How (and how not) Iacocca saved Chrysler

The period between 1968 and 1973 was actually a very good one for the American auto sector. Yet difficulties emerged by the early 1970s. Detroit was far too dependent for profit on large cars and had not paid enough attention to safety or fuel-efficiency. The energy crisis (partly helped by ousting the Iranian Shah), regulatory demands, and a cyclical downturn in the market were instrumental in pushing Chrysler, the weakest of the “Big Three” automobile manufacturers, to the edge.

In July 1979, John Riccardo, the then Chrysler chairman, went public with the depth of Chrysler’s difficulties, admitting that Chrysler was bleeding red ink. Second-quarter losses reached $207 million. As summer turned to fall, the news from Chrysler was bleak. Chrysler’s 1979 $1.2 billion loss was the largest recorded in US corporate history. By the end of 1979, the company was teetering on the brink of bankruptcy. Chrysler owed $4 billion, nearly 10% of all US corporate debt. Eighty thousand unsold vehicles worth over $700 million sat on dealer lots. Riccardo called for immediate federal assistance: a $1 billion US tax holiday, a two-year postponement of federal exhaust emission standards (worth $600 million to the company), and concessions from the United Auto Workers. Otherwise, he warned, the company would fail.

Enter Lee Iacocca. By 1964, Iacocca, a Princeton graduate, had already cemented a place in automotive history by bringing out the revolutionary Ford Mustang, which was an immediate and enduring success. Iacocca became Ford president in 1970, until Henry Ford II fired him in 1978. He was hired as president of Chrysler in 1979, tasked with turning around the faltering company.

Iacocca echoed Riccardo warning that without some sort of federal aid, Chrysler would most certainly fail. Chrysler’s impending demise was potentially the largest in history, and for many the company’s crisis represented the end of American postwar economic hegemony and the deindustrialization of North America. As Congress and the Carter administration haggled over the final aspects of a bailout bill, Chrysler faced its darkest days. To avoid running out of money, the company simply stopped paying suppliers. Finally, to the relief of over 250,000 Chrysler workers, in January 1980, President Jimmy Carter signed the bill Chrysler Corporation Loan Guarantee Act of 1979. The plan provided $1.5 billion in loan guarantees, but required the company to secure another $1.43 billion in private financing, concessions from banks and suppliers.

The turnaround in Chrysler’s fortunes came swiftly and stunningly. In July 1981, just two years after Riccardo’s fateful admission of Chrysler’s dire financial straits, Iacocca announced that the company had turned a profit for the second quarter. Although it was a meager $11.6 million (compared to the company’s 1979-81 losses of $3 billion), these profits were followed by a tidal wave of income, and in 1983 Chrysler paid off its federally guaranteed loans seven years ahead of schedule. Chrysler’s amazing recovery did seem, indeed, to be a miracle, and there was no doubt who had been the miracle worker behind the turnaround.

By the 1980s, Iacocca was heralded as a possible presidential candidate; motivational speakers talked about “Lessons from the Great Leaders: From Hannibal to Iacocca.” He was a television celebrity appearing in Chrysler commercials and in an episode of Miami Vice; even a children’s play was written about his amazing story. In 1985, Iacocca wound up on the cover of Time magazine.

However, the popular version of the Chrysler story with its excessive emphasis in the role of the government is a myth, which clouds and distorts important issues involved in the larger question of business-government relationship. Confronting the Chrysler myth with Chrysler facts reveals Chrysler’s real financial condition and the real impact of those federal guarantees. It shows that if the bailout is indeed the model for an American industrial policy the consequences could be disastrous.

Myth 1: Government loan guarantees prevented the Chrysler Corporation from going bankrupt.

