Atomic Bombs and Audiences

LFC points to an article by Ward Wilson suggesting that the Japanese did not surrender in WWII because of the bombs dropped on Hiroshima and Nagasaki, but because the USSR dropped its neutrality with Japan. This argument presumes that the USSR's policy change was independent of the US's decision to drop the bombs, and the US's decision to drop the bombs when it did was independent of any consideration other than motivating Japanese surrender. Given what was going on in Europe (and China) at the time this seems exceptionally unlikely. Stalin had bigger fish to fry than securing marginally better terms of surrender for the Japanese Emperor, and he had agreed at Yalta to declare war on Japan within three months. The US had already conceded half of Europe but was determined to keep the USSR out of Asia. Given the rapidly-expanding US/USSR rivalry and the US's technological advantage it was in Stalin's interest to mollify the US at least until the USSR could also develop atomic weaponry.

I.e., just move the question back a step: why did the USSR pick precisely that moment to revisit their position as a potential intermediary between the US and Japan? There are two candidates. First is the Yalta agreement. Second is the deployment of the atomic bombs. Here the timing of the US dropping the bombs becomes important. The US could have dropped the bomb at any time from July 15th forward. August 8th was the deadline for the Soviets to enter the Pacific theater per the Yalta agreement. Hiroshima was August 6th. The USSR entered on August 8th by invading Manchuria (it was still the 7th in Moscow, but the time difference meant it was the 8th in Tokyo). Nagasaki was August 9th.

There is quite a lot of evidence that Stalin did not recognize the significance of atomic weaponry until it was used, and some good reasons to think that the bombs were in fact dropped primarily for the benefit of Soviet audiences, not Japanese. Stalin believed this anyway. The bombs -- or at least the second one -- were probably dropped to keep the Soviets out of E. Asia. There is no other good explanation for why the first bomb was dropped just before the deadline for Soviet intervention on the terms agreed at Yalta, or for why the second bomb was dropped at all.

From hindsight this makes the use of atomic weapons less justifiable on strategic as well as moral grounds. The Soviets obviously took from this experience that the Americans were quite dangerous and were in fact imperial. The dropping of the bombs hardened Stalin and perhaps made the Cold War more dangerous than it needed to be. This was made clear by the Bolshoi speech in 1946. Whether or not the bombings had any deterrent effect from 1945-1949 (the period before the USSR successfully detonated a bomb) is difficult to discern, but once the Soviets had achieved nuclear parity (or close enough to it) competitive brinksmanship was probably inevitable. It may have been anyway, but the U.S. took the first step by bombing Hiroshima and Nagasaki. Any other possible paths of history were cut off at that moment.

Another example of why we should be wary of Ceteris Paribus Theories of International Relations.

Outside Options

Apropos of my recent article with SBD in The National Interest is this, (via Jonathan Dingell):

UPDATE: There's some good discussion of our article over at the always-excellent International Economic Law and Policy Blog (my go-to source for information on trade disputes and agreements-under-negotiation). (ht: Simon Lester)

US/EU Trade Deal?

The news that the US and EU will begin negotiating a bilateral trade treaty next year is welcome to me. This could be a big deal. For all the talk of China and emerging markets the US and EU are still the most important parts of the global economy:

EU-U.S. commercial links are unrivalled. Transatlantic trade in goods and services is worth $700 billion a year.

Total U.S. annual investment in the European Union is higher than in all of Asia, while EU investment in the United States far outstrips EU investment in India and China combined.

Some, like Jagdish Bhagwati, decry the proliferation of bilateral trade deals, believing that they pull momentum from the WTO and therefore limit the possibilities for widespread trade liberalization. This may or may not be true. What is true is that the Doha round of WTO talks is all but dead, as the politics remains intractable. If there are tangible gains to be found in other forms of liberalization then there is a compelling case to take them. A US/EU deal has the potential to have a big effect. It appears that the focus of the US/EU talks will mostly revolve around regulatory issues:

Businesses on both sides would like an agreement in which a car tested for safety in the United States would not have to be tested again in Europe, and a drug deemed safe by Brussels would not have to be approved as well by the U.S. government.

