Month: March 2015

US Global Leadership – More on AIIB

Following the end of the second of two devastating World Wars within three decades, the world came together to establish international institutions and norms meant to prevent another world war and to promote the shared economic and political interests of all peace loving countries. The United States led this effort and has dominated the resulting global governance structure (the UN, IMF, World Bank, WTO to name a few of the best known). The one-country-one-vote structure of the UN has limited its effectiveness. The International Financial Institutions like the IMF, on the other hand, are governed on the basis of votes and financial contributions proportional to their economic importance. Their effectiveness and legitimacy depend, in part, on maintaining such relative voting strength as countries’ economies grow.

Resolving conflicts without world war has been a magnificent achievement. But the opening of the world to freer trade and finance with broadly agreed rules under which it is conducted are dramatically important achievements as well. Economic growth is not a zero sum game. Every country has benefited from global financial cooperation. Estimates (by Bradford DeLong and the World Bank) of Global World Product rose from $1.1 trillion dollars in 1900 to 4.1 trillion in 1950 but exploded there after reaching $41.1 trillion in 2010 (all in 1990 US dollars). According to the World Bank, global poverty has been cut in half in the last twenty years.

The dominant role of the US in International Financial Institutions reflects its economic size and military strength but equally the perception of the rest of the world that the liberal, free markets and trade model promoted by the US was indeed the right one for each country’s growth and prosperity. The world’s continued acceptance of the US’s leadership rests on the general belief that the US is an honest broker, fairly promoting rules that serve the general good rather than seeking special advantage for its own people and industries. The US cannot expect other countries to abide by such international norms of behavior if it is not willing to conform to them itself (i.e. subjugate its sovereignty to international agreements in these areas).

America’s record is not pure by any means. The increasing crony capitalist nature of our military industrial complex, about which we were so presciently warned by President Eisenhower, is hardly a model of competitive market capitalism. But the political structures established after WWII have generally worked well to coordinate national cross boarder activities peacefully and without wars. To cite one example, the International Telecommunications Union has developed rules and procedures for allocating radio spectrum, satellite orbits and technical telecommunications standards that have made possible efficient and interconnected global communications systems. You could not telephone anyone you want any where in the world from anywhere in the world (not to mention the Internet) without them.

The International Monetary Fund is another example of an international cooperative agreement, in this case for facilitating the financing of trade and capital movements (cross border investments). It has played an important role in removing economic restrictions on global trade and finance, though that role has been undermined to some extent and made more complex by the US abandonment of its obligations to redeem its currency for gold under the gold exchange standard imbedded in the IMF’s Articles of Agreement when President Nixon killed what was left of the gold standard.

Few countries want the leadership provided by the US replaced by China or anyone else, but as China and many other country’s economies and trade have grown relative to the US and especially to Europe, they rightly expect to have a larger role in organizations that act for the entire world. The US congress has very shortsightedly and foolishly refused to approve the adjustments in the governance of the IMF that would accomplish that. As a result it is undermining the foundation of the US’s leadership role. “Indeed, Treasury Secretary Jacob Lew made this point implicitly in testimony this week in which he also restated U.S. reservations about the AIIB: Our continued failure to approve the IMF quota and governance reforms is causing other countries, including some of our allies, to question our commitment to the IMF and other multilateral institutions that we worked to create and that advance important US and global economic and security interests.

…The IMF reforms will help convince emerging economies to remain anchored in the multilateral system that the United States helped design and continues to lead.” http://www.lobelog.com/washington-misses-bigger-picture-of-new-chinese-bank/#more-28547

While there are legitimate arguments over whether an Asian Infrastructure Investment Bank is a good thing or whether such funds would be better spent through the Asian Development Bank (China, which would lead the new AIIB, doesn’t have such a great record with the quality of its own infrastructure spending), the real issue is whether the world will remain united in the post WWII international order and presumably under US leadership of the International Financial Institutions it helped establish. The principles of inclusiveness and a level playing field that have always been the foundation of US promoted institutions clearly call for and would be promoted by supporting the expanded role of China in these institutions in keeping with its increasing involvement in the world economy. US opposition to the IMF governance reforms and its reaction against the AIIB appear duplicitous and are undermining the foundations of its leadership. “The decision by the UK, and subsequently, France, Germany, and Italy, to participate is therefore significant not only because they will be major shareholders, but also because the decision by traditional U.S. allies signals that Washington is increasingly isolated.” http://www.cfr.org/global-governance/bank-too-far/p36290

Everyone has a strong interest in having China join and work within the established liberal economic order rather than going its own way with a competing order. Recent US behavior hardly promotes that goal.

