TPP Critics’ Nighttime Fears Fade by Light of Day

The TPP (Trans Pacific Partnership) that was finally agreed among trade negotiators of 12 Pacific countries on October 5 came as a triumph over long odds.  Tremendous political obstacles, domestic and international, had to be overcome over the last five years.  Now each country has to decide whether to ratify the agreement.

Many of the issues are commonly framed as “Left” versus “Right.”  The unremitting hostility to the negotiations up until now from the Left – often in protest at being kept in the dark regarding the text of the agreement — has carried two dangers.  One danger was that opponents would succeed in blocking negotiations altogether.  Indeed, when Democrats in Congress voted against giving President Obama the necessary authority in June, the entire negotiations were widely declared to be dead. This would have been a shame — at least in the view of most economists — because the resulting trade liberalization was very likely in the end to turn out beneficial overall.

The second danger was that the Administration would be forced at the margin to move to the “Right” in order to pick up votes from Congressmen who said they would support the outcome if (and only if) it contained provisions that were sufficiently generous to American corporations.  Those concerned about labor and the environment risked hurting their own cause by seeming to say that they would oppose the agreement no matter how well it did at including provisions to their liking, which could have undermined the White House incentive to pursue their issues.

In this light, this month’s outcome is a pleasant surprise.  In the first place, the agreement gives the pharmaceutical firms, tobacco companies, and other corporations substantially less than they had asked for — so much so that Senator Orrin Hatch (Utah) and some other Republicans now threaten to oppose ratification in the final up-or-down vote.   In the second place, the agreement gives the environmentalists more than most of them had bothered to ask for.  I don’t know the extent to which what we are seeing was the result of hard bargaining by other trading partners such as Australia.  Regardless, it is a good outcome.  The domestic critics might consider now taking a fresh look with an open mind.

The issues that are the most controversial in the US are sometimes classified as “deep integration,” because they go beyond the traditional negotiated liberalization in trade tariffs and quotas.  Two categories are of positive interest to the Left: labor and the environment. Two categories are of “negative interest” to the Left in the sense that it has feared excessive benefits for corporations:  protection of the intellectual property of pharmaceutical and other corporations and mechanisms to settle disputes between investors and states.

Now that the long-delayed agreement is completed, what turns out to be in it?  Two good things in the TPP’s environment chapter are especially noteworthy.  First, it takes substantial steps to enforce prohibition of trade in endangered wildlife — banned under CITES (Convention on International Trade in Endangered Species) but insufficiently enforced.  Second, it also takes substantial steps to limit subsidies for fishing fleets — which in many countries waste taxpayer money in pursuit of the overfishing of our oceans.  For the first time, apparently, these environmental measures will be backed up by trade sanctions.

I wish that certain environmental groups had spent half as much time ascertaining the specific possibility of good outcomes like these as they spent in sweeping condemnations of the process.  The agreement on fishing subsidies was reached in Maui in July; but critics were too busy to take notice.   Fortunately it is not too late for them to climb on board now.

Some NGOs might still worry that these provisions will not be enforced strongly enough.  But trade penalties are among the most powerful tools for enforcement of international agreements that exist; for that reason environmental groups in the past have asked that such measures be placed in the service of environmental goals.   There is no denying that the TPP provisions on endangered species and fishing are steps forward.

A variety of provisions in the area of labor practices, particularly in Southeast Asia, should also be of interest. They include steps to promote union rights in Vietnam and steps to crack down on human trafficking in Malaysia.

The greatest uncertainties were over the extent to which big US corporations would get what they wanted in the areas of investor-government dispute settlement and intellectual property protection.   On the one hand, critics often neglected to acknowledge that international dispute settlement mechanisms could ever serve a valid useful purpose.  Similarly, they often neglected to acknowledge that some degree of patent protection is indeed needed if pharmaceutical companies are to have an adequate incentive to invest in research and development of new drugs.  But, on the other hand, there was indeed a possible danger that such protections for corporations could have gone too far.

The dispute settlement provisions might have interfered unreasonably with member countries’ anti-smoking campaigns, for example.  In the end, the tobacco companies did not get what they had been demanding.  Australia is now free to ban brand name logos on cigarette packets.  TPP sets a number of other new safeguards against misuse of the investor-state dispute settlement (ISDS) mechanism as well.  For example there is a provision for rapid dismissal of frivolous suits.  The rest of the details are publically available in clear bullet point form, from USTR, if one takes the trouble to read them.

The intellectual property protections might have extended to other TPP member markets a 12-year period of protection for the data that US pharmaceutical and bio-technology companies compile on new drugs (biologic medical products, in particular), and might have made it too hard for generics to eventually bring the benefits to the public at lower costs.  In the end, these companies too did not get much of what they had wanted. The TPP agreement assures protection of their data for only 8 years in some places and 5 years in others and instead relies on the latter countries to use other measures to constrain the appropriation of the firms’ intellectual property.

The focus on new areas of deep integration should not obscure the old-fashioned free-trade benefits that are also part of TPP: reducing thousands of existing tariff and non-tariff barriers that inhibit trade.  Many of these reductions benefit US exports.   (Most US barriers against imports were already very low.)  Liberalization in manufacturing includes the auto industry, for example. Liberalization in services includes the internet.

The liberalization of agriculture is noteworthy; this sector has long been a stubborn holdout in international trade negotiations.   Countries like Japan have agreed to let in more sugar, beef, pork, rice and dairy products, from more efficient producer countries like Australia and New Zealand. In all these areas and more, traditional textbook arguments about the gains from trade apply: new export opportunities, higher wages, and a lower cost of living.

Many citizens and politicians made up their minds about TPP some time ago, based on having read seemingly devastating critiques of what was feared would emerge from the trade negotiations.   When the text of the agreement is released is the time for the critics to read the specifics that they have so long hungered to see and to decide whether they can support it after all.  They just might discover that their nighttime fears are much diminished by the light of day.

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Answering the TPA Critics Head-On

In recent op-eds and blog-posts I have argued that prospective trade agreements like the TPP (the Trans Pacific Partnership) would be economically beneficial for reasons similar to past trade agreements and that they would have geopolitical benefits too. I have also opposed adding currency manipulation to the trade negotiations.

