry’s appetite for grains.

“That combination of factors would most likely lead to increases in food prices,” Mr Diouf told the Financial Times in an interview.

Signs of the social unrest these prices could cause were seen in Mexico this year where mass protests were triggered by rising corn prices. Mr Diouf said food represented about 10-20 per cent of consumer spending in industrialised countries, but up to 65 per cent in developing nations.

“If we continue to see an increase in their [food] prices and in their import bill for food, there is a serious potential situation,” Mr Diouf said.

The warning comes as wheat prices are at a high, forcing developing countries such as India and Egypt to pay record prices for their food imports in what cereal traders described as “panic buying” to beef up reserves.

Wheat prices this week rose to a record $8.86 a bushel in Chicago, up about 60 per cent since January. Dairy product prices have also setting records, while other commodities, such as corn and soyabeans, are trading well above their historical averages.

Mr Diouf said although the biofuel industry directly increased the consumption of only a handful of agricultural commodities, such as corn and rapeseed, its effect spread to other food products because less acreage was devoted to non-biofuel crops and the cost of feeding livestock with grain was pushed up.

“The biofuel industry is a new factor creating demand for food for a non-food use,” he said.

Fears about the inflationary impact of biofuels on global food prices have prompted Cargill, the world’s largest agricultural company by revenues, to question the White House-led push for an increase in ethanol production through tax subsidies.

Chavez: Central Bank as Piggy Bank

Hugonomics has taken a turn for the worse as Venezuela seems set to give, er, Zimbabwe a run for the money in the financial tomfoolery sweepstakes. Venezuela's interbank O/N rate, the rate which banks charge each other to cover their reserve requirements, went to triple-digit figures as the central bank gave notice that it would stop some lending operations to FIs. It's part and parcel of Chavez's plan to dominate Venezuela's economy. In particular, central bank independence is in the crosshairs. Already, he has taken $17 billion worth of reserves out of the central bank for government spending. As Chavez uses the central bank as a piggy bank, there's no doubting what the answer is to the question, "Where's the pork?" [oink, oink]. From Bloomberg:

Venezuela's interbank overnight rate soared to as high as 120 percent after the central bank said it would halt some of its lending operations to financial institutions.

The rate hovered at about 40 percent at midday New York time, up from an average daily rate of 8.7 percent since Aug. 1. Banco Central de Venezuela suspended late yesterday repurchase agreements that it used at times to provide cash to the banking system. The bank made the move three days after President Hugo Chavez prodded policy makers to stop acting as an ``oxygen tank'' for banks that needed cash.

``There's just no liquidity in the market right now,'' said Richard La Rosa, a trader at brokerage ActiValores Sociedad de Corretaje SA in Caracas.

The cutback in lending is part of Chavez's effort to take greater control of the central bank and the South American country's economy. Chavez has taken $17 billion of foreign reserves from the bank to fund government spending in the past two years and is seeking to reform the constitution to strip the bank of its independence from the executive branch.

The central bank said in its statement yesterday that it will continue some lending operations, such as its role as lender of last resort.

The overnight rate rose from an average of 22 percent yesterday. Government debt sales this week also drained cash from the financial system, leaving some banks short of funds, La Rosa said. The government sold about $200 million of dollar bonds from its portfolio in a private placement with local investors, 215 billion bolivars ($100 million) of 5-year bonds and 50 billion bolivars of 91-day debt earlier this week.

APEC: Kevin Rudd floors Hu Jintao

Sorry to keep harping on the APEC Summit, but I just had to post this article. Kevin Rudd, Labor's candidate for PM and the man who is likely to succeed current Australian PM John Howard, is also a fluent Mandarin speaker. He put one over ol' John Howard today as he addressed Hu Jintao in his mother tongue for minutes. Comrade Hu and his entourage were amazed by this gweilo (foreign devil) showcasing his language skills. Hu had better et used to it for the polls suggest Howard will be trounced at the next general election. Yup, we're more likely to see this sort of thing in the future: APEC leaders who are not from native Mandarin-speaking countries learning how to speak the language in deference to China's growing economic clout. Score one for Chinese "soft power." From the Sydney Morning Herald:

Labor's Mandarin-speaking leader Kevin Rudd upstaged John Howard today in a stunning piece of linguistic one-upmanship at a state lunch for China's President Hu Jintao.

