Trade wars as a proxy for great power struggles?

The WTO can’t get no love. People criticize it for being slow, ineffectual, not comprehensive enough, too comprehensive, irrelevant, etc. Most of these arguments are as old as the GATT. If you have 3 hours, I’m happy to sit down over a few beers and hash them out again.

But every once and a while, you read something completely new. Enter Daniel Abebe. The University of Chicago Law School Faculty Blog is hosting a roundtable discussion on the future of the WTO this week, and Mr. Abebe contributes this fascinating thought experiment:

What does international relations theory tell us about these questions? ...With the end of the Cold War, the relative importance of realist concepts of security, survival and military power began to decline; the great powers all had nuclear arsenals, democracy was increasingly the preferred from of governance and globalization brought states together. Around the same time, the WTO came into existence and international trade, not naked security competition, became the prominent issue for some states in international politics... we should see great power competition to be increasingly focused on trade issues and, given the tentative claims here, we should see increasing gridlock in the WTO... the implication is that the WTO will be a venue for great power competition and struggle to generate compromises on trade issues and that changing the institutional rules is unlikely to address the underlying structural problem or variation in internal characteristics among the great powers.

I have a lot of problems with this analysis. Above all, it’s very hard to take a realist power framework and try to apply it to trade relations. Unlike traditional power struggles, trade is a positive sum game that’s underpinned by a robust international legal framework. Further, all of the major powers are still firmly committed to an open trading system and understand that constant sniping at each other will produce a worse outcome than cooperation.

I’m not suggesting that there’s no tension in global trade relationships. There’s a lot, and there have been some contentious, economically significant cases so far. But such tension is rooted much less in state-state power struggles than domestic political considerations. (Trade is a political economy issue, remember?) Countries generally bring cases in the WTO because they get complaints from domestic constituents.

Further, a brief look at the WTO’s dispute settlement understanding would suggest that the multilateral trading system makes for a pretty lousy venue for great power struggles. The Appellate Body can take years to deliver a ruling, which can then be appealed, thereby further dragging out the process. And if you’re economically powerful enough, you can ignore the AB’s rulings anyways: this has happened a number of times in post-Uruguay Round dispute settlement, and it would very likely be the case if the number of contentious cases increased. However, if all the major countries started ignoring most of the AB’s decisions, it would probably lose its credibility quickly. In short, concerted great power struggles would destroy the WTO.

Indeed, if the current crisis has shown us anything, it’s that the WTO is still remarkably fragile. The progressive rounds of trade liberalization over the past 60 years have been hard-won. The international community would do well to preserve and expand them. There's a lot of work to be done: tellingly, most of the new (post G-20 summit) protectionist measures don’t even violate obligations as they currently stand.

I think we’re a long way from trade wars supplanting real wars.

(photo from nomad photography’s photostream)

Tin miners and tourists?

Gabon, a small previously oil-rich country in Central Africa, needs some income. Having flittered away it's oil money on bureaucratic diners, the country is attempting to revamp itself as a holiday spot.

But with lacking infrastructure and inhospitable neighbors, Gabon is not a prime tourist destination and finds itself needing some quick cash to buoy the economy. 

Instead it's finding its forests overrun with Chinese prospectors instead of tourists. Chinese strategic interest in African resources is nothing new, but Gabon was once a reason for hope in Africa's dismal resource management record. 

History repeats itself.

(Photo via bear_in_va)

The paradox that is South Africa

The past week has laid bare the stark contrasts between South Africa's ambition and reality, progress and failures.

On February 21, tickets went on sale for the 2010 World Cup. ZA is the first African country to host the tournament. Its winning bid came to symbolize not just the country's post-apartheid progress, but a sense that the entire continent's development was turning a corner as well. While ZA is still racing to complete the massive infrastructure projects associated with the event, the dream many doubted would ever be realized seems all but assured. The importance of this event to a football-mad continent should not be underestimated.

If only the country's economic outlook was so hopeful. South Africa's post-apartheid economic progress is evident. But it's only part of the story. While the emergence of a growing black middle class has been one of its greatest measures of progress, it thinly veils a broader failure to bring economic empowerment to the millions of residents of townships from Soweto to Langa. The percentage of South Africans living with HIV has been estimated at 20%; in fact, life expectancy has fallen by 10 years since the end of apartheid. Crime is truly epidemic. Oh yeah, and there are the tricky issues of Jacob Zuma, the ANC civil war and rising political violence.

