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The Great Recession of 2008–09 badly shook the global market, changing the landscape for finance, trade, and economic growth in some important respects and imposing tremendous costs on average citizens throughout the world. The legacies of the crisis—high unemployment levels, massive excess capacities, low investment and high debt levels, increased income and wealth inequality—reduced the standard of living of millions of people. There is an emerging consensus that global economic governance, as well as national policies, needs to be reformed to better reflect the economic interests and welfare of citizens.

Global recovery is sluggish and the outlook uncertain. The economies of the Eurozone, which may have fallen into a “persistent stagnation trap,” and Japan remain highly vulnerable to deflation and another bout of recession; in the advanced economies that are growing, recovery remains uneven and fragile. Growth in emerging and developing economies is slowing, as a result of tighter global financial conditions, slow growth of world trade, and lower commodity prices. Because consumption and business investment have been tepid in many countries, the gradual global recovery has been too weak to create enough jobs. Official worldwide unemployment climbed to more than 200 million people in 2013, including nearly 75 million people aged 15–24.

Professor Roubini, one of the few economists who predicted the 2008 crisis, has argued that the global economy is like a four-engine jetliner that is operating with only one functioning engine, the “Anglosphere.” The plane can remain in the air, but it needs all four engines (the Anglosphere, the Eurozone, Japan, and emerging economies) to take off and stay clear of storms. He predicts serious challenges, including from rising debt and income inequality.

Relatively slow growth in the advanced economies and potential new barriers to trade over the medium term have significant adverse implications for growth and poverty reduction in many developing countries. Emerging economies, including China and India, that thrived in recent decades in part by engaging extensively in the international economy are at risk of finding lower demand for their output and greater volatility in international financial flows and investments. A combination of weaker domestic currencies against the US dollar and falling commodity prices could adversely affect the private sector in emerging economies that have large dollar-denominated liabilities.

Rising inequality is holding back consumption growth. The ratio of wealth to income, as well as the income shares of the top 1% of income earners, has risen sharply in Europe and the United States since 1980, as Professor Piketty has shown.

The ratio of the share of income earned by the top 10% to the share of income earned by the bottom 90% rose in a majority of OECD countries since 2008, a key factor behind the sluggish growth of their household consumption. During the first three years of the current recovery (2009–12), incomes of the bottom 90% of income earners actually fell in the United States: the top 10%, who tend to have much lower propensity to consume than average earners, captured all the income gains. In developing countries for which data were available for 2006–12, the increase in the income or consumption of the bottom 40% exceeded the country average in 58 of 86 countries, but in 18 countries, including some of the poorest economies, the income or consumption of the bottom 40% actually declined, according to a report by the World Bank and IMF.

Some signs of possible relief may lie ahead. In September 2014, leaders at the G20 summit in Brisbane agreed on measures to increase investment infrastructure, spur international trade and improve competition, boost employment, and adopt country-specific macroeconomic policies to encourage inclusive economic growth. If fully implemented, the measures could add 2.1% to global GDP (more than $2 trillion) by 2018 and create millions of jobs, according to IMF and OECD analysis. (These estimates need to be treated with caution, as the measures that underpin them and their potential impact are uncertain, and the nature and strength of the policy commitments vary considerably across individual country growth strategies.)

Another potential sign of hope is the sharp decline in the prices of energy, a reflection of both weaker global demand and increased supply (particularly of shale oil and gas from the United States). The more than $40 a barrel decline in Brent crude prices is likely to raise consumers’ purchasing power in oil-importing countries in the OECD area and elsewhere and spur growth, albeit at considerable cost (and destabilizing effects) for the more populous and poorer oil exporters. It could also be a harbinger of energy price spikes down the road, as the massive investments needed to ensure adequate supplies of energy may not be forthcoming as a result of their unprofitability at low prices.

Major global challenges have wide-ranging long-term implications for the average citizen. By 2030, the world’s population is projected to reach 8.3 billion people, two-thirds of whom will live in urban areas. Massive changes in the patterns of energy and resource (particularly water) use will be needed to accommodate this 1.3 billion person increase—and the elevation of 2–3 billion people to the middle class.

