International Economic Policy

  • Monetary Policy
    A Conversation with David Malpass
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    Last month, policymakers at the Annual Meetings of the International Monetary Fund and the World Bank Group expressed cautious optimism about the state of the international economy and predicted continued growth around the world.
    Event with David R. Malpass and Tom Keene November 30, 2017 C. Peter McColough Series on International Economics
  • Economics
    The Global Economy in 2018
    The global economy will confront serious challenges in the months and years ahead, and looming in the background is a mountain of debt that makes markets nervous—and that thus increases the system's vulnerability to destabilizing shocks. Yet the baseline scenario seems to be one of continuity, with no obvious convulsions on the horizon. HONG KONG—Economists like me are asked a set of recurring questions that might inform the choices of firms, individuals, and institutions in areas like investment, education, and jobs, as well as their policy expectations. In most cases, there is no definitive answer. But, with sufficient information, one can discern trends, in terms of economies, markets, and technology, and make reasonable guesses. In the developed world, 2017 will likely be recalled as a period of stark contrast, with many economies experiencing growth acceleration, alongside political fragmentation, polarization, and tension, both domestically and internationally. In the long run, it is unlikely that economic performance will be immune to centrifugal political and social forces. Yet, so far, markets and economies have shrugged off political disorder, and the risk of a substantial short-term setback seems relatively small. The one exception is the United Kingdom, which now faces a messy and divisive Brexit process. Elsewhere in Europe, Germany’s severely weakened chancellor, Angela Merkel, is struggling to forge a coalition government. None of this is good for the UK or the rest of Europe, which desperately needs France and Germany to work together to reform the European Union. One potential shock that has received much attention relates to monetary tightening. In view of improving economic performance in the developed world, a gradual reversal of aggressively accommodative monetary policy does not appear likely to be a major drag or shock to asset values. Perhaps the long-awaited upward convergence of economic fundamentals to validate market valuations is within reach. In Asia, Chinese President Xi Jinping is in a stronger position than ever, suggesting that effective management of imbalances and more consumption- and innovation-driven growth can be expected. India also appears set to sustain its growth and reform momentum. As these economies grow, so will others throughout the region and beyond. When it comes to technology, especially digital technology, China and the United States seem set to dominate for years to come, as they continue to fund basic research, reaping major benefits when innovations are commercialized. These two countries are also home to the major platforms for economic and social interaction, which benefit from network effects, closure of informational gaps, and, perhaps most important, artificial-intelligence capabilities and applications that use and generate massive sets of valuable data. Such platforms are not just lucrative on their own; they also produce a host of related opportunities for new business models operating in and around them, in, say, advertising, logistics, and finance. Given this, economies that lack such platforms, such as the EU, are at a disadvantage. Even Latin America has a major innovative domestic e-commerce player (Mercado Libre) and a digital payments system (Mercado Pago). In mobile online payments systems, China is in the lead. With much of the country’s population having shifted directly from cash to mobile online payments—skipping checks and credit cards—China’s payments systems are robust. Earlier this month on Singles’ Day, an annual festival of youth-oriented consumption that has become the single largest shopping event in the world, China’s leading online payment platform, Alipay, processed up to 256,000 payments per second, using a robust cloud computing architecture. There is also impressive scope for expanding financial services—from credit assessments to asset management and insurance—on the Alipay platform, and its expansion into other Asian countries via partnerships is well underway. In the coming years, developed and developing economies will also have to work hard to shift toward more inclusive growth patterns. Here, I anticipate that national governments may take a back seat to businesses, subnational governments, labor unions, and educational and non-profit institutions in driving progress, especially in places hit by political fragmentation and a backlash against the political establishment. Such fragmentation is likely to intensify. Automation is set to sustain, and even accelerate, change on the demand side of labor markets, in areas ranging from manufacturing and logistics to medicine and law, while supply-side responses will be much slower. As a result, even if workers gain stronger support during structural transitions (in the form of income support and retraining options), labor-market mismatches are likely to grow, sharpening inequality and contributing to further political and social polarization. Nonetheless, there are reasons to be cautiously optimistic. For starters, there remains a broad consensus across the developed and emerging economies on the desirability of maintaining a relatively open global economy. The notable exception is the U.S., though it is unclear at this point whether President Donald Trump’s administration actually intends to retreat from international cooperation, or is merely positioning itself to renegotiate terms that are more favorable to the U.S. What does seem clear, at least for now, is that the U.S. cannot be counted on to serve as a principal sponsor and architect of the evolving rules-based global system for fairly managing interdependence. The situation is similar with regard to mitigating climate change. The U.S. is now the only country that is not committed to the Paris climate agreement, which has held despite the Trump administration’s withdrawal. Even within the U.S., cities, states, and businesses, as well as a host of civil-society organizations, have signaled a credible commitment to fulfilling America’s climate obligations, with or without the federal government. Still, the world has a long way to go, as its dependence on coal remains high. The Financial Times reports that peak demand for coal in India will come in about ten years, with modest growth between now and then. While there is upside potential in this scenario, depending on more rapid cost reductions in green energy, the world is still years away from negative growth in carbon dioxide emissions. All of this suggests that the global economy will confront serious challenges in the months and years ahead. And looming in the background is a mountain of debt that makes markets nervous and increases the system’s vulnerability to destabilizing shocks. Yet the baseline scenario in the short run seems to be one of continuity. Economic power and influence will continue to shift from west to east, without any sudden change in the pattern of job, income, political, and social polarization, primarily in the developed countries, and with no obvious convulsions on the horizon. This article originally appeared on project-syndicate.org.
