The Economist Articles for Oct. 2nd Week : Oct. 11th(Interpretation), Oct. 12th(Discussion)

[도진]

Hong Kong protests

The Party v the people

The Communist Party faces its toughest challenge since Tiananmen. This time it must make wiser decisions

Oct 4th 2014 | From the print edition

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OF THE ten bloodiest conflicts in world history, two were world wars. Five of the other eight took place or originated in China. The scale of the slaughter within a single country, and the frequency with which the place has been bathed in blood, is hard for other nations to comprehend. The Taiping revolt in the mid-19th century led to the deaths of more than 20m, and a decade later conflict between Han Chinese and Muslims killed another 8m-12m. In the 20th century 20m-30m died under Mao Zedong: some murdered, most as a result of a famine caused by brutality and incompetence.

China’s Communist Party leaders are no doubt keen to hold on to power for its own sake. But the country’s grim history also helps explain why they are so determined not to give ground to the demonstrators in Hong Kong who want to replace the territory’s fake democracy with the real thing (see article). Xi Jinping, China’s president, and his colleagues believe that the party’s control over the country is the only way of guaranteeing its stability. They fear that if the party loosens its grip, the country will slip towards disorder and disaster.

In this section

• The Party v the people
• Wealth without workers, workers without wealth
• Don’t let history repeat itself
• The rise of the Vallenzi
• A plea for change

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• Arab Spring
• Egyptian Protests
• North African Politics
• Egyptian politics
• War and conflict

They are right that autocracy can keep a country stable in the short run. In the long run, though, as China’s own history shows, it cannot. The only guarantor of a stable country is a people that is satisfied with its government. And in China, dissatisfaction with the Communist Party is on the rise.

Bad omens

Hong Kong’s “Umbrella revolution”, named after the protection the demonstrators carry against police pepper-spray (as well as the sun and the rain), was triggered by a decision by China in late August that candidates for the post of the territory’s chief executive should be selected by a committee stacked with Communist Party supporters. Protesters are calling for the party to honour the promise of democracy that was made when the British transferred the territory to China in 1997. Like so much in the territory, the protests are startlingly orderly. After a night of battles with police, students collected the plastic bottles that littered the streets for recycling.

For some of the protesters, democracy is a matter of principle. Others, like middle-class people across mainland China, are worried about housing, education and their own job prospects. They want representation because they are unhappy with how they are governed. Whatever their motivation, the protests present a troubling challenge for the Communist Party. They are reminiscent not just of uprisings that have toppled dictators in recent years from Cairo to Kiev, but also of the student protests in Tiananmen Square 25 years ago. The decision to shoot those protesters succeeded in restoring order, but generated mistrust that still pervades the world’s dealings with China, and China’s with its own citizens.

In Hong Kong, the party is using a combination of communist and colonial tactics. Spokesmen have accused the protesters of being “political extremists” and “black hands” manipulated by “foreign anti-China forces”; demonstrators will “reap what they have sown”. Such language is straight out of the party’s well-thumbed lexicon of calumnies; similar words were used to denigrate the protesters in Tiananmen. It reflects a long-standing unwillingness to engage with democrats, whether in Hong Kong or anywhere else in China, and suggests that party leaders see Hong Kong, an international city that has retained a remarkable degree of freedom since the British handed it back to China, as just another part of China where critics can be intimidated by accusing them of having shadowy ties with foreigners. Mr Xi, who has long been closely involved with the party’s Hong Kong policy, should know better.

At the same time, the party is resorting to the colonialists’ methods of managing little local difficulties. Much as the British—excoriated by the Communist Party—used to buy the support of tycoons to keep activism under wraps, Mr Xi held a meeting in Beijing with 70 of Hong Kong’s super-rich to ensure their support for his stance on democracy. The party’s supporters in Hong Kong argue that bringing business onside is good for stability, though the resentment towards the tycoons on display in Hong Kong’s streets suggests the opposite.

Yet the combination of exhortation, co-option and tear gas have so far failed to clear the streets. Now the government is trying to wait the protesters out. But if Mr Xi believes that the only way of ensuring stability is for the party to reassert its control, it remains possible that he will authorise force. That would be a disaster for Hong Kong, and it would not solve Mr Xi’s problem. For mainland China, too, is becoming restless.

Party leaders are doing their best to prevent mainlanders from finding out about the events in Hong Kong (see article). Even so, the latest news from Hong Kong’s streets will find ways of getting to the mainland, and the way this drama plays out will shape the government’s relations with its people.

The difficulty for the Communist Party is that while there are few signs that people on the mainland are hungering for full-blown democracy, frequent protests against local authorities and widespread expressions of anger on social media suggest that there, too, many people are dissatisfied with the way they are governed. Repression, co-option and force may succeed in silencing the protesters in Hong Kong today, but there will be other demonstrations, in other cities, soon enough.

A different sort of order

As Mr Xi has accumulated power, he has made it clear that he will not tolerate Western-style democracy. Yet suppressing popular demands produces temporary stability at the cost of occasional devastating upheavals. China needs to find a way of allowing its citizens to shape their governance without resorting to protests that risk turning into a struggle for the nation’s soul. Hong Kong, with its history of free expression‎ and semi-detached relationship to the mainland, is an ideal place for that experiment to begin. If Mr Xi were to grasp the chance, he could do more for his country than all the emperors and party chiefs who have struggled to maintain stability in that vast and violent country before him.

The world economy

Wealth without workers, workers without wealth

The digital revolution is bringing sweeping change to labour markets in both rich and poor worlds

Oct 4th 2014 | From the print edition

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TECHNOLOGICAL revolutions are best appreciated from a distance. The great inventions of the 19th century, from electric power to the internal-combustion engine, transformed the human condition. Yet for workers who lived through the upheaval, the experience of industrialisation was harsh: full of hard toil in crowded, disease-ridden cities.

The modern digital revolution—with its hallmarks of computer power, connectivity and data ubiquity—has brought iPhones and the internet, not crowded tenements and cholera. But, as our special report explains, it is disrupting and dividing the world of work on a scale not seen for more than a century. Vast wealth is being created without many workers; and for all but an elite few, work no longer guarantees a rising income.

In this section

• The Party v the people
• Wealth without workers, workers without wealth
• Don’t let history repeat itself
• The rise of the Vallenzi
• A plea for change

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• China

Computers that can do your job and eat your lunch

So far, the upheaval has been felt most by low- and mid-skilled workers in rich countries. The incomes of the highly educated—those with the skills to complement computers—have soared, while pay for others lower down the skill ladder has been squeezed. In half of all OECD countries real median wages have stagnated since 2000. Countries where employment is growing at a decent clip, such as Germany or Britain, are among those where wages have been squeezed most.