The Prime Minister's own speech went down well.

But when Mr Rudd started addressing the leader of one-quarter of the world's population - fluently in his own tongue - the effect was stunning.

There was an almost audible intake of breath among the scores of Chinese political and business heavyweights in the audience.

Many sat bolt upright in their chairs, beaming at Mr Rudd's virtuosity.

The effect could not have been greater had the family's precocious nine-year-old played a Chopin prelude perfectly for the visiting relatives after Christmas lunch.

But it worked so well because Mr Rudd was not acting like a show-off.

He spoke at length in English first, displaying a commanding grasp of China's history and development into an economic giant, before seeking his audience's indulgence to welcome Mr Hu personally in Chinese.

And when he did, he must have made Mr Howard squirm in his seat.

He spoke not for a few lines but for a few minutes.

It was, quite simply, a moment made to measure for the former diplomat.

Not only is he consistently trouncing Mr Howard in the polls, but here he was looking like a genuine statesman at an APEC forum which Mr Howard, as host, is no doubt expecting will enhance his own international reputation.

His audience included two former Labor prime ministers - Gough Whitlam, who recognised China in the 1970s when it was not politically popular to do so, and Bob Hawke, who got the APEC ball rolling in 1989.

It also included China's foreign and commerce ministers, Hong Kong's chief executive Donald Tsang Yam-kuen, business heavyweights such as BHP's Chip Goodyear and Woodside Petroluem's Don Voelte, Defence Force chief Angus Houston and, with 11 months left until the Beijing Olympics, Australian IOC member Kevan Gosper.

Mr Rudd could not have scripted a bigger occasion on which to shine.

He also managed to trump Mr Howard on the issue of China's "panda diplomacy".

"It was once ping pong; now pandas are making a contribution to our relationship," Mr Howard said to warm applause after Mr Hu announced two pandas would be sent to Adelaide Zoo.

"That has nothing to do with the fact that my foreign minister comes from South Australia."

Mr Howard might have been better omitting any mention of Alexander Downer, because earlier he had made a humorous quip about panda mating habits which might not translate all that well in Beijing.

After a news conference where an expert mentioned that pandas mated only three or four times a year, Mr Downer told Australian reporters: "I'm glad I wasn't born a panda. Suck on that."

Mr Rudd said in his speech: "Should my party succeed at the next election, we would also welcome pandas coming to my home city of Brisbane."

UPDATE: After making his speech in Mandarin, Kevin Rudd had the opportunity to sit and talk with Hu Jintao. To no one's surprise, he did away with an interpreter and spoke with Comrade Hu in Mandarin. Current Aussie Foreign Minister Alexander Downer then accused Rudd of showing off by speaking to Hu in his mother tongue. Downer retorts that he speaks fluent French. (Good luck impressing the Chinese with your French, Downer):

The Labor leader, Kevin Rudd, drew on his fluency in Mandarin and his past as a diplomat in Beijing to launch his charm offensive in a meeting with the President of China, Hu Jintao, in Sydney yesterday.

Mr Rudd and Mr Hu conducted the 30-minute meeting in Mandarin, avoiding the need for interpreters, which can introduce a stop-start tenor to international meetings.

The Minister for Foreign Affairs, Alexander Downer, was unimpressed. He accused the Opposition Leader of being a show-off and pointed out that he too was a former diplomat with a foreign language - French.

Mr Rudd told reporters he had started by making light-hearted conversation with Mr Hu in Mandarin and then the two men had continued their dialogue in that language.

"When I've been to Beijing before, sometimes conversations are in Chinese, sometimes in English," he said.

"President Hu seemed quite desirous in continuing the conversation in Chinese and I was pretty relaxed about that. It's a matter of the way in which the Chinese wish to conduct these conversations so, yes, we conducted our conversation in Chinese."

