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Diplomacy in Action

Economic Instability and the Future of Global Democracy

FPC Briefing
Professor Sharyn O'Halloran
Foreign Press Center
New York, New York
March 25, 2009

Date: 03/25/2009 Location: New York, New York Description: Professor Sharyn O

3:00 PM, EDT



MODERATOR: Thank you all for coming today, and for – and thank you, Professor, for coming. Profession O’Halloran will be speaking today about economic instability and the future of global democracy.

Dr. O’Halloran is the George Blumenthal Professor of Political Economics and Professor of International and Public Affairs at Columbia University. A political scientist and economist by training, Professor O’Halloran has written extensively on the issues related to the political economy of international trade and finance, regulation and institutional reform, economic growth and democratic transitions, and the political representation of minorities.

And you have her full bio in the email that went out for this briefing. And without further ado, Professor.
MS. O’ HALLORAN: Well, thank you very much. I always enjoy coming to these sessions. It’s always a good sense to get a real nice set of diversity of interests and questions that come, so thank you very much for setting this up. So what I was asked to do was actually address an issue I think that’s going to become increasingly important as a lot of the implications of the economic crisis shake out. I was looking at how this economic crisis is going to be impacting future global democracy or stability. And I think that this will be one of the long-term consequences or implications of the ongoing crisis.

So let me just give you a little bit of a backdrop to how we think about some of these issues, at least in the political economy type literature. And what we have noted over the last 50 years, if you’ll take a sample, is that more countries are democratic now than ever before. And much of the growth in democracy or these reforms have really been seen in what are called partial democracies that are countries that have democratic institutions, some democratic institutions – such as regular elections that are competitive and so on, but are not fully democratic. So there would be things such as limits on freedom of the press, or perhaps, they lack an independent judiciary system.

And many of these partial or emerging democracies are also associated with emerging markets. And these are the countries that are most vulnerable to political disturbances as a result of large economic shocks. Just to give you a sense of the spread of democracy, what we see as the light colors are the democratic – sort of the democratic institutions; darker colors are less democratic, if we want to think in that spectrum. And this is just one of the standard indexes that you use. You could use Freedom House, Polity Score, what have you. And what you see is that many of the Latin American countries – Brazil, Argentina and so forth – are newly emerging democracies. You have India and then you have the Eastern European countries and the ex-Soviet states.

You can also see this rise of partial democracies. You’ve seen that. So after the last, say, 50 years, what you’ve done – is that democracies – and that’s the blue spectrum above – democracies have actually increased. The number of autocracies – less free democratic societies – have actually decreased. But what we see as the largest growing proportion is really the partial democracies, again, those newly emerging democracies. And what we know from the literature is that these are the most unstable, that is, the ones that are most likely to transition back to have political unrest and perhaps even civil wars.

Now what are some of the key economic dimensions that impact democracy? And this is where I think the current crisis is going to come into play. Well, one of the few things we know in politics is that growth causes democracy and it’s correlated with democracy, and there’s always a debate. But really, it’s a key function that with the capital accumulation, you have the rise of the middle class, and this is one of the impetus to democratic formation. And we see this perhaps most clearly in three key indicators: for GDP per capita, okay, that is growth and – growth of individual wealth. And low GDP per capita means that you are less likely to become democratic or stay democratic as a country.

GDP growth – and that’s the expansion of the economy – as growth increases, right, it helps countries get out of autocracy. And as the economy expands, people demand increasing political freedoms. Again, this is correlated with the middle class. And these transformations we know are limited when growth is low. The third key economic indicator is trade openness. And trade helps stop democracies from backsliding, from moving from a partial democracy back to an autocracy. And once a country is democratic and it engages in the dialogue of international exchange, it really does help prevent that return to democratic – to autocratic regimes.

So the question is: How have these countries fared on these dimensions lately? Now this is a splash diagram. This is supposed to be, “Oh.” And not that we’re to read anything other than everything’s fallen off a cliff, right. Every possible lead indicator and so forth – and the real one to think about is the GDP trade and so on – everything that you would care about or think that matters has basically fallen off a cliff. So if there’s ever a time, though, when there’s been an external shock to the system, you’re seeing it, and it’s being captured in the data. So this is going to impact. Wherever there’s a fragility within the system, whether it be economic, within our regulatory structure, within our political structure, this is going to put stress on it.

