The Trump-Xi Summit Paves the Way to New Realism in US-Chinese Trade

April 12, 2017

Despite preliminary pessimism, the Trump-Xi Summit showed greater trade pragmatism than initially expected, even though it was overshadowed by a raw display of US military power.

President Donald Trump says he developed a “friendship” with President Xi Jinping at Mar-a-Lago. However, US missile attacks against Bashar al-Assad’s forces in Syria overshadowed the meeting. Apparently, the White House hoped to kill two birds with one stone: to show to al-Assad who was in control and to Xi what might happen to North Korea if China would not intervene more decisively.

In the process, geopolitics cast a shadow over the meeting’s economic agenda, which had evolved after December when State Councilor Yang Jiechi visited Trump Tower and spoke about Chinese core interests. A day later, Trump talked on the phone with Taiwanese President Tsai Ing-wen and suggested that decades-old one-China policy could be used as a bargaining chip.

Apparently, the White House hoped to kill two birds with one stone: to show to al-Assad who was in control and to Xi what might happen to North Korea if China would not intervene more decisively.

After a bilateral rhetoric tit-for-tat, Washington and Beijing began efforts to reduce tensions and a complementary channel was opened by China’s US ambassador Cui Tiankai with Jared Kushner, Trump’s son-in-law and trusted senior adviser. In February, these efforts led to Trump’s re-affirmation of the one-China policy and in March Secretary of State Rex Tillerson’s Beijing visit where he described the basis for US-China ties as “non-conflict, non-confrontation, mutual respect, and win-win cooperation”. While Democratic and Republican critics saw it as a sign of appeasement, optimists saw it a new bilateral opening.

The stakes are huge. Starting with Deng Xiaoping’s economic reforms, US-China merchandise trade has grown from $2 billion in 1979 to $579 billion in 2016. Today, China is the US’s second-largest merchandise trading partner, third-largest export market, and biggest source of imports.

White House Divided

During the campaign, Trump threatened to use 35-45% import tariffs against those nations that have a significant trade surplus with the US. In the White House, his team has floated 10% tariffs. To signal determination, Trump’s trade warriors – the head of the National Trade Council Peter Navarro, US Trade Representative Robert Lighthizer, trade advisor CEO Dan DiMicco and Secretary of Commerce Wilbur Ross – have singled out nations that have large trade surplus with the US. In 2016, the deficit list was topped by China ($347 billion), Japan ($69 billion), Germany ($65 billion), Mexico ($63 billion), and Canada ($11 billion).

In substance, Trump’s bilateral deficit obsession is a relic from the mercantilist era. Historically, US trade deficits began in the 1970s, not with China’s rise in the 2000s. Moreover, these deficits are multilateral, not bilateral. They have prevailed more than four decades with Asia; first with Japan, then with the newly-industrialised Asian tigers and more recently with China and emerging Asia. However, since Trump won the presidency with his mercantilist rhetoric, he needs perceived deficit concessions.

At Mar-a-Lago, besides the Trump-Xi talks, US cabinet officials held meetings with their Chinese counterparts. Led by the Treasury Secretary Steve Mnuchin, the economic teams had a breakfast meeting on Friday, while a trade meeting included Commerce Secretary Wilbur Ross and Director of the National Economic Council Gary Cohn. It was a Goldman Sachs play. Cohn is the investment bank’s former president; Mnuchin, its former hedge fund manager. The two support a tough but more cooperative approach with China.

It is a not-so-secret-secret that the White House’s advisers have been split by internal battles between those Trump advisers (Navarro, DiMicco), who advocate aggressive measures to challenge China on trade, and their opponents (Mnuchin, Cohn), who prefer a moderate tone. While sympathetic to the trade hawks, Ross leans onto the moderates. Like Trump, they know only too well that short-term wins in trade battles could easily be undermined by long-term friction in bilateral relations that could hurt vital US fiscal, monetary, defense and security interests.

Toward Bilateral Investment Treaty

By 2015, barely 1% of the stock of US FDI abroad was in China. But things are changing. After US investment in China peaked at more than $20 billion in 2008, it has stayed around $12-$15 billion annually. In the same time period, China’s investment in the US soared from a few hundred million dollars to $15 billion in 2015, tripling to $45 billion in 2016.

Since 2008, Washington and Beijing have been in talks about a Bilateral Investment Treaty (BIT) to expand investment opportunities in the two countries. While the original goal was to complete an agreement by the end of President Obama’s second term, the latter’s geopolitical plays undermined the investment objective.

Somewhat like China’s membership in the World Trade Organization (WTO) in 2001, China’s pursuit of a BIT with the US offers domestic gains as well. It could accelerate structural economic reforms in the mainland and is very much in line with President Xi’s medium-term goals and the rebalancing of the Chinese economy.

While the BIT would certainly facilitate investments in the two nations, it would support Trump’s infrastructure initiatives. Nevertheless, the Trump administration would have to portray it as a trade pact that would not result in US jobs being offshored to China.

One possible bilateral scenario that has been discussed involves Chinese investment in US infrastructure, including bridges, roads and airports. Beijing is interested in such prospects, but the Trump administration would still have to reconcile such ideas with its “Buy America” doctrines.

While the BIT would certainly facilitate investments in the two nations, it would support Trump’s infrastructure initiatives. Nevertheless, the Trump administration would have to portray it as a trade pact that would not result in US jobs being offshored to China.

Toward a Compromise Trajectory

Before the Summit, the White House hoped President Xi would in some way address Trump’s concerns about the US trade deficit with China. For instance, Beijing has pledged to reduce overcapacity in steel, but the central government has not yet engaged in broad plant closures. Instead, local governments, which depend on factories for taxes and employment, still maintain substantial production levels.

If these issues were addressed behind closed doors, the Chinese negotiators may have reassured the Trump advisers that broad-scale plant closures are in the agenda but that likely to ensue only after the Chinese politburo summit in the fall.

Tough economic reforms require political consensus in both China and the US.

Like the Reagan administration did with Japan in the 1980s, the Trump administration may also have hoped for a deal in which China would “voluntarily” agree to limit production and exports to carry out its pledges about overcapacity and to ease trade tensions. However, China is neither Japan nor dependent on the US alliance system in Asia Pacific, as Japan is. Moreover, US-Chinese trade involves much more than autos and consumer electronics. Consequently, incentives for voluntary restraints are marginal.

After the two-day summit at Mar-a-Lago, the US and China announced a 100-day plan to improve strained trade ties and boost cooperation between two nations. Trump negotiators characterised the first Trump-Xi Summit with references to “positive” chemistry.

Reportedly, China will offer better market access for US financial sector investments, while ending the ban on US beef imports that has been in place almost 15 years. While Washington would like Beijing to lower the 25% tariff on automotive imports, Beijing would like Washington to relax restrictions on advanced technology sales to China. Meanwhile, the Trump administration is preparing an executive order that would probe dumping from foreign companies and could result in tariffs, while steel and aluminum will be targeted.

While such concessions represent relatively modest progress in bilateral relations, Commerce Secretary Ross believes both sides agreed to speed up trade talks to recalibrate their bilateral imbalance: “This may be ambitious, but it’s a big sea change in the pace of discussions.”

Dialogue Matters

Before the Trump-Xi Summit, some felt it was premature and could undermine recent progress in bilateral relations. Others saw the meeting as a window of opportunity that should not be missed – as happened in 2013 in Sunnylands, California, when Obama rejected Xi’s offer of “new type of major power relations”.

As Xi said at Mar-a-Lago: “There are a thousand reasons to make the Sino-US relationship work, and no reason to break it.”

The simple reality is that, without efforts at stabilisation in the US-Sino relationship, aggressive bilateral rhetoric could derail more than four decades of bilateral normalisation. As Xi said at Mar-a-Lago: “There are a thousand reasons to make the Sino-US relationship work, and no reason to break it.”

That’s where the Trump-Xi Summit did succeed – it paved a way for a sustained dialogue and potential compromise trajectories, despite differences.

Featured image: US President Donald Trump and Chinese President Xi Jinping at the Mar-a-Lago © AFP

The original version was published by China-US Focus on April 11, 2017.

Go to top

About the Author

Dan Steinbock is the Founder of Difference Group and has served as Research Director of International Business at the India China and America Institute (US) and a Visiting Fellow at the Shanghai Institutes for International Studies (China) and the EU Centre (Singapore). For more, see http://www.differencegroup.net

Trade is Slowing Down: What Does This Imply for Globalisation and Public Policy?

April 9, 2017

By Danny Leipziger

The phenomenon of slower world trade growth coincides with new protectionist sentiment and challenges to the view that globalisation is welfare-enhancing, fair, and consistent with national economic objectives. Public policy will need to adjust to these changes in the global economy and in the global dialogue.

As is widely reported by the IMF and others, global trade is growing at a far slower pace since 2012 than at any time in the previous 30 years. This is all the more worrying since economic growth itself has been anemic since the Great Recession and current forecasts are not terribly ebullient. Do these factors spell doom for globalisation as we have come to experience it? Is this further validation of the “Realpolitik” of more vigorous pursuit of national economic interest as noted by Prof. Dani Rodrik in his Globalization Paradox (2011)? Let’s first take a look at the slowdown in world trade.

According to IMF’s World Economic Outlook (October 2016), the fall-off in trade values can potentially be traced back to cyclical factors such as the slowdown in global investment as well as the re-balancing in China, if one looks at the demand side. The WEO claims that three-fourths of the trade slowdown can be attributed to weaker economic activity and a subdued investment picture. This may also include the indirect effects of a levelling off in logistics improvements. More interesting, however, is the claim that there has been a marked shift in Global Value Chains, namely, that the process of off-shoring may have reached its limits.

According to IMF’s World Economic Outlook (October 2016),there has been a marked shift in Global Value Chains, namely, that the process of off-shoring may have reached its limits.

If we dig further than the recent global under-performance of economic growth as a result of near-recession in Europe, slower growth in China and other BRICS, and a reluctance of consumers to spend, businesses to invest and governments to pursue fiscal expansions, we need to look at the composition of trade itself. An important 2015 IMF working paper by Constantinescu, Mattoo, and Ruta (WP/15/6) seeks to find the roots of the trade slowdown in structural forces, concluding that at least half the recent slowdown stems from a now lower elasticity of trade to GNP than observed in the 2000s. Moreover, this follows a declining pattern seen in the first decade of the 2000s as compared with the 1990s, where in the US and even in China, the trade to income relationship has declined. The same researchers then attribute much of this decline not to a change in trade composition per se, but rather to a fall in the tradable component of manufactures.

If indeed, China’s rebalancing involves a re-retrenchment in its own import basket, and new and potentially disruptive technologies begin to offset the cost advantages normally associated with global value chains (GVCs), then the process of de-globalisation has already begun. This can only be further accelerated by populist rhetoric that blames trade for the majority of job losses in the US, still the most vibrant and open market, as well as the anti-centrifugal forces inside the EU that seem to be in play post Brexit.

What can be the logical consequences of these phenomena that seem to be moving in a singular direction? First, again drawing on Constantinescu et al, there is a sense that we have passed the peak in terms of trade driven by GVCs and that a retrenchment of production is already well underway. These authors present data showing a marked decline in the rate of growth of foreign value added to domestic value added in global exports, indicating that the expansion of global supply chains is faltering. This process implies that domestic sources of growth will become more important in future, which could provide some relief to industries that are struggling to compete; however, the great risk is that this will produce disguised protectionism. The only antidote to this phenomenon is vibrant competition and markets that are truly contestable and exhibit low barriers to entry.

We are already seeing signs of protectionism in various guises in the EU, whether actions against Uber or others; and market concentration in many sectors has arguably increased due to scale economies. The only way to counteract these forces is to allow for vigorous competition, such as that provided by new technologies. This disruption will cause greater stress in labour markets, however, and trade will not be the culprit. As we see from the work of Autor, Dorn and Hanson (NBER, 2013), job losses in the US can be ascribed much more to technological factors than to rising imports, although there is no doubt that some job displacement did occur. Public policy will need to come to grips with the problem through more effective active labour policies, more redistributive social policies, and greater opportunities to reskill and grab new employment opportunities. For globalisation to continue, albeit at a slower pace, we will need to see the income inequality that it produces and was presaged by Professor Joseph Stiglitz in his Globalization and Its Discontents (1999) dealt with by both business practices and public policy.

The solution lies in more enlightened and more effective national economic policies combined with a halt to the rampant abuse of globalisation by firms engaging in tax avoidance, creative transfer pricing and tax inversions.

The business community will have to weigh the tradeoffs between policies that park profits offshore against the threats of protectionism that may be enacted to offset the financial tax losses and severely disrupt GVCs. Governments will have to weigh the benefits for their consumers of low-cost imports versus the costs of adjustment assistance policies or employment incentives to deal with those adversely affected. Imposing new protectionist measures is the worst option since tariffs are largely regressive, affecting the bottom of the income distribution the most. Nevertheless, since the benefits of more open trade involve widely dispersed and long-term welfare gains, whereas labour dislocation is narrowly focused and immediate in its negative impact, the policy dilemma is clear.

