Unfinished business

How September 11th and the early successes in Afghanistan have

changed the debate in America about Saddam Hussein
Dec 6th 2001

BACK in 1998, when he was merely a dean at Johns Hopkins University, Paul Wolfowitz visited Capitol
Hill to give some bad-tempered views to a congressional committee. This was 42 days after United Nations
weapons inspectors gave up trying to make Saddam Hussein comply with all the disarmament obligations
clamped on him at the end of the 1991 Gulf war. Mr Wolfowitz's target was the pusillanimity of the Clinton
administration. Lacking a serious policy on Iraq, grumbled the then dean, the administration persisted in
pretending that sanctions were keeping Saddam in a “strategic box”, and that the only alternative to the
pretence was to march American troops into Baghdad. This, he insisted, was not true. There was a safer way
to rid Iraq of its dictator.

The safer way was to help the Iraqi people to free themselves. This could be done by creating a secure
enclave in southern Iraq similar to the semi-free Kurdish zone in the north. Here a provisional government,
defended by American air power and special forces, could build support against the regime, seize Iraq's
largest oilfield, and provide a haven for refugees and defecting soldiers. This would, confessed Mr
Wolfowitz, be a formidable undertaking and not without opponents in the UN Security Council. But once
America's seriousness of purpose became clear, Saddam's regime might swiftly unravel.

Mr Wolfowitz is now back at the Pentagon as America's deputy defence secretary. The vision that he and
others set out three years ago has not come to pass—not, that is, in Iraq. But something like it is taking place
in Afghanistan. There, America's forces have so far avoided bloody engagements on the ground. The
Taliban regime has been unravelled by American air power, augmented by special forces, with local
opposition armies invading from the safe enclave of territory controlled by the Northern Alliance. It has
worked in Afghanistan. Could it work in Iraq? And should it be tried?

In this special report

• Suddenly, in Bonn
• » Unfinished business «
• Stage one almost done, time to start planning stage two - Fighting terrorism

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• Biological weapons: A viral bust-upDec 6th 2001

• Stage one almost done, time to start planning stage two - Fighting terrorismDec 6th 2001

Sour triumph

More than ten years have passed since George Bush senior sent American forces to drive Mr Hussein's
invading army out of Kuwait. After they did so, Mr Bush decided not to pursue Iraq's troops to Baghdad.
Although he called on the Iraqi people to overthrow Mr Hussein themselves (and, he now says, confidently
expected the dictator to fall), changing the Iraqi regime was never a formal aim of that war. “All of us”, Mr
Bush wrote recently, “underestimated Saddam's cruelty and brutality to his own people, which keeps him in
office.”

If it was right to leave Mr Hussein in office in 1991 and the decade that followed, why remove him now?
Three things have changed. First, another Bush is president. As Mr Hussein allegedly tried to assassinate the
senior George Bush in 1993, his son may be said to have unfinished family business in Iraq. Second, there is
a recognition that the policy of sanctions and arms inspections designed to keep Mr Hussein in his “box” is
failing. The inspectors had to leave in 1998 with their job unfinished. The sanctions have ruined Iraq without
either weakening Mr Hussein's grip or making him take the inspectors back.

The third change is September 11th. Although an Iraqi agent is said to have twice met Mohammed Atta, the
lead hijacker, in Prague, no publicised “smoking gun” yet connects Iraq with the twin towers or the anthrax
letters. But Iraq and terrorism are connected in Mr Bush's mind. “If anybody harbours a terrorist, they're a
terrorist,” he said last week. “If they fund a terrorist, they're a terrorist...if they develop weapons of mass
destruction that will be used to terrorise nations, they will be held accountable. And as for Mr Saddam
Hussein, he needs to let inspectors back in his country, to show us that he is not developing weapons of mass
destruction.”

It will take more than words. Mr Hussein has proved many times that he would sooner put up with economic
sanctions and military strikes than dismantle his terror weapons. After the Gulf war, the UN trussed Iraq in a
cat's cradle of resolutions requiring Mr Hussein to stop developing weapons of mass destruction and accept
a monitoring programme under which a UN commission (Unscom) would make sure that it remained free of
them. Until 1998, the inspectors had access to Iraq, where they were able to discover much about its illicit
weapons efforts and to dismantle most of what they discovered. Even so, Iraq was obstructive from the start.

At first, for example, it denied having had a nuclear-weapons programme. But between 1991 and 1994
inspectors found and dismantled a secret network of some 40 nuclear-research facilities, including three
uranium-enrichment programmes, plus evidence that Iraq had begun to develop a radiological weapon (ie, a
“dirty bomb”). Only in 1995, after a defector told almost all, did Iraq admit having launched a programme in
August 1990 to develop a nuclear weapon within a year.

Iraq also said that it had never tried to make weapons using VX nerve agent. But in 1995 it at last admitted
to having made four tons of the stuff (though Unscom thinks it had imported enough material for 200 tons).
It denied having a biological-weapons programme. But then it owned up to a research programme. Later still
it said that this had in fact been a full-fledged weapon programme under which it had produced botulinum,
anthrax, aflatoxin and clostridium, along with bombs and warheads to deliver these toxic agents. Although
required to destroy all missiles with a range of more than 150km, Iraq is believed to have hidden up to a
dozen Scud-type missiles of the sort it fired at Saudi Arabia and Israel in the Gulf war.

A box full of holes

In 1998, Iraqi obstruction reached a point where Unscom's executive chairman, Richard Butler, felt
compelled to pull out his inspectors. The response of the Clinton administration (with Britain in tow) was
Operation Desert Fox, four days of bombing and missile strikes designed to destroy targets associated with
Iraq's weapons-building activities, weaken the regime and reduce Iraq's capacity to threaten its neighbours.
This was no pinprick: the Americans reckon these attacks killed or wounded about 1,400 members of Iraq's
praetorian Republican Guard and other units. But Mr Hussein stayed in power; and the inspectors stayed out.
 When the Kurds rose, this happenedAP

By the time of Mr Bush's election, America's policy was a mess. Ten years of sanctions had cost Iraq some
$150 billion of forgone oil revenues, curbing Mr Hussein's ability to rebuild his arsenal and intimidate his
neighbours. But the box in which America hoped to keep him was full of holes: Mr Hussein has enjoyed
improving relations with almost all his neighbours. And the sanctions have meanwhile caused immense
suffering. Although food and medicine are formally exempt, Iraq's impoverishment has on some estimates
trebled the death rate among under-fives since 1990, a calamity which Mr Hussein has purposely
exacerbated, refusing to order the medicines and food Iraqi children need, in order to acquire a propaganda
advantage over his tormentors.

Before September 11th, America and Britain, stalwarts of the sanctions policy and the only enforcers of the
so-called “no-fly” zones above Iraq, faced growing isolation in the Security Council. Last week, this
changed. Having previously resisted, the Russians agreed to replace the presentsanctions regime with “smart
sanctions”, the UN's third attempt at adjustment. In 1996 Iraq accepted a plan that lets it use oil revenues to
buy food and medicine under UN supervision. And in 1999 a resolution offered to suspend sanctions on
non-military imports if Iraq co-operated with arms inspectors.

It is hoped that the smart sanctions will come into effect next May. They will allow Iraq to import freely,
except for a long list of military-related goods which its neighbours will be asked to intercept at its borders.
Although Iraqi oil revenues will still be supervised by the UN, the change is designed to focus sanctions on
Iraq's weapons ambitions and minimise collateral damage to the civilian economy. But will this change
satisfy Mr Bush if—as seems certain—Mr Hussein continues to keep the weapons inspectors at bay?

That looks unlikely. Mr Bush has already warned Mr Hussein that if he keeps the inspectors out he can
expect new punishment. And with America now fully re-engaged against “rogue regimes”, the temptation to
pile military pressure on top of the sanctions is strong. But how?

Templates and temptations

On closer inspection, Iraq does not fit so easily into the Afghan template. Its battered army is still a
considerable force: Mr Hussein's Republican Guard alone numbers almost 100,000 well-armed men.
Vulnerable from the air, the Iraqis would not last long against an invading American army, in the unlikely
event of a big one being sent to do serious battle against them. But there is no equivalent in Iraq of an
Afghan Northern Alliance with the numbers, weapons or motivation to do the grunt work for America on the
ground.

After the Gulf war, Iraq's Kurds rose against Mr Hussein. Swiftly crushed, they are now penned into a semi-
autonomous northern enclave, lightly armed but protected mainly by the no-fly zone that extends down to
the 36th parallel (see map). The chance that they might again invade Mr Hussein's heartland is small. The
Kurds are divided between the rival parties of Masoud Barzani and Jalal Talabani, whose fratricidal strife in
1996 led to the collapse of CIA operations in the enclave. The two Kurdish leaders have since promised to
work together, but although both are members of the Iraqi National Congress (INC), Iraq's umbrella
opposition group, they also maintain links with Baghdad.

Even united, the Kurds may make reluctant liberators. All their enclave's neighbours—Syria, Turkey and
Iran—have restive Kurdish minorities and would resist any change that might encourage the emergence of
an independent Kurdistan. Turkey is nervous enough about the separatists of the PKK who find shelter in the
existing enclave. Knowing that they will never achieve formal independence, but having enjoyed autonomy
for a decade, some Iraqi Kurds calculate that they have little to gain from reintegration as a minority within
liberated Iraq.

That is why advocates of a Wolfowitz-style strategy concentrate on the south, the focus of Shia Muslim
opposition to Mr Hussein's predominantly Sunni regime. Like the Kurds, many Shias rose up after the Gulf
war, and were crushed with the same brutality. The south is also protected by a no-fly zone, up to the 33rd
parallel, but this is an area where Iraqi security forces operate openly and organised opposition is weak. So
America would have to raise, arm, train and insert an opposition army more or less from scratch.

Assembling such a force from the loose confederation of opposition groups that make up the INC would
take a very long time. Although America's Congress has passed an Iraq Liberation Act, which would
authorise it, the United States has not yet given any military training to Iraqi opposition groups in exile.

If the military potential of the Iraqi opposition is in doubt, so is its ability to form a coherent successor
regime. In 1999, when he was still in charge of America's forces in the Middle East, Anthony Zinni, the
marine general trying now to organise a truce in Palestine, warned Congress that a fragmented and
disintegrating Iraq could pose greater dangers to the region than a Saddam-ruled Iraq still safely in that
“box”.

Some such calculation plainly influenced George Bush senior's decision not to support the Kurdish and Shia
uprisings that followed the liberation of Kuwait, although he had called for them himself. A perennial worry
in Saudi Arabia is that if Iraqi Shias broke loose from Baghdad some might line up with Iran, or inspire
secessionist dreams among the Shias of the Saudis' eastern province. And America has long assumed (as
when it “tilted” towards Saddam in the Iran-Iraq war of the 1980s) that in the zero-sum politics of the Gulf a
weaker Iraq is liable to mean a stronger Iran, the other nuclear-ambitious regional power it seeks to
“contain”.

Apart from this, the ramifications of a renewed American attack on Iraq could well extend beyond the
region. America might be hard put to win the support of many big countries other than Britain, and maybe of
any. It is unlikely that NATO would again invoke Article 5, as it has in Afghanistan. An Iraqi war might
thus put America back into its unilateralist box, which would not help it in the wider war against terror, and
might complicate several of its other foreign-policy objectives, such as winning Russian co-operation for
missile defences.
Until September 11th the military difficulties entailed in removing Mr Hussein, and the uncertainties that
would follow, argued for caution. But the fairly swift successes in Afghanistan have changed the terms of
debate in Washington.

Those who want to dislodge him now challenge all the preceding assumptions. Yes, Iraq has deep ethnic and
religious divides, but nothing to rival the tribal fissiparity of Afghanistan, where a post-Taliban government
is nonetheless beginning to take shape. Iraq's army is better at digging in than the rag-tag Taliban (it was
bombed for six high-precision weeks in 1991), but America's aerial weapons are a decade cleverer than they
were then. The opposition may be a shambles; but is not Mr Hussein a bloodstained dictator, hated beyond
his inner circle, whom his people will gladly drag down the moment an opportunity arises? America's Arab
allies, although they see Mr Hussein as a threat, say vehemently that they oppose a new onslaught on his
regime, and that the Arab “street” would revolt; but once the superpower was “on a roll”, as one State
Department official puts it, would these allies really stand in its way?

Today the debate in Washington dwells less on whether to remove Mr Hussein than on when and how. As to
how, the plan that Mr Wolfowitz set out three years ago is not the only one: assassination, from land or air,
has failed before but may one day succeed. As to when, the administration's unanimous message is that there
is no rush. The Afghan victory must be made secure first, and even then Iraq need not be next on the list. A
harder question, on which there is less agreement, is why.

A deterrable monster?

America went to war in 1991 to rescue Kuwait and remove Mr Hussein's hand from the West's oilpipe. If
American forces are now permanently in Saudi Arabia and Kuwait, this threat exists no longer. Nor—
pending new evidence of an Iraqi hand in September 11th—is America's “war on terrorism” sufficient
ground for war on Iraq. The regime harbours a few semi-defunct Palestinian terror groups and murders its
own dissidents abroad. But Mr Hussein would have to be madder even than he is thought to be to risk
international terrorism with America in its present mood. The strongest case for removing him therefore
rests on his search for weapons of mass destruction, especially the biological ones that might be most
difficult to track down even if the inspectors returned.

Smile, and be a villain

How bad would it be for Mr Hussein to acquire the nuclear or biological weapons he craves? His would not
be the first nuclear-armed dictatorship; and Stalin's was surely no less mad, bad or dangerous. In North
Korea, the West has relied on deterrence-cum-incentives to keep a potential nuclear menace at bay. Mr
Hussein, admittedly, has shown that he is reckless as well as ruthless. He invaded Iran; he invaded Kuwait;
and he fired missiles at Tel Aviv even though he knew Israel to have the bomb already. But he can also be
deterred: he never dared to use his chemical weapons against the Israelis or Americans. Besides, say some of
those who counsel deterrence, an oil-rich and technically advanced country such as Iraq will one day join the
expanding nuclear club no matter who is president. Why risk war now to stave off the inevitable?
These are strong arguments. But most depend on the idea that removing Mr Hussein before he acquires his
weapons of mass destruction would entail many risks: a price in American lives, the possibility of leaving
Iraq even worse off and the danger of destabilising America's friends in the Middle East. Before September
11th, it was accepted that these unavoidable costs outweighed the possible benefits. Now, some Americans
have concluded from the terror attacks on New York that their own power does not deter every vengeful or
fanatical foe, and they have concluded from events in Afghanistan that America can win wars far from home
without paying a heavy butcher's bill. As much gruesome history attests, the last war is seldom a reliable
guide to the next.

In Lula's footsteps

Dilma Rousseff is cruising towards victory on the coat-tails of a

popular president. But there is more at stake in October’s election
than meets the eye
Jul 1st 2010 | SÃo Paulo

AT THE moment only one thing matters to Brazilians: the performance of the national football team in the
World Cup, where lifting the trophy for the sixth time is considered almost a right. Even a normally hard-
working city like São Paulo, where supermarkets open at 7.00am and heavy traffic is a way of life, came to a
standstill for Brazil’s matches. Across the country factories, offices and even health posts shut down. But the
country’s politicians are limbering up for a different contest. On July 6th the campaign for October’s general
election formally kicks off. It will be the first presidential election since democracy was restored in the
1980s in which the name of Luiz Inácio Lula da Silva does not appear on the ballot. But Lula, Brazil’s
president since 2003, is nevertheless the dominant figure in the campaign.

For the past 18 months he has put all his efforts into trying to get Dilma Rousseff, his former chief of staff,
elected as his successor. She is not an obvious presidential candidate: an efficient though notoriously bad-
tempered administrator, she only joined Lula’s Workers’ Party (PT) in 2001. She has never before stood for
elected office. But several more senior figures in the PT were forced out of politics by a corruption scandal
during Lula’s first term, and others have proved electoral flops.
Barely known to the public at the outset, Ms Rousseff spent half of the past year recovering from lymphatic
cancer. Despite all these handicaps, she has risen inexorably in the opinion polls. This month she overhauled
the opposition’s standard-bearer, José Serra, formerly the governor of São Paulo state, for the first time (see
chart 1). The only other plausible candidate is Marina Silva, a long-time member of the PT who is standing
for the small Green Party. Like Lula, she was born in poverty, but she fell out with him over what she sees
as his government’s failure to defend the environment.