    Article by A. Michael Spence November 28, 2017 Renewing America
  • Asia
    American Asian Security Allies, Alas, Contribute More to Global Trade Imbalances Than China
    One possible U.S. international economic policy towards Asia, broadly speaking, would be to seek to align with Asia’s other economies to put more pressure on China. Xi’s rhetorical commitment to globalization seems motivated by a desire to keep global markets open to Chinese products, not by a new willingness to allow foreign products—especially manufactures—easy access to China. As a share of China’s GDP, China’s imports of manufactures for its own use are low—and China’s industrial policy seems directed at further reducing China’s imports of many high-end goods: aircraft and semiconductors most prominently. Yet there is one major obstacle to this approach: if you worry about overall trade imbalances, as opposed to headline bilateral balances*, America’s traditional Asian allies are now a bigger problem than China. The surpluses of Korea, Taiwan, Singapore, and Thailand are all exceptionally large relative to their own economies. As a share of their combined GDP, their external surplus is as large as China’s surplus was—relative to its own economy—before the global crisis. Japan’s surplus has also inched above its pre-crisis levels. Not a surprise really, given the yen’s weakness.** The combined surplus of these economies, in dollar terms, now easily tops that of China. I have no doubt that China’s internal market is rigged (see Mark Wu, among others). China imposes significant barriers on many products at the border, generally doesn’t make it easy to invest in China without a joint venture partner, and doesn’t always maintain a level playing field once a firm has set up shop in China. But thanks to a loose fiscal policy (the IMF says far too loose a fiscal policy) and a big rise in domestic credit, China has kept its external surplus down for most of the post-crisis period—with a high level of investment absorbing the bulk of China’s huge mass of domestic savings. China’s true external surplus is a bit bigger than its reported surplus—but even with an adjustment for China’s overstated tourism imports, China’s external surplus is currently far smaller than that of many of its neighbors. Other Asian countries generally do less than China to tilt their domestic markets away from imports. But they have limited their own demand and thus their imports with tight fiscal policies and, in some cases, with underfunded social safety nets. And they keep their exports high in part by actively working to keep their exchange rates weak—in Korea’s case, much weaker than it was prior to the crisis—through a mix of overt foreign exchange intervention, the channeling of public pensions into foreign assets, and more subtle efforts to encourage “private” capital outflows. Such policies almost certainly do more to maintain an unbalanced overall pattern of trade globally—and, across the Pacific—than China’s sectoral trade barriers. And they are an important reason why the trade gains from past agreements to liberalize trade between the U.S. and Asia are, in my view, a little hard to see. At least on the export side.*** KORUS certainly did not create Korea’s current account surplus. But it also didn’t do anything significant to bring it down. Neither KORUS nor any of Korea’s other free trade agreements led Korea to change its tight fiscal policy or put an end to Korea’s tendency to intervene in the foreign exchange market when the won gets too strong for the taste of Korea’s influential export sector. Korea stands out because its free trade agreements with the U.S. and Europe are relatively recent but the point applies more generally: trade barriers don’t typically drive the trade balance nearly as much as macroeconomic and foreign exchange policies. In an ideal world, America’s Asian security allies would become better economic allies, and adopt the kind of policies needed to bring down their surpluses—and to do their part to solidify the economic side of the security partnership. But in the absence of some real changes in America’s trading partners, it will remain hard to generate more balanced trade across the Pacific—no matter what China does. I don’t share President Trump’s focus on the bilateral trade balance—and certainly don’t think the U.S. can credibly criticize others for large surpluses while pursuing a tax policy that would raise the United States’ overall external deficit. But I also think that countries with macroeconomic and foreign exchange policies that produce large external surpluses do not necessarily make the best trading partners. And I am little surprised that Trump and his team haven’t made those policies more of a focus.   * If the bilateral balances were done on a value-added basis, I suspect the overall total with Asia wouldn’t change much. What would change is the attribution of the U.S. bilateral deficit across countries. The deficit with China would fall, while the deficits with Taiwan, Korea, and Japan would rise. Korea and Taiwan export a ton of semiconductors. But they almost all go to China in the first instance not the U.S., and then many are re-exported as computers and cellphones. I should also note that the amount of Chinese content in China’s exports is rising, as more components are now produced in China—and China clearly wants that trend to continue. But that doesn’t change the basic reallocation now needed. At least for goods. Bilateral services trade is horribly measured and is often so distorted by tax concerns (see Torslov, Weir, and Zucman, or spend some time with the BEA's geographic breakdown for services trade) that I am not confident that it adds all that much. The real action seems to be in the income balance. ** Since the end of 2013, net exports have contributed 2.5 percentage points to Japan’s GDP growth and domestic demand only 1.4 percentage points. Trump wasn't all wrong when he encouraged Japanese auto manufactures to raise their U.S. production, though at the current value of the yen, I suspect Japanese firms have an economic incentive to do the opposite. Japanese marks currently produce about 4 million cars in the United States. They also produce about 1.7 million cars in Japan for export to the United States (see the JAMA data, pp. 17). That works out to be roughly 1 out of every 10 cars and light trucks sold in the United States. In many ways, I think it is surprising just how reliant the Japanese economy still is on auto exports to the United States. The U.S. accounts for over 1 in 3 of all Japanese auto exports—and Japanese marks produce far more cars in Japan for sale to the U.S. (1.7 million) than they produce in Japan for the sale to the rest of Asia (0.6 million, with China accounting for only 0.2 million). Japanese auto exports to U.S. alone are larger, as a share of Japan's economy, than U.S. aircraft and aircraft engine exports to the world are as a share of the U.S. economy.  *** A couple of caveats. A significant share of U.S. exports to Asia are bulk commodities. As a result, fluctuations in the price of commodities can play an important role in the headline export numbers and the headline trade balance. Such fluctuations are, fairly obviously, not the result of any trade agreement. Tariffs on most bulk commodities are generally low in Asia; countries usually want to import needed inputs at the lowest possible price. That said, in some agricultural markets tariff and non-tariff barriers are high, and preferential trade agreements can make a difference.
    Blog Post by Brad W. Setser November 16, 2017 Follow the Money
  • Economics
    A Conversation with David Swensen
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    This is the keynote session of the Stephen C. Freidheim Symposium on Global Economics. 
    Event with David Swensen and Robert E. Rubin November 14, 2017 Stephen C. Freidheim Symposium
  • Economics
    World Economic Update
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    The World Economic Update highlights the quarter's most important and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy. 