What is increasingly evident as well is that trade-related job losses may in the end be dwarfed by technology-induced employment disruption. The latest McKinsey Global Institute study (A Future that Works, January 2017) showing that about half the occupations involve tasks or activities that are at least 40% automatable should reinforce the public policy priority for re-skilling the workforce and dealing in a more pro-active way with declining industries and increasingly declining service industries. While this process will take time, we are already confronted by a populist backlash in the US, so that policy measures need to be addressed with a sense of urgency. This points the globalisation dial squarely at national policies.

The essence of the problem rests in my view in poorly designed, poorly articulated, and largely incoherent national economic policies. In the context of the argument put forward in Rodrik’s trilemma, where countries are obliged to choose among national goals, hyper-globalisation and democracy to pick two out of three objectives, de-globalisation will not solve this problem. Rather the solution lies in more enlightened and more effective national economic policies combined with a halt to the rampant abuse of globalisation by firms engaging in tax avoidance, creative transfer pricing and tax inversions. Without reforms in both corporate and public policies, we will witness a retreat from globalisation that will be costly to many.

Without reforms in both corporate and public policies, we will witness a retreat from globalisation that will be costly to many.

We are already seeing aspects of de-globalisation in the trade slowdown precipitated by the lackadaisical response to the Great Recession, the slowdown and retrenchment occurring in China, and the end of the expanded logistics revolution. In the newer digital world in which products may not need to cross national borders so frequently and in which localised production techniques can be cost-effective, globalisation is already in retreat. If we add to this picture new increased protectionist measures, fuelled by growing concerns about joblessness and worsening income inequality, we may see that retreat accelerate.

It is for this reason that public policy and corporate policy need to be in better sync and why a more far-sighted view needs to be taken with respect to business decision-making. Since very few businesses will act in the long-run interest (Akerloff and Shiller, Animal Spirits, 2009), it will fall on public policies, namely, effective of incentives and dis-incentives, to deal with the effects of disruptive technologies, defences against protectionism, and a healthier perspective on globalisation.

Go to top

About the Author

Dr. Leipziger is Professor of International Business and International Affairs at George Washington University, where he concurrently is Managing Director of the Growth Dialogue. A former Vice President of the World Bank and Vice Chair of the Spence Commission on Growth and Development, Dr. Leipziger is a prolific author of books, journal articles, and think-pieces on economic growth, development and finance. In his book with Prof. Antonio Estache, Stuck in the Middle (Brookings, 2009), he was early to recognise the plight of the middle class and the threats to globalisation if fiscal and social policies did not deal effectively with the growing income inequality in the US. Dr. Leipziger is a Member of the WEF Futures Council on Growth and Social Inclusion, and he is a frequent media contributor.

The Growth Dialogue is an independent think-tank, a voice dedicated to working on policies of inclusive and sustainable economic growth and aimed at providing support and advice to both governments and institutions. It is a successor to the Spence Commission on Growth and Development. Its recent work has focused on urbanisation and city-led growth, growth and inequality, and the impact of disruptive technologies on shared growth objectives. For more on its activities, see www.growthdialogue.org.

Brexit and the Banks: Fight or Flight?

April 9, 2017

By Barbara Casu

This article discusses the key implications of Brexit for the UK financial services industry, looking at the differences between: membership vs. access; passporting rights vs. equivalence principle; customs union vs. free trade agreement. While negotiations have yet to start, the attractiveness of London as the European finance capital has started to lose some of its shine as banks announce relocation plans.

Even though Article 50 has yet to be officially triggered by the UK government, the decision to leave the European Union (EU) seems to have gathered momentum, as the UK parliament has supported the government’s European Union Bill, by 498 votes to 114 on February 1, 2017.

Article 50 of the Treaty on European Union (the Treaty of Lisbon) is a part of EU law that sets out the process by which member states may withdraw from the EU. While the notification is expected to take place by the end of March 2017, the British Prime Minister, Theresa May, has clarified – to a certain extent – the UK’s negotiating position. This position has become known as “Hard Brexit”, given that it seems likely to entail not only exit from the EU but also exit from the EU Single Market and, possibly, from the EU Customs Union (EUCU). The direction of travel seems a little clearer than it was in the immediate aftermath of the referendum on June 23, 2016; however the hopes of the UK financial industry to retain passporting rights seem to have been dashed. What are the implications of a “Hard Brexit” for the UK financial industry?

The European Union, the Single Market and the Customs Union

The European Union was formally established in 1993 by the Maastricht Treaty; although its history dates back to the post World War II period. The current constitutional basis of the EU is the Lisbon Treaty, which came into force in 2009. Membership of the EU has grown through a number of enlargements to the current 28 countries. Nowadays, it is the largest integrated economic area in the world, accounting for more than 20% of the world’s GDP.¹

The signing of the Maastricht Treaty also marked the official start of the EU Single Market project, which led to the establishment of the single currency, the euro, and of the European Central Bank (ECB) in 1999. The Single Market refers to the EU as one territory, without any internal borders or other regulatory obstacles to the free movement of goods and services. It accounts for around 500 million consumers and 21 million small and medium-sized enterprises (SMEs). The free movement of goods is one of the four freedoms of the Single Market. The other three fundamental freedoms are: the freedom of movement for workers; the right of establishment and freedom to provide services and the free movement of capital. The Single Market requires acceptance of all four freedoms, as this is necessary to obtain a level playing field. In this respect, the Single Market goes beyond a free trade area and, as a consequence, the benefits of membership go beyond those of access to the Single Market. Arguably, most countries in the world have access to the EU as an export destination; however membership of the Single Market also reduces “non-tariff” barriers in a way that no existing trade deal, customs union or free trade area does. The benefits of EU membership are large and substantially outweigh the costs. A recent study estimates, on a country-by-country basis, the benefits from joining the EU in terms of economic growth and productivity. Using a methodology known as SCM (synthetic counterfactuals method) the authors provide an estimate of what would have been the per capita GDP if a given country had not become a member of the EU. They suggest substantial and permanent benefits, concluding that the positive pay-offs of EU membership are clearly above the direct costs.²

It is now likely that the UK will seek a type of free trade agreement (FTA) with the EU. While FTA might mean better access to the Single Market relative to a situation with no FTA, such a deal will be difficult to achieve, it will be enormously time-consuming and will not replicate the kind of access currently enjoyed by membership.

Financial services are key beneficiaries of Single Market membership; for the UK this is particularly important as financial services account for 8 percent of the value created in the UK economy, 7 percent of tax receipts from earnings and corporate profits, and 65 percent of the UK’s service trade surplus.³

Membership of the Single Market enables financial institutions established in any EU country – either EU owned or EU subsidiaries of foreign banks – to establish branches or carry out cross-border activity in the rest of the EU and in the European Economic Area (EEA) countries. The single banking licence (or passport), first introduced by the Second Banking Co-ordination Directive in 1989, is now enshrined in the Capital Requirement directive IV (CRD IV). A number of studies have identified the importance of passporting rights and related benefits, suggesting that the UK financial sector would be disproportionately damaged outside of the Single Market, its output potentially some 7% lower in 2030.⁴ Passporting rights reduce the need to set up local subsidiaries as separate legal entities, thereby reducing the costs involved with applying for a banking licence or authorisation or meeting local regulations.

It is expected that the UK government will seek a bespoke deal for its financial services industry. However, it must be stressed that access to the Single Market for financial services firms from outside of the EEA is unprecedented and none of the existing deals the EU currently has with third countries provide passporting rights. For example, Switzerland’s bilateral agreements with the EU do not cover financial services and Swiss banks have had to establish subsidiaries in the EU.

It is expected that the UK government will seek a bespoke deal for its financial services industry. However, it must be stressed that access to the Single Market for financial services firms from outside of the EEA is unprecedented and none of the existing deals the EU currently has with third countries provide passporting rights.

In addition to leaving the EU and the Single Market, a “Hard Brexit” would also imply leaving the Customs Union. The EU Customs Union came into force in 1992; since then no customs duties are levied on goods travelling within the internal borders between the member states. In addition, unlike a free trade area, members of the Customs Union impose a common external tariff on all goods entering the EU. This implies that the EU negotiates as a single entity in international trade deals. While the latter is often seen as a constraint on British freedom to negotiate trade agreements with third countries on its own terms, it is important to note that the benefits of a Custom Unions cannot not be replicated by a free trade agreement.

Divergent Regulatory Frameworks

It is often argued that Britain and continental Europe have a fundamentally different approach to regulation (the former based on common law, the latter based on civil law); nonetheless, the UK has played a significant role in shaping EU regulation over the past 40 years. The large body of EU law is known as the acquis communautaire, which is the accumulated legislation, legal acts, and court decisions. The acquis is also the outcome of successful negotiations that have introduced flexibility and transparency over a more prescriptive regulatory approach. Brexit supporters have often claimed Britain’s ability to design its own regulatory system as one of the key reasons for the Leave vote. However, questions remain on how different the UK regulatory approach can realistically be going forward. First, as mentioned, British and European views are inextricability linked in the current aquis. It might be that post-Brexit the UK will operate under an increasingly light touch regulation, even though this option entails substantial risks. It is also possible that, as the UK will no longer be able to influence EU regulation, the respective regulatory frameworks will start to diverge substantially. This poses a number of issues for financial services. It is often claimed that even outside the Single Market, UK financial institutions will remain able to provide services within the EU thanks to the “equivalence principle”. This relates to the recognition of a foreign (third country) framework in regulation and supervision, particularly with respect to cross-border provisions. This recognition makes it possible for authorities in the EU to rely on supervised entities’ compliance with the equivalent foreign framework. If UK banks were to lose passporting rights as a result of the Brexit negotiations, one commonly made assumption is that they would benefit from full equivalence, that is the EU will recognise the UK regulatory regime as equivalent to the corresponding EU framework, as UK financial firms’ starting point would be the current EU regulatory framework. However, the range of services covered by the equivalence regimes is more limited compared to passporting rights and can potentially be withdrawn at any time if a country deviates materially from EU standards.

If the aim is to change the UK regulatory framework away from what is perceived as the excessive and over prescriptive EU regulatory burden, it is unlikely that full equivalence will be maintained going forward.

In addition, if the aim is to change the UK regulatory framework away from what is perceived as the excessive and over prescriptive EU regulatory burden, it is unlikely that full equivalence will be maintained going forward. What seems inevitable is a long period of uncertainty, as regulators prepare to shift the regulatory burden from Brussels to London. The legislative task is monumental as well as unprecedented and it is likely to last many years, well beyond the two years horizon so optimistically envisaged by the Leave campaigners. And, even in the unlikely case that a new regulatory regime can be reached seamlessly and timely, UK financial institutions may still find that following EU regulations will be the price of access to the EU markets. As a result, the regulatory landscape is likely to change very little, particularly for internationally active banks. Moreover, these institutions might have to obey two sets of rules, to operate domestically and to operate internationally, which would double the regulatory burden rather than lessen it.

Bankers and Brexit

As the UK government is firming up plans to leave the EU, bankers are making plans of their own, which mostly include leaving London. Several City executives recently confirmed contingency plans to move staff to the EU in view of the possible loss of passporting rights. Banks that have recently announced plans to move from London include JPMorgan, HSBC, UBS and Goldman Sachs. Even the UK based Lloyds Banking Group has considered Frankfurt as its base for maintaining ties to the EU.

Preliminary evidence suggests that, at least in the short run, changes will not be favourable to the UK economy. If there are any benefits to be had for the UK economy, these will take years to materialise.

A number of non-EU financial services firms have significant offices in London; contingency plans might require them to set up subsidiaries in EU countries. This, however, is dependent on the type of business carried out with EU clients and whether a restructuring of the organisation would prove optimal in the long run. The decision to leave the EU will lead firms to reassess their investment choices. Preliminary evidence suggests that, at least in the short run, changes will not be favourable to the UK economy. A recent analysis of the issuances in the UK syndicated loan market show a decrease of 25% after June 2016, relative to a set of comparable syndicated loan markets.⁵ The initial evidence suggests that the impact of Brexit will be substantial. It is rather speculative to try and predict the final effect, as negotiations are yet to start. If there are any benefits to be had for the UK economy, these will take years to materialise. The workload to disentangle from the EU and chart a new course is overwhelming.

Go to top

About the Author

Barbara Casu is the Director of the Centre for Banking Research at Cass Business School, City, University of London, UK, where she is Professor of Banking. Her main research interest is empirical banking, although several of Barbara’s research projects are cross-disciplinary and include aspects of financial regulation, structured finance, accounting and corporate governance.

References

1.Beck, T. and Casu, B. (2017) The Palgrave Handbook of European Banking. Palgrave, London. Chapter 1, An Overview of European Banking.

2.Campos, N., Coricelli, F., and Moretti, L. (2016), “Economic Growth and Political Integration: Estimating the Benefits from Membership in the European Union Using Synthetic Counterfactuals”, mimeo.

3.The Institute for Financial Studies (2016) The EU Single Market: The Value of Membership versus Access to the UK. August 2016

4.Centre for Economics and Business Research (CEBR), 2016. https://www.cebr.com/reports/how-the-uk-economys-key-sectors
-link-to-the-eus-single-market/

5.Berg, T., Saunders, A., Schäfer, L., and Steffen, S. (2016) “Brexit and the Contraction of Syndicated Lending” mimeo.

Return of Sovereign France

April 9, 2017

By Dan Steinbock

In France, President Hollande’s utter failure to foster broad consensus for structural reforms has paved the way for a contested election. While public debate focuses on Emmanuel Macron as the saviour of France, the real story is that Marine Le Pen’s agenda has shifted the French political landscape.

