Sanctioning Russia vs Sanctioning Putin's Coalition

An article from last week in the Christian Science Monitor looks at the possible effects of economic sanctions on Russia. It contrasts Russian claims that sanctions will rally people around Putin and spur greater self-sufficiency with analysis by economists who say that sanctions could send Russia into a recession and put pressure on Putin to compromise. However, both these views assume that the Russian government is motivated by concerns about the general welfare of the nation.

An alternative view would be to look at Russia through the lens of Selectorate Theory and ask what does Putin actually need to do to survive in office? Is Putin a leader who depends on a large coalition to stay in office and thus must provide good public policy to satisfy the coalition and keep his job? If this was the case, the threat of a recession would be troubling to Putin and he would both need the "people" to rally around him  and to take steps to mitigate any bad effects from the sanctions lest these same people abandon him.

Alternatively, Putin may depend on a small coalition of essential supporters to stay in office and, therefore, needs to provide private benefits to these supporters. In this case, the opinion of the public and general health of the economy would be at best secondary concerns. Putin's primary concern would be to make sure that his supporters continue to receive the private benefits upon which their support is based and to make sure that no one is in a position to offer them a better deal than they have with him. As long as he does that, the economy can go to hell and the Russians on the street can think whatever they want, short of overthrowing the whole system.

Of course, it is the second case we are dealing with here. While Putin probably depends on a larger coalition than he would like, it is clear that he stays in office by virtue of a system of private benefits doled out to essential supporters. The notorious cost overruns and performance shortfalls of the preparations for the Sochi Olympics should make it clear that government performance is not the basis for Putin's power.

Therefore, the effects of any sanctions on the Russia economy are far less important than the effects on Putin's ability to put money in the pockets of his essential supporters. Therefore, it does make sense to try to target individuals as the US and EU are doing. But hitting these supporters in the pocketbook will only be effective if Putin is unable to make good their losses (supposing there are losses in the first place) with other additional benefits.

Even if the economy goes into a severe recession, Putin will probably be able to channel enough money to his key supporters as long as the oil and gas revenues continue to roll in. Indeed, all the talk about making the economy more self-sufficient suggests that there will be many opportunities for the government to intervene in the economy in the name of resisting Western pressure. We should expect such interventions, such as investments in agriculture, to be geared towards enriching cronies more than improving economic performance.

Frankly, it is hard to see Putin's power being threatened by anything less than a significant reduction in oil and gas revenue. In the short term, this would only occur if the EU boycotts Russia gas and oil or if fighting in Ukraine broke out that physically disrupted Russia's supply lines. Of course, this will probably act as a significant deterrent to all parties involved. However, because everyone is mutually deterred, there will be plenty of room for low levels of conflict such as we are seeing.

In the long run, there may be a more credible threat to Russia's oil and gas revenues if Europe is able to find other suppliers. The problem here is that the pipelines through the Ukraine supply so much oil and, especially, natural gas, that it is currently impossible to replace the quantities supplied by Russia with similar quantities from other sources. Natural gas in particular is difficult to ship by sea and there is a dearth of tankers with which to do it.

However, capacity can be built. The Baltic states and Poland have started building port facilities to allow liquefied natural gas (LNG) to be imported from overseas. Of course, this gas has to come from somewhere. If only there was a nation with vast natural gas reserves that was currently not exporting LNG and could step into the breach...

Wait, that's us, as in the US. The US has a surplus of natural gas and has not been exporting any of it. Sadly, that also means that we are lacking in export facilities to do so and it will take years to get such facilities up and running. So, while there have been efforts in the US government to expedite the approval of exports, this really is a long term fix.

Even so, the future casts a shadow over the present and, if Putin and his supporters see a future threat to their take from the oil revenues, they may take a more moderate stance. Therefore, if the US starts to move more quickly on approving exports of gas and oil (and building the facilities for doing so) while European nations (particularly Germany)  invest in import facilities, it may have an effect on Russian actions. Consider it the economic equivalent of sending a few hundred troops to Poland.

John Mueller's "Overblown"

John Mueller was one of my professors when I was a graduate student at the University of Rochester and he always put me on my toes by questioning things that seemed to be self-evidently true. In Retreat From Doomsday, he questioned whether nuclear weapons were responsible for the peace (or lack of major war) between the US and Soviet Union. While they may have helped in this, he questioned whether the US and USSR actually would have gotten into a major war if nukes had not been invented and argued fairly convincingly that it was unlikely.

In a paper he wrote in 1991, he examined claims that the attack on Pearl Harbor was a military disaster. He argued that,if  by disaster one means something that significantly undercuts the nations ability to fight the war,  the attack on Pearl Harbor was more of a temporary setback than a military disaster. By looking closely at the data, he showed that the losses from the attack were quickly made up by the rapid mobilization in the US. Indeed, he argued the primary effect of the attack was to spur such a backlash against Japan that it ended up being more of a military disaster for them than for the US. He also dared to question whether the all out war on Japan was a good thing for the US. Could the Japanese have been handled with less force and loss of life on the US side? Would the US have been better off focusing more of its effort the larger threat of Nazi Germany while simply containing Japan?

Questions like these always put me in mind of Socrates, who angered the citizens of Athens by questioning things they "knew" to be true. In the words of Plato, they complained that Socrates was always making "the weaker argument the stronger", and this is one reason they sentenced him to death for corrupting the youth of Athens.

Mueller's 2006 book Overblown: How Politicians and the Terrorism Industry Inflate National Security Threats, and Why We Believe Them followed in this tradition. John dared to question whether we might be overreacting to the events of 9-11.  He noted that, even with the numbers from 9-11 included, the number of Americans who had died in terrorist attacks since 1960 was about the same as the number that had died in lightning strikes, accidents involving deer, or from peanut allergies. As for the prospect of terrorists using weapons of mass destruction, he noted that the 9-11 hijackers had used nothing more complex than box cutters and that the attacks would suggest that the real threat was from people use craft to turn ordinary objects into deadly weapons.

Moreover, there was nothing particularly new in this. Aircraft and skyscrapers had been around for a long a time and Mueller argued that a determined and lucky band of terrorists might have been able to sink a passenger ship like the Titanic and kill thousands of people. One might add that Timothy McVeigh was able to combine fertilizer, diesel fuel, and a rental truck to make a massive bomb. So why the sudden concern and dire predictions of  a new age of terrorism?

Of course, the answer partly lies in the public shock created by the events.  However, what interests John is the reaction to the shock. Mueller argues that, when surprised, governments are sometimes prone to overestimating the new threat and  overreacting to it. In 2006, Mueller previewed his argument in a Cato Unbound post. He wrote:

Unpleasant surprises very frequently, though not always, lead to two responses that are serially connected and often prove to be unwise. First, the surprise is treated not as an aberration, but rather as a harbinger indicating that things have suddenly become much more dangerous and threatening, will remain so, and will become worse, an exercise that might be called “massive extrapolation.” And second, there is a tendency to lash out at the threat without a great deal of thought about alternative policies including and especially ones that might advocate simply letting it be.

In his book, John looks at several examples of massive extrapolation and overreaction by the US. Given the comparisons to 9-11 and Pearl Harbor that were being made at the time, and his previous research on the Pearl Harbor attacks, it was perhaps inevitable that John would start there. Unfortunately, this led to a lot of push back, as occurred in a Fox News interview with Hannity and Colmes. Mueller is making a very nuanced argument that the US vastly overestimated Japanese capabilities after Pearl Harbor, not that the US should not have fought Hitler. Also, Muller argues that not every threat is another Hitler and that most of the current threats in the international system are windbags compared to the likes of Hitler and Stalin.

Indeed, the stronger parts of Mueller's book are those in which he looks at threats that never amounted to much but were touted as dire by analysts, such as the US-Soviet missile gap. John also traces a long lineage of "devils du jour", such as Libya's Khaddafi and Indonesia's Sukarno, who were portrayed as threats to the US. Mueller notes that there is a tendency among intelligence experts to identify threats 5-10 years in the future, a timeline which seems near enough to be threatening but is far enough in the future to make comparison  of predictions and outcomes difficult. John digs up many of these 5-10 year predictions and finds that they tend to be woefully inaccurate.

