North Korean reflections

The slew of recent, insightful articles on the Hermit Kingdom, namely North Korea, written with different approaches are well worth some comments. Although the focus and nature of every article is quite different, they can perfectly be analysed together, so that we have a better picture of the situation in North Korea.

The first article in the set is an academic paper by a reputed German expert on North Korea, Rüdiger Frank, Chair Professor of East Asian Economy and Society at the University of Vienna (you can find it here). In it, Dr Frank, who studied in Korea during the 90s and has visited the country again on several occasions, analyses North Korea's macroeconomic evolution and current situation based on the role of money in socialist economies and the recent monetary reform and the trouble it has caused the regime (see related article in Time Magazine), as well as its future implications.

This highly insightful paper argues that the regime "violated its own rules" with the limited open-market reforms it introduced in 2002 and 2003, and is now looking to revert the situation, with the clear goal of expropriating the new middle class and the possible one of setting the stage for yet another hereditary succession (although Dr Frank slightly disagrees on that) with a neoconservative swing that would counter the weakening position of Kim Jong-il.

However, the effects of monetization in the collective psyche of the North Koreans, coupled with leaked information and visual evidence of the Chinese rapid economic progress and the continued success of the South Korean economy, will be permanent. As Dr Frank says, "the North Korean state started to sell its people, its land, and its pride", and is now trying to go back in time, also trying to ignore the global setup of a globalized world. In the words, again, of Dr Frank, "from a long-term perspective, it seems safe to say that even if, and this is a big if, the currency reforms manage to achieve the goal [...] this is unlikely to remain stable for more than a few months or years, since the key problems of the North Korean economy remain."

The second article, recently published in The Economist, focuses on a recent book by Brian Myers, which argues that the North Korean regime has its ideological and political roots in the fascist dictatorship of imperial Japan under Hirohito. Although this argument seems reasoned enough and the book might be well worth reading, the approach is also polemic and probably a bit shallow.

First, while it might be correct, the argument that North Korea’s history is one of a child-race abused by foreign powers and, therefore, Koreans need a caring, protective leader, a maternal figure (as also shown by this collection of North Korean propaganda posters) is somehow biased and limited: not only North Korea does that, South Korea does this as well, and other nations are increasingly reacting that way in the midst of the current economic downturn. Moreover, the combination of fascism and race-based nationalism is not unique of Imperial Japan, nor is dictatorship coupled with a strong personality cult. Finally, it should also be remembered that the ideological extremes of communist and fascist ideologies tend to interweave, and this is a typical example thereof.

The third article, written by Sung-Yoon Lee and published in Foreign Policy, analyses what could happen in the case of a sudden power collapse in Pyongyang, arguing that, although a common contingency plan exists (namecoded OPLAN 5029 by the Pentagon), it might be insufficient to tackle any mid- and long-term effects. However, as also implied by The Economists' Banyan in a recent blog post, Mr Lee's analysis lacks an element: Chinese influence and interests. We must first take into account that a sudden demise of the Kim regime is highly improbable, as China is most interested in preserving stability in the region, and a good way of doing that is by preserving the current status quo in Pyongyang, as shown by a recent $10 billion investment in North Korea by the Chinese Government (as reported by Dr Frank).

China sees Kim's regime as a buffer state between them and americanised South Korea and Japan, and thus keeps it on life support: they don't want Koreans to starve and probably topple the regime, but they neither want to spur a sudden uncontrolled opening-up of the regime, as it might also hurt their main economic interests in the country, including mineral extraction  rights and toxic waste dumping sites (see related article in the Telegraph). In case the regime were toppled, China's reaction will be at least as important as America's and South Korea's. As suggested by Andrei Lankov, a watcher of North Korea at Kookmin University in Seoul, China could try to avert collapse by installing an authoritarian, pro-growth regime in North Korea, something along the lines of China's (and even at its mercy).