I am far from alone. Such support for giving the White House Trade Promotion Authority (TPA) is shared by most economists, including 14 former chairs of the president’s Council of Economic Advisers.  But we supporters have not sufficiently responded to the most common arguments of the critics of the TPA process:  a perceived abandonment of democracy and transparency.

Despite what one reads, I see no such abandonment, relative to the way that trade negotiations have been pursued by the United States in the past or relative to the way that they are pursued by other countries. Regarding democracy: under Trade Promotion Authority the Congress would vote on the final agreement that the executive branch has negotiated (thumbs up or thumbs down). Regarding transparency: the details of TPP or TTIP that are unknown are details that have not yet been concluded in the international negotiations.

The negotiations could not proceed if Congress were intimately involved every step of the way.  That is why it has been done this way in the past. There is nothing different this time around (unless it is the extra degree of exposure that draft texts have received).

It is true that these trade negotiations include more emphasis than many in the past on issues of labor and environment, on the one hand, and intellectual property rights and investor-state dispute settlement on the other hand. And it is true that, to get it right, the details of these issues need fine calibration.  But here is the point that everyone seems to have missed, in my view: even if it were somehow logistically possible for international negotiations to proceed while the US Congress were more intimately involved along the way, the outcome would be far more likely to get the details wrong — with big giveaways to special interests – than under the usual procedure of delegating the detailed negotiations to the White House. I know that no commentator is ever supposed to say that any political leader can be trusted.  But I do trust President Obama on this, far more than I trust Congress.

The Top Ten Reasons Why Trade Agreements Should Not Cover Currency Manipulation

President Obama is still pressing the difficult campaign to obtain Trade Promotion Authority and use it to conclude international negotiations — across one ocean for the Trans Pacific Partnership (TPP), and then across the other ocean for the Transatlantic Trade and Investment Partnership (TTIP). Many in the Congress, particularly many Democrats, insist that the trade agreements must include mechanisms designed to prevent countries from manipulating their currencies for unfair advantage.

The President is right.  The congressmen are wrong.  More suitable venues for discussing exchange rate issues with our trading partners include the IMF, the G-20, the G-7, and bilateral negotiations.

Here are the top ten reasons why including currency manipulation language in the trade negotiations would be unwise.

  1. If the US were to insist that “strong and enforceable currency disciplines” be part of trade negotiations, that would kill the negotiations.  Other countries would not go along.  And yet both the US and its trading partners stand to gain from these deals.
  2. Other countries would not go along with the manipulation language for good reason:  It is a bad idea.  True, there are times when particular countries’ currencies can be judged undervalued or overvalued and times when their trading partners have a legitimate interest in raising the question with their governments.  But even in those cases when the currency misalignment is relatively clear, trade agreements are not the right venue to address it.  The undervalued RMB  was  addressed in bilateral China-US discussions, 2004-11, eventually with success. China allowed the currency to appreciate 35% over time.  Today it is well within a normal range.
  3. Most often it is impossible to tell whether a currency is overvalued or undervalued.  Manipulation is not like the existence of a tariff or quota that can be verified by independent observers.
  4. A necessary condition for a country to be judged as manipulating its currency is that the authorities are intervening in the foreign exchange market.   The People’s Bank of China, for example, bought up a record quantity of dollars in exchange for renminbi from 2004 to 2014, and thereby kept its currency from appreciating as fast as it otherwise would have.   But, in the first place, the Chinese aren’t doing that anymore.  If anything, they have been selling dollars in exchange for renminbi over the last year, keeping the value the currency higher than it would otherwise be.   (Accordingly China’s reserves peaked at $3.99 trillion in July 2014 and then declined to $3.73 trillion by April 2015.) The implication is that US congressmen who say they want China to stop manipulating the currency might be unhappy with the consequences if that happened. Under current conditions, the renminbi would weaken, not strengthen, and American firms would find themselves at more of a competitive disadvantage, not less.  Be careful what you wish for.
  5. In the second place, there are often legitimate reasons for intervening in the foreign exchange market, including even in cases of intervention to push the currency down.   An example would be the overvalued dollar in 1985, when the US joined with Japan, Germany, and other G-7 countries in concerted  intervention  in the foreign exchange market – associated with  the Plaza Accord — to push the dollar down, bringing it off of a perch that at the time was much higher than where the dollar is today.  Certainly intervening to prevent a currency from appreciating, which is what China did over the last decade, is not per se an illegitimate policy. Indeed a heavy majority of countries pursue either fixed exchange rates, exchange rate targets, or managed floating,  all of which are legitimate policies that by definition entail buying and selling of foreign exchange to moderate or eliminate fluctuations in the exchange rate.
  6. In the third place, China isn’t even in the TPP, nor in the TTIP, the two sets of trade negotiations in which the US is involved and for which President Obama wants Congress to give him Trade Promotion Authority.
  7. Japan is in the TPP and it is true that the yen has depreciated a lot over the last year.  Some US economic interests, particularly the auto industry, accuse Japan of manipulation to keep the yen unfairly undervalued.  Many congressional critics cite Japan as the target of their proposals to insist that currency manipulation language be part of the TPP.  But the last time the Bank of Japan intervened in the foreign exchange market was 2011.  (This was an appropriate move, in the aftermath of its tsunami, to bring the yen down off a perch that was its post-war record high.)  In 2013 Japan joined other G-7 countries in agreeing to a proposal from the Obama Treasury to refrain from foreign exchange intervention.   The agreement is still in effect.

Similarly with Europe: members of the Eurozone are in the TTIP negotiations; the euro too has depreciated a lot over the last year; and some US trade critics accuse Europe of currency manipulation.   But the European Central Bank has not intervened in the foreign exchange market since 2000, and that was to support the euro not depress it.  The ECB was party to the 2013 agreement not to intervene as well.

