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On the cover China's economy is more stable than its critics think: leader, page 11. It's financial system is inefficient, unfair and in need of reform, but it also has resilient qualities, says our special report after page46

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Volume 403 Number 8786

First published in September 1843 to take partin "a severe contest between intelligence, which presses forward, and an unworthy, timid ignorance obstructing our progress. "

Editorial offices in London and also: Atlanta, Beijing, Berlin , Brussels, Cairo, Chicago, Hong Ko ng, Johannesburg, Los Angeles, Mexico City, Moscow, New Delhi , New York, Pa ris, San Francisco, Sao Paulo , Singapore, Tokyo, Washington DC

7 The world this week

Leaders

11 China's economy How strong is it?

12 The future ofthe European Union The choice

14 Bangladesh's politics Hello, Delhi

14 Energy markets The charges of the light brigade

16 Azerbaijan and Eurovision Nul points

Letters

18 On the euro, Thailand, Facebook, trains, Alice Munro, Spanish banks

Briefing

23 The euro crisis An ever-deeper democratic deficit

26 The costs of a Greek exit Cutting up rough

United States

29 Government transparency The best disinfectant

30 Utah's health reform UnObamacare

32 Military innovation Stress testing

32 Fish stocks Plenty more in the sea

34 Government spending Penny wise, pound foolish

34 Maine's Senate race Crowning a King

36 Lexington Moral quandary

The Americas

38 Energy in Canada The great pipeline battle

39 The Dominican Republic After Leonel

39 Colombia Peace or justice?

40 Gay rights in Chile Atrocity prompts change

Asia

41 Politics in Bangladesh Banged about

42 Tattoos in Japan The shogun of Os aka

43 Violence in Karachi City at war

43 Pakistan and America A fateful call

44 Banyan More fun in the Philippines?

China

45 China and America A sigh of relief

46 Officials and their families Hedging their bets

46 Trouble at Shaolin temple Kung fu fighting

Special report: China's economy

After page 46

Middle East and Africa

47 Cote d'Ivoire Can it regain its shine?

48 A South African cartoon No joke

48 Strife in Yemen Hadi tries harder

49 Racism in Lebanon Black, but not beautiful

49 Syria's strife From bad to worse

50 Algeria Football v politics

Europe

51 Italian politics Tremors and rumbles

52 Spanish banks The corralito risk

52 Serbia's election The gravedigger's victory

53 Azerbaijan The sound of music

54 Charlemagne The feeling's mutual

Euro crisis A limited version of federalism is a less miserable solution than the break-up of the euro: leader, page 12. Concerns about democracy and accountability, page 23. The damage a break-up would do to Greece and the European economy, page 26. Italy's strained politics, page 51, and Spain's beleaguered banks, page 52. Summitryin Brussels: Charlemagne, page 54. Banksarestockpiling cash, raising the risks of a credit crunch, page 71

Britain's Jubilee What the celebrations for the queen's silver, golden and now diamond jubilee say about how Britain has changed: Bagehot, page 59

Obama's open government Making information public, and hiding it from the public, has never been easier, page 29. The Republicansjustwant to cut, page 34

~~ Contents continues overleaf

3

4 Contents The Economist May 26th 2012

Brazil's richest man Eike Batista is betting big on resources and infrastructure, page 63

Deutsche Bank Hard questions loom for the new bosses of Germany's national banking champion, page 74. The rise of Kotak, an Indian powerhouse, page 73

Human Lab rats How crowdsourcing is changing the way psychological experiments are conducted, and whatthey find, page 77

Britain 57 Electricity-market reform

Volt from the blue 58 Megrahi and Lockerbie

To his grave 58 Explaining economic

weakness The slack race

59 Bagehot The Jubilee as mirror

International 60 The NATO summit

The Afghan endgame 61 Climate scepticism

Toxic shock 61 Circassians

Thoughts from abroad

Business 63 Eike Batista

The salesman of Brazil 65 The internet

Breaking up is so very hard, Yahoo!

65 Google and antitrust Over to you, and hurry

66 Facebook' s flotation That sinking feeling

67 Re-imagining Piramal An Indian bets on America

67 Cars in Indonesia Letthem walk

68 Solar tariffs Blocking the sun

68 Recruitment Hiring by video games

70 Schumpeter New bosses

Finance and economics 71 Europe in Limbo

Credit crunches

72 Buttonwood The nationalisation of markets

73 Indian banking Kotak moment

73 Rajat Gupta The trial begins

74 CoLLateraL management Security services

74 Deutsche Bank Two's company

76 Free exchange America's growth potential

Science and technology 77 Experimental psychology

The roar of the crowd 78 Ichthyosaurs

Triassic lark 79 There be Dragons

SpaceX heads for the ISS 79 Nanotechnology

A fab result

Books and arts 80 Joys of walking

The wanderer's tale 81 Depression

Melancholy journey 81 The political waning of

America Unconvincing

82 The economic waning of America Myths large and small

82 Biology and instability Molecules of mayhem

83 The Barnes Collection A phoenix rises

88 Economic and financial indicators Statistics on 42 economies, plus a closer look at fiscal consolidation

Obituary 90 Dietrich Fischer-Dieskau

The Mastersinger

Next week We publish our Technology Quarterly, with articles on robots on the battlefield, open-source medical devices, nuclear-waste disposal, sloppy microchips, acoustic microfluidics, zoomable interfaces and much more

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Politics

Chen Guangcheng, a Chinese activist, arrived inN ew York to start a new life with his family. Mr Chen, who is blind, es­caped house arrest in April and turned up at the American embassy in Beijing. After assurances about his safety from the Chinese government he was taken to a hospital, but then said he wished to leave China. The incident had threat­ened to open a diplomatic rift between China and America.

Barack Obama had a wobbly week. His re-election cam­paign's attack on Mitt Rom­ney's time at Bain Capital came under fire from some Democrats for going too far in its criticisms of private equity. And in Democratic primary elections in Arkansas and Kentucky around 40% of the voters withheld their support for the president; some reck­oned Republicans had crossed party lines to cause mischief.

Tragedy avoided Officials in Argentina said they found a bomb hidden in a theatre in Buenos Aires where Alvaro Uribe, Colombia's former president, was due to speak. Mr Uribe is campaign­ing against a constitutional amendment that might ex­empt Colombia's guerrilla leaders from prosecution if they make peace.

Spain's Repsol said that an exploratory well in deep water off Cuba was dry, dashing the island's hopes of reducing its dependence on imported oil.

In another attempt to inject life into Brazil's stagnant econ­omy, the government an­nounced a fresh round of tax

cuts, this time on car sales and some financial transactions.

In a presidential election in the Dominican Republic Danilo Medina, the candidate of the ruling party, won a narrow victory. The parties com­plained of vote-buying but international observers said this did not affect the result.

It's my party Russia's president, Vladimir Putin, unveiled a government dominated by loyalists, tight­ening his grip on the economy and national security after popular protests. The new government is likely to curtail the ability ofDmitry Med­vedev, the prime minister, to pursue market reforms.

Serbia's presidential election was won by Tomislav Nikolic, who beat Boris Tadic, the liberal incumbent, by two percentage points. Mr Nikolic used to be an extreme nationalist but has changed his tune, vowing to promote integration with the European Union and promising to be a good neighbour in the Balkans.

European Union leaders attended yet another summit in Brussels aimed at solving the euro-zone's sovereign-debt crisis. At the earlier G8 summit at Camp David, in Maryland, Germany came under pressure to do more for jobs and growth, though the communi­que also concluded that "the right measures are not the same for each of us."

Abdelbaset al-Megrahi, a Libyan convicted of the 1988 bombing of a Pan Am flight over Lockerbie in Scotland, died from cancer. Mr Megrahi was released from prison by

the Scottish government on compassionate grounds in 2009, which outraged many relatives of the 270 people killed in the atrocity. He always claimed to be innocent.

With friends like these ... A Pakistani doctor who helped the CIA track down Osama bin Laden was found guilty of treason under laws that govern the country's tribal areas. Shakil Afridi, who carried out fake vaccinations near bin Laden's compound so that he could gather DNA evidence on his family, was sentenced to 30 years in prison.

In Malaysia An war Ibrahim, the leader of an opposition party and thorn to the govern­ment, was charged with in­citing and participating in an illegal street protest on April 28th. Coming just four months after he was acquitted of sodomy (which is still illegal in Malaysia), Mr Anwar said the new charges were also politi­cally motivated.

Fitch downgradedJapan's sovereign-debt rating to A+, as its politicians squabbled about passing a rise in the sales tax. Japan's public debt is forecast to rise to 239% of GDP by the endof2012.

Whom should I vote for?

Fifteen months after the fall of Hosni Mubarak, Egyptians voted in their first free presi­dential election on May 23rd and 24th, with no opinion poll confidently predicting a win­ner among the three or four front-runners. But nearly all reckoned there would be a run-off, due a month later.

Representatives of the five permanent members of the UN Security Council plus

Germany began a fresh round of talks with Iran over its nuclear plans, this time in Baghdad, hoping to persuade its government to agree to stop enriching its uranium to the high grade that would enable it to make a bomb.

At least 100 people were killed by a suicide-bomber at a mil­itary parade in Yemen's capi­tal, Sana'a. A group allied to al-Qaeda claimed to have carried out the attack ten days after Yemen's army launched an offensive againstjihadists in the southern province of Abyan.

Eleven Lebanese Shia pilgrims were kidnapped in Syria. The Free Syrian Army, a group of rebel fighters, said that govern­ment forces, hoping to be­smirch the opposition, were responsible. As a result, prot­ests erupted in the Lebanese capital, Beirut, where people are divided over the uprising in Syria.

Supporters of Mali's coup leader named him to head a new interim government in defiance of a deal brokered by the Economic Community of West African States (ECO-

w AS), a regional body that has been trying to mediate. The announcement provoked protests in Mali's capital, Bamako. Mali's interim presi­dent was beaten up by a mob.

Guinea-Bissau's military junta handed power back to a civilian government six weeks after the army staged a coup.

A South African farm worker was found guilty of killing Eugene Terre'Blanche, the leader of a white-supremacist party, the Afrikaner Resistance Movement, who was beaten to death in his home in 2010.

A debate over freedom of expression raged in South Africa over a gallery's display of a painting of }a cob Zuma, the president, with his genitals exposed. The ruling African National Congress said the painting was disrespectful and sought legal action to have the

7

artwork removed. ~~

8 The world this week The Economist May 26th 2012

Business

Share prices IPO pri ce=100

130

120

110

100

90

80

'---'--- ?o

Days after IPO Source: Thomson Reuters

Face book's long-awaited initial public offering didn't match the hype. The social network priced its shares at $38, but at the end of the first day of trading (that opened with a technical glitch) they had risen by just 23 cents, before falling well below the offer price in subsequent days, in contrast to other big tech IPOs (see Google). Adding to the disappointment, regulators began inquiries into whether favoured investors were alert­ed to Face book's weakening financial projections and dumped stock when buying was opened to the public. Still, Face book's stockmarket debut valued it at $104 billion. Mark Zuckerberg, Face book's boss, celebrated by marrying his college sweetheart.

An internet divorce After months of speculation Yahoo! announced plans to divest its 40% stake in Alibaba, a giant Chinese e-commerce firm. The pair will separate on amicable terms. Yahoo! is selling half of its stake now and will dispose of the rest later, with some of that to be sold when and if Alibaba floats on a stockmarket.

Hewlett-Packard slashed another 27.000 jobs, or 8% of its global workforce, in line with its restructuring plan. Mike Lynch, who founded Autonomy, a British software firm bought by HP for $10.3 billion last year, is to step down from his job as head of information management. HP has found it hard lately to persuade markets that it has a strategy for responding to the challenge to its business from smartphones and tablets.

The IMF'S annual review of the British economy found it to be underperforming relative to earlier expectations. The fund recommended more quantitative easing by the Bank of England and said growth-boosting measures, such as spending on infrastruc­ture, could help, but only if they were fiscally neutral.

The learning curve The Bank of England bowed to pressure to launch indepen­dent reviews of its own perfor­mance during the crisis. The reviews will look at the central bank's emergency-lending operations in 2008-09, its inflation-forecasting record and the system for providing money to banks. But its critics want the reviews to go further and examine its pre-crisis attention to financial stability.

Despite recent measures by the Reserve Bank of India to sup­port the currency, the Indian rupee continued to fall. It is the worst-performing curren­cy among Asia's emerging markets so far this year.

JPMorgan Chase suspended its much-trumpeted share buy-back programme in light of its unexpected loss of at least $2 billion in trading on credit derivatives. Since reveal-

ing the loss its share price has taken a dive, wiping $30 bil­lion from its stockmarket value. The bank was given the go-ahead for its buy-back plan after passing the Federal Reserve's latest "stress test" in March.

Barclays decided to sell the 19.6% stake in BlackRock that it had obtained as part of its deal selling Barclays Global In­vestors to the asset-manage­ment company in 2009. The proceeds from the sale could help the bank in meeting new rules on bigger capital buffers.

The trial of Raj at Gupta on insider-trading charges got under way in New York. Among other things Mr Gupta is accused of passing sensitive information about Goldman Sachs when he was a director of the bank to Raj Rajaratnam, a former hedge-fund boss who was convicted of insider trad­ing last year. Mr Gupta denies the charges.

PTT, a state-backed energy firm in Thailand, tendered a sur­prise last-minute bid of $1.9 billion for Cove Energy, trump­ing an offer from Shell. Cove holds an 8.5% stake in a huge natural-gas field in Mozambi­can waters. PTT's bid is the biggest ever by a Thai firm for a

foreign one, and underscores the rush for oil-and-gas assets off the east African coast.

Coming to a theatre near you Dalian Wanda, a Chinese property group, agreed to buy AMC Entertainment, a ubiqui­tous American cinema chain. The $2.6 billion deal is the biggest foreign undertaking yet by a privately held Chinese firm. AMC has more than s,ooo screens across North America. It had considered going public before opting for Wanda's takeover offer.

Blackstone, a private-equity firm, added Motel6 to its lengthy list of hotel acquisi­tions, by offering $1.9 billion to buy the business from its present owner, France's Accor. Motel6 was founded in 1962 by two building contractors in southern California whose plan was to provide bargain rooms for $6 a night.

Moody's upgraded Ford's debt to investment grade, allowing the carmaker to regain own­ership of the famous "blue oval" badge that stamps its vehicles, which it had mort­gaged in 2006 along with other assets to stave off bankruptcy.

Other economic data and news can be found on pages 88-89

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Ho""' strong is China's economy?

Despite a recent slowdown, the world's second-biggest economy is more resilient than its critics think

CHINA'S weight in the global government engineered a bout of "stimulus lending". economy means that it Yet the very unfairness of China's system gives it an unusu­

commands the world's atten- al resilience. Unlike the tigers, China relies very little on foreign tion. When its industrial pro- borrowing. Its growth is financed from resources extracted duction, house building and from its own population, not from fickle foreigners free to flee, electricity output slow sharply, as happened in South-East Asia (and is happening again in as they did in the year to April, parts of the euro zone). China's saving rate, at 51% of GDP, is the news weighs on global even higher than its investment rate. And the repressive state­

stockmarkets and commodity prices. When its central bank dominated financial system those savings are kept in is actual­eases monetary policy, as it did this month, it creates almost as ly well placed to deal with repayment delays and defaults. big a stir as a decision by America's Federal Reserve. And Most obviously, China's banks are highly liquid. Their de­when China's prime minister, Wen]iabao, stresses the need to posit-taking more than matches their loan-making, and they maintain growth, as he did last weekend, his words carry keep a fifth of their deposits in reserve at the central bank. That more weight with the markets than similar homages to growth gives the banks some scope to roll over troublesome loans that from Europe's leaders. No previous industrial revolution has may be repaid at a later date, or written off at a more conve­been so widely watched. nient time. But there is also the backstop of the central govern-

But rapid development can look messy close up, as our spe- ment, which has formal debts amounting to only about 25% of cial report this week explains; and there is much that is going GDP. Local-government debts might double that proportion, wrong with China's economy. It is surprisingly inefficient, and but China plainly has enough fiscal space to recapitalise any it is not as fair as it should be. But outsiders' principal concern- bank threatened with insolvency. that its growth will collapse if it suffers a serious blow, such as That space also gives the government room to stimulate the collapse of the euro-is not justified. For the moment, it is growth again, should exports to Europe fall off a cliff. China's likely to prove more resilient than its detractors fear. Its difficul- government spent a lot on infrastructure when the credit ties, and they are considerable, will emerge later on. crunch struck its customers in the West. But there is no short-

Unfair, but not unstable Outsiders tend to regard China as a paragon of export-led effi­ciency. But that is not the whole story. Investment spending on machinery, buildings and infrastructure accounted for over half of China's growth last year; net exports contributed none of it. Too much of this investment is undertaken by state­owned enterprises (soEs), which benefit from implicit subsi­dies, sheltered markets and politically encouraged loans. Ex­amples of waste abound, from a ghost city on China's north­ern steppe to decadent resorts on its southern shores.

China's economic model is also unfair on its people. Regu­lated interest rates enable banks to rip off savers, by underpay­ing them for their deposits. Barriers to competition allow the soEs to overcharge consumers for their products. China's household-registration system denies equal access to public services for rural migrants, who work in the cities but are regis­tered in the villages. Arbitrary land laws allow local govern­ments to cheat farmers, by underpaying them for the agricul­tural plots they buy off them for development. And many of the proceeds end up in the pockets of officials.

This cronyism and profligacy leads critics to liken China to other fast-growing economies that subsequently suffered a spectacular downfall. One recent comparison is with the Asian tigers before their financial comeuppance in 1997-98. The tigers' high investment rates powered growth for a while, but they also fostered a financial fragility that was cruelly ex­posed when exports slowed, investment faltered and foreign capital fled. Critics point out that not only is China investing at a faster rate than the tigers ever did, but its banks and other lenders have also been on an astonishing lending binge, with credit jumping from122% of GDP in 2008 to171% in 2010, as the

age of other things it could finance. It could redouble its efforts to expand rural health care, for example. China still has only one family doctor for every 22,ooo people. If ordinary Chi­nese knew that their health would be looked after in their old age, they would save less and spend more. Household con­sumption accounts for little more than a third of the economy.

Time is on my side That underlines the longer-term problem China faces. The same quirks and unfairnesses that would help it withstand a shock in the next few years will, over time, work against the country. China's phenomenal saving rate will start falling, as the population ages and workers become more expensive. Capital is also already becoming less captive. Fed up with the miserable returns on their deposits, savers are demanding al­ternatives. Some are also finding ways to take their money out of the country, contributing to unusual downward pressure on the currency. China's bank deposits grew at their slowest rate on record in the year to April.

So China will have to learn how to use its capital more wisely. That will require it to lift barriers to private investment in lucrative markets still dominated by wasteful SOES. It will also require a less cosseted banking system and a better social­security net, never mind the political and social reforms that will be needed in the coming decade.

China's reformers have a big job ahead, but they also have some time. Pessimists compare it to Japan, which like China was a creditor nation when its bubble burst in 1991. But Japan did not blow up until its income per head was 120% of Ameri­ca's (at market exchange rates). If China's income per head were to reach that level, its economy would be five times as big as America's. That is a long way off. •

11

12 Leaders The Economist May 26th 2012

The future of the European Union

Europe's choice

A limited version of federalism is a less miserable solution than the break-up of the euro

W HAT will become of the European Union? One

road leads to the full break-up of the euro, with all its economic and political repercussions. The other involves an unprecedent­ed transfer of wealth across Eu-rope's borders and, in return, a

corresponding surrender of sovereignty. Separate or super­state: those seem to be the alternatives now.

For two crisis-plagued years Europe's leaders have run away from this choice. They say that they want to keep the euro intact-except, perhaps, for Greece. But northern Euro­pean creditors, led by Germany, will not pay out enough to as­sure the euro's survival, and southern European debtors in­creasingly resent foreigners telling them how to run their lives.

This has become a test of over 6o years of European integra­tion. Only if Europeans share a sense of common purpose will a grand deal to save the single currency be seen as legitimate. Only if it is legitimate can it last. Most of all, it is a test of Ger­many. Chancellor Angela Merkel maintains that the threat of the euro's failure is needed to keep wayward governments on the path of reform. But German brinkmanship is corroding the belief that the euro has a future, which raises the cost of a res­cue and hastens the very collapse she says she wants to avoid. Ultimately, Europe's choice will be made in Berlin.

