Countries, similar to companies and individuals, should honor their debts. 

However, when a sovereign is faced with the dilemma of default it is a distressing one for both the lenders and borrowers, where paying back the debt requires scenarios where resolutions can be achieved with repayment goals.  The current dependence on the international community to bail out the private lenders deters countries from resolving unsustainable debts efficiently and appropriately amongst each other of their own initiative, especially since there is a lack of incentives for lenders and borrowers to do so.  The broad ramifications may be an increase in sovereign defaults and international legal issues.  The resolution is to alter macroeconomic policy in our treatment of sovereign default.  In doing so, one suggested proposal is restructuring sovereign debt by creating formal procedures, an International Monetary Fund (IMF) Country Bankruptcy Court, where lenders and borrowers through a collaborative effort will restructure the debt and the IMF will preside as the governing body through this process (restructuring of debt is not too different than debt restructuring done in the private sectors, just depends on the borrower terms and the lender’s appetite for risk).  This forthright approach was suggested by Anne O. Krueger, the First Deputy Managing Director of the IMF in November 2001.  She believed that this “formal mechanism” would have served as a “catalyst”, and provide lenders and borrowers a number of protections during the debt restructuring process.  In the following based on her proposal, I examine what leads a country to crisis or default.

Sources of Country Crisis & Economic Analysis:

It is arguable that essentially a country in crisis is a product of budget deficits, which triggers a downward-spiral in the economy through other contributing factors, such as the fixed exchange rate leading to an obscene decline in fixed exchange reserves. Also, there exists an inevitable conflict between expanding monetary policy and the fixed exchange rates. This was true in the case of Argentina. When President Carlos Menem took office in Argentina in 1989, the country had piled up huge external debts, inflation had reached 200% per month, and output was plummeting. To combat the economic crisis, the government embarked on a path of trade liberalization, deregulation, and privatization. In 1991, it implemented radical monetary reforms, which pegged the peso to the US dollar and limited the growth in the monetary base by law to the growth in reserves. Inflation fell sharply in subsequent years. In 1995, the Mexican peso crisis produced capital flight, the loss of banking system deposits, and a severe, but short-lived, recession; a series of reforms to bolster the domestic banking system followed. Real GDP growth recovered strongly, reaching 8% in 1997. Then in 1998, international financial turmoil caused by Russia’s problems and increasing investor anxiety over Brazil produced the highest domestic interest rates in more than three years, halving the growth rate of the economy. Conditions got worse in 1999 with GDP falling by 3%. President Fernando De La Rua, who was in office in December 1999, sponsored tax increases and spending cuts to reduce the deficit, which had ballooned to 2.5% of GDP in 1999. Growth in 2000 was a disappointing 0.8% (Argentina website), as both domestic and foreign investors remained skeptical of the government’s ability to pay debts and maintain its fixed exchange rate with the US dollar. Argentina, soon enough was in default.

In addition to such tensions a sovereign may face, the eminent problem which is highlighted in parts of Argentina’s story and which stems from the theory that a potentially healthy economy can experience a “self-fulfilling” financial crisis (Krugman 1999) is attributed to the role of balance sheet problems in limiting investment by the private sector, and the impact of the real exchange rate on those balance sheets which produce such powerfully negative effects on a potentially healthy economy that they lead to, for our purposes, such an enormous “credit constraint” that the sovereign falls in a state of crisis. To illustrate my point, three conditions exit in a “potentially healthy economy” subsequent to each other as the sovereign defaults.

The conditions are as follows.

1. The first is that a “Goods Market” exists and contributes to the crisis,

2. The second is the “Equilibrium in the Asset Market”. The assumption is that capital lasts only one period; this period’s capital is equal to last period’s investment.  So, the capital produced through investment and entrepreneurs is equal to the interest rate for this period times the exchange rate on goods for this period, and

3. The third condition for our purposes, is the “Credit Constraint”.  With this condition, the assumption is that investment cannot be negative and lenders cannot lend more than half their wealth (I < λW), which is a result of the profits (P) minus the domestic debt (DD), minus the foreign debt (FD); (Q) the exchange rate is applied to the foreign debt for conversion. 

If time permitted, applying real numbers to these conditions would indicate that the interaction of these three conditions will result in a depreciating exchange rate, the sovereign’s wealth will be significantly less since the declining exchange rate has already triggered a downward-spiral, and debt would be on the rise.  Figure 1 illustrates that as the exchange rate (Q) shifts to the right and continues to do so, the “Credit Constraint Line” at conflict with the “Goods Market Line” results in the sovereign’s debt rising and leading towards default.

