Kill export subsidies. Kill the Ex-Im Bank.

Kill export subsidies. Kill the Ex-Im Bank.

Imagine the Chinese government decides to help the people of Kenya. To do this the Chinese government buys 5,000 wheeled loaders and excavators from Liugong Machinery and gives them for free to the Kenyan government, Kenyan construction firms, and groups of Kenyan citizens who want to build roads and stuff.

(Real world export subsidies are much smaller, of course, but the principle is the same. Foreign customers of a domestic exporter get taxpayer-subsidized discounts, not totally free stuff.)

Who wins? Kenyan customers and Liugong’s owners and employees, who now have a huge increase in demand for their product.

Who loses? Chinese taxpayers, who must foot the bill, and the owners and employees of Liugong’s Chinese and foreign competitors, who don’t have this generous taxpayer-subsidized benefit and can’t possibly compete with free.

Now let’s journey to America to meet an (imaginary) executive from Caterpillar, an American firm competing with Liugong to sell wheeled loaders and excavators to Kenyans. Caterpillar can’t give their product away, they need to sell it. This executive goes to a U.S. policymaker and asks for a similar export subsidy to what Liugong received from the Chinese government.

Imaginary Caterpillar executive: “Caterpillar is losing business in Kenya to our Chinese competitor Liugong. The Chinese government buys equipment from Liugong and gives it to Kenya. The U.S. government needs to do the same for us. If they don’t we’ll completely lose the Kenyan market to the Chinese. American taxpayers need to put up money to buy Caterpillar wheeled loaders and excavators and then give that machinery to Kenyans. If you don’t, we’ll lose that export business and American jobs.”

American policymaker: “Let me get this straight. We should take money from American taxpayers, use it to buy equipment from your company, and then give that equipment to the Kenyans, all because the Chinese are doing the same thing with your competitor?”

Cat exec: “I agree it sounds silly, but if you don’t do this we’ll lose American jobs. It would be better if neither China nor the U.S. did this, but as long as the Chinese do, you have to as well. Unless you want to put America at a competitive disadvantage and lose the Kenyan heavy equipment market…”

American policymaker: “There’s a difference between what’s good for America and what’s good for one firm in America. China’s policy puts one American company (yours) at a tremendous disadvantage in winning business in one foreign market. I feel bad about that, but I’m not sure the solution you propose makes things better for America as a whole. For instance, while I like Kenya, aren’t you asking me to have American taxpayers subsidize your Kenyan customers? That’s not my policy goal. If I wanted to help Caterpillar owners and employees, wouldn’t it be more efficient to just have the U.S. government write a check to Caterpillar? That way we wouldn’t dilute the help by giving most of it to foreigners.”

Cat exec: “Yes, that would be more efficient, but we both know there’s no way you could sell that to Congress or the American public.”

American policymaker: “So you want me to support a less efficient policy because the more efficient one would be unpopular. What about your American competitor John Deere? Wouldn’t I be giving you an unfair advantage over them?”

Cat exec: “Well, technically, yes, but…”

American policymaker: “Technically nothing. You’re asking me replace one tilted playing field with another. And what if China decides to do the same thing for the Rwandans? Do I have to match those subsidies as well?”

Cat exec: “Unless you want us to lose that business, sure…”

American policymaker: “What if Liugong got its subsidy from the Chinese government through less-than-noble means? What if a Liugong executive’s brother-in-law’s cousin is the guy who works for the key Chinese decision-maker? Are you saying that U.S. taxpayers should target American subsidies for American firms to match foreign subsidies determined by cronyism in a foreign government? Is that right? Where does it end?”

Cat exec: “Well, when you put it that way it doesn’t sound quite as attractive. But surely you don’t want America to unilaterally disarm.”

American policymaker: “Sorry, but I don’t buy your ‘disarmament’ analogy. China’s export subsidies of Liugong don’t only hurt Caterpillar, they also hurt Chinese taxpayers and Liugong’s Chinese competitors. They distort decisions and redistribute economic resources in China in ways that make their economy less efficient. While they undoubtedly help Liugong’s owners and employees, China’s export subsidies harm other parts of the Chinese economy. You’re asking me in turn to help your firm’s owners and employees at the expense of American taxpayers and the owners and employees of your American competitors. I don’t see why I should replicate their mistake here, even the alternative is that your firm loses the Kenyan market to Chinese subsidies. Seems to me the alternative you propose is better for Caterpillar but worse for America as a whole. A better analogy would be if you said I should not quit smoking until all my friends also quit. I should quit smoking if it’s healthier for me even if my friends continue to smoke. If China wants to harm itself, there’s no reason I should do the same just to match their mistake.”

Cat exec: “And therefore you’re going to force Caterpillar to compete on an unlevel playing field with Liugong. You’ll be responsible for the layoffs at Caterpillar that result because you refused to help us.”

American policymaker: “The alternative is that you want me to force American taxpayers to subsidize foreign consumers and the owners and employees of one American firm, and to create a new titled playing field at the expense of the owners and employees of your American competitors, based in part upon decisions made in foreign capitals that may have been determined by cronyism. You agree that this policy is less efficient than one that would be unpopular in the U.S., and you’re advocating this one because you think you can disguise that it’s a worse policy. No thank you.”

Cat exec: “How about if, rather than buying the equipment in total, you just give us a partial taxpayer subsidy? We can make it either a direct subsidy or a taxpayer-backed loan guarantee, and we can do it through the government run Export-Import Bank. That way nobody will understand it.”

My view

The U.S. government should not engage in industrial policy, choosing to help certain American firms and thereby indirectly punishing other American firms. Government should not be picking winners and losers.

American taxpayers should not be subsidizing any particular subset of American business owners and/or workers. American taxpayers should also not be subsidizing foreigners, even when they are foreign consumers of American exports.

Export subsidies are bad policy. Even when well-intentioned and designed to “level the playing field” to match other countries’ export subsidies, they create other tilted playing fields and do more harm to the economy as a whole than the problem they purport to solve for one firm. They also create opportunities for cronyism and other forms of influence-based rent-seeking.

Deep and liquid private credit markets exist today that did not exist when the Export-Import Bank was created in the 1930s. Ex-Im’s primary function now is to pass though implicit taxpayer subsidies to a select group of American firms.

Export subsidies should be eliminated and the Ex-Im Bank should be killed. Export credit finance should be done, without subsidies, by private markets.


It's not just the economy, stupid

It's not just the economy, stupid

What do these four things have in common?

  1. The short-term path of the U.S. economy;
  2. The Supreme Court’s upcoming decisions on the Affordable Care Act;
  3. The economic and financial mess in Europe;
  4. A possible Israeli attack on Iran and whatever Iranian response that provokes.

I see four commonalities:

  • Each has a moderate chance of going wrong before Election Day;
  • The short-term domestic economic policy effects of each are significant;
  • Each could change the agenda and course of the U.S. election;
  • Each is largely outside the President’s control.

James Carville’s line from the 1992 campaign, “The economy, stupid,” may be too narrow this year. Yes, the domestic economy is the most important subject for the election.  But the U.S. economy may not be the only subject this fall, and if we drill down further we can find complexities beyond the simplistic political analysis of “Economy bad, incumbent loses.” President Obama’s economic campaign challenge is multidimensional.

  • The recovery is weak and recent data make it hard to claim things are getting better. The level is bad (8.2% unemployment) and the direction and rate of change are nothing to brag about.  Today the Fed knocked half a percentage point off their projected GDP growth rates for the remainder of 2012. The President and his team made a tactical political error by betting on a continuing positive trend, hoping they’d be able to argue “Things may be bad but they’re getting better because of our policies.” This backfired with the last jobs report but could change again in the next four months.
  • Downside macro risks are more significant than upside risks. Europe teeters.
  • Stimulus is behind us. The Court may overturn health care reform next week. If it does this leaves Dodd-Frank as the only lasting major economic policy accomplishment of the President’s term.
  • Stimulus and health care are also unpopular.
  • Other than raising taxes on the rich and spending a few tens of billions of dollars more, the President is not proposing a significant domestic economic agenda for the second term. He’s saying a lot but has few big policy proposals and nothing to address our medium-term fiscal challenge.
  • He also doesn’t have a good answer for how to accelerate short-term economic growth other than “Be patient.”