Getting back to the question of whether post-9/11 assesments of the threat were accurate, Muller and Mark Stewart wrote an article for International Security entitled "The Terrorism Delusion." They note that, despite all the intelligence gathered  on Al-Qaida, there is no evidence that they had an active WMD program or anything like the 5,000 sleeper agents in the US that so many analysts were worried about. Looking at the historical data, they calculate that US citizens have a 1 in 3.5 million chance of dying in a terrorist attack.

They also identify all the 50 known cases of terrorist plots in the US. They find a sharp divergence between the terrorists the government describes as a threat and the ones that actually try to carry out an attack.

In 2009, the U.S. Department of Homeland Security (DHS) issued a lengthy
report on protecting the homeland. Key to achieving such an objective should
be a careful assessment of the character, capacities, and desires of potential terrorists
targeting that homeland. Although the report contains a section dealing
with what its authors call “the nature of the terrorist adversary,” the section
devotes only two sentences to assessing that nature: “The number and high
profile of international and domestic terrorist attacks and disrupted plots during the last two decades underscore the determination and persistence of
terrorist organizations. Terrorists have proven to be relentless, patient, opportunistic,
and flexible, learning from experience and modifying tactics and targets
to exploit perceived vulnerabilities and avoid observed strengths.”

This description may apply to some terrorists somewhere, including at least
a few of those involved in the September 11 attacks. Yet, it scarcely describes
the vast majority of those individuals picked up on terrorism charges in the
United States since those attacks. The inability of the DHS to consider this fact
even parenthetically in its fleeting discussion is not only amazing but perhaps
delusional in its single-minded preoccupation with the extreme.

In sharp contrast, the authors of the case studies, with remarkably few exceptions,
describe their subjects with such words as incompetent, ineffective, unintelligent,
idiotic, ignorant, inadequate, unorganized, misguided, muddled,
amateurish, dopey, unrealistic, moronic, irrational, and foolish. And in nearly
all of the cases where an operative from the police or from the Federal Bureau of
Investigation was at work (almost half of the total), the most appropriate
descriptor would be “gullible.”

 

Terrorism in Civil Wars

Most scholarship on terrorism finds that terrorism is not particularly effective. Engaging in acts of terrorism usually means that the group responsible doesn't have long to exist. In general, groups like the Tamil Tigers and  Al-Qaida are the exception not the rule.

Jakana Thomas posted an article on the Monkey Cage based on her research into terrorism in civil wars which suggests that terrorist attacks may encourage the government to make more concessions when negotiating with rebels. She notes that this result largely depends on the context, i.e., that there is a civil war going on and that the government is negotiating with the rebels (something that is not universally the case).  As she puts it:

When both terrorism and counterterrorism inflict massive costs on civilians, the population is left with a choice of two bad options. Given that preexisting grievances are likely to have facilitated rebels’ mobilization efforts in the first place, governments are doubly likely to lose in such a contest. For these reasons, governments should be expected to pursue negotiated settlements to stop the pain caused by terrorism and to strike deals while their bargaining positions still permit favorable deals. New research by Reed Wood and Jacob Kathman similarly demonstrate that victimizing civilians may help groups achieve desirable outcomes in civil wars.

While a possible interpretation of these findings would suggest that terrorism helps groups “win” in war, it is important to note that the effects of terrorism are largely contingent upon a government’s response to it. If governments avoid feeding into terrorists’ strategies and instead engage in sound counterterrorism practices, they may be able to stymie the growth of terrorists (or at least not aid it). By offering protection and resisting the urge to use violence against civilians when responding to terrorists, governments should be able to undermine terrorists’ ability to undermine them.

Another way governments might deal with the problem is by finding effective ways of ending civil wars once they start. If governments resolve their conflicts, terrorists lose their power to hurt as war provides the context in which terrorism can work. As much as terrorism is a problem, a government refusing to seek peaceful settlements is also a problem. By dealing with the latter, governments can also address the former and resist “rewarding bad behavior.” Providing concessions to civilians or even more moderate armed groups in society, for example, may do enough to limit some of the aforementioned effects of terrorists’ strategies.

When less is more in fighting terrorism

NYPD recently announced that it was disbanding a program that sent plain clothed officers into Muslim neighborhoods to conduct surveillance of the local population. 

On the Monkey Cage, Rachel Gillum shares some research on attitudes of Muslims in the US that suggests this is a good idea. She argues that:

The Muslim-American community has served as a major resource for law enforcement since 9/11, with some scholars citing Muslim-Americans as the single largest source of initial information leading to disrupted terrorism plots since 2001. Such community assistance is particularly important in stopping homegrown attacks which tend to involve more “lone wolf” actors, making them more difficult to detect by law enforcement. Indeed, it was a Muslim immigrant who first reported suspicious activity in the 2010 case of Faisal Shazad, convicted in the Times Square bombing attempt.

The NYPD’s spying tactics, guided by a former CIA official, stirred debate over whether the NYPD was infringing on the civil rights of Muslims and illegally engaging in religious and ethnic profiling. Findings from recent studies based on MANOS data– a nationally representative survey of 500 Muslim-American respondents collected online by YouGov in March 2013 –suggest that such programs that unfairly target Muslim communities can create feelings of cynicism and reduce Muslims’ willingness to voluntarily assist police in criminal investigations.

She notes that the survey showed that only 14% of the respondents  from NYC thought that the police "behave fairly toward Muslim suspects" as opposed to 34% in the national survey. This is important because belief in the fairness of police behavior is related to people's willingness to cooperate with the police. Lower levels of belief in the fairness of police in NYC, presumably related to NYPD spying, suggests that it would be easier to keep terrorist plots a secret in NY's Muslim neighborhoods than in other such neighborhoods around the nation.

Ukraine: What a Difference a Day Makes

Yesterday, things appeared to be deteriorating in Eastern Ukraine. Today, The US, Ukraine, EU and Russia announced a deal to deescalate the crisis. BBC reports that:

Following the Geneva talks, Russian Foreign Minister Sergei Lavrov, Ukraine's Foreign Minister Andriy Deshchytsia, US Secretary of State John Kerry and EU foreign policy chief Catherine Ashton said there was agreement that all illegal military formations in Ukraine must be dissolved, and that everyone occupying buildings must be disarmed and leave them.

They added that there would be an amnesty for all anti-government protesters under the agreement, and talk of "inclusivity" - possibly a suggestion that Russian-speaking areas of Ukraine might be granted more autonomy.

These steps will be overseen by monitors from the Organization for Security and Co-operation in Europe (OSCE).

Of course, this deal did not include the people in Eastern Ukraine that are taking over government buildings and attacking Ukrainian security forces. So there is a tacit reliance on Russia's leadership role with the protesters. Hopefully, Russia's participation in this agreement will convince the protesters to declare victory and stand down, even if they are not taking direct orders from Moscow. At the very least, they may not be counting on intervention if they provoke a little violence.

I would note that the agreement calls for the OSCE to monitor the situation. This is the same international organization that Russian troops blocked from entering Crimea but now it is coming in handy for them. Of course, that is what international organization are for, to facilitate cooperation and conflict resolution when states want to cooperate and resolve conflicts (not to force them to do so).

Regulatory Response to 2008 Financial Crisis

The Economist provides a good overview of The Origins of the Financial Crisis in one of their crash courses (which appear to be accessible without a subscription)

One of the reforms instituted in the wake of the financial crisis is the establishment of the Financial Stability Board (FSB, unfortunately the same acronym as Russia's intelligence service). The board is intended to coordinate the activities of national central banks & finance authorities (such as the US Federal Reserve, Securities and Exchange Commission and Department of Treasury) and international organizations (such as the European Central Bank, European Commission, IMF, World Bank). [List of FSB members]

The mandate of the Financial Stability Board is to:

• assess vulnerabilities affecting the financial system and identify and oversee action needed to address them;
• promote co-ordination and information exchange among authorities responsible for financial stability;
• monitor and advise on market developments and their implications for regulatory policy;
• advise on and monitor best practice in meeting regulatory standards;
• undertake joint strategic reviews of the policy development work of the international standard setting bodies to ensure their work is timely, coordinated, focused on priorities, and addressing gaps;
• set guidelines for and support the establishment of supervisory colleges;
• manage contingency planning for cross-border crisis management, particularly with respect to systemically important firms; and
• collaborate with the IMF to conduct Early Warning Exercises.

