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Currency Manipulation and the Trans-Pacific Partnership: What Art Laffer, Fred Bergsten, and Other Hawks Get Wrong

Daniel J. Ikenson

U.S. Trade Representative Michael Froman is bullish on the trade agenda. But his estimate of completing the Trans-Pacific Partnership (TPP) negotiations in March discounts the possibility that Congress will issue any tough demands in its Trade Promotion Authority (TPA) legislation. A congressional mandate to include enforceable “currency manipulation” provisions in trade agreements, for example, would push completion of the TPP into the next administration or kill it altogether.

Just like green energy subsidies, “Buy American” laws, 25 percent pick-up truck tariffs, and industry bailouts, currency manipulation distorts markets. Global resources would be more efficiently allocated if currency values were market-determined. But does currency manipulation stand out among the hodgepodge of popular interventions as a big enough problem with a net beneficial solution to warrant delaying or killing TPP?

Some industries, led by the K Street-savvy Detroit automakers and U.S. steel producers, think so and have pledged to work against the agreement unless it includes tough provisions to deter a particular brand of currency manipulation. (Of course, Detroit has been opposed to the TPP from the outset and even more so since its attempt to block Japan from joining the talks failed, so the conditional threat of non-support rings a bit hollow.) Their position seems to be buttressed by the views of supply-side favorite Arthur Laffer, establishment economist Fred Bergsten, and some of his colleagues at the Peterson Institute, who argue that currency manipulation demands an aggressive U.S. policy response. But their arguments for enforceable currency provisions, whether inside or independent of trade agreements, are unconvincing.

Saddling the TPP, the TTIP, and other trade agreements with provocative and unnecessary currency provisions would be a grave mistake.”

The question of whether and how to respond to foreign currency manipulation has been vexing policymakers since 2003 when Sen. Chuck Schumer (D-NY) first introduced a bill calling for a 27.5 percent tariff on all imports from China to compel the Chinese government to permit the Yuan to appreciate. Currency manipulation — in this context — is said to occur when governments take actions to suppress the values of their currencies, effectively taxing imports and subsidizing exports, to give advantages to their country’s producers.

That may certainly seem unfair to U.S. producers, but Schumer’s idea was roundly rejected as a massive consumption tax on the American people — and World Trade Organization-illegal to boot. But that didn’t stop him from re-introducing the same bill in subsequent Congresses with Sen. Lindsey Graham (R-SC) — also, to no avail. The measure, which was welcomed by domestic auto and steel producers (and other trough regulars), would have been a disaster for U.S. consumers, who would have had less to spend even on US-made goods and services, and for export-oriented U.S. producers and their workers, who would have suffered the wrath of foreign retaliation.

Since then other proposals have come and gone and come again, including the idea that currency manipulation should be treated as a subsidy and remedied under the U.S. Countervailing Duty law. Even though any benefits conferred by suppressing a currency’s value are available broadly to producers in the “offending” country, which is an attribute that disqualifies the “offense” as a countervailable subsidy under U.S. law and according to the WTO Agreement on Subsidies and Countervailing Measures, there is support for this approach in Congress. Bergsten has been hot, cold, and recently hot again on this idea, lending support to it in a Foreign Affairs piece published January 18th:

[T]he administration should authorize the imposition of countervailing duties on imports from countries that manipulate their currencies, whether or not they are members of trade agreements with the United States. Such manipulation is as much an export subsidy as any other against which the United States would normally countervail, and failure to do so is an absurd anomaly.

This endorsement comes after Bergsten all but rejected the idea in a Peterson Policy Brief in January 2014:

Determining the existence and extent of currency misalignment, especially as a possible trigger for remedial action [i.e., specifically, the application of countervailing duties under the Countervailing Duty law], has proven enormously difficult, however, both intellectually and politically. Numerous conceptual approaches to defining and measuring currency “misalignment” have been attempted. The IMF uses three different measures that often produce very different results. Most official discussions, and even many academic efforts, have foundered at this initial level.

To be sure, that was not the first time Bergsten changed his mind on this issue. He expressed support for countervailing duties as part of an aggressive four point plan a little more than one year prior in a December 2012 Peterson Policy Brief with his colleague Joseph Gagnon. But a review of how Sen. Schumer came to choose 27.5 percent as his magic number illustrates why Bergsten’s January 2014 skepticism about applying countervailing duties continues to be warranted.

When Schumer introduced his bill, economists were generally in consensus that the Chinese currency was undervalued. But they disagreed widely about the magnitude. Economists from the IMF, the OECD, the Federal Reserve, the U.S Treasury, think tanks, and academia were all producing different estimates of undervaluation. Schumer chose 27.5 percent because it was the midpoint in a range of dozens of these estimates spanning from 10 percent to 45 percent. More important than the obvious imprecision in Schumer’s approach is the fact that reputable economists from esteemed institutions disagreed widely in their estimates of undervaluation. This meant that they took different approaches to estimating the difference between the yuan’s actual value and its true market value, which reveals what Bergsten implies in his January 2014 quote above: that there is no consensus among economists about how to estimate currency undervaluation because there is disagreement about how to ascertain the true market value of a currency unless it is free-floating and determined by its supply and demand. This conclusion yields some important implications.

First, without knowing the true market value of a currency, it is impossible to calculate accurate countervailing duties to offset the effects of currency manipulation. A 10 percent countervailing duty implies that the currency is priced below its actual market value by 10 percent or that the manipulation amounts to a 10 percent subsidy for exports. But at best, a countervailing duty could only be an estimate of the value of a subsidy conferred through manipulation of the currency. Considering that economists’ estimates of Chinese currency undervaluation varied by as much as 35 percentage points, and that any methodology employed by the U.S. Department of Commerce — in its zeal to protect domestic producers above all else — would certainly differ from one employed by an MIT or IMF economist, countervailing duties would likely worsen any distortions caused by currency manipulation and inflict collateral damage on consumers and import-using producers.

Second, countervailing duties would address only the export subsidy portion of the distortion, leaving in place the import tax effect of the currency manipulation, even magnifying its adverse impact on U.S. exporters by keeping foreign products that would have been bound for the United States, but for the countervailing duty, in the foreign market, increasing the supply and suppressing prices. There might also be overt retaliation. U.S. exporters, in other words, would get no relief and, in fact, would be punished by CVD measures.

Third, if a currency’s true market value is determined by the intersection of its supply and demand curves, it is important to recognize that those curves (their shapes and positions) are affected by underlying economic activity, as well as public policy — monetary, fiscal, and regulatory. In other words, currency values reflect all sorts of policy decisions that it would be improper to indict direct manipulation occurring through currency market interventions, but not indirect manipulation delivered through other policy channels. After all, it is the effect of policy and not its intent that matters to the real economy. It is the effect of policy and not just its intent that is evaluated in WTO dispute settlement.

Accordingly, the Federal Reserve’s policy of quantitative easing, which drove down the value of the dollar by increasing the supply of dollars in circulation had no practical difference in consequence from Chinese or Japanese government currency market interventions, which likely will be indistinguishable from the consequences of the European Central Bank’s decision last week to cut interest rates. Each set of policies has similar depreciating effects on the currencies of the governments engaging in those policies. Though the intent of direct currency market intervention may be to drive down the value of the currency, and the intent of monetary easing may be to stimulate demand, both have the effect of reducing the value of the currency. It is that consequence that matters.

Acknowledging — as Bergsten did, before changing his mind, again — the distortions and other shortcomings of treating currency manipulation as a countervailable subsidy, the American Automotive Policy Council (Detroit’s auto lobby), last year, put forth a different solution based on the recommendations in Bergsten’s January 2014 piece. Rather than attempt to calculate undervaluation and then apply countervailing duties, the AAPC side-stepped the measurement problem and proposed that currency manipulation be inferred from certain actions taken by governments. If a country has a current account surplus over a six-month period, adds to its foreign exchange reserves over that period, and has more than adequate foreign exchange reserves (defined as more than enough to cover three months of normal imports), then that country is manipulating its currency.

