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The World 2015FT SPECIAL REPORT

www.ft.com/reports | @ftreportsWednesday January 21 2015

Inside

World must addresschronic ailmentsSecular stagnation andweak financial systemspersist, says Martin WolfPage 2

Falling rouble adds topressure on PutinSigns of a tilt towardscompromise on UkrainePage 3

Xi Jinping begins toshow his true mettleBeijing boosts its foreignpolicy and the war ongraftPage 4

Flames of Sunni-Shiaconflict reigniteMiddle East needs tofind new solutions toentrenched problemsPage 5

T he World Economic Forumin Davos is a kind of annualstocktaking for interna-tional political, businessand financial leaders. This

year’s forum is convening after 12months in which Russia has fallen out ofthe international system and the US hasplunged back into war in the MiddleEast.

This year’s Davos will also focus onproblems closer to its Swiss home.When WEF delegates met last year, thegeneral mood was one of cautious opti-mism about Europe. Delegates arereconvening in 2015 at a time of growinganxiety about a possible resurgence ofthe euro crisis. The fact that Greece willbe holding crucial elections on January25, just as the forum comes to aclose, ensures that events in Greeceand their implications for the euro

willbeahot topic intheDavoscorridors.That discussion will illustrate the

close connections between the future ofthe European economy and the re-emergence of political radicalism inEurope. Tensions between Europe’sMuslim population and wider societywill also influence the discussions atDavos — following the recent terroristattacks in Paris, the anti-Islamisationdemonstrations in Germany and therise of anti-immigration parties in coun-tries such as Sweden, Denmark and theUK. The average Davos delegate is rich,politically mainstream and in favour ofimmigration, so the rise of the politicalextremes across Europe will be a majorsourceofconcern.

The other parts of the world that arecertain to attract anxious attention areRussia and the Middle East. For the pastdecade and more, the Russians have

sent a big delegation to Davos — includ-ing appearances by President VladimirPutin and prime minister (and formerpresident) Dmitry Medvedev. The highRussian profile at the forum was a visi-ble sign of the country’s integration intothe global economy and international“polite society”. So the size of the Rus-sian delegation, what Russian spokes-men say and how they are received willall be watched intently at this year’sevent. The WEF is precisely the kind ofvenue where informal conversationscan take place to gauge whether there isscope for a rapprochement betweenRussia and the west. There certainlyseems to be some desire for that in west-ern Europe, with President FrançoisHollande of France, who will attend the

forum, pressing publicly for an easing ofwesternsanctionsonRussia.

It will be hard to find many optimistsabout the Middle East. The usual Davosformula for improving this region is“peace talks, plus trade and invest-ment”. Events have spiralled wellbeyond that stage with civil wars ragingin Syria, Iraq and Libya. Last year’sforum revealed open discord betweenthe Saudis and the Americans aboutwhat action to take over Syria. So it willbe interesting to see whether the USdecision to take military action againstthe jihadis has helped to heal the breach— or actually widened it. The receptionof Benjamin Netanyahu, the prime min-ister of Israel, will be watched carefully.Over the past year, hopes for new peacetalks with the Palestinians have col-lapsed and Israel has waged a bloody

Continuedonpage3

Little room foroptimismas globalanxiety growsWorld leaders face problems that stretch fromEurope right across the globe, saysGideon Rachman

Illustration:JamesFerguson

TheWEF is preciselythe kind of venuewhereinformal conversationscan take place

2 ★ FINANCIAL TIMES Wednesday 21 January 2015

The last time the global economic elitemet in Davos, 2015 was seen as the yearEurope would finally emerge from theshadows of the four-year eurozone debtcrisis.

The European Commission was in theprocess up upgrading its 2015 growthforecasts, European Central Bank chiefMario Draghi was dismissing fears ofeurozone deflation and Davos organis-ers assembled a high-profile panel ask-ing:“IsEuropeBack?”

“I think the eurozone, overall, is nolonger at the centre of all the concerns ofthe world economy,” Wolfgang Schäu-ble, the powerful German finance min-ister, told a keynote Davos panel on theglobaleconomicoutlook.

What a difference a year makes. Notonly is the eurozone back on the frontburner as one of the global economy’smost significant risk factors, but alsopolitical turmoil is back with a venge-ance. Anti-euro populist parties madestriking gains in May’s European Parlia-ment elections in France and Spain, aswell as in German regional elections. InGreece, the far-left, anti-austerity Syr-izaparty is leading inpollsaheadofSun-day’snationalelections.

“Europe’s economics are in substan-tially better shape than at the height ofthe eurozone crisis but the politics isnow much worse,” wrote the EurasiaGroup risk consultancy earlier monthafter naming “the politics of Europe” asits top risk factor to the global economyin2015.

The European Commission believesthe eurozone will grow only 1.1 per centthis year, down from the 1.8 per centBrussels forecast shortlyafterDavos lastyear, and that unemployment will fall to11.3 per cent, below the 11.9 per cent itreachedat thepeakof thecrisis,butwellabovehistoricnorms.

More troubling to many economists isthe prospect of Japan-style deflationgripping Europe’s common currency.Both the commission and the ECB havebeen forced to slash inflation expecta-tions for this year. Brussels now believes

it will be just 1.1 per cent in 2015, whileFrankfurt is projecting 1 per cent. Bothforecasts were made before the recentswooninoilprices.

The combination of political instabil-ity and falling prices have raised theprospect that jitteryconsumersandcor-porate boardrooms will further scaleback spending and investment plans —causinggrowthtoslowevenfurther.

“We see the beginnings of a new phasein the lingering eurozone crisis, wherethe worst may be behind us, but wherecertain issues remain ahead,” wroteStandard & Poor’s in a recent report ontheeurozone.

The response from Brussels has beena stimulus plan that aims to use €21bnin EU guarantees to raise €315bn in pri-vate capital over the next three yearsthat will be invested in public infra-structure projects. Although the planhas been broadly welcomed, similarschemes have failed to spur economicgrowthinthepast.

“Member states are gradually turningthe page of the crisis,” Jean-ClaudeJuncker, the newly elected commissionpresident, said in his first major addressof 2015. “But that crisis still leaves anasty legacy: high unemployment, highdebt, tight access to finance. We riskleavingascaronsociety.”

