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Public Lecture Presentation Slide (11.29.2013) Naomi Fink: Abenomics and the Japanese Wealth Gap

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  • 1. Abenomics and the Japanese wealth gap Naomi Fink – CEO, Europacifica Consulting November 2013 1
  • 2. Intro: A framework to examine Abenomics In the early days of the Abe Administration, public (and market) expectations appear to be riding high What are the chances the public will be disappointed? Hint: in order to estimate this, we need to agree about what we expect from Abe, as well as what we expect from the rest of the world What are the implications for the conduct of policy given these expectations? 2 What are the implications for welfare (aggregate or relative) if Abe’s policy succeeds or fails? 2
  • 3. What can we expect from public policy? We assume that elected policy-makers attempt to maximise the welfare of their electorate (or at least minimise the loss), if only to remain in office. Most OECD governments, even those with purported “free market” platforms, not only care about aggregate welfare, but also relative welfare (to some degree) and thus some form of redistribution (transfers, national insurance, pensions, tax progressivity, etc). Example: OECD notes that social transfers allayed much of the shock to market income from GFC Devising a redistribution rule that leaves nobody worse-off is a tough proposition. 3 The attractiveness of Reaganomics/Thatcherism came alongside the image of the “rising tide” (aggregate growth) that “lifts all boats”. Did it? Possibly not, but it mattered more at the time whether we believed it would. 3
  • 4. Framework for examining public policy Setup of the policy problem: To stay in office, governments will make policy promises to minimise welfare losses (and thus stay in office) Circumstances will often lead to temptation to shift policy to gain a more optimal result, abandoning commitment If the public perceives that temptation is greater than the political cost of breaking promises given (a) particular outcome(s), they shift their expectations such that the implemented policy may no longer be optimal (enforcement) Policy with commitment is more likely when the cost of enforecement outweighs temptation to deviate 4 Incomplete markets mean there exists uncertainty… 4
  • 5. A few sources of uncertainty Economic cycles Probabilities associated with welfare gains/losses associated with economic fluctuations Externalities Natural disasters Geopolitical risk Economic crises Overseas investment flows/foreign exchange Asymmetries 5 “Disorderly” inflation risk is greater than welfare loss associated with deflation 5
  • 6. Source: http://www.kantei.go.jp/ What does this mean for Abe? We need to estimate all of these factors if we want to answer our initial questions on Abenomics! We can use Reagan/Thatcher policy examples for qualitative comparison/contrast(since we know outcomes) in doing so. 6
  • 7. What can we expect from Abenomics? Expectations: So far, things look good for Abe: early gauges – market signals (stock market, yen) show positive expectations Problem: Some probability for implementation to diverge from expectations (no commitment), and if potential divergence is too far, this means loss of credibility. Is the cost to the Abe administration of credibility loss (eventual regime change) greater than the temptation to deviate from reform promises? Sources of Uncertainty: 7 Asymmetrical credibility risks (especially for the BOJ) Externalities: e.g. US monetary policy, Chinese growth, crises in the rest of the world 7
  • 8. What do these possibilities mean for the wealth gap? Although cutting capital taxes are a fairly robust way to maximise future aggregate consumption growth and thus aggregate welfare (e.g. Chamley, Atkeson/Chari), cutting capital taxes too radically can widen welfare gaps (Conesa/Kitao/Kruger, Marcet/Mila/Ventura) If implementation succeeds, it is possible that the wealth gap widens, in the absence of income transfers (either implicit or explicit) This is one area in which comparing/contrasting Abenomics with the policies of Reagan and Thatcher may be useful 8 If implementation fails, it is possible that Japan continues to “spread the disutility” – deflation is not only damaging to debtors, it is regressive without fiscal adjustments 8