The monthly jobs and GDP data are the most important data points affecting the choice this November, but they are not the only ones. It’s not just the economy.

(photo credit: Aaron Webb)

Free trade voting patterns in Congress

Free trade voting patterns in Congress

I find I can learn a lot by graphically examining legislative voting patterns. The recent enactment of implementing legislation for three Free Trade Agreements gives us a wonderful opportunity to compare the two political parties and the House and Senate on free trade.


The Bush Administration negotiated free trade agreements (FTAs) with Korea, Colombia, and Panama.  South Korea’s economy is big enough that the Korea FTA was economically important not just for South Korea, but also for the U.S. FTAs with smaller Colombia and Panama are important to the U.S. for several non-economic reasons:

  • These countries are our friends and allies (so is South Korea).
  • There is a long run philosophical battle for the shape of Central America, with Venezuela’s Chavez and Cuba’s Castro brothers on the other side. Helping Central American countries that want to expand freedom, democracy, capitalism, and free trade helps our side in that broader struggle.
  • It is important for the U.S. to send a signal to smaller nations of the world that we will pursue free trade with countries whose economies are quite small relative to ours.
  • We also want to promote the idea of free trade generally.

Upon taking office President Obama said all three FTAs were flawed and sent his trade representative to renegotiate each one.  Even after renegotiations concluded in late 2010, the President sat on them for many months.  He sent implementing legislation for all three agreements to Congress in October of this year.  All three were ratified by Congress in less than three weeks.

The two years of renegotiations were politically convenient for President Obama, as they allowed him to avoid asking Speaker Pelosi to bring up legislation that most of her caucus opposed.  The following vote analysis will show this.

Partisan support ratios

Since I want to focus principally on comparing the two parties, I think that looking at partisan support ratios for the FTAs.


  • 219 House Republicans voted for the Korea FTA, while 21 voted against it, for a ratio of 10:1 House Rs FOR.
  • 66 House Democrats voted for the Korea FTA, while 123 voted against it, for a ratio of 2.2:1 House Ds AGAINST.
  • As a whole, 278 House Members vote for the Korea FTA, while 151 voted against it, for a ratio of 1.8:1 House Members FOR.

I found that looking at raw vote counts gets klunky.  Look at how much easier it is when we compare ratios and have an apples-to-apples comparison of different groupings:


House Rs

House Ds

1.8:1 FOR

10:1 FOR


Even better, we can look at it as a graph:


This means that for every 1 House Republican who voted against the Korea FTA, 10 of them voted for it.  In contrast, for every 1 House Democrat who voted for the Korea FTA, 2.2 of them voted against it.

Obviously, an FTA would pass the House only if its total support ratio (Rs+Ds) is greater than 1:1.

Now this voting pattern is not unusual for the House on any legislation.  As a majoritarian body, the House is naturally partisan. Bills usually pass the House relying mostly if not entirely on the majority party’s votes.  We can see that this is the case for all three FTAs in October:


We can learn a few things from this graph:

  • In each case, House Republicans voted overwhelmingly in favor of the FTA.  The lowest ratio was for Korea, and that was still 10:1 FOR.
  • In each case a majority of House Democrats voted against the FTA (that’s why the ratios are measured as AGAINST).  But also in each case, the Democratic party split more deeply than Republicans (since the ratios are closer than 1:1).
  • As a working hypothesis from looking at these House votes, we can conclude that House Democrats are generally against free trade, but House Democrats are less unified as a party than the pro-free trade House Republicans.
  • We also have a plausible explanation for why President Obama took so long.  All three FTAs split his party deeply with most of his partisan allies opposed.  By taking two years to renegotiate the FTAs, he did not have to put his House allies in an uncomfortable position while he was relying on them to enact the stimulus, health care, and Dodd/Frank.

Now let’s test these hypotheses by looking at the corresponding Senate votes:


This is more interesting than the House vote.  Remember that Democrats are still in the majority in the Senate.

  • In all three cases Senate Republicans voted even more overwhelmingly for free trade than did House Republicans.  But for the Maine Republican Senators Snowe (2 nos) and Collins (1 no), Senate Republican support for all three FTAs was unanimous.
  • Unlike House Democrats, a majority of Senate Democrats voted for the Panama and Korea FTAs.  More Senate Ds voted no on Colombia than voted aye, but the ratio (1.4:1 AGAINST) was much closer than among House Ds (5:1 AGAINST).
  • Almost all Senate Republicans and a majority of Senate Democrats supported Panama and Korea, while the Colombia FTA leaned more heavily for passage on Republican votes.

I also did some aggregate tabulations, combining the votes of all three FTAs together.  This is useful for comparing the political parties in the aggregate.  It also gives more weight to the House than the Senate, since there are more House members than Senators.


These results won’t surprise anyone who has followed trade policy and politics in the U.S.

  • The Congress (House + Senate combined) voted 2:1 FOR the three trade agreements.
  • Republicans voted 21:1 FOR free trade.
  • Democrats voted 1.9:1 AGAINST free trade.

Can we extend the results from these three FTAs to a broader analysis of the two parties on free trade?  Yes and no.

  • The renegotiation and a Democrat in the White House provided more political cover for on-the-fence Democrats to vote aye.  That would suggest these ratios are a free trade high water mark for the Democratic party.
  • Partly offsetting this, many of the House Democrats who lost their seats in the 2010 tidal wave election were in more centrist/purple districts and may have been more free trade than those who survived the wave.  I think this factor is small relative to the first, however.
  • The above ratios are even more free trade than I expected from Republicans.  Protectionist Republicans tend to be from the South (textiles), and none of these FTAs economically threatened the American South.  I would generally guess between an 8:1 and a 12:1 FOR ratio for Congressional Republicans rather than the 21:1 that we saw in October.

Free trade in the U.S. results from a center-right legislative alliance.

  • In my experience the above analysis reflects a broad historic trend, at least over the past 15 years or so.  See the free trade vote here for a comparison.
  • In the U.S. free trade agreements pass the Congress with a broad center-right legislative alliance that includes almost all Republicans and splits Democrats roughly one-third for free trade and two-thirds against it.
  • When looking at all three FTAs combined, House Democrats voted 2.6:1 AGAINST free trade in October, even with a Democratic President supporting the FTAs.  You need a House Republican majority to get any free trade done.  There’s no way a Democratic Speaker can bring free trade legislation to the floor when her own party is so heavily opposed to it.
(photo credit: Aaron Morton)

Three layers of the European debt crisis

Three layers of the European debt crisis

This post is for Americans who know nothing about the debt crisis in Europe.  I am going to try to provide a big picture framework and draw attention to what I think should matter most to Americans.  If you have expertise in this topic I hope you’ll help me improve my analysis.  This topic is somewhat new for me.

I think of the European debt crisis in three layers:

  1. national debt crises in several European countries;
  2. a structural crisis of the Eurozone; and
  3. potential banking crises in Europe and the U.S.

Most current press coverage is about the middle layer: can European leaders prevent the Eurozone from dissolving? The top and bottom layers deserve more attention than they are receiving. American policymakers need to think hard about and plan for the possibility that a really bad outcome in Europe leads to another American banking crisis.

On the top layer we have national budget crises in several countries. For weeks and in some case months, Portugal, Ireland, Italy, Greece, and Spain (the so-called PIIGS) have each had trouble issuing government bonds at a sustainably affordable interest rate. Each of the PIIGS has some combination of unsustainably high budget deficits, high government debt, and weak economic growth. As a result investors worry that if they loan money to these governments they won’t get it back in full and on time.  They therefore insist on a high interest rate to compensate for this risk. In the case of Greece those fears were well-founded, as private investors “voluntarily” (yeah right) took about a 50% haircut on the value of their Greek bonds.

