Author Archives: jfrankel

The Sugar Swamp

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(June 25, 2017)
As the US, Mexico and Canada get ready to begin talks on the re-negotiation of NAFTA – possibly as early as August – governments are giving a lot of attention to one particular product:  sugar.   The outcome will predictably be a sweet deal for the US sugar industry, quite the opposite of Trump promises to “drain the swamp” of disproportionate influence in Washington by special interests.

It’s an old story, in the US as in other industrialized countries.  The politically powerful sugar producers receive protection in the form of tariffs and quotas on imports, to keep the domestic price of sugar far higher than the price in such low-cost supplier countries as Brazil, Australia, the Dominican Republic, the Philippines, and Mexico.

Sugar in NAFTA

As part of NAFTA, the US was supposed to open up the American sugar market to Mexico.   Indeed sugar was one of the few products in which free trade meant the removal of high US barriers, whereas the Mexicans had high barriers on many US products that NAFTA required them to remove.  But the required sugar liberalization was delayed long after NAFTA took effect in 1994.

Mexican sugar exports to the US did not rise strongly until 2013.  Then when they did, American producers and refiners lost no time in seeking protection.  The Commerce Department decided to give it to them:  tariffs up to 80%. This threat forced Mexico to agree in 2014 to limit its sugar exports and to explicitly prop up the US price.

Mexico this month apparently agreed to extend the limits.   According to Commerce Secretary Wilbur Ross, “The Mexican side agreed to nearly every request by the US industry.”  (The recent agreement apparently has as much to do with protecting American refiners per se by tightening the limits on trade in raw sugar, as with any adjustment in the overall level of protection of the sugar industry a whole.)

Why is sugar protection bad?   Consider some cost/benefit analysis.

Let’s start with the benefits, because the list is short.  The beneficiaries are American sugar growers – particularly a small group of wealthy cane producers concentrated in Florida plus sugar beet farmers in places like Minnesota and the Dakotas.  They have a long history of generous campaign contributions to the relevant politicians.  For example the famous Fanjul brothers, Alfonso and Jose (who incidentally are Palm Beach neighbors and friends of Secretary Ross), reportedly gave a half million dollars for the inauguration ceremonies of President Trump in January.  Another company, US Sugar, has been donating equally generously to Florida Governor Rick Scott.

Economic costs of sugar protection

The costs of measures to protect the sugar industry are far more numerous than the benefits.

  • As with trade barriers in most industries, American consumers are hurt by the high price of US sugar, which has been double the world price on average over the last 35 years.  The cost to consumers has been estimated at $3 billion a year.
  • Candy and ice cream companies of course use sugar in their production and so are also hurt by the distortedly high price. They have been shedding employment for years, as confectioners move their factories offshore where their chief input is less expensive.   (Outsourcing of manufacturing jobs, anyone?)  The International Trade Agency of the US Commerce Department found that “sugar costs are a major factor in relocation decisions” and estimated that “For each one sugar growing and harvesting job saved through high U.S. sugar prices, nearly three confectionery manufacturing jobs are lost.”
  • One might think that making sugar expensive would at least have big benefits for Americans’ health. But no.  For one thing, the artificially high price of the white crystals was partly responsible historically for the explosion in the production of high-fructose corn syrup as a substitute and its use in a startlingly wide variety of foods.  HFCS is at least as bad as sugar health-wise.
  • Sugar cane in Mexico is produced by hundreds of thousands of small, mostly poor, farmers. Depriving them of their livelihood is bad foreign policy.  Think of the undesirable alternatives to which those farmers might turn.  Or think of the larger message that is sent to the world when our actions are seen to contradict its lectures about the virtues of the market system.
  • Limiting imports is also bad for our exporters. The macroeconomic channels may not be obvious.  But if Mexicans can’t earn dollars by exporting to the US, they won’t have dollars to spend on US goods; the dollar will appreciate against the peso and so render US exports uncompetitive.  More tangibly, if the US were to ratchet up tariffs against Mexican sugar as  we threaten (which we would do in the name of fighting dumping and subsidies), the Mexicans would immediately respond by raising tariffs against our exports (again in the name of fighting dumping and subsidies).
  • The taxpayer is on the hook as well. Besides import barriers, another way that the US government protects domestic sugar farmers is a policy of putting a floor under the price via non-recourse marketing loans (from the USDA’s Commodity Credit Corporation).   When the domestic price dips down near the floor, as it did in 1999 and 2013, the government in practice subsidizes the producers at taxpayer expense (despite “no-cost” promises to the contrary).