Economist Arthur Laffer lent his support to this inferential approach to identifying currency manipulators in a recent paper published by the Laffer Center, which the AAPC has seized upon in its efforts to convince free market types that they, too, should support measures to rein in currency manipulation. But Laffer’s paper is less a convincing exposition that currency manipulation requires a response than it is a lesson in the virtues of floating exchange rates. His failure to acknowledge that indirect currency manipulation through other policy channels can have the same effect as direct intervention lends itself to the remedy prescribed by the AAPC — forfeiture of trade agreement benefits for one year — without really endorsing that solution. But the AAPC’s proposed conditionality test and remedy are both problematic.

First, as a trade agreement provision this would never fly because its terms are asymmetric. As the issuer of the world’s primary reserve currency, the United States has little need to accumulate reserves. Likewise, the United States hasn’t had a current account surplus in decades and, barring a collapse in demand and a massive increase in savings rates, won’t anytime soon. Under the AAPC’s definition of manipulation, the United States would be free to engage in additional rounds of quantitative easing or other policies that depress the dollar’s value without meeting the triggering criteria of the provision, as long as its current account remains in deficit. However, countries that traditionally run current account surpluses — such as Japan, Singapore, Vietnam, Malaysia, and Brunei among TPP countries — would already be one third of the way toward losing their tariff benefits.

Second, the proposal whiffs of financial imperialism and is an affront to national sovereignty. Governments engage in foreign reserve accumulation for a variety of reasons — as insurance against capital outflows, to attract foreign investment, to prepare for leaner economic conditions, to share today’s exhaustible bounty (in the case of commodity-dependent economies) with future generations, and so on. Reserve accumulation far in excess of “three-times imports” is not at all uncommon. Governments that accumulate reserves also tend to run current account surpluses. By targeting conditions that may also reflect benign intentions, these rules would impose de facto limitations on the policy options available to foreign governments to exercise their domestic sovereignty. Therefore, it is certain to be opposed by other TPP negotiating partners, causing delay or derailment of the deal.

Third, the penalty of withdrawing trade agreement benefits is anything but targeted. It would hurt U.S. businesses that have begun cultivating relationships with foreign suppliers, disrupt production and supply chains, deter inward foreign direct investment, and penalize consumers, rendering the cure worse than the ailment.

Fourth, the measures would do nothing to remedy the distortions on the export side. Currency manipulation is said to pose a de facto tax on U.S. exports, but none of the remedies considered by the currency hawks does anything to alleviate that burden, as if these producers are interested only in protecting their home markets and not in competing for market access abroad. Why else would they content themselves with the remedies they support?

Fifth, currency hawks have exaggerated the impact of currency values on trade flows. Of course they matter, but with the proliferation of global supply chains and cross-border investment, the overwhelming majority of trade flows today are intermediate goods, so the effect of currency values on final prices cuts in different directions. That’s why, despite a 38 percent appreciation of the Chinese Renminbi vis-à-vis the dollar between 2005 and 2013, the bilateral U.S. trade deficit with China didn’t decrease, but rather increased by 46 percent. That’s why Yen depreciation, by increasing the cost of imported inputs priced in foreign currencies, raises the cost of production in Japan and can make Japanese producers less competitive in the global economy, not more. If only 50 percent of the value of a country’s exports reflects domestic value (and the other 50 percent reflects foreign value), as is the approximate case with China, a depreciating yuan cuts in both directions. Globalization is the best remedy for currency manipulation.

Finally, the claims of Bergsten, Laffer and others that currency manipulation, through a persistently high current account deficit, has led to lower GDP and fewer jobs belies the facts of a strongly positive relationship between deficits and jobs and between deficits and GDP. Why is it that in times of rising trade and current account deficits we tend to see faster economic growth and job creation? It must have something to do with the fact that a current account deficit is matched by a capital account surplus, which means that the net outflow of dollars that occurs when Americans buy more goods and services from abroad than they sell to foreigners is matched by a net inflow of dollars from foreigners who invest more in the United States than Americans invest abroad. In other words, there is no “leakage” of economic activity. Foreign investment in the United States (direct, equity, debt) contributes to U.S. economic activity and job creation here. So, for those who claim that foreign currency manipulation drains the economy through a persistent trade deficit, the problem would seem to be self-regulating through the capital account surplus and global supply chains.

The TPP, the TTIP, and other trade agreements represent opportunities for economic growth. Saddling them with provocative and unnecessary currency provisions would be a grave mistake.

Daniel J. Ikenson is the director of Cato’s Herbert A. Stiefel Center for Trade Policy Studies

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Saudi Arabia: New Leader, Same Medieval State

Emma Ashford

The death of Saudi Arabia’s King Abdullah, though not unexpected, caused a spike in oil prices, and a frenzied interest in the succession process and the future rulers of Saudi Arabia, owing much to the state’s outsized role in global markets and Middle Eastern affairs. The succession was in fact painless. But the process highlights the archaic nature of the Saudi regime, and should prompt us to think more closely about why the United States still regards Saudi Arabia as one of its closest allies, despite the nation’s objectionable domestic politics and its foreign meddling.

The succession itself was smooth, elevating Crown Prince Salman to King, and Deputy Crown Prince Muqrin to replace him. Though Salman’s health has been regularly questioned by western commentators – it has even been suggested that he has Alzheimer’s or dementia — he seemed relatively healthy in his first broadcast to the nation. Regardless, he is 79, and the appointment of his half-brother Muqrin, who is ten years younger, as Crown Prince, was key for longer term stability.

The succession will bring no major policy changes, a fact Salman was at painsto point out in his first television address. This is also unsurprising: although Saudi Arabia is nominally an absolute monarchy, in fact most decisions are made by a consensus among a number of senior princes. As King Abdullah’s health worsened in recent months, Salman appears to have been increasingly involved in policy decisions. Saudi policies on a number of key issues, including Syria, Iran and OPEC production levels, are therefore likely to remain entirely unchanged.

The most interesting development is the appointment of Muhammed bin Nayef to deputy Crown Prince, the first third-generation Saudi prince to be placed in the direct line of succession. As the date when the crown will pass to the third generation approaches, internal family politics play an increasing role:  Muhammed is Salman’s full-blood nephew, son of his brother Nayef. Salman and Nayef were members of the Sudairi Seven, the largest group of full brothers born to King Abdulaziz. As such, while they all lived, they formed a powerful bloc within the ruling family. The appointment by Salman of his nephew within the line of succession is likely not due only to Muhammed’s experience as head of the powerful Interior Ministry, but also to a desire to keep the crown within the Sudairi branch of the family. It remains to be seen whether Muhammed’s appointment would be maintained by new Crown Prince Muqrin should he ascend to the throne.

King Salman’s ascent to the throne in Saudi Arabia won’t change much in the Kingdom. And that is precisely the problem.”

Though all these facts are important, they obscure the fact that the succession system itself is completely archaic. Even the recently created Allegiance Council, designed to codify the transfer of power, is merely a more formalized family conference to choose the next heir. In the 21st century, Saudi Arabia is still governed in a way more reminiscent of medieval Europe than any modern state. King Abdullah was lauded as a reformer, but change has been at best incremental: the recent flogging of blogger Raif Badawi illustrates the Saudi state’s stance on freedom of speech, while Saudi women are still neither permitted to drive nor to perform a variety of basic tasks without permission from a male “guardian.”

It is true that good foreign policy often requires working with allies which have domestic politics that are distasteful, and U.S. leaders’ tributes to King Abdullah tended to highlight his role as a U.S. ally in the Middle East. Secretary of State John Kerry described him as a “man of vision and wisdom,” and the White House statement noted that ”the closeness and strength of the partnership between our two countries is part of King Abdullah’s legacy.”

