Brexit and Lingua Franca: Does Foreign Language Training Make Economic Sense?

by Ingo Walter

Not known for his sparkling sense of humor, EU Commission president Jean-Claude Juncker may be seriously underrated in the “zinger” department. In a well-reported speech (in French) a couple of weeks ago, he prefaced his remarks by noting (in English) that after Brexit the English language would gradually lose its commercial importance to the 24 continental European languages, notably French and German - the two post-Brexit EU “working languages.” His remarks, widely reported in the media and overanalyzed by the global elite, raised some interesting questions.

Imagine how much brainpower is invested by the thousands of Eurocrats, members of the European Parliament, national delegates, lobbyists and other hangers-on who are fluent or at least competent in four languages - the three current working languages plus the language of their home countries. The English, French and Germans get one exemption   each as do the Irish and Maltese, for whom English is the official language.  Plus many countries retain local dialects that have been remarkably persistent over the centuries, part of the enduring charm of Europe.

Becoming fluent in a modern foreign language takes a lot of time and effort, and comes at the expense of other activities that might be more productive. In the implicit cost calculus of the EU bureaucracy, it probably ranks with moving the annual plenary sessions of the European Parliament to Strasbourg from its HQ in Brussels due to political concerns early in the EU’s history. But things being what they are, within the halls of the EU and its agencies, the extraordinary commitment to modern foreign languages is likely to continue well after Brexit. Except maybe at the European Central Bank, which works in English despite the absence of the UK among its members.

Modern foreign languages have both personal and commercial value. Learning them involves investment in consumption or production, or both. Consumption-driven language investment allows access to literature in the original language, the performing arts, ability to converse across cultures, enhancement of tourism and a generally better informed and more cultured existence. Production-driven language investment allows better market access, lower information and transaction costs that ease commerce – international trade in goods and services, foreign investment and all kinds of financial flows. It can pay off very directly for a tour guide, for example, or in much more subtle ways that result in higher incomes that come from functioning more effectively in a multi-lingual world.

Languages are economic catalysts. They create lots of benefits without themselves being consumed in the process. And the more a language gets used, the more it gets used, with a tendency toward a winner-takes-all lingua franca. Unfortunately for Jean-Claude Juncker, it isn’t French or German. The drift toward English began in the far distant past, with the British exploration, trading and colonial history depositing the language the world over. Others like Spain and Portugal provided alternatives, but none had the domestic commercial, legal and business infrastructure to form a serious global challenge - or a powerful US acolyte. Even a credible newcomer like China stands little chance.

Today English is far enough down the slope of lingua francaness that arguing against it is like challenging gravity. Outside of commerce, English has come to dominate much of academia and technology as well, where ideas are heavily globalized. Other languages have liberally contributed key words or phrases for which English has no easy replacements - like entrepreneur and Schadenfreude, fait accompli and Wanderlust - and the English language is happy to incorporate them.  It is also relatively easy to learn, constantly evolving (as annual additions to the Merryam-Webster English Dictionary show) and eager to export plenty of its own words and expressions to other languages free of charge.

Even in the EU. It seems that 66% of EU citizens are competent in a foreign language, according to Eurostat – the EU’s statistical office - with 94% of them studying English, 34% studying French and 23% studying German at the secondary school level. At the primary school level 79% are studying English versus 4% French.[1]

In a recent study that one of my students, Jessica Yang, conducted an interesting empirical analysis of the relationship between commercial and financial integration and cross-border migration in the EU and investments in learning foreign languages among pairs of member countries.[2] The study was based on a data panel containing both language-education stats and economic flows among four countries - Spain, France, Germany and Italy – so that paired conclusions could be drawn.

The causality, of course, could run both ways. Language education could lead to higher intensity of economic relationships among the EU countries examined. Or stronger economic ties among these countries could increase the personal payoffs from investment in language education and encourage attainment of fluency.

