The Power and the Money

Some crude nonsense: Trump, AMLO, and OPEC

OPEC has been trying to negotiate production cuts in order to prop up oil prices. Mexico resisted making any cuts. AMLO then declared that he had asked the United States to make part of the requested cuts on Mexico’s behalf. Trump, in a press conference, announced that the U.S. would make the cuts but request “reimbursement at a later date.”

What does it all mean?

1. AMLO really loses his senses when oil is concerned. Right now, Mexico loses money on every barrel it points. Inasmuch as it is geologically possible for Pemex to cut production, Pemex should cut production. But AMLO refuses to accept that. It may be because he believes that he’s linked his reputation to increasing oil production and that failing to do so will hurt him politically. But he believes that then he is a terrible politician … and we have evidence that he is not a terrible politician. Which leaves us with the conclusion that he really like to dig hydrocarbons out of the ground and set them on fire because he likes to dig hydrocarbons out of the ground and set them on fire.
2. President Trump does not have the authority to cut U.S. oil production. Individual state governments do have that authority—the Texas Railroad Commission is famous for controlling production in that state—but there is no sign that the President intends to call in state regulators and ask them to order private producers to shut wells.
3. S. production is crashing anyway. Unconventional oil wells in the United States decline hyperbolically. That means that companies need to keep drilling just to keep up production. When prices are low, they stop drilling, and production falls. The EIA projects that U.S. production will fall by at least 500,000 barrels per day this calendar year and another 700,000 barrels in 2021. This isn’t a hard projection to make, considering as production is already down 600,000 bpd from last week.
4. AMLO is putting on a show for OPEC. He’s trying to get OPEC to pretend that a U.S. production fall that would have happened anyway is actually a deliberate action on the part of the United States to help out Mexico. OPEC knows this is bullshit, but will likely give AMLO the fig leaf he’s looking for.
5. Trump’s demand for compensation is meaningless, but not for the reasons you think. When I was a kid back in New York, we’d talk about the “favor bank.” (Often called the “Irish favor bank” for reasons I don’t understand at all.) You’d pay into the favor bank, you’d make withdrawals from the favor bank. Donald Trump has never played by the favor bank. If he wants something from you, he will do whatever he can to get it from you. If Donald Trump wants something from Mexico in the future then he will ask for it regardless of whatever “favors” he granted now. And he will threaten Mexico in order to get it. In that sense, AMLO’s request was costless.
6. OPEC wanted Mexico on board because reasons. This is the only part of the story that I don’t understand. Why couldn’t OPEC have just ignored Mexico’s posturing.

In other words, this is much ado about nothing.

In fact, if this is right, then it really was about nothing for nothing ...

 

Saudi Arabia plans to issue a statement blaming Mexico for not agreeing to cut its production (by the allocated amount of 400k) #OOTT

— Amena Bakr (@Amena__Bakr) April 10, 2020

Buying Greenland

Back in 2009, I made the modest proposal that Iceland become an unincorporated territory of the United States. It wasn’t serious. 

But it looks like the Trump administration is serious about buying Greenland. Or, well, “serious,” because it is the Trump administration. To start with, they want to negotiate with the government of Denmark, when they should be negotiating with the government of Greenland. Constitutionally, Denmark does not have the authority to transfer the sovereignty of Greenland to anyone but the duly-elected government of Greenland.

But the government of Greenland, well, it can do whatever it wants.

So what the hell! I have seen some numbers out there and I think that I can do better. What price would make sense and make it hard for the Greenlanders to refuse?

The administration could offer every resident of Greenland a cool one million dollars, or $57 billion. It could also promise to take over the $535 million Danish annual transfer payment. In fact, the U.S. could do Denmark one better: in 2009, Denmark froze the transfer in nominal terms. (See Kevin McGwin, Denmark’s annual state of the kingdom report paints a rotten picture of Greenland’s economy, The Arctic Journal, April 20, 2017.) For some reason the number $750 million keeps getting thrown around, so let’s say we up our subsidy offer.

So would that be overpaying? Well, it turns out that in 2014 the Danes estimated that the mineral and oil rights under Greenland would bring in a cool $69.8 billion over the next 40 years. At the current U.S. 30-year-bond rate of 2.07%, that would have a net present value of about $47.9 billion. Subtract from that the $20.3 billion 40-year NPV of the subsidy, and you have a get that Greenland’s mineral rights are worth about $27.6 billion, or $485,000 per Greenlander. 

Is there a strategic value to Greenland? Yes, but we already have that! A 1951 Treaty gives the U.S. carte blanche to do pretty much whatever we think we need to do, subject to a potential Danish veto over the establishment of new military facilities. Is getting rid of that veto worth $27.6 billion? 

No, but come on. We all know that Trump wants to buy Greenland because it would be cool and awesome. That would be worth $27.6 billion. Or he could just offer each Greenlander $485,000 and see if they bite. 

Any Greenlanders out there? Could you get a majority to vote to become an unincorporated territory of the United States for somewhere between a half-mil and a mil for every woman, man, and child on the island?

Of course, getting concurrent majorities in the House and Senate or getting two-thirds of the Senate to approve the resulting agreement would be ... difficult. Still, somehow Jimmy Carter managed to get the supremely unpopular Panama Canal Treaty passed.

That said, Donald Trump has not exactly proven himself to be a master of the Senate. 

And that, of course, is why this boneheaded idea is not going to go anywhere. I suspect that President Trump could bribe the Greenlanders to switch metropoles. I do not for a minute believe that he can bribe Moscow Mitch (let alone Nancy Pelosi) to get them to agree to drop $27.6 billion (let alone $57 billion) on this vanity project.

I have to admit, though, that the sheer craziness of the fact that I am writing this as an analysis of a real proposal by the POTUS has me quite amused. And scared, but mostly, for the moment, amused.

Lessons from day care for President Trump

Bloomberg reports that President Trump is moving towards making good on at least one of his campaign promises: making a profit off American overseas deployments. 

The story is that he plans to introduce “Cost plus 50” as the standard: i.e., basing costs plus 50%. Now, this won’t earn the United States a whole lot of money. Basing costs just aren’t very high. The U.S. could conceivably gross about $15 billion from our allies, including a $5 billion markup. We would net less than $15 billion, however, considering that Japan currently kicks in about $1.8 billion and South Korea and Germany add another $800 million each. (South Korea just agreed to up that last to $1 billion.) But hey, $11.4 billion is still $11.4 billion. 

The thing is, the administration also plans to reduce the charge for countries that align their foreign policies with the United States. In other words, the plan would give governments concrete incentives to follow American foreign policy.

Before you get too excised about that, note that the United States already does exactly this. In 1983, the U.S. passed a law requiring the State Department to report how closely countries voted with the U.S. in the U.N. General Assembly. Since then, study after study has turned up the same pattern: countries that vote with the U.S. get either more U.S. financial support or more support from U.S.-supported institutions, like the IMF. 

Wait, the IMF is a tool of American foreign policy? Who would have imagined? Besides everybody, that is. (Specifically: Barro and Lee (2005) found that IMF loans are associated with similarity to U.S. voting patterns in the UN and economic ties with the United States. Stone (2008) and Eichengreen et al. (2006) found that countries that receive substantial amounts of U.S. foreign aid are more likely to be eligible for IMF financing.)

And of course the U.S. trades favors in even subtler ways. Germany and France support the U.S. at times when they otherwise wouldn’t because they know that the U.S. will support them even especially if the Russians invade. 

So who cares if the Trump administration turns subtext into text? Or even supertext, a sort of neon-green megawatt Bat Signal of our intentions, with a specific price tag attached? Heck, economists always say that certainty is good and prices are good. Trump will certainly bring more of both. Maybe we will get a big bang for our $11.4 billion bucks. 

Or maybe not. Sometimes, you see, it is better for quos and quids to remain implicit.

Consider what happened when an Israeli day-care chain introduced late charges. The number of late parents went up. By a factor of two. And if you are wondering, this was a controlled study, in which only some centers introduced the charges. 

The lesson? Before the centers introduced fines parents tried hard to arrive on time because it was the right thing to do. After the fine was introduced, arriving late became simply another commodity that you could buy, even if that price was called a “fine.” Be late, pay the fine, cleanse your conscience, free of any worries that other parents will disapprove. 

In other words, right not countries cooperate with the U.S. in part because they consider it the right thing to do. The U.S. might reward them, but only as part of an unspoken system of mutual favors between friends.

But in a Trumpian world, well, now U.S. support becomes just another commodity with a price tag on it. If the cost is too high, then a foreign government may as well just pay the price. Keep U.S. bases on your soil but follow whatever bloody foreign policy suits you, plus a small check to Washington.

In short, for an additional $11.4 billion per year (or less) the Trump administration will likely get a whole lot less cooperation while preserving most of our overseas commitments. Nice job, I suppose.

Of course, we would bet that this will not ultimately happen, the same way we predicted that NAFTA would not be abolished.

Reposted without comment from March 2016: How much could President Trump win from our s̶a̶t̶r̶a̶p̶i̶e̶s̶ allies?

 So, Donald Trump wants to turn America’s hegemony into a protection racket. Okay, then. How would those negotiations go?

First thing to do is estimate how much the U.S. could save by pulling out of Germany, Japan, and South Korea.

First take: billions and billions! The link goes to a 2009 study by the Commonwealth Institute. They get a cost of $127.1 billion for fiscal 2010: $132.1 billion in cost minus tribute host payments of $5 billion. (Page 9.) But that estimate is dumb. It simply pro-rates the defense budget by the number of personnel stationed overseas. Now, maybe some president might save all that money by simply downsizing the military. (Well, the Army would be “downsized” in that scenario; the Navy would be gutted.) 

Since Trump has made it clear that he has no intention of shrinking the military, then those personnel will simply be redeployed back to the United States. 

Second take: In 2013, the U.S. Senate took a look at basing costs. It estimated costs around $10 billion, 70% in Germany, Japan, and South Korea. (Page 1.) These costs do not include personnel costs or overhead: rather, they are the direct costs of keeping up the bases in those countries. German bases cost $4 billion. South Korean bases cost $1.9 billion. (Page 18.) Japanese bases cost $2.5 billion. (Page 40.)

But South Korea and Japan, unlike Germany, pay pretty large portions of the U.S. cost! (Hold that thought on Germany; this is based entirely on the Senate report.) In South Korea, U.S. taxpayers foot only $1.1 billion of the cost; South Koreans make up for $800 million. (Page 21.) Japan, meanwhile, covers more than 70% of U.S. costs, to the tune of $1.8 billion per year. Until 2010, in fact, Japan covered all U.S. basing costs. (Page 41.) So President Trump might wrap up the American empire-by-invitation in Asia for savings of ... $1.8 billion. Get out of Germany at the same time and you save $5.8 billion per year. 

Only you don’t! Consider the cost of transferring 7,000 Marines from Okinawa to Guam: $19.3 billion. (Page 49.) Scale that up by the other 43,000 American forces in Japan and you get $119 billion to withdraw without demobilization. Add in the 29,000 forces in South Korea and you get $197 billion. Throw in the 36,000 troops planned to still be in Germany in 2017 and you get $296 billion. 

Now, that is a one-time cost, not an annual flow. And it is likely exaggerated, since most of the Naval and Air Force personnel overseas will not be as expensive to relocate as the Marines. So lets arbitrarily cut the cost by 60%. 30-year treasury bonds are currently yielding around 2.5%. Call it an annual expense of $5.8 billion between 2017 and 2047. 

$5.8 billion ≈ $5.8 billion. No savings. With interest rates at a near all-time low and shaving 60% off the topline estimate. Huh!

And now lets return to the German issue. Germany pays a share of American construction costs for our bases, but those costs are lumpy. In  2009, Rand estimated total German support to total $831 million. (Page 154.) If that number is accurate for other years, then the U.S. pays only $5.0 billion for our three main overseas presences. And $5.8 billion > $5.0 billion.

Third take: This big Rand report. It is long and complicated and does not cover the complete withdrawal option. But their minimum posture saves around $2.9 billion per year ... assuming that foreign contributions remained unchanged.

In other words, the American defense perimeter does not cost all that much. 

Now we need to figure out what these cost estimates imply for the negotiations.

President Trump, in this world, cannot simply threaten to walk away, because that would cost him. He needs to make one of two additional threats:

1. He is willing to incur costs to the United States if negotiations break down. That is, he tells his counterparts in Berlin, Tokyo and Seoul that he is willing to pay money to bug out unless our satraps allies fork over even more money. Good luck with that one.

2. He is willing to bug out and downsize the American military budget. Now those cuts do not have to be large for us to come out ahead — we are talking maybe 1% of the total defense budget — but they would need to be made. 

So, yeah, I suppose a cost-cutting President Trump could threaten to cut American military spending unless those foreigners pay us more. But unless he is willing to resort to an outright protection racket, he would net us 1% of the military budget on the threat of making a 1% cut in the military budget. 

Yeah, that makes sense. Totally worth it. After all, it isn’t like you could just, you know, cut the military budget without threatening our allies ... 

Thinking outside the box on Venezuela

Boz, one of the most perceptive analysts of Latin America out there, wrote the following: 

If the only Venezuela policy options you can think of are no sanctions, targeted sanctions and oil sanctions, you lack imagination.

— boz (@bloggingsbyboz) August 4, 2017

So I thought about it! Mexico City is conducive to the imagination. And here is what I came up with, in order of reverse crazy.

(1) Blockade: I do not mean “bloqueo” the way Cubans hyperbolically refer to it. I mean a real genuine blockade, nothing in or out. That would strangle the Venezuelan economy. It would also kill small children. And be an act of war. Not a good idea.

(2) Covert action: Venezuela is a perfect target for American covert action. We have full intelligence. We have full cultural understanding. Hell, POTUS is practically venezolano! So it is certainly tempting. But it is still a bad idea. Playing with coups is dangerous, even at home. 

(3) Oil sanctions: The United States could stop buying Venezuelan oil. How much would that hurt? Badly, but not as badly as banning American exports to Venezuela. Right now, Venezuela is exporting about 1.9m bpd, expected to fall to 1.7m bpd by the end of the year. Of that, the U.S. takes about 750,000.

Venezuela produces heavy sulfurous crude. That requires specialized refineries to process it. American Gulf coast refineries are so specialized. Elsewhere, not so much: as of 2011, the United States possessed a bit more than half of all heavy-crude refining capacity. (Figure 4.) That has been changing, however, as China builds new capacity. In addition, Europe has some refineries that could process heavy crudes if need be. In other words, alternative markets exist for that 750,000 bpd.

It would cost Venezuela. First, shipping cost estimates run as high as $6 per barrel. (Page 15 and page 25.) That is around $4 more per barrel than to ship to the gulf coast. Second, foreign refineries would need to be bribed to take Venezuelan oil over its counterparts. Third, Venezuela currently imports light oil to blend with its exports in order to make them more palatable for refineries; it would have to import even more if it had to move its oil to refineries less optimized to take it. Switching to other suppliers there would cost another dollar per barrel. Call it a worst-case loss around $7 per barrel. Considering that the Venezuelan export basket fetches around $44, that is a lot. 

But it is not catastrophic. The U.S. could wreck Venezuela by imposing a ban suddenly, but that would also hurt U.S. refiners and raise oil prices at home. A phase-in would avoid that, but it would also give the Venezuelans some time to adjust. If the U.S. imposes sanctions, there will be a phase-in, so count against catastrophe. 

The awful drawback is that oil sanctions would kill children from the resulting (further) contraction in imports, since the current regime seems to have no compunctions about cutting off supplies to its enemies. And the best case is that the resulting hardship promotes either a coup (see above) or civil war. (Luckily the Russian Federation is broke; otherwise it would also result in a giant Russian naval base in the Caribbean and Tupolevs buzzing U.S. airspace from the south.) I am not a fan of this option.

(4) Criminal indictments: Not a terrible idea, but not likely to work. First, while European law is clear, American law is far fuzzier. Second, it would have the effect of making the regime dig in for fear of what might happen should they step down. And unless we are willing to do a bigger version of Operation Blue Spoon — call that Option Zero — it would not have much effect.

(5) Targeted sanctions: Already happening. Note that people are willing to pay money for power. So good luck with that. 

(6) Diplomatic isolation: A great idea, but you run into the problem of the West Indian microstates. Venezuela will not be able to keep buying them off for long, but it has done a good job of it for longer than anyone expected. This resulting diplomatic fracaso is another reason why the West Indies should become one country as of yesterday, as if more reasons were needed, but that’s unlikely to happen before my children battle robot armies in the world revolution or Skynet kills us all. 

The list shows imagination, even if the images are mostly stupid. So what else? Well, Boz suggests trying to help the Venezuelan population. I am all in favor of that. But I do not see how it would weaken the regime. Consider Africa: aid has been blamed for propping up dictatorships and prolonging civil wars. (The link is a to a paper by Nathan Nunn and Nancy Qian.) Still, the Nunn and Qian paper suggests that food aid has little to do with starting civil wars, which is what we want to head off in Venezuela. It also finds that the effect is more pronounced in countries with a recent history of civil war, which Venezuela does not have. (Mostly.) So it probably will not lead to war but it could prop up the dictatorship.

Is this missing anything? Help! A great American nation needs your ideas. 

What does the word “civilizational” mean in French?

There’s been a bit internet pile-on President Macron over the past few days. I dislike these things, on principle. The tweets that fill up my feed seem more designed to let the tweeter enjoy their own self-righteousness or special enlightenment than to express true outrage. It’s all rather unpleasant. I was sad to see the author of one of my favorite books join in.

