Magnus vs Donovan: The emails | FT Alphaville

Magnus vs Donovan: The emails

Here’s an interesting promo for the new book by UBS senior economic adviser, George Magnus.

To drum up a bit of attention for ‘Uprising: Will Emerging Markets Shape or Shake the World Economy?’ the Swiss bank has released a selection of internal emails between UBS economists (that would be Paul Donovan and Magnus, for the most part) on the future role of government-owned infrastructure banks; which for the record, Magnus thinks are needed to soothe global imbalances before they reach breaking point.

In late September, Erika Karp, head of global sector research, fired off an email to several UBS economists soliciting views on the possibility of governments setting up their own banks to “intermediate” in the financial system.

The below, they say, was the (presumably highly-edited) outcome. It’s long, but well worth a read since it provides a refreshingly two-sided view from a major bank.

Email number one:

From: Karp, Erika
Sent: 21 September 2010
To: Magnus, George; Donovan, Paul
Subject: Government owned banks, infrastructure funding

Gentlemen – When you have a moment, I would be extremely interested in your respective thoughts from a different angle relating to government involvement in the banking sector. Alongside European, UK and US governments increasing their role in banking (through regulation or direct ownership), there is now some discussion of whether governments should go a step further, and establish national banks to guide infrastructure developments. Any thoughts?



Email number two:

From: Donovan, Paul
To: Karp, Erika; Magnus, George
Sent: Tue Sep 21 2010
Subject: Government owned banks, infrastructure funding.

Well, I would agree that the OECD economies need to upgrade their infrastructure (on environmental grounds, if nothing else). And I can see why the idea of a government run bank is appealing. From an economic point of view, it might serve to increase the velocity of circulation of money (because it will lend). This it will re-intermediate where the private sector (for whatever reason) is failing to intermediate. If done well it can be successful. So much for the good news. The bad news for me is in two areas.

This is exactly what I mean by the coming “Global war for capital”. Government run banking is almost certain to be parochial (“nationalistic” “patriotic”, whatever you want to call it) and not allow capital outside of its own borders. There is a grave risk that we get “buy America” or “buy French” clauses inserted into any loan agreements, reducing global trade for projects. What if the sensible economic policy is for capital to be invested overseas? What if the best way for a project to move forward is to import foreign capital equipment? Will this bank invest overseas? Politically it is hard to see that happening. The world economy gets a sub optimal mix of capital investment.

This is bad enough, but to my mind there is also a bigger problem – the backward looking nature of the political process. The problem is that politicians have an incentive to preserve old infrastructure because that is where jobs currently exist, and they believe those jobs need to be preserved. They are not prepared to contemplate investment in future infrastructure. The cash for clunkers in the US was a good case in point. Economically and environmentally this is a disastrous program, because it is investing in an obsolete transport infrastructure (cars) which (in the view of this economist) America should not make and which are one of the least environmentally friendly methods of transport. However, auto plant workers have the vote today – solar powered monorail drivers (or whatever) only have a hypothetical vote in the future. Politicians will go for preserving antiquity not developing the future.

The damage here is that infrastructure shapes the future, by definition. Build roads and cars and you can not switch to rail transportation at will in thirty years time, however prudent that may be (the UK rail network is a case in point – Dr Beeching savaged the network because he believed railways should give way to cars. The costs of reversing that decision are overwhelming). Obviously the private sector can make bad decisions with infrastructure investments, but anything with political overtones is likely to make worse decisions because “preserved jobs = preserved votes”. Paul

Email number three:

From: Magnus, George
Sent: Tuesday, September 21, 2010
To: Donovan, Paul; Karp, Erika
Subject: Government owned banks, infrastructure funding.

I beg to differ with Paul (for a change! Actually we agree on quite a lot, but this is an important matter of public policy). The point is, in my view, that we haven’t got time and space to get into the nitty gritty that Paul elevates. If government wants to get involved in the business of banking, we would normally be suspicious or hostile.

