Should the U.S. Pursue Closer Ties with India?

Matthew Continetti asks a good question:

Why do Americans spend so much time analyzing China's growth, but not India's? Yes, the growth of Chinese economic and military power since Deng Xiaoping proclaimed "to get rich is glorious" has been nothing short of extraordinary. But India has also embraced markets over the years, and the results have been equally amazing. We tend to think of India in terms of its relations with Pakistan and Afghanistan, and in terms of its cultural power, rather than in terms of the economic and geopolitical benefits of a prosperous South Asian democracy. But that should end. We have a lot to gain by befriending India, and a whole lot to lose.

The Bush administration made it a point to solidify ties with this formerly nonaligned country. It seems like the Obama administration shares the same goal, but unfortunately also sees India as a lower priority than Afghanistan, Iran, reset with Russia, and "strategic reassurance" with China. Of course, an India closely aligned with the United States could help with some of these strategic dilemmas, and hedge against other threats. Why can't Obama spend less time assuaging America's competitors, and more time supporting her friends? A good place to start would be an Indian-American free trade agreement. It's one European idea Obama ought to emulate.

I think he's completely right about this. Christopher Hitchens has also argued this point vehemently a number of times. India is a largely-secular, largely-democratic, largely-open country in South Asia of rising economic and security importance. It would be disastrous if the U.S. were to waste the chance to become strong allies with India.

Still, there are are two reasons why the U.S. hasn't spent as much time on India as it has with China, and both have to do with time constraints. First is the U.S. relationship with Pakistan, whom the U.S. continues to view as a short-term ally of necessity in the fight for Afghanistan. Publicly cozying up to India could jeopardize what little cooperation we've gotten from Islamabad, and would make an already-difficult task much harder. I wouldn't leave the point there, tho. The U.S. has an opportunity to leverage its potential relationship with India to pressure Pakistan to do much more than it has done, and it should consider doing so. If Pakistan doesn't play ball, then the U.S. can turn to India or threaten to, further isolating Pakistan from the rest of Asia. And if the AfPak effort fails, cooperation between Pakistan and the U.S. will likely dry up anyway. In the short run, then, treading water with India makes sense.

Second is the related fact that India isn't going anywhere. Opportunities for building rapport with India will continue to be available over the next decade and beyond. India already has fairly close ties with Europe, and won't turn against the West to join with China, say. The U.S. has some time to try to deal with more pressing short run concerns before turning to a longer-term relationship with India. I'm not sure that the Obama administration is thinking at that level of abstraction, but I do think it's true.

Despite that, a good governor can juggle more than one ball at a time, and Obama should be doing more to strengthen ties with New Delhi. There is no reason why security initiatives with Pakistan should preclude economic ties with India, for example. And the U.S. should not allow itself to be blackmailed by Pakistan in any way, shape, or form. So I do think it's time for a closer relationship with India.

Factor Price Equalization, Part II

This NYTimes article, which features a quote by Barry Eichengreen, focuses on the shift of textile manufacturing from China to places like Bangladesh:

It is the sort of place to which foreign manufacturers may increasingly turn, if the rising wage demands of factory workers in China prompt companies to seek new pools of cheap labor elsewhere.

Already, in factories behind steel gates and tall concrete walls, tens of thousands of workers, most of them women, spend their days stitching T-shirts, pants and sweaters for Wal-Mart, H&M, Zara and other Western retailers and brands.

One of the Bangladeshi companies here, the DBL Group, employs 9,000 people making T-shirts and other knitwear. Business has been so good that the company is finishing a new 10-story building with open floors the size of soccer fields, planted with row after row of sewing machines.

Eichengreen adds on his Twitter that China should be worrying that this trend will continue. Maybe it should, but China is moving up the value-added production ladder very rapidly. It may be willing to lose some textile jobs so long as it is adding semi-durable and technological jobs. Importing consumer non-durables from places Bangladesh could help keep inflation down a bit and help steer investment to more lucrative production. Such as providing inputs to manufacturing in Bangladesh, as the article points out. Yes, China still has hundreds of millions of under-employed, but many of those were never going to work in sweatshops anyway. China should be a bit worried... but not mortified.