Last summer this newspaper argued that to break the euro zone's downward spiral required banks to be recapitalised, the European Central Bank (ECB) to stand behind solvent coun­tries with unlimited support, and the curbing of the Teutonic obsession with austerity. Unfortunately, successive European rescue plans fell short and, though the ECB bought temporary relief by supplying banks with cheap, long-term cash in De­cember and February, the crisis has festered and deepened.

In recent months we have concluded that, whether or not Greece stays in the euro, a rescue demands more. If it is to ban­ish the spectre of a full break-up, the euro zone must draw on its joint resources by collectively standing behind its big banks and by issuing Eurobonds to share the burden of its debt. We set out the scheme's nuts and bolts below. It is unashamedly technocratic and limited, designed not to create the full super­state that critics (and we) fear. But it is plainly a move towards federalism-something that troubles many Europeans. It is a gamble, but time is running short. Rumours of bank runs around Europe's periphery have put savers and investors on alert (see page 71). The euro zone needs a plan.

Goodbye to all that Is the euro really worth saving? Even the single currency's die­hard backers now acknowledge that it was put together badly and run worse. Greece should never have been let in. France and Germany rode a coach and horses through the rules de­signed to prevent government borrowing getting out of hand. The high priests of euro-orthodoxy failed to grasp that, though Ireland and Spain kept to the euro's fiscal rules, they were vul­nerable to a property bust or that Portugal and Italy were

trapped by slow growth and declining competitiveness. A break-up, many argue, would allow individual countries

to restore control over monetary policy. A cheaper currency would help match wages with workers' productivity, for a while at least. Advocates of a break-up imagine an amicable split. Each government would decree that all domestic con­tracts-deposits and loans, prices and pay-should switch into a new currency. To prevent runs, banks, especially in weak economies, would shut over a weekend or limit withdrawals. To stop capital flight, governments would impose controls.

All good, except that the people who believe that countries would be better off without the euro gloss over the huge cost of getting there (see page 26). Even if this break-up were some­how executed flawlessly, banks and firms across the continent would topple because their domestic and foreign assets and li­abilities would no longer match. A cascade of defaults and lawsuits would follow. Governments that run deficits would be forced to cut spending brutally or print cash.

And that is the optimistic scenario. More likely, a break-up would take place amid plunging global share prices, a flight to quality, runs on banks, and a collapse in output. Devaluation in weak economies and currency appreciation in strong ones would devastate rich-country producers. Capital controls are illegal in the EU and the break-up of the euro is outside the law, so the whole union would be cast into legal limbo. Some rich countries might take advantage of that to protect their produc­ers by suspending the single market; they might try to deter economic migrants by restricting freedom of movement. Prac­tically speaking, without the movement of goods, people or capital, little of the EU would remain.

The heirs of Schuman and Monnet would struggle to re­store the Europe of 27 when it had been the cause of such may­hem-even if a euro-rump of strong countries emerged. Col­lapse would be a gift to anti-Eu, anti-globalisation populists, like France's Marine Le Pen. There would be so many people to blame: Eurocrats, financiers, intransigent Germans, feckless Mediterraneans, foreigners of all kinds. As national politics turned ugly, European co-operation would break down. That is why this newspaper thinks willingly abandoning the euro is reckless. A rescue is preferable to a break-up.

A problem shared But not just any rescue. Too much of the debate over how to save the euro puts the emphasis merely on a plan for growth. That would help, because growth makes debt more manage­able and banks healthier. Mrs Merkel should have been more accommodating on this. But any realistic stimulus would be too modest to stem the crisis. The ECB could and should cut rates and begin quantitative easing, but official funds for in­vestment are limited. More ambitious ways of boosting growth, such as the completion of a single European market for services, are sadly not even on the table.

In any case, the euro zone's troubles run too deep. Banks and their governments are propping each other up like Friday­night drunks. The ECB's support for the banks cannot prevent the weak economies of Spain, Portugal, Italy and Ireland from ~~

The Economist May 26th 2012

~ enfeebling their banks and governments. For as long as bond yields are high and growth is poor, sovereigns will face doubt about their capacity to service their debt and banks will see loans go bad. Yet that same uncertainty pushes up sovereign yields and stops bank lending, further inhibiting growth. Fear that the state might have to deal with a banking collapse makes government bonds riskier. Fear that the state could not cope makes a banking collapse more likely.

That is why we have reluctantly concluded that the nations in the euro zone must share their burdens. The logic is straight­forward. The euro zone's problem is not the debt's size, but its fragmented structure. Taken as a whole, the stock of euro-zone public debt is 87% of GDP, compared with over100% in Ameri­ca. Similarly, the banks are not too big for the continent as a whole, just for individual governments. To survive, Europe has to become more federal: the debate is how much more.

What's German for demoi? A lot, according to some gung-ho federalists. For people like Germany's finance minister, Wolfgang Schauble, the single currency was always a leg on the journey towards a fully inte­grated Europe. In exchange for paying up, they want to harmo­nise taxes and centralise political power with, say, an elected European Commission and new powers for the European Par­liament. Voters will be scared into grudging acquiescence pre­cisely because a euro collapse is so terrifying. In time, the new institutions will gain legitimacy because they will work and Europeans will begin to feel prosperous again (see page 23).

Yet to see the euro crisis as a chance to federalise the EU would be to misread people's appetite for integration. The wartime generation that saw the EU as a bulwark against strife is fading. For most Europeans, the outcome of the Eu's most ambitious project, the euro, feels like misery. And there is no evidence that voters feel close to the EU. The Lisbon treaty and its precursor, the Eu's aborted constitution, were together re­jected in three out of six referendums; ten governments re­neged on promises to put constitutional reform to the vote. The parliament is hopelessly remote.

Another version of the superstate is to accept that politics remains stubbornly national-and to increase the power of governments to police their neighbours. But that, too, has pro­blems. As the euro crisis has shown, governments struggle to take collective decisions. The small countries of the euro zone fear that the big ones would hold too much sway. If Berlin pays the bills and tells the rest of Europe how to behave, it risks fos­tering destructive nationalist resentment against Germany. And like the other version of the superstate, it would strength­en the camp in Britain arguing for an exit-a problem not just for Britons but for all economically liberal Europeans.

The €50,300 ($64,000) question That is why our rescue seeks to limit both the burden-sharing and the concession of sovereignty. Rather than building a fed­eral system, it fills in two holes in the single currency's original design. The first is financial: the euro zone needs a region-wide system of bank supervision, recapitalisation, deposit insur­ance and regulation. The second is fiscal: euro-zone govern­ments will be able to manage-and reduce-their fiscal bur­dens only with a limited mutualisation of debt. But in both cases the answer is not to transfer everything to the EU level.

Begin with the banks. Since the euro's creation, European integration has moved farthest in finance. Banks sprawl across national borders. German banks fuelled Spain's property

Leaders 13

boom, while their French peers funded Greece's borrowing. The answer is to move the supervision and support of

banks (or at least big ones) away from national regulators to European ones. At a minimum there must be a euro-zone­wide system of deposit insurance and oversight, with collec­tive resources for the recapitalisation of endangered institu­tions and regional rules for the resolution of truly failed banks. A first step would be to use Europe's rescue funds to recapital­ise weak banks, particularly in Spain. But a common system of deposit insurance needs to be rapidly set up.

These are big changes. Politicians will no longer be able to force their banks to support national firms or buy their govern­ment bonds. Banks will no longer be Spanish or German, but increasingly European. Make no mistake: this is integration. But it is limited to finance, a part of the economy where mone­tary union has already swept away national boundaries.

The fiscal integration can also be limited. Brussels need not take charge of tax and spending, nor need Eurobonds cover all government debts. All that is required is for overindebted countries to have access to money and for banks to have a "safe" euro-wide class of assets that is not tied to the fortunes of one country. The solution is a narrower Eurobond that mu­tualises a limited amount of debt for a limited amount of time. The best option is to build on an idea put forward by Ger­many's Council of Economic Experts, to mutualise the current debts of all euro-zone economies above 6o% of their GDP.

Rather than issuing new national government bonds, every­body, from Germany (debt: 81% of GDP) to Italy (12o%) would issue only these joint bonds until their national debts fell to the 6o% threshold. The new mutualised-bond market, worth some €2.3 trillion, would be paid off over the next 25 years. Each country would pledge a specified tax (such as a vAT sur­charge) to provide the cash.

So far Mrs Merkel has opposed all forms of mutualisation (and did so again this week-see Charlemagne). Under our scheme, Germany would pay more on a slug of its debt, sub­sidising riskier borrowers. But it is not a move to wholesale fis­cal federalism. These joint bonds would not require intrusive federal fiscal oversight. Limited in scope and time, they do not fall foul of Germany's constitutional constraints. Indeed, they can be built from last autumn's beefed-up "six pack", which curbs excessive borrowing and deficits; and January's fiscal compact, which enshrines budget discipline in law and is now being ratified across the euro zone.

Even this more limited version of federalism is tricky. The single banking regulator might require a treaty change, which would be difficult when ten EU countries, including Britain, are not members of the euro. The treaty setting up Europe's bail-out fund would also have to be changed to allow money to be supplied directly to banks. Countries would have to find convincing ways to commit future governments to pay their share of the interest on the Eurobonds. Greece's debts so out­weigh its economy that it would need a further rescue before entering any mutualisation scheme-though the sum in­volved is small on a continental scale.

So it is a long agenda; but it is more manageable than trying to redesign Brussels from the top down, and it is less costly than a break-up. Saving the euro is desirable and it is doable. One question remains: will Germans, Austrians and the Dutch feel enough solidarity with Italians, Spaniards, Portuguese and Irish to pay up? We believe that to do so is in their own in­terests. The time has come for Europe's leaders, and Mrs Mer­kel in particular, to make that case. •

14 Leaders The Economist May 26th 2012

Bangladesh's toxic politics

Hello, Delhi

It is up to India to try to stop Sheikh Hasina ruining Bangladesh

THEPunch-and-Judyshowof the hounding of Mohammad Yunus, a pioneer of microfi­Bangladeshi politics, in nance, creator of the Grameen Bank and a Nobellaureate, is

which the ruling party-run by seen as payback for his temerity in 2007 in trying to launch a the daughter of a former presi- "third force" in politics. Meanwhile, journalists and activists dent-bashes the opposition- face intimidation and worse, and the vibrant NGOS that keep run by the widow of a former the spirit of democracy alive worry that proposed legislation president-before swapping would leave them at the mercy of government whims. places with it, has been running Last year the League did away with the provision that care-

for decades. The outside world rarely pays attention because taker administrations should oversee elections. The arrange­nothing seems to change. ment was not ideal. In January 2007 protests led by the League,

Recently, though, the squabbling has turned into a crisis convinced that the BNP would rig an election, led to a coup. (see page 41) which threatens to make life still worse for the But without some assurance of fair play the BNP will boycott 170m poor Muslims who suffer under one of the world's worst the next election, due in 2014. So there is the prospect of yet governments. Since Bangladesh's political leaders show no in- more protests, which in Bangladesh often take the form of crip­terest in their fate, outsiders need to do so. pling strikes. There is also the real prospect of utter political pa-

When Sheikh Hasina, leader of the Awami League and cur- ralysis, risking even worse turmoil on the streets. rent prime minister, and Khaleda Zia, leader of the Bangladesh Nationalist Party (BNP ), alternated in power in the 1990s, things were pretty bad, but in the past decade they have got worse. The administration Mrs Zia headed from 2001 to 2006 was a brutal kleptocracy. It was followed by army-backed un­elected technocrats. Then in 2008 the Awami League swept to power in a landslide victory. The League has 229 of 300 parlia­mentary seats compared with 31for Mrs Zia's BNP. Sheikh Ha­sina has used this mandate to consolidate power and hound her enemies, real and imagined.

There has been a spate of mysterious disappearances. This month 33 senior members of the opposition were arrested on charges of vandalism and arson. A war-crimes tribunal to in­vestigate the atrocities in Bangladesh's war of independence in 1971-some of the bloodiest in modem history-now looks like an attempt to discredit the BNP and its Islamist allies. And

Energy markets

The only voice in Dhaka The outside world is trying to do its bit. The World Bank has scrapped a deal to pay for a big bridge because of its suspicions of corruption. EU ambassadors have denounced the treat­ment of Mr Yunus and the harassment of activists. Hillary Clinton flew to Dhaka this month to stand by Mr Yunus.

But the government seems unmoved. In a snub to Mrs Clin­ton, it announced a review into ownership of Grameen, a move to take over (and probably destroy) the bank. The only country to have much influence in Dhaka is India. Until recent­ly the regional superpower tolerated Sheikh Hasina's ex­cesses, in part because Bangladesh has cracked down on Is­lamists. India now seems to be hedging its bets between the two parties. But if it still wants to have a functioning democra­cy next door, it needs to speak out far louder in favour of it. •

The charges of the light brigade

The market, not the government, should determine the price of electricity in Britain

BRITAIN created the first elec- within the next decade, and if the country is to meet its EU tar-Domestic electridty tric light bulb and a pioneer- gets, new capacity must come from low-carbon sources. Pence per kWh, July-December

2011 ing national grid. Then, in 1990, The government's solution to all these problems is to re-

Britain

EU15

10 1s 20 it built one of the rich world's place a de regulated market with a command-and-control one. most liberalised energy mar- It has stated how much it expects each renewable technology kets. For years it enjoyed low to generate by 2020, as well as how many nuclear plants it prices and lectured other coun- wants, and where. It will create long-term contracts for supply­tries about the virtues of dereg- ing low-carbon energy, setting a minimum price for solar pow­

ulation. Not for it French-style state-owned monopoly utility er, another for offshore wind and so on (see page 57). The hope firms. But the country has gradually lost faith in a free energy is that this will give energy firms the assurances needed to in­market. A bill published on May 22nd signals a drastic change. vest in new forms of generation. The certainty is that David

The bill is a response to two developments. One-particu- Cameron's Conservative-led coalition government is rowing larly worrying to politicians-is rising electricity prices. The hard against the free market. This is odd, and wrong. second, further off, is a looming capacity crunch. Roughly one- The market has not failed. Prices have been rising in Britain, fifth of Britain's existing power stations are due to be retired but they remain among the lowest in Europe. Out of 15 EU ~~

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16 Leaders

~ countries, only Greek and Dutch consumers pay less. Bills have gone up because most British electricity is generated by burning gas, the cost of which has rocketed. If gas prices were to fall (as they may, with improving technology and plenty of shale gas) bills would come down again.

Best ways to be green The country certainly needs more generating capacity, espe­cially of the low-carbon kind. But it is going the wrong way about encouraging it. Specifying how much power is to be generated from nuclear and from each form of renewable power means picking winners-something that governments generally do badly. Offshore wind and nuclear, the govern­ment's favoured technologies, are among the most expensive ways to get carbon out of the energy system. And all political promises to guarantee energy prices are notoriously unreli­able and unlikely to spark investor confidence. In 2011 Ger­many suddenly decided to shut its nuclear power stations.

Rather than interfere with and second-guess the market, the government should strengthen it. For investors to view the electricity-generating business with enthusiasm, they must be able to find out what the real price of electricity is. At present

Azerbaijan and Eurovision

Nul points

The Economist May 26th 2012

that is impossible, because most electricity in Britain is "traded" between the generation and supply arms of the same firms. The government should have threatened to split them up (a gambit that worked wonders with British Telecom) and forced trading onto open exchanges, as happens in Germany.

The best way to encourage green energy is to tax carbon. Australia took that brave step in 2011, admittedly with plenty of giveaways and exemptions for the early years. Under the European emissions-trading scheme carbon does have a price in Britain, but it is too low to be effective and is hard to increase. If Britain commits itself to unilateral action, the early price would still be low, but the government could promise to in­crease it over time. It is the price of carbon in 20 or 30 years, not now, that determines investment decisions. This move would encourage cleaner technologies but allow the market to choose which it favours and how much to pay. It is simple and more likely to endure than complex interventions.

The energy business is changing fast. The price of solar power has fallen; the price of oil has soared. Shale gas is boom­ing. Wave power, carbon-capture technologies and electricity storage could all prove revolutionary. All the more reason to let investors, not Mr Cameron, pick the winners. •

More care should be taken over where to hold international pageants

0 N THE face of it, Ilham Turkey. Along with the country's sensitive location-between Aliev, the president of Russia and Iran-the oil helps explain the West's often indul­

Azerbaijan, and the Eurovision gent attitude to Mr Aliev. Yet the indulgence must have a limit. Song Contest, held in his coun- Eurovision should have been beyond it. try this week, are a good fit. Eu­rovision, in which viewers across Europe (broadly defined) select a winning song from com­

peting national entries, is an annual festival of kitsch. Mr Aliev's fondness for opulence, his strongman moustache, and the cult of personality he has built around his father, Heidar, from whom he inherited his post in 2003, are all suitably retro. Alas, his regime also has some less amusing traits, which sug­gest that the organisers of shindigs like Eurovision should be more careful about where they are staged (see page 53).

The story behind the songs is a sad one. Protests against Mr Aliev's rule, especially after the rigged elections that keep him in power, are routinely crushed. His critics have been beaten and imprisoned. Not only do Azerbaijan's human-rights abuses make a grim backdrop to the clowning of Eurovision: some have been perpetrated on its account. According to hu­man-rights groups, scores of families have been forcibly evict­ed from their homes to make way for a new concert hall. Ab­surdly but terrifyingly, in previous Eurovisions Azerbaijanis were interrogated for voting for Armenia-the Caucasian neighbour with which Azerbaijan fought a war in the 1990s and may yet fight another. The lavish cost of the preparations is itself obscene in a place where many lack basic amenities, despite the gridlock of imported cars in central Balm, the capi­tal. But then, Azerbaijan scores the full12 points for corruption.

The wealth of a favoured few in Azerbaijan derives from oil and gas, pumped out of the Caspian and through a pipeline to

Politics by other means A similar awkwardness recently arose over a more important tournament, the forthcoming European football champion­ship, and a bigger country, Ukraine, its eo-host. Commendably, some diplomats are refusing to turn up unless Yulia Tymosh­enko, a former prime minister now imprisoned on doubtful charges, is treated humanely. A long time has elapsed since Uk­raine, with Poland, was awarded the football tournament in 2007: the intervening years have seen it not only build stadi­ums, but also lapse from a struggling but hopeful democracy into a darker place. Eurovision presents a different problem. Azerbaijan is host because it won last year's contest-some­what unfortunately, in light of Mr Aliev's reputation, the victo­rious song was entitled "Running Scared".

That rule should be changed. The bodies that oversee these extravaganzas are avowedly non-political; they argue that such contests promote international goodwill. But they be­come political tools, nonetheless. Although stable, democratic countries often approach them with wry amusement, for nas­ty leaders such as Mr Aliev these spectacles are valuable pro­paganda: Eurovision, the biggest thing in Azerbaijan since it became independent in 1991, has been presented as a dip­lomatic imprimatur. More discretion, for example relying on independent human-rights data, should be used in allocating them. Eurovision would have done more to further peace and fraternity if Azerbaijan had been refused the right to be the host until its government upheld those values. •

-~- :ja ' I

~~;;~ iii c':<':;1 '~? .. . Senior VIce President IBM Research IBM

~~·~ ·~ Vice President & Chief Technology Officer Chevron

18

SIR- Echoing the sentiments Greece on the precipice Finally, I would like to point ler to "remind" them that the

of my co-peripheralist in Dub- out that the lese-majeste law is there is no talking in the quiet SIR- Leaving the euro zone is lin (Letters, May 12th), I too am part of Thailand's criminal carriage. I have never seen this no option for Greece ("Fiddling frustrated by the widespread code, which also contains technique not work. while Athens burns", May misuse of the term" austerity". provisions on defamation and BILL LEFFINGWELL

19th). The new drachma would It must surely seem "austere" libel for private individuals. Rockville, Maryland be valueless, as there would be to cut by 30% the pension of a The law gives protection to the no demand for it. A country Greek civil servant who was rights or reputations of the SIR- Whenipointoutto that finds it difficult to run its undoubtedly counting on that king, the queen, the heir-ap- phone offenders that they are fiscal affairs cannot manage a income to live out the next 25 parent or the regent in a similar in a quiet carriage the usual national currency. The restored years of his life. But when the way that libel law does for response is that they are only drachma would stay in circula- specific pension in question is, commoners. It is not aimed at making a short call. A three-tion only if the Greeks were for example, the monthly curbing people's rights to minute call from half the denied access to foreign ex- €1,8oo ($2,300) paid to a re- freedom of opinion and ex- people in a 75-seat carriage change, preventing the infor- tired assistant garbage-truck pression, nor the legitimate ensures a constant babble all mal use of the euro. That driver in the Peloponnese (I exercise of academic freedom, the way from London to Bris-would require draconian kid you not), perhaps some including debates about the tal. I did once move to the seat exchange controls of the type other term would be more monarchy as an institution. beside a persistent offender in put in place by Germany after appropriate. The new pension RUTCHABHOOM BOONRAWD mid-call and recited Cole-the first world war, which level of €1,200 is still so% Embassy ofThailand ridge's "Kubla Khan" aloud to ensured the circulation of the above the starting wage of a London him. Somewhere in the deep depreciating mark during a schoolteacher. romantic chasm he under-period of hyperinflation. Austerity, like beauty, is in

Losing some friends stood my point and desisted. What can Europe do for the eye of the beholder. PAUL BEARDMORE

Greece? It can provide it with a ALEXANDER SINGER SIR- Your report on Face- London stable monetary unit: the euro. Athens book's valuation missed the What can Europe not do for central conflict that jeopardises From one author to another Greece? Well, it cannot give it a The Thai monarchy the firm's future success sound fiscal system. The ("Zuckerberg's rocket, ready for SIR- Please tellJonathan Greeks have to achieve that SIR- I want to provide you lift-off", May 12th). Millennials Franzen that I went quite nutty themselves if they wish to with some facts on the death like myself flocked to the social with happiness over what he remain a sovereign country. of Ampon Tangnoppakul, network because it was young said about my work ("Pur-ERNST JUERG WEBER whom you wrote about in and "cool". That strength now posefully dreaming", April Associate professor of your article on Thailand's serves as its greatest weakness 28th). Not to say blurbs aren't economics lese-majeste law(" An inconve- as Face book asks us to over- welcome ... University of Western Australia nient death", May uth). First, look its youthful indiscretions ALICE MUNRO

Perth we are deeply saddened by the over privacy and hand over Clinton, Canada death of Mr Ampon. An initial our credit cards.

