Zaki Laïdi has a fascinating op-ed in the Financial Times blasting the current state of global governance. It's fascinating because of the mix of not-entirely-accurate observation and breathtakingly naïve prescription. The good parts version:
In principle, the emergence of a multipolar world, in which the US is no longer the only very powerful country, should boost “multilateralism” – institutionalised co-operation among states in pursuit of shared objectives. It should boost efforts to achieve free trade via the World Trade Organisation, poverty reduction through the World Bank, and international security through the UN.
Yet the reality is different. Countries are seeking to extricate themselves from global agreements in order to extract concessions from partners on a bilateral basis or to protect national sovereignty.
Take the case of the WTO. A conflict between India and the US over agricultural subsidies derailed a final compromise in the summer of 2008. This would have – finally – concluded the Doha round of trade talks, which were launched in Qatar in 2001. Negotiations have stalled since the US-India spat. The main responsibility for this failure falls on the US, which believes the system of multilateral trade no longer offers the advantages it used to. The priority for the US is to secure access to markets through enhanced bilateralism. Hence the Obama administration’s drive to agree the trans-Pacific Partnership for Asia and, more recently, to conclude the Transatlantic Trade and Investment Partnership for Europe.
In each case, the strategic objective is to contain China’s rise by setting a high bar for regulatory standards. The novelty is that Europe, which has long defended multilateralism, is now succumbing to the temptation of bilateralism even while it remains completely incapable of assuming political responsibility for its trade policy...
It is important to understand that the collapse of multilateral trade we are witnessing today is far from being an isolated case. Climate talks since the 2009 Copenhagen conference have challenged the multilateralism heralded by the Kyoto protocol of 1997. The idea then was to move forward on the basis of a shared objective – the reduction of greenhouse gas emissions. Today countries only make commitments on climate change on the basis of a very narrow assessment of their national interests. The idea that shared commitments – rather than individual interests – shape behaviour is now dead....
Since the end of the cold war, Europeans have believed deeply in the existence of a global commons – and the declining importance of national sovereignty. The conduct of both the US and emerging countries suggests the opposite. Power politics is back. Multilateralism is dying.
OK, a few things here:
1) It was a lot easier to take this "Europeans don't really believe in national interests anymore, we're so above all that, so the rest of the world should listen to us" guff prior to the Eurozone crisis. Watching Germany and other Northern European nations make sure that their national interest gets executed through EU institutions, however, makes this canard a bit harder to swallow.
2) I hate to break it to Laïdi, but during the 1990s the Europeans could afford the luxury of believing in the growing power of multilateralism. That suited their beliefs and seemed to accord with the facts on a surface level. In point of fact, however, it was the growing power of the United States -- along with the strong support and coordination of its European allies -- that made multilateralism work. The idea that multilateralism should work better when power is more dispersed is an ... odd notion.
3) If Laïdi is really gonna go there on trade, let's ask blunt question -- exactly which jurisdiction triggered the explosion in bilateral free-trade agreements and preferential trade agreements? Hold on, I'll wait ... but I bet everyone already knows the answer.
4) As I've argued at length elsewhere, focusing on Doha and Copenhagen will lead to Laïdi's conclusions -- but those cases are not necessarily representative of global governance writ large. On a raft of other dimensions, the multilateral system has worked surprisingly well.
5) Finally, the real problem with Laïdi's argument is that it fosters a spectacularly naïve narrative about how multilateral arrangements are created in the first place. This is hardly the first moment when great powers have created club-like arrangements in an effort to move the multilateral status quo. In fact, I'm pretty sure that some big books have been devoted to this topic.
The reason the European Union has had success in pushing its version of global rules has little to do with its love of multilateralism and a lot to do with its market power and institutional capabilities. The sooner that European international relations commentators appreciate this, the better.
Am I missing anything?
So, after reading up on the Cyprus deal from the Financial Times, the Economist, and Quartz, I think I have a pretty good idea of what happened. Tyler Cowen isn't happy with the deal, and I can see why, but I don't think that means the deal won't stabilize things for a spell. My four quick takes:
1) I've been pretty insistent that the most surprising thing about the aftermath to the 2008 financial crisis is how much global policy norms haven't changed. By and large the major economies are still rhetorically and substantively committed to trade liberalization, foreign direct investment, and a constrained role for the state in the private sector. The one exception? Capital controls. The earth has moved here, and the fact that this deal will require fair amounts of financial repression and cross-border controls is just the latest sign of this fact.
From a normative perspective, I can't say I'm too broken up about this. It's not that I'm a huge fan of capital controls or anything. In the various policy trilemmas or unholy trinities that Dani Rodrik and others talk about, however, it strikes me that unfettered capital mobility is the policy preference with the least upside. And Cyprus does seem to be the fifth iteration of the lesson that countries that live by large unregulated offshore finance will die by large unregulated offshore finance.
2) If the FT's Peter Siegel and Joshua Chaffin are correct, then the political backlash in Cyprus from this deal won't be that great:
In Nicosia, political leaders generally greeted the deal as painful but necessary.
The city streets were quiet and peaceful, with most businesses closed for a public holiday.
Even before the agreement was clinched, most Cypriots had come to grips with the fact that the offshore financial business sector that has powered the economy since the Turkish invasion in 1974 would be but a shell of its recent self.
And as the Economist explains, the current Cypriot reaction is based on the fact that the new deal is a damn sight better for them than the previous deal:
On March 16th Cyprus’s president, Nicos Anastasiades, desperate to protect Cyprus’s status as an offshore banking model for Russians, had decided to save the two biggest banks and thus to spread the pain thinly. He would have applied a hefty tax to all depositors: 9.9% for those too big to be covered by the EU-mandated €100,000 deposit guarantee, and 6.75% for the smaller depositors.
But after a week of brinkmanship—including protests by Cypriots, the extended closure of banks to avoid the outrush of money, a failed attempt by Cyprus to throw itself at Russia’s feet, an ultimatum by the European Central Bank and an eleventh-hour threat by Cyprus to leave the euro zone—a different decision was made: to apply the pain much more intensely, but on a smaller number of large depositors.
Which leads me to....
3) So much for Russia as a counterweight to the European Union. Cyprus tried to realign itself closer to Moscow, but it didn't take. Furthermore, the new deal really puts the screws on the large deposits of Russian investors that have parked their money in Nicosia. As Felix Salmon explains:
In the Europe vs Russia poker game, the Europeans have played the most aggressive move they can, essentially forcing Russian depositors to contribute maximally to the bailout against their will. If this is how the game ends, it’s an unambiguous loss for Russia, and a win for the EU.
The Financial Times makes a similar point:
One Moscow businessman blamed the harsher haircut on the Kremlin, which he accused of failing to protect Russia’s interests, “thereby allowing the Germans to bully Cyprus and thousands of Russian depositors”.
“As soon as the EU saw that Russia was not going to protect its citizens, the confiscation of Russian money in Cyprus was pushed by the EU. All that was necessary for Russia to do was to provide €2.5bn secured by Cyprus’s nationalised assets,” he said.
With Xi Jinping's visit to Moscow, there's been a lot of chatter about "rise of BRICS" and "Russia turns East" and "SCARY!! SCARY!!" Bear in mind, reading all of this, that Moscow couldn't budge the ostensibly enervated EU from its position on the EU member with the closest ties to Russia.
[Can't Russia just mess with the Europeans on energy?--ed. Um... no. Sure, they could try to do that, but the long-run implications of that move for Russian exports ain't good. To paraphrase an old Woody Allen joke, Russia might find its economic relationship with the European Union to be totally frustrating and irrational and crazy and absurd... but Russia needs the eggs.]
4) What I said about Cyrprus last week still seems to hold for this week. So I guess this means Cyprus now falls under the "good enough" global governance category, with the caveat that this involves eurozone officials, so "good enough" here is defined down to mean "managed not to wreck the rest of the global financial system."
Am I missing anything?
Well, this sounds like very bad news for the global financial system:
A plan to rescue the tiny European country of Cyprus, assembled overnight in Brussels, has left financial regulators, German politicians, panicked Cypriot leaders and a disgruntled Kremlin with a bailout package that has outraged virtually all the parties.
In the end, a bailout deal that was supposed to calm a financial crisis in an economically insignificant Mediterranean nation spread it wider. Word of the plan unnerved markets across Europe, raised fears of bank instability in Spain and Italy and sent pensioners into the streets of the island’s capital, Nicosia, in protest.
As markets tumbled and the Cypriot Parliament fell into turmoil, salvos of blame were hurled back and forth across the Continent.
Officials scrambled to explain what went wrong and how best to control the damage of what Philip Whyte, a senior research fellow at the Center for European Reform, called a “completely irrational decision” to make bank depositors liable for part of the bailout. The deal flopped so badly that finance ministers who came up with it shortly before dawn on Saturday were on the phone to each other Monday night talking about ways to revise it.
Now, on the one hand, you would be hard-pressed to find anyone who will defend the Cypriot deal as it was announced on Saturday -- but it's pretty easy to find critics of the proposed deal across the political spectrum. So this seems like yet another data point confirming the truly mind-boggling stupidity of European governments and regulators. It's particularly galling that they did this during a time when global capital markets are still fragile from the 2008 financial crisis.
Oh, except, wait a minute, it turns out that those markets aren't as fragile as the perception suggests. If you burrow into the McKinsey Global Institute's latest report on global asset markets, it turns out that, excepting Europe, the rest of global finance has experienced a decent recovery from the 2008 crash. According to MGI:
With the pullback in cross-border lending, foreign direct investment from the world’s multinational companies and sovereign investors has increased to roughly 40 percent of global capital flows. This may bring greater stability, since foreign direct investment has proved to be the least volatile type of capital flow, despite a drop in 2012.
Of course, this was written before the Cypriot stupidity, so now markets are really roiled, right? Well... here's Business Insider's Joe Weisenthal's take early this a.m.:
Markets are down a bit in Europe although not dramatically so yet.
US futures were flat, and Asia was actually up nicely, with Japan gaining 2%.
That seems like a thoroughly appropriate reaction. And over at the New York Times, Andrew Ross Sorkin explains why that's the rational and appropriate reaction:
While the bailout of Cyprus is a fascinating case study and raises interesting theoretical questions about moral hazard for policy wonks and talking heads, here is the reality: It is largely irrelevant to the global economy. Cyprus is tiny; its economy is smaller than Vermont’s. And the bailout is worth a paltry $13 billion, the equivalent of pocket lint for those in the bailout game.
Even the larger issue about bailing out a country by taking money from depositors — which quickly created outrage around the world — seems overblown....
[I]n truth, the smart money knows that the bailout of Cyprus says very little about future actions.
“I would assume that anyone in Spain, Portugal or elsewhere who knows about the taxation of Cypriot depositors also would know that the Cypriot banking system is a very different animal than anywhere else in the euro zone,” Erik Nielsen, chief economist at UniCredit, wrote in a note to clients.
Mr. O’Neill of Goldman also acknowledged: “I am sure it will not set a precedent.”
Cyprus is unique. Besides being tiny, its banking system looks different from those in most other countries. Much of the big money deposited in its banks is from foreign investors, including Russians who have long been suspected of money laundering. Those investors had fair warning that Cypriot banks were troubled. The issue has been simmering for six months. But those investors left their money in the bank, in part because they were gambling that the banks would be bailed out at no cost to them. If the current plan is approved, depositors will have lost that bet.
Now this is a perfectly rational analysis. What's significant is that it seems like markets are making the same calculation. When financial markets are fragile, when there's a fear of financial contagion, they don't make the rational calculation -- they freak out. That hasn't happened with Cyprus.
I know I'm at the risk of pulling a Donald Luskin here, but what's happening in Cyprus right now primarily affects Cypriots, with a small concern about regional effects. It doesn't look like it's triggering the same kind of concerns of either the Lehman collapse or the Greek sovereign debt crisis. And anytime the abject stupidity of European financial statecraft can be confined to Europe, that's a very, very good thing indeed for the global financial system.
