Stagnant Wages Do Not Explain Trump

The mainstream media are busily reproaching themselves for having been so out of touch with the economic troubles of angry white working men that they were late in taking Donald Trump’s presidential campaign seriously.   Most of us can join in to admit that we were very slow to take Trump seriously.   For one thing, we all thought that any candidate would be permanently derailed by even a small number of the many things that Trump has said.  We used to call these gaffes — either the ones that seemed designed to alienate particular groups (Hispanics, women, etc.) or the ones that revealed his lack of familiarity with real-world issues.

But can the under-estimation of Trump’s candidacy really be attributed to inadequate appreciation of the economic troubles of American workers?

The increase in inequality is very real, particularly the stagnation over the last 40 years of wage income among low-skilled men (defined as those without college education).  For many years, Democrats have made proposals to ameliorate the problem, while Republican presidential candidates have consistently pursued tax cuts for the rich as their number one policy response.

The puzzle is why anyone thinks that Donald Trump’s candidacy offers a break with this particular pattern.  The problem is not that he himself inherited great wealth.  The problem is rather that his policy proposals, such as they are, would not address the inequality issue.   He, like virtually all Republican candidates, proposes big tax cuts for the rich, with no way of paying for the lost revenue.

But he has also said something that no candidate has ever said: “wages are too high.”  He said it at least twice:  November 10, 2015, in the Republican presidential debate on Fox and November 11, on MSNBC’s Morning Joe.  (He has also denied having said it.  But the tapes are very clear. This is a pattern we have seen many times, of course.  Sometimes he brazenly accuses the media of having made up the quote.)

The elite media have beaten themselves up over their eliteness many times before.  Remember how, during the GWB years, journalists swallowed Karl Rove’s line that Republican votes were rising on an unstoppable tide of middle-America family values?  This was before people noticed that the red zip codes had higher rates of divorce, teenage pregnancy, and other indicators of lack of personal responsibility than the blue zip codes.

I don’t claim to understand the remarkable Trump phenomenon.   But whatever is the explanation, it is not a response by working white men that could have been logically predicted based on their stagnant incomes.

 

Posted in 2016 Presidential Campaign, Candidates, inequality, Presidential, Uncategorized | Tagged , , , , | Leave a comment

Did the Markets Overlook a Sign of Fed Bullishness in the March 16 FOMC Statement?

Financial markets reacted to the outcome of the FOMC meeting on Wednesday, March 16, as if what the Fed had revealed was highly dovish, that is, diminishing expected future interest rates.  The markets focused on the shift in the “dots plot” which formally rescinds the Fed’s previous forecast that it would raise interest rates four times in 2016.  (Now it says twice.)   Furthermore, Chair Yellen in her press conference said, “Most Committee participants now expect that achieving economic outcomes similar to those anticipated in December will likely require a somewhat lower path for policy interest rates than foreseen at that time.”

But this is old news. It reflects developments at the start of the year, such as the US report that GDP growth had been weak in the 4th quarter and the global financial market volatility in January and early February (especially related to China).  Everyone knew all this a month ago.

The new news pertains to what has happened since mid-February.  A lot of trends that had appeared to be negative have reversed in the last month.  Statistics on US domestic final sales in January suggest that GDP will likely be stronger in the first quarter. Meanwhile, strong employment reports continue the record-long streak of private jobs gains, which have been running in excess of 200,000 per month.  And globally, downward pressure on the renminbi, the stock market, and commodity prices — which had so worried investors – all abated in February-March.

So did the Fed recognize these signs of economic strength in its statement Wednesday?  Yes, it did.   Gone was the January sentence “…economic growth slowed late last year.”   In its place was a note that “economic activity has been expanding at a moderate pace…”   (Also “Inflation picked up in recent months.”)  Unless I am mistaken that language wasn’t there before, only the longstanding positive language about employment.  It seems to me that the markets this week may have missed an acknowledgement from the Fed that things have turned around since the first six weeks of the year.

 

Posted in dot, Fed, Federal Reserve, FOMC, Interest rates, Investing, Markets, Monetary Policy, Yellen | Leave a comment

Who is right on US financial reform? Sanders, Clinton, or the Republicans?

Eight years after the financial crisis broke out in the United States, there is as much confusion as ever regarding what reforms are appropriate in order to minimize the recurrence of such crises in the future.