However, such moves would probably be insufficient to avert chaos should the North Korean regime suddenly fall, as it would create a giant tide of 23 million disoriented people. If Mr Myers' book is right in one aspect, it is the infantile hopelessnessof the North Korean people: they are thoroughly vulnerable in the hands of a global world of competitive capitalism. Despite some "green shots" (for instance, see this article from BBC News) and the clear signs of entrepreneurship, specially among females, noted by Dr Frank in his paper, North Koreans are not ready to immediately and seamlessly integrate in societies such as South Korea's and China's. as shown by the deep socioeconomic and psychological anxiety experimented by North Korean defectors in South Korea (see, for instance, this article).

As pointed out both by Banyan and Dr Frank, any comparison with Germany's situation 20 years ago is fully inaccurate for several reasons. First, West Germans were much wealthier back then that South Koreans are now, while East Germans were better of than our North Korean contemporaries, West Germans are still paying a special 10% tax that goes to the eastern Länder. Moreover, West Germany had a much higher population than its socialist counterpart, while South Korea's population is barely higher than the North's, making all economic needs related to reunification and reconstruction north of the 38th parallel even more daunting.

Secondly, as Dr Frank clearly explains, both Germanys had much closer and deeper ties back then than South and North Korea do now. In other words, East Germans received parcels and were visited by their West German relatives, saw Western Audis and BMWs rolling along their Trabants in highways to Berlin and were able to watch West German TV since the 1970s. North Koreans are thoroughly isolated of the outside world, and that of course includes their southern brothers. As attested by this humble writer in a recent visit to the Hermit Kingdom, even privileged members of the society (in this case, English-speaking tourist guides) felt compelled to ask foreigners for information about their own country's wheelings and dealings. While this shows that some members of the North Korean society realise that their Government is hiding important information from them, it also shows their thorough lack of knowledge of today's global context.

For a deeply alienated people such as North Korea's, sudden toppling of the current regime can cause a serious humanitarian crisis. The best possible scenario going forward would probably be a gradual political and economic opening under joint Chinese, South Korean, American and Japanese leadership. However, recent indications are not encouraging, chiefly the recent wheeling and dealing with currency reform, allegedly masterminded by the appointed successor, Kim Jong-il's third son Kim Jong-eun. Nothing is sure as of now, but the status quo of the Korean regime should not last forever. As Banyan points out in his blog, maybe North Korea will find a way forward, most probably with Chinese characteristics.

The way to an European pension system

After reading Charlemagne's latest blog entry in The Economist, I can't help but thinking that European pension systems should be revamped. That's of course no news at all: most national governments are currently working towards that goal, with varying degrees of success and hurry. 

Greece should do it right now if it wants to at least try to comply with the bailout-like conditions imposed by the EU hardcore countries. Ireland already cut pension benefits for its civil servants, among other painful budget-cutting measures, just to avoid Greece's fate. The Spanish government has proposed a progressive raise of the retirement age from the current 65 to 67 years –to much public disdain, as showed by yesterday's demonstrations (see related article in The Irish Times)–, and France is also tinkering with its pension system, where current official retirement age is 60, one of the OECD's lowest.

My proposal would rather take it a bit further: what Europe needs is a coordinated reform of its pension systems, not just independent efforts by some national governments. Although a full-fledged handover of the national pension system to a hypothetical European authority is just a chimera, as it would require that all European (or, at least, Eurozone) governments transfer their Treasury departments and taxes to a European authority, who would then manage them. Sadly, this is a politically and socially unacceptable idea in today's half-united half-divided Europe, as it would –quite understandably– be opposed by the richest and most efficient countries, namely France and Germany, while also requiring a huge scale revamping of all national civil services, probably leading to painful cuts in redundant positions. However, some coordinated structural changes could be agreed upon, to great benefit of all European economies.

First, a consensus should be reached on a common retirement age, as the current mishmash of retirement ages in Europe only causes confusion and resent between citizens of different countries. Germans loathe having to rescue Greek finances and then realising that, while they retire at 67, Greeks do it when they are only 61. Spaniards are puzzled by their government's plan to raise retirement age when they see that most of their French neighbours retire 5 years earlier than they do, when they reach the age of 60. A common European retirement age should change these perceptions.

