SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PRODUCTION - The Nobel Peace Prize for 2012 - Dilemma of the Indian Central Bank - Obama Reelected: Good or Bad? You decide.
The Fortnight In Brief (30th October to 12th November) US: Improved Economic Data Amidst Obamas Re-election With President Barack Obama winning the second term on 6 Nov, the focus now has shifted to the imminent fiscal cliff. The Democrats increased their majority in the senate while the Republicans retained their control of the house of representatives. The election came with a backdrop of improved economic data, with the ISM manufacturing index increasing from 51.5 in September to 51.7 in October and the private sector adding 163,000 jobs in October. The report on job creation was above expectations, with gains becoming more broad-based, indicating a labour market in healing mode. Asia Pacific ex-Japan: Upbeat Economic Data to Welcome Chinas New Leadership Currencies throughout Asia rose with Barack Obamas reelection, with the Taiwan dollar advancing 0.5% and the Thailand baht, South Koreas won and Philippines peso all gaining 0.3%. The rise indicates the view that Obama is likely to continue increasing dollar supply which can be invested in Asia. Meanwhile in China, exports in October grew its fastest since May, with overseas shipments increasing 11.6% compared to a 10% estimate. Retail sales, a measure of consumption spending saw a 14.5% rise, up 0.3% from September. This points to a potential rebound of the China economy and the avoidance of a hard landing. The upbeat economic data comes at a time where China transits to a new leadership. EU: Healthcare Reform Test for New Dutch Government The recently sworn in dutch coalition government is showing strains as healthcare reform drives a wedge between the liberal and labour parties. Mark Rutte, the liberal prime minister, negotiated a coalition agreement with the labour party which will introduce progressive insurance premiums. This has riled many of his party members and supporters alike, driving some to call him "Marx Rutte". An income tax cut at the top end from 52% to 49% is expected to compensate the higher income group but the cap on premiums means that top income earners come out ahead while the upper middle class gets squeezed. Prime Minister Rutte seeks to clear up this fiasco and renegotiate a deal with labour, but the staunch labour party is unlikely to budge on the agreement. This untimely setback could throw a monkey wrench to the plans to initiate tough reforms amidst the European debt crisis.

ISSUE 28 12 NOVEMBER 2012

IN COLLABORATION WITH

PROUDLY SUPPORTED BY

The Nobel Peace Prize for 2012

By Henry Chan, Singapore Management University
The Norwegian Nobel Committee has decided that the Nobel Peace Prize for 2012 is to be awarded to the European Union (EU). The union and its forerunners have, for over six decades, contributed to the advancement of peace and reconciliation, democracy and human rights in Europe. In the inter-war years, the Norwegian Nobel Committee made several awards to persons who were seeking reconciliation between Germany and France. Since 1945, that reconciliation has become a reality. The dreadful suffering in World War II demonstrated the need for a new Europe. Over a seventy-year period, Germany and France has fought three wars. Today, war between Germany and France is unthinkable. This shows how, through well-aimed efforts and by building up mutual confidence, historical enemies can become close partners. In the 1980s, Greece, Spain and Portugal joined the EU. The introduction of democracy was a condition for their membership. The fall of the Berlin Wall made EU membership possible for several Central and Eastern European countries, thereby opening a new era in European history. The division between East and West has, to a large extent, been brought to an end; democracy has been strengthened; many ethnically-based national conflicts have been settled. The admission of Croatia as a member next year, the opening of membership negotiations with Montenegro, and the granting of candidate status to Serbia all strengthen the process of reconciliation in the Balkans. In the past decade, the possibility of EU membership for Turkey has also advanced democracy and human rights in that country. The EU is currently undergoing grave economic difficulties and considerable social unrest. The Norwegian Nobel Committee wishes to focus on what it sees as the EU's most important result: the successful struggle for peace and reconciliation and for democracy and human rights. The stabilizing part played by the EU has helped to transform most of Europe from a continent of war to a continent of peace. The work of the EU represents "fraternity between nations", and amounts to a form of the "peace congresses" to which Alfred Nobel refers as criteria for the Peace Prize in his 1895 will. Oslo, 12 October 2012