SIR- When are you going to autopsy report confirms that Themagnetofcoolvan- Punishment fits the crime wake up to the fact that the he died from liver cancer. The ished the moment they European federalist dream is final report of his autopsy, claimed to be responsible SIR- Regarding the current over? The euro is finished as a including a tissue-sample adults. Investors are chasing a travails at Spanish banks ("A world currency. This sorry saga examination and toxicology moving target. rude awakening", Mayuth), has been dragging on for two testing, will be released in due STEPHEN SENTOFF Barcelona, arguably the birth-years now, bringing Europe course. It is regrettable that Arlington, Virginia place of the modern bank, did "ever closer", not to greater certain groups have tried to not tolerate bankrupt bankers. union but to being torn asun- gain publicity from his death

Clickety clack According to Edwin Hunt's der. The euro was a grand for their own political means. andJames Murray's history of scheme that pushed the Second, Mr Amp on, as with SIR- I found it interesting that business in medieval Europe, boundaries of globalisation by other prisoners with health designated quiet carriages on under a law passed in 1321 trying to subsume countries problems, was provided with trains don't seem to be very bankers who were in default whose peoples have enduring proper medical treatment for quiet in some parts of the were given only bread and national identities into some his illness in the corrections world ("Shhhh!", Mayuth). I water and had to settle their kind of postmodern techno- department hospital. He was also found the proposed sol- accounts within a year. In 1360 cratic paradise. Yet polls show allowed to leave the correc- utions of signal jamming, fines one banker, Francesc Castello, that those peoples actually tions facility to receive chemo- and extra charges equally "was beheaded in front of his liked their currencies and the therapy treatment at an MRI interesting, and a little stupid. own bank." control it gave them over their centre five times in 2011 and I frequently travel by train DAN CHURCH

economies. twice this year. from Washington, DC, to New Bethlehem, Pennsylvania • What this crisis has thrown Third, the legal proceedings York on the Amtrak Acela and

a light on is that we are not against Mr Amp on were car- have never had a problem "Europeans" after all, but ried out in accordance with with noise in the quiet car. Letters are welcome and should be

Greeks, Germans, French, Thai law and due process, What keeps the quiet and the addressed to the Editor at

British and so on. Let's hope including the right to a fair peace is good old-fashioned The Economist, 25 StJames's Street, London SWlA lHG

that light doesn't blind us trial, assistance from lawyers peer pressure. The minute E-mail: letters@economist.com when we all rush for the exits. and ample opportunity to anyone gets on their phone or Fax: 020 7839 4092

THOMAS WILLIAMS contest the charges. He was starts talking to their seatmate, More letters are available at:

Dover, Kent also entitled to appeal. there is always a fellow travel-Economist.comjletters

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The Economist May 26th 2012

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The Economist May 26th 2012

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21

The billion-baht man Na Kham M we, the commander of the Democratic Karen Buddhist Army, lords it over a tiny strip of Myanmar near the Thai border. His relationship with Myanmar's government has grown cordial recently. ButThailand's drug tsar has put a gobsmacking bounty on his head Economist.comfnode/21555860

United States: Bringing the Bain If Mitt Romney cannot defend himself against Barack Obama's attemptto turn his business experience into a liability, he does not deserve to be president Economi st.comf node/ 21555845

Technology: Difference engine Why people drive what they drive Economist.comjnode/21555829

Middle East: Seeds of the future On line activists continue to play an important role in the Arab spring Economist.comfnode/21555839

China: Blame the messenger India-China relations might improve if their national press corps were better acquainted, or agreed on the purpose of journalism Economist.comjnode/215557 44

Battle igloo Frugal innovation is usually associated with entrepreneurs in emerging markets developing low-cost products. Butthe process can happen in the rich world, too: a British company planning to entertain festival-goers has ended up disrupting the business of battlefield simulation Economist.comfnode/21555777

Europe: Eurovision diary Playing hostto this year's Eurovision song contest gives Azerbaijan a chance to show off the fruits of its oil boom Economi st.comf node/ 21555 7 3 7

Business: GoodTube Google wants You Tube, its popular on line video service, to become less about entertainment and more like the BBC Economi st.comf node/ 21555 7 55

Business education: Stop planning How to make studying entrepreneurship more like being an entrepreneur Economist.comfnode/21555752

Technology: More than just text Two-dimensional scans of books, while useful, leave out plenty of information Economist.comjnode/21555556

P pa for op rtunity

The music's over As a genre, disco gets a rotten press. It tends to conjure up images of hairy chests, medallions and the worst kind of dad-dancing.Buttherecentdeathsoftwo disco heavyweights, Donna Summer and Robin Gibb, provide an opportunity for a re-evaluation of its origins and delights Economist.comfnode/21555794

Americas: War of attrition The stalemate between students and the Quebec government over university tuition fees shows no sign of ending Economist.comfnode/21555828

Sport: The leopard changes his spots Two British climbers prepare fora daunting challenge in the former Soviet Union Economist.comjnode/21555734

Culture: The price of being female Depictions of women often command the highest prices at art auctions. Works by them do not. Butthatis changing Economist.comjnode/21555730

Links to all these stories can [!] • . ~-~ be found at Economist.comf ~.-- ~.:! node/21555844 or by scanning ~ this code [!] " · •'

Economist Intelligence Unit

An ever-deeper democratic deficit

The level of further integration necessary to deal with the euro crisis will be hard to square with the increasing cantankerousness of Europe's voters

FOR the past six decades, steps forward tional governments. Some countries, un­to greater European union have taken der some conditions, may put up with see­

place at moments of incipient crisis. None, ing their governments so constrained for a though, has been taken in a time of disas- while: Italy and Greece (until recently) ter. The next leap in integration looks set to have had unelected, technocratic prime change that. All the plausible solutions to ministers, in large part as a result of pres­the self-inflicted mess of the euro crisis re- sure from outside creditors. But elsewhere, quire a significant new level of fiscal and and in the long run, people seem likely to potentially political union, not least be- want to do the constraining they think cause some countries, such as Germany, proper by means of the ballot box, rather actively want greater political union and than having it forced upon them. see it as the price of their co-operation. In order to make any such solution work, Eu­rope's elites will have to address a problem they have long shirked: that of the demo­cratic deficit at the heart of integration. And they will have to do so under the worst of conditions.

The past week's near-continuous high­level summitry has done little to reduce the risk of a Greek exit from the euro, which rose to higher levels than ever after the inconclusive results of the country's election on May 6th. The risk shows no signs of receding before the next vote, on June 17th. After that, risk may become reali­ty (see next story).

A consensus is slowly emerging that, whether a Greek exit is to be averted or weathered, there will have to be a greater level of integration in the euro zone, with tighter constraints on the freedom of na-

If only you'd asked A new paper written for the European Council on Foreign Relations (ECFR) by Ul­rike Guerot and Thomas Klau quotes a German government official putting his finger on the nub of the problem: "the weakness of the system is not about spending and how to promote growth, but about legitimacy." A move to fix the euro crisis with greater political union that does not take this into account will, at best, store up grave political problems for the future. At worst it will prove impossible to imple­ment at all because of the politics of the here and now.

The architects of the 1992 Maastricht treaty, who included Jacques Delors, then European Commission president, and Hel­mut Kohl, then German chancellor, always wanted political union to accompany the

Also in this section

26 The costs of a Greek exit

In other sections

54 Charlemagne: The feelings mutual

71 Europe in limbo

monetary union that the treaty envisaged. Some critics of the project, including the German Bundesbank, argued that the sin­gle currency would not work without it.

But Maastricht, like many edifices, did not end up quite as the architects had wanted. There were rules on budget defi­cits that implicitly reached into the politi­cal decision-making of the member states. But they were not taken seriously, and swiftly broken without censure.

In what has become something of a pattern in Europe, most voters were not asked whether they wanted such a treaty. Those who were showed themselves equivocal: a French referendum on the Maastricht treaty squeaked through by the narrowest of margins. Most of the euro zone's citizens came to accept the currency, as they have accepted the European Union (Eu), because until the crisis hit it seemed to bring clear benefits, or at least to do no harm. Once things started to go wrong, though, the voters protested.

23

Since the euro crisis began in early 2010, no fewer than nine of the zone's17 national leaders have been ejected from office. The approval ratings for many countries' mem­bership of the EU have been declining (see chart 1 on next page). Voters have been giv­ing more support to fringe parties. The Greek election took this swing to extremes, ~~

24 Briefing The euro crisis The Economist May 26th 2012

Flagging fortunes ~ with almost 70% of the votes going to par­

ties that wanted to modify or tear up the country's bail-out deal. But something similar, if more muted, is visible from Fin­land to the Netherlands to Germany. It can be hard to tell anti-incumbency feeling from anti-Brussels feeling-but that is part of the problem. With no way to influence Brussels except through governments that seem not to be listening, the cynical anti­politics of impotence easily takes hold.

"My country's membership of the EU is a good thing", % polled

Democracy, eurocracy This democratic deficit in Europe's institu­tions is hardly new. Europe's first helms­men deliberately eschewed populism-the tool of fascists and communists, in their eyes-in favour of dispassionate well­planned gradualism as a road to the sort of ever closer union that would banish war from the continent. Thanks to the decisive intervention of Charles de Gaulle-whose "empty chair policy" meant refusing to send French emissaries to Brussels, and thus paralysing the nascent institutions until his demands were met-the project soon veered from a more centralised vi­sion to a more inter-governmental one; but the powerful non-national institutions re­mained.

Although it was an elite venture light on such fripperies as voters' consent, still less accountability, the European project incor­porated many less direct democratic fea­tures from the start. Most fundamentally, membership was only open to democra­cies. The inter-governmental Council of Ministers and European Council-now the EU's prime driver of policy-thus repre­sented the people. The commission-its members chosen by elected national gov-ernments-would propose

From January 2002

Germany - Poland - EU average

- France Britain

80

70

60

50

40

30

20 I l l _1. 1-

2002 03 04 05 06 07 08 09 10 11

Source: Eurobarometer

A third was to claim that the European project was mainly about technical mat­ters such as competition, regulation and rules for the single market, all of which could happily and unproblematically be dealt with out of sight of the voters (in most countries they are dealt with techno­cratically). The argument was that, so long as the EU did not touch the most important political issues for ordinary voters-such as tax, spending, education, defence or health care-its apparent lack of account­ability would not matter.

Coming unstuck Now the crisis has struck, all the putative responses to the democratic deficit are be­ing found wanting. The qualified majority voting introduced by the Single European Act of the 1980s and the subsequent en­largement of the union mean that nations, especially small ones, can frequently feel

marginalised, and their elec­legislation; it would then have I to be approved by both the One-way trip

torates voiceless; the system is opaque, complex and remote. Countries outside the euro zone are not party to some de­cisions, which can make them fear marginalisation; the "six

Council and the European Parliament, another mode of legitimation. To begin with the parliament's members, too, were nominated by gov­ernments from their national parliaments. From 1979 on­wards the members have been elected directly.

The role of governments in setting policy and appointing personnel was one response to concerns about democratic accountability within the na­scent EU. Another was to ar­gue that what really mattered for European citizens was "output legitimacy": the no­tion that, so long as the com-mon project produced evi-dent benefits in the form of prosperity, economic oppor-tunities and job creation, vot­ers would accept it, and even come round to welcoming it.

Turnout in European Parliament elections % oftotal electorate

1979

1984 1989 1994

1999

2004

2009

Source: European Parliament

65

60

55

50

45

40

35

0

pack" of fiscal regulations agreed last year and the newly devised fiscal compact erode even further the ability of a government within the zone to control its own fate. Cru­cially, the pact imposes fines on governments in breach of its strictures automatically, un­less a qualified majority of all the others votes against doing so. In 2002 Francis Mer, newly installed as French finance minister, dismissed commis­sion requests for budget cuts to comply with the stability and growth pact by saying that "France has other priorities." Pierre Moscovici, Fran<;ois Hollande's new finance minis­ter, stands no chance of being

PIIGS focus from January 2007

Portugal

Greece

2007 08

Ireland

Spain

09 10

- Italy

80

70

60

50

40

30

20 I 1-

11

similarly highhanded. This lack of govern­mental override worries not just debtor nations but also some creditor countries such as the Netherlands-and even Ger­man states.

The other responses to the democratic deficit look even more tattered. Output le­gitimacy is a hard sell when the outputs voters use to reach a judgment are a crisis they didn't create and austerity they don't want. The idea that the EU is all about dis­tant technical adjustments is laughable now that the euro is impinging on many basic functions of sovereign national gov­ernments, most obviously in Greece, Ire­land and Portugal, but also in all the parties to the fiscal compact. If the euro is to sur­vive, it will likely do so by impinging on them yet further.

And what of the European Parliament? It has, if anything, widened the deficit it is meant to make up. It has increased its pow­ers with every EU treaty, including the fis­cal compact; but it has seen no parallel growth in its legitimacy. In the commission and in national capitals alike, frustration with the parliament has been growing. It is almost always in favour of new regulation and always in favour of more spending. Any claim that this is what the voters want is undermined by the fact that the voters show ever less interest in it. At every elec­tion for the European Parliament since 1979, the turnout across the continent has plumbed a new low (see chart 2). National elections see higher turnouts almost everywhere. And if fringe parties are doing well in many regional and national elec­tions-as the Pirate Party has been in Ger­many, and Beppe Grillo's "Five Star move­ment" in Italy (see page 51)-they tend to do even better in votes for Strasbourg.

How to elect a president If a more tightly knit euro zone needs bet­ter democratic credentials, then there is no shortage of ideas about what to do. The most obvious is to limit the extent of cen­tralised powers. Constraints on national budget deficits-which the fiscal compact ~~

The Economist May 26th 2012

~ wants written into national constitu­tions-do not need to mean common rules on spending or harmonisation of taxes. The long-established principle of subsid­iarity should leave as much discretion as possible to national or local levels of gov­ernment. Yet much tighter constraints on fiscal policy will still curtail national free­dom, so they may need to be offset by schemes designed to increase democratic legitimacy.

Old-style federalists say this means now is the time to bolster the European Parliament still more. One possibility would be to up the ante in its elections by making them indirect elections for the commission president as well. The idea is that the big political groups (the centre­right European People's Party, the Social­ists and the Liberals) should each have pre­ferred candidates, and the member states should agree to choose the candidate of the block that does best at the next elec­tions, due in 2014.

Such schemes ignore the degree to which the parliament has become part of the problem, rather than the solution-un­loved by the Eu's institutions, the govern­ments of its member states, and its citizen­ry. In its judgment on the Lisbon treaty, the German constitutional court cast doubt on the democratic credentials of the Euro­pean Parliament, arguing that the Bundes­tag had greater legitimacy.

Another possibility, if elections are the answer, is to avoid the parliament and elect the president of the commission di­rectly. Wolfgang Schauble, Germany's fi­nance minister, has espoused this idea, most recently in his acceptance speech for the Charlemagne prize on May 17th. Last November, his party, the Christian Demo­cratic Union that Angela Merkelleads, also came out in favour of an elected president. The opposition German Social Democrats are also interested.

As in many matters, German enthusi-

Continental covenants EU treaty referendums since 1992

asm is not enough in itself to win the day. Direct elections for a president (unlike ap­pointment on the advice of the parlia­ment) would require a new treaty. Even be­fore the euro crisis, new treaties had proved hard sells (see timeline below). The EU's Lisbon treaty crept into force only be­cause 26 of the 27 member states avoided putting it to a vote, and the 27th, Ireland, al­lowed itself a second vote after the first went the wrong way.

The executive and the excluded If treaties are to be changed, though, Ver­non Bogdanor, a professor at King's Col­lege, London, would push the elections yet further, and elect the entire commission on a Europe-wide basis. He argues that the euro zone is at a similar stage to the embry­onic United States in the early 1780s. That was the moment when Alexander Hamil­ton took the big step of federalising the states' debts. In the euro zone, too, Mr Bog­danor suggests, it is time to move towards federalism with a new democratic input: hence the notion of an elected European Commission. To those who claim that there is no European demos to underpin such democracy, he argues that a Europe­wide election will itself create one.

This is the sort of thing that Larry Sie­dentop, a former Oxford academic, warns against under the heading of "faux democ­racy". Sharing the general dissatisfaction with the European Parliament, Mr Sieden­top doubts things can be improved by an­other elected body. In his prescient "De­mocracy in Europe", published in 2000, Mr Siedentop warned that, after creating the single currency, "European elites today are in danger of creating a profound moral and institutional crisis in Europe-a crisis of democracy." His suggested solution was to set up an appointed Senate, chosen from national parliaments; to those who feel de­mocracy needs elections he points out that America's Senate was appointed untill913.

Briefing The euro crisis 25

An alternative, and attractive, source of democratic accountability might be found in Europe's national parliaments. Before 1979 there was an umbilical link between the European Parliament in Strasbourg and national parliaments, with some mem­bers circulating between the two. Now the different parliaments tend to see each oth­er as rivals rather than as colleagues trying to hold the executive to account. The Lis­bon treaty gives national parliaments only a limited role. Charles Grant, director of the Centre for European Reform in Lon­don, suggests enlarging this. He would give more prominence to cosAc, the group that brings together national parliaments' European affairs committees, perhaps put­ting a delegation of national MPS in Brus­sels to work more closely with the Euro­pean Parliament. Others want to give the budget committees in national parlia­ments a clear role in monitoring and ap­plying the fiscal compact.

A continuing issue in all this is the bal­ance between an inter-governmental and a federal system. Those leaning towards a bigger role for national parliaments and governments naturally favour the first. But Mr Klau of the ECFR points out that such a method makes it more likely that Ger­many, the biggest power and also largest creditor, will be identified as a target by the rest. Inter-governmentalism favours big countries, which is why small ones talk up the role of Brussels.

