The Power and the Money

Nots on the new Brexit deal

The new Brexit deal seemed like a weird animal.

The old Brexit deal kept the whole U.K. in a customs union with the E.U. since nobody wanted a customs border running down the Irish Sea. The new Brexit deal seems to run a customs border down the middle of the Irish Sea. Surely there is more than that? I thought to myself.

So I read the damn thing. And here is what it says:

1. Article 4 says that the U.K. may strike free trade agreements (FTAs) with third countries, “provided that those agreements do not prejudice the application of this Protocol.” Meaning that the protocol does not guarantee that foreign goods will enter N.I. tariff free. Rather, it guarantees that N.I. goods may be exported to other countries tariff free as long as the U.K. has an FTA with them.
2. Article 5 establishes that the only way you can move a good from the Rest of the United Kingdom (RUK) to N.I. is to prove that: (a) That good will not be processed in any way once in N.I.; and (b) That good is determined to be not-at-risk of entering the E.U. by the “Joint Committee.” There are no clauses about the makeup or procedures of the Joint Committee. At some point, then the U.K. will have to make this determination, either before the good leaves the RUK or when it enters N.I.
3. Article 6 establishes that protecting the U.K. against smuggling from the E.U. is entirely up to the U.K., as long as they do it in the North Sea or the RUK.
4. Article 7 creates a separate “Made in UK(NI)” tag for goods made in N.I.
5. Article 10 requires the U.K. to stick to E.U. rules on state aid for private companies.
6. Article 12 lets European officials monitor the way U.K. officials enforce European law in N.I. It also retains the authority of the European Court.

In short, yes, N.I. stays in the E.U. single market, unless both London and Brussels agree that a particular good can be shipped into N.I. without any problem. 

So this is not some sort of technowonder panacea. It is a deal that Europe offered the U.K. quite a while ago. Leo Varadkar must be pleased that London finally caved, although he can not say so. (Note the title of this post!) 

To be honest, I can see why this might be better from the point of view of a Brexiteer. The Brexiteers seem to have given up on keeping the United Kingdom together as a primary goal anyway. Given that, what is so bad about an internal customs boundary? Article 12 looks a bit squicky, true, but it only applies to Northern Ireland and the Joint Committee (however it is constituted) will give London a bigger say than it has now.  

On the other hand, it seems like a pretty radical plan, separating N.I. from the RUK. But so was Brexit. 

One of these things is not like the others, trade war edition

So, the Trump administration just announced tariffs on a swathe of European imports, and the Europeans announced they would retaliate. More Trumpian trumpety trump?

No. The WTO is working as it is supposed to work, regardless of the predilections of member governments.

A bit more detail: a WTO panel just ruled that the E.U. was illegally subsidizing Airbus and gave the U.S. the right to slap tariffs on $7.5 billion of European exports ... out of $488 billion last year. Now, as @geoffreygertz will tell you, trying to ID unfair trade practices in aerospace is a fool's errand. But that didn't stop the WTO panel, which ruled the way it ruled. So the Trump administration is acting just like any other in imposing the tariffs. (With one wrinkle and one threat, which we will get to at the end.)

But what about the European threats of retaliation? Isn't that a sign that we're in a whole new world?

Nope. The Europeans have actually threatened to retaliate WHEN and IF they win their own WTO case against the USA for illegal subsidies to (you guessed it!) aerospace. You then get two perfectly legal outcomes.

1. Both sides keep the subsidies and keep the new tariffs.
2. Both sides (or one) walk back both the subsidies and the tariffs. The WTO was /designed/ to make outcome (1) palatable, even if most politicos at the time expected (2) to be the common outcome.

The WTO does not prevent trade conflicts or outlaw protectionism. What the WTO does is keep trade spats within bounds. The E.U. and the U.S. punch each other. The WTO referee then decides if the blows were kosher or below-the-belt. If the latter, the WTO referee then gives the wronged party one-and-only-one chance to punch back. After that, we hope both fighters will kiss and make up, but even if they don’t, the point is that they then stop punching. 

The WTO stops endless retaliation. It does not prevent one or two rounds of tit-or-tat. Right now, therefore, the system is working as designed. And it will even if the Europeans win their case and impose tariffs on the USA. Of course, this is Trump World, and who the hell knows what might happen? But as of right now, nobody should think there's anything weird about these tariffs.

But there is a wrinkle. The U.S. is thinking of imposing rotating "carousel" tariffs on an ever-changing selection of European products. That would hurt the Europeans more (and increase uncertainty) but look okay under the rules.

Kinda violates the spirit, but hey. Even there, though, the wrinkle is not the Trump Administration: it is the Trade and Development Act of 2000, which allows the USTR to periodically revise the list of products subject to retaliation when another country fails to implement a WTO dispute decision. Mexico employed them against the U.S. last year.

Of course, with all the norm breaking going on, it is possible that Europe will break the rules. The French finance minister has implied that Europe should go to the mattresses and apply sanctions now.

That said, I doubt that Europe will throw out the WTO handbook unless the U.S. does so first. The German foreign minister, Heiko Maas, stated that Europe will follow the rules and wait until it wins (it assumes) its counter-case against U.S. subsidies. And the collective nature of European decision-making makes it unlikely that the E.U. will throw caution to the wind; there is no one official to damn the torpedos.

In short, while the Trump administration has broken many many rules and trashed the world trading system, this latest kerfuffle is an example of the system working precisely as intended. 

Stating the obvious about the tariffs on Mexico

I am union-bound to say this, I suppose. The Mexican tariffs are stupid.

First, they will not achieve their stated goal, which is to get Mexico to stop Central Americans from arriving at the U.S. border. Consider what the Mexican government is currently doing:

1. Inviting Central Americans to stay in Mexico. The problem there has been that the Trump administration does not believe that Central Americans will stay in Mexico. Rather, it believes that legalizing their presence in Mexico only makes it easier to get to the border. Under pressure, the Mexican government suspended its visa program after 13,000 applied. But Mexico has allowed Central Americans to apply for asylum from Mexico, as the Trump administration wanted. 
2. Arresting and repatriating Central Americans: 29,660 in the first two months of 2019, about the same as the 29,239 average for those months in 2016, 2017, and 2018. President Trump actually thanked AMLO for this just last month. Through May, Mexico has detained 72,410 migrants and deported 53,371. That is less than the 340,944 Central Americans the CBP detained so far this year, but it is a substantial number. It is far from clear that Mexico could do better given the limited resources available to the Mexican government. 

Second, if the administration sticks to the plan, it will be an own-goal for President Trump. The tariffs on China are bad enough, but companies can adapt and the economy is strong enough to withstand them. Moreover, they are politically popular. Tariffs on Mexico are a different story. These are tariffs that will mess with supply chains. Alonso de Gortari (Princeton) recently calculated that 30% of the headline value of Mexican manufacturing exports to the U.S. consists American exports to Mexico. So they not only hits American consumers, they punch American producers as well. Plus, President Trump can kiss goodbye any chance of ratifying the USMCA. There are cheaper ways to keep immigration on the front burner for 2020, which I presume to be the political goal. 

Third, the tariffs benefit China by taking Mexico off the table as a potential site. Manufacturing has been moving to Mexico from China for years now. The trade war would have accelerated that, at least a little. It is a good thing for America to have industry move next door. But now, well, not so much.

Finally, here is something that is not a problem for this administration: the loss of any credibility as a negotiating partner. Yes, China and Europe will take notice of how the U.S. told Mexico that all it had to do was renegotiate NAFTA but then turned around and screwed it anyway. But that is a feature, not a bug. The current administration intends to impose tariffs forever. Sure, the President will tack back and forth according to political pressures, temporary advantages, and his own strange ego. But the goal is clear, as we reported back in October 2018. Blowing up your credibility just makes it all that much easier to insure that you cannot win the trade wars that you start. 

I have to admit, however, that I think the administration is going to back down on this one. The logic of point (2) above is pretty clear. So put that down as a prediction ... albeit not one that I am particularly confident in. 

The method behind the madness of Trump’s trade policy

There is a recurring criticism of President Trump’s trade policy: it is badly designed to obtain its ostensible ends. The tariffs against China are supposed to pressure Beijing into changing its intellectual property policy. But the strategy is poorly designed for that end. Consider:

1. Instead of heavily taxing employment-heavy Chinese sectors, like toys and textiles, you moderately tax the intermediate and capital goods used by American industries;
2. Instead of building a coalition against China, you start trade conflicts with your allies ... once again over intermediate goods like steel and aluminum;
3. You further alienate our allies by threatening automobile tariffs* ... that won’t affect China;**
4. You don’t give the Chinese government any face-saving way out of the trade war. 

As a policy designed to change Chinese development policy, this is stupid. 

But as an exercise, my MBA and undergraduate students separately walked through this policy, and they came to a different conclusion: if you want to make sure that high tariffs on Chinese exports are hard to reverse, then the strategy makes sense. Hurting American industries and forcing them to rework their value chains is a feature, not a bug. Making it hard for the Chinese to back down is a feature, not a bug. And alienating the rest of the world, to further insure that the Chinese won’t compromise, is a feature, not a bug. 

