US-South Korea Free Trade Agreement

I am kind of surprised by the lack of chatter about the US-South Korea Free Trade Agreement. Without question this is the most important FTA the U.S. has signed since NAFTA. As the International Herald Tribune summarizes, "The United States has reached its biggest free trade agreement since NAFTA, clinching a last-minute deal with close security ally South Korea that it hopes will bolster bilateral ties and provide added spark to global trade talks.

"The free trade agreement...is a historic accomplishment," Deputy U.S. Trade Representative Karan Bhatia told reporters on Monday after eight days of talks. "It is an agreement for the 21st century."

Prominent American legislators are already criticizing the agreement; Max Baucus, D-Mont. is unhappy about Korea's treatment of American beef (do you think Montana is a large beef producer?) while Sander Levin, D-Mich. is unhappy about Korea's apparent reluctance to buy American cars (do they still produce cars in Michigan?). The big auto companies are none too pleased either.

"Levin, who chairs the House Ways and Means Trade Subcommittee, said the deal faces certain defeat in Congress. "The U.S. did not get what was needed - an agreement that assures that the U.S. automotive industry will no longer face the barriers to their products, that trade will be truly a two-way street," Levin said, noting that South Korean companies export 700,000 vehicles to the U.S. annually while the U.S. sells less than 5,000 in South Korea. Earlier this month, Levin had proposed that USTR offer South Korea a tariff-rate quota that would grant a zero tariff for a number of autos that would grow only as U.S. auto exports to South Korea increased in the future. "

Seeing how a lot of Americans prefer Hyundais to Hummers these days, I am not sure why our ability to buy small, reliable, and fuel-efficient cars should be dependent upon Koreans' willingness to buy gas guzzling SUVs. But that's just me--I drive an import.

The agreement seems to go a long way toward accommodating American auto producers' concerns. According to the USTR, the agreement "will eliminate discrimination in engine displacement-based taxes, long a significant impediment to market access in Korea. The agreement contains strong commitments to addresses the specific standards-related concerns raised by U.S. auto manufacturers and to create a working group to review auto-related regulations being developed as an early warning mechanism to prevent new problems from arising and to promote good regulatory practice in Korea. The agreement also contains a special enhanced dispute settlement mechanism for auto-related measures, with strong remedies to deter actions on autos that are inconsistent with the agreement."

The vote should give an early indication of the prospects for getting a WTO agreement through Congress. Initial signs are not encouraging...

The World Cup: High Politics and Low Journalism

For some reason, IR students and scholars seem to be much more interested in soccer. Maybe it's because it's the world's sport. Maybe it's because significant international events like the Football War have been influenced by the game. Maybe it's because researchers can link soccer performance to national cultures of violence (pdf). Pop social scientists and public intellectuals have also found soccer a ripe subject for examining the world.

IPE@UNC is no exception. We've had a lot of posts discussing soccer and its role in international politics. So I was pleased today to see a couple of news items relating soccer and international studies. First, Emmanuel points out how soccer broadcasts may be used as a type of weapon by South Korea on North Korea:

Recently, the South Koreans have claimed that the fatal sinking of one of their military vessels was due to foul play from the North Koreans. While we wait for more solid evidence to this effect from the South Koreans, it seems they have come up with their own unique way to get back at Dear Leader Kim Jong-il's strange play acting. It turns out that, in the absence of a solid telecommunications infrastructure, North Korea relies on South Korea to provide a retransmission of international broadcasts of the World Cup. So, if South Korea really wants to turn the screws into North Korea, it's "no World Cup football for you, murderous regime."

If this is true it will have to go down as one of the strangest sanctions threats in the history of international politics, if it even qualifies as a sanctions threat. Is there a demand attached, or is this mere retaliation? And could this possibly have a real effect on politics within the DPRK, or on relations between the North and South? I doubt it, but I suppose stranger things have happened.

Like this:



Gize? Srsly. South Africa is not a continent. But if it were it wouldn't be South America. Unless, as Deadspin notes, South Africa just won a war that nobody knew about. Come on, people! It's almost World Cup time! Time to start figuring out where other places are! We've only got a month!

The High Politics of ROK/DPRK Trade

It is hurting:

Inter-Korean trade has fallen about 30 percent this year, largely affected by South Korea's move to cut almost all business relations with North Korea after the North sank one of its naval ships in a torpedo attack in March, the customs office said Wednesday.

This is to be expected. But this surprised me:

According to data provided by the Korea Customs Service (KCS), trade between the two Koreas amounted to US$464 million during the January-November period, down from $649 million recorded a year earlier.

That is more trade than I thought. North Korea's GDP is ~ $27bn, so that $650mn in trade represents about 4% of DPRK GDP*. To put that in perspective, in 2009 the U.S. and China traded $366bn in goods, or about 3.8% of (U.S.) GDP.

Perhaps that plays into why the DPRK backed down earlier this week: they literally can't afford to keep playing high stakes poker when they're so short-stacked. As any poker player knows, "in a heads-up game, the size of your stacks is as important as the cards in your hand". The ROK is in a position to lean on the DPRK, the DPRK doesn't have a bankroll to fall back on, and both know it. Especially because much more than just $650mn is at stake:

Despite such a sharp shrinkage, trade through the Kaesong industrial complex, tallied in a separate statistic, remained robust. Trade amounted to $1.31 billion during the 11-month period, up 62 percent from a year earlier. ...

South Korea is the North's second-largest trade partner after China. A suspension of inter-Korean business would significantly impact the reclusive communist nation's efforts to secure cash, according to experts.

Long and short: the ROK can trade with the U.S., Japan, and everyone else in the world. The DPRK can't. There's an important asymmetry here that the ROK can, and apparently is, using to its advantage.

