But the recent period of Euro-pessimism has been long and particularly tough: crisis after crisis, each with great destructive potential, along with accumulating external threats such as Putin’s Russia, conflicts in the southern Mediterranean and jihadist terrorism.

It all started back in 2005, when first France and then the Netherlands voted against a treaty to adopt a European constitution. The situation worsened with the start in 2007-08 of the Great Recession, and deepened further still with the 2010 euro crisis. 2016 was a veritable “annus horribilis” for the EU, with Brexit, the election of Donald Trump, and an ongoing refugee tragedy. In the words of Jean-Claude Juncker, president of the European Commission, the EU in recent years has gone through a “true existential crisis”.

Fortunately, things have begun to change over the first semester of this year. The feeling in Brussels is that Europe is back on track and that an EU of 27 member states (without Britain) stands united to face its current challenges and determine its future.

There has been a spate of good news. Election results – in Austria, the Netherlands, several German states and, above all, France – have taken the steam out of the populism that had run rampant across the continent. A Brexit-Trump-Le Pen triumvirate would have been lethal for the EU. Election victories by Emmanuel Macron, a genuine advocate of Europe and of strong relations with Germany, are a determining factor in the re-launching of the EU. Macron’s plans for France involve, precisely, the relaunching of the EU.

At the same time, the EU itself is taking strategic decisions based on a White Paper on the Future of Europe presented March 1, which was followed by the European Council’s Rome Declaration on March 25 that declared its commitment to integrating the continent. The EU is defining its institutional architecture, consistent with a differentiated flexibility, in which there are hard-core countries and more peripheral circles. The Franco-German axis, reinforced by the good relationship between Macron and Angela Merkel, is at the core, which in principle would be comprised of members of the euro zone.

What’s more, the EU is determined to regain its citizens’ support, and to do that it has planned measures in three priority areas: defense and security (both external and internal), immigration (refugees) and economy (fixing the euro’s defects and anti-crisis measures to support investment and growth and fight unemployment). The goal is to make the EU capable of taking decisions in those areas where European-wide policies make more sense than individual measures by member states.

Europe is back and both Brexit and Trump have, ironically, served as catalysts. As for Brexit, activated March 29 by Britain, the EU has already finalized its negotiating plan, which consists of resolving three basic issues before entering into final talks:

1) The situation of EU nationals in the U.K., and that of British nationals in the EU

2) The payment of €100 billion that the U.K. owes

3) Avoiding borders between Northern Ireland and the Republic of Ireland.

The EU’s preparedness comes in sharp contrast to the U.K.’s uncertainty, especially after the early legislative elections called by Theresa May, which have weakened considerably her negotiating position.

As for Trump, the EU has reached important conclusions after his unfortunate recent European trip, as expressed clearly by Merkel: “The time has come for Europeans to take the reins of our future into our own hands.” Merkel has also referred to Britain and the U.S. as being partners who are no longer reliable.

All indications are that the process of relaunching the EU will gather strength after German elections in September. If, as looks likely, Merkel wins for the fourth consecutive time, she and Macron will be key figures in this push. Europe will return to the good days of the Franco-German axis, the outlook is promising and the pro-Europeans are, finally, celebrating. After 12 years of Euro-pessimism, when the very future of the union often seemed doubtful, it’s about time.

The post Is the European Union Poised for Relaunching? first appeared on Economics Outlook.

That reflects reality. In 2014, China became the largest economy on the planet, if you calculate Gross Domestic Product (GDP) in purchasing-power parities: in other words, by measuring the production of final goods and services with a common system of international prices. China’s new role as global superpower was celebrated with little fanfare. But in my opinion it’s the source of many of the global economy’s recent shifts and shocks. My favorite way to explain the current situation is that we’re witnessing a collective silent scream on behalf of the West in response to the loss of its worldwide dominion.

If you want to understand why, just look at my map. With China in the center, Europe is moved to the periphery. The relevant oceans become the Pacific and the Indian, from which China’s growth radiates out. China’s contribution to world growth increased from 3 percent in 1970 to 31 percent in 2015. That growth is rolling across South Asia and East Africa. It’s also noteworthy that the Pacific countries in Latin America are doing better than the Atlantic countries there.

The transition may feel especially jarring because, since World War II, we have been living through a period in human history that is extraordinary in its absence of violent global conflict. That relative peace has allowed much of the world to concentrate on growth, technology, innovation, prosperity, and energy.

This period has also given space for economies around the world, and especially those in Asia, to catch up with Western countries. Just look at how Korea, Singapore, Japan and other Asian nations have achieved a rapid, unprecedented catch-up with the United States in terms of GDP per capita.