The second coordinated decision should come on how pension entitlements should be calculated. This is another contentious issue in several countries planning reforms, such as Spain, where pension entitlements are currently calculated on the basis of the last 15 years of the individual's working life, something the Government is also planning to change (upping it to the last 25 years). Moreover, and although it is by no means as controversial as the retirement age itself, the widely diverse calculation methods also fuel inequalities and resent between countries.

Finally, a bracket of allowable entitlements should also be defined at the European level. No external, neutral observer would deem adequate that, for instance, civil servants in Greece can retire on 80% of their final basic salary, while German ones have to work longer years to get pension rates in the low 70% range of final basic salaries. Entitlements vary quite wildly among countries and even sectors, so sensible and responsible European regulations should be called for both to improve fiscal reponsibility among some countries and also to create a further feeling of equality among all Europeans, independently from their country of origin and occupational sector. This is not to be confused with with a "hard cap" or exact retribution percentages, as room should be made for fiscally responsible countries that can afford paying more generous pensions to their citizens; however, this manoeuvering space should be limited, and any significant deviation should be supervised and approved at the European level.

As Charlemagne reports, "even the news that the Greek government was planning to raise the legal retirement age from 61 to 63 as part of swingeing austerity measures seems to have been like a red rag to a bull in Germany, which not long ago increased its legal age from 65 to 67". That's exactly the problem that such a measure would solve: reaching an agreement on an European retirement age would be the first step towards a better, safer and more stable economic and political integration. Keeping the current status quo might otherwise prove fatal for the future of the continent's public finances.

PS: Just out of curiosity: while searching for relevant articles to document this post, I stumbled upon an old article by AP published in The Independent almost 5 years ago. Guess what it said: "The European Union has warned Greece that within five years it will face a problem due to increased aging of its population." Of course, warnings were promptly ignored.

The Era of High Joblessness

Yesterday evening, I had the great chance to stumble upon this excellent essay by The Atlantic's Charlie Brooker, focused on the sociological, psychological and economic effects of prolonged unemployment affecting a high rate of the economically active population.

Although the article is focused on the United States market, economy and idiosyncrasies, most of its analysis, insights and conclusions could be adapted to the similar situations in other Western countries with high unemployment rates, such as Spain, so I think it's worth reading even if one is not particularly interested in the US case.

It also looks like I have not been the only one showing keen interest in this essay: David Brooks of The New York Times has summarised and analysed Charlie Brooker's essay in his daily op-ed article. Although he mentions some of the relevant facts pointed in the original article and gives his particular vision on possible solutions to address them, I recommend spending an hour carefully reading the article in The Atlantic. It's really worth the time.

Bad debt case

The recent announcement of the US Federal Budget for fiscal year 2011  (see relevant article in USA Today) has spurred quite a lot of reactions. Although President Obama is set to introduce some debt-cutting measures, such as ending the Bush tax cuts for the richest Americans and freezing some domestic spending for three years, those won't be nearly enough to return deficit to normal levels (see another related article in The New York Times).

The deficit will almost reach $1.6 trillion in the current fiscal year, a post-World War II record, and projected deficit for the coming year will nearly be $1.3 trilion, as the country still fights to exit  the recession and create jobs. However, it is obvious that deficits totalling 10 or 11 percent of the country’s entire economic output are not sustainable in the long run (see relevant article in The New York Times), and although Mr Obama has stated that the deficit for fiscal year 2013 will be equal to just over 4 percent of the gross domestic product, the Administration also reckons that, by the end of the decade, annual deficits will begin moving up inexorably, reflecting the fast-rising costs of health and retirement programs for an aging baby-boom population.

US Government debt is still considered one of the safest assets for investors, as their Aaa rating attest. However, Moody's has already warned that this status could be lost due to the rapid worsening of public finances (see releavant article in Bloomberg News). The equation is easy: growing debt, caused by big budget deficits, will erode the confidence of both American and foreign investors with cash reserves to buy US debt. And nowadays, the biggest investor in US Treasury bonds is no other than China.