Under current circumstances though, I can see a compelling reason and, if adopted, I will be cheering from the rafters. The reason, at the risk of repetition, is that this is a very serious crisis with very serious economic and social implications, as are becoming clearer all the time. I won’t say ‘I told you so’, but too many of our profession simply don’t get it….still.

We have had what I’ve called a bungee jump recovery in production,
and even in capital spending, from an abyss that no one foresaw, and it’s now losing its momentum – just as we’re running into concerted and large fiscal restraint.

What America and Europe need, above all else, are jobs and new growth drivers; these are not coming, whatever gloss we put on the near term data. The proverbial man on the Clapham omnibus gets it! Even if they find it hard to articulate, people sense we are in a crisis, and fear the consequences. Listen to the politics. Observe the manner in which the right wing, say, in the US, is hijacking popular rage. Note the stall that’s coming in the Western economies with US unemployment (broadly defined) at over 17pct, and widespread underemployment elsewhere. Sense the anger in Washington and occasionally Brussels and even in some emerging markets over Chinese trade and foreign exchange policy intransigence.

For ages, developed economy infrastructure has been in decay and decline. Even a decade ago, I recall discussions with equity analysts about this. The OECD thinks its members have a $50 trillion infrastructure deficit to make up between now and 2030. So I think there’s a perfect match. And a national focused, government owned investing bank is a good way of facilitating it at a time when private sector borrowing and spending has gone into hibernation, perhaps for a long period of time.

The idea of governments picking national champions and backing specific companies is something we generally don’t like – and don’t approve. But so what if a government acts to prioritise investment and development in domestic sectors like wind, solar, high speed, new battery technologies, etc.? We could talk about the Chilean salmon farming industry, or Chinese automobiles and parts, or Brazilian light aircraft as key sectors that benefitted from government involvement, if not outright leadership. Or, take the one country, allegedly renowned for its hostility and abstinence regarding ‘industrial policy’, the United States. The US government was certainly no slouch when it came to nurturing railroads, canals and the development of highways. Agriculture and housing have persistently been beneficiaries of Washington policies. And its 20th century momentum and reputation in aerospace, radio, telecommunications, autos, Silicon Valley, the Internet, and so on came, in significant measure, not from divine intervention, foreigners or from private sector animal spirits, but from the nurturing role of government.

Sometimes this was down to blatant protection, tariffs and quotas, sometimes down to tax and subsidy policies, and sometimes to high profile public and financial assistance and research grants. But the main thing is that government has a particularly important role at times of stress and uncertainty to provide a climate of collaboration between government and the private sector, using financial policy, sector participants, supplier groups, venture funds and so on, designed to kick-start or accelerate investment, jobs and development in modern sectors.

The bottom line for me is that a government-run infrastructure investment bank is a fundamentally good idea, whose time has come, and which allows it to shape the future.

I actually think we will see some governments do this, perhaps all the more so, when the next bouts of quantitative easing – or quantitative policy as you call it Paul, are seen to have failed, which they must. In other words, there will be intervention by the government to make loans to or provide relief in some form for small and medium sized businesses, and (where relevant) to alleviate the mortgage burden on households.

If there are “Buy America” or “Buy France” clauses, so what? I accept it is protectionism by any other name, but it is soft protectionism. And sometimes, it can be justified up to a point. If it helps bring improvement in the labour market, it’ll have been a price worth paying I reckon.


Email number four:

From: Donovan, Paul
To: Magnus, George; Karp, Erika
Tue Sep 21 2010
Subject: Government owned banks, infrastructure funding.

It is not that I object to the investment in OECD infrastructure (I have taken a taxi to JFK many a time. If ever there were a case study on the need for infrastructure spending it is that). Nor do I particularly object to investment in domestic technology if it happens (though surely it is wasting money if the comparative advantage lies elsewhere – why should the EU impose tariffs on Chinese solar panels, for instance?).