  1. The critics who accuse Japan and other major countries of currency manipulation presumably know that they haven’t been intervening in the foreign exchange market in recent years.  They generally point instead to recent loosening of monetary policy, such as quantitative easing, i.e., the purchases of domestic bonds, which the Bank of Japan and the European Central Bank have prominently pursued with the predictable side effect of depreciating their currencies.  But countries can hardly be enjoined from easing monetary policy when domestic economic conditions warrant, as was so obviously the case in Japan and Europe.
  2. If monetary expansion does not merit the charge of currency manipulation just because it can be expected to keep the value of the currency lower than it would otherwise be, still less do other sorts of economic policies.  Some have argued that even though the People’s Bank of China has stopped buying US and other foreign assets, China’s Sovereign Wealth Funds still do, and that this too counts as manipulation.  But for China to put some of its saving abroad is a perfectly sensible and legitimate thing to do.  The United States would worry if China and other countries did not want to buy its assets.
    Moreover, think of the reductio ad absurdum.  Every country makes policy decisions of many sorts every week, many of which can be expected to have an indirect side effect on the exchange rate in one direction or the other direction.  (Often stupid policies are the ones that weaken the currency – think of Argentina, Russia, or Venezuela.  But not always.)  That a particular policy might have the effect of weakening the currency does not mean that the country is a manipulator.
  3. Finally is the point that if legal language were written to include the actions of the major trading partners’ central banks that US congressmen accuse of currency manipulation, then it could also be applied the other direction, against the United States.  This would not be a case of misusing a tool – which is common enough among trade remedy cases when interest groups lobby for protection against foreign competition. (An example is the use of Anti-Dumping measures that were originally supposed to address cases of predatory pricing.)  Rather it would be a case of using the tool in precisely the way it was written to be used.   The Fed adopted quantitative easing in 2008 in response to the weakening US economy, just as trading partners have done recently.   It continued to pursue QE up until recently. This had the effect of depreciating the dollar from 2009 to 2011, prompting the same charges of “beggar thy neighbor policies” (allegations of attacks in a supposed currency war) that US congressmen now level against others.

In either direction, whether by the United States or against it, such charges are on shaky ground.   Monetary stimulus in one country may even have a beneficial effect on the rest of the world, as its own restored income growth leads to increased imports from its trading partners.   But in any case, other countries are free to adopt whatever monetary policy suits their own economic circumstances. Whether one considers charges leveled against the US in 2010, against its trading partners in 2015, or against some unknown defendant in the future, it would be asking for trouble to have a trade agency rule on them.


The Fiscal Stimulus and Market Turnaround: 5-Year Anniversary

Commentators are taking note of the five-year anniversary of the fiscal stimulus that President Obama enacted during his first month in office.   Those who don’t like Obama are still asking “if the  fiscal stimulus was so great, why didn’t it work?”    What is the appropriate response?

Those who think that the spending increases and tax cuts were the right thing to do have given a number of responses, which sound a bit weak to me.  The first is that the stimulus wasn’t big enough.  The second was that the Great Recession would have been much worse in the absence of the stimulus, perhaps a replay of the Great Depression of the 1930s.  (The media are fond of this line of reasoning because it allows them to escape making a judgment.  They can just say “nobody knows what would have happened otherwise.”)    The third response is that the fiscal stimulus was short-lived, and in fact was reversed by the Congress by 2010.

I believe that each of these three statements is true.   But they sound weak because they look like attempts to explain away the absence of a visible positive impact.  Listening to these arguments,  one would think that no effect of the Obama stimulus could be seen by the naked eye in the U.S. economic statistics of 2009.    Nothing could be further from the truth.

Recall the timing.  Obama was sworn in on January 20, 2009. The economy and financial markets had been in freefall ever since the Lehman Brothers failure four months earlier (September 15).   The President quickly proposed the American Recovery and Reinvestment Act, got it through Congress despite strong Republican opposition, and signed it into law on February 17.

If one judges by the economic statistics, the effect could not have been much more immediate, whether the crierion is job loss, GDP, or financial market indicators.   Look at the graphs below.

The stock market, which had been falling steeply since September, hit bottom on March 9, 2009, and then started a 5-year upward trend.   The index shown in Figure 1 is the S&P 500.  The turnaround can’t be missed.  Wall Street should get ready to celebrate the anniversary on March 9.

The much-maligned TARP and bank stress-tests also played important roles, unfreezing financial markets.  Bank interest rate spreads were back to pre-Lehman levels by February 2009 and back to pre-subprime-crisis levels by June.

What about the real economy?  That is what matters, after all.   Economic  output was in veritable freefall in the last quarter of 2008: a shattering 8.3 % p.a. rate of decline (BEA).  More specifically, the maximum rate of contraction came in December 2008, according to the monthly GDP estimates from the highly respected MacroAdvisers.   (For charts in the form of growth rates, see Figures 1 and 2 ofmy post on the 3-year anniversary.)  The free-fall stopped in the first quarter of 2009.   As the GDP graph below shows, economic activity was flat, scraping along the bottom until June, after which growth resumed.   The official end  of the recession thus came in June.   Visible to the naked eye.

The rate of job loss bottomed out in March 2009.  It is there for anyone to see.   The graph shows private sector employment changes.  Thus the turnaround does not count government jobs directly created by the fiscal stimulus.  Job creation turned positive after the end of the year.  Since then, though employment gains have been much too slow, they have on average exceeded the rate during the corresponding period under George W. Bush.

Of course there are always a lot of things going on. One cannot say for sure what was the effect of the Obama stimulus. And one can debate why the pace of the expansion slowed after 2010. (My own prime culprit is the switch to fiscal austerity.)

But whether looking at indicators of economic activity, the labor market, or the financial markets, the idea that the fiscal stimulus of February 2009 had no apparent impact in the numbers is wrong.

[Comments can be posted at the Econbrowser version or in the always-lively debate at Economist’s View.]

What Do Obamacare and the EITC Have in Common with Cap-and-Trade?

My preceding blog post described how market-oriented mechanisms to address environmentally damaging emissions, particularly the cap-and-trade system for SO2 in the United States, have recently been overtaken by less efficient regulatory approaches such as renewables mandates.   One reason is that Republicans — who originally were supporters of cap-and-trade — turned against it, even demonized it.

One can draw an interesting analogy between the evolution of Republican political attitudes toward market mechanisms in the area of federal environmental regulation and hostility to the Affordable Care Act, also known as Obamacare.   The linchpin of the program is the attempt to make sure that all Americans have health insurance, via the individual mandate.  But Obamacare is a market mechanism, in that health insurers and health care providers remain private and compete against each other.