Am I missing anything?
A little more than a year ago I blogged that global policymakers had reached a "focal point" moment on the merits of austerity as a macroeconomic policy during a global recession. Namely, central bank authorities had concluded that the policy doesn't really work well at all. If true, this was a big deal. One could argue that from the May 2010 Toronto G-20 summit to the end of 2011 was a period where the austerity policies were widely touted and occasionally implemented. If this was the wrong policy, and there was a shift, that's kind of a big deal.
So where are we now on this?
On the public commentary side, I'd say we're approaching near-consensus on the failures of austerity for large economies. The passing of time has allowed for a comparative look at the data, and the results are not pretty for austertity enthusiasts. Martin Wolf sums up the indictment rather neatly, riffing off of a paper by Paul De Grauve and Yuemei Li:
[T]he chief determinant of the reduction in spreads over German Bunds since the second quarter of 2012, when OMT [the ECB pledge to open up its monetary taps] was announced, was the initial spread. In brief, "the decline in the spreads was strongest in the countries where the fear factor had been the strongest."
What role did the fundamentals play? After all, nobody doubts that some countries, notably Greece, had and have a dreadful fiscal position. One such fundamental is the change in the ratio of debt to gross domestic product. The paper makes three important observations. First, the ratio of debt to GDP increased in all countries even after the ECB announcement. Second, the change in this ratio turned out to be a poor predictor of declines in spreads. Finally, the spreads determined the austerity borne by countries.
On the policy output side, there's been a demonstrable but partial shift. In the past year, the European Central Bank, Federal Reserve, and Bank of Japan have rejected austerity policies in favor of greater levels of quantitative easing. Furthermore, contrary to the outright hostility developing countries directed at quantitative easing in the fall of 2010, the reaction to the past half-year of quantitative easing has been far more muted. When the latest G-20 communique said:
Monetary policy should be directed toward domestic price stability and continuing to support economic recovery according to the respective mandates. We commit to monitor and minimize the negative spillovers on other countries of policies implemented for domestic purposes.
That was code for "hey, G-7 central banks, you gotta do what you gotta do. We get that." Which is demonstrably different from yelling "currency wars", a meme that seems not to have caught fire this time around.
Top central bank authorities have also been willing to speak truth to power -- in this case, GOP members of Congress. John Cassidy recounts Ben Bernanke's testimony from yesterday:
Departing from his statutory duty of reporting to the Senate Banking Committee on the Fed’s monetary policy, Bernanke devoted much of his testimony to fiscal policy, warning his congressional class that letting the sequester go ahead would endanger the economic recovery and do little or nothing to reduce the country’s debt burden.
"Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant," Bernanke told his students, who included a number of right-wing Republican diehards, such as Senator Bob Corker, of Tennessee, and Patrick Toomey, of Pennsylvania. "Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run."
Translated from Fed-speak, that meant that congressional Republicans have got things upside down. Bernanke has warned before about the dangers of excessive short-term spending cuts. But this was his most blunt assertion yet that Mitch McConnell, John Boehner, et al. should change course. "To address both the near- and longer-term issues, the Congress and the Administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run," Bernanke said. "Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the federal budget."
So does this mean some additional policy shifts? Alas, probably not. The consensus against austerity seems pretty strong on the monetary policy side of the equation. On the fiscal policy dimension, however, austerity remains the de facto policy for a lot of economies. This includes the United States, which is conventionally depicted as not having embraced austerity. The New York Times' Binyamin Appelbaum outlines the current fiscal austerity in his story today:
The federal government, the nation’s largest consumer and investor, is cutting back at a pace exceeded in the last half-century only by the military demobilizations after the Vietnam War and the cold war.
And the turn toward austerity is set to accelerate on Friday if the mandatory federal spending cuts known as sequestration start to take effect as scheduled. Those cuts would join an earlier round of deficit reduction measures passed in 2011 and the wind-down of wars in Iraq and Afghanistan that already have reduced the federal government’s contribution to the nation’s gross domestic product by almost 7 percent in the last two years.
The cuts may be felt more deeply because state and local governments — which expanded rapidly during earlier rounds of federal reductions in the 1970s and the 1990s, offsetting much of the impact — have also been cutting back.
Federal, state and local governments now employ 500,000 fewer workers than they did on the eve of the recession in 2007, the longest and deepest decline in total government employment since the aftermath of World War II.
Total government spending continues to increase, but those broader figures include benefit programs like Social Security. Government purchases and investments expand the nation’s economy, just as private sector transactions do, while benefit programs move money from one group of people to another without directly expanding economic activity.
The reason for this split does not require rocket science. Monetary policy is a tool of politrically insulated central bankers. Fiscal policy is a tool for elected politicians. The public might dislike specific budget cuts, but damn if they don't love austerity in theory.
So, in retrospect, I think early 2012 was a focal point -- but only for central bankers and commentators. As Cassidy notes, there remain elected politicians who are super-keen on austerity:
Corker, a former builder who is a long-time critic of Bernanke’s expansionary policies, called him "the biggest dove since World War Two." Toomey, a former head of the conservative lobbying group Club for Growth, questioned whether the sequester would have any real impact on the economy. Bernanke shrugged off the criticisms, calmly and methodically laying out the realities of the situation.
Like other wonks, I watched last night's State of the Union address with a mixture of curiosity and whiskey. As I noted a few days ago, each State of the Union address contains some statements that history will judge rather harshly. Initially that was my focus in listening to last night's speech. That was quickly supplanted by a more interesting undercurrent to Obama's text, however.
Foreign policy wonks like Fred Kaplan have argued that there wasn't much foreign policy content in the speech. That's true only if one has a rather narrow definition of foreign policy. What was striking to me was Obama's global justifications for a lot of his economic policy. Throughout his speech, he used the specter of foreign economic threats to prod Congress into action. Consider the following:
Every day, we should ask ourselves three questions as a nation: How do we attract more jobs to our shores? How do we equip our people with the skills needed to do those jobs?....
After shedding jobs for more than 10 years, our manufacturers have added about 500,000 jobs over the past three. Caterpillar is bringing jobs back from Japan. Ford is bringing jobs back from Mexico. After locating plants in other countries like China, Intel is opening its most advanced plant right here at home. And this year, Apple will start making Macs in America again.There are things we can do, right now, to accelerate this trend....
After years of talking about it, we are finally poised to control our own energy future. We produce more oil at home than we have in 15 years....
Four years ago, other countries dominated the clean energy market and the jobs that came with it. We’ve begun to change that. Last year, wind energy added nearly half of all new power capacity in America. So let’s generate even more. Solar energy gets cheaper by the year – so let’s drive costs down even further. As long as countries like China keep going all-in on clean energy, so must we.....
America’s energy sector is just one part of an aging infrastructure badly in need of repair. Ask any CEO where they’d rather locate and hire: a country with deteriorating roads and bridges, or one with high-speed rail and internet; high-tech schools and self-healing power grids. The CEO of Siemens America – a company that brought hundreds of new jobs to North Carolina – has said that if we upgrade our infrastructure, they’ll bring even more jobs....
Let’s also make sure that a high school diploma puts our kids on a path to a good job. Right now, countries like Germany focus on graduating their high school students with the equivalent of a technical degree from one of our community colleges, so that they’re ready for a job....
In each of these passages, Obama was using comparative language to contrast the United States with other countries -- or, as he would put it, other magnets for jobs. The explicit thesis is that unless the United States makes the necessary investments, scarce jobs will leave American shores.
Obama has used this kind of rhetoric on the campaign trail and in previous SOTUs. It reveals a somewhat mercantiilist worldview, one in which jobs and economic growth have a zero-sum, relative gains quality to it.
[So, what, Dan? Most Americans see the world through a mercantilist lens as well. Will this kind of rhetoric matter?--ed.] I'm honestly not sure. Here's the foreign economic policy component of the SOTU:
Even as we protect our people, we should remember that today’s world presents not only dangers, but opportunities. To boost American exports, support American jobs, and level the playing field in the growing markets of Asia, we intend to complete negotiations on a Trans-Pacific Partnership. And tonight, I am announcing that we will launch talks on a comprehensive Transatlantic Trade and Investment Partnership with the European Union – because trade that is free and fair across the Atlantic supports millions of good-paying American jobs.
Now on the one hand, announcing the formal start of negotiations with the EU on a trade deal augurs well for my prediction last year about foreign economic policy playing a big role in Obama's second term. On the other hand, viewing trade through a mercantilist lens will make tough negotiations even tougher ... which means I might owe Phil Levy an expensive DC dinner.
In a speech in which traditional security threats seemed very much on the wane in terms of actual threat as well as political salience, it would be a cruel twist of fate to ratchet up ill-conceived foreign economic threats as a substitute.
The mobilization towards an agreement reflects the changing landscape of global trade. If a deal emerges, it will allow the U.S. and EU more leeway to set the rules of the road for the industries that matter most to them....
This potential trade deal is also a further sign of the collapse of the movement toward global free trade. The new round of WTO negotiations is effectively dead, and a major deal between two of the world’s largest economies would be a further signal that bilateral negotiations are once again becoming the norm.
Finally, this deal shows us that the BRICs are not quite as influential as many think. A U.S.-EU trade deal is essentially a way to ignore countries like Brazil and India while crafting rules that will govern some of the high-tech industries and information-based services that play a growing role in US-EU trade.
Mead is correct to point out the advantages of the US and EU trying to craft an FTA template, particularly for the sectors they care about a lot. Still, a few quibbles and disagreements.
First, a transatlantic deal doesn't signal a "collapse of the movement toward global free trade" -- it signals a different pathway towards that goal. The collapse of Doha suggests that the traditional multilateral round negotiaions are dead, but it's worth remembering that the global economy got very close to zero barriers in the late 19th century and there was nary a multilateral institution to be found. True, the trade agreements of the 19th century had most-favored nations clauses and their 21st century counterparts do not. Nevertheless, the political economy of trade diversion still generates competitive incentives for a growth in FTAs, thereby leading to a similar end outcome -- a world blanketed in free-trade agreements.
Second, contra Mead, I'd suggest that a transatlantic trade deal is not a sign of US-EU strength, but rather its weakness. There have been rumblings and trial balloons to do something like this for the past fifteen yewars, but it never really got off the ground. The reason it never got off the ground was simple -- both Americans and Europeans were worried that any trade deal this massive would scupper the WTO system. It would seem like a developed country effort to completely rewrite the rules of the global trading game. Since everyone had a lot of skin in the WTO game, it didn't seem like it would be worth it.
Two things have changed. First, the traditional method of multilateral trade liberalization has died. Second, while both the US and EU are major trading states, they're not quite as pivotal as they used to be. Ironically, it's their declining (though still appreciable) importance in global trade that makes a US-EU agreement feasible now. The BRIC economies are now sufficiently large that a transatlantic trade deal doesn't seem like an existential threat.
So, I see that the Nobel Peace Prize committee has become a retro music station -- they're trying to award the greatest hits of the past:
The European Union has been awarded the Nobel Peace Prize for six decades of work in advancing peace in Europe.
The committee said the EU had helped to transform Europe "from a continent of war to a continent of peace"
Let's look a little more closely at that Nobel statement:
The union and its forerunners have for over six decades contributed to the advancement of peace and reconciliation, democracy and human rights in Europe....
The dreadful suffering in World War II demonstrated the need for a new Europe. Over a seventy-year period, Germany and France had fought three wars. Today war between Germany and France is unthinkable. This shows how, through well-aimed efforts and by building up mutual confidence, historical enemies can become close partners....
The EU is currently undergoing grave economic difficulties and considerable social unrest. The Norwegian Nobel Committee wishes to focus on what it sees as the EU's most important result: the successful struggle for peace and reconciliation and for democracy and human rights. The stabilizing part played by the EU has helped to transform most of Europe from a continent of war to a continent of peace.
