Tag: AIIB

The Rule of Law: China and the U.S.

The rule of law has been an essential and critical foundation of successful free market economies. It provides the certainty of property rights and contracts needed for entrepreneurs to risk their capital in business undertakings. But as our business and other activities cross borders, whose laws apply?

“Among the earliest examples of legal codes concerning maritime affairs is the Byzantine Lex Rhodia, promulgated between 600 and 800 C.E. to govern trade and navigation in the Mediterranean.” https://en.wikipedia.org/wiki/Law_of_the_sea  Leaping forward, international air travel, satellite communications, spectrum allocation for radio, TV, internet, and other telephonic transmission would be impossible without firm agreements among countries–the international rule of law.

Laws facilitate commerce–buying and selling–by establishing rules for doing so (e.g. contract enforcement rules) that are stable and applicable to all. They lower the costs and reduce the risks of trading. The United States Constitution recognizes the importance of this in the commerce clause of Article I Section 8, which is used to prevent individual states from taxing or otherwise interfering with interstate commerce. Achieving the same law-based freedom to trade across national borders is more difficult, requiring the negotiation of agreements and treaties that establish common rules between sovereign nations.

The World Trade Organization (WTO) develops and enforces the rule of law in the area of cross border trade. The difficulty of achieving global agreement on the rules of various aspects of trade is reflected in the fact that no new agreements have been reached since the establishment of the WTO (taking over the General Agreement of Trade and Tariffs) on January 1, 1995. “The WTO agreements cover goods, services and intellectual property. They spell out the principles of liberalization, and the permitted exceptions. They include individual countries’ commitments to lower customs tariffs and other trade barriers, and to open and keep open services markets. They set procedures for settling disputes.” the WTO – what is it?

China was admitted to the WTO as a developing country on December 11, 2001. Chinese officials immediately expressed the desire to understand and conform to the international rules required by the WTO and requested technical assistant from the IMF for doing so. In July of 2002, the IMF sent me to Beijing to review their needs with them.  They were particularly keen to have an American banking supervisor to advise them. I had a perfect candidate who was just finishing a two-year posting to Hong Kong. Everyone I spoke to in Beijing, as well as my Chinese colleagues at the IMF, stated that virtually all Chinese officials agreed on where China wanted to go–full liberalization according to WTO rules. They only differed with regard to how fast they thought they should move to get there.

Our condition was that our resident banking supervision advisor had to have his office located with the other Chinese banking supervisors and that he would have an open door. This was enthusiastically accepted by the Deputy Governor who apparently had not informed the Governor of these details. Unfortunately, when the Governor was presented the contract of his signature, he killed the arrangement. I was, however, able to enjoy wonderful tours of the Great Wall, the Forbidden City, and dine on the best Peking Duck I have ever had.  

An economically rising China is lifting millions of people out of poverty. We rightly welcome its newly productive economy contributing to increasing world output and living standards. The challenge is to square China’s authoritarian political regime with an international free market trading system. The vehicle has been the WTO and other international rule setting bodies that exist to harmonize diverse economies in the direction of freer and more open trade. The rules were being set by the dominant, largely free market economies that China wanted to join.

Beyond an American led WTO itself, the multilateral trade agreement that established the highest standards yet for tariff reduction and the incorporation of more modern trade issues such as non-trade barriers, services, protection of intellectual property, minimum labor standards, and dispute resolution (the rule of law cannot meaningfully exist without credible dispute resolution procedures) was the Trans-Pacific Partnership (TPP) negotiated between 2006 and 2015. The TPP agreement between Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the United States was announced on October 5, 2015.

Three days later, on October 8, I spoke in New York City at a seminar hosted by the Chinese Chamber of Commerce of New York on the internationalization of China’s currency, the renminbi. All of the talk by the Chinese attending was about the TPP. Why was China excluded? Could they join? My reply was that China would be very welcomed to join when they were able to meet the treaty’s conditions. TPP was another powerful magnet pulling China into the liberal international trading order.  