The election has now become Ms Rousseff’s to lose. Her rise in the polls shows that Lula has been able to
transfer his own extraordinary popularity to her. A former trade-union leader, Lula has a rapport with
ordinary Brazilians that no other politician enjoys. But he can also point to solid accomplishments. He has
presided over both a steady increase in economic growth which is now—conveniently—reaching new
heights, and a sharp reduction in poverty. Even allowing for an expected slowdown, the economy will have
grown by around 8% in the year before the vote. The polls show that roughly 75% of Brazilians approve of
the job Lula has done. Alexandre Marinis, a political consultant in São Paulo, notes that recent elections
show a close correlation between the president’s popularity and his candidate’s success.

All this makes Mr Serra’s job exceptionally hard. A minister in the government of Fernando Henrique
Cardoso, Lula’s predecessor, he trumps Ms Rousseff in political experience and has been an effective
governor of São Paulo, the country’s second-most-powerful job. His supporters are counting on his
opponent to make gaffes. But Ms Rousseff is looking increasingly assured. And he is struggling to make his
experience count in an election where most Brazilians—especially in the country’s poorer areas—want
continuity.

To see why, visit places like Jardim Iguatemi, a favela (a self-built settlement) straggling over steep hills on
the eastern extremity of São Paulo. Bordered by forest, it is an hour and a half’s drive from the city centre.
Mr Serra’s state government built a big new school and a health clinic there. But it is the president who
commands the sympathy of many residents. They credit Lula with Bolsa Família, a programme under which
12m of the poorest Brazilian families get a monthly stipend of up to 200 reais ($111), paid to mothers
provided they keep their children in school and take them for health checks. His government also opened a
free technical college nearby in Itaquera. “He’s made a big effort. He thought a lot about concrete
problems,” says Milene Ribeiro, a single parent of three children, whose ambition to be a teacher was
frustrated when she had to drop out of university for lack of funds. “Living here so far from the world, we
have to vote for someone who will do something for us,” says Quitéria de Souza, a separated mother of three
girls.

The statistics of social progress in Brazil are remarkable. The number of people living in poverty has fallen
by 20m under Lula, from 49.5m (or 28.5% of the total) in 2003 to 29m (16% of the total) in 2008, according
to calculations by Marcelo Neri, a social-policy expert at the Fundaçao Getulio Vargas, a university.
Although the world recession and its brief impact in Brazil temporarily halted the progress, it did not reverse
it. Using different criteria, Ricardo Paes de Barros of the Institute for Applied Economic Research, a
government-linked body, paints a similar picture. He finds that the number of Brazilians too poor to feed
themselves properly has fallen from 17% of the population in 2003 to 8.8% in 2008.

Levelling the playing field

At the same time Brazil’s notoriously unequal distribution of income is becoming a bit less so (see chart 2).
The Gini coefficient, a standard statistical measure of inequality, has fallen steadily since 2001 (though it
remains very high by international standards). Over that period the income of the poorest 10% of the
population has grown at 8% a year, while that of the richest tenth has grown at only 1.5% a year, according
to Mr Paes de Barros.

In various ways Brazil is starting to become a more homogeneous society. Regional inequality has been
diminishing, too: average income in the poor north-east has been growing faster than the national average. A
majority of Brazilians (some 52%, up from 44% in 2002) now belong to what marketers call social class C,
or the lower-middle class, meaning that they have a monthly household income of between 1,064 and 4,561
reais.

This progress stems from a mixture of faster economic growth and government policies. Though there is
debate about the details, around half of the fall in poverty comes from higher income from employment.
Better social policy accounts for a big share of the fall in inequality—or at least of the narrowing of the
bottom of the pyramid. Bolsa Família has been particularly effective in helping the poorest.

How much of the credit does Lula deserve for all this? His government turned Bolsa Família from a small-
scale experiment into the world’s biggest conditional cash-transfer programme. He also raised the minimum
wage by two-and-a-half times since 2003, taking its purchasing power to its highest level since 1979. This
has not destroyed jobs: some 13m new jobs in the formal (ie, legally registered) economy have been created
since 2003. Lula is also proud of a government programme under which 12m people in rural areas have
gained access to electricity, and another programme that provides subsidised housing for the poor. Above
all, the polls suggest, he has given poorer Brazilians a new sense both of self-esteem and that their
government is not just for the rich.

But faster economic growth and the social transformation are also the result of longer-term trends. Mr
Cardoso’s two governments tamed inflation, creating the stability that has allowed credit, investment and
jobs to grow. And part of the fall in inequality (which began in 2001, before Lula took office) stems from a
big effort over the past quarter of a century to expand Brazil’s previously woeful education. The average
Brazilian worker now has 8.3 years of schooling, up from 6.1 in 1995.
Certainly Lula deserves praise for not imitating the economic populism of some of the other left-wing
leaders who have come to power in Latin America over the past decade. Broadly speaking, his government
has stuck to the responsible macroeconomic policies that have kept inflation low. After some
procrastination, it has also continued the progress in education. His education minister, Fernando Haddad,
has introduced standardised national tests of schoolchildren, for example. And as Ms Rousseff points out,
the government has respected the contracts under which private companies, including foreign ones, have
invested in Brazil.

The state and the nation

The question the candidates have to answer in the next three months is how to sustain Lula’s legacy and
build on it. There is broad political consensus about economic stability, the importance of education and, to
a degree, on social policies (Mr Serra would maintain Bolsa Família, for example). Apart from foreign
policy (which matters to some Brazilians but not to the mass of voters), the differences between the two
main candidates are sharpest over the role of the state in the economy.

In many ways Lula has been a lucky president. Brazil has benefited hugely from China’s industrialisation.
China’s appetite for foodstuffs and iron ore has boosted Brazil’s exports, helping growth and eliminating the
balance-of-payments troubles that so often dogged the country in the past. But this has masked some
important weaknesses that Lula did not fix, and may even have exacerbated.

Mr Serra likes to say that Brazil holds three negative world records: it has the highest interest rates in the
world, the heaviest tax burden of any emerging country and one of the lowest rates of public investment. All
of these, he has argued, stem from an “obese” federal government that is spending too much on public-
sector jobs for its supporters. He says he would slash wasteful public spending, leaving room for interest
rates to fall (the Central Bank’s benchmark rate is 10.25%). That in turn would allow the real, which is
overvalued, to weaken, helping manufacturers cope with competition from China. He would simplify and
reform the labyrinthine tax system. The aim would be to boost investment, both public and private, so that
Brazil could take greater advantage of the opportunity granted by its commodity boom, which will not last
forever.

The shortfall in investment means that, by common consent, Brazil cannot sustain this year’s growth spurt.
If the economy is to continue to expand at 5% a year, Brazil needs to double its annual investment in
infrastructure, to 4% of GDP, according to Marcelo Carvalho of Morgan Stanley, an investment bank.

The airports are clogged. Off Santos, Brazil’s biggest port, a line of ships queuing to load stretches to the
horizon. The lack of good roads and railways adds to the costs of business. This year soyabean-growers in
Mato Grosso, an inland state, spent up to 38% of their revenues just on getting their crop from the farm to
the docks, according to José Roberto Mendonça de Barros, an economic consultant in São Paulo. Under
Lula, the price of electricity for industrial users has more than doubled.

The government has cautiously allowed private investment in roads, railways and ports. But airports are run
by an inefficient state body. Such mismanagement is a luxury Brazil can ill afford—if only because it will
need to handle visitors to the football World Cup, to be held in the country in 2014, and the Olympic games,
in Rio de Janeiro two years later.

Meanwhile, the government is spending more and more on pensions. Fábio Giambiagi, an economist at the
National Development Bank (BNDES), notes that although only 6% of Brazilians are of pensionable age,
the country spends 11.3% of its GDP on them; in the United States, by contrast, the 12% of the population
who are pensioners receive around 6% of GDP. Spending on pensions for private-sector workers in the
formal economy has tripled as a share of Brazil’s GDP since 1988. This is partly because the economy grew
quite slowly (until recently), but mainly because of the generosity of the pension regime. Many affluent
Brazilians retire in their 50s, and many pensions have risen steeply because they are tied to the minimum
wage.
The result is that the federal government bails out the national pension system to the tune of 1.5% of GDP.
Mr Giambiagi points out that the number of pensioners will grow by about 4% a year for the next ten years.
Provided the economy grows at a similar rate and the next government slows the rise in the minimum wage,
the pension burden will be just about manageable. But it reinforces Brazil’s inequalities. Mr Paes de Barros
notes that the government transfers ten times more money to pensioners than to children. He is advising the
third candidate, Ms Silva, the only one who talks much about pension reform.

Banking on industrial policy

The government’s critics also worry about the implications of a big expansion of the role of state banks
(Brazil has three large ones). This came about partly as a result of the world financial crisis, when private
banks temporarily cut back their lending. But the BNDES, in particular, has become an important agent of
industrial policy under Lula. Over the past two years the federal government boosted the bank’s capital base
with two long-term loans worth 180 billion reais. Its annual lending has reached 4.5% of GDP, and should
be double its 2008 level by year’s end. Its loans are mainly long-term (for up to 30 years), with priority for
infrastructure, investment in industry and services and seed money for innovation. They cost around half of
the Central Bank’s benchmark interest rate.

The BNDES has given big loans to state-owned electricity companies (revived by Lula) and to Petrobras,
the government-controlled oil giant. But it has also financed takeovers by big private companies, both at
home and abroad, creating national champions in businesses ranging from food to pulp and paper. Eduardo
Giannetti, an economist in São Paulo, worries that all this involves big, but opaque, subsidies (of perhaps 8
billion to 12 billion reais a year, he thinks) while extending government influence over business.

Luciano Coutinho, the BNDES’s president (who is tipped to be finance minister if Ms Rousseff wins),
insists that the bank deploys professional techniques of credit analysis and dismisses as a “conservative
fiction” the notion that its loans are governed by political criteria. The bank’s role is transitional, he says,
until private capital markets develop long-term savings and lending instruments.

Ms Rousseff champions industrial policy—indeed her critics see her as more dirigiste than Lula, whose
instincts are pragmatic. But Mr Coutinho says that this does not involve a return to the big Brazilian state
and the high tariff protection of the 1960s and 1970s, as the critics charge. Brazil’s economy is more open
today. Mr Coutinho says his inspiration comes from Asian countries such as South Korea and China (though
average tariffs are still higher in Brazil than in those countries).

This debate is most intense over how to develop the vast new oil deposits found deep beneath the Atlantic in
2007. Their discovery followed Mr Cardoso’s decision to open up the oil industry to competition and subject
Petrobras to market discipline (though the company continues to be controlled by the government, a
majority of its shares are publicly traded).

Since Lula’s administration thinks it clear that there is much more oil to be found, it wants to change the
rules governing the industry. Instead of concessions under which oil companies pay royalties and taxes but
keep the oil they extract, in any future fields the oil will belong to a new state company and Petrobras will be
the sole operator (though it can team up with partners under production-sharing agreements). These changes
are embodied in four laws, though only one—allowing the government to vest oil deposits in Petrobras as a
way of increasing its capital—has so far been approved by Congress.

The government also hopes to create a national oil-supply industry. It is drawing up requirements that
equipment, from tankers to service platforms and drilling rigs, should be mainly locally produced. Already
Petrobras is doing much of its procurement locally, and officials point to a revival in Brazil’s shipbuilding
industry as an early success. Provided such restrictions are temporary, they may pay off for the oil industry.
But there are risks. One is a repeat of the mistakes of the 1970s, when a government attempt to develop a
computer industry by banning imports cut Brazil off from new technology. Another is placing too much
strain on Petrobras, which has also been required by the government to build four new refineries.
 Serra ponders how he fell behind

This month Petrobras unveiled a huge increase in its five-year investment plan, to $224 billion (up from
$187 billion). But the next day it abruptly postponed until September a planned share offering expected to be
worth up to $25 billion. The price of the company’s bonds has fallen recently because of fears that the
accident at a BP rig in the Gulf of Mexico will add to the cost of deep-sea oil operations.

Oil now accounts for 12% of Brazil’s GDP, a fourfold increase since 1997. It will climb as high as 20%,
reckons Adrian Pires, an industry regulator under Mr Cardoso. The opposition’s nightmare is that Ms
Rousseff might use oil revenues to entrench the PT in power and that Brazil might go the way of other oil-
rich Latin American states, such as Hugo Chávez’s Venezuela or Mexico under the Institutional
Revolutionary Party. But officials have other models in mind, such as democratic Norway, which has saved
much of its oil revenues. “We want to use the oil wealth in ways such that it doesn’t contaminate the rest of
the economy,” says Márcio Zimmermann, the energy minister.

Brazilians thus face a choice in October. Mr Serra would provide them with a strong but lean state, that
would make room for more private investment and initiative and would tax its citizens less. Ms Rousseff’s
advisers think that Brazil has time to bring down interest rates and taxes gradually, and that the state should
promote industrial development and redistribute income. After 16 years of stability and policy continuity
under Mr Cardoso and Lula, neither candidate offers a radical change of course. What is at stake is the speed
of the country’s progress.

Poverty amid progress

A revolution in South America's fastest-growing economy is not

reaching everyone
May 8th 2008 | lima
 Corbis

BLOCKS of flats or offices are under construction on nearly every street. New hotels and restaurants sprout
on every corner, while shopping centres multiply in what were once shantytowns. Across the city,
thoroughfares have been torn up to make way for new bus lanes and terminals. Such is the anarchic volume
of traffic that just crossing the street has become a time-consuming and perilous exercise. Lima, Peru's
capital of 8m people, is shedding its former air of provincial lassitude and turning into a bustling metropolis.

The city is the visible face of a boom that has made Peru South America's fastest-growing economy (see
chart). That performance owes much to record prices for mineral exports. But newer export products, from
designer cotton T-shirts to mangoes and artichokes, are also flourishing. As well as trade, private
investment, growing at 20% a year, and domestic consumption are driving the economy forward at an
accelerating pace (in the year to February, GDP grew by 9.2%).

Thanks to high world prices for food and fuel, inflation has spiked to 5.5%, having been low for years.
Nevertheless, the growth looks to be built on solid foundations. The national savings rate has risen to 24% of
GDP, high by regional standards, and the government last year posted a fiscal surplus of 3% of GDP. A free-
trade agreement with the United States is about to come into effect. In recognition of such achievements,
Peru's debt was awarded an investment-grade credit rating last month by Fitch, a ratings agency.

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Yet there are paradoxes at the heart of the boom. Despite the growth, poverty has fallen only slowly. And
many Peruvians are disgruntled. The president, Alan García, was once a radical populist who presided over
hyperinflation and debt default in a first term in office in the 1980s. He returned to office in 2006 a reformed
character. But his people give him little credit for the strong economy. He is one of the least popular
presidents in Latin America, with an approval rating of just 26% in a poll taken in the main cities in April by
Ipsos-Apoyo, a pollster.

There are several reasons for the relatively slow fall in poverty. Although the number of formal-sector jobs
is expanding at 9% a year, many Peruvians still labour in the informal sector of unregistered businesses,
where productivity is low. Wages for the unskilled have been slow to rise.

A bigger reason is geography. The capital, the Pacific coastal strip and most of the north of the country are
all thriving. The problem is the southern Andean region, where poverty reaches 70% of the population.
Helped by tourism, mining and microcredit some Andean cities, such as Cajamarca, Cusco, Huaraz and
Huancayo, are prospering. The big divorce is with the surrounding, often mountainous, countryside, where
many Andean Indians remain trapped in subsistence farming on small plots. Whereas 60% of the labour
force in Lima are waged workers, only 27% are in Apurímac, notes Efraín González, an economist at Lima's
Catholic University.

These unwaged people are often more or less cut off from the market economy. And it is market connections
that make economic growth “trickle down” to the poor, points out Richard Webb, a social researcher and
former central-bank governor. Enabling that to happen is thus a job for public policy. Better roads, education
and social policy are all needed.

At least in theory, Mr García's government recognises this. It has set an ambitious target of cutting poverty
to 30% by the end of its term, in 2011. For the first time in three decades the state has money to invest—but
it is finding it hard to do so.

