Wind, water and sun beat other energy alternatives, study finds

The best ways to improve energy security, mitigate global warming and reduce the number of deaths caused by air pollution are blowing in the wind and rippling in the water, not growing on prairies or glowing inside nuclear power plants, says Mark Z. Jacobson, a professor of civil and environmental engineering at Stanford.

Wind power is the most promising alternative source of energy, according to Mark Jacobson.
And "clean coal," which involves capturing carbon emissions and sequestering them in the earth, is not clean at all, he asserts.

Jacobson has conducted the first quantitative, scientific evaluation of the proposed, major, energy-related solutions by assessing not only their potential for delivering energy for electricity and vehicles, but also their impacts on global warming, human health, energy security, water supply, space requirements, wildlife, water pollution, reliability and sustainability. His findings indicate that the options that are getting the most attention are between 25 to 1,000 times more polluting than the best available options. The paper with his findings will be published in the next issue of Energy and Environmental Science but is available online now. Jacobson is also director of the Atmosphere/Energy Program at Stanford.

"The energy alternatives that are good are not the ones that people have been talking about the most. And some options that have been proposed are just downright awful," Jacobson said. "Ethanol-based biofuels will actually cause more harm to human health, wildlife, water supply and land use than current fossil fuels." He added that ethanol may also emit more global-warming pollutants than fossil fuels, according to the latest scientific studies.

The raw energy sources that Jacobson found to be the most promising are, in order, wind, concentrated solar (the use of mirrors to heat a fluid), geothermal, tidal, solar photovoltaics (rooftop solar panels), wave and hydroelectric. He recommends against nuclear, coal with carbon capture and sequestration, corn ethanol and cellulosic ethanol, which is made of prairie grass. In fact, he found cellulosic ethanol was worse than corn ethanol because it results in more air pollution, requires more land to produce and causes more damage to wildlife.

To place the various alternatives on an equal footing, Jacobson first made his comparisons among the energy sources by calculating the impacts as if each alternative alone were used to power all the vehicles in the United States, assuming only "new-technology" vehicles were being used. Such vehicles include battery electric vehicles (BEVs), hydrogen fuel cell vehicles (HFCVs), and "flex-fuel" vehicles that could run on a high blend of ethanol called E85.

Wind was by far the most promising, Jacobson said, owing to a better-than 99 percent reduction in carbon and air pollution emissions; the consumption of less than 3 square kilometers of land for the turbine footprints to run the entire U.S. vehicle fleet (given the fleet is composed of battery-electric vehicles); the saving of about 15,000 lives per year from premature air-pollution-related deaths from vehicle exhaust in the United States; and virtually no water consumption. By contrast, corn and cellulosic ethanol will continue to cause more than 15,000 air pollution-related deaths in the country per year, Jacobson asserted.

Because the wind turbines would require a modest amount of spacing between them to allow room for the blades to spin, wind farms would occupy about 0.5 percent of all U.S. land, but this amount is more than 30 times less than that required for growing corn or grasses for ethanol. Land between turbines on wind farms would be simultaneously available as farmland or pasture or could be left as open space.

Indeed, a battery-powered U.S. vehicle fleet could be charged by 73,000 to 144,000 5-megawatt wind turbines, fewer than the 300,000 airplanes the U.S. produced during World War II and far easier to build. Additional turbines could provide electricity for other energy needs.

"There is a lot of talk among politicians that we need a massive jobs program to pull the economy out of the current recession," Jacobson said. "Well, putting people to work building wind turbines, solar plants, geothermal plants, electric vehicles and transmission lines would not only create jobs but would also reduce costs due to health care, crop damage and climate damage from current vehicle and electric power pollution, as well as provide the world with a truly unlimited supply of clean power."

Jacobson said that while some people are under the impression that wind and wave power are too variable to provide steady amounts of electricity, his research group has already shown in previous research that by properly coordinating the energy output from wind farms in different locations, the potential problem with variability can be overcome and a steady supply of baseline power delivered to users.

Jacobson's research is particularly timely in light of the growing push to develop biofuels, which he calculated to be the worst of the available alternatives. In their effort to obtain a federal bailout, the Big Three Detroit automakers are increasingly touting their efforts and programs in the biofuels realm, and federal research dollars have been supporting a growing number of biofuel-research efforts.

"That is exactly the wrong place to be spending our money. Biofuels are the most damaging choice we could make in our efforts to move away from using fossil fuels," Jacobson said. "We should be spending to promote energy technologies that cause significant reductions in carbon emissions and air-pollution mortality, not technologies that have either marginal benefits or no benefits at all".

"Obviously, wind alone isn't the solution," Jacobson said. "It's got to be a package deal, with energy also being produced by other sources such as solar, tidal, wave and geothermal power."
During the recent presidential campaign, nuclear power and clean coal were often touted as energy solutions that should be pursued, but nuclear power and coal with carbon capture and sequestration were Jacobson's lowest-ranked choices after biofuels. "Coal with carbon sequestration emits 60- to 110-times more carbon and air pollution than wind energy, and nuclear emits about 25-times more carbon and air pollution than wind energy," Jacobson said. Although carbon-capture equipment reduces 85-90 percent of the carbon exhaust from a coal-fired power plant, it has no impact on the carbon resulting from the mining or transport of the coal or on the exhaust of other air pollutants. In fact, because carbon capture requires a roughly 25-percent increase in energy from the coal plant, about 25 percent more coal is needed, increasing mountaintop removal and increasing non-carbon air pollution from power plants, he said.

Nuclear power poses other risks. Jacobson said it is likely that if the United States were to move more heavily into nuclear power, then other nations would demand to be able to use that option.
"Once you have a nuclear energy facility, it's straightforward to start refining uranium in that facility, which is what Iran is doing and Venezuela is planning to do," Jacobson said. "The potential for terrorists to obtain a nuclear weapon or for states to develop nuclear weapons that could be used in limited regional wars will certainly increase with an increase in the number of nuclear energy facilities worldwide." Jacobson calculated that if one small nuclear bomb exploded, the carbon emissions from the burning of a large city would be modest, but the death rate for one such event would be twice as large as the current vehicle air pollution death rate summed over 30 years.

Finally, both coal and nuclear energy plants take much longer to plan, permit and construct than do most of the other new energy sources that Jacobson's study recommends. The result would be even more emissions from existing nuclear and coal power sources as people continue to use comparatively "dirty" electricity while waiting for the new energy sources to come online, Jacobson said.

Jacobson received no funding from any interest group, company or government agency.
Energy and vehicle options, from best to worst, according to Jacobson's calculations:
Best to worst electric power sources:
1. Wind power
2. Concentrated solar power (CSP)
3. Geothermal power
4. Tidal power
5. Solar photovoltaics (PV)
6. Wave power
7. Hydroelectric power
8. A tie between nuclear power and coal with carbon capture and sequestration (CCS).

Best to worst vehicle options:
1. Wind-BEVs (battery electric vehicles)
2. Wind-HFCVs (hydrogen fuel cell vehicles)
3. CSP-BEVs
4. Geothermal-BEVs
5. Tidal-BEVs
6. Solar PV-BEVs
7. Wave-BEVs
8. Hydroelectric-BEVs
9. A tie between nuclear-BEVs and coal-CCS-BEVs 11. corn-E85 12.cellulosic-E85.

Hydrogen fuel cell vehicles were examined only when powered by wind energy, but they could be combined with other electric power sources. Although HFCVs require about three times more energy than do BEVs (BEVs are very efficient), HFCVs are still very clean and more efficient than pure gasoline, and wind-HFCVs still resulted in the second-highest overall ranking. HFCVs have an advantage in that they can be refueled faster than can BEVs (although BEV charging is getting faster). Thus, HFCVs may be useful for long trips (more than 250 miles) while BEVs more useful for trips less than 250 miles. An ideal combination may be a BEV-HFCV hybrid.

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When does one good deed deserve another?

Rationality suggests that trust should build slowly and that people should proceed cautiously when building a relationship. But what if you only have one chance to decide whether to trust someone? In that case, caution might be a poor choice: it can be perceived as distrust and thus reduce the possibility of engendering trust. To investigate this, J. Keith Murnighan of the Kellogg School of Management, with Madan M. Pillutla (London Business School) and Deepak Malhotra (Harvard Business School), performed two experiments using the Trust Game. In the Trust Game, a player (Player 2) decides whether and how much to reciprocate when given money by an anonymous person (Player 1), with both players knowing that however much Player 1 sends, Player 2 gets triple that amount.

Game theory, which analyzes the best courses of action in competitive situations, predicts that Player 1 will send no money because of the risk of getting nothing back, even though sending nothing sacrifices the benefits that come from tripling the amount sent. For both players to obtain these benefits, Player 1 must bear the risks, with rational models of trust development suggesting that initial risks taken be relatively small. If the acts of trust are too small, however, then they may not be recognized as trust and they might even anger Player 2s who expect Player 1s to see the benefits of sending more.

