China’s big fiscal package may be starting to work

“ONLY when all contribute their firewood can they build up a strong fire,” says a Chinese proverb. With the world economy in its worst crisis in 70 years, every country needs to do its bit to rekindle global demand. The American government, which plans to run a budget deficit of 12% of GDP this year, has called on its Group of 20 partners to do more. Is China one of the misers? Its budget, published last week, showed that it plans to run a deficit of only 3% of GDP. Was the 4 trillion yuan ($586 billion) infrastructure package unveiled last November, worth 14% of GDP, a sham?

Beijing’s stimulus is smaller than the number announced last year, but it is still the biggest in the world. The fact that America is set to run a budget deficit four times the size of China’s as a share of GDP does not mean its demand stimulus is bigger; America started this year with a much bigger deficit. America’s deficit will increase by more than China’s this year, largely because it is suffering a deeper recession which will depress tax revenue. The correct measure of a fiscal stimulus is the change in the budget deficit adjusted for the impact of the economic cycle.

In China, however, even this would understate the true stimulus, because some public-infrastructure investment will be done by state-owned firms or local governments and financed by banks. Tao Wang of UBS estimates that new infrastructure investment, tax cuts, consumer subsidies and increased spending on health care will amount to a stimulus by the central government of about 3% of GDP in 2009. Adding in bank-financed infrastructure spending might lift the total to 4% of GDP.

Chinese investment in railways, roads and power grids is already booming. In the first two months of this year, total fixed investment was 30% higher in real terms than a year earlier, and investment in railways tripled. China has been much criticised for focusing its stimulus on investment, rather than consumption, but in China in the short term this is the quickest way to boost domestic demand.

What about the other tool for boosting domestic spending, namely monetary policy? Since the start of last year, China has cut its interest rates by only half as much as America’s Federal Reserve has. New figures showing that consumer prices fell by 1.6% in the year to February have brought the first whiff of deflation, suggesting that China has not done enough to boost demand. But this is not true deflation, where falling prices are accompanied by shrinking money supply and credit. Bank lending grew by 24% over the past year. The true gauge of monetary easing is not the cut in interest rates, but whether it succeeds in spurring new lending. China is one of the few countries in the world where credit has accelerated since the start of the global credit crunch—though some of the lending is of the state-directed sort.

China has not only accomplished considerable fiscal and monetary easing. By allowing the yuan to rise by 18% in trade-weighted terms over the past 12 months, Beijing is passing on some of that boost to the rest of the world.

The real question is whether China’s stimulus is big enough? Exports fell by a sharper-than-expected 26% in the year to February and may yet drop further. The 12-month rate of growth in industrial production also dropped to only 3.8% in the first two months of 2009, and retail-sales growth slowed to 15%. But there are some tentative signs of a recovery in domestic demand. As well as the increases in investment and bank lending, car sales and electricity consumption have picked up. Mingchun Sun of Nomura reckons that the stimulus will be enough to achieve 8% growth this year. But the government has made it clear that if the economy remains feeble, it will supply another fiscal boost.

Such injections may be able to drag growth back to 8% this year, but they cannot keep the economy running at this pace if global demand remains depressed. The need for China to shift the mix of growth from exports to consumption has become more urgent. Chinese officials are right to say that it will take years for higher public spending on health care and a social safety net to reduce household saving—all the more reason to speed up such policies. If not, even China’s fire could burn out.

Source: The Economist ( Mar 14- 20)

                                 

A spat looms over reforming bank capital-adequacy rules

SOMETIMES the only thing people can agree on is a mediocre idea. Ahead of the G20 meeting, some regulators are pushing to introduce dynamic provisioning for banks. Under this system, in boom years banks make provisions against profits which then sit on their balance-sheets as reserves against unspecified potential losses. In the bad years they draw down on these reserves. This smooths banks’ profits over the cycle, making their capital positions “counter-cyclical”. Supporters point to Spain, which uses this approach and whose lenders are in relatively good nick.

