Anyone who has studied a little economics knows that popular fiction usually avoids economic themes, and if it does not, butchers them. Yet this year, two novels landed under our Christmas tree that place economic themes front and center and treat them well. The books are Nineteenth Street Northwest by Rex Gosh (Greenleaf Book Group) and Super Sad True Love Story by Gary Shteyngart (Random House).
Rex Gosh, better known to econ wonks as IMF economist Atish R. Gosh, sets his tale of terror and high finance at the fictional International Monetary and Financial Organization (IMFO), whose address and functions are oddly close to those of the real-world IMF and World Bank. The central character is the brilliant and beautiful Sophia Gemaye. Sophia, the daughter of a martyred third-world freedom fighter, has a big grudge against the developed world. At the same time, her upbringing in England has made her squeamish about blowing up planeloads of holiday-bound mothers and children. She reconciles her conflicting values by infiltrating the IMFO's young economists program, where her goal is to draw attention to her homeland's plight by engineering a bloodless crash of the world financial system. Once inside the IMFO, she steals central bank intervention data, which she plugs into a fiendish neural-network model (described by the author in lovingly accurate detail) that is designed to execute the mother of all bear raids. What happens next you will have to read for yourself.
I will confess that I sat down to read this little thriller with very low expectations regarding its likely merits as literature. The first couple chapters did seem predictably clunky, but pretty soon Gosh gets into the rhythm of things, and the text starts to read more like a novel and less like an IMF working paper. Passion, greed, revenge, and suspense interplay nicely with econometrics and exchange rate dynamics. Gosh avoids some of the most obvious stereotypes, for example, by giving his terrorist plotters a wide variety of backgrounds and motivations that make them, while not exactly sympathetic, at least credible as characters.
Where Gosh's thriller is grimly serious, Shteyngart follows the Russian literary tradition of laughter through tears. Super Sad True Love Story depicts a near-future dystopian United States in which economic and social trends already at work today have plunged us deep into a tunnel that has no obvious light at the end.
The world monetary system has undergone several changes in Shteyngart's near future. Debt, inflation, and repeated devaluation have turned the poor greenback into a parody of its present proud status as a reserve currency. The dollar continues to circulate as a medium of exchange, but it can no longer serves as a reliable unit of account. Instead, prices and contracts are indexed to the yuan, so that they adjust automatically to changes in the exchange rate. If you are a HNWI (high net-worth individual), your income and assets are pegged the the yuan but your expenses and debts are not. If you are a LWNI, it is the other way around. Anyone who remembers Russia in the 1990s would immediately understand the system. The European monetary system is not described in as much detail, but there are references to a monetary unit called the "Northern euro" that suggest that much the same has happened there.
Meanwhile, the U.S. political scene has evolved into a single-party system under the aegis of the Bipartisan Party--an entity that bears uncomfortable resemblance to Vladimir Putin's party, United Russia. The Bipartisans are intent on pursuing a losing war in Venezuela, despite the fact that they can't pay their returning veterans. Their economic policy consists of begging the Chinese central bank for more loans and exhorting fellow Americans with slogans like "Spend More! Together We Will Surprise the World!"
Everyone carries around an iPhone-like apparat that includes a handy face-recognition feature. Point your apparat at any stranger, and you can immediately download all kinds of personal data, including the person's all-important credit rating and several other personal indexes that I would perhaps best not describe here. Texting is the dominant mode of communication, although when in close proximity, people occasionally still engage in "verbaling". Reading is out, scanning text streams for data is in, except for Shteyngart's super-nerd hero, who has hidden away a smelly two-volume copy of War and Peace for his private enjoyment.
Rest assured, beneath all the economic and social satire, there is a real love story between a real boy and girl, but the "Super Sad" part of the title seems to refer not so much to their fate as to that of the country. At one point Love Story's hero, who, like its author, comes from a family of Russian immigrants, laments "the looks on the faces of my countrymen--passive heads bent, arms at their trousers, everyone guilty of not being their best, of not earning their daily bread, the kind of docility I had never expected from Americans, even after the many years of our decline. Here was the tiredness of failure imposed on a country that believed only in its opposite."
In short, these are two nice winter reads, and when you finish them, you can put them down with the comforting thought that they are, after all, only fiction. Right?
