Synopsis: Paul Krugman provides a graphical representation of S.R.’s article, which discusses the flaws with the claim that China has wasted $6.8tn on investments.

Click here to read the original article.

Click here to read the blog post on S.R.'s article.

Discussion:
This article substantiates the article written by S.R. (found here), while pointing out the graphical representation of Mr. Xu and Mr. Wang’s paper and thus highlights the problem with their claims.

Krugman also adds that an increasing ICOR does not mean wasted investment; it just suggests diminishing marginal returns.

Context:
Looking at Figure 1, which describes diminishing returns as we move along the curve from A to B to C, we must notice that Krugman has used the axes titles “output per worker” and “capital per worker”. Why has he used per worker instead of “total output” and “total capital”? If the graph were to show “total output” and “total capital” with the same curve, the analysis would be as such: the reason why total output does not increase as total capital increases is because there aren’t enough workers to use the increasing amounts of capital. This does not show diminishing returns, it just shows inefficiency. If we measure both per worker, which standardises the unit between both axes, we can see diminishing returns.

Synopsis: Has China really wasted $6.8 trillion on useless investments?

Click here to read the original article.

Discussion:

This article discusses the flaws in Mr. Xu and Mr. Wang’s ICOR calculations for China, which claim that China has wasted $6.8tn on worthless investments.

ICOR, or incremental capital-output ratio, is a measure of the amount of investment needed to produce an extra unit of GDP in an economy. It is calculated by (investment/incremental GDP). The higher the figure, the less efficient it is.

Mr. Xu and Wang’s calculations show 2.59 as the ICOR from 1979-1996 and 4.03 as the ICOR from 1997-2013. Using 2.59 as the base ICOR, they calculate the difference between the ICOR of another year and the base years to arrive at the amount of worthless investments of that year.

For example, in 2009, the ICOR was 5.01, which is about 48% less efficient than 2.49. Messrs Xu and Wang conclude that 48% of all investment in 2009 – or 7.9tn yuan – was wasted. This is done for every year since 2009 to arrive at a total of 6.8tn USD.

The author, S.R., cites two problems with this method:
1) Why are the base years 1979-1996? If we were to calculate the ICORs for every decade rom 1980, it shows that China’s investments were 21% less efficient from 2009-2013. While this is still a shockingly high figure, it is only about half their original estimate.

2) ICOR is not a measure of wasted investment spending. If you invest in something that produces $100 return in one day and $50 in the other, nobody says that $50 was wasted in the investment – it just means that the return on investment has reduced.

While S.R.’s conclusions do not suggest that China’s economy is doing well, it does mean that $6.8tn is an unfounded number.

Context:
1. While this point is not integral to this article, it is very important to know. Very near the end of the article, S.R. mentions “China’s stimulus package”. What is this? After the 2008 global financial crisis, China tried to help its economy recover by investing in its economy. The pros and cons about investments during a recession can be read about here. China spent around $0.5tn in investments. It is the aftermath of these investments that we are seeing and trying to measure now, which is why S.R. is especially concerned with the period from 2009-2013: this was when the stimulus package really began.

2. This article deals with analysing the return on investments. The last phrase of the article provides one way to measure the returns “looking at average ICORs over a longer period”. The word ‘average’ is integral here to measuring investments. Consider this scenario: You invest in a coffee making factory in 2014. After one year, you measure the return on the investment, and it comes to -2%. Does it mean that there was no point in investing in the coffee factory? No, because in 2016, the return might be 0.2%, and in 2017, it might be 5%. How do we see the general return on investment? The answer is a rolling average. A rolling average measures the average of the return on investment for a set number of years (usually investments show returns after 3 to 4 years). This is much more accurate in seeing the ICOR.

This blog post is supplemented by another one written by Paul Krugman, who shows the graphical representation of S.R.’s points.

Synopsis: A quick article on the points covered in the Lindau conference.

Click here to read the original article.

Discussion:
This article starts by discussing the fact that David Ricardo’s theory of comparative advantage is no longer as applicable in today’s society. Such problems and more were raised in the recent Nobel economic conference in Lindau.

Professor Eric Maskin, who won the Nobel Prize in 2007, suggests an alternate version of Ricardo’s model. He states that man of the assumptions made in the old model are no longer justified. Such assumptions include labour mobility.

