His first question, expectedly, was concerned with the model of a “good society” to which such control, were it to be regained or built from scratch, would lead. To which I answered, that whereas there seems to be widespread, world-wide even if not universal consensus that an alternative and hopefully better society is conceivable, and that the present-day society stops well short of the ideal – we are nowhere near the consensus when it comes to describe that ideal: what one would be inclined to call the “good society”. We know what we would wish, and feel imperative, to run from; where to to run is however another matter altogether.

I believe that the debate about the shape of a “good society” lost much of its past zeal and momentum due mostly to the crisis of agency: the big doubt that underlies the dropping of the “good society” model from the public agenda is that there is no agency in sight that can be trusted with the capacity and willingness to make it real. This doubt in turn derives from the ever more visible divorce between power (that is, ability to have things done), and politics (that is, the ability to decide which things need/ought to be done). The two abilities, conjoined for a few centuries in the institutions of the nation-state, inhabit now, in the result of globalization processes, two different spaces (to use Manuel Castells’ terminology, the “space of flows” and the “space of places” respectively).

Much of the power evaporated from the nation-state into the supra-national, global space – while politics remains, as before, local: confined to the boundaries of the state’s territorial sovereignty. What we confront therefore is, on one hand, a free-floating power cut off from political supervision and guidance and on the other fixed and territorially-limited politics that in addition is bound to suffer from a perpetual deficit of power. The first, the powers-that-be, we suspect with good reasons are neither interested nor willing to reform the status quo, whereas the second would not be capable of undertaking, let alone see trough a reform whether it would or wouldn’t be fond of that idea.

None of the inherited/extant political agencies, designed originally to serve a society integrated at the nation-state level, is fit for the role; none is resourceful enough to match the volume and gravity of the task. In so many countries, even the most resourceful among them, citizens are exposed day in, day out to the un-edifying spectacle of governments looking to the “markets” for permission or prohibition of doing what they intend to do – and in particular of what their citizens would dearly wish and demand them to do. It is “the markets” now who have usurped (not without connivance or even explicit or tacit endorsement and sponsorship of the helpless and hapless state governments) the first and the last word in negotiating the line separating the realistic from the unrealistic. And “markets” are a shorthand name for anonymous, faceless forces with no address: forces which no one elected and no one has empowered to call to order and keep away from mischief; no one is able to constrain, control and guide.

The gathering and well founded popular impression, but increasingly the expert opinion as well, is that elected parliaments and the governments which the parliaments are constitutionally obliged to direct, monitor and supervise, are incapable of doing their jobs. No more capable of performing their jobs are the established political parties, notorious as they are to retreat on their poetic electoral promises the moment their leaders enter ministerial offices and find themselves confronted with the prose of overwhelming while untouchable market forces and stock exchanges, well beyond the reach of the entitlements ascribed to and/or tolerated in the organs and agencies of the ostensibly “sovereign” nation-states. Hence the deep and deepening crisis of trust. The era of trust in the acting capacity of the nation-state institutions is giving way to the era of institutional un-self-confidence and popular mistrust in the governments’ ability to act.

The idea of the territorial state’s sovereignty goes back to 1555, when at a meeting called to Augsburg by the warring dynastic rulers desperately seeking an exit or at least a respite from protracted gory and devastating religious wars tearing the Christian Europe apart the formula cuius regio, eius religio (he who rules, determines religion of the ruled) was coined. The ruler’s sovereignty that formula suggested, as elaborated by Machiavelli, Luther, Jean Bodin (in his exceptionally influential De la Republique published 21 years after the Augsburg treaty) or Hobbes, meant a full, unconstrained right of Kings to proclaim and execute the laws binding whoever happen to inhabit the territory under their rule (variously described as ascendancy, supremacy, or dominance). Sovereignty meant supreme – unconstrained by external interference and indivisible – authority within a territory: since its inclusion into the political vocabulary the concept of sovereignty referred to a territorially confined state of affairs and territorially fixed entitlements. As Machiavelli argued, and all the politicians worthy of that name were to reiterate since, the sole obligation of the Prince is to raison d’état – “état” – state, Staat – being admittedly, invariably  territorial entities defined by their borders. As the Stanford Encyclopaedia of Philosophy puts it,

Sovereign authority is exercised within borders, but also, by definition, with respect to others, who may not interfere with the sovereign’s governance

those “others” being, obviously, the authorities also territorially fixed – though located on the other side of the borders. Any attempt to meddle with the order of things established by the sovereign on the territory of his rule is therefore illegal, condemnable, a casus belli; the Augsburg formula may be read as much as the founding act of modern phenomenon of state sovereignty as well as it is read, simultaneously and necessarily, as the textual source of the modern concept of state borders.

It took however almost one hundred years of more bloodletting and devastation, until  1648 and the “Westphalian Sovereignty” agreement negotiated and signed that year in Osnabrück and Münster, for the principle recommended by the Augsburg formula to take hold of European social and political reality: a full sovereignty of every ruler on the territory he ruled and over its residents – that is, the ruler’s entitlement to impose “positive” laws of his choice that may override the choices made individually by his subject, including the choice of God they ought to believe in and must worship. It was this formula that was inadvertently destined to provide, by a simple expedient of substituting “natio” for “religio”, the mental frame or stencil used shortly later to create and operate the (secular) political order of the emergent modern Europe: the pattern of nation-state – that is, of a nation using the state’s sovereignty to set apart “us” from “them” and reserving for itself the monopolistic, inalienable and indivisible right to design the order binding for the country as a whole, and of a state claiming its right to the subjects’ discipline through invoking the commonality of national history, destiny and well-being – those two constitutive elements of the pattern having been presumed and/or postulated to be territorially overlapping.

That historically composed pattern, chosen from many other conceivable, feasible and plausible ordering principles, has been in the course of subsequent centuries “naturalized” – endowed with the status of self-evidence and un-questionability – in most of Europe; as well as gradually yet steadily imposed by Europe-centred world empires on the planet as a whole in and through long series of wars waged against the local, all-too-often stubbornly resistant realities (think for instance of the crudely and bluntly artificial “national borders” of the post-colonial states barely containing tribal feuds, or the gory fate of the post-Yugoslav republics). When after the horrors of the twentieth century thirty-years world war the first attempt in history to establish a plausibly sustainable consensual order of the planet-wide peaceful cohabitation was undertaken, it was on the Westphalian model of sovereignty that the Charter of United Nations, of the assembly of the rulers of sovereign states called to collectively monitor, supervise and tooth-and-nail defend that state of peaceful coexistence, was founded. 2(4) article of that Charter prohibits attacks on “political independence and territorial integrity”, whereas the article 2(7) sharply restricts the eventuality of an intervention from outside into affairs of a sovereign state, however outrageous such affairs could be.

We live still in the “post-Westphalian era”, licking the as yet unhealed (perhaps incurable) wounds, which the cuius regio, eius natio rule has delivered and continues to deliver to social bodies seeking or struggling to protect and retain their integration. The process of emancipation from the shadows cast by “Westphalian sovereignty” is protracted and has been thus far painful and anything but uniform. While many powers (finances, commercial interests, information, drug and weapon trade, criminality and terrorism) have already obtained in practice if not theory the freedom to defy and neglect that phantom, politics (the ability to decide how and what for powers are to be deployed) is still smarting under its constraints. The conspicuous absence of global political agencies capable of catching up with the already global reach and capacity of powers and regain its lost control over them is arguably the main obstacle on the rough and bumpy road towards the “cosmopolitan consciousness” matching the new global interdependence of humanity.