Before TV debates, the French presidential election featured 3-4 viable candidates, which together accounted for 85-90 percent of the total vote. Until recently, the leader of the Front National, Marine Le Pen, and the centrist Emmanuel Macron, have garnered about 25 percent in the polls, followed by the centre-right François Fillon (20%), and the socialist Benoît Hamon (15%).

After merciless campaigns, scandals and mud-slinging, Macron has a very slight lead among first-round voters (27%), ahead of Marine Le Pen (26%) and Fillon (17%), while socialist Hamon has lost ground for far-left Jean-Luc Melenchon (12% each). French voters go the polls on April 23 and May 7 in the two-round election. Since no candidate can garner absolute majority in the first round, it is the second round that really matters. And in that race, Macron (64%) seems to have an overwhelming lead against Le Pen (36%).

Even if Le Pen would win the first round, she would face great odds in the second. Yet, in one sense, she has already won. In France, the political future belongs to her agenda (see Box: ÉLYSÉE PALACE’S NEW AGENDA ).

Macron’s Stance – and Funders

Emmanuel Macron’s (40) current tie with or slight lead against Le Pen in polls is not based on his perceived success. His stint in Hollande’s government as a business-friendly economy minister alienated most socialists while failing to win over most conservatives, not to speak of the French majority. However, as Fillon has been swept by an embezzlement debacle and socialists have failed to put up a fight, Macron is pretty much all that’s left from the old French centre-right elite.

Politically, Macron is a proponent of a “third way”. To him, political right and political left have less importance in the contemporary world. What matters is economic pragmatism. Like his heroes, Tony Blair in the UK and Bill and Hillary Clinton in the US, Macron advocates whatever is expedient, from Rotschild’s neoliberal profits to Hollande’s bureaucratic socialism. Over time, he may share the ultimate fate of Blair and the Clintons: initial excitement followed by disillusion and resentment.

In reality, Macron is a typical product of the elitist École nationale d’administration (ENA). After a stint as an investment banker at Rotschild & Cie Banque, he served in Hollande’s socialist governments, where he advocated business-friendly reforms that undermined Hollande’s support among the government’s socialist constituencies, while fostering Macron’s clout among the socialist opposition and big business.

Married with his 24 year older high school teacher he first met at 15, Macron’s personal life and policy stances remain equally ambiguous. Last November, he declared that he would launch a social liberal bid under the banner of his new movement En Marche!. By design, the name of the party shares Macron’s initials. He likes to portray it as a “social liberal party” to attract the centre-right movement, and a “progressive movement” to court Le Pen’s supporters and socialist dissidents.

In reality, En Marche! is a one-man façade. It is registered at the address of Laurent Bigorgne, director of Institut Montaigne director. It was launched with people representing corporate giants, such as the commercial real estate titan Unibail-Rodamco, the international banking behemoth BNP Paribas, and the aerospace mammoth Safran. The Paris-based Institut Montaigne promotes competitiveness and social cohesion. It was founded by millionaire Claude Bébéar, former CEO of AXA, the French multinational insurance, investment and financial colossus, which is funded by the likes of Allianz, Bank of America Merrill Lynch, BNP Paribas, Capgemini, IBM France, McKinsey & Company, Microsoft France, and, of course, Macron’s former employer, Rothschild & Cie Banque.

Macron needed a new platform because he had alienated socialists while failing to gain enough support among conservatives. He is the ultimate Europhile and federalist. He supports integration and structural reforms. In controversies about immigration, secularism, security and terrorism, Macron has favoured a balancing act – one that is well-aligned with the ideological position of Institut Montaigne.

His real political success has been the ability to pick up endorsements from both center-right and – left, including from François Bayrou of the Democratic Movement, EU parliament member Daniel Cohn-Bendit, the leftist ecologist candidate François de Rugy, and Socialist parliament member Richard Ferrand.

Who’s Afraid of Marine Le Pen

Marine Le Pen (49) is the youngest daughter of the veteran FN leader Jean-Marie Le Pen, a French far-right politician who supported euro-skepticism, opposed immigration and pushed for law and order, traditional culture and values. As long as he led the FN, it was a marginal far-right, anti-Semitic party with politically incorrect neo-Nazi associations. In the past decade, Marine Le Pen has successfully “mainstreamed” FN away from the margins and extremism. Nevertheless, since major French banks oppose her political platform, she has had difficulties funding her campaign.

In her campaign, Le Pen has supported traditional values, law and order, while opposing immigration and the EU. As her campaign kicked off, she reaffirmed the FN’s anti-immigration, protectionist and anti-EU stance. “The divide is not between the left and right anymore, but between patriots and globalists,” she said. “Financial globalisation and Islamist globalisation are supporting each other. Those two ideologies want to bring France to its knees.”

Le Pen wants to pull out of the Euro and a return to French franc, a referendum on EU membership within 6 months, and taxes on imports and the employment of foreigners in France. Building on Gaullist legacies, she is a critic of and wants to pull France out of the NATO. She would like to revise French relations with the US and has denounced French bandwagoning toward Washington. Her France would be more independent in the international arena. She would rely on neo-gaullist geopolitics in the new multipolar world.

In the coming weeks, Macron will portray her as a threat to France, and chaos to the European Union, with support by centre-right and conservative media in France and US-based international business media. Indirectly, this portrayal will be fostered by Hamon and Melenchon who will paint her in far darker colours since socialists and far-left share blue-collar worker constituencies with the Front National.

The Other Anti-Pen Musketeers

Born into privilege, François Fillon (63) became nationally known as President Sarkozy’s Prime Minister. He represents conservative Republicans (Sarkozy’s former Union for a Popular Movement, UPM). Years ago – a long time before Macron’s failed attempts – Fillon undertook controversial reforms of the labour code and the retirement system.

Unlike the “Europhile” Macron, Fillon is the ultimate “Anglophile”, a French Thatcherite who would like to balance the budget and abolish the wealth tax. He would raise retirement age to 65 and reduce the public sector by cutting half a million civil-service jobs. He is the man the socialists love to hate and that is too sincere for Macron’s financiers. They need somebody who shares Fillon’s economic policy tenets but could implement them without public opposition and street fights.

In foreign affairs, Fillon is tough about immigration, Islamic radicalism and terrorism. But like Thatcher, he is also a great believer in realpolitik and has called for dialogue with al-Assad’s Syria and Putin. While Fillon stands for the West, he sees the expansion of NATO to Russia’s borders in the 1990s as a provocation that was bound to alienate Moscow and foster redundant friction. These stances have made him unpopular in neoconservative Washington.

Last fall, Fillon still appealed to the conservative “silent majority” but that was before a widening investigation following charges that he had paid his wife and children almost 1 million euros from the public payroll for no work. While he attributed blame to a “political assassination”, magistrates recently found him under formal investigation for embezzling state funds. As a result, his polls are fizzling.

Until recently, the third viable candidate was Benoît Hamon (49), a French socialist (PS) who defeated the centrist and business-friendly Manuel Valls in the party primaries. While Harmon is portrayed as a new figure, a sort of “Youtube Guevara”, he is actually a veteran party bureaucrat and has served in the European Parliament (2004-9), and as Hollande’s Junior Minister for the Social Economy (2012-4) and Minister of National Education (2014). He supports a basic income to all French citizens, a 35-hour workweek, legalisation of cannabis and euthanasia, and huge investments in renewable energy.

Hamon is critical of neoliberal economic policies and the NATO. He represents the left wing of the PS and is an admirer of US Democrat Bernie Sanders. That’s not enough for the French old left, which sees him as too malleable. The far-left Jean-Luc Mélenchon, who heads the new “Unsubmissive France”, would like France to leave both the euro and NATO. As Hamon’s ratings have slightly eroded, those of Mélenchon have slightly increased.

Together, the two could battle either Macron or Le Pen, or both. But that would require a unified left and viable appeal in centre-right.

Economic Erosion Prevails

The nerve-racking French election is the direct result of half a decade of policy failures, which climaxed last summer in a failed effort to reform the French labour code. It was not the first time. Years ago, huge strikes forced President Chirac to back down from proposed changes in the pension system. Similar strikes led to fierce union opposition when President Sarkozy raised the retirement age. But under Hollande, a socialist government was pitted against unions and the far-left, which fostered apprehension, disappointment and fragmentation in the left.

When Hollande replaced the conservative Sarkozy as the French president in May 2012, his popularity hovered at around 58 percent. By late 2016, Hollande’s ratings had plunged to less than 5 percent. While France cannot avoid the overhaul of its labour legislation in the future, a socialist president cannot drive a neoliberal labour agenda. That’s the lesson of Hollande’s fall.

After half a decade of near-stagnation, French economy has been benefiting from a cyclical rebound, thanks to a more accommodative external environment, especially lower oil prices, a depreciated euro, record low interest rates and the European Central Bank’s quantitative easing. However, these shifts cannot compensate for France’s longstanding internal rigidities, which overshadow the economy’s medium-term potential.

In the 1980s and 90s, French growth still exceeded 2.2 percent; in the 2000s, it hovered around 1.8 percent; now it is around 1.1 percent and likely to decelerate to less than 1 percent by early 2020s. In the past decade, French competitiveness, as reflected by the country’s share in world export markets, has declined significantly as well. What’s worse, French real wage growth has been solid, despite declining productivity growth. The equation is unsustainable. The implication is that the French economy is penalising future generations for its current distortions.

If the external environment grows still more adverse, while reform progress is hardly evident, French banks, given their size and interconnectedness, could generate adverse effects not just domestically but through spillovers, especially in Italy and emerging Europe.

France remains the world’s sixth largest economy. If it begins to shake, Italy cannot avoid a quake and ailing Eastern European economies could take multiple hits. That, in turn, would have adverse implications across the Eurozone and globally.

ÉLYSÉE PALACE’S NEW AGENDA

By Dan Steinbock

In order to win the election and sustain the victory, the next French president must coopt Le Pen’s agenda.

After Prime Minister Mark Rutte was able to deter the surge of radical-right Geert Wilders in the recent Dutch elections, the EU leaders sighed for relief. In international media, the centre-right Rutte’s win was reported as triumph for “democracy”. In reality, it was boosted by his appeal to Dutch ethnocentrism. After months behind Wilders in polls, Rutte stated that he shared feelings of those who thought that people who “refuse to adapt and criticise our values should “behave normally, or go away”. The pre-election clash between the Netherlands and Turkey allowed Rutte also to play the same card internationally. The tacit signal was: Why would you want to vote for Wildeers, if I can deliver the same goods?

The real story of the French election is not whether the winner is Macron, but that the winning agenda has been re-defined by the rise of Marine Le Pen.

Less Integrated Europe, Ah Oui!

Domestically, the new president will struggle to push for (subdued) structural reforms with or without the consent of the unions, while taking a stricter view of immigration and a tougher stance against Islamic fundamentalism.

France will have a more critical stance toward further EU integration, and the euro, which the French voters now share from centre-right to centre-left. In practice, that means a “multi-speed Europe”, in which one size will not fit all, while uneven development will increase. Integration will make room for fragmentation, which will be called “differentiation” because the latter sounds better.

As Hollande himself recently acknowledged: “For a long time, the idea of a differentiated Europe, with different speeds and distinct paces to progress, has provoked a lot of resistance. But today this idea is necessary. Otherwise, Europe will explode.”

In Brussels, Macron is seen as a potential saviour of France and the EU. The greatest fear of the EU leaders involves Le Pen’s quest to unilaterally take France out of the Euro in 6 months, which would be followed by the effective redenomination of €1.7 trillion of French public debt into francs. Since 80 percent of this debt is not under international law, FN would have the right to change the currency.

Unsurprisingly, the international ratings agencies, which are headquartered in the US and the (about to Brexit) UK, have already warned that the net effect would be the largest sovereign default on record, nearly 10 times larger than the €200bn Greek debt restructuring in 2012.

Like biblical prophets, Le Pen’s adversaries have warned that her victory would mean a French Armageddon, the plunge of euro, and chaos in the world financial system. In contrast, Le Pen’s economic advisers argue that reintroducing a national currency would allow French franc to fall in value against the euro. That, in turn, would lower France’s total debt burden and permit Paris to begin competitive devaluation.

After all, Le Pen might say, isn’t that something Americans have excelled for decades? The franc served the French well for centuries, while the euro has caused the French and many other European economies one nightmare after another after just one decade, she might add, If Le Pen wins, Paris will also start a process that could ultimately result in a “Frexit”. That’s something that would be unthinkable to the Europhile Macron.

More Independence in Foreign Policy

Like her supporters in right and left, Le Pen believes in French patriotism that relies on a sovereign state that is not reliant on conservative capital, socialist class struggle or Washington’s neoconservative tutelage. That’s classic Gaullism, which stresses national sovereignty and unity. Macron would not use the same terms, but he does emphasise French national interest, along with EU federalism.

Neither De Gaulle nor the Gaullists supported Europe as a supranational entity. However, they favoured European integration as a confederation of sovereign states engaged in common policy, and autonomous from the superpowers, such as the United States and the bygone Soviet Union. That project failed as other European powers chose to remain closely allied to Washington. While all French candidates see France among the West, none advocate Sarkozy-like reliance on Washington any more.