Kamis, 30 Desember 2010
Minggu, 19 Desember 2010
U.S. Ethanol Subsidies: A Bad Policy That Refuses to Die
U.S corn farmers and ethanol distillers are among those celebrating passage of last week's tax bill. A little-noticed provision of the law extends ethanol tax credits ($.45 per gallon, plus a bonus for small producers) and tariffs on ethanol imports ($.54 per gallon), previously set to expire at the end of 2010. Should the rest of us also celebrate? I think not.
U.S. ethanol policy contradicts every principle of sound economics. It encourages use of fuels whose opportunity costs are high while discouraging use of those whose costs are low. It promotes trade flows that run opposite to comparative advantage. It creates new market failures instead of correcting those that already exist.
First consider opportunity costs. Economists use this term to mean the full costs of goods and services, taking into account all opportunities sacrificed to produce and use them. The opportunity costs of petroleum, ethanol, and other transportation fuels include costs of production, most of which are reflected in market prices, plus other costs, which are not. The effects of pollution, including both climate impacts and harm to local air quality, are one reason that opportunity costs exceed market prices. National security risks arising from dependence on foreign energy suppliers are a further important opportunity cost. The ostensible purpose of ethanol policy is to offset these costs by encouraging substitution of low-carbon domestic fuel for high-carbon foreign fuel, but in reality, the policy makes the situation worse, not better.
One problem is that corn-based ethanol, the kind produced in the United States, saves little if any carbon and produces little if any net gain in energy compared with petroleum. Measuring the exact carbon and energy efficiency of corn ethanol is not easy. Different assumptions regarding technologies, fuels consumed in farming and distilling, energy value of byproducts like cattle feed, land use impacts, and so on, give answers ranging from small net carbon and energy gains to small net losses. But even the most optimistic studies give corn ethanol only a tiny advantage over petroleum, nowhere near large enough to justify the scale of current subsidies.
What is more, even if corn ethanol were much more carbon- and energy-efficient than petroleum, subsidies would be the wrong way to bring prices into line with opportunity costs. Instead of subsidies, every type of fuel, including but not limited to ethanol and oil, should bear a surcharge equal to its external costs, calculated to account for climate change, local local air pollution, national security, and any other external effects of production and consumption. Gasoline, ethanol, biodiesel, compressed natural gas, and electricity would each bear a larger or smaller charge. Whereas ethanol subsidies act only to encourage substitution between ethanol and gasoline, a broader system would encourage many kinds of substitution. It would spur use of low-carbon, domestic energy sources like natural gas and electricity at the expense of both gasoline and gasoline-ethanol blends. At the same time, it would encourage across the board reduction in transportation fuel use by giving people incentives to buy smaller cars, move closer to work, use more local goods, and make other life-style changes. The fuel surcharges would be likely to generate considerable revenue, which could be used to reduce the marginal rates of other taxes or used to reduce the government's deficit.
Let's turn next to trade and comparative advantage. In the case of ethanol, comparative advantage belongs, hands down, to sugarcane-based ethanol from Brazil. The net energy yield from sugarcane-based Brazilian ethanol is about 8:1, compared to barely more than, or perhaps less than, 1:1 for the U.S. corn-based product. Unfortunately, Brazilian ethanol is saddled with a prohibitive $.54 per gallon tariff, just renewed. The result is an enormous loss of potential gains from trade in the form of a cleaner environment and lower consumer costs--gains that far outweigh the added profits of U.S. corn farmers and ethanol distillers. Need I add that Brazil is a friendly, democratic country, unlike the often corrupt, hostile, or authoritarian regimes from which we import much of our petroleum?
Comparative advantage in ethanol trade takes another kick in the face from a quirk of policy under which some Caribbean sugarcane producers can export ethanol to the United States duty free. For years they did not do so. Their inefficient sugar industries instead catered to the European Union, which granted them the same subsidized prices set for even less efficiently produced European beet sugar. Now the EU has reformed its sugar regime, and that particular free ride has ended. Rather than look for something they can produce efficiently, the Caribbean sugar producers are closing sugar mills and opening distilleries that cater to the sheltered U.S. ethanol market.
