Free Trade: Here We Go Again

I don't intend here today to try to prove the case for free trade all over again. It's been done many times before, but it doesn't seem to stick. For academic types, I simply refer you to the absolute advantage arguments of Adam Smith, and their refinement into comparative advantage by David Ricardo. Somewhere in there we should place Frederic Bastiat, whose arguments for free trade were not only correct, but fun to read. If he were alive today, he would be a frequent guest on Kudlow and Company.

Briefly and simply, absolute advantage says we benefit if we do what we do best and trade for the rest. Smith said the cause of the wealth of nations was the division and specialization of labor, which is limited by the extent of the market. International trade extends the market enhances the benefits of specialization.

Comparative advantage carries the argument a step further and says that it pays to specialize and trade even if one party can produce everything more cheaply than the other. My favorite example from school was the executive and his secretary (showing my age with that word). Even if he can type faster and more accurately than she can, it probably still pays for him to leave the typing to her since his advantage over her as a typist is not likely as great as his advantage as an executive. Comparative advantage is a most-best or least-worst phenomenon.

Notice I haven't mentioned jobs or trade balances. The benefits of opening up trade are indicated more by the increased volume of trade than which party develops a surplus or deficit. It's hard to predict the net impact on jobs initially, but over time it will tend to even out since more imports tend to stimulate exports and more exports tend to stimulate imports. The net number will tend to end up the same, but presumably they will be in areas of comparative advantage instead of areas protected by barriers to trade.

Bastiat's Petition on behalf of the candle makers to the French Parliament is the classic defense of free trade. He points out how unfair it is for the French candle makers to have to compete with the sun for the provision of light and argues for a law requiring the shutting of blinds and shutters to level the playing field. He goes into great detail about the secondary benefits that spread from the candle makers to other related industries and create a general prosperity. (See Why Bastiat is my Hero in 2001 speeches at http://www.bobmcteer.com/.)

While Bastiat's arguments for free trade are more fun, a more succinct statement was provided by Henry George, who pointed out that protectionists want to do to their country during peacetime (close its borders to imports) what the country's enemy would want to do to it during wartime.

Most educated people understand the benefits of free trade, and that probably includes educated politicians. However, many who understand are only too willing to pander to the many more that don't. The reason many don't is that the benefits of free trade are widely dispersed while the costs are more concentrated. Free trade helps almost everyone a little bit, but hurts a few a lot. Furthermore, the higher standard of living associated with, and attributable to, free trade is not easily identified — while a job lost at a plant moving to China is easily associated with it.

Theoretically, those benefited could use a portion of those benefits to help those harmed get trained for the new jobs created by trade. But, alas, it's easier for politicians to feed the ignorance than to try to educate their constituents, and that seems true for two-thirds of our presidential candidates.

The return of Silvio Berlusconi

Mamma mia

Italians may come to regret electing Silvio Berlusconi once again

ASTONISHINGLY, il Cavaliere is back. At the ripe age of 71, Silvio Berlusconi won a convincing victory in Italy's general election on April 13th and 14th, giving him a big majority in both houses of the Italian parliament. There is every sign that his government will last. His political group, People of Freedom, has absorbed the right-wing National Alliance party, he has shed one unreliable ally in the centrist UDC party, and his main partner, the Northern League, will be reluctant to unseat him. Despite a dotty electoral system, foisted on the country by Mr Berlusconi himself in 2006, Italy may be in for five years of relatively stable government (see article).

Why did Italian voters return Mr Berlusconi for a third time, after his previous wins in 1994 and 2001? There are three answers. The most important was disappointment with the bickering centre-left government of Romano Prodi. It may have repaired Italy's unruly public finances, but only by the unpopular means of raising and collecting more taxes. It did little by way of broader reforms. Because the election came only 23 months after Mr Prodi took office, his successor as centre-left leader, Walter Veltroni, had too little time to establish himself as a credible alternative.

The second explanation for Mr Berlusconi's success is, as ever, his grip on Italy's media. Through his Mediaset empire, he controls most of Italian private television. Now that he is back in government, he will indirectly control state-run television too, giving him influence over some 90% of Italian TV. It is to the centre-left's eternal discredit that in its two recent periods in office it did nothing to deal with Mr Berlusconi's conflicts of interest in the media. Nor did it reverse the mish-mash of judicial and procedural laws that Mr Berlusconi pushed through to help him stave off conviction in the myriad court cases that Italy's magistrates have brought against him.