On this top layer of national debt crises there are a few important things to remember:

  • Each of the PIIGS’ fiscal situations is different. Spain had a housing bubble like we did in the United States. Ireland incurred a lot of debt because they bailed out their banks in 2008 and 2009. The Italians have a lot of debt while the Greeks have huge deficits. Each of these countries is having trouble issuing government (“sovereign”) debt at an affordable interest rate, but for different reasons.
  • A growing economy can cover up a lot of problems.  An economic slowdown in Europe has revealed problems in the PIIGS that have been building, in some cases for years.
  • At this fiscal solvency layer the idea of “contagion” from one of the PIIGS to another is overblown. The underlying fiscal solvency crises in these governments are basically independent. While the reactions of policymakers to Greece is affecting investors’ expectations about the value of debt issued by Italy, Spain, or Portugal, the underlying fiscal solvency problems in these countries were not caused by the problems in Greece. Contagion pops up in other parts of this story, but the term is often misused in this layer.  See this Lazear op-ed for more on this point.
  • From a broad American perspective we care about each of these countries because we want our friends and allies to succeed economically. From a narrow American economic self-interest viewpoint, we care about each because they are our trading partners. But on the raw numbers the economic fate of each of them (separately) will have only a small effect on the U.S. economy. If we in the U.S. did not have to worry about the other two layers, then this would probably not be the most important current issue for most American economic policymakers.  The worrisome quantitative hit to the U.S. economy comes if Europe as a whole goes into a deep recession, or if European debt problems cause a banking crisis that spreads to the U.S.

In the middle layer we see the Europeans trying to solve the structural flaw of having a centralized monetary policy in a Eurozone economy that is still heavily balkanized, especially on fiscal policy. Because my point today is to emphasize the relative importance of the other two layers relative to this one which is getting all the public attention, today I’ll mention only a few important points about this layer.

  • Outside of a monetary union, a government that borrows in its own currency and develops debt problems has the option of inflating away its liabilities. This generally also occurs in the context of a currency devaluation. The PIIGS don’t have this option as long as they are members of the Eurozone, since they don’t control their own monetary policy, inflation, or currency. This means they must either make dramatic changes to solve their underlying fiscal problems (which, presumably is quite difficult given that they haven’t done it so far) or they have to get someone else to help them pay their bills. (translation: “someone else” = Germany)
  • In theory Greece or Portugal could leave the Eurozone, reinstitute their own currency, and then devalue. In practice ut the treaties that formed the Eurozone don’t describe how to do this, and you have to worry about capital flight, how to get anyone to use your new currency, and how to deal with old contracts and debts denominated in Euros when you’re now using drachmas or lira.  I have yet to find someone who can describe how a country could successfully do this, legally or financially.
  • Given this huge uncertainty about whether and how a country could actually leave the Eurozone, there appear to be a few possible outcomes:
    • Everyone now in the Eurozone stays in it;
    • Some of the smaller periphery countries (Greece, Portugal? Ireland?) leave it (but how?), while the rest in the core stays intact; or
    • The whole Eurozone falls apart.
  • If the whole Eurozone falls apart, then Europe as a whole probably falls into a deep recession. That would seriously hurt the rest of the world’s economies, including ours. This is a bad scenario for a U.S. economy that is already growing way too slowly. It’s also a scenario that American policymakers can do little to prevent.  Chancellor Merkel and President Sarkozy are doing everything in their power to avoid this outcome.

The bottom layer, the interaction between European sovereign governments and banks in Europe and the U.S., is not getting nearly enough policy or press attention, and it worries me a lot. From an American self-interest perspective, the direct economic effects of a Eurozone collapse on U.S. exports would be very bad and could easily tip the U.S. into recession. But the effects of a collapsed Eurozone or an Italian default on European banks, and the indirect effects that are passed through to American banks, could be far, far, worse. Think 2008 financial crisis worse.  The worst case scenarios for Europe appear to pose a low probability, high consequence threat of another horrific U.S. banking crisis.  This is why American policymakers should care deeply about Europe — because if the Europeans screw it up badly, it could do serious damage to the American economy, transmitted through still flawed and vulnerable banking systems.

A sudden dip in the value of Italian debt could create solvency problems and/or liquidity problems for banks and other large financial institutions.  Here is the solvency scenario that really scares me:

  • Italy defaults on its sovereign debt or the Eurozone collapses. Italian debt is suddenly worth much less.
  • Everyone holding Italian bonds, or derivative securities based on Italian bonds, suddenly must realize a big loss.
  • Large European banks that were holding massive quantities of Italian debt must realize huge losses. The biggest concern here is probably the big French banks, but there could be others throughout Europe that face similar risks.
  • These European banks fail. European governments begin rescuing their banking systems (again).
  • While large American banks appear to face little direct exposure to the risk of losses on Italian bonds, they could face much larger counterparty exposure to failing large European banks that hold those Italian bonds.
  • Failures of European banks trigger large losses in large American banks.
  • Some of the biggest American banks fail. Again.

To put it even more simply, I worry about this:

(Eurozone collapses or Italian government defaults) –> European banks fail –> U.S. banks fail

A second and closely related scenario derives from European banks using PIIGS government bonds as collateral for short-term interbank loans.  If a European bank needs an overnight loan from another bank, and that second bank won’t take Italian government bonds as collateral, then the first bank may need to sell other assets to raise cash. If a whole class of collateral for liquidity is no longer available, it can have broader effects in liquidity markets, including for U.S. banks that don’t use European sovereign debt as collateral but rely on these wholesale markets for short-term liquidity.  This could force the U.S. Fed to once again provide emergency liquidity to American banks.

From a narrow American economic self-interest standpoint, our second biggest concern should be whether our trading partners go into a deep recession and what that would mean for U.S. exports and U.S. GDP growth.  Our biggest concern should be the value of Italian bonds. Why? Because there are a whole lot of them, and because they are concentrated in large European banks that (as best I can tell) are counterparties to large American banks.

You may notice parallels to 2008. Then, big American banks failed in part because they concentrated huge amounts of highly correlated mortgage risk on their balance sheets. When those housing-related financial assets declined sharply in value, those banks failed. The same could happen in Europe, where government debt has previously been (mistakenly and stupidly) treated as a risk-free financial asset. We Americans should care specifically about Italian debt because there is so much of it, because it is concentrated on the balance sheets of some large European financial institutions, and because these institutions are now realizing it’s risky and worth less than they had previously thought.

An even better 2008-era analogy would be debt issued by Fannie Mae and Freddie Mac. U.S. rules allowed banks and other financial institutions to treat this Agency debt as risk free and as functionally equivalent to U.S. Government bonds. As a result, financial institutions around the world concentrated huge amounts of apparently risk free Agency debt on their balance sheets. When in 2008 Fannie and Freddie were deemed to be insolvent, we in the Bush Administration worked with the regulator to in effect guarantee that Agency debt would be worth 100 cents on the dollar. We did this because the alternative would have triggered failures in financial institutions around the world. The U.S. financial system mistakenly treated Agency debt as risk free. When that was no longer true because the underlying institutions were recognized to be insolvent, we had to step in to make it risk free or else, we thought, face the collapse of much of the global financial system. European sovereign debt, and especially Italian bonds, appear to be the 2011 equivalent, at least in Europe, of 2008 era Agency debt.

Over the past week there have been significant policy actions on all three layers of the crisis:

  • New Italian Prime Minister Mario Monti has proposed and is trying to enact new laws to address his government’s underlying solvency problems;
  • European leaders and finance ministers are working furiously to figure out how to hold the Eurozone together; and
  • The U.S. Federal Reserve started a new stress test of big American banks to figure out whether they could withstand an economic shockwave from a European implosion.

While the press focuses almost entirely on the Eurozone negotiations, American policymakers should be focusing even more on whether PM Monti is successful in Italy and especially on the results of the U.S. Fed’s stress tests.

Unlike with U.S. mortgages in 2008 and thereafter, the Italian government can solve its underlying solvency problems.  Through some combination of cutting government spending, raising taxes, and economic reforms that will allow more economic flexibility and competition and faster productivity growth, the Italian government can reduce the risk of insolvency and increase the value of Italian debt.  This would help Italy, it would make it easier to keep Europe intact, and it would reduce the risk to the European and banking systems. Win-win-win.

At the same time the U.S. Fed is requiring the biggest banks to test a scenario in which U.S. GDP declines eight percent and the unemployment rate jumps to 13%. I hope they are also requiring the American banks to prove they can survive if their European counterparts fail or if liquidity suddenly dries up.  These stress tests, and corrective actions demanded of any American banks that fail the tests, are the most important thing American policymakers can do now to protect the American economy from the worst case scenarios in Europe.

