Topic: International Economics and Development

Improving the Business Environment in Paraguay… Really?

President Bush addressed the Council of the Americas yesterday, a business organization whose stated goal is to promote democracy and free markets in the Americas.  Among the different subjects he touched in his speech, Bush highlighted the work of the Millennium Challenge Account (MCA) in Latin America.

The MCA’s goal is to provide bilateral aid to countries whose policies promote good governance and economic freedom. In Latin America, some of the standard bearers of good governance and economic freedom according to the MCA are Honduras, Nicaragua and Paraguay.

Bush proudly said in his speech that “In Paraguay, we’re working… with local leaders to reduce the cost of starting new businesses.” It sounds quite good, but when you look at the MCA’s Threshold Quarterly Report for Paraguay, you find among the accomplishments of the program this:

The Finance Ministry conducted simulated purchases to detect firms not following local tax regulations, resulting in the suspensions of more than 70 businesses. The business suspensions received significant positive media coverage and have generated greater tax compliance overall.

It sounds like U.S. aid money is being spent to shut down businesses in Paraguay. That hardly fits my idea of encouraging economic freedom in Latin America.  

No Way to Treat the Customers

Suppose you work for a company experiencing phenomenal revenue growth. Most of that growth is attributable to rapidly increasing sales to new customers with potentially limitless demand for your products.

Then the CEO unveils next year’s strategic plan, which includes actions likely to offend and financially injure those new customers, causing them to take their business elsewhere and jeopardizing your company’s future.

If you work in almost any goods-producing industry in Indiana or North Carolina, the above is not hypothetical. It is precisely what you confront if either Senator Clinton or Senator Obama becomes the next president.

You see, both candidates profess deep skepticism about international trade. Both plan to halt new trade agreements and to force our partners to renegotiate existing deals. Both support provocative, unilateral actions that would ultimately hurt American producers, consumers, and investors. And both insinuate that our trade partners are untrustworthy adversaries.

But Indianans and North Carolinians should recognize those trade partners as something different – like their fastest-growing customers.

Indiana’s producers shipped $26 billion worth of goods to foreign customers in 2007, which was 14 percent more than the year before and 80 percent more than in 2001. Since 2001, the state’s exports have grown at a rate one-third faster than U.S. exports overall.

North Carolina’s producers shipped $23 billion worth of goods to foreign customers in 2007, which was 10 percent more than the year before and 59 percent more than five years ago.

In 2007, exports accounted for 20 percent of U.S. manufacturers’ total sales revenues -— the highest percentage in modern history. And nowhere in America is manufacturing more important to the economy than it is in Indiana, where the sector accounts for over 30 percent of the state’s gross domestic product. Manufacturing accounts for 22 percent of North Carolina’s economy, ranking it fifth in that measure.

In China, Canada, and Mexico – the primary villains in the candidates’ antitrade narratives – Indiana’s and North Carolina’s producers are building relationships that are yielding extraordinary returns. Exports from Indiana to China increased by a whopping 36 percent between 2006 and 2007 (twice the rate of total U.S. export growth to China) and nearly quadruple Indiana’s exports to China in 2001. Indiana’s exports to our NAFTA partners (Canada and Mexico) grew 9 percent from 2006 and 67 percent from 2001, eclipsing overall U.S. export growth to NAFTA in both periods.

Exports from North Carolina to China increased a spectacular 32 percent between 2006 and 2007 (nearly twice the rate of total U.S. export growth to China), and its exports to NAFTA customers grew 46 percent to $7.4 billion over the past five years.

This export growth is not concentrated is one or two industries either. Out of 32 broad industry groupings, 28 in Indiana experienced export growth between 2006 and 2007 and 30 experienced growth between 2001 and 2007. Of the 28 industries showing export growth between 2006 and 2007, 23 experienced double- or triple-digit percentage growth.

In North Carolina, 25 of 32 industries experienced export growth between 2002 and 2007 and the growth rates were at least double-digit for each industry. Over the past year, 23 industries in North Carolina experienced double-digit export growth rates.