Environmental costs of sugar protection

  • If the US hadn’t historically blocked sugar imports from countries such as Mexico and Brazil, it could have used sugar-based ethanol in auto gas tanks, at lower cost to both the environment and the consumer. (This policy failure was worse before 2012.  The American taxpayer paid directly to subsidize corn-based ethanol produced in Iowa, under an incorrect claim of environmental benefits.  At the same time, the US maintained a tariff of 54 cents per gallon on imports of sugar-based ethanol from Brazil, which is indeed good for the environment on net. Even after those egregious features were removed five years ago, an inefficiently high fraction of corn production is still diverted from food use into ethanol.)
  • Speaking of the environment, the last negative effect on the list brings us back to the topic of swamps.  The Everglades – the unique system of wetlands in southern Florida that includes a National Park – have suffered environmental degradation for a century.  They have shrunk to half their original size because the incoming flow of water was diverted by federal water projects early in the last century (by the US Army Corps of Engineers).  Furthermore, phosphorus run-off has altered the eco-system (choking out  sawgrass, feeding algae blooms).  In recent years, plans to reverse the damage to the “river of grass” legislated by Congress in 2000 have been delayed.   The main problem all along has been the nearby sugar cane industry, which demands the diverted water, supplies the phosphorus run-off, and lobbies politicians with some of the resulting profits.  Most recently, sugar interests have posed financial and political obstacles to efforts to build a reservoir (south of Lake Okeechobee) as part of the year-2000 Everglades restoration plan.

Under a free market, it would not be profitable to grow so much cane on valuable South Florida land, if any.  But Trump’s idea of “draining the swamp” in Washington is evidently to artificially stimulate the sugar industry through import protection and subsidies, and to let everyone else bear the cost:  consumers, candy manufacturers, Mexico, and the environment.  That includes draining the Everglades.

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

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The Case against Subsidizing Housing Debt

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SINGAPORE — At the end of the first quarter, according to the Federal Reserve Bank of New York, American consumer debt for the first time exceeded its previous peak (in dollars).  That peak was in the 3rd quarter of 2008, just as the global financial crisis hit.  Although car loans and student debt have been rising especially rapidly, housing debt remains more than 2/3 of the total ($8.6 trillion out of $12.7 trillion).

As a share of income, household debt is nothing like the threat to the national economy that it was ten years ago.   But the new statistic is a good reminder that American households don’t save enough.

Some would say that there must be something cultural in the tendency of Americans to spend while Asians, for example, tend to save.   But there is an important policy component as well.  US government policy is designed as if to encourage as many American families to take on as much housing debt as possible.

Economists hesitate to explain to people that they should borrow less.  The advice sounds too “schoolmarmish.”   It seems to lack sympathy for those whose incomes are not keeping up with the standard of living that they had expected based on historical trends.   But for those concerned with the reach of the nanny state, the state is precisely what encourages citizens to borrow.  And it does nobody any favors to get them overly indebted, as the millions of homeowners who went underwater in the housing crisis ten years ago discovered.

Does homeownership have spillover effects?

Owning your own home is said to be an essential part of the American dream.   There is nothing wrong with planning for a good future.  But there is nothing wrong with renting, either.   Buying a house is not a cause of a family’s prosperity, it is typically a consequence.   Owning is a blessing; over-indebtedness is a curse.

The Economist magazine estimates that the overall effective subsidy to American housing debt runs about 1% of national income per year.   Does owner-occupied housing have spillover benefits to justify this subsidy?

The “ownership society” view argues that homeowners take better care of their properties than renters, which has positive externalities for the neighborhood.   But there is also an argument against artificial public encouragement of home owning:  It contributes to the decline in labor mobility.  In the last recession many who lost their jobs could not move to other parts of the country where jobs were more plentiful, because they couldn’t sell their homes.  There is good evidence that the housing crisis boxed in job seekers.