One would expect these persistent problems to only worsen now that the economy appears to be falling of a cliff. The government reported today that the economy contracted in Q4 2008, ending the country's longest economic expansion on record. Thousands of jobs are being shed by foreign mining firms. Manufacturing output has slumped to a 40-year low. Even gold production, in which South Africa was the world's leader until 2007, plummeted to its lowest level in 86 years. This is troubling for a sector that accounts for 2.5% of GDP.

I know- quite the pessimistic outlook for a country that has been hailed as a model for post-conflict reconciliation and economic development. But South Africa faces a difficult year, all the while preparing for a remarkable one in 2010. Like other emerging market stars, South Africa represents a bright future. But there are dark days ahead.

Stanford's Cardinal Sin

The ongoing collapse of the Stanford financial services empire is global news, but just the latest in a series of high-profile fiascoes in the Latin American banking sector. The Caribbean island of Antigua hosted the headquarters of Stanford, which had operations across Latin America: in Colombia (suspended), Peru (suspended) Ecuador (seized), Panama (taken over), Mexico (investigated), Venezuela (seized), and Miami (raided). Venezuela was hardest hit, with an estimated $2.5 billion invested in Stanford banks and investments, because the company spread aggressively across a country neglected by most international firms given the poor investment climate.

Many have noted the similarities between the Stanford and Madoff frauds, but few have noted the Latin America connection. This writer even calls Stanford "the Madoff scandal done Latin American style," ignoring the impact of the Madoff case in the region, where thousands of investors lost several billion dollars, largely through Banco Santander and the Fairfield Greenwich Group. This is largely because wealthy investors in Brazil, Colombia, and Mexico largely stayed quiet about their losses in the Madoff collapse, out of embarrassment and a fear of exposure to extortion and other financial crimes.

Of course, the Madoff scandal was the high-end version of the related "pirámides" and DMG frauds Colombia, which lured in millions of small-scale, often peasant, clients. Several classic Ponzi schemes collapsed simultaneously as the Colombian government cracked down, wiping out the life savings of millions. DMG was the most prominent of the scams, promising and delivering exorbitant interest rates by laundering billions in cocaine profits from the country's biggest cartels.

So, are Latin Americans just gullible? Financial literacy is a problem in the region, but Madoff and Stanford pulled the wool over the eyes of savvy investors around the world. The real problem is a combination of lack of regulation and poor domestic banking sectors. The SEC obviously dropped the ball on Madoff and Stanford, and the Colombian sat on their hands while the pyramids were constructed across Colombia. Without accessible and secure banking options at home, the poor are pushed into fly-by-night operations like DMG and the rich send their money to murky overseas funds.

While the losses are tragic, if the recent scams inspire an effort towards basic financial education, expanding access to banking, and economic transparency, they won't have been a total loss. While it may be warranted in this case, the news of Ecuador and Venezuela seizing Stanford banks indicates that in the short term, however, these frauds are more likely to be used as justification to nationalize banks and erect barriers to international finance.


(Photo from Whirling Phoenix's photostream)

The copper campaign

Building on Rory's discussion of China's investment in Rio Tinto, it's worth noting that China's most recent move to develop a stake in the international copper market goes back to early 2006, when demand for copper in China far exceeded growth in the industry. By March of that year, investments in copper smelting and the production of copper-based value added products like wires and cables seemed like a safe bet. According to some estimates, demand for copper grew by nearly 87 percent between 2001 and 2006.

If you were reading government publications, you might have thought otherwise. Just months before, in late 2005, five government ministries came together to publish "Proposals on Curbing Blind Investment in the Copper Smelting Industry," citing worries about the stability of copper prices, international copper supply, the environment, and the financial risks linked to loans for new smelting facilities. But news of these worries did not seem to hit mainstream media until August 2006, nearly a year later.

The most recent decline in commodity prices has kept these same copper smelting facilities and copper dependent industries on edge - over the course of 2008, growth in the industry dropped to less than 3 %. In December, Mineweb offered some interesting observations that bode poorly for copper's future. For one, they agreed with many economists that growth in China will no longer be in the double digit percentage range. And while "infrastructure counts for some 40% of copper consumption with the bulk being for power cables," the demand for copper is likely to fall proportionately with growth in the economy. Looking closer, "factory closures, leading to workers seeking new jobs, fits labor intensive infrastructure projects like roads, railways, bridges etc. rather than unwanted electricity generating and distribution capacity." On top of this, many power supply companies canceled orders for copper cables and some provinces have even begun using aluminum for cheaper medium voltage cables.