The case for greater national involve­ment in running the euro zone is very strong. Whether Greece leaves or stays, the euro zone must be more politically inte­grated or fall apart. But deeper political un­ion could provoke a backlash, in both cred­itor and debtor countries, that brings the whole system crashing down. In last year's Finnish election the True Finns under Timo Soini went from almost no support to close to 20% by campaigning against euro-zone bail-outs. In the Netherlands Geert Wild- ~~

Result: for/ against

EUROPEAN MAASTRICHT TREATY:

TREATY OF AMSTERDAM:

TREATY OF NICE:

CONSmUTION FOR EUROPE:

TREATY OF USBON:

FISCAL COMPACT:

~ ~ Denmark (2/6/92) 49.3/ 50.7

Ireland (18/6/92) 69.1/ 31.0

1

4 ~ France (20/9/92) 51.0/ 49.0

~~ Denmark (18/5/93) 56.7/ 43.3

4 Ireland (22/5/98) 61.7/ 38.3

~~ Denmark (28/5/98) 55.1/ 44.9

4 Ireland (7 /6/01) 46.1/ 53.9

4 Ireland {19/10/02) 62.9/ 37.1

1992 93 94 95 96 97 98 99 2000 01 02 03

THE EURO:

Source: The Economist

January 1st 1999

Single currency launched: Austria, Belgium, Finland,

France, Germany, Ireland, Italy, Luxembourg, Netherlands,

Portugal, Spain

January 1st 2001 Greece joins

04

_ Spain (20/2/05) 77.0/ 17.1

4 ~ France (29/5/05) 45.3/ 54.7

, : Netherlands (1/6/05) 38.5/ 61.5

05

: Luxembourg (10/7 /05) 56.5/ 43.5

06 07

January 1st 2007

Slovenia joins January

1st 2008 Cyprus and Malta join

4 Ireland Ireland {12/6/08) {31/5/12) 46.6/ 53.4 ?/ ?

4 Ireland (2/10/09) 67.1/ 32.9

,.,.... 08 09 10 11 12

cL

January 1st 2011 Estonia

January joins 1st 2009 Slovakia joins

26 Briefing The euro crisis

~ ers, who has just precipitated an election by withdrawing his support from the gov­ernment, is now running as much on an anti-bail-out ticket as his more familiar anti-Muslim one. France's National Front has long been anti-euro as well as anti-im­migrant, and Marine Le Pen's stand against the single currency contributed a lot to her strong showing in the first round of the presidential election.

Given that voters are making their an­tipathy heard by means of their national elections, they might feel better represent­ed if national MPS and governments played a bigger role in policing the bound­aries of political union of the euro zone. But this may be too sanguine. A significant number of voters clearly want not a more democratic version of the EU, but a funda­mentally different institution. With views highly polarised, it is hard to see how any useful treaty could now get accepted by all 27 nations-which is one of the reasons why the fiscal compact has an opt-in sys­tem. When Ireland votes on the compact on May 31st, it will be voting in or out for Ireland alone, not threatening to block everyone else.

If Europe seeks a new political constitu­tion, though, a dramatic lurch towards a re­jectionist or extremist party on one coun­try could lead to a break-up of the club. And there is also a profound structural pro­blem. The new round of political integra­tion is being driven by the need to govern the euro zone better; but ten of the 27 are not part of it. And although many of them have historically aspired to join, Britain and Denmark have formal opt-outs from the euro, and Sweden is also unlikely to join for many years, if ever. These coun­tries have a strong interest in ensuring that, as the euro zone becomes more integrated, they do not lose their influence in debate or their part in decisions. But their voters are unlikely to accept commitment to a stronger political union. David Cameron's "veto" of the fiscal compact in December 2011 was seen as a petulant obstacle to pro­gress by many of his fellow heads of gov­ernment; his party's supporters in Britain greeted it with inordinate enthusiasm.

When the architects of Maastricht were unable to produce a political union some of them comforted themselves with the idea that a common currency would in and of itself bring further economic inte­gration from which political integration would naturally flow. They did not foresee that it would do so by throwing the conti­nent into crisis. And they did not provide the mechanisms by which the citizens of the union could feel they were both in part to blame for the problem, as some are, and in a place to help find a solution. A political settlement that protects the euro without incorporating new ways to get and earn their assent is unlikely to last long-or to deserveto. •

The Economist May 26th 2012

The costs of a Greek exit

Cutting up rough

How much do Greece and the rest of Europe stand to lose?

I T COULD come sooner; it might well drag out longer; it can still be averted: but

the week following the next Greek election on June 17th still looks set to be the time when the euro zone's debilitating fever peaks, and the patient's prognosis be­comes clear. That election could well pro­duce a government determined to renege on or radically renegotiate the reforms and austerity measures its predecessor com­mitted the country to at the time of the sec­ond bail-out, earlier this year. If that hap­pens, the rest of Europe will have to decide whether to be party to those negotiations or to walk away.

If European leaders follow through on their threats to enforce those terms, the flow of bail-out money to the Greek gov­ernment will stop. Since March Greece has received half of the €145 billion ($185 bil­lion) it is due to get from the European Fi­nancial Stability Facility (EFSF), the euro area's temporary rescue fund, by the end of 2014. And it has received a first payment of €1.6 billion out of a total €28 billion due from the IMF by early 2016.

Although the Greek government is close to running a primary budget surplus (ie, before interest payments) it still needs further official loans to honour obligations due this year, notably redemptions of bonds held by the European Central Bank (ECB), which were excluded from the re­structuring in March that slashed the face value of €2oo billion of debt held by priv­ate bondholders by over half. If the lifeline from the EFSF were cut off by its creditor nations, Greece would be unable to pay

those debts. And if the ECB makes it a mat­ter of principle not to lend (or permit the Bank of Greece to lend) to banks against collateral consisting of bonds and guaran­tees from a government in default, then it in turn would cut Greece off. Greek banks currently rely upon some €130 billion of central-bank funding. Without the ECB

money the entire banking system would collapse. If the flow of money was re­duced, and the conditions it is lent on tight­ened, the Greek government might start to issue 1ous to its workers to make up the shortfall. If the flow stopped, leaving the banks no euros to pay out, a new currency would be the only alternative.

The government would redenominate domestic bank assets and liabilities into drachma and insist that domestic con­tracts, such as pay and prices, be also set in drachma. Capital controls would be neces­sary because the drachma would immedi­ately fall against the euro, possibly losing so% or more of its value in a trice.

In the short term Greece's economic ag­ony-its economy shrank by 13% from 2007 to 2011 and is expected to contract by al­most 5% this year-would intensify. A pre­cipitous exit without preparation would leave the country without notes and coin. The surrounding chaos would paralyse economic activity, causing consumers and businesses to stop spending. Economists at UBS, a Swiss bank, have estimated that the cost of a catastrophic exit might amount to 40-50% of G DP in the first year.

That figure assumes that Greece would have to leave the EU as well as the euro, ~~

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28 Briefing The euro crisis

~ and thus lose access to the single market. On strict legal grounds that may be the case, in part because exit requires capital controls, and those controls are illegal un­der EU treaties. In practice European policymakers are making it clear they would do their utmost to keep Greece in the EU. Assuming such helpfulness, Mark Cliffe, an economist at ING, a Dutch bank, reckons that the effect would be less. He puts the first-year extra loss of output at 7.5% (see chart).

Run like the wind If Greece's new currency avoided lurching into hyperinflation-which in a chaotic country with a weak government and a new currency would be a serious risk-the country might regain some of its losses the following year. Rather than having to spend years grinding down domestic costs, the exchange-rate fall would provide them overnight, boosting competitive­ness. If the country looked safe, stable and welcoming, other Europeans would flock to take their holidays in the Aegean.

That is another rather large if; and other Europeans may have a lot more to worry about than holiday planning. European governments would bear losses on the loans they have made to Greece in the va­rious bail-outs. The ECB for its part is ex­posed in two main ways. Firstly, to calm market tensions after the May 2010 rescue it bought Greek bonds worth about €40 billion. Second, the Bank of Greece owes the ECB around €130 billion in "Target 2" debt, internal obligations within the Euro­pean central banking system, which would turn into real debt in the event of an exit. All in all, the Greek government owes the governments and institutions of the euro area over €290 billion, about 3% of euro-wide GDP, say economists at Bar­clays Capital. After an exit most of this would probably never be repaid.

On top of that, there is the exposure of the private sector. At the end of 2011 Greek companies and households owed interna­tional banks $69 billion. And, harder to quantify but just as real, there are losses from uncertainty and increased bond yields in other vulnerable countries that will follow from the demonstration that the euro really can be left.

What might this mean in numbers? Re­cent forecasts by the European Commis­sion project the euro zone's GDP declining by 0.3% this year, and then growing by 1% in 2013. Mr Cliffe estimates that following an orderly and well-managed Greek exit­one with very limited contagion and some continuing support to Greece from the euro zone and IMF-the euro area would suffer an extra first-year GDP loss of 1.6%, making a mild recession harsher. The oth­er troubled peripheral economies would be hit hardest, though in this model they would increase their commitment to struc-

I Bad timing Additional change in annual GDP caused by: %

First year Second year orderly Greek exit - -

complete euro break-up •

10 8 4 2 - 0 + 2

Greece

Italy

Spain

Ireland

Portugal

Euro area

France

Netherlands

Germany

United States

Source: ING

tural reform having seen the alternative. Germany would be least affected. Its econ­omy is in any case forecast to do better than the euro area, expanding by 0.7% in 2012 and 1.7% in 2013; relative to this base­line it would incur a first-year output loss of 1%. America, he thinks, might be hit half that badly.

But could a Greek exit really be con­tained at its borders? European banks re­main worryingly weak, not just in small economies like Cyprus-already in trou­ble, and very exposed to Greece-but also in large ones like Spain, the fourth biggest in the euro area. Bad loans in Spain have risen by a third over the past year, to €148 billion or 8-4% of outstanding loans, the highest since August 1994. Spanish banks are widely believed to require an injection of public capital of at least €30 billion (3% of GDP) and perhaps a lot more. Borrow­ing that much would be a hard task for the deficit-stricken Spanish government (which has yet again raised its estimate for last year's deficit, to 8.9% of GDP).

With Spanish banking woes so promi­nent (see page 52), there is a danger of bank runs as citizens of vulnerable economies fear ending up with devalued deposits. Such runs would become much more like­ly after a Greek exit, but it is possible that they could start before one, and indeed precipitate it-possibly the worst of all bad options. If confined to relatively small economies like already bailed-out Ireland and Portugal this might be manageable. In an economy the size of Spain's or Italy's they would be a terrible danger.

The "firewall" which is supposed to protect against contagion is neither de-

The Economist May 26th 2012

signed for bank runs nor adequate to the needs of large economies. At present the EFSF, the temporary bail-out fund, has €250 billion of uncommitted funds which it could use to provide financing for gov­ernments that find themselves cut off from the markets or facing punitive rates as they try to save their banking systems. The per­manent rescue facility, the European Sta­bility Mechanism (ESM) is due to start in July, but has not yet been ratified by several countries, notably Germany. Even when it does get going, the new lending capacity available from the two funds will be capped at €500 billion, supplemented by possible support from the IMF of up to $430 billion.

Beyond the adequacy or otherwise of the funds' size, there is the problem of what they can be spent on. If they were used to bail out commercial banks directly, they could break the pernicious circle in which unstable banks use the debt of bare­ly solvent governments to shore them­selves up. But as things stand neither the ESM nor the EFSF is allowed to do that. To free them in this way would require both agreements to be ratified again, a political­ly risky and time-consuming process.

That leaves the ECB as the last bulwark. It could buy bonds again, but this tactic would be less effective than before unless it dropped its insistence on being protected against any future haircut. If it does not, bond investors will regard every purchase it makes as pushing them down the peck­ing order, thus reducing any residual appe­tite they might have. It could also provide near unlimited liquidity through yet an­other huge long term refinancing opera­tion. But this would involve loosening its collateral conditions and exposing the cen­tral banks to greater and greater risk.

If neither the rescue funds nor the ECB can do enough, a wider break-up might en­sue, with huge costs all around. Mr Cliffe says that a disintegration of the euro would be catastrophic even for core Eu­rope, with first-year output losses of 8.9% for the euro area (as was). This time Ger­many would not be spared, incurring a GDP loss of 8.2% as its exporters contended with the strength of a reborn n-mark. Across the former euro area, there would be a wave of bankruptcies as firms sud­denly found themselves either owed mon­ey in a depreciating currency or owing money in an appreciating one.

Currency unions have cracked before, but none with the scale, ambition or inter­connectedness of the euro area. Contem­plating the dread consequences of such a disintegration may yet prompt conces­sions from both Greece and its creditors that prevent the worst happening. But can the level of fear be adequate to engender such a change of heart while not so power­ful as to trigger panic? Again, the prognosis is uncertain. •

Government transparency

The best disinfectant

ATLANTA

Hopes of "open government" under Barack Obama have been only partly fulfilled

BARACK OBAMA accepted an award ing what records and meetings are public. honouring his administration's corn- These regulations are commonly known

mitment to transparency on March 28th as sunshine laws. 2011. It was given by a coalition of open- Eric Holder, Mr Obama's attorney-gen­government advocates. But the meeting eral, issued FOIA guidelines to agency and was closed to reporters and photogra- department heads encouraging disclosure, phers, and was not announced on the pres- and promising that his Justice Department ident's public schedule. Occasionally life would take a much narrower view of what provides perfect metaphors. constitutes a defensible withholding of in-

On his first full day in office Mr Obama formation than his predecessor's had. Mr declared that "government should be Obama has not once claimed executive transparent," and said that his administra- privilege to avoid turning over informa­tion "is committed to creating an unprece- tion to Congress. His predecessor, George dented level of openness in government". Bush, made six such claims during his two And so, in December 2009, he issued his terms, and the previous Democratic presi­Open Government Directive, which or- dent, Bill Clinton, made five. dered federal departments to formulate And yet in this arena, as in others, Mr and publish plans to become more trans- Obama has been better at rhetoric than re­parent. Those plans were all duly pub- ality. David Sobel, senior counsel for the lished within five months. Also that De- Electronic Frontier Foundation, a digital­cember he created a new National rights group, says that despite Mr Holder's Declassification Centre (No c), designed to promise of greater FOIA disclosures, streamline the declassification of govern- "Those of us who file litigation in this area ment documents. haven't really seen that happen." The NDC

The federal government now publishes has made public a paltry 22.6m of the a vast array of data at Data.gov. At Recov- 400m pages of classified data that is cur­ery.gov meanwhile, citizens can track how rently in its backlog. The rate of document their stimulus funds were spent. Foia.gov, classification remains far higher than the launched in March 2011, lets people see rate of declassification. whether agencies are fulfilling their obliga- Mr Obama's administration is proving tions to disclose information under the as fond of wartime secrecy as the adminis-1966 Freedom of Information Act (FOIA). tration he replaced. The American Civil That act governs what information must Liberties Union is suing under FOIA to get be released to the public. It is federal, but all it to reveal records of the use of drones by so states have their own versions govern- the CIA and the armed forces to kill partic-

Also in this section

30 Utah's health-care reform

32 Military innovation

32 Fish stocks

34 Government spending

34 Maine's Senate race

36 Lexington: Moral quandary

For daily analysis and debate on America, visit

Economist.comfunitedstates

ular people. The CIA'S response has been to "neither confirm nor deny the existence or non-existence of records responsive to this request".

Yet perhaps none of Mr Obama's tran­sparency promises has rung hollower than his vow to protect whistleblowers. Thom­as Drake, who worked at the National Se­curity Agency, was threatened with life im­prisonment for leaking to the Baltimore Sun unclassified details of a wasteful pro­gramme that also impinged on privacy. The case against him failed-ultimately he pleaded guilty to a misdemeanour charge of "exceeding authorised use of a comput­er"-but not before he was hounded out of his job. Mr Obama's administration tried to prosecute him under the Espionage Act, a law passed in 1917 that prohibits people from giving information "with intent or reason to believe that it is to be used to the injury of the United States or to the advan­tage of a foreign nation". Mr 0 barn a has in­dicted six whistleblowers, including Mr Drake, under the Espionage Act, twice as many as all prior administrations com­bined, for leaking information not to a "for­eign nation" but to the press.

All of this comes despite the fact that whistleblowers often do a great deal of good: in 2010, for instance, 77% of the $3.1 billion that America won in fraud-related judgments and settlements came from suits brought by them. Of course any gov­ernment is entitled to keep some secrets, and of course people who leak genuinely damaging information ought to be prose­cuted. But the prosecution of Mr Drake and others like him smacks more of vindictive­ness and message-sending than justice.

29

If the federal government is dragging its feet, however, several states are powering ahead. Sam Olens, Georgia's attorney-gen­eral, led an effort to update Georgia's open­records and open-meetings laws. Mr Olens ~~

30 United States

~ said that the laws, which had not been overhauled in many years, had grown con­voluted and ambiguous. He also cited complaints that local governments were ignoring open-records requests. The changes Mr Olens championed-and which Nathan Deal, Georgia's Republican governor, signed into law on April 17th­lower the cost of records obtained by the public from 25 cents a page to 10 cents, and require agencies to alert requesters if the records will cost more than $25 to provide (sunshine laws require agencies to provide information; they do not require it to be free). They increase the penalties for offi­cials who violate the law, and let prosecu­tors bring civil charges, not just criminal ones, against violators.

The law includes data, data fields and e­mail in its definition of public records, and it lets citizens bring their own devices to a government agency to make electronic copies. Georgia thus joins a growing num­ber of states that explicitly open electronic communication to and from government officials to the public. Among the most am­bitious such programmes is Florida's Pro-

Utah's health-care reform

UnObamacare

SALT LAKE CITY

ject Sunburst, which its Republican gover­nor, Rick Scott, announced on May 2nd. £-mails sent or received by the governor or 11 of his senior staff members will be post­ed to a searchable database within a week of transmission. Another of Mr Scott's ini­tiatives provides extensive pension and salary information for state employees.

Some complain that by posting such in­formation Mr Scott, whose budgets have trimmed Florida's already lean workforce, is stoking public anger against state em­ployees and their generous pensions. Oth­ers warn that Sunburst's requirements can be avoided by such archaic practices as talking in person or by phone rather than by e-mail. And of course government em­ployees can always skirt open-records laws by using personal rather than official e-mail accounts.

But even so, the data show that in states with strong FOIA laws politicians are less likely to be corrupt, and those that are cor­rupt are more likely to be caught. "Sun­light", wrote Louis Brandeis, a Supreme Court justice, nearly a century ago, "is said to be the best of disinfectants." •

A conservative state believes it has a better answer to the health-care question

GARY HERBERT, the governor of Utah, loathes everything about Barack

0 bama's health-care reforms, not least, he says, the way "Obama has come along and spoiled the name 'exchange'." After all, Utah conceived its own version of health reform, called the Utah Health Exchange, long before Barack Obama signed his Pa­tient Protection and Affordable Care Act in 2010. Utah's reform is "market-based", says Mr Herbert, whereas "Obamacare" is a big­government monstrosity. But it too relies on exchanges, so now the word is tainted. Republican governors in New Mexico and New Jersey have even vetoed attempts by their legislatures to build health-care ex­changes.

For Utah this means that its reform needs a new brand name. "We'll have a contest," says Mr Herbert. Beyond that, Keeping them healthy Utah will continue its fight, with 25 other states, to get Mr Obama's reforms re­pealed, something that could happen as soon as next month, if the Supreme Court rules against them. But however that turns out, Utah will push on with its own re­form, because "we think it's really cool," and a potential model for the other 49 states, says Norman Thurston, the man chiefly responsible for getting it up and

running. The history of the Utah Health Ex­

change is a reminder of the bizarre, tangled genealogies of America's various health­care reforms. Utah's was nursed into being in the past decade when}on Huntsman, a Mormon Republican, was governor. At that time the main alternative reform was being cooked up in Massachusetts by its

The Economist May 26th 2012

then-governor, Mitt Romney, also a Mor­mon Republican. Both men advocated a "mandate" that required everybody to buy insurance, an idea that originated in a con­servative think-tank. But Mr Huntsman and Utah subsequently dropped that idea, whereas Mr Romney held on to it. Since then, and unexpectedly, the notion of mandates has become toxic in conserva­tive circles.

Utah also decided that government subsidies should play no part in its reform, whereas the one in Massachusetts was based on them. Thus Mr Romney's plan became, more or less, the basis for Obama­care, whereas Utah started seeing its plan as a free-market alternative. (This year Mr Huntsman lost to Mr Romney in the Re­publican presidential primaries, which has not stopped most Utahns from swing­ing their support behind Mr Romney, a lo­cal hero not only because he is Mormon but also because he was brought in to res­cue the Salt Lake City winter Olympics.)

So the Utah Health Exchange is decid­edly not Romneycare or Obamacare. But what is it? At first glimpse, it is a snazzy web portal where four of Utah's five largest health insurance companies offer about 140 plans to about 6,6oo employees of 285 small businesses. Each employer deter­mines in advance how much he will con­tribute to an employee's insurance, as in a defined-contribution pension plan. The employee then filters the plans and selects his favourite-again, as he might choose mutual funds in his defined-contribution pension plan.

As Patty Canner, the exchange's direc­tor, explains, this has advantages over tra­ditional corporate health insurance. In the old system employers had no certainty about premiums, which often rise abrupt­ly. And employees, offered little if any choice, often got stuck with inappropriate plans. Small businesses, specifically, of­fered no insurance in Utah. Their employ­ees and families account for many of the state's 300,ooo uninsured, more than 10% of the population.