What are they beating up the French president about? Well, his comment is here:

President Macron expresses doubt that aid will work without institutional reform, favors more aid and direct French involvement in security, praises growth in African nations, calls the continent “a land of opportunity,” and supports aid. Those comments do not seem to be the cause of the outrage.

One issue seems to be that the President misreported fertility rates. Only Niger has a total fertility rate above seven; for most of the continent, the number is around five. Perhaps I am too generous, but this seems like an entirely forgivable mistake.

A second issue is whether high fertility contributes to African poverty. A large literature on demographic dividends implies that yes, it does, at least on the margin. I do not see grounds to criticize the French president on that.

A third issue seems to be that he left out references to the negative impact of the European empires. This blog certainly has an interest in the subject. But Macron has been outspoken in his critiques of France’s imperial past. And in his quote he actually agrees with the idea of a Marshall Plan for Africa; he certainly is not dismissing the idea that Europe owes Africa a debt. I am, however, open to an argument that Françafrique imposes a rhetorical special burden on French presidents. (Does it?)

Which leaves us with his choice of the word “civilizational.” My friend Gabriel Mathy pointed out to me that Macron’s statement is the logical equivalent of calling Africans “uncivilized,” and that, I think most observers will agree, would have been offensive. Language, however, is not algebra: I have no idea of Macron’s odd word choice (to speakers of English or Spanish) has an offensive connotation in French.

At the end of the day, whether there is any basis for outrage hinges on that one word. If it has a racist connotation, like “Oriental,” then Macron deserves connotation. If it does not, then there seems to be nothing here, and I fail to understand the reasons for the pile-on.

And I do wish, sometimes, that the mockery and outrage would stop.

Department of Things That Will Obviously End Well

Many years ago, in what seems like another life, I wrote a case about Blackwater. When I began researching the case in 2008, not long after my time in Afghanistan, the company was at the peak of its ambitions. It’s training ground in Moyock, North Carolina, was very impressive — and it still is — but the amazing part of Erik Prince’s vision was that he wanted the company to manufacture, deploy and operate a panoply of advanced hardware. These included the Grizzly APC (interior pictured), an armed frigate (see page 53), armed reconnaissance blimps, and a small private air force.

There is a rationale behind the idea of privatizing some military functions. Much of what is called “combat service support” has a civilian equivalent. In theory,  a private company could maintain a large reserve support capacity and rent it out to various clients, including the military, for less than it would cost any of those clients to maintain such capacity internally. In practice, it’s less clear that outsourcing logistical and support functions generates savings or improves readiness, but that’s an issue for another day.

The issue for today is that Russian Federation appears to be deploying private organizations to take and hold Syrian territory in return for oil and mining concessions. (The link is to the New York Times.) This is bad on about a hundred different levels. The small problems have to do with the problems of outsourcing core military functions to private organizations. The big ones have to do with the incentives.  

Not only do these contracts encourage Russian companies to go buccaneering, they encourage Moscow to broaden the war as much as possible. They also encourage Moscow to pressure Damascus into fighting to the bitter end and give corrupt Russian officials incentives dump public resources into subsidizing ostensibly private military operations. The officials don’t even have to be corrupt in a Venezuelan bribe-taking sense; all you need is an open-door between public service and lucrative private posts in the companies that stand to benefit.

Private military forces are, sadly, a thing. Erik Prince is running a small private air force for the UAE in Libya. But I’m not sure that I’ve heard of mercenaries paid with contingency fees financed out of the spoils of war. That seems new. I am sure that there must be a giant hole in my logic and this experiment with profit-driven pacification will end well.

Was the French Empire predatory?

There is a long debate over colonialism, particularly the late-19th-century variant. Most of the literature focuses on long-term effects. So it often loses sight of a simple question: did imperial institutions function basically the same as capitalist institutions in non-colonized places or did they serve to transfer resources to the metropole? That is, did colonialism simply bring areas into the modern world economy (for better or for worse) or did it directly suck resources out of the colonies?

This is not an easy question to answer. In a classic work, for example, Davis and Huttenback showed that British colonial enterprises were less profitable than similar British enterprises at home, in the Dominions, or in the Americas. But profitability tells us little. Imagine that British colonial enterprises had been phenomenally profitable. Would that have meant that they were bad for the colonies? Clearly not! Some other measure is needed. 

So here comes Federico Tadei (Universitat de Barcelona) with an obvious measure: did colonial commodity producers receive the same price for their goods as producers elsewhere, accounting for differences in transportation and insurance costs? 

In a bit more detail, here is what he does:

1. Gather prices at French ports for each commodity between 1898 and 1959. Also gather producer prices (what African farmers received at the farm gate) at African ports. Tadei can do the latter because French African statistics broke port out trade costs from producer prices; 
2. Construct estimates of trading costs including Atlantic shipping, insurance, inland transportation, port charges, and export taxes;
3. Calculate (1) − (2) to get what producer prices should have been under non-predatory institutions;
4. Compare (3) to the actual prices received by African farmers;
5. Check the results by comparing (1) against producer prices for U.S. cotton and wheat exporters or European settlers in Africa to see if American producers selling to Britain were as disadvantaged as French African producers selling to France;
6. Check the results by seeing how much of an increase in world prices is passed on to French African producer prices, plus a few more abstruse checks.

Here is the headline result, as a % of prices:

And here is French Africa compared to the United States for cotton:

Moreover, there is a plausible mechanism for extraction: monoposonistic trading companies and compulsory harvest quotas. The effect of the former is obvious; the effect of the latter was to prompt African producers to grow more than they would have in a competitive market. In addition, poll taxes might have induced African workers to enter the labor market, driving down production costs for African farmers and thereby prompting them to grow more. (Forced labor may have had the same effect, inasmuch as it also drove down costs for African producers.)

What I would like to see is the same method applied to Latin American and Asian producers. Brazil, Ecuador and various Caribbean countries exported cocoa; China exported peanuts; Brazil exported cotton. As for palm oil … well, forget that. (United Fruit introduced it into Guatemala, Panama and Honduras in the 1920s without much success. I was involved in a failed effort to introduce it to Chiapas in 1999.) But it is a way of stress-testing the hypothesis. If producers in Latin America and China faced similar extraction rates, then formal imperialism might not have been the problem.

Thoughts?

Did the U.K. gain independence with Brexit?

As if poor Prime Minister May didn’t have enough on her plate, here comes another possible complication. (“Poor” may be the wrong adjective, as she is bringing most of the problems upon herself.) Could the U.K. be sued by foreign investors for damage inflicted by Brexit?

Right now, foreign investors in the U.K. have two ways to enforce their rights against the British state. The first is the legal system. That is, you go through British courts and ultimately the European Court of Justice. The second is through the arbitration clauses in British bilateral investment treaties (BITs); that is, via the investor-state dispute settlement (ISDS) mechanism that attracted so much opprobrium during the controversy over the TPP. 

Roger Alford of Notre Dame points out that when Argentina devalued the peso it led to massive arbitration claims. Many of those arbitrations were based on “legitimate expectations,” that is, the idea that foreign investors had the right to expect stable laws and regulations. So Argentina could not just, say, slap price controls on gas without violating its bilateral investment treaties. 

Well, could a foreign investor sue the U.K. if Brexit slams their profits? As Alford suggests, might Nissan sue the U.K. if Brexit causes British car exports to have to pay a 10% tariff to enter the European Union? Or could foreign banks sue over their loss of access to the European market? Heck, might Airbus and Bombardier sue over disrupted supply chains and the need to shut down U.K. facilities?

Scary thought.

But unlikely to happen.

Consider the list of British BITs. Not a lot of developed nations there. In fact, not a lot of E.U. members, save some ex-Communist countries. It is possible that investors in the U.K. carefully shopped around for nations to route their investments through in order to gain legal protection: this is why American oil companies became Dutch for the purpose of investing in Venezuela. But it seems unlikely. It would have taken a remarkable level of foresight. 

In other words, the threat could in theory be huge, but in practice it is not something that Ms. May should worry about. And not just because she is about to have a lot of things on her plate ...

Wagging the Dog: Lessons from France and Gabon

In 2011, France was wracked by corruption scandals in which African leaders, from Côte d’Ivoire and Gabon in particular, passed off millions of dollars in cash to the Jacques Chirac and Dominique de Villepin. It was the flip side an earlier scandal in which the French national oil company, then called Elf Aquitaine, funneled millions of dollars per year into the coffers of Gabonese leaders. The African tail had begun to wag the French dog; some politicians called it “reverse colonization.”

And now it looks like something similar could happen under President Trump. Consider our own former colony in the Philippines. President Rodrigo Duterte has appointed Jose E.B. Antonio to be Manila’s special representative to the United States. Antonio also happens to be the CEO of Century Properties Group, which is building the Trump Tower Manila and paid the organization around $5 million for the privilege of using the Trump name. More payments are due: one Trump deal in Puerto Rico involved a 12.5% share of profits plus a 4% slice of operating revenues in addition to the up-front fee. 

What happened in France was illegal. What is happening in America appears to be legal: the payments from the Philippines are not coming directly from the government.

But what happened in France had tangible effects on Africa. France continued to prop up the execrable Bongo dynasty well past its sell-by date. In 2008, for example, the French government shut down an investigation into the provenance of Omar Bongo’s Parisian real estate portfolio. In 2010, the American embassy in Cameroon reported that the Gabonese government embezzled funds from the Banque des Etats de l’Afrique Centrale — that is to say, one of the two central banks serving French West Africa — and used them to support President Nicolas Sarkozy. When Bongo’s son, Ali, won the 2016 election with a razor-thin (and clearly fraudulent) margin the country erupted into riots. Ironically, the 2011 corruption scandal made France reluctant to pressure Gabon with anything stronger than mild language: not because Gabonese oil is so important, and not because Hollande received Gabonese money, but because the public scandal itself made any French actions in Gabon appear to be a continuation of the illicit ties between the two nations. 

Right now, a legal battle between President Bongo and his sister is bringing some of the looting to light and the European Parliament threatened sanctions on February 2nd. But Bongo is still there and Gabon is looking far more fragile than an oil-rich coastal statelet of 1.5 million people has any right to be. 

So now in the Philippines you have Duterte running death squads and cozying up to China. Maybe no U.S. president would have been able to do much about the former (and the latter likely deserves no response). But President Trump is not even going to try. And maybe he would not have tried no matter what. But the stench of corruption lies about it. Françafrique, meet Philamerica.

And worse yet, there are other, even more depressing places involved. Wagging the dog, indeed.

Mercosur and the Malvinas: An Argentine question alone

In the previous post, some readers questioned how the Argentine government could unilaterally offer the Falkland Islands access to Mercosur. The answer is easy: Mercosur recognizes Argentine sovereignty over the islands. The Mercosur parliament ratified the previous declaration in stronger terms in August 2016.

The upshot is that Mercosur-Falklands relations are in the hands of Buenos Aires. If the Argentine government chooses to give the Falklands access to its market, then those goods will be Argentine to all extents and purposes. They can therefore not only be re-exported to the rest of Mercosur, they can be exported directly to other Mercosur ports. There is no need for anyone to recognize U.K. sovereignty ... or even the local government of the Falklands. All that is needed is for Argentina to declare that it will treat exports from the Malvinas as local production and ask Mercosur to do the same.

Now, in fact Mercosur is not so legalistic: the European Union this is not. But no other Mercosur nation has ever given any sign of opposing Argentine claims over the island. They all recognize that to do so would cross an Argentine red line and sound the death knell for the troubled organization.  Given that, and the relative unimportance of squid to those countries, they will follow the Argentine lead.

Argentina, of course, will not give the Falklands access to their market without extracting a pound of political flesh from the U.K. I am not sure what form that pound will take: it could be as little as having London agree to discuss the question.  So do not expect revolutionary change. Do, however, expect incremental Argentine gains in what will be a very long game. 

The failure in Yemen and the President

By now, most of you have heard of the tragic fiasco in Yemen. An attempted U.S.-Emirati raid went badly wrong, resulting in unnecessary loss of military and civilian lives. 

On one hand, the fault lies with the U.S. military, which proposed the operation.

But the buck stops with the President. It is easy to imagine a Commander-in-Chief disapproving or postponing the raid. This particular Commander-in-Chief chose not to do so, and thus the failure lies with him, just as it lay with President James Carter in 1980. There is no way around that.

Tragic mistakes happen. Failing to own up to them is inexcusable. The President has the authority and the responsibility. Regardless of the other failures on the chain of command, he is the one who needs to learn from the mistake and force his underlings to do the same. 

There is no Soviet domination of Eastern Europe, redux

The title of this post is a famous line in the Ford-Carter presidential debate in 1976.

President Ford was asked a question about the Helsinki agreement, which according to the moderator, recognized that “the Russians have dominance in Eastern Europe.” Now, outside the Baltics, the moderator’s claim was false! The agreement did not admit that Moscow had the right to govern the Warsaw Pact countries. In fact, the agreement did exactly the reverse, by disavowing both armed intervention and the use of economic sanctions as means of coercion. 

President Ford started to say, “I can’t under any circumstances believe ... that by signing the agreement ... 35 nations have turned over to the Warsaw Pact nations the domination of Eastern Europe. It just isn’t true!” And that would have been a fine answer to a loaded question. Unfortunately, he went on to add, “There is no Soviet domination of Eastern Europe and there never will be under a Ford administration.” 

Man, that was a gaffe. President Ford knew exactly what he was talking about, he just said something stupid and then refused to walk it back. (If you watch the clip, you can see him beginning a good recovery, and then blowing it by saying that he did not think that the Poles considered themselves dominated by the Soviet Union.) 

Well, yesterday, Gary Johnson made a much more serious gaffe in an interview on MSNBC. The transcript:

Mike Barnicle asked Johnson: “What would you do if you were elected, about Aleppo?”

“About?” asked Johnson.

“Aleppo,” replied Barnicle.

“And what is Aleppo?” asked Johnson.

“You’re kidding,” responded Barnicle.

“No,” said Johnson.

Uh. That boggles the mind. Stunning. Ford made a gaffe, Johnson just admitted to total political malpractice and disqualifying ignorance. I stand in slack-jawed amazement ... and now I understand why Mitt Romney has refused to endorse. 

Anyone who wanted the Libertarians to become a real third party force in America should be very angry at Gary Johnson right now. As should anyone who believes that running for President of the United States is, you know, a serious thing. 

Puerto Rico is no longer foreign in the domestic sense, it is domestic in the domestic sense

 In another post, J.H. and I had an interesting discussion about Puerto Rico’s political status. Is it a colony in which the U.S. constitution does not apply — what American law calls an “unincorporated territory”? Or is it an old-fashioned territory, like Alaska and Hawaii before 1959 or Arizona and New Mexico before 1912?  

I am going to argue that Puerto Rico is in fact a de facto incorporated territory, just like the area covered by the Northwest Ordinance or Colorado before 1876. Bit by bit, in scattered pieces of legislation, Congress has fully extended the Constitution to Puerto Rico. Sure, Congress could pass an organic act and declare the Commonwealth to be an old-fashioned territorial government, but that would change nothing. It is now just an old-fashioned territory, like Arizona used to be.

Some history: the United States annexed Puerto Rico along with the Philippines in 1898. For purely racial reasons, there was zero support for taking over the Philippines as an ordinary territory, thereby bringing 7 million “Malays” into the American polity. Congress therefore created a special colonial status for the Philippines, under which the U.S. government would exercise sovereignty but within which the U.S. Constitution would not apply. That status was extended to Puerto Rico (essentially by default) and the Supreme Court ratified it in the infamous insular cases, which ruled that Puerto Rico was “foreign in a domestic sense.”

After 1898, however, Congress  and the Supreme Court slowly but surely extended the Constitution to the island. In 1917, Puerto Ricans became American citizens. In 1947, Congress extended Article IV, Section 2 of the Constitution to the island. In 1952, it went further, declaring that anyone born in Puerto Rico (regardless of parental citizenship) would be a citizen. The Supreme Court then extended the First, Fourth, Fifth, Eleventh and Fourteenth amendment to the territory; extending the latter brought along the Sixth and Eighth amendments with it. 

The Seventh Amendment, which guarantees a jury trial in civil cases, does not apply to Puerto Rico. But it does not apply to any state, either: in 1877, in Pearson v Yewdall, the Supreme Court held that the 14th Amendment does not impose the Seventh upon the states.  

What about criminal law? Didn’t the Supreme Court recently rule that someone could not be tried separately in federal and Puerto Rican courts? Well, yes it did, but the logic of 2016’s Puerto Rico v. Sanchez Valle stated only that Puerto Rico was not a state, sovereign under the 11th Amendment. Rather, it was a creation of Congress. But that gives Puerto Rico the same status as any pre-1959 territorial government; nothing in the reasoning derives from Puerto Rico’s original colonial status. 

Puerto Rico is indeed treated differently in terms of federal funding — a big part of the recent crisis is in fact due to Congress’s decision to fund Medicaid at a far lower rate on the island. But is that because Puerto Rico is unincorporated? No: Alaska was similarly shortchanged for federal highway money before statehood.