A recent report from the Peterson Institute of International Economics (June 23, 2020) stated that: “The Trans-Pacific Partnership (TPP) was designed in 2016 to be almost China-proof, with stringent obligations requiring transparency and trade liberalization. As former US Trade Representative Michael Froman put it, Chinese participation would be welcomed only when China could meet TPP’s terms, which it was far from doing. The United States was not keeping China out; China was just not ready to come in.” “China and Trans Pacific Partnership-in or out”

Broadly speaking, the aim of the WTO is to increasingly move its member countries toward the freest trade possible with fair competition (a level playing field), thus promoting a more productive allocation of economic resources and lifting global incomes.  The organization is not without its problems. But rather than working to strengthen the WTO, President Trump turned to negotiating bilateral trade agreements and raising rather than lowering import tariffs. Clearly bilateral agreements are easier to conclude than are global or broad multilateral agreements. Trump focused on China and its large bilateral trade surplus with the U.S. out of the mistaken belief that its surplus (our deficit) was harmful to the U.S. and that reducing it would increase American jobs. “Who pays Uncle Sam’s deficits”

In one of his most short-sighted actions from a sadly long list, President Trump withdrew the U.S. from the TPP on January 23, 2017. In addition to tweaking a few existing trade agreements, such as the North American Free Trade Agreement (NAFTA) by incorporated many of the newer provisions of the TPP and the United States-Japan Trade Agreement and the United States-Japan Digital Trade Agreement, and imposing protective tariffs on solar panels, washing machines, steel and aluminum imports in the name of national security and “America First,” the Trump administration has focused its trade war bilaterally on China (with occasional pot shots at our friends in Europe and elsewhere).  “Trade Office fact-sheets and-annual-report”   A Brookings Institution study assessed the result of all of this for the American economy and workers as follows: “American firms and consumers paid the vast majority of the cost of Trump’s tariffs. While tariffs benefited some workers in import-competing industries, they hurt workers in sectors that rely on imported inputs and those in exporting industries facing retaliation from trade partners. Trump’s tariffs did not help the U.S. negotiate better trade agreements or significantly improve national security.”  “Did-Trump’s-tariffs-benefit-American-workers-and-national-security”

The remaining eleven countries that had signed the TPP agreed in January 2018 on a revised treaty they renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership” (CPTPP).  CPTPP is substantially the same as TPP, but omits 20 provisions that had been of particular interest to the U.S. These provisions can be relatively easily restored should the U.S. choose to rejoin. “Trade and Globalization”

With the increasing power of Xi Jinping, China’s President and the General Secretary/Chairman of the Central Committee of the Chinese Communist Party (now for life), China has played an increasingly active role in the IMF, WB, WTO and other international bodies. In addition, it has launched several regional organizations that it leads (the Asian Infrastructure Investment Bank, the New Development Bank–BRICS, and the Belt and Road Initiative) “The Asian Infrastructure Investment Bank and the SDR”  Xi Jinping claimed that the AIIB would adhere to the highest international standards. But as President Trump and others have noted, there are a number of important areas in which China does not abide by the WTO rules. The policy question is what should be done about it.

The Cato Institution began a recent review of China’s trade practices as follows: “There is a growing bipartisan sentiment in Washington that Chinese trade practices are a problem, since these practices are unfair to American companies in a number of ways. But there is disagreement about the appropriate response. Can multilateral institutions be of use here? Or is unilateralism the only way?” Their conclusion is that the WTO and other multilateral institutions would be the most effective way of continuing to pull China into compliance with the international rule-based system. “Disciplining China’s trade practices at the WTO-how -WTO complaints can help”

President Trump has unilaterally gone the other way. He has blocked Huawei, the world’s leading seller of 5G technology and smartphones, from U.S. 5G mobile phone systems and urged our European allies to do the same because of Huawei’s links with the Chinese government. He is attempting to block the sales of U.S. and other non-Chinese manufacturers of the semiconductor chips used in Huawei and other Chinese products to China.  “A-brewing-US-China-tech-cold-war-rattles-the-semiconductor-industry”  He is trying to ban TikTok, WeChat and other popular Chinese products from U.S. markets and raising tariffs on an increasing number of Chinese products imported into the U.S. Some of these measures might be justified on national security grounds but some seem more protectionist of U.S. companies that are not otherwise competitive.