As indicated before, the United Nations, an institution brought into being as a reaction to the war initiated by acts of aggression perpetrated by some sovereign nation-states against other nation-states’ sovereignty and coming closest to the idea of a “global political body”, has the entrenchment and tooth-and-nail defence of the Westphalian principle written into its Charter. The kind of “international” (read: inter-state, inter-governmental, inter-ministerial) politics which the UN is bound to promote and practice and the only one it is permitted and capable of promoting and practising, far from being a step on a road leading towards genuinely global politics would prove to be a major barrier set across such road, were such a road ever to be entered. On a somewhat lower but structurally homomorphic level, look at the fate of euro: the absurdity of a common currency served/sustained by seventeen finance ministers, each bound to represent and defend his/her country’s sovereign rights. The plight of euro, exposed to the vagaries of local (nation-state) politics smarting under pressures coming from two distinct, starkly heterogeneous, uncoordinated and thereby not easily reconcilable authoritative centres (nationally confined electorate and supra-national European institutions, all too often instructed to act, and acting, at cross-purposes), is just one of many manifestations of a double bind: the condition of being clenched as in a vice, immobilized and incapacitated between the ghost of the Westphalian state sovereignty on one side and the realities of the global, or less than global but nonetheless supra-national, dependency on the other. When I write these words, the debate conducted by the 27 member states of the European Union on the ways to save the euro, Greece and perhaps European Union itself has been suspended (with the possibility of grave consequences of reaching a point of no return, and a certainty of yet more collateral damages brought on Europe as a whole by another month of free-for-all presented to the stock-exchange gamblers and currency speculators) until Greek and French parliamentary elections.

To put this in a nutshell: we are still deprived of a global equivalent/homologue of the institutions invented, designed and put into operation by our grandfathers and great-grand fathers at the level of the territorial nation-state in order to secure the marriage of power and politics: such institutions as serve or at least meant and pressed to serve the coalescence and coordination of diffuse interests and opinions, their proper representation and reflection in the practice of executive organs and universally binding code of laws as well as juridical procedures. What is left to us is to wonder whether this challenge can be met and this task performed by the extant political institutions, created after all and groomed to serve a quite different (nation-state) level of human integration and to protect that level from all and any intrusions “from above”. It all started, let’s recall, from the monarchs of Christian Europe fighting to stave off the Popes’ pretences to oversee their dominions.

For a few centuries, that inherited settlement was relatively well attuned to the realities of their time, time of power and politics locked in each other company at the level of budding nation state, time of Nationalökonomie and of Reason identified with raison d’état – but this is no longer the case. Our interdependence is already global, whereas our instruments of collective action and will-expression are as before local and stoutly resisting extension, infringement and/or limitation. The gap between the scope of interdependence and the reach of institutions called to service it is already abysmal, yet day by day widening and deepening. Filling or bridging that gap is in my view the “meta-challenge” of our time – one that ought to be given the top rank among preoccupations of the residents of 21^st Century: the challenge that needs to be adequately met so that other, lesser yet derivative and inalienable challenges, can start being earnestly, properly and effectively confronted.

The “austerity party” is not against growth. It calls for the same type of growth which all governments have tried to achieve over the last decade – through structural reform focusing on liberalization, privatization and employment policies based on the weakening of labour market institutions. By presenting growth as “their policy”, progressives neglect to criticize the type of growth conservative governments think should be achieved.

The question progressives should pose is whether growth can be achieved by way of intervention on the labour markets, as claimed by the ECB and the supporters of fiscal consolidation. Labour market institutions can adapt to global change by making a country more investment- and start-up-friendly. But they cannot actually create jobs out of nowhere. Far from being fuelled by labour market reforms, growth over the last decade among many countries now facing recession was based on asset hypertrophy. When unemployment is cyclical – resulting from credit crunches and cuts in government spending – there is no reason for the private sector to create jobs. Reforms aimed at easing firing can only have the effect of increasing unemployment and further depressing demand as long as the recession is on.

Some empirical evidence might prove useful: Italy – with its large use of atypical contracts at the margin and rather robust protection of standard employment – has experienced an overall limited increase of unemployment since the beginning of the crisis, but the increase disproportionately affected the atypical young workers. Among the under-25 unemployment rose from 20.5% in 2007 to 29.7% in 2011, whilst the increase has been of just 2 percentage points among the over-25. These numbers were negatively outperformed by the countries facing sectoral shocks, such as Spain – which saw an increase of youth unemployment of 30 percentage points – and Ireland – 20 points. Among the Mediterranean countries, flexibility or wage deregulation cannot be further increased at the margin, so where there is the direst need of job creation. Claiming that the Spanish youth do not work due to the rigidity of the Spanish labour market institutions means to deny that the sectoral shock in the construction sector played any role in the current increase of unemployment. An assumption which is at odds with reality.

This suggests that reforms extending or increasing flexibility for standard work contracts, as recommended by the troika to the peripheral eurozone countries, would have little effect on youth unemployment and do not foster growth. They can help job creation when growth picks up – but at the same pace it leads to job destruction in case of a recession. And embarking on austerity all together within a currency union is a recipe for not allowing growth to pick up.

But if the response of the “party of growth” is then to increase demand by way of relaxing budgetary discipline, fundamental constraints persist at the national level. Simply put, borrowing costs in deficits countries are unsustainable. And the assumption that Germany and other surplus countries should boost demand by profiting from negative borrowing costs does not hold: policy-induced reversal of marginal propensity to save relies on very weak empirical evidence, and peripheral countries’ industrial bases will not become more competitive if funds for infrastructure, education, and the quality of administration and the judicial system are subject to cuts, as they are under austerity measures.

This leads to the conclusion that the national level can do very little for growth both on the supply and the demand side, meaning that borrowing costs can only be reduced through the European level. Some well-designed form of debt unification and common issuance would lead to more jobs and growth than any labour market reform. This would imply an increase of Germany’s borrowing costs, even though it is now enjoying negative real interest rates. In other words, if growth has to be demand-sided, the money will have to come from Germany. This explains the disappointing results of the last Council, but this is not a surprise considering that Merkel’s electoral difficulties are likely to increase the toughness of the German position and therefore German isolation. But without this, any proposal for growth would be probably ineffective.

The table below indicates that during the 2000s (prior to the financial crisis), the major EU countries had a structural budget deficit on average in the range 2 to 3 per cent of GDP. A budget deficit of that order of magnitude on average would lead to debt to GDP ratio of about 40 to 60 per cent (with a nominal growth rate of 5 per cent per annum). Seeking to move from a structural budget deficit of the order of 2 to 3 per cent to a balanced one requires not only cuts in public expenditure and significant increases in tax rates, but also an accommodating change in private behaviour with regard to savings and investment, without any clear rationale for thinking that such accommodating changes will take place.

In the ‘fiscal compact’ the concept of ‘structural budget’ is not defined and we have to assume that the term is being used synonymously with cyclically adjusted budget position to mean the budget position which would correspond to the economy operating at some ‘normal’ level of output (relative to trend) – what is now often referred to as ‘potential output’. ‘Potential output’ is itself a problematic concept and slippery to define and measure which raises doubts about the implementation of a rule (of balanced structural budget) relying on such a problematic concept – for example, whose measure of ‘potential output’ is to be used in the calculations of the structural budget position.

Let us for a moment accept that some notion of ‘normal’ or ‘potential’ output can be agreed upon, and consider the implications of the ‘balanced structural budget’ rule. George Irvin in his recent contribution set out the national income accounting relationships involved.

The key relationship can be written:

Budget Deficit = Private Savings – Private Investment + Capital Account Inflow (=Current Account Deficit)

Thus for there to be a balanced structural budget (deficit equals zero), Private Savings minus Private Investment must equal Current Account Surplus, and for the economy to be operating at ‘normal’ (or potential output). Hence for a balanced structural budget, the amount people and corporations wish to save at ‘normal’ output, the amount firms wish to investment along with the current account position should satisfy that equation. But is there any reason to think that the intentions of firms and households with regard to savings and investment will satisfy that equation?