There continue to be some good Hollywood movies concerning the crisis, including one nominated for multiple Oscars at the February 28 Academy Awards.  The Big Short has been justly praised for making such concepts as derivatives easy for anyone to understand.  As has been true since the first of the movies about the crisis, they are good at reflecting and crystalizing the audience’s anger.  But they are not as good at giving clues to those walking out of the theater as to the implications.  What policy changes would help?  Who are the politicians that support the desirable reforms?  Who opposes them?

If an American citizen is “mad as hell” at banks, should he or she respond by voting for the far left?  By voting for the far right?   (Or by refusing to vote at all?)   Each of these paths has been chosen by many voters.  But each is misguided.

There is a place in political campaigns for short slogans that fit on cars’ bumper stickers.  (“Wall Street regulates Congress.”)   And there is a place for ambitious goals.  (“Shrink the financial sector.”)  But the danger is that those who are attracted to inspirational rallying cries and sweeping proposals will lack the patience required to identify which is the right side to support in the numerous smaller battles over financial regulation that take place every year and that ultimately determine whether our financial system is becoming structurally safer or weaker.

Breaking up banks

Senator Bernie Sanders has proposed breaking up the banks into little pieces.  It is the centerpiece of his campaign for the Democratic presidential nomination.   The goal is to make sure that no bank is too big to fail without endangering the rest of the financial system.   That would require quite a sledge hammer.  The American banking system historically featured thousands of small banks.   But having thousands of small banks did not prevent runs on depositary institutions in the United States 1930s.

Continental Illinois was the original case of a bank that was deemed “too big to fail” in 1984, when it was bailed out by the Reagan Administration.   So banks would have to be broken into smaller pieces than that.  Merely turning the deregulatory clock back 30 years would not be enough to do it.

I am not sure whether or not, if one were designing a system from scratch, it would be useful to make sure that no bank was above a particular cap in size chosen so that any of them could later be allowed to fail with no further government involvement.   I do know that having a financial system dominated by just five large banks did not prevent Canada from sailing through the Global Financial Crisis of 2008-09 in better shape than almost any other country.

Attacking banks is emotionally satisfying, for understandable reasons.  But it won’t prevent financial crises.

Reforms proposed by Hillary Clinton

Hillary Clinton is correct in pointing out that the most worrisome problems lie elsewhere:  hedge funds, investment banks, and the other so-called non-banks or shadow banks.  These are financial institutions that are not commercial banks and that therefore have not been subject to the same regulatory oversight and the same restrictions on capital standards, leverage, and so on.  Recall that Lehman Brothers was not a commercial bank and AIG was an insurance company.

Secretary Clinton has done her homework and proposes specific measures to address specific problems with the non-banks.     Four examples:

  • She puts priority on closing the “carried interest” loophole that currently allows hedge fund managers to pay lower tax rates on their incomes than the rest of us pay.  This is a more practical step than most proposals to address the very high compensation levels in the financial sector that cause so much resentment.  It would help moderate inequality, reduce distortion, and raise some tax revenue to help reduce the budget deficit.
  • She proposes a small tax targeting certain high-frequency trading prone to abuse. (Sanders proposes a tax on all financial transactions.)
  • She also supports higher capital requirements on financial institutions, including non-banks, if necessary, beyond those increases already enacted.
  • She proposes a “risk fee” on big financial institutions that would rise as they get bigger.  This is reminiscent of a fee on the largest banks that the Obama Administration proposed in 2010, to discourage risky activity while at the same time helping recoup some revenue from bailouts.  It was going to be part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, but in the end three Republican senators demanded that it be dropped as their price for supporting it.

The Dodd-Frank reforms

The Dodd-Frank law was a big step in the direction of needed financial reform.  It included such desirable features as increasing transparency for derivatives, requiring financial institutions to hold more capital, imposing further regulation on those designated “systemically important,” and adopting Elizabeth Warren’s idea of establishing the CFPB, the Consumer Financial Protection Bureau.

It goes without saying that Dodd-Frank did not do everything we need to do.  But the law  would have moved us a lot further in the right direction if many in Congress  had not spent the last six years chipping away at it.  Those who worked to undermine the financial regulatory reform legislation – mostly Republicans – appear to have paid no political price for it, since most of these issues are below the radar for most voters.