Banks should be encouraged to save more for a rainy day. But the importance of Spain’s system has been oversold. Going into the credit crisis, its two big banks had an extra buffer equivalent to about 1.5% of risk-weighted assets. Banks like UBS or Citigroup have had write-offs far beyond this, equivalent to 8-15% of risk-weighted assets. Whether dynamic provisions influenced managers’ behaviour is also questionable. Spain’s BBVA was run using an economic-capital model that, according to its 2007 annual report, explicitly replaced the generic provision in its income statement with its “best estimate of the real risk incurred”.

Accounting standard-setters, meanwhile, are not amused. They support the objective of counter-cyclical capital rules but think dynamic provisioning is a bad way to achieve this. Why not simply require banks to run with higher capital ratios, rather than go through a circuitous route by smoothing profits, which investors tend to dislike? Accountants worry their standards are being fiddled with needlessly, after a decades-long fight to have them independently set to provide accurate data to investors.

Is there a solution? If anything, the crisis shows that accounting and supervision should be further separated to break the mechanistic link between mark-to-market losses and capital. Investors should get the information they want. Supervisors should make a judgment about the likelihood of losses and set the required capital level accordingly. Warren Buffett, an astute investor, has endorsed this approach.

Sadly, bank supervision is as dysfunctional as the banks. The Basel 2 accords took five years to negotiate. Local regulators interpreted them differently and many failed to enforce them. Confidence in their integrity is now so low that many investors and some banks and regulators have abandoned Basel as their main test of capital. Given this mess, it is easy to see why policymakers might view tweaking accounting standards as an attractive short cut: with some arm-twisting, the rules can be changed quickly and are legally enforceable. But this is a matter where short cuts are not good enough.

Source: The Economist ( Mar14- 20 )

                                 

In a guest article, Dani Rodrik argues for stronger national regulation, not the global sort

THE clarion call for a global system of financial regulation can be heard everywhere. From Angela Merkel to Gordon Brown, from Jean-Claude Trichet to Ben Bernanke, from sober economists to countless newspaper editorials; everyone, it seems, is asking for it regardless of political complexion.

That is not surprising, perhaps, in light of the convulsions the world economy is going through. If we have learnt anything from the crisis it is that financial regulation and supervision need to be tightened and their scope broadened. It seems only a small step to the idea that we need much stronger global regulation as well: a global college of regulators, say; a binding code of international conduct; or even an international financial regulator.

Yet the logic of global financial regulation is flawed. The world economy will be far more stable and prosperous with a thin veneer of international co-operation superimposed on strong national regulations than with attempts to construct a bold global regulatory and supervisory framework. The risk we run is that pursuing an ambitious goal will detract us from something that is more desirable and more easily attained.

One problem with the global strategy is that it presumes we can get leading countries to surrender significant sovereignty to international agencies. It is hard to imagine that America’s Congress would ever sign off on the kind of intrusive international oversight of domestic lending practices that might have prevented the subprime-mortgage meltdown, let alone avert future crises. Nor is it likely that the IMF will be allowed to turn itself into a true global lender of last resort. The far more likely outcome is that the mismatch between the reach of markets and the scope of governance will prevail, leaving global finance as unsafe as ever. That certainly was the outcome the last time we tried an international college of regulators, in the ill-fated case of the Bank of Credit and Commerce International.

A second problem is that even if the leading nations were to agree, they might end up converging on the wrong set of regulations. This is not just a hypothetical possibility. The Basel process, viewed until recently as the apogee of international financial co-operation, has been compromised by the inadequacies of the bank-capital agreements it has produced. Basel 1 ended up encouraging risky short-term borrowing, whereas Basel 2’s reliance on credit ratings and banks’ own models to generate risk weights for capital requirements is clearly inappropriate in light of recent experience. By neglecting the macro-prudential aspect of regulation—the possibility that individual banks may appear sound while the system as a whole is unsafe—these agreements have, if anything, magnified systemic risks. Given the risk of converging on the wrong solutions yet again, it would be better to let a variety of regulatory models flourish.

Who says one size fits all?