A citizen-centered policy agenda would need to reform national economies to spur growth and job creation, placing greater reliance on national and regional markets and the sustainable use of resources; emphasize social policies and the economic health of the lower and middle classes; invest in human capital and increase access to clean water, sanitation and quality social services, including a stronger foundation during the early years of life and support for aging with dignity and equity; improve labor market flexibility to employ young people productively; and enhance human rights and the freedom of people to move, internally and internationally. These policies would need to be complemented by policies that use collective action to mitigate risks to the global economy.

To prevent another global crisis, there is an urgent need to strengthen global economic governance, including through global trade agreements that favor the bottom half of income distribution; reform of the international monetary system, including the functioning and governance structure of the international financial institutions; encouragement of inclusive finance; and institution of policies to discourage asset bubbles. To achieve sustainable growth, all countries need to remove fossil fuels and other harmful subsidies and begin pricing carbon and other environmental externalities.

Worldwide surveys show that citizens everywhere are becoming more aware and active in seeking changes in the global norms and rules that could make the global system and the global economy fairer and less environmentally harmful. This sense is highest among the young and better-educated, suggesting that over time it will increase, potentially leading to equitable results for all citizens through better national and international policies.

Headline image: World Map – Abstract Acrylic, by Free Grunge Textures. CC-BY-2.0 via Flickr.

The post Where is the global economy headed and what’s in store for its citizens? appeared first on OUPblog.

        

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By Edward Zelinsky

Public pension plans should not invest in private equity deals. These deals lack both transparency and the discipline of market forces. Private equity investments allow elected officials to assume unrealistically high rates of return for public pension plans and to make correspondingly low contributions to such plans. This is a recipe for inadequately funded pensions, an outcome good for neither public employees nor taxpayers.

Ben Bernanke. Source: United States Federal Reserve.

In this low return environment, public defined benefit pension plans generally assume that they can earn annual investment returns in the vicinity of 8%. Such aggressive return assumptions allow governors and legislators to authorize smaller tax-financed contributions to such public pensions on the theory that anticipated investment gains will fund the retirement benefits promised to public employees.

A primary defense of this practice is that plans’ assumptions should reflect long-term experience. From this vantage, the current low interest rate environment is an historic anomaly. For the long run, the argument goes, public pension plans will earn higher returns.

Whatever the theoretical merits of this approach, it is troubling in practice, an invitation to push into the future the problem of inadequately funded public pension plans. That problem exists today and needs to be confronted today, as the Baby Boomer cohort retires in unprecedented numbers and places corresponding demands on public and private retirement plans.

A second defense of high assumed rates of return is that public pension plans can earn aggressive gains through so-called “alternative” investments such as private equity partnerships. Publicity about Mitt Romney’s IRA has focused attention on the often lucrative results obtained by at least some private equity investors. Many public pension plans have effectively become addicted to private equity deals and their promises of outsized investment returns.

It is, however, doubtful that these promised returns are generally obtained by the private equity industry or that such returns are obtained on the scale sought by public pension plans. Private equity is, by definition, private. Much of the good news we hear about this industry comes from the industry itself. Since there are no active markets for these investments, investors in private equity deals are ultimately dependent upon valuations by the sponsors of these deals.

In a recent paper, Professor K.J. Martijn Cremers of the Yale School of Management concluded that private equity investors have in the last 10 years done no better than investors in the stock market. Others, such as Professor Steven Kaplan of th

We’re still buzzing about the Superbowl (including the actual game, halftime show, ads — view all of them here — and the social media record that was set during the last three minutes of the game, where a whopping 10,000 tweets were sent... Read the rest of this post

By Edward Zelinsky

On a personal level, I enjoyed the news reports that Mitt Romney holds assets worth tens of millions of dollars in his individual retirement account (IRA). These reports confirm a central thesis of The Origins of the Ownership Society, namely, the extent to which defined contribution accounts, such as IRAs and 401(k) accounts, have become central features of American life.

I was also gratified as colleagues, friends and neighbors who are often skeptical of what I do for a living (“You actually teach about pensions?”) sought my opinion about Mitt Romney’s IRA. Since we don’t have all of the details, my answers entailed a certain amount of conjecture. For those too sheepish to ask, here are the questions most frequently posed to me and my answers:

Mitt Romney. Photo by Gage Skidmore. Source: Wikimedia Commons.

