The Power and the Money

Angela Merkel finds her inner Teddy Roosevelt: Lessons from Santo Domingo

 It appears that the German government has just announced that it wants Greece to renounce its sovereignty in return for more credit. (Well, at least in return for the release of existing credit lines.) The idea isnt new: in 2002, two prominent economists seriously proposed that Argentina give up its sovereignty for five years. Of course, Argentina has done quite well for nine years by breaking all the rules, but it is far from clear that Greece could copy that, or that Argentina will continue to do well.

There is a historic parallel: the U.S. and the Dominican Republic in 1905. (Actually the U.S. and lots of Latin American countries, ranging as far afield as Peru and Bolivia, plus Liberia ... but let’s wait on that.) Short takeaway: Washington was way more generous back in those benighted days, with very little at stake, than Berlin is being today, despite massive repercussions for Germany if things go wrong.

The backstory was about what you might expect. The D.R. had defaulted; its government was facing multiple armed revolts; and the Germans were nosing around. This latter made Washington nervous that a rebel force (or one of the rapidly-changing governments of the day) might transfer a naval base to Germany in return for aid. In fact, after U.S. intelligence captured a letter from General Demetrio Rodríguez openly requesting aid for President Carlos Morales, Captain James Miller “invited” Rodríguez on board his ship, where he explained: “Neither he [Morales] nor anyone must think for a moment that Germany or any other foreign power could be situated in any portion of the Dominican territory.”

President Morales saw an opportunity. If he could convince the United States to take over his country’s customhouses, using the German threat as motivation, then he could kill three birds with one stone. First, having U.S. troops in the ports would remove them as strategic targets for rebel forces. Second, U.S. officials could manage the customhouses far better than corrupt Dominicans, thereby increasing revenue. Third, if the Americans could be convinced to skim a bit off the top and use that to guarantee debt repayments, then the D.R.’s borrowing costs would go down, and Morales could borrow more on top of the increased revenue. Win win win! Who needs sovereignty? (Two out of the three points, one might think, would apply to Greece today.)

Uncharacteristically, President Theodore Roosevelt (in his own words) chose to  “put off the action until the necessity became so clear that even the blindest can see it.” He was a bit worried that American public opinion might not be thrilled with the idea of involvement in somebody else’s civil war, not while the Philippine War had only just ended two year previously, and not with U.S. troops still fighting in Mindanao. So Roosevelt waited, and the Dominican situation got worse, and the Europeans kept nosing around, and American investors kept screaming, and finally in May 1904 the President proclaimed his famous corollary to the Monroe Doctrine. It read:

Any country whose people conduct themselves well can count upon our hearty friendship. If a nation shows that it knows how to act with reasonable efficiency and decency in social and political matters, if it keeps order and pays its obligations, it need fear no interference from the United States. Chronic wrongdoing, or an impotence which results in a general loosening of the ties of civilized society, may in America, as elsewhere, ultimately require intervention by some civilized nation, and in the Western Hemisphere the adherence of the United States to the Monroe Doctrine may force the United States, however reluctantly, in flagrant cases of such wrongdoing or impotence, to the exercise of an international police power.

Thing is, it still took a while to build support, and there was, you know, an election to win. President Roosevelt didn’t agree to Morales’s request until December 1904, a month after the U.S. presidential vote. The Senate, it turns out, had other ideas. Roosevelt decided that with the election past, that wasn’t a problem, and so the U.S. took over the customhours without a treaty on March 31, 1905.

Under the agreement, the U.S. directed 55% of customs revenue towards debt payments, but it did not do so mindlessly or automatically. Rather, it banked the money until February 1907, when it finally forced the D.R.’s creditors to accept a 50% haircut on their outstanding principal. (The average coupon was reduced to 5%.) In fact, if expropriation claims are excluded, creditors accepted a 57% haircut on their debt.

Moreover, the agreement worked: there was no austerity. Even after the U.S. took 55% off the top, government spending did not fall. Moreover, the D.R. managed to go to the capital markets as early as May 1907, when it refinanced its outstanding post-haircut debt of $15.8 million and borrowed an additional $3.9 million. ($3.9 million is, as a share of U.S. GDP, the equivalent of $1.7 billion in 2010.)

And therein lies the rub. Or rubs. First, the D.R. was not a democracy in 1904; Greece is one in 2012. Second, the D.R. asked for the receivership; the Greek government is not. Third, the U.S. used its good offices to obtain a very favorable debt restructuring; the E.U. (meaning the Germans, really) is letting Greece hash things out with its creditors on its own. Finally, in the case of the D.R. the U.S. really was able to improve custom collection; I’m not sure that anyone believes that a foreign administrator will be able to easily improve the Greek internal revenue service inside a culture of widespread evasion.

In other words, the U.S. was much more generous to its dirt-poor neighboring nondemocracy than the Germans are being towards their not-as-poor fellow democracy. Good luck with that. Unless, of course, failure is the plan.

Argentina beats a dead cow, and finds oil

 Argentina has oil! Lots of oil. The problem is politics. More specifically, high export taxes that effectively cap the price of oil for producers.

In November, Repsol YPF found a billion barrels at Loma La Lata. (That’s “Tin Can Hill” in English, which I really like.) Loma La Lata is in the Vaca Muerta region (yes, Tin Can Hill is in Dead Cow) which has seen previous shale oil discoveries. In December, it made another discovery.

How fast can the oil be pumped out of the ground? Shale oil (also called “tight oil”) is produced by hydraulic fracking, where you drill a vertical well, turn it horizontal through the shale, blast explosives into the rock, and then pump pressurized fluid in to break it up further and liberate the hydrocarbons.

Shale oil wells have hyperbolic decline rates. A typical well might initially produce 900 barrels per day, declining to 200 by the end of the first year, and well under 100 by five years. Wells are generally spaced at 160 acres. So, back of the envelop: YPF is prospecting 428 square kilometers, or 661 160-acre blocks, which at an average daily production (over five years) of 260 bpd translates to about 170,000 barrels per day. Multiply that by two (for the second field) and you have just increased Argentina’s production from around 800,000 bpd to 1.14 million! Actual exploratory wells in the Vaca Muerta have started at 500 bpd, which would still leave you with 990,000 bpd after just these two discoveries.

Existing production will decline, but Argentina is lucky in the sense that it can adopt technologies from elsewhere: oilfield surveillance is two decades behind the U.S. Better oilfield surveillance means better use of secondary recovery techniques. As far as those techniques go, YPF is a world leader. Combine new surveillance technology with YPF’s existing expertise, and there is a good chance that existing fields will continue to produce for some time. In 2010, YPF managed to replace all of its reserves entirely through secondary recovery.

(In terms of gas, the picture is even brighter: Argentina looks to have the second-largest shale gas reserves on the planet, after the United States. But that is for another post.)

The production tax regime is fairly light, as these things go. The provinces charge a 12% royalty, plus a 2% revenue tax on upstream companies. The feds then charge a 35% income tax. Taxes have to be relatively light, because production is expensive! Operating costs in shale plays in Texas are around $8 per barrel; in Argentina they are likely to be around $10. Capital costs are even higher: wells cost about $12 million in Argentina. Total costs, then, could range as high as $56 per barrel. Now that is a worst case scenario: a more-likely number is $27 and it could be as low as $19 ... but the high number is not outside the realm of possibility. Certainly marginal costs will go that high once production ramps up.

And therein lies the rub. Argentina controls oil prices. Well, no, it doesn’t quite control them; it only does that for gas. (And that is why shale gas development is not going to go very fast.) But it has very high export taxes which effectively cap the price of oil at $42 per barrel ... which is a bit of a problem for high-cost shale plays. 