Here are a few examples of how Dodd-Frank has been undermined:

  • I mentioned the abandonment of the fee to discourage risk-taking by large banks and of an earlier proposed global bank levy.
  • Auto-dealers, amazingly, lobbied successfully to get themselves exempted from regulation by the CFPB, allowing the resumption of some abusive lending practices that resemble the sub-prime mortgages which played such a big role in the 2008 financial crisis.  There are 17,838 auto dealers.  I guess highly concentrated industries are not the only ones that can buy their way to special-interest carve-outs.
  • The Dodd-Frank law was supposed to require banks and other mortgage originators to retain at least 5% of the housing loans they made, rather than repackaging every last mortgage and reselling it to others.  The reason is that the originators need to have “skin in the game” in order to have an incentive to take care that the borrowers would reasonably be able to repay the loans.  Under heavy pressure from Congress, that requirement was gutted in 2014.   (This one is not especially the fault of the Republicans.  Virtually every American politician in both parties still acts as though the goal should be to get as many people into as much housing debt as possible, even if many will not be able to repay the loans and even after such practices caused the worst financial crisis and recession since the 1930s. Other countries manage to do this better.)
  • The Congress has refused to give regulatory authorities such as the SEC (Securities and Exchange Commission) and CFTC (Commodities Futures Trading Commission) budgets commensurate with their expanded regulatory responsibilities, in a deliberate effort to hamper enforcement.  Many Republicans appear still to believe that these agencies represent excessively aggressive regulation.  This is remarkable in light of the financial crisis.  Remember that Bernie Madoff — who is himself now the subject of new Hollywood portrayals — was able to run his Ponzi scheme right up until 2008 despite repeated tip-offs to the SEC, because it systematically refrained from pursuing investment management cases during this period.

Who can get the job done?

Sanders has indicated that if he were president, nobody with past experience on Wall Street would be allowed to serve in his administration.  A blanket rule like this would be a mistake.  Judging people by such superficial criteria as whether they have ever worked for Goldman Sachs, for example, would have deprived us of the services of Gary Gensler.  As CFTC chairman from 2009-2014 Gensler worked tirelessly to implement Dodd-Frank.  To the consternation of many former Wall Street colleagues, he aggressively pursued regulation of derivatives and, for example, prosecution of a case against five financial institutions who had colluded to manipulate the LIBOR interest rate (London Interbank Offered Rate]. Yet Sanders tried to block his appointment in 2009.

Financial issues are complicated.  Getting the details of regulation right is hard.  (The examples mentioned here are just the tip of the iceberg.)  We need leaders and officials who have the wisdom, experience, patience, and perseverance to figure out the right measures, push for their enactment and then implement them.  If such people are not the ones who receive political support for their efforts, we should not be surprised if the financial sector again escapes effective regulation and crises recur in the future.

 

Posted in 2016 Presidential Campaign, Democrats, Financial Crisis, Financial Regulation, Investing, Republicans | Tagged , , , , , , , , | Leave a comment

China crash?

An extended version of my column on “China’s slowdown” now appears at VoxEU, including academic references.

Someone at Seeking Alpha responds with the following question:  What are the odds of an outright recession in China, with substantially negative GDP growth?

My reply:

This scenario is certainly possible. I have even described financial bubbles-and-crashes as a sort of “rite of passage” that newly arrived economic powers undergo (Holland 1637, England 1720, US 1929, Japan 1990, Korea 1997).  In China the crash would probably come from the accumulation of bad loans (especially in the shadow banking system) and financing of unused capacity (especially in residential construction).

I would put a 25% probability on a Chinese recession happening within the next few years. Even then, however, China would more likely recover before long, as Korea did, rather than stagnate as the US did in the 1930s or Japan in the 1990s-2000s.

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Posted in China, Chinese, Financial Crisis, Rite of passage | Leave a comment

China’s Slowdown

Investors worldwide are closely watching the steep decline in China’s stock market.  The Shanghai Stock Exchange Composite Index is down more than 40% since June 2015.

The reason observers are concerned is not because they themselves are invested: China’s stocks are overwhelmingly held by Chinese themselves.  Rather, many are interpreting it as evidence that China’s economy is going down the tubes.

China’s growth rate has indeed slowed down and there are plenty of reasons to believe that the slowdown is not just temporary.  But none of them have much to do with the stock market.

For one thing, market prices are still well above where they were in 2014.  That was a time when many observers were bullish on China, proclaiming that its economy had just surpassed the US to become the world’s largest, on the basis of new PPP-based GDP statistics.  But in fact the slowdown in Chinese growth began four years ago.  According to the official statistics, growth averaged 10% over the three decades 1980-2010, but slowed down to the 7%-8% range in 2012-14.