The article then discusses the nature of globalisation today and analyses how it can be improved. The problem with globalisation today is that it increases income inequality in a country (although the Gini coefficient between the countries themselves has been falling). One solution would be to subsidise education and healthcare, a model that Brazil has used successfully to decrease income inequality in its own economy. Professor James Mirlees, another Nobel Laureate quoted in this article, proposes a similar solution of subsidies in the UK to aid the poorer workers.

In response to criticism that such measures (subsidies) will destroy higher growth (the equity vs equality argument), Professor Joseph Stiglitz says that evidence contradicts this claim: it is with higher equality that growth thrives.

He also warns against a plutocracy, which is an inevitable consequence of income inequality.

Context:
To understand the article and the points made in the Lindau conference better, we must study a few things in more detail.

1) Why is the theory of comparative advantage becoming outdated? What assumptions no longer hold true? This very short press release by the Lindau Nobel Laureate Meetings itself should clear things up. The main reason why the theory of comparative advantage is coming under attack is because this theory, according to the press release, predicts that the income inequality between countries should decrease, when the exact opposite is happening.
Professor Maskin’s alternative model suggests that the reason why inequality is increasing is because the more skilled workers can now migrate to more economically advanced countries, where standard of living for themselves increase. Hence, inequality still persists.

2) What is the equity vs equality argument? The argument is that these two things cannot coexist: a country must lean towards one or the other. Equity is where people keep what they earn. Hence, those earning more keep more, and those earning less keep less. Resultantly, income inequality is persistent. Conversely, equality is where there are social safety nets created from the income of the rich (i.e. a progressive taxation structure) to provide a minimum standard of living for the poorer and/or unemployed. The reason why some people favour equity is because it is speculated that equality hinders growth: higher taxes on the rich and general government interference do not allow growth to blossom. In this Lindau conference, Professor Joseph Stiglitz dismisses this claim, citing statistics showing that the two work well hand in hand.

3) It is also important to know the different ways to subsidise. In the article, Pritchard discusses one of the three main ways, a tactic that Brazil used.
                 a. The first type of subsidy is a price subsidy on goods and services. This is the subsidy that most people think of. Examples of countries that use this are India, Indonesia and the U.S. with medicare. Generally, the problem with this type of subsidisation is that the money, in lower income countries, gets stolen along the way.
                 b. Direct cash transfers (handing people money directly). I do not know examples of countries that use this.
                 c. Conditional cash transfers, which is what Brazil used. As explained by the article, this is a cash transfer to people’s bank accounts, given that they send their children to school and invest in general healthcare for their children. In Brazil, this tactic was widely successful in increasing education levels and decreasing health problems, which, in turn, helped productivity.

Synopsis: The abysmal state of the Italian economy and how it can recover.

Click here to read the original article

Discussion:
This article discusses the dismal state of the Eurozone, focusing on Italy, and stresses the importance of QE as a means of recovery.

Many economies are doing abysmally, such as France, Germany and Italy, all of whoom had great hopes of recovery. As GDP in Italy slows down to 0.1% and debt rises, the debt/GDP ratio rises to 145%.

The high debt/GDP ratio worry many, and the writer, Ambrose Evans-Pritchard, calls upon Mario Draghi (the head of the ECB) to start QE in a serious way, as opposed to the timid plans that are being discussed by the ECB.

Italy is now practicing contractionary fiscal policy to lessen its high debt.

Zolt Darvas, quoted in the article, rom the Bruegel think tank in Brussels, warns that relying on additional lending by ECB will do minimal good. Instead, QE, in the form of asset purchases, is needed to stimulate the economy.

Whether or not Italy’s current prime minister, Matteo Renzi, will “meekly” participate in further austerity and fiscal cuts, one thing is clear: only if the ECB begins QE in a meaningful way will the Italian economy be saved.

