TOPICS IN POLITICAL ECONOMY

CHINA, CONVERGENCE, AND MARKET CAPITALISM

Most of the noise coming out of this week’s meeting of the  G-20  heads of state in London will be about regulation,  “stimulation” and new barriers to international trade.   But there Is very likely to be one truly significant long-run political outcome: the functional acceptance of China by “the West” as a major financial and economic power.

This acceptance will take the form of communiqué  language that makes it clearer than ever that China’s share of voting power in the International Monetary Fund (and, perhaps, in the World Bank) will be increased substantially within the next two years.  This shift in voting power will be facilitated by a large increase in IMF resources contributed by member governments, most prominently the Chinese.  

The Death of Market Capitalism?  At the same time, noisemakers at the G-20 meetings will add decibels to the continuing funereal chorus from the chattering classes about “the death of market capitalism.” This, despite the fact that China owes its rise to global power thanks to its embrace of the key elements of market capitalism:  market prices to provide incentives to producers and letting individuals own the means of production and grow rich.

Market capitalism is not going to wither away just because financial regulators around the world decide to insist on less risk-taking by (government-supported) financial institutions, such as FDIC-insured banks, “too big to fail” investment banks, and government real estate lending agencies (FNMA and Freddie Mac). 

It was a form of market capitalism that lifted 400 million Chinese out of dire poverty in the fifteen years between 1990 and 2005, and which now makes some pundits muse about turning global leadership over to the “G-2” – the United States and China. 

Why Losing Market Share May Be Progress.  If market capitalism is not dying, then perhaps the U.S. is threatened by China because of a shrinking share of global economic output?  This notion surfaces in numerous discussions about China’s extraordinary economic achievements as well as international comparisons  of spending on research and development,  patents issued, educational achievements and a myriad of other measures.

But the emphasis on “market share” is simple-minded and incorrect, if the absolute level of economic well-being continues to improve.  In this situation, which certainly describes the past 15 years or so, a smaller market share for #1 simply reflects more rapid growth by lower-ranked countries. 

Furthermore, as Nobel prize winning economist Edward Prescott and Stephen Parente have suggested, if all countries would dismantle “barriers to experimentation”  (ranging from civil strife to monopolies to trade protectionism), “there is no reason why the whole world should not be as rich as the leading industrial country.”  In short, China’s progress over the past two decades is a strong argument in favor of what is known as the “convergence” hypothesis among economic growth theorists – as well as market capitalism.

Cut the Bad-Mouthing.  So, when China sits down in a much bigger chair at IMF board meetings in 2011, there is no reason to bad-mouth either the U.S. or market capitalism.  Instead, congratulate the Chinese and remind yourself that it was a form of market capitalism that got them there.

THE POLITICAL ECONOMY OF THE CLIMATE CHANGE "CRISIS"

Something there is in the body politic that loves a "crisis."  And the more widespead the apparent problem, the better.

Some of the many crises we are supposed to be in today include: drug abuse, illegal immigration, Darfur, energy, health care and (where I live, at least) public transit. But the most popular flavor of the moment is "climate change."  And the chief doomsayer is ex-Vice President Al Gore.  This worthy has found a rewarding way to get back into the public eye, the ever-lasting goal of the driven politician. Al's latest foray was the series of "Live Earth" concerts on July 7th.

A Global Governance Stalking Horse?

How nice it is that the sharpest response to the Gore-fronted climate change road show has come from another politician, Vaclav Klaus, born under a communist regime, former finance minister and now President of the Czech Republic.  In a recent Financial Times op-ed, Klaus forcefully argues that those calling for radical measures to "do something" about the weather have an essentially political agenda: "the biggest threat to freedom, democracy, the market economy and prosperity [is] ambitious environmentalism."  Or, as Steven Hayward of AEI put it earlier in his sterling review of the eco-pessimist literature, "global governance for the sake of the environment."