Indeed, the reason that China’s stock market started to ascend at the end of 2014 is that the People’s Bank of China began to cut interest rates in November, in an appropriate response to the slowdown in economic growth that was already evident.  But the market’s continuing rise took on the character of a credit-fueled bubble in the spring of 2015.  The peak came on June 12, when the China Securities Regulatory Commission tightened margin requirements.

The bubble has now been reversed.  That doesn’t necessarily convey much information about China’s growth prospects.

There are plenty of reasons not to be surprised that China’s growth rate has slowed down and not to expect it to return to 10%.  The human instinct of some forecasters five years ago was simply to extrapolate the preceding three decades.   But casting a wider statistical net would have revealed that a fourth decade at 10% would have been historically unprecedented.

The Middle Kingdom is not exempt from the broader statistical regularities.  Some see the slowdown as a case of the middle-incometrap. Others find that the more relevant statistical pattern is regression to the mean in growth rates.

What are the economic forces behind the tendency for a rapidly growing country to slow down?  There is a wide variety of possible economic interpretations. Six come to mind:

  • One is diminishing return to capital.  China’s investment in steel mills, transportation infrastructure and residential construction became “too much of a good thing.”
  • Another interpretation is the observation that productivity growth is easier when it is a matter of copying the technologies, production processes, and management practices of the Western countries.  When the gap between the economic frontier and the newcomers narrows, the latter countries have to do some of the innovating on their own.
  •  A third explanation is that rural-urban migration has been a big source of China’s growth, but that the surplus labor has finally been used up, wages have risen, and the competitive advantage in labor-intensive manufactures has been lost.  (The “Lewis turning point” has been reached.)
  • A fourth is that the population is ageing.  The working-age population peaked in 2012.  The ratio of retirement-age people to working-age population is rising.  This demographic transition occurs naturally in advanced countries; but the one-child policy accelerated it prematurely in China.
  • A fifth is that urban land prices have been bid up and the “carrying capacity” of the environment has been exhausted.
  • A sixth is that the composition of the economy is shifting away from manufacturing and into services, which is appropriate but which entails slower growth because in all countries there is less scope for productivity growth in services than there is in manufacturing.

Thus a shift from 10 per cent growth in China to a more sustainable long-term 5-7 per cent trend is perfectly natural.  The important question is whether the transition takes the form of a soft landing or a hard landing.  In a soft landing China would continue to grow at the slower-but-sustainable trend rate.  In a hard landing it would suffer a financial crisis and more severe economic recession.

High dependence on investment spending and debt financing can work well during a high-growth phase but then lead to excess capacity and financial crisis when the long-run growth rates slows down.  Precedents include post-1980s Japan and 1997-98 Korea.

Some say that the official statistics seriously overstate GDP and that the true growth rate has already fallen well below the 6.9 per cent that the government has reported for 2015.  It is indeed suspicious that official growth statistics seem in most years to come close to the numbers in plans that had been announced by the government ahead of time.  So the skeptics reasonably turn to more tangible measures.  They point out that energy consumption, freight railway traffic, and output of such industrial products as coal, steel, and cement have slowed sharply.  (These are components of the so-called Keqiang Index.)  But Nicholas Lardy persuasively argues that those statistics are also consistent with the interpretation that the composition of China’s economy has been shifting away from heavy manufacturing and toward services.

The shift away from manufacturing to services is one component of a desirable package of policies to smooth the transition to a sustainable growth rate.  Another is a reduced reliance on investment spending and export demand, and a greater role for household consumption.  Other desirable reforms include increasing the flexibility of land markets and labor markets.  For example labor mobility is still impeded by insecure land rights in the countryside and the hukou system in the cities.  More generally, the markets should continue to play a growing role in the economy.  State-owned enterprises should be reined in.  Reforms are also needed in health care, social security, and the tax system.  And, of course, environmental regulation and the end of the one-child policy.

Chinese economists and leaders know all this. Indeed a very similar list of reforms was the outcome of the Communist Party’s Third Plenum in 2013.  Beijing has taken some steps to implement them over the last two years.  But there is still a long way to go and it is by no means guaranteed that the implementation will be fully successful.  As Shang-Jin Wei of the Asian Development Bank points out, the fate of China’s economy depends a lot more on how well the reforms go than on anything about last year’s stock market bubble and its subsequent reversal.

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Posted in Asia, China, Convergence, Growth, Investing, Stock market | Leave a comment

Forecasting 2016 Economic Developments & Candidates’ Reactions

As the new year starts, Politico asks a set of economists for forecasts.  Prognostication from 23 appears at “Could the Economy Tank in 2016?

