An evening with Paul Donovan, Global Economist

I recently had the privilege to meet Mr. Paul Donovan, Global Economist, Managing Director UBS Investment Bank on September 23, 2013 in Dubai. Paul co-authors the Global Economic Perspectives publication with other members of the Global Economic team. Paul regularly appears on CNN, Bloomberg TV, and CNBC.
Paul, very comprehensively, covered various developments in the global economy ranging from the selection of US FED chair to the Japanese issuing bonds, devaluation of currencies and region-wise economic outlook.
There was a Q/A session which allowed me to put forward questions/opinions to Paul and I am glad he answered those questions to my satisfaction. The following were the communications exchanged

1 - Creation of Fake Capital

“I own apples and Paul owns oranges and we both agree to exchange each fruit worth millions. Paul sells me the oranges and I sell Paul apples. Next morning, we are no more fruit vendors but banks with assets worth millions. How this creation of fake capital is preventing organizations and economies to bounce back?" I related this to what happened in Iceland (shift from fish to investment banking) and other European economies.

Paul’s response: As this was the very first question to Paul that evening, he smiled to me and said that this is quite unfortunate and many bankers in the hall will not like us for discussing this. He added that banks have realized this and regulations are being brainstormed and developed to overcome these issues. Banks are becoming more systematic than before. He added that a bad situation in Euro will result in good outcomes. Many banks have recently either ceased or limited their operations in the Middle East and other regions. Banks like BNP Paribas have ceased operations in most of the gulf countries and Barclays has limited its operations too. These banks have been influenced by their respective countries’ governments to return and invest in their local economies. The increase in lending within the Euro bloc will improve the economic conditions over the medium term.

2 - Volatile Commodity Prices

“Theoretically prices decline when demand falls. Prices of coal, gold and several other commodities have either declined or remained volatile amid increasing demand trends year over year. What is to be blamed for low commodity prices? Am I right in saying that high capex is to be blamed for low commodity prices ?”

Paul’s response: “Yes, it is true that excessive capex in certain regions has resulted in volatile commodity prices. Expanding upon your statement mis-allocation of capex and resources is to be blamed for volatile commodity prices.”

3 - Asset Nationalization

“Asset rationalization, by Jan 2014, in countries like Indonesia can create serious issues in the global economy as China imports more than 80% of its bauxite requirements from Indonesia. What implications will this carry for the Global economy ?”

Paul’s response: “As a global economist I am more concerned whether the world’s global resource requirements will be fulfilled. China has invested in countries in Africa and has acquired mines, which it cannot fully rely upon because in the past sudden shifts in the governments in Africa has also caused disruptions in the mining activities and complicated ownership structure. As a global economist Indonesia must continue to supply raw material to China as China processes resources primarily for its local economy. Indonesia’s move is politically correct but not on economic terms because it has energy crisis and processing industries need adequate and cheap energy supplies. This move will worry the Chinese and will have a global impact.” 

And, the intellectual evening came to an end.

A great mind: Ibn Khaldun

One article on this great personality will be considered as a disservice and I  shall try my best, within my capacity, to read and research more and write about the great works of the historian Ibn Khaldun who was born in 1332 in Tunis. He was educated in the religious studies of Qur'an, Hadith, jurisprudence, and law, as well as sciences such as physics, mathematics, philosophy and logic. His strong base in a wide variety of disciplines helped him to analyze the worldly affairs, specially governments, in greater depth.

Ronald Reagan, 40th president of the United States, commented on Ibn Khaldun by saying: 

“May I offer you the advice of the 14th century Arab historian Ibn Khaldun, who said: “At the beginning of the empire, the tax rates were low and the revenues were high. At the end of the empire, the tax rates were high and the revenues were low.”

And, no, I did not personally know Ibn Khaldun, although we may have had some friends in common!”[1]

His economic ideas which he analyzed during the 14th century became part of the governments’ fiscal policies around the globe. Very correctly, a co-relation has been established between the tenor of the governments and the tax rates. As per the guidelines of Islam, the Zakat (philanthropy/charity tax) is 2.5% of accumulated wealth. Other taxes like land tax, inheritance tax and tax on spending have not been popular in the Muslim World. It is quite comprehensible from the above that if the tax rates are low, the public is encouraged to pay tax and the governments end up collecting greater tax revenues. Furthermore, Ibn Khaldun stated:

“The reason for this is that when the dynasty follows the ways (sunan) of the religion, it imposes only such taxes as are stipulated by the religious law, such as charity taxes, the land tax, and the poll tax. They mean small assessments, because, as everyone knows, the charity tax on property is low.”[2]

And then he added:

“At the beginning of the dynasty, the revenues are distributed among the tribe and the people who share in the ruler’s group feeling, in accordance with their usefulness and group feeling and because they are needed to establish the dynasty, as we have stated before. Under these circumstances, their leader refrains in their favor from (claiming) the revenues which they would like to have.”

Ibn Khaldun studied government’s behavior in great depth and it seems the same behavioral trends exist till date.  Governments prefer using public finances for the welfare of the tribes and societies and to establish a strong liking or aptitude towards their rule. In contrast, when governments sway from the path and corruption becomes the culture, the tax revenues are siphoned off to non-productive areas bearing nil or negative results.

Accountability, Self-checks and balances

Umar Bin Al Khattab, the second caliph of Islam, was known to have two lamps that he would use to light his house. One lamp was funded by the tax payer’s money and he would use that only during his work, in his official capacity, as the leader of the vast empire. The second lamp was personally funded by the caliph and he would use that when engaged in personal affairs, and not of the government. It was Umar bin Al Khattab’s accountability which contributed to the strong foundations of a successfully run and contolled empire.

Ibn Khaldun opposed high levels of taxation

“The result [of high taxation] is that the interest of the subjects in cultural enterprises disappears, since when they compare expenditures and taxes with their income and gain and see the little profit they make, they lose all hope. Therefore, many of them refrain from all cultural activity. The result is that the total tax revenue goes down, as (the number of) the individual assessments go down.”

Governments tend to increase taxes excessively to finance public debt and extravagant ventures within the boundary and overseas. This negatively impacts the willingness of the public to contribute or participate in the economics of the country. Excessive taxes have discouraged investments and consumerism and this has had further effects on poverty, employment and crime rates. The words of Ibn Khaldun can be very rightly analyzed in the form of the Laffer curve as below.

The Laffer Curve, named after the American economist  Arthur Laffer, credited his work to the great Ibn Khaldun

Ibn Khaldun’s ideas have actually been known to us in the form of the Laffer curve (advocates supply-side economics). The Laffer Curve helps the economists to ascertain the optimum tax rates which maximizes the tax revenue, without the need of increasing the tax rates in proportion. The basis of setting an optimum tax rate is to encourage businesses to re-invest their profits in expanding their businesses which creates opportunities. As purchasing power increases, businesses earn more, and more jobs are created a greater number of individuals and corporations tend to fall in the tax bracket. 

I prefer to refer to the graph above as Khaldun's curve and his immense contribution to the economics of the world is extraordinarily remarkable.

---

[1] Ronald, Reagan. “There They Go Again.” New York Times February 18 1993, n. pag. Web. 1 Dec. 2012

[2] Ibn Khaldūn. The Muqaddimah, An Introduction To History.