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A joint initiative of Ludwig-Maximilians University’s Center for Economic Studies and the Ifo Institute for Economic Research Bulletin Volume 19 No. 3 July 2009 Globalisation and Intellectal Property Rights Innovation is key to a knowledge economy. But what if your ideas and products get commercialised without you seeing a penny for your efforts? As Edwin Lai points out, there are unquestionable interactions between globalisation, intellectual property rights protection, and innovation, an area he continued to explore while at CES. (page 3) Trichet on the ECB Credit Policy Ifo News A special Munich Seminar was held at the University of Munich to hear European Central Bank President Jean-Claude Trichet explain his bank’s steps in tackling the financial crisis and providing enhanced credit support. (page 7) (p. 4-5) Munich Economic Summit (p. 2) Venice Summer Institute (p. 2) Featured Researchers Chinese Fertility As the most populous nation on Earth, everyone takes notice of China’s fertilitiy policies. But, as Carol H. Shiue’s research has found out, there is more than just fertility policies behind that country’s fertility behaviour. (page 6) Softer Constraints Lower levels of government, such as provinces or federal states, tend to be more profligate when it comes to spending. As Thomas Stratmann observes, the softer budget constraints they are often subjected to tend to make them less fiscally responsible. (page 7) Sascha O. Becker (p. 6) Dirk Jenter (p. 6) Wolfgang Keller (p. 3) Edwin Lai (p. 3) Kalina Manova (p. 8) Carol H. Shiue (p. 6) Thomas Stratmann 8th Munich Economic Summit (p. 7) Jean-Claude Trichet (p. 7) From nukes to trees, taxes to extraction caps: no weapons in the battle against the CO2 enemy were left undissected during this year’s Munich Economic Summit. (page 2) Offshore Determinants Offshoring is usually defined as the movement of jobs to other countries. What moves companies to take the step? Wolfgang Keller finds that money is but one among many other determinants. (page 3) Business Climate Perks Up For the fifth month in succession, the Ifo Business Climate Index rose in July. The economy appears to be gaining traction once again. (pages 4-5) CEO Performance/Turnover Realities Are CEO dismissals sensitive to performance at all? Dirk Jenter’s research suggests that this is indeed so, in any case, more than previously thought. (page 6) You can also download this bulletin from www.cesifo.de Vol. 19, No. 3 July 2009 8th Munich Economic Summit: Climate Policy Conundrums converted into cash in a cap-and-trade system would be a start. For a long time we have worried that there may be too little fossil fuel left in the Earth’s crust to supply our needs. Now comes global warming and, with it, the realisation that the problem is actually that we have too much fossil fuel left. That the worst thing we could do is to extract it all as quickly as we are doing now. We also, at least in Germany, started to veer away from nuclear power. Its waste is dangerous, lasts for too long and requires too much storage room. And then comes the climate problem and, with it, the realisation that nuclear is not all that bad after all. It is practically carbondioxide free. And nuclear waste lasts for only a few thousand years compared to carbon dioxide, which lasts forever. As to final storage, carbon dioxide requires a volume many thousands of times larger than nuclear waste. So for the time being we are just storing it in the air we breathe. These two facts go to show that the climate change discussion contains not a few paradoxes, and that fresh thinking is urgently required if we want to devise an effective strategy to curb global warming. This is what the recently held 8th Munich Economic Summit provided. The Summit started from the basis of a fundamental, unavoidable fact: every carbon atom in the gas, coal or oil that we extract from the ground to use it as fuel ends up in the atmosphere. A significant part of it will stay there forever, contributing to the greenhouse effect that warms up our planet and threatens to make it unlivable. There are only two things we can do to correct this: either we extract less carbon from the ground, or we put it back underground after extracting its energy. Our efforts, however, go in neither of these two directions. What we have been trying to do, at great financial cost, is turn to alternative, CO2-free energy sources and to use energy more efficiently. But despite all the sacrifices, our efforts have not reduced in the least the amount of CO2 emitted globally, which continues to increase unabated. Which means, carbon extraction continues unabated. Evidently, somebody is buying 2 the carbon we do not consume and burning it in our stead. And, on top of that, acquiring it at cheaper prices thanks to our demandreducing, price-depressing strategies. The Summit examined the idea of taking the carbon out of the atmosphere and storing it where it would not contribute to the greenhouse effect. There is the promising technology of sequestering carbon, i.e. capturing it, compressing it and storing the resulting liquid. But the great promise