It might not be the best way to insure that high tariffs stay around for the next few decades regardless of the electoral outcomes in 2018 and 2020, but it isn’t a terrible one either. Especially if causing collateral damage to American industries is the point.

In other words, there is method to the madness. High tariffs are not a tool, but the outcome. The trade war is not meant to be won, but to be continued forever.

* The new USMCA (oh God, do I have to change my NAFTA tag now?) is said to have a side agreement exempting Mexico and Canada from those potential tariffs. More on this when I have it. 

** Ford did announce that it was not going to start making cars in the People’s Republic, so it is not impossible to imagine that threatened auto tariffs might have some effect. But then you aim the car tariffs at China, not the world. 

Raising barriers to pay for a wall: we anticipate Trumpian logic!

Back in March of 2016, we suggested that a Trump administration could repeal NAFTA and claim that Mexico was paying for the wall via higher tariffs. A static back-of-envelope calculation implied that the U.S. would receive about $2 billion a year in additional revenue. Cutting that in half to account for falling trade volumes would give you about a billion. Thirty-year treasuries are currently yielding about 2.875%, so that billion-dollar revenue stream could plausibly be said to allow for $19.9 billion in borrowing to finance the wall, currently estimated to cost about $18 billion.

In reality, repealing NAFTA would not pay for the wall for two reasons. First, the economic dislocations would almost certainly reduce other tax revenues. Second, much (most?) of those tariffs would fall on American consumers more than Mexican producers. Third, inasmuch as Mexican producers will pay, many of those producers are American owned. Add that up, and repealing NAFTA will cost rather more than the additional tariff revenue.

But you could, in a static sense, claim that repealing NAFTA would pay for the wall. 

And now, in a fairly incoherent interview for the Wall Street Journal, the President has now jumped on the “logic” we laid out last March. “[Mexico] can pay for [the wall] indirectly through NAFTA. We make a good deal on NAFTA, and, say, I’m going to take a small percentage of that money and it’s going toward the wall. Guess what? Mexico’s paying.” 

The obvious read is that he intends to bring back tariffs on U.S.-Mexico trade (the small percentage) and will use that revenue to pay for the wall. If there was any consistency to this White House at all, I would take that as the death knell for the trade agreement.

But who knows what the President meant? Does he even know what he meant?

Brexit is over?

There is nothing really new in the piece. I am just laying out my thoughts, because I am a little confused. Which I suppose is standard for anyone trying to think about Brexit.

Specifically, I am confused as to why commentators continue to discuss the future form of Anglo-European trade relations. As far as I can tell, the U.K. just agreed to remain part of the single market and customs union for trade in goods. 

This would be rather more integration than Norway or Turkey currently enjoy. 

Norway is in the single market but not the customs union. It follows European regulations and trades tariff-free with the E.U., but there are customs checks on the borders because Norway imposes its own tariffs on goods from third countries. Turkey is in the customs union but not the single market. It imposes the same tariffs as the E.U. on imports from third countries but it does not follow European regulations. So there are customs checks on its borders to insure that only goods that conform to European law are allowed to enter the E.U.

But the U.K. cannot have customs checks on the Irish border. So unless Northern Ireland agrees to leave the British Customs Area, the U.K. needs to stay in (at least for goods) both the single market and the customs union. And that is what the recent declaration says. The U.K. “will maintain full alignment with those rules of the Internal Market and the Customs Union which, now or in the future, support North-South cooperation, the all-island economy and the protection of the 1998 Agreement.”

So no customs checks because the U.K. will follow every European rule on every single physical tangible thing that anyone might want to bring into the country. Which also means accepting the decisions of the European Court of Justice about the interpretations of those rules.  

This represents an unprecedented level of economic integration for a non-E.U. country. Heck, I am not sure if there is anywhere in the world that integrated absent some sort of political union. 

London will still in theory be able to stop Europeans from being able to legally work in the U.K. in return for giving up access to the European market for British service exports. But no more “global Britain” signing trade agreements with countries around the world. 

I am surprised that the political reaction in Britain has not been stronger. Where are the Brexiteers? Or have they been yelling and I am just missing it on this side of the Atlantic?

Three worthwhile Canadian puzzles

So, to continue with my recent interest in Canadiana, impelled by, well, being in Canada!

There is an interesting puzzle about Canadian economic development. Well, there are many many interesting puzzles, but what particularly grabs my attention at this moment is why Canadian productivity has persistently lagged the United States.

Below I show Canadian total factor productivity (TFP) as a percentage of American TFP between 1950 and 2014. Save for a few halcyon years in 1973-80, Canada has consistently lagged the United States. Moreover, the gap turned into a chasm in the 1980s and grew even larger after the Great Recession. 

The productivity gap predates WW2. After World War 2, Canada lagged the United States in total factor productivity. That is to say, a Canadian worker in the same industry with the same skills and working on the same machinery produced less than her American equivalent. In the early 20th century, the superficial gap was just as large: the average Canadian worker added only 81% as much value per hour as his counterpart south of the border.* (Table 6 on page 25.**) Canadian workers, however, used rather less machinery than their American counterparts, so TFP closed to about 94% of the U.S. level ... remarkably similar to the gap in 1950-67.

In fact, the gap widens if you go further back. In 1900, GDP per capita (the crudest measure) in Canada ranked only 80% of the United States. In 1870, it was 70%. Canada appears to have had more-or-less that income gap with the United States back to 1820. 

Heck, the gap goes back to even before the existence of either the United States or Canada! Vincent Geloso (Texas Tech) has a paper comparing 18th-century Quebec with New England and finds that living standards were about 31% lower in what eventually became Canada. (Remember, there was no settled European population in modern Ontario back then.) 

So what caused the gap? A seminal 1964 paper by H.E. English pinned the gap on American protectionism: Canadian businesses operated at too a small scale and tried to produce too wide a variety of products. In other words, Canada wasn’t big enough. (You can find a 1980 study making the same argument here.)

This seems plausible. And as theories go, it has the advantage of explaining why the United States has enjoyed such a lead for so long over so many places. Everywhere else is too small! There are just too many damn countries in the world. Those of you who have read my opinions about  secessionism will know that I would find this a very gratifying conclusion.  

But the scale explanation does not seem to fit with the big widening of the gap since free trade.

Or does it? It is true that trade costs between the U.S. and Canada are still pretty high. And it is true that interprovincial trade barriers place even bigger obstacles on Canadian firms than American protectionism.  And it is true that the returns to scale in Canadian businesses are pretty high. (Page 130 of the 2009 World Development Report.) Canada has lots of small firms compared to America (consistent with the scale economy argument) and those small firms tend to be less productive than their American counterparts (sort of maybe could-be consistent with the scale economy argument). 

Statistics Canada ran an interesting thought experiment to test the hypothesis. They found that if you altered the size mix of Canadian firms to look like American ones you would close the productivity gap by 5 percentage points while if you made Canadian small firms as productive as American ones you would close it by nine. (Table 6, counterfactuals one and two.) Fixing both effects would close two-thirds of the gap, call it 16 points.

But that is not the entire gap. In fact, it leaves an unexplained gap bigger than the total gap in the 1950s.

Or the 1870s, for that matter. Kris Inwood (University of Guelph) and Ian Keay (Queen's University) conducted a similar exercise for Canada in 1870. They could get Canadian TFP to rise from 93% of the U.S. level to 97%, which cuts most of the gap. (You can find an outline of their paper here; the main one is paywalled.) Strangely, they downplay their finding, which seems like a very Canadian thing to do. The punchline is not that a gap remained, the punchline is that they explained more than half of it!

So the fact that Canada had a protected small market explains a little more than half the 19th century gap and about two-thirds of the modern one. But that still leaves two puzzles. First, what explains the rest of the gap in both periods? And second, why has the gap grown so much larger recently, despite NAFTA and all the ways modern communications should make service exports easier?

It is a great pair of questions.

But I mentioned three in the title, no? What’s the third puzzle?

I will post on that later, but it’s even weirder than the productivity gap ... it’s that median incomes in Canada may have finally pulled even with the United States. That is to say, for the first time ever it matters not to most Canadians that they live in a fundamentally less-efficient economy than their southern neighbors. And that’s the biggest puzzle of all.  

* The gender shift is deliberate.

** John Baldwin and Alan Green, “The Productivity Differential Between the Canadian and U.S. Manufacturing Sectors: A Perspective Drawn from the Early 20th Century,” The Canadian Productivity Review (Statistics Canada: December 2008).

The Jones Act is stupid, but not colonialism

The Merchant Marine Act of 1920 reserves shipping between American ports to American-built vessels with American crews. The reason was to protect the merchant marine from British, Norwegian and (especially) Japanese competition. After all, the U.S. wanted to be sure that it would have a merchant marine in wartime; that meant protecting the industry in peace. The same logic was later applied to airlines.

The problem? Well, the U.S. industry collapsed despite protection. Railroad dieselization and the interstate highways drove down the cost of land transport. The result was the collapse of the merchant marine despite the act. A tiny fleet of 93 Jones-Act-qualified ships schlumps on by having a high-priced lock on transport between the Lower 48 and Alaska, Hawaii, Puerto Rico, and the other insular territories.