During the 2000s most governments operated with a budget deficit, and also with a structural budget deficit. As compared with the conditions prevailing in the 2000s, the achievement of a balanced structural budget would not only require that there is some combination of lower public expenditure and higher tax rates but also that there is a corresponding change in the ‘normal’ levels of savings, investment and current account position. The direction of change would need to be for higher investment, lower savings and larger current account surpluses.

The table below indicates the averages of budget deficits for four major countries and the euroarea as a whole over the period 2001-2007 with the output gap close to zero on average, and we use these figures to illustrate some of the issues. If, over this period, a balanced budget had been achieved on average (which would be close to but not identical with a balanced structural budget), then (as a matter of national accounting arithmetic) Germany would have needed investment to be 16 per cent higher, or savings 11 per cent lower, or the current account position to have been 2.7 per cent of GDP further in surplus. This is not a matter of investment rising by 16 per cent from one year to another, but of investment being one-sixth higher every year (than it was during the period 2001-2007). Thus if a balanced structural budget is to be achieved, it has to be explained why and how investment is going to be one-sixth higher, and how that would come about without specific government measures. A similar set of arguments can be applied to savings and to net exports.

Economists have long argued over whether the desires to save and to invest would be compatible with each other and with full employment (and more recently with output equal to potential output). The pre-Keynesian answer was that those desires and intentions would be compatible provided that the rate of interest was adjusted to the ‘natural rate of interest’, where, by definition, the intention to save and the intention to invest would be aligned. As a consequence, there would be no need for a budget deficit, and indeed a budget deficit would be seen to crowd out private investment. The Keynesian answer has been that decisions to save and decisions to invest are made by different groups and driven by quite different factors, and there was little reason to think that savings and investment intentions will be aligned. The ‘fiscal compact’ puts into law the pre-Keynesian answer with its insistence that a balanced structural budget can be achieved, and that the market left to itself will achieve it. It seeks to outlaw the Keynesian answer, even though that is the correct one!

Best of luck to you as you leave the academy for your chosen professions in finance. Over the course of your careers, Wall Street and its kindred institutions will need you. Your training in financial theory, economics, mathematics, and statistics will serve you well. But your lessons in history, philosophy, and literature will be just as important, because it is vital not only that you have the right tools, but also that you never lose sight of the purposes and overriding social goals of finance.

Unless you have been studying at the bottom of the ocean, you know that the financial sector has come under severe criticism – much of it justified – for thrusting the world economy into its worst crisis since the Great Depression. And you need only check in with some of your classmates who have populated the Occupy movements around the world to sense the widespread resentment of financiers and the top 1% of income earners to whom they largely cater (and often belong).

While some of this criticism may be over-stated or misplaced, it nonetheless underscores the need to reform financial institutions and practices. Finance has long been central to thriving market democracies, which is why its current problems need to be addressed. With your improved sense of our interconnectedness and diverse needs, you can do that. Indeed, it is the real professional challenge ahead of you, and you should embrace it as an opportunity.

Young finance professionals need to familiarize themselves with the history of banking, and recognize that it is at its best when it serves ever-broadening spheres of society. Here, the savings-bank movement in the United Kingdom and Europe in the nineteenth century, and the microfinance movement pioneered by the Grameen Bank in Bangladesh in the twentieth century, comes to mind. Today, the best way forward is to update financial and communications technology to offer a full array of enlightened banking services to the lower middle class and the poor.

Graduates going into mortgage banking are faced with a different, but equally vital, challenge: to design new, more flexible loans that will better help homeowners to weather the kind of economic turbulence that has buried millions of people today in debt.

Young investment bankers, for their part, have a great opportunity to devise more participatory forms of venture capital – embodied in the new crowd-funding Web sites – to spur the growth of innovative new small businesses. Meanwhile, opportunities will abound for rookie insurance professionals to devise new ways to hedge risks that real people worry about, and that really matter – those involving their jobs, livelihoods, and home values.

Beyond investment banks and brokerage houses, modern finance has a public and governmental dimension, which clearly needs reinventing in the wake of the recent financial crisis. Setting the rules of the game for a robust, socially useful financial sector has never been more important. Recent graduates are needed in legislative and administrative agencies to analyze the legal infrastructure of finance, and regulate it so that it produces the greatest results for society.

A new generation of political leaders needs to understand the importance of financial literacy and find ways to supply citizens with the legal and financial advice that they need. Meanwhile, economic policymakers face the great challenge of designing new financial institutions, such as pension systems and public entitlements based on the solid grounding of intergenerational risk-sharing.

Those of you deciding to pursue careers as economists and finance scholars need to develop a better understanding of asset bubbles – and better ways to communicate this understanding to the finance profession and to the public. As much as Wall Street had a hand in the current crisis, it began as a broadly held belief that housing prices could not fall – a belief that fueled a full-blown social contagion. Learning how to spot such bubbles and deal with them before they infect entire economies will be a major challenge for the next generation of finance scholars.

Equipped with sophisticated financial ideas ranging from the capital asset pricing model to intricate options-pricing formulas, you are certainly and justifiably interested in building materially rewarding careers. There is no shame in this, and your financial success will reflect to a large degree your effectiveness in producing strong results for the firms that employ you. But, however imperceptibly, the rewards for success on Wall Street, and in finance more generally, are changing, just as the definition of finance must change if is to reclaim its stature in society and the trust of citizens and leaders.

Finance, at its best, does not merely manage risk, but also acts as the steward of society’s assets and an advocate of its deepest goals. Beyond compensation, the next generation of finance professionals will be paid its truest rewards in the satisfaction that comes with the gains made in democratizing finance – extending its benefits into corners of society where they are most needed. This is a new challenge for a new generation, and will require all of the imagination and skill that you can bring to bear.

Good luck in reinventing finance. The world needs you to succeed.

Copyright Project Syndicate, the world’s pre-eminent source of original opinion commentaries. (Follow PS on Facebook and Twitter)

The ‘austerians’, facing this inconvenient reality, are now slightly adapting their position. They are now arguing that austerity did not work, not because it was wrong to cut deficits in the face of a weak recovery, but because the strategy was incomplete. Fiscal austerity should have been ‘complemented’ with some action on the side of growth with some growth-generating action. Policy proposals to this effect, such as mobilizing currently unused European structural funds and inserting new capital into the European Investment Bank so that it can finance major European investment projects, are already circulating. The end result of this ‘new’ approach, which we can call an “Austerity Plus” plan, is that fiscal consolidation is to be continued if accompanied with the type of policy actions described above. In this way,  neither the principle of fiscal cuts nor the new Fiscal Compact treaty are put into question, not even in the face of mounting evidence of the economic and social disaster that brutal austerity is producing.

Can we have austerity and growth at the same time? One key reason to be skeptical is that the equation as proposed by the ‘austerians’ does not add up. The policy action on growth which some European policy makers are now proposing is simply too limited to be able to compensate for the negative effect of fiscal contraction. Take the example of Spain. According to official targets, Spain will be forced to cut its deficit from 8.9% of GDP (2011) to 5.3% in 2012 and 3% the year after. However, to realize an ex post 6% cut in the deficit over a two year period, thereby taking into account the impact on growth and second round negative effects on the deficit, Spain will need to do an ex ante  fiscal cut that is almost double that amount and close to 12% of GDP. It does not take a highly trained econometrician to understand that this will push the Spanish economy into several years of recession, in exactly the same way as it did with Greece.

Now let’s suppose that the ‘austerians’ come through on their promises and provide, through the European Investment Bank, additional finance for projects and funds backing up demand and growth in the Spanish economy. Let’s also suppose that this doubles the amount of investment projects Spain has accessed in 2011 through EIB finance. This amounts to 17 billion euros, representing around 1.5% of Spanish GDP. However, even if such an injection in the Spanish economy is highly welcome, it will offset only a small part of the total 6 to 12% contractionary shock that would be administered to Spain in the course of the next two years. A similar calculation can be made for France, where the objective is to cut the deficit from 5.2% of GDP in 2011 to 3% by 2013. This boils down to an ex ante fiscal adjustment of 4% of GDP.