pales when confronted with the reality of actually doing it. Scrubbing carbon dioxide from combustion exhaust and liquefying it consumes as much as a third of the energy obtained from the fuel in the first place, and the resulting volume is still so large, even in liquefied form, that our planet simply does not offer enough room to store all of it. This results from the fact that combustion adds two oxygen atoms to each carbon atom burned, turning it into carbon dioxide. This gas will always be several times more voluminous than the original fuel, even if you compress it to the limit of physical laws. There is, however, a device that neatly captures carbon dioxide from the air, strips it of those troublesome oxygen atoms and stores it in a harmless, even highly beneficial, form. In the process, it releases the oxygen atoms to the atmosphere, improving it for our breathing. These devices, best of all, consume practically no fossil energy to function and, unlike some non-carbon energy sources, such as wind turbines, are not a blight on the landscape. Quite the contrary, in fact. Unfortunately, instead of fomenting the widespread use of such devices, grouped under the generic name of “forests”, many countries are busily destroying them. A sensible climate policy should reward every country or institution or company that promotes reforestation and afforestation. Carbon credits that could be Bulletin But, unfortunately, neat as trees are, they cannot by themselves remove all the excess carbon from the atmosphere. So, the second approach: extract less of it. But how to go about it? After all, countries like Venezuela need to extract their resources to finance 21st century socialism, Nigeria to lift its masses from poverty, Russians to buy football clubs and Middle Eastern potentates for that extra Rolls. Convincing them to leave more of it underground will be a tough sell. A bit of history may be of help here. During the war, rationing coupons helped allot scarce resources as evenly as possible. A similar system could well regulate the amount of carbon being supplied at a global level: a carbon trading system that sets the supply level, in effect turning into a scarce resource of which there is no more than that on offer, and that encompasses the entire world in one go. To avoid partisanship, it would have to be administered by the United Nations. Under such a system, if a country wants to consume fossil fuels, it must be in possession of the corresponding certificate. It will be allowed to consume only the amount stipulated in it. This would focus the minds wonderfully on how to generate and use energy in a more planetfriendly manner, an area where our current efforts would find a perfect fit. The keywords here are “all-encompassing” and “in one go”. No countries may be allowed to trade outside the system, and for this very reason they all have to come on board at the same time. But such a mechanism is surely something for times of war, not for generally peaceful ones such as now? Actually, we are in a state of war. In fact, a war that, if we do not defend ourselves, could prove to be the ultimate one. The war against an enemy destroying the only planet we have. The Munich Summit is organised by the BMW Stiftung Herbert Quandt and the CESifo Group Munich in partnership with The Times, the Wall Street Journal Europe, and Handelsblatt. Vol. 19, No. 3 | July 2009 Globalisation and Intellectual Property Rights Limits to Offshoring Lai Keller Globalisation has worked wonders for the bottom line of many a company, by expanding markets and offering access to cheaper labour or services. But it has one problem: the protection of intellectual property rights (IPR). Many countries clone foreign products with abandon without bothering with such nuisances as obtaining licenses or paying royalties. Still, globalisation is here to stay. And there are unquestionable interactions between globalisation, intellectual property rights protection, and innovation. This is the field that Edwin Lai, of the Hong Kong University of Science and Technology, will be exploring in depth while at CES. Global trade in IPR-sensitive goods is increasing fast, but there has been large international variation in the strength of IPR protection and IPR standards across countries, at least before the signing of the TRIPS agreement (Agreement on TradeRelated aspects of Intellectual Property Rights) in 1994. The agreement provides a set of universal minimum standards to ensure that IPR are protected more uniformly worldwide. Yet many of the provisions of the agreement are still not fully enforced by developing countries. A few research questions arise, such as what explains the large international vari- ation in strength of IPR protection before TRIPS? Is there any economic rationale for international policy coordination on IPR standards? (Can coordination be Pareto-improving?) How does globalisation affect government incentives to raise IPR standards and research intensities of countries? Edwin Lai is a Professor of Economics at the Hong Kong University of Science and Technology. He was Senior Research Economist and Advisor at the Federal Reserve Bank of Dallas until