Pricing Ebola: Risk in an Age of Fear

Fear may end up causing up to 90% of the outbreak’s economic toll, with devastating effects on poverty alleviation and state stability. Markets can help.

In early November, the World Health Organization declared that the Ebola virus could soon be producing up to 40,000 new cases per month. This week, the organization issued a heartening update, announcing that emerging infections are declining. An aggressive, coordinated public health program coupled with massive inflows of international aid should, in time, contain what Margaret Chan, the WHO’s Director-General, called “the greatest peacetime challenge the United Nations and its agencies have ever faced.” Despite some renewed cause for optimism, fear – by governments, investors, aid agencies, and the citizenry – shows no sign of abatement.

Ebola spread through West Africa not because of its uniquely destructive pathophysiology – across the continent, the Ebola death count is (and will likely continue to be) dwarfed by Malaria and diarrheal diseases – but because of failures of governance, economic resiliency, and human fallibility. This is important because it is fear itself, rather than the disease’s physical attributes, that is causing cascading economic and social welfare burdens to an otherwise containable health crisis.

More than anything, fear has stymied the response. Though the lack of health worker training, inadequate resources, and red tape are real institutional roadblocks, the black shroud of fear blankets all attempts at effective intervention. In August, an Ebola treatment facility was ransacked by an angry mob, causing sick patients to flee and discouraging the newly sick from seeking treatment. In September, a three-day lockdown in Sierra Leone hindered contact tracing and disrupted economic activity. These are not isolated incidents, but rather highlight a pattern of crisis response failures with roots in institutional and economic frailty. After all, when communication breaks down, the sick go untreated and community leaders bloviate, fear is an intuitive human response.

Now the damage is coming around. The disease is straining grossly underdeveloped regional healthcare systems and is weakening already weak states. Sierra Leone and Liberia had just started recovering from protracted civil war and were enjoying relatively strong rates of GDP growth. Unemployment was falling and foreign direct investment (FDI), particularly in the mining industry, was surging in. A sharp reversal of this economic progress now seems all too likely.

With capital fleeing and exchange rates wobbling, cross-border trade has drastically slowed. FDI is drying up and the tourism industry is near collapse. The World Bank now expects Liberia’s economy to contract by nearly 5% this year (from a healthy 8% growth rate in 2013) and has slashed expected growth in Sierra Leone from 11% to 2%. Inflation, too, is creeping up, largely a consequence of underemployed factors of production – idle or abandoned farmland, labor stuck at home sick or fearful of becoming so, and capital without an appetite for risk, or unable to price it. Rising food prices (by 150% for cassavas, a staple, in Monrovia), and supermarkets struggling to resupply their shelves may yet spark violent conflict and social unrest that would parallel, if not exacerbate, the misery brought on by the epidemic.

The World Bank has identified a $290m fiscal hole in West African governments’ budgets. It is essential that in a time of national crisis and declining tax revenues, governments are not forced to cull essential staff. Not only would this adversely affect the running of their states, but it could spark an unnecessary public backlash.

The World Bank has promised $500m to support damaged health systems in West Africa, and indeed a lot of international money is going into Ebola treatment and prevention. But more needs to go into shoring up national stability. That is, the international community must ensure that basic government services continue to be rendered, that contracts are enforced through the courts, and that the rule of law does not further deteriorate. “The final economic toll of Ebola will not be driven by the direct costs of the disease itself – expensive drugs, sick employees and busy caregivers. It will be driven by how much those who are not infected trust their governments,” writes Marcelo Giugale, Senior Director of the World Bank’s global practice for macroeconomics and fiscal management. This is the price of fear. Giugale’s Ebola Impact Index predicts that the economic impact could top $33 billion if government mismanagement of the disease leads to 200,000 cases.

Fear hampers economically efficient decision-making by mispricing risk. Research from Nobel Prize-winning behavioral economist Daniel Kahneman tells us that individuals fear losses more than they value corresponding gains. Fear reduces labor force participation by overvaluing the risk of contracting the disease (remember that, in the aggregate, other tropical ailments are a lot more deadly) over the benefits of work. That is, risk is measured by fear, not probability.

That same fear has closed border crossings, led to farmers abandoning their crops, canceled business events, and halted exports. According to Jim Yong Kim, President of the World Bank, as was the case for both the SARS and H1N1 epidemics, the “tide of fear” triggered by the Ebola outbreak could cause 80% to 90% of the economic impact.

Remedying state fragility and propping up fiscal gaps should be made a priority if the world does not want to see countries that beat Ebola fail shortly thereafter. That will require a lot of money and incessant public reassurance by all political leaders as to the real, objective probabilities of risk, rather than the perceived risk. Some of our leaders are trying to help: IMF Managing Director Christine Lagarde was recently spotted sporting an “isolate Ebola, not countries” badge and warning an audience against terrifying investors away from Africa. Others, like New Jersey Governor Chris Christie, seek only to score political points by stoking fear of an ill-defined threat to his constituency.

Likewise, rather than quarantining West Africa through travel bans and other over-zealous mobility impediments such as mandatory 21-day quarantines for asymptomatic persons, the West should actively encourage trade and transit. Some media have rightly lauded the heroism and selflessness of healthcare professionals heading into harm’s way. A similar international effort is needed to encourage businesspersons, investors, and financiers to shore up West African economies. Opportunities that bolster growth industries, stimulate commercial interests and generate broader market participation are plentiful.

This need not come out of altruistic benevolence; market mechanisms are well placed to encourage such behavior if a rational risk premium can be modeled. There are economic opportunities in West Africa, long unnoticed or unexploited, which if leveraged, could be both commercially lucrative and politically stabilizing, creating a strong foundation on which to combat this and future diseases.

Opportunities abound for distressed securities funds to invest in undervalued assets or debt in imminent default. West African governments, corporations, and local subsidiaries of international corporations have a myriad of assets they may want or need to divest themselves of. International investment in those assets would lubricate the domestic economy and put the three nations most at risk of collapse on the path to recovery. Such investments and development opportunities reap social and economic rewards to both investors and host nations.

The Mount Coffee Hydroelectric Plant on the St. Paul River in Liberia is a poignant example of one such opportunity. Having promised to bring cheap and reliable electricity to a nation ravaged by two decades of civil war, its construction site now sits idle. Laborers stay home, fearful of falling sick, and foreign managers have been evacuated. All the while, fixed and financing costs have to be borne, straining the Liberia Electricity Corporation and international contractors Norplan AS and Fichtner GmbH.

Similarly, Sifca Group, an Ivory Coast-based agribusiness, has halted rubber exports from Liberia due to border closures and staff shortages. Its wares now sit idly in expensive Monrovian warehouses. Even in Ebola-free Gambia, hotel bookings are down 60% due to fears that the virus could spread, severely straining the tourism industry and putting leisure industry companies at risk of bankruptcy. Securities funds willing and able to accurately price risk are well placed to acquire discounted stakes in assets like these with significant potential for returns. Diversifying their investments across the region would help mitigate against the concentration risk in any one sector or country. In doing so, they’ll also be keeping people employed and providing a much needed financial lifeline to governments, companies, and individuals suffering from the economic consequences of fear.

Liberia, Sierra Leone, and Guinea are going through hell, and to quote Winston Churchill, they’ll have to keep going. A Churchillian effort on the part of NGOs, aid agencies, donor states, and private capital is indeed required if the world is to prevent the disease from spreading and states from failing. If our action is inadequate, fear will reign – people won’t go to work, businesses will close, economies will collapse, and social order will disintegrate, likely violently. Because fear and its associate, loss-aversion, may come to result in up to 90% of Ebola’s economic toll, it is paramount that this scourge is contained. The market can help, and opportunities are plentiful for those with a taste for calculated risk. And let us not forget the responsibility of our leaders in steering us away from mass hysteria; it could end up being an even bigger killer than Ebola.

Diplomacy and Governance in the Arctic: Coordinated Bonanza or new Cold War?

The Arctic sits at the intersection of US-Russia relations, the global crisis of climate change, and international trade. How Arctic nations deal with these issues is likely to be one of the defining struggles of international relations in the 21st century