In foreign policy, the new president will be more cooperative with Russia and President Putin, from the Middle East to Ukraine and energy issues. While France may actually invest more in defense spending, Gaullism is predicated on greater skepticism toward the NATO and harder push for French national priorities.

In foreign policy, Macron is closest to Washington and his team has suggested that Russia may be intervening in the French election. Other candidates do not share his view and France is not as vulnerable to Russophobia as the United States. Furthermore, recent Wikileaks disclosures suggest that it is not so much Moscow that Paris should be concerned about – but Washington.

US Efforts to Shape French elections

In the 2012 French presidential election – as classified CIA “tasking orders” indicate – the agency engaged in a spying campaign ahead of the election. The documents reveal that all major French political parties were targeted for infiltration by the CIA’s human and electronic spies in the seven months leading up to France’s 2012 presidential election. According to the most recent WikiLeaks documents, televisions, smartphones and even anti-virus software are all vulnerable to CIA hacking, which makes any effort to shape the outcome of the impending elections and referendums in Europe relatively easy.

There is no reason to presume that these practices have changed. Washington and Pentagon favour pro-NATO candidates and will walk the talk. However, the two also tend to like candidates, who portray themselves as “beyond left and right”, as Macron has done, but who understand the US interests. That’s what he proved already in 2012 when he joined the pro-US French-American Foundation (FAF). It is a think-tank that was launched by the US-based Council on Foreign Affairs in the 1970s to counter anti-French sentiment in the US and anti-Americanism among the French elite.

As a FAF “Young Leader”, Macron is walking in the footprints of Bill and Hillary Clinton in the US, and president Hollande and former prime minister Alain Juppé in France. Unlike Le Pen who wants more independence, or Fillon who believes in realpolitik, not to speak of anti-NATO socialists, only Macron is seen as a proven quantity in Washington.

Featured Image: French far-right presidential candidate Marine Le Pen gives a campaign speech in Lyon on February 5, 2017 © Jeff Pachoud, AFP
http://www.france24.com/en/20170205-france-marine-le-pen-far-right-speech-brexit-trump-immigration-lyon

Go to top

About the Author

Dr. Dan Steinbock is an internationally recognised expert of the nascent multipolar world. In 2010, he predicted that Brussels opted for misguided policies to overcome the European sovereign debt crisis, which would prolong rather than resolve the challenges. In spring 2016, he forecast the UK Brexit and the outcome of the Italian referendum.

Dr. Steinbock is the founder of DifferenceGroup. He has served as Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see www.differencegroup.net

Salespeople: A Canary in the Economic Coal Mine

April 9, 2017

By Ben Laker and Nicholas Read

Since 2008, sales performance was restored to a modicum of health. But the metrics are starting to backtrack again. Solving the problem requires a reboot of interdependencies across a wide gamut of sales, marketing, support, technology and compensation issues – a field rarely owned by a single executive and therefore difficult to pull off.

Findings from our recent sales research are concerning, and suggest that a decline in global sales effectiveness will trigger another downward economic cycle.

If company policy is to stop hiring in a tough market, sales managers are bound by the same rules and told to make do with what they have or lose the headcount. This draconian policy flies in the face of every assembled statistic that shows a sales team that is pruned and replenished annually remains more competitive than those where the weeds are allowed to grow.

Those managers lucky enough to have open slots find the average time for a new salesperson to become profitable is almost eight months. This means where sales reps were given a 3-6 month probation to prove their worth, managers saw trees axed just as they were about to bear fruit.

Often the wrong person is hired into an open sales role. There are several reasons. Cronyism, lack of inspection, or being under time pressure to fill the slot rate high. Then there’s the coup of departments managing to transfer their own problem children to “try their hand at selling”, which amounts to a high-risk game of musical chairs.

A poor recruitment choice will cost an organisation 1.8 times the direct salary of the non-performing salesperson.

Whatever the cause, a poor recruitment choice will cost an organisation 1.8 times the direct salary of the non-performing salesperson. This does not include the ancillary costs of training, recruitment, and the drain on the manager’s availability, nor the cost of lost opportunities as a poor seller burns their territory. Some analysts project the total cost of a bad hire is closer to 3X a role’s basic salary.

When an organisation makes a good hiring decision, but the talent leaves in the first year, more than $1 million in enterprise value walks out the door with them. Retention has never been more important, but only if it’s retention of the right people. This is why more companies are adopting psychology-grade competency and behavioural assessments as part of the hiring process: it’s now possible to know if a candidate is a 10% fit or a 90% fit to any product or service sales role.

More companies are adopting psychology-grade competency and behavioural assessments as part of the hiring process

The advances in this field are nothing short of breathtaking in their accuracy, leaving no excuses for talent not working out. Yet more than 86% of companies still cling to the “I’ll know talent when I see it” approach to sales recruiting.

The numbers speak for themselves on how well that’s working. Over the past eight years, performance metrics in the average sales organisation worldwide have plummeted. This doesn’t just affect the end of quarter or fiscal year-end numbers; this collapse is endemic at all stages of the sales process. Is this new? No, we’ve seen this before – in the years immediately preceding the 2008 global financial crisis. And it appears to be happening again.

Back in 2006 a retrospective analysis of sales effectiveness measures showed the number of calls converting into leads had been dropping steadily since 2004. So too were the number of leads converting into first calls or meetings, meetings to presentations, presentations to proposals, and proposals to contracts. Across the end-to-end process, a 97% reduction in effectiveness was recorded.

The salesforces of the world didn’t know it at the time, but the belt-tightening they were fighting in their pipelines was a canary in the economic coalmine, a bellwether of things to come across global markets.

Since 2008, sales performance was restored to a modicum of health. But the metrics are starting to backtrack again.

Buying decisions of large enterprise service or sales solutions now take almost six months to go from “Hi” to “Buy”. Thirty-two percent of sales leaders expect this to lengthen as risk-averse decision-makers take more purchasing decisions by committee.

As sales thinker Neil Rackham commented, “When the economy goes down, the decisions go up.”¹ It may be sage and timely advice.

Another problem area is that the average salesperson spends only one-third of their available time actually selling to customers. The number of calls or meetings needed to move “from contact to contract” is increasing, with 70% of companies reporting that 3 to 9 well-prepared presentations are required to secure major deals. The other 70% of selling time is spent on internal administration and meetings.

As one software president commented: “Using only 30% of our time to sell is like sending salespeople out on January 1 and calling them back on April 20, never to go out again. We pay them to do more non-selling than selling. What’s wrong with this picture?”

Solving the problem requires a reboot of interdependencies across a wide gamut of sales, marketing, support, technology and compensation issues – a field rarely owned by a single executive and therefore difficult to pull off.

The usual remedy is to raise targets and wring more effort out of the salesforce. This might have worked in the past. It won’t work anymore. Here’s why:

A national workplace study conducted across 12,000 executives by a major healthcare brand produced some shocking but irrefutable findings:

• More than 62% of employees feel burned out.

• 57% report low morale.

• 63% are irritated and stressed.

• 56% are exercising less, spending more time at their desk.

• 69% report a serious erosion of their work/life balance, leading to absenteeism, a malady that’s easily obscured by the fact that salespeople don’t always work from the office.

• Most critically, 78% fear they personally lack the capacity to take on any new challenge in the year ahead.²

Consider this last statistic. Before you even hand your salespeople their target for the year, nearly 80% are telling themselves they can’t do it, whatever the number is.

A soon-to-be-published book, The Salesperson’s Secret Code (LID Publishing, 2017), notes that “working harder” is a trait of the bottom five percent of salespeople doomed to remain tactical and reactive, with the belief that the more calls they make, the luckier they’ll get. Perhaps they’re right: even a blind squirrel finds a nut now and then.

Faced with higher team quotas, emotionally detached sellers, better-informed buyers and broken internal processes, sales managers must pick the targets of their attention carefully. They can’t boil the ocean.

Some devolve to “salesperson behaviour”, riding shotgun on every large deal, unwilling to leave anything to chance. Some paint a new veneer of sales training over last year’s varnish. Some performance-manage the life out of their weakest salespeople, making them the team’s sacrificial lambs to explain underperformance. Some round on Marketing and the Inside Sales call centre for not sending better quality leads.

Despite investment in CRM systems, less than 44% of sales opportunities ranked at higher than 75% probability on the forecast are actually closed on time or on target. It is important to note that this isn’t the entire pipeline of opportunities, but those with an assigned revenue value, a close date, and a commit from the salesperson as being closable. Of these, 30% result in a loss and 21% result in “no decision”. The last statistic has been trending upwards in recent years, either the result of insufficient qualification upfront, or inadequate justification at the close.

A related finding is that while it’s taking longer on average to close large deals (146 days) compared to smaller less complex sales (84 days), it takes longer still to report the losses (231 days).

This indicates that salespeople are keeping deals on the forecast longer than the date of the customer’s decision to buy from a competitor or to not buy at all. In some cases this is because the customer hasn’t disclosed their decision, leaving salespeople to chase them for answers in the hope the deal might be resurrected.

Sometimes it’s because salespeople record a new “contact” as a new “opportunity”, even when there is no formal project on the horizon. At other times the anomaly is from salespeople inflating their pipelines to avoid prospecting duty, or by pursuing opportunities incapable of being closed.

When sales managers are asked if they received any formal training on how their new role is different to being a salesperson, 92% disclose their job promotion included an orientation on their reporting and HR responsibilities, yet nothing on how to plan territories, select winners, design compensation plans, or provide coaching and leadership. Most new managers take what they knew as a salesperson, mimic what they saw their old manager do before them, adapt as needed and hope for the best.

When a sales manager invests a minimum of three hours per month coaching their salespeople, the number who hit their end of year target jumps from an average of 46% to 107%.

Improvements in sales management will readily yield high returns. The Sales Executive Council reports that when a sales manager invests a minimum of three hours per month coaching their salespeople, the number who hit their end of year target jumps from an average of 46% to 107%.³ But despite having the science, few follow it.

Implications for Executives

76% of CEOs say they plan to improve their organisation’s sales performance effectiveness in 2017. But 63% cannot define the steps and dependencies of their existing sales process, and of the remaining 37%, a little more than half had confused sales training or CRM with the sales process itself, and so learned they didn’t have a process in place at all.

These statistics confirm that while executives are aware the old world is gone and sales performance needs a reboot, the questions of what and how have not been thought through with anywhere near the level of rigor required. Part of the problem stems from too many junior or mid-level staff with limited sales acumen being placed in roles where they make decisions about the tools, training and steps that salespeople will use on the job.

A final source is that too often, companies abdicate the sovereignty they deserve to map their own sales process, because they hand it over to a piece of software or training vendor they’re buying from, whose methodology or tool becomes a defacto business process in the absence of the company designing one itself.

However, there is hope. Evidence exists that a paradigm shift is underway on what constitutes competitive advantage, with clear implications for the sales process.

Until recently, competitive advantage was thought of in terms of Porter’s model; an amalgam of innovation, labour, product, pricing, routes to market and barriers to entry. In other words, the “what”. Today, it’s shifting to the “how”, and with that CEOs are more interested in having business processes transparent enough to be inspected, improved and sustained. Top-line growth is the new frontier for value creation.

Understanding the end-to-end sales process allows board executives to cut through the veil of mystique, hearsay and false assumptions that too often shroud the sales department, and obtain clarity about what is working and what is not.

Armed with these insights, executives can know which levers to pull, in which direction, and which activities to discard altogether. But they can only do so when they map sales as a mission critical business process and not something that only happens below decks.

Go to top

About the Author

Dr. Ben Laker is a Partner at Transform Performance International who cofounded The Centre of High Performance, a collaboration between Oxford and Kingston University, London Business School and Duke CE senior faculty. He has worked with Apple, NASA, and the New Zealand All-Blacks among others, and has published three Harvard Business Review articles on organisational improvement. His research is described as “Phenomenal” by BBC Newsnight and “Influential” by Thinkers50.

Nicholas Read is a researcher and bestselling sales author, who was formerly Executive Director of Ernst & Young’s revenue growth advisory practice following a career in sales and management. His sales coaching methods have been deployed to more than 40 countries, helping clients win more than £20B more than forecast.

References

Selling to the C-Suite. Read & Bistritz, (McGraw-Hill, 2009)

Human Performance Index. Johnson & Johnson (Wellness & Prevention Inc, 2010).

Building Solutions-Ready Sales Managers. (Sales Executive Council, 2005).

Why Trump’s Anti-Globalisation Agenda is Bad for America

April 9, 2017

By Devashish Mitra

The Trump administration has been capitalising on the “dark-side of globalisation”. However, Devashish Mitra advances that an anti-globalisation campaign might not be the best for the United States. The article is both a critique to current government direction and a call to salvage America.

Globalisation, in all its forms, is under siege from the Trump administration. Importantly and unfortunately, last week’s G-20 financial leaders’ meeting ended without its usual commitment to promote free trade or resist protectionism. On inauguration day itself, the new administration announced that they were pulling out of the Trans-Pacific Partnership and would be renegotiating the North American Free Trade Agreement. Setting aside for the moment that globalisation has lifted over a billion people out of poverty all over the world, making it safer and more secure, here is why anti-globalisation policies are actually bad for America.

