Only the Debt Is National

Imagine this set of transactions.

1. A bank in rich country A makes a loan of X to the government of poor country B. Let’s say for concreteness that A is the United States, B is Nigeria, and X is $1 billion. So now we have a liability of $1 billion of the Nigerian government to the US bank, and deposit of $1 billion at the US bank owned by the government of Nigeria.

(Nigeria might just as well be Egypt or Mexico or Argentina or Greece or Turkey or Indonesia. And the United States might just as well be Germany or the UK. )

2. The deposit at the bank is transferred from ownership of the government to ownership of some private individual. It’s easy to imagine ways this can be done.

3. The residents of Nigeria, via their government, still have a liability of $1 billion to the bank, obliging them to make annual payments equal to the interest rate times the principal. In this case, let’s say the interest rate is 5%, so debt service is $50 million.

4. The payments can be met by running an annual export surplus of $50 million. As long as this $50 million annual payment is maintained, interest payments can be made and the principal rolled over; the debt will remain forever.

5. The private individual from step 2 moves from Nigeria to the United States, eventually becoming a citizen there.

The result of this: a family in the United States has wealth of $1 billion (plus whatever they already had, of course). Meanwhile, the people of Nigeria make payments of $50 million each year to the United States forever, in the form of uncompensated exports. In their important book Africa’s Odious Debts and related work, Boyce and Ndikumana demonstrate that this story describes much of sub-Saharan Africa’s foreign debt. It applies elsewhere in the world as well.

I wonder how various people evaluate this scenario. Do we agree there is something wrong here? And if so, what, and what is the solution?

The orthodox view, as far as I can tell, is: what’s the problem? People should pay their debts. Nigeria (or Argentina etc.) is a person, it has borrowed, it must pay. The fact that some private individual chooses to hold their wealth in one country rather than another has nothing to do with it.

More generally, the dominant view today is that the ability to carry transactions like those describe above is an unmixed blessing; in fact it’s the whole point of the international system. The three pillars of the European union are free movement of people, free movement of goods, and free movement of finance.  Argentina’s Macri is hailed as a hero — by Obama among others — for removing capital controls.  If you are committed to capital mobility, then it’s hard to see where the objection would be. Third World governments and New York banks are consenting adults and can contract on any terms they choose. And of course the fact that a possessor of wealth happens to be located in one country cannot, in a liberal order, be an objection to them owning an asset somewhere else.

Maybe it’s the last step that is the issue? Outside of Europe, the free movement of people does not have the same place in the economic catechism as the free movement of money or goods. And even in Europe it’s a bit shaky. Still, most governments are happy enough to welcome rich immigrants. (A few months ago, my FT dislodged a glossy pamphlet, a racially ambiguous woman in a bikini on the cover, advertising citizenship by investment in various Caribbean countries.)  This post was provoked by a Crooked Timber post by Chris Bertram; I’d be curious what he, or other open-borders advocates like my friend Suresh Naidu, would say about this scenario. Does an unrestricted right of human beings to cross borders imply an unrestricted right to transfer property claims across them also?

If the solution is not limits on movement of people, perhaps it is limits on cross-order transfers of financial claims, that is, capital controls. This used to be common sense. It’s not entirely straightforward where capital controls would operate in the sequence above; the metaphor of “capital” as a substance that moves across borders is unhelpful. But in some way or other capital controls would prevent the individual in country B from coming into possession of the bank deposit in country A.

There are two problems with this solution, one practical and the other more fundamental. The practical problem is that many routine transactions — payment for imports say — involve the creation of bank deposits in one country payable to some entity in another. It is hard to distinguish prohibited financial transactions from permitted payments for goods and services — and as Boyce and Ndikumana document, capital flight is usually disguised as current account transactions, for instance by over-invoicing for imports. Eric Helleiner [1] quotes Jacob Viner: “Because of the difficulty of distinguishing between capital account and current account transactions, capital controls could be made effective only by ‘censorship of communications and by crushing penalties for violation.'” [2]

The more fundamental problem is that these transactions — and capital flight in general – may be perfectly legal by the rules in force when they take place. Or if formally illegal, they are usually carried out by high government officials and/or members of the country’s elite. So the government of the poor country is unlikely to aggressively apply any restrictions that do exist. A subsequent government might well feel differently — but what claim do they have on a private bank account in a foreign country?