*To be clear, that $650mn is not entirely on the North's end. It's total trade. But the North exports more to the South than vice versa, and is definitely more dependent on that trade. From the article:

South Korea's exports to the North came to $130 million during the cited period, down 28 percent a year earlier, while imports dropped 29 percent on-year to $334 million, the data showed.

Via.

Korea

When I went to bed last night the news sites were all saying that a resumption of the conflict on the Korean peninsula was possible -- even "imminent" according to one source -- if the South proceeded with its plans to hold a military exercise in disputed territory. I went to bed thinking that I'd wake up to no news, which would certainly be good news. That turns out to have been right, so here's some thoughts on the situation.

1. The security dilemma is still the most important concept in international relations. Obviously the South is spooked by the North's nukes and occasional belligerence, and felt the need to demonstrate its defensive capabilities. The North is obviously spooked by the fact that a huge, well-funded military backed by (still) the only global superpower is right below it, and it can't necessarily count on its only ally (China) for much support.

2. Schelling is still boss. He first identified the "cliff-dancing" strategy in his 1960 book, and it is still relevant. The South just danced a bit closer to the brink, and it worked.

3. North Korea is very weak, but it is not crazy. Neither impression is the one Kim Jong Il wishes to leave, but that conclusion is inescapable at this point. The North threatened retaliation if the South conducted this exercise, but immediately back-tracked since those threats were clearly not credible. In fact, it appears that once its bluff was called it was willing to do quite a lot to walk back its earlier threats. It offered possibly-meaningful concessions in negotiations with Bill Richardson, including resumption of the six party talks, access to its nuclear facilities by outside inspectors, and the return of the remains of U.S. soldiers that died during the Korean War. I'm not at all suggesting that the South should continue to posture in this way, but in this case it appears to have worked.

4. Nukes only get you so much deterrence capability. Namely, they can (perhaps) act as a repellent, but cannot compel others to

5. For all of the talk about shifting power structures in Asia, the U.S. and its ally still won the day. Not just by holding the exercise without retaliation, which was sort of a "remind them who's boss" maneuver, but also by the response of the other regional powers. China and Russia implored the South to stand down, to no avail, indicating a clear lack of power and influence in the region. This follows the U.S.'s decision to conduct joint exercises with South Korea last month, a move China opposed because it occurred in China's "exclusive economic zone" but did nothing to prevent.

6. This incident is really the first time the Obama administration has been willing to stare down some of the U.S.'s antagonists, and he won: the other side blinked (DPRK) or sat down (China). Not only the military exercises, which not only involved moving the USS George Washington strike group to the Yellow Sea, but also passed the ROK-US trade agreement. I'm not sure whether this will encourage more risk-taking by the administration or even whether it should, but it is notable.

7. Keep all of this in mind when you hear that Iran is crazy, undeterrable, will be able to marshall nuclear capabilities to blackmail the Middle East, etc. All of those ideas have been tested over the past month in Korea, and all of them have been found wanting.

UPDATE: Drezner also posted thoughts. I like his #4, but I don't buy it. I think #3 is more likely, and if true is a positive sign for the future of Asia.

Car Imports, Gas Prices, and Counter-productive Protectionism

Americans are again buying lots of imported cars. The graphic on the right suggests that Americans care more about the fuel efficiency of the cars they buy when gas prices rise (gee, who would have thought?).

Two additional facts of interest. One, the first figure (which excludes imports from Canada and Mexico) reflects increased imports from Japan and South Korea. Two, the cars that Japan and Korea produce and export from home are smaller and more fuel efficient (think Prius) than the cars and trucks they produce inside the U.S.

Conclusion? Americans have responded to higher gas prices by shifting away from large gas guzzling cars and trucks that happen to be produced in the U.S. toward small and more fuel efficient cars that happen to be produced overseas. The solution for American auto producers would thus seem to be, shift production to the small fuel efficient cars that Americans now want to buy.

Yet, in a non sequitur of massive proportions, "Senator Carl Levin, a Michigan Democrat, is...vexed," because this trade imbalance reflects a lack of market openness in Asia. "Citing Census Bureau data and his staff’s calculations, Mr. Levin argues that “immense barriers” erected by Japan and South Korea keep down vehicle exports from the United States to those countries. Car, truck and parts imports from Japan, for example, reached $60.2 billion last year, he said, while similar exports to Japan from the United States were a tiny $2.3 billion. He put the Korean imbalance at $12.4 billion versus $751 million."

Does anybody who does not represent Michigan in Congress really think that the desire of Japanese consumers to drive Hummers, Suburbans, and Excursions through Tokyo is being foiled by trade barriers? That is, do we really expect Asian consumers to behave differently than Americans when it comes to buying cars? And with Americans less eager to buy large gas guzzling American cars, wouldn't one think that Asians would also be less eager?

The broader concern is the following: Levin and other congressional trade skeptics focus on this imbalance in auto trade as reason to oppose the FTA with So. Korea. Yet, free trade with Korea (and Japan, for that matter) would, by reducing the cost of more fuel efficient cars, promote environmental objectives that Democrats favor. Restricting this trade would thus increase emissions relative to what is possible. Hence, more trade is also good for the environment (though to be sure one would have to compare the extra emissions generated by shipping from Asia to the emissions saved via the shift to more fuel efficient cars).

Restricting trade in autos, therefore, is not only bad trade policy, it is also bad environmental policy given the Dems' stated environmental goals.

Obama Finally Talks About Trade

Yes, there was the pie-in-the-sky "double exports in 5 years" talk during the SOTU address, but in a meeting with House Republicans today Obama got a bit more specific:

On the specific issue of trade, you're right, there are conflicts within and fissures within the Democratic Party. I suspect there are probably going to be some fissures within the Republican Party, as well. I mean, you know, if you went to some of your constituencies, they'd be pretty suspicious about it, new trade agreements, because the suspicion is somehow they're all one way.