We are basically forcing China to build its own alternative rules and approach to trade. It is even offering its own global tracking system in place of the GPS system the U.S. has given the world and they seem well along in dividing the World Wide Web and other Internet protocols into two worlds. https://www.voanews.com/east-asia-pacific/voa-news-china/chinas-rival-gps-navigation-carries-big-risks

A November 20, 2020 article by William Pesek highlights what Trump’s misguided trade war with China is producing: “On his presidential watch, Donald Trump did manage to make one thing great: economic cooperation within North Asia.

So chaotic and pernicious was the outgoing US president’s pivot away from Asia that China, Japan and South Korea are dropping the hatchet and joining hands. The unlikely union was formalized on November 15 with the signing of the 15-nation Regional Comprehensive Economic Partnership, or RCEP, free trade agreement.”  “US sidelined as China Korea and Japan unite”  The RCEP is a lighter more limited trade agreement than was the TPP (now the CPTPP) but it is led by China rather than the U.S.  Rather than converging to WTO standards it creates an alternative. 

“President Xi Jinping’s Friday [Nov 20, 2020] announcement of China’s intent to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), a high-standard mega regional trade pact, has been seen as a bold move to reassure the world of the country’s continuing commitment to reform and opening-up.” “News analysis: an uphill task for China to negotiate CPTPP accession agreement”  While Xi Jinping’s strategy for China’s ascension is to take over the leadership in forging the rules for the international order more to the liking of his regime, China’s younger and upcoming managerial and entrepreneurial class, many of whom studied in the U.S. and Europe, have seen and liked the freer and more open capitalist societies. Their patriotism and commitment to a rising China is informed by the knowledge that freer and more open economies thrive more than centrally controlled ones.  We should not overlook their potential for returning China to a path of liberalization and integration with the liberal international order enjoyed by the rest of us.

Xi Jinping and his government’s goal is to retain power by delivering rapid economic growth, which allows and requires a vibrant private sector, while overseeing tight political control. One example is provided by its Social Credit System.  “China’s social credit system-mark of progress or threat to privacy?”  This requires a different set of rules for cross border trade than set out by the WTO. But many of China’s world traveling citizens see China’s successful rise in more closely embracing free market capitalism. We should incentivize the later view.

President Trump’s trade policies have damaged the world’s rule-based trading system and hurt the American economy while turning China in a different direction. President elect Biden has indicated his interest in rejoining the TPP. He should give it and the rebuilding of the WTO and other multilateral bodies high priority.

Trump’s Foreign Policy and Mexico

“From this day forward, it’s going to be only America First. America first!” Video of Trump’s inaugural address. Or was it “Trump First?”

If President Trump’s plea for others, such as Mexico, to treat the U.S. fairly were merely an embarrassing gesture, we might overlook it having grown used to Trump’s need for approval. But this is the status and fate of my country at stake. In a hysterical satire made by Dutch television, they ask whether if America is First, they might be second: Dutch youtube satire

There is little disagreement that American foreign policy should serve America’s interests. Even the neocons see the promotion of democracy as ultimately good for America, if we can survive the wars they want us to fight to impose it on the rest of the world. We have and should continue to see our interests in long-run terms—enlightened self interest. As he has shortsightedly done with trade, “Trump outlined a world in which foreign relations are collapsed into a zero-sum game. They gain, we lose.” Charles Krauthammer on Trump’s foreign policy revolution /2017/01/26/.

The real issue is which policies actually serve our interests. These policies should keep us safe and prosperous.

Military: Obviously we need a military capability sufficient to protect our shores from attack, but we need to avoid devoting more of our resources to our military than necessary for that purpose (with a reasonable margin for error) because every dollar spent on the military is a dollar taken away from building our economic strength, which is equally important for our defense and well being.

Diplomacy: We also need to invest in building good relations with other countries, especially our immediate neighbors, in part to minimize the prospect of ever needing to use our military. Thus we must devote the resources, including training, needed by our State Department to build our effective soft power. In an article in Time magazine January 26, 2017, Mikhail Gorbachev, the last president of the Soviet Union said:   “No problem is more urgent today than the militarization of politics and the new arms race. Stopping and reversing this ruinous race must be our top priority.” Gorbachev on Putin – Trump

Treaties: But here is the part least appreciated by the American public and least understood by Trump (I don’t know about the rest of his team yet and eagerly await his appointment to the Undersecretary of State position). Just as the rule of law has been critical to development and vitality of our economy and the protection of our liberties at home, it remains as important when we cross the border. This extends far beyond the critically important agreements on trade, the international monetary system, and the rules of war, to the more mundane aspects of every day life as well.