The problems with making capital controls effective were recognized clearly in the runup to Bretton Woods. In White’s 1942 draft for the agreements — again quoting Helleiner — “governments were required (a) not to accept or permit deposits or investments from any member country except with the permission of the government of that country, and (b) to make available to the government of any member country at its request all property in form of deposits, investments or securities of the nationals of the member country.” Even this wouldn’t be enough, of course, in the case where the wealthowner ceases to be a national. And it might not help in the case of a corrupt government that doesn’t want to repatriate private funds — though it might, if (as was also discussed) countries with balance of payments problems were required to draw on foreign exchange in private hands before being granted official assistance. In any case, it seems challenging to impose effective capital controls without granting the government control of all foreign assets — which will often require the cooperation of the country where those assets are held.

Needless to say nothing like this was included in the Bretton Woods agreements as signed. The US government would not even accept its allies’ pleas to assist in repatriating flight capital to help with the acute balance of payments difficulties following the war. Now it’s true, Second Circuit Judge Griesa recently claimed even more extensive authority that the government of Argentina would have had under White’s proposals, seizing the US assets of third parties who’d received payments from the Argentine government. But that was strictly to make payments to creditors. No such access to foreign assets is generally available.

This situation can arise even if governments themselves don’t even have to borrow abroad. As we recently saw in the case of Ireland, a government can strictly limit its debt and still find itself with unmanageable foreign liabilities. If private institutions — especially banks, but potentially nonfinancial corporations as well — borrow abroad, government that wishes to keep them operational  in a crisis may have to assume their liabilities. Or at least, they will be strongly urged to do so by all the guardians of orthodoxy. What, are you going to just let the banks fail? Meanwhile, any foreign claims generated by the activities of the banks before they failed are out of reach.

Financial commitments create obligations; when circumstances change, sometimes they can’t be met. Someone isn’t going to get what they were promised. In modern economies, the state (often in the guise of the central bank) steps in to assume or redenominate claims, to impose an ex post consistency on the inconsistent contracts signed by private agents. But with foreign-currency commitments to foreigners the authorities’ usual tools aren’t available. And just as important, there are other authorities — the ECB in the case of Greece, the US federal court system in the case of Argentina — that are ready to use their privileged position in the larger payments system to enforce the claims of creditors. In effect, while domestic contracts are always subject to political renegotiation, foreign contracts are — or can be made to seem — objective fact.

What we’ve ended up with is a situation in which private parties have an absolute right to make whatever financial commitments they choose, and national governments have an absolute duty to honor the resulting balance sheet commitments. Wealth belongs to individuals, but debt belongs to the people. They are bound by past government commitments forever.

Or as Marx observed, “The only part of the so-called national wealth that actually enters into the collective possession of modern peoples is their national debt. …in England all public institutions are designated ‘royal’; as compensation for this, however, there is the ‘national’ debt. ” 

 

 

[1] The Helleiner book, along with Fred Block’s Origins of International Economic Disorder, is still the best thing I know on the evolution of international monetary arrangements since World War II. Has anything better been written in the 20 years since it came out?

[2] This brings out two general points on financial regulation that I’d like to develop more. First, it is one thing to establish different rules for different kinds of activity, but the classification has to actually match up with the legal and accounting categories in which actual economic transactions are organized. The category of “banks” is a currently relevant example. This is part of the larger issue of what I call the money view, or economic nominalism — we need a perspective that regards money payments and the labels they bear as fundamental, rather than seeing them as reflections of some underlying structure. Second, and relatedly, it is hard for individual regulations to be effective in a setting in which anything that is not explicitly forbidden is permitted, since for any regulated transaction there will normally be unregulated ones that are economically equivalent.