    Event with Caroline Atkinson, Douglas Rediker, Jeromin Zettelmeyer and Sebastian Mallaby November 6, 2017 World Economic Update
  • Digital Policy
    The Rise of Digital Protectionism
    In July 2017, the Council on Foreign Relations’ Maurice R. Greenberg Center for Geoeconomic Studies held a workshop to examine the drivers behind digital protectionism in Asia and Europe, its implications on the U.S. economy and foreign policy, and policy responses to mitigate the problem. The workshop, hosted by then CFR Senior Fellow Jennifer M. Harris, was made possible by the support of the Carnegie Corporation of New York. The views described here are those of workshop participants only and are not CFR or Carnegie Corporation positions. The Council on Foreign Relations takes no institutional positions on policy issues and has no affiliation with the U.S. government. Introduction Digital protectionism in Asia (especially China) and Europe increasingly threatens the only area of cross-border economic activity still growing nearly a decade after the global financial crisis. Web censorship, forced transfer of intellectual property, data localization, and onerous privacy rules have combined to hamstring the development of the data-based digital economy—the commerce in virtual, not physical, goods. On July 20, 2017, CFR gathered more than two dozen current and former government officials, technology executives, economists, and trade lawyers at the half-day workshop “The Rise of Digital Protectionism: Implications for U.S. Interests and Possible Solutions,” in San Francisco, to examine these issues and explore options available to U.S. policymakers to counter the protectionist measures. The Problem With China’s Digital Protectionism China’s embrace of digital protectionism is just a page from its standard playbook, many participants said, meant to undercut foreign competitors and boost Chinese companies. President Xi Jinping has “stepped on the gas,” one workshop participant argued, making state control of the digital economy a “huge priority” for the Communist Party of China as it seeks to meet ambitious growth targets. The protectionism takes many forms: web censorship through the so-called great firewall, forced technology transfer through mandated joint ventures with foreign firms, and a new cyber security law that places onerous requirements on nearly every foreign company doing business in China. The requirements in the new law that data be physically housed in China, in particular, and limits to data flows out of China are akin, one participant said, to a “Roach Motel”: the data comes in but cannot get out. Participants suggested that two forces have driven the tougher new digital regulations. First, as it did in the past several decades with traditional industries, China seeks global dominance in several high-tech sectors projected to be at the forefront of growth in coming decades—artificial intelligence (AI), robotics, biotechnology, and autonomous vehicles, among others—and uses digital protectionism to carve out a privileged space for Chinese firms. Second, the Communist Party sees the free flow of data and digital communications as a threat to regime stability and seeks greater state control of data flows. Such protectionism is neither new nor unique to China. But participants stressed that the sheer size and global importance of the Chinese economy makes Beijing’s “bare-knuckle” approach to digital protectionism problematic for U.S. policymakers. Some African countries are already replicating the mercantilist Chinese model, as evidenced by increasing government restrictions on the internet and data flows in Ethiopia, Nigeria, and South Africa. Meanwhile, Western countries and international firms have been loath to push back against Chinese restrictions for fear of losing access to the world’s largest economy by purchasing power parity. The Need to Push Back Against China In recent years, the European Union (EU) has ramped up its digital protectionism, vowing to create a digital single market with Europe-wide rules on data flows, implementing rigorous privacy standards, cracking down on hate speech, policing social media, and challenging the market dominance of (predominantly American) technology firms. Participants noted that Europe’s digital protectionism is in line with Brussels’ legalistic, top-down, heavily regulated approach to economic policy and that, like other EU initiatives, it lacks a comprehensive appreciation of the interplay of privacy, security, and innovation in the digital economy. U.S. firms are asked to do more than European firms with respect to privacy protections, for example. These and other requirements, such as data localization in different member states, create a regulatory burden that is especially costly for small- and medium-sized tech firms. Many participants underscored what appears to be an anti-American bias in European digital regulation, pointing to high-profile antitrust cases and limits on American tech firms doing business there. But many attributed that to poor, not protectionist, policies. They argued that European policymakers, hostage to overlapping jurisdictions, are not equipped to tackle interrelated problems such as privacy, security, and economic innovation in a unified way and often introduce flawed policies based on a misunderstanding of what technology can actually do and what effects the policy actually has on businesses and consumers. Laws intended to rein in corporate titans often impose substantial compliance burdens that ironically hurt small tech firms while the Googles of the world easily meet those requirements. One participant summed up Europe’s approach to the digital economy as “not protectionist, just flawed—and wrong.” Despite the limitations brought about by Europe’s digital restrictions, participants largely agreed that Europe is more an irritant than a major threat and that the EU could help the United States push back against Chinese digital protectionism. A Digital Economy Drives Globalization Barriers to the free flow of data and digital information are consequential to the United States, participants said, because the global digital economy has quickly become a large part of cross-border trade flows. Participants estimated that cross-border data and digital flows account for between $2.8 trillion and $4 trillion of the $7 trillion to $15 trillion in total cross-border flows of goods and services. Moreover, although cross-border flows in traditional goods and services flatlined after the 2008 financial crisis, data and digital flows have continually grown, increasing eighty-fold since 2005. Participants noted that the digital economy is the sole part of globalization that is still proceeding apace and is more diffuse than traditional globalization, given the active role that smaller firms and smaller countries play. One participant argued that the digital economy is “shifting the nature of globalization,” by deepening cross-border trade in virtual goods even as growth in physical trade has been nearly stagnant. New technologies are creating economic opportunities, but creeping protectionism, especially in China, could threaten U.S. competitiveness in critical sectors. Participants highlighted massive Chinese investment in semiconductors, for example, as well as China’s dominance of the supply chains for fifth-generation mobile phones, not to mention Chinese determination to stake out a leading position in sectors such as AI, robotics, electric and autonomous vehicles, and biotechnology. China’s digital approach, one participant noted, has already resulted in its dominance of crucial sectors, “and they will dominate going forward.” But It Affects the Old Economy, Too Digital protectionism does not just pose a risk to U.S. competitiveness in sectors at the center of the future economy, it also threatens traditional sectors such as manufacturing, energy, and agriculture. Participants noted that advanced manufacturing has a large and growing data component: 3-D printing and digital manufacturing, for example, rely on cross-border data flows as well as a data-intensive research and development program. Traditional