tag:blogger.com,1999:blog-42410641777693924522009-05-02T20:12:22.654+02:00The random economist"But part of the job of economics is weeding out errors. That is much harder than making them, but also much more fun." Robert SolowJoe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comBlogger31125tag:blogger.com,1999:blog-4241064177769392452.post-63767211239855751682009-05-02T19:39:00.003+02:002009-05-02T20:12:22.678+02:00The Big Drop: Trade and the Great RecessionRecent trends in trade have invited a mix of consternation and hyperbole in the business and economics press and blogosphere alike. Discussion has ranged from worries about export credit shortfalls to resurgent import protection. The focus has been on finding the cause, and the assumption has been that the collapse in trade is unprecedented, inconsistent with the general level of economic downturn, and indicative of a trade-related set of problems calling for trade-specific solutions. There are indeed important public policy questions here. Is this recession being confounded by a set of trade-specific problems and issues? If so, how big, and should we be worried?<br /><br />In confronting these questions, we need to be careful when comparing real and nominal changes in trade. The last 12 months have seen a dramatic drop in commodity prices, so that real and nominal trade data can tell a very different story. In addition, because the importance of various sectors in trade varies from their importance in GDP, and also varies considerably across countries, we also need to pay close attention to how we deflate trade flows to control for falling prices across a range of commodities. We also need to examine what is happening to domestic production (specific elements of GDP) before deciding we have a mismatch between trade and GDP trends. <br /><br />Global trade plummeted in the last months of 2008. Indeed, world trade volumes fell 13.7% from December 2008 to February 2009. (This is somewhat better than than the November-January drop of 17.5%, reflecting a 0.8% rise in February.) In the three months ending in February, Japanese exports were down 29.1%. EU15 exports were up 0.3% in February over January levels, after falling 2.3 percent in December and 5.3 percent in January. (CPB World trade monitor from April 21, 2009). The projections for the entire year 2009 offer little comfort. The WTO has forecast a 9% decline in global export volumes for 2009. <br /><br />When digesting this information, the arcane question of appropriate price deflators is important. Real trade figures can vary substantially according to the underlying prices used for deflating the data. The recent, highly cited WTO-figures rely on world GDP prices. There are problems with this approach. GDP includes a high share of non-traded components. Trade prices have fallen considerably, not least due to the large decline in oil prices. According to the CPB, energy prices were down 51.1% in the 4th quarter, compared to the 3rd. Consequently a smaller real drop is to be expected when deflating the value of trade flows with trade prices. The CPB figures quoted above are based on world trade price developments. In a modelling exercise by the French Centre d’Études Prospectives et d’Informations Internationales (Bénassy-Quéré et al. 2009) these differences are illustrated very clearly with trade falling – under identical scenarios concerning world GDP growth – by 8.9% when deflated by the GDP deflator and only by 1.7% when using constant trade prices. Thus, a large part of the story hinges on global price developments. Nominal EU-27 exports grew by 3.1% in 2008, while in real terms they had already fallen by 0.9% over the year due to the oil-price hike and subsequent fall that ran through 2008. Interestingly this comes from falling real intra-EU exports (-2.3%), while extra-EU exports still grew in real terms (by 3.6%) in 2008. In the US, nominal exports grew by as much as 12.4% in 2008, but with 6.4% only half as much in real terms. <br /><br />What is striking is the rapid drop in trade in the second half of 2008. This is shown in the figure below. Through August 2008, U.S. exports were still 20% above corresponding August 2007 levels in nominal terms. However, the trade tides have turned quickly, and by January 2009 exports at current prices were 21.5 percent below January 2008 levels, very much noticed by the general public. Similar trends can be seen in European data. But even in real terms, the drop was huge. Real year-on-year growth rates in the US exceeded 10% up until August 2008, followed by a stagnation of real exports and real declines starting to be seen in November and amounting to as much as 19.9% in February 2009. This explains the alarm bells. <div><br /><br />Figure 1. Growth Rates for US Trade, Jan. ’08 – Feb. ‘09</div><div><br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://www.intereconomics.com/blogs/jff/images/fig1.png"><img style="float:center; margin:0 10px 10px 0;cursor:pointer; cursor:hand;width: 414px; height: 272px;" src="http://www.intereconomics.com/blogs/jff/images/fig1.png" border="0" alt="" /></a><br /><br />The trade data are certainly disturbing. The fact that GDP contractions have been relatively minor compared to trade (5 or 6 percent in some countries in the last quarter of 2008, but nowhere near 20% as witnessed in early 2009 for trade) is the reason alarm bells have woken up trade policy makers. Before we roll out the trade policy guns, however, we need to identify the underlying forces at work. If we break down recent trends in U.S. trade, and control for the broad mix of price and sector changes driving the overall result, the trade changes look relatively consistent with the general pattern of this recession. The problem is not trade finance, but rather “finance” finance. This recession has been characterized by a massive collapse of credit mechanisms that has hit the capital goods and vehicle sectors particularly hard. It turns out that motor vehicles are also the driver of much of the recent trend in OECD trade data. We focus here on the U.S., but a similar story can be told with German data as well. <br /><br />The figure below presents a break down in the change in U.S. trade flows for the 12 months ending February 2009. We present both nominal flows, and also real flows. For real changes, we use BEA price deflators for traded goods by broad Census categories, as reported by the BEA. We have used these to express all real flows in 2007 dollars.</div><div><br /><br />Figure 2. Change in US Exports, Feb. ’08 – Feb. ’09.<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://www.intereconomics.com/blogs/jff/images/fig2.png"><img style="float:center; margin:0 10px 10px 0;cursor:pointer; cursor:hand;width: 414px; height: 272px;" src="http://www.intereconomics.com/blogs/jff/images/fig2.png" border="0" alt="" /></a><br /><br /><br />From the figure above, it is clear that roughly half of the drop in imports over the 12 months ending in February 2009 was due to a drop in raw materials like oil (“industrial supplies” in the figure). However, much of this was due to the collapse in commodity prices. Once we control for this, 55.7 percent of the “real” drop in exports is in motor vehicles and capital goods. Raw materials represent another 24 percent of the drop. Motor vehicles and capital goods represent 61.9% of the real drop in exports. The drop in motor vehicle trade actually lags the corresponding drop in U.S. production. According to BEA, domestic production of cars was down 60% from February 2008 to February 2009 – from 342.8 thousand units to 138.7 thousand. Over the same period, real exports fell “only” 45%, which is slightly better than the 47% drop from January 2008 to January 2009.</div><div><br /></div><div>The table below presents the trade situation for a broader set of countries. For some countries, the decline in real terms was greater than in nominal terms, implying an underlying fall in export prices. For other countries real changes are lower than nominal changes, i.e. prices in 2008 were still rising, even if moderating.<br /><br />Table 1. Year-on-Year Growth Rates of Monthly Exports, Jan. ’08 – Feb. ’09.<br /><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="http://www.intereconomics.com/blogs/jff/images/tradetab.png"><img style="display:block; margin:0px auto 10px; text-align:center;cursor:pointer; cursor:hand;width: 408px; height: 175px;" src="http://www.intereconomics.com/blogs/jff/images/tradetab.png" border="0" alt="" /></a><br />Source: Eurostat COMEXT, and BEA.<br /><br />We have clearly been witnessing a dramatic drop in world trade. For policy purposes though, an important question is whether the decline is out of line with the global shock to GDP and the underlying credit crisis. At the moment, trade seems to be a victim, but one reflecting non-trade weaknesses in credit and demand. The countries with the greatest trade shocks are also more exposed to sectors hit hard by the recession. They are also victims, so far, of the general pattern of recession rather than of systemic protection. This does not mean we should let down our guard against protection. Rather, while maintaining a rearguard action on the import protection front, the cure for the symptoms lies in curing the underlying illness -- recession linked to a deep credit crisis.<br /><br />REFERENCES<br /><br />Bénassy-Quéré, A., Y. Decreux , L. Fontagné, D. Khoudour-Castéras (2009), “Explaining the steep drop in international trade with mirage”, presentation at the informal workshop on ‘The Impact of the Economic Crisis on Trade’, April 9 2009, hosted by the OECD, Paris.<br /><br />Bureau of Economic Analysis, US trade data downloaded on 20 April 2009 from: <a href="http://www.cpb.nl/eng/research/sector2/data/trademonitor.html">http://www.bea.gov/newsreleases/international/trade/2009/trad0209.htm</a>.<br /><br />CPB Netherlands Bureau for Economic Policy Analysis (2009), “CPB Memo: World Trade Monitor”, downloaded on 21 April 2009 from: <a href="http://www.cpb.nl/eng/research/sector2/data/trademonitor.html">http://www.cpb.nl/eng/research/sector2/data/trademonitor.html</a><br /><br />Eurostat, Common External Trade Database, download on 20 April 2009 from: <a href="http://epp.eurostat.ec.europa.eu/">http://epp.eurostat.ec.europa.eu</a><br /><br /></div><div><span class="Apple-style-span" style="font-style: italic;"><span class="Apple-style-span" style="font-weight: bold;">note:</span></span></div><div><span class="Apple-style-span" style="font-style: italic;">This post is written jointly with Julia Woerz, and is also </span><a href="http://www.voxeu.org/index.php?q=node/3527"><span class="Apple-style-span" style="font-style: italic;">published on VoxEU here</span></a><span class="Apple-style-span" style="font-style: italic;">:</span></div><div><a href="http://www.voxeu.org/index.php?q=node/3527"><span class="Apple-style-span" style="font-style: italic;">http://www.voxeu.org/index.php?q=node/3527</span></a><span class="Apple-style-span" style="font-style: italic;"><br /></span></div><div><span class="Apple-style-span" style="font-style: italic;"><br /></span></div><div><span class="Apple-style-span" style="font-style: italic;">You can download a </span><a href="http://www.intereconomics.com/blogs/jff/images/VoxEUontradeJFF-JW_v5.pdf"><span class="Apple-style-span" style="font-style: italic;">pdf version here</span></a><span class="Apple-style-span" style="font-style: italic;">.</span><br /><br /><br /></div><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-6376721123985575168?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-19965905865885891742009-03-06T17:39:00.003+01:002009-03-06T17:56:25.145+01:00Trade is Falling, but Credit is not Due to Protectionism (yet)Alarm bells are ringing. Trade is falling, and so we have rounded up the usual suspect -- import protection. Yet we really have not seen a sustained wave of protection so far, only a wave of anxiety. What we have seen is a real collapse in trade volumes, caused by a mix of falling demand, buyer uncertainty, and an apparent lack of export credits. It is striking that in recent revisions to U.S. GDP statistics for the end of 2008, it now appears that U.S. real exports fell 23.6 percent in the last quarter of 2008, while real imports fell 16.0 percent.<br /><br />The drop in world trade is very real. The jury is out on the cause. How deep is the collapse? According to Wharton, the Baltic Dsy Index for shipping prices is down 90% from its May 2008 peak. In addition, there is evidence that perhaps half the global shipping fleet is idle. This is the mirror to falling domestic economic activity across the globe. Import protection certainly will not help. However, we need to devote energy to a better understanding of what has driven the collapse so far if we want to address the issue. Credit may be a big part of the picture. Apparently, carmakers in Japan are unable to get loans for their American customers, while exporters in a range of industries complain that lack of credit makes international shipments almost impossible.<br /><br />References<br /><a href="http://www.nytimes.com/2009/03/04/business/worldbusiness/04trade.html?ref=asia">Countries Stepping in to Finance Export Trade</a>, New York Times, 3 March 2009.<br /><a href="http://knowledge.wharton.upenn.edu/article.cfm?articleid=2165">Trade Wars: Will Protectionism Win out over Recovery?</a>, Wharton Knowledge, 18 February 2009.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-1996590586588589174?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-81314845311228452742009-02-04T12:26:00.009+01:002009-02-04T14:17:21.863+01:00The New Protectionism and Negative EngineeringDynamic markets produce innovation. Financial markets have innovated around regulation, internet content providers innovate around censorship, and now we are seeing the political marketplace drive innovations to get around constraints on protectionism. Following the global experience of the 1930s, the post-War multilateral system has been surprisingly successful at driving a process of collective tariff reductions and restrictions on backsliding through treaty-bound bindings on tariff increases. Political safety valves (antidumping, countervailing duties, etc) greased the wheels that keep this negotiating machinery moving forward. Adam Smith would not have been surprised by the result: falling trade costs and generally rising trade, innovation, and prosperity.<br /><br />Figure 1b: Trade cost indices, 1921-1939 (1921=100) [1]<br /><br /><img style="float:left; margin:0 10px 10px 0;cursor:pointer; cursor:hand;width: 425px; height: 316px;" src="http://www.voxeu.org/files/image/NVF2.JPG" border="0" alt="" /><br /><br />While the system has targeted tariffs, it has been less successful at limiting export subsidies, procurement preferences, exchange rate manipulation, and production and R&D subsidies. With the rise of multinationals and the globalization of service firms, which rely on mobility of information and workers, the global market for goods and services has also moved into regions largely unregulated by the multilateral system.<br /><br />Not surprisingly, in the current economic crisis, the political market place is innovating, selling protection through channels not tightly regulated by the global and regional bindings on import tariffs that are at the core of the NAFTA, WTO, and European Economic Area. Instead of tariffs, governments are moving to provide tax breaks, subsidies, procurement preferences, and the like. They are also under pressure to limit the ability of global firms to operate on the global labor market, in the belief that this will weaken the bargaining position of business vis-a-vis local workers. We are witnessing a new protectionism: less transparent, couched in resurgent xenophobic rhetoric, and outside the mechanisms regulated by international treaties.<br /><br />Some musings on what have we seen in the past weeks:<br /><br /><div><li><u>Strikes in Britain over foreign workers</u>: Technically, the United Kingdom is a member of the European Union. This means that British goods and services have free access to European markets, and vice-versa. This also means British workers must compete with European workers, but are also allowed to compete on the broader European labor market. This past week British labor unions have called strikes to protest Italian workers in Britain. This is where the political class should be cold and clinical, and try to calm emotions with facts. According to estimates published by the OECD (2008), there are roughly 28 thousand British workers in Italy, and 57 thousand Italian born workers in Britain. The bigger picture though is one of millions of Brits working abroad, and millions of OECD-born workers in Britain. On net, from these same data, there are roughly 100,000 more British born workers elsewhere in the OECD than there are OECD-born workers in Britain: 2.66 million workers from the OECD in Britain; and 2.76 British workers in other OECD countries. Segmenting labor markets geographically is not the answer to the crisis. Otherwise, perhaps the English should be banned from working in Scotland, workers in Glasgow should be prohibited from working in Belfast, and the 3 millions Brits working overseas in the OECD should be sent home? This would be a sad day for British pubs abroad, but a great one for the competing Irish pubs. Hopefully, obligations in various treaties governing the European Union will preclude truly stupid actions by leaders tempted to act irresponsibly. [2,3]</li></div><div><br /><br /></div><div><li><u>Buy America</u>: After years of pressing foreign governments to give improved access conditions to U.S. suppliers (reflected in The plurilateral Agreement on Government Procurement (GPA) in the WTO), the U.S. Congress is now turning a general economic stimulus package into a vehicle for subsidies through "Buy America" provisions, where contracts involving U.S. funds would be forced to buy from U.S. suppliers. Of course, what's good for the goose if good for the gander, and such a move will quickly lock U.S. multinationals out of foreign contracts as there will be no moral high ground left for the U.S. Trade Representative to stand on. If the U.S. wants a level playing field when selling Caterpillar equipment, Boeing planes, and engineering expertise on foreign projects, this is a really bad idea. [4]</li><br /><br /></div><div><li><u>Agricultural export subsidies</u>: OECD Members have spent over a decade on negotiations and economic research (through the OECD Secretariat) to move towards a rational set of farm policies that benefits tax payers and does not punish low income producers. So what are they now doing? The EU has resumed farm export subsidy payments. Operationally, they are exporting the impact of low prices onto the rest of the world. This means they are moving back to policies that cost the tax payer money and punish producers in low income countries. [5]</li><br /><br />This is the time for responsible political dialog on managing a global crisis. Cutting the world economy into pieces does not seem a logical step in this direction. We risk building what Bastiat called a negative railroad. Extending this metaphor, we should call the builders of the new protectionism what they are: negative engineers, building new systems to destroy jobs and prosperity. [6]<br /><br /><u>Notes</u>:<br /><br><br />[1] The figure is from "<a href="http://www.voxeu.org/index.php?q=node/1545">Globalisation and the costs of international trade from 1870 to the present</a>," David Jacks, Christopher M. Meissner, and Dennis Novy, VoxEU, 16 August 2008.<br /><br><br />[2] <a href="http://news.bbc.co.uk/2/hi/uk_news/politics/7868777.stm">Foreign labour row deal rejected</a>, BBC news, Wednesday, 4 February 2009.<br /><br><br />[3] <a href="http://www.oecd.org/document/51/0,3343,en_2649_33931_40644339_1_1_1_37415,00.html">Database on Immigrants in OECD countries</a> (DIOC), OECD 2008.<br /><br><br />[4] <a href="http://news.bbc.co.uk/2/hi/americas/7868631.stm">Will US stimulus trigger a trade war</a>?, BBC news, Wednesday, 4 February 2009.<br /><br><br />[5] <a href="http://www.cattlenetwork.com/Content.asp?ContentID=283407">EU Dairy Export Subsidy Measures Requires U.S. Response</a>, Cattle network 1/16/2009 9:11:00 AM .<br /><br><br />[6] <b><a href="http://www.econlib.org/library/Bastiat/basSoph4.html">The Negative Railroad</a></b><br /><br />M. Simiot raises the following question:<br /><br />"Should there be a break in the tracks at Bordeaux on the railroad from Paris to Spain?"