China’s Remarkable Recovery From the Great Recession, and Implications For Its Future

Although China was hit hard by the Great Recession, its economy rebounded very quickly. Why?

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The Great Recession was a period marked by a sharp decline in economic activity, beginning in December 2007 and lasting officially until June 2009. It started in the United States when the housing market crashed, but contagion effects spread to the United States’ trading partners, one of the biggest of which was China. China’s economy relies hugely on exporting their goods overseas, and when American households lost about $16 trillion of net worth in the recession, they couldn’t afford to buy as many imported goods from China. Despite China’s permanent level of exports falling by 45%–a staggering amount–its economy rebounded incredibly fast, faring much better than that of any developed country. The crisis even affected countries without close financial links to the United States, such as Russia and South Africa, with these nations also decreasing their demand for Chinese products. Why did China recover so fast, given its export-driven growth model, while the rest of the world didn’t? The answer lies in the response of the Chinese government and a party system with the control necessary to push through stringent domestic policies, even if they caused short-term pain for its already struggling firms.

To start with, China introduced a RMB¥ 4 trillion (equal to $584 billion) stimulus package in 2008, to be put into infrastructure and social welfare programs by 2010. This stimulus was comparable in size to the United States’ own stimulus packages, but it came from an economy about one-third the size at the time, so the effect was more drastic and the initiative much bolder than any other country dared to enact. With its packages, China hoped to spur economic activity and increase its citizens’ total demand for goods and services, or aggregate demand, through the creation of jobs and welfare initiatives. If consumers use the money from these support policies to purchase more goods and services, their spent money circulates and get re-spent on new goods and services, bolstering the economy otherwise weakened from the recession. All of this went superbly for China: “total industrial production in China nearly doubled between 2007 and 2013 despite the crisis and an extremely weak international demand for Chinese goods, whereas the United States has experienced zero growth in industrial production and that in the European Union and Japan has declined by 9.3% and 17.1%, respectively.”

The United States enacted programs with similar goals, so why did China’s work while the United States’ didn’t? The difference was largely influenced by the Chinese government’s control of the economy. China has a market authoritarian system, where the government can keep a much closer handle on any economic activity in their country. In the United States, there is a much less restrictive free market system, and firms are under less pressure to do anything for the good of the country, instead focusing on minimizing profit loss. Once the Great Recession hit, American firms were hesitant to borrow and invest in expanding operations when aggregate demand was still low, and consumers weren’t willing to spend when firms weren’t hiring. In China, this wasn’t the case; they had things like state-owned enterprises (SOEs) run by the government, and the government took rapid steps to help the country even though they incurred debt and loss in the short run.  

China’s state-owned enterprises also acted as a sort of automatic stabilizer for their economy. Automatic stabilizers are policies and programs designed to balance fluctuations in a nation’s economic activity without needing intervention by policymakers. This stands in contrast to the pro-cyclicality of typical, privately-operated firms, which tend to restrict their operations in times of recession. While this minimizes the risks they take during a downturn, it also means firms are less eager to do business, dragging out the length of economic recovery. Normally SOEs are supposed to maximize profit just like privately owned enterprises, but beginning in 2008, they consented to increased production and investment spending, which provided major benefits to the economy and helped the economy start to grow again. Favorably for China, almost 20% of industrial employment following the 2008 crisis came from SOEs; with so many jobs remaining active during and after the recession, their economy was able to recover much more quickly and effectively in a manner not possible in countries without SOEs or similar programs.

While China’s policy actions involving SOEs worked out in the short run, risks posed by its Keynesian approach should be addressed. The timeline for the recovery of demand can vary greatly, so Chinese firms that stepped up production post-recession would be in an even worse position if their increased output went unpurchased. Past efforts by the Chinese government to influence demand have been notoriously unsuccessful, especially thanks to its people’s strong propensity to save. Data also show that from 2008 to 2015, China’s M2 measure of money (total cash and checking deposits plus savings deposits, money market securities, mutual funds, etc) increased by 16 percent annually, but during the same period, China’s economy expanded at a rate less than half that. Domestic inflation, as well as expectations of inflation, has been high since 2008. Taken as a whole, China’s success should be taken with a grain of salt and under different circumstances may have even damaged the economy more.

Beyond these unrealized risks, China also created several other hazards for itself set to materialize in the coming years, including increases in its already dangerous levels pollution and higher inequality among Chinese citizens. It has overproduced steel thanks to government subsidies and tax breaks, drawing the ire of competing steel-producing nations. Its debt has risen to approximately 50% of its GDP in part because of its post-recession policy actions, and it’s uncertain how easily they can repay it. Furthermore, with demand for Chinese exports unlikely to return to pre-recession levels, and because investment already accounts for almost half of its economic activity, China should look to do things like boost household incomes through higher wages and lower social security contributions, put in place fairer resource prices, interest rates, and distribute dividends from state-owned enterprises, or increase spending on pensions and healthcare if it wants to continue its economic growth and achieve its promise for the future.

The Rough Road to Reunification: Germany’s Struggles Toward Economic Convergence

The political reunification of Germany in 1990 moved at an astounding pace. Integrating the two regions economically, however, has proven to be far more difficult, and this process will certainly be ongoing for years to come.

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Image Description: This image, painted on a section of the Berlin Wall, depicts an East German Trabant (“Trabi”) driving through the Wall into the Western side, with the date of the fall of the Wall on the license plate. This little car, with an engine akin to that of a lawn mower, was a prized possession for East Germans (it took approximately 15 years of saving to get one) and has become an iconic symbol of East German culture.

Travelers arriving in Berlin are bound to notice that memories of the Cold War still linger in the city. A succession of stones marking the location of the Berlin Wall bisects the city, just as the Wall itself once did. The famous “Fernsehturm” (“TV Tower”) still stands in the eastern part of the city, although it no longer blocks television signals from Western Europe, as it was designed to do when half of Berlin belonged to the communist German Democratic Republic (GDR, also known as “East Germany”). Yet when the Cold War ended, the GDR ceased to exist and became part of the unified Germany that we see in Europe today. In many ways, eastern and western Germany are now one–they share the same political system, for example, and citizens on both sides of the former Iron Curtain enjoy freedom of movement within Germany and within the European Union as a whole. Economically, however, the two continue to be vastly different, leading some to wonder if the Iron Curtain was ever truly lifted.

The political process of German reunification moved at an astounding pace. By the end of 1990, a reunified Germany existed on the European landscape, a Germany that now included the five “new federal states” of Mecklenburg-Vorpommern, Brandenburg, Saxony, Saxony-Anhalt, and Thuringia, as well as the entirety of Berlin. Integrating the two regions economically, however, has proven to be far more difficult, and this process will certainly be ongoing for years to come. Remnants of the Soviet-style command economy used by East Germany have hindered the region’s development, leading Germany’s new federal states to trail the rest of Germany in almost every measure of economic prosperity. And although German taxpayers have poured more than $2 trillion into helping the former GDR develop, Germany’s new federal states continue to experience significantly lower labor productivity and significantly weaker private sectors than their western neighbors, which in turn has contributed to chronic high unemployment and lower average incomes. Furthermore, despite large investments in the new federal states, the former GDR has lacked opportunity relative to Germany’s western states, and a steady stream of outward migration has caused the region to lose almost two million people since the fall of the Iron Curtain. This large outflow of workers and their families has exacerbated the region’s demographic challenges, and the outflow of human capital dampened economic prospects for the region and for the East Germans who decided to stay.