The Nobel Peace Prize has been on an unfortunate downward trajectory for some time, and this Prize ain't going to help matters, for a couple of reasons:
1) As the statement suggests, this award is entirely retrospective. It's for things the EU did in the past. In contrast, Obama's peace prize was suggestive of things he would do in the future. There's no consistency.
2) Look, the EU really does deserve a fair amount of credit for fostering a remarkably calm security situation in a bloody continent -- but if the committee was going to be honest about things, then NATO and the U.S. Strategic Air Command would have been co-winners of that Peace Prize.
3) Since the start of the 21st century, the following organizations have won a Nobel Peace Prize besides the EU: The United Nations, the International Atomic Energy Agency, Grameen Bank, and the Intergovernmental Panel on Climate Change. So... maybe not winning a Nobel Peace Prize is better.
Still, I would like to thank the Nobel committee for a very humorous start to this Friday.
As China gears up for its 18th Party Congress and the trial of Bo Xilai's wife Gu Kailai on charges of murdering a British business partner, there have been accompanying press stories (even from the Chinese press) about the opaque nature of the Chinese regime. For example, consider this Edward Wong and Jonathan Ansfield New York Times front-pager about the relationship between China's civilian leadership and the People's Liberation Army:
During a holiday banquet for China's military leadership early this year, a powerful general lashed out in a drunken rage against what he believed was a backhanded move to keep him from being promoted to the military’s top ruling body.
The general, Zhang Qinsheng, vented his fury in front of President Hu Jintao, according to four people with knowledge of the event. At the banquet, he even shoved a commanding general making toasts; Mr. Hu walked out in disgust.
The general’s tirade was one of a series of events this year that have fueled concerns among Communist Party leaders over the level of control they exercise over military officials, who are growing more outspoken and desire greater influence over policy and politics.
With China’s once-a-decade leadership transition only months away, the party is pushing back with a highly visible campaign against disloyalty and corruption, even requiring all officers to report financial assets.
“Party authorities have come to realize that the military is encroaching on political affairs,” said one political scientist with high-level party ties. “Although the party controls the gun, the expression of viewpoints from within the military on political issues has aroused a high level of alarm.” He, like others who agreed to discuss internal party affairs, spoke on the condition of anonymity because of fear of reprisals.
Now if you read the whole article, it's really not clear at all just how much of a problem this is. We learn that Hu Jintao's relationship with the PLA is weak, even though he has engineered promotions of his favored generals (including, apparently, Zhang). We learn Ju's likely successor Xi Jinping allegedly has better ties to the military, but that Hu might keep control of the Central Military Commission for the next few years anyway. Oddly, we also learn that some PLA hardliners want to see China adopt a more liberal political model -- like Singapore.
In other words, we know a bit more about the machinations than we do in, say, North Korea. But we don't know much.
Western readers are now likely clucking to themselves and thinking, "Man, am I glad that we don't have to live in a regime with that much political uncertainty and caprice." To those readers: Let's take a tour of Europe and the United States now, shall we?
In Europe, there was a long WSJ front-pager about Italian prime minister Mario Monti and his efforts to push back against Angela Merkel's austerity policies. The impresssion that was given in the beginning of the article is that Mnti was successful... and then we get to this:
Mr. Monti didn't want Rome and Madrid to suffer the stigma of applying formally for aid or signing a list of policy demands written in Brussels, fearing this would undermine his public standing at home, as well that of his ally, Spain's premier Mariano Rajoy....
The evening before the [June EU Summit meeting], Mr. Monti hatched a plan to hijack the summit. Unless Ms. Merkel accepted his proposal on bond-market intervention by Europe's bailout fund, Mr. Monti would veto the growth pact -- stymieing Ms. Merkel in her parliament.
Italy had previously lobbied for the growth pact, so Mr. Monti's threatened veto -- announced just before Europe's leaders were due to sit down for dinner -- was a bombshell....
Mr. Monti's blockade lasted until 4 a.m., when leaders finally agreed to a text hashed out by their aides. It promised that Europe's bailout funds would be used "in a flexible and efficient matter" to stabilize the bond markets of vulnerable euro members.
It didn't go as far as Mr. Monti had originally wanted: Italy and Spain would still have to apply for any aid and sign a policy memorandum. But by planting the need to stabilize bond markets in the declaration, Italy had convinced Germany to recognize Italian reform efforts and pushed its approach for tackling the crisis into the spotlight.
An ebullient Mr. Monti spoke to reporters, claiming satisfaction for Italy and for Europe. A tired Ms. Merkel slunk off to her hotel.
German media and lawmakers were convinced their chancellor had buckled under Mr. Monti's pressure, granting Italy and Spain unconditional access to Germany's treasury. Her protestations later that morning that the fine print preserved the existing procedure for aid went largely unheard.
So did Monti get what he wanted? Beyond political optics, I don't think so, but the article makes it unclear. Actually, to be fair, the summit declaration itself makes it unclear as well, as the Financial Times' Peter Spiegel explains:
Last week’s signal from Spain’s prime minister that he may be prepared to request assistance from the eurozone’s €440bn rescue fund to drive down his country’s borrowing costs has shifted the debate back to where it was more than a month ago: What strings will be attached to such aid?
Eurozone leaders had hoped to put the question to bed during an all-night summit in late June, where Mario Monti, Italy’s prime minister, thought he had won agreement that new aid from the bailout fund to buy a struggling country’s bonds would come with few additional conditions.
Indeed, Herman Van Rompuy, who chaired the summit as president of the European Council, publicly declared there would “not be any more countries” subject to full monitoring if they sought bond-buying assistance from the fund, the European Financial Stability Facility.
The only conditions, Mr Van Rompuy said, would be living up to existing commitments under EU budget rules.
Even before the summit wrapped up, however, that conclusion came into dispute. Indeed, the summit’s final communiqué appears to contradict itself.
At one point, it asserts bond buying programmes would be executed “in a flexible and efficient manner” -- code words for light conditions sought by Mr Monti and his Spanish counterpart, Mariano Rajoy. But in another section it says such aid would only be granted under “existing guidelines” -- code words for the more onerous conditions that existed before the summit (emphasis added).
So I'm gonna say that the EU is not winning a lot of points in the transparency department right now.
Well, there's always the United States, right? Right? Oh, wait, what's this New York Times front-pager from Monday saying?
A rising number of manufacturers are canceling new investments and putting off new hires because they fear paralysis in Washington will force hundreds of billions in tax increases and budget cuts in January, undermining economic growth in the coming months.
Executives at companies making everything from electrical components and power systems to automotive parts say the fiscal stalemate is prompting them to pull back now, rather than wait for a possible resolution to the deadlock on Capitol Hill....
All told, the political gridlock in the United States, along with the continuing debt crisis in Europe, will shave about half a percentage point off growth in the second half of the year, estimates Vincent Reinhart, chief United States economist at Morgan Stanley.
More than 40 percent of companies surveyed by Morgan Stanley in July cited the fiscal cliff as a major reason for their spending restraint, Mr. Reinhart said. He expects that portion to rise when the poll is repeated this month.
“Economists generally overstate the effects of uncertainty on spending, but in this case it does seem to be significant,” he added. “It’s at the macro- and microeconomic levels.”....
In Washington, powerful business lobbies like the National Association of Manufacturers, the Business Roundtable, and more specialized groups like the National Electrical Manufacturers Association have grown more vocal about their frustration with the inaction of Congress, and the possible dangers ahead.
“It’s totally irresponsible and absolutely insane,” said Evan R. Gaddis, the president of the electrical manufacturers’ group. “The two parties are really dug in. Companies see the writing on the wall and business decisions are now being made on this.”
Sure, China is an opaque mess when it comes to governance. Sure, praising China's governance in an uncritical fashion should trigger critical blowback. Let's face it, however -- 2012 is not a year for democracies to be crowing about how their governing model is more transparent.
The term "inflection point" has become one of those overused bits of meaningless jargon in political discourse. I'm rather more fond of the notion of a "focal point" -- that is to say, an event or cluster of events in which everyone that cares about a particular problem focuses on the same set of stylized facts -- after which, they conclude that, gee, maybe the status quo set of policies ain't working so well and there should be a new status quo.
The fall of 2008 was one such focal point, during which there was remarkable consensus that a Keynesian boost in public spending was the only way to avert another Great Depression. At the fiirst G-20 leaders summit in Washington, there was consensus on expansionary fiscal policy. Oh, sure, there were grumblings about "crass Keynesianism," but even Germany reluctantly went along.
The Greek sovereign debt crisis was another such focal point. Greek profligacy seemed to be a synecdoche for excessive government borrowing and lax fiscal discipline. With the global economy seemingly still in the doldrums, a lot of Europrean governments climbed on the "expansionary austerity" bandwagon. By the Toronto G-20 summit in June 2010, the consensus had switched from Keynesian stimulus to fiscal rectitude. Oh, sure there were mutterings about "short-term austerity makes no macroeconomic sense whatsoever in a slack economy" but even Barack Obama started talking about slashing government spending.
Are we at another focal point? Consider the following:
1) According to the New York Times' Stephen Castle, European leaders now seem to recognize that austerity on its own ain't working:
Bowing to mounting evidence that austerity alone cannot solve the debt crisis, European leaders are expected to conclude this week that what the debt-laden, sclerotic countries of the Continent need are a dose of economic growth.
A draft of the European Union summit meeting communiqué calls for ‘‘growth-friendly consolidation and job-friendly growth,’’ an indication that European leaders have come to realize that austerity measures, like those being put in countries like Greece and Italy, risk stoking a recession and plunging fragile economies into a downward spiral.
2) The data is starting to come in on governments that have embraced austerity whole-heartedly, and it's pretty grim. Cue Paul Krugman on Great Britain:
Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.
Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.
And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.
3) Even commentators who would be tempermentally sympathetic with austerity are starting to
bash Germany question whether it's a solution. Consider Walter Russell Mead:
It takes some truly talented screw ups to come up with a worse plan for Greece than the one the Greeks have developed for themselves, but the Germans have risen to occasion in fine form....
Deep reform is needed if Greece is to stay in the euro, and so far the Greek political establishment — firmly backed by public opinion — is digging in its heels. Much whining, much talk, many promises and precious little action seems to be the favored Greek approach to the crisis. On the other hand, the austerity policies the Germans favor are hopelessly biased in favor of German banking interests and are aimed more at the preservation of the reputations of German politicians than at helping Greece.
The German political establishment seems willing to destroy Europe to avoid telling German voters the truth about how stupid it has been.
[UPDATE: For exhibit B of this trend, see this Niall Ferguson interview with Henry Blodget. My favorite part of the interview is this quotation: "I think the reason that I was off on that was that I hadn't actually thought hard enough about my own work.... My considered and changed view is that the U.S. can carry a higher debt to GDP ratio than I think I had in mind 2 or 3 years ago."]
4) U.S. 4th quarter data reveals that, consistent with GOP criticisms, the government has been the real drag on the U.S. economy. Not quite consistent with GOP criticisms: the reason why the government is dragging down the U.S. economy. Cue Mark Thoma:
[P]remature austerity -- cutting spending before the economy is ready for it -- is taking a toll on the recovery. The fall in government spending reduced fourth-quarter growth by 0.93 percent; if government spending had remained constant, GDP growth would have been 3.7 percent, rather than 2.8 percent.
This is the opposite of what the government should be doing to support the recovery. We need a temporary increase in government spending to increase demand and employment through, for example, building infrastructure. That would help to get us out of the deep hole we are in. Instead, the government seems to be trying to make it harder to escape.
We do need to address our long-run budget problems once the economy is healthy enough to withstand the tax increases and program cuts that will be required. But the idea of "expansionary" austerity has failed. Austerity in the short-term simply makes it harder for the economy to recover and delays the day when you can finally address budget issues without harming the economy. The lesson is that government needs to support the recovery, not oppose it through a false promise that contraction of one sector in the economy will be expansionary.