The system actually works as follows: when the international price goes above $42, the export tax kicks in at $18.90 per barrel. When the international price hits $60.90 ($42 + $18.90), the tax effectively becomes 100% of all revenues above $42. Argentine firms have managed to get around that by selling at higher domestic prices: in 2011, some companies realized crude sales as high as $60 per barrel, with an average around $55. (See page 14.)

This is going to be a mess to change. Shale oil could get a special rate, of course. (In practice, that would probably be a rebate of some sort.) Domestic oil prices could be allowed to rise. (Probably not a terrible idea, although who knows? Maybe there are giant increasing returns to oil consumption in the agricultural sector.) Export taxes could be lowered in general. (Which also, of course, means allowing domestic prices to rise ... and would deprive the government of much-needed revenue.) But it is still going to be a mess. No American has any business these days criticizing foreign democracies for having sclerotic political institutions, but President Fernández has a tricky political situation at home. I would not be that optimistic.

And then, of course, there are the Mapuche. As Setty has pointed out, early statements from the industry do not bode well.

I wish Argentina luck. But I think it might take a little longer than the analysts believe.

A short primer on the Ethiopian banking system

 Because this is what I do.

Ethiopia’s banking system is weird. It’s like a throwback to an earlier Africa, the Africa of the 1970s or 1980s. Three reasons.

First, the system is dominated by two big state owned banks. One of them — the Commercial Bank of Ethiopia — accounts for almost 50% of all lending, by itself. Throw in the other one (the Development Bank of Ethiopia) and the majority of lending in the country is being done by state-owned banks. That was pretty common in Africa thirty years ago, when almost everyone had a big state-owned bank or two that dominated the sector. But in 2012, state-owned banks are an endangered species. About half of all African countries don’t even have them anymore. In those that do, the state-owned bank is usually small and specialized, focused on some neglected sector like agriculture.

There are a couple of reasons for this. One is that, historically, African state-owned banks generally didn’t work very well. Another is that the big multinational lenders — the World Bank and the IFC — dislike state-owned banks, and have encouraged African countries to break them up and privatize them, or at least shrink and marginalize them. (For the record, I think this was mostly a positive thing — but like a lot of World Bank/IFC policies, it’s been applied in a rather ideological and ham-handed way. A lot of bad, corrupt, ineffective old state banks needed to go, but a lot of babies got thrown out with that particular bathwater.)

Ethiopia, though. Ethiopia is run by a bunch of former revolutionaries who are very nationalistic and not inclined to trust or listen to the World Bank and its ilk. So they’re keeping their big state-owned banks. But at the same time, they’ve allowed — no, encouraged — the growth of a vibrant private banking sector. There are about fifteen private banks in Ethiopia today, and they account for about 40% of lending and about 60% of deposits. They’re a vital part of the economy already, and they’re growing by leaps and bounds. So the banking sector is a true public-private hybrid. In this, Ethiopia looks a bit like a less-developed version of Brazil, where public banks are common and the BNDES development bank plays a major economic role ... but keep reading.

The second odd thing about the sector is that it’s closed and protected: no foreign banks are allowed. Ethiopia has no Barclays, no Bank of Africa, no Citi or HSBC. That’s also weird and unusual, because in 2012 most African and Latin American countries have opened up their banking sectors to foreign competition. Among other things, you can’t join the World Trade Organization unless you agree to do this — and everyone wants to join the WTO. Out of 54 African countries, all but seven or eight are already WTO members. (The ones that aren’t in the WTO are either oil-rich — Libya, Sudan, Equatorial Guinea — or recluse states like Eritrea, or tiny places like the Comoros. Oh, and Somalia, which doesn’t have a functioning government.) So pretty much everywhere in Africa, from Botswana to Senegal, you’ll encounter a bunch of international banks. But not in Ethiopia.

The third weird thing: the Ethiopian Central Bank? The guys who regulate the banks, control the money supply, set interest rates and all that? The Central Bank is not independent. Doesn’t even pretend to be. It’s an arm of the executive branch. It’s there to do all the normal central bank stuff, but it’s also there to carry out government policy. (In this, Ethiopia is also quite different from Brazil. The Banco Central do Brasil has little statutory independence, but plenty of de facto autonomy.)

Here’s an astonishing example. Couple of years back, the Ethiopian government wanted to build a hydroelectric dam. Huge, huge thing. Going to light up half the country. Also going to displace tens of thousands of villagers and do untold ecological damage, including possibly wiping out Lake Turkana, but do you want electricity or not? — So they want to build a dam, but for various reasons nobody wants to lend them money to build it. (Ethiopia’s credit is not good: Dagong rates the government at CCC, and Moody’s and Standard & Poor’s don’t even bother.) Where to get the money, then?

Well, the government of Ethiopia simply followed the Willie Sutton principle. The Central Bank told the private banks that they needed to start buying dam bonds. Lots of them. In fact, the Central Bank announced that for every dollar lent by a private bank, they would have to buy twenty-seven cents worth of bonds. Since commercial loan rates in Ethiopia are around 12% to 15%, and dam bonds pay just 3%, the banks were not very happy about this. But they had no choice: if they didn’t comply, the Central Bank would shut them down. So they’ve been buying dam bonds — millions and millions of dollars of them. And now the government has money to build its dam.

So, a mixed public-private banking system that’s protected from international competition, run by a non-independent central bank with a history of brutal intervention. How’s that working out?

Surprisingly well. But this may need another post.

In Ethiopia

 So, I’m in Ethiopia.

Addis Ababa, to be specific — the capital. This is a job for my current employer, and it’s relatively short as these things go — just ten days. I’ve been here a week already, so I go back in a few days. Meanwhile, a few things about Ethiopia.

It’s high. Most of the country is mountains or plateaus. Addis is about 2300 meters or 8000 feet up. You can definitely notice this. I have the habit of running or trotting up stairs; after three flights, I’m noticeably wheezy, and half an hour on the hotel’s treadmill the other night left me light-headed and shaky. There’s about 25% less air in every breath, so I guess one must either breath 1/3 more deeply or 1/3 more often.

The altitude also means that it’s not that hot during the day, and it’s actually coolish at night. You see people walking around with jackets and sweatshirts, which is not something I’m used to in Africa. (It also means Ethiopia is mostly free of malaria mosquitoes and some of the more hair-raising parasites.)

It’s Africa. But it’s slightly askew. By which I mean that in some ways, it’s very typically Sub-Saharan African, but in others it’s just weird. For instance, it’s mostly Christian and part Muslim, which is pretty common in Africa. But the Christianity isn’t Catholic or Protestant. No, it’s the Ethiopian Orthodox Church, which is 1700 years old, rather Old Testament (no pork, lots of fast days), and looks down on Catholicism as an upstart newcomer. Or: everyone speaks English as a second language, which is common enough. But the first languages are Oromo or Amhara, and everything is written in both English and the Amharic script — which is its own weird alphabet that resembles nothing so much as Armenian.

Ethiopians look different, too. On one hand, there are some very typical Ethiopian faces — one spots that right away. On the other, there’s a remarkable range of skin colors and hair textures. My tentative assumption is that I’m looking at different ethnic groups, but that’s just a guess. Certainly the place has had a history complex enough to support a lot of mixing.

The food is supposed to be excellent. Unfortunately, I’m here on business, which means I’m gravitating towards bland foods that are thoroughly cooked. I broke with this rule one day, and had some chili, and ended up getting really sick for a day — nausea, chills, you name it. (Man, I hate chills.) Business travel makes you conservative, y’know? So I can’t talk much about the food. Well, I can note that the coffee is brutally strong, and any meat is going to be tough. (Seriously. Africans generally enjoy their meat tougher than Europeans or Americans, but Ethiopians seem to take this to an extreme.)