Labor productivity in the former GDR (and in eastern Europe in general) has been, and continues to be, significantly lower than labor productivity in western European countries. In 1990, East German labor productivity was just two-fifths that of West Germany, despite the fact that education levels in the GDR were similar to those of western Germany, and perhaps even higher. This is largely because the GDR used outdated technology and capital stock, which prevented East Germans from producing as much per capita as their West German peers. This also required firms to take on a large labor force whose sole purpose was to service the equipment and keep it running. In the 1990s, funding from the German government allowed these firms to upgrade their capital stock, a much needed reform for a region whose firms would be competing on the global market. However, the presence of such funding eliminated the need for large service teams, ultimately costing many East Germans their jobs.

East Germany’s low labor productivity also meant that East German labor became quickly overvalued following reunification. During reunification, then-chancellor Helmut Kohl offered the East a monetary union in which East German marks could be exchanged for West German marks on a 1:1 basis. While the move was politically popular, it proved to be an economic disaster as firms in the former GDR quickly found themselves with a labor force that they could no longer afford. “Instead of one to one,” former German Interior Minister Thomas de Maizière recalled, “the exchange rate should have been one to three or one to four, to reflect the economic reality….” The shock that came from the 1:1 exchange rate forced eastern firms to lay off workers en masse–in the industrial sector, two-thirds of all employees were laid off in a short period of time.

It is important to note that over the past 28 years, the former GDR has made tremendous strides in improving labor productivity, and has fared far better than Germany’s eastern European neighbors. The benefits of Germany’s $2.34 trillion investment in the former GDR are certainly visible–in 2014, the productivity gap between eastern and western Germany hovered around 20 percent, whereas the productivity gap between eastern European countries and western Germany hovered around 60 percent. High labor productivity is crucial for any economy, without it, it becomes very hard for that economy’s workers to be competitive in a global market. Thus, the reforms that were made to increase labor productivity in the former GDR, while painful, have been necessary.

Since 1990, the former GDR has experienced significantly higher unemployment rates than Germany as a whole, largely due to the layoffs spurred by increases in labor productivity. The new federal states struggled with double digit unemployment figures throughout the 1990s and into the early 2000s, with unemployment peaking at 18.5 percent in 2005. In some states, the figures were even worse–throughout the 1990s, around 49 percent of the working-age population of the eastern state of Saxony-Anhalt was either registered as unemployed or participating in an employment initiative. Significant progress has been made in decreasing eastern Germany’s unemployment rate. Yet even in 2016, western Germany had an unemployment rate of 5.6 percent, while eastern Germany had a rate of 8.5 percent, a gap of 2.9 percentage points.

Despite the extensive financial support that the former GDR has received since 1990, eastern Germany also continues to experience structural weakness due to an underdeveloped private sector. Eastern German firms are typically half the size of the average western German firms, and out of Germany’s 500 largest firms, only 34 have their headquarters in former East Germany. None of those 34 are part of Germany’s authoritative DAX stock index. Large firms bring many benefits to the regions where they are headquartered by attracting skilled labor,  providing a variety of employment opportunities, and by crucially stimulating innovation. The lack of a large business presence in eastern Germany has thus caused the region to miss out on all of these benefits.

One side effect of eastern Germany’s weak private sector includes lower levels of research and development (R&D) funding, particularly from private sources. In western Germany, more than half of R&D funds come from private sources, whereas in eastern Germany, more than half of R&D funds come from universities and government grants. Although research funding as a whole has been increasing in the former GDR, private R&D investment has not increased at the same rate. In 2013, for example, the former GDR had reached 86 percent of the western German level of overall R&D spending, but only 50 percent of the western German level of R&D spending funded by private sources. Eastern Germany also sees relatively few patentable innovations, compared to western German states, producing only one-third as many patents as western Germany in 2010.

Much has been achieved thus far in the process of unifying Germany’s eastern and western regions. Standards of living in eastern Germany are approaching those of western Germany. Workers in eastern Germany have become much more productive since 1990, and the East’s GDP per capita has risen considerably as well. Average levels of life satisfaction, which dropped sharply in the early 1990s in eastern Germany, are now the highest that they have been in both regions since reunification. Even so, reunification has not been without its painful side effects.

The story of Germany’s reunification, while unique, offers lessons for countries, politicians, and individuals around the world, extending far beyond the boundaries of Germany itself. The experience of East Germans and the transition of eastern Germany is interesting because it offers guidance as to how to help countries formerly ruled by dictatorships succeed in the global market economy. Today, the European Union contains many countries that were formerly behind the Iron Curtain–Poland, Hungary, Slovakia, the Czech Republic, to name a few, who still have a long way to go to catch up to their Western European neighbors in the economic sense. Furthermore, given the planned accession of countries in the Western Balkans to the European Union, the story of German economic reunification could not be more relevant.

 

 

 

 

The Market for Citizenship

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Every country has a comparative advantage, the ability to produce some sort of good or service and produce it well. The United States, for example, has a thriving airplane industry, France is known for its cheese, and Saudi Arabia is a major oil producer. Some countries, however, have found more unusual niches. In the case of some, especially smaller island nations such as Dominica, that comparative advantage appears to be purchasing citizenship.

The number of “Economic Citizenship Programs” (ECPs or Citizenship by Investment Programs) worldwide has surged in recent years. Such programs allow wealthy individuals to legally obtain citizenship and a passport in return for a large contribution to a national development fund or a sizable real estate investment in that country. What’s more, many of these programs don’t require individuals to relinquish their existing citizenship, and instead allow them to hold multiple citizenships simultaneously. The concept of the ECP is not new; St. Kitts and Nevis’ program dates back to 1984, and Dominica introduced its Citizenship by Investment program in 1993. Today, between 30 and 40 countries have such programs, offering either immediate citizenship in exchange for an investment or a faster track to obtain citizenship for those who make a large investment in that country.

Worldwide, several thousand individuals spend around $2 billion per year to obtain citizenship and passports through ECPs. The market for citizenship is growing, with most investors coming from China, Russia or the Middle East, places where political circumstances at home make international travel difficult. ECPs tend to target wealthy individuals from developing countries who may have the means to travel internationally, but lack a passport that will enable them to do so. A wealthy executive from the Middle East, for example, will likely be able to travel to many more countries visa-free with a Caribbean passport than he would be able to with a passport issued by a country such as Iraq. For wealthy individuals from poor or otherwise unstable countries who love to travel, going through the process to buy a second passport, while often time-consuming and expensive, is entirely worth it.