With the help of the World Bank, the government has drawn up a new anti-poverty strategy which focuses
on trying to end the malnutrition that affects 30% of Peruvian children, most of them in the southern Andes.
It has ramped up social spending while trying to target it more closely on the poorest areas. But Ivan
Hidalgo, the official in charge, accepts that a lack of good managers, especially in local governments, is
hindering this effort. He does not add that, in a misguided gesture, Mr García slashed salaries for top public-
sector jobs.
Similarly, money for public investment in roads or to help farmers lies unspent at all levels of government,
partly because of fears of corruption. In another paradox, Peru has created “a culture of fiscal propriety”
whose side-effect is that officials are ignoring a social emergency in the Andes, says Mr Webb.

Tackling this effectively means reforming the education and health ministries as well as local government.
Mr García's government has made some effort to improve the performance of teachers, but has otherwise
done little. “It's a government that insists on investment and not on reforms,” says Julio Cotler, a sociologist
at Lima's Institute of Peruvian Studies.

Like his predecessor, Alejandro Toledo, Mr García is handicapped by his unpopularity and by his lack of a
legislative majority. In the presidential election, the southern Andes voted heavily for Ollanta Humala, a
populist former army officer. According to Ipsos-Apoyo, Mr Humala is today more popular than the
president. “To be popular in Peru you need a populist discourse,” says Mr Cotler. “It doesn't get anyone out
of poverty but it soothes people's rancour and resentments.”

Nevertheless, the economic boom is going hand in hand with a deeper cultural change. In the 1970s and
1980s, Peru was a collectivist country: first a military government nationalised much of the economy and
then Mr García, in his first term, took over a chunk more, egged on by a powerful left-wing opposition.
Since then Peru has undergone a “capitalist revolution”, as Jaime de Althaus, a liberal journalist, argues in a
recent book. This revolution is based not just on big mining companies, but on thousands of small-scale
farmers on the coast, who broke up their state co-operatives into commercial plots, and on small
businessmen in the shanty towns, who are exporting everything from clothes to electrical components.

When leftists complain the capitalism is “savage” they sometimes have a point: while some companies post
record profits, many Peruvians work long hours for low wages with few labour rights. Away from Lima and
the north coast, which have embraced globalisation, many Peruvians cling to nationalist and statist attitudes,
says Alfredo Torres of Ipsos-Apoyo. Unless the politicians do a better job of defending the capitalist
revolution and spreading its benefits, it will be threatened by the rancour of those who feel left out.

Scarcity amid abundance

Arguments over price controls

Apr 12th 2007 | caracas

ON THE last Saturday in March the broad Avenida Bolívar in the heart of Venezuela's capital was
transformed into an open-air, government-run “mega-market”. Shoppers, mainly from poorer parts of the
city, formed orderly queues to buy food at officially regulated prices—something that is often impossible in
ordinary shops. “How can there be scarcity in a country with so much land and resources?” asked Ramón
Díaz, a pensioner, as he rested on a bench after doing his shopping. “Who controls the supply of meat? The
oligarchy has it monopolised.”

Who controls the food supply and why a fertile and oil-rich country should have problems getting food to its
27m people are questions that pit the leftist government of Hugo Chávez against much of the private sector.
Venezuela has one of the world's highest inflation rates (see chart). Food prices are rising even faster than
the overall index. That is despite—or because of—the fact that food, medicines and basic services have been
subject to price controls since 2003. Meat, milk, black beans and sugar are among many products that, from
time to time, disappear from the shelves—even those of Mercal, the government-run supermarket chain.
Often, though, these goods can be found at much higher prices in the hands of street traders.

The government has a simple answer to the conundrum. “It's part of the curse of capitalism,” according to
Mr Chávez. In February he declared war on “hoarders and speculators”, issuing a decree mandating jail
sentences of up to six years for anyone interfering with food supplies. The government promptly seized a
slaughterhouse and a cold-store.

Related items

• Venezuela: Glimpsing the bottom of the barrelFeb 1st 2007

Many businessmen and shopkeepers have a different view. They complain that controlled prices are set so
low that they are obliged to sell at a loss. If they don't, they risk fines, temporary closure, expropriation or
even imprisonment. In late March, for instance, the government temporarily closed 17 butchers' shops it
accused of breaking price regulations. Mr Chávez has said that if he has to take over the entire food industry
he will, although many Venezuelans doubt the government would be capable of running it.

Officials usually say that the problem is hoarding, not shortages. But Jorge Giordani, the planning minister,
recently admitted that an overheating economy (it grew by over 10% last year) was causing inflation and
scarcity. Public spending has doubled in the past two years. There are two other factors, says Pavel Gómez
of IESA, a Caracas business school: the price controls themselves, which have boosted demand and cut
supply, and an expectation that prices will rise further, leading people to bring forward purchases.

To make matters worse, the government recently curbed imports, ostensibly to protect local manufacturers.
Some of them now complain that they cannot obtain the materials they need to make their products. Many
businessmen are reluctant to invest, citing uncertainty over Mr Chávez's intentions and lack of legal
protection. In which case, say government supporters, the state should step into the breach. Expect more
shortages.

Pummelling the Palestinians

If the Israeli onslaught on the Islamists of Hamas silences them for

a while, it could alter the odds in Israel’s coming general election
Dec 30th 2008 | Jerusalem
 Reuters

“BY THE time we’re finished,” Israel’s deputy chief of staff, General Dan Harel, told a group of mayors
from towns close to the Gaza Strip on December 29th, “there won’t be a Hamas building left standing in
Gaza.” They could well believe him. In four days of bombing that began with a massive, sudden raid on
December 27th, Israeli jets, unmanned drones and helicopters killed some 350 Palestinians, smashing offices
belonging to Hamas, the Islamist movement that has run the strip since booting out its secular Fatah rivals a
year-and-a-half ago, as well as police stations, ministry buildings, Gaza’s Islamic university, refugee camps
and workshops. In a raid by 40 aircraft on December 28th, dozens of arms-smuggling tunnels under the
border with Egypt were destroyed.

The onslaught is meant to stop Hamas firing rockets at Israel. But the general predicted that “the worst is
still ahead”. UN agencies said between 50 and 90 of 300-plus killed in the first three days were non-
combatants. If tanks and artillery enter the fray, civilian deaths may mount faster. In the past year, before the
latest onslaught, 420-plus Gazans had been killed in Israeli raids, at least a fifth civilian, according to
B’Tselem, an Israeli human-rights lobby.

In the first four days of “Operation Cast Lead”, four Israelis (including one soldier) were killed by
Palestinian rockets, bringing the total number of Israeli civilian deaths at Hamas’s hands in 2008 to five.
Three of the victims were struck down in the towns of Netivot, 12km (seven miles) east of Gaza, Ashkelon,
11km up the coast, and Ashdod, a port, 30km north of the strip. Villages even farther away were hit.

Related items

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Israel’s defence minister, Ehud Barak, said the operation had been planned for months, long before a shaky
six-month ceasefire with Hamas ran out on December 19th. Intelligence sources identified scores of Hamas
targets in the densely populated territory, where 1.5m Palestinians, more than half of them refugees or their
descendants, have been hemmed into the sandy coastal strip some 40km long.

Stopping or drastically reducing Palestinian rocket fire will be the political touchstone of this military
campaign, as it was in the month-long war between Israel and Hizbullah, Lebanon’s well-armed Shia
movement, in the summer of 2006. At that time, Ehud Olmert, Israel’s prime minister, who is to step down
after an election on February 10th, had hoped that air raids would silence the missile launchers. Three weeks
later, with a third of Israel virtually at a standstill because Hizbullah’s missiles are far more lethal than
Hamas’s mostly home-made projectiles, a massive Israeli ground force was finally sent in but got bogged
down against Hizbullah’s dogged fighters. An eventual ceasefire left Hizbullah claiming victory and Israel’s
generals and politicians locked in recrimination.
“After Lebanon,” says Tzachi Hanegbi, chairman of the foreign affairs and defence committee of Israel’s
parliament, “everyone understands that rocket fire can’t be silenced by air power alone.” But everyone
understands, too, that Hamas, completely outgunned from the air, seeks to lure Israeli ground troops into the
heavily built-up Gaza Strip to engage them with street-fighting guerrillas. Hamas, too, has been preparing
long and hard for this showdown.

As in all its wars, Israel feels it is fighting against the clock. Its diplomats say they sensed an initial surge of
approval, albeit muted, from many world capitals and even among moderate Arab governments. George
Bush’s administration has been plainly in Israel’s corner. But the high death toll and the prospect of a lot
more killing if the operation is “broadened and deepened”, to use Mr Barak’s words, could spur European
governments to pay more heed to protests mounting in the Arab world.

Israel says it intends its armed incursions, if they come, to be brief and not to drag it into a renewed
occupation of the strip. If the Hamas regime collapses under the onslaught, so much the better, though there
is no certainty that the Fatah-led Palestinian Authority, forcibly ousted from Gaza by Hamas in June 2007
but still in charge in the Palestinians’ bigger West Bank, would be able to return to power.

If Hamas does stop firing rockets, Mr Barak’s standing could rise fast. Mr Olmert is formally still in charge
until a new government is formed after the election. But the Gaza operation is widely seen as Mr Barak’s.
He and his Labour party have been trailing well behind the foreign minister, Tzipi Livni, and her Kadima
party and Binyamin Netanyahu and his hard-right opposition Likud party. In desperation, before the
onslaught, Mr Barak had mounted a campaign on billboards and on the internet, declaring himself “not
nice”, “not cuddly” and “not trendy”. If Hamas’s rockets are silenced, albeit for a while, Israel’s voters may
warm to those harsh qualities.

Japan deserves credit for not intervening sooner

Richard Koo our guest wrote on Sep 27th 2010, 21:06 GMT

THE recent Japanese intervention in the foreign exchange market is somewhat unfortunate for reasons not
fully appreciated abroad. When the Lehman shock hit Japan, its industrial production and GDP fell further
than any other major country for two reasons. First, the yen went sky high to become the strongest currency
in the world, and second, its industry was concentrated in building quality durable goods the demand for
which fell dramatically compared with non-durables or services. As a result, Japan’s industrial production
fell to the level of 1983, and its trade balance recorded a deficit for the first time in nearly 30 years. The
collapsing production and employment also renewed domestic price deflation as well.

These economic indicators all justify Japanese intervention in the foreign exchange market, and the Swiss
National Bank, facing a similar predicament, did not shy away from intervention at all. The People’s Bank
of China also intervened massively to keep the Chinese currency from appreciating against the dollar.

Japan, on the other hand refrained from intervening for a full two years following the Lehman shock, even
though its currency was at its all-time high in effective terms and its economy was suffering more than that
of any other country.

The country did not intervene because Prime Minister Taro Aso, who was leading Japan when Lehman
collapsed, was a student of history and knew what happened in similar circumstances during the 1930s. At
that time, all the countries tried to pull themselves out of recessions by pushing their currencies lower in
what is now known as competitive devaluation. That, in turn, prompted countries to put on protectionism
which ended up devastating world trade.

Referring to this history, Aso argued that if a surplus country like Japan (even though at that time Japan was
running deficit) tries to weaken its exchange rate by intervening, it will give deficit countries ten times the
reason to do the same which will surely push the world back into the 1930s again. Thus even though his
stance was extremely unpopular domestically for obvious reasons, he refused to intervene in the foreign
exchange market.
This stance toward intervention was fully shared by Mr Hirohisa Fujii, the first finance minister under the
new DPJ government and also a student of history. Even though his stance was bashed repeatedly by the
media and industry leaders, he argued that Japan will not pull the trigger for competitive devaluation. Mr
Naoto Kan, who is no student of history, initially flirted with the idea of pushing the yen lower when he
succeeded Mr Fujii as a finance minister. But he was quickly converted to his predecessors’ stance most
likely by like-minded officials of the ministry.

In other words, Japan took it upon itself to stop the world from falling into the 1930’s scenario even though
it was suffering more than those countries that created the financial disasters.

Unfortunately, none of this sacrifice was appreciated abroad or at home. No European or American officials
expressed praise for Japan's NOT intervening. If such a praise was issued, Mr Kan might have refrained
from intervening on September 15, but none was forthcoming.

So after enduring two full years of strong yen, Japan finally decided that enough is enough. With the yen
creeping even higher and most of the turmoil caused by the Lehman shock largely behind them, historians
retreated and gave way to realists who than decided to intervene. But the record still stands that during the
most critical two years (September 15, 2008 when Lehman collapsed, to September 15, 2010, when the
intervention took place), Japan consciously sacrificed its interest in order to save the world.

It is hoped that one day, when a history of this crisis is written, someone would notice that the sacrifice
Japan consciously made succeeded in keeping the history from repeating itself even though it came
dangerously close to doing so.

Not good enough

Suing Arizona and bashing the Republicans will not solve

America's immigration problem
Jul 8th 2010

HOW often should you give a politician the benefit of the doubt—take what he says at face value, trust in
the sincerity of his motives, make allowances for the baffling complexities of his predicament? Never, says
the jaded half of Lexington’s brain. Sometimes, answers the half that still likes words such as hope and
change and has a soft spot for Barack Obama. The president brings out this reaction in a lot of people. Polls
show that even among voters who loathe his policies a great many continue to admire the qualities of the
man himself.

When it comes to the politics of immigration, however, it is getting harder to give Mr Obama the benefit of
the doubt. On July 1st he made a big speech on how to reform America’s broken immigration system. He
laid out the problem at hand with his customary clarity. Thanks to decades of porous borders, some 11m
illegal immigrants live in the United States. America cannot give them a blanket amnesty because that
would encourage a further surge of illegal immigration. But since they are now woven into the fabric of the
nation and its economy, nor can they all be slung out. So what they need is a pathway to legal status: they
should register, admit that they broke the law, pay a fine, and taxes, and learn English. “They must get right
with the law before they can get in line and earn their citizenship,” said the president.

The only decent solution

This is surely right. America cannot kick out all its illegal immigrants without undertaking one of the biggest
forced migrations in history. America could not do such a thing and still be true to itself. Illegal immigrants
from Mexico have picked America’s fruit, shined America’s shoes and sweated in America’s workshops;
many of their children have grown up to become Americans themselves. That is why Mr Obama’s plan is
both the only practical and decent plan and, in essence, the same one the Republican administration of
George Bush pushed for.

Good speech. Good plan. So why the cynicism? Because making a speech, and having a plan, are not the
same as doing something. And Mr Obama does not intend to do anything right now. He is not proposing a
particular piece of legislation. At most, his speech is a promissory note, a reminder to America’s Hispanic
voters that they can at some point count on the Democrats to do the right thing. Hispanics voted in droves
for Mr Obama in 2008 but their ardour has cooled: the proportion approving of his performance fell from
69% in January to 57% in May, says Gallup.

Hence, concludes the jaded half of Lexington, Mr Obama is merely pandering to an important segment of
his political base. And this comes soon after a cynical manoeuvre by Harry Reid, the Senate majority leader,
who in April contrived to give the misleading impression that Congress intended to enact immigration
reform before the end of this year. That did not damage Mr Reid’s prospects in Nevada, where he faces a
desperate battle in November and 25% of the population is Hispanic. But it did damage the Democrats’
relations with Senator Lindsey Graham, part of the small band of Republicans in the Senate who are still
true believers in comprehensive immigration reform.

Mr Obama’s defenders argue that the president cannot match words with deeds at present. As he said in his
speech, no law will pass without some Republican support: “That is the political and mathematical reality.”
And the Republicans in their present obstructive mood show little appetite for this cause. Even a potential
partner such as John McCain, who with the late Ted Kennedy was the brains of the reform efforts of Mr
Bush’s second term, has bent with the nativist winds as he fights for re-election in Arizona, one of many
states in which a moral panic against illegal immigration has taken hold. No Republican votes, no reform
bill: you cannot blame Mr Obama for that, can you?

Perhaps you can. Mr Obama is president; he chooses his own priorities. Had he not promoted health care
above immigration, a comprehensive reform might have been put before Congress before the mid-terms
made it toxic. But the bigger point is that if he cannot move on what he calls this “moral imperative” this
year he must do so in 2011, before the presidential election of the following year casts an equally chilling
shadow. That means he should be bending every sinew to preserve relations with the small band of senior
Republicans who support the cause and whose co-operation will be no less essential in 2011.

Instead, Mr Obama in his speech and Mr Reid in his stratagem seem to have gone out of their way to inject
immigration into the mid-terms and place exclusive blame on the Republicans—even though many
Democrats in Congress are no less obstructive. And nothing could be better calculated to alienate potential
Republican partners than this week’s move by the Department of Justice to invoke the supremacy clause of
the constitution to strike down the new law in Arizona that gives the police wider powers to identify illegals.
Arizona’s law is an abomination, says Tamar Jacoby, president of a pro-reform lobby, ImmigrationWorks,
but suing Arizona will baffle and anger the 60% of Americans who say they support it. Only the federal
government can fix what is wrong with immigration, she says—but not with a lawsuit.