The truth is that the Chrysler has gone bankrupt by every normal definition of the word. Starting from 1979, Chrysler had renegotiated its debts and restructured its organization in a way that greatly resembles a company going through Chapter 11 bankruptcy. Its creditors, like those of bankrupt firms, were forced to swallow sizeable losses.
This was the result of a clause in the Chrysler Corporation Loan Guarantee Act of 1979 that required creditors to make certain “concessions” to Chrysler. With this clause to exploit and with Treasury Department officials pressuring its creditors, Chrysler was able to pay off more than $600 million in debts. In addition, the company was allowed to convert nearly $700 million in debts into a special class of preferred stock, worthless in the financial markets because the shares earned no dividends and were unredeemable for some time.
Chrysler’s creditors were not alone in being socked by the company’s quasi-bankruptcy. The firm’s workers had paid an even greater price. Despite the fact that the loan guarantees were approved by Congress mainly to protect jobs at Chrysler, the company has sent home nearly half of its employees, cutting its white collar work force by 20,000 and laying off 42,600 of its hourly workers since the loan guarantees were signed into law. Many observers complained that the number of employees laid off at Chrysler in this period is at least as large than the number of jobs that probably would have been lost had Chrysler actually been forced into bankruptcy.

Myth 2: Loan guarantees were justified because Chrysler’s financial problems were brought on by the federal government.

Although federal regulations have certainly played a part in the financial decline of the automobile industry, these rules apply to every firm in the industry, not just Chrysler. It was Chrysler’s management, rather, which put it on the road to bankruptcy. Throughout the late 1930s and into the early 1940s, Chrysler was the second largest car manufacturer in America, ahead of Ford. The company’s problems began shortly after WW2, when it decided to stick with prewar manufacturing and styling methods instead of retooling to meet the expectations of postwar automobile buyers. Ford and GM, in contrast, developed a sleek and streamlined design that sold well.
By the time Chrysler’s management admitted their mistake in the 1950s, the company had slipped to third place among the nation’s automakers. But because Chrysler’s new management reacted by emphasizing sales and production over engineering, the firm’s cars were little more than delayed copies of Ford and GM products. Regulations may have played a part in forcing Chrysler over the edge, but the stage had been set for Chrysler’s problems long before seat belts and bumper standards were a gleam in the regulators’ eyes.

Myth 3: Loan guarantees cost nothing since Chrysler had not gone bankrupt.

Under the provisions of the Loan Guarantee Act, Chrysler was supposed to compensate the federal government for the risk that the government has taken in making the guarantees. The House Committee on Banking, Finance, and Urban Affairs defined this risk as “the difference between the rate that the guaranteed loans carry and the rate that Chrysler would be required to pay if the loans were obtained without the federal guarantees.”
Just how large is the difference between the two rates? In early 1980, Chrysler was able to issue government-guaranteed bonds at an interest rate of only 10.35%, while Ford was forced to pay about 14.5% for its unguaranteed bonds. If Chrysler did not have the loan guarantees, it would almost certainly have to pay a higher interest rate on its bonds than the more secure Ford. In addition, Chrysler paid only 1% government guarantee fee, amounting to $12 million a year. Chrysler attempted to make up the difference by giving the government 14.4 million “warrants,” which are certificates that give the government the right to purchase a share of Chrysler stock at $13 a share. In early 1983, Chrysler publicly demanded that the Treasury Department return the warrants to Chrysler, claiming that cashing in now-valuable warrants would amount to “usury.” Due to adverse public reaction, a Chrysler spokesman said that the company “would not press” the demand at this time. Moreover, Chrysler had petitioned the federal government to reduce the 1% loan guarantee fee to the statutorily mandated minimum of 0.5%.

Myth 4: Chrysler’s top management took deep salary cuts until Chrysler’s financial problems were resolved.

When Chrysler was petitioning the federal government for the financial assistance it wanted, in 1979, the company announced its Salary Reduction Program. Executive salaries were cut 2-10%; Lee Iacocca reduced his salary to one dollar a year (although it was made clear that, under the program, Iacocca would collect the balance of a recruitment bonus due to him in 1980). If Chrysler’s financial performance was adequate after two years, the executives would be eligible to receive retroactive salary payments to make up for these reductions.
Despite the fact that Chrysler lost nearly $500 million in 1981, the Salary Reduction Program ended that year, and executive salaries were restored to their 1979 level. Moreover, the company made retroactive payments to its executives for about two-thirds of the income they lost while the program was in effect, on the theory that its stock price in 1981 was about two-thirds of its 1979 price. Iacocca himself received over $360,000 in salary supplemental payments and director’s fees in 1981.

