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Tulane Journal of Tulane International Journal of Affairs International


Volume I , Number 1. FALL 2011.

Volume I , Number 1. FALL 2011.


Foreword The modern iteration of the field of international relations arose from conflict. From the well-intentioned, idealistic, war-banning attempt that was the League of Nations to its dissolution and the creation of the United Nations and, consequently, the treaties which form the foundation of the current field of international relations, the major developments in the field resulted from war, and a reactive attempt to prevent it in the future. Because of the issues and conflicts that spurred, and immediately followed, the creation of the incipient, modern conception of international relations, such as development of the nuclear bomb and other weapons of mass destruction, Cold War tensions, authoritarian regimes, and forced disappearances, in the mid-20th-century going forward, it seems invalid to state that now is a particularly volatile and interesting time in international relations, and thus we will refrain. Nevertheless, there are many issues which are currently of great importance on the international stage. It is clear, from issues pertaining to the first/third world dichotomy and the myriad, complicated, seemingly never-ending conflicts in the Middle East and elsewhere, to those of the Occupy protests which are spreading to an international scope, to issues as specific as the seemingly-anachronistic problem of piracy, that the current state of international affairs is extremely volatile and undoubtedly fascinating to those of us studying the field. Though the problems which face the international community are many, we believe that through knowledge comes the capacity for coherent discussion, diplomacy, and cooperation, and thus the potential for peace. In an effort to contribute to this discussion, we hope that each edition of this journal will present some particularly valid contributions from the Tulane undergraduate community to the vast, still-developing field of international affairs. Katie Weaver Editor-in-Chief, Tulane Journal of International Affairs

The Editors Editor-in-Chief Katie Weaver Managing Editor Henry Marrion Section Editors Angela Filardo Mat Freimuth Ophir Haberer Anthony Holland Kaela Lovejoy Gracia Mvula Layout Editor Ophir Haberer

Special Thanks to: Maxwell Coll, Founding Editor Jamie Arkin, Kelsey Atherton, Kamil Ammari and Zoe Clements



Greasing Gulf Conflict: An Examination of Oil’s Direct and Indirect Roles in Gulf Conflict Austin Parker PAGE 23

Globalization and its Consequences: Illegal Immigration in the 21st Century Mariana Alcoforado PAGE 31


Poverty and Inequality in Brazil Sean Higgins PAGE 47

In the Name of National Security Brennan Foxman PAGE 65

The US-China Bilateral Trade Imbalance Nat Lavin

Greasing Gulf Conflict: An Examination of Oil’s Direct and Indirect Roles Austin Parker Oil is often directly related to the roots of war in the Persian Gulf. The region is dominated by a state-type that is derived directly from its petrodollar revenues. Understanding the source and extent of these revenues provides a clear indication of the nature of the conflict-prone Gulf states; because, as Edmund Burke wrote, “the revenue of the state is the state…All depends upon it, whether for support or for reformation… (It is) (t)hrough revenue alone (that) the body politic can act”(emphasis added).1 Unlike the ancien régime of 18th century France that Burke spoke of, many of the Persian Gulf states do not rely on taxing domestic sources of revenues for income.2 This is because in many Gulf countries, the state itself is the primary source of domestic revenue.3 In the Gulf, high levels of oil exports enable nationalized oil industries to produce nearly all the revenues they need, thus allowing them to “embark on large public expenditure programs without resorting to taxation.”4 High state expenditure programs inevitably overtake any preexisting domestic economies, as the state itself steadily becomes the primary source of domestic revenue. By the time the state gains total control of the domestic economy, the nation’s sociopolitical and economic reality is afflicted with a degenerative malaise that instills a sense of rebellion in society. The state’s ability to secure itself from a discontented society hinges on its oil revenues, which is demonstrated in section I. With large oil revenues, the state is able to forgo the need to rule with popular legitimacy by continually purchasing itself a material legitimacy.5 When the value of oil- and therefore the state’s oil revenues- is low, the state’s security 1 Edmund Burke, 3rd ed. (London: J. Dodsley, 1790), 334. 2 In their writings on the political economy of the rentier state, Hazim Beblawi and Giacomo Luciani progress the conception of “state” as the apparatus or organization of government or power that exercises the monopoly of the legal use of violence. Throughout this paper, until otherwise noted, I will utilize this conception of state. See Hazem Beblawi and Giacomo Luciani, vol. 2 (London: Croon Help, 1987), 51. 3 Douglas Yates (Trenton: Africa World Press, 1996), 15. 4 Hussein Mahdavy, “The Pattern and Problems of Economic Development in Rentier States: The Case of Iran” (Oxford: Oxford University Press, 1970), 428. 5 Yates, 16.


is threatened; this often leads to interstate and intrastate conflicts. The role of oil in Gulf conflict, however, is not limited to its ability to create states and societies that are predisposed to conflict. Oil also provides a direct motivation for international and intraregional conflict in the Gulf. International actors have long been involved in the region’s conflicts. Though their engagement in Gulf conflict may be directly motivated by a different reliance on oil than the Gulf states (i.e. international actors engage in conflict to secure its consumption, not its production), their engagement is nonetheless directly motivated by oil. Comprehending the two roles of oil in Gulf conflict is a necessary condition of understanding why there has been so much conflict in the region, but is not sufficient on its own. To aid in this, the role that oil plays in Gulf conflict can be classified into two categories: an indirect role, as oil helps create states and societies that are predisposed to conflict; and a direct role, as oil is a potential, though not necessarily exclusive, motivation to engage in Gulf conflict. It is important to realize that, while the thesis of this paper asserts that oil constantly has an indirect role in Gulf conflict and frequently has a direct role in it, nowhere is the claim made that in the Gulf, “a war entirely about oil.” Even in conflicts like the Second Gulf War and the 2003 Iraq War, in which oil’s direct role was most evident, there were other contributing factors. In section I, an extensive framework that facilitate a compendious analysis of oil’s role in Gulf conflict. In section II, an empirical examination is made of oil’s role in Gulf conflict with an analysis of oil’s role in the Iranian revolution and the Iran-Iraq War; this will continue in section III with an analysis of oil’s role in the Second Gulf War; finally, in section IV, there will be analysis of oil’s role in the 2003 Iraq War. Because, like any conflict, these events did not occur in a vacuum, any information that is necessary to progress the thesis will be presented accordingly. I In this section, the effects oil revenues have had in the Persian Gulf and, briefly, the impacts oil and its revenues has had on international interest in the region will be examined. To do this, (i) a brief history of the two decades in which the industrial demand for oil brought the Persian Gulf states into the global spotlight will be provided. Following this, (ii) the concept of the rentier state as it applies Persian Gulf countries will be introduced. Understanding rentier states in regards to the Persian Gulf 6

will help account for the international concern for access to the region’s oil because: 1. If one imports oil from a rentier state, then one provides oil revenues to a rentier state. The rentier state uses these revenues in a way that increases its control over its citizens, which thus increases its predisposition to conflict. 2. If an oil-producing rentier state is predisposed to conflict, then it poses a relative threat to one’s access to oil because conflict can restrict the export of oil. 3. If one increases the amount of oil one imports from a rentier state, then one increases the threat of not having access to oil. This argument is sound because the states that have been directly involved in major Gulf conflict in the last sixty years are rentier states and because of this, they are prone to conflict, as states with underdeveloped, undiversified economies that are controlled by oppressive, authoritarian figures usually are. (i) Before World War II, Middle-Eastern oil production accounted for less than five percent of the world’s output of crude oil.6 However, in the post-war recovery period, Europe’s demand for oil drastically increased. A newly adopted, advantageous financing scheme that split the net profits between the Western oil companies and the oil producing government fifty-fifty allowed the oil producing states in the Middle East to dramatically raise revenues. In Iraq, government-controlled oil revenues increased from almost fourteen million to over fifty-one million pounds in 1951. Oil revenues in Saudi Arabia went from half a million dollars before World War II to fifty six million dollars in 1950 and over two hundred million in 1956.7 With oil revenues creating opportunities for economic development, the outlook of the once impoverished nations of the Persian Gulf was initially transformed. Though the unquenchable industrialized thirst for oil certainly gave the Gulf states an international significance disproportionate to its populations, it was not until the 1973 oil embargo that the Gulf states exercised a determining role in world affairs. In the 1950s, major international petroleum companies had exclusive control of oil exportation and marketing. However, in 1959, when oil companies twice cut oil prices in half without notifying their Middle-Eastern suppliers, the major oil producers banded together to form the Organization of Petroleum Exporting 6 7

Peter Mansfield (New York: Penguin Books, 2003), 281. Ibid. 7

Countries (OPEC).8 Accounting for ninety percent of oil exports outside the communist world, the members of OPEC followed Mohammad Mosaddeqh’s Iranian example and nationalized their own oil companies by the end of the 1960s.9 Despite gradual price increases during these years, which were precipitated by the Iranian Shah and indicated a degree of control in the oil market, industrial demanders were wholly unprepared for what the Gulf states did next. In 1973 Saudi Arabia, a “swing” producer with an oil production that is one-third of OPEC’s, responded to the United States’ decision to send over two million dollars of military aid to support Israel in the Arab-Israeli War by instituting an oil embargo against the United States. Other Arab oil producers also cut back on their oil production, which only exacerbated the effects of the American embargo. This led OPEC to set the price of oil at eleven dollars and sixty-five cents a barrel—over eight dollars higher than the previous year.10 As a result, the United States experienced an energy crisis that affected everything from shares on the New York Stock Exchange, which lost ninety seven billion dollars, to Americans’ ability to display Christmas light decorations, which was advised against by state governments and even prohibited in the state of Oregon.11 The fact that the 1973 oil embargo could send America into such an energy crisis, even though it was the world’s largest oil producer, showed how Arab oil could be used as a devastating weapon. Furthermore, considering how vulnerable the United States was to Arab oil at a time when it only imported one-third of its oil, how vulnerable is it today as it imports seventy percent of its oil and continues to be the highest consumer of oil in the world?12 To deal with its ever-increasing dependency on Gulf oil and vulnerability to its abuse, the United States adopted a strategy in 1973 to promote its energy security that centered on stabilization and, when necessary, intervention. Such a stabilization strategy necessitated a large American presence in the region because the region is dominated by a conflict-prone state-type—the rentier state. (ii) As established in the last subsection, the production of oil in the 8 William Cleveland (Bolder: Westview Press, 2000), 441. 9 Mansfield, 283. 10 Cleveland, 442. 11 David Frum, How we got here: the 70’s : the decade that brought you modern life (for better or worse) (New York: Basic Books, 2000), 318. 12 David Victor, “Axis of Oil?” Foreign Affairs 82, no. 2 (March & April 2003): 49. 8

Persian Gulf has increased exponentially since World War II. However, it was only after the Gulf states transformed the existing “ex-colonial models of petroleum exploitation” into radically nationalized petroleum industries that these rentier states flourished.13 Control over their nation’s oil production and the possession of its exorbitant rents—defined as “the income derived from the gift of nature”—enabled the Gulf states to move further from the Western model of a production state to the allocation model of a rentier state.14,15 A rentier/allocation state, as conceived by Hussein Mahdavy, is a state whose revenues are derived predominantly from oil or other foreign sources and has expenditures that account for a substantial share of its gross domestic product.16 Such a succinct conception of a rentier state allows us to immediately qualify those states that have been involved in Gulf conflict, i.e. Iran, Iraq, Kuwait, and Saudi Arabia. Though the remaining Gulf states have categorically exhibited the necessary conditions at one point in their post-1950s existence, it is outside the scope of this paper to categorize them as rentier states. Oil’s ability to create Gulf states and societies that are predisposed to conflict is most evident in those nations that have been directly involved in conflict. Oil’s ability to create states and societies that are predisposed to conflict in the Persian Gulf was largely aided by the type of states that were present during its initial explosion. With copious amounts of oil revenues flowing into state coffers, the autocratic monarchs of the state were able to temporarily secure their status by adopting the allocation scheme of the rentier state. This began with the effective abolishment of domestic taxation. In a tax-dependent production state, domestic tax collection requires widespread voluntary societal compliance and implies

13 Mahdavy, 432. 14 Hazem Beblawi, “The Rentier State in the Arab World,” ed. Giacomo Luciani (London: Routledge, 1990), 85. 15 In their writings on the political economy of the rentier state, Hazim Beblawi and Giacomo Luciani progress the conception of “state” as the apparatus or organization of government or power that exercises the monopoly of the legal use of violence. Throughout this paper, until otherwise noted, I will employ this conception of “state.” See The Rentier State,vol. 2, Nation, State and Integration in the Arab World, ed. Hazem Beblawi and Giacomo Luciani (London: Croom Helm)1987 page 51. Helm, 1987 16 Mahdavy, 70. 9

the existence of a relationship between taxation and legitimacy.17,18 Not relying on society for its income allows the rentier state to sidestep any constraints of accountability and pursue its own ideal end-state unabated, thereby embodying the notion of “no taxation, no representation.” Due to its massive oil revenues, the rentier state is able to extensively fund public works projects, which clearly reflects the state-building agenda of creating societal peace and political acquiescence.19 In the process of such state building, a country is able to manufacture a sense of legitimacy, albeit of the material variety. As long as a state is able to keep its society full of carrots, it is able to remain secure, even as its economy-dominating allocations create a society that is predisposed to conflict. It is only when an autocratic rentier state’s underdeveloped, undiversified economy can no longer be greased with oil revenues that the likelihood of a societal rebellion is statistically significant.20 However, due to the fact that oil’s value can be dramatically affected by external price shocks and thus incapacitate the state’s ability to sustain the domestic economy with oil revenues, it is appropriate to classify a society of an autocratic Gulf rentier state as predisposed to conflict. It is important to note that a society’s predisposition to conflict is a function of its dependence on the oil revenues of the state. A society that receives 80 percent of its domestic revenue from state allocations has a substantially higher predisposition to conflict than a society that receives 55 percent of its domestic revenues from state allocations. There are several reasons why the economies of rentier states are underdeveloped and undiversified. Considering the availability of external rents and the fact that its income is not determined by domestic production, the state does not have a financial incentive to transform its underdeveloped, undiversified economy.21 Furthermore, any economic 17 Christine Fauvelle-Aymar, “The Political and Tax Capacity of Government in Developing Countries,” Kyklos 52 (1999): 406. 18 Hootan Shambayati, “The Rentier State, Interest Groups, and the Paradox of Autonomy: State and Business in Turkey and Iran,” Comparative Politics 26, no. 3 (April 1994): 308. 19 Rolf Schwarz, “The political economy of state-formation in the Arab Middle East: Rentier states, economic reform, and democratization,” Review of International Political Economy 15, no. 4 (October 2008): 609. 20 Mirjam Sørli, “Why Is There so Much Conflict in the Middle East?” The Journal of Conflict Resolution 49, no. 1 (February 2005): 160. 21 Michel Chatelus, “Towards a New Political Economy of State Industrialization in the Arab Middle East,” International Journal of Middle East 10

development that the state promoted would inherently curtail its control over society, which depends on the state for its economic welfare. One may then reasonably wonder about the prospects of private economic development. However, in a rentier state there is little incentive for private economic entrepreneurship. Because the principal source of domestic revenue is by definition state expenditures, entrepreneurs invariably adopt the rentier mentality and try to gain the government’s favor by establishing patron-client ties with powerful individuals within the state structure.22 There are fundamental inconsistencies in the recommendations for the diversification or development of rentier states. This is because the state’s allocations are a function of the structure of its revenue; therefore, there are structural constraints on what is conjecturally possible.23 Ultimately, economic recommendations for the diversification of a rentier state’s sources and structures of income in a significant way are recommendations to abolish the rentier state. The manner in which oil revenues are used to create a rentier state and a society that is predisposed to conflict have been previously established. The logic holding that a rentier state is predisposed to conflict it fairly straightforward. Whereas the society of a rentier state is predisposed to conflict due to a combination of economic malaise, political oppression and a reliance on oil revenue expenditures, the state’s predisposition to conflict is rooted in its reliance on external rents for its security. In the Gulf rentier states, external rents are predominately oil rents. However, they also come in the form of strategic rents, which are bilateral or multilateral foreign-aid payments such as foreign development assistance or military assistance.24 Without a critical level of external rents, an autocratic rentier state is unable to secure itself from its society and from other states. There is another element of this dynamic that affects not only a state’s security from society, but also from other states: much of a state’s allocations go towards building its military. A large military with external rents allows a state to simultaneously create large amounts of domestic revenue and strengthen its security apparatus; thus, when the Studies 16 (1984). 22 Kiren Aziz Chaudhry, “The Price of Wealth: Business and State in Labor Remittance and Oil Economies,” International Organization, 43 (Winter 1989) 43 (Winter 1989): 115. 23 Yates, 23. 24 Mick Moore, “Revenues, State Formation, and the Quality of Governance in Developing Countries,” International Political Science Review 25 (2004): 306. 11

state’s external rents are low, it is vulnerable to an attack. With such a high degree of dependency on external rents for its security, a rentier state has two modes of financial crisis management at its disposal—one internal and one external. Because both of these options frequently result in some form of conflict, I believe that it is appropriate to classify the rentier state as predisposed to conflict, whereby the level of predisposition to conflict is a function of its reliance on external rents for its security. A state’s internal mode of financial crisis management aims to solve its economic problems domestically by making a more effective use of its existing rents, usually through austerity measures; Iran instituted these in 1978. This often includes state military action to further subjugate its society. A state’s external mode of financial crisis management attempts to solve its economic problems internationally. To carry out an external mode of crisis management, a state can attempt to attain new sources of external rents, an immediate cause of the Second Gulf War. A state can increase the size of its external strategic rents-, which Saddam Hussein attempted during the two Gulf Wars-, or a state can increase its external rents by influencing the oil production of other states as to affect the value of oil. This was attempted before the Second Gulf War, albeit superficially.25 In this section, a framework was provided that established how oil can create a rentier state and society that are predisposed to conflict and how the state’s predisposition to conflict fundamentally commands international interest. With this framework, one will be able to recognize oil’s role in Gulf conflict in the sections to follow. II In this section the role oil played in the (i) Iranian Revolution and in the consequent (ii) Iran-Iraq War is examined. As previously stated, the fact that this analysis is limited to the role oil played in Gulf conflict does not imply that oil was the only contributing factor. Because oil’s role in Gulf conflict is so obvious, one may be inclined to infer that oil has been the only motivation for some conflicts. However, as is shown in the following sections, while it may be an underlying motivation, it is never the only cause of turmoil. (i)The role oil played in the 1979 Iranian Revolution was indirect, as it created an Iranian state and society that were predisposed to conflict. With the forced abdication of Iran’s military despot, Reza Shah, in 1941, 25 12

Schwarz, 611.