In the coming years the disruption will be felt by more people in more places, for three reasons. First, the rise of machine intelligence means more workers will see their jobs threatened. The effects will be felt further up the skill ladder, as auditors, radiologists and researchers of all sorts begin competing with machines. Technology will enable some doctors or professors to be much more productive, leaving others redundant.

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Second, wealth creation in the digital era has so far generated little employment. Entrepreneurs can turn their ideas into firms with huge valuations and hardly any staff. Oculus VR, a maker of virtual-reality headsets with 75 employees, was bought by Facebook earlier this year for $2 billion. With fewer than 50,000 workers each, the giants of the modern tech economy such as Google and Facebook are a small fraction of the size of the 20th century’s industrial behemoths.

Third, these shifts are now evident in emerging economies. Foxconn, long the symbol of China’s manufacturing economy, at one point employed 1.5m workers to assemble electronics for Western markets. Now, as the costs of labour rise and those of automated manufacturing fall, Foxconn is swapping workers for robots. China’s future is more Alibaba than assembly line: the e-commerce company that recently made a spectacular debut on the New York Stock Exchange employs only 20,000 people.

The digital transformation seems to be undermining poor countries’ traditional route to catch-up growth. Moving the barely literate masses from fields to factories has become harder. If India, for instance, were to follow China’s development path, it would need skilled engineers and managers to build factories to employ millions of manufacturing workers. But, thanks to technological change, its educated elite is now earning high salaries selling IT services to foreigners. The digital revolution has made an industrial one uneconomic.

Bridging the gap

None of this means that the digital revolution is bad for humanity. Far from it. This newspaper believes firmly that technology is, by and large, an engine of progress. IT has transformed the lives of billions for the better, often in ways that standard income measures do not capture. Communication, knowledge and entertainment have become all but free. Few workers would want to go back to a world without the internet, the smartphone or Facebook, even for a pay increase. Technology also offers new ways to earn a living. Etsy, an online marketplace for arts and crafts, enables hobbyists to sell their wares around the world. Uber, the company that is disrupting the taxi business, allows tens of thousands of drivers to work as and when they want.

Nonetheless, the growing wedge between a skilled elite and ordinary workers is worrying. Angry voters whose wages are stagnant will seek scapegoats: witness the rise of xenophobia and protectionism in the rich world. In poor countries dashed expectations and armies of underemployed people are a recipe for extremism and unrest. Governments across the globe therefore have a huge interest in helping remove the obstacles that keep workers from wealth.

The answer is not regulation or a larger state. High minimum wages will simply accelerate the replacement of workers by machines. Punitive tax rates will deter entrepreneurship and scare off the skilled on whom prosperity in the digital era depends. The best thing governments can do is to raise the productivity and employability of less-skilled workers. That means getting rid of daft rules that discourage hiring, like protections which make it difficult to sack poor performers. It means better housing policy and more investment in transport, to help people work in productive cities such as London and Mumbai. It means revamping education. Not every worker can or should complete an advanced degree, but too many people in poor countries still cannot read and too many in rich ones fail to complete secondary school. In future, education should not be just for the young: adults will need lifetime learning if they are to keep up with technological change.

Yet although governments can mitigate the problem, they cannot solve it. As technology progresses and disrupts more jobs, more workers will be employable only at lower wages. The modest earnings of the generation that technology leaves behind will need to be topped up with tax credits or wage subsidies. That need not mean imposing higher tax rates on the affluent, but it does mean closing the loopholes and cutting the giveaways from which they benefit.

In the 19th century, it took the best part of 100 years for governments to make the investment in education that enabled workers to benefit from the industrial revolution. The digital revolution demands a similarly bold, but swifter, response.

Criminal justice

The kings of the courtroom

How prosecutors came to dominate the criminal-justice system

Oct 4th 2014 | NEW YORK AND WASHINGTON, DC | From the print edition

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CAMERON TODD WILLINGHAM was accused of murdering his daughters in 1991 by setting fire to the family house. The main evidence against him was a forensic report on the fire, later shown to be bunk, and the testimony of a jailhouse informant who claimed to have heard him confess. He was executed in 2004.

The snitch who sent him to his death had been told that robbery charges pending against him would be reduced to a lesser offence if he co-operated. After the trial the prosecutor denied that any such deal had been struck, but a handwritten note discovered last year by the Innocence Project, a pressure group, suggests otherwise. In taped interviews, extracts of which were published by the Washington Post, the informant said he lied in court in return for efforts by the prosecutor to secure a reduced sentence and—amazingly—financial support from a local rancher.

In this section

• The kings of the courtroom
• Placing Holder
• Decisions, decisions
• The dynast, the doctor and the gator-wrestler
• Yes means yes, says Mr Brown
• The loneliest man in Congress

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• Trials
• Criminal trials
• Criminal sentencing
• Ted Stevens
• Eric Holder

A study by Northwestern University Law School’s Centre on Wrongful Convictions found that 46% of documented wrongful capital convictions between 1973 and 2004 could be traced to false testimony by snitches—making them the leading cause of wrongful convictions in death-penalty cases. The Innocence Project keeps a database of Americans convicted of serious crimes but then exonerated by DNA evidence. Of the 318 it lists, 57 involved informants—and 30 of the convicted had entered a guilty plea.

“The prosecutor has more control over life, liberty and reputation than any other person in America,” said Robert Jackson, the attorney-general, in 1940. As the current attorney-general, Eric Holder, prepares to stand down (see article), American prosecutors are more powerful than ever before.

Several legal changes have empowered them. The first is the explosion of plea bargaining, where a suspect agrees to plead guilty to a lesser charge if the more serious charges against him are dropped. Plea bargains were unobtainable in the early years of American justice. But today more than 95% of cases end in such deals and thus are never brought to trial.

The pressure to plead guilty

Jed Rakoff, a district judge in New York, thinks it unlikely that 95% of defendants are guilty. Of the 2.4m Americans behind bars, he thinks it possible that “thousands, perhaps tens of thousands” confessed despite being innocent. One reason they might do so is because harsh, mandatory-minimum sentencing rules can make such a choice rational. Rather than risk a trial and a 30-year sentence, some cop a plea and accept a much shorter one.

In such negotiations prosecutors “hold all the marbles”, says Alexandra Natapoff of Loyola Law School. Mandatory sentencing laws prevent judges from taking into account all the circumstances of a case and exercising discretion over the punishment. Instead, its severity depends largely on the charges the prosecutor chooses to file. In complex white-collar cases, they can threaten to count each e-mail as a separate case of wire fraud. In drugs cases they can choose how much of the stash the dealer’s sidekick is responsible for. That gives them huge bargaining power. In Florida 4-14g of heroin gets you a minimum of three years in prison; 28g or more gets you 25 years.

