Category Archives: emerging markets

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 Fed, China and Oil

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My answers to three questions at the start of 2016 (from Chosun Ilbo, leading Korean newspaper):

1. How do you analyze the recent US interest hike, and how will it influence the global economy in the coming year?

The Fed had telegraphed its decision to raise the interest rate so far in advance and (by December) so clearly, that the policy change was already fully reflected in markets.  For example most of the substantial appreciation of the dollar since 2014 can be attributed to anticipation of the Fed tightening.   Furthermore, the movements in relative monetary policy — the end of quantitative easing in the United States, the first increase in interest rates, simultaneous monetary easing in other countries and the appreciation of the dollar – all reflect relatively greater strength in the US economy compared to most others.  It will create difficulties for some commodity-producing countries that had gone back to large-scale borrowing in terms of dollars.  But the pattern of US growth, monetary tightening, and dollar appreciation is not bad news for the rest of the world overall.

 

2. What is your view on China’s economy, and how will it economy influence the global economy this year?

It was inevitable that China would not be able to sustain a fourth decade of growth rates in the neighborhood of 10%.   Some of the sources of its growth have begun to run into diminishing returns, such as rural-urban migration, heightened capital/labor ratios and an over-stretched environment.

The open question is whether the transition to a more sustainable and moderate rate of growth that we are now seeing will be a soft landing or a hard landing (e.g., a crisis arising from unneeded construction, shadow banking, and bad loans).   A good scenario, the soft landing, is by no means ruled out yet.  The 2015 stock market bubble and crash was not as important as observers thought.  Much of what we are seeing could be the desired shift in the composition of China’s economy, away from the production of manufactured goods and their sale for exports or physical investment, and toward the production of services and their sale to the consumer sector.

Even though China is slowing down a lot, its economy occupies a much larger share of the world economy than it used to.  For this reason, it will continue to be an engine of growth in the world, just not as quite as strong an engine as had been forecast by those who rely on simple extrapolation of past trends.

3. What is your view on oil prices recently? How will the oil price change impact the global economy this year?

The fall in dollar oil prices has many causes, both on the supply side (US fracking, Saudi decisions) and the demand side (weakened demand from much of the world, especially China).   One cause that is often overlooked is the strength of the dollar against other currencies.

Needless to say, the fall in oil prices hurts oil exporters and benefits oil importers.   The benefits for oil importing countries in Asia and Europe in 2016 will probably be greater than what has been evident so far.

Low retail prices for fossil fuels are bad for the environment.  All countries should take advantage of the recent fall in oil prices by either shifting their taxes onto fossil fuels or else, if they currently have wasteful subsidies to fuel consumption, then they should cut them.  They should take their cue from developing countries such as Egypt, India, Indonesia, Mexico and the UAE that have done that recently.

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Gas Taxes and Oil Subsidies: Time for Reform

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World oil prices have been highly volatile during the last decade.   Over the past year they have fallen more than 50%.

Should we root for prices to go up, down, or stay the same?   The economic effects of falling oil prices are negative overall for oil-exporting countries, of course, and positive for oil-importing countries.  The US is now surprisingly close to energy self-sufficiency, so that the macroeconomic effects roughly net out to zero.  But what about effects that are not directly economic?   If we care about environmental and other externalities, should we want oil prices to go up or down?  Up, because that will discourage oil consumption?  Or down because that will discourage oil production?

The answer is that countries should seek to do both: lower the price paid to oil producers and raise the price paid by oil consumers.  How?   By cutting subsidies to oil and refined products or raising taxes on them.   Many emerging market countries have taken advantage of the last year of falling oil prices to implement such reforms.  The US should do it too.

Congress continues to shamefully evade its responsibility to fund the Federal Highway Trust Fund.  On July 30 it punted with a 3-month stop-gap measure, the 35th time since 2009 that it has kicked the gas-can down the road!  There is little disagreement that the nation’s roads and bridges are crumbling and that the national transportation infrastructure requires a renewal of spending on investment and maintenance.  The reason for the repeated failure to put the highway fund on a sound basis for the longer term is the question of how to pay for it.  The obvious answer is, in part, an increase in America’s gasoline taxes, as economists have long urged.  The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries.  Ideally the tax rate would be put on a gradually rising future path.