So part of what we've been trying to do is to make sure that we're getting the enforcement side of this tight, make sure that if we've got a trade agreement with China or other countries, that they are abiding with it -- they're not stealing our intellectual property or making sure that their non-tariff barriers are lowered even as ours are opened up. And my hope is, is that we can move forward with some of these trade agreements having built some confidence -- not just among particular constituency groups, but among the American people -- that trade is going to be reciprocal; that it's not just going to be a one-way street.

You are absolutely right though, Peter, when you say, for example, South Korea is a great ally of ours. I mean, when I visited there, there is no country that is more committed to friendship on a whole range of fronts than South Korea. What is also true is that the European Union is about to sign a trade agreement with South Korea, which means right at the moment when they start opening up their markets, the Europeans might get in there before we do.

So we've got to make sure that we seize these opportunities. I will be talking more about trade this year. It's going to have to be trade that combines opening their markets with an enforcement mechanism, as well as just opening up our markets. I think that's something that all of us would agree on. Let's see if we can execute it over the next several years.

Read one way, this would seem to indicate that Obama would prefer a multilateral approach with built-in enforcement mechanisms to a series of bilateral agreements that leave more wiggle room. But if that's the case, then why hasn't he spent any time trying to jump-start Doha?

There's also some cognitive dissonance going on here. Take this part: "And my hope is that we can move forward with some of these trade agreements having built some confidence that trade is going to be reciprocal; that it's not just going to be a one-way street."

Well, it's pretty difficult for trade to not be reciprocal (it is trade, after all), but his point is that he doesn't want to enter into agreements where other states can manipulate the U.S. As someone in the blogosphere (can't remember who) recently wrote, Obama seems to only like exports. But imports are good too, especially when incomes are falling!

I don't find this encouraging or reassuring. Obama is signaling that he will put domestic interest groups at the forefront of his trade agenda. Which means, I think, that there is little hope for progress on the trade front during his administration. That's too bad.

The Indirect Effects of the Dollar As Reserve Currency

Paul Krugman has a post on how holding the world's reserve currency gives the U.S. economy no great advantage. As I've written before, I think he's right on the economics (it seems to be the consensus view), but there's a few points worth adding:

1. While it may not be especially important for the world's reserve currency to be the dollar, it is important that there is some global reserve currency. And it is important that it be controlled by a central bank that is willing to inject liquidity into the global economy during periods of stress, and serve as an international lender of last resort. Call this Kindleberger's Law. Right now, the U.S. Fed seems to be the only central bank that is able and willing to serve that role.

2. More broadly, I wonder if international monetary economists are asking the wrong question. Rather than trying to quantify how much the "exorbitant privilege" is worth to the U.S., why not look at how other countries respond to policy changes in the U.S.? Putin says the "dollar zone" includes the entire globe, and so the whole globe has ideas about how the U.S. should conduct its monetary policy. Brazil imposes capital controls when the U.S. pursues monetary easing, China holds $1tn or more in reserves and has oriented its entire macroeconomic policy to respond to the U.S., South Korea put exchange rates at the top of its G20 agenda, etc. This suggests that the effects of U.S. policy choices are much more important than getting a few billion from seniorage and foreign holdings of dead presidents.

3. This foreign reliance on the U.S. gives us quite a lot of domestic policy flexibility. We're not constrained by the "small open economy" models in the ways that South Korea is, for example. If our major trading partners are pegging to the dollar, then we're not constrained by the trilemma, either. We can pursue expansionary monetary policy when and how we like. We have essentially no currency risk, S&P downgrade notwithstanding. This policy flexibility is worth much more than the $25 billion a year that Krugman estimates.

4. It also reinforces the centrality of the U.S. in the international economic system, which not only provides the U.S. with cheap capital when we need it ("flight to safety"), but also gives us a lot of leverage in global governance negotiations. In other words, it allows us to skew the rules to suit our preferences to a greater degree than other states. This is obviously not an absolute power, but neither is it negligible (to the extent that global governance is not negligible, that is). South Korea was not able to get an exchange rate agreement at the G20, because the U.S. has no reason to comply. The U.S. has a large impact on global real exchange rates, so when it wants to devalue it can, even when other countries maintain nominal pegs.

These are mostly indirect effects that a simple analysis of "value of having the reserve currency" would likely miss. And it may be impossible to accurately measure. But these factors should not be ignored. They shape the politics that shapes the broader global macroeconomy. And we've seen plenty of evidence that this effect is not small. The world's emerging markets have been upfront in their desire to move to a multilateral reserve currency, such as the IMF SDR, that would give them more influence in managing the international monetary systems. They've also pressured the IMF to concede that capital controls can be a legitimate policy response to U.S. monetary easing, and have built massive piles of reserves. This indicates how important U.S. monetary policy is to the world, which should give us some indication of how important it is for us.

Korea

A former student e-mailed me and asked for advice on a paper he was writing about the Korea situation. Up until last week he had been focusing on China's role as facilitator of negotiations. He wanted my take on last's week attack, and the responses from the South, China, and the US since then. A few days late, but this was my off-the-cuff response:

I'm not sure how to read China right now. On the one hand, there is a long history of N Korea doing belligerent things to get attention, and then negotiating some agreement that gets them some aid or something in exchange for them not being stupid anymore. My first reaction is to consider their more recent actions in the same vein, given that history. In that case, you could maybe interpret China's nonplussed reaction as buying into that strategy to get all sides back to the negotiating table.

On the other hand, this recent action is more serious than past actions, and occurs in a different context: succession of power from Kim Jong Il to his son. I don't think this is going to lead to war necessarily, but I do think that it signals that the current status quo is likely untenable. The likelihood of a resumption of fighting has certainly gone way up, and S Korea appears to be losing patience. China also said (I think yesterday) that joint US-S Korean military exercises in the Pacific violated China's economic sovereignty (b/c China uses that water for shipping), which is a sign that China is not interested in marginalizing N Korea to get closer to the US and S Korea right now. Again... this could be a negotiating ploy, but then you'd have to think that both N Korea and China are bluffing. That could be correct, but I'm not very confident that it is.