  • 9. Japan’s wealth gap: “spreading the disutility” High income earners are getting no richer… but poor are getting poorer ..Yet deflation is regressive – high-capital earning retirees gain more in deflation years 2.7 2.6 3000000 2.5 P90/P50 disposable income decile ratio i 2.3 2.2 2.1 2 1.9 1.8 2900000 P50/P10 disposable income decile ratio i 2.4 2600000 2800000 Median disposable income (constant prices) 2700000 2500000 Mean disposable income 65+ age group 2400000 2300000 2009 2006 2003 2000 2200000 1985 1985 1995 2000 2003 2006 2009 1995 1.7 Source: http://www.oecd.org/ 9
  • 10. Post Crisis: Wealth gap shows why OECD fears Japan-like pattern Japan is still in the disutilityspreading minority But transgenerational gap is growing across OECD 5. Poorer households tended to lose more or gain less Annual percentage changes in disposable income between 2007 and 2010 1, by income group 5% Total (↗ ) 0% Top 10% -5% -10% Bottom 10% Ic el M and e G xico re e Ire ce Es land to n S ia N Hu pa ew n in ga Ze r al y an d I Tu taly U ni rk te ey d J U Ki a p a ni ng n te d d om St N Po ates et rtu Lu her ga xe lan l m ds b N our o g A u rwa st y Sl ral ov ia e Fr nia an ce C z e B Ko r ch el ea gi R u e m D pub en lic m Fi ark nl an Is d G ra er e m l Ca an n y Au ada Sw stri ed a e Sl C n ov ak Po hile R lan ep d ub lic O EC D -3 3 -15% Notes: See notes to Figure 1. Information on data for Israel: http://dx.doi.org/10.1787/888932315602. Source: OECD Income Distribution Database (www.oecd.org/social/income-distribution-database.htm) Source: http://www.oecd.org/ 10
  • 11. 11 Identifying Policy Parameters First steps: we can identify Reagan/Thatcher expectations and outcome and find policy analogues for Abe 11
  • 12. Commitment, under Reagan and Thatcher Reagan/Thatcher ideologies mostly comprised: Rhetorical/ideological commitment to monetarist policies, pressure for central bank to fight inflation (not to monetise debt) and (in Thatcher’s case) rejection of Keynesian policies Reagan: Emphasis on capital tax cuts and elimination of progressivity of inflation, reallocation of spending to defence Thatcher: Emphasis on deregulation of industry and privatisation – “structural” reform 12 12
  • 13. Use potential outcomes to identify policy paths…. Actual outcomes for Reagan/Thatcher: Perceived commitment to their respective policy paths, independent of popularity of these policies. Temptation<Enforcement Reagan: capital tax cuts and reallocation of government spending Thatcher: deregulation of labour and numerous government privatisations Inflation, high at first in both areas decreased (possibly thanks to the Volcker Fed’s commitment) Economic growth (one measure of welfare), anemic at first, picked up by the end of both administrations (no definitive causality) Fiscal, policy, structural consequences: US government debt/GDP swelled, UK debt/GDP subsided The “great moderation” in inflation continued Greater wealth gap at the end of Reagan/Thatcher regimes 13 13
  • 14. Plus lower-probability (now 0%)events, for example… Stagflation: Volcker Fed fails to maintain credibility, falls prey to asymmetric inflation expectations, fails to subdue inflation, unemployment remains high and real incomes drop within Reagan’s two terms; cost: welfare loss, risk of regime change (for Reagan, possibly for Thatcher) Reagan: Capitalists show scepticism over Reagan’s corporate tax cuts (perceiving temptation>enforcement), fearing budgetbalancing hikes in the future (in actuality, Reagan did hike 11 times). Growth fails to pick up; cost: perceived welfare loss, risk of regime change 14 14
  • 15. Plus lower-probability (now 0%)events, for example… Thatcher: budget hike fails to quell investor concerns over the UK government budget (clashes with BoE seen as loss of central bank autonomy sabotaging inflationfighting credentials), UK sees flight of capital and forced austerity is imposed; cost: perceived welfare loss (rise in rates, drop in transfers), risk of regime change Thatcher: deregulation of labour loses traction among voting populace and reform is diluted (optimal, but time inconsistent policy), companies fail to increase hiring activity, unemployment remains high; cost: failure of welfare improvement, regime change Reagan: Failure to negotiate an increase in the debt ceiling (raised 18 times under Reagan), compelling renewed, unpopular tax hikes, forcing reversal of prior cuts (time inconsistency). cost: perception of default, regime change 15 15
