The Future of U.S-China Relations

President Obama and Chinese Premier Hu Jintao

While most of the (political) world was transfixed on the spectacle of the health care summit yesterday, the U.S.-China Economic and Security Review Commission was holding hearings on the current and future status of U.S.-China relations. The hearings, which interestingly included testimony from two of my favorite bloggers, Daniel Drezner and Simon Johnson, as well as about a half-dozen other experts, provides a compelling analysis of the challenge of U.S. debt for China.

The basic issue under consideration was the degree to which China, which boasts a massive currency reserve held mostly in U.S. dollars, could leverage its fiscal resources into achievements in its other foreign policy goals. China currently holds at least $755 billion in U.S. Treasury Securities as part of its estimated $2.5 to $3 trillion in dollar-denominated assets. This massive financial reserve was garnered primarily as a result of China running massive trade surpluses with the United States. Ironically, however, those trade surpluses led to a situation of mutual dependence, in which the United States depended on China’s willingness to buy U.S. Treasury certificates and other dollar-denominated assets in order to finance its large trade deficits, which in turn allowed China to continue to increase its exports to the United States.

So what of the future? Sino-American relations have suffered some setbacks in recent months, as witnessed by the Google-China incident, the Obama administration’s decision to move forward on arms sales to Taiwan and meet with the Dalai Lama, the inability of the two countries to negotiate a meaningful outcome at the Copenhagen summit, various bilateral trade disputes, and continued and repeated rumblings in the United States regarding the perceived overvaluation of the Chinese renminbi.

In his testimony, Drezner argued that despite the widespread rumblings about the threat posed by China’s massive trade surpluses, it has generally been unable to covert its massive financial wealth into other foreign policy goals. With the notable exception of a couple of very minor cases (for example, using the promise of aid and assisting in the financing of government debt to Costa Rica in exchange for switching its diplomatic recognition from Taipei to Beijing), the Chinese government has been limited in its ability to use financial resources to achieve other foreign policy aims. The fungability [glossary] of financial power in the international arena is, in this respect, limited.

What’s more, while the Chinese government has expressed a desire to move away from the dollar as the de facto international reserve currency, the feasibility of most alternatives remains limited. China could push harder, but such a strategy would entail considerable costs for the Chinese government and economy, not the least of which includes a devaluation of its $3 trillion in dollar-denominated assets. As a result, it appears the U.S. and China remain in an uneasy situation of mutual dependency, each expressing dissatisfaction with the current political and economic arrangements, but each equally unable to move away from them.

Quick Updates

There’s a number of good posts coming from the political blogosphere over the past couple of days. The following are definately worth a read:

• Duncan Green argues that “human capital” is an abomination.
• Steve Walt contends that Bob Gates needs an to take an intro to IR course.
• Andrew Sullivan states that the military needs more human rights training.

How to Write a Political Science Essay

Tip of the hat to Daniel Drezner, whose latest blog entry points out  Henry Farrell’s “Good Writing in Political Science” primer. It’s now required reading for all of my courses!

The IMF’s Policy Shift

IMF Managing Board

Last Friday, the International Monetary Fund released a staff position note  (basically, a working paper) entitled “Rethinking Macroeconomic Policy.” The impetus for the paper, writing in a surprisingly clear and jargon-free tone, seemed clear enough. In the introduction, the authors argue that macroeconomists and policymakers had been lulled into a false sense of complacency about how to conduct macroeconomic policy. The onset of the global economic crisis—or perhaps more accurately, the inability of our macroeconomic policy toolkit to address the crisis—challenged that complacency, creating the need to rethink our policies.

But the surprising part doesn’t come from the paper’s assertion that we need to think about what our post-crisis macroeconomic policy might look like. Rather, the surprising part—and the part that has generated considerable discussion in the blogosphere—are the recommendations themselves. The report recommends that central banks and the International Monetary Fund make several key changes in their policy outlook:

1. Increasing the inflation target from 2 to 4 percent.
2. Automatic lump sum payments should be introduced for poorer families if unemployment crosses a pre-determined threshold.
3. Exchange rate intervention should be permitted for developing countries heavily dependent on international trade.
4. Central banks should be granted greater regulatory authority and capacity.

These proposals represent a dramatic departure from the Washington Consensus [glossary] that dominated international economic policy since the early 1980s. Indeed, the Financial Times noted that, “The suggestion that inflation targets should be raised to 4 per cent will cause many central bankers to choke on their breakfasts, since they have spent their whole careers gaining and preserving the creditability of keeping inflation at levels close to 2 percent.”

Needless to say, the proposal has sparked considerable coverage. While Ben Bernanke still seems to be committed to keeping inflation under the 2 per cent target, Paul Krugman and James Vreeland have both already chimed in the on discussion, offering some important contributions. (Krugman importantly notes that the current financial crisis facing Greece and the other PIIGS countries has its roots in this low-inflation policy). And Joseph Stiglitz has written several books critiquing the Consensus. But the new position note comes from within the IMF, suggesting a more dramatic policy shift may be on the horizon.