From an American economic self-interest perspective, this bottom layer of the European debt crisis is by far the most important. If events in Europe could cause American banks to fail, American policymakers need to know this and deal with it before disaster strikes.

(Hat tip to the students in my Stanford Business School class who have been helping me learn and think about the European crisis and how to explain it.)

(photo credit: FurLined)

Intro to nuclear power and the Fukushima plant crisis

Intro to nuclear power and the Fukushima plant crisis

I’m going to start occasionally recommending other reading.  Much of it will focus on the site I run for the Hoover Institution, Advancing a Free Society.  Today, however, I want to promote two excellent things I found that help understand the ongoing problems at the Fukushima nuclear power plant.

The first is Maggie Koerth-Baker’s simple and clear post, Nuclear energy 101: Inside the “black box” of power plants.  Maggie wrote this respond to a reader who wrote “The extent of my knowledge on nuclear power plants is pretty much limited to what I’ve seen on The Simpsons.”

The second is geologist Evelyn Mervine’s phenomenal set of telephone interviews with her dad, a retired Naval and civilian nuclear engineer.  Through this you can hear near real-time expert analysis of ongoing events.

Thanks to Maggie and to Evelyn and Command Mark Mervine (ret.) for their fantastic posts.  Their work blows away anything I have so far seen in the MSM.

(photo credit: DigitalGlobe)

What is the Strategic Petroleum Reserve (SPR)?

What is the Strategic Petroleum Reserve (SPR)?

Yesterday Meet the Press host David Gregory asked White House Chief of Staff Bill Daley if the President was considering releasing oil from the Strategic Petroleum Reserve (SPR):

MR. GREGORY: But what about the shorter term? Does the president—there’s calls to tap the strategic petroleum reserve, which comes up during these spikes. Is the president considering doing something that can arrest that spike?

MR. DALEY: Well, we’re looking at the options. There’s—there—the spike—the, the issue of, of, of the reserves is one we’re considering. It is something that only is done—has been done in very rare occasions. There’s a bunch of factors that have to be looked at, and it is just not the price. Again, the uncertainty—I think there’s no one who doubts that the uncertainty in the Middle East right now has caused this tremendous increase in the last number of weeks.

MR. GREGORY: But it’s on the table, which I think is the significant development.

MR. DALEY: Well, I think all consider—all matters have to be on the table when you go through—when you see the difficulty coming out of this economic crisis we’re in and the fragility of it.

Let’s look at the Strategic Petroleum Reserve and the President’s option to release oil from it.

What is the Strategic Petroleum Reserve?

The SPR is a bunch of holes in the ground. The Strategic Petroleum Reserve is a collection of salt caverns at four locations in Louisiana and Texas along the Gulf Coast.  Those salt caverns hold 727 million barrels of oil, managed by the Department of Energy.

The SPR is a national insurance policy. Specifically, it insures the U.S. against a severe oil supply disruption. Without this insurance, our economy could be even more sensitive to a big oil supply shock than it already is.

Created in 1975 after the Arab oil embargo, the SPR is designed to be an emergency reserve.  If Venezuela’s Hugo Chavez suddenly were to decide he is no longer going to sell oil to the U.S., we would face a short-term supply disruption while we waited for supplies to arrive from other producer nations.  President Bush (41) released oil from the SPR when Operation Desert Storm began in January 1991, in anticipation of supply disruptions in the Middle East.  When Hurricane Katrina damaged much of the Gulf of Mexico oil infrastructure, we suddenly lost about 25% of domestic production and President Bush (43) released oil from the SPR.  If terrorists were to blow up major elements of the global or domestic oil supply chain, that could cause a severe supply disruption.  The SPR is not a backup supply to be used frequently when gasoline gets expensive, it’s an emergency strategic supply to be used only in a crisis.

Releasing oil from the SPR is a Presidential decision, based principally on the advice of the Secretary of Energy.  The President’s White House economic and national security advisors are usually involved in the decision as well.

The U.S. relies more heavily on government stocks than private reserves.  The same is true for the Japanese.  The Europeans rely more on privately held commercial stocks.  Since their governments don’t own that oil, the Europeans mandate that commercial storage facilities hold a certain amount of emergency reserves.  Also, you can’t drain your stocks down to zero; you have to leave some oil in the tanks and especially the pipes to make the hydraulics work.

The U.S., Japan, and Germany have the biggest reserves.  Then there are the Chinese, who so far have not been full participants in the international coordination system run by the International Energy Agency (IEA).  Reserve withdrawals are more effective when they are coordinated among the countries with the largest reserves.

The U.S. government fills the SPR in two ways.  They buy oil on the open market, and they receive oil as payments in kind for drilling leases granted by the government (called Royalty-in-Kind).

How big is the SPR?

The Strategic Petroleum Reserve can hold 727 million barrels of oil.  At the moment it’s full, at 726.6 million barrels.

Here are some figures for comparison:

  • The global oil market is about 86 million barrels per day (bpd).
  • The U.S. consumes about 19-20 million bpd of oil and petroleum products.  We import about half that.
  • The Desert Storm SPR release totaled 21 million barrels.
  • The Katrina SPR release coincidentally also totaled 21 million barrels.
  • There are 42 gallons of oil in a barrel.
  • A barrel of oil results in about 44 gallons of products, including about 19 gallons of gasoline, 10 gallons of diesel, 4 gallons of jet fuel, and 11ish gallons of other stuff.  This means you get a gallon of gasoline from about 2.1 gallons of oil.

As the economy grows, any fixed-size SPR gets effectively smaller. Insurance is measured in “days of import protection”: take the average number of barrels per day that we import, and divide it into the oil we have, and that’s how many days of import protection we have.

The U.S. imports (net) about 10-11 million barrels of oil each day.  At the moment the SPR is full:  there are 726.6 million barrels of oil stored in these salt caverns.  Divide 726.6 M by 10-11 M and you get 66-73 days.

Since you won’t replace lost imports barrel-for-barrel, the number is more of a relative than an absolute measure of how much your insurance is worth.  A significant SPR release might be 100,000 bpd.

We don’t worry about losing all of our imports simultaneously.  Almost one-quarter of our imports come from Canada.  Our next biggest suppliers are Venezuela (11%), Saudi Arabia (10%), Mexico (9%), and Nigeria (8%).  There are risks to each of these (much less so for Canada and Mexico).

A 2005 law requires the SPR to be increased to 1 billion barrels.  President Bush (43) proposed doubling the current SPR to 1.5 billion barrels and increasing the size of our insurance policy.  Congress has not provided significant funding for either expansion.

When should the President release oil from the SPR?

The Saudis are the first line of defense when there is a disruption in global supply.  If that worries you, then figure out ways to use less oil, because the Saudis will always have the largest and lowest cost marginal supply in the world.  The Saudis often/usually have spare production capacity that they hold in reserve.  They appear to have dialed up their production in recent weeks, offsetting most of the recently lost production in Libya.

The phrase severe supply disruption is the key to the President’s decision about an SPR release.  Oil is expensive right now for four reasons:

  1. Fundamentals — The global economy is recovering and demanding more oil.  Global supply and demand are tight.
  2. Some Libyan supply has recently gone offline – maybe 850K – 1M bpd.
  3. Oil market participants are worried that events in Tunisia, Egypt, Libya, and Bahrain could spread to other oil-producing nations in the Middle East and North Africa, further disrupting supply.
  4. Nobody is quite sure how much unused capacity the Saudis have available.

It’s hard to conclusively tease out the price effects of each factor, but policymakers need to try.  High gasoline prices alone are insufficient to justify an SPR release.  You have to look at why prices are increasing.  One expert recently surmised that about $100 of the current $115/barrel world price (Brent) results from tight fundamentals, and the other $15-ish is from actual and feared supply disruptions.

If global economic growth accelerates (oh please oh please), then global demand will increase and the price of oil will continue to climb.  That’s unfortunate and a medium-term economic problem.  It’s not a reason to tap the strategic reserve.

If supplies are further disrupted, for instance by geopolitical events, then that is a viable reason for an SPR release, if the President thinks it is severe enough to justify tapping our emergency reserve.