With the prospect of political instabil-ity looming in Greece, the eurozone isalso bracing for what could become amajor Franco-German spat over thefuture of the bloc’s economic policymaking.

In March, Brussels — with Berlin’sbacking — is poised to fine Paris for fail-ing to live up to the EU’s tough German-inspired deficit rules, something theFrench government has warned couldfurther hit growth prospects andinflame anti-EU sentiment in France.Paris has instead called on Germany,which has stubbornly clung to a pledgeto balance its budget, to use its fiscalspacetospendmore.

With such turmoil looming amongeurozone governments, focus has againturned to the ECB, which is weighingplans to spur eurozone investment bybuying sovereign bonds of eurozonegovernments. But that plan has comeunder criticism within Germany, wheresuch schemes are politically radioac-tive, limitingFrankfurt’soptions.

“The stability of the euro and thefutures of the participating countrieswill continue to be vulnerable to theshort-term exigencies of Germandomestic politics,” wrote Simon Tilford,deputy director of the Centre for Euro-pean Reform. “This is a recipe for stag-nation, deflation and political populismin France and Italy. It may culminate ina breakdown in relations between Ger-many and these countries and couldevenleadtoeurozonebreak-up.”

In other words, Europe appears onceagain poised to become the global econ-omy’sproblemchild.

European politics emerges asone of the top global risk factorsEurozone

The European Commissionhas scaled down forecastsfor growth against abackground of deflationfears, writes Peter Spiegel

The World 2015

W hat sort of world are wenow living in? The rightanswer is onecharacterised bychronic economic and

political ailments. Here then are sixenduring conditions of the“new normal”.

First, deficient demand. The ideabehind “secular stagnation” is that,without rapid asset-price inflation orexceptionally aggressive monetarypolicy, it has proved impossible togenerate enough demand to absorbpotential global supply.

Chronic demand deficiency is aglobal condition. It was in operationwell before the 2007-2009 globalfinancial crisis. It is in operation today.If anything, it is even getting worse.Overall, debt overhangs in crisis-hiteconomies remain very high.Meanwhile, the emerging economies,including notably China, have seentheir own freedom of policymanoeuvre diminish as public orprivate debts (or often both) havesoared. The only plausible offset is thefall in oil prices, which shifts incomefrom savers to spenders. It should giverelief, but only temporarily.

While demand is strengthening inthe US and UK, as one might hope afteryears of aggressive monetary policies,the eurozone remains in a dangerouslydepressed condition. Meanwhile, Japanhas still to escape its deflation trap.

Second, stagnant productivity. Sincethe latter part of the last century,underlying growth of labourproductivity in the high-incomeeconomies has fallen from close to2 per cent a year to well below1 per cent. Low growth of productivitytends to inhibit both investment andconsumption, as expected futureincomes are depressed, so exacerbatingthe deficient demand. It also makes thebite of rising inequality more severe.

Happily, however, emerging economiescan still catch up on the productivitylevels of the rich.

Third, fragile finance. The globalfinancial system is in some respectseven more fragile than it was before thecrisis. The western world’s bankingsystem is even more concentrated thanbefore. The leverage — ratio of assets toequity — of many large global banks isabout 25 to 1, which is bound to makethem vulnerable. Incentives to move

financial activity outside the highlyregulated core of the global financialsystem are, nonetheless, strong. Onesource of worry has been the financingof emerging market corporations viadollar-denominated bonds.

Moreover, the lack of transparency ofbalance sheets remains daunting. In acomplex global financial system, theability of participants to understandbalance sheets is limited. This tendsto generate cycles of overwhelming

risk-affection followed by panic-induced aversion.The low real returnson safe assets tend to exacerbate theintensity of the affection and so theextent of the aversion.

Fourth, unstable politics. Deterioratingeconomic performance and risinginequality are generating substantialpolitical stresses. Hitherto stablewestern democracies are displayingboth sharp divergences of domesticopinion and hostility towards domestic

political and business elites. A commonelement is hostility to both foreignersand supranational political projects.The UK, for example, once anexceptionally stable democratic polity,is one no longer (see chart). Suchtensions are particularly threatening tothe eurozone.

The current turn of the economicwheel will also stress politically fragileemerging countries, as commodityprices decline, bad debts emerge andthe days of cheap capital inflows end.Some areas of the world arecharacterised by weak or non-existentstates. Sometimes, states have neverreally functioned. Sometimes, brittledespotisms have collapsed, as in Syria.Either way, the absence of order invitesinterventions and spreads chaos.

Fifth, tense geopolitics. Ours is an eraof rapid changes in relative economicpower, with the rise of China, above all,and the relative decline of Europe andthe US. China is assertive; Russia isirredentist; the west is cautious. In thisworld, the possibility of seriousmiscalculation is a permanent reality.A year ago, the talk was of frictionbetween China and Japan. Now it is ofRussia and the west. Nobody can besure what will come next

Sixth, challenge overload. Thesestressed political systems confrontlarge domestic and internationalchallenges. Among those challenges arethe supply of global public goods,which includes preserving the openworld economy, peace and the globalcommons. It is always hard for a largenumber of states to co-operate closely.But some of these challenges areparticularly tough. Managing climatechange is the hardest. Yet 2014 was thehottest year on record.

These conditions are chronic, notcritical. They cannot be cured quicklyor easily. They can, however, bemanaged. They should not preventcontinued economic growth,particularly in emerging economies.But this process of convergence isoperating in the context of stressedeconomies and fragile politics. Indeed,convergence is, in important respects,exacerbating stress. We cannot affordto ignore all these difficulties. On thecontrary, we must work much harderto reduce them.

Chronic economic andpolitical ills defy easy cureSix problems with the ‘new normal’

Economic problems have fueledresentment even in stable democracies ...

... as the world adjusts to long-termshifts in relative power ...

... making it harder to tackle problemsrequiring international co-operation

Global demand remains sluggish ... ... made worse by lowproductivity growth ...

