Archives for posts with tag: growth

The End of Alchemy, Mervyn King, 2016

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The post-war confidence that Keynesian ideas – the use of public spending to expand total demand in the economy – would prevent us from repeating the errors of the past was to prove touchingly naïve. Expansionary policies during the 1960s, exacerbated by the Viet-Nam war, led to the great inflation of the 1970s, accompanied by slow growth and rising unemployment – the combination known as stagflation.

My own accounts of event (re the crises) will be made available to historians when the twenty-year rule permits their release.

Today we are stuck with extraordinary low interest rates, which discourage saving – the source of future demand – and, if maintained indefinitely, will pull down rates of return on investment, diverting resources into unprofitable projects. Both effects will drag down future growth rates.

Three bold experiments since the 1970s:  to give central banks much greater independence in order to stabilize the inflation; to allow capital to move freely between countries and encourage a fixed exchange rates (in Europe, between China and US); to remove regulations limiting  the activities of the banking and financial system (more competition, new products, geographic expansion) to promote financial stability.

Three consequences : the Good was a period between 1990 and 2007 of unprecedented stability of both output and inflation – the Great Stability with inflation targeting spreading to 30 countries; the Bad was the rise of debt level: eliminating exchange rate flexibility in Europe and emerging markets led to growing trade deficits and surpluses. Richer country could borrow to finance deficits and long term interest rates began to fall (too much saving). Low long term interest has an immediate effect: the value of assets (today’s value) – specially houses – rose. As value increased, more borrowing was needed to buy those assets – from 1986 to 2006, household debt increase from 90% of household income to 140% (in the UK). The Ugly was the development of an extremely fragile banking system. Separation between commercial and investment banking was removed. Trading of new and complex financial products among banks meant that they became closely connected: a problem in one would spread rapidly to others. Equity capital (funds provided by shareholder of the bank) accounted for a declining proportion of overall funding. Leverage (the ratio of total assets (liabilities) to equity capital rose to extraordinary level (more than 30 for most bank, up to 50 for some before the crises)

Total saving in the world was so high that interest rates, after allowing for inflation, fell to level incompatible in the long run with a profitable growing market economy.

No country had incentives to do something about imbalances. If a country had, on its own, tried to swim against the tide of falling interest rates, it would have experience an economic slowdown and rising unemployment, without having an impact on the global economy or the banking sector.

In 2002, the consensus was that there would eventually be a sharp fall in the value of the US dollar, which would produce a change in spending patterns. But long before that could happen, the banking crises of September and October 2008 happened.

Opinions differ as to the cause of the crises: some see it as financial panic as confidence in bank creditworthiness fell and investors stopped lending to them- a liquidity crises. Other see it as the outcome of bad lending decisions by banks – a solvency crises. Some even imagine that the crises was solely an affair of the US financial sector.

The story of the crises

After the demise of the socialist model, China, Soviet Union, India embraced the international trading system. China alone created 70 million manufacturing jobs, far exceeding the US 42 million jobs in US and Europe combined (in 2012). The pool of labour supplying the world trading system more than trebled in size (depressing real wages in other countries). Advanced countries benefited from cheap consumer goods at the expense of employment in the manufacturing sector. China and other Asian countries produced more than they were spending and saved more than they were investing a home (in the absence of social safety net, and a one child only policy in China preventing parents to rely on their children when retiring). There was an excess of saving, which pushed down long term interest rates around the world. Short term interest rate are determined by central banks but long term interest rate result from the balance between spending and saving in the world as a whole. IN recent times, short term real interest (accounting for inflation) have actually been negative (official rates have been less than inflation).  In the 19th century, real rates were positive and moved within 3% to 5%. It was probably 1.5% when the crises hit and since then has fallen further to around zero. Lower interest rate and higher market prices for assets boosted investment. It appeared profitable to invest in projects with increasing low real rates of return. For a decade or more after the fall of Berlin wall, consumer benefited from lower prices on imported goods. Confronted with persistent trade deficit, developed countries (US, UK, part of Europe) relied on central banks to achieve growth and low inflation by cutting short term interest to boost the growth of money, credit and domestic demand. This was an unsustainable path in many, if not most, countries. Saving in Asia and debt in the West produce major macroeconomic imbalance. Normally capital flow from mature to developing countries where profitable opportunities abound. Now emerging economies were exporting capital to advanced economies where opportunities were more limited. Most of these financial flow passed through the western banking system leading to a rapid expansion of bank balance sheets (all bank’s asset – the loans to customers – and liabilities – the deposit and loans taken by the banks). As western banks also extended credit to household and companies, balance sheets expanded. As asset prices increased, debt levels increased (more expensive to buy new houses, so more borrowing). With interest rate low, the bank also took more risk, in an increasingly desperate hunt for higher return. Central banks, by allowing the amount of money in the economy to expand, did little to prevent this better yield seeking behavior. In addition pensions funds and insurance were trying to find ways of making their saving more attractive. Banks created new financial instruments based (derived from ) basic contracts (hence ‘derivative’) such as collateralized debt obligation (CDO), more risky but with better return assets. Because return were higher (even if sometimes the financial instruments were very risky or even fraudulent) there was no shortage of buyers. Financial assets increased rapidly:  from ¼ of GDP in the US, it was 100% by 2007. It was 500% of GDp in the UK, even higher in Ireland. Bank leverage rose to 50 to 1 (for 1 dollar provided by shareholder, the bank borrowed more than 50). Substantial profits were made so regulators took an unduly benign view of these developments. The interaction between the macroeconomic imbalances (extra saving) and the developing banking system that generated the crises. Most policy maker believed that unsustainable pattern of spending and saving, would end with the collapse of the US dollar. The dollar was the currency in which emerging economies were happy to invest (the renminbi was not convertible – China in 2014 owned US$4tn). So the dollar remained strong and it was the fragility of the banks that first revealed the fault lines. First law of financial crises: an unsustainable position can continue for far longer than you would believe possible. The second law of financial crises: when an unsustainable position ends it happens faster than you could imagine.  In august 2007, BN Paribas announced it stopped paying investors on three funds invested in the sub-prime market. End of 2007 market liquidity in a wide range of financial instrument dried up: the banks were vulnerable to the US sub-prime mortgage – loans to households on low incomes who were highly likely to default. In September, central banks did not believe the problem could bring down large bank: the stock of mortgage was only US$ 1tn, so losses could not be large enough for the system as a whole. This time however banks had made large bets on sub-prime markets (derivative contracts). Although those bets cancelled out as whole, some banks were in the money, other were under water. Because it was impossible to tell those apart in the short term, all banks came under suspicion. They stooped lending to each other. Banks needed injection of shareholder’s capital (not new loans as central banks were offering). Two options: either to recapitalize or to drastically reduce lending – for the economy, the former was preferable. The system staggered for a year. In Sept 2015 Lehman Brothers failed, generating a run on the US banking system by financial institutions (such as money market funds). The run spread to other advanced economies: banks around the world found it impossible to finance themselves (because no one new which bank were safe. It was the biggest global financial crisis in history. With Bank unable to refinance themselves, the Central Bank had to intervene (with recapitalization of banks starting less than a month later). The problem was that government ended up guaranteeing all private creditors of the banks, imposing on future taxpayers a burden of unknown attitude.  Between autumn of 2008 and summer 2009, 10 millions jobs in US and Europe were lost, world trade fell more rapidly than during the Great Depression. In May 2009, the US treasury and Fed announced that banks could withstand the losses under different adverse scenarios. The banking crises ended but the economic crises remained. By 2015 there had still been no return to the growth and confidence experience earlier.

The strange thing is that after the biggest financial crisis in history, nothing much has changed in terms either of the fundamental structure of banking or the reliance on central banks to restore macroeconomic prosperity.

In practice buyers and sellers simply cannot write contracts to cover every eventuality, and money and banks evolved as a way of trying to cope with radical uncertainty.

In the middle of 2015, we were still searching for a sustainable recovery despite cuts in interest rates and the printing of electronic money on an unprecedented rate. Central banks have thrown everything at their economy and the results have been disappointing.

The sharper the downturn, the more rapid the recovery. Not this time.

From an imbalance between high and low-saving countries, the disequilibrium has morphed into an internal imbalance of even greater significance between saving and spending within economies.

Central bank had to create more money by purchasing large quantities of assets from private sector – the practice known as Quantitative Easing. QE was long regarded as a standard tool of monetary policy – but the scale on which it has been implemented is unprecedented.

Pounds, shilling and pence where already used in 1066 (Domesday book was the first inventory of wealth done at the time). The decimalization of anglo-saxon monetary unit happened on 1971.

The amount of money in the US economy remains stable at around 2/3 of GDP. The share of bank deposit in total has also been roughly constant at 90% (no less than 97% in the UK) (the rest is in coins and banknotes). The amount of money in the economy is determined less by the need to buy ‘stuff’ and more by the supply of credit created by private sector banks responding to borrowers.

The ability to expand the supply of money in times of crisis is essential to avoid a depression. The experience of emergency money reveals that the private sector will not always be able to meet the demand for acceptable money. [in short : Acceptable money is money accepted by all banks, based of confidence in these banks to meet their obligation if needed – what was missing in the early days of the crisis. In those days, only government was able to issue assets that were acceptable by all banks]

The creation of independent central banks with clear mandate to maintain the value of a currency in terms of a representative basket of goods and services, proved successful in stabilizing inflation in 1990s and 2000s. The conquering of inflation over the past twenty-five years was a major achievement in the management of money, and one, despite the financial crisis, not to be underrated.

5,500 tons of gold are in the vault of the Bank of England (worth US$235bn). 6,700 tons are in the Federal Reserve Bank of New York. The US hold 8,000 tons in reserve, 10,784 tons are in reserve in the Euro area, 1,000 tons in China, Uk only has 310 tons as reserve.(Wikipedia: est. 170,000 tons of gold mined on earth as at 2011).

Most money are created is private sector institutions – banks. This is the most serious fault line in the management of money in our societies today.

If before the crisis banks had exited the riskier types of lending, stopped buying complex derivative instruments they would, in the short term, have earned lower profit. Even understanding the risks, it was safer to follow the crowd.

It is remarkable how equal global banks are in terms of size. Among the twenty biggest banks, the ratio of assets of the largest to the smallest is little more than two to one. These 20 banks accounted for assets of US$42tn in 2014, compared with the world GDP of US$80tn, and for almost 40% of total world-wide bank assets.

Investment banks have been described as inventing new financial instrument that are “socially useless”. With their global reach, their receipt of bailouts from taxpayers, and involvement in seemingly never ending scandals, it is hardly surprising that the banks are unpopular.

Bank grew fast: JP Morgan today accounts for almost the same proportion of US banking as all of the top ten banks put together in 1960. Most of this has taken place in the last 30 years and has been accompanied by increasing concentration. The top ten banks in the US account for 60% of GDP (was 10% in 1960). In the UK, the assets of the top ten banks amount to over 450% of UK GDP, with Barclays and HSBC both having assets in excess of UK GDP.