For the purposes of this post, the relevant aspect of the climate change "crisis" is its intellectual antecedents.  Poets have used mankind's demographic and material progress on the planet Earth as evidence of crisis for centuries.  But the first widely disseminated "scientific" crisis alert can be attributed to the Reverend Malthus in 1798.  Transfixed by the law of compound interest as applied to population growth and a pessimist about raising agricultural productivity, Malthus warned that the growth of population would outstrip food supplies by the middle of the 19th century.  His book sold well.

Profitable Pessimism

So did "The Coal Question," published in 1865 by the leading neoclassical economist of the 19th century, William Stanley Jevons.  He argued that England's dependency on increasingly costly coal (as deeper and deeper seams were mined) would lead to that country's economic stagnation.

The first big "scientificially" flagged crisis of the 20th century was generated by The Club of Rome. In 1972 they published "The Limits of Growth," which argued that economic growth would be sharply limited in the very near future by declining supplies of natural resources. They did even better than Jevons, selling 30 million copies in over 30 translations, perhaps because their forecasts were based on a mathematical "systems dynamic" model built by MIT professor Jay Forrester.

Others, such as Paul Erlich and Lester Brown found strong popular demand for their updated Malthusian "population bomb" alerts.  They set up their own 501(c)(3) institutes with foundation monies and are still in business today.

Poor Projections

Unfortunately, as Hayward carefully documents, the doomsday projections of the pessimists ("massive famines," 30 billion people in the world by 2100, etc.) have consistently been shown to be incorrect.  Thus, today the eco-pessimists are careful not to make specific projections for which they can be clearly held accountable.  (Erlich famously lost a bet to economist Julian Simon over the price trend of key metals prices in the 1980s.)

The hard facts are that when individual ingenuity and entrepreneurship are allowed to flourish, standards of living rise and solutions are found for all manner of environmental and resource scarcity problems.  How else can one explain that today there are at least 200 million fewer people living in absolute poverty compared to 30 years ago - and at the same time the world's population has grown by 2.2 billion? (The latest estimate suggests the decline in absolute poverty may be as high as 390 million. See Chen and Ravallilon.)

Science or Politics?

Psychologists tell us that people like to be scared, thanks to the pleasurable adrenaline rush that results from something like a good horror movie.  Maybe this explains the body politic's fascination with the hyothesized perils of climate change.

But maybe the real peril is over-reaction by politicians like Al Gore, and that we should take to heart Vaclav Klaus' stern warning: "the issue of global warming is more about social than natural sciences, and more about man and his freedom than tenths of a degree in average global temperature."

WHERE WILL TURKEY ROOST?

My dictionary defines political economy as “the study of the interrelationships between political and economic processes.” No better example of the complex nexus between these two currents has been Pope Benedict’s visit this week to Turkey. And few countries are as important to the long-run stability in the Middle East as Turkey.

The visit originally was to be focussed on ameliorating the ancient and testy relationship between the Vatican and Orthodox Christians. (In 1204, Latin knights of the Fourth Crusade stopped off in Byzantine Constantinople - now Istanbul - on their way to the Holy Land to seize the city. They ruled the region none too gently for over fifty years.)

Instead, the Pope’s visit came to be seen as a minidrama about “the clash of civilizations” – Christianity versus Islam. But the Vatican pulled the rug out from under warriors on both sides by having the Pope express support for Turkey’s entry into the European Union (despite Benedict’s previous skepticism of such a development), and by his visit to and prayers in the famous Blue Mosque in Istanbul.

A Place in the EU?

At the same time, back in Brussels, the European Union (EU) has apparently decided to slow down the formal negotiating process for Turkish membership due to thorny political problems arising out of Turkey’s occupation of northern Cyprus in 1974. This, despite the fact that Turkey’s close ties with the EU date back to 1970 when it was agreed that they should work towards a comprehensive customs union – an objective that was achieved in 1996. Turkey is now one the EU’s top ten trading partners and roughly half of Turkish imports and exports are with the EU.