<br /><br />He answers the question in the affirmative and offers a number of reasons, of which I propose to examine only this:<br /><br />"There should be a break in the railroad from Paris to Bayonne at Bordeaux; for, if goods and passengers are forced to stop at that city, this will be profitable for boatmen, porters, owners of hotels, etc."<br /><br />Here again we see clearly how the interests of those who perform services are given priority over the interests of the consumers.<br /><br />But if Bordeaux has a right to profit from a break in the tracks, and if this profit is consistent with the public interest, then Angoulême, Poitiers, Tours, Orléans, and, in fact, all the intermediate points, including Ruffec, Châtellerault, etc., etc., ought also to demand breaks in the tracks, on the ground of the general interest—in the interest, that is, of domestic industry—for the more there are of these breaks in the line, the greater will be the amount paid for storage, porters, and cartage at every point along the way. By this means, we shall end by having a railroad composed of a whole series of breaks in the tracks, i.e., a negative railroad.<br /><br />Whatever the protectionists may say, it is no less certain that the basic principle of restriction is the same as the basic principle of breaks in the tracks: the sacrifice of the consumer to the producer, of the end to the means.<br /><br />Frédéric Bastiat<br /><i>Economic Sophisms: First Series</i>, Chapter 17<br />A Negative Railroad<br />I.17.3-I.17.19<br /></div><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-8131484531122845274?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-6058813479498014542009-02-01T03:58:00.005+01:002009-02-01T04:16:39.474+01:00The Undiscovered Country -- overhauling public finance in America<img name="" src="http://www.intereconomics.com/blogs/jff/images//rubestamp.gif" width="194" height="172" alt="" /> "Cutting taxes" has been the political snake oil, the magic elixir, sold to the American people by a generation of politicians as a way to promote everything from prosperity to family values. Sadly, tax cuts are being argued even in the current crisis. Yet, recent tax cuts have been saved rather than spent, and recent research suggests that despite past tax cuts the average tax burden is not lower than elsewhere in the OECD, given the services taxes pay for (or fail to). [1] On net, the combined state, local, and federal system is also more regressive than we like to believe. In the real world of politics, lobbying, and the rhetoric of class conflict, income tax-based systems, even if progressively structured in theory, tend toward regressive structures in fact once set adrift on the sea of lobbying, exemptions, and special interest. This appears to be a stylized political fact in representative systems -- perhaps even a law of political economy. The 30-year focus on tax cuts has served as a deliberate distraction from hard choices and uncomfortable debate. At the same time, the "cut taxes" mantra at the state and local level, where government and public services are closer to the people, has led to an increasingly regressive public system -- held together by a combination of duct tape, the municipal bond market, a wobbly property tax base, and a tax on hope (also known as the lottery) -- to fund schools, local police, and other essential services. (My sister maintains that the lottery is a tax on people who cannot do math. Either way, given the state of American education, a bad math tax and a hope tax both hit the poor disproportionately hard). [2] Once we admit to the effective use of Federal trust fund money (social security, gasoline excise taxes, etc...) to offset the otherwise even bleaker Federal budget picture, the system is also drifting markedly toward regressive features at the Federal level.<br /></br><br />The American voter has been a ready mark in this game, willing to believe many things: that public services are free or otherwise unnecessary; roads were created and are apparently maintained by our divine creator; bridges and tunnels last forever without maintenance; an innovative economy does not hinge on broad merit-based access to a world class science and education system; markets do not need regulators; and a functional representative democracy does not need to invest in the basic education of its voters. Apparently, it is also morally OK to borrow heavily against the incomes of our grandchildren at unsustainable rates, even if we are not quite sure how the money is being used.<br /><img name="" src="http://www.intereconomics.com/blogs/jff/images/tapeduct.jpg" width="196" height="166" alt="" /><br />Public finance in the United States needs to be overhauled. This is a critical housecleaning issue if America is to move ahead. It took Nixon -- a conservative Republican -- to normalize relations with Communist China, and it may take Obama -- a liberal Democrat -- to overhaul taxes and forge a pro-growth, pro-business system suitable for the post-Crisis 21st Century. [3] Unless this is done, whatever the rhetoric from the ascendant political class in Washington, the scope for substantive initiatives in the present crisis will remain greatly hindered. As it stands, the current system is complicated, multi-layered, and opaque, with features (like the alternative minimum tax) the middle class does not understand and temporary tax cuts that cannot politically be allowed to expire. Altogether, this set of features makes members of the general public feel the system treats them unfairly. It has even caught appointees who, like the middle class they aim to represent, made good faith efforts to pay taxes yet stillwere tripped up by the system. While the situation has provided a convenient whipping boy at election time, it has also fostered a sense of fiscal persecution and injustice in entrepreneurs and middle class alike, eroding the collective sense of being vested in what is supposed to be a system of self-governance. Taxes need to be defanged as a political stalking tool. Since the system in America actually does rest on its citizens, the result is that America's innate tenacity in the face of tough issues -- public health, care for our elderly parents, global responsibility, managing foreign threats, responding to natural disasters at home -- is also eroded. Also important, the system needs to be made transparent and simple, to both ensure that the snake oil salesmen still lurking about do not again distract from real economic policy debate, and to ensure that the people feel vested in the policy decisions to be made. To be blunt, America needs a relatively (politically) neutral mechanism to raise revenue. If Obamam wants to focus on positive programs, he has to take the class-conflict and otherwise distracting debates over tax cuts off the table. This is best done if taxes are made neutral and transparent. Public works programs, income support, health care initiatives, national defense, education programs, national highways, and the like represent alternative uses for the national treasure. This is how the choices should be framed for discussion. "How do we invest what resources we have?" is an appropriate approach to the challenges ahead, not "how do we avoid paying for what is necessary?"</p> <p>How did we get here ? The inflation of the 1970s escalated middle income Americans into punitive high income tax brackets. This led to high growth in the tax dodging and tax planning industry. In the voter revolt that followed, Ronald Reagan was elected with a mandate to simplify the system. At the Federal level, the system was indeed streamlined. However, because the system relies on personal and corporate income tax, lobbying by those same persons and corporations has led again to an increasingly complex system of exemptions, diversions into debate over capital gains taxation, and the making of "Joe the Plumber" as a household name during the 2008 election. Adding to the Rube Goldberg nature of public finance in America is the problem of global taxation of income. America's major trading partners rely, to a great extent, on value added taxes that tax economic activity targeting the domestic market (including U.S. companies selling in those markets) while not taxing economic activity destined for foreign markets. U.S. companies do not get this same treatment, and so are at a disadvantage in foreign markets. The extension of income tax abroad also makes multinationals reluctant to rely on American scientists, engineers, and management overseas, further eroding the competitiveness of American firms abroad and the scope for export of high value-added services. The result is a politically poisonous mix: a suspicion about off-shoring of U.S. activity; a reality of U.S. firms keeping their income abroad; a perceived loss of competitiveness; a relatively soft market for U.S. expertise; and a complicated system of corporate tax credits that repeatedly violates U.S. treaty obligations and further erodes the sustainability of current public finance structures.[4] Given the last point, there is also the risk that, at some point, U.S. trade partners will respond to the current U.S. corporate tax "offsets" with punitive tariffs on American exports. (This is sometimes known as the "nuclear option" in trade policy circles.)<br /><br />Just as a lark, imagine that American voters had the collective brass kahunas needed to demand that their elected leaders dump the system of personal and corporate taxes -- duct tape and all -- and engineer a shift to a straightforward and fully transparent value added system. Such a move has the potential to broaden the tax base substantially, exorcise failed mantras from the policy debate, make possible a deep, full, and permanent income tax cut for all households, level the playing field for U.S. goods and services sold abroad and competing at home, and provide scope for a big short-run injection of capital into the U.S. economy. The left and right could still fight -- over how much to raise in tax and how to spend it, not how to raise it operationally. In practice, this means income and related capital taxes could be eliminated at the household level. They could also be eliminated for firms, replaced by the VAT system. (VAT requirements could also be relaxed for small businesses and the self-employed.) With such a switch, the risk of off-shoring to escape taxes is also cut out, as the full value of foreign labor used by American firms abroad to produce goods and services at home would be taxed. In addition, like European nations, the United States would then impose VAT on goods and services entering and sold in the U.S., while exempting goods and services produced in the U.S. for export. This has the potential to broaden the tax base in an un-distorting way (the same tax rate would apply to domestic and foreign goods and services sold in the United States). Debate over equity polices could focus on how money is spent -- education, health care, job creation, community revitalization, science and energy research programs, infrastructure, defense -- rather than on how it is raised. Subsidy schemes might even be somewhat more transparent. (Admittedly, any system can be gamed). In addition, when Washington mandates programs to be provided at the state and local level, VAT collected centrally could be shifted (or even required to be shifted) to the sub-Federal (i.e. State) level. With the system already operationally in place nationally, it could also help wean the other half of the public finance system -- the non-Federal one -- off of regressive funding structures and put state and local governments on a more stable fiscal foundation. There is even scope for a short-run bonus in the current crisis. According to rumor, corporate America has money parked abroad because of the current system. By some accounts, they have quite a lot of it. This may or may not be the case. There is one way to find out, though. With the logic of the current system suspended, they could be invited to bring it back without penalty, but with the stipulation that perhaps half be invested for 15 years in Federal or municipal debt obligations, helping ease short-run public policy constraints. As a bonus, the incentive is gone for them to keep such funds abroad in the future. In contrast, "the current U.S. tax system appears to discourage companies from returning foreign earnings to the United States." [5]<br /><br />Of course, such musings are highly unrealistic. On the political economy front, huge rents (meaning money taken indirectly from the public in general and given to a more narrow set of recipients from across the political spectrum) rest on the current system. Short of a mix of outright bribery and thuggery, it may be well nigh impossible to overcome the influence these rents buy. My academic colleagues are also right to point out that value added systems can also be distorting and regressive (though certainly in more subtle and gentler ways than what we have now[6]). There is also a myth in the United States that somehow, like the metric system, value added tax systems are a foreign idea not to be trusted. Yet America is itself a synthesis of brilliantly re-spun "foreign" culture and ideas. President Eisenhower built a modern Federal highway system based on the "foreign" autobahn system (actually the Nazi-built system, for goodness sake) he saw in Germany, Benjamin Franklin and party built the constitution in Philadelphia around ideas born of the Enlightenment in France and England, and it was a Prussian who whipped Washington's troops into shape over the bleak winter at Valley Forge. The information technology revolution was also fueled by fresh immigrants with bright ideas from Europe and Asia. Americans are a practical people. They see problems, they adopt solutions, and when necessary they change their minds and listen to the ideas of others. If the country is to emerge from the current economic crisis with a stronger and more robust economic foundation, the one horse shay that is the current public finance system needs a complete overhaul. [7] More duct tape is not going to do it.<br /> <br />References:<br /><br />[1] "<a href="http://www.iie.com/publications/interstitial.cfm?ResearchID=1096">Did Reagan Rule In Vain? A Closer Look at True Expenditure Levels in the United States and Europe</a>."<br /> Jacob Funk Kirkegaard, Peterson Institute for International Economics, POLICY BRIEF 09-1, 2009.<br /> http://www.iie.com/publications/interstitial.cfm?ResearchID=1096</p> <p>[2] Many state/local tax systems are regressive, and this is important to keep in mind when contemplating potential regressive bias in a VA system. See "<a href="http://www.ctj.org/taxjusticedigest/2007/06/washington-state-has-low-avera.html">Washington State Has Low Average Taxes... But Also the Most Regressive Tax Structure in America</a>," The Tax Justice Digest 2007, http://www.ctj.org/taxjusticedigest/2007/06/washington-state-has-low-avera.html, and also "<a href="http://www.itepnet.org/wp2000/fl%20pr.pdf">Florida Tax System is Nation’s Second Most Regressive</a>," Institute on Taxation and Economic Policy (2003) http://www.itepnet.org/wp2000/fl%20pr.pdf. Also see "<a href="http://www.blogger.com/Senate%20on%20Budget%20and%20Policy%20Priorities%20(2002),%20http://www.cbpp.org/1-15-02sfp-pr.htm">STATE TAX SYSTEMS ARE BECOMING INCREASINGLY INEQUITABLE</a>," Senate on Budget and Policy Priorities (2002), http://www.cbpp.org/1-15-02sfp-pr.htm.</p> <p>[3] After World War II, the conservative stream of American politics forged an identity around the twin poles of fighting communism and assigning blame for those who "lost China." This identity provided ideological underpinnings for a political witch-hunt in the 1950s, and framed the culture wars that echoed from the 1960s until the election of 2002, finally crashing on the rocks of generational shift in the 2008 election. During this period, as it became obvious that America had to normalize relations with China, it proved necessary for Richard Nixon, a leader with impeccable anti-Communist credentials,to be the one to sit down with the Communists. To quote Spock in the movie The Undiscovered Country, "We have a saying on Vulcan: <a href="http://en.wikipedia.org/wiki/Nixon_in_China_(phrase)">Only Nixon can go to China</a>." See Wikipedia, "The phrase "Nixon going to China" is thus an analogy that refers to the unique ability that hardline politicians have to challenge political taboos and third-rail issues. Only a proven hardline right-wing politician can succeed in challenging a conservative sacred cow and vice versa for left-wingers." http://en.wikipedia.org/wiki/Nixon_in_China_(phrase)</p> <p>[4] "<a href="http://www.wto.org/english/tratop_e/dispu_e/cases_e/1pagesum_e/ds108sum_e.pdf">United States — Tax Treatment for 'Foreign Sales Corporations'</a>,” WTO (as of May 2008), http://www.wto.org/english/tratop_e/dispu_e/cases_e/ds108_e.htm, "US-FTC," DS 108, http://www.wto.org/english/tratop_e/dispu_e/cases_e/1pagesum_e/ds108sum_e.pdf.</p> <p>[5] "<a href="http://taxvox.taxpolicycenter.org/blog/_archives/2009/1/12/4054705.html">Is it Always a Good Time for a Holiday</a>?" by Rosanne Altshuler on Mon 12 Jan 2009 02:29 PM EST<br /> http://taxvox.taxpolicycenter.org/blog/_archives/2009/1/12/4054705.html.</p> <p>[6] See "<a href="http://en.wikipedia.org/wiki/Value-added_tax">Value Added Tax</a>," http://en.wikipedia.org/wiki/Value-added_tax. Also see "<a href="http://ideas.repec.org/p/nbr/nberwo/4387.html">Is A Value Added Tax Progressive? Annual Versus Lifetime Incidence Measures</a>," E. Caspersen and G. Metcal, National Bureau of Economic Research, working paper 4387, http://ideas.repec.org/p/nbr/nberwo/4387.html. The latter states "Using two different measures of lifetime income, we find that a VAT in the United States would be proportional to slightly progressive over the lifetime."</p> <p>[7] Oliver Wendell Holmes (1809-1894), " <a href="http://rpo.library.utoronto.ca/poem/1028.html">The Deacon's Masterpiece or, the Wonderful "One-hoss Shay</a>": A Logica.<br /> http://rpo.library.utoronto.ca/poem/1028.html.</p></td></tr><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-605881347949801454?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-518226283882146282009-01-28T22:39:00.006+01:002009-01-29T00:06:00.207+01:00It is time for me to disagree with myself -- we need both Doha and a trade standstill agreementIn other fora, here and on <a href="http://www.voxeu.org/index.php?q=node/2703">VoxEU</a>, I have argued that we need to stop focusing on the Doha Round, and move on to real dangers -- like rising protectionism outside the bounds we have placed on MFN tariffs. Times have changed. It is still true that the substance of the Doha Round will not impact the current crisis. A successful agreement would take years to implement, and it does not address the discretionary protection now threatening trade. However, in the present climate, it could serve as a potent symbol of commitment. So, for its value as a symbol, we should conclude it now, even if in a truncated form. To silence the darker voices urging our leaders to shift shared burdens onto others -- the EU has now reintroduced dairy export subsidies for example -- concluding Doha would be a sign that we choose to ignore those dark voices. Even this is not enough. There should be more. The OECD should collectively declare a temporary standstill (24 months?) on discretionary protection. This would mean no antidumping, countervailing, or safeguard actions involving partners (including non-OECD partners) that also adhere to the standstill agreement, as well as a suspension of reintroduced export subsidies, until calmer heads and markets again prevail.<br /><img name="" src="http://thefilter.blogs.com/photos/uncategorized/2007/12/20/deptrade.gif" width="377" height="201" alt="" /><br /></br>In the absence of a Trade Standstill Agreement, or something of the sort, things will get nasty. Indeed, they already are, judging from headlines just this week. The EU has started to introduce export subsidies, which means they are forcing other countries (including poor producers) to carry their share of the burden linked to depressed agricultural prices. At the same time, the United States Congress is gunning for a weakened China for maintaining an undervalued currency, even though China's exports are falling and the Chinese are needed to buy U.S. bonds and so fund Obama's new initiatives. Antidumping actions will undoubtably surge as the global economy grows worse, as evidenced by India's recent antidumping assault on China. The U.S. Congress is also trying to redirect subsidies linked to antidumping duties back to firms, even though they have been found to violate U.S. treaties. Exporters know this is a losing game. They need to press for a collective cool down period.