Because he was a better investor than you. It appears that Mitt Romney’s IRA largely consists of investments he made while a partner at Bain Capital and of the proceeds from such Bain investments. Those investments were apparently made in Mitt Romney’s 401(k) account when the investments had relatively little value. When he left Bain, these investments were rolled over, i.e., transferred tax-free, to Mitt Romney’s IRA. While these investments were modest when initially made, they are now quite valuable. That is what successful private equity investors do.

When must Mitt Romney pay taxes on the assets in his IRA?

April 1, 2018. He could start paying taxes before then but what the Code calls his “required beginning date” is April 1, 2018. This date is set by a statutory formula which is quizzical even by the standards of the Internal Revenue Code: Mitt Romney was born on March 12, 1947. He will be 70 years old on March 12, 2017. Six months after this birthday is September 12, 2017. Therefore, Mitt Romney must start to draw down and pay tax on his IRA as of April 1, 2018.

How much tax will Mitt Romney have to pay then?

It will depend on the size of the IRA at that time and the tax rates then in effect. Because Mrs. Romney is only two years younger than her husband, the first distribution from Mitt Romney’s account on or before April 1, 2018 must be at least 3.65% of the account as it then exists. This percentage is based on the Romneys’ joint life expectancies as determined by Treasury actuarial tables. Thus, for example, if Mitt Romney’s IRA is worth $100,000,000 on December 31, 2017, his first distribution from this account on or before April 1, 2018 must be $3,650,000. Assuming that Mitt Romney made only tax deductible contributions to the account, all of this distribution will be taxed as ordinary income, at whatever tax rate then prevails.

What about subsequent years?

Each year, as the IRA holder ages, the required distribution (and thus taxable income) increases as a percentage of the current account balance. For example, when Mitt Romney is 75, his required IRA distribution will be 4.37% of the account as it then exists. When Mitt Romney is 80 years old,

By Edward Zelinsky

Media reports have indicated that New York Governor Andrew Cuomo has been considering the use of public pension funds to finance the replacement of the Tappan Zee Bridge and to underwrite other infrastructure investments in the Empire State. This is a bad idea, harmful both to the governmental employees of the Empire State and to New York’s taxpayers. Using public pension monies in this fashion trades the immediate benefits of public construction for the long-term cost of underfunded public retirement plans.

If investment in the new Tappan Zee Bridge yields risk-adjusted, market rate returns, then private investors will step up to the plate and invest. Resorting to special financing arrangements with public pensions signals that a proposed investment does not pass the test of the marketplace. Market rate returns attract private capital. Such investments need not be subsidized with public pension monies.

There are projects which yield social benefits beyond their financial returns to investors. In a democracy, voters (or their elected representatives) can and should be persuaded in open deliberations to finance such projects with their tax dollars.

When governmental officials (however well-intended they may be) resort to special funding arrangements with public pension plans, it indicates that the investment in question flunks both the discipline of the market and the legitimacy of voter approval.

Such projects flout the venerable fiduciary standards for pension investments, namely, prudence and diversification.

An investment shunned by private investors is imprudent. When made by a state pension plan, such a below-market investment impairs the long-term interests of both the employees who depend on the plan for their retirement incomes and of the taxpayers who ultimately finance the plan. A prudent pension investment must, at a minimum, yield a risk-adjusted, market rate return. If pensions make investments rejected by private investors, such below-market investments are imprudent.

Moreover, an investment by New York pensions in New York infrastructure fails the test of diversification. In the private sector, it flouts the rule of diversification for a private retirement plan to invest its resources in the stock of the employer sponsoring the plan. The plan is already dependent upon the economic well-being of the sponsoring employer since the employer funds the plan. Placing the plan’s resources in the employer’s stock doubles the pension’s bet on the employer and its economic condition.

Similarly, if New York’s public pensions invest in New York projects, the pensions are doubling their bets on New York’s economy. These plans already count on New York’s economy for the tax revenues funding such plans. Concentrating New York pension investments in the Empire State is the opposite of diversification; the financial fate of these plans is already tied to New York’s ability to fund them.

