World economy: 3 risks that hardly anyone talks about

IE Focus | By Ignacio de la Torre, Professor at IE Business School

The threat of a new recession in the US, the drop in the price of raw materials, and decisions taken by the ECB, might just bring about a turnaround in the world economy.

The traveler Javier Reverte once commented how when he set out on a trip to places he did not know he made a mental provision for scams, so that when a taxi driver overcharged him he didn’t get angry, given that he had already factored the “surcharge” into his provision. Now that we are over the hurdle of the recent European summit, in which for the first time political leaders adopted that old market practice of affording a false sense of happiness by means of pre-martyrdom (i.e. by lowering expectations and then subsequently announcing measures that are not quite that bad), it’s time to shed some light on other sources of basic risk for the world economy, so that we can set up our own mental provisions.  Given that I have always criticized market players for only seeing black swans in the economy, in spite of the fact that the majority of swans are white, I am going to talk about three risks – one negative, one ambivalent, and one positive, because they are the type of risks that will allow us to think that things are not really quite so bad if they do actually happen.

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A reflection on international labor markets

IE Focus | By Gayle Allard, Professor at IE Business School

We keep hearing about “flexible” and “rigid” labor markets, but what do these terms mean exactly? Does any one model work better than others?

We are hearing a great deal lately about “flexible” and “rigid” labor markets. What exactly does this mean? Is there any particular labor market model that works better than the rest?

Generally speaking a rigid labor market is one in which it is difficult to hire and/or fire workers, because such changes are subject to strict regulations and tend to be extremely expensive exercises. In Spain, up until the labor reform implemented earlier this year, it could take four years for a company to fire a worker who had worked there for many years. These norms seemed to put companies off hiring in general and created a “dual market” where some people were permanent and enjoyed too much protection, while the rest were in a far more precarious position, as well as earning considerably less.  A situation like this tends to reduce a country’s rate of productivity, given that permanent workers have no incentives to be more productive, and temporary employees are unable to produce more because the firm is not willing to invest in training them.

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IE Ideas || 2012, a year of decisions

The world economy will not recover this year. All qualified observers forecast lower growth, unusually high unemployment levels and continued financial tension. The fearsome “double-dip” recession is a reality. But there is no reason for chronic pessimism.

A new reality characterised by the movement of economic activity -production, consumerism, investment and employment- from the North Atlantic to other areas of the world, especially but not exclusively Asia. But also because we have abandoned the world of cheap money and credit abundance and will be away from it for some time. A structural change that gives rise to an understandable feeling of malaise in developed countries, whose populations refuse to accept that the future will not necessarily always be rosier, that they will have to give up some of what they considered as inalienable rights and reform their welfare states to make them sustainable. Simply because we are witnessing the end of the exceptional condition of the West. Emerging countries now produce more than 50% of the world GDP, but they consume only 30%… a proportion that can only rise and which will undoubtedly improve the standard of living of humanity. However, it is a process that needs to be handled intelligently.

HISTORIC OPPORTUNITY
We are facing a historic opportunity that is not exempt from risk. Imperial transitions and changes in the relative power of the different states have always been solved by war. This time, it can and must be different. The price system, macroeconomic coordination, financial globalisation and international institutions are poised to ensure a peaceful transition, which does not mean that there will be no cost or tension. The world managed to avoid protectionism after the dramatic events that followed the burst of the financial bubble in the United States. The commercial world maintained its strength, and general policies for making your neighbour poorer were avoided. Regardless of how virulent its death throes may seem in Europe owing to the fact that it coincides with the questions being asked of the monetary union, it would be a paradox now that we are at the end of the crisis if we were to forget the lessons taught by history.

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It isn’t Italy that holds the key, it’s not even the ECB, “my friends”

By Fernando Fernandez, professor at IE Business School

Forget about short cuts and soft measures: Europe’s problem is that it has lost the market’s confidence, and in order to get it back it will have to take some hard measures.It’s a well worn phrase which is why I have permitted myself a certain amount of poetic license, because it seems to go perfectly with the confusion that is rife among markets and analysts following recent events. The feeling of insecurity is such that we are desperately seeking a lifeline to cling to. Someone is always up for the job of throwing said lifeline and public opinion seems to have honed in on two specific groups: governments comprised of technocrats and the European Central Bank (ECB). The former are expected to bring the required level of sanity and the ECB is supposed to start buying up debt with no thought for expenses. But once again it’s the wrong diagnosis.

The European Commission, according to its vice president Olli Rehn, has decided that the key lies in restoring confidence in fiscal sustainability and the financial system, and in speeding up reforms that stimulate growth potential. Hence we have to change our tune or we have to take notice of the Commission, but either way we should not be looking for short cuts.