So the fledgling exchange is by inten­tion not very radical. A more fundamental reform, for instance, would have tried to break free of the American peculiarity that ties most private health insurance to em­ployers rather than individuals. Indeed, Utah originally wanted to do just that, says Mr Thurston, but then decided that such a step would have to wait until federal tax law stops favouring employer contribu­tions over individual contributions. At pre­sent, the exchange merely aims to "plant the seed for defined-contribution health care", he says.

But the hope is very much that the ex­change, which is now coming out of its test phase and into full-scale operation, will blossom quickly so that within a few years most or all small businesses will sign up, ~~

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32 United States

~ then individuals as well, and finally even large employers-in short, almost every­body. And that would indeed be revolu­tionary. Utah would then do the proper conservative thing, says Mr Herbert, and privatise the exchange-like a stock ex­change, say. If other states then want to copy Utah's example, good. If not, adds Mr Herbert, that is fine too, because as a con­servative he does not believe that one model should fit all.

And that, too, turns out to be another veiled jab at Mr Obama. If the Supreme Court upholds the federal law, says Mr Thurston, the Utah Health Exchange would not be derailed, but its adoption would remain limited to small business. Utah's reform would necessarily stay modest, in short. But if the federal law falls, Utah thinks it has a model to fill the void. •

Military innovation

Stress testing

WHITE SANDS MISSILE RANGE, NEW MEXICO

Bringing the latest kit to the toughest places

IT HAS been three weeks since the Ellisian army invaded next-door Attica. The Un­

ited States, Attica's ally, quickly deployed troops to help re-establish the internation­al border, and had advanced more than so miles by May 16th.

The mission, however, was not an easy one. As well as facing rugged terrain and extreme weather, the American soldiers and Attican security forces had to contend with the radical Islamic Congress of Attica, the transnational Islamic Brotherhood for Jihad, the malicious hackers of the Wolf Brigade and the petty criminals of the area.

Death to Ellisia

Thank heaven it was, in fact, a staged exer­cise, running from Fort Bliss, in west Texas, through to the White Sands missile range, an army base in New Mexico. Some 3,800 soldiers and several thousand military and civilian personnel were taking part in this spring's Network Integration Evalua­tion (NIE), the third round of a new twice­yearly series of exercises. Their point is to test how well fancy new mapping and messaging systems would stand up to the stresses of conflict in harsh conditions.

The White Sands missile range, which dates from the 1940s, sprawls over 3,000 square miles of New Mexico. But it is not as isolated as the cacti and coyotes suggest. The army manages the area's frequency spectrum, in addition to its land and air space. The air force and the navy have a presence there too (the navy has a land­locked "ship" for testing purposes), as do federal agencies like NASA and the odd passing film crew. Fort Bliss, meanwhile, is one of the country's biggest army posts, a fact which draws private contractors and researchers to the region.

Colonel Dave Miller, deputy director of the army's brigade modernisation com­mand, explains that military communica­tions systems have sometimes lagged years behind those in the commercial world. Surprising, perhaps, given that both the internet and GPS began as Pentagon ex­periments; but when it comes to acquisi­tions, the services are often hampered by long budgeting cycles and byzantine con­tracting procedures.

The NIE, then, is part of the army's new "Agile" process. The idea is to bring in prototypes from the private sector, so that soldiers, new and experienced, can give them a spin. If a system is no better than the old version, or if a new radio tends to get jammed with sand, the army can scrap the order or retool it.

One of the items being tested last week

The Economist May 26th 2012

was the Nett Warrior, a sort of rugged smartphone. An earlier version of the de­vice had been on order last year, but was postponed when officials realised that it was much heavier, more expensive and not noticeably better than something that could be bought off the shelf.

Systems that pass muster, however, can be fast-tracked. As a result, acquisitions should be faster, fewer and shrewder-sav­ing money, but also making the army more efficient. Not that too much trust should be placed in technology. "None of these elec­tronic tools replaces human judgment or experience, period," says Colonel Dan Pin­nell, commander of the First Armoured Di­vision's second brigade, who led the mis­sion to restore Attica's border. But better to have today's smart system than a dumber one from five years ago. •

Fish stocks

Plenty more fish in the sea

Sensible policies are working

FOR American fish, this is a good time to be alive. On May 14th the National Oce­

anic and Atmospheric Administration (NOAA) reported that a record six federal fisheries returned to health last year. After a decade of similar progress, 86% of Ameri­ca's roughly 250 federally monitored com­mercial fish stocks were not subject to overfishing; 79% were considered healthy.

This is also good for American fisher­men. Commercial and recreational fishing generates an estimated $183 billion a year and supports over 1.5m full-time or part­time jobs. Rebuilding America's 45 remain­ing over-exploited fish stocks, NOAA esti­mates, could generate an extra $31 billion a year and half a million jobs.

That is a tribute to America learning a simple truth-that scientists, not fishermen or politicians, should decide how many fish can be caught-and enforcing this with simple rules. It has taken a while. Ameri­ca's main fishery law established the im­portance of scientific quotas in 1976. Yet this was routinely ignored because of poor science and weak enforcement, abetted by influential fishermen-notably in New England, which was built on once-rich At­lantic cod and haddock fisheries. The Mas­sachusetts House of Representatives con­tains a conspicuous symbol of this: the "Sacred Cod", a 20o-year-old fish of solid pine, hanging from its ceiling.

Despite this totem, in the late 1980s cod fisheries in the Gulf of Maine and Georges Bank collapsed. This led to efforts to im­prove the fishery act, in 1996 and 2006, ~~

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34 United States

~ which forced the eight regional bodies that manage federal fisheries to introduce sci­ence-based quotas and ten-year recovery programmes for depleted fisheries. The re­cent recovery of species, including New England scallops, mid-Atlantic bluefish and summer flounder and Pacific lingcod, is the result. This signals another truth: giv­en a break, the marine environment can of­ten replenish itself spectacularly.

America's fisheries are probably now managed almost as well as the world's best, in Norway, Iceland, New Zealand and Australia. Yet there is plenty of room for improvement. State-run fisheries, which tend to be close to shore and dominated by small-scale and inefficient fishermen, are less well funded and well managed and much poorer for it. New England ground­fish stocks, including cod, have also not re­covered: they account for 13 of the remain­ing depleted populations. This appears to be partly the result of environmental change, climatic or cyclical.

And the politicians are still interfering. On May 9th the House passed legislation forbidding NOAA from developing an in-

Government spending

Cresting the wave Fish-stock sustainability index*

2000 02 04 06 08 10 11

600

550

500

450

400

350

300 1-

Source: NOAA

*Based on performance of 230 key fish stocks scored 0-4; maximum score possible= 920

novative means of apportioning fishing quotas, known as catch shares. These are long-term, aiming to give fishermen a stake in the future of their fisheries; market­based, since they can be traded; and, in practice, good for fish. Sadly, the two Re­publican congressmen behind the ban consider they have been designed "to de­stroy every aspect of American freedom under the guise of conservation". •

Penny wise, pound foolish WASHINGTON, DC

Statistical surveys are not the best candidates for cuts

ROUGHLY 300,000 military veterans live in Maricopa County, Arizona;

two-thirds of them are over 55. That information comes from the American Community Survey (Acs), a Census Bureau poll sent to 3m households each year. Early this year researchers from the Department of Veterans Affairs and four universities used such data to determine that poor, older veterans are up to twice as likely as non-veterans to be homeless. That sort of knowledge helps target government spending on those who need it most. Yet on May 9th Republicans in the House of Representatives voted to scrap the ACS.

Daniel Webster, a Republican con­gressman from Florida, led efforts to kill the programme. In his view, "what really promotes business .. .is liberty, not de­mand for information." Republicans have done battle with number-crunchers before. In 2009 Michele Bachmann, a congresswoman and would-be president from Minnesota, refused to complete the form she was sent as part of the country's ten-yearly census. The bill targeted by Mr Webster already contained cuts of $2om for this year's Economic Census, a survey of businesses.

Liberty is not all Republicans are bothered about. Mr Webster bemoaned the estimated cost of the programme, up

to $2.5 billion over a decade. Sloppy argument feeds perceptions of waste. Mr Webster complains that the survey is "random" rather than "scientific". Yet random sampling is a vital part of statis­tical analysis.

Some Republicans also suggest that the survey is "unconstitutional". In fact, the constitution requires a ten-yearly census just a few paragraphs in-arguably a sign that the Founders had no great fears of mere data collection. From the mid-19th century the census gathered economic and demographic informa­tion, a development that was recently contested and upheld in court. In the 1990s Congress spun the (now defunct) "long-form" version of the census into an annual survey, the ACS, in response to demand for better and more frequent data. Its results now shape policy at all levels of government, touching on $400 billion in annual spending, and are use­ful for businesses, too.

The Senate, in which Democrats hold a majority, is unlikely to follow the House in scrapping the Acs. Yet a com­promise between them may nonetheless scale back its budget. In 2008 Barack Obama quipped that his Republican foes seemed to "take pride in being ignorant". In this area, congressional Republicans seem to feel that ignorance is bliss.

The Economist May 26th 2012

Maine's Senate race

Crowning a l{ing

BRUNSWICK , MAINE

An independent Main er wants to shake up partisan Washington

"'{ '1 ]HEN Maine's Olympia Snowe, one VV of the Senate's few moderate Repub­licans, announced in February that she was not seeking re-election, she pointed to partisanship and the increasing difficulty in finding common ground as the explana­tion. And so she set the stage for Angus King, a popular former governor, to run for the Senate as an independent.

Flinty Mainers quite like the idea of electing an independent as an antidote to the problems of which Ms Snowe so de­spaired. Although a Democratic state when it comes to presidential elections, both Maine's current senators are Republi­can and more than a third of its voters are registered as independent. It has elected two independent governors in the recent past, including Mr King, who is now reck­oned to have an excellent chance of win­ning in November.

But how independent is independent? Lance Dutson of the Maine Heritage Policy Centre, a think-tank, points out that Mr King is socially liberal, has endorsed Ea­rack Obama this time round and backs his health-care reforms; on the other hand he also backed George Bush in 2000, is a sup­porter of guns, and is no fan of the deluge of financial regulation emerging from the Dodd-Frank bill.

Mr King describes being independent as "liberating". He can hire staff across party lines and is not answerable to any­one but voters. "We could send Pericles, Aristotle and Thomas Jefferson to Wash­ington, but if they were Republicans, they would answer to Mitch McConnell [the minority leader of the Senate]," he says. He wants to remain independent, but is realis­tic, so will probably end up caucusing with one or other party if he is elected. But he has not said which one.

Is Mr King's coyness good for Maine? Freshmen senators do not have much power-they traditionally keep a low pro­file while they learn the ropes. Parties pro­vide support, from helping to get on com­mittees to sorting out office space and staff. Mr King would be at the bottom of the to­tem pole. But he might end up with a lot more power than that. It is conceivable that he could hold the balance of the Sen­ate in his hands, if Mr Obama is re-elected and the Republicans end up with so seats and the Democrats get 49 in November, as all looks entirely possible on the evidence of recent polls. "I could be the most popu­lar girl at the prom," he jokes. •

36 United States

Lexington I Moral quandary

IN MANY respects, Mitt Romney makes a perfect spokesman for America's religious right. He certainly looks the part: his clothes

crisply creased, his hair neatly gelled, his face habitually frozen in a look of square-jawed conviction. His personal life seems blameless. He is a regular churchgoer, and appears to live by the tenets of his faith. He married his high-school sweetheart, who bore him five strapping sons, who in turn have provided him with 18 grandchildren. He is a teetotaller, but not, like George W. Bush, as a break with the waywardness of his youth. Mr Romney spent much of his youth as a missionary, trying to persuade the French to give up wine. He once told a reporter that his greatest failing was that he devoted only one day a week to helping the needy (smugness is clearly a bit of an issue, too). The closest he has come to a scandal is the revelation that in his teens he once forcibly cut the hair of one of his schoolmates, in a prank that strayed across the line into bullying.

Yet Mr Romney does not like to talk about his faith in any but the broadest terms, presumably to avoid reminding voters that he is Mormon, a religion that many Americans find peculiar and some doctrinaire Christians consider heretical. 0 bservers, trying to make sense of his inconsistent stances on abortion, gay mar­riage and the like, often assume that he is simply feigning abhor­rence of them to curry favour with religious voters. But it is just as plausible that he faked the more tolerant views he used to es­pouse to curry favour with the liberal voters of Massachusetts, where he ran unsuccessfully for Senate and successfully for go­vernor. At any rate, as a church leader Mr Romney is said to have encouraged women to favour child-rearing over their careers and to have discouraged them from having abortions.

It is ironic, then, that even when "social issues" dominate the news, Mr Romney says almost nothing about them. For weeks the media have been parsing and probing Barack 0 bama's recent decision to endorse gay marriage. Yet Mr Romney simply reiterat­ed his opposition to it before attempting to change the subject.

This is part of the natural rhythm of a presidential election. Candidates tend to play to the base of their party during the pri­maries, only to quench the fire and brimstone once they have se­cured the nomination, the better to appeal to swing voters. But it is also a reversal of sorts. Republican strategists used to assume

The Economist May 26th 2012

that social issues were a vote-winner for them; now they seem to worry that too much righteous talk will put off centrists by mak­ing the party seem unpalatably moralising. Very few Americans rate gay marriage as the most pressing issue of the day, and those that do have surely long ago decided how they will vote; oppo­nents for Mr Romney, and supporters for Mr Obama.

Much the same goes for other subjects that rile the conserva­tive faithful. Mr Romney suddenly seems to have few thoughts about illegal immigration, global warming or activist judges. In­stead, he devotes himself almost exclusively to talk of the econ­omy, with the odd jab at Mr Obama's health-care reforms. That, after all, is what swing voters care most about, and the area in which they are most unhappy with the president's performance.

It's not just the economy, stupid The hitch is that "pivoting to the centre", as the election jargon has it, is an especially awkward manoeuvre for Mr Romney. For one thing, the Republican faithful have always worried that the real Mr Romney is the relative liberal of his two races in Massachu­setts, and that the present ardent conservative is the impostor. To allay their fears, Mr Romney must pivot more slowly and less far than he otherwise might. Thus when his appointment of an openly gay spokesman on foreign affairs caused a stir in conser­vative circles, the campaign quickly fired him.

Try as he might, Mr Romney will find it almost impossible to get away from social issues over the next five months. Mr 0 bama, after all, is doing his best to avoid dwelling on the weakness of the economy. His campaign has, instead, spent the past week try­ing to stir up indignation about a Republican electioneering outfit that seems to have considered (but decided against) running an ad campaign about Mr Obama's ties to Jeremiah Wright, the pas­tor of a church the president used to attend and whose many rac­ist, paranoid and unpatriotic utterances caused him great embar­rassment during the 2008 campaign. That ploy forced Mr Romney to spend several days denying that he intended to bring up divisive racial issues, instead of hammering away at the presi­dent's stewardship of the economy.

Mr Obama will be abetted in such diversions by those same Republicans who doubt Mr Romney's conservative bona fides. They are constantly cooking up new schemes to promote their notion of personal rectitude, in spite of the damage it does to the party's brand, especially among swinging (in both senses) single women. Last week, for example, Republicans in Virginia's House failed to approve the appointment of a judge whose sole disqual­ification seemed to be that he was gay. Republicans in Congress, meanwhile, are trying to restrict access to abortion in Washing­ton, DC, a city none of them represents. And several states will hold referendums on gay marriage on election day.

What is more, dogmatic legislators are not the only trouble­some Republican voices. Anyone with a gripe and a fortune can now weigh in on the election via a "super P AC", a new sort of campaign group that can raise and spend as much as it wants on advertisements as long as it does not have any formal ties to a party or candidate. It was thanks to a super P AC that Mr Wright found himself in the news again, for example. Others have sprung up to fight abortion and gay marriage. Whatever the im­pact on Mr Romney's fortunes, in short, the religious right shows no inclination to let him run the election campaign he wants. •

Economist.comfblogsflexington

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Energy in Canada

The great pipeline battle

OTTAWA

The energy industry and Stephen Harper's government try to ensure tar-sands oil gets to market

AT FIRST glance, the public hearing of .1'"\.canada's National Energy Board that began on May 23rd involves only a minor matter. Enbridge, an energy distributor, wants permission to reverse the flow of Line 9, a duct of 195km (121 miles) which moves imported oil westward to petro­chemical plants in Sarnia, Ontario. In­stead, En bridge wants the pipeline to carry light crude oil eastward, from Alberta and North Dakota to a refinery in Nanticoke, Ontario, and then to others in Quebec. But environmentalists in both Canada and the United States have filed petitions against the switch. They worry that, if it is ap­proved, Line 9 will soon start moving oil from the Alberta tar sands to Montreal and then, if the flow of another pipeline is re­versed, to Portland, Maine for export.

Oil production from the tar sands is set to rise from 2m barrels a day (b/ d) to 3.3m by 2020, or from 58% to 72% of Canada's to­tal oil output. Getting this oil to market is a mounting worry for Canada's energy in­dustry and for Stephen Harper's Conser­vative government. That is because the necessary infrastructure is opposed both by local communities and by greens, who want to halt development of the tar sands. Per barrel, the extraction of oil from bitu­men emits between three and four times as much carbon and other greenhouse gas­es as conventional oil does, according to the Pembina Institute, an environmental think-tank in Calgary. But other estimates

are much lower. The Line 9 hearing comes as two other

potential routes for tar-sands oil face pro­blems. The Obama administration has withheld approval of the Keystone XL

pipeline, which would take oil to Gulf coast refiners. (TransCanada, Keystone's promoter, still hopes for approval.) Mr Har­per has courted China as an alternative market for the oil, but that depends on ap­proval of Enbridge's Northern Gateway project, a C$5.5 billion ($5-4 billionh,177km twin pipeline from Edmonton to Kitimat in British Columbia. The route crosses the land of so or so First Nations bands (indig­enous tribes). More than 4,000 people have registered to speak at the environ­mental hearings, which began in January.

Last month another energy firm, Kin­der Morgan, said it would spend $4.1 bil­lion to double the capacity of the Trans­Mountain to Vancouver, the only existing line to Canada's west coast. It hopes to start work in 2016. Vancouver's mayor opposes the idea, worrying that tourism will be wrecked by tanker traffic and spills.

The government is pulling out all the stops to get these projects approved. The budget bill includes sweeping changes to the cumbersome procedures that govern environmental approval of energy pro­jects. These now involve up to 40 federal departments and agencies. Under the bill, only those directly involved would be able to intervene in hearings; fishery habitat

Also in this section

39 The Dominican Republic's election

39 Peace or justice in Colombia

40 Gay rights in Chile

For daily analysis and debate on the Americas, visit

Economist.comjamericas

will no longer automatically be consid­ered; and most assessments will have to be completed within 18 months. The federal government would have the power to overrule the energy board, but also to cede the assessment process to the provinces. These changes could quicken the pros­pects of big hydropower schemes in Mani­toba, Labrador, British Columbia and Que­bec, aimed at exporting electricity to the United States.

But pipelines are the government's pri­ority. That is because natural-gas exports, long the mainstay of the energy industry, are threatened by shale gas in the United States (they have fallen by 5% over the past year). While there are legitimate environ­mental worries, replacing gas exports with tar-sands oil is vital for economic growth, argues Matthew Akman, an analyst at Sco­tiabank. Investment is pouring into the tar sands, but potential oil exports will out­strip pipeline capacity by 2015.

Unless, that is, existing pipelines are re­jigged-and not just Line 9. TransCanada's 3,oookm main line has carried Alberta's gas to Ontario and Montreal for more than so years, but now runs at less than half of capacity. Converting the line to oil, and adding a spur to a refinery at Quebec City, would cost more than C$5 billion and take several years. But it could still beat the Northern Gateway, and be politically more attractive. Refiners in eastern Canada cur­rently use imported crude costing $20-30 a barrel more than western Canadian oil.