China illustrates the extraordinary scale of the catch-up, as well as how much progress there has been. Back in the 1950s, China had less than 5 percent of the per capita income of the United States. Today that number has increased to 25 percent. That lags well behind Korea and Japan, which are both at 80 percent, but the scale and speed of China’s ascent is  big enough to make us rethink the geography of the world. As China leverages its size going forward, it will become more and more a source of global growth.

So much change, of course, is unsettling. And when things are unsettled, international trade often gets jostled, because trade is such a delicate thing. Trade requires both a complicated mix of public sector and private sector activities. And trade is politically perilous because trade comes with unavoidable imbalances; it leaves the whole richer off, but there are winners and losers, and it doesn’t lift all boats at the same time. Some of the biggest, most obvious losers are manufacturing workers who are undercut by lower-wage competitors. And if you are working in heavy manufacturing and you’re not computer literate, you may be unemployable until you die. And if you’re such a person and you live in a country without a strong safety net, you may have little to protect you.

The Great Recession, and the anti-trade backlash that has followed, are a painful reminder of trade’s fragility. And of this hard fact: While we have global trade, we don’t really have global governance. That means governments can’t easily respond to this anti-trade, protectionist wave, at least quickly.

The lack of political response to unsettling change conspires to make groups of people become desperate or hopeless, to lose faith, and to lash out. It’s very easy for smart, populist politicians to pick up on this, and gain votes and power by blaming trade or immigration, or by appealing to that ultimate trump card, national security.

The response we are seeing in many places is the re-institution of controls on trade and global exchange, despite the costs. Such controls aren’t new. The biggest came after the Sept. 11, 2001 attacks, with tight new screening measures in airports, and the time and money that this wastes.

What is the best response to this backlash and these controls? For me, that question reminds me of a saying we have in Spanish (I’m originally from Madrid) that translates as: “You kill the dog, no more rabies.” You want to find ways to get rid of the rabies—or, to unpack the metaphor, the disease of unsettling change under globalization—without killing the dog. One approach is to defend free trade directly, since we economists understand that trade is not a zero-sum game; rather, it’s a positive game, with winners who could compensate the losers.

Still, as an economist trained in free trade and the research on it, I’ve begun to rethink whether we need a more robust response that would mean profound changes for Americans.

For one thing, we might have to become much more serious about providing a social safety net. Being from Europe, I’m struck by how many of my American students at UCLA have this instinctive aversion to anything that comes from the state, even badly needed safety-net programs. It seems to me there’s an imbalance in this country—so much private wealth, and not enough safety net. (I see a similar imbalance in L.A. traffic: You have all these private cars, especially fancy cars, but not enough public roads, so no one can go fast enough to get the full benefit of their great cars.)

This moment requires some hard questions and rethinking. How well does free trade really fit with the other things we want in modern societies? I was just re-reading work on globalization from an economist colleague, Dani Rodrik, at Harvard. And he says you cannot have all three of the following things simultaneously: democracy, national sovereignty, and free trade. For example, you cannot have international trade without some international rules, and those rules have to be enforced by somebody with international power. So if you want a globally integrated world, you have to give up some sovereignty.

Or you have to go the Chinese way and forget about democracy. You have trade and national sovereignty, but capital controls and top-down management. The theory here, extended to Western liberal democracies, is that you don’t give the electorate a say in economic policy because they’ll support Le Pen or Brexit or Trump.

I’m also not sure I’ve fully taken into account the risks of globalization and trade. Look at the recession of 2008; the risks are pretty high that something like this will happen again. A more economically integrated world would transmit any shocks that happen anywhere on the planet, and that could produce havoc.

It’s clear that putting up walls, trade barriers and restrictions will not solve a more fundamental problem here in the United States: that the county has too little savings relative to investment, and that this gap needs to be financed from abroad, and this requires a current account deficit. Perhaps this idea is not easy to understand, but it is an accounting and an economic truth.

I also find myself thinking of the Nobel laureate Paul Samuelson, and the famous challenge he was issued by the mathematician Stanislaw Ulam to “name me one proposition in all of the social sciences which is both true and non-trivial.” Samuelson eventually answered by citing the concept of comparative advantage, the idea that gains from trade follow from allowing economies to specialize. If one country’s economy is better at making computers than coffee, it makes sense for it to invest more in computers and export them, to be able to afford to purchase coffee from some other country.

