Tag Archives: trade

The world’s largest free trade area is being negotiated and it’s taking place behind closed doors

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Chances are, you probably haven’t heard about the TTIP.  Last month the fourth round of the Transatlantic Trade and Investment Partnership (TTIP) negotiations took place between the US and EU.  These so-called ‘secretive talks‘ have been hailed as an ‘assault on democracy’ by some commentators.  Indeed, the negotiating mandate for the EU remains a restricted document, but what is the TTIP and why is it causing such a stir?

The Goals of the TTIP

The main aim of the TTIP is to remove a number of trade barriers between the EU and US ‘to make it easier to buy and sell goods and services between the EU and the US‘.  The negotiations will not only focus on removing traditional barriers to trade such as tariffs but they will also attempt to remove so-called non-tariff barriers (NTBs) to trade.   NTBS refer to prohibitions, conditions or specific market requirements that make the importation or exportation of products more costly or difficult.  NTBs between two trading partners can arise in a number of different forms examples include, differences in domestic testing standards, differences in mandatory labelling requirements and divergent customs and administrative procedures.  The TTIP has highlighted NTBs in a number of key sectors including chemicals, pharmaceuticals, automobiles and cosmetics.

What are the Potential Benefits from the TTIP?

NTBs can impact upon trade in to two ways.  Firstly, NTBs can restrict market access through traditional methods such as import quotas.  Such quotas can restrict supply of foreign goods into the domestic market and thus impact consumers through higher prices.  Alternatively, NTBs can raise the costs of doing business for firms by, for example, necessitating the costly reconfiguration of products to meet stringent technical standards.  Such regulations can make foreign firms less competitive in a domestic market.  The EU states that costs of dealing with unnecessary bureaucracy is the equivalent to adding a tariff of 10-20% to the price of goods, an extra expense which is paid by the consumer.

A number of studies have predicted that the elimination of both tariffs and NTBs, and thus a move towards regulatory convergence between the US and EU, could significantly boost trade between the two economic powers.  For instance, CEPR argues that:

An ambitious and comprehensive transatlantic trade and investment agreement could bring significant economic gains as a whole for the EU (€119 billion a year) and US (€95 billion a year). This translates to an extra €545 in disposable income each year for a family of 4 in the EU, on average, and €655 per family in the US.

In addition, CEPR states that EU exports to the US could increase by 28% (equivalent to an extra €187 billion of EU exports) whilst an earlier study, conducted by Ecorys in 2009, argues that the deal could lead to gains in GDP of 0.7%  and annual wage increases of 0.8% for the EU. German think tank Bertelsmann Foundation takes a different approach by stating that the European countries that currently have the most trade with the U.S. will gain the most from the agreement.  The countries set to benefit most are listed below.

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Source: Wilson Centre, America’s Trade Policy

Overall the results of the study, show that the deal could lead to increases in GDP of up to 4.82% and 1.31% for the US and EU respectively (figures derived from the study by OFSE).

So the TTIP is a win-win situation?

Not exactly, although the TTIP sounds good in theory some have challenged the methodologies applied for by these studies.  The most comprehensive criticism comes from a recent study by the Austrian Foundation of Development Research.  The authors argue that the studies focus mainly on the large overall gains of the TTIP, whilst failing to point out that such benefits are only projected to accrue over a period of around 10 to 20 years.  Consequently, even in the most optimistic scenario for the EU, the gains would amount to only 0.13% growth in GDP annually (1.31% spread out over the lower bound of ten years).

In addition, the authors argue that many of the studies fail to highlight the social issues that could arise due to the deal.  For instance, the elimination of NTBs and the adoption of a common regulatory standard could require to a loosening of regulations in the EU.  This could lead to a welfare loss for society as public policy goals such as consumer safety, public health and environmental safety are compromised.  For instance, in the US only eleven substances are restricted in cosmetics compared to over 1300 in the EU (Euractiv.com).  Adopting the lower standard in many industries could therefore have implications for consumers.