So why the move? The argument presented in the position note concludes that because the inflation targets were set so low, there was no room for central banks to maneuver once the global economic downturn hit. Central banks quickly lowered interest rates, attempting to stimulate the economy. But when this did not work, monetary policy provided few good options for addressing eh economic crisis.

Inside North Korea

The South Korean-North Korean Border (courtesy flikr)

I just rediscovered VBS TV, a group of investigative journalists who do some great reporting. They have a new documentary in which two of them manage to get into North Korea. Their report gives an unusual inside view of one of the world’s most reclusive regimes. After enduring days of indoctrination, scripted tours, and “unique” restaurants, in the final clip they conclude that the division between North Korea and the West is similar to the division between the West and the Soviet Union during the height of the Cold War. The challenge, they note, is that North Korea remains an authoritarian society isolated from the rest of the world. As they note in the video, “They [North Koreans] didn’t have punk. They didn’t have jazz. They didn’t have blues. There are no cultural similarities whatsoever…This is a time machine. This is 1930s Russia; 1950s Soviet Union. So they see me as the imperialist aggressor, and I see them as the land that time forgot.”

It’s an interesting notion. And it leads to some interesting conclusions. If the threat of hard power against North Korea (in the form of sanctions or the use of military force) has been unsuccessful in deterring them from pursuing nuclear weapons, is it possible that the use of soft power could be more effective? Could student and cultural exchanges bring down the North Korean regime in a way that the threat of force could not? And if so, what does this suggest about U.S. policy toward Cuba? The Cuban embargo, which has been in place since 1960, has clearly not forced Cuba’s hand. Could cultural exchanges and social pressure be more effective in promoting change in Cuba than the threat of hard power? It’s an interesting possibility.

Measuring Success at the Winter Olympics

Stephen Cobert's SI Cover

With the 2010 Winter Olympics scheduled to open in Vancouver this week, http://www.vancouver2010.com/ the Games are in the news. In Canada, which hosts the Olympics this year, embattled Prime Minister Stephen Harper is hoping for an “Olympics bounce” to boost his sagging popularity. The broadcasting network NBC, which paid $820 million for the rights to cover the Games, is hoping to limit its losses to $200 million. And Stephen Colbert has been making waves with his sponsorship of the U.S. speed skating team, landing himself on the cover of Sports Illustrated in the process.

With the athletes descending on Vancouver in search of gold medals, national pride is often at stake. But the question of how to compare the relative performance of countries remains. Should we use total medal count? Or should only gold medals count? Should we factor in the population of the country? What about the size of its economy? Playing with the data produces fundamentally different results—an important lesson for students of global politics!

So without further a due, here are the top Winter Olympic performers (sort of):

Top Winter Olympic Performers by Total Medal Count

1. Russia/USSR (761 medals)
2. United States (544)
3. Germany (533)
4. Canada (496)
5. Norway (428)
6. Sweden (393)
7. Finland (389)
8. Switzerland (289)
9. Austria (249)
10. Czech Republic and Slovakia (226)

But what if we just look at gold medals? After all, that represents the pinnacle of Olympic performance.

Top Winter Olympic Performers by Gold Medal Count

1. Russia/USSR  (388 gold medals)
2. Canada (203)
3. United States (156)
4. Germany (136)
5. Norway (134)
6. Sweden (119)
7. Switzerland (82)
8. Finland (73)
9. Austria (71)
10. Italy (67)

So far, no real changes. Russia remains on top, the US and Canada switch places, Italy nudges the Czech Republic and Slovakia out of the top 10. But the bulk of the countries in the top ten remain the same.

But why should large and small countries be counted in the same way. Shouldn’t we expect a country with a large population (like the United Sates) to outperform smaller countries (like New Zealand), given that the United States has so much larger a pool of talent to draw upon to field its Olympic team? To get a sense of this, consider population per medal. How many people does it take to earn a medal?

Top Winter Olympic Performers by Population per Medal (2008)

1. Liechtenstein (3,955 people per medal)
2. Norway (11,350)
3. Finland (13,767)
4. Sweden (23,757)
5. Canada (68,540)
6. Austria (33,626)
7. Switzerland (26,918)
8. Czech Republic and Slovakia (70,506)
9. Russia/USSR (186,501)
10. The Netherlands (199,870)

Using this measure, we start to see some real changes. Russia falls from first to ninth, while the United States drops from second to 21st.  Liechtenstein (a country with a total population of about 35,000 people), rockets from 22nd place to first.