But the most fundamental objection to global regulation lies elsewhere. Desirable forms of financial regulation differ across countries depending on their preferences and levels of development. Financial regulation entails trade-offs along many dimensions. The more you value financial stability, the more you have to sacrifice financial innovation. The more fine-tuned and complex the regulation, the more you need skilled regulators to implement it. The more widespread the financial-market failures, the larger the potential role of directed credit and state banks.

Different nations will want to sit on different points along their “efficient frontiers”. There is nothing wrong with France, say, wanting to purchase more financial stability than America—and having tighter regulations—at the price of giving up some financial innovations. Nor with Brazil giving its state-owned development bank special regulatory treatment, if the country wishes, so that it can fill in for missing long-term credit markets.

In short, global financial regulation is neither feasible, nor prudent, nor desirable. What finance needs instead are some sensible traffic rules that will allow nations (and in some cases regions) to implement their own regulations while preventing adverse spillovers. If you want an analogy, think of a General Agreement on Tariffs and Trade for world finance rather than a World Trade Organisation. The genius of the GATT regime was that it left room for governments to craft their own social and economic policies as long as they did not follow blatantly protectionist policies and did not discriminate among their trade partners.

Fortify the home front first

Similarly, a new financial order can be constructed on the back of a minimal set of international guidelines. The new arrangements would certainly involve an improved IMF with better representation and increased resources. It might also require an international financial charter with limited aims, focused on financial transparency, consultation among national regulators, and limits on jurisdictions (such as offshore centres) that export financial instability. But the responsibility for regulating leverage, setting capital standards, and supervising financial markets would rest squarely at the national level. Domestic regulators and supervisors would no longer hide behind international codes. Just as an exporter of widgets has to abide by product-safety standards in all its markets, global financial firms would have to comply with regulatory requirements that may differ across host countries.

The main challenge facing such a regime would be the incentive for regulatory arbitrage. So the rules would recognise governments’ right to intervene in cross-border financial transactions—but only in so far as the intent is to prevent competition from less-strict jurisdictions from undermining domestic regulations.

Of course, like-minded countries that want to go into deeper financial integration and harmonise their regulations would be free to do so, provided (as in the GATT) they do not use this as an excuse for financial protectionism. One can imagine the euro zone eventually taking this route and opting for a common regulator. The Chiang Mai initiative in Asia may ultimately also produce a regional zone of deep integration around an Asian monetary fund. But the rest of the world would have to live with a certain amount of financial segmentation—the necessary counterpart to regulatory fragmentation.

If this leaves you worried, turn again to the Bretton Woods experience. Despite limited liberalisation, that system produced huge increases in cross-border trade and investment. The reason is simple and remains relevant as ever: an architecture that respects national diversity does more to advance the cause of globalisation than ambitious plans that assume it away.

Source: The Economist ( Mar14- 20 )

                                 

The world economy faces the biggest rise in unemployment in decades. How governments react will shape labour markets for years to come

LAST month America’s unemployment rate climbed to 8.1%, the highest in a quarter of a century. For those newly out of a job, the chances of finding another soon are the worst since records began 50 years ago. In China 20m migrant workers (maybe 3% of the labour force) have been laid off. Cambodia’s textile industry, its main source of exports, has cut one worker in ten. In Spain the building bust has pushed the jobless rate up by two-thirds in a year, to 14.8% in January. And in Japan, where official unemployment used to be all but unknown, tens of thousands of people on temporary contracts are losing not just their jobs but also the housing provided by their employers.

The next phase of the world’s economic downturn is taking shape: a global jobs crisis. Its contours are only just becoming clear, but the severity, breadth and likely length of the recession, together with changes in the structure of labour markets in both rich and emerging economies, suggest the world is about to undergo its biggest increase in unemployment for decades.

In the last three months of 2008 America’s GDP slumped at an annualised rate of 6.2%. This quarter may not be much better. Output has shrunk even faster in countries dependent on exports (such as Germany, Japan and several emerging Asian economies) or foreign finance (notably central and eastern Europe). The IMF said this week that global output will probably fall for the first time since the second world war. The World Bank expects the fastest contraction of trade since the Depression.

