Peterson Institute for International Economics Update Newsletter
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PIIE Update Newsletter
June 1, 2012

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  Working Paper 12-10
The Dollar and Its Discontents

Olivier Jeanne
  Olivier Jeanne Has the US dollar delivered the benefit that the rest of the world is expecting from its holdings of international liquidity? US government debt has been liquid and safe, and it is supplied in sufficient quantity. But it has given a low return to the countries that accumulated the most reserves, especially when those returns are measured in terms of the countries' own consumption. Jeanne argues that countries that accumulate the most reserves should expect a low return in terms of their own consumption and that international monetary reform can do little to change that fact.

>> Read full working paper [pdf]

  RealTime Economic Issues Watch
Despite Its Troubles, the Euro Area Is Making Progress

Jacob Funk Kirkegaard
  Jacob Funk Kirkegaard Jacob Funk Kirkegaard notes that behind discouraging headlines from the euro area are several recent and encouraging developments. First, the Spanish government is finally owning up to the full scale of its banking crisis. The new capital requirement of troubled Bankia is estimated at €23.5 billion, an amount the Spanish government must now finance with or without European help. Second, Germany's political parties have engaged with each other over a proposal for a European Redemption Fund (ERF), which would convert euro area government debt in excess of 60 percent of GDP into de facto eurobonds. This large pool of senior joint liability bonds will make up a pool of debt to rival the US Treasury market for liquidity and will serve to force—or provide incentives for—member states to implement structural reforms and sound fiscal policies to retain access to the ERF. Third, the recent informal European Council session marked another policy step towards integration by directing European Council President Van Rompuy to report at the next meeting in June on how to achieve the goal of strengthening economic and monetary union. The European Central Bank (ECB) has been campaigning for a "European Banking Union," and its record in securing the financial stability of the euro area—and its willingness to extract political concessions from elected leaders—have made progress on integration of the euro area banking system increasingly likely. Doom will get the headlines, but this is a more important development.

>> Read full blog post

The End of the Euro: A Survivor's Guide

Simon Johnson and Peter Boone
  In Europe soon, millions of people will wake up to realize that the euro, as we know it, is gone. Europe's crisis to date has been a series of supposedly decisive turning points that each turned out to be just another step down a steep hill. The troika of the European Commission (EC), European Central Bank (ECB), and International Monetary Fund (IMF) has proved unable to restore the prospect of recovery in Greece, and any new lending program would run into the same difficulties. It is time for European and IMF officials, with support from the United States and others, to work on how to dismantle the euro area. While no dissolution will be truly orderly, there are means to reduce the chaos. Many technical, legal, and financial market issues could be worked out in advance. Europe needs plans to deal with: the introduction of new currencies, multiple sovereign defaults, recapitalization of banks and insurance groups, and divvying up the assets and liabilities of the euro system. Some nations will soon need foreign reserves to backstop their new currencies. Most importantly, Europe needs to salvage its great achievements, including free trade and labor mobility across the continent, while extricating itself from this colossal error of a single currency.

>> Read full op-ed

What Is India's Real Growth Potential?

Arvind Subramanian
  Arvind Subramanian As economic growth in India declines from its giddy precrisis level, questions abound on the true growth potential of the country. The 9 percent growth rate before the global crisis appears to have been an aberration, says Subramanian, and the current rate of close to 7 percent is likely the real potential. The puzzle is not why growth is slowing but why it was high in the first place in the precrisis years. In terms of market-based reform, India has lagged most developing countries in Africa, Latin America, and perhaps also China. Yet its growth was nearly twice the average for developing countries outside Asia. Benign international conditions before the global crisis—which, after all, benefited all countries—also do not explain India's unusually strong performance. What is clear, however, is that growth is decelerating—and inflation is high—because supply is failing to keep up with rising demand. In the absence of significant supply-enhancing reform, India may have to get used to lower rates of growth—6 or 7 percent—as the norm. Chronic rent-seeking by the government and private sector has impaired the supply capacity of the economy: Rent-seeking in land (terrestrial rents) has affected the provision of infrastructure. Rent-seeking in coal (subterranean rents) has affected power generation capacity. Rent-seeking in spectrum (ethereal rents) nearly paralyzed the process of government itself. The government's recent policies to address the epic corruption and venality that it has presided over seem like it is correcting one wrong by committing another. Each of its actions—whether the retroactive amendment on taxes or the new guidelines for the telecommunications sector—may have some extenuating rationale, but they are negatively affecting private investment and risk taking. The plunging rupee is, above all, an expression of deep concern about the impact of these actions on, and hence a downgrading of, India's medium-term growth prospects.