  • 16. Commitment, for Abe Monetary: Rhetorical/ideological commitment to monetarism (Deflation-fighting) without rejection of Keynesian policies. The above poses a time-consistency question for the BOJ’s monetary policy in its willingness to reflate, then in its ability to subdue eventual inflation Fiscal: expectations for fiscal easing within the cycle, expectations for eventual fiscal tightening (consumption tax hikes, goal to halve the primary balance surplus). No expectations either for aggressive moves either way Structural: Expectations for reallocation of government spending to create labour reallocation incentives; slight expectations for prouctivity-enhancing capital reallocation incentives (Japan Post privatisation, TPP, SEZ’s) but potential for temptation>enforcement here 16 16
  • 17. Use potential outcomes to identify policy paths Potential outcomes for Abe (examples): “Good” Global markets continue their rally, driving reflation in asset markets, spilling over to Japan. Yet global inflation remains low enough for the Fed to withdraw accommodation amid low inflation expectations. The BOJ leaves stimulus in place until 2% is in sight, and slowly withdraws in an inflating market, while reflation allows Abe’s regime to survive long enough to embark upon structural reform while inflating away existing debt. 17 17
  • 18. Use potential outcomes to identify policy paths “Bad” The rally in global markets proves ephemeral and the Fed leaves policy accommodation in place for longer than originally expected. Japan remains mired in deflation, as BOJ’s “commitment” to reflate the economy is not seen as strong enough, in a situation of ongoing global stagnation. Without reflation, Abe is unable to deliver on even the mild structural reforms the market expects. “Ugly” Markets lose confidence in the FOMC’s commitment to keeping inflation under control, and inflation expectations spiral uncontrollably. The BOJ, tarred by the same brush as the Fed, fails to enforce its 2% target on the upside, and is left to hike rates after prices have already zoomed. Failure to boost productivity in the services sector results in lagging wage inflation even as wage rigidities contribute to higher unemployment; meanwhile consumer savings are inflated away alongside government debt balances. 18 18
  • 19. Potential outcomes for the welfare gap (examples) “Good/Good” The rally in global markets assists capitalists, who redeploy profits and create jobs, while inflation enforces the greater progressivity of income tax brackets even as consumption tax increases are imposed. Tax receipts rise and transfers are directed to reinforcing the social safety net, facilitating implementation of labour reform and further structural reform; aggregate growth improves the situation of all and redistribution (via monetary and fiscal policy, transfers) keeps the wealth gap in check “Good/Bad” Global markets continue their rally and give rise to modest inflation, yet the combination of higher income and corporate tax revenues are insufficient to fund new transfers. To appeal to capitalists (and reverse progressivity), the government inflation-adjusts tax brackets. Interest rates rise, forcing the government to inflate away existing debt balances but reducing their capacity to establish a social safety net. Support fails to crystallise either for labour reform, trade liberalisation or other productivity-boosting measures. The wealth gap widens without structural reform 19 19
  • 20. Potential outcomes for the welfare gap (examples) II “Bad”/Good” Reflation persists for a period, but the BOJ reacts too early or aggressively and its 2% target loses credibility. However, due to a healthy global market abroad, the government is able to inflate away a large enough portion of debt to regain credibility in its efforts to regain primary balance. The BOJ’s failure to monetise debt moreover reinforces credibility in the government’s improved fiscal condition; while Japanese growth under-performs, some productivityenhancing structural reform takes place. Aggressive cuts to capital taxes do not take place, thus allowing mild reflation to introduce a greater degree of tax progressivity. “Bad/Bad” The global market rally falters and Japan falls back into deflation. Structural reforms fail to be implemented, and the government remains constrained in its fiscal maneuver; while the BOJ’s policy is time-consistent with regard to fighting inflation, it cannot be consistent in fighting deflation and it is the government’s debt-monetisation pressures that suffer from lack of credibility. The slow erosion of aggregate and relative welfare (thanks to lack of adjustment of tax brackets) continues. 20 20