This is perverse on multiple levels. First, it forces more U.S. domestic cargo onto the roads. The European Union has no Jones Act equivalent and moves 40% of its domestic freight via coastal shipping (page 22); the U.S. would likely move more considering how close our population centers are to the water. 

Second, it advantages foreign producers in the insular markets. It is cheaper to import from Europe than from the mainland United States.

Finally, it really does screw over exporters from the insular possessions. It is way easier to build up a supply chain when you are in the same country, but the Jones Act cripples Hawaiians and Puerto Rican firms that might want to plug themselves in. 

So we are in the worst of all worlds: high shipping costs but no serious domestic industry. (At least airline protectionism got us a lot of airliners.) Ironically, Malcolm McLean used Puerto Rico to test out containerization back in the day, but now there are no modern container vessels shipping between U.S. ports. One might claim that Puerto Rico is screwed because it is a territory instead of a state ... but Alaska and Hawaii are equally screwed, whereas the U.S. Virgin Islands has somehow wrangled a permanent exception.

So the Jones Act is stupid, but not, as Carlos Yu has pointed out, colonialism. Nor is it the biggest problem right now: supplies are reaching Puerto Rican ports but cannot be distributed due to lack of ground transport. 

What is stupid and colonialism is the refusal by the Trump administration to waive the act in the face of Hurricane Maria, despite such waivers being routine in other disasters. Such disasters include hurricanes which just hit Texas and Florida. Even if the Jones Act is only a marginal contribution to the suffering on the island, the different treatment is unconscionable.

A new chapter in the NAFTA saga? Likely not

NAFTA renegotiation is upon us. The newspapers here have plastered their front pages with stories about the united front Canada and Mexico are putting up against the elimination of Chapter 19.

What’s Chapter 19? It’s the part of NAFTA that mandates binational panels review any anti-dumping actions imposed by one NAFTA country on another. Without it, NAFTA countries would be at the mercy of national courts if they contested anti-dumping actions aimed at their exports. You can find the details of all 118 NAFTA trade cases here; roughly 69% of all cases have been against the United States. (More stats at this link.) 

It turns out to be remarkably hard to calculate success rates. Who wins more in these panels? Someone would need to go through all 118 decisions and figure that out. (The headline decisions often split the difference, so it would be a judgment call.) That said, the data here let me do a quick-and-dirty estimate: in cases brought by Canada against the United States, the panel either made no decision or found in favor of the U.S. around 65% of the time. Winning!

There is a case to replace the ad hoc panels with a genuine international court, European Union style. But that is not on the cards. Another possibility would be to trust domestic courts: let American exporters put their faith in Mexican courts and Canadians trust American ones. But national court systems are slow and expensive, so Mexico and Canada have made it clear that they would rather junk NAFTA than rely on domestic courts to make decisions.

Now one can imagine all three countries setting up special domestic trade courts to review agency decisions on behalf of NAFTA plaintiffs in a timely manner. But the Trump administration has shown no sign of wanting to reform American courts along those lines and it unlikely that Canada and Mexico would accept such reforms regardless. It really looks like Chapter 19 or nothing.

Moreover, Mexico is putting its opposition on autopilot. The Third Commission of the Permanent Committee of the Mexican Congress (don’t ask, it gets complicated) has gone on record rejecting changes to Chapter 19. A full congressional resolution could tie the hands of the Mexican negotiators ... which might be, in fact, exactly what the Mexican government wants Congress to do. Consider two idiots playing chicken on Francis Louis Boulevard at 3am in Queens. One of them throws their steering wheel out the window. That idiot would certainly have an advantage in the resulting game ...

I would bet that the Trump administration quietly backs down, but with this man in office, you never really know. Still, FDI into Mexico is keeping pace, around $25 billion so far this year, similar to the $27.4 billion in 2016, $33.3 billion in 2015, and $27.7 billion in 2014. Similarly, the peso has recovered to around 17.8 per dollar, pre-Trump levels.

So, yeah, our terrible negotiator-in-chief is not likely to win this one, which is good.  

Calling McDevite: Qatar versus the Arabian Gulf

By now, most of you have heard of the contretemps in the Arabian Gulf. Just a few notes.

1. The Saudi-Emirati coalition has not put up a blockade. They have closed their territories to all Qatari commerce, but there is ginormous difference between that and a blockade.
2. The Qataris are claiming to play nice by not expelling 250,000 Egyptians. They are not. They have no choice. The Egyptians are about 16% of the foreign population and fill a number of key roles. (Other statistics say there are only 72,000 Egyptians; 5% of the total workforce.) But even if the smaller number is correct, expelling them would be hugely costly. Egyptians are predominantly skilled and semi-skilled. In 1985-2002, 52% of Egyptian emigrants to Qatar were scientists, managers or technicians and 21% of them were university graduates. (Page 252.) The Qataris might decide eventually to retaliate by expelling the Egyptians, but it is not a move that they would take lightly. 
3. It seems obvious that this is related to the recent Trump visit. Sadly, because Trump, we do not know if he explicitly authorized it or merely gave the Saudis the assurance they needed that they could do anything without American pushback. (See our president’s recent tweet.) That said, I am curious as to the exact mechanism previous administrations used to keep Saudi policy aligned with ours. I can guess, but does anyone know?

Three and one-half more years.

NAFTA and agriculture

There was some interest in this topic but not a whole lot. So I will put up a short post, which will be pretty straightforward. I will discuss U.S. exports today.

The key thing to keep in mind is that agriculture is a global market. So if third-countries displace American agricultural products in the Mexican market, then American producers will be able to export their products to the places the third-country used to sell to. But if Mexico just reduces its consumption of all agricultural imports, then U.S. producers will lose unambiguously.

Mexico takes 8% ($1.8 bn) of American soybean exports. It takes 21% ($2.4 bn) of U.S. corn exports. It takes 11% ($0.9 bn) of our wheat exports.  It turns out that 36% of U.S. corn travelled to Mexico by sea in 2007-10. See page 10. The share is even higher for other products: 55% for wheat and 38% for soybeans; see pages 20 and 23. I used USDA data to calculate costs per ton-mile for soybeans: subtracting out $230,000 per ship Panama Canal tolls for cargoes from the U.S. costs gives you an average cost per ton-mile of 49₵ from the U.S., 43₵ from Argentina, and 39₵ from Brazil; fixed costs come to $5.70 from the U.S., $7.20 from Argentina, and, inexplicably, only $2.70 from Brazil.

With that data in hand, let’s look at those three markets and imagine that Mexico slaps MFN tariffs on the U.S. while opening to the South Americans. 

Soybeans: Mexico could easily supply itself from Argentina and Brazil. Landed costs to Mexico are already cheaper for the Latin American nations, even with higher transport costs; only South American export taxes keep us competitive.

Slap a 4% tariff on American exports (while removing them on the South Americans) and Argentina and Brazil would drive us out of the market. But remember that soybeans are sold in a world market. So more South American exports to Mexico means less South American exports to somewhere else. American production will fill up the gap. When it all shakes out, you would have a small loss for the Americans, a small gain for the Argentines and Brazilians, and about a wash for the Mexicans. 

Corn: The U.S. and Argentina have more or less the same corn production costs. But transport costs from Argentina are quite a bit higher. If Mexico imposed MFN tariffs on corn and suspended them on South American exports, the landed cost of U.S. maize would still be about 13% less than Argentine corn. Americans would lose sales via a general cutback in Mexican purchases, not a switch to South America. 

Lose-lose, although more for Mexican consumers, since U.S. producers would presumably find alternative markets. That said, Mexican corn farmers would gain, and rural voters are a major constituency, about 30% of the electorate. (See page 10. Rural voters punch slightly above their weight in turnout terms: see page 9.)

Wheat: See soybeans. 

Upshot: ending NAFTA would not be catastrophic for American soy and wheat exporters, but both would have to discover new markets right quick or suffer some unpleasant transition costs. It would be a clear boon for Argentine and Brazilian farmers, who could capture a whole new market. Mexican corn farmers will gain; Mexican consumers will lose.

Still, NAFTA probably won’t end.

Worthwhile Euro-Canadian initiative: globalization can be progressive

In April of 2016, I posted about a European initiative to reform investment tribunals. I thought it an excellent idea. The idea would be to make the tribunals more like real honest-to-goodness courts, with due process and precedent and all.

Well, now that proposal is enshrined in law in the new European trade deals with Canada and Vietnam. Better still, the Canadians and Europeans are looking to broaden the system, inviting even more countries to participate. It is refreshing on two counts. First, cooperation in this world of increasing deglobalization. Second, it is a progressive multilateral institution, one which might make the world a marginally fairer place.

Nice.

NAFTA, trade costs, and the difficulty of economic divorce

Market access can have a big impact even when the numbers are small. For example, extending normal trading relations to China did not dramatically increase access to the U.S. market. But it did increase certainty: previously, China’s access was subject to annual Congressional votes. Remove that uncertainty, and poof, suddenly firms were willing to make long-term investments aimed at the American market. (The paper on this topic is here.) 