In less than 50 years, the share of highly liquid assets held by UK banks declined from 33% of their assets to less than 2% today. The turning point came when the balance sheet of the financial sector became divorced from the activities of households and companies. Deregulation and derivatives in 1980 contributed to this divorce. Lending to companies is limited by the amount they wish to borrow. But there is no corresponding limit to the size of transaction in derivatives. The market for derivative in 2014 is just over US$20tn, about ½ of the assets of the largest 20 banks.

Since 1999 in the US, stand-alone investment bank that were previously organized as partnership (ie risk shared between partners – so more controlled) turned themselves into limited liability companies (where only assets are at stake, not borrowings to invest in shady business).

With a growing proportion of bank activity deriving from trading of complex instruments, it was difficult to work out how big the risks actually were. The banks themselves seemed not to understand the risks they were taking. And, if that was the case, there was not much hope for regulators could get to grips with the potential scale of the risk.

Whether selling oversized mortgage to poor people in the US, selling inappropriate pension and other financial product to millions of people in the UK, rigging foreign exchange and other markets, failing to stop subsidiaries  from engaging in money laundering and tax evasion, there seem no ends to the revelations about what bank had been doing. The total fines imposed on banks world wide since the banking crisis ended in 2009 amounted to around $300 billion.

Perhaps the enormous losses banks incurred in the crisis, and the fines levied by regulators around the world, will bring a change of heart in the banking sector.

Many of the substantial bonuses that were paid as a result of trading in derivatives reflected not profit earned in the past year but the capitalized value of a stream of profits projected years into the future. Such accounting proved more destructive than creative.

Someone who invested $1000 in Berkshire Hathaway in 1985 would by the middle of 2015 have an investment worth $161,000. A compound annual rate of return of 17%.

Limited liability  in a bank with only small margin of equity capital means that the owner have incentives to take risks – to gamble for resurrection- because they receive all the profits when gamble pays off, whereas their downside exposure is limited. Those who manage other people’s money are more careless than when managing their own.

Money market funds were created in the US as way to get around the regulation that limited the interest rates banks could offer on their accounts. They were attractive alternative to bank accounts. Such funds were exposed to risk because the value of the securities in which they invested was liable to fluctuate. But the investors were led to believe that the value of their funds was safe. Total liability at the time of the crisis repayable on demand was over $7tn.

All non-bank financial institutions have been describe has shadow banking. Special purpose vehicle issue commercial papers – not dissimilar to bank deposit – and purchase long term securities (such as bundles of mortgages. Edge funds are also part of this shadow banking, although because they do not demand deposit, the comparison with banks is less convincing. Financial engineering allows banks and shadow banks to manufacture additional assets almost without limits, with 2 consequences: first, the new instruments are traded between big financial institutions, more interconnection results and the failure of one firm causes troubles for the others. Second, many of the banks position even out when seen as a whole, balance sheets are not restricted by the scale of the economy. When the crisis started in 2007, no one knew which banks were most exposed to risk.

And in some country the size of the banking sector had increased to a point where it was beyond the ability of the state to provide bailouts without damaging its own financial reputation – Iceland, Ireland – and it proved a near thing in Switzerland and the UK.

Equity, debt and insurance are the basic financial contract underpinning our economy. The total global financial stock of marketable instruments (stocks, bonds) plus loans must be well over $200tn.  Over the last 20 years, a wide range of new and complex instruments has emerged (known as derivatives as elaborate combination of debt, equity and insurance contracts). Derivatives typically involve little up-front payment and are a contract between two parties to exchange a flow of returns or commodities in the future.(Wikipedia : total derivatives market value as at 2014: $1,500tn, 20% more than in 2007) .

Credit Default Swap (CDS): the seller agrees to compensate the buyer in the event of default; Mortgage Backed Securities (MBS): a claim on a payments made on a bundle of hundreds of mortgages; Collateral Debt Obligation (CDO) a claim on cash flows from a set of bonds or other assets that is divided into tranches so that the lower tranches absorb the losses first –with investor able to choose which tranche to invest in. A set of five pairs of socks – like a CDO – is a legitimate tactics by a sharp salesman to sell contracts of different value (there is always a pair of socks you would never wear….).

It was rather like watching two old men playing chess in the sun for a bet of $10, and then realizing that they are watched by a crowd of bankers who are taking bets on the result to the tune of millions of dollars.

Derivative also allowed a stream of expected future profits, which might or might not be realizes, to be capitalized into current values and show up in trading profits, so permitting large bonuses to be paid today out of uncertain future prospect. These trading, with the benefit of hindsight, were little more than zero sum activity generating little or no output.

By adopting accounting convention of valuing the new instrument at the latest observed price (marking to market) and including all changes in asset values as profits, optimism in the future, whether justified or not, created large recorded profits from the trading of these new securities. In effect, anticipated future profits were capitalized and turned into current profits.

Once markets realized that different banks had different risks of failure then the whole concept of single interbank borrowing rate (LIBOR) became meaningless. With few or no transactions taking place, it was difficult and at times impossible for banks to know what rate to quote. It matters because LIBOR is used as a reference rate in drawing up derivative contracts worth trillion dollars. The benchmark interest rate used in those contract had shallow foundations and in a storm it just blew away.

High frequency trading: trader have faster access to the exchange, the computer of such firm can watch the order flow and then send in their own orders microseconds ahead of other traders, so jumping the queue and getting to the market before the price turns against them.

The switch from a fixed rule, such as gold standard, to the use of unfettered discretion led to the failure to control inflation, culminating in the great inflation of the 1970’s. Attention turned to the idea of delegating monetary policy to independent central banks with a clear mandate to achieve price stability.

Monetary policy affects output and employment in the short-run and prices in the long run. There are lags in the adjustment of prices and wages to change in demand.

The method used to create money was to buy government bonds from the private sector in return for money. Those bond purchases were described as unconventional and known as quantitative easing (QE). But open market operations to exchange money for government securities have long been a traditional tool of central banks, and were used regularly in the UK during the 1980s.

The outbreak of the First World War saw the biggest financial crisis in Europe, at least until the events of 2008. Yet even after the assassination of Archduke Franz Ferdinand in Sarajevo on 28 June 1914, there was barely a ripple in the London markets.

Countries like Germany have become large creditors, with a trade surplus in 2015 approaching 8% of GDP, and countries in the southern periphery are substantial debtors. Although much of Germany’s trade surplus is with non-euro area countries, its exchange rate is held down by membership of the euro area, resulting in an unsustainable trade position.

The ECB would, Draghi said, ‘do whatever it takes to preserve the euro. And believe me, it will be enough’. It was clear that ECB would buy Spanish and Italian sovereign debt. 10 year bond yields started to fell. By end of 2014, ten-year yield in Greece had fallen from 25% to 8%. Spain from 6% to below 2%. By end of 2014, Spain was able to borrow more cheaply than the US. Draghi’s commitment had obviously done the trick.

The euro area must pursue one, or some combination of the following four ways forward:

  1. Continue with unemployment in the south until prices and wages have fallen enough to restore the loss of competitiveness.
  2. Create a period of high inflation in Germany, while restraining prices and wages in the south, to eliminate differences in competitiveness.
  3. Abandon the need to restore competitiveness within the euro area and accept the need for transfers from north to south to finance full employment in the periphery. Such tranfers can well exceed 5% of GDP.
  4. Accept a partial or total break up of the euro are


Some economist would like to return to the original idea of the monetary union – with a strict implementation of the no bail-out clause (which makes it illegal for one member to assume the debts of another) in the European Treaty. “Economically and politically, relaxing the no bail-out clause would open the door for a massive violation of the principle of no taxation without representation, creating a strong movement toward a transfer union without democratic legitimacy”.

Although the provisions of the European Treaty had the appearance of binding treaty commitments, in times of crisis the treaty was simply ignored or reinterpreted according to political needs of the moment.

Art 125: the no bail out clause which makes it illegal for one member to assume the debt of others.

Swiss dinars in Iraq: the value of the Swiss dinar had everything to do with politics and nothing to do with the economic policies of the government issuing the Swiss dinar, because no such government existed.

The tragedy of the monetary union in Europe is not that it might collapse but that, given the degree of political commitment among the leaders of Europe, it might continue, bringing economic stagnation to the largest currency bloc in the world and holding back recovery of the wider world economy.

The key to ending the alchemy is to ensure that the risks involved in money and banking are correctly identified and borne by those who enjoy the benefits from our financial system.

The toxic nexus between limited liability, deposit insurance and lender of last resort means that there is a massive implicit subsidy to risk-taking by banks.

Since the crisis, the minimum amount of equity a bank must use to finance itself – capital requirement – has been raised and banks must also hold a minimum level of liquid assets related to deposits (and other financing that could run from the bank within 30 days). Regulators also look at the shadow banking sector and conduct stress test. Countries such as UK and US have introduced legislation to separate, or ring-fence, basic banking operations from the more complex trading activities of investment banking. And most countries have introduced special bankruptcy arrangements (to protect depositors). Regulators have pursued cases of misconduct by bank employees and the banking system has changed a great deal:  Goldman Sachs balance sheet is 25% smaller in 2015 than in 2007. Many banks have turn to more traditional banking. Is all this enough? I fear not. More radical reforms are needed.

Since the bank bail outs in most advanced economies were huge, it is surprising that more has not been done since the crisis to address fundamental problem.

Irving Fisher : We could leave the banks free… to lend money as they please, provided we no longer allowed them to manufacture the money which they lend. In short nationalize money but do not nationalize the banks.

The prohibition on the creation of money by private banks is not likely to be sufficient to eliminate alchemy in our financial system.

It is time to replace the lender of last resort by the pawn broker for all seasons.  First ensure that all deposits are backed by either actual cash or a guaranteed contingent claim on reserves at the central banks. Second ensure the provision of liquidity insurance is mandatory and paid upfront. Third, design a system which imposes a tax on the degree of alchemy in our financial system – private financial intermediaries should bear the social cost of alchemy.


Keynes argued that when short term and long term interest rates had reached their respective lower bounds, further increases in the money supply would not lead to lower interest rates and higher spending. Once caught in this liquidity trap, the economy could persist in a depressed state indefinitely.

But the flaw with the great stability was that many people confused stability with sustainability. From the perspective of conventional macroeconomics, the situation looked sustainable. But the composition of demand was not, with disequilibrium resulting from China and Germany encouraging exports and trade surpluses. The consequence of those surpluses was significant lending to the rest of the world, with more savings invested in the world capital market. Long term interest rates started to fall (from 4% to 2% a year in 2008) and as a result asset prices (stocks, bonds, houses) rose (as future spending are discounted at a low long term rate). Household brought forward consumption and investment spending from the future to the present. GDP was evolving on a right path but the stability brought about was not sustainable: the demand was just unsustainably too high.

In 2014, Jaime Caruana, the General Manager of the Bank for International Settlements said ‘there is simply too much debt in the world today’. And Adair Turner, former chairman of Financial Service Authority, asserted that ‘ the most fundamental reason why the 2008 financial crisis has been followed by such a deep and long lasting recession is the growth of real economy leverage across advanced economies over the previous half-century’. Although such statements point to the great fragility resulting from high debt levels, debt was a consequence, not a cause of the problems that led to the crisis. Debt resulted from the need to finance higher value of stock of property. In turn, those higher values were a reflection of the lower level of long term real interest rates. The real causes of the rise of debt were the ‘saving glut’ and the response to it by western central banks that led to the fall of real interest rates.