What if China gets fed up? Much has been said about the economic interdependence and growing importance of the relationship between the United States and China, even to the point of coining a new term –first coined by the British historian Niall Ferguson– Chimerica, to reflect this crucial relationship (see relevant article in Der Spiegel). The reasons that explain this dependency have been widely analized: in short, if the dollar tumbles, China loses part of its $2.3 trillion reserves (about 70 percent of these are in dollar-denominated securities, and a large proportion of these are in US government bonds); if the US economy falters, the still heavily export-oriented Chinese economy will suffer, as 6 percent of China’s entire economic output comes from its exports to the United States. 

In fact, the mutual dependency of the two economies is also shown by one of the current sources of tension between the two powers: the perceived devaluation of the Chinese currency, the yuan, whose exchange rate has been unofficially pegged to the dollar since July 2008. To keep it undervalued, the Chinese government keeps purchasing dollars, pushing demand for the greenback and thus indirectly assuring its strength in the currency markets. American economists say the Chinese government keeps the exchange rate so low for the purpose of artificially increasing the price of American imports and making Chinese exports especially cheap, a blatant manipulation of the market which costs the US a great number of jobs. An unfair accusation, Beijing responds. Many American companies also manufacture their products in China: if prices rose because of a stronger yuan, they would suffer as well.

Based on these facts, it looks quite clear that the economic interdependency of the two powers should last. A full-scale trade war is unlikely, as both governments know the stakes are too high for both economies. However, leading analysts agree that growing tensions in Sino-US relationships could result in a collision. And while it could be argued that China has more to lose from such a standoff in the short term, there are several reasons to support the theory that, in fact, the US would suffer much more than China if the tide changes in the mid term. This is based on three clear tendencies of the Chinese economy:

First, its internal market is growing at a fast rate, thanks to the steady development of an urban middle class, to the progressive increase in wealth in rural Central and Western China and also to Government plans to spur consumption. In fact, several economists already argue that China's growth is mainly due to its internal market rather than to exterior commerce, and this trend should continue and even increase in the future. That all means that the Chinese economy is progressively becoming less export-oriented: when the global downturn started in 2008, many feared that the Chinese economy would be dragged down by a severe drop in consumption in the US. And although it suffered, reduced exports were not enough to offset the enormous growth of the internal market, which, coupled with the 4 trillion yuan stimulus program put in place by the Government in November 2008, prompted a whopping 8.7% GDP rise in 2009. For the first time, economists point to Chinese spending –not the US consumer– as the key to a global recovery. Although it is also true that other experts claim that China is still a long way from developing a strong internal market (for instance, see this article in Project Syndicate), current trends and evidence show otherwise: the stimulus program may have helped boost internal consumption and spending, but its growth had already been steady in the preceding years, as the continuous increase in Chinese imports (leven surpassing the % growth in exports) shows (for instance, see some related fresh news in China Daily).

Secondly, its export markets are diversifying. In other words, although the American, Japanese and European markets –the typical consumers of Chinese products for the last decades– are still key to its economy, but China is fastly developing other markets for its products, creating further interdependency relations with African, Asian and Latin American countries. Despite growing concern and complaints by some East Asian countries (chiefly Indonesia), China is the third largest trading partner of ASEAN since 2006, and ASEAN has become the third largest of China just recently (news published just today, see link in Spanish), right after the full implementation of the China-ASEAN Free Trade Area (CAFTA) on January 1 (see related article in the Asia Times Online), and therefore displacing Japan from the long-standing top three. As for Latin America, Central Asia, the Middle East and Africa, China does not only see them as sources of the raw materials and energy it needs to fuel its industry: under the label of cooperation and investment projects, China is arguably implementing a 21st century  form of economic neocolonialism, helping develop these countries' infrastructures and markets in exchange for access to their raw materials, energy sources and, of course, the markets it helps create. Apart from fostering alternative strategic alliances, this grand strategy will probably help create a budding consumer base in poor and developing countries, from which Chinese manufacturers will hugely profit.