The importance of permanence is why giant fluctuations in exchange rates should not be expected to have the same effects as small changes in tariffs. Exchange rates rise and fall subject to unpredictable economic forces. Tariff rates stay the same subject only to politics. Gabriel Mathy made that point here. 

So what about ending NAFTA? Would it undo economic integration between the U.S. and Mexico? 

Quite likely not.

Wait, what? Why would an end to NAFTA not benefit China and other low-wage manufacturers in Asia?

Well, simply put, they are too far away from America. In 2014, according to the Bureau of Transportation Statistics (see Table 10 and Table 11), the average container imported from Mexico carried goods worth $52,921. According to J.P. Morgan, the average cost of moving that container from Mexico was about $1,800. (The World Bank says $1,499, but that includes maritime and non-NAFTA shipments.)

So that is a cost  of roughly 3.4% ... compared to 15% from China. (The number of containers from China comes from the Maritime Administration; the value is from the Bureau of Transportation Statistics.)

This is back-of-the-envelope, but very little of the stuff that Mexico exports to the U.S. is set to move to Asia, Europe, or South America if NAFTA falls apart. Mexico is too close and its labor costs are too low.

Still, a NAFTA collapse could move production back to the USA, no? After all, it is not like U.S.-made goods don’t need to be transported to market. They do. Domestic truck and rail shipments came to $8.8 trillion in 2007. (To prevent link rot: BTS, National Transportation Statistics, Table 1-58: Freight Activity in the United States: 1993, 1997, 2002, 2007 and 2012. I used 2007 because 2012 trucking freight rate data is not available.) The total cost of moving all that stuff came to $262 billion. That comes to an average freight cost of about 3.0%. In other words, and not unexpectedly, the cost of moving goods around inside the United States is roughly equal to the cost of moving them from northern Mexico to the United States. So one would expect a rise in tariffs from zero back up to 3% to have an impact. 

But tariffs and transport costs are not the only trade costs! Total trade costs come to the difference in the markup between the factory gate and the final consumer between domestic goods and imported goods. When Dennis Novy (Warwick) used that approach (albeit indirectly) he found that NAFTA reduced the total trade cost from about 70% to around 33%. (Page 10)

How did that happen? The intuition is as follows. Signing NAFTA cut U.S. tariff rates from 3% to zero. Companies then established cross-border value chains. Those chains were not easy to set up, but once they were in place, it became far cheaper to export. Think of it this way: the first autoparts factory to open up in San Luis Potosí needed to figure out everything about selling to the United States. The fifteenth had a much easier time. Thus, NAFTA caused trade costs to drop by way more than the fall in tariffs.

The flip side of that, however, is that much of the fall in trade costs is not reversible. Abolishing NAFTA, therefore, might have remarkably little effect, taking trade costs up from 33% to 36%. Abolishing NAFTA plus a 20% border adjustment tax will reduce Mexican incomes (via depreciation) but would also have remarkably little effect on trade volumes. 

It would take a straight-up tariff in the 20%+ range to seriously undo integration in any reasonable time period, at least for manufacturing. And even then the impact would be slower and smaller than we think. In fact, most of the impact would come in the form of European cars becoming suddenly competitive in the American market. 

Agriculture would be a different story. I will discuss more if there is interest. 

The border tax and climate change

I am opposed to a 20% tariff aimed at Mexican manufactured goods. I am more ambivalent about the 20% border adjustment tax (BAT) floated by the Trump administration. In fact, I may support it. 

The basic idea is simple. U.S. companies would pay a 20% income tax. Companies could deduct domestically-sourced inputs from their income but not imported goods or services. Those imports would then, in effect, have to be at least 20% cheaper than equivalent domestic competitors. 

The idea is to make the U.S. corporate income tax look like a value-added tax (VAT). If a corporation in Mexico buys an input from overseas, it pays the Mexican VAT on the purchase. If it sells something domestically, then it also pays the Mexican VAT. But if it sells something to a company in France, then it does not pay the Mexican VAT ... but the French buyer will pay the French VAT. Under the BAT, if a corporation in the U.S. buys an input from overseas, then it pays the U.S. BAT on the purchase. Ditto it pays the BAT on all earnings from domestic sales. But if it sells something to a French buyer, then it will not pay the U.S. BAT ... but the French buyer will pay the French VAT.  

As it stands, the BAT will apply to oil imports. So an American refinery that buys foreign crude would have to pay the 20% BAT on those purchases! Right now, WTI trades around $54 per barrel. A refinery using American crude would pay $54; a refinery using imported crudes at a similar grade would pay $65. American oil prices would rise, world oil prices would fall.

And that is good for the world! Higher U.S. oil prices mean less U.S. oil consumption. Moreover, the burden will fall particularly on dirtier forms of oil. Most American crude oil imports (60% in 2015) are heavy grades. Almost half of that consists of heavy crudes from Canada, which  release about significantly more carbon during the production process than other grades of oil. (So much so that the Section 526 of the Energy Security Act of 2007 theoretically banned U.S. federal agencies from purchasing it, although that has had no concrete effect.)

Lower world prices will, of course, stimulate more world consumption. But there are two wrinkles that will reduce that impact. First, transport links lock in most Canadian output to American markets. Last year, the Trudeau government approved an expansion of the Trans-Mountain pipeline from 300,000 to 890,000 bpd, which would allow Canada to divert as much as 28% of its current U.S.-bound exports to other markets. But that will take a long time and is a drop in the bucket of world production. Second, American refineries are optimized to use heavy crudes. They will switch away, but slowly, even if the cost of their primary input rises. Finally, inasmuch as world prices do fall, that will discourage foreign exploration and development, keeping some carbon in the ground for the long-run. 

Winners:

1. Our children;
2. American heavy oil plays, of which there are not many outside Alaska;
3. American light tight oil plays (hooray!);
4. Andrés Manuel López Obrador (see below).

Losers:

1. American oil consumers, who will likely see prices rise about 30₵ per gallon;
2. Refiners who use imported crude oil—although not by very much;
3. Canadian, Ecuadorean, Venezuelan and Mexican heavy oil producers, who are locked into the U.S. market;
4. Mexican consumers, who rely on gasoline produced in the United States from Mexican heavy crude.

As far as energy is concerned, this does not strike me as a bad policy, even if it will impact Mexico quite seriously. At 2015 prices, a 20% BAT would have raised about $2.0 billion from Mexican crude oil imports, although most of that burden would fall on American consumers. The real hit for Mexico is that the increase in U.S. gasoline prices will be passed on to either Mexican consumers or the Mexican government. Inasmuch as the Peña administration hands Mexican voters a second gasolinazo, then it will be another fillip for AMLO’s chances in the 2018 elections.

So a good policy for energy: a net plus for domestic production and a net plus for decarbonization. Probably pretty good Harley-Davidson, as well.

But as far as other products markets are concerned, I’m still undecided as to whether the BAT is a good idea. Thoughts?

Maybe NAFTA is safer than we think

It is true that President Trump has made threatening noises. And it is true that he has appointed people with protectionist bents to run Commerce and the USTR office. 

But said Secretary of Commerce, Wilbur Ross, founded a major Mexican autoparts manufacturer. International Automotive Components makes parts for doors, side panels, consoles, exteriors, floors and sound systems for BMW, Fiat Chrysler Automobiles, Ford, General Motors, Honda, Mercedes, Nissan, Toyota, Volkswagen, Hyundai/Kia, Volvo Truck and Freightliner. He also owns the International Textile Group, with plants in Morelos.  

Talk about irony!

Now, Secretary Ross will presumably liquidate those holdings. So he should not have a financial stake in preserving NAFTA. But he will viscerally understand the many companies that do. 

I now suspect that the much-ballyhooed NAFTA renegotiation is going to end with stricter rules of origin, say 80% instead of 62½. There may also be some weakening of the dispute-resolution mechanism and higher labor standards. But I increasingly think that the Trump administration will refrain from blowing it all up. 

Although I still have no idea what fakery they will use to pretend that Mexico is paying for the wall.

Border adjustment, the Mexican peso, and Hoyt Bleakley

It now looks like the administration won’t (for now) be using its Economic Powers Act authority to impose a tariff on Mexican goods. Instead, he is going to ask Congress to create a border adjustment tax, which would stop American companies from deducting imports from their taxable income. At the same time, it would leave their exports untaxed. (Full explainer from Forbes, here.) 

So what would that do to the auto industry? Well, let us proceed in two stages.

1. What is the immediate impact on an American auto producer? Well, the border adjustment tax is less harmful than a tariff. The auto companies would not be able to deduct the cost of goods coming in from Mexican affiliates and suppliers, but they also would not be taxed on the cost of goods going out to Mexican affiliates and suppliers. But they would still have an incentive to source more inputs at home.
2. Except that the peso would fall (or the dollar would rise, same thing) in response to the tax. A 20% depreciation in the peso puts the auto company back where it started. 

But would Mexico allow the peso to fall that much? In the past, the Mexican central bank has acted terrified that depreciation would hammer Mexican corporations that had borrowed in dollars. That is a reasonable fear ... in theory.

In practice, it might not be. My friend and colleague, Hoyt Bleakley (with Kevin Cowan) looked at 450 non-financial firms in five Latin American countries. 