That leaves the income tax exemption. (Alaskans paid income taxes before statehood; the District of Alaska was incorporated in 1912, around the time of the 16th Amendment.) It seems fair that Puerto Ricans don’t pay those taxes on the basis of “no taxation without representation,” but the courts haven’t held that. Rather, they don’t pay because of 48 U.S. Code § 734. In other words, Congress exempted the island in 1917. Could it have done that with an incorporated territory? I have no idea and I would love to have a lawyer weigh in ... but I suspect that the answer is yes. After all, nobody doubts the constitutionality of the Empowerment Zones, which provide tax exemptions for investors and businesses that set up shop inside them. 

Finally, what about citizenship? Reader J.H. worries that Congress might strip Puerto Ricans of their citizenship should it so choose. (Or, more realistically, should Puerto Ricans vote for independence.) That, however, seems unlikely. The courts have defined Puerto Ricans as natural-born American citizens. It is extremely hard to strip a natural-born American of their citizenship. The courts have ruled that taking out a foreign nationality will not do it; hell, not even serving in the armed forces of another state will do it. (My uncle Eddie served in the IDF; he kept his citizenship.) The law now recognizes the SCOTUS decisions. Note the italics: “A person who is a national of the United States whether by birth or naturalization, shall lose his nationality by voluntarily performing any of the following acts with the intention of relinquishing United States nationality.”

That is, of course, only a law. It could be changed, but the change would only apply to naturalized citizens (maybe): the courts have been clear that the 14th Amendment protects natural-born citizens unless they explicitly declare that they intend to renounce their citizenship. 

There is a peculiar court decision from 2008 that argues that Puerto Rico has effectively become an incorporated territory. Consejo de Salud Playa de Ponce V. Rullan concluded, “Actions speak louder than words. Although Congress has never enacted any affirmative language such as ‘Puerto Rico is hereby an incorporated territory,’ its sequence of legislative actions from 1900 to present has in fact incorporated the territory.” 

No other courts have cited this ruling, but the logic seems to hold: Congress could pass an organic act incorporating Puerto Rico tomorrow, and it is not clear that anything would change. 

(Statehood, of course, is an entirely different thing.)

To conclude, I am honestly not sure that Puerto Rico’s “unincorporated” status amounts to anything. I suspect that it doesn’t. 

ADDENDUM: This piece in the The Atlantic came to my attention after I wrote the above. It is accurate in the particulars but misses the point: SCOTUS ruled against Puerto Rico on the grounds that it has no independent sovereignty, just like Alaska or Arizona or Minnesota or anywhere else before they became states. The insular cases have nothing to do with it!

(Note: Some states were sovereign before statehood: the Thirteen Colonies, Texas, and maybe if-you-squint Vermont. Hawaii was sovereign but lost it in 1898, 61 years before it became a state.)

Nobody looks good in the Peruvian debt saga

 Gramercy Funds Management is a good operation. Its founder and boss, Robert Koenigsberger, was on the side of the angels in the Argentine debt dispute. It also did good work with Nicaragua, masterminding a 2007 exchange that wrote off 95.5% of $1.4 billion in debt. (Data from here.) Moreover, Koenigsberger is a smart fellow, a graduate in Latin American history from UCSD. It is the kind of firm I find difficult to dislike, let alone villify.

But it is in the wrong on Peru, where it is suing the country for $1.6 billion in defaulted bonds under the U.S.-Peru Trade Promotion Agreement.

I wrote about the history of the bond default here. Short version: Peru issued a bunch of bonds to compensate landowners as part of a land reform in 1968-69. In the 1980s it defaulted on those bonds, even though inflation was rapidly reducing them to nothing.

The Peruvian Constitutional Tribunal, for some reason, decided that letting inflation eat up the value of the defaulted bonds would be an unconstitutional seizure of property. Note, please, that American courts have rejected that notion. In the 1970s, unexpected inflation ate up the value of debts by more than a factor of two ... good luck getting an American court circa 1980 to tell you that the Fifth Amendment means that you should get double back from a debtor in default to whom you loaned cash in 1970. 

But anyway, the Constitutional Tribunal decided that creditors in Peru deserved more protection than creditors in the United States. 

Between 2006 and 2008, Gramercy bought the bonds cheap. (Background testimony here.) In a twist that makes my Luddite self happy, they had to actually go to Peru and buy up 9,773 individual paper bonds. I find that amazingly cool; it further increases my respect for Gramercy.

They are still wrong. But I like them.

Anyway, the Peruvian government stalled and stonewalled on settling the outstanding debt. In part, this was because Gramercy insisted that the right way to value them was by running them through the Peruvian CPI. Note, however, that Peru underwent a hyperinflation over that period: calculating the CPI for a hyperinflating country involves a lot of guesswork; it would be economic malpractice to simply run the value through the inflation index unless that index had been checked and recalibrated over multiple different base years to correct for the inevitable distortions. 

The Peruvian government understandably said no. The Constitutional Tribunal then stepped in again and proposed a very sensible way to value the bonds that involved neither a specious CPI calculation nor hiring a group of economic historian to carefully recalibrate historical price indices. (Obviously, I would have preferred the latter!) It suggested rather that the value of the bonds be converted into U.S. dollars, which would then be compounded at the contemporary rate on one-year U.S. Treasury obligations.  

OK, fine. In his testimony, Mr. Koenigsberger complains about that valuation method, but it is way more sound than running it through the Peruvian CPI. But his complaints are not groundless, because the Peruvian government used a bogus exchange rate to convert the nominal value of the bonds from gold soles into dollars. Frex, at a time when the black market rate of the gold sol was around 44 per dollar, the government used a rate of 1,029 per dollar.

So he has a point.

But the claim of $1.6 billion is too big. It involves making some heroic assumptions about the accuracy of the CPI under a long and extremely volatile time period. 

What would a fair value be?

Well, on page 5 of the arbitration filing, Gramercy implies that the bonds in its possession had a face value of approximately one billion gold soles around 1972.  The exchange rate in that year was around 43 per dollar. Using a 6% interest rate would value the bonds at $283 million in 2015; alternative methods (discussed here) would put it between   $190 and $321 million. If you assume that the bonds were not dated 1972 but rather 1969, the valuation range would increase to $222−$386 milion.

That is a lot more than Peru wants to pay, but it is a lot less than $1.6 billion. 

I were the Peruvian government, I would offer to settle for around $200 million. I have no idea what Gramercy paid for the bonds. Mr. Koenigsberger says on page 11 that Gramercy bought them at a discount, but we do not know at a discount off what. Face value? CPI-adjusted face value? Something else? I suspect, however, that the company likely paid rather less than $200 million for the bonds and should be willing to settle. 

Or they could ask Fat Crybaby to make a deal for them. He does deals, right! Gangsta lean straight from Queens, only not lean, not at all. 

Paul Ryan has a tough job with the Puerto Rico oversight bill

 To recap, the Puerto Rico Oversight Act as it currently stands will:

1. Give Puerto Rico a six-month stay on all debt payments;
2. Require the Governor to create 5-year fiscal plans and submit them to an appointed Oversight Board for approval;
3. Require the Legislature to submit all passed budgets to the Oversight Board for approval;
4. Allow the Board to unilaterally cut budgets if the Governor submits a budget that does not comply with the fiscal plan;
5. Allow the Board to negotiate with creditors to restructure debts (which usually means reducing them in net-present value terms);
6. Allow the Board to suspend certain federal labor regulations on the island, including the federal minimum wage;
7. Grant bankruptcy protection to Puerto Rico (without using the term) and give the Oversight Board the ability to intervene in litigation against the island.

Without (1) and (7) the island goes to pieces right quick. You can see a (rather misleading) summary of what Republican supporters say the bill will do here.

My worry about the Oversight Board is not that it will cut budgets more drastically than an elected Puerto Rican government. The examples of Portugal, Spain, and Greece are pretty clear: when they cannot borrow anymore, elected officials do a fine job of imposing austerity. Maybe too fine a job. Rather, I worry that they won’t negotiate as hard as the government would. On the other hand, as Felix Salmon points out, the Board will consist of seasoned professionals who may be able to drive a harder bargain than Puerto Rican officials. So it is a bit of a wash.

But ... weirdly ... Republicans kept trying to neuter the bill in committee! (The link takes you to a blow-by-blow of the action.)

Consider the McClintock amendment. (Rep. McClintock, R-California, has in fact offered several amendments.) It would clarify that the bill would not apply to Puerto Rico debt obligations that are supported by a pledge of “full faith, credit and taxing power,” meaning, like, all of them. It would also clarify that nothing in the bill would alter debt holder rights or guarantees under Puerto Rico’s constitution or other laws. Which would, in effect, nullify bankruptcy protection by insuring that creditors could sue under Article 6, Section 8, of the Puerto Rican constitution.

Pretty blatant. Rejected 12 to 27. 12 Republicans in support, 16 Democrats opposed, 11 Republicans opposed.

Which Republicans opposed the amendment? Well, there was the committee chair, Rob Bishop (R-Utah). Good for Rob! The other Republicans that opposed it consisted of a collection of retirees on their way out (so under no political pressure), Raúl Labrador (R-Idaho, but born in Puerto Rico), Amata Radewagen (R-American Samoa), and a handful of others.

For most of the markup the Chairperson Bishop has been able to beat back amendments with points of order, but the more senior Republicans (including McClintock, obviously) lined up behind these poison pill amendments. The final vote was 29 to 10 and basically split the Republicans.

You gotta wonder what it will look like on the floor. If Paul Ryan lets it move without the majority of the caucus behind it, then he will have earned my respect. Sure, I may be a little disgusted at his resorts to magic asterisks to justify his silly budgets, that cut social insurance not because we have to but because he wants to ... but hey, reasonable people can disagree. If he gets this bill through and refrains from helping the Drumpfster this year, well, then the man will deserve to be the GOP nominee in 2020. Honorable opposition indeed!

Good luck with that, Paul.

I hope Bernie Sanders is talking cheap about Puerto Rico

 Short version: PROMESA would grant bankruptcy protection to Puerto Rico. (Since I hate these cutesy names Congress loves, I will henceforth call it the Puerto Rico Oversight Act.) But the bill would also put P.R. under a fiscal receivership. An Oversight Board appointed by the President of the United States from lists submitted by Congressional leaders. The Board would essentially take control of the island’s budget process. In return, the Board would get the power to take Puerto Rico’s creditors to bankruptcy court, including the holders of general obligation debt. (That suspends a provision of the Puerto Rican constitution.) The board would also have the power to suspend federal minimum wage laws.

The Oversight Act is a less-than-great deal, but it is also less than it seems. First, without it Puerto Rico’s creditors will tie the place up in lawsuits. Nobody wants a board forcing budget cuts, but it’s better than a bunch of vulture funds making the decisions. Second, Puerto Rico will have to cut its budgets in any case: it can’t afford to borrow any more. The Board might make stupid decisions, but austerity is sadly already backed in the cake. Third, Puerto Rico will be able to restructure general obligation bonds. That is more than most plans involved; in fact, it gives Puerto Rico a power that most states lack. (Although to be honest, the law on that is less than clear. Start with the 11th Amendment and go from there.)

Senator Sanders opposes the bill, calling it colonialism. And he’s right! It is.

But what’s his legislative strategy to replace it and replace it quickly? Because the bill is way better than the status quo. 

I don’t think he has a plan. I think this is an easy way to score political points, same as Senator Rubio did back when he was running for President. If it’s cheap talk, then I’m okay. But if he’s really mobilizing Democratic opposition, then he’s doing immense damage to the people of Puerto Rico and giving lots of power to hedge funds and their lawyers, aka “Wall Street billionaires.” 

It would be ironic if actual livelihoods weren’t in the balance. 

I would like to believe that the Senator from Vermont does indeed have a secret plan to get a better bill through, but I don’t.

Was Sykes-Picot treacherous?

 I used to go to the Middle East a lot. But then stuff happened. I got disinvited by the government of Bahrain, wound up on Hezbollah’s side of a debate over energy policy in Lebanon, and experienced a surprisingly less-than-warm trip to Israel. Plus, the one time my wife and I get to Dubai, the Burj was closed! These days I have not been travelling there as much.

But this is the 100th anniversary of the Sykes-Picot. So let’s visit the agreement. In the Arab middle east, Sykes-Picot is usually used as a shorthand for the European carve up that laid out the modern borders of the region between Turkey and Saudi Arabia. (Inasmuch as those borders still mean anything.)

But Sykes-Picot, in fact, laid out a rather different plan from the borders that actually emerged, as the below map shows.

Well, the map sort-of shows the agreement. You need to read the text of Sykes-Picot to really make sense of it. In essence, it worked as follows:

1. There would be an Arab state encompassing both area A and area B on the map. France and Britain would each retain preferential rights in A and B respectively, but those rights were economic, paralleling the Anglo-Russian Entente in Persia:
   • Preferential investment rights;
   • Limits on the presence of advisors to the Arab state from the other country.
2. France and Britain would engage in separate negotiations with the Arab state over their “direct or indirect administration or control” of the territories colored blue and red. 
3. The brown area around Jerusalem would be internationalized, with the exceptions of Haifa and Acre, which will go to Britain. 

The agreement is often blamed for the current chaos, In the words of the Economist:

Even so, Sykes-Picot has become a byword for imperial treachery. George Antonius, an Arab historian, called it a shocking document, the product of “greed allied to suspicion and so leading to stupidity”. It was, in fact, one of three separate and irreconcilable wartime commitments that Britain made to France, the Arabs and the Jews. The resulting contradictions have been causing grief ever since.

 Except, well, the agreement does not seem to have contradicted British promises to the Arabs. See the Hussein-McMahon Correspondence. In letter no. 4, the British say, “With regard to the vilayets of Bagdad and Basra, the Arabs will recognise that the established position and interests of Great Britain necessitate special administrative arrangements in order to secure these territories from foreign aggression, to promote the welfare of the local populations and to safeguard our mutual economic interests.” The Arabs agree to that in letter no. 5, as long as the occupation is temporary and accompanied by compensation. In letter no. 6, the British state that they have to give Aleppo and Beirut to the French; the Arabs agree in letter no. 7.  

As for the Zone A/Zone B division, that was not a partition; rather, it laid out spheres of influence inside a sovereign state, along the lines (as mentioned above) of the Anglo-Russian Entente in Persia. The British were committed to handing back the “indirect” administration in the east ... but the Arabs agreed to allow London to decide for how long it would be held.

In other words, Sykes-Picot only violated Arab expectations by hiving off the Mutasarrifate of Jerusalem ... although the Sharif of Mecca was to get a seat at the table in administering it. Otherwise, Sykes-Picot wasn’t the betrayal; the betrayal was that the ultimate borders didn’t follow it. 

That said, it’s hard to see how the Sykes-Picot borders would have been any, you know, better. You would have had one giant state combining most of what we call Syria, Jordan, and Iraq, including big swathes of Kurdish territory. You would have had an “Iraqi” province, mainly Shia, eventually turned over to the giant Arab state. (I am sure that would go well, as the peoples of East Timor and Spanish Sahara can attest.) France would have carved out a strange country combining Arab Alawites, Arab Christians, Arab Shia (non-Alawite Shia), Druze, Arab Sunnis, and a whole bunch of Turkish peasants. Jewish settlers would have still flowed into the area under international administration. It would have been a mess, albeit a different mess.

Just not a “shocking” mess.

The United States has always been at war

 The New York Times had an article today about Obama’s “war presidency.” It isn’t a bad article, but it makes much of the idea that there is something new in the idea of a U.S. fighting foreign enemies in less than “an all-consuming national campaign, in the tradition of World War II or, to a lesser degree, Vietnam.” 

The article went on to say, “The longevity of his war record, military historians say, also reflects the changing definition of war.”

Except, as I wrote in 2012 in response to the debate around Rachel Maddow’s Drift, the definition of war hasn’t changed! I was disappointed that none of the people engaged in that debate recognized that history didn’t begin in 1945. So, it has lurched up again the idea that there is something new about having the U.S. continuously engaged in small-scale low-casualty low-footprint military actions, let me repeat what I said in 2012:

In 1898, the United States went to war with Spain. Between 1898 and 1902, American troops battled Philippine insurgents. Peace came to Luzon in 1901-02, but fighting continued on Mindanao until 1912. In 1904, the U.S. navy bombarded rebel positions in the Dominican Republic; eventually U.S. Marines wound up (with the permission of the local government) occupying the customhouses. In 1906-09, we occupied Cuba, although there was (to be fair) not much fighting. In 1907 and 1911, we deployed to Honduras to halt Nicaraguan invasions. Between 1912 and 1925, U.S. Marines actively hunted insurgents (the original Sandinistas) in Nicaragua. In 1914, we once again bombarded Dominican rebels; we also occupied Veracruz to prevent arms from getting to the government. Between 1914 and 1934, we occupied Haiti: unlike Cuba in 1906-09, that one did involve quite a bit of fighting. We did the same on the other side of Hispaniola in 1916-24. In 1916-17, we invaded northern Mexico after Pancho Villa attacked Columbus.

Then there was World War 1. After which ... 

In 1917-19, U.S. troops again garrisoned Cuba. In 1919, we landed in Honduras to protect a neutral zone during a civil war. Between 1918 and 1920, American forces blundered pointlessly around Siberia doing something or other, and sustaining a lot of casualties. For a few days in Guatemala, Marines saw combat during a civil war in that country. In 1925, we invaded both Honduras and Panama during periods of unrest.  In 1933 and 1934, we waved gunboats around Cuba, but no war was necessary, since we succeeded in overthrowing the government by what would today be called covert action.

And then, peace until 1941.

Counting ... between 1898 and 1934, the United States was at peace for all of ... well, never, actually.

