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..

Posted in Asia, Fiscal Stimulus, International Cooperation, International Monetary Fund, Monetary Policy, Trade | Tagged , , , , , | Leave a comment

TPP Skeptics Should Switch Sides

Now that the TPP text has been released, I have read at least some parts of it in detail.  It seems to me that it does what the negotiators said it does.  There is a lot to like in the way it came out that many of the critics seem not to know about.   I hope that those Democrats who have been fervently opposed to the TPP  — in particular some of the Massachusetts congressional delegation — will now consider it with an open mind!

I have an op-ed appearing in the  Boston Globe this week, making the case.

I don’t discuss the currency manipulation issue there, but have done so elsewhere.

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Full Legal Text of TPP is Now Available

I have written a few columns this year supportive of the Trans-Pacific Partnership.  (E.g. “Critics Should Keep an Open Mind,” The Guardian, Oct. 11, 2015.)   Commentators on my column and critics of TPP more generally have expressed great eagerness to know when and where they could read the full legal text of the agreement.  The full text is now available.

Many skeptics seem confident in their ability to understand the significance of the detailed legal language even when they have only had a few hours to read it. I am less confident of that myself, not being a lawyer.  Fortunately there is also a user-friendly summary at the USTR site.

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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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September 22 is the 30th Anniversary of the Plaza Accord

Exactly 30 years ago, on September 22, 1985, ministers of the Group of Five countries met at the Plaza Hotel in New York and agreed on a successful initiative to reverse what had been a dangerously overvalued dollar. The Plaza Accord was backed up by intervention in the foreign exchange market. The change in policy had the desired effect over the next few years: bringing down the dollar, reducing the US trade deficit and defusing protectionist pressures.  Many economists think that foreign exchange intervention cannot have effects unless it also changes money supplies.  But the Plaza and a number of subsequent episodes of concerted intervention by the G-7 countries suggest otherwise.

In recent years foreign exchange intervention has died out among the largest industrialized countries.  Seeing as how the dollar is again strong and the US Congress once again has trade concerns, some have asked if it might be time for a new Plaza.  My answer is “no, not even close.”   The value of the dollar is not as high now as it was in 1985. More importantly, its recent appreciation is based on the economic fundamentals of the US economy and monetary policy, measured relative to those of our trading partners, whereas in 1985 the appreciation had continued well past the point justified by fundamentals.

The Baker Institute at Rice University is holding a conference on Currency Policy Then and Now: 30th Anniversary of the Plaza Accord.  Among the key figures participating is James Baker, who as the new Treasury Secretary that year was the main initiator of the agreement.   My paper for the conference, “The Plaza Accord, Thirty Years Later,” reviews 1985’s coordinated policy of intervention in the foreign exchange market and contrasts it with the current “anti-Plaza,” a recent G-7 agreement not to intervene, in an attempt to avoid “currency wars.”  I see recent fears of currency wars, i.e., competitive depreciation, as vastly over-done.

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Posted in Agreement, Baker, Competitive, Currency, Depreciation, Dollar, Exchange Rates, International Cooperation, Intervention, Manipulation, Plaza | Leave a comment

Misinterpreting Chinese Intervention in Financial Markets

September 7, 2015

It is tempting to view economic events in China through a single template: the view that they are driven by government intervention because the authorities haven’t learned to let the market operate.  After all, Mao’s portrait still hangs on the wall and the Communist Party still governs.   But the lens of government intervention has led foreign observers to misinterpret some of the most important developments this year in the foreign exchange market and the stock market.  An instance of such misinterpretations is the confused positions of many American congressmen which have helped bring about the opposite of what they really want from China’s exchange rate.

To be sure, Chinese authorities do often intervene strongly in various ways.   In the foreign exchange market, the People’s Bank of China intervened heavily during the decade 2004-13, buying trillions of dollars in foreign exchange reserves and thus preventing the yuan from appreciating as much as it would have if it had floated freely.  Hence years of US allegations of currency manipulation. More recently, in the stock market, the authorities have deployed every piece of artillery they could think of in a crude attempt to moderate the plunge that began in June of this year.

But some important episodes that foreigners decry as the result of government intervention are in fact the opposite.  Two developments this year have dominated the financial pages, but have often been misinterpreted.  One is the depreciation of the yuan against the dollar on August 11.  The other is the bubble in the Chinese stock market that led up to the June peak.