Particularly for those countries that are smaller and less affluent, ECPs generate large revenue streams with little hassle. Frequently, when a national government needs money, it will resort to either raising taxes, cutting spending, or issuing sovereign debt. Raising taxes and cutting spending can be politically unpopular, especially during a recession. Sovereign debt, while a popular option, does require governments to pay interest to investors, thus introducing a financial obligation. Legally selling passports, however, imposes no additional costs on the taxpayer base and does not require a national government to pay back investors. Instead, a national government can capitalize on the appeal of citizenship and use these earnings to finance other debts, development programs, and disaster recovery programs. (Disaster recovery programs are especially important for hurricane-prone Caribbean nations).

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A street in Malta’s capital, Valletta. While Malta’s ECP is pricier than many, it does offer investors easy access to continental Europe via Malta’s EU membership.

Take the case of Dominica’s Citizenship by Investment Program, one of the world’s most lenient ECPs, allowing individuals to receive almost immediate citizenship and a passport in exchange for either a $100,000 donation to the country’s Economic Diversification Fund or a $200,000 investment in a government-approved real estate development project. It only requires that the investor hold on to the property for at least three years. Furthermore, Dominica’s program has no residency requirement whatsoever. In other words, it is possible to become a citizen of Dominica with no intention of ever going there.

Dominica’s Citizenship by Investment Program has had remarkable success, with the tiny island nation selling around 2,000 passports per year. Dominica is not an affluent country — its GDP per capita was $7,144 in 2016 — and its main industries, namely tourism, agriculture, and light manufacturing, are not especially lucrative. Recruiting foreign investment through citizenship, therefore, allows Dominica to capitalize on its status as a small country with a benign presence on the world stage. Dominican citizenship is especially attractive to wealthy individuals from unstable regions of the world, as Dominican passport holders can travel to over 120 countries without a visa. Furthermore, the Dominican government has gone to great lengths to make the island a business-friendly place. In Dominica, there are no capital gains, inheritance, foreign income, or wealth taxes, and qualifying entities can be exempted from import duties.

One of the oldest ECPs, that of St. Kitts and Nevis, began as a means to cope with the withdrawal of European sugar subsidies, which destroyed the local economy. Today, anyone interested in obtaining citizenship from the tiny nation of 55,000 can do so either by contributing $250,000 to St. Kitts and Nevis’ Sugar Diversification Industry Fund, which is tasked with diversifying the sugar-dominated economy, or by investing $400,000 in a government-approved real estate project. So far, St. Kitts and Nevis has sold over 10,000 passports for at least $250,000 each, and earnings from its program now account for around 25 percent of its GDP. These inflows have also benefited St. Kitts and Nevis’ real estate, tourism, and construction industries.

Small Caribbean nations are not the only countries to have citizenship by investment programs. Approximately half of European Union member states have immigrant investor programs, and those who buy in benefit from the freedom of mobility throughout the EU under the Schengen Agreement. Typically, these programs cost more than programs in the Caribbean and have stricter residency requirements, but those who do buy in are able to live and work anywhere in the EU. Even the United States has an immigrant investor route: the EB-5 (Employment-Based Fifth Preference Immigrant Investor) visa program reserves around 10,000 visas per year for immigrants who invest at least $1 million to create or preserve jobs in the United States (or $500,000, if the investment is made in a high-unemployment or rural area). A qualifying immigrant investor, plus a spouse and children, then receive 2-year conditional green cards that can potentially be converted into permanent resident status, and eventually, citizenship.

ECPs, however, have come under criticism, and have been exploited for purposes of criminal activity. Italian businessman Francesco Corallo, for example, managed to purchase a Dominican diplomatic passport despite being on Interpol’s most-wanted list for tax evasion and bribing politicians. When confronted, Corallo tried to claim diplomatic immunity by saying that he was Dominica’s permanent representative to the UN’s Food and Agriculture Organization (his claim failed to sway the authorities, however, and he is now being held in St. Maarten). Similarly, St. Kitts and Nevis’ program has drawn criticism from around the world for its lax controls, and in November 2014, Canada revoked St. Kitts and Nevis citizens’ visa-free travel privileges, thus diminishing the power of the St. Kitts and Nevis passport. The United States’ program has also drawn criticism and has been accused of “selling American citizenship” as opposed to merely attracting foreign investment. Furthermore, it is very difficult to measure the impact that immigrant investors have had on the American economy, leading many to question the EB-5 program’s effectiveness and efficiency.

ECPs provide an innovative way for countries to raise revenue without having to raise taxes or take on more sovereign debt, often providing revenue for development projects, and sometimes disaster recovery that would not have been available otherwise. Yet the success of these programs relies on a solid design that promotes the efficient use of investor funds and that prevents criminals from exploiting the system. If designed well, these programs are a lifeline; if not, they can become pipelines for international crime.

 

 

 

The Argentine Inflation Problem

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In the final week of 2017, Argentina’s Merval index, the most important index of Argentina’s stock exchange, hit the 30,000 point mark for the first time in history, surging 77 percent in 2017 alone. Economic growth within Argentina appears to be strengthening, and the Organization for Economic Cooperation and Development (OECD) is optimistic that Argentina will continue to experience growth in its agriculture, manufacturing, retail and construction sectors in the near future. All of this is welcome news, both for Argentina’s president, Mauricio Macri, and for the people of Argentina, as the country appears to be emerging from recession. Yet despite this welcome news, the Argentinian economy remains beleaguered by one particularly insidious force: high inflation.

According to Argentine daily newspaper La Nación, Argentina had the second highest rate of inflation in the entirety of Latin America in 2017, ending the year with an inflation rate of 24.8 percent. The only Latin American country with an inflation rate higher than that of Argentina was the catastrophic Venezuela, which experienced an inflation rate of 2,616 percent in 2017. Argentina’s high inflation rate has plagued the country, leading to the deterioration of the Argentine peso vis-à-vis other currencies while causing prices to soar, and must be brought under control if Argentina and its industries are to succeed on a global scale.

High inflation wreaks havoc on economies via a rapid rise in prices, the erosion of the purchasing power of an individual’s income, and the deterioration of the value of an individual’s savings. An extremely high rate of inflation (a rate of 1,000 percent or more) is known as a hyperinflation, which cripples economies and can be very difficult to recover from. Zimbabwe’s inflation rate, for example, hit 500 billion percent in 2008, marking the worst hyperinflation event in global history. When billions, even trillions, of Zimbabwe dollars became less valuable than the paper they were printed on, the country was forced to give up its national currency. Today, Zimbabweans conduct transactions using foreign currencies such as the U.S. dollar, the British pound and the Indian rupee.