We consistently find that, contrary to the predicted sign of the net-worth effect, firms holding more dollar debt invest more than their counterparts in the aftermath of a depreciation. We show that this result is due to firms “matching” the currency denomination of their liabilities with the exchange rate sensitivity of their profits. Because of this matching, in equilibrium, the negative balance sheet effects of a depreciation on firms holding additional dollar debt were more than offset by the larger competitiveness gains of these firms.

In other words, depreciation might not be that harmful.

The other reason the central bank might not want to let the peso fall is fear of inflation. But that depends a lot on the reputation of the central bank and the structure of wage bargaining. Banxico is very credible and Mexico has weak unions, so while a fall in the peso will lead to a one-time increase in costs, it seems likely that Mexican workers would just have to suck up the fall in their living standards. It is hard to see how they could demand the kind of compensating wage increases that you would need to set off an inflationary spiral.

So yes, the peso could fall.

In short, the Trump tax would likely make Mexicans poorer with no compensating gains for American workers. But also no losses for fans of big American cars like the amazing Dodge Challenger, like my son. In other words, a gratuitous punch in the nose of those perfidious foreigners! And you can pretend that the tax flows are coming from those foreigners, when they are really coming from American consumers. 

Yeah, I can see why this might actually happen. 

The Trump tariff and the American auto industry

I have no idea if the Trump administration plans to impose a 20% tariff on Mexico. It seems now that the surprise announcement had to do with plans for a border adjustment tax, which is a different thing. But who knows? This is the Trump administration! Why are you asking me to make predictions?

Anyway, yesterday I mentioned that any tariff would impose serious problems on the American auto industry. The big problem is twofold: first, Mexican suppliers provide a large chunk of the inputs into American auto production. Second, many of those parts in fact cross the border multiple times. The end result is that a tariff would raise the cost of producing domestic cars by quite a lot. 

Some figures: in 2012, the state of Michigan published a report on the Ford Motor Company’s Michigan Assembly Plant. The report found that the plant purchased about $3.1 billion from Tier I suppliers; of that, $831 million (or 27%) came from Mexico. (Roughly $3,800 per vehicle.) In 2014, the U.S. auto industry consumed $42 billion in intermediate inputs from Mexico (pages 10-11), approximately $3,500 per vehicle. So at first glance, the tariff would raise the cost of American-built small cars by $760 and all vehicles by about $710.

That is a lower bound, however. In the course of making a motor vehicle, auto parts cross the border as much as eight times. If the tax was applied at each crossing, the cost would go up commensurately. If you assume that components cross from Mexico four times, doubling in value-add each time, then the total cost per vehicle would rise from $710 to $1,300. 

The cost increase would hit small cars more than large ones ... but consumers would see the price hike in the large car sector. The reason is that auto companies in the United States need to sell a certain percentage of small cars in order to hit their fleet fuel economy standards. They will therefore hold down the price on small cars, transferring the impact to their larger vehicles.

The problem is that the U.S. producers more larger vehicles than small cars. 

How much would production shift back to the United States? I suspect less than the current studies predict. Why? Well, the Mexican peso would likely fall. The real exchange rate would go down and stay down. Mexican workers, who consume a lot of imports, would become poorer but they would also become cheaper. A 20% nominal decline in the peso means a drop from 22 per dollar to 26 per dollar. That is certainly conceivable. Hell, 30 per dollar is conceivable. A messy drop would potentially hurt the Mexican economy, if it turns out that Mexican companies have a lot of hidden dollar liabilities, but would nonetheless increase competitiveness.

And so, you would have a temporary increase in the price of large automobiles and light trucks, followed by a drop in Mexican costs. Some production would return to the U.S. (in order to avoid uncertainty) but in unsteady and unpredictable way. It would not be an economic apocalypse for the United States, but it would cause havoc across the Mexican economy with little (if any) employment gain in the USA and big losses for shareholders. And unless the tariff is extended to all countries, the big winners would be car manufacturers from Europe and Asia. 

That said, this is all theory. Who knows what the Administration will do?

A 20% tax on Mexican imports? Why, yes.

Now the Trump administration is floating the imposition of a 20% tax on Mexican imports to pay for the wall. Obviously, this would violate NAFTA, but the U.S. President likely has the unilateral authority to impose such a tax.

The International Emergency Economic Powers Act of 1977 gives the President the power to “investigate, block during the pendency of an investigation, regulate, direct and compel, nullify, void, prevent or prohibit, any acquisition, holding, withholding, use, transfer, withdrawal, transportation, importation or exportation of, or dealing in, or exercising any right, power, or privilege with respect to, or transactions involving, any property in which any foreign country or a national thereof has any interest by any person, or with respect to any property, subject to the jurisdiction of the United States.”

Presumably, the tax would be considered regulation of importation under the above paragraph.

Now, the Economic Powers Act also compels the President to “consult with the Congress,” but it is not clear that imposes a significant limit on his tax powers.

Alternatively, President Trump could use the Trading with the Enemy Act of 1917, which Richard Nixon invoked to impose a 10% import surcharge in 1971. But the Trump tax could be appealed to the  U.S. Court of International Trade USCIT). It turns out that there is some case law on this.  In United States v Yoshida International, USCIT’s predecessor ruled that the courts would not challenge the validity of a Presidential declaration of a state of war or national emergency but would check to see that the remedy imposed was appropriate to the nature of the emergency. I suppose that the emergency would be the existence of illegal immigration from Mexico and the remedy would be the wall. (Judging from U.S. v Yoshida, I do not think that the tax would stand under Trading with the Enemy but it might under the Economic Powers Act. Either way, it could be in place for years.)

The courts would have to review if this violates the NAFTA Implementation Act of 1994, but my guess is that the Implementation Act would not be held to supercede Presidential powers under the Trading with the Enemy Act or the Economic Powers Act. 

And even if it did, the Trump administration could announce that it was withdrawing from NAFTA. The logic would be that the NAFTA agreement allows withdrawal and the NAFTA Implementation Act gives the president the power to proclaim tariffs as laid out in the NAFTA. Poof, a rationale for unilateral Presidential powers. 

Of course, if you abrogated NAFTA, you could easily enough pay for the wall with the imposition of pre-NAFTA levies. It looks like the Trump administration is looking for more than that, however: they seem to want to damage U.S.-Mexico commerce as much as possible. 

Or at least drive down the value of the peso even further. 

The tax would also have to exempt autoparts. More on this later ... 

Peña-Trump meeting cancelled!

Over the past week, it seems to have sunk in to the Mexican commentariat that Trump is serious about building a wall and renegotiating NAFTA. Newspaper articles have gone from “Hey, maybe there is an upside here, we can modernize NAFTA!” to “We are at war.” 

Then President Peña cancels his meeting with the American president.

As I have pointed out, many Mexicans blame Peña for Trump’s election. They’re probably not wrong. The logic is that Peña could have humiliated Trump. Then he recently brings back Videgaray, who had to resign over the Trump summit, on the theory that Videgaray is down with the Trump administration. But then the American president orders construction on the wall and continues to insist that Mexico pay for it. It leaves Peña with the worst of all worlds. 

The signs are that the Mexican president is under great strain. His approval rating is down to 7%. “He stays late in his office and sleeps little,” says an administration insider. 

Ford is not moving jobs to Mexico

Head, hits desk. Eric Loomis (hat tip: Andrew Reeves) just repeated the Trump lie that Ford is moving jobs to Mexico. Ford is expanding production in Mexico, it is true. But Ford is keeping up production in the United States and Ford would be expanding production in Mexico even without NAFTA. 

The biggest piece of evidence for this is that Ford says so. But hell, don’t trust them. Look at what NAFTA changed.

Before NAFTA, the U.S. tariff on small cars was only 2.5%. That is not nothing, but nor is it enough to compensate for lower labor costs. Note that the real exchange rate of the peso has fallen by 5.4% since the beginning of the year. 2½ percent is barely a speed bump. Now, if you want to argue about NAFTA, you can argue about the 25% tariff that the United States imposed on trucks. That was a real tariff. But Ford isn’t moving truck production; it’s moving small cars. And NAFTA has fuck-all to do with that.

There is a discussion to be had about NAFTA. But I must wonder if Loomis is willing to have it in good faith.

Ian Bremmer is blowing smoke

In this video, he says that he has not met a single Fortune 100 CEO who would change their investment strategy based on who wins the election, so the election does not matter. 

But that is just a fucking weird claim.

Look at the list. Number one is Walmart. Maybe Walmart’s CEO does not believe that a Trump Administration would hike trade barriers between the U.S. and its suppliers. But there is no goddamned way that is true, not in a world where debate performances move exchange rates. 

Berkshire Hathaway cares a lot about the Clean Power Plan. Ditto ExxonMobil, Chevron, Valero, Marathon, Energy Transfer Equity, ConocoPhillips, Exelon, and Tesoro. The car companies care a lot about CAFE standards. The banks care a huge amount about repealing or amending Dodd-Frank. Alphabet lives and dies on tiny changes in intellectual property. (To be fair, I doubt Trump has any sort of I.P. policy at all. But that lack will be almost as much a concern as much as having a definite one.) Boeing cares about the Iran deal. The medical and insurance companies care about Obamacare. The defense companies care a whole lot about defense budgets.