In recent posts I noted that a rise in China's exchange rate would not necessarily benefit American import-competing manufacturers, since production would simply shift to other developing countries. Consider this another data point supporting that claim.

Also note that workers in Bangladesh have already gained more bargaining power than they had before the trade came, and that multinational corporations have (at least sometimes) sided with the labor movement. Local corporations, however, have resisted:

In January, H&M, Wal-Mart, Gap, Tesco and other Western clothing buyers asked the Bangladeshi government to raise the minimum wage and reset it every year, although the group did not specify what the wage should be. A spokeswoman for H&M, Malin Bjorne, said the company was willing to pay more for clothing to help support higher wages. It is unclear whether other companies would do the same.

But factory owners here argue that a big increase in wages would make them uncompetitive against Vietnam and other big producers, which have higher labor costs but also have better infrastructure and are more efficient producers. If that happened, Bangladesh’s China opportunity could prove all too fleeting, they say.

“If it’s 5,000 taka, I would close all my factories,” said Anisul Huq, a former head of the Bangladeshi garment industry’s trade group and a factory owner whose customers include H&M and Wal-Mart. “Even if it’s 3,000 taka, lots of factories will close within three or four months.”

Here we see the "California effect" and the "race-to-the-bottom" in play at the same time. Sort of. These countries are practically at the bottom already, so it's not clear how much further they can go. And even though some manufacturing is shifting around looking for the lowest wages, it appears that overall wages and working conditions are going up everywhere MNCs go. Yesterday China, today Bangladesh, tomorrow Vietnam?

Apropos of Not Much

-- European banks are in trouble. Could be the story of 2011, and the Euro isn't safe just yet.

-- Bryan Caplan (a libertarian) makes his best case for conservatism. I wish more would attempt such an exercise, but Caplan's actual argument doesn't seem very... conservative.

-- Germany's trading partners are jealous.

-- A free book on The Future of Finance from the LSE. Some impressive contributors, but I haven't read any of it yet.

-- A free book on microfinance by David Roodman. I've linked to it before, but worth a reminder.

Factor Price Equalization

Somewhat apropos of my last post comes this report on the increased bargaining power of (some) Chinese workers:

In recent months, as the country’s export-driven juggernaut has been revived and many migrants have found jobs closer to home, the balance of power in places like Zhongshan has shifted, forcing employers to compete for new workers — and to prevent seasoned ones from defecting to sweeter prospects.

The shortage has emboldened workers and inspired a spate of strikes in and around Zhongshan that paralyzed Honda’s Chinese operations last month. The unrest then spread to the northern city of Tianjin, where strikers briefly paralyzed production at a Toyota car plant and a Japanese-owned electronics factory.

Although the walkouts were quelled with higher salaries, factory owners and labor experts said that the strikes have driven home a looming reality that had been predicted by demographers: the supply of workers 16 to 24 years old has peaked and will drop by a third in the next 12 years, thanks to stringent family-planning policies that have sharply reduced China’s population growth. ...

The other new reality, perhaps harder to quantify, is this: young Chinese factory workers, raised in a country with rapidly rising expectations, are less willing to toil for long hours for appallingly low wages like dutiful automatons.

I'm always skeptical of this sort of Tom Friedman-esque formulaic reporting, in which one or two (perhaps isolated) incidents are tied to a lazy statistic or two, and out pops a New Rule. So I certainly don't want to push this too far. But new UNC poli-sci professor Xi Chen has done research on contentious politics (e.g. the labor movement) in China, and his conclusion is that despite the popular imagination of Chinese social and economic organization as originating from top-down planning, quite a lot of it actually comes from a bottom-up process. (I believe a book on the topic is forthcoming soon.) A lot of low-level negotiation between employers and employees is certainly consistent with that thesis.