Another major reform was the Basel III set of regulations produced by the  Basel Committee on Banking Supervision at the Bank for International settlements. These regulations, which are recommendations for national level authorities, provide guidance on acceptable levels of risk in capital markets and the amount of reserves banks need to keep on hand to meet obligations and cover bad debts. They are highly technical and focus a lot on the role of Central Counterparty (CCP) clearing. [FTSE has a short video that explains Basel III if you are interested in the details.] Of course, it is up to each nation to implement the rules for itself and the Federal Reserve has done so in the US

An IMF Survey report, "Safer Global Financial System Still Under Construction, Says IMF" notes that the organization feels there is still more work to be done in the following areas:

•  the need for a global-level discussion on the pros and cons for direct restrictions on certain business activities for banks, rather than just requiring them to hold more capital for these activities;

• monitoring, and a set of prudential standards if needed, for nonbank financial institutions posing systemic risks within the so-called shadow banking sector;

• careful thought on how to encourage the use of simpler products and simpler organizational structures;

• further progress on sorting out large institutions that get into financial trouble, including cross-border resolution to help secure the benefits of financial globalization.

In a Finance and Development article, "Fixing the System",  Laura Kodres and Aditya Narain note that regulators have focused attention on the central causes of the crisis, especially the shadow banking system, and have essentially picked the low hanging fruit of regulatory reform. This leaves them with the following more difficult tasks:

• identifying and building tools—still in the early stages of development—to mitigate systemic risk;
• improving the ability of the authorities to deal with the aftermath if the tools designed to prevent systemic events fail; and
• providing a framework for financial intermediation (the transfer of savings to investments) to assist in strong and stable economic growth, without overly prescriptive regulation.

Now it's the Ukrainian Crisis

I have been referring to the Russia annexation of Crimea as the Crimean Crisis, party in the hope that it would remain confined to that area. Unfortunately, the unrest has spread to other parts of Eastern Ukraine and so it must be called the Ukrainian Crisis.

The violence that is emerging in Donetsk and other cities in Eastern Ukraine is exactly the kind of thing one would expect to trigger a Russian intervention. Indeed, the lack of violence in Crimea was part of what made Russia's intervention in Crimea so surprising. Of course, in Crimea, many Russian troops were already there and they just had to fly more into their base. While Russia has 40,000 troops massed on Eastern Ukraine's border, the fact that they have to cross the border is a symbolic and legal obstacle to intervening that was not present in Crimea. Crossing the border amounts amounts to crossing a threshold that will escalate the crisis.

Also, the fact that Russia intervened in Crimea first will undercut any Russian claims that they are simply responding to violence against ethnic Russians, as they rather successfully claimed when they invaded Georgia. Of course, it is hard to see this as much of a deterrent if wide spread violence occurs, but it has certainly put them on the back foot as far as international reaction is concerned.

I do not profess to have a crystal ball, and certainly didn't see the rapid occupation of Crimea coming, but I don't see the situation in Eastern Ukraine going well. Pro-Russian groups have almost certainly been emboldened by Russia occupation of Crimea and its massing of troops on the border. Therefore, they probably think that all they need to do it cause some trouble and get into a little fight with government troops (as opposed to firmly taking control of the region) to trigger a Russian invasion. The Ukrainian government, with larger numbers of pro-Ukrainian citizens in the the East than in Crimea (and no Russian forces there yet) cannot easily avoid a fight. Indeed, not reacting to the uprising (or completely botching the reaction, as the Ukrainian government is in danger of doing) would effectively cede the region.

The question then is how does the Ukrainian "Anti-Terror" campaign go? If the Ukrainian government can gain firm control of the region, one could imagine Russia contenting itself with using political and economic pressure on Ukraine. Indecisive fighting and any kind of publicized major loss of life will make it hard for Russia to sit there with 40,000 troops on the border and do nothing. Of course, this could be what Putin is waiting for as it would provide a fairly good pretext for intervening.

Indeed, whether by accident or design, the events in Eastern Ukraine are far better orchesterated than those in Crimea. In Crimea, the pro-Russian groups seized the local parliament and declared for Russia from the start (the referendum, held under Russian occupation, appeared to be an after thought). In Eastern Ukraine, pro-Russian groups are demanding a referendum from the Ukrainian government, which puts the government in the position of seeming to deny them the right to vote on the issue. While there is a lot of legitimacy in refusing to agree to a referendum at gun point, it does muddy the waters. If things get out of hand in Eastern Ukraine, the Russian could push for OSCE involvement and use international law and organizations (or at east their refusal/inability to act) for its own purposes. 

With the Chinese curse of "May you live in interesting times" in mind, the situation is getting more interesting by the day.

Here are some misc thought and links:

 In "Do Crimeans actually want to join Russia?", Grigore Pop-Eleches and Graeme Robertson look at regional attitudes within Ukraine towards identity issues relevant to the crisis. In the various bar graphs they offer, one can clearly see the East-West divide on issues such as language and orientation towards Europe vs Russia. However, it is worth noting that Eastern Ukraine is not as unified in its pro-Russia attitudes as is Crimea. Therefore we can expect much more dissension among the population and, sadly, perhaps much more violence among them. 

The less Americans know about Ukraine’s location, the more they want U.S. to intervene:  The authors report survey results in which only 16% of respondents could find Ukraine on a map. The survey used an interactive map that recorded where respondents actually thought Ukraine was and , thus, could measure how far off they were. While only 13% supported using force against Russia, support for using force increased with the inaccuracy of respondents placement of Ukraine on the map.

Meanwhile, in Russia, BBC reports that a website has been launched that seeks to connect Ukrainian women looking for a place to live in Russia with Russia men who will offer them accommodation in exchange for... well it's pretty sexist. The interesting points here are the implicit assumption (perhaps even fact) that there are large numbers of Ukrainians seeking refuge from the new government in Ukraine, and the labeling of the new Ukrainian government as Banderite. Apparently, Stepan Bandera was a Ukrainian nationalist who took advantage of the Nazi invasion of Russia to declare Ukrainian independence and sought Germany as an ally in this effort. Despite the fact that the Nazis shipped him to a concentration camp, Bandera was eventually killed by the KGB and vilified in Soviet propaganda as a Nazi collaborator.

Bandera is a divisive figure in Ukraine, having been embraced by Ukrainian nationalists. In 2010, then Ukrainian President Victor Yuschenko (and current leader of the Our Ukraine party) controversially  awarded Bandera the title of Hero of the Ukraine (which was later annulled). Statues have been erected to Bandera in Western Ukraine, a commemorative stamp issued in honor of his 100th birthday, and Wikipedia features a photo of Lviv (Bandera's birthplace) soccer fans displaying a banner with his picture with the caption "Bandera- Our Hero" at a soccer game versus Donetsk (ground zero in the latest pro-Russia demonstrations/violence).

The embrace of Bandera by Ukrainian nationalists and his association with the Nazis in Soviet era propaganda  undoubtedly plays a role in the Russian government's claims that the new Ukrainian government is controlled by fascists and the Russian public's belief in those claims. Keep in mind that the fight against Germany in the "Great Patriotic War" is a huge part of Russian culture. For example, where American brides traditionally through their bouquet of flowers to a crowd of single women, Soviet newlyweds would go to the local war memorial and lay the bouquet there in honor of the war dead. While this practice may have been more common in the Soviet era and modern Russian brides have adopted the custom of throwing the bouquet, a tour of local historical sites and placing of flowers at war memorials is still common.

Speaking of WWII memorials, AFP Reports that a German tabloid has launched a protest against a display of WWII Russian tanks in a war memorial by the Brandenburg Gate in Berlin. This memorial is a holdover from the Soviet occupation of East Berlin and is dedicated to the 80,000 Soviet troops that died in the Battle of Berlin and so touches on two sensitive subjects, the former division of the country and Germany's war guilt. It is also interesting to note that Germany agreed to preserve Russian war memorial and consult Russia before making changes to them as part of the 1990 reunification treaty. If this campaign to change the memorial takes off, it may lead to some interesting diplomatic exchanges.

IMF Reforms

Last week, the finance chiefs of the member nations of the IMF met in Washington and ended their meeting with a call for the US to approve a reform package passed by  the IMF Board of Governors in 2010. US approval will require an act of Congress, which so far the White House and Congressional leadership have been unable to pass. The G20 nations have set a deadline of the end of the year for the US to approve the reforms before they begin looking at other option (though what those options might be is unclear given the US' veto power in the IMF).