The finding? Rien du tout, Garnichts, niente. nada. Nothing? For better or worse, is seems that English swamps everything else. Casual observation over a couple of decades savoring the delights of Paris or Madrid – on and off the beaten tourist track - confirms this English language-creep, and practical business-related motives doubtless have a lot to do with it. But go ahead and study modern foreign languages anyway. You will be better for it. But for most people it won’t pay the rent.

In the rarified EU halls in Brussels, of course, form doesn’t necessarily follow function, and there seem to be plenty of resources to waste, including brainpower dedicated to mastering multiple languages. Even so, English will doubtless continue to gain market share in remaining 27 member states well after the EU’s official languages drop from three to two after Brexit. Britain will leave behind a gift that keeps on giving. Stay tuned for Jean-Claude Juncker’s next bon mot on the subject.

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[1] As reported in The Economist, May 13, 2017, p.47.

[2] Jessica Yang, “Foreign Direct Investment, Trade and Cross-border Migration as Drivers of Foreign Language Education,” Stern School of Business, New York University, 2015.

David Solomon will Face Tough Challenges

By Roy C. Smith

Goldman Sachs‘ announcement on Tuesday that David Solomon will replace Lloyd Blankfein as CEO was expected, but when the actual change occurs on Oct 1 it will brings to an end the super-eventful 16-year period in which Blankfein reshaped the firm – not once but twice – while maintaining its preeminent role as one of the world’s foremost investment banks even through the worst financial crisis since the 1930s.

Blankfein took over as Fixed Income Commodities and Currency chief in 2002 just as the three-year “tech-wreck” crisis was ending. Working with Hank Paulson, Goldman’s CEO at the time, Blankfein smoothly managed a massive expansion of the firm’s trading business, transforming Goldman Sachs from a cautious, client-oriented investment bank into a global trading colossus engaged with “counterparties” all over the world. By 2006, when Blankfein replaced Paulson as CEO, more than 70% of the firm’s profits were from trading.

But, by the end of that year Blankfein and others among the firm’s top managers noticed changes in the housing market and sharply adjusted trading positions, which enabled the firm to survive the maelstrom that followed better than any of its competitors. But the crisis, and the regulatory aftermath that followed changed everything, so Goldman had to affect another transition -- to decrease its reliance on trading. In 2017, trading accounted for only about 20% of profits, about the same as 2000.

This second transition, however, has been Blankfein’s major undertaking of the past ten of his 12 years as CEO. He has called the process “re-engineering” in a labyrinth of regulation to strike the right balance between the firm’s traditional businesses, while investing heavily in new technology to make the process more efficient and to open up opportunities. Today 25% of Goldman’s total headcount of 36,000 are engaged in various engineering roles. 

Though the combined market value of all tradable financial assets in the world, according to McKinsey Global Institute, has grown from $200 trillion in 2007 to more than $300 trillion today, the financial services industry has been in a slump. Besieged by an avalanche of regulatory costs, restrictions and litigation settlements, and hamstrung by a slow growth economy with markets distorted from intervention by central banks and competition from new and different sources, the “systemically important financial institutions” have struggled to get things right. Though Goldman Sachs has performed better than almost all of its peers, its returns on equity capital have only marginally exceeded its cost of equity capital since 2010, and its price-to-book value ratio today is only 1.18.

Many banking industry observers believe that the highly-leveraged, go-for-glory days of the industry are permanently in the past and that most banks now can only look forward to a regulated public utility existence.

Blankfein’s approach throughout the transition has been to keep all four wheels on the road, tinker with the engine and the chassis, but let the vehicle do what it has always done well. He has looked at strategic possibilities – spin offs, mergers or investing in retail banking or insurance – but (in traditional Goldman fashion) found nothing better than sticking with the tried and true.

David Salomon’s job will be to figure out a way back to double digit growth that will be worthy of the Goldman DNA of the past. First, he will have to form a management team of his own, get around and schmooze up all Goldman’s important clients, regulators and the financial media in the US, the EU and Asia, and then figure out how and when he is going to address the tough strategic questions that face the firm.