An economic collapse on this scale is bound to hit jobs hard. In its latest quarterly survey Manpower, an employment-services firm, finds that in 23 of the 33 countries it covers, companies’ hiring intentions are the weakest on record (see chart 1). Because changes in unemployment lag behind those in output, jobless rates would rise further even if economies stopped contracting today. But there is little hope of that. And several features of this recession look especially harmful.

The credit crunch has exacerbated the impact of falling demand, pressing cash-strapped firms to cut costs more quickly. The asset bust and unwinding of debt that lie behind the recession mean that eventual recovery is likely to be too weak to create jobs rapidly. And when demand does revive, the composition of jobs will change. In a post-bubble world indebted consumers will save more and surplus economies, from China to Germany, will have to rely more on domestic spending. The booming industries of recent years, from construction to finance, will not bounce back. Millions of people, from Wall Street bankers to Chinese migrants, will need to find wholly different lines of work.

For now the damage is most obvious in America, where the recession began earlier than elsewhere (in December 2007, according to the National Bureau of Economic Research) and where the ease of hiring and firing means changes in the demand for workers show up quickly in employment rolls. The economy began to lose jobs in January 2008. At first the decline was fairly modest and largely confined to construction (thanks to the housing bust) and manufacturing (where employment has long been in decline). But since September it has accelerated and broadened. Of the 4.4m jobs lost since the recession began, 3.3m have gone in the past six months. Virtually every sector has been hit hard. Only education, government and health care added workers last month.

So far, the pattern of job losses in this recession resembles that of the early post-war downturns (starting in 1948, 1953 and 1957). Those recessions brought huge, but temporary, swings in employment, in an economy far more reliant on manufacturing than today’s. As a share of the workforce, more jobs have been lost in this recession than in any since 1957. The pace at which people are losing their jobs, measured by the share of the workforce filing for weekly jobless claims, is much quicker than in the downturns of 1990 and 2001 (see chart 2).

The worry, however, is that the hangover from excess debt and the housing bust will mean a slow revival—looking more like the jobless recoveries after the past two downturns than like the vigorous V-shaped rebounds from the early post-war recessions. Ominous signs are a sharp increase in permanent-job losses and a rise in the number of people out of work for six months or more to 1.9% of the labour force, near a post-war high.

Official forecasts can barely keep up. In its budget in February the Obama administration expected a jobless rate of 8.1% for the year. That figure was reached within the month. Many Wall Street seers think the rate will exceed 10% by 2010 and may surpass the post-1945 peak of 10.8%. Past banking crises indicate an even gloomier prognosis. A study by Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard University suggests that the unemployment rate rose by an average of seven percentage points after other big post-war banking busts. That implies a rate for America of around 12%.

Moreover, the official jobless rate understates the amount of slack by more than in previous downturns. Many companies are cutting hours to reduce costs. At 33.3 hours, the average working week is the shortest since at least 1964. Unpaid leave is becoming more common, and not only at the cyclical manufacturing firms where it is established practice. A recent survey by Watson Wyatt, a firm of consultants, finds that almost one employer in ten intends to shorten the work week in coming months. Compulsory unpaid leave is planned by 6% of firms. Another 9% will have voluntary leave.

Europe’s jobs markets look less dire, for now. That is partly because the recession began later there, partly because joblessness had been unusually low by European standards and partly because Europe’s less flexible labour markets react more slowly than America’s. The euro area’s unemployment rate was 8.2% in January, up from 7.2% a year before. That of the whole European Union was 7.6%, up from 6.8%. For the first time in years American and European jobless rates are roughly in line (see chart 3).

Within the EU there are big variations. Ireland and Spain, where construction boomed and then subsided most dramatically, have already seen heavy job losses. Almost 30% of Ireland’s job growth in the first half of this decade came from the building trade. Its unemployment rate has almost doubled in the past year. In Britain, another post-property-bubble economy, the rate is also rising markedly. At the end of last year 6.3% of workers were jobless, up from 5.2% the year before. Figures due on March 18th are likely to show unemployment above 2m for the first time in more than a decade.