... and the financial system still showssigns of fragility

Forecasts

Shares of global GDP (at purchasing power parity, %) Global average temperature(deviation from 1981-2010 average, ºC)

0

5

10

15

20

25

1991 95 2000 05 10 15 19 1890 1900

ChinaIndia

US

EU

Japan

-1.0

-0.5

0

0.5

4020 60 80 2000 20

Annual average growth in labour productivity (GDP per person employed) (%)

0 0.5 1.0 1.5 2.0 2.5

Australia

Canada

France

Germany

Italy

Netherlands

UK

US

1990-2007 2009-2013

* Average of YouGov polls for Dec 2014

Share of vote in UK general elections (%)

0

10

20

30

40

50

1970 74 74 79 83 87 92 97 01 05 10 15*

Conservative

Labour

Liberal/LibDem

Other

Sources: IMF; The Conference Board; Bloomberg; House of Commons library, YouGov; Japan Meterological Agency

Real GDP for G7 group of advanced countries(1980=100)

100

150

200

250

300

1980 90 2000 10 16

Real G7 GDPTrend, 1980 to 2007

Selected large banks’ assets-to-equity ratioQ4 2013

0 5 10 15 20 25 30 35

Barclays

Deutsche Bank

Commerzbank

UBS

Royal Bank of Scotland

Société Générale

BNP Paribas

Credit Suisse

Lloyds Banking Group

Morgan Stanley

Stagnantproductivitymakesthe bite ofrisinginequalitymore severe

Drachma vs euro: Syriza, Greece’s anti-austerity party, leads in the polls —Getty

‘But that crisis still leaves anasty legacy . . . we riskleaving a scar on society’

COLUMN

MartinWolf

Wednesday 21 January 2015 ★ FINANCIAL TIMES 3

The World 2015

Contributors

Gideon RachmanChief foreign affairs commentatorMartin WolfChief economics commentatorPeter SpiegelBrussels bureau chiefKathrin HilleMoscow bureau chiefDavid PillingAsia editorMegan MurphyWashington bureau chiefGeorge ParkerPolitical editorJoe LeahyBrazil bureau chiefDavid GardnerInternational affairs editorVictor MalletSouth Asia bureau chief

William WallisAfrican affairs writer

Emma BoydeCommissioning editorSteven BirdDesignerAndy MearsPicture editor

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war in Gaza, so Mr Netanyahu’s recep-tionmaybefairlychilly.

While Europe, Russia and the MiddleEast will — in different ways and to dif-ferent degrees — evoke expressions ofconcern, the discussions about the US,Asia and the wider global economic out-lookare likelytobenuancedintone.

Over the past six years, the forum’sconsensus attitude to US PresidentBarack Obama has mirrored interna-tional opinion — with initial euphoriagiving way to disappointment. But theObama administration is likely to gointo this year’s Davos with its reputationin better shape than for some years.Economic growth, which is alwaystreated as a rough-and-ready gauge ofsuccess, is now fairly strong in the US.Mr Obama is beginning to show signs ofthe boldness on the international stagethat he once seemed to promise. Thenormalisation of US relations with Cubawill be greeted with interest and excite-ment at the WEF, particularly since itpromises to offer new opportunities fortrade and investment. Many delegateswill be wondering whether the USbreakthrough with Cuba is a harbingerof a deal between Iran and the US duringthe final two years of the Obama admin-istration.

There will be considerable curiosityabout China under President Xi Jinping.Almost all the major multinationals andbanks that show up at Davos have vastbusiness interests in China but theirattitudes to President Xi have yet toharden into a consensus. Some believethat Mr Xi is a free-market reformer —in the Davos mould — who is intent oneradicating corruption, liberalisingmarkets and building a more co-opera-tive relationship with the US. Othersfear that the Chinese economy is losingmomentum and that President Xi’sdrive for stronger central control carriestoostrongawhiffofMaoist ideology.

The year 2014 was one that beganwith rising concern about tensionsbetween China and Japan but whichended with a sense that China was look-ing forsomesortofrapprochementwithits immediate neighbours and with theUS. However, the stability of “greaterChina” is now on the agenda followingthe demonstrations in Hong Kong andgains for pro-independence parties inTaiwan.

Continued frompage1

The future direction of India willattract huge interest. The election ofNarendra Modi as India’s prime minis-ter in May has excited hopes forfar-reaching economic reforms in India,as well as fears of civil conflict. Davoswill provide a venue for a public assess-ment by international big business ofwhether the Modi administration ismeeting the hopes and expectations ofeconomic reformers. Mr Modi himself,however, is unlikely to attend Davos. Heis preparing for a state visit from Presi-dent Obama, who is due to attendRepublic Day celebrations in India onJanuary26.

As ever, the outlook for the globaleconomy will shape all discussions inDavos. Once again the mood is ambigu-ous, reflecting neither the soaring opti-mismofpre-crisis2007or thedeepanx-ietyofpost-crisis2009.

The big new factor that will be on eve-rybody’s mind is the collapse in the glo-bal oil price — a phenomenon thatneatly ties together all of the chief WEFpreoccupations: economics, geopolitics,technology and the environment. Foronce, it is hard to forecast what the con-sensus view will be on energy and oilprices. That will make the discussion allthemore interesting.

The overarching subject in Davos,however, will be the stability of an inter-national system that allows multina-tional businesses, international banksand global oil companies to operateacross theworld.

The global economic framework cur-rently looks more stable than for someyears. But the international politicalenvironment, from Greece to Russia tothe Middle East, looks increasinglythreatening.

Little room foroptimismas globalanxiety grows

L ess than six months agoVladimir Putin seemed invin-cible. Russia’s president hadtriggered a clamour of out-rage across Europe by annex-

ing Crimea from Ukraine. None of thesanctions imposed by western govern-ments in response looked likely to makehim change course. At home, his popu-larity ratings rose to an all-time recordof88percent.

These months of triumph seem longago. The collapse of the rouble late lastyear following the steep drop in oilprices has pushed Russia into crisismode.

The government expects the econ-omy, which grew by 0.8 per cent lastyear, to contract by at least 4 per cent in2015. Moscow has already committedmore than Rbs590bn ($9.7bn) to propup banks and large companies in thewake of the rouble rout and more dark

cloudsaregatheringonthehorizon.Therating agency Standard & Poor’s is con-sidering downgrading Russia’s sover-eignratingto junkstatus.