Small companies who make household appliances, lighting and wiring equipment say prohibitive costs of certifying products for different requirements in Europe and the United States make it impossible currently to export, according to a public consultation by Brussels-based lobby group Business Europe.

These types of restrictions make little sense on welfare grounds, and lifting them will almost surely have a positive effect on efficiency. Also true to form is that lifting agricultural restrictions is off the table:

But both sides appear likely to leave much of the highly sensitive agricultural sector out of the agreement altogether, diplomats say. Washington maintains a 15-year-old ban on EU beef imports imposed because of American concerns about mad-cow disease. The European Union says the ban breaks World Trade Organisation rules.

The United States, in turn, faces prohibitively high tariffs for its beef and pork products, running into Europe's complex definitions of high-quality meat.

Genetically engineered foods are also contentious, with the United States in favor of developing the industry but with the European Union against. "They will not be part of the deal," said one EU diplomat in Brussels.

It's worth remembering that the GATT -- the precursor to the WTO -- only had 23 members at first. These members were predominately the later EU members (and the remnants of their empires) and the US*. The WTO now has 157 members, with a wide range of conflicting interests, plus a rule of unanimity. That makes it very difficult to get a comprehensive deal passed.

So in a sense a bilateral US/EU deal is a step backwards. It could also be a precursor to future action. If the US/EU successfully pass a bilateral deal it might provide an impetus for their antagonists in the WTO to make further concessions to get a multilateral deal through the WTO process rather than be locked out of trade arrangements. This deal is the US/EU exercising its outside option. Having good ones increases bargaining leverage. So Bhagwati could actually be wrong: bilateral trade deals could actually be a force for completion of WTO rounds.

This is less than certain of course, and perhaps this US/EU deal will either fall apart or be less than transformative. But it's at least a possibility that the conventional wisdom is wrong.

*The full list is Australia, Belgium, Brazil, Burma, Canada, Ceylon, Chile, China, Cuba, Czechoslovakia, France, India, Lebanon, Luxembourg, Netherlands, New Zealand, Norway, Pakistan, Southern Rhodesia, Syria, South Africa, United Kingdom and the United States.

Brinksmanship and Grexit

Henry Farrell re-ups his view of the eurozone as being a game of brinksmanship between Germany and Greece. I objected to this characterization back in February, and I still don't think it's the best. Take this:

If there weren’t any possible resolution, there wouldn’t be any incentive to engage in crisis bargaining. What we’re seeing suggests that the players on both sides think that there is a real chance of catastrophe, but also a real chance of a deal.

Whether or not there is a possible resolution is most likely private information. (Or, more accurately, neither side knows the truth.) Let's look at this from Germany's perspective. Who are they negotiating with? For all intents and purposes Greece does not have a government that is capable of negotiating. Any future Greek government also has an inability to make a credible commitment to uphold any negotiated settlement in the future, which is why Germany had previously asked for all political parties in Greece -- whether in the government or not -- to approve of the previous bailout program. It is not clear right now who "Greece" is, much less what it is willing to accept.

Nor is it necessarily clear (to me) that Germany believes that there is a real chance of catastrophe for them if Greece exits. Perhaps there is, but it's probably not an economic catastrophe. At this point it might be cheaper to shore up the banks than to keep funding Greece indefinitely. Remember that Greece's creditors have already taken very large haircuts. Remember that European banks have had years to prepare for this, and European regulators have (presumably) been forcing them to do so. Euro governments, the ECB, and the EFSF would lose something on the order of €200bn from a full Greek default, of which €75bn would come from Germany. This is not nothing -- about 3% of Germany's GDP -- but it isn't enough to sink Germany either.

More likely Germany is worried about the political ramifications of a break-up of the eurozone, but in that case they should be interested in ensuring that they are not blamed when that happens. This implies that they will engage in negotiations right up until the end, and perhaps even after it, to demonstrate that they made a good faith effort to keep the monetary union intact even if they believe that there is no possible resolution that actually keeps the monetary union intact.

Farrell:

At a guess, Greece has considerably more bargaining leverage than it might seem to at first. One useful index of bargaining strength is relative levels of sensitivity to breakdown/catastrophe/failure to reach a deal. It’s plausible that Greece is relatively indifferent to breakdown at this point – years of grinding austerity inside EMU seem barely preferable to the costs of exiting the euro. In contrast, Germany could see the collapse of the euro (and consequent very serious economic costs) if a Greek exit leads to the collapse of confidence in Spanish, Irish, and worst of all, Italian banks. If I were to lay a bet on which side is likely to fold first, I’d be putting my money on the Germans.