What Do People Need to Know About International Trade?

On the first day of my trade class, we read Paul Krugman’s article “What Do Undergrads Need to Know About Trade?” In an admirably succinct four pages, it captures all the important things that orthodox trade theory claims to tell us about trade policy. I don’t think orthodox views on trade policy have changed at all in the 20 years since it was written. [1]

So what’s Krugman’s answer? What undergrads need to know, he says, is just what Hume and Ricardo were saying, 200 years ago: If relative costs of production are different in two countries, then total world output, and consumption in each individual country, will always be greater with trade than without, and prices will adjust so that trade is balanced. Free trade is always beneficial for all countries involved.

Krugman’s additions to this Ricardo-Hume catechism are mostly negative — a list of things we don’t need to talk about when talk about trade.

Don’t worry about development. The idea that a country can benefit from changing the sectors or industries it specializes in is, he says “a silly concept.” Yes, we look around the world and see workers in rich countries producing things like airplanes and software, which are worth a lot, and workers in poor countries putting the same effort into producing agricultural goods and textiles, which are worth much less. But

Does this mean the rich country’s high standard of living the result of being in the right sector, or that the poorer country would be richer if it tried to emulate the other’s pattern of specialization? Of course not.

Of course not. This blanket dismissal is rather odd, since the work Krugman won the Nobel for explicitly supports an affirmative answer to both questions. [2] It’s a case of esoteric versus exoteric knowledge, I guess — some truths are not meant for everyone. Or as Krugman delicately puts it, “the innovative stuff is not a priority for undergrads.”

Don’t worry about demand. In debates over policy, “the central issue is employment” in the arguments on both sides. But this is wrong, he says:

The level of employment is a macroeconomic issue, depending in the short run on aggregate demand and depending in the long run on the natural rate of unemployment, with policies like tariffs having little net effect. Trade policy should be debated in terms of its impact on efficiency…

It’s not immediately obvious why the claim that employment depends on aggregate demand is inconsistent with the claim that trade flows have important employment effects. After all, net exports are a component of demand. The implicit assumption is evidently that the central bank (or some other domestic policymaker) is maintaining the level of demand at the full-employment level, and will offset any effects from trade. [3]

Don’t worry about trade deficits, and the financing they require. “The essential things to teach students are still the insights of Ricardo and Hume. That is, trade deficits are self-correcting…”

The whole piece is frankly polemical — it’s clear that the goal is not to educate in the normal sense, but to equip students to take a particular side in public debates. This is not specific to Krugman, of course. If anything, most contemporary textbooks are even worse. [4] One  reason I am using Caves and Frankel in my class is that it has less obnoxious editorializing than other texts I looked at. But less is still a lot.

Enough Krugman-bashing. What’s the alternative? What should people know about international trade? Matias Vernengo has one good alternative list. Here is mine.

There are three frameworks or perspectives in which we can productively think about international trade. The questions we ask in each case will depend on whether we are thinking of trade flows as the adjusting variable, or as reflecting an exogenous change to which some other variable(s) must adjust.

1. Trade flows are part of aggregate expenditure. On the one hand, a good way to predict trade flows is to assume that a fixed fraction of each dollar of spending goes to imported goods. As Joan Robinson and others have stressed, in the short run at least, adjustment of trade balances comes mainly or entirely through income changes. (This is also the perspective developed in Enno Schroeder’s work, which I’ve discussed here before.) On the other hand, if we can’t assume there is some level of full employment or potential output to which to which the economy always returns, then we have to be concerned with trade flows as one factor determining the level of aggregate income. This might be only a short-run phenomenon, as in mainstream Keynesian analysis, or it might be important to economic growth rates over the long run, as in models of balance of payments constrained growth.