It is true that with the exceptions of Mexico, Siberia, and Cuba, most of the American interventions were not sold as protecting what we would today call the Homeland. But those are three large exceptions! 

In short, President Obama’s experience as a “president at war” rather than a “war president” is nothing new. McKinley, Roosevelt, Taft, Wilson, Harding, Coolidge and Hoover would find it very familiar. 

Reforming investment tribunals

 One of the advantages of living in Washington, D.C., is the chance to go to presentations and roundtables organized by the capital’s myriad think tanks. Cato is one of the best. I’m sure that statement surprises some of our readers, but it’s true. They get a lot of good people to talk about interesting issues.

In this case, the interesting issue is the horribly-named ISDS. That’s the acronym for investor-state arbitration, a subject this blog has written a lot about. Basically, the system allows foreign investors to sue governments when those governments are alleged to have expropriated (or at least damaged) their investments. The arbitral rulings are then enforced in national courts, meaning that a British investor “wronged” by the Ecuadorean government can sue for damages in an American court and have that court attach Ecuadorean assets or income streams … including, potentially, PetroEcuador’s oil sales or the proceeds from any foreign bond sales organized by the Ecuadorean government. It’s a powerful tool. And I would argue that it’s much better than a world where investors go back to their home government and ask it to bitch-slap the government that “wronged” them until it pays up.

(Of course, that still happens with some regularity, but that’s a different subject.)

The thing is, the system is profoundly undemocratic and exceedingly odd. First, the tribunals are essentially ad hoc. The parties to the dispute choose at least two of the typical three arbiters, often they choose all three. The arbiters are generally selected from a small rotating group of people … who also often act as counsel in other arbitration proceedings. (It’s like your judge in a civil was also a similar plaintiff’s lawyer.) There’s no appeal process. Decisions are (usually but not always) published but proceedings are confidential. And the system is molasses slow. It’s a goddamned mess.

(Which is why state-to-state bitch-slapping persists, but again, that’s a different subject.)

Few people care in the United States, but in Europe ISDS is a big deal. In part, that’s because Europeans are more concerned with the way the system appears to be biased towards large imperial corporate power. (In practice, the bias is less clear: governments win more than they lose. But I would argue that it nonetheless exists.) But it’s also because European governments are getting hit with seats suits; thirty at last count for poor beleaguered Spain. And Germany has been smacked with a €3.8 to €4.7 billion claim over its nuclear policies.

While I was writing The Empire Trap, I had a long conversation with Steve Haber about the arbitral system. I suggested that the system would be a lot better if it more resembled an actual judicial system, with standing courts, open proceedings, real appeals and reliance of precedent. He agreed … but added that the idea was a Nirvana thesis. Wasn’t gonna happen. He was right four years ago.

And if European governments hadn’t started getting hit with suits, he would still be right! But they did, and the European public noticed, and the European Commission was seized with the issue. Which is why I got to hear Rupert Schlegelmich, the Director General of Trade, present the European reform proposals at Cato. 

The Commission’s proposals would basically turn ISDS into the Investment Court System (ICS): a real genuine court system like the one I proposed to Steve in 2012. The Europeans would write this new system into all new bilateral investment treaties (BIT). Any BITs signed by the European Union would then supersede any old BITs signed by European national governments.

First, the European proposal would enshrine a “right to regulate” in order to insure that the system could not be used to overturn legitimate public concerns, the way the Phillip-Morris, for example, has tried to use ISDS to force Australia to pay it for losses incurred by that country’s cigarette-labeling laws.

Second, it would define “fair and equitable treatment” of investors as the following:

1. No outright denials of justice;
2. No manifest arbitrariness in state actions;
3. No discrimination on manifestly wrongful grounds;
4. No abuse, meaning coercion, duress or harassment.

Third, it would define expropriation as the following:

1. Causing substantial deprivation for the investors;
2. Causing more than an economic impact on their interests;
3. Not including “normal regulatory activities” concerning “health, safety and the environment” unless they were “manifestly excessive.”

Finally, it would create a permanent court with judges appointed by E.U. governments. Said judges (like all real judges) could not serve as lawyers in other investment disputes. Cases would be allocated randomly among the judges. And there would be full transparency in all proceedings, including video.

Wow! Sounds great. But then came Miriam Shapiro to point out with a smile that there was still a lot of daylight between the U.S. and E.U.

The United States, she pointed out, agrees with Europe that it would be a great idea to improve the selection of arbiters so as to put them “above reproach” and let tribunals rapidly dismiss frivolous cases. She also allowed that Washington would smile upon greater transparency.

She then pointed out some wrinkles where it might be hard to find common ground. Frex, how early on can the new court dismiss frivolous claims? Can states provide binding guidance on treaty interpretation before cases are brought? Who pays attorneys fee? Current tribunals can award that to one side or another; the European proposal will award those to the winner. What will the special mechanisms to make it easier for small companies to sue look like? And will there be a binding review clause to evaluate the new system after five years?

But … you can forget an American administration signing on to an appeals mechanism, even if Congress likes it. Simply put, governments win at arbitration and the U.S. wins a lot. Like, always. An appeals process could change that. From Washington’s position, what ain’t broke don’t need fixing.

Anyway, interesting stuff. If the European reform happens, it will be yuuuge, another move from global governance to something more like actual global government. Which may be why, like D.C. statehood, I’m skeptical that the European proposal will fly.

Two of these places are not like the others

 So the intrepid data team at the Economist collated all internet mentions of the term “51st state” and came up with the following map:

Don’t ask me to explain the references to existing states. But for most of the foreign countries, I get it. Australia, Britain, Japan, very close treaty allies. Canada and Mexico, in NAFTA. (Canada’s also a very close treaty ally.) Taiwan, special relationship. Caribbean, Philippines, Ireland, lots of emigrants to the U.S. (Bora Bora and Brunei, that’s just weird, but whatever.) 

In fact, I’m surprised that more Latin American countries didn’t crack the top ten: Colombia, El Salvador and Panama have a right to feel slighted. 

But what are Russia and North Korea doing on this list?? Who refers to them as America’s 51st state? And why?

Observatorio Argentino 31: China is not a superpower

 OK, I am only hearing about this now, which is a little embarrassing: but last month the Argentine Naval Division (its coast guard) sunk a Chinese fishing vessel that was encroaching on the Argentine exclusive economic zone (EEZ). 

One might have thought that China would use its putative economic might to demand apologies or compensation or something. After all, the country regularly buys U.N. votes and threatens the neighbors. But in this case, pretty much nothing. The captured Chinese weren’t even sent home until April 10th. 

In the words of the Argentine ambassador, “It is very clear that this was a police matter and has nothing to do with diplomatic issues.” 

It may be that China is merely speaking softly while carrying a big stick. But its behavior elsewhere makes me doubt that. Rather, its stick ain’t that big.

This is not going to get Mexico to pay for the wall

 Well, now we know Trump’s big leverage over Mexico: force people to show ID in order to make money transfers.

Really, that’s it. That’s the big idea. So let’s briefly unpack it.

First, it would take some time. The Trump administration would need to go through the regulatory process. So this “Day 3” bullshit it just that. 

Second, it would then immediately hit the courts under multiple grounds, not least NAFTA. So more delays.

Third, let’s say it happens. Suddenly, undocumented immigrants can’t make money transfers via Western Union. Well, they would immediately move towards other means. And illegal transfer organizations would spring up. Bitcoin? Well, yes, but as this World Bank report from 2005 discusses, also “ethnic stores, travel agencies, moneychangers, hawala-type systems, courier services, hand-delivery, etc.” Some of which would, in 2017, use Bitcoin to actually send the money. 

This would all raise costs for the migrants sending money home, but it would not stop the flow. So the Trump administration would have to go after them. That can be done, but more delays. (Here Carlos will mention that the administration will be facing massive bureaucratic pushback, slowing things further.) 

At this point the Mexican government has been chuckling at Washington’s blundering for about two year. But finally, somehow, the screws go in. Then what?

Well, to figure out what the Mexican government will do, you need to look at Mexican politics. Half of all remittances go to eight states. Two of them are the D.F. and Mexico State. Those are rich places; no elected officials are going to come under pressure if remittances dry up. Of the top-ten states, few households receive remittances: 10% in Michoacán and Guanajuato; 7% in Guerrero. These households would take roughly a 15% hit to their incomes, with some knock-on effects for local economies. (Page 115.) One good counterfactual might be the Great Recession, which put a big brake on remittances from the United States.  This Banxico paper shows the results. They were unpleasant.

But would they be so unpleasant as to get the Mexican government to pay to avoid them? Uh ... no. First, it is not like Mexican governments are bending over backwards to address rural poverty now. Second, even if all the affected households decided to vote against the incumbent government, the swing would be less than 5%. Third, the swing by people not affected will be more, since, you know, they would be the ones paying the taxes to build the border wall they don’t want.

Note that the above completely avoids any Mexican nationalism. Which is, in fact, a thing and means that no government would pay. So we are back to cancelling NAFTA and ... yes, this is in the proposal ... raising visa fees. Because “even a small increase in visa fees would pay for the wall.”

OK. The U.S. issued 1.5 million non-immigrant visas to Mexicans (including border crossing cards) and 82,476 immigrant visas. Let’s say the U.S. issued $17 billion in 30-year bonds to pay for the wall. You could finance the resulting $804 million annual expense by raising visa fees a mere $502 per visa. A small increase, indeed. I mean, it is possible that demand might go down a tad if the modal visa fee went from $160 to $662.

I am wasting my time, obviously.

How big is the threat that oil exports will be seized in a Venezuelan default?

 It is pretty clear that oil exports could be attached if PDVSA defaulted on its bonds. It would work as follows. PDVSA would sell oil to a refinery in the United States. Creditors would sue. The refinery would still get the oil, but a U.S. court would attach its payment to PDVSA and transfer it to the creditors. PDVSA, therefore, would get nothing from its exports.

If the Venezuelan government defaulted, however, the legality would get a bit dicier. It is possible that American courts would “pierce the corporate veil” and conclude that PDVSA is an instrumentality of the Bolivarian Republic, but that is not certain. Still, it is the way many investors and lawyers (inclduing myself) would bet. 

So in theory sovereign default would lead to a fall in oil prices, as exporting countries with state-owned companies cast around for alternative markets.

In practice, however, the courts are slow and (as mentioned above) the legalities are far from certain. It is quite possible that a defaulting country would merrily continue selling oil while its buyers merrily continued buying. After all, the buyers might not care. They would still get the oil; what do they care if the seller wouldn’t get its money?

But the seller would still want its money. It would likely therefore sell to middlemen who would demand a discount and then resell the oil at some legal risk to themselves. In other words, the price of oil exports would certainly go down.

The empirical question, however, given all the legal uncertainties, is how quickly it would go down. It is quite plausible that the export price of a country’s oil would not be affected by default for months or years.

Well, Ecuador provides a nice test of that question!

Let me walk you through the data. This is going to be a little chart heavy, so I ask readers to comment if it is ever unclear or you lose the chain of the argument.

Ecuadorean oil generally trades a discount to the WTI benchmark price. That is because its oil is heavier than WTI and needs to travel from Ecuadorean fields to (mostly) Californian refineries. The below chart shows the percentage discount on Ecuadorean oil between the start of 2006 and the end of 2009. It shows a very steep fall in November 2008.

That seems convincing, until you add a control. Mexico also exports heavy oil to the United States. Its discount on WTI also widened in November 2008, although Mexico did not default.

Still, the increase in the discount on Ecuadorean oil was greater than the discount on Mexican oil. Might that have something to do with the default? Certainly! But to be sure of that, you need to also account for the fact that Ecuador and Mexico sell into two different geographic markets. Ecuadorean oil goes primarily to refineries in California, whereas Mexican oil goes overwhelmingly to the Gulf Coast of the United States. The price of crude oil can vary by several dollars per barrel between the two locations, given transport costs and varying demand conditions. 

The below chart, therefore, compared the export price of the two countries’ blends to the price paid by refineries in California and the Gulf Coast (60% in Texas), respectively. Once you account for the fact that the price of oil in California fell more than the price of oil on the Gulf Coast, then the oil price dynamics in the two countries look pretty similar between 2006 and the end of 2008. This chart compares the price received by the exporting countries and the price paid by their primary customers:

 

The dynamics look similar when you express the discounts in dollar terms, rather than as percentages of the sale price. The stark increases in November 2008 go away completely, as artifacts of the general fall in oil prices. Mexican crude is a bit more volatile in the lead-up to November, but otherwise looks similar to Ecuadorean:

It is true that Mexican oil recovered faster than Ecuadorean oil. In fact, after January ‘09, Pemex managed to sell its oil for roughly the average price paid by all Gulf Coast refineries, elimating a long-standing discount. PetroEcuador also managed to improve its position relative to the pre-crisis era, but it took rather longer. 

I do not know what happened in the Gulf Coast oil market. There are two hypotheses to explain the Ecuadorean recovery, however. One is that the Ecuador announced the form of its default in mid-2009 — a form brilliantly and perfectly designed to leave creditors without legal recourse. Freed of fears of attachment, therefore, the discount fell.

The other is that May is around when PetroEcuador began selling its oil to state-owned Chinese middlemen at a significant premium. The discount on Ecuadorean oil fell because Chinese companies absorbed it. 

It is still possible, of course, that without the default Ecuadorean oil prices would have bounced back in January 2009 like Mexican ones and without the need to involve the People’s Republic of China. But there is no direct evidence for that story.

The next thing to do would be to nail down an explanation for the disappearance of the Mexican discount in January 2009. If an explanation for that can be found that Ecuador could not possibly have replicated, then the hypothesis that the Ecuadorean default affected the export price of its oil is likely incorrect. On the other hand, if the strategy employed by Pemex was one that Ecuador was prevented from using because it was in default, then the default cost Ecuador.

To be frank, my prior is that whatever happened to Mexican oil in January 2009 was likely idiosyncratic. I doubt that Ecuador suffered in oil markets for its big sovereign default.

Now, this is not to say that default would be costless for Venezuela. It could prove very costly! Eventually, Venezuelan receivables would probably be attached; sooner if PDVSA debt goes into default rather than Venezuelan sovereign debt. But in both cases Venezuela could continue to sell oil.

In short, the evidence from the Ecuadorean default of 2008 is not completely clear-cut ... but the preponderance of the evidence seems to be that any fall in oil prices will take some time to manifest.

Sources tell me that Venezuelan ministers fervently believe that default will lead to cut off in immediate oil exports, or at least a drastic fall in realized oil prices. I suspect that they are wrong ... but it is a good thing for creditors that they do not know that they are wrong.

Additional savings from going all America First

 The previous post looked at overseas basing costs and concluded that there were no real savings from shutting them down unless the United States also cut the military budget. Which, of course, we could do without ending our defense obligations.

The post did not account for the fact that NATO has a common budget, funded in part by the United States. That common budget comes to ... €2.1 billion, or $2.4 billion. The U.S. pays 22% of the common budget, or $523 million per year.

There are also individual NATO trust funds established for particular projects. They come to a grand total of €69 million, or $78 million. The U.S. share can vary, but assuming it’s around 22%, then you get a total U.S. contribution of $17 million. (The trust fund projects aren’t annual, but let’s run with that.)

So destroying the entire postwar Atlantic alliance system would save us $540 million per year. Call it a buck-seventy for every man, woman and child in the United States. 

That is not a lot of money. But hey, it is something. Make the Euros cough that up! Yeah! U-S-A! Winning!

How much could President Trump win from our s̶a̶t̶r̶a̶p̶i̶e̶s̶ allies?

 So, Donald Trump wants to turn America’s hegemony into a protection racket. Okay, then. How would those negotiations go?

First thing to do is estimate how much the U.S. could save by pulling out of Germany, Japan, and South Korea.

First take: billions and billions! The link goes to a 2009 study by the Commonwealth Institute. They get a cost of $127.1 billion for fiscal 2010: $132.1 billion in cost minus tribute host payments of $5 billion. (Page 9.) But that estimate is dumb. It simply pro-rates the defense budget by the number of personnel stationed overseas. Now, maybe some president might save all that money by simply downsizing the military. (Well, the Army would be “downsized” in that scenario; the Navy would be gutted.) 

Since Trump has made it clear that he has no intention of shrinking the military, then those personnel will simply be redeployed back to the United States. 

Second take: In 2013, the U.S. Senate took a look at basing costs. It estimated costs around $10 billion, 70% in Germany, Japan, and South Korea. (Page 1.) These costs do not include personnel costs or overhead: rather, they are the direct costs of keeping up the bases in those countries. German bases cost $4 billion. South Korean bases cost $1.9 billion. (Page 18.) Japanese bases cost $2.5 billion. (Page 40.)

But South Korea and Japan, unlike Germnay, pay pretty large portions of the U.S. cost! (Hold that thought on Germany; this is based entirely on the Senate report.) In South Korea, U.S. taxpayers foot only $1.1 billion of the cost; South Koreans make up for $800 million. (Page 21.) Japan, meanwhile, covers more than 70% of U.S. costs, to the tune of $1.8 billion per year. Until 2010, in fact, Japan covered all U.S. basing costs. (Page 41.) So President Trump might wrap up the American empire-by-invitation in Asia for savings of ... $1.8 billion. Get out of Germany at the same time and you save $5.8 billion per year. 

Only you don’t! Consider the cost of transferring 7,000 Marines from Okinawa to Guam: $19.3 billion. (Page 49.) Scale that up by the other 43,000 American forces in Japan and you get $119 billion to withdraw without demobilization. Add in the 29,000 forces in South Korea and you get $197 billion. Throw in the 36,000 troops planned to still be in Germany in 2017 and you get $296 billion. 