A March 2014 CRS report, "IMF Reforms: Issues for Congress" summarizes the package of reforms as follows:

• Doubling IMF quota and rollback of the NAB[New Arrangements to Borrow, temporary measures taken to increase IMF funding]: The reform package calls for a doubling of IMF quota, and a corresponding rollback of the NAB. Although IMF quota has been periodically increased before, if adopted, this would be the largest proportional quota increase in the history of the IMF.

• Shifting IMF quota to emerging economies: The reform package also calls for a 6% shift in quota share to emerging markets, which would increase their voting power at the IMF, as well as their relative financial commitments to the institution. If implemented, the negotiated changes in quota shares would result in China becoming the third-largest shareholder at the IMF, and India and Brazil would also join China and Russia among the 10 largest shareholders.  The United States quota share would fall slightly, but the U.S. quota would still be sufficient to ensure it had more than the 15% of the total voting power needed to veto major IMF policy decisions. See Table A-1 for more details about how IMF quota shares would change for major economies. [US quota would go from 17.69% to 17.40%]

• Creating an all-elected IMF Executive Board: Rather than continuing the practice of having the five largest shareholders at the IMF appoint Executive Directors to the Board, the proposed reform would make all Executive Directors on the Executive Board elected. This reform could pave the way for future consolidation of European representation on the Executive Board.

•  Reducing representation of advanced European economies on the Executive Board: Ten seats on the Executive Board represent advanced European economies. The reform proposal reflects a commitment by the membership to reduce the number of Executive Directors representing advanced European economies by two, so emerging and developing countries have more representation on the Board. 

In the IMF's own summary of the reform package highlights the following key facts:

• All BRIC countries will be top 10 IMF shareholders
• More than 6 percent shift in quota share to dynamic emerging market and developing countries
• Voice of poorest countries maintained by preserving their voting shares.

So who pays for the shift?
• The bulk of the shift—about 80 per cent—comes from a reduction in the shares of advanced economies and some oil producers
• 110 countries will gain or maintain quota share, of which 102 are emerging market and developing countries.

Once reforms in place, rebalancing to be mirrored in IMF’s Executive Board
• Advanced European economies will hold two fewer seats
• All Executive Directors will be elected.

With regard to the IMF's funding quota (or core funding), the summary notes:

Member countries’ quotas, the IMF’s principal source of financial resources, will double under the 14th General Review of Quotas to SDR 476.8 billion (about $755.7 billion at current exchange rates) from SDR 238.4 billion agreed under the 2008 quota and voice reform.

As part of the agreement, the New Arrangements to Borrow (NAB), a backstop arrangement between the IMF and a group of IMF members to provide additional lending resources to the Fund, will be rolled back.

Since major policy decisions at the IMF require an 85% vote, the US voting share of 17.69% means that the US must approve these changes for them to go into effect.

While the CRS notes that these reforms will have minimal effects on the US, it does note that there is opposition to the reforms. Without naming names, the report notes that some raise technical objections that the IMF has sufficient funds to do it job and that the New Arrangements to Borrow have better safeguards on the use of the funds in them than is the case for the IMF's core funds. Others are reluctant to increase representation of emerging markets due to concerns about the commitment of these nations to the existing norms and standards of international financial institutions.

In general, this is a fairly modest set of reforms that is going to increase quota funding by giving emerging markets a bigger role in the organization (and thus a bigger quota). The US has long had a voting share that is below its quota share (about 21.6% in 2011) and so the quota can be redistributed without the US losing voting share or its veto. Given that the US will retain its veto, it is hard to give much credence to concerns about emerging market nations subverting the norms of the organization. Within this veto constraint, the reforms do make the organization more inclusive, which will enhance its credibility.

However, most of this is irrelevant to members of Congress who (even if they personally get it) must play out any vote on the package in the arena of election year politics. The hope, of course, is that the lame duck Congress will pass a bill approving the reforms after the elections in November (which will be ahead of the G20 deadline).

Conventional Security Wisdoms from WWII

When talking about security issues, it is natural to draw on historical examples. However, very frequently, the lessons of history that we have in our heads are really just conventional wisdom’s that have been passed around the society. This is particularly true with World War II, which is spawned a lot of conventional wisdom’s that, while not completely false, don’t hold up to very close scrutiny.

One conventional wisdom that I find irksome is the notion that the United States was unprepared for World War II. While the US was certainly not prepared enough for the conflict that emerged, the US actually had taken a number of significant steps to improve its readiness. Starting in 1934, Congress began increasing the size of the U.S. Navy. Their efforts were led by the chairman of the House Naval affairs committee Carl Vinson (the one we named an aircraft carrier after) and this led to a series of acts that marginally increase the Navy. For instance, the Naval act of 1938 , also known as the second Vinson act, mandated a 20% increase in the Navy largely in response to the Japanese invasion of China in the German annexation of Austria. In July 1940, Congress passed the two Ocean Navy act, which mandated a 70% increase in the size of the Navy, with the goal of allowing the Navy to operate in both the Atlantic and Pacific oceans (hence the name). While the US found itself lacking in aircraft carriers at the start of the war, it had 2 new battleships (the North Carolina and Washington) on hand and 8 other battleships building. 4 of these joined the fleet by August 1942 thereby making up most of the losses at Pearl Harbor. [Note: The new battleships were fast and bristling with anti-aircraft guns. Rather than being vulnerable to air attack, they were formidable area air defense systems and were primarily used to protect the carriers from air attacks.]

As far as the Army goes, the United States launched its first peacetime conscription in 1940 with the Selective Training and Service Act of 1940.  The US also mobilized 18 National Guard divisions and 29 aerial squadrons for per year of training and reorganization. A US Army history of the mobilization gives the sense of an Army under great pressure to expand when it makes the following claim:

“Although full-scale mobilization remained politically impossible, the government started the financial transition from parsimony to abundance. Appropriations came faster than the Army could absorb them, over $8 billion in 1940 and $26 billion in 1941, dwarfing the half billion dollars that had been allotted for expansion early in 1939. By the time of Pearl Harbor, Congress had spent more for Army procurement than it had for the Army and the Navy during all of World War I.”

Unfortunately, these numbers appear to be a bit inflated (perhaps the author was using inflation adjusted dollars). If we look at historical figures on defense spending from 1939 to 1945, we see a smaller, but still dramatic, up tick in US defense spending in fiscal year 1941 (Oct 1, 1940 to Sep 30, 1941):
FY1939  $1.9 billion
FY1940  $2.2 billion  (15% increase over previous year)
FY1941  $7.2 billion  (227% increase over previous year)
FY1942 $27.1 billion (165% increase over previous year)
FY1943 $70.4 billion (159% increase over previous year)
FY1944 $86.5 billion (22% increase over previous year)
FY1945 $93.7 billion (8% increase over previous year)

The $7.2 billion in FY1941 doesn't sound like a lot of money to us today, but in 1941, the entire GDP of the United States was only $129.4 billion. This means that the United States spent 5.5% of its GDP on defense in 1941 (rather from Oct 1940 through Sep 1941). Also, it is interesting to note that the biggest percentage increase in defense spending occurred in fiscal year 1941 prior to the attack on Pearl Harbor. . When you add the specter of drafting people into the peacetime military for the first time ever, one certainly doesn't get the impression of a nation sitting idly by while the world burns around it.

A corollary to the unpreparedness wisdom is the conventional wisdom that the United States was pursuing an isolationist policy. To be sure, there was a strong strain of isolationism in US policy, which led to the passing of a number of neutrality acts in the 1930s. However, from 1940 on, the US was in fact beginning to take fairly aggressive steps on the international stage.

In December 1940, Pres. Roosevelt declared the United States, the Arsenal of Democracy in a radio address promising to help Great Britain fight Nazi Germany.  The US at that point was selling arms to belligerents, albeit on a cash and carry basis, and continued to do so until it became clear that the UK could no longer afford to buy weapons. In March 1941, Congress passed “An Act to Further Promote the Defense of the United States”, better known as Lend-Lease. Under this policy, the United States provided more material to Great Britain, China, and the Soviet Union free of charge (albeit subject to a vague promise to return the material when the war was over).

