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PIIE Update Newsletter
August 1, 2012

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American Exceptionalism: Time for New Thinking on Economics and Security

Robert B. Zoellick
  Robert B. Zoellick The connection between economics and security is usually assumed, not analyzed. Robert B. Zoellick, former President of the World Bank and US Trade Representative, illuminates this relationship through recounting the history of US foreign and economic policy and suggests that the earlier American foreign policy tradition—rather than being antiquated—points toward economic fundamentals that are essential to future security in this new era.

For its first 150 years, American foreign policy was deeply infused with economic logic; however, during the Great Depression, the United States withdrew from the world economy, and World War II and the Cold War led to a sharp break in the American foreign policy tradition, according to the standard account. Economics became a resource factor in the national security state—the handmaiden of the strategic policy process. The crucial difference in the way the 20th century national security model embraced economics is that its focus on resources of the state treated international economic issues as benefits to be exchanged to support security aims: trade concessions, foreign assistance, military aid—not necessarily inclusive growth, good governance, and open, competitive markets.

This difference is important. The national security perspective of state power risks overlooking an important reality: that sound economic policies are the underpinning of both individual freedom and national power—not only military power but also the dynamism, innovation, and influence of the economy and society. The 20th century concept of national security also overlooked how economic change—within economies and internationally—can be a powerful force of its own in international relations.

Zoellick offers a revisionist history of international economics and security since World War II. He suggests the international economy has been marked by three phases: from the creation of the Bretton Woods system to its breakdown in the 1970s; a capitalist revival from the late 1970s through the end of the Cold War; and the rise of globalization in the 1990s, extending to the Crash of 2008. The world is now stumbling into a fourth phase—one that it is vital for the United States to shape. Zoellick stresses that the earlier US experience points toward economic fundamentals that are essential to future security in this new phase. The United States does not need just any budget deal; it needs one that rebuilds the fundamentals of long-term growth and that limits government spending and encourages private sector innovation and productivity. The United States should combine economic revival at home with adaptive and flexible adjustment of the international economic system. And free trade is one of the best drivers of microeconomic and structural reforms, but the trade agenda has stalled. Zoellick concludes that the United States will lose its identity on the global stage if it loses its economic dynamism.

>> Read full speech [pdf]

The IMF Should Heed This Resignation

Arvind Subramanian
  Arvind Subramanian The resignation letter of a senior International Monetary Fund (IMF) official released last week was important for what it implied: The IMF is failing in two key respects. It has not provided independent intellectual leadership, most evidently on the euro area crisis, and it is unprepared to provide stability for the next big global crisis. With Spain and possibly Europe inching back towards the abyss, that crisis looms. The possibility of the IMF being missing in action is cause to sound the alarm bells. On the euro crisis, especially in its adjustment programs, the IMF has toed the official European line and not been an independent voice. It has also not sought to build a bigger IMF to cope with a big future crisis. Frustrated with the difficulty in reforming the IMF, emerging market countries, especially China, are gradually contemplating alternatives. The BRIC (Brazil, Russia, India, and China) nations have set up a bank for effecting resource transfers, and East Asian monetary arrangements are being strengthened. These new initiatives are the consequences of a weak and unresponsive IMF. If the IMF leadership does not take corrective action, the world might well be asking why the Fund was asleep as adviser and financier even as the European driver was taking the car over the cliff.

>> Read full op-ed

The Role of International Financial Institutions in Addressing the Financial Crises of the 21st Century: Confrontation or Cooperation?

Edwin M. Truman
  Edwin M. Truman Have nations ceded too much sovereignty to international financial institutions? The answer is no. Whether the international financial institution is formal, like the International Monetary Fund (IMF); informal, like the Financial Stability Board (FSB); or institutionalized, like the euro area, an excessive attachment to national sovereignty is holding back cooperation. National sovereignty and multilateral cooperation are complementary in the sense that without greater international cooperation, the value of national sovereignty is nugatory. Without international cooperation, the international financial institutions are rendered powerless. Contrary to the current pattern in Europe, where the name of the game appears to be political confrontation, cooperation is essential to maintain and promote economic growth and stability. The governance of international institutions must be further updated, but non-advanced G-20 countries, who should play an enlarged role, also must accept substantially greater responsibility for the performance of the system as a whole if international financial institutions are to perform their appropriate roles in an increasingly integrated global economy and financial system. The question for the future is whether the increasing supply of international cooperation will keep up with rising demands to address the inevitable financial crises of this century. If the world as we know it is to survive, international cooperation must be deepened.