The IMF Country Bankruptcy Court Proposal & Economic Analysis:

As illustrated in Figure 1, since lenders will no longer want to lend the sovereign funds, and the sovereign will have no option, but to default as a result of its downward-spiral economy.  For such sovereigns the question that comes up is: did Ms. Krueger’s IMF Country Bankruptcy Court proposal rescue them?  In order to answer this, we will review the proposal more closely.  Ms. Krueger sets up her approach to restructuring sovereign debt on two pillars: firstly, on “reforming the architecture” of the IMF and secondly, on “involving the private sector in crisis resolution”.  Regarding the first pillar, she believes since the IMF is focusing on better national policies and reforms, such as “encouraging better communication between IMF and its members, creating the Contingent Credit Line facility offering countries with sound policies a public “seal of approval”, and now with more urgency, assisting to resolve balance sheet problems in the financial and corporate sectors”, today, the IMF is in a better position to have additional powers.  These revisions to prevention and crisis management measures were highlighted by Ms. Krueger to justify that if such centralization of power were to occur, the IMF, despite the satirical political machine that it is with a multitude of politically aligned motivations it has had in emerging countries, has the foundation necessary in resolving sovereign debt issues. 

To date, there is no IMF Country Bankruptcy Country Court and Ms. Krueger’s proposal, a novel idea and resolution to the dilemma discussed has not happened via the IMF yet. There are however, technical assistance and remedies to resolve sovereign debt default of countries and managing the domestic turmoil caused, offered by the IMF. These resolutions are a solution and aid in restructuring sovereign debt issues, but most of all the economy is in constraint like the “credit constraint” illustrated earlier. My strong inclination is that sovereign default is one of the worst predicaments a country can face: it impacts rising food costs, unemployment, inflation, political unrest likely, reduction in essential healthcare services, and extreme poverty overall. The remedy seems to be a restructuring of debt at favorable terms and a plan in place over time to achieve this goal. What good is the IMF if there is no collaboration or resolution scenarios? The IMF Bankruptcy Court was not “just a novel idea,”  but a strong blueprint for resolving the issues of any country in sovereign debt default, and if does ever come to fruition it would lead to aiding many countries with default scenarios and effective resolutions that can also achieve collaborative private sector and public sector support. 

Sonal Patney is a corporate and investment banker and author having originated, marketed, structured, executed, and closed over 100 debt and equity financings that ranged from $5M to $4B. As of October 2022, Sonal became an author with the international publishing of her book on sustainable finance debt by Europe Books – “How Should We Think About Debt Capital Markets Today? ESG’s Effect on DCM”. As a graduate of Columbia University, and New York University, she holds an MPA with a concentration in International Economic Policy, and a BA in Political Science, respectively. Her academic research has focused on emerging market countries and trade. Additionally, she has been a pro bono SCORE LI mentor for small business’ and the recipient of a mentoring award from SCORE; a member of varying nonprofit associations and a former Board member of some. She is also a “Contributor” for The Financial Executives Networking Group Journal online on capital markets topics.

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Introduction

Since 2018, the United States and China have been embroiled in a trade war. The trade war stems from US President Donald Trump’s decision to impose tariffs on several products and commodities imported from China. In response to the policy, China also imposed tariffs on several products and commodities imported from the US. Research conducted by Chad P. Bown (2022) from the Peterson Institute forInternational Economics shows that as of July 2018, the average US tariff on imports from China was still 3.8%. However, tariffs on imports from China gradually increased until they peaked at 21% in September 2019 and then dropped to 19.3% in February 2020.

Meanwhile, on the Chinese side, in July 2018, the average tariff on imports from the US was at 7.8% and then gradually increased to 21.8% in September 2019. As of February 2020, Chinese tariffs on imports from the US decreased to 21.3% and reached a low of 21.2% on July 2020. Furthermore, based on the impact of tariffs on the percentage of trade, around 66.4% of US imports from China and 58.3% of Chinese imports from the US in June 2022 are still affected by tariffs set against each other.

There are efforts between the US and China to defuse the trade war through the Phase One agreement, which was agreed upon in December 2019. The two countries agreed on structural reforms to China’s economic and trade regime, particularly in intellectual property, technology transfer, agriculture, financial services, and currency and foreign exchange. In the deal, China also committed to increasing the imports of goods and services from the US. Furthermore, a dispute resolution system was established with immediate and effective implementation and enforcement. Finally, the US agreed to modify Section 301 of the Trade Act of 1974. Despite these efforts, as shown from the data in the previous paragraph, the tariffs that the US and China imposed on each other remained relatively high.

The US put several Chinese companies on the Entity List as the trade war escalated between the two countries. The US Bureau of Industry and Security (2022) reported on August 23rd, 2022, that about 600 Chinese companies were already included on the list, with 110 companies included during President Joe Biden’s tenure. In practice, companies on the Entity List will have restrictions on access to commodities, software, and technology from the US. However, US entities may export, re-export, and transfer such matters to companies on the Entity List with a license from the US Bureau of Industry and Security.