The US efforts did not stop here. In September 1939, at the very beginning of the war, the United States established a neutrality zone in the north Atlantic. The U.S. Navy began the first of what we called Neutrality Patrols  that would observe and report the movement of warships west of latitude 65° and protect merchant shipping within this zone. Despite the name, neutrality patrols greatly favored the British as it relieved them of the responsibility for protecting shipping i about half the North Atlantic. Furthermore, in June 1941, the United States occupied Iceland, which the British had invaded in 1940 to prevent it from falling into German hands.

Meanwhile, in the Pacific, United States was taking an even more aggressive stance towards Japan. In September 1940, the Japanese occupied French Indochina in the United States responded by cutting off exports of scrap metal to Japan (74% of Japan scrap iron and 93% of its copper came from the US) and closing the Panama Canal to Japanese shipping.  In early 1941, the US Pacific Fleet was moved from San Diego with the intention of restraining Japanese behavior. Negotiations ensued but continued Japanese aggression in China led the US to freeze Japanese assets in July 1941 and to embargo all oil and gasoline exports in August.  Since 80% of Japan’s oil came from the US, this was a particularly dramatic step as it left the Japanese with about a 2 year supply of oil on hand and an urgent need to secure new supplies.

Essentially, the United States put Japan in the position of choosing between withdrawing from China or securing access from someplace else to the resources it needed to continue its conquest of China. The closest oil to Japan was in the Dutch East Indies, today’s Indonesia, and the Dutch had already refused to sell them enough oil to continue their war in China. This led the Japanese to plan for an invasion of what they called the Southern Resource Area. However, the British naval base at Singapore and the US naval bases in the Philippines lay on either side of the sea route to this area and, therefore, had to be secured as part of Japan’s massive Southern Operation. This set the stage for a war with the US and the UK (not to mention the Dutch and Australians).

It is interesting to note that a Gallup poll taken shortly before the Japanese attack on Pearl Harbor asked Americans. “Do you think the United States will go to war against Japan some time in the near future?”  52% of respondents said they expected war with Japan, while only 27% did not, and 21% had no opinion.  So, while the attack on Pearl Harbor was shocking surprise, the war itself was hardly unexpected.

Bhagwati on the WTO

Jagdish Bhagwati, a prominent advocate for free trade, served on a group of experts that advised the director general of the WTO on future chage needed at the organization. He summarized his own views on the subject in a short article entitled Reshaping the WTO. (Note: this is a relatively short and accessible paper.)

Bhagwati argues that there several fallacious criticism of the WTO be promoted by otherwise well-meaning NGOs like Oxfam and Action aid. These include the following:

• "Poor countries suffer from systematic rich-country “hypocrisy” leading to “double standards” in trade policy, with the rich countries having more trade barriers than the poor ones."  Bhagwati notes that developed nations in fact have much lower levels of tariff protections than developing nations do.
  
• "While trade liberalization by rich countries is beneficial, for the poor countries trade liberalization does not bring benefits." Bhagwati argues that the scholarship and empirical evidence argues to the contrary, despite the repeated claims of a small number of economists. Also, he argues that protection given to 'infant industries', which is the primary alternative to liberalizing trade, tends to be indiscriminate in nature, stifles the competitiveness of the industry, and becomes politically entrenched. In his view the infant industry argument "...has always been indulged to excess whereas experience shows otherwise."

• "Agricultural subsidies in the rich countries are keeping the developing world poor." Bhagwati notes that 45 out of 49 LDCs are net importers of food and thus benefit from the agricultural subsidies of other countries. He argues that middle income countries with large agricultural exports, who are negatively impacted by these subsidies, have been trying to link this issue to the welfare of poorer nations for political convenience. 

The Erosion of Non-Discrimination: Bhagwati feels that the proliferation of Preferential Trade Agreements (PTAs) between nations has eroded the norm of non-discrimination between nations that was established under GATT. Bhagwati would expand on this argument in his 2008 book Termites in the Trade System: How Preferential Trade Agreements Undermine Free Trade. In his 2005 paper he argued:

All economists now recognize the resulting “spaghetti bowl” problem, as I have christened it. The world trading system is charcaterized by a chaotic criss-crossing of preferences, with a plethora of different trade barriers applying to products depending on which countries they originate from. This is a fool's way of doing trade—not only does it destroy the efficient allocation of resources, but it flies in the face of the fact that today it is becoming almost impossible to define which product is whose. It is hard to believe that sensible men in charge of trade policy today, including the USTR, the EU Trade Commissioner and other luminaries of trade are so unmindful of the fact that, in the name of free trade, they are damaging the world trading system through discriminatory PTAs as much as the protectionists did in the 1930s.

Encroachment of Unrelated Agendas: The other problem Bhagwati sees for the WTO is the lobbying by rich nations to attach other issues, such as protections for intellectual property right, to the WTO's rules. He sees PTAs as a means for these nations to insert these issues into the international agenda and build legitimacy for the inclusion of issues into the WTO. 

 Yet another threat to the multilateral trading system arises from the ability of rich-country lobbies to capture, through use of PTAs and the design of S&D preference schemes, the trade liberalization process to advance their unrelated agendas. These lobbies pretend, of course, that “fair trade” and respect for “collective preferences”—both self-serving phrases that conceal the pernicious nature of the demands—require that their pet concerns such as labor standards be worked into trade agreements and institutions such as the WTO.  

This has united the major developing countries such as India and Brazil, both led by democratically elected progressive leaders, against the inclusion of such extraneous issues into trade negotiations and institutions. The Free Trade Agreement of the Americas (FTAA) has also been held up by Brazil, which insists correctly on confining it to trade liberalization, while the United States wishes to corrupt the FTAA with several extraneous issues. Revealingly, none of the many PTAs among the poor countries ever include these extraneous issues—their inclusion arises only when the U.S. and the EU are members.

The WTO's Bali Package

The WTO meeting at Bali passed an agreement known as the Bali Package last December which is the first significant agreement in years on the Doha Round of negotiations. Here are some new articles that discus the package

The WTO Bali Package by Carlos A. Primo Braga at IMD: This is the clearest  explanation of the Bali package and the negotiations leading to it that I could find. This is worth a thorough read.

Trade: the real cost of red tape by Caspar van Vark at The Guardian: van Vark discusses the of border thickness that the trade facilitation part of the package seeks to address.

Analysts of cross-border trade commonly refer to the "thickness" of a border. The more red tape and documentation required to move goods across a border, the thicker it is. Lack of co-ordination between customs directorates, poor IT infrastructure and corruption all add to this, and developing countries tend to have the thickest borders.

These burdens all add to the cost of trade and therefore encumber economic growth in developing countries. According to a report by the World Economic Forum, if every country improved just two key supply chain barriers – border administration and transport and communications infrastructure and related services – even halfway to the world's best practices, global GDP could increase by US$2.6tn (£1.6tn).

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One of the key areas of negotiation in Bali will be on the second section of the draft agreement, which sets out the basis for special and differential treatment for developing countries and for the technical assistance and capacity building needed by them for the implementation of the agreement.

Unusually, the agreement proposes that developing countries stagger their commitments in a self-selected way across three categories of commitment: A for obligations that can be implemented immediately, B for obligations that require longer time frames, and C for obligations that need both longer time frames and technical assistance.

This menu-driven approach means that individual countries will have their own tailor-made form of special and differential treatment, which one speaker pointed out was uncharted territory for the World Trade Organisation. At the same time, developing countries are also facing a level of commitment which was described as being "against the spirit of the Doha Round", the negotiations that started in 2001.

Anti-poverty groups condemn WTO pact as big business boost by Philip Inman at The Guardian: As is often the case there is the criticism that the WTO negotiations are biased towards the interests of developed countries and their corporations.

Why farming subsidies still distort advantages and cause food insecurity at Poverty Matters blog: The blog post goes into some detail about the issues at stake in the agricultural policy negotiations:

Since the WTO's Agreement on Agriculture took effect in 1995, world trade patterns have changed, and there are forces distorting food trade that are not being adequately addressed. Subsidies that wealthy countries give their farmers and agribusinesses are mostly classified as "non-distorting" measures, and remain high. A few multinational agribusinesses have increased their domination of global trade and food distribution. Speculation in commodity futures markets is creating volatile price movements that do not reflect true changes in demand and supply.