As the force of the economic crisis become a reality, China stepped forward to make a significant effort that may save the chunk of its economy leveraged by the copper industry. This effort began in January 2009 when China released a stimulus package aimed at infrastructure projects that will inevitably require copper wire and cable. Just a few weeks after this, they bought a huge stake of copper options with the hope of maintaining a supply of cheap unrefined copper. This has become a high profile campaign, but the stakes of unemployment and economic collapse in China is a high profile game that government cannot afford to lose.

(Photo from planewalker001's photostream)

Double, double oil and trouble

Little publicized fact: the $787 billion stimulus bill that Obama signed last week contains $16.6 billion for the Energy Efficiency and Renewable Energy (EERE) Office of the Dept of Energy. This increases the EERE’s budget tenfold, and it’s yet another signal that Obama is serious about alternative energy. That’s good.

Also this week, crude oil dipped below $40 for the first time in 2009, which has caused a stall in new energy projects. That’s bad. Oil prices are low because the economy is in terrible shape, which stifles demand. But the longer prices stay low, the harder it will be to commercialize advanced biofuels, which by one estimate will need an oil price of $80-$120 in order to be competitive in a reasonable timeframe.

This is a paradox worth watching as it plays out over the next 25 years. Ideally, you want clean and cheap energy. But that's still a ways off, and for now it seems like you can mainly have one or the other. Which is more important? How do you balance the two demands?

(photo from ifijay's photostream)

Protectionism coverage at the World Bank

Check out my new coverage on the rise of protectionism over at the World Bank's Youthink! blog.

Social media enters...

the O.R.?

That's right, Twitter is in a Michigan hospital.

Seriously?

I am among social media's biggest fans, but I'm pretty sure there is a time and place for media 2.0-ing... and I'm gonna go out on a limb and say: while removing a cancerous tumor from a man's kidney is neither the time, nor the place.

According to CNN, Dr. Craig Rogers (lead surgeon in the Henry Ford surgery) said the reason for Twittering was to "let people know that a tumor can be removed without taking the entire kidney."

Ok, Dr. Rogers... I understand that social media gives the general public the power to share their ideas with massive amounts of people instantaneously, but I'm pretty sure that you can share that information AFTER the surgery is over.

Another gentleman quoted in the CNN story "tweeted" his own varicose vein-removal surgery as it was happening because:

A) It minimized his nervousness

B) He felt like he had support

C) He wanted a "record for other people who might be interested in the same surgery"

D) It later allowed him to connect with others with the same issues

No comment...

I want to be clear: I absolutely support the use of social media in the most innovative ways possible. I just seriously question the judgement of a medical practitioner that sees value in twittering DURING a procedure, as opposed to utilizing the same forms of media AFTER surgery. Again- time & place...

Don't you people watch medical dramas? Doctors don't need any more distractions.

Poland solves economic crisis by going back in time

Poland deserves some recognition: they brought us Lech Kaczyński (left) and Jarosław Kaczyński (right). In 2006, Lech, the president of Poland, appointed his twin brother Jaroslaw as Prime Minister. While dutifully manging the fragile coalition government and promoting a conservative Christian agenda, the duo became overnight YouTube sensations (as well as the butt end of a new wave of politically charged one-liners). In 2007, the Law and Justice party that was co-founded by the twins lost its majority in Parliament and Jaroslaw, became leader of the opposition. Lech will continue to serve his five-year term as President until 2010.

On February 10th, Poland set another precedent (unless you consider Medvedev Putin's twin) by announcing a solution to the country's currency problems. The economics minister, Waldemar Pawlak, announced that the Polish government will pass a law allowing companies to renegotiate currency option contracts established last year. Back then economists believed Poland's currency, the zloty, would continue to strengthen into 2009 and threaten Poland's export industry. These companies had the option of purchasing currency in advance at prices below the predicted value. Had the currency continued to appreciate, these companies would have been able to continue to sell products overseas at more competitive prices than the predicted exchange rate would allow. This was before the economic downturn. Now these companies are holding currency options priced well above the going rate. According to the Economist, the zloty has lost nearly 37% of it's value against the Euro since 2008 and led to cumulative losses estimated at $5 billion. Many of these companies face bankruptcy and or failure.

To solve this crisis, the Polish government is going to allow businesses to retroactively renegotiate or simply back out of their currency options. In this scenario, the burden of the currency decline will weigh more heavily upon banks and save many companies from catastrophe. Aside from the legal mess that this will create, the move is flat out sketchy business; not unlike appointing your own brother to a top political office. Laugh all you want, but these backwater politics just may stave off the collapse of the country's export industry.