For my earlier comments on the AIIB see: https://wcoats.wordpress.com/2015/03/18/the-asian-infrastructure-investment-bank-aiib/

The Asian Infrastructure Investment Bank – AIIB

Last evening CCTV, the China Central Television company, contacted me about an interview about the AIIB at 8:15 am the next morning (i.e., this morning). I have appeared on their Biz Asia show several times in the past. I agreed to the interview and they arranged for a car to pick me up at 7:15am. Due to a mistake in scheduling the car, it did not arrive in time to get to the studio. Rather than go back to bed I am writing this note to share with you what I would have said.

Background

Frustrated with the slow pace of governance reform of the existing international financial institutions (IMF, World Bank, Asian Development Bank) in which China was under-represented in relation to its economic size, China began discussing the establishment of alternative institutions. The first was the New Development Bank of BRICS (Brazil, Russia, India, China, and South Africa) to be headquartered in Shanghai, China. The AIIB was launched with a signing ceremony in Beijing on October 24, 2014 that included, in addition to China, representatives from Bangladesh, Brunei, Cambodia, India, Kazakhstan, Kuwait, Laos, Malaysia, Mongolia, Myanmar, Nepal, Oman, Pakistan, the Philippines, Qatar, Singapore, Sri Lanka, Thailand, Uzbekistan, and Vietnam. It will focus on the development of infrastructure in developing countries in the Asian-Pacific region.

The United States, which has traditionally held the Presidency of the World Bank and on whose territory are housed the headquarters of both the World Bank and the International Monetary Fund, has been cool to these developments, which initially resulted in Australia, New Zealand, and European countries as well as the U.S. declining to join (as financiers). However, last week Britain’s Chancellor of the Exchequer, George Osborne, announced that the UK would join as a founding member and was quickly followed by Germany, France, and Italy. Australia and New Zealand are reconsidering their earlier lack of interest. If that weren’t embarrassing enough for the US, a US government official told the Financial Times, “We are wary about a trend toward constant accommodation of China, which is not the best way to engage a rising power.”

CCTV Interview

Early this morning I received the following email from CCTV.

“Hello Warren,

“This is Qingzhao from China24 program, CCTVNEWS. Thanks for joining our studio AIIB discussion. You will discuss with two more guests in Beijing studio. They are Mr Ding Yifan, senior fellow of the Institute of World Development under the Development Research Center of the State Council. And John Ross, Senior Fellow of Chongyang Institute for Financial Studies, Renmin University of China. He is also the former adviser of ex-London mayor Ken Livingstone.  Question 3 and Question 5 are for you, please take a look.

“Q1: The first question is for you, Mr Ding. So far, the number of countries that have joined or are in the process of joining as a founding member have surpassed 30…Talk to us about the tangible benefits to Europe and Asia as more nations from the EU want to join the AIIB.

“Q2: John, the UK, Germany, France and Italy ALL applying to join as founding members of the AIIB. What’s the attraction for western countries to join in?

“Q3: Warren, following now FOUR western European nations wanting to join the Asian Infrastructure Investment Bank…U.S. Treasury Secretary, Jack Lew is urging HIS country’s lawmakers to pass reforms of the International Monetary Fund. Will IMF reforms finally be pressured to pass and if so, impact on attractiveness of AIIB?

“Q4: Mr Ding, with more western countries applying to join the AIIB, some people have concerns that their participation will, to some extent, weaken China’s role in the system. What’s your take? What’s the possibility of some countries turning out to be a Trojan horse?

“Q5: Warren, Washington views the AIIB as a rival to the U.S. led World Bank and IMF, but China has said the AIIB will COMPLEMENT existing multilateral institutions. What’s your take on AIIB’s role?”