The budgetary pressures on Governor Cuomo and other states’ chief executives today are severe. Those pressures make it tempting to turn to public pension funds to finance infrastructure when private investment can’t be obtained and voters cannot be convinced to pay taxes for such infrastructure.

It is precisely at such moments that the sage tests of prudence and diversification play their most important role –  protecting the long-term interests of retirees and taxpayers by precluding pension trustees from making investments which flunk the criteria for sound fiduciary decisionmaking.

The most recent reports indicate that Governor Cuomo may be reassessing the desirability of using public pensions to finance in-state infrastructure investments. Let us hope so. A new Tappan Zee bridge is a great idea. It should be pursued the right way, by formulating

Marc Palatucci, Intern

David Bach is the best-selling author of the Finish Rich book series. In his latest work, The Finish Rich Dictionary, Bach provides definitions for over a thousand financial words and terms. Interspersed throughout the definitions are ten essays designed to help the reader navigate today’s financial environment, and avoid it’s many pitfalls and perils. In this excerpt, Bach gives seven rules to follow in planning for ones retirement.  To read other excerpts from this book click here.

Here are seven rules for planning for retirement:

1. Invest for growth. Even with the recent downturn in the stock market, it’s still critical that, when you invest in your retirement accounts, you invest for growth. Many people are now making the crucial mistake of thinking that the stock market will never go up again and, as a result, they are putting all of their money in guaranteed investments (like certificates of deposit). The problem with investing in something that is guaranteed is that the return may be less than inflation, which means you are actually losing money each year. The cost of living has been climbing steadily, at an average of slightly more than 3 percent a year. Playing it safe will not allow you to beat that rate. If your retirement account doesn’t grow faster than inflation, you’re not going to have enough money to live on when you retire, 20, 30, or 40 years from now.
While seeking growth requires you to invest some of your money in stocks (and that means more risk), over the long term, you should come out ahead and be able to build a bigger nest egg.

2. Take advantage of free money. One of the smartest things you can do when it comes to saving for the future is taking advantage of the free money your employer may give you. In many cases, employers will supplement your retirement plan contributions with contributions of their own. These matching contributions usually start at 20 percent of what you’ve put in and sometimes go as high as 100 percent. At the same time, you should still make the maximum allowable contribution, not just the percentage of your paycheck that your company will match. If your employer stops matching your contributions (as many companies have recently started doing), don’t make the critical mistake of stopping your contributions to your retirement account. With or without a match, you want to use your retirement account at work.

3. Don’t borrow from your retirement plan. Although your retirement plan may allow you to borrow money from your account without paying taxes or penalties, don’t do it. Why? For starters, imagine being laid off from work. At the worst possible time, your company tells you, “You have to pay back your 401 (k) loan.” Without a paycheck, you can’t pay back your loan, right? Your company then reports your loan as a distribution, and now you owe the IRS taxes on the loan, plus a 10 percent penalty fee. But wait, you’re not working. How will you pay the IRS? See the problem here? This is happening to thousands of Americans right now. Don’t let it happen to you. Leave your retirement money alone until you’re ready to retire.

4. Consolidate your accounts. Many people remember Grandma’s advice about not putting all your eggs in one basket, but they often misunderstand it. Not putting your eggs in one basket means diversifying your risk - putting your money into different kinds of assets, such as stocks, bonds, mutual funds, and other investment vehicles. It doesn’t mean opening an IRA at a different bank or brokerage firm every year.

There is simply no way you can do a good job managing your retirement accounts if they are spread all over the place. If that’s what you’ve done, consider consolidating them into one IRA custodial account. Not only can you completely diversify your investments withing a single IRA, but you’ll also find it much easier to keep track of everything.

5. Be careful who you list as the beneficiary of your retirement account. Many people follow their lawyer’s advice to create a living trust to protect their estate, put all their assets in their trust’s name. This is a big mistake. When you do this, your rollover, which allows, for example, a widow to take over her late husband’s IRA and put it in her name, without having to pay any taxes on it until she actually starts taking the money out. If the husband has transferred ownership of his IRA to a trust, the wife can’t take it over in the event of his death. Instead, the account goes to the trust, and the proceeds become taxable. For much the same reason, you shouldn’t make a trust the beneficiary of any of your IRAs or 401(k) plans. You should also make sure that, if you or your partner has been married before, your ex isn’t still listed as the beneficiary on any of your retirement accounts. Finally, if you’re newly married, make sure that your spouse has put you down as the beneficiary of his or her accounts. Many people when they marry have “Mom” down as a beneficiary. No offense to “Mom” or “Sis,” but you want your name on that beneficiary statement. Also, make sure you list your kids as contingent beneficiaries.