You also shouldn’t expect an SPR release to have a huge effect on the pump price of gasoline.    With oil around $100/barrel, if the President were to release 100,000 b/d from the SPR, that would probably lower the price of oil by about $2/barrel initially.  That’s about ten cents per gallon of gasoline, maybe a bit more if the release were coordinated with other nations and reduced the fear premium in global oil markets.  The effect would wear off over time as markets adjust to the increased supply.

Should President Obama release oil from the SPR now?

Mr. Gregory asked Chief of Staff Daley if the President is considering releasing the SPR because the price of gasoline has spiked.  He further asked if the President is “considering doing something to arrest that spike.”

The President should consider a release only if he determines there’s a severe supply disruption, not just because the price of gasoline has increased.  And if he does approve a release, it will not “arrest” the price increase at the pump.

The U.S. imports almost no oil directly from Libya – they supply about 0.6% of all our imports.  Most Libyan oil goes to Europe, and some to China.  Still, it’s best to think of oil as if it were a single big global pool.  If more Libyan production were to go offline, prices in Europe would jump.  Oil tankers in the Atlantic headed west for the U.S. might turn around and head east seeking out those higher prices, causing prices to rise in the U.S.  (The reverse happened after Hurricane Katrina – tankers headed for Europe turned around and headed for the Southeastern U.S. after prices jumped from lost Gulf of Mexico supply.)

So far it appears the Saudis are mitigating much of the lost Libyan production.  Based on public information, I think it’s hard to justify an SPR release now.  If a lot more supply goes offline (in Libya or elsewhere), and if the Saudis lack the spare capacity to offset that additional loss, then the President will have a tough call to make.

(photo credit: Department of Energy, Office of Fossil Energy)

The President's hidden trade message

The President's hidden trade message

At the U.S. Chamber of Commerce yesterday the President spoke about trade:

[W]e finalized a trade agreement with South Korea that will support at least 70,000 American jobs – a deal that has unprecedented support from business and labor; Democrats and Republicans. That’s the kind of deal I’ll be looking for as we pursue trade agreements with Panama and Columbia and work to bring Russia into the international trading system.

This sounds like a free trade agenda, or at least a pro-trade agenda, which would be good from a President whose party often leans heavily toward protectionism.  The problem is that the U.S. already has trade agreements with Panama and Colombia.  The President is in reality saying that he is undoing those deals.  He also appears to be saying that “unprecedented support from … labor [and] Democrats …” is a precondition to further progress on free trade.

When President Obama took office, he found three signed Free Trade Agreements (FTAs) on his desk awaiting Congressional approval:  the [South] Korea FTA, the Colombia FTA, and the Panama FTA.

Congress must approve any trade agreement negotiated by the President (more accurately, by his U.S. Trade Representative) with another country.  Under normal legislative procedures, the implementing legislation for a trade agreement would be subject to amendments in Congress.  Since any trade agreement will make compromises that sacrifice certain geographically or economically  limited interests for a broader national benefit, it would be vulnerable to being amended in Congress after it has been negotiated.  Foreign negotiators know this.  They don’t want to negotiate with the USTR and then have their deal reopened by Congress.

The clever solution to this collective action problem is called trade promotion authority (TPA), formerly known as fast track authority.  Congress passes and the President signs a law that gives the President and his USTR authority to negotiate and sign trade deals for a certain number of years.  In this legislation, the Congress limits itself to a simple yes-or-no vote on the whole treaty.  Through this law they surrender their later rights to amend the treaty when it comes before them.  In legislative parlance, we say that the treaty gets a straight up-or-down vote in both the House and Senate.

This binary choice strengthens a U.S. President and his trade negotiator.  While they still must convince the foreign power that they can get Congress to support the agreement being negotiated, they don’t have to worry that Congress will amend the agreement.  This gives U.S. negotiators the ability to get a better deal, because their counterparts have a high degree of confidence that the U.S. team can deliver on its commitments.

The Korea, Colombia, and Panama FTAs were all negotiated under now-expired trade promotion authority that Congress gave to President Bush.  President Bush did not send any of these FTAs to Congress because Speaker Pelosi made it clear she would kill all three trade agreements, either through procedural means or by rallying the votes to defeat them.

When President Obama arrived, he said the South Korea FTA negotiated during the Bush Administration was a bad deal for the United States.  Rather than submitting it to Congress for approval, he directed his USTR Ron Kirk to renegotiate certain parts of it with the Koreans.  Those negotiations resulted in a new Korea FTA which looks a lot like the old one.

The Korea FTA is a big deal for both the U.S. and Korea.  South Korea is our seventh-largest trading partner, and this agreement would rank second only to NAFTA in economic impact on the U.S.  Almost two-thirds of U.S. agricultural exports would immediately be duty-free, and tariffs and quotas on almost all other U.S. agricultural goods would phase out over the next decade.  The treatment of U.S. beef was a hotly contested issue, as the Koreans argued that a 2003 outbreak of mad cow disease in the U.S. justified continued import barriers.  The other contentious issue was trade in autos.

The President now must deal with Republican Speaker John Boehner.  Republicans are by no means universally in favor of free trade, but the party leans more heavily in that direction than Democrats.  Free trade in the U.S. is typically enacted by a center-right coalition.  About a third of Democrats ally with >80% of Republicans to deliver the votes needed.  It is therefore easier for the President to get an FTA through with Speaker Boehner than it might have been with Speaker Pelosi.

In his State of the Union address, the President said,

This [South Korea free trade] agreement has unprecedented support from business and labor, Democrats and Republicans – and I ask this Congress to pass it as soon as possible.

This sounds great.  Other than some complaining by Senate Finance Committee Chairman Baucus over beef (and he is a critical legislative player on trade), the South Korea FTA looks like it’s in good shape.  We finally have a legislative configuration that should allow the implementing legislation to be quickly enacted.

Isn’t it great that this agreement has “unprecedented support from business and labor, Democrats and Republicans?”  The problem is that this unprecedented support, and in particular from labor unions and their allies in Congress, was not costless.  In this case, it slowed things down by two years.

We see from yesterday’s remarks that the President wants this to be the model for future trade agreements.  This gives labor unions and their Congressional allies tremendous leverage to water down or even block FTAs they don’t like.

Some business leaders at the Chamber probably smiled yesterday when they heard the President say “trade agreement … South Korea … Panama and Colombia.”  But opponents of free trade listening carefully heard the President’s hidden message:  I am reopening the agreements with Panama and Colombia, and giving you the ability to block them and other future FTAs by denying your support. If labor and Democrats oppose a future free trade deal, it won’t be “the kind of deal I’ll be looking for.”

This will certainly slow things down, and could easily result in a halt to expanded trade as labor unions and other interest groups that oppose free trade leverage the President’s reluctance to go with a center-right strategy.

The President knows that all the economic juice for the U.S. is in the Korea FTA.  FTAs with Colombia and Panama would be a big deal for those economies, but not for the U.S.  They’re just too small for it to have a measurable economic effect outside of Florida and a few other states.

Congressional Republican leaders fear that they will enact the South Korea FTA and then the President will never get around to finalizing the other two.  The President will repeatedly tout the economic benefits of the Korea FTA.  At the same time he will say he is hard at work on the other two, but never quite able to bring them to conclusion, because they lack “unprecedented support … from labor and Democrats.”  U.S. labor unions that oppose the Colombia FTA argue that the Colombian government has not done enough to crack down on violence against union activists.  Their opposition to the Panama FTA hinges on Panama’s rules for allowing unions to be formed.

If the direct economic benefits to the U.S. of the Colombia and Panama FTAs are small, why should we worry about them?

  • Colombia and Panama are free and democratic allies in Central America.  We want to promote freedom, democracy, and friendship with the U.S. throughout Central America, especially relative to that thug Chavez in Venezuela.  We do that by helping their economies grow; by promoting capitalism, free trade, freedom, and democracy; and by further strengthening our ties with them.
  • Other small countries outside of Central America will learn about the U.S. from how we interact with these two.  We should show the world that we treat all our friends well, not just the ones who can help us economically.
  • Every Free Trade Agreement is a small movement in a positive economic direction.  Economists (and I) generally prefer a few good multilateral FTAs to many smaller bilateral agreements, but I’ll take forward movement wherever we can get it, especially when protectionism is slowly growing around the world.
  • It weakens U.S. trade negotiators in future negotiations when the President (or Congress) reopens past agreements.   It should always be the case when you’re negotiating with the U.S. that a deal is a deal.