Ethiopia is poor, but it’s also seeing very rapid economic growth. Very, very rapid. As in: better than 8% average growth per annum sustained for over a decade. Since the turn of the century, they’ve more than doubled the size of their economy. Since their population is growing rapidly, per capita income has only grown by about 50%. But that’s still pretty impressive. And you can see the growth happening in real time: downtown Addis is basically one huge construction boom. I haven’t seen anything like it since 1990s China.

Of course, it’s growth from a very low base. Ethiopia is still very poor. It’s poor even by African standards. And you see that too — people in ragged clothes, beggars, you name it. But fifteen years ago, it was very very poor. Now it’s just very poor.

I’ll probably have more to say about the economic stuff in a day or two. Meanwhile: questions about Ethiopia? 

Great debate attempt #6: The true unthinkability of interstate war in western Europe

 For various mostly-professional reasons, I have been thinking about war lately. (References: Winning the War on War and Where Have All the Soldiers Gone?) In an earlier discussions Jussi Jalonen argued that war will not disappear, but I was not convinced.

“Unthinkable” is an overused term. It’s usually used to mean  “awfully bad, and to be avoided.” Or, more accurately, “Too unlikely or undesirable to be considered a possibility.” That meaning, obviously, is hyperbole.

But there is a second meaning: impossible to imagine occurring in reality. That is a very concrete meaning. One can imagine all sorts of impossible things, but an unthinkable one is something that slips from your grasp when you sit down and try to think about how it might come about.

There are a lot of incredibly improbable things that are not unthinkable on a 50-year scale. Since this great debate attempt is about war, let’s give an example: a civil war in the United States. That is incredibly bloody unlikely even in a 50-year scale, I’d bet large sums against it, I’ll argue strongly that it won’t happen ... but one can imagine plausible scenarios. It reaches the first level of unthinkability (too improbable to be worth seriously considering) but not the second.

Proposition: interstate war in Western Europe has reached the second level of unthinkability. There is no set of imaginable circumstances that will lead a western European government to decide that it needs to kill citizens of another European government in an organized fashion.

Revolution update: not much has changed

 There was a time when this blog gave Hugo Chávez some credit. I wrote that he was building a pretty effective political machine;  I went so far as to call it “Daleyismo,” after the way this guy ran Chicago. I also gave him credit for raising domestic non-oil tax collection. And when the electricity shortages broke out, I pointed out that Chavista policy hadn’t been a complete failure: there had been a lot of investment in generation, but the country was hit by a really terrible drought.

Sadly, it looks as though the Bolivarian Republic isn’t following through even on its successes. The electricity piece, for example, praised the country’s investment in generation capacity, but lambasted the Bolivarian Republic for letting the transmission grid fall apart and encouraging massive wastage. Not a whole lot has changed: Venezuela has brought a lot of new thermal generation capacity on-line, but blackouts continue. Even more embarrassing, Venezuela has been unable to raise natural gas production, forcing it import gas from Colombia, gas produced by one of the oil companies that the Bolivarian Republic is fighting at ICSID. (As Setty reports, the problem was that Venezuela insisted on paying low prices for domestic gas.)

Housing doesn’t look much better. There’s a conflict over how many houses were built in 2011, but the statistics through the third quarter of 2011 don’t look that encouraging:

And, of course, the tax reforms have gone nowhere. Estimated non-oil tax collection will be 12.4% and 12.8% of GDP in 2011 and 2012, respectively, about what it was in 2008. 

I should take the opportunity to add this report about Maracaibo’s metro to nowhere. Although the cable cars in Caracas are a pretty good idea, albeit taken from Colombia.

We won’t talk about crime. It’s too depressing. If you must, here is a report on the situation. The President has said that he shouldn’t be held responsible for the crime rate, and who am I to argue?

Not terribly much to show for all the noise.

Not worried about the Straits of Hormuz

 A number of people have been asking about the risk that Iran will shut down the Strait of Hormuz. The short answer is: we’re not worried about it. But it’s worth running down why.

The ostensible reason why the Iranian government might want to shut down the strait is retaliation against a Western oil embargo. Sanctions are already causing Iran pain;  there is little doubt that such an embargo could be devastating. The European Union purchases 18% of Iranian production; Japan and South Korea take another 27%. China absorbs 22%, and could take more, but probably won’t for two reasons. First, after China’s recent self-imposed foreign policy disasters, the People’s Republic seems to have little appetite for antagonizing the West. Second, China and Iran are right now embroiled in a pricing dispute that could cut Iran’s exports by 40%. The truth is that God only knows if the European Union will get its act together, but let’s say that they do. 

Would Iran respond militarily? Military actions against commerce will, of course, provoke a response by the United States Navy. The ensuing naval war has two outcomes:

(1)  Iran loses. That would be a bad result. The best-case loss for Iran is something like the 1988 battle. (This was called Operation Praying Mantis back in the day when the Defense Department chose names for reasons other than propaganda.) The worst case loss is a wrecked export infrastructure, no naval capacity, and airstrikes against the nuclear facilities. All that, and you get blamed as the aggressor in the court of world opinion.

(2)  Iran wins. Is that possible? Probably not. But … back in 2002 the United States held a wargame called Millennium Challenge 2002. The results were rather interesting.  

Red, commanded by retired Marine Corps Lt. General Paul K. Van Riper, used old methods to evade Blue’s sophisticated electronic surveillance network. Van Riper used motorcycle messengers to transmit orders to front-line troops and World War II lighting signals to get airplanes off the runways without using radio communication.

Red received an ultimatum from Blue that was essentially a surrender document that Red must respond to within 24 hours. Given that Red knew that Blue was coming, by the second day of the exercise Red used a fleet of small boats to determine the position of Blue’s fleet. In a preemptive strike, Red launched a massive salvo of cruise missiles, overwhelming the Blue forces’ electronic sensors, destroying sixteen warships. This includes one aircraft carrier, ten cruisers and five out of the six amphibious ships. The equivalent of this success in a real conflict would have resulted in the death of over 20,000 service personnel. Soon after the cruise missile offensive, another significant portion of Blue’s navy was “sunk” by an armada of small Red boats carrying out both conventional and suicide attacks, able to engage Blue forces due to Blue’s inability to detect them as well as expected.

At this point, the exercise was suspended and Blue’s ships were “re-floated” and changes were made to the rules of engagement; later this was justified by General Peter Pace as: “You kill me in the first day and I sit there for the next 13 days doing nothing, or you put me back to life and you get 13 more days’ worth of experiment out of me. Which is a better way to do it?” … Due to his concerns about the scripted nature of the new exercise, Van Riper resigned his position in the midst of the war game. Van Riper later expressed concern that the wargame’s purpose had shifted to reinforce existing doctrine and notions of infallibility within the U.S. military rather than serve as a learning experience.

Iran has invested heavily in mine technology, which suggests they are at least committed to making a plausible threat. Their mines would be a lot better — more destructive, smarter/more selective, and harder to detect — than they were in 1988. They’re believed to have several thousand, and could plausibly get hundreds of them in the water on short (less than 48 hours) notice. Iran has also invested in cheap, dumb anti-ship missiles: in increasing order of size and scariness, the Kosar, Noor, and Raad. That last is a 3-ton subsonic shore-to-ship cruise missile with a payload that could probably disable a warship with a clean hit. The Kosar and Noor are smaller and shorter-range but can be mounted on small boats — these are the missiles modeled in Millennium Challenge. The U.S. counter-campaign would not be as simple as just sailing in and claiming naval control of the Straits; a sensible admiral will want to see missile launch, radar and airbase sites suppressed first.