sectors such as agriculture are seeing a growing role for data, for example, in biotechnology and the development of new strains of seeds. Likewise, extractive industries and the energy sector are being transformed to rely increasingly on data, from geological big data crunching that enabled the hydraulic fracturing revolution to global shipping that is becoming increasingly automated. In that sense, some participants suggested, China’s digital protectionism, while boosting its dominance of high-tech sectors, could backfire in other areas. The rise of big data across a growing number of sectors is helped by jurisdictions such as the United States that allow unfettered data flows. Europe’s tough privacy laws also discourage innovation among technology firms; data localization requirements push tech startups to American shores, where compliance costs are lower. One participant suggested differentiating and regulating data—from anonymous industrial data to regular user information, to extremely sensitive, personal information such as health records—according to its sensitivity. Maintaining cross-border data flows with few government restrictions will be important as the digital transformation plays out in traditional sectors. As one participant put it, networks matter: an economy that tries to insulate itself from global data flows by throwing up restrictions to cross-border data-sharing risks cutting itself off rather than protecting its national champions. Conversely, for the United States, the data-rich patina overlaying sectors such as advanced manufacturing represents an opportunity for an open economy desperate to right its distorted trade balances. As one participant emphasized, “If we are going to boost exports to regain leadership for the U.S. in manufacturing, you can’t avoid thinking about the role of digitization.” Digital Protectionism Threatens National Security To the extent that Chinese digital protectionism gives Beijing an advantage in the global economy, it could also give China an advantage on the battlefield, some participants warned. The United States’ edge in military technology is threatened by concerted Chinese advances in areas that could enhance China’s cyber capabilities. Some participants warned that digital restrictions, especially Europe’s rigorous privacy protection, could make it harder for the United States to properly defend against national security threats, especially terrorism. While U.S. policymakers try to balance security, privacy, and economic concerns with digital regulation, Europe pursues each area of policymaking on its own separate track, which could have dire consequences for U.S. security. Other less obvious security concerns arise from the trend toward digital protectionism. Data localization in Russia, for example, forces U.S. firms to store data from Russian users on servers in that country, opening the possibility of digital reprisals from Moscow in the event of U.S. sanctions against Russia, such as happened after the invasion and annexation of Crimea. One participant characterized the “new constraints” that data localization placed on Washington’s ability to use economic sanctions as a foreign policy cudgel. How U.S. Policymakers Should Respond Workshop participants agreed that the first order of business is to address the Donald J. Trump administration’s focus on traditional sectors of the economy and its corresponding lack of understanding of the scope of the threat from digital protectionism. One participant noted that the administration’s public discussions of trade policy favor goods over services and tangible cross-border flows over data. “We need to explain to a manufacturing-obsessed administration why it should care about digital and data,” one participant argued. Others suggested that the first step should be to educate policymakers about the linkages between the traditional and the digital economies and about how digital protectionism could affect U.S. economic prospects. U.S. government agencies also need to build a more coordinated approach to digital issues. The State Department and the National Security Council, for example, wall off digital innovation from cybersecurity issues, complicating interagency and intragovernmental coordination on data and digital policies more broadly. One participant recommended crafting an international charter that would set the basic rules for regulators on how to approach data mobility and security, akin to the early trade guidelines that bounded the General Agreement on Tariffs and Trade and eventually morphed into an accepted, global trade architecture. Even if such a charter failed to secure a consensus among the United States, China, and Europe, it would at least put competing tradeoffs on the table—privacy versus security versus innovation—and avoid policymaking that treated each as an isolated issue. Some participants suggested prioritizing data and digital issues in upcoming trade talks, whether in the North American Free Trade Agreement (NAFTA) renegotiation or the continuing talks between the United States and Europe about a free-trade pact. Older trade agreements such as NAFTA could be revised now to address digital issues that were not apparent twenty-five years ago. Other participants, however, doubted the appropriateness of trade talks for digital issues. Lobbies for traditional sectors such as steel and agriculture dominate trade discussions; tech firms are either unable or unwilling to do the same. Further, ambitious trade deals, such as the Trans-Pacific Partnership (TPP) and Transatlantic Trade and Investment Partnership (TTIP), which seek to better deal with data and digital trade, face problematic futures. Asian and Latin American countries are trying to salvage a shrunken TPP after the U.S. withdrawal, while TTIP is burdened by EU divides, Brexit, and a skeptical public attitude in the United States and Europe toward free trade. Other participants stressed that the U.S. government cannot tackle digital protectionism on its own. Many suggested that the Trump administration should work with the business community to strengthen its resistance to unreasonable digital oversight, since many firms—eager to dive into the Chinese market—acquiesce to restrictive digital regulations with little or no pushback. To get businesses on board, participants recommended modifying the Foreign Corrupt Practices Act (FCPA), which outlaws the transfer of money to foreign governments, and similar laws meant to prevent bribery and corruption by U.S. firms overseas. Expanding the concept of the FCPA to include in-kind handovers—such as data, access to networks, or veto over the ultimate use of corporate data—could force companies to stop accepting onerous digital rules. At the same time, many participants stressed the importance of the United States enlisting other countries, particularly those in Europe, to push back against Chinese digital protectionism. While many smaller economies are hesitant to do so for the fear of losing Chinese investment, participants said that the EU could play a role alongside the United States in pressuring China, especially on privacy, because, as one participant noted, “as many differences as we have with the Europeans, we both have more with China.” Several participants, noting that timid U.S. government responses to Chinese protectionism in the past had ultimately encouraged such behavior, urged a tougher line. They suggested using the World Trade Organization to tackle digital protectionism, starting with smaller countries to set precedents before taking aim at Chinese abuses, or retaliating using trade authority under U.S. domestic law. Other participants pointed to additional elements of U.S. leverage, such as access to the U.S. market. Reforming the Committee on Foreign Investment in the United States, for example, to more closely scrutinize and, if needed, block potentially sensitive foreign investment in digital technology, could nudge China toward more reciprocal behavior. Yet others recommended a more aggressive use of export controls, which would hurt China’s current acquisition spree and could ultimately drive concessions on digital protectionism.
