America appears to lack a high-probability strategy for how to get China, India, and Russia to agree to self-impose a significant positive carbon price.

The Administration and its Congressional allies are trying to impose a significant carbon price in the U.S. through something like the Waxman-Markey bill, while entering an international negotiation process in which as much as 60% of global carbon emissions could face little to no carbon price.  The likely outcome would dramatically tilt the global economic playing field, harming U.S. workers and firms relative to their counterparts in China and India.  At the same time, it would make little progress toward addressing the risk of severe global climate change, as a large portion of global carbon emissions would remain effectively uncapped.

In that post I identified two questions that American policymakers need to answer to fill that hole.  The first of those was:

What tools should we use to try to convince the government of China to impose a positive carbon price as part of a global effort?  (choose one or more)

1. Leadership:  U.S. goes first and self-imposes a price.  Then we use diplomacy to try to convince the Chinese to do the same.
2. Carrots:  The U.S. pays the Chinese to reduce their emissions.
3. Sticks:  The U.S. imposes import tariffs on Chinese goods as long as the government China does not impose a carbon price.

I now see that I was eight days behind Dr. Paul Krugman in identifying this challenge.  On May 14th, he wrote in his New York Times column “Empire of Carbon”:

(T)he people I talk to are increasingly optimistic that Congress will soon establish a cap-and-trade system that limits emissions of greenhouse gases, with the limits growing steadily tighter over time. And once America acts, we can expect much of the world to follow our lead.

… But that still leaves the problem of China, where I have been for most of the last week. … But China cannot continue along its current path because the planet can’t handle the strain. … And the growth of emissions from China — already the world’s largest producer of carbon dioxide — is one main reason for this new pessimism.

I’d like to compare where I think Dr. Krugman stands on various elements of the strategic question I posed, and compare them with my own views.  We differ in our concern about the risks and costs of severe climate change, and that difference leads us to radically different policy recommendations.

I should state at the outset my views on the science and risk of climate change.  There is a significant amount of evidence that there is a long-term risk of severe climate change.  But there is little discussion about the numbers:  How big of a risk?  How much warmer?  How quickly?  How certain are we?  And the numbers matter a lot.  If we knew with certainty that Earth would warm 10 degrees over the next 20-30 years, I would be screaming for an immediate big carbon tax.  If instead we think Earth is likely to warm one degree over the next century or two, then climate change is a trivial concern and we needn’t worry about it.  The problem is that nobody knows where we are between these two extremes.  This uncertainty matters a lot, and it makes the problem hard.

Given this uncertainty, I believe there is a small but non-trivial risk that there will be severe climate change over the next century or two.  And so I am willing to consider significant and effective policy actions to slow the growth of greenhouse gas emissions to reduce that risk.  I do not, however, believe that risk is so great or so certain that we must immediately commit to drastic changes in our economy, or that we must ignore the costs of those policy actions.  I treat this like any other policy question:  Given tremendous quantitative uncertainty, what are the marginal costs and benefits of our current emissions path, compared with various recommended policy options?  I will quantify my thinking on these questions in a separate post.  I am willing to consider policies to set a domestic carbon price, if I can be convinced that they’re worth it and will work.  So far I have not seen any carbon pricing proposal that I think (a) would have benefits that exceed the costs, and (b) is feasible in the real world of nation-states with differing national interests.  But I’m open to suggestions.

For now, let’s focus on two different answers to the China/India question in the American climate strategy.

• Dr. Krugman appears to believe that, if China does not slow its global greenhouse emissions growth, actions by the rest of the world will be insufficient to significantly slow global emissions.  Krugman:  “In January, China announced that it plans to continue its reliance on coal as its main energy source and that to feed its economic growth it will increase coal production 30 percent by 2015.  That’s a decision that, all by itself, will swamp any emissions reductions elsewhere.”  I agree with him on this point.
  
• I agree with Dr. Krugman’s read of the official Chinese position:  “So what is to be done about the China problem?  Nothing, say the Chinese.  Each time I raised the issue during my visit, I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels.”  This is consistent with what I know about the Chinese position from our Administration negotiators in 2007 and 2008 , and with what the Financial Times reported last Friday:  “Beijing reiterated its belief that developing countries, including China, should curb emissions on a voluntary basis, and only if the cuts ‘accord with their national situations and sustainable development strategies.’”  Translation:  We’re not setting a domestic carbon price.  The Chinese are proposing that the U.S. and other rich nations choose answer (B) Carrots from my menu above:  rich countries pay China to reduce their emissions.
• It appears that Dr. Krugman believes Chinese leaders will not be swayed by option (A) Leadership:  “And once America acts, we can expect much of the world to follow our lead.  But that still leaves the problem of China …”  I largely agree with him on this point.
• Dr. Krugman appears to presume that we must slow the growth of global greenhouse gas emissions starting now. I disagree with Dr. Krugman on this point, and am more persuaded by Dr. Bjorn Lomborg.  The state of technology is such that economic costs of near-term emissions reductions are high, and the long-term climate benefits are small.  As an example, Dr. Lomborg estimates that $1 expended through the Kyoto agreement would produce the equivalent of about 30 cents of long-term climate benefits.  To the extent you believe long-term climate change must be addressed, we are better off devoting resources to technology pushes that try to reduce the cost of carbon-r

  educing technologies.  The less expensive these technologies, the easier it is for everyone to make significant emissions reductions, and the easier it would be to get a global emissions reduction agreement that includes China and India (presuming you think such an agreement is necessary).

