Anger in America

Andrew Sheng , Xiao Geng  

Spectators watch the Henley Royal Regatta

HONG KONG – Many blame today’s populist rebellion in the West on the far right, which has won votes by claiming to be responding to working-class grievances, while stoking fear and promoting polarization. But, in blaming leaders who have seized on popular anger, many overlook the power of that anger itself, which is aimed at elites whose wealth has skyrocketed in the last 30 years, while that of the middle and working classes has remained stagnant.

Two recent analyses get to the heart of the issues at play, particularly in the United States, but also in the rest of the world. In his new book Tailspin, the journalist Steven Brill argues that US institutions are no longer fit for purpose, because they protect only the few and leave the rest vulnerable to predatory behavior in the name of the free market. According to Brill, this is an upshot of America’s meritocracy: the best and brightest had the chance to climb to the top, but then essentially pulled the ladder up behind them, as they captured democratic institutions and used them to entrench special privileges for themselves.

The author Matthew Stewart agrees, arguing that, “the meritocratic class has mastered the old trick of consolidating wealth and passing privilege along at the expense of other people’s children.” Stewart shows that in the mid-1980s, the share of US wealth held by the bottom 90% of the population peaked at 35%; three decades later, they owned just 20%, with almost all of what they lost going to the top 0.1%. The 9.9% between these two groups – what Stewart calls the “new American aristocracy” – comprises what used to be called the middle class. In 1963, the 90% would have had to increase their wealth sixfold to reach the level of the 9.9%; by the 2010s, they would need 25 times their wealth to reach that level.

Much of the US population is working harder than ever, yet has suffered a decline in living standards, compounded by high levels of household debt and, in many cases, lack of health insurance. The top 10% have easy access to higher education that will enable their children to have the same privileges as them; the bottom 90% must work much harder to cover sky-high tuition fees, and typically graduate with a heavy debt burden. The top 10% receive first-rate medical care; the bottom 90% often do not, or must pay an exceptionally high price for it.

Taxation is supposed to level the playing field. But US Republicans have long pushed to lower taxes on the rich, arguing that lowering marginal tax rates will promote investment, employment, and economic growth, which will cause the wealth to “trickle down” to the rest of society. In fact, tax cuts for the rich merely further entrench their advantages, exacerbating inequality.

Making matters worse, the poor pay more indirect taxes (on land, real estate, and consumer goods), and the bottom 20% of the US population pays more than twice what the top 1% pays in state taxes. Add to that the challenges posed by automation and robotization, not to mention increasingly frequent and intense natural disasters, and it is not hard to see why so many people are so furious.

According to Stewart, the 9.9% is “the staff that runs the machine that funnels resources from the 90% to the 0.1%,” happily taking its “cut of the spoils.” But the inequality that this machine generates can have serious consequences, as it spurs social discontent and, as we are seeing in the US today, erratic policymaking. As the Austrian historian Walter Scheidel argues, inequality has historically been countered through war, revolution, state collapse, or natural disaster.

Avoiding such a dramatic event would require the 10% to do a much better job of advancing the interests of the 90%, in terms of income, wealth, welfare, and opportunities. Yet a combination of economic myopia and political polarization has led many instead to try to divert popular anger toward immigrants, China, and trade (including with close allies). As a result, the entire world is now caught in an escalating protectionist war that nobody will win.

It is true that, historically, internal contradictions and imbalances have often led to interstate conflict. But that is not inevitable. Rather, the outcome depends on the quality of leadership. In the US, for example, George Washington, Abraham Lincoln, and Franklin D. Roosevelt succeeded in strengthening their country because they recognized the need to address internal divisions in the light of America’s core values, global position, and long-term goals.

US President Donald Trump has exploited popular anger to advance his own interests. But he did not create that anger; America’s elites have spent decades doing that, creating the conditions for a figure like Trump to emerge. Now that Trump is in charge, the conditions of the 90% are set to deteriorate further. His approach to trade, in particular, will not only fail to help the people he purports to represent; it will also destroy the sense of fairness and stewardship that has historically bound the masses to their leaders.

Blaming outsiders is politically expedient. But the only way to “make America great again” is by addressing its internal injustices. No import tariff or border wall can do that.

Andrew Sheng, Distinguished Fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance, is a former chairman of the Hong Kong Securities and Futures Commission, and is currently an adjunct professor at Tsinghua University in Beijing. His latest book is From Asian to Global Financial Crisis.