By the way, I think my forecast last time, two years ago, turned out to hold up pretty well:

Something important will get better in 2014: Fiscal policy will stop hurting the economyThe biggest impediment to economic expansion over the last three years has been destructive budget policy coming out of the CongressThere are good grounds for optimism in 2014. For the first time in four years, Congress will probably not inflict contractionary fiscal policy on the American people. If the government sector stops making a negative contribution, that will show up as economic growth.”

This time I focused on the following question from Politico:

Q: How will the 2016 presidential candidates have to adapt to economic realities and unforeseen developments in the coming year, such as the risk of recession, as they make the case to voters about their own economic visions?

A:  Recessions are not forecastable.  A downturn is no more likely in 2016 than in a typical year, nor less likely.

The next president will, like his or her predecessors, have to shift gears from the campaign and adjust to a very different set of developments and realities upon taking office.  But this is because of politics, not mainly because of uncertainty regarding what lies ahead.   The adjustment process will not begin until after the election, even if major new developments in the domestic or global economy take place during 2016.  The polite way to phrase it is to observe that “politicians campaign in poetry and govern in prose.”

Republican nominees, for example, always promise to cut taxes, increase military spending, protect seniors, and yet to run a strong budget balance, even though that combination is arithmetically impossible.  Democratic nominees too make unrealistic claims about how they will be able to combine spending increases with budget discipline.   Unforeseen disasters – financial, economic, national security – do not cause candidates to rethink their plans, but only to double down.   It is only after they take office that they are forced to confront the arithmetic, and sometimes they can postpone facing up to it for several years.

Some presidents adjust to fiscal realities immediately, during the presidential transition (Bill Clinton), some after a year or two of fiscal failure (Ronald Reagan and George H.W. Bush), and some later still (George W. Bush).   But none do it before the election.

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Posted in 2016 Presidential Campaign, Budget, Candidates, Democrats, Fiscal, Forecast, Presidential, Recession, Republicans, Tax cuts | Leave a comment

The Fed, China and Oil

My answers to three questions at the start of 2016 (from Chosun Ilbo, leading Korean newspaper):

1. How do you analyze the recent US interest hike, and how will it influence the global economy in the coming year?

The Fed had telegraphed its decision to raise the interest rate so far in advance and (by December) so clearly, that the policy change was already fully reflected in markets.  For example most of the substantial appreciation of the dollar since 2014 can be attributed to anticipation of the Fed tightening.   Furthermore, the movements in relative monetary policy — the end of quantitative easing in the United States, the first increase in interest rates, simultaneous monetary easing in other countries and the appreciation of the dollar – all reflect relatively greater strength in the US economy compared to most others.  It will create difficulties for some commodity-producing countries that had gone back to large-scale borrowing in terms of dollars.  But the pattern of US growth, monetary tightening, and dollar appreciation is not bad news for the rest of the world overall.

 

2. What is your view on China’s economy, and how will it economy influence the global economy this year?

It was inevitable that China would not be able to sustain a fourth decade of growth rates in the neighborhood of 10%.   Some of the sources of its growth have begun to run into diminishing returns, such as rural-urban migration, heightened capital/labor ratios and an over-stretched environment.

The open question is whether the transition to a more sustainable and moderate rate of growth that we are now seeing will be a soft landing or a hard landing (e.g., a crisis arising from unneeded construction, shadow banking, and bad loans).   A good scenario, the soft landing, is by no means ruled out yet.  The 2015 stock market bubble and crash was not as important as observers thought.  Much of what we are seeing could be the desired shift in the composition of China’s economy, away from the production of manufactured goods and their sale for exports or physical investment, and toward the production of services and their sale to the consumer sector.

Even though China is slowing down a lot, its economy occupies a much larger share of the world economy than it used to.  For this reason, it will continue to be an engine of growth in the world, just not as quite as strong an engine as had been forecast by those who rely on simple extrapolation of past trends.

3. What is your view on oil prices recently? How will the oil price change impact the global economy this year?

The fall in dollar oil prices has many causes, both on the supply side (US fracking, Saudi decisions) and the demand side (weakened demand from much of the world, especially China).   One cause that is often overlooked is the strength of the dollar against other currencies.

Needless to say, the fall in oil prices hurts oil exporters and benefits oil importers.   The benefits for oil importing countries in Asia and Europe in 2016 will probably be greater than what has been evident so far.