June 2009. Before that he was Assistant Professor at Vanderbilt University, Associate Professor at City University of Hong Kong and Associate Professor at Singapore Management University. Mr Lai has been a consultant to the World Bank, a visiting scholar with Boston University and a visiting fellow with Princeton University. He got his B.S. in Engineering from the University of Hong Kong and M.A. and Ph.D. in economics from Stanford University. Mr Lai’s main research areas are international trade, industrial organization, technological change and growth. He is also interested in studying the economies of East Asia and China. He has published in American Economic Review, RAND Journal of Economics, International Economic Review, Journal of International Economics and other respected journals in the field. Special Issue of CESifo Economic Studies Next September CESifo Economic Studies will publish a double issue focusing on two highly topical questions: executive compensation and inequality in China. Published by Oxford University Press on behalf of CESifo, the journal will include articles on bonus payments and fund managers’ behaviour, a short history of executive compensation regulation in America, insider information and performance pay, and the search for reasonable executive compensation, among others topics, to shed light on an issue that keeps regulators and board rooms awake at night. The second section will examine China’s rising inequality, a phenomenon that could have momentous consequences on social stability in the years to come in that country. Topics will include what lies behind rising earnings inequality in urban China, power as a driving force of inequality, and rural income volatility. For more, visit http://cesifo.oxfordjournals.org Bulletin What exactly makes a job offshoreable? Lower wages is the acknowledged key attraction for firms to offshore, true, but actually the phenomenon is generally not well understood. Wolfgang Keller, of the University of Colorado at Boulder, will work at correcting this while at CESifo. Mr Keller’s research stresses two principal factors prompting companies to take the offshoring plunge, namely geographic distance and technological complexity. In his paper “Global Production and Trade in the Knowledge Economy” (with Stephen R. Yeaple), he shows that multinational companies typically sell more in countries that are geographically close: Procter & Gamble’s affiliate in Mexico, for example, has higher sales than its affiliate in Brazil. The reason is that offshoring involves technology transfer costs because there is a phase during which workers need to learn how to get the technology to ‘work’. The technological complexity of the activities to be offshored imposes a second limit. If the host economy has a limited absorptive capacity to manage such technology, or if relatively complex tasks require more problem-solving communication between managers in the multinational parent and the workers of the affiliate, the technology transfer costs will increase substantially, damping offshoring. While at CESifo, Mr Keller will seek additional new evidence on this by studying the activities of US and possibly also Swedish and German multinational companies. Wolfgang Keller, Professor at the University of Colorado at Boulder since 2005, is one an acknowledged expert on the transfer of technology between different countries. His research on the roles of international trade and foreign direct investment (FDI) in this process are often cited by other academic economists and development organizations such as The World Bank. He obtained his PhD from Yale University (1995) and his MA from the University of Freiburg (1990). 3 Vol. 19, No. 3 | July 2009 News Ifo Business Climate Brightens Up The Ifo Business Climate for industry and trade in Germany rose again in July. The firms are no longer quite so dissatisfied with their current business situation as in the previous month, and they are again less sceptical regarding business developments for the coming half year. It seems that the economy is gaining traction. Their scepticism regarding foreign business, however, has weakened further. credit conditions are likely to remain restrictive due to recession caused writeoffs. On the assumption that the oil price stabilizes at USD 70 per barrel of Brent and that the dollar/euro exchange rate fluctuates around 1.40 over the forecast horizon, inflation should move to 0.1% in September and 1.0% in December. The Euro-zone Economic Outlook is jointly produced by the German Ifo Institute, the French INSEE institute and the Italian ISAE institute. Credit Conditions Remain Restrictive In June the credit constraints for German industry and trade were only slightly lower than in the previous month. After 42.9% in May, 42.4% of the firms have appraised bank lending policies as restrictive. Euro-zone Economic Outlook: Economic prospects remain subdued The euro-zone is still in recession. Real GDP dropped sharply in Q1 2009 by 2.5%, after a fall of 1.8% in Q4 2008. Economic prospects remain subdued, but the contraction of activity is likely to be less sharp in the coming quarters. Real GDP is forecasted to