Of course, other, more basic issues are also present. The presence of several million Turks in Germany, the Netherlands and elsewhere creates fears of a further massive influx if Turkey becomes a full EU member. And history counts, too: I have had more than one European cite the Ottoman Empire’s near capture of Vienna in 1529 as an argument against “letting the Turks in” today.

The High Politics of Trade

All of which goes to show that entry into the European Union is first and foremost a political decision by both parties, and not a straightforward economic calculus worked up by corporations and economists. As a sometime government official in Washington in the 1970s and 1980s, I became quite familiar how high politics played major roles in creating the Caribbean Basin Initiative (invigorate regional economies to resist the charms and arms of Castro) and NAFTA (build a bloc large enough to counterbalance the growing political strength of the European Union).

If the EU members are smart, they will make sure that Turkey eventually is admitted. Most of the political requirements for membership (reforms of the judiciary, human rights, primacy of civilian ministers over military generals, etc.) have been supported by Western-oriented Turks. Minority groups in Turkey, in particular, the Kurds, have supported membership for these reasons. Economic reforms in line with EU mandates in such areas as energy and telecommunications have been extensive.

Concerns over spreading religious fundamentalism are generally overwrought. Having spent five months in Turkey recently and traveled in different parts of the country, it seems to me that terrorism arising out the Kurdish minority problem (and supported by Kurdish elements in northern Iraq) should be a much larger concern. Under Turkey’s constitution, all religions are closely supervised by the state. Islam is treated in much the same fashion as Catholicism is in France. It is ironic that France, a leading opponent of Turkey’s membership in the EU, is at one with it in prohibiting the wearing of scarves by women in schools and similar public institutions.

The most vocal proponents of letting women wear scarves that I met were Friedmanesque libertarians. The most adamantly opposed appear to be military officers, who cite the Turkish constitution’s “secularism” clauses - although the officers may be more upset over their waning political power.

Where Would Turkey Perch?

Like France, Turkey is a proud and nationalistic country. If membership negotiations were to collapse, we can expect a serious rethinking of where its long-run interests lie. Some will argue for a substantive free trade agreement with the United States, an attractive if difficult to accomplish objective (and one which our policy planners might start thinking about). Others will argue for a reinvigorated Black Sea economic association, with an emphasis on Russia (Russians supply most of Turkey’s natural gas and are now the second largest source of tourists). Finally, derailing membership negotiations is the best way to stop or reverse a multitude of politically liberalizing and economy-opening initiatives, projects in which the EU itself has played an important role.

Maybe similar thoughts entered the heads of Vatican officials and Pope Benedict as they prepared for his visit to the Blue Mosque and the Virgin Mary’s house in Ephesus. It would ironic if it takes a major religious figure from Rome to focus Europe on the high politics of Turkish membership in the EU.

BULLS IN THE CHINA SHOP

So, there goes another $3.1 billion into a wobbly Chinese bank. Last week it was Citigroup and a set of partners, including IBM. In May there was a $10 billion IPO for the Bank of China. Last year it was an $8 billion IPO for the China Construction Bank, which had picked up $3 billion earlier from Bank of America.

There is nothing more dangerous to a financial system than a group of bankers throwing money at poorly run firms in a rapidly expanding economy, particularly if those firms happen to be a another set of banks. Anyone who has read financial history, or who was part of the great developing country debt crisis of the early 1980s, as I was, can attest to this.

Western bankers today explain to their shareholders that the long-run outlook in China is very favorable, that the Chinese government has helped its banks clean up their bad loan portfolios and that as board-sitting shareholders they will make sure the banks are run well. And many of them add the ultimate herd-minded excuse, "everyone else is doing it." No doubt those who have already invested (or helped to underwrite those very large IPOs) are feeling pretty good. But the underlying rationales for sizable long-term equity investments are dangerously weak.