Short term Keynesian stimulus boosts consumption, reduces saving, and encourages households to borrow more. But in the long term, US and UK need to shift away from domestic spending toward exports, to reduce trade deficit, to raise the rate of national saving and investment. The irony is that those countries most in need of the long term adjustment, the US and UK, have been most active in pursuing the short term stimulus.

By 2015, corporate debt defaults in the industrial and emerging markets economies were rising. Disruptive though a wave of defaults would be in the short run, it might enable a reboot of the economy so that it could grow in a more sustainable and balanced way. More difficult is external debt…Sovereign debts are likely to be a major headache for the world in years to come. Should these debt be forgiven? Greece encapsulates the problems. When debt was restructured in 2012, private sector creditors were bailed out. Most Greek debt is now owed to public sector institutions (ECB, IMF). There is little chance that Greece will be able to repay its debt (austerity in Greece cannot work because exchange rate cannot fall to stimulate trade).

In 1931, a crisis of the Austrian and German banking system led to the suspension of reparations. They were largely cancelled altogether at the Lausanne conference in 1932. In all Germany paid less than 21 billion marks (out of 132 billion original figure of the Reparations Commission), much of which was financed by overseas borrowing on which Germany subsequently defaulted. ‘ A debtor country can pay only when it has earned a surplus on its balance of trade, and …the attack on German exports by means of tariffs, quotas, boycotts etc. achieves the opposite result’ (Schaft, 1934)

One way of easy the financing problems of the periphery countries would be to postpone repayment of external debt to other member of the Euro area until the debtor country had achieved export surplus.

Debt forgiveness, inevitable though it may be, is not a sufficient answer to all our problems. In the short run, it could even have the perverse effect of slowing growth.

Resentment towards the conditions imposed by the IMF (or the US) in return for financial support has also led to the creation of new institutions in Asia, ranging from Chiang Mai Initiative, a network of bilateral swap arrangments between China, Japan, Korea and ASEAN, to the Chinese led Asian Infrastructure Investment Bank created in 2015.

Because the underlying disequilibrium has not been corrected, it is rational to be pessimistic about future demand. That is a significant deterrent to investment today. To solve this our approach must be twofold: to boost expected income through raising productivity and encourage relative prices, especially exchange rate, to move in a direction that support a more sustainable pattern of demand and production. The second element can be achieved through promotion of trade and restoration of floating exchange rates.

After the crisis, demand for Chinese exports fell away, and chines authority allowed credit to expand in order to boost construction spending. But before the crisis there was already excessive investment in commercial property. As a result, empty blocks of apartment and offices are a commonplace sight in new Chinese cities.

Chine now faces serious risks from its financial sector.  A policy of investing one half of its national income at low rates of return financed by debt is leading to an upward spiral of debt in relation to national income.

Germany will find that it is accumulating more and more claims on other countries, with the risk that those claims turn out to be little more than worthless paper. That is already true of some of the claims of the euro area as a whole on Greece.



Treasure Islands, Nicholas Shaxson, 2011

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More than half of the world trade passes, at least on paper, through tax havens. Over half of all banking assets and a third of FDI by multinational corporations are routed offshore. Some 85% of international banking and bond issuances takes place in the so-called Euromarket, a stateless offshore zone.  IMF estimated that in 2010 the balance sheet of small island financial centers added up to US$ 18 trillion, a third of world’s GDP.

A tax haven might offer a zero tax rate to non-residents but tax it own residents fully. This ring fencing between residents and non-residents is a tacit admission that what they do can be harmful.

Another way to spot a secrecy jurisdiction is to look for whether its financial services industry is very large compared to the local economy. The IMF uses this tool in 2007 to finger Britain as an offshore jurisdiction.

Transfer pricing : by artificially adjusting the price for internal transfer, multinationals can shift profits into a low-tax haven and costs into high-tax countries where they can be deducted against tax….Sometimes the prices of these transfers are adjusted so aggressively that they lose all sense of reality: a kilogram of toilet paper from China has been sold for US$4,121, a liter of apple juice has been sold out to Israel at US$2,052; ballpoint pens have left Trinidad values at US$8,500 each. Most example are far less blatant (unclear why unit price is high – transfer pricing works with product sold to offshore company at production price (to avoid taxes) and those product are resold to buying country at a price just lower the market price, so that profit in the selling country are small (and therefore not taxed much). The large difference between purchase and selling price is in the offshore country – not taxed).

Developing countries lose an estimated US$160 billion each year just to corporate trade mispricing of this kind.

The world contains about 60 secrecy jurisdictions, divide into 4 groups: Europeans, the British zone centered on the City of London, US influence zone and the fourth include some oddities (Somalia, Uruguay….)

In Europe, Switzerland, since at least the 18th century, sheltered the money of European elites. Netherland is a major tax haven. 20 times Dutch GDP ($18 trillion) flowed through Dutch offshore entities in 2008. Bono shifted his band’s financial empire to Netherland in 2006, to cut its tax bill.

Luxembourg is among the world biggest tax haven: North Korea Kim Jong Il has stashed some 4 billion dollars in Europe.  Luxembourg, South Korea Intelligence said in 2010, is a favoured destination for this money.

The second group, accounting for half of the world secrecy jurisdiction, is the most important and centred on the City of London. Jersey, Guernsey, Isle of Man, Cayman island, all substantially controlled by Britain, but also Hong Kong, Singapore; Dubai, Ireland, Vanuatu which are deeply connected to the City of London. This network account for almost half of the international bank assets.

The third group:  US is now, by some measures, the world’s single most important tax haven in its own rights, with a three tier system. At federal level: Tax exemptions, secrecy provisions, US banks may accepts proceeds from a range of crimes as long as the crimes are committed overseas. Individual US states offer a range of offshore lures: Florida, Wyoming, and Delaware with strong and unregulated corporate secrecy. And a network of islands such as Virgin Islands, Liberia, Marshall Islands (flag of convenience, managed by a private firm in Virginia, after a shipping registry was developed in 1986 with USAID support. Deep Water Horizon was registered in Marshall Islands. A small opaque tax haven grew alongside the shipping registry. Forming a Marshall Islands company can be done in a day for $650 and names of directors and shareholders are not mandatory in the registration process…),Panama, the biggest US influenced haven, a black hole that has become one of the filthiest money laundering sinks in the world.

Offshore finance has quietly been at the heart of the Neoconservative schemes to project US power around the globe.

The most important tax haven in the world in an island: the island of Manhattan. The second biggest is located on an island: London.

The difference between tax avoidance (legal but getting around the intent of elected legislature) and tax evasion (illegal) is the thickness of a prison wall.

US corporations paid about 2/5 of all US income taxes in the 1950’s; that share has fallen to 1/5. The top 0.1% of US taxpayers saw their effective tax rate fall from 60% in the 1960 to 33% in 2007. Billionaire Warren Buffet found that he was paying the lowest tax rate among his office staff, including the receptionist.  Overall taxes have not declined, the rich have been paying less and everybody else has had to take up the slack.

Russian dirty money favors Cyprus, Gibraltar, Nauru, all with strong British links. Much foreign investment in China goes via the British Virgin Islands.

A drug dealer may have money in a bank account in Panama. The account is under a trust set up in Bahamas. The trustees may live in Guernsey and the trust beneficiaries could be a Wyonming corporation with directors that are professional nominees who direct hundreds of similar companies. They have company lawyers, or trustees can be lawyers themselves, who are prevented by attorney-client privilege from giving out any details. Some trust may even have a flee clause: the moment an enquiry is detected, the structure flits to another secrecy jurisdiction and assets will automatically hop elsewhere.  Hong Kong is preparing legislation to allow incorporation and registration of new companies within minutes….

In 2005 Tax Justice Network estimated that wealthy individuals hold perhaps $11.5 trillion worth of wealth abroad. It is about ¼ of global wealth and equivalent to GNP of the US. This is $250 billion of taxes lost (2 or 3 times the size of the aid budget). And this is just individuals, not corporations…


Global Financial Integrity programme (Center for International Policy in Washington) calculated that $1.2 trillion in illicit financial flows in 2008 from developing countries. For every dollar of aid money, the west has taken back $10 of illicit money under the table.


Eurodad has a book called Global Development Finance: illicit flow report 2009 which  seeks to lay out every comprehensive official estimate of global illicit international financial flows: every page is blank.

The global offshore system helped generate the latest financial and economic crisis since 2007. 1 -By helping financial corporations to avoid regulation, offshore system helped them grow explosively, achieving “too big to fail” status and gaining the power to capture the political establishment in Washington and London. 2-As secrecy jurisdiction degraded their own financial regulations, they forced onshore jurisdiction to compete in a race towards ever laxer regulations. 3- huge illicit cross border flows (much of it unmeasured) have created massive net flows into deficit countries (US, UK) adding to the more visible macroeconomic imbalances that underpinned the crisis. 4- offshore incentives encouraged companies to borrow far too much. 5- As companies fragmented their financial affairs around the world’s tax haven, this created complexity which fed the mutual mistrust between market players that worsened the financial crisis.

Before WWI Britain did not tax profits made overseas. When war broke out, income taxes rose from 6% in 1914 to 30% in 1919 and Britain started to tax companies on their income worldwide.

The UN produced a draft model tax treaty in 1980 that was supposed to shift the balance back in favour of source countries and developing countries. The OECD intervened aggressively to stop this to ensure its own model treaty favoring rich country remained the preferred standard.  The rich country model has achieved a position of near-total dominance today. Not only is there double non-taxation, but plenty of tax that would in a fairer world be paid in poor countries is paid in rich country instead.

Trusts emerged in the middle ages when knights leaving for the crusades would leave their possessions in the hands of trusted stewards, who would look after them while they were away on the behalf of the knights’ wives and children. Trusts are secrets between lawyers and their clients. When a trust is set up the original owner of an asset in theory gives it away to a trust:  the trustee becomes the legal owner of the asset and must obey the terms of the trust deed. Even if the original owner dies, the trust remains and trustee is bound by law to follow its instructions. British upper classes feel comfortable separating themselves from their money and leaving it to be managed by trusted strangers (a cultural issue). Their education prepares them to recognize those would will respect their claims and whom they can trust.

Many of the structured investment vehicles that helped trigger the latest economic crisis were set up as offshore trusts, with several trillion dollars’ worth worldwide shrouded in deep secrecy.

A pervasive story exists that Switzerland put bank secrecy into place to protect German Jewish money from the Nazis. It is a myth. Amid the great depression (early 30s) workers called for more control over the banks. Bankers pressed fiercely for a new law to make it a crime to violate Swiss bank secrecy. The law was passed in 1934 making violation of bank secrecy a criminal offence. Swiss financial secrecy has existed for centuries. Catholic French kings valued Geneva’s bankers’ discretion highly – it would have been disastrous for it to be known they were borrowing from heretical Protestants.