Since a spike in energy prices will hurt almost everyone, world opinion would set firmly against Iran pretty quickly. Notable exceptions would likely include Venezuela and Russia, with the latter being important for its Security Council veto. So, military counteraction won’t have the benefit of a U.N. resolution. Another interesting legal aspect is flagging. Under international law an attack on a flagged ship can be treated as an attack on the flag nation, so if a Panamanian-flagged tanker hits an Iranian mine, Panama has a formal casus belli. Mines have gotten a lot smarter, but not yet so smart they can detect a flag. Moreover, the GCC will firmly line up against Tehran. The U.K. will almost certainly back military action, and France is even more likely to act. (France has a small military base in Abu Dhabi.) In other words, the lack of a UNSC resolution will probably do little to slow Western action.

Let’s say, then, that Iran could win the opening battles of a naval war in the Persian Gulf. Then what? The U.S. and E.U. won’t lift sanctions. The world’s largest navy will regroup and counterattack. There will be a period of prolonged high oil prices, but that won’t make the West (or the GCC) more willing to back down.

The nature of a counterattack would be open to considerable debate. Attacking the oil export facilities, for instance, could cripple Iran’s economy — but would also ensure that oil prices would stay high, as Iranian production would be offline for a long period of time. Nonetheless, even limited American action will destoy a great deal of Iran’s export capability along the way. Attacking the nuclear facilities would mean a dramatic expansion of war aims. It would probably be expensive, too — those facilities are far inland, dispersed, and well protected. Still, Iran will run a high risk that the U.S. will take the opportunity to attack the nuclear program: after all, Iran will have already used the biggest arrow in its quiver, and a counter-campaign will have to involve prolonged airstrikes on Iranian coastal defenses. 

In theory, of course, Iran could escalate further. Iran could launch missile attacks against GCC targets, but the U.S. and its Arab allies would respond with strategic attacks of their own — e.g., the destruction of Iran’s export capability. Iran could intervene in Iraq, but the U.S. no longer has combat troops in that country. A year ago, Iran could possibly call on Syrian support, but nowadays Syria has other problems. Finally, Iran could attempt to mobilize Hezbollah, but launching a Third Lebanon War isn’t in Hezbollah’s interests at the present time. Moreover, Hezbollah can do nothing to dissuade the United States.

In other words, if Iran loses the naval war, then it loses. If Iran wins the naval war, then it loses, possibly worse. There is no obvious endgame that ends with Iran ahead.

If a war starts by Iranian action, it won’t be because there is an international payoff. The reasons would be domestic. Some elements in Iran might consider a conflict with the U.S. worthwhile, even if Iran clearly comes off the worse, as long as critical regime assets are not endangered. There’s nothing like a foreign war for rallying popular support, after all. The most likely scenario would involve an actor or actors rather than the central government as such — the Revolutionary Guards, or some other group, taking an action that pulls Iran out on a limb. Nonetheless, that seems unlikely. 

Therefore, we will be greatly surprised if Iran mines Hormuz or otherwise attacks shipping, except in retaliation for an American (or Israeli) air raid. It simply has nothing to gain.

A one-sentence counterargument below the fold.

Financing the Revolution

 In an earlier post, I marvelled at Hugo Chávez’s mishandling of PDVSA. The same applies, however, to the fellow’s handling of the Bolivarian Republic’s fiscal accounts. There is something truly amazing about watching an oil-rich republic run into severe budget problems at a time of record oil prices. The upshot is that Venezuela might be even less able to thumb its nose at ICSID than people currently believe.

How bad are Venezuela’s budget problems? Francisco Rodríguez, whose work has been mentioned three times before on this blog, has done the dirty work of digging into the Bolivarian Republic’s accounting. That isn’t easy, because Venezuela has increasingly resorted to off-budget accounts, which now account for about a fifth of all public spending.

Let’s take them in turn. The first is Fonden. Fonden is ... well, it’s hard to say. The “National Development Fund” gets part of its money from PDVSA and part from the Central Bank. The Central Bank turns over “excess reserves” to Fonden. What does that mean? Answer: a sneaky way of financing the government by printing money. Consider: the Venezuela central bank prints bolívares and exchanges them for dollars. It then hands the dollars over to Fonden. If Fonden uses the money to import stuff, then the process ends. But if Fonden buys domestic goods and services, then it has to hand the dollars back to the central bank in exchange for bolívares. As of the end of 2009, $30.1 billion of Fonden $58.1 billion has come from the Central Bank. (See page 121.) This is, in effect, borrowing.

The second are the Chinese funds, financed by loans from ... duh ... China. Venezuela has borrowed $12 billion from China, going through PDVSA, and an additional $30 billion that is entirely obscure. (The $30 billion is a 10-year financing facility; it does not seem that the Bolivarian Republic has yet drawn any money from it.) It pays back interest and principal on the $12 billion by shipping back oil. How much oil? Well, PDVSA makes it impossible to tell, by mixing fuel oil and crude in the statistics. (See page 127.) You gotta love that.

On page 9, Rodríguez estimates that the country ships about 89 million barrels to China every year in loan payments. At $97 per barrel, that will be $8.6 billion, so either Venezuela is going to pay that debt off very quickly or China is charging an insanely high interest rate. (Inasmuch as PDVSA is shipping fuel oil instead of crude, the loan will paid off even faster.) Private sources estimate  the rate is LIBOR plus 2.85%, about 4.0% at the moment. That is a very low rate, consistent with a very short payback period for the loans. Nonetheless, I would not discount the possibility that China may be, in fact, running away with the store.

Finally, PDVSA has taken over many state functions directly, and the Bolivarian government carries out a lot of functions outside the official bureaucracy. That increases both spending and revenues.

The upshot, as a % of GDP:

That’s a pretty phenominal level of mismanagement for a country in the middle of an oil boom. The estimate is that the deficit was 7.9% in 2011, and will be 10.9% in 2012. The government will have access to $10.9 billion of central bank reserves (e.g., printed money), $7.7 billion of new Chinese lending, $15 billion of internal debt, and at least $15 billion of external debt. The reason I say at least is because Venezuela does not issue external debt solely to finance the government; Venezuela also issues external debt to prop up its exchange rate. For example, in the first half of 2011, the government needed only $12 billion, but tapped external financing sources totaling $24 billion.

Venezuelan debt financing:

The result is that at least until the country devalues (which would solve a lot of the financing problems, by raising the bolívar value of oil exports) Venezuela will need access to foreign financing. If that is going to come from private markets, then ExxonMobil will be able to attach it in order to pay any ICSID judgments. If that is going to come from multilateral lending institutions, then Venezuela will need to satisfy the U.S. government: Argentina is the only country to have ignored an ICSID judgment, and the Obama administration has declared that it will oppose new lending to that country. (The relevant testimony comes in this video at minute 41:40; more details here.) Venezuela will likely face even greater opposition. Lastly, if the money is going to come from the Chinese government, then China is going to attach strings (or charge quite a bit) ... and it is far from clear that China would want to weaken the existing system of investor-state arbitration.

Either way, Venezuela’s fiscal problems are a bit stunning to behold. It’s an impressive accomplishment, in its own strange way.