Again, it's not clear who "Greece" is or what their bargaining position is. As Daniel Davies says in comments on Farrell's post, there is no reason to think that Greece is indifferent between staying in or getting out. Something like 80% of Greeks say that they want to stay in. Even Tsipras has stated no intention to exit. The best case scenario of leaving -- probably Argentina -- is not very good, and I wouldn't be optimistic about the best case scenario obtaining in this case. So how much leverage does that really give Greek leadership? If their citizens want to stay in, and the costs of leaving are extreme, then Germany can demand quite a lot.

Nor is it clear that a Greek exit would lead to a collapse in Spain, much less Italy, or that such a thing could be avoided even if Greece stays in. The fundamentals are crap either way. It's not clear that a collapse in these countries would be devastating for Germany. They've maintained economic growth thus far, and capital flight from the GIPSIs would likely move into Germany, giving them further fiscal flexibility to deal with their banks and macroeconomy.

Right now the political dynamic in Europe is about who gets the blame for a Greek exit. If blame cannot be assigned in a politically satisfying way then they will continue to muddle through. However the greater the costs associated with keeping Greece in, the more likely the blame will shift away from Germany and the more likely that Germany will refuse to pay on any terms that are acceptable to Greek leaders.

Edward Hugh writes of the choices:

Right now there are two, and only two, options on the table: help Greece with an orderly exit from the Euro (and crystallise the losses in Berlin, Washington, etc), or print money at the ECB to send a monthly paycheck to all those Greek unemployed. This latter suggestion may seem ridiculous (then go for the former), but so is talk of printing to fuel inflation in Germany (go tell that old wives tale to the marines). If Greece isn’t allowed to devalue, then some device must be found to subsidise Greek labour costs and encourage inbound investment – and remember, given the reputational damage inflicted on the country this is going to be hard, very hard, work.

The second of those is not palatable. It would wreck what remains of the political integrity of the Euro project, which has already been corrupted by the less-than-democratic approach to the bailout. Political integrity is not about keeping Greece in on whatever terms... moral hazard is a real risk and the original institutions designed to combat moral hazard (eg Stability and Growth Pact) have been obliterated as has the independence of the ECB. In other words, it's not clear what political integrity Germany would really be fighting for. The entire EU social contract has to be re-written anyway, at least implicitly.

Given that, Germany may wish to re-write it on more stable terms.

There is a very real chance that over a medium term time horizon Germany would be better off with Greece out of the eurozone. If that's the case then this isn't a brinksmanship game.

Brinksmanship in Political Economy

Henry Farrell has written a very useful post describing the eurozone crisis in terms of Schelling's conception of brinksmanship as a negotiating ploy. I am in broad agreement with everything he says about the theory of strategic interaction itself, and in particular this part:

There is a fundamental internal contradiction in Kirkegaard’s argument. You can’t simultaneously claim that we are in that happy world where we can effectively disregard the possibility of disaster, and tell us that actors are using brinkmanship to convince Greece that it needs to undertake internal reforms. Either we are in a world where there is a real risk of disaster, which is what allows Germany and northern European states to engage in brinkmanship. Or we are in a world without such a risk, in which case there is no space for brinkmanship. You can’t have your theoretical cake and eat it too.

I'm a big fan of incorporating concepts generally applied to "high politics" -- guns and bombs -- to IPE, and it is easy to conclude that the tactic of brinksmanship may have its uses in situations like these. While I agree with Farrell's take on the theory itself, I'm not sure how well it applies to this particular situation for the reason he lays out: either there is a "real risk of disaster" or there isn't. I don't think there is.