The meeting covered the economic relationship between Australia and China, including Beijing's interest in longer-term co-operation on energy supply and Labor's interest in creating more opportunities for Australian banks and financial service companies to operate in China.

"I was also able to reflect with the President that, when he came here for the first time in the 1980s, he was working then in the Chinese Communist Youth League and part of my job at the embassy in Beijing in 1986 was to prepare for his visit to Australia then, and I vaguely remember working on the details of that particular visit."

Asked on ABC radio whether the Government had been upstaged by the Labor leader in its dealings with the visiting Chinese President, Mr Downer said: "Well, remember I'm the Foreign Minister so I work every day with people who can speak foreign languages and I can speak French."

Presenter: "Do you?"

Mr Downer: "I speak French. That's not seen in diplomacy as a great party trick - to be able to speak a foreign language."

Mr Downer and the ABC presenter Jon Faine then conversed on-air in French before the Foreign Minister resumed in English.

"I mean I don't think in diplomacy the fact that you can speak foreign languages is anything special, and obviously he runs the risk of being seen by a lot of Australians as a show-off."

China's Hack Headquarters?

You are undoubtedly familiar with the seemingly endless stories about the Chinese hacking into Western government's computers. Hack Germany. Hack the United States. Hack Great Britain. Is this part of China's efforts at building up its "asymmetric warfare" capabilities? The principle behind this kind of warfare is to not confront opponents head-on in a conventional battle. China may be calculating that it would not fare very well against Western countries in a straight confrontation given its current military capabilities. Instead, determining the vulnerabilities of these countries' information infrastructure and undermining them in times of conflict may be a more cost-effective way to attack should things go sour in the future.

Perhaps you've read through the Unrestricted Warfare book that two Chinese colonels, Qiao Liang and Wang Xiangsui, published a few years back. It repeatedly mentions the possibilities for waging "electronic warfare" and "information warfare." Of course, there is no telling how much this publication informs Chinese military policy, but I would suggest there's a link. In any case, the Independent has a feature on the purported headquarters of all this hacking activity in the economically prosperous Chinese town of Guangzhou. [Cue up the Bond theme...]

Somewhere here in Guangzhou, the balmy capital of the booming southern province of Guangdong, a shadowy group of computer scientists is said to be hard at work under the supervision of the People's Liberation Army, waging cyber warfare on Western military and industrial targets.

Their fellow scientists in the dusty city of Lanzhou in northwestern China, not far from where the Chinese space mission is based, are also reportedly hacking into government files in Whitehall and the Pentagon.

It's hard to believe in the 30-degree-plus heat of Guangzhou, but this city has been named one of the epicentres of the Cold Cyber War. Instead of missiles pointing atcapital cities, and huge standing armies facing each other across ideological divides and barbed-wire fences, the only weapons in this secret war are keyboards, some sharp minds and a lot of caffeine pills.

The experts tell of how cyber spies breach supposedly unbreachable firewalls as smoothly as a skilled jewel thief, before swooping on a hard drive, snatching the secret files, and sending them to a third country, usually somewhere in Asia such as South Korea or Hong Kong. Then they make good their escape, often leaving no trace of the raid.

The secret agents and operatives are bleary-eyed computer whizzkids, cranked on cigarettes and coffee as they snoop through computer networks at Western military bases, armaments companies and aerospace giants. They hang out in online chatrooms rather than barrack rooms or smoky bars in communist enclaves, but they are just as hard to track as their Cold War counterparts.

Their methods may be hi-tech but the strategy is ancient – Trojan Horse software developed by the PLA's computer whizzes, disguised as PowerPoint or Word programmes, which find their way into computer systems in the corridors of power of London, into the Foreign Ministry and other government departments, even into the House of Commons. They redirect the programmes via South Korean networks or Taiwanese servers to disguise where they came from.

"There's a huge amount of cyber warfare going on here aimed at gathering intelligence and probing networks. There is also a huge amount of cyber espionage to access information about intellectual property rights and trade matters," said one security expert who did not wish to be named.

