by David Steven | Feb 11, 2008 | South Asia
On Saturday, I wrote about the black mood that’s gripping Pakistan, with many here asking whether the country faces a descent into chaos.
So, how serious is the threat?
Very, if you believe the 2007 Failed States Index, which places Pakistan twelfth, only a couple of points behind its neighbour, Afghanistan. The country was 36th in 2005.
Pakistan’s decline is unsurprising. It sits on the modern world’s key geopolitical, religious and ethnic fault lines. Any country that borders Afghanistan, India, China and Iran is in for a hard time. Add in disastrous domestic politics and a dose of counter-productive international meddling and you’re left with a toxic brew.
But three less obvious drivers have caught my eye during a visit here. Each of these ‘hidden drivers’ (I use the term loosely) suggests ongoing trouble for the country, even if its geopolitical problems begin to ease.
First, there’s the country’s rotten demography – or more accurately the interaction between its demographics and rotten policy. Last week, I met Durre Nayab, a demographer at Pakistan’s Institute of Development Economics whose work draws heavily on the research of my sometime co-author, the economist David Bloom.
Bloom’s work (summarised here) demonstrates the demographic dividend countries can collect while they have young populations. This dividend, he has shown, accounts for around a third of the East Asian economic miracle. But it is only on offer if countries can educate their workers, employ them productively, and give them opportunities to save. At present, Pakistan does none of these things.
Durre Nayab:
The demographic dividend is inherently transitory in nature. Due to lack of prior planning, Pakistan has wasted the first 15 years of the opportunity demography has offered it…Time is running out to put appropriate policies in place, the absence of which may result in large-scale unemployment, [and] immense pressure on health and education systems.
In short, a socio-economic crisis may take place making the demographic dividend more of a demographic threat.
Then add the second hidden driver – the growing impact of scarcity on the Pakistani working and middle classes.
Pakistan’s newspapers, at the moment, are full of complaints about rocketing food and energy prices. The price of flour has more than doubled in recent times, a situation the government is trying (and failing) to control. Electricity is also in short supply, due to a failure to build new power stations in line with rising demand. A World Bank report published a few days sums up the situation.
Pakistan is one of the most water stressed countries in the world, and water resources are depleting rapidly. With its water infrastructure in poor condition… Pakistan has to invest around Rs60 billion (US$1 billion) per year in reservoirs and related infrastructure over the next five years. In the energy sector, the country will face severe power shortages of around 6,000 megawatts by 2010. Similarly, inefficiencies in the transport sector cost the economy between 4-5 percent of GDP each year.
The report is extremely pessimistic about Pakistan’s ability to correct these deficits.
Three factors are causing this problem. First, there are global factors in play, as my colleague Alex Evans has extensively documented. Energy prices are high; food and oil prices are now linked; and water scarcity is certain to increase. Climate change adds another layer of threat, both globally and within Pakistan (recent electricity shortages have been partly been down to a lack of water for hydropower).
Second, there is the Pakistan government’s total failure to develop infrastructure. More people, rising living standards, and falling prices for energy-hungry appliances have all increased demand for energy, but rulers have failed to respond to clear warnings of trouble ahead. Instead, the government is engaged in what will surely prove to be a futile attempt to keep prices low through subsidies and controls. The country is already struggling to pay its fuel bills, with the government budgeting for an oil price at less than 70 dollars per barrel, and suffering as it heads ever higher.
And finally, there is the impact of unrest, instability and out-and-out sabotage. John Robb highlights the potential damage that this type of tax can do to a fragile economy in his book, Brave New War (drawing on this analysis by James Harrigan and Philippe Martin). “Singular terrorist events (black swans), such as 9/11, do not affect city viability,” Robb writes. “The costs of a singular event dissipate quickly. In contrast, frequent attacks (even small ones) on a specific city can create a terrorism tax of a level necessary to shift to a [lower] equilibrium.” In other words, the city will be out of kilter – literally not worth living in – until it shrinks.
This effect may be underway in Pakistan’s urban centres, and possibly in the country as a whole, as insurgent attacks combine with political instability and sheer unrest to erode the country’s infrastructure. According to the Daily Times:
Violence has grown in the cities most hit by load-shedding and outages. Karachi and Hyderabad are the two cases in point. After the assassination of Ms Bhutto on December 27, there was anger and fury which vented itself on public property. Not all of the protesters were the workers of the PPP. Some were common criminals looting banks, but a large number were ordinary citizens habituated to violence through Karachi’s most cruel period of power outage in the summer of 2007.