When he gets to it, he will have to ask himself three simple questions: (1) can the $1 trillion (assets) business model we have, weighted down by the combined burdens of regulation, damaged industry public relations and now permanent exposure to big-ticket litigation, ever get back to sustainable double-digit growth? (2) if we are going to end up as a glorified public utility, how do we keep all the overachieving hot-shots around here from going somewhere else? and (3) can we transform some of the high valued-added stuff we do in lending, investing, venture capital and FinTech into a more entrepreneurial, private equity format and split if off from the overburdened rest? 

David Salomon has more than 30-years’ experience in the industry, most of it at Goldman Sachs in fixed income and investment banking, which he led.  But being CEO is a tough job for which no one is ever adequately trained or prepared. But the selection process has been solid from among highly qualified inside candidates that are well and truly steeped in the Goldman Sachs culture. And, as a graduate of Hamilton College, he well knows the line from the musical about the school’s namesake in which the young Hamilton announces “I am not throwing away my shot!” Nor should he. It’s his turn now.

From Financial News, July 17, 2018

The Tariff Wars Begin

By Roy C. Smith

Officially the trade war with China has now begun as the first wave of tariffs has been imposed and retaliated against. Escalation is likely to follow. Except for Peter Navarro, no serious economist thinks tariff wars can be anything but lose-lose exercises.  Anyway, the timing is all wrong.  

Rising costs in China have made their export machine less competitive with other Asian countries, and China is trying to shift its economy to one with more domestic consumption. Indeed, Chinese exports have dropped from 68% of GDP in 2009 to 38% in 2017 and in Feb 2018, China’s current account balance (goods, services and foreign income) was a $25 billion deficit. This was probably a temporary event, but it signified that China is being driven by market forces to becoming less dependent on exports.  Indeed, as its export capacity declines, China must develop its domestic consumption and employment base to sustain even a (modest for China) 6% growth rate. China’s most important economic initiative – its “Made in China 2025” program that aims to develop the country’s domestic technology industries -- is an example of how it is trying to restructure the economy.

Meanwhile the US economy is recovering. Inflation remains relatively low despite considerable fiscal and monetary stimulus, and unemployment is the lowest since the 1970s. Much of China’s trade surplus is the result of the global supply chain developed over the years by US companies to improve their competitiveness and lower consumer prices. China also invests most of its surplus in US government and other securities and in direct investments in US companies and factories.

All things netted out, China does not pose a threat to the US economy.

So why is Mr. Trump doing this?  There is the “base,” of course, but there are probably more Trump supporters among the customers of Walmart than those whose jobs were lost because of China’s exports.  Whatever the base may believe now, the history of tariff wars is that they hurt people from the working classes (i.e., the base) more than anyone else.  

Mr. Trump invented the China threat, then promised to remove it by negotiating a better deal.

Well, there is room for improving our bi-lateral terms of trade and investment with China, even if they are not essential to our own well-being. Most serious economists believe that while tariff wars are not a good way to settle things, they may be effective as bargaining chips to gain concessions that otherwise might never be given. And the concessions Trump seems to have in mind could be good for all Americans.  Martin Feldstein, an eminent Harvard economist and former Chairman of the Council of Economic Advisers under President Reagan, in a recent op-ed in the Wall Street Journal, points out that if the tariff bargaining chip could be traded for China’s dropping its requirement that US companies doing business in the country have a Chinese partner to whom it must divulge its latest technologies, this alone would be worth all the fuss that departure from international economic orthodoxy has created.

There is a lot more to negotiate as well. Opening of Chinese markets to financial and other services, agreeing to acceptable governance structures for overseas investments, and perhaps most important, limiting government subsidies to state owned enterprises that compete in markets with private companies.  This last one is an especially tough one because there are 150,000 state owned companies of various sizes in China, and even those that are not state owned are beneficiaries of China’s command system for allocating economic resources.  The Made in China 2025 initiative, Mr. Trump suspects, will be laden with direct and indirect subsidies for the technology companies China wants to support.