Intervention versus the foreign exchange market

China in August gave American politicians an instance of the adage, “Be careful what you wish for, because you might get it.”  The widely decried 3% “devaluation” of the yuan was the result of a change by the People’s Bank of China in the arrangement for setting the exchange rate, a change that constituted a step in the direction of letting the market decide.  This is what US congressmen have long claimed they wanted and, even now, confusedly still claim they want.

The change sounds technical, but is easily described.  China’s central bank has for some time allowed the value of the yuan to fluctuate each day within a two per cent band, but has not routinely allowed the movements to cumulate from one day to the next.  The change on August 11 was to allow the day’s depreciation to carry over fully to the next day.  Thus market forces can play a greater role in determining the exchange rate.

It is probable that China would not have chosen this time to give the market a larger role in setting the exchange rate if market forces were not working in a direction, toward depreciation, that would help counteract this year’s weakening of economic growth.  And, peering within the country’s decision-making process, it is likely that China’s political leaders were primarily motivated by the desire to support the weakening economy while the People’s Bank of China was primarily motivated by its longer-term reform objectives.

But these two motivations are consistent: market forces would not be pushing so clearly in the direction of currency depreciation if it did not correspond to the fundamentals of the economy.    Market determination of exchange rates can indeed serve a useful function, even if the American politicians who demanded that China float did not realize what the result would be.   In any case, if what they really wanted was something different, one can hardly blame the authorities for taking them at their word.

It is said that a year is a long time in politics.  A year should have been enough time for American politicians to figure out that market forces had reversed direction in mid-2014 and that an end to Chinese intervention in the foreign exchange market would now depreciate the currency rather than appreciate it.

To be sure, China is far from a free-floating currency, let alone from full convertibility of the yuan.  Convertibility would require further liberalization of controls on financial inflows and outflows.  Unification of onshore and offshore markets, not floating of the currency, is what would be required for the yuan to merit an IMF decision this year to include the currency in the definition of its SDR (Special Drawing Right).  Much commentary ahead of the IMF decision underestimated the importance of the criterion that the currency must be “freely usable.”   Increased flexibility alone was not going to be enough to do the trick.

In truth, a 3 percent change in the exchange rate – the size of the so-called “devaluation” against the dollar – is negligible. For example the euro and Japan’s yen have each depreciated far more than this over the last year, against both the dollar and the yuan.

China’s adjustment is said to have triggered a “currency war” of devaluations, relative to the dollar, among a number of emerging market countries.  Most of this was due to happen anyway.  It has been at least a year since the economic fundamentals shifted against emerging markets (and especially away from commodities) and toward the US.   It is natural for exchange rates to adjust to the new equilibrium.  The Chinese move likely influenced the timing.  But the currency war framework is misleading.

Intervention versus the stock market

What about China’s stock market?  The commentary says not only that the authorities consistently pursued a variety of artificial measures to try to boost the market on the way down but also that they did the same during the huge run-up in stock prices between mid-2014 and mid-2015.  The allegation is that the Chinese authorities, particularly the stock market regulator, have not learned how to let the market operate and that they had only themselves to blame for the bubble in the first place.

There is some truth to this overall story.  There was some simple-minded cheer-leading of the bull market in government-sponsored news media, for example.

But many commentators have failed to notice that the regulatory authority, the China Securities Regulatory Commission, took steps to try to dampen the last six months of market run-up.   It tightened margin requirements in January 2015.  It did it again in April.  At that time it also facilitated short-selling, by expanding the number of stocks that could be sold short.  And the event which apparently in the end “pricked” the bubble was the June 12 announcement by the CSRC of plans to limit the amount brokerages could lend for stock trading.

The adjustments in margin requirements are the sort of counter-cyclical  macro prudentialregulatory policy that we economists often call for, but less often see in practice among advanced economies.  Perhaps surprisingly, it is more common in Asia and other emerging markets.  A recent study, for example, found that China and many other developing countries adjust bank reserve requirements counter-cyclically.  Another found effective use of ceilings on loan-to-income ratios to lean against excessive housing credit.

Yes, the extraordinary run-up in stock market prices from June 2014 to June 2015, when the Shanghai stock exchange composite index more than doubled, was fueled by an excessive increase in margin borrowing.  Reasons for the increase in margin borrowing include its original legalization in 2010-11; easing of monetary policy by the People’s Bank of China since November 2014 in response to slowing growth and inflation; and the eagerness of an increasing number of Chinese to take advantage of the ability to buy stocks on credit.

Nevertheless, the stock market regulator responded by leaning against the wind.  Similarly, when the People’s Bank of China has intervened in the foreign exchange market over the last year, it has been to dampen the depreciation of the yuan, not to add to it. These are not trivial points.

