To Fix Europe, Break It


Last week, British Prime Minister David Cameron negotiated a deal with his fellow Europeans that may save the EU—or, more likely, accelerate its demise. It was Cameron’s mission to extract more favorable terms for his country. The Prime Minister emerged from the talks with an agreement that, among other things, allows the UK to cut benefits received by migrant EU workers. While British Eurosceptics—including six of Cameron’s senior ministers—saw the deal as more form than substance, their Continental neighbors understood the significance of granting these special privileges to a member country. Some fear it to be a “kiss of death” for the European experiment.

Now, Cameron has set a date—June 23rd—for a referendum on his country’s membership in the EU, given the concessions—or lack thereof, depending your point of view—that he obtained. The Prime Minister will campaign for Britain to remain in the Union, while Boris Johnson, the popular mayor of London (and potential Cameron successor), will urge his compatriots to leave.

The fundamental issue at hand, which the UK’s status within Europe obscures, is that monetary union without political integration generates tension and instability. Just consider the havoc wreaked by Europe’s equivocal approach to unification.  Countries like Greece are stuck with an overvalued currency that makes them uncompetitive, while richer nations like Germany are made ultracompetitive by a de facto undervalued currency. The situation creates tremendous pressure on the system, with no meaningful ways to resolve imbalances except through counter-productive austerity measures.

By contrast, the United States of America, which integrated politically and monetarily, does not have these problems, despite large disparities in federal tax contributions and benefits between states. Given the European experience, I suspect potential future monetary unions, like the Gulf Common Currency, that lack the political integration of the US, but whose states could benefit from independent monetary policy, will not get far.

The European economic outlook is dire. Countries like Italy and Greece rank low in economic freedom. Growth is anemic, and Greece remains stuck in recession, with farmers clashing with police in recent weeks over austerity measures. Unemployment in Europe is high—averaging 10.4%, but reaching 25% in Greece. Further, a million migrants entered the region in 2015, and states have struggled to respond. It’s only getting worse, and the dynamic is adding pressure on states to erect impenetrable national borders.

For these reasons, the European Union—a historically unique attempt at bloodless state formation—is at an inflection point. It is very unstable today and will either politically integrate into a “United States of Europe,” as Winston Churchill put it, or revert to the land of drachmas, marks, francs, and solid borders. I’m not betting on an outcome, but if I were, it would be on the breakup of the monetary union and the dissolution of the common currency within the next 10 years.

I’m not betting on an outcome, but if I were, it would be on the breakup of the monetary union and the dissolution of the common currency within the next 10 years.

If the EU must move decisively towards an “ever closer union” to survive, the provision granted to the UK last week may be a harbinger of disintegration. Cameron’s success in obtaining language that frees the UK from any obligation of “further political integration” sets a precedent. The concessions imply a wounded Brussels desperately clinging to the hope of union. It’s a not-so-subtle admission that the European experiment is failing, that political union appears unachievable.

Elsewhere on the continent, French Eurosceptic Marine Le Pen, who is running for President in 2017, promises to lead a “Frexit” referendum. The Dutch and Italians are also harboring strong anti-European movements.

Whether or not countries actually leave the EU, Cameron’s gambit has paved the way for members to extract concessions from Brussels by threatening a referendum, potentially dooming the idealistic dream of a coherent European superstate.

Given the political barriers to further integration, the best strategy may well be to embrace dissolution of the Euro, and perhaps with it the European Union—at least in its original conception. Doing so might enable the restoration of democratic legitimacy, and the re-emergence of independent monetary controls might help improve the region’s economic outlook. Greece, for instance, would regain control of its own fiscal and monetary policy. Despite having seen its GDP shrink by one-third, a depreciated drachma 2.0 might increase the appeal of Greece in a global economy, quite possibly putting it on a path to a sustainable recovery.

The pressures on the economies of Europe are unlikely to dissipate anytime soon. As such, it's time to admit the unification experiment isn't working and that to fix Europe, we likely need to break it.

Modi’s Manufacturing Mantra May Mean Malaise for Millions


Indian Prime Minister Narendra Modi is spending this week promoting his “Make In India” campaign, an ambitious program designed to turn the subcontinent into a “global manufacturing hub.” Modi’s vision is grand: he hopes to create 100 million manufacturing jobs in the next 6 years and spur the development of a middle class that will power the Indian economy for years to come.

Many are bullish on this vision. I’m not. I worry that productivity gains arising from automation have made manufacturing-driven development an antiquated approach. Although it worked for China, India is too late to reap the benefits of this strategy. Simply put, technology has progressed so rapidly over the past few decades that only very cheap wages can compete with capital equipment. And to be competitive with the rise of robotics, those wages must stay low – exactly the opposite of what India’s economy needs.

