Friday, 19 March 2010


US and EU together make 27% of the world’s total exports and take in 34% of the world’s total imports. But that is not what is really important.

Where Europe and the US come into their own in the field of overseas investment. The EU and the US combined make 75% of all Foreign Direct investment in the world.

European investment is hugely important to America. Europe provides more than half of all FDI in US (except in Rocky Mountain States where it provides 41%)

Texas, New York, and California are the big destinations for European FDI in the US. FDI is responsible for 10% of all output in NY.

It is responsible for 25% of output in London, and much of that foreign investment in London comes from the United States.

But surely, one might suggest, the emerging markets of China, Brazil and Russia are more important nowadays?

Not so.

US investment in China is only70% of US investment in Ireland.

US investment in Brazil is only 70% of its investment in Spain.

US investment in Russia is 50% that in Italy.

In 2009, US FDI fell by 44% pa to Europe ... but by 185% to China. So Europe is holding its own in relative terms.

Europe is still the place where a vital part of America’s wealth is kept. And it is the same in reverse.

What does this mean in practice? It means that we own part of one another. We have a bigger stake in one another than either of us has in anyone else.


But the world is changing.

Since 1989, it could be argued that the world is experiencing a bigger supply side shock than any that has occurred since the European discovery of the Americas, that discovery transformed the world economy by opening up new supply sources of raw materials.

Since 1989, there has been an equally dramatic increase in the worlds available supply of labour, as billions of Chinese, Indian , Brazilian and other emerging market workers entered the world market and, thanks to IT, are now , able to perform tasks for Europeans and Americans, that previously could only be done in Europe and America .For example Indian radiologists can now read US X Ray results without ever leaving India..

3 billion new people joined the world economy in the 1990’s That is a huge change.

As a result, even in the midst of a crisis caused a bigger loss in wealth in western countries than occurred in 1929, 5 of the world’s 7 billion people are seeing their living standards improve, and are enjoying new opportunities their parents could only have dreamed of. That is the other side of globalisation.

As China’s rural population joins its export economy, they add the equivalent of an entire French or Italian workforce to the world’s available workforce every year. China produced 1% of worlds GDP in 1980, it produces 11% today and that share is rising fast.


The effects of all this are only beginning to be felt. It is highly disruptive, just as the discovery of the Americas was disruptive to medieval Europe!.

Globalisation is redistributing income and wealth within our own societies, because some people can gain from it, the educated and the well placed, while others, with few skills and facing new Chinese and Indian competitors, can only lose. Making sure those among us who lose are helped is a matter for ourselves, not for the Chinese or the Indians. Protectionism is not the answer.

The fear of unemployment corrodes confidence. The median duration of unemployment here in the US is now 20 weeks, twice what it was in the 1981/2 recession. 20% of men between 25 and 54 are not working now, as against 5% of that age group who were not working in the mid 1960’s.

This follows a period in the 1990s, when the rate of growth in wealth has far outpaced that in jobs. For ten years we had jobless growth.

In Europe we have another problem, that of people retiring too early. Only 46% of people over 55 are still at work in Europe, as against 62% here in the United States.


Both Europe and the United States have come to rely heavily on the financial sector as a source of jobs.

The financial sectors share of EU GDP was 30% just before the crisis. It was only 13% in 1970. The financial sector has become increasingly concentrated. The three biggest banks in the UK already were worth 200% of British GDP in 2005. By 2008 they were worth 400% of it.

In Europe the financial sector It made 42% of all profits in 2008, as against 25% in the mid 1980’s. It also attracted the biggest share of the talent coming out of our universities.

This was placing a very big bet on one horse.


Both Europe and the United States are going to have to undertake a huge transformation of our economies, to identify and capture the niches in the world economy where we will enjoy a comparative advantage against our competitors in Asia and the other emerging economies.

We will be competing for resources, human, material and financial, with a whole range of new competitors that were not there before.

As we seek to transform our economies, we can afford to let no capital go to waste, least of all can we afford to waste human capital.

Unemployment is a waste of human capital, and a permanent diminution in the earning power of people, even when they eventually get back to work.


How much human capital is wasted when a young person leaves school without a qualification?

I do not know the answer.

We do not measure that, but just because something is hard to measure, does not mean that it does not count.

It is not all about throwing more resources at the problem. Ireland spends 5700 dollars per elementary school pupil, but gets better test results in international comparisons in reading, science and math than does the US, which spends 9156 dollars per pupil.

But South Korea has more students per teacher than either Ireland or the United States does, and gets far better test results than either.

Any response to the challenge of the emerging markets has to start with education.

We need skills if we are to compete. 50% of Japan’s 25 to 34 year olds have a university degree, 40% of Americans in that age group do, but only 30% of Europeans.