In brinksmanship situations the risk of disaster must be mutual. To stick with Schelling's example -- two men, chained together, dancing ever closer to the edge of a cliff -- the risk must be that both parties will tumble over into oblivion. In a nuclear exchange between the U.S. and U.S.S.R. that was a very real risk; in the E.U. debt negotiations I am not sure that it is. The risk is that Greece tumbles over the cliff, while the rest of Europe watches them fall from above. That is not to say that Greece's collapse would have no adverse consequences for the rest of Europe, but there is nothing close to symmetry: Greece needs Europe much more than Europe needs Greece. If this were not the case, the terms of the proposed bailout -- which, in addition to another round of exceptionally austerity, now includes the virtual abolishment of the democratic process in Greece -- would be nothing like they are.

Throughout this process Greece has had two big plays: default -- which would hurt European creditors, including many banks in northern Europe -- and exit from the eurozone -- which would damage the credibility of the European political project. Both have become less worrisome to northern Europe over time. In the first case, the cost of bailing out Greece now exceeds the cost of bailing out the banks, particular if the ECB continues to make funds available to major European financial institutions. Moreover, European banks have known for a long while now that some form of default was coming, and have (I hope and expect) already made preparations for it. This doesn't mean that a Greek default would be painless, but given the enormous sums of money already committed to Greece and the €200bn now being proposed, shoring up the banks would almost surely require less of a fiscal commitment from other European countries. Moreover, it is more likely that that money will be recouped in full from the banks than from Greece, whose politics are unstable. If done correctly a European "TARP" could even end up breaking even or turning a small profit, as it has in the U.S.

Which brings me to the second potential worry. The exit of Greece from the eurozone would not harm the real economy very much -- Greece's GDP contributes only 2% to the eurozone total -- but could potentially damage the progress of the political union. This is a real concern, but the alternative now appears to be the abolishment of the democratic process in Greece altogether. European leaders are now negotiating with an unelected Greek government, and as a precondition for the release of funds are demanding adherence to the bailout terms from all political parties in the country. Previously they had asked for approval of future Greek budgets. This usurpation of Greek sovereignty, and the derogation of the democratic process within that country, should be as much of an affront to the European political process as the exit of one its least consequential members -- which cooked the books to join the union in the first place and may have never been in compliance with its obligations. Anyway, if a major worry in Europe is the dominance of Germany on the continent, then giving them and their friends such authority over the politics of a member state is not likely to be reassuring.

Another concern has often been expressed: that a Greek default will lead to "contagion". This fear rests on a misunderstanding of what contagion is. If a Greek default led to insolvencies in the banking sectors of other European countries, which then led to the inability of those banks to repay their counterparties in other countries, then this would constitute contagion and might be a real worry. But given the fact that European banks have been preparing for this possibility, given that European governments have already earmarked hundreds of billions of euros for bailout funds, given that the European central bank is finally (sort of) acting like an actual central bank, this should be less of a concern than at any point in the past few years.

The fear that a Greek default will have a negative effect on Portugese bond rates, say, is not about contagion. If investors observe new developments in the European political economy and revise their attitudes towards the riskiness of bonds, that is not contagion. It's simply a rational response to changed circumstances. The European authorities can deal with this in a number of ways, but the most important thing is that no country in Europe is in as desperate of a situation as Greece, or has a real economy in as poor of shape as Greece.

European leaders may believe that Greece -- which now (astoundingly) has a primary budget surplus -- is still capable of generating growth sufficient enough to repay their creditors and remain in the eurozone. If that's the case, then harsh terms on bailout funds are counter-productive. Yet what we observe are the harshest conditions demanded to this point in the process. Given all of the above, it is almost impossible to come to any other conclusion than that European leaders are trying to force Greece out in a way that they can then claim that it was Greece's choice, not theirs.

That is not brinksmanship. That is something else entirely.

UPDATE: See Daniel Davies's "Choose your own adventure" view of the situation, which maps out the difficulties and options nicely and thoroughly.

The Politics of Hard Keynesianism in the E.U., Part Two

I posted yesterday on how I see the short-run political dynamics of the EU political economy, and why specifically why a holding pattern until 2013 makes some sense for EU leaders. At some point the EU will likely need to decide whether to contract membership or expand its political reach, but that decision doesn't have to be made immediately, and won't be due to local political pressures in member states.