At first glance, you might not notice the problems with the Make in India strategy. Modi’s plan has, after all, attracted significant foreign investment. Last summer, electronics manufacturer Foxconn announced plans to invest $5 billion in a factory in western India, while GM unveiled $1 billion in planned investments on the subcontinent. Other companies, including Airbus and Hyundai, also announced major investments in India to expand their global manufacturing footprint. Overall, foreign direct investment increased 39% over the last 18 months, making India the #1 destination in the world for foreign investment.

This is all great news for India. But it may not create the jobs Modi needs to achieve his goal. Bluntly put, the outlook for the Make in India campaign is not as rosy as recent investments suggest. The country only created 4 million manufacturing jobs between 2010 and 2014. At that rate of growth, the sector would only produce eight million more jobs by 2022, far below Modi’s target.

A likely culprit for this likely shortfall is embodied by one of Prime Minister Modi’s distinguished guests at this week’s promotional events. It was not the CEO of a powerful multinational, the prime minister of a major European country, or even an accomplished development economist. It was a robot.


On Saturday, Modi met YuMi, "a collaborative, dual arm, small parts assembly robot solution that includes flexible hands, parts feeding systems, camera-based part location and state-of-the-art robot control.” Robots like YuMi are the future of manufacturing.

Thanks to rapid technological progress and the consistently falling prices of robots, production processes are becoming increasingly automated. As the Boston Consulting Group put it, "Many industries are reaching an inflection point at which, for the first time, an attractive return on investment is possible for replacing manual labor with machines on a wide scale.”

Even Foxconn, a company that uses more than 1 million employees to assemble Apple products such as the iPhone and iPad, plans to automate 70% of its assembly line work over the next three years. The future of global manufacturing is clear: more robots, fewer workers. And this means a huge pool of low-cost labor is no longer a competitive advantage in development. Manufacturing may never again be the job-creation engine it once was.


If manufacturing cannot create the much-needed jobs, it’s hard to imagine how the Make In India campaign will generate the broad-based, sustainable growth the country seeks. Even if India becomes a global production hub, the declining labor-intensity of manufacturing suggests the rewards from this accomplishment will be highly concentrated among very few. The economic tide may rise, but everyone won’t have a boat.

The dilemma reminds me of the story about Henry Ford, who on a factory tour with United Auto Workers chief Walter Reuther smugly asked “How are you going to get these robots to pay your dues?” Without missing a beat, the story goes, the UAW boss responded, “How are you going to get them to buy your cars?”

The extreme automation represented by YuMi may seem new, but the dynamic of diminishing returns to industrialization has been in place for decades. Researchers have noted the share of manufacturing jobs in industrializing economies has been consistently peaking at lower income levels. In America, manufacturing employment peaked when per capita income was at $17,700; decades later, South Korean peaked around $12,700; and in Brazil, the level was $8,700. More recently, some African countries have seen manufacturing employment peak with income levels around $2,000 per capita. As the Economist bluntly concluded, “The technological transformation now under way appears to be permanently changing the economics of development…China may be among the last economies to be able to ride industrialisation to middle-income status.”


Further, remember that per capita calculations are affected by demographics. Given that India is slated to become the world’s most populous country by 2022, the pressures to create jobs and incomes are rising. An additional 150 million Indians will enter the workforce over the next 15 years—roughly the population of Russia, the world’s ninth largest country. Will these new workers find jobs? And how much will these jobs pay? The reality is that productivity-enhancing technologies allow economies to produce more with less. India needs to produce more with more.

Highly productive robots address worker scarcity. But India has plenty of potential workers. What India needs is jobs, and lots of them. The country’s labor pool is currently growing by more than 1 million workers each month. The problem with productivity is that it exacerbates issues arising from abundance. Automated manufacturing is very similar to adding workers to an already large pool of available workers. It’s the opposite of what India needs.

It’s hard to imagine that anyone – in India or elsewhere – will succeed at putting the productivity genie back in the bottle. But focusing on what worked in China is a recipe for disappointment. It’s time to rethink the Make In India campaign, and it’s best to do so soon. Without a new strategy, Modi’s manufacturing mantra may mean malaise for millions. And worse, it may mean India never emerges into a developed nation.



On the Brink…


I've had a busy six weeks since my last email, having given talks in the Cayman Islands, Bahamas, and Puerto Rico so far this year.  While in Cayman, I spent about 45 minutes talking with Grant Williams, a friend from my investing days.  He's now helping run Real Vision TV, an online portal for finance videos, and I did a taped interview with him that he converted into a "Think Piece" for the site.   CLICK HERE FOR THE VIDEO.