To take a little bit of a step back and break this out, you can see that there has been significant economic contraction, and you can see the contraction both in the purchasers and manufacturing index, and this is – you can see this pretty uniformly by country, where everything moving to the – below the 50 percent mark is – indicates a contraction. And the other part you could see is just looking at global new orders, both in servicing and manufacturing, which have also declined precipitously. So what you see here is that there’s been across-the-board contraction in economic activity, and that in advanced industrial countries – if you look at the bottom part of that chart, the advanced industrial countries – Japan, Denmark, Germany – have actually fared worse than, say, newly emerging markets – India, China, Brazil – at least for now.

And one of the things that we – again, we care about within our indicator is not only growth, but also a trade component. And what we see is that when we look at global industrial production, that it’s been coupled with a significant decline in global trade. And what we know is that GDP reduction is – actually, one of the largest components in that decline has been the precipitous decline in trade. And we can see this on the U.S. front with U.S. imports and exports declining. And what – the impact of this has really been a reduction in resource utilization, both capital utilization and manpower utilization, all right? And this has – again, has been a global phenomena, although it has impacted the developing – the developed countries perhaps most strongly at least for right now.

Now one of the concerns is what is going to happen with the emerging markets. And I think China actually gives us a very good cut into this – a slice into this view. First, we see that the same patterns that are happening in the U.S. are also happening in China. You can see in its large decline in trade taking place. And you can also see that this is happening not only in the aggregate level, but in some of its primary exports, such as mechanical and electrical products – which has shown up in the small graph on the corner – and that this phenomena isn’t just regional, but it’s pretty much ubiquitous with all of its primary trading partners. And the question is or the concern is that this raises issues or creates stresses for the sustainability of an open trading system.

And we’re now seeing the type of backlash that may actually occur. Mexico very recently just announced that it will levy tariffs of 10 to 45 percent on at least 90 U.S. goods, and this is in response to the U.S. scrapping the test program whereby Mexican truckers could actually extend out to a zone above the U.S.-Mexican border.

China plans to file a WTO complaint against the U.S. for using what it calls unfair or protectionist measures that have restricted its chicken imports of meat. And we’ve also seen a growing number of subsidies to key economic sectors in the economy, such as the auto industry, and the World Bank estimates is now about $48 billion worldwide that has been infused to the automakers. Consequently, this raises concerns or the possibility of future countervailing duty types of actions against those countries that have subsidized those industries.

So what’s the implication for this economic stability or instability for global democratic stability? And as individual wealth, right – as we call GDP per capita growth, a change in the GDP and trade decline – fewer countries are likely to transition to a full democracy. So countries such as Malaysia and Turkey and Russia who have actually made enormous strides during the economic expansion are going to face increased stresses, whether they can be able to sustain their movement along the path to increased democratic institutions.

And countries on the cusp of democracy are going to have incentives to backslide, countries like Zambia, Nigeria, right – Ethiopia, countries that are already under an enormous amount of pressure. And the – I think it has to be realized that the international community has a stake in helping these countries achieve and retain these gains, because if we think about it, much of the growth that came – that did take place, the real growth, was actually in the emerging markets. And consequently, it is in developed countries’ interest, the G-20’s interests to sustain that growth and help those countries economically as well as politically. And I hope that this is an issue that the G-20 will be taking up in its discussions in London.

So I’m happy to take any questions at this moment.

MODERATOR: Just wait for the microphone and state your name and organization.

QUESTION: Nardo Lucentini (ph) of the (inaudible) magazine. I’d like to know whether you see any implication for your scheme of things in the present orientation of the Obama Administration.

MS. O’HALLORAN: The Obama Administration has had a nebulous statement towards protectionism and openness of the global economy, I would say. Mostly, if you’ve seen one, they have talked about reopening the Northern American Free Trade Agreement and whether, in fact, that has benefitted all parties. They have talked about putting in place a U.S. trade representative that used to be a former mayor of Dallas that would have certain perspectives on U.S.-Mexican relations.

So my sense is the Obama Administration has yet to define its trade agenda. And on those areas that they have indicated, it is less perhaps promoting of global trade and open agenda than one would hope, especially in these economic times.

QUESTION: Have you seen the stimulus overseas for possible perfectionist tendencies?