Had I made it to their studio I would have said the following:

Question 3: Secretary Lew has been trying to get the IMF reforms passed by the US Congress for several years. Ironically the US was very instrumental in pressuring European countries to reduce their representation on the IMF’s Executive Board in favor of increasing the representation of the BRICS and other emerging market countries, by bringing IMF member country quotas closer to those calculated on the bases of their economic size and share in world trade. Europe has long been over represented and the emerging market countries under-represented on this basis. The US voluntarily accepted a smaller quota than this formula would produce long ago (thus reducing its financial contribution as well as its vote) and the proposed new amendments would not further reduce the US quota share. Moreover, the proposed doubling of the IMF’s quota resources would not increase the US financial contribution. Rather it would convert the large loan from the US to the IMF made during the recent financial crises from a loan to a quota increase. Thus it is strange for the US now to hesitate to support these reforms. Given that the International Financial Institutions (World Trade Organization, IMF, and WB) that the US helped create are part of the new post World War II world order of global trade from which the US and other market economies have so benefited, this strange US behavior is extremely short sighted.

I would like to think that Congress would get around to approving these reforms independently from the threats posed by China’s new institutions. Virtually every other IMF member country has, but the US enjoys veto power by virtue of its large quota of 17.5% and the requirement that any amendments to the IMF Articles of Agreement must be adopted by members collectively with 85% of the quotas. The reality seems to be the other way around. China was pressured to create competing institutions because the US has failed so far to endorse governance reforms in the existing one.

Question 5: The AIIB is more of a rival to the Asian Development Bank than to the World Bank, and is no rival to the IMF, which does not make development loans, at all. China claims that the AIIB is a compliment rather than a rival to the other development banks. It will have the virtue of a clear and relatively narrow mandate; while the World Bank is all over the map. Voting membership by the UK, Germany, France, etc. should help ensure that its loans meet the standards set by the ADB and the WB. The US has maneuvered itself out of that possibility, not that Congress would ever approve the funds for it anyway. On the other hand, establishing a new institution will absorb a lot of time and other resources in developing its staff, procedures and facilities that would not have been necessary if China had contributed the same funds for the same purposes to the ADB. The traditional Japanese Presidency of the ADB, whose headquarters are in the Philippines, is likely to yield to new governance provisions in the future, giving China a shot at the Presidency, just as the American and European leadership of the WB and IMF are likely to yield in the future as well.

In short, this is all political and the US has played it poorly to say the least. In the past US leadership internationally, whether through the institutions it helped build or in other ways, has been welcomed and accepted because the US stood for principles others could embrace and promoted and applied them fairly. More recently, and I mean for the last decade or two, and certainly in the case of the IMF and AIIB, it is behaving more like the king on the mountain leading others to want to knock it off. This promotes neither the American nor the global community’s interests.

Economic Sanctions

Economic sanctions can be a political tool to punish and hopefully stop or deter bad behavior by another country, group, firm, or individual. However, sanctions are rarely effective, often hurting the wrong people. Robert Pape’s examination of past sanctions on countries found that only 4% were clearly effective. Their virtue is that they tangibly register disapproval of bad behavior without going to war. An important policy question is when to use them. In my opinion sanctions should be used very rarely against countries when there is a broad global consensus that the behavior of the country is significantly and unacceptably at variance with established international norms. This is both because they are rarely effective, in part because they often hurt the general public rather than the leaders responsible for the bad behavior, and because it should generally not be the business of our government to dictate how other governments behave unless that behavior is directly against us. What that means, for example, is that sanctions should not generally be used against countries whose human rights behavior we disapprove of.

Under what circumstances might the use of economic sanctions be justified and effective? The effectiveness of economic sanctions varies greatly with their nature and the circumstances in which they are applied. In what follows I very briefly illustrate the range of experience and possibilities.