Xiao Geng, President of the Hong Kong Institution for International Finance, is a professor at the University of Hong Kong.

Private Equity: So Hot Even Second-Hand Funds Can Sell at a Premium

Market used to be driven by desperate sellers, now buyers are bidding up the secondary market for private-equity funds

By Paul J. Davies

Jeremy Coller, co-founder and chief investment officer of Coller Capital. In April, Coller Capital and Goldman Sachs Asset Management bought out the existing investors in a fund raised in 2008 by Nordic Capital, a Swedish firm. Photo: Patrick T. Fallon/Bloomberg News

The market for unwanted stakes in private-equity funds used to be where investors who desperately needed cash offloaded holdings at steep discounts.

Now, the market is much more active and mature with bigger deals and surprisingly high prices: some investors have paid more than the funds’ assets are worth. But risks may be growing along with the market. Buyers are using borrowed money to juice returns, which means putting leverage on a portfolio of companies that are already indebted.

Last year saw a record of nearly $50 billion worth of deals globally, according to Credit Suisse ’s private fund group. That was a jump from the $35 billion to $40 billion range in the previous three years, which in turn was much higher than the years before 2014.

Borrowed money was used to help fund almost one-quarter of 2017’s deals, according to Triago, an advisory firm. Where leverage is used, it is typically 40%-60% of the value of the deals, according to Credit Suisse. 


Total sales of unwanted stakes in private-equity funds

Source: Credit Suisse Private Fund Group

This year has brought one of the biggest deals ever done. In April, Coller Capital, a specialist secondary investor, and Goldman Sachs Asset Management paid €2.5 billion ($2.9 billion) to buy out the existing investors in a fund raised in 2008 by Nordic Capital, a Swedish firm.

Nordic’s fund was at the end of its expected life so investors were expecting their money back. The deal meant those investors could cash out, but Nordic got another five years to keep improving the underlying companies with new backers.

The deal was unusual because it was so big, but it represents a growing trend of sales led by private-equity firms restructuring their funds rather than by one or two investors wanting to cash out early.

When the market was dominated by distressed sellers and only a few specialist buyers, the sales used to be done at steep discounts to the net asset value of the investments in the fund.

Things have changed: this year the average stake in a private-equity fund is selling at face value and many sell for a premium, according to Palico, an online market for stake sales.

Average selling price of stakes in private equity funds as a discount to net-asset value

Source: Credit Suisse Private Fund Group

In Nordic’s case, Coller and GSAM paid 111% of the value of the fund based on Nordic’s previous quarterly report to investors. Some stakes have been sold for much more. Palico tracked 36 deals in the six months to the end of May and of those, 21 were done at face value or more. The highest price was the 115% of face value paid for an EnCap Energy Capital fund. Last year, one stake went for nearly 135% of face value, according to MJ Hudson, a law firm.

High values are paid for popular fund managers, or where investors believe portfolio companies will get much more valuable. But use of leverage is also lifting prices, especially on older funds.

Borrowing is also supporting new investments into private equity: Many investors selling stakes are raising cash for commitments to new private-equity funds. Some investors are doing this without selling their stakes but simply by borrowing against them using more expensive debt from specialist lenders like London-based 17 Capital. 

For now, all this activity is relatively small compared with the $1 trillion of capital that buyout firms are trying to invest globally. But it is yet another sign of the heat building in private asset markets—and the risks that it could end in disappointing returns.

A tale of 19 mega-cities

China is trying to turn itself into a country of 19 super-regions

The planned city clusters are far larger than any others around the world 

CHINA’S urbanisation is a marvel. The population of its cities has quintupled over the past 40 years, reaching 813m. By 2030 roughly one in five of the world’s city-dwellers will be Chinese. But this mushrooming is not without its flaws. Rules restricting migrants’ access to public services mean that some 250m people living in cities are second-class citizens (see chart), who could in theory be sent back to their home districts. That, in turn, has crimped the growth of China’s cities, which would otherwise be even bigger.

Restraining pell-mell urbanisation may sound like a good thing, but it worries the government’s economists, since bigger cities are associated with higher productivity and faster economic growth. Hence a new plan to remake the country’s map. The idea is to foster the rise of mammoth urban clusters, anchored around giant hubs and containing dozens of smaller, but by no means small, nearby cities. The plan calls for 19 clusters in all, which would account for nine-tenths of economic activity (see map). China would, in effect, condense into a country of super-regions. Three are already well on track: the Pearl River Delta, next to Hong Kong; the Yangtze River Delta, which surrounds Shanghai; and Jingjinji, centred on Beijing.