In continental Europe’s biggest economies, the consequences for jobs of shrivelling output are only just becoming visible. Although output in Germany fell at an annualised rate of 7% in the last quarter of 2008, unemployment has been only inching up. The rate is still lower than it was a year ago. Even so, no one doubts the direction in which joblessness is heading. In January the European Commission forecast the EU’s jobless rate to rise to 9.5% in 2010. As in America, many private-sector economists expect 10% or more.

Structural changes in Europe’s labour markets suggest that jobs will go faster than in previous downturns. Temporary contracts have proliferated in many countries, as a way around the expense and difficulty of firing permanent workers. Much of the reduction in European unemployment earlier this decade was due to the rapid growth of these contracts. Now the process is going into reverse. In Spain, Europe’s most extreme example of a “dual” labour market, all the job loss of the past year has been borne by temps. In France employment on temporary contracts has fallen by a fifth. Permanent jobs have so far been barely touched.

Although the profusion of temporary contracts has brought greater flexibility, it has laid the burden of adjustment disproportionately on the low-skilled, the young and immigrants. The rising share of immigrants in Europe’s workforce also makes the likely path of unemployment less certain. As Samuel Bentolila, an economist at CEMFI, a Spanish graduate school, points out, the jump in Spain’s jobless rate is not due to fewer jobs alone. Thanks to continued immigration, the labour force is still growing apace. In Britain, in contrast, hundreds of thousands of migrant Polish workers are reckoned to have gone home.

Despite having few immigrants, Japan is also showing the strains of a dual labour market. Indeed, its workforce is more starkly divided than that of any other industrial country. “Regular” workers enjoy strong protection; the floating army of temporary, contract and part-time staff have almost none. Since the 1990s, the “lost decade”, firms have relied increasingly on these irregulars, who now account for one-third of all workers, up from 20% in 1990.

As Japanese industry has collapsed, almost all the jobs shed have been theirs. Most are ineligible for unemployment assistance. A labour-ministry official estimates that a third of the 160,000 who have lost work in recent months have lost their homes as well, sometimes with only a few days’ notice. Earlier this year several hundred homeless temporary workers set up a tent village in Hibiya Park in central Tokyo, across from the labour ministry and a few blocks from the Imperial Palace. Worse lies ahead. Overall unemployment, now 4.1%, is widely expected to surpass the post-war peak of 5.8% within the year. In Japan too, some economists talk of double digits.

In emerging economies the scale of the problem is much harder to gauge. Anecdotal evidence abounds of falling employment, particularly in construction, mining and export-oriented manufacturing. But official figures on both job losses and unemployment rates are squishier. Estimates from the International Labour Organisation suggest the number of people unemployed in emerging economies rose by 8m in 2008 to 158m, an overall jobless rate of around 5.9%. In a recent report the ILO projected several scenarios for 2009. Its gloomiest suggested there could be an additional 32m jobless in the emerging world this year. That estimate now seems all too plausible. Millions will return from formal employment to the informal sector and from cities to rural areas. According to the World Bank, another 53m people will be pushed into extreme poverty in 2009.

History implies that high unemployment is not just an economic problem but also a political tinderbox. Weak labour markets risk fanning xenophobia, particularly in Europe, where this is the first downturn since immigration soared. China’s leadership is terrified by the prospect of social unrest from rising joblessness, particularly among the urban elite.

Given these dangers, politicians will not sit still as jobs disappear. Their most important defence is to boost demand. All the main rich economies and most big emerging ones have announced fiscal stimulus packages.

Since most emerging economies lack broad unemployment insurance, the main way they help the jobless is through labour-intensive government infrastructure projects as well as conditional cash transfers for the poorest. China’s fiscal boost includes plenty of money for infrastructure; India is accelerating projects worth 0.7% of GDP. However, a few emerging economies have more creative unemployment-insurance schemes than anything in the rich world. In Chile and Colombia formal-sector workers pay into individual unemployment accounts, on which they can draw if they lose their jobs. Many more countries have created prefunded pension systems based on individual accounts. Robert Holzmann of the World Bank thinks people should be allowed to borrow from such accounts while unemployed. Several countries are considering the idea.