In 1996 police found a safe in Stephanie George’s house containing 500g of cocaine. She said it belonged to her ex-boyfriend, who had the key and admitted that it was his. Prosecutors could have charged Ms George with a minor offence: she was obviously too broke to be a drug kingpin. Instead they charged her for everything in the safe, as well as everything her ex-boyfriend had recently sold—and for obstruction of justice because she denied all knowledge of his dealings. She received a mandatory sentence of life without the possibility of parole. Her ex-boyfriend received a lighter penalty because he testified that he had paid her to let him use her house to store drugs. Ms George was released in April, after 17 years, only because Barack Obama commuted her sentence.

Under Mr Holder the federal mandatory-minimum regime has been softened for non-violent drug offences. But this has only curbed the power of federal prosecutors, not state ones, and only somewhat.

Another change that empowers prosecutors is the proliferation of incomprehensible new laws. This gives prosecutors more room for interpretation and encourages them to overcharge defendants in order to bully them into plea deals, says Harvey Silverglate, a defence lawyer. Since the financial crisis, says Alex Kozinski, a judge, prosecutors have been more tempted to pore over statutes looking for ways to stretch them so that this or that activity can be construed as illegal. “That’s not how criminal law is supposed to work. It should be clear what is illegal,” he says.

The same threats and incentives that push the innocent to plead guilty also drive many suspects to testify against others. Deals with “co-operating witnesses”, once rare, have grown common. In federal cases an estimated 25-30% of defendants offer some form of co-operation, and around half of those receive some credit for it. The proportion is double that in drug cases. Most federal cases are resolved using the actual or anticipated testimony of co-operating defendants.

Co-operator testimony often sways juries because snitches are seen as having first-hand knowledge of the pattern of criminal activity. But snitches hoping to avoid draconian jail terms may sometimes be tempted to compose rather than merely to sing.

Sing or suffer

It is not unusual for a co-operator to have 15 or 20 long meetings with agents and prosecutors. It is hard to know what goes on in these sessions because they are not recorded. Participants take notes but do not have to write down everything that is said; nor do they have to share all their notes with the defence. The time that co-operators and their handlers spend alone is a “black hole”, says a prosecutor quoted in “Snitch: Informants, Cooperators and the Corruption of Justice”, by Ethan Brown.

Co-operators have become more common in corporate cases since the Justice Department started bringing in more lawyers experienced in dealing with organised crime. Business cases typically involve mountains of hard-to-fathom documents and turn not on actions but intent. Often, the only way to convince a jury that the defendant knew a transaction was dodgy is to have a former colleague say so.

A common way to recruit co-operators is to name lots of a defendant’s colleagues as “unindicted co-conspirators”. (In the Enron fraud case there were 114.) An unindicted co-conspirator can be indicted at any moment; his lawyer will therefore usually advise him, at the very least, not to annoy the prosecutor by helping the defence.

In 2009 James Treacy, a former executive of Monster Worldwide, an employment website, was convicted of illegally manipulating (or “backdating”) stock options and handed a two-year sentence. He blames “slanted” testimony by former colleagues turned co-operators. After his release, one of them asked to meet him. Over lunch she tearfully “described the government’s intimidation tactics,” he says. “Some were almost comical: broken chairs to sit in; investigators flashing their holstered guns; and long, miserable hours of ‘good cop, bad cop’ routines, with few water or bathroom breaks. Other techniques were more serious. Prosecutors played the innuendo game, suggesting an indictment if the witness did not co-operate.”

Mr Treacy has an axe to grind, but he is not alone in arguing that the system encourages embellishment, or in believing that some prosecutors overstep the mark because they hope to parlay courtroom victories into lucrative partnerships at law firms or platforms to run for public office.

Co-operators feature extensively in insider-trading cases. James Fleishman, a former manager at Primary Global Research, was first approached by FBI agents to help them ensnare his superiors. When he refused to co-operate, insisting he knew of no illegal activity, he became a target himself. His conviction rested on co-operation from two former clients who had been put under immense pressure to be helpful to prosecutors. (They told one they would seek to have him jailed for 50 years if he declined their offer.) In a self-published book, Mr Fleishman argues that the testimony of both was littered with fabrications, including phone conversations that never took place. The co-operators got probation. Mr Fleishman was jailed for 30 months.

There is no way to confirm‎ Mr Fleishman’s version of events. There was, however, an intriguing moment at his trial. During cross-examination Mr Fleishman’s lawyer complained that his opposing number was mouthing words to a co-operating witness who appeared to be going off-script. The prosecutor’s response was: “If I did that, and I’m not disputing what he said…I’m sorry.”

It is not clear how often prosecutors themselves break the rules. According to a report by the Project on Government Oversight, an investigative outfit, compiled from data obtained from freedom of information requests, an internal-affairs office at the Department of Justice identified more than 650 instances of prosecutors violating the profession’s rules and ethical standards between 2002 and 2013. More than 400 of these were “at the more severe end of the scale”. The Justice Department argues that this level of misconduct is modest given the thousands of cases it handles.

Judge Kozinski worries, however, that there is “an epidemic” of Brady violations—when exculpatory evidence is hidden from defence lawyers by prosecutors. For example, in 2008 Ted Stevens, a senator from Alaska, was found guilty of corruption eight days before an election, which he narrowly lost. Afterwards, prosecutors were found to have withheld evidence that might have helped the defence. Mr Stevens’s conviction was vacated, but he died in a plane crash in 2010.

Prosecutors enjoy strong protections against criminal sanction and private litigation. Even in egregious cases, punishments are often little more than a slap on the wrist. Mr Stevens’s prosecutors, for example, were suspended from their jobs for 15 to 40 days, a penalty that was overturned on procedural grounds. Ken Anderson, a prosecutor who hid the existence of a bloody bandana that linked someone other than the defendant to a 1986 murder, was convicted of withholding evidence in 2013 but spent only five days behind bars—one for every five years served by the convicted defendant, Michael Morton.

Disquiet over prosecutorial power is growing. Several states now require third-party corroboration of a co-operator’s version of events or have barred testimony by co-operators with drug or mental-health problems. Judge Rakoff proposes two reforms: scrapping mandatory-minimum sentences and reducing the prosecutor’s role in plea-bargaining—for instance by bringing in a magistrate judge to act as a broker. He nevertheless sees the use of co-operators as a “necessary evil”, though many other countries frown upon it.

Prosecutors’ groups have urged Mr Holder not to push for softer mandatory-minimum sentences, arguing that these “are a critical tool in persuading defendants to co-operate”. Some defend the status quo on grounds of pragmatism: without co-operation deals and plea bargains, they argue, the system would buckle under the weight of extra trials. This week Jerry Brown, California’s governor, vetoed a bill that would have allowed judges to inform juries if prosecutors knowingly withhold exculpatory evidence.