The authors also point out that the macroeconomic adjustment costs – in terms of unemployment, changes to the current account balance and losses of public revenues –  could be substantial.   For example, tariffs are important income source for the EU – in 2012 roughly 12% of the EU budget was financed by tariffs.  The report states that the loss of tariff revenues from US imports could lead to a permanent annual revenue loss of 2.7% for the EU budget.

A much bigger issue at stake?

Despite the economic concerns many argue that there is a much bigger issue at stake, namely investor-state dispute settlements (ISDS). With the US pushing for its inclusion in the deal, ISDS has become the main source of disagreement between the negotiators.  In essence, ISDS empowers foreign investors to challenge national authorities in international courts, in order to claim financial compensation if they deem that their investment potential (and related profits) are being hindered by regulatory or policy changes that have occur at the national level.

ISDS are controversial for many reasons.  For instance, in 2011 tobacco giant Philip Morris sued the Australian government over a new law making plain packaging mandatory on cigarettes, stating that the plan violated a bilateral investment treaty.  Critics claim that ISDS challenges a country’s sovereignty through non-transparent and unaccountable arbitration tribunals which bypass the national court system.

The TTIP therefore raises some important issues for the EU.  To date the EU has launched a public consultation amid concerns, however the lack of transparency within the deal leaves, for many, alot to be desired.  As the largest bilateral trade deal ever attempted it begs the question whether the public should have more of a say on such a deal.

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When Economists Get It Wrong! The Worst Economic Predictions Of All Time

Economics is often described as the ‘dismal science’. Unlike other traditional sciences, economics rarely provides a simple solution to present day issues. Furthermore economists have a poor record of predicting the future. Even notable economists such as Joe Stiglitz agree that economists only get it right at best around 3 or 4 times out of ten. However it should be acknowledged that economic forecasting is a difficult art at best – human behavior is forever changing and the economy is a complex mechanism with many working parts. Nevertheless I thought it would be entertaining to highlight some of the most wildly inaccurate forecasts in recent times. Here are some of the best…

1. The Great Depression

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Almost every economist failed to predict the great crash of 1929. Most famously the economist Irvine Fisher (who Milton Friedman regarded as “the greatest economist the United States has ever produced”) predicted that stock market prices had reached “what looked like a permanently high plateau”. A week later the stock market crashed and didn’t bottom out until 1932, with the Dow Jones recording a 88% total loss in value.

Even the great John Maynard Keynes failed to see the fore-coming shock allegedly stating in 1927 that “We will not have any more crashes in our time.” 

2. The Japanese Automobile Industry

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In 1968 the BusinessWeek magazine stated that, “With over 15 types of foreign cars already on sale here, the Japanese auto industry isn’t likely to carve out a big share of the market for itself.” Fast forward to the present day and Japanese car manufactures now account for around 36% of the total US car market. Add in other Asian car makers and this figure jumps spectacularly to around 49.9%

3. The Soviet Economy

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In 1989 nobel winning economist Paul Samuelson asserted in his best selling textbook Economics that, “The Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and even thrive.” Two years later the Soviet economy collapsed.

4. Dot Com Bubble

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Numerous predictions failed to foresee the dot com bubble. For instance in 1999 Smart Money magazine highlighted AOL, Yahoo and MCI WorldCom as some of its top picks for the forthcoming year. By 2001 AOL had lost 70% of its stock value after its merger with Time Warner. Later in 2002, MCI WorldCom became involved in one of the largest bankruptcy cases the US had ever seen.

However no prediction about the Dot Com boom was as profound as that made by James Glassman and Kevin Hassett in 1999. In their book, “Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market”  Glassman and Hassett argued that the Dow Jones Industrial Average may rise to 36,000 within just a few years.  After reaching an initial high of 1,750.28 in January 2000, the Dow Jones fell to a low of low of 7,286.27 in October 2002. Even today the average remains still below 15,000. Glassman and Hassett’s book can now be found on Amazon for $0.01.

5. The Credit Crunch and Financial Crisis.

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In 2008 the sub prime mortgage crisis led to the collapse of a number of financial institutions and a global economic recession. However before 2008 many economists had an optimistic outlook for oncoming years, growth had been steady and inflation was finally under control. Despite the impending financial crisis many economists and policymakers were contend with the health of the banking sector. 