The trade effects of ethanol policy would be bad enough if they only involved the closing of U.S. markets to imports, but in reality, matters are even worse. When the effects of tax credits are added to those of import tariffs, they are, together, enough not just to block imports, but to turn the United States into a net exporter of ethanol. Ethanol exports are officially expected to run a record 315 million gallons this year, more than double the 2009 figure. True exports might be half again that if ethanol blended with exported gasoline is included. Exactly how do subsidized ethanol exports promote U.S. energy independence? Go figure.
The bottom line? Yes, there are market failures in transportation fuels. Yes, this is an area where government intervention in markets could actually make us better off. But current policy does not do so. Instead of mitigating market failures arising from pollution and national security effects, U.S. ethanol policy exacerbates them. A 2008 study by Robert W. Hahn of the AEI-Brookings Joint Center estimated that the costs of U.S. ethanol policy exceeded its benefits by more than $3 billion per year. Letting ethanol subsidies and tariffs expire as scheduled would have been a fine holiday gift for the U.S. economy. The next step would be a comprehensive rationalization of energy policy that took into account all opportunity costs of all fuels. Would this mean the end of ethanol as a motor fuel? Not necessarily. Some might still be imported from Brazil and elsewhere, boosting national security by diversifying energy sources. Research into cellulose-based ethanol would continue, although that potential clean domestic energy source has been slower to come on line than some have hoped. But our goal need not be a world free of ethanol--just one free of bad ethanol policy.
Follow this link to view or download a short slideshow on the economics of ethanol.
U.S. ethanol policy contradicts every principle of sound economics. It encourages use of fuels whose opportunity costs are high while discouraging use of those whose costs are low. It promotes trade flows that run opposite to comparative advantage. It creates new market failures instead of correcting those that already exist.
First consider opportunity costs. Economists use this term to mean the full costs of goods and services, taking into account all opportunities sacrificed to produce and use them. The opportunity costs of petroleum, ethanol, and other transportation fuels include costs of production, most of which are reflected in market prices, plus other costs, which are not. The effects of pollution, including both climate impacts and harm to local air quality, are one reason that opportunity costs exceed market prices. National security risks arising from dependence on foreign energy suppliers are a further important opportunity cost. The ostensible purpose of ethanol policy is to offset these costs by encouraging substitution of low-carbon domestic fuel for high-carbon foreign fuel, but in reality, the policy makes the situation worse, not better.
One problem is that corn-based ethanol, the kind produced in the United States, saves little if any carbon and produces little if any net gain in energy compared with petroleum. Measuring the exact carbon and energy efficiency of corn ethanol is not easy. Different assumptions regarding technologies, fuels consumed in farming and distilling, energy value of byproducts like cattle feed, land use impacts, and so on, give answers ranging from small net carbon and energy gains to small net losses. But even the most optimistic studies give corn ethanol only a tiny advantage over petroleum, nowhere near large enough to justify the scale of current subsidies.
What is more, even if corn ethanol were much more carbon- and energy-efficient than petroleum, subsidies would be the wrong way to bring prices into line with opportunity costs. Instead of subsidies, every type of fuel, including but not limited to ethanol and oil, should bear a surcharge equal to its external costs, calculated to account for climate change, local local air pollution, national security, and any other external effects of production and consumption. Gasoline, ethanol, biodiesel, compressed natural gas, and electricity would each bear a larger or smaller charge. Whereas ethanol subsidies act only to encourage substitution between ethanol and gasoline, a broader system would encourage many kinds of substitution. It would spur use of low-carbon, domestic energy sources like natural gas and electricity at the expense of both gasoline and gasoline-ethanol blends. At the same time, it would encourage across the board reduction in transportation fuel use by giving people incentives to buy smaller cars, move closer to work, use more local goods, and make other life-style changes. The fuel surcharges would be likely to generate considerable revenue, which could be used to reduce the marginal rates of other taxes or used to reduce the government's deficit.
Let's turn next to trade and comparative advantage. In the case of ethanol, comparative advantage belongs, hands down, to sugarcane-based ethanol from Brazil. The net energy yield from sugarcane-based Brazilian ethanol is about 8:1, compared to barely more than, or perhaps less than, 1:1 for the U.S. corn-based product. Unfortunately, Brazilian ethanol is saddled with a prohibitive $.54 per gallon tariff, just renewed. The result is an enormous loss of potential gains from trade in the form of a cleaner environment and lower consumer costs--gains that far outweigh the added profits of U.S. corn farmers and ethanol distillers. Need I add that Brazil is a friendly, democratic country, unlike the often corrupt, hostile, or authoritarian regimes from which we import much of our petroleum?