5) Central banks are acting more gung-ho on expansionary monetary policy. The unspoken quid pro quo in Europe seems to the that the ECB will expand its balance sheet and turn on the monetary taps in return for some kind of fiscal compact. The U.S. Federal Reserve announced a zero-interest rate policy for the next three years. Even China is showing (halting) signs that its reverted back to monetary easing.
Given that the United States has been the country to move the slowest on austerity, and given that the United States is doing the best job among the OECD economies (an admittedly low bar) of restoring confidence among investors and paying down non-governmental debt, have we reached another focal point?
One could argue that Krugman and Thoma are just biased in favor of Keynesianism, that Greece and the other Club Med countries haven't really embraced austerity, that the Euromess is dragging down British economic growth, and that the long-term numbers on developed country debt are really very scary. There are some large grains of truth in many of those statements.
It doesn't necessarily matter, however. Greece was not a genuine harbinger of the fiscal problems of large markets -- but it was a useful hook for austerity advocates to spread their gospel. What matters now is not whether these perceptions about the failure of austerity are 100% accurate, but whether they are accurate enough to become the new conventional wisdom.
What do you think?
Yesterday, in commenting on the eurozone crisis, Barack Obama said the two words all political scientists hate to see:
"Europe is wealthy enough that there's no reason why they can't solve this problem," Obama told reporters at the White House.
"If they muster the political will, they have the capacity to settle markets down, make sure that they are acting responsibly and that governments like Italy are able to finance their debt." (emphasis added)
By and large, political scientists hate the concept of political will. As I've said numerous times on the blog, "political will" is usually tantamount to saying, "if only politicians would completely ignore short-term political incentives and do the right thing!" Or, to put a finer point on it, "if only politicians stopped acting like politicians!" Because we as a profession tend to focus on structural forces and immutable preferences, "leadership" as a variable often (though not always) falls by the wayside.
Looking at the latest EU summit/eurozone machinations, however, I'm beginning to wonder if we need to think about "first image" explanations for what just happened. As the Wall Street Journal, Felix Salmon, Financial Times, Paul Krugman, and Economist are all reporting, it was pretty friggin' disastrous. Salmon provides the most complete autopsy -- here's a snippet:
[A]nother half-baked solution is exactly what we got. Which means, I fear, that it is now, officially, too late to save the Eur ozone: the collapse of the entire edifice is now not a matter of if but rather of when.
For one thing, fracture is being built into today’s deal: rather than find something acceptable to all 27 members of the European Union, the deal being done is getting negotiated only between the 17 members of the Euro zone. Where does that leave EU members like Britain which don’t use the euro? Out in the cold, with no leverage. If the UK doesn’t want to help save the euro — and, by all accounts, it doesn’t — then that in and of itself makes the task much more difficult.
But that’s just the beginning of the failures we’re seeing from European leaders right now. It seems that German chancellor Angela Merkel is insisting on a fully-fledged treaty change — something there simply isn’t time for, and which the electorates of nearly all European countries would dismiss out of hand. Europe, whatever its other faults, is still a democracy, and it’s clear that any deal is going to be hugely unpopular among most of Europe’s population. There’s simply no chance that a new treaty will get the unanimous ratification it needs, and in the mean time the EU’s crisis-management tools are just not up to dealing with the magnitude of the current crisis.
The fundamental problem is that there isn’t enough money to go around. The current bailout fund, the European Financial Stability Facility, is barely big enough to cope with Greece; it doesn’t have a chance of being able to bail out a big economy like Italy or Spain. So it needs to beef up: it needs to be able to borrow money from the one entity which is actually capable of printing money, the European Central Bank.
But the ECB’s president, Mario Draghi, has made it clear that’s not going to happen. Draghi is nominally Italian but in reality one of the stateless European technocratic elite: a former vice chairman and managing director of Goldman Sachs, he’s perfectly comfortable delivering Italy the bad news that he’s not going to lend her the money she needs. He’s very reluctant to lend it directly, he won’t lend it to the EFSF, and he won’t lend it to the IMF. Draghi has his instructions, and he’s sticking to them — even if doing so means the end of the euro zone as we know it.
So, what explains this mess -- the inexorable structural problems of the European Union, or the lack of political leadership? At this point, I'm genuinely uncertain. For example, the facile explanation for British Prime Minister David Cameron's rejection of an EU treaty is catering to his domestic interests -- namely the British financial sector. Then, however, we get to this bit from the Economist:
After much studied vagueness on his part about Britain's objectives, Mr Cameron's demand came down to a protocol that would ensure Britain would be given a veto on financial-services regulation (see PDF copy here. The British government has become convinced that the European Commission, usually a bastion of liberalism in Europe, has been issuing regulations hostile to the City of London under the influence of its French single-market commissioner, Michel Barnier. And yet strangely, given the accusation that Brussels was taking aim at the heart of the British economy, almost all of the new rules issued so far have been passed with British approval (albeit after much bitter backroom fighting). Tactically, too, it seemed odd to make a stand in defence of the financiers that politicians, both in Britain and across the rest of European, prefer to denounce....
Britain may assume it will benefit from extra business for the City, should the euro zone ever pass a financial-transaction tax. But what if the new club starts imposing financial regulations among the 17 euro-zone members, or the 23 members of the euro-plus pact? That could begin to force euro-denominated transactions into the euro zone, say Paris or Frankfurt. Britain would, surely, have had more influence had the countries of the euro zone remained under an EU-wide system.
As for Merkel, well, my take on her leadership style has been documented already. She's dealing with an opposition that is castigating her for not taking swifter and more drastic action to resolve the eurocrisis. In response, she's pushing for changes that will take months, if ever, to accomplish -- and, if they are accomplished, have no guarantee of actually solving the problem. It doesn't seem like the eurozone has that time.
As for Draghi, well, one could attribute his range of half-hearted measures to his excessively cautious leadership -- after all the ECB is an ostensibly independent institution, so presumably Dragh has the greatest amount of autonomy. It's not that simple, however -- Draghi wouldn't have been selected as the new ECB head unless he demonstrated the kind of policy traits that made him acceptable to Germany in the first place. Oddly enough, although Draghi currently has the most freedom of action, the structures that ensured he would become the new ECB head ensured he would be the least likely person to exploit that freedom.
So, stepping back, there appears to be a role for the quality of political leadership as an explanatory factor for the current eurozone crisis. Properly defining that role, however, is beyond the capacity of this blog post.
What do you think?
So the eurozone crisis is metastasizing from really bad to even worse. Over at The New Yorker, James Surowiecki blogs that what's so frustrating about the situation is that the impediments to a solution are easily surmountable:
[W]hat’s easy to miss, amid the market tremors and the political brinksmanship, is that this is that rarest of problems—one that you really can solve just by throwing money at it....
The frustrating thing about all this is that there is a ready-made solution. If the European Central Bank were to commit publicly to backstopping Italian and Spanish debt, by buying as many of their bonds as needed, the worries about default would recede and interest rates would fall. This wouldn’t cure the weakness of the Italian economy or eliminate the hangover from the housing bubble in Spain, but it would avert a Lehman-style meltdown, buy time for economic reforms to work, and let these countries avoid the kind of over-the-top austerity measures that will worsen the debt crisis by killing any prospect of economic growth....
So the problem is not that the E.C.B. can’t act but that it won’t. The obstacles are ideological and, you might say, psychological.
As someone who agrees with Surowiecki on the economic diagnosis, the political scientist in me is forced to call a flagrant foul on this kind of analysis. In labeling the problem as one of "ideology" or "psychology," Surowiecki is explicitly arguing that it's just so absurd that the correct policy is not being pursued. If only someone could talk some sense into the key policymakers, then -- snap! -- the crisis would be resolved.
As someone who studies this stuff for a living, simply saying that political ideology, interest, or institutions can be easily changed borders on the comical. Ideas, interests and institutions are the bread and butter of politics, and all of them are far stickier than economists would like you to believe. There's more than seven decades of entrenched thinking that would require the Bundesbank and the ECB to alter their approach. Crisis or no crisis, that's not just easily dismissed.
Furthermore, looking at the Franco-German crisis bargaining, any actual deal to bolster EFSF resources, empower the ECB, and/or create something approximating a fiscal union would require that Southern Europe agree to remake their domestic economies to more closely resemble the German model. This has always been Merkel's bargain: she's been willing to cede greater power to the EU provided that EU policy preferences looks more like Germany. This makes sense for Germany, but the kind of wrenching changes and adjustments that will be asked of Spain and Italy are massive. The fact that Berlin -- rather than Brussels -- is the source of this diktat will add a fun new level of political difficulties as well.
A deal could be reached, but no one should be kidding themselves -- it is fantastically difficult, and saying that just "politics" or "ideology" or "psychology" is getting in the way doesn't make it any easier.
Hey, remember when about ten days ago I blogged that things were getting so bad in Europe that it was legitimate to bring up the 1930's? What's happened since that seemingly hyperbolic warning?
As Felix Salmon blogged earlier this week, the European banking system is headed towards a full-blown liquidity crisis. Yields on Spanish and Italian debt are hovering around the 7% mark, which was the tipping point that forced Greece, Ireland and Portugal to seek assistance from the European Financial Stability Facility and the IMF. Multiple European countries, including France, have had difficulty completing bond auctions this week.
So it would seem that the European Central Bank needs to do something. The New York Times, Wall Street Journal, and Financial Times all have lead stories today pointing out the enormous pressures that are being put on the European Central Bank this week. We'll excerpt the non-gated NYT story to set things up:
Only the fiercely conservative stewards of the European Central Bank have the firepower to intervene aggressively in the markets with essentially unlimited resources. But the bank itself, and its most important member state, Germany, have steadfastly resisted letting it take up the mantle of lender of last resort....
At issue is whether the bank has the will — or the legal foundation — to become a European version of the Federal Reserve in the United States, with a license to print money in whatever quantity it considers necessary to ensure the smooth functioning of markets and, if needed, to essentially bail out countries that are members of the euro zone.
Traditionally, and according to its charter, the European bank has viewed its role in much narrower terms, as a guardian of the value of the euro with a mission to prevent inflation. But as market unease has spread over the past two years, critics say the bank’s obsession with what they say is a phantom threat of inflation has stifled growth and helped bring the euro zone to the edge of a financial precipice.
With events threatening to spin out of control, the burden now rests on Mario Draghi, an inflation fighter in the president’s job at the bank barely two weeks who surprised many economists by immediately cutting interest rates a quarter point.
This morning, however, in his first speech as the head of the ECB, Draghi pivoted and redirected the pressure back at the politicial stewards of the EU:
National economic policies are equally responsible for restoring and maintaining financial stability. Solid public finances and structural reforms – which lay the basis for competitiveness, sustainable growth and job creation – are two of the essential elements.
But in the euro area there is a third essential element for financial stability and that must be rooted in a much more robust economic governance of the union going forward. In the first place now, it implies the urgent implementation of the European Council and Summit decisions. We are more than one and a half years after the summit that launched the EFSF as part of a financial support package amounting to 750 billion euros or one trillion dollars; we are four months after the summit that decided to make the full EFSF guarantee volume available; and we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five and that declared the EFSF would be fully operational and that all its tools will be used in an effective way to ensure financial stability in the euro area. Where is the implementation of these long-standing decisions?
The truly scary thing is that, given the state of the Italian and Spanish bond markets, even the full EFSF won't be enough to calm markets down.
And so the pressure gets redirected back to Germany, as the most powerful actor in the ECB and EU. As Matthias Matthijs and Mark Blyth explain in Foreign Affairs, however, Germany has not been reading its Charles Kindleberger:
In order to guarantee the strength of any international economic system, Kindleberger explained, a stabilizer -- only one stabilizer -- needs to provide five public goods: a market for distress goods (goods that cannot find a buyer), countercyclical long-term lending, stable exchange rates, macroeconomic policy coordination, and real lending of last resort during financial crises. The United States did not supply these things in the 1930s. Germany fails the test on all five items today.