Plus ça change, plus elle ressemble à un tas de debans de rue de Brooklyn

  A while ago, I discussed the problems of correctly implementing what should be, in theory, the world’s easiest counterinsurgency strategy for a country as rich as the United States: bribe your opponents. The U.S. has tried it in multiple ways; at best, it’s been a partial success, in the sense that things could be worse. But only partial. In October of last year, the Taliban hit the headquarters of the Panjshir provincial reconstruction team. When I was there in ‘06, Panjshir was quiet, well-protected by the local militia. That said, there were plenty of incidents like this, albeit not as deadly. Bribery is expensive, it is long-term, and it needs to be institutionalized (either formally or informally) in a way that aligns everyone’s incentives.

Are there lessons from history? Well, yes, but they’re not good. My co-blogger and I give you a report from 170 years ago:

The deceptive quietude of Afghanistan which followed the sharp lessons administered to the Dooranees and the Ghilzais was not seriously disturbed during the month of September 1841, and Macnaghten was in a full glow of cheerfulness. His services had been recognised by his appointment to the dignified and lucrative post of Governor of the Bombay Presidency, and he was looking forward to an early departure for a less harassing and tumultuous sphere of action than that in which he had been labouring for two troubled years. The belief that he would leave behind him a quiescent Afghanistan, and Shah Soojah firmly established on its throne, was the complement, to a proud and zealous man, of the satisfaction which his promotion afforded.

One distasteful task he had to perform before he should go. The Home Government had become seriously disquieted by the condition of affairs in Afghanistan. The Secret Committee of the Court of Directors, the channel through which the ministry communicated with the Governor-General, had expressed great concern at the heavy burden imposed on the Indian finances by the cost of the maintenance of the British force in Afghanistan, and by the lavish expenditure of the administration which Macnaghten directed. The Anglo-Indian Government was urgently required to review with great earnestness the question of its future policy in regard to Afghanistan, and to consider gravely whether an enterprise at once so costly and so unsatisfactory in results should not be frankly abandoned.

Lord Auckland was alive to the difficulties and embarrassments which encompassed the position beyond the Indus, but he was loth to admit that the policy of which he had been the author, and in which the Home Government had abetted him so eagerly, was an utter failure. He and his advisers finally decided in favour of the continued occupation of Afghanistan; and since the Indian treasury was empty ... Macnaghten was pressed to effect economies in the administration, and he was specially enjoined to cut down the subsidies which were paid to Afghan chiefs as bribes to keep them quiet.

Macnaghten had objected to this retrenchment, pointing out that the stipends to the chiefs were simply compensation for the abandonment by them of their immemorial practice of highway robbery, but he yielded to pressure, called to Cabul the chiefs in its vicinity, and informed them that thenceforth their subsidies would be reduced. The chiefs strongly remonstrated, but without effect, and they then formed a confederacy of rebellion.

The Ghilzai chiefs were the first to act. Quitting Cabul, they occupied the passes between the capital and Jellalabad, and entirely intercepted the communications with India by the Khyber route.

Macnaghten did not take alarm at this significant demonstration,regarding the outbreak merely as “provoking,” and writing to Rawlinson that “the rascals would be well trounced for their pains.” Yet warnings of gathering danger were rife, which but for his mood of optimism should have struck home to his apprehension. Pottinger had come down from the Kohistan, where he was acting as political officer, bent on impressing on him that a general rising of that region was certain unless strong measures of prevention were resorted to ...

Is Sint-Maarten an independent state?

 The Kingdom of the Netherlands is a strange animal. It isn’t much of an empire. Nor is it a proper federation; it doesn’t even have a federal government per se. International treaties apply differently to the different parts. (See Articles 24-28 of the Charter of the Kingdom.) The Caribbean members have duty-free access to the European Union, but there is no true common market. In theory, Article 35 requires that they pay for their own defense. (In reality, it doesn’t matter: the insular Caribbean outside Cuba is a de facto military protectorate of the United States.) The Supreme Court of the Netherlands is the ultimate court of appeal, but most of the ex-British insular states (save Barbados and Guyana, but including Mauritius an ocean away) still use the Privy Council. It uses a different currency, with its own central bank. Finally, the Caribbean countries can all withdraw fairly easily, using provisions laid down in the Charter. Sint-Maarten could remove Dutch influence far more easily than the Bahamas could get rid of the United States.

So is the Kingdom meaningless? Are the constituent countries simply independent countries without a seat in the U.N.? Well, not quite. First, there is a common citizenship. Immigration and naturalization laws may vary (the latter by rather little), but once you’ve got that Kingdom passport you’re a full citizen. If Great Britain had been willing to extend that to the West Indies Associated States, I doubt that any of them would be sovereign countries today. (To be fair, the WIAS had other issues, not least of which that there was no equivalent of the Charter. British officials treated the association as nothing more than a British administrative inconvenience, which rankled on the islands.)

Second, law enforcement. The relationship is a bit of a mess. This Dutch document goes into it: since I am not a Dutch speaker, and translation software is overvalued, I can’t say that I understand the details. That said, while Dutch police have less authority in Sint-Maarten than, say, the FBI does in Puerto Rico, they do have authority, even if they generally need local approval to make arrests. That is a bit more authority than, say, OPBAT gives American officials in the Bahamas, or than DEA agents have in Colombia or Mexico.

Third ... well, here it gets interesting. The Netherlands provides financial support to the other countries in the Kingdom, but it is phasing it out. Development and fiscal aid is supposed to end by 2013. In fact, transfers have been generally miniscule. According to IMF data, in 2008 aid to Sint Maarten amounted to only 0.3% of GDP.

Recently, however, that has changed. Aid rose to 2.0% of GDP in 2009 and 6.2% in 2010, most of it to pay off Sint-Maarten’s debt arrears. More substantively, the Netherlands took over the debt from the former government of the Netherlands Antilles that otherwise would have gone to Sint-Maarten, a gift worth approximately 30% of the country’s GDP. In return, however, the island has had to accept Dutch financial supervision. The Financial Supervision Authority is supposed to stick around until 2013, by which point Sint-Maarten is supposed to have trained up enough people to take over the functions formally carried out by the government of the Netherlands Antilles. We’ll see.

In short, being part of the Kingdom of the Netherlands is a bit more substantive than simply lacking a U.N. seat. That said, technical sovereignty matters very little. The U.S. routinely took control of the finances of Latin American countries before WW2, and the IMF effectively does so today. (A country can refuse IMF money, of course ... but Sint-Maarten can, in theory, also refuse Dutch support.) Similarly, law enforcement officials from a powerful state can often find ways to exercise their authority inside a weaker one. Finally, lots of nominally sovereign countries share or outsource judicial authorities. What matters, rather, is citizenship and the moral authority to call on Dutch resources when necessary. It is a relatively weak relationship, but a real one nonetheless.

The French side of the island is completely different. If there’s interest, I’ll discuss it later.

Old evil vendepatria PDVSA saves new socialist PDVSA!

 On the turn of the New Year, the International Chamber of Commerce (ICC) awarded ExxonMobil $907.6 million in its dispute with PDVSA over the Venezuelan government’s nationalization of its interest in the Cerro Negro project in the Orinoco oil belt. The press has been pretty quick to call it a victory for PDVSA, considering that the company initially claimed that its investment was worth $12 billion. Exxon, they say, received only book value for its investment, and Chávez has run away with the store.

Is that true? My job here is to argue that it’s not. Exxon received from PDVSA what it was contractually entitled to get. The standard used by the ICC was the market value of the assets, not book value. The assumptions used to calculate that market value, however — chief among them estimates of the expected future price of oil — were limited by a clause in ExxonMobil’s 1998 association contract that effectively put a ceiling on the value of the company’s investment.