shrink by 0.6% in Q2 and by 0.4%, respectively, in Q3 and Q4. The fall of industrial production is likely to continue but at a progressively slowing pace: recent business surveys indicate slightly improving production growth expectations but the economic environment remains unsupportive. Private consumption is expected to fall by 0.6% in Q2, 0.4% in Q3 and 0.5% in Q4. While purchasing power could be stimulated by tax cuts associated with the massive fiscal packages, the deterioration of the labour market situation is having a dampening effect. Investment is expected to diminish further by 3.2% in Q2, 2.5% in Q3 and 1.4% in Q4. Firms’ earning prospects are still depressed and 4 In manufacturing the credit hurdle fell from 45.4% in May to now 43.8%. For the larger firms in particular, complaints about credit conditions abated somewhat. Nevertheless, at 50.9% more than half of the large manufacturers still complain about difficult credit negotiations. The large firms are still feeling a credit crunch. For mid-sized firms the credit hurdle rose slightly from 40.4% to 40.7%. Smaller firms reported restrictive bank lending policies less often. The share of “restrictive” responses has fallen from 41.8% in the previous months to 39.7%. In construction the credit hurdle fell somewhat and now stands at 45.5% compared to 47.2% in May. A contrary development was reported in wholesaling and retailing, where 39.9% of the firms see themselves subject to more restrictive lending policies compared to 38.9% last month. Ifo Economic Forecast 2009/2010: Downturn Continues The world economy is in the midst of the deepest recession since the Great Depres- Bulletin sion. The pace of the contraction, however, has probably slowed since this spring. Worldwide programmes to boost economic activity have been implemented, and the expansive monetary policies of the central banks are gradually having an effect. Also measures to stabilise financial markets have been taken in numerous countries. Finally, real incomes have been boosted by the strong decline in raw material prices. The world economic climate as surveyed by the Ifo Institute improved in the second quarter of 2009 for the first time since autumn 2007. However, the rise of this indicator was solely the result of more favourable expectations for the next six months, whereas the appraisals of the present economic situation continued to deteriorate, falling to a new historical low. A quick recovery of the world economy is not to be expected. A major problem is still the precarious equity capital situation of the banking sector in the United States and Europe. This is the result of the necessary write-downs and valuation adjustments of a magnitude that threatens the existence of the banks. To be sure, after the insolvency of Lehman Brothers in September 2008, massive government intervention has prevented more bankruptcies of major financial institutions. However, additional value adjustments of considerable amounts are still looming. Also the recession-induced defaults on loan repayments may play an increasingly important role. In several important countries the real-estate markets are depressed, which likewise will increase banks’ writeoff requirements. As a result, the banks will strive to reduce their balance sheets noticeably in order to improve the extremely strained relationship of their capital to their balance-sheet totals. This will affect bank lending policies towards private households and non-financial businesses especially when the demand for credit, which has been dampened by the recession, picks up again. For this reason economic recovery will unfold only very hesitantly, with the current downturn lasting much longer than would otherwise be expected. Vol. 19, No. 3 | July 2009 In total, world GDP will decline by 1.8% in 2009 before it increases by 2% in 2010. This forecast is based on the countries taken into consideration by the International Monetary Fund (IMF), whose growth rates were weighted using 2008 purchase power parities. Inflation will flatten out strongly worldwide, but unemployment is expected to increase markedly. This forecast is based on the assumption that the price for Brent crude oil will fluctuate around 70 US dollars per barrel in the forecast period and that the euro/dollar exchange rate will stabilise at 1.40. Under these assumed conditions, world trade will continue to decline initially before it gradually recovers. It will fall by 1.4% in 2009 and increase by 3% in 2010. The German economy is experiencing the worst recession in the history of the Federal Republic. According to the now available official statistics, economic output fell in the first quarter of 2009, seasonally and calendar adjusted, by 3.8%, and already in the fourth quarter of 2008 the economic output had declined by 2.2%. Germany has thus experienced the sharpest collapse in growth of all major European economies. The main reason for this catastrophic economic development since last autumn is the simultaneous worldwide collapse in demand for capital goods and consumer durables that occurred in the wake of the international financial crisis. The German economy has been particularly hard-hit