Here's something you don't see every day in the global political economy

While Occupy Wall Street has been garnering many headlines with outrage about the financial sector, the Bank of International Settlements just released a paper that's likely to have more actual impact on said financial sector.  The paper is an effort to estimate the costs and benefits from requiring global systemically important banks (G-SIB's) to increase their capital buffers.  From the executive summary: 

[R]aising capital requirements on the top 30 potential G-SIBs by 1 percentage point over eight years leads to only a modest slowdown in growth. GDP falls to a level 0.06% below its baseline forecast, followed by a recovery. This represents an additional drag on growth of less than 0.01 percentage points per year during the phase-in period. The primary driver of this macroeconomic impact is an increase of lending spreads of 5-6 basis points. Soon after implementation is complete, growth is forecast to be somewhat faster than trend until GDP returns to its baseline. The aggregate figures conceal significant differences across countries, which reflect differences in the role of G-SIBs in the domestic financial system and in current levels of bank capital buffers. International spillovers are also important, and in some countries are likely to be the dominant source of macroeconomic effects.

The overall results are robust to variations in key assumptions. Using a longer list of banks, scaling by assets rather than lending, shortening the implementation period, or limiting the ability of authorities to offset slower growth with monetary or macroprudential policy were all found to increase the growth impact, but not markedly.

What will be the effect of the full package of the Basel Committee's proposals for stronger capital requirements - the set of buffers that will be required of all banks under Basel III, combined with the additional buffers to be carried by G-SIBs? The impact of the Basel III proposals, using the end-2009 global capital levels as a starting point, was calculated by the MAG [Macroeconomic Assessment Group] in 2010. On top of this, we assume for illustrative purposes that the top 30 G-SIBs will need to raise their capital ratios by an additional 2 percentage points, and that both parts of the reform are implemented over eight years. Adding together these two components, we find that the impact is again quite small, with GDP at the point of peak impact forecast to have fallen 0.34% relative to its baseline level. Roughly 0.04 percentage points are subtracted from annual growth during this period, while lending spreads rise by around 31 basis points. As before, different assumptions lead to different effects, with faster implementation or a weaker monetary policy response increasing the impact on GDP.

The benefits of the G-SIB framework relate primarily to the reduction in the exposure of the financial system to systemic crises that can have long-lasting effects on the economy. The LEI estimated the benefits of Basel III by multiplying the degree to which it reduces the annual probability of a systemic crisis, by an estimate of the overall cost of a typical crisis in terms of lost output. Drawing on the [Basel Committee Long-term Economic Impact Study's] results, the MAG estimated that raising capital ratios on G-SIBs could produce an annual benefit in the order of 0.5% of GDP, while the Basel III and G-SIB proposals combined contribute an annual benefit of up to 2.5% of GDP - many times the costs of the reforms in terms of temporarily slower annual growth.

Let me just translate how the BIS would put this to a lay audience:

Hey, you know how Jaime Dimon and all the other bankers who contribute to the Institute for International Finance, American Bankers Association, and Financial Services Forum keep saying that raising their capital requirement is "anti-American" and will lead to catastrophic economic consequences?  Yeah, well, they don't know what the f**k they're talking about.  Raising their capital requirements causes a extremely small dip in expected growth -- and by small we mean less than one tenth of one percent of GDP.  This is massively outweighed by preventing the expected lost output that would result from recessions triggered by another financial crisis. 

Now, it's not terribly surprising that global regulators will say that they're right and the banks are wrong.  One would expect that the interest group power of Wall Street, however, would have the upper hand.  What is surprising, as the Wall Street Journal's Sara Schaefer Munoz notes, is that the banks seem to be losing their battle with regulators:

The tug-of-war between banks and regulators over post-crisis financial rules has so far moved in the watchdogs' favor with banks largely failing to upend the tougher proposals in the U.S. and Europe....

Even before Monday's report, regulators didn't seem responsive to the industry's arguments. In the U.S., lawmakers have already determined that the country's big banks must hold more capital, but haven't yet specified how much.

The Dodd-Frank financial overhaul law, enacted more than a year ago, mandated many new restrictions on banks but left it to regulatory agencies to write the rules. Wall Street and the financial industry have spent millions of dollars lobbying to shape the rules, with little success so far.

They lost in their efforts to block new limits on the fees they can charge merchants when consumers use debit cards. Regulators are expected to vote Tuesday to issue a proposed "Volcker Rule," a part of the Dodd-Frank law designed to curtail trading activities at bank. Now they appear likely to fail in their efforts to block or water down a rule requiring them to hold extra capital.

In 2010, securities and investment firms spent a record $101.6 million on lobbying, up from $92.3 million in 2009, according to the Center for Responsive Politics. Through early October 2011, the firms had shelled out $49.5 million.

There are plenty of ways in which large banks can continue to fight the suggested rules, particularly on the implementation side.  Still, this is not how open economy politics traditionally works.  Traditionally, bank preferences are communicated to national governments, which then get expressed in BIS/Basle Committee meetings.  This certainly happened in the actual Basel III negotiations.   This kind of back and forth, in which regulators appear to trump the arguments of the financial sector, is highly unusual. 

I confidently predict that this post will not generate the kind of comments that, say, an Occupy Wall Street post has in the past week.  That's kind of a tragedy, because this ongoing tug of war between the BIS and IIF will likely have more far-reaching consequences than anything those protestors achieve. 