The budget bill also includes money to investigate whether green charities are en­gaging in political activities incompatible with their status. But there are risks-not least to Canada's international image-in demonising environmentalists. The argu­ments for developing the tar sands are strong, but the opponents cannot be sim­ply shrugged aside. •

The Economist May 26th 2012

The Dominican Republic

After Leonel

SANTO DOMINGO

The new president risks governing in his predecessor's shadow

ECONOMIC storms have battered the eign investors in perfect New York English. Caribbean of late, blowing away the He was a beguiling salesman for his coun­

tourists and remittances on which most is- try: "When businesspeople go to speak to lands depend. Most of the region has bare- Fernandez, they hear what they want to," ly seen any growth since 2009. Several says a diplomat, who calls him "the oracle governments have been washed away by of Santa Domingo". the slump: in the past six months unhappy His opponents' claim that Mr Fernan­voters have kicked out the ruling parties in dez exercised a "constitutional dictator­Jamaica and the Bahamas. But the sun still ship" is an exaggeration. But the PLD,

shines in the Dominican Republic, where which will control both houses of Con­growth has continued at over 5% a year. On gress until at least 2014, has colonised all May 2oth Dominicans duly rewarded the branches of the government. As head of ruling Dominican Liberation Party (PLD). the National Council of the Judiciary, Mr But only just: Danilo Medina, its presiden- Fernandez was able to oversee the ap­tial candidate, won 51% of the vote, amid pointment of members of the Supreme allegations of fraud. Court and the Electoral Tribunal. He also

Mr Medina faced a weak opponent in chose the members of the Chamber of Ac­Hip6lito Mejia of the Dominican Revolu- counts, which keeps an eye on govern­tion Party, who campaigned under the ment spending. Patronage is baroque: the enigmatic slogan "Here's Daddy". Mr Me- government at one stage included 334 dep­jia mishandled a banking crisis when he uty-ministers, and the foreign ministry was president between 2000 and 2004. He employs 113 ambassadors despite having cried fraud this week. Observers from the only 45 embassies. The PLD outspent its Organisation of American States certified opponents in the campaign. the election result but confirmed reports of Mr Medina promised "safe change". vote-buying. Participaci6n Ciudadana, a Certainly some things require reform. local NGO, says that both main parties of- Nearly a third of Dominicans still live in fered between soo and 2,500 pesos ($13 to poverty, a higher figure than before the $65) to buy people's voting cards. No one banking collapse. Fast-growing telecoms knows the scale of the fraud, but the elec- and finance industries do not provide toral authorities received 400,000 applica- many jobs. Temistocles Montas, the econ­tions for duplicate cards in the weeks be- amy minister, says the country needs to de­fore the poll. The government's velop higher-value tourism and swap tex­vote-buying appeared greatly to exceed tile factories, vulnerable to Chinese that of the opposition, claims Francisco Al- competition, for high-tech ones. That re­varez of Participaci6n Ciudadana. quires more highly skilled workers. Educa-

Mr Medina takes over from Leonel Fer- tion spending is equal to only 2% of GDP,

nandez, who as president for 12 of the past less than half the Latin American average. 16 years has dominated his country's polit- Doubling it, as promised, means expand­ical life, restoring confidence after the ing tax revenues, which are a paltry 13% of banking crisis and bringing inflation down G DP. Consumers must also pay more for from so% to 8%. Mr Fernandez wooed for- electricity, which is heavily subsidised and

Fernandez, Cedeno and Medina keep the party going

The Americas 39

subject to power cuts. Squeezing people will be hard when

many suspect that taxes are misspent. Some officials connected with public works have become inexplicably wealthy, according to local media. Transparency In­ternational, a watchdog, labels the country the most corrupt after Haiti among the larger Caribbean states. It is the worst of 142 countries studied by the World Eco­nomic Forum for wastefulness of public spending, the second-worst for "favourit­ism in decisions by officials" and third­worst in diversion of public funds. (But it scores well for investor-friendliness.)

Crime is another worry. The murder rate has risen from 14 per 1oo,ooo people to 25 within the past decade, as drug smug­glers seek to evade the crackdown in Mexi­co. Last year police killed 289 people in a country of fewer than 10m. Again, corrup­tion is hindering progress: leaked cables from the United States embassy linked se­nior officials to drug trafficking.

Mr Medina risks having to govern in his predecessor's shadow. Mr Fernandez's wife, Margarita Cedefio, will be the new vice-president. Mr Fernandez himself will be eligible to run for a fourth term in 2016, and many suspect he will do so. Many of the country's problems pre-dated Mr Fer­nandez, and were even worse before him. Even so, if Mr Medina wants to make his own mark, he could start by trying to clean up public life. •

Colombia

Giving peace a chance

BOGOTA

Or lettingjustice rule untrammeled

HIS "obsession", Juan Manuel Santos often says, is to hand over a country at

peace by the time he steps down as Colom­bia's president. Although army pressure has diminished the threat from the left­wing guerrillas of the FARe and ELN, it is unlikely to persuade them to lay down their arms after almost half a century of fighting, especially if their reward is a life­time in jail. To secure peace, the govern­ment thinks it also needs legal tools so that it can offer the guerrilla leaders some in­centives. These are embodied in a constitu­tional amendment wending its way through Congress. It has sparked a furious national debate.

As approved on May 15th, in the sixth of eight votes, the amendment would give Congress the power to set the criteria de­termining which crimes (and thus crimi­nals) would be investigated by prosecu­tors, and which might be dealt with in ~~

40 The Americas

~ other ways, such as by a Truth Commis­sion. It would also allow Congress to legis­late on the conditions under which sen­tences could be suspended. Congress would be called upon to legislate on these issues only if and when serious peace talks were under way.

These proposals have aroused the op­position of some strange bedfellows, in­cluding Alvaro Uribe, Mr Santos's hardline predecessor, and Human Rights Watch (HRW), a New York-based pressure group. Both see them as tantamount to an amnes­ty. Jose Miguel Vivanco of HRW says that the amendments "guarantee impunity" for those who have committed crimes against humanity. It would be better to of­fer sharply reduced sentences, he argues, rather than suspended ones or no prosecu­tion at all.

On the day of the congressional vote on the amendment, another of the vocal crit­ics, Fernando Londoiio, narrowly survived a bomb attack on his car that killed two of his bodyguards. "Bogota covered in blood and the ... govt is pressing Congress to ap­prove impunity .. .for heinous crimes," tweeted Mr Uribe, whom Mr Londoiio served as interior minister. (This week po­lice in Argentina found a bomb in a cinema where Mr Uribe was due to speak.)

Mr Santos's supporters point out that the amendment seeks to prevent the mis­takes Mr Uribe made in handling the de­mobilisation of some 30,000 right-wing paramilitaries. His government's Justice and Peace Law of 2005 at first offered a vir­tual amnesty. But the Constitutional Court toughened the law, limiting the reduction of jail sentences only to those who made full confessions. Beneficiaries were also supposed to compensate their victims. Be­cause it failed to make a sharp enough dis­tinction between ringleaders and the rank­and-file, the Justice and Peace Law has proved almost impossible to implement. There have been only seven convictions.

Mr Uribe said at the time that "defini­tive peace is the best justice" and said his law was "adjusting the equation" between justice and peace. So in his current stance he is guilty of hypocrisy, or at least incon­sistency.

The government's argument is, in es­sence, that the demands of justice should not make peace impossible. Striking the balance should be the responsibility of a democratically elected legislature, rather than unelected international lawyers. But the legislators' hands are partly tied. When Colombia signed up to the International Criminal Court (ICe) in 2002, it deferred the court's jurisdiction over war crimes for seven years, to try to encourage peace talks with the different warring factions. With the deferral over, the ICC now has full ju­risdiction, which means any amnesty for war crimes could be challenged there.

International humanitarian law en-

The Economist May 26th 2012

Gay rights in Chile

An atrocity prompts change SANTIAGO

A sad milestone in the battle for tolerance

0 N March 3rd a young gay man, Dan­iel Zamudio, was beaten to a pulp in

a park in Chile's capital, Santiago. His assailants carved swastikas on his body. He died in hospital three weeks later. Four men, alleged to have ties to a neo­Nazi group, have been charged with his murder. But the public outrage over Mr Zamudio's fate has had wider conse­quences: having languished in Congress for seven years, an anti-discrimination law has been hastily approved.

Chile has never been an easy place for homosexuals. The Catholic church main­tains a formidable, if waning, grip on public morality. Divorce was banned until2004, and gay sex decriminalised only in 1999 (in Argentina and Brazil it has been legal since the 19th century). Chile is one of only four countries in South America where the age of consent is higher for gays than for heterosexuals. In March the Inter-American Court of Human Rights berated the country for denying a lesbian mother, who was also

Coming out in memory of Daniel Zamudio

courages states to grant former insurgents amnesty for crimes such as rebellion, sedi­tion and treason, but never for crimes against humanity such as deliberate at­tacks against civilians, murder, torture, rape, forced recruitment of minors and forced displacement. But these serious crimes have been the rule rather than the exception in the Colombian conflict. To complicate matters yet further, in a bizarre ruling Colombia's Supreme Court has de­cided that merely belonging to an illegal armed group constitutes a crime against humanity.

Mr Santos enjoys a majority in Con­gress, and the amendment is likely to pass. But the debate in Colombian society about

a judge, custody of her three daughters. In 2004 the Supreme Court had ruled that it would be detrimental to the girls' development to stay with their mother because she lived with another woman.

But attitudes seem to be changing at last. President Sebastian Piiiera, an eco­nomic conservative but a social liberal, has boldly promoted gay rights, despite distaste from within his own coalition. He surprised many in 2009 by including openly gay couples in his campaign commercials. He invited gay activists to attend his state-of-the-nation address on May 21st. In this year's census, for the first time those Chileans who live with a gay partner can register the fact.

For years Chile's homosexuals have gazed enviously over the Andes to Argen­tina, where sexual attitudes are more relaxed and where gay marriage is legal. It will be a while yet before Chile follows suit. But Mr Zamudio's horrible fate has helped to make the country a bit more tolerant.

how to strike a balance between justice and peace will continue. The country must find a solution that is "neither carte blanche nor a straitjacket", says Angelika Rettberg, a political scientist at Bogota's Los Andes university.

The guerrillas, who still number about n,ooo, are no doubt watching with inter­est. Both main groups have recently flirted with the idea of peace talks. But the attacks continue. The FARC may have been re­sponsible for the attempt on Mr Londoiio's life. A dozen soldiers were killed on May 22nd in a FARe attack launched from Ven­ezuelan territory. Both sides in this argu­ment will see such incidents as reinforcing theircase. •

Politics in Bangladesh

Banged about

DHAKA

The prime minister sets the country on a dangerous path

INCHING through the crowded streets of a sense of fear." Bangladesh's capital brings both exhila- There is plenty more darkness about. In

ration and frustration. Dhaka's garishly recent months Bangladesh has endured a painted tricycle rickshaws, battered buses, spate of other mysterious killings-a Saudi occasional goats and luxury cars some- diplomat shot dead; a trade-union activist how all manage to creep onward. Drivers tortured and murdered; a pair of journal­skilled at furious honking are also masters ists butchered after investigating corrup­of compromise and smiles. tion. This correspondent was trailed in

If only the bitter politicians could prove Dhaka by a pair of secret-service men on a so deft. Some 18 months before a general motorbike. A rumour of a bizarre coup at­election, Bangladesh suffers street protests. tempt, in January, was used by the govern­Opposition leaders are sent to jail, and dis- ment to get closer political control over the appearances and murders are widely army. blamed on an old rivalry for power. A con- One of the country's best known fig­frontation over the next poll-who should ures, Muhammad Yunus of Grameen oversee it, and whether it will be fair-is al- Bank, has been harassed for some time. An ready so strident that some observers increasingly paranoid Mrs Hasina sees doubt a contested one will be held at all. Meanwhile, Bangladeshis fret over prices 1 of food and fuel, chronic power cuts and Improving lives broken promises of new roads. Bangladesh, population Living on Less

than $1.25 a day {2005 PPP*).% oftotal

1984 86 89 92 96 2000 05 10

70

60

50

40

30

20

10

0

As the leader of the Bangladesh Nationalist Party (BNP), Khaleda Zia, tells it, all ills lie at the government's door. She ticks off a list of wicked acts she blames on her antagonist in an ancient rivalry, the prime minister, Sheikh Hasina. A young BNP politician abducted a month ago and very probably murdered. Two others killed earlier. Some 33 opposition figures, including senior MPS, dumped in jail this month over a trumped-up case of arson. In all, she says, 3,000 BNP members have been arrested. "It is to intimidate, to create Source: World Bank *Purchasing-power parity

Also in this section

42 Tattoos in Japan

43 Violence in Karachi

43 Pakistan and the United States

44 Banyan: More fun in the Philippines?

For daily analysis and debate on Asia, visit

Economist.comfasia Economist.comfblogsfbanyan

him as a political threat. This month in Dhaka Hillary Clinton, America's secre­tary of state, met theN o bel laureate and as­sured him of her support. It brought no re­lief. Ministers snipe at him, and the government has just ordered yet another official review of his bank.

"We are very worried that the commis­sion has been formed and terms of refer­ence include ownership," says Mr Yunus. In effect, the government is seeking ways to grab Grameen, which is 97%-owned by its poor members, many of them women. Officials are also bent on settling scores with Mr Yunus, who oversees an ungainly charitable empire that includes a telecoms company as well as the bank. Over a lavish dinner, a group of government spies brags of having a thick file of allegations ready against the "money-monger".

Engine trouble The list of gripes against the government is long. Corruption is pervasive enough for donors to be alarmed. The World Bank has scrapped funding for a bridge over the Padma river. Japan, the largest single giver of aid, has just sent its deputy prime minis­ter to Dhaka to demand a clean-up. In a case of recent graft, a railway minister, who quit after police found sacks of cash in his aide's car, was suddenly cleared by an in­ternal inquiry of any corruption and rein­stated to the cabinet. Meanwhile, strong doubts persist about the fairness of de­mocracy. The United States's ambassador in Dhaka this week repeated Mrs Clinton's warning that the next election must be "participatory", ie, run fairly so the opposi­tion will take part.

41

Most telling would be a shift in India's attitude. Long a close ally of Sheikh Ha­sina's Awami League-cheering her crack­down on Islamic extremists and insur­gents from India's north-east, and being ~~

42 Asia

~ open to more trade-India's ruling Con­gress party may now, sensibly, be hedging its bets. Pranab Mukherjee, India's finance minister, called on Mrs Zia recently, invit­ing her back to Delhi. Mrs Zia chuckles that she will go after Delhi's summer heat is past. She also calls the neighbour a "friend", a possible hint of change in a party that often seeks popularity by bash­ingindia.

As Sheikh Hasina looks ever more stri­dent, people may start tiptoeing away from her. Not every ill in Bangladesh can be laid at the prime minister's door. Although she did mess with the constitution, scrapping arrangements she had previously insisted on in opposition for a neutral caretaker to run the government for three months be­fore election day, she now appears to want to keep her options open, possibly in order to be better able to skew the outcome of the next election. Meanwhile, Mrs Zia's party orders street protests and hunger strikes, and threatens angry mass rallies in June. The sad result is that politics grows more polarised and confrontational.

Still, Mrs Hasina is not quite the all­powerful bogeywoman her bitterest op­ponents suggest. Certainly she seems set on cracking down on civil groups, for ex­ample with a new bill to put non-govern­ment organisations more firmly under po­litical control. But it is hard to see how the murders and attacks on activists and jour­nalists help her government, other than to spread a general sense of intimidation.

The opposition, too, has a reputation for thuggery, corruption and intimidation, and does not bother much to hide it. A vet­eran leader of the BNP says that, should his party boycott the next election, 20 days of street protests by BNP supporters would then be followed by violent attacks by his party workers on their rivals.

The shame of it all is how little heed the squabbling politicians pay to what should matter more: keeping the economy grow­ing and reducing poverty further. In the face of electricity shortages, blocked roads and land disputes, the Bangladesh econ­omy has been doing remarkably well. Its clothing industry has the potential to gen­erate over $40 billion a year from exports, according to McKinsey, a consultancy.

Indicators of well-being have been im­proving. If annual economic growth of over 6% is sustained, a country that not long ago was a byword for poverty can contemplate reaching middle-income lev­els in barely a decade. But that needs sin­gle-minded focus by the government on dealing with the country's economic bottlenecks and social needs. Instead, like Dhaka's wretched roads, politics looks jammed. Uncertainty leading up to the next election, and growing anxiety among diplomats and foreign observers of Ban­gladesh, suggest a hard, tense time ahead. More than anyone, blame the driver. •

Tattoos in Japan

The shogun of Osal<a TOKYO

A revealing political crackdown on a usually hidden form of art

I T IS easy for outsiders to admire those in Japan who sport tattoos. First, think of

the pain. The body art known as irezumi is inflicted on a wearer's torso with wooden needles and charcoal ink. During up to so sessions, the irezumi master brooks no tar­diness, insobriety or whingeing.

Then there is the lifetime of pariah sta­tus that follows. Bathhouses and onsen (hot springs) usually forbid entry to tattoo wearers. So do swimming pools. Men may believe their swirling, ornate body engrav­ings reflect a roguish masculinity. But the worst of it is that many Japanese women disagree. And so body-art narcissism takes place mainly among other tattooed men. Such groups of even innocent men imme­diately take on the air of gangsters, for ya­huza and irezumi are inseparable.

You might assume that an up-and-com­ing politician with a maverick streak, a de­scendant of social-outcast communities who used to dye his hair blond, would sympathise with such people. Yet Toru Hashimoto, the 42-year-old mayor of the huge city of Osaka, does not. He is on a mission to force workers in his govern­ment to admit to any tattoos in obvious places. If they have them, they should re­move them-or find work elsewhere (though big companies are just as tattoo­phobic). Even Lady Gaga, the tattooed diva who has raised a fortune for victims of the March nth tsunami, would not get a job in his government, he insists.

The crackdown says a few things about this clever nationalist, who is gaining huge

Yakuza, irezumi, mikoshi-and surely sake?

The Economist May 26th 2012

attention inJapanese politics. First, he likes a bit of blood sport. Picking fights with people who cannot easily defend them­selves keeps him in the media gaze. Mr Hashimoto's campaign follows his order forcing teachers in Osaka to stand for the national anthem.

Second, it sets him firmly in the socially conservative camp, displaying even a dash of authoritarianism. Since the end of the second world war, tattoo-wearers have mostly faced social-though not official­ostracism. During the periods before then when tattoos were banned, it was either by repressive shoguns or by the Meiji moder­nisers in the late 19th century, who thought the sight of naked men with engraved but­tocks would earn Japan ridicule in the West (which was mostly fascinated in­stead). Aligning himself with strongmen may serve only to boost Mr Hashimoto's popularity, at a time when many Japanese are fed up with the weak-willed characters in national government.

The curious bit is that many of the tat­tooed have right-wing tendencies too. Many seem to approve of Mr Hashimoto's crackdown. Horiyoshi the Third, an ire­zumi master based in Yokohama, is forgiv­ing of the Osaka mayor. He says he be­lieves Mr Hashimoto understands very well that public officials showing off their tattoos must be considered threatening. The tattooist, whose silk paintings are now on display at London's Somerset House, keeps his own painted "body armour" well hidden beneath a pale-blue seersuck­er suit with a diamante broach on the la­pel. Most of the time, the master says, ire­zumi should be concealed.

Then he pulls back his sleeve a few inches to show the start of swirling decora­tions travelling up his arm. The simple act of revealing those tattoos, he says, is sup­posed to intimidate. Mr Hashimoto has a different way of showing that he means business, but it is equally effective. •

The Economist May 26th 2012

Violence in Karachi

City at war

KARACHI

In the commercial capital, politicians and gangsters are bound together

CIVILIANS armed with rocket-pro­pelled grenades and AK-47S firing at

police in armoured personnel carriers are not images associated with the urban hearts of commercial capitals. But Karachi is no ordinary city. Earlier this month its crime-infested quarter of Lyari, a sprawl­ing network of alleyways housing rm peo­ple, saw battles that pitted police against a powerful local gang. In one scene locals flattened a carrier's tyres with gunfire. Then they kept firing at the stationary vehi­cle, killing an officer inside.

The 31 people who were killed, in addi­tion to five policemen, were mainly inno­cents caught in the crossfire and included a seven-year-old. For a week residents were besieged. They had little access to food, water or power, as shops shut down and the battle had damaged infrastructure. Then a defeated government called the op­eration off. The police promised to return after 48 hours, but never showed up again. A senior police official was close to tears when he explained that the gangsters wielded weapons that law-enforcers did not know they possessed.

The Lyari violence highlights the com­plicated relationship between crime and politics in Karachi. Political parties are or­ganised along ethnic or sectarian lines, and represent the city's Urdu-speakers, Sindhis, Baloch, Pashtuns and Barelvi Sun­nis. In turf wars over neighbourhoods, they attack each other's activists and or­dinary folk alike. (This week indiscrimi­nate firing on a Sindhi rally killed 11 peo­ple.) When deaths exceed a handful a day, the commercial capital grinds to a halt. It is this violence, rather than Islamist extrem­ism, that holds Karachi hostage.