From the largest goods-producing industries to the smallest, in Indiana, North Carolina, and, indeed, throughout the country, strong export growth is evident. A study just published by the U.S.-China Business Council found that 406 of 435 congressional districts experienced triple-digit export growth to China between 2000 and 2007. Those figures and other facts from the study were highlighted in a Wall Street Journal editorial today.

Blaming trade for all that ails is a time-honored political tradition. Acting on that impulse by imposing trade barriers or otherwise retreating from the global economy is never the proper course, but it would be particularly foolish in the current environment, where industry after industry is experiencing and benefiting from an export boom.

That boom couldn’t be happening at a better time. In the past, when the U.S. economy slowed, the world economy slowed along with it. But with the recent awakening of demand in long-slumbering developing economies, growth remains strong in many parts of the world. The U.S. economic slow down might therefore be short-lived, as export growth keeps the economy moving ahead. That is unless policymakers do something to risk U.S. access to foreign markets.

Treating the customers with disdain and hostility just might be the plan that kills the golden goose.

Ag Committee Chair Demands Higher Food Prices

Not content with a protected near monopoly of the domestic market, American sugar producers are demanding that Congress make their pot of subsidies and protection even sweeter.

Chairman of the House Agriculture Committee, Rep. Colin Peterson (D-Minn.), is pushing language in the latest proposed farm bill that would raise domestic price supports for sugar and mandate that sugar imports be used for ethanol production.

His proposals would virtually lock in an 85 percent share of the U.S. market for domestic sugar beet and cane growers, even though a number of foreign countries can grow sugar more cheaply than most American growers. And by the way, did I mention that Rep. Peterson’s district is among the nation’s top producers of sugar beets?

The Bush administration, to its credit, opposes Peterson’s changes in the farm bill. The sugar industry, of course, loves the idea. A spokesman for the pro-protection American Sugar Alliance told this morning’s Wall Street Journal, “We have an administration that seems more interested in supporting foreign producers, than producers right here in America.”

Notice the sugar industry doesn’t mention American consumers. U.S. agricultural policies should not be about favoring “our” producers over “theirs,” but about advancing such national interests as freedom, prosperity, and a more peaceful world. As we’ve explained in detail at the Center for Trade Policy Studies, the U.S. sugar program favors American sugar producers primarily at the expense of the rest of America. American families pay higher prices at the store, while U.S. producers that use sugar as an input — bakeries, food processors, restaurants, candy makers, etc. — incur higher costs because of our sugar program.

As we read daily in the newspaper about soaring food prices, this Congress is the verge of passing a farm bill designed explicitly to raise domestic food prices.

Blinded by Ideology

A letter writer in the Washington Post complains about this Post editorial, which criticized the repression in Cuba, particularly the lack of freedom of expression and the right to emigrate. The writer declares,

Cuba is managing its economy and is making incremental changes and reforms within its socialist and human-needs-oriented system. The U.S. government and The Post shouldn’t lecture Cuba when we have our own problems with the economy, the budget, health care, infrastructure and our moral standing in the world.

I’ve just published a book, most of whose 300 pages are devoted to criticisms of the U.S. government on a far wider range of issues than that, so I’m no knee-jerk defender of any government, much less of the Bush administration. But let’s take a closer look at the writer’s claims:

Cuba is managing its economy…

Well, every country manages its economy in some sense. The Cuban government has managed to turn a beautiful country of tropical beaches 90 miles from North America into one of the poorest countries in the world.

…and is making incremental changes and reforms…

Yes, as the Post editorial noted:

In the past few weeks, Cuban President Raúl Castro has introduced a handful of micro-reforms to the oppressive and bankrupt regime left behind by his brother. Cubans are now officially allowed to buy cellphones, computers and microwave ovens; state workers may get deeds to apartments they have been renting for decades; and farmers may be able to sell part of what they grow at market prices. The measures won’t have much impact (though they have evidently annoyed the officially retired Fidel Castro): The vast majority of Cubans can’t afford to buy electronic goods, and the agricultural reforms fall short of steps taken years ago by North Korea.

So reforms are good. Wake me when they reform more than North Korea.

…within its socialist and human-needs-oriented system.