<br /><br />Ignore the dark voices. We are in this together. Just say no....</p><p><u>Further reading</u>:<br /><br />"<a href="http://www.weeklytimesnow.com.au/article/2009/01/28/46475_dairy.html">Producers brace for tariff pain</a>," <em>AUSTRALIAN dairy farmers are under attack after the European Commission launched a barrage of export subsidies on to the world market....</em>, Weekly Times Now, 28 January 2008.<br /><br />"<a href="http://www.google.com/hostednews/afp/article/ALeqM5ipUC61MSlxKK4H_SziedhVb-vxqA">China slams EU anti-dumping move, threatens WTO action</a>," <em>China Wednesday blasted an EU decision to slap hefty anti-dumping duties on Chinese-made screws and bolts and said it may take the issue to the World Trade Organisation...</em>, AFP 29 January 2009.<br /><br />"<a href="http://www.rotor.com/Default.aspx?tabid=510&newsid905=60547">ECONOMIC STIMULUS INCLUDES ANTI-DUMPING RELIEF FOR DOMESTIC LUMBER, STEEL & CEMENT FIRMS</a>," <em>Domestic lumber, steel and cement firms now required to pay back anti-dumping funds they received earlier this decade could seek their bills covered under a provision senators have included in the Finance Committee’s $455 billion economic stimulus measure...,</em>Rotor News 27 January 2009.<br /><br />"<a href="http://www.ft.com/cms/s/0/578002b2-ec11-11dd-8838-0000779fd2ac.html">Beware trade wars</a>," <em>The threat to world trade comes from the Omnibus Trade and Competitiveness Act of 1988. Should the Treasury officially determine China to be a currency manipulator, itcould unleash a range of remedies, including antidumping measures, countervailing duties and safeguards...,</em> Willem Buiter FT blog, Published: January 27 2009.<br /><br />"<a href="http://www.thehindubusinessline.com/2009/01/29/stories/2009012951051600.htm">India begins anti-subsidy probe against China</a>," <em>After setting off an avalanche of anti-dumping probes into a diverse range of manufactured products against China by responding to the domestic industry’s concerns in recent months, the Commerce Ministry has for the first time begun an anti-subsidy probe into imported sodium nitrite from China...</em>, Business Line 29 January 2009.</p><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-51822628388214628?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-26294495735230535502008-12-18T16:29:00.004+01:002008-12-18T16:37:08.634+01:00Prizes for Everyone [1]The motor vehicle industry is playing an interesting game. General Motors produces in Europe under various names (Opel, Vauxhall) [2], produces as Holden in Australia, and has plants scattered elsewhere across the globe as well. As the economic downturn forces rationalization of the global capacity glut in motor vehicles, this places GM in a position to play off local governments against each other. GM announced plans to reduce production in Thailand, [3,4] while holding this as an example in extracting subsidies from the Australian government. GM is not the only one playing this game. Indeed, U.S. automakers (GM and Ford), together with Toyota, have already extracted 4.3 billion US dollars in subsidies (to be stretched out over the next decade) [4], even as they lobby Washington for more assistance. [5] In the U.S., we have the same mix of players lobbying against each other rather than cooperating, as Japanese MNEs (multinational enterprises) in the Southern United States try to block assistance to their U.S. based competitors. Not surprisingly, this is also shaping up as an inter-state game within the Federal system to support various local producers across the United States.<br /><br /> There have been worries surfacing in the policy research community about the death of the Doha Round, and the risk of rising protectionism. Narrowly read, the dominant risk is not really old fashioned protectionism -- higher import tariffs (see my VoxEU column on this. [6] ) Yes, we are seeing some of this (so far at the margins). Far more interseting is tax competition, seen through a lens darkly. There has been an emerging literature on competition between jurisdications to attract MNEs. [7,8,10,11,13,14] Emphasis is on new plants, and the tendency for firms to extract extra tax payer largesse by locating in multiple locations. Much of this literature is theoretical, though the empirical evidence already shows that global firms make local taxation difficult. We are learning much more as the current economic crisis causes a game of industrial musical chairs. Everyone is circling, and when the music stops, not all motor vehicle MNEs will be sitting comfortably. [2,3] As some go, some local jurisdictions will see their factories close as well. This reveals more elements to the tax competition game. Multiple plants mean more degrees of flexibility for extracting rents (i.e. Blackmailing) local tax payers. In addition, the game can be run in reverse. Open plants (creating a local constituency of suppliers and labor and government), threaten to close some, and demand compensation. In such a game, it may even make sense to build far too much capacity, if the losses from excess plants are covered by an increased expected taxpayer financed subsidy.<br /><br /> There is another important element to this game as well. In the U.S. for example, the rhetoric has become predictably nationalistic.[5] U.S. firms vs. European firms vs. Japanese firms. Yet, if we look closely at the set of automakers, where they operate, and who owns them, the national labels make less and less sense. European pension funds own American firms, Japanese firms are listed on the American stock exchanges, and American firms lobby in Europe as European producers and ask Australia for R&D subsidies. Capital markets are global, ownership of the corporate world is global, and the challenges posed are therefore global as well. U.S. subsidies to GM will be a subsidy for European pension funds, and the Australians are hoping the American taxpayer will subsidize their industry as well.<br /><br />The European Union has taken steps to limit tax competition [9] -- hence the intervention the the European Commission against the GM subsidy game in Europe. The OECD has also flagged this as a problem issue. It may be time to take this global. [12] In a world with global firms and local tax authorities, WTO discussions limiting public assistance would help level the paying field for local taxpayers against blackmail by global firms. <br /><br />References<br /><br />[1] Lewis Carroll (1865), <em>Alice in Wonderland, </em>"<a href="http://ebooks.adelaide.edu.au/c/carroll/lewis/alice/chapter3.html">Everybody has won, and all must have prizes</a>," in CHAPTER III: A Caucus-Race and a Long Tale<br /><br />[2] "<a href="http://news.bbc.co.uk/1/hi/business/7742407.stm">EU warns against car subsidy race</a>," BBC 21 November 2008.<br /><br />[3] "<a href="http://www.bangkokpost.com/181208_Business/18Dec2008_biz28.php">Isuzu aims to avoid Thai layoffs</a>," Bankok Post, 18 December 2008.<br /><br />[4] "<a href="http://www.earthtimes.org/articles/show/244629,car-sales-crash-in-australia.html">Car sales crash in Australia</a>," The Earth Times, Thu, 04 Dec 2008.<br /><br />[5] "<a href="http://online.wsj.com/article/SB122940448541910059.html">Tax Fairness for U.S. Auto Makers</a>," editorial letter, Wall Street Journal, 16 December 2008. (from Stephen Collins, President, Automotive Trade Policy Council Washington.<br /><br />[6] "<a href="http://www.voxeu.org/index.php?q=node/2703">The economic crisis, Doha completion, and protectionist pressure</a>," 17 December 2008 VoxEU column. <br /><br />[7] Baldwin, R.E. and P. Krugman (2004), "<a href="http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6V64-48M7XY5-1&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=0bdb0281ba1f05c87b4fdd2d79290936">Agglomeration, integration and tax harmonisation</a>," European Economic Review, Volume 48, Issue 1, February 2004, Pages 1-23.<br /><br />[8] Davies, R.B. (2005), "<a href="http://ideas.repec.org/a/eee/inecon/v67y2005i2p498-512.html">State tax competition for foreign direct investment: a winnable war?</a>," Journal of International Economics, Elsevier, vol. 67(2), pages 498-512, December.<br /><br />[9] European Commission, "<a href="http://ec.europa.eu/taxation_customs/taxation/company_tax/harmful_tax_practices/index_en.htm#OECD">Harmful tax competition</a>," Europe website. <br /><br />[10] Hauflera, A. and I. Wooton (1999), "<a href="http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6V76-3V4JMG2-7&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=b9323640ad0b2dfdf16cb6d81b3e62cb">Country size and tax competition for foreign direct investment, Journal of Public Economics</a>," Volume 71, Issue 1, 1 January 1999, Pages 121-139.<br /><br />[11] King,I., R.P. McAfee & L. Welling, (1993), "<a href="http://ideas.repec.org/a/cje/issued/v26y1993i3p590-608.html">Industrial Blackmail: Dynamic Tax Competition and Public Investment,</a>" Canadian Journal of Economics, Canadian Economics Association, vol. 26(3), pages 590-608, August.<br /><br />[12] OECD, "<a href="http://www.ingentaconnect.com/content/oecd/16080246/1998/00001998/00000004/2398041e">Harmful Tax Competition: An Emerging Global Issue</a>," 1998. <br /><br />[13] Ottavianoa, G.I.P and T. van Ypersel (2005) "<a href="http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6V6D-4F05G6W-7&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000050221&_version=1&_urlVersion=0&_userid=10&md5=3555c181195ab0ea14dfe6ed4f9d86af">Market size and tax competition</a>," Journal of International Economics, Volume 67, Issue 1, September: Pages 25-46.<br /><br />[14] Winner, H. (2005) "<a href="http://www.springerlink.com/content/m777851jg7641568/">Has Tax Competition Emerged in OECD Countries? Evidence from Panel Data</a>," International Tax and Public Finance, Volume 12, Number 5/September.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-2629449573523053550?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-8515831199568017562008-10-20T10:11:00.007+02:002008-10-20T10:23:55.181+02:00The GATT (aka the WTO) worksThere has been a dispute in the academic literature about the impact of the GATT on trade liberalization. The first shot was a set of papers by Andrew Rose. [1]. His papers have since been savaged by follow-up literature. [2]<br /><br />The ongoing financial crisis has rendered this literature, quite literally, academic. What I mean is that, basically, the real test is what has just (not) happened. As Doug Irwin noted in his review of the GATT and its transition to the WTO, the first part of the 20th Century -- World War I and the early years of the Great Depression -- were characterized by savagely competitive tariff wars. [3] The framers of the Bretton Woods system had this firmly in mind when they set up the post-War system. [4] We may wonder at times exactly what the IMF and World Bank are doing at the moment. We no longer have to wonder about the GATT (aka the WTO). It is a systemic safeguard, and it seems to be working. Notice the deafening sounds of silence along Smoot-Hawley lines. Indeed, we have calls for further trade liberalization in the WTO. Recent events may also shed a new light on regionalism. In the academic literature, regional agreements have been seen as potential stumbling blocks to the multilateral system. Yet, as safeguards against protectionism in a big global crisis, the EU and NAFTA appear to be complementary safeguards. We have been focused, in much of the literature on the GATT and on regional trade negotiations, on the process of marginal concessions and terms-of-trade manipulation. Aside from all this academic analysis, in the real world the multilateral trading system is doing what it was actually meant to. There will be rising protectionist responses as we sink further into recession. However, as long as the system holds, this will not be broad based.<br /><br />[1] A.K. Rose (2003), "<a href="http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6V6D-49H0S1N-4&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_version=1&_urlVersion=0&_userid=10&md5=5932de180bc1ac07addcaa6b2840d3cd">Do WTO members have more liberal trade policy?</a>" Journal of International Economics Volume 63, Issue 2, July 2004, Pages 209-235.<br /><br />[2] A. Subramaniana and S-J Wei, "<a href="http://www.sciencedirect.com/science?_ob=ArticleURL&_udi=B6V6D-4MVN0DT-1&_user=10&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_version=1&_urlVersion=0&_userid=10&md5=1ad3a50773cd51e5da537d65f1ab044f">The WTO promotes trade, strongly but unevenly</a>," Journal of International Economics, Volume 72, Issue 1, May 2007, Pages 151-175.<br /><br />[3] D. Irwin (1995), "<a href="http://www.jstor.org/pss/2117941">The GATT in Historical Perspective</a>," The American Economic Review, Vol. 85, No. 2, pp. 323-328.<br /><br />[4] J. Toye and R. Toye (2005), "<a href="http://www.unhistory.org/reviews/FDS_Toye.pdf">From Multilateralism to Modernisation</a>," Forum for Development Studies, No. 1, pp. 127-150.<br /><br />[5] K. Bagwell and R. Staiger (1999), "<a href="http://www.ssc.wisc.edu/econ/archive/wp9815.pdf">An Economic Theory of the GATT</a>," The American Economic Review, Vol. 89, No. 1, pp. 215-248.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-851583119956801756?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-83844114545737944982008-10-18T16:43:00.004+02:002008-10-18T17:04:34.286+02:00Watch the DollarThe dollar has appreciated strongly on world markets since the October Crisis began -- around 15% on the Canadian dollar, the euro, and the British pound. The banter on the financial talking head shows is that this reflects a flight to quality. This is an interesting thought. Financial markets in the United States are on a roller-coaster, the mortgage-backed securities market has collapsed, the Federal Reserve is more or less printing money, and the pundits talk quality. There may be more at play. The current financial crisis has involved a collapse in the credit mechanisms that modern economies rely on. The machinery that creates credit has become frozen. As a result, while the central banks pour money into the fuel tank of the commercial credit engine, this has not led to actual creation of financial credit. Rather, the broken "credit multiplier" means the supply of dollars and related dollar credits at the market level has dropped. With an effective shortage, the price has gone up. Europe has been more aggressive in taking steps to restart its credit mechanisms in this regard. Hence, the rise of the dollar may signal the continued relative failure of dollar-denominated credit mechanisms. This might not be a flight to credit, but a collapse of supply. As recent new proposals to insure inter-bank loans come on line (and if this is expanded further to cover commercial loans), a signal of a successful restart of the credit machine in the U.S. may ironically be a drop in the dollar as the flow of dollar-denominated credits expands again. Watch the dollar.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-8384411454573794498?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-58025159038496916422008-10-15T15:32:00.002+02:002008-10-15T15:39:35.105+02:00Time to Recapitalize HouseholdsIn the last few weeks we have seen dramatic shifts in the position of governments on the current financial crisis. In the UK, Gordon Brown has spearheaded direct government equity stakes in banks, and is pushing for long-run structural fixes.[<a href="http://www.telegraph.co.uk/finance/3201885/Gordon-Browns-call-for-a-new-Bretton-Woods-gains-traction.html">1</a>] Following similar moves elsewhere in Europe, the Bush administration has jumped on board as well. Markets have now factored in expected government support, in the form of debt forgiveness (i.e. tax payer bailouts) and equity injections. As such, we should not expect dramatic changes in market performance at the moment unless new information emerges.<br /><br />As this drama unfolds, here has been a parallel debate in the context of the U.S. Presidential elections on what to do with bad mortgages. The McCain plan was a version of the Bush plan -- have taxpayers take over bad loans. This has been heavily criticized. Yet, they are correct that something needs to be done in the housing market. In the old days, with the FSLIC, if a Savings and Loan failed, the government would have been the one to ultimately step in and clear housing stocks. This did not end well last time, and it is not clear why the current analogue will be any better. Already we are seeing discussion of what to do about increasing foreclosure rates.[<a href="http://www.bloomberg.com/apps/news?pid=20601070&sid=ahfMrINj__Mw&refer=home">2</a>]<br /><br />Here is a crazy idea, instead of just buying up bad mortgages at face value -- <em>Recapitalize Households</em>. What I mean is the following.<br /><ol><li>in cases where households now owe more than their house is worth, but where they can make payments on a mortgage at the current value (i.e. a proper credit check), the government buys the mortgage from the current holder at the current value of the property -- NOT at the face value of the mortgage</li><br /><li>The government takes an equity stake (up to perhaps 25%) in the property itself, shared with the homeowner and to be recovered at sale of the house. </li><br /><li>Details can be worked out, but a logical set-up is that the government shares any future increase in property value with the homeowner. This provides an incentive to the homeowner to care for the value of the house, while providing relief from the drop in values. It also imposes part of the cost and responsibility on the owner. </li><br /><li>The government uses its greater market power to borrow, and finances a new mortgage for actual equity at a better rate -- improving the cash-flow position of the household. </li><br /><li> A provision is included to allow homeowners to trade more equity to the government, up to some limit, in exchange for cash now.<br /><br /></li></ol>Such a program would have the following effects:<br /><ul><li>banks would receive some relief as we reduce pressure from bad mortgages and they recover market value without all the risks of dumping a large stock of vacant housing</li><br /><li>homeowners can stay in their homes</li><br /><li>the government recapitalizes households (relieving cash-flow and solvency problems) </li><br /><li>households and banks both carry the costs of the bad loans</li><br /><li>government will recover costs as the housing market recovers </li></ul>Given the stricter redrafting of bankruptcy laws in the U.S., something of the sort will be necessary to prevent a political firestorm if housing markets get much worse.<br /><br />References<br /><br />[1] "<a href="http://www.telegraph.co.uk/finance/3201885/Gordon-Browns-call-for-a-new-Bretton-Woods-gains-traction.html">Gordon Brown's call for a new Bretton Woods gains traction </a>," 15 October 2008, The Telegraph.<br />http://www.telegraph.co.uk/finance/3201885/Gordon-Browns-call-for-a-new-Bretton-Woods-gains-traction.html<br /><br />[2] Matthew Benjamin, <a href="http://www.bloomberg.com/apps/news?pid=20601070&sid=ahfMrINj__Mw&refer=home">McCain, Obama Promoting Populist Appeals on Rescue (Update2)</a>," 14 October Bloomberg. http://www.bloomberg.com/apps/news?pid=20601070&sid=ahfMrINj__Mw&refer=home<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-5802515903849691642?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-7677530810328552872008-10-05T10:46:00.007+02:002008-10-05T13:25:05.830+02:00The Orthogonality of Leadership and Crisis<span style="color: rgb(102, 0, 0);">or·tho·go·nal</span> (ôr-<strong>thog</strong>-uh-nl)<br /><blockquote>Adj. 1. <span class="style2">irrelevant</span> - having no bearing on or connection with the subject at issue; "an irrelevant comment"; "irrelevant allegations."<br /></blockquote><span style="color: rgb(102, 0, 0);">misregulation</span> (mis-<strong>reg</strong>-yuh-ley-shuhn)<br /><blockquote>Noun. 1. wrong or imperfect regulations. 2. a process of deliberately wrong or imperfect regulation for personal gain.<br /></blockquote>The U.S. does not have a monopoly on leadership failure. In a recent editorial in the New York Times and Herald Tribune, Paul Krugman states the obvious.<br /><blockquote><em>...the people who should be steering us away from that abyss are out to lunch.