While it is true that the Chinese government has helped its major banks take billions of bad loans off their books, there is precious little evidence that the underlying management culture (and local politics) which generated those bad loans has been reformed. When in China two years ago, I asked the President of a brand new and ostensibly "private" university where the financing for his attractive and rapidly growing campus came from, he said simply, "the banks." I don’t think it hurt that the President was also a member of the provincial Peoples Assembly.

Most of the big Western investors have obtained representation on bank boards, but that is very different from effective control. Citigroup trumpets the fact that the investment consortium in which it is a member will hold 86% of the 500-branch Guangdong Development Bank. However, Citigroup will have only 20% of the shares, while the Chinese state-related companies that are other members of the group will hold the rest, except for IBM’s 5%. When push comes to shove, whether it is getting rid of well-connected but redundant staff, lending to prominent state-owned enterprises or to a local politician’s pet project, it is hard to be optimistic about how such investments are going to work out.

The more general issue is the reality of continuing Communist Party control over key policy decisions affecting the economy. An independent central bank is critical to a healthy economy. In such an environment, free financial markets are in constant judgment, through movements in stock prices and interest rates, on the efficacy of central government economic policy.

Even if such a situation is the ultimate outcome desired by some reformist policymakers, I doubt that the Party will consistently tolerate such a public, constantly updated judgment on how well the government is doing. It certainly is not the way the government is presently trying to slowdown the economy, preferring instead Party and ministerial orders to banks to cut back on lending.

But it looks like the bulls are going to be rummaging in the China Shop for a bit longer. Just don’t expect them to emerge without a few bloody scars.

DUMPING ON "DUMPING"

     Here we go again. Later this month the International Trade Commission in Washington will start reviewing whether, in the absence of special anti-dumping tariffs, imports of clad steel plate from Japan (as well as pasta from Italy and Turkey) would impose "material injury" on U.S. producers of these products. Meanwhile, over at the Department of Commerce, the Import Administration Bureau will conduct back-of-the-envelope exercises to see whether foreign producers are selling below their "cost of production" - on which they tack an arbitrary 10% profit margin.

     The special tariffs on both these products have been in effect for ten years, having already survived one set of five-year "sunset" reviews. What is the likelihood they will be lifted?

     Don’t expect too much support for doing away with the tariffs on pasta. The mis-named Consumer Federation of America is not interested in the cost of spaghetti dinners for working families; they spend most of their time asking for increased government regulation and intervention to protect us from media-whipped crises. And 99.9% of working families probably don’t even know about the tariffs.

     But the steel tariffs are a different issue, because they affect an important, high-value added input for the automobile manufacturing industry. So, this time around the major U.S. automakers are banding together and cranking up their Washington operations to make the case for lifting them. For the three U.S. producers, General Motors, Ford, and Daimler-Chrysler, lifting the tariffs would represent one small but important reduction in their manufacturing costs and in their struggle for survival.

     No doubt U.S. steel producers will trot out their standard arguments in favor of the duties: we need protection to maintain employment and investment, foreigners are violating the law, and similar customary complaints. But the on-going consolidation of the global (and U.S.) steel industry is clearly giving the producers increased pricing power and profitability, and will make the industry’s pleas ring hollower than in the past.

     The irony of anti-dumping legislation is that it was originally conceived as a way to protect buyers, not producers. The theory was that "predatory" pricing on foreign imports would drive all domestic producers out business and permit foreigners to monopolize the domestic market. But in a globalized trading world, this is nearly impossible. International cartels are extremely hard to organize and other laws, such as anti-trust, can generally keep them in check. Current U.S. law, in contrast to, say, Canada, does not even formally require U.S. agencies to consider the impact of anti-dumping duties on consumers.