The mortgage tax deduction

What are the US policies that artificially encourage housing debt?   Top of the list is the tax-deductibility of home mortgage interest.  The deduction, though very popular, is hard to justify on grounds of income distribution:  the benefit only goes to those who have a high enough income to itemize deductions.  Also it loses the treasury a lot of revenue.

Republicans say they want revenue-neutral efficiency-enhancing tax reform, which is properly defined as lowering marginal tax rates but simultaneously eliminating distortionary deductions, so that total tax revenue does not fall and the budget deficit does not rise.  If the desire for revenue-neutrality were genuine, the home interest deduction should probably be the first one to curtail.  Outright elimination is too radical politically.  But the deduction could be limited to $250,000 per person and second homes could be excluded.

If Donald Trump manages to get any economic legislation passed at all, even next year, it is likely to be a tax cut.   The White House has already explicitly said that the home interest mortgage deduction is off the table, a sign that they are not serious about genuinely revenue-neutral tax reform.

Five other policies that subsidize housing finance

Particularly suspicious in the case of Trump is his support for giveaways in the tax code that benefit only real estate developers like him.  One such loophole lets them deduct real estate losses that exceed their investments in the business.  This is how he is presumed to have avoided paying taxes for many years, though the experts have to guess since he won’t release his tax returns.  Another loophole is the use of “like-kind exchanges” to avoid capital gains tax.

But the problem goes well beyond Trump or the Republicans.   The policies that favor mortgage debt are extremely popular.  Virtually all politicians of both political parties have long supported them, taking the goal of maximizing home-ownership as self-evident.  And of course they reflect the views of their constituents.

The list of ways in which the US system tilts toward housing debt goes on.

Some borrowers are encouraged to make down payments as little as 5 per cent (or even less) of the value of the house they buy, rather than the more standard 20%.  Such low capital ratios can quickly go to zero and worse if the house price falls even a little.   Many other countries, such as Korea and Singapore, have ceilings on loan-to-value ratios and other regulations limiting how much households can borrow.   They even manage to tighten the loan limits and tax measures counter-cyclically.  Such macroprudential regulation is the recommended way to help stabilize the housing cycle.

But the US is not the only country with measures that distort decisions toward excessive housing debt.  The United Kingdom has had a sequence of programs such as the Help to Buy initiative, which subsidizes purchases with down payments of only 5%.

Another way the US government has long subsidized housing debt is the role of huge public underwriters, particularly Fannie Mae and Freddie Mac.   They were privately owned leading up to the financial crisis but had an implicit government guarantee from taxpayers, a classic case of moral hazard.  Sure enough, they were put in federal conservatorship in 2008.  Congress could easily repeat the mistake of privatizing them while failing to credibly eliminate the implicit guarantee.   Their capital standards should be raised, just as the regulators have appropriately done for banks.

The Dodd-Frank financial reform bill, signed into law by President Obama in 2010, had many good features to help reduce the chances of another big financial crisis. But the law would have moved us further in the right direction if many in Congress had not spent the last seven years chipping away at it. Here is one example.

The Dodd-Frank law wisely required banks and other mortgage originators to retain on their books at least 5% of the housing loans they made, rather than repackaging every last mortgage and reselling it to others. The reason is that the originators need to have “skin in the game” in order to have an incentive to take care that the borrowers would reasonably be able to repay the loans. Under heavy pressure from Congress, that requirement was gutted in 2014.  This was yet another way to encourage the borrower and lender to skip the part of the meeting in the lender’s office where they check to see if the borrower will be able to pay back the loan.

Home ownership rates

One would think that the US encouragement of housing debt would at least raise home ownership rates.  But it doesn’t seem to, relative to other countries.  Even at the peak of the housing boom, the subsidies bid up the price of housing more than they increased the quantity.  Home ownership was no higher than in many countries with more sensible mortgage policies like Canada (which has no tax deduction for interest).  The result of the 2007-09 crisis was to bring ownership rates down, from 69% to 63%.  And of course the housing debt distortion was itself a key contributor to the housing bubble and crash — perhaps the policy mistake that was most easily identified ahead of time.

People are not aware that most economists have long considered these policies bad for the economy.  They may not care:   We are told that they no longer want to hear from experts.  When did that loss of faith happen?   Wasn’t it when the economy was hit by a housing and financial crisis — which economists supposedly failed to predict?

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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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