<br /></em><a href="http://www.iht.com/articles/2008/10/03/opinion/edkrugman.php">A leadership vacuum</a>, NYTimes, 3 Oct 2008<br /></blockquote>The economic crisis in the U.S. is deep and real, and requires leadership to match. The mismatch between leadership needs and the crew in charge is frightening. At the same time, a similar drama is unfolding on the other side of the Atlantic. In some ways, it offers more potential to go wrong in many more frightening ways than in the U.S., as it is exposing historical fractures linked to the most base tribal instincts of the European leadership class. This is one reason why the open letter from academic economists posted on VoxEU to European policy makers needs to be taken seriously.<br /><blockquote><em>This is a once-in-a-lifetime crisis. Trust among financial institutions is disappearing; fear may spread. Last week’s US experience showed that saving one bank at a time won’t work. A systemic response is needed and in Europe this means an EU-led initiative to recapitalize the banking sector. Unless European leaders immediately unite to address this crisis before it spirals out of control, they may find themselves fighting over how best to salvage the aftermath...</em><br /><a href="http://www.voxeu.org/index.php?q=node/1729">Open Letter to European leaders on Europe’s banking crisis: A call to action</a> .<br /></blockquote>How bad is the crisis in Europe? In a recent posting, I noted that the <a href="http://www.intereconomics.com/blogs/jff/2008/10/three-card-monty-on-streets-of-new-york.html">the European and Asian exposure to the toxic financial sludge floating around global financial markets is probably at least as bad as in the U.S</a>. However, while the U.S. has set aside an initial $700 billion, and the pundits are admitting that more will be required, the only coordinated (meaning European) response so far has been the early renewal of existing European Central Bank credits for €32 billion, and the breaking up of an emerging cross-border banking system back into national sub-units. (In the Fortis bailout out, for example: the government intervention is breaking up the cross-border group along national lines, including the interest in ABN AMRO it bought in a consortium with Royal Bank of Scotland and Banco Santander.) The Irish step to guarantee deposits was also discriminatory (beggar-thy-neighbor) in implementation. The exposure of European banks to bad debt may be as bad as in the U.S. In my view, the relaxed approach to shielding investors from information they might not like (misleading them) is at the core of the problem. Indeed, the editorials and blogs pointing to the "failures of deregulation and market capitalism" miss the point. This crisis is the consequence of globally mixing bad math, misinformation, and good-old-boy politics with financial misregulation.<br /><br />At one level, the issue is the global nature of the unfolding banking crisis. Recent news includes the <a href="http://www.reuters.com/article/gc06/idUSTRE49314H20081004">nationalization of Fortis Bank by the Dutch</a> government (including the retail banking business of ABN-AMRO), the <a href="http://www.rte.ie/news/2008/1005/economy.html">collapse of the rescue package for Hypo Real Estate</a> this weekend, and increased agitation in Europe as<a href="http://afp.google.com/article/ALeqM5hcWdSreh2tNafF5YVZbb2Te-Eivg"> beggar-thy neighbor national solutions are emerging for what is really a Continental problem</a>. In Ireland, for example, the decision of Ireland to provide a 100% guarantee to the deposits of Irish banks is causing a shift in deposits from non-Irish banks, <a href="http://www.reuters.com/article/bankingFinancial/idUSL252209520081003">obviously helping Irish banks but at the expense of other (e.g. British) banks</a> operating in the same market but without guarantees.<br /><br />At another level, this crisis is also a test for Europe. Following an announcement this weekend by European leaders that they would follow a more coordinated approach,<br /><blockquote><em>"<a href="http://afp.google.com/article/ALeqM5hcWdSreh2tNafF5YVZbb2Te-Eivg">Germany's Chancellor Angela Merkel insisted states would mainly act individually</a>..." </em><br /></blockquote>This position has been backed by the head of the ECB, who has sided with Merkel. In response, like Ireland, Greece has also now guaranteed deposits.<br /><br />Sigh.... Merkel's reactive undermining of a joint solution should be an alarm bell. Europe has been pushing deeper integration, including cross-border integration of its locally fragmented financial sectors. This is a good thing and a political necessity given history. It reflects hard work and real costs by the post-War generation. However, notwithstanding the pro-German reaction of the ECB, with the benefits of more integrated markets comes a responsibility for a more integrated approach to regulation and crisis management. A piecemeal approach to the current crisis will inevitably be beggar-thy-neighbor. There needs to be an integrated approach at a European level. Failure by European leaders to find a European solution risks setting back decades of European economic and political integration and efforts to exorcize Europe's tribal demons. Without a coordinated and aggressive attack on this crisis of confidence, it may get much much worse. Once European leadership is locked into national solutions, economic borders will grow wider and the slide back go tribal rivalry may begin yet again. The time to sort out responsibility (presumably the ECB is worried over wrong incentives and moral hazard) is after the crisis has been weathered.<br /><br />Europeans deserve better from their leaders (and their Central Bankers) than a narrow local focus. They need to demand wider vision. A narrow, nationalist approach will not fix this problem, and will carry long term costs. It is important that national leaders in Europe act responsible and talk about positive, European approaches to the problem. Nationalist rhetoric may be appealing and easy. It is also irresponsible and reprehensible, especially given the shared burden of European history.<br /><br />Quoting the letter again:<br /><blockquote><em>The problem is not a lack of understanding of how to stop financial crises. The problem is a lack of political will</em>.<br /></blockquote>ADDENDUM:<br />There is a good discussion of the European exposure by Daniel Gross and Stefano Micossi on RGE Monitor: "<a href="http://www.rgemonitor.com/globalmacro-monitor/253833/crisis_management_tools_for_the_euro_area">Crisis Management Tools for the Euro Area</a>." There is also some emerging realization that Europe's schadenfreude at the "American" crisis was premature. This crisis does not prove the "superiority of the general European banking model." Indeed a number of European state-owned banks have been caught in the same mess. As I have noted earlier, European banks have been staging mini-crisis for a while now (look up <a href="http://www.wienerzeitung.at/DesktopDefault.aspx?TabID=4082&Alias=wzo&cob=307442">BAWAG scandal</a> in google). Also see: "<a href="http://www.washingtonpost.com/wp-dyn/content/article/2008/10/01/AR2008100103406.html">Europe Beginning to Realize Its Lenders Share in the Blame</a>."<br /><br />References:<br /><br />[1] <a href="http://www.voxeu.org/index.php?q=node/1729">Open Letter to European leaders on Europe’s banking crisis: A call to action</a>, VoxEU, October 2008.<br />http://www.voxeu.org/index.php?q=node/1729<br /><br />[2] Paul Krugman,"<a href="http://www.iht.com/articles/2008/10/03/opinion/edkrugman.php">A leadership vacuum</a>," NYTimes 3 October 2008.<br />http://www.iht.com/articles/2008/10/03/opinion/edkrugman.php<br /><br />[3] Joseph Francois, "<a href="http://www.intereconomics.com/blogs/jff/2008/10/three-card-monty-on-streets-of-new-york.html">Three Card Monty on the streets of New York, or "If this crisis is so different, why is it so familiar?</a>" The Random Economist, 2 October 2008.<br />http://www.intereconomics.com/blogs/jff/2008/10/three-card-monty-on-streets-of-new-york.html<br /><br />[4] Reuters, "<a href="http://www.reuters.com/article/gc06/idUSTRE49314H20081004">Dutch media split over Fortis nationalization</a>," 4 October 2008.<br />http://www.reuters.com/article/gc06/idUSTRE49314H20081004<br /><br />[5] RTE News, "<a href="http://www.rte.ie/news/2008/1005/economy.html">German bank on verge of collapse</a>," 5 October 2008.<br />http://www.rte.ie/news/2008/1005/economy.html<br /><br />[6] AFP, "<a href="http://afp.google.com/article/ALeqM5hcWdSreh2tNafF5YVZbb2Te-Eivg">Europe fights financial storm as bank deal collapses</a>," 5 October 2008.<br />http://afp.google.com/article/ALeqM5hcWdSreh2tNafF5YVZbb2Te-Eivg<br /><br />[7] Reuters, "<a href="http://www.reuters.com/article/bankingFinancial/idUSL252209520081003">EU rescue fund rejected as U.S. bailout advances</a>," 3 October 2008.<br />http://www.reuters.com/article/bankingFinancial/idUSL252209520081003<br /><br />[8] Daniel Gross and Stefano Micossi, <a href="http://www.rgemonitor.com/globalmacro-monitor/253833/crisis_management_tools_for_the_euro_area">Crisis Management Tools for the Euro Area</a>, RGE Monitor, 2 Ocrtober 2008. http://www.rgemonitor.com/globalmacro-monitor/253833/crisis_management_tools_for_the_euro_area<br /><br />[9] Craig Whitlock and Edward Cody, "<a href="http://www.washingtonpost.com/wp-dyn/content/article/2008/10/01/AR2008100103406.html">Europe Beginning to Realize Its Lenders Share in the Blame</a>," Washington Post, 1 October 2008. http://www.washingtonpost.com/wp-dyn/content/article/2008/10/01/AR2008100103406.html<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-767753081032855287?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-22781903662646702782008-10-02T18:03:00.006+02:002008-10-03T09:44:49.153+02:00Three Card Monty on the streets of New York, or "If this crisis is so different, why is it so familiar?"In a recent New York Times editorial/blog, Paul Krugman argues that for the U.S. as a whole, there may be little net cost from the sub-prime bailout. <a href="http://krugman.blogs.nytimes.com/2008/09/30/where-will-the-money-come-from/">[1]</a> In the end, the cost to the U.S. taxpayer will depend on the people in charge acting responsibly and competently. We will witness massive transfers from the middle class taxpayer to Wall Street, but might not see comparable net costs to the U.S. There is a wide range of opinions and worries floating on the web about how competent and trustworthy the actors involved will really be. <a href="http://www.openleft.com/showDiary.do?diaryId=8743">[2]</a> At the same time, there is another player in the room, and he will lose massive sums of money. Indeed, in one way, we are looking at big losses for this other player no matter what happens in Washington. To explain what I mean, it helps to review history. <br /><br />In the late 1970s and early 1980s, the Members of the OECD embarked on largescale deregulation of international investment flows. In Japan, the combination of high savings and foreign investment restrictions had led to an accumulated stock of domestic savings earning low returns. When the floodgates were opened, Japanese institutional investors poured into the United States. In a paper written at the time, a Japanese academic offered the following contemporary perspective: <br /><blockquote><br /> "Since the basic change in Japan's law on foreign exchange controls in December 1980 toward deregulation Japanese banks, securities companies and institutional investors especially life insurance companies were gradually freed form rigid regulations on their overseas activities, and their management horizons and business activities were expanded on a world-wide scale. One of the new developments in Japan's foreign direct investment in the last few years is a sharp increase in investment in real estate business abroad, especially in the United States... Since around 1984 they are increasingly investing in real estate properties in the United States."<a href="http://www.e.u-tokyo.ac.jp/cirje/research/dp/87/f13/dp.pdf">[3]</a><br /></blockquote><br />Indeed, Japanese investment in real estate in the 1980s in the U.S. skyrocketed. An estimated $300 billion was poured into "high-profile properties like Rockefeller Center in New York and the Pebble Beach Golf Club in California."<a href="http://query.nytimes.com/gst/fullpage.html?res=950DE4D61F38F935A15752C0A9639C8B63&n=Top/Reference/Times%20Topics/Subjects/F/Foreign%20Investments">[4]</a> Yet more was poured into U.S.-based financial institutions and instruments. As the subsequent Savings and Loan crisis rolled across the U.S. economic landscape, their holdings in commercial real estate alone lost roughly half their value. This coincided with a steep fall in the value of the dollar. The Japanese liquidated their positions at a fraction of original costs. Making a crude guesstimate, and assuming a 50% loss on their commercial property investments, they lost $150 billion by 1990 or roughly $230 billion in 2008 dollars. In other words, Japanese investors may have carried more than half the cost of the S&L crisis. The U.S. tax payer also paid a bit less than half, while on net for the U.S. much of this was just a net domestic transfer. From that point, of course, the Japanese went through a further real estate collapse of their own (Business Week estimated in 1998 that households may have suffered $250 billion in losses in Japan as real estate prices fell 70% from 1992 levels <a href="http://www.businessweek.com/1998/20/topstory.htm">[5]</a>).<br /><br />So today, in 2008, we are looking at $700 billion set aside in reserves (so far) to clean up the U.S. exposure to sub-prime backed securities. More may be needed up front, but much will also be recovered over time as markets recover. Also, as Paul Krugman has stressed <a href="http://krugman.blogs.nytimes.com/2008/09/30/where-will-the-money-come-from/">[1]</a>, much of these costs are essentially a domestic transfer. We are looking at a big debt for equity swap, where the shortfall is picked up by the U.S. taxpayer but a number of U.S. investors are saved in the process. To the extent we are saving U.S. shareholders and investors, these are "just" massive internal transfers. Unless this gets messier, and more expensive.<br /><br />However..... rewind back to the 1980s, when Japanese institutional investors were badly burned by the U.S. real estate meltdown, and may have lost $250 billion or more in today's terms (with a worse hit adjusting for the ongoing exchange rate hit at the time). Today, we are looking at a sub-prime mess where half of the "stinky mortgages" (a phrase I steal from the sub-prime primer <a href="http://gregmankiw.blogspot.com/2008/03/subprime-primer.html">[6]</a>) are held in the U.S., and the other half are overseas. Indeed, while the Chinese and Japanese may be holding massive amounts of U.S. Federal debt obligations, Europeans may own $250 billion in sub-prime junk, Japan may hold $200 billion, and China may hold $260 billion. Taiwan and Korea may hold another $50 billion. I say "may" because one problem here is continued lack of transperency, which has obviously contributed to the ongoign financial market jitters. ("Might it not be the case that we understood too little about the risks banks had taken on?"[<a href="so far">7</a>]) It is not clear what the foreign exposure actually is, and the estimates quoted here from 2007 may be low.<a href="http://www.moneymorning.com/2007/08/21/subprime_bodies/">[8] </a><br /><br />So, the U.S. is apparently ready to bail out U.S. holders of sub-prime securities. This is only half the problem. To a large extent, the U.S. bailout involves internal transfers. At the same time however, we may want to use U.S. taxpayer costs as a money metric of the cost imposed on foreign investors, who will not be bailed out by the U.S. Congress and face very very real losses. Basically, much and perhaps most of the net financial cost of this crisis will fall on foreign investors. We are looking at the unwinding of an unintended real estate scam, where foreign investors lose several hundred billion dollars inside the U.S. financial system. In New York, Three Card Monty <a href="http://www.threecardmonte.com/police_three_card_monte.html">[9]</a> is illegal. The city does, however, offer much more elaborate ways to see your money disappear. <br /><br/>References<br /><br/><br /> [1] Paul Krugman, "<a href="http://krugman.blogs.nytimes.com/2008/09/30/where-will-the-money-come-from/">Where Will the Money Come From?</a>," NYTimes, September 30, 2008, 9:04 am.<br /><br />http://krugman.blogs.nytimes.com/2008/09/30/where-will-the-money-come-from/<br /><br />[2] Matt Stoler, "<a href="http://www.openleft.com/showDiary.do?diaryId=8743">As the Senate Votes</a>," Wed Oct 01, 2008 at 19:57 <br /><br />http://www.openleft.com/showDiary.do?diaryId=8743<br /><br />[3] Ryutaro Komiya, "<a href="http://www.e.u-tokyo.ac.jp/cirje/research/dp/87/f13/dp.pdf">Japan's Foreign Direct Investment: Facts and Theoretical Considerations</a>," University of Tokyo, October 1987.<br /><br />http://www.e.u-tokyo.ac.jp/cirje/research/dp/87/f13/dp.pdf<br /><br />[4] Terry Pristin, "<a href="http://query.nytimes.com/gst/fullpage.html?res=950DE4D61F38F935A15752C0A9639C8B63&n=Top/Reference/Times%20Topics/Subjects/F/Foreign%20Investments">COMMERCIAL REAL ESTATE; Echoes of the 80's: Japanese Return to U.S. Market</a>," NYTimes January 26, 2005.<br /><br />http://query.nytimes.com/gst/fullpage.html?res=950DE4D61F38F935A15752C0A9639C8B63&n=Top/Reference/Times%20Topics/Subjects/F/Foreign%20Investments<br /><br />[5] Business Week, "<a href="http://www.businessweek.com/1998/20/topstory.htm">JAPAN'S REAL CRISIS: Until its hidden debt mess is cleared up, no recovery is possible</a>," 1998.<br /><br />http://www.businessweek.com/1998/20/topstory.htm <br /><br /> [6] "<a href="http://gregmankiw.blogspot.com/2008/03/subprime-primer.html">Subprime Primer</a>:How SubPrime Really Works," BigPicture, Friday, February 15, 2008 | 11:15 AM<br /><br /> http://bigpicture.typepad.com/comments/2008/02/how-subprime-re.html<br /><br />[7] J.F. Francois, "<a href="http://www.intereconomics.com/blogs/jff/2007/10/firewalls-and-firestorms.html">Firewalls and Firestorms</a>," The Random Economist blog, Sunday, October 28, 2007.<br /><br />http://www.intereconomics.com/blogs/jff/2007/10/firewalls-and-firestorms.html<br /><br />[8] Martin Hutchinson, "<a href="http://www.moneymorning.com/2007/08/21/subprime_bodies/">Where are the subprime bodies buried?</a>" Money Morning, Tuesday, August 21st, 2007.<br /><br />http://www.moneymorning.com/2007/08/21/subprime_bodies/<br /><br />[9] Glenn Hester, "<a href="http://www.threecardmonte.com/police_three_card_monte.html">Three Card Monte from a Police Officer’s Perspective</a>," threecardmonty.com.<br /><br />http://www.threecardmonte.com/police_three_card_monte.html<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-2278190366264670278?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-69055199624060854002008-05-11T13:18:00.003+02:002008-05-11T13:36:24.304+02:00Politics in America, Twain, and Confidence MenWith the presidential election well underway in the United States, I find it amusing to listen to spectating Europeans complain about how complicated the process is. In reality, leadership selection is rather convoluted on both sides of the Atlantic, and I think it fair to also ask your European "man on the street" to explain how the management team of the European Union is selected, the next time he or she comments on the American process. Actually, both the leadership selection mechanisms in the Euroepan Union, and the electoral college in the United States, seem somewhat akin to selection of the Doge in Venice:<br /><blockquote><br /> "Thirty members of the Great Council, chosen by lot, were reduced by lot to nine; the nine chose forty and the forty were reduced by lot to twelve, who chose twenty-five. The twenty-five were reduced by lot to nine and the nine elected forty-five. Then the forty-five were once more reduced by lot to eleven, and the eleven finally chose the forty-one who actually elected the doge.." (Wikipedia, "<a href="http://en.wikipedia.org/wiki/Doge_of_Venice">Doge of Venice</a>").<br /></blockquote><br />There may be wisdom behind such complexities. It shields us from true populism, prevents us from feeling too vested in our leadership, and makes the system harder to game on a consistent basis. <br><br />So, if the process of leadership selection in the United States is hard to explain in detail, the spirit is easier to explain. We just need to turn to the pages of Twain. To understand what goes on spiritually in American politics, it helps to first remember that there is an important entertainment element to the whole thing. With this in mind, I recommend reading <em>Adventures of Huckleberry Finn</em>, and in particular the chapters relating to the Duke and King. In Chapter 23, they put on a play. Think of the play as a political administration. What the Duke and King advertise is <br><br /> "<em>The Royal Nonesuch</em>. 