and the Western installation of his son Muhammed Reza Shah, the autonomy of the Iranian state significantly eroded. It was only after the 1953 coup of Prime Minister Muhammad Mosaddeqh that the Shah’s state regained some measure of autonomy.26 One of the coup’s consequences was that large quantities of oil rents flowed into the state’s reserves and allowed the Shah to manufacture a secure rentier state.27 By 1960, oil exports contributed 41 percent of Iran’s total revenue. Oil contributions to government revenues continued to increase through the rest of the decade, and by 1971, oil accounted for 55 percent of total revenue. After the 1973 Arab oil embargo, Iran’s oil income more than quadrupled and contributed 84 percent of the total budget in the 1974-75 fiscal year.28 Notwithstanding the fact that pre-revolution Iran was the first rentier state, Iran’s state allocation scheme was characteristic of an autocratic rentier state.29 Thus, the state’s main relationships to Iranian society were mediated through its expenditures: on the military, on development projects, on modern construction, on consumption subsidies, et c. Suspended above its citizens, the Iranian state bought them off, rearranged their lives, and repressed any dissidents among them.30 Attempting to create a modern, industrial Iran, many of the state’s allocation programs were intended to supplant Shiite influence on society.31 Land reform in the 1960s dispossessed many individual clerics and religious institutions, and served to cut the clergy’s ties to the landed upper class. Welfare as well as educational and legal reforms created modern, professional, state-employed competitors to the Shiite clergy in all of the clergy’s historically important social functions.32 Before the state could eliminate Islam’s influence on its society, a politically aggressive and populist brand of Islamic traditionalism was developed. Even after being exiled from the state in 1964, Ayatollah Khomeini continued to preach against the Shah and call on the ulama to assert their right to lead the Islamic community in direct opposition to such an unjust authority.33 However, as long as the economy of the Iranian rentier state was sufficiently greased with oil, the patron-client relationship that existed 26 Shambayati, 317 27 Ervand Abrahamian (Princeton University Press, 1982), 419. 28 Hussein Mahdavy, 430. 29 Yates, 16. 30 Shambayati, 319. 31 Cleveland, 411 32 Theda Skocpol, “Rentier State and Shi’a Islam in the Iranian Revolution,” Theory and Society 11, no. 3 (May 1982): 274. 33 Cleveland, 415. 13

between the state and its society stayed in place. In the beginning of the decade to follow, as explained in section I, OPEC raised oil prices. The Iranian state immediately had huge revenues that only expanded its dominion. Along with windfall profits, rising wages, and new employment opportunities, urban Iranians nonetheless experienced escalating inflation.34 Then, in 1975-77, the demand for Iranian oil decreased, and many projects had to be cut, which forced much of the labor force into unemployment. From 1974 to 1975, the state’s budget fell nearly 6 billion dollars to hold a deficit of 1.7 billion dollars. The following year, the state budget deficit plunged further to 2.4 billion dollars.35 As explained in the last section, when in a time of financial crisis, a rentier state has two modes of management. In 1978, in an effort to keep the state afloat, the Shah employed the internal mode of crisis management. The state adopted a new economic policy that was a political and an economic disaster and only fueled society’s revolutionary predisposition. In order to reduce inflationary pressures, the government decided to slow down the economy. The regime imposed wage freezes, canceled dozens of construction projects, and introduced a general austerity program.36 These policies quickly created a recession that led to widespread unemployment among urban workers, who accounted for 50 percent of the population. Displaced from their rural existence and not yet fully integrated into urban life, they were receptive to the calls for protest issued by the Shiite clergy.37 With no oil revenues to elevate itself over society, the autocratic state fell vulnerable to rebellion. Unfortunately for the Iranian state, Iran’s oppressed society was most emboldened to rebel while the state was most vulnerable. There were no carrots. There was no state popularity. There was no reason for Iranian society not to rise up; the success of the state hinged not on its competency but on its external rents. In the case of a revolution, the society of a rentier state would be free of oppression but still be able to collect external rents. As the tide of societal unrest gathered momentum, the huge coalition of discontent found its voice in Ayatollah Khomeini, who was still in exile and still issuing uncompromising demands for the Shah’s abdication over a decade later.38 Under Khomeini, the movement against the Shah 34 35 36 37 38 14

Cleveland, 422. Elie Kedouri (London: Frank Cass, 1980), 241. Cleveland 413. Ibid 415 Ibid.

was transformed from a moderate reformist movement of the professional middle classes to a popular Islamist one.39 Strikes and riots became demonstrations, which led to a revolutionary protest movement. Even the state’s bloody efforts to create a military rule could not dilute the revolutionary zeal; it was too late for any possibility of violent coercion. On January 18, 1979, the Shah fled Iran and on February 1, 1989, Ayatollah Khomeini returned to lead the new Islamic republic. In the case of the Iranian revolution, oil’s role in creating a state and society predisposed to conflict is evident. Oil facilitated the creation of an autocratic rentier state that resided over an economy with no domestic viability. The economic and political reality of the Iranian rentier state created the grounds for a grievance-based conflict. Because the manifestation of this conflict was dependent on the value of oil, oil played an indirect role in the Iranian Revolution. One should also note that the growth of political Islam occurred during Iran’s financial crisis. This is consistent with the notion that the state’s ability to control society is hinged on its ability to purchase society’s consent and welfare. (ii) There are a host of valid explanations regarding Saddam Hussein’s choice to invade Iran in 1980 that range from political and historical to personal. In this subsection (a), the popular belief that Hussein invaded Iran out of fear that Ayatollah Khomeini would inspire the Iraqi Shiites to revolt against the Iraqi state will be analyzed.40,41 This belief is inconsistent with the framework established in section I, because the only time that the security of a rentier state is significantly threatened is when it has an insufficient amount of external rents, which Iraq most likely had. After this analysis, oil’s direct role in the conflict will be examined (b), as it provided motivation for Hussein to invade Iran and explains America’s involvement in the conflict. Oil’s indirect role in the conflict will also be investigated, as rentier states like Kuwait and Saudi Arabia with significant interests in Iraq’s survival financially aided Iraq’s war efforts. To understand why many people believe that Saddam Hussein’s concern over domestic affairs in Sunni-controlled but majority Shiite Iraq provided a motivation for the Iraqi invasion of Iran in 1980, one needs to look not only at Iraq’s domestic political reality, but also at post-revolution Iran.42 As leader of the Islamic Republic of Iran, Ayatollah Khomei39 Skocpol, 270. 40 Swearingen, 411 41 This motivation should not be confused with Saddam’s possible strategic motivation of invading Iran in order to preempt a war with Iran. 42 Shambayati, 320. 15

ni advocated an end to the oil monarchies of the Middle East. He viewed the Arab rentier states of the Persian Gulf as threats to the survival of Islam.43 It is a popular belief that Khomeini’s vociferous calls for the exportation of the Islamic Revolution substantively affected Saddam in neighboring Iraq. After all, the size of his “oil monarchy” was seconded only by Saudi Arabia.44 But unlike in Saudi Arabia, the Iraqi population was 60 percent Shiite - many of whom regarding Khomeini as their foremost spiritual leader- and only 20 percent Sunni Arab.45 The notion that Saddam feared that an Iraqi Shiite revolution inspired by Khomeini is nonetheless inconsistent with the idea that an autocratic rentier state’s security is only significantly threatened when it does not have a sufficient amount of external rents. At the time, the Iraqi state did have a sufficient amount of external rents to prevent a successful internal revolution: in 1979, Iraq hit its peak oil production and was expected to amass 30 billion dollars in 1980, before the war broke out.46,47 Had those 30 billion dollars not been sufficient to prevent a revolution, the Iraqi government would still have been able to quell a Shiite revolution because it would have been in the best interest of the Arab league and the United States to at least lend the necessary difference in the form of strategic rents. (b) In an effort to identify the factors of the Iran-Iraq War, oil’s role cannot be overlooked. Oil played a role in the Iran-Iraq War in the following ways: (1) Saddam Hussein’s decision to invade Iran was influenced by Iran’s oil and its stake in the Shatt al-Arab, a major waterway used to export oil. (2) As fellow rentier states created by oil revenues, Kuwait and Saudi Arabia had vested interests in the survival of the Iraqi state. (3) American involvement was directly motivated by its fundamental need for a continued access to oil. (1) Five days before Iraq invaded Iran, Saddam Hussein abrogated the 1975 Algiers Agreement, which had the unmistakable character of a declaration of war. This stems from the controversy surrounding the signing of the 1975 agreement. Essentially, the 1975 agreement was Iran’s creation, as it manipulated a set of circumstances that threatened Iraq and 43 Dilip Hiro, The longest war: the Iran-Iraq military conflict (New York: Routledge, 1991), 37. 44 Ibid, 40 45 Swearingen, 412. 46 ALISON SMALE, “Official Says Iraqi Oil Production Still Lagging,” The New York Times, September 22, 2005, 22petrol.html?_r=1 (accessed March 7, 2010).

47 16

Hiro, 38.

forced them to sign. The Iraqi government had no choice but to accede to the treaty by Iranian promotion of a Kurdish revolt that threatened to dismember Iraq and to deprive it of its primary oil-producing region. In exchange for Iran’s pledge to stop supporting the revolt, Iraq gave up a large portion of the vital Shatt al-Arab, which provided a direct outlet to the Gulf for oil exports.48 Despite Saddam’s de facto declaration of war, which he justified by claiming that the Islamic Republic of Iran was allowing Kurds to seek refuge in Iran from the Iraqi military in violation of the 1975 Algiers Agreement, it is clear that Iraq’s motivation for invading Iran was not limited to recovering the area of the Shatt al-Arab it unduly lost in 1975. Oil was no small part of the calculus of Hussein’s decision to go to war. At the beginning of the war, Iraq was producing 6 million barrels per day. Had Saddam succeeded in seizing Khuzestan Province in western Iran and the Kharq Island oil terminal, he would have almost doubled oil production under his control to 11 million barrels per day—nearly 20 percent of world oil consumption.49 (2) As the Iran-Iraq War continued, however, Iraq’s ability to export oil was severely crippled by Iranian air attacks.50 Dependent on external rents to function, Iraq was forced to borrow from abroad to finance its war effort. Saudi Arabia and Kuwait quickly became Iraq’s chief lenders. Together, they supplied Iraq with 50 to 60 billion dollars worth of aid.51 Considering how the rentier states of Saudi Arabia and Kuwait were also targets of Islamic transformation, it is no wonder why they were so willing to support Iraq’s effort. However, as was established above, their security would not necessarily be threatened domestically. But if Iran controlled nearly 20 percent of the world’s oil consumption, the Arab rentier states would assuredly be threatened by its invasion. (3) When the Iran-Iraq War broke out, America’s twin pillars policy for regional stability, which sought to balance the power of Iran and Iraq, was reevaluated. A policy of containment was adapted instead. No longer was the Baath regime of Iraq the largest threat to the interest of the United States. Before 1987, America’s support of the Iraqi war effort had been limited. Beginning in 1982, however, President Reagan took steps to increase its support of Iraq by removing the country from its list of 48 49 50 51

Swearingen, 408 Bruce Jentelson (New York: W.W. Norton & Company, 1994), 41. Cleveland, 404. Ibid. 17

state sponsors of terrorism.52 This allowed the American arms to be sent to Iraq from Jordan and Kuwait.53 In 1987, when Iran increased its attacks on Kuwaiti oil tankers in retaliation against Kuwait’s support of Iraq in the war, the United States allowed Kuwait’s ships to fly the American Flag. This implied that any further Iranian attack would be equivalent to an attack on an American ship.54 The United States was determined to contain Khomeini to such an extent that it ignored the brutality of Saddam’s regime in order to prevent the spread of the kind of Islamic radicalism and anti-American sentiment fostered by the theocratic Shiite regime.55 Oil reserves, not human rights, were at stake for the United States. The pro-Western Arab Gulf states controlled over half the world’s known supply of oil and the United States required continual access.56 Oil’s direct role in the conflict was belied by America’s active involvement. III By the time the Iranian leadership accepted the cessation of hostilities with Iraq, it was evident that neither side had won. The longest war of the century took the lives of over 200,000 Iranians and 100,000 Iraqis.57 While Iran funded its own war efforts, Iraq experienced financial woes following the war. During the war, Iraq spent over 95 billion dollars, of which 60 billion was borrowed from Kuwait and Saudi Arabia and another 30 billion dollars were taken from various other countries.58 Hussein was keenly aware of the vulnerability his state faced; it was initially estimated that Iraq would finish 1990 bankrupt, between 8 billion and 10 billion dollars in the red.59 In an effort to return the Iraqi state to its pre-1980 stature, Saddam enacted a rentier state’s external mode of financial crisis management by: (a) attempting to increase Iraq’s amount of strategic rents from Arab states, (b) attempting to increase Iraq’s external rents by influencing Kuwait’s oil production, and (c) attempting to 52 Steven A. Yetiv, The absence of grand strategy: the United States in the Persian Gulf, 1972-2005 (Baltimore, MD: Johns Hopkins University Press, 2008), 51. 53 Ibid. 54 Yetiv, 61. 55 Cleveland, 405. 56 Ibid, 406 57 Hiro, 250. 58 Ibid, 4 59 Simon Henderson, Instant empire: Saddam Hussein’s ambition for Iraq (San Francisco: Mercury House, 1991), 219. 18

expand Iraq’s source of external rents by invading Kuwait. Though one may appropriately consider Saddam’s attempt to decrease Kuwait’s oil production as superficial and part of an insidious rationalization for what he knew was inevitable, it will be included in this elucidation of oil’s role in the Second Gulf War. The very employment of these management techniques by Hussein is indicative of his status as a rentier state autocrat. Oil’s direct role in the conflict is also evident in the response taken by the United States and the rest of the world, whose guaranteed access to oil was severely threatened by Saddam’s successful annexation of Kuwait. Unfortunately for the United States, its actions throughout this “war of necessity” are said to have mobilized Osama bin Laden against the United States, thereby germinating the seeds for the next Gulf war thirteen years later. (a) Initially, Hussein hoped to relieve his financial burdens in an appeal to the Arab states, and in particular, Kuwait. He wanted Kuwait to pay Iraq 10 billion dollars and forgive its war debt, because Hussein believed that the “assistance” Kuwait provided Iraq during the war should not be considered “debt.”60 Then, at a meeting of the Arab Cooperation Council, Hussein demanded 30 billion dollars, threatening that if he did not receive it, “(he) (would) know how to get it,” i.e. invading and annexing Kuwait.61 Hussein claimed that the Iraqi defense of the Arab Gulf states against Iran was a sacrifice and that they should participate in a sort of “Arab Marshall Plan” for Iraq.62,63 Hussein also accused Kuwait of stealing 2.4 billion dollars worth of Iraqi oil from the bordering Rumeila oil field.64 (b) However, the most substantive accusation he made against Kuwait regarded its continued production of oil above the OPEC production quota, which caused a decline in the price of oil and Iraq’s oil revenues.65 Hoping to placate the saber- rattling despot, Kuwait undertook a number of conciliatory gestures in July 1990. For instance, it agreed to reduce its oil output by nearly 25 percent.66 Nevertheless, Hussein still claimed its past overproduction, use of the Rumeila oil field, and refusal to cancel Iraqi debt 60 Walid Khalidi (Washington D.C.: Institute for Palestine Studies, 1991), 11. 61 Charles Tripp (Boulder: Westview Press, 1996), 44. 62 Cleveland, 464. 63 Khalidi, 12. 64 Fred Halliday, The Middle East in international relations: power, politics and ideology (Cambridge, UK: Cambridge, 2005), 144. 65 Khalidi, 20. 66 Mehran Kamrava (Los Angeles: University of California Press, 2005), 185. 19

amounted to economic warfare against Iraq. Thus, on August 2, 1990, approximately one hundred thousand Iraqi troops invaded Kuwait, taking its capital in a matter of hours.67,68 (c) Hussein’s calculations as to whether or not he should invade Kuwait proved to be completely erroneous. He assumed that his invasion of Kuwait would not be met with international opposition. However, Iraq’s quick seizure of Kuwait City was not reflective of its ability to use Kuwait’s oil to expand his external rents. Totally miscalculating Iraq’s military capabilities, Hussein believed that his military was strong enough to protract American intervention until it became politically infeasible for them to continue. However, he could not dissuade the international community from condemning Iraq’s occupation of Kuwait and calling for the restoration of Kuwaiti sovereignty.69 Hussein wanted Kuwait for the same reasons the international community could not let him keep it. Oil’s direct role in conflict could not be more pronounced. Iraq would have become the dominant local power had it continued to possess all of Kuwait’s financial and mineral resources. Iraq would not have needed to be in physical control of Saudi Arabia and the other much smaller Gulf states’ territories or resources to have exercised tremendous influence over them; it would have dominated the Arab world and OPEC.70,71 The United States agreed to the Saudi government’s formal invitation to deploy troops to defend the kingdom and in doing so further established itself in the region. By October 1990, the American troop presence in Saudi Arabia was over 200,000.72 The Saudi decision to reject Osama bin Laden’s offer to protect the kingdom with his Islamic militants was the severing point between the two. And when bin Laden was exiled from his own country to facilitate good American will, he directed his anger not at the Saudi government, but at its American patrons. With such a large show of force, the United States assumed that it could intimidate Saddam into leaving Kuwait, but Hussein would not back down. As political pressure on Iraq increased, so did American troop presence, which grew to 500,000 by the time the United Nations’ deadline for Iraqi withdrawal expired. When Iraq refused to leave Ku67 Cleveland, 465. 68 Kamrava, 183. 69 Ibid, 185 70 Richard Haass, War of necessity: war of choice (New York: Simon & Schuster, 2009), 72. 71 Ibid,132 72 Cleveland 465 20

wait, an American-led coalition, which eventually grew to include thirtysix countries, liberated Kuwait militarily. Saddam Hussein and George H. W. Bush both explicated a number of reasons for going to war in 1990. For instance, Saddam made the historical evocation that Kuwait had been an administrative sub-district of the Iraqi province of Basra in Ottoman times and should be returned to Iraq, while Bush claimed that Kuwait’s national sovereignty should be restored.73,74 However, as was shown in this section, it is apparent that their interest in Kuwait lay not in its political past or future, but solely in its fossil fuel resources. IV Oil’s direct role in the 2003 Iraq war does not need much promotion. While it was by no means the only motivation for the American invasion, oil is popularly believed to have directly influenced America’s course of action.75 Other possible motivations range from neoconservative desires for regime change to the need to remove weapons of mass destruction. But as the United States attempted to secure inexpensive and continual access to fossil fuels, oil as a direct motivation for the invasion will be examined. Because Saddam Hussein’s status as the autocrat of a rentier state has already been thoroughly covered, an analysis of oil’s indirect role in the 2003 Iraq War would be superfluous. Iraq had enormous growth potential for oil production, a phenomenon that certainly motivated the United States to invade. Iraq’s potential can be viewed as enormous precisely because it had been hamstrung over the past twenty-five years. Between the Iran-Iraq War, the Second Gulf War, subsequent UN sanctions, and Saddam’s own mismanagement and corruption, Iraq’s growth potential had been truncated and its oil infrastructure was in disarray.76 Iraq’s various conflicts with the United Nations resulted in a drop in production from an average of 2.6 million to 2 million barrels per day from 1999 to 200. Indeed, UN Resolution 986 implied that only a less sanctioned, western-friendly regime could have reversed this decline.77 But many analysts believed that, with a totally rebuilt oil infrastructure, Iraq could have increased oil production to an estimated 6 to 12 million 73 Khalidi, 10. 74 Haas, 46. 75 Yetiv, 128. 76 Yetiv, 130 77 Dresdner, Kleinwort, Wassersetin research, “Oil Pices-Short-Term Strength Masking Longer-Term Weakness,” World Oil Report, no. 2 (July 24, 2002). 21

barrels per day within a decade.78 Thus, because American energy security required continual access to oil and, as this section established, regime change in Iraq provided greater U.S. access to Iraqi oil, it is evident that oil’s role in the 2003 Iraq War was direct and present. It is argued in this essay that oil has two roles in Gulf conflict. The first is an indirect role that is used to build a rentier state, one whose revenues are derived predominantly from oil or other foreign sources and has expenditures that account for a substantial share of its gross domestic product.79 In the Persian Gulf, this has allowed autocratic states to exist autonomously from their societies. Unfortunately for the rentier state, because it relies on oil revenues to subdue its resentful society, it is particularly vulnerable to rebellion when oil revenues are low, as was seen in Iran. Oil’s second role in Gulf conflict is direct. . Oil’s direct role in conflict is apparent when a belligerent’s presence in a conflict is influenced by a direct motivation for oil. Unlike oil’s indirect role, oil’s direct role is limited by a state-type. Underlining the two roles of oil and their implications has provided insight into the dynamic role of oil in Gulf conflict, as it not only motivates states for wars, but it creates states and societies that are predisposed to conflict.