Certainly the security dilemma is present, and there is some risk of spiraling. You can also think about how deterrence can have negative side effects... the US' security guarantee for S Korea could make S Korea *more* likely to retaliate and escalate the conflict. They know they have a powerful ally, so that will give them much more confidence than they'd have otherwise.

The US obviously does not guarantee N Korea's security, but China might. If so, then you might have a situation in which neither side (US or China) wants to escalate and both sides know it. In that case, N Korea might think that it can act with impunity. Think of it this way: N Korea knows that neither the US nor China want war, and will do whatever it takes to prevent it. The N Korean leadership is also going through a power shift, and the new leaders will want to demonstrate to their citizens that they are strong leaders, and worthy of support. What better way to do it than to attack S Korea in a limited fashion, and not suffer any repercussions? It's true that the only reason there won't be repercussions is because of China and the US, but the N Korean citizens don't know that. (There's a domestic politics information asymmetry too.)

Anyway, that's how I'm reading the situation right now.

Balancing Act

Just to piggy-back off of Dr. Oatley's post below. Geithner wants to cap current account surpluses or deficits at 4% of GDP. What effect would that have? Well, U.S. GDP is roughly $14tn. 4% of that is $560bn. In other words, a persistent 4% deficit in the current account is still quite large. Large enough that during most periods the U.S. was well within that boundary, though not during the mid-2000s. As the picture above shows, only in the last few years has the U.S.'s balance of payments been that sharply out of balance. (Note: that is nominal yearly data.)

What's interesting to me about the G20 kicking around these types of proposals are the distributional implications:

Representatives of the world’s largest economies, meeting in South Korea, reached tentative agreement early Saturday on the need to rein in trade imbalances, as part of an American-brokered compromise on calming exchange-rate tensions that have threatened to disrupt the uneven global recovery.

The Obama administration on Friday urged the other economic powers that make up the Group of 20 to agree to curb persistent surpluses and deficits that could contribute to the next financial crisis.

The proposal, which included a numerical limit, was backed by South Korea and quickly drew support from Britain, Canada and Australia. But it met with resistance from Germany and ambivalence from Japan, both major export countries. China, whose currency battle with the United States has threatened to derail the process of global economic cooperation, did not formally weigh in.

So after a marathon negotiating session that stretched into the predawn hours Saturday, the G-20 representatives agreed on the goal of “reducing excessive imbalances” — without a specified limit — and called on the International Monetary Fund to examine the causes of “persistently large imbalances.” The draft statement, to be ratified later Saturday, will also call on countries to “refrain from competitive devaluation” of their currencies, officials said. ...

Four countries have current-account surpluses exceeding 4 percent: Saudi Arabia (6.7 percent), Germany (6.1 percent), China (4.7 percent) and Russia (4.7 percent.) But under the American proposal, countries like Russia and Saudi Arabia that are “structurally large exporters of raw materials” would be exempt from the 4 percent limit, so the pressure would have fallen on China and Germany.

Two G-20 countries have current-account deficits larger than 4 percent: Turkey (5.2 percent) and South Africa (4.3 percent). The United States is next, at 3.2 percent.

A lot of stuff in here. First note that, once again, the expansion of the G7 to the G20 seems to have made it practically impossible to reach meaningful agreements with actionable language. How to reduce these imbalances? Umm... How much should they be reduced? No hard limit. What is the consequence of not reducing imbalances? None that I can see.

Of course the most important thing is who is reducing imbalances. As Dr. Oatley noted, it doesn't matter what countries like Turkey and South Africa do. Nor Russia or Saudi Arabia. It only matters what the U.S., China, and Germany do. The U.S. is under the proposed 4% limit, so is it any surprise that that is the level Geithner picked? It's the number that directly targets China and Germany, and to a lesser-extent Japan. The U.S. is trying to make China, Germany, and Japan pay for international macroeconomic adjustment. No wonder that those countries immediately rejected a firm requirement.

Meanwhile, Justin Fox notes that Keynes proposed something very similar during the Bretton Woods discussions:

Not impossible-to-enforce targets, but a system with incentives built in that would have made big trade imbalances unattractive to both sides. There’s that little matter of creating a new global currency and getting everybody to accept it, but this was at the tail end of World War II. If the U.S. had decreed that the International Clearing Union was a go, the International Clearing Union would have been a go. But at the time, the U.S. ran big trade surpluses and assumed it would do so forever. Its delegates at the Bretton Woods meetings were vehemently opposed. So the idea went nowhere.

Imagine that! Powerful governments decided not to pursue actions that went against their domestic interests. Who could have foreseen it?

The same dynamics are still at play even if some of the roles have reversed, so asking the IMF to investigate causes is a waste of time. China, Germany, and Japan have strong domestic political incentives to pursue policies that generate large current account surpluses. Their political survival depends on continued economic growth, and their economies are so structured that growth has to come largely from exports. The IMF will surely highlight the policies that lead to these outcomes, including exchange rate machinations, but it won't matter because they won't address the underlying political processes that generate the policies in the first place. Even if leaders wanted to bite the bullet and reverse these policies, their domestic constituents wouldn't allow it.

If the U.S. wants to address this issue, it's going to take much more than a vaguely-worded G20 communique. It will have to build a large constituency of other large economies. It will have to find a way to appease Germany and Japan while isolating China. It will have to massively boost domestic savings. And it will have to push a binding agreement through the IMF or WTO. That's a very tall order right now, and I don't see how they can pull it off. As the NYT article linked above notes:

Desmond Lachman, a former I.M.F. official now at the American Enterprise Institute in Washington, praised Mr. Geithner’s message. “It’s a constructive and imaginative proposal and it broadens the discussion away from an exclusive focus on currency to the wider set of policies needed to bring balance about,” he said. “But if you don’t have the Germans and the Chinese, this isn’t going to go very far.”