In the words of Steven Bodzin: “So for all the rhetoric about how the Old PDVSA sold out the patria etc. etc., the only reason the New PDVSA was able to do so well in arbitration was because of clever bargaining by the Old PDVSA?”

I’m going to briefly walk through the Orinoco value chain. Then I’ll briefly describe some key features of the Cerro Negro contract. Finally, we’ll run some numbers.

Let’s start with Cerro Negro. The project is in the Orinoco oil belt — but keep in mind that until 1956 it was actually called the Orinoco tar belt. (The “faja bituminosa del Orinoco.”) The crude oil there is “extra heavy,” meaning that its specific gravity exceeds that of water. At room temperature, the stuff is gunky and practically solid. Put it into a beaker and turn it upside down; the oil will stick.

That creates a bit of problem in terms of transporting the stuff. There are three solutions. The first is to heat it up and sent it out in special ships. That’s expensive and really only done for oil intended to be made into asphalt. The second is to mix the extra-heavy gunk with lighter crudes and export it. Venezuela’s “Merey” blend is a mix of 61.8% gunk and 38.2% lighter “Mesa” crude. (That’s nice, because it means you can calculate a market price for the gunk.) The third is to build an “upgrader,” where you partially refine the gunk, mix it with a diluent and then export the resulting “synthetic crude.”

The Cerro Negro project covers 115 square miles and includes an upgrader. Its costs, therefore, are not low. The cost to get the extra-heavy crude out the ground isn’t that high. Wikileaks documents indicate that it is around $4 per barrel, but it isn’t as though that number is top secret: Bernard Mommer, formerly the People’s Vice-Minister for Hydrocarbons and currently the Bolivarian Republic’s representative on OPEC’s Board of Governors, estimated them at $3.60. Upgrading costs, on the other hand, are significantly more expensive: Mommer reported them to be $9 per barrel. That comes to a total production cost of $12.60 per barrel of syncrude.

Production costs aren’t the only costs, of course. In 2002, the Bolivarian Republic hiked royalties from 1% to 17%. In 2006, it hiked them again, this time to 33%. That same year, it raised the income tax rate from 34% to 50%. Taxes and royalties, therefore, are very substantial.

When Hugo Chávez converted the Cerro Negro oil extraction project into a majority-PDVSA joint venture in May 2007, ExxonMobil rejected Venezuela’s (undisclosed) compensation offer and went to arbitration. It went to arbitration in two forums: the ICC and ICSID. The ICC arbitration was based on ExxonMobil’s association agreement, which established the Cerro Negro venture between ExxonMobil (41.67%), PDVSA (41.67%), and BP (16.66%). Article 15, “Consequences of Certain Governmental Actions,” stated that Exxon could take PDVSA to arbitration if PDVSA refused to “restore the economic benefit that the foreign party would have received had the discriminatory action(s) not occurred.”

What were the lost economic benefits? Well, at the prevailing oil price for Venezuelan blends in 2007 (and assuming a 9% nominal discount rate and 2% inflation) Exxon would have earned an average of $325 million per year (nominal), with a net present value of $3.0 billion. That’s a lot more than $907.6 million! So was Exxon robbed?

Well, no. The first (and minor) point is that in 2007 it was far from clear that high oil prices were going to last. When ExxonMobil signed the contract in the late 1990s, Venezuelan oil was bouncing around $16 per barrel. So it is possible that Venezuelan lawyers might have persuaded the arbitration panel to use a lower oil price, under the assumption that prices might have crashed. If that had been the case, I would unhesitatingly call the $907 million result a victory for the Revolution.

The nice thing, however, is that we don’t need to resort to hair-splitting. Article 15 of the association agreement tells us the price the arbiters had to use:

… after the first period of six consecutive months during which the price of Brent crude oil is in excess of the threshold price [$27 in inflation-adjusted 1996 dollars], Lagoven CN [PDSVA’s subsidiary in the Cerro Negro venture] will not be required to compensate any foreign party for any discriminatory action(s) with respect to any fiscal year in which the average price of Brent crude oil is in excess of the threshold price, and such foreign party received net cash flow commensurate, after taking into account the effect of the discriminatory action(s), with a reference price for the production produced by the parties that bears at least a reasonable relationship, adjusted for quality and transportation differences, to the threshold cash flow for such fiscal year.

Translation: the highest possible oil price that can be used to value damages in the event of expropriation is $27 per barrel in 1996 dollars, or $37.50 in 2007 dollars. Moreover, that’s the highest price — Venezuela, after all, doesn’t sell Brent but rather lower-priced blends. That price can be marked down to adjust “for quality and transportation differences.” E.g., the arbiters can pick a lower one.

Ah hah! Brilliant! When Brent traded at $37.50, Mesa crude traded at around $32. At $32 per barrel (adjusted for 2% inflation), Exxon would have expected to earn an average of $95 million per year through 2035. At a nominal discount rate of 9%, that would value ExxonMobil’s investment at $865.8 million. It only takes a little tweaking of the discount rate or oil price to get us to the figure that the ICC finally came up with. 

What does this imply for the results of the upcoming ICSID arbitration? Damned if I know. That arbitration is against the Bolivarian Republic, not PDVSA. So Article 15 doesn’t apply. Rather, the relevant document is the bilateral investment treaty that defines what the Venezuelan government can and cannot do. Moreover, it is possible that ExxonMobil will be able to argue not only that the 2007 expropriation was illegal, but that the big royalty and tax hikes the year before were also illegal under the Netherlands-Venezuela bilateral investment treaty. My gut feeling is that Venezuela is going to win, but I’m not sure why exactly I suspect that will be the case.

To sum up, then, this case was not a victory for the Bolivarian Republic. Rather, it was a victory for the PDVSA negotiators who wrote Article 15 of the association agreement back when the plain old Republic of Venezuela invited foreign companies in to develop the Orinoco oil belt. ExxonMobil got basically the maximum that it could have expected to get. So what was that initial $12 billion claim all about? Well, as Michele Bachmann would mispronounce, nothing but chutzpah.

A new nation in the Caribbean

 Every Christmas, we go to a different Caribbean island to meet my wife’s family. This year, we went to Sint Maarten, Saint Martin, and St. Vincent. The first two, I should add, share the same island.

Sint Maarten, which makes up the southern half of a tiny Caribbean island in the north of the Lesser Antilles, is a new country in two ways. First, it really is a new country. The Kingdom of the Netherlands is not a small country on the northwestern coast of Europe. Rather, it is a federacy of several different countries, called, well, “countries.” In 1954, when the former empire was turned into a federacy via the Charter, the Kingdom consisted of the Netherlands, Suriname, and the Netherlands Antilles. (Dutch New Guinea was not part of the new structure.) In 1975, Surinam became independent in a disgusting little racist episode engineered by Prime Minister Joop den Uyl. Aruba split from the rest of the Netherlands Antilles in 1986, but remained part of the Kingdom. Finally, last year the Netherlands Antilles dissolved into two more countries, Curaçao and Sint Maarten, while the three remaining territories (Bonaire, Saba, and Saint Eustatius) became part of the Netherlands. Sint Maarten’s status as a country, then, is only a little over a year old.

Sint Maarten is a new country in another sense, however: more than three-quarters of the population consists of the descendents of immigrants who arrived after 1960. The sugar and cotton industries collapsed after the abolition of slavery in 1863. Maartenese laborers went to Cuba, Puerto Rico, and the Dominican Republic to work in the sugar industry. In 1918 a giant oil refinery opened on Curaçao, followed by one in Aruba in 1928, sucking out more labor from Sint Maarten. The result was stagnation: in 1960, the population was only 2,728. The island looked to be sinking into a backwater, an unpopulated remnant.