3 Nights only! World-Renowned David Garrick and Edmund Kean! Admission - 50 cents. Ladies and children not admitted."<br> <br />What they deliver is the King prancing around the stage naked, along with a revelation that the audience has been conned, tricked out of their hard-earned money. Rather than admit they have made a mistake, the audience decides to talk the rest of the town into going to the play the next night.<br /><blockquote><br /> "Hold on! Just a word, gentlemen." They stopped to listen. "We are sold- mighty badly sold. But we don't want to hear the last of this thing as long as we live. No. What we be the laughing-stock of this whole town, I reckon, and never want, is to go out here quiet, and talk this show up, and sell the rest of the town! Then we'll all be in the same boat. Ain't that sensible?"<br /></blockquote><br />Basically, having chosen wrong, they support forcing a second performance on the rest of the town (a second term in office, so to speak), rather than admit to a mistake. Eventually, however, the town does throw the rascals out, in dramatic fashion complete with rotten eggs, cabbages, and dead cats. This is what we are witnessing now. We have had repeated performance of <em>The Royal Nonesuch</em> these last 8 years in Washington. The electoral wheel is turning, and the town mob is gathering their eggs, cabbages, and dead cats and getting ready for political change. This is what is happening, metaphorically speaking, as the elections proceed. Pay no attention to the procedures. Enjoy the theater. <br /><p>References<br /><br />(1) Wikipedia, "<a href="http://en.wikipedia.org/wiki/Doge_of_Venice">Doge of Venice</a>."<br /><br />(2) Mark Twain, <a href="http://www.americanliterature.com/Twain/TheAdventuresofHuckleberryFinn/23.html">Adventures of Huckleberry Finn</a>, Chapter 23.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-6905519962406085400?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-766397830582715152007-11-02T21:22:00.000+01:002007-11-03T10:50:19.714+01:00Scapegoating migrants<p><u>The nativist myth</u>: When God created the world, in his wisdom he placed a fixed number of jobs in each country. He also dictated that people within a country should stay only in that country, regardless of famine, drought, war, or love. They should not migrate to other countries, as they would upset the balance and there would be too many people and too few jobs. Therefore it is the job of people in a country to protect the jobs they have, for they will never get more, and the ones they have might be stolen and carried away in a box to another country, along with their cars and other belongings<br /><br />Assuming that people really believe the story above is the only way I can make sense out of recent anti-migration rhetoric in the US and EU. Indeed the news this week has been surreal. I have been listening to reports and call-in show hosts on BBC stoking the perception that migrants cost money, and encouraging discussion on their contribution to crime. Government officials are also stoking the rhetoric. "<a href="http://news.bbc.co.uk/2/hi/uk_news/politics/7070756.stm">Gordon Brown has pledged more jobs for British workers</a>." And when government policy fails (like <a href="http://news.bbc.co.uk/2/hi/uk_news/politics/7071612.stm"> housing in the UK</a>) it is easy to blame foreigners as they may pay taxes but may not vote. In the Netherlands, there are serious proposals to throw Poles (apparently just Poles for some reason, perhaps because they work too hard) out after six months in Holland-- notwithstanding EU treaties. "<a href="http://www.expatica.com/actual/article.asp?channel_id=1&story_id=45389">Rita Verdonk..said she found the discussion on the integration of Poles unnecessary since Poles should not settle here permanently</a>." Italy is planning to deport EU nationals (i.e. Romanians) for petty crime -- again in violation of EU treaties. ("<a href="http://www.telegraph.co.uk/news/main.jhtml?xml=/news/2007/11/02/witaly202.xml">Italy has begun rounding up thousands of Romanian immigrants for deportation</a> after passing a new "public order and security" law...The move appeared to have the blessing of the European Union. Nello Rossi, the head of Italy's National Magistrates Association, said that "The new law does not appear to conform to our own constitution or to the European law which recognises the right of European citizens to circulate freely and stay within the territory of any member state.") And the Swiss have plans to deport entire families when a child falls short of the law. (<a href="http://www.nytimes.com/2007/10/08/world/europe/08swiss.html?hp">"The SVP party has begun a campaign seeking the 100,000 signatures necessary to force a referendum ...(that) </a>calls for the deportation of the entire family if the convicted criminal is a minor... The initiative is reminiscent of the Nazi practice of Sippenhaft, or kin liability.") The rhetoric across Europe is disturbingly racist and tribal. And in the US, the racist anti-migrant rhetoric (immigrant bashing has an anti-Hispanic tone in the US) is steeped in irony. Many (most?) "native" US citizens have Irish or German or Italian ancestors who were refused work because they were Irish or German or Italian. Indeed my own grandmother was an undocumented migrant from Ireland to the US. She was not a criminal. She was simply undocumented.<br /><br />And then I read stories like this: <a href="http://www.nytimes.com/2007/09/26/nyregion/26riverside.html?_r=1&hp&oref=slogin"><em>Towns rethink laws against immigrants</em></a>, New York Times, 26 September 2007. To quote: "A little more than a year ago, the Township Committee in this faded factory town became the first municipality in New Jersey to enact legislation penalizing anyone who employed or rented to an illegal immigrant.Within months, hundreds, if not thousands, of recent immigrants from Brazil and other Latin American countries had fled. The noise, crowding and traffic that had accompanied their arrival over the past decade abated. The law had worked. Perhaps, some said, too well. With the departure of so many people, the local economy suffered. Hair salons, restaurants and corner shops that catered to the immigrants saw business plummet; several closed. Once-boarded-up storefronts downtown were boarded up again...(the mayor) was voted out of office last Fall." <br><br />Yes, when an economy works properly, migrants create work, and pay taxes, and generate demand for goods and services. They can even build housing. When an economy fails to deliver jobs and services, it is not because of migrants. But they are an easy target, and Europe has a long history of stealing the lives and property of easy targets. By promoting deeper integration, the EU was meant to help Europe rise above this dark tendency from its past. Sadly, this week has been a serious step backwards. <br><br />Strangely, this week I find myself thinking the EU needs more money to allocate across Europe for its mix of crazy agricultural subsidies, paper-work heavy research subsidy schemes, and infrastructure subsidy schemes. This way, when the Dutch turn to the center for cash, the Poles can remind them of their hospitality as hosts, and the Romanians can similarly remind the Italians. And maybe the EU can serve as a more distant scapegoat, rather than our hard-working mixed-accent neighbors.</p><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-76639783058271515?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-80420260441506339892007-10-28T16:40:00.000+01:002007-10-28T17:07:02.836+01:00Firewalls and Firestorms<p>This past Summer has seen the sub-prime lending crisis in the United States turn into a global liquidity crisis. Subsequent events illustrate two important things about financial globalziation. First, no financial crisis is really local. The U.S. crisis has sparked a bank run in the UK and has forced the German authorities to use tax payer money to support German banks in crisis. At the same time, because we are able to spread local shocks globally, the markets outside North America are absorbing some of the brunt of the U.S. crisis. In similar fashion, when we next have a crisis somewhere in Asia or Europe, the local impact will be less as global markets are better equipped to handle the shock than are local markets. This logic follows from the simple algebra of portfolio diversification and risk. And yet...<br /><br />The current crisis also illustrates other, less sanguine, aspects of the emerging global financial architecture. One important aspect of modern banking is the blending of commercial banking services (managing the operating funds and transactions of businesses and households) with investment banking, speculation, and underwriting. For example, Germany's IKB Deutsche Industriebank AG had to receive financial support from the state-owned KfW development bank (along with other banks) because of its exposure to risks linked to the sub-prime crisis in the U.S. Its problems are linked to the bank's investment activities through Rhineland Funding. For those versed in the history of financial crises and regulation, this sounds uncomfortably like problems -- linked to investment activities of banks -- that preceded the crash of 1929. Indeed, in Europe it seems we are always facing banking scandals. It is clearly hard to bring perpetrators to task, and regulation is opaque and politically susceptible. This brings us to another aspect of the European side of the crisis -- an inherent instinct to distrust investors and hide information. Indeed, in a surreal twist on the logic of regulation, senior EU officials are calling for <u>less transparency</u>. To paraphrase Bank of England governor Mervyn King: "<a href="http://www.moneymarketing.co.uk/cgi-bin/item.cgi?id=152930&d=340&h=341&f=342">the European Market Abuse Directive was partly to blame for the crisis that hit Northern Rock by not allowing the Bank to act covertly</a>." This follows similar statements by the European Commissioner Colin McCreevy (commissioner for the internal market). <a href="http://www.moneymarketing.co.uk/cgi-bin/item.cgi?id=152930&d=340&h=341&f=342">McCreevy is on record criticizing the UK for applying too much transparenc</a>y. He said: “Unfortunately, in recent weeks, gold-plated transparency rules stood in the way of the quiet resolution of a problem before it became a crisis: The result was that transparency rules that were intended to underpin investor confidence, when put to the test, actually promoted investor panic." In other words, if we had been able to hide the problem from investors, we could have found a way to keep it quiet until the whole thing blew over. Elsewhere in the press it has been noted that "<a href="http://www.ifaonline.co.uk/public/showPage.html?page=479351">He said regulators would be wise to learn from the crisis and should adjust rules regarding transparency, saying it was often beneficial for issues affecting the stability of major financial institutions to be carried out behind closed doors.</a>" What?! Do recent scandals like Parmalat, Enron, and Bawag mean anything? Might it not be the case that we understood too little about the risks banks had taken on?<br /><br />It may be time to revisit the logic and working of the old U.S. system that was underpinned by the <a href="http://en.wikipedia.org/wiki/Glass-Steagall_Act">Glass-Steagall Act</a>. Following the Great Crash that opened the show for the Great Depression, the U.S. Congress introduced a system of financial firewalls. Some were geographic, with a deliberate segmentation of regional financial markets. Others related to areas of operation. Basic commercial banking had to be kept separate from investment banking. This was accompanied by Federal guarantees of commercial bank deposits. The cost of this guarantee was regulation. With financial innovation, and the ability of investment firms to offer bank-like services (like money market accounts), this system was eventually dismantled, ending with repeal of Glass-Steagall in 1999. This was accompanied by a wave of financial mergers in the U.S. that, many believe, did promote greater efficiency in the financial services sector. The geographic fragmentation of U.S. banks did lead to small and capital-weak institutions unable to weather the liquidity crisis set off in 1929. And there are benefits to bigger banks. Yet, in light of present events one might wonder about the merits of segmentation of commercial and investment services... We again find ourselves in a world where banks are blending investment and basic banking activities. The result is that institutions that are important to the working of the basic monetary system underpinning the economy are threatened by financial cross-obligations in their investment arms. At the same time, it is not clear that incentives and rules are structured properly for full transparency about risks undertaken.<br /><br /> There are arguments for letting banks collapse in the current crisis, to send the "right signal" to the market that management (and investors) are responsible for their decisions. In the absence of explicit government guarantees, it is the role of investors, management, and rating agencies to sort out risk and communicate information. However, it is clear that we live under a second-best set of political constraints. It is not possible to let major banks go under, along with corporate and private savings. Instead there will be bailouts. Witness <a href="http://business.timesonline.co.uk/tol/business/columnists/article2752059.ece">Northern Rock </a>,<a href="http://www.iht.com/articles/ap/2007/10/16/business/EU-FIN-COM-Germany-IKB.php"> IKB Deutsche Industriebank AG</a>, and <a href="http://eurojust.europa.eu/press_releases/2006/15-09-2006.htm">BAWAG</a>. Whether is is explicit (like the deposit insurance scheme in the US) or implicit (like repeated bailouts in the EU), we live in a world where political constraints mean risk-taking behavior by bank management is underwritten by the public purse. We may wish it was otherwise. We may be able to argue that theoretically the world would be better if this were not so. However, the reality of populist politics in the industrial world means it is not possible let such institutions fail. If we admit that a mix of implicit and explicit guarantees is unavoidable, then we need to rethink regulation. This includes capital requirements under Basel II, but it also means more. We need to revisit the concept of firewalls between the basic liquidity services of financial institutions, and their more adventurous investment activities. It is encouraging that the chairman of the Basel Committee on Banking Supervision Nout Wellink is skeptical of US bank plans to fix the current problem with conduits (junk bonds?) with an "uber-conduit" or superconduit. <a href="http://www.marketwatch.com/news/story/basel-bank-watchdog-has-mixed/story.aspx?guid=%7B7312B52E-EB74-4FD7-AD5D-7BF4A6649AEF%7D">Wellink's comments are diplomatic</a>. <a href="http://letters.salon.com/tech/htww/2007/10/16/super_conduit/view/?show=all">Comments on the blogosphere are less diplomatic</a>. (For example "<em>I'll be the first to admit I'm not a financial expert. But engaging in even more of the same behavior? Sounds like trying to solve a gambling problem by gambling your way out</em>.") Also, notwithstanding the opinions of Messrs. McCreevy and King, we need more transparency, not less. We also need to at least consider modern versions of the 20th Century's financial firewalls. We can then let the investment industry be as innovative as it likes (within the law) while maintaining a more stable though admittedly less exciting sub-sector for basic transaction services. <br /> <br /> Further reading:<br /><br /> [1] "<a href="http://www.cftech.com/BrainBank/SPECIALREPORTS/GlassSteagall.html">Understanding How Glass-Steagall Act Impacts Investment Banking and the Role of Commercial Banks</a>," Brain Bank. <br /><br /> [2] "<a href="http://business.timesonline.co.uk/tol/business/columnists/article2752059.ece">Suspend Rock shares – it’s a false market</a>," <em>The Sunday Times</em> online, October 28, 2007.<br /><br /> [3] "<a href="http://www.nytimes.com/2007/10/26/business/worldbusiness/26euro.html?em&ex=1193544000&en=106d26a491b60aab&ei=5087%0A">Credit Crisis Spreading New Jitters in Europe</a>," <em>The New York Times online</em>, October 26, 2007.<br /><br /> [4] "<a href="http://www.moneymarketing.co.uk/cgi-bin/item.cgi?id=152930&d=340&h=341&f=342">European Commissioner McCreevy blames UK gold-plating for Northern Rock debacle</a>," <em>MoneyMarketing</em>, Paul Mcmillan - 26-Oct-2007.<br /><br /> [5] "<a href="http://www.nytimes.com/books/first/m/morris-money.html?_r=2&oref=slogin&oref=login">Boom and Bust in Early America</a>," in <em>Money, Greed, and Risk: Why Financial Crises and Crashes Happen</em> By CHARLES R. MORRIS, Times Business online (Chapter 1). This provides a good read on earlier times. The present crisis is nothing new. To quote: "The secret of successful banking, reported a New York practitioner of the banker's dark arts in 1836, was to issue notes with 'a real furioso plate, one that will take with all creation—flaming with cupids, locomotives, rural scenery, and Hercules kicking the world over.'"<br /><br />[6] "<a href="http://letters.salon.com/tech/htww/2007/10/16/super_conduit/view/?show=all">Super Conduit to the rescue!</a>" Salon.com letters to the editor, 16 October 2007. <br /><br /></p><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-8042026044150633989?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-92091551991752915592007-10-28T16:36:00.000+01:002007-10-28T16:39:15.833+01:00Ich bin übersiedelt.I have not been writing here lately, as I have been focused on the minor issue of moving this Summer from Holland to Austria. The experience has brought many things to mind -- migration and integration rules in Europe, market failure in the home construction and renovation market, the long way Europe has to go before its service markets are really integrated, variations in education policy across the EU, and such. When I moved to Holland ten years ago a local banking scandal (the <a href="http://www.essex.ac.uk/ECPR/events/jointsessions/paperarchive/grenoble/ws16/vries.pdf">South Holland banking scandal</a>) was wrapping up, and as I moved to Austria a comparable banking scandal is unfolding in the local press. (The <a href="http://www.wienerzeitung.at/DesktopDefault.aspx?TabID=4082&Alias=wzo&cob=307442">BAWAG scandal</a> -- and <a href="http://eurojust.europa.eu/press_releases/2006/15-09-2006.htm">efforts to apprehend the parties involved</a> --makes interesting reading.) And then there is the very real (yet seemingly surreal) question, should we hedge our children's college funds better against currency risk? And most important, what do you do when DHL loses your professional library in shipment? (They did eventually find it, but the experience makes one think.) The dust has not settled, but the teaching term has begun and we are covering the global macroeconomy. The topics we cover in class are being mirrored in the financial markets, so there is much to talk about in class.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-9209155199175291559?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-73102642850587949332007-07-02T01:18:00.000+02:002007-07-02T01:25:31.752+02:00It is time to declare victory and go homeWe have been here before<br /><p>We are still negotiating the Uruguay Round. This may come as a surprise to casual observers and negotiators alike. After all, documents were signed in Marrakech in 1994 concluding the Round.</br><br /><br />As the Uruguay Round drew to a close, US and EU negotiators were unable to make substantive progress on agriculture, middle-income countries were demanding credit for unilateral liberalisation undertaken outside the GATT, and LDCs were demanding one-sided concession from the OECD. The unelected leaders of the nascent anti-globalisation movement, flush from their first kill with the death of the Multilateral Agreement on Investment, demanded that the representatives of elected governments either give them some control over the process (a “seat at the table”) or end the process entirely. Lester Thurow declared the GATT dead, and....