Posts by JeffreyFrankel:
- The budget. It is estimated that energy subsidy reform globally (including coal and natural gas along with oil) would offer a fiscal dividend of $3 trillion per year. The money that is saved can either be used to reduce budget deficits or recycled to fund desirable spending, such as US highway construction and maintenance, or cuts in distortionary taxes, e.g., on wages of lower-income workers.
- Pollution and its adverse health effects. Outdoor air-pollution causes an estimated annual 3.2 million premature deaths worldwide. A gas tax is a more efficient way to address the environmental impact of the automobile than alternatives such as CAFÉ standards which mandate fuel economy for classes of cars.
- Greenhouse gas emissions, which lead to global climate change.
- Traffic congestion and traffic accidents.
- National security. If the retail price of fuel is low, domestic consumption will be high. High oil consumption leaves a country vulnerable to oil market disruptions arising, for example, from instability in the Middle East. If gas taxes are high and consumption low, as in Europe, then fluctuations in the world price of oil have a smaller effect domestically. It is ironic that U.S. subsidies to oil production have often been sold on nationalsecurity grounds; in fact a policy to “drain Americafirst” reduces self-sufficiency in the longer run.
- Income distribution. Fuel subsidies are often misleadingly sold in the name of improving income distribution. The reality is more nearly the opposite. Worldwide, fossil-fuel subsidies are regressive: far less than 20% of them benefit the poorest 20% of the population. Poor people aren’t the ones who do most of the driving; rather they tend to take public transportation (or walk). As to producer subsidies, owners of US oil companies don’t need the money as much as construction workers do.
Gas Taxes and Oil Subsidies: Time for Reform
August 12th, 2015
By Jeffrey Frankel.
World oil prices have been highly volatile during the last decade. Over the past year they have fallen more than 50%.
Should we root for prices to go up, down, or stay the same? The economic effects of falling oil prices are negative overall for oil-exporting countries, of course, and positive for oil-importing countries. The US is now surprisingly close to energy self-sufficiency, so that the macroeconomic effects roughly net out to zero. But what about effects that are not directly economic? If we care about environmental and other externalities, should we want oil prices to go up or down? Up, because that will discourage oil consumption? Or down because that will discourage oil production?
The answer is that countries should seek to do both: lower the price paid to oil producers and raise the price paid by oil consumers. How? By cutting subsidies to oil and refined products or raising taxes on them. Many emerging market countries have taken advantage of the last year of falling oil prices to implement such reforms. The US should do it too.
Congress continues to shamefully evade its responsibility to fund the Federal Highway Trust Fund. On July 30 it punted with a 3-month stop-gap measure, the 35th time since 2009 that it has kicked the gas-can down the road! There is little disagreement that the nation’s roads and bridges are crumbling and that the national transportation infrastructure requires a renewal of spending on investment and maintenance. The reason for the repeated failure to put the highway fund on a sound basis for the longer term is the question of how to pay for it. The obvious answer is, in part, an increase in America’s gasoline taxes, as economists have long urged. The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries. Ideally the tax rate would be put on a gradually rising future path.
Fuel pricing is a striking exception to the general rule that if the government has only one policy instrument it can achieve only one policy objective. A reduction in subsidies or increase in taxes in the oil sector could help accomplish objectives in at least six areas at the same time:
The conventional wisdom in American politics is that it is impossible to increase the gas tax or even to discuss the proposal. But other countries have political constraints too. Indeed some governments in developing countries in the past faced civil unrest or even overthrow unless they kept prices of fuel and food artificially low. Yet some of them have managed to overcome these political obstacles over the last year. The list of those that have recently reduced or ended fuel subsidies includes Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates which abolished subsidies to transportation fuel subsidies effective August 1.
Besides raising taxes on fuel consumption, the US should also stop some of its subsidies to oil production. Oil companies can “expense” (immediately deduct from their tax liability) a high percentage of their drilling costs, which other industries cannot do with their investments. Most politicians know that sound economics would call for this benefit to be eliminated. But they haven’t been ab le to summon the political will. Among the other benefits given to the oil industry, it has often been able to drill on federal land and offshore without paying the full market rate for the leases.