“As long as oil continues sliding, therouble will, too,” says a senior executiveat one of Russia’s oligarch-owned con-glomerates. “They can try to defend itby threatening speculators but theycan’t win.” The central bank’s predica-ment was “like sitting in a lighthousewithguys inthewoodswithbazookasallaround”.

Like many other observers, the seniorexecutive blames Moscow’s policy mak-ers formakingmattersworsebyfloatingthe rouble in November but beingunwilling to spend large chunks of for-eign exchange reserves to defend it. Heis also of critical of Moscow’s efforts toclean up the banking sector while a cur-rencycrisiswasdeveloping.

“This is a stress test — for our econ-

omy and for a lot of people, includingthe number one in the country,” saysIgor Vayn, chief executive of Renais-sanceCapital,an investmentbank.

Suddenly, financial analysts are dis-cussing the possibility of another finan-cial meltdown and the opposition, longcowed and marginalised, has starteddiscussingscenarios forMrPutin’spolit-icaldemise.

Alexei Navalny, the lawyer and anti-corruption blogger who led street pro-tests against Mr Putin’s rule three yearsago, has certainly felt emboldened — somuch so that on January 5 he cut off theelectronic tag that monitored his move-ments while under house arrest. Thenext day, he went out and then bloggedaboutthesteeprise inprices.

Mr Navalny aims to convince the Rus-sian public, long supportive of Mr Putin,that the good times are over. Indeed,inflation, which hit 11.4 per cent at the

end of last year, is forecast to surge.Some observers expect this to trigger awave of bankruptcies. “In February orMarch, people will start losing theirjobs,”saystheRussianexecutive.

Mr Putin shows little sign of changingtack but there are indications that Mos-cow might seek to tilt towards compro-mise in the international arena. Forweeks the Kremlin has been in talksaimed at finding a political resolution oftheUkrainecrisis.

The opaque nature of Mr Putin’s ruleand his record of surprise geopoliticalmoves are fuelling speculation on how

the Russian leader will react now that heisdealingwithaneconomicslump.

“There is the western idea of a Rus-sian leader plotting, but Putin is muchmore ad hoc than that,” says JonathanEyal, international director at the RoyalUnited Services Institute, a think-tank.“He wants to crack open the territorialstatus quo in Europe and the long-termobjective is to create a sphere of influ-enceforRussia,butheisanopportunist,and Crimea was an opportunity hegrabbed.”

The latest opportunity the Kremlinappeared to see was the gun attack on

the French satirical magazine CharlieHebdo in early January. Within hours,Mr Putin sent his condolences and theRussian foreign ministry stressed theneed for Russia and the west to standtogether incombatingterrorism.

The opening Moscow is zeroing in onnow is the EU’s need to decide on theextension of the sanctions it imposed onRussia last year. “If some of those unrea-sonable sanctions can be lifted, thatwould be the beginning of an improve-ment in relations between Europe andus,” says a senior Russian foreign policyofficial.

Falling rouble pilesthe pressure on PutinRussiaEconomic crisismode raises urgency forMoscow to reach a politicalsolution onUkraine and secure easing of EU sanctions, writesKathrin Hille

Slim pickings: there is less on the shelves after Moscow banned some imports in response to sanctions — Getty/Sasha Mordovets

4 ★ FINANCIAL TIMES Wednesday 21 January 2015

The World 2015

For any second-term US president,there comes a point when the adminis-tration’s priorities shift away from thegruelling politics of day-to-day govern-ingtowardshoringupalegacy.

For Barack Obama, that has meantadopting a new strategy: going it aloneto accomplish his policy goals, withoutwaiting to win the approval of a recalci-trantCongress.

Instead of reeling from the drubbinghis Democratic party took in Novem-ber’s midterm elections, Mr Obama haschosen to go on the offensive, takingbold, often unexpected actions on arangeofkey issues.

He has overhauled immigration rulesto shield as many as 5m unauthorisedimmigrants from deportation, signed alandmark climate change deal withChina and restored relations with Cubaaftermorethanfivedecadesofhostility.

Buoyed by a stronger economy, hehas criss-crossed the country as part ofhis annual State of the Union address tooutline fresh initiatives to boost middle-class families.

These range from promising two freeyears of community college for studentsto making it easier for first-time buyersto gain a foothold on the housingmarket.

Republicans may have expected tostart the year on the front foot, now thattheir party holds majorities in both theSenate and the House of Representa-tives.

They have instead been forced on tothe defensive, as they debate how todeal with a president who has simplytakenthemoutof theprocess.

Mr Obama’s resurgence has beenmade possible in part by an economicrecovery that continues to gathersteam.

While the International MonetaryFund has been busy slashing growthforecasts for the eurozone, Japan andkey emerging market economies suchas Russia and Brazil, the US has stoodoutasoneof thefewcountrieswheretheeconomy is doing considerably betterthanexpected.

Growth in the US is expected to hit 3.1per cent this year, according to a fore-cast from the International MonetaryFund — well ahead of the 2.2 per centrecorded in the previous two years, andwell above the average IMF forecast forother advanced economies of just 2.3percent for2015.

Figures released last week by theDepartment of Labor show that the USadded more jobs in 2014 than it has inanyyearsince1999.Theunemploymentrate has fallen to 5.6 per cent, its lowestlevel insixandahalfyears.

Other factors also look set to favourthe US this year. The dive in oil priceswill ultimately stimulate consumerspending and be a boon for economicgrowth, officials at the Federal Reservebelieve.

Still, the US economy is not withoutits weaknesses. Inflation at well belowthe Fed’s 2 per cent target is one con-cern.Tepidwagegrowthisanother,witha broad swath of America’s middle classyet to feel the recovery in their paycheques.

The key debate on the US economynow is how Fed officials will weigh thesegood factors against the bad in decidingwhen to raise interest rates, and howfast.

But the split recovery is also fuelling aseparate, if equally critical, politicaldebate: how to appeal to those voterswhohavebeenleftbehind.

Like other developed economies, theUS is grappling with rising inequality.The median wealth of the nation’s mostaffluent families was 70 times thewealth of lower-income families in 2013— the widest gap recorded in three dec-ades, according to a recent report fromthePewResearchCenter.