He added: “They want the U.S. to reduce its deficits, but they don’t want to reduce their surpluses.”

And vice versa.

Road Tripping: Obama in Afghanistan (or, Why Obama Would Fail POLI 150)

This morning I give President Obama an F in POLI 150 ("Intro to International Politics" at UNC) for the flawed analysis in his administration's Afghanistan policy.

The core policy is: deploy 30,000 troops now and bring them home in 18 months. Obama defends the approach against reasonable criticism in the following way:

"When I asked Obama if the Taliban wouldn't simply wait us out, he was dismissive: "This is an argument that I don't give a lot of credence to, because if you follow the logic of this argument, then you would never leave. Right? Essentially you'd be signing on to have Afghanistan as a protectorate of the United States indefinitely."

I fail Obama for this response. As I would explain to the President were he to turn up in my office to ask why he failed, two really large and quite different flaws are at fault.

First, Obama commits an error of reasoning. One cannot discount an argument because one dislikes its implication. One can challenge an argument's logical coherence. One can assert that a logically coherent argument has little empirical support. One cannot do what Obama does here which is to give this argument little credence because he doesn't want to face the possibility that success in Afghanistan requires an indefinite commitment. Disliking the implications of heliocentrism doesn't make the theory any less true.

Second, Obama commits an error of historical analysis. American foreign policy since 1919 is (arguably) defined by precisely the implication Obama gives "little credence." The failure to recognize the need for a permanent American presence in Europe after WWI created the conditions that made WWII possible. Need I point out that the US still has a military presence in Germany? The Truman administration's failure to define its permanent interest in South Korea may have encouraged North Korea to believe it could invade with impunity. Need I point out that the US still has troops in South Korea? More generally, the lesson of 20th century US foreign policy is that we use indefinite commitments to defend important interests.

In short, Obama fails because his analysis rests on wishful thinking rather than logic and history. I wish the impact of Obama's flawed analysis was limited to a bad grade. Unfortunately, his flawed analysis produces an incoherent policy. If Afghanistan is important enough to American security to merit 30,000 additional troops today, then the U.S. ought to be committed to its defense indefinitely. If Afghanistan is not important enough to merit an indefinite commitment, there is no reason to deploy additional troops now. I see no logical basis for Obama's policy. Why send 30,000 additional people to defend a country today that he admits he is unwilling to defend in the same way two years from now?

What Might a US-EU FTA Mean for International Investment Treaties?

In a previous post, Will discussed how a potential US-EU free trade agreement might effect widespread trade liberalization through inclusive institutions such as the UN. Indeed, many commentators are wary of the possible deal, believing it to signal the end of inclusive negotiations that characterize the WTO (though Will provides a nice counter to such alarmist claims).

A ratified US-EU FTA also has the capacity to change international investment law quite fundamentally. At stake is whether an agreement would have an investor-state dispute clause (ISD). Unlike traditional dispute settlement mechanisms, ISDs allow firms to sue states directly, usually within the context of an international arbital board such as the International Centre for the Settlement of Investment Disputes (ICSID). ISDs are controversial primarily because there is a widespread fear that MNC with deep pockets will engage in litigation wars of attrition. Furthermore, when investors can sue states directly, governments no longer have access to diplomatic tools to smooth over disputes. And, to the extent that the long term viability of open goods and capital markets requires some flexibility to deal with domestic push-back, the removal of states as arbiters of which investment disputes are worth pursuing and which are better left ignored could have lasting negative implications for the political viability of economic openness.

Unlike some other aspects of FTAs, ISDs can actually become salient issues. In South Korea there were a series of protests against the ISD provision of the recently ratified US-South Korea FTA. Other countries, including India, South Africa, and Australia, have recently decided to nullify portions of trade and investment treaties that include ISD provisions. Still, ISDs are widespread. The model US Bilateral Investment Treaty includes an ISD provision and ISD clauses are standard in US FTAs. However, the types of treaties that contain ISD clauses tend to be signed between states characterized by economic asymmetries.* BITs are a prime example - while over 2000 such treaties exist, there are no BITs between two advanced industrial economies.

So, the question then is whether a US-EU FTA agreement will include an ISD clause. Generally, advanced industrial countries have shown they are more interested in promoting legal regimes that protect "their" MNEs while less willing to cede jurisdiction over investment disputes in which they might be a defendant. For instance, Australia has decided to drop ISD clauses from its BIT and FTA regime after it was sued by Philip Morris; Philip Morris used Australia's BIT with Hong Kong to establish ICSID jurisdiction. Given growing dissatisfaction with the costs of ISD, it will be interesting to see if such clauses would persist if the US and EU decide to not subject themselves to such extra-territorial juridical measures.

My quick, speculative take is that ISDs will be less widely used in the future. As advanced industrial economies begin to receive more FDI from emerging economies with which they have such dispute clauses, they will seek to extract themselves from such agreements. Moreover, a movement away from ISDs may be a good thing. First, ISDs tend to create duplicated layers of juridical authority that generate confusion. Second, as mentioned above, ISDs make it harder for governments to intercede in investor-state disputes in ways that allow for flexibility necessary to maintain broad coalitions of support for deep economic integration. Finally, there is some evidence that states with ISDs tend not to pursue meaningful domestic legal reforms, and thus ISDs can contribute to the persistence of partial economic reforms that ultimately impede broad-based growth.** Removing ISDs may help overcome some of these problems.