You’d think socialists would have stopped claiming Cuba. If Cuba is socialist, then socialism is a disaster. While the rest of the Americas grow, Cuba declines. Cubans keep their 1950s American cars shiny and clean because that’s what they have. Socialism’s great accomplishment is to try to freeze the economy at the level to which capitalism (in this case, a corrupt and crony capitalism) had brought it.

As for “human-needs-oriented,” millions of Cubans express their human needs by getting on rickety boats to try to sail to America. One might say that Cuba is like a vast open-air prison, except that American prisoners get better food and more choices in books, newspapers, and television than Cuban citizens do. It’s a rule of thumb around the world: the more a government proclaims its orientation to “human needs,” the less well it actually serves human needs.

The U.S. government and The Post shouldn’t lecture Cuba when we have our own problems with the economy…

Yes, our economy is growing only slightly these days, and we have looming fiscal disasters because our own government has introduced socialism into health care and retirement savings. But Americans don’t flee to Cuba, and our GDP per capita is estimated at something like 10 times that of Cuba. 

…the budget…

Yes, our federal budget is a disaster. But it hasn’t — yet — destroyed our standard of living, and I doubt that the adoption of Fidel Castro’s budgeting methods would help.

…health care…

Yes, we have the best and the most expensive health care in the world. If we had less socialism in health care, we could bring down our costs. But more drugs are created here, more medical advances are made here, and people come to American hospitals from all over the world, especially from the often-touted Canadian system.

…infrastructure and our moral standing in the world.

My colleagues and I have written very critically about the Bush administration’s war in Iraq, its treatment of the accused, its accumulation of executive power, and other actions that have harmed America’s standing in the world. (Not to mention President Clinton’s unauthorized uses of military force in Europe, Africa, and the Middle East.) But if America’s moral standing in the world is less than that of the totalitarian Castro-Castro regime, then that is an embarrassment to the world, not to the United States.

As Human Rights Watch reports, “Cuba remains the one country in Latin America that represses nearly all forms of political dissent. There have been no significant policy changes since Fidel Castro relinquished direct control of the government to his brother Raul Castro in August 2006. The government continues to enforce political conformity using criminal prosecutions, long-term and short-term detentions, mob harassment, police warnings, surveillance, house arrests, travel restrictions, and politically-motivated dismissals from employment. The end result is that Cubans are systematically denied basic rights to free expression, association, assembly, privacy, movement, and due process of law.” And Human Rights Watch doesn’t even take note of the economic liberties that are systematically suppressed.

The Post’s “lecture” concluded this way:

Let Mr. Castro respect the International Covenant on Civil and Political Rights his government recently signed, which guarantees not only freedom of assembly but the right to freely leave the country. Cuban officials recently hinted that the current ban on foreign travel by average citizens might be changed; let it be removed. Then Mr. Castro can discover just how many of Cuba’s 11 million people are willing to go on enduring a regime whose idea of reform is permitting the sale of microwave ovens.

The letter-writer might encourage the Castro regime to follow this advice, and then perhaps Cuba would have some small measure of moral standing in the world.

Re: Wall Street Journal Editorials — The Fed Caused the Rise in Food and Oil Prices?

In numerous unsigned editorials, The Wall Street Journal has argued that cutting the federal funds rate to 2% from 5 1/4% last September has been the main reason prices of crude oil and food commodities have soared in recent months. Such commodities are priced in dollars and the dollar was generally falling through February, though not in the past two months (even though the funds rate was reduced by one percentage point).

An April 28 editorial, “The Fed’s Bender,” notes that “since 2003 the dollar price of oil has climbed far more rapidly than the euro price — 273% in dollars, compared to 146% in euros.” It is not likely that the whole 2003-2008 picture reflects “the European Central Bank’s sounder monetary management,” as the editorial implies. The euro had dropped to below parity with dollar until late 2002. And the fed funds rate was repeatedly increased from 1% in 2003 to 5 ¼% in mid-2006 (well above the ECB’s equivalent 4% rate). The euro rose partly because it had first fallen, but also for reasons other than central bank interest rates (economists have no reliable model for forecasting floating exchange rates).