Moreover, the ambition does not stop with the 3% deficit target. After 2013, the idea is to rapidly eliminate budget deficits altogether along with planning a systematic fall in public debt ratios as described in the Fiscal Compact. Massive cuts in public budgets are therefore to continue beyond 2013. Unless entirely unrealistic proportions are assumed, there is no way a European investment program can deal with this.

Instead of trying to give credibility to a strategy that is simply  non-credible, this week’s  informal European Council should decisively go for a ‘Growth Plus’ plan. Europe needs to break with fiscal austerity and turn things upside down by starting to work from the growth side of the equation. Here’s how such a ‘Growth Plus’ plan works:

First, the focus of policy action needs to be shifted towards growth and away from austerity cuts. To do so, the proposals now being launched on European wide investments mainly supporting the ‘deficit’ countries together with EIB finance are a good basis to start from. At the same time, this must be accompanied by a temporary moratorium on new fiscal consolidation measures. To give growth and recovery a chance at least one a year of ‘fiscal healing’ is in order.

Once the economy reconnects with growth, then (and only then!), the public finance side of things is to be taken into account. However, this is not to be done by imposing brutal fiscal consolidation programs but by letting growth dynamics do their work. If, as we can witness from the renewed recession, austerity is self defeating, then the opposite is also true: growth and investment is self rewarding. By putting the economy back on the track of growth, public deficits will fall automatically. Even better, public debt ratios will also start falling because of the combined positive effect of a falling nominator (deficits) and a rising denominator (nominal GDP). However, it also needs to be understood that “self rewarding” growth is not a sprint but more like a marathon: it is a process that takes time and that needs to be given that time. This implies that the objectives of reaching a 3% deficit by 2013 or a zero deficit by 2016 or 2017 need to be spread over a longer period of time, unless (but we do not expect that to happen) the economy starts booming.

However, this still isn’t a ‘free lunch’. In fact, such a process of gradual and growth driven reduction of deficits does imply continued fiscal discipline. The benefits of growth need to be managed. Member states need to be prevented from squandering away the positive effect growth has on deficits and debt  by, for example, engaging in another round of supply side/competitive tax cutting. In other words, deficit targets are to remain a firm part of European economic governance, provided they are flexible and adapted to the position of the economy in the business cycle.

If the Heads of Government are really serious about addressing the many problems Europe is facing, the European Council should stop ‘kicking the can down the road’ by making cosmetic changes to its austerity strategy and instead go for the ‘Growth Plus’ plan described above. If not now, then when?

The European System of Central Banks (ESCB) is quite complex. The “backdoor” lender of last financing of the banks in the PIIGS that are losing deposits through the ECB is less than transparent. In spite of its complexities, the ECB can move quickly to arrest this problem. Of all the financial maladies that exist, the one with which the world has the most experience and therefore has developed the most effective tools to address is a bank run.

It is therefore a bit of a puzzle why one of the most commonly cited fears about a Greek departure from the Eurozone is that it would lead to a bank run in other Eurozone countries. The reason for the fears, as with all things European, is that politics prevents a common sense response. Politics is an obstacle, but in that panicked weekend in the future when the powers that be are worried about what might happen on Monday morning, all of the theoretical political obstacles that had prevented action will be forgotten. The points are obvious ones, but sometimes it is useful to reiterate the obvious in order to identify the real risks that exist in as complicated a set of circumstances as a Greek departure from the Eurozone might entail.

The obvious point to make is that deposit insurance is a proven cost-effective way of limiting downside risk in a financial meltdown. Bank runs are liquidity problems, not solvency problems. This is important because insolvent institutions rarely fail as long as they are liquid. Thus, it is not necessary to restore the solvency of an institution when a bank run develops and incur all the trouble and expense that this entails. All one need do is reassure depositors that they have access to their money. Moreover, keeping deposits in a bank eliminates the need to liquidate the asset side of the balance sheet at fire sale prices. Even a normally solvent institution can become insolvent if it were forced to liquidate its assets too rapidly.

The run on the banks on Europe’s periphery is already huge and is accelerating. In a FT article Gavyn Davies provided a table and a chart that illustrate this point.

And from David Mackie at JP Morgan:

The table reflects March or April data and the chart reflects mid Q1 2012 data. Target 2 refers to Trans-European Automated Real-time Gross Settlement Express Transfer. It is the euro system’s operational tool through which the national central banks of member states provide payment and settlement services for intra/euro area transactions. Target 2 claims can arise from trade and current account transactions as well as purely financial transactions. Recently financial transactions have become dominant. Funds have been taken out of banks on Europe’s periphery and have been deposited in banks in the north of Europe, principally in Germany. The bank receiving the deposit has its funds delivered through the national central banks to the bank on the periphery that has lost deposit funds. That is a Target 2 transaction. The so-called Target 2 outstanding balance is the net position of such claims between two European countries.

ELA stands for Emergency Liquidity Assistance. Such assistance is extended by single national central banks to their banking systems. The risk is borne at the national level. The collateral requirements imposed upon a commercial bank for obtaining ELA funds is less than the collateral requirements needed for obtaining Target 2 funds. However, though I am not absolutely sure of this, the national central bank in a country like Greece with commercial bank deposit runs – ultimately funds its ELA financial assistance to its commercial banks from the ECB.

In a recent Bloomberg article, it was suggested that the deposit runs from Greece, Ireland, and Portugal combined to date have been equal to 52% of the original pre-run deposits. I suddenly realized that, if the first two columns in the above table were additive, the total deposit runs from these two banks could be half of all original deposits. Why? Put very simply, the sum of “ECB repos and ELA” and “Target 2” for Greece, Ireland, and Portugal in the above table is 606 billion euros and the sum of the remaining bank deposits in these same countries is 596 billion euros. If the first two columns in the above table correspond to total lender of last resort financing, which should be roughly equal to the total deposit run as of that date, that run of 606 billion euros is roughly equal to 52% of the original deposit position (today’s outstanding deposits of euro 596 billion plus the total such “flight” deposits of euro 606 billion.)

How can that be? The total deposit run from the banks of Greece, Ireland, and Portugal must no doubt exceed the Target 2 and ELA financing, since some of those deposit funds surely went to banks outside the euro area like the Swiss banks and dollar-based banks. If the flight of deposits went to such non euro banks in large measure, that part of the deposit run would have forced closure of banks in Greece, Ireland, and Portugal unless they received lender of last resort financing from the ECB. Such lender of last resort financing would be above and beyond total Target 2 and ELA financing. That is probably the source of the ECB repo financing in the above table.

We can see from the above chart that Portugal, Ireland, Greece, Italy and Spain have been losing deposits and most of these deposits have gone into German banks. The flight deposit funds that have gone into German banks have been recycled back to the banks on the periphery through Target 2 and the associated ELA (Emergency Liquidity Assistance). For now let’s not worry about the institutional details.

Most commentators estimate the run on the Greek banks to date is equal to about a third of the original Greek bank deposits. The above table suggests the deposit loss is larger. It would seem from this table that the Greek deposit flight into euro area banks has been over 40% of the original deposits. From what I can tell the Greek flight deposit funds recycled back through the ECB and ELA may be more than is reflected in this table. In addition there have no doubt been additional deposit losses that have gone into dollar, Swiss franc, and other non euro system banks.

In other words, the deposit run to date on Greece has been enormous. The same could be said of the Irish banks.

So far the deposit losses from Italian and Spanish banks are a much smaller share of the original outstanding deposit liabilities. However, these deposit runs have accelerated greatly through the end of April, prior to the Greek and French elections. For Spain the Target 2 claims due to deposit runs has gone from a little more than 10% of Spanish GDP at year end 2011 to almost 30% of GDP by the end of April. For Italy these same numbers have gone from roughly 10% of Italian GDP at the end of 2011 to 20% at the end of April. Based on the Greek precedent, these deposit runs could become much larger in a fairly short time now that there is a heightened concern about a possible euro exit of all these peripheral countries or alternatively a German exit from the euro.