Lech Kaczyński Photo via the President of the Republic of Poland
Jaroslaw Kaczyński Photo via the Chancellory of the Prime Minister

Commodity price collapse: who wins and who loses?

One of the great back stories of the ongoing economic crisis is the collapse in commodity prices, which occurred in the second half of 2008 after a record boom period lasting at least five years. The bursting of the bubble has produced clear winners and losers. Thanks to our fantastic contributors, zzzeitgeist has had excellent coverage of these repercussions. I thought I’d try to tie things together.

The biggest winners are consumers, particularly first-world automobile drivers. In the last 7+ months, oil has fallen from $147/barrel to about $37/barrel now. Economists reckon that amounts to a ‘stimulus’ of more than $240 billion. Also, now that the world food crisis has largely subsided, developing-world consumers stand to benefit from cheaper food prices. This means a lot when you spend more than 50% of your budget on food.

The mining sector is obviously a huge loser. Mining is often a boom and bust industry, because it takes a long time to develop new mining projects. It’s hard to forecast future supply/demand fundamentals (remember when this seemed like a good idea?) and unfortunately they can change drastically and rapidly, which is exactly what has happened in the last year. As a result, a number of firms are closing mines, because prices are too low to justify operating costs. Mining firms often take on a lot debt out of necessity – digging mines ain’t cheap. But thanks to the financial crisis and the disappearance of cheap credit, heavily indebted companies are suddenly struggling to stay afloat. Case in point: Rio Tinto, the world’s second largest mining conglomerate. See Rory’s excellent treatment of Rio’s debt woes here.

Finally, commodity-dependent countries suffer perhaps the worst. When prices are high, resource-rich countries are suddenly flush with cash, which they can use to advance geopolitical aims, reward cronies, or invest in infrastructure, education and health to avoid the resource curse (don’t hold your breath). Falling commodity prices have scaled back these ambitions. See Dan’s analysis of Venezuela, Rory’s take on Russia, or this money quote about Iran.

In my mind, these are the biggest winners and losers, but this list is by no means exhaustive. Falling commodity prices also have an enormous effect on agricultural trade, international cooperation, foreign direct investment, Guinea, South Africa, Australia, several Latin American countries, etc. Who else am I missing?

(photo from jeff-o-matic’s photostream)

China: the ultimate value investor

On Febraury 12th, Rio Tinto announced plans for a $19.5bn cash injection by Chinese state-owned firm Chinalco. The heavily indebted mining group will issue convertible bonds and receive investments in three strategic partnerships, giving Chinalco minority positions in some of Rio Tinto's best mining assets and increasing its total share of the firm to 18%. The plan is subject to shareholder approval and requires official permission by the governments of Australia (which swiftly moved to amend its foreign investment rules to consider convertible bonds as equity) and Chile; approval is far from certain and the deal is already highly controversial amongst Rio's existing shareholders.

Rio is effectively selling pieces of its best assets to one of its biggest customers; empowering a shareholder whose self-interested desire for low commodity prices directly conflicts with the interest of the others (high prices). But should the deal succeed, it would be the biggest Chinese investment ever in a foreign company, and herald a new focus in China's pursuit of resource security. China's investments in Africa are well-documented and readers of zzzeitgeist will surely be familiar with China's "FDI for access" bargain. But an 18% capital investment in one of the world's largest mining groups suggests a higher profile campaign to leverage the relative economic strength of the Chinese government towards the acquisition of strategic corporate assets.

While the era of the sovereign wealth funds came and went with a whimper, state-owned companies with decent balance sheets seem primed for a foreign buying spree, particularly in the heavily indebted mining sector. With mining assets cheap, and the financial backing of the Chinese state strong, the opportunities for Chinese companies abroad are immense. That is, if they can overcome the tricky little problem of economic nationalism.

A final academic point: the US has been referred to as the world's largest venture capitalist. Perhaps we should begin referring to China as its largest value investor.

(photo from kt_bluesky's photostream)

What do Google and Dunder Mifflin have in common?

Paper Mills. No, Google isn't making a foray into the forest products and packaging industry. The company will obviously use the defunct paper mill to house a massive data center.

This is an unremarkable story unto itself, but to me, it represents a symbolic transition of old industry to new. There's also a tinge of irony here. A company that categorizes and delivers knowledge to people electronically replaces one that profited from the delivery of information through an anachronistic channel: the printed page. (If you don't think that paper is outdated, may I remind you that your are reading a blog on a computer and that Amazon just launched the Kindle 2 this week.)