Myth 5: Chrysler’s profitability showed that it is on the road to financial recovery.

Chrysler’s supporters were elated when the company reported a net profit of over $170 million in the first quarter of 1983 — the largest quarterly profit in the company’s history. Chrysler claimed that cost cutting has been an important factor in the company’s success. At the time, Chrysler’s cost cutting program provided little optimism for long-term profitability.

Chrysler’s massive losses in 1979, 1980, and 1981 have given the company large tax deductions to cut its tax bills almost to zero throughout the 1980s.

Chrysler boosted R&D spending from $161 million in 1972 to $358 million in 1979 (or $207 million in 1972-equivalent dollars). But between 1979 and 1982, R&D spending was cut to $307 million (only $133 million in 1972 dollars).

In January 1982, Chrysler reached an agreement with the UAW to defer $220 million in pension fund contributions.

In January 1981, Chrysler negotiated special concessions from the UAW that saved the company more than $600 million in 1981 and 1982.

Summarizing…

After suffering a big decline in the period from 1978 to 1983, the industry experienced the benefits of resurgence in consumer confidence that, while not inevitable, was expected in the highly cyclical auto sector. The more general economic turnaround, accompanied by a decline in record-high interest rates that benefited car sales significantly, boosted this confidence. Chrysler’s new products (K-Car and the minivan) were also appealing to consumers. Trade policies helped fuel the Chrysler and Big Three rebound. The 1981 “voluntary export restraints” imposed by President Ronald Reagan’s administration on Japan provided some relief for American carmakers. On his part, Iacocca undertook four major strategic moves, (in addition to restructuring and cost cutting) which helped Chrysler to turnaround its fortunes and eventually go out of the red.

First, Iacocca used Chrysler’s dire situation to convince the vast number of individuals, groups, and interests affected by the crisis (as well as the public) that saving the company his way was the best and only option for Chrysler. Iacocca needed to keep the company afloat while emphasizing the organization’s precarious situation of being “on the brink” to achieve management goals.
Iacocca needed little help in publicizing Chrysler’s situation. Headlines screamed that an estimated 400,000 workers would lose their jobs if Chrysler failed, and that unemployment in Detroit would jump from 8.7% to 16%-19%. The American economy would lose $30 billion or 1.5% of America’s entire GDP. At a time when America’s trade balance was already in sharp deficit, a Chrysler failure would add a further $1.5 billion. These dire warnings became Iacocca’s talking points to the nation. Pragmatism with a dash of patriotism proved to be Iacocca’s most effective tool in convincing Americans of both the severity of the crisis and the need for aid.

Second, Iacocca asked the American government for aid. He had to persuade Americans that government aid through loan guarantees was not only necessary in this case, but also not un-American. Iacocca recalled that during the debate over Chrysler’s fate, “Everybody was beating on us. Everybody saying, ‘How dare you violate the altar of free enterprise and ask for a loan guarantee?’ . . . We did not take taxpayer money. We had a guarantee, but for fifty years they’ve guaranteed.” Unsurprisingly, many both within the auto industry and without saw this as anathema.

Third, Iacocca successfully managed and negotiated the myriad networks of management, unions, suppliers, and banks within the Chrysler constellation to position the company to take advantage of the government loan package. Among Chrysler employees, Iacocca had to fire thousands of managers and salaried staff. On the union side, the UAW leadership was mostly onside and agreed to concessions, though not without acrimony. Similarly, many suppliers initially balked at the concessions required by the company, though they all eventually agreed. Perhaps most difficult of the stars within the Chrysler constellation were the banks.