Those politicians who complain the loudest about the evils of government handouts are often the biggest supporters of handouts in the oil sector. Political contributions and lobbying from the industry must be part of the explanation. Even so, it is surprising that self-described fiscal conservatives see more political mileage in closing the Export-Import Bank – which earns a profit for the US Treasury while it supports exports – than in ending oil subsidies, which cost the Treasury a great deal. ‘
A recent study from the IMF estimated that global energy subsidies at either the producer or consumer end are running more than $5 trillion per year. (Petroleum subsidies account for about $1 ½ trillion of that. A lot also goes to coal, which does even more environmental damage than oil.) US fossil fuel subsidies have been conservatively estimated at $37 billion per year, not including the cost of environmental externalities.
Leaders in emerging market countries have now recognized something that American politicians have apparently missed, that this is the best time to implement such reforms. Oil prices have recently fallen to around $50 a barrel – down from a level well over $100 a barrel in the summer of 2014. So governments that act now can reduce energy subsidies or increase taxes without consumers seeing an increase in the retail price from one year to the next.
For the US and other advanced countries it is also a good time for fuel price reform from the standpoint of macroeconomic policy. In the past, countries had to worry that a rising fuel tax could become built into uncomfortably high inflation rates. Currently, however, central bankers are not worried about inflation except in the sense that they are trying to get it to be a little higher.
Congress will have to come back to highway funding in September. If other countries have found that the “politically impossible” has suddenly turned out to be possible, why not the United States?
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New and improved trade agreements?
May 22nd, 2015By Jeff Frankel.
In marketing the TPP, Obama tends to emphasize some of the features that distinguish it from earlier pacts such as the North American Free Trade Agreement (NAFTA). These include commitments by Pacific countries on the environment and the expansion of enforceable labor rights, as well as the geopolitical argument for America’s much-discussed strategic “rebalancing” toward Asia.
As with consumer products, the slogan “New and improved!” sells. NAFTA and other previous trade agreements are unpopular. So the Obama administration’s argument is apparently, “We have learned from our mistakes. This agreement will fix them.”
But the premise is wrong: The previous agreements did benefit the US (and its partners). The most straightforward argument for TPP is that similar economic benefits are likely to follow.
The economic arguments for the gains from trade of course go back to David Ricardo’s classic theory of comparative advantage. Countries benefit most from producing and exporting what they are relatively best at producing and exporting, and from importing what other countries are relatively better at producing.
Moreover, trade boosts productivity, which is why exporters pay higher wages than other companies, on average – an estimated 18% higher in the case of US manufacturing. And the purchasing power of income is enhanced by households’ opportunity to consume lower-priced imported goods. The cost savings are especially large for food and clothing, purchases that account for a higher proportion of lower-income and middle-class households’ spending
American trade debates have long been framed by the question of whether a policy will increase or reduce the number of jobs. This concern is a first cousin to the old mercantilist focus on whether a policy will improve or worsen the trade balance. A “mercantilist” could be defined as someone who believes that gains go only to the country that enjoys a higher trade surplus, mirrored by losses for the trading partner that runs a correspondingly higher deficit.
Even by this sort of reasoning, one could make an “American” case for the ongoing trade negotiations. The US market is already rather open; TPP participants such as Vietnam, Malaysia, and Japan have higher tariff and non-tariff barriers against some products that the US would like to be able to sell them than the US does against their goods. Liberalization would thus benefit US exports to Asia more than Asian exports to the US.
The late 1990s offer a good illustration of how trade theory works in the real world. The volume of trade increased rapidly, owing partly to NAFTA in 1994 and the establishment in 1995 of the World Trade Organization as the successor to the General Agreement on Tariffs and Trade.
For the US during this period, imports grew more rapidly than exports. But the widening of the trade deficit had no negative effect on output and employment. Real (inflation-adjusted) GDP growth averaged 4.3% during 1996-2000, productivity increased by 2.5% per year, and workers received their share of those gains as real compensation per hour rose at a 2.2% annual pace. The unemployment rate fell below 4% – as low as it goes – by the end of 2000.
A stronger trade balance in the late 1990s would not have added to output growth or job creation, which were running at full throttle. Further increases in net export demand would have been met only by attracting workers away from the production of something else. That is why the gains from trade took the form of bidding up real wages, rather than further increasing the number of jobs.