The editorial boldly concludes that “had the dollar merely retained the same purchasing power as the euro, today’s price of oil would be below $70 a barrel.” That is a counterfactual exercise that makes little sense.

Even if we accept the half-true premise that the dollar-euro exchange rate is sensitive to relative short-term interest rates, the dollar might have “retained the same purchasing power as the euro” by having the ECB lower interest rates to 3% and the Fed to keep ours at 3%. Or the Fed might have kept the funds rate at 5% and the ECB at 4%. Although either option might have stabilized that particular exchange rate, they would not have had the same effect on global economic growth and therefore on the world demand for oil.

If oil had been priced in dollars and the euro had not appreciated against the dollar, then the euro area would not have been as insulated as it was against the rising cost of oil. Because demand is responsive to price (particularly business demand), Europe would have bought less oil than it did. Or, to use the editorial version, if the U.S. still faced $70 oil then we would try to buy more. Either way, the price in dollars would not have remained the same.

The Economist index covers the prices of 25 commodities, excluding oil and gold, with food accounting for 56% of the index. By April 22 it was up 31% for the year and 3.7% for the month, when measured in dollars.

That was mostly because of food. Industrial commodities were up only 1.6% for the year.

If we are going to blame the rising price of oil and food commodities on the dollar, do we need a different theory to explain why industrial commodities have barely risen?

Here’s another anomaly: Measured in British pounds, the commodity index was up about the same as it was in dollars—31.6% for the year and 4% for the month. That can’t be because Britain has a weak currency—the pound buys 8.9% more dollars than it did a year ago. It can’t be because the Bank of England cut interest rates too much, since 3-month interest rates are 5.86% in Britain, compared with 1.97% in the U.S.

I happen to agree that the Fed (and ECB) have paid too little attention to the impact of exchange rates on prices of internationally traded commodities. And I suspect the Fed has already gone too far with rate cuts and will have to put rates back up shortly after the election. But to single-out a few sensitive commodity prices that have risen the most (in dollars or pounds) and blame just those prices on the Fed is going too far.

AZ-Verify

Arizona’s law requiring employers to use the federal government’s “E-Verify” system to check workers’ immigration status has employers there “confused by the law’s requirements and ‘terrified’ at the prospect of losing their business licenses if they run afoul of its provisions,” according to a local chamber of commerce official.

My recent paper on electronic employment verification calls it “Franz Kafka’s solution to illegal immigration.”

Re: Martin Feldstein — The Fed Should Stop Helping Commodity Speculators?

In The Wall Street Journal on April 15, Martin Feldstein of Harvard took a position between Makin and Chapman, saying the Fed should have left the federal funds rate at 2 1/4%, because a lower rate would cause “rising food and energy prices.” Feldstein told The Guardian the dollar had to fall further on April 11, so the link he envisions between Fed policy and commodity markets is not through exchange rates (I’ll discuss that in a later post), but just upside speculation alone:

Lower interest rates induce investors to add commodities to their portfolios. When rates are low, portfolio investors will bid up the prices of oil and other commodities to levels at which the expected future returns are in line with the lower rates.

But investors go short as well as long–betting the price will fall– and they can use credit for that too.

The only reason to make a leveraged bet that the price of oil, gold or corn will go higher is if you expect the prices to rise by enough (during the holding period) to exceed the interest expense.

Ignoring trading costs, if you can borrow at 5% to invest in something whose price is expected to rise by 8% that may look like easy money. Yet oil futures are cheaper than near-term spot prices, and gold has recently fallen by about 13%, so momentum trading is dangerous. It is properly called “greater fool investing” – just like paying too much for a Las Vegas condo on the assumption that some greater fool will later pay even more.

It seems unlikely that today’s quarter-point cut in the fed funds rate will result in lower margin rates for commodity traders. But even if it did that is not nearly enough to make a significant difference for more than a day or two.

U.S. politicians seem equally angry with upside “speculators” and downside “shorts,” but it is the contest between the two that constantly gropes for the right price.

I am shorting oil through an exchange-traded fund (DUG), and shorting precious metals through a mutual fund (SPPIX). I’m also slightly long the dollar (UUP). Don’t try this at home without a net. But if I win those bets, the world economy wins too.