Precipitous acts of trust, which on the surface may seem irrational, can accelerate trust development.

Earlier studies of the relationship between trust and reciprocity often used Prisoner’s Dilemma games in which the rational, short-term strategy is for a prisoner to confess. This leads to a better outcome regardless of their partner’s choice. But if both use this logic and confess, both prisoners go to jail for a much longer period than they would if they both kept quiet. Keeping quiet leads to the most efficient outcome and depends on the prisoners trusting each other. When the players know they will see each other in the future, the cooperative outcome becomes more likely.

Trust and Reciprocity
In Pillutla, Malhotra, and Murnighan’s experiments, players had only one interaction, giving them no opportunity for reputation building. Participants, all Player 2s, were told that an anonymous player (Player 1) could send them any portion of a fixed amount of money ($10 or $20), and they would actually receive three times the money sent. Thus, if Player 1 sent $5, Player 2 received $15. Player 2 then decided how much, if anything, to return to Player 1. The investigators experimentally manipulated the amounts (from $2 to the entire amount) sent by Player 1.

Feelings of obligation or indebtedness might compel Player 2 to return some money, especially if Player 1 chose to send all or most of their money. By setting up the experiments so Player 2 could receive more or less than the amount Player 1 retained, the authors could directly examine the influence of the amount sent on feelings of obligation as well as actual reciprocity.
Player 1s in the Trust Game face a difficult choice: the more they send, the more they risk, because Player 2 is not required to return any money. Thus, Player 1s must balance their risks with their expectations that Player 2s will reciprocate; if Player 2s do not reciprocate, any money sent is lost. Murnighan and his co-authors speculated that with maximal trust—sending everything—Player 2s would feel a strong sense of obligation, reciprocity would be the greatest, and non- reciprocation would be least likely. After the experiment, participants responded to a questionnaire concerning their feelings about Player 1s, the amount they returned, and the characteristics they attributed to Player 1s.

Greater Trust, Greater Returns

Both experiments showed that reciprocity increased as the money sent increased: sending more increased reciprocity. When Player 2s could achieve equal outcomes (because Player 1s sent them enough), 80 percent of the recipients returned just enough to equalize the two players’ final outcomes. Although maximal trust actually did not increase the likelihood of reciprocity, it did increase the chance that—when players did reciprocate—they would return an amount that equalized returns. And when Player 1s only sent small amounts, recipients frequently returned nothing. Feelings of obligation completely explained the relationship between the amounts sent and returned: larger amounts sent led to greater feelings of obligation and greater returns. Also, after playing the Trust Game, Player 2s viewed Player 1s who sent more money as more trusting and more intelligent.

The results contrast markedly with rational prescriptions for trust development which favor caution. Instead, these findings indicate that precipitous acts of trust, which on the surface may seem irrational, can accelerate trust development. Precipitous acts of trust do entail risk, as evidenced by the frequent instances of zero returns. According to Murnighan, “There may be too much risk and very little payoff for sending a lot of money.” Nevertheless, the amounts returned were higher for maximal and almost-maximal trust. From a societal standpoint, the authors conclude, “Sending everything maximizes joint outcomes, and, if reciprocity could be guaranteed, might increase Player 1 outcomes by as much as 50 percent.” People who exhibited more trust and took greater risks benefited more—in this case monetarily—and people who exhibited less trust and took smaller risks often missed a golden opportunity.

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How not to lose the top job

Advice from a veteran executive coach on building relationships and defusing land mines on your way to the corner office.

Your CEO has just told you that the decision is in. You’re the chosen one—the company’s next chief executive! Nothing is going to be put in writing for now, he explains. A premature public announcement might surprise other executives who are angling for the job and could trigger departures. More important, if the announcement comes too early, it could make him look like a lame duck and create confusion about who really is in charge.

The CEO smiles and assures you, “I’m confident that if you just do your job, everything will work out. We’re going to have a great transition!” You leave the meeting feeling wonderful. Your succession, you believe, is now only a matter of time.

In my 31 years of executive coaching, I have been amazed by the number of “future CEOs” who reported having a conversation like this—yet didn’t get the position. In one of my client corporations, three different executives believed that they had received this assurance from the CEO, and each was certain that he or she was going to be the company’s next leader. Surprise! This CEO later told me that he was shocked that all these candidates thought they already had the job.


In the vast majority of cases where this type of miscommunication occurs, no one is lying. The CEOs want to convey an aspirational message to the potential heirs but truly believe that no promise was made. The potential heirs tend to hear what they want to hear and honestly believe that their appointment is a done deal.

The fact is, no succession is ever a sure thing, even when an executive actually does have the enthusiastic backing of the CEO. The last leg of the road to the corner office can contain unexpected hazards, and aspiring CEOs can find themselves suddenly knocked out of contention—or out of the company altogether. In most instances I have seen, this happens because something has gone wrong between the potential successor and one or more important constituencies.

Six Reasons Why CEO Succession Candidates Don’t Get the Job—Despite Their Best Efforts

1. The potential successor and the CEO miscommunicate. The executive who believes the CEO has anointed him as heir is never really in line for the job. He hears what he wants to hear.
2. The CEO and the board miscommunicate. The CEO believes she has the board’s backing for her choice as successor, but the board never really approves the selection. She hears what she wants to hear.
3. The CEO decides to stay put. When the time to leave comes, the CEO realizes he doesn’t want to give up the job and concludes that the successor is not ready—regardless of what the successor has done.
4. The board falls in love with an outsider. Even though the board thinks the potential successor is a great choice and intends to promote him, members become enamored with an external star and give her the job.
5. A board member takes the job. The potential successor is derailed by a board member who gets an inside track on the job.
6. Company performance tanks. External events or internal blunders (including scandals) send profits into a nosedive or otherwise taint the company. No one from the inside is going to be promoted under these circumstances.

Understanding Your Stakeholders
Much of what has been written about CEO succession ignores the personal drama that unfolds when it’s time to pass the torch of leadership. Succession isn’t an entirely rational process. CEOs, heirs, and their key stakeholders are human. Very few of the articles and books on this topic, however, deal with soft personal issues like relationships, egos, or (God forbid) feelings.

In practice, succession decisions may be influenced as much by stakeholders’ gut feelings and emotions as they are by business logic. Strains in the relationships between stakeholders and the heir apparent can emerge and quickly scuttle succession plans, and faulty assumptions can cause decision makers to suddenly change their minds about who should lead the company next.

There are six key stakeholders—or stakeholder groups—whose perceptions can alter the succession decision: The current CEO, the potential successor’s peers, his or her direct reports, customers, analysts and shareholders, and, of course, the board of directors. The advice that follows can help you strengthen your essential relationships with these stakeholders and get the top job.

The CEO
In 1978 many observers considered Ford Motor president Lee Iacocca the obvious candidate for the CEO position that Henry Ford II would shortly vacate. Iacocca, of course, not only didn’t get the position but was fired. In explaining why he cut Iacocca loose, Ford famously remarked, “Sometimes you just don’t like somebody.”
In my work I’ve seen this dynamic time and time again. If the current CEO doesn’t like you or doesn’t want you to get the job, you probably won’t get it.
It’s critical for CEO candidates to maintain the trust and full support of the current CEO. If you can’t do this, perhaps you should look for another job. This may seem simple and obvious, but I’ve seen several executives derail their careers by making avoidable blunders with their CEOs. One that I witnessed involved a series of e-mails between a potential CEO and a friend inside the company. The first e-mail to the friend provided an elaborate description of “why the current CEO is an idiot.” The friend sent a reply. Several rounds of e-mails followed. Then the friend sent an e-mail containing a funny joke. The potential CEO decided that the current CEO would love this joke and forwarded it to him. You can guess what happened next. The CEO scrolled down the e-mail chain and found the “idiot” message. The heir apparent was gone in a week.
Even subtle comments that the current CEO construes as hostile or simply inappropriate can have the same effect. One heir apparent talked a little too openly about “what the company will be like when I’m in charge” and was eliminated from the running because the CEO thought he was being “cocky” and “acting as if he had the job before it was given to him.” As heir, you have to strike a delicate balance between projecting your readiness to be CEO and conveying your loyalty and support for the current regime. There is a fine line between an assertive leader and a cocky candidate.
A CEO candidate also can do everything right but not get the job because the CEO never intended to promote him or her in the first place. I saw this happen when I was asked to coach one CFO for the top job. The CEO had told the CFO that he would become the new chief executive if he improved his interpersonal skills. The CFO was assured that all his technical and functional skills—including those in marketing—were fine. I coached the CFO for a year, and at the end a report from 15 of his colleagues documented a dramatic improvement in his social skills. The CEO nonetheless denied his promotion because, he said, the CFO “lacked the marketing skills needed to do the job”—the very same marketing skills that the CEO told him he possessed a year earlier.
What went wrong? It turned out that the CEO didn’t particularly like the CFO, needed him in his current position, and had used the carrot of the promotion—and the coaching requirement—to keep him in the corporation. Of course, when the CFO actually did improve his interpersonal skills, the CEO had to devise another reason to block his advancement.
Sometimes the CEO truly intends to promote the successor but, when push comes to shove, just can’t let go and leave the job. Walking away from the money, status, influence, and fame of the top position can be tough. Not only are CEOs often reluctant to give up the perks of the job, but they may be anxious about potentially losing their identity and facing a less exciting future. What’s more, the heir’s performance can be seen as a reflection on the retiring CEO. If the successor fails, the former CEO will have to deal with the guilt of having recommended a poor replacement and the pain of the company’s declining stock value. If the heir succeeds and improves the firm’s performance, the CEO will have to confront embarrassing comments like “The company has really done well since you retired.” The former CEO can come off as a loser either way!
To help ensure that you have the support of the CEO:

• When the CEO anoints you as heir, have a heart-to-heart talk to confirm that what the CEO is saying, and what you’re hearing, are the same. In a diplomatic way, repeat what you have heard and say what you believe it means. Often the implied promise of a promotion is less solid than it seems.
• Take stock of whether you have the trust of the CEO. Evaluate whether past conflicts, perceived insults, or other relationship missteps with the CEO could undermine your candidacy.
• Determine if you need to make changes in your personal style or relationship-building approach to get the CEO’s full backing and then make them. Don’t try to fake these changes; your boss is not stupid. Most important, addressing your weaknesses is the right thing to do for both you and the company. One of the greatest frustrations that I hear from CEOs when discussing successors is “If he just made this one change to his style, he would become so much more effective. I have told him this over and over. Why doesn’t he just do it?”
• Go out of your way to maintain an authentically positive relationship with the CEO. Many stakeholders who have the power to challenge your bid are watching how you and the CEO relate. Be sensitive to the CEO’s emotional experience of letting go, but don’t suck up or provide artificial praise. If you have concerns about the CEO’s decisions, share them with the CEO privately. Don’t ever talk about her behind her back. Period. Not only might it damage your relationship with her, but it may cause others to lose confidence in her—either of which could undermine the future success of your firm.
• Make sure you and the CEO agree on how to manage your direct reports’ performance. I have seen candidates criticized by CEOs both for failing to “deal with” poor performers and for “unfairly” dismissing loyal employees.

Your Peers
It will be exceedingly hard to get the top job without your peers’ support. The CEO, board, and other stakeholders will be watching closely for any indication that your colleagues aren’t behind you. One chief executive flat out told his potential successor (who was my client), “If you can’t build positive relationships with your current peers, you can’t become our next CEO. You will need their commitment if the company is to prosper after I leave.”
In another case, I had been brought in to work on the successor’s leadership skills, a process that depends on assessments by stakeholders. It quickly became clear that his peers had no interest in helping this potential CEO improve (in fact, they wanted him to be fired). Eventually, the current CEO and the board realized that this candidate’s peers had written him off and were never going to give him a fair chance, no matter what he did. Shortly thereafter, he learned that it was unlikely he would ever become the chief executive.
Managing peer relationships when you’re the heir apparent is a perilous balancing act. If you’re too assertive, you may be viewed as pushy or arrogant. If you’re not assertive enough, you may be seen as lacking the leadership skills needed to run the company. Either perception can undermine your chances of success. Remember that while you want to behave like a great CEO by demonstrating professionalism, leadership, and knowledge of the business, you don’t want to act as if you are the CEO by, for instance, giving orders to your peers. This, too, may seem obvious, but you’d be amazed at how often I’ve seen heirs make this mistake.
One factor complicating your relationship with peers is that many of them may believe that they, too, have a shot at the top job. In extreme cases, they may do whatever they can to sabotage your chances for succession. If you think this is happening, don’t sink to their level. Take the high road and just concentrate on doing what is right for the company. In the long run, your reputation for integrity will increase your effectiveness in the firm while saboteurs’ behavior will ultimately become apparent and undermine theirs.
To help ensure that you have the support of your peers:

• Focus particular attention on building or reinforcing personal relationships with them, especially those you want to stay at the company. For example, if the head of a certain division has customer relationships that are critical to the firm, competitors may try to court him when you’re promoted. Find out what’s important to him and how to keep him on board—before the succession decision is announced. Enlist the current CEO’s help in finding the correct balance between being too pushy and not providing enough leadership. You’ll inevitably have conflicts with some peers during your run for the top job; make sure that you win the important battles—and let go of those that are not worth winning.
• Ask your peers for ideas about how you can be a great team player. Take their suggestions, and Avoid competitive or destructive comments about your peers, even if they make these types of comments about you. Such dysfunctional behavior ultimately does the perpetrator more harm than good.

Your Direct Reports
The leadership feedback that you (and your CEO) receive from your direct reports can be an excellent predictor of your ability to lead the company. Poor feedback from a direct report can sabotage an heir apparent, just as poor feedback from peers can.
Take the case of one division president and potential CEO I was asked to coach. His direct reports had concluded that he was incapable of making clear decisions and setting a strategic course for his division. The current CEO had held the role of division president before him and still had close relationships with the potential successor’s direct reports. They had frequent dialogues with the CEO and conveyed their dissatisfaction with the president’s leadership. In spite of my efforts as a coach—and the president’s efforts to change his behavior—I was dismissed, and he was demoted. Whether the reports were right or wrong in some absolute sense is irrelevant. The CEO respected these people, and the president did not convince them that he could be an effective leader.
My good friend and mentor, leadership expert Paul Hersey, taught me that “leadership is not a popularity contest.” Sometimes as a potential CEO you will be asked to execute tough decisions that the current chief executive doesn’t want to deal with—reining in budgets, cutting staff, or shutting down projects, for example. Ultimately, you need to do what is right for the company and its customers, even if that means ruffling some feathers (or worse). On the other hand, my good friend and colleague Jim Kouzes, also a leadership expert, has noted that “leadership is not an unpopularity contest.” If you want to be the CEO, you have to demonstrate that you can get the job done and still build and maintain good relationships with your reports. Again, this requires walking a fine line: If you focus too much on whether your reports like you, you’ll come off as lacking in courage. If you’re too directive, you can seem authoritarian and disrespectful. The key is to gain the commitment of your reports by soliciting their ideas and involving them in decisions whenever appropriate.
To help ensure that you have the support of your direct reports:

• Get confidential 360-degree feedback that includes input from direct reports. Build upon your perceived strengths, identify opportunities for improvement, and regularly follow up with your reports to ensure progress. In a study involving more than 86,000 participants from eight companies, my research partner, Howard Morgan, and I found that confidential feedback—when combined with disciplined follow-up—significantly increases direct reports’ perceptions of an executive’s leadership effectiveness.
• Work with the current CEO to strike the right balance between being demanding of direct reports and showing them respect, especially in a turnaround situation. This can strengthen your relationships with both your reports and the CEO. Ask the HR team members to help you by sharing with you what they know about the sensitivities of individual executives.
• Some of your direct reports may have personal relationships with the CEO and may discuss your performance with her. Don’t become defensive or try to insulate the CEO from their criticism of you. Doing so can corrode your relationship with both the report and the CEO. Instead, do your best to modify the behavior your reports are unhappy about.
• Never make destructive or otherwise inappropriate comments about key stakeholders in front of your direct reports. It will make them wonder what you say about them behind their backs, eroding their trust.
• When you and the CEO agree on any move that may negatively affect your reports, show your support for the decision. Never say, “The CEO is making us do this.” Passing the buck conveys a lack of both loyalty and leadership ability. If you don’t agree with the move, talk with the CEO about it face-to-face and present your case. But after the final decision is made, you must take responsibility for its execution and demonstrate unity with the CEO.