Samuelson was right, but the problem is that too many people, including many in power, don’t understand the concept. And they don’t understand that even if the United States tried to fix its trade imbalance with China, there would be a backlash, retaliation and the demise of thousands of companies and jobs.

What we need is to adjust to the world as it is, not to the old maps on the wall, with the Atlantic Ocean at the center. We must recognize the value of trade, and do more for the losers. And we must reckon with the reality of China’s ascendancy and the increasing role that machines will play in our lives.

Originally published in Zócalo Public Square

The post In the New Global Trade Map, China Commands the Center first appeared on Economics Outlook.

In Europe, all eyes will be on Brexit. European economies have shown surprising resilience to the Brexit news, but the potential negative impact cannot be ignored.

The three aspects of EU membership most valued by the UK are free trade, financial passporting and the global influence that comes with being an EU member. On the flip side, the UK opposes several key features of eurozone membership: freedom of movement of EU nationals, UK contribution to the EU budget and the inflexibility of certain European rules.

The European Commission has always stated that four freedoms come as a pack: free movement of goods, services, capital and labor. Hence, the UK cannot pick and choose which ones it will accept. Furthermore, the effective negotiation timeline is actually shorter than two years, since it must also encompass ratification by the EU member states. Due to these time constraints and the complexity of the negotiations, a soft Brexit seems unlikely. It would not be surprising if the first agreement reached is that more time is needed to complete the negotiations.

On the bright side, the EU will celebrate the 60th anniversary of the Treaty of Rome in March. This milestone would be a golden opportunity for Europe to address issues that most concern EU nationals, as well as present initiatives that foster a more coherent and coordinated vision of where the EU is going. In the meantime, hot button issues such as fiscal spending and volatility will remain high, with all media reports about the EU’s post-Brexit future having a strong impact on public opinion.

Inflation is another issue on the 2017 table. The expansionary policy spearheaded by ECB President Mario Draghi bought more time for the eurozone to carry out urgently needed discussions on structural reforms. Unfortunately, this opportunity has not been seized. High unemployment and increasing inequality have led to a rise in populism in many European countries and negative interest rates in the form of penalties that European banks must pay to keep their cash reserves in the ECB. This situation has further undermined the profitability of the banking sector in an already fragile financial landscape.

In a context of moderate growth and inflation, the ECB has announced its plans to extend its bond-purchasing program for longer than previously announced. Rising commodity prices and a fragile economic recovery have led to higher inflation, mitigating the need to sustain an accommodative monetary policy. Nonetheless, the odds of a rate hike in 2017 are low, given the subdued nature of the economic recovery.

Looking towards the United States, President Donald Trump promised a significant fiscal expansion through an increase in government spending and cutbacks in personal and corporate taxes. This fiscal boost has prompted many analysts to improve their 2017 forecasts of U.S. growth. These policies would lead to a significant increase in public debt and would also generate rising inflation expectations. Stronger growth momentum and an upsurge in commodity prices could potentially result in an increase in inflation and prompt the Federal Reserve to raise interest rates several times over the upcoming year.

The biggest uncertainty rests on the question of what campaign promises Donald Trump will ultimately fulfill. If he opts for moderate fiscal expansion, and his protectionist talk does not translate to action, we could see a positive short-term boost in the U.S. economy. On the other hand, if he promotes important trade tariffs and restrictions on immigration, effects on the global economy will be detrimental in the long term. While global analysts think that the first scenario is more likely, volatility will reign no matter what action Trump takes.

However, when it comes to Russia, China and emerging countries, there is more clarity of what lays ahead in 2017. Most analysts expect Russia to return to positive growth by 2017. The latest IMF figures estimate a GDP growth of 1 percent. The recovery of oil prices will provide a significant boost, as well as a possible lessening of geopolitical pressures. The IMF has predicted that the Chinese GDP will grow 6.2 percent, despite a huge increase in corporate debt, among other factors. And emerging economies, according to the IMF, will continue to drive GDP growth, expanding at more than twice the pace of advanced economies.

Potential scenarios in 2017 are anyone’s guess. A worst-case scenario would include a sharp rise in protectionism and retaliation by different countries. A severe upsurge in protectionism would significantly push up labor costs in the U.S. and reverse any short-term positive effects of expansionary fiscal policies. In Europe, the political calendar could take its toll and depress investment. Geopolitical risks could also intensify and depress global expectations.

A best-case scenario would be one with a bolstered U.S. economy acting as an engine for global growth and constructive Brexit negotiations proceeding between the UK and EU. A strong recovery could also strengthen exports in emerging economies and ease geopolitical tensions globally, with Trump’s trade threats falling by the wayside.

