A Time for Peace, A Time for Debt: The Cost of Colombian Reconstruction

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After 54 months of peace talks in Havana between the FARC (Armed Revolutionary Forces of Colombia) and the Colombian government, a tentative deal was signed with the intention of ending the longest civil war in modern history. The conflict began in the mid-1960s as a byproduct of the Cold War and served as a proxy battleground for Soviet and U.S. forces. After their ties to the Soviet Union were severed, however, the FARC turned to drug-running, kidnapping, extortion, and even all-out territorial war to fund their campaign. This delegitimized their political claims and turned them into what many agreed was just another violent, rent-seeking group in Colombia, masked under the guise of political ideology.

As of 2012 (the year peace talks began and a ceasefire was agreed upon), over 220,000 people had been killed in the conflict, and around 6 million more had been displaced from their homes. The deal was therefore of critical importance to the future of the nation, and it was the first of its kind to have any real chance of success. Nevertheless, the treaty was, at that stage, merely symbolic, and Colombians would have to ratify it in a plebiscite set for Oct. 2, 2016. The results were unexpected, as the “No” vote won by less than half a percentage point. The president and 2016 Nobel Peace Prize laureate, Juan Manuel Santos, urged his citizens not to lose faith in the process; his predecessor, Alvaro Uribe, basked in the failure of what he had called “a fraudulent peace.”

One of the most controversial and distorted aspects of the agreement was its possible impact on the Colombian economy. While it is difficult to ascertain the potential economic consequences of the deal, there are some figures that can be analyzed and truths which can be pieced together to forecast what could happen if peace were to be signed under similar circumstances.

First, we must acknowledge that reconstruction is a costly affair. The Colombian minister of finance, Mauricio Cardenas, pegged the amount at around $30 billion USD; Capital Economics, an economic research firm, said it would be around $60 billion; and Global Risk Insights, a political risk analysis group, put the price tag at $90 billion. A study conducted by BBC Mundo found that costs would come from three major sources over a 10-year period. The authors estimate that the per-year cost would be at least $3.5 billion in subsidies and programs for victims, $1.8 billion for agricultural reform and investment, and $2 billion for the integration of rebel combatants into society. Their estimate, therefore, came to around $73 billion over the next decade.

Despite this massive price tag, the “Sí” campaign believed other factors would counterbalance the new debt issued as a result of the deal. They touted the possible upsurge in foreign and domestic investment, arguing that a more stable business environment would foster improved consumer confidence, leading to more jobs for incoming ex-fighters and other Colombians. The reality, however, is not so straightforward.

Counterinsurgency experts David Kilcullen and Greg Mills explain in their feature for the Center for Complex Operations that “most campaigns struggle with connecting improvements in security with sustainable employment creation, especially in rural areas” and that “job creation is key, because it will help dissipate much of the sense of grievance that has historically fueled conflict.” Most rebel combatants are from rural areas of the country, and the $18 billion or so dedicated to this routinely overlooked sector might be in vain if the funds are not strategically invested. Past public investments in agriculture have been plagued by unmet deadlines, corruption, and the misuse of funds. There was little evidence public agents could be trusted again with such a complicated and expensive task, and many saw the probable failure of this endeavor as an opportunity for ex-rebels to join gangs and other guerilla groups when the legal route failed.

The $20 billion allocated for “integration” was a very vague and controversial point in the deal as well. Identity changes, safety nets, and police protection for common rebel soldiers were included in the agreement, but the extent to which these safeguards would be implemented was dubious at best. Would a company know whether a potential employee was a member of a Marxist guerilla movement? Why were taxpayer dollars being put in the pockets of individuals who were killing Colombian soldiers not a month ago? These were all bitter pills to swallow for the average hard-working Colombian, especially given the country’s already exorbitant tax rates (Colombia has the fifth highest tax-to-GDP ratio in the world). There was also uncertainty about the skills these ex-rebel fighters had (or lack thereof), and how they would translate into a formal economy where gunfighting and survival skills aren’t in much demand.