First, rather than providing peripheral countries with a market for their distress goods, the Germans have been enthusiastically selling their manufactured goods to the periphery. According to Eurostat, Germany's trade surplus with the rest of the EU grew from 46.4 billion euro in 2000 to 126.5 billion in 2007. The evolution of Germany's bilateral trade surpluses with the Mediterranean countries is especially revealing. Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion. Between 2001 and 2009, moreover, Germany saw its final total consumption fall from 78.5 percent of GDP to 74.5 percent. Its gross savings rate increased from less than 19 percent of GDP to almost 26 percent over the same period.
Second, instead of countercyclical lending, German lending to the eurozone has been pro-cyclical. Indirectly (through buying bonds) and directly (by spreading its exchange rate through the euro), the country has basically given the periphery the money to buy its goods. During the economic boom of 2003-2008, Germany extended credit on a massive scale to the eurozone's Mediterranean countries. Frankfurt did quite well for itself. "European Financial Linkages," a recent IMF working paper, reveals that in 2008, Germany was one of the two biggest net creditors within the eurozone (after France). Its positive positions were exact mirrors of Portugal, Greece, Italy, and Spain's negative ones. Of course, as the financial crisis began to escalate in 2009, Germany abruptly closed its wallet. Now Europe's periphery needs long-term loans more than ever, but Germany's enthusiasm for extending credit seems to have collapsed.
And what about the third public good, stable exchange rates? By definition, the euro gives the countries that choose to join it a common external float, the credibility that comes with banking in a potential global reserve asset, and the credit rating of its strongest member. This is both true and where the problems begin. At the core of the eurozone lies a belief that, if countries adhere to a set of rules about how much debt, deficit, and inflation they can have, their economies will converge, and the same exchange rate will work for all members. This is true in theory, but only so long as countries obey the rules. And, despite being the author of many of those rules, Germany showed a singular lack of leadership and responsibility when it came to following them. When it broke the Stability and Growth Pact (SGP) in 2003, it sent the signal to the smaller countries that fiscal profligacy would go unpunished. The result was heightened public sector borrowing and increased public spending. Germany's enthusiastic lending to the periphery only exacerbated the problem.
Fourth, economic health requires the stabilizer to coordinate macroeconomic policy within the system. In this domain, Germany failed spectacularly, by insisting that the rest of the world follow its peculiar ordoliberal economic philosophy of export-oriented growth. By ignoring long-established ideas such as the Keynesian "paradox of thrift" or the "fallacy of composition," Germany is advocating a serious dose of austerity in the European periphery without even a hint of offsetting those negative economic effects with stimulus or inflationary policies at home. German growth, after all, was partially fueled by demand in Southern Europe (made possible by excess German savings). By the iron logic of the balance of payments, one country's exports are another country's imports and one country's capital inflows are another's capital outflows. So, the eurozone as a whole cannot become more like Germany. Germany could only be like Germany because the others countries were not. Insisting on ordoliberal convergence is guaranteed to produce economic instability, not stability.
Finally, Kindleberger would want Germany -- or, rather, the ECB, which is dominated by Germany -- to act as a lender of last resort by providing liquidity during the current crisis. Germany instead insisted on IMF conditionality for the bailout countries and on severe fiscal austerity measures in exchange for limited liquidity, thus failing Kindleberger's final test. The most obvious example is German obstinacy against letting the ECB play the role that the Federal Reserve played in the United States in 2008 and 2009. By lending heavily, the Fed was able to arrest the United States' slide into despair. Only a couple of days ago, Jens Weidmann, the president of Germany's powerful Bundesbank, flat-out rejected the idea of using the ECB as "lender of last resort" for governments, warning that such steps "would add to instability by violating European law." It is hard to see how yet one more violation of European code will add significantly to the already horrendous levels of instability, when brushing democracy aside is considered good for the euro.
It looks as if there's a plan in the works for the ECB to do a legal end-around by loaning money to the IMF and then having the Fund loan to the GIIPS economies. If that happens, however, it won't be announced until next month. And the way credit markets are playing out right now, I'm not sure the eurozone has that much time.
Now is usually the point in the post at which the instinct to provide some sweeping narrative about the state of the eurozone -- a la David Brooks -- is very compelling. What's the point, however? The eurozone is in contagion mode right now, which means it doesn't matter which countries were virtuous and which countries weren't during the last decade of binge borrowing. They're all on the same sinking ship, and the Merkel Algorithm seems to be playing out again.
Developing.... in a way that truly scares the living crap out of me.
I swear, I wasn't going to watch tonight's CNBC debate on economic policy. I'd had a long day, I was tired, and Wednesday night at the Drezners we watch The Middle and Modern Family. But since neither of those shows were on the air tonight, I switched over to the debate.
While Rick Perry's major league gaffe will command all the headlines, I thought the most reealing answers were given to the first question of the night -- what to do about Italy? Here are the responses of the co-frontrunners:
HERMAN CAIN: "There's not a lot that the United States can directly do for Italy right now, because they have -- they're really way beyond the point of return that we -- we as the United States can save them."
MITT ROMNEY: "Well, Europe is able to take care of their own problems. We don't want to step in and try and bail out their banks and bail out their governments. They have the capacity to deal with that themselves."
The responses by Ron Paul, Rick Perry and Jon Huntsman were similar in tone and content.
Now, philosophically, there's a logic to these answers, avoiding moral hazard and all. But recall how earlier this week conservatives were castigating Barack Obama for giving Western Europe the cold shoulder? I believe Michael Goldfarb phrased it as a problem of Obama "abandoning allies."
I raise this because, if the eurozone actually did need American help, the response by the GOP candidates for president would be to... abandon America's allies.
One of Richard Nixon's saltier lines on foreign economic policy was, "I don't give a f**k about the lira." I think it's safe to say that the current GOP doesn't give a f**k about the euro.
The National Journal's Jim Tankersley frames this exactly right:
Europe’s problems should absolutely terrify anyone who cares about the American economy; its sovereign debts could infect banks around the world, potentially triggering a new wave of financial crisis, and a European recession would drag on already slow U.S. growth.
But the candidates who assembled at the CNBC debate in Detroit treated those threats as a far-away nuisance, like famine in Africa or an earthquake in Mongolia: very serious, very sad, not our problem....
It’s stunning that a Republican field that includes a former ambassador, a former House speaker and two successful former businessmen – and which, to a candidate, gushed over the virtues of markets throughout the debate – so casually brushed aside the struggles of the world’s largest collective economy (the Eurozone is bigger, economically, than the United States) and America’s largest trading partner.
You don’t have to believe America should bail out Italy, Greece or the entire Eurozone – a straw-man concept that no one in Washington is even floating, but several candidates took pains to denounce on Wednesday night – to recognize that the United States has a role to play in averting another global financial crisis. At the very least, you should expect lawmakers, and presidential candidates, to be making plans for how to respond if the European crisis escalates.
There were no such plans to be found on the debate stage on Wednesday.
My latest Bloggingheads diavlog is with NSN's Heather Hurlburt. We discuss Greece, Palestinian recognition, and the state of the foreign policy debate among the GOP 2012 candidates.
Given those topics, be warned: I might have been liberal in my use of profanity in the diavlog below.
[NOTE: The following is a public service message from the hard-working team at FP Magazine to the policy wonks and market analysts inside the Beltway--ed.]
Has this happened to you in 2011? You're stressed out from a long day of reading/writing/number crunching/contingency planning and you're looking to unwind and enjoy yourself. Then you see the latest announcement of a European summit meeting and proclamations of a breakthrough deal that will resolve the plight of the Greek economy, the fragile state of European banks, and the perilous credit rating of southern Mediterranean countries.
As you see stocks rise, credit markets soar, and the euro appreciate, the euro-optimism becomes intoxicating. Pretty soon, the euro-giddiness starts to get to you. You start to tweet things like, "the corner has been turned," post on Facebook that, "it's time to Europarty!!" and talk up the metric system again. Nicolas Sarkozy looks like the brilliant progenitor of grand ideas and grand summits, and Angela Merkel is the shrewd politician who made the bankers blink.
After a few hours or so of this, all the problems in the world look eminently solvable. In your head, you've devised brilliant, intricate plans that solve the Israeli/Palestinian peace process, the India/Pakistan enduring rivalry, and the BCS college football rankings. Before you know it, you've organized and presented a talk in which you provide the Mother of All Powerpoint Presentations to Solving Global Problems, charging the entire, catered affair to the Brookings Institution.
Beware!! You are a victim of Eurogoggles. As the Economist will observe, "in the light of day, the holes in the rescue plan are plain to see." Both AFP and Bloomberg will point out that the policy euphoria has faded the next day. It will turn out that details are left unexplained. The size of the bailout package, which looked massive the night before, will prove to be a limp, unsatisfying half-measure the next day. The bank rescue fund and the Greek deal remain incomplete. All you'll be left with is that vague sense of self-loathing at having been suckered again, and a strem of angry voice-mail messages from a DC think tank. The walk of shame to your water-cooler the next day, in which co-workers mock your tweets of the night before, will be humiliating.
Eurogoggles -- don't let it happen to you or your colleagues.
[NOTE: the following reads much better if you read it using the voice of Rod Serling!--ed.]
There's a subtle art to reading broadsheet American journalism. Reporters strain for objectivity, and in the process, strain to avoid anything that smacks of the prejorative. If you squint real hard at the text, however, you can occasionally detect moments when the reporter is dying, just dying, to state their blunt opinion on the matter at hand.
I bring this up because Liz Alderman of the New York Times, in her story on the possibility of a big deal in Europe to enlarge the European Financial Stability Facility, appears to be ever-so-subtly banging her head against her keyboard:
The rally in American stock markets was set off by a report late Tuesday on the Web site of The Guardian, a British newspaper, that France and Germany had agreed to increase the size of the rescue fund — the European Financial Stability Facility — to as much as 2 trillion euros to contain the crisis and backstop Europe’s banks. But almost as soon as those hopes soared, European officials quickly brought them back to earth, with denials flooding forth from Brussels, Paris and Berlin.
This latest round of rumors and rebuttals about a European solution was a repeat of earlier situations. Such episodes have played out several times since the debt crisis intensified this year. Most recently, investors have been pegging hopes on a meeting of Europe’s leaders set for this coming Sunday in Brussels, anticipating that a comprehensive solution to the debt crisis might be unveiled (emphasis added).
It would appear that Ms. Alderman has discovered that there is a fifth dimension of reporting, beyond that which is known to ordinary economic journalism. It is a dimension as vast as developed country sovereign debt and as timeless as currency itself. It is the middle ground between austerity and stimulus, between national sovereignty and supranational authority, and it lies between the pit of man's fears and the summit of his knowledge. This is the dimension of European political economy. It is an area which we call... the eurozone.
When I woke up this morning and scanned the headlines, I knew what I was going to blog about -- the stories in the press about how the European Union was, after much hemming and hawing, beginning to move towards a closer fiscal union. I was then going to not-so-humblebrag about my own prediction that this would indeed happen. This was all going to be a great set-up to the last-minute reverse course -- i.e., this Financial Times op-ed by German Finance Minister Wolfgang Schäuble in which he declared his "unease when some politicians and economists call on the eurozone to take a sudden leap into fiscal union and joint liability."
Here's the thing, however -- if you read my eurozone blog post from this past February, you'll see that almost the exact same dynamic played itself out six months ago. This time the Germans are pre-emptively balking before the peripheral countries can balk in response to German calls for austerity... but you get the general idea.
So... in the interest of avoiding IPE déjà vu for readers, I hereby promise not to blog about this again until something actually happens beyond news reports of preliminary steps-towards-fiscal-centralization-followed-by-political-pushback. I will simply observe that Ryan Avent's basic question will be the one to ask going forward:
Europe's leaders know what they'll have to do to stabilise the situation. The key question now is: what is the set of euro-zone countries consistent with the political will to save the currency area? Europeans in Europe's core will share a currency with "outsider" countries, but they won't fight to save them. So who are the outsiders? Who has to go to convince core voters that the cost of saving the euro zone is worth bearing?....