Most prosecutors are hard-working, honest and modestly paid. But they have accumulated so much power that abuse is inevitable. As Jackson put it all those years ago: “While the prosecutor at his best is one of the most beneficent forces in our society, when he acts with malice or other base motives, he is one of the worst.”

Polling in Brazil

Blind data

The tricky art of predicting Brazil’s election

Oct 4th 2014 | São Paulo | From the print edition

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WHIZZY statistical models were ten-a-penny during the presidential election in the United States in 2012, when Nate Silver and fellow “forecaster-pundits” produced uncannily accurate predictions of a solid win for Barack Obama. In Brazil, where voters will cast first-round ballots on October 5th, they remain scarce. Election-watchers prefer instead to divine trends, poll by poll. The latest show Dilma Rousseff, the left-wing incumbent, opening up a lead of six to eight percentage points over Marina Silva, her nearest challenger, in a likely second-round run-off later this month.

Models come in three broad types. The first, made famous by Mr Silver, takes polls released each week, then aggregates and weights them to come up with a prediction. Another looks at how “fundamentals”—which can mean anything from unemployment to government-approval ratings—have shaped past elections. A hybrid approach mixes the two, increasing the weight of the polling data as election day draws nearer.

In this section

• Single point of failure
• Blind data
• Thumbs down
• Three countries or one continent?

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• Nate Silver
• Brazil
• Dilma Rousseff

All three methods hit snags in Brazil, says Clifford Young of Ipsos, a research company. Because direct elections for president were introduced in Brazil only in 1989, fundamentals models have just six data points to play with, against 17 in the United States (where accurate opinion surveys started in 1948). The power of poll aggregation, too, is curbed by the dearth of data. Fewer than 40 usable national polls have been published in Brazil so far, says Mr Young; Mr Silver had at least 4,000 to hand in 2012 (including robust state-level ones). By their nature, hybrid models have both problems.

A handful of number-crunchers have nevertheless given it a whirl. João Pinho de Mello of Insper business school uses consumer-price levels and government-approval ratings (which are on the rise as Ms Rousseff has used ample media exposure to play up her successes). Mr Young considers only the latter, but factors in incumbency and augments the small historical sample by drawing on elections elsewhere in the world. Neale El-Dash of Polling Data, a website, plumped for poll-aggregation.

Their models confirm‎ that momentum is with Ms Rousseff. Mr El-Dash’s model flipped from 62% in favour of Ms Silva late last month to 74% for Ms Rousseff as The Economist went to press. That brings it into line with Mr Young’s forecast, which has always put the chances of a Rousseff victory at 60-78%, and Mr Pinho de Mello, who estimates the president’s probability of winning at 55%.

Japan, America and the Trans-Pacific Partnership

Stalemate

Trade talks unexpectedly break down

Oct 4th 2014 | TOKYO | From the print edition

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AMERICA and Japan are the two biggest participants in the Trans-Pacific Partnership (TPP), an ambitious “21st-century” proposal for a free-trade area involving a dozen countries and a third of world trade. A conundrum for anyone following negotiations in recent months has come from measuring the upbeat rhetoric emanating from both camps against the apparent lack of progress. The conundrum was solved on September 24th when TPP negotiations between the two sides suddenly collapsed. Japan’s economy minister, Akira Amari, stormed out of talks in Washington, DC with the American trade representative, Michael Froman, leaving only his sandwiches on the table.

The TPP was supposed to be central to plans by Japan’s prime minister, Shinzo Abe, to pep up the economy. Japanese farming is heavily protected and inefficient. Mr Abe promised big changes when it came to “sacred” areas protected by swingeing import tariffs including rice, wheat, beef, dairy and sugar.

In this section

• The empire strikes back
• What a ride
• Edging closer
• A shot across the bow
• Stalemate
• Charming, disarming
• Closing down
• Joining the dashes

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• United States
• Business
• Trade
• Japan
• Tariffs

The American side knows Japanese farmers need time to adjust. Still, negotiators have recently been underwhelmed by what was on offer—a refusal by the Japanese side to contemplate big cuts in tariffs. Perhaps the Japanese judged that the Americans needed a deal more. If so, they miscalculated. Piqued, the Americans withdrew an offer to cut tariffs on imported car parts. And that was that. One Japanese policymaker describes it as the most acrimonious episode since the bruising bilateral trade wars of the 1980s.

The Americans had hoped for an “agreement in principle” by the time of the East Asia Summit in Myanmar on November 11th. With no progress between Japan and America, overall progress in TPP will have to wait. Japan, for its part, reckons that little can in any case be achieved before America’s mid-term congressional elections in November, after which President Barack Obama hopes to win “fast-track” authority, meaning that Congress must vote up-or-down on trade deals, not meddle with the provisions. Yet the already daunting task of winning such authority will be harder without concessions from Japan. The TPP bus is stalled.

Charlemagne

The will to power

The European Parliament would like you to know that it matters

Oct 4th 2014 | From the print edition

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FRIEDRICH NIETZSCHE, an early advocate of European unity, introduced the concept of the Übermensch, a heroic figure whose concerns rise above those of ordinary beings. The European Parliament, home to a number of political also-rans and second-raters, is not overflowing with such specimens. But it neatly embodies another of the philosopher’s ideas: the will to power.

Armed with the superficially attractive argument that it is the only European institution directly accountable to voters, the parliament has accrued powers over the past few decades. Like a child receiving sweets, each goody it acquires feeds its demands for more. Since the first European elections in 1979 the parliament has earned the right to veto appointments to the European Commission (the EU’s executive arm, reshuffled every five years), won approval rights for the vast majority of EU legislation, and expanded, as the EU enlarged to central and eastern Europe, to 751 members, making it one of the largest parliamentary chambers in Europe. Its political groupings may be unwieldy and its priorities sometimes odd, but it is no longer Europe’s ugly duckling.

In this section

• How to deal with Syria’s Kurds
• Chinks in the armour
• The company he keeps
• On the edge of recession
• The will to power

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• Europe
• European Commission
• European People's Party
• European Parliament
• European Union

Much of the parliament’s legislative work is tedious, technical and of interest only to lobbyists. But every five years it interrogates the individuals nominated for posts in the European Commission, and it relishes the opportunity. This year is no exception: this week and next the 27 candidate commissioners (one from each EU member; the president is spared) are enduring three-hour grillings on their respective policy areas at the hands of MEPs, some of them well-informed, others merely peacocking before the press or their colleagues. In previous years the parliament has used the threat of a veto to force commission presidents to reject candidates it finds unseemly or incompetent. It could do so again this time: after failing to convince first time around, some have been asked to return for a second hearing.