    Report October 18, 2017 Greenberg Center for Geoeconomic Studies
  • Diplomacy and International Institutions
    Trump, the World Bank, and the IMF: Explaining the Dog that Didn’t Bark (Yet)
    A big surprise of Donald Trump’s “America First” presidency has been the moderate tone he has adopted toward the World Bank and International Monetary Fund (IMF), which hold their annual meetings in Washington this week. Few observers expected this outcome back in January. Trump, who had spent his campaign railing against globalization, delivered a dark inaugural address praising protectionism. Stephen K. Bannon, his chief strategist, pledged that populist nationalists would put globalist elites in their place. The Bretton Woods institutions, as pillars of the post-1945 liberal world order, seemed obvious targets. That hasn’t happened, making the international financial institutions (IFIs) an anomaly. Trump has blasted multilateral trade arrangements from the Trans-Pacific Partnership (TPP) to the North American Free Trade Agreement (NAFTA) to the World Trade Organization (WTO). He’s belittled NATO, America’s most important alliance. He’s chastised and slashed the budget of the United Nations. And he’s renounced the most important international accord of the twenty-first century, the Paris Climate Agreement. The IFIs have fared better—at least in comparative terms. Much of this can be attributed to savvy diplomacy on the part of its leaders—particularly Jim Yong Kim, president of the World Bank, but also Christine Lagarde, managing director of the IMF. Still, bankers will be holding their breath to see if their overtures can translate into more sustained support from the Trump administration. To be sure, early signs pointed to a bumpy relationship between the IFIs and their new neighbor in the White House. In April the Trump administration rattled Group of 20 (G20) finance ministers by refusing to sign onto an IMF communique pledging to avoid “all forms of protectionism” (language the fund quickly dropped). When Lagarde warned against protection, Commerce Secretary Wilbur Ross accused her and other free traders of “sloganeering,” while ignoring the real trade barriers the United States faced abroad. Nor has the World Bank been unscathed. Mnuchin has taken it to task for high lending to middle-income countries and has insisted that the Bank focus on “outcomes, results and accountability.” The president’s proposed FY18 budget, moreover, would cut $650 million in U.S. support for multilateral development banks (MDBs) over three years, with the bulk of savings coming from reduced outlays for the International Development Association (IDA)—the World Bank’s window for concessional loans to 77 of the world’s poorest countries. Still, it could have been much worse. The administration’s overall request for the World Bank is $541 million larger than the figure proposed by appropriators in the Republican-controlled House, who would have reduced Bank funding by a whopping 52 percent (from $1.4 billion in 2017 to under $659 million). Some of this reduction can be justified, moreover, as a reversion to the mean following the great recession. Between FY08 and FY14, U.S. funding for MDBs more than doubled, from $1.28 billion to $2.67 billion, as donors pumped more capital into the Bank’s non-concessional lending facilities and issue-specific trust funds. The relative modesty of these cuts reflects the influence of Cohn and Mnuchin. The two are creatures of Wall Street who understand that the Bank has a valuable role to play in leveraging private sector investment in developing countries, just as the Fund can help stabilize nations experiencing balance of payments difficulties. Speaking at the Spring IMF meetings in April, Mnuchin praised the IMF for doing “a great job,” adding that its “expert guidance and financial assistance” remained “crucial.” Moreover, the IFIs themselves have played their weak hands skillfully, if controversially. In the immediate wake of the election, senior management at both the IMF and World Bank went into damage-control mode, instructing staff to refrain from public comment on possible directions the new administration might take, particularly provocative statements that might goad Trump and his coterie into a confrontation. Lagarde’s own pronouncements were bland, as in February, when she described the IMF as “an agent of financial stability in any country where we operate…” adding: “A leading power like the United States has a vested interest in economic stability and peace.” This quietist approach paid off, as the President directed his tweetstorms at other targets. More proactively, the institutions’ leaders have sought to build bridges with the administration. Jim Kim has ingratiated himself with Trump by forging an alliance with his daughter Ivanka on the issue of women’s empowerment. At the G20 meetings in Hamburg, the Bank unveiled a Women Entrepreneurs Finance Initiative (the outcome of conversations among Kim, Ms. Trump, and Prime Minister Justin Trudeau of Canada). The fund was established with “a speed unusual at the World Bank.” Intended to help women in developing countries gain access to the funding, technical assistance and networks needed to start businesses, it seeks to leverage $325 million raised from donor nations to draw commercial finance. In July, President Trump pledged $50 million to the initiative. The “Ivanka Fund,” as it inevitably became known in Bank corridors, has raised eyebrows. Half of its initial capital of $200 million will come from Saudi Arabia and the United Arab Emirates, neither poster children for gender equality. And while the Bank already administers a number of standalone funds, making a deal with a president’s daughter presents a potential reputational risk and conflict of interest, since the Bank will have political difficulty pulling out if the fund underperforms. In another savvy if controversial move, the World Bank in late May begun advising the Trump administration on its infrastructure plans. After Ms. Trump introduced the Bank president to her father, Mr. Kim offered to gather experts to provide informal advice on U.S. infrastructure plans. As Kim has sought to deepen relationships with the Trump administration, he has also moved aggressively to position the Bank as an ‘honest broker’ between private capital and developing countries. Kim’s ‘cascade’ financing model seeks to leverage the Bank’s technical expertise and lending capacity to reduce risks to private investment in developing countries. The approach complements other Bank initiatives to tap private markets and lower dependence on donor largesse, such as the introduction of pandemic and IDA bonds. This focus on unlocking investment opportunities for the private sector is likely to find friends in the Trump administration. This strategy seems to be paying off. In July, Trump proclaimed his support for Kim, whose legitimacy came into question after his presidency was extended hurriedly ahead of the November U.S. election. During the speech at the G20 summit where Trump announced his $50 million donation, he referred to Kim, the World Bank president, as “my friend” and a “great guy.” The big prize though would be U.S. approval for a World Bank capital increase. While it’s unlikely that the administration will agree to such a change next week, the meetings could set the stage for a decision next year. Although less brazenly than the Bank, the IMF has also reached out to the Trump administration. While continuing to warn about the dangers of protectionism, the Fund has begun to acknowledge the economic dislocation driving populist politics in the United States and other Western nations. At a WTO meeting in Geneva late last month, Lagarde offered something of a mea culpa, conceding that while globalization had lifted millions out of poverty, it had also wreaked havoc on numerous cities and towns across the United States. Observers perceived this as a nod to the “forgotten” men and women who constitute much of Trump’s populist base. Lagarde also recently weighed in on economic priorities for the United States, focusing on tax reform, infrastructure investment, and cutting business regulations—a list that bears striking resemblance to Trump’s own priorities. The dog may yet still bark. At least two senior U.S. Treasury nominations are known for their antipathy towards the IMF. One is David Malpass, the recently confirmed undersecratary of the Treasury for international affairs. A veteran of the Reagan and George H. W. Bush administrations, Malpass has been outspoken in his belief that the Fund does little to enhance economic growth and has criticized its role in bailing out governments. Another is Adam Lerrick, nominated to serve as assistant secretary for international finance. A visiting scholar at the American Enterprise Institute, Lerrick has consistently criticized the IMF and has called on the World Bank to stop lending to middle-income countries. If the American dog does begin to bark, look for Kim and Lagarde to hedge their bets, by cozying up to their major emerging shareholder, China. Kim is already looking for ways that the Bank can support China’s Belt and Road initiative, while Lagarde joked in July that the Fund may move its headquarters to Beijing. In playing this game, they would be taking a page from UN Secretary-General Antonio Gutteres, who has said that China is ready to fill any global leadership vacuum left by the Trump administration.