  • 21. Potential outcomes for the welfare gap (examples) III “Ugly”/Bad Inflation surges far above the BOJ’s 2% target and despite the tax-progressiveness of inflation, languishing productivity fails to keep wage growth in line with inflation on aggregate. The ability for firms in certain sectors to innovate (manufacturing, IT sectors) and thus reduce costs contrasts starkly with those who cannot (services, in which 70% of the labour force is employed) and aggravates the two-speed economy, widening the wealth gap along sector lines. The services sector fails to maintain its function of absorbing capacity spillover from the more productive manufacturing sector. The government inflates away debt but its credibility damaged, is unable to spend a sufficient amount to establish an adequate redistribution rule. “Ugly/Ugly” inflation spirals out of control and depositors dump the yen and capital flight ensues. Those who get out in time retain a far greater part of lifetime wealth. 21 21
  • 22. Assign probabilities to each scenario, solve backward… If we can do this in a manner that reflects public opinion, we can estimate the distribution of risks (to the upside and downside) to welfare that will dictate the credibility of the Abe administration in its ability to carry out its stated policy goals. By setting relative wealth as the welfare measure, we also estimate the risks to the welfare gap – to the upside and downside, as a function of how the public is likely to react in each scenario (weighted by likelihood, of course). 22 22
  • 23. Recovering First Best We want the optimal outcome, and if only to remain in office, so does Abe. How do we get it? 23
  • 24. Back to the “Three Arrows” Fiscal policy The policy: Promising reflationary growth alongside maintaining fiscal discipline is by nature a tough proposition. With little room to ease, they are reliant on the BOJ to offer monetary stimulus (which can be time-inconsistent). Mentions of potential corporate tax cuts gain a lukewarm reception. Consumption tax hikes may reinforce fiscal credibility but are seen by many (e.g. IMF) as insufficient. Is it optimal? The risk of jeapordising the BOJ’s credibility is not optimal. There remains “temptation” either for the BOJ to give up its 2% target or for the government to abandon goals to halve the primary balance deficit by 2015 24 24
  • 25. Back to the “Three Arrows” Monetary policy The policy: Stock and foreign exchange markets tell us they rate the Kuroda BOJ’s 2% inflation target and stepped up asset purchases, but to some extent, this rally is driven by cyclical recovery in Japan and abroad, supported by the Fed’s monetary policy. Is it optimal? There is asymmetric risk of inflation surging out of control. So long as everybody believes the probability of this event is extremely low this policy could be optimal. 25 25
  • 26. Back to the “Three Arrows” Structural reform The policy: Carrying through a partial privatisaton of Japan Post. Pursuing experimental labour and capital reform through special economic zones, with emphasis on specific sectors. Trade liberalisation (TPP) seen as one avenue to bolster productivity. Is it optimal? Most likely too early to tell and pathdependent. As the Koizumi administration learned, reflation makes structural reform more palatable to voters. For now, substantial risks remain in the timing, as well as the temptation to deviate from promises of more aggressive reforms. 26 26
  • 27. Comparison to Reagan/Thatcher Platforms: Monetary: Reagan reinforced inflation-fighting activities from Volcker’s Fed while Thatcher used fiscal policy to subvert BoE power to fight inflation. Fiscal: Reagan voiced commitment to tax cuts; Thatcher to spending cuts (alongside some income tax cuts) - overall fiscal tightening. Structural reform: Reagan’s fiscal reform credentials overshadowed regulatory; Thatcher’s platform focused around privatisations and labour deregulation 27 27