>> Read full op-ed
>> See related interview: Slowdown in India: Rent-Seeking Squelches Growth

  Working Paper 12-9
The Microeconomics of North–South Korean Cross-Border Integration

Stephan Haggard and Marcus Noland
  Marcus Noland Economic integration between North and South Korea occurs through three modalities: traditional arm's-length trade and investment, processing on commission (POC) trade, and operations within the Kaesong Industrial Complex (KIC). In order, these three modalities are characterized by decreasing exposure of South Korean firms to North Korean policy and infrastructure. Through a survey of 200 South Korean firms operating in North Korea, the authors find that these modalities of exchange matter greatly in terms of implied risk. For example, firms operating in the KIC are able to transact on significantly looser financial terms than those outside it. The authors find that direct and indirect South Korean public policy interventions influence these different modalities of exchange and thus impact entry, profitability, and sustainability of South Korean business activities in the North. In effect, the South Korean government has substituted relatively strong South Korean institutions for the relatively weak Northern ones in the KIC, thus socializing risk. As a result, the level and type of cross-border integration observed in the survey is very much a product of South Korean public policy.

>> Read full working paper [pdf]

Peterson Perspectives Interviews

audio  Slowdown in India: Rent-Seeking Squelches Growth
Arvind Subramanian analyzes the factors behind India's decelerating growth, saying that the failure to reform the government's stranglehold of the economy diminishes prospects in the future. Tune in next week for another interview with Subramanian on the US-India Strategic Dialogue.

audio  Slowdown in China: Did Chinese Leadership Drop the Ball?
Nicholas R. Lardy assesses the latest evidence of decelerating economic growth in China, saying that the leadership in Beijing may have been distracted by the recent political turmoil.

audio  Stimulus vs. Austerity in Europe
Anders Åslund says it is more important for ailing European countries to cut their budgets, reduce their debts, and win market confidence than to embark on economic stimulus right now.

Recent Blog Posts

RealTime Economic Issues Watch   China Economic Watch    North Korea:  Witness to Transformation
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Despite Its Troubles, the Euro Area Is Making Progress

US Anti-Dumping Duties on Chinese Solar Cells: A Costly Step

A Foreign Exchange Reserve Mystery: Which Major Advanced Economy Is Not Reporting the Currency Composition of Its Reserves?

Latvia Shows the Way, Proving Some Famous Merchants of Doom Wrong

Implementing Basel III in the European Union: A Deeply Flawed Compromise
  A Statistical Snapshot

Income Inequality and Economic Rebalancing

SOE Dividends and Economic Rebalancing

Can China Reflate the Housing Market?

Wen Jiabao Has the Wrong Solution for China's Banks
  Traitors and Criminals, or, A Man is Known by the Company That He Keeps

Bulldozer Jr.?

Continuing North-South fallout from economic sanctions

The Northern Limit Line Controversy: New Historical Documents

Not Satire: Mamata Banerjee and North Korea

PIIE Noted in the News and on the Web

Greek Euro Exit Chances Under 5 Percent
Jacob Funk Kirkegaard puts the odds of Greece exiting the euro area at less than 5 percent, noting that Greek politicians realize 80 percent of the Greek population opposes leaving the euro.

CNN Money
Maybe Greece Needs a Run on the Banks
CNN Money considers Jacob Funk Kirkegaard's suggestion that a Greek bank run might counterintuitively help the euro area.

Help Wanted. But Not For Mid-Level Jobs
Howard F. Rosen explains that the process of "labor polarization"—where more mid-level positions are lost and replaced by bottom- and top-level ones—has been occurring for a couple decades but is now more visible with the higher number of people looking for work.

Iran Talks—An Attempt to Buy Time?
Gary Clyde Hufbauer explains the Iran nuclear talks will buy time for the United States to get through the November elections, while Iran hopes the talks may help ease sanctions a little bit. Hufbauer notes the sanctions are truly affecting Iran's economy by reducing the volume and price of its oil sales.

US Department of State
Country Reports on Human Rights Practices for 2011
The US Department of State's Country Reports on Human Rights Practices for 2011 for the Democratic People's Republic of Korea extensively cites Stephan Haggard and Marcus Noland's book, Witness to Transformation: Refugee Insights into North Korea.

Preview of Our Next Issue

What Putin's Piecemeal Reforms Will Look Like
Anders Åslund

In This Issue

Featured Book
Who Needs to Open the Capital Account? Who Needs to Open the Capital Account?

Olivier Jeanne
Arvind Subramanian
John Williamson

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