Key Customers

It’s possible to have the support of the CEO, your peers, and your direct reports, and still be vetoed by key customers, as I saw at one manufacturing company that was a major supplier to the defense industry. Years before, when a potential successor to the CEO was a young salesman, he had alienated a junior officer. Now the same officer was wearing two stars—and was an important customer. This officer made it clear to his friends on the board that if the potential CEO ever became the actual CEO, he would have second thoughts about continuing to do business with the company. The succession candidate didn’t get the job. Though it may have been too late for this heir apparent to repair the customer relationship, for other executives there often is time during the succession process to mend fences.
If your company’s customers are primarily transactional, buying products and services with little concern for ongoing relationships, they’re unlikely to have much influence on your run for the CEO office. However, if your company has key relationship customers who generate a substantial amount of revenue, customer feedback may be a critical factor in whether or not you get promoted. For example, many banks and financial services firms have chief executive clients who want to deal directly with the bank’s CEO. Given the social and business circles they move in, these clients often have relationships with the bank’s board members. Building relationships with them before becoming a CEO candidate will improve an executive’s chances of getting the job and of succeeding in it.
To help ensure that you have the support of key customers:

• Work with the CEO to identify the most important customer relationships that involve high-level executives, and get to know those people as soon as possible. Don’t just discuss immediate business with them; go out of your way to build personal relationships with them.
• Determine which customers have close personal relationships with board members. Work with the CEO to understand those relationships and the CEO’s role in them.
• Discuss the balance between customer satisfaction and business needs with the CEO. In some cases (such as pricing) you may have to make hard decisions that anger customers. When you make a decision that may not be in the customer’s best interests but is required for the good of the company, explain the rationale to the customer.

Analysts and Shareholders
If analysts believe that a potential CEO has misled them, he or she may never be able to overcome that stigma. Consider this case: One client company’s future CEO was president of the business’s largest division. He made stretch commitments to the current CEO regarding the future market share for his unit. Coincidentally, the company’s leading competitor launched a more attractive product at a cheaper price that ate voraciously into the company’s market share. Rather than admitting an error in projections, the president assured the CEO that his team would make the numbers. The CEO gave the projections to the analysts, and the analysts shared these projections with the business press. When the unit missed its numbers by a huge margin, not only did the analysts’ trust in the president evaporate, but the press leaped on the discrepancy between the projections and the actual results. Both the CEO and president were publicly portrayed as out of touch. The president, his reputation tarnished, left the company, and ultimately the board dismissed the CEO.
Had the president been willing to level with the CEO about the problems meeting the numbers, the two could have worked together to communicate revised projections and strategies to the analysts. They probably would have retained the analysts’ trust and confidence, and might have remained on the company’s leadership team.
Major activist shareholders can also sway boards on CEO selection. This is especially true if the company is facing difficult times and the stock price is falling. CalPERS and other major shareholder groups are becoming increasingly active in their role as investors and have been known to pressure boards on leadership decisions. CalPERS was instrumental in forcing Richard Grasso out of the New York Stock Exchange, for instance.
To help ensure that you have the support of analysts and shareholders:

• Don’t shrug off respected colleagues who tell you that the results you’re promising cannot be delivered. Ask yourself whether you’re fully confident you can hit the forecasts you’ve given to analysts, shareholders, or the press.
• Provide honest—and even conservative—projections. One big miss can eliminate your chances for succession. If it appears that the results will fall short, issue a revision as soon as possible.
• If your company has individual shareholders who own a large percentage of the stock, get to know them and work to address their concerns.
• Work with the CEO to prepare for and manage the unexpected in shareholder meetings. One executive was derailed in part because a somewhat eccentric shareholder with minimal holdings succeeded in making him look like an idiot at a major shareholder event.

The Board of Directors
At the end of the day, the final vote on CEO selection is made by the board. Some potential successors never get this and fail to manage their board relationships as carefully as they manage those with other stakeholders. Big mistake!
Board members are no more or less human than anyone else. A potential CEO who was a client of mine got into a single heated argument with a couple of board members—and from then on was viewed as stubborn and insensitive. Although this executive worked hard at improving his interpersonal behavior—and had no further problems with the board—a year later some board members still recounted this one disagreement as evidence that this leader might not be qualified to be the CEO. He eventually got the job, but it was a close call.
Even if you have blundered with one board member or another over the years, it’s possible to overcome such missteps, as this executive did. The key is to know what the board’s impression of you is, what concerns individual board members may have about you, and even what board members’ individual communication preferences are. Armed with this knowledge, you can tailor your interactions with the board to efficiently convey your strengths. One CEO successor, for example, learned to give a financially oriented director detailed explanations of the numbers before board meetings—while giving an HR-focused director detailed explanations of the strategy for developing people. You can also shore up perceived weaknesses and, if needed, try to fix damage from past mistakes.
The potential for colliding expectations among stakeholders is perhaps the greatest danger in the heir’s dealings with board members. The board may be seeking a change agent, for example, while peers and reports don’t want a CEO who will rock the boat. In my experience, one of the biggest mistakes a potential successor can make is to tell different stories to different stakeholders. Here’s an example of a CEO-elect who managed a potentially tough situation at the board level in a way that worked: He had decided that changing a certain product line was necessary for the future of the company—even though this change would be very costly to a current board member, who was also a former key customer. The candidate knew that pushing through the change could threaten his succession but worked with the current CEO to clearly communicate the rationale behind the decision to the interested board member—even though this director was excused from voting on the decision because of the potential conflict of interest. The board member took the high road, crediting the candidate for having the courage to do what was right for the company even though it risked his promotion. The appointed successor became the CEO.
To help ensure that you have the support of board members:

• Talk with the CEO about the board members’ perceptions of you. Learn if there are areas in which the directors believe you need to improve. Work with the CEO to help change their perception if needed.
• Review the connections that board members have with your other stakeholders. If any of these parties have enough clout with board members—and don’t want you to get the job—your promotion may get derailed. If you have succeeded in improving key stakeholder relationships that were in doubt, work with the CEO to ensure that these positive changes are communicated to the board.
• Ask the CEO to help you prepare for presentations to the board. Assuming the CEO wants you to get the job, he or she can offer the best advice about how to meet the board’s expectations.
• Understand whether the board is seeking a change agent in the new CEO, an executive who will execute the current strategy, or something in between. Work with the current CEO to determine the best way to gain this insight. Be sure that the strategic vision you convey meets the board’s expectations but doesn’t undermine the vision of the current CEO.

Doing What’s Right
One of the greatest Fortune 500 CEOs that I have met—who is widely considered the top leader in her industry—was discussing the importance of key stakeholder relationships with her potential successor. When she delivered some negative feedback she’d gotten on his behavior, the successor became a little annoyed and grumbled, “Does this coaching mean that I have to watch everything that I say—in every meeting—for the rest of my career?”
The CEO smiled wearily and replied, “Welcome to my world. If you ever want to be the CEO, get used to it.”
Following the suggestions presented in this article requires a lot of work. As the wise leader in this anecdote noted, if you ever want to be a CEO, get used to it. The greatest CEOs are the ones who continue to build and maintain support among all their key stakeholders. Practicing this behavior before you get the job will only help you after you get the job.
Finally, you should do all this work not just because it will help your career but because it’s the right thing to do. The effort you spend on building relationships will make you a better leader and a better person—and that’s good for you and good for the company, whether you become the CEO or not.

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Swinging the axe

Job-cutting has begun in earnest. But will the axe be wielded wisely?

THE headlines screamed that January 26th was “Black Monday” for jobs, after firms such as Caterpillar, Corus, Home Depot, ING, Pfizer and Sprint Nextel announced cuts of several thousand jobs each, due mostly to the rapidly deteriorating global economy. Alas, the consensus among the corporate bigwigs gathered this week at the World Economic Forum in Davos was that this marked only the beginning of the axe-swinging, and that there are blacker days to come.

This proved to be one of the big points of difference between the company bosses and the politicians brainstorming in the mountains. The politicians are primarily concerned with restoring demand enough to reverse the rising trend in unemployment; for many of the corporate leaders, ensuring the survival of their firms takes precedence over saving jobs. The difficult decision they face is not whether to cut, but how to do so in a way that strengthens their competitive position in the medium term rather than seriously damaging it.

The gloomy mood among bosses in Davos makes the worst-case scenario outlined in a new forecast from the International Labour Organisation (ILO) seem the most plausible of its possible outcomes. This supposes that if every economy in the developed world performs as it did in its worst year for unemployment since 1991, and every other economy performs half as badly as in its worst year, then the global jobless rate will rise to 7.1% this year—some 230m people, up from 179m in 2007.

The ILO’s most optimistic prediction is that global unemployment will rise only to 6.1% (from 6% in 2008). But that assumes that the world economy performs as the IMF forecast in November: global GDP growth of 2.2% in 2009, with a slight recession in the developed economies. The IMF has since become much glummer: this week it forecast growth of just 0.5%.
Already, firms are starting to find that their first round of cuts after the onset of the crisis is not enough. Caterpillar’s latest cut of 5,000 jobs is in addition to 15,000 already announced. Such is the frenzy of cutting that Challenger, Gray & Christmas, a recruitment firm that tracks employment trends in America, sought a crumb of comfort in its finding that over 50% of firms have cut jobs: it proclaimed in its latest report that “nearly half of employers avoid lay-offs.” But it pointed out that things would be even worse without the various innovative schemes adopted by companies to reduce labour costs without shedding jobs. These include salary cuts, reduced hours and “forced vacations”.