During the interview, I discussed a range of geopolitical and economic risks that I see emerging from the Chinese slowdown and the collapse of hard commodity and energy prices. These included the potential for a failed state in South Africa, a country with astronomically high unemployment; deepening recession in Canada; and domestic unrest in Saudi Arabia. With China, I explained why I foresaw an economic trough as its economy shifts from investment- to consumption-led growth.

Looking beyond today's seemingly chaotic economic and political environment, I noted the risk of conflict in the Arctic and described my bullish outlook for animal protein.  I specifically noted the potential for a demand shock from a growing global middle class on all the elements of the protein production chain, from fertilizer to grain to meat. Closer to home, I also touched on how the global financial crisis affected the mindsets of college students.

Speaking of college students, the Yale seminar on business ethics I teach to undergraduates has gotten off to an exciting start this semester. Guests to date have included Mike Peel, former head of HR for General Mills; Matthew Winkler, former editor-in-chief of Bloomberg News; Jude Scott, CEO of Cayman Finance; and Claire Criscuolo, proprietor of Claire's Corner Copia, the legendary New Haven restaurant that recently celebrated its 40th birthday.  It's been a blast to teach this course and I feel privileged to have such great students and guests who stimulate wonderful discussions.

For my weekly insights on navigating our increasingly interconnected and uncertain world, do not forget to follow me on my various social media channels. To stay up to date with my work on Facebook, please like my page here. Follow me on Twitter here and LinkedIn here. And for those receiving this email from a friend or colleague, you can add yourself to my mailing list here.

Best wishes for safe passage through today's global cross-currents.


America Is Enabling Tax Evasion

Inequality has been a central issue in the US presidential race, and tax havens are understandably a flash-point in this debate. In this short comment that generated more than 300,000 views, I point out that it is hypocritical for candidates to criticize offshore centers like the Cayman Islands without addressing the fact that the United States is one of the worst offenders of all.  


Is The Sharing Economy About to Stop Sharing?

The most prominent tech companies—from Uber to Facebook—do not own the assets and content they connect their users to.  In this note, I describe a countervailing trend that could upend this dynamic, with companies like Netflix pivoting to produce their own content and companies like Uber planning to own self-driving cars. 


Another Pandemic En Route?

The Zika virus has emerged as an enormous global public health issue. My note argues that the risks posed by the spread of the virus could include serious demographic disruptions as well as a potential impact on the Rio 2016 Olympics.  I also spoke with CNBC Asia about the potential economic ramifications of the outbreak.


Can the Fed Fight Global Conditions?

The new year's market turbulence was yet another sign that the Fed is unlikely to stick to the course of rate hikes it signaled in December. In this short comment, I describe the global conditions that are making investors and policymakers alike squeamish. 


I'm Playing Powerball...and Why You Should Too

Last month, the Powerball jackpot swelled to become the largest lottery pool in human history. I described the dismal economics of the game—and why it was nevertheless worth playing. 


Tax Evasion in the United States of Anonymity


The combination of increasing inequality and anemic economic growth has thrown a political spotlight on tax havens. Research has shown that governments are losing at least $200 billion in potential tax dollars every year because of them. Politicians throughout the world are feeling pressure to address this perceived injustice.


Consider, for example, Democratic presidential candidate Hillary Clinton’s recent comments about companies “routing income through the Bahamas or the Cayman Islands or wherever” in an effort to minimize or avoid taxes. Clinton would like America to capture lost tax revenues from corporations booking profits in their offshore subsidiaries.

My guess is that your image of tax havens, like Clinton’s, is a small island with free-flowing rum and sun-kissed, care-free locals. You may remember The Firm, the 1993 film based on the John Grisham thriller, in which Tom Cruise plays a lawyer who gets mixed up with a firm that helps clients launder money through the Cayman Islands.

But Cayman entities are not as secretive and opaque as they once were, especially compared to other jurisdictions. The territory now complies with regulations (like America’s FATCA) mandating automatic information transfer about foreign account holders to their home countries.  Further, anonymous corporations in which ultimate ownership is unknown no longer exist in Cayman: it has collected beneficial ownership information about corporations set up under its jurisdiction for fifteen years.  Preventing the existence of anonymous shell corporations makes it more difficult for individuals and firms to hide taxable income from authorities.


Ironically, there is strong evidence that some of the most egregious tax havens are more like the country Secretary Clinton hopes to lead than the islands she highlighted.  In fact, major OECD countries are guilty of doing exactly what these more notorious havens once did. In a 2009 audit study published in the Journal of Economic Perspectives, a researcher attempted to set up anonymous shell corporations using 45 different firms across 22 different countries. More than 75% of firms in OECD countries agreed to set up anonymous shell corporations, compared with less than 15% of firms in the traditional tax havens.  That's right, it's probably easier to set up an anonymous corporation

A recent Bloomberg report described how the United States in particular has become "effectively the biggest tax haven in the world," with the global rich moving their offshore funds from “the Bahamas and the British Virgin Islands to Nevada, Wyoming, and South Dakota.” The reason?  These American states allow anonymous bank accounts. Further, the US has refused to sign on to the OECD’s new standards that would require American financial firms to disclose accounts held by foreigners to their home countries. This comes off as hypocritical to much of the world, because the US —through FATCA—requires other countries to do provide information about foreign accounts owned by Americans.