Political parties coexist with criminal gangs, tacitly supporting some and actual­ly controlling others. Lyari's dominant gangsters, the People's Aman Committee (P AC), have traditionally lent their support to the country's ruling Pakistan People's Party (PPP). Yet police appear to have launched the Lyari operation because some members of the ruling party had de­veloped a rivalry with elements of the P AC. The rundown district has long been a bastion of the PPP, which had put up with or worked with Lyari gangsters for de­cades. But its neglect of the area has strengthened the PAC, especially once the gang started providing social services. "This operation was political victimisa­tion," claims Zafar Baloch, the racket's sec-

Asia 43

Pakistan and the United States

A fateful call ISLAMABAD

A man who helped find bin Laden is condemned as a traitor

PAKISTAN and the United States are meant to be allies, but their differences

are starkly drawn in the case of Shakil Afridi. He is regarded as a hero by Ameri­can officials and a traitor by Pakistan.

The CIA secretly recruited the Pald­stani doctor during the hunt for Os am a bin Laden. He set up a fake vaccination programme, going from door to door in the northern town of Abbottabad, seek­ing a DNA sample from the house in which Americans suspected the al­Qaeda leader was living. On May 23rd Dr Afridi was sentenced in Pakistan, with­out a lawyer and under a hasty system of tribal justice, to 33 years in jail for treason.

Behind the scenes, Americans scrab­bled but failed to reach a deal to free Dr Afridi from Pakistani custody. His activ­ities were discovered by Pakistan's spies

and-in-command. "The people of Lyari have supported the PPP for 40 years, but when we spoke out against the lack of de­velopment here we were targeted."

Karachi politics plays out at the ex­pense of civilian lives. It did not hurt that the police operation would have pleased the Muttahida Qaumi Movement (MQM),

a coalition partner, at a time when opposi­tion parties are campaigning for the resig­nation of the prime minister, Yousaf Raza Gilani. The MQM (also involved in extor­tion in Karachi) complained that the gov­ernment was targeting its people while let­ting the P AC get away with crime.

But perhaps what makes the Lyari oper­ation typical of Karachi was how, just as it

Just another day in the commercial capital

after the American special-forces oper­ation a year ago that killed bin Laden. Le on Panetta, America's defence secre­tary, insisted Dr Afridi "was not in any way treasonous towards Pakistan".

Working for a foreign intelligence agency is a crime in many places, in­cluding America. Pakistanis feel justified in punishing Dr Afridi. Although bin Laden was clearly an enemy of Pakistan, too, the American operation that killed him is seen as a national humiliation. The collapse in relations it sparked en­dures today (see page 6o).

Not only Pakistani nationalists are angry at the CIA for using Dr Afridi. It has also damaged the credibility of vaccina­tion programmes in Pakistan, including the one against polio. NGos condemn the ploy. The CIA is unrepentant.

was escalating into a policing and humani­tarian disaster, it suddenly came to a halt. Since then the P AC has not retaliated. Per­haps some unpublicised bargain has been struck. If so, that would be in line with the usual pattern of violence in the city. Kara­chi manages to hold together because bouts of brutal, though contained, vio­lence are interspersed with dealmaking and calm. Imran Ayub, a journalist on the Karachi beat, thinks the P AC and the gov­ernment will strike a bargain that pre­serves the PPP's Lyari constituency despite this disastrous operation. "This was no fi­nal showdown", he says. In the context of Karachi's violence, it is sobering to think what a final showdown would look like. •

44 Asia The Economist May 26th 2012

Banyan I More fun?

A flurry of optimism about the Philippines, a regional underachiever, is only partly justified

IT WAS sadly typical for the Philippines. When it played host at the beginning of May to the annual meeting of the Asian Devel­

opment Bank, the biggest single news story the event generated overseas was a negative one: that hoardings had been erected so delegates would not see some unpleasant slums. Sadly, too, the story itself is rather typical: giving things a sleek appearance sometimes seems to matter more than fixing sordid reality.

The Philippines has, that incident notwithstanding, enjoyed an image boost in recent months. Under Benigno Aquino, a presi­dent avowedly intent on tackling corruption, economic pros­pects look good. It is one of few countries in Asia expected to grow faster this year than last-though partly because a slump in government spending dragged the growth rate down in 2011. The stockmarket has been one of the world's rare performers this year. Attention is now focused on the country's many assets: a young population; mineral wealth; robust external finances; even the strength of its sometimes ridiculed democracy, restored in 1986. A much-cited projection by a bank, HSBC, of the world in 2050 highlights "the striking rise of the Philippines, which is set to become the world's 16th-largest economy, up 27 places."

The Philippine economy grew at an annual average rate of roughly 2% in the 1980s and 3% in the 1990s. It has achieved about 4.5% since the turn of the century. Future prospects are indeed en­ticing: besides the unexploited mineral resources, business-pro­cess outsourcing is booming, already employing some 6oo,ooo people. Remittances from all those Filipinos overseas have re­mained strong through economic crises. As costs rise in China, the Philippines is among places manufacturers eye as an alterna­tive. Tourism has huge potential, recognised by the government's nicely pitched campaign: "It's more fun in the Philippines."

It is also more fun with a newish president. Some of the pre­sent feel-good mood stems from what people call a "halo effect". The unlikely saint is Mr Aquino, known as N oynoy, or P-N oy (in a country fond of nicknames, the national one is "Pinoy"). He was swept to power in 2010, partly on a wave of affection for his late mother, Corazon Aquino, the first president after the dictatorship of Ferdinand Marc os. An undistinguished record as a senator did little to build hopes of a bold presidency.

Yet Mr Aquino remains broadly popular. His government's

stand against perceived Chinese bullying in the South China Sea seems to go down well with a public mostly insouciant of the risks involved. A 52-year-old bachelor, Mr Aquino's love life fits the national penchant for turning politics into soap opera. But above all, he is liked as a welcome change after the nine-year presidency of Gloria Macapagal Arroyo, which in its final years was widely seen as corrupt. He has gained kudos for trying to bring her to account. The focus of that struggle at the moment is the attempt in the Senate to convict the chief justice, Renato Co­rona, who was among Mrs Arroyo's appointments to the Su­preme Court, and has been accused of trying to shield her.

The Senate trial, televised daily, has become crucial to the ad­ministration, both as a means of breaking the perceived hold of its predecessor over the judiciary, and as proof of its zeal in com­bating corruption. This has also entailed submitting a number of allegedly suspicious contracts awarded by Mrs Arroyo's govern­ment to fresh tenders. Clean-ups in the tax and customs authori­ties have impressed some businessmen, while vexing others who say procedures are now gummed up.

The government has also started making some important re­forms. In an effort to raise its revenues-at present a paltry12% of GDP-it wants to jack up "sin" taxes on alcohol and tobacco. The bill enacting this made important progress in May when it passed a House of Representatives committee-a triumph over powerful tobacco and alcohollobbies.lt still has to pass the full House and the Senate, however.

In fact, the Aquino administration has little concrete to show for its two years in power. The centrepiece of its programme, pub­lic-private partnerships to tackle the inadequate infrastructure which is such a hindrance to all the nation's economic hopes, is only now stuttering to life after just one of the ten projects sched­uled for approval last year saw contracts awarded. The pursuit of Mrs Arroyo and the chief justice is a distraction as well as a mis­sion. Securing Mr Corona's conviction might entail so many promises to senators that the point of the exercise-enhancing the government's clean image-is lost. Failure to do so however, would leave the administration looking weak and silly.

So Mr Aquino has his critics. Mr Corona, for example, who this week was in intensive care after a possible heart attack, por­trays himself as the victim of a vendetta after a court ruling that land belonging to the Aquino clan should be redistributed. Mr Aquino's supporters scoff at this, and praise the president's scru­pulous hands-off approach. But that too has a flip side. Some on the left have promoted a craze for "Noynoying", a form of protest involving striking a languid, idle pose. A common view has Mr Aquino as a reluctant president, who, just as his mother is said to have done, crosses off on a calendar the days until his term ends.

Cometh the Manny? They are going by fast. Philippine presidents, barred from serving consecutive six-year terms, do not have long to make their mark. The backward-looking settling of accounts with Mrs Arroyo does not help. Already there is speculation about the 2016 presidential election. Pundits feel better placed in naming one of the front­runners for 2022, who, being under 40, will be constitutionally barred in 2016: a world-champion boxer and congressman, Manny Pacquiao. If Mr Aquino's presidency is to be remembered as more than an interlude under a decent, likeable man who did his best, he needs to give some dynamic leadership to the reforms the Philippines so badly needs. Noynoyingjust does not cut it. •

China and America

A sigh of relief

BEIJING

A vital relationship survives a critical test

The arrival of Chen Guangcheng, a blind Chinese activist, in New York on

May 19th marked a quiet resolution to a thorny problem for American diplomacy with China over human rights. It also sug­gested that, in spite of political tension at the highest levels of the Communist Party, Chinese leaders remain united enough to handle a crucial relationship pragmatical­ly. But compromising with the superpower involves a balancing act at home.

Chinese diplomats say privately that pressure from nationalist sentiment among Chinese citizens has become a growing complication in their dealings with the West. Negotiations between Chi­nese and American officials over how to deal with Mr Chen involved painstaking efforts by both sides to avoid provoking China's nationalists, who criticise any per­ceived weakness in the Chinese govern­ment, and whose ire (officials supposed) might have scuppered a deal.

Mr Chen had taken refuge for six days in the American embassy in Beijing after escaping from house arrest on April 22nd. In the eyes of hardliners, that made him a traitor. Quietly, however, Chinese officials arranged for Mr Chen and his family to be put on a plane to America. They ordered the media to say virtually nothing about his departure or about any concession made to America (and it certainly was a concession: local officials enraged by Mr Chen's escape have been terrorising other

family members and friends in rural Shan­dong province since his departure).

If Chinese officials had wanted to point out to their American counterparts how deep suspicion of foreigners runs, there was plenty of evidence in the days leading up to Mr Chen's departure. Anti-foreign comments were circulating on the inter­net, triggered by amateur videos of two in­cidents. One appeared to show a British man attempting to sexually assault a Chi­nese woman in a Beijing street. The other was of a Russian man harassing a female Chinese passenger on a train, as he rested his bare feet on her headrest. (His behav­iour resulted on May 22nd in his dismissal from his post as the principal cellist of the Beijing Symphony Orchestra.)

Some newspapers suggest that public outrage over the alleged sex attack may have been one motive for the launch on May 15th of a 100-day campaign in Beijing against the illegal employment of foreign­ers. Another motive may have been to show toughness at home when a conces­sion was being made to America. It has been described as the first such publicly announced crackdown in the capital, which has become a magnet in recent years for unemployed Westerners hoping to cash in on China's boom. Some do not have proper work permits.

On May 16th Yang Rui, a well-known presenter for the English-language service of Chinese state television, expressed sup-

Also in this section

46 Moving the family abroad

46 Trouble at Shaolin temple

For daily analysis and debate on China, visit

Economist.comfchina Economist.comfblogsfanalects

port for the campaign in an astonishing rant on his microblog. The police, he said, were "getting rid of foreign trash" and ar­resting "foreign scum". Mr Yang said for­eigners who could not find work in their own countries were coming to China and getting involved in "illegal business activi­ties such as human trafficking and espio­nage". Many were living with Chinese women as a cover for their spying, he said. He praised the expulsion from China earli­er this month of an experienced American journalist working for Al Jazeera, calling her a "foreign bitch". Mr Yang later said "shrew" would be a better English transla­tion. His comments, he said, were "a reac­tion of the moment and nothing more".

In the case of the activist Mr Chen, however, Chinese officials dealing with his case probably had little to fear from fi­ery nationalists and their online tirades. Indeed, officials might be more concerned that, throughout the recent saga of Mr Chen's flight and eventual departure for America, online comment has been most­ly sympathetic towards him. Caixin, a pop­ular online news portal, said both America and China had been "rational and prag­matic" in their handling of the crisis.

According to American press reports, China's negotiator in the discussions about Mr Chen's fate at one point angrily said he did not want to talk to his Ameri­can counterpart any more. But it could be there was less resistance within the leader­ship to a deal than might have been sup­posed. China has long used dissidents as bargaining chips, sometimes allowing them to leave the country, knowing that once abroad their influence usually dimin­ishes and the doors can be shut to their re­turn. Global Times, a newspaper known for its nationalist views, called Mr Chen's case a "colourful bubble" that leaves noth­ing when it bursts. •

45

46 China

Moving the family abroad

Hedging their bets

BEIJING

Officials, looking for an exit strategy, send family and cash overseas

THE phrase "naked official", or luo guan, was coined in 2008 by a bureaucrat and

blogger in Anhui province, Zhou Peng'an, to describe officials who have moved their family abroad, often taking assets with them. Once there, they are beyond the clutches of the Communist Party in case anything, such as a corruption investiga­tion, should befall the official, who is left back at home alone (hence "naked"). Mr Zhou says the issue has created a crisis of trust within the party, as officials lecture subordinates on patriotism and incorrupt­ibility, but send their own families abroad.

You do not have to be corrupt to be "na­ked", however. Sending your family abroad is simply a state of maximum readiness. It does not suggest huge confi­dence in a stable Chinese future. Many wealthy businessmen have also been pre­paring exit strategies. One of the most common legitimate routes involves immi­grant-investor programmes in America, Canada or Hong Kong, typically requiring an investment of up to $rm. Chinese na­tionals have rushed to apply for these. Three-quarters of applicants for America's programme last year were Chinese.

The less well-heeled obtain passports from other countries-in the South Pacific, Africa or Latin America-at more afford­able prices (as low as $2o,ooo). Li Cheng­yan, director of the Centre for Anti-Corrup­tion Studies at Peking University, says countries that do not have an extradition treaty with China are particularly popular among corrupt officials. One crooked for­mer governor of Yunnan province was found to have five foreign passports. "No need to wait for a visa if they have to run," saysMrLi.

For senior officials the usual first step to getting naked is to send children overseas to study. Perhaps the most famous exam­ple is the recently purged party chief of Chongqing, Bo Xilai. Mr Bo's son, Bo Gua­gua, is a graduate student at Harvard Uni­versity, after attending Harrow School and Oxford University in Britain. Mr Bo's wife, Gu Kailai (now detained on suspicion of murdering a British businessman in Chongqing), has lived abroad, and their broader family is worth more than $10om, according to the New York Times.

The government has done little to stop the emigration. It began formally to moni­tor the whereabouts of officials' families and assets only last year, and then only by asking officials to fill in forms. In 2011 the

The Economist May 26th 2012

Trouble at the temple

Everybody was l<ung fu fighting DENGFENG

Shaolin temple takes a hit

AS THE sun rises over the foothills of 1"\..Mount Song, thousands of young martial artists are kicking, punching and spinning spears and swords in unison on a huge open parade ground. They have flocked here to train at Shaolin temple, the birthplace of Shaolin kung fu.

The parade-ground scene is timeless, but the surrounding temple is not. In December it failed its examination by China's National Tourism Association, after inspectors condemned the poor conditions of the sprawling temple com­plex and the abundance of pushy touts and dodgy fortune-tellers.

Such hangers-on have arrived as part of the commercialisation of the Shaolin brand, tirelessly promoted since the 1990s by the temple's abbot, Shi Yongxin (pictured). Mr Shi is known in the Chi-

Shi Yongxin, the cEo?

central bank published an estimate on its website, attributed to the Chinese Acad­emy of Social Sciences, that up to 18,000 officials had fled the country between 1995 and 2008 with stolen assets totalling 8oo billion yuan ($130 billion at today's ex­change rate). The bank then claimed the figures were inaccurate, and scrubbed them from its website (though not from the memories of those who had read them). The chief prosecutor, Cao Jianming, says that in 2011 foreign governments helped ar­rest 1,631 Chinese fugitives for "work-relat­ed crimes" (including officials and employ-

nese media as "the CEO monk". He has rented out the Shaolin name for films, reality-television shows and computer games, and approved an online store selling Shaolin kung fu manuals for 9,999 yuan ($1,6oo). Many Chinese believe he leads too lavish a life for a holy man. In 2009, the temple's website was hacked twice. In one instance a fake apology letter from the ab bot was posted on the site, listing his alleged misdeeds. In the other, a message was scrawled saying "Shaolin evildoer Shi Yongxin, go to hell".

The temple last year twice issued statements rejecting unspecified ru­mours about Mr Shi that had spread widely in Chinese media and online. In its second statement in October, the temple even announced it was setting up a hotline offering a reward of 50,000 yuan for information leading to the source of the rumours. But as the temple feared in its statements, the damage to its reputation had already been done. The number of visitors during the Chinese new year holiday in January this year, traditionally high season for tourists, fell by nearly half.

Then on May 16th, after spending millions of yuan sprucing up the temple, Shaolin passed the tourism board's re-examination, and so was able to retain its five-star scenic-spot status. Abbot Shi remained bullish: "The Shaolin scenic spot's problems are mostly caused by the intervention of the government," he said after the announcement. "I hope to re­turn Shaolin temple to a peaceful reli­gious environment."

Restoring such an environment may not be so easy. Just days later, Chinese media reported that discussions were under way about building a magnetic­levitation train around Shaolin, in order to boost tourism.

ees of state-owned firms) and to recover 7.8 billion yuan in stolen assets.

Some senior officials have pushed for reform. In January Guangdong province in southern China announced that officials whose families have emigrated will be barred from high-level posts. But this is an exception. Officials who can afford to send their families abroad are usually the most powerful, and the most aware of China's problems. Says Mr Li of Peking University, "They know better than anyone that the China model is not sustainable and that it's a risk to everybody." •

In the future, transport net\Norks will think for themselves.

Tomorrow's trains could be capable of adapting to changing travel patterns.

HSBC is helping finance the evolution of transport systems around the world

and making smart trains a reality. The future starts today.

There's more on infrastructure at www.hsbc.com/inthefuture

Issued by HSBC Holdtr1gs p:<.:. AC:?/967

HSBC a~

ACKNOWLEDGMENTS

In addition to those quoted in the text, the author would like to thank the following for their help in preparing this special report: Vivek Arora, Kent Calder, Stephen Green, Han Gaofeng, Louis Kuijs, Edwin Lim, Koji Nomura, Jack Rod man, Andrew Sheng, Michael Spence, Murtaza Syed, Mark Williams, Xiao Geng and Wenlang Zhang

The Economist May 26th 2012

SPECIAL REPORT CHINA'S ECONOMY

Pedalling prosperity

China's economy is not as precarious as it looks, says Si m on Cox. But it still needs to change

IN 1886 THOMAS STEVENS, a British adventurer (pictured above), set off on an unusual bicycle trip. He pedalled from the flower boats of Guang­zhou in China's south to the pagodas of Jiujiang about 1,oookm (620 miles) to the north. He was disarmed by the scenery (the countryside out­side Guangzhou was a "marvellous field-garden") and disgusted by the squalor (the inhabitants of one town were "scrofulous, sore-eyed, and mangy"). His passage aroused equally strong reactions from the locals: fascination, fear and occasional fury. In one spot a "soul-harrowing" mob pelted him with stones, bruising his body and breaking a couple of his bicycle's spokes.

A century later the bike was no longer alien to China; it had become symbolic of it. The "bicycle kingdom" had more two-wheelers than any other country on Earth. Many of those bikes have since been replaced by cars-one obvious sign of China's rapid development. But even today the bicycle looms large in the battle for China's soul.

For China's fast-diminishing population of poor people, bikes re­main an important beast of burden, piled high with recycled junk. For China's fast-expanding population of city slickers, the bicycle represents everything they want to leave behind. "I'd rather cry in the back of your BMW than laugh on the back of your bicycle," as China's material girls say. Some dreamers in government see a return to the bike as an answer to China's growing problems of prosperity-pollution, traffic and flab. The country's National Development and Reform Commission wants government officials to cycle to work one day a week, though only if the distance is less than 3km.

Even if it is a fading symbol of Chinese society, the bicycle remains a tempting metaphor for its economy. Bikes-especially when heavily lad- ~~

CONTENTS

5 Exports The retreat of the monster surplus

8 Investment Prudence without a purpose

10 Local government The ballad of Mr Guo

12 Finance Bending not breaking

12 Cross-border flows Homeric wisdom

14 Shadow banking Shades of grey

15 Consumers Dipping into the kitty

17 The next chapter Beyond growth

A list of sources is at Economist.comjspedalreports

An audio interview with the author is at Economist.comfaudiovideof spedalreports

3

4

SPECIAL REPORT CHINA'S ECONOMY

I The alchemy of China's growth 11 Contributions to growth, percentage points: % ofGDP: - China - South Ko rea = Ja pan - China's GDP growth

%increase on year ago Consumption Investment Net exports Private consumption Investment

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~ en-are stable only as long as they keep moving. The same is sometimes said about China's economy. If it loses momentum, it will crash. And since growth is the only source of legitimacy for the ruling party, the economy would not be the only thing to wobble. From1990 to 2008 China's workforce swelled by about 145m people, many of them making the long journey from its ru­ral backwaters to its coastal workshops. Over the same period the productivity of the workforce increased by over 9% a year, ac­cording to the Asian Productivity Organisation (APO). Output that used to take 100 people in 1990 required fewer than 20 in 2008. All this meant that growth of 8-10% a year was not a luxury but a necessity.