And finally, a third hidden driver: the worrying role being played by the Pakistan army, once a source of national stability and pride. It is no secret that the army has hollowed out many, if not all, of the country’s political institutions, but less well understood is its growing economic dominance, a phenomenon excellently explored in Ayesha Siddiqa ground-breaking recent book, Military Inc – Inside Pakistan’s Military Economy (allegedly banned in Pakistan, but I found a copy on sale in a Lahore hotel).
The army, Siddiqa reports, controls bakeries and banks, fertilizer plants and television channels, shopping malls and motorway toll booths. It is also a massive land owner, co-opting state land and acquiring private land, sometimes by coercion. And of course, it can use its political and military might to protect its investments, while using its wealth to gain permanent autonomy from civilian control.
The growth of the military’s economic empire… was parallel to the increase in the organization’s political power and influence in national decision-making. As the military consolidated itself into a class, it gained greater confidence to exploit national resources and acquire greater opportunities, which benefited it as an institution and also filled the pockets of the senior generals…
The crystallization of these economic interests is a major determinant to the future of democracy in the country.
So you have an army that is engaged in banditry…hordes of alienated young people…an economy that is vulnerable to scarcity and disruption… in a country that is already prey to many other stresses. It’s a sobering outlook. For a couple of years, I suppose, the country can continue to muddle through. But corrective action is now desperately needed.
After all, you never know which straw is the last one until you hear the camel’s back snap.
by Alex Evans | Feb 11, 2008 | Cooperation and coherence, Influence and networks, UK
Peter Riddell at the Times has the details:
Further far-reaching changes in the running of 10 Downing Street are imminent … The two big appointments so far this year – of Jeremy Heywood as permanent secretary at 10 Downing Street, and of Stephen Carter, from the private sector, as chief of strategy and principal special adviser in charge of political strategy, communications and research, including the policy unit – will now be followed by the addition of more new staff. Mr Heywood is bringing in some civil servants to strengthen the private office and domestic policy side and a number of special political advisers are being recruited. This is to provide a new viewpoint and to beef up the policy unit. In addition, new advisers on developing a media strategy are being hired. This inevitably raises questions about the creation of a prime minister’s department in substance if not in title, an issue that everyone involved wants to dodge.
As significant as these changes is Mr Brown’s acceptance that he misjudged what was necessary to run No 10. There was an unprecedented turnover of staff when Tony Blair left Downing Street last summer because virtually all the special advisers left (apart from two in the policy unit) and there were changes among most of the key Civil Service officials. The result was an initial sharp fall in the number of people working in No 10, which, visitors said, felt much less crowded than in Mr Blair’s heyday. This was partly deliberate as Mr Brown sought publicly to distance himself from both the “sofa government” and presidential aspects of his predecessor’s style. Consequently, he brought over only a handful of officials and advisers from the Treasury to run No 10. Mr Brown now accepts that this was not sufficient to handle an operation as complicated as a prime minister’s office. Like many of his predecessors, he has been struck by the intensity of the media pressure: when one thing goes wrong, so do two or three others.
These concerns led to the reappraisal by the Brown inner circle before and during Christmas that led to the appointments of Mr Heywood and Mr Carter. They now share an office next to the Cabinet Room, which, before last June, was used by Mr Blair as his den or private office. Mr Brown now uses a small room on the other side of the lobby outside the Cabinet Room as his private office, although he meets visitors upstairs in what is now called the Thatcher Room next to the state rooms on the first floor overlooking Horseguards Parade.
The Heywood-Carter team has reviewed the operation and concluded that it has been short of numbers, and weight, in some areas. Mr Heywood is familiar with the No 10 operation from his days as principal private secretary under Mr Blair: his rank and authority are now much greater. Mr Carter, whose main experience has been in the business and media worlds, has had to adjust to the tight and tribal world of the Brown inner circle and to the private language and understandings of politicians and advisers.
It’s reminiscent of the story of the National Security Council under the Bush Administration, which initially slashed staff numbers, only to increase them again under Stephen Hadley when it became clear that the inter-agency co-ordination process was foundering – not least for want of capacity at the centre.
by Alex Evans | Feb 11, 2008 | Conflict and security, Influence and networks, North America
Lawrence Wright has an excellent interview with US Director of National Intelligence Mike McConnell in the last edition of the New Yorker. Read the whole thing; but here are three highlights.
First, note McConnell’s assessment of the relative place of terrorism on America’s threat list – which chimes with remarks made here in the UK by Richard Mottram before Christmas:
I asked McConnell if he believed that Al Qaeda was really the greatest threat America faces.