78 Fadhil Chalabi, “Iraq and Future Oil World,” Midd East Policy 7 (October 2000). 79 Mahdavy, 70. 22

Globalization and its Consequences: Illegal Immigration in the 21st Century Mariana Alcoforado With the increasing flow of goods, services and citizens, globalization has significantly altered the dynamics of the world economy, creating a much more integrated and interdependent international community. James H. Mittelman, defines this phenomenon as the “increase of interconnections or growing interdependence on a world scale, […] a surge in global flows such as investment, migration, and consumer goods, facilitated by new technologies, especially in communication and transportation.”1 Therefore, the benefits of this new economic system go far beyond the simple exchange of cultural practices, goods and capital. They are also embedded in the sharing of certain values and ideologies, helping maintain social order as well as a peaceful international community. Globalization has brought upon international actors a greater degree of political and economic cooperation, which has also contributed significantly to the socio-economic development of several countries. In addition globalization has encouraged the development of new technologies and means of transportation, which have greatly benefited society, particularly in the global north, broadly defined as “developed” nations. Nonetheless, the negative consequences of globalization cannot be overshadowed by positive impacts of exchange between groups and countries, having severe implications on the global community, particularly in developing countries. As the former president of Brazil Fernando Henrique Cardoso points out “Globalization is inevitable and so are its consequences, its disasters, exclusion and social regression.”2 Although this new economic regime has been in many ways beneficial to the international community, globalization is far from bringing equal development and opportunities across the globe. According to several world leaders and scholars, while responsible for an increasing flow of information, capital, and business, globalization is also the cause of numerous socio-economic and political problems currently faced by the international community. Critics attribute severe cultural and environmental degradation, heightened state repression in some areas of the world, as well as the intensification of class struggles to the spread of liberal practices 1 Richard Stubbs and Geoffrey R.D. Underhill, Political Economy and the Changing Global Order (New York: Oxford University Press, 2006), p.64. 2 Richard Stubbs and Geoffrey R.D. Underhill, Political Economy and the Changing Global Order (New York: Oxford University Press, 2006), p. 66. 23

under globalization. Among these so-called “high costs” is the reduction of state power and sovereignty, which may be becoming obsolete, considering our increasingly globalized and interdependent international community. Above all of these, one of the most severe consequences of this new economic regime is the unequal development brought upon by liberal practices, which make globalization an extremely exclusive system. Globalized economic practices today disproportionately concentrate gains in the hands of the global north, usually the same nations that create and advocate new policies, while imposing losses on governments, economies, and populations of the global south. Consequently, the latter’s consolidation the international community has faced high chronic levels of unemployment and increasing inequality, which have led to severe problems concerning poverty, famine and unequal distribution of land and resources. Socio-economic disparities have also increased tremendously, not only between the global north and south, but mostly within developing countries, where several local businesses struggle to compete with major multinational companies under the free market principles of liberalism. As a result, poverty, violence, and disregard for worker’s rights have increased tremendously in developing countries, leading many critics to refer to globalization as a new form of imperialism. Therefore, inequality has become one of the most pressing issues under globalization, as it is not only significantly damaging on its own, but also leads to numerous severe socio-economic problems, such as illegal immigration, one of the main current challenges faced by nation-states in the global north. Unauthorized entrance of foreigners in global north countries has direct links to the inequality and social issues brought upon globalization. Illegal immigration has increased exponentially over the past few decades, as men and women of distinct age groups and nationalities abandon their countries in the search for better working and living conditions. According to the Migration Policy Institute (MPI), over 40% of immigrants who entered the United States from 1980 to 2005 were unauthorized3, while in most Western European countries, the foreign-born population accounted for between 7 and 15% of the entire population,4 and this rate is only expected to increase. There are several root causes behind the recent increase in both le3 Migration Policy Institute, available at research/usimmigration.php, accessed December 5th, 2008. 4 Migration Policy Institute, available at http://www.migrationinformation. org/Feature/display.cfm?ID=402, accessed December 5th, 2008. 24

gal and illegal immigration to the global north, particularly to Western European countries such as England and Spain, as well as to the United States. Among the sources of this phenomenon are wars, political repression, poverty and unemployment—all of which are directly and indirectly brought upon or intensified as a result of globalization. This issue has severe socio-economic implications, not only to the countries involved, but also when it comes to the lives of those migrating and their families, as it is not only costly but extremely dangerous to attempt to cross boarders illegally. Most immigrants face extremely dangerous situations when attempting to reach the United States or Europe illegally, and in addition to the risks of the actual trip, most have no guarantee that they will be able to find adequate jobs or a place to live, or even if they will make it across the border alive and without being deported. According to the U.S. border patrol, 472 people died in 2005 attempting to cross the Mexico-United States border illegally,5 and millions are deported upon reaching the country. These numbers represent the importance of properly addressing this issue, which causes disruption for both the countries receiving such a great flow of foreigners, but mostly to developing countries. When citizens are forced to leave their families behind in order to seek better work and living opportunities, there is a severe disruption within society, as well as in the local economy, which only further increases the problems faced by developing countries. In addition, if able to reach a developed country, illegal immigrants normally live and work in extremely unsafe conditions, often in exchange for low salaries in unregulated facilities. Most have very little or no access to healthcare whatsoever, and they usually avoid seeking medical attention due to high costs and fears of being forcibly deported. Another serious issue, particularly in Europe, is the mistreatment and virtual enslavement of illegal immigrants, predominantly women who are brought to countries such as Portugal and Spain and forced to engage in prostitution, as approximately 500,000 women are trafficked into Europe annually. Above all, one of the most serious implications of the increase of both legal and illegal immigration is the xenophobic response on behalf of many citizens within developed countries, concerned with their jobs, safety, culture, and economic conditions. In the United States this is a particularly serious issue, considering the proximity with Mexico and other countries in Latin American that face severe inequality and social 5 Leslie Berestein, at “Sign on San Diego,� available at http://www., accessed on December 5th, 2008. 25

problems. The sheer size of the Mexico-U.S. border makes it impossible to seal off, and the presence of over eleven million immigrants in the United States contributes to the increase of prejudice and discrimination against foreigners. Although the United States was a country formed by immigrants from several distinct nationalities and backgrounds, recent waves of immigration have not been as easily accepted, and immigrants (particularly those from Latin America) are often not well-integrated in society, constantly being victims of discrimination, suspicion and prejudice-something experienced by immigrants in several regions of Europe as well. Several authors and scholars negatively refer to the recent increase in illegal immigration as a severe threat to American culture and values. According to Samuel P. Huntington, “the persistent inflow of Hispanic immigrants threatens to divide the United States in two peoples, two cultures, and two languages.”6 This notion that immigrants represent a degradation of the local culture well illustrates the social problems exacerbated by illegal immigration, particularly in terms of discrimination. When it comes to the actual impact of illegal immigration on developed countries such as the United States, there is very little consensus and facts are often times replaced by xenophobic and nationalist rhetoric. One of the main threats posed by illegal immigration concerns national security, as it is crucial for a nation-state to be able to control and regulate the entrance of visitors. A state’s inability to effectively protect its borders has serious implications, not only in terms of security and sovereignty, but also when it comes to issues such as drug trafficking. In addition, the increasing flow of immigrants leads to a certain dilemma in developed countries, as leaders are often unsure of how to address to the issue and whether or not to deport illegal foreigners already in the country. Though many citizens demand harsher legal actions against unauthorized immigrants, arguing that they are responsible for economic crises and persistent unemployment, these claims are often based on xenophobic assumptions rather than on actual facts. In the case of the United States, illegal immigrants represent nearly 5% of the labor force in the country7, and work mostly in sectors in which extensive education or training is not required. According to Tim Kane and Kirk Johnson, leaders must learn to discern “illusory immigration problems from real ones […] and the real problem presented by illegal immigration, is security, not the 6 Samuel P. Huntington, “The Hispanic Challenge,” Foreign Affairs (April 2004). 7 Denise Bacoccina, Folha de Sao Paulo, available at, accessed on December 5th, 2008. 26

supposed threat to the economy.�8 As described by the scholars, although many American citizens and leaders claim that illegal immigration is detrimental to the economy, immigrants add over $88,000 dollars annually in tax revenues, and social security payroll taxes from undocumented workers have amounted to a $463 billion funding surplus.9 Even if seen as detrimental and costly by many, immigrants represent a significantly large share of the US economy and generally work undesirable jobs that most Americans will not. Although illegal immigration has severe consequences and impacts on the entire international community, little has been done to efficiently address this phenomenon or the causes behind it. Both in the United States and in European countries measures taken by leaders represent more of a palliative than comprehensive solution. In the case of the United States much has been done recently to improve security along the USMexican border in an effort to reduce the flow of people attempting to cross it illegally, as thousands of immigrants are deported and each year over one million immigrants are kept from reaching the United States. In addition, Mexico was included in the creation of the North American Free Trade Agreement (NAFTA) in 1993, in an attempt to promote growth within the country and reduce the socio-economic inequality visà -vis the United States. Nonetheless, few measures efficiently address root causes of immigration, such as poverty, inequality and political instability. Instead, most immigration laws created over the years establish a quota for legal immigrants and prioritize the enhancement of border security and the development of adequate legislation to address illegal immigrants within the United States. In 1952 the Immigration and Nationality Act (INA) was created to restrict immigration into the country and has been modified throughout the years, particularly after the terrorist attacks of September 11, 2001.10 This bill, also known as the McCarran-Walter act, established a quota of immigrants based mostly on ethnicity and country of origin, the quota for 8 Tim Kane and Kirk A. Johnson, The Heritage Foundation: The Real Problem with Immigration, and the Real Solution, available at http://www., accessed on December 5th, 2008. 9 Tim Kane and Kirk A. Johnson, The Heritage Foundation: The Real Problem with Immigration, and the Real Solution, available at http://www., accessed on December 5th, 2008. 10 U.S. Citizenship and Immigration Services, available at http://www. 27

which was later abolished. In the United States under George W. Bush, similar measures were taken to avoid illegal immigration to the country, including the creation of the Secure Fence Act of 2006, authorizing the creation of over 700 miles of double-reinforced fence along the national border from California to Texas11. However, some additional legislation seeking to improve the quality of lives of illegal immigrants has been proposed, such as the Development, Relief and Education for Alien Minors act (DREAM act) of 2001, attempting to provide the opportunity of residency for undocumented high school students.12 European leaders have taken a similar approach and have recently strengthened immigration laws and increased border security, particularly in Italy, Spain, United Kingdom and France. The latter nation receives over 100,000 new entries per year, and continues to focus primarily on policies of deterrence when it comes to immigration.13 In the case of the UK, several immigration laws have also been implemented recently, particularly in preventing the employment of illegal workers through new requirements and punishments for employers, a system known as the Work Permit Regime.14 In 2008 Italy also began strengthening immigration restrictions, and the government has alluded to a new policy which would allow the state to confiscate property rented to illegal immigrants, restrict granting of asylum, and increase police search for undocumented immigrants within the country.15 Nonetheless, the European Union has recently announced plans of addressing more efficiently the causes behind immigration by allocating resources to African countries such as Morocco and Libya in order to increase job creation and quality of life within the ?vgnextoid=f3829c7755cb9010VgnVCM10000045f3d6a1RCRD&vgnextchannel =f3829c7755cb9010VgnVCM10000045f3d6a1RCRD, accessed on December 6th, 2008. 11 The White House, available at releases/2006/10/20061026.html, accessed on December 6th, 2008. 12 Dream Act Portal, available at, accessed on December 6th, 2008. 13 Virginie Guiraudon, Brookings Institution: Immigration Policy in France, available at, accessed on December 6th, 2008. 14 Morgan Lewis, The New UK Immigration System: What Employees Need to Know Now, available at /670d18c6-60a6-4256-b785-569ecf6d1ed6/fuseaction/publication.detail, accessed on December 6th, 2008. 15 The Economist: Rome V Roma, available at world/europe/displaystory.cfm?story_id=11412932, accessed on December 6th, 2008. 28

countries. In addition to increasing patrols on the coast, the EU also seeks to develop a program called the “European Job Mobility Portals� in Africa, in order to increase communication and discuss the opportunities of jobs in Europe.16 American and European anti-immigration policies have been widely controversial not only within these regions, but also in the international community as a whole, as the inability to properly address illegal immigration and inequality has severe consequences both to developed and developing countries. The increase of border patrol in the United States, as well as the additional miles of double fences approved by the government have contributed to a sense of American isolationism from the rest of the world and an increasing differentiation between first and third world. These radical measures have been widely criticized not only on account of human rights but also for encouraging the spread of xenophobic and racist feelings towards immigrants within the United States. As a result, prejudice against Latin American foreigners has increased tremendously in the past decade, contributing to the dissemination of a new form of racism within the United States. In addition to severe impact of these measures on unauthorized immigrants, increases in border control also significantly affect the U.S., as they are extremely costly and due to the size of the border, have limited efficacy in reducing flow. Increasing security along the borders to this extent has another negative externality: more immigrants choose to remain in the country, therefore attempting to cross the borders only once rather than leaving their home countries seasonally for short periods of time. Recent anti-immigration measures are also quite detrimental to undocumented immigrants and their home countries, particularly due to the impact on their societies and on their families, who are often only able to survive on remittance money sent by those who have illegally crossed the border. Society within developing countries which have experienced a constant flow of emigration are often disrupted and since anti-immigration policies fail to address the root causes of this increasing flow of citizens, the is little improvement for the population of the developing world. Although criminal, illegal immigration must be addressed with a certain amount of caution, as drastic measures only exacerbate the global north-south divide, as well as inequality within developing countries. In order to efficiently address the issue of illegal immigration, a new level of cooperation must be established between developing and developed 16 Europa: The European Job Mobility Portal, available at http://www.europa., accessed on December 6th, 2008. 29

countries, creating the proper mechanisms to address root causes. Countries such as the United States need to improve their policies on the issue, especially when it comes to dealing with illegal immigrants that are already on the country. Though perhaps widespread amnesty would not be the solution, certain measures such as the creation of temporary or seasonal work permits as well as the establishment of easier access to legal citizenship would allow the state to engage more directly and effectively. In addition, immigrants and their children should be granted access to good education and healthcare, and there should be more government programs to integrate these foreigners within society, with the goal of eradicating prejudice and discrimination. More measures to reduce inequality in the international community should also be put to practice, as the reduction of the gap between the global north and south would not only address the root causes behind immigration but would also gradually reduce the flow of unauthorized immigrants to developed countries. Governments of developing countries should also seek to improve quality of life for their citizens, create more jobs and provide more equal opportunities in order to ensure that it remains profitable for them to remain in their homeland. Different groups within society, such as NGOs and humanitarian organizations should also attempt to work together with local governments in order to provide support to illegal immigrants and their families and in order to improve the living conditions in their own countries. Finally, if developed countries continue to adopt isolationist policies, issues concerning inequality and illegal immigration will never be effectively addressed and may lead to increasing animosity between the global north and south. This may result in serious social consequences for the local population of both developed and developing countries, resulting in a conflictive and uncooperative international community.


Poverty and Inequality in Brazil Sean Higgins Abstract As a result of data discrepancies, it can be difficult to reach conclusions about the magnitude of poverty and inequality and their trends over time. Since data on poverty and inequality are often used to evaluate social programs and formulate policy, it is important to understand these inconsistencies. Therefore, the objectives of this paper are as follows: first, to identify the sources of data on poverty and inequality in Brazil; second, to compare poverty and inequality for the period 1985 to 2007 from the different data sources and attempt to identify what might explain the observed discrepancies in both levels and trends; third, to analyze what happened to poverty during the economic crisis of 1990-1992, when gross domestic product (GDP) per capita fell at 2.7% per year on average; and fourth, to analyze an observed fall in poverty and inequality since 2001 and assess the impact of Bolsa Família, a conditional cash transfer (CCT) program implemented in 2003. Discrepancies in the Data: What Can We Conclude about Poverty and Inequality in Brazil? Despite showing promises of economic growth two decades earlier, Brazil’s outlook seemed dismal in 1990. Between one third and one half of Brazilians were living in poverty.1 GDP per capita fell by 5.9% in 1990, beginning a macroeconomic crisis that would last until 1992.2 Income inequality had reached an all-time high one year earlier; the Gini coefficient in 1989 was 0.63,3 making Brazil the second most unequal country in the world, narrowly behind Sierra Leone.4 1 The 1990 poverty headcount ratio, calculated using the methodologies explained later, was 48.0% according to ECLAC ( ConsultaIntegrada.asp?idAplicacion=1), 34.2% according to the World Bank (, 37.7% according to SEDLAC (http://www.depeco.econo.unlp eng/dynamics-searches.php), and 34% according to IPEA (; all online databases accessed October, 2009. 2 World Bank, “World Development Indicators,” accessed December, 2009, 3 World Bank, “World Development Indicators,” accessed December, 2009. 4 Francisco H. G. Ferreira, Phillippe G. Leite, and Julie A. Litchfield, “The Rise and Fall of Brazilian Inequality: 1981-2004,” Macroeconomic Dynamics 12, supplement 2 (2008): 199. However, for a detailed discussion of the 31

More recently, conditions appear to be improving. Since 2001, the data sources show an overall decline in poverty in Brazil using various poverty lines and multiple measures of poverty. The headcount index, poverty gap, and squared poverty gap all decreased by between 25% and 40% over the years 2001 to 2007. Income inequality has also dropped significantly: the Gini coefficient decreased an average of 1.2% per year over the period 2001-2007.5 Some of this decline in inequality can be attributed to Bolsa Família, a conditional cash transfer program introduced in 2003.6 This paper analyzes the trends of poverty and inequality in Brazil over time. Section 1 describes each of the data sources and the household surveys used. Section 2 compares the data on poverty and inequality for the period 1985-2007. Section 3 analyzes the evolution of poverty during the crisis of 1990-1992 and looks at how the different methodologies used by each data source might explain the discrepancies. Section 4 describes the Bolsa Família program, its main characteristics, and its effects on poverty and inequality. Section 5 presents conclusions. 1. Data sources on poverty and inequality Four well-respected data sources produce data on poverty and inequality in Brazil: the United Nations’ Economic Commission for Latin America and the Caribbean (ECLAC), the World Bank, the SocioEconomic Database for Latin America and the Caribbean (SEDLAC), and the Brazilian government’s Applied Economics Research Institute (IPEA). While all of these sources derive their figures from the same micro-data source (annual household surveys conducted by the Brazilian government’s Institute of Geography and Statistics [IBGE]), they often use different calculation methods and arrive at different values for various common indicators of poverty and inequality. Their different methodologies do not present large problems if the data they produce problems associated with country inequality rankings, see Miguel Székely and Marianne Hilgert, “What’s Behind the Inequality We Measure? An Investigation Using Latin American Data,” Oxford Development Studies 35, no. 2 (2007): 197-217. 5 Ricardo Barros et al., “Markets, the State, and the Dynamics of Inequality in Brazil,” in Declining Inequality in Latin America: a Decade of Progress?, ed. Luis F. López-Calva and Nora Lustig (Washington, D.C.: Brookings Institution Press, 2010), 134-6. 6 Sergei Soares et al., “Conditional Cash Transfers in Brazil, Chile and Mexico: Impacts upon Inequality,” Estudios Económicos Special Issue (2009): 219 and Barros et al., “Markets,” 145-54. 32

still agrees on poverty levels and trends, but levels and trends often differ, which can create contradicting conclusions. When discrepancies or inconsistencies exist among sources, using poverty and inequality data to assess social policy becomes a more complex task. Before looking at the data, trends, and methodologies of each organization, it is useful to understand their common source: the IBGE household survey. Each year, IBGE conducts a survey of over 100,000 households called the Pesquisa Nacional por Amostra de Domicílios (PNAD); sample sizes over the time frame 1985-2007 have ranged from 291,000 to 525,000 individuals. The survey did not have complete national coverage from 1985 to 2003 because the rural parts of the North Region were not included in the sample until 2004.7 The survey measures income rather than consumption, even though consumption is smoother over time, can be more accurately measured, and better reflects a household’s ability to meet basic needs.8 This can tend to overstate inequality, especially when one takes into account that income volatility in Brazil is higher than in the rest of Latin America—a region already known for high income volatility.9 This leads to an overestimation of Brazil’s inequality ranking in the world because many developing countries use only expenditure-based questions on their surveys. Indeed, using data from consumption-based surveys considerably lowers inequality estimates: the consumption-based Gini coefficient for Brazil in 1996 was around 0.45, compared to an income-based Gini coefficient of 0.60.10 Although there are surveys that ask questions about both consumption and income, like the Pesquisa de Orçamentos Familiares and the Pesquisa sobre Padrões de Vida, they are too infrequent to be useful for comparisons across time. The PNAD does not ask adequate questions to capture non-monetary 7 Ferreira, Leite, and Litchfield, “Rise and Fall,” 201 and 224. 8 Aline Coudouel, Jesko S. Hentschel, and Quentin T. Wodon, “Poverty Measurement and Analysis,” in A Sourcebook for Poverty Reduction Strategies Volume 1: Core Techniques and Cross-Cutting Issues, edited by Jeni Klugman (Washington, D.C.: World Bank, 2002), 30. 9 Leonardo Gasparini, “Different Lives: Inequality in Latin America,” in Inequality in Latin America: Breaking with History?, ed. David de Ferranti et al. (Washington, D.C.: World Bank, 2004), 49-50. 10 Chris Elbers et al., “Poverty and Inequality in Brazil: New Estimates from Combined PPV-PNAD Data,” in Inequality and Economic Development in Brazil, ed. Carlos Eduardo Vélez, Ricardo Barros, and Francisco H.G. Ferreira (Washington, D.C.: World Bank, 2004), 81-104; see also Gasparini, “Different Lives,” 48-50. 33