MS. O’HALLORAN: There – there is a concern about making sure American jobs stay in America. So we saw companies that were seeking to outsource certain jobs that were part of the TARP program did, in fact, get questioned as to moving those jobs overseas, even if they made perfect economic sense and even if they were part of a long-term strategy. So you are seeing some concerns by the Administration about outsourcing. And I believe that there is also the concerns of – by American that get raised in the stimulus package and what – and how far those would be extended and to what areas. So you do see the seeds. However, they really have not surfaced into high-level trade wars yet, and my hope is they will not.

The one area that we have seen sort of beggar-thy-neighbor policies taking place has been in the currency exchanges, mostly through – in the – among the European countries. So that, I think, as of right now – the immediate area of concern.

QUESTION: Tom Detola (ph) with Polish Newsweek. From the data you showed us, it looks like the rich countries have more – there are likely to be more problems right now than emerging markets. So my question is: Barack Obama is flying next week to Europe to talk with – on the G-20 summit and also talk to Europeans. Do you see any chance of coordinating – coordinated activity with, like you said, economic and political support for the poorest countries? And if there is a decision – a political decision to help them, how this help should look like?

MS. O’HALLORAN: Right. So the coordination that we have seen to date among the developing countries has been on monetary policy, less so on fiscal policy. I think we can express that. I think the way that coordinated action will take place will be by increased funding for the IMF and perhaps World Bank. And that, I think, is probably the most effective way to contribute to stabilizing any potential disruptions that happen to these emerging markets.

I also think that there is a real commitment to do it. Whether there are funds to do it is always another question. But we have to realize even though we’re not seeing the economic impact in the data now, it’s clearly coming. No one is immune to these trends, especially when you think of the exports and the imports that are taking place, it will directly affect those emerging markets. Think of India. Turkey is becoming much more active and engaging in that, although they’ve fared fairly well so far.

So I do believe that will probably be the most effective means of managing that. And I think this has to become an issue on the front burner because we can’t have economic instability become political instability and then lead to increasing problems worldwide. And I think that would be shortsighted for us not to acknowledge this.

QUESTION: Martin Souter (ph), Switzerland. President Bush used to speak a lot about democracy and Obama does not seem to have this uppermost in his mind as a concept. My question is really, according to your research, how big a factor can, you know, those political attitudes and political movements be vis-à-vis the economic factors which you outlined?

MS. O’HALLORAN: Right. I don’t – this definition is not shared by the former president, I assure you. These are – these are just objective criteria of institutions of, you know, elections, turnover, you know, some of the basic freedom house type of indicators. So that’s what these are. They’re not an ideological component, first of all.

Second of all, about do we care that the people we trade with are democratic, and I think that’s really – you know, and do the – and is that the concerns that are – would arise? Well, why we care about that is because democracy is associated with economic growth and political stability. And if we care about, you know, global peace, global prosperity and so on, we should care that, in fact, these institutions, whatever they are, have the opportunity to be expressed. So that’s – I mean, that’s the level at which to think about it.

Do I think that the Obama Administration sees democratic transformation as the key component? No. Do I think they see that security issues are important and growing? I think they do, yes. And do they see that democracy is one means to achieve those security issues? I don’t think they’ve come to that judgment yet, but they probably will. And I think that’s – you know, just because when you look at the data, you look at the patterns and you look at the trends, it’s sort of one of the few things that jumps out at you. And so I think that’s probably where their dialogue is right now.

QUESTION: I have a question. I’m wondering how your research will impact on the world peace and security. Because I observed that the full democracies are very stable. The full non-democracies are also stable. But the countries at – between are not stable. So I’m wondering, from your research, look – what I refer that to – these – the countries that you listed there will become less stable than it used to be?

MS. O’HALLORAN: There is a potential. There is a potential. And that – I mean, you never want to say someone has a blank probability of becoming, you know, unstable. But there is a potential that the economic crisis will impact those fragile democracies most significantly. And I think we need – and that’s what we need to take away from this, because that gives you the impetus to be very aggressive in providing the international support that will be necessary to make sure that they’re able to move along their path towards democracy.

QUESTION: Yes, (inaudible) from Geneva. I was wondering, what about the – yes, what about the international institutions? UN, the Britain (inaudible) institutions?


QUESTION: Do you think that they will be – you know, strength by this crisis or the opposite?