Ever since Robert Peary’s historic voyage to the North Pole in 1909, the world has marveled at its mystery, beauty, and more recently, its vast economic potential. For hundreds of years, mariners risked life and limb plundering the frigid waters of the far north for cod, halibut and whale blubber, but rarely went within a thousand kilometers of the North Pole – a barren wasteland encrusted in impenetrable ice year-round.
The 21st century will bring many changes to the region. Climate change, technological advancements and an insatiable demand for resources may finally unlock the vast economic potential of the circumpolar north. The nations surrounding the pole, which had previously looked south for economic growth, are increasingly asserting territorial claims in the far north as Arctic sea ice hastens its retreat.
As international climate scientists predict polar ice free summers within a decade, regional actors are lining up billions of dollars for investments in fishing, transportation, resource extraction and portentously, military infrastructure.
As the pole thaws and nations move into this pristine territory, the likelihood of conflict is set to rise. Most analysts dismiss the prospects for an armed clash in the Arctic, but predict an arms buildup and fierce competition in the international arena for recognition of expansive territorial claims. If this race is badly managed, the chance of a miscalculation runs unacceptably high.
Is the Arctic being primed for a new Cold War? This essay will examine the issues at stake in the far north. It will look at the interests and positions of the littoral polar nations – the United States, Canada, Denmark (via Greenland), Norway and Russia – to gauge where competition is likely to be most aggressive. It will also look at the role of the United Nations and the Arctic Council in mediating disputes. Moreover, it will explore the concerns of environmentalists and native communities; as one of the world’s last great frontiers, these pressure groups are rightly concerned that exploration and development will spoil a pristine habitat. Finally, this essay will put forward an expansive set of policy prescriptions for managing the development of, and inevitable disputes in, the Arctic.
A New Arctic
The Arctic, about 8% of the world’s surface, is warming twice as fast as the rest of the planet. The summer sea ice nadir has steadily shrunk since 1979, the first year of reliable satellite measurements. According to the UN Intergovernmental Panel on Climate Change (IPCC), the ice cap has retreated over 40% in this period, a trend unmatched in human history. The summer of 2012 saw Arctic sea ice cover just 3.5 million square kilometers, down from an average of 8 million square kilometers in the 1980s. An added worry is that vanishing ice is likely to exacerbate the warming problem; ice reflects much of the sun’s heat back into space while open ocean acts as a heat sink.
A shrinking ice cap opens up a host of economic opportunities. Increasingly temperate temperatures would make the exploitation of marine and mineral resources more economical. The Beaufort Sea off of Alaska and Canada is believed to hold over 90 billion barrels of oil and 44 billion barrels of liquid natural gas according to a report by Ernst and Young.
A policy brief by the Brookings institute estimates that by 2030 unreinforced commercial liners will be able to safely sail through the northern Canadian archipelago (the Northwest Passage) or around Russia (the Northeast Passage) in the summer months. In 1906, Roald Amundsen first navigated the Northwest Passage looking for a shortcut to Asia; the completion of the Panama Canal in 1914 however lessened the need for this precarious route. Now, a hundred years later, strategic planners are once again looking to the North-east and west Passages for a speedy route around the continents.
Territorial Claims
The Arctic is of primary strategic significance to the five littoral Arctic Ocean states – The United States, Canada, Russia, Norway and Denmark. The Council on Foreign Relations, in a policy brief on Arctic disputes, argues that Russia is the most dominant player in the Arctic, investing billions of dollars in its northern infrastructure. Its main naval bases are arranged in a crescent around the pole.
That said, all Arctic nations are set to invest profusely in the region in the coming decades. New shipping lanes, oil fields, trawling basins and even tourism opportunities will affect the economic and security welfare of all littoral states. Non-Arctic nations such as China and the European Union countries would also benefit; shorter trade routes through the arctic would be a boon for export driven nations, and increased drilling for oil and gas could lower global prices.
Although each nation state has sovereignty over its tranche of the Arctic, bilateral and international agreements address certain areas of cooperation. The Arctic Council is the preeminent forum for regional collaboration and dispute resolution while the 1982 United Nation Convention on the Laws of the Sea (UNCLOS) serves as an overarching legal framework for the governance of the world’s oceans.
UNCLOS is significant in that it sets territorial sea boundaries to 12 miles offshore and allows for a 200 mile exclusive economic zone (EEZ). Under specific rules and through a UN commission, a country can petition to have its continental shelf rights extended up to 350 miles offshore. All Arctic nations have done just this despite the fact that most of the Arctic Ocean lays within the five EEZs; the 1.1 square miles of open ocean at the very north of the planet, sometimes referred to as the “donut hole”, is considered high seas and thus outside any national jurisdiction.
The five nations affirmed their commitment to UNCLOS (the United States has not ratified the treaty but abides by its provisions) with the Ilulissat Declaration of 2008. They agreed to a basic formulation for sovereignty in the Arctic region and on addressing the effects of climate change. That said, two minor territorial disputes persist – between Canada and the United States in the Beaufort Sea and between Canada and Denmark over a small island in the Nares Strait. These are not very contentious and the parties are likely to split the differences amicably.
Of greater contention is the status of the Northwest Passage. Canada asserts that it is an inland waterway over which it maintains exclusive jurisdiction. The United States and others maintain that it is an international strait with free navigation rights. Russia similarly claims that parts of the Northeast Passage are within its internal waters.
The issue first erupted with the undeclared passage of the USS Manhattan, an ice-strengthened oil tanker, though the Northwest Passage in 1969. At one point, local Inuit stood on the sea ice in front of the ship, refusing to move until the captain asked for transit permission. He did, and permission was duly granted. This has been the custom since, but it has not stopped Canadian politicians from raising the issue to shore up nationalist credentials. Unable to stand up to America militarily but needing to do something about the controversy, the Canadian Parliament passed the Arctic Waters Pollution Prevention Act in 1970 to strengthen de jure control over the passage.
The passage issue came to the fore again in 1985 with the Polar Sea controversy. The USCGC Polar Sea planned to navigate through the Northwest Passage to Alaska from Greenland without formal Canadian government authorization. Viewing the passage as an international strait with full freedom of navigation, the vessel, cognizant of the diplomatic implications, sought only to notify Canada rather than ask for permission. The Canadian public, and conservatives chiefly, were enraged at the disregard of sovereignty, even though the plan provided for Canadian observers aboard the ship.
Adding fuel to the fire, the Soviets spoke in support of the nationalist outcry, stating that it believed in Canada’s right to sovereignty in the Northwest Passage just as the Soviets believed in their sovereignty over the Northeast Passage. Bowing to nationalist pressure, the Mulroney government decided to take action – straight territorial baselines were set around the outer perimeter of the country and the Polar 8 Project, the proposed construction of a new class of icebreakers, was approved.
These aggressive moves bore fruit. Although the US position on the passage had not changed, overarching security interests and legal constraints forced it to capitulate somewhat. The US could not challenge Canada’s territorial baseline change at the United Nations because it had not ratified UNCLOS. Most significantly however, the rising concern over a new generation of Soviet nuclear submarines, along with Canada’s stated intention of interfering with a US presence in the Arctic, prompted a quick resolution. According to Philip J. Briggs, an Arctic military scholar, it was the Pentagon’s view that an increased assertion of Canadian sovereignty in the north would compromise its ability to deploy forces in the defense of Europe.
A simple 2 page agreement, reached in 1988 between Joe Clark of Canada and George P. Shultz of the United States, provided that the Americans would always ask for permission for navigation in the waters claimed by Canada. What was not written, but was widely acknowledged as the Canadian counterpoint, was that Canada would always grant permission. Canada could never admit this due to domestic political considerations, but diplomacy often works best in these grey areas, when diplomats understand and trust each other. The agreement still stands, and the two nations are currently conducting joint geological surveys to determine continental shelf delimitations.
Today, a voyage from Shanghai to Hamburg through the Northeast Passage shaves roughly 30 percent of the distance off a similar trip though the crowded Suez Canal. 71 vessels made such trips last year, but this is tiny compared to the 17,000 ships which passed through Suez in 2013. Last year, the Danish bulk carrier Nordic Orion traversed the Northwest Passage rather than passing through the Panama Canal, reportedly saving $80,000 in fuel costs. “I want to stress the importance of the Northern Sea Route as an international transport artery that will rival traditional trade lanes” noted Vladimir Putin in 2011.
It will take at least a decade though for traffic in the Arctic to dent circulation in traditional shipping lanes. On both routes the shipping season remains very short, expensive icebreaker escorts often have to be hired and insurance is hard to obtain due to uncertainty. The industry is waiting for more warming.
New Cold War?
The issue which has undoubtedly gotten the most press attention however is Russia’s claim to a continental shelf extension based on the Lomonosov ridge, an undersea mountain range bisecting the Arctic Ocean. In 2007, the Russian submarine Arkitka boldly planted the flag of the Russian Federation on the seabed of the North Pole. This sparked a diplomatic incident, with Peter McCay, the Canadian Foreign Minister at the time, pronouncing:
“[The Russians] are fooling themselves if they think dropping a flag on the ocean floor is going to change anything. There is no question over Canadian sovereignty in the Arctic. We’ve made that very clear. We’ve established – a long time ago – that these are Canadian waters and this is Canadian property. You can’t go around the world these days dropping a flag somewhere. This isn’t the 14th or 15th century.”
Sergei Lavrov, the Russian foreign minister, retorted that the flag planting was little more than a legal fact finding mission, responding:
“We from the outset said that this expedition was part of the big work being carried out under the UN Convention on the Law of the Sea, within the international authority where Russia’s claim to submerged ridges which we believe to be an extension of our shelf is being considered. We know that this has to be proved. The ground samples that were taken will serve the work to prepare that evidence.”
This posturing is significant because both nations have submitted claims to the UNCLOS commission charged with defining continental shelf extensions.
In mid-March, as the world watched Russia annex Crimea, Russian officials quietly announced another territorial coup, this one to the East. The “Peanut Hole”, a 52,000 square kilometer basin in the Sea of Okhotsk believed to be rich in oil and gas, was recognized as Russia’s by the United Nations Commission on the Law of the Seas.
Almost 15 years ago, Russia submitted a continental shelf extension claim to the UN; it was finally approved in March. Their minister of natural resources and environment proudly announced that this most recent decision would only advance their other causes. The Lomonosov claim is pending, and is the most significant as a win would open up gigantic oil and gas fields for exploration and exploitation in contested seas.
“Few countries have been as keen to invest in the Arctic as Russia, whose economy and federal budget rely heavily on hydrocarbons,” CFR writes. “Of the nearly sixty large oil and natural-gas fields discovered in the Arctic, there are forty-three in Russia, eleven in Canada, six in Alaska, and one in Norway, according to a 2009 U.S. Department of Energy report.”
“Russia, the only non-NATO littoral Arctic state, has made a military buildup in the Arctic a strategic priority, restoring Soviet-era airfields and ports and marshaling naval assets,” CFR adds. “In late 2013, President Vladimir Putin instructed his military leadership to pay particular attention to the Arctic, saying Russia needed ‘every lever for the protection of its security and national interests there.’ He also ordered the creation of a new strategic military command in the Russian Arctic by the end of 2014.”
The crisis in Ukraine should not affect Arctic cooperation. In early April, the eight members of the Arctic Council went ahead, as planned, with a summit in Canada. “The Russians have been quite cooperative in the Arctic during the past decade, probably because they realize how expensive it would be to take another approach, especially one involving militarization” noted international-law professor Michael Byers on CBC, a Canadian news outfit.
Diplomacy has indeed taken center stage in Arctic disputes. In 2010, Norway and Russia resolved a decades old maritime boundary dispute in the Barents Sea, equally dividing 67,600 square miles of contested waters. It is a model of Arctic cooperation that all nations should take note of.
Policy Prescriptions
The Arctic Council, established in 1996, develops policies focused on environmental protection, maritime security and sustainable development. Every nation but the United States appoints an ambassador-level diplomat to represent their interests. The US should follow suit and, according to the Brookings Institution, establish a Regional Bureau for Polar Affairs in the Department of State. It should also ratify UNCLOS, if not to settle disputes then at least to have a say in the regulations that govern the world’s oceans.
This is particularly important as Arctic politics are no longer under Arctic state monopoly; southerly economic powers like China, Japan and India have interests in the region, and are increasingly willing to fork out vast sums to secure them. China considers itself a “near-arctic state” and has increased funding for polar research to $60 million annually. Japan has a fleet of whalers serving national culinary interests, to much international criticism. India, like the other two countries, has an interest in new trade routes in the far north. These three countries, plus the UK, Netherlands, Poland, Spain, Germany, France, Singapore, Italy and South Korea are Arctic Council observer states.
The Arctic Council will have to go further though if it wishes to remain relevant. It currently bans discussion of military matters. This is a mistake; the leaders should be encouraged to strengthen military cooperation, including marine surveillance and search and rescue. It should also encourage further integration of national regulatory regimes in the Arctic. The EU has already done much to harmonize environmental and fishing rules within its borders; the Arctic Council should aim for something similar in its region.
Except for Russia, all Arctic council members are either in NATO or in the EU. To avoid a dangerous arms race or other forms of military escalation, Russia cannot be left feeling cornered or bullied. Such exclusion and distrust will encourage her to assert national interests outside the established international system. Russia has thus far, in the Arctic at least, played by international rules because she views them as impartial and necessary. It would be a tragedy for the 7 other members to force Russia to revise that calculation.
Melting polar ice caps are sure to spur further energy development. In 2013, the Arctic Council members signed a maritime oil-pollution preparedness and response agreement aimed at improving crisis response coordination. Energy development regulations are however still left to individual states. According to Russia’s own Ministry of Economic Development, over 3.5 million barrels of oil are spilled into the Arctic by substandard Russian infrastructure every year. By comparison, the Deepwater Horizon oil spill, the largest oil spill in history, released 4.9 million barrels. The Pew Research Center recommends standardizing spill response equipment, imposing limits on winter drilling and installing redundant systems.
Climate change will exacerbate these existing infrastructure deficits. As permafrost melts and soils sink, much existing infrastructure will be damaged, burdening locals with substantial costs. Building code best practices should be shared, and national governments should pledge funds to help the northern communities most affected by climate change mitigate its effects. Most importantly, existing ports and pipelines need to be renovated and stabilized now to minimize costs when permafrost melts en masse, predicted by midcentury.
It is perhaps ironic that the burning of fossil fuels, which through greenhouse gas emissions is opening up the Arctic to drilling, will lead to further carbon emissions and a warmer planet. Climatologists believe that nations should be cutting back on fossil fuels and move towards renewable sources of energy if we are to be spared the worst effects of climate change. The prisoner’s dilemma that is international greenhouse-gas controls does not however make altruistic drilling moratoriums very rewarding. Greenpeace however proposes just that; it believes that the environmental risks associated with Arctic drilling are too high and propose an outright ban. In 2013, 30 Greenpeace activists were arrested in Russia for harassing Gazprom’s Prirazlomnaya platform in the Pechora Sea, a key element of Russia’s plans to develop the Arctic. It is Russia’s first offshore field in the Arctic.
With regards to shipping guidelines, the Arctic Council encouraged member states to support the UN’s International Maritime Organization (IMO) in harmonizing ship design, crew training and marine safety. The Arctic Council also agreed to a draft “mandatory polar code” on shipping practices. CFR recommends that it go further, implementing restrictions on the use of heavy fuel oil and emissions of black carbon, both big contributors to global warming.
Conclusion
The Arctic is the final frontier; in many respects we know more about the moon than the northernmost reaches of our planet. Climate scientists do however universally agree that the Arctic is warming – its sea ice is melting, opening up countless opportunities for the exploration and exploitation of resources which had previously been locked away. The rate of change is frantic, and is having profound geopolitical repercussions. The Arctic sits at the intersection of US-Russia relations, the global crisis of climate change, and international trade. These forces are transformative and, if poorly managed, risk sparking a geo-economic contest reminiscent of the Cold War. The United States cannot sit back; it needs to strongly assert itself as an arctic nation. UNCLOS and the Arctic Council are useful arbiters in this arena, but they need to be fortified and have their scopes expanded. The Arctic isn’t in a crisis today; its stakeholders are largely cooperative and engaged. In the long term however, the potential benefits Arctic exploration – energy, shipping, tourism, fishing – need to be balanced against environmental and strategic concerns. Whatever Arctic nations decide, billions of dollars will have to be spent. They should coordinate their efforts.