The US-led multilateral process of getting rid of trade barriers, initiated after World War II, was motivated, to a large extent, by the terrible interwar experience with escalating worldwide protectionism. This “beggar-thy-neighbour” protectionism, used by several countries on each other, played a significant role in converting a regular recession into the Great Depression. This important lesson, that the rest of the world does not remain passive to any country’s protectionism, has been forgotten while interpreting the recent evidence showing US wage and job losses from trade with Mexico and especially China. Besides, the recent studies don’t take into account the possible increase in automation from restricting trade, as if it is good enough to bring jobs home for American robots.

Trump and his associates have mentioned the possibility of a 20 percent tariff on imports from Mexico to pay for the “wall”

The Trump administration is gearing up to slap higher tariffs on imports. Trump and his associates have mentioned the possibility of a 20 percent tariff on imports from Mexico to pay for the “wall”. During the campaign, Trump also advocated for a 45 percent tariff on imports from China. The alternative to tariffs is the Ryan-Brady border tax adjustment plan, which is potentially more protectionist, but also less transparent. Under this plan, American producers will be given tax exemptions on domestically produced inputs, but not on imported ones. The plan also provides for the deduction of wages while taxing domestic production, without such provision in case of imports. And, export revenues will be totally tax exempt. Thank goodness Trump finds it “too complicated”. He is in favour of plain old tariffs, without any apologies whatsoever.

Whichever form of protection is implemented, it is likely to be challenged at the WTO for US’s failure to honour past commitments. Besides, import protection is going to lead to large-scale destruction of global production networks. It is virtually impossible to find a manufactured product completely made in a single country. The modern production process is divided into many fragments, located in different parts of the world, depending on where each is the cheapest to perform, e.g. low-skill tasks in China but high-skill and research-intensive ones in America. Obviously, this process requires imports of semi-finished goods and inputs produced abroad. Destroying international production networks, through import restrictions, will not take much time. However, the creation of new domestic networks will not happen overnight and will take considerable time. Such networks, if and when completed, will result in much higher costs of production and lower firm profitability than under free trade. Costlier domestic inputs will reduce the ability of American firms to compete in the world market with foreign firms, and, in turn, seriously hurt their exports and production. As a result, many American firms may be thrown out of business and many workers out of their jobs. Thus, protectionist policies, that superficially look job-creating for the US, may end up destroying many American jobs. This argument applies not just to goods but also services that are part of global production networks. There is speculation that the cap on H1-B visas will be reduced and the minimum salary for processing such visas will be raised significantly. This will restrict hiring high-skill workers, brought on these visas, needed to supervise and communicate with service-sector workers in their home country performing tasks located there by global American firms. Thus, apart from being a barrier to skilled immigration, H1-B restrictions will block imports of services, often used as inputs, in combination with domestic US workers, into production by American businesses.

Import protection is going to lead to large-scale destruction of global production networks. It is virtually impossible to find a manufactured product completely made in a single country.

Adding to the administration’s anti-globalisation stance is the flawed argument by their National Trade Council chief that a reduction in trade deficit will increase GDP. In very good times, often the US has had a large trade deficit. The US trade deficit with China means that the goods and services Americans send to the Chinese cannot fully pay for what we get from them. The US pays China for that difference by selling them financial assets, such as US Treasury bills. This means China is lending us money, adding to the supply of loanable funds here and pushing down the cost of borrowing (or the rate of interest). Therefore, restricting or ending trade with China will reduce or stop these “capital inflows” and make borrowing more expensive in the US. Besides hurting home ownership, higher education, domestic investment, entrepreneurship and anything else that requires borrowing money, this will be a big blow to Trump’s infrastructure building plan aimed at creating new jobs, as such a plan can only be financed by government borrowing in the presence of huge proposed tax cuts for the rich.

The solution to our jobs problem is not trade protection but social protection and subsidised higher education.

To conclude, the solution to our jobs problem is not trade protection but social protection and subsidised higher education. Those low-skill manufacturing jobs of the past are not coming back, no matter what the policies are and who the president is. The future of this country is in high-skill jobs, for which we need more government investment in higher education and worker retraining. We also need a more generous unemployment insurance system, along with a robust system of wage insurance, with a wide coverage, that partially makes up for the lower wage in the new job that a worker might have to take up, in case technological change or globalisation ends up destroying her old job.

Featured image: Republican U.S. presidential nominee Donald Trump holds a campaign rally in West Bend, Wisconsin August 16, 2016. © Eric Thayer / Reuters

Go to top

About the Author

Devashish Mitra is Professor of Economics and Gerald B. and Daphna Cramer Professor of Global Affairs at the Maxwell School of Citizenship & Public Affairs, Syracuse University.

China Down: The Weight of the Past on China’s Struggle for Development

April 5, 2017

By Richard Westra

Dr. Richard Westra historically contextualises China’s 21^stcentury meteoric growth in terms of its post World War II socialist development and the particular modalities of the post 1978 market reform process. It is argued that no state can free itself from generalised patterns of global accumulation as these have shaped the world economy from the 1980s into the present. Thus, despite decades of high growth, China will never become an advanced economy as did South Korea. Rather, China’s development path as the consumer goods assembly hub of the world has saddled it with mounting travails that portend the breakdown of its current order. How, then, will China egress from its economic girdles?

In all recorded world history, per capita GDP growth over 6 percent for an extended period has occurred only three times with each episode taking place in post World War II (WWII) East Asia. Japan’s spurt, averaging over 8 percent annually from 1955 to 1973, is the first. South Korea and Taiwan’s growth in GDP per capita in the period 1982-1996, averaging 7.4 percent and 7.1 percent respectively, is the second. Third, there is China’s post 1978 trajectory averaging around 7 percent GDP growth per capita to 2005 and beyond which is the longest in human history.¹

Though Japan’s industrialisation commenced in the late 19^th century, what catapulted it into the premier league of global competitiveness following WWII was the spectre of Mao Zedong’s peasant army marching triumphantly into Beijing. Besides thousands of technology patents lavished gratis upon Japan, United States (US) taxpayer booty flooding in for Japan’s support of the Korean and Vietnam War efforts spurred the near quadrupling of its industrial output. South Korea, finding itself on a Cold War fault line, was the recipient of US taxpayer dole for both civilian and military use from 1945 to 1976 amounting half of that received by all Latin America in that period.² This enabled South Korea to solve the development “catch-22 of having to export in order to pay for imports but being unable to produce for export without first importing materials and machinery”.³

Returns of Socialism

Paradoxically, on the one hand, the deep roots of meteoric East Asian growth reside in US vehement anticommunism which impelled the encirclement of China with a bulwark of anti-communist showcase economies. On the other hand, only China’s exclusion from the “free world” international system saved it from the fate that befell the “third world”. After all, from this post WWII kaleidoscopic group only South Korea and to some extent Taiwan have attained full scale industrialisation and mass living standards commensurate with that in advanced economies (“city state”, trading entrepôts Singapore and Hong Kong do not count here). An earlier generation of so-called “miracle” economies from Latin America all foundered on shoals of indebtedness, being entrapped in perpetuity by the development “catch 22” under the dogma of “comparative advantage”.

China’s exclusion from the “free world” international system saved it from the fate that befell the “third world”.

Mao’s socialist policy initially mimicked the Soviet formula of a centralised command economy constructing a heavy industrial base. Yet, two policy divergences significantly impacted China’s future. First, in China’s predominately agrarian society, Mao set about slow socialisation of agriculture moving in stages from land-to-the-tiller to cooperatives, culminating in formation of People’s Communes by the early 1960s. Though avoiding the brutality of Stalinist collectivisation, Mao deployed a “scissors” policy which manipulated agricultural prices to support urban industrialisation. Second, China’s development proceeded under a draconian household registration or hukou system mandating access to all social services, housing and education predicated upon registered birthplace. This unique institutional impedance to urban migration was compensated by socialist state investment in rural infrastructure, health care and education.

On the cusp of its opening to the world China did not have the international debt which drove erstwhile “miracle” economies into the talons of the International Monetary Fund for “shock therapy”.

Therefore, on the cusp of its opening to the world China did not have the international debt which drove erstwhile “miracle” economies into the talons of the International Monetary Fund for “shock therapy”, and it housed a connected network of heavy industry state owned enterprises (SOEs) along with a healthy, educated, disciplined labour force.⁴ China further opened up in a region that had been economically pumped up on anticommunist steroids to contain it.

“Get Rich First” Reforms

Two major policy thrusts mark the post 1978 market reforms initiated by Deng Xiaoping. First, a sweeping reform of agriculture dubbed the “household responsibility system” de-communised China dividing all farmland on a per capita basis into allotments for individual households. Contracts, initially set for a few years, though soon extended to fifty, arranged for delivery of specific quantities of basic agricultural goods to the state but, beyond that, land was used for both family consumption and market sale. Agricultural productivity rose exponentially and the release of labour from staples production to variegated farming and off-farm activity spawned the economic phenomena of town and village enterprises (TVEs) which propelled China’s growth into the early 1990s. Second, Deng fastened upon the idea of special economic zones (SEZs) as “windows to the world” to attract foreign capital and know how. Commencing with 4 SEZs in China’s southern coastal provinces, by 1984 SEZs had opened across 14 coastal city regions, all attracting foreign direct investment (FDI) in joint ventures. It was in the 1986-1992 second phase of the SEZ experiment that 100 percent foreign ownership was first countenanced prompting Deng, dizzy over purported SEZ success, to officially proclaim China “a socialist market economy”.

However, it was a confluence of these policy thrusts that saddled China with a set of economic pathologies. First, due to the hukou anchoring rural masses to their villages, the fact that labour released for off-farm work by productivity increases of the household responsibility system maintained a guarantee of subsistence in agriculture, predisposed it to part-time, irregular, and contingent employment. For the expanding presence of export oriented foreign capital in SEZs, the agricultural fallback option hukou institutionalised made for repression of wages below subsistence levels and employment insecurity. The state also benefitted from a gargantuan “floating population” reaching 211 million in 2009 and estimated to rise to 350 million migrants by 2050 that lurch between contingent employments: denied state benefits in the urban areas to which they “float”, their intermittent absence from villages allows the state to turn its back on rural social investment.⁵ In short, compared to Japan, South Korea or Taiwan which modernised agriculture as populations shifted to permanent urban employment under conditions of overall rise in wages fostering domestic consumption, China’s development has been horribly lopsided with hourly manufacturing pay remaining below one tenth of US wages into the 21^st century.⁶

Second, as the ostensibly collectivist planned economy accommodated private market activities, the instituting of a “dual track” pricing system in the context of nebulous property rights led to an orgy of corruption as those connected at the apex of the Communist Party-state apparatus gobbled up vast tracts of prime land as their fledgling business ventures benefitted from “buying low and selling high” in producer and consumer goods. Provincial and local elites soon jumped on the bandwagon privatising TVE collectives and “asset stripping” public companies to fund spending sprees on everything from “ivy league” educations for their offspring to Bentley’s and monster homes.⁷Deng’s exhortation to China’s populace to “get rich first” was certainly taken literally by his family along with other offspring of revolutionary scions, dubbed the “princelings”, who soon gained private suzerainty over important economic sectors.⁸

Globalisation Matrix

In addition to their anticommunist Manna, Japan and later South Korea rocketed to the forefront of a world economy which, following WWII, had been configured to grow “economic nationalist”, full scale industrialised states. Commencing in the US by the early 1970s and spreading across the advanced capitalist world in the following decades, the combination of rising real wages and high levels of capacity utilisation which fuelled that post WWII “golden age” reached their “upper bound” pressuring profits and slowing investment.⁹ Supported by capital newly impelled across the globe in search of lucrative investments, whole advanced economies saw their production systems disintegrated and disarticulated to low wage areas.

Manufacturing suddenly exploded across the “third world”, particularly in the East Asian region. However, from the 1980s global production systems became sliced and diced into “value chains” with trade flows composed of “intermediate goods”. The impact upon the region was that the proportion of intermediate goods as a percent of exports along with the export dependency ratio leaped. For China, intermediate goods jumped to 59 percent of manufacturing imports as its exports turned predominately upon electronics and information and computer technologies. Instructively, as the US abdicated its production centred economy, it opened a gaping current account deficit, approximately 50 percent of the global aggregate in 2006, met by China’s large current account surplus, around 22 percent of the global aggregate, while the share of the US trade deficit accounted for by Japan and the East Asian region dropped.¹⁰

Though disconcerting for US policy makers, China’s bloating trade surplus followed from emergence of China as a major recipient of FDI and rapid expansion of China’s SEZ network. From the 1992-2001 third phase and fourth phase following China’s 2001 ascension to the World Trade Organization, FDI streamed into increasingly wholly owned foreign subsidiaries in SEZs such that by 2006 it was estimated foreign capital controlled 21 out of 28 leading economic sectors.¹¹ Of China’s export of technology products, 80 percent derives from foreign subsidiaries. While high value added technology components enter its assembly mills from the reconfigured anticommunist region with which it runs a trade deficit, the upper rungs of the technology ladder elude China.¹²

With global trade and investment conducted in US dollars, economies are compelled to become externally orientated to gain means of dollar payment through either borrowing on financial markets or selling more goods for dollars than they buy.