incomes or returns from assets, like rents and interests.11 Furthermore, changes in the PNAD survey over time make cross-time comparisons less useful. A new survey was introduced in 1992, and changes were made in 2004. Starting in 2004, the survey includes the rural areas of Brazil’s North Region (which had previously been excluded), and more detailed questions regarding transfer incomes were added.12 The PNAD was not conducted in 1991 or 2000 (because they were census years) or in 1994.13 In short, Brazil’s statistics on poverty and inequality are provided by four main sources: ECLAC, the World Bank, SEDLAC, and IPEA. All four sources calculate levels of poverty and inequality using micro-data from the PNAD household surveys. 2. Evolution of poverty and inequality: 1985-2007 Each organization, to estimate poverty, provides figures for the headcount index. This measure is useful to the extent that it provides a general idea of the percentage of the population living below a given poverty line. There are a number of trends: for example, according to each of the three organizations that have data for 1985-1989, there was a very large drop in the incidence of poverty in 1986,14 but poverty almost entirely returned to prior levels in 1987 and continued to rise in 1988. In addition, all of the organizations seem to agree that the headcount ratio has been falling since 2003. Despite the agreement on some trends, the percent of 11 Ricardo Barros, Samir Cury, and Gabriel Ulyssea, “A Desigualdade de Renda no Brasil Encontra-se Subestimada? Uma Análise Comparativa usando PNAD, POF e Contas Nacionais,” in Desigualdade de Renda no Brasil: uma Análise da Queda Recente, ed. Ricardo Barros, Miguel Foguel, and Gabriel Ulyssea (Brasilia: Instituto de Pesquisa Econômica Aplicada, 2007), 250-256. 12 Ferreira, Leite, and Litchfield, “Rise and Fall,” 212 and 224. 13 Centro de Estudios Distributivos, Laborales y Sociales (CEDLAS) and World Bank, “A Guide to the SEDLAC Socio-Economic Database for Latin America and the Caribbean,” accessed October, 2009, http://www.depeco.econo., 6. 14 What happened in 1986? Ferreira, Leite, and Litchfield attempt to answer this question. A portion of the drop could have been caused by the 1986 Crusado stabilization plan. However, the magnitudes of the drop in poverty do not coincide with a comparable increase in GDP or reduction in income inequality. Income grew by 46% using PNAD micro-data, but GDP only grew by 7% according to national accounts. Ferreira, Leite, and Litchfield note that there were no methodological changes in the survey and conclude that the household survey results overstated income and therefore underestimated absolute poverty for the year 1986. 34

people living in poverty according to ECLAC is significantly higher than the same percentage according to the other organizations. This observation is unambiguous; it holds true throughout the time period 1985-2007. Extreme poverty follows a similar pattern to total poverty, but one important discrepancy occurs during Brazil’s crisis of 1990-1992. The sources show contradictory trends for the evolution of extreme poverty during the crisis. Inequality trends, on the other hand, are generally consistent from 1985 to 2007. The only interesting discrepancy is the consistently higher Gini calculated by ECLAC. The evolution of poverty and inequality between 1985 and 2007 is a topic of some agreement and some disagreement between data sources. They all agree that the headcount ratio has been consistently falling since 2003, and that the evolution of extreme poverty levels resembles the evolution of total poverty levels. The organizations also generally agree on inequality trends, as measured by the Gini coefficient. They disagree on the evolution of extreme poverty during the crisis of 1990-1992. 3. Poverty during the crisis of 1990-1992 During the period 1990-1992, Brazil experienced an economic crisis: GDP per capita fell by 2.7% per year on average15 and hyperinflation reached an annual rate of 1509% in 1990.16 Figure 1 shows each source’s headcount ratio during the crisis years using their respective extreme poverty lines. Unfortunately, there are no data points for 1991 since it was a census year; nevertheless, a comparison of the data points from 1990 and 1992 can be used to determine whether poverty increased or decreased during the crisis. The trends are completely contradictory: SEDLAC shows an increase in extreme poverty of 0.2 percentage points between 1990 and 1992, while IPEA shows no change and the World Bank shows a decrease of 2.2 percentage points. How can these inconsistencies be explained? Year 1990 1992

SEDLAC 19.1 19.3

IPEA 20.0 20.0

World Bank 15.5 13.3

Figure 1. Headcount index in Brazil using the extreme poverty line. Each organization determines its own extreme poverty line. ECLAC is not included because it does not have a data point for 1992. Data is from each source’s online database: World Bank (http://; SEDLAC ( ar/sedlac/eng/dynamics-searches.php); IPEA (, all accessed

15 16

World Bank, “World Development Indicators,” accessed December, 2009. Ferreira, Leite, and Litchfield, “Rise and Fall,” 219. 35

October, 2009. Note that SEDLAC no longer provides estimates for poverty using an extreme poverty line lower than $2.50 PPP per day, which are the estimates shown here.

One of the most important—and sometimes arbitrary—aspects of the headcount index is the choice of a poverty line. The most intuitive explanation for poverty data discrepancies is the different poverty lines selected by each organization. The World Bank and SEDLAC use international poverty lines established by the World Bank to allow for poverty comparisons across countries. In addition, the World Bank’s PovcalNet database allows users to select any poverty line. As the World Bank often does,17 I used $1.25 per day (US dollars adjusted for purchasing power parity [PPP], using 2005 as the base year)18 as the extreme poverty line and $2.50 PPP per day as the poverty line. This extreme poverty line approximately represents the average national poverty line of the bottom fifteen low-income, less-developed countries,19 and therefore probably does not accurately reflect the cost of fulfilling nutritional requirements in Brazil. SEDLAC stresses the importance of using higher poverty lines than $1.25 and $2.50 PPP per day; in fact, for total poverty SEDLAC recommends a $4 PPP per day line.20 For comparative purposes, however, I selected $2.50 PPP per day for total poverty. ECLAC, on the other hand, adopts the food energy intake method to determine the extreme poverty line and calculates the cost in local currency of a food-only basket that will meet households’ minimum caloric and protein requirements. Consequently, the extreme poor are defined as people who live in households that do not have enough income to meet the minimum nutritional needs of each family member, even if the household spent 100% of its money on food. To account for price differences across areas, ECLAC calculates an urban and rural extreme poverty line for each of Brazil’s five official geographic regions, resulting in a total of ten distinct extreme poverty lines. To calculate the total poverty line, ECLAC uses a multiplier to impute the cost of basic non-food expenditures and adds those to the basic needs basket. The national headcount index aggregates the number of people who live below their respective 17 Shaohua Chen and Martin Ravallion, “The Developing World is Poorer than We Thought, but No Less Successful in the Fight Against Poverty,” The Quarterly Journal of Economics 125, no. 4 (2010): 1577-1625. 18 From here on, “$1.25 per day (US dollars adjusted for PPP, using 2005 as the base year)” will be abbreviated as “$1.25 PPP per day.” 19 Chen and Ravallion, “Developing World,” 1581. 20 CEDLAS and World Bank, “A Guide,” 28. 36

poverty line and divides this by the country’s total population.21 IPEA follows a similar methodology, using the cost of basic needs method. IPEA first determines what products to include in the basic needs basket, using data from a nutritional household survey and a consumption-based survey carried out in 5-10 year intervals. Then, they determine the price of this basket in 24 regions, which include 14 metropolises, the urban sectors of Brazil’s five official geographic regions, and the rural sectors of the five geographic regions.22 The price of this basket in each of the 24 regions determines the extreme poverty lines, which contrasts with ECLAC’s method of using a food-only basket to determine the extreme poverty lines. The highest IPEA extreme poverty line for the year 2009, at R$124.96 reais (metropolitan Porto Alegre), is 1.86 times higher than the lowest extreme poverty line of R$67.24 reais (rural East Region).23 Given their different methods of choosing a poverty line, it is not surprising that the different organizations show different levels and trends for poverty. For example, the World Bank and SEDLAC, when using a poverty line of $2.50 PPP per day, produce similar numbers. ECLAC and IPEA, which calculate the price of a basket in different regions in Brazil, will have higher poverty lines—and therefore a higher incidence of poverty and poverty gap—than the World Bank and SEDLAC (assuming that the cost of a basic needs basket in Brazil is higher than the $2.50 PPP per day poverty line used by the World Bank and SEDLAC).24 21 ECLAC, “Social Indicators and Statistics: Poverty and income distribution: Population Living below the Poverty and Extreme Poverty Lines, by Urban and Rural Areas,” technical note, accessed October, 2009, http://websie.eclac. cl/infest/ajax/cepalstat.asp?carpeta=estadisticas&idioma=i. 22 IPEA, “Metodologia na Determinação das Linhas de Pobreza e Indigencia (por Insuficiencia no Consumo de Calorías por Dia),” technical note, accessed November, 2009, 23 A spreadsheet with the 24 (extreme) poverty lines calculated each year by IPEA for the years 1976-2009 can be downloaded at br/doc/LinhasPobrezaRegionais.xls. The East Region, which is not one of the five official geographic regions, is the Southeast Region without São Paulo and Rio de Janeiro states. 24 This is a valid assumption because the World Bank uses a deliberately conservative standard, “anchored to what ‘poverty’ means to the world’s poorest countries” (Chen and Ravallion, “Developing World,” 1580). Whether the difference between ECLAC’s poverty line and the World Bank’s $2.50 PPP poverty line is substantial enough to overpower methodological issues—like the fact that ECLAC corrects for underreporting (which should lower its reported 37

A few other differences exist between the organizations in their poverty calculation methods. These differences help to further explain the discrepancies and inconsistencies in data values and trends (in particular, between the World Bank and SEDLAC, using the same poverty line of $2.50 PPP per day). The first difference relates to the use of equivalence scales to compensate for the fact that different people in a household have different needs based on age, gender, and other characteristics. Generally in Latin America, equivalence scales are not used.25 SEDLAC, however, does account for differences in needs by using equivalence scales. SEDLAC employs the equation that the total number of adult equivalents in a household equals (0.5K1 + 0.75K2 + A)0.9, where K1 represents children ages 0-5, K2 represents children ages 6-14, and A represents adults ages 15 and over.26 The equation’s exponent accounts for economies of scale within households. The other organizations do not adjust for adult equivalence or economies of scale. Since children do not need as many calories as adults to fulfill their daily requirement, and since larger households might experience economies of scale, adjusting for these factors would lower the incidence of poverty. This might explain why the majority of SEDLAC’s headcount index data points are lower than the World Bank’s corresponding data points. The second difference relates to another common problem faced by organizations or economists trying to produce poverty statistics: the treatment of missing and zero incomes. Each organization treats these differently. For example, ECLAC imputes values for non-reported incomes, whereas SEDLAC throws out non-reported incomes and keeps zero incomes in their poverty measures.27 Despite these differences in methodology, it is comforting to know that Székely et al. tested the robustness of Brazil’s poverty measures to adjustments for missing and zero incomes and found that the minimum and maximum values for Brazil’s headcount index only differed by 2.8 percentage points.28 The third difference relates to another issue with measuring poverty using household survey data: underreporting. ECLAC estimates the level of underreporting by comparing aggregated survey data to national headcount ratio)—is not within the scope of this paper. 25 Miguel Székely et al., “Do We Know how much Poverty there is,” Oxford Development Studies 32, no. 4 (2004): 531. 26 CEDLAS and World Bank, “A Guide,” 24. 27 ECLAC, “Social Indicators,” 1; CEDLAS and World Bank, “A Guide,” 1820. 28 Székely et al., “Do We Know,” 524. 38

accounts data, and corrects for this underreporting.29 This practice increases incomes and thereby decreases poverty indicators. The World Bank re-scales their income data in the opposite direction to address a different issue—the idea that consumption is a more accurate welfare measure than income. Thus, they multiply income by a marginal propensity to consume to obtain a value for consumption and use this to calculate their poverty measures.30 Since the marginal propensity to consume is by definition less than or equal to one, this practice down-scales people’s incomes and thereby increases poverty indicators. In addition to SEDLAC’s adjustment for adult equivalence and economies of scale, the World Bank’s adjustment for marginal propensity to consume could help explain why the majority of the World Bank’s headcount index data points are higher than SEDLAC’s corresponding data points. Clearly, each data source uses a different combination of adjustments to address the issues of using survey data to develop poverty statistics. The issues are the choice of a poverty line, adjustments for adult equivalence scales and economies of scale, methods for treating missing and zero incomes, and adjustments to handle income misreporting. Each adjustment affects the levels and trends of poverty measures, and this section has identified the ways in which different methodological choices can affect the data. However, since each source combines all of their adjustments to produce a set of poverty and inequality figures, it is difficult to link inconsistent trends to a specific adjustment used by one data source and not used (or used differently) by another. Thus, I was not able to determine why the extreme poverty headcount ratios showed contradictory trends during the crisis. In particular, determining why the World Bank showed a decrease in extreme poverty from 1990 to 1992, while SEDLAC showed an increase and IPEA showed no change requires further analysis that goes beyond the scope of the present paper. A further look at the 1990-1992 crisis reveals that it did not affect everyone equally; Figure 2 shows that while the rural population enjoyed a significant decrease in poverty and extreme poverty despite the crisis (which may have been part of an unstoppable trend of declining rural-urban labor market segmentation),31 the effect on urban poverty was ambiguous. According to ECLAC, the incidence of urban poverty decreased, but according to SEDLAC it increased during the crisis years. So, in terms of trends, the discrepancy is regarding urban poverty. How29 30 31

ECLAC, “Social Indicators,” 1. Székely et al., “Do We Know,” 536. See Barros et al., “Markets,” 158-65. 39

ever, there is also a discrepancy regarding rural poverty, in terms of the magnitude of its reduction: SEDLAC shows significantly lower declines in rural poverty than ECLAC. The underlying causes of this require further research that goes beyond the scope of the present paper. Year 1990 1992 1993

ECLAC Urban (Extreme PL) 16.7

ECLAC Rural (Extreme PL) 46.1

ECLAC Urban (PL) 41.2

ECLAC Rural (PL) 70.6





SEDLAC Urban 29.4 31.2 31.2

SEDLAC Rural 62.3 61.0 59.4

Figure 2. Rural and urban headcount index in Brazil. This table includes ECLAC data with two poverty lines and SEDLAC data with one poverty line. PL stands for poverty line. The year 1993 is included because ECLAC does not have data for 1992. Data is from each source’s online database: ECLAC ( ConsultaIntegrada.asp?idAplicacion=1); SEDLAC ( ar/sedlac/eng/dynamics-searches.php), both accessed October, 2009.

4. The decline in poverty and inequality since 2001 Since 2001, absolute poverty and income inequality in Brazil have declined significantly. All four data producers agree on this trend. The decline in the percent of the population living in poverty (measured by the headcount ratio) is especially evident from 2003 on. A portion of the recent fall in poverty and inequality can be directly attributed to monetary transfers through the Bolsa Família program, implemented in late 2003. This section will take a closer look at poverty and inequality data for the period 2001-2007, describe Bolsa Família and its main characteristics, and analyze the impacts of the program. Using 2001 and 2007 as two points of comparison, the recent reduction in poverty has been impressive. All four data sources show a large drop in the headcount ratio: the reduction varies from 7.2 percentage points (ECLAC) to 11.2 percentage points (World Bank). The absolute number of people living in extreme poverty has decreased by 11 million in spite of population growth. The amount of resources needed to eradicate poverty (equivalently, the total poverty gap) has decreased substantially from R$63 billion reais per year to R$45 billion reais per year, which makes the alleviation of poverty more feasible. These impressive drops in poverty are partially explained by falls in inequality over the period: 62% of the reduction in extreme poverty can be attributed to decreased income inequality.32 Inequality has also fallen substantially between 2001 and 2007. The Gini has declined 6.9%, and the 2007 income distribution Lorenz-dominates the 2001 distribution. The average annual rate of income growth of 32 40

Barros et al., “Markets,” 137.

the bottom decile is nearly three times the national average and is higher than the average annual income growth rate of any other income group. In 2007, the Gini coefficient reached its lowest level in over 30 years.33 Some of the recent reduction in levels of poverty and inequality is attributable to Bolsa Família, a conditional cash transfer program (CCT). Bolsa Família was introduced in October, 2003 to organize and merge the various CCTs in existence, which had separate financing schemes, implementing agencies, conditions, and information systems. These CCTs included the Programa de Erradicação do Trabalho Infantil, run by the Social Assistance Secretariat of the federal government and created in 1996; the Bolsa Escola Federal, run by the Ministry of Education; the Bolsa Alimentação, run by the Ministry of Health; and the Cartão Alimentação, run by the Ministry of Social Development. Because the information systems of the old CCTs did not exchange information, one family could receive all four benefits while an equally needy family received none.34 More than 12 million households spanning all of Brazil’s municipalities receive cash transfers from the Bolsa Família program;35 over 46 million people live in households that receive transfers from the program.36 It is extremely well-targeted37 and only households with percapita household income below the poverty line are eligible (for the purposes of Bolsa Família, the poverty line is household per capita income of R$140 per month).38 Thus, there are almost no leakages to the nonpoor and the policy is highly progressive. The eligibility requirements and transfer size are as follows. The base benefit transfers R$68 per month to any family—with or without children—living in extreme poverty (household per capita income below R$70 per month). The variable benefits award an additional R$22 a month per child age 0-15 (up to 3 children) and R$33 a month per adolescent age 16 or 17 (up to 2 adolescents). Families in moderate poverty39 are not eligible to receive the base benefit, but receive the variable benefits based on the number of children 33 Barros et al., “Markets,” 134-6. 34 Sergei Soares and Natália Sátyro, “O Programa Bolsa Família: Desenho Institucional, Impactos e Possibilidades Futuras,” IPEA Textos Para Discussão, no. 1424 (2009): 8-10. 35 Ministério do Desenvolvimento Social e Combate à Fome (MDS), “Bolsa Família,” accessed December, 2009, 36 Barros et al., “Markets,” 147. 37 Soares et al., “Conditional Cash Transfers,” 209-24. 38 MDS, “Bolsa Família,” accessed December, 2009. 39 Families in moderate poverty are families with a household per capita below the poverty line but above the extreme poverty line.


they have. Any family in extreme poverty is eligible, and any family in moderate poverty with at least one child under age 18 is eligible.40 Families are selected based on information entered by municipal civil workers into Cadastro Único—a data collection system with the objective of identifying all poor families in the country. Municipal civil workers also verify that the conditions of the program are being met. The conditions are divided into three categories: education, health, and social assistance. Under education, children and adolescents between the ages of 6 and 15 must have at least 85% school attendance, while 16- and 17year-olds must have at least 75% school attendance. Under health, children between the ages of 0 and 6 must adhere to a calendar of vaccinations. Pregnant women and breast-feeding mothers must attend prenatal and postnatal care sessions. Under social assistance, children under 16 who are at-risk or employed in child labor must attend provided socioeducational service sessions.41 The program, which is administered by the Ministério do Desenvolvimento Social e Combate à Fome (MDS), has received increased funding over the years. Progress in poverty and inequality is measured by IPEA; economists from IPEA even decompose inequality data to determine how much of a given inequality reduction was due to Bolsa Família. While IPEA is a government agency, it is a separate government agency from MDS, and IPEA analysts are often academics. As a result, Bolsa Família has a credible mechanism to assess its evolution and impact. Since its implementation in 2003, the Bolsa Família program has played an important role in the reduction of poverty and inequality and should continue to be expanded. Logically, transferring income to families in moderate and extreme poverty (with more transferred to families in extreme poverty) will reduce inequality in an absolutely progressive way. In addition, it will reduce poverty by directly giving poor families enough income to move above the poverty line. Finally, the conditions of Bolsa Família should lead to higher investments in human capital among the poor, which will help to fight the poverty cycle in the long term. Nevertheless, the direct (quantifiable) impact of the program on poverty and inequality is important information for policymakers who must often choose between competing social programs. Barros et al. decompose the decline in inequality between 2001 and 2007 to determine the impact of Bolsa Família on inequality. 40 41 42

MDS, “Bolsa Família,” accessed December, 2009. MDS, “Bolsa Família,” accessed December, 2009.