    Blog Post by Stewart M. Patrick October 11, 2017 The Internationalist
  • Economics
    Financial Crises and the Failure of Economics
    Richard Bookstaber critiqued the discipline of economics as it has historically been practiced and discussed the challenges of managing risk and uncertainty in a complex macroeconomic environment. Participants had a lively conversation about financial regulation and what they perceived as being the most pressing threats to economic stability and prosperity in the post-2008 world. 
    Event with Richard Bookstaber and Benn Steil September 29, 2017
  • Trade
    International Trade Policy: A Conversation With Representative Sander Levin
    Play
    Representative Sander Levin discusses the future of U.S. international trade policy.  
    Event with Sander Levin and Carla A. Hills September 25, 2017
  • Monetary Policy
    How We Know Eurozone Monetary Policy Is Working Again
      In 2013, I showed that the ECB’s monetary transmission mechanism had broken down in the crisis-hit periphery countries. ECB rate cuts were not being passed on to rate cuts on new loans to businesses. Perhaps the strongest sign that the crisis has ended is that this mechanism has now been restored in the periphery countries. In fact, the link between ECB rates and the rates banks charge on new business loans is now, on average, considerably stronger in the periphery than in the core—as can be seen in the main graphic above. (I use the overnight interbank rate as a substitute for the ECB’s policy rate, as it captures both the ECB’s policy rate and the effects of its QE and lending to banks.) The turning point was the ECB’s June 2014 announcement of a negative deposit rate and cheap long-term loans to banks—known as targeted longer-term refinancing operations, or TLTROs. This is because these new measures have disproportionately benefited periphery banks. Periphery banks borrow from the ECB, and have been able to lower their funding costs by switching into cheap TLTROs—which have gotten cheaper with the decline in the ECB policy rate. Banks in Italy and Spain account for over 60 percent of TLTRO holdings. Banks in the core countries, in contrast, tend to hold funds at—rather than borrow from—the ECB, and have been disproportionately hit by the negative deposit rate. As of June, German banks have €551 billion parked with the central bank, just 4 percent shy of the record set in May. In the first half of 2017 alone, they paid, rather than received, €900 million in interest charges—just marginally below the €1 billion they paid for all of 2016. The ECB’s asset purchase program (APP)—which began in late 2014, and was expanded to include sovereign bonds in 2015—has also disproportionately benefited periphery banks, which made capital gains on their security holdings. Core banks, on average, did not. With lower funding costs from TLTROs, and higher profits from APP, periphery banks have lowered lending rates to business customers considerably more than core banks have, as the small inset graph shows. The health of eurozone banks broadly remains poor. But the fact that ECB policy is once again affecting lending rates across the marks an essential step on the path to a sustained recovery.
    Blog Post by Benn Steil September 15, 2017 Geo-Graphics
  • Monetary Policy
    Can the Fed and ECB Work Together To Reduce Imbalances?