‘It’s no use to pressuring the Swiss government, to get change, you must pressure the bank’, as demonstrated by the agreement between the US and UBS to share information on 4000 American account holders in 2010.

In 1929, culmination of a long period of deregulation and economic freedom, the richest 24,000 Americans received 630 times as much income on average as the poorest 6 million families, and the top 1% received nearly a quarter of all the income – a proportion slightly greater than the inequalities at the onset of the global crisis in 2007.

When bonds and shares are first issued, they flow into productive investment. This is generally healthy. Next a secondary market appears, where these shares and bonds are traded. These trades do not directly contribute to productive investment: they merely shuffle ownership. Well over 95% of purchases in global market today consist of this kind of secondary activity, rather than real investment. Shuffling ownership of bits of paper ought to help capital flow to those projects that offer the highest returns. A little speculative trading in these markets improve information and smooth prices. But when the volume of this dealing is a hundred times bigger than the underlying volume of trade, the result had proved to be a catastrophe.

From 1950 to 1973 annual growth rate amid widespread capital controls (and extremely high tax rates) average 4% in America and 4.6% in Europe. Per capita income in developing countries grew by a full 3% in the 60s and 70s, far faster than the rate since then. In the 80s, as capital controls were progressively relaxed around the world and tax rates fell and offshore system really began to flower, growth rates fell sharply. Countries that have grown most rapidly have been those that rely least on capital flow. Financial globalization has not generated increased investment or higher growth in emerging countries.

We msut be cautious about inferring too much from these facts, other reasons exists for high growth rates…but it shows that it is possible for countries to grow quickly while under capital control.

What has happening since the 1970s is financial liberalization on steroids: the offshore system has served as accelerator for flighty financial capital, bending capital flows so that they end up not where they find the most productive investment, but where they can find the greatest secrecy.

The Mont Pelerin society (1947, challenge to Keyne incubated in Switzerland –the world premier tax haven at the time): foundation of the global fightback against Keynes. “We must raise and train an army of fighters for freedom” Hayek. One attendee was Friedman, whose subsequent work inspired Thatcher and Reagan.

In 1957, the Pound Sterling still financed about 40% of world trade. With the empire crumbling and the pound sterling started to totter, this role was in great peril. Britain wanted to stop capital draining away by curbing bank’s overseas lending. The City objected and threatened to bankrupt the government. Curbing on lending would eventually apply to pound sterling loans by London merchant banks only. These bank – for which the international lending business was vital – simply shifted the international lending from pound to dollars. The Bank of England deemed that those transactions not to take place in the UK (as in foreign currency) and did not regulate those (as regulations would mean admission of responsibility, it was better not to regulate those markets!). While the Euromarket was undermining US control over the dollars, the US did nothing to stop its banks to work on the Euromarket. In the 1960, experts thought that the market would gradually disappear as soon as interest rates in the US would rise to European levels. In addition, the US banks wanted to keep this offshore system as quiet as possible – it was not a political issue before 1975…Eurodollars helped the US finance its deficits, fight foreign wars and throw its weight around. This was the birth of the Eurodollars and Euromarkets (which actually are not link to the Euro and exist in all main world currencies – not only dollars). Euromarkets are a booking exercise: banks would record onshore any transaction involving at least one British party, and would record of offshore operations where neither parties was British. Moscow Narodny Bank was the first on that market: Moscow was not comfortable keeping its dollars in New York in the middle of the Cold War and preferred to keep those dollars in London instead: a Marxist nation was nurturing the most unfettered capitalist system in history!  And as the sterling ship sank, the city was able to scramble aboard a much more seaworthy young vessel, the Eurodollar – the City transformed itself into an offshore island.  Before the 60s , countries were relatively well insulated against financial calamities that happen elsewhere, but the Euromarket connected up the world financial sectors and economies…as it grew, tides of hot money began to surge back and forth across the globe.

Starting with 200m in 1957, the euromarket kept booming. By 1970 it was measured at 46bn and by 1975 it was reckoned to have grown to exceed the size of the entire world’ foreign exchange. This market was the route through which the oil rich state surpluses (from the oil shocks) were routed to deficit plagued consumer countries. Market reached 500bn in1980, 2.6tn in 1988. By 1997, 90% of all international loans were made through this market. It is not anymore measured by the Bank of International Settlement…Every now and then government tried to tax this market – and failed. There are always technical details that allows the business to continue to flourish – it is considered a the most momentous financial innovation since the banknote, but it is very little researched.

In the Euromarket in London, the banks are not required to hold any reserve (it is unregulated, although most banks do have their own set of rules). Bank can create as much money as they want: the first $100 deposit will turn into a lending of $100, which turn into another deposit of $100 etc. etc. It never happened quite like that and there has been huge controversy about how much the Euromarket has really contributed to expanding the amount of money – since the Bank of International Settlement has stopped measuring it, we won’t know. With unlimited money creation, credit will expand into places where it was not previously able to, in more risky business. Euromarkets made it possible for credit quality to deteriorate out of sight of the regulators.

[ not a quote: In short an attempt to regulate the financial sector and control the flow of money lent to the rest of the world by London based banks led to the creation of the largest unregulated financial market (the euromarket) which contributed significantly to the financial crisis by allowing uncontrolled money creation and spread of the crisis to all financial sectors worldwide.]

The loan-back technique: mobster would move out money from the US in suitcases, put it in secret swiss account, the bank would loan back to the mobster in the US. The mobster can even deduct loan interest repayment from its taxable income…

The US Volcker commission probing the assets of dead Jews found an internal memo from a large Swiss bank that creaming off money from dead people’s account was the usual way to accumulate reserves. Not only this: in secrecy jurisdiction, depositors willingly accept below market interest rates, in exchange for secrecy. It is hardly a surprise that banks became so interested in offshore private banking.

Global Financial Integrity study (2010) between 1970 and 2008, illicit financial outflow from Africa were approximatively $854bn. Total illicit outflow may be as high as $1.8tn. Developing countries lost up to a trillion dollars in illicit outflows just in 2006 – that is 10 dollars for every dollar of aid flowing in.

Univerist of Massachussetts in 2008: real capital flight over 35 years in 40 african countries from 1970 to 2004 is about $420bn – $607bn with interest earnings. Yet the total external debt was only 227bn. Africa is a net creditor to the rest of the world and its assets vastly exceeds its debts. But these assets belong to a narrow elite, while public debt are born by the people.

The rise of the third world lending in the 70s and 80s laid the foundations for the global tax haven network that now shelter the most venal citizens. Some suggest that at least half of the money borrowed by the largest debtor countries flowed right out again under the table. Third world debt were match almost exactly by the stock of private wealth their elite had accumulated in the US (in 1990s). Loans to Russia to deal with nuclear safety in 1990’s all disappeared…For Mexico, Argentina, Venezuela, the value of their elites offshore wealth was several times their external debt. Today the top 1% of households in developing countries own an estimated 70-90% of all private financial and real estate wealth.

Wealthy foreign investors buy up distressed sovereign debt at pennies on the dollar – typically at a 90% discount – then reap vast profits when those debts are repaid in full. One trick is to make sure that influential locals are secretly part of the investor buying the discounted rate. They help make sure the debt gets repaid. Their involvement must be hidden behind the shield of offshore secrecy.

If we consider that $18tn flowed through the netherland in 2008, just one of the many conduit havens, it is not unreasonable to estimate to tens of even hundreds of bn dollars of tax revenue are at stake for developing countries.

In 2007, the two biggest sources of foreign investment in China were not japan or the US but Hong Kong and British Virgin islands. The biggest source for investment in India is not the US or Britain or China but Mauritius, a rising star in the offshore system. A wealthy indian will send his money to Mauritius, then disguised as foreign investment, is being returned to India. The sender can avoid Indian tax on local earnings, and also use the secrecy to build monopoly by disguising the fact that a diverse array of competitors in the market is in fact controlled by the same interest.

Delaware State, in the 80’s: Chase Manhattan and JP Morgan banks hired an expert to draft the tax law and help convince the state to adopt it. The law was drafted without any analyses of a Delaware official. The law was to remove interest rate ceiling (which were in place for 200 years, law against usury) on credit cards, on personal loans, car loans and more. Banks would have powers to foreclose on people’s homes if they faulted on credit card debts, they could establish places of business overseas or offshore, and they got a regressive state tax structure to boot. And crucially, this was to be rolled out across America. The fact that Delaware law could be enacted in other states is a sign of health competition…critics says this illustrates the ability of powerful private interests to pass laws with national ramifications by singling out and exploiting the weakest and most malleable states.

Because it is small, Delaware can take advantage of opportunities, they are small, they move fast and can fill the void. They can give bankers what they need faster than anyone else. Delaware’s legislature is for hire.

Credit card debt, money market funds and numerous other instruments that fueled the borrowing binge and the crisis – the deregulation of interest rates had effect that are incalculable and is seen as one the single most important cause of the 2007 crisis.

[Not a quote: in short, the removal of interest rate cap in Delaware, led banks to do better business there and the law to be exported to other states. This led to massive credit card debt ( e.g. consumers credit card debt and loans against homes to pay credit card bills) and creation of money market funds (which supplied banks with money) were key source of the 2007 crisis. ]

Delaware became a major player in the securitization industry – the business of parceling up mortgages and other loans, and repackaging the debt and selling them on. Delaware again simply established the exact legal framework that corporation desired.  The 1981 law contained a section exempting ‘affiliated finance companies’ from all state taxes. These company act like bank but are not formally banks so fall outside financial regulations. They are part of the global shadow banking system that dragged the world into economic crisis from 2007.

In 1988 the statutory trust act which provide protection of trust assets from creditors. This made Delaware the top jurisdiction for setting up so-called balance sheet CDOs (collateral debt obligations) which allowed banks to offload their assets onto other investors, another important contributor to the crisis.

Limited liability:  since the middle of 19th century: if a limited liability company goes bust, owners and shareholders may lose the money they invested, but their losses are limited to that: they are not liable for the additional debts the corporations has racked up. This was introduce to encourage people to invest. In exchange companies must have their account properly audited, and these audit published, to keep the risk manageable.

A partnership: responsibilities on losses and debt in full, lower taxes and accounts are private and undisclosed.

Jersey introduced the Limited Liability Partnership: the partnership allows less disclosure and the LL protection altogether. This is an example of having the cake and eating it. When debt are not covered, they end up being covered by the government, ultimately people’s taxes. With all audit company moving to LLP status (in UK, Aus, NZ…), it diluted auditor’s incentives to take care with their accounting. Had auditors personally faced getting into big trouble when they screwed up, they might not have been so hasty to sign off on all the off-balance sheet financing.

IMF 2010 report shows that funding flows related to Greece crisis from 15 main countries: barring France and Germany, all are major secrecy jurisdiction.

Banks achieved a staggering 16% annual return on equity between 1986 and 2006, and the banks are now big enough to hold us all to ransom. Unless taxpayers give them what they want, financial calamity ensues. This is the too big to fail problem- courtesy of offshore.