Fuel pricing is a striking exception to the general rule that if the government has only one policy instrument it can achieve only one policy objective.   A reduction in subsidies or increase in taxes in the oil sector could help accomplish objectives in at least six areas at the same time:

  1. The budget. It is estimated that energy subsidy reform globally (including coal and natural gas along with oil) would offer a fiscal dividend of $3 trillion per year. The money that is saved can either be used to reduce budget deficits or recycled to fund desirable spending, such as US highway construction and maintenance, or cuts in distortionary taxes, e.g., on wages of lower-income workers.
  2. Pollution and its adverse health effects.   Outdoor air-pollution causes an estimated annual 3.2 million premature deaths worldwide.  A gas tax is a more efficient way to address the environmental impact of the automobile than alternatives such as CAFÉ standards which mandate fuel economy for classes of cars.
  3. Greenhouse gas emissions, which lead to global climate change.
  4. Traffic congestion and traffic accidents.
  5. National security.   If the retail price of fuel is low, domestic consumption will be high.  High oil consumption leaves a country vulnerable to oil market disruptions arising, for example, from instability in the Middle East.  If gas taxes are high and consumption low, as in Europe, then fluctuations in the world price of oil have a smaller effect domestically.   It is ironic that U.S. subsidies to oil production have often been sold on nationalsecurity grounds; in fact a policy to “drain Americafirst” reduces self-sufficiency in the longer run.
  6. Income distribution.  Fuel subsidies are often misleadingly sold in the name of improving income distribution.  The reality is more nearly the opposite.  Worldwide, fossil-fuel subsidies are regressive: far less than 20%  of them benefit the poorest 20% of the population.  Poor people aren’t the ones who do most of the driving; rather they tend to take public transportation (or walk).   As to producer subsidies, owners of US oil companies don’t need the money as much as construction workers do.

The conventional wisdom in American politics is that it is impossible to increase the gas tax or even to discuss the proposal.   But other countries have political constraints too.  Indeed some governments in developing countries in the past faced civil unrest or even overthrow unless they kept prices of fuel and food artificially low.  Yet some of them have managed to overcome these political obstacles over the last year.  The list of those that have recently reduced or ended fuel subsidies includes Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates which abolished subsidies to transportation fuel subsidies effective August 1.

Besides raising taxes on fuel consumption, the US should also stop some of its subsidies to oil production.  Oil companies can “expense” (immediately deduct from their tax liability) a high percentage of their drilling costs, which other industries cannot do with their investments.  Most politicians know that sound economics would call for this benefit to be eliminated.  But they haven’t been ab le to summon the political will.  Among the other benefits given to the oil industry, it has often been able to drill on federal land and offshore without paying the full market rate for the leases.

Those politicians who complain the loudest about the evils of government handouts are often the biggest supporters of handouts in the oil sector. Political contributions and lobbying from the industry must be part of the explanation.  Even so, it is surprising that self-described fiscal conservatives see more political mileage in closing the Export-Import Bank – which earns a profit for the US Treasury while it supports exports – than in ending oil subsidies, which cost the Treasury a great deal.   ‘

A recent study from the IMF estimated that global energy subsidies at either the producer or consumer end are running more than $5 trillion per year.  (Petroleum subsidies account for about $1 ½ trillion of that. A lot also goes to coal, which does even more environmental damage than oil.)  US fossil fuel subsidies have been conservatively estimated at $37 billion per year, not including the cost of environmental externalities.

Leaders in emerging market countries have now recognized something that American politicians have apparently missed, that this is the best time to implement such reforms.  Oil prices have recently fallen to around $50 a barrel – down from a level well over $100 a barrel in the summer of 2014. So governments that act now can reduce energy subsidies or increase taxes without consumers seeing an increase in the retail price from one year to the next.

For the US and other advanced countries it is also a good time for fuel price reform from the standpoint of macroeconomic policy.  In the past, countries had to worry that a rising fuel tax could become built into uncomfortably high inflation rates.  Currently, however, central bankers are not worried about inflation except in the sense that they are trying to get it to be a little higher.

Congress will have to come back to highway funding in September. If other countries have found that the “politically impossible” has suddenly turned out to be possible, why not the United States?

[A shorter version of this column was published at Project Syndicate.  Comments can be posted there.]

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