The jet age (and Fidel Castro) changed all that. The Cuban Revolution removed that island as a destination for North American tourists. Sniffing opportunity, in 1964, the Antillean government relocated and expanded Princess Juliana International Airport.

Tourists began to arrive en masse, the cruise ships followed. And the population grew. And grew. And grew. To only 40,000 people, admittedly, but the entire country covers only 13 square miles. By 1992, only 30% of the population had been born in St. Maarten, and a solid chunk of those were the children of post-1964 immigrants.

It is possible to be naturalized as a Dutch citizen, but it isn’t easy. (Strangely, it seems as though I may qualify for Dutch citizenship without the need to be naturalized, just as I qualified for Spanish citizenship until last Tuesday.) In 2001, citizens made up 51% of the population. 30% of the population was (still) native-born; an additional 10% came from elsewhere in the former Netherlands Antilles and 2% came from the Netherlands proper. The math, then, shows that only 9% of the population consists of naturalized citizens.

Who naturalizes? It isn’t easy to tell, but it is easy to see who doesn’t naturalize: in 2001, people born in the British West Indies made up 20% of the population, whereas citizens of those countries made up 21% — they do not naturalize; neither did a small number of their Sint-Maarten-born children. Even more dramatically, the Haitian-born made up 8% of the population, but Haitian citizens made up 12% — very few of their children naturalize. Finally, Dominican-born made up 12% of the population and while Dominican citizens made up 10%; of the three major groups, they are the most likely to naturalize. (Two-thirds of the foreign born outside those three groups and developed-world expats become Dutch citizens. Most of them are from Cuba, South America, and Lebanon.) The West Indians may be unlikely to receive Dutch citizenship, but they are also next-to-invisible on the Dutch side. The initial plantation owners on that side of the island were from Britain; they brought English. Everyone speaks it fluently, from birth, with a faint West Indian inflection. 

The Dominicans, on the other hand, are pretty distinctive. Our first contact with them actually came on the French side of the island. We were walking along Orient Bay in the evening, and heard tropical music coming from one of the beach clubs, all the way at the southern end of the beach. It was a live band, and an awesome live band. Everyone in there except for us (including the waitress) was Dominican. (There are no border controls.) It was awesome ... and by day an utterly nondescript beach bar populated by tourists.

On the Dutch side, you can see money-sending places, Spanish service shops, and evangelical iglesias scattered around the poorer outskirts of Philipsburg. The Dominicans are visible. The migration is skewed towards women: 61%. According to the Sint Maarten government, most of the initial migration came in illegally from Romana and San Pedro de Macoris. The migrants provided fake work sponsors to Sint Maarten’s then-lackadaisical immigration officials. It’s also skewed towards the unskilled: Dominicans make up 29% of all unskilled workers, with Haitians filling an additional 30%.

The Haitian migration is almost the mirror image of the Dominican one in terms of gender: it’s 59% male. It’s also the mirror image in terms of visibility. The only easily-spotted presence is the fishermen near the airport, and the stalls where they sell their products.

Policy, as you can imagine, has been confused, although it is getting better. Before August 1, 1996, education was neither free nor compulsory for immigrant children. The legal school population doubled in 1990-95, and so educating immigrants was not particularly popular, especially since many of the Haitians were refugees fleeing the chaos of the early 1990s and living in tent cities.  Nonetheless, the government came around to the idea that creating a large uneducated underclass was a bad idea, and so compulsory education was extended to all. State health insurance, however, is not available for undocumented immigrants, who often cross over the French border to receive emergency care. 

Thoughts?

Bad news from Afghanistan: In order to bribe people not to fight, you have to make sure that they stay bribed

 There is no shortage of bad news from Afghanistan. One new piece appeared in today’s New York Times. President Karzai has decided to abolish a northern militia currently paid for by NATO. This is a problem.

The above photo is not of members of the Afghan National Army. It is of Panjshiri militiamen in 2006, guarding the headquarters of the Panjshir provinicial reconstruction team. (In unrelated news, the Panjshir PRT was recently attacked by Taliban suicide bombers.) Afghanistan is loaded with armed militia, including the ones that make up the anti-government forces collectively referred to as the “Taliban.”

One strategy for establishing peace in a wartorn country is to bind armed militia to the state. You basically bribe people not to fight you, the government, or each other. In the process, you hope that you create lasting institutions that can create, over time, a legitimate chain of command that can permanently integrate (and subordinate) the formerly warring factions into the state. It is slow, it is painful, it can undercut other nation-building goals, but it is nonetheless vital to get it right. We botched it badly in Iraq, and paid quite a price. Of course, if you are going to bribe people not to fight ... sorry, integrate armed men into state institutions ... then you have to make sure that they stay bribed. That means that you (be it the local government or foreign overlords) have to make a credible commitment that the flow of benefits will continue as long as the militia obeys orders. By cutting off the flow of NATO money, Karzai has simultaneously undercut NATO’s ability to strike bargains and his own status as a credible partner.

There are reasons for President Karzai’s decision. Members of the Critical Infrastructure program (and the “Afghan Local Police” more generally, as the integrated militia are called) have been known to extort the citizenry, and they are not inside the chain of command of the Afghan National Police. The problem? Taking them off the NATO payroll is not going to get them to stop extorting the citizenry, or bring them under government control. Quite the reverse, actually. It is a dumb decision, and it bodes ill for other places in Afghanistan (like Panjshir) where independent militia have been de facto bought off.

It isn’t all bad. Karzai has (under pressure!) agreed to allow the Taliban to set up an office in Qatar from which peace negotiations can be conducted. But the President of Afghanistan isn’t exactly showing himself to be steadfast negotiating partner, and the decision to defund the Critical Infrastructure program bodes ill for the country’s post-American future.

POSTSCRIPT: There is some evidence that NATO was botching the integration programs, at least in the north. (The programs I saw in Panjshir in 2006 were well-run, but Panjshir is a special case on multiple levels.) Some salaries have not been paid. (This was a huge problem for the Afghan National Police in Nangarhar province back in ‘06; we dealt with it using a system much like the one that doesn’t seem to be working for the Afghan Local Police in Kunduz province.) The German government is worried about the lack of the long-term program to integrate the militias into the state’s chain of command. (The report to the German legislature can be found here.) Finally, here is the U.S. military’s investigation (written, surprisingly, by a one-star!) into allegations of human rights abuses by the Afghan Local Police, with recommendations for increasing American “command, control, and influence” over them. Of course, if the program is disbanded by the Afghan national government, then any hope of getting the militia under control goes out the window ...

Dubai in Central America?

 It seems as though Honduras is going ahead with a Charter City. I’ll have a bit to say about that in some later posts, but right now I just want to aggregate some primary source information about what the Honduran legislature  has and has not passed. The basic idea is to create a city where national laws and national institutions do not apply. Instead, new rules can be written on a clean slate, with a government that can outsource and contract functions to any other government (or private entity) that it wants. The result, it is hoped, with be economic growth with political order, a made-to-measure version of Dubai. After all, if an absolute monarchy bordering Saudi Arabia could do it, why can’t anyone?

The first part was a pair of constitutional amendments. Article 304 now allows Congress to select judges (with a two-thirds vote) for special courts in the “Special Development Regions.”