Yet these tributes ignore not only unsavory Saudi domestic politics, but also the many destabilizing actions the country has taken in recent years. Saudi Arabia was the key player in efforts to roll back the protests of the Arab Spring, including military intervention in Bahrain. The Saudis were also instrumental in the early growth of the Syrian civil war, funding and arming anti-regime rebels, often with little attention to where such arms ended up. Today, Saudi leaders are vehemently opposed to a U.S. nuclear deal with Iran, as the long-running Saudi rivalry with Iran would not be well-served by a ratcheting down of tensions. Even the current instability in Yemen is partly due to Saudi meddling in Yemeni tribal politics.

Ultimately, the succession will not alter Saudi foreign policy or the Saudi stance on other major issues like the price of oil. If there is a succession crisis, it is many years away, and the royal family remains firmly ensconced in power. However, the transfer of power can perhaps serve to highlight our often reflexive support for the Saudi government. The system by which a new king is chosen may seem outdated, but it is just one facet of Saudi Arabia’s distasteful domestic politics. Rather than simply welcoming a new monarch, it might be good for U.S. leaders to look more closely at our relationship with Saudi Arabia and their recent foreign policy actions. It’s time to ask whether we should really continue to describe such a regime as one of our closest allies.

Emma Ashford is a visiting research fellow at the Cato Institute with expertise in international security and the foreign policies of petrostates.

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Washington and the World According to Mac Thornberry

Christopher A. Preble

The newly installed chairman of the House Armed Services Committee, Rep. Mac Thornberry (R-Texas), discussed the role of Congress in national security during a recent speech at theAmerican Enterprise Institute. There were no big surprises. For example, few would dispute Thornberry’s assertion that the federal government’s first responsibility is to defend the homeland; and most agree that Congress has a vital role in making national security decisions.

But while it’s oddly refreshing to hear a congressional leader defend the legislature’s role in national defense, the chairman’s frame is unduly narrow. He defines Congress’ responsibility for determining the “size, shape, and soul of the military,” but omits Congress’ equally crucial role in authorizing or sustaining military operations abroad. Indeed, Thornberry suggests that the president was essentially free to use the military that the Congress hands to him, which turns the Constitution on its head. At a minimum, Chairman Thornberry might have spelled out his views on the need for a new Authorization to Use Military Force to fight ISIS in Iraq and Syria.

The other point that stood out from the speech is Thornberry’s view of the world, and America’s role in it. Thornberry, echoing many of his colleagues, believes that the world is dangerous, and getting more so. He contends that none of his “predecessors [as HASC committee chairman] had to face such a wide array of serious, complex threats to our security as we do today.”

The just-departed HASC chairman Rep. Buck McKeon (R-Calif.) might agree with that assessment, but former Rep. Carl Vinson (D-Ga. and HASC chair 1949-1953; 1955-1965) or former Rep. Charles Melvin Price (D-Ill. and HASC chair 1975-1985), were they still alive, probably would not.

Thornberry, like many of his colleagues, would be well advised to question the assumptions that drive his views on national security issues.”

For example, Thornberry incredibly claims that “the thought of the Capitol burning as in 1812 was inconceivable for two centuries” and that “only the courage of passengers on United Flight 93 stopped it from happening again on 9/11.” To be clear, no one should doubt the bravery of the Flight 93 passengers, and the role that they played in stopping a genuine disaster. But it is curiously myopic to claim that the very thought of direct attacks on Washington, DC had disappeared from the nation’s collective consciousness for more than 200 years. Tell that to those who lived through the Cold War. Vinson and Price every day pondered a massive thermonuclear strike by Soviet planes and missiles, one that wouldn’t merely destroy the Capitol building, but the entire capital city — and, much of surrounding Maryland and Virginia.

Thornberry’s answer to the threats posed by a supposedly more dangerous world is primacy: a foreign policy that hinges on a forward-deployed military geared to stopping prospective threats before they materialize. But primacy requires a large and costly military, far larger and more expensive than can be supported by $496 billion in 2015 dollars in annual Pentagon spending (the average called for by the Budget Control Act) and more expensive, even, than the military that contended with the Soviets and their supposed clients and proxies for decades (U.S. military spending during the Cold War averaged $458 billion per year, in 2015 dollars).

While Thornberry correctly understands that the resources provided to the U.S. military are insufficient to execute an ambitious global policing mission in the 21st Century, he wrongly sees increased spending as the only solution. We could, and should, revisit the military’s mission, especially by calling on other countries to defend themselves and their interests, and relieve the crushing burden on U.S. troops and taxpayers. How much more U.S. spending would it take if we don’t change course? He doesn’t say. In response to a question from AEI’s Tom Donnelly, Thornberry refused to commit to a minimum floor below which Pentagon spending could not safely fall. In the meantime, the new chairman seems adamant about removing the BCA spending caps (i.e. sequester) and has left open all options — including possible tax increases — in order to get a deal.

It is encouraging that Thornberry is sober-minded enough to realize the need for compromise, and that he won’t be able to get everything he wants for the Pentagon without making difficult or politically painful trade-offs elsewhere. He also wants to remove the slush fund known as Overseas Contingency Operations (OCO). The chairman should stick to his guns on that one.

But overall, Thornberry, like many of his colleagues, would be well advised to question the assumptions that drive his views on national security issues. If the world is not as dangerous as the news tells us it is, if our wealthy allies can do more to protect themselves and their interests, and if we can identify and implement meaningful reforms within the Pentagon’s budget, we need not bust the BCA spending caps in order to maintain the world’s preeminent military.

Christopher Preble is vice president for defense and foreign policy studies at the Cato Institute.

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America’s Frightening “Policing for Profit” Nightmare

Roger Pilon

In a move to check certain abuses inherent in the nation’s asset forfeiture law, Attorney General Eric Holder announced last Friday that the Justice Department would limit its practice of “adopting” state and local law-enforcement seizures of property for subsequent forfeiture to the government. Under the practice, to circumvent state laws that limit forfeitures or direct forfeited proceeds to the state’s general treasury, state or local officials who seize property suspected of being “involved” in crime ask the Justice Department to adopt the seizure, after which the proceeds, once forfeited pursuant to federal law, are then split between the two agencies, with 20 percent usually kept by Justice and 80 percent returned to the local police department that initiated the seizure.

If that sounds like “policing for profit,” that’s because it is. And the abuses engendered by this law’s perverse incentives are stunning. In Volusia County, Florida, police stop motorists going south on I-95 and seize amounts of cash in excess of $100 on suspicion that it’s money to buy drugs. New York City police make DUI arrests and then seize drivers’ cars. District of Columbia police seized a grandmother’s home after her grandson comes from next door and makes a call from the home to consummate a drug deal. Officials seized a home used for prostitution and the previous owner, who took back a second mortgage when he sold the home, loses the mortgage. In each case, the property is seized for forfeiture to the government not because the owner has been found guilty of a crime — charges are rarely even brought — but because it’s said to “facilitate” a crime. And if the owner does try to get his property back, the cost of litigation, to say nothing of the threat of a criminal prosecution, often puts an end to that.

So bizarre is this area of our law — when lawyers first stumble on a forfeiture case they’re often heard to say “This can’t be right” — that a little background is necessary to understand how it ever came to be. American asset-forfeiture lawhas two branches. One, criminal asset forfeiture, is usually fairly straightforward, whether it concerns contraband, which as such may be seized and forfeited to the government, or ill-gotten gain, instrumentalities or statutorily determined forfeitures. Pursuant to a criminal prosecution, any proceeds or instrumentalities of the alleged crime are subject to seizure and, upon conviction, forfeiture to the government. Courts may have to weigh the scope of proceeds or instrumentalities. Or they may have to limit statutes that provide for excessive forfeitures. But forfeiture follows conviction, with the usual procedural safeguards of the criminal law.