Remoteness between ownership and operation is an evil in the relations among men. (Keynes) This is the flaw in the grand bargain at the heart of the globalization project. [in relation to ownership that is transferred from owner to owner by finance institutions, with no link with the real operation in the economic world]

In 1998, the OCED new project was the first serious and sustained intellectual assault on the secrecy jurisdictions in world history.  The Coalition for Tax Competition, at the Cato Institute, was set up to counter the move.

A branch of economics known as public choice theory which rejects the notion that politicians act on the behalf of people and societies and instead look at them as self-interested individuals. James Buchanan and Vernon Smith, economists, studies this.

The rich have seen their wealth and income soar. They also shifted their income out of personal income tax category into corporation tax, to be taxed at far lower corporate tax rates.The richest 400 Americans in 1992 booked 26% of their income as salaries and 36% as capital gains. By 2007, they recorded 6% as salaries and 66% as capital gains. The same happened in all high-income categories and in all OECD countries since at least the 1970s. IN contrast, working population has seen its personal income taxes and social security contributions rise over the last 30 years.

Between 1990 and 2001, corporation tax revenues in low income countries fell by 25%. This is especially troubling because developing countries find it much easier to tax a few big corporations than millions of poor people.

IMF study in 2009 concluded that tax incentives, which are supposed to attract investors, slash tax revenues but do not promote growth.

In the golden age of 1947-1973 the US economy grew at nearly 4% a year, while top marginal tax rate was between 75 and 90%. Those tax rates did not cause that growth, nut high taxes didn’t choke it either.

It is inequality, rather than absolute level of poverty and wealth, that determines how society fare on almost every single indicator of well-being.

The low income countries that have been growing the fastest, like China, tend to be those that have exported capital, not imported it.

The best way for countries to share information is through the so-called automatic exchange of information, where they tell each other about their taxpayers’ financial affairs. This happens inside Europe and in a few other countries. But there is another way of sharing information, ‘on request’: a country will agree to hand over information but only on a case by case basis, only when specifically asked and only under very narrow conditions – the requested must be able to demonstrate why they need the information. In other word, the requester must already know, more or less, what it is [they are looking for]. No fishing expeditions are allowed.  You can’t prove criminality until you get the information, and you can’t get the information until you prove criminality.

The human factor of life of offshore: There is something about island life that stifles dissent and encourages the pervasive groupthink. ‘An enemy on an island is an enemy forever’ There is no blending into anonymous background, no neighboring society to shift toward. Islanders are required to watch their step, moment by moment. The ability to sustain an established consensus and suppress troublemakers makes islands especially hospitable to offshore finance. The local establishment can be trusted not to allow democratic politics to interfere in the business of making money [which in general benefit the islands but is to the detriment of the rest of the world]

In small jurisdictions – not necessarily islands- it is so easy for collective inferiority complexes to emerge, where residents come to see themselves as defenders of local interests against the predations of bigger, bullying neighbors.

In tiny states, everyone knows everyone else, and conflicts of interest and corruption are inevitable.

When Irish musician Bono, for years the world’s most prominent poverty campaigner, shift its financial affairs to Netherlands to avoid tax and is still warmly welcomed in society, the battle seems lost.

The shadow banking system: structured investment vehicles, asset-backed commercial paper conduits and other unregulated structures whose assets, by the time of the crisis in 2007, were greater than the entire $10tn US banking system, and which nearly brought the world economy to its knee.

In 1997, the Labour gave the Bank of England its operational independence, a gift of economic and political power to the City, the most radical shake up of the Bank in its 300-year history.

London has more foreign banks than any other financial center: by 2008 it accounted for half of all international trade in equities, 70% of Eurobond turnover, 35% of global currency trading and 55% of international public offerings. New York was bigger in areas like securisation, insurance, mergers and acquisitions and asset management, but much of its business is domestic, making London the world’s biggest international – and offshore – financial hub.

Richard Branson, who owns his business empire through a maze of offshore trusts and companies, said in 2002 that his company would be half its size if it had not legally avoided tax via offshore structures.

International Accounting Board Standard (IASB) sets the rules for how companies around the world publish their financial data. Over one hundred countries use these standards. Its rule let multinational corporations consolidate results in different countries into one single figure.  There is no way to unpick the numbers to work out profit in each country. Given that 60% of world trade happens inside multinational corporations, this is massive opacity.  The IASB is not a public rule-setting body, accountable to democratic parliaments; it is a private company registered in Delaware, financed by the big four accountancy firms and some of the world’s biggest corporations. This is an example of privatization of public policy making.

The City of London is the oldest continuous municipal democracy in the world, the Corporation boast. It dates from 1067 and is rooted in the ancient rights and privileges enjoyed by citizens before the Norman Conquest in 1066. It has remained a political fortress withstanding tides of history. Britain’s rulers have needed the City’s money and given the City what it wants in exchange.

The Bank of England, like other financial regulators, answers to Parliament, not to the Corporation, but its physical location at the centre of City reflects where its heart lies.

When the Government launched an inquiry in 2008 into the financial crisis, every single one of the team’s 21 members had background in financial services. It was hardly a surprise when the report recommended no real changes.

English libel laws are among the comforts for those with dirty money who come to London. There is no constitutional protection for free speech and the burden of proof is deposited squarely on the shoulder of the defendant, unlike nearly everywhere else. Libel litigation in England and Wales cost 140 times the European average. Many things in this book have been self-censored. Effective change in the law would significantly weaken Britain’s offshore empire.

In Britain, 0.3% of the population owns 2/3 of the land, in famously unequal Brazil, 1% of the population owns half of the land.

Until 1970’s offshore explosion, UK banks expanded their balance sheet cautiously, in line with spending in the economy, and combined they were worth half of the GDP. In the beginning of twenty-first century their balance sheets had grown to over 5 times of GDP.

Ancien regime in France fell in the 18th century because the richest country in Europe, which had exempted its nobles from taxation, could not pay its debt.

Recommendations: The veil of silence and ignorance can be lifted; blacklisting of havens; country by country accounting reporting for big corporations; automatic information sharing between countries; priorities the needs of developing countries; focus on improving tax systems in developing countries; confront the British spider web, the most aggressive single element in the global offshore system; new taxation approach based on the substance of what they do in the real world, rather than on the legal fictions its accountants have cooked up; Onshore tax reform with focus on land and land rental value which encourage the best use of land – and proof against offshore escape. Other focus should be on mineral rich countries with oil money sluicing into the offshore system, distorting the global economy; tax and regulate the financial industries according to an economy’s real needs – ignoring the threat of relocation offshore by companies; tackle the intermediaries and private users of offshore (e.g. pressure on banks, not only on governments); corporate responsibility – limited liabilities is a privilege for instance, corporations can be held to a set of obligations to the society (notably transparency). Offshore undermined this: privilege are still there but obligations have withered; Reevaluate corruption, it worsen poverty and inequalities. Parallels between bribery and the business of secrecy is no coincidence – we are talking about the same thing; change the culture: pundits, journalist, politician can not fawn over people who get rich by abusing the system. Professional associations of lawyers, accountants and bankers need to create code of conduct to prevent assisting financial crimes.

The Great Surge, Steven Radelet, 2015


The proportion of countries living in extreme poverty has fallen from 42% in 1993 to juts 17% in 2011. The opening of China accounts for a large share of the change, but  the fall also affects dozens of countries in every region of the world (sample of 109 developing countries with population greater than 1 million is considered)

People in developing countries have incomes today that are nearly double those of their parents 2 decades ago.

People born in developing countries live 1/3 longer than they did 20 years ago.

In 1980, only half of the girls enrolled and completed primary education. Today 4 out 5 are.

In 1983, 17 countries had democracies. By 2013 the number had tripled to 56.Violence decline sharply. Since 1980, incidence of civil war in developing countries has been cut by half. Battle deaths in war have fallen by more than 75%.

But there are still 1 billion people in extreme poverty and those just above $1.25 a day are hardly well off. Every year, 6 million children still die of preventable disease.

When the global food crisis struck in 2007, many predicted that poverty would rise sharply, but developing countries showed their resilience, and poverty continued to fall. The financial crisis of 2008 slowed the pace of progress but developing countries rebounded faster than rich countries.

Paul Theroux ‘I can testify that Africa is much worse off than when I first went there 50 years ago’. Evidence points to the contrary. Africa today is less poor, less sick, better educated, and better  governed. Dambisa Moyo charges that ‘evidence overwhelmingly demonstrates that Aid to Africa has made the poor poorer’. The facts are rather different: poverty is falling, incomes are growing, debt levels have plummeted, inflation is at its lowest in decades, investment is pouring in as never before and civil conflict has fallen.

Explaining development through the long term perspective: David Landes “The Wealth and Poverty of Nations”: Europe’ ascendancy had much to do with its culture, work ethic, attitudes toward science and religion, and social organization. Jared Diamond “Guns, Germ and Steel” found that Europe’s prosperity was largely the result of differences in geography, demography and ecology. Daron Acemoglu argues that the repressive institutions set up by European colonizers to extract resources through violence are central to understanding institutions in developing countries today. All these conclusion do not explain why so many developing countries began to turn at roughly the same time in the 1990s.

Explaining development through analysis at the micro level: Esther Duflo focuses at specific impact of actions and programmes in particular context. They help design programs and help understand why people make decisions but fail to explain why a country that was stagnating turns the corner.

Explaining development through the idea of “poverty traps”. Jeffrey Sacks, Paul Collier have refined the model. Sachs shows that developing countries are more prone to endemic disease. Collier argues that poor countries are more vulnerable to conflict and war. Bad governance keeps countries poor and poverty makes it harder to build the legal, government and political institutions necessary to improve governance. Most people in developing countries have been trapped in one way or another for much of the last several centuries. And that some escaped does not mean the traps are not real for those left behind.

Three major catalysts sparked the great surge. First, a geopolitical shift: the end of the cold war and the collapse of Soviet Union. Obstacles to development melted away. Second, globalization and new technologies provided new opportunities. Financial flows to developing countries now top $1 trillion a year, 12 times larger than in 1990. Third, the surge required the right skills and capabilities, in particular leadership to bring about institutional changes. Nelson Mandela, Cory Aquino, Oscar Arias (Costa Rica), Lech Walesa, and many others worked to build new and more inclusive political system. Civil Society gave greater voice to everyday citizens. As effective leadership began to emerge in some countries, it spread to others.

Foreign aid played a supporting role in bolstering development progress. The bulk of the evidence shows that on the whole aid has moderate positive impact on development progress. It had in particular strong effect on improving global health, mitigating impact of natural disasters and humanitarian crises, and helping jumpstart turnarounds from war in some countries. The bulk of the research shows a modest positive relationship between aid and economic growth.  Duke University Sarah Bermeo found that after 1992 foreign aid from democratic donors was associated with an increase in the likelihood of a democratic transition. Aid from non-democratic donors – such as china – did not have that effect.

Economic growth in the world’s leading economies will increasingly depend on growth and prosperity in developing countries. Development in developing countries is good for 3 reasons: it enhances global security; it is good for trade, business and global income growth; it helps spread shared values of openness, prosperity and freedom.

There is no guarantee that the surge that started 20 years ago will continue.

