E-Notes

For a New International Economic Policy

by Bernard E. Munk

June 15, 2001

Bernard E. Munk, a Senior Fellow at the Foreign Policy Research Institute, is president of Munk Advisory Services, a senior fellow at the Wharton School of the University of Pennsylvania, and co-chairman of FPRI’s Roundtable on International Political Economy, which will commence in the fall of 2001. This essay is a condensed version of an article that appears in the Summer 2001 issue of Orbis.

The principal drivers of international economic policy (IEP) in all presidential administrations have been the promotion of domestic economic welfare and the international security interests of the United States. During most of the past half-century, security interests took precedence as policies were crafted to promote the economic strength of America’s Cold War allies. Indeed, during the most vigorous phase of the conflict with communism, one might have easily concluded, paraphrasing Clausewitz, that American IEP was “a mere continuation of politics by other means.” The end of the conflict with communism, however, has shifted the relative importance of these two drivers of American international economic policy. As the threats from the communist world receded, the promotion of domestic economic welfare has tended to trump international security concerns.

A Post-Post-Cold War Shift

We now appear to be leaving the post-Cold War environment behind. Strategically, the “unipolar moment” is unlikely to last. Further, the very high rates of growth that was the hallmark of the past decade may subside. As a result, the Bush administration may find its maneuvering room considerably restricted.

Certainly, the global macroeconomy is important to the U.S. economy, even if not for strictly geopolitical reasons, because globalization and interdependence have changed the way Americans view their principal trading partners. What counts now is how foreign economies influence the U.S. economy as a whole, as well as particular industries with domestic constituencies that clamor for special dispensation. This highlights the fact that “domestic economic welfare,” as a driver of IEP, is far from monolithic. Rather, it encompasses at least two separate and sometimes conflicting concerns: macroeconomic interests and the microeconomic concerns of special sectors or industries. The principal problem of the Bush administration will be how to resolve the claims of these competing interests.

The Bush Team’s Agenda of Issues

The U.S. domestic economy is likely to be the paramount driver for Bush’s IEP, just as it was for Clinton’s. The new administration has to define a suitable IEP in an interconnected but insecure world, and then sell that package to the Congress, domestic interest groups, and voters. Bush’s issues agenda must include coordinated policies for: (1) international financial arrangements and international assistance; (2) international commercial policy; (3) international migration policies and property rights protection; and (4) international energy and environmental policy. Only the first three are discussed here.

The passing of the Cold War has unmasked some of the fault lines previously concealed by an overarching security interest and made IEP far more susceptible to domestic political considerations. As a result, IEP will become inchoate unless domestic interests can be disciplined by an ideological commitment that can take the place of the fear of the communist threat. For the Bush administration, that commitment appears to be — and should be — based on devotion to the operation of free markets. A strong and consistently applied free-market focus could suffice to corral divergent domestic interests in the name of a larger national interest. The devil is in the details, however. The examples below serve to illustrate the potential pitfalls the new administration will face.

The “New Architecture” of International Financial Arrangements

Under Bill Clinton, there was a much-ballyhooed debate over a “new international financial architecture.” After crises in Mexico, Asia, and Russia, the need for it seemed, to some, self-evident. Even though the mobility of international capital market took the blame, however, these crises were much more the result of policy failures: inconsistent exchange rate systems (“movable pegs”) that distorted incentives and encouraged financial crises. Policies that mask the true political and economic risk in any given economy only increase the likelihood of explosive outcomes. The real need, therefore, is to develop and enhance institutions that maximize market efficiency while encouraging a suitable pricing of risk for both local and foreign investors. Markets go up and down, but bad policies ensure that eventually the worst outcomes prevail.

The Yen, the Euro, the Dollar, and Beyond

A key test for any new approach to international financial architecture will be Japan. For many years, Japan’s economic success made it possible for its politicians to conceal growing problems from the public. For much of the past decade, Japanese officials hid behind currency issues, often seeking "international cooperation" arrangements that ran counter to free-market outcomes. More than once, they dragooned Washington into supporting arrangements that diverted attention from such issues as the huge volume of nonperforming loans on the books of Japanese commercial banks and the inability to clear the market of real estate tied to such loans. Officials also used exchange rate concerns to excuse an insufficiently expansive monetary policy.

Japan’s fundamental problem is its macroeconomic policies, not its exchange rate. The dollar-yen rate, which has deteriorated sharply in the past few months, is only a manifestation of underlying economic weakness in Japan. It would therefore be a mistake to focus on exchange rates. Bush must instead focus on the policies that caused a weak Japanese domestic economy in the first place. U.S. policymakers ought to be strongly supportive of political forces in Japan that have the resolve to pursue fundamental economic reform and monetary expansion. An economically healthy Japan is in the long-term interest of the United States.