Senator Graham, Senator McCain and John Kyl, Arizona’s junior senator, could form the nucleus of
Republican support for a bipartisan reform of immigration next year. In theory, both parties will have an
interest in co-operating. Mr Obama needs to redeem his promise to Hispanic voters and Republicans need to
restore their standing with a constituency whose power to swing elections grows with every passing year.
But Mr Obama has put the noses of those who should be key allies out of joint. The instinct to give him the
benefit of the doubt may be understandable. But on this occasion, no need to give the man a break.

A muted normality

United Germany is becoming more comfortable in its skin

Mar 11th 2010

Better one than

two

“GERMANY is plagued by a severe economic malaise and by uncertainty about its place in the world,”
wrote The Economist in a special report in 2002. A lot has changed in eight years. These days Germany
lectures other countries on economic management and sends troops to Afghanistan. It may still not be a
“normal” country. But now that the Federal Republic is a matronly 60 and unification is approaching a post-
adolescent 20, the likely shape of normality is becoming clearer.

Germany has become more at ease with itself. That became obvious during the football World Cup held in
Germany in 2006, when its black, red and gold flag fluttered above cars and balconies as though patriotism
had never gone out of fashion. Atonement for Germany’s awful past is woven into the constitution and still
shapes foreign and domestic policies; it is one reason why Germany is Israel’s best friend in Europe. But
now it is invoked less often as an excuse to avoid doing something that would otherwise make sense. The
economic crisis, ironically, has been a psychological boost; to Germans, the social-market economy looks
more like a solution than a cause.
This portends a Germany that can be both more assertive and more useful to its allies. Its armed forces get
involved in conflicts in the Balkans, the Middle East, Africa and Afghanistan, to which Germany is the
third-largest contributor of troops. In January, under pressure from America, it agreed to raise the maximum
number of soldiers it could send to Afghanistan from 4,500 to 5,350 and to double its aid for civilian
reconstruction.

In this special report

• Sources and acknowledgments

• Getting closer
• Older and wiser
• Inside the miracle
• The green machine
• Much to learn
• What a waste
• Steady as she goes
• » A muted normality «
• Offer to readers

Germany now defends its national interests more frankly, especially in Europe. Helmut Kohl, the chancellor
who guided Germany to unification, was responsible for the last great act of self-denial, the surrender of the
D-mark. The tone changed with his successor, Gerhard Schröder, who made it clear that Germany would not
reach for its cheque book every time the European Union put out its hand. He also signed a deal to build a
gas pipeline from Russia that bypasses Poland and the Baltic states (and now works for the consortium that
is constructing it), suggesting that a more self-confident Germany would also be a more selfish one.

This marks a generational change. Responsibility is passing from the ‘68ers, moral prosecutors of the crimes
committed by their parents, to the youth of 1989, notes Joschka Fischer, whose progress from radical street
fighter to foreign minister sums up the arc of his generation. The next one has less need of the EU to keep it
on the straight and narrow, or of NATO to protect it from attack. Last summer Germany’s constitutional
court ruled that the EU lacked the democratic legitimacy to push European integration further.

Yet the ‘89ers face new anxieties that keep them hanging on to the old structures. Germans were the biggest
beneficiaries of the post-war bargain under which Europe outsourced its security to America and used the
money it saved to build the welfare state, notes Jan Techau of the NATO Defence College in Rome. But
Europe is no longer the front line and America’s focus is shifting to the Pacific. Europeans fret that China
and America will make global decisions over their heads.

The answer to that is for the Europeans to speak with a more coherent voice and to strengthen their
partnership with the Americans. Terrorism, climate change and the rise of China are probably best faced by
investing more in the main alliances, not less. But the alliances themselves are under strain from a variety of
causes. It falls to Germany to help.

Angela Merkel, a more self-effacing character than Mr Schröder, has sent mixed signals. She was
instrumental in securing the passage of the Lisbon treaty, which strengthens the EU’s role in justice,
migration and foreign policy. Yet when it came to picking the first holders of the top jobs created by the
treaty—the president of the European Council, which represents heads of government, and the high
representative for foreign affairs—she joined her fellow leaders in choosing figures too puny to compete
with them. In European emergencies Mrs Merkel has been watchful of German treasure and national
prerogatives. Like her predecessor, she wants a permanent seat for Germany on the UN Security Council.
Germany is coming to resemble France in balancing European cohesion with the pursuit of national status,
says Gunther Hellmann of Johann Wolfgang Goethe University in Frankfurt.

Once burned, always shy

Yet unlike the victors of the second world war it remains, in the words of Constanze Stelzenmüller of the
German Marshall Fund, a “self-shackled republic”. Germany’s NATO partners see it as passive, reactive
and foot-dragging. Post-war pacifism remains vigorous. Germans respect their armed forces but a 2007
survey by the Bundeswehr found that only 42% of the population were proud of their achievements,
compared with 87% of Americans. Most want Germany to pull out of Afghanistan as soon as possible.

What is striking, however, is how little the Germans protest. Even though they disapprove of the
Afghanistan operation, 60% accept that such missions are unavoidable, according to Allensbach, a polling
organisation. Germany’s most popular politician is Karl-Theodor zu Guttenberg, the aristocratic defence
minister. Similarly, the EU inspires little enthusiasm, but few people doubt that Germany’s destiny lies
within it. National pride is partly linked to a sense of international duty.

Germany’s friends no longer worry much that pride will ever become hubris again. A federal state with a
declining population embedded in democratic alliances is unlikely to be a threat. But they do fear that its
sense of duty will flag. As Germany comes of age, it seems unsure whether to assume more responsibilities
or merely more prerogatives. Its allies are depending on Germany to become wiser with age.

Kenya's crumbling government

The great rift

Only greed and pressure from abroad now bind the ruling
politicians together
Apr 23rd 2009 | nairobi

AFTER the horrendous violence that followed Kenya’s flawed general election in 2007, the mediation of
Kofi Annan, a former secretary-general of the United Nations, was acclaimed for pushing the two main
political parties into a coalition government. This at least stopped the bloodshed. Now, however, the deal is
unravelling—fast. At a recent summit feuding government ministers could not even agree on what to discuss
in order to find common ground. The Orange Democratic Movement (ODM) of the prime minister, Raila
Odinga, stomped out before the meeting had even begun, accusing President Mwai Kibaki’s Party of
National Unity (PNU) of blocking the agenda.

Among the foreign diplomats looking on, optimists refer to the squabbling coalition as an “unconsummated
marriage”. The less charitable say Kenya does not have a functioning executive at all, just an unholy alliance
of fierce rivals. A schedule of constitutional, electoral, judicial, security, land and economic reforms was
laid out in the original agreement between the two parties. A domestic tribunal to judge those responsible for
the post-election mayhem was supposed to be set up and a truth commission established. Yet more than a
year later the ODM and PNU have failed to agree on any of these issues.

New corruption scandals, confined to no party, are regularly revealed by Kenya’s papers. With so many
senior figures from the main parties co-opted into the government—which has 94 ministers and deputies,
each earning over $15,000 a month—Kenya has become almost a one-party state. Ministers constantly
squabble over pay, protocol, seniority and even who gets the best rooms at government get-togethers. The
churches, NGOs and foreign diplomats are left to play the role of opposition, cajoling and threatening from
the sidelines.

Related items

• Kenya: Next machetes, then machineguns?Mar 12th 2009

The infighting and bickering have also confounded hopes for measures to tackle the causes of the post-
election violence, or even the country’s increasing gang violence. For example, Mr Odinga backed calls for
the resignation of the soldier turned chief of the police, Major-General Hussein Ali, after he had been
heavily criticised by human-rights groups and the UN over the activities of police death-squads. But Mr
Kibaki, who appointed Mr Ali, has refused to let him go, despite an agreement to have a civilian head of the
police. This week clashes in central Kenya between villagers and gang members of a criminal sect known as
the Mungiki, who belong to the Kikuyu group, Kenya’s biggest, left another 40 or so people dead.

Parliament reconvened this week. The next elections are not due until 2012, but so grave is the impasse that
politicians are already attending to their political futures rather than present troubles. Martha Karua, who
resigned as justice minister on April 6th in protest at Mr Kibaki’s decision to appoint judges without
consulting her, has said she will run for president. She gives press interviews, addresses crowds and
lambasts the government she so recently abandoned as if a national poll were due for next week. Ms Karua
is popular because she gives voice to the disgust felt by ordinary Kenyans towards their politicians. Her
resignation is seen as a rare display of principle.

Unfortunately for Kenya, all that holds the coalition together now is mutual greed and pressure from abroad.
Despite everything, foreign donor governments are nonetheless determined that the coalition should not
collapse entirely. They believe any government is better than none, fearing yet more violence.

Mr Annan may intervene again. Within a few months, unless the domestic courts deal with the matter
properly, he promises to hand over to the International Criminal Court the names of ten people considered
by a special Kenyan commission to be responsible for the post-election violence. The removal of these
figures from Kenya’s politics, and even from the cabinet itself, might give a useful jolt to the country’s
dysfunctional political system.

State pensions in Europe

The crumbling pillars of old age

If governments and employers cannot be trusted to provide for old

age, who can?
Sep 25th 2003

ON TUESDAY September 23rd, Silvio Berlusconi, the prime minister of Italy, briefed employers and union
leaders on a long-anticipated plan to reform his country's state pension system. It is in dire need of reform.
Italy has one of the lowest birth rates in the world and one of the most generous state pension schemes—an
unsustainable combination that leaves an ever diminishing workforce paying for an ever rising number of
pensioners. Many other countries in Europe are saddled with similar problems, largely based on promises
made before the workers who will pay for them were even born.

The Bank of Italy and Confindustria, the employers' association, say (rightly) that Mr Berlusconi's package
does not go nearly far enough. However, Italy's three main unions, the CGIL, UIL and CISL, think it goes
too far. They have threatened “a fighting response...a strike.”

If the package survives future labour unrest, it will at least have taken some steps in the right direction. For
example, it proposes that from 2008 the mandatory retirement age be raised from 60 to 65, and that the
minimum number of years to be spent in employment in order to qualify for a full state pension be lifted
from 35 to 40. It also proposes scrapping the so-called seniority pensions that allow Italians to retire at 57 if
they have worked for 35 years. The proposal is due to be approved by the Italian cabinet on September 29th
before being submitted to parliament.

In this special report

• » The crumbling pillars of old age «

Related items

• State pensions in Europe: Work longer, have more babiesSep 25th 2003

Attempts to trim state pensions in recent years have aroused the anger of workers across Europe. On June
3rd this year France was virtually closed by a nationwide strike against the government's proposed pension
changes, on the same day that Austrians brought their country to a halt over pension reform. Normally a
model of cosily consensual industrial relations, Austria saw more than a million people take to the streets to
demonstrate their grievances over pensions.

In France and Italy, political leaders have repeatedly backed down when strikes over pension reform have
threatened to paralyse their countries. In 1995 the then French prime minister, Alain Juppé, lost his job over
the issue. Leaders in Austria, Germany and Spain have avoided strikes largely by avoiding serious attempts
at reform, muddling through in the meantime with timid tinkering that does not touch the fundamentals.

This year, however, has been significantly different. The French prime minister, Jean-Pierre Raffarin,
claiming grandiloquently that the pensions issue was “about the survival of the republic”, pushed through
unpopular reforms and managed to keep his job. So too did Wolfgang Schüssel, his Austrian counterpart.

Gerhard Schröder, the German chancellor, has not yet taken steps as radical as his two neighbours', but he
may soon have to do so. On August 29th, an advisory panel recommended that he gradually cut pension
payments by as much as 10% in real terms over the coming years, and that he progressively raise the
retirement age from 65 to 67.

You pay as they go

Europe's state-administered pension systems are, for the most part, financed on a pay-as-you-go (PAYG)
basis. There is no huge pot out of which future obligations can be met. Those in work pay (via a tax on their
current wages) for the pensions of those who have retired. In Italy and Austria, public pensions gobble up as
much as 15% of GDP annually; in France and Germany the figure is about 12%. By 2040, says
Commerzbank, a German bank, some governments' overall unfunded pension liabilities will be three times
their country's GDP, if nothing is done before then. The bank goes on to say that the PAYG schemes
underlying most state pensions would see their practitioners thrown in jail if they were private operations.

The outlook for state pensions is not equally dire across Europe. Britain, the Netherlands, Scandinavia and
Switzerland, for example, have already shifted much of their pension burden from what is known as the first
pillar (the state) to the second pillar (the employer), and even in places to the third pillar (the individual
pensioner-to-be). In Britain and America, government spending on pensions accounts for only 5-6% of GDP
a year.

Pay-as-you-go systems were introduced as long ago as 1889 by Otto von Bismarck, Germany's chancellor.
They worked well for as long as the active workforce vastly outnumbered the retirees—as they did in
Bismarck's day. The retirement age then was 70, and the average life expectancy was 48.

But life expectancy has been rising now for 300 years, and it rose particularly quickly in the second half of
the 20th century. Between 1950 and 1995, average life expectancy in Britain increased from 69.2 years to
76.2, and in France from 66.5 to 77.1. Moreover, it has not stopped rising yet. Between 2000 and 2020 the
remaining life expectancy of a 65-year-old male in Germany is expected to increase from 12.1 years to 14.9.

This ageing of the population is being combined with falling birth rates, a relatively new phenomenon.
During the baby boom of the 1960s—between 1960 and 1965—the overall birth rate in the European Union
was 2.7 children per woman, comfortably above the rate of 2.1 required to maintain the size of the
population. By 1995, however, that rate had fallen dramatically to 1.5 children per woman. In Italy, the
figure is even lower. In a paper published this week, David Willetts, the British Conservative Party's
spokesman on pensions, wrote that Europe's pension problem “is not life expectancy. It is birth rates.
Europe's working-age population is set to fall by 40m, or 18%, by 2050.”

Low birth rates are an old-world phenomenon. America has a much higher birth rate and a higher rate of
immigration. (Immigration, however, does not boost populations as much as is sometimes assumed, because
immigrants tend to have few children in their new country.) At the moment, the EU's population is some
90m greater than America's. But by 2050 America could have 40-60m more people than today's EU member
states.

Germany and Austria illustrate the remorseless consequences of this demographic pincer movement. Seven-
tenths of Germans' pensions still come from the Bismarckian state system. Last year the levy on wages to
pay for this, half of it from workers and half from employers, was 19.1%. Today, fewer than three workers
support each German pensioner. But if current ageing and fertility trends continue, that figure could be
halved by 2030.

In Austria, had Mr Schüssel not fought for his government's reform, workers would have been obliged to
channel almost half of their wages into the state pension scheme in 20 years. Under those circumstances, any
Austrian with portable skills would almost certainly choose to take them elsewhere.

Pretend it's painless

As the pension time-bomb has ticked away, European governments have become more imaginative in
finding methods to cut back on the promises of the state pension system. Their main aim has been to make
the cuts seem as painless as possible, and to encourage people to save on their own for their retirement.

Governments are, for instance, prolonging the number of years that a person has to work in order to qualify
for a full state pension. This is proving to be one of the least unpopular reforms—people are more unhappy
about increases in contributions or cutbacks in benefits—except in France. There the increase in the number
of years that public-sector employees must work in order to qualify for a pension (from 37.5 to 40, and later
to 42, the same as the requirement in the private sector) was the most controversial part of this year's reform
bill.
Another step that is being taken in order to ease the pressure on state pensions is to switch any indexation of
the benefits from wage inflation to price inflation. France was one of the first to do this (in 1993), but the
reform applied only to the private sector. As wages tend to rise by more than prices, the move was inevitably
accompanied by a rush aux barricades.

A more simple reform is to raise the retirement age. This year Austria decided to increase its retirement age
for men gradually from 61.5 to 65 years, and for women from 56.5 to 60 years. Italy is now planning to raise
its retirement age to 65—though Giancarlo Fontanelli of Inpdap, the social-security agency for public-sector
workers, would like 70 to be the retirement age for everyone. And Germany, which has already raised its
retirement age from 63 to 65, may yet go further. Bert Rürup, an economist on Mr Schröder's advisory
panel, is proposing it be raised in monthly increments to 67 between 2011 and 2035.