The $1.25 (in 2005 prices) is WB extreme poverty. It is not picked out of the air. It is roughly equal to the average of the national poverty lines in the poorest 15 countries in the world. WB PovcalNet database.

From 1.3bn of people living with less than a $1 dollar a day in 1993 to 600 million in 2011. Abject poverty dropped by more than half in just 18 years.

The decline of extreme poverty ranks as one of the most important achievements in global economic history, with far reaching economic, political and security implications.

The biggest force behind the decline in poverty is clear: China. 84% of the Chinese population was extremely poor in 1981. Deng Xiaoping began to introduce economic reform. In 2011, the number of extremely poor had dropped to 84 million, just 6% of the population.

Sub Saharan Africa is the only region were the total number of extremely poor is not yet falling, but the number essentially level off in 2002. The % went down from 59% in 1993 to 47% in 2011.

Developing countries started to invest in health, education, social safety nets to support the poor and strategies to support agriculture.

For the first time in human history there are more people living on more than $5 a day than on less than $1.25 a day.

In 1980, trade between developing countries accounted for less than 6% of the global total; by 2010 it accounted for more than 21%.

Economist often use 2% per capita growth as a standard because it is roughly equal to the average long term growth rate of the US and major economies and to the average world growth rate since 1960.

21coutries achieved a 2% per capita growth rate from 1977 to 1994. 71 did it from 1995 to 2013. The number more than tripled.

Not only are developing countries more important to the global economy, but it is clear that economic policy makers in developing countries are much more astute and skilled than their predecessors.

Investment and other financial flow peaked in 2007, fell rapidly in 2008 and 2009, but by 2010 they were back to their previous high. Trade was back to its peak within 2 years.

The idea of a turnaround just as a commodity boom is too simplistic.  Turnaround started in 1995, long before the current boom. In fact, late 1990s global commodity prices were falling.

There has been growth, more jobs and higher wages. Growth benefitted the poor: while growth is not the only driver for poverty reduction, there is no force more powerful for reducing extreme poverty than sustained economic growth. This relationship is not automatic and depends a lot on the policies and strategies that country pursue. Cases in which the poor do not benefit from growth are the exception, not the rule.

Public demand for conservation grows in tropical developing countries as they reach upper middle income status.

‘The haves and the Have-nots: a brief and idiosyncratic history of global inequality’ – Branko Milanovic.

It is true that within some countries inequality has gotten worse – such as China – but inequality has improved in others – such as in Brazil. For the majority of developing countries, inequality hasn’t changed much, even alongside the acceleration in growth.

Since so many poor countries have been growing so fast for the last decade, the income gap between rich and most poor countries has been shrinking.

Inequality across countries is not worsening: in 1994 the average income in the world’s richest countries was more than 8 times larger than the average in 109 developing countries, by 2011 the ratio has closed to around 6. Still a large gap, but also a big drop in 20 years.

Malaria mortality declined 47% between 2000 and 2013; AIDS related death reduced by 35% in 8 years to 2013; Tuberculosis death fell 33% in 10 years to 2013; Children death from diarrhea was reduced 7 times between 1990 and 2013 (from 5 millions to 760,000)

Polity IV Project with data on political regime characteristics and transitions, complementary to Freedom House focus on basic rights.

In 1405 Admiral Zheng commenced a 2 year journey to Vietnam, Indonesia, Sri Lanka and India. He had 317 ships and 27,000 men. The fleet included 62 enormous treasure chips which measured 120 meters long. The 4 ships of Vasco de Gama and 3 ships of Columbus could all fit on the deck of one treasure ship.  In 1424 the new emperor of china ended the expeditions and turned China inward (to focus at the defense against the Mongols and avoid the enrichment of merchant that would be hard to control).

Total trade share of GDP in developing countries jumped from 66% to 95% from 1990 to 2012: trade increased 50% faster than GDP. Financial flows are 12 times larger (1990 to today); FDI is up to 600billion a year, up from 26 billion in 1990.

International private capital flows to developing countries (investments, bond, lending) declined during the 1980s in real terms. They doubled from 91 billion in 1990 to 215 billion in 2000, then expanded more than fivefold to 1.1 billion in 2012. A 12 time increase since 1990.

The origins of the Asia economic miracle: it all began with the green revolution and the increases in agricultural productivity and nutrition that came with it.

The Center of Disease Control was originally founded in 1946 to fight malaria. It was located in Atlanta, in the midst of US’s major malarial zone.



The Future, Declassified. Mathew Burrows, 2014


mathew burrows

A member of the European Parliament went on to describe how Internet has ruined her life. Constituents were overly demanding and relentless; it had become a 24/7 world where longer term goals could no longer be worked on. It was clearly a trend. Everyone agreed that individual empowerment was the number one megatrend and the right starting for looking at the future. However, more and more voices sounded the alarm. Individual empowerment comes at a high risk. Ethnic affinity is a reality of life, but can be politicised and become a weapon for conflict. Populism that’s anti-market, anti-welfare, anti-government is on the rise. Growing fragmentation comes with individual empowerment.

Over the next couple of decades, a majority of the world’s population won’t be impoverished, and the middle class will be the most important social and economic sector – not in the West but in the vast majority of countries around the world.

2015 is the first time in three hundred years in which the number of Asian middle class consumer will equal the number in Europe and North America. China could become the largest single middle class market in 2010. But China might be overtaken by India in the following decade thanks to the country’s more rapid population growth and more even income distribution. Much of this global middle class will be lower middle class by Western standards. The top half of this new middle class – likely to be more in line with Western standards – will be substantial, rising from 350 millions in 2010 to 679 millions in 2030.

Poverty won’t disappear, and the fear of slipping back is likely to haunt many in the new middle class.

Today about 1 billion people are living in extreme poverty (less than $1.25 a day) and 1 billion are undernourished. The number of those living in extreme poverty has been stable for a long time, but the rate has been declining with population growth. Absent a global recension, the number of poor could drop by 50% by 2030 as incomes continue to rise in most part of the world but could still remain substantial – nearly 300 million in Africa alone.

Under any scenario, there will still be plenty of poor people: the problem may be harder to solve because many of these people are concentrated in countries with few inherent sources of economic opportunities.

AIDS appears to have hit its global peak – around 2.3 million deaths per year – in 2004.

The main symbol of the new middle class (in Brazil) has been the explosion in formal employment – workers with a formal employment contract rather than a cash-only arrangement. During the 2000s, formal job creation outpaced informal job growth by a 3 to 1 ratio. People were not only consuming but investing in their future. The growth rate in education was very high.

Slower economic growth in the West will ingrain the perception of a struggling middle class that faces greater competition from an increasingly global employment market, including competition for job requiring higher skills.

Some estimates (ADB) see middle class consumption in North America and Europe only rising by 0.6% a year over the next couple of decades. In contrast, spending by middle class Asian consumers could rise 9% a year through 2030.

Samuel Huntington has talked about the middle class that tends to be born revolutionary and become conservative by middle age. Middle classes are defenders of social and political order, but only if it serves their interest. In this day and age, that means the state must provide good public services. In Brazil, there was a growing resentment because the middle class did not see their taxes translated into better services, especially in health and education.

Senior UAE officials told us of their worries about satisfying growing expectations for democratic rights despite the high standard of living. They worry that western NGOs interested in advancing democratic and human rights could prey on this sense of public dissatisfaction with the lack of rights and increase the level of political discontent. They also see religious extremism as a symptom of growing dissatisfaction and link any outside effort to bolster democracy and human right groups as helping religious extremists.

China is slated to pass the threshold of US$15.000 per capita in the next five year or so. The US$15.000 per capita is often a trigger for democratisation, especially when coupled with high level of education and a mature age structure.

Democracy is a goal for many Chinese, including, oddly enough, some in the Communist party. The Party School has held conferences on democracy. It is not a matter of if, but when. The problem is that no one had an idea of how to undertake political reform without major disruption or disorder. Individuals will be ‘more important’ in determining the future. At the same time, the rising middle class is seen as a ‘destabilising factor’ in rich countries as well in developing countries .In China, new problems have been created, with growing demands and higher expectations of government.

The economics of globalisation have spread the West’ ideas of scientific reason, individualism, secular government, and primacy of law to societies seeking the west’s material progress. But many citizens in these states are reluctant to sacrifice their cultural identities. Religion is likely to be at the center of these ideological debates within and across societies. Islam especially has strengthened owing to global increases in democratisation and political freedoms that have allowed religious voices to be heard, and owing as well to advanced communications technologies and the failure of governments to deliver services that religious groups can provide. A 2013 Pew poll underlines the overlap between the strong belief in democracy and the desire by Muslim publics for religion to play a prominent role in politics. A large number of Muslims across the world say religious leaders should have influence over political matters.

Nationalism is another force that is intensifying particularly in regions where there are unresolved territorial disputes and countries’ fortunes may be rapidly changing. Pew’s research showed that beliefs in moral and cultural superiority are strongly held everywhere. This sentiment is particularly strong in developing countries. Fully 9 in 10 in Indonesia and South Korea and more than 8 in 10 in India are strong boosters of their own culture.

The move to the city is leading to increased expression of religious identity. Immigrants – mostly Muslims in Europe and Russia for example – are coalescing along religious lines. Urbanisation is driving demands for social services provided by religious organisations. Islamic and Christian activists have been effective in using this to bolster cohesion and leverage.

2012 European Union study on the global middle class showed that around four in every five people worldwide believe that democracy is the best available system of government.

From 2000 to 2012 BRICS grew on average by 6.2% a year. This won’t happen again as BRICS did not push ahead with structural reforms. The recession in the west affected the developing countries which still look the West as trade and investment partners.

There is no longer a country or a group of countries like the G7 that have the political and economic leverage to drive the international community toward collective actions. This adds up to global cooperation being difficult to forge in the best of times and breakdown becoming increasingly likely.

The BRICS are so diverse – some autocratic, other firmly democratic – and have so many competing interests that they are highly unlikely now or in the future to share a unified vision.

Doctor Watson is the IBM robot that beat two human champion to Jeopardy in 2011… To keep up with the state of the medical literature would take a human 180 hours a week according to one estimate – an impossible feat. However, it’s child’s play for a superendowed robot. Watson provides doctors recommendations for treatment based on its surveying of all the available literature and what is in the patient file.

The rapid growth of Asian and African minority in low fertility West Europe states risks increasing erosion of social cohesion and growing reactionary politics.

Soon a lot more things will be connected to the internet; some estimates place the current figure at over 15 billion internet connected objects – the Internet of Things-, everything from smartphone, PCs to sensors monitoring agriculture production, city functions, medical devices, forests and individual trees.

In general, the countries most vulnerable to food inflation will be import dependent poor countries, the primary line of defence to cope with rising food prices will be to expand existing subsidies on basic foodstuff. This is difficult proposition, especially as many of these countries are waging a battle against ballooning budgets.

The amount of land that was acquired between 2000 and 2010 equals an area eight times the size of UK.

The Fund for Peace’s failed state Index.

In late September 2013, millions in Dakar, Senegal, were left stranded without drinking water when a pipeline carrying water over 155 miles to the city residents burst. Their plight provides a taste of the possible scale of urban disruption if infrastructure is not kept in good repair.