MS. O’HALLORAN: Right. So the UN has called for a expansion to the – you know, from the G-20 for it to be really a UN body that considers management of the international crisis and what’s the appropriate coordinated response to this.

I haven’t seen the G-20 countries jump onto that proposal, so I’m not clear yet whether this will be a strengthening of those institutions or whether, in fact, what we see is what we’ve always seen, which is coordination will take place on a limited level, such as what we can do in observables such as the monetary policy, and areas where there’s significant disagreement because of the way in which we manage unemployment, social security nets and so on that gets represented in our fiscal stimulus packages. There will significantly be differences.

And then they will seek to – why not harmonize, but coordinate across on financial regulations and allowing while probably not mutual recognition, but at least allowing for there to be some means by accepting home country rule and supervision of existing institutions that work on a global presence. So I think there will be a move down that path. I don’t necessarily see the global – like the UN taking precedent in – or leads in those conversations.

I do see that there will be a growing importance of the World Bank and the IMF, especially when the IMF is bailing out countries like Iceland that there is an enormous amount of interest in getting that right and in making sure those institutions are adequately funded. So if there’s a strengthening, it should be the IMF, the World Bank, not necessarily the UN.

QUESTION: My name is Louise Bid (ph). I’m from a newspaper in Denmark, (inaudible). I wonder if you could talk a bit about forecasts or about possible outcomes of this. Let’s say the worst-case scenario is there’s less trade, not international response, and the whole thing becomes a vicious circle, or on the best-case side, I mean, when are we likely to kind of see a turnaround and step out of this? And could you talk about the two different scenarios? Thank you.

MS. O’HALLORAN: Right. So the worst-case scenario would be contraction of trade, that that line significantly grows, GDP growth moves into negative, you have deflationary pressures not only on consumer prices, but on commodity goods, right? And so all the trends that we saw happening in January, that were really being accentuated with those falling off the cliffs. And not the tick-ups in the February/March data, but if those kept going back down, then you would anticipate a significant contraction of world economic activity. And the stimulus packages that were being proposed would be inadequate by any measure.

So those are significant concerns. So on what areas, then, would you see that impacting, of course? One, there should be pressure on devaluation of the currencies. Two, there would be probably increased demand for more stimulus or government spending, which again would put pressure on currencies. Three, there would be more protectionist pressures as we’re seeing with Mexico and other type of unilateral moves that’ll take place, so – and then four, you would see a lack of commitment to the international institutions where – your “Me first” type of mentality.

I don’t – I don’t believe those would happen. One, we’ve – the monetary policies – I’m going to take the U.S. perspective – have been very aggressive in increasing liquidity. And the Fed has actually done a fairly good job in making sure the credit has been out there, there’s sufficient liquidity, while interbank lending has actually been increasing and that’s important, even though it may not yet be filtering all the way down to the consumer lending and commercial lending. So the interbank lending is actually quite vigorous and taking place. And buying up assets and securities, what the Fed has been doing directly, I think is very important.

The second component, the stimulus package, I think will have some impact, but mostly on the U.S. side. The stimulus package is really gap-filling for the states on unemployment insurance, which is done through state agencies, unemployment of food stamps, Medicaid, where there would have had to be significant cuts by the states if the federal government didn’t fill in. The rest, not a huge amount, about 20 percent, is the discretionary spending for that shovel-ready, you know, get out the bridge, get out the types of work programs. So that will have, for the most part, I think limited impact, but some stimulating effect.

And then third is managing the financial institutions themselves and revamping that. That is – the first discussion has been the TARP, and then we’ve now had the latest reincarnation of the TARP, so – in managing and purchasing what are now called legacy – (laughter) – assets. We can put whatever name are we on, but bad assets that have to be managed that don’t have a true – that don’t have a market value, and infusing significant money into that, so almost up to a trillion dollars of committed funds.