This may seem like a bleak prognosis, but it is important to consider the alternative. Since its independence in 1810, Colombia has rarely experienced a moment of peace. It is a historically violent country with an inherited propensity for war, and only extreme measures can break the cycle. The U.S. government invested in and made concessions to the Confederate states after the Civil War, as did the U.K. after its deal with the IRA – peace is as difficult as it is necessary. Though Colombians weren’t convinced by this particular agreement, they must not lose hope for a peaceful future. War is an unsustainable and expensive activity, which hinders more lives than any price tag, tax increase, or awkward labor environment ever will.

Financial Crimes and Fines: A Misguided Approach

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In the wake of the Great Recession, populist opinion has responded approvingly to regulatory agencies’ stronger approach against wrongdoing by financial firms. Companies in the financial industry have increasingly found themselves subjected to fines as a result of this greater scrutiny. Yet, regulatory agencies are losing out on a superior alternative to fines. Criminal charges against individuals, including executive-level managers, should be employed as a more effective, targeted punishment that does not harm innocent employees and increase systemic risk in the process.

The U.S. Department of Justice’s recent charges against Deutsche Bank provide one example of the possible downsides of using fines as punishment. In September, the DOJ proposed a $14 billion fine against Deutsche Bank for selling mortgage-backed securities during the financial crisis without proper disclosure. The possibility of such a large fine sparked doubts in investors’ minds about the firm’s ability to pay, leading to a further decline in the already troubled firm’s share price. Fear of the ramifications of the fine was not limited solely to Deutsche Bank’s investors, either. Other financial firms became nervous at the precedent that the DOJ could set with this large fine. Some analysts were worried about the systemic risk Deutsche Bank could pose to the highly interconnected banking industry, should the fine significantly damage Deutsche Bank’s liquidity and endanger its ability to do business.

One of the main benefits of the use of criminal charges rather than general fines is that it allows regulatory agencies to avoid increasing systemic risk. Fines against a firm can reduce its liquidity, and if the fine is large enough, this reduction in liquidity could cost the firm more than the face value of the fine. In response to a liquidity shortage, the firm may have to engage in fire sales of assets, accepting lower prices to sell them quickly and damaging the value of similar assets held by other firms. Or, to fulfill regulatory capital ratios, the firm may have to issue additional equity, diluting current shareholder value. Thus, if enforcement agencies wish to avoid collateral damage to firms not implicated in a criminal investigation, then there is necessarily an upper limit as to how much they can fine guilty firms.

Criminal charges, on the other hand, hold the potential to lessen systemic risk by avoiding the more immediate losses in liquidity resulting from fines. Thus, criminal charges can limit harm to outside parties, as the replacement of even high-level executives is less likely to be as damaging to a firm as punitive fines. Furthermore, criminal punishments can be more effective deterrents to illegal behavior. In an analysis of data from 78 firms punished for financial crimes, Cindy R. Alexander finds that the “reputational penalties” firms pay are greater with criminal, rather than civil, sanctions. These reputational penalties, which take the form of lost customers or lower prices accepted by remaining customers, damage the punished firm’s profitability over time but avoid the larger, short-run costs that fines create.

However, there are some downsides to the greater use of criminal charges against firms. Alexander found that firms attempting to recover from reputational damage may shuffle employees and managers to regain reputation. This shuffling may be indiscriminate, resulting in employees not involved in criminal wrongdoing to lose their jobs. The deterrent effect of criminal charges, though, may counter this risk by discouraging firms from engaging in wrongdoing in the first place.

Historically, the use of criminal charges in response to financial firms’ misdeeds has been used sparingly by the DOJ and other enforcement agencies, especially against upper-level managers. Many were outraged when firms bailed out by the U.S. government during the financial crisis kept their executives without facing criminal charges. Regulatory authorities have, however, brought criminal charges against high-level traders in recent years. In July, the DOJ announced that it would charge two HSBC trading executives for manipulating currency prices. When firms are guilty of significant wrongdoing, as in the case of Deutsche Bank, enforcement agencies should ensure that senior executives face the same criminal charges that lower-level employees would face for their crimes, including possible jail time.

While many are happy to see regulatory agencies adopt a hardline approach with large fines like the one proposed against Deutsche Bank, such a method has unintended consequences that extend beyond just the guilty parties. On the contrary, the use of criminal charges against individuals, including high-level executives, offers an effective alternative that avoids many of the negative externalities created by fines. In a global economy that is increasingly interconnected, it is important that regulatory agencies punish wrongdoing with strong deterrents like criminal charges that do not cause wider economic harm.