    Fed Governor Lael Brainard’s speech on central bank coordination last week was quite interesting—I think it should be read for far more than a signal on when the Fed is likely to next raise the policy rate. For one, Brainard argues that the ECB (and BoJ’s) asset purchases have had an impact on global yields. Makes sense. The ECB and BoJ are both buying more than their respective governments are issuing, so they are reducing the net supply of eurozone and Japanese government bonds on the market. That forces bond investors into other assets—be it short-term deposits at the ECB, bank bonds in Europe, or U.S. bonds of various stripes. That though wasn’t the central banking orthodoxy a few years ago. The spillover of U.S. asset purchases onto say European government bond yields was not apparent back when the U.S. was doing QE. In fact, QE2 generally coincided with generally rising eurozone government bond yields. In part because the eurozone was experiencing its own version of a self-created government funding crisis, as the creation of the euro meant that countries that previously issued bonds in their own currency were now issuing bonds in the ECB’s currency so to speak. And in part because QE2 coincided with a large U.S. fiscal deficit—it reduced the new supply of Treasuries investors needed to absorb, but it didn’t on net remove supply from the market.* But the really interesting bit isn’t the technical argument about global spillovers from asset purchases. It is the hint—at least in my reading—that the Fed and the ECB should pursue different tightening strategies. Consider a simplified global economy that constitutes three blocks. Two blocks have independent monetary policies and let their currencies float, and both have two central bank policy instruments—the policy rate, and the balance sheet. And the third block pegs, more or less, to one of the other blocks. The block that is now in a tightening cycle has a current account deficit of around 3% of GDP (and a sizeable net external debt position, so an underlying stock imbalance too). The block in an easing cycle (for now) has a current account surplus of around 3% of its GDP (a bit more actually). The block that pegs has a current account surplus of around 3% of GDP (after adjusting for some, umm, irregularities in its trade data) and pegs to the currency of the deficit country. The three blocks are obviously the U.S., the eurozone, and China. This model leaves a lot out. Japan and the newly-industrialized-economies (NIEs) combined have a current account surplus of well over 5% of their combined GDP. And the U.S. NAFTA partners all have sizeable current account deficits too. Brainard postulates that tightening through increasing the policy rate has a bigger impact on the exchange rate than tightening through balance sheet reduction. And thus the choice of central bank policy instrument can have an impact on net exports, and ultimately the equilibrium current account deficit. If I read her comments correctly, this argues for putting a priority in the U.S. on balance sheet reduction rather than raising the policy rate. That is because the dollar is already strong, and already distorting (in my view) the composition of U.S. output.I cannot find evidence to support McKinsey’s argument that a combination of robots (automation), cheap natural gas, and rising wages in emerging markets are going to reduce the U.S. trade deficit in manufactures at current levels of the dollar. Rather the contrary.** At current levels of the dollar, the U.S. trade deficit in sophisticated “capital goods” is actually rising. Basically, if given a choice, a country with a large existing trade deficit should choose to tighten its monetary policy in the way that puts the least pressure on the dollar, and the least pressure on the tradables sector. Interestingly, the opposite holds true for the central bank of a large surplus region. It should choose to tighten through raising the policy rate rather than through balance sheet reduction. That would help bring the economy into better external balance. It, in Europe, also probably has some positive financial stability spillovers. The nightmare scenario that reverses the eurozone’s current positive momentum is a blowout in Italian yields (see The General Theorist). And that risk would rise if the ECB is selling its Italian government bond (BTP) portfolio at the same time as regulatory efforts at “risk reduction” force the Italian banks to diversify their own government bond portfolio. ECB balance sheet expansion has expanded the supply of “safe” euro area assets while taking both duration and sovereign credit risk out of the market. An ECB that tightens through rates and a Fed that relies on balance sheet roll off, in theory, would work together to in effect weaken the dollar and reduce the U.S. trade deficit and European surplus. That at least is how I read this paragraph in Brainard’s speech: “Let's turn to the case in which the two central banks choose to rely on different policy tools. In this case, one country responds to the positive shock by hiking its policy rate to reduce output to its initial level, while the second country responds by shrinking its balance sheet. The country that relies on the policy rate to make the adjustment experiences an appreciation in the exchange rate, a deterioration in net exports and some expansion of domestic demand, while the country that chooses to rely solely on the balance sheet for tightening experiences a depreciation of its exchange rate and an increase in net exports. Thus, while both countries achieve their domestic stabilization objectives, whether the requisite policy tightening occurs through increases in policy rates or reductions in the balance sheet matters for the composition of demand, the external balance, and the exchange rate.” A weaker dollar would also make it much easier for the third block, China, to avoid a big depreciation that would raise its surplus. China now seems to manage against the dollar, more or less (though officially it manages with reference to a basket). It appears to have successfully carried out a modest controlled depreciation after the dollar’s 2014 rise—though the process itself wasn’t totally smooth. The yuan is now stable, in part because stability (against the dollar) creates expectations of stability and thus reduces outflow pressures, and contributes to stability (in reserves). And in part because China reversed its premature financial account liberalization. Indeed, if China decides it wants to manage with respect to a basket for real, the yuan should appreciate against a depreciating dollar. Which would help the PBOC convince the market (and more importantly Chinese residents) that the yuan isn’t a one way bet, and also help keep the U.S. trade deficit from rising—China’s export volume growth in the second quarter was extremely strong, so I suspect China’s surplus is now poised to expand if the yuan remains constant. It is potentially win-win-win, so to speak. Of course, it all depends on the assumption that raising the policy rate and balance sheet reduction (quantitative tightening) can be calibrated to achieve the same level of domestic tightening with a different exchange rate impact. A two central bank, two instrument world has to differ in some fundamental ways from a two central bank, one instrument world in order to create new possibilities for de facto coordination. And it depends on the assumption that the eurozone’s current momentum will allow the ECB first to scale back its easing and then start a tightening cycle. It makes sense to me, though. And I think I see hints of it all in Governor Brainard’s speech.   * QE2 also didn’t weaken the dollar much, which led some to underestimate the foreign currency impact of ECB easing. The absence of a bigger impact on the dollar reflected two things I think: (a) the dollar was fairly weak at the time; and (b) foreign central banks—setting the ECB aside—intervened heavily to keep their currencies from appreciating. All this matters—net exports never contributed much to the U.S. post-crisis recovery (a rise in exports did help the US in 2007 and the first part of 2008, and a fall in imports helped cushion the demand blow of the crisis in 2008 and 2009, but net exports subsequently didn’t do much—until the dollar’s 2014 appreciation). ** I liked a lot of the recommendations in the McKinsey study, but it really seemed to suffer from an omitted variable—namely the value of the dollar. I guess that is too obvious to generate consulting fees. But it clearly matters. Technology (see Richard Baldwin) isn’t confined to a single country’s workers any more. And the postulated positive impact on cheap gas on U.S. manufacturing has clearly been trumped by other variables (one example suffices: Aluminum was one of the postulated winners from cheap gas as it is hugely energy intensive), and, well, the gap between U.S. and global gas prices has shrunk significantly since 2014 as global prices have come down. The reality is that the U.S. manufacturing deficit soared back in 2014 and 2015, and shows no signs of coming down (the rise in the deficit actually preceded the rise in the dollar, as there was a surge in imports in 2014—but the dollar clearly had the expected impact on exports).
    Blog Post by Brad W. Setser July 20, 2017 Follow the Money
  • China
    Have the Economic Constraints on China’s Geostrategic Ambitions Diminished?