Sources:

Intergovernmental Panel on Climate Change, ‘Working Group 13: The Physical Science Basis’ (2013)

Dale Nijoka et al, ‘Arctic Oil and Gas’ Ernst and Young (2013)

Ebinger, Schackmann and Banks, ‘Offshore Oil and Gas Governance in the Arctic: A Leadership Role for the U.S.’ Brookings Institution Energy Security Initiative (March 2014) Policy Brief 14-01

Brigham, Byers, Conley and Laruelle, ‘Emerging Arctic’ Council on Foreign Relations (2014)

The Ilulissat Declaration, Arctic Ocean Conference (Ilulissat, Greenland, 27 – 29 May 2008 )

Philip J. Briggs, ‘The Polar Sea Voyage and the Northwest Passage Dispute’ Armed Forces & Society (Spring 1990) vol. 16 no. 3 437-452

‘Canada and United States of America: Agreement on Arctic Cooperation’ Signed at Ottawa on 11 January 1988

Gleb Bryanksi, ‘Russia’s Putin says Arctic trade route to rival Suez’ Reuters (22 September 2011)

Paul Reynolds, ‘Trying to head off an Arctic Gold Rush’ BBC (29 May 2008)

Ministry of Foreign Affairs of the Russian Federation, ‘Transcript of Remarks and Replies to Media Questions by Russian Minister of Foreign Affairs Sergey Lavrov at Joint Press Conference with Philippine Foreign Affairs Secretary Alberto Romulo, Manila, August 3, 2007’ (2007)

Uri Friedman, ‘The Arctic: Where the U.S. and Russia Could Square off Next’ The Atlantic (28 March 2014)

Far East bonanza: Resource-rich Sea of Okhotsk all Russian, UN confirms’ Russia Today (15 March 2014)

Arctic Council ‘Agreement on maritime oil-pollution preparedness and response in the Arctic’ (2013)

Nataliya Vasilyeva, ‘In Russia’s northern oil fields, an environmental tragedy drip by drip’ AP Enterprise (20 December 2011)

Brandon MacGillis ‘Arctic Standards: Recommendations on Oil Spill Prevention, Response, and Safety’ The Pew Charitable Trusts (23 September 2013)

Dmitri Sharomov, ‘Russia drops charges against Greenpeace activists’ Reuters (25 December 2013)

The Cost of Inequality: Distributional Economics and its Impact on Development

Rising Inequality has wide ranging economic costs and casts an ever lengthening shadow on political stability. It is likely to be one of the most pressing politico-economic dilemmas of the 21^st century.

May 4^th, 2014

The study of the political economy emerged in the late 18^th century as an industrializing England and France sought to understand the dramatic economic changes of the day in order to formulate policies to better manage future developments. Thomas Malthus, one of the most preeminent political economists of the era, famously predicted that overpopulation would overwhelm limited factors of production, leading to dangerous political upheaval and inescapably, a correction in the population through starvation, disease or war. Like every political economist since, he provided policy solutions to this imminent threat: that governments cut off assistance to the poor and, if necessary, forcibly limit their reproduction.

Malthus, and later David Ricardo, were wrong to assume productive capital was limited; agricultural productivity gains and the conquest of the Americas meant land was no longer the scarce factor of production the two economists believed would threaten the capitalist system.

That said, in the short run – and economic decisions are usually taken in the short run – limited factors of production can lead to enormous profits for the holders of capital. Such wealth accumulation can, because of political-economic policies, persist through the generations even after technology has made the initially scarce and profitable factor abundant.

Like Karl Marx before him, Thomas Piketty, author of the blockbuster Capital in the Twenty-First Century, attempts to provide an economic theory of everything – an all-encompassing model of the relationship between capital, growth and inequality.[1] To him, distribution, or redistribution rather, is the central issue in economics, and should thus form the backbone of the discipline and of how we think about growth. Where Marx saw capitalism as ultimately flawed because of the “infinite accumulation of capital” by its owners, Mr. Piketty understands capitalism in the 21^st century as a product of political decisions largely benefiting the owners of capital at the expense of those trading their labor for wages.

Most importantly, Marx, Malthus and Ricardo failed to anticipate the effects of rapid technological and population change. With regards to inequality, such changes, and the rate of economic growth, are hugely important in reducing the relevance of wealth accumulated by previous generations.

This is why Mr. Piketty’s new book is so groundbreaking: the political-economic decisions governments take to protect wealth accumulation do little to spur economic growth while entrenching inequality. That is, inequality is a political choice, rather than a deterministic consequence of technological progress (skill-biased change) or globalized economic forces (superstar economics, in the industry jargon.) This conclusion is somewhat counter intuitive, and has important consequences for how we view and address the structural causes of inequality.

Mr. Piketty does not however delve into the relationship between inequality and growth, presuming rather ideologically (he is a socialist) that inequality is a problem in itself. He also assumes, rather blithely, that inequality will lead to conflict. This essay will look at the relationship between inequality and growth, and examine whether Mr. Piketty’s recommended redistributive policies would weaken growth. It will also explore the literature on inequality and social conflict, bringing data to Mr. Piketty’s assumptions.

Inequality and Growth

Economists largely agree that some inequality is integral to the effective functioning of a market economy and serves as the incentive needed for economic growth. Entrepreneurship would rarely be worth the risk without the opportunity of financial reward. Arthur Okun, an American economist, famously argued that societies cannot have perfect equality or efficiency, and must choose how much of one to sacrifice for the other.[2] How much to sacrifice one way or another forms the root question of almost all political-economy decisions.

Classical economic thinking has tended to assume that redistribution hurts growth, as higher taxes and regulations discourage work and investment.[3] Private sector losses are likely to be a rising function of the tax rate, given the convexity of deadweight costs; losses from redistribution are minimal when tax rates are low but rise steeply with the tax rate.[4]

More recent literature has recognized that redistributive policies need not inherently be detrimental to growth.  Investments in infrastructure, education and healthcare, paid for through taxes on property, pollution and inheritance for example, provide public goods and help address market imperfections. A redistributive tax code can increase the welfare of the poor, reducing society’s burden of caring for them and fostering entrepreneurship and risk taking.

The right redistributive mix has long been seen as a political question, couched in the language of compassion and morality. “Taxes are the price we pay for a civilized society” argued Oliver Wendell Holmes, a famously progressive US Supreme Court Justice. Barack Obama too, on the campaign trail in 2012, regularly spoke of the rich having to “pay their fair share”. Increasingly however, the question is taking on a purely economic dimension; high levels of inequality can, in the long run, harm the rich as well. Rising inequality worldwide, last as high in the 1920s, is leading to a reevaluation of inequalities’ economic costs.

Poor health and low productivity, correlates of poverty, hamper growth in rich but extremely unequal societies. In the United States for example, 16% of the population is believed to live below the poverty line, according to the US Census Bureau.[5] The poor die younger, have a higher birth rate, commit more crime and are less likely to have health insurance, passing on those and other burdens to society. Inequality may also reflect a lack of access by the poor to financial services, and thus fewer opportunities for them to invest in education or entrepreneurial activity. Redistributive policies which act as a substitute for risky borrowing on education and healthcare will yield positive economic dividends. This is the logic behind universal schooling and healthcare; they act as societal insurance schemes, helping the poor mitigate economic shocks.