The United States has more than enough natural gas for domestic needs for decades to come, and potentially substantial exports. With the new super fracking technologies, recovery rate could dramatically increase.

The IEA see renewables becoming the second largest source of electricity before 2015, approaching coal as primary source by 2035, but 2/3 of the increase in power generation from renewables [will be] in non-OECD countries…the increase in China will be more than that in the EU, US and Japan combined.

Butterfly Solar Farms in Botswana that had simple in-field assembly and panels with double efficiency of normal ones. It could be used for desalinisation systems, for crop drying, and to power freezers in slaughterhouse of dairy farms.

These good ideas (energy saving ideas) need some sort of government help. Poor countries won’t be able to manage it. They are not only coming from behind – not having adequate infrastructures to begin with – but they also face the greatest challenges going forward, including rapid population growth, deleterious climate change, and environmental devastation that hits food and water supplies. For them, without assistance, the future does look Malthusian.

Four game changers stand out for me: a China that can’t manage the next development leap, the growing possibility of war, possible runaway technology and a United States that can’t stay on top of an increasingly complex world.

The bigger question may be whether China wants to rewrite the current rules for how the international system operates. Although ambivalent and even resentful of the US-led international order, I don’t think Chinese leaders have a vision for a new international order. Along with other emerging powers, they are eager for a greater say in the running of the global institutions like the UN or the IMF.

Capital in the Twenty-First Century – Thomas Piketty (2014)




When the rate of return on capital exceeds the rate of growth of output and income, as it did in the nineteenth century and seems quite likely to do again in the twenty-first, capitalism automatically generates arbitrary and unsustainable inequalities that radically undermine the meritocratic values on which democratic societies are based.  There are nevertheless ways democracy can regain control over capitalism and ensure that the general interest take precedence over private interests…

Whenever one speaks about distribution of wealth, politics is never very far behind.

In 1798, Malthus, like his compatriots, was very afraid of new political ideas emanating from France, and to reassure himself that there would be no comparable upheaval in Great Britain he argued that all welfare assistance to the poor must be halted and that reproduction by the poor should be severely scrutinized. It is impossible to understand Malthus’s exaggeratedly somber predictions without recognizing the way fear gripped much of European elite in the 1790s.

Kuznets (1953) noted a sharp reduction in income inequality in the US between 1913 and 1948. In 1913, the upper decile of the income distribution (the top 10% of US earners) claimed 45-50% of annual national income. By 1948, the share had decrease to 30-35%. This was considerable and equivalent to the share of the poorest 50% of Americans. Inequality was shrinking. According to the “Kusnets curve” inequality can be expected to follow a “bell curve”. It should first increase and then decrease over the course of industrialization and economic development, as a larger and larger fraction of the population partakes of the fruits of economic growth. The data and the theory became a powerful political weapon in the context of the cold war: the intent of his optimistic predictions was quite simply to maintain the underdeveloped countries within “the orbit of the free world”.  The Kuznets’s curve theory was formulated in large part for the wrong reasons. The sharp reduction in inequality was due above all to the world wars and violent economic shocks they entailed. It had little to do with the tranquil process of intersectoral mobility described by Kuznets.

WTIP : world top income database

Just as income tax returns allow us to study changes in income inequality, estate tax returns enable us to study changes in the inequality of wealth.

First conclusion: one should be wary of any economic determinism in regard to equalities and wealth and income. The history of distribution of wealth has always been deeply political, and it cannot be reduced to purely economic mechanisms.  The reduction of inequality between 1910 and 1950 was due to wars and policies to deal with shocks. The resurgence of inequality after the 1980 was largely due to the political shifts in regard to taxation and finance.

Second conclusion: the dynamics of wealth distribution reveal powerful mechanisms pushing alternately toward convergence and divergence. Furthermore, there is no natural, spontaneous process to prevent destabilizing, inegalitarian forces from prevailing permanently.

The main forces for convergence are the diffusion of knowledge and investment in training and skills. The emergent economies are now in the process of catching up with the advanced ones by adopting modes of production of the rich countries and acquiring skills comparable to those found elsewhere.

The forces of divergence? First, top earners can quickly separate themselves from the rest by a wide margin. More importantly there is a set of forces of divergence associated with the process of accumulation and concentration of wealth when growth is weak and the return on capital high. This is the principal threat to an equal distribution of wealth over the long run.  It is not out of question that those two forces of divergence come together in the 21st century. This has already happen to some extent and may yet become a global phenomenon, which could lead to level of inequality never seen before. The top decile in the US claimed 45-50% of the national income in 1910-20; 30-35%  from the 1940s to 1970s and rapidly rose from 1980 to 45-50% in 2000s.  This spectacular increase in inequality reflects an unprecedented explosion of very elevated incomes from labor, a veritable separation of the top managers of large firms from the rest of the population. These top manager by and large have the power to set their own remuneration, sometimes without limits and in any case without any clear relation to their individual productivity.

In slow growing economies, past wealth naturally takes on disproportionate importance, because it takes only a small flow of new savings the stock of wealth steadily and substantially. When the rate of return on capital significantly exceeds the growth rate of the economy, then it logically follows that inherited wealth grows faster than output and income. It is almost inevitable that inherited wealth will dominate wealth amassed in a lifetime’s labor and the concentration of capital will attain extremely high levels potentially incompatible with principles of social justice. It is possible to imagine public institutions and policies that would counter the effects of this logic: for instance a progressive global tax on capital.

It was not until the coming of the 21st century that the wealthy countries regained the same level of stock market capitalization relative to GDP that Paris and London achieved in the early 1900s.

It has been the demographic growth of the New World that has ensured that inherited wealth has always played a smaller role in the US than in Europe. This explain why the structure of inequality has always been so peculiar.[ US went from 3M at the time of independence to 300M today, France went from 30 million to 60 million in the same period. US is not the same country anymore. France example is more typical and pertinent for understanding the future. ]

Many commentators continue to believe that ever more fully guaranteed property rights, ever freer markets and ever purer and more perfect competition are enough to ensure a just, prosperous and harmonious society. Unfortunately, the task is more complex.

Capital/Labor split: at historically low level in the 1950’s, the growth of capital share accelerated with the victories of Margaret Thatcher in England in 1979 and Ronald Reagan in the US in 1980, followed by financial globalization and deregulation in the 1990’s. By 2010, despite the crises in 2007-2008, capital was prospering has it had not done since 1913.

National income: subtract from GDP the depreciation of capital that made the production possible (10% of GDP in most country) and add the net income received from abroad. A country that own a large portion of the capital of other countries may enjoy a national income higher than its domestic product.

In most rich countries the residents own as much in foreign real estate and financial instruments as foreigners own of theirs. France is not owned by Californian pension funds of the Bank of China. US does not belong to Japanese of German investors. The reality is that inequality with respect to capital is a far greater domestic issue than it is an international one.

Public wealth in most developed countries in currently insignificant: private wealth accounts for nearly all wealth almost everywhere.

Since the 1980s many countries have more or less balanced net asset positions, but those positions are quite large in absolute terms. Many countries have large capital stakes in other countries and those other countries also have stakes in the country in question, and the two positions are more or less equal, so net foreign capital is close to zero. Net income from abroad is just slightly positive in Japan, France, US, Britain, with 1-2% of GDP. Japan and Germany, whose trade surpluses have enabled them to accumulate over the past decades substantial reserves, have a net income from abroad at 2-3% of GDP. All continental blocs are close to equilibrium but for Africa where income is roughly 5% less than the continent output ( and 10% in some countries): this means that some 20% of African capital is owned by foreigners.

In developed countries today, the capital/income ratio generally varies between 5 and 6, and the capital stock consist almost entirely of private capital.

The population of the planet is close to 7 billion in 2012, and global output is slightly greater than 70 trillion euros, so that global output per capita is 10,000 euros. If we subtract 10% for capital depreciation and divide by 12, this yield an average per capita monthly income of 760euro. If the output was equally distributed each individual would have an income of 760 euros per month.

Sub Saharan Africa, with a population of 900 million and annual output of 1.8 trillion (less than the French GDP if 2 trillion) result in a per capita output of 2000 euro/year, the poorest economic region. China has 8000 euro/year.

The world clearly seems to have entered a phase in which rich and poor countries are converging.

The fact that rich countries own part of the capital of poor countries can have a virtuous effect by promoting convergence. Wealthy country residents will obtain better return on their investment by investing abroad, the poor country will produce more and close the gap between them and the rich countries. However this mechanism does not guarantee convergence of per capita income.  Then after the wealthy countries have invested in their poorer neighbors, they may continue to own them indefinitely: poor countries must continue to pay to foreigners substantial share of what their citizens produce (as African countries have done for decades).

None of the Asian countries that have moved closer to the developed countries of the West in recent years has benefited from large foreign investments (Japan, South Korea, Taiwan, China).

Many studies show that gains from free trade come mainly from the diffusion of knowledge and from the productivity gains made necessary by open borders, not from static gains associated with specialization.

The poor catch up with the rich to the extent that they achieve the same level of technological know-how, skill and education, not by becoming the property of the wealthy.

Growth: illusions and realities

The 21st century may see a return to a low growth regime.

According to the best available estimates, global output grew to an average annual rate of 1.6% between 1700 and 2012, 0.8% of which reflects population growth, while another 0.8% came from growth in output per head.

According to the UN forecast, the demographic growth rate should fall to 0.4% by the 2030s and around 0.1% in 2070, a rate similar to the low growth regime before 1700 and far from the spectacular peak of 2% of the 1950-1990.


A 2% growth rate is equivalent to a cumulative generational growth (over 30 year) of 81%. After 100 year, the wealth is multiplied by 7.

A stagnant or, worse, decreasing population increases the influence of capital accumulated in previous generations. The same is true for economic stagnation. Inherited wealth will make a comeback. On the contrary growth can increase social mobility for individuals whose parents did not belong to the elite generation. This phenomenon not only decrease income inequality but also limit the reproduction of inequality of wealth.

The end of growth: the key point is that there is no historical example of a country at the world technological frontier whose growth in per capita output exceeded 1.5% over a lengthy period of time. A growth of 3-4% per year is illusory.

It was essentially inflation that allowed the wealthy countries to get rid of the public debt they owed at the end of World War II. Conversely, the wealth-based society that flourished in the 18th and 19th centuries was inextricably linked to the very stable monetary conditions that persisted over this very long period. Despite slight adjustments, the conversion rate between French and Britain currencies remained quite stable for two centuries (parities with gold and growth was slow so the amounts of money changed only very gradually over time). Until World War I money had meaning.

Today’s public debt is nowhere near the astronomical levels attained at the beginning of the 19th century, but it is at historical levels in France and some other countries and is probably the source of much confusion. Britain’s public debt attained extremely high levels, around 200% of GDP in only two occasion: after WWII and after the Napoleonic wars. While the French defaulted on 2/3 of its debt (in the 1800s) Britons who had the necessary means lent what the state demanded without appreciably reducing private investment: the debt was largely financed by increased private savings. It is quite clear that the very high level of public debt served the interest of the lenders- investing in government bond was good business for wealthy people. For over 100 years, British government did not repay the principal and only paid the annual interest due on the debt. The British budget was always in substantial primary surplus: tax exceeded expenditures by several % of GDP. It was only growth of GDP and income from 1815 to 1914 that ultimately allowed Britain to reduce its public debt (and never defaulted). After WWI, the inflation of the 1950s (4% a year) and of the 1970s (15% a year) help reduce the debt from 200% to a 50% of GDP ratio.