This was all in response to an article by Henry Farrell and John Quiggin in Foreign Affairs that proposed a "Hard Keynesian" legal-institutional overhaul to the eurozone Stability and Growth Pact, that forces a build-up of surpluses during expansions so that states have necessary fiscal flexibility during downturns. That, in turn, should prevent the huge debt pressures that now threaten the integrity of the monetary union. (Note: As usual at Crooked Timber, the comments are well worth reading. Daniel Davies corrects some misconceptions I had about the Irish banking sector, and others responded with some points about the Irish economy that I'm drawing from here.)

What I didn't get around to yesterday was discussing the political feasibility of the Farrell/Quiggin proposal itself. It's certainly an attractive technocratic solution, at least in some ways, but that doesn't necessarily mean that the necessary commitment from member states is credible, which means that a first-best technocratic solution may not be feasible. The Stability and Growth Pact, which intended to serve much the same purpose, certainly wasn't. Farrell and Quiggin admit that monitoring and enforcement capabilities will be necessary, but they're light on specifics. But before getting into the necessary institutional design, I think it's worth asking what is meant by Hard Keynesianism.

As I understand it, Hard Keynesianism (aka "Keynesianism") argues that states should build up "rainy day funds" that can be drawn down when economies are stressed. Essentially, this requires a counter-cyclical fiscal policy to match a counter-cyclical monetary policy. This is similar to the budget requirements of U.S. states, many of which have constitutional mandates to maintain balanced budgets. Since maintaining a balanced budget is very painful during recessions, states often try to build surpluses during expansions. For national governments, this will often mean paying down debt during expansions, and expanding debt during recessions.

The graphic at the top of this post shows the Irish debt-to-GDP ratio, as reported by Ireland's National Treasury. From 1993-2007, Ireland slashed its debt as a percentage of GDP by 70 percentage points. From 1999, when Ireland joined the euro, to 2007 Ireland's debt-to-GDP ratio nearly halved. That's a huge reduction in a short period of time, and any EU "Hard Keynesian" rule would surely consider a debt-to-GDP ratio of 25% to be acceptable. (And if it didn't, of the EU27 only Bulgaria, Estonia, and Luxembourg would be in compliance as of the most recent EU data.) Moreover, this report (linked to by Quiggin in comments at CT) indicates that as of 2007, Ireland ran government surpluses in 10 of the previous 11 years. Quiggin argues that this Keynesianism isn't hard enough, but then what would be? Until the bust, Ireland was the shining example of fiscal rectitude in the EU. How could Ireland's leaders have persuaded voters in 2005 that following all that debt reduction, what was really needed for economic health was to raise taxes and cut spending? Especially considering that much of Ireland's debt reduction came from high growth rates, which were attributed at the time to supply-side factors, not Keynesian counter-cyclical policies.

Also in comments at CT, Farrell linked to this discussion of former Irish Finance Minister Charlie McGreevey's famous maxim: "When I have it I spend it, and when I don't, I don't". The conclusion of the article is that this "negligence" and "madness" was embedded into the culture of Ireland during the Celtic Tiger days:

In the space of a generation the Irish had gone from a people that saved before they bought, questioned any extravagance, and were wary of debt, to a nation only too happy to blow their paycheque on nights out, put the bills on the credit card, and become sodden in debt to buy their dream home and all the trimmings in one go. For a long time the Irish had been a people who simply didn’t have it to spend. Now that we had it, by god we were going to spend it.

The author, Cian O’Callaghan, attributes this shift in mentality to some sort of neoliberal voodoo, but I imagine the Irish citizens didn't need a lot of persuading. After all, other countries went through the same thing. The U.S. shifted from decades of budget deficits to a brief moment of surplus after following a classic counter-cyclical Keynesian policy in the 1990s. It raised taxes on the rich, cut some welfare programs and defense spending, and didn't reinvest the tax proceeds that came from robust growth. It was the height of center-left technocratic management, in the U.S. at least, and it wasn't very popular. Those that were created those policies were first impeached, and then voted out of office in 2000, in favor of the candidate who promised to blow through that surplus by cutting taxes. Arguably this was the proper Keynesian choice too, considering the US was in recession, but the move back to balance (much less surplus) never happened.