• Since Dr. Krugman believes that we must persuade the Chinese to change their growth path “because the planet can’t handle the strain,” he appears to conclude that we should threaten a carbon import tariff.  His phrasing is quite careful, but he is clearly floating the idea:

As the United States and other advanced countries finally move to confront climate change, they will also be morally empowered to confront those nations that refuse to act. Sooner than most people think, countries that refuse to limit their greenhouse gas emissions will face sanctions, probably in the form of taxes on their exports. They will complain bitterly that this is protectionism, but so what? Globalization doesn’t do much good if the globe itself becomes unlivable.

• Technically, Dr. Krugman does not say (1) the U.S. (2) should propose (3) a carbon import tariff.  He instead predicts that “sanctions, probably in the form of taxes on their exports” will be imposed by unnamed countries “sooner than most people think.”  By itself, this is only a prediction,  But in the following two bolded sentences, he endorses such “sanctions, probably in the form of taxes on [Chinese] exports” by unnamed countries.  With this clever phrasing, Dr. Krugman has floated an aggressive but ultimately deniable policy proposal:  a carbon import tariff.
• I believe there are cures that are worse than the disease.  An import tariff would be protectionist (Dr. Krugman concedes this point).  In the context of a global climate change negotiation in which different countries are establishing different domestic carbon prices, and in which two of the world’s largest economies (China and India) refuse to do the same, it is easy to see how a carbon import tariff by the U.S. could set off a global trade war, with potentially devastating effects on the world economy.  It appears that Dr. Krugman is willing to bear the increased risk of a global trade war for the benefit of an increased probability that China (and India?) will slow their greenhouse gas emissions.  I am not.

For completeness, my answer to my own strategic question is “(D) None of the above.”

• Even if the U.S. establishes a domestic carbon price through a cap-and-trade or carbon tax, diplomacy alone will be unable to convince the Chinese and Indian leaders to do the same in their countries.   Option (A) Diplomacy won’t work by itself.
• Without reductions in Chinese and Indian emissions, I expect that the total climate benefits of the likely global reductions in future emissions growth would not be worth the economic costs to the U.S. of a domestic carbon price (in the near term).
• I oppose the U.S. paying large developing countries like China and India to reduce their emissions.  I am confident the U.S. Congress would agree with this view.  Option (B) will not happen in the U.S., nor should it.
• Because I think the risks of significant damage from severe climate change are small, and the costs of near-term emissions reductions using current technology are high, and because I am deeply concerned that a carbon import tariff might provoke a global trade war, I strongly oppose option (C) Sticks, including any form of carbon import tariff.  Free trade, including with China, is more important to me than the possibility of creating leverage on Chinese leaders to try to change their energy development path.
• We are not talking about small numbers here.  China thinks developed countries should contribute 1/2 – 1 percent of GDP to help poorer countries cut their emissions, and the economic effects of domestic carbon prices are measured in the same orders of magnitude.  When you’re measuring things in percent of GDP, you’re shooting with real bullets.  I oppose imposing such a tariff, threatening one, or even floating the idea as Dr. Krugman has done.
• Therefore, I conclude the best policy is for the U.S. not to impose a domestic carbon price in the near future.  To the extent policymakers believe severe climate change is a risk that should be addressed, I instead recommend they focus on pushing carbon-reducing technology R&D, and reducing tariffs and other trade barriers to the exchange of such technologies, as Dan Price has recommended.
• I would be comfortable with the U.S. contributing taxpayer funds to a joint international R&D effort, if it were an alternative to a domestic carbon price, and as long as U.S. firms maintained their property rights to such research.

I have tremendous respect for Dr. Krugman’s past work as an international economist.  I am surprised that he is willing to risk a global trade war, and that he would apparently fire the first shot when the global economy is so weak.

The Smoot-Krugman carbon import tariff

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. The wrong way to address climate change
2. The G-8 agreement (especially on climate change)
3. What did President Bush announce today on climate change?

Keith Hennessey, a former top economic adviser to President George W. Bush, saw this one coming. He rightly predicted that the Group of 20 would drop a key word from its communique at the conclusion of the London Summit: Free.

Here is my original post from Wednesday:  A quick guide to the G-20 summit.

Unfortunately the problem is even bigger than just dropping the word “free” before “markets.”  Let’s compare the text of the November G-20 leaders’ declaration and the April G-20 leaders’ declaration.