Argentina’s inflation woes stretch back decades. In the mid-1970s, Argentina’s inflation rate shot up and averaged 300 percent per year for the next 15 years. In 1989, the inflation rate in Argentina hit a whopping 3,079 percent. In an attempt to cure the hyperinflation of the late 1980s, Argentina introduced a currency board in 1991, under which the peso was pegged one-to-one with the U.S. dollar. In other words, as the dollar appreciated and depreciated in relation to other currencies, the value of the peso would move with it. For a short period of time, the currency board was successful and tamed Argentina’s high inflation levels. However, over the course of the 1990s, as the dollar appreciated, Argentina’s currency board became overvalued, harming the country’s competitiveness globally and plunging the country into recession. With the collapse of the dollar peg also came elevated inflation, and the currency board was abandoned in 2001.

Inflation dropped to 10 percent in 2003, but it began to rise again during the presidential administrations of Nestor Kirchner and his wife and successor, Cristina Fernández de Kirchner. Yet as the inflation rate became worse and worse, Argentina’s government chose to deny it: when told in 2012 that the inflation rate in Argentina was 27 percent, Ms. Kirchner scoffed. “If it were as high as they say it is,” the then-president retorted, “the country would explode.” During Cristina Kirchner’s presidency, INDEC, the government statistical office in Argentina, began producing doctored inflation statistics that grossly underestimated the true inflation rate and nearly destroyed the country’s relationship with the International Monetary Fund. The Economist stopped printing the inflation statistics published by INDEC in its weekly issues.

Persistent high inflation has pushed up market interest rates, forcing Argentina’s government to pay an interest rate of around 25 percent to borrow in pesos. It has also destroyed Argentina’s mortgage market, forcing many Argentinians to pay upfront (and often in dollars, given the peso’s volatility), in addition to diminishing private sector lending overall by causing interest rates to skyrocket. Across low and middle-income economies, private sector lending constituted around 97 percent of GDP in 2016, and in Latin America, that number was approximately 49 percent. In Argentina, private sector lending constituted a mere 14 percent of GDP in 2016, giving Argentina one of the lowest rates in the entire world. This rate is on par with rates seen in deeply impoverished countries, such as Zimbabwe (12 percent) and Haiti (18.3 percent).

Confidence in the Argentine peso faltered, and over the next few years, it dramatically dropped in value vis-à-vis the dollar. Argentinians dumped the pesos they had and poured their wealth into U.S. dollars before their savings would wither away any further – a practice that soon became largely illegal. President Cristina Kirchner instituted currency controls that made it nearly impossible for Argentinians to purchase dollar assets. These currency controls had the unintended consequence of making Argentinians poorer compared to savers in other countries, as they were being forced to invest in an asset that was rapidly losing value. Upon the implementation of the currency controls, a black market for U.S. dollars quickly emerged in Argentina. Known as the “blue market,” it enabled Argentinians to purchase dollars against the law, albeit at exorbitant prices. In Buenos Aires, cuevas, or caves, popped up across the city to facilitate dollar purchases, and even the smallest cuevas would handle $50,000 to $75,000 in transactions per day.

When Mauricio Macri was elected president in November of 2015, he soon embarked on a variety of much needed, albeit painful, reforms to rehabilitate the Argentine economy. The former mayor of Buenos Aires quickly restored the independence of INDEC, charging the agency with creating a new and accurate inflation rate. While the move restored credibility to INDEC (The Economist began to publish INDEC’s inflation statistics again in 2017), it revealed how uncomfortably high Argentina’s inflation rate actually was. Under President Cristina Kirchner, inflation in Argentina averaged around 10 percent per year according to INDEC. Upon the election of Mauricio Macri, INDEC found that number to be closer to 25 percent.

President Macri also ended the Kirchner-era currency controls, once again allowing the peso to float freely. While this allowed Argentinians to invest in more stable assets and freed Argentina’s exporters from the burden of an overvalued peso, it also caused the value of the peso to decline further, and pushed inflation up to 40 percent in 2016. The day that the end to the currency controls was announced, the Argentine peso fell by 29 percent against the dollar

President Macri’s economic reforms initially eroded his popularity, and by metaphorically “biting the bullet” and pushing through the economic reforms that Argentina desperately needed, President Macri put himself and his party at great political risk. In 2017, however, Argentina’s fortunes began to turn around. In July, the Argentine economy expanded by 4.9 percent, and salaries began to rise. Furthermore, business confidence rose, the percentage of Argentinians living under the poverty line fell, and inflation began to fall as well. President Macri and his “Let’s Change” coalition experienced a much-needed popularity boost as well, with the coalition winning 41 percent of the vote in Argentina’s October 2017 midterm elections. This electoral mandate encouraged the president to go ahead with work on reforming the tax code and reducing Argentina’s budget deficit.
Overall, Argentina’s prospects are looking up. Argentina’s stock market had a banner year in 2017, and on February 20, Forbes published an article titled “Is Argentina The New Darling Of Emerging Markets?” Yet persistent high inflation threatens to derail Argentina’s economic recovery. The sooner its inflation rate can be brought back to a low, stable and predictable level, the better.

Will Trump Tariff Solar Panels at the Cost of American Service Jobs?

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One of President Trump’s main promises on the campaign trail was to crack down on free trade in the name of protecting American businesses, particularly the manufacturing sector. Despite the charged rhetoric during his campaign, President Trump has been a relatively traditional Republican when it comes to trade policy, outside of withdrawing from the Trans-Pacific Partnership (TPP). Last month, however, the Trump administration announced the imposition of new tariffs on imported solar panels and washing machines, a move designed to protect domestic manufacturers against a market flooded with cheap foreign goods, mainly from Asia. The tariffs on solar panels, which start at 30 percent and decline by 5 percent each year until 2021, have particularly profound implications for the expanding market of solar panels and solar energy.

As the cost of producing and installing photovoltaic solar cells has fallen drastically, the market for solar energy has grown rapidly, transforming the idea of widespread adoption of solar energy from an environmentalist’s pipe dream to a practical source of power. According to Bloomberg’s New Energy Finance Team, the price of solar energy has fallen from $350 per megawatt hour in 2009 to about $100 in 2018, with some projections estimating that average solar costs will fall below those of coal in the next decade. The International Energy Agency reported that 2016 saw solar grow faster than any other source of energy, with most of the activity coming from China, whose governmental support has enabled its producers to capture almost half of the entire market.

In many ways, China is on the forefront of the solar energy boom; the country alone added more solar capacity this past year than the total energy capacity of Germany and is responsible for driving much of the innovation that has caused the price of solar energy to fall so drastically. However, Chinese dominance in the solar sector has not been a blessing to American manufacturers struggling to compete with low-cost Chinese panels. Two companies, Suniva and SolarWorld Americas, complained to the White House and the International Trade Commission that they could not compete with the cheap photovoltaic cells imported from China without government intervention to “restore fair competition in the U.S. market.”