I don't think this has much to do with neoliberalism per se. To the contrary, neoliberals have generally been perjoratively accused of forcing balanced budgets (or at least reduced deficits) on others, through the IMF or otherwise. I think it has more to do with the fact that the politics of surpluses is very bad for the technocrats. There is no constituency built around "surpluses in good times". There are plenty of constituencies built around "lower taxes" or "more generous pensions" or "smaller class sizes" or "more funding for alternative energies" or "more aid to the developing world" or ______________.

Viewed in a certain way, we can think of the maintenance of a budget as a common pool resource: we'd be collectively better off in the long run if everyone could commit to maintaining balance (or surplus) in good times as insurance, but we're all individually better off in the short run by defecting. In democracies, the incentives for legislators will always be to appease their constituents via tax cuts or spending increases. So this could be viewed as a collective action problem of sorts*.

Of course it's possible that a major crisis could shake that political equilibrium long enough to erect legal and institutional reforms that lock in the technocratic solution. Perhaps the debt crisis is such an event. If ever there was one this would probably be it. The Germans want to ensure they won't always be on the hook for bailouts in the periphery. The indebted in the periphery need funds to such a great extent that they may accept significant restraints on their future sovereignty in exchange. It's not clear that the Germans want such a Hard Keynesian rule, much less that they'd have much leverage over the EMU17 legislatures that *aren't* in need of bailout, but let's just pretend that interests are sufficiently aligned for this to happen.

Obviously such a rule needs an enforcement mechanism that doesn't require collective action, or else we're right back where we started. This was the problem with the Stability and Growth Pact. But what sort of mechanism would that be? The power to sanction? To levy tariffs? Fines? The best bet would seemingly be the withholding of Structural/Cohesion funds, but those apply to the whole EU27, not just the EMU17. And why would the legislators in periphery states not receiving EFSF funds agree to this? That could have worked

There is one final issue I wanted to cover, and that is that this particular crisis was so severe that no prior Hard Keynesian arrangement could possibly have contained it, so any technocratic mechanism runs the risk of being anachronistic: observed when it's not needed, and neglected when it is. But this is already too long, so I'll have to save that for another day.

*I tend to not like this sort of framing of distributional issues, but I'm trying to present a technocratic objection to a situation that was mostly presented as a technocratic problem.

Private Information

The Daily Show - Define and Conquer
Tags: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

Suppose the U.S. wanted Gaddafi to step down. Does the U.S.'s inability to characterize its intentions towards, and commitment to, Libya make that more or less likely?

Just asking.

Some Politics of Debt, Default, and the EMU

Tyler Cowen notes that Irish (and Portuguese and I'd add Spanish) are not yet out of the clear, and writes:

The first country which can, with no shame, credibly threaten to leave the eurozone or outright default can blackmail Brussels and Berlin into further aid, due to fear of contagion effects. Some are arguing that Portugal is already assuming that strategic stance.

Let's try to tease this out a little bit. One of the first rules of bargaining theory is that the side with the best outside options has quite a lot of negotiating leverage. Eric Voeten has looked at this dynamic in the context of international institutions, where there is an asymmetric power distribution among the members. Specifically, he looked at the UNSC and found that the presence of strong outside options makes multilateral agreements more likely, so long as there is some incentive not to exercise them. But, and this is key, Voeten argues that "the first condition for multilateral action is the [most powerful state] be willing to act alone or with close allies" (p. 856). In other words, thinking only about how the PIGS have leverage over Berlin is probably not the best way to go about it.

Which most needs a Euro that includes Ireland, Greece, and Portugal: those countries, or Germany? Well, departure from the Euro (and ensuing debt restructuring/default) will massively impair those countries' abilities to engage international credit markets for a long while to come. Michael Tomz has written about the reputational effects of debt defaults, and it's not pretty. Defaults not only adversely affect countries access to foreign credit in the short-run, thus making austerity inevitable, but these effects persist. In other words, possible EMU defaulters have two choices: austerity with devaluation (which reduces real wealth but boosts competitiveness) but no external finance, or austerity without devaluation but with external finance (in the form of ECB/EFSF plus continued access to bond markets in at least some form). The question is which benefit is greater: access to foreign finance that can help smooth out the pain from austerity, or the shock treatment of devaluation. So far the answer appears to be the former.

