International – Donald Marron

Can Trump Make Mexico Pay for the Wall?

Mexico won’t willingly write the check for Donald Trump’s wall. So the president is hunting for a way to make Mexico pay.

That search isn’t going well.

Last week, press secretary Sean Spicer floated one idea: the destination-based cash flow tax. The DBCFT taxes imports and exempts exports. We import about $50 billion more from Mexico each year than we export. So the DBCFT could raise substantial revenue from trade with Mexico. Maybe Trump could earmark that money to pay for the wall?

Such earmarking sounds superficially plausible. But it has fundamental budget and logic flaws.

The budget problem is that Congress has other plans for that money. The DBCFT is the centerpiece of the House proposal for tax reform. House leaders insist reform will be revenue neutral. Any new money from the DBCFT will offset money lost from cutting business taxes. That leaves nothing for Trump’s wall.

Broader point: You can’t pay for anything with revenue-neutral tax reform (or, for that matter, with revenue-losing “tax relief”).

Trump may be more concerned with messaging than with these budget niceties. So he could still try to rhetorically link the DBCFT to paying for the wall.

But that leads to the logic problem. We run trade deficits with many countries. If the DBCFT makes Mexico pay for the wall, what does it make China pay for? Germany? Japan? Vietnam? And what about countries like Hong Kong, where America has a trade surplus? Are we paying them for something? And what happens when the wall has been paid for? Does Mexico become exempt from the DBCFT? Or does it start paying for something else?

These questions have no sensible answers. The DBCFT treats Mexico like every other nation, so it can’t make Mexico pay for the wall.

Some observers initially thought Spicer was suggesting a new tariff on Mexican imports. Most economists rightly hate that idea and fear it could spark retaliation against American products. And it seems clear that Spicer really meant the DBCFT. But let’s give that interpretation some credit. A tariff, unlike the DBCFT, could raise new revenue specifically from trade with Mexico.

But a tariff still faces a fundamental economics problem. A tariff doesn’t work like Las Vegas. Just because it targets Mexican products doesn’t mean the tax stays there. Instead, businesses will raise prices, passing some tax on to American customers. Consumers would pay more for cars, TVs, and avocados. Businesses would pay more for auto parts, trucks, and telecommunications equipment. Some burdens would decline over time as businesses shift to suppliers outside Mexico. But some shift of the burden to Americans is inevitable. A tariff would thus make American consumers and businesses, not just Mexicans, pay for Trump’s wall. And that’s without any retaliation.

If President Trump wants to target Mexico alone, he needs another strategy. Neither the DBCFT nor a tariff can make Mexico pay for the wall.

The Egalitarian, Cosmopolitan Core of Economics

Economists are often criticized for a worldview that emphasizes, and sometimes encourages, selfishness. In today’s NYT, Tyler Cowen highlights another, less-discussed aspect of that worldview, its deep tradition of egalitarianism:

If you treat all individuals as fundamentally the same in your theoretical constructs, it would be odd to insist that the law should suddenly start treating them differently.

As I’ve argued before, one way this manifests itself is in economists’ generally cosmopolitan view of immigration. As Tyler explains:

A distressingly large portion of the debate in many countries analyzes the effects of higher immigration on domestic citizens alone and seeks to restrict immigration to protect a national culture or existing economic interests. The obvious but too-often-underemphasized reality is that immigration is a significant gain for most people who move to a new country.

Michael Clemens, a senior fellow at the Center for Global Development in Washington, quantified these gains in a 2011 paper, “Economics and Emigration: Trillion-Dollar Bills on the Sidewalk?” He found that unrestricted immigration could create tens of trillions of dollars in economic value, as captured by the migrants themselves in the form of higher wages in their new countries and by those who hire the migrants or consume the products of their labor. For a profession concerned with precision, it is remarkable how infrequently we economists talk about those rather large numbers.

Truly open borders might prove unworkable, especially in countries with welfare states, and kill the goose laying the proverbial golden eggs; in this regard Mr. Clemens’s analysis may require some modification. Still, we should be obsessing over how many of those trillions can actually be realized.

IN any case, there is an overriding moral issue. Imagine that it is your professional duty to report a cost-benefit analysis of liberalizing immigration policy. You wouldn’t dream of producing a study that counted “men only” or “whites only,” at least not without specific, clearly stated reasons for dividing the data.