All this is bad for small producers, who do not benefit from price increases and lose out when prices decline with import surges. It is also bad for poor consumers, who face much higher prices for their food. In many developing countries this has created two linked problems: food insecurity because of high and volatile food prices, and livelihood insecurity of food producers because of rising costs and uncertain supply. 

In the meantime, developing countries must find some way to ensure their citizens' food and livelihood security. Many countries try to do so by introducing measures to make food affordable for low-income consumers or by encouraging domestic food production, particularly through supporting small farmers.

The trouble is that such measures sometimes come up against existing WTO rules. Thus, India's recent law that seeks to provide food security to one of the largest undernourished populations in the world has been challenged by the US in the WTO, even though India's scheme would cost a fraction of what the US provides in food subsidies.

NGOs in the News

Here are 6 news links relevant to NGOs for my POL2260 students. The last one is perhaps the most important.

Putin says West may use NGOs to stir unrest in Russia.- Russia has been clamping down on NGOs that it sees as strengthening opposition to Putin's regime (see next link). Now we have a linkage to the increased tension between Russia and the West over Ukraine.

Russia: “Foreign Agents” Law Hits Hundreds of NGOs: This Human Rights Watch report goes into some detail about the difficulty Russia NGOs are having. It is also interesting to scroll through the list of NGOs if only to get a sense of the different types working in Russia.

Monitoring NGOs: Civil society groups say govt trying to control their activities: Russia isn't the only country that is clamping down on NGOs. This article from Pakistan's Express Tribune reports claims that the government is trying to control NGO activities with new audit and reporting regulations. Give it a quick read and then, while you are there, click around on the paper's website to see what Pakistanis are hearing about. Keep in mind that the upper class in Pakistan generally operates in English and so this site is aimed at them.

First official estimate: An NGO for every 400 people in India: There not much to this beyond the astonishingly large number of Indian NGOs.

NGOs best suited to tackle child abuse: Bhagwati: This short piece from 2009 quotes former Indian Chief Justice P. N. Bhagwati (even the Indian press doesn't want to type out Prafullachandra Natwarlal) as saying the NGO are better suited to deal child abuse and sex trafficking than the government. He blames government apathy for a lack of action. (Note he is the brother of  the economist Jagdish Bhagwati.)

Justice P.N. Bhagwati Lectures on India's Human Rights Law: This article summarizes PN Bhagwati's reflections on the development of India's human rights laws, or rather the judicial interpretation of them. This is worth a thorough read because it shows an activist judiciary at work, but the last 7 paragraphs are particulrly rekevant as they describe the role Indian NGOs have played in the courts. In India, the courts have allowed NGOs to petition the court on behalf of other people (epistolary jurisdiction) and to file friend of the court (amici curiae) briefs on the behalf of poor people who cannot afford to be represented.

Criticism of NAFTA: Wage Stagnation

One of the criticisms of NAFTA (and often of globalization) is that it has led to wage stagnation in the US.
Public Citizen offered this argument in a report released this February:

Trade affects the composition of jobs available in an economy. The aggregate number of jobs available can be better explained by fiscal and monetary policy, the impacts of recessions and other macroeconomic realities. The United States has lost millions of manufacturing jobs during the NAFTA era, but overall unemployment has been largely stable (excluding the fallout of the Great Recession) as new low-paying service sector jobs have been created. Proponents of NAFTA raise the quantity of jobs to claim that NAFTA has not hurt U.S. workers. But what they do not mention is that the quality of jobs available, and the wages most U.S. workers can earn, have been degraded.

According to the U.S. Bureau of Labor Statistics, two out of every three displaced manufacturing workers who were rehired in 2012 experienced a wage reduction. Two out of every five displaced manufacturing workers took a pay cut of greater than 20 percent. For the average manufacturing worker earning more than $47,000 per year, this meant an annual loss of at least $10,000.

 Such displacement not only spells wage reductions for former manufacturing workers, but also for existing service sector workers. As increasing numbers of workers displaced from manufacturing jobs have joined the glut of workers competing for non-offshorable, low-skill jobs in sectors such as hospitality and food service, real wages have also fallen in these sectors under NAFTA.

 The shift in employment from high-paying manufacturing jobs to low-paying service jobs has thus contributed to overall wage stagnation. The average U.S. wage has grown less than one percent annually in real terms since NAFTA was enacted even as worker productivity has risen at more than three times that pace. Given rising inequality, the median U.S. wage has fared even worse and today remains at the same level seen in 1979. (Public Citizen, 2014, p 10-11).

In shifting the focus from the total number of jobs in the US economy to the quality of jobs, this argument side steps arguments based on the unemployment rate in the US, such as I made in a previous post. Therefore, this argument deserves separate consideration.

For a first cut we can turn to an interview with the Council on Foreign Relations in which Edward Alden argues

There is no question that [due to] NAFTA and the other trade agreements that have happened since the big Uruguay Round [of global trade talks] that concluded at the end of 1993, and the entry of China into the World Trade Organization in 2000, that the U.S. manufacturing sector is facing much tougher competition than it did twenty or thirty years ago. What we’ve seen happen are two things: We’ve seen manufacturing productivity in the United States increase dramatically, which means fewer workers. Industries have shed workers as they’ve become more capital intensive. They’ve become more efficient since that’s the only way they can compete. A lot of American companies have moved portions of their operations offshore to take advantage of lower wages. Overall, American manufacturing output hasn’t really shrunk—it’s grown slightly. 

First of all, where Alden says that American manufacturing output has "grown slightly", the Fred graph below shows that US manufacturing output (see graph below) increased 70% from 1993-2007 and is currently 64% larger than it was when NAFTA went into effect.

That quibble aside, Alden makes the argument that global competition, not just competition from Mexico and Canada have forced US companies to enhance productivity, cut down on employees, and use a higher proportion of skilled labor. In itself, this argument suggests that NAFTA itself is not to blame but rather that the global trade environment is behind the trend. However, saying that NAFTA is a small part of a larger trend is unlikely to sell anyone on the value of trade.

A better argument might come from asking the question, if it weren't for NAFTA, and international trade in general, would manufacturing productivity not have increased as it did? That is to say, without foreign competition, would US manufacturers not have invested in labor saving technology that has replaced large numbers of unskilled workers with fewer more highly skilled ones?

If you look at the graph of manufacturing output above, you will see that output climbed during the nineties until suffering a set back in the 2001 recession (the first shaded area in the graph). It then grew at a slightly slower rate than in the 1990s until the Great Recession (the second larger shaded area in the graph). I suppose you could blame the slower growth from 2002 to 2007 on increased foreign competition, particularly from China, but you would have to ignore the much larger impact of the two recessions.

The impact of these two recessions is even more evident if one looks at the number of people employed in the manufacturing sector. The FRED graph of manufacturing employment below shows that decreases in manufacturing employment line up with the two recessions (again indicated by shaded areas). Manufacturers shed 3 million workers during and after the 2001 recession and 2.5 million more during the great recession. These two reductions combined amount to a 31% decrease in the number of people employed in manufacturing, from 17.5 million  to 12 million workers.

In both recessions, manufacturing output shrunk (see first graph) and than fought its way back after the recession, but employment stayed down. This is because productivity was increased as manufacturers found ways to make more with less employees. As you can see in the FRED graph below, productivity (the blue line) increased at a higher rate immediately after each recession than immediately before it. However, if you look at the whole period, the overall trend is quite steady. I have inserted a dotted black line from the beginning and end point of the productivity graph and you can see that output per hour increased along that line in the 1990s before increasing above it from 2001-2008.  While the blue line climbs away from the dotted black line in the immediate aftermath of the 2001 recession, it doesn't trend back towards the dotted line until the Great Recession. Note that after the Great Recession, the blue line climbs away but then trends back towards it and follows it quiet closely for the last couple of years.

While this is a very informal and cursory look at one piece of data, it suggests to me that the increase in manufacturing productivity from 2002-2004 was probably a direct result of the 2001 recession. The growth from 2004-2008 may have been fueled by increased international competition to roughly the extent that productivity increased above the dotted trend line.

Here is where the red line, which represents real compensation per hour, comes in. Note that from 2004-2008 compensation stays flat. This may be the wage stagnation that NAFTA critics are talking about. Clearly from about 2004 on, wages do not follow the trend they did from 1993 to 2004 (the dotted red line). Of course, the fact that wages have not trended up since the Great Recession is not surprising given that unemployment  has been high. However, from 2004-2008, unemployment was quite low and trending downward. So we cannot entirely rule out some effect from international trade.