*An important semi-exception is that NAFTA includes ISD provisions. However, this clause remains quite controversial in Canada. Canada has not yet ratified the ICSID convention, reiterating the extent to which countries are quite resistant to ceding final arbital authority to an international tribunal. Additionally, the US-Australia FTA suggests, but does not require, dispute settlements between investors and states.
** A place to start reading about this: Ginsburg, Tom (2005) "International Substitutes for Domestic Institutions: Bilateral Investment Treaties and Governance" International Review of Law and Economics 25:107-123.

Iranian Government Retires Four-Elevenths of the Soccer Team's Starting Line-up

From CNN:

Four Iranian footballers have been "retired" from the national side after protesting against the contested election result in the country during a match against South Korea, according to media reports.

Members of Iran's national soccer team sported green armbands in their game against South Korea.

The players drew attention to the situation in Iran by wearing green armbands during last week's World Cup qualifying match in Seoul.

Green was the color used by opposition leader Mir Hossein Moussavi during his campaign for the presidency and has been widely worn by supporters protesting since Mahmoud Ahmadinejad was announced the winner.

Six players wore the armbands during the first half of the match, returning in the second minus the accessories.

However, according to Iranian news reports four players -- Ali Karimi, 31, Mehdi Mahdavikia, 32, Hosein Ka'abi, 24 and Vahid Hashemian, 32 -- have been "retired" from the sport following the gesture.

The pro-government newspaper, Iran, reported the players had received the equivalent of a life ban.

Ahmadinejad is a known football fan, and has taken a keen interest in the national team's affairs.

Last week he compared protesters in Tehran to fans of a losing soccer team.

In 2006 Iran was banned from international competition for a short time by the world governing body FIFA after claims of improper interference by his government.

Who Says IPE Is Boring?

Brawls broke out in the South Korean legislature over a proposed U.S./S. Korea trade pact:

Scuffles broke out as dozens of opposition members and their aides attempted to push their way into the office. TV footage showed people from both sides shoving, pushing and shouting in a crowded hall at the National Assembly building amid a barrage of flashing cameras.

Opponents later used a sledgehammer and other construction tools to tear open the room's wooden doors, only to find barricades of furniture set up inside as a second line of defense.

Opponents counter that it will cause pain to key sectors in both nations — agriculture in South Korea and automobiles in the United States.

Note that this "free trade" deal is causing a lot of controversy primarily because tariffs aren't the only trade-distorting regulations in the two countries. The opposition party in S. Korea is (justifiably) worried that U.S. subsidies to American farmers will make S. Korean farmers unable to compete if their protections are discarded. They may be right: U.S. agricultural policy is a tragicomedy of perverse incentives, corporate welfare, and inefficiencies. American and European agricultural policies are also killing the agricultural sectors of developing countries, and this has lead to the near-abandonment of the Doha round of WTO negotiations.

America is poised to lose much of its automobile industry anyway; the only question seems to be whether we let it happen now or in a few years when the pill may be easier to swallow. So, without having studied it in depth, this deal looks great for Americans; less good for S. Koreans. Still, I tend to believe than in normal circumstances any reduction in trade barriers will bring a net gain to society, so I'd like to see this pact pass. But it's another reminder that not all "free trade" is truly free.

My hope? Deals like this will eventually force the U.S. and E.U. to abandon their own agricultural subsidies and open their markets to exports from the developing world. This would be helpful on so many levels: it could provide good jobs and strong industries to the countries that need them the most (esp. in Africa and S. America), it could eliminate a great source of waste and inefficiency in American and Europe, it could further the passage of Doha, and give the West more credibility when it talks about markets and liberty to the rest of the world.

Will that happen? I doubt it. But that's what I'd like to see.

UPDATE: Dr. Oatley posted a short video in October that highlights some of relevant points about the politics of farm subsidies. It is here

The Decline

Consider the never-ending narrative of American decline. My historical knowledge isn't super-deep, but I know for certain that that drum has been kicked at least since Sputnik ('50s), continuing through the Vietnam War ('60s), the closing of the gold window and the oil embargo/stagflation ('70s), the rise of Japan ('80s), European integration ('90s), and now the rise of the BRICs, especially China. During this entire period critics of the U.S. have focused on its sclerotic political system and messy "laissez-faire" capitalism (ha!), which was clearly inferior to the svelte technocratic industrial policies of the USSR OPEC Japan NICs E.U. China. The U.S. is becoming more and more irrelevant, I keep hearing. The quick rebound of China, Brazil, and Germany is proof that the world is decoupling from the U.S. The world is becoming more multipolar, the U.S. needs to learn how to shift into obsolescence and be just another state among states.

And yet when the U.S. announces that it is going to reduce some of the maturity of its sovereign debt in order to boost domestic demand -- an equivalent action to normal monetary policy operations, except on 5-year T-bills rather than shorter maturities, at a time when markets expect deflation (see graph above) -- the world goes ballistic. Huh? If the U.S. was as vulnerable as folks make it out to be, and the rest as powerful and resilient, this shouldn't even register. Instead the Chinese complain about "currency manipulation" as if QE2 wasn't a demand-side domestic monetary policy. Brazil complains about capital inflows creating bubbles, and institutes capital controls to counteract them, as if protecting local capital owners and commodity exporters in one of the most inegalitarian countries on earth had nothing to do with it. Japan enacts its own QE, and South Korea is pushing for, er, something to deal with exchange rates at the upcoming G20 meeting it hosts. The entire industrialized world is concerned that a relatively small program in the U.S. is going to threaten their entire economies.

(Either that or they're using it as cover to justify policies that they wish to enact anyway. I actually think this is more likely, since they can always continue to devalue against the dollar without retribution if they wish, and anything that boosts American demand is good for Chinese, Japanese, Brazilian, and South Korean exporters. But I don't know that for certain; maybe these leaders really are freaked out.)

Of course all of this follows a financial crisis that originated in the U.S. but was not contained within it. Forgive me for thinking that at this point the importance of the U.S. to the global economy almost cannot be overstated. At this point I wouldn't be terribly surprised if the replacement of Bretton Woods II is a variant of Bretton Woods I. The U.S. needs to recognize its place in the world, and act like a hegemon should. There's not chance the G-20 is capable of doing it.