6. Always take your retirement money with you. When you leave a company where you’ve been contributing to a 401(k) plan, don’t leave your retirement money behind. Rather, immediately inform the benefits department that you want to do an IRA rollover. Your former employer will then transfer your retirement funds either to a new custodial IRA that you’ve set up for yourself at a bank or brokerage firm, or to the 401(k) plan at your new employer (assuming there is one and it accepts money from other plans). If you leave money in an old 401(k) plan, your beneficiary, upon your death, would have to go back to a company where you may not have worked in years to get your money. The process can take as long as a year, and the money could be subject to taxes before your beneficiary can collect it.

7. Don’t shortchange yourself. Whatever else you do in your financial life, take retirement planning seriously. There is nothing you can do that will have more impact on your future financial security than maximizing your contributions to a retirement account and making sure that money works really hard for you.

Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America.  In this article, Zelinsky discusses the federal government’s promotion of common stock investments for 401(k) participants. He suggests that, in light of the Crash of 2008, that promotion constitutes misguided paternalism.

Even as we contemplate the financial carnage of the Crash of 2008, the federal government sends a strong, paternalistic and, ultimately, misguided message to 401(k) participants: Invest your retirement savings in common stocks.

Congress, in the Pension Protection Act of 2006 (PPA), directed the Secretary of Labor to promulgate regulations specifying the “default investments” to which 401(k) funds will be directed if participants fail to make their own investment choices. Under the regulations issued by the Secretary of Labor, a plan fiduciary obtains immunity from liability for a participant’s investment decisions only if the plan’s default investment constitutes a “qualified default investment alternative.” Among other requirements, a qualified default investment alternative must satisfy one of three mandatory patterns: a “life-cycle” pattern under which “a mix of equity and fixed income” investments changes for the individual participant as the participant ages, a “balanced” portfolio under which each participant has the same “mix of equity and fixed income” investments “consistent with a target level of risk appropriate for participants of the plan as a whole,” or a “managed account” under which an investment manager allocates a particular participant’s account to “a mix of equity and fixed income” assets.

When one cuts through the bureaucratic verbiage, a strong message emerges: 401(k) funds, particularly the funds of younger participants, should be invested in common stocks.

At one level, the PPA and the DOL regulations which implement it reflect a plausible investment theory, namely, that common stocks, for the long run, do better than do more conservative investments. The PPA and the DOL regulations also respond, in light of this theory, to two accurate perceptions about the 401(k) world: First, unless participants direct otherwise, 401(k) plans have historically placed participants’ resources into conservative, low-yield investments like money market funds. Second, 401(k) participants often fail to diversify their holdings out of these conservative default investments.

Hence, the PPA and the DOL regulations channel 401(k) funds toward common stocks by effectively requiring that at least part of passive participants’ accounts be invested in such stocks.

Surveying the wreckage of the Crash of 2008, this looks like misguided paternalism. Many investors who buy common stocks in the current bearish environment are likely do well in the long run. But, as they say, past performance is no guarantee of future success. And some, particularly smaller investors, may sincerely and (from today’s perspective) rationally prefer to avoid the volatility associated with common stocks.

There is, as we have just seen, a reason that the extra projected profit associated with common stocks is labeled a “risk premium.” The passive 401(k) participant who leaves his funds in conservative, low-yield investments looks more reasonable today than he did when Congress passed the PPA in the bull market of 2006.

A defender of the PPA and the DOL regulations could retort that they do not require participants to invest in common stocks, but merely send 401(k) funds to equity investments unless the participants direct otherwise. True. But the PPA and the DOL regulations nevertheless reflect a father-knows-best attitude, taking it as the federal government’s responsibility to privilege its preferred approach to investing and enshrining that stock-based approach in the law.

Before the Crash of 2008, such paternalism looked plausible. At an as yet unknown date in the future, such paternalism may look plausible again. Today, it looks misguided.

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