How pervasive is the shift in market power from employers to employees described in the article above? I can't be sure. But I can be fairly sure that it's more common today than it was fifteen years ago. This trend would be unlikely without trade, and should factor into any calculations about whether we should seek to structure trade policy to benefit American over Chinese workers. Would it change any minds if they knew that securing advantages for American workers means consigning Chinese workers to sweatshop conditions?

How Free Is Trade? How Free Should It Be?

Tim Duy says that tariff and non-tariff barriers (like quotas and subsidies) to trade are not the only pressing concern:

When I express concerns over free trade, I am really expressing immense frustration over an international financial architecture that sustains and maintains global imbalances that yield outcomes that I believe are very difficult to justify and yet are accepted due to a blind faith in free trade. In essence, the ability to manipulate capital flows has made a mockery of the free trade crowd. I know. I used to be in that crowd, and in many ways still am. But I can no longer wrap myself in the free trade flag to justify the negative impacts of financial account manipulation. And if the US cannot seriously address financial account manipulation on a global basis - and if the Pettis article is correct, the US Treasury will fall short of what is needed even with the announced adjustment to Chinese currency policy - what choices are you left with? Either accept continued economic stagnation, or act unilaterally on the current transactions (tariffs) or financial (reciprocative devaluation or capital controls) side of the accounts. None of which are pleasant options.

To which Kevin Grier responds:

Here are some points to consider:

1. The current global trading system is very very far away from free. To criticize any current outcome and blame it on free trade is simply incorrect (If you don't believe me, take a look at "Travels of a T-shirt" or "Misadventures of the Most Favored Nations").

2. The dollar doesn't have to adjust for relative prices to adjust. The relevant relative price is the real exchange rate. US exports can become more competitive with a fixed nominal exchange rate simply by US prices rising more slowly than those of their trading partners. Higher productivity growth in the US would produce this effect.

3. Everybody has a comparative advantage. Statements like "America apparently has little left in the comparative advantage department" are non sequiturs.

4. I do agree that financial account manipulation should be discouraged, but it is way too simplistic to say it's good for China and bad for the US. It's good for US consumers, especially low income consumers and it's bad for Chinese consumers, especially higher income consumers.

I agree to some extent with all of this, although I think that Duy's conclusion -- "Financial barriers to trade are a problem, so let's try to fix it by erecting other barriers to trade" -- doesn't get us very far. To me, the interesting questions arise from #s 1 and 4 in Grier's list. The current global trading system is very far away from free, and the patterns of protectionism are not coincidental. They have political causes, which we need to understand before we start advocating retaliation. First, the U.S. is not innocent of trade-distorting practices on the current or capital accounts (Duy acknowledges this), so it will be difficult to mount an international coalition to side with us against the Chinese. (This is a point that Krugman seems to not understand.) Can we really be sure that other states will have our back if we decide to really confront China? Do those countries want a devaluation of the dollar? If we go against China alone are we prepared to take the blowback while the economy is so weak?

Second, the current policy mix benefits some groups in China, Europe, and the U.S. and harms other groups. As Grier says, "it is way too simplistic to say it's good for China and bad for the U.S." Given that the U.S. low- and middle-income consumers benefit, and that consumption represents about 70% of the U.S. economy, why should we think that the U.S. would be better off in aggregate if the RMB spiked? Most Americans would become immediately (if temporarily) poorer, and it is doubtful that non-durable manufacturing jobs would come back to the U.S. anyway. Production would simply shift to Vietnam, or someplace else. The adjustment would take a little while, and involve some pain, but in five years the overall picture would probably look the same. In other words, it is likely that Chinese capital account manipulations hurt their fellow developing countries more than the U.S. Ending this manipulation would hurt low-income Americans (in the short run), hurt low-income Chinese (in the long run), benefit low-income Vietnamese (in the long run), and have little effect on the U.S. trade balance. I don't see how that's a "win".

Third, right now the U.S. needs capital inflows to fund budget deficits and investment. Keynesians complain that fiscal stimulus is "leaky" because of capital account manipulations, but don't acknowledge the corollary which is that deficit spending is also much less expensive for the same reason. In the current climate it is hard to see how such a policy would be economically successful.