As has been pointed out countless times, this was originally a conservative approach, designed to work via the marketplace:  The alternative is to have the government either (i) directly provide the health insurance (a “single payer” system, as in Canada; or under US Medicare for that matter) or (ii) directly provide the health care itself (”socialized medicine,” as in the UK; or the US Veterans Administration hospitals).  The new approach was proposed in conservative think tanks such as the Heritage Foundation. It was enacted in Massachusetts by Republican Governor Mitt Romney. By the time President Obama adopted it, however, it had become anathema to Republicans, most of whom forgot that it had ever been their policy.

One can trace through the parallels between clean air and health care.  The market failure in the case of the environment is that pollution is what economists call an externality:  In an unregulated market, those who pollute don’t bear the cost. The market failure in the case of health care is what economists call adverse selection:  Insurers may not provide insurance, especially to patients with pre-existing conditions, if they have reason to fear that the healthy customers have already taken themselves out of the risk pool.

Government attempts to address the market failure can themselves fail.  In the case of the environment, command-and-control regulation is inefficient, discourages innovation, and can have unintended consequences.   For example, CAFÉ standards (Corporate Average Fuel Economy) were partly responsible for the rise of the SUV.  Corn ethanol mandates raised food prices and accomplished nothing for the environment.  When “New Source Review” requires that American power companies adopt the most stringent available control technology if they build a new power plant, they respond by keeping dirty old plants running as long as possible (Stavins, 2006).

In the case of health care, a national health service monopoly can forestall innovation and provide inadequate care with long waits.  In general, the best government interventions are designed to target the failure precisely – using cap-and-trade to put a price on air pollution or using the individual mandate to curtail adverse selection in health insurance — and otherwise let market forces do the rest more efficiently than bureaucrats can.

American conservatives often talk as if the alternative they would prefer is no regulation at all.  But few in fact would want to go back to the unbreathable pre-1970 air of Los Angeles, London, or Tokyo.  Even those few who might want to should recognize that most of their fellow citizens feel differently.  Political reality shows that the alternative in practice is an inefficient rent-seeking system in which solar power, corn-based ethanol, and fossil fuels all get subsidies or mandates.  Analogously, few conservatives in fact will say that they want hospital emergency rooms to turn away critically ill patients who lack health insurance.  Even for those who might want this, reality shows that the alternative in practice is hospitals that give emergency care to those who lack insurance, whether because of personal irresponsibility or for reasons beyond their control, and then pass the charges on to the rest of us.

A third example is the Earned-Income Tax Credit.  It was originally considered a conservative idea: an implementation of Milton Friedman’s proposed negative income tax, it was championed by Ronald Reagan as a pro-work market-friendly way of addressing income inequality.   President Obama proposedexpanding the EITC in his State of the Union address last month.  But conservatives, again forgetting that it was their own creation, have opposed expansion of the EITC as verboten redistribution.   So proposals to increase the minimum wage get more political traction as a way to address income inequality, even though that approach is more interventionist and less efficient.

[This is the second of a two-part post, which in turn is the extended version of an op-ed published atProject Syndicate.  Comments may be posted there; or join the debate at Economist’s View.]

IMF Reform and Isolationism in Congress

A long-awaited reform of the International Monetary Fund has now been carelessly blocked by the US Congress.   This decision is just the latest in a series of self-inflicted blows since the turn of the century that have needlessly undermined the claim of the United States to global leadership.

The IMF reform would have been an important step in updating the allocations of quotas among member countries.  From the negative congressional reaction, one might infer that the US was being asked either to contribute more money or to give up some voting power.   (Quotas allocations in the IMF determine both monetary contributions of the member states and their voting power.)  But one would then be wrong.  The agreement among the IMF members had been to allocate greater shares to China, India, Brazil and other Emerging Market countries, coming largely at the expense of European countries.  The United States was neither to pay a higher budget share nor to lose its voting weight, which has always given it a unique veto power in the institution.

The change in IMF quotas is a partial and overdue adjustment in response to the rising economic weight of the newcomers and the outdated dominance of Europe.   Voting share in the IMF is supposed to be in proportion to economic weight, not equal per capita or per country.  This acknowledgement of reality, the principle of matching the representation to the taxation, is sometimes known as the Golden Rule: “He who has the gold, rules.”  The principle is probably one of the reasons why the IMF has usually been a more effective organization than others such as the UN General Assembly.

It’s not that President Obama hasn’t tried to exercise global leadership, as just about any US president would.  He pushed for this agreement to reform the IMF at the G20 summit in Seoul in November 2010 (the first meeting of the group of leaders to have been hosted by a non-G7 country).  He prevailed despite understandable European reluctance to cede ground.

Some American congressmen may not be aware of the extent to which the IMF reform agreement represented the successful efforts of the US executive to determine the course of the international negotiations.  But then the rejection by the US Congress of an international agreement that the president had painstakingly persuaded the rest of the world to accept is not a new pattern.    It goes back a century, to the inability of President Woodrow Wilson to persuade a tragically isolationist US Congress to approve the League of Nations (1919).   Examples over the last century also include the International Trade Organization (1948), SALT II (1979), and the Kyoto Protocol (1997), among others.  A past history of trying to re-open international negotiations that the executive has already concluded is also the reason why Congress has to give President Obama trade promotion authority (that is, the usual commitment to fast-track congressional votes on trade agreements), or else our trading partners will not negotiate seriously.  This would impede ongoing talks in the Pacific, with Europe, and globally (in the venues, respectively, of the Trans-Pacific Partnership, Trans-Atlantic Trade and Investment Partnership, and the World Trade Organization).

Commentators have been warning since the 1980s that the US may lose global hegemony for economic reasons, as an effect of budget deficits, a declining share of global GDP, and the switch from net international creditor to net debtor.  One version is the historical hypothesis of imperial overstretch (Kennedy, Rise and Fall of the Great Powers, 1987).