If you want to put the President’s strategy in a positive light, you would say that he has found a strategy on Korea that seems to be working.  He renegotiated that FTA and in doing so mitigated significant opposition from the left, making it highly likely that implementing legislation will be quickly enacted.  You would argue that he is now trying to replicate that model with Colombia and Panama, and will submit those for approval when they are good and ready.  His strategy is slow, you would argue, but effective.  You would admit that this strategy damages negotiations with other countries by reopening previously signed deals, but would argue that this is a small price to pay for broader Congressional support for the final deals.

If you’re a skeptic, you are nervous that the President intends to let Colombia and Panama languish after enacting Korea.  This would damage two allies in Central America.  It would undermine our ability to strengthen our ties through free trade with other countries, and it would weaken our trade negotiators who would be less able to convince their counterparts that a signed deal would be final.  It would give opponents of free trade and open investment further opportunities to slow things down and erect other protectionist barriers.

You are further worried that the President is signaling to domestic interest groups that oppose free trade that he will not move forward without them.  This will at best slow progress, and at worst it will kill the Colombia and Panama FTAs, as well as any other free trade opportunities while President Obama is in office.

Senate Minority Leader McConnell and new Senate Finance Committee Ranking Republican Orrin Hatch expressed these concerns in a letter to the President:

We appreciate your support for prompt implementation of the U.S. – South Korea Free Trade Agreement.  … We are disappointed, however, not to see the same level of commitment from your administration for trade agreements with Colombia and Panama. … We urge your support in passing these through Congress without delay.

… Colombia and Panama are key allies of the United States in Latin America, a region of particular strategic importance to our country.  Further delay in implementing these agreements risks sending the signal to other countries in Latin America that the United States is not interested in closer economic engagement in the region and is unable to follow through on our commitments to our allies.

Finally, given what we believe is broad, bipartisan support in Congress for these agreements, we would like to make clear that we see no need for further negotiations with Colombia and Panama.  As currently written, they are solid agreements which benefit our nation and our workers.  We are confident that they would receive strong support in the Senate and the House of Representatives. We urge you to immediately engage with Congress to achieve Congressional approval to get these agreements signed into law as soon as possible.

This letter reinforces the same message from Speaker Boehner, “Now more than ever, America needs strong leadership to complete and implement the three pending trade deals in tandem with one another.”

We should neither abandon our friends in Central America nor risk leaving them behind.  The President should submit and Congress should quickly pass Free Trade Agreements with South Korea and Colombia and Panama.  He should not give labor unions or anyone else the ability to block progress on free trade.  This is an area where Congressional Republicans will happily work with the President, if only he will do the same.

(photo credit: Wikipedia)

The 10 most important American economic policy issues of 2010

Here is my view of the 10 most important American economic policy issues of 2010.

1.  The weak U.S. macroeconomy

In 2010 a weak macroeconomy once again swamped in importance all other economic policy issues.  Forecasters had predicted a tough year — the 9.7% average unemployment rate for the first 11 months of the year is not far above the Administration’s 9.3% forecast for the year.

In 2011 the most important metric will once again be the unemployment rate.  Economically as well as politically the focus will once again be almost entirely on job creation.  We need the economy to be generating hundreds of thousands of net new jobs each month.  That is unlikely but not impossible.

Most forecasters project a stronger U.S. economic growth path in 2011 than 2010, but few are projecting that growth will be robust enough to bring the unemployment rate down rapidly.  While this week’s unemployment claims took a turn for the better, that’s a volatile data set, and the labor picture over the past few months has been weak.  If the forecasts hold up, things will be bad but improving throughout 2011.  You decide whether the politics and press will focus on the bad or the improving part.

Please remember not to lean too heavily on economic projections.  My rule of thumb is that the best macroeconomic forecasts get unreliable six months out and are not much more than guesses beyond a year.

2.  The failure of fiscal stimulus

This trend began in 2009 and solidified in 2010.  The fiscal stimulus debate camps and arguments are well established, and because the debate relies on comparison to a counterfactual it may never be provably resolved, allowing economists to argue ad nauseam.

Whatever your view on the policy question, as a political matter the stimulus failed miserably.  There are a few easily identifiable errors.

  • The President repeatedly took too optimistic of a tone relative to what his experts projected on something that was largely beyond his control.
  • Team Obama gambled and lost by creating an unverifiable “jobs saved or lost” metric.  Sometimes the unverifiability worked for them, but ultimately it broke against them because a job saved by policy is neither provable nor visible.
  • The policy path the President chose in early 2009 (more accurately, the path to which he acquiesced when Congress chose it) set up countless “waste, fraud, and inefficiency” stories throughout 2010.
  • After February 2009, every time the President signed another bill “to create jobs,” he reinforced the message that his first stimulus law was failing or at best insufficient.

3.  The stimulus vs. austerity debate

The U.S. is now left of Germany and the U.K. on fiscal policy in rhetoric if not result.  That is both weird and disturbing.

4.  (Temporary?) enactment of the health care laws

The President and his allies had a huge policy victory here.  I think these laws are an unmitigated disaster, the largest economic policy mistake in a long time.  The President and his allies created a massive new entitlement, spent budget offsets needed to address our long-term spending problem and therefore made future middle class tax increases a near certainty, and turned health insurance into a regulated utility.

The ongoing pushback from Republicans, even after enactment, was a wonderful surprise from a party that had for too long been afraid to debate health policy.  Democrats had to delay implementation of the most expensive provisions for a few years, allowing Republicans time to mount a repeal campaign that continues to build steam.  My first big blog mistake of the year was prematurely declaring the legislation dead after Scott Brown’s surprise victory in Massachusetts.  My second (unpublished) mistake was assuming that the President’s signature was the endgame.  It appears the 2012 Presidential election will be in part a referendum on these laws.

5.  Enactment of financial services reform (Dodd-Frank)

This is another big policy win from the Administration’s perspective.  I have mixed feelings on the law.  Some parts (like creating resolution authority for regulators to shut down too-big-to-fail firms) are essential, others (like the Consumer Financial Protection Bureau) are harmful, and still others (like the long-term resolution of Fannie Mae and Freddie Mac) are unresolved.

Many policymakers appear to have convinced themselves that new policies and structures are (or, in a few years when the regs are complete, will be) in place to prevent large institutions from failing.  I worry that we still don’t have a good solution for the next Black Swan event when (not if) one or more of those huge institutions do fail in spite of the new, better informed, and more powerful regulators.

6.  Carbon pricing implosion

In less than four years carbon pricing has gone from front burner to burnt toast.  The Climategate data fudging scandal undermined a previously strong positive public perception of climate scientists and their advocacy.  In Copenhagen the global negotiations imploded after confronting the problem of the China-India hole in the U.S./green strategy.  A Democratic House and Senate could not agree to carbon pricing legislation, demonstrating that regional economic perspectives are at least as important as policy philosophy.  The President walked a tightrope between demonstrating to greens that he was with them and allowing himself an exit strategy when legislation inevitably failed.  West Virginia Governor (and now Senator) Joe Manchin erased any doubt by literally shooting the Waxman-Markey bill in a campaign ad.

We now appear headed down the worst possible policy path.  Congress will not enact legislation but the Environmental Protection Agency will start regulating greenhouse gas emissions and allowing/encouraging States to do so.  This is the most economically burdensome way to regulate carbon emissions.  It will be large enough to impose significant constraints on domestic power production and heavy manufacturing now, and maybe on other sectors later.  Yet any reductions in U.S. emissions will be small relative to uncapped increases from China and India.  EPA’s rules and Congressional efforts to block them will create policy uncertainty, deterring needed investment in the expansion of U.S. power production and slowing long-term economic growth.  EPA’s regulatory authority always served two purposes to those who want to price carbon:  as a threat to try to force legislative action, and as a costly fallback if legislation failed.  The fallback option never made sense.  It should but probably won’t be abandoned.