“No, no, no, not at all,” he said. “Terrorism can kill a lot of people, but it can’t fundamentally challenge the ability of the nation to exist. Fascism could have done that. Communism could have. I think our issue going forward is more engagement with the world in terms of keeping it on a reasonable path, so another ism doesn’t come along and drive it to one extreme or another. And we have to have some balance in terms of equitable distribution of wealth, containment of contagious disease, access to energy supplies, and development of free markets. There are national-security ramifications to global warming.”
He looked down at the patchwork quilt of the Pennsylvania countryside. His thoughts quickly turned back to terrorism. “One of the things I worry about most would be something like a pandemic, particularly if it could be weaponized, like avian flu,” he continued. “You could turn that into a human virus. You could have fifty million to five hundred million deaths.”
Second, the article notes the interesting creation of:
…an intelligence version of DARPA, the Defense Advanced Research Projects Agency, which was created in 1958, after the Soviet launch of Sputnik, and led to the development of the Internet, the Global Positioning System, night-vision goggles, Predator drones, and Stealth aircraft….
Like DARPA, the O.D.N.I. version sponsors radical innovation — “game-changing breakthroughs,” as [ODNI head of science and technology, Steve] Nixon puts it. The program has only a few dozen employees, but it expects to collaborate with private businesses, nonprofits, and universities. The most significant product of this effort so far is Argus, a program that monitors foreign news reports and other open sources looking for evidence of bird die-offs, crop failures, an unusual number of death notices—anything that could provide an early warning of an epidemic, nuclear accident, or environmental catastrophe.
The program, which began in 2004, spotted the appearance of avian flu in 2006 and a recent outbreak of Ebola in Angola. During flu season last year, the program tracked more than a thousand socially disruptive diseases simultaneously. Argus now monitors a million Web pages in twenty-eight languages and in nearly every country in the world—except the U.S., where such scrutiny would stir concerns about domestic spying.
Finally, a useful piece of advice given to McConnell by Colin Powell, when the latter was Chairman of the JCS and the former his intelligence officer:
“Tell me what you know, then tell me what you don’t know, and only then can you tell me what you think. Always keep those three separated.”
by Alex Evans | Feb 11, 2008 | Global system
Time to remind ourselves that while we’ve all been cooing over Obama and fretting over NATO cohesion, the small matter of the security of the world’s financial system has continued to smoulder. At dinner with a group of hedge fund analysts last week, it was abundantly clear that just because the issue has disappeared from the front pages for a time doesn’t mean it’s gone away: au contraire, one analyst was bluntly stating that all we’ve seen so far has been no more than the trailer.
Nouriel Roubini, bearish as ever (though let’s remember that he’s been consistently right so far), asks the big question:
Why did the Fed ease the Fed Funds rate by a whopping 125bps in eight days this past January? It is true that most macro indicators are heading south and suggesting a deep and severe recession that has already started. But the flow of bad macro news in mid-January did not justify, by itself, such a radical inter-meeting emergency Fed action followed by another cut at the formal FOMC meeting.
To understand the Fed actions one has to realize that there is now a rising probability of a “catastrophic” financial and economic outcome, i.e. a vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe. The Fed is seriously worried about this vicious circle and about the risks of a systemic financial meltdown.
So to cheer you on your way on a foggy London morning in February, here’s Roubini’s 12-step “‘nightmare’ or ‘catastrophic’ scenario that the Fed and financial officials around the world are now worried about” – which “has a rising and significant probability of occurring”. Here’s the executive summary for those of you too lazy to set up a free subscription to read the whole thing:
1. This is already the worst housing recession in US history; prices will fall 20-30% from their peak. That would imply about 10 million homes in negative equity.
2. Financial system subprime losses are now estimated at $250 to $300 billion; and now spreading to near-prime and prime, through the same lax lending criteria: “this is a generalized mortgage crisis and meltdown, not just a subprime one”. And don’t forget all the off-balance sheet Structured Investment Vehicles etc., and the fact that “because of securitization the securitized toxic waste has been spread from banks to capital markets and their investors in the US and abroad, thus increasing – rather than reducing systemic risk – and making the credit crunch global”.
3. “The recession will lead – as it is already doing – to a sharp increase in defaults on other forms of unsecured consumer debt: credit cards, auto loans, student loans.” All of which makes the credit crunch even more severe – and takes it from large banks through to smaller banks. [Loan companies are already scrambling to tighten up lending criteria in the UK, as the FT set out over the weekend.]