by this external demand shock due to its high dependency on foreign trade and its specialisation in cyclically sensitive industrial products. After the drastic drop in the winter half year 2008/09, economic output has likely also fallen in the second quarter, albeit at a reduced pace (current rate: –0.7%), mainly as a result of a drop in manufacturing, financing, leasing and business services. Signs of the start of a gradual stabilisation are seen in recent developments of a number of important cyclical indicators such as production and incoming orders as well as the Ifo Business Climate. For the first semester of 2009 a seasonal and calendar adjusted decline in real GDP of 5.2% will occur in comparison to the second half of 2008; in a year-on-year comparison the decline amounts to 7.5%. The downturn will continue throughout the forecast period. After a temporary increase in summer primarily driven by fiscal stimulus, the basic tendency of economic output will be further contraction. Although no further dampening effects are foreseeable from net exports, the decline in equipment and construction investments will continue. The reduction in inventories has also not yet been concluded. In addition, private consumption will fall starting in the autumn months due to the decline in employment and strong increases in unemployment. Not until spring 2010 can we expect the fall in production and demand to bottom out. Afterward, real economic output should increase somewhat. As the world economy gradually recovers, exports will increase somewhat; also equipment investment should recover moderately. Towards the end of 2010, anticipatory effects are likely due to the restoration of the declining balance method of depreciation. The economic stimulus packages will stimulate construction investment. On the whole, however, the economic dynamics will not be strong due to the weakness of private consumption so that the operating rate of the economy will fall. On average for 2009 total economic output will decline by 6.3%, in both unadjusted and calendar adjusted terms. In 2010, due to the low initial level, a decline of only 0.3% (calendar adjusted: 0.4%) is expected. The recession will become increasingly noticeable on the labour market as of the summer months of 2009. The build-up of reduced working hours will come to a standstill and the numbers of unemployed will increase at an accelerated rate. On average for this year, employment numbers will fall by 460,000 and next year by as much as 1.05 million. The number of unemployed will rise by 320,000, on average for 2009, and by 760,000 in 2010. At the same time, consumer prices will remain virtually stable. For this year an inflation rate of 0.2% is expected; in 2010 it will average only 0.4%. The budget deficit will grow unusually strongly in the forecast period. In 2009 the deficit will increase to 3.4% of nominal GDP but in 2010 to 6.0%. This is caused by the economic situation, which will lead to enormous revenue shortfalls and additional expenditures, but there are also strong discretionary impulses in connection with the government’s stimulus packages. Bulletin 60th Annual Meeting of the Ifo Institute The sixtieth annual meeting of the Ifo Institute was held on 23 June 2009 at the University of Munich. After words of welcome by the University's Vice President, Reinhard Putz, Hans-Werner Sinn presented the latest Ifo economic forecast. He sees great risks for further setbacks in the world economy and renewed his criticism of the strong export orientation of the German economy, which as a result has been particularly hard-hit by the sharp downturn in world trade. According to Mr Sinn, the danger of deflation is stronger than that of inflation. To combat the financial crisis the state should take on temporary shares in the banks. Guest speaker was Axel Weber, president of the German Bundesbank, who spoke of the reactions and the lessons from the global financial crisis. The event concluded with a panel discussion featuring Axel Weber, Hans-Werner Sinn, Georg Fahrenschon, Bavarian State Minister of Finance, and Theodor Weimer, executive board spokesman of HypoVereinsbank. The presentation by Hans-Werner Sinn and the panel discussion are available as a video on the Ifo website. Prizes for Ifo Researchers As recognition of and incentive for highquality research, the Friends of the Ifo Institute society awards an annual prize for academic research. The requirement is publication in a peer-reviewed scholarly journal. The 2009 prize went to Marko Köthenbürger, for a number articles published in international refereed journals. The prize for outstanding success in the management of contract studies is given for work on a major research contract of recognised quality content, with international country comparisons, and within the time and budget allotted. This year, the prize went to Marc Piopiunik, Christian Holzner, Ludger Wößmann, and Edith Banner for the project 'Measuring Human Capital in Germany: How it grew and how it is being utilised'. Another special prize went to Christian Holzner, Sonja Munz, Herbert Hofmann, Thiess Büttner, and Edith Banner for the project “Evaluation of the Experimentation Clause in Par. 6c SGB II: Macroanalysis and Regional Comparisons”. 