With which countries do core voters sufficiently identify themselves as to make a large, ongoing commitment acceptable? Answer that, and you probably have a good idea how this mess will end.
Readers are requested to state which countries get the Euroboot in the comments below.
[WARNING: THE FOLLOWING IS A VERY PESSIMISTIC GLOBAL POLITICAL ECONOMY POST]
So, just to sum up the past week or so of global political economy events:
1) U.S. government debt got downgraded by Standard & Poor;
2) Global equity markets are freaking out;
London Britain is burning;
This all sounds very 2008, except that it's actually worse for several reasons. First, the governments that bailed out the financial sector are now themselves the object of financial panic and political resentment. Second, the tools used to try and rescue the global economy in 2008 are partially to blame for what's happening right now. Despite all the gnashing of teeth about the Fed twiddling its thumbs, it's far from clear that a QE3 would actually stimulate anything besides a rise in commodity prices.
With both Europe and the United States unable to stimulate their economies, and China seemingly paralyzed into indecision, it's worth asking if we are about to experience a Creditanstalt moment.
The start of the Great Depression is commonly assumed to be the October 1929 stock market crash in the United States. It didn't really become the Great Depression, however, unti 1931, when Austria's Creditanstalt bank desperately needed injections of capital. Essentially, neither France nor England were willing to help unless Germany honored its reparations payments, and the United States refused to help unless France and the UK repaid its World War I debts. Neither of these demands was terribly reasonable, and the result was a wave of bank failures that spread across Europe and the United States.
The particulars of the current sovereign debt crisis are somewhat different from Creditanstalt, and yet it's fascinating how smart people keep referring back to that ignoble moment. The big commonality is that while governments might recognize the virtues of a coordinated response to big crises, they are sufficiently constrained by domestic discontent to not do all that much.
So... is this 1931 all over again?
There are three aspects of the current situation that make me fret about this. The first is the sense that developed country governments have already tapped out all of their politically feasible methods of stimulating their economies. This is the time when both politicians and voters start to ask themselves, "Why not pursue the crazy idea?"
The second is whether the Chinese government will do something to satiate their nationalist constituency. Neither Joe Nye nor James Joyner thinks this is likely, and I tend to agree that any effort at economic coercion will hurt China as much as the United States. When autocrats are up against the wall, however, then they might take risks they otherwise would never consider.
The third is this working paper on what causes societal unrest in developed economies (h/t Henry Farrell). The abstract suggests more trouble on the way:
From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble crosscountry evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor.
So... there are, unfortunately, numerous reasons to think that we're headed down a bad road... which is the pretty much point of this post.
Readers are encouraged in the comments to offer counterarguments for why things aren't as bad as 1931. I'll be offering some thoughts about why 1931 won't happen again later in the week.
Germany's move—marking a contrast with the U.S. and other countries that have largely stuck to plans to continue pursuing nuclear power—is a U-turn from a contentious plan that Ms. Merkel engineered just last fall that would have extended the lifetimes of some of Germany's reactors into the 2030s, more than a decade longer than previously scheduled. Ms. Merkel's latest move is effectively a return to an agreement to phase out nuclear power approved in 2002 by a center-left Social Democrat-Green coalition....
In few countries is nuclear energy the hot-button issue it is in Germany, where polls show some 70% of the populace opposes it, the legacy of a broad-based antinuclear movement that harks back to the 1986 Chernobyl accident. Since the Fukushima accident, antinuclear protests have taken place across the country.
Ms. Merkel's change in course, though, hasn't produced the desired political effect. Conservative allies have been frustrated by her turn away from a cherished policy victory, and nuclear opponents have seen the move as opportunistic. Those perceptions contributed to several stinging regional election losses for the Christian Democratic Union this spring, and have led to a surge in clout for the opposition Green Party.
And now the NYT:
For Mrs. Merkel, the embrace of clean energy represents a transformation based on the politics of the ballot box. Just last year, her center-right coalition forced through an unpopular plan to extend the life of nuclear power plants, with the last to close in 2036. That action inflamed public opinion but the Fukushima disaster politicized it. The nuclear crisis is widely believed to have caused Mrs. Merkel’s party to lose control of the German state of Baden-Württemberg for the first time in 58 years, in a March election that became a referendum on energy policy.
By Monday, Mrs. Merkel said the country must “not let go the chance” to end its dependence on nuclear power.
And, finally, Reuters:
The German chancellor has, in nine months, gone from touting nuclear plants as a safe "bridge" to renewable energy and extending their lifespan to pushing a nuclear exit strategy that rivals the ambitions of the Social Democrats and Greens.
Merkel had her atomic epiphany after the Fukushima disaster in Japan in March, announcing a moratorium on nuclear power and launching an urgent overhaul of German energy policy, resulting in the exit strategy announced on Monday.
Her change of heart, however genuine as it may be, coincides with a string of disastrous election results for her Christian Democrats (CDU) and their Free Democrat (FDP) allies that have been partly blamed on her unpopular pro-nuclear policy so far.
With the FDP losing popularity almost as fast as the Greens gain it, and the Greens unseating the CDU in their heartland of Baden-Wuerttemberg in March as well as outpolling them for the first time in Germany in Bremen this month, Merkel has upgraded the nuclear moratorium to a rush for the exit.
Watching Merkel's performance during the myriad euro crises of the past two years, I'm beginning o detect a decision-making algorithm at work. Let's call it The Merkel Algorithm. It consists of the following steps:
1) A problem festers;
2) Dither and do nothing;
3) Public opinion polls drop;
4) Let things fester some more;
5) Lose an electioon somewhere;
6) Announce new policy that reverses prior position
7) Lose even more political support.
Merkel appears to have brilliantly executed this strategy on both the eurozone and nuclear power. In all seriousness, what I don't understand is the long periods of dithering and festering. I get that politicians will sometimes be wrong-footed on policy shocks. Merkel, however, really does seem to wait until the worst, most cravenly political moment to do something. Why?
Your humble blogger hereby calls on all Germany-watchers to offer either an explanation or a more nuanced take on the Merkel Algorithm -- because your humble blogger is good and truly flummoxed.
Your humble blogger has not been
contributing to the Osama-a-thon here at FP blogging all that much, because he was busy being a moosehead attending the 2011 Estoril Conference. Many Important topics were covered at this conference, including:
1) The eurozone crisis;
2) The global governance crisis;
3) The crisis in the Middle East;
4) Other global security challenges;
5) The life and times of Larry King.
It was that kind of conclave.
Actually, that really doesn't do it justice. Here's a link to the opening video. Even that doesn't do it justice -- the opening ceremonies featured a sporano suspended 50 feet in the air, a gospel choir, a drum corps, and what I can only assume are the backup dancers for Lady Gaga's music videos.
For a rundown of what the Big Cheeses said at the conference, check out my Twitter feed. The major substantive takeaway I got from the conference is that Portugal would like to do a serious hurt dance on Fitch, Moody's, and Standard & Poor. Half of the conference presenters were Portuguese, and most of the audience was as well. Here is a sampling of the questions the Portuguese asked anyone talking about anything remotely related to economics:
"Why do the bond rating agencies still influence markets after they failed so badly in 2008?"
"Shouldn't the bond-rating agencies be punished for their malfeasance last decade?"
"Aren't the bond-rating agencies to blame for everything bad that has happened since 2008?"
"What do you think of the idea of creating a European standard-ratings agency?"
"Say, has anyone thought about taking the heads of the bond-rating agencies and putting them in a duffel bag?"
OK, I made that last one up, but not the others.
Obviously, the Portuguese have very good reasons to be stressed out. And the bond-rating agencies deserrve an awful amount of flack. Still, the idea that they -- and they alone -- triggered both the 2008 financial crisis and Europe's sovereign debt crisis is absurd. They are far more the symptom than the cause of the crisis.
More blogging after
my eyes adjust to not seeing Lady Gaga's backup dancers everywhere I turn the weekend.
Your humble blogger is taking a brief break from teaching and
zombie book-whoring publicizing recently-released research to start work on new research. This requires me to be in Europe for the week. So, for some local color, it's worth asking how things are in the land of the euro, the eurozone, and the eurocracy.
Last year, during the epth of the Greek crisis, I argued that, "When going backwards isn't an option, and muddling through is no longer viable, the only thing left to do is move further along the integration project."
Last week, it seemed that France and Germany had come to the same conclusion. The Guardian's John Palmer provided a cogent summary on the deal that was being negotiated at Friday's European leaders' summit:
Angela Merkel, Nicolas Sarkozy and the other EU chiefs will sound out the parameters of a breakthrough deal which could take the euro area – at the heart of the EU – towards a de facto economic government. The deal will offer massive financial support for countries under the currency market cosh in return for governments accepting that national economic policy in future will first have to secure the broad approval of the rest of the euro area.
[You must be feeling sooooo vindicated right now!!--ed.] Oh, you betcha, got this one right on the money... wait, what's this Financial Times story by Peggy Hollinger and Peter Spiegel saying?
New cracks emerged at a summit of European leaders on Friday, as the prime ministers of several countries raised strong objections to a Franco-German plan that would commit all 17 users of the single currency to co-ordinating their economic policies....
[T]heir initiative triggered a backlash from other European Union leaders anxious to defend their national economic, labour and welfare policies.
In the summit’s concluding communiqué, European leaders also appeared to back off a commitment to give the eurozone’s €440bn bail-out fund new tools to help shore up struggling “peripheral” economies.
An initial version of the conclusions committed the EU to giving the fund more “flexibility” – a code word for new authorities such as buying sovereign bonds of struggling countries on the open market. After extensive debate, that language was taken out, however, and now only binds members to give the fund “necessary effectiveness”, a clear watering-down.
What happened? The Wall Street Journal's Irwin Stelzer explains:
Most countries profess broad agreement of the need for reforms along the lines Germany is demanding. Yet when confronted with the German-French package—the French have always favored some form of centralized economic management of the EU, including strict regulation and heavy taxation of the financial services sector that is centered in Britain—they balked.
Austria, with one of the lowest effective retirement ages in the euro zone, won't go along with an increase in the retirement age. Portugal won't buy into the end of wage indexation with inflation because it wants to offer a sop to public-sector workers whose wages have been cut by 5%. Neither will Belgium, Spain and Luxembourg. All in all, almost 20 countries at Friday's EU summit objected to the Germanization of their countries for one reason or another. So Germany refused to sign on to an increase in the size of the euro-zone bailout fund. "It was truly a surreal summit," commented Yves Leterme, Belgium's prime minister.
Stezler goes on to predict that there will be yet more Euro-muddling as a result of this deadlock. I'm sticking to my original prediction, however. As much as the European periphery dislikes the proposed grand bargain, some form of it will likely be accepted because the alternative outcomes seem even more unappetizing.
Hey, remember the rest of the world?
The Financial Times' Ben Hall and James Blitz report on a surprising degree of defense cooperation between London and Paris:
David Cameron, British prime minister, and Nicolas Sarkozy, French president, hailed their summit in London on Tuesday as an unprecedented move towards closer integration between Europe's pre-eminent military powers brought on by budgetary austerity but also a closer alignment of the two countries' foreign policies.
They signed two treaties: one covering the sharing of technology used to maintain nuclear warheads and another on initiatives about conventional forces.
Mr. Sarkozy said the agreement to share a new research facility in France for the testing of nuclear warheads was testament to a "level of confidence between our two nations unequalled in history".
Until now, France and Britain have closely guarded the secrets of their nuclear deterrents, regarding them as the bedrock of their independence.
Mr Cameron said the two treaties would commit the French and British armed forces to working "more closely than ever before".