Comparative advantage in ethanol trade takes another kick in the face from a quirk of policy under which some Caribbean sugarcane producers can export ethanol to the United States duty free. For years they did not do so. Their inefficient sugar industries instead catered to the European Union, which granted them the same subsidized prices set for even less efficiently produced European beet sugar. Now the EU has reformed its sugar regime, and that particular free ride has ended. Rather than look for something they can produce efficiently, the Caribbean sugar producers are closing sugar mills and opening distilleries that cater to the sheltered U.S. ethanol market.
The trade effects of ethanol policy would be bad enough if they only involved the closing of U.S. markets to imports, but in reality, matters are even worse. When the effects of tax credits are added to those of import tariffs, they are, together, enough not just to block imports, but to turn the United States into a net exporter of ethanol. Ethanol exports are officially expected to run a record 315 million gallons this year, more than double the 2009 figure. True exports might be half again that if ethanol blended with exported gasoline is included. Exactly how do subsidized ethanol exports promote U.S. energy independence? Go figure.
The bottom line? Yes, there are market failures in transportation fuels. Yes, this is an area where government intervention in markets could actually make us better off. But current policy does not do so. Instead of mitigating market failures arising from pollution and national security effects, U.S. ethanol policy exacerbates them. A 2008 study by Robert W. Hahn of the AEI-Brookings Joint Center estimated that the costs of U.S. ethanol policy exceeded its benefits by more than $3 billion per year. Letting ethanol subsidies and tariffs expire as scheduled would have been a fine holiday gift for the U.S. economy. The next step would be a comprehensive rationalization of energy policy that took into account all opportunity costs of all fuels. Would this mean the end of ethanol as a motor fuel? Not necessarily. Some might still be imported from Brazil and elsewhere, boosting national security by diversifying energy sources. Research into cellulose-based ethanol would continue, although that potential clean domestic energy source has been slower to come on line than some have hoped. But our goal need not be a world free of ethanol--just one free of bad ethanol policy.
Follow this link to view or download a short slideshow on the economics of ethanol.
Selasa, 14 Desember 2010
Does Argentina's "Nike Effect" Hold Lessons for Europe?
What happens when a country faces forced austerity, a banking crisis, a risk of sovereign default, and pressure to abandon a currency peg it has has sworn to be eternal and unbreakable? Several European countries are in this position today, but there is nothing really new about it. It's all happened before, most recently in Argentina in the winter of 2001-02. So what became of Argentina? Are there any lessons there for today's Europe?
Argentina introduced what it called its "convertibility plan" in April 1991 as a way of stopping its latest episode of recurrent hyperinflation. Rather than opting for outright dollarization, as Ecuador would do a few years later, Argentina introduced a new version of own currency, the peso, and pegged it to the U.S. dollar at a 1-to-1 rate. The peg was underpinned by a currency board arrangement, which required the central bank to hold sufficient dollar reserves to back the entire monetary base (paper currency in circulation plus bank reserves) and to exchange pesos freely for dollars.
At first it worked. A fixed exchange rate can be a powerful tool to stop run-away inflation. As inflation came down, Argentina experienced a few years of good growth. However, it was not long before the fixed exchange rate showed its negative side: inflexibility in the face of external shocks. The Mexican "tequila crisis" and a devaluation of the Brazilian real, among other things, left Argentina with an overvalued currency, a big trade deficit, and excessive dependence on foreign borrowing. In addition, Argentina had a hard time mustering the fiscal discipline needed to live with a fixed exchange rate. By the end of the 1990s, Argentina was again in crisis. With IMF encouragement, it first tried fiscal austerity, and when that did not work, more radical measures, including a freeze on withdrawals of bank deposits. "This buries whatever hypothesis may exist that we will devalue," said Finance Minister Domingo Cavallo, speaking, in December 2001, of the banking freeze. But just a month later devalue they did, and defaulted too.