So far I think we've done a reasonably good job -- the trading system has remained intact, warnings of competitive currency depreciations have been all smoke and no fire, countercyclical lending has gotten to states (like Greece) that have needed it, international institutions have held together remarkably well -- but we can do even better. Now is the time to finish the Korea FTA and give fast-track negotiating authority to Obama. Doha isn't going anywhere right now, but in a few years time there could be a window for movement, and it would be good to have the tracks laid ahead of time. Now is the time to let other countries devalue against the dollar if they need to, while still pursuing policies that will boost domestic demand, including demand for imports. Yes that hurt employment in tradable sectors, but mostly in the sort of less-skilled manufacturing that will not yield new jobs anyway. In the meantime, it will boost employment in importing sectors, and provide low-cost goods for struggling households. I wish it were possible to push for immigration reform too, since it's the time for that as well, but I'm pretty sure the sort of immigration reform we'd be likely to see right now isn't the sort I'd support.

Now is emphatically not the time to "get tough" with other countries that also pursue policies in their domestic interest, even if they have some short-run negative consequences for the U.S. There is a lot of low-hanging positive-sum fruit hanging out there. There's no need to take an axe to the trunk.

After all, if the Federal Reserve can't get the U.S. economy moving, the Bank of Japan won't be able to either.

The U.S. should not set policy out of fear of decline.

Politics Everywhere, Even Where It's Supposedly Not Allowed (Reprise)

Variations on a theme, I guess:

All foreign relations have, it seems, now been made subservient to domestic concerns.

That statement was not made (primarily) about the U.S., but rather about China, North Korea, Myanmar, the Philippines, Vietnam, and Taiwan. None of which are paragons of democracy; all of which must maintain tight domestic coalitions to remain in power.

The rest of the op-ed is very interesting, and concerns the U.S. relationship with Southeast and East Asia, Sec. Clinton flexing her muscles, U.S. diplomacy towards South Korea and Indonesia (both of which are of large importance, in my view), and -- if you want to view it that way -- signs of balancing maneuvers to restrict potential regional hegemonies.

Your grain of salt: It was written by Yuriko Koike, an opposition member of the Japanese government, and former Minister of Defense and National Security Advisor. Of course, the current Japanese government is the first in decades to displace the America-friendly Liberal Democratic Party, of which Koike was (presumably) a member. I'm not well-versed enough in Japanese politics to know whether or how much that fact obscures the analysis. Perhaps a reader can enlighten?

Capabilities Cost Money

Steve Sailer looks for ways to trim the costs of empire, and searches for the logic behind American troop deployments:

For example, almost 20 years after the fall of the Berlin Wall, we have 56,200 military personnel based in Germany. Doing what, exactly? Protecting Germany from whom? France? Poland?

We have 33,000 troops in Japan, another expensive country, and 28,000 in South Korea. ...

So, what's the war-fighting reason for deploying only moderately large numbers of troops overseas? It sounds like we have, in the unlikely event of a central European war, not enough troops in Germany to win, but, instead, just enough troops to suffer the worst defeat in American history.

I believe that it was Thomas Schelling who argued that putting 10,000 troops in W. Berlin would be enough of a deterrent to prevent a Soviet invasion of W. Germany. Why? Certainly not because they could actually repel an invasion, but because a "moderately large number of troops" sent a credible signal that we were committed. If the Soviets invaded, we'd have the rest of the US Armed Forces in the theater within a week. Staffing bases with a skeleton crew (or out-sourcing maintenance to the local population, as Sailer suggests) during peacetime signals that we aren't committed, and may invite aggression.

Of course we're not in the Cold War anymore, and a central European war is unlikely, but neither are the military personnel in Germany just defending Germany. The bases there give us capabilities to act in Africa and the Middle East as well as Europe. The 1990s interventions in the Balkans and Africa would have been much more difficult without the German bases, as would the 2000s interventions in the Middle East. Similarly, the bases in Korea and Japan allow us to act all over Asia, while preventing regional arms races and brinksmanship. It's about capabilities and being able to quickly react to unforeseen developments.

Maybe that rationale would not satisfy Sailer -- it doesn't satisfy Harvey Sapolsky -- but that is the rationale. It would be absurd if 60,000 American troops were only in Germany to defend that country. But that's not why they're there.

ASEAN: More Like NAFTA or EU?

The Association of Southeast Asian Nations (ASEAN) met last week in Thailand to continue work on Asian economic integration. They continued lowering tariffs and expanding investment into each other's countries. Meanwhile, China and Japan jockeyed for position as the leading power in Asia.

There are several proposals for a future East Asian free-trade zone — the Japanese version is called the East Asian Community — but all are vague, and leaders say they are a long way from reality.

The proposals are often compared to a European Union-style single market, but analysts say a pan-Asian economic bloc would be unlikely to have open borders, free movement of labor and common security policies.

China did not publicly offer its vision of an East Asian community, but a statement issued after a meeting of what is known as Asean plus three — the leaders of Asean, China, Japan and South Korea — said those 13 countries would form the “main vehicle toward the long-term goal of building an East Asian Community.” That would seem to exclude a role for the United States.

Japan still wants the U.S. to be involved. (Unlike Emmanuel ASEAN isn't my area of expertise, but I have a feeling that China wins this battle for regional influence. That doesn't mean that the U.S./Japan go away completely -- we're too big to ignore -- but it does mean a greater role for Beijing in maintenance of the Asian economy. In my view, this isn't necessarily a bad thing for the U.S.)

I'm not surprised that ASEAN will stay away from labor and security arrangements. These policies have been controversial in Europe, which is much richer, less competitive, and more ideologically similar than SE Asia. Most of these countries still have tons of unemployment, so it would be politically impossible to have open labor markets. And could you imagine Japan and China agreeing on a security arrangement? China and S. Korea? Burma and Singapore? Me either.