The passage above is the press release of the Norwegian Nobel Committee on the award of the 2012 Nobel Peace Prize to the EU. It comes at a most surprising moment when the EU's very existence has been called into question following the four year old debt crisis. The Peace Prize was not awarded during the EUs heyday the time when many people thought it was a viable alternative to US in world leadership during the post-cold war era and when the euro was shaping up to be a feasible substitute to the US dollar as the dominant world reserve currency. Instead, it is given at the lowest ebb of EU in its history. Nobel committee's intention is clearly to remind EU citizens that the union's most important aim is to transform Europe from a continent of war to a continent of peace, and EU's success should not be measured based on simple economic terms of dollars and cents alone. Taking the peace dividend into account, Europe today remains a success and the EU is still a viable institution. Probably not everyone will buy the line of reasoning of the Nobel committee, however, the prize has greatly strengthened the emotional resolve of many pan Europe believers. The peace prize has the potential to influence future projects the EU and its leaders must undertake to implement the decisions of the June 29 EU summit on integrated financial framework, integrated budgetary framework1, integrated economic framework and enhanced pan European political institution legitimacy. German Chancellor Merkel already declared that the prize would inspire her to press ahead with closer integration.

2 Copyright 2012 SMU Economics Intelligence Club

Euphoria generated in the expansion of EU and birth of the euro in the early part of last decade were the reasons behind the sudden disappearance of financial and fiscal prudence in that era. The imprudence deepened the pre-existing structural defects of the EU peripheral countries currently embroiled in the crisis. The financial collapse of 2008 exposed the deep structural problems of those countries and brought the uncontrollable debt spiral forward in 2009. The unexpected 2008 crisis divided the EU into rich North and poor South. The North blames the South for not living up to the budget cut commitments while the South blames the North for acting imperialistically and imposing unreasonable hardship on its poor Southern cousins. However, setting aside politically weak leadership in Greece, which had spent three years from 2009 to early 2012 in essential inaction and just started to embark on serious structural reform lately, other EU countries such as Ireland and Portugal have made reasonable progress to achieve meaningful recovery going forward. Although many observers have questioned the progress the EU has made in the past 4 years to resolve its crisis, an objective assessment will show that there was indeed some sort of progress. The Southern European debt crisis is a classic current account deficit2 problem. A look at the graph below prepared by Deutsche Bank shows that dramatic progress was achieved in the last 2 years and the Southern European countries can return to a sustainable current account situation in two years, if proper support is given to them. In the absence of the typical IMF massive devaluation3 type of current account adjustment, the EU peripheral countries have adjusted their current account much faster than conventional wisdom dictates. Figure 1: Current Account Balances in Peripheral Countries

The market has raised the bar for the euro and EU to survive as the fierce attack on the euro and European Banks in the second half of 2011 and first half of 2012 have shown. The stability of the European financial market and euro in the second half of 2012 is a testament that the EU has slowly convinced the market that it still stands a chance to succeed. The EU had proceeded on the path of a Banking Union and definite progress on integrated budgetary framework and economic policy framework were made. The EU North has demonstrated a new found understanding of the dilemma of the South by extending Greek budgetary compliance and allowing the ECB to help Spain work out its funding problem on its own time frame. The Nobel Peace Prize is indeed a timely reminder to the EU citizens that the fundamental aim of the union is not just in economic terms, it is also meant to build a peaceful Europe. To do so, citizens must sacrifice for it. The implicit message that the peace dividend should be counted as part of the restructuring cost will be very helpful to get the political leadership moving in the right direction. The EU as a whole still runs a current account surplus and the total member state countries debt to GDP ratio is comparatively better than many of its peers. The markets fear of a euro zone breakup was incited more by the failure of the EUs political leadership than its economic fundamentals. If a deeper fiscal and political union can be put in place, not only will Europe consolidate itself as a zone of peace

3 Copyright 2012 SMU Economics Intelligence Club

and prosperity, its pioneering experimental geopolitical institution will be inspiring to the world. EU is the only successful transnational setup in which members are willing to subordinate national sovereignty to such a degree for the common goal. In a world embroiled in many transnational negative externalities, such as Global Warming, the EU provides a good working model. Let us hope the emotional call of the Nobel committee will work and in ten years from now, we can all agree, on hindsight, that it has made the right decision to award the 2012 Nobel Peace Prize to EU.

1A

system where budget policies are collectively agreed upon by the nations involved.

2 When

the exports of goods and services are lesser than imports, making the entity a net debtor to the rest of the world.
3

A reduction in the currency value with respect to goods and services the currency can buy.