Low retail prices for fossil fuels are bad for the environment.  All countries should take advantage of the recent fall in oil prices by either shifting their taxes onto fossil fuels or else, if they currently have wasteful subsidies to fuel consumption, then they should cut them.  They should take their cue from developing countries such as Egypt, India, Indonesia, Mexico and the UAE that have done that recently.

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Posted in Appreciation, China, Dollar, Emerging markets, Fed, Monetary Policy, Oil, Tightening | Leave a comment

The Paris Agreement on Climate Change, C’est Bon

How should one evaluate the agreement reached in Paris December 12 by the 21st Conference of Parties to the UN Framework Convention on Climate Change (UNFCCC)?   Some avid environmentalists may have been disappointed in the outcome.  The reason is that the negotiators did not commit to limiting global warming to 1 ½ degrees centigrade by 2050, nor will the new agreement directly achieve the 2 degree limit.

But such commitments would not have been credible.  What came out of Paris was in fact better, because the negotiators were able to agree on meaningful practical near-term steps. Virtually all countries agreed concretely to limit their emissions in the near term, with provisions for future monitoring and periodic checkup and renewal. This is a more important achievement than setting lofty goals for the distant future while giving little reason to think that they would be met.  The important thing is to get started.

In four key respects, the agreement is a good one, for those who see global climate change as an important problem and who want down-to-earth steps to address it.

First, and most salient, is comprehensive participation.  More than 186 countries offered individual commitments, called Intended Nationally Determined Contributions (INDCs), to go into effect in 2020. These countries account for 96% of global emissions, compared with the current coverage of the Kyoto Protocol which is only 14% of global emissions.  In the past, only advanced countries were expected to agree to commitments to reduce emissions of greenhouse gases.  Developing countries were explicitly spared that within the UNFCCC.  One reason it is so important for them to make explicit commitments is that the growth in emissions is now taking place exclusively in developing countries, not among the advanced countries.  Furthermore, countries like the United States would not agree to limit their emissions if they feared that the effect might simply be a migration of carbon-emitting industry to developing countries.

Second is the agreed process of future assessment and revision of targets.  The decision was to take stock and renew the commitments every five years. (Some negotiators had been arguing for ten-year intervals.)  Future steps can adjust targets to be either more aggressive or less, in light of future developments.  Probably more aggressive, if the scientists’ predictions are borne out.  The second set of INDCs is to be decided in 2018.

Third is transparency in monitoring, reporting and verifying each country’s progress.  Countries are to report every five years, starting in 2023, how well they have done compared to what they had said they would do.  The United States and Europe had to push hard on China and India to get agreement on this.  But without it, the INDCs would not have been credible.

Fourth are mechanisms to facilitate international linkage, including scope for firms operating in rich countries to finance emission reductions in poor countries.  This is important in order to achieve the environmental goals in an economically efficient way:  it is cheaper to pay a poor country to refrain from building new coal-fired power plants than to shut down plants that are already operating in rich countries.  Achieving the first period’s INDCs at low cost will in turn be important for willingness to take further steps in future periods.

Some may be disappointed that the Paris Agreement did not explicitly commit to more aggressive environmental goals, particularly limiting warming to 1 ½  degrees centigrade (above pre-industrial levels) or zero greenhouse gas emissions in the second half of the century, leaving these as aspirations.  And in truth the INDCs are nowhere near enough in themselves even to limit warming to 2 degrees Celsius (3.6 degrees Fahrenheit), the long-term global goal that was agreed at an earlier Conference of the Parties in Cancun in 2010.

Actually achieving such environmental goals would of course be desirable, in order to minimize risk of disaster scenarios.  But proclaiming ambitious collective numbers is very different from achieving them.  It is almost beside the point that, by now, a goal of 1 ½ degrees would be very high-cost economically. The plan needs to be credible if it is to determine myriad business decisions made today.   But collective goals are not credible without assignment of individual responsibility; and leaders in any case can’t make credible commitments 35 years into the future.

Others, from developing countries, are disappointed for another reason:  the figure of $100 billion in finance from rich countries does not appear in the legally binding body of the agreement.  They did get an admission of moral responsibility to help small island states, for example, cope with “loss and damages” from sea level rise.  But the rich countries rejected demands for concession of legal liability.  I judge this a reasonable outcome in a difficult situation.

Rich countries can’t deny that their past emissions have inflicted harm on the world.  The entity whose land was flooded would have a claim to compensation from the entity that had caused the damage, if they were operating within a domestic legal system.  But sovereign countries are not operating in such a legal system.  The $100 billion in finance has always seemed to me problematic.  The developing countries fear that the rich countries won’t in the end deliver it, not in cash; and they are right.  The rich countries fear that if they did send “reparations,” much of it would disappear into the pockets of local elites; and they are right.  Better, then, not to make promises in the first place.