For some urban planners, the strategy is beguiling. They see the clusters as engines for growth that could transform China into a wealthy, innovative powerhouse. But others think it is a trap—a government-driven exercise in development that will lead to gridlock and waste.

Hu Qiuping, a safety manager for a chemicals company, is in the urban vanguard. She lives in Wuxi, a city of 6m about 150km west of Shanghai. A trip between the two used to take a couple of hours. Today the bullet train takes just 29 minutes. Every Monday and Friday she works in Wuxi, inspecting the chemicals factory. From Tuesday to Thursday she travels to the firm’s headquarters in Shanghai. She could have based herself in either city, but living costs were much lower in Wuxi. At first she wondered whether her commute was unusual. It was not. “I see familiar faces on the train every day,” she says.

For those in bedroom communities near London or Manhattan, Ms Hu’s train rides probably sound familiar. But three features make China’s super-regions exceptional. The first is scale. The biggest existing city cluster in the world is greater Tokyo, home to some 40m people. When it is fully connected the Yangtze delta, where Ms Hu is based, will be almost four times as big, with 150m people. The average population of the five biggest clusters that China hopes to develop is 110m. Part of the reason is that the physical area of most of the Chinese clusters will also be bigger. The most prosperous, the Pearl delta, is expected to cover 42,000 square kilometres, about the same as the Netherlands.

Given that spread, it might seem nonsensical to talk of the clusters as unified entities. But the second point is the speed of transport links, notably the bullet trains between cities. This expands the viable area of China’s clusters. The Jingjinji region around Beijing has five high-speed train lines today. By 2020 there should be 12 more intercity lines, and another nine by 2030. Towns that are woven into the networks can see their fortunes change almost overnight. Plans for a new intercity train to Haining, a smaller city in the Yangtze River Delta, partly explain a doubling of house prices there. “The way that we measure distances has changed from space to time,” says Ren Yongsheng of Vantown, a property developer in Haining.

The third difference is the top-down nature of the clusters. China is far from alone in wanting to knot cities together. “Cluster policy” has been in vogue in urban planning for years, with governments trying to devise the right mix of infrastructure and incentives to conjure up the next Silicon Valley, or something like it. But China has intervened more heavily than most. To encourage people to disperse throughout clusters, it has raised the barriers to obtaining a hukou, or official residency permit, in the wealthiest cities and lowered them in smaller ones nearby. Whereas Shanghai is picky about granting permits to migrants, Nanjing, to its west, has flung its doors open to university graduates. As construction gets under way in Xiong’an, a new city designed to relieve pressure on Beijing, efforts to push people out of the capital could become more aggressive. The scenes of police forcing thousands of migrant workers to leave Beijing last winter might prove to have been a preview.

The concept of city clusters is grounded in the theory of agglomeration benefits, which holds that the bigger the city, the more productive it is. A large, integrated labour market makes it easier for employers to find the right people for the right jobs. As companies gather together, specialised supply chains can take shape. Knowledge also spreads more easily. In advanced countries, the doubling of a city’s population can increase productivity by 2-5%, according to the Organisation for Economic Co-operation and Development, a club mostly of rich countries. Studies have found that the potential gains in China are even bigger, perhaps because of its cities’ surprising lack of density. Take Guangzhou, one of China’s more crowded cities. If it had the same density as Seoul, it could house an additional 4.2m people on its existing land, according to the World Bank.

But China’s government has long resisted the emergence of true megacities. It aims to prevent the population of its two biggest cities, Beijing and Shanghai, from exceeding 23m and 25m, respectively, in 2035—little bigger than they are today. City clusters are a workaround. In the jargon of urban planners, they represent “borrowed size”: cities can, in principle, have the benefits of agglomeration with fewer of the downsides such as congestion. Alain Bertaud of New York University says that, if integrated well, China’s city clusters could, thanks to their size, achieve levels of productivity never seen in other countries. He says it would be comparable to the differences between England and the rest of the world during the Industrial Revolution.