Here is the key paragraph from the November summit, hosted in Washington by President Bush.  Thanks to President Bush’s negotiators, led by his “Sherpa,” Dan Price, and Treasury Under Secretary for International Affairs Dave McCormick, the following text is incredible.  Last November, I wrote about this paragraph:  “Let’s look at some important wins in the actual text of the declaration.  Formerly Communist China and Russia (along with all the other participating nations) agreed to the following text.”

12. We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems. These principles are essential to economic growth and prosperity and have lifted millions out of poverty, and have significantly raised the global standard of living. Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.

Let’s parse it a bit:

1. “… a commitment to free market principles …”
2. “… rule of law …”
3. “… respect for private property …”
4. “… open trade and investment …”
5. “… competitive markets …”
6. “… and efficient, effectively regulated financial systems.”
7. “… we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows …”

Now let’s examine yesterday’s text:

3.  We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared; and that our global plan for recovery must have at its heart the needs and jobs of hard-working families, not just in developed countries but in emerging markets and the poorest countries of the world too; and must reflect the interests, not just of today’s population, but of future generations too. We believe that the only sure foundation for sustainable globalisation and rising prosperity for all is an open world economy based on market principles, effective regulation, and strong global institutions.

Parsing this new language:

1. “… a commitment to free market principles …” has been replaced by “… based on market principles …”.  Note that the word “free” is nowhere in the document.
2. “… rule of law …” is nowhere in the document
3. “… private property …” is nowhere in the document
4. “… open trade and investment …” has been replaced by “… open world economy …”  (This one is fine, I think.)
5. “… competitive markets …” and the word “competitive” are nowhere in the document
6. “… efficient, effectively regulated financial systems” has been replaced by “effective regulation, and strong global institutions.”
7. The over-regulation caution is gone.

What makes this so disappointing is that all G-20 nations agreed to the November text.  It should have been an extremely easy lift for negotiators from capitalist countries to insist that this leaders’ declaration merely repeat what the leaders agreed to last November.

Wednesday I wrote, “In the short run, it is easy to see how a negotiator might give this up for a more concrete immediate objective.  In the long run, few things are as important.”

What happened to FREE markets in London?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. What was accomplished at the G-20 Summit?
2. President Bush’s speech on financial markets and the world economy
3. A quick guide to the G-20 summit

I wrote last November about the first G-20 Economic Summit, initiated and hosted by President Bush.  You can see some neat behind-the-scenes photos of the gorgeous National Building Museum and read about the accomplishments of that summit.  Last November the press tried to write the story “Lame duck President … not much accomplished.”  That storyline was incorrect.  Now we have a new American leader and one fundamental policy shift, but much of the agenda remains consistent.

There is a symbolically important change to watch for in the text of the leaders declaration, compared to that in the November text.  I fear that the word “free” may be absent in the successor statement to this sentence from the November leaders declaration:

12.  We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems.

Losing “free” would be an enormous step backward.  All G-20 nations agreed to the above statement last November, so there is no good reason to change it if the U.S. objects.  In the short run, it is easy to see how a negotiator might give this up for a more concrete immediate objective.  In the long run, few things are as important.  I hope the American team will insist on repeating this language, and in particular keeping the phrase “a commitment to free market principles,” as our negotiator did last fall.

Four of the five major topics of discussion at the summit are extensions and continuations of the November efforts.  There is one big difference, influenced greatly by our new President.  After reviewing the available press and talking with Dan Price, President Bush’s “sherpa” for the first G-20 summit last November, here are my expectations for the London G-20 summit.

1. Global macroeconomic stimulus — The big difference is the new #1 agenda item for the G-20, global macroeconomic stimulus.  President Obama’s first domestic economic policy effort was the enactment of a law that he argues will stimulate near-term macroeconomic growth.  He is pushing other nations to take similar actions, and for the G-20 as a whole to support similar global efforts.

   I expect the final G-20 statement will broadly support national actions for macroeconomic stimulus, but will not include any numbers.  It will say something like “Nations should do what is necessary…”  It may also emphasize the fiscal actions already taken by a large number of nations.  Reading between the lines of President Obama’s answer to a question in a press conference this morning confirmed this expectation.

2. Financial market stabilization — I expect this will be a continuation of efforts in November, but with some details fleshed out.  The final statement will likely highlight three subgoals to financial stabilization: restarting lending, enhancing the capital structure of financial institutions (aka recapitalizing banks), and dealing with toxic assets.  This is consistent with discussions from last fall, but I expect a greater American emphasis on the last item from the new team.

3. Regulatory reform – While financial market stabilization focuses on short-term actions the G-20 nations need to take, the regulatory reform section will focus on longer-term reforms to reduce the chance that these same problems recur in the future.  The negotiators and their staffs have spent a lot of time on these issues, and I expect the final product will continue to flesh out the construct created last November, with a lot of details now filled in.

   I expect an emphasis on improving oversight and greater cooperation among national regulators.  To my delight, I do not anticipate any mention of any sort of “single global regulator.”  There is a so-called “college of supervisors” that was part of the November and prior efforts, but my expert advisors on this subject assure me that this group is about coordination, not the creation of a supra-national sovereign group.  Participant nations appear interested in coordination of national efforts while maintaining national sovereignty.  This is a big deal for me.  Let’s work together, but Americans should have the final say in what America does.

