Interview: Peter Sutherland's good sense
Peter Sutherland is the recipient of the ‘Business&Finance' Outstanding Contribution Award 2007. He talks to Constantin Gurdgiev about the global financial crisis, central bank responses to the credit crunch and socio-economic policies in Europe.
On a sunny Saturday morning, old trees lend the large bay window an air of comfort and equilibrium as they sway in a gentle breeze. Seated in a comfortable, yet formal, chair opposite me, Peter Sutherland, who has just accepted an appointment as chairman of the London School of Economics (LSE) - Europe's most prestigious academic institution in social science - looks more like a senior academic than a legal legend, a founding chairman of the World Trade Organisation (WTO), an EU commissioner, an ambassador, a banker or a man at the helm of one of the largest oil companies in the world. Yet, it is global business and the climate of current credit markets in turmoil that come up as first topics in our lengthy conversation.
Depth of crises
"Nobody really knows how deep the crisis is in financial markets," says Sutherland. "I think it is really deeper than everyone is thinking. Nobody had foreseen the implications of what appeared to be a discrete issue, the subprime [lending], and I think that in reality it has been exacerbated by some events. For example, the handling of the Northern Rock situation in Europe that left people with an increasing degree of uncertainty. It has led to a reassessment of risk and that reassessment has not been completed. People are uncertain as to where the bottom actually is with respect to some of the financial institutions, in the United States in particular. So it is combined with a time when there is increasing uncertainty about the global economy - and the fact that transparency is not yet available in terms of the real effects on financial institutions is very worrying. The second point I would like to make is that there are those who made the case that there is a decoupling between the financial services sector [and the real economy]. Some weeks ago, I was at the IMF-World Bank meeting in Washington and there was an air of complete doom and gloom, but at the same time equity markets [were] riding reasonably high and there were also those who said: ‘Oh, the US economy may be faltering, but we should not take this too seriously because the global economy has been transformed by China and India and the growth of the BRICs'. To me that has never been a persuasive argument. Not least because the US accounts for 30% of global GDP. The Chinese economy has been developed largely on the back of exports to the United States, so if consumer confidence goes in the United States and if credit goes and if property prices fall precipitously, it has to have an effect and that effect will be serious. I am not trying to suggest an apocalyptic outcome to this. I hope it can be handled properly, but there is no denying the fact that we have not seen the end of it yet. I think [the credit crisis] has quite some way to run. I also think that the disallocations that are going to follow from devaluation of the dollar are quite serious. I hope that they don't engender a spirit of protectionism which will be very destructive to the global economy, but I think it is time for defensive postures in terms of investment strategies."
The apparent disconnection between the credit markets and the financial services sector, and the securities markets and the real economy in general, has led some analysts to suggest that the stock markets and healthy trade balance figures for some European economies are sustained artificially. After all, some €40bn to €60bn in petrodollars flows into Europe annually on the back of rising oil and gas prices. Commodity price appreciation adds more fuel to European economies.
Sutherland is more cautious and more pragmatic in his assessment of the sources of stock market buoyancy. "Since that view was expressed in the relative equanimity at the World Bank-IMF meeting, the equity markets have fallen. In some instances, they have fallen to what appears to be ludicrously low levels, sometimes in the financial sector, in banking sector in particular, where the yields from dividends are extremely high and valuation has plummeted. We have seen this in Britain and in Ireland, of course. So I think that this can be overdone. As to the effect of petrodollars - at the end of the day, where do the vast amounts of liquid profit which has been gained by the Gulf states and so on rest? At the end of the day, of course equity markets are partially sustained by petrodollars, so are markets of all kinds and descriptions because they are awash with money and they have to invest money somewhere. I think that in many instances there will be bargains in equity markets because of drops of valuations which are excessive. And I don't think we are going to find the petroleum [exporting] economies and those with the money to dispose of, withdrawing from the global markets. It's not in their interest to do so and I think they will continue to invest to sustain equity markets."
Ireland is an example of a market where stock market valuations might have got out of touch with reality, and in particular in the banking sector. As the latest results from, for example Anglo Irish Bank show, a healthy balance sheet, strong growth in profits and solid lending performance are no guarantee of share price stability. But does this jitteriness in the Iseq speak about the psychology of our investors or the possibility that companies' fundamentals have very little to do with stock prices? A large proportion of shares in Irish companies are held by multinational hedge funds and other large institutional investors with entirely different investment objectives than an individual investor. How realistic is our conversation about fair valuations in relation to the Irish market?