But the main problem seems to be a lack of will rather than a lack of wallet.   Or perhaps it would be more accurate to describe the problem with US domestic politics as wild swings of the pendulum between excessive isolationism and excessive foreign intervention in reaction to short-term events, untempered by any longer term historical perspective.   After the United States lost 18 rangers in Somalia in October 1993 (Blackhawk Down), Congress became highly resistant to just about any foreign intervention, no matter how big the “bang for the buck.”   Then, after September 11, 2001, it was prepared to follow President George W. Bush into just about any military intervention, no matter how dubious the benefit or how high the cost.   The total cost of the wars in Iraq and Afghanistan has recently been estimated at $4 trillion by my colleague Linda Bilmes, co-author with Joe Stiglitz of The Three Trillion Dollar War, 2008.  (It’s not just that the wars lasted for ten years; the biggest costs of such wars come subsequently, particularly for medical care that veterans need for the rest of their lives.)  These days, the pendulum has apparently swung back to the isolationist direction once again.

One had hoped that myopic congressmen had been made aware that among the costs of the foolish US government shutdown three months ago was damage to the country’s global credibility and leadership.   Most visibly, to deal with the shutdown, the White House in October had to cancel its participation at the leaders’ summit of APEC (Asia-Pacific Economic Cooperation) in Bali and thereby stymie progress on the US-led Trans-Pacific Partnership.  It was widely reported that the Asian countries drew from Obama’s absence the conclusion that they should play ball with China instead (Drysdale, “Asia Gets on with It While America’s out of Play,” Oct. 7, 2013.)

The increasing power of China and other major emerging market countries is a reality.  It is precisely what makes it important that the United States support a greater role for these countries in international institutions such as the IMF, the G20, and APEC.

The rise of China could go well or badly for international relations.  It depends in part on whether the status quo powers make room for the newcomer (Nye, 2013).This historical pattern famously goes back to Thucydides’ description of the rising power of ancient Athens and the resulting war with Sparta (History of the Peloponnesian War).  Examples of the consequences of failing to accommodate the new arrival include the role of Germany’s rise in the origins of World War I 100 years ago (e.g., Gilpin, War and Change in International Politics, 1981).

The new Chinese President, Xi Jin Ping, has used the phrase “New Type of Great Power Relationship.” It sounds anodyne but may carry greater significance.   The phrase apparently demonstrates awareness of the historical “Thucydides trap.”  It signals China’s openness to working with other countries to avoid the tragedies of 460 BC and 1914 AD. It is only sensible to take him up on his offer and so smooth international relations into the future.

The potential for US leadership has survived remarkably well the loss of national status as an international creditor.   This has partly been a matter of luck.  In Asia, historical and territorial frictions among Japan, Korea, and China, have kept US participation far more welcome in the Pacific than it would otherwise be. Meanwhile, in Europe, fiscal follies have been even more egregious than America’s.  Asians are aware that the IMF has stretched the rules to lend into the euro crisis on a greater scale than it did during the Asia crisis of 1997-98.  They understandably feel entitled to a greater say in the running of the Fund.   But the emerging market countries have been so disunited, for example, that no two of them could come together in 2011 to support a common candidate for IMF Managing Director, notwithstanding that the three previous incumbents were European men who flamed out before completing their terms in office.  (The result was a European woman, Christine Lagarde.  She has done a good job rather than kowtowing to Europe; but that is beside the point.)

The latent demand around the globe for enlightened US leadership, which first appeared at the end of World War I, is still there.  It can survive budgetary constraints (and apparently can survive misguided military interventions).  But it cannot survive an abdication of interest on the part of the US Congress.

[This column appears at East Asia Forum. It is an extended version of an op-ed, titled “Absent America,” that appeared first at Project Syndicate.  The author would like to thank Joe Nye and Ted Truman for comments.]

Will Financial Markets Crash Before October 17, or After?

October 4 is the first Friday of the month, the day when the Bureau of Labor Statistics routinely reports the jobs numbers for the preceding month.   Is the havoc created by our current political deadlock over fiscal policy showing up as job losses?   We have no way of knowing.  On October 1 the BLS closed for business, like many other “non-essential” parts of the government.  There will be no more employment numbers until the shutdown ends.

Last week, Wall Street economic analysts responded to the usual surveys as to what they thought the upcoming employment numbers would be.   (These surveys are what the media refers to each month when they tell you that employment rose or fell “more than economists expected.”)    The median forecast in last week’s  Bloomberg survey, for example, was a prediction that the BLS would report that “Payrolls increased by 175,000,” the biggest gain in four months.   But there was no word on how many of the respondents recognized that there would in fact probably be no number at all on October 4, because the Labor Department would have been closed by the government shutdown.

It seems to me that this minor blind-spot is symbolic of a failure of Wall Street to focus adequately, until now, on the long-impending government shutdown and still-impending October 17 deadline for raising the national debt ceiling.   One reason for the lack of concern up until this point is that observers are jaded; they feel they have seen this movie before (with fiscal cliffs, sequesters, shutdowns, and ceilings); that it is “only politics;” and that Washington always averts catastrophe at the last minute. Well, maybe not this time.

Another reason is that the financial markets all summer long were busy over-reacting to developments regarding the Federal Reserve.   The stock market reached a high two weeks ago on the information, which was considered news, that monetary policy was not going to be tightened imminently after all.   Now the fixation is passing from monetary policy to fiscal policy. Not a moment too soon.

Both sides in Washington are firmly dug in, and don’t plan to back down.  If the politicians don’t get their act together  and the debt ceiling is really not raised, the results will be very bad indeed.   I actually mean “if the Republicans don’t get their act together.”  I think President Obama is fully credible when he says he will not let one faction in one party in one house of congress, in one branch of the government, threaten to blow us all  up if they don’t get their way on the Affordable Care Act.

The US has never defaulted on its obligations before.  Some continue to imagine that the government could stay within the debt ceiling but meet its obligations out of incoming tax revenue.  This is wrong.  Even if there were enough tax revenue to service the treasury debt for awhile, there would not be anywhere near enough to meet all the other legal obligations that the federal government has already incurred under the congressionally passed budget.  If the government doesn’t pay Staples the money that is owed for office supplies that it bought last month, that is a legal default just as much as if it fails to service its bonds.