   There is an interesting debate about “convergence” of national regulatory structures that underlies this question.  I expect the statement will emphasize the goal of “convergent” regulatory structures.  A tension exists between two goals.  We want a level playing field across nations so that government policies distort capital flows as little as possible.  In this respect, convergence of national regulatory structures can be a good thing.  At the same time, if they converge to a consensus position that is unwise, then that’s a bad thing.  My own instinct is to worry that, in a politically governed process negotiated by national governments and regulators, there will be a tendency to converge to a structure that is overly restrictive and burdensome.  This is a tension that will play out in obscure international regulatory fora over months and years, and can have long-lasting and important consequences on the international flows of capital.  I could be OK in theory with “convergence” language, if I knew what the final details would look like.  Since no one can know that in advance, “convergence” language makes me nervous now, as it did last November.

   I further expect that the regulatory reform section will talk about the importance of better oversight of “systemically important institutions” (read:  too-big-to-fail) in ways that parallel how Secretary Geithner, and Secretary Paulson before him, and Chairman Bernanke, have spoken about the issue.  This will send an international signal that the problem of regulation of institutions that are deemed to be too big to fail is a critical area for future policy development.  My own view is that this is the big enchilada.  I trace back much (most?) of our current financial pain, as well as almost all of the tension between Wall Street and Washington, to consequences from being on the back end of a too-big-to-fail problem, where all options are terrible.  I think it’s our primary long-term financial policy challenge.  I wrote about the causes of the financial crisis last October, following a speech by President Bush.

   There is an important follow-on question about the relative importance of strengthening the oversight of huge banks and insurance companies on the one hand, versus expanding regulation into hedge funds and private pools of capital on the other.  I am absolutely convinced that the former needs major reform.  I am far less certain that the second is as large of a problem.  I am in the minority in this view.  This is a topic for further discussion.

   I also anticipate that the final statement will say something on tax havens.  My views here on international convergence of taxation differ significantly from those expressed in the past by those who are now senior American officials.  I will refrain from commenting while they are overseas negotiating.  They have the ball for America.

   I expect the regulatory reform section will talk about the importance of moving the trading of Credit Default Swaps (CDS) onto organized exchanges, which parallels efforts that Secretaries Paulson and Geithner have pushed here in the U.S.  This is a good and important thing.

   I expect the statement will continue to flesh out work to harmonize accounting standards.  This is simultaneously mind-numbingly boring and incredibly important.

   There will also be some structural changes to the Financial Stability Forum – they will change the name to the Financial Stability Board and add more members from the G-20.  They will also have language, I think, similar to that in the November document on executive compensation.

4. Increased resources for the IMF and restructuring of the World Bank and IMF – One of the advantages of being Treasury Secretary is you get some leeway to push issues that are important to you.  Secretary Geithner has spoken of tripling the IMF’s budget, and Prime Minister Gordon Brown has spoken of doubling it.  We will see where the number ends up, but it’s clearly going to increase.  I am interested to see how willing Congress will be to fund the increased U.S. contribution.

   They will also change the governance structure of the IMF and World Bank.  I anticipate that China and other developing countries will get more weight in decisions of these international bodies, but only if they pay their share of the budgets.  There is an important thematic here for China and India that crosses a range of international economic policy issues.  In international negotiations, China and India sometimes try to have it both ways.  Their negotiators argue they should have the same say in international economic policy questions as major developed economies like the U.S., Japan, and major European economic powers.  At the same time, they plead poverty and argue that they cannot possibly sacrifice economic growth for the global good.  My view is:  in or out.  You decide.  If you want to be a first-tier economic nation, that’s fantastic.  You play by the same rules as everyone else, and you make the same sacrifices for the global good.  You cannot have it both ways.

   Finally, I anticipate the U.S. and Europe will give up what some call the “knightship rights” of choosing the leaders of the World Bank and the IMF.  I expect one result will be some kind of new (supposedly) merit-based selection process.

5. Fighting protectionism – This is the topic that I hope will make almost all of the G-20 leaders uncomfortable.  In November the G-20 leaders agreed to a fantastic strong statement that opposed protectionism, in which they said,
   

   We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary.

   And yet on March 17th the World Bank reported that 17 of the G-20 nations “have implemented 47 measures that restrict trade at the expense of other countries.”  The U.S. is one of the 20, and the World Bank highlighted “the US direct subsidy of $17.4 billion to its three national [auto] companies.”  President Obama’s Monday announcement extending the auto loans make this a challenging topic for him in London.

   I’d like to praise World Bank President (and former U.S. Trade Representative and Deputy Secretary of State) Bob Zoellick for this excellent and well-timed study.  We need more “name and shame” tools to highlight protectionist actions by governments.  The fragile world economy makes it even more important that everyone push for free trade and open investment.