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Posted in Asia, Bubble, Financial Regulation, Intervention, Macro-prudential, Margin requirement, RMB, Shanghai, Stock market, Yuan | Leave a comment

Gas Taxes and Oil Subsidies: Time for Reform

World oil prices have been highly volatile during the last decade.   Over the past year they have fallen more than 50%.

Should we root for prices to go up, down, or stay the same?   The economic effects of falling oil prices are negative overall for oil-exporting countries, of course, and positive for oil-importing countries.  The US is now surprisingly close to energy self-sufficiency, so that the macroeconomic effects roughly net out to zero.  But what about effects that are not directly economic?   If we care about environmental and other externalities, should we want oil prices to go up or down?  Up, because that will discourage oil consumption?  Or down because that will discourage oil production?

The answer is that countries should seek to do both: lower the price paid to oil producers and raise the price paid by oil consumers.  How?   By cutting subsidies to oil and refined products or raising taxes on them.   Many emerging market countries have taken advantage of the last year of falling oil prices to implement such reforms.  The US should do it too.

Congress continues to shamefully evade its responsibility to fund the Federal Highway Trust Fund.  On July 30 it punted with a 3-month stop-gap measure, the 35th time since 2009 that it has kicked the gas-can down the road!  There is little disagreement that the nation’s roads and bridges are crumbling and that the national transportation infrastructure requires a renewal of spending on investment and maintenance.  The reason for the repeated failure to put the highway fund on a sound basis for the longer term is the question of how to pay for it.  The obvious answer is, in part, an increase in America’s gasoline taxes, as economists have long urged.  The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries.  Ideally the tax rate would be put on a gradually rising future path.

Fuel pricing is a striking exception to the general rule that if the government has only one policy instrument it can achieve only one policy objective.   A reduction in subsidies or increase in taxes in the oil sector could help accomplish objectives in at least six areas at the same time:

  1. The budget. It isestimated that energy subsidy reform globally (including coal and natural gas along with oil) would offer a fiscal dividend of $3 trillion per year. The money that is saved can either be used to reduce budget deficits or recycled to fund desirable spending, such as US highway construction and maintenance, or cuts in distortionary taxes, e.g., on wages of lower-income workers.
  2. Pollution and its adverse health effects.   Outdoor air-pollution causes anestimated annual 3.2 million premature deaths worldwide.  A gas tax is a more efficient way to address the environmental impact of the automobile than alternatives such as CAFÉ standards which mandate fuel economy for classes of cars.
  3. Greenhouse gas emissions, which lead to global climate change.
  4. Traffic congestion and traffic accidents.
  5. National security.   If the retail price of fuel is low, domestic consumption will be high.  High oil consumption leaves a country vulnerable to oil market disruptions arising, for example, from instability in the Middle East.  If gas taxes are high and consumption low, as in Europe, then fluctuations in the world price of oil have a smaller effect domestically.   It is ironic that U.S. subsidies to oil production have often been sold onnationalsecurity grounds; in fact a policy to “drain Americafirst” reduces self-sufficiency in the longer run.
  6. Income distribution.  Fuel subsidies are often misleadingly sold in the name of improving income distribution.  The reality is more nearly the opposite.  Worldwide, fossil-fuel subsidies are regressive: far less than 20% of them benefit the poorest 20% of the population.  Poor people aren’t the ones who do most of the driving; rather they tend to take public transportation (or walk).   As to producer subsidies, owners of US oil companies don’t need the money as much as construction workers do.

The conventional wisdom in American politics is that it is impossible to increase the gas tax or even to discuss the proposal.   But other countries have political constraints too.  Indeed some governments in developing countries in the past faced civil unrest or even overthrow unless they kept prices of fuel and food artificially low.  Yet some of them have managed to overcome these political obstacles over the last year.  The list of those that have recently reduced or ended fuel subsidies includes Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates which abolished subsidies to transportation fuel subsidies effective August 1.

Besides raising taxes on fuel consumption, the US should also stop some of its subsidies to oil production.  Oil companies can “expense” (immediately deduct from their tax liability) a high percentage of their drilling costs, which other industries cannot do with their investments.  Most politicians know that sound economics would call for this benefit to be eliminated.  But they haven’t been ab le to summon the political will.  Among the other benefits given to the oil industry, it has often been able to drill on federal land and offshore without paying the full market rate for the leases.