Reality will probably end up somewhere in the middle. Without a doubt, 2017 promises to be anything but a smooth ride.

The post Economy 2017: Slightly Better but More Volatile first appeared on Economics Outlook.

Second, it would be desirable for systemic central banks – the U.S. Federal Reserve and to some extent, the European Central Bank – to take into account the international repercussions of their policies.

Let us start with the recession. Banks need to fix their damaged balance sheets, which usually leads to a credit crunch that impacts aggregate demand (AD): less investment because of a lack of credit, less consumption due to lower employment and the burden of household debt, and worsening expectations. This scenario prompts a negative feedback loop that intensifies as time goes on.

Higher government spending can slow the momentum toward depression, at least temporarily. Austerity policies, or fiscal contractions, may be inevitable, but they will definitely hinder growth in the short run. Growth-friendly austerity policies do not exist, and should not be confused with prudent fiscal management under full employment conditions.

The alternative is to boost foreign demand by stimulating exports. A small, open economy will do this by devaluing its currency. Members of the eurozone do not have this option, but perhaps lowering domestic prices would have the same effect.

Nonetheless, there is an essential difference between these two types of devaluation: a conventional devaluation will increase demand for exports without impacting domestic aggregate demand. Since nationals have become poorer only in relation to foreign goods, it can be assumed that the total effect on aggregate demand will be positive.

On the other hand, an internal devaluation implies lower wages, which impoverishes domestic workers and consequently decreases consumption. This effect is amplified if the decline in wages is achieved at the expense of higher unemployment. Whether or not a drop in domestic spending is offset by potentially higher exports is an open question. If the answer is negative, the internal devaluation is counterproductive. Furthermore, other factors must be considered before advocating an internal devaluation.

First, when discussing trade between countries, comparative advantage is the proper standard, not the red herring of “competitiveness.” Hence, the customary practice of using aggregate data on unit labor costs (ULCs) fails to provide the full picture: a decomposition of aggregate exports into sectors is the proper basis for inter-country comparisons of “competitiveness.”

Second, an internal devaluation is more effective when both wages and prices fall, since real wages – and consequently, domestic consumption – decrease less than in the wage-only case. Additionally, it is most effective when monetary policy can react to lower prices by reducing the policy interest rate (a monetary expansion), as Jordi Galí and Tommaso Monacelli contend.

The case of Spain

These combined factors give us reason to suspect that an internal devaluation was unnecessary in the case of Spain: the loss of competitiveness was exaggerated, it was a wage-only devaluation, and the behavior of exports during the crisis seemed to have had minimal impact on price changes.
When it comes to mitigating the impact of a financial crisis on aggregate demand, the aforementioned analyses point to the following conclusions: implement a strategy of fiscal expansion, avoid fiscal contractions and regard alternative measures with caution.

The stock problem is the “mountain of debt” that financial crises leave in their wake. A large volume of debt relative to the income flow of the debtor, whether public or private, constricts spending. To the extent that recessions stem from a deficiency in AD, excessive debt aggravates the situation and slows down economic recovery. The failure to properly address debt in the ongoing crisis in the eurozone amply demonstrates this.

One thing, however, is clear: austerity, while commendable at the individual level, is detrimental at the aggregate level since it hinders growth.

The debt problem has thus far been left unresolved, although, as Carmen Reinhart and Kenneth Rogoff have indicated, past crises generally prompted some sort of debt relief. Slow growth – both in terms of population and productivity – and mounting pressure to expand public services like health care and higher pensions only add to the problem.

The launch of the euro was probably premature, but the lack of real convergence was not the root of the crisis: excessive indebtedness was. Moreover, the nature of debt is important: in the case of private debt, the creditor takes the hit, whereas default on bank debt – the main instrument used in Europe – puts the entire financial system at risk.

Critics of the euro have been very vocal in expressing their belief that a fiscal union must accompany a monetary union. Nonetheless, the U.S. had a single currency long before a fiscal union was in place. Moreover, federal transfers, even today, are very limited in amount. Debt ceilings would have lessened the impact of the crisis in some of the peripheral countries without putting the euro at risk.

The current crisis has taught us some valuable lessons. At its core, the crisis illustrates the need to disregard age-old principles. Unfortunately, creditors’ dogged adherence to some longstanding doctrines has led to misconceived policies, inflicting unnecessary pain on some without putting an end to the crisis. For some, the question of whether recovery will come soon enough is still up in the air.

The post The Financial Crisis: Lessons Learned first appeared on Economics Outlook.