The measure of President Obama’ssuccess this year may well be a matter ofmaking middle-class Americans feelmore optimistic about their own eco-nomic prospects, as well as his politicalones.

“The fundamental challenge”, saysDavid Madland, managing director ofeconomic policy at the Center for Amer-ican Progress, a think-tank, is to “makethe economy benefit everyone, not justthewealthyfew”.

Obama eyeshis legacy andgoes on theoffensive

US

Republicans are on the backfoot as the president, buoyedby the economy, pushesthrough popular initiatives,writes Megan Murphy

3.1%The IMF’s newestforecast for USgrowth this year

5.6%Department ofLabor data for USunemployment

The UK is going through an identity cri-sis. In 2014, it looked briefly as if thecountry would cease to exist. Now vot-ers in a general election in May 2015 arebeing invited to consider what place thecountry should have in Europe and theworld.

Uncertainty pervades British politics.Tribal loyalties between left and righthave broken down with the vacuumfilled by smaller parties trading on thepolitics of identity. Only the foolhardywould confidently predict the outcomeof theelectiononMay7.

David Cameron, Britain’s prime min-ister, survived his first big political triallast September when Scotland voted55-45 per cent to remain part of the UK.But the Scottish National party remainsapowerful force.

Mr Cameron’s response has been topass more powers to Scotland and, atthe same time, plan to give more powers

to English MPs over English laws atWestminster.

Having survived that challenge, MrCameron goes to the polls in 2015 offer-ing voters the prospect of a referendumthat will decide Britain’s position in theworld: a straight in/out choice onwhether the UK should remain part oftheEU.

“I don’t think the right answer is forBritain to leave the EU,” Mr Camerondeclared on January 7 at a DowningStreet press conference alongside astony-faced Angela Merkel. The Ger-man chancellor might have been askingherself why, then, Mr Cameron was ask-ingtheBritishpeople thequestion.

Mr Cameron fought hard to resistholding such a referendum. He pleadedwith his party to “stop banging on aboutEurope”, but in the end he bowed topressure from his own eurosceptic MPsand the advancing UK Independencepartyto finallysettle the issue.

IfMrCameronwinsonMay7hecouldspendthebestpartof twoyearstryingtonegotiate a better deal for Britain in theEU. A referendum is promised beforetheendof2017.

Ed Miliband, the Labour oppositionleader, would scrap the referendumplan, saying that Mr Cameron is

“flirting” with a Brexit (British exit) andsending out a signal to business andinternational partners that Britain isturning its back on the world and harm-ing investment.

“This is an important issue for Brit-ain’s place in the world,” says PatMcFadden, Labour’s Europe spokes-man. “There’s a battle between peoplewho are fearful of global change andwant Britain to disengage and those whowant Britain to be outward looking andshapethefuture.”

The rise of Ukip has been widelyinterpreted as a sign that Britain may beabout to side with the first group in MrMcFadden’s argument: retreatingbehind the white cliffs of Dover, spurn-ing globalisation and closing its doors tothe migrant workers who have beendrawn to the UK’s reviving economyandbooming labourmarket.

Things may not be that simple. WhileUkip isananti-EUparty, its leader,NigelFarage, recognises that British votersarenotobsessedaboutEurope.Far fromit: polls say the UK’s election will bedecided on the economy, the state of theNational Health Service and immigra-tion.

Mr Farage, therefore, has changed histack to focus on immigration, blaming

the EU’s free movement rules for theinfluxofPoles,Romaniansandothers.

While Britons are relatively uninter-ested in EU matters compared withother more pressing matters of dailylife, polls suggest that if Mr Camerondelivers on his referendum the countrymaywelldecidetostay in.

A poll by Ipsos Mori in October 2014showed support for British EU member-shipata23-yearhigh,with56percentofBritons wanting to stay in the EU, com-pared with 36 per cent who wouldchooseto leave.

“A Conservative victory would clearlyincrease the probability of a costly exitbut, with opinion polling suggesting amajority in favour of EU membership,we would still consider ‘Brexit’unlikely,” Goldman Sachs said in a brief-ingnoteearlier thismonth.

Goldman predicts that the Ukip phe-nomenon will fade and that the Con-servatives will emerge narrowly withthemostseats in theHouseofCommonson May 7, though not with enough togive Mr Cameron a majority. A repeatcoalition deal with his current LiberalDemocrat partners might then comeintoview.

But Mr Miliband’s Labour party iscurrently ahead in the polls — a Labour

coalition with the pro-European LiberalDemocrats is another possibility. So toois a Labour deal with the ScottishNational party, which is threatening tosweep aside many of Mr Miliband’s can-didatesnorthof theborder.

Some kind of coalition, pact or minor-ity government seems the most likelyoutcome. This would still be somethingof a novelty in a country more accus-tomed to single-party rule. But in a UKthat is questioning its very identity,political flux is starting to look like thenorm.

Polls set to provide national identity testUK

Vote in May seems likely toreflect uncertainty overposition in Europe and theworld, writes George Parker

When the president of Brazil went toDavos last year, she was under pressureto justify her government’s interventionin the economy and the country’s slidefrom Latin tiger to South Americansloth.

This time, while she will not be per-sonally attending the World EconomicForum, Dilma Rousseff will be dispatch-ing her new finance minister, fiscalhawk Joaquim Levy, to sell her attemptto remodel herself as a reformer whowill returnBrazil tosustainablegrowth.

Her new message will be put to aforum that seemed unconvinced by herarguments last year, when she promised

Brazil would grow again even as thecountry was slipping into a technicalrecession thanks partly to a lack ofinvestorconfidence.

Mr Levy, a respected Chicago-trainedeconomist who joined Ms Rousseff’sgovernment this year, told journaliststhis week that he would tell investors inDavos that Brazil “knows how to makethe necessary changes in the conduct ofmacroandmicroeconomicpolicy”.

Ms Rousseff, who won October’s pres-idential election by a narrow margin,hardly needs any reminders of the lackof confidence. Investment as a percent-age of gross domestic product hasdeclined, the economy is expected togrow less than 1 per cent this year andthe trade balance has turned negativefor thefirst timein14years.

While her government has blamedthe global financial crisis and the end ofthe commodities supercycle for theslowdown, other economies in theregion, aside from the market pariahs of

Argentina and Venezuela, are still grow-ing.