But we could also consider the countries’ relative wealth. Shouldn’t relatively wealthier countries, which can afford to subsidize their athlete’s training programs through corporate sponsorships or the construction of advanced training facilities, perform at a higher level? One way to think about this is the size of the economy relative to the number of medals. In other words, how much GDP does it take a country to get a medal? In other words, which countries are most efficient in their pursuit of Olympic medals?

Top Winter Olympic Performers by Total Medals Per $ of GDP (2008 Nominal)

1. Liechtenstein ($554.78 GDP per medal)
2. Finland ($698.89)
3. Norway ($1,055.68
4. Sweden ($1,218.73)
5. Czech Republic and Slovakia ($1,379.46)
6. Austria ($1,665.98)
7. Switzerland ($1,731.00)
8. Russia/USSR ($2,203.14)
9. Canada ($3,023.29)
10. Estonia ($3,872.00)

Here we see some interesting shifts as well. Liechtenstein again moves up dramatically, while the United States, with the world’s largest economy, falls to 25th, earning one medal for every $26.5 million of GDP. Now that’s some fun with data!

Solving the Somali Pirate Problem

Danuel Sekulich’s Modern Day Pirates blog had an interesting proposal for dealing with the piracy challenge in Somalia. It’s pretty simple, actually. Sekulich proposes establishing a moratorium on foreign fishing within Somalia’s exclusive economic zone. According to Sekulich, this “would allow Somali fishermen who claim to have turned to piracy because of the foreign fishers to be allowed to work in safety. And it would undermine any of the claims being put forth that Somali pirate gangs are somehow ‘defending’ their own people.”

Sekulich’s proposal is useful because it addresses the underlying reasons for piracy. Many Somalis turn to piracy out of poverty. They are former fisher people who, as a result of the dumpling of waste and overfishing off the Somali coast, have turned to piracy as a way to earn a living. United Nations backed naval patrols may increase the cost of piracy, but it will not end the practice. Only providing an alternative to piracy will. It’s a parallel situation to the challenge of the opium trade in Afghanistan. And it’s a great example of the interaction of environmental degradation and national security.

Taxes, Big Government, and Economic Growth

It’s often taken as a truism that lower taxes lead to higher levels of economic growth. The National Center for Policy Analysis, an anti-tax think tank, goes so far as to assert that if the United States had lowered its marginal tax rate to the “optimal tax rate,” growth in the United States would have increased from 3.4 percent per year to 4.6 percent per year between 1950 and 1995. They argue that lowering taxes will encourage people to work more, thus increasing the total revenue collected by the government through taxes. It’s a restatement of the Laffer Curve. It’s also the argument advanced in every introductory economics textbook. And according to most studies, it’s also wrong.

Baseline Scenario has a great analysis of the relationship between tax rates and growth in gross domestic product in the United States since the end of World War II. Their finding? There is no relationship. An analysis of the data comparing unemployment rates and tax rates in OECD countries suggests that there is no direct relationship there either. Baseline Scenario’s conclusion is a good one:

I don’t think these pictures prove anything. Well, maybe they prove one thing: that the real world is more complicated than the first-year economics textbook…If there’s one thing I’d like people to take away, it’s that any theoretical economic argument that can be stated in a sentence is as likely to be untrue as true in the real world, no matter how clever or intuitive it is.

The Challenges of Monetary Union

Paul Krugman’s recent analysis of the “Spanish Tragedy” deserves more consideration than it’s received. Krugman’s argument is essentially that the current problems faced by several European Union members (chiefly the high rate of sovereign debt) are the result not of irresponsible governments spending recklessly. Rather, the fundamental problem is the European Monetary Union itself.

Monetary Unions are interesting things. When the Euro was established as the single currency for many European Union members, there were two schools of thought. The first (pro-integration) position was that it would lower transaction costs, increase efficiency, and make the European Union an important global player. The second (anti-integration) position argued that the single currency would be difficult to manage because of the competing impulses and demands of the individual member states. A single currency makes using monetary policy [glossary] to manage the economy across a large area increasingly difficult. Encouraging economic expansion in Spain, for example, by expanding the money supply could only work if the other monetary union members went along. If the European Central Bank is concerned about inflation in Germany and stagnation in Spain, what is it to do? The two problems require fundamentally different (indeed, opposite) policy approaches under monetarism. 

As Krugman summarizes the situation:

Spain is an object lesson in the problems of having monetary union without fiscal and labor market integration. First, there was a huge boom in Spain, largely driven by a housing bubble — and financed by capital outflows from Germany. This boom pulled up Spanish wages. Then the bubble burst, leaving Spanish labor overpriced relative to Germany and France, and precipitating a surge in unemployment. It also led to large Spanish budget deficits, mainly because of collapsing revenue but also due to efforts to limit the rise in unemployment.

The Spanish crisis, in other words, resulted from the monetary union. Can the monetary union now be its savior? Doubtful, but we’ll see.