Now will that have an impact that’s an intermediary term impact, okay? And it will have some effect, okay? But the – but you really have to rethink about managing and using something like a resolution trust corporation on these very large institutions that are insolvent. So my – that’s what I see. So I don’t see the worst-case scenario taking place. But if it did, that’s what it would be. This is how the response has been. The best-case scenario is all those things have enormous multiplier effects. And in the next six months, all of those upticks – and we’re seeing some impact of it, you know, in new housing starts and in sales of homes and so forth – and we have upticks on each of those trends that moves us back into a normal range, a 2 percent inflation with moderate growth, about 1 to 2 percent, which is hoped for, and a moderation of unemployment. You know, it’s now projected to be – and this is, again, U.S. – 11 percent, maybe down to the 8 percent range. So those are the hopes that could take place. So that’s the rosy scenario; that’s the less rosy scenario. I believe we’ll be somewhere in the middle.

QUESTION: (Inaudible) recovery?

MS. O’HALLORAN: Well, I mean, everyone is estimating that the recovery does not take place in 2010 – maybe 2011, if you wanted to see all the working out through the job market situation. I would – my knowledge and the data seems to support that. But if the rosy picture comes, we might be early 2010. But again, I’m the intermediate. I would go with the intermediate stage.

QUESTION: My name is (inaudible) from Iceland.

MS. O’HALLORAN: Yes, hi.

QUESTION: Icelandic broadcasting radio. One political analyst talked of – we were talking about TARP, the son of TARP.

MS. O’HALLORAN: The reincarnation, right. (Laughter.)

QUESTION: Exactly. What about the – are the U.S. and the European Union on the same page in fiscal policy? And also perhaps you could share a comment on the role of China?

MS. O’HALLORAN: Yeah. So no, it does not appear, first of all, that the U.S. and the European Union are on the same page with the fiscal policy and the stimulus. One, I think, because Europe has in place much more aggressive social security nets than the U.S. does. So the amount of extra spending that they have to do to ensure smooth market, you know, functioning is less. So I think that’s one issue in place. And the second thing is it’s not clear to what extent that they feel that most of this can’t be worked out in a normal cyclical business cycle way.

And the third, I believe that they’re worried about the impact on the currencies and what that’s going to lead for inflationary pressures down the future. Once you’ve expanded your budget, how do you pull it in? How do you pay for it? And I think there’s a real concern of the European institutions – European countries that already have huge tax bases that there’s not much leeway for them to increase taxes or reduce spending. And therefore, they have to be very careful about any increase in discretionary spending going forward. We have a little more leeway in the U.S., but still we face the same pressures.

The second question was about China. I see China as very important in moving forward, one, because they’re such a large export engine, if you will, and they really do signify to me the leader of the emerging market and the pressures that are going to come for transforming the system.

So the recent call to change from a dollar base to a basket of currency index is actually very important and I think something that you have to take seriously, one, because it will have an enormous amount of impact on the U.S. and other industrialized countries’ economies, but also because it in some ways could be destabilizing. And I think we have to understand the pros and cons of that. But as pressure and as the U.S. and other European countries’ dollars become depreciated and devalued, that’s going to increase the likelihood that developed countries make those calls. So I see that as very important.

I also see that the Chinese, besides working through the stimulus, the first stimulus package of China seems to have limited effect because you saw the huge drops taking place. Even in China, the – you know, the amount of exports and their imports and so forth. The second round of stimulus seems to be getting a little bit more traction. And what they’re doing is developing their own domestic market. I mean, they have an incredible population that hasn’t really engaged in the world market, so by bringing those consumers on board, they’re substituting – you know, think U.S. market, U.S. consumers. And long term, that could position them incredibly well for growth, say, in the next five to seven years.

So their perspective has been, I think, exactly right. They’re taking the right approach to it. Whether this leads to very aggressive demands for, you know, currency changes to an index, you know, increased domestic – increased pressures – protectionist pressures, so on, are the concerns that I have about China.

QUESTION: Yes. You quantify the relationship between democracy and the economic underpinnings. What about conflict and war? I mean, have you gone into this field? And is there --

MS. O’HALLORAN: Yeah, there --

QUESTION: -- is there a kind of a level of, you know, movement that can --

MS. O’HALLORAN: Right. There’s a whole – there’s a whole huge literature – I’ve mostly focused on the democratic – but there’s a whole huge literature that yes, in fact, when you get – it leads to instability. Genocide, in particular, is one of the types of – and civil wars are the types of extreme responses to large shocks, economic shocks in the system, and these partial democracies.

So – but that’s not my research. My research is focused predominantly on the democratic transitions and those institution – and the institution formation part. But yes, there’s a very large literature that looks exactly at that, and those two are correlates. Whether one pushes the other is a question, but they definitely go hand-in-hand. That’s why if these impacts and these huge cliffs work their way through the emerging markets, that could be the destabilizing forces that could take place.