"It is true of Ireland but, in different ways and different quantities, it is true of everywhere - hedge funds have impacts," says Sutherland. "Inherent value, I think, comes through despite interventions of hedge funds. There are elements of vulnerability in smaller economies - there is no doubt about that - and we have an ability in this country to have an excessive reaction both upwards and downwards in terms of the markets. We run for the hills at the first sign of trouble and, at the same time, the day before we may be proclaiming the superiority of some so-called ‘Irish model' of economic growth. I think we are often too volatile in our own reactions."
The Federal Reserve has been very active in terms of stepping in to address the credit crisis by cutting rates dramatically, both the prime rate and the discount rate, in two consecutive moves. To some of its critics, the European Central Bank (ECB) has dragged its heels behind, especially after last week's refusal to lower rates. Although the markets now price in a 70% chance of the rates having peaked in the euro zone, there is strong pressure on the ECB to start targeting economic growth in earnest.
Peter Sutherland disagrees with the ECB's critics. Instead, he views it as "a very stabilising force in Europe". Even the decision to keep the rates steady at last week's meeting is, in Sutherland's view, a reflection of the ECB's willingness to address pressing problems in the markets. "The real problem in the global economy has been caused by mismanagement, in my view, in the US, where the deficit situation has been allowed to get completely out of control and now you have Bernanke in a very difficult position. I think myself that he should continue to try and sustain the economy and I think we certainly will have, or should have at least, further interest drops in the US. Of course, this has implications for the US currency."
Bottom dollar
Dollar devaluation can be interpreted as an effective way for the US to shift the burden of its trade deficit on to trading partners, such as euro-zone economies. In this light, some economists suggest the ECB recognises this trend and keeps euro zone rates in line with those in the US. Again, Sutherland offers a much more pragmatic insight into the interest rates links to the forex markets.
"I think that the ECB has to conform with its own mandate and this mandate concerns price stability and only price stability. I think the ECB should continue firmly on that line. I appreciate the risks of this, but I think that in so far as the interest rates have a fundamental bearing on currency rates they can be exaggerated as well. I think the euro is inherently stronger than the dollar at the moment and it will remain stronger irrespective of a half-percentage point drop in the interest rate."
At the latest Opec meeting, Venezuela and Iran made significant noises about the need for moving pricing of oil off the dollar standard and to the euro. At the same time, China's central bank was signalling it might be willing in the near-future to reduce its dollar-denominated foreign exchange reserves. Other countries with substantial dollar-denominated foreign exchange reserves - Russia and India - have also been voicing their dissatisfaction with the dollar direction. Does this signal that there is still significant room for downward pressure on the dollar - and should we be concerned about the disruptive effects this might have on the global economy?
"These actions could damage the global economy," says Sutherland, "if they were to actually happen, but they will not happen in my opinion. Iran and Venezuela, and in particular the rhetoric of Mr Chavez, is extremely unfortunate. It is so nakedly political, instead of being based on a realistic economic appraisal, that no one can take it seriously. I don't see [oil producers] moving off the dollar. The reality is that the Saudis are the dominant force in the oil markets and they have clearly stated that they have no intention of doing so. And whatever about concerns about the dollar, concerns that the Chinese might have about the dollar-based global economy, they must recognise that they have already taken a hit in terms of dollar devaluation. They also recognise we are shortly getting to the stage where there is an upside potential for the dollar, rather than a downside. We are virtually at $1.50 equals €1. I am not saying it can't get worse, but there is a point at which it becomes utterly untenable in terms of exchange rate and no longer represents any realistic assessment of real value. I don't see a huge move out of the dollar. People have too many assets in the dollar to take the risk of actually creating an even greater collapse."
Social choice
The key to the European exchange rates and trade surpluses, of course, lies within the social choice nature of European economic policies. "We have been complaining about European economies for the last 20 years, but the reality is that when you are looking at the external trade figures for Europe, they are considerably better-balanced - and in a large measure for the last 20 years they have been in surplus - than the external trade figures for the US. Europe has made certain choices in terms of economic growth as opposed to the lifestyle. You can agree or disagree but the fact remains that Europeans work 25% to 30% less than the Americans do. And significantly less, again, than people in some of the BRICs, certainly in China and India. That's a societal choice and there is a price to be paid for it. But if you take that out of the equation and if you take out labour market participation by both the old and women, and if you take out demographic deficit out of the equation, Europe has done remarkably well. Now, you can say that you can't take them out of the equation, but Europe has made societal choices on these. It's an entirely legitimate choice."