Paris and London also agreed to set up an "integrated carrier strike group", allowing each to fly combat aircraft from the other’s carrier once Britain has an operational ship equipped with its U.S.-built Joint Strike Fighter jets, by the beginning of the next decade. In the next 10 years, the French and British navies would centre co-operation on the Charles de Gaulle, France’s only carrier.
What's interesting about this is not the military effects -- in the end, this is about trying to do more with less -- but the political ones. In a world of austerity, there is some logic in close allies working together to eliminate redundant platforms and/or other fixed costs that could be pooled across countries. Furthermore, this kind of defense integration, once started, would strike me as very hard to reverse.
This year has seen a lot of people predicting the end of the EU and NATO as Europe struggles with its economic misfortune. I wonder, however, if hard times are actually having the opposite effect of forcing European and NATO countries closer together. This might not be popular, but it's the only viable policy option in some instances.
Europe's debt crisis is not going away anytime soon, which means that the crisis over European monetary union won't be going away either. As it turns out, the European Commission is on this, proposing things like "excessive deficit procedures" and the like.
Will this work? Well … let's go to the Economist's explanation for why the previous set of rules failed to prevent this from happening:
The “stability and growth pact” was supposed to limit each country’s budget deficit to 3% of gdp and public debt to 60% of GDP. It failed, in part because France and Germany refused to abide by it -- and even rewrote the rules when they breached the deficit limit.
In contrast, the problems that arose because different economies responded differently to the zone’s common monetary policy were underestimated. The sudden drop in real interest rates on joining the euro in Greece, Ireland and Spain fuelled huge spending booms. (Portugal had enjoyed its growth spurt in the late 1990s in anticipation of euro membership.) Rampant domestic demand pushed up unit-wage costs relative to those in the rest of the euro area, notably in Germany, hurting export competitiveness and producing big current-account deficits.
The euro allowed these internal imbalances to grow unchecked and now stands in the way of a speedy adjustment, because euro-area countries whose wages are out of whack with their peers’ cannot devalue.
So, what is to be done? In the past, European integrationists have been quite adroit at using periods of crisis and malaise to jumpstart further integration efforts. It's possible that this could happen again.
In this case, however, integration efforts are going to be very costly. The Economist explains:
[T]here are three ways for a country to restore competitiveness: devaluation (which reduces wages relative to those in other exporting countries), wage cuts or higher productivity. In the euro area, the first option is out. The other two rely on easing job-market rules so that pay matches workers’ efficiency more closely, and workers can move freely from dying industries and firms to growing ones.
I'm thinking unions will
develop breakout nuclear capabilities aren't going to be big fans of that second option. The third option seems like the ultimate political dream, except it involves eliminating regulations that likely benefit a lot of entrenched interest groups.
Another possibility is greater fiscal centralization. The Economist is not keen on this, but that's besides the point -- as Mary Sarotte points out at Foreign Affairs, there's a Very Important Country that's not going to go along with the move:
The challenge now is governance reform, not expulsion of member states. Reverting to national currencies would drive the values of reissued southern currencies into the ground and the deutsche mark into the sky, thereby undermining Germany's export competitiveness and job market, to say nothing of the collateral damage to the European Union and the single market. The eurozone crisis should not signal the end of the euro but rather the start of a long-overdue overhaul. The idea of a European Monetary Fund, endorsed by Wolfgang Schäuble (an elder statesman from the days of German unification and now a subordinate of Merkel), faded after Merkel dismissed it but deserves broader support. Germany also needs to reconsider its calls for painful fiscal discipline on the part of the weakest countries until their economies regain footing. Ideally, but perhaps not realistically, Merkel should return to previous German form and spearhead a revision of the Maastricht Treaty, leading a fresh effort to do for political union what Kohl and Mitterrand did for monetary union.
The unlikelihood of such a move exemplifies a fundamental problem within the whole European Union: there exists a built-in tension between the lofty goals of integration and member states' collective unpreparedness to think through the consequences of their ambitious project. The great achievement of the past has been to reconcile these contradictory impulses by focusing on practical agreements. It is time to do so once again and realize that the necessary consequence of monetary union is greater political union.
In some ways, what happens from here on out will be an excellent test of whether economic interdependence really alters national incentives. As I blogged a few months ago, "When going backwards isn't an option, and muddling through is no longer viable, the only thing left to do is move further along the integration project."
Of course, the European have spent the past few months muddling through some more. Given current trends, however, that option is going to disappear sooner rather than later.
This week Japan has provoked the ire of the United States and Europe by unilaterally intervening in currency markets to depreciate the yen against other major currencies. Japanese Prime Minister Naoto Kan has responded to these criticisms by
telling the US and EU to go suck a lemon stating that further "resolute actions" would be taken on this front.
This comes on the heels of mounting U.S. frustration with China's "go-slow" policy on letting the yuan appreciate against the dollar. [What do you mean by "go slow"?--ed. Let's put it this way: the tortoise thinks that China is being pokey on this question.]
So, is this the beginning of beggar-thy-neighbor? Will other countries start intervening in foreign exchange markets to gain a competitive advantage for their export sectors?
The New York Times' Hiroko Tabuchi thinks not, because Japan can't unilaterally devalue its currency like in the old days:
It is unlikely, though, that intervention by Japan alone will sway currency markets in the long term. The global volume of foreign exchange trading has grown rapidly in recent years, which prevents intervention by a single government from countering bigger market trends.
Other countries are unlikely to help Japan’s cause, because they need to keep their own currencies weaker to bolster exports. A weak currency makes a country’s exports more competitive and increases the value of overseas earnings.
Much of the yen’s weakening came from investors selling the currency on expectations that the Japanese government would be more active in keeping the yen in check. Japan did not disclose how much it had spent in currency transactions, but dealers put the initial amount at 300 billion to 500 billion yen ($3.5 billion to $5.8 billion).
But as Switzerland found this year, a single government’s efforts to weaken its currency can prove futile. Switzerland abandoned that effort, after its central bank had lost more than 14 billion Swiss francs ($14 billion) in foreign currency holdings in the first half of the year, after a fall in the euro’s value ate into the bank’s reserves.
The Swiss franc is also seen by investors as a relative haven and has also strengthened amid global financial unrest. This month, the franc hit a record high against the euro.
Hmmm.... maybe. Japan's economy is much larger than Switzerland, so I'm not sure the comparison holds up. The real problem, however, appears to be that countries perceived of as "safe havens" wind up with overvalued currencies.
This little parable also makes me wonder whether we might see beggar-thy-neighbor policies in a different guise this time around. This is going to sound a little crazy, but here goes: rather than explicit exchange rate intervention, what if countries decided to play fast and loose with Basle III and other measures to strengthen financial integrity?
This really does sound crazy -- it suggests that governments would be willing to tolerate a higher risk of domestic banking collapse in order to avoide being a "safe haven" status for capital. That said, think of how much Europe benefited from the depreciation of the euro due to the Greek crisis. Basle III, by taking so long for banks to meet standards allow those countries with more insolvent financial institutions **cough** Germany **cough** to take their own sweet time in having them meet new capital adequacy standards. This would allow Germany to have the euro stay relatively cheap without abandoning its anti-inflationary zeal.
Now, in all likelihood, not even the Germans would purposefully do this. This is crazy talk. What I'm suggesting, however, is that there is more than one way for a country to have its currency depreciate, and these policies are substitutable. Looking only at explicit exchange rate intervention might be just a bit too narrow. And if more countries find more ways of keeping their currency undervalued, well then, the days of beggar-thy-neighbor would have arrived.
The Financial Times has been working overtime to discussing an emergent trend: multinational CEOs in Europe and the United States ripping into China.
In some ways, this started earlier this year. There was Google's complaint, of course. And, as TNR's James Mann noted, "Both the American Chamber of Commerce in Beijing and the European Chamber of Commerce in China have issued reports in recent months conceding that the business climate for foreign companies there has steadily worsened."
Things have been heating up in July, however. First, as Guy Dinmore and Jamil Anderlini report, GE CEO Jeffrey Immelt ripped into China while in Europe:
He warned that the world’s largest manufacturing company was exploring better prospects elsewhere in resource-rich countries, which did not want to be “colonised” by Chinese investors. “I really worry about China,” Mr Immelt told an audience of top Italian executives in Rome, accusing the Chinese government of becoming increasingly protectionist. “I am not sure that in the end they want any of us to win, or any of us to be successful."....
“China and India remain important for GE but I am thinking about what is next,” he said, mentioning what he called “most interesting resource-rich countries” in the Middle East, Africa, Latin America plus Indonesia. “They don’t all want to be colonised by the Chinese. They want to develop themselves,” he said. The comments echo a rising chorus of complaints from foreign business groups in China about the regulatory environment they face.
Gideon Rachman notes that Immelt is hardly alone in his complaints:
[W]hen Google, Goldman Sachs, and GE all run into difficulties simultaneously, it seems clear that a bigger trend is at work. Privately, senior US officials have been worrying for some time that Chinese trade and economic policy is taking a more nationalist direction that is penalising US companies. They worry that, after 30 years of strong economic growth, China believes it can now afford to take a less welcoming attitude to foreign investment, and instead concentrate on promoting national champions.
What's interesting is that European firms are now joining in the chorus of complaints. Furthermore, as Jamil Anderlini notes, they're not doing it in private dinners -- they're blasting the Chinese leadership publicly and directly:
Two of Germany’s most prominent industrialists have attacked the business and investment climate in China during a meeting with Wen Jiabao, the Chinese premier.
The criticism from the businessmen, the chief executives of Siemens and BASF, came against a backdrop of rising discontent among foreign businesses operating in China.
The German executives’ comments were all the more striking as they were made directly to the Chinese premier, and in public, as part of Angela Merkel’s four-day state visit to the country.
Jürgen Hambrecht, chief executive of BASF, the chemical producer, hit out at restrictions on foreign business and complained of foreign companies being forced to transfer business and technological know-how to Chinese companies in exchange for market access.
“That does not exactly correspond to our views of a partnership,” Mr Hambrecht told Mr Wen at the weekend meeting in the western Chinese city of Xi’an.
Addressing government procurement practices, a recent area of complaint by foreign executives and governments, Peter Loescher, chief executive of Siemens, the industrial conglomerate, said foreign companies operating in China “expect to find equal conditions in the fields of public tenders”.
Mr Loescher, who is also chairman of the Asia-Pacific Committee of German Business, called on Beijing rapidly to remove trade and investment restrictions in sectors such as automobiles and financial services.
BASF and Siemens had combined sales in greater China of more than €9bn ($11.6bn) last year and employ more than 36,000 people in the area.
Mr Wen responded to the criticism by telling Mr Hambrecht to calm down, insisting that China remained open to foreign investment and did not discriminate against foreign companies. “Currently there is an allegation that China’s investment environment is worsening. I think it is untrue,” Mr Wen said.
Alan Beattie and the ubiquitous Mr. Anderlini provide some general context for the latest venting:
The risk-reward calculation between staying quiet and speaking up has shifted towards the latter. With China employing policies including ignoring intellectual property rights, forced technology transfer and government procurement skewed towards domestic companies, some foreign businesses feel they are being pushed out of the country. “We are feeling less and less welcome in China, which is why you are seeing more people speaking out and reconsidering their futures in China,” says John Neuffer of the US Information Technology Industry Council.
Business leaders say Beijing’s appetite for more liberalisation of foreign investment has waned after a rapid burst of reform around China’s accession to the World Trade Organisation in 2001. So even when current policies only represent a standstill, they feel like going backwards.
At best, current policies are moving very slowly towards liberalization. The good news is that China is seeking to join the WTO's Government Procurement Agreement, which liberalizes trade among participating countries for government-commissioned projects. The bad news is that China's latest offer is
half-assed tokenism underwhelming in terms of what's on offer, and likely to be rejected by the US and EU.