To isolate the contribution of Bolsa Família transfers to income inequality reduction, Barros et al. first decompose household per capita income, which is used to determine inequality measures, into its four proximate determinants: labor income per working adult, proportion of adults working, non-labor income per adult, and proportion of adults in the household. In Brazil, changes in all four of the proximate determinants during 2001-2007 were equalizing, with changes in the distribution of non-labor income having the largest effect. The authors then split non-labor income into seven categories; one of these categories is Bolsa Família and its predecessors. By performing counter-factual simulations to simulate what would have happened if the distribution of each non-labor income source had not changed, the authors found that Bolsa Família explained 13% of the overall decline in income inequality. That number is substantial, considering that Bolsa Família transfers only made up 0.5% of total national income in 2007.42 The decline of poverty and inequality in Brazil since 2001 has been notable. There is no disagreement between the data sources that poverty and inequality have fallen significantly in recent years. Hopefully, the Brazilian government will pursue social policies that have a high chance to sustain these trends of falling poverty and inequality. Expansion of the Bolsa Família conditional cash transfer program would be an excellent way to attempt to maintain or even improve the falling rates of poverty and inequality in the country. It is an economically efficient program that has produced excellent results in the past; while it only made up 0.5% of total income in 2007, it was responsible for 13% of the decline in income inequality between 2001 and 2007. It is a large-scale program that is effectively targeted, promotes investment in human capital, avoids significant leakages to the non-poor, and has a credible mechanism to assess its progress and impact. 5. Conclusions There are four main organizations that provide data on poverty and inequality in Brazil: the Economic Commission for Latin America and the Caribbean (ECLAC), the World Bank, the Socio-Economic Database for Latin America and the Caribbean (SEDLAC), and a Brazilian governmental agency, the Instituto de Pesquisa Econômica Aplicada (IPEA). All of them use micro-data from an income-based household survey called the Pesquisa Nacional por Amostra de Domicílios (PNAD) that is completed nearly every year by the Brazilian government’s Institute of 42

Barros et al., “Markets,” 134-174. 43

Geography and Statistics (IBGE). Data from the four organizations for the period 1985-2007 often showed discrepancies, both in the levels of poverty and inequality and in their trends over time. The inconsistencies in magnitude were often the result of different methodologies used to choose a poverty line, adjust for adult equivalence, adjust for economies of scale, compensate for missing and zero incomes, and handle income misreporting. For example, SEDLAC’s method to adjust for adult equivalence and economies of scale and the World Bank’s downscaling of income by a marginal propensity to consume likely both contribute to the World Bank’s higher values for poverty (despite using the same poverty line as SEDLAC). During the crisis of 1990-1992, there are many inconsistencies in the trends of poverty. For example, the extreme poverty headcount ratio decreased according to the World Bank, increased according to SEDLAC, and did not change according to IPEA. In addition, the evolution of urban poverty during the crisis is inconsistent across sources: ECLAC shows a decrease in urban poverty while SEDLAC shows an increase. Determining the underlying factors behind these discrepancies will require further research. Since 2001, both poverty and inequality have been decreasing in Brazil according to all four data sources. The program Bolsa Família has contributed substantially to the recent reduction of poverty and inequality in Brazil. Since it is a well-targeted, progressive program without significant leakages to the non-poor, maintaining (and ideally expanding) the program should continue to have a direct impact on poverty and income inequality in a country notorious for its vast favelas and high levels of inequity.

Bibliography Barros, Ricardo, Mirela de Carvalho, Samuel Franco, and Rosane Mendonça. “Markets, the State and the Dynamics of Inequality in Brazil.” In Declining Inequality in Latin America: a Decade of Progress?, edited by Luis F. López-Calva and Nora Lustig, 134174. Washington, D.C.: Brookings Institution Press, 2010. Barros, Ricardo, Samir Cury, and Gabriel Ulyssea. “A Desigualdade de Renda no Brasil Encontra-se Subestimada? Uma Análise Comparativa Usando PNAD, POF, e Contas Nacionais.” In Desigualdade de Renda no Brasil: uma Análise da Queda Recente, edited by Ricardo Barros, Miguel Foguel, and Gabriel Ulyssea, 237-273. Brasilia: Instituto de Pesquisa Econômica Aplicada, 2007. 44

CEDLAS (Centro de Estudios Distributivos, Laborales y Sociales) and World Bank. “A Guide to the SEDLAC Socio-Economic Database for Latin America and the Caribbean.” Accessed October, 2009. sedlac/pdfs/guide_sedlac .pdf Chen, Shaohua, and Martin Ravallion. “The Developing World Is Poorer Than We Thought, But No Less Successful in the Fight against Poverty.” The Quarterly Journal of Economics 125, no. 4 (2010): 1577-1625. Coudouel, Aline, Jesko S. Hentschel, and Quentin T. Wodon. “Poverty Measurement and Analysis.” In A Sourcebook for Poverty Reduction Strategies Volume 1: Core Techniques and CrossCutting Issues, edited by Jeni Klugman, 27-74. Washington, D.C.: World Bank, 2002. ECLAC (Economic Commission for Latin America and the Carribean). “Social Indicators and Statistics: Poverty and Income Distribution: Population Living below the Poverty and Extreme Poverty Lines, by Urban and Rural Areas.” Technical note. Accessed October, 2009. cepalstat.asp?carpeta=estadisticas&idioma=i. Elbers, Chris, Jean O. Lanjouw, Peter Lanjouw, and Phillippe G. Leite. “Poverty and Inequality in Brazil: New Estimates from Combined PPV-PNAD Data.” In Inequality and Economic Development in Brazil, edited by Carlos Eduardo Vélez, Ricardo Barros, and Francisco H.G. Ferreira, 81-104. Washington, D.C.: World Bank, 2004. Ferreira, Francisco H. G., Phillippe G. Leite, and Julie A. Litchfield. “The Rise and Fall of Brazilian Inequality: 1981-2004.” Macroeconomic Dynamics 12, supplement 2 (2008): 199-230. Gasparini, Leonardo. “Different Lives: Inequality in Latin America.” In Inequality in Latin America: Breaking with History?, edited by David de Ferranti, Guillermo E. Perry, Francisco H. G. Ferreira, and Michael Walton, 35-76. Washington, D.C.: World Bank, 2004. IPEA (Instituto de Pesquisa Econômica Aplicada). “Metodologia na Determinação das Linhas de Pobreza e Indigencia (por Insuficiencia no Consumo de Calorías por Dia).” Technical note. Accessed November, 2009. MDS (Ministério do Desenvolvimento Social e Combate à Fome). “Bolsa Família.” Accessed December, 2009. http://www.mds. 45 Soares, Sergei, and Natália Sátyro. “O Programa Bolsa Família: Desenho Institucional, Impactos e Possibilidades Futuras.” IPEA Textos Para Discussão, no. 1424 (2009): 8-10. Soares, Sergei, Rafael Guerreiro Osório, Fábio Veras Soares, Marcelo Medeiros, and Eduardo Zepeda. “Conditional Cash Transfers in Brazil, Chile and Mexico: Impacts upon Inequality.” Estudios Económicos Special Issue (2009): 207-224. Székely, Miguel and Marianne Hilgert. “What’s Behind the Inequality We Measure? An Investigation Using Latin American Data.” Oxford Development Studies 35, no. 2 (2007): 197-217. Székely, Miguel, Nora Lustig, Martín Cumpa, and José Antonio Mejía. “Do We Know how much Poverty there is?” Oxford Development Studies 32, no. 4 (2004): 523-558. World Bank. “World Development Indicators.” Accessed December, 2009. do?Step=12&id=4&CNO=2.


In the Name of National Security Brennan Foxman The Problem September 11, 2001 was not the beginning of the War on Terror. Indeed, America has been fighting terrorism and terrorist activity for over thirty years, from the Beirut bombing to the attack on the USS Cole. Over the course of this new-aged battle, the United States has been struggling with the proper balance between national security and our civil liberties. This struggle became exponentially more complicated after the 9/11 attacks and ensuing deaths of nearly 3,000 Americans. Consequently, both American foreign and domestic policy has included provisions that challenge our Constitutional rights and freedoms in the name of national security. This problem presents an interesting challenge for the court system. On the one hand, the courts must face the fact that we are at war with not only an enemy but also an ideology. Ruling against all violations of our civil liberties will inhibit the tools that law enforcement need in order to combat terrorism and keep our country safe. On the other hand, the courts must also keep protecting our Constitutional rights their primary objective. Regardless of the threat level, the courts have a history of protecting our rights, particularly our First Amendment rights to freedom of speech and association. It is in this atmosphere in which the Roberts Court ruled on the Antiterrorism and Effective Death Penalty Act (AEDPA) and the Humanitarian Law Project on June 21, 2010. The Case In 1996, the Antiterrorism and Effective Death Penalty Act stipulated that, “it is a federal crime to knowingly provide material support or resources to a terrorist organization.”1 Expanded upon, the term “material support” means any property or service, tangible or intangible, excluding the exchange of medicine or religious materials. This includes monetary instruments, expert advice, communication equipment, facilities, weapons, personnel, training, or safe houses. Over the course of its history, the definition of “material support” has been narrowed down to clarify that a violation of this law requires the knowledge of the groups designation as a terrorist organization and to specifically address the definitions of the 1 Antiterrorism and Effective Death Penalty Act, codified at U.S. Code 18 (1996 & Supp. 2005), § 2339. 47

words “training”, “expert advice or assistance”, and “personnel”.2 In addition, the designation of a group as a terrorist organization lies with the Secretary of State. The Humanitarian Law Project has been battling this law for over 12 years in the District Court of Los Angeles, the Court of Appeals in the 9th Circuit, and finally the Supreme Court. The issue revolves around two groups designated as foreign terrorist organizations, the Kurdistan Workers Party (PKK) and the Liberation Tigers of Tamil Eelam (LTTE). Although both groups are designated as terrorist organizations, they both have peaceful and nonviolent aspects of their organizations for which the Humanitarian Law Project wishes to assist or aid.3 For example, American Tamal doctors who are amongst the plaintiffs wish to return to Sri Lanka and provide medical assistance and infrastructure to the areas devastated by the tsunami. The Humanitarian Law Project focused on challenging the material support statute at two basic levels. First, the AEDPA violated their freedom of speech and association under the First Amendment because it made it illegal to provide “material support” to the PKK and LTTE and it did not put the burden on the government to prove that the plaintiffs wished to further the group’s unlawful activities. Second, they claimed that the statute was unconstitutionally vague.4 On June 21, 2010 Chief Justice Roberts delivered the opinion of the Court. In terms of its vagueness, the Court explains that the law does not violate the Due Process Clause of the 5th Amendment. The plaintiffs do not argue that the material support statute awards too much discretion to the federal government; therefore the only challenge would be whether the statute “provides a person of ordinary intelligence fair notice of what is prohibited.”5 The Court believes that Congress specifically added more detailed definitions of terms to increase the clarity and therefore reduced the potential vagueness. In terms of this specific case, the actions of the plaintiff are clearly addressed by the statute. They wish to conduct activities that fall within the realm of “training” and “expert advice”. Even though the plaintiffs try to challenge the law based on hypothetical situations, the Court did not rule on such questions and only applied the law to this specific case. 2 § 2339A(b)(2) 3 “Holder v. Humanitarian Law Project,” Center For Constitutional Rights, (accessed November 12, 2010). Humanitarian Law Project v. Holder. 561 U.S. ___(2010) 4 5 Williams, 553 U.S., at 304. (2008) 48

Consequently, the challenge of vagueness was automatically discredited. In addition, some of the activities in which the plaintiffs which to engage in, including “political advocacy”, are entirely legal under the revisions of the material support statute. In order to violate the “personnel” section of the law, one must work “under that terrorist organization’s direction or control.”6 In terms of independent advocacy, the law does not apply. The final question then rested with the supposed restrictions on speech and the infringement on the First Amendment rights to freedom of speech. The Humanitarian Law Project claimed that Congress had banned their pure political speech. The government, on the other hand, wished to argue that the AEDPA only limits conduct, not speech, and therefore the courts should implement intermediate scrutiny. This level of scrutiny implies that “…a content-neutral regulation will be sustained under the First Amendment if it advances important governmental interests unrelated to the suppression of free speech and does not burden substantially more speech than necessary to further those interests.”7 The Court disagreed with applying the O’Brien Test because the AEDPA regulates the plaintiff’s speech on the basis of its content. That is to say, the law outlaws certain types of speech based on the content that is in question. O’Brien is a lenient standard the Court uses if the content being regulated by the government is neutral. This not being the case, the Court applied a “more demanding standard” on the government based on Texas v. Johnson.8 The Court further contended that the government is justified in their actions, despite the stricter scrutiny, because it does in fact serve a compelling government interest. Although the plaintiffs argued that they wish to advance strictly the nonviolent activities of these organizations, the Court concluded that there is strong evidence that these groups do not adequately separate their violent and non-violent activities. For example, Hamas uses money from charitable organizations to fund their terrorist operations. This information was taken from congressional and executive views on the subject and the Court deferred to their advice due to their own lack of expertise in foreign affairs and national security. 9 In terms of a conclusive answer as to the constitutionality of the AEDPA, the Court made no overarching opinions. They refused to rule on 6 § 2339B(h). 7 United States v. O’Brien, 391 U.S. 367, 377. (1968) Texas v. Johnson, 491 U.S. 397, 403. (1989) 8 9 Humanitarian Law Project v. Holder, 08-1498 Reporter of Decisions (BNA) (June 21, 2010), 08-1498. pdf (accessed November 19, 2010). Pg 24. 49

hypothetical situations that were brought up by the plaintiffs and instead focused specifically on the actual actions conducted. Furthermore, the Court remarked that this ruling would not rule out any future cases on the AEDPA in terms of free speech or advocacy. As a result, it is unclear whether or not the Court believed there could be instances in which the law violated the First Amendment. The dissenting justices, Breyer, Ginsburg, and Sotomayor, agreed with the majority opinion that the law was not unconstitutionally vague. However, they disagreed with the notion that the government has showed that the restrictions of speech serve their compelling interest. The dissent pointed out that this type of speech in which the plaintiffs wish to engage in, political and peaceful speech, usually receives the strongest protection under the First Amendment.10 Furthermore, the law prohibits providing “personnel” to an organization designated to be a terrorist organization. The Court has previously shown that that association, regardless of its specific role, is protected by the First Amendment.11 The dissenting justices believe that association with a group, regardless of the group’s unlawful activities, does not automatically assume the same guilt. The dissenting opinion ceded the fact that the government had a compelling interest, our national security, in implementing the AEDPA. They argued, however, with the notion that restricting the plaintiff’s specific form of speech would somehow render us “less secure”. The dissenters were not convinced with the justifications of the government and therefor believe that the restrictions on the plaintiff’s speech are not consistent with the First Amendment to the constitution. Unavoidable Reality: Although the courts have usually erred on the side of protecting speech even during wartime, it is important to understand that the founding fathers understood that, above all else, the government’s main objective was national security. Even during the debate over the ratification of the Constitution, Alexander Hamilton remarked, “the principle purposes of the newly created federal government was the common defense of the members; the preservation of the public peace as well against internal convulsions as external attacks.”12 Most of his peers agreed, arguing that the powers of government to protect the people must exist without limitation. George Washington too, during his inaugural address, stated, 10 11 12 50

New York Times Co. v Sullivan, 376 U.S. 254, 269 (1964) NAACP v. Claiborne Hardware Co., 458 U.S. 866, 911 (1982) THE FEDERALIST NO. 23, 153 (Alexander Hamilton)

“To be prepared for war is one of the most effectual means of preserving peace.”13 This being said, national security has always been regarded as one of the most fundamental elements of our nation. The Court obviously agreed in Humanitarian Law, stating that national security concerns are high enough to warrant restrictions on speech and association. One of the main grievances used by the plaintiffs, however, was the desire to provide “material support”, including money and financial help, to organizations for their humanitarian and charitable means. The Court addressed this issue. Due to the fact that money is fungible, terrorist organizations often use this to their advantage. It is a well-known fact that terrorist groups often conceal their violent activities behind political, charitable, or social fronts. Al Qaeda, for example, began to use charitable operations to fund their terrorist activities in the late 1990s. They would install terrorists into leadership positions at various charitable organizations and funnel money into their operations.14 Groups like the LTTE, Hamas and the PKK use “legitimate” organizations such as charitable foundations in order to “train, fund, and dispatch suicide bombers to attack civilian targets.”15 It is exactly this blurred line between legitimate and illegitimate activity that forced the Court to rule in favor of the Government in Humanitarian Law. In theory, advancing or contributing to a group’s nonviolent and legal activities would be constitutionally protected. However, these groups manipulate all aspects of their organization to benefit their illegal and violent aims. In addition, the Government took particular care in the creation of the AEDPA and the revisions in the Patriot Act in an attempt to avoid constitutional issues. Accordingly, the Court acknowledged this special care. The Government allows for advocacy, the basic pillar in our freedom of speech, and membership, the basic tenant of our freedom of association. They only seek to limit specific forms of speech and membership that will cause a heightened level of national security to our immediate national interests. The Court believed in the reasoning and justifications provided by the government. It is in this atmosphere that they ruled that 13 Lawrence B. Evans, Writings of George Washington (Knickerbocker Press, 1908). Pg 329. 14 Zachary Abuza, Terrorist Financing, GAO Report. (December 2003). 15 Matthew Levitt, Hamas Politics, Charity, and Terrorism in the Service of Jihad, (Yale University Press 2006). 51

national security, in this specific case, trumps the right to speech and certain association under the First Amendment of the Constitution. History Revisited: One of the main supporters of the plaintiffs was The Victims of the McCarthy Era, a group of individuals who had family members who were persecuted by McCarthy and the American Government. Naturally, this group sympathized with the plaintiffs because they felt political speech and association was being silenced much like it was during the Red Scare. They provided an Amicus Curiae brief on behalf of the Humanitarian Law Project in which they made several correlations between this case and previous ones in an attempt to draw distinctions and conclusions. Two of which are very important to this case and shed light onto whether or not the Court made a consistent and correct ruling in Humanitarian Law. The Victims of the McCarthy Era tried to draw correlations between the AEDPA and the Smith Act, which made it a crime to “advocate, advise, teach, or publish material espousing the duty, necessity, desirability, or propriety of overthrowing or destroying the government of the United States.” In addition and most importantly, the Act also made it a crime to become a member of, or affiliated with, any group espousing these same beliefs.16 In essence, the law infringed on the right of association granted by the First Amendment. The Court ruled on the Smith Act in 1961 in Scales v. United States and sternly declared in favor of the right to association and against the Membership Clause of the Smith Act. They outlined two very important limitations on the government; (1) blanket prohibitions on association with groups that have legitimate and unlawful practices is unconstitutional and (2) it is also unconstitutional to impose criminal sanctions on individuals who do not specifically intend to further a groups illicit aims.17 In terms of Humanitarian Law Project v. Holder, the Court responded to certain aspects of Scales and rejected others. The Court ruled that the AEDPA did not outlaw independent advocacy and it was therefore not restricting independent association; the plaintiffs were free to advocate for terrorist groups without facing criminal punishment. The Court also made an attempt to rationalize their decision with the 2nd limitation of Scales by claiming that although, under normal circumstances, criminal sanctions for individuals not involved in criminal activity would 16 17 52

Alien Registration Act, codified at U.S. Code 18 (1940), § 2385. Scales v. United States, 367 U.S. 203 (1961)

not be allowed. This case is different because the groups in question do not distinguish between their illegal and legal activities. As a result, the Court felt that this precondition would not apply because legal aspects of a terrorist organization could often be used to manipulate or advance their illegal aims. However, the 1st limitation outlined in Scales presents a far more interesting dilemma for the Humanitarian Law case. The Court addresses independent advocacy and association, but makes little justification for AEDPA in regards to the first limitation set out in Scales. The Court explains that membership is not a criminal activity, but rather providing “material support”. These two conditions, however, are not readily distinguishable. For example, the word “personnel” can be translated into a variety of other terms, including laborer, staff, employ, or worker. All of these definitions imply that joining an organization at any level above just a “member” is illegal under AEDPA. The Court does not address this issue but instead claims membership is legal under AEDPA and therefore presents no constitutional problem with the First Amendment right to association and precedent laid out in Scales. They also try to use national security as justification for the restrictions on association but make no reference to the fact that national security was invoked during the Scales case and failed. In fact, the Court specifically addressed the relationship between limitations on speech and association and national security in United States v. Robel. “The concept of national defense cannot be deemed an end in itself, justifying any exercise of legislative power designed to promote such a goal. Implicit in the term national defense is the notion of defending those values and ideals which set this nation apart…It would be ironic if, in the name of national defense, we would sanction the subversion of one of those liberties—the freedom of association—which makes the defense of the Nation worthwhile.”18 This glaring defense of wartime rights, particularly the right to association by way of “personnel” and “material support”, was not only ignored but also arguably contradicted by Humanitarian Law. An almost identical correlation between the Scales and Humanitarian Law exists in which the Court decided in the latter to put the burden on the government to provide a compelling reason for the abridgement of such rights. Even in the face of a serious communist threat, the Court refused to allow the government to use this as a justification. This Court, however, was 18