Not so with civil asset forfeiture, where most of the abuses today occur. Here, law-enforcement officials often simply seize property for forfeiture on mere suspicion of a crime, leaving it to the owner to try to prove the property’s“innocence,” where that is allowed. Unlike in personam criminal actions, brought against the person, civil forfeiture actions, if they are even brought, are in rem, brought against “the thing,” on the theory that it “facilitated” a crime and thus is “guilty.”

Grounded in the “deodand” theories of the Middle Ages, when the “goring ox” was subject to forfeiture because it was “guilty,” this practice first arose in America in admiralty law. Thus, if a ship owner abroad and hence beyond the reach of an in personam action failed to pay duties on goods he shipped to America, officials seized the goods through in rem actions. But except for such uses, forfeiture was fairly rare until Prohibition. With the war on drugs, it again came to life, although officials today use forfeiture well beyond the drug war. And as revenue from forfeitures has increased, the practice has become a veritable addiction for federal, state and local officials across the country, despite periodic exposés in the media.

Civil asset forfeiture is a big challenge. While the Justice Department has recently stepped up to limit the scope of this problem, it is time for Congress to act.”

Thus, behind all of this is a perverse set of incentives, since the police themselves or other law-enforcement agencies usually keep the forfeited property — an arrangement rationalized as a cost-efficient way to fight crime. The incentives are thus skewed toward ever more forfeitures. Vast state and local seizures aside, Justice Department seizures alone went from $27 million in 1985 to $556 million in 1993 to nearly $4.2 billion in 2012. And since 2001,the federal government has seized $2.5 billion without either bringing a criminal action or issuing a warrant.

There will be some cases, of course, in which the use of civil asset forfeiture might be justified simply on the facts, as in the admiralty case just noted. Or perhaps a drug dealer, knowing his guilt, but knowing also that the state’s evidence is inconclusive, will agree to forfeit cash that police have seized, thereby to avoid prosecution and possible conviction. That outcome is simply a bow to the uncertainties of prosecution, as with any ordinary plea bargain. But the rationale for the forfeiture in such a case is not facilitation — it’s alleged ill-gotten-gain. By contrast, when police or prosecutors, for acquisitive reasons, use the same tactics with innocent owners who insist on their innocence — “Abandon your property or we’ll prosecute you,” at which point the costs and risks surrounding prosecution surface — it’s the facilitation doctrine they’re employing to justify putting the innocent owner to such a choice. In such cases, the doctrine is pernicious: it’s simply a ruse — a fiction — serving to coerce acquiescence.

Because it lends itself to such abuse, therefore, the facilitation doctrine should be unavailable to any law-enforcement agency once an owner challenges a seizure of his property. And once he does, the government should bear the burden of showing not that the property is guilty, but that the owner is and, therefore, his property may be subject to forfeiture if it constitutes ill-gotten-gain or was an instrumentality of the crime, narrowly construed (e.g., burglary tools, but not cars in DUI arrests or houses from which drug calls were made). In other words, once an owner challenges a seizure, criminal forfeiture procedures should be required. Indeed, “civil” asset forfeiture, arising from an allegation that there was a crime, is essentially an oxymoron in such cases. The government should prove the allegation, under the standard criminal law procedures, before any property is forfeited.

Short of such a fundamental reform, Holder’s move is welcomed, but it makes only a dent in the problem. As the Department’s press release said, “adoptions currently constitute a very small slice of the federal asset forfeiture program. Over the last six years, adoptions accounted for roughly three percent of the value of forfeitures in the Department of Justice Asset Forfeiture Program.” Moreover, the new policy does not apply to seizures resulting from joint federal-state task forces, joint investigations or coordination, or federal seizure warrants obtained from federal courts to take custody of assets originally seized under state law. And of course the reform does not limit the ability of state and local officials to seize assets under their state laws.

Regrettably, many if not most of the abuses today take place at the state level, yet changes in federal law, which often serves as a model for state law, can affect state law as well. In his recent statement, Holder said that “this is the first step in a comprehensive review that we have launched of the federal asset forfeiture program.” Members of Congress from both parties, already working on forfeiture reform, welcomed that news. Conceivably, then, this is one area in which the new Republican Congress can work with the administration to bring about further reforms. And in that, they would do well to study the course taken by the late Henry J. Hyde of Illinois, who paved the way for the Civil Asset Forfeiture Reform Act of 2000. That act made several procedural reforms, but it left in place the basic substantive problem — the “facilitation” doctrine. The abuses have thus continued, so much so that two former directors of the Justice Department’s civil asset forfeiture program recentlywrote in the Washington Post that “[t]he program began with good intentions but now, having failed in both purpose and execution, it should be abolished.”

If that is not possible, Congress should make fundamental changes in the program. In particular, if a crime is alleged, federal law-enforcement officials should have power to seize property for subsequent forfeiture under only four conditions: first, when the property is contraband; second, when in personam jurisdiction is not available, as in the admiralty example above; third, when, in the judgment of the officials, the evidence indicates that a successful prosecution is uncertain but there is a high probability that the property at issue is ill-gotten-gain from the alleged crime and the target does not object to the forfeiture, as in the drug-dealer example above; and fourth, when the property would be subject to forfeiture following a successful prosecution and there is a substantial risk that it will be moved beyond the government’s reach or otherwise dissipated prior to conviction — but such seizures or freezes should not preclude the availability of funds sufficient to enable the defendant to mount a proper legal defense against the charges, even though some or all of the assets may be dissipated for that purpose.

Those reforms would effectively eliminate the facilitation doctrine, except for a narrow reading of “instrumentalities,” and would largely replace civil forfeiture proceedings with criminal proceedings. Consistent with last Friday’s reform, however, Congress should put an end to the underlying incentive structure by requiring that forfeited assets be assigned to the federal treasury, rather than to the Justice Department, which should not be allowed, in effect, to “police for profit.” In 2013, the federal Asset Forfeiture Fund exceeded $2 billion, having more than doubled since 2008 and increased twenty-fold since it was created in 1986. Not coincidentally, the growth in civil asset forfeiture closely parallels the ability of law enforcement agencies to profit from their activities. In fact, a veritable cottage industry has arisen that instructs officers how to stretch their legal authority to the absolute limit and beyond. It’s a system that more resembles piracy than law enforcement.

At the least, if the reforms above are not made, Congress should require the government to show, if challenged, that the property subject to forfeiture had a significant and direct connection to the alleged underlying crime, not simply that it was somehow “involved” in the crime, as now. And the standard of proof should be raised from a mere preponderance of the evidence, again as now, to clear and convincing evidence. Similarly, a proportionality requirement should be imposed to ensure that the government does not seize property out of proportion to the offense. Congress should require officials to consider the seriousness of the offense, the hardship to the owner, the value of the property, and the extent of a nexus to criminal activity. If a son living in his parents’ home is convicted of selling $40 worth of heroin and officials try to take the home, as recently happened in Philadelphia, a proportionality requirement would ensure that prosecutors cannot take a home for a $40 crime.

Finally, assuming that the facilitation doctrine is not eliminated, current law affords an innocent owner defense, but the burden is on the owner to prove his innocence by a preponderance of the evidence. Just as people enjoy the presumption of innocence in a criminal trial, property owners never convicted or even charged with a crime should not be presumed guilty in civil asset forfeiture proceedings. The burden of proof should be on the government to prove, by clear and convincing evidence, that the owner knew or reasonably should have known that the property facilitated a crime and he did nothing to mitigate the situation or that the property reflected the proceeds of a crime.