What happened next is very interesting. Devaluation and default did not bring the end of the world. Hyperinflation did not return. The peso, when floated, did not go into free fall, but instead settled into a range between 3 and 4 to the dollar, where it remains to this day. Most importantly, the real economy recovered strongly. Since 2003, Argentina has grown more rapidly even than neighboring Brazil, widely touted as a developing-world success story. One of my students dubbed Argentina's recovery the "Nike effect" because of the resemblance between a graph of Argentine GDP growth and the shoe company's famous "swoosh" logo.
Does Argentina's Nike effect hold a lesson for embattled euro area countries like Ireland, Greece, Spain and Portugal, or for those like Latvia, Lithuania, and Bulgaria, whose currencies are pegged to the euro with currency boards or similar policies? Could devaluation and even default be a better path to recovery than forced austerity?
The first lesson is that fixed exchange rates work best when all partners in a currency area have similar exposure to shocks. In the case of Argentina, probably the greatest problem lay in pegging the peso to the currency of the United States, a country with which it carried on only about 8 percent of its trade. Shocks like the Mexican crisis and the Brazilian devaluation, which hit Argentina hard, were hardly noticed in the U.S. With regard to trade in goods and services, the euro area makes much more sense than did the Argentine currency board. Intra-euro trade shares run in the 60 to 70 percent range. However, asymmetrical financial shocks remain a problem for the euro. Germany and a few other countries with persistent trade surpluses are sources of financial outflows. During the boom of the mid-2000s, countries like Ireland, Spain, and Latvia were in the opposite position, with large current-account deficits and huge financial inflows. When the global financial crisis exposed the fragility of the asset values that had attracted the inflows, those countries were left high and dry.
The second lesson is that a fixed nominal exchange rate does not protect countries from real exchange rate misalignment. A 22 percent real appreciation of the Argentine peso from 1998 through 2001 contributed to the problems of the convertibility policy by undermining the country's competitiveness and adding to its current account deficit. Similarly, as the following chart shows, some of the most distressed EU members experienced real currency appreciation in the years leading up to the crisis, both relative to the rest of the world, and relative to Germany, the anchor economy of the euro. Since Ireland, Spain and Germany all use the euro, and Latvia's lats has been pegged to the euro since 2005, nominal exchange rate changes account for none of differences in the evolution of real exchange rates. Instead, most of the real appreciation in the peripheral euro countries was caused by higher inflation than in Germany, and the inflation, in turn, was largely fueled by financial inflows chasing real estate bubbles.
The third lesson is that when all options are bad, the unthinkable may become the least bad. The orthodox recovery path for a currency-area member is "internal devaluation," that is, real devaluation through deflation of wages and prices rather than through nominal devaluation. Tax increases plus public sector wage and spending cuts are used to bring the budget back into balance. High unemployment, perhaps supplemented by labor market reforms, is used to force down private sector wages and prices. Once prices fall enough and creditor confidence is restored, growth can resume again. The IMF has traditionally favored this set of policies when giving assistance to countries like Argentina, Greece, and Latvia, in part because they protect foreign creditors, who tend to include the most influential IMF members. But it is a slow path to recovery, and one that is socially and politically painful for the patient.
The alternative to austerity and internal devaluation is to abandon the fixed exchange rate. That option, too, is not free of pain. For one thing, in an attempt to make the fixed exchange rate maximally credible, it will often have been locked in by constitutional amendment or treaty or some other mechanism above the reach of mere administrative authority. In addition, it may not be possible to devalue without triggering both public and private defaults on borrowing denominated in foreign currencies. If banking problems have not already been a trigger of the crisis, as in Ireland, devaluation is likely to bring about a banking collapse, as it did in Argentina. Despite all those drawbacks, however, devaluation can open the door to a more rapid recovery than is possible under internal devaluation--a Nike effect.
The bottom line: Life in a fixed-rate currency area is not for everyone. Some countries are structurally unsuited for a fixed exchange rate because of their patterns of trade, their exposure to external shocks, or their inflexible labor markets. Others may be structurally suited but lack the needed fiscal or financial discipline. A country locked into a currency union for which it is not suited is like a spouse locked in a bad marriage. Sticking to one's vows and blaming one's own failures for all the problems of the relationship is certainly one alternative. But the option of divorce should not be too hastily taken off the table.
Follow this link to view or download a short slideshow on Argentina, the collapse of its currency board, and its subsequent recovery.