On the other hand, if one were to adjust for the amount of household work performed outside normal working hours, the effective time spent in leisure is very similar for Americans and the average European. But, as Sutherland points out, this too "is something that is rooted in our reluctant societal attitudes [to using professional services and new technology in delivering household services], which in my view are totally ridiculous".
There is a deeper implication of these choices made by the European citizenry than a simple resistance to move away from the household production model of the family. Can the high standard of living that Europe is enjoying today be sustained without Europeans getting their hands dirty in work, without having greater productivity and without sacrificing hours of leisure for work?
To Sutherland, the answer is an unequivocal no.
"I think we clearly have a problem regarding productivity and we have a problem, above all, in terms of demographics in Europe as a whole. These create significant challenges and if we do not address them, it is beyond doubt that we will be in a position of relative decline against other countries. I think that these challenges can be addressed, will be addressed, but not by a radical transformation in terms of people's attitudes. I also don't think that everything is bleak. If you take the pharmaceutical sector, we were hearing five to six years ago that the pharmaceutical sector was dead in Europe and that everything was migrating to the United States. Actually, if you look at it today, over the last five years the [European] pharmaceutical sector has done quite well. So there are positive areas, but in overall productivity we have to be smart in terms of maintaining and developing economic growth. The key issue for me, and this is important for Ireland, is that we have a proper education system. I know that this is the sort of mantra we've been hearing about for a number of years, but we are not doing it. I don't think we have a meritocratic system here. Our actual expenditure on universities here, when you compare it with the UK, we are not actually investing in the areas in which we really should be investing. Now, at the research end, we invest quite a lot. I don't know how effective that is. I am not an expert to evaluate if we are getting a return on investment that we are making there. But our universities really need more support than they are getting now and this needs courage, because we really need to take on the issue of fees. We are not going to get the universities we need without fees. We have to address these issues - there is no ducking them. But the political class will duck them."
Addressing these issues requires reforms of third-level institutions but, more importantly, a reform of the ways in which we fund these institutions.
Noble craft
"I think that the teaching profession is the most noble profession in the world and it should be properly rewarded. And it is properly rewarded - it probably pays per hour of work in Ireland more than anywhere in the world. But, we have to also introduce meritocratic evaluations at all levels of teaching. We can't have a situation where it is impossible to evaluate, impossible to judge the performance of schools because no one is going to allow any sort of rankings or analysis.
"It is impossible to also have student selection not on the basis of money but on the basis of intellectual ability. We have to get away from the dumbing down of our education system. And also the sort of sense that you have that instead of the system that would ensure that the best universities were getting the most in terms of grants because they have performed, that the money has to be spread over every regional area of the country irrespective of the merits of each particular project."
Sutherland is quick to compare Irish academic anaemia with the robustness of the academic and managerial discipline at LSE and further afield. "I know the way that the LSE thinking is going and that to me is absolutely the key. $36bn or $40bn dollars in endowment funds is available to Harvard, Princeton, Yale, Stanford and they have blind admission in terms of students' abilities to pay fees - so that only meritocratic considerations matter - we already have the situation where the best Irish students are going over there and it will be difficult to keep our best academics if we have non-differentiated pay levels for academics. [Education policy] is a classic failure to address tough issues and to face down vested interests which do not wish to take on the issue of meritocratic choice in terms of financial support from the State. We have to recognise that there is a pecking order in the system and that people should be assessed by their ability and capacity to teach."
PhD production
Ironically, the Government has been approaching the issue of education reforms from an entirely different angle, stressing numerical targets over and above quality considerations. Perhaps the most public admission of this direction for future policy is Minister Mary Hanafin's determination to see a doubling of PhD graduates at Irish universities.
As always, Peter Sutherland, thinks in much more global experience terms. "I think that the OECD analysis of our current level [of third-level graduate output] supplemented by the excellent study by our Royal Academy, showed that the number of PhDs we have is significantly less - I think it is just about one-third less - than the number of PhDs in Scandinavian countries. That I think shows a deficiency. So I think ideally there should be a better balance between third-level graduate output and PhDs. But the real question is whether we are capable of producing quality PhD graduates. Have we got the teaching capacity and the one-on-one teaching capabilities to produce the required number? And I think we are not at the stage where we are able to do this."