United States v. Robel, 389 U.S., 263-64 (1967) 53

presented with a far less serious national security threat, yet allowed the government to essentially prohibit the right of association by means of “material support” between American citizens and terrorist organizations. Both Scales and Robel allow us to view the 2010 case differently. In both cases, the Court decided that the government would need to make a compelling case for national security in order to limit our First Amendment freedoms. In addition, the presence of such cases does not automatically mean our rights should be forfeited either. In Humanitarian Law, however, the Court often deferred to the government’s advice and recommendations in assessing the threat level of these organizations. In particular, the Court stated that respect for the government’s factual conclusions is necessary due to the Court’s lack of expertise and knowledge in regards to foreign affairs and national security. This, however, was clearly not the precedent. In fact, the government used extremely strong language in Robel, stating that Communism “can no longer be viewed passively as a group of mere political and ideological dissidents, but must be looked upon with all seriousness as a military fifth column actively aiding our enemies.”19 Despite this, the Court stood its ground and ruled that even this was not compelling enough to abridge the rights of association. They did not defer to the government’s superior knowledge of the situation like the Court did in Humanitarian Law. Perspective: The War on Terror Since the Court decided that the government had provided a compelling interest, our national security, it seems important to discuss this interest in the context of our nation’s history in terms of war and national security. Specifically, it is imperative that we explore the role of free speech and association during wartime in an attempt to understand the legitimacy and necessity of restricting it in the War on Terror. Sanford Levinson, a professor of law at The University of Texas, stated that, “It is difficult to read our constitutional history … without believing that the Constitution is often reduced at best to a whisper during times of war.”20 Most people would agree that, over the course of our nation’s brief history, we have developed a tendency to abandon our core values during times of war. But Humanitarian Law Project v. Holder, a case entirely dependent on the government’s ability to prove that our 19 Government brief at pg. 22, United States v. Robel, 389 U.S., 263-64 (1967) 20 Sanford Levinson, “What is the Constitution’s Role in Wartime? Why Free Speech and Other Rights Are Not As Safe As You Might Think,” Findlaw (Oct. 17, 2001). 54

national security interests trump our civil liberties, asks us to investigate exactly how this war and this specific law stack up against previous threat levels and subsequent policy initiatives that quash our basic civil liberties. Certainly advocates of the AEDPA can point to the Civil War for examples of wartime legislation that disrupted civil liberties. Lincoln, for example, suspended habeas corpus, seized telegraph lines and railroads, and even arrested people for singing Confederate songs.21 The First World War was also a moment of great governmental intrusion on our liberties. World War I witnessed the Espionage Act of 1917, a legislative assault on first amendment freedoms that allowed for the suppression of all materials and speech that were seen as disloyal.22 World War II also had its own infringements. Amongst these were the outrageous Japanese internment camps and the censorship of all news by President Roosevelt following the Pearl Harbor Attacks.23 And, as previously discussed, the Cold War had its own set of daunting and invasive attacks on the First Amendment’s freedom of speech and association. All of this considered, however, it is important to draw distinctions between our previous national security crises and the one we are experiencing today. How does the War on Terror stack up? In short, it does not stack up too well. The Civil War resulted in the deaths of over 300,000 Americans. The country was ravaged from top to bottom and suffered for decades in recovery. The two World Wars combined for nearly half a million American casualties. And, even though the country suffered no direct deaths in combat with the Soviet Union, proxy wars were waged in both Korea and Vietnam that cost America over 100,000 casualties. 24 In addition, the Cold War brought on the possibility of nuclear war with the Soviet Union, which could have resulted in the complete destruction of our nation. Despite all of this, the courts throughout these conflicts still made attempts to defend our civil liberties. United States v. Robel is an example in which the government showed a compelling interest, our national security, yet was restrained by the Supreme Court. In Humanitarian Law, 21 Michael Linfield, Freedom Under Fire: U.S. Civil Liberties in Times of War (Boston: South End Press, 1990), p. 2. 22 Paul Murphy, World War I and the Origin of Civil Liberties (New York: W. W. Norton & Company, Inc., 1979), p. 69. 23 Korematsu v. United States, 323 U.S. 214 (1944). 24 R Lee. “The History Guy: Casualties From America’s Wars” http://www. 55

however, the Court deferred to the government’s assessment of the threat to national security in order to justify its restrictions on speech. In context, however, this threat level is extremely overdramatized. Notwithstanding all the hype and chatter over the lengthy amount of time in both Afghanistan and Iraq, American forces have suffered around 6,000 deaths, a number strikingly low compared to the hundreds of thousands of deaths that resulted from other previous wars. In addition, the domestic security threat as a result of terrorist activity has been highly overdramatized as well. Over the past ten years, a little over 3,000 civilian lives have been lost due to terrorist attacks, nearly all of which came from the September 11th attacks on the World Trade Center.25 In fact, the likelihood of getting killed by a terrorist attack, which is estimated to be between 1/80,000 and 1/110,000, is similar to the probability of getting killed by an asteroid.26 Certainly, given this statistic, it seems unreasonable that the Court would deem the threat level during the War on Terror as high enough to warrant governmental intrusions on our First Amendment liberties, especially considering the precedent of previous courts’ ruling in defense of individual liberties during periods of more serious national security threats. And what of our enemy? Surely if national security is to be used to justify an infringement on our First Amendment rights we must be facing an enemy so powerful that merely giving “expert advice” to such a group would jeopardize our national security interests. The problem is that our enemy, Al Qaeda, has only about 100 fighters in all of Afghanistan27. The Court essentially decided that the War on Terror presents a more urgent national security crisis then the Cold War (considering the decision in Robel and that of Humanitarian Law), yet our enemy is no bigger than a mid-size law firm. Again, the Court neglected to put the War on Terror into context in making its decision. Some Problems Arise The Court clearly stipulated the government has the right to implement the AEDPA as it relates to the Humanitarian Law Project and its activities. Having said this, certain situations that are illegal under the 25 “9 Years Later, Nearly 900 9/11 Responders Have Died, Survivors Fight for Compensation”. FOX News. September 11, 2010. 26 John Mueller, Atomic Obsession (New York: Oxford University Press, 2010), 181-201. 27 Richard Esposito, “President Obama’s Secret ,” ABC News , December 2, 2009, 56

AEDPA are worth exploring and discussing in an attempt to understand the Court’s decision. For example, the Court declared that association by way of providing “personnel” to a group that is designated a terrorist organization is illegal because there is no definitive line between the group’s illegal and legal means. Assume, for arguments sake, that we ignore the precedent laid out in Scales or Robel. Amongst the groups of plaintiffs represented by the Humanitarian Law Project were physicians and other humanitarian groups who wished to work with the LTTE in Sri Lanka. This group is designing as one of the terrorist organizations on the U.S. Department of State’s list of Foreign Terrorist Organizations. In fairness, this group has shown extensive amounts of terrorist activity over the past several decades. They carried out assassinations, bombings, and kidnappings in an attempt to gain independence from Sri Lanka. The problem, however, is the fact that this group has controlled vast amounts of territory in the Northern Sri Lanka. In fact, the LTTE served as a functioning government in a vast region in Sri Lanka for an extensive period of time.28 This region controlled by the LTTE was home to thousands of Sri Lankans that were devastated by not only civil war, but also the tsunami in December of 2004. These citizens, however, were deprived of American humanitarian aid and assistance because of the AEDPA and its ban on “material support” for the LTTE. Despite efforts of physicians and humanitarian groups to help the people of northeastern Sri Lanka, these individuals were not allowed to receive our aid due to the fact that they would be providing personnel for the LTTE, a designated terrorist organization. The Court was able to ignore this situation because the LTTE surrendered to the Sri Lankan government in 2009. As a result, the Court assumed that this situation was no longer applicable and therefore did not rule on the parties in regards to the Liberation Tigers of Tamil Eelam. However, the concept of a ruling organization that is both the functioning government of a specific population and a supposed terrorist organization is left unresolved. The Court clearly asserted that working in a subordinate position to a terrorist organization is illegal but did not make this ruling in a case involved a governing organization. This being the case, it would seem unlikely that the government could provide a “compelling” reason for why speech and association, in terms of working to help a 28 “Holder v. Humanitarian Law Project,” Center For Constitutional Rights, (accessed November 12, 2010). 57

population recover from a natural disaster, under the auspices of a “terrorist organization”, should be restricted. Although it would seem that such a scenario is highly unlikely, there are several examples that present serious legal and moral consequences. Take, for example, Hamas, which is the governing party of Gaza and a terrorist organization according to the State Department. With somewhere between two and five million American Muslims, many of our citizens are restricted from providing personnel to Hamas, even if it is to advance their non-violent objectives. If the government would allow this participation, assuming the activists wished to advance only the legal and nonviolent means of Hamas, there is a possibility that this association and speech alone would have a positive impact on Hamas as a whole. Historical evidence supports this claim as well. Groups such as the PLO and Fatah had strong histories of terrorist activity. These organizations were once seen as serious threats to American national security as well as the security of our allies, including Israel. As time evolved, however, participation and personnel changes in these organizations began to diversify and varying opinions began to emerge on the representative stages, respectively. The PLO and Fatah both experienced conversions from terrorist organizations into recognized representative bodies as they changed their ways and adapted to both external and internal pressures.29 This being the case, inhibiting participation in these organizations, specifically association and speech that only advances nonviolent and legal practices, would be depriving the opportunity for these groups to convert themselves into legitimate organizations. Therefore the issue presents two distinct moral and practical problems for America. First, the ban on association and speech as it pertains to the plaintiffs and the AEDPA (personnel and material support) has the possible effect of depriving innocent civilians of much needed aid and resources that are entirely independent of their governing organization. Second, the ban on speech and association in the AEDPA effectively eliminates the opportunity for American citizens to try and internally advance the nonviolent goals of a terrorist organization. Such internal advancements, which could possibly convert an organization into a law abiding and legitimate group and effectively lower the threat level posed to the United States, are impossible to achieve under the AEDPA. 29 “Fatah faces reform crossroads”. BBC. News. 2005. 58

Governmental Power Stretched Too Far? Another main concern with the ruling is the power granted to the State Department in deciding which group(s) should be designated a terrorist organization. The legal criteria for such a designation is quite simple; the group must (1) be a foreign organization, (2) it must engage in terrorist activity as defined in section 212(a)(3)(b) of the INA30, and it must (3) threaten the national security of the United States. If these conditions are met, the State Department can designate a group as a terrorist organization with a seven-day review period by Congress.31 This loose set of guidelines provides for a wide-range of leeway for the State Department. Furthermore, the Government could classify a group as a terrorist organization in a direct effort to inhibit the group’s speech. This would also mean that, under the AEDPA, providing personnel to this organization would be a criminal act. In essence, the State Department could use this channel of classification to inhibit the civil liberties of previously protected organizations. What group would the Government try to dismantle purely to inhibit their speech? One answer is a relatively new and extremely controversial organization, Wikileaks. The Court has traditionally protected the press, even in times of national security crisis.32 33 But the Humanitarian Law ruling could allow for organizations such as Wikileaks to be silenced if the government deems them a terrorist organization. Granted, the definition of a terrorist group is quite specific. Wikileaks does not seem to be in violation of any of the criteria for such a distinction, but the government nonetheless has the ability to classify them as such. Even prominent members of Congress openly support this designation, including Congressman Peter King of New York, the next Chairman of the House Homeland Security Committee.34 Although this scenario is unlikely to play out for both legal and political reasons, it still raises interesting questions as to the scope and power of the AEDPA, which is now reinforced with the Humanitarian Law 30 Immigration and Nationality Act, codified at U.S. Code 8 (1996) §1182(a)(3)(B) 31 Antiterrorism and Effective Death Penalty Act, codified at U.S. Code 18 (1996 & Supp. 2005), § 2339. 32 Near v. Minnesota, 283 U.S. 697 (1931) 33 New York Times Co. v Sullivan, 376 U.S. 254, 269 (1964) 34 Max Fisher, “Is Wikileaks a Terrorist Organization ?” The Atlantic Wire, November 30, 2010, view/opinion/IsWikiLeaks-a-Terrorist-Organization-5978 59

decision. In this case, the power of the State Department was well understood by the Court, but the Court made no remarks as to the extent or scope of its application. In fact, the Court deferred to the Government’s expert advice in matters of national security and stated that they must do so considering the Court’s lack of expertise. It is seemingly clear then that the Court could not, in a future case, challenge the power or expertise of the State Department to classify a group or organization as a terrorist organization. That being said, if Wikileaks were to legally fit within the confines of a terrorist organization, the State Department would have full ability to classify them as such, regardless of the organization’s otherwise protected rights to free press. Concern over Impartiality Humanitarian Law v. Holder presents us with an interesting historical parallel in which outside influences, including public opinion, fear, and political pressure influence the Court into a specific decision. Korematsu v. United States also shared similar circumstances and outcomes to the 2010 decision and both cases resulted in the Supreme Court siding with the government, despite a level of “strict scrutiny”. In Korematsu, the Court held that Executive Order 9066, which provided for the internment of all Japanese Americans, was constitutional35. This ruling also received a level of “strict scrutiny” but nonetheless sided with the Government. Both Korematsu and Humanitarian were entirely dependent on the perceived threat levels presented to the Court at the time of the case. And, in both cases, the Court ruled that restrictions on basic civil liberties were permissible because of national security concerns. These concerns, however, can be manipulated, distorted, and overdramatized by all parties. Both cases straddle the border between the Court’s sense of impartiality and individual levels of emotions. The decisions both would have resulted in different outcomes if, for example, the Justices were under the impression that the threat level was not high enough to warrant such governmental actions. Consequently, the media and “expert” influences in the case have an unprecedented amount of power over the outcome. In essence, the liberties of the plaintiffs, including the freedoms of speech and association, are entirely dependent on the ability of either side to persuade the Justices of the threat level of such actions. We need not look further then the dissenting opinions of Justices Breyer, Ginsburg, and Sotomayor. The dissent, above all else, was simply 35 60

Korematsu v. United States, 323 U.S. 214 (1944)

not convinced by the Government as to the correlation between speech and association of the plaintiffs and a higher level of insecurity. They based their dissent on the fact that the government did not prove a “compelling interest” in limiting these forms of speech and association. As a result, the dissenting Justices felt that the AEDPA, as applied to the case of the plaintiffs, was unconstitutional. To be differentiated from most cases, the dissenting justices and the majority agreed on virtually all aspects of the case. They diverged, however, simply because they experienced different levels of persuasion by the Government. It is hard to accept the fact that our civil liberties and Constitutional rights depend on factors independent of the law. Indeed, the security of these rights rests with the ability of Justices to find the true correlation between national security concerns and our freedoms of association and speech. We live in a world where media outlets depend on over-dramatizing content to boost profits and politicians hype up threat levels for political gains. It is hard to imagine that a group of Justices could sort through all the hype and hysteria to find the truth. Until then, unfortunately, we continue to live in a country that will occasionally truncate our civil liberties in the name of national security. Where Do We Stand Now? The Humanitarian Law ruling has a distinct effect on where we stand now as well as where we are going. The ruling was particularly interesting because it was one of the rare instances in which the Court ruled in favor of the Government, despite a policy of “strict scrutiny”. Nevertheless, the decision has numerous implications in terms of its scope as well as its own limitations. It is interesting to note that the plaintiffs believed that they would not only win, but that the Court would also rule even more broadly on the issue and state that Congress cannot make a person liable for the criminal acts of others.36 It is fascinating that, although the Humanitarian Law Project lost this case, they essentially won on many issues. For example, the group wished to advocate on behalf of the LTTE and PKK and this request was determined by the Court to be outside the limits of the AEDPA and very much legal. In addition, the group wished to argue that they had a right to membership within these groups. The Court agreed, but clarified that the AEDPA does not restrict mere membership in a group. Both of these is36 “Holder v. Humanitarian Law Project,” Center For Constitutional Rights, (accessed November 12, 2010). 61

sues were key points in the plaintiffs’ case and were ruled legal by being outside the confines of the law. That being the case, the decision in favor of the Government has broad repercussions as well as unanswered questions. First, the Government can assume they have the power to limit civil liberties, to an extent, as long as they can keep the public and courts in a constant state of fear and insecurity. The AEDPA was reinforced by the Patriot Act, a behemoth piece of legislation passed in 2001 that simultaneously increased the power of the federal government and decreased the rights of American citizens. This legislation allowed for extended wiretapping, seizure of mail and messages, and searches with delayed warrants.37 All of these components have previously been outlawed due to various infringements on civil liberties, but the Government enjoys protection because of a heightened level of national security. To be fair, the courts have also struck some measures of Patriot Act down as being unconstitutional, regardless of the level of national security. For example, in 2004 a federal judge in New York ruled that a key component of the USA Patriot Act was unconstitutional because it gave the FBI the power to demand information from Internet service providers without judicial oversight. She emphasized that the provision “effectively bars or substantially deters any judicial challenge” and violates freespeech rights by imposing permanent silence on targeted companies.38 Similar cases have appeared since 2001 and have shown that the courts are not entirely willing to rationalize governmental intrusion in the name of national security. Furthermore, the Humanitarian decision implies that, as it pertains to the plaintiffs, the AEDPA does not violate our civil liberties. We are free to advocate, speak, and write about any terrorist organization as we wish. We have the liberty to act on behalf of a terrorist organization and communicate with them as much as we would like. We are also permitted to join an organization as long as we do not provide “material support”. The AEDPA was revised in 2005 to provide narrower definitions of the terms used in the original statute. Consequently, the Court also ruled that AEDPA was not unconstitutionally vague in this case because the desired actions of the plaintiffs fit well within the terms outlined in the law. 37 Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, Public Law 107-56 (October 26, 2001). 38 Dan Eggen, “Key Part of Patriot Act Ruled Unconstitutional,” Washington Post , September 30, 2004, A59626-2004Sep29.html 62

In addition, the ruling implies that certain situations would probably render the AEDPA unconstitutional. For example, the plaintiffs proposed speech and conduct that fall directly within the confines of terms used in the AEDPA, including “personnel” and “training” that provides “expert advice beyond common knowledge”. The Court mentions, however, that if the plaintiffs intended to provide information to these organizations that straddled the border between “common knowledge” and “expert advice” (for instance, geography) then the ruling might have been different. Furthermore, the decision was dependent on the fact that there is no separation between the illegal and legal activities of the group as it pertains to the proposed conduct of the plaintiffs. If, for example, the plaintiffs wished to provide expert advice only to the civilian population living under the rule of a terrorist organization, even if they had membership status in such a group, the Court might have delivered a different ruling. The Court, however, paid close attention to avoid ruling on specific things in the AEDPA. They justified the law with Scales by claiming that membership was not a crime, but made no reference to the term used in the AEDPA, “personnel”, that covers virtually all contributing members of an organization. In addition, the Court avoided ruling on the humanitarian aid to the LTTE by dismissing it all together due to the defeat of the Tigers in 2009. In terms of vagueness, the Court made a very narrow ruling, stating, “...of course, the scope of the material-support statute may not be clear in every application. But the dispositive point here is that the statutory terms are clear in their application to plaintiffs’ proposed conduct.”39 Finally, they qualified the ruling by saying that it has no bearing on future cases or situations involving the constitutionality of the AEDPA. This close tiptoeing around key issues leaves the door wide open for future challenges as well as misinterpretations of the current law. National security will always be at odds with our civil liberties. Over the course of our nation’s history, the Supreme Court has consistently acted as the decider between national security concerns and infringements on our rights as citizens. Now, as in the past, the Court feels that the threat level is high enough to warrant certain intrusions on these rights. Granted, the extents to which our liberties are violated under the AEDPA are mild at best. Most Americans have no interest in providing “material support” or any type of support to a group deemed to be a terrorist organization. Even if someone wished to advance the cause of such 39 Humanitarian Law Project v. Holder, 08-1498 Reporter of Decisions (BNA) (June 21, 2010), 08-1498. pdf (accessed November 19, 2010). Pg 16. 63

a group they would have a vast amount of legal leeway to do so, including membership, advocacy, and participation. Regardless of the scope of the decision, however, it is possible that the Court has relied too heavily on the opinions and influences of the Government. When it comes to decisions regarding restrictions of First Amendment rights, the Supreme Court does not usually defer to the federal government’s “expert” advice. Rather, they assess the situation themselves and provide an impartial ruling. In Humanitarian Law v. Holder, however, the Court decided to rely on the government’s assessment of national security concerns. As a result, we can be sure that the government will continue to over-dramatize threat levels as long as the courts rely on their assessment of national security.