   

The third reason is that China is also steadily diversifying its economy and industry. China  is undeniably the world’s manufacturing workshop, specially for cheap, low value-added products, but also increasingly a worthy competitor in most industries and, increasingly, a major source of research and development. Apart from the big "national champions", huge state-owned enterprises (SOEs) in strategic sectors, business in the coastal areas, mostly led by an elite of foreign-trained Chinese enterpreneurs, are increasingly focusing on delivering quality products, with superb design and cutting-edge technology. Moreover, to further bolster this trend, the Chinese government has set higher education as one of its top priorities. As a recent article in China Economic Review attests, some Chinese MBA programs are becoming global competitors. Meanwhile, according to several sources, the Chinese government now spends billions of yuan –at least 1.5% of its gross domestic product– on higher education, with the aim of propelling its best institutions. According to Professor Richard Levin, he president of Yale University, China's top universities could soon rival Oxford, Cambridge and the Ivy League (see relevant article in The Guardian). And, if that's not enough, the data and forecasts offered by a recent article by Robert Fogel in Foreign Policy clearly show the aim of the country leaders: more educated workers are much more productive workers, while better educated managers are more innovative and successful.

The combination of these three key economic factors with a growing sense of self-confidence among Chinese intellectuals, businessmen and policymakers could foster a more belligerant attitude towards other countries, chiefly the United States. And while Western powers at both sides of the Atlantic are increasingly worried about China's recent threats and menacing words (see relevant article in The Washington Post), there's still a long way to go for China to even consider a cut a big chunk of its economic ties with the US.

However, if current trends continue, it is not impossible to envision an scenario in which China progressively disrupts its economic ties with the US. It could first come in the form of explicit or implicit restrictions for foreigners that want to invest in China, although they already exist anyway and also despite that the prospects for foreigners to undertake profitable, undisrupted business activities in China are becoming darker by the day (for instance, see this interesting article in Seeking Alpha and this one in The New York Times). 

Although not all experts agree (see this article from a Brookings Institution expert), one of the immediate threats for the US would be that China stops buying its debt or even starts selling the large pile it possesses (about 10% of the total US Treasury debt owned by the public). Emerging stronger from the global crisis, China can afford it more than ever, and its relative strength position will only keep growing. The sense that it would be better to dissolve the forced  Sino-American union sooner rather than later is growing within China's Communist Party. According to Der Spiegel, Financial managers within the party are already exchanging long-term US Treasury securities for more short-term securities. While it  is undeniable that a generalisation and radicalisation of such measures can notably hurt Chinese economy, but we must bear in mind that it would flat out destroy the value of the dollar in international markets and, not least important, make America default on its debt.

In any case, this would be a surprisingly dramatic move for all parts involved, and obvioulsy one that should be avoided at all costs. How can these risks mitigated? Two measures are key to secure global financial stability and reining in China's pereceived danger:

The first would be taking serious steps towards reducing US fiscal deficit and public debt levels, even if that means raising taxes. Sadly enough, no politician seems ready to admit it, neither in America nor in other Western democracies, as it would cause dissatisfaction among voters and doom reelection prospects. However, it seems many are still keen on proposing further tax cuts, a populist and self-destructive measure that is indeed still popular among many voters (related to that view, here's a very interesting and critical article that appeared in Slate). Be as it may, current budget deficits are too large to be sustainable, and they can only be controlled via a tax raise or by slashing spending in a country where 46 million people don't yet enjoy full medical coverage and where 40 million –or 13% of the total population– live below the poverty line (source: US Census Bureau) and where improving aging infrastructures and energy efficiency are also to be considered short-term priorities.

The second way to appease China would be a deep reform of the international monetary system, so that the dollar is no longer the only reference currency. Instead, a basket of reference currencies, including the euro and the yuan, should be created. When Zhou Xiaochuan, head of the People's Bank of China, called for the dollar to be replaced in the long term as the world's reserve currency, he was also sending a clear signal: Beijing politicians want to have a stronger voice in bodies such as the International Monetary Fund. They don't want to leave it completely in the hands of their rival on the other side of the Pacific. Above all, what China wants for now is to prevent the US from printing too much money to stimulate its economy, as high inflation would cause the dollars China has invested in the US to quicly lose value, while also force it to buy even more dollars to keep the yuan undervalued. Anyhow, such a reform would not only make the Chinese happy, but also give extra stability to the battered global financial markets, as Dominique Strauss-Kahn, the managing director of the International Monetary Fund, has already acknowledged (see relevant article in El Economista). Even better, it would force China to adopt a fairer exchange rate policy, which would clearly be good news also for the US.