But the pressure is easing. Last year the ranks of working­age Chinese fell as a percentage of the population. Soon their number will begin to shrink. The minority who remain in Chi­na's villages are older and less mobile. Because of this loss of de­mographic momentum, China no longer needs to grow quite so quickly to keep up. Even the government no longer sees 8% an­nual growth as an imperative. In March it set a target of 7.5% for this year, consistent with an average of 7% over the course of the five-year plan that ends in 2015. China has been in the habit of surpassing these "targets", which represent a floor not a ceiling to its aspirations. Nonetheless the lower figure was a sign that the central lead­ership now sees heedless double-digit growth as a threat to stability, not a guarantee of it.

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50

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mand to China's growth has always been exaggerated, and it is now shrinking.

It is investment, not exports, that leads China's economy. Spending on plant, machinery, buildings and infrastructure ac­counted for about 48% of China's GDP in 2011. Household con­sumption, supposedly the sole end and purpose of economic ac­tivity, accounts for only about a third of GDP (see chartl). It is like the small farthing wheel bringing up the rear.

A disproportionate share of China's investment is made by state-owned enterprises and, in recent years, by infrastructure ventures under the control of provincial or municipal authori­ties but not on their balance sheets. This investment has often been clumsy. In the 188os, according to Stevens, China showed a "scrupulous respect for individual rights and the economy of the soil". The road he pedalled took many wearisome twists and turns to avoid impinging on any private property or fertile plot. These days China's roads run straight. Between 2006 and 2010 local authorities opened up 22,000 sq km of rural land, an area the size ofNew}ersey, to new development.

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The large circumference of the penny-farthing's

T I 8 E T

front wheel carried it farther and faster than anything that pre­ceded it, much as China's economy has grown faster for longer than its predecessors. Asked to name the big wheel that keeps China's economy moving, many foreign commentators would say exports. Outside China, people see only the Chinese goods that appear on their shelves and the factory jobs that disappear from their shores; they do not see the cities China builds or the shopping aisles it fills at home. But the contribution of foreign de-

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The Economist May 26th 2012

Keep those wheels turning

~ tion. This rapid urbanisation is a big part of the country's eco­nomic success. But it has come at a heavy price in depleted natu­ral resources, a damaged environment and scrupulously disrespected property rights.

The imbalance between investment and consumption makes China's economy look precarious. A cartoon from the 188os unearthed by Amir Moghaddass Esfehani, a Sinologist, shows a Chinese rider losing control of a penny-farthing and falling flat on his face. A vocal minority of commentators believe that China's economy is heading for a crash. In April industrial output grew at its slowest pace since 2009. Homebuilding was only 4% up on a year earlier. Things are looking wobbly.

But China's economy will not crash. Like the high-wheeled penny-farthing, which rolled serenely over bumps in the road, it is good at absorbing the jolts in the path of any developing coun­try. The state's influence over the allocation of capital is the source of much waste, but it helps keep investment up when private confidence is down. And although China's repressed banking system is inefficient, it is also resilient because most of its vast pool of depositors have nowhere else to go.

Not so fast The penny-farthing eventually became obsolete, super­

seded by the more familiar kind of bicycle. The leap was made possible by the invention of the chain-drive, which generated more oomph for every pedal push. China's high-wheeling growth model will also become obsolete in due course. As the country's workforce shrinks and capital accumulates, its saving rate will fall and new investment opportunities will become more elusive. China will have to get more oomph out of its in­puts, raising the productivity of capital in particular. That will re­quire a more sophisticated financial system, based on a more complex set of links between savers and investors.

Other innovations will also be needed. China's state­owned enterprises emerged stronger-too strong-from the downsizing of the 1990s, but the country's social safety net never recovered. Thus even as the state invests less in industrial capaci­ty, it will need to spend more on social security, including health care, pensions, housing and poverty relief. That will help boost consumer spending by offering rainy-day protection.

The chain-drive was not the only invention required to move beyond the penny-farthing. The new smaller wheels also needed pneumatic tyres to give cyclists a smoother ride. In the absence of strong investment to keep employment up and social unrest down, China's state will also need a new way to protect its citizens from bumps in the road ahead. •

The Economist May 26th 2012

SPECIAL REPORT CHINA'S ECONOMY

Exports

The retreat of the monster surplus

China's current-account surplus is on the verge of extinction THREE DINOSAURS LURK in a former factory district of Beijing. Bright red, with "Made in China" embossed on

their bellies, they look like the cheap plastic toys China exports to the rest of the world. But these model dinosaurs are life-sized, towering over passers-by. And they look hungry.

The three beasts are one of the imposing installations at the 798 Art District in Beijing. Sculpted by Sui Jianguo, a former fac­tory worker, they are imprisoned in three cages, stacked on top of each other, like the 20-foot containers that carry the country's manufactures to the world. In resin, bronze and steel, the sculp­ture embodies the widespread fear that China's exporters will gobble up foreign markets and manufacturers. When it was made in 1999, the country's exports were less than a third of America's. Ten years later China was the world's largest export­er. Of the toys shipped to America and the European Union, 85-90% were made in China.

The country's roaring exports contributed to a growing cur­rent-account surplus, which exceeded10% of its GDP in 2007 (see chart 3, next page). China's surpluses-its failure to import as much as it exported, spend as much as it earned, or invest as much as it saved-became an economic cause celebre, generating an equally impressive surplus of commentary and explanation.

Ben Bernanke, now chairman of America's Federal Re­serve, argued that China's surplus was adding to a "global sav­ings glut".lt was the subject of much debate and diplomacy at G20 summits, and the object of much blame and many bills in America's Congress. The latest of those, which passed the Sen­ate in October, calls for retaliation against any country that engi­neers an oversized surplus with an undervalued currency. Mitt Romney, the presumptive Republican nominee for president, has threatened to brand China as a currency manipulator on his first day in the White House.

China's trade surplus with America remains large and con­troversial, but its current-account surplus with the rest of the world is dying out. Last year it narrowed to $201 billion, less than ~~

Safely caged

5

6

SPECIAL REPORT CHINA'S ECONOMY

Less cheap China's exchange rate, March 2005=100

140

2005 06 07 08 09 10 11 12

Sources: Hong Kong Institute for Monetary Research Working Paper; BIS

~ 2.8% of the country's GDP, the smallest percentage since 2002. In money terms it was smaller than Germany's.

Is that small enough? The Senate bill relies on IMF methods to calculate a current-account "norm" for a country like China. Such calculations are more art than science: one exercise by the European Central Bank estimated China's norm 16,384 different ways. But an unofficial study using the IMF'S methods calculated a benchmark of about 2.9% of GDP over the medium term, which suggests China's surplus is about where it should be. Whether it remains there depends partly on why it narrowed in the first place. In its latest World Economic Outlook, the IMF id en-

Domestic demand in China's big trading partners has been slow to recover from the crisis. China's own spending, on the other hand, has surpassed all expectations. Investment as a share of GDP rose by over six points between 2007 and 2010 as banks lent liberally to help stimulate the economy. The IMF reck­ons that this rise in investment in itself accounted for between a quarter and a third of the narrowing of China's surplus. But it may also have been a contributory cause of some of the other factors, such as the rise in commodity prices and the increase in Chinese wages and prices.

Will it return? The surplus could widen again, for one of two reasons.

First, China's high investment could set the stage for a renewed export boom. Second, China's investment rate could falter with­out consumption rising to make up for it, forcing China to rely on foreign demand to keep the economy moving.

To imagine the first scenario, you only have to examine the recent past. Pieter Bottelier of the Conference Board, a think­tank, argues that China's big surpluses before 2008 owed some­thing to an investment boom around the time China joined the World Trade Organisation in 2001. This investment created ex­cess capacity in industries such as cars, construction materials and especially steel. At first these new factories displaced im­ports; then, when the domestic market proved too small, they flogged their surplus wares on foreign markets instead. China went from being a net importer of steel in 2004 to being the world's largest net exporter, note Brett Berger and Robert Martin

of the Federal Reserve.

The future of China's export monster depends on whether China's high investment rate is sustainable. Manythinkitis not

But a repeat is unlikely. It would re­quire China's low consumption rate to move still lower to make room for so much investing and exporting. It would also require China to make further rapid gains in global market share.

tifies four reasons: China's exchange rate, its terms of trade, glo­bal spending and China's own investment expenditure.

China's exchange rate has risen, if not as far or as fast as many Americans had hoped. This appreciation can be measured in various ways. The measure most economists watch is the real effective exchange rate (REER) adjusted for consumer-price infla­tion and weighted by trade. This has gone up by 27% since July 2005. An alternative gauge is the internal real exchange rate (IRER), which measures the price of Chinese goods that cannot be traded across borders relative to the price of things that can. According to a study by the Hong Kong Institute for Monetary Re­search, China's internal real exchange rate rose by over 35% be­tween July 2005 and December 2011 (see chart 2). This apprecia­tion encourages the Chinese to make more non-tradable goods and to buy more tradable ones. Both help narrow its surplus.

The size of China's surplus also depends on some volatile prices, such as the cost of crude oil and other commodities that China imports. The price of China's imports has risen relative to the price of its exports in recent years. According to the IMF, this deterioration in China's terms of trade could explain up to half the drop in its surplus between 2007 and 2011. Those terms are unlikely to improve. As long as China remains the dominant force in the market for its main imports and exports, it will con­tinue to influence the price of both.

This pincer movement shows up in surprising ways. One British scholar argues that cheap Chinese exports have deterred burglaries in his country because a £19.99 DVD player is hardly worth stealing. But others say that China's imports of copper have contributed to a rise in metal theft because China's appetite for such commodities has made them a more tempting target.

The post-crisis investment boom was also different from the post-wTo one. It was weighted towards inland provinces, far from the seaports that ship China's goods to the rest of the world. Inland China's share of fixed-asset investment matched that of the coastal provinces for the first time in 2009, then ex­ceeded it in 2010. The investment boom in 2009-10 was also con­centrated in infrastructure and property. Neither can be traded across borders.

But some economists believe that the latest investment boom will prove unsustainable. If construction collapses, some of the industries that fed China's building rush will turn their at­tentions overseas, as they did in 2006.

Back where it belongs China's current-account surplus As % ofGDP

10

8

4

2001 03 05 07 09 11

Source: CEI C

The future of China's ex-port monster thus depends on whether China's high invest­ment rate is sustainable. Many think it is not. Economists like Paul Krugman, a professor at Princeton University and a commentator for the New York Times, have gone from bashing China for its underpriced cur­rency to fretting about its over­priced property. Its spectacular building boom has diverted China's energies inwards, suck­ing in imports and displacing exports. It has thus eased the world's fear of China. But it has raised fears for China. •

The Economist May 26th 2012

8

SPECIAL REPORT CHINA'S ECONOMY

Investment

Prudence without a purpose

Misinvestment is a bigger problem than overi nvestment GENGHIS KHAN SQUARE in Kangbashi, a new city in the northern province of Inner Mongolia, is as big as Tianan­

men Square in Beijing. But unlike Tiananmen Square, it has only one woman to sweep it. It takes her six hours, she says, though longer after the sandstorms that sweep in from the Gobi desert. Kangbashi, or "new Ordos", as it is known, is easy to clean be­cause it is all but empty. China's most famous "ghost city", it has attracted a lot of journalists eager to illustrate China's overin­vestment, but not many residents.

Ordos was one of the prime exhibits in an infamous pre­sentation by Jim Chanos, a well-known short-seller, at the Lon­don School of Economics in January 2010. Mr Chanos argued that China's growth was predicated on an unsustainable mobil­isation of capital-investment that provides only for further in­vestment. China, he quipped, was "Dubai times 1,000".

His tongue-in-cheek reference to the bling-swept, debt­drenched emirate caused a stir. But not everywhere in China shrinks from the comparison. One property development that actively courts it is Phoenix Island, off the coast of tropical Sanya, China's southernmost city. It is a largely man-made islet, much like Dubai's Palm ]umeirah. Its centrepiece will be a curvaceous seven-star hotel, rather like Dubai's Burj Al Arab, only shaped like a wishbone not a sail. The five pod-like buildings already up resemble the unopened buds of some strange flower. Coated in light-emitting diodes, they erupt into a lightshow at night, featur­ing adverts for Chanel and Louis Vuitton.

After a visit to Ordos or Sanya, it is tempting to agree with Mr Chanos that China has overinvested from its northern steppe to its southern shores. But what ex­actly does it mean for a country to "overin­vest"? One clear sign would be invest­ment that was running well ahead of saving, requiring heavy foreign borrow­ing and buying. The result could be a cur­rency crisis, like the Asian financial crisis of 1997-98. Some veterans of that episode worry about China's reckless investment in tasteless property. But although China invests more of its GDP than those crisis­struck economies ever did, it also saves far more. It is a net exporter of capital, as its controversial current-account surplus at­tests. Indeed, for every critic bashing Chi­na for reckless investment spending there is another accusing it of depressing world demand through excessive thrift. China is in the odd position of being cast as both miser and wanton.

Even an extravagance like Kangbashi is best understood as an attempt to soak up saving. The Ordos prefecture, to which it belongs, is home to a sixth of China's

(not to mention its rare earths and soft goat's wooD. According to Ting Lu of Bank of America Merrill Lynch, Kangbashi is an at­tempt to prevent Ordos's commodity earnings from disappear­ing to other parts of the country.

China as a whole saved an extraordinary 51% of its GDP last year. Until China's investment rate exceeds that share, there is no cause for concern, says Qu Hongbin of HSBC. Anything China fails to invest at home must be invested overseas. "The most wasteful investment China now has is us Treasuries," he adds.

When talking about thrift, economists sometimes draw on a parable of prudence written three centuries ago by Daniel De­foe. In that novel the resourceful Robinson Crusoe, shipwrecked on a remote island, saves and replants four quarts of barley. The reward for his thrift is a harvest of 8o quarts, a return of 1,900%.

Castaway capital Investment is made out of saving, which requires con­

sumption to be deferred. The returns to investment must be set against the disadvantage of having to wait. In Robinson Crusoe, the saving and the investing are both done by the same English­man, alone on his island. In a more complicated economy, households must save so that entrepreneurs can invest. In most economies their saving is voluntary, but China has found ways of imposing the patience its high investment rate requires.

Michael Pettis of Guanghua School of Management at Pe­king University argues that the Chinese government suppresses consumption in favour of producers, many of them state­owned. It keeps the currency undervalued, which makes im­ports expensive and exports cheap, thereby discouraging the consumption of foreign goods and encouraging production for foreign customers. It caps interest rates on bank deposits, depriv­ing households of interest income and transferring it to cor­porate borrowers. And because some of China's markets remain largely sheltered from competition, a few incumbent firms can extract high prices and reinvest the profits. The government has, in effect, confiscated quarts of barley from the people who might want to eat them, making them available as seedcorn instead. ~~

coal reserves and a third of its natural gas China's answer to Dubai

The Economist May 26th 2012

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SPECIAL REPORT CHINA'S ECONOMY

~ What has China got in return? Invest-ment, unlike consumption, is cumulative; it leaves behind a stock of machinery, buildings and infrastructure. If China's capital stock were already too big for its needs, further thrift would indeed be pointless. In fact, though, the country's overall capital stock is still small relative to its population and medium-sized relative to its economy. In 2010, its capital stock per person was only 7% of America's (con- Boom, boom verted at market exchange rates), accord-ing to Andrew Batson and ]anet Zhang of GK Dragonomics, a consultancy in Beijing. Even measured at purchasing-power par­ity, China has only about a fifth of America's capital stock per person, depending on how its PPP rate is calculated.

China needs to "produce lots more of almost everything", argues Scott Sumner of Bentley University, even if it does not produce "everything in the right order". Its furious homebuild­ing, for example, has unnerved the government and cast a shad­ow over its banks, which worry about defaults on property

loans. But it still needs more places for people to live. In 2010 it had 140m-150m urban homes, according to Rosealea Yao of GK Dragonomics, 85m short of the number of urban households. About three-quarters of China's migrant workers are squeezed into rented housing or dormitories provided by their employer.

The ballad of Mr Guo

SINGING KARAOKE WITH Taiwanese in­vestors, smearing birthday cake on the cheeks of an American factory owner, knocking back baijiu, a Chinese spirit, with property developers: Guo Yongchang would do anything to attract investment to Gushi, a countyof1.6m people in Henan province, where he served as party secre­tary. His antics are recorded in "The Transi­tion Period", a remarkable fly-on-the-wall documentary about his last months in office, filmed by Zhou Hao.

Mr Guo persuades one developer to raise the price of his flats because Gushi people are interested only in the priciest properties. After a boozy dinner he drapes hi m self over the developer's shoulder and extracts a promise from him to add more storeys to his tower to outdo the one in the neighbouring city.

The one-upmanship exemplified by Mr Guo has generated great economic dynamism, but also great inefficiency. When the centralgovernmenttries to stop economic overheating, local governments resist. Conversely, when the government urged the banks to support its 2008 stimu­lus effort, local governments scrambled to claim an outsized share ofthe lending. The result is a local-government debt burden worth over a fifth of China's 2011 GDP.

The worst abuses, however, involve land. Local officials can convert collective­ly owned rural plots into land for private development. Since farmers cannot sell their land directly to developers, they have

Nor is China's capital stock conspicuously large relative to the size of its economy. It amounted to about 2.5 times China's GDP in 2008, according to the APO. That was the same as Ameri­ca's figure and much lower than Japan's. Thanks to China's stim­

to accept what the government is willing to pay. Often that is not very much.

Such perverse incentives have caused China's towns and cities to grow faster in area than they have grown in population. Their outward ripple has engulfed some rural communities without quite erasing them. The perimeter ofWenzhou city in Zhejiang province, to take one example, now encompasses clutches of farmhouses, complete with vegetable plots, quacking ducks and free-range children. This results in some incongruous sights. Parked outside one farmhouse are an Audi, a Mercedes and a Porsche. Alas, they do not belong to the locals but to city slickers who want their hub caps repainted.

Oddly, where electoral reforms have given Chinese villagers a bigger say in local government, growth tends to slow, accord­ing to Monica Martinez-Bravo of Johns Hopkins University and her colleagues. This is partly because elected local officials shift their efforts from expanding the economy to providing public goods, such as safe water. But it is also because a scattered electorate cannot monitor them as closely as their party superiors can.

Fear of their bosses and hunger for revenues keep local officials on their toes. Mr Guo, star of"The Transition Period", was eventually convicted of bribery. He was not entirely honest in the performance of his duties, and not always sober either. But with all the parties, banquets and karaoke, no one could accuse him of being lazy.

ulus-driven investment spree, the ratio in­creased to 2.9 in 2010, but that still does not look wildly out of line.

Malinvestors of great wealth In Defoe's tale, Robinson Crusoe

spends five months making a canoe for himself, felling a cedar-tree, paring away its branches and chiselling out its innards. Only after this "inexpressible labour" does he find that the canoe is too heavy to be pushed the 100 yards to the shore. That is not an example of overinvestment (Crusoe did need a canoe), but "malin­vestment". Crusoe devoted his energy to the wrong enterprise in the wrong place.

It is surprisingly hard to show that China has overinvested, but easier to show that it has invested unwisely. Of China's misguided canoe-builders, two are worth singling out: its local govern­ments (see box) and its state-owned enter­prises (soEs).

China's soEs endured a dramatic downsizing and restructuring in the 1990s. Thousands of them were allowed to go bankrupt, yet those that survived this cull remain a prominent feature of Chinese capitalism. Even in the retail, wholesale and restaurant businesses there are over 2o,ooo of them, according to Zhang Wenkui of China's Develop­ment Research Centre.

soEs are responsible for about 35% of the fixed-asset investments made by Chinese firms. They can invest so much because they have become immensely profitable. The 120 or so big enterprises owned by the central government last year earned net profits of 917 billion yuan ($142 billion), according to their supervi­sor, the State-owned Assets Supervision and Administration Commission (sA­SAC). It cites their profitability as evidence ~~

The Economist May 26th 2012