Fourth, the status quo persists because it reflects the balance of power within these countries. U.S. trade policy is skewed towards low-income consumers and middle/high-income producers. Chinese trade policy is skewed towards low-income producers and high-income consumers. Does anyone think that's an accident? Does anyone think that a reversal of those dynamics will stand for very long? It would require a shift in interest-group power, and that seems very unlikely.

In the future, capital account distortions should be addressed just as current account distortions are: within the auspices of the WTO. That will be difficult to do for a host of reasons, especially because of the implications for domestic monetary autonomy, but it will be necessary. But I don't think the world is ready for that right now, and I don't think the initiation of a trade war is the right way to go about it.

FinReg

Up till now, I've refrained from commenting on the financial regulation bill that now looks set to become law for two reasons. First, it wasn't clear exactly what would be in the bill. Second, it wasn't clear whether anything would pass. Now that we have pretty clear expectations about both of those things, I'll share a few thoughts.

This bill is not designed to prevent the next financial crisis from occurring. In fact, it would not have prevented the last crisis. This is a very good thing. Too often, regulatory policy is shaped as if by "generals fighting the last war," i.e. regulatory policy is designed to protect against the last event rather than improving the overall ability of the system to withstand disruptions. This approach is self-defeating, since financial crises seldom have the same proximate causes, so this approach will never get it right.

So is this bill good? I think so. To understand why, consider this:

If there's any problem it solves, it's the regulatory confusion and weakness we saw amidst the last financial crisis. That's different than the regulatory confusion and weakness that allowed the last financial crisis to happen, of course.

The bill does that in two ways: The first is providing regulators with a lot more information. By placing derivatives on exchanges and clearinghouses, by creating a systemic risk council, by forcing banks to provide "funeral plans" that explain how to unwind them in the event of a failure, by creating an Office of Financial Research to collect daily data and provide quick analysis on transactions, there's much less chance that a financial crisis would leave regulators totally confused about what's going on, and who owes what to whom.

The second way is by providing regulators with more power to oversee all financially important institutions, rather than just banks, and giving them clear legal authority and a predictable method for executing a failing institution. That's the resolution authority you're always hearing about, and though the number of sign-offs it requires before it can be used (Fed, Treasury, FDIC, and three bankruptcy judges) seems so onerous that it'll make early implementation impossible, once everyone agrees that a firm needs to be brought down, it'll be much easier to do.

In other words, this bill presupposes that financial disruptions will occur in the future and makes preparations for dealing with them. The focus is on increasing transparency, preparedness, and planning for winding down insolvent firms. It doesn't do much on liquidity or capital adequacy requirements, which are the focus of the international negotiations of the Basel Committee. (I'll have more to say on that soon.)

A few weeks ago Tyler Cowen ran through the major provisions and offered commentary. The mantra was "the devil is in the details", and they most certainly are. How much transparency we get and how robust the resolution authority is matters quite a lot, and it is probably impossible to fully know in advance how these things will work. Cowen's conclusion:

The bottom line: the good parts of the bill aren't nearly as good as they should be, and the bad parts became much better with time. The biggest omissions are simple and tougher restrictions on leverage and reform of the mortgage agencies. Overall consider this a victory for the status quo and you should realize that the underlying problems have not been solved.

I'm more optimistic than Cowen. I don't think the "underlying problems" can be solved solved so easily. Trying hard to do so may invoke the Peltzman Effect, which (arguably) played a major role in this crisis. Remember that many derivatives were created to avoid regulation; the resulting opacity was a major contributor to the crisis. Is anyone sure that we can close all loopholes or anticipate all possible weaknesses in the future? If you want a less complicated, more open financial system, then the solution is likely not to create ever-more-complicated regulations that incentivize the exploitation of loopholes. The solution is reduce opacity, strengthen overall stability, and be prepared for adverse scenarios. I think this bill makes some progress on those fronts.

Sometimes Truth Is Stranger Than Fiction

Scott (aka squid314) explains why the History Channel's "World War II" is the least believable show on television, even less believable than Doctor Who and Battlestar Galactica. It's pretty much unexcerptable but isn't very long, so just read the whole thing.