5 Vol. 19, No. 3 | July 2009 I Will See You to the Door, Mr CEO Chinese Fertility Behaviour Jenter Shiue A spate of high-profile CEO dismissals after the dismal performance of their companies seems to point to a sort of divine justice for non-performing executives. Still, most of them left with generous severance packages in their pockets. And then there are many companies doing poorly with their CEOs still firmly on their seats. What is the actual performance/CEO turnover reality? capital markets and on questions of corporate governance. His recent research projects have examined the capital structure decisions of US firms, option and stock compensation for top executives and other employees, insider trading by managers, the role of institutional investors in mergers and acquisitions, and the effects of the business cycle on forced CEO turnover. Carol H. Shiue, PhD, Yale University, is an Associate Professor of Economics at the University of Colorado whose research interests are in the economic history of market development and trade in China, the political economy of famine relief, and long-run comparisons of living standards and economic growth in China and Europe from the 17th to the 20th centuries. Dirk Jenter, of Stanford University, is devoting part of his research agenda while at CES to this issue. His research has shown that CEO dismissals are considerably more sensitive to performance than previously thought, and especially so in the beginning of tenure. Preliminary results also suggest large cross-sectional differences in the turnover-performance relation across firms with different governance structures. Dirk Jenter is an Assistant Professor of Finance at the Graduate School of Business at Stanford University, where he teaches the introductory finance course in the Stanford MBA program. Before joining Stanford, Mr Jenter was an Assistant Professor of Finance at the MIT Sloan School of Management, where he taught corporate finance in both the MBA and executive education programs. He won the MIT Sloan Teacher of the Year Award in 2005 and the MIT Sloan Award for Excellence in Teaching in 2007. Another focus of her research is on kinship organisation and social mobility in China over the last several centuries. This is an ongoing project that uses genealogical records of education and occupation among members of the clan to study changes in demographic behaviour and family size over time. The presence of fertility-control behaviour in the absence of income or technological shocks suggests that there may be a much broader set of economic factors that can lead to lower fertility behaviour. He received his undergraduate education at the University of Frankfurt and the University of Cambridge, an MPhil degree in Economics from the University of Cambridge, and his MA and PhD degrees in Business Economics from Harvard University. His research has won several awards and been featured in The Wall Street Journal, the Financial Executive Magazine, Smart Money, and on CNN. These relationships are important for understanding how demographic transitions come about, and whether the demographic transition was primarily a response to the economic changes of industrialisation, or whether there could be a demographic role for economic growth. A second project he will pursue while at CES examines the effects of exogenous CEO departures (that is, those caused by illness or death) on firm behavior and performance. The project’s primary goal is to establish the importance of individual executives for firms’ policy choices. A secondary goal is to show that many firms led by long-tenured, entrenched CEOs pursue policies that are far from valuemaximising. Mr Jenter’s research also includes the interaction of managers and firms with She has been a visiting scholar at the Russell Sage Foundation in New York City and the World Bank. The Many Roles of Education Sascha O. Becker is currently SIRE Professor of Economics at the University of Stirling, Scotland. He studied Economics at the Universities of Bonn, Germany, and at the Ecole Nationale de la Statistique et de l’Administration Economique (ENSAE) in Paris, France. He obtained his PhD at the European University Institute in Florence in 2001. In 2000, he was a visiting scholar at the Center for Labor Economics at the Uni- 6 versity of California in Berkeley. From 2001 to 2008, he worked at the Center for Economic Studies of the LudwigMaximilians University of Munich. In 2006, he spent 7 months at the University of California in San Diego (UCSD). While at CESifo, he continued research on two projects with Ifo researchers. The first one, with Erik Hornung and Ludger Woessmann, looks into the role of education in Prussia’s industrialisation process. Bulletin The second project, with Francesco Cinnirella and Ludger Woessmann, studies the relationship between education and fertility before the 1849 demographic transition. His research has appeared in the Quarterly Journal of Economics and the European Economic Review, among others. Vol. 19, No. 3 | July 2009 The ECB’s Enhanced Credit Support Soft Constraints Trichet