Now, that is a one-time cost, not an annual flow. And it is likely exaggerated, since most of the Naval and Air Force personnel overseas will not be as expensive to relocate as the Marines. So lets arbitrarily cut the cost by 60%. 30-year treasury bonds are currently yielding around 2.5%. Call it an annual expense of $5.8 billion between 2017 and 2047. 

$5.8 billion ≈ $5.8 billion. No savings. With interest rates at a near all-time low and shaving 60% off the topline estimate. Huh!

And now lets return to the German issue. Germany pays a share of American construction costs for our bases, but those costs are lumpy. In  2009, Rand estimated total German support to total $831 million. (Page 154.) If that number is accurate for other years, then the U.S. pays only $5.0 billion for our three main overseas presences. And $5.8 billion > $5.0 billion.

Third take: This big Rand report. It is long and complicated and does not cover the complete withdrawal option. But their minimum posture saves around $2.9 billion per year ... assuming that foreign contributions remained unchanged.

In other words, the American defense perimeter does not cost all that much. 

Now we need to figure out what these cost estimates imply for the negotiations.

President Trump, in this world, cannot simply threaten to walk away, because that would cost him. He needs to make one of two additional threats:

1. He is willing to incur costs to the United States if negotiations break down. That is, he tells his counterparts in Berlin, Tokyo and Seoul that he is willing to pay money to bug out unless our satraps allies fork over even more money. Good luck with that one.

2. He is willing to bug out and downsize the American military budget. Now those cuts do not have to be large for us to come out ahead — we are talking maybe 1% of the total defense budget — but they would need to be made. 

So, yeah, I suppose a cost-cutting President Trump could threaten to cut American military spending unless those foreigners pay us more. But unless he is willing to resort to an outright protection racket, he would net us 1% of the military budget on the threat of making a 1% cut in the military budget. 

Yeah, that makes sense. Totally worth it. After all, it isn’t like you could just, you know, cut the military budget without threatening our allies ... 

The U.N. did not just give the Falklands back to Argentina

 There seems to be some confusion about a recent U.N. decision to let Argentina expand its territorial waters. Some correspondents seem to think that the U.N. stripped away the Falklands’ exclusive economic zone. That’s not what happened.

What happened: In 2009, Argentina filed a claim to its continental shelf under Article 76, paragraph 8, of the United Nations Convention on the Law of the Sea (aka, UNCLOS). The Obama administration gently reminded the U.N. that the United States does not recognize Argentina’s Antarctic territory, and so the U.N. did not consider it. (The Russians did the same.) The U.N. agreed.

The U.K. also rejected Argentine claims to Antarctic waters but went a little further. It pointed out that the Falklands lie on the same continental shelf, and so the U.N. had better not apportion out any territory adjacent to the Falklands’ maritime zone, because, you know, the Falklands might also want to expand its claim. This map shows the total Argentine claim (absent Antarctic waters) and divides that claim up into the parts that the U.K. was okay with and the parts to which it strenuously objected:

If you want to see a map with all Argentine claims on it, see this post. A dagger pointed at the heart of Antarctica.

The U.N. just made a preliminary advisory ruling granting all of Argentina’s claims. So nothing is settled. But for reasons unclear in this age of low oil prices, British observers are quite upset that the U.K. might possibly be locked out of the bonanza that is the South Atlantic. The Falklands will be encircled! Or something. It isn’t clear. 

But there you have it. I wonder what Donald Trump thinks?

How Mexico might go on offense against a Drumpf administration

 How might Mexico go on offense against a hostile United States?

Alejandro Hope suggests six possibilities. Here they are, with some comments;

1. Sanction: If the U.S. sanctions Mexico, Mexico should hit back with countervailing tariffs, procurement restrictions, and others. This strikes me, however, as a bad idea. If Mexico sticks with conventional retaliation, it would be entering a battle it can’t win. If it goes outside the box and starts doing things like invalidating U.S. copyrights or restricting profit repatriation, it would put its own international reputation at risk.
2. Sue: Oh, yeah. Sue the Americans in U.S. courts on civil rights grounds, sue at the WTO and NAFTA panels, sue everywhere. If you win the international suits, you gain the ability to start sanctioning without the fear for your reputation. As for the domestic suits, well, see comments here: the Drumpf administration would be opening itself up to endless endless litigation.
3. Organize: “The Mexican government should openly support all efforts by Mexican and Mexican-American communities to organize resistance within the United States. That could include initiatives that help Mexican-Americans register to vote and Mexicans with permanent resident status become S. citizens (and voters).” This strikes me as a very dangerous game, given the chance of provoking American public opinion. It is also very hard to carry out — the Mexican government has futilely tried before to mobilize Mexican-American opinion.
4. Stop cooperating: This is the scary one for the United States, if not necessarily for a Drumpf Administration. I suspect that Mexico will continue to cooperate on organized crime, but not on migration.
5. Build alliances: “There are significant interests in the United States that would be opposed to a protectionist and isolationist agenda.” This is great idea, but those opponents will mobilize regardless of Mexican efforts. I don’t think an active program is necessary, although there’s no reason not to either, since it’ll be low cost. On the other hand, it would make a lot of sense for Mexico to spend a lot of money on an public relations campaign aimed at explaining to the American public just how much Mexico cooperates on their behalf.
6. Isolate them: “A sealed border, an assault on remittances or protectionist policies would not only hurt Mexico, but also most of Latin America. And that policy package would not find many friends either in Europe or Asia. In the event of Trump-led harassment, Mexico should take its case forcefully to multilateral bodies, such as the OAS and the UN. A Trump administration should be forced to pay a diplomatic cost for pandering to its xenophobic supporters.” This is exactly what H. suggested in more detail, and I think it would be devastating.

As Hope realizes, all of these actions are fraught with risk. But with the Mexican foreign minister calling Drumpf “ignorant and racist,” it certainly seems to be setting the stage for an active confrontation if the Donald becomes the 45th president of the United States.

Could repealing NAFTA pay for a border wall?

 It is hard to come up with counterfactual tariff revenue if NAFTA is repealed. You need to go through the U.S. uniform tariff schedule, apply those tariffs to the current duty-free trade with Mexico, and then estimate how much trade volumes would decrease if tariffs were reimposed. 

Here is a back-of-the-envelope estimate. In 1991, tariffs on imports from Mexico came to around $567 million on $39 billion of imports. Imports from Mexico are now around $294 million. That would imply revenues around $4.5 billion. A slightly more (but not much) sophisticated estimate uses the tariff rates from 1991 and adjusts for the share of imports using USITC data. At the two-digit level (which is a blunderbuss) that would get you revenue of $3.9 billion today.  

Of course, the Uruguay Round then cut tariffs by about half, so assuming that Mexico would retain normal trading relations after the U.S. repealed NAFTA, then those revenues would fall to something around $2.0 billion. 

Even if you cut that by half again for falling trade volumes, you get $1 billion per year. Enough for the wall?

One engineer estimated the amount of materials needed. A second estimated the cost. Cut that materials cost in half (for only 1000 miles of wall) and you have $8.5 billion. Double that again for total cost: $17 billion. 

Given low U.S. borrowing costs, the Drumpf administration could plausibly claim that ending NAFTA did indeed force Mexico to pay for that wall, even if some of that tariff incidence fell on American consumers. (Once NAFTA is finished, President Trump could try to get Congress to remove normal trading relations from Mexico and raise tariffs further, or impose taxes on wire transfers from the United States, but that is not something he could legally do on his own.) Over two decades or so, those revenues could finance a wall. If you squint really hard. And Donald sure is squinty-eyed.

The things I think about these days.

How Mexico might defend against a Drumpf administration

 A strategy is a set of moves that takes into account the likely moves of various other players. One of the hallmarks of a bad strategist is that they fail to realize how an opponent will respond to their moves.

Alejandro Hope has already pointed out how a Drumpf Administration would adversely affect Mexican security. Now, he lays out some Mexican countermoves to mitigate those impacts:

1. Reinforced security measures in border communities:
   1. Deploy more personnel to border communities;
   2. Provide additional funding to local and state law enforcement agencies;
   3. Focus on particularly violent gangs.
2. Enhanced orderly repatriation programs: “The worst possible scenario for Mexico would be to have a large population of returnees stranded along the border. To prevent it in the face of massive deportation, it will be necessary to increase the financial and human resources of existing orderly repatriation programs (i.e., assistance to returning migrants to get back to their home communities) and probably support other similar initiatives.”
3. Focused subsidies to selected communities: “Some localities, either along the border or inland, could be overwhelmed by a large influx of returning migrants. There might be a need for temporary and targeted assistance for those communities, including everything from housing to jobs programs. Otherwise, they could turn into a recruitment fair for criminal gangs.”
4. Strengthened agency-to-agency ties: “Cooperation between US and Mexican security agencies will not stop, even under a Trump presidency. But it could become far more contingent on personal relationships and ad hoc arrangements. Those ties should be fostered beforehand, even if that means getting rid of the so-called ‘single window’ policy (i.e., the practice whereby all security-related dealings between US and Mexican agencies have to go through the Interior Secretariat).”

These are good measures, but there is a problem. (1) has been tried before; its results were questionable. (2) and (3) will require money that the Mexican government may not have, especially if oil prices remain low. And (4) requires some important flexibility on the Mexican side. I have some doubts that the first three measures will accomplish much.

And Hope realizes this! As he writes, “If Donald Trump really means what he is saying, a containment policy would not be enough. In a scenario of mass deportation, trade war, and a tightening border, the resources of the Mexican government would be overwhelmed rather quickly. That is why Mexico would need to play offense.”

And what would playing offense consist of? Watch this space. But before we discuss Hope’s ideas, your suggestions are welcome! How should Mexico respond to Donald Tru ... Drumpf?

Do countries pay arbitration awards? Ecuador and Occidental

 International arbitration is a potentially powerful tool for investors. They can use it to attack governments that have changed contractual terms. Sometimes those defenses are battles by robbed investors against unfair expropriation; sometimes they are attacks by international oligarchs on the democratic rule of law. Usually, they are both.

But there is a problem for investors: arbitration is slow and expensive. This is true even after a decision comes down. To enforce you need to go to national courts and start chasing down assets and sales. That is doable, but it is not easy.

As a result, most arbitrations are settled after a decision comes down, simply to spare the investor the hassle. What we do not know is the gap between the awards granted and the amount paid.

In 2012, ICSID ordered Ecuador to pay Occidental Petroleum $1.77 billion plus interest.  In total, that came to $2.26 billion as of 2012, compounded at 4.188%. After that, the award accrued interest at the 6-month LIBOR (compounded monthly), which would put its total value at $2.29 billion as of November 2015.

That month, a second ICSID panel granted a partial annulment, reducing Ecuador’s liability to $1.07 billion. (Page 133; explanation here.) With interest, that would make the November 2015 value of the award $1.38 billion. 

And how much will Occidental get? $980 million. ($979.9 million, to be exact.) That is a full 29% discount off the arbitral award. In short, Occidental decided that $980 million now was worth an additional $379 million after who knows how many years and legal battles. (I also suspect that Ecuador also agreed to let Occidental back into the country, although that option won’t be worth much until oil prices rise.)

In short, yes, countries pay arbitration awards. They pay those awards because private companies can impose very real sanctions if they do not pay. But the system is slow and expensive ... to in this case almost a third of the headline value. Whether that is a feature or a bug probably depends on your politics. 

The benefits of American empire

 “The United States provide the majority of security on earth. What would the world look like without that security? Would South Korea exist? Would they be selling us Hyundais and Kias? Would Taiwan exist? How would the Cold War have ended? Would Germany still be divided? Who would control the largest known oil reserves on earth? Would Israel exist? The armed forces of the United States guarantee certain conditions on planet Earth, conditions with which much of the Western world is happy. It is worth considering what the world would look like without them.”  

Those words come from a review by Adrian Lewis (U-Kansas) than damns with faint praise a book called State of War: The Political Economy of American Warfare, 1945–2011, by Paul Koistinen (Calstate-Northridge). Koistinen describes the rise of the national security state in the United States. He does not quite call the defense industry a “vampire squid,” but he does write: “The [defense] industry became characterized by inefficiency, waste, and corruption; defense contractors too often turned out defective or failed weapons and equipment. Over time, massive expenditures for defense have had a very deleterious effect on the economy. … Of crucial significance … DOD budgets have distorted public priorities and spending, denying adequate attention and resources to infrastructure, education, medical care, and other public services and interests.”

But Koistinen, like a lot of liberal critics, acts as though the national security state came out of nowhere and survives for no reason other than its ability to lobby. Lewis acerbically points out that Koistinen needs two more chapters. One should explain why the American people “continuously put into office political leaders who sustain the Military-Industrial Complex, and who, after the Vietnam War, failed to show up to fight.” The second should describe the threats that the national security state evolved to confront. The pithy paragraph opening this post comes from that second proposed chapter.

Lewis actually saves his final one-two punch for the end. It is a doozy: “I will recommend this book to some of my graduate students. There are a few points, however, with which I strongly disagree; for example: ‘Although the armed forces had acquired some new weapons and equipment, the military as a whole appeared to be in no better shape in 1989 than it had been in 1981’ (p. 29). Having served in the Army throughout this period, though, I know this is just not true.”

Ouch!

In short, State of War seems pretty mediocre, but Adrian Lewis has pithily penned one of the best and most succinct briefs in favor of the American empire (at least as it behaved until 1991) that I have read in a long time. 

A European Border and Coast Guard?

 I once categorized the European Union as a country with a legislature and a judiciary but no executive. Doug Muir took exception to that, but I still think it holds. Europe has a bureaucracy, yes, but with a single exception of competition policy those bureaucrats do not tell private actors what to do. Rather, they tell the executive agencies of E.U. states to tell private actors what to do. People in, say, Spanish uniforms inspect car emissions (or contract with private labs to inspect car emissions), collect tariffs, monitor borders, arrest miscreants, impose fines, inspect vegetables, and carry out all the other policy missions determined in Brussels.

This is very different from real federal countries, like the United States. Europe has food and drug regulators. They never ever ever dress up like the guy on the right, who is an FDA agent named Robert Maes in the process of raiding a facility in Los Angeles. (Yes, FDA. Not a typo.) In the European Union, the European Medicines Agency might find out about a violation, but the people with guns who show up would work for (say) the Agencia Española de Medicamentos y Productos Sanitarios. 

But now under pressure from the mass migration out of Syria (and to a lesser extent elsewhere) the European Commission has just proposed the creation of a European Border and Coast Guard Agency. Go read the link. Impressed? You should be. A more detailed Q&A is here. You can find the full legislative proposal here. 

It still isn’ t quite a fully federal European Coast Guard. Yes, the EBCG will have its own uniformed personnel. Yes, the EBCG will maintain its own equipment pool. Yes, the EBCG will have the power to operate inside E.U. states without the local government’s approval. But most of its capabilities will be provided by reserve pools of uniformed personnel. The EBCG can call those personnel up for European duty whenever the E.U. so chooses, but the personnel will continue to wear their national uniforms (plus a blue armband, see page 49) and will operate under the same restrictions that the state government applies to its own law enforcement personnel. 

The authorization for all this is under Article 77 of the Treaty on the Functioning of the European Union, the first part of which reads:

1. The Union shall develop a policy with a view to:

(a) ensuring the absence of any controls on persons, whatever their nationality, when crossing internal borders;

(b) carrying out checks on persons and efficient monitoring of the crossing of external borders;

(c) the gradual introduction of an integrated management system for external borders.

I guess you could call the proposal an “integrated management system,” although that seems like a bit of an understatement. For all its limitations, it strikes me as one hell of a leap towards a federal Europe, if it happens. 

So, readers, will it happen? The recent history of the Eurozone makes me wonder. 

How socialist beer destroyed the British Empire

 A long time ago, an internet forum that I was involved with considered how the world would have been different had the settler colonies of the British Empire been able to hold themselves together into some sort of federation. Imagine a 125 million-strong country consisting of Canada, the British Isles and Australasia. A federated Commonwealth might not quite have gotten out of World War 2 as a superpower but it would have been much more of an equal to the United States. 

To a casual observer, in fact, it seems a bit mysterious that the U.K. allowed colonies whose initial settlement came overwhelmingly from Britain (save Canada) to just drift away. Why not give them seats in Parliament and keep the new territories in the fold? 

Well, one thing that surprised me is just how early Britain began allowing the settler colonies to impose their own tariffs. Even before responsible self-government, for example, New South Wales began taxing imports from Great Britain. Up until 1843 imports from the U.K. received preferential access ... but they still paid tariffs. And after 1843, tariffs had to apply equally to imports from everywhere in the Empire. That had the effect of ratcheting up tariffs on British goods, rather than (as London seemed to hope) lowering rates on imports from India. 

One of the things that made Imperial Federation a nonstarter was that the Dominions, by the late-19th-century generally democratic and self-governing (I am going to ignore the abominable Union of South Africa) had little desire to fight the political battles necessary to create a common Imperial economic space. Moreover, the U.K. had pledged to defend them and was seen as unlikely to renege on that commitment. So why pay more for Imperial defense when the U.K. taxpayer was going to pay for most of your defense for you? Even in retrospect that proved to be a pretty good deal: sure, the U.K. failed to defend Australia in any serious way in WW2, but it seems unlikely that an Imperial Federation would have been able to devote more resources to the south Pacific than our far-less-organized British Empire actually managed. 