More importantly, this story illustrates the merits of creative destruction. One could draw the conclusion from Stora Enso's press release that Google itself may be partly responsible for the mill's "persistent losses in recent years and poor long-term profitability prospects". Even so, Google offers society exponentially more value in return. As our economy falters and businesses fail, I hope that our leaders (and opinionators) carefully consider actions (and words) that may impede transformative process of creative destruction.

We may never know the next great American car company if we artificially extend the life of the incumbents. So when you see an empty paper mill or idle auto manufacturing plant, think not of jobs lost, but imagine the next great product or service from a company that will take over that space.

Bolithia

• New York Times, "In Bolivia, Untapped Bounty Meets Nationalism," Simon Romero, February 2, 2009.
  
  
• McClatchy, "Lithium could be Bolivia's future, if politics don't get in way," Tyler Bridges , January 30, 2009.
  
  
• TIME, "For Lithium Car Batteries, Bolivia Is in the Driver's Seat," By Jean Friedman-Rudovsky, January 22, 2009.

Who sent out the memo to every stringer in South America? There's no obvious hook that would have inspired them independently. Did they all see this story last year and decide to carpool out to the Salar de Uyuni salt flats?*

Those grabbed by the haunting photo on the cover of the Gray Lady won't be disappointed. The market for lithium has exploded along with the demand for more efficient car batteries, and as the largest source of the mineral, Bolivia is trying to negotiate how get the maximum social benefit out of this potential windfall. Given the tensions over Bolivia's natural gas reserves and the fact a similar technology-driven mineral boom in the Congo (in that case involving coltan, a key cell phone input) has escalated and drawn out the brutal conflict there, some might worry about a "lithium curse." But the major difference is that lithium is found in the pro-government south, whereas the opposition controls the country's natural gas deposits in the "half-moon" region to the north and east. If President Evo Morales manages the situation prudently, most of the lithium from the salares will end up in Bolivian salaries.

* I typed that facetiously, but copying the links above, I noticed the photo credit for the Times piece is Noah Friedman-Rudovsky, uncannily similar to the author of the TIME story, Jean Friedman-Rudovsky. Trolling the interwebs, I don't see an obvious connection between them, but it does nothing to dispel the perception that foreign reporting is a bit cliquish.

New Secretary of State, new diplomacy

On February 5th Secretary Clinton held a Town Hall meeting for State Department employees... and to my delight, she addressed a question that has been on my mind for quite some time:

Does DOS plan to utilize new media in global public diplomacy initiatives, and if so, how?

On the security issue and on outreach and public diplomacy, we must figure out a way consistent with security to use these new tools. There is no doubt in my mind that we have barely scratched the surface as to what we can use to communicate with people around the world, and in fact, to use [new technologies] as tools ...to further our own work and to be smart about it. … If people have ideas about how better to use these tools, please let me know because we’re going to work very hard – we have some people already looking at this – to see what more we can do to stay in touch with the world, which is our job, after all, to try to do that.

Dear Secretary Clinton,

Call me, I looooove staying in touch with the world!

Love,
Emily

Is it an onus?

Pundits like to act outraged when they hear Wall Streeters complain that $500,000 isn't that much money. They're right that it's a lot of money...if you don't live an upper crust lifestyle in New York. 

When a basic apartment goes for more than a million, 500k can go pretty quick. Obama and his economic team are quite right that all firms should be cutting back in this " winter of hardship" (seriously?). But capping executive pay is a pretty blunt and inefficient method of forcing companies to do this. Companies receiving federal bailout funds should certainly be subject to strict scrutiny, but if an executive can successfully employ this "bridge" money to shore up balance sheets and lead a return to profitability, shouldn't they be rewarded accordingly? 

Wall Street's "bonus" culture has been entrenched for so long that we seem to forgot exactly what one normally earns a bonus for. We shouldn't embrace it in it's current form, nor should we pay regulators the exorbitant amounts previously earned by execs. As always in times of hardship, we swing from one extreme to the other and suggest heavy handed ways to counter problems we didn't see coming and are all occasionally guilty of hyperbole.

Let's let government service remain just that and reinstitute the true meaning of bonus.

(Photo via c-weiss)

Be afraid, be very afraid

This is the single most frightening passage I've read since Lehman Brothers fell. If it's true, then it sure gives credence to the doomsday prophets.