Stratmann Jean-Claude Trichet, the President of the European Central Bank, delivered an outstanding lecture on July 13 at the University of Munich, within the framework of CESifo’s Munich Seminar series. Speaking to a packed audience, he reviewed the ECB’s policy actions in these times of exceptional challenges for monetary policy-makers. In the last two years the environment in which the ECB operates has changed profoundly. “We are still in uncharted territory”, Mr Trichet warned. The ECB’s actions since the onset of the financial crisis have been bold, with unprecedented action taken in August 2007, on day one of the financial tsunami. And it seems to have worked: since the crisis began, he stressed, “not one systemically important financial institution has collapsed in the euro area”. Since October 2008, the ECB’s key policy rate has been cut from 4.25% to 1%, reflecting a policy of fully accommodating banks’ liquidity needs. And the bank has been far from passive in recent months, broadening the set of measures that, collectively, represent the policy toolkit that Mr Trichet calls “enhanced credit support”. But first, he provided the ECB’s assessment of the current situation in the euro area: economic activity is expected to continue declining for the remainder of this year, he said, but significantly less strongly than it did in the first quarter of 2009. Looking ahead into next year, following a period of stabilisation, a gradual recovery with positive quarterly growth rates is expected by mid-2010. Inflation, in turn, will stay below but close to 2%, in line the bank’s Governing Council’s aim. The financial turmoil since late 2007 has made it unavoidable to take monetary policy measures that are unprece- dented in nature, scope and magnitude. These measures fall into two categories: first, standard measures in the form of interest rate changes; and second, a number of non-standard measures, which together constitute the ECB ’s policy toolkit of enhanced credit support. These are special and primarily bank-based actions we have taken to enhance the flow of credit above and beyond what could be achieved through interest rate reductions alone. These measures include fixed-rate fullallotment, expansion of collateral, longer-term liquidity provision, liquidity provision in foreign currencies, and financial market support through purchases of covered bonds. He stressed that all the ECB’s policies are conducted in full continuity of its mission of pursuing price stability. Moreover, all measures are deliberately designed in a way that they can be unwound once any upside risks to price stability should emerge. This, he said, will contribute to what is lacking most, namely confidence on the part of households and companies, and will lay the groundwork for a return to sustainable prosperity. Economic research has demonstrated that two-thirds to three-quarters of European households are “Ricardian”. This means that they consume less and save more if they lack confidence in the soundness of future public finances. The anchoring of sound policies in a medium to long-term framework is more important than ever if we want to effectively counter the present adverse circumstances. The ECB, for its part, he concluded, will do all that is necessary to continue to be a solid and reliable anchor of stability and confidence in these challenging times. Bulletin Lower levels of government, such as states or provinces, often tend to enjoy softer budget constraints compared to the central governments’. Just think of the profligate ways of Argentinean provinces or Brazilian states. But the phenomenon affects European countries and the US as well. Thomas Stratmann, a Professor of Economics at George Mason University, will devote part of his research while at CESifo to studying the determinants of fiscal responsibility of such lower levels of government. In many countries, the subordinate governments’ soft budget constraints fuel their expectation to be bailed out by higher level governments in the event of severe financial crises. Often, soft budget constraints are institutionalised by a national intergovernmental transfer system that equalises budgets per capita across states. These institutions in federal systems can give rise to perverse incentives leading to unsound fiscal policies. Since the bail-out guarantee is given to all state governments, budget constraints may appear to be equally soft across states. There are, however, state-specific political factors that may influence the softness of the budget constraint. Some states have more political power than other states, and a simple political economy model predicts that politically influential states will obtain more transfers, have higher deficits, and will not pursue fiscally responsible policies because they expect to receive help from the federal government in times of financial crises. In Germany, for instance, some states are politically more influential than others because states’ voting weights differ in the upper chamber of the German parliament, the Bundesrat, with smaller German states being overrepresented relative to their population. Something similar occurs in the US, where smaller states are overrepresented in the Senate. Mr Stratmann will analyse whether smaller states receive more federal transfers than larger ones, have larger deficits, and pursue less efficient policies. 