Inequality may also have psychological impacts, like threatening public confidence in free trade, genetically modified crops and credit. The voting bloc most opposed to the growth boosting Trans Pacific Partnership, a free trade deal, is the economically disillusioned, formerly unionized middle class.[6] Stiglitz has stressed the role of political economy factors (particularly the influence of the rich) in allowing inequality to rise to dangerous levels.[7]

More worryingly, inequality may sow the seeds of conflict. Raghuram Rajan, now governor of the Reserve Bank of India, has written on governments’ response to inequality by boosting the availability of credit to poor households. When the credit stops flowing, as it inevitably must, the poor suffer foreclosure, penalizing interest payments and lowered living standards.[8] Kumhof and Ranciere have similarly underscored the importance of understanding the complex links between growth, inequality and political crises in light of the Arab Spring.[9]

Two papers by the International Monetary Fund have tried to shed light on the relationship between inequality and growth. Pinning down the relationship is tricky because every country responds to inequality differently. As Mr. Piketty illustrates in his book, the root causes of inequality is political choice, with structural explanations playing a secondary role.

In a 2011 paper Andrew Berg and Jonathan Ostry argue that inequality does not affect economic growth per se, but rather its duration.[10] Because it is much easier to get an economy growing than to keep it growing, this durational consequence of inequality is extremely significant when looking at economic performance. The authors look at 15 developing economies, plotting the relationship between the duration of growth spells and the Gini coefficient (a measure of income concentration ranging from 0, representing perfect equality to 100, where all income flows to a single person).

They find that closing half the inequality gap between Latin America (Gini: 50) and emerging Asia (Gini: 40) would more than double the expected duration of the former’s growth spell. More broadly, they find that a 10 percent decrease in inequality increases the length of a growth spell by 50 percent. There is however little consensus as to at which point further reductions in inequality begin to harm growth spells, or indeed growth itself.

They find three channels through which income inequality affects growth sustainability: credit market imperfection, the political economy and political instability. In the first – credit market imperfection – they argue that the poor may not have the means to finance their education, healthcare and entrepreneurship. That is, a more equal distribution of income would increase investments in human capital and thus fuel growth in the long run. In the political economy channel, they argue that in economically unequal countries, political power is distributed more equally than economic power, resulting in populist, growth damaging calls for tax raises and regulation. In the political instability channel, they argue that income inequality increases political risk, creating uncertainty that reduces investment incentives, impairing growth.

Because sustained economic growth is central to poverty reduction, these data have important policy implications. The authors are quick to point out however that, while increased inequality may shorten growth spells, poorly designed efforts to lower inequality could distort economic incentives, undermining growth and hurting the poor even more. They propose targeted subsides and improved economic opportunities for the poor, such as active labor market interventions to boost employment. Unlike Mr. Piketty, they do not recognize inequality as a problem rooted in wrongheaded political decisions, and indeed that is not the scope of their paper, but they do recommend political-economic interventions to right inequality.

Redistribution may also work to even out the business cycle, according to Barry Cynamon and Steven Fazzari.[11] Rising inequality reduced income growth for the bottom 95 percent of Americans beginning in about 1980, but the group’s consumption did not fall proportionally. To keep up, they borrowed ever more, increasing the fragility of their balance sheets. This was easy in a time of loose credit, and indeed such liquidity helped the economy grow. This fragility however eventually tanked the economy, and with it the consumption to income ratio for the group. The resulting balance sheet inundation, and inability to generate adequate demand, helps explain the prolonged recovery.

A more equal, more redistributive economy would have softened this fall by tempering the rise. For one, the bottom 95 percent would not have had to be as leveraged to ‘keep up with the Jones’” or any other idealistic vision of American prosperity increasingly out of reach to middle class citizens. More importantly however, redistributive government outlays are less cyclical, and may even grow during recessions, helping keep the economy healthy. This is significant when we look at the long term effects of preventable economic malaise, youth unemployment being the most obvious, on the long term growth prospects of an economy.

In another IMF paper, Berg, Ostry and Charalambos write that it may not be inequality itself that harms growth but rather government responses to reduce it that do.[12] “Even if inequality is bad for growth, taxes and transfers may be precisely the wrong remedy” they argue. They use a data set containing Gini coefficients of 173 economies over 50 years to look at the redistributive effects of government policies, like taxing and spending, and how they interact with inequality. The difference in Ginis between market income and net income after taxes and transfers allows the authors to plot the relationship between inequality and redistribution. In America, redistribution cuts the pre-tax and transfer Gini by 10 points; in Sweden, a more egalitarian society, redistribution cuts it by 23 points. Some economies, like that of Germany, are more unequal than that of Britain before redistribution, but less so after.

Interestingly, global median inequality has held steady over the past 50 years. Market inequality however has been rising steadily in OECD countries and falling in developing countries. Net inequality has also been rising in OECD countries over the past several decades as redistribution has not kept pace with rises in market inequality. Finally, the gap between market and net inequality is lower in developed countries, presumably because their redistributive tax and transfer systems are more extensive.

They find that more unequal societies tend to redistribute more, that redistribution appears to be benign in terms of impact on growth, and that lower net inequality is robustly correlated with faster and more durable growth (for a given level of redistribution). That level of redistribution, the authors calculate, is a difference of over 13 points between the net and market Ginis. In much of Western Europe, the gap is greater than this, possibly shortening a typical economic expansion.

Likewise, a high Gini for net income is correlated to slower growth in income per person. Loosening redistributive policies to the tune of 5 Gini points for example would knock half a percentage point off annual economic growth. Keeping redistribution constant, a one point Gini rise increases the risk that a period of economic expansion will end by 6 percent. All this to say, redistribution that reduces inequality will most likely boost growth.

That said, this is a generalization and the authors are quick to point that not all treatments for inequality are equal. Some lead to more equality at the expense of economic efficiency, such as nationalizations, while others promote both efficiency and equality, such as taxing land to fund apprentice schemes, or penalizing excessive risk taking in the financial sector. Infrastructure spending in particular is generally both pro-growth and pro-equality. “The macroeconomic effects of redistributive policies” they conclude “are likely to reflect a balance between different components of the fiscal package, and it would appear to be an empirical question whether redistribution in practice is pro- or anti-growth.”

r>g

Now that we have established that net inequality harms economic growth, and that redistributive policies tend to boost economic performance, it is important to look at the natural economic trends which fuel market inequality. Thomas Piketty’s new book provides some interesting answers to this question.

“If you’re going through hell, keep going” noted Winston Churchill, Britain’s wartime Prime Minister. Wars are hell; they maim, kill, destroy property and halt production. War also eats into a country’s capital stock – land, factories, raw materials and infrastructure – gradually reducing its prosperity and ability to produce. The chaos of the early twentieth century, and the redistributive Keynesian economic policies that followed, wiped out much of the world’s accumulated wealth. It also fueled inflation, reducing the returns rentiers expected from their capital. Out of hell, the post-war period was a great equalizer, and set the stage for decades of broad based economic growth.

Simon Kuznets was one of the first economists to look at the relationship between inequality and growth, concluding that in developed economies, inequality falls as economies grow. This ‘Kuznets Curve’ became the underpinning of modern economics’ approach to inequality and distribution.[13] One of the major arguments of Mr. Piketty’s book is that the curve is flawed – based on a limited post-war period where normal economic processes did not apply. Economies do not show a natural movement towards a more equitable distribution on wealth as they grow, he argues, but rather concentrate wealth in the hands of a few elite owners of capital.

Some forces push do for greater equality – note for example that global income inequality has fallen due to the rise of emerging economies. Piketty calls this spread of ideas and technology from rich areas to poor ones “the principal force of convergence”. This comes with an addendum: the countries which have most successfully caught up to the West have done so on the backs of high domestic savings rates, rather than foreign direct investment. China is the best example of the former, and Africa the latter; he argues that foreign ownership perpetuates institutional weakness because it creates incentives for autocrats to break contracts and expropriate foreign capital. The gains for Africa are mostly down to a transfer of knowledge rather than the economic benefits of industrialization. This analysis is flawed; economic autarky has never been a viable strategy for convergence. Africa’s failed states owe more to factitious ethno-religious infighting than failed nationalizations. Similarly, Africa’s booming states – Ghana, Angola and Nigeria – owe much of their wealth and stability to Chinese FDI and export markets for their goods. Oddly, Mr. Piketty does not seem to appreciate the transformative power of the internet in diffusing information and ideas, empowering the curious poor and bringing transparency to finance. He instead writes that knowledge is under the near monopoly of the state and therefor investment in it, or more likely underinvestment, does not make it a natural force of convergence.

At the same time, even greater forces push the global economy towards less equality, the most important of which is the ability of the rich to secure favorable economic benefits for themselves – a “force of divergence”. We see the consequences of this everywhere – inequality within the American economy is particularly stratospheric. In 2012, the top 1 percent of American earners had real income gains of 32 percent while the bottom 99 gained less than 1 percent.[14] Piketty points to big drops in top marginal tax rates since the 1980s, particularly in Britain and America, writing that “the size of the decrease in the top marginal income tax rate between 1980 and the present is closely related to the size of the increase in the top centile’s share of national income over the same period.” This soaring inequality of labor income, uncorrelated with rising productivity growth, is just one of two dynamics at play.

The second dynamic is the ratio of private wealth in an economy to GDP. It was only a little higher than it is today by the end of the 19^th century, tumbling during the first half of the 20^th century and rebounding thereafter. Mr. Piketty introduces the “fundamental force for divergence”: r>g where r is the return on capital (rents, profits, dividends, etc.) and g is the rate of economic growth.

If the rates of return on capital are greater than economic growth, and he proves that they generally are, the owners of everything from intellectual property to scarce land, mineral resources to fine wines, are accumulating vast, and Piketty would argue disproportionate to their effort, sums of wealth. By the same token, a slowdown in economic growth leads to greater concentrations of wealth. Mr. Piketty estimates that global growth rates will slow to about 1.2 percent by the end of the century, quite a fall from the 4 percent of the past 60 years. As growth slows, the ratio of wealth to GDP rises.

Between 1700 and 2012, population growth accounted for about half of average GDP growth, Piketty finds. As population growth slows to Victorian era levels, the breakneck change in individual fortunes of the 20^th century will slow dramatically. Indeed Japan and Italy, both rapidly aging and low growth economies, have the highest ratios of wealth to GDP in the world.[15] This growth slowdown is important to inequality because of the power of cumulative growth. A stagnant economy, over long periods of time, impedes social change and entrenches class structures. In the centuries leading up to the industrial revolution, where growth rates averaged 0.2 percent, culture, art and technology were practically static. The lengthy shadow of past, inherited wealth suffocated all attempts at economic and political reform. It may be about to do so again.