Putting more in the pot

As the extent of the pensions crisis began to unfold, a number of countries set up reserve or buffer funds to
help them pay the bills. The earliest funds were created in the 1960s and 1970s in America, Canada and
Japan, but they were designed as a safeguard for the social-security system as a whole, not specifically for
pensions. The funds set up by Belgium, France and Ireland over the past decade, on the other hand, were
specifically intended to back their PAYG schemes.

The French buffer fund, the Fonds de Réserve pour les Retraites (FRR), was set up in 1999 with the aim of
raising as much as €150 billion ($172 billion) by 2020 to help finance public pensions for the following ten
years. September 12th this year was the closing date for applications from private-sector firms to manage the
27 separate pools into which the €16.6 billion that the FRR has so far managed to accumulate has been
divided. There was no shortage of candidates for the jobs.

Governments in Europe have also tried to encourage their citizens to save for themselves by sweetening new
individual savings schemes with tax breaks. In 2001, for example, Sweden allowed its workers to put 2.5%
of their wages (out of their 18.5% payroll-tax contribution) into an individual account.

In the same year, Germany introduced the Riester pension, named after Walter Riester, the labour minister
responsible for the reform. This gives German workers the option of putting 1% of their pay into their own
retirement account, a percentage that is to rise in steps to 4% by 2008. The Riester scheme has failed to take
off as planned, though, despite generous subsidies to encourage low-earners and parents with dependent
children to take part. Some say the scheme is too hard to understand; others claim that savers are still too
scarred by the recent bear market.

Occasionally governments are more blunt. Either they increase the mandatory contributions to the pensions
scheme—in 1997, for example, the Netherlands increased the pensions levy on wages from 15.4% to
18.25%, and Finland introduced an employee contribution in addition to the existing employer's contribution
in 1993—or they reduce the pension benefits, a move as detested as any increase in the tax. In Austria, for
example, benefits for new pensioners will be cut by 13.5% next year, and Austrians retiring early will suffer
cutbacks in their pension benefits.

The corporate option

European governments hoping that corporations will solve the pensions crisis for them will be disappointed.
The problems experienced by American and British companies' pension funds in recent years are a stark
warning to countries trying to make the switch from public- to private-sector pension provision.

Most American and British companies' employee pension funds were set up as defined-benefit schemes,
schemes that promise to pay a given pension at a given age. This left the companies to assume the risk if the
funds' returns proved insufficient to meet those defined obligations. And sure enough, after the prolonged
bear market, huge holes have been appearing in companies' pension funds. Not surprisingly, companies have
been scrambling to convert their existing pension plans into so-called defined-contribution schemes, where
the full pension cost is predictable.

Even so, some 44m Americans are still covered by defined-benefit plans, and American companies' pension
funds now have a combined deficit (the amount by which the value of the scheme's assets falls short of the
current value of the pensions they are pledged to pay in future) of about $400 billion. Many firms have
started to make large contributions to bridge some of the gap and to satisfy statutory requirements. Last year,
for example, they pumped $31.6 billion into their pension funds. This year they would have had to pay an
estimated $125 billion in top-ups if the rules on pension-fund solvency had not been relaxed.

Pension obligations have become a huge drag on corporate earnings and, as such, they are threatening the
American economy's timid recovery. Two bills currently in Congress are seeking to provide relief while still
maintaining the health of corporate pension funds. On September 17th, the Senate's finance committee voted
to give companies some relief on their pension funding, a move that could save them about $60 billion over
the next three years. A bill introduced by Republicans in the House of Representatives would save them only
about $25.5 billion over the next two years.

The Confederation of British Industry puts the shortfall in British corporate pension funds at £160 billion
($265 billion). Companies such as Sainsbury's, Marks & Spencer, HSBC, BT and GlaxoSmithKline are
closing their defined-benefit schemes to new employees and replacing them with defined-contribution plans.
This switch has cost British employees up to £1.6 billion a year in pension payments, according to Close
Wealth Management, an investment manager. About 900,000 people have seen their defined-benefit plans
closed down and their employers substantially reduce their contribution to the alternative (defined-
contribution) plan, sometimes by as much as half.

Funding for yourself

With the expansion of defined-contribution plans, which lumber the individual with the investment risk of
his or her pension, the distinction between the second and third pillars of support is blurring. So it makes
more sense for people to organise their own pension plans instead of leaving them up to an employer, with
whom they are less and less likely to remain for the whole of their working life. What's more, with an
individual private retirement account people are free to decide for themselves when to stop working. Every
extra year of work increases their pension pot.
So Europe should look to Latin American countries, which pioneered this do-it-yourself approach by
introducing individual retirement savings accounts. In 1980, Chile set up a funded scheme to replace the
country's bankrupt PAYG system. The scheme requires workers to pay 10% of their annual income into
private retirement accounts, which they own and control. About 5.6m Chileans are contributing to the
scheme, although it is compulsory only for the 3m of the country's workforce who are in full-time
employment.

Other Latin American countries have introduced similar, though less comprehensive reforms. Mexico, for
instance, introduced obligatory, privately managed retirement-savings accounts for its private-sector workers
in 1997. Bolivia, one of the poorest countries in the region, replaced its state pension system in 1997 with
private retirement savings accounts. Bolivians, like Chileans, now pay 10% of their wages into this pension
scheme. El Salvador introduced a system very similar to the Chilean model in 1998, and Colombia,
Argentina and Uruguay have also partially privatised their systems.

If private contributions to retirement savings accounts are not mandatory, as they are in Latin America, there
is concern that, left to their own devices, individuals may not save enough for their old age. The Association
of British Insurers warns that there is a £27 billion gap between what people in Britain are saving and what
is needed for them to enjoy a comfortable retirement. (About one-third of Britons are not saving anything at
all, while a good part of the rest save for holidays or cars but not for their long-term welfare.)

One solution is to introduce an element or two of compulsion. In Britain, for instance, the government could
make its stakeholder pensions, a new low-charge private investment scheme, compulsory for all employees.
Likewise, Germany's Riester pension could become mandatory for employees there.

Of course, the transition from the first to the third pillar cannot happen overnight. The longer a PAYG
pension system has been going, and the more generous its benefits, the bigger the build-up of implicit debt
in the system. Because of this heavy transitional burden, no country with a large PAYG scheme can make a
rapid switch to a privatised alternative. For one thing, that would impose a double burden on the current
working generation. They would have to build up their own funded pension at the same time as they pay
today's pensioners for previous governments' promises.

When younger members of the workforce feel the full weight of the burden they are being expected to carry,
they may start to protest, and so provide a political counterweight to the ageing voters who are determined to
protect their own entitlements at the expense of those coming after them. Alternatively, of course, younger
people could remove the need to fund a pension for themselves by returning to the oldest pension plan on
the planet—a large number of children. That, of course, would solve the birth-rate problem too.

What cannot be said in five minutes

Jul 20th 2010, 11:37 by J.B. | KABUL

 WEARY
international conference-goers could be forgiven for pinching themselves to remember they were not in
Tokyo, Paris, Bonn—or indeed any of the nine cities around the world where foreign ministers have been
meeting over the past nine years to discuss all things Afghanistan.

The themes were all wearily familiar, particularly to anyone who attended the London meeting held in
January this year, at which the international community called for progress on state-building, tackling
corruption and training the Afghan National Army (ANA). Sitting around a huge table in the Afghan foreign
ministry, the 68 delegates were given five minutes each to say what mattered to them. For some it was more
effective spending of foreign aid money. Others called for a greater focus on overhauling Afghanistan’s
corrupt judiciary. But, with the exception of the Iranian foreign minister who went amusingly off-message
(and well over his five minutes) with a rant about international forces being the cause of rising insecurity,
the delegates did not say anything to set the pulse racing. In fact, about the only novelty value in Tuesday’s
conference was the fact that of all the meetings held since 2001, it was the first to be held in Afghanistan
itself.

The hope is that this might prove to the world that, nine years after the international community descended
on the pile of rubble made by 30 years of war, Afghanistan’s government is on the way towards being able
to look after itself. That day cannot come soon enough for most of the foreign ministers sitting around the
big table in Kabul. Many of them are struggling to justify this government’s expense, in foreign blood and
treasure, to the public back home. Hillary Clinton, America’s secretary of state, did not shrink from
mentioning the possibility of failure: “Citizens of many nations represented here, including my own, wonder
whether success is even possible—and if so, whether we all have the commitment to achieve it.”

Sadly for Afghanistan, the majority view among diplomats and the country’s long-term observers is that
success is probably not possible. The foreign powers are thought to lack the stamina it would take to stand
up an Afghan government capable of withstanding a resilient insurgency while holding its own in a region
of meddlesome neighbours. With that gloomy assumption in mind, most of the five-minute speeches
sounded absurdly beside the point. Hamid Karzai, Afghanistan’s president, said the country is so well
endowed with mineral wealth (30% of its untapped resources are worth between $1 trillion-3 trillion,
according to him) and so well placed in the region that it can become “the Asian Roundabout” for trade.

Much faith was vested in the ANA, which is being rapidly enlarged while its standard of training is
improved. The hope is that better recruitment and training, along with a similar build-up of the Afghan
National Police, will allow for a transition to full Afghan control of the armed forces by 2014. But, again,
the growing band of pessimists have little faith that the ANA—which still struggles to recruit southern
Pushtuns—will ever be able to control the provinces of the rebellious south.
For these reasons, many of the delegates are putting their hopes in a grand political deal with insurgents.
Their idea is to trade legitimacy for stability, so as to allow their own troops to go home. The most hard-
nosed realists, including some of the diplomats sitting behind their foreign-minister bosses, say that
extraordinary compromises will have to be made, particularly on women’s rights. Perhaps even the
country’s territory would have to be traded away: the south handed to the Taliban, the north to a grizzly
collection of old warlords, with only a token national government left in Kabul.

Not that any of this was said aloud at the conference table. And remarkably little was said about efforts to
encourage insurgent leaders to "reconcile" with the government. Though Mr Karzai takes far more interest
in the issue of reconciliation than in, say, the international community’s obsessions over corruption and poor
governance, he kept his remarks on the subject short and very much in tune with the American-approved
message: there will be deals only for insurgents who are "willing to accept the constitution and renounce ties
to Al-Qaeda’s network of terror".

With the surge of American forces continuing to show disappointing results, it will be remarkable if the
foreign ministers have not moved on from such tired themes in November, when they meet next—in Lisbon.

Israel and its natural resources

What a gas!

Israel’s new gas finds may affect its strategic friendships too
Nov 11th 2010 | Jerusalem

THE old, sad, Jewish joke about Moses taking a wrong turn and ending up in a corner of the Middle East
without any oil can at last be discarded. Israel has struck gas—lots of it. Deep-sea wells off the north of the
country should soon supply all the country’s own gas needs, and much more is in prospect for export. But
such bonanzas inevitably bring headaches.

Tension with next-door Lebanon over demarcating the maritime border is rising. A big battle has begun in
Israel over royalties, with some demanding a sovereign-wealth fund when the money starts flowing. There is
excitement and volatility on the Tel Aviv stock exchange, where the government has moved belatedly to
curb heady trading in drilling licences.

The find could also have far-reaching strategic consequences, especially if a pipeline is laid across the
seabed to Greece, where relations with Israel have been noticeably warming as Turkey moves to shut down
its longstanding alliance with the Jewish state.

For decades Israel drilled for oil with scant success. But in 1999 a maritime drill struck gas in commercial
quantities just 250 metres beneath the Mediterranean, 40km (25 miles) out from Israel’s southern port of
Ashdod. Production began in 2004 at what is called the Mari-B, and some 2.8 billion cubic metres of gas are
piped ashore each year from reserves that may be as large as 22 bcm.

But that is a mere bubble compared with the Tamar field discovered last year, also in the Mediterranean,
90km off the northern end of Israel’s coast. Tamar, where the gas is much deeper down, holds 238 bcm.
Production, by a consortium led by the same Israeli and American partners who own Mari-B, is to begin in
2014. Tamar was the world’s largest gas find in 2009.

But it, too, may be dwarfed by another find by the same consortium, 45km farther out to sea. Noble Energy,
the consortium’s American part, says this field, called Leviathan, has a potential of 453 bcm and an even
chance of “geological success”. An exploratory drill is under way. The results should be known early next
year. If good, production could begin by 2016.
The two fields could provide gas worth $4 billion a year. As Israel’s energy bill is $10 billion—more than
5% of GDP—the gas would sharply improve the country’s trade balance. Indeed, Tamar should supply all
Israel’s domestic gas needs, both for industry and household consumers, for at least 20 years. Leviathan’s
reserves should be available for export.

This is where Greece may come in. The two countries, cold and distant in the past, have suddenly become
bosom friends. Israeli military aircraft, no longer welcome in Turkish skies, are training over Greece in
concert with the Greek air force. The two prime ministers, Binyamin Netanyahu, an arch-capitalist, and
George Papandreou, a socialist scion, have exchanged cosy visits. Israeli businessmen and tourists who once
flocked to Turkey are switching to Greece. Recent diplomatic talks in Jerusalem included a session with
Israel’s petroleum commissioner. Israel sees Greece not only as a gas purchaser but also as a European hub
from which Israeli gas could be sold and piped on.

But Greece may not sign on the dotted line until Israel has agreed with Lebanon and Cyprus on where a
border is to be drawn in the sea, demarcating each country’s economic exclusion zone. Israeli and Lebanese
ministers have already traded accusations and threats. Tension has risen since Iran began offering to help
develop Lebanon’s share of the undersea wealth.

The Israelis say they are close to agreeing with Cyprus on a “median line” to let them share some of the
seabed between them; as economic exclusion zones generally extend 200 miles (322km) out to sea, there is
an overlap. The Israelis then intend gingerly to approach Lebanon, though the two countries are formally in
a state of war, in the hope eventually of holding a UN-backed international arbitration.

Meanwhile, the Israelis have run a string of buoys into the sea off the coastal border point between Israel
and Lebanon. But the Lebanese say they are angled too far northward. The Israelis point out that Tamar and
Leviathan (see map) are anyway well south of the line that Lebanon claims as the correct maritime one.

In any event, unlike Mari-B, where a derrick standing on the sea floor pumps up the oil, Tamar and
Leviathan will present no target above the waterline for anti-Israeli guerrillas from outfits such as Hizbullah,
the Lebanese Shia party-cum-militia. Nearly 2,000 metres deep, the wells will be installed and operated by
robot-like machines capable of withstanding the intense underwater pressure.

The Palestinians, especially in Gaza, are watching developments twitchily. A decade or so ago, British Gas
wanted to work with the Palestinian Authority to develop the Marine field off Gaza; most or all of the gas
was to be sold to Israel. But Ariel Sharon, when he was Israel’s prime minister, vetoed the project,
ostensibly on security grounds, and the field lies unexploited.

A big bonus for poor Israelis?

Back on land, a committee of experts appointed by the finance minister has recommended a steep rise in the
government take on successful gas or oil finds. A series of tax breaks and low royalties would mean, the
committee found, that Israeli citizens would do poorly out of their country’s natural resources by
international standards. So the committee proposed progressive taxes on profits that could mean the
government taking 66% of profits on flourishing gasfields. Oil and gas executives, apparently backed by the
American administration, are complaining loudly. The offshore consortium has retained legions of lobbyists
and public-relations people to make its case.

Lined up against them are civil-society campaigners such as Michael Melchior, who hailed the
recommendations as “a significant step in the right direction”. As a former chief rabbi of Norway and later
an Israeli politician linked to the Labour party, he is urging the government to follow Norway’s example by
putting the state’s share of profits into a sovereign wealth fund and earmarking the income for social
welfare. “A one-time chance,” he says, “to bring truly historic change to Israeli society.”

China's stockmarket
Sand in the gears

A new tax hits the euphoric Chinese bourses

May 31st 2007 | shanghai

COULD it really be that easy? This week China abruptly raised the “stamp duty” it levies on share
purchases. For a day or so, the increase seemed to accomplish what dire warnings by Chinese officials could
not—a fall in China's bubbly stockmarket. On May 30th prices on the Shanghai Composite Index dropped
by 6.5%. But they promptly regained 1.4% by the end of the following day.

For months, the authorities have been as eager as any bear for a market decline. In the past jawboning had
some effect. But recently a swelling throng of retail buyers, and even many experienced bankers, have felt
sure the government would not seriously spoil their party until after the Olympic games to be held in Beijing
next summer.