Still unfit

It was Mr Berlusconi's conflicts of interest and his tangled web of judicial proceedings that first led The Economist to judge him unfit to be prime minister. We stick to that view. When he suggests that magistrates should be subject to mental-health checks, or when one of his close associates, a senator who is appealing against conviction for associating with the Mafia, says a convicted mob killer was a hero, there are good reasons to argue that Mr Berlusconi should not lead his country.

Yet the biggest challenge now for Mr Berlusconi does not concern conflicts of interest, court cases or the Mafia. It is the dire state of the Italian economy. Indeed, economic woes provide the third explanation why disillusioned voters preferred him to the centre-left. They felt that Mr Prodi's government had done nothing for them except to increase their tax bills. And, against all previous experience of Mr Berlusconi's tawdry governments, many people still want to believe in the magic that made him Italy's richest man. They hope that some of it may rub off on them, making all Italians richer.

Voters have good cause to fret about the economy. In the past two decades Italy has unquestionably become the sick man of Europe. The IMF forecasts that, both this year and next, its economy will grow by a mere 0.3%, the slowest rate of growth in the European Union and among G8 rich countries. This year Italy's GDP per head has fallen below the EU average for the first time. Next year, it will fall below Greece, after being overtaken by Spain in 2006. Even against a slowing world economy, Italy stands out for its dim prospects.

The country's slow growth has persisted under governments of centre-right and centre-left. Its causes are deep-rooted and structural, so they will take years to remedy. Italy is deemed by international watchdogs to be one of the most heavily regulated of all rich countries. Trade unions and special interests have repeatedly fought off attempts at reform. Infrastructure is crumbling, the investment climate is unwelcoming, inflation is troubling and productivity growth has been low (indeed, it has recently been negative). The education and health-care systems are deteriorating. Public administration is inefficient and corrupt, especially in the south—the latest evidence being the Naples garbage mountain.

Time to liberalise

What Italy needs is wholesale liberalisation and the promotion of more competition to reinvigorate its legion of entrepreneurs and small businesses. There is no reason to assume that it would fail. The north of Italy has done well even as the south has stagnated. Italian exporters have proved nimble and creative. Fiat has been transformed. The banks, once notoriously inefficient, have become internationally competitive.

Mr Berlusconi and his finance minister and chief ideologue, Giulio Tremonti, now have a golden opportunity to build on these successes by exploiting their huge parliamentary majority to bring in sweeping supply-side reforms. The question is whether they will take it. The ousting of the far-left from parliament may risk making confrontations over reforms or spending cuts worse. But if the government succeeds in reforming, our verdict on Mr Berlusconi would have to be tempered by the acknowledgment that even he is capable of improvement. Unfortunately there are grounds for scepticism about the new government's reforming credentials.

Mr Tremonti has taken to railing against globalisation as the primary cause of Italy's (and Europe's) problems. The Northern League, which did well in the election, is even more overtly anti-immigration and protectionist. Mr Berlusconi's own words about the future of Alitalia, the country's sickly airline, suggest that he is keener on state-fostered national champions, however inefficient, than on the discipline of the free market. Indeed, he and Mr Tremonti often prefer to cast blame on the EU, the euro and the European Central Bank than to accept that Italy's ills are largely home-grown.

Yet the omens are not all bad. Mr Berlusconi seems to understand, belatedly, the seriousness of Italy's economic situation. His comfortable majority means that he has no more excuses for putting off reforms. This will be his biggest test; hope, for Italy's sake, that he passes it.

Paraguay's elections

Liberation politics

After 61 years, Paraguay may finally see a change of government

IF THE poll numbers hold, the world's longest-ruling political party will be dismissed by Paraguay's voters on Sunday April 20th. The Colorado Party, which came to power two years before China's Communist Party, has governed for so long that Paraguay sometimes feels like a run-down country club that exists purely for the benefit of party members. Yet despite fielding a good candidate, the Colorados could well lose to a complete political novice.