This vision of hyper-productive Chinese clusters is a pipe dream for now. The government first mentioned city clusters as a development strategy in 2006. It was not until 2016 that it elaborated the concept. Of its 19 identified clusters, just a few have published detailed plans so far. The gap between talk and policy remains vast. Officials have called for more region-wide governance, a welcome change from the municipal turf battles that have bedevilled China. In January the Yangtze River Delta area established an office for regional co-ordination, the first of its kind. But it is a bureaucratic minnow, with little more than a dozen employees. Stefan Rau of the Asian Development Bank says it is essential that regional offices have power over budgets if they are to play a useful role.

Lustrous clusters

Evidence about economic gains from clustering in China is promising, if limited. Counties enjoy a 6% boost in productivity from being tied into the Yangtze super-region, according to an article published last year in the Journal of the Asia Pacific Economy. But the researchers found few such gains in other regions. That might be because they looked at old data. A more recent study, published in April by the National Bureau of Economic Research in America, supported the idea of big knowledge spillovers in super-regions. When cities were connected by high-speed rail, the quantity and quality of academic papers by local researchers increased by nearly a third, according to the authors.

Sceptics, however, note that the most successful clusters tend not to be creations of the government. As China’s economy has modernised, the tendency towards concentration has been irresistible, especially in coastal areas. Some towns have specialised in electronics, others in the clothing industry and so on. There has also been much more migration to the coast than to other regions. It is the clusters that have coalesced naturally, especially the deltas of the Pearl and Yangtze rivers, that have the brightest prospects.

Beyond these coastal conurbations, the outlook is dimmer. Several of the 19 designated clusters seem fanciful. An economic zone linking Nanning, a poor provincial capital, to Haikou, a port on Hainan island, some 500km and a ferry crossing away, is unlikely to amount to much. The proposed cluster in the middle reaches of the Yangtze, a territory larger than Poland, is too expansive to make sense. Even within promising areas, government plans can be counter-productive. Beijing could benefit from shifting some of its universities and businesses to other cities in the Jingjinji region. But Xi Jinping, the president, has decided that an entirely new city, Xiong’an, should be created, some 100km away. A similar development closer to Beijing would have a better shot at success.

The main concern for those trying to lead productive lives across the vast super-regions is more mundane: how easy it is to get from A to B. The government classifies clusters as “one-hour economic zones” or “two-hour economic zones”, depending on the time it takes to cross the cluster by high-speed rail. But it often takes longer to get to train stations within cities than to travel by train between cities. Ding Shu works in Shanghai and lives in Kunshan, a satellite town linked to Shanghai by a subway. Factoring in her bus ride to the subway, security checks to enter the station, walking time and waiting time, she spends about four hours a day commuting. She says she is thinking about looking for a job closer to home. New rail lines to Shanghai might eventually help. But for now, Ms Ding sees herself as a victim of urban sprawl, not the denizen of a seamless city cluster.

North Korea slams US denuclearisation demands

State media says Pompeo’s unilateral calls go against spirit of the Singapore Summit

Demetri Sevastopulo and Katrina Manson in Washington and Bryan Harris in Seoul


North Korea has accused the US of making “robber-like” demands in denuclearisation talks, in the first public sign of serious discord since Donald Trump and Kim Jong Un met in Singapore.

After US secretary of state Mike Pompeo left Pyongyang on Saturday, North Korean state media said the US had made unilateral demands that breached the spirit of the Singapore summit.

“We expected that the US side would come with productive measures conducive to building trust in line with the spirit of the North-US summit and we considered providing something that would correspond to them,” said KCNA, the North Korean state-run media agency.

Mr Pompeo was making his third trip to Pyongyang and first visit since the summit. He described the talks as very productive. But it was the first time that he did not meet Kim Jong Un during a visit to Pyongyang, in another sign that the talks had not gone smoothly — which was later underscored by the North Korean statement.

Mr Pompeo said North Korea was still committed to the complete denuclearisation of the peninsula. But KCNA later criticised the US for pushing for “complete, verifiable, and irreversible denuclearisation”. CVID had been US policy until the Singapore summit, but was not included in the joint statement, sparking criticism at the time that Mr Trump had gone soft on Pyongyang.

Following the Singapore summit, Mr Pompeo described suggestions that Mr Trump had taken a softer stance by not including the phrase CVID as “ludicrous”. But the North Korean statement on Saturday suggested that the US had behind the scenes been pushing for CVID — something North Korea resists because of the potential for US weapons inspectors to roam around the country.