But whatever happens this month the parliament has already left its mark, thanks to a clever manoeuvre executed by its largest political groups several months ago. Before May’s European elections the leaders of the groups proposed so-called Spitzenkandidaten, candidates for the presidency of the European Commission, perhaps the most important job within the EU. Some heads of government, including David Cameron, Britain’s prime minister, and Angela Merkel, the German chancellor, saw this as an unseemly power grab; in previous years they had stitched up the job between themselves. But their objections were ignored: in May the centre-right European People’s Party (EPP) won the most seats, and its Spitzenkandidat, Jean-Claude Juncker, duly took the commission job. Few think that was a one-off. Notably, parliamentary types now speak casually of “our commission”.

Spitzenkandidaten, say the parliament’s cheerleaders, are an answer to critics who complain that there is no such thing as a European electorate, only 28 national ones. This time, voters across the continent were able to weigh the political merits of various individuals and, indirectly, to vote for the one they preferred. Manfred Weber, chair of the EPP, says he also detected the emergence of pan-European debates for the first time: on a proposed free-trade deal with America, and on budget-cutting within the euro zone. Another senior parliamentarian says the unparalleled involvement of EU members in one another’s affairs after the euro crisis is helping shape something like a European “demos”, even if it is rather uglier than some might have hoped.

That is probably an exaggeration: polling found that the Spitzenkandidaten motivated just 12% of voters in Germany and Austria, and even fewer everywhere else. Television debates between the candidates were lifeless affairs. But for MEPs and others, this is just the beginning: look how long, they say, it took for America’s federal institutions to settle in. And why stop here? As the parliament’s powers grow, its political groupings are exerting more control over their members, just as in national legislatures. Enthusiastic parliamentarians long for a budget commensurate with their ambitions (the EU’s amounts to a piddling 1% of GDP), and for the right to propose, rather than merely approve, new laws. The rise of the European Parliament, they say, is nothing more than the slow march of democracy into the EU.

Human, all too human

Yet it does not feel like that. Just as steadily as it has expanded its powers, the European Parliament has been losing votes. Turnout in European elections has dropped from 62% in 1979 to just 43% this year (though that is a little more than in elections to the American congress). And grumpy outfits opposed to the whole affair, such as the United Kingdom Independence Party or France’s Front National, are thriving; anti-establishment parties of various hues won around one-third of the parliament’s seats this year.

There is an irony to this. Eurosceptics tend to leave the nitty-gritty of committee work and lawmaking to the insiders. And since May the parliamentary arithmetic has meant that the two biggest groups—the EPP and the centre-left Party of European Socialists—must now work together in a mushy, grand-coalition way to get things done. This is vintage EU: a grumpy outburst from voters leads to a strengthening of the status quo.

Does any of this matter? Most big decisions about foreign policy, economic governance and the like are still taken by meetings of heads of government as the European Council; the concerns that matter most to voters lie generally with national governments. But the parliament’s influence will be felt beyond the bubbles of Brussels or Strasbourg (its second, expensive home). In the coming years it will play a crucial role in debates on trade, the digital economy and energy policy. And by hugging the commission close it has already helped shape Mr Juncker’s priorities. Not quite an Überparliament. But it is trying.

Electricity companies

Adapting to plug-ins

Electric cars could help save power utilities from a “death spiral”

Oct 4th 2014 | WASHINGTON, DC | From the print edition

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AFTER “rate hikes”, the most common phrase in America’s electricity industry these days is “death spiral”. The recession clobbered demand, and it has not recovered. Last year Americans used 2% less electricity than in 2007. The government’s Energy Information Administration reckons demand will grow by less than 1% a year between now and 2040 (see chart).

Consumers are buying more electric gadgets than ever, but the power these machines use is tumbling. Electricity consumed by TVs has fallen by a quarter in five years. Tablets and laptops use less than desktop computers, and cloud computing means businesses need fewer power-hungry servers. And then there is “distributed generation”, which covers everything from household solar and geothermal systems to on-site electricity generation by large businesses and college campuses. All steal sales from power companies.

In this section

• Tying up the cable business
• A bit too cosy?
• What is it really worth?
• The Germans are coming, again
• Launching into the unknown
• Adapting to plug-ins
• Good, in parts
• Philosopher kings

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• United States
• Technology
• Science and technology
• Automotive technology
• Electric vehicles

The utilities are required to guarantee continuity of the electricity supply, which means they must keep spending on infrastructure and maintenance even as customers build their own power sources. So far the main response of the companies’ generally risk-averse bosses has been to propose building conventional generation and distribution projects, and to lobby regulators to let them raise their prices to pay for these—including imposing extra charges on customers who have solar panels.

But this only makes “home-brew” electricity more competitive—so consumers buy even less power from the utilities, deepening the death spiral. Small wonder that analysts at Barclays bank recently downgraded the bonds of the entire American electricity industry. Given the utilities’ endless need for cheap funding, this was dire news: if investors switch off, that supply of money will shrivel.

What the industry needs is a new business model. The best prospect, thinks Elias Hinckley, an energy-finance specialist at Sullivan and Worcester, a law firm, is plug-in electric vehicles. Today, Americans’ daily spending on energy can be split into two large chunks: about $1 billion on electricity and $1.4 billion on fuel for their vehicles. In the past, electricity providers had no way to tap into the latter market. Plug-in cars should change that.

A modest 250,000 plug-in cars now glide silently along American roads, and they currently account for fewer than 1% of vehicles sold. But sales have been almost doubling each year (compared with about 5% annual growth for the entire car industry), and homes that own a plug-in car typically consume 58% more electricity, according to Opower, a seller of energy-conservation software. The Edison Electric Institute, a power-industry trade body, recently issued a report that called plug-ins a “quadruple win” for utility companies. In other words, they could help the industry increase demand, meet environmental goals, get closer to customers and cut costs by electrifying its own vast vehicle fleets.

Missing a trick

Power companies are not exactly rushing into the market. Some big ones, including Dominion, NRG Energy and Duke Energy, have between them installed a few hundred plug-in car-charging stations; some of them have pilot programmes that let owners sell power stored in the cars’ batteries back to the grid at times of peak demand. But none is partnering with plug-in carmakers to offer cheap installation of home chargers, and fewer than one in ten offers special tariffs to plug-ins’ owners—two lost opportunities that, says Mr Hinckley, “boggle my mind”.

The utilities are standing by as firms such as ChargePoint, CarCharging and SemaConnect build networks of thousands of fast public and private chargers—inserting themselves into the customer relationship that plug-in car owners might have with electricity providers. The utilities, thinks Mr Hinckley, fail to understand that “they could literally own America’s future transportation infrastructure”.

The picture is somewhat confused because, in America at least, early adopters of plug-in cars are often among the first to start generating their own electricity. Opower found that 32% of plug-ins’ drivers (admittedly in the wealthier, sunnier, western parts of the country that it surveyed) also have rooftop solar panels. The reduction in these consumers’ purchases of electricity from the grid, as a result of owning solar panels, slightly outweighs the increase from having plug-in cars, so they end up buying a little less power from the utilities than households with neither.