The poor countries do have a strong case.  The average American still emits ten times as much greenhouse gases as a citizen of India.  India cannot be deprived of the right to develop economically.  But the best place to take account of these fairness concerns is in the agreed emissions targets.  The efforts that the richer countries promise in these agreements should be – and generally are — greater than the efforts of poor countries.  The richer a country is, the earlier the date at which its emission targets should peak.  The richer it is, the more sharply its target should cut relative to emissions baseline.  With targets that take into account countries’ stage of development, i.e., that continue to grow in the short term, the poor countries can get paid for additional emissions cuts under the international linkage mechanisms.  This fulfills the important principle of “common but differentiated responsibilities and respective capabilities” that was and is a key feature of the UNFCCC under which the Paris Agreement has been reached.

The Paris Agreement incorporates both fairness and efficiency.  In light of the very big obstacles and long odds that they faced, the negotiators were surprisingly successful in converging on a plan that offers hope of practical progress.

shorter version was published by Project Syndicate.

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Posted in Agreement, Climate Change, Environment, Global Warming, International Cooperation, UNFCCC | Leave a comment

Japan’s Economic & Foreign Policies

In a sort of year-end look back on Prime Minister Abe’s record and on Japan’s current situation, Reuters Japan has asked for action points or policy suggestions regarding economic and foreign policy.  Here are the responses I offered.

  1. Economic policy

To address the problems of the Japanese economy, all three arrows of Abenomics are necessary. The monetary arrow was shot well; but a big fiscal arrow was aimed in the wrong direction; and the structural reform arrows have hardly been taken out of the quiver.

When the new monetary policy (Quantitative and Qualitative Easing) was enacted in early 2013, the intended effects showed up immediately in the financial markets: an increase in stock market prices and an increase in the price of foreign exchange. Although both effects worked to stimulate demand for Japanese goods, the boost to GDP turned out to be short-lived.  Growth faltered after April 2014. The most obvious explanation is the increase in the consumption tax from 5% to 8%.  As many had warned, it apparently turned expansion into contraction.

It is true that the long-run debt situation in Japan is unsustainable. But a further large increase in the consumption tax before the economy has recovered is not advisable. Much better would be to enact a 20-year schedule of very small annual increases in the consumption tax. This would assure long-run fiscal sustainability and investor confidence (thus continuing to keep real interest rates low) while still helping to maintain positive expected inflation and growth in the short-term.

2. Foreign policy.

Moving beyond the “history issue” is important both for diplomatic reasons (if Japan wants a seat on the UN Security Council, for example) and for economic reasons (frictions with other Asian countries have become a serious obstacle to business).  But moving beyond the history issue requires Japan to face up to some unpleasant historical realities that it has not wished to confront.

Other countries also have dark chapters in their past, but are readier to acknowledge them. The US and European countries were guilty of subjugating native peoples in previous centuries, which took such forms as slavery and high rates of mortality, but today nobody defends that history. If Germany had not already thoroughly apologized for the historical sins of World War II, it could not today be the economic and political leader of Europe. In my view, Japan should both re-commit to the peace constitution and decide henceforth to avoid actions that are unnecessarily provocative to the Asian neighbors that suffered so much earlier in the 20th century.

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Posted in Abe, Apology, Consumption tax, History, Japan, QQE | Leave a comment

Games Countries Play

Calls for International coordination of macroeconomic policy are back, after a 30-year hiatus.  To some it looks anomalous that the Fed is about to raise interest rates at a time when most major central banks see a need to extend further monetary stimulus.

The heyday of coordination in practice was the decade 1978-1987, beginning with a G-7 Summit in Bonn in 1978 and including the Plaza Accord of 1985, of which this year is the 30th Anniversary.  Economists were able to provide a good rationale for coordination based in game theory: because each country’s   policies have spillover effects on its trading partners’ economies, countries can in theory do better when agreeing on a cooperative package of policy adjustments than in the non-cooperative equilibrium where each tries to do the best it can while taking the policies of the others as given.

Then coordination fell out of fashion.  The Germans, for example, regretted having agreed to joint fiscal expansion at the Bonn Summit; reflation turned out to be the wrong objective in the inflation-plagued late 1970s.  Although the Plaza Accord and associated intervention in the foreign exchange market were successful in bringing down an overvalued dollar, the Japanese had come to regret the appreciated yen by 1987.   Some of the other G-7 summit communiques had little effect, for better or worse.  Furthermore, as the economies and currencies of Emerging Market (EM) countries became increasingly important, their lack of representation in global governance became problematic.