The European problem is a simple one. Investors have lost confidence in the Euro, not just in Italy. Let’s not confuse the symptoms of this particular illness. They have done it for a series of institutional reasons – the well-known design faults of the Monetary Union – and mistakes made in the way the crisis has been managed. In my opinion they include two particularly big mistakes. The first was to declare that European sovereign debt is restructurable – albeit only Greek debt, but who on earth believes that at this stage – without having the necessary financial resources or legal instruments to effect an immediate exchange, and the second was to punish banks for their sovereign debt holdings without having the necessary resources to fill the hole created. Both decisions have had consequences that were impossible to recover from in the short-term: they have made sovereign debt a credit asset, a financial instrument that competes with emerging debt, and have eroded the credibility of the European banking system, which has been forced to divest its sovereign debt. 

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Take your seat… Why the Euro is here to stay!

By Rolf Strom-Olsen, Director of Studies and Professor at IE University

Articles and media reports predicting the imminent demise of the Euro have become so commonplace over the last months that I suspect the next release of Microsoft Word will include it as a new document template: blank page, letter, CV, “Euro is doomed” article. A quick search on Google for the exact phrase “the euro is doomed” produces so many results (over 65,000), that I cannot even be bothered to look for variants. Pundits and politicians, bloggers and journalists, have all climbed aboard the euro-is-doomed train and cannot wait to tell us all about the destination which is envisioned, variously, as end-of-Euro land, end-of-Europe-itself land, global-financial-Armageddon land (for the real enthusiasts), etc….

Muh. Send us a postcard when you arrive.

That is a postcard I don’t expect to receive. Why not? Simply put because the so-called euro crisis is the product of a narrative gone wild. It has swept up otherwise sober-minded people and produced a wave of incessant hysterical shrieking, fulfilling that deep lizard-brain desire to really enjoy a catastrophe.

Except that catastrophe is largely an artefact of a market-, media- and punditry-driven narrative, increasingly divorced from the underlying reality of what is going on.

What we are really looking at is a sovereign debt crisis rephrased into a “euro-is-doomed” narrative. How sustainable is that? About as sustainable as Greek borrowing patterns.

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2012: the BRICs will take the growth lead

IE Business School survey reveals that expectations for economic growth in 2012 are focused on the BRICs. The highest growth rates in 2012 will be found in the BRIC countries. So say 94% of the directors who participated in the 2012 IE Global Alumni Forum (GAF)  survey of the world economic outlook for 2012.

Some 827 directors from 61 countries in all five continents took part in the survey, drawn up by IE Business School in the lead up to its Global Alumni Forum – GAF Madrid 2011, set to take place on September 30. Speakers include Ángel Gurría, General secretary of the OECD, who will be examining the world economic Outlook, together with Guillermo de la Dehesa, President of IE’s International Advisory Board de IE.

According to participants in the survey the BRICs are the countries with the greatest potential for growth in 2012, with Brazil being the country most expected to have the highest rates (40%), followed by China (39%), India (17%)  and Russia (5%). Meanwhile, 91% of participants think that the Latin American region will either maintain its current rate or grow faster. The survey results point to a generally held belief that the Latin American countries with the best future potential were Brazil (58%), Chile (17%) and Peru (10%). With regard to Europe, 77% feel that the European economy will stabilize or grow in 2012. Sixty two percent think the same about the EU. Within the EU, 64% consider that Germany will have the best growth rate, followed by Poland (7%) and the UK (5%).

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Astrology and economic forecasts

The current crisis has once again shown how wrong economic forecasts often are. So why is it such a deeply flawed profession? John Galbraith once said that “The only function of economic forecasting is to make astrology look respectable.” Although many of us are avid readers of economic forecasts issued by the OECD, the IMF, and the EU (the government’s forecasts tend to suffer from a general lack of creditability), it is questionable if our confidence in them is well founded. In my opinion, which is based on my experience, it is not.

Firstly, a large number of economic models try to predict the future by extrapolating the past. The current crisis, like so many others, has highlighted the folly of this method. Such models also predicted in the 1950s that the USSR would become the world’s most powerful economy (its economic growth rate was three times that of the west at the time), and the same was said about Japan (remember the best seller Japan as Number 1, by Harvard Professor Ezra Vogel?), the Asian dragons in the 90s, and now it’s China’s turn. The logic of projecting past growth rates onto the future is an intellectual and economic fallacy, as stated by Paul Krugman in his excellent paper “The Myths of Asia’s Miracle”. 

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IE Focus || Germany 4 – Spain 0

By David Bach, Professor at IE Business School, published on IE Focus

Germany has scored more economic goals than Spain because it applied the structural reforms needed before the crisis took hold, and because Merkel, has controlled spending from the start.Spain may have beaten Germany in both the European Football Championship and the World Cup, but where economy is concerned there is no doubt that Germany has the upper hand. Last Thursday´s news that the largest economy on the continent had grown by 3.6% in 2010 (the highest level since the unification in 1990) has surprised even the experts. The Spanish economy, however, closed 2010 with an average reduction of 0.2%. What does Angela Merkel know about economics that the Spanish president doesn’t? One analysis of the German success shows that the causes behind the differences go beyond the current Chancellor´s policies and also clearly point the path Spain should take.

Germany´s economic strength (and Spain´s weakness) is based fundamentally on four pillars:

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