QUESTION: Russian News Agency. Professor, what do you think – how realistic is this idea backed by China and Russia to substitute dollar as the international reserve currency regarding negative reaction in Washington? And what can we expect from G-20 summit?

MS. O’HALLORAN: Right. So the G – the proposal is to use a basket of currencies versus the U.S. dollar to denominate, you know, and convert. That would create a lot of concerns from the United States’ perspective, clearly because as the denominated or the denominator, you actually gain benefits. People use your currency. Your markets are easily accessible. Dollars are widely available. There’s demand for your bonds because it’s on the dollar. It’s viewed as a stable currency, right?

If all of a sudden we were to move to a basket of goods, it’s not clear how any individual sort of currency gets valued via that and what – you know, you’ll still – you’ll have up – an increase/decrease and so on, but nominating it across like, value of bonds, government bonds and so on. So that would be enormously difficult for the U.S. because we are now selling, you know, U.S. treasuries as a way to finance this. So that will be the negative reaction from the United States.

Abroad, many of the countries own U.S. bonds. So if you devaluate the value of this, they will have impact immediately. I think that’s the other pressure. So I think – but as the advanced industrial countries’ currencies become less, how shall we say, stable or there’s pressures because of deficits, this could increase the calls for moving to something like an index. And so that’s why I think Germany is actually correct in being very careful about how it stimulates and how it spends its discretionary money.


QUESTION: The G-20 summit?

MS. O’HALLORAN: Oh, the G – I’m sorry, you would like me to answer how that will be accepted – received at the G-20 summit?

QUESTION: Yeah, and also how it can be discussed and possibly, what could this outcome of the meeting moving forward?

MS. O’HALLORAN: I believe that it will be discussed at the G-20 summit because it has the impacts I just stated, which are significant. The U.S. would not find that something that would be – it could accept at this moment. And I think many other advanced industrial countries would not want to, at this moment, move to a basket.

However, it would – it would then lead to the conversations – well, then, if you are the primary currency that gives responsibilities to maintain a fiscal policy – right, that is responsible, you cannot be exporting the deficit abroad and around the world. And I think those are where the conversations will go. So that will put restraints or constraints on the U.S.’s mobility, both domestically, because of the role that its currency plays internationally.

QUESTION: Thanks. I wonder if you looked at how the current crisis might impact the chances of moving forward with climate and curbing emissions and replacing Kyoto in Copenhagen in December?

MS. O’HALLORAN: Yeah, I haven’t looked at that per se, but anything that right now adds cost is going to be hard. Anything that requires additional financing is hard. Although you had China say that they’re willing to move to cap-and-trade. It is on the U.S. proposal and it’s being part of the budget, although Obama is willing to consider that as a separate piece of legislation. I think there is a sense that this is a good time to move there, and both the science and the will is there. Right now, it’s a question of money, and I think we can start looking at maybe low-hanging fruit alternatives right now as a way to get to the cap-and-trade. And I think we should move down that path, but probably not as quickly as otherwise.


QUESTION: (Inaudible.)

MS. O’HALLORAN: Well, we can – first of all, we do have certain emissions controls in place, looking at the way in which – so for example, the use of giving – the use of transfer of technology to developing countries and making that available, right? That’s one way. The Clinton initiative actually funds those types of things. Looking at other third-party private or, you know, quasi sort of public-private relations that could be able to facilitate those types of transfers as of right now, then moving to more government policies and the enforcement of those policies, then moving to – so if we could even do what we do on the books now better, we could actually make a substantial impact.

And then moving to the cap-and-trade, which would put significant impact on both the government structure to handle it, as well as industries that partake in it, I think could be where we go. But that’s – I think that’s a longer-term conversation.

MODERATOR: Any other questions? Professor, do you have any final comments for us?

MS. O’HALLORAN: No, I just think that this is actually a very great forum and thank you very much and these are important issues. Thank you.

MODERATOR: Sorry, one more question.

QUESTION: Would it be possible for you to mail that slide show?

MS. O’HALLORAN: I’ll send it out. Yeah. Okay.

MODERATOR: All right. Thank you very much, Professor, and thank you all for coming.