On C-Span, Rep. Paul Kanjorski (D-PA) explained how the Federal Reserve
told members of Congress about an electronic run on the banks "to the tune of
$550 billion dollars" within "an hour or two" last fall. According to Kanjorski,
on September 18, 2008 the Fed tried to "stem the tide" by pumping money into the
financial system but it didn't work and decided instead to announce an immediate
increase in deposit insurance to $250,000 per account to stop the panic.
Said Kanjorski: "If they had not done that, their estimation is that by 2 p.m. that
afternoon, $5.5 trillion would have been drawn out of the money market system of
the U.S., would have collapsed the entire economy of the U.S., and within 24
hours the world economy would have collapsed. It would have been the end of our
economic system and our political system as we know it."

The Great Game revisited

The Great Game is a term used to describe the 19th century struggles between the British and Russian Empires for supremacy in Central Asia. It’s henceforth been a term that also tends to get thrown around anytime Russia butts heads with a Western power over territory in Central Asia. It happens to be a great day to revisit the Great Game.

Last week, Kyrgyz President Kurmanbek Bakiyev announced in Moscow that Kyrgyzstan will discontinue U.S. access to an air base that is key to military operations in Afghanistan. Why did he make this announcement from Russia? Well, because he had just finished a meeting where Russian President Medvedev pledged to lend Kyrgyzstan $2 billion, write off $180 million in debt, and add another $150 million in aid.

Where to begin? No one wins the Great Game. The base in Kyrgyzstan is currently the only good US access point to Afghanistan, as the Uzbekistani government stopped allowing US operations back in 2005. This will drastically affect the war on terrorism right as the Obama administration was preparing to deploy as many as 30,000 additional troops to Afghanistan this week. Oops.

Moreover, the Kyrgyz sanctioned US use of the base was really the last show of any good relations between the Kyrgyz Republic and the US. Since Kyrgyzstan’s Tulip Revolution in 2005, freedom and human rights have not taken off as the West would have hoped. The country is increasingly turning to its closer neighbor - Russia - for support. Now with this large fiscal promise from Medvedev, the Central Asian country is sure to back slide even further away from the goals of the color revolutions.

Sounds bad? It gets worse. Russia is angling for leverage in running the war on terrorism on its own terms, but she is in no position to make these promises of loans and aid. If history is any indication, Russia is now setting a precedent. It cannot follow through on similar promises to the other Central Asian nations, but will certainly have to go through the motions. Unless the economy hits a dramatic up-turn, Russia is setting itself up to fail.

And the big loser in the Great Game? Well, that continues to be the people of Central Asia. Human rights, independent media, and basic freedoms will continue to decline. The initial capital from Russia will most likely boost a number of government programs, but nothing will be sustained. My advice? We’re all better off playing Risk.

(Photo via markusbc)

Devaluing the rouble

Last month, the Bank of Russia announced a floor under the rouble. So much for that. The floor was already tested this week and the central bank is burning through reserves faster than Putin does ABBA cover bands. On the surface, we would expect Russia to have little difficulty in defending the rouble, given the substantial accumulation of foreign exchange reserves in recent years (high commodity prices + booming exports + the long shadow of the 1998 rouble crisis = big time reserves). But look a little deeper, and that cushion isn't quite a comfortable as it appears.

In fact, Russia is in big, big trouble.

The Russian government didn't anticipate the sudden, rapid decline in commodity prices (to be fair, few did), and it is now struggling to balance its obligations amidst declining revenues and FX earnings. Its 2009 budget relies on $95/barrel oil, and billions of dollars have been committed in support of the banking sector (not to mention the money provided major companies crippled with debt). Defending the rouble and supporting the banking sector/companies alone consumed approximately 40% of Russia's FX reserves since summer 2008, and were a major factor in the Fitch downgrade on Wednesday. If the government's recent actions are any indication, Russia's foreign exchange reserves will come under increasing pressure in 2009. It delayed discussions on amending the budget, and publicly stated that it won't make any cuts to this year’s spending. With social instability spreading, it is unlikely the government will make any significant cut to the budget over 2009-2010. Furthermore, its new crisis strategy directly targets the banking sector, which should be applauded, but will require a significant amount of capital.

Which brings us back to the rouble. The central bank's ability to defend the rouble will be seriously constrained by the budget and banking sector support. Its decision to gradually devalue the rouble, as opposed to allowing it to freely fall to its market equilibrium, has proven ill advised and sacrificed a greater share of foreign exchange reserves than was otherwise necessary. Little official debt, falling imports, and the complacency of the Russian elite would have made a single devaluation possible. But now the central bank is in a bind; let the rouble fall and you risk a loss of confidence in the central bank, keep defending it in the hope that the oil price recovers and you play a dangerous game of Russian roulette (no pun intended).

Russia's spending and banking sector support are necessary under the current economic and financial conditions. The market already expects a further devaluation of the rouble; artificially supporting it is a losing battle that only increases the risk of a serious run on the currency and drains its foreign exchange reserves. Russia should set the rouble free.