What this may mean is that utilities enjoy a recovery in demand as plug-in cars become popular, then a renewed fall as solar kits (whose price has halved in the past five years) also become ubiquitous. Rich, sunny bits of America will see this phenomenon first, but it will surely come to the rest of the country, and other parts of the world, too.

Nevertheless, it still makes sense for the power utilities to move swiftly into providing charging systems for electric cars, contracting with their owners to buy back energy stored in the vehicles’ batteries and indeed into installing and maintaining solar-power kits (as some already do). For these businesses have many years of growth ahead of them, unlike the power companies’ existing business. The utilities have a stark choice: sit back and be disrupted, or embrace the shock of the new.

Schumpeter

Philosopher kings

Business leaders would benefit from studying great writers

Oct 4th 2014 | From the print edition

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IT IS hard to rise to the top in business without doing an outward-bound course. You spend a precious weekend in sweaty activity—kayaking, climbing, abseiling and the like. You endure lectures on testing character and building trust. And then you scarper home as fast as you can. These strange rituals may produce a few war stories to be told over a drink. But in general they do nothing more than enrich the companies that arrange them.

It is time to replace this rite of managerial passage with something much more powerful: inward-bound courses. Rather than grappling with nature, business leaders would grapple with big ideas. Rather than proving their leadership abilities by leading people across a ravine, they would do so by leading them across an intellectual chasm. The format would be simple. A handful of future leaders would gather in an isolated hotel and devote themselves to studying great books. They would be deprived of electronic distractions. During the day a tutor would ensure their noses stay in their tomes; in the evening the inward-bounders would be encouraged to relate what they had read to their lives.

In this section

• Tying up the cable business
• A bit too cosy?
• What is it really worth?
• The Germans are coming, again
• Launching into the unknown
• Adapting to plug-ins
• Good, in parts
• Philosopher kings

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• Harvard Business School

It is easy to poke fun at the idea of forcing high-flying executives to read the classics. One could play amusing games thinking up titles that might pique their interest: “Thus Spake McKinsey”, or “Accenture Shrugged”, perhaps. Or pairing books with personality types: “Apologia Pro Vita Sua” for a budding Donald Trump and “Crime and Punishment” for a budding Conrad Black. Or imagining what Nietzschean corporate social responsibility would look like. Or Kierkegaardian supply-chain management.

Then there are practical questions. Surely high-flyers are decision-makers rather than cogitators? And surely they do not have time to spend on idle thought? However, a surprising number of American CEOs studied philosophy at university. Reid Hoffman, one of the founders of LinkedIn, was a philosophy postgraduate at Oxford University and briefly contemplated becoming an academic before choosing the life of a billionaire instead. Anyway, executives clearly have enough time on their hands to attend gabfests such as Davos, where they do little more than recycle corporate clichés about “stakeholders” and “sustainability”. Surely they have enough time for real thinkers.

Inward-bound courses would do wonders for “thought leadership”. There are good reasons why the business world is so preoccupied by that notion at the moment: the only way to prevent your products from being commoditised or your markets from being disrupted is to think further ahead than your competitors. But companies that pose as thought leaders are often “thought laggards”: risk analysts who recycle yesterday’s newspapers, and management consultants who champion yesterday’s successes just as they are about to go out of business.

The only way to become a real thought leader is to ignore all this noise and listen to a few great thinkers. You will learn far more about leadership from reading Thucydides’s hymn to Pericles than you will from a thousand leadership experts. You will learn far more about doing business in China from reading Confucius than by listening to “culture consultants”. Peter Drucker remained top dog among management gurus for 50 years not because he attended more conferences but because he marinated his mind in great books: for example, he wrote about business alliances with reference to marriage alliances in Jane Austen.

Inward-bound courses would do something even more important than this: they would provide high-flyers with both an anchor and a refuge. High-flyers risk becoming so obsessed with material success that they ignore their families or break the law. Philosophy-based courses would help executives overcome their obsession with status symbols. It is difficult to measure your worth in terms of how many toys you accumulate when you have immersed yourself in Plato. Distracted bosses would also benefit from leaving aside all those e-mails, tweets and LinkedIn updates to focus on a few things that truly matter.

Looking for answers

The business world has been groping towards inward-bound courses for years. Many successful CEOs have made a point of preserving time for reflection: Bill Gates, when running Microsoft, used to retreat to an isolated cottage for a week and meditate on a big subject; and Jack Welch set aside an hour a day for undistracted thinking at GE. Clay Christensen of Harvard Business School was so shocked at how many of his contemporaries ended up divorced or in prison that he devised a course called “How will you measure your life?”. It became one of HBS’s most popular courses and provided the basis of a successful book.

“Mindfulness” is all the rage in some big corporations, which have hired coaches to teach the mix of relaxation and meditation techniques. Big ideas are becoming as much of a status marker in high-tech hubs as cars and houses are in the oil belt. Peter Thiel, a Silicon Valley investor, holds conferences of leading thinkers to try to improve the world. David Brendel, a philosopher and psychiatrist, offers personal counselling to bosses and recently penned a blog for the Harvard Business Review on how philosophy makes you a better leader. Damon Horowitz, who interrupted a career in technology to get a PhD in philosophy, has two jobs at Google: director of engineering and in-house philosopher. “The thought leaders in our industry are not the ones who plodded dully, step by step, up the career ladder,” he says, they are “the ones who took chances and developed unique perspectives.”

Inward-bound courses would offer significant improvements on all this. Mindfulness helps people to relax but empties their minds. “Ideas retreats” feature the regular circus of intellectual celebrities. Sessions on the couch with corporate philosophers isolate managers from their colleagues. Inward-bound courses offer the prospect of filling the mind while forming bonds with fellow-strivers. They are an idea whose time has come.

Commodity prices

Oil and trouble

Tumbling resource prices suggest the world economy is slowing

Oct 4th 2014 | From the print edition

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GIVE commodity markets credit: they are anything but boring. Between 2000 and 2011 broad indices of commodity prices tripled, easily outpacing global growth and stoking Malthusian hysteria. Jeremy Grantham, a wealthy financier, noted at the time that it was not so much “peak oil” that would undo humanity but “peak everything else”. Yet since then commodity prices have slumped by about a quarter, and roughly 11% since June alone. That is not, however, an unalloyed good.

This reversal of fortunes, naturally, is much better news for net importers of resources than for net exporters. For consumers, a drop in the price of natural gas or rice is like a tax cut: it leaves households with more disposable income. Rising oil prices often tip importing countries into recession, and can put pressure on currencies as current-account deficits widen. The cheap resources of the 1990s, in contrast, helped to buoy real wages in the rich world.