I could go on. I will, however, call bullshit on my man from Chelsea, Massachusetts. The claim is untrue on its face, unless Ian is speaking to a select group of CEOs ... in which case he is deliberately misleading his viewers by implying that said CEOs are representative.

Now, I can believe that the radical tax cuts a Trump Administration would usher in would not affect investment that much. But not at all? Corporate tax rate cuts of the magnitude Trump is proposing will have no effect on investment decisions?

And then he throws out this pearl of wisdom: “Ultimately, Obama was a radically different President than Bush and how much difference did he make in terms of policy?” Well, if your counterfactual is Hugo Chávez, then maybe not much. But if your counterfactual is hundreds of billions of dollars of investment flows then he made quite a fucking big difference. Dodd-Frank, the Recovery Act, Obamacare, the CPP, just for starters.

What I do not understand is why Bremmer would make such a silly ... oh, heck, stupid claim. Bremmer has built a multi-million dollar political risk business. He has mastered tweeting. (Nate Jensen is better.) He knows what he is doing. His brand is not mindless contrarianism. Quite the reverse, actually. 

So what the hell is up with this stupid video? I lost IQ points from watching it.

The Brexit recession and the cost of self-discovery

I am very hesitant to discuss something that confuses Paul Krugman. Very hesitant. 

There is a great paper by Ricardo Hausmann and Dani Rodrik from 2003: “Economic Development as Self-Discovery.” The basic story is that it really isn’t just what it is that poor countries are best at producing. Are Salvadoreans really making the most of the country’s endowments of human capital and raw materials? Probably not ... but what then should they be doing? That isn’t clear either. Figuring out what industries a country is best at doing is very hard. Moreover, the first people who figure out what a country is best at won’t reap all the benefits: others will imitate their business models and pile in. That reduces their incentive to figure out those business models in the first place. Of course, you could try granting monopolies or some such — a nation-wide version of a patent — but then you have the problem of picking which industries to back. If you back all of them, then investment will flow into monopolies that turn out to be bad bets as well as ones that are good ... and you saddle your countries with lots of, well, monopolies.

Sticky! But what does this have to do with the idea that Brexit will cause a recession followed by slow growth? Well, Prof. Krugman gives the following example:

Let’s be slightly spuriously concrete. Suppose you think Brexit might have seriously adverse effects on service exports from the City of London. This would mean that investment in, say, London office buildings would become a bad idea. On the other hand, it would also mean a weaker pound, making investment in industrial properties in the north of England more attractive. But you don’t know how big either effect might be. So both kinds of investment are put on hold, pending clarification.

OK, that’s a coherent story, and it could lead to a recession next year.

At some point, however, this situation clarifies. Either we see financial business exiting London, and it becomes clear that a weak pound is here to stay, or the charms of Paris and Frankfurt turn out to be overstated, and London goes back to what it was. Either way, the pent-up investment spending that was put on hold should come back. This doesn’t just mean that the hit to growth is temporary: there should also be a bounce-back, a period of above-normal growth as the delayed investment kicks in.

That makes sense! But there is another way to think about the problem. You believe that Brexit might have seriously adverse effects on service exports from the City of London. This means that investment in, say, London office buildings would become a bad idea. On the other hand, it would also mean a weaker pound, making investment in ... uh ... well ... by gosh, just what is Britain going to become better at exporting? Manufactures from the north of England? Maybe. Wind power from offshore Scotland? Could be. Videogames written up in London exurbs? Possible. Music and are from London? Hmm! Or maybe the U.K. could build giant spaceships, like this one I saw off in the distance in Birmingham back in ‘12? 

The problem is that you have no idea what the best thing to invest in is, if finance does not pan out. You know that Brexit means finance is not the future, but you have no idea what the future is. And failure certainly is an option, as the slow growth of many many countries in many many time periods tells us.

So right now, investment goes on hold, which triggers a recession. (If that is indeed what is happening.) If Prime Minister May somehow stops Brexit, “or the charms of Paris and Frankfurt turn out to be overstated,” then investment roars back into finance!

But if she does not, well, uh ... it slowly trickles back as Britain undertakes that long slow process of self-discovery. There is no countervailing boom once the policy uncertainty is resolved.* Just a slow recovery followed by slow growth.

Somehow I suspect that there must be a giant hole in this logic. 

Temper Tantrum Trump and trade policy

 OK, the fat crybaby from Queens becomes President and gets upset because Mexico looks at him funny, or something. What can he do?

Well, he can cancel NAFTA. It is not 100% clear that doing so will immediately cause tariffs to snap back. It is also possible that Mexico will regain its GSP preferences. The NAFTA Act of 1993 is silent on cancelling the agreement. But Fat Crybaby can do what he wants until a court decides. So boom, Mexico!

(Section 2 of the NAFTA Act implies that ... well, go read it and tell me. Canadians in particular.)

But that just hits them with America’s low existing tariffs. Fat Crybaby, he’s a mean mofo from Jamaica Estates. Gangsta lean straight from Queens, except whiny. So what else can he do without going full Mussolini? Well, step one is Section 122 of the Trade Act of 1974. Wham! 15% tariff surcharge plus quotas as tight as President Fat Crybaby wants to make them. (Presumably, tight enough to raise import prices 45%.) 

Could he go further? Sure! President Nixon did in 1971. Now, the Customs Court found against him, but keep two things in mind. First, we do not know how higher courts would have ruled. Second, Nixon imposed the tariff surcharge on  August 15, 1971. The court ruled on July 8, 1974. That is a long time.

But if gets better! Section 338 of the Tariff Act of 1930 allows retaliatory tariffs of up to 50%! Badabing! Now, in point of fact, Section 338 is aimed at tariff jurisdictions that discriminate against the United States compared to other countries. But hey, see above about how long it will take for legal challenges to say that the authority does not apply to target to be decided. 

And should President Fat Crybaby decide that China is the target, well, the International Trade Commission has already issued a finding under Section 337 of the same law. Whammo! In the nose!

And then there is the Emergency Economic Powers Act of 1977. It involves foreign exchange transactions, but it could be used to effectively impose quotas. So if a court ruled against the above, Fat Crybaby could pull out Section 203 of the Economic Powers Act and wait for the courts to decide that one. 

In short, if Fat Crybaby throws a temper tantrum in office, then he can pretty much do whatever he wants, at least for several years. Sure, the WTO will rule, but whatever. Winning!

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.

Trump on his website

 I cannot believe I actually did this. But I did. I went to his website and looked at his policy proposals.

On immigration, well, there is less than I would have expected. Nothing about mass deportation, only a bit about deporting more criminals. (Right now, ICE does not have the budgetary authority to deport all criminals after their sentences.) Some blather about repealing the 14th Amendment. Surprisingly, neither DACA nor DAPA appear. But there is a call for a wall ... and a clear statement that a Trump administration will wreck relations with Mexico all the way down to pulling out of NAFTA in order to pay for it. Expect a President Trump to destroy our southern relations. Which would be a shame, because right now Mexican governments of all stripe pretty much do whatever the United States needs them to do. 

On trade, he seems to be calling for a trade war with China. Except ... uh ... can he start one? He can declare China a currency manipulator. After which, well, lets go to the relevant part of the Omnibus Trade Act of 1988:

“If the Secretary considers that such manipulation is occurring with respect to countries that (1) have material global current account surpluses; and (2) have significant bilateral trade surpluses with the United States, the Secretary of the Treasury shall take action to initiate negotiations with such foreign countries on an expedited basis, in the International Monetary Fund or bilaterally, for the purpose of ensuring that such countries regularly and promptly adjust the rate of exchange between their currencies and the United States dollar to permit effective balance of payments adjustments and to eliminate the unfair advantage. The Secretary shall not be required to initiate negotiations in cases where such negotiations would have a serious detrimental impact on vital national economic and security interests; in such cases, the Secretary shall inform the chairman and the ranking minority member of the Committee on Banking, Housing, and Urban Affairs of the Senate and of the Committee on Banking, Finance and Urban Affairs of the House of Representatives of his determination.”

Got that? The law will allow the Trump administration to ... start negotiations. Which is, to be fair, all he calls for on the website. 

There is also a fun bit where Trump contradicts himself within two sentences: “The U.S. Trade Representative recently filed yet another complaint with the WTO accusing China of cheating on our trade agreements by subsidizing its exports. The Trump administration will not wait for an international body to tell us what we already know. To gain negotiating leverage, we will pursue the WTO case and aggressively highlight and expose these subsidies.”

In other words, the Trump administration will not wait for an international body. Rather, it will pursue a case against China in an international body. Yes, tough indeed.

On taxes, it is all crazy. But that’s the GOP for you these days.

The whole thing is a little crazy, but I was expecting more. In other words, Trump has got a lot of room to walk back a lot of things once he gets the nomination ... with one exception: blowing up our relations with Mexico.

I concur with Carlos in comments.

Anyway, none of this is relevant for the Democrats, because the way to go after Trump is mockery. Pure, unending mockery. 

Vox has a talent for making to me opposed to positions that I support

 Vox headline: “An NYT op-ed argued for making China poorer to make Americans richer. That’s appalling.”