But how did those Dominions come to have their own trade policies? Well, here it gets strange: London seems to have actively encouraged them to tax imports and set up local industries.

Consider Australia. New South Wales (NSW) started taxing alcohol imports in 1800; alcohol was the obvious thing to tax and most booze was imported, so the tariffs were also, in fact, the first taxes in the country. (Raised to pay for a pair of jails, which seems somehow ironic.) The import taxes rapidly gave rise to import substitution ... directly financed by the government in London. “The introduction of beer into general use among the inhabitants would certainly lessen consumption of spiritous liquors,” wrote the colonial secretary in 1802 (page 7). “I have therefore in conformity with your suggestion taken measures for furnishing the colony with a supply of ten tons of Porter, six bags of hops and two complete sets of brewing materials.”

Sadly, the subsidized importation of brewing equipment by the authorities back in London failed, so the colonial government set up its own brewery in 1804. In 1821, the British Parliament cut the alcohol tax on alcohol distilled in NSW from £0.50 to £0.13 while leaving the tax unchanged on imported spirits. 

You got that right: parliamentarians in London kick-started import substitution in New South Wales. In 1827 they added insult to injury by taking a 5% duty on manufactured imports from places other than Britain and extending it to Britain. 

Er?

Eventually the Australian colonies gained self-government, but by the then the urge to protect was well-established. South Australia separated from NSW in 1836; by 1846 it had ad valorem tariffs on even more goods than NSW. Victoria separated from NSW in 1851; by 1859 it had an organized “Tariff League” and in 1866 there came an openly protectionist Customs Act designed to promote the local manufacture of textiles, hats, leather goods, woodenware, furniture, toys, woollen blankets and rugs, glass and glassware, earthenware and porcelain. (Page 9.) Cigarettes soon followed. 

By this point, Australia was clearly on its own economic policy path. Even had London been able to get its act together about inviting Dominion representatives into the Parliament, the negotiations would have been difficult. It is more surprising that the Australian colonies managed to knit themselves together into the Commonwealth of Australia than that they failed to build lasting economic links to Britain.

One has to wonder if things would have been different had British bureaucrats been more proactive about keep Oz and Albion in the same economic space. More concretely, I have to wonder why those self-same bureaucrats put Australia on the road to economic independence, to the point of passing an Act of Parliament. It seems strange and goes beyond simply wanting to make the Dominions self-financing. (Which they never were, if you count the cost of imperial defense.) 

I understand why once you had local booze, independence was near inevitable. What I don’t understand is why London wanted them to have their own booze. But either way, the first sign of the inevitable end of the British Commonwealth came when that first Ozzie cracked open that first locally-brewed government beer. 

American aid and Greek economic growth

 Two years ago, I wondered about the importance of property rights in economic growth. The reason for my doubt was the example of Greece. The country has terrible property rights, yet managed to grow remarkably quickly between 1950 and 1980. As illustrated in the below figure (nicked from here), its annual output per worker rose from the level of Colombia to the level of France, before falling slightly behind. 

Well, what happened? One useful line of inquiry might be to dig deeper into history. In 1950, Greece had suffered greatly from World War 2 and the subsequent Greek Civil War. It is entirely plausible that the country possessed reserves of human capital far in excess of its contemporaneous Latin American counterparts. Maybe there is nothing miraculous about its catch-up economic growth in the subsequent decades.

But then I came across a recent paper by Carmen Reinhart and Christoph Trebesch. On page 11, I spotted this rather stunning figure:

Wow.

Now, the aid between 1946 and 1949 went to fight the war, but it meant that the opportunity cost of equipping the Greek National Army was essentially zero. It also meant that Greek civilians avoided much privation that might otherwise have been expected. In fact, the economy managed to grow during the war, albeit from the depressed levels at the end of the Axis occupation. (See page 30 here.) 

American aid continued after the war, however. In fact, it was not until 1961 that high levels of direct support metamorphosed into (rather soft) loans. 

To be frank, I do not think that American aid caused rapid Greek postwar growth. I am still not sure what caused that. But even had Greece avoided a Communist takeover without the aid, the chances are very high that the country would have slid into counterproductive redistributionist battles had American taxpayers not agreed to cover Greece’s continuing current account deficits. My prior would be that a counterfactual Greece without American aid would go the way of Argentina, at best. Some catch-up growth, rapidly petering out, followed by relative stagnation at the level of a wealthy Latin American country. 

Of course, we did it to keep the Communists at bay, not promote Greek economic growth. But it makes you wonder. Could foreign aid at the right time have kept Argentina, for example, from running off the rails in the postwar decade?

And what was it about Greece, anyway, that let it catch up so fast to the rest of Western Europe once aid covered the cracks? There had to be something else different about the place compared to Argentina or Mexico. No? 

Vultures attack Peru!

 In 1968, a left-wing military government ascended to power in Peru. It expropriated a lot of things, not least a bunch of American investments. The Americans had the power of the United States behind them: as I explain here, they were more than fairly compensated. Domestic Peruvian landowners, however, were of no interest to Richard Nixon. They were forced to accept Agrarian Reform Bonds denominated in the local currency and paying between 4% and 6%  interest over 20-30 years. (See page 5.) 

Unfortunately for everyone involved, the Peruvian government stopped paying interest on the bonds around 1982. (See page 4.) Why they defaulted, I could not tell you: the country was entering a period of hyperinflation that reduced the effective value of those bonds to zero. If the Belaúnde and García administrations had just kept on paying, the debt would have been inflated to nothing and the current government would have been spared a major headache. 

But default they did, and thus the current problem. In 2001, the Constitutional Tribunal declared that the government had to repay the bonds with some adjustment for inflation. To do otherwise violated Article 70 of the Peruvian constitution: “No one shall be deprived of his property, except, exclusively, on grounds of national security or public need determined by law, and upon cash payment of the appraised value, which must include compensation for potential damages.”

The decision was not a surprise to the Peruvian government. In 2000 the Fujimori administration (then on its last legs) issued a decree which said that the government would honor the unpaid debt by converting it into U.S. dollars at the exchange rate prevailing at the date of issue and then applying a 7.5% interest rate, compounded annually. So far so good ... except the government did not move to pay cash. Rather, it moved to issue interest free debt for the face-value of the bonds due in 2030. In other words, the compensation offered was fair, but wouldn’t be paid for three decades. (Page 16.)

The creditors were not satisfied. When the new Toledo administration proved unwilling to alter the terms of the Fujimori offer they went back to court. In 2004 the Tribunal declared that bondholders could accept the government’s terms, but only if they wanted to. So it went back into the government’s lap.

The Toledo administration ran out the clock and handed things over to incoming President Alan García in 2006. (Yes, that would be the same García who helped create the problem when he was president in 1985-90.) President García did nothing, handing off the problem to the newly-elected Humala administration in 2011.

Three months after President Humala’s inauguration, the bondholders sued again. In 2013, they got a decision. The Tribunal once again ruled that the government had to pay. But the Tribunal also said that the government didn’t have to simply run the value of the debt through the Peruvian CPI, because that would lead to number so high that it would break the Peruvian fisc. (Page 18.) It suggested rather that the value of the bonds be converted into U.S. dollars, which would then be compounded at the contemporary rate on one-year U.S. Treasury obligations.  

Basically, the method gives the bondholders what they would have earned had they plonked their money into one-year T-bills back in 1969 and kept renewing them. Maybe not fair, but not patently unfair either: the rates on T-bills were higher than the 4%-6% coupons on the original Peruvian bonds until around 2001. (See below.)

How much money are we talking about? In 2006, the total unpaid principal came to about 2.5 billion old soles. (They were actually called “gold soles,” but old soles is more straightforward.) Adjusting for inflation the simple way (which, remember, the Tribunal said not to do) would bump that up to 10.0 billion new soles, or US$3.5 billion, plus unpaid interest. The investors claim that they are owed $5.1 billion with interest using this method. (Page 7.) 

Using the suggested Peruvian method (compounding at contemporary T-bill rates, see page 2), the 2006 value of the debt would be around 1.9 billion new soles, or US$568 million, assuming that it all dates back to 1969. (I have interpolated for the missing years. Data from the Fed here.) Unpaid interest included. 

Alternatively, the government could just convert the debt to dollars at the exchange rate at the date of issue and compensate investors at the interest rate they were promised. At 6%, that would come to 1.7 billion new soles, or $531 million. (The actual amount would be lower, since the actual coupons varied between 4 and 6 percent.) The result would also be similar to assuming that the investors would have plonked their money into long-term T-bills: the 20-year Treasury bond yielded 6.32% in 1969. At that interest rate you get a 2006 value around $595 million. 

So far, so good; it may not be what the bondholders want, but the proposed method seems to give fair and reasonable values. So why are vulture funds involved? What is all the yelling about?

Well, the government proposed that the value of the bonds be converted to U.S. dollars not at the 1969 official exchange rate of 38.7 per dollar, or the open market rate of 43.5 (which the above calculations use) but the somewhat absurd rate of 1,029 per dollar. (Page 8.) 

Under that calculation the debt would have been worth in 2006 (for comparability) 78 million new soles ... or only $24 million. 

My. That is some difference! Add to that insult the injury that the government intends to compensate different bondholders in different ways and still has not made it clear whether they will be paid in cash, bonds with a market value around the equivalent amount in cash, or some other method. Plus other stuff. But that exchange rate calculation is where the Peruvians are giving the bondholders a giant middle finger and the real source of the trouble. 

So now the vulture funds intend to attack Peru, first in Peruvian courts, then using the stipulations in its Free Trade Agreement with the United States. If that fails, they will presumably do the full Argentina. I cannot say if they will be successful, but Peru (unlike Argentina) needs outside funding. 

I understand why Peru is wary. The national debt is a little under $38 billion, with about $18 billion of that owed to foreigners. Interest on the foreign debt amounts to about $1 billion per year. Why add to that? 

But still. There is something a little gratuitous about this, even for me. The $5 billion that the bondholders want is too much, but something on the order of $500-$600 million is entirely reasonable and entirely affordable. Lima should pay.

A modest proposal: reparations for Jamaica

 Prime Minister Cameron has rightfully faced questions about reparations for slavery during his recent trip to Jamaica.

How much is owed? Well, that gets controversial, but let’s take a stab at it. Slavery seized the wages otherwise due the slaves, minus the cost of keeping the slaves alive. Since slaves were considered an investment, the price of slaves reflected the value of that stolen income. 

One rough estimate of the value of Jamaica’s slaves in the late 1820s, before Parliament started seriously debating abolition, comes to £14.0 million. 

There is a problem with this method, which is that slaves were tortured into working far more hours at far higher effort than any free worker would have agreed to. (The best work on this comes from Roger Ransom and Richard Sutch on the American South.) This measure only captures the damage inflicted by that torture inasmuch as it created higher value for the torturers. It does not capture the damage the torture inflicted on the tortured.

It also captures only the value of the wages to be stolen from enslaved Jamaicans who were alive in the 1820s. It does not take into account the value of the wages stolen from enslaved people who had the bad luck to die before abolition. In fact, it does not account for wages already stolen from the people alive at abolition. 

But let us start with the number we have. How do we convert that into a 2015 value? One possibility is to simply adjust for inflation. That would give us £1.3 billion.

Wow! That is not a lot of money. Add in the rest of the West Indies and you get only £4.3 billion. In 2013, the U.K. spent £11.5 billion on overseas aid. Come on, Cameron! Cut a check and go home. 

Or at least that is what a reasonable government would do if it believed that the above was the correct and unassailable calculation. Of course, it is not. The value extracted from the slaves was invested in other things. One quick-and-dirty assumption is that the value of those investments increased with the value of the United Kingdom’s GDP. Use that assumption, and you get a current value of £53.3 billion, which is a substantial amount of money ... and still does not account for all the costs of slavery. 

If you think that £53.3 billion is the correct amount (or possibly something even higher) then I can see why you might be reluctant to admit to even £4.3 billion in damages. At current long-term rates, it would cost the U.K. about £1.5 billion per year to compensate Jamaica for that. 

Maybe the Jamaicans should demand to become part of the United Kingdom. Why not? Let Scotland go and replace it with Jamaica! Consider that in 2014 the United Kingdom subsidized the Scottish budget to the tune of £10.9 billion. (That figure allocates North Sea oil and gas revenues to Scotland.) Jamaica would be much cheaper! Public spending per person in England is about £8500. The price level in the U.K. is 2.2 times higher than in Jamaica, so equalized real spending would cost the exchequer only £3900 per person; roughly £10.6 billion per year. 

But Jamaica already generates tax revenues around £2.3 billion. And helpful people at the IMF (see pages 16 and 26 here and page 44 here) have calculated how much could be collected with better enforcement brought to you courtesy of the good people of Her Majesty’s Revenue and Customs, which would up the amount to £3.1 billion. Add in the £300 million collected by brining Jamaican VAT rates up to U.K. levels, and you have  £3.4 billion, for a net cost to the Exchequer of only £7.0 billion! (Rounding explains the discrepancy.) 

Take off the part of that due as reparations for slavery, and Jamaica requires only £5.5 billion to join the U.K! Moreover, considering that Jamaica has a GDP of only £8.6 billion, you would need to phase that subsidy in over at least two decades. Include the phase-in, and you get a net present cost of bringing Jamaica into the U.K. of only £66.7 billion over 20 years, scarcely more than the £53.3 billion reparations bill! 

Plus savings if Scotland walks out in the meantime. 

And then there are the growth effects on Jamaica. If Jamaica became as rich as French Guiana (the poorest overseas department of France), its nominal GDP would increase to £36 billion. 

What is not to like about that? Sure, it would still be a net drain on U.K. coffers, generating taxes of £14 billion against expenditures of £23 billion, but now you are quibbling. It is still cheaper than Scotland! 

So the solution is obvious. Cameron should offer membership in the United Kingdom to Jamaica.

Ecuador is still not a colony of China

 Now that the New York Times has breathlessly put Chinese imperialism in Ecuador on the front page of its Sunday edition, I feel like I must point out that China is securing neither physical supplies of Ecuadorean oil nor favorable prices. And it is certainly not earning rents on the money it lends the Ecuadorean government. China may be buying goodwill and it may be buying the rights to develop some of the last untapped conventional oilfields on Earth ... but it is getting neither cheap.

We covered physical shipments back in 2012. Nothing has changed. Most of the molecules pulled out of the ground in Ecuador wind up in Californian refineries.

What about price? The oil might physically end up in California, but most of it passes through Chinese ownership. In theory, that would give the Chinese middlemen monopsony power. In practice, it does not. In fact, the Chinese overpay for the oil.

Up until 2012, the loans-for-oil deals required the Chinese lenders to take Ecuadorean oil in repayment valued at a premium over the WTI price. In December 2012, Ecuador stopped charging a premium for its oil. That sounds like maybe perhaps now the Chinese were finally taking advantage of their position ... but such a conclusion would be wrong. Traditionally, Ecuadorean oil traded at a discount under WTI because it was of low quality and could only be sold to California refineries unless it was shipped through the Panama Canal. In 2012, however, for the first time ever, Ecuadorean crude sold at a premium over WTI around US$4 per barrel. (Californian refineries needed that heavy oil.) The Chinese buyers did not wish to pay a premium over the premium, and so the Ecuadoreans agreed to deliver the oil at the market price.

Maybe the contracts were just folderole? Perhaps canny Chinese traders managed to squeeze out monopsony profits regardless? Well, we can check that. PetroEcuador sells its oil mostly to Chinese buyers. The private companies operating in Ecuador do not. (They technically turn their oil over to the Ecuadorean government for a per-barrel fee, which then sells it back to them, at which point they sell it again at a further markup upon which they pay taxes.) The prices at which PetroEcuador and the private companies sell their oil is publicly available. And what do those prices tell us?

The blue line shows the difference between the price charged by PetroEcuador (which sells to the Chinese) and the price charged by the private producers. PetroEcuador generally receives more money per barrel. In fact, PetroEcuador managed to take advantage of a spike in Californian prices in early 2011 that passed the other producers right by.

The red line shows the difference between the price received by PetroEcuador and the landed price of oil in California, which is the relevant market. It shows no trend: the increase in oil sales to Chinese middlemen does not drive up the spread between the price paid by Californian refineries and the price received by PetroEcuador. (The spread does increase at the end of 2014; that is an effect of the general oil price crash, as all Ecuadorean producers tried to keep up their market share.) 

OK, then. The oil is still going to California and the Ecuadoreans are receiving a good price. So maybe the Chinese are charging extortionate interest on their loans? It certainly could be. But again, that is easy to check. 

How do the terms on the Chinese loans stack up against those offered by private creditors? The red bars show the lending rate on the Chinese loans. The blue bars show the yield on Ecuador’s 2015 bond at the time the loans were made. In every case, the red line is below the blue line. The last loan, from the Chinese Ex-Im Bank, uses Ecuador’s new issue due in 2024 as a benchmark ... which brings home just how incredibly cheap that last loan happens to be. 

The New York Times article mentions “steep interest payments” on the Chinese loans. I have no idea what they are talking about.

The Times article also states, “Along with taking the bulk of oil exports, the Chinese companies also collect $25 to $50 in fees from Ecuador for each barrel they pump.”