What about Germany? Now that it's in a currency union it's better to keep it. The EMU is very good for German exporters. If the union splits, and peripheral European economies devalue, Germany's exports become much more expensive for those economies. Additionally, if some of the weaker members left the Euro the currency's value would likely increase against other international currencies. That, too, would bad for German exports. So Germany has incentives for keeping the EMU intact, and thus fulfills one of Voeten's criteria. On the other hand, Germany would do fine under a narrower Eurozone. The value of EMU membership that accrues to Germany is significant, but limited. There is a price tag that is simply too high for it to pay. That should give Germany quite a lot of leverage in Voeten's framework.

This is where Cowen's mention of contagion could come in. I'm not sure what he means by that; it could be Asia1997-style currency contagion across the PIGS, or it could be the fact that German (and French) banks are heavily exposed to PIGS' debt, so a sovereign default could have large knock-on effects for the financial systems at the core of the Eurozone. From Germany's perspective, the latter is much more salient. It increases the costs associated with a break-up in the EMU, and thus provides incentives to keep the union intact. But these costs, too, are not infinite. At some point it might be easier to bail out the financial sector than to bail out Europe's periphery, especially if domestic polities in the PIGs revolt against austerity or demand better terms from the EFSF.

So Cowen's right: the PIGS have some blackmail room, but only until the German and French banking sectors recapitalize. Meanwhile, Berlin has the nuclear option. If it comes to blows, Germany will end up in far better shape than the PIGS. So given what we know about the ways that powerful states use international institutions to help them achieve their goals, the most likely outcome seems to be either that the PIGS pay up, or that there is an intermediate period where the ECB/EFSF provides some funding to the periphery basically as a stalling tactic, buying time for the banks, and then pulls out the rug. The former seems to describe Ireland, the latter may end up being the story of Greece and Portugal.

IPE Everywhere: The Original Tea Party

It was less about principle than we often believe:

Indeed, for consumers, anger over the tea tax had never made much economic sense. For one thing, many drank Dutch-supplied tea, which was smuggled and therefore tax-free. Benjamin Woods Labaree, the most attentive scholar of the Colonial tea trade, estimates that three-quarters of the 1.2 million pounds of tea that Americans consumed each year was smuggled. Meanwhile, the tax on legal tea was largely offset by a tea-tax refund passed the same year. But in 1772 that tax refund shrank, making British tea more expensive and enhancing smugglers’ price advantage. Tea piled up in the British warehouses of the East India Company, which owed money to the British government and also needed to ask it for a loan. Someone had an idea: why not raise cash by dumping the company’s surplus tea on the American market? Parliament agreed to help by restoring the old refund in full and by allowing the company to export tea directly rather than through merchant middlemen. With the new measures, the price of legal tea was expected to halve. Consumers would save, Parliament needn’t lose quite so much on its bailout of the East India Company, and smugglers would be driven out of business.

Boston’s big businessmen felt threatened. Not only might smuggling cease to be profitable but, if the experiment of direct importation were to succeed, it might cut them out of the supply chains for other commodities as well.

The whole article is about how prominent businessmen -- who were often smugglers as well -- riled up the public to support their (the businessmen's) economic interests. Highly recommended.

Via Blattman

Rum Diaries

Here's an interesting article on how an obscure provision in the U.S. tax code has caused two U.S. territories to go to the mattresses:

Now the spirit once called Kill-Devil has set off a bitter dispute between two United States islands, Puerto Rico and the Virgin Islands, over a tax that the federal treasury collects on rum.

The fight began when the Virgin Islands persuaded the world’s largest distiller, which said it was leaving Puerto Rico, to move to St. Croix by offering a staggering $2.7 billion in tax incentives. The new distillery, for Captain Morgan spiced rum, will provide no more than 70 permanent jobs on the south shore of St. Croix — but it will entitle the Virgin Islands to collect billions in rum tax revenue from Washington.

That bounty comes at the expense of Puerto Rico, where 90 percent of the revenue from the rum tax had been used for public projects and social services rather than corporate incentives. The Virgin Islands has promised to give nearly half its tax revenue back to the distiller, the British company Diageo, prompting a series of charges and countercharges between neighbors roughly 50 miles apart in the Caribbean. ...

The billions of dollars at stake are the result of a quirk in the tax code that was intended to aid the islands while preventing their offshore distilleries from gaining an unfair advantage over competitors in the states.