Inflation

One of the primary ways the owners of capital guarantee that r>g is through the control of inflation. In an inflation free environment, as was much of the 19^th century under the gold standard, public debts were managed over the course of several decades by running large budget surpluses. Elite rentiers collected substantial income from their holdings of public debt, paid for by public taxation out of funds which would have otherwise been earmarked for education or healthcare. Public debts of the postwar period by contrast were inflated away rather quickly, with bondholders grudgingly accepting negative yields in exchange for security. Resources once paid out to rentiers were instead diverted to funding the booming welfare state, lowering inequality. To quote Mr. Piketty: “Debt is the vehicle of important internal redistributions when it is repaid as well as when it is not.”

Federal Reserve Chairman Paul Volcker’s inflation targeting in the early 1980s got the financial pendulum swinging back the other way. By the mid-1970s, the ranks of government creditors included plenty of non-rich persons – individual investors, pension funds and savers. As dogged stagflation ate into savings, support for disinflation grew, with creditor interests (preserving the value of money) being put ahead of worker interests. Modern inequality has its roots in this policy shift.

The only way to constrain inflation was to squeeze wage growth, and labor’s share of income. Because in the US labor’s cost as a proportion of business expenses averaged 70 percent, constraining wage growth was seen as the easiest way to rein in inflation. “Any time wages accelerated, central banks tightened monetary policy, pushing up unemployment and squeezing labor’s share” writes Ian Harnett of Absolute Strategy Research.[16] As a corollary, corporate profits have exploded and are now at post-war highs as a percentage of GDP. The rich, who own most corporate shares, have benefited accordingly. They have also exercised their political influence to lower capital gains and inheritance taxes, levies which disproportionality touch the rich.

More inflation won’t by itself reduce inequality. Above target inflation squeezes real wages, and Piketty’s research has shown that the lower-middle class, which tends to keep a small and liquid rainy day fund, is most affected by the inflation tax. Unlike the rich, they cannot use intermediaries like property to shield their wealth because such safety is unaffordable, or they misunderstand the effects of inflation.

Conclusion

Inequality matters; it eats into the duration of economic booms, stymies human progress and creates a host of socioeconomic ills. Unless countered – by war, economic shocks or redistributive polices – inequality will continue to rise. More likely, political leaders’ unconcern over inequality’s rising costs will lead to society’s potentially violent rejection of unjust institutions. Some countries, particularly in Northern Europe, do manage to redistribute effectively. They show that egalitarian economies can grow robustly, and incidentally score the highest on measures of human development.

Inequality however is a global economic phenomenon, and in time will require global solutions. Mr. Piketty recommends a global tax on capital of about 10 percent a year for the biggest estates. A utopian idea he admits, but one which needs to be discussed in light of inequality’s costs and capital’s tendency to grow faster than output. A slightly more realistic proposal, unmentioned in his book, would be a universal basic income – a kind of inheritance for all.

Mr. Piketty concludes that, like at the turn of the 20^th century, we find ourselves at an economic juncture. Distributional worries are back, unaided by lackluster economic growth, falling real wages and the prospect of deflation. Few people are unconcerned that the world’s richest 85 people have a combined wealth exceeding the poorest 50% – or 3.5 billion souls. We look back at Malthusian fear-mongering with the smugness of hindsight, forgetting that the early twentieth century saw 100 million war deaths and another 100 million from the Spanish Flu.

Distributional issues are difficult to discuss, principally because until recently neo-liberal assertions that market interventionism constrains growth monopolized almost all policy debate. In the interests of political stability, human development and continued economic growth, this new debate needs to mature into concrete public policy responses.

 

[1] Thomas Piketty Capital in the Twenty-First Century. Belknap Press, 2014.

[2] Free Exchange, ‘Inequality v Growth’ The Economist, March 1^st 2014

[3] A. M. Okun, ‘Equality and Efficiency: the Big Trade-Off’ (1975, Brookings Institution Press, Washington D.C.)

[4] Barro, “Government Spending in a Simple Model of Endogeneous Growth” Journal of Political Economy 98(5): 103–25.

[5] DeNavas-Walt, Carmen, Bernadette D. Proctor, and Jessica C. Smith, “Income, Poverty, and Health Insurance Coverage in the United States” U.S. Census Bureau, Current Population reports 2013: 60-245

[6] Thomas B. Edsall, ‘Is the American Middle Class Losing Out to China and India?’ The New York Times April 1, 2014

[7] Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future. W. W. Norton & Company, 2012.

[8] R. Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy. Princeton University Press, 2010.

[9] Kumhof, M., and R. Rancière, “Inequality, Leverage and Crises” IMF Working Paper 2010: 10/268

[10] Berg, A., and Ostry, D., “Inequality and Unsustainable Growth: Two Sides of the Same Coin?” IMF Note 2011: 01/04

[11]Barry Cynamon and Steven Fazzari, “Inequality, the Great Recession, and Slow Recovery” Working Paper. January 2014. Avaliable at SSRN: http://dx.doi.org/10.2139/ssrn.2205524. Accessed on 4.25/2014

[12]Ostry, Berg, Tsangarides. “Redistribution, Inequality and Growth” International Monetary Fund 2014.

[13]Acemoglu, Daron, and James A. Robinson. “The political economy of the Kuznets curve.” Review of Development Economics 6, no. 2 (2002): 183-203.

[14] Buttonwood, ‘Collateral Damage’ The Economist, March 25^th 2014

[15] Free Exchange, ‘All Men are Created Unequal’ The Economist, January 4^th, 2014

[16] Buttonwood, ‘Collateral Damage’ The Economist, March 25^th 2014

Canadian Diplomacy, Keystone XL and the geopolitical implications of North American energy independence

I feel I need a little bit of a challenge so instead of the usual lecture on what poor countries need to do I’m going to call on the United States to get its act together. This post is a little long, so to summarize, I will argue that the Keystone XL pipeline should be built and all US crude export controls be lifted. US domestic politics has thus far gotten in the way; despite being outspent tenfold by the oil lobby, the environmental movement has thus far managed to block the pipeline’s approval. Approval would however give both economies a needed boost, as well as help put North America on a path towards energy independence. By purchasing fossil fuels from a friendly neighbor rather than Middle Eastern autocrats, the United States would yield foreign policy dividends, increase its energy security and give its economy a much needed boost.

The Project

The Keystone XL Pipeline is a proposed 1,179-mile crude oil pipeline beginning in Hardisty, Alberta and extending south across the US-Canada border to Steele City, Nebraska. It would connect the Canadian oil sands to the existing Keystone pipeline network in the United States. It would transport around 830,000 barrels of crude oil a day, most of it from Canada’s oil sands to refineries in Port Arthur, Texas.

Most of the pipeline has already been built; at issue is whether the President of the United States should authorize the 1,179 mile pipeline extension across the border. It proponents claim that it is “a critical infrastructure project for the energy security of the United States and for strengthening the American economy”[1].

The Canadian government, oil companies and union groups have spoken in favor of presidential approval. They argue that it will create construction jobs and ease the import of oil and gas from a friendly neighbor, putting North America on a path towards energy independence. Refineries in Texas are also in favor because they have already spent millions upgrading their plants to refine Canadian crude in anticipation of approval. Furthermore, the Keystone XL Pipeline will support the growth of crude oil production in North Dakota’s Bakken Formation by allowing American oil producers there easier access to refineries along the Gulf Coast.

Environmentalists, ranchers and landowners subject to eminent domain suits are opposed to Keystone XL. They argue that its construction would be a step backwards in the fight against climate change and make the US economy ever more dependent on fossil fuels by retarding investments in renewable sources of energy.[2] Ranchers and landowners also fear the consequences of a possible leak. Some Native American tribes have also voiced objection on religious grounds.[3]

Americans as a whole support the project, by 66% to 23%, according to a recent Pew Research center poll.[4] The US State Department, in an exhaustive impact assessment released in February, estimated that approval would create about 2000 construction jobs, but only 50 permanent jobs, and contribute $3.4 billion to the US economy.[5]

Pipeline Politics

Minutes after the release of the State Department report, Canada’s Conservative government launched an online ad campaign bluntly calling on the US President to “approve Keystone XL now”. Stephen Harper, the Prime Minister of Canada, has also called the approval a “no brainer”, would “not take no for an answer” and threatened to sell the Albertan oil to Asia.[6]

Construction is a priority for Conservative government of Stephen Harper; throughout 2013, the Canadian Prime Minister dispatched bands of ministers to Washington D.C. to lobby their counterparts in Congress and the White House. At the most recent meeting of the G8 in London, Stephen Harper personally brought up the pipeline with Barack Obama.

Mr. Harper has indeed spent a lot of political capital in trying to get the American president to approve the project. He hails from energy rich Alberta, and his electoral prospects are intractably to be tied to the continued growth of Canada’s resource-based economy. Mr. Harper has often referred to Canada as an “energy superpower” and sees the efficacious exploitation of the country’s bountiful mineral wealth as an important component of his Prime Ministerial legacy.[7]

The Canadian government is believed to have spent over $25 million on pipeline related advertisements and lobbying in 2013. Pro-approval ads have sprung up in the Wall Street Journal and Politico, the latter an online journal for political junkies. Earlier this year, bus and metro stops near the Capitol were plastered with advertisements, paid for by the Canadian government, emphasizing Canada’s role as a reliable energy supplier and “world environmental leader” on energy issues.

Government efforts however pale in comparison to spending by industrial groups such as the American Petroleum Institute, who have together quaffed up an estimated $178 million on advertising, lobbying and promotion tours in 2013.[8]

A Bloomberg analysis on corporate lobbying titled “Keystone Pipeline Support Enlists Oil Firms to U.S. Jews” found 48 groups that had lobbied on the proposed pipeline during the first three months of 2013.[9] Thus far their biggest success has been to discourage the use of the phrase “tar sands” while promoting the less dirty sounding “oil sands”.

The absence of concrete results in the face of such torrents of spending can only be explained by the complexities of domestic politics. While America’s carbon emissions have been declining since 2009, Canada’s have been rising. South of the border, shale gas is replacing coal for energy production while ever increasing Canadian oil production is driving emission rises there.[10] Stephen Harper has rejected the opposition Liberal Party’s plans for a price on carbon, and has issued little more than draft regulations for industrial polluters.