Article 329 meanwhile, now states: “The Special Development Regions shall have their own legal personality, their own public administration, their own legal system that will be approved or disapproved by a simple majority of the national Congress, their own legal exemption in conformity with Article 304 of this Constitution, the power to sign treaties and international agreements concerning trade and cooperation in matters under their control, subject to the ratification of the national Congress … In the fields of budgets, taxes, tax collection, tax administration, as well as the ability to sign contracts that shall pass into the next national administration, and the ability to borrow internally or externally as long as such debts lack any guarantee from the State of Honduras.”

So far, so vague. But on August 23rd, Congress passed the enabling legislation for the special development regions. It added that the regions will have the ability “shall establish their own police and have the power to exercise their function themselves or by delegation. To this effect, they have the power to sign cooperation agreements to strengthen the same with other countries.” More impressively, the statute restricts the ability of the national government to intervene in the special region’s affairs, and states that any “jurisdictional conflicts” will be settled by an arbitration panel of three judges selected from a pre-assigned list of forty people, half selected by Congress, and half selected by the “Transparency Commission” that runs the region. (An unofficial translation of the amendments and the legislation can be found here.)

The Transparency Commission is kind of sort of limited by the “Normative Councils,” elected by the region’s permanent residents (foreign and Honduran). The normative councils set taxes and ratify changes to the region’s governmental organization

Now, Hondurans will be allowed free entry to the region, and any businesses there will need to have at least 90% of their workforce and 85% of their payroll go to Hondurans, except that “both ratios can be modified in exceptional cases determined by the special development region’s regulations.”

Finally, on December 6th, President Porfirio Lobo appointed the Transparency Commission. It consists of five people: two American economics professors, the former head of the INCAE business school in Costa Rica, a former IABD vice-president, and a former Singaporean general.

The boundaries of the region have not yet been established, and although the Economist mentioned that the region will use the Mauritian legal system (and therefore ultimately the British one, since Mauritius, like the Bahamas, still uses the Privy Council as its ultimate court of appeal), I have not yet obtained independent confirmation of that fact.

And there you have it. Before I discuss what I think the implications will be, what do you think? Does this idea have potential, or will it be a failure?

In which I double down on Assad’s survival

 Back in August, I made a bet with John Quiggin of Crooked Timber. Midway through a long comment thread, John said, “I’d be happy to take Assad as a test case. Doug sees him as a likely survivor, I don’t.”

I replied:

I like Assad’s chances. He’s not the brightest bulb on the tree, at all. But he’s not the sort who’s going to flee the country just because things have gone a little hinky, either. And he’s got some good cards in his hand. The military and security forces are totally dominated by his fellow Alawites; NATO is never going to intervene; the Russians are running interference for him in the UNSC; Iran is firmly on side; the opposition is divided and lacks credible leadership; the Israelis are quietly rooting for him; and the anarchy and chaos of postwar Iraq is still fresh in everyone’s mind.

Sure, Assad could fall. Stranger things have happened. I can easily imagine a couple of scenarios, especially if the West plays it smart. (Targeted economic sanctions for this one. No military intervention.) But I don’t think it’s the way to bet.

Come to think of it, why don’t we do just that? Side bet: if Assad loses power in the next six months — flees the country, overthrown in a coup, taken out and shot, what have you — you win. If he’s still in power on March 1, 2012, then I win. (If he dies or is killed without first losing power, or if he’s lost control of at least 1/3 of the country but is still clinging to power in the capital, we’ll call it a draw.)

Loser donates $50 to a charity of the winner’s choice. And if I lose, I’ll throw in a “Why I Was Wrong” post over at Noel Maurer’s blog, gratis.

John then said: “I’d want a year from now... the process is a protracted one.”

To which I responded: “[If] Assad does fall, I don’t think the process will be very protracted. He has all the top military and security commanders on side, and the dissidents have no guns and no hope of military intervention. So the most likely scenario would be an internal coup by his fellow Alawites — the generals and secret police deciding to throw him overboard. That’s going to happen fast if it happens at all. But anyway. Sure, I’ll go with a year. I’m betting Assad will still be in power at COB Syrian time on August 31, 2012. You’re betting he won’t.”

Over 100 days have passed since our bet. During that time, the uprising has continued without a break, and an estimated 2,000 additional people have been killed. In an unprecedented move, the Arab League has voted to sanction Syria. Even neighboring King Abdullah of Jordan — one of the least confrontational, most conservative of Arab leaders — has risen up to condemn Assad. The rebels have developed a rudimentary leadership structure, the Syrian National Council, with a command based in neighboring Turkey. The Syrian Army has seen a steady stream of defections. Syria’s economy is in deep trouble as trade has declined and tourism has vanished. Even Fareed Zakaria has changed his mind, writing, “I now think this regime is going to collapse after all.”

So what do I think now?

I think Assad will still be in power on August 31, 2012.

None of the things I mentioned in my original post have changed. Assad is not likely to flee the country; he’ll stand or die. The military and security forces are still completely dominated by his fellow Alawites. The Alawites are about an eighth of the population, and they’re absolutely certain that the fall of the current regime will lead to a genocidal bloodbath against them. Even if it doesn’t, they’re sure to lose their current privileged position. So the Alawites are not giving in, either. The reason the regime has not been able to crush the opposition yet is because there aren’t enough Alawites; they dominate the security services and the officer corps of the military, but the actual army is a bunch of poorly trained young draftees whose reliability is uncertain. So simply crushing the rebellion by brute force — as Assad pere did in Hama back in 1982, when he flattened the city to rubble and killed an estimated 20,000 civilians — is not as easy as it looks. But on the other hand, those conscripts can’t easily lead a rebellion either. It’s a recipe for stalemate: the rebels can’t easily be crushed, but neither will the Army turn against the regime.

Meanwhile, foreign intervention is right out. NATO is never going to intervene — see the reasons for that in this post — and the Russians are still loyal allies, running diplomatic interference for Assad while firmly vetoing any meaningful Security Council Resolution. In fact, the Russians just closed a major arms deal with the Syrian government, delivering a bunch of shore-launched antiship missiles. Which is not only a gesture of friendship but a quiet middle finger to NATO; if they do try intervening, they’ll have to deal with supersonic cruise missiles. (That thing where France parked the Charles de Gaulle a few miles off the Libyan coast so the big aircraft carrier could launch strikes all over the place? That would not happen in Syria.) Iran is still firmly on side. The Israelis are still quietly rooting for Assad. The only remotely plausible source of foreign intervention is Turkey — and while Erdogan is clearly very pissed, his country is not really in a position to launch a full-scale invasion of Syria. Support to rebels on the cheap, sure; and if the rebels were ever to gain serious traction, I could imagine a future where Turkey gave significant military assistance to them. But supporting the rebels is not without costs — Assad has made it clear that he’s going to counter tit-for-tat by supporting Kurdish separatists inside Turkey. Moreover, Turkish assistance alone is not nearly enough, until and unless the rebels can gain control of large chunks of Syria’s territory. And that’s not happening.

I’ll say again that nothing is certain and things could change. But I’m just not seeing how the rebels get to victory from here in the next nine months. If Assad does fall, the most likely outcome is that his generals or his inner circle take him out in a coup, blue-on-blue, hoping that they can save the regime by changing its face.

Incidentally, it appears that the folks at Intrade agree with me. They’re giving him a 90% chance to survive into 2012, a 67% chance to reach June 30, and a 55% chance to still be in power on December 31, 2012.

I’m not picking my charity yet. But I am saying that the deep dynamics of this struggle have hardly changed. I would give the rebels slightly better odds today than I would have in August — but “slightly better” here means I think their chances have risen from less than 5% to maybe more like 10%. It’s still long odds.

As noted before, I’d be tolerably happy to be wrong.  But meanwhile, yeah, doubling down.