   Dan Price was President Bush’s international economic advisor in the White House, and also the President’s “sherpa” for the November G-20 summit.  Dan suggests that President Obama could demonstrate U.S. leadership with a move that promotes both free trade and his clean technology agenda, by getting the G-20 nations to agree to eliminate tariffs on clean energy technologies.  President Bush launched this effort last November, and it would be a huge win on multiple fronts for our new President if he could bring this to a successful closure.  I strongly agree with Dan.

   I conclude with a warning from Dan Price, who says, “In the process of needed reform, there is a risk of political demonization of particular products or services, like CDS or securitization, that in fact perform a very useful function.”

   I wish President Obama and his team the best in their efforts to represent America at the G-20 summit.

A quick guide to the G-20 summit

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. What was accomplished at the G-20 Summit?
2. The G-20 Summit in pictures
3. President Bush’s speech on financial markets and the world economy

This is the second of a two-part note.  Here’s the first part.

A fair amount of the press coverage followed a ready-made storyline:  “Lame duck President … not much accomplished.”  This storyline is incorrect.  Let’s look at some important wins in the actual text of the declaration.

• Formerly Communist China and Russia (along with all the other participating nations) agreed to the following text:

12.  We recognize that these reforms will only be successful if grounded in a commitment to free market principles, including the rule of law, respect for private property, open trade and investment, competitive markets, and efficient, effectively regulated financial systems. These principles are essential to economic growth and prosperity and have lifted millions out of poverty, and have significantly raised the global standard of living. Recognizing the necessity to improve financial sector regulation, we must avoid over-regulation that would hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.

• All 20 nations agreed to reject protectionism, to refrain from raising new trade barriers for a year, and to continue working toward a global free trade “Doha” agreement:

13.  We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports. Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO’s Doha Development Agenda with an ambitious and balanced outcome. We instruct our Trade Ministers to achieve this objective and stand ready to assist directly, as necessary.  …

• All 20 nations agreed on the “root causes of the crisis.”  It’s not as clear as the President’s explanation, but it’s quite close, especially given that this is the result of a 20-nation negotiation.

3. During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system.  Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.

4. Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.

• All 20 nations agreed on five key principles:
  1. strengthening transparency and accountability;
  2. enhancing sound regulation;
  3. promoting integrity in financial markets;
  4. reinforcing international cooperation; and
  5. reforming international financial institutions.

• The document never talks about a “single global regulator” or anything approaching that.  Instead, it emphasizes coordination and cooperation among national regulators.

Regulation is first and foremost the responsibility of national regulators who constitute the first line of defense against market instability. However, our financial markets are global in scope, therefore, intensified international cooperation among regulators and strengthening of international standards, where necessary, and their consistent implementation is necessary to protect against adverse cross-border, regional and global developments affecting international financial stability.

• The document emphasizes strengthening transparency and accountability, thus allowing well-informed market forces to provide market discipline:

We will strengthen financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions. …

• While agreeing on the need for financial sector reform, the leaders sounded a cautionary note against over-regulation warning that it would “hamper economic growth and exacerbate the contraction of capital flows, including to developing countries.”  This is similar to what the President said last Thursday.
• The leaders committed to continue to work to alleviate poverty and address the needs of the most vulnerable.
• The leaders agreed to meet again by April 30^th of next year “to review the implementation of the principles and decisions agreed today.”
• You’ll note that pages 6-10 of the declaration are an “action plan” of 47 specific to-do’s.  The list addresses:
  • accounting standards;
  • addressing the valuation of complex illiquid securities, especially during times of market stress;
  • requiring financial institutions to disclose more information about their risks and losses on an ongoing basis;
  • looking for opportunities to better coordinate among national financial regulators;
  • improving bankruptcy laws to allow for an orderly wind-down of “large complex cross-border financial institutions”;
  • reforming the regulation of credit rating agencies;
  • strengthening capital standards “in amounts necessary to sustain confidence”;
  • actions to reduce risk in the markets for credit default swaps;
  • enhancing regulatory guidance “to strengthen banks’ risk management practices”; and
  • steps toward reforming international financial institutions like the International Monetary Fund and the World Bank.

Skim the document and judge for yourself.  We think this summit was a big success, both in the good things that were agreed to, and the bad things that were not.

What was accomplished at the G-20 Summit?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. A quick guide to the G-20 summit
2. What happened to FREE markets in London?
3. The G-20 Summit in pictures

This is the first of a two-part note.  Part one will describe the mechanics of the Summit and show some photos.  Part two will describe the substance.

The action began in mid-October after the President met at Camp David with French President Nicolas Sarkozy and Manuel Barrosso, President of the European Commission:

A statement released after that meeting included the following:

[The three leaders] agreed they would reach out to other world leaders next week with the idea of beginning a series of summits on addressing the challenges facing the global economy.

World leaders will be consulted about the idea of a first summit of heads of government to be held in the U.S. soon after the U.S. elections, in order to review progress being made to address the current crisis and to seek agreement on principles of reform needed to avoid a repetition and assure global prosperity in the future. Later summits would be designed to implement agreement on specific steps to be taken to meet those principles.