According to The Washington Post: “Trump proposes internal high-level committees to examine multilateral treaties, with a view toward leaving them….

“John B. Bellinger III, who served as legal counsel to both the National Security Council and the State Department in the George W. Bush administration, said the treaty examination was based on a ‘false premise . . . that the United States has become party to numerous multi­lateral treaties that are not in the United States’ interest.’

“’There are “many hundreds of multi­lateral treaties that help Americans every day in concrete ways,’ he said. Without them, ‘Americans could not have our letters delivered in foreign countries; could not fly over foreign countries or drive on foreign roads using our state driver’s licenses; could not have access to a foreign consular official if we are arrested abroad; could not have our children returned if abducted by a parent; and could not prevent foreign ships from polluting our waters.’” Trump-lays-groundwork-to-change-US-role-in-the-world/2017/01/26/

The Bretton Woods institutions created after World War II (the International Monetary Fund, World Bank, and World Trade Organization) established the institutional arrangements for cooperation in developing the rules of international trade and finance. American leadership in creating the international institutions through which we interact with others abroad, i.e., through which the rule of law is established and enforced internationally, has ensured that the international order has remained true to the liberal values on which America was founded. We would be wise to keep China as strong and active a member of these institutions and the rules they oversee as possible. US global leadership and the AIIB. It would be tragically misguided to undermine these institutions and our leadership of them. But this is the direction President Trump seems to be headed.

Mexico: Close to home, Mexico provides a tragic example of Trump’s failing approach to foreign policy. Our relationship with Mexico is one of our most important in the world. We share a 2,000 mile border with Mexico and it is our second largest export market earning $235 billion in 2016 while importing $296 billion worth of goods and services. The difference of $61 billion, the so-called trade deficit, reflects net Mexican investments in the U.S. Though Mexicans have been leaving the U.S. on net for the last few years, illegal immigration across our shared border has been a big campaign issue for Trump, and the Mexican border is the gateway for many non-Mexican Central American illegal immigrants. The flow of drugs across that border is also an issue.

Close cooperation with Mexico in dealing with these issues has been a critical aspect of managing them. The North American Free Trade Agreement (NAFTA) has been an enormous benefit. Former Mexican President Carlos Salinas told G.H.W. Bush that “goods bought by American consumers will be produced by Mexican workers, it is only a question of where those Mexican workers live!” He also indicated that in addition to jobs that keep Mexicans in Mexico, NAFTA also helped bring the rule of law to Mexico. Jerry Jordon

Illegal immigration reflects and responds to the incentives faced by potential immigrants. These include the quality of life, including jobs, in their home country, the demand for workers in the U.S., and the option of legal immigration. The problem of illegal immigration to the U.S. would be helped by a better legal immigration law, such as proposed by George W Bush in 2007 or later as contained in the Senate law drafted by the Gang of Eight in 2013. Better enforcement of work permit requirements with American employers could help a great deal.

President Trump’s approach has been grossly adversarial rather than cooperative. He has threatened to tear up (or at least renegotiate) NAFTA and build a wall on the U.S. –Mexican border that he would force Mexico to pay for. His approach is disastrously wrong. “President Trump’s Homeland Security secretary, John F. Kelly, has been clear about his views on a border wall with Mexico: It won’t work.” Homeland Security John Kelly on border wall – NYT. Mexican billionaire Carlos Slim stated that: “The best wall is investment, which generates employment in Mexico…. Mexico is the best partner the U.S. has.” Mexico digs in and Trump lashes back as border wall standoff deepens /2017/01/27/

The Mayor of Berlin Michael Mueller urged US President Donald Trump “not to go down the road of isolation.” He warned that such division causes “slavery and pain” and would “destroy the lives of millions.” BBC 1/27/2017. This doesn’t seem fully applicable to the Mexican wall, but still the Berliners know a lot about walls. John Oliver provides a hilarious but informative commentary on The Wall on Last Week Tonight. John Oliver video on The Wall

President Trump’s continued insistence on building the wall and his insulting claim that Mexico will pay for it has damaged the cooperative relationship that we badly need to maintain with Mexico. Trump’s tweet that Mexico should pay for the wall or Mexican President Enrique Peña Nieto should cancel his planned visit to Washington and stay home is an insult beneath the dignity of an American President as well as stupid. That President Trump is surely ignorant of these and other seriously damaging knock on effects of his mishandling of our relations with Mexico is no excuse for his insane behavior. Trump’s ruinous stance on Mexico-deportation-border-wall-tariff-trade.