4 Copyright 2012 SMU Economics Intelligence Club

Dilemma of the Indian Central Bank

By Marodia Anshuman, Singapore Management University
In the Jim ONeills latest book, The Growth Map, he suggested that the BRICs1, which are undergoing rapid growth, need to be extremely careful with the use of monetary policy. One of the major issues addressed was the conflict between high investment and high inflation. Jim ONeill explains that good domestic monetary policy should be one that suppresses inflation, even if it means restricting investments in an economy. India, in particular, is facing such a dilemma. A brief overview of the last 6 months in India In 2007, Economists predicted that even if the entire nation goes off to sleep, India would still grow at an 8% rate. The growth rate of India dipped to 5.3% in the first quarter of FY2012, a big shock for the economy. Adding to this problem is the issue of inflation (7.5%) and low rainfall (22% below the Long Period Average) which further compounds the problem. After the results of the first quarter were released, the Central Bank was expected to lower the interest rate. Yet, they held fast against such expectations and stated that their priority was to keep inflation in check. In the second quarter of FY2012, the growth rate increased by 0.2% to 5.5%, while the inflation rate dropped to 6.9%. While the growth rate was still well below par for a growing economy such as India, the inflation rate drop was a positive sign. Figure 1: Historical Inflation and GDP growth rates
18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% GDP Growth Inflation

Source: WorldBank

With the reduction in inflation, there is added pressure on the Central Bank2 to reduce the interest rates which are expected to boost investments and increase the growth rate of the economy. But monetary expansion is not without costs and it brings the likelihood of going back to a high inflation period (as shown in Figure 1), a frightening phenomenon the Central Bank is extremely wary of. Inflation, growth and interest rates When the interest rate is lowered, the cost of borrowing reduces. Big companies grasp this opportunity to expand at a low cost and implement more projects which in turn generate revenue for the economy and pushes up the GDP. In the face of lower rates, consumers will attempt to smooth out their consumption3 and start borrowing from banks. This leads to greater aggregate demand in the economy. When aggregate demand increases and supply does not increase by the same quantity, there is a rise in the overall price level of the economy due to the forces of demand and supply. This is known as demand-pull inflation.

5 Copyright 2012 SMU Economics Intelligence Club

Investors and Businessmen India is a nation whose strength lies in its companies. The growth of these companies is reflected in the growth of the GDP. The sluggish growth in recent years has primed risk-averse investors to think twice before making investments. Investors and businessmen are pressurizing the Central Bank to reduce the interest rate to give the economy a boost. However, the Central Bank argues that interest rates do not explain the slump in investment. Central Bankers go on to insist that it is possible that a low interest rate might not improve the growth rate. In fact, low interest rates might cause a rise in the inflation rate. Politics The Congress-led coalition4 has been surrounded with controversies. With elections coming up in 2014, there is a need for them to do something that favors the wider public and gain votes. While the Bharatiya Janta Party (BJP) was in power, there was tremendous growth but inflation was high. Usually, growth due to monetary policy is immediately visible while inflation takes time to kick in. To gain popularity, the Congress might resort to the same strategy of growing but inflating. In fact, the new Finance Minister has already cut consumer loan rates in State-owned banks to boost demand, marking the start of the adoption of a looser monetary policy. A dilemma that cannot be easily solved At the end of the first quarter of FY2012, when the Central Bank did not slash the bank rate and international economists praised it as the best Central Bank in the world. Things are different now the Finance Minister has changed, the inflation has lowered, and after two consecutive bad performances in terms of quarterly growth, there is a lot of economic tension. With the global markets in such a sluggish state, lowering interest rates comes across as an even more viable option. However, lowering interest rates can easily increase demand and lead to demand-pull inflation. As mentioned by Jim ONeill, the BRICs should prioritize keeping inflation in check before resolving other issues. The question here becomes whether the inflation in India is already in check. And regarding this, Central Bankers think it is not. However, because of the low rainfall this year, food prices are still expected to rise. Usually, there is a lot of public outcry due to a hike in prices. But because there is such a great deal of political turmoil in the country, inflation is being overlooked by the masses. This too can be a disadvantage for the Central Banks resolve to not cut rates. After all, when there are 1.2 billion people against you, it is hard to say no!
1 The

BRICS consist of Brazil, Russia, India, China and South Africa. These nations are characterized by their high growth rates. However, they are very different culturally, socially, and politically.
2 The

Central Bank of India is also called the Reserve Bank of India (RBI). It is a separate entity from the government and can make decisions independently.
3Smoothing

out consumption refers to the consumption of goods and services equally along the lifetime of a consumer.
4The

Congress-led coalition is headed by Dr. Manmohan Singh. It is his second continuous term. There have been a lot of issues this term especially because of high levels of corruption and anti-corruption movements against the government. Sources: The Growth Map, Economist, IndiaTimes, WorldBank

6 Copyright 2012 SMU Economics Intelligence Club

Obama Reelected: Good or Bad? You decide.