Washington cannot compel another sovereign state to leave its currency alone vis-à-vis the dollar, but it should make clear its commitment to market-based solutions. Getting rid of policy-induced instability requires telling markets that the United States intends to shun currency interventionism and condemns “beggar thy neighbor” policies that arise from explicit measures to depreciate or appreciate a country’s currency in order to frustrate foreign capital flows or rectify internal macroeconomic imbalances.

Unfortunately, the United States is now facing efforts from the euro bloc that parallel previous policy mistakes by Japan. Ill-judged monetary policies are causing an unnecessary depreciation of the euro, to which the Europeans have responded by seeking trilateral exchange rate understandings with the United States and Japan. This represents a serious threat to market-driven determination of exchange rates. The Bush administration should turn a deaf ear to these pressures. What matters is the strength of the U.S. economy, not the exchange value of the dollar. In the unhappy event that the economy goes into recession, the dollar may fall-and rightly so. If it does, it should not be because of exchange rate intervention to deflate a “dollar bubble,” but because foreign investors see less promise in the U.S. economy than elsewhere.

Concurrent with a market-based view of exchange rate determination should be a greater tolerance for alternative monetary arrangements in emerging markets. In particular, Washington should be willing to go along with some countries' currency board arrangements that use the U.S. dollar as a monetary base with a guarantee of full convertibility at a fixed exchange rate. If foreign governments are willing to give up their seignorage rights, policymakers in Washington should have no real objection.

The plight of Indonesia serves as a vivid example of what can go wrong in a clash of wills over monetary arrangements. The IMF (with clear U.S. support) pilloried Indonesian efforts to move to a currency board in early 1998, partly on the grounds that it would offer an escape mechanism for Indonesian asset holders to convert rupiah into dollars and flee the country at foreign lenders’ expense. As it turned out, monetary instability bent the Indonesian economy into a pretzel. Was a “doctrine of fairness” such as this really superior to a currency board? Impoverishing an economy will certainly dent the net wealth of important asset holders, but the rich will always have means for protecting their assets. It is the poor who are left jobless as firms cut payrolls to survive. That is not a recipe for democracy, and the Bush administration ought to subject the reigning “doctrine of fairness” to the strictest scrutiny. The Bush administration should therefore advocate policies permitting either true floating rates or, where circumstances permit, currency boards. The middle solution— movable pegs— is untenable and prone to crisis.

Reforming the Institutions

International financial arrangements have shifted drastically since the 1944 Bretton Woods accords established the IMF and World Bank, and the missions of both institutions have changed as well. Thus, fundamental reform requires redefining what the IMF and the World Bank can and should do.

According to the March 2000 report by the International Financial Institution Advisory Commission (known as the Meltzer commission), the IMF’s policies often lead to the very results they wish to avoid. The fund’s frequent intervention makes short-term private lending seem more secure than it is, and markets have come to count on IMF bailouts in the event of trouble. Indeed, the report concluded that “most crises in the past quarter century involved not too little lending, but too much.” Therefore, the continued cycle of IMF repair followed by further crisis down the road must end.

Similarly, the World Bank’s lending history shows that countries learn to behave (or misbehave) in accordance with the predictable behavior of their would-be rescuers. Any performance standard for the World Bank should take into account how well countries actually institutionalize sound economic practices. The World Bank needs to stop rewarding failure by recipient countries with further loans to finance their continued malfeasance or folly.

International Commercial Policy

Bush administration policy statements appear to be grounded in a fierce commitment to free-market solutions, limited government, and a deep respect for national sovereignty. The fulcrum upon which the Bush IEP teeters, however, is the performance of the U.S. domestic economy. Should it continue to sputter as it now seems to be doing, policy attention will be diverted from the international to the domestic arena, and special interests seeking indulgences will find Congress receptive. Perhaps, through a combination of aggressive monetary policy and supply-side-directed tax cuts, the U.S. growth engine can restart by the second half of 2001. If so, Bush may achieve traction next year and avoid a protectionist detour. In the meantime, his market-oriented principles will face severe challenges.

American commercial policy over the past decade has moved from a multilateral to a regional focus with regard to reducing tariff and nontariff barriers. NAFTA, for example, is in essence a preferential arrangement. Ongoing efforts to create regional trade agreements in Europe, the Americas, and East Asia have all sidetracked the multilateral approach to reducing trade barriers. Regional arrangements are attractive because the lists of concessions obtained for concessions granted are written in black and white, unlike the "invisible" gains promised by global agreements. The White House has to show consumers how they are better off as free trade expands, but this may be a hard sell.

American industry and labor may pose the biggest obstacles to a new policy on international trade. The Bush administration has signaled that it would curtail funding for both the Export-Import Bank (which subsidizes export-credit financing) and the Overseas Private Investment Corporation (which provides political risk insurance). One can only hope that the administration will succeed. Simply stated, these programs are examples of corporate welfare that a market-oriented administration should not pursue. Those who tend to reap the greatest benefits of these subsidies are often the largest political donors.