In developed countries, governments’ past responses to high unemployment have had lasting and sometimes harmful effects. When joblessness rose after the 1970s oil shocks, Europe’s governments, pressed by strong trade unions, kept labour markets rigid and tried to cut dole queues by encouraging early retirement. Coupled with generous welfare benefits this resulted in decades of high “structural” unemployment and a huge rise in the share of people without work. In America, where the social safety net was flimsier, there were far fewer regulatory rigidities and people were more willing to move, so workers responded more flexibly to structural shifts. Less than six years after hitting 10.8%, the post-war record, in 1982, America’s jobless rate was close to 5%.

Policy in America still leans towards keeping benefits low and markets flexible rather than easing the pain of unemployment. Benefits for the jobless are, if anything, skimpier than in the 1970s. Unemployment insurance is funded jointly by states and the federal government. The states set the eligibility criteria and in many cases have not kept up with changes in the composition of the workforce. In 32 states, for instance, part-time workers are ineligible for benefits. All told, fewer than half of America’s unemployed receive assistance. The benefits they get also vary a lot from state to state, but overall are among the lowest in the OECD when compared with the average wage.

America’s recent stimulus package strengthened this safety net. Jobless benefits have increased modestly, their maximum duration has been extended, and states have been given a large financial incentive to broaden eligibility. The package also includes temporary subsidies to help pay for laid-off workers’ health insurance. Even so, benefits remain meagre.

Housing is a far bigger drag on American job mobility. Almost a fifth of American households with mortgages owe more than their house is worth, and house prices are set to fall further. “Negative equity” can lock in homeowners, making it hard to move to a new job. A recent study suggests that homeowners with negative equity are 50% less mobile than others.

Europe’s governments, at least so far, are trying hard to avoid the mistakes of the 1970s and 1980s. As Stefano Scarpetta of the OECD points out, today’s policies are designed to keep people working rather than to encourage them to leave the labour force. Several countries, from Spain to Sweden, have temporarily cut social insurance contributions to reduce labour costs.

A broader group including Austria, Denmark, France, Germany, Hungary, Italy and Spain, are encouraging firms to shorten work weeks rather than lay people off, by topping up the pay of workers on short hours. Germany, for instance, has long had a scheme that covers 60% of the gap between shorter hours and a full-time wage for up to six months. The government recently simplified the required paperwork, cut social-insurance contributions for affected workers, and extended the scheme’s maximum length to 18 months.

Britain has taken a different tack. Rather than intervening to keep people in their existing jobs, it has focused on deterring long-term joblessness with a package of subsidies to encourage employers to hire, and train, people who have been out of work for more than six months.

Of all rich-country governments, Japan’s has flailed the most. Forced to confront the ugly reality of its labour market, it is trying a mixture of policies. Last year it proposed tax incentives for companies to turn temps into regular employees—a futile effort when profits are scarce and jobs being slashed. The agriculture ministry suggested sending the jobless to the hinterland to work on farms and fisheries. As Naohiro Yashiro, an economist at the International Christian University in Tokyo, puts it: “Although temporary and part-time workers are everywhere in Japan, they are thought to be a threat to employment practices and—like terrorists—have to be contained.”

Recently, a more ambitious strategy has emerged. The government is considering shortening the minimum work period for eligibility to jobless benefits. It is providing newly laid-off workers with six-month loans for housing and living expenses. It is paying small-business owners to allow fired staff to remain in company dorms. It is subsidising the salaries of workers on mandatory leave. It is paying firms for rehiring laid-off staff, and offering grants to anyone willing to start a new business.

Whether these policies will be enough depends on how the downturn progresses. For by and large they are sticking-plasters, applied in the hope that the recession will soon be over and the industrial restructuring that follows will be modest. Subsidising shorter working weeks, for instance, props up demand today, but impedes long-term reordering. The inequities of a dual labour market will become more glaring the higher unemployment rises. Politicians seem to be hoping for the best. Given the speed at which their economies are deteriorating, they would do better to plan for the worst.