>> Read full speech [pdf]

Growth and Social Outcomes in India
Part One | Part Two

Arvind Subramanian
  How important is growth for social outcomes? The frenzied downgrading of India's growth prospects at the same time the government has stepped up its social spending has raised this important question. State-level data is available for four key social outcomes: poverty, life expectancy, child malnutrition, and inequality. Indian states that have a higher standard of living on average tend to have lower levels of poverty, higher levels of life expectancy, and lower levels of child malnutrition. A state like Karnataka that is about 125 percent richer than Uttar Pradesh (UP) will have a poverty ratio that is about 13 percentage points lower (Karnataka's headcount poverty ratio was 24 percent, and UP's 37 percent). Similarly, Himachal Pradesh, which was one-and-half times as rich as UP, will be associated with a life expectancy higher by seven years (67 versus 60 for UP). Overall, the positive correlation between long-run income of states and their social achievements makes sustained economic growth and its pursuit desirable, a lesson that this UPA (United Progressive Alliance) government has sadly not acted upon.

>> Read Part One
>> Read Part Two

Economic Sanctions Against Iran: Is the Third Decade a Charm?

Jeffrey J. Schott
  Jeffrey J. Schott Past US sanctions against Iran—focused on constraining Iranian oil production by reducing foreign direct investment in the country—have not led to major Iranian policy changes. Consequently, the new US policy enacted in December 2011, Section 1245 of the National Defense Authorization Act (NDAA), targets Iran's oil customers and threatens stringent extraterritorial sanctions against foreign financial institutions unless the country with the primary jurisdiction over those firms cooperates with US policy and significantly reduces their oil purchases from Iran. In parallel, the European Union enacted new sanctions against Iran in January 2012 that are designed to complement US measures.

Sales of Iranian crude are down, and Iran reportedly is offering incentives to sanctions evaders, indicating that the US and EU sanctions are lowering Iran's net revenues. Iran will undoubtedly try to divide the sanctions coalition by offering to negotiate constraints on its nuclear program in return for a relaxation of the restrictions on purchases of its oil, and then stretch out the negotiating process and implementation of their concessions. Thus, to encourage countries to comply with their sanctions policies, and to hold the sanctions coalition together, US and EU officials should 1) obtain commitments from Saudi Arabia to cover potential shortfalls in world oil markets, and 2) the United States should pre-announce the release of surpluses of its strategic petroleum reserves (SPR). Combined, these measures would help reduce the likelihood of a significant oil price increase and hopefully discourage Iran from pursuing its costly weapons development program.

>> Read full article

Why Moldova Has Turned Its Back on Russia

Anders Åslund
  Anders Aslund Moldova and its pro-Russian breakaway Transdnestr region illustrate Russia's dysfunctional foreign policy in the post-Soviet space. Moldova has become the poorest country in Europe because of a troublesome transition and the protectionism of the European Union, Russia, and Ukraine. Being dominated by agriculture, it has been more vulnerable than any other post-Communist country. Russian policy on Moldova can be described as a six-pronged hostile attack that consists of trade discrimination, pressure for joining the customs union, Gazprom aggression, support for Transdnestr, obstruction through the Russian Orthodox Church, and a clear bias in favor of the Communist Party. Transdnestr stays outside Chisinau's jurisdiction because of the presence of 1,000 Russian soldiers, which the Kremlin classifies as peacekeepers. Russia has generally pursued a capricious and unfriendly trade policy toward Moldova. In 2006, it suddenly prohibited the import of wines from Moldova, halving Moldova's exports to Russia. Russia's policy in the post-Soviet space is costly to all, but most of all to Russia because it gives the Commonwealth of Independent States (CIS) countries little choice but to turn their backs on Russia.

>> Read full op-ed

Peterson Perspectives Interviews

audio  US Tax Policy and Outsourcing: Part II
Gary Clyde Hufbauer continues his analysis of tax policy and outsourcing, explaining that US-based multinationals that expand overseas usually expand and create jobs in the United States as well.

audio  US Tax Policy and Outsourcing: Part I
Gary Clyde Hufbauer says that despite what President Obama says, Governor Mitt Romney's proposal to lower the corporate tax rate would create jobs in the United States as well as overseas.

audio  Breakthrough on Approval of a Trade Accord with Russia
Anders Åslund explains that a bipartisan deal that would tie a human rights measure to improved trade status with Russia appears headed for Congressional approval.

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New Testimony and More Questions in the Interest Rate Rigging Scandal
Simon Johnson explains that Barclays could not have rigged the LIBOR rate by itself. He says the firm is merely the low-hanging fruit for authorities investigating this big, collusive scandal.

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Demand for Power in India Outstrips Current Energy Infrastructure
Arvind Subramanian discusses the challenges of matching supply with demand for energy in India and the reasons for India's current power grid inefficiencies.

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EU Could Suspend ETS Scheme on Airlines
Gary Clyde Hufbauer explains why sovereignty issues and international law may force the European Union to suspend its emissions trading scheme (ETS) for airlines.

Preview of Our Next Issue

The International Economy in 2011 [pdf]
John Williamson

In This Issue

Title Setting the Record Straight on Cost-Benefit Analysis and Financial Reform at the Securities and Exchange Commission

Dennis Kelleher, President and CEO of Better Markets, presented his organization's report, which concludes that requiring cost-benefit analysis would greatly weaken or even kill financial regulatory reform.

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