The complaints made by Suniva and SolarWorld are not unfounded. Suniva, a Chinese-owned company based in Georgia, filed for Chapter 11 bankruptcy last spring as a direct result of the influx of foreign panels. The International Trade Commission recommended a tariff of 35 percent on imported solar panels, and the Trump administration delivered with last month’s decision. Domestic producers of solar cells, such as Suniva, SolarWorld, First Solar and Tesla, stand to win as they will be able to sell their panels tariff-free and face less competition from their Chinese rivals. The possible benefits that these firms may receive from the tariff were reflected in their stock prices, as both SolarWorld AG’s and First Solar’s stock prices jumped shortly after the decision was made public. There is also no doubt that the creditors of struggling U.S. solar manufacturing firms have a positive view of the tariff, as the value of their investments will appreciate as a result. As far the U.S. solar manufacturing sector is concerned, the tariff does what it is supposed to do.

Proponents of the tariff overlook one crucial fact about the solar industry in America: the vast majority of jobs in the solar industry are not in manufacturing. In 2016, there were about 260,000 people employed in the solar industry (twice that of coal), but only 38,000 of those jobs were in manufacturing (14 percent) and only 2,000 were involved in the direct production of solar cells. Most of the jobs in solar are involved in the development and installation of residential and utility-level solar projects. The Bureau of Labor projects growth of 105 percent in the number of solar installers in the next 10 years, which would make it one of the fastest growing occupations in the country. The tariff will restrict the supply of panels available in the United States and thus raise their prices; in turn, higher panel prices will lead to fewer installations, forcing layoffs. The Solar Energy Industries Association estimates that as many as 23,000 jobs could be lost as a result of the tariff, and Green Tech Media estimates that the tariff could reduce solar installations by as much as 11 percent, setting the United States back in the adoption of clean energy. While some proponents of the tariff may point to the fact that Chinese companies like Jinko Solar have announced plans to build factories in America, the relatively few jobs that these highly automated factories would produce likely wouldn’t make up for the loss of jobs caused by the tariff itself.

Considering the net job loss that will result from this trade decision, it is hard to justify the implementation of the tariff. This decision seems to not result from economic analysis alone, but rather from a desire to maintain congruence between campaign trail rhetoric and public policy. President Trump promised to bring manufacturing jobs back to the United States, and this tariff might do just that – albeit relatively few. The fact that the tariff might slow the adoption of solar energy and bolster other forms of energy may also be a deliberate strategy to play to his base of support. “America First” intentions aside, the tariff’s economic ramifications will harm the livelihoods of many Americans, which should be the preeminent consideration on any policymaker’s mind.     

    

Renegotiating NAFTA May Harm College-Educated African Americans

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Introduction

A key promise of Donald Trump’s presidential campaign – the renegotiation of the North American Free Trade Agreement (NAFTA) – is well under way, with a fifth round of trilateral talks held last month. It is no secret that President Trump has been highly critical of the trade deal, as he has taken to Twitter to slam Canada and Mexico for being “difficult” during the negotiations and suggested that his administration will “probably end up terminating NAFTA at some point.”

Proponents of free trade assert that it leads to cheaper foreign goods, additional income in the pockets of consumers, and an increase in overall economic well-being. In fact, economists tend to favor the concept of trade liberalization, with a 2007 survey finding that 83 percent of members of the American Economic Association agreed with the notion that the United States should eliminate its remaining trade barriers. Despite such a widespread consensus among economists, the American public remains divided on the virtues of free trade: a recent survey from the Pew Research Center found that 52 percent of Americans believe that free trade agreements are good for the United States, with 40 percent disagreeing.

This article investigates the differential labor-market effects of NAFTA by linking the wages, industries and geographic locations of impacted workers to changes in tariffs induced by trade liberalization. I find that African American workers experience drastic effects due to trade liberalization, while there is little evidence of a differential impact for Native American workers. In my main regression specification, individual characteristics including age, race, marital status, ability to speak English, educational attainment, worker industry tariffs and Mexican comparative advantage account for about a quarter of the variation in wage levels. Furthermore, I find that trade liberalization has stronger negative effects for less-educated workers, who tend to be employed in industries with higher initial, pre-NAFTA tariffs.

Background

As a general matter, there are deep distinctions in economic security among white, Hispanic and African American families: on average, white families have approximately ten times the wealth of Hispanic families and 13 times the wealth of African American families. Additionally, research by Amitabh Chandra finds very slow rates of wage convergence between white and African American male workers from 1950 to 1990, with African American male workers earning approximately 75 percent of what their white counterparts do, when excluding non-workers. Such large racial discrepancies in earnings introduce the possibility of endogeneity when attempting to quantify the labor-market effects of NAFTA; in other words, it is difficult to disentangle the effects of NAFTA attributable to race from the effects of other underlying factors that also influence wages. Therefore, it is important to take any prima facie relationship between race and NAFTA with a grain of salt.

Economists John McLaren and Shushanik Hakobyan have explored the local labor-market effects of NAFTA, finding evidence of substantially lower wage growth among low-education workers in areas most vulnerable to trade liberalization. Moreover, they find evidence of a “multiplier effect,” with liberalization putting significant downward pressure on wages across all industries in NAFTA-vulnerable regions. Finally, in their seminal 2013 paper, David Autor, David Dorn and Gordon Hanson find significant evidence of downward pressure on American workers’ wages as the share of Chinese imports increased.

Data and Methodology

The dataset used in my analysis incorporates publicly available U.S. Census information from 1990 and 2000, maintained through the IPUMS project of the Minnesota Population Center. The U.S. Census divides the country into 543 similarly-sized, overlapping regions determined primarily through economic integration called Consistent Public Use Microdata Areas (ConsPUMAs). The U.S. Census also defines 89 traded-goods industries. Table 1 includes summary statistics for the sample workforce for 1990 and 2000.

Table1

While most of the above measurables are fairly stable over time, there are some differences to note. First, the workforce was more diverse in 2000 than it was in 1990, as the proportion of the country identifying as “white” dropped by approximately 5.3 percentage points. Second, there is a perceptible difference in educational attainment levels, with a slightly larger proportion of workers having a college degree in 2000.

For each industry, I designated τ to be the average tariff that the United States levies on Mexican imports in that industry, similar to McLaren and Hakobyan’s convention. However, since vulnerability to NAFTA is only important if Mexico has a comparative advantage in the production of a particular good, I use a weighted-average tariff for each ConsPUMA that incorporates Mexico’s revealed comparative advantage (i.e., the share of Mexico’s world exports of a particular good relative to the share of Mexico’s world exports across all goods). The change in the weighted-average tariff from 1990 to 2000 for each ConsPUMA c is given by locΔτc.