To simplify the total value of public debt increased over the long run to roughly 100% at the end of 20th century. This increase reflects the expansion of the economic role of the state, the development of ever more extensive public services (health, education) and infrastructures. The total value of public assets in France is 150% of national income.

In the 1980s started a wave of liberalization and deregulation. The memory of the Great Depression had faded. The stagflation of the 1970s demonstrated the limit of post war Keynesian consensus. With the end of the reconstruction and the Trente Glorieuse it was only natural to question the indefinitely expending role of the state and its increasing claims on national output. Privatisation, deregulation followed. Public wealth fell to very low levels and private wealth slowly returned to levels of the early 20th century. France totally transformed its national capital structure.

Capital in the US took some specific forms first because land was abundant and did not cost very much, second because of the existence of slavery and finally because of the [strong] demographic growth (accumulating smaller amount of capital).

In the 1850s, the low capital/income ratio in America (3 years of national income as opposed to 6-7 in Europe) signified in a very concrete way that the influence of landlords and accumulated wealth was less important in the New World. With a few years of work, the new arrival were able to close the initial wealth gap (more rapidly than in Europe).

The United States is more than 95% American owned and less than 5% foreign owned.

In 1770-1810, If one adds the market value of slaves to other component of wealth, the value of southern capital exceeds 6 years of southern states’ income, or nearly as much as the total value of capital in Britain and France. Conversely in the North, with no slaves, total wealth was quite small: 3 years of income (as much as in the south of Europe).

Note that the phenomenon of international cross-investments is much more prevalent in European countries (France, Britain, Germany) where financial assets held by other countries represent between ¼ and ½ of the total domestic financial assets (which is considerable), than in larger economies such as US or Japan (around 1/10). This increases the feeling of dispossession. People forget that while domestic companies and government debt are largely own by the rest of the world, residents hold equivalent assets abroad.

Return on capital, from the 18th to the 21st century oscillated around a central value of 4-5% a year whereas in the early 21st century only it seems to be approaching 3-4%.

Too much capital kills the return on capital: it is natural to expect that the marginal productivity of capital decreases as the stock of capital increases.

Numerous studies mention a significant increase in the share of national income in the rich countries going to profit and capital after the 1970s, along with a concomitant decrease in the share going to wages and labor (linked to new and useful things to do for capital, mobility of capital, competition between states to attract investment, opportunities to substitute capital to labor)

The only thing that appear relatively well established is that the tendency for the capital/income ratio to rise, as observed in rich country and might spread to other countries around the world if growth (especially demographic growth) slows in the 21st century, may well be accompanied by a durable increase in capital’s share of national income and a decrease in return on capital.

In 1900-1910 in France, Britain, Sweden, the richest 10% owned 90% of the nation’s wealth.The wealthiest 1% owned 50% of the wealth. In other words, there was no middle class. The emergence of a patrimonial middle class was an important, if fragile, historical innovation. To be sure, wealth is still extremely concentrated today: the upper 10% own 60% of Europe’s wealth (more than 70 in the US). And the poorer half of the population owns 5% of wealth (as in 1900-1910). Basically all the middle class managed to get its hands on few crumbs : scarcely 1/3 of Europe wealth and ¼ in the US. The rise of a propertied middle class was accompanied by a very sharp decrease of the wealth of the upper 1% (from 50% in Europe in 1910 to 20-25% in 2010).

Since 1980, income inequality has exploded in the US. The upper decile’s share increased from 30-35% in 1970s to 45-50% in 2000s. Early data from 2011-2012 suggest the increase is still continuing. Financial crisis as such cannot be counted on to put an end to the structural increase of inequality in the US.

The US : a record level of inequalities of income from labor (probably higher than in any other society at any time) together with a level of inequality of wealth less extreme than in Europe in 1900-1910. If both logic continue and combine their effects, the future could hold in store a new world of inequality more extreme than any that preceded it.

In practice the Gini coefficient varies from 0.2 to 0.4 in distribution of labor income in actual societies;  from 0.6 to 0.9 for distribution of capital ownership; from 0.3 to 0.5 for total income inequality. Scandinavia in the 70/80s of labor income was 0.19. Conversely, Belle époque Europe had a Gini Coefficient of 0.85, not for from absolute inequality. Coefficients, synthetic indices are inevitably misleading. It seems to me far better to analyze inequalities in terms of distribution tables indicating the shares of various deciles and centiles in total income and total wealth.

To sum up: the reduction of inequality in France during the twentieth century is largely explained by the fall of the rentier and the collapse of very high incomes from capital. No generalized process of inequality compression seems to have operated over the long run, contrary to the optimistic predictions of Kuznets’s theory.

There is no doubt that the increase inequality in the US contributed to the nation’s financial instability. One consequence of increasing inequality was the virtual stagnation of the purchasing power of the lower and middle classes, which made it more likely for modest household to take on debt. Banks, freed from regulation and eager to earn good yields on enormous savings injected into the system by the well-to-do, offered credit on increasingly generous terms.

It is important to note the considerable transfer of US national income (some 15%) from the poorest 90% to the richest 10% since 1980. This internal transfer between social groups is nearly 4 times larger than the impressive deficit the US ran in the 2000s (on the order of 4 point of national income). The trade deficit, which has its counterpart in China, Japan and Germany trade surpluses, is often describe as one of the key contributor to global imbalances that destabilized the US and global financial system. That is quite possible, but the internal imbalances are four times larger than the global imbalances. The place to look for solutions may be more within the US than in China or other countries.

The top thousandth in the US increased their share from 2% to 10% over the past decades. A share of 2% means people enjoy an income 20 times the average – 10% means people enjoy an income a 100 times the average. In France and Japan, the top thousandth share rose barely from 1.5% to 2.5% from 1980 to 2010. From a macroeconomic point of view, the explosion has thus far been of limited importance in continental Europe and japan. The rise is impressive but too few people have been affected to have had an impact as powerful as in the US where transfer of income to the 1% involve 10-15 points of national income.

In emerging and poor countries, tax data reveal much higher – and more realistic – top income levels than do household surveys. The highest incomes declared in household surveys are generally only 4-5 times higher than the average income.  The top centile share would be less than 5% of wealth. This is not very credible. Clearly household surveys, which are often the only source used by international organisations (WB) and government for gauging inequality, give a biased and misleading complacent view of the distribution of wealth.

Financial globalization seems to be increasing the correlation between the return on capital and the initial size of the investment portfolio, creating an inequality of returns that acts as an additional force for divergence in the global wealth distribution.

It is an illusion to think that something about the nature of modern growth or the laws of the market economy ensures that inequality of wealth will decrease and harmonious stability will be achieved.


According to Forbes, the planet boasted 140 billionaires in 1987  but counts more than 1,400 in 2013. They owned 0.4% of private wealth in 1987 and 1.5% in 2013 ($5.4 trillion). The average wealth of the group has increased from just over US$1.5bn in 1987  to US$15 bn in 2013n (6.4% a year, above inflation). For the sake of comparison; average global wealth per capita increased by 2.1% a year and world GDP by 3.3% (all after deduction of inflation). The amounts remain small but the rate of divergence is spectacular. If this continues, the share of these tiny groups (billionaires and 1/100 million fractile) could reach substantial levels by the end of 21st century. Only a progressive tax on capital can effectively impede such dynamic.

Approximate conclusions: Global inequality of wealth in the early 2010 appears to be comparable in magnitude to that observed in Europe in 1900-1910. The top thousandth seems to own nearly 20% of total global wealth, the top centile 50% and the top decile somewhere between 80 and 90%. The bottom half owns less than 5% of total global wealth. These estimates are highly uncertain.

The rate of inflation in the wealthy countries has been stable at around 2% since 1980. This is much lower than the peak inflation in the 20th century and much higher than the prevailing rate up to WWI.

Although the effect on inflation are complex, evidence suggests that the redistribution induced by inflation is mainly to the detriment of the least wealthy and to the benefit of the wealthiest.

Sovereign funds (imperfect estimates) from China; Hong Kong, Singapore, Dubai, Lybia, Iran, Azerbaijan etc. today own 1.5% of the world private wealth (same as the billionaires). The annual rent derived from exploitation of natural resources has been about 5% of GDP since 2000 (half of which is petroleum, the rest being gas, coal, minerals, wood…) compared with 2% in the 1990 and 1% in 1970s. If rate continue to increase – with the barril as high as $200 by 2020-2030, sovereign wealth funds could own 10-20% of global capital by 2030-40. No economic law rules this out but sooner or later this would trigger political reactions (restriction on purchase of real estate, industrial assets etc.). Petroleum rents might well enable the oil states to buy the rest of the planet (or much of it) and to live on the rents of their accumulated capital. China, India are different: they have a large populations whose needs remain far from satisfied.

In the future, the threat of gradual acquisition of rich countries by China seems less credible and dangerous than a process in which the rich countries would come to be owned by their own billionaires. The rich countries are not about to be taken over by the poor countries, which would have to get much richer and that would take many more decades.

Are the rich countries really poor? The net asset position of the rich countries relative to the rest of the world is in fact positive (rich countries own on average more than the poor countries) but is masked by the fact that the wealthiest residents of the rich countries are hiding some of their assets in tax havens (which can account for up to 10% of GDP, or 2-3 times more according to NGOs). [If one adds up financial statistics, poor and rich countries have a negative position : it seems that Earth must be owned by Mars]

The inequality r>g (return on capital>growth of income) implies that wealth accumulated in the past grows more rapidly than output and wages. This inequality expresses a fundamental logical contradiction. The entrepreneur inevitably tend to become a rentier, more and more dominant over those who own nothing but their labor. Once constituted, capital reproduce itself faster than output increases. The past devours the future. The long term consequences are potentially terrifying, especially when one adds that the return on capital varies directly with the size of the initial stake (the higher the stake, the higher the return) and that divergence are occurring on a global scale.

There is ample reason to believe that growth rate will not exceed 1-1.5% in the long run. Growth can be encourage by investing in education, knowledge and nonpolluting technology. But none of these will raise the growth rate to 4-5%. With a average return on capital at 4-5%, it is therefore likely that r>g will again be the norm for the 21st century, as it was until WWI. It took two world wars to reduce the return on capital, thereby creating the illusion that the structural contradiction of capitalism had been overcome.

If we are to regain control of capitalism, we must bet on democracy – and in Europe, democracy on the European scale. In small countries of Europe which will soon look very small indeed in relation to the global economy, national withdrawal can only lead to even worse frustration and disappointment than currently exist with the European Union. Nation state is the right level to modernize social and fiscal policies but only regional political integration can lead to effective regulation of the globalized pratimonial capitalism of the 21st century.