Admittedly, it is harder to make the case for freer trade – particularly for unilateral liberalization – when unemployment is high and output is below potential, as was true in the aftermath of the financial crisis and recession of 2007-2009. Under such circumstances, there is a kernel of truth to mercantilist logic: trade surpluses contribute to GDP and employment, coming at the expense of deficit countries.
Of course, if one country erects import barriers, its trading partners are likely to retaliate with “beggar-thy-neighbor” policies of their own, leaving everyone worse off. That is why the case for multilateral renunciation of protectionism is as strong in recessionary conditions as ever. In response to the 2008-2009 global recession, for example, G-20 leaders agreed to refrain from new trade barriers. Contrary to many cynical predictions, Obama and his counterparts successfully fulfilled this commitment, avoiding a repeat of the debacle caused in the 1930s by America’sintroduction of import tariffs.
In any case, mercantilist logic is no longer relevant. The US unemployment rate has fallen well below 6% – not quite full employment, but close. If output and employment were rising this year as rapidly as in 2014, the Federal Reserve would probably have felt the need to start raising interest rates as early as this June. As it is, the Fed will almost certainly delay raising rates for a while longer. If trade deals do boost US exports more than imports, the Fed will probably have to put a brake on the economy that much sooner.
But the bottom line is that if the US can boost auto exports to Malaysia, agricultural exports to Japan, and service exports to Vietnam, real wages will be bid upward more than by the creation of more jobs. That is why, if it is allowed to proceed, the TPP will, like past trade deals, help put real median US incomes back on a rising trend.
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Why the ECB Should Buy American
March 20th, 2014By Jeffrey Frankel.
CAMBRIDGE – The European Central Bank needs to ease monetary policy further. Eurozone-wide inflation, at 0.8%, is below the target of “close to 2%,” and unemployment in most countries remains high. Under current conditions, it is hard for the periphery countries to reduce their costs to internationally competitive levels, as they need to do. If inflation in the eurozone as a whole is below 1%, the periphery countries are condemned to suffer painful deflation.
The question is how the ECB can ease policy, given that short-term interest rates are already close to zero. Most of the talk in Europe concerns proposals to undertake quantitative easing (QE), following the path taken by the US Federal Reserve and the Bank of Japan. This would mean expanding the money supply by buying member countries’ government bonds – a realization of ECB President Mario Draghi’s “outright monetary transactions” scheme, announced in August 2012 in the midst of growing uncertainty about the euro’s future (but never used since then).
But QE would present a problem for the ECB that the Fed and other central banks do not face. The eurozone has no centrally issued and traded Eurobond that the central bank could buy. (And the time to create such a bond has not yet come.) By purchasing bonds of member countries, the ECB would be taking implicit positions on their individual creditworthiness.
That idea is not popular with the eurozone’s creditor countries. In Germany, ECB purchases of bonds issued by Greece and other periphery countries are widely thought to constitute monetary financing of profligate governments, in violation of the treaty under which the ECB was established. The German Constitutional Court believes that the OMT scheme exceeds the ECB’s mandate, though it has temporarily tossed that political hot potato to the European Court of Justice.
The legal obstacle is not merely an inconvenience; it also represents a valid economic concern about the moral hazard that ECB bailouts present for members’ fiscal policies in the long term. That moral hazard – a subsidy for fiscal irresponsibility – was among the origins of the Greek crisis in the first place.
Fortunately, interest rates on Greek and other periphery-country debt have fallen sharply over the last two years. Since he took the helm at the ECB, Draghi has brilliantly walked the fine line required to “do whatever it takes” to keep the eurozone intact. (After all, there would be little point in upholding pristine principles if doing so resulted in a breakup, and fiscal austerity alone was never going to return the periphery countries to sustainable debt paths.) At the moment, there is no need to support periphery-country bonds, especially if it would flirt with illegality.
What, then, should the ECB buy if it is to expand the monetary base? For several reasons, it should buy US treasury securities. In other words, it should go back to intervening in the foreign-exchange market.
For starters, there would be no legal obstacles. Operations in the foreign-exchange market are well within the ECB’s remit. Moreover, they do not pose moral-hazard issues (unless one thinks of the long-term moral hazard that the “exorbitant privilege” of printing the world’s international currency creates for US fiscal policy). Finally, ECB purchases of dollars would help push down the euro’s exchange rate against the dollar.