So, why is China suddenly so hostile towards western multinationals? The simple realpolitik answer is that China is simply more powerful than it used to be, and its flexing its muscles now because it has them. In the Wall Street Journal, David Wessel offered a revealing anecdote that suggests President Obama shares this quasi-relative gains view:
Mr. Obama, who took office in an economy far worse and far more hostile to trade than the one Mr. Clinton inherited, appears less convinced of the virtues of free trade per se. He loves exports, easily sold as creating jobs. But he seems to view world trade like a basketball game: He wants to win, and doesn't like feeling that others are taking advantage of his team. He needles aides who worked in the Clinton administration that they let China into the WTO with a better hand than the one he has to play. Aides counter that China would be even more of a threat if not bound by WTO rules. He is unpersuaded....
Mr. Obama's trade strategy is becoming clearer. In international forums, as he did at the Copenhagen climate-change talks, he is arguing that China is posing as a developing country even though it has grown up and needs to be treated like the economic powerhouse it is. At home, he knows—no matter what his economists tell him—that neither voters nor Democrats in Congress will be convinced that free trade is good for them. So he is styling himself as a tough bargainer, who can beat other countries at their own game.
Obama could be right, but on one key dimension his bargaining hand will actually be stronger than those of past presidents. China, by continuing to alienate and frustrate western multinational corporations, is also effectively weakening the strongest pro-China lobbies in both Washington and Brussels. As Rachman notes:
Were it not for the power of big business, the relationship between the US and China might have gone sour years ago. There are forces on both sides of the Pacific – Chinese nationalists, American trade unionists, the military establishments of both countries – that would be happy with a more adversarial relationship. For the past generation it has been US multinationals that have made the counter-argument – that a stronger and more prosperous China could be good for America.
So it is ominous, not just for business but for international politics, that corporate America is showing increasing signs of disillusionment with China....
In the past, American business has acted as the single biggest constraint on an anti-Chinese backlash in the US. If companies such as GE, Google and Goldman Sachs qualify their support for China or refuse to speak up, the protectionist bandwagon will gather speed.
The Chinese government, of course, is not stupid. China’s growing confidence in dealing with the US, and the world in general, is still matched by a cautious desire to avoid conflict. At strategic moments, the Chinese government is likely to make tactical concessions – whether on Google or the currency – in an effort to head off a damaging conflict with the US. But with American business and the American public increasingly restive, the risks of miscalculation are growing.
And here I must dissent from Rachman. In some ways, I do think the Chinese government has been pretty stupid over the past year in executing its "Pissing Off As Many Countries As Possible" strategy. China rankled the Europeans over its climate change diplomacy at Copenhagen. For all of Beijing's bluster, it failed to alter U.S. policies on Tibet and Taiwan. It backed down on the Google controversy. It overestimated the power that comes with holding U.S. debt. It alienated South Korea and Japan over its handling of the Cheonan incident, leading to joint naval exercises with the United States -- exactly what China didn't want. It's growing more isolated within the G-20. And, increasingly, no one trusts its economic data.
This doesn't sound like a government that has executed a brilliant grand strategy. It sounds like a country that's benefiting from important structural trends, while frittering away its geopolitical advantages. Alienating key supporters in the country's primary export markets -- and even if Chinese consumption is rising, exports still matter an awful lot to the Chinese economy -- seems counterproductive to China's long-term strategic and economic interests.
Developing.... in a very interesting way.
Alexander F. Yuan-Pool/Getty Images
Last week I predicted that, contrary to expectaions, the Greek crisis would force the European Union to abandon their "muddling through" approach to
security regulation volcanoes everything under the sun economic policy and start some serious centralization. Not that this was a great option -- but all the other options were even less palatable.
So, did the weekend package confirm my hunch? Well, Anne Applebaum seems to think so:
Though the European Union has always required a partial surrender of sovereignty from its member states, Greece no longer has much sovereignty at all. IMF agreements also impose conditions, but the language is somewhat different: The indebted country requests help, the IMF responds. In this case, the EU has decided what Greece "shall" do. I don't believe anybody knew that the EU had so much power over its member states, least of all the Greeks.
Well, yes, but on the overall question of the centralization of eurozone decision-making, I think the weekend's events actually prove me wrong. Indeed, this New York Times story by Steven Erlanger, Katrin Bennhold, and David Sanger suggests that the member states have managed to come up with yet a new way to muddle through without arrogating power to the Commission:
Germany was insisting on a solution that involved bilateral loans from European member states, similar to the much smaller Greek bailout agreed to a week earlier. But countries like Italy and Spain feared that they would be unable to raise the amounts required and lobbied for loan guarantees on funds raised by the European Commission.
As the evening unfolded, Germany, Britain and the Netherlands all opposed the commission’s proposal to raise money on capital markets guaranteed by member states. The British and Dutch said the proposal was tantamount to giving a “blank check” to the European Union’s governing commission, according to a European diplomat who spoke on condition of anonymity.
Near midnight Sunday night, the talks appeared deadlocked, these participants said. “The deal is exploding,” read the text message of one French official to Paris, where Mr. Sarkozy was demanding regular updates and was pushing for a bigger agreement.
Then came the deal-making idea — put together, according to different officials from different countries, by the French, the Italians, the Dutch and a crucial German banker.
Axel Weber, the president of the conservative Bundesbank, who is favored to succeed Jean-Claude Trichet as the next president of the European Central Bank, suggested a mechanism for Europewide loan guarantees that finally won support from a reluctant German government during a midnight call, participants said.
The idea was for a new mechanism euphemistically called “a special purpose vehicle” — essentially eurobonds created by intergovernmental agreement among euro zone countries. That vehicle, supposedly to last only three years, would raise up to 440 billion euros on the markets with loans and loan guarantees, depending on the need.
The Germans, together with other northern Europeans like the Dutch, British and Austrians, insisted that the European Commission not control the vehicle but only manage it — in conjunction, as with the Greek deal, with the International Monetary Fund. The fund would provide discipline, as well as roughly one euro for every two from Europe.
The “special purpose vehicle” finally broke the French-German deadlock.
[F]or all the excitement about the scale of the effort, it is important to remember that the core fund does not now exist. The fund, known as a special purpose vehicle, would raise money by issuing debt and making loans to support ailing economies. The European countries would guarantee that fund.
So the package is merely a commitment for the vehicle to borrow money if a large economy like Spain, which represents 12 percent of the output in the euro zone, asks for assistance. The International Monetary Fund is pledging 250 billion euros to support the effort. Sixty billion euros under an existing lending program pushes the total to near $1 trillion.
The fund is therefore more a theoretical construct than the Troubled Asset Relief Program that was created in the United States, and that is where things get tricky.
By definition, if Spain came to a point where it could no longer finance itself, interest rates would be on the rise. The several hundred billion euros for the fund would not only come at a high cost, but would bring additional pain to already indebted countries like Portugal, France, Italy and the United Kingdom, which back the special purpose entity, thus compounding the region’s debt woes.
So, in other words, because Germany and others don't want to transfer either real power or real ability to borrow to the European Commission, the result is a jerry-rigged bailout fund that has some disturbing dynamics if things go further south.
We'll see how the markets respond in the coming days and months. For everyone's sake, I hope I'm wrong and the EU can muddle through. But my fear is that this strategy is not going to be viable for that much longer.
So, the question of the day is, will bond markets feel suitably shocked and awed by the eurozone's decision to throw more than $950 billion at the Greece problem in order to prevent the spread of contagion?
For some reason, I can't get this scene from Dirty Harry out of my head when I think about the answer. To paraphrase it for our purposes, wouldn't this whole drama be easier if some eurozone finance minister could confront bond traders with the following speech:
I know what you're thinking. Is this my last rescue package, or do I have another source of credit in reserve? Well, to tell the truth, in all this excitement I kinda lost track myself. But being this is a €720bn rescue package, the most powerful one in the world, and would wipe away any short position you've taken in the past week, you've got to ask yourself one question. 'Do I feel lucky?' Well do you, punk?"
The thing is, Dirty Harry is a lot more convincing than Angela Merkel.
Steve Walt is pessimistic about the future of the European Union:
There are in theory two ways that the EU could go in response to these events. One possibility is that these recent failures will eventually prompt a further expansion of all-European institutions. This view is the modern version of old-style functionalism: if Europe needs certain institutions to work properly, it will eventually create them.
The second possibility-which I'd deem more likely -- is that we have in fact seen the high-water mark of the EU project. Nationalism is still alive and well in Europe, the Cold War is over and there is thus less need for unity against an external threat, Germany is gradually shedding its post-World War II reticence, and the consequences of over-expansion and excessive ambition have been fully exposed. I'm not saying the Union is headed for the dust-heap of history or anything like that (no bureaucracy goes out of business that quickly, especially when there are thousands of pages of laws involved), but a significant consolidation of power in the near future seems most unlikely.
Given that the EU Union has been one of the more interesting political experiments in recent decades, this is going to be fascinating to watch. Time for IR theorists to place their bets?
It's really in vogue to predict the downfall of the European Union, and for good reason -- they have had a truly awful 2010. Steve, like any good realist, predicts the stalling out of the European project. And he may very well be right.
There are two things that hold me back from making a similar prediction, however. First, the EU has had significant policy reverses in the past -- and the institution has always responded with further economic and political integration. If I had said, the day after Black Wednesday, that the EU would create a single currency in less than a decade, all my realist IR friends would have
bared their teeth in an effort to simulate laughter laughed. Similarly, the failure of the EU constitution last decade did not deter the EU from creating new offices designed to centralize foreign policy coordination. These offices haven't really been put to good use yet -- but new leadership could change that.
Second, I'm not sure the eurozone can go backwards -- the common currency might be locked in. There are suggestions that Greece needs to exit the eurozone for a spell, but there's no mechanism and/or infrastructure to make that transition (let me add here that the functionalist argument would predict that there should be a few departurues from the euro, for reasons that Paul Krugman laid out last Friday). Since Greek debt is denominated in euros, and since I doubt the French and Germans will allow that debt to be devalued because it will kill their financial institutions holding Greek debt, Athens has strong incentives to stay in the euro fold.
When going backwards isn't an option, and muddling through is no longer viable, the only thing left to do is move further along the integration project.
It's entirely possible politics will get in the way of this -- but my 51/49 prediction is that come 2020, the European Union will look more centralized than it does today.
What do you think?
THOMAS LOHNES/AFP/Getty Images
NSN's Heather Hurlburt and I did a bloggingheads diavlog earlier today -- and it's been posted in record time . Topics include Greece, the European Union, the vagaries of the bond market, my surprising sympathy for Gordon Brown, and the Korea kerfuffle. Enjoy!
It's Patriots' Day here in Massachusetts, and in honor of that holiday, here's a Financial Times story by Joshua Chaffin that reports on a phenomenon that occurs, oh, maybe once a decade or so: the European Union admitting that the U.S. regulatory model is superior on a particular issue.
In this case, the issue is the prolonged grounding of European flights in response to The Volcano That
Cannot Shall Not Be Named:
European officials on Monday acknowledged weaknesses in the computer models that guided their decision to ground thousands of flights during the past week following a volcanic eruption in Iceland.
Many of the flights would have gone ahead under US aviation standards, they said, and urged that these be considered in the future.
The admission is likely to provide ammunition for critics who believe that authorities have shown excessive caution in the wake of the eruption. The airline industry, in particular, has argued that the no-fly zone over much of Europe should be eased.
It is estimated that airspace closures are costing airlines $200m a day in lost revenue....
In the US, air carriers are left with the responsibility to determine whether or not it is safe to fly – a system that [EU director-general for mobility and transport Matthias] Ruete said Europeans should consider adopting in the future. “The American model is not a model of less safety. You just need to look at the statistics to see that,” he said....
I'd just add that the politics of this are highly unusual. Ordinarily, it's quite easy to point to the direct costs of less stringent regulation, and more difficult to point to the indirect gains. In this case, however, it appears that even Europeans have recognized that maybe they were a bit too risk-averse.
Jeff J Mitchell/Getty Images
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.