As Challenger suggests, this seems in keeping with the suggestion by Barack Obama in his inauguration speech that people should “cut their hours [rather] than see a friend lose a job.” Already, by way of example, White House staff earning $100,000 or more have had their salaries frozen. Companies including Avis, Starbucks and Yahoo! have announced pay freezes for 2009.

Yet these creative job-saving schemes are unlikely to go anywhere near as far as Mr Obama would like. They may appeal as a way to buy some time as companies try to get a clearer picture of where the economy is heading, or to retain talented workers who are likely to be needed in the future, if not now. But they have little appeal once a firm has decided that it needs to scale back its operations. As the boss of a big American retailer put it privately at Davos, “We have to decide who we want on the bus and to motivate them as much as possible.” Clever ways to share the pain can demotivate everyone, especially if they are seen as merely postponing the inevitable job cuts, making everyone fearful.

Painful choices

Equally candidly, many bosses admit that the crisis is giving them a chance to restructure their firms in ways that they should have done before, but found a hard sell when things were going well. As a rule of thumb, a careful cull of the 10% of lowest performers can make a firm leaner by removing fat without damaging muscle. It is going beyond the 10%, as many firms are now starting to do, that poses the real risks to a firm’s competitiveness.

During the relatively modest downturn at the start of this decade, for example, many professional-services firms cut too deeply, especially in their lower ranks, and found they were poorly positioned when strong growth resumed sooner than expected, says Heidi Gardner of Harvard Business School. Firms built on pyramid structures in which senior managers mentored larger numbers of employees below them suddenly found that, in a growing economy, they lacked the mentors needed to manage the army of new recruits. Instead, they had to re-hire ex-staffers at higher salaries and, in some cases, abandon proven policies of hiring senior managers only from within, says Ms Gardner, who worked for McKinsey at the time.

This crisis is revealing how few firms have really thought through their talent strategies, says Mark Spelman of Accenture. Claims that “our workers are our most valuable assets” are too often platitudes, the emptiness of which is now being revealed. But those firms that have thought seriously about their talent needs have the opportunity to get ahead of those that haven’t, says Mr Spelman, not just by shedding poor performers but also hiring scarce talent from outside, in what is now a buyer’s market. Other tips from Mr Spelman include avoiding voluntary redundancy programmes, which encourage the most employable people to quit, and not firing the newest recruits on a crude “last in, first out” basis, as this cuts off the supply of future talent. Instead, firms should identify which workers they need to keep, and do what they must to retain them.

Governments can play a useful role or a harmful one, depending upon their attitude to companies, says David Arkless of Manpower, an employment-services firm. If they focus on working with firms to smooth the movement of labour to where the future work will be, for example by providing skills training and financial incentives to workers in transition, then the economic downturn could be less painful than now seems likely. (A quick recovery in lending to small businesses, the main drivers of job creation in most countries, would also help.) But if governments try to prevent firms from making the changes to their workforces that they want, the result is likely to be prolonged gloom.

Although Mr Obama’s support for strengthening the ability of unions to enter workplaces is arguably a worrying sign, the American economy is far more accommodating of flexibility in employment than many European countries. Mr Arkless, for one, says that without a dramatic change of attitudes to job-cutting in Europe, “there is no doubt that American firms will come out of this downturn better than anywhere else in the world, due to their flexible employment model.” This will provide no comfort to anyone facing the prospect of unemployment, but it is a message that politicians would do well to take to heart.

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(Nearly) nothing to fear but fear itself

CRISES feed uncertainty. And uncertainty affects behaviour, which feeds the crisis. Were a magic wand to remove uncertainty, the next few quarters would still be tough (some of the damage cannot be undone), but the crisis would largely go away.

From the Vix index of stockmarket volatility (see chart), to the dispersion of growth forecasts, even to the frequency of the word “uncertain” in the press, all the indicators of uncertainty are at or near all-time highs. What is at work is not only objective, but also subjective uncertainty, or what economists, following Chicago economist Frank Knight’s early 20th-century work, call “Knightian uncertainty”. Objective uncertainty is about what Donald Rumsfeld (in a different context) referred to as the “known unknowns”. Subjective uncertainty is about the “unknown unknowns”. When, as today, the unknown unknowns dominate, and the economic environment is so complex as to appear nearly incomprehensible, the result is extreme prudence, if not outright paralysis, on the part of investors, consumers and firms. And this behaviour, in turn, feeds the crisis.

It affects portfolio decisions. It has led to a dramatic shift away from risky assets to riskless assets, or at least assets perceived as riskless. It sometimes looks as if investors around the world only want to hold American Treasury bills. Why? At the start was the realisation that many of the new complex assets were in fact much riskier than they had seemed. This realisation has now morphed into a general worry about nearly all risky assets, and about the balance-sheets of the institutions that hold them. “Better safe than sorry” is the motto. Unfortunately, while the motto may make sense for individual investors, it is having catastrophic macroeconomic consequences for the world. It is triggering enormous spreads on risky assets, a credit crunch in advanced economies, and major capital outflows from emerging countries.

It affects consumption and investment decisions, and is largely behind the dramatic collapse in demand we have observed over the last three months. Sure, consumers have lost a good part of their wealth, and this is reason enough for them to retrench. But there is more at work. If you think that another Depression might be around the corner, better to be careful and save more. Better to wait and see how things turn out. Buying a new house, a new car or a new laptop can surely be delayed a few months. The same goes for firms: given the uncertainty, why build a new plant or introduce a new product now? Better to pause until the smoke clears. This is perfectly understandable behaviour on the part of consumers and firms—but behaviour which has led to a collapse of demand, a collapse of output and the deep recession we are now in.

So what are policymakers to do? First and foremost, reduce uncertainty. Do so by removing tail risks, and the perception of tail risks. On the portfolio side, establish a price, or at least a floor on the price, of the troubled assets. Ring-fence them or take them off bank balance-sheets. On the consumption side, commit to do whatever it will take to avoid a Depression, from fiscal stimulus to quantitative easing. Commit to do more in the future if necessary. Above all, adopt clear policies and act decisively. Do too much rather than too little. Delays in financial packages have cost a lot already. Further rounds of debate will stoke uncertainty and make things worse.

Second, undo the effects of uncertainty on the portfolio side, and help recycle the funds towards risky assets. The standard advice here is to return the private financial sector to health through recapitalisation. That is absolutely right, but easier said than done. And, while damage is slowly repaired, it makes sense for states to recycle part of the funds themselves. To caricature: if the world loves American Treasury bills but the funds would be more useful elsewhere, then the government should issue the bills, and use the proceeds to channel the funds where they are needed. It should buy some of the riskier assets, and return some of these funds back to emerging-market countries to offset capital outflows. This is indeed close to what America’s Federal Reserve is now doing with quantitative easing at home and swap lines to foreign central banks. The only difference is that the Fed issues money rather than treasury bills in exchange for its purchases. It would make more sense for the Treasury to be involved, and to separate more clearly the role of fiscal and monetary policy, but, in the current state of play, this is a minor wrinkle. Either will do.

Retail therapy
Third, undo the effects of the wait-and-see attitudes of consumers and firms on the demand side. Get them to spend more, and have the state do some of the spending itself. Offer incentives to buy now rather than later; for example, temporary subsidies to consumers who turn in a clunker and buy a new car, a measure adopted in France. Increase spending on public infrastructure, a central component of President Barack Obama’s programme. Both types of measures are indeed present in the fiscal programmes more and more countries are putting in place. If tailored and communicated well, these programmes cannot only stimulate and replace private demand, but also convince consumers and firms that they are not in for another Depression. This will ensure that they stop waiting and start spending again.

Coherent financial, fiscal and monetary measures are all needed. All three will have direct effects on demand. But, as importantly, they will help reduce uncertainty, lower risk spreads, and get consumers and firms spending again. If policymakers act decisively, private demand will recover sooner rather than later. And, within a year or less, we can be on the path to recovery.

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Big government fights back

Public debt is rising at its fastest pace since the second world war as governments battle financial crisis and recession. Will the fiscal firepower work?

FEW now doubt that the world economy is in its most parlous state since the 1930s. Demand is slumping across the globe as firms and consumers are battered by a pernicious, self-reinforcing bombardment of dysfunctional financial markets, falling wealth, higher unemployment and rampant fear. The IMF’s latest forecasts, published on January 28th, suggest 2009 will bring the deepest global recession in the post-war era.