By Gabriel Tan, Boston University
Whenever a political head changes, it is difficult to predict how his/her position will affect the economy. President Obama has recently released his detailed economic plans for his second term. A lot of the information can be found by wading through the white houses public blue print. This article aims to present to you the major policies President Obama is going to be spearheading and a succinct economic analysis of each policy. It is virtually impossible to assign numerical figures to each policy because of the lack of detailed information in each plan (such as how much tax cuts will affect the federal deficit). Hence the title of the article; it is up to the reader to draw his or her own conclusion about not only each individual policy, but the net effect all of them have when working in tandem. Let us now look at each major group of policies. Individual Taxes A lot of the presidential campaign revolved around the issue of taxes. Obama wants to enact the Buffett Rule, whereby all individuals who make over US$ 1 million will have to pay an income tax rate of at least 30%. Currently the highest income tax bracket stands at 35%, however, many of the wealthiest people in America are able to reduce their realized tax to less than 30% through accounting and legal loopholes. The reduction of such loopholes is of specific concern to the President. The second major change relates to middle-income families. Although Obama is determined in making the Bush-era tax cuts for middle income families permanent and signaling his intention to lower the corporate income tax rate from the current 35%, he failed to specify an exact figure. The third and final major tax change will be the ending of tax breaks for single individuals who earn more than US$200,000 per year and for married couples making more than US$250,000 per year. Whenever we consider taxes we should be thinking about two main things: labor force implications and the federal budget. Firstly, the effect of tax rates are essentially reductions in a workers realized wage. From labor economics, one would know a change in the wage rate would have an ambiguous effect on a workers hours worked and income levels. If we consider the tax increase on the wealthy, economic theory would presume that the wealthy (at least those who are wealthy through work and not inheritance) value income quite highly with respect to leisure. Hence, we can presume the income effect of a reduction in wage would outweigh the substitution effect of leisure becoming cheaper (an hour of work and hour of leisure can be thought of as substitutes). If this is the case, then we should expect the wealthy to work more and increase economic productivity. Secondly, if wealthy workers are now working more to achieve the same level of wealth prior to tax increases, the government should be collecting more in income taxes. These tax cuts, under these very specific assumptions, should reduce the national deficit while increasing GDP. The same analysis can be applied to middle income families, but it is less clear what assumptions are to be made about middle income individuals preferences of leisure and income. This is one of the many points where the reader must decide if tax cuts will increase productivity more than the decrease in tax revenues. Domestic Job Creation Obamas main tools in driving job creation and industry expansion domestically are tax credits. Firstly, Obama wants to enact a tax credit for firms who move their manufacturing capabilities back to the US. This tax credit will effectively help firms write off 20% of its costs of moving. Secondly, Obama is considering increasing the current tax rate deduction for firms that manufacture domestically. Finally, Obama wishes to instate US$15 billion worth of tax credits to spur manufacturing growth and domestic clean energy investments. The main goal behind tax credits is an incentive system that encourages free markets to behave in a certain manner. In this case, Obama is hoping the tax credits will draw jobs back to the US and make investing in the US more affordable. The increase in employment and GDP through investments domestically will hopefully drive economic expansion and this expansion would pull in more taxable revenue as compared to the initial deficit that is a result of increasing tax credits.