The conflict between the US and China is not limited to political economy issues but also security politics. China’s claim to much of the South China Sea, known as the nine-dashed line, is contrary to the principles of the US freedom of navigation. This situation leads to freedom of navigation operations (FONOPS) by the US Navy in those waters that China regards as part of its territories as opposed to its claims. The existence of Taiwan also creates issues between the two countries. Although since 1972, it has recognized the communists in Beijing as the sole representative of China, the US maintains its ties with nationalists in Taipei and ensures their independence from Beijing. China’s growing economic and military power over the past two decades allows the country to become increasingly assertive of Taiwan. This raises tensions with the US as Taiwan’s ally and security guarantor.

The conflict between the US and China prompted the two countries to reduce their dependence on each other. US manufacturing imports from China have decreased, while Asian countries categorized as low-cost countries, have increased. At the same time, the issue of reshoring US companies’ operations in China arose. A survey conducted by A.T. Kearney (2022) found that about 47% of executives of US manufacturing companies operating in China have moved part of their operations back to the US in the past three years. 29% said they would restore parts of their operations in the next three years, and 16%said they had considered reshoring but are yet to make a decision. In the survey, US company executives also outlined that their options also include Mexico, Canada, and Central American countries (nearshoring), not limited to reshoring to the US. This decision coincides with the trend of automation by US companies; instead of looking for cheap labor, they are replacing them with robots. The process creates challenges for countries that host part of US companies’ operations characterized by the labor-intensive and technology-laden process.

From the Chinese side, the disruption caused by the conflict with the US encourages them to become more economically self-sufficient. Such efforts to achieve self-sufficiency are made through the dual circulation model, which includes changing the growth model from export-based to domestic consumption and reducing dependence on imports. Concerning the second element, according to the Economist Intelligence Unit (2020), China focuses on three sectors. First, technology with a priority towards semiconductors. China provides fiscal incentives and subsidies, and encourages cooperation between industries and universities to reduce dependence on US semiconductor companies or companies from other countries that use US technology. China also provides fiscal incentives and subsidies, and encourages cooperation between industries and universities. The second sector is energy. China does not rely on the US or its allies for energy supplies, however, shipping oil and gas by sea is vulnerable to a blockade or interception. The threat of a blockade prompted China to increase its renewable energy sector investment. The third sector is food. China’s agricultural sector is labor-intensive, but they experience labor shortage and are dependent on imports of seed and technology. This limitation prompted a policy of agriculture modernization from labor-intensive to technology-intensive.

Alfin Febrian Basundorois a graduate student at the Strategic and Defence Studies Centre, Australian National University, Canberra, Australia.

Muhammad Irsyad Abraris a graduate student at the Department of International Relations, Universitas Gadjah Mada (UGM), Yogyakarta, Indonesia.

Trystantois an undergraduate student of international relations at Universitas Gadjah Mada (UGM), Yogyakarta, Indonesia.

To read the abstract as it was originally posted by the Journal of World Trade Studies, click here.

To read the full research article, click here.

The post The Positive Impact of US-China Trade War on Global South’s Position in the Global Value Chain appeared first on WITA.

For Southeast Asia, growth prospects look comparatively better against the global backdrop at 4.6% as forecast by the Asian Development Bank (ADB). This was a slight downgrade from earlier predictions, due to lower export growth and a deceleration of industrial activity. Regional growth has been anchored by domestic demand and services, and the recovery of tourism activities. The need to fully leverage the region’s growth momentum amidst economic uncertainty and rising geopolitical risks was aptly highlighted by Indonesia’s ASEAN Chairmanship theme, ASEAN Matters: Epicentrum of Growth. The conclusion of the 43rd ASEAN Summit and Related Summits in September was once again a testament of Indonesia’s leadership, with over 90 documents issued and concrete deliverables announced throughout the three-day meetings that include several dialogue partners. Now that it has passed the baton to Laos, our Analysis contributors assess Indonesia’s Chairmanship and whether it has lived up to expectations.

Although it was unable to move the needle on the Myanmar crisis and the South China Sea, Jakarta managed to reaffirm ASEAN Leaders’ commitment to strengthen economic resilience. Among the Summit’s key economic outcomes were the launch of the Digital Economic Framework Agreement (DEFA) negotiations and the adoption of the ASEAN Blue Economy Framework. These outcomes embrace the region’s new growth drivers in an inclusive and sustainable way. With this in mind, this issue casts a Spotlight on the region’s many different emerging economic drivers. Our contributors look at potential growth engines in the region, from the quest for an ASEAN single QR payments network to the rise of unicorns, and the role of innovation in advancing digital health. Looking at external partners, regional experts examine how the Indo-Pacific Economic Framework for Prosperity (IPEF), the European Green Deal, and the Korea-ASEAN Solidarity Initiative can help unlock new economic and development pathways.