Perhaps, given the desperation of the situation when the time comes, President Obama could try one of the gimmicks that have been proposed, such as minting the trillion dollar coin or taking the position that the debt ceiling violates the constitution or other laws.   These are not attractive options because they would probably provoke a constitutional crisis.   So let’s assume that he doesn’t take them.

It seems to me that this then leaves two possible outcomes: either the financial markets fall before October 17 and the Republicans respond by backing down or the financial markets fall after October 17 and the Republicans respond by backing down.   Precedents for financial markets forcing such a reversal include the delayed congressional passage of the unpopular TARP legislation in the fall of 2008 and the delayed passage of an unpopular IMF quota increase 10 years earlier.   (In the last debt ceiling showdown, in August 2011, default was avoided at the last minute;  but the stock market fell sharply anyway, when S&P for the first time ever downgraded US debt from AAA.)

After a remark by Obama about the markets yesterday, some accused him of “scare tactics,” of fanning Wall Street fears for political advantage.  The reality is almost the reverse:  if Obama thinks like a pure politician, he will let the Republican Party complete the process of committing suicide (suicide by means of binge tea partying).  The way to do this would be to wait until October 17 and let the Republicans take the blame not just for a decline in the stock market or for the inconvenience to anyone who has to deal with the government during the shutdown, but – if there is no resolution in time to raise the debt ceiling – to take the blame for the likely result: a second global financial crisis and global recession.

But that would be a very high price to pay for political advantage.  Even if the Republicans cave in within a few days after October 17, so as to avert the global recession, by then the creditworthiness of US Treasury debt will have been irreparably harmed.  My guess is that Obama thinks it would be much better for the country if the markets were to tank and the Republicans to back down before October 17 rather than after, even though the Tea Party would then live to fight another day.

[I discussed these matters this morning on BBC radio, “US Shutdown Risk to Global Economy,” and Fox Business News, “Who Will Listen to the President’s Warning to Wall Street?” Varney & Co..  One of the Fox team claimed that the stock market has usually gone up in government shutdowns.  It turned out that her statistic referred to the subsequent month;  in other words the market goes up when the shutdown is ended.  In fact it typically goes down during shutdowns, by 2 ½ % in the case of those lasting 10 days or more. It looks to me that this exchange was excluded from the segment posted on the Fox website.]

Recent Jobs & Growth Numbers: Good or Bad?

This morning’s US employment report shows that July was the 34th consecutive month of job increases.   Earlier in the week, the Commerce Department report showed that the 2nd quarter was the 16th consecutive quarter of positive GDP growth.   Of course, the growth rates in employment and income have not been anywhere near as strong as we would like, nor as strong as they could be if we had a more intelligent fiscal policy in Washington.  But the US economy is doing much better than what most other industrialized countries have been experiencing.   Many European countries haven’t even recovered from the Great Recession, with GDPs currently still below their peaks of six years ago.

US job growth has averaged 186 thousand per month over the last two years, or 167 thousand per month over the last three years.  Most people are aware of the improvement relative to the horrendous job loss during the 2008-09 recession.   But they are probably not aware of how the recent recovery record looks compared to the previous business cycle, the six years of recovery between the end of the 2001 recession and the economic peak at the end of 2007.  Job growth during those six years averaged 100 thousand per month, substantially lower than now.  The difference is even greater if one looks at private sector jobs numbers, because government employment expanded substantially under the Bush Administration whereas it has been contracting in recent years.

GDP growth has fallen well below 2% in the last three quarters.   But I think we know the reason for that:  dysfunctional fiscal policy.  Washington has been the obstacle to a normal robust recovery, through a combination of such factors as spending cuts since 2011, the expiration of the payroll tax holiday in January 2013, the sequester in March, and now business uncertainty arising from new time-bombs in the next two months, once again the needless result of partisan deadlock over passing a budget and raising the debt ceiling.  Given all that, it is surprising that private consumption and investment have held up as well as they have.

The right policy bargain, of course, is fiscal stimulus in the short term, not fiscal contraction, combined with steps today to address the entitlements problem in the long-term.   That would get us back to solid growth.  Our current pattern of pro-cyclical fiscal policy is exactly backwards.

[Comments can be posted at the Project Syndicate site or at Economist’s View.  I have been appearing on Fox Business, where Stuart Varney again today asked why we aren’t achieving high growth.  He also worries about the recent increase in part-week employment, apparently not realizing that this is an effect of the government sequester.]

Fear of Fracking: The Problem with the Precautionary Principle

An amazing thing has happened over the last five years.   Against all expectations, American emissions of carbon dioxide into the atmosphere, since peaking in 2007, have fallen by 12%, back to 1995 levels.  (As of 2012. US Energy Information Agency).   How can this be?   The United States did not ratify the Kyoto Protocol to cut emissions of greenhouse gases below 1997 levels by 2012, as Europe did.

Was the achievement a side-effect of reduced economic activity?   It is true that the US economy peaked in late 2007, the same time as emissions.   But the US recession ended in June 2009 and GDP growth since then, though inadequate, has been substantially higher than Europe’s.  Yet US emissions continued to fall, while EU emissions began to rise again after 2009 (EU).  Something else is going on.

The primary explanation, in a word, is “fracking.”   In fourteen words: the use of horizontal drilling and hydraulic fracturing to recover deposits of shale gas.

One can virtually prove that shale gas is the major factor behind the fall in US emissions.  Natural gas, especially when burnt in combined-cycle gas turbine power plants, emits only half as much greenhouse gas (GHG) as coal.   Ten years ago domestic natural gas production appeared to be reaching its limits; the industry was so sure of this that it made big investments in terminals to import Liquefied Natural Gas (LNG).  Yet the fracking revolution has increased the supply of natural gas so rapidly since then that LNG facilities are being expensively converted to export.   Clean natural gas occupies a rapidly increasing share of the generation of electric power.   It has come largely at the expense of coal’s share.  Within power generation, natural gas is up 37% since 2007, while coal is down 25%.  As a result, natural gas has drawn close to coal as the number one source of US power — unthinkable a short time ago. Renewables have been rising, but still constitute only 5% of power generation in the US.  This is less than hydroelectric and far less than nuclear, let alone coal or gas.