These Target 2 and ELA flows are part of an established ECB lender of last resort mechanism. The rules allow for this kind of lender of last resort financing of deposit runs up to certain collateral limits. Without going into the details, it seems to me that there could be another 40% run on the remaining Greek bank deposits before these collateral limits are reached. In other words, under the current ECB rules all of these countries could have ECB lender of last resort financing and deposit runs up to perhaps 60% of their original deposits. That would constitute an aggregate deposit run of almost three trillion euros from the five PIIGS.

As a consequence, the system of European central banks would be on the hook for losses, possibly from exchange devaluation if all these five peripheral countries left the euro, of some substantial percentage of a euro three trillion liquidity finance exposure. Almost everyone assumes that the Germans will not allow this liquidity financing of deposit runs on the periphery to proceed. They will stop such financing. The Germans will opt out of the euro.

In Gavyn Davies’ article he says:

As the table (from David Mackie of J.P. Morgan) shows, the outstanding bank deposits of the periphery are many times larger than the current exposures of the ECB and core governments to the periphery. It seems inconceivable that core countries like Germany will be willing to expose themselves to these risks if the deposit flight continues.

I disagree. I believe the Germans are trapped. They almost cannot and in fact will not stop this deposit run if it continues up to the collateral rule limit. Why?

• To stop such lender of last resort lending as long as there is adequate collateral would be to abrogate ECB procedures and rules and, in doing so, cut off liquidity financing to banks experiencing runs. This would force those banks to suspend deposit withdrawals. The failure of the ECB to perform its lender of last resort role in any one of these countries would immediately accelerate deposit runs in other European countries. This could extend beyond the five PIIGS to France and other countries. I do not believe any German government officials or ECB bureaucrats would take responsibility for such an outcome, even if they had the authority.

• I believe that a German exit from the ECB to limit such Target 2 loss exposure is even less likely. Germany is bound by a treaty. Any move to exit would require some kind of debate and possibly a referendum in Germany. On the first move in such a direction a massive run would be precipitated on banks not just in the five distressed peripheral countries but in other countries including France as well.

• Although all the flight deposit funds are going into German banks, under the ECB rules Germany’s loss exposure is limited to its 28% participation in the ECB. Were Germany to exit the euro its banking system including the Bundesbank might be exposed to almost all of such losses rather than the mere 28% under the current euro system.

• Lastly, any such German euro exit could cause its new exchange rate to soar which would be very adverse to its large international trade exposure. Furthermore, any such move that brought calumny to the banks elsewhere in Europe and thereby to those economies might greatly impair German international trade relations within Europe for a long time.

The bank run is already very large and could be exploding. Germany is not in a position to either limit the run under ECB rules or exit the euro in order to contain its loss exposure to the liquidity financing of banks on the European periphery. Germany is trapped.

Gavyn Davies reports that at the G-8 meeting Italy’s Mario Monti proposed up front deposit insurance rather than “backdoor” Target 2 and ELA financing to deal with Europe’s bank run. 

Mario Monti apparently took a plan to the G8 summit to offer jointly-funded guarantees on bank deposits to apply across the entire eurozone. This would certainly help, but whether it would be sufficient to eliminate fears of exchange rate losses if the euro were to disintegrate is another matter. To fix that problem, belief in the integrity of the euro as a single currency needs to be restored. The bank run could bring matters to a head.

Because Germany is trapped, I believe that Europe including Germany will go this route.

As Gavyn Davies says, for such deposit insurance to succeed will require lesser “fears of exchange rate losses if the euro were to disintegrate”.

Some of that ‘clueless-ness’ can be seen in ‘loose talk’ going around at present about the relationship between Ireland and the EU and the other EU member countries. An awful lot of this loose talk revolves around how damaged that relationship would be if the Irish people choose not to join in the Fiscal Compact. A further chunk of the ‘chit-chat’ revolves around the question of where else we would borrow ‘the money’ from when (much more so than ‘if’) we need a further dose of ‘austerity medicine’.

I will skip over the blatant inconsistency of a Government that insists we are on the correct path with light at the end of the tunnel under a fully funded and committed financial program while at the same time hastening to arrange the paperwork on yet more borrowings. But not without pointing out that the Taoiseach has recently reiterated and reaffirmed that the existing borrowing program supersedes the envisaged ESM facility that may be provided by the Fiscal Compact.

I will also skip over the issue of whether the Fiscal Compact is a smart or pragmatic or sensible or even a ‘pro-European’ step to take.

I will skip over these things to state some boring, practical banking ‘facts of life’.

There is an ‘old saw’ from the banking world which states that if you owe the bank 400,000 you have a problem, if you owe the bank 4 million you both have a problem and if you owe the bank 40 million the bank has a problem.

By the end of 2012, all financial sectors of the Irish economy, its households, businesses and the State, will be massively in debt. The State particularly will have a debt/GDP ratio about 120%. This is the level at which it becomes a very dicey proposition for both borrower and lender to go any further into debt.

But the most important thing about this debt is that this money is ALL SPENT. It is not sitting on deposit in a Swiss bank account.

You can debate all you like about whether we did the right things with that money. You can argue until you are blue in the face about whether we can repay it and grow our economy at the same time. You cannot deny that the money is gone and that all that remains is our promise to pay it back.

Those who lent it to us have no lien on the State. There is no court they can turn to enforce any security or charge because there is no such court and they have no security. And, once again, the money is not on deposit somewhere where they can go and seize it.

The only choice our lenders have is on what terms to lend us any more money. A refusal by them would put us into default.

So the issue is not where we can borrow. The issue is on what terms we will continue to repay.

Now, that is the hard practical business reality of it. If that is an uncomfortable truth for you, you should be aware that this is the reality that confronts every lender to every State that gets into financial difficulty. It is not some uncharted territory or some nightmare of eternally shattered reputation and financial purgatory. The experience of Iceland proves that. In fact, the experience of Ireland after it’s 1993 devaluation proves that. And anyone who suggests that devaluation and default are different things betrays their hopeless ignorance of the mindset and disposition of the investment and bond trading communities.

One of three things will happen in our near term future. The happiest and least likely is that we will resume some solid growth in the economy and will slowly but steadily repay these debts over a fifteen to twenty year span. The unhappy probable outcome will be that we will have weak growth and the economy will move sideways for a decade or two. The unhappy possible third option is that there will be a default which may, or may not be, ‘graceful’ and ‘managed’.

If and when that day comes for Ireland, some people will seek refuge in economic theories, some hope in protection of laws and regulations, some will seek solace in the arms of supra-national entities and a few will still seek help from deities. But the reality is that bankers and accountants will sit down with the politicians and thrash out what can be paid and seek to extract as much as possible for themselves and their clients.

If a country has leaders who care about it and who have some ability and some understanding of how the real world works, when they sit down to negotiate at that post-default table, then a positive and helpful result can be achieved for the people while being fair to the lenders.

Before that day comes it is still possible for leaders to start us down the path of a more sustainable debt burden that will in the end be fairer to both the borrower and the lenders by simply starting to talk realistically about these overarching realities. But they have neither the ability, the expertise, the self-confidence nor the courage to rock the ‘European boat’ and are content to be errand boys for the apparatchiks and the bankers by continuing on the path to default while asking us to swallow ever greater doses of pointless austerity.

This column was first published by Progressive Economy @ TASC

Between themselves journalists, marketing experts and social researchers (in that order…) assembled into the imagined formation (class? category?) of “Generation Y” young men and women between about 20 and 30 years of age (that is, born roughly between the middle of 1980s and the middle of 1990s). And what is becoming more obvious by the day is that the Generation Y, so composed, may have a better founded claim to the status of a culturally specific “formation” that is a bona fide “generation”, and so also a better justified plea for an acute attention of traders, news-chasers and scholars than had its predecessors.