  • 28. Comparison to Reagan/Thatcher Commitment: perception of time-consistent policy kept both in office Was it optimal? Monetary: The Fed’s ability to keep inflation in check has been lauded, but there remains no proof that this policy was by nature optimal (Primiceri paper) Fiscal: Laffer curve dynamics (espoused by Reagan especially in justifying supply-side policies) do not actually differ so greatly in Japan and the US.. Corporate tax rates are comparable, bases are narrow Structural: Thatcher’s reforms were credible – some argue optimal on aggregate; many argue sub-optimal when examined with respect to relative wealth. 28 28
  • 29. Reagan Thatcher & inflation cost: Too great to deviate? Good luck: One massive difference is that the US/UK were in an enviable position when in regard to monetary policy – they were in a position to tame the huge inflation created in the 1970’s by the Oil shock. High inflation risk also meant high cost of deviation: the cost of losing credibility on inflation-fighting was likely perceived as much greater than the temptation to re-optimise policy to give rise to interim growth Would Fed policy have worked under different conditions? 29 Primiceri results give rise to scepticism 29
  • 30. Even Volcker’s activism is questioned in retrospect “Too loose” policy in 70’s & 80’s vs activist in 90’s But Primeceri questions Fed activism effect Source: Cogley & Sargent (2003) Source: Primeceri (2005) 30
  • 31. For Abe, structural reform is contingent upon… Successful monetary policy – money is neutral long-term, but reflation is a pre-requisite to structural reform Credible fiscal policy – nobody expects the world from Abe, given limited range of maneuver, so refraining from aggressive fiscal tightening may be as much as we can hope for. Still, Japanese debt holders perceive risk of Japanese default, so “temptation” to deviate from primary balance targets is substantial. Good luck – “Goldilocks” growth in the US and “just right” accommodation from the Fed, attenuation of Europe crisis risks, etc 31 Structural reform will remain, in retrospect the true measure of Abenomics’ success 31
  • 32. Structural Reform and Productivity Can Abe attain Japan’s post-bubble holy grail of policy? 32
  • 33. Potential for Structural Reform in Japan Via structural reform, we strive to maximise the contributions of factors of production Capital: Japan’s capital/output ratio rose in the 1990’s (as did depreciation costs) Labour: Labour hours dropped significantly over the 90’s and have kept decreasing– labour’s share of income also decreased Labour “productivity” (output per worker) rose as labour hours fell faster than output Total Factor Productivity growth (highly correlated with per capita output) has been on a downtrend since the 1990’s. 33 Technlological advancement Efficiency gains in allocation of labour Efficiency gains in allocation of capital 33
  • 34. Drivers of Japanese Growth Study by Hayashi & Prescott: TFP contributed 0.43% of the 3.95% decline in value-added between pre and post lost decade (the periods of 1983-1991 and 1992-1998). Similar results from my own model (next slide). 34 34
  • 35. Drivers of Japanese growth Source: Naomi Fink, 2013 35
  • 36. What is unusual about Japan TFP? Source: BIS, 2013 36
  • 37. Why it is necessary to take a closer look at deflation Price declines are not only due to lack of demand – some of them are thanks to technology! 37 Source: Naomi Fink, 2013 37
  • 38. Deflation and “investment specific technology” An even better fit in simulation using IST! Base case: With investment-specific technology: Detrended real GDP per working age person in Japan 130 base case model Index (1989=100) 120 38 110 data 100 90 1989 1991 1993 1995 1997 1999 2001 2003 2005 Source: Naomi Fink, 2013 38
  • 39. TFP: No surprise; gap in sector growth accounting 39 Source: JIP, Naomi Fink, 2013 39
  • 40. TFP: Results hold upon more detailed sector examination 40 Source: JIP, Naomi Fink, 2013 40
  • 41. Empirical Studies: Panel Regression 1, Regulation & Subsidies Endogenous variables: Exogenous variables (from the JIP database): A = our own measure of productivity growth (Solow residual), by industry TFPDA: TFP growth rates (baseline case, adjusted for quality of labour only) TFPDB: TFP growth rates (ex- quality of labour) TFPDC: TFP growth rates adjusted for capacity utilization, intermediate inputs) TFPDD: TFP growth rates adjusted for capacity utilization, production indices). REG1 : Regulation index with some relevant categories subject to regulation REG2: Regulation index with all relevant categories subject to regulation RDY: ratio of knowledge stock to value added 41 RDL: ratio of knowledge stock to vaue added, lag of 3 years ITY: ratio of IT capital stock to value added LK: capital/labour ratio (input measure) SI: log value of real value added SUB (included in 2nd round of regressions): Subsidies, at 5y intervals TT = Time trend 41