The Civil Asset Forfeiture Reform Act of 2000 has proven inadequate for curbing abuses, as countless Americans across the nation, having done nothing wrong, continue to lose their homes, businesses, and, sometimes, their very lives to the aggressive, acquisitive policing that this law encourages. There is broad agreement today that Congress should act quickly and decisively to fix a system that is badly in need of reform.

Roger Pilon is vice president for legal affairs at the Cato Institute and director of Cato’s Center for Constitutional Studies.

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The Real Problem with Obama’s State of the Union Address

David Boaz

“Nobody shoots at Santa Claus.” Al Smith’s jibe at FDR came to mind as I listened to President Obama’s laundry list of free stuff in the State of the Union speech.

The laundry list could have been worse. Cato Institute researchers counted 104 separate proposals in President Clinton’s 2000 address. I didn’t have the patience to count last night, but I’m sure there were fewer. There were some big tickets there, though, from tax hikes to free college.

As a libertarian, of course, I’d like to hear something like, oh, “the era of big government is over.” And maybe a program of economic freedom, civil liberties and peace.

Instead, we got a sweeping vision of a federal government that takes care of us from childhood to retirement, a verbal counterpart to the Obama campaign’s internet ad about “Julia,” the cartoon character who has no family, friends, church or community and depends on government help throughout her life. The president chronicled a government that provides us with student loans, healthcare, oil and the Internet.

Coercion, collectivism and bureaucracy are poor tools for decision making and progress.”

The spirit of American independence, of free people pursuing their dreams in a free economy, was entirely absent. Indeed, the word “freedom” appeared only once in the speech.

Obama prefers words such as “together” and “one people.” It’s common for political leaders to use such language, and then to present themselves as the embodiment of the nation, so that criticism of the official or his policies is divisive and unpatriotic.

Barney Frank memorably said, “Government is simply the name we give to the things we choose to do together.” But I didn’t choose to invade Iraq. Or to saddle the country with $18 trillion in public debt. Coercion, collectivism and bureaucracy are poor tools for decision making and progress.

The highest-profile item in the speech was a proposed $320 billion tax increase (over ten years), introduced rather evasively as “let’s close the loopholes that lead to inequality by allowing the top one percent to avoid paying taxes on their accumulated wealth.”

The president wants more and better jobs. And yet he wants to raise taxes on the savings and investment that produce economic growth and better jobs. And he proposes a higher minimum wage, which would cost some low-skilled workers their jobs. Those proposals are not well thought out.

Speaking of doing things together: If he wants to reach across the aisle and work with Republicans, why not work together on a tax-reform plan that would bring down the world’s highest corporate tax rate and eliminate loopholes? Why derail bipartisan cooperation on immigration by unilateral executive action?

The president declares he wants an economic program that benefits the middle class. What benefits the middle class, indeed what created the middle class, is a market economy in which people are free to produce, trade and invest. Taxes, government spending and regulation burden that process. President Obama’s tax-spend-and-regulate policies have given us the slowest recovery since World War II. You want to help the middle class? Lift those burdens.

The president spoke a lot about the future. He mentioned Social Security, Medicare and Medicaid. And he twice boasted of shrinking deficits. But he never addressed the elephant in the room: The deficit is about to head back up, reaching $1 trillion in a few years. The national debt is $18 trillion and still growing. Worse, those entitlements programs have an unfunded liability of around $90 trillion. What’s his plan to avert an unprecedented financial crisis a few years after he leaves office? He didn’t say, because he has no plan.

When he turned from economics, the president offered a bit more to libertarian-minded voters. He said that we don’t want to be “dragged into costly conflicts that strain our military and set back our standing” or “dragged into another ground war in the Middle East.” He said that “when the first response to a challenge is to send in our military, then we risk getting drawn into unnecessary conflicts, and neglect the broader strategy we need for a safer, more prosperous world.” Music to noninterventionist and realist ears.

But the reality is somewhat different. He has officially ended the wars in Afghanistan and Iraq, but American troops remain in both countries, which are hardly experiencing postwar tranquility. He has bombed seven countries, three more than President Bush. We are getting more deeply entangled in a new war in Iraq and Syria, without congressional authorization. Obama asked Congress to “pass a resolution to authorize the use of force against ISIL. We need that authority.” Really? He hasn’t shown any need for it these past six months. Nor did he ask for authorization to wage war in Libya. The senator who said in his 2008 campaign, “The President does not have power under the Constitution to unilaterally authorize a military attack in a situation that does not involve stopping an actual or imminent threat to the nation,” has become a president who acts as if he does.

Libertarians applaud the president’s promise to pursue trade agreements. But instead of taking the opportunity to tell a huge audience about the benefits of free trade, he presented trade as an unfortunate necessity and promised that his trade agreements would be less bad than previous agreements. At least he wants to remove the failed embargo against Cuba.

He acknowledged the civil-liberties problems presented by the surveillance state, but merely assured us that the surveillance agencies are going to make nice from now on.

I applaud his desire to work on a bipartisan basis for criminal-justice reform and look forward to more specifics. Since, as he noted, he has no more campaigns to run, and he has demonstrated his willingness to exercise the powers of the office (and then some), perhaps he could start with a more generous use of the pardon power for people serving long prison terms for nonviolent offenses. And why no mention of the growing movement to legalize marijuana?

Finally, I appreciate the president’s inclusiveness in his rhetoric and his policies. In 2013, he paid tribute to “Seneca Falls, and Selma, and Stonewall.” This year he cited gay marriage as “a story of freedom”—indeed, his only mention of freedom—and he touched on the deepest roots of our liberty and our civilization in this passage: “we are a people who value the dignity and worth of every citizen: man and woman, young and old, black and white, Latino and Asian, immigrant and Native American, gay and straight, Americans with mental illness or physical disability.”

In discussing the Cuban embargo, Obama said, “When what you’re doing doesn’t work for 50 years, it’s time to try something new.” How many applications that maxim might have!

How about fifty years of a drug war that has created crime, corruption and overflowing prisons, but hasn’t stopped drug use or abuse? Or fifty years of education spending increases with no increase in test scores? Or fifty years of an interventionist foreign policy that has indeed dragged us into costly and unnecessary conflicts? Or fifty (now fifty-one) years of a War on Poverty that has cost our economy $16 trillion, but has not ended poverty and unemployment?

To reiterate: “When what you’re doing doesn’t work for 50 years, it’s time to try something new.”

Early in the speech the president said, “We need to set our sights higher than just making sure government doesn’t screw things up, the government doesn’t halt the progress we’re making. We need to do more than just do no harm.” Please, just do no harm. Americans will make plenty of progress if government doesn’t interfere.

David Boaz is Executive Vice President of the Cato Institute and author of The Libertarian Mind, to be published by Simon & Schuster on February 10.

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Allow Highly Skilled Immigration and Boost the Economy

Alex Nowrasteh

Sen. Orrin Hatch (R-Utah) just introduced the bipartisan Immigration Innovation Act (I-Squared), which aims to liberalize and expand the immigration system for highly skilled workers.

As virtually all the research shows, attracting more high-skilled immigrants will stimulate economic growth and job creation by boosting innovation and productivity.

Hatch touted I-Squared by writing that even “[t]he president recognizes we face a high-skilled worker shortage that has become a national crisis.” Although there are tight labor markets for some high-tech occupations, the information sector is not one of them, and it’s by no means a national crisis. Wages for computer scientists, many engineers, and scientists are growing more quickly than for other occupations, but wage increases and a tight labor market are not the same as a shortage.

The real benefits of I-Squared wouldn’t come from filling jobs in “shortage” occupations, which don’t exist for most technology occupations, but from increasing the productivity of the American economy.

The productivity gains from immigrant inventions and innovations are tremendous.”