7 Vol. 19, No. 3 | July 2009 10th CESifo Venice Summer Institute Survival Through Differentiation Manova The CESifo Venice Summer Institute celebrated its 10year anniversary with a range of workshops that atracted over one hundred participants to its venue at Venice International University, on San Servolo, a tiny island across the water from San Marco in the bay of Venice. Over the years, the Summer Institute, one of CESifo’s most popular events, has attracted nearly 1,000 scholars to some 50 workshops. Both seasoned economists and young upcoming talents have found here the perfect setting for a fruitful exchange of ideas. The secluded, relaxed atmosphere of San Servolo lends itself ideally for intensive study and informal networking during the day, with a truly unique town just ten minutes away by boat to enjoy in the evening. As Peter Neary of the University of Oxford puts it, “you are in the midst of the most tourist-infested spot on the planet, and yet cocooned in a setting that offers you the best conditions for academic learning and quiet interaction with your peers.” Many other guests over the years have expressed similar opinions. Some of them have been world-class figures, such as Nobel laureates Robert A. Mundell, Edmund Phelps and Edward C. Prescott, and Jeffrey Sachs, Robert J. Shiller, Martin Wolf, Philippe Aghion, Jean-Paul Fitoussi, Lucas Papademos, Christopher Pissarides, the late Pentti Kouri, and Jorma Olilla, to name but just a few. This year’s workshops opened with Economics and Politics of Climate Change. Organised by Mika Widgrén and Panu Poutvaara, it had keynote lectures by HansWerner Sinn and Larry S. Karp. Parallel to it, a workshop on European Unemployment, organised by Christopher Flinn and Klaus Waelde, included keynote lectures by Christopher Flinn, Jean Marc Robin, Robert Shimer, and Lars Ljungqvist. By mid-week, the workshop Behavioural Public Economics, organised by Bernd Genser and Jean-Robert Tyran, had keynote lectures delivered by Arno Riedl and Joel Slemrod, and ran parallel to another workshop dealing with Operating Uncertainty using Real Options, organised by Yu-Fu Chen and Michael Funke. Two further workshops rounded off the Summer Institute, Rethinking the Privatisation of Social Security, organised by Gerhard Illing and Efraim Sadka, with keynote lectures from Stephen Zeldes, Gary Burtless and Laurence J. Kotlikoff, and Heterogeneous Firms in International Trade, organised by Peter Egger, Stephen Redding and John Whalley, with the cooperation of NORFACE, the Centre for Economic Performance, the London School of Economics, and CIGI, with a keynote lecture by Peter Schott. As someone said about the Institute, thoughtfully looking out the window over San Servolo’s park, “there are worse settings for an economics conference...”. Quite so. So, see you there next year! Kalina Manova, an expert on firms’ participation in international trade and investment, will work on three research projects during her stay at CESifo. The first one explores firms’ potential to differentiate the quality of their product across export markets in response to the toughness of market competition, using a uniquely rich and detailed dataset on the export activities of Chinese firms. The second project establishes stylised facts about the extent of firm heterogeneity in these data, in terms of the number of export destinations firms target, the range of products they export, and the frequency of firm and product turnover. These stylised facts shed light on the cost structure of exporting, and highlight distinctions between private and state owned Chinese corporations, joint ventures, and affiliates of foreign multinationals. The last project will examine the collapse of international trade flows in response to the current financial crisis. Ms Manova’s research on international trade and investment shows a special interest in the nature and significance of firm heterogeneity. Her recent research projects have explored the role of credit constraints in firms’ exporting and FDI decisions, the effects of equity market liberalisations on countries’ trade flows, the implications of financial development for aggregate growth and volatility, and the consequences of IT outsourcing for firm and industry performance. Kalina Manova is an Assistant Professor at the Stanford University Department of Economics. She received her BA, MA and PhD degrees from Harvard University, and her research has been published in the Journal of International Economics. Bulletin Munich Society for the Promotion of Economic Research (Münchener Gesellschaft zur Förderung der Wirtschaftswissenschaft, CESifo GmbH) is the international platform of Ludwig-Maximilians University and the Ifo Institute for Economic Research. President and CEO: Hans-Werner Sinn Address: CESifo, Poschingerstr. 5, 81679 Munich (Germany) Telephone +49 (0) 89/9224-1410, Fax: +49 (0) 89/9224-1409 Editor: Julio C. Saavedra. Ifo News provided by Annette Marquardt.