Those politicians who complain the loudest about the evils of government handouts are often the biggest supporters of handouts in the oil sector. Political contributions and lobbying from the industry must be part of the explanation.  Even so, it is surprising that self-described fiscal conservatives see more political mileage in closing the Export-Import Bank – which earns a profit for the US Treasury while it supports exports – than in ending oil subsidies, which cost the Treasury a great deal.   ‘

A recent study from the IMF estimated that global energy subsidies at either the producer or consumer end are running more than $5 trillion per year.  (Petroleum subsidies account for about $1 ½ trillion of that. A lot also goes to coal, which does even more environmental damage than oil.)  US fossil fuel subsidies have been conservatively estimated at $37 billion per year, not including the cost of environmental externalities.

Leaders in emerging market countries have now recognized something that American politicians have apparently missed, that this is the best time to implement such reforms.  Oil prices

he summer of 2014. So governments that act now can reduce energy subsidies or increase taxes without consumers seeing an increase in the retail price from one year to the next.

For the US and other advanced countries it is also a good time for fuel price reform from the standpoint of macroeconomic policy.  In the past, countries had to worry that a rising fuel tax could become built into uncomfortably high inflation rates.  Currently, however, central bankers are not worried about inflation except in the sense that they are trying to get it to be a little higher.

Congress will have to come back to highway funding in September. If other countries have found that the “politically impossible” has suddenly turned out to be possible, why not the United States?.

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Did China’s regulators exacerbate its recent stock market bubble?

The plunge of China’s stock market that has taken place since June 2015 has received a lot of attention.  All the commentary says not only that the Chinese authorities have taken a variety of artificial measures to try to boost the market on the way down but also that they did the same during the huge run-up in stock prices between mid-2014 and mid-2015, when the Shanghai stock exchange composite index more than doubled.  The finger-wagging implications are that the Chinese authorities, particularly the stock market regulator, have not learned how to let the market operate and that they had only themselves to blame for the bubble in the first place.

There is unquestionably a lot of truth to this overall story.  But am I the only one to notice that the Chinese authorities repeatedly tightened margin requirements during the bubble, in January and April 2015?   And that in fact the event which apparently in the end “pricked” the bubble was the June 12 announcement by the China Securities Regulatory Commission of plans to limit the amount brokerages can lend for stock trading?

It seems pretty clear that the extraordinary run-up in stock market prices from June 2014 to June 2015 was indeed fueled  by an excessive increase in margin borrowing.  Reasons for the increase in margin borrowing include its original legalization in 2010-11; easing of monetary policy by the People’s Bank of China since November 2014 (in response to slowing growth and inflation); and the eagerness of an increasing number of Chinese  to take advantage of the ability to buy stocks on credit.   Nevertheless, it appears that the stock market regulator responded by leaning in the opposite direction.

This is the sort of counter-cyclical macroprudential regulatory policy that we economists often call for, but less often see in practice.  (I survey some of the research  in the 2015#2 issue of theNBER Reporter.   A recent study by Federico, Végh, and Vuletin, for example, found that China and a majority of other developing countries also adjust bank reserve requirements counter-cyclically.)

Someone could criticize the Chinese increases in margin requirements by saying either, on the one hand, that their effects on the stock market did not last long (January and April, 2015) or, on the other hand, that they caused the recent crash (June).  But at least the moves were in the right direction, which is not a trivial point..

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Only Tsipras Can “Go to China”

Alexis Tsipras, the Greek prime minister, has the chance to play a role for his country analogous to the roles played by Korean President Kim Dae Jung in 1997 and Brazilian President Luiz Inácio Lula da Silva in 2002.  Both of those presidential candidates had been long-time men of the left, with strong ties to labor, and were believed to place little priority on fiscal responsibility or free markets.  Both were elected at a time of economic crisis in their respective countries. Both confronted financial and international constraints in office that had not been especially salient in their minds when they were opposition politicians.  Both were able soon to make the mental and political adjustment to the realities faced by debtor economies.  This flexibility helped both to lead their countries more effectively.

The two new presidents launched needed reforms.  Some of these were “conservative” reforms (or “neo-liberal”) that might not have been possible under more mainstream or conservative politicians.

But Kim and Lula were also able to implement other reforms consistent with their lifetime commitment to reducing income inequality.  South Korea under Kim began to rein in the chaebols, the country’s huge family-owned conglomerates. Brazil under Lula expanded Bolsa Familia, a system of direct cash payments to households that is credited with lifting millions out of poverty.

Mr. Tsipras and his Syriza party, by contrast, spent their first six months in office still mentally blinkered against financial and international realities.  A career as a political party apparatchik is probably not the best training for being able to see things from the perspective of other points on the political spectrum, other segments of the economy, or other countries.  This is true of a career in any political party in any country but especially one on the far left or far right.