Instead, economists attribute Brazil’swoes partly to her government’s statistapproach during her first four-yearterm. The government sought to controlprices in energy, petrol and transport, aswell as interest rates and other areaswhile relying too heavily on state-run

banksandtaxbreaks topropupafadingconsumption boom and an inefficientindustrialbase.

The government mismanaged state-run company Petrobras, forcing it tooffer a fuel subsidy at the expense ofminority shareholders. This was madeworse by revelations of a corruptionscandalat thecompany.

“Brazil has got to go back to thebasics,” says Alberto Ramos, economistatGoldmanSachs.

This is exactly what finance ministerMr Levy has promised. This year, he istargeting a return to a primary budgetsurplus — the money left over beforeinterest payments on government debt— of 1 per cent, moving up to 2 per centnext year. Economists regard 2.5 percent as the level required to stabiliseBrazil’sgrosspublicdebt.

“The new economic team and Levywill buy her some time,” says JoãoAugusto de Castro Neves of political riskconsultancy Eurasia Group. Mr Levy’s

influence could have some positivespillover effect on other sectors, headds. But the government still needs todevelop a fresh vision for Brazil. Earlierpresidents stabilised the economy andboosted the size of the middle class byexpanding credit and consumption.Now the challenge is to deliver betterpublic services to this middle class whilefindinganewgrowthmodel.

“Brazil’s political system, the way it isframed, requires someone there with alot of political ability to govern,” says MrCastro Neves. For this reason, it will beimportant for Ms Rousseff to ensure MrLevy arrives in Davos armed with abroader vision of Brazil’s future and aroadmaponhowtoget there.

So far at least, he seems to be on theright track, telling journalists he wouldseek to reassure investors in Davos thatthe government is prioritising the pri-vate sector. “Brazil is a market economyin which private initiative is what drivesthings,”hesays.

Struggling Rousseff needs convincing vision of futureBrazil

Economists speak of anurgent need to restoreconfidence in governmentpolicies, says Joe Leahy

Dilma Rousseff: won by a slim margin

I t was in November 2012 that Xi Jin-ping stepped on to the stage for thefirst time as leader of China’s Com-munist party with the words “sorryto have kept you waiting”. More

than two years later, we are betterplaced to understand precisely what wewere waiting for. Though Chinese poli-cies remain opaque, the broad outline ofMr Xi’s presidency has come into focus.In three areas of domestic, foreign andeconomic policy we can more easilygraspwhereChina isheading.

Domestic policy is the easiest to ana-lyse. Mr Xi has launched the mostaggressive anti-corruption drive everseen in Communist China. What startedout as a seemingly routine assault ongraft has become Mr Xi’s all-out war on“tigers and flies”. At the level of the flies,state apparatchiks live in terror of aknock on the door. Lavish banquetshave stopped, or become ultra discreet.Gift-giving is less generous. Sales ofexpensive cognac and watches aredown.SoareMacaugamingrevenues.

The tigers — or at least some of them— have been yet more exposed. In

December, after months of speculation,Zhou Yongkang, the former head ofChina’s fearsome state security services,became the most senior Communistparty cadre ever to face formal corrup-tioncharges.

There are, of course, still questionsabout whether this is a genuine crack-down or an attempt to consolidatepower by eliminating Mr Xi’s enemies.“It’s both,” says Minxin Pei, professor ofgovernment at Claremont McKennaCollege in California. “Mr Xi is deeply offended by what he considers the para-sites of the regime,” he says. He addsthat the public’s perception of corrup-tion among officials is sapping the Com-munistparty’s legitimacy.

Second is foreign policy. Mr Xi hastaken a stronger grip on steering inter-national relations than his predecessor.He takes personal charge, for example,of relationswithJapanover thedisputedSenkaku Islands, known as Diaoyu byBeijing. On the whole, China has beenmore assertive with its neighbours,although there have been signs in recentmonthsofamorecalibrated,evensofter

approach. Still, under Mr Xi, Beijing hasdeclared — to name just two such events—anairdefence identificationzoneovertheEastChinaSeaandrattledVietnam’scage by drilling for oil in waters claimedbyHanoi.

There has been much more subtlediplomacy, too. Mr Xi has travelledextensively around the region and inAfrica and Latin America. China hasmade several initiatives that togetherpose the beginnings of a challenge to theUS-dominated Bretton Woods institu-tions that have prevailed since the sec-ond world war. Beijing has launched aBrics bank together with Brazil, Russia,India and South Africa. It has estab-lished a $50bn infrastructure fund thatlooks like a direct challenge to the AsianDevelopment Bank, which has beenjointly run by Washington and Tokyosince its inception in 1966. As if thatwere not enough, China is promoting a$40bn Silk Road Fund charged withestablishing an “economic belt” acrosscentralAsia toEurope.

Economic policy is the trickiest tointerpret. Things here are changing,

though how fast and to what effect is notclear. At the third plenum party con-clave inNovember2013,MrXi’sgovern-mentannouncedanumberof initiativeswith the basic aims of making the statesector more efficient and yielding moreroomtomarket forces.

“There’s been lots of talk aboutreform, but limited action,” says DongTao,regionaleconomistatCreditSuisse.Efforts to rein in the credit-fuelled statesector have not gone far enough, hesays, adding that the possibility of a sys-temic crisis is real. “They are buildingwindmillswithoutwind.”

Yet there are signs of progress. A bankdeposit insurance scheme is about to beestablished, which could make it easierto liberalise interest rates further. Fiscalceilings have been set for local govern-ments, which are being nudged to prior-itisequalityoverquantityofgrowth.

Arthur Kroeber, head of GavekalDragonomics, says Beijing’s economicpolicy making looks far more dynamicthan that in the US, Europe and Japan.“Is what’s happened enough? Clearlynot,”hesays.“But thedirection isset.”

Beijing boostsits foreignpolicy and thewar on graft

ChinaTwo years after taking the reins, Xi Jinping isbeginning to showhis truemettle, saysDavid Pilling

Diplomacy: XiJinping on arecent visit toBrazilAFP/Nelson Almeida

‘Thepresident isdeeplyoffended bywhat heconsiderstheparasites ofthe regime’

David Cameron: facing eurosceptics

Wednesday 21 January 2015 ★ FINANCIAL TIMES 5

Sub-Saharan Africa’s progress towardsgreater economic self reliance and polit-ical stability has been underpinned atmost times over the past decade byfavourableexternalconditions.