We have to ask very hard questions about how well our education is preparing people for the entirely new world in which they must compete. Are they adaptable enough? Do they have the language skills in Chinese, Portuguese and Spanish?

Are too much of our resources going to things that do not add to our competitiveness?


Healthcare, which might more accurately be described as illness care, is absorbing an ever increasing share of our resources - 25% of US Federal spending today, as against 11% in 1980. Europe does not spend quite as much, but the upward trend in Europe is just as fast.

I was really surprised to see the main Opposition party in a major European country recently promise to cut spending in every area, presumably including education, but to exempt health spending. That is the wrong priority.

If we take note of the fact that baby boomer generation will soon retire, and of the fact that their health and pensions will have to be paid for by a much smaller generation of people of working age, this sort of promise makes little sense. It is not the best use of scarce resources.


That brings me to the problem of Greece and the eurozone,. and to the problems of Portugal, Spain, and other eurozone countries with large deficits and debts.

The problem may present itself as a problem of borrowing or of exchange rates. But they are only symptoms of the real problem which is the misallocation of increasingly scarce resources.

Scarce resources being committed to the wrong things in Greece and the other countries in difficulty. Or as economists like to describe it, it is a structural problem.

In Greece, people can retire too early on a state pension, taxes are not collected efficiently, and the bureaucracy is overstaffed. That is poor use of scarce resources.

In Spain and Ireland, too much resources were ploughed into building houses, again a poor use of scarce resources, in a notoriously cyclical sector of the economy.

There will be no default by Greece or any other European country.

As the economist Charles Wyplosz recently told the European Parliament,

“No European country has any reason to default because they have all the taxing ability to raise enough resources to service their debts and because a default would cause enormously costly disruption”

The problems of Greece do not call the euro into question.

Of course the euro exchange rate that suits Germany might not always suit Italy. But the dollar exchange rate that suits New York might not always suit Michigan. In both cases the former can live with a stronger currency than the latter, but have to hang together because they do not want to hang separately.


The pact that governs the euro, the Stability and growth Pact, needs to be improved.

The assumptions, on which national budgets are prepared, must be consistent and honest.

They should be independently vetted. Opposition parties need to be part of that vetting process, so they are not taken by surprise by the state of the finances if the take over power, as the new Greek Government was.

The mystery and the secrecy should be taken out of budget making in Europe. That will go a long way toward introducing greater discipline, because no one really wants to be seen pass on big liabilities to their children.

A European Monetary Fund to provide fiscal policy insurance to member states of the euro is a good idea, especially if it involves higher premiums having to be paid by countries which are running excessively big deficits, ones that are not caused by short term problems that will reverse themselves.

Just as China cannot run a policy that privileges exports, neither can Germany.

An export led policy will only work as long as other people can afford to import.

It took Germany twenty years of investment to make a success of reunification with the ex Communist east.. A tremendous achievement. In that period, it needed to save.

Now, it needs to provide a market for its trading partners, just as the United States did after World War two, helping the recovery of Europe and Japan . It can do that by liberalising its economy, including liberalising shop opening hours.

Within the EU, economic policy is a matter of common interest. That is what the EUTreaty says.

German consumers can help the Greek recovery by taking a holiday in Greece, and buying some Greek wine! That is the best way to ensure that the German banks that have bought Greek bonds get all their money back, with interest!


We must avoid a big disagreement across the Atlantic on how to change the rules governing finance so we can minimise the risk of another bubble economy. This is no small risk. We should not forget that our efforts to deal with the dot com bubble, contributed to the build up of the sub prime bubble.

We are not going to have exactly the same rules in the EU and in the US. Our political systems and traditions are very different.

But we should aim at equivalence and mutual recognition, rather than at having the same rules. But we must avoid a situation where bad practices creep back in because we are competing to have more lax rules in order to steal business from one another.

Remuneration of top people in finance is controversial. Incomes in our societies have become more unequal in many sectors, not just banking. That inequality reduces a sense of mutual solidarity, which is an important value for Europeans. It makes it harder to persuade taxpayers that it is in their own interests to pursue pro business policies.

A distinction might perhaps be made between rewarding top employees with company stock, where they share in the downside risk, and stock options where they can avoid risk and have only potential gain.


Should we be optimistic or pessimistic?

It is not an original thought but we should look the opportunity the crisis creates. The crisis should make it possible to make changes that it would be harder to get people to agree to in calmer times.

Let us not forget that 50% of today’s Fortune 500 companies were formed during a bear market.

Microsoft was formed in 1979.

The 1991-93 recession in Finland led to the creation of Nokia.

Every segment of our society –our political system, our educational system, our healthcare system- must ask itself it is contributing all it can to innovation, to cost cutting, and to the building up of human and material capital that will enable our societies to meet the huge economic challenge of the emerging economies.

Speech to The Financial Services Roundtable in the St Regis Hotel, New York on 18th March 2010

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