Cuba

Clearly the sanctions of one country against another, such as outlawing trade in certain products or outlawing trade and financial transactions of any sort, are of very limited effectiveness as the sanctioned country can simply trade with others instead. Cuba illustrates this point. First imposed over 50 years ago by President John F. Kennedy and now enforced through six different statutes, the United States forbids most trade with Cuba by its citizens or companies. President Bill Clinton extended and stretched the reach of this embargo to apply to the foreign subsidiaries of American companies as well. The purpose of this embargo as stated in the Cuban Democracy Act of 1992 is to encourage the Cuban government to move toward “democratization and greater respect for human rights”.

Though the U.S. has put a lot of pressure on other countries to restrict their own trade with and travel to Cuba, it has been largely ignored. The U.S. pretty much stands alone. The cost of the embargo has fallen more on the U.S. than on Cuba. The U.S. Chamber of Commerce estimates the cost to the U.S. economy at $1.2 billion per year in lost sales and exports. More over it has not improved governance in Cuba nor led to regime change. In 2009, Daniel Griswold, director of the Cato Institute’s Center for Trade Policy Studies, criticized the embargo by stating:

“The embargo has been a failure by every measure. It has not changed the course or nature of the Cuban government. It has not liberated a single Cuban citizen. In fact, the embargo has made the Cuban people a bit more impoverished, without making them one bit more free. At the same time, it has deprived Americans of their freedom to travel and has cost US farmers and other producers billions of dollars of potential exports.” Former Secretary of State George P Schultz called the embargo “insane.”

Cuba is a mess not because of U.S. sanctions but because of the highly repressive Marxist regime in control for the last 52 years. The American embargo has given the Castro government an escape goat for its own failures—and the Castro government still rules. President Obama recently reestablished diplomatic relations with Cuba but the embargoes will remain until Congress amends or removes them. The President has been criticized for not getting enough in return for reestablishing relations and its link with Cuba’s freeing of American spy Alan P. Gross is certainly unfortunate, but the U.S.’s diplomatic recognition of a country should have nothing to do with whether we approve of its government and its approach to governing. The 50 plus year-old embargo has totally failed in its objectives as well, which were not justified in any event. It should finally be lifted and we, and our government, should continue to criticize the Cuban government’s oppressive and destructive policies.

Iran

Economic and financial sanctions against Iran have been more successful. Though the U.S. initially imposed limited sanctions following the Iranian revolution in 1979, international sanctions were imposed by the U.N. Security Council in 2006 and later by the EU in response to Iran’s refusal to suspend its uranium enrichment program. These sanctions banned supplying Iran with nuclear-related materials and technology, and froze the assets of key individuals and companies related to the program. In the following years these sanctions were expanded to include an arms embargo and broader freezes on assets held abroad and monitoring the activities of Iranian banks, and inspecting Iranian ships and aircraft.

These sanctions have reduced Iran’s export (largely oil) revenue and sharply restricted its imports of materials needed for its uranium enrichment program. The international arms embargo has negatively impacted Iran’s military capacity as it is now reliant on Russian and Chinese military assistance. The U.S./EU embargo on oil shipments was made more effective when the EU extended its embargo to ship insurance resulting in most supertankers refusing to load Iranian oil. Excluding Iran from international payments via SWIFT has significantly complicated such payments. The value of Iranian rial plunged by 80% and the standard of living is suffering.

While smuggling has allowed wide spread evasion of many restrictions, they significantly raise the cost of, and thus reduce the gains from, trade. In the list of unintended consequences, Fareed Zakaria argues that sanctions have strengthened the state relative to civil society because in Iran the market for imports is dominated by state enterprises and state-friendly enterprises, thus smuggling requires strong connections with the government.

While it is difficult to assess the impact of sanctions on public attitudes, they seem to be succeeding in increasing pressure on the government to reach an agreement with the U.S. and EU to reign in its uranium enrichment program. This qualified success reflects the broadly accepted purpose for the sanctions (thwarting Iran’s nuclear weapons potential), and hence broad (but not universal) enforcement of such sanctions.

Islamic State — Da’ish

Da’ish is not a recognized state but is so widely seen as an evil pariah that it constitutes an entity and cause for which sanctions should have their maximum impact. Moreover it is being resisted and attacked militarily as well. While direct U.S. military engagement would be counterproductive in the long run (it is their region and interest, not ours), logistical and weapons support to the government of Iraq and close coordination with Iraq’s neighbors has been and will be helpful. Blocking every possible source of income, payments, and weapons procurement by Da’ish will gradually degrade its ability to fight and to hold on to the territory it needs to fulfill its Islamic caliphate objective.