So it's unlikely that we'll see E.U.-style integration in Asia any time soon. But that doesn't mean that NAFTA-style trade and investment arrangements wouldn't be beneficial.

Looks Like America's Got A Credibility Problem

The United States, the champion of the free market, "the beacon of unfettered, free market capitalism", has implemented a policy "that the most liberal Democratic administration would [have never implemented] in its wildest dreams," says Ron Chernow, a leading American financial historian in today's NY Times. Interesting observation. But even more interesting is the effect that this bailout policy may have on global perceptions of American free market capitalism and America's ability to dictate a global economic response to a future international financial crisis. 

I was in the process of putting together a post on the American paradox of nationalization and its effect on the global economy, when the NY Times stole the idea from my head and beat me to it by posting an article highlighting this effect on their website. I sat thinking earlier this evening about the financial policies that the United States has currently implemented in its financial market when facing a crisis, while at the same time prescribing to developing nations facing financial panic/crisis, a radically different approach. Essentially, the United States has instructed the developing world to deregulate, privatize their financial markets and not intervene during financial crises, even in the face of financial disaster. For example:

In parts of Asia, the bailouts [yesterday of AIG] stirred bitter memories of the different approach the United States and the International Monetary Fund adopted during the economic crises there a decade ago.

When the I.M.F. pledged $20 billion to help South Korea survive the Asian financial crisis of the late 1990s, one of the conditions it imposed was that the Korean government allow ailing banks and other companies to collapse rather than bail them out, recalled Yung Chul Park, a professor of economics at Korea University in Seoul, who was deeply involved in the negotiations with the I.M.F.

If the United States is not going to follow its own advice of not intervening in its own financial market to bail out failing domestic firms when staring down one of the biggest financial crises in its history, why should/would any other nation follow the non-intervention policy when a similar financial panic occurs in their economy?

Has the United States lost all credibility to prescribe strict free-market, non-interventionist solutions to financial panic around the world? Has it lost its ability to place conditions, including massive privatization and deregulation, on its development loans even though it seemingly nationalizes and regulates when it deems it necessary? It sure looks like it. 

Stranger Than Fiction

A rare nervous moment for Obama:

This week, President Obama hosted South Korean President Lee Myung-Bak at the White House. The meeting was cordial, of course, and the countries vowed their mutual allegiance, of course. But everyone had to tiptoe around the elephant in the room: the Korea-U.S. Free Trade Agreement. ...

The Koreans did their part: The government opened its market to some U.S. beef exports, a politically difficult and highly divisive move that brought over a million protesters into the streets of Seoul and threatened to bring down the Korean cabinet. The United States did... nothing. We left the Koreans standing at the altar. Democrats in Congress, including then-Senator Obama, opposed the agreement. Perhaps the most significant reason given for opposition was that the Korean government meddled too much in its auto sector.

Seriously.

Actually, Korea had agreed to cut its tariffs on autos and to take some measures to address its non-tariff auto trade barriers; however, opponents contended that those measures would not go far enough. This criticism, of course, predated the Obama administration's decision to take over much of the U.S. auto sector and erect its own non-tariff trade barriers.

IPE@UNC covered the proposed U.S./S. Korea free trade deal in a series of posts.

It's really too bad Obama and Myung-Bak tiptoed around the controversy. Yawn. Things would have been different if the meeting had taken place in Seoul rather than Washington. The South Korean parliament deals with such matters much differently:

Oh My

I literally cannot believe this:

One thing I’m hearing, now that all hope of useful fiscal policy is gone, is the idea that trade can be a driver of recovery — that stuff like the South Korea trade agreement can serve as a form of macro policy.

Um, no.

Our macro problem is insufficient spending on U.S.-produced goods and services; this spending is defined by

Y = C + I + G + X – M

where C is consumer spending, I investment spending, G government purchases of goods and services, X is exports, and M is imports. Trade agreements raise X — but they also lead to higher M. On average, they’re a wash. ...

There is a case for freer trade — it may make the world economy more efficient. But it does nothing to increase demand.

That is international economist and Nobel Laureate Paul Krugman, arguing that trade does not matter for GDP or employment, but only for "efficiency". The post is entitled "Trade Does Not Mean Jobs". But trade markets don't operate in a fundamentally different way than other types of markets... does Krugman also believe that those markets have no effect on GDP or employment? Maybe he does, but it's wrong. Efficiency gains from markets leads to an increase in overall production. This is the logic of comparative advantage that Krugman used to defend so powerfully.

Let me break this down. GDP ('Y') can go up through trade in two ways: 1. If 'X' is greater than 'M', so that the economy is producing more than it is consuming; 2. If efficiency gains from trade leave people with more disposable income overall, which they then spend part of on domestically-produced goods ('C').

To see why number 2 is important let's think through a stylized example. Suppose we used to have to buy kim chi from Korea at $10/pound, because we had to pay a 100% tariff on the import. Suppose that tariff goes away through a free trade agreement. We can now buy our kim chi for $5, and have $5 left over to buy haircuts from Americans. The quantity demanded of Korean kim chi and American haircuts will both go up, as will GDP and employment in both countries. That is how gains from trade happen.

That is also why this makes no sense:

And there’s even an argument to the effect that increased trade reduces US employment in the current context; if the jobs we gain are higher value-added per worker, while those we lose are lower value-added, and spending stays the same, that means the same GDP but fewer jobs.

But why should we expect spending to stay the same? If we gain higher-value added jobs, we are also gaining income. If we are gaining income, we will spend more. That means higher GDP and more jobs.

I have Paul Krugman's textbook on international economics. It is very good. It covers standard trade models nicely. Maybe he should read it. Or any of his columns from the 1990s.