Fourth, Iacocca made a conscious decision to become the very public face of the company and utilized his skills as a salesperson to create a marketing and communications strategy that made him the central actor in this Chrysler turnaround strategy. Along with communicating to the company’s workers, Iacocca took the step that was perhaps the most pivotal in the Chrysler turnaround story. He leveled with the American people. This effort started small, with Iacocca signing “open letters” to the American people, in the form of full-page newspaper and magazine articles placed at the height of the crisis. The ads attempted to debunk the “myth” of Chrysler’s “gas guzzlers” and clarify Chrysler’s situation. Then came the commercials, which utilized Iacocca’s marketing skills (“If you can find a better car, buy it”) and natural charisma, which helped saving the ailing Chrysler.

Paulson mistakes and chapter 11

A brief but illuminating summary of recent blunders of Henry Paulson, an expert on the Great Depression.

Treasury Secretary Henry Paulson made some disastrous decisions that had major unintended consequences.

One of those was the decision to nationalize Fannie Mae and Freddie Mac. Once the government took over Fannie Mae and Freddie Mac, supposedly preemptively, shareholders of every other financial company that perhaps needed capital were left with no choice but to sell aggressively, fearing the government might decide to preemptively wipe them out also. This made it impossible for any company to raise the capital it needed or wanted.

About a week later Lehman Brothers filed for bankruptcy, Merrill Lynch was forced to sell to Bank of America, and AIG was extended a huge government loan, all completely or nearly wiping out shareholders.

Then Paulson forced nine major banks to receive capital infusions from treasury, effectively partly nationalizing them, and creating a huge American Sovereign Wealth fund.

The above referenced nationalizations created a bizarre situation where the government contended that financial institutions needed more capital, and that it should be private capital that will solve the problem. But the government also indicated that it stands ready to provide additional assistance in the future, thus destroying the equity stakes of those prospective capital providers. Why would private capital invest, if it believes it is the policy of the government to later intervene and dilute it?

Enter the pernicious crash of October-November 2008.

The smartest CEO, John Thain of Merrill, understood the new landscape before anyone else and quickly sold at the then still available price, albeit a fraction of his company’s value at its peak. In doing that he saved Merrill from the ignominious fate it was inevitably headed towards, the same fate that awaited Lehman Brothers.

And by letting Lehman Fail, the counterparty risk was unleashed on the economy of the world, as Lehman was involved in thousands of trades all over the globe and was much bigger than Bear Stearns. That brought to the forefront the systemic risk that is now looming above us like a dark cloud. All of a sudden even money market funds were losing principal. Secured bond holders are losing money (unlike the creditors of Bear Stearns, Fannie and Freddie, who emerged whole). Nobody knew who could be trusted, and short term credit markets ceased to function, severely impairing the economy further.I believe Secretary Paulson’s policies aggravated the crisis. At the moment, Citigroup and JP Morgan are struggling; locked out of the market for private capital and their shares are in free fall. Despite major capital infusions, most financial stocks are down sharply. The nine institutions that received the first cash infusion from Washington have seen their shares fall more than 40% since then. Goldman Sachs last week was trading at a value less than just the amount of money it raised recently. So many financial institutions are failing, making the federal government their built-in savior and enervating the Fed’s resources with their insatiable demand for fresh cash.All this is making it palpably clear that the Treasury’s policy did nothing to build confidence or stabilize the markets. The sickening, precipitous drop of the equity markets in October and November are the market’s judgment on the merit of Treasury’s policies.

Here is the original article from the Huffington Post.

He accepted his errors by saying, “We’re not proud of all the mistakes that were made by many different people, different parties, failures of our regulatory system, failures of market discipline that got us here.” His solution was then and now to “buy bad assets and the administration has allocated $US100 billion for that portion of the program,” referring to the $700 billion bailout program.

His approach however looks more like a band-aid, which will postpone but by no means prevent a near certainly future problems in the financial markets. As one shrewd expert admits, “The government cannot repeal the law of gravity and stop markets from falling. Nor can it turn back the clock to reverse our financial blunders.”