This environmental laissez faire, while popular with his Conservative constituents, has significant consequences across the border. In economies as tightly intertwined as that of Canada and the United States, domestic policy is not created in a vacuum. President Obama has always been skeptical of the pipeline, and particularly its approval’s domestic political consequences. Environmentalists are amongst his strongest supporters. In 2008, candidate Barack Obama promised to “free America from the tyranny of oil once and for all”.

Mr. Harper’s environmental intransigence is unlikely to do much to convince Mr. Obama of the project’s environmental bona fides. On both sides of the border, the Keystone XL pipeline has become a symbol and rallying cry for environmental groups. Tens of thousands have demonstrated against it and thousands more have directly disrupted operations by chaining themselves to equipment and laying across access roads. This is set to continue; over 50,000 activists have signed a pledge to physically resist the construction of the pipeline if approved.[11]

On July 24^th 2013, President Obama, in an interview with the New York Times, badgered Canada about its environmental record and chided the project backers’ claim to it being a jobs plan. In diplomatic terms, this amounted to a slap in the face to the Canadian Prime Minister. The Canadian media and diplomatic corps rather stereotypically took it in stride, with only Gary Doer, ambassador to the United States, gutsily pointing to a State Department report that the pipeline would create over 42,000 jobs.

Although no one will readily admit it, the delay has strained an otherwise amicable relationship. Canadian diplomatic behavior has been characterized as docile and malleable throughout this affair but things may be changing. The spending, on advertisements, junkets and conferences by the Canadian government is unprecedented. In the 1950s, a similarly significant infrastructure project, the Saint Lawrence Seaway, was repeatedly held up by the American Senate, to quiet Canadian irritation.

This time, Canada has enlisted the help of American unions, energy companies and, through its American consulate network, regional politicians, to sell the project across America.[12] In January, speaking to the U.S. Chamber of Commerce, Canada’s foreign minister complained that the United States owes Canada a response on the Keystone XL pipeline, stating that “we can’t continue in this state of limbo.”[13] Although approval is ultimately up to the President, the hope is that political expediency and a cacophony of pro-pipeline voices will force him to acquiesce.

Whether this public diplomacy – the communication with foreign publics to establish a dialogue designed to inform and influence – strategy works remains to be seen. In Canadian politics, this is known as a Team Canada Mission. Although led by the Prime Minister, provincial ministers, cabinet secretaries and the diplomatic corps work in unison to promote Canadian business development and long-term trade and investment opportunities.[14]

So far, Mr. Obama seems content on taking his time. Unfortunately, the pipeline has begun to be associated with the Republican Party, which has officially pushed for its construction for over a year. This could make Mr. Obama even more hesitant to approve the project as it would be tantamount to giving the opposition a win – political suicide in an election year.

Adding to Canada’s woes is the American surge in hydraulic fracturing (“fracking”) which has led to some predictions of American energy independence by 2035.[15] Mexico too has begun to liberalize its energy sector, and looms as a potential rival to Canadian oil. Its oil is sweet (it contains less Sulfur than Canadian oil), which is what most American refineries already process, and is less environmentally damaging. Stephen Harper, Republicans, unions and the oil industry must do all they can to secure Keystone’s approval before market forces send interest gushing elsewhere.[16]

The Geopolitics of Keystone

Keystone XL approval would have consequences far beyond North American shores. It would indeed be a boon to America’s allies around the world. Canadian crude shipped through America could, if export controls were lifted, compete with extortionate suppliers like Russia.

In Europe, this could lead to a weaning of the continent off Russian oil and gas and would deal a near fatal blow to the energy-export reliant Russian economy. Mr. Putin could eventually divert Europe bound oil and gas to China but the infrastructure needed to do this in significant quantities is still decades away. A threat by Mr. Obama to lift export controls, which he can do if he deems it in the national interest, would be a potent geopolitical stick in the current spat with Russia over Ukraine.

Lifting export controls could make American energy prices rise slightly, but this would only encourage more drilling, cushioning the upswing. Moving the world away from coal and towards oil and natural gas would also be good for the environment, in that a cleaner fuel is displacing an exceedingly dirty one.

Japan too sources a large share of its energy imports from Russia and is vulnerable to supply disruptions of Middle Eastern energy shipped through the straits of Malacca and Hormuz. Oil and gas from North America would alleviate this strategic vulnerability somewhat and make it harder for China to cut off Japanese energy shipments in a crisis. Furthermore, in Asia natural gas sells for three times its price in North America; in Europe double. Not only are there huge profits to be made from this price spread but it would tighten fraying alliances.

Approval would also lessen future oil shocks by turning America into a swing producer. Coupled with oil and gas from fracking in Texas and North Dakota, the United States could moderate the booms and busts of international energy markets by continuously adjusting domestic output. Canada, America’s closest ally, would readily boost production to stabilize prices in response to a global supply shortage.

Finally, North America would be consuming North American energy, which means money previously finding its way into the coffers of autocrats in the Middle East and South America would now flow into the pension funds of teachers and other shareholders. David Woo of Bank of America/Merrill Lynch notes that America’s petroleum deficit has fallen to 1.7% of GDP while Europe’s has grown to nearly 4%, the consequence of which is a dollar and an economy less sensitive to oil prices.[17]

This newfound energy independence should not however serve as an excuse for increasing American isolationism. A decade of war and bloated government budgets have led to calls on both sides of the political aisle for disengagement from far away conflicts. Why police the Middle East if America can supply its own energy? The newfound fortune should lead to a reevaluation of America’s foreign policy, they argue.

This is not politically, economically or geo-strategically sensible. Firstly, the domestic political argument is intellectually indolent. America’s strength at home is a product of its influence overseas. A step back from international obligations will invariably lead to threatening instability abroad with dangerous consequences at home (note the costs of US disengagement from Afghanistan after the Soviet withdrawal in 1989).

There is also a strong economic case for continued American engagement in international energy affairs. The price of oil depends on global supply and demand; America is not insulated. Middle Eastern and South American oil will affect prices around the world for the foreseeable future. It is thus in America’s interest to keep shipping lanes open and not, say, let the Chinese do the job. For all the Chinese talk of rising peacefully within the international system, only America can guarantee the continued respect of international norms such as the freedom of navigation and trade.

Lastly, American foreign policy should not bow to the temptations of isolationism; such retrenchment invites other powers to fill the security and diplomatic vacuum. China is already doing this in parts of Africa long forgotten by American diplomats, businesspersons and the military. This unchecked expansion of its sphere of influence is adverse to American interests and the US-centric global system. The current crisis in Ukraine was at least partially caused by the allure of subsidized Russian gas. Europe’s unwillingness to stand up to Vladimir Putin’s intimidation rests in no small part to their unfortunate dependence on Russian gas. Arizona Senator John McCain recently called Russia “a gas station masquerading as a country”; unfortunately for Europe, it’s the only gas station, and it has a political agenda.

Saudi Arabia fears that the US, its principal security guarantor against an Iran led ‘Shia crescent’, may be pulling out of the Middle East. It has voiced extreme dissatisfaction with the foreign policy of the administration of Barack Obama, who it accuses of dereliction of duty in the region. American withdrawal from the Middle East due to energy independence would be extremely destabilizing, handing power to regional strongmen and possibly encouraging an arms race between the Gulf States and Iran. The former have recently gone on a military spending binge to ostensibly prepare for a conflict with Iran unchecked by an American security guarantee.[18]

To conclude:

Canada and the United States are on track to becoming the world’s leading petrostates. This has three distinctive advantages. Firstly, if the Keystone XL pipeline is approved and crude export controls are lifted, North American energy could fuel much of the developed world, giving it a reprieve from bullies like Vladimir Putin and Cristina Fernández de Kirchner. Unlike oil from OPEC, a cartel dominated by despotic regimes, Canadian oil doesn’t come with strings attached. Secondly, North America, with its hydraulic fracturing and the exploitation of its oil sands, would set an example for environmentally conscious Europe that could lead to a reevaluation of its failed renewable energy strategy and reliance on Russian gas. Thirdly, a world with America as swing producer would experience fewer oil shocks and a more predictable business environment.

President Obama should approve the Keystone XL pipeline – it is privately built, provides thousands of shovel ready jobs, and yields extremely favorable foreign policy dividends by shifting petroleum power away from the volatile Middle East and an obstinate Russia.

---

[1] ‘Keystone XL Pipeline Project’ TransCanada, accessed 3/12/2014 <http://www.transcanada.com/keystone.html&gt;

[2] ‘Keystone XL Pipeline’ Friends of the Earth, accessed on 3/12/ 2014 <http://www.foe.org/projects/climate-and-energy/tar-sands/keystone-xl-pipeline&gt;

[3]  Rob Hotakainen “Native Americans vow a last stand to block Keystone XL pipeline” McClatchy DC (Feb 17, 2014)

[4] Juliet Eilperin “The public’s interest in climate change is waning” The Washington Post (April 2, 2013)

[5] ‘New Keystone XL Pipeline Application’ United States State Department, accessed 3/15/2014 <http://www.keystonepipeline-xl.state.gov/&gt;

[6] “A Pipeline Runs Through It” The Economist (Feb 8, 2014)

[7] Jeremy van Loon and Rebecca Penty, “Canada at Crossroads in Bid to Become Energy Superpower” Bloomberg (December 2, 2013)

[8] Yves Engler “Canadian Government Deploys Money, Diplomacy for Keystone XL” Truthout Magazine (June 21, 2013)

[9] Laura Litvan and Jonathan D. Salant, “Keystone Pipeline Support Enlists Oil Firms to U.S. Jews” Bloomberg (April 29, 2013)

[10] “It’s hard to XL” The Economist (July 31, 2013)

[11] Ibid at 7

[12] Ulian Beltrame and Mike Blanchfield “Harper government tells Canadian diplomats to follow the money” The Vancouver Sun (Nov 27, 2013)

[13] Charles Krauthammer, “Stop jerking Canada around” Washington Post (23 January, 2014)

[14] ‘The Canadian Trade Commission Service’ Government of Canada, accessed on 12/3/2014 <http://www.tradecommissioner.gc.ca/eng/trade-missions/previous-missions.jsp&gt;

[15] Rick Ungar “IEA Report: USA Set To Become Number One Oil Producer By 2020-Energy Independent By 2035” Forbes (November 12, 2012)

[16] Ibid at 6

[17] “Saudi America” The Economist (Feb 15, 2014)

[18] Catherine Boyle, “Arms race on again as Middle East and Asia jostle” CNBC (February 7, 2014)