So why report cost-benefit results only for United States citizens or residents, as is sometimes done in analyses of both international trade and migration? The nation-state is a good practical institution, but it does not provide the final moral delineation of which people count and which do not. So commentators on trade and immigration should stress the cosmopolitan perspective, knowing that the practical imperatives of the nation-state will not be underrepresented in the ensuing debate.

Read his whole piece.

After 20 Years, Sweden’s Labor Market Still Hasn’t Recovered

By many accounts, Sweden did a great job managing its financial and fiscal crises in the early 1990s. But more than 20 years onward, its unemployment rate is still higher than before the crisis, as noted in a recent commentary by the Cleveland Fed’s O. Emre Ergungor (ht: Torsten Slok):

And its labor force participation rate is still lower:

Does Sweden’s experience portend similar problems for the United States? Ergungor thinks not. Instead, he attributes this shift to a structural change in Swedish policy that has no direct analog in the United States:

One study of public sector employment policies published in 2008 by Hans-Ulrich Derlien and Guy Peters indicates that for many years, the labor market had been kept artificially tight by government policies that replaced disappearing jobs in failing industries with jobs in the government. The financial crisis was the breaking point of an economic system that had grown increasingly more unstable over a long period of time. It was a watershed event that marked the end of an unsustainable structure and the beginning of a new one. Public sector employment declined from 423,000 in 1985 to 240,000 in 1996 mainly through the privatization of large employers—like the Swedish postal service, the Swedish Telecommunications Administration, and Vattenfall, the electricity enterprise—and it has remained almost flat since then.

With such a large structural change, what came before the crisis may no longer be a reference point for what will come after. Having corrected the root of the problem, the Swedish labor market is now operating at a new equilibrium.

That doesn’t mean smooth sailing for the United States, as he discusses. But it does leave hope that perhaps we do better than Sweden in creating jobs in the wake of a financial crisis.

How Creative Tax Policy Can Substitute for Devaluation

Taxes are the Swiss Army Knife of economic and social policy. With enough ingenuity, you can attempt almost any policy goal, from encouraging health insurance to discouraging pollution to stimulating the economy, to name just three. Over at Bloomberg Businessweek, Rina Chandran explains yet another use: helping a troubled economy achieve the moral and economic equivalent of a currency devaluation, without actually devaluing. That’s particularly intriguing for countries in the Euro zone:

The idea of fiscal devaluation originates with John Maynard Keynes. [Harvard Professor Gita] Gopinath’s insight was to advocate fiscal devaluation for Europe’s beleaguered currency union in a 2011 paper she co-authored with her colleague Emmanuel Farhi and former student Oleg Itskhoki, now an assistant professor at Princeton. …

The paper examines a “remarkably simple alternative” that doesn’t require countries to abandon the euro and devalue their currencies to revive growth through exports, Gopinath says. By increasing value-added taxes while cutting payroll taxes, a government can affect gross domestic product, consumption, employment, and inflation much as a currency devaluation would.

The higher VAT raises the price of imported goods as foreign companies pay the levy on the products and services they export to that country. The lower payroll tax helps offset the extra sales tax for domestic companies, reducing the need for them to raise prices. Since exports are VAT-exempt, the payroll cost saving allows producers to sell goods more cheaply overseas, simulating the effect of a weaker currency, according to the paper. The policy also can help on the fiscal front, as increased competitiveness can lead to higher tax revenue, Gopinath says.

Why Many Economists Favor Immigration

In today’s New York Times, Greg Mankiw offers a nice explanation for why many economists favor immigration:

First, many economists, especially conservative ones, have a libertarian streak. Ever since Adam Smith taught us about the wonders of free markets and the magic of the invisible hand, we have been loath to prohibit mutually advantageous trades between consenting adults. If an American farmer wants to hire a worker to pick fruits and vegetables, the fact that the worker happens to have been born in Mexico does not seem a compelling reason to stop the transaction.

Second, many economists, especially liberal ones, have an egalitarian streak. They follow the philosopher John Rawls’s theory of justice in believing that policy should be particularly attuned to its impact on the least fortunate. When thinking about immigration, there is little doubt that the least fortunate, and the ones with the most at stake in the outcome, are the poor workers who yearn to come to the United States to make a better life for themselves and their families.

Third, economists of all stripes recognize that our own profession has benefited greatly from an influx of talent from abroad.

