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LQD: Growth, debt, and the World Bank

by das monde Mon Dec 19th, 2011 at 05:33:57 AM EST

The recent article of Archdruid Report references this article

Growth, debt, and the World Bank
by Herman Daly

It offers a straight perspective of the gears turning the world in the last decades:

When I was in graduate school in economics in the early 1960s we were taught that capital was the limiting factor in growth and development. Just inject capital into the economy and it would grow [....] Capital was magic stuff, but scarce. It all seemed convincing at the time.

Many years later when I worked for the World Bank it was evident that capital was no longer the limiting factor, if indeed it ever had been. Trillions of dollars of capital was circling the globe looking for projects in which to become invested so it could grow. The World Bank understood that the limiting factor was what they called "bankable projects" -- concrete investments that could embody abstract financial capital and make its value grow at an acceptable rate, usually ten percent per annum or more, doubling every seven years.


Right, this is well visible in recently liberated economies. Quite a few services and infrastructures are abandoned as not yielding enough for "decent" living.


Since there were not enough bankable projects to absorb the available financial capital the WB decided to stimulate the creation of such projects with "country development teams" set up in the borrowing countries, but with WB technical assistance. No doubt many such projects were useful, but it was still hard to grow at ten percent without involuntarily displacing people, or running down natural capital and counting it as income, both of which were done on a grand scale. And the loans had to be repaid. Of course they did get repaid, frequently not out of the earnings of the projects which were often disappointing, but out of the general tax revenues of the borrowing governments. Lending to sovereign governments with the ability to tax greatly increases the likelihood of being repaid -- and perhaps encourages a bit of laxity in approving projects.

The world exists for capital owners. What is actually being solved by governments is the problem of capital savers of what to do with their rich financial positions.

... the WB had to figure out why its projects yielded low returns. The answer sketched above was ideologically unacceptable because it hinted at ecological limits to growth. A more acceptable answer soon became clear to WB economists -- micro level projects could not be productive in a macro environment of irrational and inefficient government policy. The solution was to restructure the macro economies by "structural adjustment" -- free trade, export-led growth, balanced budgets, strict control of inflation, elimination of social subsidies, deregulation, suspension of labor and environmental protection laws -- the so-called Washington Consensus. How to convince borrowing countries to make these painful "structural adjustments" at the macro level to create the environment in which WB financed projects would be productive? The answer was, conveniently, a new form of lending, structural adjustment loans, to encourage or bribe the policy reforms stipulated by the term "structural adjustment." An added reason for structural adjustment, or "policy lending," was to move lots of dollars quickly to countries like Mexico to ease their balance of payments difficulty in repaying loans they had received from private US banks. Also, policy loans, now about half of WB lending, require no lengthy and expensive project planning and supervision the way project loans do. The money moves quickly. The WB definition of efficiency became, it seemed, "moving the maximum amount of money with the minimum amount of thought."

And the rest is becoming history.

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... the WB had to figure out why its projects yielded low returns.

Of course for an infrastructure loan, such as for a hydro-electric project or a road to yield an "acceptable" return there needs to be additional loans to projects that make profitable use of that infrastructure. The IMF was hardly going to finance "socialism" by investing in factories. That might cut into revenue streams from existing private investment in countries supporting the IMF.

It was easier to turn a blind eye to local elites skimming a sizable "take" off of the original loan in return for them using the coercive power of their state to extract the payment from those who derived little to absolutely no benefit from the project, such as by squeezing the money out of existing agricultural producers or allowing the development of the land inhabited by indigenous people -- "Shock Capitallism" in action.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Dec 19th, 2011 at 07:25:46 AM EST
The most remarkable thing about this is that "low returns" oe "not bankable" means "returns below 10% per annum".

The required rate of return strikes again...

tens of millions of people stand to see their lives ruined because the bureaucrats at the ECB don't understand introductory economics -- Dean Baker

by Migeru (migeru at eurotrib dot com) on Mon Dec 19th, 2011 at 07:35:53 AM EST
[ Parent ]
By way of comparison, we kept savings in CDs until the rate dropped below 2%, so, empiracally, our "required rate of return" would be >2%. Rates at local banks are below 1%.  Really, one needs about 4% just to maintain purchasing power. I have seen comments to the effect that real returns are about negative 2%. Food has certainly become more expensive in stores and the cost of medical care and education keeps rising.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Dec 19th, 2011 at 08:29:22 AM EST
[ Parent ]
From the comments to Short termism is hurting us by Jerome a Paris(May 23rd, 2011)
... Poterba and Summers (1995) surveyed Chief Executive Officers (CEOs) at Fortune-1000 firms. They found that the discount rates applied to future cash-flows were around 12%, much higher than either equity holders' average rate of return or the return on debt. This excessive discounting implied that some firms were rejecting positive net present value (NPV) projects. Echoes, here, of Pigou's defective telescope.