For instance in 2005 Alan Greenspan declared, “The use of a growing array of derivatives and … more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions … Derivatives have permitted the unbundling of financial risks”.  

Similar optimism was forwarded by individuals such as David Lereah, chief economist for the National Association of Realtors, who in February 2006 published “Why the Real Estate Boom Will Not Bust,” which was essentially a guide for homeowners on how to profit from the expanding real estate market!

However these predictions fall short in comparison to the statement made by Federal Reserve Chairman Ben Bernanke  in 2007 who famously declared that, “The impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

 

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Combating Deflation – The Japanese Experience

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The recent announcement by Japan’s new central bank governor Haruhiko Kuroda to engage in a new round of quantitative easing and combat deflation has been met with a rather positive response. This round will increase the monetary base by around 60 to 70 trillion yen a year. The monetary base will increase from the current 29 per cent of GDP to 55 per cent by the end of 2014,  but such a policy does not come without risks.

Firstly we must ask why deflation is such a problem. In the scheme of things a falling price level is good for everyone, right? Well unfortunately deflation can lead to a spiral of reduced demand, production and prices, known as an deflationary spiral. If prices are falling one might ask themselves, “why should I buy now when next week or even next year the price of the item will be lower?” This may lead consumers to withhold demand, lower demand in effect leads to lower prices and at lower prices businesses will be willing to produce less. This in turn leads to lower wages and again decreased demand and the process continues…

Policy makers further fear deflation because it typically renders traditional fiscal policy ineffective. To boost the aggregate demand and prices, central banks will lower nominal interest rates to stimulate investment and make saving less attractive. However if deflation is present the real rate of interest, that is the nominal rate minus the level of inflation, may become negative. This is because the central bank can only lower interest rates to a floor of 0% and not beyond. Doing so would mean that banks would be effectively paying borrowers to borrow from them. Consequently traditional methods of monetary policy become ineffective when interest rates reach 0% in the face of deflation.

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Japan’s experience with deflation began in the 1990s after it the collapse of the real estate and stock asset bubble in 1990. During the 1980s the Japanese economy had been booming and this had led to a substantial increase in the amount of available credit. As a result assets such as stocks and real estate inflated well above their intrinsic values whilst banks continued to lend to investors. When the prices collapsed in 1990 triggered by the an interest rate hike, many banks were left with a large proportion of bad loans. The economic slump meant many firms could not repay their loans and furthermore the the banks could not retrieve the full value of their loans because the price of the collateral (real estate) had declined sharply. Instead of accepting these losses and liquidating these malinvestments the banks were propped up by the government in the hope that asset prices would recover. This in effect tied up essential economic resources and led to a marked decrease in domestic investment. This is the beginning of what most commentators have began to call the lost decade.

Since this crisis Japan has been marred by further crises which have hit aggregate demand and thus put deflationary pressure upon prices. Such crises include the Japanese financial crisis and Asian financial crisis in the latter half of the 1990s; the collapse of the US dot com bubble in the early 2000s and most recently the 2008 global financial crisis. All of which have damaged the Japanese financial system and its ability to provide capital.

In addition to this other factors have hurt demand whilst supply has increased. For instance, the rising cost of imports for many Japanese firms has meant that they have been forced to streamline operations and cut costs. This has meant many job losses despite increases in labour productivity. As the graph below shows, taken from Musha research, wages have fallen significant since 1990 despite increased productivity which goes strictly against micro economic theory.

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Japanese firms have realised that they can cut investments in labour because productivity has increased. The result is an excess supply of labour which has driven down wages and ultimately consumption. The above factors have all contributed to the deflationary output gap, meaning aggregate supply is outpacing aggregate demand.

To deal with deflation the Japanese have resorted to a unconventional form of monetary policy named quantitative easing. Quantitative easing works through the central bank purchasing financial assets such as bonds, in an effort to increase the reserves of the banks and hence the money supply. The main difference from traditional open market operations is that the purchases made are long-term rather than short-term bonds and that it has a money supply target rather than an interest rate target in mind.