Four days later, we released a Statement by Press Secretary Dana Perino, which included the following:

Today, the President is inviting the leaders of the Group of 20 countries to a summit in the Washington, D.C. area, on November 15 to discuss financial markets and the global economy.

… G-20 members are: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, South Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the United States, and the European Union.

The Managing Director of the International Monetary Fund, the President of the World Bank, the United Nations Secretary-General, and the Chairman of the Financial Stability Forum have also been invited to participate.

Normally a summit like this takes at least a year to plan.  The work of an incredible team from the Administration built an incredible summit in only 24 days.

As you can see, the G-20 actually includes 19 States, plus the European Union.  The meeting also included the heads of the major international financial institutions (IFI’s, pronounced “IF-ees”):  the International Monetary Fund (IMF), the World Bank, the U.N. Secretary General, and the Financial Stability Forum.  In addition, the final summit meeting included the heads of Spain and the Netherlands.

Events began last Friday evening with the President spending almost an hour greeting leaders at the North Portico of the White House.

(Game:  Name that Leader.  Answers are at the bottom.)

After a reception in the East Room, the President hosted a dinner in the State Dining Room with the leaders.  Here he is offering a toast:

We are here because we share a concern about the impact of the global financial crisis on the people of our nations.  We share a determination to fix the problems that led to this turmoil.  We share a conviction that by working together, we can restore the global economy to the path of long-term prosperity.

Each nation had four representatives in the Saturday summit discussions:

1. The leader (for the U.S., President Bush);
2. the finance minister (for the U.S., Secretary Paulson);
3. the “Sherpa” (for the U.S., Dan Price); and
4. the deputy finance minister (for the U.S., Dave McCormick).

The “Sherpa” is an interesting position.  It’s derived from the annual G-8 meeting.  Each leader appoints a personal representative to carry his or her heavy load in the negotiations leading up to the leaders’ meeting.  For the U.S., the Sherpa is always the senior international economic policy advisor in the White House.  Dan and Dave led all the negotiations leading up to the G-20 summit (since the U.S. was a host), and they are key players in the success of that summit.  In the G-8 context, the Sherpa’s deputy is known as the “sous-sherpa”, and the #3 person is the “yak.”

The Saturday summit meeting was held at the beautiful National Building Museum in Washington, DC.  Our advance team did all this setup beginning late Thursday night.  Some White House staff showed up at 5 AM Saturday to help escort the delegates:

The meeting began with the traditional “family photo”.

The leaders then went to the summit session.  The inner square is the leaders with their finance ministers.  Behind each is a small table with the Sherpa and Finance deputy.

Here’s the President’s view:

Here are two different angles on the room:

And here’s a view from the U.S. Sherpa/finance deputy table:

After the “plenary session,” the Leaders broke for lunch:

The Leaders left after lunch (one report said there were over 400 vehicles in the motorcades combined), while the President made a statement to the press:

Part two of this note looks at what was actually accomplished at the summit.

Answers to Name that Leader:

1. Mexican President Felipe Calderon
2. Chinese President Hu Jintao
3. Australian Prime Minister Kevin Rudd
4. Indian Prime Minister Manmohan Singh
5. Russian President Dmitryi Medvedev
6. Brazilian President Luiz Inacio Lula da Silva of Brazil (aka “Lula”)

The G-20 Summit in pictures

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. A quick guide to the G-20 summit
2. What was accomplished at the G-20 Summit?
3. President Bush’s speech on financial markets and the world economy

This speech is a prelude to the financial summit the President will host this weekend.  I’ll write separately about the Summit, and about the elements of today’s speech that talk about principles for reform.

I want to draw your attention to two parts of the speech.

The first is where the President reprises his explanation for the economic causes of our current situation.

Over the past decade, the world experienced a period of strong economic growth.  Nations accumulated huge amounts of savings, and looked for safe places to invest them.  Because of our attractive political, legal, and entrepreneurial climates, the United States and other developed nations received a large share of that money.

The massive inflow of foreign capital, combined with low interest rates, produced a period of easy credit.  And that easy credit especially affected the housing market.  Flush with cash, many lenders issued mortgages and many borrowers could not afford them.  Financial institutions then purchased these loans, packaged them together, and converted them into complex securities designed to yield large returns.  These securities were then purchased by investors and financial institutions in the United States and Europe and elsewhere — often with little analysis of their true underlying value.

The financial crisis was ignited when booming housing markets began to decline.  As home values dropped, many borrowers defaulted on their mortgages, and institutions holding securities backed by those mortgages suffered serious losses.  Because of outdated regulatory structures and poor risk management practices, many financial institutions in America and Europe were too highly leveraged.  When capital ran short, many faced severe financial jeopardy.  This led to high-profile failures of financial institutions in America and Europe, led to contractions and widespread anxiety — all of which contributed to sharp declines in the equity markets.