The reader may not know the story of “The Gorilla in the Room”, but it reveals the fact that while we focus on one thing, we often fail to see another, much more important story happening at the same time. Now, let us apply the lesson of the story to income inequality. Consider 1988 to 2008, when the main economic event to take place was the expansion of global markets, starting with the appearance of China, Eastern Europe and, to a lesser extent, India on the world economic scene, and ending with the onset of the current crisis. World income as a whole has grown enormously thanks to this larger market, but not everyone has benefited in the same measure. Since we hear every day about the plight of the middle classes, let us ask the question, how have they fared?

On its horizontal axis, the figure features deciles of the world’s income distribution: 10 corresponds to the poorest 10 percent, 20 to the next poorest, all the way to the richest 10 percent, starting at 90 and reaching, say, 99 – the richest 1 percent. The vertical axis measures the cumulative real per capita household income gain from 1988 to 2008 in percentages.

This figure shows how much each segment of the world’s population has seen its average income grow during the entire period. The shape of the graph resembles a mammoth, hence the title of this article.

Following the economist Branko Milanović, we can distinguish three points on the figure:

• Point A, at the top of the mammoth’s head
• Point B, below the tip of its trunk
• Point C, at the tip of its tusks.

Point A corresponds on the horizontal axis to a point that is a little to the right of the 50 mark – the median – that separates the world population in two halves: a poorer one to the left and a richer one to the right.

Those around A, between the 40 and 60 marks, are those who have done best. On average, their income has grown almost 80 percent in 30 years. They are the winners of this big change. Who are they? Mostly the emerging middle classes of East and South Asian countries, especially China, but also Indonesia and Vietnam (South Korea and Japan are to the right of the median).

Around point B, at the 80th centile, we find the losers: no growth for the last generation. Who are they? The not-quite-rich of the rich countries, the lower-middle to middle class of North America and Europe; the lower half of countries like Germany. In short, most of us. Lastly, the world’s richest meet at point C, the upper 1 percent. Half of its inhabitants are U.S. citizens, the rest come from Western Europe, Japan, Oceania, Brazil and South Africa. They, too, have done well: their average income has grown by 60 percent since 1988.

The distance to the right, between points B and C explains the current wrath of the rich countries’ middle classes: they have not progressed at all during the crisis, while witnessing the rich further enrich themselves. That accounts for most of the increase in inequality within rich countries. But what has happened on the left is much more important. This is because:

1. It predates the crisis
2. It has potentially greater impact
3. It lies entirely beyond the reach of national economic policies

It is the true mammoth in the room.

A large part of the story is simply the result of globalization: trade has made labor less scarce in richer countries (since products that use a lot of labor are simply imported from emerging economies), hence relatively cheaper.

So labor in richer countries has been the loser, while in emerging economies it has been the winner. Furthermore, globalization is not only trade: entire production units are built abroad to replace those at home (what we call outsourcing and offshoring), and a lot of the middle-skilled jobs, both in production and in administration and management, are exported along with them.

In simple terms: under free trade, wages converge. But where? At the Norwegian level (€50/hour) or the Philippine level (€1.10/hour)? This simple theory does not tell us, but history may help.

Those at the top of the mammoth will continue to catch up with richer countries, whose middle classes should not expect to see their relative position improve much. Significant redistribution within each country, even if politically feasible, will in all likelihood not be enough to compensate for the push from behind – a push that will come from 80 percent of the world’s population.

On the other hand, perhaps we shouldn’t complain too much, since the losers of globalization are, on average, 10 times richer today than the winners. Furthermore, one should be wary of taking any of the above as more than a suggestion. After all, our world is not at peace and by looking too closely at our mammoth, we may fail to see even bigger beasts in the room.

The post The Mammoth in the Room: Factors Behind Income Inequality first appeared on Economics Outlook.

The Kingdom of Saudi Arabia is the world’s largest oil producer, controlling about 16% of the world’s proven petroleum reserves. Oil represents almost 90% of government revenue and 90% of the country’s exports. When oil prices declined in 2015, Saudi Arabia ran a budget deficit of 13% of GDP.

Vision 2030 is a package of ambitious economic reforms that notably includes the sale of 5% of the state-owned Saudi Arabian Oil Company, known as Aramco, to the private sector. When making the announcement, Prince Mohammad bin Salman touted the strategy as a way to end Saudi Arabia’s “dangerous addiction to oil”.