For the purposes of estimation, I use what is known as the LASSO, or least absolute shrinkage and selection operator, to penalize the inclusion of additional, irrelevant variables to my model. The following is the preliminary model specification, prior to LASSO feature selection:

Model

The dependent variable in the model, log(wi), is the natural logarithm of worker i’s wages in 2000. The independent variables include educ, which measures the maximum educational attainment of each worker; border, which applies to those geographical areas along the border between the United States and Mexico; and X, a set of personal characteristics intrinsic to worker i, such as sex, race, age, marital status and ability to speak English. The two other independent variables, minwage and chnm, represent the state-level minimum wage and the employment-adjusted share of Chinese imports in the worker’s industry, respectively. In my analysis, the parameters of interest are β4 and β5, which measure the geographical impact of NAFTA on wages, disaggregated by race.

Results

The results of my analysis are included in Table 2. I find that African American workers with a college education likely benefited from trade liberalization resulting from NAFTA. This may be due to higher-than-average growth in the proportion of African Americans with a college degree relative to the rest of the workforce between 1990 and 2000. Additionally, college-educated African Americans were typically employed in industries that had fewer trade protections, and thus saw tariffs decline by less on average. This is an important point because industries that are less protected are more likely to benefit from economic integration and a higher demand for exports. Hence, in these industries one would expect less outsourcing of labor to low-wage countries, ultimately benefiting the worker.

I also find that NAFTA had a roughly uniform effect on Native American workers, as there is no statistically significant evidence of a slope change, which indicates that the effects of NAFTA on Native American workers are independent of other factors like educational attainment or industry-specific tariff reductions. This likely reflects the fact that college-educated Native American workers are more prevalent in higher-protected industries that saw larger declines in tariffs, on average. When coupled with the negative wage shock for Native Americans, the result is likely a mixed, insignificant effect of NAFTA on the wages of Native American workers. Furthermore, I conclude that the change in the share of Chinese imports in a worker’s industry, while indeed placing downward pressure on a worker’s wages, has effects that are separate and distinguishable from those caused by NAFTA’s trade liberalization.

Table2

Conclusion

From my findings, I conclude that while trade liberalization had no significant impact on the wages of Native American workers, college-educated African American workers greatly benefited from trade liberalization policies resulting from NAFTA. This likely results from the fact that college-educated workers are concentrated in industries that are less protected from Mexican competition, giving employers little incentive to outsource their jobs. However, the wage growth seen by African American workers who did benefit from NAFTA was slower than that of their white counterparts – further evidence of the persistent wage gap between white and African American workers in the United States.

Moreover, my findings suggest that President Trump’s desire to renegotiate NAFTA may reverse key gains made among urban, college-educated African Americans while failing to actually bring back blue-collar manufacturing jobs. In addition, while it may be the case that trade liberalization depressed wages for less-educated workers, American workers – including racial minorities – are becoming more educated. Thus, free, unrestricted access to Canadian and Mexican markets for professional services may benefit minorities with higher levels of educational attainment and help narrow the massive income disparity between racial groups in this country.

Much Ado About Rice: Thailand’s Rice Market Exploitation Wildly Backfires

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On August 25, former Thai Prime Minister Yingluck Shinawatra was due to appear in court to hear the verdict on her trial over involvement in a rice subsidy scandal. If she is found guilty of negligence, she could face up to ten years in prison. Yet Ms. Shinawatra never showed up in court, and many officials believe she may have fled the country.

The rice subsidy program, which led to Ms. Shinawatra’s impeachment in January of 2015 as well as her subsequent trial, started off as a well-intentioned plan to help Thailand’s agricultural sector. It was one of the main selling points for her populist party, Pheu Thai, during the 2011 campaign cycle, and helped to win the party a landslide victory. Approximately 23 percent of the Thai population are farmers, and the subsidy program was intended to help Thailand’s rice farmers earn more for their crop.

The program worked like this: the government would buy rice from farmers at up to double the market price. Then, the rice would be stockpiled and withheld from the global market in order to drive global rice prices up. Once global rice prices rose, the Thai government would sell the rice and make a profit in the process.

At the time the program was implemented, Thailand was the world’s largest exporter of rice. In addition to having a warm, damp climate, Thailand has an abundance of fresh water sources, making it an ideal location for rice production. Furthermore, the Thai people have plenty of experience producing rice–it has been their staple crop for over 5,000 years. (“In the water there are fish, in the field there is rice” is a proverbial Thai saying). All of these factors combine to give Thailand an overall advantage in rice production vis-a-vis many other countries, which have neither the climate nor the experience in such a line of production.

When a country has this comparative advantage in the production of a good, it means that that country can produce that good more efficiently than other countries can. For example, Thailand can produce rice more efficiently than Norway can because its climate and topography are better suited for rice production. Therefore, Thailand will gain the most economically if it can focus its resources on rice production, thereby producing more rice at a lower cost.  Thailand can then purchase the goods and services it does not produce as efficiently from countries that do have comparative advantages in those lines of production. If we consider the Thailand and Norway example, we notice that Thailand can sell its rice to Norway and in turn buy oil, a good that Norway has a comparative advantage in. If two countries can play to their comparative advantages and focus on what they can produce most efficiently, they can produce more, sell more, and purchase other goods at lower prices. Thus, two trading partners can actually gain from trade.

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Former Thai PM Yingluck Shinawatra has come under fire for the rice debacle

It is important to remember, however, that a comparative advantage in a certain line of production does not guarantee that a country will dominate a given market. In designing the rice subsidy program, this was the Thai government’s — and Ms. Shinawatra’s — critical mistake. There is no such thing as a patent on rice production; anyone who lives in an area with ideal conditions for growing rice can do so. Thailand is not the only country with ideal conditions for growing rice. When Thailand withdrew rice from the global market, countries such as India and Vietnam jumped in to fill the gap. The presence of these competitors meant that the global price of rice did not rise as the Thai government had hoped. Instead, rice prices plummeted, going from a peak of $1,000 per ton in 2008 to around $390 per ton in 2014. Thai farmers were edged out of the global rice market, rice exports fell by a third, and the Thai government was forced to stockpile 18 million tons of rice in the first year of the program alone. In the end, the rice subsidy fiasco cost Thailand around $15 billion. Given that GDP per capita in Thailand hovers around $6,000, this is a gargantuan sum.

Despite the heavy losses that the Thai government sustained, then Prime Minister Shinawatra refused to end or reform the program. As the program lost more and more money, government scandals and social unrest ensued. In February of 2014, a group of rice farmers threatened to park 100 tractors at Bangkok’s airport as they had not been paid for their rice. In May of 2014, Ms. Shinawatra was removed from office by the Thai Constitutional Court after six months of anti-government protests, riots, and occupations of government buildings. In July of this year, the military junta now in control in Thailand froze some of Ms. Shinawatra’s bank accounts and ordered her to pay $1 billion in civil damages. And on August 25, the same day Ms. Shinawatra failed to appear in court, her former commerce minister, Boonsong Teriyapirom, was sentenced to 42 years in prison for falsifying government-to-government rice deals with China in an attempt to cover up losses on the rice subsidy scheme.