<br><br /><br /> <a href='http://www.voxeu.org/index.php?q=node/331'>You can read the rest of this posting on VoxEU.</a><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-7310264285058794933?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-66401174578872200412007-06-19T21:49:00.000+02:002007-11-02T22:28:19.129+01:00How Big is China?China-bashing is back in fashion in Washington and Brussels. The U.S. Congress is demanding that China re-value its currency to correct what is perceived as a trade imbalance. The financial press has called this, delightfully, a product of “<a href="http://www.fxstreet.com/futures/market-review/thoughts-from-the-frontline/2007-06-16.html">The collective brain deficit trust, otherwise known as the US Congress</a>.” Europe is also growing increasingly <a href="http://news.scotsman.com/latest.cfm?id=962392007">impatient with the Chinese</a> propensity to undervalue its currency – and more broadly with the Asian tendency to do the same. With massive imbalances in the English-speaking world, and Asian currencies effectively pegged, the euro has been left to pick up the slack. Logically, this leaves exporters in Europe unhappy. The U.S. current account problem is not, of course, China’s fault. The Bush Administration, aided and abetted by local governments and private households, has been fiscally profligate. Combined with dismally low savings rates, this means the U.S. ran a current account deficit of 6.5 percent of national income, according to the IMF, in 2005 and 2006. Thankfully, this is projected to fall to “only” a deficit of only 6.1 percent in 2007.<br /><br /> China’s exchange rate policy mirrors, in some ways, the growth path followed by German from 1947 through 1970. Germany built its economic miracle on a strong export industry supported by an undervalued D-mark and by the recycling of its surplus through foreign investment and aid. (See <a href="http://www.richmondfed.org/publications/economic_research/economic_quarterly/pdfs/spring2002/hetzel.pdf">Hetzel</a> for more on this.)<br /><br /> So… if China is following a path marked by Germany, what exactly is the problem? To put it bluntly, the problem is the dragon in the middle of the room. China’s economy has grown, to be hyperbolic, to epic proportions. Before I discuss numbers, I should briefly review the concept of purchasing power parity and the Balassa-Samuelson effect. Because wages are low, service prices tend to be low in developing countries. This translates into a general low price for non-traded goods, so that official exchange rates understate the actual value (and hence size) of the domestic side of developing economies. Various efforts are made to adjust for this (i.e. to make values reflect relative prices) when we compare per-capita incomes. This means that the size of China’s economy is underestimated when we use world prices. This is even before we add the issue of an undervalued exchange rate. This point is illustrated in the figure below.<br /><br /><br /><img src="http://www.intereconomics.com/blogs/jff/images/China.png" width="363" height="240" /><br /><br /><br />In the figure, the left-hand axis plots China’s GDP, while the right-hand axis plots China’s current account surplus as a percent of GDP. The first set of numbers is at nominal prices, and the second reflects adjustment of China’s GDP to reflect differences in prices and purchasing power (known as a PPP adjustment). What emerges is that while China’s trade surplus, as a share of GDP, is huge at official exchange rates, it is actually quite reasonable given the actual size of the Chinese economy. Indeed, if we valued the basket of China’s domestic (i.e. non-traded) goods and services at U.S. prices, the Chinese economy is roughly 81% the size of the U.S. economy, while the trade surplus is only 2.7 percent, rather than the 10.0 percent estimated by the IMF at official exchange rates. A consequence of China’s current exchange rate policy is to overstates its trade surplus, and understate the size of the underlying domestic economy. Indeed across Asia we tend to understate the size of the regional economies and overstate trade relative to domestic activity for the same reason. You can make these, and similar calculations, yourself with <a href="http://www.imf.org/external/pubs/ft/weo/2007/01/data/index.aspx">data from the IMF's World Economic Outlook</a>. <br /><br />In the interest of overkill and overstatement, the second figure compares Germany, China, and the U.S. in 1980 and 2007. Again, we are looking at GDP and the current account surplus, adjusted for PPP. What this shows is that, valued at OECD prices, China’s economy has surged past Germany, and is now over 4 times as big as Germany’s. This contrasts sharply with unadjusted data. At official exchange rates and without adjusting for China’s price levels, the two economies are roughly the same size. Also striking is the size of the relative trade surpluses. The IMF projects that Germany will have a current account surplus of 5.3 percent (at official exchange rates), which is equal to 6.1 percent of PPP-adjusted GDP. China’s trade surplus, on the same basis, is 2.1 percent of PPP-adjusted GDP. In terms of the share of goods and services produced and priced on the same basis, Germany’s current account surplus is 3 times larger than China’s on a share basis. Yet Congress is not bashing the euro zone. Congressional moves attacking currency manipulators (i.e. Baucus-Grassley-Schumer-Graham) target Asia, not Europe. </p><br /><p><img src="http://www.intereconomics.com/blogs/jff/images/China2.png" width="363" height="240" ><br /><br /> Given the relative under- and over-valuation of Asian and European currencies, and the relative size of current accounts relative to actual GDP, one is left a bit bemused. China is following a macroeconomic growth path marked out by Germany, and for this it is being condemned. At the same time, U.S. imbalances are being pegged on everybody but the U.S. itself. And no one is talking about the real reason why China’s surpluses have such a big impact on the world economy. Quite simply – China has grown huge, and this is masked by current exchange rate policy, combined with a healthy does of Balassa-Samuelson effects. For a long time, as the world’s biggest kid on the block, U.S. imbalances have had a major impact on global capital markets, sometimes sucking capital in from smaller countries and regions. China (abetted by Japan) appears to be softening this effect somewhat. Do we really want this to end abruptly? <a href="http://www.fxstreet.com/futures/market-review/thoughts-from-the-frontline/2007-06-16.html">Be careful what you wish for,</a> as you may actually get it.<br /><br /> <u>Further reading</u><br /><br /> [1] <a href="http://www.fxstreet.com/futures/market-review/thoughts-from-the-frontline/2007-06-16.html">Be careful what you wish for</a>,” John Mauldin, <em>FXstreet.com</em>, 16 June 2007.<br /><br />[2] <a href="http://www.richmondfed.org/publications/economic_research/economic_quarterly/pdfs/spring2002/hetzel.pdf">German Monetary History in the Second Half of the Twentieth Century: From the Deutsche Mark to the Euro</a>,” R.L. Hetzel, <em>Federal Reserve Bank of Richmond Economic Quarterly Volume</em> 88/2 Spring 2002: 29-64. <br /><br />[3] <a href="http://ipezone.blogspot.com/2007/06/baucus-grassley-schumer-graham.html">Baucus-Grassley-Schumer-Graham</a>,” International Political Economy Zone: Tales of Power, Money, and Occasional Violence, Wednesday June 13 2007.<br /><br />[4] <a href="http://en.wikipedia.org/wiki/Balassa-Samuelson_effect">Balassa-Samuelson Effect</a>," Wikipedia.<br /><br />[5] The IMF's <a href="http://www.imf.org/external/pubs/ft/weo/2007/01/data/index.aspx">World Economic Outlook database</a>. <br /><br />[6] <a href="http://web.worldbank.org/WBSITE/EXTERNAL/DATASTATISTICS/ICPEXT/0,,menuPK:1973757~pagePK:62002243~piPK:62002387~theSitePK:270065,00.html">The International Comparison Program</a>. <br /><br />[7] "<a href="http://news.scotsman.com/latest.cfm?id=962392007"> France Raises Prospect of New Bra Wars</a>," <i>The Scotsman, 19 Jun 2007. </i><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-6640117457887220041?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-6196100397980002662007-05-18T19:30:00.000+02:002007-05-19T01:45:33.294+02:00We must all hang together, or most assuredly we shall all hang separatelyEurope and Russia are in a <a href="http://www.allaboutlifechallenges.org/enabling-and-codependency-faq.htm">codependent relationship</a>. West European powers in Brussels are playing the role of a codependent spouse, denying injuries to the children and believing that somehow they can manipulate things toward a positive outcome while ignoring outright attacks on Members of the EU family. Russia plays the role of the abusive partner in this very real drama.<br /><br />Imagine if Russian interests (whether government or mafia based) shut down the computer systems of the UK or U.S. government, and all the banks and financial firms in London or New York, cutting them off from the financial world. Imagine further that the <a href="http://www.forbes.com/business/feeds/afx/2007/05/18/afx3735575.html">cyber attacks</a> were extended to the emergency services, aiming to cripple the police and ambulance services. At the same time, imagine that Russia blockaded a major pipeline supplying oil to Germany, and imposed a boycott on agricultural exports from France. And imagine if the car of a Swedish Ambassador was attacked by supporters of President Putin. Indeed, all this is happening to EU and NATO Members at the moment. Only the names have been changed. Except the Swedish ambassador. <a href="http://www.guardian.co.uk/russia/article/0,,2070898,00.html">That really did happen</a>. The other victims are new Members of the European Union. They are Poles, Estonians, and Lithuanians. The EU is being tested on the foreign policy front. It is being tested and it is failing miserably. This proves the case for a stronger European executive (president, foreign minister, etc) for, to quote Benjamin Franklin “<a href="http://www.ushistory.org/franklin/quotable/quote71.htm">We must all hang together, or most assuredly we shall all hang separately</a>.” Maybe the Eurocrats in Brussels also need a refresher in history. Quite simply, Russia wants to neuter the East Europeans again. Germany has -- one hopes unwittingly -- again been a party to this process, with its complicity in Russia’s effort to isolate them politically and economically. Witness evolving German energy policy in the region. As West Europeans seem to have a short historical memory, I will provide a quick historical recap here.<br /><br />To understand Russia’s diplomatic trouble with Central and Eastern Europe, one has to look at it through the lens of history -- the history of Russia's past imperial adventures in the Baltics. The closest parallel I can think of is Japan’s continued problems with China, Taiwan, Korea, and much of Southeast Asia. Japan was a brutal imperial power, slaughtering hundreds of thousand of civilians as it aimed to subjugate populations and build an East Asian empire. Yet it still has not faced up to its role as an aggressor. It teaches in schools that it was a victim in World War II, it still denies well-documented war crimes, and suffers from repeated gaffes by political leaders with a penchant to cause riots in Seoul and Beijing. Similarly, Russia’s view of its own 20th Century history is at odds with the memories of many countries that Russia stepped on during the 20th Century as it chased imperial ambitions. Russia was both victim and aggressor in World War II. Yet it only remembers half of this experience. Judging by Japan’s experience, Russia’s problems with the European Union may run for decades unless its view of its own history is revised. Russia is acting like post-Imperial Japan, quick to remember its role as victim but with no sense of guilt about its own aggression.<br /><br />The European preliminaries that led to World War II included the Soviet Russian absorption of the Baltic States, with the complicity of Nazi Germany. Indeed Nazi Germany and Soviet Russia started as allies. On the basis of a non-aggression pact (<a href="http://www.historyplace.com/worldwar2/timeline/pact.htm">the Molotov-Ribbentrop Pact</a>), they divided up Central and Eastern Europe into spheres of influence, and the East Europeans emerged from the hellish consequences of this German-Russian gamesmanship only in the 1990s. <a href="http://en.wikipedia.org/wiki/Partitions_of_Poland">This mirrored an earlier absorption of Poland by the Austro-Hungarian, German, and Russian Empires in the 18th Century.</a> In the 20th Century repeat of this carving up of Central Europe, both Germany and Russia were brutal imperial masters. After the war, Germany took responsibility for its actions, and has served admirably at the center of the European Experiment (the EC/EU) since. Russia, on the other hand, still resents losing territory it had seized when it worked in concert with Nazi Germany to divide Europe. After the war Soviet Russia was allowed to keep the parts of Poland it occupied in 1939, annexing them to the Soviet Union. (They are now part of Ukraine, Belarus, and Lithuania). Indeed Stalin moved all borders West at the end of the war. This historical episode colors the conflicting views on current Russian claims that they should be viewed as liberators by Estonia. The Estonians (and the Baltics in general) remember that independence was first lost when the Soviet Russians made a deal with the Nazis and then invaded. Similarly, Poland remembers that it was the Russians who massacred tens of thousands of Poles in <a href="http://www.geocities.com/katyn.geo/">the Katyn forest</a>. (Gorbachev finally admitted to the massacre only in 1989.) The Russian Army also<a href="http://worldwar2database.com/html/warsaw.htm"> halted its advance on Warsaw</a> to allow the Wehrmacht time to finish killing off the Polish Home Army (55,000 Polish defenders died during the delay) so that they could install a Communist government – waiting 66 days for before they moved back into Warsaw – an occupation that really only ended in the 1990s. The Poles also remember that they were left behind the Iron Curtain when the war ended.<br /><br />So what should Europe do? In theory, the EU represents a deliberate, collective break from a past colored by centuries of European civil war. To be an effective brake on repeated history, it needs to stand together to fight collective tendencies to repeat history. This means the EU15 (and Germany in particular) need to overcome their collective penchant to engage in appeasement, selling out Central and Eastern Europeans to outside bullies. The cyber attack is state sanctioned (if not sponsored) terrorism. If these were UK banks that were being targeted, or French or German trade sanctions, Brussels would be up in arms. If all EU citizens have equal rights, a higher profile protection of its Eastern Members is called for. Russia needs help fighting its own historical deamons. The EU is acting as an <a href="http://www.phoenixhouse.org/National/FamilySupport/familysupport_activeuser.html">enabler</a>. Turning off electronic bank transfers across the Russian border might catch Russia’s attention. Withdrawing all European Union ambassadors, collectively, for consultation, also seems appropriate. Holding joint summits seems inappropriate to me. It is like giving your abusive spouse more money for his next round of binge drinking. If this continues, eventually it will be German and British Banks, Austrian and Italian energy, and demands of a more military and territorial nature.<hr/><br />Further reading<br />(1) <a href="http://www.forbes.com/business/feeds/afx/2007/05/18/afx3735575.html">NATO experts investigate 'well-organised' cyber attacks on Estonia</a>.<br />(2) <a href="http://www.fordham.edu/halsall/mod/1939pact.html">the Molotov-Ribbentrop Pact</a><br />(3) <a href="http://www.phoenixhouse.org/National/FamilySupport/familysupport_activeuser.html">Tough love vs. Enabling of an Abusive Family Member</a><br />(4) <a href="http://www.eubusiness.com/news_live/1179500401.52">Moscow had a hand in Estonia riots, cyber-attacks: experts</a><br />(5) <a href="http://www.neurope.eu/view_news.php?id=73863">Druzhba: The not-so-friendly Russian oil pipeline</a><br />(6) <a href="http://euobserver.com/24/23972">Estonia calls for EU help on Russia embassy siege</a><br />(7) <a href="http://www.guardian.co.uk/russia/article/0,,2070898,00.html">EU protests over Russian attacks on ambassadors</a><br />(8) <a href="http://www.nytimes.com/2007/05/18/world/europe/18cnd-russia.html?hp">‘E-stonia’ Accuses Russia of Computer Attacks</a><br />(9) <a href="http://jurnalo.com/jurnalo/storyPage.do?story_id=34701">Russian response in meat row "insufficient", EU says.</a><br />(10)<a href="http://www.allaboutlifechallenges.org/enabling-and-codependency-faq.htm">Enabling and Codependency.</a><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-619610039798000266?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-9903868126291121412007-05-16T00:06:00.000+02:002007-05-16T03:14:50.478+02:00As long as we are talking about corruption...The European sharks smell blood and are circling. Paul Wolfowitz, President of the World Bank, as of this writing has just received further backing from the Bush Administration. This is possibly a signal that they want him to stand tall as they push him out of the administration's sinking lifeboat. The problem, technically, is the cloud of corruption surrounding the President of the World Bank. This is somewhat problematic, as the World Bank is the OECD's anti-corruption missionary. <br /><br />Someone has to carry the anti-corruption flag, as neither the Europeans, nor the Americans, are up to it. Indeed, as long as we are discussing corruption, it seems to me we should bring up some European cases to balance the scales. For example, can someone explain to me why German Chancellor Gerhardt Schroeder is not in prison? At the end of his term as Chancellor, he negotiated a gas pipline deal with the Russians that, in essence, turned over a bit more of Europe's collective energy security to Russia. He made security concessions to the Russians while representing his country at the negotiating table. According to the International Energy Agency, "<a href="http://www.mosnews.com/money/2005/12/30/iaeagainstpipeline.shtml">the Northern Pipeline will make Germany even more dependent on Russia in terms of gas supplies</a>." Schroeder's government even gave a <a href="http://www.mosnews.com/news/2006/04/02/schroeder.shtml">€1billion guarantee to Gazprom</a>. As a reward, when he retired he switched sides at the table, assuming chairmanship of Nord Stream. This looks to me like conflict of interest. It certainly seems as bad as many things the Bush Administration has done -- like Cheney's handling of the U.S. energy industry's interests. Then again Cheney is not in jail either. However, I am not convinced the Bush Administration deliberately sold U.S. security for profit. Rather it was collateral damage. In Schroeder's case, he quite simply sold German (and European) energy security interests to the Russians, and retired into a high-salaried job working for the other side. In a country obsessed with investigating corporate corruption, I am baffled as to how this one has stayed out of the courts. If the Germans won't do it, maybe the Poles could put him in jail. Yes, a German sold Polish security to the Russians (again...) <br /><br /> Another, more current question, relates to British bribery. Britain belongs to the OECD, and has signed onto the OECD Anti-Bribery Convention. In December, the Serious Fraud Office in Britain closed an inquiry into rather obvious allegations that BAE had paid substantial bribes linked to sales in Saudi Arabia. The Blair government pressed for closure of the investigation (something that surely involved Blair himself) because the investigation "risked jeopardizing relations with the Saudis." In other words, notwithstanding treaty obligations against corruption, when it comes to British defense exports to the Middle East, corruption is ok. This is not over. Since Swiss bank accounts were used to pay the bribes, the Swiss are investigating. The U.S. Congress is also investigating, and may use the issue to block further BAE expansion into the U.S. defense market. In addition, while the Saudi arms deal, known as al-Yamamah and worth an estimated £40 billion, stretched over many years, there are new allegations involving BAE and Saab (yes, even the squeaky clean the Swedes are now caught up in corruption scandals) sales of Griepen fighters. In this case prosecutors from Austria, Britain, the Czech Republic, Sweden and Switzerland are all working on the investigation. So here is a case where a British company, BAE, is having problems with its moral image (if not its behavior -- a decision for the courts). And in this case the British Prime Minister has apparently intervened to extricate the company from a corruption investigation. It has not helped national security, as the company will be punished in OECD markets for its behavior in the Middle East.