What it does not tell you is that said fee is in fact a triumph of Ecuadorean resource nationalism. Remember how private oil producers (Chinese and Western) in Ecuador turn over their production to the government and then buy it back? Well, that fee is what the government pays them for their oil. The difference between that and the market price is pure rent for the Ecuadorean state. It is the exact opposite of imperial exploitation. (The contracts are quite clever; the newest ones give the companies a higher price if they reduce costs.) The government also takes 70% of the profit on oil sales. (Page 178.) 

The article’s phrasing, however, makes it seem as though Chinese companies take the oil for free and then charge a fee on top of that. Very misleading.

The article also says, “China’s terms are putting countries in precarious positions.” But that doesn’t make any sense! The terms of the loans are great for the borrowers. Falling oil prices are what is putting Ecuador in a precarious position. As for China’s ability to threaten trade or other sanctions should Ecuador default ... well, tell that to the Argentines or the Greeks. Western creditors, public and private, are also pretty good at that sort of thing. (I wrote a book about it!) 

Ditto the way that China forces the recipients of its finances to buy its products and contract with its companies. My co-blogger knows more about development aid than I ever will, but from what I saw on the ground in Afghanistan and Africa that sort of thing seems to be the rule ... even if it is technically disallowed. (Doug?) And I must also admit that while the anecdotes about Chinese labor and environmental practices are quite telling, I also doubt that they are much worse than the Western record. (Setty?)

Finally, love it or hate it, the Refinería del Pacífico is a purely Ecuadorean idea. If it turns out to be a bad one (I suspect it is) then perhaps one could blame the Chinese for going along Ecuadorean desires. But the refinery is not a boneheadedly stupid idea. There are real reasons to support it; opponents (like myself) are making a judgment based on the risk of failure; reasonable people can disagree about whether the potential reward is worth the risk. Moreover, most of the debt for the refinery will be effectively collateralized. Many of the losses will fall on Chinese banks.

The above, I think, is the opposite of imperialism. Ecuador sold the refinery idea to China and looks as though it might get the Chinese to put up most of the money and take on most of the risks. 

If this is a Chinese empire, it makes the American empire look well-run and logical. Which is saying a lot.

There is still no good economic theory of the Scramble for Africa

 There is no commonly accepted explanation for why European powers carved up the African continent in the 1880s. Most historians today discount economic explanations: by the 1880s African commodity exports were a sideshow. Rather, the explanations have to do with prestige-seeking by European governments combined with the fact that military imbalances made annexation easy. Related explanations add two sorts of security dilemma: (1) the fear that if one country did not annex an area another would; and (2) local political crises driving expansion as the easiest solution. 

Now come Ewout Frankema (Wageningen University), Jeffrey Williamson (UW-Madison), and Pieter Woltje (Wageningen University) to show that African commodity prices enjoyed a sustained upturn between 1845 and 1885. Moreover, that upturn was stronger than for other regions.

This is pretty neat stuff, but as an explanation for colonialism it leaves a lot to be desired. No matter how you slice it, the profits from this trade were pretty small. In addition, we need to know how much of those profits were seized by Europeans even in the absence of formal control — my prior is that it would be a lot. Finally, we would need to know why the scramble waited until the 1880s: after all, the price rise started 40 years previously. (The authors partially address this with the point that French inland expansion started earlier.) 

That said, these results do blow a hole in the Hopkins thesis that declining commodity prices caused intra-African wars over the remaining rents, thereby opening the door to European conquest. Neat stuff. 

When U.S. law is an ass, but the Venezuelan government is a CENSORED

 Setty and I have been having a pretty good back-and-forth at his place. (Am I going to have to join Twitter? Please, no.)

We came to a consensus about the propiety of personal sanctions against foreign officials, in which we both changed our initial opinions. (Yes, it happens on the Internet!) Here is the state of play:

There is an argument for the use of economic sanctions against foreign officials. The opposition to their use generally stems from two sources. The first is a blanket aversion to the use of American power; we don’t have a lot to say about that. The second, however, is a worry that such sanctions are applied without due process. That is a reasonable worry, but it is misplaced.

It is possible for foreign residents to harm Americans while outside the reach of the police power of the U.S. government. The alternative to applied sanctions is the issuance of arrest warrant. The problem is that when the foreign resident is outside the reach of American law, issuing an arrest warrant is a hollow move. The only options would be to do nothing or dispatch American forces to carry out an arrest inside the territory of a foreign state. The former is practically unacceptable for any representative government; the latter runs massive foreign policy risks. Sanctions on individuals believed to have violated American law or otherwise harmed American interests is an excellent way to square that circle. 

The problem of extraterritorial jurisdiction is compounded when the targeted foreign resident is an official of a foreign state acting in their capacity as a member of the government. In that case, the U.S. has no right to simply criminalize their actions without tossing aside the totality of international law. Moreover, the U.S. has no way short of invasion to enforce any such criminalization. It can impose sanctions on the government. But imposing sanctions on the government harms civilians …. which sometimes is what you want to do, but sometimes is gratuitous or counterproductive. 

Once again, you come to personalized sanctions as the best option between a complete abdication of the state’s responsibility and an economic sledgehammer. 

In short, the analogy with due process doesn’t hold. We’re not on much of a slippery slope, either. First, individual sanctioning is not something new and it has not yet led us to perdition. Second, the wording of the Economic Powers Act, specifically section 1702, makes it clear that the President has less power here than your typical local government under America’s (admittedly appalling) civil forfeiture laws.

But there is another issue, which is that American law is an ass when it comes to human rights. Setty: “The U.S. should support human rights, without having to (pretend or really) pee itself in fear of the human rights violator or his or her country. I think this sort of language unnecessarily alarms and alienates some people who would be natural allies of efforts in favor of human rights. The U.S. continues to act like a scrappy underdog even when much of the world sees it as an over-muscled bully.”

Exactly! The International Emergency Economic Powers Act should be for actual emergencies. There may be cases where a foreign government’s internal political actions really do constitute “an unusual and extraordinary threat.” For example, a repressive government could be in the process of starting a civil war. Or it might be generating large-scale refugee flows. Or it might be threatening American expats. None of which is really yet on the table on Venezuela, thank the Lord. 

In other words, the U.S. needs better legislation. The Venezuela Defense of Human Rights and Civil Society Act of 2014 (ohmigod reading the name of that bill hurts HURTS makes me sad a crime against English it is) could have contained its own authorization instead of going through the Economic Powers Act. Better still, Congress could create a new sanctions law, along the lines of the Venezuela Rights Act. Even better than that would be a law authorizing the President to impose sanctions in pursuit of resolutions from the U.N. or OAS.

Still, absent that, we have the laws we have. They are not terrible. The law may be an ass, but the Maduro government may just need a kick from one.

Really, calling it a national security threat was the only way to sanction Venezuela

 Professor Greg Weeks (UNC) suggests that President Obama could have used the horribly-named “Venezuela Defense of Human Rights and Civil Society Act of 2014” to sanction Venezuelan officials without going through the foderol of calling the country a national security threat.

Well, no, he couldn’t. 

Section 5 of the Act does not independently authorize the President to do anything. Rather, it authorizes “The exercise of all powers granted to the President by the International Emergency Economic Powers Act.” [Italics mine.] 

Which means that President Obama still had to jump through all the hoops laid out by the Emergency Economic Powers Act, including the declaration of a national security threat.

Basically, the President had three options. (1) Don’t impose sanctions. (2) Break American law. (3) Declare Venezuela to be a threat to national security. He went with option (3).

Maybe option (1) is a better idea. (I know y’all have opinions!) But option (2) sounds like a really really bad one. Which left us with option (3) and a highly amusing kerfuffle, which although big on the Internet, really was brought to my attention the old-fashioned way.

Is Venezuela a threat to U.S. national security? No, but that does not matter

 I’m in Trinidad, and my father-in-law just asked me why President Obama would declare Venezuela to be a “unusual and extraordinary threat to the national security.” This was in the context of the kind of argument that he loves, where he insists that Venezuela’s economic woes are the fault of American intervention and I tell him that’s the dumbest thing I’d heard since that British guy in the previous post. We go back and forth, I admit that duh-obviously the U.S. cares, he admits that he has no reason to think that U.S. actions have contributed in any material way to the woes of the Bolivarian Republic. 

Then the President of the United States declares, “The situation in Venezuela ... constitutes an unusual and extraordinary threat to the national security and foreign policy of the United States, and I hereby declare a national emergency to deal with that threat,” and I gotta start all over again.

At the same time, my friend James Nicoll decides to make an anti-American jab. “DOES AMERICA NEED A CUBA? That is, some eternal enemy to show the other New World nations what the alternative to be a satrapy is? Just sticking to horrible petrostates, the Saudis do worse but they’re smarter diplomatically than the guys down in Caracas.” 

So here I am with an explainer.

(1) Nobody believes that Venezuela is a threat to national security.

The reason for the wording of declaration isthat the authority to sanction Venezuelan officials comes from the  International Emergency Economic Powers Act of 1977. From Section 1701: “The authorities granted to the President by section 1702 of this title may only be exercised to deal with an unusual and extraordinary threat with respect to which a national emergency has been declared for purposes of this chapter and may not be exercised for any other purpose.” 

And so the President had to declare that the situation in Venezuela was indeed an “threat to national security” if he was going to impose personal sanctions.

The legislative history behind the 1977 act is interesting. Presidents had long imposed economic sanctions in response to foreign events, especially under the Trading with the Enemy Act of 1917. The problem was that those emergency declarations were open-ended and subject to no oversight. The post-Watergate congresses were not happy about that, and so they passed the Economic Powers Act to regulate the imposition of sanctions. The law does not directly limit presidential power, but it forces him or her to make six-month reports on the actions being taken and gives Congress the ability to terminate those actions under the National Emergencies Act of 1976.

(2) The Administration cares about Venezuela because it is in this hemisphere and the U.S. cares about democracy in this hemisphere.

I would love to find that the U.S. has some nefarious purpose in Venezuela. In fact, I wrote an entire book  about U.S. actions in Latin America that had a nefarious purpose. (Go read! James, I will send you a free copy on request. Would you review it?) I am having trouble seeing how these sanctions will advance American goals in Venezuela. Regarding our public goals, the sanctions thus far apply to individuals and will not worsen the economic situation. Those individuals are unlikely to change their behavior due to the threat. 

For two decades, the U.S. has put democracy promotion atop its Latin American agenda. It is extremely difficult for the United States to claim that democracy is an important foreign policy goal when a major government is violating the norms of democracy. With the rest of the Latin America apparently unwilling to move (for various reasons) that left the United States few other options other than acquiescing to Maduro’s dictatorial actions. That is certainly an option, of course ... but why would you want the United States to do that?

While the sanctions themselves will not change behavior, they will have two salubrious goals. First, it will put Caracas on notice that it cannot cancel or subvert the upcoming elections without courting diplomatic isolation. Second, it will embolden the opposition, at least on the margin. Finally, as a Hail Mary it might exacerbate some cracks in the Chavista coalition.

As for private benefits from U.S. action ... well. American companies are not getting paid, but those are not the policies that the U.S. is sanctioning. Washington can and will leave that to ICSID and wait for Venezuela to default on those obligations. 

(3) Nobody in Washington cares about hypocrisy and neither should you.

The U.S. is inconsistent about supporting democracy in this hemisphere. Across time, well, our record is worse than bad. The only two periods where we supported democracy in any sort of remotely consistent way were the 1920s (really! It surprised me too) and since 1990. 

Across space, well, on the one hand we have (rightfully!) decided that it is time to open relations with Cuba and (not quite as rightfully) look the other way in Honduras. (I am not referring to the 2009 coup; I am referring to the current actions of the current government. Like these.) So we are not consistent, even in our hemisphere.

But so what? There are good reasons to engage with Cuba. There are good reasons not to sanction Honduras. I have no idea what purpose perfect consistency would serve.

In short: these are mild personal sanctions, imposed to declare that the U.S. is serious about democratic norms in Venezuela. They will have little direct effect, but at least on the margin they make it a little more likely that elections will be held on schedule. And I do not see a cost for U.S. interests. So why not?

I invite James to change my mind! Why should the Obama administration have done nothing instead?

The Philippines move right!

 Carlos Yu and I have a long-term plan to write a book on the Philippines under American rule. But it won’t be done until 2018 at the earliest.

One thing that we discovered while writing our book on the Panama Canal was that Panamanians drove on the left until April 15, 1943. The reasons for the changeover are obvious; less so is why Panama started out on the left. The influx from the British West Indies is often cited. (Colombia did not start to regularize its traffic codes until Panama had already seceded but appears to have always driven on the right.) Argentina drove on the left between 1889 and 1945. The first traffic code, from 1872, mandated driving on the right but the country switched to the left in emulation of the British-built railroads. (You can still see this in the Buenos Aires subway.) It moved back to the right on June 10, 1945.

But neither of us had any idea that the Philippines also drove on the left until March 10, 1945! That is more than slightly amazing. The vast majority of cars were imported from the United States. So how did the rule survive so long? Even more amazing, the reason for the shift given in the text of the executive order implies that imported cars had been physically reconfigured to right-hand-drive before the switch:

EXECUTIVE ORDER NO. 34: AMENDING TRAFFIC REGULATIONS FOR VEHICLES

WHEREAS it is deemed advisable to change the existing regulations providing for the driving of vehicles on the left side of the road so that the vehicle traffic in the Philippines shall conform with the practice of driving on the right side of the road obtaining in most countries of the world;

WHEREAS such a change would bring about certain economic advantages to the people of the Philippines in that it would reduce the price of motor vehicles imported into the Philippines from the United States;

WHEREAS during the present emergency the great majority of the motor vehicles of the United States Army used on the roadways in the Philippines are right-hand driven and the drivers thereof are accustomed to driving on the right side of the road; and

WHEREAS the present affords the most propitious opportunity to effect this desired change;

NOW, THEREFORE, by virtue of the powers vested in me by the Constitution and the laws of the Commonwealth of the Philippines, particularly Commonwealth Act No. 671, I, Sergio Osmeña, President of the Commonwealth of the Philippines, do hereby order;

1. That section 60 of the Revised Motor Vehicle Law, Act No. 3992, be amended, as it is hereby amended, to read as follows:

“SEC. 60. Drive on right side of road.—Unless a different course of action is required in the interest of the safety and security of life, person, or property, or because of unreasonable difficulty of operation in compliance herewith, every person operating a motor vehicle or guiding an animal drawn vehicle on a highway shall pass to the right when meeting persons or vehicles coming toward him, and to the left when overtaking persons or vehicles going the same direction, and, when turning to the left, in going from one highway into another, every vehicle shall be conducted to the right of the center of the intersection of the highway.”

2. That all other sections or parts of the said Revised Motor Vehicle Law and amendments thereof shall be considered as amended or modified as they are hereby amended or modified accordingly so as to conform with the provisions of the Executive Order; and all other provisions of law inconsistent with or contrary to the provisions of this Executive Order shall be considered repealed as they are hereby repealed.

Done at the City of Manila, this tenth day of March, in the year of Our Lord, nineteen hundred and forty-five, and of the Commonwealth of the Philippines, the tenth.

SERGIO OSMEÑA
President of the Philippines

Unless most American imports had been reconfigured before sale in the Philippines, then there is no reason why switching the side you drive on would make imports cheaper. Today the Bahamas drives on the left but enforces no such rule; neither does the U.S. Virgin Islands. Was there a mechanics lobby group in the Philippine Islands that insisted on reconfiguring imports before 1945? 

There has got to be a story here.

Sometimes the Europeans could do no right

 There is an overwhelming amount of evidence that the European empires did very little right in Africa. I will admit that these results came as a surprise to me; my prior would have been that the Europeans would have left behind some institutional innovations or physical infrastructure of value. That case, however, turns out to be extremely hard to demonstrate outside of Southern Africa. 

The slave trade, of course, was one of the most egregious ways in which the Europeans managed to play havoc with Africa. It follows, of course, that ending it should have positive effects. And it did! The Middle Passage was a horrifying meatgrinder ... no possible cost could outweigh the reduction in human suffering from insuring that fewer people would suffer in it.

But the passage of the U.K. Slave Trade Act of 1807 may have had the consequence of boosting conflict in Africa. James Fenske (Oxford) amd Namrata Kala (Yale) argue that it did, by weakening the authorities whom had enriched themselves off slave exports. They take advantage of the fact that the British were rather more successful in reducing human trafficking from West Africa than elsewhere as a form of natural experiment to test their hypothesis.

The time series evidence is fairly compelling that something happened around then:

But I am not wholly convinced of the validity of their experiment. First, look at the above figure: there are a disconcerting number of zeroes among the controls. Second, look at the map to the right, which shows the treatment area in red and the control in blue. Are they really comparable regions?

The authors do vary the treated area and find the same result. In the map, the treated area consists of everything within 1,000 kilometers of a slave-trading port. They varied that distance to as low as 250 kilometers, with the same result. They also defined the treated zone as the current borders of countries with historical slave ports; again, similar results. Finally, they threw out the four territories annexed by European powers in 1807-40: Sierra Leone, Gambia, and Côte d’Ivoire. They also threw out Liberia for similar reasons. Again, the results hold.

Nonetheless, it still seems as though there may be a data problem: we know less about conflicts in the interior. And even if we did have comparable information, the interior likely had a radically different state structure and a much lower population density. The comparison seems forced.

Even without the experiment, the time series certainly make it seem like something happened to increase conflict in coastal Africa in 1807! The Slave Trade Act is the most probably culprit. Moreover, it is hard to argue reverse causality, i.e., that the Act was a response to rising levels of intra-African conflict. They do a good job of demonstrating that British interest in the slave trade had no correlation with interest in African conflict. (Google Ngrams is pretty neat.) In short, the experiment may be unconvincing ... but it also may be unnecessary. Read the paper!