Such foreign-exchange operations among G-7 central banks have fallen into disuse in recent years, partly owing to the theory that they do not affect exchange rates except when they change money supplies. But in this case we are talking about an ECB purchase of dollars that would change the euro money supply. The increase in the supply of euros would naturally lower their price. Monetary expansion that depreciates the currency is more effective than monetary expansion that does not, especially when, as is the case now, there is very little scope for pushing short-term interest rates much lower.
Depreciation of the euro would be the best medicine for restoring international price competitiveness to the periphery countries and reviving their export sectors. Of course, they would devalue on their own had they not given up their currencies for the euro ten years before the crisis (and if it were not for their euro-denominated debt). If abandoning the euro is not the answer, depreciation by the entire eurozone is.
The euro’s exchange rate has held up remarkably during the four years of crisis. Indeed, the currency appreciated further when the ECB declined to undertake any monetary stimulus at its March 6 meeting. Thus, the euro could afford to weaken substantially. Even Germans might warm up to easy money if it meant more exports.
Central banks should and do choose their monetary policies primarily to serve their own economies’ interests. But proposals to coordinate policies internationally for mutual benefit are fair. Raghuram Rajan, the governor of the Reserve Bank of India, has recently called for the advanced economies’ central banks to take emerging-market countries’ interests into account via international cooperation.
ECB foreign-exchange intervention would fare well in this regard. This year, the emerging economies are worried about a tightening of global monetary policy, not the policy loosening that three years ago fueled talk of “currency wars.” As the Fed tapers its purchases of long-term assets, including US treasury securities, it is a perfect time for the ECB to step in and buy some itself.
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Stan Fischer, the Fed, and Sub-par US Growth
January 19th, 2014By Jeff Frankel.
Now that Janet Yellen is to be Chair of the US Federal Reserve Board, attention has turned to the candidate to succeed her as Vice Chair. Stanley Fischer would be the perfect choice. He has an ideal combination of all the desirable qualities, unique in the literal sense that nobody else has them. During his academic career, Fischer was one of the most accomplished scholars of monetary economics. Subsequently he served as Chief Economist of the World Bank, number two at the International Monetary Fund, and most recently Governor of the central bank of Israel. He was a star performer in each of these positions. I thought in 2000 he should have been made Managing Director of the IMF.
One has trouble thinking of another economist-at least, since Keynes!-who has done as well as he at combining analytical skill, good policy sense, clear expression, selfless dedication toward making the world a better place, and the ability to get everything done — and with imperturbable good humor as well.
Most relevantly, he has a lot of experience at crisis management, having been on the firing line at the IMF during the currency crises of the 1990s and again having responsibility for the economy of Israel during the Global Financial Crisis of 2008-09. Janet Yellen, who is expected to be anointed imminently as the new Fed Chair, also has an unusually good combination of qualifications in both the academic and policy realms. But she is at her best when she has had a chance to prepare meticulously. She would be usefully complemented by someone who has a lot of experience at dealing with crisis situations where one often does not have time to prepare. Together they constitute a great team.
Fischer’s qualities were glowingly attested to at a conference in honor of his 70th birthday last month, the IMF’s Annual Research Conference, November 7-8, in Washington. Among those doing the attesting were outgoing Fed chairman Ben Bernanke, who in the 1970s was one of Fischer’s many doctoral students when he taught at MIT. (As was I.)
The same conference has been much discussed for another reason: Larry Summers, Paul Krugman, and Fed officials in their presentations to the large gathering each put forward provocative theses concerning the slow pace of economic growth in recent years. These claims will be important to the Fed’s job in 2014 and beyond.
The controversial Summers explanation for slow growth has received perhaps the most attention over the last month. He said that the economic crisis is not over until it is over, which is not yet. He boldly suggested that the reason for sub-par growth over the last ten years is a fundamental structural change, which he identified as secular stagnation: the natural or equilibrium real rate of interest may have fallen below zero permanently, perhaps as low as negative 2 or 3 per cent. Summers offered two possible reasons for the fall in the real interest rate: a saving glut coming from Asia or a long-term IT-induced decline in the relative price of capital goods that has reduced needed investment relative to saving. (Krugman offers two more possible explanations: a decline in the population growth rate and a decline in the productivity growth rate.)