Daniel W. Drezner

Grading Mitt Romney's foreign policy white paper

As I noted previously, compared to his GOP rivals, Mitt Romney has some actual foreign policy thinking going on.  On the other hand, as Dan Trombly points out, doing better than Herman Cain or Rick Perry is a really low bar.  So, looked at objectively, what's my assessment of Romney's foreign policy white paper

I could go through it line by line, but James Joyner already did that for The Atlantic.  As it turns out, I'm reaching a course called The Art and Science of Statecraft that will require students to write a grand strategy document.  Sooo.... if Mitt Romney was one of my students, how would I grade him?  See below:



You and your study team have clearly put a lot of work into "An American Century."  It's cogently written and organized.  Your basic statement of purpose -- "advance an international system that is congenial to the institutions of open markets, representative government, and respect for human rights (p. 7)" -- fits perfectly within the mainstream of American foreign policy thinking. You've done an excellent job of demonstrating an awareness of the complexity of threats that face the United States in the 21st century.  I liked it on p. 6 when you noted that:

In the highly dynamic realm of national security and foreign policy there are seldom easy answers. Discrete circumstances in disparate regions of the world demand different kinds of approaches. There is no silver bullet for the problem of securing the United States and protecting our interests around the world.

You've also demonstrated an appropriate awareness that American power rests on more than a strong military.  When you note that a Romney administration would "apply the full spectrum of hard and soft power to influence events before they erupt into conflict (p. 8)," I caught myself nodding along.  

Some of the details are intriguing as well.  I need to look more into these "Reagan economic zones" that you mention a lot, but applying them to Latin America and the Pacific Rim make a great deal of strategic and economic sense.  I'm not fully persuaded that your notion of creating regional envoys to organize all "soft power resources" is all that different from the foreign policy czars or special envoys of administrations past, but this kind of argument fits well with your management background. 

That said, there are some logical flaws and major gaps in this draft that will have to be corrected if you want to earn a better grade.  The first problem is the style.  I recognize that you've written this as a campaign document, so you're never going to completely eliminate the unadulterated horsheshit allegations about the current president going on an apology tour.  Maybe you could do it a bit more subtly in the future, however? 

Secondly, there's a lack of historical awareness in some parts of the document.  For example, on page 7 the paper says:

[A] Romney foreign policy will proceed with clarity and resolve. The United States will  clearly enunciate its interests and values. Our friends and allies will not have doubts about where we  stand and what we will do to safeguard our interests and theirs; neither will our rivals, competitors, and adversaries.

Now, reading this, I kept thinking back to the Bush administration and its repeated assetions that that there would be no hypocrisy in foreign affairs.  Much like Bush, reality turned out to be trickier.  I suspect you know this, from the other excerpts noted earlier.  So get rid of this fluff:  I'm sure statements like this play well in a management consulting boardroom, but it's not going to cut it in the real world. 

Similarly, for someone who says that, the Obama administration is "undermining one’s allies (p. 3)" in contrast to you, who will "reassure our allies (p. 13)", you don't actually talk about America's treaty allies much at all.  True, you do talk about expanding America's alliance system to include India and Indonesia.  Mexico gets some face time.  Israel gets a lot of face time.  On the other hand, NATO is not mentioned once in this entire document.  Neither is the European Union.  Japan and South Korea get perfunctory treamtment at best.  Turkey is a major treaty ally but you treat it like a pariah state.  For someone who's claiming that the U.S. will reassure its major allies, you didn't seem to give them much attention at all.  This is a really important problem, because Japan and Europe have been crucial allies in a lot of major American initiatives -- and they're getting weaker.  Even in discussing new possible allies, I'm kind of gobsmacked that Brazil is never mentioned. 

Another big problem is that your approach to China is so shot full of contradictions that I don't know where to begin.  Do you seriously believe what you wrote on p. 3: 

The easiest way... to become embroiled in a clash with China over Taiwan, or because of China’s ambitions in the South or East China Seas, will be to leave Beijing in doubt about the depth of our commitment to longstanding allies in the region.

Really?  See, I'd say the easiest way to get embroiled in a clash with China is to write Taiwan a blank check on their defense needs.  The second easiest would be to publicly bluster on about Taiwan to a Chinese leadership that feels increasingly insecure and will be tempted to stoke the fires of Chinese nationalism by creating another Quemoy and Matsu crisis. 

Furthermore, you talk explicitly about supplying Taiwan with "adequate aircraft and other military platforms (p. 18)" in supposed contrast to the Obama administration.  You also talk about strengthening relationships with other countries that neighbor China in an effort to preserve American dominance.  Now, this might be a bit provocative, but I get the rationale.  Here's the thing, though -- you can't simultaneously do this and assert that you will "work to persuade China to commit to North Korea’s disarmament (p. 29)."  Really?  How exactly are you gonna persuade them on this point?   Do you really think that arming Taiwan to the teeth and blasting its human rights record will do the trick? 

If the section on China is contradictory, then your discussion of Pakistan is worse.  You state on p. 31-32:

It is in the interests of all three nations to see that Afghanistan and the Afghanistan/ Pakistan border region are rid of the Taliban and other insurgent groups.... Pakistan should understand that any connection between insurgent forces and Pakistan’s security and intelligence forces must be severed. The United States enjoys significant leverage over both of these nations. We should not be shy about using it. 

There are at least two assertions in the quoted section that are highly dubious -- I'll let you find them on your own.   

One final point, should you choose to revise this draft strategy -- you need to prioritize the threats you discuss in the paper.  You list a whole bunch of them -- rising authoritarian states, transnational violence, failing states, and rogue states.  If you have to prioritize, which threats merit greater attention?  This should actually be pretty easy, since you absurdly overhype the threats posed by some of these countries (Venezuela, Cuba and Russia in particular). 

I look forward to reviewing your later work. 

Grade:  B