(...)

Most recently, in 2011 PriceWaterhouseCoopers conducted a survey of FTSE-100 and 250 executives, the majority of which chose a low return option sooner (£250,000 tomorrow) rather than a high return later (£450,000 in 3 years). This suggested annual discount rates of over 20%. Recently, Matthew Rose, CEO of Burlington Northern Santa Fe (America's second biggest rail company), expressed frustration at the focus on quarterly earnings when locomotives lasted for 20 years and tracks for 30 to 40 years. Echoes, here, of "quarterly capitalism".

If even the World Bank requires 10% return on its development projects...

tens of millions of people stand to see their lives ruined because the bureaucrats at the ECB don't understand introductory economics -- Dean Baker
by Migeru (migeru at eurotrib dot com) on Mon Dec 19th, 2011 at 08:56:16 AM EST
[ Parent ]
Though that is very easy to achieve when you're a bank because of leveraging and the fact that banks, being banks, put almost none of their own capital into a project, generally 10% or less at most.   A loan with a 1% margin can easily generate an irr over 25% if you borrow 90% of your funds for the loan from others.
by santiago on Mon Dec 19th, 2011 at 01:55:16 PM EST
[ Parent ]
That works great until you are caught highly leveraged when suddenly everyone has severe doubts about the counterparty quality of both creditors and debtors.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Dec 19th, 2011 at 02:06:07 PM EST
[ Parent ]
That's true, but that's always the problem of banks, which are in the business of making commitments to some and accepting the commitments from others -- they are in the social relationship, or governance, business, not the work of building and risking actual things.  So business school measures like NPV and IRR really don't mean the same thing for banks that they might for actual investors of one's own capital.
by santiago on Tue Dec 20th, 2011 at 12:11:47 PM EST
[ Parent ]
... since I have to run now:

Financial assets (bonds, common stock and money) are not capital (machinery, knowledge and raw materials), and economists confuse the two at the peril of talking nonsense.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Dec 19th, 2011 at 10:38:56 AM EST
See Cambridge capital controversy from Wikipedia.

tens of millions of people stand to see their lives ruined because the bureaucrats at the ECB don't understand introductory economics -- Dean Baker
by Migeru (migeru at eurotrib dot com) on Mon Dec 19th, 2011 at 10:41:24 AM EST
[ Parent ]
Unfortunately, Wiki attributes the origin of neo-classical economics to conflicts with Marx. Gaffney showed that the real reaction was to Henry George and that George's critique was more dangerous to the interests that neo-classical economics was created to protect in that it justified the taxation of the value of land as the primary basis of income for the government. That would have seriously derailed one of the most profitable wealth accumulation strategies of the period since the US Civil War.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Dec 19th, 2011 at 02:18:48 PM EST
[ Parent ]
No, the problem is more general than that.

Even if you can aggregate capital smoothly and without problems, it would still be wrong to say that there is lots and lots of capital sloshing around looking for gainful employment. The correct formulation is that there is lots of financial assets sloshing around, looking for capital to gainfully employ.

This formulation - quite independent of how you measure the volume and value of real capital - illustrates that the problem is a shortage rather than an excess of capital (including raw materials).

At the moment, we also happen to have a shortage of financial assets, due to the inability or unwillingness of policymakers to distinguish between physical capital (which must be paid for in sweat and raw materials) and financial assets (which can be created ex nihilo and consigned to oblivion essentially for free and in whatever volume required for the optimal functioning of the productive economy.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Dec 20th, 2011 at 05:28:55 AM EST
[ Parent ]
The correct formulation is that there is lots of financial assets sloshing around, looking for capital to gainfully employ.

This formulation - quite independent of how you measure the volume and value of real capital - illustrates that the problem is a shortage rather than an excess of capital (including raw materials).

But the problem is not a shortage of capital to gainfully employ.

The problem is the outlandish definition of gainfully. And, if capital is scarce, it must be relative to an overabundance of financial claims.

Paradoxically, because there's an excess of money, not enough money is gainfully employed. Is there some sort of Giffer good effect here?

Because there is more money than hoarders know what to do with, the rate of return they obtain for actual investment is bid down to where they are not actually interested in investing, and the real economy starves for funding while financial assets slosh around charging double-digit returns which may be mythical or, if actually realised, basically just inflate the financial hoard making the problem worse.

tens of millions of people stand to see their lives ruined because the bureaucrats at the ECB don't understand introductory economics -- Dean Baker

by Migeru (migeru at eurotrib dot com) on Tue Dec 20th, 2011 at 06:16:46 AM EST
[ Parent ]
Global Savings Glut or Global Banking Glut?  naked capitalism

Yves here. It has been striking how little commentary a BIS paper by Claudio Borio and Piti Disyatat, "Global imbalances and the financial crisis: Link or no link?" has gotten in the econoblogosphere, at least relative to its importance.