If the Summers claim were right, we would really be in trouble. Central banks already can have difficulty in severe recessions attaining a sufficiently low real financial interest rate — i.e., nominal interest rate adjusted for expected inflation — because the nominal interest rate cannot go below zero. (This problem used to be called a liquidity trap and is now called the “Zero Lower Bound.”) At a minimum, they can’t do it without inflation higher than we would like. In the Summers scenario, the low equilibrium rate would mean chronically low growth. (He did actually say “forever.”)
At the conference, Fischer himself seemed more optimistic that monetary policy can work, even under current conditions. Quantitative easing can push down the long-term interest rate. So canforward guidance. And there are other channels besides the real interest rate, whether short-term or long: the exchange rate, stock market prices, the real estate market, and the credit channel. As Ken Rogoff said on the same panel, “you throw the kitchen sink at it; you do everything that is possible.”
Top Fed staff members are not usually the sort of people who go out on a paradigm-shaking limb in the way that professors are prone to do. But David Wilcox, Director of Research and Statistics, and his Fed co-authors (Dave Reifschneider and William Wascher), did it at the IMF conference. Their thesis was that US output and employment in the last few years has reflected slow supply growth — not because of an exogenous structural change of the Summers sort, but as an endogenous consequence of the financial crisis. The severity and duration of the downturn that began in December 2007 has been steadily eroding the capital stock and the size and skills of the labor force. Business fixed investment has been low. (Firms don’t build new factories, even when the cost of capital is low, if they don’t have the customers to sell to.) Long-term unemployment has been high. (Workers who have been out of a job for a long time have trouble finding someone willing to hire them and may drop out of the labor force altogether.) The result is that productive capacity and the effective labor force have moved onto diminished growth paths. The cumulated supply shortfall – the authors estimate that potential output is by now 7% below the pre-2007 trajectory –may be larger than the current shortfall in output attributable to the ongoing lack of aggregate demand itself.
What are the implications for policy? On the one hand, this unfortunate recent history makes the Fed’s job even harder that it has been, because it further limits the ability to stimulate growth without causing inflation. On the other hand, it makes it all the more important to maintain adequate demand stimulus so long as unemployment is high, because otherwise the negative effects on growth will be long-lasting. The Wilcox paper, even though representing “the views of the authors alone,” thus supports continued monetary ease in 2014.
The Krugman thesis is as surprising as the other two propositions presented at the IMF conference: Concerns about US fiscal deficits and debt are misplaced even in the longer term. Deficit hawks worry that at some point global investors will lose their enthusiasm for holding ever-greater amounts of US debt, resulting in a sharp depreciation of the dollar. Krugman’s controversial claim is that, even if this were to happen, interest rates would not rise and the effect of the depreciation on the US economy via an increase in net exports would be expansionary, not contractionary. No hard landing for the dollar. (The big difference between the US and the situation of emerging markets in the 1990s – where devaluation was contractionary — is that all the US debt is denominated in its own currency.) The policy implication is that there is less reason to worry about the long-term debt problem and more reason to worry that fiscal contraction over the last three years has been depriving the economy of needed demand.
The record of the last few years has indeed been discouraging. Even though prompt action halted the 2008 financial crisis and the initial monetary and fiscal stimulus helped end the recession itself in 2009, the recovery since then has been painfully slow.
The bottom line seems to me that the main problem has been destructive fiscal policy coming out of the Congress: misguided fiscal drag in the short-term in 2010-13; repeated unnecessary disruptive and uncertainty-maximizing political crises in 2011-13 (debt ceiling showdowns, government shutdown, and sequestration); and little progress on the genuine longer-term fiscal problem, which is the 40-year prognosis for US debt (a result of projected growth in entitlement spending). These fiscal failures have together probably subtracted more than a percentage point from US growth in each of the last three years. Especially if Wilcox is right about the supply-side exacerbation of slow demand growth, then fiscal obtuseness can explain what is going on by itself; there is no need for Summers’ deus ex machina.
But there are grounds for optimism in 2014. For the first time in four years, Congressional fiscal policy will probably not have a negative effect on growth. True, it would be better if fiscal policy could actually make a positive contribution. But ending the negative contributions is a political development that deserves more celebration than it has received.
And meanwhile monetary policy will be in good hands, especially if Fischer joins the team.
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