Quantitative Easing: Wherever the Wind Blows

Since the 2008 crisis, developing countries have benefited from the loose monetary policy and near-zero short term interest rates of the developed world; international capital flocked to where it could find better returns. The Fed’s recent tapering of its asset purchasing program, quantitative easing or QE, has led to a fall in the demand for emerging market assets as yields rise in the developed world.
Emerging markets are in turmoil. Argentina, Turkey and South Africa have had to raise interest rates fairly significantly in response to torrents of foreign capital fleeing their economies. Bonds and equities are being hammered. Central bankers from Brasilia to Delhi are cantankerous, blaming their problems on the developed world and their “dollar imperialism”.
This turmoil cannot solely be blamed on the Fed. Several of these countries managed their domestic economies appallingly and binge-drank foreign capital like sailors on shore leave – without thought or concern for the inevitable hangover. They ran large current account deficits irresponsibly fueled by short term capital inflows. Fiscal deficits were ignored and persistently high inflation tolerated. Turkey and Argentina are the worst offenders, and are likely to struggle through the legacy of their capital gorging for several years.
Rodrik of Princeton and Arvind Subramanian of the Peterson Institute argue that there is also an asymmetry of cooperation – that the developed world was thrilled at the global surge of monetary and fiscal stimulus in the aftermath of the 2008 crash, despite its self-interested raison d’etre. The Fed did not act for emerging markets then, and did not expect nor receive any help from them (exchange rate appreciations in China for example would have helped the developed world export its way out of recession).
Another train of thought postulates that emerging markets are, through no real fault of their own, victims of developed world ‘secular stagnation’ – a permanent economic state whereby the supply of savings exceeds its demand from investment. Larry Summers of Harvard University and Paul Krugman of Princeton have regularly written, rather depressingly, on the theories’ two logical conclusions: that the developed world faces a permanent slump because the private sector saves too much and invest too little, or that money is funneled into risky high-yield projects such as subprime mortgages and emerging market assets.
What underlies the three theories of emerging market malaise – dollar imperialism, foreign capital binging and secular stagnation – is the idea that global finance is cyclical.
Helene Rey argued that there exists a global financial cycle in credit growth, asset prices and capital flows which co-moves with measures of uncertainty and risk aversion across international markets. Countries with large inflows of credit, usually developing countries selling high yield products, are more sensitive to the global cycle.
Symptoms of this sensitivity have been popping up across the developing world – inflated asset prices, excess credit creation and imported inflation. Rey’s analysis points to a correlation between the global financial cycle and the Federal Reserve’s monetary policy (QE and short term rates at zero). She concludes that an independent monetary policy is only possible if the capital account is managed, and suggests policy options for carrying this out. This runs contrary to the traditional assumption that with free capital mobility, independent monetary policies are only feasible if exchange rates are floating (the macroeconomic policy trillema, discussed below).
Rey argues for targeted capital controls, for using macro-prudential policies to even out the cycle and for acting on the transmission channel structurally by limiting the leverage of financial intermediaries.
Unlike Mr. Raghu Rajan, head of the Reserve Bank of India, she does not think it possible to act against the monetary policy of the Fed or other powerful central banks. These central banks must legally serve domestic interests and so it is up to individual countries to find the right policy mix which provides adequate access to international capital markets without being overly sensitive to the cycle.
Mr. Osborne, Britain’s Chancellor of the Exchequer, echoed this in Hong Kong this week, saying that each country had to put its own house in order and that “the Fed does not and indeed should not set monetary policy to be appropriate for emerging markets“. He does not believe that international coordination of macroeconomic policy is neither desirable nor feasible.
He is right about the latter but not the former. Federal Reserve decisions may hurt emerging markets by flooding their nascent financial systems with cheap cash. Countries which have not “put their houses in order” – fiscal discipline, a competitive economy and effective financial regulation – are understandably more susceptible to such external shocks, as Mr. Osborne contends, but cheap money temps all financially underdeveloped or undercapitalized economies.
Mr. Rajan, critical of Mr. Osborne’s position, treads a fine line on this point, stating during an interview on Bloomberg that in developing economies “the easy money which flowed into their economies made it easier to forget about the necessary reforms, the necessary fiscal actions that had to be taken.”
Broadly speaking, good housekeeping is a positive-sum benefit to the global economy but some policies, such as keeping exchange rates artificially low to boost exports, are zero-sum and hurt neighbors. They may indeed spark a devaluation war. International coordination of central bank policies could help alleviate these worries. It would be desirable.
That said, Osborne was right in stating that “the Fed has a legal and democratic requirement to set monetary policy to be appropriate for the US economy”. That is, it is unfeasible to ask that it take into consideration policy consequences that are beyond its mandate.
Don’t coordinate for the sake of developing economies, argues Barry Eichengreen, a former senior adviser at the IMF, but tread carefully because negative policy repercussions in developing countries affect the United States’ economy (over a third of global GDP is produced in developing countries) and its position as global lender of last resort.
Indeed international monetary coordination is not without precedent. Big economies conspired to weaken the dollar in 1985, they also worked to stop the dollar’s fall in 1987, and more recently agreed to fight the recession with coordinated fiscal stimulus in 2008.
This argument was also put forward at a meeting of G20 central bankers in Sydney this week. Mr. Rajan argued for further international monetary cooperation, only to be quickly rebuffed by Messrs. Osborne, Lew and Schäuble. Echoing the summits talking point – orderly houses – Mr. Rajan spoke of the difficulty of addressing domestic reforms while being continuously battered by external shocks, or “gales of capital” as he called them, emanating from the developed world. He proposed that the central bankers of the developed world issue ‘forward guidance’ (statements on policy prescriptions in response to certain domestic economic indices such as inflation and unemployment rates) for emerging market turmoil.
The Fed and the European Central Bank do not do this; they care about policy side effects only if they impact domestic markets. Janet Yellen said just this during Congressional testimony this week. But as the world economy becomes ever more globalized, shocks to one nation will invariably affect others.
If capital controls are imposed to alleviate the damage of such shocks, it could very well prevent international financiers from quickly withdrawing capital from trouble spots. The lack of coordination would also further encourage the balkanization of international finance, limiting cross-border investment opportunities and reducing the efficiency of the markets. A global savings glut born from the inability of finance to cross borders to find investment opportunities could make secular stagnation a self-fulfilling prophecy. As Mr. Rajan concluded:
The message that has gone out is you are on your own. Nobody is going to come to your help… [Therefore] build your reserves, shrink your current account deficit, have a very competitive exchange rate. If that is the message that goes out, we are setting in place the roots of the next crisis, which is capital flowing back to the industrial countries, world demand being lower than it should be, because the emerging markets are not spending as much as they should, and you set in place the conditions for the global savings glut.
So if the developed world continues to eschew monetary cooperation, what can the developed world do? Former Fed Chairman Bernanke proposed floating exchange rates as a way of insulating emerging markets from capital torrents. This is an endorsement of the macroeconomic policy trillema as observed by Maurice Obstfeld and Alan Taylor. It claims that a country can only enjoy two of three basic macroeconomic powers: a fixed exchange rate, capital mobility, or an independent monetary policy. This may mean absorbing inflationary shocks or politically undesirable interest rate hikes.
Rey’s research, discussed above, and Mr. Rajan, disagree on the trillema’s applicability. “Whenever capital is freely mobile, the global financial cycle constrains national monetary policies regardless of the exchange-rate regime” according to Rey. That leaves capital controls, anathema to the developed world and their Washington consensus of free movement, free trade and free markets (although the IMF has recently stated that it may be ok in certain instances). Brazil for example imposes a tax on foreigners buying its bonds and shares.
There is a final option: make the world less dependent on the dollar. By expanding the use of the Euro, the British Pound and the Renminbi as viable alternative reserve currencies, the Feds actions will have more muted impact. Furthermore, as emerging economies develop their own financial sectors, they will be able to persuade foreigners to lend to them in their own currencies, narrowing the “currency mismatch” between assets and liabilities. If their exchange rate slides, either naturally or because the government cannot afford to keep propping it up with reserves, foreign denominated debt will not be an insurmountable burden.
Ultimately, what is desirable is not always feasible. Emerging economies are on their own through this financial maelstrom and have to seek out their own path through the gale, whichever direction it blows.

The Thai Isthmus Canal: How a New Gateway to East Asia Could Enhance Regional Integration

Europe had its canal at Suez. By avoiding the perilous Cape of Good Hope and cutting over a thousand miles off a steamship trip from London to Bombay, the canal was, in the words of Prime Minister Anthony Eden, Britain’s “great imperial lifeline”. The Americans had theirs in Panama. It pushed America west; through its locks passed the hundreds of thousands of men and women who would go on to realize America’s Manifest Destiny.

A canal across the isthmus of Thailand, if ever built, promises to dramatically shake up existing trade routes, regional relationships and defence policy in East Asia, much as the Suez and Panama canals did for Europe and North America respectively. The enormous technical and financial resources needed to pull off such a feat of engineering would most likely require a wide consortium of investors, from the ASEAN members to China and Japan. Such East Asian involvement would render a Thai Canal the next instalment in a long established tradition of canal building by regional powers with global ambitions. Unlike the Panama and Suez canals however, the Thai canal would disrupt a well established, well regulated and popular shipping route.

Although China has the most to gain from a canal being built (it finds the current status quo wholly unstable and unsustainable), the project would be a boon to the entire East Asian region and ASEAN’s goal of regional integration. Major nations in East Asia are pitted against each other – on the Trans-Pacific Partnership, on what to do with North Korea, on island disputes in the East and South China Seas, and other issues. Joint development of common interests could bring conflicting parties together, in the spirit of peace, security and profit.

The Malacca Strait is strategically vulnerable. The sheer volume of trade and oil that flows through that chokepoint makes an alternative route extremely attractive. Despite this, no single country could, or would want to, fund the canal alone; a wide consortium is required to diversity risks and pool assets.

A new canal is not without risks. The Thai canal, in a bid to compete against the Malacca Strait, could grant vessels anonymous and unregulated passage. It would also be economically damaging to Singapore and Malaysia, whose ports have benefited from the monopoly. Chinese involvement in the financing or construction of the canal could pull Thailand further into its sphere of influence. The United States and Singapore have a long history of partnership in keeping the Malacca Straits open for business, cooperating on issues such as smuggling, piracy and environmental protection. A Thai canal would threaten Singapore’s control and could thus undermine American efforts in the region.

There are ways to control for this: an open and transparent financing instrument is essential, ideally with input from all ASEAN members, granting them shares much as European nations and private citizens were shareholders of the Suez Canal Company. ASEAN would have to be consulted; a need for the canal should be established at the next ASEAN Summit and further explored at the next meeting of transportation ministers. A renewed commitment by Thai authorities to fully incorporate and implement American anti-smuggling and proliferation agreements is also crucial.