Economists at Rutgers and Princeton found that a 1-percentage-point increase in college-educated immigrants as a share of the population increased patents per capita by 9 percent to 18 percent. Economists from Harvard and the University of Michigan also found a 10 percent increase in the number of workers with H-1B visas in a city boosts the entire city’s patent output by almost 1 percent, a huge increase given the small numbers of H-1Bs relative to the workforce. They concluded that H-1B workers boost patents and innovation so much that they have a significant effect on long-term economic growth while also creating more jobs for Americans with similar skills.

The productivity gains from immigrant inventions and innovations are tremendous. From 1990 to 2010, 10 percent to 25 percent of the total combined productivity growth across 219 American cities was caused by H-1B workers in the science, technology, engineering and mathematics (STEM) professions. Those large gains occurred not just because of patenting but because skilled immigrants have different skills than Americans with similar educations. A larger, more diversely skilled immigrant workforce in the STEM occupations boosts wages and jobs for American workers.

Influential research by University of California, Berkeley, economist Charles Jones found that 50 percent of U.S. productivity growth from 1950 to 1993 could be attributed to growth in the share of scientists and engineers in the workforce. I-Squared’s reforms to the H-1B system could more than triple the annual flow of engineers and scientists into the United States. If history is any guide, I-Squared’s increase in those occupations could jump-start the U.S. economy for decades to come.

The bill, of course, does more than liberalize the H-1B visa. It also boosts the number of employment-based green cards for highly skilled immigrants, more than doubling them by creating numerous exemptions. Skilled immigrants with green cards are very entrepreneurial, as are immigrants at every skill level.

Between 1995 and 2005, 25.3 percent of all technology and engineering firms established in the United States had at least one immigrant founder. In Silicon Valley, 43.9 percent of technology and engineering startups had at least one immigrant co-founder between 2005 and 2012. Company creation is a big driver of employment growth and innovation, and immigrants do a lot of it.

Hatch is right that I-Squared would boost American economic growth, productivity and create jobs for Americans. However, I-Squared would not fill an urgent labor shortage, as he claims, except in some specialized occupations or regions of the country.

Opponents of I-Squared, however, are far more mistaken. Skilled immigrants do not “take our jobs,” as virtually all economists who study this issue have found. I-Squared would be a big win for the U.S. economy. Let’s just make sure we know the real reasons why that’s true.

Alex Nowrasteh is an immigration policy analyst at the Cato Institute’s Center for Global Liberty and Prosperity.

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Thankfully, Obama’s Dumb Capital Gains Plan Is Going Nowhere

Chris Edwards

President Obama’s new tax proposals show that he is not interested in bipartisan tax reform. The plan to be outlined in his State of the Union address is anti-growth, anti-savings, and pro-complexity. Left-wing political consultants might like the plan, but not serious tax reformers. Obama himself has called for simplifying the tax code, but his proposals — including the expansion of tax credits — would make the code more complicated.

Obama’s worst idea is raising the top capital gains tax rate from 24 to 28 percent, which would come on top of his previous increase from 15 percent. Low capital gains tax rates are not some sort of unjustified loophole. We’ve had reduced rates virtually the entire time we’ve had an income tax, and for very good reasons. Low capital gains rates are crucially important for spurring entrepreneurship, investment, and growth.

Recognizing that, nearly every other high-income nation has reduced capital gains tax rates. The average top long-term rate in the 34 Organization for Economic Cooperation and Development (OECD) nations is just 18 percent, according to Tax Foundation. By contrast, the U.S. rate, including both federal and state taxes, would jump to 32 percent under the Obama plan — far higher than the rate in most other nations.

The plan outlined in his State of the Union address is anti-growth, anti-savings, and pro-complexity.”

Congress will likely reject the Obama plan, and here is a quick refresher why it should:

  • Inflation – If an individual buys a stock for $10 and sells it years later for $12, part of the $2 in capital gains will be inflation. By taxing inflation, the tax code reduces real returns, and thus suppresses investment, particularly in growth companies. A lower statutory rate partly solves the problem.
  • Double Taxation – Corporate share values generally equal the present value of expected future earnings. If expected earnings rise, share values will rise, creating a capital gain to the individual. But those future earnings will be taxed at the corporate level when they occur, so also hitting individuals with a capital gains tax is double taxation. Dividends are also double taxed, with the result that our tax system is biased against corporate equity and in favor of debt, which destabilizes companies and the overall economy.
  • Competitiveness – Capital has become highly mobile, prompting nearly every country over the years to cut taxes on corporations, wealth, estates, dividends, and capital gains. When Canada cut its federal capital gains tax rate to 14.5 percent a number of years ago, a parliamentary report recommended that “international competitiveness be the criterion guiding the choice of a capital gains tax regime.” The higher are U.S. tax rates on capital, the more job-creating investments will be scared away.
  • Growth Companies – Reduced capital gains taxes encourage entrepreneurship because the after-tax capital-gain payoff from a successful start-up is increased. Low tax rates also boost outside investment from angels and venture capitalists because their reward for taking risks on unproven young companies is a possible gain years down the road. The higher the tax rate on gains, the fewer business investments will get the green light. Higher capital gains taxes would particularly hit areas — such as Silicon Valley — that rely on growth-oriented industries.
  • Government Revenue – A 2012 Congressional Budget Office study found that the longer-term responsiveness of capital gains realizations to the tax rate is quite large. That means that the government’s revenue gain from a capital gains tax hike would be only a small fraction of what policymakers might expect. Also, to the extent a capital gains tax hike reduced entrepreneurship and investment, the overall economy would be hurt, which would further suppress revenues.

Aside from raising the tax rate, President Obama is also proposing to tax capital gains at death, instead of the current system that allows a “step-up in basis” for assets passed to heirs. The problem is that the government already has a 40 percent estate tax that separately hits wealth at death. Most nations have either an estate or inheritance tax, or they tax capital gains at death, not both. For example, Canada does not have an estate or inheritance tax, but it taxes capital gains at death at the top federal rate of just 14.5 percent. So Obama’s plan to add more taxes at death is a huge overkill.

With the Obama administration, economic policy always seems to be a zero-sum game. The administration dreams up new ways to subsidize some people, piles the tax punishment onto others, and ends up undermining economic growth for everybody. But tax reform should be a win-win proposition. By reducing the most damaging taxes — such as the capital gains tax and the corporate income tax—real reform would spur broad-based growth, which would benefit workers and entrepreneurs alike.

We can help the middle class — as Obama says he wants to — not by hooking them on more federal benefits, but by reducing government hurdles to economic growth. Cutting tax rates, not raising them, is the real way to make economic policy work for all Americans.

Chris Edwards is director of tax policy studies at the Cato Institute. He is the author of “Advantages of Low Capital Gains Tax Rates,” Cato Institute, 2012.

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What about the Ruble?

Steve H. Hanke

The Russian ruble ended 2014 in bad shape. Not as bad as the Ukrainian hryvnia or the Venezuelan bolivar, but bad, nevertheless. For most of 2014, Russia faced an ever-increasing ratcheting up of economic sanctions. These set the stage for what was to come late in the year: the collapse of oil prices and the announcement on November 10th that the ruble would be allowed to float. When combined, these three ingredients created a perfect storm.


In the storm, the ruble fell like a stone. In addition to witnessing most of the ruble’s purchasing power vanish, the Russians saw the volatility of their currency explode, reflecting the increased uncertainty of the ruble’s course. Not a pretty picture (see the accompanying chart). But, one that can be brought into some focus by reflecting on analogies with the Indonesian financial crisis of 1997-98.

On August 14, 1997, shortly after the Thai baht collapsed on July 2, Indonesia floated the rupiah. This prompted Stanley Fischer, Deputy Managing Director of the International Monetary Fund, to proclaim that “the management of the IMF welcomes the timely decision of the Indonesian authorities. The floating of the rupiah, in combination with Indonesia’s strong fundamentals, supported by prudent fiscal and monetary policies, will allow its economy to continue its impressive economic performance of the last several years.”