Because rum producers in the islands are exempt from federal excise taxes, the government imposed an “equalization tax” on Puerto Rican rum producers in 1917 and gave the money to the commonwealth. In 1954, the United States extended the arrangement to the Virgin Islands.

Now the islands are competing to lure producers with tax incentives. Many are complaining that the tax revenue should go to the people, not the corporations, but if the corporations leave there's no revenue for the people at all. So the islands compete against each other, some of the revenue gets redistributed from Puerto Rican citizens to the corporation, and some other revenue gets redistributed from Puerto Rican citizens to Virgin Islands citizens. Bad for Puerto Ricans, but great for Virgin Islanders.

Of course, absent the equalization tax the corporation would have moved out of the U.S. jurisdiction entirely, likely to Guatemala or Honduras, and both U.S. territories would lose. In any case, tax incentives matter, and they can be very distorting.

Economics of the Somali Pirate Business Model

This semester, I'm teaching four recitation sections of POLI 150: Intro to International Relations here at UNC (which is being taught by Dr. Oatley with Sarah and Will as fellow TA's). In each recitation I always like to spend the first five to ten minutes of class talking about current news and events in international politics and try to connect the theories and frameworks that we are teaching our students to the real world so they see that what they're learning actually does have value and provides explanatory power over topics outside of the classroom.

For my Wednesday afternoon recitation, after whatever pressing new events (this week it was the coup in Niger, the Winter Olympics, Greek sovereign default, and the Dalai Lama meeting) that they bring up have been explored, somehow the conversation always turns to pirates, how Somali piracy works, how and why countries respond to pirate attacks, etc. It's a great topic to discuss anarchy, collective action problems, bargaining, state vs. non-state actors and informal networks and markets. It seems like my obsession with pirates is starting to rub off on my students as each week they're bringing up new interesting questions and finding really awesome articles like the one I'm linking to below.

I was going to go into detail about this article, but instead I'm just going to completely outsource this post to Wired Magazine who provide an absolutely fantastic analysis of the incentives, costs and benefits facing not only Somali pirates but "shippers, insurers, private security contractors and numerous national navies" operating off the coast of Somalia. This is just an absolute must-read. Here is the opening:

The rough fishermen of the so-called Somali coast guard are unrepentant criminals, yes, but they're more than that. They're innovators. Where earlier sea bandits were satisfied to make off with a dinghy full of booty, pirates who prowl northeast Africa's Gulf of Aden hold captured ships for ransom. This strategy has been fabulously successful: The typical payoff today is 100 times what it was in 2005, and the number of attacks has skyrocketed.

Like any business, Somali piracy can be explained in purely economic terms. It flourishes by exploiting the incentives that drive international maritime trade. The other parties involved — shippers, insurers, private security contractors, and numerous national navies — stand to gain more (or at least lose less) by tolerating it than by putting up a serious fight. As for the pirates, their escalating demands are a method of price discovery, a way of gauging how much the market will bear.
The risk-and-reward calculations for the various players arise at key points of tension: at the outset of a shipment, when a vessel comes under attack, during ransom negotiations, and when a deal is struck. As long as national navies don't roll in with guns blazing, the region's peculiar economics ensure that most everyone gets a cut.

All of which makes daring rescues, like the liberation in April of the Maersk Alabama's captain, the exception rather than the rule. Such derring-do may become more frequent as public pressure builds to deep-six the brigands. However, the story of the Stolt Valor, captured on September 15, 2008, is more typical. Here's how it played out, along with the cold, hard numbers that have put the Somali pirate business model at the center of a growth industry.

Some very interesting tidbits:

An ordinary Somali earns about $600 a year, but even the lowliest freebooter can make nearly 17 times that — $10,000 — in a single hijacking. Never mind the risk; it's less dangerous than living in war-torn Mogadishu.

The insurance business is a gamble. Insurers know that some ships will be hijacked, forcing the companies to dispense multimillion-dollar settlements. However, they know the chance of this happening is minuscule, which by the calculations of their industry makes it worth issuing policies. In 2008, only 0.2 percent of ships sailing Somali waters were successfully hijacked.

(The hat tip goes to Paula, one of my students in class who found and emailed me the article).