To support this theory they cite the unwillingness of the authorities to do anything with great bite. Interest
rates have been raised twice this year, but not by much. The issuance of new mutual-fund shares was capped
in December, but the restrictions ended when share prices dropped in February. There have been threats of a
capital-gains tax, and brokers must now tell the hordes of new customers packing into their offices that
prices can fall as well as rise. But brokers say that as long as prices go up, their customers do not care. The
only message they heed is the one on the tape.

Related items

• Chinese bankruptcy: Euthanasia for companiesMay 31st 2007

The tripling of the stamp tax, to 0.3%, makes the position of regulators abundantly clear. But the duty fails
to address why valuations in China have become unhinged. For a market to work effectively it needs
information. In China corporate disclosure is weak. There is a desperate need for regulatory pressure to force
public companies to say more about what they do and to tell the public, not just a tiny pool of connected
investors. Encouraging information, however, is not a Chinese speciality.

Conversely, China needs fewer regulatory restraints on the investment options available to its citizens. It
should allow them to invest more freely abroad, or in commercial paper and bonds. Instead it tries to widen
opportunities by encouraging public offerings, priced to jump on issuance. This has dangerously stoked
demand.

Suppose the authorities were to find a way to bludgeon the stockmarket, knocking, say, a quarter off share
prices. That would inflict misery on the new investor class, and valuations would still not be particularly
cheap. The best way to curb the excesses of China's sharebuyers is to give them somewhere else to put their
money.

Battle of the bourses

Exciting times for an ancient industry

Nov 18th 2005

After a little reflection, it ought to be no surprise that financial exchanges—the marketplaces where shares,
commodities, options and futures are bought and sold—are as old as capitalism itself, and maybe a bit older.
Capitalism, after all, requires that capital be raised, priced and allocated. The Amsterdam stock exchange,
which claims to be the world’s oldest, dates from 1602, when it was established for the trading of shares in
the Dutch East India Company. Trading in futures and options began there a few years later.

You might expect industries this old to have settled into maturity long ago, with arthritic structures,
established habits and a whiff of stately decline. Not this one. For one thing, it is booming—especially in
derivatives. On the Chicago Mercantile Exchange (CME), an average of 5.2m futures and options contracts
a day were traded in September 2005, 45% more than a year before. Daily volumes now sometimes brush
10m. And upheaval has become the norm. Several exchanges have given up their old, mutual status in
favour of a stockmarket listing. Exchanges have merged with one another, looked for new markets for their
products and developed new products for their markets. Be ready for more of all this in 2006.

Underlying these trends is rapid technological change, which means that trades in an ever-broadening set of
financial instruments can take place anywhere, any time, and faster than ever. Funnily enough, in some ways
this technological shift makes the trading industry shed some of the image that has made it look, well, a bit
brash for one of such advanced years. Think of derivatives traders especially and you may imagine fortunes
being made and lost in a whirl of coloured jackets, frantic hand signals and screamed buy and sell orders. In
most exchanges this open-outcry system has either already vanished or is being supplanted by electronic
methods. But the same technological forces that are making trading quieter are shaking up the industry.

In 2006 these shifts will continue in at least two main ways. First, some big exchanges will probably buy
others, large or small. In Europe, it would be a surprise if the fate of the London Stock Exchange (LSE)
were not settled soon. The LSE wants to stay independent, and has rebuffed informal advances from
Germany’s Deutsche Börse and from Euronext (which controls the Brussels, Lisbon and Paris stock
exchanges as well as venerable Amsterdam). Deutsche Börse’s attentions faded when its shareholders
rebelled, forcing out its chairman and chief executive. Euronext’s management still looks keen—though its
shareholders do not. Macquarie Bank of Australia has shown an interest too. Conceivably, Deutsche Börse
could try again; or it might look at Switzerland’s SWX, which its new chief executive used to run and with
which it owns Eurex, a derivatives business.
Mergers may be in the air across the Atlantic too. For instance, ties between the CME and the Chicago
Board of Trade (CBOT) have been getting closer. The two old Chicago rivals already have a common
clearing operation, which, say some, amounts to most of a merger already. Even if the CME does not tie the
knot with its neighbour, it might well use its heft to buy elsewhere. It certainly has the wherewithal: its
shares, floated at $35 in 2002, were fetching $340 in October 2005.

The second trend is geographical spread, as exchanges expand their operations far beyond their home turf.
The question is, what works best? One strategy is to take a share of the market from local incumbents. Eurex
has tried to do this in Chicago. The New York Mercantile Exchange would like its new London floor to
wrest trading in Brent crude-oil futures from the local International Petroleum Exchange. It is hard to make
this work, because in trading liquidity is everything, and siphoning it away from a liquid incumbent is
notoriously hard. It has been done before: Eurex’s predecessor won trading in German government-bond
futures from Liffe, now part of Euronext, in 1998. But that was an exception.

The same technological forces that are making trading quieter are shaking up the industry

An alternative strategy will prove more fruitful: the creation of satellite trading hubs in different parts of the
world, to exploit existing products more fully rather than try to steal business in which others are
entrenched. Technology now allows a given contract to be bought and sold anywhere, not just on one
trading floor in one city. The hubs allow exchanges to tap new sources of liquidity and thus to increase
revenue without increasing costs by very much. The CME, for instance, has set up trading hubs in Europe
and Asia, to enable its own products to be bought and sold on its Globex trading system 24 hours a day.

There is more to watch out for. Derivatives exchanges will offer one new future or option idea after another.
And the exchanges will have to battle not only with each other but also sometimes with their customers—
mainly financial institutions—which are seeking cheaper ways of trading. So much for maturity.

The tea-partiers' little red book

Sep 23rd 2010, 15:53 by Lexington

MY PRINT column this week argues that under the influence of the tea-party movement too many
Americans have begun to turn admiration for the Declaration of Independence and the Constitution into a
form of worship, and that this is unfortunate. I know it is a trifle impertinent for a Brit to say such things,
and I am bracing for the tar and feathers. But there are, of course, many Americans who say so too, and one
of those I spoke to whilst writing my piece deserves more attention than the column was able to give him.
Michael Klarman, who teaches constitutional history at the Harvard Law School, was a lot ruder than I
dared to be when he gave a "constitution day" lecture to John Hopkins last week.

Professor Klarman made four main points about what he calls "constitutional idolatry". They are (1) that the
framers' constitution represented values that Americans should abhor or at least reject today; (2) that there
are parts of the constitution America is stuck with but that are impossible to defend based on contemporary
values; (3) that for the most part the Constitution is irrelevant to the current political design of the nation;
and (4) that the rights that are protected today are mostly a result of the evolution of political attitudes, not of
courts using the Constitution to uphold them.

Point (1) is surely unarguable: the protection of slavery, the restriction of suffrage and so on. Point (2): two
senators per state regardless of population, restricting the presidency of a nation of immigrants to those born
in America; (3) beyond Congress, the courts and the executive branch today's political system includes a
fourth branch, the administrative state, which the framers could never have imagined and which is almost
certainly "unconstitutional" in many ways but which no court will ever strike down; (4) when the Supreme
Court has ruled to uphold rights it has generally been motivated by changing public opinion, not by a textual
study of the Constitution. Judges, Mr Klarman says, are too much a part of contemporary culture to take
positions contrary to dominant public opinion, no matter what the Constitution says.
Sadly, I cannot yet point to a transcript of Mr Klarman's provocative lecture. But before you head off to our
offices in Washington, DC, with your tar and feathers, allow me to suggest heading instead for a certain
institution of higher learning on the banks of the Charles River in Cambridge, Mass. It has long been full of
dangerous revolutionaries.

Asylum-seekers

Mar 25th 2010

The UN High Commissioner for Refugees reckons that 377,160 people sought asylum in industrialised
countries last year, almost exactly the same number as in 2008. The number of asylum-seekers rose in 19
countries and fell in another 25. The fall was sharpest in southern Europe, where almost a third fewer people
sought refuge last year than in 2008. America remained the most favoured destination, receiving 49,020
applications in 2009. The number of people seeking refuge in Nordic countries rose by 13%. More asylum-
seekers came from Iraq than from any other country during 2008. But last year Iraqis were outnumbered by
Afghans, 26,800 of whom sought asylum in rich countries, 45% more than during 2008.

A coming test of virtue

Once a byword for financial busts, Latin America has so far

escaped this credit crunch unscathed. But for how much longer?
Apr 10th 2008 | miami

WHEN Latin Americans get together with bankers on American soil it has usually been to seek succour for
their sickly economies. Yet at the annual meeting of the Inter-American Development Bank (IDB) in Miami
this week, the relative health of the participants was reversed. Thousands of empty flats in gleaming new
skyscrapers clustering around Miami's downtown hotels bear witness to the severity of the housing-market
bust in South Florida. Distracted by their own losses, the investment bankers were in subdued mood or
stayed away. The Latin Americans, for their part, were preening themselves over the vigour of their own
economies. They hope they have “decoupled” from their giant neighbour to the north.
Are such hopes justified? Latin America is doing better than at any time since the 1960s. Economic growth
has averaged over 5% a year since 2004, inflation has been generally low, direct investment is arriving in
record quantities, and the region's current account and fiscal accounts are both in surplus. Of course the
average conceals wide (and widening) variations. But to the surprise of some, the credit crunch has so far
had little discernible effect. Indeed, as world prices for many of Latin America's key commodity exports
continue to rise, the pace of growth has even accelerated in some countries.

Interest-rate cuts in the United States have prompted a number of investors there to buy higher-yielding
Latin American shares and bonds. Most Latin American stockmarkets have been holding up relatively well.
The region's sovereign bonds are no longer tracking junk bonds up north; spreads (ie, the premium over the
yield on American Treasury bonds) have risen barely more than one-and-a-half percentage points since last
July, while those on American junk bonds have risen five times as much. This month Fitch, a credit-rating
agency, raised Peru's bonds to investment grade.

Related items

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• Free trade with Colombia: CountdownApr 10th 2008
• Venezuela: Strategic moveApr 10th 2008
• Ecotourism in Peru: Rumble in the jungleApr 10th 2008
• Brazil's economy: This time it will all be differentJan 17th 2008
• The world economy: Test of staminaApr 12th 2007

But strains and anxieties are starting to emerge. Higher world prices for energy and food mean that inflation
is edging up. That is testing the policy regime (of inflation targets and flexible exchange rates) that has
underpinned the achievement of price stability in many countries over the past decade. Several central
banks, including those of Chile and Colombia, have missed their inflation targets. Some have begun to
tighten interest rates. Brazil's Central Bank is widely expected to raise rates on April 16th, ending three
years of monetary easing. But this may cause currencies to strengthen further, causing difficulties for
exporters just when the current-account surplus is narrowing; Brazil is expected to post a current-account
deficit of perhaps 1% of GDP this year, for example.

Meanwhile, the troubles in the outside world are raising doubts about growth. So far the best guess is that a
mild recession in the United States and a slowing world economy will cut growth in Latin America this year
by one point, to 4.5%. Commodity-exporting South America should be relatively unscathed. Even in
Mexico, where four-fifths of exports go to the United States, the economy has remained surprisingly robust.
But Mexico's economy still moves in tandem with industrial production north of the border, and this may
have further to fall. Production is currently flat; in 2001, when both countries were last in recession, it fell by
5%.

The real worry is 2009. A prolonged recession in the United States would be costly for Mexico, Central
America and the Caribbean; they would receive less in remittances from migrants and fewer tourists, as well
as exporting less. Since that kind of slump would prompt slower growth in Europe and Asia, prices for many
commodities would fall, hitting South America too. In such a situation, capital flows to Latin America
would almost certainly diminish.

The question is whether Latin America's governments have the policies in place needed to counteract a
slowing world economy, notes Andrés Velasco, Chile's finance minister. “In Chile the answer is yes,” he
says. The government has saved some $15 billion of its windfall copper revenues, and can spend this
whenever the economy needs stimulation. To a much lesser extent, this goes for Mexico, Peru and some
smaller countries, too. Mexico's government has launched a public-works programme that will add perhaps
1% of GDP to growth this year. In small and poor Honduras, where migrant remittances account for a
quarter of GDP, the government is preparing a similar programme, says Rebeca Santos, the finance minister.
At the other extreme, Venezuela, which has used its oil revenue to ramp up public spending and is running a
fiscal deficit amid bonanza, will be stretched.

Some economists argue that other countries should do more to imitate Chile's rigorously counter-cyclical
policies. In a paper prepared for the bankers' meeting (“All that glitters may not be gold”), the IDB's
research department notes that 77% of the extra tax revenues generated by higher growth are being spent in
ways that create new entitlements, rather than being invested or saved. It argues that almost two percentage
points per year of Latin America's recent growth, and much of the improvement in its fiscal and external
accounts, is the result of good fortune (favourable world conditions) rather than better management.

Maybe so. But whatever the cause, most of the region's economies are much more robust than they were.
For most countries, a repeat of past collapses is “very unlikely”, concedes Santiago Levy, the IDB's chief
economist. “But that's not the relevant question. The real issue is what we need to do to preserve reasonable
growth” in a harsher environment. This means tackling Latin America's traditional weaknesses in education,
productivity and technology. Optimists argue that this is starting to happen, thanks to the past few years of
growth and stability. Sceptics are yet to be convinced.

The Americas

Chinese leapfrog

Jan 22nd 2008

JUST as sports fans care deeply about their team’s position in the league, countries feel the same about their
economic ranking. In 2007, there was much leapfrogging in league tables, with America often a loser to
China. China's exports exceeded America’s for the first time last year. Yet more table-topping is expected in
2008. However, China may be less proud to overtake America as the world’s largest carbon-dioxide emitter.
But measured per person, the average Chinese will be responsible for much lower emissions than the
average American.
Leapfrogging or piggybacking?

The economies of India and China are not as sophisticated as they

appear
Nov 8th 2007

THE back of Gopal Raj's book “Reach for the Stars” carries a black-and-white photograph of the nose cone
of a sounding rocket, carried on the back of a bicycle. The book chronicles the unlikely beginnings of India's
space programme, which launched its first rocket in 1963 from Thumba, a fishing village in the state of
Kerala. Thumba was chosen as the launch site in preference to another location whose name translated as
“White Elephant Island”.

The programme's founder had little patience for scoffers. “One is often told that such and such a thing is too
sophisticated” for a developing nation, he wrote. But “I have a dream, a fantasy maybe, that we can leapfrog
our way to development.”

India's path since then has remained idiosyncratic. The skills demanded by its industries are those of a much
richer country. This can be shown, roughly, by statistics; more sharply by anecdote. General Electric's
technology centre in Bengalooru (formerly Bangalore), to pick one, is working on advanced propulsion
systems for jet engines. India's Tata Consultancy Services (TCS) produces the software for Ferrari's Formula
One cars. India's drugmakers offer 60,000 finished medicines; only three countries produce a bigger volume.

In this special report

• Transcending the genre

• » Leapfrogging or piggybacking? «
• Running fast
• E-hinterland
• Splendid miscegenation
• Does not compute
• Offer to readers
• Imitate or die
• Sources and acknowledgments
 • Consumer champion
• Old parts, but a new whole
• For all the PCs in China

China's evolution also has its peculiarities. In 1964, recently estranged from its Soviet patron, it devoted a
larger share of its GDP (1.7%) to R&D than it ever has since. But after the decade-long Cultural Revolution,
this is how one study described the state of its industry on the eve of Deng Xiaoping's economic reforms in
1978: “vans and transformers that failed to keep out rainwater, sewing machines that leaked oil onto the
fabric, power tillers rusting outside a factory that churned out fresh batches of unwanted inventory”.

Now, according to Dani Rodrik of Harvard University, China's exports are as sophisticated as those of a
country three times richer. The goods it sells to America overlap to a surprising extent with the merchandise
America buys from members of the OECD, a club of rich democracies, argues Peter Schott of Yale. By this
measure, China's exports are more highly evolved than those of Brazil or Israel.

Particularly stunning is the growth of China's exports of information and communication technology (ICT),
a category covering high-tech staples, such as telecoms equipment, computers, electronic components, and
audio and video equipment. In 2004, the OECD reports, China passed America to become the world's
biggest exporter of such goods (see chart 2).