With world prices softening for theraw materials many African economiesrely on for export earnings, the cost ofdebt rising on international marketsand western donor funding comingunder strain, the surpluses of the lastdecadecannolongerbeassured.

“It has been easy to be bullish aboutAfricawithcommoditypricesgoingup,”says Charlie Robertson, chief economistat Renaissance Capital, the Russianinvestment bank that has championedAfrican growth. “[Falling commodityprices are] now the biggest challenge totheAfrica-risingthesis,”hesays.

There is still a wall of money eager toexploit commercial opportunities inAfrica’s underdeveloped markets —exemplified by the record privateequity fund of $1.1bn raised by HeliosInvestment Partners, the London-basedfund specialising in African invest-ments, earlier this month. But in a moreconstrained global environment Afri-can governments may have to workharder to sustain the momentum; 2015looksset tobeatestingyear.

On the continent’s western flank,Guinea, Liberia and Sierra Leone arestill struggling to contain the worst everoutbreak of the Ebola virus, with morethan 8,000 dead since early 2014 andbillions wiped off the value of theireconomies. Health officials are predict-ing that it could be another year beforetheepidemic is fullycontained.

Another epidemic, of Islamistextremism, is weighing on the largesteconomies in the east and west, withsecurity forces in both Nigeria andKenya struggling to contain a terroristonslaught. Meanwhile a heavily chargedelection timetable, with polls due inmore than 10 countries, ensures a tur-bulent year of politics ahead. The moreso, because there will be less money topaperovercracks.

Many economists and investmentanalysts point out that the continentalrenaissance of the last decade was notjust about commodities. It was aboutsmart policy choices, improved macro-economic management, sounder bal-ance sheets, in the wake of westernbacked debt relief, and a boom in con-sumer spending. Nevertheless the risingtide that floated all boats was causingsoaring demand for raw materials, sus-tainedbythegrowthofChina.

In the next chapter, says the Zambianeconomist and writer Dambisa Moyo,poorer performing countries will be

more exposed, while those that improvethecompetitiveenvironment for invest-mentaremore likelytoprosper.

There are some obvious winners andlosers already. Zambia has beenexposed by the falling price of copper onwhich it depends for the vast majority ofits foreign currency earnings. Thedownturn in mining has been com-pounded by a government decision —taken during the boom — to bring in leg-islation due to take effect this month toraise the gross royalty on mines from 6per cent to 20 per cent. Barrick Gold hasannounced the suspension of activity atitsLumwanacoppermineasaresult.

The collapsing price of oil is a moremixed blessing. The continent’s largest

economy, Nigeria, faces a tumultuousperiod with tense elections due in Feb-ruary, at a time when state revenues,more than 70 per cent of which comefrom oil, have halved. The developmentof recent oil finds in east African coun-trieswillalsobedelayed.

However, for the continent’s net oilimporters, lower energy costs, andsmaller importbillscouldproveavalua-ble boon, says Steve Kayizzi-Mugerwa,the African Development Bank’s chiefeconomist. Mr Kayizzi-Mugerwabelieves that rapid urbanisation and theemergence of a new class of consumersin many African cities will sustain thegrowth story, while large-scale infra-structure investment such as the $10bnChinese-backed railway from Mombasainland into Kenya will continue to openuptheregion.

But Renaissance Capital’s Mr Robert-son says for African economies to gainaccess to the capital needed to sparkindustrialisation, they will have to offseteffectsof fallingcommodityrevenues.

In addition, although sub-SaharanAfrican economies have grown fast overthe past decade, most have failed tocome close to creating enough jobs foryoung people entering the market. Todo that, says David Ndeye, a Kenyaneconomist, governments will have tobecome far more strategic about howthey use scarce resources, encouragethe development of skills and maketheir economies competitive. He says:“For transformation you need a coher-ent and proactive policy agenda. Thatyou don’t have. Most of us are freewheeling.”

Fall in commodity prices curbsthe bullishness of recent yearsAfrica

Ebola, extremism andelections compound growthproblems faced by many inthe sub-Saharan region,writesWilliam Wallis

The World 2015

W hen the radical totali-tarians of the IslamicState of Iraq and theLevant, known as Isis,burst out of eastern

Syria into north and central Iraq lastsummer, they announced not just a newcaliphate. They had also “broken”Sykes-Picot, the secret Anglo-Frenchpact of 1916 to carve up the OttomanEmpire’s Arab provinces and throw dis-parate religious and ethnic groups intoEuropean-stylenation-states.

The political physiognomy of theMiddle East has rarely looked moremenacing and — as this month’s jihadikilling spree in Paris chillingly illus-trated — able to export its violence totheworld.

But Iraq and Syria had already startedcoming apart before Isis gained ground.De facto partition of Iraq, a state shat-tered by the Anglo-American invasionof 2003, was well under way. Syria,where the regime of Bashar al-Assad hasbeen massacring its own people sincethe uprising against his tyranny in 2011,was fragmenting along sectarian lines.This came about with the Assads wield-ing a sectarian knife to bolster their ulti-matelyself-fulfillingnarrativethatwhatthey faced from the beginning wasjihadi terrorism.

What had been a Sunni-Shia subplotin thisdrama—goingbacktotheschismin seventh century Islam — burst on tocentre stage after the invasion of Iraq.That catapulted the Shia minoritywithin Islam (a majority in Iraq) into

power in an Arab heartland country forthe first time in centuries. The balanceof power was tilted towards the IslamicRepublic of Iran, which is also Shia, Per-sian and with ambitions as a regionalhegemon.

This fanned the embers of the longSunni-Shia stand-off into millenarianflame. Iraq dissolved into a sectarianbloodbath. Syria, similar in its ethno-sectarian make-up, has been taken thesame way: grafting the Sunni-Shiaschism and the Saudi-Iranian contestfor regional power on to what started asanother Arab struggle against despot-ism.