But negotiations appear to be on hold – not much is happening as the initial tariffs go into effect. China had previously indicated a willingness to discuss many of the demands that the Trump team presented on its two-day visit to Beijing in May, but since then China and most other observers have been searching to learn what the Deal King’s real objectives are.  In the meantime, things are marinating in an environment that seems to favor the US. The US economy may produce a growth rate for the second quarter as high at 4%, and its financial markets and the dollar are strong. China’s stock market, on the other hand, is down 17% this year and the yuan dropped 3.6% against the dollar just since the beginning of June. China’s growth rate is decelerating, despite easy credit conditions, too much debt and too much of it in danger of default. The US is China’s largest export market, and tariffs will slow growth further.  Mr. Trump is probably just waiting for China to blink first.

The situation, however, also presents a great opportunity for the developed world (i.e., the US, EU, Canada and Japan) to present the budding Chinese colossus with a common front to set new trading and investment rules for the next decade. The new rules would update the lax ones that China has been able to get away with since joining the World Trade Organization as a developing country in 2001. If China wants to avoid tariffs in all the world’s largest markets for its goods and services, and have free access to investments in these markets, it needs to make some reciprocal concessions. Negotiating as a bloc would increase the group’s bargaining power to levels China could not resist.

But Mr. Trump is not big on multi-lateral economic agreements such as the Trans Pacific Partnership or NAFTA and he has unilaterally imposed tariffs on steel and aluminum exports from the EU, Canada and Japan.  Nor is he much interested in strengthening and modernizing the World Trade Organization that the US established in 1948 to expand world trade.  Trade now accounts for 60% of global GDP – but it is almost entirely multi-lateral, not bi-lateral as Mr. Trump seems to think.

Nevertheless, Mr. Trump is likely to agree something with the Chinese that he can claim to be a victory, probably just before the mid-term elections in November.  He has already deferred the NAFTA negotiations “until after the mid—terms,” so it is clear he has them in mind, but he might have been better off to have wrapped up NAFTA before the new Mexican president, a populist- socialist assumed office.

He is also waiting for the EU to offer to drop tariffs on imported cars from the US from 10% to the US rate of 2.5%, in exchange for removing the steel tariffs. This seems likely, but relations with the EU have soured significantly since Mr. Trump’s withdrawal from the Paris Environmental Accord and the Iran Nuclear Agreement, and his threats to reconsider NATO if the members don’t increase their contributions to it. There is also the effect of US sanctions on EU businesses doing business with Iran, which are scheduled to go into effect soon even though Europe still maintains the agreement.

The market appears to believe that Mr. Trump’s opening salvos in his multiple trade wars will end up in deals that may provide some marginal gains to the economy, or at least not hurt it very much.

But there is a deeper downside. If, annoyed and humiliated as some of our major trade counterparties may be, they may come under political pressure to push back harder than Mr. Trump expects and not do the deals he wants. There may be a lengthy standoff that could decrease US exports, increase the cost of imports, screw up corporate supply chains and earnings, and slow down foreign direct investment, which together could materially slow US growth in the latter part of 2018 and 2019, when current growth forecasts begin to turn back to the 2% level. Similar, possibly worse, effects could occur outside the US, jeopardizing global growth and triggering a global market sell off, all of which could be blamed on Mr. Trump’s policies.

So far, markets have believed that Mr. Trump’s actions have been part of a broad ranging plan to renegotiate the US’ economic relations with the world, from which no serious harm is likely to result. But if it turns out that there really is no master plan and he’s just winging it, then the emperor may be seen to have no clothes after all, and a major market reaction could result.

As Mr. Trump often says, “we will just have to wait and see.”