Xu Zhijun, now head of marketing for Huawei, China's leading vendor of telecoms equipment, recalls the
“distrust and doubt” he faced from 1998 to 2001. The customers he courted would not believe the products
were Huawei's own: “We had to make 100 or maybe 1,000 times the efforts of an American or European
company.” Kiran Mazumdar-Shaw, boss of Biocon, an Indian biopharmaceutical company, describes a
similar progression: “In the early days, we were taken with a big pinch of salt in India. Now we are
beginning to upset the big guys. We have nuisance value. That means we are successful.”

A sliver of riches

How big is the technological gap between America and China? Forty-five nanometres, about 1/2,000th of
the width of a human hair. That, at least, is the answer you might reach if you visit Semiconductor
Manufacturing International Corporation (SMIC), China's leading maker of silicon chips. The company was
founded in 2000 by Richard Chang, a Taiwan-born American citizen, who spent 20 years working for Texas
Instruments. Having built chip foundries or “fabs” in Taiwan, Italy, Japan and elsewhere, he decided to do
the same in China.

Two measurements sum up the stature of a chipmaker: the diameter of the silicon wafers it turns out (bigger
is better), and the scale at which it etches them (the smaller the better). Prior to 2000, China could make 6-
inch (15cm) wafers, good enough for washing machines perhaps, but more than a decade behind the state of
the art. SMIC now boasts two factories that can make 12-inch wafers, as big as any in the industry.
Moreover, it can etch circuits at a scale of 90 nanometres; just 45 nanometres behind the industry's leaders.

SMIC's Shanghai fabs defy the stereotype of China's labour-intensive assembly lines. Its wares are not
glued, stitched or soldered; they are coated, patterned, etched, doped, annealed, plated and polished. Wages
account for no more than 5% of the cost of chipmaking: it is the capital not the labour that steals the show.

Cassettes of wafers move from one expensive piece of kit to the next on overhead tracks, picked and placed
by robotic arms. First coated with a thin insulating film and a light-sensitive layer, the silicon is lined up
under a “mask”, which leaves some bits exposed to a beam of ultraviolet light, other bits protected. The
beam inscribes a pattern, like strap marks on a sunbather, which is then etched into the chip by a jet of
plasma. The etch-marks expose the silicon beneath, which is then implanted with phosphorus or boran.
These impurities, or “dopants”, transform silicon from its natural state as an insulator—a tidy latticework of
atoms with no loose electrons—into its famous modern role as a semiconductor, permitting electrons to stop
or go as the chip designer pleases.

Thanks to its prodigious output of electronic gear, China is now the biggest market for integrated circuits in
the world. All the laptops and handsets, as well as the refrigerators and air conditioners, rolling off its
production lines have chips inside. But China's foundries can satisfy only a tiny fraction of that demand.
Their supply amounts to $3.1 billion, whereas China's demand is $62 billion. The supply shortfall could
reach $112 billion by 2010.

This gap is one reason why Lee Branstetter of Carnegie Mellon University and Nicholas Lardy of the
Peterson Institute for International Economics caution economists like Mr Rodrik not to overestimate China.
China's firms have not managed “to leapfrog ahead and bend or even suspend the law of comparative
advantage”. China is where electronic goods are made, not where much of the value is added.

As is so often the case, Apple's iPod is the best example. The 30-gigabyte video version was manufactured
in China by Inventec, a Taiwanese company. It sold for about $224 wholesale in 2005. But where did that
money go? Three economists—Greg Linden of the University of California, Berkeley, together with Jason
Dedrick and Kenneth Kraemer of the University of California, Irvine—have peered into the white box to
find out. Of the iPod's 424 parts, they reckon 300 cost one cent or less. The display module was worth about
$20, but that was made in Japan by Toshiba-Matsushita. China did assemble all these bits and pieces and test
them. But that accounted for just $3.70 of the iPod's value. The largest bite was claimed by Apple: about
$80 in gross profit.

Perhaps only 15% of the value of China's electronic and IT exports is added in China, Messrs Branstetter
and Lardy think. The rest is imported. Look again at China's trade figures for ICT: exports amounted to
almost $300 billion in 2006, the highest in the world. But imports were $226 billion. China had a trade
surplus in computers, video cameras, TVs and telephones; but it had a deficit of $92 billion in electronic
components, including semiconductors, integrated circuits and audio and video parts.

China fetches low prices for its high technologies. The TV sets it sold in 2003 were worth about $73 a unit,
according to Mr Rodrik's numbers. Malaysia's were worth twice that. The machinery America buys from
other members of the OECD, according to Mr Schott, is four times as expensive as the stuff it buys from
China.

China's high-tech firms are cheap; they are also not very Chinese. None of the top ten, by 2005 revenues,
was native-born. Foreign firms owned one-fifth of the assets in the ICT sector in 2004, accounted for the
lion's share of exports, provided 16% of the employment and claimed 20% of the earnings. The wages they
pay stay in China; as do whatever profits they reinvest. But their know-how stems from overseas. Some
Chinese firms may soon make their mark in high-tech industries, Messrs Lardy and Branstetter argue. But
the transition of the economy “from net importer of technology-intensive goods to net exporter is likely to
take many decades.”
At your service

As the digital professionals of Bengalooru gather themselves for the punishing commute home from
Electronics City, a group of exuberant young men parade noisily in the opposite direction. Streaked from
head to shoulder with bright powder paint, they dance and holler ahead of a plastic icon of Ganesh, the
elephant-headed god, whose birthday fell some days before. Ganesh appears in some unofficial versions of
the Mahabharata, a Hindu epic, as a scribe, whose quill pen breaks in his haste to record the poem as a sage
recites it. Not to be beaten, Ganesh snaps off one of his tusks, dips it in ink and does not miss a line.

Those virtues of determination and improvisation explain much of the success of India's celebrated IT firms,
such as TCS, Wipro and Infosys. Each firm has its epic tales of deadlines made and obstacles overcome.
Their exports of IT services (which do not include other back-office services) grew by 36% in the last fiscal
year (which ended March 31st) to reach $18 billion, according to NASSCOM, the industry association. IT
services employed about 560,000 people. Most of them seem to clog Bengalooru's Hosur Road each
morning. The big three have landed several deals each worth over $300m (with companies such as Skandia,
General Motors, United Biscuits and British Telecom) and margins are still healthy: Infosys, for example,
reported an operating margin of 28% for the third quarter.

The god of small bitsAFP

But some in the industry think India should be doing more with its intellectual resources. It should aspire to
be the poet, not the scribe. India's exports of its own software—or licensing of its own intellectual property
(IP)—amounted to about $450m in the year ending March 31st, a tiny fraction of its service exports. India,
argues Craig Mundie of Microsoft, must go beyond renting out IQ and start creating IP.

Services are labour-intensive; products require a bit of capital. It thus makes sense that India started out by
specialising in the former. In the 1970s it had lots of well-trained engineers, bred for an industrial future that
somehow failed to materialise. Add a roomful of computers and a company could get to work. Indeed, in the
early days, even the computers were sometimes lacking. The so-called “body-shopping” model—
despatching Indian engineers to work on the site of an American or British client—first established itself
after IBM quit India in 1978. At that time, it was easier to export an Indian programmer to an American
computer than it was to import the machine to India.

But it is precisely the labour-intensity of services that must ultimately limit the industry's growth. To double
its revenues, a service company has more or less to double its headcount, says Kiran Karnik, head of
NASSCOM. That is expensive: wages of IT professionals are growing by 15% a year. TCS, for example,
now has over 100,000 employees, having added over 12,000 bodies in the most recent quarter. Will its
headcount need to swell to 200,000 before its revenues reach the $9 billion-$10 billion mark?
Eventually, argues Ravi Venkatesan of Microsoft India, the country's firms will need to embody their brain-
work in a patentable software product that, like an original poem, can be copied and sold, over and over
again. What is stopping them?

One clue is given by a small advert posted in the second-class carriage of a Mumbai commuter train. It
proclaims the virtues of Tradeannex, a four-in-one package created by a local software house, which offers
small-business owners help with sales, purchases, inventory and taxation. But as well as selling the product,
the advert also confesses the company's need for “distributors and channel partners”.

Revenue per headIndia Picture

Indian software firms often lack the wherewithal to push a product in the marketplace, and to survive the
marketplace's whims. Services yield predictable returns: it is like “an annuities business,” says Mr Karnik.
Products, on the other hand, require a heavy outlay up-front, which may never be recouped if the package
fails to find enough distributors, “channel partners” and customers. I-flex solutions, India's biggest software-
product success, survived its early years by running a services business on the side. Its vice-chairman, R.
Ravisankar, thinks other Indian firms lacked the “front-end spit and polish” that a successful brand requires.

To make a successful product, a company needs to be close to its customers. But Indians do not use much
software—they bought only $1.6 billion-worth last fiscal year—and when they use it, they do not pay for it.
Piracy rates are as high as 72%. One company, Tally, has succeeded by writing accounting programs for
small businesses in India and other emerging markets. It touts “the power of simplicity” and traces its
origins to the efforts of its founder and his son to computerise their own company's accounts in the 1980s.
You can buy the silver edition of Tally's ninth release for 11,232 rupees ($290). This compares well with
foreign packages that are “atrociously expensive” and “require two or three PhDs to run,” as Mr Karnik puts
it.

Meanwhile, the services firms themselves seem happy renting out IQ. Their aim is not just to add heads but
to earn more revenue per head. To do this, they will have to earn money from the right side of their brains as
well as the left. K. Ananth Krishnan, the chief technology officer for TCS, uses the analogy of an expensive
hairdresser, who might examine you for 15 minutes, then snip two locks of hair. He charges you not for how
much he cuts, but for what is left and how he has shaped it. Likewise, India's leading firms hope to move
away from charging clients on the basis of inputs—“time and materials”—or even outputs—pieces of code.
They want to charge customers on the basis of the gains their IT services can deliver, such as cutting their
billing costs.
Mr Karnik thinks it little exaggeration to say that companies are either born as product companies or as
service companies, not both. Scribes want to become better scribes. To become a poet, you probably need to
be born as one.

Learning to live with Big Brother

The second article in our series looks at the new technologies for
collecting personal information, and the dangers of abuse
Sep 27th 2007

IT USED to be easy to tell whether you were in a free country or a dictatorship. In an old-time police state,
the goons are everywhere, both in person and through a web of informers that penetrates every workplace,
community and family. They glean whatever they can about your political views, if you are careless enough
to express them in public, and your personal foibles. What they fail to pick up in the café or canteen, they
learn by reading your letters or tapping your phone. The knowledge thus amassed is then stored on millions
of yellowing pieces of paper, typed or handwritten; from an old-time dictator's viewpoint, exclusive access
to these files is at least as powerful an instrument of fear as any torture chamber. Only when a regime falls
will the files either be destroyed, or thrown open so people can see which of their friends was an informer.

That old-time data: East Germany's filesAP

These days, data about people's whereabouts, purchases, behaviour and personal lives are gathered, stored
and shared on a scale that no dictator of the old school ever thought possible. Most of the time, there is
nothing obviously malign about this. Governments say they need to gather data to ward off terrorism or
protect public health; corporations say they do it to deliver goods and services more efficiently. But the
ubiquity of electronic data-gathering and processing—and above all, its acceptance by the public—is still
astonishing, even compared with a decade ago. Nor is it confined to one region or political system.

In China, even as economic freedom burgeons, millions of city-dwellers are being issued with obligatory
high-tech “residency” cards. These hold details of their ethnicity, religion, educational background, police
record and even reproductive history—a refinement of the identity papers used by communist regimes.

Related items

• Terrorism and civil liberty: Is torture ever justified?Sep 20th 2007

• Civil liberties under threat: The real price of freedomSep 20th 2007
• Privacy: Information overlordJan 18th 2007
Britain used to pride itself on respecting privacy more than most other democracies do. But there is not
much objection among Britons as “talking” surveillance cameras, fitted with loudspeakers, are installed,
enabling human monitors to shout rebukes at anyone spotted dropping litter, relieving themselves against a
wall or engaging in other “anti-social” behaviour.

Even smarter technology than that—the sort that has been designed to fight 21st century wars—is being
used in the fight against crime, both petty and serious. In Britain, Italy and America, police are
experimenting with the use of miniature remote-controlled drone aircraft, fitted with video cameras and
infra-red night vision, to detect “suspicious” behaviour in crowds. Weighing no more than a bag of sugar
and so quiet that it cannot be heard (or seen) when more than 50 metres (150 feet) from the ground, the
battery-operated UAV (unmanned aerial vehicle) can be flown even when out of sight by virtue of the
images beamed back to a field operator equipped with special goggles. MW Power, the firm that distributes
the technology in Britain, has plans to add a “smart water” spray that would be squirted at suspects, infusing
their skin and clothes with genetic tags, enabling police to identify them later.

Most of the time, the convenience of electronic technology, and the perceived need to fight the bad guys,
seems to outweigh any worries about where it could lead. That is a recent development. On America's
religious right, it was common in the late 1990s to hear dark warnings about the routine use of electronic
barcodes in the retail trade: was this not reminiscent of the “mark of the beast” without which “no man
might buy or sell”, predicted in the final pages of the Bible? But today's technophobes, religious or
otherwise, are having to get used to devices that they find even spookier.

Take radio-frequency identification (RFID) microchips, long used to track goods and identify family pets;
increasingly they are being implanted in human beings. Such implants are used to help American carers
keep track of old people; to give employees access to high-security areas (in Mexico and Ohio); and even to
give willing night-club patrons the chance to jump entry queues and dispense with cash at the bar (in Spain
and the Netherlands). Some people want everyone to be implanted with RFIDs, as the answer to identity
theft.

Across the rich and not-so-rich world, electronic devices are already being used to keep tabs on ordinary
citizens as never before. Closed-circuit television cameras (CCTV) with infra-red night vision peer down at
citizens from street corners, and in banks, airports and shopping malls. Every time someone clicks on a web
page, makes a phone call, uses a credit card, or checks in with a microchipped pass at work, that person
leaves a data trail that can later be tracked. Every day, billions of bits of such personal data are stored, sifted,
analysed, cross-referenced with other information and, in many cases, used to build up profiles to predict
possible future behaviour. Sometimes this information is collected by governments; mostly it is gathered by
companies, though in many cases they are obliged to make it available to law-enforcement agencies and
other state bodies when asked.

Follow the data

The more data are collected and stored, the greater the potential for “data mining”—using mathematical
formulas to sift through large sets of data to discover patterns and predict future behaviour. If the public had
any strong concerns about the legitimacy of this process, many of them evaporated on September 11th 2001
—when it became widely accepted that against a deadly and globally networked enemy, every stratagem
was needed. Techniques for processing personal information, which might have raised eyebrows in the
world before 2001, suddenly seemed indispensable.

Two days after the attacks on New York and Washington, Frank Asher, a drug dealer turned technology
entrepreneur, decided to examine the data amassed on 450m people by his private data-service company,
Seisint, to see if he could identify possible terrorists. After giving each person a risk score based on name,
religion, travel history, reading preferences and so on, Mr Asher came up with a list of 1,200 “suspicious”
individuals, which he handed to the FBI. Unknown to him, five of the terrorist hijackers were on his list.
The FBI was impressed. Rebranded the Multistate Anti-Terrorism Information Exchange, or Matrix, Mr
Asher's programme, now taken over by the FBI, could soon access 20 billion pieces of information, all of
them churned and sorted and analysed to predict who might one day turn into a terrorist. A new version,
called the System to Assess Risk, or STAR, has just been launched using information drawn from both
private and public databases. As most of the data have already been disclosed to third parties—airline
tickets, job records, car rentals and the like—they are not covered by the American constitution's Fourth
Amendment, so no court warrant is required.

In an age of global terror, when governments are desperately trying to pre-empt future attacks, such profiling
has become a favourite tool. But although it can predict the behaviour of large groups, this technique is
“incredibly inaccurate” when it comes to individuals, says Simon Wessely, a professor of psychiatry at
King's College London. Bruce Schneier, an American security guru, agrees. Mining vast amounts of data for
well-established behaviour patterns, such as credit-card fraud, works very well, he says. But it is
“extraordinarily unreliable” when sniffing out terrorist plots, which are uncommon and rarely have a well-
defined profile.

By way of example, Mr Schneier points to the Automated Targeting System, operated by the American
Customs and Border Protection, which assigns a terrorist risk-assessment score to anyone entering or
leaving the United States. In 2005 some 431m people were processed. Assuming an unrealistically accurate
model able to identify terrorists (and innocent people) with 99.9% accuracy, that means some 431,000 false
alarms annually, all of which presumably need checking. Given the unreliability of passenger data, the real
number is likely to be far higher, he says.

