Author Archives: jfrankel

How to Re-Negotiate NAFTA

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The Trump Administration says it is sticking with its core campaign promise to renegotiate NAFTA, which remains unpopular with many Americans even though economists think it has been beneficial. The President said again on April 20 that he will invoke the procedures for renegotiating the trade agreement soon (within “the next two weeks”). After that comes a 90-day consultation period with Congress before actual talks begin. It is worth asking how it could be done right.

Of course Mr. Trump could any day think it over more carefully and abandon the promise, as he (fortunately) has now done with the oft-repeated but inaccurate pledge to name China a currency-manipulator on “day one” of his administration and with so many other promises. For now, however, businesspeople and government officials have little choice but to consider the possibility that the currently stated policy will be in fact be pursued.

Options for Mexico

If the US tries to bully its smaller neighbor, for example to raise tariffs in violation of NAFTA and the WTO, Mexico has some options. It could:

  • Raise tariffs to its old high “bound rates” (without violating NAFTA or the WTO)
  • Buy more corn from Brazil and Argentina instead of the US.
  • Accelerate trade agreements with other countries.
  • Allow the passage of Central American migrants through Mexican territory to the US border, rather than impeding them as it currently does.
  • Curtail cooperation with US law enforcement authorities in areas such as drug crime.
  • Suggest that a re-opening of NAFTA should be accompanied by a re-opening of the 1848 Treaty of Guadeloupe Hidalgo which, at the point of a gun, ceded half of Mexico’s territory to the US, including California and the rest of today’s southwest. Perhaps Anglos who have moved to these territories since then would be asked to present documentation papers to the Mexicans who were there before them. (Well, maybe this option is less practical.)
  • Most worryingly, Mexicans could retaliate against US provocation by electing as president their own nationalist, Andres Manuel Lopez Obrador in 2018.

But if only for the sake of argument, let us take at face value that the Trump Administration may want to renegotiate NAFTA in good faith. Mexico’s leaders, for their part, have taken the position that if renegotiation is what the US wants, then “let’s get on with it already”.

Six ways NAFTA could be improved

It has been 23 years since the three-country trade agreement went into effect. If NAFTA is seriously to be renegotiated, how could it be improved? Consider six ways it could be improved.

  1. Updating for some new issues that did not exist when NAFTA was originally negotiated, such as e-commerce and data localization.
  2. Greater protections for labor, such as guaranteeing throughout the region that workers can form independent unions, banning child labor, and strengthening enforcement against human trafficking.
  3. Greater protections for the environment, such as steps to protect the oceans and provisions to enforce bans on trade in endangered species and illegal logging.
  4. The backing up of environmental and labor provisions by a dispute settlement process and threats of economic penalties that are as serious as those that back up regular mercantile disputes.
  5. Some protection against corporate abuse of Investor-State Dispute Settlement. There should be provision for summary dismissal of frivolous suits, such as when a multi-national corporations challenges a new regulation simply on the grounds that it diminishes their ability to earn profits.
  6. The inclusion of more countries in the agreement. Good candidates would be some in South America, including Peru and Chile, and others in Asia and the Pacific. There are various benefits to a broader multilateral approach.
  • For one thing, even though the Trump Administration has expressed a preference for making bilateral deals (and for targeting bilateral trade balances), it is in fact easier to come up with deals that benefit everyone when more countries are in the deal at the same time. For example, as Trump has found out, US dairy producers want Canada to reduce barriers to US dairy products. But Canada wants Japan to remove barriers to its pork, beef, and wood products, more than it wants anything from the US. A trade agreement that includes Japan and other Asian and Latin American countries is more likely to satisfy the requirement that each member sees clearly what export opportunities are in it for them.
  • For another thing, bringing more countries into the agreement might make it easier for firms to deal with the Rules of Origin that govern various American trade agreements. These are provisions that are written to prevent Americans, for example, from buying tariff-free products that are assembled in Canada or Mexico but derive much of their value-added in Asia or elsewhere. The Rules of Origin are currently so onerous that some US importers reportedly choose simply to dispense with the benefits of NAFTA and the accompanying paperwork and instead to pay the low normal tariff that would apply even without NAFTA.
  • Instead of streamlining the rules of origin for US trade, White House advisor Pater Navarro actually wants to make them more demanding by requiring a higher share of local content in order for a product to qualify for NAFTA duty-free treatment. But this approach is unlikely to be very effective. Rather than responding by raising the local value-added in North American trade, it could lead even more importing firms to dispense with the benefits of NAFTA and choose instead to default to the normal US tariff rate (even if the product includes a lot of imported inputs from outside the region). The average normal rate [“bound rate”] for US tariffs is only 3 ½ per cent. The reason is that the US unlike Mexico had low tariffs even before negotiating NAFTA.