“The US just came out with such unilateral and robber-like denuclearisation demands as CVID, declaration and verification that go against the spirit of the North-US summit,” said KCNA, adding that the “shortest path” to denuclearisation would be to “boldly break away from the failure-ridden methods of the past”.

In one exchange during the visit, Kim Yong Chol, the second most powerful person in North Korea who is leading the nuclear talks, referred obliquely to problems, telling Mr Pompeo at the start of their second day that: “Thinking about those discussions [on day one] you might have not slept well last night”.”

Mr Pompeo responded that he had slept well, but both men said there were “things” they had to clarify with their leaders.

In another sign of disagreement, North Korea demanded new approaches “based on trust and in a phased and synchronous principle”. The US has previously insisted that it would not agree to a step-for-step approach that would see North Korea be rewarded at different points along the path to denuclearisation, and has stressed that economic sanctions will remain in place until North Korea has completed the denuclearisation process.

The first signs of serious turbulence since the Singapore summit will make it harder for the Trump administration to rebut critics who say the US president was hoodwinked by Mr Kim. After returning to the US following the Singapore meeting, Mr Trump had provoked widespread ridicule for declaring that there was “no longer a nuclear threat” from Pyongyang.

“Either some of us are taking crazy pills and hallucinating about the canyon between US and DPRK interpretations, or this jig will be up soon one way or another,” tweeted Vipin Narang, a nuclear expert at the Massachusetts Institute of Technology, who said the US would either be “living in denial about NK nukes or . . . exploding at perceived betrayal and Kim’s ‘duplicity’.”

US tariffs pose a danger to the global economy

Innovation and productivity will be casualties from a trade war

The US commerce secretary Wilbur Ross said that the rise in US steel prices reflected 'profiteering' by speculators © EPA

Having spent a long time hoping that it was all bluster, the world’s investors, companies and policymakers have been forced to admit that a trade war is under way. How far it escalates remains unclear, but initial responses do not suggest an easy way of defusing the conflict.

The companies in the line of fire will certainly be affected. Shares in German carmakers — the auto sector is the next industry in Donald Trump’s sights — fell in unison this week after Daimler was the first major vehicles company to issue a profit warning because of tariffs. The US president’s threats against EU car exports are still in their early stages, but Daimler suffered because its US operations, which sell into China, will be hit by the retaliatory duties Beijing is imposing on American cars.

No country wins in a trade war, whatever Mr Trump thinks. The bizarre comments by his commerce secretary, Wilbur Ross, that the rise in US steel prices following the imposition of tariffs reflected “profiteering” by speculators merely underlined the economic illiteracy involved. If you restrict the supply of something, its price tends to go up. That is how tariffs are supposed to work.

There is no excuse for ignorance about the potential import of what Mr Trump has done. When the US hit trading partners with its infamous Smoot-Hawley tariff in 1930, Congress spent almost no time beforehand discussing potential for retaliation. The escalation into a global tit-for-tat protectionism, though it did not cause the Great Depression, made it worse. Many years of patient work during the creation of the postwar trading order were required to undo it.

These days, there should have been little doubt that the likes of China and the EU — and even Canada, despite its dependence on trade across the American border — would reciprocate Mr Trump’s tariffs. That makes those tariffs even more reckless.

If anything, the pain that countries will cause by retaliating is even more immediate than in the 1930s. Compared with earlier decades, the global integration of supply chains means that many imports are destined for use in domestic production. Cutting one’s own car manufacturers off from specialist imported components is a spectacularly stupid move.

True, the estimated direct cost of even a severe trade war is less dramatic than might be feared. The Peterson Institute in Washington reckons that if Mr Trump imposed his 25 per cent tariffs on cars and car parts across the board and all trading partners retaliated, it would reduce output in the US car industry by 5 per cent and employment by 4 per cent. That would be a shock, but not a huge one. Even a full-blown trade war, with tariffs on all goods worldwide raised to 10 per cent, would reduce global GDP by less than 2 per cent.

But more damaging than the immediate threat is likely to be the longer-term impact on innovation and productivity. Modern supply chains are not just disaggregated production lines. They are networks for learning and technology in which knowledge is created and disseminated across the globe.

The US is right that China, with its forced technology transfer, attempts to capture and exploit too much of this knowledge purely for its own benefit. But the answer to that is to make the system run more openly and fairly, not to destroy it.

Mr Trump’s tariffs are leading the global economy into a highly dangerous place. More enlightened governments must do their best not to multiply his egregious errors.