To stem the slump, governments are fighting back with an activism rarely seen outside wartime (see interactive graphic). In some countries, notably China, official estimates overstate the likely fiscal stimulus. But even adjusted for bureaucratic hyperbole the government response is hefty. Weighted by their economies’ size, the plans of 11 big advanced and emerging economies are worth an average of 3.6% of GDP—though spread over several years. The IMF expects tax cuts and spending worth 1.5% of global GDP to kick in this year.

In many rich countries the stimulus has been matched—and often dwarfed—by the upfront costs of financial rescues, including the recapitalisation of banks and guarantees for troubled assets. America’s Treasury has so far promised about $1 trillion (7% of GDP) for the finance industry.
Add in the tax revenues lost from slumping output and falling asset prices as well as the spending on higher unemployment benefits, and the IMF expects rich countries’ combined fiscal deficit to rise to 7% of GDP in 2009, up from less than 2% in 2007. By the end of this year the developed world’s gross government debt, as a share of GDP, may be 15-20 percentage points higher than it was two years ago.
Emerging economies are spilling less red ink, both because their banking industries are in less of a mess and because their stimulus plans, in general, are smaller. But they, too, will shift from a budget surplus in 2007 to a deficit of 3% of GDP. All told, public-sector debt is rising at its fastest pace since the second world war.
Most economists agree that the red ink is both unavoidable and appropriate. To prevent a steep recession becoming a depression, governments must step in to forestall financial collapse and counter the slump in private demand. Financial markets seem to agree. Yields on government bonds in most rich countries are extremely low as shell-shocked investors clamour for the safety of public debt.
Yet a few signs of skittishness are emerging. Prices of credit-default swaps on sovereign debt have risen sharply, suggesting that investors see growing risks of default. Within the rich world, risk premiums have risen dramatically for already-indebted governments such as those of Greece and Italy. Yields on America’s 30-year bonds saw their biggest jump in two decades in mid-January, as investors fretted about Uncle Sam’s demand for cash.
This skittishness partly reflects uncertainty about how the government debt will be financed. But the real worry is that the ultimate public price tag will be much bigger than today’s figures suggest.
That seems plausible. Large as they are, the immediate costs of the financial clean-ups seem modest against the scale of the banking mess and costs of previous banking crises. So far America’s government has put less than half as much public money into the financial sector, relative to the size of its economy, as Japan did in the 1990s. More will be necessary if, as is rumoured, Barack Obama’s team creates a bad bank to take on troubled loans and puts more capital into banks. Goldman Sachs recently estimated that the total value of troubled American bank assets was $5.7 trillion; that makes an initial cost of several trillion dollars seem possible.
The net cost—and hence the net addition to long-term public debt—will be much smaller. On average, the IMF reckons, rich countries recover half their outlays for financial rescues. Sweden, whose banking rescue is seen as a model, recouped more than 90%. America may eventually manage something close to that, but the initial investment must be big.
Relax and spend
Unfortunately, the political cost of bailing out bankers and the huge sums involved mean that many politicians in rich countries are loth to spend heavily. History suggests that is a mistake. Failure to mend a broken financial system quickly means a longer recession; it also renders fiscal stimulus much less potent. Contrast Japan, which had numerous fiscal-stimulus packages in the 1990s, but failed to emerge from its slump until its debt problem was finally dealt with, with South Korea in 1997, which spent 13% of GDP on a large, speedy bank-rescue package.
The fiscal costs of that error can be enormous. In a recent paper Carmen Reinhart of the University of Maryland and Ken Rogoff of Harvard University estimated that the big banking crises of the post-war period, on average, raised real public debt by more than 80% of GDP. Most of that rise came not from financial rescues but from prolonged recessions and the fiscal expansions designed to combat them. Even this year, half the deterioration of the rich world’s deficits has stemmed from economic weakness.
If fiscal stimulus is no substitute for financial clean-ups, it is an important support at a time of slumping demand. But much depends on how well the plans are structured. All the big economies foresee some tax cuts, particularly for individuals. (Only a few, including Canada and Russia, plan to cut corporate taxes.) But the focus of the global fiscal boost is on spending, particularly on infrastructure.
Economic theory suggests that makes sense. When firms and consumers are gripped with uncertainty, government spending is a surer way to boost demand. Consumers and firms might save the money. The empirical evidence, however, is less than conclusive. Economists’ estimates for the “multiplier” effect of government spending and tax cuts vary widely, with equally reputable studies showing opposite results. More important, the scale of the global slump means that historical multipliers may not mean very much. That suggests a broad strategy—involving both tax cuts and spending—is prudent.
Less sensible, however, is the distribution of stimulus between countries. America’s fiscal package, at $800 billion or more, will be by far the biggest in absolute terms and one of the biggest relative to the size of its economy. Lamentably, rich creditor countries, such as Germany, are doing much less. In the emerging world China’s boldness is laudable, and fat reserve cushions have also given other emerging economies more room. But many will find their ability to borrow constrained by investors’ flight from risk—and the surge in public debt in the rich world. In its latest estimates, the Institute of International Finance, a bankers’ group, expects private-capital flows to emerging economies of only $165 billion this year, down more than 80% from 2007.
If politicians dither over bank rescues, if countries that can stimulate safely do not do enough, and if fearful investors shy away from emerging markets, the odds of a lasting recovery of the global economy seem slim. And that, in turn, will mean far bigger rises in public debt. A multi-year downturn could easily send government-debt ratios up by 30% of GDP or more.
This need not be calamitous. Governments can work off huge debt burdens without default or high inflation. During the second world war, for instance, Britain’s gross debt burden rose above 200% of GDP; America’s topped 120%. During the 1990s, fast growth and fiscal prudence allowed countries from Ireland to Canada to cut their debt levels sharply.
The difference this time is that the rich world already faces the costs of an ageing population, which promise a fiscal burden many times greater than even the darkest scenarios for the financial crisis. Right now fiscal activism is indispensable, but the consequences will be bigger and longer-lasting than many realise.

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Troubled tigers

IT SEEMS so unfair. Most Asian economies have been models of prudence. While American and European households were borrowing up to the hilt, Asian ones were tucking away their savings. While rich-country banks were piling into ever-riskier assets, Asian banks kept their holdings of such assets small. And while America and Britain were sucking up the world’s savings, Asian governments piled up vast stocks of foreign reserves.

Yet many of Asia’s tiger economies seem to have been hit harder than their spendthrift Western counterparts. In the fourth quarter of 2008, GDP probably fell by an average annualised rate of around 15% in Hong Kong, Singapore, South Korea and Taiwan; their exports slumped more than 50% at an annualised rate. Share prices in emerging Asia have plunged by almost as much as during the Asian financial crisis a decade ago. That crisis was caused by Asia’s excessive dependence on foreign capital. This time the tigers have been tripped up by their excessive dependence on exports.Asia’s emerging economies have long been the world’s most dynamic, with GDP growing at an annual rate of 7.5% over the past decade, two and a half times as fast as the rest of the world. Only last summer, many of these countries were being warned by foreigners that they were growing too fast and needed to raise interest rates to prevent a surge in inflation. Now, many seem to be in free fall and the news is likely to get grimmer.

In the fourth quarter of 2008, real GDP fell by an annualised rate of 21% in South Korea and 17% in Singapore, leaving output in both countries 3-4% lower than a year earlier. Singapore’s government has admitted the economy may contract by as much as 5% this year, its deepest recession since independence in 1965. In comparison, China’s growth of 6.8% in the year to the fourth quarter sounds robust, but seasonally adjusted estimates suggest output stagnated during the last three months.

Asia’s richer giant, Japan, has yet to report its GDP figures, but exports fell by 35% in the 12 months to December. In the same period, Taiwan’s dropped by 42% and industrial production was down by a stunning 32%, worse than the biggest annual fall in America during the Depression.

Asia’s export-driven economies had benefited more than any other region from America’s consumer boom, so its manufacturers were bound to be hit hard by the sudden downward lurch. Asian exports are volatile anyway (see chart 1). And though the 13% fall in the region’s exports in the 12 months to December was slightly smaller than in 1998 or 2001, those dismal records seem certain to be beaten soon.

The plunge in exports has been exacerbated by the global credit crunch, which made it harder to get trade finance. Destocking on a huge scale has further slashed output. Trade within Asia has dropped by even more than the region’s sales to America or Europe. Exports to China from the rest of Asia were 27% lower in December than a year earlier, partly reflecting weaker demand for components for assembly into goods for re-export.

Shocking as the export figures are, they are not entirely to blame for Asia’s woes. A closer look at the numbers reveals that in most countries imports have fallen by even more than exports, and that weaker domestic demand explains a larger part of the slump.