The US House of Representatives has said that intelligence gained through cyber espionage has allowed China to copy many scientific and technological breakthroughs from the West.

And traditional espionage is also on the rise as global competition intensifies for new products. Defectors tell of plans to obtain hush-hush industrial information through operatives working at embassies, and post-graduate students or private individuals employed by companies for years. Pure John Le Carré territory.

At times, cyber espionage and good-old fashioned spying overlap – the greater use of laptop computers has led to more people having their secrets stolen from beside them on the evening train home or from their hotel room on business trips. German businessmen travelling to China with the Chancellor, Angela Merkel, were told to bring their computers with them during state banquets.

Cyber espionage costs British companies billions of pounds every year, not only in the direct effects of stolen secrets, but in the loss of competitive advantage. There have long been reports that China operates a web of operatives throughout Europe, who penetrate all levels of key industries. "As cyber warfare grows, so does cyber espionage. There have been significant advances in China but I still think China is playing catch-up on the West in this game – the West has a lot more to spend – just look at the Chinese military budget and compare it to the American spending on defence," said the analyst.

Chinese cyber warfare and cyber espionage have been in the news since the German magazine Der Spiegel ran a report about Chinese hackers breaking into IT systems in the Chancellery using Trojans – just as Ms Merkel's plane was touching down at Beijing airport.

The timing of the report was embarrassing for the Chinese government, forcing Premier Wen Jiabao to stress China's anti-hacker credentials and pledge that China would co-operate closely with Germany to prevent such activity.

"The Chinese government attaches great importance to the hacker attack on the German government networks," he said, promising "determined" and "forceful" measures to combat it.

The news of cyber warfare from China was followed by reports that cyber warriors had penetrated the computer systems of the Pentagon in June.

Computer security experts say the key to the success of the cyber wars was deniability. The cyber spies use third-party computers in other countries as a way of covering their tracks. There could easily be a Trojan Horse sitting on your computer, creating a network right now, without your knowledge.

News of a security compromise is normally confined to officials with high security clearance, and not for public consumption, which has made some commentators sceptical that the Government would ever reveal any information about security breaches, unless it had sound political reasons for doing so.

"Ultimately, if Whitehall's secret networks were accessed, then there was a weakness there, so we'll never know how deeply the security breach went because no government will ever reveal that kind of weakness.

"A lot of this is a kneejerk reaction. If the alarm system in your house was compromised and someone broke into your house, would you publicise it?" said a security analyst.

One internet commentator points out how the US controls the domain name system (DNS), and could do a lot of damage to China by simply removing the "cn" domain.

The webheads speculate about just how the hackers were tracked, given that the routes they took are supposedly untraceable. And they say that spammers and organised gangs using automated penetration tools are a much greater threat than the Chinese army.

Other security experts believe that China is as much a victim as it is a perpetrator in this conflict and that the Chinese are being scapegoated for what is a much wider problem.

Around 60 per cent of attacks on US national defence systems are said to emanate from within America itself, said the analyst. That leaves 40 per cent for the rest of the world, which means that it can't all be China.

Russians are no slouches when it comes to hacking. In May this year, Estonia's websites were the victims of the world's biggest online assault by cyber vigilantes from Russia. Government ministries, banks and newspapers had their websites jammed after Estonia caused offence by re-burying a Russian soldier from the Second World War.

"Every government does it and no government is beyond accusation. The manner in which these breaches were supposed to have been carried out shows it was extremely clever programming. And at the end of the day, totally deniable."

A Chinese Foreign Ministry spokesman, Jiang Yu, said the accusations were groundless and reflected a Cold War mentality. "China and the US are now devoted to constructive relations and co-operation. The bilateral military ties enjoy a sound momentum of development. Under this backdrop, some people make wild accusations against China, suggesting that the PLA made cyber raids against the Pentagon," said Jiang. "Hacking is a global issue and China is a frequent victim in this regard. China is ready to enhance co-operation with other countries including the US in coun