Argentina introduced what it called its "convertibility plan" in April 1991 as a way of stopping its latest episode of recurrent hyperinflation. Rather than opting for outright dollarization, as Ecuador would do a few years later, Argentina introduced a new version of own currency, the peso, and pegged it to the U.S. dollar at a 1-to-1 rate. The peg was underpinned by a currency board arrangement, which required the central bank to hold sufficient dollar reserves to back the entire monetary base (paper currency in circulation plus bank reserves) and to exchange pesos freely for dollars.
At first it worked. A fixed exchange rate can be a powerful tool to stop run-away inflation. As inflation came down, Argentina experienced a few years of good growth. However, it was not long before the fixed exchange rate showed its negative side: inflexibility in the face of external shocks. The Mexican "tequila crisis" and a devaluation of the Brazilian real, among other things, left Argentina with an overvalued currency, a big trade deficit, and excessive dependence on foreign borrowing. In addition, Argentina had a hard time mustering the fiscal discipline needed to live with a fixed exchange rate. By the end of the 1990s, Argentina was again in crisis. With IMF encouragement, it first tried fiscal austerity, and when that did not work, more radical measures, including a freeze on withdrawals of bank deposits. "This buries whatever hypothesis may exist that we will devalue," said Finance Minister Domingo Cavallo, speaking, in December 2001, of the banking freeze. But just a month later devalue they did, and defaulted too.
What happened next is very interesting. Devaluation and default did not bring the end of the world. Hyperinflation did not return. The peso, when floated, did not go into free fall, but instead settled into a range between 3 and 4 to the dollar, where it remains to this day. Most importantly, the real economy recovered strongly. Since 2003, Argentina has grown more rapidly even than neighboring Brazil, widely touted as a developing-world success story. One of my students dubbed Argentina's recovery the "Nike effect" because of the resemblance between a graph of Argentine GDP growth and the shoe company's famous "swoosh" logo.
Does Argentina's Nike effect hold a lesson for embattled euro area countries like Ireland, Greece, Spain and Portugal, or for those like Latvia, Lithuania, and Bulgaria, whose currencies are pegged to the euro with currency boards or similar policies? Could devaluation and even default be a better path to recovery than forced austerity?
The first lesson is that fixed exchange rates work best when all partners in a currency area have similar exposure to shocks. In the case of Argentina, probably the greatest problem lay in pegging the peso to the currency of the United States, a country with which it carried on only about 8 percent of its trade. Shocks like the Mexican crisis and the Brazilian devaluation, which hit Argentina hard, were hardly noticed in the U.S. With regard to trade in goods and services, the euro area makes much more sense than did the Argentine currency board. Intra-euro trade shares run in the 60 to 70 percent range. However, asymmetrical financial shocks remain a problem for the euro. Germany and a few other countries with persistent trade surpluses are sources of financial outflows. During the boom of the mid-2000s, countries like Ireland, Spain, and Latvia were in the opposite position, with large current-account deficits and huge financial inflows. When the global financial crisis exposed the fragility of the asset values that had attracted the inflows, those countries were left high and dry.
The second lesson is that a fixed nominal exchange rate does not protect countries from real exchange rate misalignment. A 22 percent real appreciation of the Argentine peso from 1998 through 2001 contributed to the problems of the convertibility policy by undermining the country's competitiveness and adding to its current account deficit. Similarly, as the following chart shows, some of the most distressed EU members experienced real currency appreciation in the years leading up to the crisis, both relative to the rest of the world, and relative to Germany, the anchor economy of the euro. Since Ireland, Spain and Germany all use the euro, and Latvia's lats has been pegged to the euro since 2005, nominal exchange rate changes account for none of differences in the evolution of real exchange rates. Instead, most of the real appreciation in the peripheral euro countries was caused by higher inflation than in Germany, and the inflation, in turn, was largely fueled by financial inflows chasing real estate bubbles.
The third lesson is that when all options are bad, the unthinkable may become the least bad. The orthodox recovery path for a currency-area member is "internal devaluation," that is, real devaluation through deflation of wages and prices rather than through nominal devaluation. Tax increases plus public sector wage and spending cuts are used to bring the budget back into balance. High unemployment, perhaps supplemented by labor market reforms, is used to force down private sector wages and prices. Once prices fall enough and creditor confidence is restored, growth can resume again. The IMF has traditionally favored this set of policies when giving assistance to countries like Argentina, Greece, and Latvia, in part because they protect foreign creditors, who tend to include the most influential IMF members. But it is a slow path to recovery, and one that is socially and politically painful for the patient.