Six ways to improve NAFTA: Updating for new issues, strengthening protections for labor and the environment, improving settlement mechanisms, and including more countries in the agreement…. Is this all pie in the sky? Would it be impossibly difficult to negotiate a new agreement that had every one of these desirable properties? The trade negotiators already did it. It is called the Trans-Pacific Partnership.

[A shorter version of this column appeared at Project Syndicate. Comments can be posted there or at Econbrowser.]

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Mnuchin and Manipulation of Money

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US Treasury Secretary Steven Mnuchin already finds himself hemmed in on all sides.

Domestic constraints come from the promises that he and President Trump have made and the laws of arithmetic.    How, for example, is he ever going to be able to reconcile the specific tax proposals that candidate Trump campaigned on with the promise of the “Mnuchin rule” that taxes won’t be cut for the rich?  That is even harder than the traditional conundrum that faces Republican Treasury Secretaries: having to explain how massive tax cuts (to which they are truly committed) can be reconciled with a reduction in the budget deficit (to which they claim to be committed).

Many of his predecessors found that they had more latitude in the international part of their job than the domestic part.  Their voice would often receive more respectful hearings from their foreign counterparts on the international stage, at multilateral meetings like the recent G-20 gathering in Baden-Baden, than from domestic political players in Washington.

But Mnuchin will have a harder time in the international context.  To begin with, the current Administration has indicated in many ways that it no longer wants the job of leader of the global system.  The leader is the one who persuades other countries that certain agreed-upon rules, such as an open trading system, are in everybody’s interest.  The Trump administration has no interest in playing that role.  Its view is that the appropriate thing to do in international negotiations is to make unilateral demands.

It is fortunate that Mnuchin realized that the scheduled opportunity to name China a currency manipulator comes in April, when the biannual Treasury report to Congress is due, rather than, the day that Trump assumed the presidency as promised.  But he should pass on the opportunity.  He needs to explain to his boss that China is no longer manipulating its currency, preferably in time for Trump’s meeting with Chinese President Xi Jin Ping, scheduled for April 6-7, at Mar-a-Lago.   President Trump has explicitly re-asserted his earlier campaign allegations of manipulation by the Chinese.

“Deal-makers” don’t do well with ill-informed bluster that they are subsequently forced to back down on.  This principle was illustrated when Trump challenged the “One-China” policy in December but was then unsurprisingly forced to reverse himself, in a February 9 phone call with President Xi.  Unpredictability is not always an advantage, as he seems to think.  Chinese know the difference between a bargaining chip and loss of face.  Trump is now that much weaker in dealing with China.  A leader who has a very good brain should learn the lesson.

Is China manipulating its currency?  The language regarding “manipulating exchange rates” originated in a 1977 decision by IMF members. Of the various criteria to determine whether a country is guilty of intentional manipulation to gain competitive advantage and frustrate balance of payments, the sine qua non is the systematic purchase of foreign exchange reserves to push down the value of the national currency (“protracted large-scale intervention in one direction in the exchange market”).  The other two criteria are the partner’s current account balance and the value of its currency (e.g., judged by international price competitiveness relative to an appropriate benchmark).

Those are the three criteria in international law.   The US Treasury’s biannual reports to Congress on foreign exchange policies of major trading partners were originally mandated in a 1988 law, later “intensified” in a 2015 law.  The Treasury is directed to include the country’s bilateral trade balance vis-a-vis the US as one of the three criteria, even though bilateral balances per se play no role in either the IMF rules or economic logic.  (That the US runs bilateral trade deficits with many countries has far more to do with factors other than their currency policies.  For one thing, the US runs a trade deficit overall because it has a low rate national saving.  This is bound to worsen under Trump fiscal policies.)  A statistical analysis of Treasury decisions regarding whether to name countries as possible manipulators in particular reports shows a significant role for the US unemployment rate in election years, along with the bilateral balances.

It is true that the RMB was undervalued in 2004 (by roughly an estimated 30%), according to a wide variety of criteria.  But as of today China no longer qualifies as a currency manipulator under any of the three internationally accepted criteria:  exchange rate level, trade balance, and use of foreign exchange reserves.  The RMB appreciated 37% between 2004 and 2014 (on a real broad trade-weighted basis).  Its trade surplus, after peaking at 9% of GDP in 2007, then adjusted to the receding price competitiveness: the surplus has been less than half that level each year since 2010.

Furthermore in 2014 – as the Chinese economy slowed relative to the US economy — China’s capital inflows turned to capital outflow.  As a result the overall balance of payments went into deficit.  Foreign exchange reserves peaked in July of that year and have been falling since then.  The People’s Bank of China, far from pushing the renminbi down, has spent a trillion dollars of reserves over the last three years trying to support the currency in the foreign exchange market, by far the largest such intervention in history.  The authorities have also tightened controls on capital outflows, again with the objective of resisting depreciation. They have succeeded, in the sense that despite some adverse fundamentals the RMB has continued to be one of the world’s more appreciated currencies, second only to the dollar and a few others that are even stronger.