The Greek Prime Minister seemed to think that calling the July 5 referendum on whether to accept terms that had been demanded previously by Germany and the other creditor countries would strengthen his bargaining position.  If he were reading from a normal script, he would logically have been asking the Greek people to vote “yes” on the referendum.   But he was asking them to vote “no”, of course, which they did in surprisingly large numbers.   As a result – and contrary to his apparent expectations — the only people’s whose bargaining position was strengthened by this referendum were those Germans who felt the time had come to let Greece drop out of the euro.

The Greek leadership discovered that its euro partners, predictably, are not prepared to offer easier terms than they had been in June, and in fact are asking for more extensive concessions as the price of a third bailout.  Only then, a week after the referendum, did Mr. Tsipras finally begin to face up to reality.

The only possible silver lining to this sorry history is that some of his supporters at home may – paradoxically – now be willing to swallow the bitter medicine that they had opposed in the referendum.  One should not underestimate the opposition that reforms will continue to face among Greeks, in light of the economic hardship already suffered.  But like Kim dae Jung and Lula, he may be able to bring political support of some on the left who figure, “If my leader now says these unpalatable measures are necessary, then it must be true”.  As they say, Only Nixon can go to China.

None of this is to say that the financial and international realities are necessarily always reasonable.  Sometimes global financial markets indulge in unreasonable booms in their eagerness to lend, followed by abrupt reversals.  That describes the large capital inflows into Greece and other European periphery countries in the first ten years after the euro’s 1999 birth.  It also describes the sudden stop in lending to Korea and other emerging market countries in the late 1990s.

Foreign creditor governments can be unreasonable as well.   The misperceptions and errors on the part of leaders in Germany and other creditor countries have been as bad as the misperceptions and errors on the part of the less-experienced Greek leaders.   For example the belief that fiscal austerity raises income rather than lowering it, even in the short run, was a mistaken perception.  The refusal to write down the debt especially in 2010, when most of it was still in the hands of private creditors, was a mistaken policy.  These mistakes explain why the Greek debt/GDP ratio is so much higher today than in 2010 — much higher than was forecast.

A stubborn clinging to wrong propositions on each side has reinforced the stubbornness on the other side.  The Germans would have done better to understand and admit explicitly that fiscal austerity is contractionary in the short run.  The Greeks would have done better to understand and admit explicitly that the preeminence of democracy does not mean that one country’s people can democratically vote for other countries to give them money.

In terms of game theory, the fact that the Greeks and Germans have different economic interests is not enough to explain the very poor outcome of negotiations to date.  The difference in perceptions has been central.  “Getting to yes” in a bargaining situation requires not just that the negotiators have a clear idea of their own top priorities, but also a good idea of what is the top priority of the other side.   We may now be facing a “bad bargain” in which each side is called upon to give up its top priorities.  On one side, Greece shouldn’t expect the ECB and the IMF to be willing explicitly to write down the debt they hold.  On the other side, the creditors shouldn’t expect Greece to run a substantial primary budget surplus.  A “good bargain” would have the creditors stretch out lending terms even further so that Greece doesn’t have to pay over the next few  years and would have the Greeks committing to structural reforms that would raise growth.

One hopes that the awful experience of the recent past has led both sides to clearer perceptions of economic realities and of  top priorities.   Such evolution is necessary if the two sides are to arrive at a good bargain rather than either a bad bargain or a failure of cooperation altogether. The non-cooperative equilibrium is that Greek banks fail and Greece effectively drops out of the euro. This may be even worse than a bad bargain, although I am not sure.

Admittedly, both Kim and Lula had their flaws.  Moreover, Korea and Brazil had some advantages that Greece lacks, beyond Syriza’s delay in adapting to realities.  They had their own currencies. They were able to boost exports in the years following their currency crises.

But a recurrent theme of the Greek crisis ever since it erupted in late 2009 is that both the Greeks and the Euro creditor countries have been reluctant to realize that lessons from previous emerging market crises might apply to their situation.  After all, they said, Greece was not a developing country but rather a member of the euro.   (This is the reason, for example, why Frankfurt and Brussels at first did not want Greece to go to the IMF and did not want to write down the Greek debt.)  But the emerging market crises do have useful lessons for Europe.  If Tsipras were able to shift gears in the way that Kim dae Jung did in Korea and Lula did in Brazil, he would better serve his country..

Posted in Europe, Financial Crisis, Financial Regulation, Monetary Policy | Leave a comment

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..

Posted in International Trade, Monetary Policy, Obama Administration | Leave a comment