Source: The Economist ( Mar 14 -Mar 20)

                                 

Prohibition has failed; legalisation is the least bad solution

A HUNDRED years ago a group of foreign diplomats gathered in Shanghai for the first-ever international effort to ban trade in a narcotic drug. On February 26th 1909 they agreed to set up the International Opium Commission—just a few decades after Britain had fought a war with China to assert its right to peddle the stuff. Many other bans of mood-altering drugs have followed. In 1998 the UN General Assembly committed member countries to achieving a “drug-free world” and to “eliminating or significantly reducing” the production of opium, cocaine and cannabis by 2008.

That is the kind of promise politicians love to make. It assuages the sense of moral panic that has been the handmaiden of prohibition for a century. It is intended to reassure the parents of teenagers across the world. Yet it is a hugely irresponsible promise, because it cannot be fulfilled.

Next week ministers from around the world gather in Vienna to set international drug policy for the next decade. Like first-world-war generals, many will claim that all that is needed is more of the same. In fact the war on drugs has been a disaster, creating failed states in the developing world even as addiction has flourished in the rich world. By any sensible measure, this 100-year struggle has been illiberal, murderous and pointless. That is why The Economist continues to believe that the least bad policy is to legalise drugs.

“Least bad” does not mean good. Legalisation, though clearly better for producer countries, would bring (different) risks to consumer countries. As we outline below, many vulnerable drug-takers would suffer. But in our view, more would gain.

The evidence of failure

Nowadays the UN Office on Drugs and Crime no longer talks about a drug-free world. Its boast is that the drug market has “stabilised”, meaning that more than 200m people, or almost 5% of the world’s adult population, still take illegal drugs—roughly the same proportion as a decade ago. (Like most purported drug facts, this one is just an educated guess: evidential rigour is another casualty of illegality.) The production of cocaine and opium is probably about the same as it was a decade ago; that of cannabis is higher. Consumption of cocaine has declined gradually in the United States from its peak in the early 1980s, but the path is uneven (it remains higher than in the mid-1990s), and it is rising in many places, including Europe.

This is not for want of effort. The United States alone spends some $40 billion each year on trying to eliminate the supply of drugs. It arrests 1.5m of its citizens each year for drug offences, locking up half a million of them; tougher drug laws are the main reason why one in five black American men spend some time behind bars. In the developing world blood is being shed at an astonishing rate. In Mexico more than 800 policemen and soldiers have been killed since December 2006 (and the annual overall death toll is running at over 6,000). This week yet another leader of a troubled drug-ridden country—Guinea Bissau—was assassinated.

Yet prohibition itself vitiates the efforts of the drug warriors. The price of an illegal substance is determined more by the cost of distribution than of production. Take cocaine: the mark-up between coca field and consumer is more than a hundredfold. Even if dumping weedkiller on the crops of peasant farmers quadruples the local price of coca leaves, this tends to have little impact on the street price, which is set mainly by the risk of getting cocaine into Europe or the United States.

Nowadays the drug warriors claim to seize close to half of all the cocaine that is produced. The street price in the United States does seem to have risen, and the purity seems to have fallen, over the past year. But it is not clear that drug demand drops when prices rise. On the other hand, there is plenty of evidence that the drug business quickly adapts to market disruption. At best, effective repression merely forces it to shift production sites. Thus opium has moved from Turkey and Thailand to Myanmar and southern Afghanistan, where it undermines the West’s efforts to defeat the Taliban.

Al Capone, but on a global scale

Indeed, far from reducing crime, prohibition has fostered gangsterism on a scale that the world has never seen before. According to the UN’s perhaps inflated estimate, the illegal drug industry is worth some $320 billion a year. In the West it makes criminals of otherwise law-abiding citizens (the current American president could easily have ended up in prison for his youthful experiments with “blow”). It also makes drugs more dangerous: addicts buy heavily adulterated cocaine and heroin; many use dirty needles to inject themselves, spreading HIV; the wretches who succumb to “crack” or “meth” are outside the law, with only their pushers to “treat” them. But it is countries in the emerging world that pay most of the price. Even a relatively developed democracy such as Mexico now finds itself in a life-or-death struggle against gangsters. American officials, including a former drug tsar, have publicly worried about having a “narco state” as their neighbour.