Anonymous banking facilitates crime and corruption. The UN estimates that between two and five percent of global GDP is laundered every year. A recent 60 Minutes report demonstrated how the US facilitates these illegal financial flows. The show recounted how Global Witness, a corruption watchdog, sent an employee undercover as a representative of a corrupt African politician to seek legal assistance to move dirty money offshore.

The nonprofit arranged 16 face-to-face meetings with New York lawyers— including the then-head of the American Bar Association — and only one outright refused to help. As Charmian Gooch, the head of Global Witness, pointed out, US law requires bankers to report such requests, but it does not require lawyers to do the same.

The real problem, former Senator Carl Levin pointed out, is that US law does not demand disclosure of beneficial ownership of new corporations, a practice that has become standard in places like the Cayman Islands. The American Bar Association, he pointed out, has been a particularly vigorous opponent of this.   The result: it is easier to set up an anonymous corporation in the US than it is in traditional tax havens.

As the US presidential elections move forward, if candidates want to criticize traditional tax havens and avoid hypocrisy, they better start taking a cold, hard look at their home turf.



Is The Sharing Economy About To Stop Sharing?


Today's sharing economy has a cutting edge feel to it. It screams “innovation” and disruption. It's seems futuristic.  We’re living in a world where the most valuable media company — Facebook — produces no content; the world’s biggest taxi company — Uber — owns no vehicles, and the world’s most valuable hospitality company — Airbnb — owns no hotels.


Networks, it seems, are more valuable than the services they facilitate. And in some ways, this makes sense. They are enabling stranded assets liked parked cars or empty beds to be economically productive. The networks are valuable precisely because they connect those with needs and those who can help fulfill them.

There’s reason to believe, though, that the so-called “sharing economy” is a fleeting moment in economic history. Digital giants and upstarts alike are realizing that networks can be fickle, while ownership of and control over the services they facilitate hold the key to a sustainable advantage and long term profits.

Take transportation, for example. Uber is famous for being a giant, car-less taxi company, preferring to let its drivers supply the vehicles. In doing so, though, it has to give them a significant cut. What if it didn’t have to pay for drivers at all? That’s the promise of driverless cars.

As Uber founder and CEO Travis Kalanick told a tech conference in 2014, the service is more expensive than it should be "because you’re not just paying for the car — you’re paying for the other dude in the car. When there’s no other dude in the car, the cost of taking an Uber anywhere becomes cheaper than owning a vehicle.”

What happens to car demand in a world where it’s cheaper to take an Uber than own a car? Sure, it might shrink a bit as cars are more heavily utilized and meet more driving needs. But the more interesting fact may be that the network suddenly owns all the cars.

Last year, Uber launched a lab in Pittsburgh to facilitate the development of autonomous car technology. While Uber may be a car-less taxi company today, it has its sights on owning all the cars in the future.

It’s no surprise, then, that GM recently announced a $500 million investment in Uber’s main rival Lyft, building a network-manufacturer partnership that could compete with the prospect of a vertically integrated Uber. As NPR reported, "In the short-term, GM will rent cars to drivers. In the long-term, GM will build a self-driving fleet in which cars are owned by a company — not bought by individual consumers.” Meanwhile, Google plans on spinning off its driverless car unit into a standalone business later this year.



The “sharing economy” may eventually morph into the “platform owns everything” economy. Just consider what’s going on in the entertainment sector. Netflix, which has grown rapidly by connecting other people’s content to end users, is now focused on producing its own original content. In 2016, the company plans to produce 600 hours of original programming. Amazon is now producing original shows as well, and doing so quite well. Amazon’s “Mozart in the Jungle” recently won two Golden Globe Awards. At one point in early January, the top 5 TV shows, according to ratings on Rotten Tomatoes, were produced by either Netflix or Amazon.

While Facebook has not announced plans to produce news (which is not particularly lucrative anyway), it is getting publishers to host their content with them. Much more consequential, however, is its approach to virtual reality. Facebook bought Oculus in 2014…and drum roll please... Oculus has a studio of its own—Oculus Story Studio—which is funding original content. If the future of visual media is in VR, then Facebook will be one of its earliest producers.

Might Airbnb someday find itself wanting to scoop up some property of its own? It’s too soon to tell, but I wouldn’t be shocked if they did. One thing seems clear: we can’t assume that network owners will be content until they have control.


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