Ms. Shinawatra’s rice subsidy program, which started off as a well-intentioned plan to help Thai farmers, ended in losses and Ms. Shinawatra’s removal from office. Interestingly, much of the instability that stemmed from the program and the government’s response to its failure is rooted in economics, or rather, faulty economic assumptions. It is true that Thailand has a comparative advantage in rice production. Yet the benefits of a comparative advantage can only be reaped if a country sells the goods it produces well and maintains its market share. Pulling out of the market is very dangerous, for a competitor may be ready and willing to take your place.

 

Small change, huge impact: How remittances assist development in impoverished regions of the world

 

remittancesIn 2016, Mexicans living abroad sent home $27 billion in remittances home to Mexico, the largest remittance influx that Mexico has ever received. Remittance inflows now surpass crude oil and tourism as major sources of income for Mexico, and much of these inflows go to Mexico’s most rural, impoverished areas, where they are a lifeline. Most of the remittances sent to Mexico came from the United States due to a strong U.S. labor market, a weakening Mexican peso, and fears that the Trump administration may tax remittances in order to pay for a border wall.

Often, due to poor economic prospects and a lack of opportunity at home, migrants will seek work abroad and send back a portion of their earnings to help friends and family. These funds that are sent back are called remittances. Between 1960 and 2010, the number of migrants increased from 90 million to 215 million worldwide, and migration to western Europe and the United States accounts for around two thirds of this growth. In 2015, more than $431 billion in remittances were sent to developing countries, with each remittance (also referred to as a transaction) averaging around $200. In many developing countries, remittances constitute a huge source of cash inflow; in 2013, remittance inflows globally were three times larger than inflows from official foreign aid, and remittances regularly exceed foreign direct investment in developing countries. When considering a nation’s development, it is common for policymakers and others to only consider foreign aid and largely disregard remittances as a source for development funds. It is important to remember, however, that the remittances that migrants send home have powerful impacts on encouraging development and reducing poverty in the developing world.

In developing regions around the world, remittances are a lifeline, bringing much needed funds to people who are barely scraping by. India was the biggest destination for remittances in 2015, followed by China, the Philippines, and then Mexico. Some countries could not function without substantial funds from abroad–remittances make up 29 percent of Nepal’s GDP, and in Tajikistan, that number is 42 percent. For countries that were formerly part of the Soviet Union, such as Tajikistan, remittances are especially vital.

In impoverished parts of Mexico, remittances constitute around 19.5 percent of income, which is an even higher percentage than the contributions to income from government welfare programs. The remittances that families receive are put to use covering basic needs first, with the rest going towards investments and paying back debts, allowing those who receive enough in remittances to begin to focus on getting out of poverty. A report published by the Inter-American Development Bank found that in rural Mexico, 74 percent of remittance monies are used to cover basic costs of living, with 16 percent used to pay debts and 5 percent used towards investing in the home. Furthermore, remittances have a tendency to act like insurance for recipients. Remittances tend to be  countercyclical–during an economic downturn or after a natural disaster in migrants’ home countries, remittance flows actually increase, allowing some of the poorest members of the global population to better weather financial crises.

In many cases, recipients of remittances use those funds to enroll their children in school, which allows them to achieve higher levels of education that can lead to higher-paying jobs. Data from the World Bank show that in many countries in Latin America, children in families that receive remittances are more likely to stay in school and have higher educational attainment. Thus, remittances provide a means for families to invest in the skills of their children, giving them tools that can help them break the cycle of poverty in later life.

There is also evidence that increases in remittance flows received by people in Mexico correspond directly to a decrease in crime. A study by the Inter-American Development Bank found that for every percentage point increase in remittances, street robberies in Mexico declined by 0.19 percent and homicides decreased by 0.4 percent. This decline can be attributed to several factors. First, as mentioned above, remittance flows give families the opportunity to send their children to school, reducing the incentive for these children to commit crimes. Not only does being in school prevent children from engaging in criminal activity, but the extra years of education allow students to eventually get higher-paying jobs that allow them to make ends meet without having to resort to crime. Second, remittances increase income and therefore decrease the benefits derived from committing crimes, and studies conducted in Brazil and in Colombia confirm this. Finally, 5 percent of remittance funds in Mexico are used towards home expenses, which stimulates the construction sector leading to the creation of construction jobs. These jobs offer people, particularly those with little education, the chance to earn a living without having to turn to crime.

In January of 2017, Mexican immigrants in the United States sent $2 billion back to Mexico, up 6.3 percent from this time last year. While a weaker peso did play a role in this jump, much of the increase stems from fears about a potential tax on remittances being sent from America. It is true that large sums of money flow from the United States into Mexico each year. However, this money is put to good use in impoverished regions where it is needed most. It allows children to stay in school longer and makes them less likely to commit crimes. It enables families to make ends meet and lays the groundwork for recipients to lift themselves out of poverty. Given the important role that remittances play in assisting in the development of impoverished regions of Mexico, such a tax would significantly hurt the people who rely heavily on those remittances to make ends meet.

Filling the breach: Exploring China’s role in post-TPP Asia

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This month, U.S. Secretary of State Rex Tillerson met with top Chinese officials to pave the way for talks between the two countries’ leaders. Chinese economic policies in the Pacific will surely be discussed, especially as China exploits the demise of the Trans-Pacific Partnership (TPP) to assert itself as a powerful influence on trade policy in Asia. As the talks near, China’s new trade agreements with other Asian countries will offer valuable insight into how China has sought to expand its economic influence and upset Asia’s political landscape in the process. Amid rising tensions in Asia, the leaders of the United States and China must both recognize the futility of their attempts to use trade agreements as tools to dominate political developments in the Pacific region. Furthermore, while these two superpowers compete unsuccessfully for regional power, it will be the economic prosperity of other Pacific nations that suffers.

Discussions of Asia without the TPP may come as a surprise to some, especially considering the Obama administration’s strong support for the agreement. However, carried into office by the surging tide of populism, President Donald Trump has quickly acted to reverse any pro-globalization policies promoted by the previous administration. Without ratification from the United States, the TPP cannot go into effect, removing any possibility of the trade deal further integrating the economies of Asia and the United States. When President Trump put an end to the agreement, critics speculated that in response to U.S. actions, China would step in as the new economic leader in the Pacific region through trade deals excluding the United States. At the time of Trump’s withdrawal from the TPP, China had not yet enacted any such agreements, leaving its future role in the region unclear.

However, it did not take long for China to adjust to the United States’ withdrawal from the TPP and champion new international trade policy in the Pacific. After the TPP’s demise, many countries in Asia turned to the Regional Comprehensive Economic Partnership (RCEP) as the primary trade agreement, intended to promote freer trade between the many Pacific nations involved. Glaring differences between the RCEP and the TPP include the RCEP’s inclusion of China, as well as the absence of the United States despite its position as a major trading partner with many of the nations involved in the RCEP. Although negotiations among the 16 participating countries are ongoing, the RCEP agreement primarily focuses on lower tariffs, without any rules on environmental and labor protections. The trade deal will further integrate the economies of the participating countries, allowing for supply chains unhindered by expensive tariffs.