“For 70 years, we sustained an international system of open commerce and democratic alliances that has enabled America and the West to grow and thrive. Global leadership is what made America great. We abandon it at our peril.” [Krauthammer]

The Asian Infrastructure Investment Bank and the SDR

By Warren Coats and Dongsheng Di

Jin Liqun, President of the new Asian Infrastructure Investment Bank (AIIB) announced on January 17, 2016 that all of its loans would be in U.S. dollars, “signaling that Beijing will not use the development bank as a platform to promote renminbi internationalization.”[1] In this note we argue that the AIIB should make all of its loans in SDRs. Doing so would make a major contribution to promoting the replacement/supplementation of the U.S. dollar for international payments that was called for by People’s Bank of China’s Governor, Zhou Xiaochuan in 2009.[2] As the SDR valuation basket will include the Chinese renminbi after October 1, 2016[3] it will also contribute, but more modestly, to the international use of the renmimbi.[4]

As the AIIB is a Chinese initiative and is headquartered in China, it was initially thought by some that its operations would be denominated in RMB. However, denominating its loans in RMB and actually disbursing RMB would suffer several disadvantages for the AIIB and for its loan recipients. There was concern by some that the use of the RMB might further strain the already complicated US-China bilateral relationship. In might also force the pace of China’s financial and capital account liberalization faster than other conditions warrant. Moreover, with greater exchange rate volatility of late, loan recipients would be exposed to greater exchange rate risk. The AIIB’s choice of the U.S. dollar avoids these risks but continues to subject its borrows to exchange risks associate with the dollar, which has varied considerably over the years. For these reasons the IMF, for example, denominates its loans and other financial operations in its Special Drawing Right (SDR), whose value is based on the market value of specific amounts of the five freely useable currencies in its valuation basket.[5] Thus for most countries, the international value of the SDR is more stabile than is the value of the dollar or another of the other currencies in its valuation basket. This logic applies fully to the operations of the AIIB and other development banks. The case for creating “private” SDRs to disburse to AIIB loan recipients rests on the contribution it would make toward developing the SDR issued by the IMF into a global reserve asset to supplement or replace the U.S. dollar, Euro and other national currencies in countries foreign exchange reserves.

The development and use of private SDRs, SDR denominated bank liabilities, is described in detail in an article one of us wrote over thirty four years ago in the IMF Staff Papers.[6] The AIIB would establish SDR denominated deposits with its bank (e.g., the BIS) and instruct its loan recipients to establish SDR accounts with their banks. AIIB loans would be disbursed by transferring the appropriate amounts of its SDR balances at the BIS to the recipients’ account at its banks. The dollar value of these SDRs would be determined in the same way as is the IMF’s official SDR. Following the procedures used by the IMF when disbursing its SDR denominated loans, recipients could request to receive their loans in the equivalent value of a freely usable currency of their choice (or in any or all of the five currencies in the valuation basket). In the first instance, AIIB loan recipients are likely to be governments with accounts in their central banks. Thus these central banks would need, in addition to their SDR accounts with the IMF, to establish (private) SDR accounts for their governments and commercial banks. If the loan recipient is able to spend these SDRs (pay its contractors and suppliers) directly it would do so, but most often it would need to exchange them for the currency wanted the ultimate recipients. This exchange would most likely be executed by its bank providing the SDR deposit.

Cross border private SDRs payments would be cleared and settled in the same general way as are U.S. dollar payments. Net outflows of SDRs from the banks of one country via their central bank to another country via its central bank, would be settled by the transfer of official SDRs on the books of the SDR Department of the IMF. Alternative clearinghouse arrangements are also possible has suggested by Peter Kennan in his comments on the 1982 IMF Staff Papers article. When such loans are repaid, if the repaying government (or other loan recipient) doesn’t have sufficient balances in its private SDR account with its central bank to transfer to the AIIB’s account with the BIS it would use other currencies to buy additional private SDRs. It might also use its official IMF allocated SDRs to either buy private ones or to transfer directly to the AIIB (assuming that like most other development banks and the BIS it has become an “other holder” of official SDRs). Private and official SDRs would have essentially the same relationship with each other as do base money and bank money in national currencies.

