In IS210, we will be reading about domestic political economy next week. Understanding the role of state and market, politics and economics, we can learn about what causes some countries’s economies to grow quite rapidly and other countries’ economies to grow more slowly. We’ll look at the role of domestic institutions and policy choices as key root causes in economic development. [How does this contrast with Inglehart’s arguments, or Weber’s idea of the ‘Protestant work ethic?’] Increasingly, though, our ever more globalized and interdependent world economy provides domestic economies with opportunities and threats that didn’t exist to nearly this extent even 50 years ago. We’ll look at economist N. Gregory Mankiw’s New York Times editorial piece on the “trilemma of international finance.”
Have a look at this Frontline excerpt on the Asian financial crisis of 1997 and the role that fixed exchange rates played:
One of the leading scholars of IR theory is Joseph Nye, who teaches at Harvard University. He, along with co-author Robert Keohane, wrote one of the seminal works in IR theory–Power and Interdependence. Here is a short, but interesting TED talk in which Nye explains, amongst other things, the distinction between power transition and power diffusion, the “rise of China” and what “smart” power is.
Victor Shih, currently an assistant professor of political science at Northwestern University, keeps a blog at which he addresses issues related to Chinese politics. The blog deals mainly with topics related to Chinese political economy (an increasingly important topic as the rate for your car/home/student loan is intimately connected to the amount of US Treasury bonds purchased by the Chinese Central Bank) and elite politics in China.
The average person may not know the difference between “offshoring” and “outsourcing”, but one would think that it would be a condition of employment for someone who writes for the business section of the Washington Post. In an otherwise informative story on the decreasing attractiveness of China as an “outsourcing” location for US companies, we are witness to another example of a member of the traditional media seemingly uninformed of basic facts.
Outsourcing is simply the idea that a company chooses to have another company produce a good or service rather than produce that same good or service in-house. Outsourcing has been happening for a long time, and an example is when the Ford Motor Company decided that it would be better to use their productive capacity to produce engines, and outsource the task of making tires to a different company rather than make tires itself. This helped increase productivity by allowing Ford to concentrate on the making of engines, and have the other company (Goodyear, Bridgestone) focus on making better tires.
Offshoring simply means sending work beyond one’s national boundaries. Notice that not all offshoring is also outsourcing. In fact, I have previously read (but I can’t find the source) that most offshoring is, in fact, not also outsourcing. How can this be? Well, what happens when General Motors decides to close down a car factory in Flint and make begin producing vehicles in Windsor, Ontario instead? That production (and the jobs accopanying it) has been offshored (moved to a different country–Canada) but it hasn’t been outsourced, since GM is still producing the vehicles. Here’s a little chart that will help you understand the difference.
As for the article itself, it demonstrates that rising fuel costs have increased the cost of shipping to such an extent that the potential savings for a US company of producing in China are completely eliminated. One such company has repatriated production to the US from China (I suppose that’s called “onshoring”?) We read:
SHANGHAI — Harry Kazazian built his business on sleeping bags that are made in China and shipped across the ocean to the United States, but he realized recently that the math doesn’t work anymore.
With fuel prices at record highs, the cost of sending a standard 40-foot container of goods has gone from $3,000 in 2000 to about $8,000 today, squeezing profit.
So this summer Kazazian, chief executive of Exxel Outdoors, a Los Angeles-based maker of recreational equipment, did something radical: He moved the manufacturing back to Haleyville, Ala.
Soaring energy costs, the falling dollar and inflation are cutting into what U.S. manufacturers call the “China price”– the 40 to 50 percent cost advantage once offered by Chinese producers.
The export model that has powered China and other Asian countries for three decades will be compromised if fuel prices continue to rise, said Stephen Jen, a managing director for Morgan Stanley.
“Globalization has gone a little bit too far. It has overshot,” Jen said. “We’re not saying Asia is going to crumble, but we are saying Asia enjoyed extraordinary conditions in the past. Now the conditions are changing very quickly because of the energy shock, and Asia is coming under pressure.”
The ripple effects have been far-reaching. The trade imbalance between the United States and China — a source of political tension for years — is beginning to right itself as Chinese exports fall and U.S. exports rise. Global trade routes are being transformed, suggesting a possible return to a less integrated world economy.