Even though it can be argued that adopting such measures would also mean a big change of the current status quo –i.e. the US borrowing billions to finance its growing public debt and China accumulating dollar-denominated securities while keeping its currency undervalued–, it would surely make for a much less dramatic change than any radical breakup of the current system due to growing tensions. In fact, it is still possible to revert some dangerous tendencies. Instead of imposing trade sanctions and protectionist measures, Western countries should rather look for consensuate solutions to bolster stability. If the right steps are taken, currently growing tensions between China and the West could abate, paving the way for a safer and fairer global economic market on the basis of free trade. Yet some analysts are already wondering what will happen to Chimerica, claiming that, sooner or later, this forced economic marriage will come to a painful end (see this relevant article in Newsweek). And, if it happens, the partner who will suffer the most will surely be the debt-laden US economy.

67 'til I die

On a day of gloomy news related to the Spanish labor market, a proposal formulated by the Labour Minister took the spotlight: Spanish legal retirement age would be progressively raised from 65 to 67 years of age (see article in Bloomberg) between 2013 and 2025.

It is quite a bold statement from a Government which has otherwise been troublingly ineffectual in dealing with the effects of the global downturn in Spain. With unemployment rate already at 19% and likely to surpass 20% in the coming months (see article in Spanish in El País) and soaring budget deficit, which has already reached 11.4% of the Spanish GDP, it was clear that the government should change its ways of appeasing trade unions and civil servants.

The measure has been labeled as 'exaggerate', 'unnecessary' and 'hurried' both by trade union leaders and opposition parties (see article in Spanish in La Vanguardia). Although the argument that the current situation of the Spanish social security accounts is not yet worrying (they ran a surplus until last year), things can only worsen if the problems are not addressed soon. Spaniards are aging: according to Spain's Instituto Nacional de Estadística (INE), the number of people over 64 years of age will double by 2050. That's certainly a fact nobody should ignore. Moreover, the current proposal does not intend to establish a new age limit overnight, but just progressively and during the years where the last generation of Spanish baby boomers will enter retirement age.

However, this proposal has another side, maybe less discussed but equally important: the clampdown on early retirements by financially healthy companies that just want to slash payroll avoiding doling out heavy compensations on fired long-term employees. Although legal retirement age is set at 65, the real average retirement age in Spain is currently at 63.5, mainly thanks to this phenomenon. According to Celestino Corbacho, Spain’s Industry Minister, it’s not about banning early retirements but making companies responsible for the related costs. In other words, under the new proposal, solvent companies would be forced to pay for the pensions and entitlements of its former employees until they reach the legal retirement age, which means lowering the current burden on public finances. Moreover, the proposal also includes raising the minimum age to accede to early retirement from 52 to 58 (see article in Spanish in El País).

Markets, investors and companies needed some signal that the Government would fight to limit and reduce spending, even if it’s a rather long-term plan. Although the government raised taxes on income from savings and announced an increase in value-added tax to take effect July 2010, further expenditure savings were also needed.

Therefore, plans to slash the budget deficit by two thirds by adopting spending cuts of as much as 50 billion euros by 2013, mostly centered on the budget for the body of civil servants–new hires will be frozen, as probably will also salaries–are an important step towards fiscal responsibility. The Spanish government needed to step in and implement measures that, although unpopular with some sectors of the population, are needed to steer public finances in the right direction.

Although this might mean many–including this correspondent–will have to work longer to earn their entitlements, soaring deficits, bleak economic projections and the fast ageing of the population made reforms in the current welfare state necessary if Spanish people want to be entitled to old age pensions when they reach retirement age.