When there is dislocation, the issue of “fair trade” comes to the fore. It is a bogeyman. In practice, “fair trade” has amounted to little more than a mutual exchange of hostages— a bargaining format in which each side only offers concessions in exchange for others. In carrying out that bargaining, politically important protectionist interests have often had the loudest voices.

The Bush administration needs to invoke the logic of free trade — not targeted concessions — as a device to discipline those who seek subsidies, anti-dumping measures, and nontariff barriers such as the sugar quota. The list of such interests is endless because of the financing requirements of democratic politics: all contribute, all lobby. If the Bush administration is serious about moving to reform the tax code and the international finance system by a return to truly free markets, it should likewise stick with multilateral free trade. All interests are special, above all the American national interest.

Human Capital

The series of financial crises experienced in the 1990s highlighted the growing importance of capital movements in the global economy. Financial capital, however, is not the only kind whose movement challenges national borders. Human capital also crosses borders, in the form of immigration and intellectual property transfers. Both forms of human capital movement have legal and illegal aspects, but each is responsive to economic incentives. This means that public policy has both the responsibility and the capability to influence the outcomes. It also means that when these movements occur, there are winners and losers. How a nation responds to these opportunities or threats has important implications.

The crux of the problem of movement of human capital is to limit the damage to existing stakeholders while at the same time ensuring that legitimate human claims are not ignored. What should be American policy with regard to enforcing its own immigration laws or protecting intellectual property in the fields of technology or pharmacology? To ignore suffering that could be alleviated by reasonable prices of drugs, for example, will only stoke the fires of those opposing globalism. At the same time, to ignore the claims of the owners of intellectual property would be to stifle the incentives that lead to innovation. Since drug discovery and testing are costly processes, the Bush administration needs to develop policies that protect patent rights while being mindful of the ethical implications of “pricing out” needy recipients.

Because policy in this area is still rudimentary, it is wide open to creative thinking. One possible solution to the patent protection dilemma is for the Bush administration to open a dialogue with developing countries offering to trade some patent protection for limited but dependable enforcement. Another tactic would be to "expand the chessboard" by linking greater access to the U.S. market for agricultural or fiber imports to the acceptance by developing countries of a limited form of enforceable patent rights.

As for the immigration issue, people will continue to move so long as there is a large disparity in wage levels across countries and increasing availability of technical education in the poorer countries. This raises substantial issues for countries that lose human capital to the high-income U.S. economy. Similarly, as the United States hollows out its traditional industrial economy, the growth in service jobs is a powerful draw for immigrants willing to work in the informal economy. For the Bush administration, the issue is whether— and how effectively— the United States will enforce its own immigration laws. This is a truly gray area in IEP. Given how much more important human capital has become in the modern economy, it is likely that this decade will be one of rapidly growing human capital movement. Forging successful policy in this arena will require ideas, ideals, and some deliberate risk taking.

It is important to note that the influx of labor from abroad has undoubtedly lengthened and amplified America’s long economic boom. The United States has been gaining population and enlarging its skilled and unskilled workforce. Somewhat counterintuitively, the unemployment rate has gone down due to the pace of job creation, a fact not lost on other countries whose shrinking populations imperil their respective welfare and pension systems.

What is at stake in the case of both immigration and the transfer of intellectual property is a question of legal and social contracts. The problems presented by these aspects of human capital movements are exceedingly difficult to resolve, but they are likely to become some of the more crucial ones of the decade.

An IEP Menu for Bush

The new administration has a full plate of challenges laid out before it. Let us hope it has a good appetite. In the area of international financial architecture, the Bush economic team should strive to (1) let market forces determine exchange rates; (2) help other countries promote domestic monetary and fiscal stability; (3) encourage hard pegs (currency boards) as well as truly floating currency arrangements; (4) and redefine the ends and means of the IMF and World Bank by restricting the IMF’s mission to limited short-term financing and obliging the World Bank to reward successful implementation of sound policy in recipient countries.

With regard to international commercial policies, the Bush team should (1) make free trade its mantra to enforce domestic political discipline and bury the rhetoric that is often nothing but a fig leaf for protectionism; (2) promote regional trade agreements such as NAFTA, but in tandem with a bolder, multilateral focus that applies globally; (3) lobby Congress hard for fast-track authority but, if that fails, continue to seek multilateral reduction in tariffs and nontariff barriers; (4) allow domestic market adjustments to occur, with suitable attention to worker retraining and relocation where possible.

Finally, with regard to international movements of people and property, the Bush administration must (1) redraft U.S. immigration laws that are both salutary and enforceable; and (2) experiment with creative negotiating strategies to maximize property rights protection in emerging markets, without which economic development is greatly retarded.

This is a daunting agenda for the new administration, but success will reward both the American national security interest and the domestic economy.

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