Anychanceofanendtothecarnage inSyria and Iraq, and a return to a level ofstability, may depend on an interna-tional deal on Iran’s nuclear ambitions,unlocking US rapprochement with Iran.That would have to lead to a cessation ofthe proxy war across the Middle Eastbetween Shia Iran and Sunni Saudi Ara-bia. These rivals for regional hegemonywould have to conclude that their sec-tarian tactics had rebounded — not leastin the eruption of Isis, a deadly threat tothemboth.

The US-led coalition against Isis,backed by the Saudis and other SunniGulf states but also in tacit alignment ifnot overt alliance with Iran, may con-strain the jihadis. But putting Iraq andSyria back together, as well as otherimploding mosaic states from Libya toYemen, will be enormously difficult.There is a slim chance — if ways can befound to transmute fragmentation into

an institutionalised devolution of powerwithin a set of new national compacts —to preserve unitary but not uniformstates.

The ultra-centralism of Arab autoc-racy that provided an illusion of stabil-ity in the past is part of the problem, notthe solution, which requires a muchmore inclusive narrative, with guaran-tees forallminorities.

Unfortunately, western alarm at thechaos caused by the chain of Arabupheavalsof the last fouryears,andpre-occupation with counterterror meas-ures, is reviving the seductive old modelof regional strongmen. Thus, the Egyptof Abdel Fattah al-Sisi, who followed his2013 army coup against an electedIslamist government with a ferociouscrackdown, is almost back inside thewesterntent.

Yet President Sisi’s criminalisationnot only of Islamists but liberals andleftists is almost certainly exacerbating

extremism. Similarly, the Wahhabi reli-gious absolutism of Saudi Arabia, theWest’s main Gulf ally, is doctrinally sim-ilar to ideas espoused by Isis. Suchclosed systems are recruiting sergeantsfor jihadism. Tunisia, the only so-calledArab Spring country to blossom, recog-nises this: restoring some ancien régimepersonnel but through democraticmethods.

A further spur to extremism was lastyear’s collapse of negotiations betweenIsrael and the Palestinians. Just beforeYitzhak Rabin was murdered 20 yearsago by a Jewish extremist, an Ammansummit unveiled a plan for an economicconfederation between Israel, Jordanand an independent Palestine. Now, Jor-dan and Israel are drifting apart, andIsraeli colonisation of the occupied ter-ritorieshasputaviablePalestinianstatebeyond reach, saddling future genera-tions in that cramped and combustiblespacewithpermanentconflict.

Renewed flamesof Sunni-Shiaconflict threatento engulf regionMiddle EastAn end to the carnagemay depend onan international deal with Iran, saysDavid Gardner

There were some stern words of cautionin India for Narendra Modi’s new gov-ernment lastmonth.

“India does not have time on its side,”Tharman Shanmugaratnam, the Singa-pore finance minister and chair of theInternational Monetary Fund’s policysteering committee told the Indianfinance ministry’s Delhi EconomicsConclave. While India was the economywith the largest unrealised potential inthe world, he said, it faced huge obsta-cles. “There’s a race against countries,there’s a race against machines andthere’saraceagainstdemography.”

These must have been sobering wordsfor Arun Jaitley, the finance minister,and other cabinet members. They havespearheaded a vigorous programme ofadministrative and economic reformssince the Bharatiya Janata party won anoverwhelming general election victorylast May. An estimated 1m net new jobswill be needed each month to keep pacewith the projected growth of newentrants totheworkforce.

Mr Modi has energised a bureaucracythat had sunk into sclerosis and deepcorruption under 10 years of Congressrule, and the government has launchedinitiatives to boost investment in infra-structure and manufacturing in theworld’s third-largesteconomy.

India has increased foreign directinvestment limits from 26 per cent to 49per cent in the defence and insurancesectors,andnowallows100percent for-eign stakes in railway infrastructureand most big construction projects. It isselling stakes in state companies,including banks and natural resourcesgroups, albeit without conceding major-itycontrol to theprivatesector.

The government has also tentativelyopened the door for eventual privateinvestment in coal mining, simplifiedlegislation for land acquisition, abol-

ished the planning commission andlauncheda long-awaitedplantoconsoli-date a burdensome system of state taxesintoanationwidegeneral sales tax.

Mr Modi has been extraordinarilylucky with oil. India, one of the world’sbiggest importers, is an unambiguousbeneficiary of the collapse of world oilprices. This has permitted a painlessabandonment of diesel subsidies, pro-tected the current account, curbed per-sistent domestic inflation and allowedfuel excise increases that will help thegovernment meet its budget deficit tar-get of 4.1 per cent of gross domesticproduct for the financial year ending inMarch2015.

Economists agree that the stage hasbeen set for a gradual economic recov-ery from the low point of the final twoyears of the previous Congress govern-ment, when GDP growth fell below 5 percent. Nomura, the Japanese bank, forexample, predicts real GDP will expand5.5percent in fiscal2014-15.

If Mr Modi accelerates restructuringandreform,there isnoreasonwhyIndiashould not overtake China within a fewyears to become the world’s fastest-growing largeeconomy.

After more than six months ofreformist rhetoric and bold announce-ments, the challenge now is implemen-tation. “What we’ve yet to see is privateinvestment picking up,” Arvind Subra-manian, the chief economic adviser,admittedwhenhepresentedthefinanceministry’s latesteconomicanalysis.

Mr Subramanian has tried to inject anote of caution and realism into policymakers plotting India’s resurgence as aglobaleconomicplayer.

He suggested a re-evaluation of medi-um-term fiscal strategy to allow a surgeof public investment in infrastructuregiven the weakness of the recovery andpaucity of private investment. “There’sgrowing ground for hope, but narrowingroomforcomplacency,”hesaid.

Ebola: affected countries are still struggling to contain the virus — AFP/Getty Images

Narendra ModiIndia has launchedinitiatives to boostinvestment ininfrastructure andmanufacturing

NarendraModi has noroom for complacency

‘For transformation youneed a coherent andproactive policy agenda’

Regional conflict: Iraqi security forces training to fight Isis — Reuters/Azad Lashkari

India

Competition, mechanisationand a demographic time-bomb could all hinderprospects, says Victor Mallet

6 ★ FINANCIAL TIMES Wednesday 21 January 2015