The currently prevalent and rather dogmatic approach of avoiding filing for the Chapter 11 is mostly due to a misconception. It is commonly thought that a company or an organization filing for the bankruptcy (immediately) ceases its activities and (virtually) its existence. This is wrong. Usually the causes (especially in high-tech cases) to file for Chapter 11 include overwhelming debt, defensive maneuver against temporary legal liabilities and need for reducing labor problems. For the duration of being under the Chapter 11 protection, the company/organization continuous its operations. The difference mainly comes in guise of added supervision and control. The debtor usually remains in possession of the company’s assets, and operates the businesses under the supervision and control of the court and for the benefit of creditors. The debtor in possession is a fiduciary for the creditors. The objective and desired result of the Chapter 11 protection is make the company cut costs, re-orient itself and streamline in resources in efficient manner in order to return to profitability. Although admittedly the rate of successful Chapter 11 reorganizations is low (estimated at 10% or less), it is still a better solution, and is not only considered by small and medium but by large multinational corporations such as GM (which follows the same path of peering into the public money instead of doing an internal restructuring, refocusing and cost cutting as was done to save IBM in a similar case in 1993). In addition to other benefits, for the GM case, Marketing expert Seth Godin goes to the extreme of proposing, “Use the bankruptcy to wipe out the hated, legacy marketing portion of the industry: the dealers.” And then adding, “We’d end up with a rational number of “car stores” in every city that sold lots of brands. We’d have super cheap cars and super efficient cars and super weird cars. There’d be an orgy of innovation, and from that, a whole new energy and approach would evolve.” I agree.

Companies coming out of the Chapter 11 (usually few years after the initial filing) are leaner, healthier and better positioned. The most famous case in point is WorldCom.

One way or another, financial policies so far espoused by the US Treasury and Fed not only come short of calming markets and inducing confidence in money-needing banks, but also continue wasting tons of taxpayer dollars, imposing a heavy financial burden on younger generations.

On Louis Gerstner and IBM

A bit of historical perspective is here.

Year 1993, a once-mighty behemoth IBM, a former pacesetter in its field with a sterling reputation that was slowly fading into history, was considered a “state in a state” with 300,000 employees, billions dollar budget and its unique culture and myriad of rules and regulations.

However, IBM was then losing ground and money to likes of Apple, Intel and Microsoft. IBM offered early-retirement buyouts to employees shortly before Mr. Gerstner arrived. The company expected 25,000 people to take the offer, but about twice as many did. As employees headed for the exits, predictions of IBM’s demise were commonplace in magazine articles and books. The mainframe computer, IBM.’s lifeblood, was said to be dead. The future belonged to the fleet-footed leaders of the personal computer industry, Microsoft and Intel. To compete, IBM was pursuing a plan to break up the company into a collection of smaller ones.

Enter Louis V. Gerstner Jr., an outsider to the technology industry with a reputation as a leader and strategist, a management gun-for-hire whose résumé included RJR Nabisco, American Express, McKinsey & Company and Harvard Business School (graduated in 1965).

The IBM he saw he later described (in his book and subsequent seminars) in evocative metaphors and equally astounding ways. He likened the company to an elephant, the late Roman Empire, the Kremlin, the Titanic and an animal raised in captivity that is suddenly returned to the jungle. Still, most persuasive is IBM as the sick patient. When Gerstner arrived, the company was sclerotic, senile and hemorrhaging. It lost $5 billion in 1992 and $8 billion in 1993. Its market share had dropped 50%; 45,000 employees had just been laid off.

A few weeks after Mr. Gerstner joined IBM, a chauffeured car, as usual, arrived at his Connecticut home one morning to pick him up. As the car drove up, he was surprised to see someone already in the back seat. It was Thomas J. Watson Jr., the then 79-year-old former chief executive and son of the company’s founder. He told Mr. Gerstner that he was angry about what had happened to ”my company” and urged Mr. Gerstner to shake it ”from top to bottom.”