<br /><br />And while we are at it, in addition to Swedes (Saab), the British Prime Minister, and the former German Chancellor, we can add the former Presidents Chirac of France and Berlusconi of Italy, who both avoided criminal prosecution for corruption by virture of the office they held.<br /><br />This whole epidose is steeped in irony. In retrospect it is clearly ironic that the Republicans, under the Clinton Administration, felt free to go after President Clinton for what was clearly personal behavior problems. This was somehow reprehensible. Under such a standard, it is ironic that the Bush Whitehouse characterizes the apparent rule-breaking of Wolfowitz as somehow ok. If you remember the spectacle of an impeachment surrounding a sexual peccadillo, it is hard to know how to take it when Press Secretary Tony Snow says Wolfowitz "<a href="http://www.alertnet.org/thenews/newsdesk/L15698175.htm">made mistakes</a>," but shouldn't be fired. It is also hard to know how to take it when the European pot calls the American kettle black. Lewis Carrol would approve.<br /><br /><u>Further reading</u><br/><br />1. <a href="http://www.oecd.org/department/0,2688,en_2649_34855_1_1_1_1_1,00.html">The OECD Anti-Bribery Convention </a></hr><br />2.<a href="http://www.iht.com/articles/2007/05/15/business/bae.php">Swiss confirm BAE inquiry</a><br />3.<a href="http://news.monstersandcritics.com/europe/article_1068065.php/Schroeders_Gazprom_pipeline_job_provokes_storm">Schroeder's Gazprom pipeline job provokes storm</a><br />4.<a href="http://www.mosnews.com/news/2006/04/02/schroeder.shtml">Schroeder Govt Guaranteed Credit for Russia’s Gazprom, Report Confirmed</a><br />5. <a href="http://www.mosnews.com/money/2005/12/30/iaeagainstpipeline.shtml">International Energy Agency Speaks Out Against Russia’s Baltic Gas Pipeline</a><br />6. <a href="http://www.expatica.com/actual/article.asp?subchannel_id=25&story_id=39748">Chirac after the presidency</a><br />7. <a href="http://news.bbc.co.uk/2/hi/europe/3630647.stm">Italian PM's fraud trial resumes</a><br />8. <a href="http://www.goenglish.com/ThePotCallingTheKettleBlack.asp">Today's Idiom = "The Pot Calling The Kettle Black"</a><br />9.<a href="http://www.kellscraft.com/throughthelookingglasscontent.html">Through the Looking Glass</a><br />10.<a href="http://tomburka.com/archives2/2007_05.php#001005">Wolfowitz barricades self in World Bank office.</a><br />11. <a href="http://www.comedycentral.com/motherload/?lnk=v&ml_video=86189">The Daily Show spin on the Wolfowitz scandal</a><br /><br />Endnotes:<br /><br /><u>1</u>/ "What sort of things do you remember best!" Alice ventured to ask.<br /><br/> "Oh, things that happened the week after next," the Queen replied in a careless tone. "For instance, now," she went on, sticking a large piece of plaster on her finger as she spoke, "there's the King's messenger. He's in prison now, being punished: and the trial doesn't even begin till next Wednesday: and of course the crime comes last of all."<br /><br/>Lewis Carroll, <em>Through the Looking Glass</em>: Chapter 5 "<a href="http://www.kellscraft.com/throughthelookingglassch5.html">Wood and Water</a><em>", </em>M. F. Mansfield & A. Wessels: New York 1899 .<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-990386812629112141?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-13760269762525618002007-04-16T18:34:00.000+02:002007-04-17T14:40:58.505+02:00Sometimes appearances are everythingThe headlines following the G-7 and World Bank-IMF meetings this last week were not all about global imbalances, the changing role of the World Bank in poverty reduction, growing unease about globalization, or calls for reform of the IMF. No, they have also been focused on the relationship of the president of the World Bank to a former Bank employee, and the manner in which he has handled the appearance of conflict of interest in managing the departure of this romantic interest when he took over at the Bank. Who needs substance, when you can have scandal? <br /><br />If you work for the U.S. government as a civil servant, you need to follow a certain set of rules guiding ethical behavior. If you look closely at those rules, you will find that they do not really proscribe behavior that is unethical. Rather the rules proscribe the appearance of such behavior. I was, at one time, baffled by those rules. They are made by a Congress who generally and explicitly exempt themselves from those same ethics rules (so that they can and do continue to run ethically amok, individually and collectively.) Yet the rules do serve a purpose. For the electorate to have faith in the workings of the government, they must believe it is ethical and fair. An ethical and fair regime populated by career employees that appear corrupt will be crippled in its operations. You can vote out unethical congressman and parliamentarians. A functioning civil service shows much more inertia in terms of (potential and actual) employee turnover. For this reason, it is a necessary though not efficient condition that civil servants appear to be free of corruption, regardless of the tabloid-based entertainment provided by politicians. Indeed, if a politician wants to go after the civil service, he will attack its reputation in this regard individually or collectively (witness Reagan's attack on the U.S. civil service in the 1980s, and the Valerie Plame affair more recently).<br /><br />In a similar vein, international civil servants must also appear operationally honest. This is especially true for the man/woman tasked with running the World Bank. The Bank, among other tasks, has appointed itself a promoter of good governance. It cannot do this, and has no credibility if it tries, under present circumstances. If there is the appearance of corruption around its top employee -- aka Bank President Paul Wolfowitz -- then that employee must go. If he is going to stay, it simply has to be the case that doubts about his ethical character can be fully removed. If they cannot, then regardless of the actual ethical qualities of the situation, he must go.<br /><br />Now maybe the Bush administration is playing a deep game, and their strategy is to attack the World Bank from within by piling it from the top down with corrupt leadership. I do not believe they are capable of actually managing such a game (though if they were they would try). But regardless of whether the present situation is deliberate or accidental, it must end.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-1376026976252561800?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-65956961133814552252007-04-11T21:43:00.000+02:002007-04-11T22:07:54.812+02:00Simplicity -- a screed in two paragraphsI have been reading a recent short book by Timothy Gowers, on mathematics and models and such (<i>Mathematics: a very short introduction</i>). In it he makes a point I agree with: "When devising a model, one tries to ignore as much as possible about the phenomenon under consideration, abstracting from it only those features that are essential to understanding it..." This is from a mathematician effectively explaining that there is a special art in good science, since theoretical models are by definition simplifications and abstractions. I made a similar point in a 1997 book, when discussing partial equilibrium models: "By definition partial equilibrium models do not take into account many of the factors emphasized in general equilibrium trade theory. While this is the root of the practical limitations of applied partial equilibrium modeling, it is also the source of its basic advantage... It may be difficult to justify... more complex and less transparent models, when they may yield only margin extensions of the basic insights drawn from simpler approaches." The critical thing is that good models (theoreical or empirical) offer useful simplifications. Musicians (Charles Mingus: "Making the simple complicated is commonplace; making the complicated simple, awesomely simple, that's creativity." ) and super-mega-geniuses (Albert Einstein: "Everything should be made as simple as possible, but not simpler.") would agree. But apparently not all members of the tribe of trade theorists. Some would, though. Some of my favorite theory papers are by Krugman. His papers can display a brilliant ability to boil down potentially complex and difficult issues to sharp, clear expositional models. His 1980 <i>AER</i> paper on gains from trade, in a world with identical two countries with identical tastes, endowments, and technologies and only one sector, for example, is brilliant. So is his explanation of linkages between productivity growth and the process of job creation and construction, using the example of hot dogs and buns. (from an editorial in <i>Slate</i>). Yes you can make the model in his <i>AER</i> paper more complicated, and subsequent literature has. But the basic point is best seen in a simple structure. <br /><br />So what do you say when referees, and journal editors who should know better, send you letters and reports that basically say "the point you make is clear, and a relevant one, and the model is simple and clear. However, the referees feel you should use a more complicated model...because it will make the theory more interesting"? What? Interesting as in more complicated, harder to follow, with a more circuitous mathematical path to the same basic results? This is definitely where we step out of the realm of math and science, and into the realm of fashion trends and complexity for the sake of complexity. Complexity with the purpose of making what we are doing look too hard and complicated for others to grasp. In terms of models, minimalism (where possible) should be the rule. If it is not necessary, don't build it in. And if your model is too complicated to explain anything with, well... I told you so. Enough said.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-6595696113381455225?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-64854873408860519862007-04-10T09:23:00.000+02:002007-04-11T12:04:58.862+02:00Time for crazy ideas -- part 2 (spaghetti or spiderwebs?)In a previous post, I suggested that we give up on agriculture in order to complete the Doha Round. I want to focus here on the bread-and-butter business of the World Trade Organization -- prospects for negotiations to reduce merchandise tariffs. For the impatient, the punch line is a call for either zero manufacturing tariffs by the OECD on an MFN basis, or else an OECD-based plurilateral agreement in the WTO for zero tariffs in manufactured goods. For the more patient, read on.<br /><br />In the run-up to the NAFTA in the 1980s, the word on the street was that multilateralism was in trouble. More bluntly, the catchphrase was "GATT is dead." Unable to win sufficient points with the EC on agriculture, and the developing world on services, the U.S. focused instead on a bilateral strategy. An important added ingredient in the policy mix was the belief that a major Asian trading partner (Japan) was unfair and kept its currency low to promote exports. So the U.S. turned to its neighbors -- Canada and Mexico. Intellectually, we had Jagdish Bhagwati condemning NAFTA and Paul Krugman selling the idea of strategic trade policy. In fact, this does not sound so different from the present day. Yes, the EC was smaller than the EU. And yes the U.S. Congress is railing against China instead of Japan. Yet multilateral trade negotiations in Geneva are again stuck, and impatient negotiators are working on relatively easy bilateral agreements to take their minds off the impasse in Geneva. The U.S. has signed a deal with Korea, while the EU is busy negotiating with Korea as well. Asian parties are also talking (again) of regional solutions --though so far this has been dominated by bilateral agreements. The web of bilateral and regional agreements grows increasingly complex.<br /><br />There are important differences between the previous dance of regional agreements on the grave of multilateralism, and the current one. The spider's web of regional agreements now in place has done serious damage to the basic non-discrimination principle of the trading system. (This is commonly referred to as a spaghetti bowl rather than a web, usually as in "Prof. Jagdish Bhagwati has called this the Spagheti bowl..." Sorry, but I do not think a bowl of pasta sounds sufficiently sinister. So, since this is my space, I will use the spiderweb metaphor...) When the GATT was set up, a founding principle was the idea that small countries should be treated as equal to big ones, so that there would be no side deals that might lead to a repeat of colonial trading empires or to unbalanced (and unfair) negotiations between unequal partners. Any pretension that this is still the case is gone. The EU now actively uses preferential trading arrangements (can we call this a neo-colonial trading system yet?) to push its agenda in developing Africa, while the U.S. now routinely incorporates trade deals in its geopolitical maneuvers. In this way the US tries to tie Jordan and Egypt and Central America with commercial bindings. With the exception of a few of these agreements, none, individually, really matter much for the U.S. and EU. Trade agreements with Botswana and Jordan and Costa Rica and Israel are not going give a big boost to the economies of Europe and North America. Rather, the logic is geopolitical. In the Cold War era, the OECD Members all saw a global trading system as an important strategic asset in keeping the west united against the communist threat. Clearly, this no longer holds. The result is the use of free trade agreements to cement bilateral political deals. This has led, predictably, to FTA burnout. The U.S. Congress is tired of the recent string of regional trade agreements. They cost political capital to support, and the economic benefits are not all that big. Similarly, while the European Commission pushes ahead with regional agreements, the European electorate also appears to suffer from globalization burnout. And we clearly do not have a Bill Clinton to drive the GATT/WTO negotiating round home this time around.<br /><br />In a sense, the irony of trade as a geopolitical tool in the Cold War was that trade was removed in an important way from the political arena. I do not mean that it was not a political issue. Rather, the push for a broad multilateral system coincided with post-World War II efforts to dismantle bilateral trading systems that were an offspring of old colonial empires. It also meant that the U.S. perceived its foreign policy interest to include promoting liberal trade regimes. So trade was less bilateral (and so less a tool of bilateral and partisan dealings.) The non-discrimination clause of the GATT was important here. It helped to prevent a slide back into the economic underpinnings of centuries of trade-based military conflict involving European commercial empires. (Just think of the Dutch and British wars in the Indies, the Opium War, the British and French Wars, everyone looting the Spanish empire, Japan and its East Asian Co-prosperity Sphere vs the West, England in the Indian subcontinent, &tc &tc). Given the apparent long-run historical implications of bilateralism, we should be worried by its vigorous revival.<br /><br />The Doha Round is supposed to promote the interests of developing countries. Negotiators have tried to follow past GATT negotiating rounds, with the adoption of a tariff cutting formula. Yet, it is proving almost impossible to fit a formula to the varied tariffs of developed and developing countries. In addition, our spider's web of regional agreements (ok, you can call it a spaghetti bowl) has created conflicting incentives for developing countries. This system helps some countries by discriminating against others. In many cases it helps the poor by hurting the not-quite-as-poor. It also confuses matters with complex requirements for rules of origin. These are necessary because, given an FTA, there is otherwise a risk of transshipment. There is evidence that rules of origin prevent takeup up notional trade preferences, or at least impose costs that eat significantly into their benefits.<br /><br />There may be a simpler way to move forward, without the need to balance formula coefficients across North and South. It is time for the high-income countries to simply declare zero tariffs for all manufactured goods. In one step, this would present a maximum concession to developing countries, eliminate entirely the need for rules of origin, and greatly simplify the administrative costs of doing trade. It would also undo recent damage linked to FTAs, preferential North-South deals, and the return of bilateralism. Most multinational firms in the OECD (computer manufacturers, motor vehicle manufacturers, &tc) would embrace such a simplifiction of the rules they face. Indeed this is exactly what happened with the Information Technology Agreement. It started with 29 members, and now has 70, covering 97% of trade in information technololgy products. A similar approach could be followed collectively across the OECD either simply as binding commitments, or perhaps as a plurilateral agreement. (A plurilateral agreement would be one that applied to all signatories.) The advantage of a plurilateral is that simple conditions could be set for developing countries (such as flat tariffs in a band of 8 to 10 percent, for example, with a schedule for reduction) to immediately sign on, and to realize benefits today from a concrete commitment to rationalize their own policies tomorrow. It would also take the wind out of the sails of conspiracy theorists that argue that poor countries are poor because of OECD protection. (As an aside, most import protection against developing countries is imposed by other developing countries.) Such an approach could set in motion a tremendous, relatively automatic rationalization of trade rules. Unlike bilateral agreements with small countries and city-states, such an agreement would be worth spending political capital in Washington or Brussels to promote.<br /><br />But what about all the fans of FTAs? How would they feel about such a WTO-based approach. In a sense, this is one logical path mapped out by the intra-OECD FTAs that now include, in various combinations, the U.S., Canada, Mexico, Korea, Australia, and New Zealand. Indeed, one could pitch this when necessary as a super-FTA, with pre-defined membership criteria. They could have their FTAs and the WTO too.<br /><br />Further reading:<br /><ul><br /> <li>"<a href="http://blogs.ft.com/wolfforum/2007/04/a_koreanamerica.html#comments">Comments in the Financial Times on the U.S.-Korea FTA.</a>," M. Wolf, J. Bhagwati, F. Bergsten, A. Sapir, D. Vines, and more leading characters in this drama. There is even a bit of he-said she-said between Bhagwati and Bergsten. This is good stuff! </li><br /> <li>"<a href="http://www.ft.com/cms/s/adb840b4-e636-11db-9fcf-000b5df10621.html">America's Bilateral Battle Against Free Trade,</a>" J. Bhagwati on the real risks posed by the emphasis on regionalism instead of multilateralism, Financial Times, April 2007.</li><br /> <li>"<a href="http://www.pkarchive.org/trade/WhosAfraidofTradeWar.html">Who's Afraid of an All-Out Trade War? We'll Do Okay if Push Comes to 'Shove Off'</a>," P. Krugman on the joys of trade wars circa 1990 (or as Peter Sellers would say, "how I learned to love trade wars...") </li><br /> <li>"<a href="http://www.columbia.edu/~ap2231/Policy Papers/overview-we(1).pdf">The Regionalism Debate: An Overview</a>," A. Panagariya, published in <em>World Economy</em>, June 1999, 477-511.