I’d add a fourth item to Greg’s list: Many economists, both liberal and conservative, have a cosmopolitan streak. They thus place great weight on the wellbeing of foreigners, not just native Americans. From the libertarian side, that means caring about the liberty of the Mexican worker, not just the American farmer. And from the egalitarian side, that means caring about the poor immigrant worker seeking a better life, not just the person who employs them or the resident worker competing for similar work.

Such cosmopolitanism isn’t universal, of course. For example, some economists oppose greater immigration on the egalitarian, but non-cosmopolitan, concern that it would drive down wages for existing U.S. workers. On average, though, that perspective seems less common among economists than among non-economists.

Swedish Lessons for EU Bank Owners

Sweden is rightly admired for the way it handled its banking crisis in the early 1990s (and its ensuing fiscal challenges).

In yesterday’s Financial Times, Dag Detter looks back for some lessons for Europe as it struggles to resolve its current banking crisis:

When the Swedish banking system crashed in 1992, the government faced an identical problem. Yet in the end, Sweden’s taxpayers came very well out of their experience of bank ownership. How was this achieved, and what lessons can be learnt for Madrid and the EU’s new bank resolution policy?

First, move fast. Spain and bankers have been in denial about the scale of bad lending for too long. The Rajoy government rightly came to office this year on a promise to force banks to write down bad loans. The situation has predictably turned out to be much worse than assumed, but their policy is the right one. Painful as it is, transparency on the scale of bad debt is vital for the market to be confident that it understands risk and uncertainty in Spain and can therefore price it properly.

Catharsis can come only with a purge of bad assets. Banks should present plans to handle problem assets, strengthen controls and improve efficiency. This might require government or even supranational assistance in the orderly closure of moribund institutions. In addition, “bad” bank parts must be demerged from the “healthy” to facilitate recapitalisation. The state should never be left holding the junk while the healthy part of a bank wriggles free.

Second, maintain commercial principles. In Sweden, each state bank investment was made on what would have been commercial terms in a normal market, always with the aim of maintaining competitive neutrality. The terms of the investment must be structured in a way that gives the bank and its owners no grounds to request more state funding than is necessary, combined with the incentives to facilitate a swift exit. Yet it must be sufficient to ensure that the bank can return to profitability without additional government assistance.

The whole piece is worth a read.

Will September Bring Another Banking Crisis?

Over at the Economist, Greg Ip points us to a new IMF working paper that surveys all the systemic banking crises–147 in all–since 1970. As Greg notes, one of Luc Laeven and Fabian Valencia’s most striking findings is that banking crises disproportionately begin in the second half of the year, with a particular spike in September:

So let’s enjoy what few days of June remain.

P.S. Theories to explain this pattern are appreciated. Or maybe it’s a spurious correlation, at Tyler Cowen hints.

Update: Joshua Hedlund at PostLibertarian crunches the underlying data and finds that (a) the authors provided a date for only 63 of the crises and (b) that 22 of the 25 in September happened in 2008. ht: Tyler Cowen

Financial Repression and China’s Extractive Elite

Financial repression and extractive institutions are two of the big memes in international economics today.

Financial repression occurs when governments intervene in financial markets to channel cheap funds to themselves. With sovereign debts skyrocketing, for example, governments may try to force their citizens, banks, and others to finance those debts at artificially low interest rates.

Extractive institutions are policies that attempt to redirect resources to politically-favored elites. Classic examples are the artificial monopolies often granted by governments in what would otherwise be structurally competitive markets. Daron Acemoglu and James Robinson have recently argued that such institutions are a key reason Why Nations Fail. Inclusive institutions, in contrast, promote widely-shared prosperity.

Over at Bronte Capital, John Hempton brings these two ideas together in an argument that Chinese elites are using financial repression to extract wealth from state-owned enterprises. In a nutshell, he believes Chinese authorities have artificially lowered the interest rates that regular Chinese citizens earn on their savings (that’s the repression), and have directed these cheap funds to finance “staggeringly unprofitable” state enterprises that nonetheless manage to spin out vast wealth for connected elites and their families.

I don’t have the requisite first-hand knowledge to judge his hypothesis myself. But both his original post and recent follow-up addressing feedback are worth a close read.

2,000 Years of Economic History in One Chart … and Another

Michael Cembalest, head of investment strategy at JP Morgan, is famous for his beautiful, insightful charts. His latest (courtesy of Paul Kedrosky) illustrates two millennia of world economic history:

According to the chart, India (orange) and China (red) together comprised more than two-thirds of the globe’s economic activity back in year 1 (well, not so much the globe, but the chosen countries). By 1950, their share had fallen to only one-eighth, thanks to the growth of the United States (green), Western Europe (shades of blue), Russia (gray), and Japan (yellow). Since then, China has been gaining share.