Vision 2030: A difficult transition to end Saudi Arabia’s “dangerous addiction to oil”

His statement begs the question: What makes the transition away from a resource-dependent economy so difficult? A highly desirable natural resource can lead a country’s other export sectors to atrophy and increase its economic dependence on the natural resource. If a country exports a resource that is in high demand, the inflow of revenue will appreciate the local currency. That is, as foreign entities attempt to buy the resource, they raise demand for the local currency and cause it to increase in value. A more expensive local currency makes it more difficult for other export sectors to compete internationally. This phenomenon is popularly known as “the Dutch disease”.

Moreover, natural resources are, in a sense, “easy money.” A natural-resource export sector doesn’t require a large, well-educated workforce, a well-functioning judiciary and regulatory system, or well-developed capital markets. In the presence of a profitable natural resource, governments have less incentive to encourage the development of these and other institutions essential for a modern, advanced economy.

Both of these factors are relevant in the case of Saudi Arabia. Tawfiq al’Rabiah, the Saudi commerce and industry minister, explicitly referenced Dutch disease as one of the country’s key challenges, and among the goals included in Vision 2030 is transforming the “Public Investment Fund” into the largest sovereign wealth fund in the world. However, countries with existing sovereign wealth funds can afford to keep export revenue out of the domestic economy because most of their revenue comes from taxation, whereas taxes in Saudi Arabia are practically nonexistent. Furthermore, employment statistics reinforce the lack of diversification in the resource-cursed economy: only about 20% of private-sector jobs are held by Saudis and nearly 90% of Saudi workers are employed by the government.

Perhaps the most publicized part of Vision 2030 is the sale of part of Aramco. However, it’s important to note that this sale doesn’t necessarily represent a decline in the overall amount of oil production. In fact, Aramco announced that it intends to further increase production in the near future. Officials have stated that the total company valuation is around $2 trillion, implying that a sale of 5%would yield roughly $100 million. The state goal is to place these assets in the Public Investment Fund. This fund will be restructured with greater transparency and independence from the government.

Yes, the sale of Aramco will somewhat reduce the Saudi dependency on oil. However, while this represents a diversification measure and a large injection of cash into government coffers, the sale itself will not transform the Saudi economy. Rather, it merely represents a reduction on the reliance on one asset, Saudi oil reserves, to another asset, the financial assets acquired by the revenue from this sale.

Real challenges for Arabian economy

The real challenge for long-term reform is changing the employment structure and private-sector productivity. Only 41% of the working population in Saudi Arabia is currently employed (the OECD average is around 60%). Over the years, the Saudi government has implemented various programs to increase the percentage of Saudi Arabians working in the private sector. However, the vast majority of Saudi employees work in the public sector and their positions are, on average, paid considerably more than their equivalent in the private sector. One of the world’s largest populations of migrant workers and expatriates hold the country’s private-sector jobs.

Why? Because of skills mismatch: Saudi Arabians are overeducated for low-skilled manual labor but not skilled enough for high-paying specialty fields. For example, there is a limited supply of new graduates in STEM (science, technology, engineering and mathematics) fields, and enrollment in technical colleges remains low relative to the OECD average. In addition, the absorption of women into the labor force has been slow, particularly outside of traditionally female fields such as education. Resolving these structural issues in the Saudi labor market to reduce unemployment and dependence on the public sector is an extensive, long-term project that requires modifying worker expectations and preferences.

All in all, a diversification effort of this scale is ambitious and unprecedented. Saudi Arabia’s successes and setbacks will undoubtedly hold important lessons for other countries that similarly face the need to diversify in light of reduced commodity demand. Vision 2030: Saudi Arabia post-oil?

The post Vision 2030 Plan: Saudi Arabia post-oil? first appeared on Economics Outlook.