2. Trade flows are part of the balance of payments. In a capitalist world economy, there are many different money payments and obligations between countries, of which trade flows are just part. In a world of liquidity constraints, certain configurations of money payments or money commitments are costly, or cannot be achieved at all. That is, a country in the aggregate cannot in general borrow unlimited amounts at “the” world interest rate. The tighter the constraints on a country’s financial position, the more positive a trade balance it must somehow achieve. On the other hand, for a given level of financing constraint, a more positive trade balance allows for more freedom on other dimensions. This interaction between trade flows and financial constraints is central to the balance of payments crises that are such a prominent feature of the modern world economy.

3. Trade flows involve specialization. Thinking now in terms of baskets of goods rather than money flows, the essential thing about international trade is that it allows a country’s consumption and production decisions to be made independently. Given that productive capacities vary more between countries than the mix of consumption goods chosen at a given income and prices, in practice this means that trade allows for specialization in production. If we take productive capacities as given, it follows that trade raises world output and income by allowing countries to specialize according to comparative costs. This is the essential (and genuine) insight of Ricardo. On the other hand, if we think that inherent differences between countries are small and that differences in productive capacity arise mainly through production itself, then international trade will lead to a historically contingent pattern of international specialization in which some positions are more advantageous than others. If causality runs from trade patterns to productive capacities and not just vice versa, then there is a case for including activity trade policy in any development strategy.

The orthodox trade theory has legitimate value and deserves a place in the curriculum. As we’ll discuss in the next post, simple textbook models of the Ricardo-Mill type can be used to tell stories with more interesting political implications than the usual free-trade morality tales. But they are only part of the picture. Much of what matters about trade depends on the fact that it involves flows of money and not just exchanges of goods.

[1] Have Krugman’s views changed since he wrote this? As reflected in his textbooks, no they have not. As reflected in his blog, seems like sometimes yes, sometimes no. Someone should ask him.

[2] For example, one of Krugman’s more widely cited articles is this one, which develops a model in which an innovating region (“the North”) develops new products, which it exports to a non-innovating region (“The South”). In the model,

Higher Northern per capita income depends on the quasi-rents from the Northern monopoly of new products, so the North must continually innovate not only to maintain its relative position but even to maintain its real income in absolute terms. 

This is hard to distinguish from the arguments for industrial policy that Krugman dismisses as silly.

[3] What’s especially odd here is that orthodox theory says that in a world of mobile capital, the only tool the central bank has to maintain full employment is changes in the exchange rate. In standard textbooks (including Krugman’s own), it is impossible for monetary policy to boost employment unless it improves the trade balance.

[4] For example, David Colander’s generally undogmatic intro textbook includes a section titled “If trade is so good, why do so many people oppose it?”The answer turns out to be, they’re just confused.

International Trade: What Are the Questions?

This semester, I’m teaching an upper-level class at Roosevelt on international trade. Trade is an interest of mine, but not something I’ve ever taught. So it will be a learning experience for me at least as much as for the students.

One way to organize a class like this is to start with the orthodox approach and then present the various heterodox alternatives. I don’t know if that’s the best way to do things; but it is what I am doing. So we divide things up:

1. Orthodox trade theory. Orthodox approaches to trade (the first half of any standard textbook; we are using Caves and Frankel) treat trade as an exchange of goods for goods. We assume that trade is always balanced and that all resources are fully employed, and show how specialization by different countries in their preferred activities leaves everyone better off. We can divide this approach into Ricardian models, which treats countries preferred activities as dictated by inherent differences in productive capacities, on the one hand; and on the other, the Heckscher-Ohlin models that regard countries as having the same productive technology but different “endowments” of (a relatively small number of) “factors of production.” As far as I can tell, these two kinds of models are not associated with distinct schools of thought in any larger sense; but it seems to me that the tension between them is one of the more interesting things in the orthodox theory.