It is common to argue that what grounds the claim and justifies the plea is first and foremost the fact that the members of Generation Y are the first humans who have never experienced a world without internet and know as well as practice digital communication “in real time”. If you share in the widespread assessment of the arrival of informatics as a watershed in human history, you are obliged to view Generation Y as at least a milestone in the history of culture. And it is so viewed; and so, spied out, found and recorded. As an appetizer of sorts, Brafman suggests that the curious habit of the French to pronounce “Y” in case it is linked to the idea of a generation in an English way – as “why”, could be explained by this being a “questioning generation”. In other words, a formation taking nothing for granted.

Let me, however, add right away that the questions that generation is in habit to ask are addressed by and large to the anonymous authors of Wikipedia, to Facebook pals and Twitter addicts – but neither to their parents or bosses nor “public authorities”, from whom they don’t seem to expect relevant, let alone authoritative, reliable and so worth listening-to answers.

The surfeit of their questions, I guess, is like in so many other aspects of our consumerist society an offer-driven demand; with an iPhone as good as grafted onto the body there are constantly, 24 hours a day and 7 days a week, loads of answers feverishly searching for questions as well as throngs of answer-peddlers frantically seeking demand for their services. And another suspicion: do the Generation Y people spend so much time on the internet because of having been tormented by questions they crave to be answered? Or are rather the questions which they ask once connected to the hundreds of their Facebook friends updated versions of Bronis?aw Malinowski’s “phatic expressions” (as for instance “how do you do” or “how are you”, the kind of elocutions whose only function is to perform a sociating task, as opposed to conveying information, the task being in this case to announce your presence and availability for sociating – not far from the “small talk” conducted to break boredom, but above all to escape alienation and loneliness at a crowded party).

Of the surfing of infinitely vast internet expanses the members of Generation Y are indeed unequaled masters. And of “being connected”: they are the first generation in history measuring the number of friends (translated nowadays primarily as companions-in-connecting) in hundreds, if not thousands. And they are the first who spend most of their awake-time sociating through conversing – though not necessarily aloud, and seldom in full sentences. This all is true. But is it the whole truth of Generation Y? What about that part of the world which they, by definition, did not and could not experience, having therefore had little if any chance to learn how to encounter it point-blank, without electronic/digital mediation, and what consequences that inescapable encounter might have? The part which nonetheless pretends, and with a spectacularly formidable and utterly indismissable effect, to determine the rest of, and perhaps even the most important rest, of their lives’ truth?

It is that “rest” which contains the part of the world that supplies another feature standing Generation Y apart from its predecessors: precariousness of the place they have been offered by society they are still struggling, with mixed success, to enter. 25% of people below 25 years of age remain unemployed. Generation Y as a whole chain up to the CDD (Contrat à durée déterminée, fixed-term contracts) and stages (training practices) – both shrewdly evasive and crudely, mercilessly exploitative expedients. If in 2006 there were about 600 thousand “stagiaires” in France, their current number is estimated to vacillate somewhere between 1.2 and 1.5 million. And for most, visiting that liquid-modern purgatory renamed “training practice” is unmissable: agreeing and submitting to such expedients as CDD or “stages” is a necessary condition of finally reaching, at the advanced average age of 30, the possibility of a full-time, “infinite” duration (?) employment.

An immediate consequence of frailty and in-built transcience of social positions which the so-called “labour market” is capable of offering is the widely signaled profound change of attitude toward the idea of “job” – and particularly of a steady job, a job safe and reliable enough to be capable of determining the middle-term social standing and the life prospects of its performer. Generation Y is marked by the unprecedented, and growing, “job-cynicism” of its members (and no wonder, if for instance Alexandra de Felice, reputable observer/commentator of French labour market, expects an average member of Generation Y, if the current trends continue, to change bosses and employers 29 times in the course of their working life; though some other observers, as Rouen Business School professor Jean Pralong, call for more realism in estimating the youngsters’ chances of matching the pace of job-change to the cynicism of their job-attitudes: in a labour market in its present condition, it would take a lot of daring and courage to snap one’s finger at the boss and tell him face-to-face that one would rather go than stay with such a pain in the ass.

So, according to Jean Pralong, the youngsters would rather bear with their dreary plight however off-putting that plight might be, were they allowed to stay longer in their quasi-jobs. But seldom are they, and if they are they would not know how long the stay of execution could last. One way or another, members of Generation Y differ from their predecessors by complete or almost complete absence of job-related illusions, by a lukewarm only (if any) commitment to the jobs currently held and the companies which offer them, and a firm conviction that life is elsewhere and resolution (or at least a desire) to live it elsewhere. This is indeed an attitude seldom to be found among the members of the “boom” and “X” generations.

Some of the bosses admit that the guilt is on their side. They are reluctant to lay the blame for the resulting disenchantment and nonchalance prevalent among young employees on the youngsters themselves. Brafman quotes Gilles Babinet, a 45 years-old entrepreneur, bewailing the dispossession of the young generation of all or nearly all autonomy their fathers had and successfully guarded – priding themselves of possessing the moral, intellectual and economic principles of which their society was presumed to be the guardian and from which it wouldn’t allow its members to budge. He believes that the kind of society which Generation Y enters is on the contrary anything but seductive: if I was their age, Babinet admits, I’d behave exactly as they do.

As for the youngsters themselves, they are as blunt as their predicament is straightforward: we have not the slightest idea, they say, what tomorrow is likely to bring. The labour market closely guards their secrets – just as impenetrable fortresses do: little point in trying to peep inside, let alone attempting to break the gates open. And as to the guessing of its intentions – it’s hard to believe that there are any. Tougher and more knowledgeable minds than mine are known mostly for their abominable misjudgments in the guessing game. In a hazardous world, we have no choice but being gamblers. Whether by choice, or by necessity; and it does not matter in the end by what, does it?

Well, these state-of-the-mind reports are remarkably similar to the confessions of the more thoughtful and sincere among the precarians – members of the precariat, the most rapidly growing section of our post-credit-collapse and post-certainty world. Precarians are defined by having their homes erected (complete with bedrooms and kitchens) on quicksand, and by their own self-confessed ignorance (“no idea what is going to hit me”) and impotence (“even if I knew, I wouldn’t have the power to divert the blow”).

It has been thought until now that the appearance and formidable, some say explosive, expansion of the precariat, sucking in and incorporating more and more of the past working- and middle-classes, was a phenomenon arising from the fast changing class structure. It is indeed – but isn’t it, in addition, also a matter of a changing generational structure? Of bringing forth a state of affairs in which a suggestion “tell me the year of your birth, and I’ll tell you to which social class you belong” won’t sound that much fanciful at all?

This column is part of a project on youth unemployment in Europe run by the Friedrich-Ebert-Stiftung and Social Europe Journal

The question is reasonable enough if we don’t give it an American twist. To the American mind, there can be only one superpower, so China’s rise will automatically be at the expense of the United States. Indeed, for many in the US, China represents an existential challenge.

This is way over the top. In fact, the existence of a single superpower is highly abnormal, and was brought about only by the unexpected collapse of the Soviet Union in 1991. The normal situation is one of coexistence, sometimes peaceful sometimes warlike, between several great powers.

For example, Great Britain, whose place the US is often said to have taken, was never a “superpower” in the American sense. Despite its far-flung empire and naval supremacy, nineteenth-century Britain could never have won a war against France, Germany, or Russia without allies. Britain was, rather, a worldpower – one of many historical empires distinguished from lesser powers by the geographic scope of their influence and interests.

The sensible question, then, is not whether China will replace the US, but whether it will start to acquire some of the attributes of a world power, particularly a sense of responsibility for global order.

Even posed in this more modest way, the question does not admit of a clear answer. The first problem is China’s economy, so dynamic on the surface, but so rickety underneath.