Their main opponent is Fernando Lugo, a Catholic bishop who gave up his job preaching liberation theology to the poor in order to stand for office. In person, he is rather less charismatic than his story suggests. But since being chosen as the figurehead for a coalition of the biggest opposition parties, he has turned into a formidable candidate. Those close to him say he has struggled to switch from officiating at mass to talking confidently about fixing Paraguay. But he has cut his hair, had his teeth polished and embodies a fresh start—unlike his two main rivals.

For in addition to the Colorado candidate, Mr Lugo faces Lino Oviedo, a former general accused of planning a coup in 1996 and of being involved in the assassination of Paraguay's vice-president in 1999. After two spells in jail and five years in exile (in Argentina and Brazil), Mr Oviedo, a Colorado presidential candidate in 1998, re-emerged last September as another champion of the poor. Now candidate of the National Union of Ethical Citizens, he looks set to do well, though the presidency is probably beyond his grasp.

Meanwhile, the Colorados are wondering where they went wrong. Their candidate, Blanca Ovelar, a former teacher, education minister and basketball player, is reckoned to be the best they have produced for a long time. She has a powerful party machine behind her. And Paraguay's economy grew by 5.5% last year, its best rate for over a decade. Yet the party has not capitalised on its good fortune. This is partly due to the strange behaviour of the outgoing president, Nicanor Duarte Frutos. His attacks on the press for perceived bias, and on agri-business for making too much money, have sounded bitter. Some of his outbursts have just been plain odd: at one recent event, he mentioned the word “masturbation” seven times.

As the election draws closer, worries about fraud are increasing. Juan Carlos Cabezudo, a Patria Querida Party candidate for Congress, says his party has so far identified 25,000 people on the electoral register who are either dead, in jail, in the army or living abroad, and who therefore should be disqualified from voting. The electoral tribunal that oversees elections is dominated by the Colorado Party.

If Mr Lugo does win, he will seek to renegotiate the revenues Paraguay receives from Itaipu, a big hydro-electric dam built jointly with Brazil. Under the terms of the contract, Paraguay has to sell any unused electricity to Brazil at a fraction of the current market price. Unsurprisingly, Brazil has no plans to renegotiate it. Behind the scenes, Mr Lugo's team are therefore working on a subtler approach that involves presenting their man as a disciple of Brazil's president, Luiz Inácio Lula da Silva, who would spend increased revenues from the dam on the kind of social measures that Brazil has already implemented.

A President Lugo would find himself pulled in different directions by ruthless political operators on the one hand and small far-left parties on the other. When combined with his lack of experience, this could be a disastrous mixture. The Liberal Party, the dominant partner in his coalition, hopes to save him from doing anything too rash. But perhaps a little rashness is just what Paraguay needs if it is ever to get rid of the Colorados.

Royal Bank of Scotland

And the cupboard was bare

Banks pass round the begging bowl

EVER since the emperor bought new clothes, there have been few instances of self-delusion quite as stark as that of cavalier British bankers at the start of 2008. Just as rivals in America and other parts of Europe were writing down billions on their investments in dodgy mortgage loans and frantically raising money, the bosses of Britain’s biggest banks were instead blithely increasing their dividends in a blustery display of financial strength. Just how hollow it was became apparent on Friday April 18th when it emerged that Royal Bank of Scotland, the country’s second biggest bank, might have to raise money to satisfy bank regulators.

The amount will not be trivial, not will be its impact on shareholders. Analysts reckon that Royal Bank may have to raise between £10 billion ($19.9 billion) and £13 billion, about a third of its current market value of £37 billion. It is expected to do so through a share sale which will probably be announced at its annual shareholders’ meeting on April 23rd.

At issue is Royal Bank’s “core capital”—a cushion composed mainly of shareholders’ money that regulators insist banks hold against bad times—which stands at about 4.5% of risk-weighted assets. This is the lowest of any big British bank and well below the 6% that most banks consider a reasonable minimum level. For Sir Fred Goodwin, the chief executive of Royal Bank, the prospect of having to go cap in hand to shareholders for a bailout would be a deep humiliation and many believe that Sir Fred’s head may well be the price that shareholders demand in exchange for supporting a share issue that may dilute their existing holdings by as much as 50%. If that is the case it would mark the end of a career that was marked by both brilliance and hubris.