At the same time, it is hard to argue that this effect was determinant. Output per hour (the blue line) was not increasing that much above the trend line for the overall period. In 2008 the actual index of output per hour was at about 180 (up 40 points from the end of the 2004 recession) when the trend line would have put it at 170 (up 30 points from the end of the recession). If we attribute this difference entirely to global competition (and not to technological innovations or domestic market pressures), one could argue that international competition produced 25% of the growth in output per hour, but that 75% would probably have occurred without it.

Of course, this additional 25% may have been enough to blunt wage growth, so we can't reject the stagnation argument completely. Instead, we can put it in context by noting that trade may have exacerbated and existing trend for 4-5 years but that we are now exactly where we would have been if productivity had kept increasing at the rate it did in the 1990s. Of course, putting it in that sort of context rather undercuts the wage stagnation argument as a whole.

In general, I think the wage stagnation criticism of NAFTA is a case of confusing correlation with causality. We have clearly seen a trend of manufacturers and other employers using more technology and high skilled labor. This has resulted in the earnings of high skilled employees to go up while stagnating or deflating the wages of low skilled employees. It has gotten to the point that PEW Research talks about the rising cost of not going to college. However, this trend is not limited to manufacturing but affects all industries and has little to do with international trade.

Dani Rodrik on the Bretton Woods Compromise and Hyper-Globalization

Dani Rodrik is one of the leading economists who is critical of the Free Trade orthodoxy in economics. While Rodrik is very much in favor of countries pursuing an outward-focused and export-oriented strategy of growth (which sets him apart from non-economists who vehemently lambaste what they call the Neo-Liberal model or bias), he is critical of the view that nations need to fully and immediately embrace the policies promoted by Free Trade advocates.

Rodrik is a big fan of the Fox and Hedgehog metaphor and view the proponents of rapid and comprehensive trade liberalization, such as Jagdish Bhagwati, as hedgehogs promoting the big idea of Globalization. One manifestation of this big idea is the Washington Consensus which created a laundry list of domestic institutional changes that proponents argued were necessary for nations to implement if they wanted to grow. Rodrik characterizes this push to have nations conform to a rigid (and growing) set of policy guidelines as Hyper-Globalization.

Rodrik argues that this approach differs greatly from that used at the end of World War II under the Bretton Woods system. While the Bretton Woods conference is more closely associated with monetary policy, Rodrik views it as part of a broader international effort to open trade and promote global economic growth. In Rodrik's view, the key to the success of this approach was that it encouraged the growth of international trade without dictating that nations implement specific policies. This gave nations a good deal of policy space within which to craft their own unique policies and strategies for achieving the goals being promoted by the international community. He calls this approach the Bretton Woods Compromise and argues that it was very successful at achieving high levels of growth in domestic economies and international trade.

In contrast, Hyper-Globalization leaves very little policy space within which nations can craft their own growth strategies and pursue the policy goals they deem most important. Worst of all, adhering to the rigid requirements of Hyper-Globalization does not guarantee economic growth and in many cases has led to economic turmoil. So, where Thomas Friedman sees Globalization requiring nations to don a Golden Straitjacket, Rodrik argues that there is nothing golden about it.

Furthermore, Rodrik argues that, in the end, the Golden Straightjacket isn't much of a straightjacket either. That is to say, when push comes to shove, democratic leaders will respond to domestic political demands over international economic pressure or they will be replaced by other leaders who do so. Indeed, if leaders ignore domestic demands in favor of international ones, the democracy of the nation would be impaired.

Of course, national leaders do have to deal with conflicting demands from domestic and international sources.  Rodrik sees this conflict as part of a trilemma in the world economy. International integration (or globalization), nation states (or the preservation of their current role), and democratic politics (or the ability for populations to pursue their desired goals) create conflicting demands.

Rodrik argues that only two sets of demands can be reconciled at a time. Hyper-Globalization (or the Golden Straightjacket) satisfies the demands of international integration and the nation state, but does so at the expense of democracy. The Bretton Woods Compromise satisfied the demands of the nation state and democratic politics at the expense of international integration. Some sort of global federalism that allows democratic participation in setting the rules of international integration could satisfy the demands of democracy and international integration at the expense of diminishing the nation state's current role. However, Rodrik argues that, not only is the world a long way away from such a system, but it is unlikely that the diverse interests of developed and developing nations could be reconciled under one government.

Therefore, Rodrik argues that some sort of modified Bretton Woods Compromise is the best approach to managing the world economy. At Project Syndicate, Rodrik lays out seven principles that he thinks nations would agree to if they held a Bretton Woods type conference today. The essay is quite concise and worth reading in its entirety, but the seven principles are as follows :

1. Markets must be deeply embedded in systems of governance.
2. For the foreseeable future, democratic governance is likely to be organized largely within national political communities.
3. Pluralist prosperity.
4. Countries have the right to protect their own regulations and institutions.
5. Countries have no right to impose their institutions on others.
6. International economic arrangements must establish rules for managing interaction among national institutions.
7. Non-democratic countries cannot count on the same rights and privileges in the international economic order as democracies.

Reflections on the UN

When I was an undergrad at Drew University, I got the chance to study at the UN for a semester in the fall of 1983. This consisted of piling into a bus every Tuesday and Thursday morning for trip  to New York where we had class in a basement conference room across the street from the UN building. Each day we had two speakers from either the UN Secretariat or some nation's delegation to the UN. Though the experience is now 30 years in the past, I thought I would share my takeaways from it.

The UN is not a world government: We heard this from practically every member of the UN staff and many of the country delegations. One got the distinct impression that these folks were weary of criticisms of the UN's inability to govern the world and impose decision on nations.  The standard argument was that the UN was set up to help nations cooperate and coordinate actions and this presupposed that nations wanted to do so. The fact that many nations (such as the US and Soviet Union) did not, was an unfortunate reality that the UN was never intended to overcome.

About a decade later, the Iraqi invasion of Kuwait provided an example of the kind of situation the UN was intended to handle. Iraq's invasion almost perfectly fit the UN Charter's definition of aggression and there was a consensus among the leading powers that it was illegitimate. This allowed the Security Council to pass a number of resolutions condemning Iraq and authorizing the use of force. This is turn facilitated the building of a large coalition that included many nations such as Syria that might otherwise not have been on board with an entirely US led effort.

If we didn't have a UN, we would need to create one: This was the second most common comment from UN staff. The argument here was that the UN provided an indispensable means of communication and contact between nations. It was often pointed out that not every nation could afford to have an embassy in every other nation in the world. Many relied on their delegation to the UN to conduct direct diplomacy with other nations. Also, the UN provided a means of contact between adversarial nations that could not have direct contact for political reasons. Israel and the Palestinian Liberation Organization (which had oberserver status) was one common example.

Most of the important work at the UN goes on behind closed doors: Supposedly, the Security Council has a separate chamber for private discussions in which the "real" diplomacy is conducted prior to going into the official chamber to make public declarations. Whether or not this is technically true, we heard time and again that a government's actual position on an issue often differs from what they say in public and how they vote in the General Assembly or Security Council. Also, many off-the-record bilateral contacts are made between delegations from individual countries.

One of the things I repeatedly heard from my professors is that nations do not conduct their more sensitive negotiations and diplomacy with other nations in public. This was reinforced by the fact that all our guest speakers spoke to us under the condition of non-attribution and we were reminded of this before and after each presentation. Indeed, after this experience, every classified briefing and class I got in the Army was a major disappointment.

One example that comes to mind is Turkey's annexation on Northern Cyprus, which it was then occupying. We heard about this in our class at least a month before it happened. Obviously, Turkey had floated the news in order to gauge the reaction of the international community. Officially, almost every nation condemned it as a violation of international law. Unofficially, it was viewed by many as an action that solved more problems than it created. The back channel communications allowed Turkey to avoid surprising nations by its annexation and to get some feedback before committing itself.

Factoid:US Trade Under NAFTA

In February, The Council on Foreign Relations had a light piece on the Economic Impact of NAFTA. I say light because they just touched on some of the issues but it was a pretty fair overview of NAFTA and the differing opinions on its economic impacts.

However, they included a graphic from the Congressional Research Service report of NAFTA from 2013 that I had forgotten about.