The alternative to austerity and internal devaluation is to abandon the fixed exchange rate. That option, too, is not free of pain. For one thing, in an attempt to make the fixed exchange rate maximally credible, it will often have been locked in by constitutional amendment or treaty or some other mechanism above the reach of mere administrative authority. In addition, it may not be possible to devalue without triggering both public and private defaults on borrowing denominated in foreign currencies. If banking problems have not already been a trigger of the crisis, as in Ireland, devaluation is likely to bring about a banking collapse, as it did in Argentina. Despite all those drawbacks, however, devaluation can open the door to a more rapid recovery than is possible under internal devaluation--a Nike effect.
The bottom line: Life in a fixed-rate currency area is not for everyone. Some countries are structurally unsuited for a fixed exchange rate because of their patterns of trade, their exposure to external shocks, or their inflexible labor markets. Others may be structurally suited but lack the needed fiscal or financial discipline. A country locked into a currency union for which it is not suited is like a spouse locked in a bad marriage. Sticking to one's vows and blaming one's own failures for all the problems of the relationship is certainly one alternative. But the option of divorce should not be too hastily taken off the table.
Follow this link to view or download a short slideshow on Argentina, the collapse of its currency board, and its subsequent recovery.
Minggu, 05 Desember 2010
Progress on Korea-US Trade Offers Contrast with Talk of Protectionism
This week's finalization of the long-delayed Korea-US Free Trade Agreement (KORUS FTA) offers a welcome contrast with all the gloomy talk of a protectionist response to the ongoing global crisis. The Bush administration first negotiated the deal, which would be the biggest since NAFTA, in 2006, under the since-expired system for "fast track" approval by Congress. Due mainly to opposition from auto and beef interests, it was never ratified.
The Obama administration made revival of the stalled agreement a centerpiece of its National Export Initiative. Final renegotiation of KORUS FTA was supposed to be a big take-home from the otherwise lackluster G-20 summit in Seoul last month, but last-minute snags ruined the timing. Finally this week the two countries were able to announce agreement on the difficult issue of automobile trade. Korea will admit 25,000 cars each year from each U.S. automaker, and the United States will eventually, but not immediately, lower tariffs. The beef issue remains unresolved.
What has changed to offer hope that Congress may ratify KORUS FTA now, when the parties seem deadlocked on nearly all other issues? Nothing much has changed in the economic case for KORUS FTA. In terms of the usual models, which attempt to balance the interests of consumers, firms, and workers against one another in an unbiased manner, it is hard to see the agreement as anything but a win-win deal. Instead, the important changes have all been political.
In two ways, the political trade game is played by different rules than the economic game. First, whereas economists tend to focus on net gains, politics is very sensitive to the fact that any change in trade policy produces some losers along with the winners. Second, the political influence of winners and losers is not necessarily proportional to the magnitude of their economic gains or losses. Instead, well-organized groups, like corporations, farm groups, and unionized workers, have disproportionate political power compared to poorly organized groups like consumers and non-unionized workers.
KORUS FTA provides a perfect illustration of the political economy of free trade. The strongest opposition to the original treaty came from the Big Three automakers and their unions, which controlled enough Democratic votes in Congress to block ratification. Opponents claimed that US-Korean automobile trade is inherently unfair because Korea exports 700,000 cars a year to the United States while importing 100 times fewer US cars. Little attention was paid to the fact that KORUS FTA would lower Korean auto tariffs by more than US tariffs would be lowered, or that Korean and US automakers each produce many cars in the others' country, which do not show up in import figures, or that trade in auto parts is closer to balance than trade in finished cars.
Additional opposition came from US beef producers. Korea has blocked US beef imports, alleging risks of mad cow disease. This has infuriated Senator Max Baucus (D-Mont.), Chairman of the Senate Finance Committee, which is a key gateway for ratification. Many observers think Korean health concerns are bogus, but whatever the science behind them, they are political reality. An earlier attempt to lift the beef ban led to riots in the streets of the Korean capital, and the government now views beef in third-rail terms.