Sir Fred made his name at Royal Bank after its hostile takeover of NatWest, another British bank in 2000. Although he was not the main architect of the deal, he was responsible for making it work. He did so skilfully and ruthlessly, in the process earning the moniker “Fred the shred” when he cut some 18,000 jobs. His reign at Royal Bank was characterised by a curious mix of authoritarianism and prickliness. (He once started to sue a big newspaper for libel after it joked in a column that he had wanted a private road built from his bank’s headquarters to the airport and had been denied membership of a swanky golf course. He denied the suggestions entirely.)

More important is that in recent years Sir Fred has alienated shareholders with a spate of contentious acquisitions abroad that, although vastly expanding the empire he manages, has served mainly to depress his company’s share price. The most recent of these was his bank’s participation last year in the €72 billion ($101 billion) takeover of ABN AMRO, a Dutch bank, by a group that also included Spain’s Santander and Fortis, a Belgian-Dutch bank. This deal, which was paid for mostly in cash, is the main reason that Royal Bank’s balance sheet is so stretched (although writedowns on the value of credit derivatives have not helped).

And, although analysts have speculated for months that the bank would need to raise new capital, he has brusquely brushed aside their concerns. On February 28th when he presented the bank’s annual results, he unequivocally told analysts that he had “no plans for any inorganic capital raisings or anything of the sort.”

Rival bankers, however, are advised to keep their Schadenfreude in check. On Friday Citigroup posted a $5.1 billion loss for the first quarter and said it plans to cut 9,000 more jobs. And in Britain, analysts expect other banks to follow in Royal Bank’s footsteps in beating a path to shareholders’ doors. Analysts at JPMorgan Chase, an investment bank, reckon British banks need to raise about £37 billion. Among the worst affected are HBOS, which they reckon may need to raise as much as £11 billion, and Barclays, which could be short of about £8 billion. Self delusion may be dying hard among Britain’s banks, yet the sooner they face facts, the sooner they can move on.

Friday, April 18, 2008

Soros Plays Politics

Investor's Business Daily

Politics: As election season kicks into high gear, who should jump in front of the cameras but George Soros. A string of worshipful media stories suggest he's just talking financial shop. We think it's campaign politics.

After several months of seeming hibernation, the leftist billionaire speculator, who calls himself the "stateless statesman," has somehow gotten himself a lot of sudden press coverage. Starting most prominently with CNBC's Maria Bartiromo, Soros has been telling interviewers that this is "the worst market crisis in 60 years" and "the end of an era."

Ahem. What the media blitz really coincides with is the heating up of the U.S. election. Soros is well-known for his political views, calling last year, for example, for "a certain de-nazification" of America.

Soros hasn't made any overtly political statements since news he funded MoveOn.org, the radical group that smeared Gen. David Petraeus ("General Betray Us") last fall. But he's still making political contributions. On the receiving end are not only the Barack Obama campaign, but also 501(c) nonprofits and 527 political groups that amount to shadow campaigns.

His newest project is said to be a $40 million startup called "Progressive Media USA" and is explicitly targeting John McCain. The big money group is to be led by professional smear campaigner David Brock, otherwise known for the Media Matters group that tries to nudge mainstream news outlets even further leftward.

But don't expect that to figure much in the perfectly baked puff pieces that call Soros "The Face of a Prophet," as the New York Times gushed Friday, and deal out more of his doom and gloom.

"I consider this the biggest financial crisis of my lifetime," the Times quoted him as saying. The dollar, he predicts, will be replaced as a global currency and things will get worse before they get better. A week earlier he told the Financial Times that the current crisis was all Ronald Reagan's and Margaret Thatcher's fault.

The problem with all this negativity is that it amounts to a thinly disguised form of political campaigning. The statements he makes — and he makes a lot of them — influence perceptions, particularly of voters who aren't in the markets themselves. This helps the left in the same way as straight political campaigning.

Soros presents himself to media sycophants as a wise old philosopher with the global good in mind. To us, he looks more like a market speculator with political opinions that get more attention than they deserve.