Conservative fiscal policy in Japan prevents rise in inflation

The Japanese economy is facing an unusual series of problems which have proved difficult for officials to address. Low birth rates and strict nationalization policies have resulted in an aging, shrinking population. Although Japan has the third largest Gross Domestic Product (GDP) in the world, it has had virtually no growth in the past two decades. Structural problems and, as we will examine in this article, overly cautious monetary policy have caused deflation in recent years.

Negative interest rates, the promise of 0% interest on a 10-year bond, and attempts at actively discrediting the Bank of Japan (BOJ) have all failed to raise inflation rates in Japan. Even in a world where developed countries are stuck in a state of secular stagnation due to sky-high corporate savings rates, Japan stands out. If one adheres to Ben Bernanke’s prescription that the mission of a central bank is to “strive for low and stable inflation,” and “promote stable growth in output and employment,” then it is the responsibility of the BOJ to fix the problem of zero growth and deflation.

According to Martin Wolf at Financial Times, corporations in Japan are saving over 20% of their capital. This makes up nearly 8% of Japanese GDP. When money is being held in banks instead of invested, money changes hands less frequently, effectively decreasing the money supply. Like with most things, the less money there is in circulation, the more it is worth. Wolf refers to this as a “savings glut.” Conservative corporate policy is currently causing deflation in Japan and hindering growth.

This negative externality created by the private sector should clearly be disincentivized. By creating seigniorage — profit created by issuing currency — the BOJ could effectively tax this stockpiling of yen. Printing more bank notes would increase the money supply and therefore decrease its value. This currency devaluation would create more incentives to invest rather than save, and, as an added benefit, would create much-needed growth in the manufacturing sector.

Issuing currency with nothing to back it may seem bold, but it has been tried before. In 2011, the European debt crisis caused the euro to crash. Believing that it was a strong, safe currency, many investors began trading their euros for Swiss francs. Switzerland’s currency began to gain value very rapidly. In order to prevent the massive appreciation of the franc, the Swiss central bank committed to printing as many francs, and purchasing as many euros, as needed to keep the franc to euro ratio above 1.20. As shown below, the franc first depreciated due to the announcement itself, but the policy was first put to the test in January 2012.

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Data from: Global Financial Data

 

Capping the franc turned out to be a success. The creation of seigniorage stopped the growth in deflation and even managed to create some small inflation. The policy would not be put to the test again until the franc began to appreciate again in late 2014. This time, however, the Swiss central bank did not remain as astute. Instead of allowing the policy to take effect, they lifted the cap, and as a result, deflation skyrocketed.

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Data From: http://www.inflation.eu

 

If the BOJ adopted a similar policy, it could jump start its countries slow economy and move towards its goal of consistent growth. Savings rates would decrease, spurring more investment. The yen would depreciate, spurring growth in the manufacturing sector. Finally, this printed money could be used to pay for additional social programs for the aging population, or to pay back some of the massive debt the country has acquired.

A welcome from the editorial board

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From Brexit to the U.S. presidential election, from the Panama Papers to the Petrobras scandal, political and economic fractures and fissures have shaped the majority of 2016 across the world. While basking under the unrelenting sunshine of Los Angeles, it’s easy to see the consequences of socioeconomic illiteracy as a product of chaos. However, as undergraduates at the University of Southern California, we have challenged ourselves to take the abstract laws and theorems and functions and policies from our lectures and research to apply them to the challenges of the real world. While we may not have Ph.Ds, millennials have grown up with the privilege of constant, global access and awareness through the Internet and the advent of social media. With the foundation of the USC Economics Review, we aspire to analyze and comment on economic issues as close to home as LA’s Metro expansion to those as far away as Japanese monetary policy using the unique theoretical education afforded by our studies at USC Dornsife as well as a practical education fostered by our coming of age in the information era.

As we publish our own opinions and explorations of complex topics, the USC Economics Review welcomes you to post your own questions or otherwise challenge us in the comments section. We aim to represent a wide spectrum of ideological diversity and to initiate a dialogue and an understanding for not just those involved in economic academia, but also for simply curious and civic-minded readers. On that note, welcome to the beginning and beyond of the USC Economics Review.

Sincerely, the inaugural USC Economics Review Editorial Board.