When virtually the whole world is behind sanctions, we have many tools and capability to make them effective. But even in this most obvious and potentially effective case, there are challenges. While strongly and rightly defending the right of anyone to offend the Prophet or anyone else we can hardly forbid public statements in support of Da’ish. The British “human rights group” CAGE, for example, is under attack for calling Jihadist John “a beautiful young man.” The group, led by former Guantanamo Bay inmate Moazzam Begg, is being attacked by both public and private groups in the UK for its jihadist sympathies. Similar issues exist in the U.S. Read more: http://www.dailymail.co.uk/news/article-2972757/Fury-charities-fund-ISIS-Jihadi-John-apologists.html and http://www.bbc.com/news/uk-31657333

But what about financial support to terrorist groups from their sympathizers? Striking the right balance between fighting terrorists and freedom of expression will require care. Who of my generation can forget the controversies raised in the 1970s and 80s over the financial contributions of Irish Americans and their charities to the Irish Republican Army (officially a terrorist group)?

Russia

In general, the modern world is blessed with many positive incentives for people and countries to behave well. The broadly embraced values of the Enlightenment, and classical liberalism’s respect for each individual and his and her rights has established a presumption against force and coercion and hence against war. It is far more profitable (for both sides) to buy what we want than to try to take it (trade vs war). But unfortunately this has not always been enough to deter bad behavior necessitating consideration of deterrents. Russia’s President Vladimir Putin, whose behavior I can only understand as that of a self enriching gangster who is happy to exploit the fears and paranoia of the average Russian to enhance his power and control, but who cares little for the future well being of his country, is grossly violating post Westphalian principals of sovereignty. Our interest in Ukraine is marginal and Putin’s is intense for reasons of Russian history and its emotional value for Russian support of its new autocrat. U.S. intervention of any sort in Ukraine would likely precipitate intensified interference by Russia. Where and when would the escalation on each side end? Would Russia’s bankruptcy end the fighting before reaching the nuclear level? We should not try to find out. Whether we should provide the pro west Ukraine government with defensive arms is a more difficult question, but would risk ill-advised escalation by Ukraine, a risk we should not take. This leaves us with economic sanctions as the most appropriate deterrent of Russia’s bad behavior.

Interestingly and frustratingly the vary interdependencies that develop with trade also create weapons that can be used by either side to promote a country’s aims. Da’ish is not in a position to deprive us of anything in retaliation to sanctions we impose on it. Even shutting down all exports of oil in the territories it controls or is likely to control would be barely noticed. On the other hand, Russian threats to shut off the flow of oil and gas to Europe and especially Germany, which receives 40% of its oil from Russia, must be taken very seriously. All of the natural gas consumed in Estonia, Finland, Latvia, Lithuania, and Macedonia comes from Russia as does over 50% in Bulgaria, Czech Republic, Greece, Hungary, Montenegro, Serbia, Slovenia, Turkey, and Ukraine. A Russian cut off of gas and to a lesser extent of oil would be devastating to Europe. On the other hand, the loss of that revenue would be devastating to Russia. This is the two-sided nature of trade. It introduces caution into measures to harm trading partners.

Russia’s recent deal to supply oil and gas to China will reduce its reliance on its European market and hopefully Europe will also take steps to reduce its reliance on Russia. However, the U.S. has moved slowly if at all to increase its capacity to ship gas and oil to Europe, which is currently heavily dependent on existing pipelines from Russia. Russia has spent billions of dollars in Europe through environmental groups and others to discourage the development of Europe’s oil shale potential and to encourage the reduction of its use of nuclear energy. http://www.thenewamerican.com/world-news/europe/item/18546-nato-head-russia-is-funding-anti-fracking-movement http://www.washingtontimes.com/news/2015/feb/2/richard-rahn-vladimir-putin-funding-opposition-to-/

Sanctions so far have been carefully (and wisely) targeted to a few specific individuals and companies. It is difficult to determine whether they are having any effect on Putin’s behavior. If they are increased, the risk of Russian retaliation will increase as well, the burden of which would fall on Europe, not the U.S. Russia has cut off the flow of its gas and oil to Europe before for relatively short periods but has resisted doing so for the last few years. Putin is now threatening it again: http://www.washingtonpost.com/world/europe/putin-threatens-to-cut-gas-to-ukraine-as-showdowns-shift-to-economy/2015/02/25/b0d709de-bcf6-11e4-9dfb-03366e719af8_story.html.