The US-China Bilateral Trade Imbalance Nat Lavin Introduction Over the past 250 years, leading economists have debated extensively on the merits of trade imbalance. Adam Smith thought it
absurd to think that if one nation ends up with a current accounts surplus or deficit, the wealth of the nation has grown or deteriorated by that amount.1 Frederic Bastiat argued that not only were trade deficits not a cause for concern, but that they were a manifestation of profit. He argued that a successful growing economy should hold greater trade deficits, while an unsuccessful economy should have lower deficits.2 Milton Friedman felt that most concerns about trade deficits were unfair and were promoted by domestic exporting industries that would profit from changes in macroeconomic policy. He believed that free markets would fix the trade balance, as a nation’s currency gains value with increased exports and loses value with increased imports, making it harder for a debtor nation to maintain a current accounts deficit.3 However, John Maynard Keynes believed that the trade imbalance ultimately helped contribute to the Great Depression because international lending by the United States due to a current accounts surplus exceeded the capacity of sound investment. According to Keynes, this led to funding being diverted into non-productive and speculative uses which were more prone to default, causes a liquidity crisis and a sudden stop to lending.4 Many contemporary economists will argue similarly that, although the US-China bilateral trade imbalance may not have been a direct cause of the recent financial crisis and recession, it was a contributing factor.5 As we seek to learn from the recent financial crisis, we must first under1 Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. Ed. Edwin Cannan and Max Lerner. Vol. Book 4. New York: Modern Library, 1937. Print. 2 Bastiat, Frederic. Selected Essays on Political Economy. Irvington-onHudson, NY: Foundation for Economic Education, 1848. Library of Economics and Liberty. The Liberty Fund Inc. Web. 03 Dec. 2010. <http://www.econlib. org/library/Bastiat/basEss13.html>. 3 Friedman, Milton, and Rose D. Friedman. Free to Choose: a Personal Statement. New York: Harcourt Brace Jovanovich, 1980. Print. 4 Crowther, Geoffrey. An Outline of Money. London: T. Nelson, 1948. Print. 5 Suominen, Kati. “Did Global Imbalances Cause the Crisis?” Vox EU. VoxEU.Org, 14 June 2010. Web. 03 Dec. 2010. < php?q=node/5175>. 65

stand its underlying causes. In this paper, we will examine the roots and causes (reword “roots and causes”, repetitive) on both the supply and demand sides of the US-China bilateral trade imbalance. This paper is divided into three main sections, followed by a conclusion. First, the paper will examine the roots and causes of the US-China trade imbalance. It will explore the structural and political causes behind the imbalance, as well as the results of the imbalance in both China and the United States. Finally, it will discuss how best to address these problems and how to better balance trade between these two nations. Understanding Trade Imbalance For the purposes of this paper, the United States represents a typical debtor nation, and China represents a typical creditor nation. A trade imbalance occurs when a nation imports more than it exports or exports more than it imports. The funding for this deficit comes from foreign nations investing in the national debt. By buying American debt, creditor nations keep the American dollar strong; as long as the US dollar remains in high demand, a trade deficit can be sustained. If the deficit is not maintained, the dollar devalues. This decreases American imports and increases their exports as their prices become cheaper relative to the currencies of other nations. Additionally, having high net exports raises China’s currency value, decreasing their exports. In this way, trade imbalances are not always an issue because the markets are capable of correcting themselves. The problem with assuming the markets will correct themselves is that it relies on freely floating currencies and a free and open currency market. It is apparent that this is not the case, as governments and central banks are major actors in the currency market, manipulating exchange rates in accordance with monetary policy goals. When trade imbalances are sustained over long periods, it suggests that underlying structural issues in both the national economy and in the international architecture are creating these disturbances. In 1985, the United States ran a trade deficit with China of $6 million. By 1990, the deficit grew to $10.4 billion, and by 2008, the deficit had grown to $268 billion.6 The trade deficit did not shrink until 2009 as imports from China declined at a sharper rate than American exports to China in the wake of the global financial 6 U.S. Census Bureau. “U.S. Trade Balance with China.” Foreign Trade Statistics. U.S. Census Bureau, 10 Nov. 2010. Web. 19 Nov. 2010. <http://www.>. 66

crisis of 2008.7 As global trade dropped 12% in 2009, we can expect this drop to effect imports and exports proportionately. Between 2007 and 2009, we saw global trade imbalances fall 26%.8 The United States’ current account/GDP deficit alone was halved during the crisis, dropping from 6% in 2006 to 3% in 2009.9 This does not reflect a positive trend, as far as the logical mechanical result of the financial crisis’ impact on international trade. Under these conditions, were trade to return to its pre-crisis rates, the imbalance would continue to grow at pre-crisis rates as well. When trade deficits not only maintain but grow, over a 23-year period, it is indicative of underlying structural problems of national economies. Because these issues are structural, the policies that seek to correct them in the long term will need to be more than demand management tools such as tariffs or quotas. According to the Vox EU report on trade imbalance, shifts in expenditure patterns that are large enough to eliminate significant amounts of the current account imbalances will rely on inter-sectoral shifts in resources within economies.10 These shifts in the economy will have significant supply-side effects. Additionally, they must be followed up with incentives for other countries to reduce (the) accumulation of the US Dollar. A powerful tool for rebalancing trade in the United States would be to increase savings. This will reduce demand for imports, although statistics demonstrate that China would be far less affected than other nations that export to the United States. If a sustained or growing imbalance is not indicative of an issue within the structure of an economy, it reveals distorted economic policies. Widely accepted as the cause of the US- China trade imbalance is the undervaluation of Renminbi (RMB).11 When a government rec7 Freund, Caroline. “Adjustment in Global Imbalances and the Future of Trade Growth.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. Print. 8 Ibid 9 Aizenman, Joshua. “On the Causes of Global Imbalances and Their Persistence: Myths, Facts and Conjectures.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 2330. Print. 10 Claessens, Stijn, Simon Evenett, and Bernard Hoekman. “Editors Overview.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 3-9. Print. 11 Williamson, John. “Exchange Rates to Support Global Rebalancing.” Rebalancing the Global Economy: A Primer for Policymaking. Ed. William R. Cline. London: Center for Economic Policy Research, 2010. 77-80. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <http:// 67

ognizes a distortion in the market, it is logical to undertake distorting policies to correct the market imbalance. However, if a natural market balance fails to occur, the policy itself is a distorting factor in the global economy. To gauge the distortion China’s monetary policy is causing, the undervaluation of the RMB was calculated at 30% in January of 2010.12 Current distortions in the market are further discussed in the next section, where we go more in depth into how these problems are affecting the economies of both the United States and China. The trade imbalance has a cyclical relationship with distorting capital flows. The United States has had a trade deficit for 34 years, but the problem significantly worsened in the wake of the Asian financial crisis of the 90’s.13 As a result of the crisis, East Asian countries began consistently running larger current account surpluses, in the hopes that accumulated foreign exchange reserves could help buffer against speculative attacks on their currencies. Because the United States was the largest market for these exports and the dollar is the world’s reserve currency, greater portions of Asian reserves were invested in dollar assets.14 This inflow, in combination with a low interest rate, kept the dollar strong and depressed the value of Asian currencies. This helped make Asian exports more competitive and helped the United States maintain and expand current account deficits. However, these trade imbalances increased the United States’ economy’s vulnerability to international capital flows. These imbalances reflected a global savings glut, which resulted in the underpricing of risk that in turn helped cause the recent global financial crisis. Papers by Bernenke, Obstfeld and Rogoff all credit the global imbalance as an important factor in the severity of the crisis, and state that a more stable financial system must involve more balanced capital flows.15>. 12 Mann, Catherine L. “External Imbalances: Costs and Consequences of Unsustainable Trajectories.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 43-49. Print. 13 U.S. Department of State. “History of the U.S. Trade Deficit.” Economics at About.Com. About.Com. Web. 01 Dec. 2010. < foreigntrade/a/trade_deficit_h.htm>. 14 Lim, Linda Y.C. “Rebalancing in East Asia.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 31-35. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 15 Freund, Caroline. “Adjustment in Global Imbalances and the Future of Trade Growth.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. Print. 68

Another contributing factor to the trade imbalance between the United States and China is the asymmetry in the structure of trade barriers. The United States has mostly liberalized markets, yet China’s service sector, specifically their financial sector, remains heavily protected. Whereas China has a comparative advantage in the production of labor-intensive products such as tradable goods, the United States has a comparative advantage in the production of human capital, or non-tradable goods. The asymmetry in the structure of trade barriers within these two industries leads to the buildup of unsustainable, welfare reducing imbalances.16 The comparative advantage of these two countries in their respective strengths, and the stifling of the United States’ advantage in the service sector by protectionist Chinese policies is a major contributor to the trade imbalance.17 In essence, the problem of trade imbalance is not as simple as overconsumption by the (in the) United States and under-consumption by (in) China. There are numerous structural causes of imbalance within both countries. The dollar is overvalued due in large part to it being the world reserve currency, but also because China invests heavily in US treasury bonds, thereby propping up the value of the dollar while suppressing the value of the Renminbi. Additionally, because the United States’ economy relies more on service based industry, while China’s economy is focused on export-oriented growth, the industries of these nations compete with each other in asymmetrical arenas as these two types of industry face different trade barriers. Now that we understand the basic issues behind the trade imbalance, let us examine the supply-side of this trade imbalance, as well as its causes and effects. Causes and Effects: China Since China’s markets have opened, they have seen unparalleled growth. The Chinese economy has grown by an average of 10% annually, and its poverty rate has dropped from 53% to 2.5% within the last

16 Kowalski, Przemyslaw, and Molly Lesher. “A Commercial Policy Package for Rebalancing the Global Economy?” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 127-37. Print. 17 Kowalski, Przemyslaw, and Molly Lesher. “A Commercial Policy Package for Rebalancing the Global Economy?” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 127-37. Print. 69

30 years.18,19 China’s foreign trade has steadily grown faster than its GDP over the last 25 years. In the second quarter of 2010, China became the second largest economy in the world by GDP at $1.33 trillion.20 In addition, exports composed approximately one-quarter of China’s GDP in 2009, as opposed to approximately 7% in the United States.21 Throughout China’s economic expansion, the government has maintained control of China’s service sector. Most of China’s financial institutions remain state-owned, as are 98% of the nations’ banking assets.22 Although Chinese policy allows and enterprise or individual to obtain loans, over 75% of state bank loans are awarded to state-owned enterprises.23 According to Przemyslaw Kowalski and Molly Lesher of the OECD, this disproportionately large amount of public ownership is indicative inhibitive regulatory barriers in the services sector.24 Ultimately, this failure to liberalize Chinese non-tradables has led to the over development of China’s industrial sector and exports. As a result, the Chinese economy has been over-reliant on exports to promote economic growth. Approximately one-quarter of all Chinese exports are exported to the United States.25 Due to inconsistencies in trade calculation, this number is probably higher as exports routed through 18 Staff, “China’s Economic Growth Eases to 10.3 Percent -” International. CNN, 15 July 2010. Web. 19 Nov. 2010. <>. 19 Poverty Statistics in China. Rural Survey Organization of National Bureau of Statistics, China, Sept. 2006. PDF. 20 “China’s Gross Domestic Product (GDP) Growth.” China Economic and Business News, Statistics and Analysis. Chinability, 27 Dec. 2009. Web. 19 Nov. 2010. <>. 21 Data derived independently based on GDP and export data from the two countries. Raw data was obtained from U.S. Census Bureau. “U.S. Trade Balance with China.” Foreign Trade Statistics. U.S. Census Bureau, 10 Nov. 2010. Web. 19 Nov. 2010. < html>. 22 Chiu, Becky, and Mervyn Lewis. Reforming China’s State-owned Enterprises and Banks. Cheltenham, UK: Edward Elgar Pub., 2006. Print. 23 Ibid 24 Kowalski, Przemyslaw, and Molly Lesher. “A Commercial Policy Package for Rebalancing the Global Economy?” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 127-37. Print. 25 U.S. Census Bureau. “U.S. Trade Balance with China.” Foreign Trade Statistics. U.S. Census Bureau, 10 Nov. 2010. Web. 19 Nov. 2010. <http://www.>. 70

major ports such as Hong Kong or Singapore may be counted as Hong Kong or Singaporean exports. Additionally, goods that are exported from China and then used for manufacturing in other East-Asian economies are exported in large part to the United States.26 In order to keep the US economy consuming Chinese exports, the Chinese government needed to ensure that the United States could sustain a running debt. As a result, the Chinese government has engaged in buying large amounts of American debt. Although reports from the US Treasury indicate that China’s holdings of US Treasury bonds is $883.5 billion these numbers likely understate how much US debt China actually owns.27 MIT economist Simon Johnson reported to Congress in March that “a great deal” of last year’s $170 billion increase in Treasury holdings by the United Kingdom were likely due to “China placing offshore dollars in London-based banks”, using the funds to purchase Treasury debt.28 Figures from the Treasury Department do not reveal the ultimate country of ownership when debt is held through an intermediary in another jurisdiction. Through the acquisition of foreign debt, the People’s Republic of China has kept the currency of importing countries relatively strong. To rephrase this, the PRC has managed to keep the Renminbi undervalued, for economists estimate that the RMB is undervalued by as much as 30%.29 This acts as an export subsidy and furthers the trade imbalance. This negatively affects China’s economy in two ways. First, as China accumulates more American debt, their return on that investment diminishes. Ultimately, it is an inefficient use of funds. Second, since the Chinese economy relies disproportionately on exports, and the current global trade imbalances cannot be maintained, a continuation of this practice could lead to an even greater global economic collapse than the 2008 financial crisis and subsequent recession.30 26 Ibid 27 “Major Foreign Holders of Treasury Securities.” Major Foreign Holders of Treasury Securities. United States Treasury Department, 16 Nov. 2010. Web. 03 Dec. 2010. <>. 28 Staff. “China Holds More U.S. Debt than Indicated.” The Washington Times. The Washington Times, 2 Mar. 2010. Web. 19 Nov. 2010. <http://www.>. 29 Mann, Catherine L. “External Imbalances: Costs and Consequences of Unsustainable Trajectories.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 43-49. Print. 30 Lee, Jong-Wha. “Asia’s Role in Global Rebalancing.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic 71

The law of diminishing returns is a fundamental rule of economics. Applied here, it states that for each unit of debt that China buys from the United States, China will get less benefit out of it. Taking into account that the world economy cannot maintain pre-crisis trade imbalances, and China’s consequent need to shift towards a more service-based economy, we can see a clear negative impact for China in its continued investment in American debt. China currently faces numerous economic problems that must be fixed in order for the country to sustain long term growth. For example, China faces major problems in disparities of wealth. Today, they face their largest disparity since liberalization began, with over half of China’s population holding 12% of its wealth.31 The average income in a Chinese city is over three times the average income in the Chinese countryside. Chinese economists expect this disparity to keep growing as current Chinese investments focus on urban sprawl rather than rural development. By investing in rural development, the Chinese government could mitigate what they openly admit is a “serious threat to social stability”.32 Education and employment are also significant problems in China. In regards to education, China faces problems with the public’s access to and the cost of education.33 These problems are indicative of a misallocation of funds, and have detrimental effects in the long run on China’s economic growth. Even today we see the effects of these education problems, as multi-national firms operating in China struggle to find qualified workers to help their companies expand.34 Somewhat paradoxically, China also faces problems finding jobs for much of their population. Publicly, China’s unemployment rate is 4.1%, with 9.05 million Policy Research, 2010. 97-101. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 31 Moore, Malcolm. “China’s Wealth Gap the Widest since Economic Reforms Began.” Telegraph Media Group Ltd, 02 Mar. 2010. Web. 03 Dec. 2010. < Chinas-wealth-gap-the-widest-since-economic-reforms-began.html>. 32 Jia, Chen. “Wealth Gap Poses Threat to Stability.” China Daily Online. China Daily, 9 Jan. 2010. Web. 03 Dec. 2010. < china/2010-01/09/content_9292221.htm>. 33 Staff. “Three Major Problems in China’s Education System.” People’s Daily Online. People’s Daily Newspaper, 9 Jan. 2009. Web. 03 Dec. 2010. <http://>. 34 Rein, Shaun. “China’s Surprising Unemployment Problem.” Forbes, 7 Sept. 2010. Web. 19 Nov. 2010. < china-economy-unemployment-leadership-managing-rein.html>. 72

urban Chinese reportedly unemployed.35 This may not seem high because China’s population is over 1.3 billion, and only 9.05 million claim unemployment in urban areas, meaning there are tens of millions of workers in rural areas without employment who are looking to join the growing urban economy. Job development programs need to be created to integrate these unemployed rural workers into the urban workforce. The lack of such programs, or at least effective programs to handle this many workers is further indicative of a misallocation of funds. An added benefit of these improvements in education and job training is that they help eliminate the need for precautionary savings by Chinese households.36 Although a current accounts surplus may not seem problematic, it can be demonstrative of neglect. China faces numerous challenges in the future to its economic growth, and there is worry that it is not adequately preparing itself. By continuing to invest in US Treasury Bonds, they are not readying themselves for necessary changes in the international economy or domestic changes in Chinese society. Although continued investment in promoting exports may not be directly responsible for any of these issues, they are all problems that could be fixed with the proper allocation of funds that are currently being spent on American securities. Causes and Effects: United States The Chinese government, in order to maintain its growth in exports, has spent trillions on United States Treasury securities. As a result, the dollar has remained over-valued and United States interest rates have been kept low. Many economists feel that this relaxation of America’s credit constraints encouraged borrowing and contributed to the housing bubble.37 The growth of this bubble led to the undervaluing of risk, which ultimately led to the sub-prime mortgage crisis. This liquidity shock is what ultimately crippled the global financial system. The Chinese government is not entirely to blame for the American trade deficit or its overvalued dollar. Between 1996 and 2004, the US’s current account deficit grew from 1.6% of GDP to 5.5%, whereas the in35 Ibid 36 Lim, Linda Y.C. “Rebalancing in East Asia.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 31-35. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 37 Krueger, Anne O. “Persistent Global Imbalances.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 185-90. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 73

vestment rate remained largely unchanged at approximately 19% of GDP and the savings rate declined by only about 2.5% of GDP.38 The increase in spending is accounted for by a large increase in capital inflows from abroad. Because the US dollar is the standard currency for global trade, it is the currency of choice for foreign investment. Globally, over the eightyear period leading up to the financial crisis, we saw emerging markets increase their capital account surpluses. In developing Asian countries excluding China, there was a $150 billion increase in external surplus by 2006.39,40 In addition, like the emerging Asian markets, oil-exporting countries increased their current account surplus by $140 billion in the same period. In these expanding markets and oil producing countries, we saw an overall decline in domestic development and an increase in investments in foreign capital markets.41 There are two underlying causes of this swing from moderate capital account deficits to substantial capital account surpluses. First, in oil producing nations, increases in oil prices boosted oil exporters’ incomes by more than those countries were able or willing to increase spending, thereby leading to higher saving and current account surpluses. Second, the Asian financial crisis led to a series of policy changes in these emerging markets such as resistance to currency appreciation and accumulation of foreign exchange reserves.42 Growth in the United States’ export-oriented sectors has been restrained by this over-valuation of the US dollar, rendering Americanmade goods overvalued as well. This has negative effects on the United States in two ways. First, this leads American companies to outsource jobs to nations where capital is less expensive. The loss of American jobs and American manufacturing lowers the nation’s GDP while strength38 Bernanke, Benjamin. “FRB: Speech--Bernanke, Global Imbalances: Recent Developments and Prospect.” Board of Governors of the Federal Reserve System. The Federal Reserve Bank, 11 Sept. 2007. Web. 03 Dec. 2010. <http://>. 39 This is somewhat counterintuitive, as developing nations should be the recipient, not provider of funds. Developing economies have higher ratios labor to capital. They are also farther away from the technological frontier, which means investment in these nations has greater potential for higher returns. 40 Lardy, Nicholas. “Parsing China’s Trade Surplus.” BusinessWeek. Bloomberg L.P., 13 Jan. 2006. Web. 03 Dec. 2010. <http://www.businessweek. com/bwdaily/dnflash/jan2006/nf20060113_8659_db053.htm>. 41 Bernanke, Benjamin. “FRB: Speech--Bernanke, Global Imbalances: Recent Developments and Prospect.” Board of Governors of the Federal Reserve System. The Federal Reserve Bank, 11 Sept. 2007. Web. 03 Dec. 2010. <http://>. 42 Ibid 74