In this section

• Oil and trouble
• Gross and net returns
• Plastic stochastic
• Prudence penalised
• Home is where the capital is
• Breaking the camel’s back
• Up and at ’em
• Concrete benefits

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• Emerging markets
• Economic indicators
• Coincident Economic Indicators
• Gross Domestic Product
• Recessions and depressions

Producing countries, many of which are relatively poor, suffer when prices drop. The last great bust, which began in the late 1970s, was a drag on developing economies for two decades (while the commodity boom of the 2000s was a big contributor to fast-growing incomes in the developing world). Low prices can mean financial turmoil for governments that relied on high ones to fund generous spending. A big enough bust could rattle financial markets around the world.

Just how much trouble to expect depends on the scale of the drop. In the short term commodity prices are a function of shifts in expectations of global demand, along with passing interruptions in supply. When the financial crisis took hold in late 2008, the price of raw materials plummeted. Oil, for example, fell from a high of $144 a barrel in the summer of 2008 to $33 a barrel in December of that year. Yet by late 2010, as global growth recovered on the back of rapid expansion in emerging markets, the price was nearing $100 again.

The current, gentler slide in prices also reflects a weakening world economy. Since 2010 global GDP growth, measured on a purchasing-power-parity basis, has slipped from more than 5% a year to just over 3%. The Chinese economy expanded at a double-digit pace in 2010 but may struggle to grow by 7% this year.

Global trade is decelerating too (see chart 1). In 2010 it made up lost ground from the recession, expanding by 12.8%. It has since slowed, to 6.2% in 2011 and to 3.0% in 2013. The World Trade Organisation (WTO) had forecast growth of 4.7% this year but revised that figure down to 3.1% in September. One of the main culprits, it reckons, is weak growth in imports in commodity-exporting countries, due to their straitened circumstances.

The WTO forecasts a rebound in growth and trade next year. Yet a return to the heady growth rates of the 2000s is unlikely, and risks abound, from conflict in Ukraine to Ebola in west Africa. The rich world’s recovery is anything but assured; the euro zone, which accounts for 13% of global output, is once again teetering on the brink of recession. China, an almost insatiable consumer of raw materials in recent years, is perhaps the biggest risk. The authorities there are trying to rebalance growth away from commodity-intensive investment in housing and other infrastructure. They also want to stem credit growth. If they overshoot and undermine growth, commodity prices will fall further.

Meanwhile, the investments in new supply initiated when prices were at their peak are finally coming to fruition. America’s oil production, for instance, has grown by 4m barrels a day since 2008 thanks to the fracking revolution.

Finding new mineral deposits or new land to cultivate takes time, and once new supplies have been identified, bringing them to market can take years as mines, wells and canals are dug and infrastructure is built. As a result, prices may rise for several years before the anticipated new supply materialises. Once it does, however, markets can become saturated and prices then fall for a prolonged spell.

This pattern is commonly called the commodity-price super-cycle. A few times, notes David Jacks of Simon Fraser University, the cycles for several different commodities have become synchronised during episodes of broad global growth—such that wheat, oil and nickel, say, all seem scarce at the same time. During such booms fears inevitably proliferate that the world will run out of essential raw materials. During the last great commodity wave, in the 1960s and 1970s, Paul Ehrlich, a biologist at Stanford University, published “The Population Bomb”, which gave warning that the world could not provide for its growing number of inhabitants. In 1980 Mr Ehrlich bet an economist, Julian Simon, that a basket of metals would rise in price over the next ten years. Mr Simon won, as supplies grew while consumers became better at conservation.

Production of most commodities has risen sharply over the past decade. The world’s output of iron ore, for example, has roughly tripled since 2000. Supply growth has begun to outstrip rising consumption for some commodities (see chart 2). With the world economy growing less frenetically than in the 2000s, lower commodity prices are inevitable.

The most worrying possibility is that lower prices may feed on themselves. Emerging markets were a big driver of global GDP growth in recent years; if commodities can no longer be counted upon to provide a tailwind, growth might sputter. Slower global growth could then feed back into weaker commodity demand. The cycle might be amplified by financial havoc as firms and governments in commodity-producing countries find their budgets stretched by tumbling prices and their balance-of-payments stressed by the reversal of capital flows.

Some commodity exporters are better equipped to manage a slowdown than in the past. A few used the boom to fill sovereign-wealth funds, to build stockpiles of foreign-exchange reserves or to pursue broader economic reforms. Colombia, Indonesia and Peru, for instance, have put themselves on a sounder economic footing as commodity prices have risen. In other countries, such as Russia and Venezuela, the bust is revealing the extent of the rot. The lower prices go, the more mismanagement will be laid bare.

Free exchange

Concrete benefits

Public investments in infrastructure do the most good at times like the present

Oct 4th 2014 | From the print edition

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THOSE trying to fly to or from Chicago in the past week learned first-hand the shortcomings of America’s public infrastructure. A suicidal employee set fire to a nearby air-traffic-control centre, resulting in the cancellation of thousands of flights, the third such interruption this year. The chaos is aggravated by a system dating from the 1950s that relies on radar. Unpredictable funding has delayed its planned replacement with a system that uses satellites.

Public infrastructure is one of the few forms of government spending that both liberals and conservatives support. Ports, power lines and schools are essential to the smooth running of the economy. But as America’s outdated air-traffic-control system shows, public investment is at the mercy of the fiscal weather. Cash-strapped governments are loth to pile on debt or raise taxes even for something as popular as a new road. After a burst of stimulus spending in the immediate wake of the recession, public investment has fallen back in the rich world (see charts).

In this section

• Oil and trouble
• Gross and net returns
• Plastic stochastic
• Prudence penalised
• Home is where the capital is
• Breaking the camel’s back
• Up and at ’em
• Concrete benefits

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• Politics
• Government and politics
• Political policy
• Public finance
• Government spending

This is profoundly short-sighted. That is the message of a new study by the International Monetary Fund, released as part of its half-yearly “World Economic Outlook”. It found that in rich countries at least, infrastructure spending can significantly boost growth through higher demand in the short run and through higher supply in the long run. This comes with caveats: the results depend on how the investment is financed, how efficiently it is carried out and what the prevailing economic conditions are. As it happens, the present conditions are perfect.

Upfront fixed costs for infrastructure projects are typically high and operating costs relatively low. For these reasons, public infrastructure is often a natural monopoly: a city needs only one local telephone network, electricity grid or sewer system, so they are frequently publicly owned or regulated. They are also expensive and politically sensitive and can thus be hard for private firms to finance.