</li><br /> <li>"<a href="http://www.columbia.edu/~ap2231/Policy%20Papers/Foreign%20Policy_Protection%20in%20Developing%20Countries.pdf">Liberalizing Trade in the Developing Countries</a>," A. Panagariya, takes apart the neo-protectionist arguments in the antiglobalization/NGO school of thought, published in <em>Foreign Policy</em>, September/October 2005. </li><br /> <li>"<a href="http://ideas.repec.org/p/dgr/uvatin/20050073.html">Preference Erosion and Multilateral Trade Liberalization</a>," J. Francois, B. Hoekman and M. Manchin, final version published in <em>The World Bank Economic Review</em> 2006 20(2):197-216. Takes a critical look at how much scope there really is for preference erosion, and quantifies rules of origin costs in the context of EU preference schemes. </li><br /> <li>"<a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=964161">Clothes Without an Emperor: Analysis of the Preferential Tariffs in ASEAN</a>," M. Manchin and A. Pelkmans, 2007. Offers evidence that Asian tariff preferences have largely been a farce, eroded almost completely by rules or origin and related compliance costs. </li><br /></ul><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-6485487340886051986?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-78736368853694226122007-02-27T01:05:00.000+01:002007-02-27T01:18:56.130+01:00The Trade Deficit and the Politics of MisdirectionThe political class in Washington is becoming increasingly agitated about the U.S. trade deficit... again. The reaction is to blame Europe, Japan, and China. We have House of Representatives Speaker Nancy Pelosi and her team saying, "We ask you again to join us and develop a meaningful action plan that addresses the burgeoning deficit" in <a href="http://edition.cnn.com/2007/BUSINESS/02/13/us.tradedeficit.reut/">a letter to President Bush</a>. We have blogs trolling through past episodes of <a href="http://www.truthabouttrade.org/article.asp?id=7097">U.S. deficit panic</a>. We have been here before. Well, maybe not here, but in a frighteningly parallel universe version of here, with ballooning trade deficits, large budget deficits, and general panic in Washington. Yet past episodes usually involved a high dollar making imports cheaper and exports uncompetitive. Real U.S. exports are actually up 25 percent since 2001. As a percent of GDP, they are also up from 10.2 percent to 11.1 percent of GDP since 2001. In contrast, when the trade deficit surged between 1991 and 1994, the dollar was up 22 percent. At the moment it is down by a comparable amount between 2001 and 2006. While things are similar, superficially, to recent past deficit scares, they are also different in important ways. <br><br /> The situation is at once deceptively simple, and yet quite complex. From national income identities, a growing deficit "squeezes" GDP. Throw in some mindless accounting, and you can argue that it costs jobs. Throw in a video camera as well, and some air time on CNN, and you have the Lou Dobbs show. (No I am not going to link to mind candy. Google it yourself). Yet things are not so simple. The U.S. has an unsustainably low national savings rate. The IMF projects that the U.S. may borrow 7 percent of GDP in 2007. In part, (and technically by definition) this is what drives the growth of the trade deficit. Congress should be asking itself if, as policy, the U.S. should feel comfortable borrowing 7 percent of GDP, given that it will need to borrow even more (publicly or privately) to fund surging retirement and health care benefits in the immediate future.<br><br /> It is also informative to work the numbers a bit, and deconstruct the surging deficit. An obvious candidate is inflation. If we look at the deficit in constant dollars (you can <a href="http://www.bea.gov/international/index.htm#bop">download these from BEA in 2000 dollars</a>), the trade deficit since the Bush White House took over in 2001 has grown by one-third. Another 10 percent of the nominal growth is due to a general increase in U.S. prices. So roughly one-quarter of the growth is simply inflation. Another force driving the nominal deficit growth is linked to the drop in the dollar. On a trade-weighted basis, the <a href="http://www.federalreserve.gov/releases/h10/summary/">Federal Reserve's nominal broad dollar index</a> has fallen by about 14 percent since 2001. This is despite the broad Asian peg to the U.S. dollar. Against the euro, the dollar has lost more than 35 percent. On this basis, in foreign currency terms, another third of the surge in the deficit is clearly linked to exchange rate changes. The same imports cost more. The ironic thing here is that the move in the dollar -- down -- should be helping the trade deficit, all other things being equal. However (and this is the proof that we have not really been here before despite the déjà vu) the currency is being driven this time by the same forces driving the trade deficit itself. The U.S. wants to borrow increasingly more money. There apparently is not sufficient growth in the supply of credit from our collective foreign bankers. So.... mathematically something has to budge. Since the U.S. borrowing spree has refused to budge, the solution in the market has been to drive down the dollar, so that the same foreign currency-denominated credit goes farther in dollar terms. You can borrow more dollars when they are worth less. The remaining growth in the deficit, about one-third of the total nominal growth, can be linked to rising oil prices and growing U.S. demand for foreign credit.<br><br />So, in a roundabout way, I agree with the Democratic leadership of the U.S. Congress. Something needs to be done. That something includes a more economically literate discussion of the issues. The American public does not need populist economic rhetoric. The growth in the deficit is large, but not as large as advertised in the current round of speeches, and not for the reasons cited. In real terms, most of the growth has been driven by the surge in U.S. collective borrowing, combined with high oil prices. Any real policy debate should therefore start with U.S. borrowing (federal, state and local, and private) and the reasons for rising oil import bills. Beating up on China, the EU, and Japan is a sideshow at best -- populist rhetoric. The Euro has appreciated by roughly 50 percent against the dollar (the flip side of the dollar falling by 35%) since 2001. What are they supposed to do exactly? The Asian peg is a problem, but the U.S. needs to be very careful how it unwraps that particularly complex web of excess global liquidity (from Japan's implicit support of the massive Yen carry trade) and U.S. need for more and more buyers in domestic bond markets. Discussion on budget (not trade) deficits and energy policy would be a constructive response to the deficit. Beating up on trading partners is not. </p><div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-7873636885369422612?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-39173998462311455262007-01-27T00:22:00.000+01:002007-01-27T20:37:02.456+01:00We know the weather reports are wrongWe have an innate desire to know what will happen. It can manifest itself in the form of very practical questions related to technology and applications of physics and biology, like "if I sharpen this stick, and throw it at one of those mammoths, can I feed my family with it?" Questions can be strategic in nature, like "if I invade Persia with my legions, will I win?" Big questions at the moment include "if we continue to pour carbon into the atmosphere at current rates, are we doomed?" and "if we increase our commitment of troops in Iraq, will we be reelected?" The path to answers has ranged from the scientific method to scapulimancy, computer simulation of prototype machinery, eminent study group reports, the I Ching, consultation of sacred texts or oracles, business forecasts, and climate change models. At one level, all of these represent a genuine effort, given beliefs and available technology, to discern the future. Depending on your cultural predispositions, some of these methods are preferred to others. For those that belong to the tribe of Aristotle and Bacon, the drive to understand has led us to a combination of formulating theories about cause and effect, and confronting them with experiment and mathematics.<br> <br />In an uncertain world, what is the role of scenario or policy studies? I include here macroeconomic forecasts, as well as climate change models and the recent hybrid of the two -- studies of the economic consequences of climate change. <br><br /> An important example now in play at the monent is the <a href="http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm">Stern Report</a>. The report offers us a synthesis and interpretation of available climate and economic simulation modeling. There has been heated discussion in editorials and blogs (see <a href="http://www.realclimate.org/">the RealClimate blog</a>) about the quality of these estimates. If the report is correct, then inaction in the face of rising levels of global warming and greenhouse gasses implies very high opportunity costs relative to the alternative path of corrective behavior. If it is wrong, corrective action can be a costly mistake. <br><br /> What is the function of an inherently political report on economic and climate forecasts? For that matter, what is the function of the broader family of forecast and simulation-based policy studies? At one level, they are certainly meant to quantify the issues at hand. Viewed in this way, it really is important that the numbers be right. If we are going to make decisions, we want accurate forecasts. This seems to be the spirit behind much of the critical economic discussion (dissection?) of the <a href="http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm">Stern Report</a>. Did we get interest rates (i.e. the discount rate for future costs and benefits) correct? (Jane Galt offers a <a href="http://www.janegalt.net/archives/009585.html">good discussion of the discount rate issue</a>). Are underlying assumptions about the trajectory of technical change correct? (See <a href="http://news.bbc.co.uk/2/hi/science/nature/6295021.stm">"Running the rule over Stern's numbers</a>," BBC). Is opportunity cost calculated correctly?<br><br /> This discussion and criticism is important, especially if the purpose of the forecasting study really is to accurately forecast. Indeed, from this starting point, the criticism of the Stern Report has been quite harsh. Richard Tol, from Carnegie Mellon University, is quoted by BBC4 saying "There is a whole range of very basic economics mistakes that somebody who claims to be a Professor of Economics simply should not make...Stern consistently picks the most pessimistic for every choice that one can make. He overestimates through cherry-picking, he double counts particularly the risks and he underestimates what development and adaptation will do to impacts." These criticims are from people who believe climate change is happening, and that something needs to be done. At one level, the criticims are valid. However, I think many of the critics have missed the point of the study. The purpose the study is not really to get an accurate prediction of exact economic costs 30 years from now. Rather, the purpose of the report is to serve as a focal point for discussion, and to provide a broad sense of alternative directions and magnitudes. It is a policy study, and hence by definition is something of a straw man. The discussion it fosters will most certainly discard many of the premises of the study, and will move in directions not covered in the original forecasts and estimates. This is ok. The role of policy studies (even when the economics are sloppy) is to serve as starting points for discussion by creating a structured, rational inventory of our uncertainties. The Stern Report creates a space for constructive argument. Arguably, reports by oracles and high priests have served a similar purpose in the past. In this sense, they are all important and useful, even if wrong. <br><br /> To illustrate the point, I am going to quote Kenneth Arrow out of context. In a very personal, worldview discussion of uncertainty and the hopelessness of accurately modeling what will happen in the real world of markets, Arrow offers the following anecdote from World War II:<br><br /> '<em>'Some of my colleagues had the responsibility of preparing long-range weather forecasts, i.e., for the following month. The statisticians among us subjected these forecasts to verificiation and found they differed in no way from chance. The forecasters themselves were convinced and requested that the forecasts be discontinued. The reply read approximately like this: ' The Commanding General is well aware that the forecasts are no good. However, he needs them for planning purposes.' </em>'' <sup>[<a name="id394062" href="#ftn.id394062">*</a>]</sup> <br><br /> Arrow's point is that, at one level, the weather reports really were useless because they were wrong. Yet he then goes on to say that <em>"Accuracy of prediction is a desirable aim, but it is not the only aim of economic theory. As in meteorology, understanding is possible, desirable, and useful even when predictability is very limited</em>." Like CGE studies of trade policy, finance ministry and Congressional Budget Office budget forecasts, and military plans, we know the precise estimates in the Stern Report will prove wrong. This does not preclude their usefulness for policy debate.<br><br /> We stress accuracy and statistical robustness when we teach econometrics and modeling. We also get bogged down in debate on the merits of observation vs. simulation. Maybe, in paying attention to the accuracy of the art, we sometimes lose sight of its purpose. Accuracy is not the only important function of forecasting and numerical modeling. It may also be to create space for constructive argument. We need policy studies for planning purposes.</p><br><br /><u>Further reading</u>:<br><br />1. The <a href="http://www.hm-treasury.gov.uk/independent_reviews/stern_review_economics_climate_change/sternreview_index.cfm">Stern Report</a>.<br />2. The BBC4 report, <a href="http://news.bbc.co.uk/2/hi/science/nature/6295021.stm">"Running the rule over Stern's numbers</a>".<br />3. "<a href="http://volokh.com/posts/1169820012.shtml">BBC Finds Stern Report Wanting</a>", (The Volokh Conspiracy)<br>4. Robert Mendelsohn's "<a href="http://www.cato.org/pubs/regulation/regv29n4/v29n4-5.pdf">A Critique of the Stern Report</a>"<br>5. The <a href="http://www.realclimate.org/">RealClimate</a> blog.<br>6. Jane Galt's discussion on <a href="http://www.janegalt.net/archives/009585.html">the discount rate issue</a>.<br /><br /><hr><br /><sup>[<a name="ftn.id394062" href="#id394062">*</a>]</sup> K. Arrow (1992), "I Know a Hawk From a Handsaw," in M. Szenberg, editor, <em>Emminent Economists: Their Life Philosophies</em>, Cambridge University Press.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-3917399846231145526?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.comtag:blogger.com,1999:blog-4241064177769392452.post-89486064113752850422007-01-19T19:10:00.000+01:002007-01-20T19:08:25.701+01:00ECON 101 -- Opportunity Costs (a transatlantic tale of guns and butter)In introductory economics classes, one of the first basic concepts we cover is <i>opportunity cost</i>. <a href="http://en.wikipedia.org/wiki/Opportunity_cost">Wikipedia defines opportunity cost</a> as "the cost of something in terms of an opportunity forgone (and the benefits that could be received from that opportunity), or the most valuable forgone alternative (or highest-valued option forgone), i.e. the second best alternative." This definition is ok as far as it goes. The challenge in the classroom is to find examples that students can easily grasp. In older U.S. textbooks, the long shadow of the Vietnam War meant that the example was typically guns and butter. Another classic student examples is "pizza and beer." To update these examples, I offer here both a European and U.S. spin on the concept, based on things the typical undergraduate has probably heard about through the European and North American news services. My modest hope is that, with examples like this, students might better understand the opportunity costs of public policy and expenditures.<br><br /><u>A U.S. example -- The Iraq War</u><br><br />The <a href="http://www.nytimes.com/2007/01/17/business/17leonhardt.html?hp&ex=1169096400&en=7b447527f13af5dd&ei=5094&partner=homepage">New York Times</a> and <a href="http://www.iht.com/articles/2007/01/16/business/leonhardt.php">International Herald Tribune</a> recently published estimates that place the cost to the U.S. of the War in Iraq at approximately $1.2 trillion dollars. This offers, of course, a classic chance to ask "what if..." along the lines of the old Vietnam War era examples. I have done some price checking on a list of items -- NASA's manned Mars proposal, the price of Hummers, and the total value of income by U.S. State. Based on these, we can scale the $1.2 trillion spent as follows:<br><br /><li> We could fund the <a href="http://www.usatoday.com/news/science/2004-01-14-bush-space_x.htm">proposed NASA manned and unmanned Mars program ($120 billion)</a>, and have enough money left over for 9 International Space Stations (with full funding of operating costs -- <a href="http://en.wikipedia.org/wiki/International_Space_Station#Overall_ISS_costs_for_NASA">$120 billion</a> each).</li><br /><li>We could <a href="http://www.thespacereview.com/article/221/1">permanently colonize the moon ($50 billion) and Mars ($1 trillion.)</a>.</li><br /><li>We could <a href="http://www.hummer.com">buy 44 million brand new H3 hummers</a>. This is enough for 7 out of every 10 married couples in the United States. It is also enough for every adult in California, New York, and Texas.</li><br /><li>We could buy everything, goods and services (i.e. <a href="http://www.bea.gov/bea/newsrel/gspnewsrelease.htm">state GSP</a>), produced by the U.S. plains states (Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, South Dakota) and the New England states (Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, Vermont) for an entire year -- and throw it away.</li><br /><li>We could by all the U.S. manufacturing output in all 50 states (cars, trucks, laptops, jetskis, microwave ovens, 747s, again based on <a href="http://www.bea.gov/bea/newsrel/gspnewsrelease.htm">state GSP</a>) manufactured in the United States for an entire year -- and throw it away.</li> <br /><br /><u>A European example -- The <a href="http://en.wikipedia.org/wiki/Common_Agricultural_Policy">Common Agricultural Policy</a></u>:<br><br />A more peaceful example of costs involves the EU's Common Agricultural Policy (the CAP). The European Commission spends roughly $65 billion (<a href="http://en.wikipedia.org/wiki/Talk:Common_Agricultural_Policy#Size_of_budget">€50 billion</a>) a year on subsidies to farmers. This has, naturally, been a highly controversial subject in European politics. Over a ten year horizon, the annual costs work out to only $650 billion. This is only half the projected cost of the Iraq War. Working within this budget, Europe could have done the following instead:<br><br /><li> <a href="http://www.thespacereview.com/article/221/1">Colonize the moon ($50 billion)</a> and split the cost with the U.S. to <a href="http://www.thespacereview.com/article/221/1">colonize Mars ($500 billion for half)</a>.</li><br /><li> Buy the <a href="http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)">entire output of Denmark, Ireland, and Finland</a> for one year (goods and services). </li><br /><li> Buy all the outstanding shares in IBM ($120 billion), Boeing ($70 billion), Daimler-Chrylser ($63 billion), and General Electric ($392 billion), based on market valuation on 19 January 2007 (according to <a href="http://finapps.forbes.com/finapps/jsp/finance/compinfo/CIAtAGlance.jsp?tkr=dcx">Forbes</a>). </li><br /><li> Increase gross domestic expenditure on R&D by 25% a year. This assumes EU27 GDP is $13.4 trillion, the CAP costs $65 billion a year. It also uses the official <a href="http://epp.eurostat.ec.europa.eu/portal/page?_pageid=1996,45323734&_dad=portal&_schema=PORTAL&screen=welcomeref&open=/&product=STRIND_INNORE&depth=2"> Eurostat estimate</a> that total R&D spending in Europe is 1.84% of EU27 GDP.</li> <br />Public policy involves tradeoffs, and this implies that to do some things, we use resources that might have been used to do something else. This holds as much for governments and countries (and humanity) as it does for individuals and households. This is an important lesson to keep in mind.<div class="blogger-post-footer"><img width='1' height='1' src='http://res1.blogblog.com/tracker/4241064177769392452-8948606411375285042?l=www.intereconomics.com%2Fblogs%2Fjff%2Fblogger.html'/></div>Joe Francoishttp://www.blogger.com/profile/17691835657248892767noreply@blogger.com