Thailand would benefit from thousands of construction jobs and the national pride associated with a project over three hundred years in development. The project would also be a showcase for the ASEAN Way and, by obtaining Singaporean and Malaysian acquiescence, a testament to the consultative yet efficient organization they have built. This would also be an opportunity for South Korea, Japan and the Asian Development Bank to flex their financial muscles in building lasting regional relationships.

The canal should be built, with a diversified group of actors capitalizing an investment vehicle. Ultimately however, the Thai Canal needs to overcome a 300 year legacy of failure.

North Korea in South America: Maduro’s Ruinous Economic Policies

Venezuelan President Nicolás Maduro is at it again. Seemingly unsatisfied that only a few dozen basic goods such as toothpaste, toilet paper and cooking oil are practically impossible to find on super market shelves, he has decided to enact price controls on all electronic appliances, essentially ensuring that retailers would either cease to stock them due to unprofitability or else go bust. Indeed, electronics stores were looted by bargain hunters in the wake of the announcement, with government troops caught on film participating in the carnage. With Maduro promising that the decree will be extended to other sectors, retailors are understandably petrified.

This stupidity is not without consequence; support for his United Socialist Party of Venezuela (PSUV) is crumbling rapidly ahead of local elections due next month. But Maduro has a solution to that too: move Christmas (and end-of-the-year bonuses) to late November, just a week before the elections. Funny, but this is nothing new. Maduro rules the country through bribery – direct cash transfers of oil revenue to party members; heavily subsidized fuel; bloated government payrolls and unsustainable wage increases to name a few lavish policies.

Call me an elitist, but I don’t think a semi-illiterate former bus driver without any economics education can ever be a competent president.  On state television last week, he yet again illuminated his sheer ineptitude: “If I bring down the price of appliances by 1,000%, it is sure to have an impact on November’s inflation figure, right?” he said as he turned to his economic ministers, none of whom dared utter a word.

Stepping Off the Road to Serfdom

I’ve been getting increasingly frustrated, perhaps unreasonably, with the blatant economic illiteracy that plagues so many middle income countries, with Venezuela, Argentina and Brazil being the worst offenders. This post will argue that just as our notions of justice and human rights have evolved over time, so now must they evolve to accommodate international norms of economic behaviour. The wanton death and destruction of World War II led to a United Nations Declaration on Human Rights, a powerful and prescient document which laid out the basic tenets of what it meant to be human. There are some glaring omissions though, excusable in an age before communism’s horrors were universally acknowledged, but not so today. The leading cause of preventable deaths in the 20th century after all was not war but disease and famine bred through socialist economic mismanagement. Conversely, the Green Revolution, which introduced Norman Borlaug’s high yield crops to India, Pakistan and Mexico and thus averting serious famines, is an example of pioneering human ingenuity only possible when free peoples in free markets are left to do what they do best.

Brazil’s economy has stalled under the weight of protectionism, over regulation and punitive taxation, with economic growth standing at a less than impressive 0.9% in 2012. Argentina suffers from similar government meddling and is serially uncompetitive, depending on the same bovine (that’s cattle) economic strategy that made them wealthy in the 19^th century. Venezuela’s economy is in such disrepair that part of me thinks there is a great power duty to invade the country and topple the current regime to protect its increasingly destitute citizens. Currency and capital controls, state owned enterprises, local procurement laws, limits on the free movement of people and goods, putative taxation regimes, and irresponsibly generous employment protections are all back in vogue. What ever happened to the Washington consensus and the post Berlin Wall new normal of liberal, interconnected, the-world-is-flat globalization?

It’s easy to point to the Great Recession, soaring inequality, environmental degradation and youth unemployment as factors that led to what I’ll call, using the language of my favourite pint-sized Venezuelan autocrat, Bolivarian economic policies. Russell Brand recently gave this movement a face in the West though his embarrassing Jeremy Paxman interview and disorganized, rambling, pseudo-intellectual column in the New Statesman. Between sermons on the glories of neo-Marxism and the virtues of rage induced political apathy he did get something right: our society is far from perfect. His genius, and that of the Bolivarians, (and that of the New Statesman in plugging their leak in declining readership) is that they present their disjointed ideas as solutions to some massive international conspiracy or institutional cover up. If only, they argue, people would wake up and “see the truth”, their prescriptions would make sense. Of course, there is no cover up, there is no conspiracy; our problems are just exceedingly complicated, affecting multiple stakeholders and their entrenched values and beliefs. Anyone like Brand and his Bolivarian colleagues who say otherwise, who claim the answer is obvious, who preach “common-sense solutions”, are modern snake oil salesmen.

But let’s get back to Brazil: In 1994, the real was introduced, taming hyperinflation and sowing the seeds of a miraculous economic expansion which lifted tens of millions out of poverty. Markets were liberalized, trade was deregulated, capital controls were lifted, labor laws were simplified and taxes were cut. At the same time, the country invested in schools, healthcare, infrastructure and a widely lauded anti-poverty program.

It seems however that the government got complacent. Anti-profit rhetoric started making its way into presidential speeches. Pension plans were fattened and the retirement age lowered – that’s money that could otherwise go towards schools or healthcare going to healthy 54 years old retiring with 70% of final pay for life. Tariffs on everything from bubblegum to aircraft were dramatically increased to “protect” domestic industries. Private sector involvement in infrastructure development was resisted. Unable to easily tap into international capital markets due to capital controls, investment was just 18.4% of GDP in 2012, not nearly enough to build the airports, seaports, rail lines and motorways it needs to escape middle income stagnation and pay for an aging population. Competitiveness was lost; productivity levels went down from 2000 to 2012 while India, China and Russia’s went up.

If that doesn’t mean much to you, consider this: the same domestic appliances and cars cost 50% more in Brazil than in the United States. For everyday items like toothbrushes and toys, it is even higher than that. The tax burden, at 36% of GDP, is amongst the highest in the world. According to a McKinsey report, a mid-sized firm takes 2600 hours to prepare their annual taxes, ten times the global average.

Argentina is even worse. The government has so repeatedly lied about official economic indices that the IMF censured it this year, threatening a complete cut off from international money markets. A friend in Argentina recently told me that the black market rate for dollars was over twice the official rate. “Dollars are like gold dust here” he explained without a hint of exaggeration. It doesn’t stop there. Taxes on goods bought abroad are subject to a 20% tax “to prevent capital flight”, a phenomenon which ironically only happens when people don’t trust the government. The government has restricted imports on a long list of items, ostensibly because a friend of the president manufactures something similar. Investor confidence is down the drain, companies can no longer compete, consumers are getting shoddy products, basic goods such as shampoo and diapers are scarce and thus too expensive for many families.

Venezuela is the worst of the three, if only because it managed to mess everything up despite vast oil wealth (by some estimates the world’s largest reserves). During his 14 years in power, Chavez practically dismantled every economic entity he could not directly control. His “21^st century socialism” has given the Venezuelan people a 45% inflation rate, daily brownouts and bare supermarket shelves. Prices are controlled, exchange rates are controlled, the movement of money is controlled; the economic distortions are nothing less than Stalinesque. And yet instead of facing the music, Nicolas Maduro blames the food shortages, the inflation, power cuts and other indicators of economic malaise as an American “economic war”. It responded to toilet paper shortages with a military takeover of a toilet paper factory, shutting down production. It’s revolting.

Even if we disregard the inhumanity of sapping human potential, the dire economic consequences of Bolivarianism too often leads to violent conflict. In June, Brazil was under siege as thousands of protesters demonstrated against rising inflation, a flat lining economy and money squandered on lavish stadiums and the politically connected contractors who build them. In Argentina, Cristina Fernández de Kirchner’s Peronist party received a shellacking in October’s mid-term elections. It is a testament to the resilience of the Argentine people and their faith in democracy that they vented their frustration at 25% inflation, Marxist economic policies and the president’s crusade against the judiciary and independent media through the ballot box and not on the streets. She still has two years in office though and further economic deterioration, which is almost certain, could very well lead to an outbreak in violence. In Venezuela, the wholesale handout of oil revenues is the only thing keeping the government from being violently overthrown. Even so, Maduro’s ascent to the presidency in May was marred by electoral violence. Further social unrest is inevitable in a country ranked 168^th out of 176 countries on Transparency International’s corruption index and whose capital, Caracas, is one of the world’s most violent. Peace isn’t an end in itself but a means to development and prosperity. By sowing the seeds of violence however these three countries are denying their people the opportunity to better their lives and improve the human experience.

You see, ultimately it is not the president, the generals, the oligarchs, the tycoons or police chiefs that suffer from economic mismanagement. They will engage in rent seeking (obtain some reward, a bribe for example, in exchange for access to an artificial privilege), avoid taxes by parking their money off shore and send their children to private schools and hospitals abroad. It is the ordinary people who suffer, see their savings inflated away, their businesses expropriated, trust in institutions eroded, great ideas squandered and find hope for a better future as elusive as an honest Argentine statistic.

It is thus time to enshrine the free trade of goods and services across borders, the free movement of capital, non-punitive taxation, market set prices, transparent government budgets and the accurate representation of economic indices as human rights, with their breach constituting crimes against humanity. Crimes against humanity are defined by the Rome Statute of the International Criminal Court as being “particularly odious offenses in that they constitute a serious attack on human dignity or grave humiliation or a degradation of human beings.” The economic mismanagement examples described above clearly fall within this definition.

It is time to disconnect international justice from crimes of physical aggression and incorporate incompetence, fraud, corruption and negligence as punishable offences. The duty to protect should apply equally to victims of murderous dictators (like it did and does in Serbia, Libya and Syria) as to the citizens of slave state communist kleptocracies like North Korea, Cuba and Venezuela. I get that in developed countries there will be a lot less of an impetus to intervene, that’s the duty to protect, when a foreign nation descends into a socialist nightmare than when children are being gassed, not that the latter guarantees intervention either. A breach of a human right need not lead to invasion, but it should warrant international condemnation and censure. The first step is acknowledgement. The international community needs to name and shame violators, it needs to fund opposition groups, it needs to freeze the assets of the ruling elite and it needs to deny the regime legitimacy until reforms are enacted. Sanctions only perpetuate economic disenfranchisement and so should rarely be used.

The status quo is unacceptable. Too many of our fellow human beings are daily denied the opportunity to better their condition because of artificial barriers to progress. We need to do something. Enshrining a broad conceptualisation of liberal economics as human rights would not fix everything but it would be a first step off the road to serfdom.

References:

‘Gaucho blues’, The Economist, Apr 13th 2013 Buenos Aires

‘Grounded’, The Economist, September 28^th 2013 London

‘Maduro’s balancing act’, The Economist, September 28^th 2013 Caracas