Translation: a New York Times op-ed writer argued that competition from cheap labor hurts some American workers and thinks imposing tariffs might be a good response.

The Vox piece itself is a mish-mash of assertions. For example, it is true that most of the particular poverty in the South has nothing to do with foreign competition. But some of it does, as the author also admits. It is also true that tariffs impose deadweight costs. But the study on tire tariffs cited in the piece contains no error bars. (The methodology itself is also a little weird, assuming for example that tire manufacturers spend none of their income save wages, but leave that be.) The deadweight costs are quite likely negligible. And anyway, in this case, the point of tariffs would be to affect the income distribution inside the United States. 

And then there is the moralization. It is true that imposing tariffs on foreign goods makes foreign exporters poorer. Yes. True. That is decent argument in favor of free trade. It is, in fact, an argument that I agree with. But saying that it is “appalling” to want to impose some marginal costs on the Chinese export sector to gain some marginal benefits for lower-income American workers is an attempt to shut down debate by painting any restraints on trade as immoral. 

Well, now. If you are going to that, I want evidence about the distribution of the impact of U.S. tariffs on Chinese workers and employers. Come on now, if you are going to call something appalling, then you really have to show us the money. 

La reforma energética y tu vida: edición 1

There is a big ad campaign underway in Mexico to sell energy reform. Here is one of my favorites, spotted on Revolution Avenue a little bit south of the Barranca del Muerto metro station:

So is it true? Maybe! But probably not.

OK, that’s not satisfying. Let’s take it from the top. Mexico’s natural gas market is dominated by private local distribution monopolies. Pemex is the biggest wholesale player, but it is not the only one. The market, however, is tightly regulated, with prices linked to the import price at the U.S. border. (Specifically, Reynosa and Ciudad Pemex. The latter is actually far from the border, but it has a direct pipeline link. The price does not vary much between them. Click the link, then go to “Precio de venta de primera mano.”

That said, the gas distribution companies do not buy their gas at the reference price. There are serious capacity constraints in the pipeline links with the United States. Moreover, with one exception the pipelines basically stop in the northern states: there is only one small tube down to the industrial heartland.

The result has been that Mexico has begun to import LNG in large quantities, now exceeding a fifth of total imports. Most of those come through the Altamira regasification plant (opened in 2006) with smaller amounts through the Manzanillo facility, which opened last year. There is also a mostly-unused facility in Ensenada (Costa Azul on the below map): LNG imports to Ensenada cannot be efficiently moved to the rest of Mexico, and Baja now gets cheap gas from the United States.

So what’s the problem? The problem is that imported LNG became hella expensive over the past few months. Landed prices at Altamira have shot up from around $4 per Mcf to north of $16. It is hard to see how these increases have effected overall wholesale prices in Mexico, but Pemex is the biggest import player, and it is easy to see how they have affected Pemex. Pemex applied for a permit to import LNG via the United States in October 2012; it began to sell imported gas a few months later. Here is what happened to Pemex’s wholesale costs:

 

Until late 2012, Pemex’s wholesale cost unsurprisingly paralleled the average U.S. export price. (Figures in dollars per Mcf.) Around late 2012, Pemex started to experience some supply troubles: at times it had to go out and buy gas on the Mexican secondary market, rather than directly from U.S. suppliers. That is when the blue line started to get jumpy. (The secondary market in Mexico is rather opaque; other than the landed cost at Altamira, which is reported by FERC, data is hard to come by.) In May 2013, Pemex started to buy LNG directly (the dotted line shows the percentage of Pemex purchases that come from LNG) ... and behold, that drove the landed price of LNG in Mexico through the roof. It also caused a sustained rise in Pemex’s cost of natural gas: by November, it paid an average of $6.22 per Mcf, at a time when U.S. gas could be bought for $3.29 ... if you could find the pipeline capacity to transport it.

Did the rise in wholesale cost translate into a rise in retail costs? Yes, yes it did ... but not enough. Let’s take Mexico City as an example. Wholesale prices rose (and those are prices at which Pemex sells) ... but by the last few months, the average marginal cost for Pemex to purchase natural gas exceeded the wholesale price.

In fact, it’s much worse. Pemex buys LNG at the margin for $16.40 per Mcf ... rather more than even the retail residential price of gas! Pemex loses money on its last few sales, as do the other wholesalers. The result has been occasional shortages.

So how will energy reform help? Well, in the long-run it will allow for capital to enter looking for shale gas. Mexico has a lot and the current wholesale prices are high enough to encourage exploration and development ... in the absence of land acquisition costs. (E.g., assuming that the government gives out licenses for free.) But that is some years off; the barriers to fracking are real. (And the subject of another post.)

The movement of pipeline authority away from Pemex could speed up pipeline construction, enabling the importation of cheap U.S. gas ... but note two things. First, private companies already can own and operate natural gas pipelines. Reform might get rid of red tape, move up approvals, get them built faster, remove the need for special legislative approval ... but it will still take years to get them built.

Second, the Los Ramones pipeline is already under construction ... but won’t be finished until 2018. Pemex can already partner with foreign companies for pipelines, so I am unclear as to why the CEO of Pemex is so bullish on the new reform’s impact. A secondary market in pipeline capacity will help, but does not seem a magic bullet. 

Finally, although Mexico has access to U.S. gas under NAFTA, there are lots of places for recalcitrant American regulators to hold things up. Since exports to Mexico will raise prices in the U.S., the politicians have incentives to let them ... although to be honest, I do not think that this will be a major barrier.

In short, energy reform will help quickly if it speeds up the planning process for pipelines and increases the incentives that investors have to build them: e.g., very high rates. (An outline of the challenges, written by the Mexican CRE, is here.) But the change is not revolutionary (the sector was mostly opened in 1995) and it will take a while.

So if you live in Mexico, get used to high bills and occasional shortages. It will be a while.

The Eurozone is not in the Rose data set

Currency unions are a hot topic, for obvious reasons. The Eurozone has gone spectacularly off the rails. There is some evidence that currency unions boost trade (see Andy Rose here and here and this post) but considering the rolling disaster that is southern Europe many would consider that a small gain.

Therefore, a recent paper from Andy Rose has attracted a lot of interest: he finds that currency regimes have no systematic effect on macroeconomic performance. That is quite a find! It implies that the southern European countries would have been in trouble anyway. I found it via Tyler Cowen, who led me to comments by Paul Krugman and Antonio Fatas.

Except there is one thing about the paper. Page 3: “I exclude from the sample the five systematically important economies of China, the Eurozone, Japan, the UK, and the USA.”

Neither Krugman, Cowen, nor Fatas mentioned that the Eurozone countries are not in the data set; perhaps it is too obvious? It is still a great paper. And Tyler Cowen provides a solid explanation of the results.

But I am not sure that it tells us anything about the effect of the euro.

Mexico is gaining jobs, not wages, part 2

Part 1 is here.

Part 2 is based on a stunning report from Bank of America: nominal dollar wages in Mexico are now lower than in China. (Hat tip: Beyond Brics. But note that we here at TPTM called it first!)

This is a great thing for China, obviously, and it has benefits for Mexico. It means that “nearshoring” will continue, as Mexico gains competitiveness against China. In fact, Mexico became competitive back in 2008, right after the big depreciation in the peso. The below chart shows Alix Partners’ decomposition of the landed costs (i.e., wholesale cost for U.S. sales) for five representative goods. In 2005, China was cheaper than Mexico; by 2008, that was no longer true.

But is it a good thing for Mexico? I am less certain. A boom based on nearshoring and continuing low wages ($2.50 an hour from BofA; $4.53 from the BLS) is a good thing for investors and the resulting employment boom is a good thing for Mexicans, but it does not presage much future growth. (In addition, the gains from the good news are already priced into the markets; ship-sailed if you’re looking for easy returns.)

Mexico is a solid middle-income democracy with a serious (but not existential) organized crime problem. It has made amazing strides in eliminating unnecessary volatility. The country works. But looking over the recent hype it’s attracting (see here and here and here.) I feel a little like Chris Rock. “You’re supposed to have a democracy! You’re supposed to have a middle class! You’re supposed to have factories! What do you want, a cookie?”

In other words, Mexico is performing just as you would expect a stable middle-income country with substantial long-term problems to perform. The expectations of super-returns and blather about Aztec Pumas (or whatever) is just hoping for a cookie.

P.S. Noah Smith expects rising demand for Mexican manufactures to raise wages. (You should all read his blog! It is a very good blog.) His error is simple: the demand for Mexican manufactures is extremely elastic, because Mexico is not the only country in the world.

P.P.S. No, I have not started to follow Twitter feeds. I hate that thing even more than Facebook.

El perro que no ladra

 One strange thing about the upcoming Mexican election is how little the economy seems to matter. I don’t mean questions of long-term growth or distribution; those are very much an issue. I mean short-term business cycle stuff. Manufacturing output is up. The peso is down, but the central bank seems relaxed. Judging from the results on inflation-linked bonds, so are the markets. Consumer confidence has followed suit. Nobody is running a campaign like the ones in the United States or Europe. Growth since the 2008 shock is slow, but steady, as the below chart of GDP (in millions of 2003 pesos) shows.