Eval‎uating the effect of public investment on growth is muddied by the question of causality: does infrastructure spending boost growth or do faster-growing countries spend more on infrastructure? The IMF answered this question by studying public investment “shocks” in 17 rich countries between 1985 and 2013, when investment grew more than forecast, on the theory that politicians are unlikely to have boosted spending at the last minute because the economy was doing well. The results were striking. On average, an unexpected increase in public investment equal to 1% of GDP boosted GDP by an underwhelming but still beneficial 0.4% in the same year and by a more impressive 1.5% four years later. The extra spending did not result in unsustainable debts; quite the opposite. Thanks to higher GDP, the debt-to-GDP ratio fell by 0.9 percentage points in the first year and four percentage points after four years, although the authors do not set any store by the latter figure because there was so much variation in the results.

Importantly, however, those averages cloak significant differences. When investment is financed without borrowing—that is, with higher taxes or cuts to other spending—it has a small but still positive impact, which grows over time. The authors interpret this as evidence that even when public investment does not directly lift demand, it does so indirectly by “crowding in” private investment, for example by stimulating the construction of houses and factories when new roads and water mains are installed. Private investment, the authors note, rises in line with the new, elevated level of GDP after a burst of public investment.

Debt becomes them

The stimulus is heightened when the investment is financed by borrowing: an increase in public investment equivalent to 1% of GDP boosts GDP by 0.9 points in the first year and 2.9 points in the fourth. This would not be so if debt-financed spending inevitably drove up interest rates and thereby diminished private investment. But the effect is bigger in a slow-growing economy, when rates are low and competition for loans subdued. Under those circumstances, a boost in public investment equal to a percentage point of GDP boosts GDP by an impressive 1.5 points in the first year and three points in the fourth. By contrast, in a fast-growing economy, the impact is actually negative in the first year, and only marginally positive in the fourth, suggesting that “crowding out” can indeed be a problem.

Judging by these results, the time is now optimal for more public investment. The added demand would be welcome since unemployment is still too high in most rich countries and interest rates near zero. The supply-side effects may also be considerable; declining public investment has led to a shrinking stock of infrastructure relative to GDP (see charts). Investment and the capital stock are higher relative to GDP in emerging countries, but they are much lower per person, and thus also ripe for a boost.

Still, identifying a general shortfall in infrastructure investment is easier than working out what projects to spend extra money on. Of the seven biggest rich economies, only Germany and America have suffered a clear deterioration in infrastructure investment since 2006. And public investment is easily wasted on vanity projects such as football stadiums or inflated contracts with politically connected suppliers. Even in relatively transparent, democratic places such as America, with lots of bureaucrats to conduct cost-benefit analyses, identifying the most beneficial investments is hard. The interstate highway system, built mostly during the 1950s and 1960s, delivered huge productivity benefits, according to a 1999 study by John Fernald of the Federal Reserve Bank of San Francisco; returns to expanding the system would presumably not be as big. Moreover, in America, it takes between nine and 19 years to plan and build a big highway. By that point, the optimal moment for boosting public investment may have come and gone several times.

Buttonwood

Gross and net returns

The lessons from a star money manager’s exit

Oct 4th 2014 | From the print edition

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THE departure of Bill Gross, the world’s best known bond manager, from PIMCO, the investment firm he helped to found, has many potential lessons. At its simplest, it can be portrayed as a Shakespearean drama; the ageing king who refused to loosen his grip on power. Eventually, his subordinates rebelled and overthrew him.

PIMCO’s other titan, Mohamed el-Erian, departed earlier this year, prompting a reorganisation of the management team. The next generation of leaders wanted to expand in new areas, something Mr Gross apparently resisted. The Securities and Exchange Commission, an American regulator, recently announced an investigation into pricing at the Total Return fund, the main outlet for Mr Gross’s talents, creating the potential for damage to his reputation. Mr Gross ostensibly moved to Janus, a smaller fund manager, to focus more on investment and less on management, but he clearly jumped before he was pushed. The lesson could be that founders are rarely good at succession planning; they often stay in place too long.

In this section

• Oil and trouble
• Gross and net returns
• Plastic stochastic
• Prudence penalised
• Home is where the capital is
• Breaking the camel’s back
• Up and at ’em
• Concrete benefits

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• Pacific Investment Management
• Business
• Fixed-income securities
• Bill Gross
• Financial markets

A second lesson concerns whether investment firms are wise to rely on the reputation of a “star” fund manager. At its peak, the Total Return fund had assets of $290 billion, a good chunk of PIMCO’s $2 trillion total. Mr Gross’s occasionally eccentric pronouncements (he once devoted a section of his newsletter to the death of his pet cat) were avidly watched by other investors.

In recent years, he has made some big calls on the bond market. Four years ago, he talked of the British bond market resting on a bed of nitroglycerine; three years ago, he worried that yields would rise when the Federal Reserve ended its second round of quantitative easing. Neither bearish bet on bonds paid off and the Total Return fund suffered a slump in performance; its return is below the average for similar bond funds over the past five years.

In the short term, PIMCO may be damaged as clients follow Mr Gross to Janus. But the Total Return fund was already suffering outflows because of its faltering performance. In the long run, PIMCO may benefit if clients are drawn more by the strength of its team, and less by the abilities of an individual. Analysing the global bond markets, with their many different countries, currencies, maturities and credit ratings is not a one-man job.

The third lesson is for investors: beware big funds if they are actively managed. If a large bond fund is to beat the market (and justify its fees), the manager probably has to make some big bets on the economy. This is not the same thing as finding a few neglected companies, whose bonds are undervalued because investors have overlooked a crucial fact. Fund managers have no advantage in predicting the economic outlook; indeed, most economists failed to foresee the recession in 2008.

The “big fund” problem previously emerged at Fidelity, where its Magellan equity fund rose to prominence under manager Peter Lynch. After he left in 1990, the fund underperformed the S&P 500 in 12 of the next 20 years, although it did not reach its peak size of $110 billion until 2000. It has since shrunk to $17 billion.

This is a perennial issue. When fund managers perform well, they attract clients and the fund gets bigger. Eventually, however, the fund will stumble. There are three possible reasons for a reversion to the mean. First, the initial strong performance was down to luck, not skill. Second, the initial performance was due to a trend, such as rising technology stocks or falling interest rates (which boost bond prices); eventually, the trend changes. Third, the manager will struggle to excel as the fund grows bigger, perhaps because it has to invest in the shares of bigger companies, or because it must buy more liquid assets; eventually the fund starts to resemble the index.

When performance falters, money will exit again. Thus, in what might be called the Sod’s law of fund management, a fund’s worst year will probably occur when it is at its biggest. The last clients to jump on the bandwagon will be those who earn the weakest returns.

The same rules do not apply to passive funds, which explicitly try to match the index. In those cases, a bigger fund should lead to economies of scale which can be passed on to clients in lower fees. But the expense ratio of 0.46% on the Total Return fund translates into costs of $1 billion a year at its current size. According to Morningstar, an agency that rates funds, this charge “is a lot more than one might expect given [its] size”. Investors are betting big on PIMCO’s ability to beat the market.