These developments have placed a heavy burden on hardworking people around the world.  Stock market drops have eroded the value of retirement accounts and pension funds.  The tightening of credit has made it harder for families to borrow money for cars or home improvements or education of the children.  Businesses have found it harder to get loans to expand their operations and create jobs.  Many nations have suffered job losses, and have serious concerns about the worsening economy.  Developing nations have been hit hard as nervous investors have withdrawn their capital.

The second is the last two pages of the speech.  I tried to summarize and excerpt from this, and instead have concluded that the best thing I can do is allow the President’s words to speak for themselves.

All this leads to the most important principle that should guide our work:  While reforms in the financial sector are essential, the long-term solution to today’s problems is sustained economic growth.  And the surest path to that growth is free markets and free people.  (Applause.)

This is a decisive moment for the global economy.  In the wake of the financial crisis, voices from the left and right are equating the free enterprise system with greed and exploitation and failure.  It’s true this crisis included failures — by lenders and borrowers and by financial firms and by governments and independent regulators.  But the crisis was not a failure of the free market system.  And the answer is not to try to reinvent that system.  It is to fix the problems we face, make the reforms we need, and move forward with the free market principles that have delivered prosperity and hope to people all across the globe.

Like any other system designed by man, capitalism is not perfect.  It can be subject to excesses and abuse.  But it is by far the most efficient and just way of structuring an economy.  At its most basic level, capitalism offers people the freedom to choose where they work and what they do, the opportunity to buy or sell products they want, and the dignity that comes with profiting from their talent and hard work.  The free market system provides the incentives that lead to prosperity — the incentive to work, to innovate, to save, to invest wisely, and to create jobs for others.  And as millions of people pursue these incentives together, whole societies benefit.

Free market capitalism is far more than economic theory.  It is the engine of social mobility — the highway to the American Dream.  It’s what makes it possible for a husband and wife to start their own business, or a new immigrant to open a restaurant, or a single mom to go back to college and to build a better career.  It is what allowed entrepreneurs in Silicon Valley to change the way the world sells products and searches for information.  It’s what transformed America from a rugged frontier to the greatest economic power in history — a nation that gave the world the steamboat and the airplane, the computer and the CAT scan, the Internet and the iPod.

Ultimately, the best evidence for free market capitalism is its performance compared to other economic systems.  Free markets allowed Japan, an island with few natural resources, to recover from war and grow into the world’s second-largest economy.  Free markets allowed South Korea to make itself into one of the most technologically advanced societies in the world.  Free markets turned small areas like Singapore and Hong Kong and Taiwan into global economic players.  Today, the success of the world’s largest economies comes from their embrace of free markets.

Meanwhile, nations that have pursued other models have experienced devastating results.  Soviet communism starved millions, bankrupted an empire, and collapsed as decisively as the Berlin Wall.  Cuba, once known for its vast fields of cane, is now forced to ration sugar.  And while Iran sits atop giant oil reserves, its people cannot put enough gasoline in its — in their cars.

The record is unmistakable:  If you seek economic growth, if you seek opportunity, if you seek social justice and human dignity, the free market system is the way to go.  (Applause.)  And it would be a terrible mistake to allow a few months of crisis to undermine 60 years of success.

Just as important as maintaining free markets within countries is maintaining the free movement of goods and services between countries.  When nations open their markets to trade and investment, their businesses and farmers and workers find new buyers for their products.  Consumers benefit from more choices and better prices.  Entrepreneurs can get their ideas off the ground with funding from anywhere in the world.  Thanks in large part to open markets, the volume of global trade today is nearly 30 times greater than it was six decades ago — and some of the most dramatic gains have come in the developing world.

As President, I have seen the transformative power of trade up close.  I’ve been to a Caterpillar factory in East Peoria, Illinois, where thousands of good-paying American jobs are supported by exports.  I’ve walked the grounds of a trade fair in Ghana, where I met women who support their families by exporting handmade dresses and jewelry.  I’ve spoken with a farmer in Guatemala who decided to grow high-value crops he could sell overseas — and helped create more than 1,000 jobs.

Stories like these show why it is so important to keep markets open to trade and investment.  This openness is especially urgent during times of economic strain.  Shortly after the stock market crash in 1929, Congress passed the Smoot-Hawley tariff — a protectionist measure designed to wall off America’s economy from global competition.  The result was not economic security.  It was economic ruin.  And leaders around the world must keep this example in mind, and reject the temptation of protectionism.  (Applause.)

There are clear-cut ways for nations to demonstrate the commitment to open markets.  The United States Congress has an immediate opportunity by approving free trade agreements with Colombia, Peru*, and South Korea.  America and other wealthy nations must also ensure this crisis does not become an excuse to reverse our engagement with the developing world.   And developing nations should continue policies that foster enterprise and investment.  As well, all nations should pledge to conclude a framework this year that leads to a successful Doha agreement.