ening its demand for exports.43 Second, as the trade imbalances correct themselves, resources will have to be shifted from the non-tradable to the tradable sector, and this transition can be costly and painful.44 New, expensive training programs will have to be put in place and vast amounts will have to be spent on employee training. The overconsumption and underproduction of tradable goods in the United States led indirectly to the recent financial crisis and subsequent recession. In the course of the recession, private consumption in the United States has fallen for the first time in over 20 years.45 From the beginning of the recession until March 2009, over 5 million American jobs were lost, the largest jump in unemployment since the 1940’s.46 Although the recession officially ended in June 2009, it was the most dramatic and longest recession since World War II.47 Numerous economic analysts consider the trade imbalance to be a handmaiden for the recession and financial crisis.48 How to Fix the Trade Imbalance This section will address the three main causes of the trade imbalance. The first is the unequal levels of liberalization between the tradable 43 Cook, John, and Paul Nyhan. “Outsourcing’s Long-term Effects on U.S. Jobs at Issue.” Seattle Pi Business. Hearst Seattle Media LLC, 10 Mar. 2004. Web. 03 Dec. 2010. < asp>. 44 El-Erian, Mohamed A., and Michael Spence. “Global Governance: Pre and Post Crisis.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 165-72. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <http://www.>. 45 Buczynski, Richard. “Economic Crisis: When Will It End?” IBISWorld USA. IBISWorld. Web. 03 Dec. 2010. < recession2009/>. 46 Buereau of Labor Statistics. “Bureau of Labor Statistics Data.” Databases, Tables & Calculators by Subject. Bureau of Labor Statistics. Web. 03 Dec. 2010. < numbers&series_id=LNU04000000&years_option=all_years&periods_ option=specific_periods&periods=Annual Data>. 47 Aversa, Jeannine. “The Recession Is Over! So Where’s the Party?” ABC News, 20 Sept. 2010. Web. 03 Dec. 2010. <http://abcnews.>. 48 Suominen, Kati. “Did Global Imbalances Cause the Crisis?” Vox EU. VoxEU.Org, 14 June 2010. Web. 03 Dec. 2010. < php?q=node/5175>. 75

and service sectors. Because American economic growth relies disproportionately on its service industry, China’s protection of these markets hurts US output while having almost no effect on Chinese growth. We will then discuss what can be done to address the trade imbalance in regards to these policies. The second cause is the Renminbi’s distorted dollar-rate and how fixes in the exchange rate may fix the trade imbalance. Finally, this paper will examine protectionist measures as a possible solution for the US-China trade imbalance. While all of these paths may have positive effects on increasing American output and Chinese consumption, they have the potential to be damaging as well. The best approach to addressing the imbalance is likely a hybrid of all three of these approaches. The sustained trade imbalance with China is both a cause and result of numerous structural issues in the US economy. The structural problems that promote the imbalance are over-investments in US Treasury securities that in turn are exacerbated by the US dollar being used as the world’s reserve currency. Due to the dollar’s strength, American exportbased industries have been stifled. Because the United States is not profiting from tradable goods but private expenditure continues to grow, the difference comes from foreign capital inflows. This inflow perpetuates the strength of the dollar, and helped expand the housing bubble and lower the value of risk. China’s market is export-based, with very little liberalization of its service and financial sectors. Additionally, their savings glut and lack of domestic investment keeps the Renminbi weak. Solving the trade imbalance requires both reversals of the negative effects of this imbalance and a correction of the structural flaws in the American and Chinese markets that lead to these imbalances.49 Service industries make up over 70% of the global GDP, suggesting that global trade rebalancing will need to center on services.50 Boosting manufacturing in high-income deficit countries such as the US can only make a marginal difference in creating employment and helping to generate a present accounts surplus, as tradable goods only account for a small share of the total value-added. In addition, manufacturing competitiveness in an economy is determined largely by their access to low-cost, high-quality services such as telecommunications, transportation and distribution, and financial intermediation.51 Policies that improve the ef49 Claessens, Stijn, Simon Evenett, and Bernard Hoekman. “Editors Overview.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 3-9. Print. 50 Ibid 51 Lee, Jong-Wha. “Asia’s Role in Global Rebalancing.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic 76

ficiency of services should be a major goal in order to provide the boost in competitiveness that is necessary for the United States to grow. China shares similar interests in this regard. China’s savings glut means domestic consumption must be expanded. Education, research and development services, health insurance, and other service industries are necessary to for broader economic growth. Growth in these industries not only boosts consumption, but studies have shown that improving productivity and efficiency of national service industries contribute to sustaining high rates of economic growth.52 As discussed in the section on the causes and effects of the imbalance in China, China’s service industry and financial sector remains largely overprotected and state-owned. While manufacturing has been liberalized, China still has some of the world’s most restrictive policies in regards to service growth.53 The Chinese government recognizes that it cannot continue to maintain economic growth solely through production. As part of the current 5-year economic plan being undertaken by the PRC, numerous structural changes that address these issues are being implemented. From 2005 to 2010, service industry has grown 8% as a percentage of GDP.54 Additionally, the service industry share of national employment has increased nearly 13%. As a percentage of GDP, research and development spending has increased approximately 54%. The Chinese urbanization rate is also up from 43% to 47%.55 Furthermore, since the financial crisis, China has started to invest in a basket of other currencies for foreign reserves.56 This puts less pressure on the US dollar and is Policy Research, 2010. 97-101. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 52 Francois, J. and B. Hoekman (2010) “Services Trade and Policy,” Journal of Economic Literature, forthcoming (CEPR Discussion Paper 7616) 53 Kowalski, Przemyslaw, and Molly Lesher. “A Commercial Policy Package for Rebalancing the Global Economy?” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 127-37. Print. 54 “Facts and Figures: China’s Main Targets for 2006-2010.” NPC and CPPCC National Committee Annual Sessions 2006. Government of the People’s Republic of China, 6 Mar. 2006. Web. 03 Dec. 2010. < english/2006-03/06/content_219504.htm>. 55 Government of the People’s Republic of China. “The 11th Five-Year Plan.” GOV.CN. Government of the People’s Republic of China. Web. 03 Dec. 2010. <>. 56 Staff. “China Diversifies Foreign Reserves Basket.” New China Daily Website. Tencent, 19 Aug. 2010. Web. 03 Dec. 2010. <http://www2.chinadaily.>. 77

a step forward in helping adjust the exchange rate. In order to achieve global rebalancing, domestic spending in countries that have payments deficits must be undertake. To achieve this without causing inflation or deflation, gradual steps towards what John Williamson of the Peterson Institute for International Economics refers to as an “immaculate adjustment” must be taken. Williamson, using a model developed by William R Cline, investigated G20 countries and their surpluses and deficits. Using IMF forecasts, they adjusted exchange rates in trying to achieve an account balance that was, at most, 3% of the nation’s GDP away from balance. The model uses export price elasticity to estimate the needed changes in effective exchange rates, and then translates those effective rates in regards to a bilateral change against the dollar. Cline and Williamson’s modeling made obvious the need for a 15% adjustment in the real effective exchange rate of the RMB, which translates to a 24% increase in its dollar rate.57 In conjunction with these numbers, the model found that the US dollar needed to devalue by approximately 8% in terms of the real effective exchange rate. Of the G20 countries, it was found that China had the largest current undervaluation of its currency, while the United States has the second highest overvaluation of its currency.58 Empirically, the major disequilibrium in the global economy is the overvaluation of the dollar and the undervaluation of the Renminbi.59 Because China’s exchange rate is pegged to the US dollar, it is largely up to the Chinese government to reverse this disequilibrium if the mechanism of exchange rate adjustment is to be utilized.60 In devising policy to help correct the trade imbalance, there is a fear that policymaking may be “hijacked” by corporations or other special interest groups. This hijacking can lead to inefficiencies in the market 57 Williamson, John. “Exchange Rates to Support Global Rebalancing.” Rebalancing the Global Economy: A Primer for Policymaking. Ed. William R. Cline. London: Center for Economic Policy Research, 2010. 77-80. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <http://>. 58 Second to South Africa. Considering that the United States’ economy is over 49 times the size of the South African economy, we can see how the United States’ overvaluation of 8% is far more distorting of global markets than the 14% overvaluation of the South African Rand. 59 Ibid 60 Cline and Williamson’s paper also found that when China does correct its exchange rate, other Asian countries such as India, Japan, Indonesia, and Korea will need to as well in order to avoid becoming undervalued. 78

while helping to prop up industries that are increasingly uncompetitive.61 The American auto industry is often cited as an example of such “policy hijacking” by playing to political fears of the United States no longer being a “producing” nation. From a producer’s standpoint, it would make sense to lobby the government for protectionist measures to limit competition. Because the undervaluation of the Renminbi acts as both a subsidy to Chinese producers and to American consumers of Chinese goods, protectionist measures are often brought up in the discussion of how to tackle the trade imbalance. Protectionist measures, although generally damaging, are not necessarily inconsistent with economic rebalancing. As seen in regards to Chinese chicken imports or switchblades, or more recently, Chinese tires, it is politically feasible to put up trade barriers between the United States and China. In doing so, domestic output expansions can arguably increase national income and savings,62 helping narrow the trade imbalance. In addition to imposing trade barriers to assist domestic output expansion, the government has sometimes distorted markets by propping up failing industries or companies. Companies such as Chrysler and General Motors receive subsidies from the government that distort competition and supposedly help American output and private sector earnings and savings. However, there are numerous problems with protectionist measures, the first being that subsidizing failing industries is generally considered a misallocation of funds. There are major issues with moral hazard, and propping up these failing industries does not necessarily guarantee that these companies will improve in the future. Aside from subsidizing failing corporations, putting up trade barriers may also be problematic. While technically, imposing tariffs on Chinese imports may solve the bilateral trade deficit, given the Chinese government’s propensity for retaliation, this could easily trigger a trade war, which would greatly damage the American consumer. Another more fundamental issue is that 61 Aggarwal, Vinod A., and Simon Evenett. “Rebalancing Will Require Supply Side Policy Changes, But Pitfalls Abound.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 139-45. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 62 Aggarwal, Vinod A., and SImon Evenett. “Rebalancing Will Require Supply Side Policy Changes, But Pitfalls Abound.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 139-45. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 79

unless raising these trade barriers triggers savings and investment, it will have little effect on the trade balance.63,64 Opening markets facilitates the movement of resources to their most productive uses, raising income levels. Liberalization also raises income growth by expanding returns to investment in high-productivity firms and sectors. Because international trade has expanded both with and without growing imbalances, evidence shows that liberalization does not necessarily have an impact on imbalances.65 In fact, as discussed earlier, a major cause for the imbalance is a lack of liberalization. More helpful than raising trade barriers on exports from China would be for China to lower trade barriers on American services. As previously stated, asymmetric trade barriers are a major contributor to the imbalance. This asymmetry could be solved by raising trade barriers on goods or lowering trade barriers on service. Given the clear benefits of liberalization, lowering trade barriers on services in China seems to be the most desirable path. Problems with the trade balance between the United States and China are three-pronged. First, there is a structural difference between the two economies that contributes to the imbalance. Because China developed as an export-oriented market and the United States’ economy has already developed and is now largely service-based, there are asymmetries in trade. As China has developed, it has yet to liberalize its service industries to foreign firms to the extent that the United States has liberalized its markets for foreign goods. This structural difference is a major cause of imbalance. In addition, China’s deliberate undervaluation of the Renminbi acts as a subsidy for Chinese exports while propping up the American dollar. This not only makes Chinese exports cheaper but causes American exports to be more expensive. Moreover, the dollar’s value is propped up by a large international demand for dollar reserves. Because international demand for the dollar is high, American exports are kept overvalued, harming American export growth. Both the undervaluation of the Renminbi and the overvaluation of the dollar are major components to the trade imbalance. One possible way to help correct the imbalance would be to impose a tariff on Chinese exports; however, this may not be particularly helpful in the long run. As some imbalance may be desirable, it is difficult 63 Similarly, liberalization will not have an effect on trade imbalances if it does not have an effect on savings and investment. 64 Freund, Caroline. “Adjustment in Global Imbalances and the Future of Trade Growth.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. Print. 65 Ibid 80

to determine the extent to which trade barriers should be imposed. As discussed by Kowalski and Lesher, the uncertainty surrounding the benefits of reducing imbalances have to be weighed against the benefits of trade and investment.66 Improvements in efficiency related to specialization according to comparative advantage, economies of scale, access to a wide variety of intermediate and final products, and technology transfer associated with international commerce would all be limited by the imposition of trade barriers.67 The best approach then would then be to fight the problem of imbalance on all three fronts: liberalization of the service industry in China, a devaluation of the US dollar in conjunction with a raise in value of the Renminbi, and resistance to protectionist pressures. By pursuing an adjustment in the values of both currencies, we minimize the problems caused by a unilateral adjustment by spreading the costs of this market distortion across both nations. While debtor nations are typically to blame, it is undeniable that the Renminbi has been deliberately kept undervalued by the Chinese government, so Chinese help in correcting this distortion, although unlikely, is not unreasonable. Additionally, by fighting protectionist measures in China’s service sector and resisting protectionist pressures in the United States, we can promote higher levels of trade and fight against the issues caused by the US and Chinese currency revaluations. Trade liberalization does not necessarily go hand in hand with growing imbalances. Our goal should be to expand trade while removing structural asymmetries in competition. In doing so we can improve the welfare of both nations while reducing the trade imbalance, creating a more profitable and stable global economy. Conclusion There are numerous structural issues to blame for the imbalance. First, there is the issue of developing companies maintaining trade surpluses, which they do in order to boost savings and to invest in American treasury securities to ensure their currency against shocks.68 In doing so, 66 Kowalski, Przemyslaw, and Molly Lesher. “A Commercial Policy Package for Rebalancing the Global Economy?” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 127-37. Print. 67 Ibid 68 Lee, Jong-Wha. “Asia’s Role in Global Rebalancing.” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 97-101. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <>. 81

this practice forces capital to flow from areas where there is much opportunity for good investment into areas where there is little opportunity for investment. As a result, in a manner similar to what happened during the Great Depression, money was invested into riskier and more speculative holdings, which ultimately defaulted and led to the liquidity crisis that caused the financial crisis.69 Additionally, complications are caused by deliberate Chinese macroeconomic policies aimed at expanding their developing economy. First, there was their undervaluation of the Renminbi. which is estimated to be undervalued by about 30%. This means that Chinese goods cost 30% less than they should, giving them an advantage over American-made goods. Additionally, whereas the American economy is largely service-based, China’s service industry still has numerous trade barriers in place. The asymmetric competition between the two countries prevents bilateral trade from being more balanced by canceling out the principal of comparative advantage.70 By giving their own exports a 30% subsidy and preventing the United States from being able to be economically competitive in China, China has all but ensured a trade imbalance that is guaranteed to grow as the Chinese economy expands. Though the trade imbalance has declined since the crisis, this is a natural result of a recession.71 There is no evidence to suggest that as the global economy recovers, the trade imbalances will continue to shrink.72 As structural adjustments to the American and Chinese economies have not been made, we can expect these imbalances to grow. Both the global financial crisis as well as domestic economic problems caused by the imbalance in China and the United States has shown that China cannot 69 Aizenman, Joshua. “On the Causes of Global Imbalances and Their Persistence: Myths, Facts and Conjectures.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 2330. Print. 70 Kowalski, Przemyslaw, and Molly Lesher. “A Commercial Policy Package for Rebalancing the Global Economy?” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. 127-37. Print. 71 One effect of the financial crisis that is long term, however, is the decline in demand for the dollar. Emerging markets are now diversifying their foreign reserves holdings since the crisis in to currencies besides the dollar. This should lead to a decline in capital inflows which help raise the US interest rate, thereby increasing American savings and reducing American consumption. 72 Freund, Caroline. “Adjustment in Global Imbalances and the Future of Trade Growth.” Print. Rpt. in Rebalancing the Global Economy: A Primer for Policymaking. London: VOX EU.Org, 2010. Print. 82

continue to expand solely with export-oriented growth. China cannot sustain current rates of growth based on exports, as the rest of the world has shown they cannot continue to sustain the levels of demand required for that particular economic strategy to work.73 Additionally, the United States’ consumption must be reduced as well. The United States, with a population of around 300 million people, which is less than 5% of the global population, was consuming more than 20% of the world’s output until the crisis. China, with about 20% of the world’s population, was consuming between 2-3% of global output.74 These figures are at the root of the imbalance, and measures to bring them more into balance could help lay the foundation for sustainable economic growth. The trade imbalance is caused by competitive asymmetries in the Chinese and American economies. These asymmetries can be remedied two ways: by bringing down unfair trade barriers, or by raising trade barriers in previously open markets. China could help fix these asymmetries by revaluing its currency to more accurately reflect the demand for the Renminbi. By ridding itself of what amounts to a 30% export subsidy, the country could help bring about better global economic balance. Additionally, by opening up their markets for services, they can help increase American exports to the region to bring about better trade balance. Whereas these would be the best-case-scenario options because they fix the trade imbalance through economic expansion, trade barriers may also bring about trade balance. If China does not go about fixing the structural asymmetries on their own, the United States has reason to impose an across-the-board tariff on all Chinese goods to help counteract the undervaluation of the Renminbi. The financial crisis of 2007-2010 was sparked by an international shortage of liquidity caused by a savings glut in developing and oil producing nations and, domestically by an undervaluation of risk in conjunction with low domestic interest rates.75 Whereas typically interest rates rise as debt increases, this was not the case in the United States. Inter73 Ibid 74 O’Neill, Jim. “Does the Rise of the BRICs and the Credit Crisis Make It Easier to Rebalance the World Economy? Yes!” Rebalancing the Global Economy: A Primer for Policymaking. London: Center for Economic Policy Research, 2010. 73-76. Vox EU. Center for Economic Policy Research, 23 June 2010. Web. 3 Dec. 2010. <> 75 Bernanke, Benjamin. “FRB: Speech--Bernanke, Global Imbalances: Recent Developments and Prospect.” Board of Governors of the Federal Reserve System. The Federal Reserve Bank, 11 Sept. 2007. Web. 03 Dec. 2010. <http://>. 83

est rates were depressed through consistently large amounts of capital inflows. These inflows came from both developing and oil producing nations hoping to use the U.S. dollar to back their domestic currencies. Large amounts of capital inflows also came from China, who had a vested interest in keeping the US interest rates low to support the consumption of Chinese exports. As a result, the economy of the United States, and the rest of the world, was poorly poised to handle the financial crisis. In the crisis, US and European banks lost over $2.8 trillion in assets.76 Since June 2007, Americans have lost an estimated $14 trillion of their household wealth,77 and by November 2008, the S&P 500 was down 45% from its 2007 high.78 Total retirement assets dropped by 22% from 2006 to 2008, and savings and investment assets lost $1.2 trillion while pension assets lost $1.3 trillion.79 The unemployment rate increased to its highest rate since 1983 (10.1%), and the average hours per workweek declined to its lowest level since the government began collecting data in 1964.80 These figures help illustrate how important it is to bring the world economy back into balance. Although achieving this through open markets is likely the best option, there is little reason to believe China’s service markets will open within the next few years, or that they will undergo a currency revaluation on a large enough scale to bring about genuine rebalancing. While all economists can agree that putting up trade barriers is expensive, it seems that the benefits of avoiding another financial crisis may outweigh the costs of slower economic growth.

76 Reuters. “-U.S., European Bank Writedowns, Credit Losses.” Reuters Online. Thomson Reuters, 05 Nov. 2009. Web. 03 Dec. 2010. <http://www.>. 77 Luhby, Tami. “Americans’ Wealth Drops $1.3 Trillion.” Cable News Network, a Time Warner Company, 11 June 2009. Web. 03 Dec. 2010. < ?postversion=2009061113>. 78 Altman, Roger C. “Detailed Record Title: The Great Crash, 2008: A Geopolitical Setback for the West.” Foreign Affairs 88.1 (2009): 2-14. Print. 79 Ibid 80 Herbst, Moira. “Even the Employed Lose with Hour and Wage Cuts.” BusinessWeek. Bloomberg L.P., 10 July 2009. Web. 03 Dec. 2010. <http://www.>. 84

The Tulane Journal of International Affairs is seeking submissions! Please submit papers completed during your undergraduate academic career to For more details, see the Submissions page on our website, Papers submitted before March 2012 will be considered for our Spring 2012 issue. Later submissions will be considered for subsequent issues.

Tulane Journal of International Affairs, Fall 2011  

Tulane Journal of International Affairs: Volume I, Number 1

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