1. Brexit shows the primacy of politics and emotion over economic rational calculation. It is very difficult to understand the decision of British people otherwise. Britain, or what would be left of it after potential secession by Scotland and Northern Ireland, is likely to become a less open economy with a long-term decrease in productivity potentially. What is most striking about the Brexit decision is that there does not seem to be a plan for what to do next  … other than a generic call to national sovereignty, reflected in Nigel Farage’s description of Brexit as an “independence day.” Most of the pro-Brexit arguments were based on the recovery of self-government, excessive contributions to Brussels, and the control over immigration.
2. When a referendum is called, people may respond not so much to the question posed, but out of a desire to punish or complaint. In this case, globalization – represented by the London and Brussels political and business elites – was perceived as being to blame for industrial decline, low wages and poor social services. The easy (and populist) response was to find a culprit. This also happened in the 1930s because of an impoverished middle class.
3. Finding the culprit in Brussels was fueled by years of blaming the European Commission for anything that went wrong. This irresponsible behavior on the part of local politicians, which is quite widespread in the European Union, coupled by David Cameron’s political maneuvering to solve internal problems in the Conservative Party, has led to disaster. The outcome may now be a “little England.”
4. Simple majority rule exercised once with no minimum participation cannot be the base of decisions as important as to remain in or leave the EU. Brexit won by 52% to 48%, with a participation of about 70%. This means that only slightly more than 36% of eligible voters were in favor of leaving. For such important decisions, qualified majorities which remain stable over a certain period, should be necessary . Otherwise, minor events may determine major changes that people might later regret.
5. Prediction markets failed to forecast the outcome. A potential reason is that they fell prey to the “this cannot happen” narrative, since most of the traders shared social and work circles in financial hubs where the remain option was prevalent. In short, the participants in the prediction markets were not diverse enough to efficiently aggregate the preferences of the voters.
6. Now comes the real test of whether a UK in the EU or outside of the EU is better equipped to cope with globalization. The likely outcome, contingent of the final association arrangement with the EU, will be some output decline for the UK and a test of the endurance of the EU and the Eurozone in particular. The EU also has to think about how to design sound procedures allowing for the exit of member states without there being major disruption.
7. Finally, the negotiation process that will open now between the UK and the EU should be based on a long-term perspective – guided by the welfare of European citizens, and not by short-sighted partisan interests. This might help limit populism and support the survival of the European project.
   

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   Read other posts regarding Brexit by IESE professors

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• The technological innovation related to the extraction of shale oil which allowed the US oil industry two roughly double its daily production since 2009.
• The decision of the Organization of Petroleum Exporting Countries (OPEC) to compete for market share rather than try to stabilize prices has been another key cause of plunging oil prices over the past 18 months.

But where do oil prices go from here?

A standard approach for predicting the future is to look at the past. Having established that price decreases have been mainly driven by supply, a natural question is to ask how persistent positive supply-side effects were in the past.

Since the early 1980s, there have been two major slumps in inflation-adjusted oil prices prior to the current one. One took place in the mid-1980s and another during the financial crisis of 2008/2009. It is clear that the latter was based on a drop in demand, due to worsening economic conditions.

But what was the main driver of the price fall in the 80s? It turns out that – just like the current oil price bust – it was based on a positive supply-side shock, primarily due to a sharp increase in production by non-OPEC countries. Other than the recent demand-based oil price crash, when prices recovered rapidly, the supply-side oil bust of the 80s lasted for 15 years. In light of this, the outlook for oil prices seems grim. However, before jumping to a conclusion it is a good idea to consider the matter from a couple of different angles.

Firstly, in 2015, the supply of oil consistently exceeded oil consumption. The production surplus was purchased and put in storage, leading to current levels of global crude oil inventories at an all-time high. These inventories will eventually return to the market, potentially limiting an increase in oil prices in the short term.

Another factor affecting oil prices is global monetary policy. A stronger-than-expected tightening of monetary policy by the Federal Reserve will put the currencies of major oil consuming regions – such as the EU, China, India and Japan – under further depreciation pressure, after already having lost value relative to the dollar in 2015.

Further currency devaluation in consuming regions will reduce oil consumption at any given Dollar price. At the same time, an appreciation of the dollar relative to the currencies of oil producing nations increases their profit margins at a given Dollar oil price, incentivizing higher production. As both the demand and supply effect of an appreciation of the dollar go in the same direction, an appreciation of the dollar would put further downward pressure on oil prices. A weakening of the dollar would have the opposite effect.

However, no analysis of the oil market is complete without considering OPEC. So far, OPEC has responded competitively to the entry of new shale oil competitors to the market, which has contributed to the sharp fall of oil prices. One rationale behind this decision is the goal of driving higher-cost competitors out of the market. This strategy seems to be working, when considering te number of active drilling rigs in the US. While it might be economical to extract shale oil from a well in operation, even at the current price level, it is clearly not profitable to develop new wells at the current low prices. The short life span of shale oil wells then explains the sudden decline of their numbers.

OPEC might alternatively decide to reduce production levels in order to increase oil prices. However, the shale oil revolution not only introduced a new technology, but also a change in the market microstructure of the oil market. The costs of developing a shale oil well are much lower (and their life spans much shorter) than that of conventional wells, enabling small players to enter the market and thus increasing competition throughout it. And the more competitive the market is, the harder it is to control prices by unilaterally changing the output. Not to mention that an overall decrease of OPEC production levels seems somewhat unlikely with Iran’s return to the global oil market.