In China, for example, weaker domestic spending—mainly the result of a collapse in housing construction—accounted for more than half of the country’s slowdown in 2008. In South Korea, net exports actually made a positive contribution to GDP growth in the fourth quarter, while consumer spending and fixed investment fell at annualised rates of 18% and 31% respectively. South Korea is an exception to the rule of Asian prudence. Its households’ debt amounts to 150% of disposable income, even higher than in America. The banking system, which borrowed heavily abroad to finance a surge in domestic lending has also been badly hit by the global credit crunch, making it harder for firms to finance investment.

Domestic spending has collapsed elsewhere. Over the past 12 months, retail sales have fallen by 11% in Taiwan, 6% in Singapore and 3% in Hong Kong. As big financial centres, the two city-states have been battered by the global storm. Both have high levels of share ownership, so tumbling stockmarkets and property prices are depressing consumption. In Hong Kong average house prices have already fallen by almost 20% since the summer and Goldman Sachs, an investment bank, forecasts another 30% drop by the middle of 2010.

A recent report by Frederic Neumann and Robert Prior-Wandesforde, two economists at HSBC, a large bank, argues that Asia is suffering two recessions: a domestic one as well as an external one. Domestic demand had been expected to cushion the blow of weaker exports, but instead it was hit by two forces. First, the surge in food and energy prices in the first half of 2008 squeezed companies’ profits and consumers’ purchasing power. Food and energy account for a larger portion of household budgets in Asia than in most other regions. Second, in several countries, including China, South Korea and Taiwan, tighter monetary policy intended to curb inflation choked domestic spending further. With hindsight, it appears that China’s credit restrictions to cool its property sector worked rather too well.

The two recessions reinforced one another. Part of the slump in domestic spending is attributable to falling exports, which force firms to cut investment and lay off workers. This makes it hard to say whether domestic or external demand is more to blame for Asia’s distress. The importance of exports to the Asian miracle has long been controversial anyway. The crude figures show that, on average, emerging Asia’s exports amount to 47% of their GDP, up from 37% ten years ago. The share varies from 14% in India to 186% in Singapore (see chart 2). In Japan, which is often viewed as an export-driven economy, exports are only 16% of GDP.

But this ratio overstates a country’s dependence on external demand if exports have a high import content. China’s exports account for 36% of GDP, but about half of them are “processing exports”, which contain a lot of imported components. Thus the impact on GDP growth of a fall in exports is partially offset if imports fall too. Estimates suggest that domestic value-added from Chinese exports is a more modest 18% of GDP.

An alternative measure of the importance of exports is the change in net exports in real terms. Between 2002 and 2007 the increase in net exports contributed only 15% of real GDP growth in China. In contrast, net exports accounted for half of all growth in Singapore and Taiwan. This measure understates the total impact, though, because it ignores the spillover effects of exports on business confidence, investment, employment and consumer spending. Either way, the smaller economies, Hong Kong, Singapore and Taiwan, are heavily export-dependent; the giants, China and India, less so.

Asia’s recoveries from previous downturns have been led by a rebound in exports to the rich world. This is unlikely in the near future. The question is, might domestic demand now take up some of the slack? There are reasons to think so. Falling commodity prices are boosting consumers’ purchasing power, just as they squeezed it last year. More important is the impact of monetary and fiscal expansion.

With the exceptions of South Korea and India, Asia has so far been spared the financial dislocations that are plaguing the West. The HSBC economists reckon that the region is more likely to suffer a credit pinch than a full-scale crunch. In contrast to America and Europe, where excessive debt could depress spending for years, most Asian households and firms (except in South Korea) have modest debts. And, because of healthier banking systems, Asian banks are less likely than Western ones to react to the crisis by refusing to lend. Hence interest-rate cuts and the easing of credit controls should be more potent than elsewhere. No less important is Asia’s massive fiscal pump-priming. This is also likely to be more effective than elsewhere because the private sector is in better shape and able to respond by spending more.

Asia has never before deployed its monetary and fiscal weapons with such force. Every country across the region has cut interest rates and announced a fiscal stimulus. In previous downturns, Asian governments were often constrained by dire public finances or the need to support currencies. But most countries entered this downturn with small budget deficits or even surpluses. All the main Asian emerging economies apart from India have relatively low ratios of public debt to GDP.

Though the true size of the fiscal stimulus in some countries, notably China, is probably less than the headline-grabbing figures suggest, they are still impressive. After correcting for double counting and unrealistic measures, China, Singapore, South Korea and Taiwan will all enjoy a fiscal stimulus of at least 3% of GDP in 2009. China has signalled that more measures may follow over the next couple of months; it can certainly afford to spend more. On January 22nd, Singapore’s government announced a package of measures equivalent to 8% of GDP. For the first time, this will be financed partly by dipping into the government’s vast reserves.

The effectiveness of fiscal easing depends on its composition as well as its size. Income-tax cuts planned in South Korea and Taiwan will have only a modest impact if the money is saved not spent. Corporate tax cuts, planned in Singapore, may not spur investment when profits are plunging. Taiwan’s government is attempting to boost consumer spending by issuing shopping vouchers worth NT$3,600 ($107) per person. Economists are sceptical about whether this will produce new spending, but the scheme is being watched closely by other Asian governments.

More promising is the fact that every country is planning to boost infrastructure spending. In the short term, this is probably the best way for governments to boost spending and jobs; in the longer term better roads and railways should boost productivity. Fiscal tightening in emerging Asia after the 1998 crisis caused governments to reduce capital spending; as a result, public infrastructure in some countries, notably Indonesia and Thailand, is probably worse than a decade ago. So there is plenty of room to spend more.
If (still a big if) China and others fully implement their stimulus plans, domestic demand could start to recover in the second half of this year even if exports remain weak. Average growth in emerging Asia might fall to only 4-5% in 2009 as a whole, half its pace in 2007 and the slowest rate since the Asian financial crisis. But it would be well above the trough of 2.4% in 1998 (see chart 3). That average conceals a wide variation. The economies of Hong Kong, Singapore, South Korea and Taiwan will all contract this year, while the bigger, but less open economies of China, India and Indonesia should hold up better.
Shop or drop
However, Asian governments have more than this year’s growth rate to worry about. Beyond the immediate crisis, where will growth come from? America’s consumer boom and widening trade deficit, which powered much of Asia’s growth over the past decade, has come to an end. America’s return to thrift is unlikely to prove a cyclical blip. For years to come, Americans will have to save more and import less. Asia’s export-led growth therefore seems to have reached its limits.
It needs a new engine of growth: in future it must rely more on domestic demand, especially consumption. In recent years, it has been doing the opposite: consumer spending has fallen as a share of GDP, while the share of exports and investment has climbed (see chart 4). Two decades ago, consumer spending accounted for 58% of Asia’s GDP. By 2007 it had fallen to 47%. Consumer spending in China is just 36% of GDP, half the American share. An analysis by CLSA, a broking firm, finds that the weight of exports in GDP now exceeds that of private consumption in six of the 11 Asian countries it tracks.
So how can Asia lift consumption? That depends on why it has been declining in the first place. The popular explanation is that it is all because frugal households have been saving a bigger slice of their income in response to uncertainty over pensions and social welfare—uncertainty that will presumably increase in a recession.
But this doesn’t quite fit the facts. In many countries, notably South Korea and Taiwan, household savings have fallen relative to income in the past decade; in China they have been broadly flat. (The rise in China’s savings rate comes from firms and the government, not households.)
If households are not saving more, why has consumer spending declined as a share of GDP? The answer is that wage incomes have fallen relative to GDP. In China the share of wages dropped from 53% in 1998 to 40% in 2007.
One reason for this is that job creation has slowed as governments have encouraged capital-intensive industries. Across Asia, and particularly in China, low interest rates have encouraged investment and policies such as undervalued exchange rates and subsidies have favoured manufacturing over labour-intensive services.
So if Asia is to shift the mix of growth towards consumption, the usual prescription of urging households to spend more will not be enough. A raft of government policies will have to change to lift households’ share of national income. They include: reducing the bias towards capital-intensive manufacturing; speeding up financial liberalisation to lift the cost of capital; scrapping subsidies and tax breaks which favour manufacturing over services; and attacking monopolies and other barriers to services. Stronger exchange rates would also shift growth away from exports and boost households’ real spending power by reducing the cost of imports in local currency terms.
In contrast, some in China are foolishly calling for a devaluation of the yuan to support the economy. This would do little to bolster exports, which have been hurt by weak external demand rather than declining competitiveness, but would hinder the necessary economic adjustment.
Even if household saving rates have been falling, they are still high, at around 20% in both China and Taiwan. This partly reflects the fact that younger populations tend to save more for retirement. An IMF study estimates that as populations age and retired workers run down their savings, this could push up consumption-to-GDP ratios in some countries by eight percentage points or more in the next decade.
Clawing it back
Policy changes can also help nudge up saving rates. In poorly developed financial systems, households find it hard to borrow and so need to save for a rainy day. Easier access to credit could reduce such saving. But the recent credit boom and bust will make governments even more cautious about financial reform.
Inadequate social-welfare nets do encourage people to save. So higher public spending on health, education and welfare support could encourage households to save less and spend more. The recent news that China plans to spend 850 billion yuan ($125 billion) over the next three years to provide basic health care for at least 90% of the population by 2011 is therefore welcome. But the details are sketchy.
After the Asian crisis, many foreigners were quick—too quick—to pronounce the regional miracle dead. Economies bounced back not just because of the appetite of American consumers, but also because Asia still had the key ingredients of growth: rising productivity; high savings to finance investment; low import barriers to spur competition. These will help Asia remain the fastest growing region in the world. But a bigger share of those gains needs to go to workers and consumers.
Asia’s low rate of consumption and borrowing means that it has huge scope to make consumption the engine of growth over the next decade. In previous downturns, Asians were forced to take nasty medicine. Having to go out and spend would surely make a nice change.