Troubling for the world is persistence of this excrescence, referred to politely as the “global imbalance”, where the US economy with savings near zero, the world’s largest debt, gaping capital account, budget and trade deficits, remains in the global driver seat. Yet this is the essence of financialisation, the flip side of globalisation, which ultimately entails global dollarising backed by nothing but US Treasury IOUs. With global trade and investment conducted in US dollars, economies are compelled to become externally orientated to gain means of dollar payment through either borrowing on financial markets or selling more goods for dollars than they buy. Under dictates of deregulation and liberalisation Wall Street acts as the command centre managing globally dollarised banking systems by remote control. Easily terrorised by predatory financial flows unleashed by Wall Street, economies are forced to hold vast war chests of dollars as reserve. Global dollarising therefore constitutes an automatic borrowing mechanism for the US economy without which it would not grow!

No Way Out

If Japan had backstopped globalisation with its purchase of vast quantities of US Treasury IOUs in the 1990s, China bought into the game with a vengeance in the 21^st century after it watched with abject fear Wall Street bring Korea to heel during the Asian Crisis. Instructively, in the 2008 throes of global meltdown, the positive net international investment position of Japan plus China covered the negative position of the US.¹³ China’s economy is also protected by a largely closed capital account where the moving of money in or out by businesses, banks or individuals is subject to stringent regulations. Yes, FDI and portfolio inward flows are smoothed. But getting money and investments out continues to be controlled and neither China’s recent currency swaps nor inclusion in the “special drawing rights” relic does much to change this.¹⁴ In fact, recent evidence is that oversight of the individual foreign exchange quota of $50,000 is becoming tighter.¹⁵

Proclamation of China as “a socialist market economy” was actually accompanied by centralised macroeconomic management and a deluge of state led investment.

Proclamation of China as “a socialist market economy” was actually accompanied by centralised macroeconomic management and a deluge of state led investment. Yet, due to hukou skewing the price of labour, and ambiguous land entitlements, a monumental resource misallocation followed. Predatory local officials “grabbed” land at little cost and either sold it at astronomically high prices to real estate developers (helping to blow a real estate bubble) or below market value for industrial parks. This latter, 80 percent of transfers, garnered lucrative income flows from taxes on industrial use 10 times higher than agriculture as access to undervalued land supported large scale investment projects in resource and capital intensive heavy industries. China did develop competitive capacity in steel, cement and machinery equipment, particularly in catering to construction demand of the new coastal elite. But the sheer extent of such investment further distorted a labour market where 40 percent of China’s 1.3 billion people remain rural denizens ensconced in a subsistence agriculture milieu.¹⁶

Closed capital account is another ingredient here. Topping up hukou related wage repression, financial repression of interest rates helps the state use banks as ATMs funnelling cheap money to all manner investments in infrastructure, industry (including “zombie” SOEs) and real estate. Massive dollar reserves endow China’s central bank with manoeuvrability to hold down the renminbi’s value for the benefit of exports but to the disadvantage of domestic consumption which faces higher prices.¹⁷ This feeds maintenance of the closed capital account as economic growth is driven by exports not domestic consumption.¹⁸

When the 2008 meltdown stalled China’s export engine a mammoth stimulus package was unleashed further depressing consumption and boosting fixed investment to a whopping 50 percent of GDP. Ratcheted-up spending on duplication and triplication of everything from transportation infrastructure through condos and luxury government offices sent the world of commodity markets and exporters into a synchronised boom.

In China, firstly, it produced the phenomena of “ghost” cities, malls, airports and so forth. Estimates have it that $6.8 trillion was wasted investment from 2009.¹⁹ Secondly, it helped foment China’s own stock market bubble. With its closed capital account, notwithstanding the aforementioned skewed residential land pricing, and recalling our point on financial repression, property is one of the few “safe” investments. China’s Party-state elite have shown no hesitation in marshalling “brute force” against equity market selling to sustain the bubble, engendering capital flight of over $800 billion in 2015 alone.²⁰ Thirdly, continued fixed investment stimulus policy is made, after all, by the same Party-state elite battening on control of the heavy industries which supply the fixed investments. Hence, it is no accident that China has topped the US in number of billionaires in 2016.²¹

Indiscriminate lending flowing from China’s banks through a congeries of “shadow banks” has seen private debt rapidly skyrocket to well over 200 percent of GDP.

Yet the end is nigh. Indiscriminate lending flowing from China’s banks through a congeries of “shadow banks” has seen private debt rapidly skyrocket to well over 200 percent of GDP. Debt is rife in the housing market which in China constitutes approximately 20 percent of GDP as opposed to the 6 percent of GDP in the US where the 2008 bubble burst almost toppled the global economy. Then there are steel, cement (China’s use from 2011 to 2013 exceeded that of the US across the whole 20^th century) and commodities firms behind the infrastructure binge. True, China’s largely closed capital account gives it wiggle room. Even Japan propped up its banks for a time following its 1990s bubble burst. But “sitting on top of the greatest accumulation of bad debt and overcapacity in history” portends a day of reckoning.²²

Nor can the oft-repeated mantras of “rebalancing”, “reform” and “decoupling” be taken seriously. First, the “imbalance” China is saddled with stems from its enmeshment in patterns of accumulation euphemised as globalisation and financialisation from which China can extract in the medium term only by returning to socialist delinking. Second, reform of an economy with China’s raft of distortions and resource misallocation, not to mention entrenched interests of its billionaire species that spawned thence is a task for a generation. McKinsey Global suggests reform of the exhausted infrastructure growth model potentially hinges on productivity gains.²³ But producing more consumer goods with robotics and mechanising agriculture begs the question of what China’s nearly half billion rural dwellers and over 200 million “floating population” are going to do? Third, the decoupling scenario invokes the idea of China’s renminbi replacing the US dollar as hub currency. Even if China opened its capital account over the next decade or so, in a financialised world the cumbersome civil law tradition which governs China’s banking system inhibits the necessary fluidity compared to the US and British common law ruled financial sector.²⁴ And the sheer depth of the Wall Street based global financial architecture has been cultivated for a century.

Featured image: Beijing,China-August 4th,2015. In the centre of the capital in a new commercial building construction

Go to top

About the Author

Richard Westra is Designated Professor in the Graduate School of Law, Nagoya University, Japan. His most recent books are Unleashing Usury: How Finance Opened the Door to Capitalism Then Swallowed It Whole (Clarity Press, 2016) and Exit from Globalization (Routledge, 2015).

References
1. Naughton, B., 2007, The Chinese Economy: Transitions and Growth, MIT Press, pp. 142-3.
2. Westra, R., 2012, The Evil Axis of Finance, Clarity Press, pp. 52-60.
3. Eichengreen, B., 2007, The European Economy since 1945, Princeton University Press, p. 65.
4. Hung, H., 2016, The China Boom, Columbia University Press, pp. 43-50.
5. Westra, R., 2016, “China in the crash lane”, in Yokokawa, N. et al. (eds.) The Rejuvenation of Political Economy, Routledge, pp. 303-6.
6. Hung, The China Boom, pp. 69-73.
7. Westra, Evil Axis of Finance, p. 154.
8. Brown, K., 2014, The New Emperors: Power and the Princelings in China, I. B. Tauris.
9. Webber, M. and Rigby, D., 2001, “Growth and Change in the World Economy Since 1950”, in Albritton, R. et al. (eds.) Phases of Capitalist Development: Booms, Crises and Globalization, Palgrave.
10. Hart-Landsberg, M. 2013, Capitalist Globalization, Monthly Review Press, pp. 31ff.
11. Westra, Evil Axis of Finance, pp. 154-6.
12. Aglietta, M. and Bai, G., 2013, China’s Development, Routledge, pp. 137-8.
13. Westra, Evil Axis of Finance, pp. 165-6.
14. https://ftalphaville.ft.com/2015/07/17/2134607/this-isnt-the-chinese-capital-account-liberalisation-youre-looking-for/
15. http://www.scmp.com/news/china/policies-politics/article/1974750/chinas-capital-account-opening-stable-path-economist
16. Aglietta and Bai, China’s Development, pp. 142, 213-18.
17. Hung, The China Boom, pp. 148ff. on this and below.
18. Murphy, M. and Yuan, W. J., 2009, “Is China Ready to Challenge the Dollar?” https://csis-prod.s3.amazonaws.com/s3fs-public/legacy_files/files/publication/091007_Murphy_IsChinaReady_Web.pdf
19. Vague, R., 2015, “The Coming China Crisis”, Democracy, 36, http://democracyjournal.org/magazine/36/the-coming-china-crisis/
20. http://www.telegraph.co.uk/finance/economics/11756858/Capital-exodus-from-China-reaches-800bn-as-crisis-deepens.html
21. http://www.bbc.com/news/business-37640156
22. Vague, “The Coming China Crisis”.
23. McKinsey Global Institute, China’s Choice, June 2016, http://www.mckinsey.com/global-themes/employment-and-growth/capturing-chinas-5-trillion-productivity-opportunity.
24. Murphy and Yuan, “Is China Ready to Challenge the Dollar?”

Better Capitalised Banks Lend More and Lend Better

March 30, 2017

By Stephen G. Cecchetti & Kermit L. Schoenholtz

Are higher capital requirements really a drag on economic growth? Many people seem to think so. We disagree. In this essay, we describe how better capitalised banks experience lower funding costs, and how undercapitalised banks have an incentive to “evergreen” loans to low-quality firms. Our conclusion is that higher capital requirements are good for economic growth, resulting in both more lending and better lending.

Many people seem to think that when capital requirements increase, banks lend less. Adherents of this view go on to argue that, since credit is essential for economic growth, we should not impose overly tough constraints on banks. This is the basis for the conclusion that we have gone too far in making the financial system safe and the cost is lower growth
and employment.

US Treasury Secretary-designate Steven Mnuchin appears to share the view that financial regulation has restrained the supply of credit: in a recent interview, he is quoted as saying “The number one problem with Dodd-Frank is that it’s way too complicated and cuts back lending.”¹ One interpretation of this is that Secretary-designate Mnuchin will support proposals like House Financial Services Chair Jeb Hensarling’s Financial CHOICE Act to allow banks to opt for a simple capital standard as an alternative to strict regulatory scrutiny.²

Our reaction to this is three-fold. First, for most US banks, which are very small and pose little threat to the financial system, a shift toward simpler capital requirements – so long as they are high enough – may be both effective and efficient; for the largest, most systemic intermediaries, higher capital requirements should still be accompanied by strict oversight. Second, we see no evidence that higher bank capital is associated with lower lending. In fact, quite the opposite. Third, given that the 2007-09 financial crisis was the result of too much borrowing, not all reductions in lending are bad. We take each of these points in turn.³

Recently, we wrote about the Minneapolis Plan to End Too Big to Fail and its proposal to sharply increase required equity in the 13 largest US banks.⁴ Specifically, the Minneapolis Plan calls for a pure leverage ratio – the ratio of common equity to total assets – of at least 15% and possibly as high as 24%. The current requirement is 6%, and the CHOICE Act would require only 10%. Unlike the CHOICE Act, the Minneapolis Plan also embraces important aspects of current regulation (including stress tests and living wills) to contain the systemic risks of the largest, most complex, and most interconnected banks, while simplifying regulatory compliance for small banks that do not pose a threat to the financial system. We believe that the Minneapolis Plan provides a solid basis for legislation that would advance the public goal of making the financial system safe in a cost-effective way.

Important in this conclusion is our judgment that higher capital does not hamper the aggregate supply of credit. The alternative view appears to posit a choice between bank balance sheet consolidation, on the one hand, and credit growth, on the other. In fact, there is no inconsistency between making banks safer and ensuring long-run growth of credit. To see why, recall that from the bank’s perspective, equity capital is one of the sources of funds while loans and securities acquisitions are uses of funds. That is, the former is a liability while the latter are assets. In theory, an increase in bank equity can be used to fund an increase in credit provision.

But that’s theory, what about experience? Here, the evidence is compelling: strong banks lend to healthy borrowers, weak banks don’t. On the quantity of lending, countries with better capitalised banking systems prior to the start of the crisis in 2006, experienced stronger lending growth during and after the crisis.⁵ That is, higher capital did not slow recovery. Furthermore, research at the BIS has established that better capitalised banks experience lower funding costs, higher growth of debt funding, and higher growth of lending volumes.⁶

Turning to the quality of loans, scholarly studies examine both Japan and Europe. Caballero, Hoshi and Kashyap describe how, in the 1990s, regulatory forbearance delayed a thorough recapitalisation of Japan’s banks for more than a decade.⁷ Instead, insolvent Japanese banks made loans to keep insolvent Japanese borrower afloat. In their study of the impact of the ECB’s recent actions, Acharya et al. conclude that extremely accommodative monetary policy had a similar impact.⁸ That is, undercapitalised euro-area banks had an incentive to evergreen loans to
“low-quality” firms.

These results rely on data from a range of countries. What happens in the United States when bank capitalisation rises and falls? To answer this question at an aggregate level, we have plotted below bank credit (relative to GDP) on the vertical axis and bank capital (relative to assets) on the horizontal axis. The filled-red circle at the top right is the most recent observation from the third quarter of 2016.

The results are striking: rather than the downward-sloping relationship that critics of higher bank capitalisation anticipate, the relationship is strongly positive. That is, greater reliance of banks on equity funding is associated with an increase of credit!

Finally, there is the fact that decreases in lending are not necessarily bad. In fact, quite the opposite. That is what the studies of Japan and Europe highlight: loans to zombie firms made by weak banks reflect an inefficient allocation of savings and lead to slower economic growth. And surely no one wishes to see a return to the over-indebtedness of US households that contributed to the vulnerability of the financial system in 2007.