Except for the very recent past, Saudi Arabia has played the role of a swing producer. When prices dropped excessively, production was reduced, resulting in a lower boundary for oil prices. The large number of potential shale oil producers might collectively take over this role as swing producers; however, this would result in oil prices being constrained from above. The argument is as follows: as soon as oil prices rise to a level that makes developing new shale wells profitable, many wells will be developed and production will be quickly taken to the market. This will severely limit upward price moves.

What could the upper boundary be for oil prices? Whatever the answer is, it will be declining because innovation in shale oil extraction technology is ongoing. Once the genie is out of the bottle, OPEC will not be able to put it back in.

The post Shale Oil: The Change Factor Within the Oil Market first appeared on Economics Outlook.

Moreover, he uses his business way of thinking to analyze economic problems. Consequently,Trump sees countries as being big corporations that compete against each other . For him the US is a mega-Coca-Cola and China is a mega-Pepsi-Cola.

But nations are not companies: they don’t compete with each other. Countries trade with each other. And the central argument of economics, dating back to Adam Smith, is that voluntary trade is a positive sum game –meaning that those who win do not do it at the costs of others.

So does Trump’s success in the business world give him the requirements needed to be president of the United States? The answer is quite clearly no. The idea that business people know what the economy needs is just wrong.

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Economic policy requires a very different kind of thinking from that of appropriate for company strategy

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Years ago, Paul Krugman wrote an article titled “A Country is Not a Company.” He argued that economic policy requires a very different kind of thinking from that of company strategy, giving two reasons why this is the case.

• Companies are open systems. They are able to both sell their production to other people and draw in resources from outside. In contrast, countries are mostly closed systems. They mainly sell to themselves and have to make the most of the labor, land and the capital they have.
• Companies are top-down organizations in which people do what they’re told. Market economies are free-for-alls, in which the job of policy is largely to provide incentives to do things.

This second point recognizes the differences between unplanned – spontaneous – orders (such as languages and market economies) and planned organizations (such as business firms and armed forces). Spontaneous orders are the result of human action, but not of human design.

Who Is in Charge of Food Distribution in New York?

The economy, even though many think it has to be consciously directed, is a spontaneous order. Nobody is in charge of food distribution for New York or Barcelona, and yet those cities are still fed every day. There is no overarching central plan or “Big Brother” who guides and coordinates millions of individual choices, actions and plans into the larger outcome of the economy.

How is it then, that coordination is achieved? What is the social institution that coordinates the choices and actions of so many people, each with different slices of knowledge and information? The answer is the market system, that is, thousands of markets where millions of voluntary exchanges take place daily. This spontaneous order is based on the respect to both private property rights and freedom of contract.

Firms are different from markets. Firms are designed and planned organizations. As Ronald Coase explained over 80 years ago, firms exist because going to the market all the time can impose heavy transaction costs. You need to hire workers, negotiate prices and enforce contracts, to name but three time-consuming activities. Firms rely on conscious power, based on long-term contracts, when market-based arrangements are too bothersome.

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Many people think the president runs the economy. Consequently, they tend to give too much credit to whichever clever person is standing nearby at the right moment

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Managers develop skills based on setting, communicating and implementing strategies that increase firms’ profitability and improve the working environment. These policies are then handed down to employees, who work to accomplish the goals. Good managers are those who can lead and effectively take charge, assign tasks to teams or employees and establish solid deadlines.

These management skills are useful in simple organizations, like firms, but they are not very effective in complex systems like markets. Markets are NOT top-down organizations. The global economy has so many variables that even if a president were to try and take charge of the economy, he simply couldn’t. His policies do have some effect, but he actually runs very little.Nevertheless, many people think the president runs the economy. Consequently, they tend to give too much credit to whichever clever person is standing nearby at the right moment. Individuals, political parties and big companies can make a difference of course. But if there is one dominant misconception about the world, it is that we go around assuming it is much more of a planned place than it is.

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There is no doubt that a smart CEO could excel at being president. The risk, though, is that CEOs tend to think they can manage the economy as they do with their companies

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I’m not suggesting that business people cannot be outstanding presidents. There is no doubt that a smart CEO could excel at being president. The risk, though, is that CEOs tend to think they can manage the economy as they do with their companies. As Hayek put it: “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design”.

My aim is to stress that the economic way of thinking is very different from the business way of thinking. MBA students quickly understand that economics courses won’t help them run businesses. The opposite also holds: knowledge on how to run businesses is a futile expertise for economic analysis .

The post CEOs Running for President: Countries Are Not Companies first appeared on Economics Outlook.