Meanwhile, the role of coal – the dirtiest fuel — has been rising in the energy mix of the rest of the world, not falling (IEA, Dec. 2012).  Coal’s share of power has even risen since 2010 in Europe (EC), where some countries are phasing out emission-free nuclear power and no shale gas boom has appeared.    (The trans-Atlantic comparison does not offer grounds for self-righteousness, however.   GHG emissions remain far higher in the US than in Europe.)

The advent of shale gas in the United States has had a variety of implications for the economy, national security, and the environment.  The implications are surely more good than bad.

Short-run economic advantages include job creation.   Medium-run economic advantages include the “re-shoring” of some manufacturing activities.   (It would be wrong to claim job creation as an advantage in the long-run.  Jobs that are created in the oil and gas sector would otherwise be created somewhere else.  But during the last five years of high unemployment, every new job has helped.)   Long-run advantages include reducing macroeconomic vulnerability to future global oil shocks such as those that led to serious recessions in the 1970s.

Moving beyond economics, the reduction in net energy imports is good for US national security.  What happens in the Middle East will still matter, but as oil imports fall American foreign policy will not be as constrained as in the past. US net oil imports have already fallen by half since 2007 and the downward trend is expected to continue.   In Europe, the new developments have the potential to break Russia’s troublesome stranglehold on the supply of natural gas.

That leaves the environment.  Here as well the effects on net appear beneficial.   As already noted, the substitution of natural gas in place of coal slows global climate change. Indeed the United States is now on track to meet the Obama administration’s international commitment of emissions 17% below 2005 levels by 2020.  But natural gas is also better for local air quality.  Burning coal puts sulfur dioxide, nitrous oxide, mercury and particulates into the air.

Yet it is among environmentalists that heartfelt opposition to fracking has arisen.  Why?

Environmentalists seem to have three sets of fears.  First, they worry that shale gas will displace renewable energy sources such as wind and solar power.  But the fact is that GHG emissions can’t be reduced without cutting coal emissions and that shale gas is already displacing coal in the USThis is not speculation about the future.  It has already been happening.  If renewables or fusion or something else currently unknown can take over after 2050, then great.  But we would still need natural gas as a bridge from here to there.

Put differently, if the world continues to build coal-fired power plants at the rate it has been, those plants will still be around in 2050 regardless what other technologies have become available in the meantime.  Solar power can’t stop those coal fired plants from being built today.  Natural gas can.

Cheap natural gas also helps with heating buildings and increasingly with transportation as well – particularly if electric plug-in cars become more widespread.  In overall primary energy production, natural gas at 31% has now surpassed coal, at 26%. The graph below shows the two lines crossing. (Table 1.2,  US EIA).  Solar and wind together account for only 2% of US primary energy production.

Second, environmentalists worry about local risks, especially to water supplies.  There are also fears of methane leaks and earthquake triggerings.  Such concerns cannot be dismissed.    It is not enough to proclaim that fracking should be safe if operators are responsible and regulators do their job.   One must take into account the likelihood that in some under-regulated US state someone will not act responsibly and some local water supply will get contaminated.

One lesson is that we need to maintain high-quality environmental and safety regulation, with an emphasis on enforcement, unlike the sort of lax regulation of oil drilling in the Gulf of Mexico that gave us the Deepwater Horizon explosion.  The industry should follow best practices, including making public the chemicals it uses.

But in deciding whether to allow fracking to proceed – and this is what we are talking about: France has banned it and New York state has a moratorium – one must compare the risks of fracking with the risks of the alternative.  Even if there were a serious mishap with fracking, it is unlikely that it would do more damage to health, safety and the environment than the Deepwater Horizon disaster (oil), the Fukushima catastrophe (nuclear), or coal mining tragedies that happen every year (along with lung disease, water pollution from tailings, soil erosion, and other effects of coal).

Finally, some, especially in Europe, have a fear of new and unfamiliar technologies in general.  The claim that the burden of proof lies with the innovation, rather than symmetrically with the status quo, sometimes goes under the name of the “precautionary principle.”   It helps explain the tendency to forget to compare the worst-case risks of the new technology with the known downsides of the old technologies.

One analogy is Genetically Modified Organisms (GMOs).  It is true that a fundamentally new technology tends to pose risks that are unknown.   But that is no excuse for neglecting to weigh in the balance the known risks of the existing technology.  In the case of genetically modified crops, costs of doing without them include greater need for insecticides and possible food shortages in poor countries.

But GMOs may not be a sufficiently powerful example: Europeans tend to oppose them as well.  So here is a challenge to the precautionary principle with which it is difficult to argue.   Should men worried about their virility be daring enough to try the unfamiliar new technology, Viagra?  Or should they stick with the “tried and true” traditional remedy:  powdered rhino horn?

[This is an extended version of a column at Project Syndicate. Comments can be posted there.]

Debt Ceilings, Bombs, Cliffs and the Trillion Dollar Coin

Needless to say, the US has a long-term debt problem.  The problem is long-term both in the sense that it pertains to the next several decades rather than to this year.  (Indeed, the deficit/GDP ratio has been falling since 2009, despite the weakness of the economy.)   The problem is also long-term in the sense that we have known about it for a long time; it was clear in 1991 and should still have been clear in 2001.

It should be almost as needless-to-say that the approaching debt ceiling bomb is not helpful in solving our fiscal situation, any more so than were previous standoffs:  the January 1, 2013, fiscal cliff; before that, the August 2011 debt ceiling standoff, which led Standard and Poor’s to downgrade the credit rating of US debt for the first time in history; and before that, the 1995 shutdown of the government, which largely discredited Republican House Speaker Newt Gingrich.

The current debt ceiling bomb is, of course, another attempt to hold the country hostage under threat of blowing us all up.  The conflict is usually phrased as a question of ideological polarization, a battle between fiscal conservatives and their opponents.  This familiar frame does not seem right to me.  There is in fact no correlation or consistency between the practice of federal fiscal discipline and the political rhetoric, either across states or across time.

What are the demands of the hostage-takers?   Even if there existed an explicit ransom letter detailing specific severe spending cuts, in exchange for which it credibly offered to raise the debt ceiling, President Obama’s refusal to negotiate under such conditions would be fully justified.  But the situation is worse than that.  There is no specific set of demands, and never has been.  I truly believe there does not exist any set of spending cuts that the blackmailers would accept if they came from Obama.