  • 42. Empirical Studies: Panel Regression 2, Capital Allocation Endogenous variables: A = our own measure of productivity growth(Solow residual), by industry TFPD = JIP labour and capital quality adjusted measure of TFP growth Exogenous variables (from the JIP database): QL: Quality of labour index QK: Quality of capital index INTAY: Stock of intangibles (ratio to output) ECOC: Investment stock of ‘economic competencies’ (ratio to output) 42 INNY: Stock of innovative property (ratio to output) LK: capital/labour ratio (input measure) SI: log value of real value added TT = Time trend 42
  • 43. Key results, for policy guidance Deregulation correlated positively with most measures of productivity in highly-regulated industries (Non-IT, Non-manufacturing) but negatively in deregulated industries (IT, Manufacturing). Could this mean an optimum lies in between? Subsidies may be necessary for other reasons than boosting productivity but their ability to boost or damage productivity looks weak Allocation of capital matters broadly to productivity (even in the services sector); the tiny stock of innovative capital, scaled by output, correlated positively to total factor productivity 43 43
  • 44. Recommendations: Excessive focus on improving productivity in the manufacturing sector – focus on fixing the laggards Look at how non-IT businesses, above and beyond nonmanufacturing alone, can improve productivity Innovation capital is important in services, non-IT as well as in IT/manufacturing. Create incentives for reallocation of capital toward innovative capital within these lagging sectors Subsidies might be necessary – while they do not show evidence of damaging TFP too much, they do not improve it either. Use subsidies as an interim measure in non-IT sectors. There may be an optimal level of regulation between the highly-regulated non-manufacturing/non-IT sectors and their dereglated counterparts. Focus deregulations on these sectors, particularly partial regulations that might damage competitiveness among substitutible goods/services. 44 Could there be a message for postal privatisation here? 44
  • 45. R&D expenditures rise alongside trade, financial openness R&D expenditures have risen with trade/financial openness across the OECD Rise in quality of labour across IT/Non IT but stagnation of Non-IT quality of capital …higher relative wages for skilled workers in traded industries Source: JIP, Naomi Fink, 2013 45
  • 46. References Amador & Coimbra, 2008. Total Factor Productivity in G7 Countries, IFC Bulletin No 28 (BIS) Atkeson, A., Chari, V.V. and P.J. Kehoe, 1999. Taxing Capital Income: A Bad Idea. Federal Reserve Bank of Minneapolis Quarterly Review, Vol. 23, 3-17. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121. Roberto M. Billi & Klaus Adam, 2004. "Optimal Monetary Policy under Commitment with a Zero Bound on Nominal Interest Rates," Computing in Economics and Finance 2004 67, Society for Computational Economics T. Cogley and T.J. Sargent, (2002). ”Evolving Post-World War II U.S. Inflation Dynamics,” NBER Macroeconomics Annual 2001, Volume 16, pages 331-388 Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2009. "Taxing Capital? Not a Bad Idea after All!," American Economic Review, American Economic Association, vol. 99(1), pages 25-48, March Teresa Garcia-Milà & Albert Marcet & Eva Ventura, 1995. "Supply side interventions and redistribution," Economics Working Papers 115, Department of Economics and Business, Universitat Pompeu Fabra Fumio Hayashi & Edward C. Prescott, 2002. "The 1990s in Japan: A Lost Decade," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(1), pages 206-235, January. Inui, Tomohiko, 2006. “Regulation and Productivity” http://www.eco.nihonu.ac.jp/center/economic/publication/journal/pdf/36/36inui.pdf 46 Growing Income Inequality in OECD Countries: What Drives it and How Can Policy Tackle it ? Forum, Paris, 2 May 2011 G. Primiceri ”Time Varying Structural Vector Autoregressions and Monetary Policy”, The Review of Economic Studies, 72, July 2005, pp. 821-852 RIETI/ESRI/HISTAT JIP data bases: http://www.rieti.go.jp/en/database; http://www.esri.go.jp/en/archive/bun/abstract/bun170index-e.html 46
  • 47. Thank you! www.europacifica.com © 2013 Europacifica 47