2. Keynesian approaches. Here the important thing is the systematic relationship between income-expenditure and trade flows. On the one hand, we think a predictable fraction of incremental expenditure will fall on imports, and on the other, net exports are a form of autonomous demand boosting income. The short-run version of this approach used to be fully respectable; one very good presentation is Dornbusch’s 1980 textbook, Open Economy Macroeconomics. [1] The long-run version of the Keynesian approach is Thirlwall’s model of balance-of-payments constrained growth. I don’t know that this has ever been respectable but I think it’s useful and sensible and, I hope, teachable.

3. New trade theory. The starting point here is that while orthodox theory says that the biggest gains come from trade between countries that are most different (in terms of productive capacities or factor endowments), what we see in the real world is that most trade is between basically similar industrialized countries. The explanation, according to this approach, is that most trade is not in fact driven by comparative advantage, but by increasing returns, which reward specialization even in the absence of any inherent differences between countries or regions. This is the stuff Paul Krugman got his prize for. One puzzle about the new trade theory is that its practitioners almost all endorse the same free-trade policy orthodoxy underwritten by the old trade theory, even though the substantive content would seem to undermine it. What the new theory says is, first, that the pattern of specialization between countries is in some important respect arbitrary and at least potentially shaped by choices; and second, that the global distribution of income is a function of who ends up with which specialty. in this sense, there is some affinity between the new trade theory and Marxist theories of imperialism, dependency and unequal exchange. I’d wondered for a while if anyone had written about this connection. The answer turns out to be yes: Krugman himself. He even cites Lenin!

4. Development, dependency and unequal exchange. There is a large body of radical theory here, which I admit I have not quite got my arms around. For current purposes, let’s think in terms of two strands of analysis — or at least two sets of questions, which may or may not correspond to different schools or bodies of theory. First, there is the relationship between trade and economic development. Historically, we could put this at the very beginning of the list, since it seems that many of the earliest writers on what we now call economics were centrally concerned with this question. But for our purposes, we are interested in the tradition that runs from Hamilton to Friedrich List to Gerschenkron to Dani Rodrik and Ha-Joon Chang. These mostly pragmatic analyses, associated politically with rising rivals to the current hegemon, include a mix of infant industry/”import protection as export promotion” arguments, and trade restrictions as devices to expand the domestic policy space (the positive side of mercantilism emphasized by Keynes.) Second, there are the various theories that go under the names of dependency and unequal exchange. The key claim here is that there is a systematic movement of prices that favors the North and disfavors the South. We may further subdivide these theories into Prebisch-Singer and related approaches, and more Marxist analyses from Hobson, Lenin and Luxembourg through Baran to Frank, Wallerstein, Amin and Emmanuel.

Another way of looking at this: Among the assumptions of the orthodox theory are that all resources are fully employed, that prices always adjust so as to balance trade (or equivalently, that goods trade directly for goods), and that countries’ productive capacities can be taken as exogenous and determine the pattern of trade. Keynesian approaches reject the first two of these assumptions, the new trade theory rejects the third; the various development/dependency approaches also reject the third assumption and in some versions the first two as well.

There reason I’m posting this here is I’d like to integrate my teaching more with this blog. So the hope is to have a bunch of posts about all this over the next few months. I’m sure I’ll get a lot of things wrong; maybe the readers of the blog can correct some of them.

[1] On the other hand, this contemporary (and very admiring) review of the Dornbusch book does chide him for starting with 

a nonmonetary “Keynesian” model with rigid prices, fixed exchange rates, and unemployment … The basic consideration is short-run full employment; long-run problems of allocation and prices are left in the background. Economists with a more “classical” turn of mind may be a little disconcerted to find tariffs introduced as instruments to raise employment and to see real wages explained by the “claims” of trade unions. They would probably prefer to start out with the long-run picture, linking monetary aspects firmly to the pure theory of international trade. 

So maybe it wasn’t ever fully respectable. One thing I’d like to understand better is exactly when and to what extent “Keynsian” theory was accepted among academic economists.