Cast in the role of outside observer to the RCEP because of its own political motivations, the United States loses out on a powerful tool for exerting its economic power to influence political and social issues in Asia. Under President Obama, the United States offered the economic benefits of lower tariffs to encourage developing nations in Asia to adopt stronger environmental and labor standards. Under the RCEP, it is unlikely that such protections would be enacted on the scale that the TPP proposed. After all, for many manufacturing-based economies in Asia, the lack of these safeguards allows their firms to produce at lower prices than many competitors can. Through the RCEP, China seeks to provide the Pacific region with the benefits of lower tariffs, without taking away the low-cost manufacturing advantage of these nations. In doing so, it hopes to assert itself as a powerful influence in the region and improve ties with other Asian countries, even as it pursues aggressive, expansionist policies in the South China Sea.

If China wishes to continue as the dominant economic force in Asia, however, it must also accept the detrimental economic effects of its politically motivated exclusion of the United States from the RCEP. Exports to the United States make up 18 percent of China’s total exports. As such, China would gain a great deal from free trade with the United States, though China would have to weigh this against regional influence lost to the United States. Furthermore, if China continues to exclude the United States from its trade agreements in the Pacific, increased tensions between the two countries could drive Trump to pursue protectionist policies. This would prove highly detrimental to the Chinese economy, threatening its ability to sell products abroad at lower prices than U.S. competitors can.

Most significantly, though, the politicized absence of the United States from Pacific trade agreements endangers the economic well-being of other Asian countries. Manufacturing-dependent economies like Malaysia and Vietnam looked to the TPP to provide access to U.S. markets like textiles, where these countries could sell their products at low prices. However, Chinese markets already have access to cheap manufactured goods produced domestically. Thus, trade deals with China would be unlikely to benefit other Asian economies to the degree that free access to U.S. markets would. Because of this, China would be less able to exert its economic leverage in pursuit of political influence in Asia, and developing economies in the region would suffer.

As talks between the leaders of the United States and China draw near, both countries must recognize the unintended consequences of trade policy as a tool for political influence. The allure of unfettered access to American markets will continue to divide the loyalties of Asian nations, even as China entices them with promises of freer trade within the region. As issues with the TPP and RCEP demonstrate, neither nation will secure uncontested political influence in the Pacific region through heavily politicized trade agreements. Instead, both the United States and China should focus on creating trade agreements to optimize economic growth in the numerous developing nations of the Pacific region through freer trade. If the United States and China cooperate on trade policy to achieve this goal, both they and many others in the Pacific region will benefit. Neither country should allow political machinations to stand in the way of economic progress.

Solving U.S. health care woes: a nonpartisan approach

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Earlier this month, Sens. Bernie Sanders and Ted Cruz engaged in a televised debate over the state of health care in the United States. While both politicians agreed with the assessment that health care as it stands now requires great reform, their solutions, not unexpectedly, fell along party lines. Americans were offered two, predictably partisan, options: Sanders called for more government involvement, while Cruz suggested cutting regulations as the key to reducing the burden of the costly system now in place. Implementing lasting reform in our broken health care system, however, will require a different approach—one guided by proper incentives and economic evidence rather than restrained by ideology.  

Both sides of the debate took an important first step when Sanders and Cruz rightly noted the shortcomings of the current system. Health care costs make up 17.1% of U.S. GDP, the highest in the world by a significant margin. Health outcomes, unfortunately, do not reflect this reality. Average life expectancy in the U.S. is only 78.7 years, ranking 26th relative to other countries in the world. Effectively, the United States is paying more for health care that does not deliver any significant improvement in health indicators. Americans are rightfully unhappy about this situation, but significant strides can be made to solve this problem in a manner that is largely nonpolitical.

In fact, many of the problems Sanders and Cruz recognized with the current system have solutions that do not fall squarely into any political ideology. Proposals like mandatory health savings accounts (HSAs) provide one instance of such policy fixes.

By ensuring citizens save money specifically for health care expenses, HSAs help eliminate financial roadblocks to health care access without limiting the ability of consumers to choose the health care provider and plan that best suits their needs. At the heart of nonpartisan improvements like this is the desired goal of a more effective, less expensive health care system, driven by the establishment of proper incentives guiding both corporations and consumers.

During the debate, for example, both politicians lamented the tragic results of unaffordable deductibles for patients with severe illnesses. However, ideologically polarized health care overhauls are not the only ways to solve this issue. One need only look at the structure of health care in a country like Singapore for a potential solution. On its face, Singapore’s policy to address the problem of unaffordable deductibles appears counterintuitive. Government funding for health care requires that no health service be provided for free.

In practice, this raises the cost of basic, day-to-day treatments like doctor visits for a mild illness, discouraging unnecessary use of medical care. This policy frees up medical resources to treat more life-threatening cases in a time-efficient and affordable manner.

Singapore also requires citizens to put money into tax-exempt health savings accounts in a program called Medisave, which has the result of discouraging spending on unnecessary medical procedures. The proper alignment of incentives for consumers in Singapore ensures that medical resources can be allocated to the most severe cases, rather than wasted on frivolous or overly expensive medical procedures.

The American health care system could also benefit from incentivising companies that provide medical services and insurance to cut unnecessary costs, without the need for heavy-handed government control. Again, the U.S. can look to the transparent system of Singapore, in which private health care providers are required to publish the prices of their policies.

By providing more information to consumers, this policy creates an environment that encourages health care providers to pursue more cost-effective policies without compromising health outcomes. This relatively light regulation of the industry can have outsized benefits, motivating cutbacks on expensive but ineffective medical procedures that contribute to the United States’ excessive spending on health care.

Another point of agreement between Sanders and Cruz was what they deemed to be the excessive costs of pharmaceuticals, a reality that prevents many Americans from receiving life-saving medicines. Sanders prescribed a greater use of the federal government’s market power as a large purchaser of drugs, while Cruz targeted excessive FDA regulation as the culprit behind high drug prices.

Rather than demonizing corporations as greedy evildoers or decrying safety regulations for drug approval as unnecessary, both parties should once again look to the establishment of proper incentives to craft policies that protect consumers without denying them affordable access to important drugs.

The Swiss system of approving pharmaceutical drugs provides one possible method to properly align incentives to benefit consumers, while still allowing companies to operate without excessive government control. In Switzerland, drug approval is contingent not only on meeting safety standards, but also on satisfying an objective calculation of cost-effectiveness for the new drug when eligible for reimbursement under health insurance plans. A system like this would discourage companies from creating overly expensive drugs, without requiring rigid price controls enacted by the government.

Out of current partisan stonewalling emerges a third, pragmatic path for health care reform in the United States: a focus on properly aligned incentives. Policies like the ones proposed here are driven not by ideology, but by economic evidence. Adopting these measures would be the first step toward the pursuit of a health care system that delivers better results at lower costs—an outcome that would be amenable to politicians and constituents across the political spectrum.