Beyond the economy, the region is facing another momentous development with several Southeast Asian countries undergoing leadership transitions. To help make sense of this changing political landscape and what it means for regional cooperation, ASEANFocus convened a roundtable featuring views from experts on seven ASEAN countries, namely Cambodia, Indonesia, Malaysia, the Philippines, Thailand, Singapore, and Vietnam.

To read the full report, click here.

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There are six sections in the survey. Section I covers the profile of the respondents by nationality, affiliation and age. Section II deals with questions on the regional outlook and viewpoints on international affairs in the past year. Section III covers regional influence and leadership of major and middle powers. Section IV deals with ASEAN’s options in the changing regional politicalsecurity architecture. Section V measures perceptions of trust among Southeast Asians towards five countries – China, US, Japan, the European Union and India. Section VI gauges levels of soft power in the region based on travel and tertiary education choices. The questions and results have been reorganised for logical flow and optimal reporting. The figures in this report have been rounded up or down to the nearest one decimal point.

To access the full report, click here.

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1. INTRODUCTION

The decade from 1985 to 1995 was a period of dramatic trade policy reform, particularly by developing countries. Many of them shed import substitution policies that had been in place since the 1950s and embraced exchange rate and trade reforms that opened their economies to the world (Dean, Desai, and Reidel 1994; Irwin 2022). In doing so, previously closed economies such as China and India became open to world trade and investment, and other emerging markets in Latin America, Asia, and Africa reduced their trade barriers and increased their participation in global trade. These policy changes reshaped the world economy, enabled the emergence of global supply chains, and produced the high level of interdependence that we see today.

Most countries opened their economies by performing the trade policy threestep: (1) devaluing their currencies and establishing competitive exchange rates, (2) abolishing foreign exchange controls and converting quantitative import restrictions into tariffs, and (3) gradually reducing the dispersion and level of those tariffs. In most cases, these reforms were undertaken unilaterally, often in the midst of an economic crisis. The lessons of experience, such as the success that Taiwan and Korea enjoyed after opening their economies in the 1960s, along with changing ideas about economic policy, contributed to the decision to reform their trade policies (Krueger 1997).

The World Bank, the International Monetary Fund (IMF), and the General Agreement on Tariffs and Trade (GATT)—then the World Trade Organization (WTO) after 1995—supported and encouraged the reform efforts. These institutions play an influential role in shaping international economic policy and their charters gave them a common purpose in promoting world trade.1 Although these organizations may not have been the driving force behind the reform efforts, what impact did they have in promoting the trade reforms of the 1980s and 1990s?2

Evaluating the contribution of these institutions to trade reform in developing countries is challenging because they approached the goal of expanding trade in very different ways. The GATT established trade rules and facilitated multilateral negotiations to reduce tariff and nontariff barriers to trade. The World Bank made loans to countries conditional on their making changes to their trade policies. The IMF sought “exchange rate stability” to help “in the elimination of foreign exchange restrictions which hamper the growth of world trade.” The institutions also differed in their ability to influence a country’s policies. The GATT/WTO was the weakest of the three in having virtually no leverage over sovereign governments. The World Bank and IMF had financial resources that they could use to win compliance with the policies that they deemed desirable.

Empirical assessments of the impact of these multilateral institutions on government policies and economic outcomes are plagued with difficulties. Studies based on observational data suffer from sample selection problems: the countries that choose to join the GATT/WTO, accept a World Bank loan, or enter into an IMF program are not randomly selected. These institutions dealt with different countries at different times and in different ways. The degree of compliance with loan conditionality is hard to observe. And it is not possible to know the counterfactual of whether a country’s policies would have changed even in the absence of those actions.

That said, it is possible to reach some tentative if impressionistic judgments, perhaps even surprising ones, about the contribution of these institutions to the trade reform process. One might suspect that the GATT/WTO, which of the three institutions focuses most directly on trade, had the biggest impact on developing-country policies, but on closer examination its impact was limited. The World Bank provided billions of dollars in trade policy loans, but this may not have had a decisive influence on a country’s decision to undertake trade reforms. Of the three, the IMF’s role in promoting trade reform may be the most underrated. The IMF focused more on stabilization and macroeconomic stability and yet it provided critical ingredients to trade reforms by encouraging countries to devalue overvalued currencies and start the process of eliminating exchange rate controls and import restrictions.

Douglas A. Irwin is a nonresident senior fellow at the Peterson Institute for International Economics since February 2018, is the John French Professor of Economics at Dartmouth College.

To read the full working paper, please click here. 

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