Key words:
1. Primary budget surplus (paragraph 10): This is where the Italian government is in surplus when the government pays back the principal borrowed, but not the interest. Once the Italian government pays the interest back to its lenders, it is facing a deficit. The solution to this is austerity measures, which allows them to stop borrowing but maintain some reasonable level of government revenue through the collection of taxes. A good analogy is found here.
2. Debt trap (paragraph 12): A debt trap is where a country borrows to pay back interest. For example, if Italy borrowed 10 billion euros with 2% interest rate per annum (not real figures), and Italy pays back the 10 billion euros at the end of the year but not the 200 million euros interest, it will borrow more money to pay back the interest. The new loan will come with its own interest rate, which Italy must pay back by borrowing from somewhere else. Ultimately, Italy will spiral into uncontrollable debt.
3. Anglo-Saxon QE (paragraph 15): U.K. and U.S. QE
4. Austerity measures: This is contractionary fiscal policy, which means an increase in tax rates and a decrease in government spending. This is usually used to reduce the debt level in a country.

Context:
1. Internal vs. external devaluation: Neither of these terms is explicitly said in the article, but both ideas are mentioned. External devaluation is when an economy’s currency is devalued, which will encourage exports and hopefully increase production in the economy. Italy, being a part of the EU cannot devalue its currency as it does not have its own currency to control. Hence, exports cannot be encouraged through external devaluation. What Italy can do is devalue its economy internally. In paragraph 17, Evans-Pritchard writes, “If Italy slashes wages and deflates the economy to further regain lost competitiveness…” This is internal devaluation. By slashing wages, there will be less for Italian citizens to spend. Because of this, the price of commodities will drop. This drop in price of commodities might encourage other countries to import goods from Italy. It is a risky game, because it increases unemployment. Hence, internal devaluation is always a second-resort option; most economies prefer external devaluation.
2. Debt/GDP ratio: this is the ratio between debt and GDP. No economy ever looks at debt on its own, because it must be in relation to its economy. Imagine Country A with $100 debt and Country B with $200 debt. While it seems like Country A is doing better, this might not always be the case. Country A has only made $10 GDP, while Country B has made $100. So, Country A’s debt is ten times the amount of its GDP but Country B’s is only twice. On this scale, Country B is doing much better. This is why debt is always taken as a ratio of GDP.

Synopsis: An update on to what extent and why Abenomics is struggling.

Click here to read the original article

Discussion:
This article discusses the problem Abenomics is facing, and focuses on the problems with Japan’s falling GDP, rising debt and stagnant inflation.

The general plan of Abenomics was as follows:

1. Aggressive QE (bond-buying programs) should increase inflation expectations

2. The rise in inflation expectations would lead to an increase in wage inflation and nominal GDP growth, which means confidence would be instilled in the market. A tightening of fiscal policy (i.e. increased sales tax) should therefore not break the confidence.

Clearly, the second step has not been achieved, as seen by the low nominal GDP growth.

The question now is whether fiscal policy should be tightened. The IMF believes it should be, stating that they fear for Japan’s increasing debt, but Paul Krugman, Lawrence Summers and the author of this article, Gavyn Davies, disagree. They warn Abe that tightening fiscal policy prematurely, when the economy is recovering, might push the economy back into a recession. Davies adds that delaying the sales tax increase will not exacerbate the debt/GDP ratio like the IMF fears; it will only increase it by 0.75 percentage points from the already existing 245%.

From this, we can see that Abe is facing a dilemma; on one hand, he can increase austerity measures (contractionary fiscal policy) and alleviate the government debt. Resultantly, consumer confidence will break, which, according to Krugman, will push the economy into a recession. On the other hand, Abe can focus on QE (expansionary monetary policy), thereby increasing government debt but solidifying consumer confidence. The IMF feels as though increasing government debt is an issue that must be tackled in the short term. Davies disagrees.

Key words:
1. Inventory shredding: This phrase is seen in the second paragraph of the article. It means to bring down the inventory. For example, if Mrs. X runs a cupcake shop and she has made 100 cupcakes, of which 5 were bought, she might stop producing cupcakes to sell off the remaining 95 of them. Selling off her excess inventory of 95 cupcakes is called inventory shredding.

Context:
What does Davies mean when he says that “nominal bond yields had to be held down as inflation expectations increased” (paragraph 7)? The purpose of holding down nominal bond yields is to decrease the value of real bond yields.

Just like with interest rates, where nominal interest rates = real interest rates + inflation:

Nominal bond yields = real bond yields + inflation

So, if nominal bond yields stayed the same, and they expected inflation to increase, then the value of real bond yields would decrease.