Putin’s behavior justifies increasing sanctions but they should remain well targeted. A total blockade of Russia, which would be extremely difficult for Europe, would lead to a collapse of the Russian economy with unpredictable political consequences. The collapse of the Soviet Union in 1991 following the end of the cold war in December 8, 1987, with the signing of the Intermediate Nuclear Forces (INF) Treaty launched the transition (for a while) to a more liberal regime. It was the most dramatic and totally peaceful regime change the world has ever seen, but it took 70 years of patience to achieve. In a letter to this week’s Economist former British Ambassador to Russia Sir Tony Brenton said: “The solution to the Russia problem is not to sanction and isolate, but to hug close and thus, eventually, subvert.” We have a strong interest in an orderly political transition in nuclear-armed Russia.

Israel

Ironically the opposite side of the page of the Washington Post story on Russia linked above reported on the very disturbing use of economic sanctions by Israel against the Palestinians living in the West Bank. Israel refused to turn on the promised water to a new upscale city (residences, shopping mall, theater complex, sports club, school, etc.) being built on a West Bank mountaintop. “Before granting water access to the planned city of Rawabi, Israel — which controls the area that the water pipe would run through — wants Palestinian Authority officials to return to an Israeli-Palestinian Joint Water Committee. The Palestinians abandoned the group in 2010 because they don’t want to approve water projects to Jewish settlements in the occupied West Bank, which are built on land that Palestinians want for a future state — and which still get plenty of water.” http://www.washingtonpost.com/world/middle_east/new-palestinian-city-has-condos-a-mall-and-a-sports-club–but-no-water/2015/02/24/d5a28dcc-b92e-11e4-a200-c008a01a6692_story.html

After driving Palestinians from their homes in the war of 1948 that established the Jewish state of Israel, the new state of Israel and the international community accepted boundaries between Israel and the rest of Palestine that were somewhat enlarged from the UN approved partition of Palestine into Israel and the West Bank and Gaza Strip. The right of the 700,000 displaced Palestinians to return to their homes remain one of the unresolved issues in the Israeli-Palestinian dispute. The Jewish settlements referred to above are in the West Bank and have been ruled illegal in a number of UN resolutions and U.S. State Department opinions. http://works.bepress.com/warren_coats/26/

On several occasions Israel has also withheld the import tariffs that it collects on behalf of the WBG government (the Palestinian Authority) in order to pressure the PA not to challenge the construction of additional illegal settlements in the West Bank. “To protest the Palestinian Authority’s move this year to join the International Criminal Court in The Hague, Israel has also withheld for three months the transfer of $381 million in custom duties Israel collects on Palestinians’ behalf.” http://www.washingtonpost.com/world/middle_east/israel-to-let-water-flow-to-west-bank-development-at-center-of-political-feud/2015/02/27/d1b598de-be84-11e4-bdfa-b8e8f594e6ee_story.html

These are examples of a country’s use of “sanctions” to achieve its own, not widely shared, political ends. In the New York Times Nicholas Kristof said: “The reason to oppose settlements is not just that they are bad for Israel and America, but also that this nibbling of Arab land is just plain wrong. It’s a land grab.” http://www.nytimes.com/2015/02/26/opinion/nicholas-kristof-the-human-stain.html?_r=0 The same can be said of Russia’s land grab in Ukraine.

Fortunately in the case of Israel, Prime Minister Netanyahu intervened on February 27 and approved turning on the water before traveling to the U.S., presumably worried about bad press from Israel’s behavior, something President Putin unfortunately but predictably doesn’t seem to care about.