The failure of the drug war has led a few of its braver generals, especially from Europe and Latin America, to suggest shifting the focus from locking up people to public health and “harm reduction” (such as encouraging addicts to use clean needles). This approach would put more emphasis on public education and the treatment of addicts, and less on the harassment of peasants who grow coca and the punishment of consumers of “soft” drugs for personal use. That would be a step in the right direction. But it is unlikely to be adequately funded, and it does nothing to take organised crime out of the picture.

Legalisation would not only drive away the gangsters; it would transform drugs from a law-and-order problem into a public-health problem, which is how they ought to be treated. Governments would tax and regulate the drug trade, and use the funds raised (and the billions saved on law-enforcement) to educate the public about the risks of drug-taking and to treat addiction. The sale of drugs to minors should remain banned. Different drugs would command different levels of taxation and regulation. This system would be fiddly and imperfect, requiring constant monitoring and hard-to-measure trade-offs. Post-tax prices should be set at a level that would strike a balance between damping down use on the one hand, and discouraging a black market and the desperate acts of theft and prostitution to which addicts now resort to feed their habits.

Selling even this flawed system to people in producer countries, where organised crime is the central political issue, is fairly easy. The tough part comes in the consumer countries, where addiction is the main political battle. Plenty of American parents might accept that legalisation would be the right answer for the people of Latin America, Asia and Africa; they might even see its usefulness in the fight against terrorism. But their immediate fear would be for their own children.

That fear is based in large part on the presumption that more people would take drugs under a legal regime. That presumption may be wrong. There is no correlation between the harshness of drug laws and the incidence of drug-taking: citizens living under tough regimes (notably America but also Britain) take more drugs, not fewer. Embarrassed drug warriors blame this on alleged cultural differences, but even in fairly similar countries tough rules make little difference to the number of addicts: harsh Sweden and more liberal Norway have precisely the same addiction rates. Legalisation might reduce both supply (pushers by definition push) and demand (part of that dangerous thrill would go). Nobody knows for certain. But it is hard to argue that sales of any product that is made cheaper, safer and more widely available would fall. Any honest proponent of legalisation would be wise to assume that drug-taking as a whole would rise.

There are two main reasons for arguing that prohibition should be scrapped all the same. The first is one of liberal principle. Although some illegal drugs are extremely dangerous to some people, most are not especially harmful. (Tobacco is more addictive than virtually all of them.) Most consumers of illegal drugs, including cocaine and even heroin, take them only occasionally. They do so because they derive enjoyment from them (as they do from whisky or a Marlboro Light). It is not the state’s job to stop them from doing so.

What about addiction? That is partly covered by this first argument, as the harm involved is primarily visited upon the user. But addiction can also inflict misery on the families and especially the children of any addict, and involves wider social costs. That is why discouraging and treating addiction should be the priority for drug policy. Hence the second argument: legalisation offers the opportunity to deal with addiction properly.

By providing honest information about the health risks of different drugs, and pricing them accordingly, governments could steer consumers towards the least harmful ones. Prohibition has failed to prevent the proliferation of designer drugs, dreamed up in laboratories. Legalisation might encourage legitimate drug companies to try to improve the stuff that people take. The resources gained from tax and saved on repression would allow governments to guarantee treatment to addicts—a way of making legalisation more politically palatable. The success of developed countries in stopping people smoking tobacco, which is similarly subject to tax and regulation, provides grounds for hope.

A calculated gamble, or another century of failure?

This newspaper first argued for legalisation 20 years ago (see article). Reviewing the evidence again (see article), prohibition seems even more harmful, especially for the poor and weak of the world. Legalisation would not drive gangsters completely out of drugs; as with alcohol and cigarettes, there would be taxes to avoid and rules to subvert. Nor would it automatically cure failed states like Afghanistan. Our solution is a messy one; but a century of manifest failure argues for trying it.

Source: The Economist ( Mar 7- Mar 13 )