Mr. Gerstner, no stranger to big companies and bureaucracy, was stunned by what he calls ”the extraordinary insularity of IBM” That resulted in a pathological focus on internal process at IBM instead of on customers and the marketplace. Three weeks into his job as the newly installed chairman and CEO in 1993, Gerstner was presiding over his first meeting at the company on the topic of strategy. Everyone in the room was actively sharing ideas. “After eight hours I didn’t understand a thing,” Gerstner recalled. Too much terminology, too many abbreviations, too many insider-oriented information pieces and references.

At one of his first meetings, Gerstner was the only attendee not in a white shirt (he wore blue); the next time he faced a sea of colors, and he soon rescinded IBM’s famously rigid dress code. Discussion at that IBM meeting, he said, seemed to be conducted in almost a private company code, like another language. Gerstner was not hearing the dispassionate, cost-driven analysis that he had been hoping for. The meeting, however, was a pivotal one for him at IBM, because it made him realize what he was up against in his charge to restore the once-great company to health.

The corporate culture could be described only as feudal. As one example, Mr. Gerstner reprints what he terms ”one of the most remarkable documents I have ever seen”: a 60-page memo from a human resources director to an aide of a senior IBM executive. It told the aide, among other things, to reset the three clocks in the executive’s office each day and included detailed instructions on how and when to buy and resupply the executive with his preferred chewing gum (Carefree Spearmint sugarless). Mr. Gerstner cited this as an instance of the ”suffocating extremes one could find all too easily in the IBM culture,” and he named the executive, who voluntarily retired just after Mr. Gerstner took over.

Within the first 100 days, he made the important decisions to keep the company together, reduce costs sharply and change the way IBM did business, overhauling sales, marketing, procurement and internal systems. He didn’t break up the company, as many were advising in response to his smaller, nimbler competition. He didn’t try to divert attention by acquiring new revenue streams, as many investment bankers were urging. Instead, he slashed prices to get badly needed cash and regain market share. He held a fire sale of unproductive assets. And he laid off 35,000 more employees (but he put so much human touch in this difficult decision: compassion and care).

He writes that the choice to keep the company together, reversing the course set by his predecessor and endorsed by the board, was ”the most important decision I ever made – not just at IBM, but in my entire career.” He based it on strategic analysis and instinct – and listening to customers. His bet was that IBM’s competitive advantage would be as the ”foremost integrator of technologies” to solve business problems for corporate customers. So much of what IBM did since then flowed from the one-company decision – the changes in sales, marketing, organization and compensation.

Before long, Mr. Gerstner also realized that trying to recapture control of the personal computer business from Microsoft was quixotic – costly, time-consuming and yesterday’s war. By the mid-1990’s, IBM’s technical leadership had noticed the Internet, and took the view that the coming ”networked world” would lead the way to the post-PC era, undermining Microsoft’s grip on the industry. ”Desktop leadership might have been nice to have,” Mr. Gerstner writes, ”but it was no longer strategically vital.”

Perhaps most important, though, Gerstner, the nontechie generalist, listened to those who anticipated that the PC revolution was entering a new stage. Few in the business then foresaw the big-system foundations of today’s networked world, in which corporate customers need soup-to-nuts services provided by a global information technologist. The now common phrase ”e-business” was coined by IBM.

He kept the company together, cut payroll and other costs, reduced IBM’s dependence on hardware and built up the services business. Under his leadership, IBM deftly caught the Internet wave, grasping its significance and translating it for baffled corporate customers. Such nimble exploitation of a fast-moving market opportunity was foreign to the old IBM.

After ten years into his job, in 2002, Gerstner left IBM with 65,000 more employees than when he arrived. The 2001 profit of nearly $8 billion marked the eighth straight year of black ink (though the company is carrying heavy debt). IBM was again an industry leader. Its culture and management were completely overhauled and put again onto the cutting edge.