When I was younger, my friend’s father would often respond to our childhood rantings with the question, “but what’s that got to do with the price of tea in China?” I still don’t really understand what it means, but in this increasingly globalized world, there is a direct causal link bewtween the price of soybeans and smog in the Argentinian capital city of Buenos Aires. The causal mechanism is outlined in this Bloomberg news report:
April 17 (Bloomberg) — Smoke from fires set by farmers to clear fields for grazing covered the city of Buenos Aires and shut down some highways leading into the Argentine capital.
Interior Minister Florencio Randazzo called the smoke a “disaster” and said 292 separate fires covering 70,000 hectares (173,000 acres) had been detected in the provinces of Buenos Aires and neighboring Entre Rios.
Farmers are burning more land as they create pastures for cattle that previously grazed fields now dedicated to soybeans, said Randazzo. An 89 percent increase in soybean futures prices in the past year, part of a global explosion in food costs, has prompted Argentine farmers to increase the area sown to the oilseed by 10 percent, according to the Agriculture Secretariat.
“Those responsible are farmers who are burning their meadows to cut costs and maximize profits without considering the consequences,” said Randazzo in a news conference at the Presidential Palace. “We are conducting investigations to find those responsible.”
Notice this chart of soybean prices below and the fact that many farmers are moving into the soybean growing business and I think we could have the potential for an intermediate-term top in the soybean market. As in many speculative markets, many would-be speculators rush in just at (or even just after) the top has been set for that particularly stock or commodity. It’s not a surprise the the record number of sales transactions for US real estate occurred in the month (around Summer 2005) as a top was setting in. If I had to bet, I’d wager that many of those new soybean farmers will wish they had remained cattle farmers.
On the first day of class, I made the argument that in order for me to fulfill my pedagogical goals this semester, I need your help. I needed you to understand that what you choose to do (or not to do) in the classroom (and on your blog) will affect not only the grade you receive and how much you learn in this course, but will also affect the learning and grades of your peers sitting beside you in class. We live in societies, in which we all–to a greater or lesser extent–have an effect on those with whom we come into contact, with whom we share work places, roads, stadia, and class rooms. We all understand that if your neighbor’s house is unkempt and the lawn is overgrown, this will have a detrimental effect on your own property values.
Since we’re talking about property and the effects of social interaction, how is it that the town of Narvik, Norway (on the Arctic Circle) has had to miss a payroll for its municipal workers as the result of residents of Stockton (CA), Miami (FL), Flint(MI), and Worcester (MA), no longer being able to pay their residential mortgages? This New York Times article helps explain, and so does Jon Stewart’s guest, CNN Personal Finance editor Gerri Willis:
— At this time of year, the sun does not rise at all this far north of the Arctic Circle. But Karen Margrethe Kuvaas says she has not been able to sleep well for days.
What is keeping her awake are the far-reaching ripple effects of the troubled housing market in sunny Florida, California and other parts of the United States.
Ms. Kuvaas is the mayor of Narvik, a remote seaport where the season’s perpetual gloom deepened even further in recent days after news that the town — along with three other Norwegian municipalities — had lost about $64 million, and potentially much more, in complex securities investments that went sour.
”I think about it every minute,” Ms. Kuvaas, 60, said in an interview, her manner polite but harried. ”Because of this, we can’t focus on things that matter, like schools or care for the elderly.”
Norway’s unlucky towns are the latest victims — and perhaps the least likely ones so far — of the credit crisis that began last summer in the American subprime mortgage market and has spread to the farthest reaches of the world, causing untold losses and sowing fears about the global economy.
Where all the bad debt ended up remains something of a mystery, but to those hit by the collateral damage, it hardly matters.
Tiny specks on the map, these Norwegian towns are links in a chain of misery that stretches from insolvent homeowners in California to the state treasury of Maine, and from regional banks in Germany to the mightiest names on Wall Street. Citigroup, among the hardest hit, created the investments bought by the towns through a Norwegian broker…
…But Narvik has $34.5 million in a second Citigroup-devised investment, known as a collateralized debt obligation, which has also lost value as a result of the broader market turmoil. The town stands to lose at least some of that money, too.
Those investments represent a quarter of Narvik’s annual budget of $163 million, and covering the losses would necessitate taking out a long-term loan, which the town could only pay off by cutting back on services.
”You can calculate this in terms of places for schoolchildren or help for the elderly,” said Mr. Hermansen, a soft-spoken man who sat in his office in near-darkness, the lights switched off…
…In 2004, Narvik and a number of other towns took out a large loan, using future energy revenue as collateral. They invested the money, through Terra Securities, in the Citigroup debt vehicle, which offered a better return than traditional investments. In June 2007, as the subprime problems were brewing, Narvik shifted some money from that investment into an even more complex one, again through Terra Securities.