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World Economy: Gloom Abounds, With Good Reason

The global slump is worsening as the US and Japanese, and possibly part of Europe, lurch further into the mire.

The European Central Bank signalled yesterday that its recent spate of cuts will stop at next week's monthly meeting as it considers the state of the eurozone economy.

German unemployment jumped as the slump started hurting the wider economy.

But for the badly damaged US and Japanese economies, the news wasn't good and won't improve.

Figures out today in Japan are expected to show another big fall in industrial production in December to go with the record 8.5% slump in November, and the 35% drop in exports in December.

A report yesterday from the government said that Japan's retail sales posted the largest decline in almost four years as the slump bites harder and the economy slides deeper into the red.

Sales in December fell 2.7% from the same month of 2007, the biggest drop since February 2005, the Trade Ministry said yesterday.

Several Japanese companies, led by Sony, reported prospective losses and held out the threat of worse to come this year, and job losses.

In the US new home sales fell further in a surprise and durable goods orders dropped in december for the 5th month in a row and fell over 2008 as a whole.

Jobless claims hit a new record last week and Ford had a record loss for the December quarter and for 2008 a whole it fell into the red to the tune of $US14.6 billion.

The news yesterday confirmed the gloomy commentary from the International Monetary Fund and the Fed.

Later today the US he government releases the first estimate of the December quarter's economic performance. While historical, it will be dramatic.

There won't be any growth: economists are saying the figures will show an economy shrinking at an annual rate of at least 4% and probably above 5.5%.

The GDP estimates will be updated twice over the next six weeks or so as more figures come in on exports, consumer spending, income and credit: all have been weak to rotten in the past four months and showing signs of worsening.

Now we have the latest statement from the Fed and commentary in various 4th quarter profit reports from leading US companies, telling that the downturn not only accelerated in December, but has deepened this month in some cases.

Indeed the New York Times Company said its advertising fell 18% in the December quarter and that this sharp fall (which worsened in the month of December) "had accelerated into this month" according to the company's CEO on a conference call.

US job losses have worsened dramatically: over 150,000 recorded in the last 10 days, with tens of thousands more going in Europe, the UK, Australia, Japan and elsewhere.

And, yesterday more gloom. Big manufacturers, textron and the 3M Company are among the manufacturers lowering 2009 profits and slashing capital spending in the year ahead, which will be further bad news.

If there was any lingering doubt (such as in the collective heads of some in politics, business and the economics profession that the global economy is heading south and dragging Australia with it, then reports and statements from the US Federal Reserve, the International Monetary Fund and the International Labour Organisation, should put that right.

The trio of commentaries from some of the world's major economic oversight and policy bodies makes clear the global slump is not ending, despite attempts in the US sharemarket to call a bounce with the $US825 billion Obama boost package heading for its first Congressional vote which it passed easily.

It's now off to the US Senate where the will be a bigger fight, with a bunch of Republican senators still in denial over their part in the disaster and determined to frustrate and delay the spending and tax cut package.

The Fed's statement in Washington after a two day meeting, was long, detailed, and if anything more gloomy than the December meeting's statement where rates were cut to 0%-0.25% and a start made on a major quantitative easing to try and restart the slumping economy.

"The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

"Information received since the Committee met in December suggests that the economy has weakened further.

"Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly.

"Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight.

The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

"In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters.

"Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term."

And this is very important: the Fed gathers comments and anecdotal evidence from across the country for briefing notes for its meeting. That's later turned into the 'Beige Book" and released.

It's the viewers of businesses across the spectrum from all parts of the US. November and December's were gloomy enough.

The updates picked up for this week's meeting must have been worse for the Fed to note in the statement that "Information received since the Committee met in December suggests that the economy has weakened further".

The Fed went on to explain that it will try virtually anything that will stop the slump, stabilise lending, economic activity and demand and try to get growth back on track.

"The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability."

The Fed said it is "prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets."

For those in Australia who reckon we are heading for an almighty crash, the Reserve Bank is still cutting rates (as it will do by up to 1% perhaps 1.25% next Tuesday), not doing what the Fed and the Banks of Japan and England will be doing in gearing up their balance sheets and buying government bonds to boost lending.

We are a long way from that, but as the IMF pointed out, the global economy is sliding towards outright negative growth this year: the Fund puts world growth at a tiny 0.50%. The word "catastrophe" was used by the IMF in its commentary. If that doesn't force doubters to think again, then they are truly thick.

The 2009 growth forecast of 0.50% is such a small margin that you can say the world economy will contract this year for the first time in 60 years.

That's also down 1.5% on the forecast late year and is despite the trillions of dollars already spent and or being committed in bank bailouts and stimulus packages in the US, Japan, Germany, Europe, the UK, Australia and elsewhere.

Rather than fruitless spending, imagine what the forecast would have been without it and what the IMF (and Fed) would have now been saying in their reports and commentaries.

That's a message that the Federal Opposition here and a growing number of in-denial US Republican members of Congress, don't get or even begin to understand the extent of the crisis.

The IMF said this will mean "Monetary and fiscal policies need to become even more supportive of aggregate demand and sustain this stance over the foreseeable future, while developing strategies to ensure long-term fiscal sustainability.

Moreover, international cooperation will be critical in designing and implementing these policies in order to avoid destabilizing distortions."

In other words, governments will have to lift their levels of spending in stimulus packages (in a fiscally responsible way) and take heed of what other governments are doing.

And it's why the world economic outlook update from the IMF should be required reading for all doubters.

The Fund says advanced countries like Australia will contract this year and in trying to counter that, will average budget deficits of around 7% of Gross Domestic Product.

That would mean a deficit here of around $A80 billion, out of a total budget of $A300 billion and GDP of over $A1.1 trillion.

But Australia's budgetary position is much sounder that the rest of the advanced world: we started the crunch with a surplus and more growth (even though it is vanishing) and no domestic debt to speak of.

So the NAB's estimate on Tuesday of a deficit of $A40 billion or so is probably more appropriate.

The IMF raised its estimate of the potential deterioration in US originated credit assets held by banks and others from $US1.4 trillion last October to $US2.2 trillion now; that's a jump of more than 50%.

The IMF is now forecasting that the global recession will be much deeper and more protracted than previously envisaged.

The fund forecast that while global growth is now expected to fall to 0.5% this year, with advanced economies expected to suffer their deepest recession since World War II, the advanced economies are expected to see their economies contract by 2% - the first annual contraction in the post war period.

That means the economies of all our major trading partners, bar China and India, will be shrinking this year: India and China will slow, with the latter's GDP estimated to rise 6.7%, which is just under the 6.8% growth seen in the December quarter.

That was the slowest growth for the best part of a decade and down two percentage points from the update late last year.

And the human cost, already evident in the surge of jobless in the US, the UK and Europe, especially in countries like Spain? The International Labour Organisation put that in perspective overnight:

The ILO said the world slump would lead to a "dramatic increase" in unemployment this year, which would certainly lead to 18 million - 30 million additional unemployed and more than 50 million "if the situation continues to deteriorate".

An extra 50 million jobless would take the number unemployed to 230 million, or 7.1% of the world's labour force.

And that's the nub of the argument at the heart of those who oppose government stimulus spending here and abroad: at least 18 million extra people out of work, most not able to get jobs, homes lost, finances and families under pressure if we do something.

Tax cuts might play a part, but we can better value by targeting the spending towards education, infrastructure and the like: we should be using the crisis to step up our investment in our future, as well as providing taxpayers with some relief.

And who cares if we spend money on imported products and services. Don't we want China, India, Japan, etc to buy our products?

If nothing extra is spent, or is badly spent, or neutered by opponents so it becomes inefficient, then an extra 30 odd million people could lose their jobs this year around the world, including quite a few in this country.

It's a no brainer, isn't it?

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