He then wrote a memoir where he documente his years at IBM. ”Who Says Elephants Can’t Dance?” is not about IBM’s Lou Gerstner; it’s about Lou Gerstner’s IBM – and, by extension, that of his predecessors, since that is what he inherited in 1993. The book can seemingly serve a good case in point for current crisis-stricken GM, which is also predicted to file Chapter 11 if not rescued by the American government.

The book has no photographs, and its first sentence is, ”This is not my autobiography.”

Failed states in 2008

The Fund for Peace is an independent nonprofit research and educational organization founded in 1957 by investment banker Randolph Compton. Since its inception, it aimed at prevention of conflicts and alleviation of causes of conflicts. Due to its historic role and analysis conducted in socio-economic, political and demographic fields, the Fund came up with the idea of evaluating countries based on indicators such as demographic pressures, economic development, and deterioration of environment, among others. From 2005 co-operating with Foreign Policy magazine, the Fund publishes its annual “Failed States Index” that provides results of analysing a large set of factors causing/contributing for a state to fail or become weak. While generally a good starting point of information for decision-makers, few criticize the notion of “a failed state” because its frequent references to countries considered a threat to the US government.

The index provides assessment only for sovereign states (determined by membership in the United Nations). Territories such as Taiwan, the Palestinian Territories, and Northern Cyprus are not figuring on the list until their political status and UN membership is ratified. Ranking is measured based on 12 indicators, which are divided into three categories: social, economic and political. For each indicator, the ratings are placed on a scale of 0 to 10, with 0 being the lowest (most stable) and 10 being the highest (least stable). The total score is the sum of the 12 indicators and is on a scale of 0 (least failed) to 120 (most failed).

Social Indicators

I-1. Mounting Demographic Pressures
I-2. Massive Movement of Refugees or Internally Displaced Persons creating Complex Humanitarian Emergencies
I-3. Legacy of Vengeance-Seeking Group Grievance or Group Paranoia
I-4. Chronic and Sustained Human Flight

Economic Indicators
I-5. Uneven Economic Development along Group Lines
I-6. Sharp and/or Severe Economic Decline

Political Indicators
I-7. Criminalization and/or Delegitimization of the State
I-8. Progressive Deterioration of Public Services
I-9. Suspension or Arbitrary Application of the Rule of Law and Widespread Violation of Human Rights
I-10. Security Apparatus Operates as a “State Within a State”
I-11. Rise of Factionalized Elites

I-12. Intervention of Other States or External Political Actors

In the words of the people from Foreign Policy:

Because it is crucial to closely monitor weak states—their progress, their deterioration, and their ability to withstand challenges—the Fund for Peace, an independent research organization, and FOREIGN POLICY present the fourth annual Failed States Index. Using 12 social, economic, political, and military indicators, we ranked 177 states in order of their vulnerability to violent internal conflict and societal deterioration. To do so, we examined more than 30,000 publicly available sources, collected from May to December 2007, to form the basis of the index’s scores. The 60 most vulnerable states are listed in the rankings, and the full results are available at ForeignPolicy.com and fundforpeace.org.

According to this year’s Index, Somalia is the number one failed state in the world while Norway is the most prosperous. Moreover, seven out of the ten most failed states in the world are from Africa (only exception being Afghanistan, Pakistan and Iraq). There are currently 35 failed states (marked in red) of which 19 are African.

The report claims Somalia is the most failed state in the world. Many researchers believe that Somalia is a collapsed state since the collapse of its national government in 1991. Somalia scored a record amount of points this year: 114.2 (out of maximum possible 120), which is also the closest a state got to complete failure since the Failed States Index was first published. The country report shows that none of Somalia’s indicators improved since the last year’s index.

Due to ongoing crisis in financial markets, Iceland (172nd on the 2008 list), considered one of the least failed or best countries in the world (the best country to live according to the UN Development Index 2007) turned in a matter of few weeks (mainly due to its almost exclusive economic reliance on the global financial markets) into a state on the verge of national bankruptcy.

Iceland is a glaring example of how “well” globalization works its magic in the modern era of interconnectedness and interdependence.