Note that in the graph the dark purple (?) bars represent US exports to Mexico and Canada, and the light  blue bars represent US imports from the two countries. The red line below zero tracks the US trade deficit with Mexico and Canada which is the difference between the dark and light bars in each year on the graph. The story I see in this graph is that US trade with NAFTA partners has been steadily growing and has tripled since the treaty went into effect. The trade deficit expanded from 2000-2007 but has shrunk considerably since the Great Recession.

If one just tracks the trade deficit between the US and NAFTA partners (the red lie), things look bleak. The deficit grew through 2008,, and, though it is much smaller now, it is still fairly large. But looking just at the red line ignores what the purple and blue bars tell us. The purple bars in particular (US exports) tell US that the flow of US goods to Mexico and Canada has tripled since NAFTA went into effect. This suggests that a lot of jobs were added in industries in which the US has a comparative advantage.

Of course, it is often argued that more jobs were lost than were added due to the growing trade deficit. Indeed, unions are adamant that NAFTA has been disaster for US workers. But does this argument make any sense if we look at US unemployment during the same period.The FRED graph below shows the Civilian Unemployment rate in the US from 1993 to 2012.

Note that in the first seven years of NAFTA, the US unemployment rate was shrinking towards an all time low of 4%. The recession in 2001 bumped it up but resumed its downward trend, getting to about 4.5% before the Great Recession sent it skyrocketing. Yet prior to the Great Recession, the trade deficit with NAFTA partners was growing and hit its peak (actually a 3 year flat spot) from 2006-2007, a period when unemployment was below 5%.

Note also that the decrease in the NAFTA trade deficit coincides with much higher levels of unemployment i the US. You might say that this is because of the slow recovery fro the Great Recession, but that's my point. US unemployment (and with it wages) are driven mainly by economic conditions in the US. While international trade is a part of those economic condition, it is a small part and certainly doesn't set the trends in the economy.

Dumping: Predation or Creative Destruction?

Dumping is a potentially predatory trade practice, which would make it unfair even by the very restricted meaning of "fair" used by economists.  In theory, a company could sell its product at a price below cost in a market and, thus, drive competitors out of business. Once that happens, the predator company could raise its prices to recoup its losses. If the new price is higher than the one that existing prior to the company's predatory pricing, then this would represent a loss to the society. That would be unequivocally bad.

Note that the essential part of the "badness" here is that the predator company takes advantage of the diminution of the competition produced by its below cost price to later raise its price above the initial market price. In such a case, the competition between companies is not based on who can produce goods more efficiently, but on who can suffer short term losses the longest.

This is what sets predatory behavior apart from good old fashioned competition in which one company eliminates the competition because they are able to produce at a lower cost. In this type of competition, the success of the more efficient company drives down prices and increases the surpluses generated from production and exchange. The companies that can't compete go out of business and free up their resources of labor and capital for other companies to use. This type of economic carnage would be considered creative destruction but it might be indistinguishable from the carnage produced by predation to those suffering from it.

Concerns about predation are not unique to foreign trade, and, indeed large national companies like Wal-Mart are often accused of this type of predation against small local businesses. However, claims of dumping are most common in international trade where there is the added concern that foreign governments might enable their domestic companies to endure short term losses in a foreign market. Governments might do that by providing export subsidies or tax credits (which are much the same thing) or by protecting their own market so that their companies can sell their products at a higher price in the domestic market to compensate for selling at a lower price abroad.

This possibility has led to "dumping" being defined rather simplistically as selling at a lower price overseas than at home. The Generalized Agreement on Tariffs and Trade (GATT) and the rules of the World Trade Organization allow nations to apply corrective or retaliatory tariffs on goods that are being dumped by this definition. The WTO explains dumping and it rules for anti-dumping actions as follows:

If a company exports a product at a price lower than the price it normally charges on its own home market, it is said to be “dumping” the product. Is this unfair competition? Opinions differ, but many governments take action against dumping in order to defend their domestic industries. The WTO agreement does not pass judgement. Its focus is on how governments can or cannot react to dumping — it disciplines anti-dumping actions, and it is often called the “Anti-Dumping Agreement”.... 

The legal definitions are more precise, but broadly speaking the WTO agreement allows governments to act against dumping where there is genuine (“material”) injury to the competing domestic industry. In order to do that the government has to be able to show that dumping is taking place, calculate the extent of dumping (how much lower the export price is compared to the exporter’s home market price), and show that the dumping is causing injury or threatening to do so.

Note that the WTO expresses an ambivalence about the fairness of dumping in the above passage.  This is partly because the simple definition of dumping misses key aspects of the predatory scenario, i.e., that the companies are selling below cost (or at an unsustainably low price) and that the ultimate result will be higher prices due to decreased competition. Therefore, not everything labeled as dumping will necessarily be predatory and it is possible that companies engaged in beneficial efficiency based competition will be accused of dumping.

Furthermore, the domestic import competing industry will suffer injury whether the low prices of the foreign industry are predatory or not. Creative destruction may be good for the economy, but it is not good for the less efficient (or comparatively disadvantaged) businesses or industries. Therefore, an accusation of dumping may simply be camouflage for protecting a domestic industry from competition. In this sense, complaining about dumping may be the "last refuge of a scoundrel" under the current rules of international trade.

To put this in the context of something we have more personal experience with, consider the case of Wal-Mart. As mentioned earlier, Wal-Mart is often accused of selling below cost to drive out competition, though this seems to have been a more popular charge to make in the 1990s and 2000s. The question is, has Wal-Mart later raised prices to benefit from the loss of competition? I think it is pretty clear that they have not since a reputation for low prices is key to the success and stock value of the company. Also, Wal-Mart faces very significant competition from Target (or tar-Jay) which comes close to matching its prices and has a reputation for higher quality goods.

The story I would tell about Wal-Mart is that they came up with a more efficient way to sell products in comparison to local and regional retailers. This means that their lower prices are not a short-term phenomena. The proof of their retail model's superior efficiency lies in the fact that Target has been able to copy it and, thus, negate the possibility that Wal-Mart can charge monopolistic prices after driving out competitors. Wal-Mart's so called downtown busting effect is, therefore, creative destruction not predation.

For an example of international dumping, consider the case of shrimp imports to the US. In 2004, the US ITC announced that it had officially found that exporters of frozen and canned shrimp to the US from  Brazil, China, Ecuador, India, Thailand, and Vietnam were dumping and that this was causing significant injury to the US shrimp industry. Tariffs were placed on shrimp imports from these nations with the proceeds from those tariffs being distributed to US shrimp companies affected by the imports (this last part is due to the somehwat controversial Byrd Amendment).

As part of the US anti-dumping process, the Department of Commerce (DoC) investigated the domestic prices of frozen and canned shrimp in three countries and compared it to the price being charged for shrimp exported to the US. In the case of Chinese exporters, the DoC calculated that most Chinese exporters were selling shrimp 55% below the price of shrimp in China (with a couple of companies selling at a margin of above 80% below domestic prices). However, in Ecuador and Vietnam the margin was about 3-5%, the margin in Thailand was about 6%, and in India and Brazil it was about 10%.

So what do we make of these numbers? You might make the case that China is doing something strategic here or that they have significantly manipulated their domestic prices to inflate the price of shrimp in China for other reasons (it is China after all). However, the other nations have much lower margins that might be accounted for by reasons other than predatory pricing. Perhaps consumers in these countries are willing to pay more for frozen and canned shrimp than US consumers. Maybe, the domestic companies are able to charge a higher domestic price due to a pro-home product bias among consumers in their country (and a anti-foreign product bias among US consumers). Of course, it could also be that the governments in these countries are supporting exports by giving tax credits for exports or preventing foreign suppliers of shrimp into their domestic markets.

A bigger point here is that, with six countries exporting shrimp to the US, is there really any danger of them raising prices if the US shrimp industry shrinks? That is to say, can we tell a convincing story about these nations colluding to swamp the US with cheap shrimp, drive US shrimpers out of business, and then collectively raise prices (like some kind of shrimp OPEC) to recoup their losses and make future profits? Or, is it more likely that whatever export supporting policies are in place will remain in place in these nations and competition between them will keep the price of shrimp low even if there are less US shrimpers? This latter scenario is not much better for the US shrimp industry, but is quite favorable for US consumers of shrimp.