The Japanese government’s goal here is to stimulate investment and spending in the economy. Furthermore it hopes by increasing the money supply the value of the Yen will decrease thus making Japanese exports more competitive. However as noted earlier the policy has risks both for Japan and the wider global economy.

Firstly if the inflation generated by quantitative easing rises more steeply than wages this could reduce both Japanese living standards and consumption. Devaluing the currency by increasing the money supply could push up the price of Japan’s principle imports – oil and gas. As a result the cost of heating, transportation and lighting would increase thus damaging consumption of other goods. In the worst case scenario the policy of quantitative might  lead to higher than expected inflation or even hyperinflation if too much money is created. Furthermore there little is known about how to stop the process once it does begin to work.

Secondly the such inflationary pressure could increase potentially lead to an increase in interest rates. If this were to happen the cost of servicing Japanese debt could increase considerably making the fiscal position unsustainable. This is extremely relevant for an economy such as Japan with gross national debt sitting at 229.773% of GDP .

However on a more fundamental and global level the policy could lead to a race to the bottom or currency war as other countries rush to devalue their currencies. Japan has now joined both the US and UK in delivering such a policy and other members of the international community have already begun to expressed their concern. Currency wars as seen from history lead to no winners as such crises cause uncertainty and therefore reduce international trade.

In conclusion, it seems that this policy is a short-medium term remedy for Japan’s longer term problems. The country must look at the structural causes of it’s economic stagnation, for instance the “demographic time bomb”, policy mismanagement and issues of accountability and transparency. Japanese business is renown for investing in long term solutions perhaps its time the government took the same approach.

 

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Convergence: The African Evidence?

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So this is only a short post today because I have been working the last 8 days in a row. The graph above, taken from the Economist, shows the recent forecasts by the IMF on African economic growth in the next 5 years. What is surprising from this graph is that 7 of the 10 fastest growing economies in the world are forecast to be African over the years 2011-2015. Could this be further evidence of the Solow growth model’s prediction of convergence? This model predicts that poor countries will tend to catch up or converge to the income levels of rich countries in the long run. Put simply, this is because in capital scarce countries an extra unit of capital increases productivity by a larger amount in comparison to a capital rich country. To visualize this, imagine a company with many workers but no machines, the addition of one machine will increase productivity more relative to the addition of that same machine to a workforce which already has many machines – this is known as the law of diminishing returns.

Transfer this to a global scale and in theory the greatest returns to capital investments should be in those countries abundant in labor but with low levels of capital.  Africa seems to be fulfilling this prediction, the graph predicts that Africa will soon overtake Asia as the fastest growing continent, whilst the western industrialized economies struggle. Whilst much of this growth has been attributed mainly to commodity price increases others have argued that the general macroeconomic climate in Africa is improving . An article  by the McKinsey Global Institute suggests that investment is now increasing due to the fact that governments have undertaken macro and micro economic reforms to increase investment. Additionally it argues the ending of many hostilities has enabled political stability and a safer environment for investment both internally and from overseas.

However Africa’s continued growth and eventual convergence is dependent on a number of conditions. Firstly many African economies are highly geared to natural resource production. Recovering commodity prices since the 2008 global crisis have been a leading driver of growth in many African economies, however such prices are vulnerable  to collapse and exhibit high levels of volatility.

Secondly many African countries are still lacking the institutional frameworks to sustain long term growth. Corruption, anti-competitive practices and state capture are still rife over the continent and this needs to be addressed. However this is improving with 36 out of 46 governments making it easier to conduct business in their respective countries according to the World Bank.

Lastly climate change may pose a significant challenge to this continuing growth. It is believed that such change is making farmland more arid and wet areas wetter. The world bank forecasts that 9-20% of Africa’s arable land will become less farmable by 2080. Furthermore increased incidences of flooding may cause substantial economic damage. For example in the year 2000 flooding in Mozambique cost the country an estimated $550 million and lowered the national GDP by 1.5 percent.