To be frank, I was worried three years ago. But the bad economy dog did not bark. Why not?

Well, I was worried that Mexico was going the austerity route. But it didn’t! Mexico was no paragon of countercyclical fiscal policy, but it avoided anything that could be called austerity. I wrote the above entry in the third quarter of 2009 ... during which government spending was essentially flat, much less than the programmed 0.7% drop. (See below chart, which shows growth in GDP expenditures between government purchases of goods and services and everything else.) In short, my fear didn’t materialize because the PAN government never followed through with its own austerity rhetoric.

Still, simply not being stupid isn’t really enough to explain Mexico’s quick recovery. Lots of countries failed to implement sufficiently large stimulus packages and suffered for it. To explain Mexico we need to turn to two other Mexican strengths and a bit of good luck.

The first strength is, paradoxically, also a weakness: Mexico had a terrible terrible financial system going into the Lesser Depression. But from the point of view of protection from the effects of a worldwide financial freezeup, it was a great thing to go in with banks that did not lend and firms that did not borrow. (I do not recommend this as a long-term growth strategy.)

That meant that the Lesser Depression hit Mexico as a good old-fashioned trade shock. The below graph measures quarterly percentage changes in the final demand for Mexican production. (It is not the same as GDP, since GDP nets out imports.) You can watch exports plummet in the last quarter of 2008. Net exports barely budged (in fact, they grew) but all those unemployed export workers dragged down private consumption and all those hurting export manufacturers stopped investing. Thus the vertiginous decline in GDP in the first quarter of 2009 that you can see in the above two charts. (Demand continued to fall in the second quarter of 2009, but manifested as a drop in imports, leaving GDP flat.)

But this brings us to Mexico’s second strength: a flexible exchange rate. The peso plunged from a little under a dime to a low of 7¢ before recovering. (In point of fact, the Banco de México intervened to stop the fall, too soon in my opinion.) By the third quarter of 2009, exports had started growing again. By the second quarter of 2010, they surpassed their previous peak. In point of fact, Mexico became even more export oriented than before: exports grew from 26% in the middle of 2008 of GDP to 35% by the middle of 2012.

And that brings us to the good luck. Any guesses before I post? It seems to have been in the news lately.

What’s the case for dollarization?

 This is not a post about organized crime in Mexico, although I will be returning to the topic shortly. This post asks simply: given all the things that can go wrong with a fixed exchange rate, let alone a currency union, why do so many countries continue to return to them? After all, when they go wrong, they can go very wrong. You can get horrible explosions like Mexico in 1994 or the Asian currency crashes in 1998, or you can slow grinding meltdowns like the depressions in Argentina around the turn of the century or the Baltic States today. 

Yet countries continue to do it. All the West Indies save Jamaica fix to the dollar. Ecuador, El Salvador, and Panama have dollarized. The Baltic States have already been mentioned. Denmark fixes to the euro. The euro itself has no shortage of suitors, even now. In fact, even with the Eurozone’s problems, countries want to form currency unions. East Africa wants to form a currency union. Why? 

Well, history is a big reason. The CFA franc, for example, exists and is linked to the euro because of the French non-empire also known as Françafrique. A similar thing can be said about the West Indian links to the dollar. These historical links make it very hard to figure out the effects of a currency link. Maybe countries link to countries with which they trade. Or countries trade more and link with countries with whom they have special political links. All that would make it hard to tell whether exchange rate certainty has a big effect on trade, because causality could run both ways. That didn’t stop Andy Rose from trying, but the results were still highly contested.

Jeffrey Frankel came up with a neat natural experiment. In his own words:

“The long-time link of CFA currencies to the French franc has clearly always had a political motivation. So CFA trade with France could not in the past reliably be attributed to the currency link, perhaps even after controlling for common language, former colonial status, etc. But in January 1999, 14 CFA countries woke up in the morning and suddenly found themselves with the same currency link to Germany, Austria, Finland, Portugal, etc., as they had with France. There was no economic/political motivation on the part of the African countries that led them to an arrangement whereby they were tied to these other European currencies. Thus if CFA trade with these other European countries has risen, that suggests a euro effect that we can declare causal. The dummy variable representing whether one partner is a CFA country and the other a euro country has a highly significant coefficient of .57. Taking the exponent, the point estimate is that the euro boosted bilateral trade between the relevant African and European countries by 76%. It is not doubling, and the timing is not perfect. But it does suggest that the effect on trade among small countries is very substantial even after correcting for endogeneity.”

It is true that the CFA franc is in a fixed exchange rate with the Eurozone, not a currency union. Still, as fixed exchange rates go, this one is very strong. It’s supported by the French treasury and not just the governments of the countries in question. Moreover, these countries are dependent on France in umpteen ways, and their governments would find it very difficult to leave the zone without risking economic and political collapse. So there doesn’t seem to be a strong institutional reason to reject the results. It isn’t quite a currency union, but it is close. So what happened in 1999 between the CFA countries and the Eurozone wasn’t quite an accidental currency union, but it was close. And even if it isn’t a real currency zone, the experiment can shed a lot of light on fixed exchange rates. 

So fixed exchange rates promote trade! Great news for those of us with strong intuitions that fixed exchange rates and currency unions should be good things for small countries. Problem is, the quantitative results are a little odd:

First, the effect starts in 1997, not 1999. It is possible that expectations of the fixed rate with the rest of Euroland caused the trade boom, but that seems a little ad hoc. Second, the effect seems to have faded out by 2006. Neither result lets one say with confidence that dollarization (or even fixing to a bigger currency) is a good thing for poor countries. Either the result from the CFA-Eurozone experiment is stronger than it looks (maybe 2005-06 were just bad years, or the authors failed to correct for some important factor), or fixed exchange rates only have brief and transitory effects. 

We still have a mystery. Thoughts? 

Keep on trucking

  A while ago, I wrote that I was fairly sanguine about the Buy-USA provisions in the stimulus bill. I prognosticated that they would probably not be applied to our NAFTA partners, and even if they were, the NAFTA dispute-resolution mechanism would limit the damage. Now along comes another dispute, this time over trucking, that poses a greater threat to trade ... although I am still confident that it will end well.

What's the story? In 1994, NAFTA passed the U.S. Congress. It mandated that all three countries open up their long-distance trucking markets to the others. The U.S., however, punted when it came to Mexico, claiming that Mexican trucks weren't safe. In 1998, Mexico took the U.S. to NAFTA arbitration.  On February 6, 2001, the U.S. lost ... partially. The panel ruled that the U.S. couldn't issue a blanket ban on Mexican trucks, but that it could assess their safety on a case-by-case basis. The Bush administration pushed Congress to issue enabling legislation that would bring the U.S. into compliance with the ruling, and with the political capital gained from 9-11, finally succeeded in November 2001. (Not everything the Bush Administration did was wrong, although much was botched ... keep reading.)   Congress authorized the FMCSA to inspect Mexican trucks, and the Bush administration issued the required regulations to implement the law. 

Problem solved! Not quite. The Bush regulations had some, well, holes big enough to drive a truck through. More below the fold.

Yet another modest proposal, in which I outrage my friends by advocating protectionism but please Canadians and Mexicans by saying it shouldn't be aimed at them

  The new stimulus bill requires that all steel be purchased domestically. Brad Delong is unhappy:

“If there's little excess capacity in the U.S. steel industry — so that the price of steel is high enough to induce people to look outside for suppliers — then a stimulus won't be much needed. If there's a lot of excess capacity so that a stimulus is needed, then steel customers should be able to bargain prices down to marginal cost — in which case foreign producers will have an extremely difficult time competing on price given that steel is heavy and distances are great.”

Well, maybe. Marginal cost can vary a lot, and there are two steel-producing nations whose companies enjoy almost as good access to American markets as their American competitors: Canada and Mexico. The price of the same product imported from the two countries varies between 14% and 65%.  (December price data below the fold.) Meanwhile, China has achieved significant import penetration, despite prices which exceed Canadian ones by 40% on average, and by 11% in the chief product category China exports to the United States. The implication is that American firms are high cost.

Normally, the fact that U.S. firms are high-cost wouldn't change anything. It would make sense to buy the cheapest steel from wherever. American consumers would save by going to the lowest cost producer, and Americans as a whole would be better off, even if American steel producers would suffer. 

Under depression conditions, however, I'm not sure the above logic still holds. Under depression conditions, using public money to buy from domestic high-cost producers has three advantages that don't mean anything in normal times. First, domestic high-cost producers will spend more of their revenues, not park them as saved profits ... after all, they have high costs! Second, the workers and suppliers of American steel companies (who make up the chief costs of the domestic producers) are far more likely to spend their wages and earnings on American goods and services than their foreign counterparts, keeping the multiplier higher than it would be otherwise. Finally, having steel mills shut down in American towns and American workers thrown out of work will have psychological costs for American consumers and businesses. They could worsen the downturn.  Such costs will be much less if the workers being tossed on the dole are in Ontario or Hebei. In short, when American resources are unemployed and their unemployment looks set to last, buy-USA provisions can make the country better off as a whole.   

More below the fold.