(photo from melted snowball's photostream)

I Drink Your Milkshake!

Venezuela, an archetypal petro-state, was bound to suffer when the price of oil collapsed late last year, but the situation has worsened rapidly, I think even faster than most expected. The government looks to be scaling back its ideologically-motivated ambitions to divert exports from the US to China. They can't find state-owned oil companies willing or able to carry out new developments, so are turning to the same private foreign firms they spurned in recent nationalizations. PDVSA, the massive national oil company, and big private service companies, are rumored to be cutting thousands of jobs to save money and deal with OPEC output reductions. Production is slowing as the government is falling behind in its billion dollar plus debts to oil service firms.

These signals are especially surprising given that oil prices are still relatively high, between $35-$40 a barrel for Venezuela's unusually heavy crude, compared to about $7 when President Hugo Chávez came to power in 1998. And the country should have a bigger cushion after a year of $100+ prices. Also, the government may be holding more bad economic and employment news until after Chávez's February 15 referendum on eliminating presidential and other term limits.

So what does it all mean? Chávez's second decade in power (which begins today after a hastily-called national holiday) may be much rougher than his first. He no longer has his handy foil, and efforts to stir things up with Obama don't seem to be catching on, for now. Without the slush fund from off-budget oil profits, Chávez is hard-pressed to fulfill his generous foreign aid commitments, and he may start to get the cold shoulder from fair-weather international friends. At home, Chávez is prioritizing social programs over oil production or investment, but he can't continue that downward spiral for too long and any reduction in benefits will erode his somewhat fickle power base. It's no surprise Venezuela relies on oil, but under Chávez the dependence has reached the point that it accounts for over 90 percent of export revenue and a huge chunk of the budget. Now it appears that well is running dry.

(photo from rhaaga's photostream)

The Daschle debate

Who will replace Tom Daschle? There may not be an equal candidate, one with the experience and potential to drive health care reform, but there is a growing line of qualified applicants for the position of Health Secretary, as well as pressure to fill the opening. The New York Times offered five possible replacements, all of them current or former governors, saying "the effort [needed] to cover the uninsured and rein in health costs...is bigger than one person."

All evidence suggests that President Obama needs to act soon to fill this position and give the new candidate the necessary tools and time to begin drafting any health care reforms. As the Economist reminds us, the longer this issue sits on the table, the uglier it starts to look. Best to handle it in "stealth".

As the financial crisis deepens, so too does the difficulty of health care reform. The costs of health care are tremendous and the complexity of the issue make it a burdensome political topic. In the past, health care has been hung up by sluggish presidencies and waning public support. As national health care benefits for low-income families decline - every 1% increase in unemployment leads to an increase of 1m in the number of unemployed and 1.1m in the numbers joining Medicaid and SCHIP - the difficulty of managing the health care crisis inversely increases.

Among that list of five governors, former Oregon Governor John Kitzhaber, represents a calculated pick. He lacks much of the political clout held by Daschle and others, but as a doctor, his commitment to the issue is sound and noteworthy. America's health care crisis may be stealth, but the man tasked with it's revival certainly shouldn't be. Kitzhaber just may be able to bring attention to this neglected post without a litany of improper tax returns.

(Sweet shorts, Doc)

The politics of network neutrality

(See Part 1: Free speech and open access provisions are unrelated to the core net neutrality debate. Outright blocking of a competitor’s product or service by a broadband carrier violates net neutrality.)

Another more controversial (and subtle) aspect of net neutrality concerns tiered service, or how fast the internet delivers content from a source to the end user. Tiered service means that packets of data could arrive at the end user much faster depending upon which tier they traveled along. Tiered service does not necessarily violate net neutrality, though the method by which a broadband carrier offers tiered service has significance.

A broadband carrier can offer tiered service with pricey high-bandwidth packages. Essentially, purchasing bandwidth works this way now: a company like Google can plow money into a bigger data pipe that connects to the Internet. Companies with more bandwidth can deliver data faster. This doesn't violate the spirit of net neutrality. A packet can arrive faster with a higher bandwidth connection, but no single data packet is discriminated against.

A broadband carrier can also offer tiered service by explicitly shaping the packet traffic across the network. Traffic shaping refers to the fact that an internet service provider (ISP) can prioritize packets according to certain criteria and thereby improve the delivery speed of the packet. Here's how it breaks down:

The good

• Applications with stringent data delivery requirements work better when prioritized. For example, voice over IP applications (VOIP) like Skype need quick packet delivery in order to support conversation with no lag.
  