Remember the occasions in the past when he has announced that he will accept the Republican position on some issue, only to have his opponents switch places, saying “if you are in favor of it, we are against it”?    One example was the idea of Obamacare itself, which originally came from conservative think tanks and Mitt Romney.   Another example was the proposal for an automatic version of what in February 2010 became the Simpson-Bowles Commission.

There are only so many dollars that can be cut out of PBS and foreign aid.   If, hypothetically, Obama were to come out in support of severe cuts in agricultural supports, oil and gas subsidies, Medicare benefits and other programs, Republicans would attack him for proposing hurtful cuts. (Remember attacks on Obama’s health plan for non-existent “death panels” and fictional cuts to Medicare benefits?)  Simultaneously, Republicans would say that the cuts were not big enough.

What would be enough?   Some debt crazies have said they think it would be fine if we failed to raise the debt ceiling.  Some are crazy enough to think it is not a problem if the US government were to default on its legal obligations.  (They may not realize that defaulting on the bill for office supplies that you ordered from Staples is as bad as  missing interest payments on your debt.)  But some want to enforce a balanced budget immediately:  the refusal to allow the government to borrow any more is not just a negotiating tactic, but is the outcome they want.  This is crazy in light of the adverse economic and financial impact (which would be much worse than that of the fiscal cliff that we just dodged two weeks ago).

But the prize for ultimate insanity must go to those who want to eliminate the budget deficit rapidly and insist on doing it without raising taxes, cutting defense, or cutting programs for seniors.  These people deserve the label “deranged” because what they are demanding is for a literally false proposition to be true.  It is arithmetically impossible to eliminate the budget deficit if the cuts are to come primarily in non-defense discretionary spending.

To be very clear, I don’t think most Republicans believe all of this.  Certainly my many economist friends who are Republicans do not.  The truly “deranged” people are just a subset of the “crazy” people, who are in turn a subset of those who are unwise enough to favor the debt ceiling threat as a tactic, who are in turn a subset of the Republican Party.   The problem is that it is this minority of a minority that is holding the whole country hostage.  The size of the minority evidently shrunk after the August 2011 debt ceiling debacle, after the November 2012 election, and after the January 1 cliff.   But it still has its finger on the grenade pin.

So that leads us to the question of tactics.  A variety of stratagems have been proposed for the White House to use to defuse the bomb, if it comes to that.  These are all designed as ways that the federal government can continue to meet its legal obligations beyond March, even if the Congress doesn’t raise the debt ceiling.   While these unconventional proposals are beyond anything that would have been contemplated under normal conditions, they must be considered, in light of the correspondingly absurd situation in which the country would find itself.  If the Congress refuses to act, the White House would have to choose between two contradictory laws: the one that Congress passed to authorize spending and taxes versus the debt ceiling law that apparently prohibits the government from borrowing to make up the difference between spending and taxes.  Following the implication of the latter law would have disastrous impacts on the country and the world if obeyed.

  • Given the contradiction between the two laws, President Obama could just ignore the debt ceiling and follow the direct implications of the spending and taxation laws. I am not qualified to judge the legality of this course of action. The courts would eventually have to sort it out. The hope is that by then the Congress would have come to its senses and raised the debt limit.
  • In the meantime, the White House might try invoking the 14th Amendment, as Bill Clinton suggested at the time of the last debt ceiling standoff, in 2011.  The Amendment includes the passage “The validity of the public debt of the United States…shall not be questioned.” Again the Supreme Court would eventually have to decide the issue.
  • The Treasury could issue “IOUs” to the office supply stores, soldiers, Social Security recipients, etc. The IOUs would just be written acknowledgements of a legal fact: that the government owes these people money. Maybe the Federal Reserve could let it be known that it will honor these IOUs. (There must be something wrong with this, or somebody besides me would have proposed it already.)
  • The government writes an option to buy all its property and buildings for $1, and then sells that very valuable option to the Federal Reserve for something like its true value. This proposal has been made by the Yale constitutional expert Jack Balkin last time around, from which I infer that it is not obviously contrary to the law.
  • And finally, the most colorful of the proposals: the trillion dollar coin. The Treasury would exercise its legal authority to mint a commemorative coin made out of platinum, with a face value of $1 trillion. The Federal Reserve would then buy the coin for $ 1 trillion, allowing the Treasury to pay its obligations by drawing down its checking account at the Fed up to that amount. This proposal originated in the blogosphere and was one of those anointed by Balkin in July 2011. Paul Krugman greatly elevated its prominence by declaring his support earlier this month.

Contrary to some fears, none of these proposals need result in the money supply being any larger than it would otherwise be.  The Federal Reserve determines the money supply.  If it creates a new component of money by buying a platinum coin, a property option or IOUs, it can offset it by shrinking other components of the money supply by the same amount, leaving the total unchanged.

The Obama Administration so far is eschewing gimmicks, and is calling on the Congress to do its job in a responsible manner.  This is the right approach.

But in the event that the minority does succeed in blocking a debt increase, it may be worth turning to some legal gimmick to avert the financial and economic catastrophe.   Of the five proposals bulleted above, the platinum coin is the one that seems to have the most experts currently expressing belief in its legality.  It is certainly clever.  Unfortunately, it would probably be the worst from a political standpoint.  The reason is – I am guessing here – there is a fairly high overlap between the debt crazies (defined above) and people who have paranoid conspiracy theories that relate to the Fed, money and precious metals (especially gold, but platinum is too close for comfort). For all I know, some of these people are the same who believe that Obama was born outside the U.S.  (That would fall into the category of deranged propositions, also defined above; but there is no need for us to go there.)  When you are dealing with a crazy person, it is best to avoid anything that would pour gasoline on the flames of his paranoia.  We actually want to win back some of those people who are merely misguided but not really insane.  After all, just getting past the current debt cliff wouldn’t solve the problem, with sequester and shutdown deadlines also looming.   So I’d go for some other legal gimmick, one that would be less likely to feed the paranoia and more likely to continuing chipping away at popular support for the extremists.

[I have been interviewed this week on the trillion dollar coin by Boston magazine and radio station WGBH.]