    The Council on Foreign Relations’ Greenberg Center for Geoeconomic Studies has just put out a new discussion paper by Willian Norris on an important topic: how China’s economic position shapes its foreign policy. The paper makes one particularly provocative argument: the extremely unbalanced economic relationship that preceded the global crisis helped moderate China’s geostrategic ambitions, as China was so dependent on open markets for its exports that it wasn’t willing to rock the boat so to speak (e.g. act too aggressively in the South China Sea). Broadly speaking, an unbalanced trading relationship created positive strategic externalities for the U.S., and the more unbalanced, the better—strategically speaking. One implication is that China’s post-crisis pivot to growth driven by domestic investment has freed China’s foreign policy hand, and allowed it to act more aggressively to promote its regional and global interests. Another is that a successful pivot from investment to consumption, while economically desirable, may also position China to act more aggressively to promote its interests abroad. The thesis broadly fits with the stylized facts—China under Xi has asserted its interests more aggressively than China under Hu. And China’s greater assertiveness coincides with a large fall in China’s dependence on exports—at least if export dependence is measured by the ratio of exports to GDP. That is down from something like 40 percent pre-crisis to about 20 percent of GDP now. China is no longer a particularly export-intensive economy (it isn’t widely recognized but China’s trade surplus now stems primarily from its comparatively low level of imports of manufactures). But the case isn’t a slam dunk. It isn’t clear that the driver of China’s strategic shift is its reduced export intensiveness. It could simply reflect Xi’s own world view. Or it equally could be a function of China’s growing economic size: A bigger China was always going to have more ability to throw its weight around no matter what. Nor is it completely clear that China’s export dependence is in fact way down. Exports to GDP may not be the right measure. The right measure could be a measure of net trade. And the right measure there, arguably, is China’s surplus in manufactured goods—which hasn’t come down much (as a share of GDP) since 2007. Manufactured exports are down as a share of GDP, but manufactured imports are down every bit as much (relative to China’s GDP). That manufacturing surplus keeps China’s manufacturing sector larger than it otherwise would be, and helps China maintain a relatively high level of manufacturing employment. And it generates the foreign exchange China needs to pay for commodity imports, the lending of its state banks and—over the past few years—private capital flight (some disguised as tourism). Even so, Norris’s argument is worth considering. The strategic implications of a China that succeeds in both pivoting toward domestic consumption and continues to reduce its need for imported goods and technology—one of the goals of China 2025—warrants a bit more thought. All this said, I don’t agree with the one of the discussion paper’s arguments. Norris claims that the imbalances that flowed from China’s export-based economy weren’t that adverse to U.S. economic interests. The positive strategic externality consequently didn’t have a significant economic cost, as the U.S. and Chinese economies were complimentary. I though never have bought into the strong version of the “Chimerica” thesis: China saves, the United States spends, and together they constitute a more balanced, more complete economy than either were individually. Obviously, I have been influenced by the work of David Autor and his colleagues. Trade generates winners and losers, and a broad swath of workers in manufacturing intensive regions of the country were on the wrong side of the ledger. A shock to manufacturing employment isn’t just a shock to manufacturing workers; it was a shock to all low-wage workers in manufacturing-intensive regions. The “China” shock was big in part because China is big. But it was also bigger than it otherwise needed to be because the underlying trade relationship was so unbalanced. The U.S. imported more goods, especially manufactures. But in aggregate it didn’t export more. As a share of U.S. GDP, exports to Asia writ large are no higher than in 1997.* Manufacturing exports to Asia are actually lower as a share of U.S. GDP now than in 1997. This isn’t just a question of looking at potentially misleading bilateral balances either. Asia is big enough that it influences the global data, which shows the same basic trend. And I tend to think that the pre-crisis trade deficit contributed to the structural weaknesses in the U.S. economy that gave rise to the 2007-08 financial crisis. Not directly, in the sense that China “caused” U.S. and European financial institutions to take excessive risks with too little capital. But indirectly. With a growing trade deficit and fewer jobs in the tradeables sector thanks to the asymmetric China shock, sustaining the demand needed for full employment required either large fiscal deficits or a lot of borrowing in the household sector. As a result, the U.S. trade deficit could persist in its pre-crisis form so long as a set of financial intermediaries were willing to in effect sell their holdings of safe U.S. assets to China, and invest instead in riskier mortgage backed securities—which in turn allowed Americans to borrow against the value of their homes to support a high level of current spending. I consequently am not persuaded by the argument—commonly made by geopolitical strategists—that the cooperative economic connections generated by China’s integration into global supply chains and the like generated “win-wins” that consistently buffered Sino-American strategic competition. No doubt some firms raised their profit margins by producing in China, and no doubt some Americans—those who saw strong wage growth and didn’t consume much oil (or other commodities whose price rose on the back of Chinese demand, at least before global supply caught up)** —benefited from lower import prices. But there were a fairly large set of people and communities who were left worse off as a result of the China shock, and they have votes. Speaking of the overall gains from an unbalanced trading relationship without considering the distribution of gains and losses leaves out too much of the picture. So if an imbalanced relationship provided strategic gains, I would argue that it did so at a significant economist cost. Yet Norris's argument that large imbalances effectively acted as a source of strategic restraint on China's foreign policy in the years before the global crisis is still worth careful consideration. * One small point: looking at the rise in U.S. exports to China after China's entry to the WTO is misleading, as the rise in part reflected a shift away from exporting through Hong Kong—and more generally in the initial phase of China’s industrialization, electronic parts that previously had gone elsewhere in Asia were redirected toward China. U.S. exports to other Asian countries were falling as exports to China were rising (relative to U.S. GDP) in the early part of the 2000s. ** Trade should raise the price of exports even as it lowers the price of imports, a point Dani Rodrik always makes. For the U.S. trade has increased the domestic price of corn and soybeans, which are inputs into a wide range of foodstuffs. Soymilk is the obvious one but, well, it isn't nearly as important as the use of corn and soybeans in the production of most meat (poultry, pork, etc). The impact of China on commodity prices has faded somewhat though as global supply increased. China provided a smaller shock to high-end manufactured exports than predicted back at the time of its entry to the WTO, though, as it quickly ramped up its domestic production of a wide range of capital goods. China's manufactured imports started to fall as a share of China's GDP in 2003 or so.  
    Blog Post by Brad W. Setser July 17, 2017 Follow the Money