But if they are right, it is depressing to think that ending the slave trade may have done as much to weaken African states as the trade itself. 

Gender shock

 We know that European colonization affected Africa in multiple ways. The direct effects were generally, well, at best neutral. Outside a few long-standing enclaves (like Dakar) and (maybe) Tunisia and South Africa, it’s difficult to imagine a counterfactual in which the Europeans never extend sovereignty and the Africans have a harder time of it in the 20th century.

One understudied way in which the Europeans might have affected Africa negatively is through gender norms. If there were benefits to, for example, learning English or French, but the colonial authorities only taught men, then gender inequality would increase. One can imagine many other channels in which this effect could have operated.

On the other hand, it is far from given that pre-colonial Africa was a paragon of gender equality, relative to Europe. It hard to see how colonization might have improved the situation, but it is possible.

So what was the effect? Well, Felix Meier (Utrecht)  and Jacob Weisdorf (Southern Denmark)  have an answer! It turns out that the Protestant churches in Kampala kept incredibly detailed occupational data going back to the 19th century. They found that the initial impact of colonialism was what you’d expect … but it didn’t last:

“We find that the arrival of Europeans in Uganda ignited a century-long transformation of Kampala involving a gender Kuznets curve. Men rapidly acquired literacy and quickly found their way into white-collar (high-status) employment in the wage economy built by the Europeans. Women took somewhat longer to obtain literacy and considerably longer to enter into white-collar and waged work. This led to increased gender inequality during the first half of the colonial period. But gender inequality gradually declined during the latter half of the colonial era, and after Uganda’s independence in 1962 its level was not significantly different from that of pre-colonial times. Our data also support Boserup’s view that gender inequality was rooted in indigenous social norms: daughters of African men who worked in the traditional, informal economy were less well educated, less frequently employed in formal work, and more often subjected to marital gender inequality than daughters of men employed in the modernized, formal economy created by the Europeans.”

In other words, the British conquest had little overall effect at the end of the day … or at least by the end of the 20th century. Thoughts?

What is Arnold Kling talking about when he says Jordan is tougher than the United States?

 A few weeks ago, I wrote about a review of my book by Elizabeth Cobbs Hoffman. I thought that she had a lot of good points, intriguing notions worth thinking about.

But I was very annoyed that she just plain ignored the facts of my argument. She wrote, “It’s hard to see how the horse-trading that achieved partial compensation for dispossessed investors was terribly different from any other bruising business transaction.” Only I presented lots of evidence that there was no horse-trading! The American investors got everything they wanted, and more.

Now along comes Arnold Kling to write about the decline of American empire hegemony. He writes of a possible cycle in which the U.S. feels less prosperous because there is less globalization, making its government less willing and able to intervene in the world, leading to more disorder and less globalization ... repeat. It is an intriguing notion, worth thinking about.

Only he goes on to just plain ignore the facts. He writes, rather unbelievably, “On a related note, what should we make of the fact that in response to the murder of one of its citizens, the United States is less forceful than Jordan?”

What??? Between February 5 and February 8, Jordan launched 56 airstrikes. And as of January 19, the United States Air Force alone had launched 9600, not counting sorties by U.S. Navy aircraft. Moreover, our F-22s escorted all of the Jordanian F-16s on those retaliatory raids that have Kling all kvelling.

So what in the name of God is Arnold Kling talking about? I find his speculations interesting and I am fine with his opinion. But I am very annoyed that he is just plain ignoring the facts.

The British Commonwealth lives on

 The British Privy Council just handed the opposition in St. Kitts and Nevis (SKN) a huge victory. Basically, the Labour government altered electoral boundaries on January 16, one month before the next general election. The fragmented opposition cried foul. (There is something quite amazing about the idea of a “fragmented opposition” in a country of only 55,000 people.) So they sued.

A judge immediately granted an injunction. The problem was that she granted it too late. Governor-General Edmund Lawrence signed the redistricting law at 6:20pm, whereas the judge issued her order at 7:38pm. Since you aren’t supposed to be able to injunct an action that’s already been taken, the injunction was discharged on January 27th.

But that was not the end of that!  SKN, you see, is a part of the Organization of Eastern Caribbean States. The OECS has a common judicial system, so the SKN opposition took the case to the Eastern Caribbean Supreme Court in St. Lucia. The opposition argued that Section 119, Article 1 of the Constitution of the Federation of SKN defined “proclamation” as “a proclamation published in the Gazette.” Since the law had not been published in the Gazette, they argued, the injunction was valid.

The Eastern Caribbean Supreme Court found for the government. “The Constituency Boundaries Commission reviewed the boundaries of the constituencies in the Federation and recommended alterations to the constituency boundaries; a draft proclamation giving effect to the recommendations of the Commission was thereafter approved by the National Assembly; the Governor General then signed a proclamation which (according to the evidence of the Attorney General) was published in the Official Gazette. All of this happened on Friday, 16th January 2015, and though one may say that the process was hurried through by the relevant authorities to gain an unfair political advantage, that is an issue of political morality and not constitutional validity, which is not suitable for judicial enquiry.”

But that was still not the end of that! SKN, like most of the Commonwealth Realms of the Caribbean (save Barbabos but including Trinidad), still uses the British Privy Council as its highest court of appeal. And so, the case went to London. Where the opposition won! 

I can’t wait to read the final decision.

Anyway, this is not a huge piece of news. After all, SKN is just a small group of islands with only 55,000 people. But it is a striking example of how the microstates of the Caribbean survive by contracting out so many state functions to other polities and organizations, be it the OECS, the CSME, or the United Kingdom.

Three reasons to build the Red Canal

 I do not think the Canal Rojo will be built. It makes no commercial sense. Most independent observers concur. Here, for example, is an article from the South China Morning Post, in which Andy Lane arrives at the same conclusion using different data. Mr. Lane has another good analysis here which doesn’t quite pan the project, but certainly leads towards skepticism.

All that said, I would like it to be built! Simply because it would be cool. But that will only happen if the government of the People’s Republic of China wants it to happen.*

So why might the government of the People’s Republic of China want it to happen?

Well, consider what China might gain from a Nicaragua Canal. Right now, it is nearly a wash between using Panama and using Suez from the East Coast of the U.S. to southern Chinese ports. Using Suez, however, also means going through the South China Sea. Most scenarios in which the South China Sea was closed to shipping would likely also involve fighting around the First Island Chain ... but not all. (An Indonesian collapse? A war with India?) And there are multiple scenarios in which Suez might be closed. A Nicaraguan Canal would provide an insurance route for cargoes to and from the east coasts of North America and Brazil. 

The problem? An expanded Panama Canal would do the same thing at lower cost. Remember: there is no way on God’s green earth that China could use the Nicaragua Canal in a situation in which Panama was closed to it. In addition, there would be political benefits to financing a second Panama Canal expansion over building a Nicaragua Canal. Financing a fourth set of Panamanian locks would set off some huffing among the usual suspects here in America, but serious observers (e.g., most plausible U.S. administrations) would be reassured by the fact that a Panama expansion would fall under the rubric of the Neutrality Treaty. Which means a greatly reduced chance of antagonizing Washington. Moreover, another Panama Canal expansion would be uncontentious in Panama ... the same cannot be said of the Gran Canal project in Nicaragua. In other words, all the security gains at less financial cost and less political risk.

In fact, Chinese companies in August of last year broached the possibility of financing a new Panamanian expansion. 

There is a second possible reason to build a Nicaragua Canal. Note that Lane does not think that the new canal will lead to price competition with Panama. His logic, however, assumes that the Nicaragua Canal is run as a business. Perhaps China does not plan to run the Canal Rojo as a money-making operation at all. Rather, it could  run it as a piece of necessary public infrastructure, operating at cost. In that scenario, a price war with the Panama Canal leading to HKND’s  bankruptcy would be a feature, not a bug. 

The problem with the second reason? Well, for China to want to do that, it would need to believe that the rates charged by the Panama Canal are a significant drag on commerce. There is not a lot of evidence for that proposition. Would reducing canal tariffs really cause Chinese consumers to buy much more raw material from the east coast of South America or prompt Chinese producers to sell many more goods to the east coast of North America? I have my doubts.

Moreover, how would China insure that its commerce captured the lion’s share of the gains from the Nicaragua Canal? As Carlos Yu and I showed in our book, when the United States tried to give preference to its own ships in the Panama Canal in 1912, British pressure forced the country to change tack. The only reason that the benefits of the Panama Canal went overwhelmingly to the United States during its first 25 years was that the Panama Canal overwhelmingly carried domestic traffic. Maybe China will be able to get away with favoring its commerce over other nations, but I doubt that too. Or maybe geography implies that most of the ships using a low-cost Nicaragua Canal will be carrying Chinese commerce. Maybe ... it would be a hell of a $50 billion bet. 

That leaves you with a third possibility: the project would be the 2020s equivalent of the 1960s landing on the Moon. China would be metaphorically planting its flag on the American continent. Sure, the U.S. Navy would remain in complete control of the sea lanes and the People’s Republic would have no sovereignty. But the opening of the Canal Rojo would trumpet the end of America’s informal empire more than anything ...

... other than the actual end of America’s informal empire. Which will not (inasmuch as it survives) be altered in a any substantive way by this project. As stated above, the U.S. Navy will still control the Western Hemisphere. Moreover, I do not see how building this project would win China diplomatic gains in Latin America worth the $50 billion cost. Perhaps I underestimate the power of symbolism?

In short, the Chinese state would obtain at least three advantages from the construction of a money-losing Nicaragua Canal:** 

1. Insurance against disruptions in Suez, the Indian Ocean, the straits of Malacca, or the South China Sea (although this insurance could be obtained more cheaply using Panama);
2. The chance to drive transit rates down to their operating cost;
3. Prestige.

Are those advantages enough for the Chinese government to lend billions of billions of dollars to an entreprise that will likely go bankrupt? 

The extraterritorial British empire

 The U.K. goes a little bit further than the United States in letting people use its courts against foreign sovereigns. The basic law is laid out in the State Immunity Act of 1978. First, the British law does not require that any state-owned property must have some sort of economic connection with the activity that gave rise the underlying claim. (E.g., there is no equivalent of Section 1610(a)(2) in the British law.)

Second, in general it is a little easier to “pierce the corporate veil” and go after the assets of state-owned companies. For example, 2006 a British company went after the Congolese Republic for unpaid debts. The Congolese government tried to sell oil through the  state0owned Société Nationale des Pétroles du Congo (SNPC), which then sold it through a web of holdings. The British courts held that SNPC was an “organ of state” because:

1. The board of SNPC could delegate powers to a chairman appointed by the President of Congo;
2. SNPC had unaudited and unverifiable financing arrangements with the state; and
3. SNPC neither declared dividends nor returned profits to the state in cash. Instead it made expenditures normally made by government.

Other than maybe the first half of the third clause, that would certainly apply to PDVSA.

Now, that case did not involve sovereign debt per se, but a similar one did in 2005. That year, a British vulture fund managed to grab the revenues from Congolese oil sales. Now, the Congolese had done a good job of protecting themselves. SNPC established a subsidiary, Cotrade.  Cotrade sold oil to the Africa Oil & Gas Corporation (AOGC), incorporated in Canada. AOGC then sold the oil to a company called Sphynx, which in turn sold it to Glencore. The vulture fund successfully intercepted the money that Glencore owed Sphynx by arguing that SNPC and Cotrade had no independent existence from the Congolese state and AOGC was nothing more than a convenient front. (This is the best link for the story.) That seems rather more direct than what happened in Texas! 

Now, to be fair, a similar attempt to go after a joint venture part-owned by the government of the Democratic Republic of the Congo failed in 2012. So while easier than in America, it is not a sure thing.

Finally, there is the global Mareva injunction. British courts can freeze assets in advance of a judgment. No sneaking things out of the country here! 

I AM NOT A LAWYER! I have no idea how difficult it would be to wield these tools against Venezuela in the advent of a default. I kinda think it would be hard, since the bonds were issued under New York law and Citgo assets are in the United States. But Mareva injunctions can be global. So I suspect U.K. courts will play a role in whatever happens.

Which will be default --> legal mess --> restructuring. Hold on to your hats.

Can Venezuela’s creditors grab Venezuelan assets in a default?

 If PDVSA defaults on its debts, then yes. It would be a standard commercial dispute. Once a court made its final ruling, U.S. officials would seize Citgo shares, sell them, and give the proceeds to the creditors after deducting expenses and taxes.

But if the Bolivarian Republic defaults, not PDVSA, then it gets harder. Let’s say I own shares in a company and I default on my debts. Creditors can go after my shares in the company, but they cannot go after the company’s assets. This is true even if I am the only shareholder in the company. (Limited liability goes both ways.)

This principle applies to companies owned by foreign states. An official House of Representatives report (see footnote 185 on page 196) bluntly stated: “Section 1610(b) [of the Foreign Sovereign Immunities Act of 1976] will not permit execution against the property of one agency or instrumentality to satisfy a judgment against another, unrelated agency or instrumentality. There are compelling reasons for this. If U.S. law did not respect the separate juridical identities of different agencies or instrumentalities, it might encourage foreign jurisdictions to disregard the juridical divisions between different U.S. corporations or between a U.S. corporation and its independent subsidiary.” 

So far, so clear. Citgo is safe from creditors of the Venezuelan government. 

But here’s the thing: I can’t hide from creditors by creating a separate me-controlled firm and transferring my assets to it. In the words of the Supreme Court, “where a corporate entity is so extensively controlled by its owner that a relationship of principal and agent is created, we have held that one may be held liable for the actions of the other.” Morever, there is a “broader equitable principle that the doctrine of corporate entity, recognized generally and for most purposes, will not be regarded when to do so would work fraud or injustice.” 

In 1983, the Supreme Court specifically extended that principle to foreign state-owned entities in First National City Bank v. Banco para el Comercio Exterior de Cuba (Bancec).

Here’s the backstory. In 1960, Bancec arranged to sell some Cuban sugar to a Canadian company. Citibank issued a letter of credit to Bancec for the sugar. Bancec handed it to the Cuban central bank  (the Banco Nacional) for collection. On September 15, 1960, the Banco Nacional presented the letter to Citibank. The next day, the Cuban government nationalized all Citibank branches. (This was remarkably poor timing.) Citibank, not surprisingly, did not pay Bancec. Bancec sued in the Southern District of New York. The Cubans let the claim sit around until 1975. When they picked it again, they argued that Bancec was an independent state-owned company; why should it be liable the Cuban government’s actions?  

The case went all the way up to the Supreme Court. The Supreme Court upheld the lower court ruling: “Bancec is not a mere private corporation, the stock of which is owned by the Cuban government, but an agency of the Cuban government in the conduct of the sort of matters which even in a country characterized by private capitalism, tend to be supervised and managed by government. Where the equities are so strong in favor of the counter-claiming defendants, as they are in this case, the Court should recognize the practicalities of the transactions. . . . The Court concludes that Bancec is an alter ego of the Cuban government.”

Alright, then. Easy! It might be impossible to seize Citgo assets because Citgo is clearly not an agent of Caracas, but it might be possible to take Citgo shares away from PDVSA. After all, it would not be hard to argue that PDVSA has not been an independent commercial entity since 2002. 

So I ran this past a lawyer friend of mine who works on this stuff.

And ... oh boy ... PDVSA does not own Citgo directly. It owns it through PDV America Inc which is in turn a subsidiary of PDV Holding Inc, both incorporated in Delaware. And those two companies are not legally beholden to PDVSA. 

So now you have to show that PDVSA has no independence and that PDV Holding Inc and  PDV America Inc have no independence. That ain’t so easy. In short, Lex is too sanguine about the prospects for seizing Citgo. It could happen, and my lawyer friends think it will happen ... but only after a long delay.

But there’s another problem! Venezuela has ICSID judgments against it. Unless Venezuela pays them, then ExxonMobil and ConocoPhillips will be sniffing around those assets. Their claims rank higher than claims by bondholders, since uncompensated expropriation, unlike default, involves a clear denial of justice. 

In short, you have a mess. Sure, the fact that Citgo is there will make the Bolivarian Republic think six times about defaulting. But the economic mismanagement in that country is of such a scale (sorry, Shah8 ☺) that Caracas no longer really has any other options.  

Now, creditors have another recourse.

The creditors could go after Venezuelan oil exports directly. There is a recent history of this. In 2007, Texas courts ordered American companies to turn over not only royalties but also physical oil due the Congolese Republic. (See here and here; the decision itself is here.) Now the legal approach used in Texas did not have legs. But to be fair, the suits were quite different than the suits that might happen regarding Venezuela. 

The Venezuelans could sell their oil at the point of embarkation and try to hide it, but that opens up foreign refineries to lawsuits. With the world awash in oil, many will be behooved to avoid going anywhere near the Venezuelan stuff. 

So here is the upshot: a default will cause much pain in Venezuela but it will not make creditors whole. Having Citgo as a target does not cancel out all the problems with legal enforcement of sovereign debt because even if the creditors win it will take forever and a day to collect. But because of the legal challenges to oil sales, default be a big enough disaster for Venezuela that the country will likely make an offer that 75% of its creditors will accept. They will then abandon any attempts to go after Citgo. 

Given what Venezuelan bonds are yielding, I’m tempted to buy them. How bad could the restructuring be?