We also believe that, given the experience of the financial crisis, it is essential to ensure that borrowers are able to repay, both to protect the financial system and to protect taxpayers.⁹ The latter concern applies to mortgage borrowing, which is now effectively guaranteed by the US government through the government-sponsored enterprises (GSEs). It also applies to student loans, which (in addition to being guaranteed by the federal government) account for nearly half of consumer credit and create decades-long financial burdens that are virtually impossible to escape even through personal bankruptcy. And then there is payday lending, which, while frequently beneficial, can also be exploited to prey on the least well-off in the United States and has been a focus of both the US Department of Defense and the Consumer Finance Protection Bureau.

So, what has happened to US indebtedness since the financial crisis? BIS data show that aggregate credit to the US private nonfinancial sector peaked at the height of the crisis (the third quarter of 2008) at 169.3% of GDP; the latest reading (first quarter of 2016) puts it at 150.1%. Virtually all of this drop is accounted for by the decline of credit to households – from 97.1% to 78.4%. And, since only a bit more than one fourth of the decline reflects a fall in bank credit, most of it arises from the behaviour of nonbank intermediaries.

From this evidence, we conclude: (1) higher capital levels are associated with more lending, with better lending, or with both; and (2) to the extent that enhanced regulation hampers lending, it is often of the type that makes the financial system less safe and can leave taxpayers on the hook.

Data from the Federal Reserve Bank of New York highlight this changing mix of intermediation that, in our view, has made the financial system more resilient and less vulnerable since the crisis. The following chart depicts the evolution since 1960 of the liabilities of three important components of the financial system: commercial banks; broker-dealers and bank holding companies (BHCs); and shadow banks (net of their own holdings of other shadow banks’ liabilities). While the commercial banking system has grown since 2007, the other segments have shrunk. Specifically, over this nine-year period, shadow banking has plunged from 120% of GDP to 76% of GDP (that’s from a peak of $18.0 trillion to a current level of $13.4 trillion). A substantial portion of this correction occurred before the July 2010 enactment of the Dodd-Frank Act, reflecting the crisis-driven demise of the underlying business model of wholesale banking without deposit insurance or a lender of last resort.

From this evidence, we conclude: (1) higher capital levels are associated with more lending, with better lending, or with both; and (2) to the extent that enhanced regulation hampers lending, it is often of the type that makes the financial system less safe and can leave taxpayers on the hook.

To be clear, we do see great scope for improving and simplifying US financial regulation. Among other things, the system could use massive streamlining; the GSEs still need restructuring; living wills and the resolution mechanism should compel systemic intermediaries to self-insure (in order to avoid bailouts); government guarantees need to be properly priced; and the financial infrastructure could be more resilient.¹⁰ But, if we’re to make the financial system both safe and efficient, we need not only much higher capital requirements, but also a strict regulatory regime that makes credible the government’s (and legislators’) promise not to bail the most systemic intermediaries.

Go to top

About the Author

Stephen G. Cecchetti is Professor of International Economics at the Brandeis International Business School, Research Associate at the NBER, and Research Fellow at the CEPR, former Chief Economist at the Bank for International Settlements, and former Director of Research at the Federal Reserve Bank of New York.

Kermit L. Schoenholtz is Professor of Management Practice in the Department of Economics of New York University’s Leonard N. Stern School of Business, Director of NYU Stern’s Center for Global Economy and Business, a member of the Financial Research Advisory Committee of the U.S. Treasury’s Office of Financial Research, and former Global Chief Economist at Citigroup.

References

1.Schlesinger, Jacob M., “Trump Treasury Choice Steven Mnuchin Vows to ‘Strip Back’ Dodd-Frank,” Wall Street Journal, 30 November 2016.

2.See http://financialservices.house.gov/choice/ .

3.See Schularick, Moritz and Alan M. Taylor, “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008” American Economic Review, Vol. 102, No. 2, April 2012, pp. 1029-61.

4.See Cecchetti, Stephen G. and Kermit L. Schoenholtz, “Ending Too Big to Fail,” www.moneyandbanking.com, 28 November 2016 and The Minneapolis Plan to End Too Big to Fail, Federal Reserve Bank of Minneapolis, 16 November 2016.

5.See Cecchetti, Stephen G. and Kermit L. Schoenholtz, “Higher capital requirements didn’t slow the economy,” www.moneyandbanking.com, 15 December 2014.

6.Cecchetti, Stephen G. and Kermit L. Schoenholtz, “Bank Capital and Monetary Policy,” www.moneyandbanking.com, 20 June 2016; and Gambacorta, Leonardo and Hyun Song Shin, “Why Bank Capital Matters for Monetary Policy,” BIS Working Paper No. 558, April 2016.

7.See Caballero, Ricardo J., Takeo Hoshi and Anil K Kashyap, “Zombie Lending and Depressed Restructuring in Japan,” American Economic Review, Vol. 98, No. 5, December 2008, pp. 1943-77.

8.See Acharya, Viral A., Tim Eisert, Christian Eufinger, and Christian W. Hirsch, “Whatever It Takes: The Real Effects of Unconventional Monetary Policy,” unpublished manuscript, October 2016.

9.See Cecchetti, Stephen G. and Kermit L. Schoenholtz, “Rolling the dice, again,” www.moneyandbanking.com, 21 October 2014.

For a broader list and discussion of Dodd Frank’s accomplishments and failings see Cecchetti, Stephen G. and Kermit L. Schoenholtz, “Dodd-Frank: Five Years After,” www.moneyandbanking.com, 15 June 2015.

What Does the New US Administration Mean for Business?

March 28, 2017

By William Hobbs, Head of Investment Strategy, UK and Europe, Barclays

How much of this new US administration’s often fluid and sometimes contradictory agenda should we assume makes it through to policy? How powerful is the POTUS? We look at some of the proposed policies and examine some of the areas where the constitutional restraints are a little looser.

The complex task of trying to understand what this new US administration means for the business world should start with a relatively simple question – Just how much power does the President of the United States have? POTUS is often depicted as the most powerful human being on the planet, whether battling alien invasions, vampires or just an assortment of home invaders, fiction portrays the inhabitant of the Oval Office as central to all our fates. The post war history of the US economy would, at first glance, seem to support this idea.

Admittedly, this period from President Truman’s second term up to President Obama’s first term, covering only 16 presidential terms and 12 different presidents (seven complete Democratic terms and nine complete Republican terms), represents a small sample size. However, we are limited in our scope by the availability of plausible economic statistics. Anyway, in their opening shot in a still lightly furnished debate, Blinder and Watson (2016) find that real GDP growth over the 60 odd years in question averaged 3.3% per annum. However, the average growth rates under Democratic and Republican presidents were starkly different: 4.3% and 2.5% respectively (Figure 1 – US GDP growth by presidential term). This startling gap in relative economic performance remains when you look at trends in employment and industrial production too.¹

Interestingly enough, Blinder and Watson find that this strong relationship survives attempts to test the significance of the political leaning of Congress, any lagged policy effects or inherited economic momentum. The dataset apparently tells us that it is the president’s political leaning that is the dominant factor to consider. So what can explain these surely damning statistics?

Those of a Democrat persuasion would perhaps like to point to sounder fiscal (and perhaps even monetary) policies, but this is not necessarily supported by the data. The differences here are more or less insignificant, though Blinder and Watson suggest that if anything, fiscal and monetary policy actions could be construed as more pro-growth under Republican presidents. The most important factors seem to be exogenous – Democrat presidents have, on average, presided over fewer harmful oil shocks than Republicans (some of which may admittedly have been induced by foreign policy), faster growth in defence spending and stronger productivity shocks. Essentially, context is as vital as ever – for example, Presidents Truman and Johnson (Democrat) oversaw increases in defence spending during the wars in Korea and Vietnam, while Presidents Eisenhower and Nixon (Republican) oversaw much of the drawdowns; to what extent were these post-war presidents subject to forces outside of their control?

The Blinder and Watson paper represents one of the few academic forays into this subject matter – understandably so; cause and effect are extremely difficult to disentangle, no matter how thorough and methodical your attempts. Even classifying Congress as dominated by one party or another in a country where party unity has historically been looser than in some parliamentary systems can be problematic.²

It is this point that is perhaps most relevant to the debate on the actual powers of the president. The US Constitution assigns the power of the purse, and most other domestic powers, to Congress, not the president. As suggested above, the ability of the president to work productively with the legislative branch is not necessarily dictated by whether Congress can be considered Republican or Democrat. Interestingly, Blinder and Watson find that presidents who were once members of Congress tend to preside over a faster growing economy. The sample size is small, but this perhaps gives some weight to the idea that the most valuable skill a president can bring to office is the ability to cut deals and locate consensus.

Blinder and Watson find that presidents who were once members of Congress tend to preside over a faster growing economy. The sample size is small, but this perhaps gives some weight to the idea that the most valuable skill a president can bring to office is the ability to cut deals and locate consensus.

Currently, you have a thin Republican congressional majority alongside a President, who changed sides of the political aisle five times between 1999 and 2012, proposing an agenda that is, in parts, some distance from Republican orthodoxy. One suspects that President Trump and his administration are going to need all their famed deal making skills to ensure that this agenda sees the light of day.

Overall though, it is safe to say that the president is neither toothless nor omnipotent. He or she needs to work closely with the legislative branch in order to effect change, with the political colour of Congress possibly less important than imagined. The most famous examples of presidents bringing about major change have come at times of major crisis, with President Roosevelt’s New Deal perhaps the most oft-cited example. Those looking for more recent examples of presidents who were hamstrung in their attempts to effect change need look no further than President Trump’s popular predecessor. The point being that absent a major crisis such as the Great Depression, we are often best served by focussing on the fundamental backdrop to the US economy, rather than who presides over it.

The Domestic Agenda

Incoming economic data tells us that the kind of economic downturn that might help cut through that congressional sludge is not imminent (Figure2 – US ISM Manufacturing Index and GDP growth). Nonetheless, it is worth preparing for at least some of this administration’s dizzying range of proposals to make it through those constitutional safeguards to policy.

For our part, we remain suspicious of the promised boost to growth from tax cuts and infrastructure spending. Tax cuts could boost economic growth – by encouraging more people to work for example – in turn leading to higher tax revenues. If the positive effects were large enough, these additional tax revenues could offset the revenue initially lost from the cuts. In practice though, there is a very patchy precedent for a positive relationship between tax cuts and long term economic growth. From the Kennedy Revenue Acts of 1962 and 1964 through to the Jobs and Growth Tax Relief Reconciliation Act of 2003, the evidence for a clear impact on trend growth is best described as elusive.³

Looking further back, the US opted for wildly different tax regimes, with top bracket marginal tax rates ranging from 7% to 94% between 1913 and 2015. Yet, a casual observation shows scant association between tax rates and GDP per capita growth.⁴

The data obviously become significantly more questionable the further back you go, however investors would be wise to assume that while tax changes may temporarily boost consumption and corporate earnings, there should be no material changes to existing trends.

On infrastructure, there certainly seems to be widespread acceptance that US infrastructure needs updating, but it’s anyone’s guess whether the necessary returns to such investment will materialise. In his excellent piece exploding some of the myths on infrastructure spending, Edward Glaeser, cites two interesting examples.⁵

First, between 1991 and late 2008, Japan spent some $6.3 trillion on new infrastructure. This staggering sum undeniably left the country with some engineering marvels, such as the Akashi-Kaikyo suspension bridge, it likely kept some people working too. However, it is hard to see that it meaningfully changed the country’s trend growth rate.

Second, an earlier example – the result of a study by Nobel laureate economist Robert Fogel, who pointed out that while the opening of the Erie Canal in 1821 brought enormous value because the inland transportation options in the US were so poor at the time, the very existence of these canals significantly reduced the benefits of the later rail system. The point being that the US already enjoys an impressive, if under-maintained, array of mobility options.

Glaeser’s paper touches upon an important point that’s often lost within the political debate – greater infrastructure alone wouldn’t necessarily lead to higher sustainable growth. In order to generate a return over and above invested capital, infrastructure spending needs to be targeted in areas where the economic activity will be when the project is finished – a difficult trick to pull off.

Reflation

All this suggests that we should be very wary of the incoming Treasury Secretary’s promise to double the US economy’s trend real growth rate. On the other hand, from a cyclical perspective, it is easier to see how many of this administration’s ideas have seen professional forecasters scrabbling to raise their inflation forecasts. With diminishing slack in the US economy, additional fiscal spending that pushes the economy above its long-run potential supply will likely be inflationary, all else being equal.

The Border Adjustment Tax (BAT) proposal, though potentially a significant revenue raiser for the government, may also fall into this category. At its very simplest, the BAT would raise the cost of imports and slash the cost of exports. In theory, these “border adjustments” would initially make imports less competitive and US exports more competitive, thus reducing demand for imports and increasing demand for exports. Theory then suggests that this would result in US dollar appreciation, which in turn should help mitigate the initial effect on competitiveness and trade flows.

However, the assumption that real exchange rates would adjust quickly and perfectly to the tax changes may well work better on paper than in the real world. The US conducts a large proportion of its trade with emerging economies, not all of which will have a free-floating exchange rate. Emerging markets have steadily increased their share of US trade over the years, and some of them will obviously be keen to use their FX reserves to limit the pace of currency depreciation against a surging US dollar.