(ht: Robert Farley)

Europe's Mounting Banking Problem

Apologies for the light posting in the last week. Frankly, there hasn't been a whole lot to comment on. But this ominous NYTimes report highlights an increasing worry for the global economic recovery:

The sovereign debt crisis would seem to create worry enough for European banks, but there is another gathering threat that has not garnered as much notice: the trillions of dollars in short-term borrowing that institutions around the world must repay or roll over in the next two years.

The European Central Bank, the Bank of England and the International Monetary Fund have all recently warned of a looming crunch, especially in Europe, where banks have enough trouble raising money as it is.

Their concern is that banks hungry for refinancing will compete with governments — which also must roll over huge sums — for the bond market’s favor. As a result, credit for business and consumers could become more costly and scarce, with unpleasant consequences for economic growth.

This has been a growing concern for some time now, and it frames Europe's economic policies in a different light than those worried about "invisible bond vigilantes" have done. The European policy mix -- sovereign bailouts + slashed government budgets -- has always had an eye on the European banking sector. If sovereigns defaulted on debt owed to banks, then the already-damaged European banking sector would likely collapse without massive government intervention. This would touch off another global financial crisis, perhaps worse than the 2007-2008 panic. By providing funds for governments to pay back their obligations to banks, European governments hope to avoid that scenario. It's a big concern:

Banks worldwide owe nearly $5 trillion to bondholders and other creditors that will come due through 2012, according to estimates by the Bank for International Settlements. About $2.6 trillion of the liabilities are in Europe.

U.S. banks must refinance about $1.3 trillion through 2012. While that sum is nothing to scoff at, analysts seem most concerned about Europe because the banking system there is already weighed down by the sovereign debt crisis.

Banks roll over obligations all the time. In normal times, when there is no credit crunch, this does not represent a problem. But if credit markets seize up again banks will find it very hard to stay afloat. If the crunch is severe enough, it could have very adverse consequences for the global economy. So far there are few signs of that happening, but the next two or three years will be perilous.

In the best case scenario for 2010-2012, as I see it, many banks will have to roll over their obligations at higher interest rates than before. This dampens profits, but does not cause major liquidity or solvency problems. Banks will limit their lending because they will not have access to funds at the same low rates that they had previously, and this will hamper economic growth. Much of Europe will remain mired in recession or low growth for several years, but the extreme adverse event -- another financial crisis -- will be averted.

I think that's the best case scenario. Maybe not. There are a lot of moving pieces here, so it's hard to know how it will play out.

Great Moments in Interviewing History

Deborah Solomon, while interviewing former Secretary of State (and Treasury) George Shultz:

It’s been seven years since we invaded Iraq, and there is so much sorrow in the world.

WTF? Somehow, the 89 year old came up with a wonderful response to that "question":

You ought to come out to California.

Elsewhere, Solomon wonders whether PBS is showing a documentary about Shultz because "they’re trying to appeal to Republicans". Could be. Or it could be that one of the most important government officials of the past half-century is interesting enough in his own right to merit an in-depth look. The rest of the interview is no better, and may even be worse.

At least Solomon didn't put words in Shultz's mouth like she has a habit of doing. Well, she doesn't appear to have done that. This time.

Why is the NY Times printing this?

John Adams on Political Science

I was doing a bit of Fourth-related reading today, and came across John Adams' Thoughts on Government, which I had never read before despite the fact that Adams has always been one of my favorite American patriots. This is from the opening paragraph:

[A]s the divine science of politics is the science of social happiness, and the blessings of society depend entirely on the constitutions of government, which are generally institutions that last for many generations, there can be no employment more agreeable to a benevolent mind than a research after the best.

Right on.

Adams wrote Thoughts on Government in the Spring of 1776, partially (it seems) because people kept asking him what government the United States should create, and he was getting tired of providing the same answer over and over. After referencing Locke and others he writes, "there is no good government but what is republican" because a republic is "an empire of laws, not of men". It's a nice little essay.

Happy Fourth, everybody.