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Austerity – Time to admit defeat? Part 2

So looking back to my earlier blog the inevitable has happened, the UK has lost its AAA credit rating, surprise, surprise! It was just a matter of time but what does the loss mean to us? Well not a lot actually and this is the point. The chancellor has been using this rating to justify the drastic cuts the country has experienced, in order to reassure the markets. The reality is however that Britain is still seen as a safe haven for investors and in addition many other major countries such as America and France have also lost their AAA ratings. This means that the government will still be able to borrow at low costs for a while yet. So what has went wrong?

Well firstly you will here a lot from the chancellor about ‘the mess the last labour government left the country in’, however when the coalition was installed the economy was recovering albeit slowly. However at this time the chancellor decided to raise VAT this as argued in a recent guardian article wiped 1% of GDP annually by flat lining demand.

To further reduce aggregate demand in the economy, the government set about cutting spending in many areas, all in the name of reducing the deficit and reassuring the markets. However the total amount of debt in the economy has increased. Why? Well when the economy is shrinking tax receipts tend to go down whilst government spending on areas such as unemployment benefits increase. This is, in the classic Keynesian view, why cutting spending during a recession is self defeating. 

The government has hoped that monetary policy through lower interest rates would counteract this fall in demand. It was also hoped that these lower rates would devalue the pound and make UK exports more competitive. However progress has been slow and the UK is still running a large deficit in its balance of payments. Demand in the global economy is at a low and therefore the gains from a currency devaluation are small. Even more worrying is that during a time when we are trying to re balance our economy towards net trade, David Cameron is proposing a referendum on the EU, the UK’s largest trading partner.

These facts again leave an observer like myself dumbfounded. Whilst monetary policy has failed to deliver the goods, Austerity hasn’t worked and if anything it has exacerbated the problem. Demand within the economy is flat, total national debt is higher than ever and the UK has lost its AAA credit rating. Its time for the government to hold its hands up and admit that an injection of spending is needed to kick start demand and economic growth as argued by prominent economists such as Joe Stiglitz. Ultimately economic performance is what will determine the confidence of the markets and thus the UK’s credit rating.

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China – a country example of the Kuznets Curve in the making?

So its Valentines day. With my girlfriend away and another 9 hour shift at work finished I’ve decided to talk about inequality! After reading this article (http://theconversation.edu.au/china-tackles-income-inequality-but-is-silent-on-state-corruption-12065) the other day it struck me that China may be fulfilling the predicted Kuznets Curve.

Observed by Simon Kuznets in 1955, the Kuznets Curve predicts that inequality within a country will follow a determined path as it develops. At low levels of income, countries may exhibit traditional industries such as subsistence farming which generates low levels of inequality. However as a country urbanizes and industrializes, income accrues to the owners of physical and human capital (e.g. factory owners and university graduates) causing inequality to rise. As more and more individuals are drawn into cities from the rural countryside, there may be calls for democratization and welfare policies. Furthermore there may be the emergence of trade unions as factories and cities allow workers to easily conglomerate and effectively organize themselves. The result is that inequality decreases leading to an inverted U-Curve as shown below.

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Originally observed as a cross sectional relationship over many countries, the Kuznets curve has been disputed by many as they argue that the relationship depends on the inclusion of Latin American countries – which typically exhibit high levels of inequality. In addition some developed countries such as the UK and United States have been exhibiting rising levels of inequality in the past decade. The curve is important because it represents the search for an implacable law of development.

It seems China may be about to follow this path. For instance in the late 1970s China’s Gini coefficient, an indicator of income inequality that lies between 0 (perfect equality) and 1 (perfect inequality), hovered around 0.27. Back then the economy was largely agriculturally based and socialist. However after years of rapid growth and industrialization the country now exhibits a gini coefficient of 0.474 whilst some unofficial estimates have been as high as 0.61.

Interestingly though the article asserts that the Chinese government has now introduced a number of reforms to combat inequality. Notably it points out that the reforms are in response to the need to maintain social stability amid concerns of rising inequality. So here we maybe seeing the Kuznets Curve in action and it will interesting to see if inequality in China does truly decrease over the next few years, more importantly I believe this may be the start of a long process of democratization in China. On the other hand it does show that the hypothesis is ultimately dependent on a number of conditions such as government action.

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