• Traffic shaping tends to create a better experience for the end user at a lower cost because ISPs can more effectively manage congested data pipes . Cox Communications is experimenting with this technique now in several markets by prioritizing certain applications over others.

The bad

• A carrier can promote its own services over a competitor’s by surreptitiously slowing traffic (The WSJ reports that outgoing FCC chairman Kevin Martin has accused Comcast of doing exactly this).
  
• ISP's can extort companies by artificially slowing the traffic of those who don't pay for premium service. For example, certain websites could load faster than others if the owners made special deals with the carriers. Tim Wu, a Columbia law professor and network neutrality expert, calls this the Tony Soprano business model.

People disagree whether prioritization with the goal of improving the user experience violates net neutrality. Even with the positive benefits of traffic shaping, it's unclear whether broadband carriers should rely on this technique. I'm apprehensive about ISPs (and more so, Congress) "picking winners", or applications to prioritize. Also, network operators may rely too heavily on congestion management rather than increasing the capacity of their networks.

A high capacity network diminishes the need to prioritize traffic. But as more data floods the internet, providers will need to improve capacity and costs will rise. Instead of exploiting their position of gatekeepers, ISPs should pass the costs onto consumers. Not an ideal situation, but a lesser evil than active meddling.

(photo from ccarlstead's photstream)

The Hills meets C-SPAN...

It's not exactly our normal content, but I couldn't let this go unnoticed.

The music takes the cake...

Shamless plug

For those of you interested in youth issues, specifically with regard to education and poverty, let me point you to a new blog at the World Bank.

The Youthink! site is a comprehensive effort by the Bank to engage youth on issues important to development. I'll be blogging there regularly. Please take a look. 

L’économie politique du Roquefort

*These observations on trade are strictly my own thoughts.

One final note on l’affaire Roquefort, in which outgoing-President Bush raised tariffs on imports of French Roquefort cheese to 300%. I have generally been disappointed by the quality of debate in the blogosphere on this issue. As I have argued many times on this blog, trade policy is not understood very well through the prism of either political science or economics. If you want to understand trade policy outcomes (not the underlying theory), it’s best to think in terms of political economy.

The Roquefort tariff was first addressed by FP Passport, whose analysis hinges on the likely political impact:

The last thing Obama wants right now is to get into a trade war with France over
a last-minute decision by his predecessor, particularly when he's looking for
French cooperation on far more pressing issues.

Turning to economics, after a first attempt, the Economist followed with a scathing post:

While the measure hurts producers (and consumers) of a large number of
scrumptious products, the greatest casualty is Roquefort cheese. Yes, while
Europeans will be relishing delicious bleu cheese, Americans can eat
hormone-injected beef with a side of stale freedom fries. The asymmetry of the
quality has predictably inspired ridicule for the duties in France.

Beyond that superficiality, the Roquefort duty in particular is poorly
targeted and hardly just. A village of 600 people will have to face the most
severe consequences of a single European anti-trade policy. The banning of the
cheese is a symbolic measure that will do little to affect France’s economy as a
whole. Instead, it serves to provoke Europe unnecessarily and to reinforce
accusations of American jingoism.

Both analyses are incomplete. Passport’s international politics framing would be a suitable analytical point for other issues, but trade policy rarely moves so fast, and it would be extremely unlikely for the US to hike tariffs for no reason. This is especially true given Mr. Bush’s predilection for free trade. The Economist correctly identifies that the tariffs were enacted as a WTO-legal retaliatory measure in response to the EU’s banning the import of American hormone-treated beef. But they are wrong to hastily conclude that the Roquefort tariff is “poorly targeted.” As I wrote recently, the WTO is in many ways a mercantilist institution, and retaliatory sanctions (tariffs) are the only punishment it can authorize in disputes. Countries which are given WTO permission to apply sanctions have an incentive to make them symbolic, painful or, if possible, both. In doing so, the offended country hopes to harness the affected domestic producers in the offending country to pressure their government to make the sanctions go away (ideally, by complying with the WTO ruling.)

For many reasons, I do not want to discuss the specifics of this particular tariff. But this is the best framework with which to view this issue. Essentially, it’s rigging a purposefully inefficient outcome with the hope of forcing a more efficient outcome (i.e. freer trade in both European cheese and American beef) than the previous equilibrium (free trade in European cheese only.) Juicy as it may be, I doubt we can draw many conclusions about Mr. Bush’s free trade record from this incident or tie it to France’s opposition to the Iraq War.

Alors...