We’re facing this challenge together and we’re going to get through it together.  The United States is determined to show the way back to economic growth and prosperity.  I know some may question whether America’s leadership in the global economy will continue.  The world can be confident that it will, because our markets are flexible and we can rebound from setbacks.  We saw that resilience in the 1940s, when America pulled itself out of Depression, marshaled a powerful army, and helped save the world from tyranny.  We saw that resilience in the 1980s, when Americans overcame gas lines, turned stagflation into strong economic growth, and won the Cold War.  We saw that resilience after September the 11th, 2001, when our nation recovered from a brutal attack, revitalized our shaken economy, and rallied the forces of freedom in the great ideological struggle of the 21st century.

The world will see the resilience of America once again.  We will work with our partners to correct the problems in the global financial system.  We will rebuild our economic strength.  And we will continue to lead the world toward prosperity and peace.

President Bush’s speech on financial markets and the world economy

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. Address by President Bush on financial markets
2. Rose Garden Statement by President Bush on financial markets
3. Rose Garden Statement by President Bush on the Economy

Q:         Why are gasoline prices so high?

A:         We’re approaching the summer driving season, crude oil prices have gone up, and some refineries are offline.

1. There is a normal seasonal increase in demand for gasoline that occurs every Spring.   As the Energy Information Administration says, “When crude oil prices are stable, retail gasoline prices tend to gradually rise before and during the summer, when people drive more, and fall in the winter.  Good weather and vacations cause US summer gasoline demand to average about 5 percent higher than during the rest of the year.  If crude oil prices remain unchanged, gasoline prices would typically increase by 10-20 cents from January to the summer.”  It’s not Summer yet, but some of the recent increase is a result of the increase in seasonal demand.
2. The price of crude oil usually accounts for about half of the price of a gallon of gasoline.  So when oil prices go up, gasoline prices quickly follow.  Crude oil is now about $65.80 per barrel, up about $11 from its average in January.
3. In addition, more refineries were/are unexpectedly offline this year.  After the cost of crude oil and taxes, refining costs are typically the 3^rd biggest component of the price at the pump.  Refineries go offline every Spring for maintenance, but this year, unexpected problems at some refineries mean that our national refining capacity is running about 4% lower than would be typical for May.  This raises the price of refining (called the “crack spread”), which raises the price of gasoline at the pump.  (At the moment, high refining costs have supplanted taxes as the 2^nd biggest component of the gasoline pump price.)

Although inflation-adjusted gasoline prices are near their all-time high, those high prices have less of an effect on the economy, and on a typical family budget, than it has in the past.  Why?  Because incomes are higher then they were decades ago, and so the high gas prices accounts for a smaller proportion of our national income, and of a typical family’s budget.

Also, even the near-record prices are unsurprising to the experts (I’m not one) – as the world economy grows, and as developing countries buy more cars (think China and India), long-term worldwide demand for oil is high, and it will stay high for the foreseeable future.  And the seasonal increase has certainly been expected.  High prices are unpleasant, but only the jump in refining costs is a big surprise.

Still, high gasoline prices are painful for everyone, and especially those with low incomes, largely because it’s hard in the short run to avoid the price increase – most people can’t move or buy a new car, so you’re generally just stuck paying more for gas.

Q:         So what can the government do about it?

A:         In the short run, almost nothing.  In the long run, the President has proposed to:

1. lower demand by increasing fuel economy standards (“CAFE”), and also to reform the way those standards are measured, to encourage sound science, safety, and keep costs low
2. increase our domestic oil supply by drilling for more oil, both in the Gulf of Mexico and off the Alaskan and Virginia coasts (these are already underway), and in Alaska (we need Congress to change the law)
3. increase our supply of alternative fuels by expanding something called the Renewable Fuel Standard, mandating that more of our fuel come from ethanol (from corn and, eventually, other plant sources), and expanding it to include other alternatives like electric vehicles, plug-in hybrids, and coal-to-liquids
4. increase our insurance policy by doubling the size of the Strategic Petroleum Reserve.  The SPR is a few big holes in the ground where the nation stores oil, just in case there’s a severe supply disruption
5. and, most importantly, encourage the development of new technologies on both the supply side and the demand side.  The President has proposed increased federal R&D funding for cellulosic ethanol, batteries and plug-in hybrid vehicles, and even a “Hydrogen Fuel Initiative” in the long run.

#1, #3, and #4 are the President’s new “20 in 10″ proposal that he rolled out in the State of the Union address this year.  Together, they would reduce our gasoline usage by up to 20% within 10 years (by 2017).  If you want to learn more about our “20 in 10″ energy proposal, you can find a good description here.

The solutions take years to have a big effect.  We’re urging the Congress to take those long-term actions now.  It’s taken years to get to this point, and it’s going to take us years to work our way out of it.  But that’s no excuse for not starting now.

I may also explain why East Coast residents are probably paying about 10¢-12¢ per gallon less than the national average, and those on the West Coast are probably paying 9¢-20¢ per gallon more than the national average.

Why are gas prices high, and what can we do about it?

© 2010 Keith Hennessey - Your guide to American economic policy

Related posts:

1. More oil supply
2. Food prices & food aid
3. Much ado about nothing: the House energy bill