4. “While there is serious uncertainty about the losses that monolines will undertake on their insurance of RMBS, CDO and other toxic ABS products, it is now clear that such losses are much higher than the $10-15 billion rescue package that regulators are trying to patch up.” As a result, their debt rating will probably get downgraded; which will lead to large losses for funds that invested in them, and another sharp drop in US equity markets. [For more background, here’s a story about monolines from last week that made the front page of the FT.]
5. Next, “the commercial real estate loan market will soon enter into a meltdown similar to the subprime one”, thanks to – guess what? – similarly reckless lending criteria. So, “the housing crisis will lead – with a short lag – to a bust in non-residential construction as no one will want to build offices, stores, shopping malls/centers in ghost towns”. [FT last week: outflows from UK commercial property up 76 per cent from third quarter.]
6. It’s entirely possible that a large regional or even national bank will go bust. “The Fed will have to reaffirm the implicit doctrine that some banks are too big to be allowed to fail. But these bank bankruptcies will lead to severe fiscal losses of bank bailout and effective nationalization of the affected institutions.” [Sound familiar?]
7. Bank losses on leveraged loans are already large, and rising – “leading to a freezing up of the CDO market and to growing losses for financial institutions”.
8. “Once a severe recession is underway a massive wave of corporate defaults will take place.” Roubini adds, “in a typical year US corporate default rates are about 3.8% (average for 1971-2007); in 2006 and 2007 this figure was a puny 0.6%. And in a typical US recession such default rates surge above 10%.”
9. The “shadow financial system” – non-bank financial institutions – will shortly get into serious trouble. And unlike proper banks, “these non-bank financial institutions don’t have direct or indirect access to the central bank’s lender of last resort support as they are not depository institutions”.
10. Stock markets in the US and abroad will start pricing in a severe recession rather than just a slowdown. Roubini notes that “in a typical US recession the S&P 500 falls by about 28%”.
11. Liquidity in financial markets will dry up all over again; the easing pf the liquidity crunch after central banks’ massive interventions in December and January will reverse.
12. “A vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction”.
All in all:
A near global economic recession will ensue as the financial and credit losses and the credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will exacerbate the financial and real economic distress as a number of large and systemically important financial institutions go bankrupt. A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress. Monetary and fiscal easing will not be able to prevent a systemic financial meltdown as credit and insolvency problems trump illiquidity problems. The lack of trust in counterparties – driven by the opacity and lack of transparency in financial markets, and uncertainty about the size of the losses and who is holding the toxic waste securities – will add to the impotence of monetary policy and lead to massive hoarding of liquidity that will exacerbates the liquidity and credit crunch…
Can the Fed and other financial officials avoid this nightmare scenario that keeps them awake at night? The answer to this question – to be detailed in a follow-up article [here] – is twofold: first, it is not easy to manage and control such a contagious financial crisis that is more severe and dangerous than any faced by the US in a quarter of a century; second, the extent and severity of this financial crisis will depend on whether the policy response – monetary, fiscal, regulatory, financial and otherwise – is coherent, timely and credible. I will argue – in my next article – that one should be pessimistic about the ability of policy and financial authorities to manage and contain a crisis of this magnitude; thus, one should be prepared for the worst, i.e. a systemic financial crisis.
by Alex Evans | Feb 11, 2008 | Middle East and North Africa, North America, South Asia
James Kirchik, writing in the New Republic, discusses the “admittedly bizarre rumor circulating at the United Nations and the State Department, where many are speculating that Khalilzad–currently America’s ambassador to the United Nations and the highest-ranking Muslim to serve in the Bush administration–is contemplating a run for Karzai’s job”. Kirchik continues:
…Khalilzad himself has done little to quiet the speculation, offering only vague, quasi-denials in person and through his spokespeople. Asked about the rumor while speaking at Columbia University earlier this month, Khalilzad first joked, “I didn’t come here to collect contributions for my campaign. I know how poor students are.” He then added, “I can say categorically that I am not a candidate for the presidency of Afghanistan.”
Lest you think that sounds like a categorical denial: “as a U.N. diplomat stressed to me, he only said he was not currently running, rather than saying he would never run”. Sounding like the fevered speculations of a media machine looking for a story? Perhaps so, but
A former State Department official told me that Khalilzad should have immediately deflated the rumor himself, and that his recent comments on the matter are still too equivocal. “When you’re the U.S. ambassador, confirmed by the U.S. Senate, representing the U.S. government, one should not tolerate rumors that you’re interested in running a foreign government,” this person told me. “It can easily be put to rest with an unequivocal, firm ‘I have no intention of seeking the office,’ ” says Bruce Riedel, a friend of Khalilzad who served on the National Security Council during the Clinton and second Bush administrations. “Why does this [rumor] keep surfacing?”