The analyst Chi Lo lucidly presents a picture of macro success alongside micro failure. The huge stimulus of RMB4 trillion ($586 billion) in November 2008, mostly poured into loss-making state-owned enterprises via directed bank lending, sustained China’s growth in the face of global recession. But the price was an increasingly serious misallocation of capital, resulting in growing portfolios of bad loans, while excessive Chinese household savings have inflated real-estate bubbles. Moreover, Chi argues that the crisis of 2008 shattered China’s export-led growth model, owing to prolonged impairment of demand in the advanced countries.

China now urgently needs to rebalance its economy by shifting from public investment and exports towards public and private consumption. In the short run, some of its savings need to be invested in real assets abroad, and not just parked in US Treasuries. But, in the longer term, Chinese households’ excessive propensity to save must be reduced by developing a social safety net and consumer credit instruments.

Moreover, to be a world economic power, China requires a currency in which foreigners want to invest. That means introducing full convertibility and creating a deep and liquid financial system, a stock market for raising capital, and a market rate of interest for loans. And, while China has talked of “internationalizing” the renminbi, it has done little so far. “Meanwhile,” writes Chi, “the dollar is still supported by the strong US political relations with most of the world’s largest foreign-reserve-holding countries.” Japan, South Korea, Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates all shelter under the US military umbrella.

The second problem is one of political values. China’s further “ascent” will depend on dismantling such classic communist policy icons as public-asset ownership, population control, and financial repression. The question remains how far these reforms will be allowed to go before they challenge the Communist Party’s political monopoly, guaranteed by the 1978 constitution.

Two important cultural values underpin China’s political system. The first is the hierarchical and familial character of Chinese political thought. Chinese philosophers acknowledge the value of spontaneity, but within a strictly ordered world in which people know their place. As the Analects of Confucius puts it: “Let the ruler be a ruler, the subject a subject, a father a father, and a son a son.”

There is also very little belief in the sanctity of human life: Buddhism holds that there is no difference between humans and animals and plants. A pledge to protect human rights was written into the Chinese constitution in 2004; but, as the recent case of the blind dissident Chen Guangcheng illustrates, this is mostly a dead letter. Similarly, private property ranks below collective property.

Then there is the Confucian doctrine of the “mandate of heaven,” by which political rule is legitimized. Today, the mandate of Marxism has taken its place, but neither has any room for a mandate of the people. Ambivalence about the source of legitimate government is not only a major obstacle to democratization, but is also a potential source of political instability.

These historical legacies limit the extent to which China will be able to share in global leadership, which requires some degree of compatibility between Chinese and Western values. The West claims that its values are universal, and the US and Europe will not cease pressing those values on China. It is hard to see this process going into reverse, with China starting to export its own values.

China has a choice: it can either accept Western values, or it can try to carve out an East Asian sphere to insulate itself from them. The latter course would provoke conflict not only with the US, but also with other Asian powers, particularly Japan and India. China’s best possible future thus probably lies in accepting Western norms while trying to flavor them with “Chinese characteristics.”

But neither choice is a scenario for China “replacing” the US. Nor, I think, is this what China wants. Its goal is respect, not dominance.

Copyright Project Syndicate, the world’s pre-eminent source of original opinion commentaries. (Follow PS on Facebook and Twitter)

The fall of princeling Bo Xilai, Communist Party boss of Chongqing, is a sordid tale that has opened a crack into the shadowy world of Chinese elites today. Several years ago, officially scorned former prime minister Zhao Ziyang warned, shortly before his death, that China had become dominated by a small power elite. The Chinese Communist Party (CCP), said Zhao, is ruled by “a tightly-knit interest group . . . in which the political elite, the economic elite, and the intellectual elite are fused. This power elite blocks China’s further reform and steers the nation’s policies toward service of itself.”

Indeed, the princeling class itself, in which the offspring of old-time party leaders have become the scions not only of inherited privilege and power but also luxury lifestyles, has become an embarrassing oddity, standing out in the land of Marxism-Leninism-Confucianism like a bikini at the North Pole. In a country in which nearly a billion people are still poor, and many of the local Communist Party honchos have attained their wealthy status through land grabs of poor people’s property that they then sold at exorbitantly inflated prices to speculators, resentment is breeding at an alarming rate. According to Chinese sociology professor Sun Liping, there were 180,000 “mass incidents” – everything from strikes to riots and demonstrations – in 2010, twice as many as in 2006, many of them protesting land grabs.

According to a recent study by Professor Yu Jianrong of the Chinese Academy of Social Sciences, there have been forcible land takings of almost 7 million hectares since 1990, and losses by farmers of over $300 billion in rights and benefits. Another study calculates that four million rural Chinese have their land appropriated every year, and that commercial land developers who purchase the land from local governments pay over 400% more than the rural residents receive in compensation. All of this feeds a slow burning resentment in the countryside, and incidents like the Chongqing incident add fuel to the flames.

But China is a paradoxical place, one where the last 10 years under the administration of President Hu Jintao and Prime Minister Wen Jiabao have seen a solid improvement in the living conditions of millions of everyday people. That, plus the risks of harassment and even imprisonment by CCP authorities for mounting any form of protest, causes many Chinese to prefer to view matters like the Chongqing scandal as something that happens among the gods on top of holy Mount Tai Shan. And China is certainly not the only major country that is ruled by “a tightly knit interest group” of political and economic elites. The global economic collapse of 2008 that began on Wall Street was caused by excessive elite influence over the American political process that led to massive deregulation of the financial industry. When combined with the subsequent failure to re-regulate Wall Street and its highflying ways, that provides tragic testament to the stunted nature of American democracy and governance.

But what remains additionally troubling about the Chinese version of elite rule is how secretive it all still is. The top political leaders exist behind a shroud of mystery that is as dark as the glazed windows of the luxury limousines that can be seen darting along the streets of Shanghai, Beijing and Chongqing in increasing numbers. Much of the reportage of this sequestered world, whether from Chinese sources or Western journalists, often have to speculate about what’s going on behind the scenes. No one seems to know, for example, how the top leaders of the 25 member Politburo, or of the highest executive nine-member Politburo Standing Committee, are selected; no one seems to know exactly how the already-picked successors to Hu and Wen, Xi Jinping and Li Keqiang, were plucked for these posts; no one seems to really know to what extent the Chinese military, the PLA, is in control of the civilian leadership or vice versa. Most of the Chinese leadership is hidden behind the doors of its own forbidden city. Its leadership selection process is as mysterious as a papal enclave, except that we know that privilege and pedigree are crucial for success in this Marxist-Leninist aristocracy. But it’s also a meritocracy to some degree, in which the princelings often are highly educated men of science and technology that run their economic fiefdoms like CEOs. Fortunately for China, some of these leaders have proven to be both competent managers as well as corrupt.

The Rumblings of Wukan

Yet despite the pre-democratic, quasi-medieval condition of its political system, China keeps uncovering the green shoots of an alternative future. The most recent one is in the fishing village of Wukan, which is only a three hour drive from Shenzhen, the famous city that has been at the heart of China’s experiments with free enterprise.

Wukan, with only 13,000 residents, became internationally known as the location of anti-corruption protests that broke out in September 2011. The protests began after local officials sold land to real estate developers without properly compensating the villagers. The protests strengthened after one of the villagers died in police custody under suspicious circumstances. The furious protestors forcefully evicted local Communist Party officials and police from the village, leading to a blockade of the village by police.In December 2011, a thousand police laid siege to the village, preventing food and goods from entering, but the locals held strong. Finally the Communist Party chief of Guangdong province, Wang Yang, intervened and agreed to the villagers’ demand to hold a local election to resolve the leadership dispute. While village elections are common in China, most of them are rigged by local CCP officials. But the election in Wukan in early January was free and fair by Chinese standards, and the villagers elected a leader of the protests to the post of village Party chief, replacing the corrupt CCP leader and his cronies who had held that position for 42 years.