7.  The Democratic Congress’ budget failures

From the perspective of Congressional Democrats, the health care and financial services victories counterbalance their two fiscal policy failures in 2010.  Tax rates on income and capital will not increase during President Obama’s first/only term.  They failed to enact full-year appropriations bills to fund the government, resorting instead to short-term continuing resolutions.  The new Congress will have to complete the leftover appropriations work in early 2011.  Many of the President’s spending goals will be unmet as he wrestles with a Republican House majority with very different priorities.  I am pleased with both outcomes, which exceeded my initial expectations.

Both results can be traced directly to decisions by Speaker Pelosi, Senate Majority Leader Reid, and their respective Budget, Tax, and Appropriations Chairmen.  They failed because they didn’t even try to govern.  They never tried to pass a budget resolution, they delayed action on taxes until the last possible minute when Republicans were strongest, and they never tried to pass appropriations bills in the Senate.  They missed an opportunity to create a reconciliation bill that would have allowed them (and the President) to win the tax extension debate.  In each case these were unforced errors by Democratic Congressional leaders that significantly affected the fiscal policy outcomes of 2010.

8.  Rise of the Tea Party

I have not much to add here other than to recognize that the small government impetus began with the early 2009 Santelli rant and exploded into summer 2009 Town Hall opposition to Obamacare.  I now think of it not as a political party, but instead as a strong and deep anti-TARP-autos-bailout-stimulus-Obamacare-cap-and-trade-government-spending-earmarks-deficits sentiment.  In simpler terms it’s a powerful populist pushback against the expansion of government.  Over the next two years Republicans can succeed to the extent they respect this sentiment and push for smaller government and a bigger private sector.

9.  Increasing awareness of medium-term fiscal problems

The bad news is America’s long-term fiscal problems are now medium-term fiscal problems.  The good news is that Americans are increasingly aware of those problems, and pressure is building on elected officials to solve them.  While nothing transformative on this front happened in 2010, several trends are important to note.

  • The shift from long-term to medium-term is a result of two factors: (1) inaction on entitlement spending over time by both parties; (2) enormous short-term deficits that are wiping out a projected temporary deficit trough before the Baby Boom spending wave hits.  Those enormous short-term deficits result from (1) the weak economy; (2) actions taken to recover from the weak economy; and (3) a generic expansion of government spending unrelated to economic stimulus.
  • In February the President’s budget launched this round of fiscal debate by intentionally leaving a large deficit hole to be plugged by recommendations from a new Presidential fiscal commission.  The President’s goals for that commission were too focused on the short run, and it’s unclear whether he intended the commission to solve the problem, provide him with cover for a proposal in early 2011, or just to buy him time through a mid-term election year.  Nevertheless, the commission reported in December with a bipartisan package of spending reforms and tax increases, teeing the issue up nicely for 2011.
  • Enormous 2009 and 2010 deficits and massive spending increases in those years raised the prominence of both the size of government and fiscal imbalance as important policy issues.
  • Fiscal crises in Europe and looming fiscal crises in various U.S. States focus attention on the U.S. federal fiscal problem.

It’s always safe to bet against a big painful fiscal policy change, but if it’s ever going to happen, 2011 seems like as good a year as any.  The 1997 budget deal was done by President Clinton, Speaker Gingrich, and Majority Leader Lott, a D-R-R alignment.  This time we have a D-R-D alignment.

10.  Round 2 of the Obama economic team

Three of the four key Obama economic advisor slots will be manned by different personnel in 2011 than a year earlier.

Out (voluntarily):  Larry Summers (NEC), Peter Orszag (Budget), and Christina Romer (CEA)

In:  Jack Lew (Budget), Austan Goolsbee (CEA), ??? (NEC)

  • The departure of WH COS Rahm Emanuel and upcoming departure of Senior Advisor David Axelrod will also have a big effect on economic (as well as other) policy.  My sources say they were heavily involved in almost all major economic decisions, sometimes operating as a separate decision-making layer between the economic team and the President.
  • Treasury Secretary Geithner and NEC Deputy Jason Furman are now the institutional memory of the Obama economic team.
  • Both Lew and Goolsbee are insiders who were promoted.
  • The President should have filled (or at least announced) Summers’ successor at NEC weeks ago.  The fall is policy development time in the White House, and the President hurt himself by not having in place a successor to his top White House economic advisor.

Have a Happy New Year.

(photo credit: Takras)


Cliff Notes: The President's Carnegie Mellon economic speech

Cliff Notes: The President's Carnegie Mellon economic speech

Last Wednesday the President spoke about the economy at Carnegie Mellon University. Administration officials billed this as a major economic address, the follow-up to his speech last April at Georgetown. I think the most accurate and fairest way to understand the views of an elected official begins with what he or she says. The problem is that this speech is more than 5,000 words, so almost no one will read the whole thing.

In summarizing it I still ended up at around 1,300 words. Think of it as getting 75% savings.

I will respond to the speech soon. For now, this is my attempt at a non-judgmental summary. Where you don’t see quotation marks I am paraphrasing him, fairly I hope.

The speech naturally breaks into three parts:

  • Part I: The Choice
  • Part II: The Foundation
  • Part III: The Laundry List

There are some obvious topical subdivisions which I have labeled.

Part I: The Choice

The oil spill is my top priority.

The macroeconomy

I inherited an extremely weak economy, “one of the worst economic storms in our history.”

I took bold and unpopular actions, and they worked. “These steps have succeeded in breaking the freefall.”

“We’re again moving in the right direction.”

“This economy is getting stronger by the day.”

[But] “It’s not going to be a real recovery until people can feel it in their own lives.”

“In the immediate future, this means doing whatever is necessary to keep the recovery going and to spur job growth.”

Why we need a new foundation

The last ten years were terrible economically for American families. “Some people have called the last 10 years ‘the lost decade.'”

There has been “a sense that the American Dream might slowly be slipping away.”

China and India and Europe are “building high-speed railroads and expanding broadband access.” They’re making serious investments in technology and clean energy because they want to win the competition for these jobs.

We can’t afford to return to the pre-crisis status quo. We can’t go back to an economy that was too dependent on bubbles and debt and financial speculation.”

“We have to build a new and stronger foundation for growth and prosperity … and that’s exactly what we’ve been doing for the last 16 months.

It’s a foundation based on investments in our people and their future; investments in the skills and education we need to compete; investments in a 21st century infrastructure for America, from high-speed railroads to high-speed Internet; investments in research and technology, like clean energy, that can lead to new jobs and new exports and new industries.

This new foundation is also based on reforms that will make our economy stronger and our businesses more competitive — reforms that will make health care cheaper, our financial system more secure, and our government less burdened with debt.”

International & Trade

“We have to keep working with the nations of the G20 to pursue more balanced growth.”

“We need to coordinate financial reform … so that we avoid a global race to the bottom.”

“We need to open new markets and meet the goal of my National Export Initiative: to double our exports over the next five years.”

“We need to ensure that our competitors play fair and our agreements are enforced.”

Republicans are partisan and for no government

Republicans keep saying no to everything we’re doing.

“And some of this, of course, is just politics.”

“But to be fair, a good deal of the other party’s opposition to our agenda has also been rooted in their sincere and fundamental belief about the role of government. It’s a belief that government has little or no role to play in helping this nation meet our collective challenges. It’s an agenda that basically offers two answers to every problem we face: more tax breaks for the wealthy and fewer rules for corporations.”

“The last administration called this recycled idea ‘The Ownership Society.’ But what it essentially means is that everyone is on their own. No matter how hard you work, if your paycheck isn’t enough to pay for college or health care or childcare, well, you’re on your own. If misfortune causes you to lose your job or your home, you’re on your own. And if you’re a Wall Street bank or an insurance company or an oil company, you pretty much get to play by your own rules, regardless of the consequences for everybody else.”

My philosophy of government is a middle ground, rejecting too much government

“Government cannot and should not replace businesses as the true engine of growth and job creation.”

“Too much government can deprive us of choice and burden us with debt.”

“But I also understand that throughout our nation’s history, we have balanced the threat of overreaching government against the dangers of an unfettered market.”