These points are not new.  True, it took a while for most American commentators to notice the sea change in China’s foreign exchange market.  By now it has been three years and most observers have figured it out.  But not the US president.

Some other Asian countries meet one or the other of the manipulation criteria.   Korea’s trade surplus has been running at around 7% of GDP and its current account even higher; but it is not piling up foreign exchange reserves the way it was several years ago.  Similarly with Thailand.  It is not clear if there is an Asian country that meets all the criteria.

Peter Navarro, director of Trump’s new National Trade Council points the finger at Germany, saying it “continues to exploit other countries in the EU as well as the U.S. with an ‘implicit Deutsche Mark’ that is grossly undervalued”.   It is true that Germany’s trade surplus is a big 8% of GDP and the current account surplus close to 9%, which is indeed excessive.   But Germany has not had its own currency since the mark gave way to the euro in 1999. The European Central Bank has not operated in the foreign exchange market in many years; and when it did, the intervention was to support the euro, not push it down.

Given the absence of direct foreign exchange intervention among G-7 countries, those who allege currency manipulation suggest that some governments are doing other things to keep their currencies undervalued, particularly expanding the money supply.  Of course central banks do engage in monetary stimulus knowing full well that one effect is likely to be a depreciation of its currency and a stimulus to its exports.  But one has to keep pointing out that:

  • Countries have the right to use monetary policy to respond to domestic economic conditions.
  • In normal cases, it would require a mind-reader to know whether currency depreciation was a major motivation for the action,
  • A successful monetary stimulus will also raise income through domestic channels and thereby raise imports, so that the net effect on the trade balance could go either way, and
  • If other countries don’t like the exchange rate and trade balance results, they are free to undertake monetary expansion of their own.

In 2010-11, these were the arguments that were given (correctly) in defense of the Fed’s quantitative easing and the dollar’s depreciation, when Brazilian leaders accused the US of waging “currency wars.”  They are just as valid when other countries are the ones needing monetary stimulus.

The Trump administration’s accusation against Germany is a uniquely foolish instance of manipulation allegations.  It is true that the European Central Bank responded to the 2008-09 global recession (belatedly) by lowering interest rates and undertaking quantitative easing, and that this contributed to a depreciation of the euro.  But it has been plain for all to see that Germany has consistently opposed the ECB’s monetary stimulus.  One does not have to read the minds of the German officials to see that a charge of manipulation would be nonsense.

Other forces have been working to weaken foreign currencies against the dollar.  Perhaps the biggest in the last five months has been Donald Trump  himself.  His talk of raising tariffs against Mexico, China, and other trading partners has worked to depreciate those currencies against the dollar.  The proposal for a Border Adjustment Tax has the same effect.  Finally, Trump has promised big tax cuts and they are likely to pass Congress — though he unintentionally delayed his tax plans substantially, by putting Obamacare repeal first.   The result (not promised) will be a rapid acceleration in the national debt, which will probably force up interest rates, the dollar, and the trade deficit.

The multilateral calendar includes a G-7 leaders meeting in Sicily in May and a G-20 summit in Hamburg in July.  Mnuchin’s unenviable task is to acquaint Trump with reality by then.

[A shorter version appeared at Project Syndicate, March 22, 2017.  Comments can be posted there.]

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Let the US Fiduciary Rule Go Ahead

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The quantity of financial regulation is not quite as important as the quality.  One must get the details right.  The case of the US “fiduciary rule” strongly suggests that President Trump will not get the details right.

Could Dodd-Frank be improved?

Earlier this month, amid the flurry of tweets and other executive orders, the new occupant of the White House issued an executive order directing a comprehensive rethinking of the Dodd-Frank financial reform of 2010.

One can imagine various ways to improve the current legislation.   The most straightforward would be to restore many of the worthwhile features of the original plan that Republicans have undermined or negated over the last seven years.  (Most recently, the House this month voted to repeal a Dodd-Frank provision called “Publish What You Pay,” designed to discourage oil and mining companies from paying bribes abroad.  Score one for the natural resource curse.)

In theory, one might also attempt the difficult and delicate task of modifying, for example, the Volcker Rule, so as to improve the efficiency tradeoff between compliance costs for banks and other financial institutions, on the one hand, and the danger of instability in the system, on the other hand.  Some in the business community are acting as if they believe that Trump will get this tradeoff right.  I see no grounds whatsoever for thinking so.

In particular, the financial system has been strengthened substantially by such features of Dodd-Frank as higher capital requirements for banks, the establishment of the Consumer Financial Protection Bureau, the designation of Systemically Important Financial Institutions, tough stress tests on banks, and enhanced transparency for derivatives.  If these features were undermined or reversed, it would raise the odds of a damaging repeat of the 2007-08 financial crisis down the road.

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