7 Copyright 2012 SMU Economics Intelligence Club

Others Notable Policies Obama plans to crack down harder on trade laws as many countries are currently not playing by the rules. He plans to create a task force to investigate illegal international trading practices. The extent to which this will help the US economically is uncertain. The President also plans on increasing spending on American infrastructure to keep up with the rest of the worlds progression. This is an interesting topic to follow because a countrys infrastructure investments can dictate the future of a countrys economy. The right investments must be made to advance the country and it is important to distinguish between excessive and forward thinking. The funding for these projects will be sourced from savings from ending the wars. Finally, under Obama, the Small Business Administration launched Startup America. This organization helps inject capital into small startups that have large growth potential. In line with this, Obama wants to remove certain red tape from the IPO process making it easier for small firms to go public. Conclusion In no way is this article meant to be a complete review of all of President Obamas initiatives and plans. This was a summary of, in my opinion, the key decisions Obama has made that will have large impacts on the US and the world economies. To end this article with some closure, I will give my personal opinion on Obamas presence and its effect on economic recovery. I believe that were seeing strong resilience in corporate America and the business side of the country is fundamentally strong. What I see as being the major causes of economic dampening in this country are Europes uncertainty, a fear of equity and unemployment. Obama can do little to affect the European situation but he has the power to boost equity markets through strong economic performance. I believe his tax hikes for the wealthy will net out positive for the country and I do believe the tax cuts on middle income families will spur increase in productivity and spending. I am less sure of his employment generation methods. I do not believe that encouraging domestic employment in the manufacturing industry is the best move. Free market movements have favored overseas manufacturing because of lower cost. I doubt tax credits will be able to change this. Instead, I believe R&D in new and developing industries can drive strong employment. New industries and technological expansion are in my opinion the things the Obama administration should be nurturing. These will bring about permanent job increases because they are fundamentally needed instead of trying to limit free market movements through tax credits. All in all, I believe Obamas second term will bring about economic recovery but as with any politician, there is much red tape and bureaucracy the President will have to face and only time will tell if the legislators of the US will work together for the betterment of the country. Exemptions, deductions, subsidies and other incentives the government has in place to assist tax-payers tax liabilities. The US governments proposed budget for the coming fiscal year. Known as Initial Public Offering, the process where a company usually issues stocks, bonds to the general investing public. In the context of law and morality, equity refers to the state of things being fair to all parties involved. Sources: White House Blue Print, An America Built to Last, 24th January 2012, Relevant news sources

8 Copyright 2012 SMU Economics Intelligence Club

The S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large- cap common stocks actively traded in the United States. It has been widely regarded as a gauge for the large cap US equities market The MSCI Asia ex Japan Index is a free float-adjusted market capitalization index consisting of 10 developed and emerging market country indices: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, and Thailand. The STOXX Europe 600 Index is regarded as a benchmark for European equity markets. It represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

Correspondents Ben Lim (Vice President, Publication) ben.lim.2010@smu.edu.sg Singapore Management University Singapore Tan Jia Ming (Publications Director) jiaming.tan.2010@smu.edu.sg Singapore Management University Singapore Vera Soh (Liaison Officer) Vera.soh.2011@economics.smu.edu.sg Singapore Management University Singapore Seumas Yeo (Editor) Seumas.yeo.2010@smu.edu.sg Singapore Management University Singapore Marodia Anshuman anshumanm.2011@economics.smu.edu.sg Singapore Management University Singapore Herman Cheong (Vice President, Operations) Wq.cheong.2011@economics.smu.edu.sg Singapore Management University Singapore Fariha Imran (Marketing Director) Farihaimran.2010@economics.smu.edu.sg Singapore Management University Singapore Randy Lai (Editor) Tw.lai.2010@smu.edu.sg Singapore Management University Singapore Henry Chan henry.chan.2012@phdgm.smu.edu.sg Singapore Management University Singapore Gabriel Tan gtan@bu.edu Boston University United States of America

Everything in this document and/or in this website is copyrighted by law and cannot be used without the written permission of its owner/publisher. It is forbidden to make digital copies or reproductions, however you may however use the information as reference material and it may be physically printed for personal use. You may also quote parts of the content of this publication, digitally or physically, if the source and author is clearly stated, together with the copyright information. All views expressed in this publication are the personal opinion of the researcher(s), do not constitute a buy or sell recommendation on any instruments, and in no way reflect the opinions, views, or thoughts of SMU and other abovementioned universities, and unless specified, of any other student clubs. All logos and/or images on these pages belong to SMU and the respective third party copyright and trademark owners. SPEX, affiliated clubs and the covering researcher accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or further communication given in relation to this document. SPEX is the brainchild of current New York University undergraduate Mr. John Ang, further developed by SMU students for the benefit of both SMU and non-SMU students.

9 Copyright 2012 SMU Economics Intelligence Club