     When the costs to buyers and the benefits to producers are added up, the net result of anti-dumping tariffs is nearly always a loss for the economy as a whole. For solid evidence, check out the latest study by the International Trade Commission on The Economic Effects of Significant U.S. Import Restraints. In every one of the 16 industries that they examined, the results from dismantling restraints were positive for the U.S. economy as a whole.

     There may be a case for helping some producers (and their workers and communities) adjust to the impact of competitive imports. But anti-dumping duties are the worst way to do this, since they delay rather than facilitate the adjustment progress. The existing Trade Adjustment Assistance program and similar legislation represent an alternative approach. Such initiatives provide training and subsidies for workers laid off due to imports, and help them find alternative employment.

     It’s time to dump the dumping laws.

(For an authoritative critique of U.S. dumping legislation by recent high Bush Administration official, see N. Greg Mankiw and Phillip Swagel article in Foreign Affairs, December 2005.)

WORLD STEEL: GLOBALIZATION RULES

On August first, Mittal Steel, a Dutch-registered, London-based, Indian-managed steel company that did not exist 25 years ago, took control of Arcelor, Europe’s largest producer. All of a sudden, a rank outsider, Lakshmi Mittal, has assembled the world’s largest steel company, with an annual capacity of more than 100 million tons of raw steel or 10% of the global market.

Mittal’s success is another manifestation of how the "Anglo-Saxon" market-based vision of economics continues to displace the statist "national champion" mindset in a world where the forces of globalization dominate.

When Mittal’s bold bid was announced in January, Arcelor tried to rally European politicians behind its campaign to stay independent. French President Jacques Chirac denounced Mittal’s bid as "purely financial, devoid of any industrial objective." Belgian and Luxembourg officials grumbled and talked about legal strategies to derail the bid. Arcelor tried to bring in a Russian "white knight," but found that control of the company was now being exercised by a multinational array of shareholders (including hedge funds) rather than managers or politicians. In the end, Mittal raised his offer to roughly $33 billion, a 40% improvement from the initial offer in January.

In recent decades, no manufacturing sector has been more influenced by political forces than the global steel industry, partly because of its traditional association with national defense. In many countries, governments owned the major producers; in most countries, trade barriers attempted to keep imported steel from putting inefficient domestic producers out of business. Government loans kept bankrupt firms in business long after they should have disappeared. As a result, compared to other major industrial sectors, the global steel industry was highly fragmented, burdened with overcapacity, and slow to adopt new technology and management processes.

Not all of the above impediments have disappeared: steel producers still have a tendency to run to government whenever imports threaten their profit margins. But the forces of globalization and the energy of individuals like Lakshmi Mittal and the American financier, Wilbur Ross (who helped to consolidate the U.S. industry) have finally brought the industry and most of the politicians into the modern age.

The drivers of globalization – the dismantling of barriers against international movement of goods, services, and finance, the collapse of the socialist model of production, and the deployment of radically new technologies in communications and transportation – continue to reshape patterns of production and ownership on a world scale. This reshaping has provided an extraordinary impetus to economic growth in many countries - and has helped to lift millions of individuals out of poverty, even as it has disrupted the livelihoods of many others.

In steel, as in every other industry, the reshaping process is far from over. The integration of Japanese, Korean, Russian and Chinese firms into a coherent global structure has just begun. It makes less and less sense to move vast amounts of iron ore and coal around the world to make hot metal in the United States and Europe instead of shipping steel slabs from Brazil or Russia to those destinations. So, more change is in prospect.

For as long as globalization rules and stimulates industry adjustments, the average person in the world is likely to enjoy gradually increasing living standards and longevity. But the economic growth that underlies these trends is "inherently a byproduct of change," as Rosenberg and Birdzell have pointed out in How the West Grew Rich. And the resistance to change, whether from anti-globalization protestors or entrenched commercial interests must never be underestimated.

(For more background on the globalization of the steel industry, see my 1999 paper, "American Steel and International Trade: The Challenge of Globalization.")