If Russia wants to avoid further ruble turmoil, it should tether the ruble tightly to the U.S. dollar.”

Contrary to the IMF’s expectations, the rupiah did not float on a sea of tranquility. It plunged from 2,700 rupiahs per U.S. dollar at the time of the float to lows of nearly 16,000 rupiahs per U.S. dollar in 1998. Indonesia was caught up in the maelstrom of the Asian crisis.

By late January 1998, President Suharto realized that the IMF medicine was not working and sought a second opinion. In February, I was invited to offer that opinion and began to operate (pro bono as usual) as Suharto’s Special Counselor. Although I did not have any opinions on the Suharto government, I did have definite ones on the matter at hand. After the usual open discussions at the President’s private residence, I proposed as an antidote an orthodox currency board in which the rupiah would be fully convertible into the U.S. dollar at a fixed exchange rate. On the day that news hit the street, the rupiah soared by 28 percent against the U.S. dollar. These developments seemed to infuriate the U.S. government and the IMF.

Ruthless attacks on the currency board idea and the Counselor ensued. Suharto was told in no uncertain terms — by both the President of the United States, Bill Clinton, and the Managing Director of the IMF, Michel Camdessus — that he would have to drop the currency board idea or forego $43 billion in foreign assistance. He was also aware that his days as President would be numbered if the rupiah was not stabilized.

Economists jumped on the bandwagon too. Every half-truth and non-truth imaginable was trotted out against the currency board idea. In my opinion, those oft-repeated canards were outweighed by the full support for an Indonesian currency board (which received very little press) by four Nobel Laureates in Economics: Gary Becker, Milton Friedman, Merton Miller, and Robert Mundell.

Why all the fuss over a currency board for Indonesia? Merton Miller understood the great game immediately. As he wrote when Mrs. Hanke and I were in residence at the Shangri-La Hotel in Jakarta, the Clinton administration’s objection to the currency board was “not that it wouldn’t work but that it would, and if it worked, they would be stuck with Suharto.” Much the same argument was articulated by Australia’s former Prime Minister Paul Keating: “The United States Treasury quite deliberately used the economic collapse as a means of bringing about the ouster of President Suharto.” Former U.S. Secretary of State Lawrence Eagleberger weighed in with a similar diagnosis: “We were fairly clever in that we supported the IMF as it overthrew [Suharto]. Whether that was a wise way to proceed is another question. I’m not saying Mr. Suharto should have stayed, but I kind of wish he had left on terms other than because the IMF pushed him out.” Even Michel Camdessus could not find fault with these assessments. On the occasion of his retirement, he proudly proclaimed: “We created the conditions that obliged President Suharto to leave his job.”

To depose Suharto, two deceptions were necessary. The first involved forging an IMF public position of open hostility to currency boards. This deception was required to convince Suharto that he was acting heretically and that, if he continued, it would be costly. The IMF’s hostility required a quick about-face: Less than a year before the Indonesian uproar, Bulgaria (where I was President Stoyanov’s advisor) had installed a currency board on July 1, 1997 with the enthusiastic endorsement of the IMF, and Bosnia and Herzegovina (where I advised the government on currency board implementation) had followed suit under the mandate of the Dayton Peace Agreement, and with IMF support, on August 11, 1997.

Shortly after Suharto departed, the IMF’s currency board deception became transparent. On August 28, 1998, Michel Camdessus announced that the IMF would give Russia the green light if it chose to adopt a currency board. This was followed on January 16, 1999 with a little-known meeting in Camdessus’ office at the IMF headquarters in Washington, D.C. The assembled group included IMF top brass, Brazil’s Finance Minister Pedro Malan, and the central bank’s Director of Monetary Policy Francisco Lopes. It was at that meeting that Camdessus suggested that Brazil adopt a currency board.

The second deception involved the widely-circulated story which asserted that I had proposed to set the rupiah’s exchange rate at an overvalued level so that Suharto and his cronies could loot the central bank’s reserves. This take-the-money-and-run scenario was the linchpin of the Clinton administration’s campaign against Suharto. It was intended to “confirm” Suharto’s devious intentions and rally international political support against the currency board idea and for Suharto’s ouster.

The overvaluation story was enshrined by the Wall Street Journal on February 10, 1998. The Journal reported that Peter Gontha had summoned me to Jakarta and that I had prepared a working paper for the government recommending that the rupiah-U.S. dollar exchange rate be set at 5,500. This was news to me. I did not meet, nor know of, Peter Gontha at that time, nor had I authored any reports about Indonesia or proposed an exchange rate for the rupiah.

I immediately attempted to have this fabrication corrected. It was a difficult, slow, and ultimately unsatisfactory process. Although the Wall Street Journal reluctantly published a half-baked correction on February 14, the damage had been done.

The Journal’s original fabrication (or some variant of it) was repeated in virtually every major magazine and newspaper in the world, and it continues to reverberate to this day, even in so-called scholarly books and journals. For example, in his 2000 memoir, From Third World to FirstThe Singapore Story: 1965-2000, Lee Kuan Yew asserts that “in early February 1998, Bambang, the president’s son, brought Steve Hanke, an American economics professor from Johns Hopkins University, to meet Suharto to advise him that the simple answer to the low exchange value of the rupiah was to install a currency board.” This bit of misinformation was a surprise, since I have never had any contact with Bambang Suharto. But, it is not just politicians who fail to “fact check” their assertions. Theodore Friend’s 2003 tome, Indonesian Destinies, misspells my name and then proceeds to say that I “counseled the [Suharto] family to peg the exchange rate at 5000.”

Setting the record straight has been complicated by the official spinners at the IMF. Indeed, they have been busy as little bees rewriting monetary history to cover up the IMF’s mistakes, and Indonesia represents one of its biggest blunders. To this end, the IMF issued a 139-page working paper “Indonesia: Anatomy of a Banking Crisis: Two Years of Living Dangerously 1997–99” in 2001. The authors include a “politically correct” version of the currency board episode, asserting among other things, that I counseled President Suharto to set the rupiah-dollar exchange rate at 5000. This pseudo scholarly account, which includes 115 footnotes, fails to document that assertion because it simply cannot be done. That official IMF version of events also noticeably avoids referencing any of my published works or interviews based on my Indonesian experience.

This episode and its manipulations are not unique in the political world. It is useful, though, after time and events unfold, to set facts straight in order to understand the situation then and now. Other countries are currently experiencing some of the vagaries of similar treatments. Let’s hope that they, as well as the rest of us, do not have to pay later for such blunders and mistakes. Indeed, that story should be a sobering lesson.

If Russia wants to avoid further ruble turmoil, further impoverishment of its citizens, and potential political upheavals, it should tether the ruble tightly to the U.S. dollar. That’s what the big oil producers in the Persian Gulf region do — and for good reasons.

Steve H. Hanke is a professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C. You can follow him on Twitter: @Steve_Hanke

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Minimum Wage Hikes Reduced Employment of Low-Skilled Workers

Daniel J. Mitchell

It’s very frustrating to write about the minimum wage. How often can you make the elementary observation, after all, that you’ll get more unemployment if you try to make businesses pay some workers more than they’re worth?

But it’s my mission to promote economic liberty, so I’ve written on why government-mandated wages can create unemploymentby making it unprofitable to hire people with low work skills and/or poor work histories. And I’ve attacked Republicans for going along with these job-killing policies, and also pointed out the racist impact of such intervention.

Heck, just about everything sensible that needs to be said about the topic is contained in this short video narrated by Orphe Divougny

But I guess I’m the Sisyphus of the free-market movement because, once again, I’m going to try to talk some sense into those who think emotion can trump real-world economics.