“[O]ne-third of the Recovery Act we designed was made up of tax cuts…”

“[D]espite calls for a single-payer, government-run health care plan, we passed reform that maintains our system of private health insurance.”

The choice

Republicans/Conservatives/Big Business have argued against many good things done by government: Social Security, Medicare, deposit insurance, seat belts, clean air and water.

“And all of these claims proved false. All of these reforms led to greater security and greater prosperity for our people and our economy. And what was true then is true today.”

“For much of the last 10 years we’ve tried it their way.”

“And now we have a choice as a nation. We can return to the failed economic policies of the past, or we can keep building a stronger future. We can go backward, or we can keep moving forward.”

Part II: The New Foundation

“The first step … has been to address the costs and risks that have made our economy less competitive — [1] outdated regulations, [2] crushing health care costs, and [3] a growing debt.”

Financial reform is good and “sweeping”

It “will help prevent another AIG”

“It will end taxpayer-funded bank bailouts.”

“It contains the strongest consumer protections in history.”

Health care reform

We did health care reform because “we can’t compete in a global economy if our citizens are forced to spend more and more of their income on medical bills; if our businesses are forced to choose between health care and hiring; if state and federal budgets are weighed down with skyrocketing health care costs.”

“The costs of health care are not going to come down overnight just because legislation passed, and in an ever-changing industry like health care, we’re going to continuously need to apply more cost-cutting measures as the years go by.”

Health care reform did good things.

“The other party has staked their claim this November on repealing these health insurance reforms instead of making them work. They want to go back. We need to move forward.”

Deficits and debt

Thanks to the Bush tax cuts and prescription drug benefit, I inherited a $1 trillion one-year deficit and projected deficits of $8 trillion over the next decade.

I inherited a severe recession “and the effects of the recession put a $3 trillion hole in our budget before I even walked through the door.” Additionally, the steps that we had to take to save the economy from depression temporarily added more to the deficit … about $1 trillion. Of course, if we had spiraled into a depression, our deficits and debt levels would be much worse.

“Now, the economy is still fragile, so we can’t put on the brakes too quickly. We have to do what it takes to ensure a strong recovery.”

We need to extend unemployment insurance.

We need to give more money to state and local governments so they don’t have to fire teachers.

“There are four key components to putting our budget on a sustainable path. Maintaining economic growth is number one. Health care reform is number two. The third component is the belt-tightening steps I’ve already outlined to reduce our deficit by $1 trillion. … The fourth component is [the Fiscal Commission.]”

Part III: The Laundry List

Education reform

  • Race to the Top
  • Replace guaranteed student loans with direct loans
  • “Revitalize our community colleges”


  • High-speed rail
  • High-speed broadband
  • Clean energy subsidies


  • “I supported a careful plan of offshore oil production as one part of our overall energy strategy. … But … only if it’s safe, and only if it’s used as a short-term solution while we transition to a clean energy economy.”
  • “It means tapping into our natural gas reserves, and moving ahead with our play to expand our nation’s fleet of nuclear power plants.”
  • We need to “put a price on carbon pollution.”
  • We will get “a comprehensive energy and climate bill” done.

Research and innovation

  • Make the research and experimentation tax credit permanent.

“The role of government has never been to plan every detail or dictate every outcome. At its best, government has simply knocked away barriers to opportunity and laid the foundation for a better future. Our people — with all their drive and ingenuity — always end up building the rest. And if we can do that again — if we can continue building that foundation and making those hard decisions on behalf of the next generation — I have no doubt that we will leave our children the America that we all hope for.”

(photo credit: Obama Visits Carnegie Mellon IX. by Patrick Gage)

Chicago’s Olympic bid & the President’s trip

Chicago’s Olympic bid & the President’s trip

I generally stick to pure economic policy issues, but will stray a bit to discuss the 2016 Olympic bid.  I am a bit of an Olympics nut, and the intersection with the Washington debate interests me.

I attended two Olympics, the Barcelona ’92 games and the Atlanta ’96 games.  I worked as a volunteer at the Atlanta Games.  I hope to attend many future Olympics to support American athletes.

In the Summer of 2008 I ran a small project in the White House, in which members of the White House staff sent personal letters to every member of the U.S. Olympic team in Beijing.  The letters were delivered to the athletes in their residential village.  It was a small gesture of support, but neat to know that each athlete representing the USA knew they had a specific person in the White House rooting for them.  A few dozen durable friendships were created by this effort, and many of the US Olympians brought their families to the White House for West Wing tours given by their new staff friends.

President Bush enjoyed enormously his time at the Beijing Summer Games, as well as the athletes’ visits to the White House.  One comment in particular struck me:  the President said that the American athletes were universally appreciative that he attended.  To them, the President was a symbol of America, not a representative of any particular political party or policy agenda.  By attending the games and supporting the team, he was demonstrating that America supports her athletes in competition with other nations.

I apply the same approach to President Obama’s trip to Copenhagen in support of Chicago’s bid to host the 2016 Summer Games.

  • I am glad the President went to Copenhagen to support the Chicago bid.
  • Yes, it represents a signaling of Presidential priorities, and yes, national security issues and health care reform are top policy priorities.  Presidents attend symbolic public events several times each week, and these events consume very little of their time.  The only thing differentiating this event is the additional time and expense of traveling to Copenhagen.  Hosting the Olympics is an element of soft power, and the host country generally benefits on the world stage.  Chicago’s loss is therefore America’s loss.
  • Federal funds do not directly support American cities when they host the Olympics.  That makes sense to me.  The Olympics are a private operation, and as a general matter federal taxpayers should not be funding it.  If a city wants to spend their own funds, that’s a decision for their local officials and citizens.
  • When an American city does host, federal funds are expended to the extent there are national and homeland security interests at stake.  This seems entirely appropriate.  The same is true for many “events of national significance,” like the Presidential Inaugural, the fireworks in DC on Independence Day, or the Super Bowl.
  • Similarly, the taxpayer-financed cost of the President’s trip to Copenhagen doesn’t bother me.  I look on this as a diplomatic trip.
  • This is particularly true given that the bid city was the President’s hometown.  I would have thought it odd had he not flown to Copenhagen to support Chicago.
  • He took a risk by placing his personal prestige on the line.  Then again, had he not traveled to Copenhagen and Chicago lost, he would be heavily second-guessed now. “If only he had attended …”
  • There is a principled conservative argument that he should not have gone, based on other higher priority uses of his time.  I do not subscribe to that argument, but it’s a reasonable argument to make.  This is clearly one of those diplomatic judgment calls that belongs solely to the President.
  • I strongly disagree with those on the right who cheer the Chicago bid loss as a diminution of a President whose policy agenda they oppose.  I have strong policy disagreements with the Obama Administration, including on some international issues.  But I never want him to fail when he is representing the U.S. in a diplomatic environment, even when I disagree with the policy agenda he is promoting.  A weaker American President on the world stage hurts America as a nation.  It’s wrong to cheer when our President is perceived as having failed overseas, and it’s counterproductive and foolish to focus too narrowly on the domestic partisan battle.
  • It’s the flippin’ Olympics.  Cut the guy some slack.

To those who claim that Chicago lost the bid because the rest of the world hates the U.S. because of the policies of the Bush Administration, I recommend a little deeper research into the internal politics of Olympic organizations.  My conversations suggest that Chicago was instead harmed primarily by the past behavior (under prior leadership) of the U.S. Olympic Committee in its dealings with the International Olympic Committee and other National Olympic Committees.  When the Olympics are held in the U.S., the global advertising revenue is much higher, and so there is a bigger revenue pie for the National Olympic Committees and the IOC to fight over.  At the same time, there is an ongoing dispute about how to divide up that pie, and I understand the IOC’s denial of Chicago to be in part related to those negotiations.  It looks to me like the IOC chose to award the host city to South America for the first time ever, as well as to send a signal to the USOC about their past behavior in the long-term international negotiation about Olympic advertising revenues.

There may have been payback against America in denying the Chicago bid, but as best I can tell it had much more to do with Olympic revenue-sharing and power struggles than with global diplomacy or the pitch made by President Obama.

I applaud President Obama for having traveled to Copenhagen to support Chicago’s bid.


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