Not surprisingly, the chart has already attracted attention in the blogosphere. Over at the Atlantic, Derek Thompson slices and dices the data to see how much of the pattern reflects the ebbs and flows of population vs. productivity.

At the Economist, meanwhile, K.N.C. channels Edward Tufte, expressing appropriate alarm about the compressed x-axis. The first millennium gets as much real estate as the 1990s. K.N.C. then offers another approach:

Given data limitations, this chart also compresses the x-axis, but using bars and variable-width gaps make it much clearer that there are jumps between years. The focus on a limited number of countries also makes it clear that the chart omits countries that account for 30-40% of world GDP. In Cembalest’s chart, in contrast, one wonders what happened to South America, the Nordic countries, Canada, Africa ex Egypt, etc. His listed countries appear to sum to 100% of world GDP, but large swathes of the world are unaccounted for.

Soros: The European Union is a Bubble

My Twitter feed lit up yesterday with folks recommending a speech by George Soros about Europe. [Link subsequently stopped working, but now it’s back.] They were right. Whether you love him or hate him, he provides a fascinating perspective on Europe’s past, present, and future and, in so doing, provides a particularly clear presentation of his critique of (what he views as) mainstream economics.

The whole speech is worth a read. Here are some excerpts describing his view that the European Union is a bubble:

Among other things, I developed a model of a boom-bust process or bubble which is endogenous to financial markets, not the result of external shocks. According to my theory, financial bubbles are not a purely psychological phenomenon. They have two components: a trend that prevails in reality and a misinterpretation of that trend. A bubble can develop when the feedback is initially positive in the sense that both the trend and its biased interpretation are mutually reinforced. Eventually the gap between the trend and its biased interpretation grows so wide that it becomes unsustainable. After a twilight period both the bias and the trend are reversed and reinforce each other in the opposite direction. Bubbles are usually asymmetric in shape: booms develop slowly but the bust tends to be sudden and devastating. That is due to the use of leverage: price declines precipitate the forced liquidation of leveraged positions.

…

I contend that the European Union itself is like a bubble. In the boom phase the EU was what the psychoanalyst David Tuckett calls a “fantastic object” – unreal but immensely attractive. The EU was the embodiment of an open society –an association of nations founded on the principles of democracy, human rights, and rule of law in which no nation or nationality would have a dominant position.

The process of integration was spearheaded by a small group of far sighted statesmen who practiced what Karl Popper called piecemeal social engineering. They recognized that perfection is unattainable; so they set limited objectives and firm timelines and then mobilized the political will for a small step forward, knowing full well that when they achieved it, its inadequacy would become apparent and require a further step. The process fed on its own success, very much like a financial bubble. That is how the Coal and Steel Community was gradually transformed into the European Union, step by step.

Germany used to be in the forefront of the effort. When the Soviet empire started to disintegrate, Germany’s leaders realized that reunification was possible only in the context of a more united Europe and they were willing to make considerable sacrifices to achieve it. When it came to bargaining they were willing to contribute a little more and take a little less than the others, thereby facilitating agreement. At that time, German statesmen used to assert that Germany has no independent foreign policy, only a European one.

The process culminated with the Maastricht Treaty and the introduction of the euro. It was followed by a period of stagnation which, after the crash of 2008, turned into a process of disintegration. The first step was taken by Germany when, after the bankruptcy of Lehman Brothers, Angela Merkel declared that the virtual guarantee extended to other financial institutions should come from each country acting separately, not by Europe acting jointly. It took financial markets more than a year to realize the implication of that declaration, showing that they are not perfect.

The Maastricht Treaty was fundamentally flawed, demonstrating the fallibility of the authorities. Its main weakness was well known to its architects: it established a monetary union without a political union. The architects believed however, that when the need arose the political will could be generated to take the necessary steps towards a political union.

But the euro also had some other defects of which the architects were unaware and which are not fully understood even today. In retrospect it is now clear that the main source of trouble is that the member states of the euro have surrendered to the European Central Bank their rights to create fiat money. … Due to the divergence in economic performance Europe became divided between creditor and debtor countries. This is having far reaching political implications … .