My point is that government run infrastructure investment banks will build coal fired power stations and not solar panel plants. Politicians will invest in existing if obsolete jobs rather than possible future jobs with a future. Surely we have to consider, environmentally and economically, whether there are some jobs that the world would be better off without?

How much faith can we have in a government run bank to get things right?

Japan’s economic growth in the 1970s and 1980s was driven in defiance of the investment programs of the assorted five year plans. In the 1980s the Japanese government was still directing capital and investment into obsolete mid sized heavy industry businesses whose model was defunct (admittedly they were directing notionally private sector banks, but we know how that ended). Why were they doing this? Because people were already employed there.

Political investment is genetically programmed to be backward looking. The British government invested heavily in the cotton mills of Lancashire in the 1950s – in an industry that had lost any kind of comparative advantage half a century before. Why did they do this? Because people were employed in the mills and politicians wanted to preserve the jobs of mill workers (to ensure their own job security through re-election).

Sure, a government investment bank will generate a cyclical boost. I am not disputing that, nor am I disputing the desirability of bringing unemployment down. The problem is that you then you get a structural headache. If we put in place the wrong infrastructure, we condemn the economy to a straitjacket for future development. Once the tracks of infrastructure are laid down, we must travel in that direction for an awfully long time (or scrap everything and start all over again).

If the tracks are going in the wrong direction today, even by a small margin, the misdirection will get larger and larger over time. We will end up in quite the wrong destination. There is more than economics here (I fear, George, that there may be more to life than economics, heretical though it is to think about this). Resource efficiency, environmental efficiency – this is a bigger deal.

George may get a short term boost to growth that will doubtless gladden his heart, but it will all come to tears in the medium term. And frankly, I don’t think we can afford that trade off any more. If this all turns out as apple pie as George suggests, with enlightened politicians subsuming their short term political ideals for the greater good, then he has a point. I don’t think this happens, however. This is an instance of the current generation achieving growth at the expense of future generations. Because the infrastructure of today shapes our futures, however, the price paid by future generations is going to be very high.


Email number five:

From: Magnus, George
Sent: Tuesday, September 21, 2010
To: Donovan, Paul; Karp, Erika
Subject: Government owned banks, infrastructure funding.

I disagree. The US, at least, has a track record that suggests some government infrastructure projects work; otherwise we would have been stuck with a government backed Western Union or Pony Express rather than the Internet.

Government can get this right, or at least as right as the market. And just because you ‘believe’ that politicians will spend money according to the votes of workers in ossifying industries rather than in the sectors of tomorrow, doesn’t mean the goal of nationally-funded infrastructure is wrong or misguided.

I know your familiarity with Japan, but this scar on your economic growing up period, is not necessarily representative. If you didn’t think my previous examples were enough, think electronics in Taiwan and Singapore. Think the hovercraft – an English invention that the nation never backed, but others did. Think French, Japanese and now Chinese high speed rail. It is worth going a long way and taking risks in the interests of new directions and above all jobs.

Ignoring the plight of the unemployed today will simply raise the instance of long term unemployment. The long term unemployed become the permanently unemployed (raising the natural rate) – a lost economic resource for the longer term – and doubtless the source of growing social friction and perhaps, even a dangerous loss of popular trust. We need to weight the political and social consequences that come from that unemployment, and elevate supply-side regeneration to a level that is as important a deficit reduction.

My basic position is that fostering the kind of structural economic
transformation and innovation that has been laid bare as essential by the
financial crisis is a – maybe the – central public purpose. The private sector cannot make the running here – certainly not yet. We have no choice. A national infrastructure bank that facilitates and channels the excess money in our economies towards, say, new and alternative energy technologies, and the type of infrastructure that might revolutionise manufacturing processes is a worthy pursuit.


Verbose, those UBS economists.

For more insights into Magnus’ thoughts on global imbalance matters, do head over to the usual place.

Related links:
Tough calls against bungee-jump recovery
– George Magnus / FT
Welcome to the OECD debt trap
– FT Alphaville
Magnus: ‘An existential crisis for the euro-system’
– FT Alphaville