Those caught up in terrorist-profiling systems are not allowed to know their scores or challenge the data. Yet
their profiles, which may be shared with federal, state and even foreign governments, could damage their
chances of getting a state job, a student grant, a public contract or a visa. It could even prevent them from
ever being able to fly again. Such mistakes are rife, as the unmistakable Senator “Ted” Kennedy found to his
cost. In the space of a single month in 2004, he was prevented five times from getting on a flight because the
name “T Kennedy” had been used by a suspected terrorist on a secret “no-fly” list.

Watching everybody

Another worry: whereas information on people used to be gathered selectively—following a suspect's car,
for example—it is now gathered indiscriminately. The best example of such universal surveillance is the
spread of CCTV cameras. With an estimated 5m CCTV cameras in public places, nearly one for every ten
inhabitants, England and Wales are among the most closely scrutinised countries in the world—along with
America which has an estimated 30m surveillance cameras, again one for every ten inhabitants. Every
Briton can expect to be caught on camera on average some 300 times a day. Few seem to mind, despite
research suggesting that CCTV does little to deter overall crime.

In any case, says Britain's “NO2ID” movement, a lobby group that is resisting government plans to
introduce identity cards, cameras are a less important issue than the emergence of a “database state” in
which the personal records of every citizen are encoded and too easily accessible.

Alongside fingerprints, DNA has also become an increasingly popular tool to help detect terrorists and solve
crime. Here again Britain (minus Scotland) is a world leader, with the DNA samples of 4.1m individuals,
representing 7% of the population, on its national database, set up in 1995. (Most other EU countries have
no more than 100,000 profiles on their DNA databases.) The British database includes samples from one in
three black males and nearly 900,000 juveniles between ten and 17—all tagged for life as possible criminals,
since inclusion in the database indicates that someone has had a run-in with the law. This is because in
Britain, DNA is taken from anyone arrested for a “recordable” offence—usually one carrying a custodial
sentence, but including such peccadillos as begging or being drunk and disorderly. It is then stored for life,
even if that person is never charged or is later acquitted. No other democracy does this.
In America, the federal DNA databank holds 4.6m profiles, representing 1.5% of the population. But nearly
all are from convicted criminals. Since January 2006 the FBI has been permitted to take DNA samples on
arrest, but these can be expunged, at the suspect's request, if no charges are brought or if he is later
acquitted. Of some 40 states that have their own DNA databases, only California allows the permanent
storage of samples of those charged, but later cleared. In Britain, where people cannot ask for samples to be
removed from the database, it was recently proposed that the best way to prevent discrimination is therefore
to include the whole population in the DNA database, plus all visitors to the country. Although this approach
is commendably fair, it would be extremely expensive as well as an administrative nightmare.

In popular culture, the use of DNA has become rather glamorous. Tabloids and television dramas tell stories
of DNA being used by police to find kidnappers or exonerate convicts on death row. According to a poll
carried out for a BBC “Panorama” programme this week, two-thirds of Britons would favour a new law
requiring that everyone's DNA be stored. But DNA is less reliable as a crime-detection tool than most
people think. Although it almost never provides a false “negative” reading, it can produce false “positives”.
Professor Allan Jamieson, director of the Forensic Institute in Glasgow, believes too much faith is placed in
it. As he points out, a person can transfer DNA to a place, or weapon, that he (or she) has never seen or
touched.

Wiretapping is too easy

More disturbing for most Americans are the greatly expanded powers the government has given itself over
the past six years to spy on its citizens. Under the Patriot Act, rushed through after the 2001 attacks, the
intelligence services and the FBI can now oblige third parties—internet providers, libraries, phone
companies, political parties and the like—to hand over an individual's personal data, without a court warrant
or that person's knowledge, if they claim that the information is needed for “an authorised investigation” in
connection with international terrorism. (Earlier this month, a federal court in New York held this to be
unconstitutional.)

Under the Patriot Act's “sneak and peek” provisions, a person's house or office can likewise now be
searched without his knowledge or a prior court warrant. The act also expanded the administration's ability
to intercept private e-mails and phone calls, though for this a court warrant was supposedly still needed. But
in his capacity as wartime commander-in-chief, George Bush decided to ignore this requirement and set up
his own secret “warrantless” eavesdropping programme.

The outcry when this was revealed was deafening, and the programme was dropped. But in August Mr Bush
signed into law an amendment to the 1978 Foreign Intelligence Surveillance Act, allowing the warrantless
intercept of phone calls and e-mails if at least one of the parties is “reasonably believed” to be outside
America. So ordinary Americans will continue to be spied on without the need for warrants—but no one is
protesting, because now it is legal.

Where's your warrant?

According to defenders of warrantless interception, requiring warrants for all government surveillance
would dramatically limit the stream of foreign intelligence available. Privacy should not be elevated above
all other concerns, they argue. But would it really impede law-enforcement that much if a judge was
required to issue a warrant on each occasion? Technology makes wiretapping much easier than it used to be
—too easy, perhaps—so requiring warrants would help to restore the balance, say privacy advocates.

Britain has long permitted the “warrantless” eavesdropping of its citizens (only the home secretary's
authorisation is required), and few people appear to mind. What does seem to worry people is the sheer
volume of information now being kept on them and the degree to which it is being made accessible to an
ever wider group of individuals and agencies. The government is now developing the world's first national
children's database for every child under 18. The National Health Service database, already the biggest of its
kind in Europe, will eventually hold the medical records of all 53m people in England and Wales.

Even more controversial is Britain's National Identity Register, due to hold up to 49 different items on
everyone living in the country. From 2009, everybody is to be issued with a “smart” biometric ID card,
linked to the national register, which will be required for access to public services such as doctors' surgeries,
unemployment offices, libraries and the like—leaving a new, readily traceable, electronic data-trail. America
plans a similar system, with a string of personal data held on a new “smart” national driver's licence that
would double up as an ID.

Companies are also amassing huge amounts of data about people. Most people do not think about what
information they are handing over when they use their credit or shop “loyalty” card, buy something online or
sign up for a loan. Nor do they usually have much idea of the use to which such data are subsequently put.
Not only do companies “mine” them to target their advertising more effectively, for example, but also to
give their more valued (ie, higher-spending) customers better service. They may also “share” their data with
the police—without the individual's consent or knowledge.

Most democratic countries now have comprehensive data-protection and/or privacy laws, laying down strict
rules for the collection, storage and use of personal data. There is also often a national information or
privacy commissioner to police it all (though not in America). Intelligence agencies, and law-enforcement
authorities often as well, are usually exempt from such data-protection laws whenever national security is
involved. But such laws generally stipulate that the data be used only for a specific purpose, held no longer
than necessary, kept accurate and up-to-date and protected from unauthorised prying.

That all sounds great. But as a series of leaks in the past few years has shown, no data are ever really secure.
Laptops containing sensitive data are stolen from cars, backup tapes go missing in transit and hackers can
break into databases, even the Pentagon's. Then there are “insider attacks”, in which people abuse the access
they enjoy through their jobs. National Health Service workers in Britain were recently reported to have
peeked at the intimate medical details of an unnamed celebrity. All of this can lead to invasions of privacy
and identity theft. As the Surveillance Studies Network concludes in its recent report on the “surveillance
society”, drawn up for Britain's information commissioner, Richard Thomas, “The jury is out on whether
privacy regulation...is not ineffective in the face of novel threats.”

Boiling the frog

If the erosion of individual privacy began long before 2001, it has accelerated enormously since. And by no
means always to bad effect: suicide-bombers, by their very nature, may not be deterred by a CCTV camera
(even a talking one), but security wonks say many terrorist plots have been foiled, and lives saved, through
increased eavesdropping, computer profiling and “sneak and peek” searches. But at what cost to civil
liberties?

Privacy is a modern “right”. It is not even mentioned in the 18th-century revolutionaries' list of demands.
Indeed, it was not explicitly enshrined in international human-rights laws and treaties until after the second
world war. Few people outside the civil-liberties community seem to be really worried about its loss now.

That may be because electronic surveillance has not yet had a big impact on most people's lives, other than
(usually) making it easier to deal with officialdom. But with the collection and centralisation of such vast
amounts of data, the potential for abuse is huge and the safeguards paltry.

Ross Anderson, a professor at Cambridge University in Britain, has compared the present situation to a
“boiled frog”—which fails to jump out of the saucepan as the water gradually heats. If liberty is eroded
slowly, people will get used to it. He added a caveat: it was possible the invasion of privacy would reach a
critical mass and prompt a revolt.
If there is not much sign of that in Western democracies, this may be because most people rightly or
wrongly trust their own authorities to fight the good fight against terrorism, and avoid abusing the data they
possess. The prospect is much scarier in countries like Russia and China, which have embraced capitalist
technology and the information revolution without entirely exorcising the ethos of an authoritarian state
where dissent, however peaceful, is closely monitored.

On the face of things, the information age renders impossible an old-fashioned, file-collecting dictatorship,
based on a state monopoly of communications. But imagine what sort of state may emerge as the best brains
of a secret police force—a force whose house culture treats all dissent as dangerous—perfect the art of
gathering and using information on massive computer banks, not yellowing paper.

The geography of recession

Dec 23rd 2009, 14:47 by The Economist | WASHINGTON

THE Census Bureau has released its latest state population estimates, covering 2009, and the effects of
recession are clear. Internal migration has plummeted; only 340,000 Americans changed states between
2008 and 2009, down from 612,000 from 2004 to 2005. This is a bit of a departure from historical trend.
Typically, migration is countercyclical—people move more when economic hardship hits. From 2000 to
2001, for instance, the number of domestic migrants in the country increased fourfold.

But this time around, many households are constrained by trouble in housing markets. One in four
households with mortgages owe more to the bank than their house is worth. That makes relocation difficult
to impossible, and the resulting decline in mobility suggests that labour market recovery will take longer
than is normally the case.

But Americans aren't entirely immobile, and the patterns of movement are revealing. There are big trend
breaks in migration for bubble hotspots like Nevada, Arizona, and Florida. In 2006, 141,000 Americans
moved to Florida. In 2009, over 31,000 moved out. Nevada also saw a shift from massive inflow of
domestic migrants to outflow, while Arizona saw its rate of inmigration slow to a trickle.

Other areas—primarily those with the lowest unemployment rates—experienced a relative boom. There
were positive trend changes in the Washington, DC area, in Massachusetts, and in Texas and Oklahoma,
three of the strongest labour markets amid recession. Interestingly, these population shifts are likely to be
self-reinforcing, as inmigration supports local housing markets and businesses, thereby widening the gap
between the recovering areas and the laggards.

There were some surprises in the data, as well. In particular, California. The state continued to suffer a net
loss of domestic migrants in 2009, but it was the smallest loss since 2001, and it was down steeply from the
outflow of 313,000 Californians in 2006. All told, California enjoyed an increase in population of nearly
400,000 people, up from the prior year and the highest total since 2002.

One obvious factor slowing population outflow from California is the extent of the bubble collapse in the
state. Many of those who would like to leave the state, and particularly the inland metropolitan areas where
unemployment rates are above 15%, cannot sell their homes.

But it's not impossible to imagine that the housing bust has helped the Golden State in some ways.
Outmigration peaked mid-decade as home prices soared beyond the reach of many middle-class households.
The steep decline in home prices suddenly makes California, with its many natural amenities, an attractive
bargain. And many of those who left California earlier in the decade decamped to Nevada and Arizona,
where conditions are currently as bad as or worse than the economic situation in California (and without the
scenic coastline and nice weather).

As housing markets and labour markets will continue to show the effects of the bubble collapse and
recession for years to come, it's unlikely that the population shifts underway have run their course. One thing
seems clear, despite the general stuck-ness of many American households—the country is going to look a lot
different after the recession than it did before.

Distrust, in all around

As America prepares for a possible attack on Saddam Hussein’s

Iraq, Muhammad Khatami, the reformist president of
neighbouring Iran, faces inescapable quandaries. Iran stands to
benefit from the ousting of Mr Hussein, but any co-operation with
America may be thwarted by Mr Khatami’s conservative opponents
Aug 15th 2002

Karzai makes friends with KhatamiAFP

IN RETURN for staying neutral in the 1991 Gulf war, Iran persuaded Saddam Hussein to surrender some
disputed territory and to start releasing the Iranian prisoners he had been holding since the two countries
fought in the 1980s. More than a decade on, Iran’s leaders are hoping to exploit Mr Hussein’s renewed
vulnerability. But neutrality may now be harder to maintain. Much as they hate the idea of American troops
on their western border, helping George Bush in Iraq could be a last chance for the clerical regime to stay
off the president’s list of condemned countries.

Ayatollah Baqer al-Hakim, a Tehran-based Iraqi dissident with followers among Iraq’s Shia majority, is
deeply involved in the Iranian-Iraqi-American imbroglio. America now wants Mr Hakim’s co-operation in
generating a popular uprising in Iraq, but he and his small army need Iran’s permission to do so.

The Americans are anxious to avoid a repeat of the fiasco after Mr Hussein’s defeat in 1991: an American-
incited rebellion among Iraqi Shias came to a tragically bloody end when Mr Hakim’s men (and members of
Iran’s Revolutionary Guard) crossed the border, and an alarmed America withdrew its support for the
venture. When Mr Hakim’s brother returns later this week from talks with American officials and other Iraqi
opposition leaders, he will no doubt tell the Iranians what America now expects of them.

Related items

• Iraq and America: The case for warAug 1st 2002

• Iran in turmoilJul 23rd 2002
• A survey of America's world role: Building countries, feeling generousJun 27th 2002
• Ever more perilous isolationMay 27th 2002
• Iran and America: Stop-start-stop talksMay 2nd 2002
• Toppling SaddamMar 11th 2002
• Alienating IranFeb 13th 2002

Ever since Mr Bush included Iran in his “axis of evil”, America’s pronouncements have been menacing, but
vague. Earlier this month, Zalmay Khalilzad, one of Mr Bush’s senior foreign-policy advisers, made it clear
that America had despaired of Iran’s “ineffective” reformist president, Muhammad Khatami. He did not,
however, as some senators and congressmen would have liked, call for a new regime in Iran. What is more,
Mr Khalilzad said that America was open to discussions with Iran, notably on creating an Iraq that was no
longer a threat to its neighbours.

But Mr Khatami’s distrust of Mr Bush has risen since the Americans, far from thanking the Iranian
government for its help in unseating the Taliban in Afghanistan, have been accusing the president’s
conservative opponents of helping al-Qaeda fighters to safety. On Tuesday, Donald Rumsfeld, the defence
secretary, reacted to the “news” that Iran had handed over 16 suspected al-Qaeda fighters to Saudi Arabia by
insisting that many more were still in Iran.

The Iranians responded by saying that they have over time arrested some 150 al-Qaeda suspects, nearly all
of whom have already been handed over to various countries. The 16 Saudis were in fact repatriated in May.
Hamid Karzai, the Afghan president, managed to sound equally friendly to Iran and to America, when Mr
Khatami visited him in Kabul this week.

Iran’s government looks for rewards in a post-Hussein regime, such as the liquidation of the Iraq-based
People’s Mujahedeen, which has spent the past two decades threatening Iran with bombs and bullets. But its
ability to influence events in Iraq is hampered, not least by Arab countries' fear of the effects that Iran-
sponsored Shia chauvinism might have on their own Shia minorities. And some influential conservative
thinkers, like Amir Mohebbian, expect America to continue to threaten Iran in the hope that its internal
fissures become irreparable. Despaired of by Mr Bush, Mr Khatami is in a quandary. Even if he co-operates
with America, his conservative opponents could repeat the spoiling tactics they are said to have employed in
Afghanistan.

For the moment, the Iranians are concentrating on short-term gains. Mr Hussein, fighting for his life, has
quietly accelerated the repatriation of his remaining Iranian prisoners of war: fewer than 1,000 are thought to
be still in Iraqi hands. Iraq is also keeping the Mujahedeen quiet. In return, Iran will continue to turn a blind
eye to the cross-border smuggling that keeps Iraqis supplied with food and other goods.

But Iran’s co-operation has limits. At a recent meeting with Mr Hussein’s elder son, Iranian military
officials are said to have refused to hand over the 100 or so war planes that Iraq misguidedly entrusted to
Iran during the Gulf war.