Some have said Wukan is an important model in the fight over illegal land transactions, which are still rampant throughout China. The popular Chinese novelist and blogger Han Han, who has been skeptical about prospects for democracy, said in an interview “In Wukan’s case, I see the light on the road to China’s future democracy.” Contrary to conventional wisdom, China already holds more elections than any other nation in the world. Under the Organic Law of the Village Committees, all of China’s approximately one million villages — home to some 600 million voters — hold elections every three years for local village committees. Critics scoff at these local elections, saying they are controlled by the local CCP which decides most of the candidate nominations, and often doesn’t even allow a secret ballot or independent oversight or review of the election.

But other researchers who have studied these local elections say an increasing number of them have been growing more competitive, with the use of the secret ballot becoming more common. For those elections where there have been independent candidates and democratic safeguards, researchers claim to have evidence of positive impacts, such as decreases in corruption and the tossing out of old CCP hacks. So Wukan was only the latest of a number of elections that have shown hopeful signs.

Others say that the impact of Wukan and other local elections has been minimal. Professor Hairong Lai, director of the China Center for Overseas Social and Philosophical Theories and coauthor of China Experiments: From Local Innovation to National Reform, says the election in Wukan was successful because the provincial government heard the desires of the people and the villagers got the election they requested. But he has doubts that “this election will lead to calls for more such elections in China,” though it could be referred to by advocates as a precedent. Professor Baogang He, a professor at Deakin University in Australia and the author of numerous books and academic papers on democratization in China, is even more skeptical. He says the election in Wukan has not led to more calls for elections or more democracy in China.

Its impact may be limited in part because high-ranking officials are afraid of what too much democracy might unleash, including upon their own careers. The provincial party chief, Wang Yang, who permitted the election to go forward, has gone out of his way to downplay the impact.

“A lot of people believe that the resolution of the problem at Wukan was the opening of a new channel and a foreshadowing of political reform,” said Mr. Wang. “But the elections were held according to the organization rules of the village and the election regulations of Guangdong province. There was nothing new about this.”

Mr. Wang has been careful not to alarm the central government in Beijing or top party leaders, which no doubt is probably smart considering the fate of Zhao and Hu Yaobang, two Chinese leaders who were at the top of the CCP pyramid, supported by Deng Xiaoping himself, until they were accused of allowing the liberal forces that led to Tiananmen Square to spiral out of control. Both ended their careers in political exile.

Nevertheless, surveys show widespread popular support for elections. In a recent survey, 84% of respondents agreed with having elections for national leaders. Professor Xinjun Gao, a Senior Researcher at the China Center for Comparative Politics & Economics, says “China’s democratization process has been underway and it cannot stop. That’s because democracy is a natural law, a core part of development of a society. If the Communist Party wants to stay in power, it must allow gradual democratization because the market economy cannot solve all things.”

Democratic authoritarianism?

But the Chinese people themselves seem to have conflicting opinions about democracy. In that same poll about having elections for national leaders, only 16% agreed with having multiparty competition. Many Chinese citizens support both the general idea of democracy as well as many attributes of authoritarianism – and they hold these views without an apparent sense of contradiction, says Shi Tianjian, writing in the book How East Asians View Democracy. Chinese attitudes reflect an attachment to “paternalistic meritocracy,” which seems to value economic well-being over political freedoms. This is the basis for China’s version of an enlightened and consultative dictatorship, a system that has components of government for the people — by elites — rather than government by the people, writes Professor Daniel Bell, a Canadian academic at Tsingua University in Beijing. China’s rulers claim their authority is rooted within a new and higher form of popular government, a “post-democratic” way of handling power, which delivers goods and services and promotes social harmony. So if the Chinese government “serves the people,” it must be “democratic.”

Despite the critics, key figures of the current Chinese leadership, which is about to step down as part of the decennial changing of the guard, have often spoken favorably about the potential of democracy. In a candid press conference in March 2012 that was broadcast live on Chinese state television, prime minister Wen Jiabao referred to Wukan as an example of how democracy could spread in China.

“If a people can run a village well, I like to think that they could run a town, and if they can run a town, they can manage a county,” he said. “We should follow such a road, to encourage people’s bold practice and allow them to receive training…I believe China’s democratic system will, in accordance with China’s national conditions, develop in a step-by-step way, there is no way to stop this.”

Mr Wen even went so far as to say that political reform was necessary in order to preserve China’s economic gains and prevent a backwards slide into monstrosities like the Cultural Revolution. He warned that China must change the “leadership structure” of the Communist Party and of the country or risk stagnation and even chaos. Mr Wen warned that the new problems emerging in Chinese society, including a huge wealth gap, endemic corruption and a public distrust of the government, could only be solved with “more economic and political structural reform.”

But Wen has entered the lame duck period of his tenure, and his critics point out that he has been saying these things for several years. Yet he has done little to act on his beliefs by prioritizing political reform, choosing instead to focus on the economy. He also has been outflanked by the more conservative leadership factions of the CCP, and has achieved no major political reforms at all during his ten years in power. His calls for reform have made him at times a lone voice, his previous speeches about reform even have been blacked out on at least two occasions by his own government. It would seem that the lessons of Tiananmen Square still hang heavily over China.

Liberties, law, microblogs and dating shows

Where Chinese democracy has made its most encouraging gains is at the level of civil society. Jim Fallows, journalist for The Atlantic in the United States and a longtime observer of East Asia and recent resident of Beijing says, “While I don’t see huge amounts of pressure for structural democratic or electoral reforms, I think there is tremendous pressure for greater liberties in China — rule of law, accountability, transparency, legal redress. I think the Bo Xilai case bears on that.”

Indeed, the charges against Gu Kailai, Bo’s wife, for the murder of British businessman Neil Heywood,  has prompted demands from both friends and foes of Gu that her trial be a test case for justice in a legal system notorious for secrecy and flouting of the rule of law.

Adam Minter, an American journalist based in Shanghai, says, “The most significant democratizing force in China today is the microblog. It places regular Chinese into intense and often direct conversation with local party leadership, law enforcement etc. There are numerous instances of Chinese officialdom responding and reacting to public opinion on the microblogs, producing a kind of informal direct democracy.”

Digital media like microblogging is how many millions of Chinese are becoming increasingly well informed. The Weibo micro-blogging site is watched closely by the government to gain insights into the country’s public opinion. It is estimated that half a billion Chinese now use the Internet, and half of those use micro-blogs, says the Asia Times. Increasingly, Chinese citizens are willing to air their grievances and this has contributed to thousands of spontaneous “mass incidents” in response to local examples of corruption, environmental damage, official abuse and illegal land grabs.

Other “soft” democratic outlets include dating and talent shows that include an audience voting component. But will such “clicktivism” and “couch potato democracy” ever translate into direct social engagement and a demand for a deeper democracy? After 30 years of broad economic reform, China has become a more complex and diverse society. Regional rivalries, corruption, real estate bubbles, serious environmental degradation, job insecurity and low wages, massive rural-urban migration and new social tensions are ongoing features of China’s landscape. As Han Han wrote recently on his popular blog, “You cannot avoid facing the realities of China by using mere words to describe the perfect democracy, the perfect freedom and the perfect human rights. Reform and democracy are negotiation processes.” And negotiation on such a broad societal scale among so many conflicting forces and factors will take many years.

Now, with Prime Minister Wen and President Hu scheduled to retire in the fall, all eyes are on the new leadership, waiting in the wings. This leadership change arguably is more important to the world than the U.S. presidential election which will be happening around the same time. What will the new leaders’ posture be toward their fellow princelings and their abuse of the Chinese system? And what will their approach be toward the Wukans of China, local elections and use of the secret ballot, internal Communist Party elections, and other reforms that have been proposed?

The whole world is waiting to find out.