China and the AIIB are in a strong position, working through the IMF or bilateral discussions, to urge central banks to open private SDR accounts for their governments and their commercial banks toward the fulfillment of their obligation under the IMF’s Articles of Agreement to make the SDR “the principal reserve asset in the international monetary system” (IMF Article XXII). Through their representatives at the World Bank, Asian Development Bank, and their New BRICS Development Bank they could press these institutions to disburse in SDRs (private and/or official) as well. As an important purchaser of oil and other globally traded commodities they could encourage their pricing in SDRs. In the first instance, many loan recipients would choose to convert their SDRs into one or more of its basket currencies. But as private SDRs and supporting clearing and settlement arrangements proliferated, holding and using SDRs for international transactions would become more convenient and would potentially grow rapidly. This is an opportunity that should not be missed.

References

Coats, Warren, 1982   “The SDR as a Means of Payment,” IMF Staff Papers, Vol. 29, No. 3 (September 1982) (reprinted in Spanish in Centro de Estudios Monetarios Latinoamericanos Boletin, Vol. XXIX, Numero 4, Julio–Agosto de 1983).

1983, “The SDR as a Means of Payment, Response to Colin, van den Boogaerde, and Kennen,” IMF Staff Papers, Vol. 30, No. 3 (September 1983).

2009, “Time for a New Global Currency?” New Global Studies: Vol. 3: Issue.1, Article 5. (2009).

2011, “Real SDR Currency Board”, Central Banking Journal XXII.2 (2011), also available at http://works.bepress.com/warren_coats/25

2014, “Implementing a Real SDR Currency Board”

_____. Dongsheng Di, and Yuxaun Zhao, 2016, Why the World needs a Reserve Asset with a Hard Anchor, http://works.bepress.com/warren_coats/34/

Footnotes

Dr. Warren Coats retired from the International Monetary Fund in 2003 where he led technical assistance missions to more than twenty countries (including Afghanistan, Bosnia, Egypt, Iraq, Kenya, Serbia, Turkey, and Zimbabwe). He was Chief of the SDR Division of the Finance Department from 1982-88. His PhD from the University of Chicago was supervised by Milton Friedman. He was part of the IMF’s program team for Afghanistan from 2010-2013 and is a U.S. citizen. Wcoats@aol.com

Dr. Dongsheng DI is an associate professor of International Political Economy with School of International Studies, Renmin University of China and also a Research fellow with International Monetary Institute of RUC. In 2015 he is a visiting researcher at Edmund A. Walsh School of Foreign Service of Georgetown University. His research interests include the political economy of global monetary affairs, RMB internationalization, and Chinese Domestic Reforms. He is also a policy advisor to NDRC and China Development Bank and is a citizen of the People’s Republic of China. didongsheng@vip.sina.com

[1] China’s New Asia Development Bank will lend in US dollars, Financial Times Jan 17, 2016 http://www.ft.com/intl/cms/s/0/762ce968-bcee-11e5-a8c6-deeeb63d6d4b.html#axzz3xWiTvQZD

[2] Zhou Xiaochuan, “Reform the International Monetary System”, Website of the People’s Bank of China, March 23, 2009;

[3] The amount of the China currency in the SDR valuation basket will be determined on September 30, 2016 such that its weight in the basket on that day is 10.92% of the total value of one SDR.

[4] Banks offering SDR denominated deposits will generally balance them with SDR denominated assets or assets in the five currencies in the SDR’s valuation basket similarly weighted.

[5] The RMB will be added to the existing basket of four currencies—USD, Euro, GBP, JPY—from October 1, 2016.

[6] Warren Coats, “The SDR as a Means of Payment,” IMF Staff Papers, Vol. 29, No. 3 (September 1982); “The SDR as a Means of Payment, Response to Colin, van den Boogaerde, and Kennen,” IMF Staff Papers, Vol. 30, No. 3 (September 1983).

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.