Understanding ‘unintended consequences’ is a key characteristic of a good economist.”

Let’s start by citing some new research.

States are allowed to increase minimum wages above the federal level. This creates interesting opportunities to measure what happens to employment when the national minimum wage is increased, since the change presumably doesn’t impact states that already are at or above that level.

Two economists from the University of California at San Diego took advantage of this natural experiment and examined employment changes in states that were “bound” and “unbound” by the law.

“…we find that minimum wage increases significantly reduced the employment of low-skilled workers.  By the second year following the $7.25 minimum’s implementation, we estimate that targeted workers’ employment rates had fallen by 6 percentage points (8%) more in ‘bound’ states than in ‘unbound’ states.  …Over the late 2000s the average effective minimum wage rate rose by nearly 30% across the United States.  Our best estimate is that these minimum wage increases reduced the employment of working-age adults by 0.7 percentage points.  This accounts for 14% of the employment rate’s total decline over this time period and amounts to 1.4 million workers.  A disproportionate 45% of the affected workers were young adults (aged 15 to 24).”

Gee, what a surprise. Fewer jobs.

But the mandated hike in wages didn’t just reduce employment.

There were also negative effects on income.

“We find that binding minimum wage increases reduced low-skilled individuals’ average monthly incomes.  Targeted workers’ average incomes fell by an average of $100 over the first year and by an additional $50 over the following two years. …We provide direct evidence that such losses translate into meaningful reductions in upward economic mobility.  Two years following the minimum wage increases we study, low-skilled workers had become significantly less likely to transition into higher-wage employment in bound states than in unbound states.”

This evidence on income is particularly important because some statists make a rather utilitarian argument that it’s okay for some people to lose jobs because others will benefit.

Jared Bernstein is Exhibit A, as you can see in this debate we had for CNBC.

But let’s not just focus on numbers. There are painful human costs when low-skilled workers are priced out of the labor market.

Here are some excerpts from a column in the Wall Street Journalabout a real-world example of people losing their jobs.

“It’s well-established in the economic literature, if not in the minds of proponents of these laws, that the result will be job losses. Yet this empirical reality fails to capture the emotional reality of the employees who are let go, or of the business owners who had no choice but to let them go. …Michigan’s minimum wage rose in September to $8.15 an hour from $7.40 (the minimum wage for tipped employees rose 17%, to $3.10 an hour). The wage will rise to $9.25 by January 2018.”

Now let’s look at the impact on a non-profit restaurant that helped disadvantaged people.

“The staff at Tastes of Life was made up of recovering addicts, recently incarcerated individuals and others who would have a hard time landing a job elsewhere. Mr. Mosley explained that on-the-job offenses for which an employee would have been “gone that day” in a traditional work setting were instead used as training opportunities at Tastes of Life. …Mr. Mosley’s financial goal was to break even and use any excess funds to subsidize Life Challenge participants. After more than two years of operation on Beck Road, 2½ miles from the center of town, Tastes of Life had a steady flow of loyal customers, but rising food costs presented a challenge. …Mr. Mosley and Ms. Tucker had planned to print new menus with higher prices to cover the food costs, but the September wage hike complicated those plans, in particular because the increase covered both tipped and non-tipped employees. …“If we had a $10 menu item, it would have to be $14,” Mr. Mosley said. The restaurant’s customer base of seniors on a fixed income and Hillsdale locals made this option a nonstarter. The restaurant also had to find roughly 250 new customers a month, unrealistic in a small town of about 8,300.”

So the inevitable happened.

“The increased minimum wage, he told me, was ‘the straw that broke that camel’s back,’ forcing him to close his doors and lay off his 12-person staff. …with the higher wage costs, the arrangement was no longer feasible, and Tastes of Life closed on Sept. 28. …Four former employees have been able to leverage their restaurant experience to find new employment, but Mr. Mosley told me that eight are still out of work. …the loss of Tastes of Life cuts deep, because the benefit for Life Challenge participants was both valuable and is not easily attained elsewhere. These unintended consequences of a minimum wage hike aren’t unique to small towns in south-central Michigan. Tragically, they repeat themselves in locales small and large each time legislators heed the populist call to ‘raise the wage.’”

Understanding “unintended consequences” is a key characteristic of a good economist.

Indeed, Bastiat’s wise words about the “seen” and “unseen” help to explain why Krugman makes so many mistakes.

But that’s a topic for another column (actually, a whole series of columns).

Today, the goal is simply to understand that it is pointlessly destructive to make low-skilled labor less affordable.

Daniel Mitchell is a top expert on tax reform and supply-side tax policy at the Cato Institute. Mitchell is a strong advocate of a flat tax and international tax competition.

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College for All Would Set Many up for Trouble

Neal McCluskey

Say not everyone should go to college, and you’re heading for a world of rhetorical hurt. “How dare you consign people to second-class citizenship,” you’ll be angrily queried. “That’s just an excuse to leave kids behind,” you’ll hear. But whether you think everyone is college material or not, reality is inescapable: The economy simply can’t handle an America full of degrees. Not even close.

Some simple facts about college and the economy should cause everyone, no matter what they want reality to be, to pause and think.

The first reality is that huge percentages of people who enter college, for everything from certificate programs to bachelor’s degrees, likely don’t finish. There are many reasons for this, but the end result is the same: millions of people have been encouraged to go to college who haven’t gotten what they expected or wanted. And it has cost both the students and taxpayers a whole lot of money.

The economy simply can’t handle an America full of degrees. Not even close.”

Okay. But if you finish, everything is Easy Street, right? Hardly.

In 2012, 44 percent of those who had just completed a four-year degree ended up in jobs that didn’t require their credential, and typically a third of all bachelor’s holders are underemployed. And while a degree may help the holder to advance farther or faster than someone without one, the New York Fed recently reported that the effects of “underemployment” have been getting worse, not better, over the last couple of decades. So on top of the millions who enter but don’t finish college are millions more who finish but reap little benefit from having gone.

Then there’s credential inflation. As the number of sheepskins has risen we’ve seen declines in time spent studyingdropping literacy among people with degrees, and employers calling for degrees for jobs that haven’t typically needed them or appreciably changed. Taken together, higher education appears to be delivering less learning per graduate while employers are increasingly using degree-holding as a basic signal of candidate value. And that signal appears to be more “there must be something wrong with this guy” for someone without a degree than “this person must be very good” for someone with one.

Of course, credential inflation is a strong economic argument for any given person to go to college; you have to just to keep pace. Economy-wide, however, it screams “stop the insanity!” It is essentially a huge time and resource sinkhole as millions of people pursue studies that confer few, if any, economically useful skills or abilities.

Perhaps the strongest economic argument against setting college-for-all as a baseline, however, is that most of the predicted job growth, at least in the near future, will be in occupations that do not require any college study. And that is even with serious credential inflation.

According to the Bureau of Labor Statistics, of the 30 occupations expected to see the highest total growth by 2022 — not the fastest growing, but producing the most jobs — only 10 typically require any formal post secondary study to enter. Only five ordinarily require a bachelor’s degree. The vast majority typically require no more than a high school diploma or GED.

Are these the most prestigious and highest-paying jobs imaginable? No, many are retail, construction, medical service, and other generally blue collar positions — just the sort of employment often derided as consigning people to “second-class” lives. But starting at the bottom with these sorts of jobs can, and often does, lead to advancement, and several pay pretty well. And we have to answer the question: Is it better for students and taxpayers to spend time and money preparing for great jobs that don’t exist, or saving time and resources by dealing with employment reality?

For anyone with the aptitude and desire to pursue in-demand, college-level skills and knowledge, we need an education system that enables them to do so. But pushing everyone into college? That’s setting up millions of people, in the name of helping them, for failure.

Neal McCluskey is the associate director of the Cato Institute’s Center for Educational Freedom.