As most readers probably know, Ben Bernanke has developed and promoted the thesis that the crisis was the result of a "global savings glut," which is shorthand for the Chinese are to blame for the US and other countries going on a primarily housing debt party. This theory has the convenient effect of exonerating the Fed. It has more than a few wee defects. As we noted in ECONNED:

   The average global savings rate over the last 24 years has been 23%. It rose in 2004 to 24.9%. and fell to 23% the following year. It seems a bit of a stretch to call a one-year blip a "global savings glut," but that view has a following. Similarly, if you look at the level of global savings and try deduce from it the level of worldwide securities issuance in 2006, the two are difficult to reconcile, again suggesting that the explanation does not lie in the level of savings per se, but in changes within securities markets.

Similarly, the global savings glut thesis cannot explain why banks created synthetic and hybrid CDOs (composed entirely or largely of credit default swaps, which means the AAA investors did not lay out cash for their position) which as we explained at some length, were the reason that supposedly dispersed risks in fact wound up concentrated in highly leveraged financial firms.


Only a mainstream economist would try to pin the blame on a miniscule one year up-tick in Asian savings rather than looking at the collapse of credit creation in the shadow banking sector which accounted for the majority of credit creation leading up to the crash. I call it 'active selective blindness'.
By contrast, the Borio/Disyatat paper tidily dispatches the savings glut story, and develops a more persuasive argument, that the crisis was due to what they call excess financial elasticity, which means it was way too able to accommodate bubbles.From Andrew Dittmer's translation of the paper from economese to English:

   The idea of "national savings" or "current account surplus" refers to the total amount of exports sold minus the total amount of imports sold (more or less). The "excess savings" theory holds that this excess had to have been financed somehow, and so presumably by countries in surplus, like China.

    However, for the US in 2010, the total amount of financial flows into the US was at least 60 times the current account deficit, counting only securities transactions. If this number were correct, then inflows would be 61 times the current account deficit, and outflows would be 60 times the current account deficit. The current account deficit is a drop in the bucket. Why would anyone assume it had anything to do with the picture at all?

    Moreover, if the "savings glut" theory was correct, we would expect there to be certain historical correlations between the following variables: (a) current account deficits of the US, (b) US and world long-term interest rates, (c) value of the US dollar, (d) the global savings rate, (e) world GDP. There aren't (see graphs). You would also expect credit crises to occur mainly in countries with current account deficits. They don't (6).

    Suppose we look at a more reasonable variables: gross capital flows. What do we learn about the causes of the crisis? Financial flows exploded from 1998 to 2007, expanding by a factor of four RELATIVE to world GDP, and then fell by 75% in 2008. The most important source of financial flows was Europe, dwarfing the contributions of Asia and the Middle East. The bulk of inflows originated in the private sector.

    If we look instead at foreign holdings of US securities, Europe is still dominant, but China and Japan are a little more prominent due to their large accumulations of foreign exchange reserves. Still, the Caribbean financial centers alone account for roughly the same proportion as either China or Japan). Other statistics provide a similar picture.

    So what caused the crisis? Clearly, the shadow banking system (mainly based around US and European financial institutions) succeeding in generating huge amounts of leverage and financing all by itself. Banks can expand credit independently of their reserve requirements) - the central bank's role is limited to setting short-term interest rates. European banks deliberately levered themselves up so they could take advantage of opportunities to use ABS in strategies, many of which were ultimately aimed at looting these same banks for the benefit of bank employees. These activities pushed long-term interest rates down. Short-term rates remained low because the Fed didn't raise them as long as inflation didn't appear to be an issue.


Keep in mind that this is not a mere aesthetic argument. If you believe the Bernanke argument, you'll argue that China needs to let the renminbi appreciate faster and provide more safety nets to its populace so they can shop almost as much as Americans do. If you accept the Borio/Disystat analysis, it means you need to regulate financial players and markets far more aggressively.

Dittmer's translation is replete with references to the BIS paper. It is amazing how well a damning paper pointing out inconvenient factors can be repressed.  

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Dec 20th, 2011 at 02:26:28 PM EST
[ Parent ]
The two concluding policy recommendations - that China allow its population more imports and that RoW cuts the balls off the financial sector - are not mutually exclusive.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Dec 20th, 2011 at 02:52:22 PM EST
[ Parent ]
I am just amazed that the BIS comes out with something so explicit - even if it did need to be translated into every day English.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Dec 20th, 2011 at 03:41:41 PM EST
[ Parent ]
BIS working papers have been shrill and subversive for some years.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Dec 20th, 2011 at 05:25:19 PM EST
[ Parent ]
If saving is bad, how terrible is capital accumulation by compound interest?
by das monde on Tue Dec 20th, 2011 at 08:06:17 PM EST
[ Parent ]


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