Since the Global Financial Crisis of 2008, attempts at coordination have made a come-back.   The larger EM countries got more representation when the G-20 became the pre-eminent leaders group.  The G-20 leaders agreed on coordinated economic expansion at the London Summit of April 2009.  They agreed at the Seoul in 2010 to give EMs quota shares in the IMF that would be more commensurate with their economic weight (though the US congress has yet to pass the necessary legislation, to its shame).

Many calls for coordination lament the outbreak of “currency wars,” a phrase that Brazil’s Finance Minister in 2010 adopted for the old phenomenon of competitive depreciation.  The concern recalls the competitive devaluations of the 1930s. The idea is that a single country can depreciate its currency, gain international competitive for its exporters and thus improve its trade balance; but if all countries try to do this at the same time they will fail.  One manifestation of the currency wars concern has been foreign exchange intervention by China and other EM countries to prevent their currencies from rising.  Another manifestation arose from successive rounds of quantitative easing by the Federal Reserve in 2010-11, the Bank of Japan in 2012-13, and the European Central Bank in 2014-15; the results were in turn depreciations of the dollar, yen and euro, respectively.

The US has led some international attempts to address competitive depreciation, including an agreement among G-7 ministers in February 2013 to refrain from foreign exchange intervention and a November 2015 side-agreement to the Trans-Pacific Partnership to address currency manipulation.  But critics are agitating for a stronger agreement backed up by the threat of trade sanctions.

The most recent fear — articulated, for example, by Raghuram Rajan, Governor of the Reserve Bank of India in 2014 — is that the US central bank will not adequately take into account adverse impacts on EM economies when it raises interest rates.

To interpret the various calls for coordination in terms of game theory is challenging, in that some players think they are playing one game and other players seem to think they are playing another game.  Consider, first, fiscal policy.  When the US urges German fiscal stimulus, as at the G-7 Bonn Summit of 1978, the G-20 London Summit of 2009; and the G-20 Brisbane Summit of 2014, it has in mind the “locomotive game.”  The assumption is that fiscal stimulus has positive “spillover effects” on trading partners.  Each country is afraid to undertake fiscal expansion on its own, for fear of worsening its trade balance, but the world can do better if the major countries agree to act together as locomotives pulling the global train out of recession.

But Germans think they are playing a “discipline game.”   They view budget deficits as creating negative externalities or “spillover effects” for neighbors, due for example to the moral hazard of bailouts, not positive externalities.  Their idea of a cooperative equilibrium is the Fiscal Compact of 2013 under which euro members agreed yet again to rules for limiting their budget deficits.

When two players sit down at the board, they are unlikely to have a satisfactory game if one of them thinks they are playing checkers and the other thinks they are playing chess.  Think of the “dialog of the deaf” that took place between the Greek governmentelected in January 2015 and its euro partners

Interpretations vary just as much when it comes to monetary policy.  Some think monetary expansion in one country shifts the trade balance against its trading partners, due to the exchange rate effect; but others think it is transmitted positively, via higher spending.   Some think that the problem is competitive depreciation and too-low interest rates; others that the problem is competitive appreciation or too-high interest rates.  Some think that the way to solve competitive depreciation for good is to fix exchange rates, as the architects of Bretton Woods did in 1944.  Others, such as some US politicians today, think that the way to do it is the opposite:  an agreement against seeking to influence exchange rates at all, even enforced by trade penalties.

Yes, regular meetings of officials can be useful.  Consultation can minimize surprises. Crisis management often requires coordination.  Exchange of views might help narrow differences in perceptions.  But some calls for international coordination are less useful, particularly when they blame foreigners in order to distract attention from domestic constraints and disagreements.

Two examples of calls for coordination obscuring domestic problems.  First: Brazil’s budget deficit was too large in 2010.  The economy overheated.  Private demand was going to be crowded out one way or another: if not via currency appreciation then via higher interest rates.  When Brazilian officials blamed the US and others for a strong real, it may have been a way to divert attention so as to avoid confronting the domestic issue.  Second:  US politicians’ ongoing efforts to ban currency manipulation in trade agreements may be rhetorical attempts to scapegoat Asians for stagnation in the real incomes of American workers.

Officials would often be better advised to improve their own policies, before they tell others what to do..

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