The political balance of forces has now changed greatly. US auto companies and their unions have lost leverage due to bankruptcies and bailouts. Max Baucus will still chair the Finance Committee, but Democratic leverage will be notably weaker. A long list of big corporations--FedEx, Microsoft, General Electric, Wal-Mart, GE and others--have favored KORUS FTA from the beginning, not least because it will significantly weaken non-tariff barriers to trade in services. Unless Senate Republicans decide to vote against KORUS FTA solely because the Obama administration backs it, we can expect ratification in the spring.
The bottom line: There is often a big gap between the economics and the politics of trade liberalization. Economics tells us that when the interests of all groups are taken into account, trade liberalization leads to net gains for both importing and exporting countries. However, in Washington, politics is played as a zero-sum game where the interests of consumers and non-unionized workers often count for little. It is only at certain moments that the economics and politics of trade liberalization line up favorably. Let us hope this is such a moment.
Follow this link to download a short slide show on trade liberalization and KORUS.
The Obama administration made revival of the stalled agreement a centerpiece of its National Export Initiative. Final renegotiation of KORUS FTA was supposed to be a big take-home from the otherwise lackluster G-20 summit in Seoul last month, but last-minute snags ruined the timing. Finally this week the two countries were able to announce agreement on the difficult issue of automobile trade. Korea will admit 25,000 cars each year from each U.S. automaker, and the United States will eventually, but not immediately, lower tariffs. The beef issue remains unresolved.
What has changed to offer hope that Congress may ratify KORUS FTA now, when the parties seem deadlocked on nearly all other issues? Nothing much has changed in the economic case for KORUS FTA. In terms of the usual models, which attempt to balance the interests of consumers, firms, and workers against one another in an unbiased manner, it is hard to see the agreement as anything but a win-win deal. Instead, the important changes have all been political.
In two ways, the political trade game is played by different rules than the economic game. First, whereas economists tend to focus on net gains, politics is very sensitive to the fact that any change in trade policy produces some losers along with the winners. Second, the political influence of winners and losers is not necessarily proportional to the magnitude of their economic gains or losses. Instead, well-organized groups, like corporations, farm groups, and unionized workers, have disproportionate political power compared to poorly organized groups like consumers and non-unionized workers.
KORUS FTA provides a perfect illustration of the political economy of free trade. The strongest opposition to the original treaty came from the Big Three automakers and their unions, which controlled enough Democratic votes in Congress to block ratification. Opponents claimed that US-Korean automobile trade is inherently unfair because Korea exports 700,000 cars a year to the United States while importing 100 times fewer US cars. Little attention was paid to the fact that KORUS FTA would lower Korean auto tariffs by more than US tariffs would be lowered, or that Korean and US automakers each produce many cars in the others' country, which do not show up in import figures, or that trade in auto parts is closer to balance than trade in finished cars.
Additional opposition came from US beef producers. Korea has blocked US beef imports, alleging risks of mad cow disease. This has infuriated Senator Max Baucus (D-Mont.), Chairman of the Senate Finance Committee, which is a key gateway for ratification. Many observers think Korean health concerns are bogus, but whatever the science behind them, they are political reality. An earlier attempt to lift the beef ban led to riots in the streets of the Korean capital, and the government now views beef in third-rail terms.
The political balance of forces has now changed greatly. US auto companies and their unions have lost leverage due to bankruptcies and bailouts. Max Baucus will still chair the Finance Committee, but Democratic leverage will be notably weaker. A long list of big corporations--FedEx, Microsoft, General Electric, Wal-Mart, GE and others--have favored KORUS FTA from the beginning, not least because it will significantly weaken non-tariff barriers to trade in services. Unless Senate Republicans decide to vote against KORUS FTA solely because the Obama administration backs it, we can expect ratification in the spring.
The bottom line: There is often a big gap between the economics and the politics of trade liberalization. Economics tells us that when the interests of all groups are taken into account, trade liberalization leads to net gains for both importing and exporting countries. However, in Washington, politics is played as a zero-sum game where the interests of consumers and non-unionized workers often count for little. It is only at certain moments that the economics and politics of trade liberalization line up favorably. Let us hope this is such a moment.
Follow this link to download a short slide show on trade liberalization and KORUS.
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