The assumption that real exchange rates would adjust quickly and perfectly to the tax changes may well work better on paper than in the real world.

This and various other real world frictions suggest that a potentially disruptive surge in the world’s reserve currency, with all its associated side effects, may not occur as advertised. However, the inherent Catch-22 in this policy proposal is that without this sharp correction in the dollar, US prices (and interest rates), may have to bear the brunt of the adjustment.

Nonetheless, we need to keep in mind that the path to policy is far from easy, as that post-war American economic history may testify. The journey through the aforementioned congressional sludge is likely to see many of these proposals significantly altered before they pass into policy. However, while constitutional checks and balances may see many of those domestic plans diluted, the world outside of the US is an area of much less fettered Presidential power…

Protectionism?

As suggested, there is more scope for the president to use unilateral power with regards to foreign and trade policy. In theory, a president can invoke a variety of Acts and statutes already in place to restrict imports without having to go through Congress. If President Trump were to unilaterally enact tariffs on major trade partners, this would surely be followed by retaliatory measures, risking a full blown trade war. The world has been here before, as many commentators rightly warn.

If President Trump were to unilaterally enact tariffs on major trade partners, this would surely be followed by retaliatory measures, risking a full blown trade war.

Based on the Peterson Institute of International Economics’ (PIIE) analysis, such a scenario would send the US economy into recession and cost millions of Americans – particularly those working in lower-skilled and lower wage sectors – their jobs. According to the PIIE’s macroeconomic model, the imposition of tariffs on China and Mexico leads to rising imported inflation, forcing the Federal Reserve to raise interest rates. Higher costs of borrowing and greater uncertainty then depress investment, pushing the economy into recession in 2019. With less in the way of congressional impediments here, we are left relying on economic self interest to drive a wedge between soap box tirades and implementable policy.⁶

Conclusion

Keep an open mind and focus on the forces already in motion in the US and world economy remains our best advice. Incoming economic data point to the forces of global growth and inflation being much less terminally impaired than was only recently widely believed amidst the aftermath of the oil price rout. In fact, the current combination of easy credit, easy fiscal and monetary policy, multi year highs in measured business and consumer confidence and a self professed “business friendly” US administration may soon prove to be a somewhat too heady cocktail if we’re not careful. It may not be President Trump’s words we want to keep an eye on but Peter Cook’s – “I’ve learned from my mistakes and I’m sure that I could repeat them exactly”.

Featured image: First meeting of the Cabinet of Donald Trump in the White House 13 March 2017

Photo courtesy: @realDonaldTrump on Twitter

Go to top

About the Author

William Hobbs joined Barclays in October 2005, working in the Equity Research team. He is now Head of Investment Strategy, UK and Europe. William is a Fellow of the Securities Institute and has around 15 years of experience in the financial sector. He has a Masters in International Business and Economic Development from Birkbeck, University of London and is a Chartered Alternative Investments Analyst.

Reference

1.Blinder, A. and Watson, M. (2016). Presidents and the US Economy: An Econometric Exploration. American Economic Review, 106(4):1015-45.

2.Dubner, Stephen. (2016). How Much Does the President Really Matter? Freakonomics. Available at http://freakonomics.com/podcast/much-president-really-matter-rebroadcast/

3.Greenberg, S., Olson, J., and Entin, S. (2016) Modelling the Economic Effects of Past Tax Bills. Available at https://taxfoundation.org/modeling-economic-effects-past-tax-bills

4.Gale, W. and Samwick, A. (2014). Effects of Income Tax Changes on Economic Growth. The Brookings Institution, September. Available at https://www.brookings.edu/wp-content/uploads/2016/06/09_Effects_Income_Tax_Changes_Economic_Growth_Gale_Samwick.pdf

5.Glaeser, Edward. (2016). If You Build It… Myths and realities about America’s infrastructure Spending. Available at https://www.city-journal.org/html/if-you-build-it-14606.html

6.Noland, M., Hufbauer, G., et. al. (2016). Assessing Trade Agendas in the US Presidential Campaign (Chapter 2). PIIE, September. Available in https://piie.com/system/files/documents/piieb16-6.pdf

Tourism and the Modern World

March 28, 2017

By Eric G. E. Zuelow

Tourism is among the largest industries in the world and many people assume that humans engaged in leisure travel from earliest times. In reality, tourism emerged much more recently. It developed as a product of modernisation but also played an important role in shaping the experience of modernity. This article traces that story from the eighteenth century to the present day.

Scholars disagree about the precise definition of “modernity” and about what makes up the “modern world”, but they nearly all concede that part of the definition involves thinking differently from those who came before. We imagine ourselves to be modern, the product of relentless progress that started when hunter-gatherers learned to farm and created the first urban centres. Moderns value technology and science, view landscapes in ways different from those in the past, and celebrate individualism to a degree not previously known. We think we’re better than those before us, more sophisticated and advanced, probably smarter. All this sets us apart.

Most of us do not think very much about tourism and yet it played an important role in enshrining the thought patterns mentioned above. This pastime/industry acted (and acts) as a teacher: educating us about politics, history, science, environment, technology, and much more besides. It helps to define who we think we are, who we think others are, and the relationships that exist between us.

Today, tourism is among the world’s largest industries. The United Nations World Tourism Organization (UNWTO) says that in 2015 the industry grew at a rate of 4.6% reaching 1,184 million tourist arrivals. Such growth rates are not new and date back with few exceptions to the early 1950s. Projections are that the expansion will continue for the foreseeable future, reaching as high as 1.8 billion annual international tourist arrivals by 2030. Such numbers are impressive — and very valuable. International tourism generated U.S.$1.5 trillion in export earnings in 2015.

It was not always so. Tourism itself is modern.

Leisure travel as we know it started to emerge in the seventeenth and eighteenth centuries. It began as a way for Queen Elizabeth I to educate the ambassadors that would be necessary to carry out ever more complicated international politics. Most English elites had scant understanding of their Continental counterparts. The educational system, such as it was, was steeped in a narrow focus on the Classics, so aristocrats read Latin and Greek, and spoke English rather than the vernacular languages that were increasingly needed to engage with French, Italian, or Dutch traders and politicians. Elizabeth started to pay her best and brightest young male subjects to visit the Continent, to learn languages, to make contacts, and to gain the tastes necessary to live abroad for extended periods. They had to develop what scholars call “cultural capital”. From the first, modern travel was connected to politics.

By the eighteenth century other aristocrats anxious to keep up with their peers started to send their sons to Europe as well. It was called the “Grand Tour”. Beyond the learning outcomes expected from the trip (languages, etc.), these young 16- to 20-year olds were supposed to develop aesthetic sensibilities, ideas that they would bring back to their estates. By putting their tastes on display in their manor houses and surrounding grounds, aristocrats could show themselves cultured, they could stress their social class and their power. Little has changed. We still gain prestige by having visited exotic locations, by being able to tell stories of travel adventures, by showing how our tastes reflect our travels.

Consequently, the “tourists” earned a rather less than stellar reputation. It was so upsetting that parliament considered legislation banning returning young men from speaking with faux-French or Italian accents.

The results of the Grand Tour often failed to match lofty goals. Rather than spend their time learning, many passed their days drinking, gambling, and sleeping with prostitutes. Consequently, the “tourists” earned a rather less than stellar reputation. It was so upsetting that parliament considered legislation banning returning young men from speaking with faux-French or Italian accents, failing to celebrate the glories of roast beef, from gesticulating like a stereotypical Continental merchant, or from using the French word “canaille”.

If travel produced anxiety at home, however, it also had its advocates. Better, these proponents said, that wild oats be sown abroad. As long as the bad behaviour didn’t continue at home, it was all for the good. What happens on the Grand Tour, stays on the Grand Tour.

The Napoleonic Wars effectively ended the eighteenth-century Grand Tour, but the accounts of travel that were written about that experience inspired the tourists of the 1800s. What was more, new steam-powered transportation — first steamboats, then trains — made it faster and cheaper to travel. Where once it took days or weeks to reach a destination, and while that journey was inevitably uncomfortable, now such concerns were evermore mute.

Almost from the debut of steam travel, working class organisations and later middle class tourism developers presented offerings aimed at nearly all economic and social groups. There were day trips for workers, global explorations for the rich. The existence of vast nineteenth-century empires meant that white and wealthy travellers could go just about anywhere in the world.

But it wasn’t merely the possibility of going someplace. The trip itself was an attraction. Tourism promised travellers the opportunity to experience a new type of mobility. Trains, for example, were almost as big an attraction as was wherever the train was going. People lined the tracks to see the new iron horses. They debated whether speed might kill, whether the noise might make people go mad, whether livestock in the vicinity of a railway might be rendered unproductive or worse by the thundering “clap clap clap” of heavy wheels on metal rails.

Later, the invention of automobiles and airplanes had a similar impact. These machines democratised travel, truly opening the possibility of exploration to virtually everybody. It took little time for automobile clubs and oil companies to issue maps, guides, and even educational videos designed to teach people to take vacations. Tourism and technology were intimately connected, a relationship that continues today if in a less overt way.

Guidebooks, maps, postcards, and other such “cultural mediators” told people what ought to be seen. They carefully described the best place to stand when gazing at a view. They celebrated a particular aesthetic perspective (itself a product of late eighteenth century Romanticism) and promised the tourist a sort of transcendence that was, in reality, often elusive. There is a reason that we nearly all take the same photographs when we travel, all shot from the same vantage points and framed in nearly identical ways.

The elements of modern tourism were all well established by the dawn of the twentieth century. As important as the technology and the ways of seeing the world through a tourist lens was the fact that the practice was now heavily democratised. Given time off, most people could be tourists. Once again, politics entered the frame.

Democratic governments viewed tourism as a way of emphasising the joys of individual choice. Many went further, offering guaranteed vacation time for all workers, “holidays with pay”.

In the years after the Great War, regimes representing every major political ideology saw in tourism a way of reaching out to the masses. Russian communists imagined tourism as a way of teaching citizens to be better Soviets and to eschew bourgeois notions of leisure as a pointless waste. It was better to use travel to bring health and to raise productivity. Time off was good for the soul and for the state. Democratic governments viewed tourism as a way of emphasising the joys of individual choice. Many went further, offering guaranteed vacation time for all workers, “holidays with pay”. And fascist programs, such as the Nazi regime’s Kraft durch Freude (KdF; or “Strength through Joy”), used tourism as a means of showing how the government was working for the people to provide cheap trips. More chillingly the KdF strove to teach Germans to be better Nazis. Destinations were selected to showcase German economic strength as compared with the turmoil still suffered in other places during the Great Depression. Organised trips could be utilised to teach specific behaviours deemed to be suitably German. And most horrifying, the right packaging made it possible to educate the people about their racial superiority to Jews, blacks, and other non-Aryans.

By the time World War II ended, people from across the social spectrum expected to be tourists; tourism developers as well as both national governments and international organisations were keen to help them. Indeed, tourism development represented fuel for postwar reconstruction.

The United States made tourism development in Europe a priority, one of three major areas (alongside industry and agriculture) targeted by the European Recovery Program, or Marshall Plan. Governments were encouraged to expand tourism, given instruction in how to run hotels in a manner attractive to Americans, and provided financial resources to make it all happen. When states dragged their feet, as happened in Ireland, Marshall Planners were not immune from making threats: develop tourism or face the end of American aid. It took little time for even the most reluctant political leaders to fall in line.

Of course, tourism development was not entirely a US-led mission. Countries around the world were keen to benefit. International organisations quickly formed — emblematic of a new approach to political and economic development that relied on international organisations and which took root after the war. The European Travel Commission was the first such transnational tourism organisation, but it was definitely not the last.Similar groups, anxious to combine forces to market their distinctive tourist products, popped up in South and Central America, the Middle East, Africa, the Caribbean, and Asia. There was even a global organisation, the International Union of Official Travel Organisations (IUOTO). It eventually merged with the United Nations and is now known as the World Tourism Organization.

Wartime austerity quickly gave way to peacetime prosperity and travel was among the most sought after commodities. Holiday camps, theme parks, travel magazines and more beckoned to an increasingly affluent middle class in both Europe and the United States. New technologies created during the war — jet engines and pressurised airplane cabins, for example — rendered travel that much quicker, more comfortable, and affordable. Like trains or cars before, leaving on a jet plane was an exciting prospect.

Wartime austerity quickly gave way to peacetime prosperity and travel was among the most sought after commodities.

Growth was rapid, stunningly so. In fact, the practice of tourism was by now so widespread that people virtually took it for granted. They assumed that humans had always traveled for fun, that leisure time was always spent in pursuit of adventures abroad. People had always been tourists.

Of course, they hadn’t. Instead, the combination of politics and economics, technology and social climbing had come together to create a new way of looking at the world that enveloped virtually all of the hopes, dreams, and aspirations that make up a modern worldview.

Go to top

About the Author

Eric G. E. Zuelow is author of A History of Modern Tourism (Palgrave, 2015) and editor of the Journal of Tourism History (Routledge). He is an associate professor of European History at the University of New England in Biddeford, Maine.

EDITOR'S PICK OF THE WEEK

WISE DECISION MAKER GUIDE

POWER INFLUENCERS

Emerging Trends

The Future of Global Trade