Do read the whole thing as it is interesting. Note, however, the really key part of the whole story in bold in the paragraph above and use the experience of Narvik to learn a very important lesson about investing. There is a clear immutable relationship in the investing world: the higher the expected return, the higher the level of risk associated with that return. If you expect to receive outsized returns, be prepared to accept outsized risk. Period. There may have been fraud perpetrated here (and it’s difficult to know without reading the signed agreements), but caveat emptor would have been valid advice in this situation.
What is the general link between subprime mortgages and other collateralized debt obligations (CDOs)–such as auto loans, student loans, and credit card debt–and the international political economy. Is there a general systemic risk to the global economy from new financial instruments, which Warren Buffett has referred to as “financial weapons of mass destruction?” Here is a panel at the 2008 World Economic Forum in Davos, which will shed more light on the financial industry.
There has been a rapid increase in food prices over the last couple of years, seen most dramatically in the recent 30% one-day rise in the price of rice worldwide. This is putting tremendous pressure on the poor and is leading to instability in countries around the world. There have been violent demonstrations–and equally violent government responses–to food rioting in Egypt and Haiti in the last couple of weeks. They may be but a harbinger of the economic and political instability to come. Here is a report from the BBC, in which an expert argues that IMF policies have contributed to the rise in food prices:
“Poor countries need to invest heavily in agriculture to feed their people. There’s been a dearth of investment in agriculture in poor countries, mainly because of IMF and World Bank policies…”
Anticipating the end of World War II, world leaders gathered in the New Hampshire town of Bretton Woods to create the financial architecture of the post-war global financial system. The three main pillars were the World Bank, the IMF (both of which were created) and the International Trade Organization (this was never built but the governing philosophy behind it eventually gave rise to the General Agreement and Trade and Tariffs (GATT), which morphed into the World Trade Organization (WTO). We’ll discuss these institutions in much more detail beginning Monday.
Here is an excerpt from a newsreel describing the meetings at Bretton Woods in 1944:
Canadian academic Thomas Homer-Dixon (we will read one of his papers this semester in Intro to IR) has written a piece for Canada’s “paper of record”–the Globe and Mail, which is titled “From Risk to Uncertainty.” Those of you in my intro to comparative politics class will surely recognize immediately the difference between the tho concepts.
Remember when we read the first two chapter of Shepsle and Bonchek on instrumental rationality, the authors used the example of then-Massachusetts Governor Weld. Weld had to decide whether to run for Governor again, or to commit to challenging Democratic Senator Ted Kennedy’s Senate seat. A win there would have given him a nice platform for an eventual presidential run. Weld, as we know, was operating in a world or risk rather than uncertainty when making his decision, given that there were public opinion polls published that estimated his chances of winning in either election.
What is the difference between risk and uncertainty and how does it apply to the contemporary global financial system (which, by the way, for those of you not paying attention is precariously teetering on the edge of meltdown–you heard it here first!)?
So the rules of the game have now fundamentally changed. Our global financial system has become so staggeringly complex and opaque that we’ve moved from a world of risk to a world of uncertainty. In a world of risk, we can judge dangers and opportunities by using the best evidence at hand [what Shepsle and Bonchek call beliefs] to estimate the probability of a particular outcome. But in a world of uncertainty, we can’t estimate probabilities, because we don’t have any clear basis for making such a judgment. In fact, we might not even know what the possible outcomes are. Surprises keep coming out of the blue, because we’re fundamentally ignorant of our own ignorance. We’re surrounded by unknown unknowns.
We’ll be playing the “Oil Game” in class tomorrow in PLSC250. When colleagues of mine used this teaching tool in their classes 4 or 5 years ago, the price of oil was about 1/3 of what it is today. In the clip, Brian Williams will tell you that oil reached a “record” high of $100.01 US a barrel. That’s only true if we’re talking about nominal dollars. In terms of real dollars it still has about 4 USD/bbl to go to hit the all-time high set in December 1979. Hmmm…I wonder what was happening in late 1979? Iran, Afghanistan, plus ca change…
Click here to see Maria Bartiromo report from NBC News.
“People are afraid that there is just not enough oil in the world to meet demand; demand which is coming not only from the United States but from emerging economies like China and India.”
es. The causal mechanism is outlined in t
Clouds, Clocks, and Sitting at Tables 
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